MORNINGSTAR, INC., 10-Q filed on 7/31/2013
Quarterly Report
Document and Entity Information
6 Months Ended
Jun. 30, 2013
Jul. 26, 2013
Document and Entity Information Abstract
 
 
Entity Registrant Name
MORNINGSTAR, INC. 
 
Entity Central Index Key
0001289419 
 
Current Fiscal Year End Date
--12-31 
 
Entity Filer Category
Large Accelerated Filer 
 
Document Type
10-Q 
 
Document Period End Date
Jun. 30, 2013 
 
Document Fiscal Year Focus
2013 
 
Document Fiscal Period Focus
Q2 
 
Amendment Flag
false 
 
Entity Common Stock, Shares Outstanding
 
46,111,853 
Condensed Consolidated Statements of Income (USD $)
In Thousands, except Per Share data, unless otherwise specified
3 Months Ended 6 Months Ended
Jun. 30, 2013
Jun. 30, 2012
Jun. 30, 2013
Jun. 30, 2012
Revenue
$ 175,428 
$ 165,968 
$ 344,284 
$ 326,727 
Operating expense (1):
 
 
 
 
Cost of goods sold
50,273 1
49,452 1
98,283 
99,768 
Development
14,154 1
12,442 1
27,794 
25,807 
Sales and marketing
28,035 1
27,373 1
56,015 
55,699 
General and administrative
28,120 1
24,946 1
55,447 
53,124 
Depreciation and amortization
11,262 1
10,619 1
22,601 
20,794 
Total operating expense
131,844 1
124,832 1
260,140 
255,192 
Operating income (loss)
43,584 
41,136 
84,144 
71,535 
Non-operating income (expense):
 
 
 
 
Interest income (expense), net
664 
1,260 
1,405 
2,129 
Gain (loss) on sale of investments reclassified from other comprehensive income
423 
37 
1,148 
(49)
Equity Method Investments Holding Gain
3,713 
3,713 
Other income (expense), net
(1,689)
(302)
(2,210)
(426)
Non-operating income (expense), net
3,111 
995 
4,056 
1,654 
Income before income taxes and equity in net income of unconsolidated entities
46,695 
42,131 
88,200 
73,189 
Income tax expense
15,955 
14,744 
28,382 
26,255 
Equity in net income of unconsolidated entities
360 
497 
857 
1,063 
Consolidated net income
31,100 
27,884 
60,675 
47,997 
Net (income) loss attributable to the noncontrolling interest
21 
64 
28 
Net income attributable to Morningstar, Inc.
$ 31,121 
$ 27,888 
$ 60,739 
$ 48,025 
Net income per share attributable to:
 
 
 
 
Basic (in dollars per share)
$ 0.67 
$ 0.57 
$ 1.31 
$ 0.97 
Diluted (in dollars per share)
$ 0.66 
$ 0.56 
$ 1.30 
$ 0.95 
Dividends declared per common share
$ 0.13 
$ 0.10 
$ 0.25 
$ 0.20 
Dividends paid per common share
$ 0.13 
$ 0.10 
$ 0.13 
$ 0.20 
Weighted average shares outstanding:
 
 
 
 
Basic (in shares)
46,400 
49,195 
46,403 
49,566 
Diluted (in shares)
46,853 
49,856 
46,756 
50,296 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
In Thousands, unless otherwise specified
3 Months Ended 6 Months Ended
Jun. 30, 2013
Jun. 30, 2012
Jun. 30, 2013
Jun. 30, 2012
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
$ 3,954 
$ 3,734 
$ 7,737 
$ 7,600 
Cost of Sales
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
1,204 
1,067 
2,407 
2,156 
Development
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
487 
465 
985 
964 
Sales and Marketing
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
522 
461 
1,034 
940 
General and Administrative
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
$ 1,741 
$ 1,741 
$ 3,311 
$ 3,540 
Condensed Consolidated Statements of Comprehensive Income Consolidated Statements of Comprehensive Income (USD $)
In Thousands, unless otherwise specified
3 Months Ended 6 Months Ended
Jun. 30, 2013
Jun. 30, 2012
Jun. 30, 2013
Jun. 30, 2012
Consolidated net income
$ 31,100 
$ 27,884 
$ 60,675 
$ 47,997 
Other comprehensive income (loss), net of tax:
 
 
 
 
Foreign currency translation adjustment
(7,128)
(8,743)
(16,199)
(1,778)
Unrealized gains (losses) on securities:
 
 
 
 
Unrealized gains (losses) on available-for-sale investments, net of income tax of $151
(166)
(541)
1,000 
368 
Reclassification of adjustments for losses (gains) included in net income, net of income tax of $414
(271)
(22)
(734)
33 
Other comprehensive income (loss), net
(7,565)
(9,306)
(15,933)
(1,377)
Other comprehensive income (loss), net
23,535 
18,578 
44,742 
46,620 
Comprehensive (income) loss attributable to noncontrolling interest
64 
(46)
206 
61 
Comprehensive income attributable to Morningstar, Inc.
$ 23,599 
$ 18,532 
$ 44,948 
$ 46,681 
Condensed Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Jun. 30, 2013
Dec. 31, 2012
Current assets:
 
