Edgar Filing: Morningstar, Inc.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

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

	FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010

	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 July 31, 2010, there were 49,560,398 shares of the Company’s common stock, no par value, outstanding.

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MORNINGSTAR, INC. AND SUBSIDIARIES

INDEX

PART 1	FINANCIAL INFORMATION

Item 1.	Unaudited Condensed Consolidated Financial Statements

	Unaudited Condensed Consolidated Statements of Income for the three and six months ended June 30, 2010 and 2009

	Unaudited Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

	Unaudited Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) for the six months ended June 30, 2010

	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009

	Notes to Unaudited Condensed Consolidated Financial Statements

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

Item 3.	Quantitative and Qualitative Disclosure about Market Risk

Item 4.	Controls and Procedures

PART 2	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

Item 6.	Exhibits

SIGNATURE

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PART 1. FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Three months ended June 30						Six months ended June 30
(in thousands except per share amounts)	2010			2009			2010			2009

Revenue	$	136,091		$	119,533		$	264,381		$	236,265

Operating expense (1):
Cost of goods sold	39,738			30,694			74,054			60,946
Development	11,899			9,438			22,788			18,738
Sales and marketing	24,435			18,010			46,996			35,546
General and administrative	23,106			19,853			43,749			37,006
Depreciation and amortization	9,246			8,850			18,185			16,716
Total operating expense	108,424			86,845			205,772			168,952

Operating income	27,667			32,688			58,609			67,313

Non-operating income (expense):
Interest income, net	593			764			1,180			1,742
Other income (expense), net	(572		)	1,208			(1,338		)	764
Non-operating income (expense), net	21			1,972			(158		)	2,506

Income before income taxes and equity in net income (loss) of unconsolidated entities	27,688			34,660			58,451			69,819

Income tax expense	10,225			14,024			21,220			24,692

Equity in net income (loss) of unconsolidated entities	454			(21		)	843			361

Consolidated net income	17,917			20,615			38,074			45,488

Net (income) loss attributable to noncontrolling interests	85			(71		)	116			18

Net income attributable to Morningstar, Inc.	$	18,002		$	20,544		$	38,190		$	45,506

Net income per share attributable to Morningstar, Inc.:
Basic	$	0.37		$	0.43		$	0.78		$	0.95
Diluted	$	0.36		$	0.41		$	0.76		$	0.92

Weighted average shares outstanding:
Basic	49,234			47,941			49,032			47,661
Diluted	50,533			49,631			50,426			49,385

	Three months ended June 30				Six months ended June 30
	2010		2009		2010		2009
(1) Includes stock-based compensation expense of:
Cost of goods sold	$	907	$	715	$	1,622	$	1,264
Development	449		413		842		767
Sales and marketing	486		422		889		778
General and administrative	1,813		1,518		3,239		2,984
Total stock-based compensation expense	$	3,655	$	3,068	$	6,592	$	5,793

See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets

(in thousands except share amounts)	June 30 2010			December 31 2009
Assets
Current assets:
Cash and cash equivalents	$	154,377		$	130,496
Investments	165,973			212,057
Accounts receivable, less allowance of $766 and $1,339, respectively	90,127			82,330
Deferred tax asset, net	1,464			1,109
Income tax receivable, net	13,114			5,541
Other	12,550			12,564
Total current assets	437,605			444,097
Property, equipment, and capitalized software, net	56,453			59,828
Investments in unconsolidated entities	24,099			24,079
Goodwill	281,813			249,992
Intangible assets, net	156,825			135,488
Other assets	5,731			6,099
Total assets	$	962,526		$	919,583

Liabilities and equity
Current liabilities:
Accounts payable and accrued liabilities	$	33,845		$	29,901
Accrued compensation	37,744			48,902
Deferred revenue	140,802			127,114
Other	950			962
Total current liabilities	213,341			206,879
Accrued compensation	4,752			4,739
Deferred tax liability, net	3,418			4,678
Other long-term liabilities	24,949			26,413
Total liabilities	246,460			242,709

