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.
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
PART 1. | FINANCIAL INFORMATION |
Item 1. | Financial Statements |
3
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.
4
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.
5
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.
6
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.
7
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.
8
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.
10
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.
11
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 | ||||
12
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 | ||||
13
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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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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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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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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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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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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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