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 10, 2005
 
MORNINGSTAR, INC.
(Exact name of registrant as specified in its charter)

Illinois	 	000-51280	 	36-3297908	
(State or other jurisdiction
of incorporation)	 	(Commission
File Number)	 	(I.R.S. Employer
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 10, 2005, Morningstar, Inc. issued a press release announcing its financial results for the second quarter ended June 30, 2005.  A copy of the press release is included herewith as Exhibit 99.1.
 
Item 9.01.           Financial Statements and Exhibits.
 
(c)           Exhibits:

Exhibit No.	 	Description	
 	 	 	
99.1*	 	Press Release dated August 10, 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 thereunto duly authorized.

 	MORNINGSTAR, INC.	

Date: August 10, 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 August 10, 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

	News Release

 225 West Wacker Drive
Chicago
Illinois 60606	

 Telephone : +1 312 696-6000
Facsimile:   +1 312 696-6009	
 
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 2005 Financial Results
 
CHICAGO, Aug. 10, 2005   —  Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its second quarter 2005 financial results. The company reported consolidated revenue of $56.2 million in the second quarter of 2005, a 30% increase from revenue of $43.2 million in the second quarter of 2004. Net income was $9.5 million, or 22 cents per diluted share, compared with $1.3 million, or 3 cents per diluted share, in the second quarter of 2004. In the six months ended June 30, 2005, revenue increased $25.0 million, or 30%, to $109.4 million compared with $84.4 million in the six months ended June 30, 2004. In the six months ended June 30, 2005, net income was $13.5 million, or 31 cents per diluted share, compared with $5.9 million, or 14 cents per diluted share, in the first half of 2004.
 
Joe Mansueto, chairman and chief executive officer of Morningstar, said, “Our revenue growth was strong in all three of our business segments, with the largest contribution coming from our Individual segment. This increase mainly reflects new revenue from the independent equity research we’re providing under the Global Analyst Research Settlements. We began providing research to five major investment banks under the settlement terms during the third quarter of 2004. Because we didn’t begin to recognize revenue for this business until that time, the year-over-year comparison was highly favorable for the second-quarter period. Beginning in the third quarter, revenue from our work relating to the settlements will be included in both the current and prior-year periods. Our performance in the Individual segment also reflects growth in Morningstar.com Premium membership service and Internet advertising sales.
 
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“Our other two business segments, Advisor and Institutional, also generated solid growth. The second biggest driver of consolidated revenue growth in the quarter was the Enterprise Edition of Morningstar Advisor Workstation, which we offer to financial advisors affiliated with larger firms. Within the Institutional segment, our Investment Consulting and Licensed Data businesses were major contributors to consolidated revenue growth for the quarter,” Mansueto said.
 
Our Key Business Drivers
 
Revenue:   Revenue in the Individual segment was $15.6 million in the second quarter of 2005, a 57% increase from $10.0 million in the second quarter of 2004.  Revenue in the Advisor segment was $18.8 million, a 16% increase from $16.2 million in the same period in 2004. Revenue in the Institutional segment was $23.0 million in the second quarter of 2005, a 21% increase from $19.0 million in the second quarter of 2004.
 
Revenue from international operations was $7.1 million in the second quarter of 2005, a 17% increase from $6.1 million in the second quarter of 2004. Foreign currency translations contributed $0.4 million of this increase. The January 2005 acquisition of Variable Annuity Research and Data Service (VARDS) contributed revenue of $0.7 million in the second quarter of 2005. Excluding the impact of foreign currency translations and the VARDS acquisition, consolidated revenue increased approximately 28% in the second 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 half of 2005, absent future cancellations, will be $193.3 million. This estimate does not include the impact of revenue from business the company closes or cancellations that occur in the remaining six months of 2005.
 