 
Cash and cash equivalents
$ 169,810 
$ 163,889 
Investments
144,973 
157,529 
Accounts receivable, less allowance of $784 and $569, respectively
110,646 
114,361 
Deferred tax asset, net
3,590 
3,741 
Income tax receivable, net
6,492 
14,267 
Other
26,874 
20,823 
Total current assets
462,385 
474,610 
Property, equipment, and capitalized software, net
95,550 
84,022 
Investments in unconsolidated entities
36,087 
35,305 
Goodwill
321,425 
320,845 
Intangible assets, net
112,073 
116,732 
Other assets
11,537 
10,438 
Total assets
1,039,057 
1,041,952 
Current liabilities:
 
 
Accounts payable and accrued liabilities
47,639 
43,777 
Accrued compensation
50,326 
67,317 
Deferred revenue
155,059 
146,015 
Other
272 
256 
Total current liabilities
253,296 
257,365 
Accrued compensation
8,144 
8,281 
Deferred tax liability, net
24,072 
21,583 
Deferred rent
14,457 
15,368 
Other long-term liabilities
21,812 
12,460 
Total liabilities
321,781 
315,057 
Morningstar, Inc. shareholders' equity:
 
 
Common stock, no par value, 200,000,000 shares authorized, of which 46,131,688 and 46,541,571 shares were outstanding as of June 30, 2013 and December 31, 2012, respectively
Treasury stock at cost, 5,943,566 shares as of June 30, 2013 and 5,214,070 shares as of December 31, 2012
(352,503)
(301,839)
Additional paid-in capital
529,334 
521,285 
Retained earnings
545,347 
496,354 
Accumulated other comprehensive income:
 
 
Currency translation adjustment
(7,132)
8,925 
Unrealized gain on available-for-sale securities
1,053 
787 
Total accumulated other comprehensive income
(6,079)
9,712 
Total Morningstar, Inc. shareholders' equity
716,104 
725,517 
Noncontrolling interest
1,172 
1,378 
Total equity
717,276 
726,895 
Total liabilities and equity
$ 1,039,057 
$ 1,041,952 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share data, unless otherwise specified
Jun. 30, 2013
Dec. 31, 2012
Statement of Financial Position [Abstract]
 
 
Allowance for Doubtful Accounts Receivable, Current
$ 784 
$ 569 
Common Stock, No Par Value
$ 0 
$ 0 
Common Stock, Shares Authorized
200,000,000 
200,000,000 
Common Stock, Shares, Outstanding
46,131,688 
46,541,571 
Treasury Stock, Shares
5,943,566 
5,214,070 
Condensed Consolidated Statement of Equity (USD $)
In Thousands, except Share data, unless otherwise specified
Total
Common Stock
Treasury Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Non Controlling Interests
Balance at Dec. 31, 2012
$ 726,895 
$ 5 
$ (301,839)
$ 521,285 
$ 496,354 
$ 9,712 
$ 1,378 
Balance (in shares) at Dec. 31, 2012
46,541,571 
46,541,571 
 
 
 
 
 
Increase (Decrease) in Stockholders' Equity
 
 
 
 
 
 
 
Net Income (Loss)
60,675 
 
 
 
60,739 
 
(64)
Other Comprehensive Income (loss)
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale investments, net of income tax of $151
1,000 
   
   
   
   
1,000 
Reclassification of adjustments for losses (gains) included in net income, net of income tax of $414
(734)
   
   
   
   
(734)
Foreign currency translation adjustment, net
(16,199)
   
   
   
   
(16,057)
(142)
Other comprehensive income (loss), net
(15,933)
   
   
   
   
(15,791)
(142)
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
(2,347)
1,286 
(3,633)
   
   
   
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net (in shares)
 
337,886 
 
 
 
 
 
Adjustments to Additional Paid in Capital, Share-based Compensation, Requisite Service Period Recognition
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
7,297 
   
   
7,297 
   
   
   
Stock-based compensation - restricted stock
194 
   
   
194 
   
   
   
Stock-based compensation - stock options
246 
   
   
246 
   
   
   
Excess tax benefit derived from stock-option exercises and vesting of restricted stock units
3,842 
   
   
3,842 
   
   
   
Common share repurchased
(51,950)
   
(51,950)
   
   
   
   
Common share repurchased (in shares)
 
(747,769)
 
 
 
 
 
Dividends declared - common shares outstanding
(11,563)
   
   
   
(11,563)
   
   
Dividends declared - restricted stock units
(80)
   
   
103 
(183)
   
   
Balance at Jun. 30, 2013
$ 717,276 
$ 5 
$ (352,503)
$ 529,334 
$ 545,347 
$ (6,079)
$ 1,172 
Balance (in shares) at Jun. 30, 2013
46,131,688 
46,131,688 
 
 
 
 
 
Condensed Consolidated Statement of Equity (Parenthetical) (USD $)
In Thousands, unless otherwise specified
6 Months Ended
Jun. 30, 2013
Statement of Stockholders' Equity [Abstract]
 
