UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
￠

FORM 8-K
￠

CURRENT REPORT
￠
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 
Date of Report (Date of earliest event reported):  August 3, 2006
 
MORNINGSTAR, INC.
(Exact name of registrant as specified in its charter)

Illinois	 	000-51280	 	36-3297908	
(State or other jurisdiction	 	(Commission	 	(I.R.S. Employer	
of incorporation)	 	File Number)	 	Identification No.)	
 	 	 	 	 	
 	 	225 West Wacker Drive	 	 	
 	 	Chicago, Illinois	 	60606	
 	 	(Address of principal executive offices)	 	(Zip Code)	
 	
(312) 696-6000	
(Registrant’s telephone number, including area code)	
 	
N/A	
(Former name or former address, if changed since last report)	

 
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
 
o             Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
 
o             Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
 
o             Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
 
o             Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 
Item 2.02. Results of Operations and Financial Condition.*
 
On August 3, 2006, Morningstar, Inc. issued a press release announcing its financial results for the second quarter ended June 30, 2006. A copy of the press release is attached hereto as Exhibit 99.1.
 
Item 9.01. Financial Statements and Exhibits.
 
(d)           Exhibits:

Exhibit No.	 	Description	
 	 	 	
99.1*	 	Press Release dated August 3, 2006.	

*                  The information furnished under Item 2.02 of this Current Report on Form 8-K, including Exhibit 99.1, is being furnished and shall not be deemed to be “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.
 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 	MORNINGSTAR, INC.	

Date: August 3, 2006	By:	/s/ Martha Dustin Boudos	
 	Name:	Martha Dustin Boudos	
 	Title:	Chief Financial Officer	
 
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EXHIBIT INDEX

Exhibit No.	 	Description	
 	 	 	
99.1*	 	Press Release dated August 3, 2006.	

*                  The information furnished under Item 2.02 of this Current Report on Form 8-K, including Exhibit 99.1, is being furnished and shall not be deemed to be “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.
 
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Exhibit 99.1

		
 	225 West Wacker Drive	Telephone: +1 312 696-6000	
 	Chicago	Facsimile: +1 312 696-6009	
 	Illinois 60606	
 
Media Contact:
 
Margaret Kirch Cohen 312-696-6383  margaret.cohen@morningstar.com
 
Investors may submit questions to investors@morningstar.com or by fax to 312-696-6009.
 
FOR IMMEDIATE RELEASE
 
Morningstar, Inc. Reports Second Quarter 2006 Financial Results
 
CHICAGO, Aug. 3, 2006 — Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its second quarter 2006 financial results. The company reported consolidated revenue of $76.3 million in the second quarter of 2006, a 36% increase from revenue of $56.2 million in the second quarter of 2005. Revenue for the second quarter included $6.8 million from Ibbotson Associates, Inc., a leading provider of asset allocation research and services, which Morningstar acquired on March 1, 2006. Consolidated operating income was $17.5 million in the second quarter of 2006, an increase of $4.4 million, or 33%, compared with $13.1 million in the same period a year ago. Morningstar’s net income was $11.2 million in the second quarter of 2006, or 24 cents per diluted share, compared with $9.5 million, or 22 cents per diluted share, in the second quarter of 2005.
 
In the first six months of 2006, revenue increased $36.9 million, or 34%, to $146.3 million, compared with $109.4 million in the same period a year ago. Revenue for the first half of the year included $11.2 million from Ibbotson. Consolidated operating income increased 83% to $36.7 million in the first six months of 2006, compared with $20.0 million in the first six months of 2005. Net income was $24.6 million, or 53 cents per diluted share, in the first half of 2006, compared with $13.5 million, or 31 cents per diluted share, in the first six months of 2005.
 
“We generated strong organic revenue growth of 23% in the second quarter, driven by several key products—Investment Consulting, Advisor Workstation, Licensed Data, and Morningstar.com. We also benefited from incremental revenue from the Ibbotson acquisition, primarily led by Investment Consulting and EnCorr,” said Joe Mansueto, chairman and chief executive officer of Morningstar. “We’ve retained all six contracts for independent equity research associated with the Global Analyst Research Settlement.
 
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Most of these contracts, which typically come up for renewal in the second quarter, cover the third year of the five-year settlement period.”
 
