UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 


 

FORM 10-Q

 


 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007

 

OR

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from         to     

 

Commission File Number: 000-51280

 


 

MORNINGSTAR, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Illinois

 

36-3297908

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification Number)

 

225 West Wacker Drive
Chicago, Illinois
60606-6303

(Address of Principal Executive Offices)

 

(312) 696-6000

(Registrant’s Telephone Number, Including Area Code)

 


 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   o

Accelerated filer   x

Non-accelerated filer   o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of August 2, 2007, there were 43,215,013 shares of the Company’s common stock, no par value, outstanding.

 

 



 

MORNINGSTAR, INC. AND SUBSIDIARIES

INDEX

 

PART 1

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Unaudited Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Income for the three and six months ended June 30, 2007 and 2006

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the six months ended June 30, 2007

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and 2006

 

 

 

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosure about Market Risk

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

 

 

PART 2

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

 

 

 

 

 

 

SIGNATURE

 

 

 

 

 

2



 

PART 1: FINANCIAL INFORMATION

 

Item 1: Unaudited Condensed Consolidated Financial Statements

 

Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

 

 

 

 

 

 

 

 

 

Three Months Ended June 30

 

Six Months Ended June 30

 

(in thousands except per share amounts)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

109,685

 

$

76,257

 

$

205,132

 

$

146,317

 

 

 

 

 

 

 

 

 

 

 

Operating expense (1):

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

29,020

 

22,052

 

54,875

 

40,725

 

Development

 

9,134

 

7,306

 

17,189

 

13,397

 

Sales and marketing

 

16,471

 

11,880

 

33,200

 

23,540

 

General and administrative

 

21,128

 

13,793

 

37,214

 

25,825

 

Depreciation and amortization

 

5,486

 

3,767

 

10,181

 

6,173

 

Total operating expense

 

81,239

 

58,798

 

152,659

 

109,660

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

28,446

 

17,459

 

52,473

 

36,657

 

 

 

 

 

 

 

 

 

 

 

Non-operating income (expense):

 

 

 

 

 

 

 

 

 

Interest income, net

 

1,437

 

858

 

3,186

 

1,917

 

Other expense, net

 

(69

)

(186

)

(305

)

(312

)

Non-operating income, net

 

1,368

 

672

 

2,881

 

1,605

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes, equity in net income of unconsolidated entities, and cumulative effect of accounting change

 

29,814

 

18,131

 

55,354

 

38,262

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

11,996

 

7,624

 

22,287

 

15,222

 

 

 

 

 

 

 

 

 

 

 

Equity in net income of unconsolidated entities

 

455

 

658

 

992

 

1,305

 

 

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

18,273

 

11,165

 

34,059

 

24,345

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of accounting change, net of income tax expense of $171

 

 

 

 

259

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

18,273

 

$

11,165

 

$

34,059

 

$

24,604

 

 

 

 

 

 

 

 

 

 

 

Basic income per share:

 

 

 

 

 

 

 

 

 

Basic income per share before cumulative effect of accounting change

 

$

0.43

 

$

0.27

 

$

0.80

 

$

.0.60

 

Cumulative per share effect of accounting change

 

 

 

 

0.01

 

Basic net income per share

 

$

0.43

 

$

0.27

 

$

0.80

 

$

0.61

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

Diluted income per share before cumulative effect of accounting change

 

$

0.38

 

$

0.24

 

$

0.71

 

$

0.52

 

Cumulative per share effect of accounting change

 

 

 

 

0.01

 

Diluted net income per share

 

$

0.38

 

$

0.24

 

$

0.71

 

$

0.53

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

42,852

 

40,925

 

42,632

 

40,641

 

Diluted

 

47,868

 

46,684

 

47,758

 

46,535

 

 

 

 

 

 

Three Months Ended June 30

 

Six Months Ended June 30

 

 

 

2007

 

2006

 

2007

 

2006

 

(1) Includes stock-based compensation expense of:

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

$

513

 

$

285

 

$

851

 

$

557

 

Development

 

371

 

131

 

624

 

245

 

Sales and marketing

 

412

 

137

 

711

 

263

 

General and administrative

 

1,907

 

1,526

 

3,351

 

2,948

 

Total stock-based compensation expense

 

$

3,203

 

$

2,079

 

$

5,537

 

$

4,013

 

 

See notes to unaudited condensed consolidated financial statements.

 

3



 

Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

(in thousands except share amounts)

 

June 30
2007

 

December 31
2006

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

94,978

 

$

96,140

 

Investments

 

65,767

 

67,611

 

Accounts receivable, less allowance of $129 and $225, respectively

 

79,648

 

65,176

 

Other

 

8,856

 

8,557

 

Total current assets

 

249,249

 

237,484

 

 

 

 

 

 

 

Property, equipment, and capitalized software, net of accumulated depreciation of $53,949 and $48,256, respectively

 

17,656

 

15,869

 

Investments in unconsolidated entities

 

19,042

 

18,659

 

Goodwill

 

122,780

 

86,680

 

Intangible assets, net

 

103,878

 

72,841

 

Deferred tax asset, net

 

16,954

 

13,789

 

Other assets

 

2,324

 

2,516

 

Total assets

 

$

531,883

 

$

447,838

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

30,051

 

$

21,014

 

Accrued compensation

 

34,580

 

40,856

 

Income tax payable

 

1,786

 

1,620

 

Deferred revenue

 

132,569

 

100,525

 

Deferred tax liability, net

 

 

1,266

 

Other

 

1,800

 

2,182

 

Total current liabilities

 

200,786

 

167,463

 

 

 

 

 

 

 

Accrued compensation

 

7,593

 

7,591

 

Other long-term liabilities

 

3,203

 

3,361

 

Total liabilities

 

211,582

 

178,415

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, no par value, 200,000,000 shares authorized, of which 43,120,121 and 42,228,418 shares were outstanding as of June 30, 2007 and December 31, 2006, respectively

 

4

 

4

 

Treasury stock at cost, 233,334 shares as of June 30, 2007 and December 31, 2006

 

(3,280

)

(3,280

)

Additional paid-in capital

 

286,959

 

268,721

 

Retained earnings

 

31,894

 

1,154

 

Accumulated other comprehensive income:

 

 

 

 

 

Currency translation adjustment

 

4,760

 

2,871

 

Unrealized losses on available-for-sale securities

 

(36

)

(47

)

Total accumulated other comprehensive income

 

4,724

 

2,824

 

Total shareholders’ equity

 

320,301

 

269,423

 

Total liabilities and shareholders’ equity

 

$

531,883

 

$

447,838

 

 

See notes to unaudited condensed consolidated financial statements.

 

4



 

Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statement of Shareholders’ Equity and Comprehensive Income

For the Six Months Ended June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Common Stock

 

 

 

Additional

 

Retained

 

Other

 

Total

 

 

 

Shares

 

Par

 

Treasury

 

Paid-in

 

Earnings

 

Comprehensive

 

Shareholders’

 

(in thousands, except share amounts)

 

Outstanding

 

Value

 

Stock

 

Capital

 

(Deficit)

 

Income

 

Equity

 

Balance as of December 31, 2006

 

42,228,418

 

$

4

 

$

(3,280

)

$

268,721

 

$

1,154

 

$

2,824

 

$

269,423

 

Cumulative effect of accounting change

 

 

 

 

 

(3,319

)

 

(3,319

)

Balance as of January 1, 2007

 

42,228,418

 

4

 

(3,280

)

268,721

 

(2,165

)

2,824

 

266,104

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

34,059

 

 

34,059

 

Unrealized gain on investments, net of income tax $6

 

 

 

 

 

 

 

11

 

11

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

1,889

 

1,889

 

Total comprehensive income

 

 

 

 

 

 

34,059

 

1,900

 

35,959

 

Issuance of common stock upon stock option exercises and vesting of restricted stock units, net

 

891,703

 

 

 

5,690

 

 

 

5,690

 

Stock-based compensation

 

 

 

 

 

5,537

 

 

 

5,537

 

Tax benefit derived from stock option exercises and vesting of restricted stock units

 

 

 

 

 

7,011

 

 

 

7,011

 

Balance as of June 30, 2007

 

43,120,121

 

$

4

 

$

(3,280

)

$

286,959

 

$

31,894

 

$

4,724

 

$

320,301

 

 

See notes to unaudited condensed consolidated financial statements.

