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Article by DailyStocks_admin    (12-09-08 01:52 AM)

The Daily Magic Formula Stock for 12/09/2008 is Morningstar Inc. According to the Magic Formula Investing Web Site, the ebit yield is 13% and the EBIT ROIC is >100 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


Dailystocks.com makes NO RECOMMENDATIONS whatsoever, and provides this for informational purpose only.

BUSINESS OVERVIEW

Morningstar is a leading provider of independent investment research to investors around the world. Since our founding in 1984, our mission has been to create great products that help investors reach their financial goals. We offer an extensive line of Internet, software, and print-based products for individual investors, financial advisors, and institutional clients. Our company also provides asset management services for advisors, institutions, and retirement plan participants. In addition to our U.S.-based products and services, we offer local versions of our products designed for investors in Asia, Australia, Canada, Europe, and Japan. Morningstar serves approximately 6.1 million individual investors, 240,000 financial advisors, and 2,400 institutional clients. We have operations in 18 countries and hold minority ownership positions in companies located in three other countries.

We maintain a series of comprehensive databases on 10 key types of investments, most of which are widely used by investors globally. After building these databases, we add additional value and insight to the data by investing in our core skills of research, technology, and design. As of December 31, 2007, we provided extensive data on more than:

• 21,000 mutual fund share classes in the United States;

• 89,000 mutual funds and similar vehicles in international markets;

• 12,000 stocks;

• 7,700 hedge funds;

• 7,300 separate accounts and collective investment trusts;

• 92,000 variable annuity/life subaccounts and policies;

• 24,000 insurance, pension, life funds;

• 1,400 exchange-traded funds;

• 2,300 closed-end funds;

• 80 state-sponsored college savings plans (commonly known as Section 529 College Savings Plans); and

• 80 years of capital markets data capturing performance of 19 market indexes.



Our business model is based on leveraging our investments in these databases by selling a wide variety of products in multiple media to three key market segments around the world.

Our data and proprietary analytical tools such as the Morningstar Rating for mutual funds, which rates past performance based on risk- and cost-adjusted returns, and the Morningstar Style Box, which provides a visual summary of a mutual fund’s underlying investment style, have become important tools that millions of investors and advisors use in making investment decisions. We’ve created other tools, such as the Ownership Zones, Sector Deltas, and Market Barometer, which allow investors to see how different investments work together to form a portfolio and to track its progress. We developed a Portfolio X-Ray tool that helps investors reduce risk and understand the key characteristics of their portfolios based on nine different factors.

In 2007, we completed a major initiative to develop data without survivorship bias. We’re now including “dead” funds (those that have merged or liquidated) in our category averages and percentile ranks to give investors a more accurate representation of fund performance. We’ve also enhanced our research to better reflect derivatives and short positions. Our portfolio statistics now reflect how these financial instruments and trading strategies affect a fund’s asset allocation and risk profile. In addition, we enhanced the methodology for our mutual fund Stewardship Grades.

Over the past several years, we’ve expanded our research efforts on individual stocks and have worked to popularize the concepts of economic moat, a measure of competitive advantage originally developed by Warren Buffett, and margin of safety, which reflects the size of the discount in a stock’s price relative to its estimated value. The Morningstar Rating for stocks is based on the stock’s current price relative to our analyst-generated fair value estimates, as well as the company’s level of business risk and economic moat. We offer a variety of qualitative measures such as Stewardship Grades, which help investors identify companies and funds that have demonstrated a high level of commitment to shareholders and stewardship of investors’ capital.

We’ve also developed in-depth advice on security selection and portfolio building to meet the needs of investors looking for integrated portfolio solutions. We believe many investors rely on these tools because they offer a useful framework for comparing potential investments and making decisions. Our independence and our history of innovation make us a trusted resource for investors.

The Morningstar Rating

We provide Morningstar Ratings on mutual funds, stocks, separate accounts, exchange-traded funds, hedge funds, and closed-end funds, as well as variable annuity/life portfolios and subaccounts. For managed investment products, the Morningstar Rating brings performance and risk together into one evaluation, with the top 10% of rated offerings receiving 5 stars and the bottom 10% receiving 1 star. The Morningstar Rating for stocks is based on the difference between a stock’s current market price and our analyst-generated fair value estimate. It also incorporates our assessment of the company’s level of business risk and economic moat, or competitive advantage.

The Morningstar Style Box

We provide three levels of detail for the Morningstar Style Box: a basic grid illustrating the overall style of a stock or fund, a basic Ownership Zone illustrating the area of the Style Box in which most of the fund’s holdings tend to fall, and a detailed Ownership Zone that plots precisely where the fund’s holdings fall within the Style Box. For the hypothetical mutual fund shown here, the first illustration shows that the funds overall style emphasizes large-capitalization stocks with a blend of value and growth characteristics.

The second illustration shows that most of the fund’s investments fall into the large-capitalization range and that the fund puts slightly more emphasis on growth stocks than value-oriented stocks.

The third illustration shows the complete distribution of the fund’s holdings. Because some individual holdings have extremely large market capitalizations, they land outside the traditional Style Box range.

Growth Strategies

Our mission is to create great products that help investors reach their financial goals. In keeping with our mission, we are pursuing four key growth strategies, which we describe below. We review our growth strategies on a regular basis and refine them as we monitor changes in the business.

1. Enhance our position in each of our three operating segments by focusing on our three major Internet-based platforms.

We operate our business in three segments: Individual, Advisor, and Institutional. We believe that individual investors, financial advisors, and institutional clients increasingly want integrated solutions as opposed to using different research tools for different parts of their portfolios. To help meet the market need for integrated solutions, one of our key strategies is to focus our product offerings on our three major platforms:

• Morningstar.com for individual investors;

• Morningstar Advisor Workstation for financial advisors; and

• Morningstar Direct for institutional investment research professionals.

These products all include integrated research and portfolio tools, allowing investors to use our proprietary information and analysis across multiple security types. We believe we can achieve deeper penetration of our current audiences with each of these platforms, as well as extend their reach to new customers. With Morningstar.com, we’re focusing on expanding beyond our core audience of mutual fund investors by attracting more stock investors and continuing to expand our reach with our core audience of experienced and engaged investors. We plan to continue intensifying and improving the Morningstar.com customer experience by upgrading the site’s content, speed, and relevance to all users. With Advisor Workstation, we plan to build on our large installed base by continuing to add functionality, such as portfolio accounting, client management, and retirement income tools, which will help us reach more advisors around the world. With Morningstar Direct, we plan to continue an aggressive development program to provide data and analysis on securities and investments around the world. We’re focusing on expanding functionality, selling more licenses to existing clients, and reaching new clients.