Other Comprehensive Income (Loss), Unrealized Holding Gain (Loss) on Securities Arising During Period, Tax
$ 151 
Other Comprehensive Income (Loss), Reclassification Adjustment for Sale of Securities Included in Net Income, Tax
$ 414 
Condensed Consolidated Statements of Cash Flows (USD $)
In Thousands, unless otherwise specified
6 Months Ended
Jun. 30, 2013
Jun. 30, 2012
Operating activities
 
 
Consolidated net income
$ 60,675 
$ 47,997 
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
Depreciation and amortization
22,601 
20,794 
Deferred income taxes
(38)
299 
Stock-based compensation expense
7,737 
7,600 
Provision for bad debt
461 
717 
Equity in net income of unconsolidated entities
(857)
(1,063)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
(3,842)
(4,548)
Holding gain upon acquisition of additional ownership of equity method investments
(3,713)
Other, net
688 
745 
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
Accounts receivable
524 
(4,394)
Other assets
(3,465)
(3,640)
Accounts payable and accrued liabilities
638 
652 
Accrued compensation
(19,581)
(26,920)
Income taxes- current
13,693 
4,525 
Deferred revenue
11,023 
12,333 
Deferred rent
(872)
468 
Other liabilities
(537)
(776)
Cash provided by operating activities
85,135 
54,789 
Investing activities
 
 
Purchases of investments
(82,299)
(133,888)
Proceeds from maturities and sales of investments
96,128 
161,523 
Capital expenditures
(18,881)
(17,922)
Acquisitions, net of cash acquired
(11,125)
Proceeds from Divestiture of Businesses
957 
Purchases of equity and cost method investments
(909)
(6,750)
Other, net
436 
Cash used for investing activities
(15,693)
2,963 
Financing activities
 
 
Proceeds from stock-option exercises, net
2,810 
4,474 
Employee taxes withheld for restricted stock units
(5,157)
(3,693)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
3,842 
4,548 
Common shares repurchased
(53,937)
(105,439)
Dividends paid
(5,889)
(10,004)
Other, net
(50)
(20)
Cash provided by (used for) financing activities
(58,381)
(110,134)
Effect of exchange rate changes on cash and cash equivalents
(5,140)
(556)
Net increase (decrease) in cash and cash equivalents
5,921 
(52,938)
Cash and cash equivalents-beginning of period
163,889 
200,437 
Cash and cash equivalents-end of period
169,810 
147,499 
Supplemental disclosure of cash flow information:
 
 
Cash paid for income taxes
14,511 
21,405 
Supplemental information of non-cash investing and financing activities:
 
 
Unrealized Gain (Loss) on Available For Sale Investments
418 
606 
NonCashFinancingArrangement
$ 4,860 
$ 0 
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information
 
The accompanying condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the Company) have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. In the opinion of management, the statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly our financial position, results of operations, equity, and cash flows. These financial statements and notes should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.
 
The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
FASB: Financial Accounting Standards Board
SEC: Securities and Exchange Commission
 
Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets
 
Acquisitions

Increased Ownership Interest in Morningstar Sweden AB

In May 2013, we acquired an additional 76% interest in Morningstar Sweden AB (Morningstar Sweden), increasing our ownership to 100% from 24%. Morningstar’s main offerings in Sweden include Morningstar Direct, Morningstar Data, Integrated Web Tools, and Morningstar.se, an investment information website for individual investors that provides fund and ETF data, portfolio tools, and market analysis. We began consolidating the financial results of this acquisition in our Consolidated Financial Statements on May 2, 2013.

Morningstar Sweden's total preliminary estimated fair value of $18,783,000 includes $14,748,000 in cash paid to acquire the remaining 76% interest in Morningstar Sweden and $4,035,000 related to the 24% of Morningstar Sweden we previously held. We determined the preliminary fair value of the previously held 24% investment independent of the acquired controlling interest by applying a minority interest discount based on analysis of comparable transactions. Accordingly, we recorded a preliminary non-cash holding gain of $3,713,000. The gain is included in non-operating income in our Unaudited Condensed Consolidated Statement of Income. The gain is preliminary pending receipt of the final valuation of our previously held investment.

The following table summarizes our preliminary allocation of the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, all of which are preliminary pending receipt of the final valuation:
 
 
($000)

Cash and cash equivalents
 
$
3,472

Accounts receivable and other current assets
 
519

Other non-current assets
 
244

Intangible assets
 
9,000

Goodwill
 
9,940

Deferred revenue
 
(1,191
)
Deferred tax liability
 
(2,118
)
Other current and non-current liabilities
 
(1,083
)
Total fair value of Morningstar Sweden
 
$
18,783



The preliminary allocation includes $9,000,000 of acquired intangible assets, as follows:
 
 
($000)

 
Weighted Average Useful Life (years)
Customer-related assets
 
$
9,000

 
14
Total intangible assets
 
$
9,000

 
14


We recognized a preliminary deferred tax liability of $2,118,000 mainly because the amortization expense related to certain intangible assets is not deductible for income tax purposes. The fair value of the acquired intangible assets and the deferred tax liability are preliminary pending receipt of the final valuation for these intangible assets.

