MORNINGSTAR, INC., 10-Q filed on 8/5/2010
Quarterly Report
Condensed Consolidated Statements of Income (USD $)
In Thousands, except Per Share data
3 Months Ended
Jun. 30, 2010
6 Months Ended
Jun. 30, 2010
3 Months Ended
Jun. 30, 2009
6 Months Ended
Jun. 30, 2009
Revenue
$ 136,091 
$ 264,381 
$ 119,533 
$ 236,265 
Operating expense (1):
 
 
 
 
Cost of goods sold
39,738 
74,054 
30,694 
60,946 
Development
11,899 
22,788 
9,438 
18,738 
Sales and marketing
24,435 
46,996 
18,010 
35,546 
General and administrative
23,106 
43,749 
19,853 
37,006 
Depreciation and amortization
9,246 
18,185 
8,850 
16,716 
Total operating expense
108,424 
205,772 
86,845 
168,952 
Operating income
27,667 
58,609 
32,688 
67,313 
Non-operating income (expense):
 
 
 
 
Interest income, net
593 
1,180 
764 
1,742 
Other income (expense), net
(572)
(1,338)
1,208 
764 
Non-operating income (expense), net
21 
(158)
1,972 
2,506 
Income before income taxes and equity in net income (loss) of unconsolidated entities
27,688 
58,451 
34,660 
69,819 
Income tax expense
10,225 
21,220 
14,024 
24,692 
Equity in net income (loss) of unconsolidated entities
454 
843 
(21)
361 
Consolidated net income
17,917 
38,074 
20,615 
45,488 
Net (income) loss attributable to noncontrolling interests
85 
116 
(71)
18 
Net income attributable to Morningstar, Inc.
18,002 
38,190 
20,544 
45,506 
Net income per share attributable to Morningstar, Inc.:
 
 
 
 
Basic (in dollars per share)
0.37 
0.78 
0.43 
0.95 
Diluted (in dollars per share)
0.36 
0.76 
0.41 
0.92 
Weighted average shares outstanding:
 
 
 
 
Basic (in shares)
49,234 
49,032 
47,941 
47,661 
Diluted (in shares)
50,533 
50,426 
49,631 
49,385 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
In Thousands
3 Months Ended
Jun. 30, 2010
6 Months Ended
Jun. 30, 2010
3 Months Ended
Jun. 30, 2009
6 Months Ended
Jun. 30, 2009
Includes stock-based compensation expense of:
 
 
 
 
Cost of goods sold
$ 907 
$ 1,622 
$ 715 
$ 1,264 
Development
449 
842 
413 
767 
Sales and marketing
486 
889 
422 
778 
General and administrative
1,813 
3,239 
1,518 
2,984 
Total stock-based compensation expense
$ 3,655 
$ 6,592 
$ 3,068 
$ 5,793 
Condensed Consolidated Balance Sheets (USD $)
In Thousands
Jun. 30, 2010
Dec. 31, 2009
Assets
 
 
Current assets:
 
 
Cash and cash equivalents
$ 154,377 
$ 130,496 
Investments
165,973 
212,057 
Accounts receivable, less allowance of $766 and $1,339, respectively
90,127 
82,330 
Deferred tax asset, net
1,464 
1,109 
Income tax receivable, net
13,114 
5,541 
Other
12,550 
12,564 
Total current assets
437,605 
444,097 
Property, equipment, and capitalized software, net
56,453 
59,828 
Investments in unconsolidated entities
24,099 
24,079 
Goodwill
281,813 
249,992 
Intangible assets, net
156,825 
135,488 
Other assets
5,731 
6,099 
Total assets
962,526 
919,583 
Liabilities and equity
 
 
Current liabilities:
 
 
Accounts payable and accrued liabilities
33,845 
29,901 
Accrued compensation
37,744 
48,902 
Deferred revenue
140,802 
127,114 
Other
950 
962 
Total current liabilities
213,341 
206,879 
Accrued compensation
4,752 
4,739 
Deferred tax liability, net
3,418 
4,678 
Other long-term liabilities
24,949 
26,413 
Total liabilities
246,460 
242,709 
Equity:
 
 
Morningstar, Inc. shareholders' equity:
 
 
Common stock, no par value, 200,000,000 shares authorized, of which 49,558,248 and 48,768,541 shares were outstanding as of June 30, 2010 and December 31, 2009, respectively
Treasury stock at cost, 208,899 shares as of June 30, 2010 and 222,653 as of December 31, 2009
(2,936)
(3,130)
Additional paid-in capital
446,305 
432,052 
Retained earnings
284,935 
246,745 
Accumulated other comprehensive income (loss):
 
 
Currency translation adjustment
(12,992)
(337)
Unrealized gain (loss) on available-for-sale securities
(217)
370 
Total accumulated other comprehensive income (loss)
(13,209)
33 
Total Morningstar, Inc. shareholders' equity
715,100 
675,705 
Noncontrolling interest
966 
1,169 
Total equity
716,066 
676,874 
Total liabilities and equity
$ 962,526 
$ 919,583 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share and Per Share data
Jun. 30, 2010
Dec. 31, 2009
Condensed Consolidated Balance Sheets
 
 
Accounts receivable, allowance (in dollars)
$ 766 
$ 1,339 
Common stock, no par value (in dollars per share)
 
 
Common stock, shares authorized
200,000,000 
200,000,000 
Common stock, shares outstanding
49,558,248 
48,768,541 
Treasury stock, shares
208,899 
222,653 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) (USD $)
In Thousands, except Share data
6 Months Ended
Jun. 30, 2010
Increase (Decrease) in Stockholders' Equity
 
Balance
$ 676,874 
Comprehensive income (loss):
 
Net income (loss)
38,074 
Unrealized loss on available-for-sale investments, net of income tax of $353
(588)
Foreign currency translation adjustment, net
(12,741)
Total comprehensive income (loss)
24,745 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
3,650 
Stock-based compensation - restricted stock units
6,280 
Stock-based compensation - restricted stock
312 
Excess tax benefit derived from stock option exercises and vesting of restricted stock units
4,205 
Balance
716,066 
Common Stock
 
Increase (Decrease) in Stockholders' Equity
 
Balance
Balance (in shares)
48,768,541 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net (in shares)
590,533 
Stock-based compensation - restricted stock
 
Stock-based compensation - restricted stock (in shares)
199,174 
Balance
Balance (in shares)
49,558,248 
Treasury Stock
 
Increase (Decrease) in Stockholders' Equity
 
Balance
(3,130)
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
194 
Balance
(2,936)
Additional Paid-in Capital
 
Increase (Decrease) in Stockholders' Equity
 
Balance
432,052 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
3,456 
Stock-based compensation - restricted stock units
6,280 
Stock-based compensation - restricted stock
312 
Excess tax benefit derived from stock option exercises and vesting of restricted stock units
4,205 
Balance
446,305 
Retained Earnings
 
