MORN_10Q_9.30.2011

Table of Contents

 

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 September 30, 2011
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)
 
 
 
22 West Washington Street
 
 
Chicago, Illinois
 
60602
(Address of Principal Executive Offices)
 
(Zip Code)
  
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  o
Non-accelerated filer   o
Smaller reporting company  o
 
(Do not check if a smaller reporting company)
 
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 October 28, 2011, there were 50,010,222 shares of the Company’s common stock, no par value, outstanding.
 


Table of Contents

MORNINGSTAR, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2011 and 2010

 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2011 and 2010
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010

 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Equity for the nine months ended September 30, 2011

 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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PART 1.
FINANCIAL INFORMATION
Item 1.
Unaudited Condensed Consolidated Financial Statements

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands except per share amounts)
 
2011

 
2010

 
2011

 
2010

 
 
 
 
 
 
 
 
 
Revenue
 
$
160,051

 
$
139,817

 
$
472,829

 
$
404,198

 
 
 
 
 
 
 
 
 
Operating expense (1):
 
 
 
 
 
 
 
 
Cost of goods sold
 
48,074

 
40,713

 
133,929

 
114,767

Development
 
13,482

 
12,703

 
39,151

 
35,491

Sales and marketing
 
27,253

 
22,881

 
80,502

 
69,877

General and administrative
 
26,431

 
23,462

 
83,255

 
67,211

Depreciation and amortization
 
10,947

 
9,897

 
31,712

 
28,082

Total operating expense
 
126,187

 
109,656

 
368,549

 
315,428

 
 
 
 
 
 
 
 
 
Operating income
 
33,864

 
30,161

 
104,280

 
88,770

 
 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 

 
 

 
 
 
 
Interest income, net
 
797

 
512

 
1,142

 
1,692

Gain (loss) on sale of investments reclassified from other comprehensive income
 
(127
)
 
5

 
270

 
14

Other income (expense), net
 
(1,249
)
 
5,689

 
(1,208
)
 
4,342

Non-operating income (expense), net
 
(579
)
 
6,206

 
204

 
6,048

 
 
 
 
 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
33,285

 
36,367

 
104,484

 
94,818

 
 
 
 
 
 
 
 
 
Income tax expense
 
12,343

 
11,917

 
35,585

 
33,137

 
 
 
 
 
 
 
 
 
Equity in net income of unconsolidated entities
 
428

 
333

 
1,397

 
1,176

 
 
 
 
 
 
 
 
 
Consolidated net income
 
21,370

 
24,783

 
70,296

 
62,857

 
 
 
 
 
 
 
 
 
Net (income) loss attributable to the noncontrolling interest
 
10

 
(106
)
 
106

 
10

 
 
 
 
 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
21,380

 
$
24,677

 
$
70,402

 
$
62,867

 
 
 
 
 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 

 
 

 
 
 
 
Basic
 
$
0.42

 
$
0.50

 
$
1.40

 
$
1.27

Diluted
 
$
0.42

 
$
0.49

 
$
1.37

 
$
1.24

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.05

 
$

 
$
0.15

 
$

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
50,278

 
49,401

 
50,082

 
49,157

Diluted
 
51,123

 
50,544

 
51,071

 
50,453


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Table of Contents

 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30
 
Nine months ended September 30
 
 
2011

 
2010

 
2011

 
2010

(1) Includes stock-based compensation expense of:
 
 

 
 

 
 
 
 
Cost of goods sold
 
$
1,117

 
$
960

 
$
3,068

 
$
2,582

Development
 
545

 
517

 
1,588

 
1,359

Sales and marketing
 
489

 
469

 
1,392

 
1,358

General and administrative
 
1,800

 
1,799

 
5,395

 
5,038

Total stock-based compensation expense
 
$
3,951

 
$
3,745

 
$
11,443

 
$
10,337


 See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income

 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands) 
 
2011

 
2010

 
2011

 
2010

 
 
 
 
 
 
 
 
 
Consolidated net income
 
$
21,370

 
$
24,783

 
$
70,296

 
$
62,857

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(12,570
)
 
18,375

 
(6
)
 
5,634

Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during period
 
(1,871
)
 
634

 
(1,472
)
 
52

Reclassification of (gains) losses included in net income
 
81

 
(3
)
 
(171
)
 
(9
)
Other comprehensive income (loss)
 
(14,360
)
 
19,006

 
(1,649
)
 
5,677

 
 
 
 
 
 
 
 
 
Comprehensive income
 
7,010

 
43,789

 
68,647

 
68,534

Comprehensive (income) loss attributable to noncontrolling interest
 
(47
)
 
(250
)
 
52

 
(47
)
Comprehensive income attributable to Morningstar, Inc.
 
