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 September 30, 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 October 24, 2014 there were 44,581,820 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 and nine months ended September 30, 2014 and 2013 | ||||
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013 | ||||
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013 | ||||
Unaudited Condensed Consolidated Statement of Equity for the nine months ended September 30, 2014 | ||||
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 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 September 30 | Nine months ended September 30 | |||||||||||||||
(in thousands except per share amounts) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Revenue | $ | 193,106 | $ | 173,482 | $ | 563,656 | $ | 517,766 | ||||||||
Operating expense (1): | ||||||||||||||||
Cost of revenue | 80,142 | 72,422 | 237,243 | 198,499 | ||||||||||||
Sales and marketing | 26,761 | 22,774 | 83,138 | 78,789 | ||||||||||||
General and administrative | 26,384 | 22,416 | 82,926 | 77,863 | ||||||||||||
Depreciation and amortization | 14,558 | 11,257 | 40,336 | 33,858 | ||||||||||||
Litigation settlement (2) | — | — | 61,000 | — | ||||||||||||
Total operating expense | 147,845 | 128,869 | 504,643 | 389,009 | ||||||||||||
Operating income | 45,261 | 44,613 | 59,013 | 128,757 | ||||||||||||
Non-operating income (expense): | ||||||||||||||||
Interest income, net | 515 | 630 | 1,734 | 2,035 | ||||||||||||
Gain (loss) on sale of investments, reclassified from other comprehensive income | 158 | (42 | ) | 505 | 1,106 | |||||||||||
Holding gain (loss) upon acquisition of additional ownership of equity and cost method investments | — | (78 | ) | 5,168 | 3,635 | |||||||||||
Other income (expense), net | (971 | ) | 261 | (942 | ) | (1,949 | ) | |||||||||
Non-operating income (expense), net | (298 | ) | 771 | 6,465 | 4,827 | |||||||||||
Income before income taxes and equity in net income of unconsolidated entities | 44,963 | 45,384 | 65,478 | 133,584 | ||||||||||||
Equity in net income of unconsolidated entities | 337 | 315 | 1,433 | 1,172 | ||||||||||||
Income tax expense | 15,149 | 14,265 | 20,188 | 42,647 | ||||||||||||
Consolidated net income | 30,151 | 31,434 | 46,723 | 92,109 | ||||||||||||
Net loss attributable to the noncontrolling interest | 29 | 29 | 64 | 93 | ||||||||||||
Net income attributable to Morningstar, Inc. | $ | 30,180 | $ | 31,463 | $ | 46,787 | $ | 92,202 | ||||||||
Net income per share attributable to Morningstar, Inc.: | ||||||||||||||||
Basic | $ | 0.67 | $ | 0.68 | $ | 1.04 | $ | 1.99 | ||||||||
Diluted | $ | 0.67 | $ | 0.68 | $ | 1.04 | $ | 1.98 | ||||||||
Dividends per common share: | ||||||||||||||||
Dividends declared per common share | $ | 0.17 | $ | — | $ | 0.51 | $ | 0.25 | ||||||||
Dividends paid per common share | $ | 0.17 | $ | 0.13 | $ | 0.51 | $ | 0.25 | ||||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 44,734 | 46,080 | 44,763 | 46,293 | ||||||||||||
Diluted | 44,889 | 46,519 | 44,990 | 46,635 | ||||||||||||
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(1) Includes stock-based compensation expense of: | ||||||||||||||||
Cost of revenue | $ | 2,177 | $ | 1,471 | $ | 5,829 | $ | 4,863 | ||||||||
Sales and marketing | 607 | 456 | 1,634 | 1,490 | ||||||||||||
General and administrative | 2,167 | 1,489 | 5,790 | 4,800 | ||||||||||||
Total stock-based compensation expense | $ | 4,951 | $ | 3,416 | $ | 13,253 | $ | 11,153 | ||||||||
(2) See Note 12, Contingencies, for additional information.
See notes to unaudited condensed consolidated financial statements.