Mansueto added, “In July, we acquired Aspect Huntley, a leading provider of equity research and information in Australia, and earlier this week we acquired the database division of InvestorForce, which will add critical mass to our institutional hedge fund and separate account coverage as well as to our client base. Both acquisitions are aligned with our growth strategies and will significantly enhance our offerings to individual investors, advisors, and institutions.”
 
Key Business Drivers
 
Revenue:   Revenue in the Individual segment was $19.4 million in the second quarter of 2006, a 24% increase from $15.6 million in the second quarter of 2005. Revenue in the Advisor segment was $24.3 million in the second quarter of 2006, a 30% increase compared with $18.8 million in the same period in 2005. Revenue in the Institutional segment was $34.3 million in the second quarter of 2006, a 49% increase from $23.0 million in the second quarter of 2005.
 
The Ibbotson acquisition contributed second-quarter revenue of $0.4 million in Morningstar’s Individual segment, $1.5 million in the Advisor segment, and $4.9 million in the Institutional segment.
 
Revenue from international operations was $9.5 million in the second quarter of 2006, a 34% increase from $7.1 million in the same period a year ago. International revenue included $0.5 million from Ibbotson. Foreign currency translations had a positive impact of $0.2 million on international revenue. Excluding the impact of foreign currency translations and the Ibbotson acquisition, consolidated revenue and international revenue both increased approximately 23% compared with the prior-year period. Revenue growth excluding Ibbotson and foreign currency is a non-GAAP measure that is reconciled to consolidated and international revenue growth rates in the accompanying financial tables.
 
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. During the second quarter of 2006, the company closed renewals and brought in new business that will contribute an estimated $99.0 million to 2006 revenue, absent cancellations.
 
Morningstar estimates that 2006 walk-in revenue plus the full-year impact of new and renewal business closed during the first half of 2006, absent additional cancellations, will total $230.6 million. During the
 
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quarter, the company reclassified a portion of its revenue composition, reducing 2006 walk-in revenue by $5.0 million, $3.2 million of which is now classified as renewal revenue. Revenue from Ibbotson has not yet been incorporated into new, renewal, or walk-in revenue.
 
Operating Income:   Consolidated operating income was $17.5 million in the second quarter of 2006, a 33% increase from the second quarter of 2005. Operating expense rose $15.7 million, or 36%, in the second quarter of 2006, primarily because of a $9.1 million increase in compensation-related expense. This includes a $4.3 million increase in accrued incentive compensation, which reflects the second-quarter impact of updated internal estimates for full-year performance versus 2005; an adjustment to bring year-to-date bonus expense in line with these estimates; and incremental bonus expense from Ibbotson. The increase in operating expense also reflects $1.6 million of amortization expense for intangible assets acquired with Ibbotson and $1.1 million in outsourced product implementation expense for the Advice by Ibbotson ® service. Morningstar recognizes these product implementation expenses as they are incurred; however, recognition of the associated revenue does not begin until client testing is complete.
 
The company’s operating margin was 22.9% in the second quarter of 2006, compared with 23.4% in the same period in 2005. The combined impact of three factors—the adjustment to bring year-to-date bonus expense in line with the updated full-year estimate, the impact of the Advice by Ibbotson product implementation expense, and the amortization of intangible assets—reduced the operating margin by 4.5 percentage points in the quarter. In the first six months of 2006, operating margin was 25.1%, compared with 18.3% in the first six months of 2005. A $2.8 million decrease in stock-based compensation expense had a positive impact on margins for the year-to-date period.
 
Income Taxes: Income tax expense in the quarter increased $3.0 million, or 66%, compared with the prior- year period, causing net income growth to lag operating income growth. The increase in income tax expense in the second quarter of 2006 was due to additional income tax expense outside the United States. In addition, the second quarter of 2005 included a one-time deferred tax benefit for research and development, which reduced income tax expense in that quarter.
 
Free Cash Flow:   Morningstar generated free cash flow of $28.3 million in the second quarter of 2006, reflecting cash provided by operating activities of $29.5 million and capital expenditures of $1.2 million. Free cash flow increased by $15.7 million in the quarter, partly because of a $6.6 million reduction in income tax payments reflected in cash provided by operating activities. The $6.6 million reduction includes approximately $8 million in cash tax benefits from the Ibbotson acquisition, partially offset by a
 
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$1.4 million increase in cash tax payments from higher taxable income. A decrease in working capital, excluding cash, and an increase in net income also contributed to the increase in free cash flow.
 