 

5



 

Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

Six Months Ended June 30

 

(in thousands)

 

2007

 

2006

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income

 

$

34,059

 

$

24,604

 

Adjustments to reconcile net income to net cash flows from operating activities:

 

 

 

 

 

Cumulative effect of accounting change, net of tax

 

 

(259

)

Depreciation and amortization

 

10,181

 

6,173

 

Deferred income tax benefit

 

(1,698

)

(717

)

Stock-based compensation expense

 

5,537

 

4,013

 

Provision for (recovery of) bad debt

 

(44

)

328

 

Equity in net income of unconsolidated entities

 

(992

)

(1,305

)

Foreign exchange loss

 

120

 

452

 

Excess tax benefits from stock option exercises and vesting of restricted stock units

 

(7,011

)

(6,508

)

Other, net

 

(125

)

36

 

Changes in operating assets and liabilities, net of effects of acquisitions:

 

 

 

 

 

Accounts receivable

 

(5,456

)

(2,758

)

Other assets

 

869

 

455

 

Accounts payable and accrued liabilities

 

3,228

 

(245

)

Accrued compensation

 

(12,891

)

(7,174

)

Income taxes payable

 

7,203

 

13,467

 

Deferred revenue

 

13,389

 

8,425

 

Other liabilities

 

(1,873

)

442

 

Cash provided by operating activities

 

44,496

 

39,429

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Purchases of investments

 

(40,243

)

(37,783

)

Proceeds from sale of investments

 

42,220

 

60,454

 

Capital expenditures

 

(5,888

)

(2,023

)

Acquisitions, net of cash acquired

 

(55,063

)

(86,363

)

Other, net

 

(3

)

(294

)

Cash used for investing activities

 

(58,977

)

(66,009

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Proceeds from stock options exercises

 

5,686

 

10,851

 

Excess tax benefits from stock option exercises and vesting of restricted stock units

 

7,011

 

6,508

 

Other

 

 

(4

)

Cash provided by financing activities

 

12,697

 

17,355

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

622

 

117

 

Net decrease in cash and cash equivalents

 

(1,162

)

(9,108

)

Cash and cash equivalents – beginning of period

 

96,140

 

92,367

 

Cash and cash equivalents – end of period

 

$

94,978

 

$

83,259

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for taxes

 

$

16,253

 

$

2,214

 

Supplemental information of non-cash investing and financing activities:

 

 

 

 

 

Unrealized gain (loss) on available for sale investments

 

$

17

 

$

(3

)

 

See notes to unaudited condensed consolidated financial statements.

 

6



 

MORNINGSTAR, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Basis of Presentation of Interim Financial Information

 

The accompanying unaudited condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the Company) included herein 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, stockholders’ equity, and cash flows. These financial statements and notes should be read in conjunction with our Consolidated Financial Statements and Notes thereto as of December 31, 2006 included in our Annual Report on Form 10-K filed with the SEC on March 16, 2007.

 

2. Summary of Significant Accounting Policies

 

Our significant accounting policies are discussed in Note 2 of our Consolidated Financial Statements included in our Annual Report on Form 10-K filed with the SEC for the year ended December 31, 2006.

 

Adoption of Financial Accounting Standard Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109

 

On January 1, 2007, we adopted Financial Accounting Standard Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48), which prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, and disclosure for uncertain tax positions.

 

The adoption of FIN 48 did not result in a material adjustment in the liability for unrecognized income tax benefits, and as a result, we did not record a cumulative effect adjustment to retained earnings at the beginning of the period. As of January 1, 2007, we had approximately $2,700,000 of gross unrecognized tax benefits, of which $2,300,000, if recognized, would result in a reduction of our effective income tax expense rate. We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense in our Consolidated Statements of Income. Interest and penalties were not material as of the date of adoption. Adjustments recorded to these balances in the first six months of 2007 were not material.

 

We conduct business globally and, as a result our subsidiaries file income tax returns in U.S. Federal, state, and foreign jurisdictions. In the normal course of business we are subject to examination by tax authorities throughout the world. For U.S. Federal and state tax returns, open tax years subject to examination generally include the years 2003 to the present. In non-U.S. jurisdictions the statute of limitations generally extends to years prior to 2003. We are currently under audit by the U.S. Internal Revenue Service, for the 2004 tax year, and by various state tax authorities. We are also under audit by the tax authorities in a non-U.S. jurisdiction for the period January 2003 through December 2004. It is likely that the examination phase of these audits will conclude in 2007. However, it is not possible to estimate the potential impact of changes, if any, to previously recorded uncertain tax positions. There were no significant changes to the status of these examinations during the quarter ended June 30, 2007.

 

Adoption of Emerging Issues Task Force No. 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, “Accounting for Compensated Absences”

 

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. On January 1, 2007, we adopted Emerging Issues Task Force (EITF) No. 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, “Accounting for Compensated Absences,” which requires that we record a liability for employees’ sabbatical benefits over the period employees earn the right for sabbatical leave. Accordingly, on January 1, 2007, we recorded a cumulative-effect adjustment to retained earnings of $3,319,000, net of tax, to reflect the portion of employee sabbatical leave that had been earned at that date. Besides recording this cumulative effect of an accounting change, the adoption of EITF No. 06-2 did not have a significant impact on our financial position, results of operations, or cash flows.

 

7



 

3. Acquisitions, Goodwill, and Other Intangible Assets

 

Acquisition of the minority interest of Morningstar Europe NV

 

Morningstar Europe NV is the holding company for Morningstar’s European subsidiaries. Morningstar, Inc., the U.S. parent company, owned 98% of the shares of Morningstar Europe NV. Stadsporten Citygate AB (Citygate) owned the remaining 2% of the shares. In April 2007, Morningstar acquired the remaining 2% share ownership from Citygate for $1,000,000 in cash. As a majority-owned subsidiary, the financial results of Morningstar Europe NV have been included in our Condensed Consolidated Financial Statements for all periods presented. We assigned the purchase price of $1,000,000 to goodwill.

 

Standard & Poor’s mutual fund data business

 

On March 16, 2007, we acquired Standard & Poor’s mutual fund data business for $55,000,000 in cash plus an additional $2,594,000 of estimated post-closing adjustments (net of acquired cash) and estimated transaction costs directly related to the acquisition. The acquisition complements one of our key growth strategies, which is to expand our brand, presence, and products for investors, advisors, and institutions around the globe. Approximately 80% of Standard & Poor’s mutual fund data business is outside the United States. The acquisition gives us a much stronger presence outside the United States, particularly in Europe. In addition, the acquisition significantly expands our client base and media partnerships in Europe and Asia. The cash paid for this acquisition in the first six months of 2007 was $54,021,000 (net of acquired cash). We expect to pay the remaining purchase price and transaction costs by the end of the third quarter of 2007.

 

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

 

 

 

($000)

 

Cash

 

$

2,974

 

Accounts receivable

 

7,392

 

Other current assets

 

1,021

 

Other non-current assets

 

71

 

Intangible assets

 

36,072

 

Goodwill

 

33,670

 

Deferred revenue

 

(16,456

)

Accrued liabilities

 

(4,043

)

Other non-current liabilities

 

(133

)

Total purchase price

 

$

60,568

 

 

The preliminary allocation includes acquired intangible assets of $36,072,000 consisting primarily of customer-related assets, technology-based assets (primarily a database covering more than 135,000 managed investment vehicles, including mutual funds, exchange-traded funds (ETFs), hedge funds, and offshore funds), and software. We have estimated a preliminary weighted average useful life of these assets of 10 years. Based on the preliminary purchase price allocation, we recorded $33,670,000 of goodwill.

