MORN_10Q_6.30.2011

Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 

FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED June 30, 2011
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from         to
Commission File Number: 000-51280
 

MORNINGSTAR, INC.
(Exact Name of Registrant as Specified in its Charter) 
Illinois
 
36-3297908
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification Number)
 
 
 
22 West Washington Street
 
 
Chicago, Illinois
 
60602
(Address of Principal Executive Offices)
 
(Zip Code)
  
(312) 696-6000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  o
Non-accelerated filer   o
Smaller reporting company  o
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of July 29, 2011, there were 50,573,958 shares of the Company’s common stock, no par value, outstanding.
 

Table of Contents

MORNINGSTAR, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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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)
 
2011

 
2010

 
2011

 
2010

 
 
 
 
 
 
 
 
 
Revenue
 
$
161,011

 
$
136,091

 
$
312,778

 
$
264,381

 
 
 
 
 
 
 
 
 
Operating expense (1):
 
 
 
 
 
 
 
 
Cost of goods sold
 
45,186

 
39,738

 
85,855

 
74,054

Development
 
13,681

 
11,899

 
25,669

 
22,788

Sales and marketing
 
26,767

 
24,435

 
53,249

 
46,996

General and administrative
 
26,207

 
23,106

 
56,824

 
43,749

Depreciation and amortization
 
10,563

 
9,246

 
20,765

 
18,185

Total operating expense
 
122,404

 
108,424

 
242,362

 
205,772

 
 
 
 
 
 
 
 
 
Operating income
 
38,607

 
27,667

 
70,416

 
58,609

 
 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 

 
 

 
 
 
 
Interest income (expense), net
 
(179
)
 
593

 
345

 
1,180

Other income (expense), net
 
188

 
(572
)
 
438

 
(1,338
)
Non-operating income (expense), net
 
9

 
21

 
783

 
(158
)
 
 
 
 
 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
38,616

 
27,688

 
71,199

 
58,451

 
 
 
 
 
 
 
 
 
Income tax expense
 
12,724

 
10,225

 
23,242

 
21,220

 
 
 
 
 
 
 
 
 
Equity in net income of unconsolidated entities
 
595

 
454

 
969

 
843

 
 
 
 
 
 
 
 
 
Consolidated net income
 
26,487

 
17,917

 
48,926

 
38,074

 
 
 
 
 
 
 
 
 
Net (income) loss attributable to the noncontrolling interest
 
(2
)
 
85

 
96

 
116

 
 
 
 
 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
26,485

 
$
18,002

 
$
49,022

 
$
38,190

 
 
 
 
 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 

 
 

 
 
 
 
Basic
 
$
0.53

 
$
0.37

 
$
0.98

 
$
0.78

Diluted
 
$
0.52

 
$
0.36

 
$
0.96

 
$
0.76

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
50,165

 
49,234

 
49,983

 
49,032

Diluted
 
51,142

 
50,533

 
51,041

 
50,426

 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30
 
Six months ended June 30
 
 
2011

 
2010

 
2011

 
2010

(1) Includes stock-based compensation expense of:
 
 

 
 

 
 
 
 
Cost of goods sold
 
$
1,072

 
$
907

 
$
1,951

 
$
1,622

Development
 
572

 
449

 
1,043

 
842

Sales and marketing
 
481

 
486

 
903

 
889

General and administrative
 
1,718

 
1,813

 
3,595

 
3,239

Total stock-based compensation expense
 
$
3,843

 
$
3,655

 
$
7,492

 
$
6,592


 See notes to unaudited condensed consolidated financial statements.

