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):  November 9, 2005
 
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 November 9, 2005, Morningstar, Inc. issued a press release announcing its financial results for the third quarter ended September 30, 2005.  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 November 9, 2005.	

*                  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: November 9, 2005	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 November 9, 2005.	

*                  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
 
Contact:
 
Media: Margaret Kirch Cohen 312-696-6383  margaret.cohen@morningstar.com
Investors: Please submit questions to investors@morningstar.com or by fax to 312-696-6009.
 
FOR IMMEDIATE RELEASE
Morningstar, Inc. Reports Third Quarter 2005 Financial Results
 
CHICAGO, Nov. 9, 2005   —  Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its third quarter 2005 financial results. The company reported consolidated revenue of $56.9 million in the third quarter of 2005, a 22% increase from revenue of $46.6 million in the third quarter of 2004. Net income in the third quarter of 2005 was $7.5 million, or 17 cents per diluted share, compared with $4.1 million, or 10 cents per diluted share, in the third quarter of 2004. In the first nine months of 2005, revenue increased $35.5 million, or 27%, to $166.4 million compared with $130.9 million in the same period a year ago. Net income was $21.0 million, or 48 cents per diluted share, in the first nine months of 2005, compared with $9.9 million, or 24 cents per diluted share, in the same period in 2004.
 
Joe Mansueto, chairman and chief executive officer of Morningstar, said, “We had a good quarter with strong revenue growth across all three of our business segments.  We also experienced growth in two other important metrics – operating margin and free cash flow – reflecting the underlying health of our business. Operating margin grew to 21.7% in the third quarter from 14.2% in the third quarter of 2004 as we continue to leverage our research and investment databases. Year to date we’ve generated $26.3 million in free cash flow versus $13.3 million in the same period a year ago. This higher cash flow level included third quarter free cash flow of $16.9 million.”
 
Mansueto added, “Two of our key products, Morningstar Advisor Workstation and Investment Consulting, made the largest contributions to revenue growth this quarter.  Revenue from Advisor Workstation Enterprise Edition, which we offer to financial advisors affiliated with large firms, benefited from continued growth in license agreements over the past several quarters. Within our Investment Consulting business, revenue growth was driven by the asset allocation and investment selection services we provide for funds
 
1

 
of funds and variable annuities. Licensed Data for institutional clients and the independent equity research we’re providing under the Global Analyst Research Settlement were also important contributors to revenue growth in the quarter.”
 
Our Key Business Drivers
 
Revenue:   Revenue in the Individual segment was $15.5 million in the third quarter of 2005, a 22% increase from $12.7 million in the third quarter of 2004.  This partly reflects the favorable impact of revenue associated with the Global Analyst Research Settlement, which the company recognized for three months in the third quarter of 2005 versus only two months in the third quarter of 2004. Revenue in the Advisor segment was $18.6 million, a 21% increase from $15.4 million in the same period in 2004. Revenue in the Institutional segment was $24.1 million, a 20% increase from $20.1 million in the third quarter of 2004.
 
Revenue from international operations was $7.5 million in the third quarter of 2005, a 19% increase from $6.3 million in the same period a year ago.  Foreign currency translations contributed $0.3 million of this increase. The January 2005 acquisition of Variable Annuity Research and Data Service (VARDS) contributed revenue of $0.5 million in the third quarter of 2005. Excluding the impact of foreign currency translations and the VARDS acquisition, consolidated revenue increased approximately 21% in the third quarter of 2005.
 
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, 2005, adjusted for cancellations, currency translations, and other routine adjustments during the year. Morningstar estimates that 2005 walk-in revenue plus the 2005 impact of new and renewal business closed during the first nine months of 2005, absent future cancellations, is $213.8 million. This estimate does not include the impact of revenue from business the company closes or cancellations that occur in the fourth quarter of 2005.
 
Operating Expense: Operating expense was $44.6 million in the third quarter of 2005, a 12% increase from $40.0 million in the prior-year period. The increase in operating expense was driven primarily by $3.3 million of additional compensation-related expense including salaries, benefits, and sales commissions. The company had approximately 1,120 employees worldwide as of Sept. 30, 2005, compared with approximately 940 as of Sept. 30, 2004. The higher headcount mainly reflects additional technical staff for Morningstar’s development center in China and equity analysts in its U.S. operations.
 