In the first six months of 2006, Morningstar generated free cash flow of $37.4 million, reflecting cash provided by operating activities of $39.4 million and capital expenditures of $2.0 million. Free cash flow in the first six months of 2006 increased $28.1 million compared with the prior-year period, reflecting a $27.8 million increase in cash provided by operating activities and a $0.3 million decrease in capital expenditures. Free cash flow is a non-GAAP measure that is reconciled to cash provided by or used for operating activities in the accompanying financial tables. Morningstar defines free cash flow as cash provided by or used for operating activities less capital expenditures.
 
As of June 30, 2006, Morningstar had cash, cash equivalents, and investments of $121.4 million, compared with $153.2 million as of Dec. 31, 2005. The decrease reflects cash used for the acquisition of Ibbotson and annual bonus payments, partially offset by cash from operations and proceeds from stock option exercises.
 
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 $19.4 million in the second quarter of 2006, a 24% increase from $15.6 million in the second quarter of 2005. Morningstar.com and Equity Research drove most of the revenue increase.
 
•                   Operating income was $6.2 million in the second quarter of 2006, a 37% increase from $4.6 million in the prior-year period.
 
•                   Operating margin was 32.1% in the second quarter of 2006, compared with 29.1% in the second quarter of 2005.
 
Advisor Segment:   The largest products in this segment based on revenue are Morningstar ® Advisor Workstation SM , Morningstar ® Principia ® , and Morningstar ® Managed Portfolios SM .
 
•                   Revenue was $24.3 million in the second quarter of 2006, a 30% increase from $18.8 million in the same period in 2005. Advisor Workstation contributed the majority of the revenue increase.
 
•                   Operating income was $6.4 million in the second quarter of 2006, an increase of 51% compared with $4.2 million in the second quarter of 2005.
 
•                   Operating margin was 26.3% in the second quarter of 2006, compared with 22.6% in the second quarter of 2005.
 
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Institutional Segment:   The largest products and services in this segment based on revenue are Licensed Data SM , Investment Consulting, Retirement Advice (including Advice by Ibbotson ® and Morningstar ® Retirement Manager SM ), Licensed Tools and Content, Morningstar Direct SM ,  and EnCorr ® .
 
•                   Revenue was $34.3 million in the second quarter of 2006, a 49% increase from $23.0 million in the second quarter of 2005. Investment Consulting, Encorr, and Licensed Data drove the majority of the revenue increase.
 
•                   Operating income was $7.3 million in the second quarter of 2006, an increase of 49% from $4.9 million in the same period in 2005.
 
•                   Operating margin was 21.3% in the second quarter of 2006, compared with 21.4% in the prior-year period.
 
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 145,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 13 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 GAAP, Morningstar uses the following measures considered as non-GAAP by the Securities and Exchange Commission:  free cash flow, operating income before stock-based compensation expense, operating margin before stock-based compensation expense, and revenue growth adjusted for the Ibbotson acquisition and the impact of foreign currency (organic revenue growth).
 
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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.
 
In the accompanying financial tables, Morningstar presents operating income before stock-based compensation expense and operating margin before stock-based compensation expense solely as supplemental disclosure to help investors better understand the performance of its business, to enhance comparison of Morningstar’s performance from period to period, and to allow better comparison of Morningstar’s performance with that of its competitors. Morningstar expects stock-based compensation expense to be a recurring cost. Morningstar uses operating income before stock-based compensation expense and operating margin before stock-based compensation expense to evaluate the performance of its business. Operating income before stock-based compensation expense and operating margin before stock-based compensation expense should not be considered alternatives to any measure of performance as promulgated under GAAP (such as operating income or operating margin), nor should this data be considered an indicator of Morningstar’s overall financial performance or liquidity. Also, the calculations of operating income before stock-based compensation expense and operating margin before stock-based compensation expense used by Morningstar may not be comparable to similarly titled measures reported by other companies. For more information on operating income before stock-based compensation expense and operating margin before stock-based compensation expense, please see the reconciliations from operating income to operating income before stock-based compensation expense and from operating margin to operating margin before stock-based compensation expense included in the accompanying financial tables.
 