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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
 
 
As of June 30

 
As of December 31
(in thousands except share amounts)
 
2011

 
2010

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
195,023

 
$
180,176

Investments
 
235,216

 
185,240

Accounts receivable, less allowance of $767 and $1,056, respectively
 
111,518

 
110,891

Deferred tax asset, net
 
2,787

 
2,860

Income tax receivable, net
 
14,381

 
10,459

Other
 
16,497

 
17,654

Total current assets
 
575,422

 
507,280

Property, equipment, and capitalized software, net
 
62,062

 
62,105

Investments in unconsolidated entities
 
24,424

 
24,262

Goodwill
 
326,543

 
317,661

Intangible assets, net
 
156,940

 
169,023

Other assets
 
7,675

 
5,971

Total assets
 
$
1,153,066

 
$
1,086,302

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
38,646

 
$
42,680

Accrued compensation
 
50,089

 
62,404

Deferred revenue
 
156,760

 
146,267

Other
 
761

 
1,373

Total current liabilities
 
246,256

 
252,724

Accrued compensation
 
4,855

 
4,965

Deferred tax liability, net
 
19,477

 
19,975

Other long-term liabilities
 
26,256

 
27,213

Total liabilities
 
296,844

 
304,877

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 50,539,113 and 49,874,392 shares were outstanding as of June 30, 2011 and December 31, 2010, respectively
 
5

 
5

Treasury stock at cost, 266,334 shares as of June 30, 2011 and 279,456 shares as of December 31, 2010
 
(6,391
)
 
(6,641
)
Additional paid-in capital
 
476,456

 
458,426

Retained earnings
 
367,310

 
323,408

Accumulated other comprehensive income:
 
 
 
 

Currency translation adjustment
 
17,070

 
4,503

Unrealized gain on available-for-sale securities
 
762

 
615

Total accumulated other comprehensive income
 
17,832

 
5,118

Total Morningstar, Inc. shareholders’ equity
 
855,212

 
780,316

Noncontrolling interest
 
1,010

 
1,109

Total equity
 
856,222

 
781,425

Total liabilities and equity
 
$
1,153,066

 
$
1,086,302

 
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, 2011
 
 
 
Morningstar, Inc. Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
Other
Comprehensive
Income
(Loss)

 
 
 
 
 
 
Common Stock
 
 

 
Additional
Paid-in
Capital

 
 
 
 
Non
Controlling
Interests

 
 
(in thousands, except share amounts)
 
Shares
Outstanding

 
Par
Value

 
Treasury
Stock

 
 
Retained
Earnings

 
 
 
Total
Equity

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

 
$
5

 
$
(6,641
)
 
$
458,426

 
$
323,408

 
$
5,118

 
$
1,109

 
$
781,425

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
—

 
—

 
—

 
49,022

 
—

 
(96
)
 
48,926

Unrealized gain on available-for-sale investments, net of income tax of $73
 
 
 
—

 
—

 
—

 
—

 
147

 
—

 
147

Foreign currency translation adjustment, net
 
 
 
—

 
—

 
—

 
—

 
12,567

 
(3
)
 
12,564

Total comprehensive income (loss)
 
 
 
—

 
—

 
—

 
49,022

 
12,714

 
(99
)
 
61,637

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
666,614

 
—

 
359

 
4,293

 
—

 
—

 
—

 
4,652

Stock-based compensation — restricted stock units
 
 
 
—

 
—

 
6,117

 
—

 
—

 
—

 
6,117

Stock-based compensation — restricted stock
 
 
 
—

 
—

 
1,308

 
—

 
—

 
—

 
1,308

Stock-based compensation - stock-options
 
 
 
—

 
—

 
67

 
—

 
—

 
—

 
67

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

 
—

 
6,171

 
—

 
—

 
—

 
6,171

Common shares repurchased
 
(1,893
)
 
—

 
(109
)
 
—

 
—

 
—

 
—

 
(109
)
Dividends declared — common shares outstanding
 
 
 
—

 
—

 
—

 
(5,042
)
 
—

 
—

 
(5,042
)
Dividends declared — restricted stock units
 
 
 
—

 
—

 
74

 
(78
)
 
—

 
—

 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2011
 
50,539,113

 
$
5

 
$
(6,391
)
 
$
476,456

 
$
367,310

 
$
17,832

 
$
1,010

 
$
856,222

 
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)
 
2011

 
2010

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
48,926

 
$
38,074

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
20,765

 
18,185

Deferred income tax expense (benefit)
 