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Operating Income: Operating income in the third quarter of 2005 was $12.3 million, an increase of 87% compared with $6.6 million in the same period a year ago. Operating income increased in all three business segments, with the Institutional segment reporting the highest growth. Excluding stock-based compensation expense, operating income was $14.4 million, an increase of 57%, compared with $9.2 million in the third quarter of 2004. Operating income before stock-based compensation expense is a measure that is not calculated in accordance with U.S. generally accepted accounting principles (GAAP). A reconciliation to operating income is included in the accompanying financial tables.
 
Operating Margin: The company’s operating margin was 21.7% in the third quarter of 2005, compared with 14.2% in the third quarter of 2004, reflecting the impact of revenue growth that exceeded the growth in operating expense.  Excluding stock-based compensation expense, the company’s operating margin was 25.3% in the third quarter of 2005, compared with 19.7% in the third quarter of 2004. Operating margin before stock-based compensation expense is a non-GAAP measure that is reconciled to operating margin in the accompanying financial tables.
 
Free Cash Flow: Morningstar generated free cash flow of $16.9 million in the third quarter of 2005, reflecting cash provided by operating activities of $18.2 million and capital expenditures of $1.3 million. Free cash flow increased by $14.2 million in the third quarter of 2005 compared with the prior-year quarter, including a $13.0 million increase in cash flow provided by operating activities and a $1.2 million decrease in capital expenditures. The increase in free cash flow was driven by higher net income and favorable changes in working capital, including a reduction in accounts receivable. In the first nine months of 2005, Morningstar generated free cash flow of $26.3 million, reflecting cash provided by operating activities of $29.9 million and capital expenditures of $3.6 million.
 
3

 
Free cash flow in the first nine months of 2005 increased $13.0 million compared with the prior-year period, reflecting a $10.8 million increase in cash provided by operating activities and a $2.2 million reduction 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.
 
Cash and Investments: As of Sept. 30, 2005, Morningstar had cash, cash equivalents, and investments of $135.4 million, compared with $95.5 million as of Dec. 31, 2004, and $82.7 million as of Sept. 30, 2004.
 
Business Segment Performance
 
Individual Segment: The largest products in this segment are paid Premium membership service for Morningstar.com ® , the company’s Web site for individual investors; and independent equity research on more than 1,600 stocks. This segment also includes several print and online publications focusing on stocks, mutual funds, personal finance, and other investing topics.
 
•                   Revenue was $15.5 million in the third quarter of 2005, a 22% increase from $12.7 million in the third quarter of 2004.
 
•                   Operating income was $4.2 million in the third quarter of 2005, compared with $2.6 million in the third quarter of 2004.
 
•                   Operating margin was 26.8% in the third quarter of 2005, compared with 20.3% in the third quarter of 2004.
 
•                   Subscriptions for Morningstar.com Premium membership service increased to 141,939 as of Sept. 30, 2005, compared with 126,672 as of Sept. 30, 2004.
 
Advisor Segment: The largest products in this segment are Morningstar ® Advisor Workstation SM , a Web-based investment planning system, and Principia ® , a CD-ROM-based investment research product. This segment also includes Morningstar Managed Portfolios SM , an asset management service consisting of portfolios of mutual funds offered exclusively through financial advisors.
 
•                   Revenue was $18.6 million in the third quarter of 2005, a 21% increase from $15.4 million in the same period in 2004.
 
•                   Operating income was $4.7 million in the third quarter of 2005, an increase of 37% compared with $3.5 million in the third quarter of 2004.
 
•                   Operating margin was 25.5% in the third quarter of 2005, compared with 22.4% in the third quarter of 2004.
 
4

 
•                   Advisor Workstation licenses in the United States increased to 102,606 as of Sept. 30, 2005, compared with 72,190 as of Sept. 30, 2004. Principia subscriptions declined to 50,484 as of Sept. 30, 2005, compared with 52,366 as of Sept. 30, 2004. Morningstar recently refined the way it counts Advisor Workstation licenses and Principia subscriptions. Refer to the accompanying supplemental data table for more details and updated historical information.
 
•                   Assets under management in the Morningstar Managed Portfolios service totaled $1.3 billion as of Sept. 30, 2005, compared with $774 million as of Sept. 30, 2004.
 
Institutional Segment: The key products and services in the Institutional segment are Morningstar Direct SM , a Web-based institutional platform providing access to Morningstar’s global databases and investment research; Licensed Data SM , a set of investment data spanning eight core databases, available through electronic data feeds; Investment Consulting, which helps clients create and maintain investment portfolios; and Morningstar ® Retirement Manager SM , a suite of services for retirement plan participants.
 
