MORN_10Q_03.31.2014

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, 2014
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 25, 2014 there were 44,734,223 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, 2014 and 2013
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Equity for the three months ended March 31, 2014
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


Table of Contents

PART 1.
FINANCIAL INFORMATION
Item 1.
Financial Statements

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Table of Contents

Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
 
 
Three months ended March 31
(in thousands except per share amounts)
 
2014

 
2013

 
 
 
 
 
Revenue
 
$
181,165

 
$
168,856

 
 
 
 
 
Operating expense (1):
 
 
 
 
Cost of revenue
 
75,714

 
61,650

Sales and marketing
 
28,428

 
27,980

General and administrative
 
26,104

 
27,327

Depreciation and amortization
 
12,387

 
11,339

Total operating expense
 
142,633

 
128,296

 
 
 
 
 
Operating income
 
38,532

 
40,560

 
 
 
 
 
Non-operating income (expense):
 
 

 
 

Interest income, net
 
585

 
741

Gain (loss) on sale of investments, reclassified from other comprehensive income
 
(24
)
 
725

Other income (expense), net
 
304

 
(521
)
Non-operating income, net
 
865

 
945

 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
39,397

 
41,505

 
 
 
 
 
Equity in net income of unconsolidated entities
 
599

 
497

 
 
 
 
 
Income tax expense
 
13,650

 
12,427

 
 
 
 
 
Consolidated net income
 
26,346

 
29,575

 
 
 
 
 
Net loss attributable to the noncontrolling interest
 
30

 
43

 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
26,376

 
$
29,618

 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 

 
 

Basic
 
$
0.59

 
$
0.64

Diluted
 
$
0.58

 
$
0.63

 
 
 
 
 
Dividends per common share:
 
 
 
 
Dividends declared per common share
 
$
0.17

 
$
0.125

Dividends paid per common share
 
$
0.17

 
$

 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
Basic
 
44,777

 
46,406

Diluted
 
45,093

 
46,814

 
 
 
 
 
 
 
Three months ended March 31
 
 
2014

 
2013

(1) Includes stock-based compensation expense of:
 
 

 
 

Cost of revenue
 
$
1,762

 
$
1,701

Sales and marketing
 
497

 
512

General and administrative
 
1,680

 
1,570

Total stock-based compensation expense
 
$
3,939

 
$
3,783


 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) 
 
2014

 
2013

 
 
 
 
 
Consolidated net income
 
$
26,346

 
$
29,575

 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
Foreign currency translation adjustment
 
2,472

 
(9,071
)
Unrealized gains on securities, net of tax:
 
 
 
 
  Unrealized holding gains arising during period
 
116

 
1,166

  Reclassification of (gains) losses included in net income
 
15

 
(463
)
Other comprehensive income (loss)
 
2,603

 
(8,368
)
 
 
 
 
 
Comprehensive income
 
28,949

 
21,207

Comprehensive loss attributable to noncontrolling interest
 
5

 
142

Comprehensive income attributable to Morningstar, Inc.
 
$
28,954

 
$
21,349


See notes to unaudited condensed consolidated financial statements.



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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
 
 
As of March 31
 
As of December 31
(in thousands except share amounts)
 
2014

 
2013

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
204,633

 
$
168,160

Investments
 
59,340

 
130,407

Accounts receivable, less allowance of $827 and $1,089, respectively
 
131,464

 
114,131

Deferred tax asset, net
 
4,381

 
3,892

Income tax receivable, net
 

 
3,942

Other current assets
 
25,124

 
26,361

Total current assets
 
424,942

 
446,893

Property, equipment, and capitalized software, less accumulated depreciation and amortization of $112,797 and $106,166, respectively
 