Preliminary goodwill of $9,940,000 represents the premium over the fair value of the net tangible and intangible assets acquired with this acquisition. We paid this premium for a number of reasons, including the opportunity to offer Morningstar's full suite of products and services to investors in Sweden and further leverage Morningstar's global reach, investment databases, and technology expertise.

Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2012 to June 30, 2013:
 
 
($000)

Balance as of December 31, 2012
$
320,845

Acquisition of remaining ownership in Morningstar Sweden
9,940

Other, primarily foreign currency translation
(9,360
)
Balance as of June 30, 2013
$
321,425



We did not record any significant impairment losses in the first six months of 2013 or 2012. We perform our annual impairment reviews in the fourth quarter.

Intangible Assets

The following table summarizes our intangible assets: 
 
 
As of June 30, 2013
 
As of December 31, 2012
($000)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
Intellectual property
 
$
29,577

 
$
(22,012
)
 
$
7,565

 
9
 
$
30,621

 
$
(21,527
)
 
$
9,094

 
9
Customer-related assets
 
138,673

 
(67,508
)
 
71,165

 
12
 
132,798

 
(63,005
)
 
69,793

 
12
Supplier relationships
 
240

 
(102
)
 
138

 
20
 
240

 
(96
)
 
144

 
20
Technology-based assets
 
79,720

 
(46,618
)
 
33,102

 
9
 
81,333

 
(43,809
)
 
37,524

 
9
Non-competition agreement
 
1,680

 
(1,577
)
 
103

 
4
 
1,765

 
(1,588
)
 
177

 
4
Total intangible assets
 
$
249,890

 
$
(137,817
)
 
$
112,073

 
10
 
$
246,757

 
$
(130,025
)
 
$
116,732

 
10
 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended June 30
 
Six months ended June 30
($000)
 
2013

 
2012

 
2013

 
2012

Amortization expense
 
$
5,337

 
$
5,976

 
$
10,962

 
$
12,031


 
We amortize intangible assets using the straight-line method over their expected economic useful lives.

We expect intangible amortization expense for 2013 and subsequent years as follows:
 
 
($000)

2013
 
$
21,155

2014
 
20,174

2015
 
19,367

2016
 
14,821

2017
 
10,362

2018
 
8,411


 
Our estimates of future amortization expense for intangible assets may be affected by changes to the preliminary purchase price allocations, additional acquisitions, divestitures, changes in the estimated average useful life, and currency translations.

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies
Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 3 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.

In addition, effective January 1, 2013, we adopted FASB ASU No. 2013-2, Comprehensive Income (Topic 220). The amended guidance requires us to show the effects of items reclassified out of each component of accumulated other comprehensive income to net income on the face of the financial statement where net income is presented. The adoption of ASU No. 2013-2 did not have a material effect on our consolidated financial statements.
Income Per Share
Income Per Share
Income Per Share 

The following table shows how we reconcile our net income and the number of shares used in computing basic and diluted income per share:

 
 
 
Three months ended June 30
 
Six months ended June 30
(in thousands, except per share amounts)
 
 
2013

 
2012

 
2013

 
2012

 
 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.:
 
 
 

 
 

 
 
 
 
Net income attributable to Morningstar, Inc.:
 
 
$
31,121

 
$
27,888

 
$
60,739

 
$
48,025

Less: Distributed earnings available to participating securities
 
 
(2
)
 
(12
)
 
(5
)
 
(27
)
Less: Undistributed earnings available to participating securities
 
 
(9
)
 
(53
)
 
(18
)
 
(88
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,110

 
$
27,823

 
$
60,716

 
$
47,910

 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
46,400

 
49,195

 
46,403

 
49,566

 
 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
 
$
0.67

 
$
0.57

 
$
1.31

 
$
0.97

 
 
 
 
 
 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
 
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,110

 
$
27,823

 
$
60,716

 
$
47,910

Add: Undistributed earnings allocated to participating securities
 
 
9

 
53

 
18

 
88

Less: Undistributed earnings reallocated to participating securities
 
 
(9
)
 
(53
)
 
(17
)
 
(87
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,110

 
$
27,823

 
$
60,717

 
$
47,911

 
 
 


 


 


 


Weighted average common shares outstanding
 
 
46,400

 
49,195

 
46,403

 
49,566

Net effect of dilutive stock options and restricted stock units
 
 
453

 
661

 
353

 
730

Weighted average common shares outstanding for computing diluted income per share
 
 
46,853

 
49,856

 
46,756

 
50,296

 
 
 


 


 


 


Diluted net income per share attributable to Morningstar, Inc.
 