$
6,963

 
$
43,539

 
$
68,699

 
$
68,487

 
 
 
 
 
 
 
 
 

See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
 
 
As of September 30
 
As of December 31
(in thousands except share amounts)
 
2011

 
2010

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
174,270

 
$
180,176

Investments
 
258,749

 
185,240

Accounts receivable, less allowance of $843 and $1,056, respectively
 
110,444

 
110,891

Deferred tax asset, net
 
3,814

 
2,860

Income tax receivable, net
 
10,045

 
10,459

Other
 
16,076

 
17,654

Total current assets
 
573,398

 
507,280

Property, equipment, and capitalized software, net
 
63,703

 
62,105

Investments in unconsolidated entities
 
24,761

 
24,262

Goodwill
 
319,367

 
317,661

Intangible assets, net
 
147,311

 
169,023

Other assets
 
5,726

 
5,971

Total assets
 
$
1,134,266

 
$
1,086,302

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
42,184

 
$
42,680

Accrued compensation
 
59,908

 
62,404

Deferred revenue
 
146,877

 
146,267

Other
 
322

 
1,373

Total current liabilities
 
249,291

 
252,724

Accrued compensation
 
5,427

 
4,965

Deferred tax liability, net
 
17,490

 
19,975

Other long-term liabilities
 
25,930

 
27,213

Total liabilities
 
298,138

 
304,877

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 50,096,106 and 49,874,392 shares were outstanding as of September 30, 2011 and December 31, 2010, respectively
 
5

 
5

Treasury stock at cost, 832,820 shares as of September 30, 2011 and 279,456 shares as of December 31, 2010
 
(38,319
)
 
(6,641
)
Additional paid-in capital
 
483,822

 
458,426

Retained earnings
 
386,148

 
323,408

Accumulated other comprehensive income (loss):
 
 
 
 
    Currency translation adjustment
 
4,431

 
4,503

    Unrealized gain (loss) on available-for-sale investments
 
(1,016
)
 
615

Total accumulated other comprehensive income
 
3,415

 
5,118

Total Morningstar, Inc. shareholders’ equity
 
835,071

 
780,316

Noncontrolling interest
 
1,057

 
1,109

Total equity
 
836,128

 
781,425

Total liabilities and equity
 
$
1,134,266

 
$
1,086,302

 

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See notes to unaudited condensed consolidated financial statements.


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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity
For the Nine months ended September 30, 2011
 
 
 
Morningstar, Inc. Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
Other
Comprehensive
Income
(Loss)

 
 
 
 
 
 
Common Stock
 
 

 
Additional
Paid-in
Capital

 
 
 
 
Non
Controlling
Interests

 
 
(in thousands, except share amounts)
 
Shares
Outstanding

 
Par
Value

 
Treasury
Stock

 
 
Retained
Earnings

 
 
 
Total
Equity

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2010
 
49,874,392

 
$
5

 
$
(6,641
)
 
$
458,426

 
$
323,408

 
$
5,118

 
$
1,109

 
$
781,425

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 

 

 

 
70,402

 

 
(106
)
 
70,296

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on available-for-sale investments, net of income tax of $584
 
 
 








(1,472
)


 
(1,472
)
Reclassification of adjustments for gains included in net income, net of income tax of $98
 
 
 








(171
)


 
(171
)
Foreign currency translation adjustment, net
 
 
 








(60
)

54

 
(6
)
Other comprehensive income (loss), net
 
 
 







 
(1,703
)
 
54

 
(1,649
)
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
792,178

 

 
410

 
6,220

 

 

 

 
6,630

Stock-based compensation — restricted stock units
 
 
 

 

 
9,489

 

 

 

 
9,489

Stock-based compensation — restricted stock
 
 
 

 

 
1,752

 

 

 

 
1,752

Stock-based compensation - stock-options
 
 
 

 

 
202

 

 

 

