MORN_10Q_03.31.2013

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 March 31, 2013
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 April 26, 2013, there were 46,499,799 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 months ended March 31, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Equity for the three months ended March 31, 2013
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


Table of Contents

PART 1.
FINANCIAL INFORMATION
Item 1.
Financial Statements

3


Table of Contents

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
 
 
Three months ended March 31
(in thousands except per share amounts)
 
2013

 
2012

 
 
 
 
 
Revenue
 
$
168,856

 
$
160,759

 
 
 
 
 
Operating expense (1):
 
 
 
 
Cost of goods sold
 
48,010

 
50,316

Development
 
13,640

 
13,365

Sales and marketing
 
27,980

 
28,326

General and administrative
 
27,327

 
28,178

Depreciation and amortization
 
11,339

 
10,175

Total operating expense
 
128,296

 
130,360

 
 
 
 
 
Operating income
 
40,560

 
30,399

 
 
 
 
 
Non-operating income (expense):
 
 
 
 
Interest income, net
 
741

 
869

Gain (loss) on sale of investments, reclassified from other comprehensive income
 
725

 
(86
)
Other income (expense), net
 
(521
)
 
(124
)
Non-operating income, net
 
945

 
659

 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
41,505

 
31,058

 
 
 
 
 
Income tax expense
 
12,427

 
11,511

 
 
 
 
 
Equity in net income of unconsolidated entities
 
497

 
566

 
 
 
 
 
Consolidated net income
 
29,575

 
20,113

 
 
 
 
 
Net loss attributable to the noncontrolling interest
 
43

 
24

 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
29,618

 
$
20,137

 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 
 
 
Basic
 
$
0.64

 
$
0.40

Diluted
 
$
0.63

 
$
0.40

 
 
 
 
 
Dividends per common share:
 
 
 
 
Dividends declared per common share
 
$
0.13

 
$
0.10

Dividends paid per common share
 
$

 
$
0.10

 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
Basic
 
46,406

 
49,938

Diluted
 
46,814

 
50,758

 
 
 
 
 
 
 
Three months ended March 31
 
 
2013

 
2012

(1) Includes stock-based compensation expense of:
 
 
 
 
Cost of goods sold
 
$
1,203

 
$
1,089

Development
 
498

 
499

Sales and marketing
 
512

 
479

General and administrative
 
1,570

 
1,799

Total stock-based compensation expense
 
$
3,783

 
$
3,866


 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 March 31
(in thousands) 
 
2013

 
2012

 
 
 
 
 
Consolidated net income
 
$
29,575

 
$
20,113

 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
Foreign currency translation adjustment
 
(9,071
)
 
6,965

Unrealized gains on securities:
 
 
 
 
  Unrealized holding gains arising during period
 
1,166

 
909

  Reclassification of (gains) losses included in net income
 
(463
)
 
55

Other comprehensive income (loss)
 
(8,368
)
 
7,929

 
 
 
 
 
Comprehensive income
 
21,207

 
28,042

Comprehensive loss attributable to noncontrolling interest
 
142

 
107

Comprehensive income attributable to Morningstar, Inc.
 
$
21,349

 
$
28,149


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 March 31
 
As of December 31
(in thousands except share amounts)
 
2013

 
2012

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
224,892

 
$
163,889

Investments
 
103,436

 
157,529

Accounts receivable, less allowance of $676 and $569, respectively
 
117,744

 
114,361

Deferred tax asset, net
 
3,343

 
3,741

Income tax receivable, net
 
2,672

 
14,267

Other
 
28,091

 
20,823

Total current assets
 
480,178

 
474,610

Property, equipment, and capitalized software, net
 
91,815

 
84,022

Investments in unconsolidated entities
 
35,635

 
35,305

Goodwill
 
315,784

 
320,845

Intangible assets, net
 
109,717

 
116,732

Other assets
 
12,420

 
10,438

Total assets
 
$
1,045,549

 
$
1,041,952

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
44,777

 
$
43,777

Accrued compensation
 
36,139

 
67,317

Deferred revenue
 
162,074

 
146,015

Other
 
242

 
256

Total current liabilities
 
243,232

 
257,365

Accrued compensation
 
8,569

 
8,281

Deferred tax liability, net
 
18,332

 
21,583

Deferred rent
 
15,046

 
15,368

Other long-term liabilities
 
21,248

 
12,460

Total liabilities
 
306,427

 
315,057

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 46,487,512 and 46,541,571 shares were outstanding as of March 31, 2013 and December 31, 2012, respectively
 