Increase (Decrease) in Stockholders' Equity
 
Balance
246,745 
Comprehensive income (loss):
 
Net income (loss)
38,190 
Total comprehensive income (loss)
38,190 
Balance
284,935 
Accumulated Other Comprehensive Income (Loss)
 
Increase (Decrease) in Stockholders' Equity
 
Balance
33 
Comprehensive income (loss):
 
Unrealized loss on available-for-sale investments, net of income tax of $353
(588)
Foreign currency translation adjustment, net
(12,654)
Total comprehensive income (loss)
(13,242)
Balance
(13,209)
Comprehensive Income
 
Comprehensive income (loss):
 
Net income (loss)
38,074 
Unrealized loss on available-for-sale investments, net of income tax of $353
(588)
Foreign currency translation adjustment, net
(12,741)
Total comprehensive income (loss)
24,745 
Non Controlling Interests
 
Increase (Decrease) in Stockholders' Equity
 
Balance
1,169 
Comprehensive income (loss):
 
Net income (loss)
(116)
Foreign currency translation adjustment, net
(87)
Total comprehensive income (loss)
(203)
Balance
$ 966 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) (Parenthetical) (USD $)
In Thousands
6 Months Ended
Jun. 30, 2010
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss)
 
Unrealized loss on available-for-sale investments, tax
$ 353 
Condensed Consolidated Statements of Cash Flows (USD $)
In Thousands
6 Months Ended
Jun. 30,
2010
2009
Operating activities
 
 
Consolidated net income
$ 38,074 
$ 45,488 
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
Depreciation and amortization
18,185 
16,716 
Deferred income tax benefit
(1,012)
(956)
Stock-based compensation expense
6,592 
5,793 
Provision for bad debt
356 
187 
Equity in net income of unconsolidated entities
(843)
(361)
Excess tax benefits from stock option exercises and vesting of restricted stock units
(4,205)
(4,544)
Other, net
1,386 
(752)
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
Accounts receivable
(6,615)
9,312 
Other assets
(511)
341 
Accounts payable and accrued liabilities
2,859 
(6,012)
Accrued compensation
(11,154)
(45,431)
Income taxes payable
(4,255)
10,396 
Deferred revenue
7,177 
806 
Deferred rent
(80)
(286)
Other liabilities
(924)
570 
Cash provided by operating activities
45,030 
31,267 
Investing activities
 
 
Purchases of investments
(85,528)
(50,273)
Proceeds from maturities and sales of investments
130,381 
38,128 
Capital expenditures
(3,839)
(6,768)
Acquisitions, net of cash acquired
(67,455)
(18,571)
Other, net
889 
629 
Cash used for investing activities
(25,552)
(36,855)
Financing activities
 
 
Proceeds from stock option exercises
3,650 
11,653 
Excess tax benefits from stock option exercises and vesting of restricted stock units
4,205 
4,544 
Other, net
205 
(178)
Cash provided by financing activities
8,060 
16,019 
Effect of exchange rate changes on cash and cash equivalents
(3,657)
2,777 
Net increase in cash and cash equivalents
23,881 
13,208 
Cash and cash equivalents - beginning of period
130,496 
173,891 
Cash and cash equivalents - end of period
154,377 
187,099 
Supplemental disclosure of cash flow information:
 
 
Cash paid for income taxes
26,396 
14,152 
Supplemental information of non-cash investing and financing activities:
 
 
Unrealized loss on available-for-sale investments
$ (941)
$ (75)
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information

1. 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, 2009, filed with the SEC on March 1, 2010.

 

The acronyms that appear in the Notes to our Condensed Consolidated Financial Statements refer to the following:

 

ASC: Accounting Standards Codification

ASU: Accounting Standards Update

EITF: Emerging Issues Task Force

FASB: Financial Accounting Standards Board

SEC: Securities and Exchange Commission

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies

2. Summary of Significant Accounting Policies

 

We discuss our significant accounting policies in Note 2 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the SEC on March 1, 2010. In addition, effective January 1, 2010, we adopted the following financial accounting standards:

 

·   ASU No. 2009-16, Transfers and Servicing (Topic 860) and Accounting for Transfers of Financial Assets and ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.

 

These accounting pronouncements change the way entities account for transfers of financial assets and determine what entities must be consolidated. The most significant amendment resulting from FASB ASU No. 2009-16 consists of the removal of the concept of a Qualifying Special-Purpose Entity (QSPE) from FASB ASC 860, Transfers and Services. ASU No. 2009-17 addresses the effects of eliminating the QSPE concept from ASC 860 and responds to concerns about the application of certain key provisions of FASB ASC 810, Consolidation, including concerns over the transparency of enterprises’ involvement with Variable Interest Entities (VIEs). These accounting pronouncements did not impact our Condensed Consolidated Financial Statements.

 

·   ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements.

 

ASU No. 2010-06 requires additional disclosures regarding fair value measurements. The amended guidance requires entities to disclose additional information regarding assets and liabilities that are transferred between levels of the fair value hierarchy. ASU 2010-06 also clarifies existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the disclosure requirements regarding the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The additional disclosures required by ASU No. 2010-06 appear in Note 6, in the Notes to our Condensed Consolidated Financial Statements.

Acquisitions, Goodwill, and Other Intangible Assets
Acquisitions, Goodwill, and Other Intangible Assets

3. Acquisitions, Goodwill, and Other Intangible Assets

 

2010 Acquisitions

 

In the first six months of 2010, we completed four acquisitions, as follows:

 

Aegis Equities Research

 

In April 2010, we acquired Aegis Equities Research, a leading provider of independent equity research in Sydney, Australia, for $10,717,000 in cash, net of cash acquired. The following table summarizes our preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

 

 

($000)

 

Cash and cash equivalents

 

$

 51

 

Investments

 

55

 

Accounts receivable

 

229

 

Other non-current assets

 

62

 

Intangible assets

 

5,100

 

Goodwill

 

6,135

 

Deferred revenue

 

(617

)

Other current and non-current liabilities

 

(247

)

 

 

 

 

Total purchase price

 

$

 10,768

 

 

The preliminary allocation includes $5,100,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases. Goodwill of $6,135,000 represents the premium we paid 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 strategic benefits of creating a larger analyst team that will enable us to broaden and deepen our coverage of Australian listed companies, providing Australian clients with more robust independent research, and giving us the potential to expand our services in multiple delivery channels. We are in the process of determining what portion of the value assigned to goodwill and intangible assets, if any, is deductible for income tax purposes.

 

Old Broad Street Research Ltd

 

In April 2010, we acquired Old Broad Street Research Ltd. (OBSR) for $16,651,000 in cash, net of cash acquired. OBSR is a premier provider of fund research, ratings, and investment consulting services in the United Kingdom, and offers an array of customized consulting services including model portfolios, advice on fund construction, and corporate governance services, that are used by many of the leading financial advisers and fund platforms.

