MORNINGSTAR, INC., 10-Q filed on 8/2/2011
Quarterly Report
Document and Entity Information
6 Months Ended
Jun. 30, 2011
Jul. 29, 2011
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, 2011 
 
Document Fiscal Year Focus
2011 
 
Document Fiscal Period Focus
Q2 
 
Amendment Flag
FALSE 
 
Entity Common Stock, Shares Outstanding
 
50,573,958 
Condensed Consolidated Statements of Income (USD $)
In Thousands, except Share data
3 Months Ended
Jun. 30,
6 Months Ended
Jun. 30,
2011
2010
2011
2010
Revenue
$ 161,011 
$ 136,091 
$ 312,778 
$ 264,381 
Operating expense (1):
 
 
 
 
Cost of goods sold
45,186 
39,738 
85,855 
74,054 
Development
13,681 
11,899 
25,669 
22,788 
Sales and marketing
26,767 
24,435 
53,249 
46,996 
General and administrative
26,207 
23,106 
56,824 
43,749 
Depreciation and amortization
10,563 
9,246 
20,765 
18,185 
Total operating expense
122,404 
108,424 
242,362 
205,772 
Operating income
38,607 
27,667 
70,416 
58,609 
Non-operating income (expense):
 
 
 
 
Interest income (expense), net
(179)
593 
345 
1,180 
Other income (expense), net
188 
(572)
438 
(1,338)
Non-operating income (expense), net
21 
783 
(158)
Income before income taxes and equity in net income of unconsolidated entities
38,616 
27,688 
71,199 
58,451 
Income tax expense
12,724 
10,225 
23,242 
21,220 
Equity in net income of unconsolidated entities
595 
454 
969 
843 
Consolidated net income
26,487 
17,917 
48,926 
38,074 
Net (income) loss attributable to the noncontrolling interest
(2)
85 
96 
116 
Net income attributable to Morningstar, Inc.
26,485 
18,002 
49,022 
38,190 
Net income per share attributable to:
 
 
 
 
Basic (in dollars per share)
$ 0.53 
$ 0.37 
$ 0.98 
$ 0.78 
Diluted (in dollars per share)
$ 0.52 
$ 0.36 
$ 0.96 
$ 0.76 
Weighted average shares outstanding:
 
 
 
 
Basic (in shares)
50,165,000 
49,234,000 
49,983,000 
49,032,000 
Diluted (in shares)
51,142,000 
50,533,000 
51,041,000 
50,426,000 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
3,843 
3,655 
7,492 
6,592 
Cost of Sales [Member]
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
1,072 
907 
1,951 
1,622 
Research and Development Expense [Member]
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
572 
449 
1,043 
842 
Selling and Marketing Expense [Member]
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
481 
486 
903 
889 
General and Administrative Expense [Member]
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
$ 1,718 
$ 1,813 
$ 3,595 
$ 3,239 
Condensed Consolidated Balance Sheets (USD $)
In Thousands
Jun. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 195,023 
$ 180,176 
Investments
235,216 
185,240 
Accounts receivable, less allowance of $767 and $1,056, respectively
111,518 
110,891 
Deferred tax asset, net
2,787 
2,860 
Income tax receivable, net
14,381 
10,459 
Other
16,497 
17,654 
Total current assets
575,422 
507,280 
Property, equipment, and capitalized software, net
62,062 
62,105 
Investments in unconsolidated entities
24,424 
24,262 
Goodwill
326,543 
317,661 
Intangible assets, net
156,940 
169,023 
Other assets
7,675 
5,971 
Total assets
1,153,066 
1,086,302 
Current liabilities:
 
 
Accounts payable and accrued liabilities
38,646 
42,680 
Accrued compensation
50,089 
62,404 
Deferred revenue
156,760 
146,267 
Other
761 
1,373 
Total current liabilities
246,256 
252,724 
Accrued compensation
4,855 
4,965 
Deferred tax liability, net
19,477 
19,975 
Other long-term liabilities
26,256 
27,213 
Total liabilities
296,844 
304,877 
Morningstar, Inc. shareholders' equity:
 
 
Common stock, no par value, 200,000,000 shares authorized, of which 50,539,113 and 49,874,392 shares were outstanding as of June 30, 2011 and December 31, 2010, respectively
Treasury stock at cost, 266,334 shares as of June 30, 2011 and 279,456 shares as of December 31, 2010
(6,391)
(6,641)
Additional paid-in capital
476,456 
458,426 
Retained earnings
367,310 
323,408 
Accumulated other comprehensive income:
 
