MORN_10Q_09.30.2012

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, 2012
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 26, 2012, there were 47,131,295 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, 2012 and 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Equity for the nine months ended September 30, 2012
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


Table of Contents

PART 1.
FINANCIAL INFORMATION
Item 1.
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)
 
2012

 
2011

 
2012

 
2011

 
 
 
 
 
 
 
 
 
Revenue
 
$
160,952

 
$
160,051

 
$
487,679

 
$
472,829

 
 
 
 
 
 
 
 
 
Operating expense (1):
 
 
 
 
 
 
 
 
Cost of goods sold
 
47,711

 
48,074

 
147,479

 
133,929

Development
 
12,857

 
13,482

 
38,664

 
39,151

Sales and marketing
 
25,732

 
27,253

 
81,431

 
80,502

General and administrative
 
23,966

 
26,431

 
77,090

 
83,255

Depreciation and amortization
 
10,822

 
10,947

 
31,616

 
31,712

Total operating expense
 
121,088

 
126,187

 
376,280

 
368,549

 
 
 
 
 
 
 
 
 
Operating income
 
39,864

 
33,864

 
111,399

 
104,280

 
 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 

 
 

 
 
 
 
Interest income, net
 
1,719

 
797

 
3,848

 
1,142

Other income (expense), net
 
161

 
(1,376
)
 
(314
)
 
(938
)
Non-operating income (expense), net
 
1,880

 
(579
)
 
3,534

 
204

 
 
 
 
 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
41,744

 
33,285

 
114,933

 
104,484

 
 
 
 
 
 
 
 
 
Income tax expense
 
15,186

 
12,343

 
41,441

 
35,585

 
 
 
 
 
 
 
 
 
Equity in net income of unconsolidated entities
 
478

 
428

 
1,541

 
1,397

 
 
 
 
 
 
 
 
 
Consolidated net income
 
27,036

 
21,370

 
75,033

 
70,296

 
 
 
 
 
 
 
 
 
Net loss attributable to the noncontrolling interest
 
34

 
10

 
62

 
106

 
 
 
 
 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
27,070

 
$
21,380

 
$
75,095

 
$
70,402

 
 
 
 
 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 

 
 

 
 
 
 
Basic
 
$
0.56

 
$
0.42

 
$
1.53

 
$
1.40

Diluted
 
$
0.56

 
$
0.42

 
$
1.51

 
$
1.37

 
 
 
 
 
 
 
 
 
Dividends per common share:
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.10

 
$
0.05

 
$
0.30

 
$
0.15

Dividends paid per common share
 
$
0.10

 
$
0.05

 
$
0.30

 
$
0.15

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
47,975

 
50,278

 
49,028

 
50,082

Diluted
 
48,481

 
51,123

 
49,664

 
51,071


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Table of Contents

 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30
 
Nine months ended September 30
 
 
2012

 
2011

 
2012

 
2011

(1) Includes stock-based compensation expense of:
 
 

 
 

 
 
 
 
Cost of goods sold
 
$
1,148

 
$
1,117

 
$
3,304

 
$
3,068

Development
 
471

 
545

 
1,435

 
1,588

Sales and marketing
 
493

 
489

 
1,433

 
1,392

General and administrative
 
1,882

 
1,800

 
5,422

 
5,395

Total stock-based compensation expense
 
$
3,994

 
$
3,951

 
$
11,594

 
$
11,443


 See notes to unaudited condensed consolidated financial statements.


