MORNINGSTAR, INC., 10-K filed on 2/28/2011
Annual Report
Consolidated Statements of Income (USD $)
In Thousands, except Per Share data
Year Ended
Dec. 31,
2010
2009
2008
Revenue
$ 555,351 
$ 478,996 
$ 502,457 
Operating expenses: (1)
 
 
 
Cost of goods sold
157,068 
128,616 
130,085 
Development
49,244 
38,378 
40,340 
Sales and marketing
95,473 
71,772 
81,651 
General and administrative
92,843 
83,596 
85,509 
Depreciation and amortization
39,664 
31,961 
25,996 
Total operating expense
434,292 
354,323 
363,581 
Operating income
121,059 
124,673 
138,876 
Non-operating income (expense):
 
 
 
Interest income, net
2,437 
3,016 
5,687 
Other income (expense), net
4,295 
(82)
(1,435)
Non-operating income, net
6,732 
2,934 
4,252 
Income before income taxes and equity in net income of unconsolidated entities
127,791 
127,607 
143,128 
Income tax expense
42,756 
46,775 
54,423 
Equity in net income of unconsolidated entities
1,422 
1,165 
1,321 
Consolidated net income
86,457 
81,997 
90,026 
Net (income) loss attributable to noncontrolling interests
(87)
132 
(397)
Net income attributable to Morningstar, Inc.
86,370 
82,129 
89,629 
Net income per share attributable to Morningstar, Inc.:
 
 
 
Basic (in dollars per share)
1.75 
1.71 
1.94 
Diluted (in dollars per share)
$ 1.70 
$ 1.65 
$ 1.82 
Dividends declared per common share (in dollars per share)
0.05 
 
 
Weighted average shares outstanding:
 
 
 
Basic (in shares)
49,249 
48,112 
46,139 
Diluted (in shares)
50,555 
49,793 
49,213 
Consolidated Statements of Income (Parenthetical) (USD $)
In Thousands
Year Ended
Dec. 31,
2010
2009
2008
(1) Includes stock-based compensation expense of:
 
 
 
Cost of goods sold
$ 3,473 
$ 2,666 
$ 2,058 
Development
1,840 
1,570 
1,402 
Sales and marketing
1,786 
1,587 
1,449 
General and administrative
6,694 
5,770 
6,372 
Total stock-based compensation expense
$ 13,793 
$ 11,593 
$ 11,281 
Consolidated Balance Sheets (USD $)
In Thousands
Dec. 31, 2010
Dec. 31, 2009
Current assets:
 
 
Cash and cash equivalents
$ 180,176 
$ 130,496 
Investments
185,240 
212,057 
Accounts receivable, less allowance of $1,056 and $1,339, respectively
110,891 
82,330 
Deferred tax asset, net
2,860 
1,109 
Income tax receivable, net
10,459 
5,541 
Other
17,654 
12,564 
Total current assets
507,280 
444,097 
Property, equipment, and capitalized software, net
62,105 
59,828 
Investments in unconsolidated entities
24,262 
24,079 
Goodwill
317,661 
249,492 
Intangible assets, net
169,023 
135,488 
Other assets
5,971 
6,099 
Total assets
1,086,302 
919,083 
Current liabilities:
 
 
Accounts payable and accrued liabilities
42,680 
30,524 
Accrued compensation
62,404 
48,902 
Deferred revenue
146,267 
127,114 
Other
1,373 
962 
Total current liabilities
252,724 
207,502 
Accrued compensation
4,965 
4,739 
Deferred tax liability, net
19,975 
14,640 
Other long-term liabilities
27,213 
26,413 
Total liabilities
304,877 
253,294 
Morningstar, Inc. shareholders' equity:
 
 
Common stock, no par value, 200,000,000 shares authorized, of which 49,874,392 and 48,768,541 shares were outstanding as of December 31, 2010 and 2009, respectively
Treasury stock at cost, 279,456 shares as of December 31, 2010 and 222,653 shares as of December 31, 2009
(6,641)
(3,130)
Additional paid-in capital
458,426 
428,139 
Retained earnings
323,408 
239,573 
Accumulated other comprehensive income (loss):
 