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Consolidated Operating Expense: Second quarter 2005 operating expense increased $3.3 million to $43.1 million, an 8% increase from $39.8 million in the prior-year period. The increase in consolidated operating expense was driven primarily by $3.2 million of additional compensation-related expense including salaries, benefits, sales commissions, and bonus expense. The company had approximately 1,070 employees worldwide as of June 30, 2005, compared with approximately 900 as of June 30, 2004. The higher headcount includes additional technical staff for Morningstar’s development center in China and equity analysts in its U.S. operations. Stock-based compensation expense declined $2.2 million; however, this decrease was offset by increases in other expense categories.
 
Consolidated Operating Income: Consolidated operating income in the second quarter of 2005 was $13.1 million, a 284% increase compared with $3.4 million in the same period a year ago. Excluding stock-based compensation expense, operating income doubled to $15.1 million from $7.5 million in the second 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 23.4% in the second quarter of 2005, compared with 7.9% in the second quarter of 2004. Excluding stock-based compensation expense, the company’s operating margin was 26.8% in the second quarter of 2005, compared with 17.4% in the second 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.
 
The company’s increase in operating margin partly reflects a difference in the timing between revenue and expenses associated with the Global Analyst Research Settlements. “We began incurring costs in the first half of 2004 in preparation for the ramp-up of our equity research efforts, but we didn’t begin recognizing revenue associated with the settlements until the third quarter of 2004,” Mansueto said. “As a result, the second quarter and year-to-date periods in 2005 include revenue that was not included in the prior-year periods, and our revenue increase was significantly higher than growth in operating expense.”
 
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He added, “It’s also important to note that total stock-based compensation expense was significantly lower in the second quarter of 2005 compared with the same period in 2004. Following our IPO, we no longer record stock-based compensation expense under the liability method. As a result, total stock-based compensation expense declined both year-over-year and relative to the first quarter of 2005.”
 
Consolidated Free Cash Flow: Morningstar generated free cash flow of $12.6 million in the second quarter of 2005, reflecting cash provided by operating activities of $13.9 million and capital expenditures of $1.3 million. Free cash flow increased by $3.7 million in the second quarter of 2005 compared with the prior-year period, reflecting a $3.2 million increase in cash flow provided by operating activities and a $0.5 million decrease in capital expenditures. In the first six months of 2005, Morningstar generated free cash flow of $9.3 million, reflecting cash from operations of $11.6 million and capital expenditures of $2.3 million. Free cash flow in the six months ended June 30, 2005, decreased $1.3 million compared with the prior-year period primarily because of higher bonus and tax payments made in the first half of 2005. 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 June 30, 2005, Morningstar had cash, cash equivalents, and investments of $116.0 million, compared with $95.5 million as of Dec. 31, 2004, and $79.7 million as of June 30, 2004. In March 2005 the SEC issued guidance that auction-rate securities should not be classified as cash and cash equivalents. Accordingly, the company reclassified its investments in auction-rate securities from cash and cash equivalents to investments in amounts ranging from $18.7 million to $23.6 million for the relevant periods as presented in the accompanying financial tables. This change in classification had no effect on previously reported total current assets, total assets, net income, income per share, or cash flow from operations.
 
Business Segment Performance
 
Individual Investor Segment: The largest product in this segment is paid Premium membership service for Morningstar.com ® , the company’s Web site for investors. This segment also includes independent equity research on approximately 1,600 companies and several print and online publications focusing on stocks, mutual funds, personal finance, and other investing topics.
 
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•                   Revenue was $15.6 million in the second quarter of 2005, a 57% increase from $10.0 million in the second quarter of 2004.
 
•                   Operating income was $5.1 million in the second quarter of 2005, compared with an operating loss of $0.3 million in the second quarter of 2004.
 
•                   Operating margin was 32.7% in the second quarter of 2005; this segment had an operating loss in the second quarter of 2004.
 
•                   Subscriptions for Morningstar.com Premium membership service increased to 139,976 as of June 30, 2005, compared with 125,697 as of June 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 $18.8 million in the second quarter of 2005, a 16% increase from $16.2 million in the same period in 2004.
 
•                   Operating income was $4.9 million in the second quarter of 2005, an increase of 22% compared with $4.0 million in the second quarter of 2004.
 
•                   Operating margin was 25.8% in the second quarter of 2005, compared with 24.6% in the second quarter of 2004.
 