 

The following table summarizes our preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The purchase price allocation is preliminary pending certain tax related matters, including the valuation of deferred tax assets and liabilities at the date of acquisition.

 

 

 

($000)

 

Cash and cash equivalents

 

$

 4,632

 

Accounts receivable and other current assets

 

962

 

Other non-current assets

 

449

 

Intangible assets

 

8,473

 

Goodwill

 

9,337

 

Deferred revenue

 

(1,075

)

Accounts payable and accrued and other current liabilities

 

(1,342

)

Other liabilities — non-current

 

(153

)

Total purchase price

 

$

 21,283

 

 

The preliminary allocation includes $8,473,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases.

 

Goodwill of $9,337,000 represents the premium we paid over the fair value of the acquired net tangible and intangible assets. We paid this premium for a number of reasons, including the strategic benefit of adding to our existing fund research team in London, and continuing to build our thought leadership in investment research. OBSR will also help us expand our investment consulting presence in the United Kingdom, where we already provide asset allocation, manager selection, and portfolio construction services to institutions and intermediaries. The goodwill we recorded is not considered deductible for income tax purposes.

 

Realpoint, LLC

 

In May 2010, we acquired Realpoint, LLC (Realpoint) a Nationally Recognized Statistical Ratings Organization (NRSRO) that specializes in structured finance. Realpoint offers securities ratings, research, surveillance services, and data to help institutional investors identify credit risk in commercial mortgage-backed securities. Institutional investment firms subscribe to Realpoint’s ratings and analytics, including money managers who invest in commercial mortgage-backed securities.

 

In conjunction with this acquisition, we paid $38,385,000 in cash, net of cash acquired, and issued 199,174 shares of restricted stock to the selling employee-shareholders. As a result of the terms of the restricted share agreements, in accordance with FASB ASC 805, Business Combinations, we account for these grants as stock-based compensation expense, and not as part of the acquisition consideration. See Note 9 in the Notes to our Condensed Consolidated Financial Statements for additional information concerning the accounting for this restricted stock.

 

The following table summarizes our preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

 

 

($000)

 

Cash and cash equivalents

 

$

 5,393

 

Accounts receivable and other current assets

 

2,647

 

Other non-current assets

 

319

 

Intangible assets

 

19,959

 

Goodwill

 

24,132

 

Deferred revenue

 

(7,316

)

Accounts payable and accrued and other current liabilities

 

(1,356

)

Total purchase price

 

$

 43,778

 

 

The preliminary allocation includes $19,959,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases.

 

Goodwill of $24,132,000 represents the premium we paid over the fair value of the acquired net tangible and intangible assets. We paid this premium for a number of reasons, including the opportunity for Morningstar to enter into the structured finance ratings and analysis business.

 

The value assigned to goodwill, intangible assets, and restricted shares at the date of grant are deductible for income tax purposes over a period of approximately 15 years from the acquisition date.

 

Footnoted business of Financial Fineprint Inc.

 

In February 2010, we acquired the Footnoted business of Financial Fineprint Inc. (Footnoted), a blog for professional money managers, analysts, and individual investors. Footnoted Pro, a service for institutional investors, provides insight on actionable items and trends in SEC filings. The acquisition includes the Footnoted.org website and the Footnoted Pro service. Terms were not disclosed. The acquisition did not have a significant impact on our Condensed Consolidated Financial Statements for the six months ended June 30, 2010.

 

2009 Acquisitions

 

The table below summarizes the six acquisitions we completed in 2009:

 

Acquisition

 

Description

 

Date Acquired

 

Purchase Price*

Global financial filings database business of Global Reports LLC

 

A leading provider of online financial and Corporate and Social Responsibility reports for publicly traded companies around the world

 

April 20, 2009

 

Not separately Disclosed

Equity research and data business of C.P.M.S. Computerized Portfolio Management Services Inc.

 

C.P.M.S. tracks fundamental equity data for approximately 4,000 securities in the United States and Canada as well as tracks and provides earnings estimates for Canadian stocks

 

May 1, 2009

 

$13.9 million

Andex Associates, Inc.

 

Andex is known for Andex Charts, which illustrate historical market returns, stock index growth, inflation rates, currency rates, and general economic conditions for the United States dating back to 1926, and for Canada dating back to 1950

 

May 1, 2009

 

Not separately disclosed

Intech Pty Ltd

 

A leading provider of multimanager and investment portfolio solutions in Sydney, Australia, Intech also manages a range of single sector, alternative strategy, and diversified investment portfolios, has one of the leading separately managed account databases in Australia, and offers the Intech Desktop Consultant, a research software product for institutions

 

June 30, 2009

 

Not separately disclosed

Canadian Investment Awards and Gala

 

Canada’s marquee investment awards program, recognizing excellence in products and firms within the financial services industry

 

December 17, 2009

 

Not separately disclosed

Logical Information Machines, Inc. (LIM)

 

A leading provider of data and analytics for the energy, financial, and agriculture sectors

 

December 31, 2009

 

$53.5 million

 


* Total purchase price less cash acquired, subject to post-closing adjustments.

 

As of June 30, 2010, we did not make any significant changes to the purchase price allocations for the acquisitions that occurred in 2009. Certain of these purchase price allocations, primarily the purchase price allocation related to Logical Information Machines, Inc. are preliminary, pending resolution of certain tax and other matters. Additional information concerning the six acquisitions completed in 2009 can be found in the Notes to our Consolidated Financial Statements included in our Annual Report on Form 10-K filed with the SEC on March 1, 2010.

 

Pro Forma Information for 2010 and 2009 Acquisitions

 

The following unaudited pro forma information presents a summary of our Condensed Consolidated Statements of Income for the six months ended June 30, 2010 and 2009 as if we had completed the 2010 and 2009 acquisitions and had consolidated Morningstar Korea, as of January 1 of each of these years. In calculating the pro forma information below, we included an estimate of amortization expense related to the intangible assets acquired.

 

 

 

Six months ended June 30

 

Unaudited Pro Forma Financial Information (in thousands except per share amounts)

 

2010

 

2009

 

Revenue

 

$

271,736

 

$

262,848

 

Operating income

 

$

58,110

 

$

67,228

 

Net income attributable to Morningstar, Inc.

 

$

37,840

 

$

45,435

 

 

 

 

 

 

 

Basic net income per share attributable to Morningstar, Inc.

 

$

0.77

 

$

0.95

 

Diluted net income per share attributable to Morningstar, Inc.