 
Currency translation adjustment
4,503 
(337)
Unrealized gain on available-for-sale investments
615 
370 
Total accumulated other comprehensive income (loss)
5,118 
33 
Total Morningstar, Inc. shareholders' equity
780,316 
664,620 
Noncontrolling interests
1,109 
1,169 
Total equity
781,425 
665,789 
Total liabilities and equity
$ 1,086,302 
$ 919,083 
Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share data
Dec. 31, 2010
Dec. 31, 2009
Consolidated Balance Sheets
 
 
Accounts receivable, allowance (in dollars)
$ 1,056 
$ 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
49,874,392 
48,768,541 
Treasury stock, shares
279,456 
222,653 
Consolidated Statements of Equity and Comprehensive Income (Loss)
In Thousands, except Share data
Common Stock
Treasury Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Non Controlling Interests
Comprehensive Income (Loss)
Total
Balance as reported at Dec. 31, 2007
(3,280)
332,164 
71,757 
7,658 
 
 
408,303 
Balance as reported (in shares) at Dec. 31, 2007
44,843,166 
 
 
 
 
 
 
 
Balance, as adjusted at Dec. 31, 2007
(3,280)
330,218 
67,815 
7,658 
 
 
402,415 
Balance (in shares) at Dec. 31, 2007
44,843,166 
 
 
 
 
 
 
 
Increase (Decrease) in Stockholders' Equity
 
 
 
 
 
 
 
 
Cumulative effect of prior year adjustments
 
 
(1,946)
(3,942)
 
 
 
(5,888)
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income
 
 
 
89,629 
 
397 
90,026 
90,026 
Unrealized gains (loss) on available-for-sale investments, net of income tax of $149, $66, and $252 for years 2010, 2009 and 2008 respectively
 
 
 
 
429 
 
429 
429 
Foreign currency translation adjustment, net
 
 
 
 
(23,972)
 
(23,972)
(23,972)
Total comprehensive income (loss)
 
 
 
89,629 
(23,543)
397 
66,483 
66,483 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
 
 
23,428 
 
 
 
 
23,428 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net (in shares)
2,439,792 
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
 
 
11,281 
 
 
 
 
11,281 
Excess tax benefit derived from stock option exercises and vesting of restricted stock units
 
 
26,638 
 
 
 
 
26,638 
Balance, as adjusted at Dec. 31, 2008
 
391,565 
157,444 
(15,885)
397 
 
530,245 
Balance (in shares) at Dec. 31, 2008
47,282,958 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income
 
 
 
82,129 
 
(132)
81,997 
81,997 
Unrealized gains (loss) on available-for-sale investments, net of income tax of $149, $66, and $252 for years 2010, 2009 and 2008 respectively
 
 
 
 
(111)
 
(111)
(111)
Foreign currency translation adjustment, net
 
 
 
 
16,029 
(29)
16,000 
16,000 
Total comprehensive income (loss)
 
 
 
82,129 
15,918 
(161)
97,886 
97,886 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
150 
16,288 
 
 
 
 
16,439 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net (in shares)
1,485,583 
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
 
 
11,593 
 
 
 
 
11,593 
Excess tax benefit derived from stock option exercises and vesting of restricted stock units
 
 
8,693 
 
 
 
 
8,693 
Non-controlling interest in Morningstar Korea
 
 
 
 
 
933 
 
933 
Balance, as adjusted at Dec. 31, 2009
(3,130)
428,139 
239,573 
33 
1,169 
 
665,789 
Balance (in shares) at Dec. 31, 2009
48,768,541 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income
 
 
 
86,370 
 
87 
86,457 
86,457 
Unrealized gains (loss) on available-for-sale investments, net of income tax of $149, $66, and $252 for years 2010, 2009 and 2008 respectively
 
 
 
 
245 
 
245 
245 
Foreign currency translation adjustment, net
 
 
 
 
4,840 
69 
4,909 
4,909 
Total comprehensive income (loss)
 
 
 