4
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
(in thousands) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Consolidated net income | $ | 30,151 | $ | 31,434 | $ | 46,723 | $ | 92,109 | ||||||||
Other comprehensive income (loss): | ||||||||||||||||
Foreign currency translation adjustment | (18,809 | ) | 11,247 | (13,476 | ) | (4,952 | ) | |||||||||
Unrealized gains (losses) on securities, net of tax: | ||||||||||||||||
Unrealized holding gains (losses) arising during period | (244 | ) | 774 | 152 | 1,774 | |||||||||||
Reclassification of (gains) losses included in net income | (100 | ) | 28 | (318 | ) | (706 | ) | |||||||||
Other comprehensive income (loss) | (19,153 | ) | 12,049 | (13,642 | ) | (3,884 | ) | |||||||||
Comprehensive income | 10,998 | 43,483 | 33,081 | 88,225 | ||||||||||||
Comprehensive loss attributable to noncontrolling interest | 83 | 40 | 98 | 246 | ||||||||||||
Comprehensive income attributable to Morningstar, Inc. | $ | 11,081 | $ | 43,523 | $ | 33,179 | $ | 88,471 | ||||||||
See notes to unaudited condensed consolidated financial statements.
5
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
As of September 30 | As of December 31 | |||||||
(in thousands except share amounts) | 2014 | 2013 | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 189,318 | $ | 168,160 | ||||
Investments | 38,490 | 130,407 | ||||||
Accounts receivable, less allowance of $1,323 and $1,089, respectively | 124,966 | 114,131 | ||||||
Deferred tax asset, net | 7,524 | 3,892 | ||||||
Income tax receivable, net | 4,427 | 3,942 | ||||||
Other current assets | 23,619 | 26,361 | ||||||
Total current assets | 388,344 | 446,893 | ||||||
Property, equipment, and capitalized software, less accumulated depreciation and amortization of $126,449 and $106,166, respectively | 112,584 | 104,986 | ||||||
Investments in unconsolidated entities | 30,428 | 38,714 | ||||||
Goodwill | 378,969 | 326,450 | ||||||
Intangible assets, net | 103,443 | 103,909 | ||||||
Other assets | 6,407 | 9,716 | ||||||
Total assets | $ | 1,020,175 | $ | 1,030,668 | ||||
Liabilities and equity | ||||||||
Current liabilities: | ||||||||
Accounts payable and accrued liabilities | $ | 38,495 | $ | 42,131 | ||||
Accrued compensation | 67,692 | 71,403 | ||||||
Deferred revenue | 150,051 | 149,225 | ||||||
Short-term debt | 30,017 | — | ||||||
Other current liabilities | 4,632 | 6,786 | ||||||
Total current liabilities | 290,887 | 269,545 | ||||||
Accrued compensation | 6,905 | 8,193 | ||||||
Deferred tax liability, net | 17,565 | 23,755 | ||||||
Deferred rent | 23,460 | 23,938 | ||||||
Other long-term liabilities | 10,839 | 13,947 | ||||||
Total liabilities | 349,656 | 339,378 | ||||||
Equity: | ||||||||
Morningstar, Inc. shareholders’ equity: | ||||||||
Common stock, no par value, 200,000,000 shares authorized, of which 44,661,350 and 44,967,423 shares were outstanding as of September 30, 2014 and December 31, 2013, respectively | 5 | 5 | ||||||
Treasury stock at cost, 7,809,277 shares as of September 30, 2014 and 7,202,896 shares as of December 31, 2013 | (493,642 | ) | (449,054 | ) | ||||
Additional paid-in capital | 553,172 | 539,507 | ||||||
Retained earnings | 618,484 | 594,626 | ||||||
Accumulated other comprehensive income (loss): | ||||||||
Currency translation adjustment | (8,833 | ) | 4,609 | |||||
Unrealized gain on available-for-sale investments | 398 | 564 | ||||||
Total accumulated other comprehensive income (loss) | (8,435 | ) | 5,173 | |||||
Total Morningstar, Inc. shareholders’ equity | 669,584 | 690,257 | ||||||
Noncontrolling interests | 935 | 1,033 | ||||||
Total equity | 670,519 | 691,290 | ||||||
Total liabilities and equity | $ | 1,020,175 | $ | 1,030,668 | ||||
See notes to unaudited condensed consolidated financial statements.