4


Table of Contents

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

 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands) 
 
2012

 
2011

 
2012

 
2011

 
 
 
 
 
 
 
 
 
Consolidated net income
 
$
27,036

 
$
21,370

 
$
75,033

 
$
70,296

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
7,375

 
(12,570
)
 
5,597

 
(6
)
Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
 
  Unrealized holding gains (losses) arising during period
 
1,026

 
(1,871
)
 
1,394

 
(1,472
)
  Reclassification of (gains) losses included in net income
 

 
81

 
33

 
(171
)
Other comprehensive income (loss)
 
8,401

 
(14,360
)
 
7,024

 
(1,649
)
 
 
 
 
 
 
 
 
 
Comprehensive income
 
35,437

 
7,010

 
82,057

 
68,647

Comprehensive (income) loss attributable to noncontrolling interest
 
16

 
(47
)
 
77

 
52

Comprehensive income attributable to Morningstar, Inc.
 
$
35,453

 
$
6,963

 
$
82,134

 
$
68,699


See notes to unaudited condensed consolidated financial statements.



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Table of Contents

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
 
 
As of September 30
 
As of December 31
(in thousands except share amounts)
 
2012

 
2011

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
152,181

 
$
200,437

Investments
 
190,899

 
269,755

Accounts receivable, less allowance of $723 and $835, respectively
 
119,877

 
113,312

Deferred tax asset, net
 
2,156

 
5,104

Income tax receivable, net
 
5,277

 
7,445

Other
 
22,546

 
15,980

Total current assets
 
492,936

 
612,033

Property, equipment, and capitalized software, net
 
77,873

 
68,196

Investments in unconsolidated entities
 
38,278

 
27,642

Goodwill
 
321,134

 
318,492

Intangible assets, net
 
122,832

 
139,809

Other assets
 
8,330

 
5,912

Total assets
 
$
1,061,383

 
$
1,172,084

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
40,356

 
$
41,403

Accrued compensation
 
55,131

 
73,124

Deferred revenue
 
164,360

 
155,494

Other
 
319

 
612

Total current liabilities
 
260,166

 
270,633

Accrued compensation
 
6,802

 
5,724

Deferred tax liability, net
 
14,262

 
15,940

Deferred rent
 
15,160

 
14,604

Other long-term liabilities
 
8,262

 
8,167

Total liabilities
 
304,652

 
315,068

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 47,479,142 and 50,083,940 shares were outstanding as of September 30, 2012 and December 31, 2011, respectively
 
5

 
5

Treasury stock at cost, 4,125,568 shares as of September 30, 2012 and 980,177 shares as of December 31, 2011
 
(232,685
)
 
(46,701
)
Additional paid-in capital
 
509,896

 
491,432

Retained earnings
 
469,295

 
409,022

Accumulated other comprehensive income (loss):
 
 
 
 
    Currency translation adjustment
 
7,548

 
1,936

    Unrealized gain (loss) on available-for-sale investments
 
1,103

 
(324
)
Total accumulated other comprehensive income
 
8,651

 
1,612

Total Morningstar, Inc. shareholders’ equity
 
755,162

 
855,370

Noncontrolling interest
 
1,569

 
1,646

Total equity
 
756,731

 
857,016

Total liabilities and equity
 
$
1,061,383

 
$
1,172,084

 See notes to unaudited condensed consolidated financial statements.

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Table of Contents

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity
For the nine months ended September 30, 2012
 
 
 
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, 2011
 
50,083,940

 
$
5

 
$
(46,701
)
 
$
491,432

 
$
409,022

 
$
1,612

 
$
1,646

 
$
857,016

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 

 

 

 
75,095

 

 
(62
)
 
75,033

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale investments, net of income tax of $794
 
 
 

 

 

 

 
1,394

 

 
1,394

Reclassification of adjustments for losses included in net income, net of income tax of $19
 
 
 

 

 

 

 
33

 

 
33

Foreign currency translation adjustment, net
 
 
 

 

 

 

 
5,612

 
(15
)
 
5,597

Other comprehensive income (loss), net
 
 
 

 

 

 

 
7,039

 
(15
)
 
7,024

Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
561,276

 

 
1,114

 
1,646

 

 

 

 
2,760

Stock-based compensation — restricted stock units
 
 
 

 

 
9,944

 

 