 

$

0.75

 

$

0.92

 

 

Goodwill

 

The following table shows the changes in our goodwill balances from December 31, 2009 to June 30, 2010:

 

 

 

($000)

 

Balance as of December 31, 2009

 

$

 249,992

 

Acquisition of Aegis

 

6,135

 

Acquisition of OBSR

 

9,337

 

Acquisition of Realpoint

 

24,132

 

Other, primarily currency translation

 

(7,783

)

Balance as of June 30, 2010

 

$

 281,813

 

 

We did not record any impairment losses in the second quarter or year-to-date periods ended June 30, 2010 and June 30, 2009, respectively.

 

The following table summarizes our intangible assets:

 

 

 

As of June 30, 2010

 

As of December 31, 2009

 

($000)

 

Gross

 

Accumulated
Amortization

 

Net

 

Weighted
Average
Useful Life
(years)

 

Gross

 

Accumulated
Amortization

 

Net

 

Weighted
Average
Useful Life
(years)

 

Intellectual property

 

$

29,093

 

$

 (13,502

)

$

15,591

 

10

 

$

28,472

 

$

 (12,147

)

$

16,325

 

10

 

Customer-related assets

 

102,184

 

(32,535

)

69,649

 

11

 

87,635

 

(27,405

)

60,230

 

10

 

Supplier relationships

 

240

 

(66

)

174

 

20

 

240

 

(60

)

180

 

20

 

Technology-based assets

 

57,605

 

(20,092

)

37,513

 

9

 

49,276

 

(16,694

)

32,582

 

9

 

Non-competition agreement

 

848

 

(632

)

216

 

5

 

820

 

(547

)

273

 

5

 

Intangible assets related to acquisitions with preliminary purchase price allocations

 

34,501

 

(819

)

33,682

 

10

 

26,129

 

(231

)

25,898

 

5

 

Total intangible assets

 

$

224,471

 

$

 (67,646

)

$

156,825

 

10

 

$

192,572

 

$

 (57,084

)

$

135,488

 

9

 

 

The following table summarizes our amortization expense related to intangible assets:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

2010

 

2009

 

Amortization expense

 

$

 5,848

 

$

 5,541

 

$

 11,316

 

$

 10,663

 

 

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

 

Based on acquisitions completed through June 30, 2010, we expect intangible amortization expense for 2010 and subsequent years as follows:

 

 

 

($000)

 

2010

 

$

23,071

 

2011

 

22,477

 

2012

 

21,257

 

2013

 

19,349

 

2014

 

18,438

 

2015

 

17,640

 

 

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

Income Per Share
Income Per Share

4. Income Per Share

 

The numerator for both basic and diluted income per share is net income attributable to Morningstar, Inc.

 

The denominator for basic income per share is the weighted average number of common shares outstanding during the period, exclusive of the restricted stock issued in connection with the Realpoint acquisition. In accordance with FASB ASC 260, Earnings Per Share, outstanding common shares that are contingently returnable until the shares are vested should be excluded from the denominator in computing basic EPS even if they have been issued.

 

For diluted income per share, we reflect the dilutive effect of outstanding employee stock options, restricted stock units, and restricted stock issued in connection with the Realpoint acquisition, in the denominator using the treasury stock method.

 

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)

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Net income attributable to Morningstar, Inc.

 

$

18,002

 

$

20,544

 

$

38,190

 

$

45,506

 

Weighted average common shares outstanding

 

49,234

 

47,941

 

49,032

 

47,661

 

Basic net income per share attributable to Morningstar, Inc.

 

$

0.37

 

$

0.43

 

$

0.78

 

$

0.95

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Net income attributable to Morningstar, Inc.

 

$

18,002

 

$

20,544

 

$

38,190

 

$

45,506

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

49,234

 

47,941

 

49,032

 

47,661

 

Net effect of dilutive stock options, restricted stock units, and restricted stock

 

1,299

 

1,690

 

1,394

 

1,724

 

Weighted average common shares outstanding for computing diluted income per share

 

50,533

 

49,631

 

50,426

 

49,385

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per share attributable to Morningstar, Inc.

 

$

0.36

 

$

0.41

 

$

0.76

 

$

0.92

 

Segment and Geographical Area Information
Segment and Geographical Area Information

5. Segment and Geographical Area Information

 

Morningstar has 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 Licensed Data, Morningstar Advisor Workstation, Morningstar.com, Morningstar Direct, and Morningstar Principia. Licensed Data is a set of investment data spanning all of our investment databases, including real-time pricing data, and available through electronic data feeds. Advisor Workstation is a web-based investment planning system for advisors. Advisor Workstation is available in two editions: Morningstar Office for independent financial advisors and an enterprise edition for financial advisors affiliated with larger firms. Morningstar.com includes both Premium Memberships and Internet advertising sales. Morningstar Direct is a web-based institutional research platform. Principia is our CD-ROM-based investment research and planning software for advisors.

 

The Investment Information segment also includes Morningstar Equity Research, which we distribute through several channels. From June 2004 through July 2009, our equity research was distributed through six major investment banks to meet the requirements for independent research under the Global Analyst Research Settlement. The period covered by the Global Analyst Research Settlement expired at the end of July 2009. The investment banks covered by it are no longer required to provide independent research to their clients. We also sell Equity Research to other companies that purchase our research for their own use or provide our research to their affiliated advisors or individual investor clients.

 

·     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 Consulting, which focuses on investment monitoring and asset allocation for funds of funds, including mutual funds and variable annuities; Retirement Advice, 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, risk levels, and investment strategies that financial advisors can use for their clients’ taxable and tax-deferred accounts.

 

Our segment accounting policies are the same as those described in Note 2 to our Consolidated Financial Statements included in our Annual Report on Form 10-K as of December 31, 2009, 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 to arrive at the consolidated financial information. 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 show selected segment data for the three and six months ended June 30, 2010 and 2009:

 

 

 

Three months ended June 30, 2010

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

External revenue

 

$

109,021

 

$

27,070

 

$

 

$

136,091

 

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

 

74,785

 

12,166

 

8,572

 

95,523

 

Stock-based compensation expense

 

2,112

 

539

 

1,004

 

3,655

 

Depreciation and amortization

 

1,582

 

44

 

7,620

 

9,246

 

Operating income (loss)

 

$

30,542

 

$

14,321

 

$

(17,196

)

$

27,667

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

1,964

 

$

20

 

$

205

 

$

2,189

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

98,986

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

37,105

 

 

 

 

Three months ended June 30, 2009

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

External revenue

 

$

97,739

 

$

21,794

 

$

 

$

119,533

 

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

 

57,770

 

8,126

 

9,031

 

74,927

 

Stock-based compensation expense

 

1,526

 

517

 

1,025

 

3,068

 

Depreciation and amortization

 

1,201

 

89

 

7,560

 

8,850

 

Operating income (loss)

 

$

37,242

 

$

13,062

 

$

(17,616

)

$

32,688

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

1,713

 