•                   Advisor Workstation licenses in the United States increased to 102,443 as of June 30, 2005, compared with 79,028 as of June 30, 2004. Principia subscriptions declined to 50,797 as of June 30, 2005, compared with 54,824 as of June 30, 2004.
 
•                   Assets under management in the Morningstar Managed Portfolios service totaled $1.1 billion as of June 30, 2005, compared with $689 million as of June 30, 2004.
 
Institutional Segment: The key products and services in the Institutional business segment are Morningstar Direct SM , a set of Web-based research tools that provide access to Morningstar’s proprietary statistics; 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 $23.0 million in the second quarter of 2005, a 21% increase from $19.0 million in the second quarter of 2004.
 
•                   Operating income was $5.7 million in the second quarter of 2005, an increase of 49% from $3.8 million in the same period in 2004.
 
•                   Operating margin was 24.7% in the second quarter of 2005, compared with 20.1% in the second quarter of 2004.
 
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•                   Morningstar Direct had 822 licenses as of June 30, 2005, compared with 654 as of June 30, 2004.
 
•                   Assets under management for managed retirement accounts offered through Morningstar Retirement Manager were $185.6 million as of June 30, 2005, compared with $56.9 million as of June 30, 2004.
 
•                   Exchange-traded funds that are based on the Morningstar Indexes and offered by a third party had assets totaling approximately $482.6 million as of June 30, 2005. These funds were introduced in July 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 shareholders at the same time in Form 8-Ks furnished to the SEC on the first Friday of every month.
 
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
 
6

 
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.
 
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.
 
# # #
 
7

 
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)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	$	56,243	 	$	43,244	 	30.1	%	$	109,447	 	$	84,371	 	29.7	%	
Operating expense (1):	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	15,674	 	14,908	 	5.1	%	31,586	 	27,174	 	16.2	%	
Development	 	4,593	 	3,664	 	25.4	%	9,742	 	7,025	 	38.7	%	
Sales and marketing	 	9,845	 	8,284	 	18.8	%	19,630	 	16,649	 	17.9	%	
General and administrative	 	11,135	 	11,176	 	(0.4	)%	24,219	 	19,864	 	21.9	%	
Depreciation and amortization	 	1,852	 	1,788	 	3.6	%	4,248	 	3,599	 	18.0	%	
Total operating expense	 	43,099	 	39,820	 	8.2	%	89,425	 	74,311	 	20.3	%	
Operating income	 	13,144	 	3,424	 	283.9	%	20,022	 	10,060	 	99.0	%	
Operating margin	 	23.4	%	7.9	%	 	 	18.3	%	11.9	%	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating income:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest income, net	 	605	 	210	 	188.1	%	1,054	 	434	 	142.9	%	
Other income (expense), net	 	(200	)	58	 	NMF	 	60	 	96	 	(37.5	)%	
Non-operating income, net	 	405	 	268	 	51.1	%	1,114	 	530	 	110.2	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before income taxes & equity in net income of unconsolidated entities	 	13,549	 	3,692	 	267.0	%	21,136	 	10,590	 	99.6	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income tax expense	 	4,600	 	2,440	 	88.5	%	8,660	 	5,114	 	69.3	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Equity in net income of unconsolidated entities	 	549	 	97	 	466.0	%	1,029	 	379	 	171.5	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	9,498	 	$	1,349	 	604.1	%	$	13,505	 	$	5,855	 	130.7	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	$	0.24	 	$	0.04	 	 	 	$	0.35	 	$	0.15	 	 	 	
Diluted	 	$	0.22	 	$	0.03	 	 	 	$	0.31	 	$	0.14	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Weighted average common shares outstanding:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	39,064	 	38,397	 	 	 	38,758	 	38,416	 	 	 	
Diluted	 	43,742	 	41,528	 	 	 	42,994	 	41,534	 	 	 	