 
Currency translation adjustment
17,070 
4,503 
Unrealized gain on available-for-sale securities
762 
615 
Total accumulated other comprehensive income
17,832 
5,118 
Total Morningstar, Inc. shareholders' equity
855,212 
780,316 
Noncontrolling interest
1,010 
1,109 
Total equity
856,222 
781,425 
Total liabilities and equity
$ 1,153,066 
$ 1,086,302 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
Jun. 30, 2011
Dec. 31, 2010
Statement of Financial Position [Abstract]
 
 
Accounts receivable, allowance (in dollars)
$ 767,000 
$ 1,056,000 
Common stock, no par value (in dollars per share)
$ 0 
$ 0 
Common stock, shares authorized
200,000,000 
200,000,000 
Common stock, shares outstanding
50,539,113 
49,874,392 
Treasury stock, shares
266,334 
279,456 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) (USD $)
In Thousands, except Share data
Total
Common Stock [Member]
Treasury Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Non Controlling Interests
Morningstar, Inc. Shareholders' Equity
Balance at Dec. 31, 2010
$ 781,425 
$ 5 
$ (6,641)
$ 458,426 
$ 323,408 
$ 5,118 
$ 1,109 
$ 781,425 
Balance (in shares) at Dec. 31, 2010
 
49,874,392 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net Income (loss)
48,926 
49,022 
(96)
48,926 
Unrealized gain on available-for-sale investments, net of income tax of $73
 
147 
147 
Foreign currency translation adjustment, net
 
12,567 
(3)
12,564 
Total comprehensive income (loss)
 
49,022 
12,714 
(99)
61,637 
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
359 
4,293 
4,652 
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net (in shares)
 
666,614 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
 
6,117 
6,117 
Stock-based compensation - restricted stock
 
1,308 
1,308 
Stock Issued During Period, Value, Share-based Compensation, Net of Forfeitures
 
67 
67 
Excess tax benefit derived from stock-option exercises and vesting of restricted stock units
 
6,171 
6,171 
Dividends declared - common shares outstanding
 
(5,042)
(5,042)
Dividends declared - restricted stock units
 
74 
(78)
(4)
Common share repurchased
 
(109)
(109)
Common share repurchased (in shares)
 
(1,893)
 
 
 
 
 
 
Balance at Jun. 30, 2011
$ 856,222 
$ 5 
$ (6,391)
$ 476,456 
$ 367,310 
$ 17,832 
$ 1,010 
$ 856,222 
Balance (in shares) at Jun. 30, 2011
 
50,539,113 
 
 
 
 
 
 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) Parentheticals (USD $)
In Thousands
6 Months Ended
Jun. 30, 2011
Statement of Stockholders' Equity [Abstract]
 
Other Comprehensive Income (Loss), Unrealized Holding Gain (Loss) on Securities Arising During Period, Tax
$ 73 
Condensed Consolidated Statements of Cash Flows (USD $)
In Thousands
6 Months Ended
Jun. 30,
2011
2010
Operating activities
 
 
Consolidated net income
$ 48,926 
$ 38,074 
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
Depreciation and amortization
20,765 
18,185 
Deferred income tax expense (benefit)
454 
(1,012)
Stock-based compensation expense
7,492 
6,592 
Provision for bad debt
530 
356 
Equity in net income of unconsolidated entities
(969)
(843)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
(6,171)
(4,205)
Other, net
(547)
1,386 
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
Accounts receivable
617 
(6,615)
Other assets
608 
(511)
Accounts payable and accrued liabilities
(5,260)
2,859 
Accrued compensation
(14,528)
(11,154)
Income taxes payable
2,742 
(4,255)
Deferred revenue
8,197 
7,177 
Deferred rent
(657)
(80)
Other liabilities
(1,043)
(924)
Cash provided by operating activities
61,156 
45,030 
Investing activities
 
 
Purchases of investments
(198,647)
(85,528)
Proceeds from maturities and sales of investments
150,360 
130,381 
Capital expenditures
(8,418)
(3,839)
Acquisitions, net of cash acquired
569 
(67,455)
Other, net
785 
889 
Cash used for investing activities
(55,351)
(25,552)
Financing activities
 