 

Based on plans in place at the time of acquisition, we recorded a liability of $1,611,000 for severance and lease termination costs. We expect that substantially all of these liabilities will be paid within the next year.

 

We began including the financial results of this acquisition in our Condensed Consolidated Financial Statements on March 16, 2007. If the acquisition of Standard & Poor’s mutual fund data business had occurred as of January 1st of each period presented, our results of operations would not have been significantly different from the amounts reported for the three and six months ended June 30, 2007 or 2006.

 

Institutional Hedge Fund and Separate Accounts Database Division of InvestorForce, Inc.

 

In August 2006, we acquired the institutional hedge fund and separate account database division of InvestorForce, Inc. (InvestorForce), a financial software and data integration company based in Wayne, Pennsylvania, for $10,051,000 in cash, including expenses directly related to the acquisition. We began including the financial results of this acquisition in our Condensed Consolidated Financial Statements on August 1, 2006. This acquisition included the Altvest database, one of the largest databases covering hedge funds, managers, and data, as well as InvestorForce’s extensive institutional separate account database. It also included several online software applications for manager search, research, and reporting. This acquisition allowed us to strengthen and expand our proprietary investment data.

 

8



 

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

 

 

 

($000)

 

Accounts receivable

 

$

343

 

Intangible assets

 

5,290

 

Goodwill

 

6,032

 

Deferred revenue

 

(1,614

)

Total purchase price

 

$

10,051

 

 

The purchase price allocation includes $5,290,000 of acquired intangible assets. These assets include technology-based assets of $2,500,000 that will be amortized over a weighted average period of five years; customer-based assets of $2,350,000 that will be amortized over a weighted average period of five years; trade names of $390,000 that will be amortized over a weighted average period of four years; and a non-compete agreement of $50,000 that will be amortized over three years.

 

The value assigned to goodwill and intangibles of $11,322,000 is deductible for U.S. income tax purposes over a period of 15 years.

 

If the acquisition of the database division of InvestorForce had occurred as of January 1, 2006, our results of operations would not have been significantly different from the amounts reported for the three and six months ended June 30, 2006.

 

Aspect Huntley Pty Limited

 

In July 2006, we acquired Aspect Huntley Pty Limited (Aspect Huntley), a leading provider of equity information, research, and financial trade publishing in Australia. This acquisition fits our growth strategy to expand our products and services outside the United States and allows us to combine Morningstar’s expertise in fund research and information with Aspect Huntley’s equity research, information, and financial media expertise in Australia.

 

The preliminary purchase price of $23,407,000 represents Australian $30,000,000 in cash (of which Australian $2,000,000 was paid in July 2007), and includes transaction costs directly related to the acquisition and post-closing adjustments. In 2006, the cash paid for Aspect Huntley, including transaction costs and post-closing adjustments, was $20,914,000 (net of acquired cash).

 

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

 

 

 

($000)

 

Cash

 

$

922

 

Accounts receivable

 

671

 

Other current assets

 

324

 

Fixed assets

 

273

 

Deferred tax asset

 

359

 

Intangible assets

 

11,019

 

Goodwill

 

16,938

 

Deferred revenue

 

(5,141

)

Other current liabilities

 

(1,850

)

Income taxes payable

 

(108

)

Total purchase price

 

$

23,407

 

 

The preliminary purchase price allocation includes $11,019,000 of acquired intangible assets. These assets include trade names of $6,622,000 that will be amortized over a weighted average period of 10 years; technology-based assets (primarily including a database) of $2,593,000 that will be amortized over a weighted average period of 18 years; and customer-related assets of $1,804,000 that will be amortized over 10 years.

 

The goodwill we recorded of $16,938,000 is not deductible for U.S. or Australian income tax purposes.

 

We began including the results of Aspect Huntley’s operations in our Condensed Consolidated Financial Statements on July 25, 2006. If the acquisition of Aspect Huntley had occurred as of January 1, 2006, our results of operations would not have been significantly different from the amounts reported for three and six months ended June 30, 2006.

 

9



 

Ibbotson Associates, Inc.

 

In March 2006, we acquired Ibbotson Associates, Inc. (Ibbotson), a firm specializing in asset allocation research and services, for $83,000,000 in cash, plus an additional $3,470,000 in cash for working capital and other items. We began including the results of Ibbotson’s operations in our Condensed Consolidated Financial Statements on March 1, 2006. This acquisition complemented our growth strategies in several key areas, including investment consulting, managed retirement accounts, and institutional and advisor software.

 

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

 

 

 

($000)

 

Cash

 

$

103

 

Accounts receivable

 

6,770

 

Income tax benefits, net

 

13,047

 

Other current assets

 

1,398

 

Fixed assets

 

1,407

 

Other assets

 

156

 

Intangible assets

 

55,280

 

Goodwill

 

46,221

 

Deferred revenue

 

(10,772

)

Accrued liabilities

 

(4,882

)

Deferred tax liability, net

 

(21,497

)

Other non-current liabilities

 

(761

)

Total purchase price

 

$

86,470

 

 

As part of the purchase price allocation, we recorded an asset of $13,047,000, primarily for the income tax benefit related to payment for the cancellation of Ibbotson’s stock options. This cash income tax benefit reduced the amount of cash we paid for income taxes in 2006. This cash income tax benefit did not impact our income tax expense or net income in 2006.

 

The purchase price allocation also includes $55,280,000 of acquired intangible assets. These assets include customer-related assets of $34,200,000 that will be amortized over a weighted average period of nine years; intellectual property (including patents and trade names) of $17,710,000 that will be amortized over a weighted average period of 10 years; technology-based assets of $3,070,000 that will be amortized over a weighted average period of five years; and a non-compete agreement of $300,000 that will be amortized over five years. The deferred tax liability of $21,497,000 results primarily because the amortization expense for these intangible assets is not deductible for U.S. income tax purposes.

 

Based on the purchase price allocation, we recorded $46,221,000 of goodwill. The goodwill we recorded is not deductible for U.S. income tax purposes. Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, prohibits recognition of a deferred tax asset or liability for goodwill temporary differences if goodwill is not amortizable and deductible for tax purposes.

 

Based on plans in place at the time of acquisition, we recorded a liability of $596,000 for severance and $761,000 for lease termination costs, net of estimated sub-lease income. As of June 30, 2007, we have made all of the related severance payments. We expect to pay the lease termination costs beginning in 2008, which is when we plan to vacate Ibbotson’s office space.

 

10



 

The following unaudited pro forma information presents a summary of our Consolidated Statement of Income for the six months ended June 30, 2006 as if we had acquired Ibbotson as of January 1, 2006. In calculating the pro forma information below, we made an adjustment to eliminate stock-based compensation expense previously recorded by Ibbotson based on the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. We also made an adjustment to record stock-based compensation expense for an estimated value of stock options assumed to be granted to Ibbotson employees. We recorded stock-based compensation expense based on the recognition and measurement principles of SFAS No. 123, Accounting for Stock-Based Compensation.

 

($000)

 

Six months ended
June 30, 2006

 

Revenue

 

$

153,708

 

Operating income

 

$

36,998

 

Income before cumulative effect of accounting change

 

$

24,320

 

Net income

 

$

24,579

 

 

 

 

 

Basic income per share:

 

 

 

Basic income per share before cumulative effect of accounting change

 

$

0.60

 

Basic net income per share

 

$

0.60

 

 

 

 

 

Diluted income per share:

 

 

 

Diluted income per share before cumulative effect of accounting change

 

$

0.52

 

Diluted net income per share

 

$

0.53

 

 

Goodwill

 

The following table shows the changes in our goodwill balances from January 1, 2006 to June 30, 2007:

 

 

 

($000)

 

Balance as of January 1, 2006

 

$

17,500

 

Goodwill acquired related to Ibbotson

 

46,221

 

Goodwill acquired related to Aspect Huntley

 

17,274

 

Goodwill acquired related to the database division of InvestorForce

 

6,020

 

Reversal of valuation allowances related to non-U.S. deferred tax assets, primarily related to net operating losses

 

(1,200

)

Other, primarily currency translation

 

865

 

Balance as of December 31, 2006

 

$

86,680

 

Goodwill acquired related to the mutual fund data business of Standard & Poor’s

 

33,670

 

Goodwill acquired related to the purchase of the minority interest in Morningstar Europe NV

 

1,000

 

Adjustment to Aspect Huntley goodwill

 

(336

)

Other, primarily currency translation

 

1,766

 

Balance as of June 30, 2007

 

$

122,780

 

 

At the date of acquisition of certain of our non-U.S. operations, we recorded a valuation allowance against the deferred tax assets related to the acquired entities’ deductible temporary differences and net operating losses. In 2006, we reversed these valuation allowances because we considered that it is more likely than not that we will realize these tax benefits. In accordance with SFAS No. 109, tax benefits recognized after the acquisition date (by eliminating the valuation allowance) are applied first to reduce any goodwill related to the acquisition. We therefore recorded in 2006 a reduction to goodwill in the amount of $1,200,000 related to the reduction of these valuation allowances.