$

148

 

$

317

 

$

2,178

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

89,286

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

30,247

 

 

 

 

Six months ended June 30, 2010

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

External revenue

 

$

212,545

 

$

51,836

 

$

 

$

264,381

 

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

 

142,430

 

23,098

 

15,467

 

180,995

 

Stock-based compensation expense

 

3,600

 

1,032

 

1,960

 

6,592

 

Depreciation and amortization

 

3,227

 

92

 

14,866

 

18,185

 

Operating income (loss)

 

$

63,288

 

$

27,614

 

$

(32,293

)

$

58,609

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

2,994

 

$

34

 

$

811

 

$

3,839

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

191,596

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

72,785

 

 

 

 

Six months ended June 30, 2009

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

External revenue

 

$

193,979

 

$

42,286

 

$

 

$

236,265

 

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

 

114,835

 

16,303

 

15,305

 

146,443

 

Stock-based compensation expense

 

2,793

 

985

 

2,015

 

5,793

 

Depreciation and amortization

 

2,272

 

109

 

14,335

 

16,716

 

Operating income (loss)

 

$

74,079

 

$

24,889

 

$

(31,655

)

$

67,313

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

5,473

 

$

332

 

$

963

 

$

6,768

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

177,434

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

58,831

 

 

 

 

As of June 30, 2010

 

 

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Goodwill

 

$

244,818

 

$

36,995

 

$

 

$

281,813

 

 

 

 

 

 

 

 

 

 

 

U.S. long-lived assets

 

 

 

 

 

 

 

$

40,573

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

$

15,880

 

 

 

 

As of December 31, 2009

 

 

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Goodwill

 

$

217,758

 

$

32,234

 

$

 

$

249,992

 

 

 

 

 

 

 

 

 

 

 

U.S. long-lived assets

 

 

 

 

 

 

 

$

42,884

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

$

16,944

 

Investments and Fair Value Measurements
Investments and Fair Value Measurements

6. 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:

 

($000)

 

As of June 30
2010

 

As of December 31
2009

 

Available-for-sale

 

$

153,963

 

$

197,306

 

Held-to-maturity

 

8,182

 

10,588

 

Trading securities

 

3,828

 

4,163

 

Total

 

$

165,973

 

$

212,057

 

 

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, 2010

 

As of December 31, 2009

 

($000)

 

Cost

 

Unrealized
Gain

 

Unrealized
Loss

 

Fair
Value

 

Cost

 

Unrealized
Gain

 

Unrealized
Loss

 

Fair
Value

 

Available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Government obligations

 

$

118,235

 

$

150

 

$

(28

)

$

118,357

 

$

174,433

 

$

439

 

$

(50

)

$

174,822

 

Corporate bonds

 

24,879

 

27

 

(69

)

24,837

 

12,268

 

44

 

(1

)

12,311

 

Equity securities

 

3,343

 

186

 

(430

)

3,099

 

2,013

 

188

 

(28

)

2,173

 

Mutual funds

 

8,000

 

 

(330

)

7,670

 

8,000

 

 

 

8,000

 

Total

 

$

154,457

 

$

363

 

$

(857

)

$

153,963

 

$

196,714

 

$

671

 

$

(79

)

$

197,306

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

$

8,182

 

$

 

$

 

$

8,182

 

$

10,588

 

$

 

$

 

$

10,588

 

 

As of June 30, 2010 and December 31, 2009, 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, 2010 and December 31, 2009. 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, 2010

 

As of December 31, 2009

 

($000)

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Available-for-sale:

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

122,134

 

$

122,209

 

$

161,453

 

$

161,817

 

Due in one to three years

 

20,980

 

20,985

 

25,248

 

25,316

 

Equity securities and mutual funds

 

11,343

 

10,769

 

10,013

 

10,173

 

Total

 

$

154,457

 

$

153,963

 

$

196,714

 

$

197,306

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity:

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

8,181

 

$

8,181

 

$

10,587

 

$

10,587

 

Due in one to three years

 

1

 

1

 

1

 

1

 

Total

 

$

8,182

 

$

8,182

 

$

10,588

 

$

10,588

 

 

Held-to-maturity investments include a $1,600,000 certificate of deposit held as collateral against two bank guarantees for our office lease 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)

 

2010

 

2009

 

Realized gains

 

$

17

 

$

9

 

Realized losses

 

(8

)

(531

)

Realized gains (loss), net

 

$

9

 

$

(522

)

 

The following table shows the net unrealized gains on trading securities as recorded in our Condensed Consolidated Statements of Income:

 

 

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

Unrealized gains (loss), net

 

$

(398

)

$

604

 

 

The fair value of our assets subject to fair value measurements and the necessary disclosures are as follows:

 

 

 

Fair Value

 

Fair Value Measurements as of

 

 

 

as of

 

June 30, 2010 Using Fair Value Hierarchy

 

($000)

 

June 30, 2010

 

Level 1

 

Level 2

 

Level 3

 

Available-for-sale investments

 

 

 

 

 

 

 

 

 

Government obligations

 

$

118,357

 

$

118,357

 

$

 

$

 

Corporate bonds

 

24,837

 

24,837

 

 

 

Equity securities

 

3,099

 

3,099

 

 

 

Mutual funds

 

7,670

 

7,670

 

 

 

Trading securities

 

3,828

 

3,828

 

 

 

Total

 

$

157,791

 

$

157,791

 

$

 

$

 

 

 

 

Fair Value

 

Fair Value Measurements as of

 

 

 

as of

 

December 31, 2009 Using Fair Value Hierarchy

 

($000)

 

December 31, 2009

 

Level 1

 

Level 2

 

Level 3

 

Available-for-sale investments

 

 

 

 

 

 

 

 

 

Government obligations

 

$

174,822

 

$

174,822

 

$

 

$

 

Corporate bonds

 

12,311

 

12,311

 

 

 

Equity securities

 

2,173

 

2,173

 

 

 

Mutual funds

 

8,000

 

8,000

 

 

 

Trading securities

 

4,163

 

4,163

 

 

 

Total

 

$

201,469

 

$

201,469

 

$

 

$

 

 

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.

 

We did not transfer any investments between levels of the fair value hierarchy in the first six months of 2010 or 2009. Based on our analysis of the nature and risks of our investments in equity securities and mutual funds, we have determined that presenting these investment categories each in the aggregate is appropriate.