Equity:
Morningstar, Inc. shareholders’ equity:
Common stock, no par value, 200,000,000 shares authorized, of which 49,558,248 and 48,768,541 shares were outstanding as of June 30, 2010 and December 31, 2009, respectively	5			5
Treasury stock at cost, 208,899 shares as of June 30, 2010 and 222,653 as of December 31, 2009	(2,936		)	(3,130		)
Additional paid-in capital	446,305			432,052
Retained earnings	284,935			246,745
Accumulated other comprehensive income (loss):
Currency translation adjustment	(12,992		)	(337		)
Unrealized gain (loss) on available-for-sale securities	(217		)	370
Total accumulated other comprehensive income (loss)	(13,209		)	33
Total Morningstar, Inc. shareholders’ equity	715,100			675,705
Noncontrolling interest	966			1,169
Total equity	716,066			676,874
Total liabilities and equity	$	962,526		$	919,583

See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statement of Equity and Comprehensive Income (Loss)

For the Six Months Ended June 30, 2010

	Morningstar, Inc. Shareholders’ Equity
											Accumulated
											Other
	Common Stock						Additional				Comprehensive			Non
	Shares	Par		Treasury			Paid-in		Retained		Income			Controlling			Total
(in thousands, except share amounts)	Outstanding	Value		Stock			Capital		Earnings		(Loss)			Interests			Equity

Balance as of December 31, 2009	48,768,541	$	5	$	(3,130	)	$	432,052	$	246,745	$	33		$	1,169		$	676,874

Comprehensive income (loss):

Net income (loss)		—		—			—		38,190		—			(116		)	38,074
Unrealized loss on available-for-sale investments, net of income tax of $353		—		—			—		—		(588		)	—			(588		)
Foreign currency translation adjustment, net		—		—			—		—		(12,654		)	(87		)	(12,741		)
Total comprehensive income (loss)		—		—			—		38,190		(13,242		)	(203		)	24,745
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net	590,533	—		194			3,456		—		—			—			3,650

Stock-based compensation - restricted stock units		—		—			6,280		—		—			—			6,280

Stock-based compensation - restricted stock	199,174	—		—			312		—		—			—			312
Excess tax benefit derived from stock option exercises and vesting of restricted stock units		—		—			4,205		—		—			—			4,205

Balance as of June 30, 2010	49,558,248	$	5	$	(2,936	)	$	446,305	$	284,935	$	(13,209	)	$	966		$	716,066

See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

	Six months ended June 30
(in thousands)	2010			2009

Operating activities
Consolidated net income	$	38,074		$	45,488
Adjustments to reconcile consolidated net income to net cash flows from operating activities:
Depreciation and amortization	18,185			16,716
Deferred income tax benefit	(1,012		)	(956		)
Stock-based compensation expense	6,592			5,793
Provision for bad debt	356			187
Equity in net income of unconsolidated entities	(843		)	(361		)
Excess tax benefits from stock option exercises and vesting of restricted stock units	(4,205		)	(4,544		)
Other, net	1,386			(752		)
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable	(6,615		)	9,312
Other assets	(511		)	341
Accounts payable and accrued liabilities	2,859			(6,012		)
Accrued compensation	(11,154		)	(45,431		)
Income taxes payable	(4,255		)	10,396
Deferred revenue	7,177			806
Deferred rent	(80		)	(286		)
Other liabilities	(924		)	570
Cash provided by operating activities	45,030			31,267

Investing activities
Purchases of investments	(85,528		)	(50,273		)
Proceeds from maturities and sales of investments	130,381			38,128
Capital expenditures	(3,839		)	(6,768		)
Acquisitions, net of cash acquired	(67,455		)	(18,571		)
Other, net	889			629
Cash used for investing activities	(25,552		)	(36,855		)

Financing activities
Proceeds from stock option exercises	3,650			11,653
Excess tax benefits from stock option exercises and vesting of restricted stock units	4,205			4,544
Other, net	205			(178		)
Cash provided by financing activities	8,060			16,019

Effect of exchange rate changes on cash and cash equivalents	(3,657		)	2,777
Net increase in cash and cash equivalents	23,881			13,208
Cash and cash equivalents—beginning of period	130,496			173,891
Cash and cash equivalents—end of period	$	154,377		$	187,099

Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	26,396		$	14,152
Supplemental information of non-cash investing and financing activities:
Unrealized loss on available-for-sale investments	$	(941	)	$	(75	)

See notes to unaudited condensed consolidated financial statements.