•                   Revenue was $24.1 million in the third quarter of 2005, a 20% increase from $20.1 million in the third quarter of 2004.
 
•                   Operating income was $6.4 million in the third quarter of 2005, an increase of 108% from $3.1 million in the same period in 2004.
 
•                   Operating margin was 26.7% in the third quarter of 2005, compared with 15.3% in the third quarter of 2004.
 
•                   Morningstar Direct had 861 licenses as of Sept. 30, 2005, compared with 729 as of Sept. 30, 2004.
 
•                   Assets under management for managed retirement accounts offered through Morningstar Retirement Manager were $225.9 million as of Sept. 30, 2005, compared with $85.3 million as of Sept. 30, 2004.
 
•                   Exchange-traded funds that are based on the Morningstar Indexes and offered by a third party had assets totaling approximately $602.1 million as of Sept. 30, 2005, compared with $163.0 million as of Sept. 30, 2004.
 
Investor Communication: Morningstar encourages all interested parties – including securities analysts, current shareholders, potential shareholders, and others – to submit questions in writing. Investors and others may send an e-mail to investors@morningstar.com, contact the company via fax at 312-696-6009, or write to Morningstar at the following address:
 
Morningstar, Inc.
Investor Relations
225 West Wacker Drive
Chicago, IL 60606
 
Morningstar will make written responses to selected inquiries available to all investors at the same time in Form 8-Ks furnished to the SEC on the first Friday of every month.
 
5

 
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 125,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 16 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 Prospectus filed on May 4, 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 defined as non-GAAP by the Securities and Exchange Commission:  free cash flow, operating income before stock-based compensation expense, and operating margin before stock-based compensation expense. Morningstar presents free cash flow solely as supplemental disclosure to help its 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.
 
6

 
Morningstar presents operating income before stock-based compensation expense and operating margin before stock-based compensation expense solely as supplemental disclosure to help its 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.
 
# # #
 
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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations

 	 	Three months ended September 30	 	Nine months ended September 30	 	
(in thousands, except per share amounts)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	$	56,927	 	$	46,573	 	22.2%	 	$	166,374	 	$	130,944	 	27.1%	 	
Operating expense (1):	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	16,261	 	13,858	 	17.3%	 	47,847	 	41,032	 	16.6%	 	
Development	 	4,749	 	4,057	 	17.1%	 	14,491	 	11,082	 	30.8%	 	
Sales and marketing	 	9,499	 	9,367	 	1.4%	 	29,129	 	26,016	 	12.0%	 	
General and administrative	 	11,849	 	10,930	 	8.4%	 	36,068	 	30,794	 	17.1%	 	
Depreciation and amortization	 	2,222	 	1,755	 	26.6%	 	6,470	 	5,354	 	20.8%	 	
Total operating expense	 	44,580	 	39,967	 	11.5%	 	134,005	 	114,278	 	17.3%	 	
Operating income	 	12,347	 	6,606	 	86.9%	 	32,369	 	16,666	 	94.2%	 	
Operating margin	 	21.7	%	14.2	%	 	 	19.5	%	12.7	%	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating income:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest income, net	 	892	 	260	 	243.1%	 	1,946	 	694	 	180.4%	 	
Other income (expense), net	 	(46	)	250	 	NMF	 	14	 	346	 	(96.0)%	 	
Non-operating income, net	 	846	 	510	 	65.9%	 	1,960	 	1,040	 	88.5%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before income taxes & equity in net income of unconsolidated entities	 	13,193	 	7,116	 	85.4%	 	34,329	 	17,706	 	93.9%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income tax expense	 	5,857	 	3,235	 	81.1%	 	14,517	 	8,349	 	73.9%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Equity in net income of unconsolidated entities	 	183	 	212	 	(13.7)%	 	1,212	 	591	 	105.1%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	7,519	 	$	4,093	 	83.7%	 	$	21,024	 	$	9,948	 	111.3%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	$	0.19	 	$	0.11	 	 	 	$	0.54	 	$	0.26	 	 	 	
Diluted	 	$	0.17	 	$	0.10	 	 	 	$	0.48	 	$	0.24	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Weighted average common shares outstanding:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	39,922	 	38,438	 	 	 	39,151	 	38,410	 	 	 	
Diluted	 	45,354	 	41,819	 	 	 	43,939	 	41,654	 	 	 	