Investments in Unconsolidated Entities
Investments in Unconsolidated Entities

7. Investments in Unconsolidated Entities

 

Our investments in unconsolidated entities consist primarily of the following:

 

($000)

 

As of June 30
2010

 

As of December 31
2009

 

Investment in MJKK

 

$

18,504

 

$

18,413

 

Other equity method investments

 

491

 

577

 

Investments accounted for using the cost method

 

5,104

 

5,089

 

Total investments in unconsolidated entities

 

$

24,099

 

$

24,079

 

 

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 Osaka Stock Exchange, “Hercules Market,” using the ticker 4765. 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
2010

 

As of December 31
2009

 

Morningstar’s approximate ownership of MJKK

 

34

%

34

%

 

 

 

 

 

 

Approximate market value of Morningstar’s ownership in MJKK:

 

 

 

 

 

Japanese yen (¥000)

 

¥

3,311,000

 

¥

2,600,000

 

Equivalent U.S. dollars ($000)

 

$

37,352

 

$

28,507

 

 

Other Equity Method Investments. As of June 30, 2010 and December 31, 2009, other equity method investments include our investments in Morningstar Danmark A/S (Morningstar Denmark) and Morningstar Sweden AB (Morningstar Sweden). Morningstar Denmark and Morningstar Sweden develop and market products and services customized for their respective markets. Our ownership interest in both Morningstar Denmark and Morningstar Sweden was approximately 25% as of June 30, 2010 and December 31, 2009.

 

Cost Method Investments. As of June 30, 2010 and December 31, 2009, our cost method investments consist mainly of minority investments in Pitchbook Data, Inc. (Pitchbook) and Bundle Corporation (Bundle). Pitchbook offers detailed data and information about private equity transactions, investors, companies, limited partners, and service providers. Bundle is a social media company dedicated to helping people make smarter spending and saving choices. Its website, Bundle.com, features a money comparison tool that shows spending trends across the United States, along with a range of information on saving, investing, and budgeting. We did not record any impairment losses on our cost method investments in the first six months of 2010 and 2009, respectively.

Liability for Vacant Office Space
Liability for Vacant Office Space

8. Liability for Vacant Office Space

 

The following table shows the change in our liability for vacant office space from December 31, 2009 to June 30, 2010:

 

Liability for vacant office space

 

($000)

 

Balance as of December 31, 2009

 

$

3,815

 

Increase liability for vacant office space

 

1,262

 

Reduction of liability for lease payments

 

(1,294

)

Other, net

 

(959

)

Balance as of June 30, 2010

 

$

2,824

 

 

In the first six months of 2010, we increased our liability for vacant office space for the former Ibbotson headquarters because we finalized sub-lease arrangements for a portion of this space. In addition, we increased our liability for vacant office space related to the equity research and data business acquired from C.P.M.S. These increases in the liability for vacant office space were recorded as an operating expense in the first six months of 2010.

Stock-Based Compensation
Stock-Based Compensation

9. Stock-Based Compensation

 

Stock-Based Compensation Plans

 

In November 2004, we adopted the 2004 Stock Incentive Plan. The 2004 Stock Incentive Plan provides for grants of options, stock appreciation rights, restricted stock units, and performance shares. All of our employees and our non-employee directors are eligible for awards under the 2004 Stock Incentive Plan. Joe Mansueto, our chairman and chief executive officer, does not participate in the 2004 Stock Incentive Plan or prior plans.

 

Since the adoption of the 2004 Stock Incentive Plan, we have granted stock options and, beginning in 2006, restricted stock units.

 

Restricted stock units represent the right to receive a share of Morningstar common stock when that unit vests. Restricted stock units granted under the 2004 Stock Incentive Plan generally vest ratably over a four-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. Stock options granted under the 2004 Stock Incentive Plan generally vest ratably over a four-year period and expire 10 years after the date of grant. Almost all of the options granted under the 2004 Stock Incentive Plan have a premium feature in which the exercise price increases over the term of the option at a rate equal to the 10-year Treasury bond yield as of the date of grant.

 

The following table summarizes the number of shares available for future grants under our 2004 Stock Incentive Plan:

 

(000)

 

As of June 30
2010

 

As of December 31
2009

 

Shares available for future grants

 

1,818

 

2,143

 

 

Prior to November 2004, we granted stock options under various plans, including the 1993 Stock Option Plan, the 2000 Morningstar Stock Option Plan, and the 2001 Morningstar Stock Option Plan (collectively, the Prior Plans). The 2004 Stock Incentive Plan amends and restates the Prior Plans. Under the 2004 Stock Incentive Plan, we will not grant any additional options under any of the Prior Plans, and any shares subject to an award under any of the Prior Plans that are forfeited, canceled, settled, or otherwise terminated without a distribution of shares, or withheld by us in connection with the exercise of options or in payment of any required income tax withholding, will not be available for awards under the 2004 Stock Incentive Plan.

 

All options granted under the 2004 Stock Incentive Plan and the Prior Plans were vested as of January 1, 2010; however, because the options under these plans expire 10 years after the date of grant, some options granted under these plans remain outstanding as of June 30, 2010.

 

Restricted Stock

 

In conjunction with the Realpoint acquisition in May 2010, we issued 199,174 shares of restricted stock to the selling employee-shareholders. The restricted stock vests ratably over a five-year period from the acquisition date and may be subject to forfeiture if the holder terminates his or her employment during the vesting period. Because of the terms of the restricted share agreements, in accordance with ASC 805, Business Combinations, we account for these grants as stock-based compensation expense, and not as part of the acquisition consideration. See Note 3, in the Notes to our Condensed Consolidated Financial Statements, for additional information concerning the Realpoint acquisition.

 

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 three and six months ended June 30, 2010 and 2009:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

2010

 

2009

 

Restricted stock units

 

$

3,343

 

$

2,735

 

$

6,280

 

$

4,905

 

Restricted stock

 

312

 

 

312

 

 

Stock options

 

 

333

 

 

888

 

Total stock-based compensation expense

 

$

3,655

 

$

3,068

 

$

6,592

 

$

5,793

 

 

 

 

 

 

 

 

 

 

 

Income tax benefit related to the stock-based compensation expense

 

$

1,008

 

$

967

 

$

1,901

 

$

1,834

 

 

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. Because our largest annual equity grants typically have vesting dates in the second quarter, we adjust the stock-based compensation expense at that time to reflect those awards that ultimately vested and update our estimate of the forfeiture rate that will be applied to awards not yet vested. In the second quarter of 2010 and 2009, we recorded approximately $228,000 and $299,000, respectively, of additional stock-based compensation expense as a result of these adjustments.

 

Restricted Stock Units

 

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 2010:

 

Restricted Stock Units (RSUs)

 

Unvested

 

Vested but
Deferred

 

Total

 

Weighted
Average
Grant Date Value
per RSU

 

RSUs outstanding—December 31, 2009

 

681,425

 

39,594

 

721,019

 

$

46.99

 

Granted

 

346,474

 

 

346,474

 

47.85

 

Vested

 

(200,462

)

 

(200,462

)

47.80

 

Vested but deferred

 

(15,996

)

15,996

 

 

 

Issued

 

 

(11,153

)

(11,153

)

49.29

 

Forfeited

 

(21,022

)

 

(21,022

)

47.13

 

RSUs outstanding—June 30, 2010

 

790,419

 

44,437

 

834,856

 

47.12

 

 

As of June 30, 2010, the total amount of unrecognized stock-based compensation expense related to restricted stock units was approximately $32,184,000. We expect to recognize this expense over an average period of approximately 36 months.

