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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar, Inc. Reports Fourth-Quarter, Full-Year 2006 Financial Results
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CHICAGO, Feb. 22, 2007—Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its fourth-quarter and full-year 2006 financial results. The company reported consolidated revenue of $87.0 million in the fourth quarter of 2006, a 43% increase from revenue of $60.7 million in the fourth quarter of 2005. Morningstar’s fourth-quarter results included $13.6 million in revenue from acquisitions completed in 2006. Consolidated operating income was $20.3 million in the fourth quarter of 2006, an increase of $6.2 million, or 44%, compared with $14.1 million in the same period a year ago. Morningstar’s net income was $13.6 million in the fourth quarter of 2006, or 29 cents per diluted share, compared with $10.1 million, or 22 cents per diluted share, in the fourth quarter of 2005.

Morningstar completed three key acquisitions in 2006—Ibbotson Associates, Inc. on March 1; Aspect Huntley Pty Limited on July 25; and the hedge fund and separate account database division of InvestorForce, Inc. on Aug. 1. Excluding these acquisitions and the impact of foreign currency translations, the company’s fourth-quarter revenue increased approximately 20%. Foreign currency translations had a positive impact of $0.5 million in the fourth quarter. Revenue excluding acquisitions and foreign currency translations is a non-GAAP measure; the accompanying financial tables contain a reconciliation to consolidated revenue.

For the year ended Dec. 31, 2006, revenue increased 39% to $315.2 million, compared with $227.1 million in 2005.  Revenue for the full year included $36.4 million from 2006 acquisitions. Consolidated operating income increased 67% to $77.5 million in 2006, compared with $46.5 million in 2005. Net income was $51.8 million, or $1.11 per diluted share, in 2006, compared with $31.1 million, or 70 cents per diluted share, in 2005.

Joe Mansueto, chairman and chief executive officer of Morningstar, said, “Our company had a great year in 2006. We generated strong organic revenue growth as well as meaningful growth from acquisitions.  All three segments of our business—Individual, Advisor, and Institutional—had double-digit revenue growth, with the majority of our growth generated by the Institutional segment. More than 40% of our revenue growth came from two key products, Investment Consulting and Morningstar Advisor Workstation.”

He added, “In addition, we performed well on two other important financial measures—operating income and free cash flow, reflecting the fundamental health of our business. Operating income grew 67% to $77.5 million year over year, and we generated free cash flow of $94.0 million in 2006, compared with $41.0 million in 2005. Even though we made several acquisitions last year, we don’t have any debt and our cash position remains very strong.”

Mansueto outlined some of the company’s key accomplishments and disappointments in 2006:

Key Accomplishments

  • We successfully completed and integrated several acquisitions, including Ibbotson Associates, a leading provider of asset allocation research and services; Aspect Huntley, a leading provider of equity information, research, and financial trade publishing in Australia; and the hedge fund and separate account database division of InvestorForce.
  • We significantly expanded our hedge fund, separate account, and European and offshore mutual fund databases. We created a pension and life fund database in the United Kingdom and established mutual fund databases in Taiwan and Singapore. We introduced new Investor Return data, also known as dollar-weighted return, to capture how the average investor fared in a fund.
  • We launched several new Web-based software applications, including Retirement Income StrategistSM, which analyzes an investor’s income needs in retirement; and Morningstar Portfolio BuilderSM, which helps advisors quickly create portfolio proposals.
  • We achieved meaningful sales of Morningstar Direct outside of the United States, with nearly 25% of Direct’s revenue now coming from international markets. We also introduced several new products overseas, including Portfolio Builder and Morningstar Hypothetical IllustratorSM, a tool that creates customized historical investment illustrations.

Disappointments

  • Software development for our upgrade of Morningstar Direct took longer than we expected. 
  • The regulatory investigations into Morningstar Associates, which began in late 2004 and early 2005, continued to consume management’s time in 2006 as we held ongoing discussions with regulators in an attempt to work toward a resolution.

Key Business Drivers

Revenue:  In the fourth quarter of 2006, revenue in the Individual segment increased 30% compared with the fourth quarter of 2005; 15 percentage points of this increase came from acquisitions. Revenue in the Advisor segment increased 29%, with 8 percentage points of the increase coming from acquisitions. Revenue in the Institutional segment increased 61%, of which 36 percentage points came from acquisitions.

Revenue from international operations was $14.0 million in the fourth quarter of 2006, an 80% increase from the same period a year ago. International revenue included $4.3 million from acquisitions. Foreign currency translations had a positive impact of $0.5 million on international revenue in the fourth quarter. Excluding the impact of acquisitions and foreign currency translations, international revenue increased approximately 18% compared with the fourth quarter of 2005. International revenue excluding acquisitions and foreign currency translations is a non-GAAP measure; the accompanying financial tables contain a reconciliation to international revenue.