 
Proceeds from stock-option exercises, net
4,652 
3,650 
Excess tax benefits from stock-option exercises and vesting of restricted stock units
6,171 
4,205 
Common shares repurchased
(109)
Dividends paid
(5,011)
Other, net
(214)
205 
Cash provided by financing activities
5,489 
8,060 
Effect of exchange rate changes on cash and cash equivalents
3,553 
(3,657)
Net increase in cash and cash equivalents
14,847 
23,881 
Cash and cash equivalents-beginning of period
180,176 
130,496 
Cash and cash equivalents-end of period
195,023 
154,377 
Supplemental disclosure of cash flow information:
 
 
Cash paid for income taxes
21,104 
26,396 
Supplemental information of non-cash investing and financing activities:
 
 
Unrealized Gain (Loss) on Available For Sale Investments
$ 220 
$ (941)
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, 2010, filed with the SEC on February 28, 2011.
 
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
EITF: Emerging Issues Task Force
FASB: Financial Accounting Standards Board
SAB: Staff Accounting Bulletin
SEC: Securities and Exchange Commission
 
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, 2010, filed with the SEC on February 28, 2011.


In addition, effective January 1, 2011, we adopted FASB ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-13 supersedes EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables and establishes the accounting and reporting guidance for arrangements when a vendor performs multiple revenue-generating activities, addresses how to separate deliverables, and specifies how to measure and allocate arrangement consideration. We are applying this guidance for revenue arrangements entered into or materially modified from January 1, 2011. The adoption of ASU 2009-13 does not significantly affect either the timing or amount of our revenue recognition.


In conjunction with the adoption of ASU 2009-13, we have updated our disclosures concerning revenue recognition, as follows:


Revenue recognition:  We recognize revenue in accordance with SEC SAB Topic 13, Revenue Recognition, ASC 605-25, Revenue Recognition:  Multiple Element Arrangements, and ASC 985-605, Software: Revenue Recognition.


We recognize revenue when all of the following conditions are met:


There is persuasive evidence of an arrangement, as evidenced by a signed contract;
Delivery of our products and services is a prerequisite for recognition of revenue. If arrangements include an acceptance provision, we generally begin recognizing revenue upon the receipt of customer acceptance;
The amount of fees to be paid by the customer is fixed or determinable; and
The collectibility of the fees is reasonably assured.


We generate revenue through sales of Licensed Data, Morningstar Advisor Workstation (including Morningstar Office), Morningstar Direct, Morningstar Equity Research, Premium membership fees for Morningstar.com, and a variety of other investment-related products and services. The revenue arrangements for these offerings are generally structured as licenses or subscriptions. We recognize revenue from licenses and subscription sales ratably as the product or service is delivered and over the service obligation period defined by the terms of the customer contract.


We also generate revenue from Internet advertising, primarily from “impression-based” contracts. For advertisers who use our cost-per-impression pricing, we charge fees each time their ads are displayed on our site.


Investment Consulting includes a broad range of services. Pricing for the consulting services is based on the scope of work and the level of service required, and includes asset-based fees for work we perform that involves investment management or acting as a subadvisor to investment portfolios. In arrangements that involve asset-based fees, we generally invoice clients quarterly in arrears based on average assets for the quarter. We recognize asset-based fees once the fees are fixed and determinable assuming all other revenue recognition criteria are met.


Our Retirement Solutions offerings help retirement plan participants plan and invest for retirement. We offer these services both through retirement plan providers (typically third-party asset management companies that offer proprietary mutual funds) and directly to plan sponsors (employers that offer retirement plans to their employees). For our Retirement Solutions offerings, we provide both a hosted solution as well as proprietary installed software advice solution. The installed customized software can be integrated with a client’s existing systems to help investors accumulate wealth, transition into retirement, and manage income during retirement. The revenue arrangements for Retirement Solutions generally extend over multiple years. Our contracts may include one-time setup fees, implementation fees, technology licensing and maintenance fees, asset-based fees for managed retirement accounts, fixed and variable fees for advice and guidance, or a combination of these fee structures. Upon customer acceptance, we recognize revenue ratably over the term of the agreement. We recognize asset-based fees and variable fees in excess of any minimum once the value is fixed and determinable.