 	 	Three months ended June 30	 	 	 	Six months ended June 30	 	 	 	
 	 	2005	 	2004	 	 	 	2005	 	2004	 	 	 	
(1) Includes stock-based compensation expense of:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of goods sold	 	$	264	 	$	526	 	 	 	$	928	 	$	784	 	 	 	
Development	 	105	 	267	 	 	 	380	 	414	 	 	 	
Sales and marketing	 	128	 	306	 	 	 	453	 	462	 	 	 	
General and administrative	 	1,441	 	3,017	 	 	 	5,064	 	4,539	 	 	 	
Total stock-based compensation expense	 	$	1,938	 	$	4,116	 	 	 	$	6,825	 	$	6,199	 	 	 	
 
NMF - Not meaningful
 
8

 
Morningstar, Inc. and Subsidiaries
Segment Information

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	15,628	 	$	9,958	 	56.9	%	$	31,136	 	$	20,419	 	52.5	%	
Advisor	 	18,784	 	16,170	 	16.2	%	35,275	 	29,897	 	18.0	%	
Institutional	 	23,027	 	18,981	 	21.3	%	45,333	 	37,433	 	21.1	%	
Eliminations	 	(1,196	)	(1,865	)	(35.9	)%	(2,297	)	(3,378	)	(32.0	)%	
Consolidated revenue	 	$	56,243	 	$	43,244	 	30.1	%	$	109,447	 	$	84,371	 	29.7	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue - U.S.	 	$	49,117	 	$	37,140	 	32.2	%	$	95,348	 	$	72,303	 	31.9	%	
Revenue - non-U.S.	 	$	7,126	 	$	6,104	 	16.7	%	$	14,099	 	$	12,068	 	16.8	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income (loss)	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	$	5,112	 	$	(273	)	NMF	 	$	9,119	 	$	839	 	986.9	%	
Advisor	 	4,850	 	3,984	 	21.7	%	8,866	 	7,361	 	20.4	%	
Institutional	 	5,683	 	3,817	 	48.9	%	10,658	 	7,608	 	40.1	%	
Corporate items and eliminations	 	(2,501	)	(4,104	)	(39.1	)%	(8,621	)	(5,748	)	50.0	%	
Consolidated operating income	 	$	13,144	 	$	3,424	 	283.9	%	$	20,022	 	$	10,060	 	99.0	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating margin	 	 	 	 	 	 	 	 	 	 	 	 	 	
Individual	 	32.7	%	NMF	 	 	 	29.3	%	4.1	%	 	 	
Advisor	 	25.8	%	24.6	%	 	 	25.1	%	24.6	%	 	 	
Institutional	 	24.7	%	20.1	%	 	 	23.5	%	20.3	%	 	 	
Consolidated operating margin	 	23.4	%	7.9	%	 	 	18.3	%	11.9	%	 	 	
 
NMF - Not meaningful
 
9

 
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets

 	 	June 30,	 	December 31,	 	
($000)	 	2005	 	2004	 	
 	 	 	 	 	 	
Assets	 	 	 	 	 	
Current assets:	 	 	 	 	 	
Cash and cash equivalents	 	$	66,884	 	$	35,907	(1)	
Investments	 	49,123	 	59,556	(1)	
Accounts receivable, net	 	40,286	 	33,668	 	
Deferred tax asset, net	 	1,993	 	2,373	 	
Other	 	4,705	 	4,250	 	
Total current assets	 	162,991	 	135,754	 	
 	 	 	 	 	 	
Property and equipment, net	 	15,851	 	17,521	 	
Investments in unconsolidated entities	 	15,589	 	14,704	 	
Goodwill	 	16,630	 	14,408	 	
Intangible assets, net	 	7,597	 	1,573	 	
Deferred tax asset, net	 	29,590	 	27,105	 	
Other assets	 	1,416	 	2,296	 	
Total assets	 	$	249,664	 	$	213,361	 	
 	 	 	 	 	 	