 
$
0.66

 
$
0.56

 
$
1.30

 
$
0.95


The following table shows the number of weighted average stock options, restricted stock units, and restricted stock excluded from our calculation of diluted earnings per share because their inclusion would have been anti-dilutive:
 
 
 
Three months ended June 30
 
Six months ended June 30
(in thousands)
 
 
2013

 
2012

 
2013

 
2012

Weighted average stock options
 
 

 
13

 

 
13

Weighted average restricted stock units
 
 
2

 

 
22

 

Weighted average restricted stock
 
 

 

 

 

Total
 
 
2

 
13

 
22

 
13


These stock options and restricted stock units could be included in the calculation in the future.

Segment and Geographical Area Information
Segment and Geographical Area Information
Segment and Geographical Area Information
 
As of June 30, 2013, Morningstar had two operating segments:
 
Investment Information. The Investment Information segment includes all of our data, software, and research products and services. These products are typically sold through subscriptions or license agreements.
 
The largest products in this segment based on revenue are Morningstar Data, Morningstar Advisor Workstation (including Morningstar Office), Morningstar Direct, Morningstar.com, Morningstar Integrated Web Tools, Morningstar Structured Credit Ratings, Morningstar Equity Research, and Morningstar Principia. Morningstar Data is a set of investment data spanning all of our investment databases, including real-time pricing and commodity data, and is available through electronic data feeds. Advisor Workstation is a web-based investment planning system for advisors that is available in two editions: Morningstar Office for independent financial advisors and an enterprise edition for financial advisors affiliated with larger firms. Morningstar Direct is a web-based institutional research platform. Morningstar.com includes both Premium Memberships and Internet advertising sales. Morningstar Integrated Web Tools is a set of services that helps institutional clients build customized websites or enhance their existing sites with Morningstar’s online tools and components. Morningstar Structured Credit Ratings is provided by Morningstar Credit Ratings, LLC, a Nationally Recognized Statistical Rating Organization specializing in structured finance. Morningstar Equity Research is sold to companies that purchase our research for their own use or provide our research to their affiliated advisors or individual investor clients. Morningstar Principia is our CD-ROM-based investment research and planning software for advisors.
 
The Investment Information segment also includes Morningstar Credit Ratings, LLC. Morningstar Credit Ratings, LLC offers Structured Credit Ratings as well as research, surveillance services, and data to help institutional investors identify risk in commercial mortgage-backed securities (CMBS).

We also offer a variety of financial communications and newsletters, other institutional and advisor software, and investment indexes.

Investment Management. The Investment Management segment includes all of our asset management operations, which earn the majority of their revenue from asset-based fees.
 
The key products and services in this segment based on revenue are Investment Advisory Services, which focuses on investment monitoring and asset allocation for funds of funds, including mutual funds and variable annuities; Retirement Solutions, including the Morningstar Retirement Manager and Advice by Ibbotson platforms; and Morningstar Managed Portfolios, a fee-based discretionary asset management service that includes a series of mutual fund, exchange-traded fund, and stock portfolios tailored to meet a range of investment time horizons and risk levels that financial advisors can use for their clients' taxable and tax-deferred accounts. In addition, we offer Managed Portfolios through our subsidiary Ibbotson Associates Australia Limited which provides asset management services primarily to institutional clients and individual investors.
 
Our segment accounting policies are the same as those described in Note 2, except for the capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions. We exclude these items from our operating segment results to provide our chief operating decision maker with a better indication of each segment’s ability to generate cash flow. This information is one of the criteria used by our chief operating decision maker in determining how to allocate resources to each segment. We include capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions in the Corporate Items category. Our segment disclosures are consistent with the business segment information provided to our chief operating decision maker on a recurring basis; for that reason, we don’t present balance sheet information by segment. We disclose goodwill by segment in accordance with the requirements of FASB ASC 350-20-50, Intangibles - Goodwill - Disclosure.
 
The following tables present information about our operating segments and by geographical area:
 
 
 
Three months ended June 30, 2013
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
141,426

 
$
34,002

 
$

 
$
175,428

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
91,751

 
16,856

 
8,021

 
116,628

Stock-based compensation expense
 
2,483

 
611

 
860

 
3,954

Depreciation and amortization
 
2,343

 
19

 
8,900

 
11,262

Operating income (loss)
 
$
44,849

 
$
16,516

 
$
(17,781
)
 
$
43,584

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
8,241

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,522

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
134,749

 
$
31,219

 
$

 
$
165,968

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
86,915

 
17,179

 
6,385

 
110,479

Stock-based compensation expense
 
2,531

 
529

 
674

 
3,734

Depreciation and amortization
 
2,300

 
38

 
8,281

 
10,619

Operating income (loss)
 
$
43,003

 
$
13,473

 
$
(15,340
)
 
$
41,136

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
6,818

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
2,110

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2013
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
277,613

 
$
66,671

 
$

 
$
344,284

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
181,620

 
32,475

 
15,707

 
229,802

Stock-based compensation expense
 
4,982

 
1,203

 
1,552

 
7,737

Depreciation and amortization
 
4,695

 
43

 
17,863

 
22,601

Operating income (loss)
 
$
86,316

 
$
32,950

 
$
(35,122
)
 