5

 
5

Treasury stock at cost, 5,379,583 shares as of March 31, 2013 and 5,214,070 shares as of December 31, 2012
 
(312,412
)
 
(301,839
)
Additional paid-in capital
 
528,754

 
521,285

Retained earnings
 
520,096

 
496,354

Accumulated other comprehensive income (loss):
 
 
 
 
    Currency translation adjustment
 
(47
)
 
8,925

    Unrealized gain on available-for-sale investments
 
1,490

 
787

Total accumulated other comprehensive income
 
1,443

 
9,712

Total Morningstar, Inc. shareholders’ equity
 
737,886

 
725,517

Noncontrolling interest
 
1,236

 
1,378

Total equity
 
739,122

 
726,895

Total liabilities and equity
 
$
1,045,549

 
$
1,041,952

 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 three months ended March 31, 2013
 
 
 
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, 2012
 
46,541,571

 
$
5

 
$
(301,839
)
 
$
521,285

 
$
496,354

 
$
9,712

 
$
1,378

 
$
726,895

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 

 

 

 
29,618

 

 
(43
)
 
29,575

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale investments, net of income tax of $398
 
 
 

 

 

 

 
1,166

 

 
1,166

Reclassification of adjustments for gains included in net income, net of income tax of $262
 
 
 

 

 

 

 
(463
)
 

 
(463
)
Foreign currency translation adjustment, net
 
 
 

 

 

 

 
(8,972
)
 
(99
)
 
(9,071
)
Other comprehensive loss, net
 
 
 

 

 

 

 
(8,269
)
 
(99
)
 
(8,368
)
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
111,482

 

 

 
2,006

 

 

 

 
2,006

Stock-based compensation — restricted stock units
 
 
 

 

 
3,563

 

 

 

 
3,563

Stock-based compensation — restricted stock
 
 
 

 

 
97

 

 

 

 
97

Stock-based compensation — stock-options
 
 
 

 

 
123

 

 

 

 
123

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

 

 
1,587

 

 

 

 
1,587

Common shares repurchased
 
(165,541
)
 

 
(10,573
)
 

 

 

 

 
(10,573
)
Dividends declared — common shares outstanding
 
 
 

 

 

 
(5,784
)
 

 

 
(5,784
)
Dividends declared — restricted stock units
 
 
 

 

 
93

 
(92
)
 

 

 
1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2013
 
46,487,512

 
$
5

 
$
(312,412
)
 
$
528,754

 
$
520,096

 
$
1,443

 
$
1,236

 
$
739,122

 
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
 
 
Three months ended March 31
(in thousands)
 
2013

 
2012

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
29,575

 
$
20,113

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
11,339

 
10,175

Deferred income taxes
 
(2,934
)
 
(1,453
)
Stock-based compensation expense
 
3,783

 
3,866

Provision for bad debt
 
175

 
525

Equity in net income of unconsolidated entities
 
(497
)
 
(566
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(1,587
)
 
(3,313
)
Other, net
 
(632
)
 
310

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable
 
(5,906
)
 
(7,439
)
Other assets
 
(6,575
)
 
(3,758
)
Accounts payable and accrued liabilities
 
400

 
703

Accrued compensation
 
(31,812
)
 
(35,168
)
Income taxes—current
 
14,487

 
7,369

Deferred revenue
 
17,769

 
14,165

Deferred rent
 
(461
)
 
716

Other liabilities
 
(451
)
 
(621
)
Cash provided by operating activities
 
26,673

 
5,624

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(3,694
)
 
(86,796
)
Proceeds from maturities and sales of investments
 
61,152

 
80,551

Capital expenditures
 
(9,118
)
 
(8,994
)
Purchases of equity- and cost-method investments
 

 
(6,750
)
Other, net
 
892

 
9

Cash provided by (used for) investing activities
 
49,232

 
(21,980
)
 
 
 
 
 
Financing activities
 
 

 
 

Proceeds from stock-option exercises, net
 
2,006

 
3,906

Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
1,587

 
3,313

Common shares repurchased
 
(15,240
)
 
(23,033
)
Dividends paid
 

 
(5,012
)
Other, net
 
(3
)
 
(17
)
Cash used for financing activities
 
(11,650
)
 
(20,843
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(3,252
)
 
2,110

Net increase (decrease) in cash and cash equivalents
 
61,003

 
(35,089
)
Cash and cash equivalents—beginning of period
 
163,889

 
200,437

Cash and cash equivalents—end of period
 
$
224,892

 
$
165,348

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
627

 
$
5,553

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain on available-for-sale investments
 
$
1,102

 
$
1,498

Equipment obtained under long-term financing arrangement
 
$
4,860

 
$

 
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, 2012, filed with the SEC on February 28, 2013.
 