107,438

 
104,986

Investments in unconsolidated entities
 
39,176

 
38,714

Goodwill
 
327,936

 
326,450

Intangible assets, net
 
98,947

 
103,909

Other assets
 
8,978

 
9,716

Total assets
 
$
1,007,417

 
$
1,030,668

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
39,790

 
$
42,131

Accrued compensation
 
41,718

 
71,403

Deferred revenue
 
159,591

 
149,225

Other current liabilities
 
6,758

 
6,786

Total current liabilities
 
247,857

 
269,545

Accrued compensation
 
7,495

 
8,193

Deferred tax liability, net
 
21,743

 
23,755

Deferred rent
 
23,541

 
23,938

Other long-term liabilities
 
10,064

 
13,947

Total liabilities
 
310,700

 
339,378

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 44,732,223 and 44,967,423 shares were outstanding as of March 31, 2014 and December 31, 2013, respectively
 
5

 
5

Treasury stock at cost, 7,485,203 shares as of March 31, 2014 and 7,202,896 shares as of December 31, 2013
 
(470,751
)
 
(449,054
)
Additional paid-in capital
 
545,358

 
539,507

Retained earnings
 
613,326

 
594,626

Accumulated other comprehensive income:
 
 
 
 
    Currency translation adjustment
 
7,056

 
4,609

    Unrealized gain on available-for-sale investments
 
695

 
564

Total accumulated other comprehensive income
 
7,751

 
5,173

Total Morningstar, Inc. shareholders’ equity
 
695,689

 
690,257

Noncontrolling interest
 
1,028

 
1,033

Total equity
 
696,717

 
691,290

Total liabilities and equity
 
$
1,007,417

 
$
1,030,668

 See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity
For the three months ended March 31, 2014
 
 
 
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, 2013
 
44,967,423

 
$
5

 
$
(449,054
)
 
$
539,507

 
$
594,626

 
$
5,173

 
$
1,033

 
$
691,290

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 

 

 

 
26,376

 

 
(30
)
 
26,346

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale investments, net of income tax of $54
 
 
 

 

 

 

 
116

 

 
116

Reclassification of adjustments for losses included in net income, net of income tax of $9
 
 
 

 

 

 

 
15

 

 
15

Foreign currency translation adjustment, net
 
 
 

 

 

 

 
2,447

 
25

 
2,472

Other comprehensive loss, net
 
 
 

 

 

 

 
2,578

 
25

 
2,603

Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
47,107

 

 

 
1,271

 

 

 

 
1,271

Stock-based compensation — restricted stock units
 
 
 

 

 
3,692

 

 

 

 
3,692

Stock-based compensation — restricted stock
 
 
 

 

 
97

 

 

 

 
97

Stock-based compensation — performance share awards
 
 
 

 

 
27

 

 

 

 
27

Stock-based compensation — stock-options
 
 
 

 

 
123

 

 

 

 
123

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

 

 
573

 

 

 

 
573

Common shares repurchased
 
(282,307
)
 

 
(21,697
)
 

 

 

 

 
(21,697
)
Dividends declared — common shares outstanding
 
 
 

 

 

 
(7,606
)
 

 

 
(7,606
)
Dividends declared — restricted stock units
 
 
 

 

 
68

 
(70
)
 

 

 
(2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2014
 
44,732,223

 
$
5

 
$
(470,751
)
 
$
545,358

 
$
613,326

 
$
7,751

 
$
1,028

 
$
696,717

 
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)
 
2014

 
2013

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
26,346

 
$
29,575

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
12,387

 
11,339

Deferred income taxes
 
(2,338
)
 
(2,934
)
Stock-based compensation expense
 
3,939

 
3,783

Provision for bad debts
 
(295
)
 
175

Equity in net income of unconsolidated entities
 
(599
)
 
(497
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(573
)
 
(1,587
)
Other, net
 
(243
)
 
(632
)
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable
 
(16,807
)
 
(5,906
)
Other assets
 
(3,301
)
 
(6,575
)
Accounts payable and accrued liabilities
 
4,539

 
400

Accrued compensation
 
(27,378
)
 
(31,812
)
Income taxes—current
 
7,221

 
14,487

Deferred revenue
 
10,151

 
17,769

Deferred rent
 
(506
)
 
(461
)
Other liabilities
 
(659
)
 