$
84,144

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
16,250

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
2,631

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
261,674

 
$
65,053

 
$

 
$
326,727

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
180,353

 
33,132

 
13,313

 
226,798

Stock-based compensation expense
 
5,090

 
1,080

 
1,430

 
7,600

Depreciation and amortization
 
4,544

 
77

 
16,173

 
20,794

Operating income (loss)
 
$
71,687

 
$
30,764

 
$
(30,916
)
 
$
71,535

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
14,215

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
3,707

 
 
 
 
 
 
 
 
 
 
 
 
As of June 30, 2013
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
280,252

 
$
41,173

 
$

 
$
321,425

 
 
 
As of December 31, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
279,164

 
$
41,681

 
$

 
$
320,845

 
External revenue by geographical area
 
 
 
 
 
 
 
 
 
 
Three months ended June 30
 
Six months ended June 30
($000)
 
2013

 
2012

 
2013

 
2012

United States
 
$
126,335

 
$
117,952

 
$
247,748

 
$
232,421

 
 
 
 
 
 
 
 
 
United Kingdom
 
14,015

 
14,714

 
27,168

 
28,450

Europe, excluding the United Kingdom
 
13,993

 
12,281

 
27,160

 
24,336

Australia
 
9,176

 
9,791

 
18,528

 
19,139

Canada
 
7,812

 
7,397

 
15,548

 
14,747

Asia, excluding Japan
 
2,661

 
2,366

 
5,256

 
4,735

Japan
 
788

 
986

 
1,617

 
1,965

Other
 
648

 
481

 
1,259

 
934

Total Non-U.S.
 
49,093

 
48,016

 
96,536

 
94,306

 
 
 
 
 
 
 
 
 
Total
 
$
175,428

 
$
165,968

 
$
344,284

 
$
326,727




Long-lived assets by geographical area
 
 
 
 
 
 
As of June 30
 
As of December 31
($000)
 
2013

 
2012

United States
 
$
74,154

 
$
60,371

 
 
 
 
 
United Kingdom
 
6,318

 
7,435

Europe, excluding the United Kingdom
 
2,169

 
2,356

Australia
 
1,114

 
1,402

Canada
 
1,484

 
1,773

Asia, excluding Japan
 
10,121

 
10,445

Japan
 
51

 
84

Other
 
139

 
156

Total Non-U.S.
 
21,396

 
23,651

 
 
 
 
 
Total
 
$
95,550

 
$
84,022

Investments and Fair Value Measurements
Investments and Fair Value Measurements
Investments and Fair Value Measurements
 
We account for our investments in accordance with FASB ASC 320, Investments—Debt and Equity Securities. We classify our investments in three categories: available-for-sale, held-to-maturity, and trading. We monitor the concentration, diversification, maturity, and liquidity of our investment portfolio, which is primarily invested in fixed-income securities, and classify our investment portfolio as shown below:
 
 
 
As of June 30
 
As of December 31
($000)
 
2013

 
2012

Available-for-sale
 
$
109,687

 
$
125,786

Held-to-maturity
 
28,343

 
26,357

Trading securities
 
6,943

 
5,386

Total
 
$
144,973

 
$
157,529




The following table shows the cost, unrealized gains (losses), and fair values related to investments classified as available-for-sale and held-to-maturity:
 
 
 
As of June 30, 2013
 
As of December 31, 2012
($000)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
25,277

 
$
11

 
$
(61
)
 
$
25,227

 
$
40,669

 
$
29

 
$
(608
)
 
$
40,090

Corporate bonds
 
54,189

 
8

 
(302
)
 
53,895

 
49,339

 
36

 
(292
)
 
49,083

Foreign obligations
 
2,437

 

 
(41
)
 
2,396

 
2,437

 
1

 
(19
)
 
2,419

Commercial paper
 
7,484

 

 
(2
)
 
7,482

 
2,000

 

 

 
2,000

Equity securities and exchange-traded funds
 
8,038

 
515

 
(220
)
 
8,333

 
19,613

 
1,359

 
(323
)
 
20,649

Mutual funds
 
10,615

 
1,838

 
(99
)
 
12,354

 
10,499

 
1,092

 
(46
)
 
11,545

Total
 
$
108,040

 
$
2,372

 
$
(725
)
 
$
109,687

 
$
124,557

 
$
2,517

 
$
(1,288
)
 
$
125,786

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
28,343

 
$

 
$

 
$
28,343

 
$
26,357

 
$

 
$

 
$
26,357


 
As of June 30, 2013 and December 31, 2012, investments with unrealized losses for greater than a 12-month period were not material to the Condensed Consolidated Balance Sheets and were not deemed to have other than temporary declines in value.

The table below shows the cost and fair value of investments classified as available-for-sale and held-to-maturity based on their contractual maturities as of June 30, 2013 and December 31, 2012. The expected maturities of certain fixed-income securities may differ from their contractual maturities because some of these holdings have call features that allow the issuers the right to prepay obligations without penalties.
 