454

 
(1,012
)
Stock-based compensation expense
 
7,492

 
6,592

Provision for bad debt
 
530

 
356

Equity in net income of unconsolidated entities
 
(969
)
 
(843
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(6,171
)
 
(4,205
)
Other, net
 
(547
)
 
1,386

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable
 
617

 
(6,615
)
Other assets
 
608

 
(511
)
Accounts payable and accrued liabilities
 
(5,260
)
 
2,859

Accrued compensation
 
(14,528
)
 
(11,154
)
Income taxes payable
 
2,742

 
(4,255
)
Deferred revenue
 
8,197

 
7,177

Deferred rent
 
(657
)
 
(80
)
Other liabilities
 
(1,043
)
 
(924
)
Cash provided by operating activities
 
61,156

 
45,030

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(198,647
)
 
(85,528
)
Proceeds from maturities and sales of investments
 
150,360

 
130,381

Capital expenditures
 
(8,418
)
 
(3,839
)
Acquisitions, net of cash acquired
 
569

 
(67,455
)
Other, net
 
785

 
889

Cash used for investing activities
 
(55,351
)
 
(25,552
)
 
 
 
 
 
Financing activities
 
 

 
 

Proceeds from stock-option exercises, net
 
4,652

 
3,650

Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
6,171

 
4,205

Common shares repurchased
 
(109
)
 
—

Dividends paid
 
(5,011
)
 
—

Other, net
 
(214
)
 
205

Cash provided by financing activities
 
5,489

 
8,060

 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
3,553

 
(3,657
)
Net increase in cash and cash equivalents
 
14,847

 
23,881

Cash and cash equivalents—beginning of period
 
180,176

 
130,496

Cash and cash equivalents—end of period
 
$
195,023

 
$
154,377

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
21,104

 
$
26,396

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain (loss) on available-for-sale investments
 
$
220

 
$
(941
)
 
See notes to unaudited condensed consolidated financial statements.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Balance as of December 31, 2010
$
317,661

Adjustments to 2010 acquisitions
1,387

Other, primarily currency translation
7,495

Balance as of June 30, 2011
$
326,543


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

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

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)

Intellectual property
 
$
32,759

 
$
(17,744
)
 
$
15,015

 
10

 
$
33,990

 
$
(15,970
)
 
$
18,020

 
10

Customer-related assets
 
137,412

 
(46,880
)
 
90,532

 
12

 
130,675

 
(39,951
)
 
90,724

 
11

Supplier relationships
 
240

 
(78
)
 
162

 
20

 
240

 
(72
)
 
168

 
20

Technology-based assets
 
81,556

 
(30,992
)
 
50,564

 
9

 
78,651

 
(25,682
)
 
52,969

 
9

Non-competition agreement
 
1,781

 
(1,114
)
 
667

 
4

 
1,751

 
(909
)
 
842

 
4

Intangible assets related to acquisitions with preliminary purchase price allocations
 
—

 
—

 
—

 
—

 
6,407

 
(107
)
 
6,300

 
10

Total intangible assets
 
$
253,748

 
$
(96,808
)
 
$
156,940

 
10

 
$
251,714

 
$
(82,691
)
 
$
169,023

 
10

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

 
2010

 
2011

 
2010

Amortization expense
 
$
6,632

 
$
5,848

 
$
13,145

 
$
11,316

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

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

2011
$
25,947

2012
24,416

2013
21,677

2014
20,407

2015
19,525

2016
14,896

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

11

Table of Contents

 
 
Three months ended June 30
 
Six months ended June 30
(in thousands, except per share amounts)
 
2011

 
2010

 
2011

 
2010

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

 
 

 
 
 
 
Net income attributable to Morningstar, Inc.:
 
$
26,485

 
$
18,002

 
$
49,022

 
$
38,190

Less: Distributed earnings available to participating securities
 
(8
)
 
—

 
(17
)
 
—

Less: Undistributed earnings available to participating securities
 
(72
)
 