Some of our revenue arrangements with our customers combine multiple products and services. These products and services may be provided at different points in time or over different time periods within the same arrangement. We allocate fees to the separate deliverables based on the deliverables’ relative selling price. This relative selling price is generally based on the price we charge when the same deliverable is sold separately.


We record taxes imposed on revenue-producing transactions (such as sales, use, value-added, and some excise taxes) on a net basis; therefore, such taxes are excluded from revenue in our Consolidated Statements of Income.


Deferred revenue represents the portion of subscriptions billed or collected in advance of the service being provided, which we expect to recognize as revenue in future periods. Certain arrangements may have cancellation or refund provisions. If we make a refund, it typically reflects the amount collected from a customer for which services have not yet been provided. The refund therefore results in a reduction of deferred revenue.




Acquisitions, Goodwill, and Other Intangible Assets
Acquisitions, Goodwill, and Other Intangible Assets
Acquisitions, Goodwill, and Other Intangible Assets
 
2011 Acquisitions
 
We did not complete any acquisitions in the first six months of 2011.
 
2010 Acquisitions
 
The table below summarizes the acquisitions completed during 2010. Some of the purchase price allocations related to these acquisitions are preliminary as they relate to tax-related balances and values of certain intangible assets. Additional information concerning these acquisitions 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 February 28, 2011.
Acquisition
 
Description
 
Date of Acquisition
 
Purchase Price*
Footnoted business of Financial Fineprint Inc.
 
Footnoted is a highly regarded blog for professional money managers, analysts, and sophisticated individual investors. Footnoted Pro, a service for institutional investors, provides insight on actionable items and trends in SEC filings.
 
February 1, 2010
 
Not separately disclosed
Aegis Equities Research
 
A leading provider of independent equity research in Sydney, Australia.
 
April 1, 2010
 
$10.3 million
Old Broad Street Research Ltd.
 
A premier provider of fund research, ratings, and investment consulting services in the United Kingdom.
 
April 12, 2010
 
$16.8 million
Realpoint, LLC
 
A Nationally Recognized Statistical Rating Organization (NRSRO) that specializes in structured finance.
 
May 3, 2010
 
$38.4 million in cash and 199,174 shares of restricted stock (valued at approximately $10 million as of the date the acquisition was announced in March 2010)
Morningstar Danmark A/S (Morningstar Denmark)
 
Acquisition of the 75% ownership interest not previously owned by Morningstar, bringing our ownership to 100%.
 
July 1, 2010
 
$14.6 million
Seeds Group
 
A leading provider of investment consulting services and fund research in France.
 
July 1, 2010
 
Not separately disclosed
Annuity Intelligence business of Advanced Sales and Marketing Corporation
 
The Annuity Intelligence business provides a web-based service that leverages a proprietary database of more than 1,000 variable annuities that includes "plain-English" translations of complex but important information found in prospectuses and other public filings.
 
November 1, 2010
 
$14.1 million
____________________________________________
* Total purchase price, less cash acquired, subject to post closing adjustments.
 
Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2010 to June 30, 2011:
 
 
($000)


Balance as of December 31, 2010
$
317,661


Adjustments to 2010 acquisitions
1,387


Other, primarily currency translation
7,495


Balance as of June 30, 2011
$
326,543






We did not record any impairment losses in the second quarter of 2011 and 2010, respectively. We perform our annual impairment reviews in the fourth quarter.


The following table summarizes our intangible assets: 
 
 
As of June 30, 2011
 
As of December 31, 2010
($000)
 
Gross


 
Accumulated
Amortization


 
Net


 
Weighted
Average
Useful  Life
(years)


 
Gross


 
Accumulated
Amortization


 
Net


 
Weighted
Average
Useful  Life
(years)


Intellectual property
 
$
32,759


 
$
(17,744
)
 
$
15,015


 
10


 
$
33,990


 
$
(15,970
)
 
$
18,020


 
10


Customer-related assets
 
137,412


 
(46,880
)
 
90,532


 
12


 
130,675


 
(39,951
)
 
90,724


 
11


Supplier relationships
 
240


 
(78
)
 
162


 
20


 
240


 
(72
)
 
168


 
20


Technology-based assets
 
81,556


 
(30,992
)
 
50,564


 
9


 
78,651


 
(25,682
)
 
52,969


 
9


Non-competition agreement
 
1,781


 
(1,114
)
 