6
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity
For the nine months ended September 30, 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) | — | — | — | 46,787 | (64 | ) | 46,723 | ||||||||||||||||||||||||
Other comprehensive income (loss): | |||||||||||||||||||||||||||||||
Unrealized gain on available-for-sale investments, net of income tax of $82 | — | — | — | — | 152 | — | 152 | ||||||||||||||||||||||||
Reclassification of adjustments for gains included in net income, net of income tax of $187 | — | — | — | — | (318 | ) | — | (318 | ) | ||||||||||||||||||||||
Foreign currency translation adjustment, net | — | — | — | — | (13,442 | ) | (34 | ) | (13,476 | ) | |||||||||||||||||||||
Other comprehensive loss, net | — | — | — | — | (13,608 | ) | (34 | ) | (13,642 | ) | |||||||||||||||||||||
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net | 317,579 | — | 1,261 | (2,617 | ) | — | — | — | (1,356 | ) | |||||||||||||||||||||
Stock-based compensation | — | — | 13,253 | — | — | — | 13,253 | ||||||||||||||||||||||||
Excess tax benefit derived from stock-option exercises and vesting of restricted stock units | — | — | 2,945 | — | — | — | 2,945 | ||||||||||||||||||||||||
Common shares repurchased | (623,652 | ) | — | (45,849 | ) | — | — | — | — | (45,849 | ) | ||||||||||||||||||||
Dividends declared — common shares outstanding | — | — | — | (22,779 | ) | — | — | (22,779 | ) | ||||||||||||||||||||||
Dividends declared — restricted stock units | — | — | 84 | (150 | ) | — | — | (66 | ) | ||||||||||||||||||||||
Balance as of September 30, 2014 | 44,661,350 | $ | 5 | $ | (493,642 | ) | $ | 553,172 | $ | 618,484 | $ | (8,435 | ) | $ | 935 | $ | 670,519 | ||||||||||||||
See notes to unaudited condensed consolidated financial statements.
7
Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
Nine months ended September 30 | ||||||||
(in thousands) | 2014 | 2013 | ||||||
Operating activities | ||||||||
Consolidated net income | $ | 46,723 | $ | 92,109 | ||||
Adjustments to reconcile consolidated net income to net cash flows from operating activities: | ||||||||
Depreciation and amortization | 40,336 | 33,858 | ||||||
Deferred income taxes | (5,367 | ) | (2,315 | ) | ||||
Stock-based compensation expense | 13,253 | 11,153 | ||||||
Provision for bad debts | 308 | 730 | ||||||
Equity in net income of unconsolidated entities | (1,433 | ) | (1,172 | ) | ||||
Excess tax benefits from stock-option exercises and vesting of restricted stock units | (2,945 | ) | (4,093 | ) | ||||
Holding gain upon acquisition of additional ownership of equity method investments | (5,168 | ) | (3,635 | ) | ||||
Other, net | 200 | 12 | ||||||
Changes in operating assets and liabilities, net of effects of acquisitions: | ||||||||
Accounts receivable | (12,588 | ) | (1,249 | ) | ||||
Other assets | (3,333 | ) | (2,887 | ) | ||||
Accounts payable and accrued liabilities | (1,224 | ) | (3,151 | ) | ||||
Accrued compensation | 3,376 | (8,404 | ) | |||||
Income taxes—current | 3,542 | 17,205 | ||||||
Deferred revenue | 548 | 6,004 | ||||||
Deferred rent | 33 | (1,273 | ) | |||||
Other liabilities | (973 | ) | (679 | ) | ||||
Cash provided by operating activities | 75,288 | 132,213 | ||||||
Investing activities | ||||||||
Purchases of investments | (10,612 | ) | (113,824 | ) | ||||
Proceeds from maturities and sales of investments | 103,120 | 108,599 | ||||||
Capital expenditures | (42,756 | ) | (27,950 | ) | ||||
Acquisitions, net of cash acquired | (64,447 | ) | (11,079 | ) | ||||
Proceeds from sale of a business | — | 957 | ||||||
Purchases of equity- and cost-method investments | — | (2,751 | ) | |||||
Other, net | 229 | 432 | ||||||
Cash used for investing activities | (14,466 | ) | (45,616 | ) | ||||
Financing activities | ||||||||
Proceeds from stock-option exercises | 3,766 | 3,172 | ||||||
Employee taxes withheld for restricted stock units | (5,122 | ) | (5,276 | ) | ||||
Excess tax benefits from stock-option exercises and vesting of restricted stock units | 2,945 | 4,093 | ||||||
Common shares repurchased | (42,100 | ) | (62,794 | ) | ||||
Dividends paid | (22,912 | ) | (11,657 | ) | ||||
Proceeds from short-term debt | 30,000 | — | ||||||
Other, net | (9 | ) | (54 | ) | ||||
Cash used for financing activities | (33,432 | ) | (72,516 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (6,232 | ) | (1,011 | ) | ||||
Net increase in cash and cash equivalents | 21,158 | 13,070 | ||||||
Cash and cash equivalents—beginning of period | 168,160 | 163,889 | ||||||
Cash and cash equivalents—end of period | $ | 189,318 | $ | 176,959 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for income taxes | $ | 22,044 | $ | 27,700 | ||||
Supplemental information of non-cash investing and financing activities: | ||||||||
Unrealized gain (loss) on available-for-sale investments | $ | (270 | ) | $ | 1,675 | |||
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 (U.S. GAAP) 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 the current period's presentation. We now include development expense, which was previously reported as a separate operating expense category, in the cost of revenue category. We have reclassified development expense to include it in cost of revenue for all periods presented.