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MORNINGSTAR, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation of Interim Financial Information

The accompanying condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the Company) have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. In the opinion of management, the statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly our financial position, results of operations, equity, and cash flows. These financial statements and notes should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 1, 2010.

The acronyms that appear in the Notes to our Condensed Consolidated Financial Statements refer to the following:

ASC: Accounting Standards Codification

ASU: Accounting Standards Update

EITF: Emerging Issues Task Force

FASB: Financial Accounting Standards Board

SEC: Securities and Exchange Commission

2. Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 2 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the SEC on March 1, 2010. In addition, effective January 1, 2010, we adopted the following financial accounting standards:

· ASU No. 2009-16, Transfers and Servicing (Topic 860) and Accounting for Transfers of Financial Assets and ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.

These accounting pronouncements change the way entities account for transfers of financial assets and determine what entities must be consolidated. The most significant amendment resulting from FASB ASU No. 2009-16 consists of the removal of the concept of a Qualifying Special-Purpose Entity (QSPE) from FASB ASC 860, Transfers and Services. ASU No. 2009-17 addresses the effects of eliminating the QSPE concept from ASC 860 and responds to concerns about the application of certain key provisions of FASB ASC 810, Consolidation, including concerns over the transparency of enterprises’ involvement with Variable Interest Entities (VIEs). These accounting pronouncements did not impact our Condensed Consolidated Financial Statements.

· ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements.

ASU No. 2010-06 requires additional disclosures regarding fair value measurements. The amended guidance requires entities to disclose additional information regarding assets and liabilities that are transferred between levels of the fair value hierarchy. ASU 2010-06 also clarifies existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the disclosure requirements regarding the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The additional disclosures required by ASU No. 2010-06 appear in Note 6, in the Notes to our Condensed Consolidated Financial Statements.

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3. Acquisitions, Goodwill, and Other Intangible Assets

2010 Acquisitions

In the first six months of 2010, we completed four acquisitions, as follows:

Aegis Equities Research

In April 2010, we acquired Aegis Equities Research, a leading provider of independent equity research in Sydney, Australia, for $10,717,000 in cash, net of cash acquired. The following table summarizes our preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

	($000)
Cash and cash equivalents	$	51
Investments	55
Accounts receivable	229
Other non-current assets	62
Intangible assets	5,100
Goodwill	6,135
Deferred revenue	(617		)
Other current and non-current liabilities	(247		)

Total purchase price	$	10,768

The preliminary allocation includes $5,100,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases. Goodwill of $6,135,000 represents the premium we paid over the fair value of the net tangible and intangible assets acquired with this acquisition. We paid this premium for a number of reasons, including the strategic benefits of creating a larger analyst team that will enable us to broaden and deepen our coverage of Australian listed companies, providing Australian clients with more robust independent research, and giving us the potential to expand our services in multiple delivery channels. We are in the process of determining what portion of the value assigned to goodwill and intangible assets, if any, is deductible for income tax purposes.

Old Broad Street Research Ltd

In April 2010, we acquired Old Broad Street Research Ltd. (OBSR) for $16,651,000 in cash, net of cash acquired. OBSR is a premier provider of fund research, ratings, and investment consulting services in the United Kingdom, and offers an array of customized consulting services including model portfolios, advice on fund construction, and corporate governance services, that are used by many of the leading financial advisers and fund platforms.

The following table summarizes our preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The purchase price allocation is preliminary pending certain tax related matters, including the valuation of deferred tax assets and liabilities at the date of acquisition.

	($000)
Cash and cash equivalents	$	4,632
Accounts receivable and other current assets	962
Other non-current assets	449
Intangible assets	8,473
Goodwill	9,337
Deferred revenue	(1,075		)
Accounts payable and accrued and other current liabilities	(1,342		)
Other liabilities — non-current	(153		)
Total purchase price	$	21,283

The preliminary allocation includes $8,473,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases.

Goodwill of $9,337,000 represents the premium we paid over the fair value of the acquired net tangible and intangible assets. We paid this premium for a number of reasons, including the strategic benefit of adding to our existing fund research team in London, and continuing to build our thought leadership in investment research. OBSR will also help us expand our investment consulting presence in the United Kingdom, where we already provide asset allocation, manager selection, and portfolio construction services to institutions and intermediaries. The goodwill we recorded is not considered deductible for income tax purposes.

