MORNINGSTAR, INC., 10-Q filed on 11/6/2013
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2013
Oct. 31, 2013
Document and Entity Information Abstract
 
 
Entity Registrant Name
MORNINGSTAR, INC. 
 
Entity Central Index Key
0001289419 
 
Current Fiscal Year End Date
--12-31 
 
Entity Filer Category
Large Accelerated Filer 
 
Document Type
10-Q 
 
Document Period End Date
Sep. 30, 2013 
 
Document Fiscal Year Focus
2013 
 
Document Fiscal Period Focus
Q3 
 
Amendment Flag
false 
 
Entity Common Stock, Shares Outstanding
 
45,953,013 
Condensed Consolidated Statements of Income (USD $)
In Thousands, except Per Share data, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Sep. 30, 2013
Sep. 30, 2012
Revenue
$ 173,482 
$ 160,952 
$ 517,766 
$ 487,679 
Operating expense (1):
 
 
 
 
Cost of revenue
72,422 1
60,568 1
198,499 
186,143 
Sales and marketing
22,774 1
25,732 1
78,789 
81,431 
General and administrative
22,416 1
23,966 1
77,863 
77,090 
Depreciation and amortization
11,257 1
10,822 1
33,858 
31,616 
Total operating expense
128,869 1
121,088 1
389,009 
376,280 
Operating income (loss)
44,613 
39,864 
128,757 
111,399 
Non-operating income (expense):
 
 
 
 
Interest income (expense), net
630 
1,719 
2,035 
3,848 
Gain (loss) on sale of investments reclassified from other comprehensive income
(42)
(4)
1,106 
(52)
Equity Method Investments Holding Gain
(78)
3,635 
Other income (expense), net
261 
165 
(1,949)
(262)
Non-operating income (expense), net
771 
1,880 
4,827 
3,534 
Income before income taxes and equity in net income of unconsolidated entities
45,384 
41,744 
133,584 
114,933 
Income tax expense
14,265 
15,186 
42,647 
41,441 
Equity in net income of unconsolidated entities
315 
478 
1,172 
1,541 
Consolidated net income
31,434 
27,036 
92,109 
75,033 
Net (income) loss attributable to the noncontrolling interest
29 
34 
93 
62 
Net income attributable to Morningstar, Inc.
$ 31,463 
$ 27,070 
$ 92,202 
$ 75,095 
Net income per share attributable to:
 
 
 
 
Basic (in dollars per share)
$ 0.68 
$ 0.56 
$ 1.99 
$ 1.53 
Diluted (in dollars per share)
$ 0.68 
$ 0.56 
$ 1.98 
$ 1.51 
Dividends declared per common share
$ 0.00 
$ 0.10 
$ 0.25 
$ 0.30 
Dividends paid per common share
$ 0.13 
$ 0.10 
$ 0.25 
$ 0.30 
Weighted average shares outstanding:
 
 
 
 
Basic (in shares)
46,080 
47,975 
46,293 
49,028 
Diluted (in shares)
46,519 
48,481 
46,635 
49,664 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
In Thousands, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Sep. 30, 2013
Sep. 30, 2012
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
$ 3,416 
$ 3,994 
$ 11,153 
$ 11,594 
Cost of Revenue
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
1,471 
1,619 
4,863 
4,739 
Sales and Marketing
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
456 
493 
1,490 
1,433 
General and Administrative
 
 
 
 
(1) Includes stock-based compensation expense of:
 
 
 
 
Allocated Share-based Compensation Expense
$ 1,489 
$ 1,882 
$ 4,800 
$ 5,422 
Condensed Consolidated Statements of Comprehensive Income Consolidated Statements of Comprehensive Income (USD $)
In Thousands, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Sep. 30, 2013
Sep. 30, 2012
Consolidated net income
$ 31,434 
$ 27,036 
$ 92,109 
$ 75,033 
Other comprehensive income (loss), net of tax:
 
 
 
 
Foreign currency translation adjustment
11,247 
7,375 
(4,952)
5,597 
Unrealized gains (losses) on securities:
 
 
 