 

 
9,944

Stock-based compensation — restricted stock
 
 
 

 

 
1,332

 

 

 

 
1,332

Stock-based compensation — stock-options
 
 
 

 

 
318

 

 

 

 
318

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

 

 
5,007

 

 

 

 
5,007

Common shares repurchased
 
(3,166,074
)
 

 
(187,098
)
 

 

 

 

 
(187,098
)
Dividends declared — common shares outstanding
 
 
 

 

 

 
(14,587
)
 

 

 
(14,587
)
Dividends declared — restricted stock units
 
 
 

 

 
217

 
(235
)
 

 

 
(18
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of September 30, 2012
 
47,479,142

 
$
5

 
$
(232,685
)
 
$
509,896

 
$
469,295

 
$
8,651

 
$
1,569

 
$
756,731

 
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)
 
2012

 
2011

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
75,033

 
$
70,296

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
31,616

 
31,712

Deferred income taxes
 
492

 
(1,559
)
Stock-based compensation expense
 
11,594

 
11,443

Provision for bad debt
 
990

 
1,076

Equity in net income of unconsolidated entities
 
(1,541
)
 
(1,397
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(5,007
)
 
(7,621
)
Other, net
 
342

 
1,607

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable
 
(6,569
)
 
(403
)
Other assets
 
(3,551
)
 
1,996

Accounts payable and accrued liabilities
 
(4,316
)
 
(5,275
)
Accrued compensation
 
(20,851
)
 
(3,242
)
Income taxes—current
 
7,220

 
9,442

Deferred revenue
 
7,684

 
618

Deferred rent
 
291

 
(984
)
Other liabilities
 
(1,111
)
 
(1,393
)
Cash provided by operating activities
 
92,316

 
106,316

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(134,929
)
 
(298,876
)
Proceeds from maturities and sales of investments
 
216,350

 
222,599

Capital expenditures
 
(22,876
)
 
(14,689
)
Acquisitions, net of cash acquired
 

 
300

Purchases of equity and cost method investments
 
(10,304
)
 

Other, net
 
(4
)
 
875

Cash provided by (used for) investing activities
 
48,237

 
(89,791
)
 
 
 
 
 
Financing activities
 
 

 
 

Proceeds from stock-option exercises, net
 
2,760

 
6,630

Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
5,007

 
7,621

Common shares repurchased
 
(183,698
)
 
(28,526
)
Dividends paid
 
(14,867
)
 
(7,539
)
Other, net
 
(18
)
 
(363
)
Cash used for financing activities
 
(190,816
)
 
(22,177
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
2,007

 
(254
)
Net decrease in cash and cash equivalents
 
(48,256
)
 
(5,906
)
Cash and cash equivalents—beginning of period
 
200,437

 
180,176

Cash and cash equivalents—end of period
 
$
152,181

 
$
174,270

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
33,163

 
$
28,437

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain (loss) on available-for-sale investments
 
$
2,221

 
$
(2,598
)
 
See notes to unaudited condensed consolidated financial statements.

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Table of Contents

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, 2011, filed with the SEC on February 24, 2012.
 
The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
FASB: Financial Accounting Standards Board
SEC: Securities and Exchange Commission
 
2. Correction

In 2012, we identified errors related to purchases of investments and proceeds from maturities and sales of investments included on our Consolidated Statement of Cash Flows for the nine months ended September 30, 2011 that had not been previously detected. We did not properly disclose the correct amount for both categories by equal, but offsetting, amounts. The financial statements have been corrected to increase the purchases of investments and proceeds from maturities and sales of investments as shown in the table below. The error existed in the first quarter of 2012, but did not exist in the cumulative statement as of and for the six months ended June 30, 2012.