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Realpoint, LLC

In May 2010, we acquired Realpoint, LLC (Realpoint) a Nationally Recognized Statistical Ratings Organization (NRSRO) that specializes in structured finance. Realpoint offers securities ratings, research, surveillance services, and data to help institutional investors identify credit risk in commercial mortgage-backed securities. Institutional investment firms subscribe to Realpoint’s ratings and analytics, including money managers who invest in commercial mortgage-backed securities.

In conjunction with this acquisition, we paid $38,385,000 in cash, net of cash acquired, and issued 199,174 shares of restricted stock to the selling employee-shareholders. As a result of the terms of the restricted share agreements, in accordance with FASB ASC 805, Business Combinations, we account for these grants as stock-based compensation expense, and not as part of the acquisition consideration. See Note 9 in the Notes to our Condensed Consolidated Financial Statements for additional information concerning the accounting for this restricted stock.

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

	($000)
Cash and cash equivalents	$	5,393
Accounts receivable and other current assets	2,647
Other non-current assets	319
Intangible assets	19,959
Goodwill	24,132
Deferred revenue	(7,316		)
Accounts payable and accrued and other current liabilities	(1,356		)
Total purchase price	$	43,778

The preliminary allocation includes $19,959,000 of acquired intangible assets. These assets primarily include customer-related assets and technology-based assets, including software and databases.

Goodwill of $24,132,000 represents the premium we paid over the fair value of the acquired net tangible and intangible assets. We paid this premium for a number of reasons, including the opportunity for Morningstar to enter into the structured finance ratings and analysis business.

The value assigned to goodwill, intangible assets, and restricted shares at the date of grant are deductible for income tax purposes over a period of approximately 15 years from the acquisition date.

Footnoted business of Financial Fineprint Inc.

In February 2010, we acquired the Footnoted business of Financial Fineprint Inc. (Footnoted), a blog for professional money managers, analysts, and individual investors. Footnoted Pro, a service for institutional investors, provides insight on actionable items and trends in SEC filings. The acquisition includes the Footnoted.org website and the Footnoted Pro service. Terms were not disclosed. The acquisition did not have a significant impact on our Condensed Consolidated Financial Statements for the six months ended June 30, 2010.

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2009 Acquisitions

The table below summarizes the six acquisitions we completed in 2009:

Acquisition	Description	Date Acquired	Purchase Price*
Global financial filings database business of Global Reports LLC	A leading provider of online financial and Corporate and Social Responsibility reports for publicly traded companies around the world	April 20, 2009	Not separately Disclosed
Equity research and data business of C.P.M.S. Computerized Portfolio Management Services Inc.	C.P.M.S. tracks fundamental equity data for approximately 4,000 securities in the United States and Canada as well as tracks and provides earnings estimates for Canadian stocks	May 1, 2009	$13.9 million
Andex Associates, Inc.	Andex is known for Andex Charts, which illustrate historical market returns, stock index growth, inflation rates, currency rates, and general economic conditions for the United States dating back to 1926, and for Canada dating back to 1950	May 1, 2009	Not separately disclosed
Intech Pty Ltd	A leading provider of multimanager and investment portfolio solutions in Sydney, Australia, Intech also manages a range of single sector, alternative strategy, and diversified investment portfolios, has one of the leading separately managed account databases in Australia, and offers the Intech Desktop Consultant, a research software product for institutions	June 30, 2009	Not separately disclosed
Canadian Investment Awards and Gala	Canada’s marquee investment awards program, recognizing excellence in products and firms within the financial services industry	December 17, 2009	Not separately disclosed
Logical Information Machines, Inc. (LIM)	A leading provider of data and analytics for the energy, financial, and agriculture sectors	December 31, 2009	$53.5 million

* Total purchase price less cash acquired, subject to post-closing adjustments.

As of June 30, 2010, we did not make any significant changes to the purchase price allocations for the acquisitions that occurred in 2009. Certain of these purchase price allocations, primarily the purchase price allocation related to Logical Information Machines, Inc. are preliminary, pending resolution of certain tax and other matters. Additional information concerning the six acquisitions completed in 2009 can be found in the Notes to our Consolidated Financial Statements included in our Annual Report on Form 10-K filed with the SEC on March 1, 2010.