 

We did not record any impairment losses in the quarter or year-to-date periods ended June 30, 2007 or 2006, respectively.

 

11



 

We amortize intangible assets using the straight-line method over their expected economic useful lives. The following table summarizes our intangible assets:

 

 

 

As of June 30, 2007

 

As of December 31, 2006

 

($ 000)

 

Gross

 

Accumulated
Amortization

 

Net

 

Weighted
Average
Useful Life
(years)

 

Gross

 

Accumulated
Amortization

 

Net

 

Weighted
Average
Useful Life
(years)

 

Intellectual property

 

$

26,710

 

$

(3,991

)

$

22,719

 

10

 

$

26,185

 

$

(2,455

)

$

23,730

 

10

 

Customer-related assets

 

45,158

 

(6,846

)

38,312

 

10

 

45,015

 

(4,410

)

40,605

 

10

 

Supplier relationships

 

240

 

(30

)

210

 

20

 

240

 

(24

)

216

 

20

 

Technology-based assets

 

9,382

 

(2,020

)

7,362

 

9

 

9,177

 

(1,180

)

7,997

 

9

 

Non-competition agreement

 

350

 

(95

)

255

 

5

 

350

 

(57

)

293

 

5

 

Intangible assets related to the mutual fund data business acquired from Standard & Poor’s

 

36,072

 

(1,052

)

35,020

 

10

 

 

 

 

 

Total intangible assets

 

$

117,912

 

$

(14,034

)

$

103,878

 

10

 

$

80,967

 

$

(8,126

)

$

72,841

 

10

 

 

Amortization expense was $5,841,000 and $2,454,000 for the six months ended June 30, 2007 and June 30, 2006, respectively.

 

As of June 30, 2007, we estimate that aggregate amortization expense for intangible assets will be $12,483,000 in 2007; $13,164,000 in 2008; $12,806,000 in 2009; $11,865,000 in 2010; $10,859,000 in 2011; and $10,271,000 in 2012. Our estimates of future amortization expense for intangible assets may be affected by changes to the preliminary purchase price allocations, primarily the allocation associated with our acquisition of Standard & Poor’s mutual fund data business.

 

4. Income per Share

 

The numerator for both basic and diluted income per share is net income. The denominator for basic income per share is the weighted average number of common shares outstanding during the period. For diluted income per share, the denominator includes the dilutive effect of outstanding employee stock options and restricted stock units using the treasury stock method. The following table shows how we reconcile our net income and the number of shares used in computing basic and diluted income per share:

 

 

 

Three Months Ended June 30

 

Six Months Ended June 30

 

(in thousands, except per share amounts)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Basic income per share:

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

18,273

 

$

11,165

 

$

34,059

 

$

24,345

 

Cumulative effect of accounting change, net of tax

 

 

 

 

259

 

Net income

 

$

18,273

 

$

11,165

 

$

34,059

 

$

24,604

 

Weighted average common shares outstanding

 

42,852

 

40,925

 

42,632

 

40,641

 

 

 

 

 

 

 

 

 

 

 

Basic income per share before cumulative effect of accounting change

 

$

0.43

 

$

0.27

 

$

0.80

 

$

0.60

 

Cumulative per share effect of accounting change, net of tax

 

 

 

 

0.01

 

Basic net income per share

 

$

0.43

 

$

0.27

 

$

0.80

 

$

0.61

 

 

 

 

 

 

 

 

 

 

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

18,273

 

$

11,165

 

$

34,059

 

$

24,345

 

Cumulative effect of accounting change, net of tax

 

 

 

 

259

 

Net income

 

$

18,273

 

$

11,165

 

$

34,059

 

$

24,604

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

42,852

 

40,925

 

42,632

 

40,641

 

Net effect of dilutive stock options and restricted stock units based on the treasury stock method

 

5,016

 

5,759

 

5,126

 

5,894

 

Weighted average common shares outstanding for computing diluted income per share

 

47,868

 

46,684

 

47,758

 

46,535

 

 

 

 

 

 

 

 

 

 

 

Diluted income per share before cumulative effect of accounting change

 

$

0.38

 

$

0.24

 

$

0.71

 

$

0.52

 

Cumulative per share effect of accounting change, net of tax

 

 

 

 

0.01

 

Diluted net income per share

 

$

0.38

 

$

0.24

 

$

0.71

 

$

0.53

 

 

12



 

5. Segment and Geographical Area Information

 

We organize our operations based on products and services sold in three primary business segments: Individual, Advisor, and Institutional.

 

                  Individual segment. Our Individual segment focuses on products and services for individual investors. The largest product in this segment based on revenue is our U.S.-based Web site, Morningstar.com, which includes both paid Premium Membership service and sales of Internet advertising space. Our Individual segment also includes Morningstar Equity Research, which we distribute through several channels. Investors can access our equity research through our Premium Membership offering on Morningstar.com. In addition, our equity research is distributed through six major investment banks to meet the requirements for independent research under the Global Analyst Research Settlement, as well as to several other companies who provide our research to their affiliated financial advisors or to individual investors. We also offer a variety of print publications on stocks and mutual funds, including our monthly newsletters, Morningstar FundInvestor and Morningstar StockInvestor, and our twice-monthly publication, Morningstar Mutual Funds. We sell several annual reference guides, including the Morningstar Funds 500, the Morningstar Stocks 500, the Morningstar ETFs 150, and the Stocks, Bonds, Bills, and Inflation Yearbook (acquired with Ibbotson). The Individual segment’s first quarter revenue typically benefits from sales of these annual reference guides. With the addition of Aspect Huntley, this segment also includes several newsletters and other publications for Australian investors.

 

                  Advisor segment. Our Advisor segment focuses on products and services for financial advisors. Key products in this segment based on revenue are Morningstar Advisor Workstation and Morningstar Principia. Advisor Workstation is a Web-based investment planning system that provides financial advisors with a comprehensive set of tools for conducting their core business, including investment research, planning, and presentations. Advisor Workstation is available in two editions: the Office Edition for independent financial advisors and the Enterprise Edition for financial advisors affiliated with larger firms. Principia is our CD-ROM-based investment research and planning software for financial planners. In addition, we offer Morningstar Managed Portfolios, a fee-based discretionary asset management service that includes a series of mutual fund and exchange-traded fund portfolios tailored to different investment time horizons and risk levels that financial advisors can use for their clients’ taxable and tax-deferred accounts. Following our acquisition of Ibbotson, we offer a series of NASD-reviewed Financial Communications materials that advisors can use to educate clients about asset allocation and demonstrate other key investment concepts, as well as data and graphs that financial advisors can license to use in published materials. As a result of our acquisition of Aspect Huntley, this segment also includes software for financial planners and other market participants in Australia. The segment also includes certain software products for financial advisors acquired from Standard & Poor’s.