 	 	Three months ended
September 30	 	 	 	Nine months ended
September 30	 	 	 	
 	 	2005	 	2004	 	 	 	2005	 	2004	 	 	 	
(1) Includes stock-based compensation expense of:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	$	274	 	$	336	 	 	 	$	1,202	 	$	1,120	 	 	 	
Development	 	112	 	157	 	 	 	492	 	571	 	 	 	
Sales and marketing	 	129	 	180	 	 	 	582	 	642	 	 	 	
General and administrative	 	1,515	 	1,897	 	 	 	6,579	 	6,436	 	 	 	
Total stock-based compensation expense	 	$	2,030	 	$	2,570	 	 	 	$	8,855	 	$	8,769	 	 	 	
 
NMF - Not meaningful
 
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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows

 	 	Three months ended September 30	 	Nine months ended September 30	 	
($000)	 	2005	 	2004	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	
Operating activities	 	 	 	 	 	 	 	 	 	
Net income	 	$	7,519	 	$	4,093	 	$	21,024	 	$	9,948	 	
Adjustments to reconcile net income to net cash flows from operating activities:	 	 	 	 	 	 	 	 	 	
Depreciation and amortization	 	2,222	 	1,755	 	6,470	 	5,354	 	
Deferred income tax expense (benefit)	 	985	 	55	 	(292	)	3,046	 	
Stock-based compensation	 	2,030	 	2,570	 	8,855	 	8,769	 	
Equity in net income of unconsolidated entities	 	(183	)	(212	)	(1,212	)	(591	)	
Other, net	 	1,198	 	386	 	1,324	 	357	 	
Changes in operating assets and liabilities, net of effects of acquisitions	 	4,465	 	(3,453	)	(6,284	)	(7,798	)	
Cash provided by operating activities	 	18,236	 	5,194	 	29,885	 	19,085	 	
Investing activities	 	 	 	 	 	 	 	 	 	
Purchases of investments	 	(24,997	)	(6,315	)	(54,938	)	(35,083	)	
Proceeds from sale of investments	 	15,420	 	1,211	 	55,830	 	24,692	 	
Capital expenditures	 	(1,298	)	(2,449	)	(3,625	)	(5,758	)	
Acquisitions, net of cash acquired	 	(35	)	—	 	(8,192	)	(210	)	
Other, net	 	—	 	15	 	18	 	53	 	
Cash used for investing activities	 	(10,910	)	(7,538	)	(10,907	)	(16,306	)	
Financing activities	 	 	 	 	 	 	 	 	 	
Payments of long-term debt and capital lease obligations	 	—	 	(11	)	(18	)	(6,559	)	
Proceeds from stock option exercises	 	2,572	 	66	 	3,964	 	158	 	
Proceeds from initial public offering, net	 	—	 	—	 	18,108	 	—	 	
Cash provided by (used for) financing activities	 	2,572	 	55	 	22,054	 	(6,401	)	
Effect of exchange rate changes on cash and cash equivalents	 	(9	)	51	 	(166	)	(201	)	
Net increase (decrease) in cash and cash equivalents	 	9,889	 	(2,238	)	40,866	 	(3,823	)	
Cash and cash equivalents - Beginning of period	 	66,884	 	30,260	 	35,907	 	31,845	 	
Cash and cash equivalents - End of period	 	$	76,773	 	$	28,022	 	$	76,773	 	$	28,022	 	
 
Reconciliation from cash provided by operating activities to free cash flow (a non-GAAP measure):

 	 	Three months ended September 30	 	Nine months ended September 30	 	
($000)	 	2005	 	2004	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	
Cash provided by operating activities	 	$	18,236	 	$	5,194	 	$	29,885	 	$	19,085	 	
Less: Capital expenditures	 	(1,298	)	(2,449	)	(3,625	)	(5,758	)	
Free cash flow	 	$	16,938	 	$	2,745	 	$	26,260	 	$	13,327	 	
 
9

 
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets

 	 	September 30,	 	December 31,	 	
($000)	 	2005	 	2004	 	
 	 	 	 	 	 	
Assets	 	 	 	 	 	
Current assets:	 	 	 	 	 	
Cash and cash equivalents	 	$	76,773	 	$	35,907	 	
Investments	 	58,637	 	59,556	 	
Accounts receivable, net	 	37,209	 	33,668	 	
Deferred tax asset, net	 	1,848	 	2,373	 	
Other	 	4,555	 	4,250	 	
Total current assets	 	179,022	 	135,754	 	
 	 	 	 	 	 	