Pro Forma Information for 2010 and 2009 Acquisitions

The following unaudited pro forma information presents a summary of our Condensed Consolidated Statements of Income for the six months ended June 30, 2010 and 2009 as if we had completed the 2010 and 2009 acquisitions and had consolidated Morningstar Korea, as of January 1 of each of these years. In calculating the pro forma information below, we included an estimate of amortization expense related to the intangible assets acquired.

	Six months ended June 30
Unaudited Pro Forma Financial Information (in thousands except per share amounts)	2010		2009
Revenue	$	271,736	$	262,848
Operating income	$	58,110	$	67,228
Net income attributable to Morningstar, Inc.	$	37,840	$	45,435

Basic net income per share attributable to Morningstar, Inc.	$	0.77	$	0.95
Diluted net income per share attributable to Morningstar, Inc.	$	0.75	$	0.92

Goodwill

The following table shows the changes in our goodwill balances from December 31, 2009 to June 30, 2010:

	($000)
Balance as of December 31, 2009	$	249,992
Acquisition of Aegis	6,135
Acquisition of OBSR	9,337
Acquisition of Realpoint	24,132
Other, primarily currency translation	(7,783		)
Balance as of June 30, 2010	$	281,813

We did not record any impairment losses in the second quarter or year-to-date periods ended June 30, 2010 and June 30, 2009, respectively.

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The following table summarizes our intangible assets:

	As of June 30, 2010								As of December 31, 2009
($000)	Gross		Accumulated Amortization			Net		Weighted Average Useful Life (years)	Gross		Accumulated Amortization			Net		Weighted Average Useful Life (years)
Intellectual property	$	29,093	$	(13,502	)	$	15,591	10	$	28,472	$	(12,147	)	$	16,325	10
Customer-related assets	102,184		(32,535		)	69,649		11	87,635		(27,405		)	60,230		10
Supplier relationships	240		(66		)	174		20	240		(60		)	180		20
Technology-based assets	57,605		(20,092		)	37,513		9	49,276		(16,694		)	32,582		9
Non-competition agreement	848		(632		)	216		5	820		(547		)	273		5
Intangible assets related to acquisitions with preliminary purchase price allocations	34,501		(819		)	33,682		10	26,129		(231		)	25,898		5
Total intangible assets	$	224,471	$	(67,646	)	$	156,825	10	$	192,572	$	(57,084	)	$	135,488	9

The following table summarizes our amortization expense related to intangible assets:

	Three months ended June 30				Six months ended June 30
($000)	2010		2009		2010		2009
Amortization expense	$	5,848	$	5,541	$	11,316	$	10,663

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

Based on acquisitions completed through June 30, 2010, we expect intangible amortization expense for 2010 and subsequent years as follows:

	($000)
2010	$	23,071
2011	22,477
2012	21,257
2013	19,349
2014	18,438
2015	17,640

Our estimates of future amortization expense for intangible assets may be affected by changes to the preliminary purchase price allocations, additional acquisitions, and currency translations.

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4. Income Per Share

The numerator for both basic and diluted income per share is net income attributable to Morningstar, Inc.

The denominator for basic income per share is the weighted average number of common shares outstanding during the period, exclusive of the restricted stock issued in connection with the Realpoint acquisition. In accordance with FASB ASC 260, Earnings Per Share, outstanding common shares that are contingently returnable until the shares are vested should be excluded from the denominator in computing basic EPS even if they have been issued.

For diluted income per share, we reflect the dilutive effect of outstanding employee stock options, restricted stock units, and restricted stock issued in connection with the Realpoint acquisition, in the denominator using the treasury stock method.

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

	Three Months Ended June 30				Six Months Ended June 30
(in thousands, except per share amounts)	2010		2009		2010		2009

Basic net income per share attributable to Morningstar, Inc.:
Net income attributable to Morningstar, Inc.	$	18,002	$	20,544	$	38,190	$	45,506
Weighted average common shares outstanding	49,234		47,941		49,032		47,661
Basic net income per share attributable to Morningstar, Inc.	$	0.37	$	0.43	$	0.78	$	0.95

Diluted net income per share attributable to Morningstar, Inc.:
Net income attributable to Morningstar, Inc.	$	18,002	$	20,544	$	38,190	$	45,506

Weighted average common shares outstanding	49,234		47,941		49,032		47,661
Net effect of dilutive stock options, restricted stock units, and restricted stock	1,299		1,690		1,394		1,724
Weighted average common shares outstanding for computing diluted income per share	50,533		49,631		50,426		49,385

Diluted net income per share attributable to Morningstar, Inc.	$	0.36	$	0.41	$	0.76	$	0.92

5. Segment and Geographical Area Information

Morningstar has two operating segments:

· Investment Information. The Investment Information segment includes all of our data, software, and research products and services. These products are typically sold through subscriptions or license agreements.