The following tables shows our previously reported amounts, the correction, and our as corrected amounts:
 
 
Nine months ended September 30, 2011
($000)
 
Previously Reported

 
Correction

 
As Corrected

Investing Activities
 
 
 
 
 
 
Purchases of investments
 
$
(281,698
)
 
$
(17,178
)
 
$
(298,876
)
Proceeds from maturities and sales of investments
 
$
205,421

 
$
17,178

 
$
222,599

Cash used for investing activities
 
$
(89,791
)
 
$

 
$
(89,791
)

3. Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 2 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on February 24, 2012.

In addition, effective January 1, 2012, we adopted FASB ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU No. 2011-04 clarifies existing fair value measurement and disclosure requirements, amends certain fair value measurement principles, and requires additional disclosures about fair value measurements. The adoption of ASU No. 2011-04 did not have a material impact on our Consolidated Financial Statements.

9


Table of Contents

4. Goodwill and Other Intangible Assets
 
Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2011 to September 30, 2012:
 
 
($000)

Balance as of December 31, 2011
$
318,492

Net change, primarily currency translation
2,642

Balance as of September 30, 2012
$
321,134


We did not record any significant impairment losses in the first nine months of 2012 or 2011. We perform our annual impairment reviews in the fourth quarter.

Intangible Assets

The following table summarizes our intangible assets: 
 
 
As of September 30, 2012
 
As of December 31, 2011
($000)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

Intellectual property
 
$
32,343

 
$
(22,488
)
 
$
9,855

 
9

 
$
32,293

 
$
(20,455
)
 
$
11,838

 
9

Customer-related assets
 
135,772

 
(62,763
)
 
73,009

 
12

 
134,396

 
(52,611
)
 
81,785

 
12

Supplier relationships
 
240

 
(93
)
 
147

 
20

 
240

 
(84
)
 
156

 
20

Technology-based assets
 
81,308

 
(41,735
)
 
39,573

 
9

 
80,694

 
(35,130
)
 
45,564

 
9

Non-competition agreement
 
1,766

 
(1,518
)
 
248

 
4

 
1,751

 
(1,285
)
 
466

 
4

Total intangible assets
 
$
251,429

 
$
(128,597
)
 
$
122,832

 
10

 
$
249,374

 
$
(109,565
)
 
$
139,809

 
10

 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2012

 
2011

 
2012

 
2011

Amortization expense
 
$
5,941

 
$
6,894

 
$
17,972

 
$
20,039

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

We expect intangible amortization expense for 2012 and subsequent years as follows:
 
 
($000)

2012
 
$
24,048

2013
 
21,317

2014
 
20,058

2015
 
19,186

2016
 
14,564

2017
 
9,954

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

10


Table of Contents


5. Income Per Share 

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

 
 
Three months ended September 30
 
Nine months ended September 30
(in thousands, except per share amounts)
 
2012

 
2011

 
2012

 
2011

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

 
 

 
 
 
 
Net income attributable to Morningstar, Inc.:
 
$
27,070

 
$
21,380

 
$
75,095

 
$
70,402

Less: Distributed earnings available to participating securities
 
(12
)
 
(8
)
 
(39
)
 
(25
)
Less: Undistributed earnings available to participating securities
 
(53
)
 
(57
)
 
(144
)
 
(189
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
27,005

 
$
21,315

 
$
74,912

 
$
70,188

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
47,975

 
50,278

 
49,028

 
50,082

 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.56

 
$
0.42

 
$
1.53

 
$
1.40

 
 
 
 
 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
27,005

 
$
21,315

 
$
74,912

 
$
70,188

Add: Undistributed earnings allocated to participating securities
 
53

 
57

 
144

 
189

Less: Undistributed earnings reallocated to participating securities
 
(53
)
 
(56
)
 
(142
)
 
(186
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
27,005

 
$
21,316

 
$
74,914

 
$
70,191

 
 


 


 


 


Weighted average common shares outstanding
 
47,975

 
50,278

 
49,028

 
50,082

Net effect of dilutive stock options and restricted stock units
 
506

 
845

 
636

 
989

Weighted average common shares outstanding for computing diluted income per share
 
48,481

 
51,123

 
49,664

 
51,071

 
 


 


 


 


Diluted net income per share attributable to Morningstar, Inc.
 