(451
)
Cash provided by operating activities
 
11,884

 
26,673

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(1,697
)
 
(3,694
)
Proceeds from maturities and sales of investments
 
73,712

 
61,152

Capital expenditures
 
(20,793
)
 
(9,118
)
Other, net
 
260

 
892

Cash provided by investing activities
 
51,482

 
49,232

 
 
 
 
 
Financing activities
 
 

 
 

Proceeds from stock-option exercises
 
1,278

 
2,088

Employee taxes withheld for restricted stock units
 
(7
)
 
(82
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
573

 
1,587

Common shares repurchased
 
(21,697
)
 
(15,240
)
Dividends paid
 
(7,644
)
 

Other, net
 
(5
)
 
(3
)
Cash used for financing activities
 
(27,502
)
 
(11,650
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
609

 
(3,252
)
Net increase in cash and cash equivalents
 
36,473

 
61,003

Cash and cash equivalents—beginning of period
 
168,160

 
163,889

Cash and cash equivalents—end of period
 
$
204,633

 
$
224,892

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
8,785

 
$
627

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain on available-for-sale investments
 
$
193

 
$
1,102

Equipment obtained under long-term financing arrangement
 
$

 
$
4,860

 
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 are unaudited and should be read in conjunction with our Audited Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 28, 2014.

Certain prior period amounts have been reclassified to conform to our current period's presentation. We now include development expense in the cost of revenue category. We have reclassified development expense to include it in cost of revenue for all periods presented. We previously reported development expense as a separate operating expense category.

Separately, as a result of our recent reorganization (including new positions created, changes in focus for some existing roles, and the refinement of employee cost categorizations as we moved to a more centralized structure), approximately 180 net positions shifted from the general and administrative and sales and marketing categories to cost of revenue. For the first three months of 2014 as compared with the same period in 2013, changes related to our more centralized organizational structure added approximately $7 million of compensation expense to cost of revenue, and reduced the compensation expense in our sales and marketing and general and administrative expense categories by approximately $4 million and $3 million, respectively. These changes did not affect our total operating expense or operating income for any of the periods presented.

The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
FASB: Financial Accounting Standards Board
 
2. Correction

In 2014, we identified and corrected an immaterial classification error related to the current and long-term balance for deferred rent included on our Consolidated Balance Sheets as of December 31, 2013. The correcting entries had the effect of decreasing accounts payable and accrued liabilities by $10.7 million and increasing deferred rent (long-term) by the same amount. The financial statements have been corrected to reduce the current balance and increase the long-term balance as shown in the table below:
 
 
As of December 31, 2013
($000)
 
Previously Reported

 
Correction

 
As Corrected

Accounts payable and accrued liabilities
 
$
52,877

 
$
(10,746
)
 
$
42,131

Deferred rent
 
$
13,192

 
$
10,746

 
$
23,938



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3. Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 2 of our Audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 28, 2014.

In addition, effective January 1, 2014, we adopted FASB ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or an Investment in a Foreign Entity (a consensus of the FASB Emerging Issues Task Force). ASU No. 2013-05 specifies that when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. Additionally, the amendments in this update clarify that the sale of an investment in a foreign entity includes both (1) events that result in the loss of a controlling financial interest in a foreign entity and (2) events that results in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date (sometimes referred to as a step acquisition). The currency translation adjustment should be released into net income upon the occurrence of those events. The adoption of ASU No. 2013-05 did not have a material effect on our consolidated financial statements.

We also adopted FASB ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force), effective January 1, 2014. This update requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (NOL) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. The update does not require new recurring disclosures. The adoption of ASU No. 2013-11 did not have a material effect on our consolidated financial statements.



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4. Goodwill and Other Intangible Assets

Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2013 to March 31, 2014:
 
 
 
($000)

Balance as of December 31, 2013
 
$
326,450

Foreign currency translation
 
1,486

Balance as of March 31, 2014
 
$
327,936


We did not record any impairment losses in the first three months of 2014 or 2013. We perform our annual impairment reviews in the fourth quarter.