 
Unrealized gains (losses) on available-for-sale investments, net of income tax of $605
774 
1,026 
1,774 
1,394 
Reclassification of adjustments for losses (gains) included in net income, net of income tax of $399
28 
(706)
33 
Other comprehensive income (loss), net
12,049 
8,401 
(3,884)
7,024 
Comprehensive income (loss), net
43,483 
35,437 
88,225 
82,057 
Comprehensive (income) loss attributable to noncontrolling interest
40 
16 
246 
77 
Comprehensive income attributable to Morningstar, Inc.
$ 43,523 
$ 35,453 
$ 88,471 
$ 82,134 
Condensed Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Sep. 30, 2013
Dec. 31, 2012
Current assets:
 
 
Cash and cash equivalents
$ 176,959 
$ 163,889 
Investments
165,918 
157,529 
Accounts receivable, less allowance of $1,005 and $569, respectively
113,688 
114,361 
Deferred tax asset, net
3,155 
3,741 
Income tax receivable, net
3,451 
14,267 
Other
26,229 
20,823 
Total current assets
489,400 
474,610 
Property, equipment, and capitalized software, net
99,007 
84,022 
Investments in unconsolidated entities
38,376 
35,305 
Goodwill
326,741 
320,845 
Intangible assets, net
109,269 
116,732 
Other assets
11,357 
10,438 
Total assets
1,074,150 
1,041,952 
Current liabilities:
 
 
Accounts payable and accrued liabilities
35,984 
43,777 
Accrued compensation
60,745 
67,317 
Deferred revenue
151,850 
146,015 
Other
6,760 
256 
Total current liabilities
255,339 
257,365 
Accrued compensation
8,467 
8,281 
Deferred tax liability, net
22,188 
21,583 
Deferred rent
13,966 
15,368 
Other long-term liabilities
15,714 
12,460 
Total liabilities
315,674 
315,057 
Morningstar, Inc. shareholders' equity:
 
 
Common stock, no par value, 200,000,000 shares authorized, of which 46,068,303 and 46,541,571 shares were outstanding, respectively
Treasury stock at cost, 6,024,254 shares and 5,214,070 shares, respectively
(358,616)
(301,839)
Additional paid-in capital
533,146 
521,285 
Retained earnings
576,828 
496,354 
Accumulated other comprehensive income:
 
 
Currency translation adjustment
4,126 
8,925 
Unrealized gain on available-for-sale securities
1,855 
787 
Total accumulated other comprehensive income
5,981 
9,712 
Total Morningstar, Inc. shareholders' equity
757,344 
725,517 
Noncontrolling interest
1,132 
1,378 
Total equity
758,476 
726,895 
Total liabilities and equity
$ 1,074,150 
$ 1,041,952 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share data, unless otherwise specified
Sep. 30, 2013
Dec. 31, 2012
Statement of Financial Position [Abstract]
 
 
Allowance for Doubtful Accounts Receivable, Current
$ 1,005 
$ 569 
Common Stock, No Par Value
$ 0 
$ 0 
Common Stock, Shares Authorized
200,000,000 
200,000,000 
Common Stock, Shares, Outstanding
46,068,303 
46,541,571 
Treasury Stock, Shares
6,024,254 
5,214,070 
Condensed Consolidated Statement of Equity (USD $)
In Thousands, except Share data, unless otherwise specified
Total
Common Stock
Treasury Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Non Controlling Interests
Balance at Dec. 31, 2012
$ 726,895 
$ 5 
$ (301,839)
$ 521,285 
$ 496,354 
$ 9,712 
$ 1,378 
Balance (in shares) at Dec. 31, 2012
46,541,571 
46,541,571 
 
 
 
 
 
Increase (Decrease) in Stockholders' Equity
 
 
 
 
 
 
 
Net Income (Loss)
92,109 
 
 
 
92,202 
 
(93)
Other Comprehensive Income (loss)
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale investments, net of income tax of $605
1,774 
   
   
   
   
1,774 
Reclassification of adjustments for losses (gains) included in net income, net of income tax of $399
(706)
   
   
   