 
202

Excess tax benefit derived from stock-option exercises and vesting of restricted stock units
 
 
 

 

 
7,621

 

 

 

 
7,621

Common shares repurchased
 
(570,464
)
 

 
(32,088
)
 

 

 

 

 
(32,088
)
Dividends declared — common shares outstanding
 
 
 

 

 

 
(7,546
)
 

 

 
(7,546
)
Dividends declared — restricted stock units
 
 
 

 

 
112

 
(116
)
 

 

 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of September 30, 2011
 
50,096,106

 
$
5

 
$
(38,319
)
 
$
483,822

 
$
386,148

 
$
3,415

 
$
1,057

 
$
836,128

 
See notes to unaudited condensed consolidated financial statements.

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Table of Contents

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
 
 
 
Nine months ended September 30
(in thousands)
 
2011

 
2010

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
70,296

 
$
62,857

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
31,712

 
28,082

Deferred income tax expense (benefit)
 
(1,559
)
 
1,769

Stock-based compensation expense
 
11,443

 
10,337

Provision for bad debt
 
1,076

 
253

Equity in net income of unconsolidated entities
 
(1,397
)
 
(1,176
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(7,621
)
 
(4,885
)
Holding gain upon acquisition of additional ownership of equity method investments
 

 
(5,073
)
Other, net
 
1,607

 
724

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable
 
(403
)
 
(7,254
)
Other assets
 
1,996

 
(2,508
)
Accounts payable and accrued liabilities
 
(5,275
)
 
2,025

Accrued compensation
 
(3,242
)
 
(2,270
)
Income taxes payable
 
9,442

 
309

Deferred revenue
 
618

 
(1,938
)
Deferred rent
 
(984
)
 
442

Other liabilities
 
(1,393
)
 
(1,384
)
Cash provided by operating activities
 
106,316

 
80,310

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(281,698
)
 
(128,043
)
Proceeds from maturities and sales of investments
 
205,421

 
177,197

Capital expenditures
 
(14,689
)
 
(7,701
)
Acquisitions, net of cash acquired
 
300

 
(88,697
)
Other, net
 
875

 
830

Cash used for investing activities
 
(89,791
)
 
(46,414
)
 
 
 
 
 
Financing activities
 
 

 
 

Proceeds from stock-option exercises, net
 
6,630

 
5,207

Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
7,621

 
4,885

Common shares repurchased
 
(28,526
)
 

Dividends paid
 
(7,539
)
 

Other, net
 
(363
)
 
(529
)
Cash provided by (used for) financing activities
 
(22,177
)
 
9,563

 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(254
)
 
1,917

Net increase (decrease) in cash and cash equivalents
 
(5,906
)
 
45,376

Cash and cash equivalents—beginning of period
 
180,176

 
130,496

Cash and cash equivalents—end of period
 
$
174,270

 
$
175,872

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
28,437

 
$
29,594

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain (loss) on available-for-sale investments
 
$
(2,598
)
 
$
71

 

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Table of Contents

See notes to unaudited condensed consolidated financial statements.

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MORNINGSTAR, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1.
Basis of Presentation of Interim Financial Information
 
The accompanying condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the Company) have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. In the opinion of management, the statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly our financial position, results of operations, equity, and cash flows. These financial statements and notes should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the SEC on February 28, 2011.
 
The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
EITF: Emerging Issues Task Force
FASB: Financial Accounting Standards Board
SAB: Staff Accounting Bulletin
SEC: Securities and Exchange Commission
 
2.
Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 3 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the SEC on February 28, 2011.

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. In accordance with ASU No. 2011-05, we present the total of comprehensive income, the components of net income, and the components of other comprehensive income (OCI) in two separate but consecutive statements, our Consolidated Statement of Income and separately, a Consolidated Statement of Comprehensive Income. We no longer present total comprehensive income in our Consolidated Statement of Equity. In addition, we now show the effects of items reclassified from OCI to net income on the face of our Consolidated Statement of Income.