 
 
As of June 30, 2013
 
As of December 31, 2012
($000)
 
Cost

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
49,646

 
$
49,421

 
$
87,599

 
$
86,784

Due in one to two years
 
39,741

 
39,579

 
6,846

 
6,808

Equity securities, exchange-traded funds, and mutual funds
 
18,653

 
20,687

 
30,112

 
32,194

    Total
 
$
108,040

 
$
109,687

 
$
124,557

 
$
125,786

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
28,339

 
$
28,339

 
$
26,352

 
$
26,352

Due in one to three years
 
4

 
4

 
5

 
5

Total
 
$
28,343

 
$
28,343

 
$
26,357

 
$
26,357


 
As of June 30, 2013 and December 31, 2012, held-to-maturity investments included a $1,500,000 certificate of deposit held primarily as collateral against bank guarantees for our office leases, primarily in Australia.

The following table shows the realized gains and losses arising from sales of our investments classified as available-for-sale recorded in our Condensed Consolidated Statements of Income: 
 
 
Six months ended June 30
($000)
 
2013

 
2012

Realized gains
 
$
2,226

 
$
470

Realized losses
 
(1,078
)
 
(519
)
Realized gains (losses), net
 
$
1,148

 
$
(49
)

 
We determine realized gains and losses using the specific identification method.

The following table shows the net unrealized gains (losses) on trading securities as recorded in our Condensed Consolidated Statements of Income:
 
 
 
Six months ended June 30
($000)
 
2013

 
2012

Unrealized gains, net
 
$
273

 
$
156



The fair value of our assets subject to fair value measurements and that are measured at fair value on a recurring basis using the fair value hierarchy and the necessary disclosures under FASB ASC 820, Fair Value Measurement, are as follows:
 
 
 
Fair Value
 
Fair Value Measurements as of June 30, 2013
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
June 30, 2013
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
25,227

 
$

 
$
25,227

 
$

Corporate bonds
 
53,895

 

 
53,895

 

Foreign obligations
 
2,396

 

 
2,396

 

Equity securities and exchange-traded funds
 
8,333

 
8,333

 

 

Mutual funds
 
12,354

 
12,354

 

 

Trading securities
 
6,943

 
6,943

 

 

Cash equivalents
 
9,489

 
9,489

 

 

Total
 
$
118,637

 
$
37,119

 
$
81,518

 
$

 
 
 
Fair Value
 
Fair Value Measurements as of December 31, 2012
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
December 31, 2012
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
40,090

 
$

 
$
40,090

 
$

Corporate bonds
 
49,083

 

 
49,083

 

Foreign obligations
 
2,419

 

 
2,419

 

Commercial paper
 
2,000

 

 
2,000

 

Equity securities and exchange-traded funds
 
20,649

 
20,649

 

 

Mutual funds
 
11,545

 
11,545

 

 

Trading securities
 
5,386

 
5,386

 

 

Cash equivalents
 
398

 
398

 

 

Total
 
$
131,570

 
$
37,978

 
$
93,592

 
$


 
Level 1:
Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2:
Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3:
Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

Based on our analysis of the nature and risks of our investments in equity securities and mutual funds, we have determined that presenting each of these investment categories in the aggregate is appropriate.

We measure the fair value of money market funds, mutual funds, equity securities, and exchange-traded funds based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from observable market data. We did not hold any securities categorized as Level 3 as of June 30, 2013 and December 31, 2012.
Investments in Unconsolidated Entities
Investments in Unconsolidated Entities
Investments in Unconsolidated Entities
 
Our investments in unconsolidated entities consist primarily of the following:
 
 
 
As of June 30


As of December 31

($000)
 
2013


2012

Investment in MJKK
 
$
20,900

 
$
20,540

Other equity method investments
 
6,366

 
6,288

Investments accounted for using the cost method
 
8,821

 
8,477

Total investments in unconsolidated entities
 
$
36,087

 
$
35,305


 
Morningstar Japan K.K. Morningstar Japan K.K. (MJKK) develops and markets products and services customized for the Japanese market. MJKK’s shares are traded on the Tokyo Stock Exchange under the ticker 47650. We account for our investment in MJKK using the equity method. The following table summarizes our ownership percentage in MJKK and the market value of this investment based on MJKK’s publicly quoted share price: 
 
 
As of June 30

 
As of December 31

 
 
2013

 
2012

Morningstar’s approximate ownership of MJKK
 
34
%
 
34
%
 
 
 
 
 
Approximate market value of Morningstar’s ownership in MJKK:
 
 

 
 

Japanese yen (¥000)
 
¥
9,218,664

 
¥
3,109,579

Equivalent U.S. dollars ($000)
 
$
93,016

 
$
36,227



Other Equity Method Investments. As of June 30, 2013 and December 31, 2012, other equity method investments consist of our investment in YCharts, Inc. (YCharts), and Inquiry Financial Europe AB (Inquiry Financial). YCharts is a technology company that provides stock research and analysis. Our ownership interest in YCharts was approximately 22% as of June 30, 2013 and December 31, 2012. Inquiry Financial is a provider of sell-side consensus estimate data. Our ownership interest in Inquiry Financial was approximately 34% as of June 30, 2013 and December 31, 2012.