$
0.56

 
$
0.42

 
$
1.51

 
$
1.37


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Table of Contents


6. 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 Morningstar Data (formerly Licensed Data), Morningstar Advisor Workstation (including Morningstar Office), Morningstar Direct, Morningstar.com, Morningstar Integrated Web Tools, and Morningstar Principia. Morningstar Data is a set of investment data spanning all of our investment databases, including real-time pricing and commodity 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 Direct is a web-based institutional research platform. Morningstar.com includes both Premium Memberships and Internet advertising sales. 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 distribute through several channels. We sell Morningstar Equity Research to companies that purchase our research for their own use or provide our research to their affiliated advisors or individual investor clients.

The Investment Information segment also includes Morningstar Credit Research and Morningstar Structured Credit Ratings. The latter is provided by Morningstar Credit Ratings, LLC, a Nationally Recognized Statistical Rating Organization specializing in structured finance. It offers securities ratings, research, surveillance services, and data to help institutional investors identify risk in commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS).

We also offer a variety of financial communications and newsletters, other institutional and advisor software, and investment indexes.

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 Advisory Services (formerly 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, exchange-traded fund, and stock portfolios tailored to meet a range of investment time horizons and risk levels that financial advisors can use for their clients' taxable and tax-deferred accounts. In addition, we offer Managed Portfolios through our subsidiary Ibbotson Australia which provides asset management services primarily to institutional clients and individual investors.
 
Our segment accounting policies are the same as those described in Note 3, except for the capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions. We exclude these items from our operating segment results to provide our chief operating decision maker with a better indication of each segment’s ability to generate cash flow. This information is one of the criteria used by our chief operating decision maker in determining how to allocate resources to each segment. We include capitalization and amortization of internal product development costs, amortization of intangible assets, and costs related to corporate functions in the Corporate Items category. Our segment disclosures are consistent with the business segment information provided to our chief operating decision maker on a recurring basis; for that reason, we don’t present balance sheet information by segment. We disclose goodwill by segment in accordance with the requirements of FASB ASC 350-20-50, Intangibles - Goodwill - Disclosure.
 

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Table of Contents

The following tables present information about our operating segments and by geographical area:
 
 
 
Three months ended September 30, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
129,357

 
$
31,595

 
$

 
$
160,952

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
85,366

 
16,145

 
4,761

 
106,272

Stock-based compensation expense
 
2,738

 
577

 
679

 
3,994

Depreciation and amortization
 
2,296

 
31

 
8,495

 
10,822

Operating income (loss)
 
$
38,957

 
$
14,842

 
$
(13,935
)
 
$
39,864

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
3,066

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,888

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
391,031

 
$
96,648

 
$

 
$
487,679

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
265,719

 
49,277

 
18,074

 
333,070

Stock-based compensation expense
 
7,828

 
1,657

 
2,109

 
11,594

Depreciation and amortization
 
6,840

 
108

 
24,668

 
31,616

Operating income (loss)
 
$
110,644

 
$
45,606

 
$
(44,851
)
 
$
111,399

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
17,280

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
5,596

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

13


Table of Contents

 
 
 
 
 
 
 
 
 
 
 
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

 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
279,451

 
$
41,683

 
$

 
$
321,134

 
 
 
As of December 31, 2011
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
277,059

 
$
41,433

 
$

 
$
318,492

 
External revenue by geographical area
 
 
 
 
 
 
 
 
 
 
Three months ended September 30
 
Nine months ended September 30
($000)
 
2012

 
2011

 
2012

 
2011

United States
 
$
114,021

 
$
112,790

 
$
346,442

 
$
334,395

United Kingdom
 
13,711

 
13,588

 
42,160

 
40,382

Europe, excluding the United Kingdom
 
11,643

 
12,609

 
35,980

 
36,750

Australia
 
10,090

 
10,614

 
29,230

 
30,600

Canada
 
7,605

 
6,723

 
22,351

 
20,124

Asia, excluding Japan
 
2,420

 
2,358

 
7,156

 
6,760

Japan
 
924

 
1,032

 
2,889

 
2,922

Other
 
538

 
337

 
1,471

 
896

Total Non-U.S.
 