   
(706)
Foreign currency translation adjustment, net
(4,952)
   
   
   
   
(4,799)
(153)
Other comprehensive income (loss), net
(3,884)
   
   
   
   
(3,731)
(153)
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
(2,104)
1,350 
(3,454)
   
   
   
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net (in shares)
 
356,023 
 
 
 
 
 
Adjustments to Additional Paid in Capital, Share-based Compensation, Requisite Service Period Recognition
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
10,493 
   
   
10,493 
   
   
   
Stock-based compensation - restricted stock
291 
   
   
291 
   
   
   
Stock-based compensation - stock options
369 
   
   
369 
   
   
   
Excess tax benefit derived from stock-option exercises and vesting of restricted stock units
4,093 
   
   
4,093 
   
   
   
Common share repurchased
(58,127)
   
(58,127)
   
   
   
   
Common share repurchased (in shares)
 
(829,291)
 
 
 
 
 
Dividends declared - common shares outstanding
(11,578)
   
   
   
(11,578)
   
   
Dividends declared - restricted stock units
(81)
   
   
69 
(150)
   
   
Balance at Sep. 30, 2013
$ 758,476 
$ 5 
$ (358,616)
$ 533,146 
$ 576,828 
$ 5,981 
$ 1,132 
Balance (in shares) at Sep. 30, 2013
46,068,303 
46,068,303 
 
 
 
 
 
Condensed Consolidated Statement of Equity (Parenthetical) (USD $)
In Thousands, unless otherwise specified
9 Months Ended
Sep. 30, 2013
Statement of Stockholders' Equity [Abstract]
 
Other Comprehensive Income (Loss), Unrealized Holding Gain (Loss) on Securities Arising During Period, Tax
$ 605 
Other Comprehensive Income (Loss), Reclassification Adjustment for Sale of Securities Included in Net Income, Tax
$ 399 
Condensed Consolidated Statements of Cash Flows (USD $)
In Thousands, unless otherwise specified
9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Operating activities
 
 
Consolidated net income
$ 92,109 
$ 75,033 
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
Depreciation and amortization
33,858 
31,616 
Deferred income taxes
(2,315)
492 
Stock-based compensation expense
11,153 
11,594 
Provision for bad debt
730 
990 
Equity in net income of unconsolidated entities
(1,172)
(1,541)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
(4,093)
(5,007)
Holding gain upon acquisition of additional ownership of equity method investments
(3,635)
Other, net
12 
342 
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
Accounts receivable
(1,249)
(6,569)
Other assets
(2,887)
(3,551)
Accounts payable and accrued liabilities
(3,151)
(4,316)
Accrued compensation
(8,404)
(20,851)
Income taxes- current
17,205 
7,220 
Deferred revenue
6,004 
7,684 
Deferred rent
(1,273)
291 
Other liabilities
(679)
(1,111)
Cash provided by operating activities
132,213 
92,316 
Investing activities
 
 
Purchases of investments
(113,824)
(134,929)
Proceeds from maturities and sales of investments
108,599 
216,350 
Capital expenditures
(27,950)
(22,876)
Acquisitions, net of cash acquired
(11,079)
Proceeds from Divestiture of Businesses
957 
Purchases of equity and cost method investments
(2,751)
(10,304)
Other, net
432 
(4)
Cash used for investing activities
(45,616)
48,237 
Financing activities
 
 
Proceeds from stock-option exercises, net
3,172 
6,752 
Employee taxes withheld for restricted stock units
(5,276)
(3,992)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
4,093 
5,007 
Common shares repurchased
(62,794)
(183,698)
Dividends paid
(11,657)
(14,867)
Other, net
(54)
(18)
Cash provided by (used for) financing activities
(72,516)
(190,816)
Effect of exchange rate changes on cash and cash equivalents
(1,011)
2,007 
Net increase (decrease) in cash and cash equivalents
13,070 
(48,256)
Cash and cash equivalents-beginning of period
163,889 
200,437 
Cash and cash equivalents-end of period
176,959 
152,181 
Supplemental disclosure of cash flow information:
 
 
Cash paid for income taxes
27,700 
33,163 
Supplemental information of non-cash investing and financing activities:
 
 
Unrealized Gain (Loss) on Available For Sale Investments
1,675 
2,221 
NonCashFinancingArrangement
$ 4,860 
$ 0 
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information
 
The accompanying condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the Company) have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. In the opinion of management, the statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly our financial position, results of operations, equity, and cash flows. These financial statements and notes are unaudited and should be read in conjunction with our Audited Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.