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 three months ended March 31, 2012 that had not been previously detected. We did not properly disclose the correct amounts 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.

The following table shows our previously reported amounts, the correction, and our as corrected amounts:
 
 
Three months ended March 31, 2012
($000)
 
Previously Reported

 
Correction

 
As Corrected

Investing Activities
 
 
 
 
 
 
Purchases of investments
 
$
(344,391
)
 
$
257,595

 
$
(86,796
)
Proceeds from maturities and sales of investments
 
$
338,146

 
$
(257,595
)
 
$
80,551

Cash used for investing activities
 
$
(21,980
)
 
$

 
$
(21,980
)

3. 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, 2012, filed with the SEC on February 28, 2013.

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


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Table of Contents

4. Goodwill and Other Intangible Assets
 
Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2012 to March 31, 2013:
 
 
($000)

Balance as of December 31, 2012
$
320,845

Net change, currency translation
(5,061
)
Balance as of March 31, 2013
$
315,784


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

Intangible Assets

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

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
Intellectual property
 
$
30,572

 
$
(22,132
)
 
$
8,440

 
9
 
$
30,621

 
$
(21,527
)
 
$
9,094

 
9
Customer-related assets
 
130,833

 
(65,110
)
 
65,723

 
12
 
132,798

 
(63,005
)
 
69,793

 
12
Supplier relationships
 
240

 
(99
)
 
141

 
20
 
240

 
(96
)
 
144

 
20
Technology-based assets
 
80,644

 
(45,341
)
 
35,303

 
9
 
81,333

 
(43,809
)
 
37,524

 
9
Non-competition agreement
 
1,768

 
(1,658
)
 
110

 
4
 
1,765

 
(1,588
)
 
177

 
4
Total intangible assets
 
$
244,057

 
$
(134,340
)
 
$
109,717

 
10
 
$
246,757

 
$
(130,025
)
 
$
116,732

 
10
 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended March 31
($000)
 
2013

 
2012

Amortization expense
 
$
5,625

 
$
6,055

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

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

2013
 
$
20,977

2014
 
19,759

2015
 
18,951

2016
 
14,360

2017
 
9,828

2018
 
7,875

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

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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 March 31
(in thousands, except per share amounts)
 
2013

 
2012

 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.:
 
 
 
 
Net income attributable to Morningstar, Inc.:
 
$
29,618

 
$
20,137

Less: Distributed earnings available to participating securities
 
(15
)
 
(16
)
Less: Undistributed earnings available to participating securities
 
(13
)
 
(46
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
29,590

 
$
20,075

 
 
 
 
 
Weighted average common shares outstanding
 
46,406

 
49,938

 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.64

 
$
0.40

 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
29,590

 
$
20,075

Add: Undistributed earnings allocated to participating securities
 
13

 
46

Less: Undistributed earnings reallocated to participating securities
 
(13
)
 
(45
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
29,590

 
$
20,076

 
 


 


Weighted average common shares outstanding
 
46,406

 
49,938

Net effect of dilutive stock options and restricted stock units
 
408

 
820

Weighted average common shares outstanding for computing diluted income per share
 
46,814

 
50,758

 
 


 


Diluted net income per share attributable to Morningstar, Inc.
 
$
0.63

 
$
0.40


The following table shows the number of weighted average stock options, restricted stock units, and restricted stock excluded from our calculation of diluted earnings per share because their inclusion would have been anti-dilutive:
 
 
Three months ended March 31
(in thousands)
 
2013

 
2012

Weighted average stock options
 

 
14

Weighted average restricted stock units
 
9

 

Weighted average restricted stock
 

 

Total
 
9

 
14


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

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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, Morningstar Advisor Workstation (including Morningstar Office), Morningstar Direct, Morningstar.com, Morningstar Integrated Web Tools, Morningstar Structured Credit Ratings, 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 that 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. Morningstar Structured Credit Ratings is provided by Morningstar Credit Ratings, LLC, a Nationally Recognized Statistical Rating Organization specializing in structured finance. Morningstar Principia is our CD-ROM-based investment research and planning software for advisors.
 