Morningstar presents revenue growth rates adjusted for the Ibbotson acquisition and the impact of foreign currency (organic revenue growth) because the company believes this non-GAAP measure helps investors better compare period-to-period results. For more information on organic revenue growth, please see the reconciliation provided in the accompanying financial tables.
 
###
 
©2006 Morningstar, Inc. All rights reserved.
 
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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations

 	 	Three months ended June 30	 	Six months ended June 30	 	
(in thousands, except per share amounts)	 	2006	 	2005	 	change	 	2006	 	2005	 	change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	$	76,257	 	$	56,243	 	35.6	%	$	146,317	 	$	109,447	 	33.7	%	
Operating expense(1):	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	22,052	 	15,674	 	40.7	%	40,725	 	31,586	 	28.9	%	
Development	 	7,306	 	4,593	 	59.1	%	13,397	 	9,742	 	37.5	%	
Sales and marketing	 	11,880	 	9,845	 	20.7	%	23,540	 	19,630	 	19.9	%	
General and administrative	 	13,793	 	11,135	 	23.9	%	25,825	 	24,219	 	6.6	%	
Depreciation and amortization	 	3,767	 	1,852	 	103.4	%	6,173	 	4,248	 	45.3	%	
Total operating expense	 	58,798	 	43,099	 	36.4	%	109,660	 	89,425	 	22.6	%	
Operating income	 	17,459	 	13,144	 	32.8	%	36,657	 	20,022	 	83.1	%	
Operating margin	 	22.9	%	23.4	%	(0.5	)pp	25.1	%	18.3	%	6.8	pp	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating income (expense):	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest income, net	 	858	 	605	 	41.8	%	1,917	 	1,054	 	81.9	%	
Other income (expense), net	 	(186	)	(200	)	(7.0	)%	(312	)	60	 	NMF	 	
Non-operating income, net	 	672	 	405	 	65.9	%	1,605	 	1,114	 	44.1	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before income taxes, equity in net income of unconsolidated entities, and cumulative effect of accounting change	 	18,131	 	13,549	 	33.8	%	38,262	 	21,136	 	81.0	%	
Income tax expense	 	7,624	 	4,600	 	65.7	%	15,222	 	8,660	 	75.8	%	
Equity in net income of unconsolidated entities	 	658	 	549	 	19.9	%	1,305	 	1,029	 	26.8	%	
Income before cumulative effect of accounting change	 	11,165	 	9,498	 	17.6	%	24,345	 	13,505	 	80.3	%	
Cumulative effect of accounting change, net of income tax expense of $171(2)	 	—	 	—	 	—	 	259	 	—	 	NMF	 	
Net income	 	$	11,165	 	$	9,498	 	17.6	%	$	24,604	 	$	13,505	 	82.2	%	
Basic income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before cumulative effect of accounting change	 	$	0.27	 	$	0.24	 	 	 	$	0.60	 	$	0.35	 	 	 	
Cumulative effect of accounting change	 	—	 	—	 	 	 	0.01	 	—	 	 	 	
Net income	 	$	0.27	 	$	0.24	 	 	 	$	0.61	 	$	0.35	 	 	 	
Diluted income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before cumulative effect of accounting change	 	$	0.24	 	$	0.22	 	 	 	$	0.52	 	$	0.31	 	 	 	
Cumulative effect of accounting change	 	—	 	—	 	 	 	0.01	 	—	 	 	 	
Net income	 	$	0.24	 	$	0.22	 	 	 	$	0.53	 	$	0.31	 	 	 	
Weighted average common shares outstanding:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	40,925	 	39,064	 	 	 	40,641	 	38,758	 	 	 	
Diluted	 	46,684	 	43,742	 	 	 	46,535	 	42,994	 	 	 	

 	 	Three months ended June 30	 	Six months ended June 30	 	
 	 	2006	 	2005	 	 	 	2006	 	2005	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
(1) Includes stock-based compensation expense of:	 	 	 	 	 	 	 	 	 	 	 	 	 	
 Cost of goods sold	 	$	285	 	$	264	 	 	 	$	557	 	$	928	 	 	 	
 Development	 	131	 	105	 	 	 	245	 	380	 	 	 	
 Sales and marketing	 	137	 	128	 	 	 	263	 	453	 	 	 	
 General and administrative	 	1,526	 	1,441	 	 	 	2,948	 	5,064	 	 	 	
 Total stock-based compensation expense	 	$	2,079	 	$	1,938	 	 	 	$	4,013	 	$	6,825	 	 	 	
 