Intangible Assets

The following table summarizes our intangible assets: 
 
 
As of March 31, 2014
 
As of December 31, 2013
($000)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
Intellectual property
 
$
29,778

 
$
(23,973
)
 
$
5,805

 
9
 
$
29,477

 
$
(23,128
)
 
$
6,349

 
9
Customer-related assets
 
141,991

 
(77,361
)
 
64,630

 
12
 
141,833

 
(74,311
)
 
67,522

 
12
Supplier relationships
 
240

 
(111
)
 
129

 
20
 
240

 
(108
)
 
132

 
20
Technology-based assets
 
80,870

 
(52,567
)
 
28,303

 
9
 
80,489

 
(50,673
)
 
29,816

 
9
Non-competition agreement
 
1,686

 
(1,606
)
 
80

 
4
 
1,661

 
(1,571
)
 
90

 
4
Total intangible assets
 
$
254,565

 
$
(155,618
)
 
$
98,947

 
10
 
$
253,700

 
$
(149,791
)
 
$
103,909

 
10
 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended March 31
($000)
 
2014

 
2013

Amortization expense
 
$
5,142

 
$
5,625

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

We expect intangible amortization expense for 2014 and subsequent years as follows:
 
 
($000)

2014
 
$
20,547

2015
 
19,719

2016
 
15,145

2017
 
10,577

2018
 
8,574

2019
 
7,386

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

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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)
 
2014

 
2013

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

 
 

Net income attributable to Morningstar, Inc.:
 
$
26,376

 
$
29,618

Less: Distributed earnings available to participating securities
 
(3
)
 
(15
)
Less: Undistributed earnings available to participating securities
 
(7
)
 
(13
)
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,366

 
$
29,590

 
 
 
 
 
Weighted average common shares outstanding
 
44,777

 
46,406

 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.59

 
$
0.64

 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,366

 
$
29,590

Add: Undistributed earnings allocated to participating securities
 
7

 
13

Less: Undistributed earnings reallocated to participating securities
 
(7
)
 
(13
)
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,366

 
$
29,590

 
 


 


Weighted average common shares outstanding
 
44,777

 
46,406

Net effect of dilutive stock options and restricted stock units
 
316

 
408

Weighted average common shares outstanding for computing diluted income per share
 
45,093

 
46,814

 
 


 


Diluted net income per share attributable to Morningstar, Inc.
 
$
0.58

 
$
0.63



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The following table shows the number of weighted average stock options, restricted stock units, performance share awards, 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)
 
2014

 
2013

Weighted average stock options
 

 

Weighted average restricted stock units
 
6

 
9

Weighted average performance share awards
 
9

 

Weighted average restricted stock
 

 

Total
 
15

 
9


These restricted stock units and performance share awards could be included in the calculation in the future.

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

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

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

The accounting policies for our single reportable segment are the same as those described in “Note 2. Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2013. We evaluate the performance of our reporting segment based on revenue and operating income.

Products and Services Information

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

External revenue by product group
 
 
 
 
 
 
Three months ended March 31
($000)
 
2014

 
2013

Investment information
 
$
141,270

 
$
135,085

Investment management
 
39,895

 
33,771

Consolidated revenue
 
$
181,165

 
$
168,856



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Geographical Area Information

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

External revenue by geographical area
 
 
 
 
 
 
Three months ended March 31
($000)
 
2014

 
2013

United States
 
$
129,952

 
$
121,413

 
 
 
 
 
United Kingdom
 
15,338

 
13,153

Continental Europe
 
15,626

 
13,167

Australia
 
8,168

 
9,352

Canada
 
7,667

 
7,736

Asia
 
3,709

 
3,424

Other
 
705

 
611

Total International
 
51,213

 
47,443

 
 
 
 
 
Consolidated revenue
 
$
181,165

 
$
168,856


Long-lived assets by geographical area
 
 
 
 
 
 
As of March 31
 
As of December 31
($000)
 