The Investment Information segment also includes Morningstar Equity Research and Morningstar Credit Ratings, LLC. 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. Morningstar Credit Ratings, LLC offers Structured Credit Ratings as well as research, surveillance services, and data to help institutional investors identify risk in commercial mortgage-backed securities (CMBS).

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, 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 Associates Australia Limited 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 March 31, 2013
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
136,187

 
$
32,669

 
$

 
$
168,856

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
89,869

 
15,619

 
7,686

 
113,174

Stock-based compensation expense
 
2,499

 
592

 
692

 
3,783

Depreciation and amortization
 
2,352

 
24

 
8,963

 
11,339

Operating income (loss)
 
$
41,467

 
$
16,434

 
$
(17,341
)
 
$
40,560

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
8,009

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,109

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
126,925

 
$
33,834

 
$

 
$
160,759

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
93,438

 
15,953

 
6,928

 
116,319

Stock-based compensation expense
 
2,559

 
551

 
756

 
3,866

Depreciation and amortization
 
2,244

 
39

 
7,892

 
10,175

Operating income (loss)
 
$
28,684

 
$
17,291

 
$
(15,576
)
 
$
30,399

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
7,397

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,597

 
 
 
 
 
 
 
 
 
 
 
 
As of March 31, 2013
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
274,631

 
$
41,153

 
$

 
$
315,784

 
 
 
As of December 31, 2012
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
279,164

 
$
41,681

 
$

 
$
320,845

 

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Table of Contents

External revenue by geographical area
 
 
 
 
 
 
Three months ended March 31
($000)
 
2013

 
2012

United States
 
$
121,413

 
$
114,469

 
 
 
 
 
United Kingdom
 
13,153

 
13,736

Europe, excluding the United Kingdom
 
13,167

 
12,055

Australia
 
9,352

 
9,348

Canada
 
7,736

 
7,350

Asia, excluding Japan
 
2,595

 
2,369

Japan
 
829

 
979

Other
 
611

 
453

Total Non-U.S.
 
47,443

 
46,290

 
 
 
 
 
Total
 
$
168,856

 
$
160,759



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

 
2012

United States
 
$
69,664

 
$
60,371

 
 
 
 
 
United Kingdom
 
6,517

 
7,435

Europe, excluding the United Kingdom
 
2,116

 
2,356

Australia
 
1,374

 
1,402

Canada
 
1,641

 
1,773

Asia, excluding Japan
 
10,291

 
10,445

Japan
 
58

 
84

Other
 
154

 
156

Total Non-U.S.
 
22,151

 
23,651

 
 
 
 
 
Total
 
$
91,815

 
$
84,022


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 March 31
 
As of December 31
($000)
 
2013

 
2012

Available-for-sale
 
$
70,193

 
$
125,786

Held-to-maturity
 
26,408

 
26,357

Trading securities
 
6,835

 
5,386

Total
 
$
103,436

 
$
157,529



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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 March 31, 2013
 
As of December 31, 2012
($000)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
17,384

 
$
27

 
$
(108
)
 
$
17,303

 
$
40,669

 
$
29

 
$
(608
)
 
$
40,090

Corporate bonds
 
30,171

 
18

 
(186
)
 
30,003

 
49,339

 
36

 
(292
)
 
49,083

Foreign obligations
 
2,433

 
1

 
(30
)
 
2,404

 
2,437

 
1

 
(19
)
 
2,419

Commercial paper
 

 

 

 

 
2,000

 

 

 
2,000

Equity securities and exchange-traded funds
 
7,351

 
943

 
(164
)
 
8,130

 
19,613

 
1,359

 
(323
)
 
20,649

Mutual funds
 
10,523

 
1,956

 
(126
)
 
12,353

 
10,499

 
1,092

 
(46
)
 
11,545

Total
 
$
67,862

 
$
2,945

 
$
(614
)
 
$
70,193

 
$
124,557

 
$
2,517

 
$
(1,288
)
 
$
125,786

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
26,408

 
$

 
$

 
$
26,408

 
$
26,357

 
$

 
$

 
$
26,357

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

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

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
49,988

 
$
49,710

 
$
87,599

 
$
86,784

Due in one to two years
 

 

 
6,846

 
6,808

Equity securities, exchange-traded funds, and mutual funds
 
17,874

 
20,483

 
30,112

 
32,194

    Total
 
$
67,862

 
$
70,193

 
$
124,557

 
$
125,786

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
26,403

 
$
26,403

 
$
26,352

 
$
26,352

Due in one to three years
 
5

 
5

 
5

 
5

Total
 
$
26,408

 
$
26,408

 
$
26,357

 
$
26,357

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


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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: 
 
 
Three months ended March 31
($000)
 
2013

 
2012

Realized gains
 
$
1,564

 
$
212

Realized losses
 
(839
)
 
(298
)
Realized gains (losses), net
 
$
725

 
$
(86
)
 
We determine realized gains and losses using the specific identification method.