The largest products in this segment based on revenue are Licensed Data, Morningstar Advisor Workstation, Morningstar.com, Morningstar Direct, and Morningstar Principia. Licensed Data is a set of investment data spanning all of our investment databases, including real-time pricing data, and available through electronic data feeds. Advisor Workstation is a web-based investment planning system for advisors. Advisor Workstation is available in two editions: Morningstar Office for independent financial advisors and an enterprise edition for financial advisors affiliated with larger firms. Morningstar.com includes both Premium Memberships and Internet advertising sales. Morningstar Direct is a web-based institutional research platform. Principia is our CD-ROM-based investment research and planning software for advisors.

The Investment Information segment also includes Morningstar Equity Research, which we distribute through several channels. From June 2004 through July 2009, our equity research was distributed through six major investment banks to meet the requirements for independent research under the Global Analyst Research Settlement. The period covered by the Global Analyst Research Settlement expired at the end of July 2009. The investment banks covered by it are no longer required to provide independent research to their clients. We also sell Equity Research to other companies that purchase our research for their own use or provide our research to their affiliated advisors or individual investor clients.

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· Investment Management. The Investment Management segment includes all of our asset management operations, which earn the majority of their revenue from asset-based fees.

The key products and services in this segment based on revenue are Investment Consulting, which focuses on investment monitoring and asset allocation for funds of funds, including mutual funds and variable annuities; Retirement Advice, 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, risk levels, and investment strategies that financial advisors can use for their clients’ taxable and tax-deferred accounts.

Our segment accounting policies are the same as those described in Note 2 to our Consolidated Financial Statements included in our Annual Report on Form 10-K as of December 31, 2009, 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 to arrive at the consolidated financial information. 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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The following tables show selected segment data for the three and six months ended June 30, 2010 and 2009:

	Three months ended June 30, 2010
($000)	Investment Information		Investment Management		Corporate Items			Total
External revenue	$	109,021	$	27,070	$	—		$	136,091
Operating expense, excluding stock-based compensation expense, depreciation, and amortization	74,785		12,166		8,572			95,523
Stock-based compensation expense	2,112		539		1,004			3,655
Depreciation and amortization	1,582		44		7,620			9,246
Operating income (loss)	$	30,542	$	14,321	$	(17,196	)	$	27,667

Capital expenditures	$	1,964	$	20	$	205		$	2,189

U.S. revenue								$	98,986
Non-U.S. revenue								$	37,105

	Three months ended June 30, 2009
($000)	Investment Information		Investment Management		Corporate Items			Total
External revenue	$	97,739	$	21,794	$	—		$	119,533
Operating expense, excluding stock-based compensation expense, depreciation, and amortization	57,770		8,126		9,031			74,927
Stock-based compensation expense	1,526		517		1,025			3,068
Depreciation and amortization	1,201		89		7,560			8,850
Operating income (loss)	$	37,242	$	13,062	$	(17,616	)	$	32,688

Capital expenditures	$	1,713	$	148	$	317		$	2,178

U.S. revenue								$	89,286
Non-U.S. revenue								$	30,247

	Six months ended June 30, 2010
($000)	Investment Information		Investment Management		Corporate Items			Total
External revenue	$	212,545	$	51,836	$	—		$	264,381
Operating expense, excluding stock-based compensation expense, depreciation, and amortization	142,430		23,098		15,467			180,995
Stock-based compensation expense	3,600		1,032		1,960			6,592
Depreciation and amortization	3,227		92		14,866			18,185
Operating income (loss)	$	63,288	$	27,614	$	(32,293	)	$	58,609