—

 
(131
)
 
—

Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,405

 
$
18,002

 
$
48,874

 
$
38,190

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
50,165

 
49,234

 
49,983

 
49,032

 
 
 
 
 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.53

 
$
0.37

 
$
0.98

 
$
0.78

 
 


 


 


 


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


 


 


 


Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,405

 
$
18,002

 
$
48,874

 
$
38,190

Add: Undistributed earnings allocated to participating securities
 
72

 
—

 
131

 
—

Less: Undistributed earnings reallocated to participating securities
 
(70
)
 
—

 
(129
)
 
—

Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
26,407

 
$
18,002

 
$
48,876

 
$
38,190

 
 


 


 


 


Weighted average common shares outstanding
 
50,165

 
49,234

 
49,983

 
49,032

Net effect of dilutive stock options and restricted stock units
 
977

 
1,299

 
1,058

 
1,394

Weighted average common shares outstanding for computing diluted income per share
 
51,142

 
50,533

 
51,041

 
50,426

 
 


 


 


 


Diluted net income per share attributable to Morningstar, Inc.
 
$
0.52

 
$
0.36

 
$
0.96

 
$
0.76


12

Table of Contents


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

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

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Table of Contents

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

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
128,116

 
$
32,895

 
$
—

 
$
161,011

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
86,484

 
13,833

 
7,681

 
107,998

Stock-based compensation expense
 
2,488

 
531

 
824

 
3,843

Depreciation and amortization
 
2,047

 
40

 
8,476

 
10,563

Operating income (loss)
 
$
37,097

 
$
18,491

 
$
(16,981
)
 
$
38,607

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
1,593

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,788

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
113,424

Non-U.S. revenue
 
 

 
 

 
 

 
$
47,587

 
 
 
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

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
731

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
1,458

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
98,986

Non-U.S. revenue
 
 

 
 

 
 

 
$
37,105


 
 
Six months ended June 30, 2011
($000)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

External revenue
 
$
248,515

 
$
64,263

 
$
—

 
$
312,778

Operating expense, excluding stock-based compensation expense, depreciation, and amortization
 
170,247

 
27,671

 
16,187

 
214,105

Stock-based compensation expense
 
4,958

 
973

 
1,561

 
7,492

Depreciation and amortization
 
3,906

 
82

 
16,777

 
20,765

Operating income (loss)
 
$
69,404

 
$
35,537

 
$
(34,525
)
 
$
70,416

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
3,523

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
4,895

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
221,605

Non-U.S. revenue
 
 

 
 

 
 

 
$
91,173

 

14

Table of Contents

 
 
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

 
 
 
 
 
 
 
 
 
U.S. capital expenditures
 
 

 
 

 
 

 
$
1,632

Non-U.S. capital expenditures
 
 

 
 

 
 

 
$
2,207

 
 
 
 
 
 
 
 
 
U.S. revenue
 
 

 
 

 
 

 
$
191,596

Non-U.S. revenue
 
 

 
 

 
 

 
$
72,785


 
 
As of June 30, 2011
(000’s)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
284,097

 
$
42,446

 
$
—

 
$
326,543

 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 

 
 

 
 

 
$
38,772

Non-U.S. long-lived assets
 
 

 
 

 
 

 
$
23,290

 
 
 
As of December 31, 2010
(000’s)
 
Investment
Information

 
Investment
Management

 
Corporate Items

 
Total

Goodwill
 
$
275,611

 
$
42,050

 
$
—

 
$
317,661

 
 
 
 
 
 
 
 
 
U.S. long-lived assets
 
 

 
 

 
 

 
$
39,496

Non-U.S. long-lived assets
 
 

 
 

 
 

 
$
22,609

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

 
2010

Available-for-sale
 
$
214,211

 
$
173,072

Held-to-maturity
 
15,496

 
7,476

Trading securities
 
5,509

 
4,692

Total
 
$
235,216

 
$
185,240

 

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Table of Contents

The following table shows the cost, unrealized gains (losses), and fair values related to investments classified as available-for-sale and held-to-maturity:
 