The following table shows the net unrealized gains (losses) on trading securities as recorded in our Condensed Consolidated Statements of Income:
 
 
 
Three months ended March 31
($000)
 
2013

 
2012

Unrealized gains, net
 
$
318

 
$
428


The fair value of our assets subject to fair value measurements and that are measured at fair value on a recurring basis using the fair value hierarchy and the necessary disclosures under FASB ASC 820, Fair Value Measurement, are as follows:
 
 
 
Fair Value
 
Fair Value Measurements as of March 31, 2013
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
March 31, 2013
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
17,303

 
$

 
$
17,303

 
$

Corporate bonds
 
30,003

 

 
30,003

 

Foreign obligations
 
2,404

 

 
2,404

 

Equity securities and exchange-traded funds
 
8,130

 
8,130

 

 

Mutual funds
 
12,353

 
12,353

 

 

Trading securities
 
6,835

 
6,835

 

 

Cash equivalents
 
9,285

 
9,285

 

 

Total
 
$
86,313

 
$
36,603

 
$
49,710

 
$

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

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
40,090

 
$

 
$
40,090

 
$

Corporate bonds
 
49,083

 

 
49,083

 

Foreign obligations
 
2,419

 

 
2,419

 

Commercial paper
 
2,000

 

 
2,000

 

Equity securities and exchange-traded funds
 
20,649

 
20,649

 

 

Mutual funds
 
11,545

 
11,545

 

 

Trading securities
 
5,386

 
5,386

 

 

Cash equivalents
 
398

 
398

 

 

Total
 
$
131,570

 
$
37,978

 
$
93,592

 
$

 

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Table of Contents

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

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

We measure the fair value of money market funds, mutual funds, equity securities, and exchange-traded funds based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from observable market data. We did not hold any securities categorized as Level 3 as of March 31, 2013 and December 31, 2012.

8. Investments in Unconsolidated Entities
 
Our investments in unconsolidated entities consist primarily of the following:
 
 
 
As of March 31


As of December 31

($000)
 
2013


2012

Investment in MJKK
 
$
21,152

 
$
20,540

Other equity method investments
 
6,019

 
6,288

Investments accounted for using the cost method
 
8,464

 
8,477

Total investments in unconsolidated entities
 
$
35,635

 
$
35,305

 
Morningstar Japan K.K. Morningstar Japan K.K. (MJKK) develops and markets products and services customized for the Japanese market. MJKK’s shares are traded on the Osaka Stock Exchange “Hercules Market” under the ticker 4765. We account for our investment in MJKK using the equity method. The following table summarizes our ownership percentage in MJKK and the market value of this investment based on MJKK’s publicly quoted share price: 
 
 
As of March 31

 
As of December 31

 
 
2013

 
2012

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

 
 

Japanese yen (¥000)
 
¥
5,054,213

 
¥
3,109,579

Equivalent U.S. dollars ($000)
 
$
53,676

 
$
36,227


Other Equity Method Investments. As of March 31, 2013 and December 31, 2012, other equity method investments consist of our investment in Morningstar Sweden AB (Morningstar Sweden), YCharts, Inc. (YCharts), and Inquiry Financial Europe AB (Inquiry Financial). Morningstar Sweden develops and markets products and services customized for investors in Sweden. Our ownership interest in Morningstar Sweden was approximately 24% as of March 31, 2013 and December 31, 2012. YCharts is a technology company that provides stock research and analysis. Our ownership interest in YCharts was approximately 22% as of March 31, 2013 and December 31, 2012. Inquiry Financial is a provider of sell-side consensus estimate data. Our ownership interest in Inquiry Financial was approximately 34% as of March 31, 2013 and December 31, 2012.

We did not record any impairment losses on our equity method investments in the first three months of 2013 or 2012.
 

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Table of Contents

Cost Method Investments. As of March 31, 2013 and December 31, 2012, our cost method investments consist of minority investments in Pitchbook Data, Inc. (Pitchbook) and HelloWallet LLC (HelloWallet). Pitchbook offers detailed data and information about private equity transactions, investors, companies, limited partners, and service providers. HelloWallet is a provider of personalized financial guidance to employees of Fortune 1000 companies.