Liabilities and shareholders’ equity	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	
Accounts payable and accrued liabilities	 	$	11,807	 	$	12,085	 	
Accrued compensation	 	15,243	 	20,204	 	
Income tax payable	 	2,694	 	3,763	 	
Deferred revenue	 	68,899	 	63,363	 	
Accrued stock-based compensation	 	—	 	15,874	 	
Long-term debt - current portion	 	—	 	18	 	
Other	 	2,701	 	3,545	 	
Total current liabilities	 	101,344	 	118,852	 	
 	 	 	 	 	 	
Accrued compensation	 	1,978	 	3,567	 	
Accrued stock-based compensation	 	—	 	23,943	 	
Other long-term liabilities	 	2,231	 	2,618	 	
Total liabilities	 	105,553	 	148,980	 	
 	 	 	 	 	 	
Total shareholders’ equity	 	144,111	 	64,381	 	
 	 	 	 	 	 	
Total liabilities and shareholders’ equity	 	$	249,664	 	$	213,361	 	
 
(1) In March 2005, the SEC issued guidance that auction-rate securities should not be classified as cash equivalents. Accordingly, in the second quarter of 2005, the company reclassified its investments in auction-rate securities from cash and cash equivalents to investments in the amount of $23.6 million as of December 31, 2004. This change in classification had no effect on the amount of total current assets, total assets, net income, income per share, or cash flow from operations as previously reported. 
 
10

 
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2005	 	2004	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	
Operating activities	 	 	 	 	 	 	 	 	 	
Net income	 	$	9,498	 	$	1,349	 	$	13,505	 	$	5,855	 	
Adjustments to reconcile net income to net cash flows from operating activities:	 	 	 	 	 	 	 	 	 	
Depreciation and amortization	 	1,852	 	1,788	 	4,248	 	3,599	 	
Deferred income tax expense (benefit)	 	(418	)	310	 	(1,277	)	2,991	 	
Stock-based compensation	 	1,938	 	4,116	 	6,825	 	6,199	 	
Equity in net income of unconsolidated entities	 	(549	)	(97	)	(1,029	)	(379	)	
Other, net	 	226	 	60	 	126	 	(29	)	
Changes in operating assets and liabilities, net of effects of acquisitions	 	1,349	 	3,198	 	(10,749	)	(4,345	)	
Cash provided by operating activities	 	13,896	 	10,724	 	11,649	 	13,891	 	
Investing activities	 	 	 	 	 	 	 	 	 	
Purchases of investments	 	(22,246	)	(9,692	)	(29,941	)	(28,768	)	
Proceeds from sale of investments	 	29,595	 	7,814	 	40,410	 	23,481	 	
Capital expenditures	 	(1,306	)	(1,841	)	(2,327	)	(3,309	)	
Acquisitions, net of cash acquired	 	—	 	—	 	(8,157	)	(210	)	
Other, net	 	(75	)	76	 	18	 	38	 	
Cash provided by (used for) investing activities	 	5,968	 	(3,643	)	3	 	(8,768	)	
Financing activities	 	 	 	 	 	 	 	 	 	
Payments of long-term debt and capital lease obligations	 	(7	)	(23	)	(18	)	(6,548	)	
Proceeds from stock option exercises	 	1,326	 	92	 	1,392	 	92	 	
Proceeds from initial public offering, net	 	18,108	 	—	 	18,108	 	—	 	
Cash provided by (used for) financing activities	 	19,427	 	69	 	19,482	 	(6,456	)	
Effect of exchange rate changes on cash and cash equivalents	 	(90	)	(78	)	(157	)	(252	)	
Net increase (decrease) in cash and cash equivalents	 	39,201	 	7,072	 	30,977	 	(1,585	)	
Cash and cash equivalents - Beginning of period	 	27,683	(1)	23,188	(1)	35,907	(1)	31,845	(1)	
Cash and cash equivalents - End of period	 	$	66,884	 	$	30,260	(1)	$	66,884	 	$	30,260	(1)	
 
Reconciliation from cash flow provided by operations to free cash flow (a non-GAAP measure):

 	 	Three months ended June 30	 	Six months ended June 30	 	
($000)	 	2005	 	2004	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	
Cash provided by operating activities	 	$	13,896	 	$	10,724	 	$	11,649	 	$	13,891	 	
Less: Capital expenditures	 	(1,306	)	(1,841	)	(2,327	)	(3,309	)	
Free cash flow	 	$	12,590	 	$	8,883	 	$	9,322	 	$	10,582	 	