Certain prior period amounts have been reclassified to conform to our current period's presentation. We now include development expense in the cost of revenue category, which we previously referred to as cost of goods sold. We have reclassified development expense to include it in cost of revenue for all periods presented.

Separately, as a result of our recent reorganization (including new positions created, changes in focus for some existing roles, and the refinement of employee cost categorizations as we moved to a more centralized structure), approximately 180 net positions shifted from the general and administrative and sales and marketing categories to cost of revenue. For the three and nine months ended September 30, 2013 as compared with the corresponding periods in 2012, we estimate that changes related to our more centralized organizational structure added approximately $7 million of compensation expense to cost of revenue, and reduced the compensation expense in our sales and marketing and general and administrative expense categories by approximately $4 million and $3 million, respectively. These changes did not affect our total operating expense or operating income for any of the periods presented.
 
The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
FASB: Financial Accounting Standards Board
 
Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets
 
Acquisitions

Increased Ownership Interest in Morningstar Sweden AB

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

Morningstar Sweden's total estimated fair value of $18,513,000 includes $14,554,000 in cash paid to acquire the remaining 76% interest in Morningstar Sweden and $3,959,000 related to the 24% of Morningstar Sweden we previously held. We determined the fair value of the previously held 24% investment independent of the acquired controlling interest by applying a minority interest discount based on analysis of comparable transactions. Accordingly, we recorded a non-cash holding gain of $3,635,000. The gain is included in non-operating income in our Unaudited Condensed Consolidated Statement of Income.

The following table summarizes our allocation of the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
 
 
($000)

Cash and cash equivalents
 
$
3,472

Accounts receivable and other current assets
 
519

Other non-current assets
 
244

Intangible assets
 
9,700

Goodwill
 
9,084

Deferred revenue
 
(1,191
)
Deferred tax liability
 
(2,272
)
Other current and non-current liabilities
 
(1,043
)
Total fair value of Morningstar Sweden
 
$
18,513



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

 
Weighted Average Useful Life (years)
Customer-related assets
 
$
9,700

 
14
Total intangible assets
 
$
9,700

 
14


We recognized a deferred tax liability of $2,272,000 mainly because the amortization expense related to certain intangible assets is not deductible for income tax purposes.

Goodwill of $9,084,000 represents the premium over the fair value of the net tangible and intangible assets acquired with this acquisition. We paid this premium for a number of reasons, including the opportunity to offer Morningstar's full suite of products and services to investors in Sweden and further leverage Morningstar's global reach, investment databases, and technology expertise.

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

Balance as of December 31, 2012
$
320,845

Acquisition of remaining ownership in Morningstar Sweden
9,084

Other, primarily foreign currency translation
(3,188
)
Balance as of September 30, 2013
$
326,741



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

Intangible Assets

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

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
Intellectual property
 
$
29,799

 
$
(22,778
)
 
$
7,021

 
9
 
$
30,621

 
$
(21,527
)
 
$
9,094

 
9
Customer-related assets
 
141,824

 
(71,343
)
 
70,481

 
12
 
132,798

 
(63,005
)
 
69,793

 
12
Supplier relationships
 
240

 
(105
)
 
135

 
20
 
240

 
(96
)
 
144

 
20
Technology-based assets
 
80,553

 
(49,017
)
 
31,536

 
9
 
81,333

 
(43,809
)
 
37,524

 
9
Non-competition agreement
 
1,692

 
(1,596
)
 
96

 
4
 
1,765

 
(1,588
)
 
177

 
4
Total intangible assets
 
$
254,108

 
$
(144,839
)
 
$
109,269

 
10
 
$
246,757

 
$
(130,025
)
 