Separately, as a result of our move to a more centralized structure in the third quarter of 2013 (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 nine months of 2014 as compared with the same period in 2013, changes related to our more centralized organizational structure added $14 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 $8 million and $6 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 | ||||||
9
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.
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for us on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
10
4. Credit Arrangements
In July 2014, the company entered into a one year, $75.0 million, single-bank revolving credit facility. The company drew on the credit facility during the third quarter and had an outstanding principal balance of $30.0 million at an interest rate of LIBOR plus 100 basis points as of September 30, 2014, leaving borrowing availability of $45.0 million.
5. Acquisitions, Goodwill and Other Intangible Assets
Acquisitions
Increased Ownership Interest in HelloWallet Holdings, Inc.
In June 2014, we acquired an additional 81.3% interest in HelloWallet Holdings, Inc. (HelloWallet), increasing our ownership to 100% from 18.7%. HelloWallet combines behavioral economics and the psychology of decision-making with sophisticated technology to provide personalized, unbiased financial guidance to U.S. workers and their families through their employer benefit plans. We began consolidating the financial results of this acquisition in our Consolidated Financial Statements on June 3, 2014.
HelloWallet's total preliminary estimated fair value of $54,006,000 includes $40,525,000 in cash paid to acquire the remaining 81.3% interest in HelloWallet and pay off HelloWallet's indebtedness as well as $13,481,000 related to the 18.7% of HelloWallet we previously held. We recorded a preliminary non-cash holding gain of $5,168,000 for the difference between the fair value and the book value of our previously held investment. The gain is included in non-operating income in our Unaudited Condensed Consolidated Statements of Income.
The purchase price valuation will be finalized upon the completion of the fair value analysis of the acquired assets and liabilities, including the preliminary intangible assets. We have not yet obtained all of the information related to the fair value of the acquired assets and liabilities to finalize the purchase price allocation. The primary areas that are not yet finalized relate to the valuation of the identifiable intangible assets and income taxes.
The following table summarizes our preliminary allocation of the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, all of which are preliminary pending completion of the final valuation:
($000) | ||||
Cash and cash equivalents | $ | 3,739 | ||
Accounts receivable and other current assets | 150 | |||
Other current and non-current assets | 318 | |||
Deferred tax asset | 7,340 | |||
Intangible assets | 9,460 | |||
Goodwill | 40,472 | |||
Deferred revenue | (2,897 | ) | ||
Deferred tax liability | (3,595 | ) | ||
Other current and non-current liabilities | (981 | ) | ||
Total fair value of HelloWallet | $ | 54,006 | ||
The preliminary allocation includes $9,460,000 of acquired intangible assets, as follows:
($000) | Weighted Average Useful Life (years) | |||||
Technology based assets | 6,670 | 5 | ||||
Intellectual property (trademarks and trade names) | 169 | 3 | ||||
Non-competition agreement | 2,621 | 5 | ||||
Total intangible assets | $ | 9,460 | 5 | |||
11
We recognized a preliminary deferred tax liability of $3,595,000 mainly because the amortization expense related to certain intangible assets is not deductible for income tax purposes. The fair value of the acquired intangible assets and the deferred tax liability are preliminary pending receipt of the final valuation for these assets.
We recognized a preliminary deferred tax asset of $7,340,000 mainly because of net operating losses of HelloWallet which will become available to Morningstar.