 

                  Institutional segment. Our Institutional segment focuses on products and services for institutions, including banks, insurance companies, mutual fund companies, brokerage firms, media firms, and retirement plan providers and sponsors. 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; Licensed Data, a set of investment data spanning 10 core databases, available through electronic data feeds; Retirement Advice, including the Morningstar Retirement Manager and Advice by Ibbotson platforms; Morningstar Direct, a Web-based institutional research platform that provides advanced research and tools on the complete range of securities in Morningstar’s global database; Licensed Tools and Content, a set of online tools and editorial designed for institutions to use in their Web sites and software; Investment Profiles and Guides, which are designed for institutions to use in communicating investment information to individual investors; the Morningstar Annuity Research Center (formerly VARDS Online); and Morningstar EnCorr, an asset allocation software package (acquired with Ibbotson). With the addition of Aspect Huntley, this segment includes financial information as well as other data feeds on Australian stocks which we sell to stock brokers, information providers, and financial Web sites. The Institutional segment also includes the hedge fund and separate account database division we acquired from InvestorForce and institutional software and tools we acquired from Standard & Poor’s. Key products acquired from Standard & Poor’s include the Workstation fund performance and analysis system and data feeds covering more than 135,000 funds in 30 countries.

 

We measure the operating results of these segments based on operating income (loss), including an allocation of corporate costs. We include intersegment revenue and expenses in segment information. We sell services and products between segments at predetermined rates primarily based on cost. The recovery of intersegment cost is shown as “Intersegment revenue.”

 

13



 

Our segment accounting policies are the same as those described in Note 2 to our Consolidated Financial Statements included in our Annual Report on Form 10-K as of December 31, 2006, except for the capitalization and amortization of internal product development costs and amortization of intangible assets. 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 the capitalization and amortization of internal product development costs, the amortization of intangible assets, and the elimination of intersegment revenue and expense, in the Corporate Items and Eliminations category to arrive at the consolidated financial information. Our segment disclosures include the business segment information provided to our chief operating decision maker on a recurring basis, and, therefore, we do not present balance sheet information, including goodwill or other intangibles, by segment.

 

The following tables show selected segment data for the three and six months ended June 30, 2007 and 2006:

 

 

 

Three months ended June 30, 2007

 

($000)

 

Individual

 

Advisor

 

Institutional

 

Corporate Items
& Eliminations

 

Total

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

External customers

 

$

22,936

 

$

30,140

 

$

56,609

 

$

 

$

109,685

 

Intersegment

 

1,233

 

69

 

945

 

(2,247

)

 

Total revenue

 

24,169

 

30,209

 

57,554

 

(2,247

)

109,685

 

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

 

16,635

 

20,722

 

37,346

 

(2,153

)

72,550

 

Stock-based compensation expense

 

660

 

977

 

1,566

 

 

3,203

 

Depreciation and amortization

 

409

 

486

 

774

 

3,817

 

5,486

 

Operating income (loss)

 

$

6,465

 

$

8,024

 

$

17,868

 

$

(3,911

)

$

28,446

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

249

 

$

1,561

 

$

1,627

 

$

461

 

$

3,898

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

 

 

$

86,538

 

Non-U.S. revenue

 

 

 

 

 

 

 

 

 

$

23,147

 

 

 

 

Three months ended June 30, 2006

 

($000)

 

Individual

 

Advisor

 

Institutional

 

Corporate Items
& Eliminations

 

Total

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

External customers

 

$

18,379

 

$

24,320

 

$

33,558

 

$

 

$

76,257

 

Intersegment

 

996

 

1

 

738

 

(1,735

)

 

Total revenue

 

19,375

 

24,321

 

34,296

 

(1,735

)

76,257

 

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

 

12,240

 

16,901

 

25,540

 

(1,729

)

52,952

 

Stock-based compensation expense

 

608

 

633

 

838

 

 

2,079

 

Depreciation and amortization

 

305

 

392

 

600

 

2,470

 

3,767

 

Operating income (loss)

 

$

6,222

 

$

6,395

 

$

7,318

 

$

(2,476

)

$

17,459

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

79

 

$

98

 

$

352

 

$

635

 

$

1,164

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

 

 

$

66,724

 

Non-U.S. revenue

 

 

 

 

 

 

 

 

 

$

9,533

 

 

14



 

 

 

Six months ended June 30, 2007

 

($000)

 

Individual

 

Advisor

 

Institutional

 

Corporate Items
& Eliminations

 

Total

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

External customers

 

$

46,006

 

$

56,061

 

$

103,065

 

$

 

$

205,132

 

Intersegment

 

2,224

 

125

 

1,841

 

(4,190

)

 

Total revenue

 

48,230

 

56,186

 

104,906

 

(4,190

)

205,132

 

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

 

34,505

 

38,659

 

67,883

 

(4,106

)

136,941

 

Stock-based compensation expense

 

1,136

 

1,691

 

2,710

 

 

5,537

 

Depreciation and amortization

 

796

 

946

 

1,522

 

6,917

 

10,181

 

Operating income (loss)

 

$

11,793

 

$

14,890

 

$

32,791

 

$

(7,001

)

$

52,473

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

329

 

$

1,780

 

$

2,168

 

$

1,611

 

$

5,888

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

 

 

$

166,399

 

Non-U.S. revenue

 

 

 

 

 

 

 

 

 

$

38,733

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2007

 

U.S. long-lived assets

 

 

 

 

 

 

 

 

 

$

10,235

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

 

 

$

7,421

 

 

 

 

Six months ended June 30, 2006

 

($000)

 

Individual

 

Advisor

 

Institutional

 

Corporate Items
& Eliminations

 

Total

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

External customers

 

$

36,717

 

$

46,068

 

$

63,532

 

$

 

$

146,317

 

Intersegment

 

1,786

 

3

 

1,336

 

(3,125

)

 

Total revenue

 

38,503

 

46,071

 

64,868

 

(3,125

)

146,317

 

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

 

25,025

 

31,557

 

46,199

 

(3,307

)

99,474

 

Stock-based compensation expense

 

1,183

 

1,204

 

1,626

 

 

4,013

 

Depreciation and amortization

 

511

 

833

 

1,030

 

3,799

 

6,173

 

Operating income (loss)

 

$

11,784

 

$

12,477

 

$

16,013

 

$

(3,617

)

$

36,657

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

120

 

$

180

 

$

660

 

$

1,063

 

$

2,023

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. revenue

 

 

 

 

 

 

 

 

 

$

128,362

 

Non-U.S. revenue

 

 

 

 

 

 

 

 

 

$

17,955

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2006

 

U.S. long-lived assets

 

 

 

 

 

 

 

 

 

$

13,198

 

Non-U.S. long-lived assets

 

 

 

 

 

 

 

 

 

$

3,842

 

 

15



 

6. Investments

 

We monitor the concentration, diversification, maturity, and liquidity of our investment portfolio, which is primarily invested in fixed-income securities. We classify our investment portfolio as follows:

 

($000)

 

June 30,
2007

 

December 31,
2006

 

Available-for-sale

 

$

56,370

 

$

63,122

 

Held-to-maturity

 

5,308

 

2,339

 

Trading securities

 

4,089

 

2,150

 

Total

 

$

65,767

 

$

67,611

 

 

7. Investments In Unconsolidated Entities

 

Morningstar Japan K.K. In April 1998, we entered into an agreement with Softbank Corporation to form a joint venture, Morningstar Japan K.K. (MJKK), which develops and markets products and services customized for the Japanese market. In June 2000, MJKK became a public company, and its shares are traded on the Osaka Stock Exchange, “Hercules Market,” using the ticker number 4765. Subsequent to MJKK’s initial public offering, the joint venture agreement between us and Softbank Corporation was terminated, but we continued to hold shares of MJKK stock. As of June 30, 2007 and December 31, 2006, we owned approximately 35% of MJKK. We account for our investment in MJKK using the equity method. The book value of our investment in MJKK totaled $17,056,000 and $16,693,000 as of June 30, 2007 and December 31, 2006, respectively. The market value of our investment in MJKK was approximately Japanese Yen 7.2 billion (approximately U.S. $58,168,000) as of June 30, 2007 and Japanese Yen 10.2 billion (approximately U.S. $85,482,000) as of December 31, 2006.