667


 
4


 
1,751


 
(909
)
 
842


 
4


Intangible assets related to acquisitions with preliminary purchase price allocations
 


 


 


 


 
6,407


 
(107
)
 
6,300


 
10


Total intangible assets
 
$
253,748


 
$
(96,808
)
 
$
156,940


 
10


 
$
251,714


 
$
(82,691
)
 
$
169,023


 
10




 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended June 30
 
Six months ended June 30
($000)
 
2011


 
2010


 
2011


 
2010


Amortization expense
 
$
6,632


 
$
5,848


 
$
13,145


 
$
11,316




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


We expect intangible amortization expense for 2011 and subsequent years as follows:
 
($000)


2011
$
25,947


2012
24,416


2013
21,677


2014
20,407


2015
19,525


2016
14,896




 
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
Income Per Share
 
We compute income per share based on the two-class method, in accordance with FASB ASC 260-10-45-59A, Participating Securities and the Two Class Method. We issued restricted shares in conjunction with the Realpoint acquisition. Because the restricted shares contain nonforfeitable rights to dividends, they meet the criteria of a participating security. Under the two-class method, earnings are allocated between common stock and participating securities. The two-class method includes an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and undistributed earnings for the period. We reduce our reported net earnings by the amount allocated to participating securities to arrive at the earnings allocated to common stock shareholders for purposes of calculating earnings per share.
ASC 260-10-45-59A requires the dilutive effect of participating securities to be calculated using the more dilutive of the treasury stock or the two-class method. We have determined the two-class method to be the more dilutive of the two methods. As such, we adjusted the earnings allocated to common stock shareholders in the basic earnings per share calculation for the reallocation of undistributed earnings to participating securities to calculate diluted earnings 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)
 
2011


 
2010


 
2011


 
2010


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


 
 


 
 
 
 
Net income attributable to Morningstar, Inc.:
 
$
26,485


 
$
18,002


 
$
49,022


 
$
38,190


Less: Distributed earnings available to participating securities
 
(8
)
 


 
(17
)
 


Less: Undistributed earnings available to participating securities
 
(72
)
 


 
(131
)
 


Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,405


 
$
18,002


 
$
48,874


 
$
38,190


 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
50,165


 
49,234


 
49,983


 
49,032


 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.53


 
$
0.37


 
$
0.98


 
$
0.78


 
 




 




 




 




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




 




 




 




Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,405


 
$
18,002


 
$
48,874


 
$
38,190


Add: Undistributed earnings allocated to participating securities
 
72


 


 
131


 


Less: Undistributed earnings reallocated to participating securities
 
(70
)
 


 
(129
)
 


Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,407


 
$
18,002


 
$
48,876


 
$
38,190


 
 




 




 




 




Weighted average common shares outstanding
 
50,165


 
49,234


 
49,983


 
49,032


Net effect of dilutive stock options and restricted stock units
 
977


 
1,299


 
1,058


 
1,394


Weighted average common shares outstanding for computing diluted income per share
 
51,142


 
50,533


 
51,041


 
50,426


 
 




 




 




 




Diluted net income per share attributable to Morningstar, Inc.
 
$
0.52


 
$
0.36


 
$
0.96


 
$
0.76




Segment and Geographical Area Information
Segment and Geographical Area Information
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 (including Morningstar Office), Morningstar.com, Morningstar Direct, Morningstar Integrated Web Tools (formerly Morningstar Site Builder), and Morningstar Principia. Licensed Data is a set of investment data spanning all of our investment databases, including real-time pricing data, and is 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. 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. Principia is our CD-ROM-based investment research and planning software for advisors.
 
The Investment Information segment also includes Morningstar Equity Research, which we sell 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 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, ETF, 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, 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 show selected segment data for the three and six months ended June 30, 2011 and 2010:
 
 
 
Three months ended June 30, 2011
($000)
 
Investment
Information


 
Investment
Management


 
Corporate Items


 
Total


External revenue
 
$
128,116


 
$
32,895


 
$


 
$
161,011


Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
86,484


 
13,833


 
7,681


 
107,998


Stock-based compensation expense
 
2,488


 
531


 
824


 
3,843


Depreciation and amortization
 
2,047


 
40


 
8,476


 
10,563


Operating income (loss)
 
$
37,097


 
$
18,491


 
$
(16,981
)
 
$
38,607


 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 


 
 