Capital expenditures	$	2,994	$	34	$	811		$	3,839

U.S. revenue								$	191,596
Non-U.S. revenue								$	72,785

	Six months ended June 30, 2009
($000)	Investment Information		Investment Management		Corporate Items			Total
External revenue	$	193,979	$	42,286	$	—		$	236,265
Operating expense, excluding stock-based compensation expense, depreciation, and amortization	114,835		16,303		15,305			146,443
Stock-based compensation expense	2,793		985		2,015			5,793
Depreciation and amortization	2,272		109		14,335			16,716
Operating income (loss)	$	74,079	$	24,889	$	(31,655	)	$	67,313

Capital expenditures	$	5,473	$	332	$	963		$	6,768

U.S. revenue								$	177,434
Non-U.S. revenue								$	58,831

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	As of June 30, 2010
	Investment Information		Investment Management		Corporate Items		Total
Goodwill	$	244,818	$	36,995	$	—	$	281,813

U.S. long-lived assets							$	40,573
Non-U.S. long-lived assets							$	15,880

	As of December 31, 2009
	Investment Information		Investment Management		Corporate Items		Total
Goodwill	$	217,758	$	32,234	$	—	$	249,992

U.S. long-lived assets							$	42,884
Non-U.S. long-lived assets							$	16,944

6. Investments and Fair Value Measurements

We account for our investments in accordance with FASB ASC 320, Investments—Debt and Equity Securities. We classify our investments in three categories: available-for-sale, held-to-maturity, and trading. We monitor the concentration, diversification, maturity, and liquidity of our investment portfolio, which is primarily invested in fixed-income securities, and classify our investment portfolio as shown below:

($000)	As of June 30 2010		As of December 31 2009
Available-for-sale	$	153,963	$	197,306
Held-to-maturity	8,182		10,588
Trading securities	3,828		4,163
Total	$	165,973	$	212,057

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 June 30, 2010									As of December 31, 2009
($000)	Cost		Unrealized Gain		Unrealized Loss			Fair Value		Cost		Unrealized Gain		Unrealized Loss			Fair Value
Available-for-sale:
Government obligations	$	118,235	$	150	$	(28	)	$	118,357	$	174,433	$	439	$	(50	)	$	174,822
Corporate bonds	24,879		27		(69		)	24,837		12,268		44		(1		)	12,311
Equity securities	3,343		186		(430		)	3,099		2,013		188		(28		)	2,173
Mutual funds	8,000		—		(330		)	7,670		8,000		—		—			8,000
Total	$	154,457	$	363	$	(857	)	$	153,963	$	196,714	$	671	$	(79	)	$	197,306

Held-to-maturity:
Certificates of deposit	$	8,182	$	—	$	—		$	8,182	$	10,588	$	—	$	—		$	10,588

As of June 30, 2010 and December 31, 2009, 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 June 30, 2010 and December 31, 2009. 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 June 30, 2010				As of December 31, 2009
($000)	Cost		Fair Value		Cost		Fair Value
Available-for-sale:
Due in one year or less	$	122,134	$	122,209	$	161,453	$	161,817
Due in one to three years	20,980		20,985		25,248		25,316
Equity securities and mutual funds	11,343		10,769		10,013		10,173
Total	$	154,457	$	153,963	$	196,714	$	197,306

Held-to-maturity:
Due in one year or less	$	8,181	$	8,181	$	10,587	$	10,587
Due in one to three years	1		1		1		1
Total	$	8,182	$	8,182	$	10,588	$	10,588

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

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:

	Six months ended June 30
($000)	2010			2009
Realized gains	$	17		$	9
Realized losses	(8		)	(531		)
Realized gains (loss), net	$	9		$	(522	)

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

	Six months ended June 30
($000)	2010			2009
Unrealized gains (loss), net	$	(398	)	$	604

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The fair value of our assets subject to fair value measurements and the necessary disclosures are as follows:

	Fair Value		Fair Value Measurements as of
	as of		June 30, 2010 Using Fair Value Hierarchy
($000)	June 30, 2010		Level 1		Level 2		Level 3
Available-for-sale investments
Government obligations	$	118,357	$	118,357	$	—	$	—
Corporate bonds	24,837		24,837		—		—
Equity securities	3,099		3,099		—		—
Mutual funds	7,670		7,670		—		—
Trading securities	3,828		3,828		—		—
Total	$	157,791	$	157,791	$	—	$	—

	Fair Value		Fair Value Measurements as of
	as of		December 31, 2009 Using Fair Value Hierarchy
($000)	December 31, 2009		Level 1		Level 2		Level 3
Available-for-sale investments
Government obligations	$	174,822	$	174,822	$	—	$	—
Corporate bonds	12,311		12,311		—		—
Equity securities	2,173		2,173		—		—
Mutual funds	8,000		8,000		—		—
Trading securities	4,163		4,163		—		—
Total	$	201,469	$	201,469	$	—	$	—

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.