Property and equipment, net	 	15,131	 	17,521	 	
Investments in unconsolidated entities	 	15,774	 	14,704	 	
Goodwill	 	16,723	 	14,408	 	
Intangible assets, net	 	7,425	 	1,573	 	
Deferred tax asset, net	 	28,766	 	27,105	 	
Other assets	 	1,582	 	2,296	 	
Total assets	 	$	264,423	 	$	213,361	 	
 	 	 	 	 	 	
Liabilities and shareholders’ equity	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	
Accounts payable and accrued liabilities	 	$	11,572	 	$	12,085	 	
Accrued compensation	 	19,738	 	20,204	 	
Income tax payable	 	1,834	 	3,763	 	
Deferred revenue	 	66,335	 	63,363	 	
Accrued stock-based compensation	 	—	 	15,874	 	
Long-term debt - current portion	 	—	 	18	 	
Other	 	2,518	 	3,545	 	
Total current liabilities	 	101,997	 	118,852	 	
 	 	 	 	 	 	
Accrued compensation	 	2,948	 	3,567	 	
Accrued stock-based compensation	 	—	 	23,943	 	
Other long-term liabilities	 	2,333	 	2,618	 	
Total liabilities	 	107,278	 	148,980	 	
 	 	 	 	 	 	
Total shareholders’ equity	 	157,145	 	64,381	 	
 	 	 	 	 	 	
Total liabilities and shareholders’ equity	 	$	264,423	 	$	213,361	 	
 
10

 
Morningstar, Inc. and Subsidiaries
Segment Information

 	 	Three months ended September 30	 	Nine months ended September 30	 	
($000)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	15,489	 	$	12,677	 	22.2%	 	$	46,625	 	$	33,096	 	40.9%	 	
Advisor	 	18,593	 	15,390	 	20.8%	 	53,868	 	45,287	 	18.9%	 	
Institutional	 	24,063	 	20,101	 	19.7%	 	69,396	 	57,534	 	20.6%	 	
Eliminations	 	(1,218	)	(1,595	)	(23.6)%	 	(3,515	)	(4,973	)	(29.3)%	 	
Consolidated revenue	 	$	56,927	 	$	46,573	 	22.2%	 	$	166,374	 	$	130,944	 	27.1%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue - U.S.	 	$	49,391	 	$	40,242	 	22.7%	 	$	144,739	 	$	112,545	 	28.6%	 	
Revenue - non-U.S.	 	$	7,536	 	$	6,331	 	19.0%	 	$	21,635	 	$	18,399	 	17.6%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income (loss)	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	4,154	 	$	2,575	 	61.3%	 	$	13,273	 	$	3,414	 	288.8%	 	
Advisor	 	4,738	 	3,451	 	37.3%	 	13,604	 	10,812	 	25.8%	 	
Institutional	 	6,426	 	3,085	 	108.3%	 	17,084	 	10,693	 	59.8%	 	
Corporate items and eliminations	 	(2,971	)	(2,505	)	18.6%	 	(11,592	)	(8,253	)	40.5%	 	
Consolidated operating income	 	$	12,347	 	$	6,606	 	86.9%	 	$	32,369	 	$	16,666	 	94.2%	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating margin	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	26.8	%	20.3	%	 	 	28.5	%	10.3	%	 	 	
Advisor	 	25.5	%	22.4	%	 	 	25.3	%	23.9	%	 	 	
Institutional	 	26.7	%	15.3	%	 	 	24.6	%	18.6	%	 	 	
Consolidated operating margin	 	21.7	%	14.2	%	 	 	19.5	%	12.7	%	 	 	
 
11

 
Morningstar, Inc. and Subsidiaries
Supplemental Data

($000)	 	Q1 2005	 	Q2 2005	 	Q3 2005	 	2005
Cumulative (2)	 	
 	 	 	 	 	 	 	 	 	 	
Revenue Composition (1)	 	 	 	 	 	 	 	 	 	
New revenue	 	$	5,905	 	$	9,091	 	$	10,129	 	$	33,794	 	
Renewal revenue	 	5,658	 	12,959	 	20,152	 	57,971	 	
Walk-in revenue	 	41,641	 	34,193	 	26,646	 	122,065	 	
Consolidated revenue	 	$	53,204	 	$	56,243	 	$	56,927	 	$	213,830	 	
 	 	 	 	 	 	 	 	 	 	