2. Become a global leader in funds-of-funds investment management.

The large number of managed investment products available has made assembling them into well-constructed portfolios a difficult task for many investors. Consequently, funds-of-funds offerings have seen strong growth within the mutual fund, variable annuity, and hedge fund industries. Cerulli Associates estimates that global multimanager assets—including publicly offered funds that invest in other funds as well as investment vehicles managed by multiple subadvisors—totaled more than $1.9 trillion as of December 31, 2007. We believe assembling and evaluating funds of funds is a natural extension of our expertise in understanding managed investment products.

Our investment management programs combine managed investment vehicles—typically mutual funds—in portfolios designed to help investors meet their financial goals. When we create portfolios made up of other funds, our goal is to simplify the investment process and help investors access portfolios that match their level of risk tolerance, time horizon, and long-term investment objectives. We draw on our extensive experience analyzing funds to combine quantitative research with a qualitative assessment of manager skill and investment style.

Morningstar Managed Portfolios is a fee-based discretionary asset management service that includes a series of mutual fund, exchange-traded fund, and stock portfolios tailored to meet specific investment time horizons and risk levels. Through our Retirement Advice platform, which includes Morningstar Retirement Manager and Advice by Ibbotson, we also offer managed account services. We offer these managed accounts for retirement plan participants who choose to delegate management of their portfolios to our managed account programs, which select investment options and make retirement planning choices for the participants. We believe that retirement plan participants will continue to adopt managed accounts because of the complexity involved in retirement planning. In addition, the Pension Protection Act of 2006 may encourage plan sponsors to adopt managed accounts as a default investment option.

In addition to the assets we manage directly, we had a total of $97.5 billion in assets under advisement in our Investment Consulting business as of December 31, 2007. We significantly expanded our assets under advisement in 2007, with the majority of the growth driven by new asset flows to existing client portfolios, both from Ibbotson Associates and Morningstar Associates. Our consulting business focuses on relationships and agreements where we act as a portfolio construction manager or asset allocation program designer for a mutual fund or variable annuity and receive a basis-point fee. We see continued potential to develop this part of our business, including in markets outside the United States. We plan to continue building this business by focusing on performance and client support, building new relationships, and developing new portfolio strategies and products.

3. Expand the range of services we offer investors, financial advisors, and institutional clients.

We plan to expand our product offerings to better meet the needs of investors. We plan to continue building new databases for additional types of investments, including various types of funds outside the United States and other widely used investment products. We expect to expand our product offerings in five primary areas:

• Enhance our expertise in 10 key investment databases and look for opportunities to develop new databases. We currently provide extensive data on mutual funds, stocks, hedge funds, separate accounts, variable annuities, pension and life funds, exchange-traded funds, closed-end funds, 529 plans, and capital markets. Our data is the foundation for all of the products and services we offer. When we build investment databases, we intend to own the data whenever possible and minimize license agreements with outside data providers. We also focus on proprietary, value-added data, such as our comprehensive data on current and historical portfolio holdings for mutual funds and variable annuities. Within each database, we continuously update our data to maintain timeliness and expand the depth and breadth of coverage. We expect to continue building out additional databases, focusing on investment products that are widely used by large numbers of investors. We also plan to continue our efforts to establish our databases as the pre-eminent choice for individual investors, financial advisors, and institutional clients in markets around the world.

• Expand and leverage our capabilities in stocks. Our equity research complements our approach to mutual fund analysis, where we focus on analyzing the individual stocks that make up each fund’s portfolio. As of December 31, 2007, we provided analyst research on more than 2,100 companies, plus an additional 250 companies listed in Australia. We’ve focused on building both depth and breadth of coverage by adding additional coverage on initial public offerings and other areas.

We currently provide research to six major investment banks under the terms of the Global Analyst Research Settlement, which covers the five-year period ending in July 2009. We’re working to sell and distribute our equity research through a variety of other channels, including through financial advisors, buy-side firms, and companies outside of the United States. We believe that investors’ increasing awareness of the value of independent research will strengthen our business over the long term.

We’ve also expanded our proprietary stock database, which we view as an important complement to our analyst research. We currently have data coverage on approximately 12,000 companies based in the United States, Canada, and Australia. Following our acquisition of the Hemscott businesses (described in more detail below), we expect to expand the number of companies covered in the United Kingdom, Ireland, and Europe, as well as add more data history and management and director information on many of the companies already in our database. We expect that our combined equity database will include comprehensive data coverage on approximately 20,000 companies after integrating Hemscott’s data.

• Expand our capabilities in hedge fund research. We plan to expand our research and data on hedge funds with the goal of making the hedge fund industry more transparent to investors. Hedge funds worldwide held more than $1.9 trillion in investor assets as of December 31, 2007, based on data from Hedge Fund Research, Inc. Offering data on hedge funds is a natural extension of our work on other managed investment vehicles. We now provide comprehensive data on about 7,700 hedge funds.

• Continue developing retirement income capabilities. As the baby boom generation approaches retirement, we believe many investors will need more information to help them manage income during retirement. We believe these trends will lead to a greater need for information and tools focusing on retirement income planning and long-term savings strategies. We currently offer Retirement Income Strategist, a Web-based financial planning tool that allows financial advisors to create comprehensive income analyses for clients who are in or approaching retirement, as part of our Advisor Workstation platform. We’ve developed several retirement income services for institutional clients within our Investment Consulting area, and we plan to incorporate additional retirement income tools and services in other products over the next several years.

• Continue expanding our index business. Over the past several years, we’ve developed a series of proprietary investment indexes. The Morningstar Indexes are rooted in our proprietary research, with each index vetted for appropriateness and investment value. They can be used for precise asset allocation and benchmarking and as tools for portfolio construction and market analysis. All of our indexes are based on transparent, rules-based methodologies that are back-tested and supported by original research papers. Each is backed by rigorous research to help investors understand, invest in, and monitor the capital markets. Consistent methodology and objective rules make the indexes well-suited for creating index-linked investment products, such as exchange-traded funds, mutual funds, and structured products. We plan to increase the number of indexes we offer, including in markets outside of the United States.

4. Expand our international brand presence, products, and services.

Over the past several years, we have expanded our product offerings outside the United States. Our recent acquisitions of several Hemscott businesses, the mutual fund data business from Standard & Poor’s, and Aspect Huntley (described in more detail below) all significantly expanded our operations outside of the United States. Our operations outside of the United States generated $89.7 million in revenue in 2007, including $31.7 million from acquisitions, compared with $44.3 million in 2006. We plan to continue expanding our non-U.S. operations to meet the increasing demand for wide-ranging, independent investment insight by investors around the globe. Because more than half of the world’s investable assets are located outside of the United States, we believe there are significant opportunities for us in non-U.S. markets. Our strategy is to focus our non-U.S. sales efforts on our major products, including Morningstar Advisor Workstation and Morningstar Direct. We also plan to increase our sales staff, build a larger analyst team outside the United States, and explore new markets, such as India, Latin America, and South Africa.