2014

 
2013

United States
 
$
88,154

 
$
84,321

 
 
 
 
 
United Kingdom
 
6,552

 
6,873

Continental Europe
 
1,666

 
1,873

Australia
 
1,005

 
1,051

Canada
 
1,101

 
1,275

Asia
 
8,854

 
9,479

Other
 
106

 
114

Total International
 
19,284

 
20,665

 
 
 
 
 
Consolidated property, equipment, and capitalized software, net
 
$
107,438

 
$
104,986


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Table of Contents


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)
 
2014

 
2013

Available-for-sale
 
$
22,975

 
$
91,461

Held-to-maturity
 
28,448

 
31,214

Trading securities
 
7,917

 
7,732

Total
 
$
59,340

 
$
130,407



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, 2014
 
As of December 31, 2013
($000)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
5,652

 
$
6

 
$

 
$
5,658

 
$
19,693

 
$
8

 
$
(3
)
 
$
19,698

Corporate bonds
 
5,206

 
5

 

 
5,211

 
49,913

 
22

 
(124
)
 
49,811

Foreign obligations
 

 

 

 

 
505

 

 
(2
)
 
503

Commercial paper
 

 

 

 

 
9,482

 
7

 

 
9,489

Equity securities and exchange-traded funds
 
8,916

 
1,068

 
(123
)
 
9,861

 
8,872

 
1,011

 
(141
)
 
9,742

Mutual funds
 
2,106

 
233

 
(94
)
 
2,245

 
2,095

 
221

 
(98
)
 
2,218

Total
 
$
21,880

 
$
1,312

 
$
(217
)
 
$
22,975

 
$
90,560

 
$
1,269

 
$
(368
)
 
$
91,461

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
28,448

 
$

 
$

 
$
28,448

 
$
31,214

 
$

 
$

 
$
31,214

 
As of March 31, 2014 and December 31, 2013, 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.


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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, 2014 and December 31, 2013. 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, 2014
 
As of December 31, 2013
($000)
 
Cost

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
9,855

 
$
9,864

 
$
45,486

 
$
45,402

Due in one to two years
 
1,003

 
1,005

 
34,107

 
34,099

Equity securities, exchange-traded funds, and mutual funds
 
11,022

 
12,106

 
10,967

 
11,960

    Total
 
$
21,880

 
$
22,975

 
$
90,560

 
$
91,461

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
28,443

 
$
28,443

 
$
31,210

 
$
31,210

Due in one to three years
 
5

 
5

 
4

 
4

Total
 
$
28,448

 
$
28,448

 
$
31,214

 
$
31,214

 
As of March 31, 2014 and December 31, 2013, held-to-maturity investments included a $1,500,000 certificate of deposit held primarily as collateral against bank guarantees for our office leases, primarily in Australia.

The following table shows the realized gains and losses arising from sales of our investments classified as available-for-sale recorded in our Condensed Consolidated Statements of Income: 
 
 
Three months ended March 31
($000)
 
2014

 
2013

Realized gains
 
$
161

 
$
1,564

Realized losses
 
(185
)
 
(839
)
Realized gains (losses), net
 
$
(24
)
 
$
725

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

The following table shows the net unrealized gains on trading securities as recorded in our Condensed Consolidated Statements of Income:
 
 
 
Three months ended March 31
($000)
 
2014

 
2013

Unrealized gains, net
 
$
69

 
$
318



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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, 2014
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
March 31, 2014
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
5,658

 
$

 
$
5,658

 
$

Corporate bonds
 
5,211

 

 
5,211

 

Foreign obligations
 

 

 

 

Commercial paper
 

 

 

 

Equity securities and exchange-traded funds
 
9,861

 
9,861

 

 

Mutual funds
 
2,245

 
2,245

 

 

Trading securities
 
7,917

 
7,917

 

 

Cash equivalents
 
643

 
643

 

 

Total
 
$
31,535

 
$
20,666

 
$
10,869

 
$

 
 
 
Fair Value
 
Fair Value Measurements as of December 31, 2013
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
December 31, 2013
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Government obligations
 