% of Revenue	 	 	 	 	 	 	 	 	 	
New revenue	 	11.1	%	16.2	%	17.8	%	15.8	%	
Renewal revenue	 	10.6	%	23.0	%	35.4	%	27.1	%	
Walk-in revenue	 	78.3	%	60.8	%	46.8	%	57.1	%	
Consolidated revenue	 	100.0	%	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, which it defines as revenue from selling additional products to current customers or from selling to new customers; 2) renewal revenue, which it defines as revenue from renewals of subscriptions or licenses; and 3) “walk-in” revenue, which it defines as revenue it expects to recognize during the year from subscriptions and license agreements in place as of January 1, 2005, adjusted for cancellations, currency translations, and other routine adjustments during the year.
 
(2)  2005 cumulative revenue is an estimate of revenue that will be recognized from business closed through the end of the third quarter. It includes 2005 walk-in revenue plus the 2005 impact, absent cancellations, of new and renewal business closed during the first nine months of 2005. This estimate does not include any revenue from new or renewal business that will be closed during the fourth quarter of 2005.

 	 	As of September 30,	 	 	 	
 	 	2005	 	2004	 	% change	 	
Our Employees	 	 	 	 	 	 	 	
Total worldwide headcount	 	1,120	 	940	 	19.1%	 	
Number of U.S. stock analysts	 	86	 	67	 	28.4%	 	
Number of U.S. fund analysts	 	27	 	26	 	3.8%	 	
 	 	 	 	 	 	 	 	
Our Business	 	 	 	 	 	 	 	
Number of Morningstar.com Premium subscriptions	 	141,939	 	126,672	 	12.1%	 	
Number of Principia subscriptions (3)	 	50,484	 	52,366	 	(3.6)%	 	
Number of U.S. Advisor Workstation licenses   (3)	 	102,606	 	72,190	 	42.1%	 	
Number of Morningstar Direct licenses	 	861	 	729	 	18.1%	 	
Assets under management for Morningstar Managed Portfolios	 	$	1.3 bil	 	$	774.1 mil	 	67.9%	 	
Assets under management for managed retirement accounts	 	$	225.9 mil	 	$	85.3 mil	 	164.8%	 	

(3) In 2005, Morningstar refined the way it counts Principia subscriptions. The company now counts subscriptions to each of the six modules in the Principia suite as separate subscriptions. Morningstar also refined the way it counts the number of U.S. licenses for Advisor Workstation to more consistently include only financial advisors licensed to use the product and exclude support staff. If the license agreement allows access by users not employed by the licensing enterprise, the company only includes actual users within the past 12 months. The following table shows historical quarterly data adjusted to reflect these changes.

 	 	3/31/2004	 	6/30/2004	 	9/30/2004	 	12/31/2004	 	3/31/2005	 	6/30/2005	 	9/30/2005	 	
Number of Principia subscriptions	 	55,493	 	54,824	 	52,366	 	51,308	 	53,048	 	50,797	 	50,484	 	
Number of U.S. Advisor Workstation licenses	 	57,166	 	75,810	 	72,190	 	80,235	 	90,323	 	101,318	 	102,606	 	
 
12

 
Morningstar, Inc. and Subsidiaries
Reconciliations of Non-GAAP Measures with the Nearest Comparable GAAP Measures
 
Reconciliation from operating income to operating income before stock-based compensation expense:

 	 	Three months ended September 30	 	Nine months ended September 30	 	
($000)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income	 	$	12,347	 	$	6,606	 	86.9%	 	$	32,369	 	$	16,666	 	94.2%	 	
Add back: stock-based compensation expense	 	2,030	 	2,570	 	(21.0)%	 	8,855	 	8,769	 	1.0%	 	
Operating income before stock-based compensation expense	 	$	14,377	 	$	9,176	 	56.7%	 	$	41,224	 	$	25,435	 	62.1%	 	
 
Reconciliation from operating margin to operating margin before stock-based compensation expense:

 	 	 	 	Three months ended September 30	 	 	 	Nine months ended September 30	 	
(% of revenue)	 	 	 	2005	 	2004	 	 	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating margin	 	 	 	21.7%	 	14.2%	 	 	 	19.5%	 	12.7%	 	
Add back: stock-based compensation expense	 	 	 	3.6%	 	5.5%	 	 	 	5.3%	 	6.7%	 	
Operating margin before stock-based compensation expense	 	 	 	25.3%	 	19.7%	 	 	 	24.8%	 	19.4%	 	
 
13