(2) Relates to adoption of Statement of Financial Accounting Standards No. 123(R).
NMF — Not meaningful, pp — percentage points
 
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Morningstar, Inc. and Subsidiaries
Operating Expense as a Percentage of Revenue

 	 	Three months ended June 30	 	Six months ended June 30	 	
 	 	2006	 	2005	 	change	 	2006	 	2005	 	change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	100.0	%	100.0	%	 	 	100.0	%	100.0	%	 	 	
Operating expense(1):	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	28.9	%	27.9	%	1.0	pp	27.8	%	28.9	%	(1.1	)pp	
Development	 	9.6	%	8.1	%	1.5	pp	9.1	%	8.9	%	0.2	pp	
Sales and marketing	 	15.6	%	17.5	%	(1.9	)pp	16.1	%	17.9	%	(1.8	)pp	
General and administrative	 	18.1	%	19.8	%	(1.7	)pp	17.7	%	22.1	%	(4.4	)pp	
Depreciation and amortization	 	4.9	%	3.3	%	1.6	pp	4.2	%	3.9	%	0.3	pp	
Total operating expense	 	77.1	%	76.6	%	0.5	pp	74.9	%	81.7	%	(6.8	)pp	
Operating margin	 	22.9	%	23.4	%	(0.5	)pp	25.1	%	18.3	%	6.8	pp	

 	 	Three months ended June 30	 	Six months ended June 30	 	
 	 	2006	 	2005	 	change	 	2006	 	2005	 	change	 	
(1) Includes stock-based compensation expense of:	 	 	 	 	 	 	 	 	 	 	 	 	 	
 Cost of goods sold	 	0.3	%	0.5	%	(0.2	)pp	0.4	%	0.9	%	(0.5	)pp	
 Development	 	0.2	%	0.2	%	—	 	0.1	%	0.3	%	(0.2	)pp	
 Sales and marketing	 	0.2	%	0.2	%	—	 	0.2	%	0.4	%	(0.2	)pp	
 General and administrative	 	2.0	%	2.5	%	(0.5	)pp	2.0	%	4.6	%	(2.6	)pp	
 Total stock-based compensation expense	 	2.7	%	3.4	%	(0.7	)pp	2.7	%	6.2	%	(3.5	)pp	
 
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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	2006	 	2005	 	
 	 	 	 	 	 	 	 	 	 	
Operating activities	 	 	 	 	 	 	 	 	 	
Net income	 	$	11,165	 	$	9,498	 	$	24,604	 	$	13,505	 	
Adjustments to reconcile net income to net cash flows from operating activities:	 	 	 	 	 	 	 	 	 	
Cumulative effect of accounting change	 	—	 	—	 	(259	)	—	 	
Depreciation and amortization	 	3,767	 	1,852	 	6,173	 	4,248	 	
Deferred income tax expense (benefit)	 	(152	)	(418	)	(717	)	(1,277	)	
Stock-based compensation	 	2,079	 	1,938	 	4,013	 	6,825	 	
Equity in net income of unconsolidated entities	 	(658	)	(549	)	(1,305	)	(1,029	)	
Excess tax benefits from stock option exercises	 	(3,819	)	—	 	(6,508	)	—	 	
Other, net	 	719	 	226	 	816	 	126	 	
Changes in operating assets and liabilities, net of effects of acquisitions	 	16,411	 	1,349	 	12,612	 	(10,749	)	
Cash provided by operating activities	 	29,512	 	13,896	 	39,429	 	11,649	 	
Investing activities	 	 	 	 	 	 	 	 	 	
Purchases of investments	 	(11,733	)	(22,246	)	(37,783	)	(29,941	)	
Proceeds from sale of investments	 	8,077	 	29,595	 	60,454	 	40,410	 	
Capital expenditures	 	(1,164	)	(1,306	)	(2,023	)	(2,327	)	
Acquisitions, net of cash acquired	 	(89	)	—	 	(86,363	)	(8,157	)	
Other, net	 	6	 	(75	)	(294	)	18	 	
Cash provided by (used for) investing activities	 	(4,903	)	5,968	 	(66,009	)	3	 	
Financing activities	 	 	 	 	 	 	 	 	 	
Proceeds from stock option exercises	 	6,253	 	1,326	 	10,847	 	1,392	 	
Excess tax benefits from stock option exercises	 	3,819	 	—	 	6,508	 	—	 	
Proceeds from initial public offering, net	 	—	 	18,108	 	—	 	18,108	 	
Payments of long-term debt and capital lease obligations	 	—	 	(7	)	—	 	(18	)	
Cash provided by financing activities	 	10,072	 	19,427	 	17,355	 	19,482	 	
Effect of exchange rate changes on cash and cash equivalents	 	188	 	(90	)	117	 	(157	)	
Net increase in cash and cash equivalents	 	34,869	 	39,201	 	(9,108	)	30,977	 	
Cash and cash equivalents — Beginning of period	 	48,390	 	27,683	 	92,367	 	35,907	 	
Cash and cash equivalents — End of period	 	$	83,259	 	$	66,884	 	$	83,259	 	$	66,884	 	
 