 
 
As of June 30, 2011
 
As of December 31, 2010
($000)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Government obligations
 
$
116,101

 
$
58

 
$
(46
)
 
$
116,113

 
$
113,597

 
$
36

 
$
(56
)
 
$
113,577

Corporate bonds
 
55,758

 
86

 
(56
)
 
55,788

 
42,839

 
63

 
(24
)
 
42,878

Commercial paper
 
25,959

 
6

 
(3
)
 
25,962

 
2,994

 
—

 
(3
)
 
2,991

Equity securities and exchange-traded funds
 
6,182

 
312

 
(46
)
 
6,448

 
4,510

 
418

 
(6
)
 
4,922

Mutual funds
 
9,006

 
894

 
—

 
9,900

 
8,146

 
558

 
—

 
8,704

Total
 
$
213,006

 
$
1,356

 
$
(151
)
 
$
214,211

 
$
172,086

 
$
1,075

 
$
(89
)
 
$
173,072

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
15,496

 
$
—

 
$
—

 
$
15,496

 
$
7,476

 
$
—

 
$
—

 
$
7,476

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

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

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
143,986

 
$
144,052

 
$
85,990

 
$
85,964

Due in one to two years
 
53,832

 
53,811

 
73,440

 
73,482

Equity securities, exchange-traded funds, and mutual funds
 
15,188

 
16,348

 
12,656

 
13,626

Total
 
$
213,006

 
$
214,211

 
$
172,086

 
$
173,072

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
15,490

 
$
15,490

 
$
7,223

 
$
7,223

Due in more than one year
 
6

 
6

 
253

 
253

Total
 
$
15,496

 
$
15,496

 
$
7,476

 
$
7,476

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

16

Table of Contents


 The following table shows the realized gains and losses arising from sales of our investments classified as available-for-sale recorded in our Condensed Consolidated Statements of Income: 
 
 
Six months ended June 30
($000)
 
2011

 
2010

Realized gains
 
$
397

 
$
17

Realized losses
 
—

 
(8
)
Realized gains, net
 
$
397

 
$
9

 

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

 
2010

Unrealized loss, net
 
$
9

 
$
398


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 June 30, 2011
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
June 30, 2011
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments
 
 

 
 

 
 

 
 

Government obligations
 
$
116,113

 
$
—

 
$
116,113

 
$
—

Corporate bonds
 
55,788

 
—

 
55,788

 
—

Commercial paper
 
25,962

 
—

 
25,962

 
—

Equity securities and exchange-traded funds
 
6,448

 
6,448

 
—

 
—

Mutual funds
 
9,900

 
9,900

 
—

 
—

Trading securities
 
5,509

 
5,509

 
—

 
—

Total
 
$
219,720

 
$
21,857

 
$
197,863

 
$
—

 
 
 
Fair Value
 
Fair Value Measurements as of December 31, 2010
 
 
as of
 
Using Fair Value Hierarchy
($000)
 
December 31, 2010
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments
 
 

 
 

 
 

 
 

Government obligations
 
$
113,577

 
$
—

 
$
113,577

 
$
—

Corporate bonds
 
42,878

 
—

 
42,878

 
—

Commercial paper
 
2,991

 
—

 
2,991

 
—

Equity securities and exchange-traded funds
 
4,922

 
4,922

 
—

 
—

Mutual funds
 
8,704

 
8,704

 
—

 
—

Trading securities
 
4,692

 
4,692

 
—

 
—

Total
 
$
177,764

 
$
18,318

 
$
159,446

 
$
—

 
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 these investment categories each in the aggregate is appropriate.

17

Table of Contents



7.
Investments in Unconsolidated Entities
 
Our investments in unconsolidated entities consist primarily of the following:
 
 
 
As of June 30


As of December 31

($000)
 
2011


2010

Investment in MJKK
 
$
18,971

 
$
19,036

Other equity method investments
 
232

 
109

Investments accounted for using the cost method
 
5,221