$
116,732

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

 
2012

 
2013

 
2012

Amortization expense
 
$
5,287

 
$
5,941

 
$
16,249

 
$
17,972


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

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

2013
 
$
21,510

2014
 
20,507

2015
 
19,687

2016
 
15,118

2017
 
10,579

2018
 
8,593


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

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

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

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

Furthermore, beginning with the third quarter of 2013, we revised our segment structure to reflect our shift to a more centralized organizational structure. We now report our results in a single reportable segment, which reflects how our chief operating decision maker allocates resources and evaluates our financial results.
Income Per Share
Income Per Share
Income Per Share 

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

 
 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands, except per share amounts)
 
 
2013

 
2012

 
2013

 
2012

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

 
 

 
 
 
 
Net income attributable to Morningstar, Inc.:
 
 
$
31,463

 
$
27,070

 
$
92,202

 
$
75,095

Less: Distributed earnings available to participating securities
 
 

 
(12
)
 
(5
)
 
(39
)
Less: Undistributed earnings available to participating securities
 
 
(11
)
 
(53
)
 
(29
)
 
(144
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,452

 
$
27,005

 
$
92,168

 
$
74,912

 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
46,080

 
47,975

 
46,293

 
49,028

 
 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
 
$
0.68

 
$
0.56

 
$
1.99

 
$
1.53

 
 
 
 
 
 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
 
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,452

 
$
27,005

 
$
92,168

 
$
74,912

Add: Undistributed earnings allocated to participating securities
 
 
11

 
53

 
29

 
144

Less: Undistributed earnings reallocated to participating securities
 
 
(11
)
 
(53
)
 
(29
)
 
(142
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
 
$
31,452

 
$
27,005

 
$
92,168

 
$
74,914

 
 
 


 


 


 


Weighted average common shares outstanding
 
 
46,080

 
47,975

 
46,293

 
49,028

Net effect of dilutive stock options and restricted stock units
 
 
439

 
506

 
342

 
636

Weighted average common shares outstanding for computing diluted income per share
 
 
46,519

 
48,481

 
46,635

 
49,664

 
 
 


 


 


 


Diluted net income per share attributable to Morningstar, Inc.
 
 
$
0.68

 
$
0.56

 
$
1.98

 
$
1.51


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

 
2012

 
2013

 
2012

Weighted average stock options
 
 

 
9

 

 
12

Weighted average restricted stock units
 
 
1

 

 
19

 
81

Weighted average restricted stock
 
 

 

 

 

Total
 
 
1

 
9

 
19

 
93


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

Segment and Geographical Area Information
Segment and Geographical Area Information
Segment, Enterprise-Wide, and Geographical Area Information
 
Segment Information

Beginning with the third quarter of 2013, we revised our segment structure to reflect our shift to a more centralized organizational structure. We now report our results in a single reportable segment, which reflects how our chief operating decision maker allocates resources and evaluates our financial results.

Because we have one reportable segment, all required financial segment information can be found directly in the Unaudited Condensed Consolidated Financial Statements.

The accounting policies for our single reportable segment are the same as those described in “Note 3. Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2012. We evaluate the performance of our reporting segment based on revenue and operating income.

Products and Services Information

We derive revenue from two product groups. The investment information product group includes all of our data, software, and research products and services. These products are typically sold through subscriptions or license agreements. The investment management product group includes all of our asset management operations, which earn the majority of their revenue from asset-based fees. The table below summarizes our revenue by product group.

External revenue by product group
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2013

 
2012

 
2013

 
2012

 
Investment information
 
$
137,216

 
$
128,392

 
$
412,332

 
$
388,468

 
Investment management
 
36,266

 
32,560

 
105,434

 
99,211

 
Consolidated revenue
 
$
173,482

 
$
160,952

 
$
517,766

 
$
487,679

 


Geographical Area Information

The tables below summarize our revenue and long-lived assets by geographical area.