For the full year, Morningstar’s five largest products by revenue were Investment Consulting, Morningstar® Advisor WorkstationSM, Licensed DataSM, Morningstar.com®, and Morningstar® Principia®.  In 2005, Morningstar’s five largest products were Licensed Data, Advisor Workstation, Principia, Morningstar.com, and Investment Consulting.

Revenue Composition:  Morningstar defines “walk-in” revenue as revenue it expects to recognize during the year from subscriptions and license agreements in place as of Jan. 1 of each year, adjusted for cancellations, currency translations, and other routine adjustments during the year. Morningstar estimates that, as of Jan. 1, 2007, it had walk-in revenue of $182.9 million, which includes $21.2 million from acquisitions completed in 2006. In comparison, Morningstar’s walk-in revenue as of Jan. 1, 2006 was $138.8 million. Walk-in revenue does not include variable revenue from asset-based services such as Morningstar® Managed PortfoliosSM, managed retirement accounts, and Investment Consulting.

Morningstar will no longer report quarterly information on new, renewal, and walk-in revenue. The company is evaluating potential new metrics that it believes may be more useful to investors.

Operating Income:  Consolidated operating income was $20.3 million in the fourth quarter of 2006, a 44% increase from the same period in 2005. Operating expense rose $20.1 million, or 43%, in the fourth quarter of 2006, primarily because of an increase in compensation costs and amortization expense. Compensation-related expense, excluding bonuses, increased $6.5 million, mainly because of an increase in staffing. Worldwide headcount increased to approximately 1,440 employees as of Dec. 31, 2006, compared with 1,130 as of Dec. 31, 2005. This increase includes employees from acquisitions and continued hiring in the company’s development center in China. Bonus expense increased $4.6 million in the quarter, primarily reflecting the fourth-quarter impact of full-year performance versus 2005 and incremental expense from acquisitions. Amortization of intangible assets related to 2006 acquisitions contributed $2.1 million to operating expense in the quarter.

The company’s operating margin was 23.4% in the fourth quarter of 2006, compared with 23.2% in the same period in 2005. For the full year 2006, operating margin was 24.6%, compared with 20.5% in 2005. A $2.3 million decrease in stock-based compensation expense contributed approximately half of the margin improvement for the full-year period.

Free Cash Flow:  Morningstar generated free cash flow of $27.8 million in the fourth quarter of 2006, reflecting cash provided by operating activities of $29.7 million and capital expenditures of approximately $1.9 million. Free cash flow increased by $13.1 million, compared with the prior-year period, mainly because of increases in net income and accrued compensation and a decrease in accounts receivable. For the year ended Dec. 31, 2006, Morningstar generated free cash flow of $94.0 million, reflecting cash provided by operating activities of $98.7 million and capital expenditures of $4.7 million. Free cash flow for the full year increased $53.0 million compared with 2005, because of increases in net income, income taxes payable, accrued compensation, and lower capital expenditures.

Free cash flow is a non-GAAP measure; the accompanying financial tables include a reconciliation to cash provided by operating activities. Morningstar defines free cash flow as cash provided by or used for operating activities less capital expenditures.

As of Dec. 31, 2006, Morningstar had cash, cash equivalents, and investments of $163.8 million, compared with $153.2 million as of Dec. 31, 2005. During the first quarter of 2007, Morningstar expects to make annual bonus payments of approximately $35 million. In addition, Morningstar expects to use

$55 million in cash, subject to post-closing adjustments, for its acquisition of Standard & Poor’s mutual fund data business, which the company announced today. For more information, please visit http://global.morningstar.com/SP .

Business Segment Performance

Individual Segment:  The largest product in this segment based on revenue is the company’s U.S.-based Web site for individual investors, Morningstar.com®. The Individual segment also includes Morningstar® Equity Research and several print and online publications.

  • Revenue was $21.8 million in the fourth quarter of 2006, a 30% increase from $16.8 million in the fourth quarter of 2005.
  • Acquisitions contributed revenue of $2.5 million to the Individual segment in the fourth quarter, the majority of which reflects new revenue from Aspect Huntley.
  • Morningstar.com was the major contributor to segment revenue growth as the number of Premium Memberships continued to expand steadily and ad sales growth remained strong. Premium subscriptions grew to 165,957 as of Dec. 31, 2006, a 13% increase over the prior-year period. Morningstar Equity Research, which includes research related to the Global Analyst Research Settlement as well as company reports and other services sold to additional customers, was another important driver behind growth in this segment for the quarter.
  • Operating income was $5.6 million in the fourth quarter of 2006, a 26% increase from $4.5 million in the prior-year period. 
  • Operating margin was 25.8% in the fourth quarter of 2006, compared with 26.6% in the fourth quarter of 2005.

Advisor Segment:  The largest products in this segment based on revenue are Morningstar® Advisor WorkstationSM, Morningstar® Principia®, and Morningstar® Managed PortfoliosSM. 