 

Morningstar Korea, Ltd. In June 2000, we entered into a joint venture agreement with Shinheung Securities Co., Ltd. and SOFTBANK Finance Corporation to establish a Korean limited liability company named Morningstar Korea Ltd. (Morningstar Korea). Morningstar Korea develops, markets, and sells products and services to assist in the analysis of financial portfolios and provides financial information and services for investors in South Korea. Our ownership interest and profit- and loss-sharing interest in Morningstar Korea was 40% as of June 30, 2007 and December 31, 2006. We account for this investment using the equity method. Our investment totaled $1,489,000 and $1,415,000 as of June 30, 2007 and December 31, 2006, respectively.

 

Other Investments in Unconsolidated Entities. As of June 30, 2007 and December 31, 2006, the book value of our other investments in unconsolidated entities totaled $497,000 and $551,000, respectively, and consist primarily of our investments in Morningstar Danmark A/S (Morningstar Denmark) and Morningstar Sweden AB (Morningstar Sweden). In August 2001, we entered into a joint venture agreement with Phosphorus A/S to establish Morningstar Denmark, which develops and markets products and services customized for the Danish market. In April 2001, we entered into a joint venture agreement with Stadsporten Citygate AB to establish Morningstar Sweden, which develops and markets products and services customized for the Swedish market. Our ownership interest in both Morningstar Denmark and Morningstar Sweden was approximately 25% as of June 30, 2007 and December 31, 2006. We account for our investments in Morningstar Denmark and Morningstar Sweden using the equity method.

 

The following table shows condensed combined unaudited financial information for our investments in unconsolidated entities:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2007

 

2006

 

2007

 

2006

 

Revenue

 

$

11,121

 

$

4,876

 

$

19,403

 

$

9,720

 

Operating income

 

$

1,911

 

$

1,473

 

$

4,070

 

$

2,885

 

Net income

 

$

1,266

 

$

1,581

 

$

2,441

 

$

3,119

 

 

16



 

8. 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 are eligible for awards under the 2004 Stock Incentive Plan. Our non-employee directors are also eligible for awards under the 2004 Stock Incentive Plan. Joe Mansueto, our chairman and chief executive officer, does not participate in the 2004 Stock Incentive Plan or prior plans.

 

Since the adoption of the 2004 Stock Incentive Plan, we have granted stock options and, beginning in 2006, restricted stock units. Stock options granted under the 2004 Stock Incentive Plan generally vest ratably over a four-year period and expire 10 years after the date of grant. Almost all of the options granted under the 2004 Stock Incentive Plan have a premium feature in which the exercise price increases over the term of the option at a rate equal to the 10-year Treasury bond yield as of the date of grant. 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. The number of shares available for future grants under our 2004 Stock Incentive Plan as of June 30, 2007 and December 31, 2006 was 2,650,888 and 2,827,006, respectively.

 

Prior to November 2004, we granted stock options under various plans, including the 1993 Stock Option Plan (the 1993 Plan), the 2000 Morningstar Stock Option Plan (the 2000 Plan), and the 2001 Morningstar Stock Option Plan (the 2001 Plan). Options granted under the 1993 Plan, the 2000 Plan and the 2001 Plan generally vested over a four-year period and as a result are substantially all vested at June 30, 2007; however, because the options under all three plans expire 10 years after the date of grant, some options granted under these plans remain outstanding at June 30, 2007. The 2004 Stock Incentive Plan amends and restates the 1993 Plan, the 2000 Plan, and the 2001 Plan (collectively, the Prior Plans). Under the 2004 Stock Incentive Plan, we will not grant any additional options under any of the Prior Plans, and any shares subject to an award under any of the Prior Plans that are forfeited, canceled, settled, or otherwise terminated without a distribution of shares, or withheld by us in connection with the exercise of options or in payment of any required income tax withholding, will not be available for awards under the 2004 Stock Incentive Plan.

 

In February 1999, we entered into an Incentive Stock Option Agreement and a Nonqualified Stock Option Agreement under the 1999 Incentive Stock Option Plan (the 1999 Plan) with Don Phillips, an officer of Morningstar. Under these agreements, we granted Don options to purchase 1,500,000 shares of common stock at an exercise price of $2.77 per share, equal to the fair value at the grant date. These options are fully vested and expire in February 2009. On the date of grant, 1,138,560 options were fully exercisable and an additional 36,144 shares became and continue to become exercisable each year from 1999 through 2008. As of June 30, 2007 and December 31, 2006, there were 540,174 and 710,174 options remaining to be exercised, respectively.

 

Accounting for Stock-Based Compensation Awards

 

Effective January 1, 2006, we adopted SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123(R)), using the modified prospective transition method. We estimate forfeitures of all 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 adjusted the stock-based compensation expense to reflect those awards that ultimately vested. As a result, in the second quarter of 2007, we recorded approximately $720,000 of additional stock-based compensation expense after making adjustments from the estimated forfeitures to actual forfeiture experience for certain of our employee stock option and restricted stock unit grants. In addition, we reduced our estimate of the forfeiture rate that will be applied to awards not yet vested.

 

Stock-Based Compensation Expense

 

The following table summarizes stock-based compensation expense recorded in our Condensed Consolidated Statements of Income:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2007

 

2006

 

2007

 

2006

 

Total stock-based compensation expense

 

$

3,203

 

$

2,079

 

$

5,537

 

$

4,013

 

 

The tax benefit recorded related to the stock-based compensation expense above was $1,181,000 and $643,000 for the three months ended June 30, 2007 and 2006, respectively, and $2,020,000 and $1,390,000 for the six months ended June 30, 2007 and 2006, respectively.

 

17



 

Restricted Stock Units

 

We measure the fair value of our restricted stock units on the date of grant based on the market price of the underlying common stock as of the close of trading 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 granted restricted stock units for the first time in May 2006. The total grant date fair value of restricted stock units granted in the first six months of 2007 was approximately $9,807,000. As of June 30, 2007, the total amount of unrecognized stock-based compensation expense related to restricted stock units was approximately $16,639,000. We expect to recognize this expense over an average period of approximately 41 months.

 

The following table summarizes restricted stock unit activity in the first six months of 2007:

 

 

 

Six months ended June 30, 2007

 

Restricted Stock Units

 

Shares

 

Weighted
Average
Grant Date
Fair Value

 

Nonvested shares—January 1, 2007

 

260,462

 

$

44.01

 

Granted

 

198,489

 

$

49.41

 

Vested

 

(56,507

)

$

44.47

 

Forfeited

 

(5,198

)

$

44.35

 

Nonvested shares—June 30, 2007

 

397,246

 

$

46.64

 

 

Stock Option Activity

 

The following tables summarize stock option activity in the first six months of 2007 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.

 

 

 

Six months ended June 30, 2007

 

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

 

Underlying
Shares

 

Weighted
Average
Exercise
Price

 

Options outstanding—January 1, 2007

 

2,871,310

 

$

11.11

 

Granted

 

569

 

$

14.70

 

Canceled

 

(5,538

)

$

15.89

 

Exercised

 

(229,596

)

$

5.90

 

Options outstanding—June 30, 2007

 

2,636,745

 

$

11.72

 

 

 

 

 

 

 

Options exercisable—June 30, 2007

 

2,241,055

 

$

11.12

 

 

 

 

Six months ended June 30, 2007

 

All Other Option Grants, Excluding Activity Shown Above

 

Underlying
Shares

 

Weighted
Average
Exercise
Price

 

Options outstanding—January 1, 2007

 

6,098,594

 

$

12.55

 

Canceled

 

(14,300

)

$

21.59

 

Exercised

 

(516,271

)

$

10.71

 

Options outstanding—June 30, 2007

 

5,568,023

 

$

12.77

 

 

 

 

 

 

 

Options exercisable—June 30, 2007

 

5,039,460

 

$

11.79

 

 

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 in the six months ended June 30, 2007 and 2006 was $30,434,000 and $31,153,000, respectively.