Acquisitions

The majority of our revenue has been driven by organic growth as we’ve introduced new products and services and expanded our marketing efforts for existing products. However, we have made and expect to continue making selective acquisitions that support our four key growth strategies. In reviewing potential acquisitions, we plan to focus on transactions that:

• offer a good strategic fit with our mission of creating great products that help investors reach their financial goals;

• help us build our proprietary investment databases, research capabilities, technical expertise, or customer base faster and more cost effectively than we could if we built them ourselves; and

• offer a good cultural fit with our entrepreneurial spirit and brand leadership.

Hemscott data, media, and investor relations Web site businesses

In January 2008, we acquired the Hemscott data, media, and investor relations Web site businesses from Ipreo Holdings LLC. This acquisition fits our strategies of building a premier global equity database and expanding our presence outside the United States. The acquisition significantly strengthens our equity coverage and adds decades of additional data history to our existing stock data coverage, as well as management and director information for United States, United Kingdom, and Canadian companies. As part of the transaction we also acquired a sizable data operation in India, a leading investor Web site in the United Kingdom, and a UK-based investor relations Web site business that leverages our data and analytics for investor relations professionals. We paid $51.6 million in cash for the acquisition, subject to working capital adjustments.

Mutual fund data business acquired from Standard & Poor’s

In March 2007, we acquired the mutual fund data business from Standard & Poor’s for $57.8 million in cash including post-closing adjustments and transaction costs directly related to the acquisition, less cash acquired. The mutual fund data business consists of data and products covering approximately 135,000 managed investment vehicles, including mutual funds, ETFs, hedge funds, and offshore funds. Approximately 80% of the mutual fund data business acquired from Standard & Poor’s is outside the United States.

We have also made other acquisitions over the past several years. For more information, refer to Note 7 of the Notes to our Consolidated Financial Statements.

Business Segments, Products, and Services

We divide our business operations into three segments:

• Individual, which focuses on products and services for individual investors;

• Advisor, which focuses on products and services for financial advisors; and

• Institutional, which focuses on products and services for institutional clients, including banks, brokerage firms, insurance companies, mutual fund companies, media outlets, and retirement plan providers and sponsors.

Individual Segment

For individual investors, our largest product based on revenue is our U.S.-based Web site, Morningstar.com, which includes our Premium Membership service and sales of Internet advertising space. Morningstar.com is consistently mentioned in major business publications as one of the best investment sites on the Web . Our Individual business segment also includes Morningstar Equity Research, which we distribute through several channels. Investors can access our equity research through the Premium Membership service on Morningstar.com. Our independent equity research is also distributed through six major investment banks to meet the requirement for independent research under the Global Analyst Research Settlement, which covers the five-year period ending in July 2009. In addition, we distribute our research to several other companies who provide our analyst reports and research to their affiliated financial advisors or to individual investors.

We also offer several print and online publications focusing on stocks, mutual funds, personal finance, and other investing topics. We sell several investment newsletters, including Morningstar FundInvestor and Morningstar StockInvestor; and annual reference guides, including the Morningstar Funds 500 , the Morningstar Stocks 500 , the Morningstar ETFs 150 , and the Stocks, Bonds, Bills, and Inflation Yearbook . This segment also includes several newsletters and other publications for investors in Australia. In 2007, about 10% of Individual segment revenue was from outside of the United States.

We offer free local Web sites for investors in Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Italy, Japan, Korea, the Netherlands, New Zealand, Norway, People’s Republic of China, Spain, Sweden, Switzerland, Taiwan, and the United Kingdom. Our Web sites and publications for individual investors reach approximately 6.1 million investors worldwide.

Within the Individual business segment, most of our products target experienced investors who are actively involved in the investing process and want to take charge of their own investment decisions. We also reach individuals who want to learn more about investing and investors who seek out third-party sources to validate the advice they receive from brokers or financial planners. Our client base in this segment consists of more than 280,000 paying customers, including 180,366 Premium members of Morningstar.com and approximately 100,000 subscribers who purchase our investment newsletters designed for individual investors. Following the Hemscott acquisition, we also have an additional 1,800 Premium subscribers for Hemscott.com in the United Kingdom. Approximately 3,800 public and private libraries in the United States subscribe to our services. We also offer a series of books and workbooks about investing, as well as formatted printable reports on individual securities.

We promote our individual investor products primarily through traditional direct mail, e-mail, promotions on our 24 investor Web sites worldwide, public relations, and advertising on related Web sites.

Our strategy is to increase the number of investors who sign up for Morningstar.com Premium Membership by continuing to develop and promote Premium content such as analyst reports, Fund Analyst Picks and Pans, and value-added portfolio tools, which we market to registered users and other investors. We use search marketing as a core marketing strategy for Morningstar.com. This includes working to optimize our site’s ranking in the search results that appear when users search for information about investing and purchasing advertisements on third-party sites such as Yahoo! and Google that can bring investors to relevant content on Morningstar.com.

In the Individual business segment, we compete with the personal finance Web sites of AOL Money & Finance, CNN Money, Google Finance, MarketWatch, MSN Money, The Motley Fool, SmartMoney.com, The Street.com, The Wall Street Journal Online, and Yahoo! Finance. Our print publications compete with Agora Publishing, Forbes, The Motley Fool, Phillips Investment Resources, and Value Line in the United States and Australian Wealth Report, Fat Prophets, Intelligent Investor, and The Rivkin Report in Australia. Our Equity Research services compete with Standard & Poor’s, Value Line, Zacks Investment Research, and several smaller research firms.

We believe the Individual segment has a modest amount of seasonality. The first quarter tends to show more sales activity for Premium Membership on Morningstar.com and our annual reference guides, including the Stocks, Bonds, Bills, and Inflation Yearbook . Sales in the Individual segment tend to be slightly lower over the spring and summer months. However, our diversified product base and recognizing revenue ratably over the term of each subscription moderates the impact of this seasonality.

Morningstar.com

Our largest Web site for individual investors is Morningstar.com in the United States. As of December 31, 2007, the free membership services offered through Morningstar.com had more than 5.8 million registered users worldwide, who have access to comprehensive data on individual stocks, mutual funds, exchange-traded funds, hedge funds, and other investments to help them conduct research and track performance. In addition, Morningstar.com features extensive market data, Morningstar articles, proprietary portfolio tools, and educational content to help investors of all levels access timely, relevant investment information. Morningstar.com also includes Portfolio X-Ray, which helps investors reduce risk and understand key characteristics of their portfolios, and a variety of other portfolio tools.

We use our free content as a gateway into paid Premium Membership, which includes access to written analyst reports on more than 2,100 stocks, 2,000 mutual funds, and 165 exchange-traded funds, as well as Analyst Picks and Pans, Stewardship Grades, and Premium Stock and Fund Screeners. We currently offer Premium Membership services in the United States, China, and the United Kingdom.