 

Restricted Stock

 

We measure the fair value of the restricted stock on the date of grant based on the closing market price of our common stock on the day prior to the grant. We amortize this value to stock-based compensation expense ratably over the vesting period. We have assumed that all of the restricted stock will ultimately vest, and therefore we have not incorporated a forfeiture rate for purposes of determining the stock-based compensation expense.

 

As of June 30, 2010, the total amount of unrecognized stock-based compensation expense related to restricted stock was approximately $9,051,000. We expect to recognize this expense over 58 months, from July 2010 through April 2015.

 

Stock Option Activity

 

The following tables summarize stock option activity in the first six months of 2010 for our various stock option grants. The first table includes activity for options granted at an exercise price below the fair value per share of our common stock on the grant date; the second table includes activity for all other option grants.

 

Options Granted At an Exercise Price Below the Fair Value Per Share on the Grant Date

 

Underlying
Shares

 

Weighted
Average
Exercise
Price

 

Options outstanding—December 31, 2009

 

809,169

 

$

17.75

 

Cancelled

 

(600

)

13.68

 

Exercised

 

(59,526

)

13.08

 

Options outstanding—June 30, 2010

 

749,043

 

18.50

 

 

 

 

 

 

 

Options exercisable—June 30, 2010

 

749,043

 

$

18.50

 

 

All Other Option Grants, Excluding Activity Shown Above

 

Underlying
Shares

 

Weighted
Average
Exercise
Price

 

Options outstanding—December 31, 2009

 

1,868,408

 

$

16.02

 

Canceled

 

(8,592

)

14.38

 

Exercised

 

(376,279

)

14.82

 

Options outstanding—June 30, 2010

 

1,483,537

 

16.69

 

 

 

 

 

 

 

Options exercisable—June 30, 2010

 

1,483,537

 

$

16.69

 

 

The following table summarizes the total intrinsic value (difference between the market value of our stock on the date of exercise and the exercise price of the option) of options exercised:

 

 

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

Intrinsic value of options exercised

 

$

14,502

 

$

25,041

 

 

All outstanding options were vested and exercisable as of January 1, 2010. The table below shows additional information for options outstanding and exercisable as of June 30, 2010:

 

 

 

Options Outstanding and Exercisable

 

Range of Exercise Prices

 

Number of Options

 

Weighted
Average
Remaining
Contractual
Life (years)

 

Weighted
Average
Exercise
Price

 

Aggregate
Intrinsic
Value
($000)

 

$8.57 - $14.70

 

926,942

 

1.8

 

$

11.44

 

$

28,810

 

$18.55 - $42.03

 

1,305,638

 

4.7

 

21.47

 

27,487

 

$8.57 - $42.03

 

2,232,580

 

3.5

 

17.30

 

$

56,297

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value all option holders would have received if they had exercised all outstanding options on June 30, 2010. The intrinsic value is based on our closing stock price of $42.52 on that date.

 

As of June 30, 2010, there was no unrecognized stock-based compensation expense related to stock options.

 

Excess Tax Benefits Related to Stock-Based Compensation

 

FASB ASC 718, Compensation—Stock Compensation, requires that we classify the cash flows that result from excess tax benefits as financing cash flows. Excess tax benefits correspond to the portion of the tax deduction taken on our income tax return that exceeds the amount of tax benefit related to the compensation cost recognized in our Statement of Income. The following table summarizes our excess tax benefits for the three and six months ended June 30, 2010 and 2009:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

2010

 

2009

 

Excess tax benefits related to stock-based compensation

 

$

1,157

 

$

4,194

 

$

4,205

 

$

4,544

 

Related Party Transactions
Related Party Transactions

10. Related Party Transactions

 

In 2009, we determined that certain incentive stock options (ISOs) granted to one former and two current executives, including Tao Huang, our chief operating officer, should have been treated as non-qualified stock options (NQSOs) for the executives’ and our income tax purposes. In the fourth quarter of 2009, we recorded an operating expense of $4,887,000 related to adjusting the tax treatment of these stock options that were originally considered ISOs. In the first quarter of 2010, we paid these individuals $4,887,000 to compensate for the difference in tax treatment.

Income Taxes
Income Taxes

11. Income Taxes

 

The following table shows our effective income tax rate for the three months ended June 30, 2010 and 2009:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2010

 

2009

 

2010

 

2009

 

Income before income taxes and equity in net income (loss) of unconsolidated entities

 

$

27,688

 

$

34,660

 

$

58,451

 

$

69,819

 

Equity in net income (loss) of unconsolidated entities

 

454

 

(21

)

843

 

361

 

Net (income) loss attributable to noncontrolling interests

 

85

 

(71

)

116

 

18

 

Total

 

$

28,227

 

$

34,568

 

$

59,410

 

$

70,198

 

Income tax expense

 

$

10,225

 

$

14,024

 

$

21,220

 

$

24,692

 

Effective tax rate

 

36.2

%

40.6

%

35.7

%

35.2

%

 

Our effective tax rate declined 4.4 percentage points in the second quarter of 2010. The deposit penalty of $3,500,000, which decreased pre-tax income in the second quarter of 2009, and which is not deductible for tax purposes, accounted for 3.7 percentage points of the effective tax rate in the second quarter of 2009, and did not recur in 2010.

 

For the first six months of 2010, our effective tax rate was slightly higher compared with the same period in 2009. The 2009 year-to-date effective tax rate included a net benefit which did not recur in 2010. The effective tax rate in the first half of 2009 reflects the impact from the first quarter of 2009 of reversing a $1,420,000 reserve for uncertain tax positions as a result of a lapse in the statute of limitations and the reversal in the second quarter of 2009 of $635,000 of reserves due to settlements and other audit activity. These non-cash benefits had a favorable impact of approximately 3 percentage points in the prior year period. This benefit was partially offset by the impact of the non-deductible deposit penalty expense, which increased our effective tax rate by approximately 2 percentage points in the first six months of 2009.

 

We conduct business globally and as a result, we file income tax returns in U.S. Federal, state, local, and foreign jurisdictions. In the normal course of business we are subject to examination by tax authorities throughout the world. The open tax years for our U.S. Federal tax return include the years 2006 to the present. Most of our state tax returns have open tax years from 2006 to the present. In non-U.S. jurisdictions, the statute of limitations generally extends to years prior to 2003.