86,370 
5,085 
156 
91,611 
91,611 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
 
274 
8,946 
 
 
 
 
9,220 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net (in shares)
1,182,069 
 
 
 
 
 
 
 
Common shares repurchased
 
(3,785)
 
 
 
 
 
(3,785)
Common shares repurchased (in shares)
(76,218)
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
 
 
12,545 
 
 
 
 
12,545 
Stock-based compensation - restricted stock
 
 
1,248 
 
 
 
 
1,248 
Excess tax benefit derived from stock option exercises and vesting of restricted stock units
 
 
7,507 
 
 
 
 
7,507 
Dividends declared - common shares outstanding
 
 
 
(2,494)
 
 
 
(2,494)
Dividends declared - restricted stock units
 
 
41 
(41)
 
 
 
 
Adjustment to noncontrolling interest
 
 
 
 
 
(216)
 
(216)
Balance, as adjusted at Dec. 31, 2010
(6,641)
458,426 
323,408 
5,118 
1,109 
 
781,425 
Balance (in shares) at Dec. 31, 2010
49,874,392 
 
 
 
 
 
 
 
Consolidated Statements of Equity and Comprehensive Income (Loss) (Parenthetical) (USD $)
In Thousands
Year Ended
Dec. 31,
2010
2009
2008
Consolidated Statements of Equity and Comprehensive Income (Loss)
 
 
 
Unrealized gain or loss on available-for-sale investments, tax
$ 149 
$ 66 
$ 252 
Consolidated Statements of Cash Flows (USD $)
In Thousands
Year Ended
Dec. 31,
2010
2009
2008
Operating activities
 
 
 
Consolidated net income
$ 86,457 
$ 81,997 
$ 90,026 
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
39,664 
31,961 
25,996 
Deferred income tax expense (benefit)
211 
(2,207)
11,901 
Stock-based compensation
13,793 
11,593 
11,281 
Provision for bad debt
413 
1,292 
242 
Equity in net income of unconsolidated entities
(1,422)
(1,165)
(1,321)
Excess tax benefits from stock option exercises and vesting of restricted stock units
(7,507)
(8,693)
(26,638)
Holding gain upon acquisition of additional ownership of equity method investments
(4,564)
(352)
 
Other, net
(90)
575 
727 
Changes in operating assets and liabilities, net of effect of acquisitions:
 
 
 
Accounts receivable
(23,652)
12,364 
(658)
Other assets
(2,341)
2,521 
1,573 
Accounts payable and accrued liabilities
(759)
(9,476)
691 
Accrued compensation
12,166 
(26,729)
(2,333)
Deferred revenue
5,752 
(8,704)
(1,595)
Income taxes payable
4,569 
11,676 
22,078 
Deferred rent
1,364 
5,679 
18,906 
Other liabilities
(638)
(1,076)
(1,537)
Cash provided by operating activities
123,416 
101,256 
149,339 
Investing activities
 
 
 
Purchases of investments
(186,283)
(176,770)
(134,117)
Proceeds from maturities and sales of investments
214,929 
92,851 
109,172 
Capital expenditures
(14,771)
(12,372)
(48,519)
Acquisitions, net of cash acquired
(102,324)
(74,175)
(105,410)
Other, net
500 
(4,209)
(250)
Cash used for investing activities
(87,949)
(174,675)
(179,124)
Financing activities
 
 
 
Proceeds from stock option exercises
9,220 
16,439 
23,428 
Excess tax benefits from stock option exercises and vesting of restricted stock units
7,507 
8,693 
26,638 
Common shares repurchased
(3,785)
 
 
Other, net
(417)
188 
671 
Cash provided by financing activities
12,525 
25,320 
50,737 
Effect of exchange rate changes on cash and cash equivalents
1,688 
4,704 
(6,637)
Net increase (decrease) in cash and cash equivalents
49,680 
(43,395)
14,315 
Cash and cash equivalents - Beginning of year
130,496 
173,891 
159,576 
Cash and cash equivalents - End of year
180,176 
130,496 
173,891 
Supplemental disclosures of cash flow information
 
 
 
Cash paid for income taxes
37,624 
38,009 
19,782 
Supplemental information of non-cash investing and financing activities
 
 
 
Unrealized gain (loss) on available-for-sale investments
$ 394 
$ (177)
$ 672 
Description of Business
Description of Business

1. Description of Business

 

Morningstar, Inc. and its subsidiaries (Morningstar, we, our), is a provider of independent investment research to investors around the world. We offer an extensive line of data, software, and research products for individual investors, financial advisors, and institutional clients. We also offer asset management services for advisors, institutions, and retirement plan participants. We have operations in 26 countries.