To help draw investors deeper into Morningstar.com, in 2007 we significantly expanded video content and the number of articles published by our editorial staff. We overhauled the cover pages for the stock and fund areas of the site and improved the conversations area of the site to better highlight user-generated content. We also created an Options Center that includes comprehensive equity option data, education, analysis, and a family of proprietary option volatility indexes.

As of December 31, 2007, we had 180,366 paid Premium subscribers for Morningstar.com in the United States plus an additional 2,100 Premium subscribers in China. Following our January 2008 acquisition of the Hemscott businesses, we had 1,800 Premium subscribers to Hemscott.com in the United Kingdom. We currently charge $16.95 for a monthly subscription, $159 for an annual subscription, $269 for a two-year subscription, and $369 for a three-year subscription for Morningstar.com’s Premium service in the United States. We also sell advertising space on Morningstar.com.

Morningstar Equity Research

As of December 31, 2007, we offered independent equity research on more than 2,100 companies, plus an additional 250 companies based in Australia. Our approach to stock analysis focuses on long-term fundamentals. Our analysts evaluate companies by assessing each firm’s competitive advantage, analyzing the level of business risk, and completing an in-depth projection of future cash flows. For the companies we cover, our analysts prepare a fair value estimate, a Morningstar Rating for stocks, a rating for business risk, and an assessment of the company’s economic moat. Economic moat is a concept originally developed by Warren Buffett that describes a company’s competitive advantage relative to other companies. For the remaining stocks included in our database, we offer quantitative grades for growth, profitability, and financial health, as well as an explanation of the company’s business operations. We currently deliver our equity research to individual investors as part of our Premium Membership service on Morningstar.com and to six major investment banks under the terms of the Global Analyst Research Settlement, as well as to several other companies who provide our research to their affiliated financial advisors or to individual investors.

We have significantly expanded our equity research coverage over the past several years. We currently provide analyst reports on virtually all of the most widely held stocks in the S&P 500 index, as well as numerous companies included in other indexes. We continue to expand our analyst staff to support these research efforts and had 112 stock analysts around the world as of December 31, 2007, compared with 100 as of December 31, 2006.

We continue to focus on building our competitive advantage by expanding the breadth and depth of our equity coverage. As part of this effort, in 2007 we increased coverage of initial public offerings, and now cover about 100 pre-IPO and newly public companies.

Pricing for Morningstar Equity Research varies based on the level of distribution, the number of securities covered, the amount of custom coverage required, and the length of the contract term. Morningstar Equity Research, which primarily consists of revenue related to the Global Analyst Research Settlement, was the second-largest product in the Individual segment based on revenue in 2007, following Morningstar.com. The period covered by the Global Analyst Research Settlement will expire in July 2009. After the settlement period expires, the investment banks covered by it will no longer be required to provide independent investment research to their clients. For further discussion about this issue, see Item 1A — Risk Factors.

Newsletters and Other Publications

We offer a variety of print and electronic publications about investing. Some of these include Morningstar Mutual Funds, a reference publication that features our signature one-page reports on approximately 1,600 mutual funds; Morningstar FundInvestor, a monthly newsletter that provides information and insight on 500 of the most popular mutual funds and a list of 175 Analyst Picks; Morningstar StockInvestor, a monthly newsletter that focuses on companies with strong competitive positions and stock prices that we believe are low enough to provide investors with a margin of safety; and the Stocks, Bonds, Bills, and Inflation Yearbook, the definitive study of historical capital markets data in the United States. In addition, we offer several other investment newsletters and a series of books about investing in stocks, mutual funds, and exchange-traded funds, which are available directly from us and in bookstores. In early 2008, we published two new investment books, The Ultimate Dividend Playbook and The Little Book that Builds Wealth.

Our Individual segment also includes several publications for investors in Australia, including IFA Magazine, Australia’s leading magazine for independent financial advisors; Your Money Weekly , which focuses on the larger companies listed in Australia; and Smaller Companies Guide, a weekly newsletter with investment recommendations and portfolio ideas focusing on smaller-sized stocks.

Advisor Segment

For financial advisors, our largest products based on revenue are Morningstar Advisor Workstation, a comprehensive Web-based investment planning system, and Principia, our CD-ROM-based investment research and planning software. We also offer Morningstar Managed Portfolios, a fee-based discretionary asset management program distributed exclusively through financial advisors. Our advisor products are integrated into the daily operations and research processes of many financial advisors who use our research and tools to provide guidance for individual investors. According to a report published in January 2005 by the consulting firm Tiburon Strategic Advisors, Morningstar was ranked as the leading provider of investment research and data, financial planning software, and asset allocation software among approximately 1,500 independent financial advisors surveyed.

We sell our advisor-related products both directly to independent financial advisors and through enterprise licenses, which allow financial advisors associated with the licensing enterprise to use our products. Most of our license agreements in the Advisor segment have terms ranging from one to three years. As of December 31, 2007, we had established relationships with approximately 240,000 financial advisors around the world. Approximately 16% of our Advisor segment revenue was from international sales in 2007. In addition to the U.S. versions of our Advisor products, we offer products for financial advisors in a variety of other countries. For example, we have versions of Advisor Workstation tailored for use in Asia, Australia, Canada, and Europe, and we offer a product similar to Principia in Canada.

CEO BACKGROUND

Joe Mansueto

Joe Mansueto founded Morningstar in 1984. He has served as our chairman since our inception, and as our chief executive officer from inception to 1996 and from 2000 to the present. He holds a bachelor’s degree in business administration from The University of Chicago and a master’s degree in business administration from The University of Chicago Graduate School of Business.

Don Phillips

Don Phillips has been one of our managing directors since 2000. He is responsible for corporate strategy, research, and corporate communications. He joined us in 1986 as our first analyst. He served as our vice president and publisher from 1991 to 1996, as our president from 1996 to 1998, and as our chief executive officer from 1998 to 2000. He has served on the Board since August 1999. He also serves on the board of directors for Morningstar Japan. He holds a bachelor’s degree in English from the University of Texas and a master’s degree in American literature from The University of Chicago.

Cheryl Francis

Cheryl Francis was elected to the Board in July 2002. She has been vice chairman, Corporate Leadership Center, since 2002 and an independent business and financial advisor since 2000. From 1995 to 2000, she served as executive vice president and chief financial officer of R.R. Donnelley & Sons Company, a print media company. She currently serves as a member of the board of directors of HNI Corporation and Hewitt Associates, Inc., as well as a trustee for Cornell University. She holds a bachelor’s degree from Cornell University and a master’s degree in business administration from The University of Chicago Graduate School of Business.