Reconciliation from cash provided by operating activities to free cash flow (a non-GAAP measure):

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	2006	 	2005	 	
 	 	 	 	 	 	 	 	 	 	
Cash provided by operating activities	 	$	29,512	 	$	13,896	 	$	39,429	 	$	11,649	 	
Less: Capital expenditures	 	(1,164	)	(1,306	)	(2,023	)	(2,327	)	
Free cash flow	 	$	28,348	 	$	12,590	 	$	37,406	 	$	9,322	 	
 
9

 
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets

 	 	June 30,	 	December 31,	 	
($000)	 	2006	 	2005	 	
 	 	 	 	 	 	
Assets	 	 	 	 	 	
Current assets:	 	 	 	 	 	
Cash and cash equivalents	 	$	83,259	 	$	92,367	 	
Investments	 	38,182	 	60,823	 	
Accounts receivable, net	 	56,924	 	47,530	 	
Income tax receivable, net	 	4,555	 	—	 	
Other	 	6,911	 	5,495	 	
Total current assets	 	189,831	 	206,215	 	
 	 	 	 	 	 	
Property and equipment, net	 	17,040	 	17,355	 	
Investments in unconsolidated entities	 	17,238	 	16,355	 	
Goodwill	 	64,582	 	17,500	 	
Intangible assets, net	 	60,474	 	7,251	 	
Deferred tax asset, net	 	8,283	 	29,729	 	
Other assets	 	2,330	 	1,906	 	
Total assets	 	$	359,778	 	$	296,311	 	
 	 	 	 	 	 	
Liabilities and shareholders’ equity	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	
Accounts payable and accrued liabilities	 	$	17,417	 	$	13,664	 	
Accrued compensation	 	22,021	 	26,463	 	
Income tax payable	 	—	 	1,259	 	
Deferred revenue	 	90,733	 	71,155	 	
Deferred tax liability, net	 	711	 	833	 	
Other	 	2,487	 	2,467	 	
Total current liabilities	 	133,369	 	115,841	 	
 	 	 	 	 	 	
Accrued compensation	 	3,201	 	4,458	 	
Other long-term liabilities	 	3,484	 	2,298	 	
Total liabilities	 	140,054	 	122,597	 	
 	 	 	 	 	 	