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies

3. Summary of Significant Accounting Policies

 

The acronyms that appear in these Notes to our 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

 

Principles of Consolidation. We conduct our business operations through wholly owned or majority-owned operating subsidiaries. The accompanying consolidated financial statements include the accounts of Morningstar, Inc. and our subsidiaries. The assets, liabilities, and results of operations of subsidiaries in which we have a controlling interest have been consolidated. All significant intercompany accounts and transactions have been eliminated.

 

We account and report the noncontrolling (minority) interests in our Consolidated Financial Statements in accordance with FASB ASC 810, Consolidation. A noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to the parent company. We report the noncontrolling interest  in our Consolidated Balance Sheet within equity separate from the shareholders’ equity attributable to Morningstar, Inc. In addition, we present the net income (loss) and comprehensive income (loss) attributed to Morningstar, Inc.’s shareholders and the noncontrolling interest in our Consolidated Statements of Income and Consolidated Statements of Equity and Comprehensive Income (Loss).

 

We account for investments in entities in which we exercise significant influence, but do not control, using the equity method.

 

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses during the reporting period. Actual results may differ from these estimates.

 

Reclassifications. Certain amounts reported in previous years have been reclassified to conform to the 2010 presentation.

 

Cash and Cash Equivalents. Cash and cash equivalents consist of cash and investments with original maturities of three months or less. We state them at cost, which approximates fair value.

 

Investments. We account for our investments in accordance with FASB ASC 320, Investments—Debt and Equity Securities. We classify our investments into three categories: held-to-maturity, trading, and available-for-sale.

 

·                Held-to-maturity:  We classify certain investments, primarily certificates of deposit, as held-to-maturity securities, based on our intent and ability to hold these securities to maturity. We record held-to-maturity investments at amortized cost in our Consolidated Balance Sheets.

 

·                Trading:  We classify certain other investments, primarily equity securities, as trading securities, primarily to satisfy the requirements of one of our wholly owned subsidiaries, which is a registered broker-dealer. We include realized and unrealized gains and losses associated with these investments as a component of our operating income in the Consolidated Statements of Income. We record these securities at their fair value in our Consolidated Balance Sheets.

 

·                Available-for-sale:  Investments not considered held-to-maturity or trading securities are classified as available-for-sale securities. Available-for-sale securities primarily consist of fixed-income securities. We report unrealized gains and losses for available-for-sale securities as other comprehensive income (loss), net of related income taxes. We record these securities at their fair value in our Consolidated Balance Sheets.

 

Fair Value Measurements. We follow FASB ASC 820, Fair Value Measurements and Disclosures. FASB ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Under FASB ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances and does not require any new fair value measurements.

 

FASB ASC 820 uses a fair value hierarchy based on three broad levels of valuation inputs as described below:

 

·                  Level 1:  Valuations based on quoted prices in active markets for identical assets or liabilities that the company has 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 provide additional information about our investments that are subject to valuation under FASB ASC 820 in Note 6 in these Notes to our Consolidated Financial Statements.

 

The Fair Value Option for Financial Assets and Financial Liabilities. FASB ASC 825, Financial Instruments, permits entities the option to measure many financial instruments and certain other items at fair value with changes in fair value recognized in earnings each period. FASB ASC 825 allows the fair value option to be elected on an instrument-by-instrument basis when the asset or liability is initially recognized or when there’s an event that gives rise to a new basis of accounting for that instrument. We do not apply this fair value option to any of our eligible assets.