External revenue by geographical area
 
 
 
 
 
 
 
 
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2013

 
2012

 
2013

 
2012

United States
 
$
124,998

 
$
114,021

 
$
372,746

 
$
346,442

 
 
 
 
 
 
 
 
 
United Kingdom
 
14,148

 
13,711

 
41,316

 
42,160

Europe, excluding the United Kingdom
 
14,666

 
11,643

 
41,826

 
35,980

Australia
 
8,041

 
10,090

 
26,569

 
29,230

Canada
 
7,603

 
7,605

 
23,151

 
22,351

Asia, excluding Japan
 
2,580

 
2,420

 
7,836

 
7,156

Japan
 
783

 
924

 
2,400

 
2,889

Other
 
663

 
538

 
1,922

 
1,471

Total International
 
48,484

 
46,931

 
145,020

 
141,237

 
 
 
 
 
 
 
 
 
Consolidated revenue
 
$
173,482

 
$
160,952

 
$
517,766

 
$
487,679




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

 
2012

United States
 
$
77,713

 
$
60,371

 
 
 
 
 
United Kingdom
 
6,611

 
7,435

Europe, excluding the United Kingdom
 
2,061

 
2,356

Australia
 
1,184

 
1,402

Canada
 
1,400

 
1,773

Asia, excluding Japan
 
9,863

 
10,445

Japan
 
45

 
84

Other
 
130

 
156

Total International
 
21,294

 
23,651

 
 
 
 
 
Consolidated property, equipment, and capitalized software, net
 
$
99,007

 
$
84,022

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

 
2012

Available-for-sale
 
$
129,316

 
$
125,786

Held-to-maturity
 
29,307

 
26,357

Trading securities
 
7,295

 
5,386

Total
 
$
165,918

 
$
157,529




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

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
28,515

 
$
8

 
$
(24
)
 
$
28,499

 
$
40,669

 
$
29

 
$
(608
)
 
$
40,090

Corporate bonds
 
67,763

 
13

 
(223
)
 
67,553

 
49,339

 
36

 
(292
)
 
49,083

Foreign obligations
 
1,297

 

 
(16
)
 
1,281

 
2,437

 
1

 
(19
)
 
2,419

Commercial paper
 
9,986

 

 
(1
)
 
9,985

 
2,000

 

 

 
2,000

Equity securities and exchange-traded funds
 
8,226

 
1,001

 
(156
)
 
9,071

 
19,613

 
1,359

 
(323
)
 
20,649

Mutual funds
 
10,624

 
2,395

 
(92
)
 
12,927

 
10,499

 
1,092

 
(46
)
 
11,545

Total
 
$
126,411

 
$
3,417

 
$
(512
)
 
$
129,316

 
$
124,557

 
$
2,517

 
$
(1,288
)
 
$
125,786

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
29,307

 
$

 
$

 
$
29,307

 
$
26,357

 
$

 
$

 
$
26,357


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

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

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
53,470

 
$
53,308

 
$
87,599

 
$
86,784

Due in one to two years
 
54,091

 
54,010

 
6,846

 
6,808

Equity securities, exchange-traded funds, and mutual funds
 
18,850

 
21,998

 
30,112

 
32,194

    Total
 
$
126,411

 
$
129,316

 
$
124,557

 
$
125,786

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
29,303

 
$
29,303

 
$
26,352

 
$
26,352

Due in one to three years
 
4

 
4

 
5

 
5

Total
 
$
29,307

 
$
29,307

 
$
26,357

 
$
26,357


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

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

 
2012

 
2013

 
2012

Realized gains
 
94

 
219

 
$
2,320

 
$
689

Realized losses
 
(136
)
 
(222
)
 
(1,214
)
 
(741
)
Realized gains (losses), net
 
(42
)
 
(3
)
 
$
1,106

 
$
(52
)

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

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

 
2012

 
2013

 
2012

Unrealized gains (losses), net
 
(741
)
 
181

 
$
(468
)
 
$
337



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

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
28,499

 
$

 
$
28,499

 
$

Corporate bonds
 
67,553

 

 
67,553

 

Foreign obligations
 
1,281

 

 
1,281

 

Commercial paper
 
9,985

 

 
9,985

 

Equity securities and exchange-traded funds
 
9,071

 
9,071

 

