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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.

“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.

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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