Total shareholders’ equity	 	219,724	 	173,714	 	
 	 	 	 	 	 	
Total liabilities and shareholders’ equity	 	$	359,778	 	$	296,311	 	
 
10

 
Morningstar, Inc. and Subsidiaries
Segment Information

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	change	 	2006	 	2005	 	change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	19,375	 	$	15,628	 	24.0	%	$	38,503	 	$	31,136	 	23.7	%	
Advisor	 	24,321	 	18,784	 	29.5	%	46,071	 	35,275	 	30.6	%	
Institutional	 	34,296	 	23,027	 	48.9	%	64,868	 	45,333	 	43.1	%	
Eliminations	 	(1,735	)	(1,196	)	45.1	%	(3,125	)	(2,297	)	36.0	%	
Consolidated revenue	 	$	76,257	 	$	56,243	 	35.6	%	$	146,317	 	$	109,447	 	33.7	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue — U.S.	 	$	66,724	 	$	49,117	 	35.8	%	$	128,362	 	$	95,348	 	34.6	%	
Revenue — non-U.S.	 	$	9,533	 	$	7,126	 	33.8	%	$	17,955	 	$	14,099	 	27.3	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income (loss)(1)	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	6,222	 	$	4,550	 	36.7	%	$	11,784	 	$	6,975	 	68.9	%	
Advisor	 	6,395	 	4,236	 	51.0	%	12,477	 	6,822	 	82.9	%	
Institutional	 	7,318	 	4,921	 	48.7	%	16,013	 	8,021	 	99.6	%	
Corporate items and eliminations	 	(2,476	)	(563	)	339.8	%	(3,617	)	(1,796	)	101.4	%	
Consolidated operating income	 	$	17,459	 	$	13,144	 	32.8	%	$	36,657	 	$	20,022	 	83.1	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating margin(1)	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	32.1	%	29.1	%	3.0	pp	30.6	%	22.4	%	8.2	pp	
Advisor	 	26.3	%	22.6	%	3.7	pp	27.1	%	19.3	%	7.8	pp	
Institutional	 	21.3	%	21.4	%	(0.1	)pp	24.7	%	17.7	%	7.0	pp	
Consolidated operating margin	 	22.9	%	23.4	%	(0.5	)pp	25.1	%	18.3	%	6.8	pp	

(1) Includes stock-based compensation expense allocated to each segment.
 
11

 
Morningstar, Inc. and Subsidiaries
Supplemental Data

($000)	 	Q2 2006	 	Q2 2005	 	change	 	Full-Year 2006 (3)	 	
 	 	 	 	 	 	 	 	 	 	
Revenue Composition (1)	 	 	 	 	 	 	 	 	 	
New revenue	 	$	11,529	 	$	9,091	 	26.8	%	$	30,789	 	
Renewal revenue	 	20,536	 	12,959	 	58.5	%	68,191	 	
Walk-in revenue	 	37,436	 	34,193	 	9.5	%	131,655	 	
Revenue excluding Ibbotson	 	69,501	 	56,243	 	23.6	%	230,635	 	
Ibbotson revenue (2)	 	6,756	 	—	 	NMF	 	—	 	
Consolidated revenue	 	$	76,257	 	$	56,243	 	35.6	%	$	230,635	 	
 	 	 	 	 	 	 	 	 	 	
% of Revenue Excluding Ibbotson	 	 	 	 	 	 	 	 	 	
New revenue	 	16.6	%	16.2	%	0.4	pp	13.3	%	
Renewal revenue	 	29.5	%	23.0	%	6.5	pp	29.6	%	
Walk-in revenue	 	53.9	%	60.8	%	(6.9	)pp	57.1	%	
Revenue excluding Ibbotson	 	100.0	%	100.0	%	—	 	100.0	%	

(1)  To help investors evaluate the company’s ongoing business results, Morningstar separates revenue into three categories: 1) new revenue, defined as revenue from selling additional products to current customers or from selling to new customers; 2) renewal revenue, defined as revenue from renewals of subscriptions or licenses; and 3) “walk-in” revenue, defined as revenue it expects to recognize during the year from subscriptions and license agreements in place as of January 1 of each year, adjusted for cancellations, currency translations, and other routine adjustments during the year.
 
(2) Revenue from Ibbotson Associates has not been incorporated into new, renewal, or walk-in revenue.
 
(3) Full-year 2006 revenue is an estimate of revenue that will be recognized from business closed through the end of the second quarter. It includes net walk-in revenue plus the full-year impact, absent cancellations, of new and renewal business closed during the first six months of 2006. This estimate does not include any revenue from new or renewal business that will be closed during the third or fourth quarters of 2006.