 

Mutual funds
 
12,927

 
12,927

 

 

Trading securities
 
7,295

 
7,295

 

 

Cash equivalents
 
18,990

 
18,990

 

 

Total
 
$
155,601

 
$
48,283

 
$
107,318

 
$

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

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
40,090

 
$

 
$
40,090

 
$

Corporate bonds
 
49,083

 

 
49,083

 

Foreign obligations
 
2,419

 

 
2,419

 

Commercial paper
 
2,000

 

 
2,000

 

Equity securities and exchange-traded funds
 
20,649

 
20,649

 

 

Mutual funds
 
11,545

 
11,545

 

 

Trading securities
 
5,386

 
5,386

 

 

Cash equivalents
 
398

 
398

 

 

Total
 
$
131,570

 
$
37,978

 
$
93,592

 
$


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

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

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


As of December 31

($000)
 
2013


2012

Investment in MJKK
 
$
21,359

 
$
20,540

Other equity method investments
 
6,322

 
6,288

Investments accounted for using the cost method
 
10,695

 
8,477

Total investments in unconsolidated entities
 
$
38,376

 
$
35,305


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

 
As of December 31

 
 
2013

 
2012

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

 
 

Japanese yen (¥000)
 
¥
8,558,222

 
¥
3,109,579

Equivalent U.S. dollars ($000)
 
$
87,123

 
$
36,227



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

As of December 31, 2012, other equity-method investments also included our investment in Morningstar Sweden. Our ownership interest and profit-and-loss sharing interest in Morningstar Sweden was 24% at that date. In May 2013, we acquired an additional 76% interest in Morningstar Sweden, increasing our ownership to 100%. Upon acquiring the full ownership, we recorded a non-cash gain of $3,635,000. This gain represents the difference between the estimated fair value and the book value of our investment in Morningstar Sweden at the date of acquisition. Because Morningstar Sweden is now a wholly owned subsidiary, we no longer account for our investment using the equity method. Beginning in May 2013, we consolidate the assets, liabilities, and results of operations of Morningstar Sweden in our Unaudited Condensed Consolidated Financial Statements. See Note 3 for additional information concerning our acquisition of Morningstar Sweden.

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

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

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

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

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

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

(in thousands)
 
2013

Shares available for future grants
 
4,563


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

 
2012

 
2013

 
2012

Restricted stock units
 
$
3,196

 
$
3,396

 
$
10,493

 
$
9,944

Restricted stock
 
97

 
444

 
291

 
1,332

Stock options
 
123

 
154

 
369

 
318

Total stock-based compensation expense
 
$
3,416

 
$
3,994

 
$
11,153

 
$
11,594

 
 
 
 
 
 
 
 
 
Income tax benefit related to the stock-based compensation expense
 
$
846

 
$
931

 
$
2,944

 
$
2,735


 

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

 
Expected amortization period (months)
Restricted stock units
 
$
32,203

 
34
Restricted stock
 
614

 
19
Stock options
 
708

 
19
Total unrecognized stock-based compensation expense
 
$
33,525

 
33


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

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

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

 
Vested but
Deferred

 
Total

 
Weighted
Average
Grant Date Value
per RSU

RSUs outstanding—December 31, 2012
 
727,145

 
18,782

 
745,927

 
$
53.37

Granted
 
244,364

 

 
244,364

 
69.99

Dividend equivalents
 
2,090

 
63

 
2,153

 
55.69

Vested
 
(256,105
)
 

 
(256,105
)
 
49.82

Vested but deferred
 

 

 

 

Issued
 

 
(2,257
)
 
(2,257
)
 
49.40

Forfeited
 
(42,862
)
 

 
(42,862
)
 
57.43

RSUs outstanding—September 30, 2013
 
674,632

 
16,588

 
691,220

 
60.40


 
Restricted Stock
 
In conjunction with our acquisition of Realpoint LLC 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 stock agreements prepared in conjunction with the Realpoint acquisition, we account for the grant of restricted stock as stock-based compensation expense and not as part of the acquisition consideration.