Steve Kaplan

Steve Kaplan served as a member of our advisory board beginning in 1998 and was elected to the Board in August 1999. Since 1988, he has been a professor at The University of Chicago Graduate School of Business where he currently is the Neubauer Family Professor of Entrepreneurship and Finance. He holds a bachelor’s degree in applied mathematics and economics from Harvard College and a Ph.D. in business economics from Harvard University. He also serves on the board of trustees of the Columbia Acorn Funds where he is a member of the governance, compliance, and performance committees.

Bill Lyons

Bill Lyons was appointed to the Board in September 2007. He served as president and chief executive officer of American Century Companies, Inc., an investment management company, from September 2000 until his retirement in March 2007. From 1987 to 2000, he served in other capacities at American Century Companies, Inc., including as general counsel and chief operating officer. He holds a bachelor’s degree in history from Yale University and a juris doctor degree from Northwestern University School of Law.

Jack Noonan

Jack Noonan served as a member of our advisory board beginning in 1998 and was elected to the Board in August 1999. Since 1992, he has served as president and chief executive officer of SPSS Inc., a software company specializing in predictive analytics, where he also currently serves as chairman of the board of directors.

Frank Ptak

Frank Ptak was appointed to the Board in February 2007. He has been president and chief executive officer of The Marmon Group of companies, a diverse manufacturing and service organization comprising more than 125 independent businesses, since January 2006, where he also serves on the board of directors. From 1996 to 2005, he served as vice chairman of Illinois Tool Works Inc., a diversified manufacturer of industrial systems and components. He holds a bachelor’s degree in commerce from DePaul University.

Paul Sturm

Paul Sturm served as a member of our advisory board beginning in 1998 and was elected to the Board in August 1999. He is a private investor who wrote a monthly column on investing for Smart Money magazine between 1992 and 2006. From 1985 to 1989, he was assistant managing editor at Business Week. From 1980 until 1985, he held a similar position at Forbes. Prior to that, he worked as a business writer for a variety of publications based in New York, Washington, and London. He holds a bachelor’s degree in economics from Oberlin College and a master’s degree in journalism from Columbia University. He received a law degree from Georgetown University Law Center.

MANAGEMENT DISCUSSION FROM LATEST 10K

The discussion included in this section, as well as other sections of this Annual Report on Form 10-K, contains forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. These statements are based on our current expectations about future events or future financial performance. Forward-looking statements by their nature address matters that are, to different degrees, uncertain, and often contain words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue.” These statements involve known and unknown risks and uncertainties that may cause the events we discussed not to occur or to differ significantly from what we expected. For us, these risks and uncertainties include, among others, general industry conditions and competition; damage to our reputation resulting from claims made about possible conflicts of interest; liability for any losses that result from an actual or claimed breach of our fiduciary duties; legal, regulatory, or political issues related to our data center in China; the potential impact of market volatility on revenue from asset-based fees; a prolonged outage of our database and network facilities; challenges faced by our non-U.S. operations; and the availability of free or low-cost investment information.

A more complete description of these risks and uncertainties can be found in Item 1A — Risk Factors of this Annual Report on Form 10-K. If any of these risks and uncertainties materialize, our actual future results may vary significantly from what we projected. We do not undertake to update our forward-looking statements as a result of new information or future events.

Understanding Our Company

Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of Internet, software, and print-based products for individual investors, financial advisors, and institutional clients. We also offer asset management services for advisors, institutions, and retirement plan participants. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

We emphasize a decentralized approach to running our business to empower our managers and to create a culture of responsibility and accountability. We operate our business in three global segments: Individual, Advisor, and Institutional. In all three of these segments, we believe our work helps individual investors make better investment decisions.

Historically, we have focused primarily on organic growth by introducing new products and services and expanding our marketing efforts for existing products. However, we have made and expect to continue making selective acquisitions that support our four key growth strategies, which are:

• Enhance our position in each of our three operating segments by focusing on our three major Internet-based platforms;

• Become a global leader in funds-of-funds investment management;

• Expand the range of services we offer investors, financial advisors, and institutional clients; and

• Expand our international brand presence, products, and services.


Key Business Characteristics

Revenue

We generate revenue by selling a variety of investment-related products and services. We sell many of our offerings, such as our newsletters, Principia software, and Premium service on Morningstar.com, via subscriptions. These subscriptions are mainly offered for a one-year term, although we also offer terms ranging from one month to three years. We also sell advertising on our Web sites throughout the world. Several of our other products are sold through license agreements, including Morningstar Advisor Workstation, Morningstar Equity Research, Morningstar Direct, Morningstar EnCorr, Retirement Advice, and Licensed Data. Our license agreements typically range from one to three years. For some of our other institutional services, mainly Investment Consulting, we generally base our fees on the scope of work and the level of service we provide and calculate them as a percentage of assets under management. We also earn fees relating to Morningstar Managed Portfolios and the managed retirement accounts offered through Morningstar Retirement Manager and Advice by Ibbotson that we calculate as a percentage of assets under management. Overall, revenue tied to asset-based fees accounted for about 16% of our consolidated revenue in 2007.

Deferred Revenue

We frequently invoice our clients and collect cash in advance of providing services or fulfilling subscriptions for our customers. As a result, we use some of this cash to fund our operations and invest in new product development. The businesses we acquired in 2007 and 2006 have similar business models, and as a result, we acquired their deferred revenue. The deferred revenue shown on our balance sheet totaled $129.3 million as of December 31, 2007 and $100.5 million as of December 31, 2006. Deferred revenue is the largest liability on our Consolidated Balance Sheets. We expect to recognize the deferred revenue in future periods as we fulfill our service obligations under our subscription, license, and service agreements.

Significant Operating Leverage

Our business requires significant investments to create and maintain proprietary databases and content. We strive to leverage these costs by selling a wide variety of products and services to multiple investor segments, through multiple media, and in many geographic markets. We believe that while the fixed costs of the investments in our business are relatively high, the variable cost of adding customers is considerably lower, particularly as our products and services focus more on Internet-based platforms and assets under management. In the past, we have made investments in building our databases and content that have hurt our short-term operating results for certain periods. In the past several years, our profitability has improved because we’ve been able to increase revenue without increasing our cost base at the same rate. We look for this operating leverage to be evident in our operations over the long term.

Operating Expense

We classify our expenses into separate categories for cost of goods sold, development, sales and marketing, general and administrative, and depreciation and amortization, as described below. We include stock-based compensation expense, as appropriate, in each of these categories.

• Cost of goods sold. This category includes the compensation expense for employees who produce the products we deliver to our customers. For example, this category covers the cost of production teams and analysts who write investment research reports. Cost of goods sold also includes other expenses such as postage, printing, and CD-ROM replication, as well as shareholder servicing fees for Morningstar Managed Portfolios.