 

18



 

Stock Options Outstanding and Exercisable

 

The table below shows additional information for options outstanding and options exercisable as of June 30, 2007:

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

 

Outstanding
Shares

 

Weighted
Average
Remaining
Contractual
Life

 

Weighted
Average
Exercise
Price

 

Aggregate
Intrinsic
Value
($000)

 

Exercisable
Shares

 

Weighted
Average
Remaining
Contractual
Life

 

Weighted
Average
Exercise
Price

 

Aggregate
Intrinsic
Value
($000)

 

$2.00 - $2.77

 

1,442,438

 

1.20

 

$

2.53

 

$

64,183

 

1,399,257

 

1.19

 

$

2.53

 

$

62,267

 

$8.57 - $14.70

 

4,636,517

 

3.47

 

$

12.65

 

159,414

 

4,632,222

 

3.47

 

$

12.65

 

159,251

 

$16.39 - $36.96

 

2,125,813

 

7.62

 

$

18.71

 

60,193

 

1,249,036

 

7.56

 

$

17.84

 

36,460

 

$2.00 - $36.96

 

8,204,768

 

4.15

 

$

12.44

 

$

283,790

 

7,280,515

 

3.73

 

$

11.60

 

$

257,978

 

Vested or Expected to Vest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$2.00 - $36.96

 

8,134,348

 

4.11

 

$

12.37

 

$

281,941

 

 

 

 

 

 

 

 

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing stock price of $47.03 on June 29, 2007, which would have been received by the option holders had all option holders exercised their options as of that date.

 

As of June 30, 2007, the total amount of unrecognized stock-based compensation expense related to nonvested stock options was approximately $7,787,000. We expect to recognize this expense over a weighted average period of approximately 17 months.

 

9. Related Party Transactions

 

In 1989, under our 1989 Nonqualified Stock Option Plan (the 1989 Plan), we granted options to purchase 1,500,000 shares of common stock at an exercise price of $0.075 per share, equal to the fair value at date of issue, to Don Phillips, an officer of Morningstar. These options were not exercised and expired in February 1999. In February 1999, in conjunction with the expiration of options granted under the 1989 Plan, we entered into a Deferred Compensation Agreement (the Agreement) with Don. Under the terms of the Agreement, on any date that he exercises the right to purchase shares under the 1999 Plan, we shall pay to him $2.69 per share in the form of cash or, at our election, shares of common stock. If on the date of purchase the fair value of Morningstar’s stock is below $2.77 per share, the amount paid per share will be reduced based on the terms of the Agreement. Our obligation to pay deferred compensation will not be increased by any imputed interest or earnings amount.

 

In May 2006, Don entered into a Rule 10b5-1 sales plan contemplating the sale of shares to be acquired through stock option exercises. Upon exercise of certain stock options, we will make payments to him, as prescribed by the Agreement. In the first six months of 2007, Don exercised 170,000 options, of which 120,000 were sold under his 10b5-1 plan. As of June 30, 2007 and December 31, 2006, our Condensed Consolidated Balance Sheets include a liability of $1,481,000 and $1,963,000, respectively, for the Agreement. The liability is primarily classified as “Other current liabilities”. The reduction in the liability since December 31, 2006 reflects amounts paid to Don in the first six months of 2007 in accordance with the Agreement.

 

19



 

10. Income Taxes

 

On January 1, 2007, we adopted FIN 48. See Note 2, Summary of Significant Accounting Policies, for additional information concerning the adoption of FIN 48.

 

The following table shows our effective income tax expense rate for the three and six months ended June 30, 2007 and 2006:

 

 

 

Three months ended June 30

 

Six months ended June 30

 

($000)

 

2007

 

2006

 

2007

 

2006

 

Income before income taxes, equity in net income of unconsolidated entities, and cumulative effect of accounting change

 

$

29,814

 

$

18,131

 

$

55,354

 

$

38,262

 

Equity in net income of unconsolidated entities

 

455

 

658

 

992

 

1,305

 

Total

 

$

30,269

 

$

18,789

 

$

56,346

 

$

39,567

 

Income tax expense

 

$

11,996

 

$

7,624

 

$

22,287

 

$

15,222

 

Effective income tax expense rate

 

39.6

%

40.6

%

39.6

%

38.5

%

 

In the second quarter of 2007, our effective income tax expense rate decreased 1.0 percentage point compared with the prior-year period because our effective tax rate in the second quarter of 2006 included additional income tax expense related to certain operations outside of the United States, partially offset by the tax benefit from disqualifying dispositions. The reduction in our effective tax rate in the second quarter of 2007 relative to the prior-year period was mitigated, though, by the impact of additional U.S. state income tax expense which we are recording in 2007.

 

For the year-to-date period in 2007, our effective income tax expense rate increased 1.1 percentage points compared with 2006. Because we had fewer disqualifying dispositions of incentive stock options in the first half of 2007 compared with the same period in 2006, the associated tax benefit also declined. This factor drove the majority of the increase in our 2007 effective tax rate. In the first half of 2007, our effective tax rate also includes the impact of additional U.S. state income tax expense. In the first half of 2006, we recorded additional income tax expense related to certain operations outside of the United States. These two factors had approximately the same impact on our effective income tax rate in the respective periods.

 

In both 2007 and 2006, our effective income tax expense rate reflects the fact that we are not recording an income tax benefit related to losses recorded by certain of our non-U.S. operations. In the year the non-U.S. entity records a loss, we do not record a corresponding tax benefit, thus increasing our effective tax rate. The foreign net operating losses may become deductible in certain international tax jurisdictions to the extent these international operations become profitable. For each of our operations, we evaluate whether it is more likely than not that the tax benefits related to net operating losses will be realized. As part of this evaluation, we consider evidence such as tax planning strategies, historical operating results, forecasted taxable income, and recent financial performance.

 

11. Contingencies

 

Morningstar Australia

 

In 2001, Mr. Graham Rich, the then managing director and chief executive officer of Morningstar Research Pty Limited (Morningstar Australia), and one of two companies controlled by Mr. Rich, filed a suit in the Supreme Court of New South Wales, Australia against Morningstar and certain of its officers and nominee directors on the board of Morningstar Australia. Mr. Rich was also a beneficial owner of shares in Morningstar Australia. Mr. Rich and his company originally sought an injunction, which, if granted, would have precluded Morningstar Australia from terminating the services of Mr. Rich and from issuing additional shares to Morningstar in exchange for the provision of further funding by Morningstar to Morningstar Australia. Further, Mr. Rich and his company sought an order that a provisional liquidator be appointed for Morningstar Australia. The court rejected this injunction application, observing that Morningstar Australia would be insolvent without financial backing from Morningstar. The application for the appointment of a provisional liquidator also failed. The services of Mr. Rich were terminated in November 2001. Mr. Rich and his company were ordered to pay Morningstar’s costs of the injunction proceedings.

 

Mr. Rich and the two companies controlled by Mr. Rich have additional pending claims, alleging, among other things, breaches by Morningstar of contracts and statutory and general law duties, misleading, deceptive, and unconscionable conduct by Morningstar, oppression by Morningstar and its nominee directors, claims under the Industrial Relations Act of New South Wales, breaches of directors’ duties by Morningstar’s nominee directors, and conflict of interest. The claims seek various forms of relief, including monetary damages in the amount of Australian $25,000,000, the setting aside of transactions which resulted in Morningstar obtaining control of Morningstar Australia, and an order either setting aside Morningstar’s acquisition of the shares formerly beneficially owned by Mr. Rich and his companies or determining a different price for this acquisition. In the alternative, Mr. Rich and his companies

 

20



 

seek an order that they be entitled to purchase the shares in Morningstar Australia at a price to be determined by the court or book value (as defined in the Morningstar Australia shareholders agreement). Morningstar has denied the claims and filed counter-claims against Mr. Rich and certain of his companies, alleging breaches of statutory, general law, and contractual duties.

 

In July 2004, the court decided Morningstar’s application for security for its potential additional costs in the litigation by ordering the two companies controlled by Mr. Rich to provide approximately Australian $925,000 to the court as security for these potential costs. Morningstar has been paid some of its costs and will be entitled to be paid its costs in the future only if the court makes a determination to that effect. The court stayed the proceedings pending its receipt of the security and indicated that it would entertain an application by Morningstar for additional security at a later time in the proceedings.