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. We have assumed that all of the remaining restricted stock will ultimately vest, and therefore have not incorporated a forfeiture rate for purposes of determining the stock-based compensation expense.
 
Stock Options

Stock options granted to employees vest ratably over a four-year period. Grants to our non-employee directors vest ratably over a three-year period. All grants expire 10 years after the date of grant. Almost all of the options granted under the 2004 Stock Incentive Plan have a premium feature in which the exercise price increases over the term of the option at a rate equal to the 10-year Treasury bond yield as of the date of grant. Options granted under the 2011 Plan have an exercise price equal to the fair market value on the grant date.

The following tables summarize stock option activity in the first nine months of 2013 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, 2012
 
282,695

 
$
20.55

Granted
 

 

Canceled
 
(250
)
 
21.25

Exercised
 
(40,942
)
 
20.77

Options outstanding—September 30, 2013
 
241,503

 
21.24

 
 
 
 
 
Options exercisable—September 30, 2013
 
241,503

 
$
21.24


 
All Other Option Grants, Excluding Activity Shown Above
 
Underlying
Shares

 
Weighted
Average
Exercise
Price

Options outstanding—December 31, 2012
 
391,784

 
$
28.98

Granted
 

 

Canceled
 
(1,352
)
 
16.08

Exercised
 
(133,219
)
 
16.59

Options outstanding—September 30, 2013
 
257,213

 
36.15

 
 
 
 
 
Options exercisable—September 30, 2013
 
221,166

 
$
32.66

 
The following table summarizes the total intrinsic value (difference between the market value of our stock on the date of exercise and the exercise price of the option) of options exercised:
 
 
 
Nine months ended September 30
($000)
 
2013

 
2012

Intrinsic value of options exercised
 
$
8,964

 
$
17,161


 

The table below shows additional information for options outstanding and exercisable as of September 30, 2013:
 
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number of  Options

 
Weighted
Average
Remaining
Contractual
Life (years)
 
Weighted
Average
Exercise
Price

 
Aggregate
Intrinsic
Value
($000)

 
Exercisable Shares

 
Weighted Average Remaining Contractual Life (years)
 
Weighted Average Exercise Price

 
Aggregate Intrinsic Value ($000)

$8.57 - $14.70
 
385

 
0.92
 
$
13.11

 
$
25

 
385

 
0.92
 
$
13.11

 
$
25

$21.18 - $48.37
 
426,656

 
1.39
 
24.15

 
23,513

 
426,656

 
1.39
 
24.15

 
23,513

$57.28 - $59.35
 
71,675

 
7.78
 
57.46

 
1,563

 
35,628

 
7.76
 
57.37

 
750

$8.57 - $59.35
 
498,716

 
2.31
 
28.93

 
$
25,101

 
462,669

 
1.88
 
26.70

 
$
24,288

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested or Expected to Vest
 
 
 
 
 
 
 
 
 
 
 
 
 
$8.57 - $59.35
 
498,716

 
2.31
 
$
28.93

 
$
25,101

 
 
 
 
 
 
 
 

 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value all option holders would have received if they had exercised all outstanding options on September 30, 2013. The intrinsic value is based on our closing stock price of $79.26 on that date.

Excess Tax Benefits Related to Stock-Based Compensation
 
FASB ASC 718, Compensation—Stock Compensation, requires that we classify the cash flows that result from excess tax benefits as financing cash flows. Excess tax benefits correspond to the portion of the tax deduction taken on our income tax return that exceeds the amount of tax benefit related to the compensation cost recognized in our Statement of Income. The following table summarizes our excess tax benefits:
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2013

 
2012

 
2013

 
2012

Excess tax benefits related to stock-based compensation
 
$
251

 
$
459

 
$
4,093

 
$
5,007

Income Taxes
Income Taxes
Income Taxes
 
Effective Tax Rate

The following table shows our effective income tax rate for the three and nine months ended September 30, 2013 and September 30, 2012:
 
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2013

 
2012

 
2013

 
2012

Income before income taxes and equity in net income of unconsolidated entities
 
$
45,384

 
$
41,744

 
$
133,584