• Development. This category mainly includes compensation expense for programmers, designers, and other employees who develop new products and enhance existing products. In some cases, we capitalize the compensation costs associated with certain development projects. This reduces the expense that we would otherwise report in this category. We amortize these capitalized costs over the estimated economic life of the software, which is generally three years, and include this expense in depreciation and amortization.

• Sales and marketing. This category includes compensation expense for our sales teams, product managers, and other marketing professionals. We also include the cost of advertising, direct mail campaigns, and other marketing programs to promote our products.

• General and administrative. This category consists mainly of compensation expense for each segment’s management team, as well as human resources, finance, and support employees for each segment. The category also includes compensation expense for senior management and corporate expenses, including corporate systems, accounting, legal, and facilities expense.

• Depreciation and amortization. Our capital expenditures consist mainly of computers, leasehold improvements, and capitalized product development costs related to certain software development projects. We depreciate property and equipment primarily using the straight-line method based on the useful life of the asset, which ranges from three to seven years. We amortize leasehold improvements over the remaining lease term or their useful lives, whichever is shorter. We amortize capitalized product development costs over their estimated economic life, which is generally three years. We also include amortization related to intangible assets, which is mainly driven by acquisitions, in this category.

International Operations

We consolidate the results of our majority-owned operations outside the United States. We account for our minority-owned investments in Japan, Korea, Denmark, and Sweden using the equity method.

Our international operations continue to become a more important part of our business. Our non-U.S. revenue increased to 20.6% of consolidated revenue in 2007—6.6 percentage points higher than in 2006.

How We Evaluate Our Business

When our analysts evaluate a stock, they focus on assessing the company’s estimated intrinsic value—the value of the company’s future cash flows, discounted to their worth in today’s dollars. Our approach to evaluating our own business works the same way. Our goal is to increase the intrinsic value of our business over time, which we believe is the best way to create value for our shareholders.

We do not make public financial forecasts for our business because they are, by their nature, subjective and could have an effect on our company’s stock price. We want to avoid creating any incentives for people within our company to make speculative statements about our financial results that could influence the stock price, or to take actions that help us meet short-term forecasts but may not be in the long-term interest of building shareholder value.

We provide three specific measures that can help investors generate their own assessment of how our intrinsic value has changed over time:

• Revenue;

• Operating income (loss); and

• Free cash flow, which we define as cash provided by or used for operating activities less capital expenditures.

Free cash flow is considered a non-GAAP financial measure under Securities and Exchange Commission (SEC) regulations. We present this measure as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate the performance of our business. Free cash flow is not equivalent to any measure of performance required to be reported under U.S. generally accepted accounting principles (U.S. GAAP), and should not be considered an indicator of our overall financial performance or liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.

To evaluate how successful we’ve been in maintaining existing business for products and services that have renewable revenue, we calculate a retention rate. We use two different methods for calculating retention. For subscription-based products (including our print newsletters, Morningstar.com Premium Membership service, and Principia software), we track the number of subscriptions retained during the year. For products sold through contracts and licenses, we use the contract value method, which is based on tracking the dollar value of renewals compared with the total dollar value of contracts up for renewal during the period. We include changes in the contract value in the renewal amount, unless the change specifically results from adding a new product that we can identify. We also include variable contracts in this calculation and use the previous quarter’s actual revenue as the base rate for calculating the renewal percentage. The retention rate excludes setup and customization fees, migrations to other Morningstar products, and contract renewals that were pending as of January 31, 2008.

The Year 2007 in Review

Industry Overview

We monitor developments in the economic and financial information industry on an ongoing basis. We use these insights to help inform our company strategy, product development plans, and marketing initiatives.

Investment Landscape, Research, and Data

Despite pronounced market volatility and a market downturn during the fourth quarter of 2007, the U.S. equity markets finished the year in positive territory. Morningstar’s U.S. Market Index, a broad market benchmark, ended the year with a 5.9% total return, compared with 15.7% in 2006. Most markets outside of the United States finished the year with higher total returns versus the U.S. Market Index.

The crisis in subprime mortgages caused extreme disruption in the financial markets beginning in late 2007. We believe that the impact of these problems in the financial services sector to date has been the most severe in areas such as mortgage lending, commercial banking, and investment banking, with less direct impact on asset management firms. However, there could be a spillover effect on other areas as the financial services sector attempts to address issues relating to the subprime mortgage crisis, uncertain credit markets, and a slowing economy.

Total U.S. mutual fund assets increased to $12.0 trillion as of December 31, 2007 based on data from the Investment Company Institute (ICI), compared with $10.4 trillion as of December 31, 2006. Net new cash flows into hybrid funds and taxable bond funds increased over 2006 levels, but cash flows into equity funds were substantially lower. The number of mutual funds declined slightly to 8,000 during 2007, compared with about 8,100 the previous year.

The Investment Company Institute estimates that about 51 million households in the United States, or 44% of all households, own mutual funds. This total is down slightly from its peak in 2001, but consistent with the levels shown over the past several years.

We believe continued asset growth and widespread usage of mutual funds is significant because a relatively large portion of Morningstar’s business has historically focused on this area. However, this percentage has been declining as we’ve expanded into equity research and other areas.

Interest in alternative asset classes, such as hedge funds, remained strong during most of 2007. Based on data from Hedge Fund Research, which tracks asset flows into hedge funds, hedge funds had about $195 billion in net inflows during 2007, compared with $127 billion in net inflows in 2006. Hedge Fund Research estimates that total hedge fund industry assets increased to $1.87 trillion as of December 2007, a 30% increase from year-end 2006.

Based on data from Cerulli Associates, assets invested in separate accounts reached $850 billion as of December 31, 2007, up from about $767 billion as of year-end 2006. Based on Morningstar’s data, we estimate that total assets invested in variable annuities totaled about $1.5 trillion as of December 31, 2007.

Assets in exchange-traded funds (ETFs) increased about 44% to reach about $608 billion as of December 2007, compared with $423 billion as of December 2006, based on data from the ICI. During 2007, the number of U.S.-based ETFs increased to more than 600, compared with about 350 previously. ETFs have gained share from mutual funds in some areas of the market and have also started being used in defined contribution plans, such as 401(k)s. To meet greater investor demand for information on ETFs, we have continued to increase analyst coverage in this area and now cover about 165 ETFs. We’re also planning to create a new cover page for the ETF area of Morningstar.com and recently introduced a new report format for ETFs.

In 2007, we also saw significant investor interest and new product development in open-end mutual funds that pursue alternative investment strategies, such as 130/30 funds, which invest in traditional long-only securities but also sell short a portion of their assets and use the proceeds to build additional long exposure. We believe this trend signifies that the lines are blurring between traditional mutual funds registered under the Investment Company Act and alternative investment strategies often used by hedge funds. We believe we’re well-positioned to meet the need for information and analysis on complex investment strategies, and that our broad investment coverage also gives us an advantage in meeting this market need.