 

In May 2005, Mr. Rich obtained conditional leave of the court to begin a proceeding in the name of Morningstar Australia against Morningstar and its nominee directors. The leave was, however, subject to the following conditions: (i) Mr. Rich must pay and bear, and indemnify Morningstar Australia against, all costs, charges, and expenses of and incidental to the bringing and continuation of the proceeding (except as the court may otherwise direct or allow) and may not seek contribution or indemnity from Morningstar Australia for any of these costs, charges, or expenses; (ii) Morningstar Australia, or Mr. Rich on its behalf, together with the two companies controlled by Mr. Rich were required to provide to the court, as security for Morningstar’s costs, approximately Australian $925,000 as described in the preceding paragraph; and (iii) approximately Australian $100,000 in costs owed by Mr. Rich and one of his companies to Morningstar in respect of the 2001 injunction proceedings were required to be paid to Morningstar. These conditions have been satisfied.

 

In September 2005, Mr. Rich and his companies filed a Second Further Amended Statement of Claim, consolidating the claims. Morningstar filed a Defence to that pleading and an Amended Cross-Claim against Mr. Rich, both his companies, and a third Australian company controlled by Mr. Rich.

 

In December 2006, Morningstar applied to the court for further security for its potential additional costs in the litigation. Mr. Rich and his companies opposed the application and in May 2007, the court held a hearing for this application and reserved judgment.

 

In February 2007, Mr. Rich and his companies notified Morningstar that they would be seeking the leave of the court to amend the Second Further Amended Statement of Claim to include a claim relating to Morningstar’s acquisition of Aspect Huntley Pty Ltd. (Aspect Huntley) in 2006. The amended claim alleged various breaches of obligations owed by Morningstar to Morningstar Australia and sought various forms of relief, including an equity interest in Aspect Huntley and compensatory damages. Morningstar opposed the leave being granted. In May 2007, Mr. Rich and his companies withdrew the application for leave to amend the Second Further Amended Statement of Claim. On the same date, the court formally dismissed the leave application and ordered Mr. Rich and his companies to pay Morningstar’s costs incurred in opposing the leave.

 

The parties have discussed settling the claims but have been unable to reach an agreement. In the fourth quarter of 2003, Morningstar offered to settle all claims for Australian $1,250,000, which then approximated U.S. $942,000, and, in accordance with SFAS No. 5, Accounting for Contingencies, Morningstar recorded a reserve in this amount. In December 2005, Morningstar increased its offer to settle all claims to approximately Australian $2,500,000, which at June 30, 2007 approximates U.S. $2,130,000, and, in accordance with SFAS No. 5, Morningstar has a reserve recorded in this amount. While Morningstar is vigorously contesting the claims against it, we cannot predict the outcome of the proceeding.

 

Morningstar Associates, LLC Subpoenas from Securities and Exchange Commission, New York Attorney General’s Office, and the Department of Labor

 

Securities and Exchange Commission

 

In February 2005, Morningstar Associates, LLC, a wholly owned subsidiary of Morningstar, Inc., received a request from the SEC for the voluntary production of documents relating to the investment consulting services the company offers to retirement plan providers, including fund lineup recommendations for retirement plan sponsors. In July 2005, the SEC issued a subpoena to Morningstar Associates that was virtually identical to its February 2005 request.

 

Subsequently, the SEC focused on disclosure relating to an optional service offered to retirement plan sponsors (employers) that select 401(k) plan services from ING, one of Morningstar Associates’ clients. In response to the SEC investigation, ING and Morningstar Associates revised certain documents for plan sponsors to further clarify the roles of ING and Morningstar Associates in providing that service. The revisions also help reinforce that Morningstar Associates makes its selections only from funds available within ING’s various retirement products.

 

In January 2007, the SEC notified Morningstar Associates that it ended its investigation, with no enforcement action, fines, or penalties.

 

21



 

New York Attorney General’s Office

 

In December 2004, Morningstar Associates received a subpoena from the New York Attorney General’s office seeking information and documents related to an investigation the New York Attorney General’s office is conducting. The request is similar in scope to the SEC subpoena described above. Morningstar Associates has provided the requested information and documents.

 

In January 2007, Morningstar Associates received a Notice of Proposed Litigation from the New York Attorney General’s office. The Notice centers on the same issues that became the focus of the SEC investigation described above. The Notice gave Morningstar Associates the opportunity to explain why the New York Attorney General’s office should not institute proceedings. Morningstar Associates promptly submitted its explanation, and continues to cooperate fully with the New York Attorney General’s office.

 

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

 

United States Department of Labor

 

In May 2005, Morningstar Associates received a subpoena from the United States Department of Labor, seeking information and documents related to an investigation the Department of Labor is conducting. The Department of Labor subpoena is substantially similar in scope to the SEC and New York Attorney General subpoenas.

 

In January 2007, the Department of Labor issued a request for additional documents pursuant to the May 2005 subpoena, including documents and information regarding Morningstar Associates’ retirement advice products for plan participants. Morningstar Associates continues to cooperate fully with the Department of Labor.

 

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

 

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

 

12. Recently Issued Accounting Pronouncements

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (including an amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The amendment to SFAS No. 115 applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years; therefore, we will adopt SFAS No. 159 in the first quarter of 2008. We are in the process of determining the effect the adoption of SFAS No. 159 will have on our Consolidated Financial Statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. 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. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years; therefore, we will adopt SFAS No. 157 in the first quarter of 2008. We are in the process of determining the effect the adoption of SFAS No. 157 will have on our Consolidated Financial Statements.

 

22


 


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The discussion included in this section, as well as other sections of this Quarterly Report on Form 10-Q, contains forward-looking statements. These statements relate to future events or to our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terminology. You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and that could materially affect actual results, levels of activity, performance, or achievements.

 

Other factors that could materially affect actual results, levels of activity, performance, or achievements can be found in our other filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2006. If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in this Quarterly Report on Form 10-Q reflects our current views with respect to future events and is subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, whether as a result of new information, future events, or otherwise.

 

Understanding our Company

 

Our Business

 

Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of Internet, software, and print-based products for individual investors, financial advisors, and institutional clients. We also offer asset management services for advisors, institutions, and retirement plan participants. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

 

We believe that while the fixed costs of the investments in our business are relatively high, the variable cost of adding customers is considerably lower, particularly as our business mix shifts more toward Internet-based platforms and assets under management. We strive to realize this operating leverage by selling a wide variety of products and services to multiple investor segments, through multiple media, and in many geographic markets.

 

We emphasize a decentralized approach to running our business to empower our managers and to create a culture of responsibility and accountability. We operate our decentralized business structure in three global business segments: Individual, Advisor, and Institutional. In all three of these segments, we believe our work helps individual investors make better investment decisions.

 

Historically, we have focused primarily on organic growth by introducing new products and services and expanding our marketing efforts for existing products. However, we have made and expect to continue making selective acquisitions that support our four key growth strategies, which we discuss in our Annual Report on Form 10-K. In March 2006, we acquired Ibbotson Associates, Inc. (Ibbotson), a firm specializing in asset allocation research and services; in July 2006, we acquired Aspect Huntley Pty Limited (Aspect Huntley), a leading provider of equity information, research, and financial trade publishing in Australia; in August 2006, we acquired the institutional hedge fund and separate account database division of InvestorForce, Inc. (InvestorForce), a financial software and data integration company; and in March 2007, we acquired Standard & Poor’s mutual fund data business, consisting of data and products covering more than 135,000 managed investment vehicles, including mutual funds, exchange-traded funds, hedge funds, and offshore funds. We include the operating results for each of these acquisitions in our Consolidated Financial Statements beginning on the acquisition date.

 

Industry Overview

 

We monitor developments in the economic and financial information industry on an ongoing basis and use these insights to help inform our company strategy, product development plans, and marketing initiatives.

 

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