We did not transfer any investments between levels of the fair value hierarchy in the first six months of 2010 or 2009. Based on our analysis of the nature and risks of our investments in equity securities and mutual funds, we have determined that presenting these investment categories each in the aggregate is appropriate.

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7. Investments in Unconsolidated Entities

Our investments in unconsolidated entities consist primarily of the following:

($000)	As of June 30 2010		As of December 31 2009
Investment in MJKK	$	18,504	$	18,413
Other equity method investments	491		577
Investments accounted for using the cost method	5,104		5,089
Total investments in unconsolidated entities	$	24,099	$	24,079

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,” using 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 June 30 2010			As of December 31 2009
Morningstar’s approximate ownership of MJKK	34		%	34		%

Approximate market value of Morningstar’s ownership in MJKK:
Japanese yen (¥000)	¥	3,311,000		¥	2,600,000
Equivalent U.S. dollars ($000)	$	37,352		$	28,507

Other Equity Method Investments. As of June 30, 2010 and December 31, 2009, other equity method investments include our investments in Morningstar Danmark A/S (Morningstar Denmark) and Morningstar Sweden AB (Morningstar Sweden). Morningstar Denmark and Morningstar Sweden develop and market products and services customized for their respective markets. Our ownership interest in both Morningstar Denmark and Morningstar Sweden was approximately 25% as of June 30, 2010 and December 31, 2009.

Cost Method Investments. As of June 30, 2010 and December 31, 2009, our cost method investments consist mainly of minority investments in Pitchbook Data, Inc. (Pitchbook) and Bundle Corporation (Bundle). Pitchbook offers detailed data and information about private equity transactions, investors, companies, limited partners, and service providers. Bundle is a social media company dedicated to helping people make smarter spending and saving choices. Its website, Bundle.com, features a money comparison tool that shows spending trends across the United States, along with a range of information on saving, investing, and budgeting. We did not record any impairment losses on our cost method investments in the first six months of 2010 and 2009, respectively.

8. Liability for Vacant Office Space

The following table shows the change in our liability for vacant office space from December 31, 2009 to June 30, 2010:

Liability for vacant office space	($000)
Balance as of December 31, 2009	$	3,815
Increase liability for vacant office space	1,262
Reduction of liability for lease payments	(1,294		)
Other, net	(959		)
Balance as of June 30, 2010	$	2,824

In the first six months of 2010, we increased our liability for vacant office space for the former Ibbotson headquarters because we finalized sub-lease arrangements for a portion of this space. In addition, we increased our liability for vacant office space related to the equity research and data business acquired from C.P.M.S. These increases in the liability for vacant office space were recorded as an operating expense in the first six months of 2010.

9. Stock-Based Compensation

Stock-Based Compensation Plans

In November 2004, we adopted the 2004 Stock Incentive Plan. The 2004 Stock Incentive Plan provides for grants of options, stock appreciation rights, restricted stock units, and performance shares. All of our employees and our non-employee directors are eligible for awards under the 2004 Stock Incentive Plan. Joe Mansueto, our chairman and chief executive officer, does not participate in the 2004 Stock Incentive Plan or prior plans.

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Since the adoption of the 2004 Stock Incentive Plan, we have granted stock options and, beginning in 2006, restricted stock units.

Restricted stock units represent the right to receive a share of Morningstar common stock when that unit vests. Restricted stock units granted under the 2004 Stock Incentive Plan generally vest ratably over a four-year period. 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. Stock options granted under the 2004 Stock Incentive Plan generally vest ratably over a four-year period and expire 10 years after the date of grant. Almost all of the options granted under the 2004 Stock Incentive Plan have a premium feature in which the exercise price increases over the term of the option at a rate equal to the 10-year Treasury bond yield as of the date of grant.

The following table summarizes the number of shares available for future grants under our 2004 Stock Incentive Plan:

(000)		As of June 30 2010		As of December 31 2009
Shares available for future grants		1,818		2,143