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

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

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

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

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

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

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

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

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

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

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

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



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

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Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2010 to September 30, 2011:
 
 
($000)

Balance as of December 31, 2010
$
317,661

Adjustments to 2010 acquisitions
1,387

Other, primarily currency translation
319

Balance as of September 30, 2011
$
319,367


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

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

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

Intellectual property
 
$
31,979

 
$
(18,529
)
 
$
13,450

 
9

 
$
33,990

 
$
(15,970
)
 
$
18,020

 
10

Customer-related assets
 
135,025

 
(49,548
)
 
85,477

 
12

 
130,675

 
(39,951
)
 
90,724

 
11

Supplier relationships
 
240

 
(81
)
 
159

 
20

 
240

 
(72
)
 
168

 
20

Technology-based assets
 
80,597

 
(32,916
)
 
47,681

 
9

 
78,651

 
(25,682
)
 
52,969

 
9

Non-competition agreement
 
1,724

 
(1,180
)
 
544

 
4

 
1,751

 
(909
)
 
842

 
4

Intangible assets related to acquisitions with preliminary purchase price allocations
 

 

 

 

 
6,407

 
(107
)
 
6,300

 
10

Total intangible assets
 
$
249,565

 
$
(102,254
)
 
$
147,311

 
10

 
$
251,714

 
$
(82,691
)
 
$
169,023

 
10

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

 
2010

 
2011

 
2010

Amortization expense
 
$
6,894

 
$
6,219

 
$
20,039

 
$
17,535

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

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

2011
$
26,287

2012
23,874

2013
21,217

2014
19,989

2015
19,118

2016
14,527

 


14


Table of Contents

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

4.
Income Per Share
 
We compute income per share based on the two-class method, in accordance with FASB ASC 260-10-45-59A, Participating Securities and the Two Class Method. We issued restricted shares in conjunction with the Realpoint acquisition. Because the restricted shares contain nonforfeitable rights to dividends, they meet the criteria of a participating security. Under the two-class method, earnings are allocated between common stock and participating securities. The two-class method includes an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and undistributed earnings for the period. We reduce our reported net earnings by the amount allocated to participating securities to arrive at the earnings allocated to common stock shareholders for purposes of calculating earnings per share.
ASC 260-10-45-59A requires the dilutive effect of participating securities to be calculated using the more dilutive of the treasury stock or the two-class method. We have determined the two-class method to be the more dilutive of the two methods. As such, we adjusted the earnings allocated to common stock shareholders in the basic earnings per share calculation for the reallocation of undistributed earnings to participating securities to calculate diluted earnings per share.
The following table shows how we reconcile our net income and the number of shares used in computing basic and diluted income per share:
 

15


Table of Contents

 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands, except per share amounts)
 
2011

 
2010

 
2011

 
2010

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

 
 

 
 
 
 
Net income attributable to Morningstar, Inc.:
 
$
21,380

 
$
24,677

 
$
70,402

 
$
62,867

Less: Distributed earnings available to participating securities
 
(8
)
 
(10
)
 
(25
)
 
(10
)
Less: Undistributed earnings available to participating securities
 
(57
)
 
(89
)
 
(189
)
 
(242
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
21,315

 
$
24,578

 
$
70,188

 
$
62,615

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
50,278

 
49,401

 
50,082

 
49,157

 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.42

 
$
0.50

 
$
1.40

 
$
1.27

 
 
 
 
 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
21,315

 
$
24,578

 
$
70,188

 
$
62,615

Add: Undistributed earnings allocated to participating securities
 
57

 
89

 
189

 
242

Less: Undistributed earnings reallocated to participating securities
 
(56
)
 
(87
)
 
(186
)
 
(236
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
21,316

 
$
24,580

 
$
70,191

 
$
62,621

 
 


 


 


 


Weighted average common shares outstanding
 
50,278

 
49,401

 
50,082

 
49,157

Net effect of dilutive stock options and restricted stock units
 
845

 
1,143

 
989

 
1,296

Weighted average common shares outstanding for computing diluted income per share
 
51,123

 
50,544

 
51,071

 
50,453

 
 


 


 


 


Diluted net income per share attributable to Morningstar, Inc.
 
$
0.42

 
$
0.49

 
$
1.37

 
$
1.24


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Table of Contents


5.
Segment and Geographical Area Information
 
Morningstar has two operating segments:
 
Investment Information. The Investment Information segment includes all of our data, software, and research products and services. These products are typically sold through subscriptions or license agreements.
 