 
 


 
$
1,593


Non-U.S. capital expenditures
 
 


 
 


 
 


 
$
1,788


 
 
 
 
 
 
 
 
 
U.S. revenue
 
 


 
 


 
 


 
$
113,424


Non-U.S. revenue
 
 


 
 


 
 


 
$
47,587


 
 
 
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


 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 


 
 


 
 


 
$
731


Non-U.S. capital expenditures
 
 


 
 


 
 


 
$
1,458


 
 
 
 
 
 
 
 
 
U.S. revenue
 
 


 
 


 
 


 
$
98,986


Non-U.S. revenue
 
 


 
 


 
 


 
$
37,105




 
 
Six months ended June 30, 2011
($000)
 
Investment
Information


 
Investment
Management


 
Corporate Items


 
Total


External revenue
 
$
248,515


 
$
64,263


 
$


 
$
312,778


Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
170,247


 
27,671


 
16,187


 
214,105


Stock-based compensation expense
 
4,958


 
973


 
1,561


 
7,492


Depreciation and amortization
 
3,906


 
82


 
16,777


 
20,765


Operating income (loss)
 
$
69,404


 
$
35,537


 
$
(34,525
)
 
$
70,416


 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 


 
 


 
 


 
$
3,523


Non-U.S. capital expenditures
 
 


 
 


 
 


 
$
4,895


 
 
 
 
 
 
 
 
 
U.S. revenue
 
 


 
 


 
 


 
$
221,605


Non-U.S. revenue
 
 


 
 


 
 


 
$
91,173


 
 
 
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


 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 


 
 


 
 


 
$
1,632


Non-U.S. capital expenditures
 
 


 
 


 
 


 
$
2,207


 
 
 
 
 
 
 
 
 
U.S. revenue
 
 


 
 


 
 


 
$
191,596


Non-U.S. revenue
 
 


 
 


 
 


 
$
72,785




 
 
As of June 30, 2011
(000’s)
 
Investment
Information


 
Investment
Management


 
Corporate Items


 
Total


Goodwill
 
$
284,097


 
$
42,446


 
$


 
$
326,543


 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 


 
 


 
 


 
$
38,772


Non-U.S. long-lived assets
 
 


 
 


 
 


 
$
23,290


 
 
 
As of December 31, 2010
(000’s)
 
Investment
Information


 
Investment
Management


 
Corporate Items


 
Total


Goodwill
 
$
275,611


 
$
42,050


 
$


 
$
317,661


 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 


 
 


 
 


 
$
39,496


Non-U.S. long-lived assets
 
 


 
 


 
 


 
$
22,609




 
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)
 
2011


 
2010


Available-for-sale
 
$
214,211


 
$
173,072


Held-to-maturity
 
15,496


 
7,476


Trading securities
 
5,509


 
4,692


Total
 
$
235,216


 
$
185,240




 
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, 2011
 
As of December 31, 2010
($000)
 
Cost


 
Unrealized
Gain


 
Unrealized
Loss


 
Fair
Value


 
Cost


 
Unrealized
Gain


 
Unrealized
Loss


 
Fair
Value


Available-for-sale:
 
 


 
 


 
 


 
 


 
 


 
 


 
 


 
 


Government obligations
 
$
116,101


 
$
58


 
$
(46
)
 
$
116,113


 
$
113,597


 
$
36


 
$
(56
)
 
$
113,577


Corporate bonds
 
55,758


 
86


 
(56
)
 
55,788


 
42,839


 
63


 
(24
)
 
42,878


Commercial paper
 
25,959


 
6


 
(3
)
 
25,962


 
2,994


 


 
(3
)
 
2,991


Equity securities and exchange-traded funds
 
6,182


 
312


 
(46
)
 
6,448


 
4,510


 
418


 
(6
)
 
4,922


Mutual funds
 
9,006


 
894


 


 
9,900


 
8,146


 
558


 


 
8,704


Total
 
$
213,006


 
$
1,356


 
$
(151
)
 
$
214,211


 
$
172,086


 
$
1,075


 
$
(89
)
 
$
173,072


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 


 
 


 
 


 
 


 
 


 
 


 
 


 
 


Certificates of deposit
 
$
15,496


 
$


 
$


 
$
15,496


 
$
7,476


 
$


 
$


 
$
7,476




 
As of June 30, 2011 and December 31, 2010, 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, 2011 and December 31, 2010. 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, 2011
 