 

There were no significant changes to uncertain tax positions in the second quarter of 2010 as a result of other lapses of statutes of limitation or audit activity. As of December 31, 2009, our Condensed Consolidated Balance Sheet included a current liability of $981,000 and a non-current liability of $5,369,000 for unrecognized tax benefits. These amounts include interest and penalties, less any associated tax benefits.

 

We are currently under audit by various state and local tax authorities in the United States. We are also under audit by the tax authorities in certain non-U.S. jurisdictions. It is likely that the examination phase of some of these state, local, and non-U.S. audits will conclude in 2010. It is not possible to estimate the impact of current audits on previously recorded unrecognized tax benefits.

 

Our effective tax rate reflects the fact that we are not recording an income tax benefit related to losses recorded by certain of our non-U.S. operations. The net operating losses (NOLs) may become deductible in certain non-U.S. tax jurisdictions to the extent these non-U.S. operations become profitable. In the year certain non-U.S. entities record a loss, we do not record a corresponding tax benefit, thus increasing our effective tax rate. For each of our operations, we evaluate whether it is more likely than not that the tax benefits related to NOLs will be realized. As part of this evaluation, we consider evidence such as tax planning strategies, historical operating results, forecasted taxable income, and recent financial performance. Upon determining that it is more likely than not that the NOLs will be realized, we reduce the tax valuation allowances related to these NOLs, which results in a reduction to our income tax expense and our effective tax rate in the period.

Contingencies
Contingencies

12. Contingencies

 

Egan-Jones Rating Co.

 

In June 2010, Egan-Jones Rating Co. filed a complaint in the Court of Common Pleas of Montgomery County, Pennsylvania against Realpoint LLC and Morningstar, Inc. in connection with a December 2007 agreement between Egan-Jones and Realpoint for certain data sharing and other services. In addition to damages, Egan-Jones seeks injunctive relief against Morningstar to temporarily prevent us from offering corporate credit ratings. While Realpoint and Morningstar are vigorously contesting the claims, we cannot predict the outcome of the proceeding.

 

Aloft Media, LLC

 

In June 2010, Aloft Media, LLC filed a complaint in the United States District Court for the Eastern District of Texas against Morningstar, Inc. and several other companies alleging that each defendant infringes U.S. Patent No. 7,593,910 and 7,596,538 which purports to relate to a computer-based platform that supports a decision making process. Aloft Media seeks, among other things, unspecified damages and costs incurred by Aloft Media because of defendants’ alleged infringing activities. Morningstar is evaluating the lawsuit but cannot predict the outcome of the proceeding.

 

Business Logic Holding Corporation

 

In November 2009, Business Logic Holding Corporation filed a complaint in the Circuit Court of Cook County, Illinois against Ibbotson Associates, Inc. and Morningstar, Inc. relating to Ibbotson’s prior commercial relationship with Business Logic. Business Logic is alleging that Ibbotson Associates and Morningstar violated Business Logic’s rights by using its trade secrets to develop a proprietary web-service software and user interface that connects plan participant data with the Ibbotson Wealth Forecasting Engine. Business Logic seeks, among other things, injunctive relief and unspecified damages. While Morningstar and Ibbotson Associates are vigorously contesting the claims against them, we cannot predict the outcome of the proceeding.

 

Online News Link LLC

 

In October 2009, Online News Link LLC filed a complaint in the United States District Court for the Eastern District of Texas against Morningstar, Inc. and several other providers of online information alleging that each defendant infringes U.S. Patent No. 7,508,789, which relates to ways for delivering online information. In July 2010, Morningstar and Online News Link entered into a license agreement covering patents relating to, among other things, the delivery of news content via electronic mail with links to additional content. The license agreement resolves the litigation. All other settlement terms are confidential.

 

Morningstar Associates, LLC Subpoena from the New York Attorney General’s Office

 

In December 2004, Morningstar Associates, LLC, a wholly owned subsidiary of Morningstar, Inc., received a subpoena from the New York Attorney General’s office seeking information and documents related to an investigation the New York Attorney General’s office is conducting. The subpoena asks for documents relating to the investment consulting services the company offers to retirement plan providers, including fund lineup recommendations for retirement plan sponsors. Morningstar Associates has provided the requested information and documents.

 

In 2005, Morningstar Associates received subpoenas seeking information and documents related to investigations being conducted by the SEC and United States Department of Labor. The subpoenas were similar in scope to the New York Attorney General subpoena. In January 2007 and September 2009, respectively, the SEC and Department of Labor each notified Morningstar Associates that it had ended its investigation, with no enforcement action, fines, or penalties.

 

In January 2007, Morningstar Associates received a Notice of Proposed Litigation from the New York Attorney General’s office. The Notice centers on disclosure relating to an optional service offered to retirement plan sponsors (employers) that select 401(k) plan services from ING, one of Morningstar Associates’ clients. The Notice gave Morningstar Associates the opportunity to explain why the New York Attorney General’s office should not institute proceedings. Morningstar Associates promptly submitted its explanation and has cooperated fully with the New York Attorney General’s office.

 

We cannot predict the scope, timing, or outcome of this matter, which may include the institution of administrative, civil, injunctive, or criminal proceedings, the imposition of fines and penalties, and other remedies and sanctions, any of which could lead to an adverse impact on our stock price, the inability to attract or retain key employees, and the loss of customers. We also cannot predict what impact, if any, this matter may have on our business, operating results, or financial condition.

 

In addition to these proceedings, we are involved in legal proceedings and litigation that have arisen in the normal course of our business. Although the outcome of a particular proceeding can never be predicted, we do not believe that the result of any of these other matters will have a material adverse effect on our business, operating results, or financial condition.

Subsequent Events
Subsequent Events

13. Subsequent Events

 

We completed the following acquisitions subsequent to June 30, 2010. We used approximately $22,500,000 of our cash and investments for these acquisitions.

 

Increased Ownership Interest in Morningstar Denmark

 

In July 2010, we acquired an additional 75% interest in Morningstar Denmark, increasing our ownership to 100% from 25%. Morningstar Denmark’s main offering is the investment information website for individual investors, Morningstar.dk, which provides fund and ETF data, portfolio tools, and market analysis.

 

Seeds Group

 

In July 2010, we acquired Seeds Group, a leading provider of investment consulting services and fund research in France. Through its subsidiary Seeds Finance, the company provides investment consulting services to pension funds, insurance companies, asset managers, banks, and brokerage firms and specializes in asset liability management, manager selection, plan construction, risk, and portfolio management in alternative investments and active strategies. In addition to investment consulting, Seeds Group also operates Multiratings.com, a fund research and investment education website for advisor groups and institutions. With both basic and premium subscription levels, the site offers editorial and video commentary, fund and industry analysis, and research tools.

Recently Issued Accounting Pronouncements
Recently Issued Accounting Pronouncements

14. Recently Issued Accounting Pronouncements

 

In October 2009, the FAS