Individual Investor Market

Based on research from Nielsen/NetRatings, total page views to retail investment Web sites decreased in the fourth quarter of 2007, with aggregate page views declining 2% from the same period in 2006. However, some sites showed large increases and others posted declines. Overall, the number of unique users to retail investment Web sites increased by about 17%. For Morningstar.com, both page views and unique users increased in the fourth quarter of 2007 from the same period in 2006. Morningstar.com continued to perform better than competing sites based on metrics such as time spent per visit and the number of pages viewed per visit.

Financial Advisor Market

In 2007, demand for financial advisory services continued to rise, as an increasing percentage of investors have been working with advisors to plan their financial futures. The independent advisor channel has had particularly strong growth over the past three years, based on research published by Financial Research Corporation. We believe this trend is important because our products are well-suited to meet the needs of the independent financial advisors, and we have a strong market position in this growing area.

Larger advisory firms have been continuing to prepare for the pending termination of the “Merrill Lynch rule,” which allowed brokerage firms to provide investment advice in exchange for an asset-based fee. We think this development is notable because we believe many broker-dealers may shift their clients out of fee-based brokerage accounts, which typically include various services, including investment advice, in exchange for an asset-based fee. We believe this highlights the ongoing regulatory complexity in the advisor segment. In addition, it may lead to additional business opportunities for the investment advisory services we offer.

Institutional Market

In the United States, there has been continuing debate about improving disclosure of fees and returns in 401(k) plans. In July 2007, the U.S. House Education and Labor Committee chairman submitted a bill that would require 401(k) plans to disclose more information to retirement plan participants each year, as well as provide for additional oversight by the Department of Labor. We believe this development is important because it highlights the need for transparency in the retirement market.

The Pension Protection Act of 2006 has led to more use of target-date funds and other qualified default investment alternatives. In addition, the Pension Protection Act has led to more opportunities for retirement advice programs offered at the employer level. We continue to expand our retirement advice offerings to meet this need, particularly in managed retirement accounts.

Merger and acquisition activity continued in the industry in 2007. In May 2007, Thomson Corporation and Reuters entered into an agreement to form a combined company, Thomson-Reuters. Pending regulatory approval, the two companies expect to complete the merger in the second quarter of 2008. We continue to monitor merger and acquisition activity in our industry because of its potential impact on our business.

As an industry-wide trend, we continued to see strong interest in retirement income in 2007. A large number of investors are currently approaching retirement and making the transition from accumulating assets to drawing down their portfolios. As a result, Financial Research Corporation estimates that total assets invested in retirement income related products will total more than $7 trillion over the next 10 or 15 years. We have continued to develop products and services to meet this need, including target spending portfolios, annuitization programs, and retirement income planning tools.

Worldwide Markets

In Europe, many financial services companies have been preparing for the upcoming implementation date of the Market in Financial Instruments Directive (MiFID). The directive took effect in November 2007 and obligates companies to be more transparent with clients and make efforts to provide better-quality service to investors. We believe Morningstar is well-positioned to help companies meet the new requirements because our services and products are already largely in line with MiFID’s objectives.

In Germany, the legislature recently passed a tax rule that involves taxing long-term capital gains of mutual funds starting in January 2009. Investors holding funds of funds, however, will have some tax protection until they sell the fund. In addition, insurance-wrapped funds will be subject to different taxation rules that are more favorable than direct fund investments. Because of this change, we expect continued asset growth and product launches in insurance-wrapped and funds-of-of funds products.

In Canada, the traditional pension fund area continues to expand. We believe that pension funds have a need for more information on the various asset classes they invest in and see opportunities for Morningstar to add value in this area. In addition, Canadian regulators recently increased the age limits and annual contribution limits for several types of savings plans.

In New Zealand, the government introduced a new Kiwi Saver retirement savings initiative in July 2007 and established a number of incentives, including government and compulsory employer contributions, that will start in April 2008.

In Japan, regulators implemented a new Financial Products Law in September 2007. The new law entails more risk disclosure and suitability requirements, which we think is positive for the industry.

Emerging markets across Asia continued their strong growth in 2007, and we’ve continued to expand our presence to meet the need for investment information in markets such as China and India. We are expanding our operations in India and plan to launch a Web site for individual investors in 2008.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The discussion included in this section, as well as other sections of this Quarterly Report on Form 10-Q, contains forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. These statements are based on our current expectations about future events or future financial performance. Forward-looking statements by their nature address matters that are, to different degrees, uncertain, and often contain words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue.” These statements involve known and unknown risks and uncertainties that may cause the events we discuss not to occur or to differ significantly from what we expect. For us, these risks and uncertainties include, among others, general industry conditions and competition, including the current global financial crisis that began in 2007; the impact of market volatility on revenue from asset-based fees; damage to our reputation resulting from claims made about possible conflicts of interest; liability for any losses that result from an actual or claimed breach of our fiduciary duties; financial services industry consolidation; a prolonged outage of our database and network facilities; challenges faced by our non-U.S. operations; and the availability of free or low-cost investment information.

A more complete description of these risks and uncertainties can be found in Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q as well as our other filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2007. If any of these risks and uncertainties materialize, our actual future results may vary significantly from what we expected. We do not undertake to update our forward-looking statements as a result of new information or future events.

All dollar and percentage comparisons, which are often accompanied by words such as “increase,” “decrease,” “grew,” “declined,” “was up,” “was down,” “was flat,” or “was similar”, refer to a comparison with the same period in the prior year unless otherwise stated.

Understanding our Company

Our Business

Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of Internet, software, and print-based products for individual investors, financial advisors, and institutional clients. We also offer asset management services for advisors, institutions, and retirement plan participants. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

We emphasize a decentralized approach to running our business to empower our managers and to create a culture of responsibility and accountability. We operate our decentralized business structure in three global business segments: Individual, Advisor, and Institutional. In all three of these segments, we believe our work helps individual investors make better investment decisions.

Historically, we have focused primarily on organic growth by introducing new products and services and marketing our existing products. However, we have made and expect to continue to make selective acquisitions that support our four key growth strategies, which are:

• Enhance our position in each of our three operating segments by focusing on our three major Internet-based platforms;

• Become a global leader in funds-of-funds investment management;

• Expand the range of services we offer investors, financial advisors, and institutional clients; and

• Expand our international brand presence, products, and services.

Industry Overview

We monitor developments in the economic and financial information industry on an ongoing basis and use these insights to help inform our company strategy, product development plans, and marketing initiatives.