As of December 31, 2010
($000)
 
Cost


 
Fair Value


 
Cost


 
Fair Value


Available-for-sale:
 
 


 
 


 
 


 
 


Due in one year or less
 
$
143,986


 
$
144,052


 
$
85,990


 
$
85,964


Due in one to two years
 
53,832


 
53,811


 
73,440


 
73,482


Equity securities, exchange-traded funds, and mutual funds
 
15,188


 
16,348


 
12,656


 
13,626


Total
 
$
213,006


 
$
214,211


 
$
172,086


 
$
173,072


 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 


 
 


 
 


 
 


Due in one year or less
 
$
15,490


 
$
15,490


 
$
7,223


 
$
7,223


Due in more than one year
 
6


 
6


 
253


 
253


Total
 
$
15,496


 
$
15,496


 
$
7,476


 
$
7,476




 
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)
 
2011


 
2010


Realized gains
 
$
397


 
$
17


Realized losses
 


 
(8
)
Realized gains, net
 
$
397


 
$
9




 


The following table shows the net unrealized loss on trading securities as recorded in our Condensed Consolidated Statements of Income:
 
 
 
Six months ended June 30
($000)
 
2011


 
2010


Unrealized loss, net
 
$
9


 
$
398






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 June 30, 2011
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
June 30, 2011
 
Level 1


 
Level 2


 
Level 3


Available-for-sale investments
 
 


 
 


 
 


 
 


Government obligations
 
$
116,113


 
$


 
$
116,113


 
$


Corporate bonds
 
55,788


 


 
55,788


 


Commercial paper
 
25,962


 


 
25,962


 


Equity securities and exchange-traded funds
 
6,448


 
6,448


 


 


Mutual funds
 
9,900


 
9,900


 


 


Trading securities
 
5,509


 
5,509


 


 


Total
 
$
219,720


 
$
21,857


 
$
197,863


 
$


 
 
 
Fair Value
 
Fair Value Measurements as of December 31, 2010
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
December 31, 2010
 
Level 1


 
Level 2


 
Level 3


Available-for-sale investments
 
 


 
 


 
 


 
 


Government obligations
 
$
113,577


 
$


 
$
113,577


 
$


Corporate bonds
 
42,878


 


 
42,878


 


Commercial paper
 
2,991


 


 
2,991


 


Equity securities and exchange-traded funds
 
4,922


 
4,922


 


 


Mutual funds
 
8,704


 
8,704


 


 


Trading securities
 
4,692


 
4,692


 


 


Total
 
$
177,764


 
$
18,318


 
$
159,446


 
$




 
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 these investment categories each in the aggregate is appropriate.


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)
 
2011




2010


Investment in MJKK
 
$
18,971


 
$
19,036


Other equity method investments
 
232


 
109


Investments accounted for using the cost method
 
5,221


 
5,117


Total investments in unconsolidated entities
 
$
24,424


 
$
24,262




 
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
 
As of December 31
 
 
2011


 
2010


Morningstar’s approximate ownership of MJKK
 
33
%
 
34
%
 
 
 
 
 
Approximate market value of Morningstar’s ownership in MJKK:
 
 


 
 


Japanese yen (¥000)
 
¥
2,674,000


 
¥
3,197,000


Equivalent U.S. dollars ($000)
 
$
33,022


 
$
38,361






Other Equity Method Investments. As of June 30, 2011 and December 31, 2010, other equity method investments include our investment in Morningstar Sweden AB (Morningstar Sweden). Morningstar Sweden develops and markets products and services customized for its respective market. Our ownership interest in Morningstar Sweden was approximately 24% as of June 30, 2011 and December 31, 2010.
 
Cost Method Investments. As of June 30, 2011 and December 31, 2010, 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 2011 and 2010, respectively.
 
Liability for Vacant Office Space
Liability for Vacant Office Space
Liability for Vacant Office Space
 
The following table shows the change in our liability for vacant office space from December 31, 2010 to June 30, 2011:


Liability for vacant office space
 
($000)


Balance as of December 31, 2010
 
$
2,429


Reduction of liability for lease payments
 
(855
)
Balance as of June 30, 2011
 
$
1,574






Stock-Based Compensation
Stock-Based Compensation
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. Since the adoption of the 2004 Stock Incentive Plan, we have granted stock options, restricted stock units, and restricted stock.