 

Concentration of Credit Risk. No single customer is large enough to pose a significant credit risk to our operations or financial condition. For the years ended December 31, 2010, 2009, and 2008, no single customer represented 10% or more of our consolidated revenue. If receivables from our customers become delinquent, we begin a collections process. We maintain an allowance for doubtful accounts based on our estimate of the probable losses of accounts receivable.

 

Property, Equipment, and Depreciation. We state property and equipment at historical cost, net of accumulated depreciation. We depreciate property and equipment primarily using the straight-line method based on the useful life of the asset, which ranges from three to seven years. We amortize leasehold improvements over the lease term or their useful lives, whichever is shorter.

 

Computer Software and Internal Product Development Costs. We capitalize certain costs in accordance with FASB ASC 350-40, Internal-Use Software, FASB ASC 350-50, Website Development Costs, and FASB ASC 985, Software. Internal product development costs mainly consist of employee costs for developing new web-based products and certain major enhancements of existing products. We amortize these costs on a straight-line basis over the estimated economic life, which is generally three years.

 

Business Combinations. Over the past several years, we have acquired companies that complement our business operations. For each acquisition, we allocate the purchase price to the assets acquired, liabilities assumed, and goodwill. For acquisitions completed in 2010 and 2009, we follow FASB ASC 805, Business Combinations. We recognize and measure the fair value of the acquired operation as a whole, and the assets acquired and liabilities assumed at their full fair values as of the date control is obtained, regardless of the percentage ownership in the acquired operation or how the acquisition was achieved. We expense direct costs related to the business combination, such as advisory, accounting, legal, valuation, and other professional fees, as incurred. We recognize restructuring costs, including severance and relocation for employees of the acquired entity, as post-combination expenses unless the target entity meets the criteria of FASB ASC 420, Exit or Disposal Cost Obligations on the acquisition date. Prior to January 1, 2009, we generally included acquisition-related costs and restructuring costs as part of the cost of the acquired business.

 

As part of the purchase price allocation, we follow the requirements of FASB ASC 740, Income Taxes. This includes establishing deferred tax assets or liabilities reflecting the difference between the values assigned for financial statement purposes and values applicable for income tax purposes. In certain acquisitions, the goodwill resulting from the purchase price allocation may not be deductible for income tax purposes. FASB ASC 740 prohibits recognition of a deferred tax asset or liability for temporary differences in goodwill if goodwill is not amortizable and deductible for tax purposes.

 

Goodwill. Changes in the carrying amount of our recorded goodwill are mainly the result of business acquisitions. In accordance with FASB ASC 350, Intangibles — Goodwill and Other, we do not amortize goodwill; instead, goodwill is subject to an impairment test annually, or whenever indicators of impairment exist. An impairment would occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. Our reporting units are components of our reportable segments. We performed annual impairment reviews in the fourth quarter of 2010, 2009, and 2008. We did not record any impairment losses in 2010, 2009 or 2008.

 

Intangible Assets. We amortize intangible assets using the straight-line method over their estimated economic useful lives, which range from one to 25 years. In accordance with FASB ASC 360-10-35, Subsequent Measurement—Impairment or Disposal of Long Lived Assets, we review intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If the value of future undiscounted cash flows is less than the carrying amount of an asset, we record an impairment loss based on the excess of the carrying amount over the fair value of the asset. We did not record any impairment losses in 2010, 2009, or 2008.

 

Revenue Recognition. We earn revenue by selling a variety of investment-related products and services. We sell many of our offerings, such as our newsletters, Principia software, and Premium service on Morningstar.com, via subscriptions. These subscriptions are mainly offered for a one-year term, although we also offer terms ranging from one month to three years. We also sell advertising on our websites throughout the world. Several of our other products are sold through license agreements, including Morningstar Advisor Workstation, Morningstar Equity Research, Morningstar Direct, Retirement Advice, and Licensed Data. Our license agreements typically range from one to three years.