 	 	As of June 30	 	 	 	 	 	
 	 	2006	 	2005	 	% change	 	
Our Employees	 	 	 	 	 	 	 	
Worldwide headcount (approximate) (4)	 	1,270	 	1,070	 	18.7	%	
Number of U.S. stock analysts	 	88	 	80	 	10.0	%	
Number of U.S. fund analysts	 	27	 	25	 	8.0	%	
 	 	 	 	 	 	 	 	
Our Business	 	 	 	 	 	 	 	
Number of Morningstar.com Premium subscriptions	 	160,100	 	139,976	 	14.4	%	
Number of U.S. Advisor Workstation licenses	 	127,057	 	101,318	 	25.4	%	
Number of Principia subscriptions	 	48,542	 	50,797	 	(4.4	)%	
Number of Morningstar Direct licenses	 	1,170	 	843	 	38.8	%	
Assets under management for Morningstar Managed Portfolios	 	$	1.5 bil	 	$	1.1 bil	 	36.4	%	
Assets under management for managed retirement accounts (4)	 	$	6.1 bil	 	$	185.6 mil	 	NMF	 	
Assets under advisement for Investment Consulting (4)	 	$	41.0 bil	 	$	17.1 bil	 	139.8	%	
 
(4) 2006 amounts include Ibbotson Associates

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	2006	 	2005	 	
Effective Income Tax Expense Rate	 	 	 	 	 	 	 	 	 	
Income before income taxes, equity in net income of unconsolidated entities, and cumulative effect of accounting change	 	$	18,131	 	$	13,549	 	$	38,262	 	$	21,136	 	
Equity in net income of unconsolidated entities	 	658	 	549	 	1,305	 	1,029	 	
Total	 	$	18,789	 	$	14,098	 	$	39,567	 	$	22,165	 	
Income tax expense	 	$	7,624	 	$	4,600	 	$	15,222	 	$	8,660	 	
Effective income tax expense rate	 	40.6	%	32.6	%	38.5	%	39.1	%	
 
12

 
Morningstar, Inc. and Subsidiaries
Reconciliations of Non-GAAP Measures with the Nearest Comparable GAAP Measures
 
Reconciliation from consolidated revenue to revenue excluding the Ibbotson acquisition and the impact of foreign currency (organic revenue growth):

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	% change	 	2006	 	2005	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Consolidated revenue	 	$	76,257	 	$	56,243	 	35.6	%	$	146,317	 	$	109,447	 	33.7	%	
Less: Ibbotson acquisition	 	(6,756	)	—	 	NMF	 	(11,176	)	—	 	NMF	 	
Less: impact of foreign currency	 	(208	)	—	 	NMF	 	(31	)	—	 	NMF	 	
Revenue excluding Ibbotson and the impact of foreign currency	 	$	69,293	 	$	56,243	 	23.2	%	$	135,110	 	$	109,447	 	23.4	%	

Reconciliation from international revenue to international revenue excluding the Ibbotson acquisition and the impact of foreign currency:

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	% change	 	2006	 	2005	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
International revenue	 	$	9,533	 	$	7,126	 	33.8	%	$	17,955	 	$	14,099	 	27.3	%	
Less: Ibbotson acquisition	 	(534	)	—	 	NMF	 	(721	)	—	 	NMF	 	
Less: impact of foreign currency	 	(208	)	—	 	NMF	 	(31	)	—	 	NMF	 	
Revenue excluding Ibbotson and the impact of foreign currency	 	$	8,791	 	$	7,126	 	23.4	%	$	17,203	 	$	14,099	 	22.0	%	
 
Reconciliation from operating income to operating income before stock-based compensation expense:

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2006	 	2005	 	% change	 	2006	 	2005	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income	 	$	17,459	 	$	13,144	 	32.8	%	$	36,657	 	$	20,022	 	83.1	%	
Add back: stock-based compensation expense	 	2,079	 	1,938	 	7.3	%	4,013	 	6,825	 	(41.2	)%	
Operating income before stock-based compensation expense	 	$	19,538	 	$	15,082	 	29.5	%	$	40,670	 	$	26,847	 	51.5	%	
 
Reconciliation from operating margin to operating margin before stock-based compensation expense:

 	 	Three months ended June 30	 	Six months ended June 30	 	
(% of revenue)	 	2006	 	2005	 	change	 	2006	 	2005	 	change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating margin	 	22.9	%	23.4	%	(0.5	)pp	25.1	%	18.3	%	6.8	pp	
Add back: stock-based compensation expense	 	2.7	%	3.4	%	(0.7	)pp	2.7	%	6.2	%	(3.5	)pp	
Operating margin before stock-based compensation expense	 	25.6	%	26.8	%	(1.2	)pp	27.8	%	24.5	%	3.3	pp	
 
13