We did not record any impairment losses on our cost method investments in the first three months of 2013 or 2012.

9. Stock-Based Compensation
 
Stock-Based Compensation Plans
 
Our shareholders approved the Morningstar 2011 Stock Incentive Plan (the 2011 Plan) on May 17, 2011. As of that date, we stopped granting awards under the Morningstar 2004 Stock Incentive Plan (the 2004 Plan). The 2004 Plan amended and restated the Morningstar 1993 Stock Option Plan, the Morningstar 2000 Stock Option Plan, and the Morningstar 2001 Stock Option Plan.

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

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

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

The following table summarizes the number of shares available for future grants under our 2011 Plan:
 
 
 
As of March 31

(000)
 
2013

Shares available for future grants
 
4,741

 
Accounting for Stock-Based Compensation Awards
 
The following table summarizes our stock-based compensation expense and the related income tax benefit we recorded in the three months ended March 31, 2013 and March 31, 2012:
 
 
 
Three months ended March 31
($000)
 
2013

 
2012

Restricted stock units
 
$
3,563

 
$
3,278

Restricted stock
 
97

 
444

Stock options
 
123

 
144

Total stock-based compensation expense
 
$
3,783

 
$
3,866

 
 
 
 
 
Income tax benefit related to the stock-based compensation expense
 
$
1,030

 
$
930

 

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Table of Contents


The following table summarizes the amount of unrecognized stock-based compensation expense as of March 31, 2013 and the expected number of months over which the expense will be recognized:
 
 
Unrecognized stock-based compensation expense ($000)

 
Expected amortization period (months)
Restricted stock units
 
$
26,014

 
31
Restricted stock
 
808

 
25
Stock options
 
955

 
25
Total unrecognized stock-based compensation expense
 
$
27,777

 
30

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

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

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

 
Vested but
Deferred

 
Total

 
Weighted
Average
Grant Date Value
per RSU

RSUs outstanding—December 31, 2012
 
727,145

 
18,782

 
745,927

 
$
53.37

Granted
 

 

 

 

Dividend equivalents
 

 

 

 

Vested
 
(2,586
)
 

 
(2,586
)
 
35.83

Vested but deferred
 

 

 

 

Issued
 

 

 

 

Forfeited
 
(9,500
)
 

 
(9,500
)
 
53.25

RSUs outstanding—March 31, 2013
 
715,059

 
18,782

 
733,841

 
53.87

 
Restricted Stock
 
In conjunction with our acquisition of Realpoint in May 2010, we issued 199,174 shares of restricted stock to the selling employee-shareholders under the 2004 Stock Incentive Plan. The restricted stock vests ratably over a five-year period from the acquisition date and may be subject to forfeiture if the holder terminates his or her employment during the vesting period.

Because of the terms of the restricted stock agreements prepared in conjunction with the Realpoint acquisition, we account for the grant of restricted stock as stock-based compensation expense and not as part of the acquisition consideration.


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Table of Contents

We measured the fair value of the restricted stock on the date of grant based on the closing market price of our common stock on the day prior to the grant. We amortize the fair value of $9,363,000 to stock-based compensation expense over the vesting period. We have assumed that all of the remaining restricted stock will ultimately vest, and therefore have not incorporated a forfeiture rate for purposes of determining the stock-based compensation expense.
 
Stock Options

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

In May 2011, we granted 86,106 stock options under the 2004 Stock Incentive Plan. In November 2011, we granted 6,095 stock options under the 2011 Plan. We estimated the fair value of the options on the date of grant using a Black-Scholes option-pricing model. The weighted average fair value of options granted during 2011 was $23.81 per share, based on the following assumptions:

Assumptions for Black-Scholes Option Pricing Model
 
 
Expected life (years):
 
7.4

Volatility factor:
 
35.10
%
Dividend yield:
 
0.35
%
Interest rate:
 
2.87
%

The following tables summarize stock option activity in the first three months of 2013 for our various stock option grants. The first table includes activity for options granted at an exercise price below the fair value per share of our common stock on the grant date; the second table includes activity for all other option grants. 
Options Granted At an Exercise Price Below the Fair Value Per Share on the Grant Date
 
Underlying
Shares

 
Weighted
Average
Exercise
Price

Options outstanding—December 31, 2012
 
282,695

 
$
20.55

Granted
 

 

Canceled
 

 

Exercised
 
(21,410
)
 
20.74

Options outstanding—March 31, 2013
 
261,285