$
19,698

 
$

 
$
19,698

 
$

Corporate bonds
 
49,811

 

 
49,811

 

Foreign obligations
 
503

 

 
503

 

Commercial paper
 
9,489

 

 
9,489

 

Equity securities and exchange-traded funds
 
9,742

 
9,742

 

 

Mutual funds
 
2,218

 
2,218

 

 

Trading securities
 
7,732

 
7,732

 

 

Cash equivalents
 
925

 
925

 

 

Total
 
$
100,118

 
$
20,617

 
$
79,501

 
$

 
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, 2014 and December 31, 2013.



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Table of Contents

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


As of December 31

($000)
 
2014


2013

Investment in MJKK
 
$
22,543

 
$
21,782

Other equity method investments
 
6,008

 
6,166

Investments accounted for using the cost method
 
10,625

 
10,766

Total investments in unconsolidated entities
 
$
39,176

 
$
38,714

 
Morningstar Japan K.K. Morningstar Japan K.K. (MJKK) develops and markets products and services customized for the Japanese market. MJKK’s shares are traded on the Tokyo Stock Exchange under the ticker 47650. We account for our investment in MJKK using the equity method. The following table summarizes our ownership percentage in MJKK and the market value of this investment based on MJKK’s publicly quoted share price: 
 
 
As of March 31

 
As of December 31

 
 
2014

 
2013

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

 
 

Japanese yen (¥000)
 
¥
8,833,406

 
¥
9,824,068

Equivalent U.S. dollars ($000)
 
$
85,949

 
$
94,999


Other Equity Method Investments. As of March 31, 2014 and December 31, 2013, other equity method investments consist of our investment in Inquiry Financial Europe AB (Inquiry Financial) and YCharts, Inc. (YCharts). Inquiry Financial is a provider of sell-side consensus estimate data. Our ownership interest in Inquiry Financial was approximately 34% as of March 31, 2014 and December 31, 2013. YCharts is a technology company that provides stock research and analysis. Our ownership interest in YCharts was approximately 22% as of March 31, 2014 and December 31, 2013.

We did not record any impairment losses on our equity method investments in the first three months of 2014 or 2013.
 
Cost Method Investments. As of March 31, 2014 and December 31, 2013, our cost method investments consist of minority investments in HelloWallet LLC (HelloWallet) and Pitchbook Data, Inc. (Pitchbook). HelloWallet is a provider of personalized financial guidance to employees of Fortune 1000 companies. Pitchbook offers detailed data and information about private equity transactions, investors, companies, limited partners, and service providers.

We did not record any impairment losses on our cost method investments in the first three months of 2014 or 2013.

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, performance share awards, 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.

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Table of Contents


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

(in thousands)
 
2014

Shares available for future grants
 
4,483

 
Accounting for Stock-Based Compensation Awards
 
The following table summarizes our stock-based compensation expense and the related income tax benefit we recorded:
 
 
Three months ended March 31
($000)
 
2014

 
2013

Restricted stock units
 
$
3,692

 
$
3,563

Restricted stock
 
97

 
97

Performance share awards
 
27

 

Stock options
 
123

 
123

Total stock-based compensation expense
 
$
3,939

 
$
3,783

 
 
 
 
 
Income tax benefit related to the stock-based compensation expense
 
$
1,079

 
$
1,030

 
The following table summarizes the amount of unrecognized stock-based compensation expense as of March 31, 2014 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
 
$
27,487

 
31
Restricted stock
 
420

 
13
Performance share awards
 
1,890

 
33
Stock options
 
462

 
14
Total unrecognized stock-based compensation expense
 
$
30,259

 
31

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


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Table of Contents

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 the 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 2014:
Restricted Stock Units (RSUs)
 
Unvested

 
Vested but
Deferred

 
Total

 
Weighted
Average
Grant Date Value
per RSU

RSUs outstanding—December 31, 2013
 
680,002

 
16,682

 
696,684

 
$
62.02

Granted
 

 