The largest products in this segment based on revenue are Licensed Data, Morningstar Advisor Workstation (including Morningstar Office), Morningstar.com, Morningstar Direct, Morningstar Integrated Web Tools (formerly Morningstar Site Builder), and Morningstar Principia. Licensed Data is a set of investment data spanning all of our investment databases, including real-time pricing data, and is available through electronic data feeds. Advisor Workstation is a web-based investment planning system for advisors. Advisor Workstation is available in two editions: Morningstar Office for independent financial advisors and an enterprise edition for financial advisors affiliated with larger firms. Morningstar.com includes both Premium Memberships and Internet advertising sales. Morningstar Direct is a web-based institutional research platform. Morningstar Integrated Web Tools is a set of services that helps institutional clients build customized websites or enhance their existing sites with Morningstar’s online tools and components. Principia is our CD-ROM-based investment research and planning software for advisors.
 
The Investment Information segment also includes Morningstar Equity Research, which we sell to other companies that purchase our research for their own use or provide our research to their affiliated advisors or individual investor clients.

Investment Management. The Investment Management segment includes all of our asset management operations, which earn the majority of their revenue from asset-based fees.
 
The key products and services in this segment based on revenue are Investment Consulting, which focuses on investment monitoring and asset allocation for funds of funds, including mutual funds and variable annuities; Retirement Solutions, including the Morningstar Retirement Manager and Advice by Ibbotson platforms; and Morningstar Managed Portfolios, a fee-based discretionary asset management service that includes a series of mutual fund, ETF, and stock portfolios tailored to meet a range of investment time horizons, risk levels, and investment strategies that financial advisors can use for their clients’ taxable and tax-deferred accounts.
 
Our segment accounting policies are the same as those described in Note 2, except for the capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions. We exclude these items from our operating segment results to provide our chief operating decision maker with a better indication of each segment’s ability to generate cash flow. This information is one of the criteria used by our chief operating decision maker in determining how to allocate resources to each segment. We include capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions in the Corporate Items category. Our segment disclosures are consistent with the business segment information provided to our chief operating decision maker on a recurring basis; for that reason, we don’t present balance sheet information by segment. We disclose goodwill by segment in accordance with the requirements of FASB ASC 350-20-50, Intangibles - Goodwill - Disclosure.
 

17


Table of Contents

The following tables show selected segment data for the three and nine months ended September 30, 2011 and 2010:
 
 
 
Three months ended September 30, 2011
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
125,804

 
$
34,247

 
$

 
$
160,051

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
89,652

 
15,587

 
6,050

 
111,289

Stock-based compensation expense
 
2,609

 
556

 
786

 
3,951

Depreciation and amortization
 
2,117

 
42

 
8,788

 
10,947

Operating income (loss)
 
$
31,426

 
$
18,062

 
$
(15,624
)
 
$
33,864

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
4,560

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,711

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
112,790

Non-U.S. revenue
 
 

 
 

 
 

 
$
47,261

 
 
 
Three months ended September 30, 2010
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
112,055

 
$
27,762

 
$

 
$
139,817

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
75,129

 
13,670

 
7,215

 
96,014

Stock-based compensation expense
 
2,326

 
525

 
894

 
3,745

Depreciation and amortization
 
1,789

 
44

 
8,064

 
9,897

Operating income (loss)
 
$
32,811

 
$
13,523

 
$
(16,173
)
 
$
30,161

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
1,975

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,887

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
99,933

Non-U.S. revenue
 
 

 
 

 
 

 
$
39,884


 
 
Nine months ended September 30, 2011
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
374,319

 
$
98,510

 
$

 
$
472,829

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
259,899

 
43,258

 
22,237

 
325,394

Stock-based compensation expense
 
7,567

 
1,529

 
2,347

 
11,443

Depreciation and amortization
 
6,023

 
124

 
25,565

 
31,712

Operating income (loss)
 
$
100,830

 
$
53,599

 
$
(50,149
)
 
$
104,280

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
8,084

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
6,605

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
334,395

Non-U.S. revenue
 
 

 
 

 
 

 
$
138,434

 

18


Table of Contents

 
 
Nine months ended September 30, 2010
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
324,600

 
$
79,598

 
$

 
$
404,198

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
217,559

 
36,768

 
22,682

 
277,009

Stock-based compensation expense
 
5,926

 
1,557

 
2,854

 
10,337

Depreciation and amortization
 
5,016

 
136

 
22,930

 
28,082

Operating income (loss)
 