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, were not available for awards under the 2004 Stock Incentive Plan.
  
In May 2011, we adopted the 2011 Stock Incentive Plan (the 2011 Plan). With the adoption of the 2011 Plan, we will not grant any additional awards under the 2004 Stock Incentive Plan. The 2011 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 2011 Plan. Grants awarded under the 2011 Plan or the 2004 Stock Incentive 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 or in 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


(000)
 
2011


Shares available for future grants
 
5,000




 


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, 2011 and June 30, 2010:
 
 
 
Three months ended June 30
 
Six months ended June 30
($000)
 
2011


 
2010


 
2011


 
2010


Restricted stock units
 
$
3,332


 
$
3,343


 
$
6,117


 
$
6,280


Restricted stock
 
444


 
312


 
1,308


 
312


Stock options
 
67


 


 
67


 


Total stock-based compensation expense
 
$
3,843


 
$
3,655


 
$
7,492


 
$
6,592


 
 
 
 
 
 
 
 
 
Income tax benefit related to the stock-based compensation expense
 
$
944


 
$
1,008


 
$
1,669


 
$
1,901




 
The following table summarizes the amount of unrecognized stock-based compensation expense as of June 30, 2011 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
 
$
33,520


 
36


Restricted stock
 
6,807


 
46


Stock options
 
1,978


 
45


Total unrecognized stock-based compensation expense
 
$
42,305


 
38






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.
 
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.


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 2011:
Restricted Stock Units (RSUs)
 
Unvested


 
Vested but
Deferred


 
Total


 
Weighted
Average
Grant Date Value
per RSU


RSUs outstanding—December 31, 2010
 
777,666


 
45,189


 
822,855


 
$
47.14


Granted
 
264,402


 


 
264,402


 
57.25


Vested
 
(221,806
)
 


 
(221,806
)
 
48.37


Vested but deferred
 
(1,726
)
 
1,726


 


 


Issued
 


 
(26,962
)
 
(26,962
)
 
46.71


Forfeited
 
(58,025
)
 


 
(58,025
)
 
47.45


RSUs outstanding—June 30, 2011
 
760,511


 
19,953


 
780,464


 
50.20




 


Restricted Stock
 
In conjunction with the Realpoint acquisition in May 2010, we issued 199,174 shares of restricted stock to the selling employee-shareholders under the 2004 Stock Incentive Plan. 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 prepared in conjunction with the Realpoint acquisition, we account for the grant of restricted shares 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.
 
We measured 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 the fair value of $9,363,000 to stock-based compensation expense over the vesting period. The stock-based compensation expense recorded in the first six months of 2011 includes approximately $396,000 of expense recognized upon the accelerated vesting of a restricted stock grant. We have assumed that all of the remaining restricted stock will ultimately vest, and therefore we have not incorporated a forfeiture rate for purposes of determining the stock-based compensation expense.
 


Stock Options


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 this 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.


In May 2011, we granted 86,106 stock options under the 2004 Stock Incentive Plan. We estimated the fair value on the date of grant using a Black-Scholes option-pricing model. The fair value of these options using this model was $23.75 per share, based on the following assumptions:


Assumptions for Black-Scholes Option Pricing Model
 
 
Expected life (years):
 
7.4


Volatility factor:
 
35.1
%
Dividend yield:
 
0.35
%
Interest rate:
 
2.87
%
Expected exercise price:
 
$57.28




The following tables summarize stock option activity in the first six months of 2011 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, 2010
 
648,885


 
$
18.91


Granted
 


 


Canceled
 


 


Exercised
 
(114,956
)
 
18.95


Options outstanding—June 30, 2011
 
533,929


 
19.32


 
 
 
 
 
Options exercisable— June 30, 2011
 
533,929


 
$
19.32




 
All Other Option Grants, Excluding Activity Shown Above
 
Underlying
Shares


 
Weighted
Average
Exercise
Price


Options outstanding—December 31, 2010
 
1,207,540


 
$
17.09


Granted
 
86,106


 
57.28


Canceled
 
(450
)
 
21.12


Exercised
 
(374,630
)
 
15.66


Options outstanding— June 30, 2011
 
918,566


 
21.71


 
 
 
 
 
Options exercisable— June 30, 2011
 
832,460


 
$
18.03