 

For some of our other institutional services, mainly Investment Consulting, we generally base our fees on the scope of work and the level of service we provide and earn fees as a percentage of assets under management. We also earn fees relating to Morningstar Managed Portfolios as a percentage of assets under management. A portion of the fees for managed retirement accounts offered through Morningstar Retirement Manager and Advice by Ibbotson are earned as a percentage of assets under management.

 

Deferred revenue represents the portion of subscriptions billed or collected in advance of the service being provided, which we expect to recognize to 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.

 

We follow the standards established in FASB ASC 605, Revenue Recognition, including subtopic 25, Multiple-Element Arrangements, and FASB ASC 985-605, Software—Revenue Recognition.

 

We recognize revenue from subscription sales in equal installments over the term of the subscription. We recognize revenue from Investment Consulting, Retirement Advice, Internet advertising, and other non-subscription products and services when the product or service is delivered or, when applicable, over the service obligation period defined by the terms of the contract. Revenue from Internet advertising is generated 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. We recognize asset-based fees once the fees are fixed and determinable assuming all other revenue recognition criteria are met. For contracts that combine multiple products and services, we assign the fair value of each element in the arrangement based on selling prices of the items when sold separately. 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.

 

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.

 

Advertising Costs. Advertising costs include expenses incurred for various print and Internet ads, search engine fees, and direct mail campaigns. We expense advertising costs as incurred. The table below summarizes our advertising expense for the past three years:

 

($000)

 

2010

 

2009

 

2008

 

Advertising expense

 

$

8,572

 

$

7,361

 

$

10,549

 

 

Stock-Based Compensation Expense. We account for our stock-based compensation expense in accordance with FASB ASC 718, Compensation—Stock Compensation. Our stock-based compensation expense is mainly related to grants of restricted stock units and restricted stock. We measure the fair value of our restricted stock units and restricted stock on the date of grant based on the closing market price of Morningstar’s 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.

 

We estimate expected forfeitures of all employee stock-based awards and recognize compensation cost only for those awards expected to vest. We determine forfeiture rates based on historical experience and adjust the estimated forfeitures to actual forfeiture experience as needed.

 

Liability for Sabbatical Leave. In certain of our operations, we offer employees a sabbatical leave. Although the sabbatical policy varies by region, in general, Morningstar’s full-time employees are eligible for six weeks of paid time off after four years of continuous service. We account for our sabbatical liability in accordance with FASB ASC 710-10-25, Compensated Absences. We record a liability for employees’ sabbatical benefits over the period employees earn the right for sabbatical leave.

 

Income Taxes. We record deferred income taxes for the temporary differences between the carrying amount of assets and liabilities for financial statement purposes and the amounts used for income tax purposes in accordance with FASB ASC 740, Income Taxes. FASB ASC 740 prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements, and also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, and disclosure for uncertain tax positions.

 

We recognize interest and penalties related to unrecognized tax benefits as part of income tax expense in our Consolidated Statements of Income. We classify liabilities related to unrecognized tax benefits as either current liabilities or “Other long-term liabilities” in our Consolidated Balance Sheet, depending on when we expect to make payment.

 

Income per Share. We compute and present income per share in accordance with FASB ASC 260, Earnings Per Share. The difference between weighted average shares outstanding and diluted shares outstanding primarily reflects the dilutive effect associated with our stock-based compensation plans.

 

Beginning in 2010, we compute income per share in accordance with FASB ASC 260-10-45-59A, Participating Securities and the Two Class Method. In May 2010, we issued restricted stock in conjunction with the acquisition of Realpoint, LLC.

Because the restricted stock contains nonforfeitable rights to dividends, it meets the criteria of a participating security. Under the two-class method, we allocate earnings 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. For purposes of calculating earnings per share, we reduce our reported net earnings by the amount allocated to participating securities to arrive at the earnings allocated to common stock shareholders.

 

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. 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.

 

Foreign Currency. We translate the financial statements of non-U.S. subsidiaries to U.S. dollars using the period-end exchange rate for assets and liabilities and an average exchange rate for revenue and expense. We use the local currency as the functional currency for all of our non-U.S. subsidiaries. We record translation adjustments for non-U.S. subsidiaries as a component of “Accumulated other comprehensive income (loss)” in our Consolidated Statements of Equity and Comprehensive Income (Loss). We include exchange gains and losses arising from transactions denominated in currencies other than the functional currency in “Other income (expense), net” in our Consolidated Statements of Income.