The third quarter of 2008 was a time of significant market volatility and uncertainty, which worsened during the quarter and into the fourth quarter. The ongoing financial crisis accelerated during the quarter as high-profile investment bank Lehman Brothers went into bankruptcy, mortgage lenders Fannie Mae and Freddie Mac were taken over by the U.S. government, insurance firms such as AIG received large cash infusions from the U.S. government, and lawmakers and regulators considered a $700 billion rescue package proposed by Treasury officials. Other large investment banks underwent significant changes as Bank of America purchased Merrill Lynch and Morgan Stanley and Goldman Sachs chose to obtain bank charters, which subjects them to strict banking regulations.

In response to these events, the U.S. equity market lost about 10% of its value during the quarter as measured by Morningstar’s U.S. Market Index, a broad market benchmark. Many global markets also lost ground during the quarter, and bond markets also experienced volatility because of widening credit spreads as well as fears of inflation. Problems in the credit markets had widespread effects even on traditional safe havens such as money market funds and high-grade commercial paper. As the third quarter progressed, market volatility and uncertainty became increasingly severe.

The recent market upheaval triggered the largest wave of monthly net redemptions in the history of the mutual fund industry. In September 2008, according to Morningstar’s data, investors pulled an estimated $47.5 billion out of long-term mutual funds. Investor concern about the deepening financial crisis and a money market fund dropping below a $1 net asset value contributed to the outflows. International stock funds and U.S. stock funds each had about $19 billion in net redemptions in September. Most other asset classes, including balanced funds, taxable bond funds, and municipal bond funds, also experienced net outflows. In contrast to previous market declines, when investors sold off stock funds and reallocated assets to bond funds, many investors have pulled their money out of mutual funds altogether. Because of these redemptions as well as the impact of market losses, total U.S. mutual fund assets declined to $10.6 trillion as of September 30, 2008, down from $11.7 trillion as of June 30, 2008 based on data from the Investment Company Institute (ICI).

Asset flows to alternative asset classes also suffered net outflows during the quarter. Based on data from Hedge Fund Research, hedge funds had $31 billion in net outflows during the quarter, compared with net inflows of $12.5 billion in the second quarter. Assets in exchange-traded funds (ETFs) totaled $580 billion as of September 30, 2008, about on par with $578 billion as of June 30, 2008, based on data from the ICI.

The environment for online advertising has been mixed. Earlier in the year, growth rates generally remained strong as advertisers continued to shift spending from traditional media to the Internet. Industry publication eMarketer currently projects that total online ad spending will reach $24.9 billion in 2008, which is below its previous forecast but still an increase of 17% over 2007. More recently, however, some companies in the financial services industry have said that they may cut advertising spending because of the weak market environment. Based on data from Nielsen/Net Ratings, aggregate page views and unique users to financial and investment sites both increased in the third quarter of 2008 compared with the same period in 2007, although the number of pages viewed per visit declined by about 2%. We believe this indicates that while some investors may be disengaged because of the market downturn, many people are still interested in investment-related content.

Overall, we believe the disruption in the financial markets continues to cause widespread investor uncertainty, and the market downturn has also created some spending cutbacks among asset management firms and other financial services companies.

The financial crisis has had two main effects on our business: lengthening the sales cycle and increasing pressure on renewal pricing. Most of the impact to date has been on new business, where we’ve been seeing longer sales cycles, tightening budgets, and more review by senior management at client organizations.

On the positive side, many of our contracts have multiyear terms, and we believe the services we provide are fairly entrenched within many areas of our clients’ organizations. At the same time, our renewal rates have remained strong (though with some pressure on pricing) and cancellations have not significantly increased.

Industry consolidation in the financial services sector has also been an ongoing trend. When our clients are acquired, the impact on us may be positive, negative, or neutral. We may lose business following an acquisition of one of our clients, but we also often have opportunities to continue providing services or expand our business with the new parent organization. We are actively monitoring business conditions for all of our major clients and continuing to work closely with them to align our products and services to meet their needs.

Overall, we remain cautious because of the difficult and uncertain market environment. However, we’re investing in our business and managing it for the long term. We’re also looking for business opportunities that may emerge from the current crisis.

Three and Nine Months Ended September 30, 2008 vs. Three and Nine Months Ended September 30, 2007

We define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow solely as supplemental disclosure to help investors better understand how much cash is available after we spend money to operate our business. Our management team uses free cash flow to evaluate the performance of our business. Free cash flow is not a measure of performance set forth under U.S. Generally Accepted Accounting Principles (GAAP). Also, the free cash flow definition we use may not be comparable to similarly titled measures used by other companies.

Third-Quarter Highlights

• Revenue increased 12.2%. Because of the difficult market environment, our 8% organic revenue growth (which we define as consolidated revenue excluding acquisitions and the impact of foreign currency translations) was slower compared with past levels and third-quarter revenue declined by 5.1% compared with the second quarter of 2008.

• Revenue from acquisitions, primarily Hemscott, contributed 4.2 percentage points to third-quarter revenue growth.

• The largest contributors to organic revenue growth this quarter were Licensed Data and our three major Internet-based platforms: Morningstar Advisor Workstation, Morningstar Direct, and Morningstar.com.

• International revenue grew about 23% and acquisitions accounted for about one-half of the growth in international revenue. The percentage of revenue from outside the United States reached 24%, up from 22% in the third quarter of 2007.

• Operating margin declined modestly to 27.2% in 2008 compared with 28.1% in 2007.

• Free cash flow increased by approximately $12.4 million to $37.3 million, reflecting a $20.9 million increase in cash provided by operating activities and a $8.5 million increase in capital expenditures related to our new corporate office.

Consolidated Revenue

Because we have made several acquisitions in recent years, comparing our financial results from year to year is complex. To make it easier for investors to compare our results in different periods, we provide information on both organic revenue, which reflects our underlying business excluding acquisitions, and revenue from acquisitions. We include an acquired operation as part of our revenue from acquisitions for 12 months after we complete the acquisition. After that, we include it as part of our organic revenue.

In the third quarter of 2008, our consolidated revenue increased 12.2% to $125.5 million. Revenue for the first nine months of the year increased 20.9% to $383.2 million. Acquisitions contributed $4.7 million to our consolidated revenue in the third quarter of 2008 and $20.7 million in the nine months ended September 30, 2008. Foreign currency translations also had a positive but much smaller impact on revenue. Because of continued market weakness and economic uncertainty, organic revenue increased at a lower rate than in the past.

Third-quarter revenue declined $6.7 million, or 5.1%, compared with the second quarter of 2008, primarily because of lower revenue from Investment Consulting and online advertising revenue from Morningstar.com. In addition, we hold our annual investment conference in the second quarter, and revenue from this event does not recur in other quarters.

Consolidated revenue excluding acquisitions and the impact of foreign currency translations (organic revenue) is considered a non-GAAP financial measure. The definition of organic revenue we use may not be the same as similarly titled measures used by other companies. Organic revenue should not be considered an alternative to any measure of performance as promulgated under GAAP.

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