(1)  In March 2005, the SEC issued guidance that auction-rate securities should not be classified as cash equivalents. Accordingly, in the second quarter of 2005, the company reclassified its investments in auction-rate securities from cash and cash equivalents to investments. Related adjustments have also been made to reflect the gross purchases and sales of these securities as investing activities. This change in classification had no effect on the amount of total current assets, total assets, net income, income per share, or cash flow from operations as previously reported. The amount of auction-rate securities reclassified for all periods presented above is as follows:

 	 	 	 	 	 	 	 	 	 	 	 	
($000)	 	March
31, 2005	 	December
31, 2004	 	June 30,
2004	 	March
31, 2004	 	December
31, 2003	 	
Amount of auction-rate securities reclassified from cash equivalents to investments	 	$	18,925	 	$	23,586	 	$	21,262	 	$	18,656	 	$	21,664	 	

11

 
Morningstar, Inc. and Subsidiaries
Supplemental Data

 	 	Three months ended June 30, 2005	 	Six months ended June 30, 2005	 	
 	 	 	 	% of	 	 	 	% of	 	
($000)	 	revenue	 	revenue	 	revenue	 	revenue	 	
 	 	 	 	 	 	 	 	 	 	
Revenue Composition (1)	 	 	 	 	 	 	 	 	 	
New revenue	 	$	9,091	 	16.2	%	$	14,996	 	13.7	%	
Renewal revenue	 	12,959	 	23.0	%	18,617	 	17.0	%	
Walk-in revenue	 	34,193	 	60.8	%	75,834	 	69.3	%	
Consolidated revenue	 	$	56,243	 	100.0	%	$	109,447	 	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.

 	 	As of June 30,	 	
 	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	
Our Employees	 	 	 	 	 	 	 	
Total worldwide headcount	 	1,070	 	900	 	18.9	%	
Number of U.S. stock analysts	 	80	 	65	 	23.1	%	
Number of U.S. fund analysts	 	25	 	24	 	4.2	%	
 	 	 	 	 	 	 	 	
Our Business	 	 	 	 	 	 	 	
Number of Morningstar.com Premium subscriptions	 	139,976	 	125,697	 	11.4	%	
Number of Principia subscriptions	 	50,797	 	54,824	 	(7.3	)%	
Number of U.S. Advisor Workstation licenses	 	102,443	 	79,028	 	29.6	%	
Number of Morningstar Direct licenses	 	822	 	654	 	25.7	%	
Assets under management for Morningstar Managed Portfolios	 	$	1.1 bil	 	$	688.8 mil	 	59.7	%	
Assets under management for managed retirement accounts	 	$	185.6 mil	 	$	56.9 mil	 	226.2	%	
 
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 June 30	 	Six months ended June 30	 	
($000)	 	2005	 	2004	 	% change	 	2005	 	2004	 	% change	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating income	 	$	13,144	 	$	3,424	 	283.9	%	$	20,022	 	$	10,060	 	99.0	%	
Add back: stock-based compensation expense	 	1,938	 	4,116	 	(52.9	)%	6,825	 	6,199	 	10.1	%	
Operating income before stock-based compensation expense	 	$	15,082	 	$	7,540	 	100.0	%	$	26,847	 	$	16,259	 	65.1	%	
 
Reconciliation from operating margin to operating margin before stock-based compensation expense:

 	 	Three months ended March 31	 	Six months ended June 30	 	
(% of revenue)	 	2005	 	2004	 	2005	 	2004	 	
 	 	 	 	 	 	 	 	 	 	
Operating margin	 	23.4	%	7.9	%	18.3	%	11.9	%	
Add back: stock-based compensation expense	 	3.4	%	9.5	%	6.2	%	7.4	%	
Operating margin before stock-based compensation expense	 	26.8	%	17.4	%	24.5	%	19.3	%	
 
12