46,931

 
47,261

 
141,237

 
138,434

 
 
 
 
 
 
 
 
 
Total
 
$
160,952

 
$
160,051

 
$
487,679

 
$
472,829




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Table of Contents

Long-lived assets by geographical area
 
 
 
 
 
 
As of September 30
 
As of December 31
($000)
 
2012

 
2011

United States
 
$
54,060

 
$
44,572

United Kingdom
 
7,611

 
7,512

Europe, excluding the United Kingdom
 
2,429

 
2,629

Australia
 
1,519

 
1,415

Canada
 
1,853

 
2,076

Asia, excluding Japan
 
10,033

 
9,656

Japan
 
207

 
282

Other
 
161

 
54

Total Non-U.S.
 
23,813

 
23,624

 
 
 
 
 
Total
 
$
77,873

 
$
68,196


7. 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)
 
2012

 
2011

Available-for-sale
 
$
165,517

 
$
247,917

Held-to-maturity
 
19,948

 
16,347

Trading securities
 
5,434

 
5,491

Total
 
$
190,899

 
$
269,755



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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, 2012
 
As of December 31, 2011
($000)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
55,300

 
$
47

 
$
(622
)
 
$
54,725

 
$
139,099

 
$
72

 
$
(402
)
 
$
138,769

Corporate bonds
 
63,810

 
78

 
(431
)
 
63,457

 
61,589

 
14

 
(280
)
 
61,323

Commercial paper
 
4,995

 
2

 

 
4,997

 
29,964

 
2

 
(7
)
 
29,959

Equity securities and exchange-traded funds
 
29,325

 
1,962

 
(346
)
 
30,941

 
8,461

 
368

 
(558
)
 
8,271

Mutual funds
 
10,360

 
1,076

 
(39
)
 
11,397

 
9,298

 
363

 
(66
)
 
9,595

Total
 
$
163,790

 
$
3,165

 
$
(1,438
)
 
$
165,517

 
$
248,411

 
$
819

 
$
(1,313
)
 
$
247,917

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
19,948

 
$

 
$

 
$
19,948

 
$
16,347

 
$

 
$

 
$
16,347

 
As of September 30, 2012 and December 31, 2011, 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, 2012 and December 31, 2011. 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, 2012
 
As of December 31, 2011
($000)
 
Cost

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
107,770

 
$
106,979

 
$
155,651

 
$
155,247

Due in one to two years
 
16,061

 
15,938

 
75,001

 
74,804

Due in more than two years
 
274

 
262

 

 

Equity securities, exchange-traded funds, and mutual funds
 
39,685

 
42,338

 
17,759

 
17,866

Total
 
$
163,790

 
$
165,517

 
$
248,411

 
$
247,917

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
19,942

 
$
19,942

 
$
16,342

 
$
16,342

Due in one to three years
 
6

 
6

 
5

 
5

Total
 
$
19,948

 
$
19,948

 
$
16,347

 
$
16,347

 
As of September 30, 2012 and December 31, 2011, held-to-maturity investments included a $1,500,000 and a $1,600,000 certificate of deposit, respectively, held primarily as collateral against bank guarantees for our office leases, primarily in Australia.


16


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)
 
2012

 
2011

Realized gains
 
$
689

 
$
270

Realized losses
 
(741
)
 

Realized gains (losses), net
 
$
(52
)
 
$
270

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

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