$
96,099

 
$
41,137

 
$
(48,466
)
 
$
88,770

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
3,607

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
4,094

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
291,529

Non-U.S. revenue
 
 

 
 

 
 

 
$
112,669


 
 
As of September 30, 2011
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
277,246

 
$
42,121

 
$

 
$
319,367

 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 

 
 

 
 

 
$
41,066

Non-U.S. long-lived assets
 
 

 
 

 
 

 
$
22,637

 
 
 
As of December 31, 2010
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
275,611

 
$
42,050

 
$

 
$
317,661

 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 

 
 

 
 

 
$
39,496

Non-U.S. long-lived assets
 
 

 
 

 
 

 
$
22,609

 
6.
Investments and Fair Value Measurements
 
We account for our investments in accordance with FASB ASC 320, Investments—Debt and Equity Securities. We classify our investments in three categories: available-for-sale, held-to-maturity, and trading. We monitor the concentration, diversification, maturity, and liquidity of our investment portfolio, which is primarily invested in fixed-income securities, and classify our investment portfolio as shown below:
 
 
 
As of September 30
 
As of December 31
($000)
 
2011

 
2010

Available-for-sale
 
$
238,990

 
$
173,072

Held-to-maturity
 
14,813

 
7,476

Trading securities
 
4,946

 
4,692

Total
 
$
258,749

 
$
185,240

 

19


Table of Contents

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

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
122,991

 
$
54

 
$
(186
)
 
$
122,859

 
$
113,597

 
$
36

 
$
(56
)
 
$
113,577

Corporate bonds
 
65,079

 
27

 
(293
)
 
64,813

 
42,839

 
63

 
(24
)
 
42,878

Commercial paper
 
34,941

 
2

 
(18
)
 
34,925

 
2,994

 

 
(3
)
 
2,991

Equity securities and exchange-traded funds
 
8,411

 
203

 
(1,197
)
 
7,417

 
4,510

 
418

 
(6
)
 
4,922

Mutual funds
 
9,180

 
45

 
(249
)
 
8,976

 
8,146

 
558

 

 
8,704

Total
 
$
240,602

 
$
331

 
$
(1,943
)
 
238,990

 
$
172,086

 
$
1,075

 
$
(89
)
 
$
173,072

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
14,813

 
$

 
$

 
$
14,813

 
$
7,476

 
$

 
$

 
$
7,476

 
As of September 30, 2011 and December 31, 2010, investments with unrealized losses for greater than a 12-month period were not material to the Condensed Consolidated Balance Sheets and were not deemed to have other than temporary declines in value.

The table below shows the cost and fair value of investments classified as available-for-sale and held-to-maturity based on their contractual maturities as of September 30, 2011 and December 31, 2010. The expected maturities of certain fixed-income securities may differ from their contractual maturities because some of these holdings have call features that allow the issuers the right to prepay obligations without penalties.
 
 
 
As of September 30, 2011
 
As of December 31, 2010
($000)
 
Cost

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
177,348

 
$
177,124

 
$
85,990

 
$
85,964

Due in one to three years
 
45,663

 
45,473

 
73,440

 
73,482

Equity securities, exchange-traded funds, and mutual funds
 
17,591

 
16,393

 
12,656

 
13,626

Total
 
$
240,602

 
$
238,990

 
$
172,086

 
$
173,072

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
14,808

 
$
14,808

 
$
7,223

 
$
7,223

Due in one to three years
 
5

 
5

 
253

 
253

Total
 
$
14,813

 
$
14,813

 
$
7,476

 
$
7,476

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

20


Table of Contents


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: 
 
 
Nine months ended September 30
($000)
 
2011

 
2010

Realized gains
 
$
270

 
$
17

Realized losses
 

 
(3
)
Realized gains, net
 
$
270

 
$
14

 

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

 
2010

Unrealized loss, net
 
$
810

 
$
75


The fair value of our assets subject to fair value measurements and the necessary disclosures are as follows:
 
 
 
Fair Value
 
Fair Value Measurements as of September 30, 2011
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
September 30, 2011
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments
 
 

 
 

 
 

 
 

Government obligations
 
$
122,859

 
$

 
$
122,859

 
$

Corporate bonds
 
64,813

 

 
64,813

 

Commercial paper
 
34,925

 

 
34,925

 
<