Income Per Share
Income Per Share

4. Income Per Share

 

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

 

(in thousands, except per share amounts)

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Net income attributable to Morningstar, Inc.

 

$

86,370

 

$

82,129

 

$

89,629

 

Less: Distributed earnings available to participating securities

 

(10

)

 

 

Less: Undistributed earnings available to participating securities

 

(335

)

 

 

Numerator for basic net income per share – undistributed and distributed earnings available to common shareholders

 

$

86,025

 

$

82,129

 

$

89,629

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

49,249

 

48,112

 

46,139

 

 

 

 

 

 

 

 

 

Basic net income per share attributable to Morningstar, Inc.

 

$

1.75

 

$

1.71

 

$

1.94

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Numerator for basic net income per share – undistributed and distributed earnings available to common shareholders

 

$

86,025

 

$

82,129

 

$

89,629

 

Add: Undistributed earnings allocated to participating securities

 

335

 

 

 

Less: Undistributed earnings reallocated to participating securities

 

(326

)

 

 

Numerator for diluted net income per share – undistributed and distributed earnings available to common shareholders

 

$

86,034

 

$

82,129

 

$

89,629

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

49,249

 

48,112

 

46,139

 

Net effect of dilutive stock options and restricted stock units

 

1,306

 

1,681

 

3,074

 

Weighted average common shares outstanding for computing diluted income per share

 

50,555

 

49,793

 

49,213

 

 

 

 

 

 

 

 

 

Diluted net income per share attributable to Morningstar, Inc.

 

$

1.70

 

$

1.65

 

$

1.82

 

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, Site Builder and Licensed Tools, 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. Site Builder and Licensed Tools are services that help 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 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 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 3, except for the capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions. We exclude these items from our operating segment results to provide our chief operating decision maker with a better indication of each segment’s ability to generate cash flow. This information is one of the criteria used by our chief operating decision maker in determining how to allocate resources to each segment. We include capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions in the Corporate Items category Our segment disclosures are consistent with the business segment information provided to our chief operating decision maker on a recurring basis; for that reason, we don’t present balance sheet information by segment. We disclose goodwill by segment in accordance with the requirements of FASB ASC 350-20-50, Intangibles - Goodwill - Disclosure.

 

The following tables present information about our operating segments:

 

2010 Segment Information

 

 

 

Year ended December 31, 2010

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Revenue

 

$

444,957

 

$

110,394

 

$

 

$

555,351

 

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

 

301,722

 

51,361

 

27,752

 

380,835

 

Stock-based compensation expense

 

8,110

 

2,032

 

3,651

 

13,793

 

Depreciation and amortization

 

7,385

 

185

 

32,094

 

39,664

 

Operating income (loss)

 

$

127,740

 

$

56,816

 

$

(63,497

)

$

121,059

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

11,796

 

$

82

 

$

2,893

 

$

14,771

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

398,215

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

157,136

 

 

 

 

As of December 31, 2010

 

($000)

 

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

 

 

2009 Segment Information

 

 

 

Year ended December 31, 2009

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Revenue

 

$

386,642

 

$

92,354

 

$

 

$

478,996

 

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

 

237,101

 

37,296

 

36,372

 

310,769

 

Stock-based compensation expense

 

5,704

 

1,965

 

3,924

 

11,593

 

Depreciation and amortization

 

5,408

 

204

 

26,349

 

31,961

 

Operating income (loss)

 

$

138,429

 

$

52,889

 

$

(66,645

)

$

124,673

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

10,633

 

$

651

 

$

1,088

 

$

12,372

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

349,836

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

129,160

 

 

 

 

As of December 31, 2009

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Goodwill

 

$

217,258

 

$

32,234

 

$

 

$

249,492

 

 

 

 

 

 

 

 

 

 

 

U.S. long-lived assets

 