  • Revenue was $24.2 million in the fourth quarter of 2006, a 29% increase from $18.8 million in the same period in 2005.
  • Acquisitions contributed revenue of $1.5 million to the Advisor segment in the fourth quarter, the majority of which reflects revenue from Ibbotson.
  • Licenses for Morningstar Advisor Workstation grew to 153,838 as of Dec. 31, 2006, a 36% increase compared with the prior-year period. The number of Principia subscriptions declined slightly to 47,835 as of Dec. 31, 2006; however, revenue was essentially unchanged.
  • Operating income was $6.5 million in the fourth quarter of 2006, an increase of 78% compared with $3.7 million in the fourth quarter of 2005.
  • Operating margin was 27.0% in the fourth quarter of 2006, compared with 19.6% in the prior-year period. 

Institutional Segment:  The largest products and services in this segment based on revenue are Investment Consulting, Licensed DataSM, Retirement Advice (including Advice by Ibbotson® and Morningstar® Retirement ManagerSM ), Licensed Tools and Content, Morningstar DirectSM, Investment Profiles™ & Guides, and Morningstar EnCorr®. 

  • Revenue was $42.6 million in the fourth quarter of 2006, a 61% increase from $26.6 million in the fourth quarter of 2005.
  • Acquisitions contributed revenue of $9.6 million to the Institutional segment in the fourth quarter, the majority of which was from Ibbotson.
  • Revenue growth in this segment was primarily driven by Investment Consulting services, which focus on asset allocation and investment selection for funds of funds. The company provided advisory services on approximately $55.5 billion in assets, including $40.5 billion from Morningstar Associates and $15.0 billion from Ibbotson Associates, as of Dec. 31, 2006, compared with approximately $22.1 billion as of Dec. 31, 2005. Assets under advisement for Morningstar Associates grew significantly, reflecting asset growth among existing clients. Licensed Data and Morningstar Direct were also significant contributors to segment revenue growth in the quarter. Morningstar Direct licenses grew to 1,348 as of Dec. 31, 2006, a 37% increase over the prior-year period.
  • Operating income was $11.6 million in the fourth quarter of 2006, an increase of 68% from $6.9 million in the same period in 2005. 
  • Operating margin was 27.1% in the fourth quarter of 2006, compared with 26.0% in the prior-year period.

Investor Communication: Morningstar encourages all interested parties—including securities analysts, current shareholders, potential shareholders, and others—to submit questions in writing. Investors and others may send an e-mail to investors@morningstar.com, contact the company via fax at 312-696-6009, or write to Morningstar at the following address:


Morningstar, Inc.
Investor Relations
225 West Wacker Drive
Chicago, IL 60606

Morningstar will make written responses to selected inquiries available to all investors at the same time in Form 8-Ks furnished to the Securities and Exchange Commission on the first Friday of every month.

Morningstar will hold its annual meeting of shareholders at 9 a.m. on Tuesday, May 22, 2007, at The University of Chicago Gleacher Center, 450 N. Cityfront Plaza, Chicago, Illinois, 60611.

About Morningstar, Inc.

Morningstar, Inc. is a leading provider of independent investment research in the United States and in major international markets. The company offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions. Morningstar provides data on more than 190,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 15 countries and minority ownership positions in companies based in three other countries.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This press release contains forward-looking statements. These statements relate to future events or to future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements.  In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terminology. You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and that could materially affect actual results, levels of activity, performance, or achievements.

Other factors that could materially affect actual results, levels of activity, performance, or achievements can be found in Morningstar’s filings with the Securities and Exchange Commission, including Morningstar’s Annual Report on Form 10-K for the year ended Dec. 31, 2005. If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in this press release reflects our current views with respect to future events and is subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, whether as a result of new information, future events, or otherwise.

Non-GAAP Financial Measures

To supplement Morningstar’s consolidated financial statements presented in accordance with U.S. Generally Accepted Accounting Principles (GAAP), Morningstar uses the following measures considered as non-GAAP by the Securities and Exchange Commission:  free cash flow, consolidated revenue excluding acquisitions and foreign currency translations (organic revenue), and international revenue excluding acquisitions and foreign currency translations.

Morningstar presents free cash flow solely as supplemental disclosure to help investors better understand how much cash is available after Morningstar spends money to operate its business. Morningstar uses free cash flow to evaluate the performance of its business. Free cash flow should not be considered an alternative to any measure of performance as promulgated under GAAP (such as cash provided by (used for) operating, investing, and financing activities), nor should this data be considered an indicator of Morningstar’s overall financial performance or liquidity. Also, the free cash flow definition used by Morningstar may not be comparable to similarly titled measures reported by other companies. For more information on free cash flow, please see the reconciliation from cash provided by operating activities to free cash flow included in the accompanying financial tables.  Morningstar presents consolidated revenue excluding acquisitions and foreign currency translations (organic revenue) and international revenue excluding acquisitions and foreign currency translations because the company believes these non-GAAP measures help investors better compare period-to-period results. For more information, please see the reconciliation provided in the accompanying financial tables.

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© 2007 Morningstar, Inc. All rights reserved.

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