As of December 31, 2012, other equity-method investments also included our investment in Morningstar Sweden. Our ownership interest and profit-and-loss sharing interest in Morningstar Sweden was 24% at that date. In May 2013, we acquired an additional 76% ownership interest in Morningstar Sweden, increasing our ownership interest to 100%. Upon acquiring the majority ownership, we recorded a non-cash gain of $3,713,000. This gain represents the difference between the estimated fair value and the book value of our investment in Morningstar Sweden at the date of acquisition. Because Morningstar Sweden is now a wholly owned subsidiary, we no longer account for our investment using the equity method. Beginning in May 2013, we consolidate the assets, liabilities, and results of operations of Morningstar Sweden in our Unaudited Condensed Consolidated Financial Statements. See Note 3 for additional information concerning our acquisition of Morningstar Sweden.

We did not record any impairment losses on our equity method investments in the first six months of 2013 or 2012.
 
Cost Method Investments. As of June 30, 2013 and December 31, 2012, our cost method investments consist of minority investments in Pitchbook Data, Inc. (Pitchbook) and HelloWallet LLC (HelloWallet). Pitchbook offers detailed data and information about private equity transactions, investors, companies, limited partners, and service providers. HelloWallet is a provider of personalized financial guidance to employees of Fortune 1000 companies.

We did not record any impairment losses on our cost method investments in the first six months of 2013 or 2012.
Stock-Based Compensation
Stock-Based Compensation
Stock-Based Compensation
 
Stock-Based Compensation Plans
 
Our shareholders approved the Morningstar 2011 Stock Incentive Plan (the 2011 Plan) on May 17, 2011. As of that date, we stopped granting awards under the Morningstar 2004 Stock Incentive Plan (the 2004 Plan). The 2004 Plan amended and restated the Morningstar 1993 Stock Option Plan, the Morningstar 2000 Stock Option Plan, and the Morningstar 2001 Stock Option Plan.

The 2011 Plan provides for a variety of stock-based awards, including, among other things, stock options, restricted stock units, and restricted stock. We granted stock options, restricted stock units, and restricted stock under the 2004 Plan.

All of our employees and our non-employee directors are eligible for awards under the 2011 Plan.

Grants awarded under the 2011 Plan or the 2004 Plan that are forfeited, canceled, settled, or otherwise terminated without a distribution of shares, or shares withheld by us in connection with the exercise of options, will be available for awards under the 2011 Plan. Any shares subject to awards under the 2011 Plan, but not under the 2004 Plan, that are withheld by us in connection with the payment of any required income tax withholding will be available for awards under the 2011 Plan.

The following table summarizes the number of shares available for future grants under our 2011 Plan:
 
 
 
As of June 30

(in thousands)
 
2013

Shares available for future grants
 
4,521


 
Accounting for Stock-Based Compensation Awards
 
The following table summarizes our stock-based compensation expense and the related income tax benefit we recorded in the six months ended June 30, 2013 and June 30, 2012:
 
 
 
Three months ended June 30
 
Six months ended June 30
($000)
 
2013

 
2012

 
2013

 
2012

Restricted stock units
 
$
3,734

 
$
3,270

 
$
7,297

 
$
6,548

Restricted stock
 
97

 
444

 
194

 
888

Stock options
 
123

 
20

 
246

 
164

Total stock-based compensation expense
 
$
3,954

 
$
3,734

 
$
7,737

 
$
7,600

 
 
 
 
 
 
 
 
 
Income tax benefit related to the stock-based compensation expense
 
$
1,068

 
$
882

 
$
2,098

 
$
1,804


 

The following table summarizes the amount of unrecognized stock-based compensation expense as of June 30, 2013 and the expected number of months over which the expense will be recognized:
 
 
Unrecognized stock-based compensation expense ($000)

 
Expected amortization period (months)
Restricted stock units
 
$
38,079

 
36
Restricted stock
 
711

 
22
Stock options
 
831

 
22
Total unrecognized stock-based compensation expense
 
$
39,621

 
35


In accordance with FASB ASC 718, Compensation—Stock Compensation, we estimate forfeitures of employee stock-based awards and recognize compensation cost only for those awards expected to vest. Our largest annual equity grants typically have vesting dates in the second quarter. We adjust the stock-based compensation expense during the third quarter to reflect those awards that ultimately vested and update our estimate of the forfeiture rate that will be applied to awards not yet vested.
 
Restricted Stock Units
 
Restricted stock units represent the right to receive a share of Morningstar common stock when that unit vests. Restricted stock units to employees vest ratably over a four-year period. Restricted stock units granted to non-employee directors vest ratably over a three-year period. For restricted stock units granted through December 31, 2008, employees could elect to defer receipt of the Morningstar common stock issued upon vesting of the restricted stock unit.

We measure the fair value of our restricted stock units on the date of grant based on the closing market price of the underlying common stock on the day prior to grant. We amortize that value to stock-based compensation expense, net of estimated forfeitures, ratably over the vesting period.

The following table summarizes restricted stock unit activity during the first six months of 2013:
Restricted Stock Units (RSUs)
 
Unvested