 

 

 

 

 

 

$

42,884

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

$

16,944

 

 

2008 Segment Information

 

 

 

Year ended December 31, 2008

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Revenue

 

$

390,693

 

$

111,764

 

$

 

$

502,457

 

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

 

241,678

 

49,010

 

35,616

 

326,304

 

Stock-based compensation expense

 

5,271

 

1,997

 

4,013

 

11,281

 

Depreciation and amortization

 

5,085

 

361

 

20,550

 

25,996

 

Operating income (loss)

 

$

138,659

 

$

60,396

 

$

(60,179

)

$

138,876

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

34,878

 

$

5,991

 

$

7,650

 

$

48,519

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

$

381,021

 

Non-U.S. revenue

 

 

 

 

 

 

 

$

121,436

 

 

 

 

As of December 31, 2008

 

($000)

 

Investment
Information

 

Investment
Management

 

Corporate Items

 

Total

 

Goodwill

 

$

155,772

 

$

31,470

 

$

 

$

187,242

 

 

 

 

 

 

 

 

 

 

 

U.S. long-lived assets

 

 

 

 

 

 

 

$

45,763

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

$

13,059

 

Investments and Fair Value Measurements
Investments and Fair Value Measurements

6. Investments and Fair Value Measurements

 

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 December 31

 

($000)

 

2010

 

2009

 

 

 

 

 

 

 

Available-for-sale

 

$

173,072

 

$

197,306

 

Held-to-maturity

 

7,476

 

10,588

 

Trading securities

 

4,692

 

4,163

 

Total

 

$

185,240

 

$

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 December 31, 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

 

$

113,597

 

$

36

 

$

(56

)

$

113,577

 

$

174,433

 

$

439

 

$

(50

)

$

174,822

 

Corporate bonds

 

42,839

 

63

 

(24

)

42,878

 

12,268

 

44

 

(1

)

12,311

 

Commercial paper

 

2,994

 

 

(3

)

2,991

 

 

 

 

 

Equity securities

 

4,510

 

418

 

(6

)

4,922

 

2,013

 

188

 

(28

)

2,173

 

Mutual funds

 

8,146

 

558

 

 

8,704

 

8,000

 

 

 

8,000

 

Total

 

$

172,086

 

$

1,075

 

$

(89

)

$

173,072

 

$

196,714

 

$

671

 

$

(79

)

$

197,306

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

$

7,476

 

$

 

$

 

$

7,476

 

$

10,588

 

$

 

$

 

$

10,588

 

 

As of December 31, 2010 and 2009, investments with unrealized losses for greater than a 12-month period were not material to the 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 December 31, 2010 and 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 December 31, 2010

 

As of December 31, 2009

 

($000)

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Available-for-sale:

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

85,990

 

$

85,964

 

$

161,453

 

$

161,817

 

Due in one to three years

 

73,440

 

73,482

 

25,248

 

25,316

 

Equity securities and mutual funds

 

12,656

 

13,626

 

10,013

 

10,173

 

Total

 

$

172,086

 

$

173,072

 

$

196,714

 

$

197,306

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity:

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

7,223

 

$

7,223

 

$

10,587

 

$

10,587

 

Due in one to three years

 

253

 

253

 

1

 

1

 

Total

 

$

7,476

 

$

7,476

 

$

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 recorded in our Consolidated Statements of Income arising from sales of our investments classified as available-for-sale:

 

($000)

 

2010

 

2009

 

2008

 

Realized gains

 

$

276

 

$

 

$

1

 

Realized losses

 

(1

)

 

(5

)

Realized gains (loss), net

 

$

275

 

$

 

$

(4

)

 

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

 

($000)

 

2010

 

2009

 

2008

 

Unrealized gains (losses), net

 

$

237

 

$

1,233

 

$

(971

)

 

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

 

December 31, 2010 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

 

4,922

 

4,922

 

 

 

Mutual funds

 

8,704

 

8,704

 

 

 

Trading securities

 

4,692

 

4,692

 

 

 

Total

 

$

177,764

 

$

177,764

 

$