 

 

Dividend equivalents
 
885

 
37

 
922

 
57.49

Vested
 
(256
)
 

 
(256
)
 
53.31

Vested but deferred
 

 

 

 

Issued
 

 

 

 

Forfeited
 
(6,893
)
 

 
(6,893
)
 
61.66

RSUs outstanding—March 31, 2014
 
673,738

 
16,719

 
690,457

 
$
62.04

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

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

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

In 2014, executive officers were granted performance share awards pursuant to which each executive becomes entitled to a number of shares of Morningstar common stock equal to the number of notional performance shares that become vested. Each award specifies a number of performance shares that will vest if pre-established target performance goals are attained. The number of performance shares that actually vest may be more or less than the specified number of performance shares to the extent Morningstar exceeds or fails to achieve, respectively, the target performance goals over a three-year performance period.

The performance conditions are not considered in the determination of the grant date fair value for these awards. We measure the fair value of our performance share awards on the date of grant based on the closing market price of the underlying common stock on the day prior to the grant date. We amortize that value to stock-based compensation expense, based on the satisfaction of the performance condition that is most likely to be satisfied over the three-year service period ratably over the vesting period.


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Table of Contents

Information as of March 31, 2014 regarding the Company's target performance share awards granted and shares that would be issued at current performance levels for performance share awards granted during the first three months of 2014 is as follows:
 
 
As of March 31, 2014

Target performance share awards granted
 
23,685

Fair value (1)
 
$
80.91

Number of shares that would be issued based on current performance levels
 
23,685

Unamortized expense, based on current performance levels
 
$
1,890,000


(1) Represents the closing market price of Morningstar's stock on March 14, 2014, which is the last closing price prior to the grant date.

Stock Options

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

The following tables summarize stock option activity in the first three months of 2014 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, 2013
 
179,559

 
$
21.47

Granted
 

 

Canceled
 

 

Exercised
 
(11,731
)
 
21.46

Options outstanding—March 31, 2014
 
167,828

 
21.68

 
 
 
 
 
Options exercisable—March 31, 2014
 
167,828

 
$
21.68

 
All Other Option Grants, Excluding Activity Shown Above
 
Underlying
Shares

 
Weighted
Average
Exercise
Price

Options outstanding—December 31, 2013
 
253,972

 
$
36.48

Granted
 

 

Canceled
 

 

Exercised
 
(35,213
)
 
29.22

Options outstanding—March 31, 2014
 
218,759

 
37.85

 
 
 
 
 
Options exercisable—March 31, 2014
 
184,236

 
$
34.18

 

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Table of Contents

The following table summarizes the total intrinsic value (difference between the market value of our stock on the date of exercise and the exercise price of the option) of options exercised:
 
 
 
Three months ended March 31
($000)
 
2014

 
2013

Intrinsic value of options exercised
 
$
2,526

 
$
5,588

 

The table below shows additional information for options outstanding and exercisable as of March 31, 2014:
 
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number of  Options

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

 
Aggregate
Intrinsic
Value
($000)

 
Exercisable Shares

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

 
Aggregate Intrinsic Value ($000)

$21.61 - $26.68
 
303,106

 
0.87
 
$
23.91

 
$
16,704

 
303,106

 
0.87
 
$
23.91

 
$
16,704

$39.31 - $49.38
 
11,806

 
1.61
 
46.86

 
380

 
11,806

 
1.61
 
46.86

 
380

$57.28 - $59.35
 
71,675

 
7.27
 
57.46

 
1,545

 
37,152

 
7.27
 
57.45

 
741

$21.61 - $59.35
 
386,587

 
2.08
 
$
30.83

 
$
18,629

 
352,064

 
1.57
 
$
28.22

 
$
17,825

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested or Expected to Vest
 
 
 
 
 
 
 
 
 
 
 
 
 
$21.61 - $59.35
 
386,587

 
2.08
 
$
30.83

 
$
18,629

 
 
 
 
 
 
 
 
 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value all option holders would have rece