Preliminary goodwill of $40,472,000 represents the premium over the fair value of the net tangible and intangible assets acquired. We paid this premium for a number of reasons, including the opportunity to bring together HelloWallet's comprehensive financial wellness expertise with Morningstar's independent, research-based retirement advice to create a holistic retirement savings and advice offering.
ByAllAccounts, Inc.
In April 2014, we acquired ByAllAccounts, Inc. (ByAllAccounts), a provider of innovative data aggregation technology for financial applications for $27,949,000 in cash. ByAllAccounts uses a knowledge-based process, including patented artificial intelligence technology, to collect, consolidate, and enrich financial account data and deliver it to virtually any platform. We began including the financial results of this acquisition in our Consolidated Financial Statements on April 1, 2014.
The purchase price valuation will be finalized upon the completion of the fair value analysis of the acquired assets and liabilities, including the preliminary intangible assets. We have not yet obtained all of the information related to the fair value of the acquired assets and liabilities to finalize the purchase price allocation. The primary areas that are not yet finalized relate to the valuation of the identifiable intangible assets and income taxes.
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 the acquisition, all of which are preliminary pending completion of the final valuation:
($000) | ||||
Cash and cash equivalents | $ | 287 | ||
Accounts receivable and other current assets | 152 | |||
Deferred tax asset | 3,685 | |||
Other current and non-current assets | 257 | |||
Intangible assets | 8,681 | |||
Goodwill | 18,778 | |||
Deferred revenue | (79 | ) | ||
Deferred tax liability | (3,299 | ) | ||
Other current and non-current liabilities | (513 | ) | ||
Total purchase price | $ | 27,949 | ||
The preliminary allocation includes $8,681,000 of acquired intangible assets, as follows:
($000) | Weighted Average Useful Life (years) | |||||
Customer-related assets | $ | 5,506 | 24 | |||
Technology-based assets | 3,020 | 4.5 | ||||
Intellectual property (trademarks and trade names) | 47 | 1 | ||||
Non-competition agreement | 108 | 3 | ||||
Total intangible assets | $ | 8,681 | 19 | |||
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We recognized a preliminary deferred tax liability of $3,299,000 mainly because the amortization expense related to certain intangible assets is not deductible for income tax purposes. The fair value of the acquired intangible assets and the deferred tax liability are preliminary pending receipt of the final valuation for these intangible assets.
We recognized a preliminary deferred tax asset of $3,685,000 mainly because of net operating losses of ByAllAccounts which will become available to Morningstar.
Preliminary goodwill value of $18,778,000 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 to integrate the service into our offerings as well as expand and develop ByAllAccounts' third-party distribution relationships.
Goodwill
The following table shows the changes in our goodwill balances from December 31, 2013 to September 30, 2014:
($000) | ||||
Balance as of December 31, 2013 | $ | 326,450 | ||
Acquisitions of HelloWallet and ByAllAccounts | 59,250 | |||
Foreign currency translation | (6,731 | ) | ||
Balance as of September 30, 2014 | $ | 378,969 | ||
We did not record any impairment losses in the first nine 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 September 30, 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 | $ | 29,539 | $ | (24,844 | ) | $ | 4,695 | 9 | $ | 29,477 | $ | (23,128 | ) | $ | 6,349 | 9 | ||||||||||||
Customer-related assets | 144,359 | (82,076 | ) | 62,283 | 12 | 141,833 | (74,311 | ) | 67,522 | 12 | ||||||||||||||||||
Supplier relationships | 240 | (117 | ) | 123 | 20 | 240 | (108 | ) | 132 | 20 | ||||||||||||||||||
Technology-based assets | 89,789 | (56,050 | ) | 33,739 | 8 | 80,489 | (50,673 | ) | 29,816 | 9 | ||||||||||||||||||
Non-competition agreement | 4,379 | (1,776 | ) | 2,603 | 5 | 1,661 | (1,571 | ) | 90 | 4 | ||||||||||||||||||
Total intangible assets | $ | 268,306 | $ | (164,863 | ) | $ | 103,443 | 11 | $ | 253,700 | $ | (149,791 | ) | $ | 103,909 | 10 | ||||||||||||
The following table summarizes our amortization expense related to intangible assets:
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
($000) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Amortization expense | $ | 5,912 | $ | 5,287 | $ | 16,555 | $ | 16,249 | ||||||||
We amortize intangible assets using the straight-line method over their expected economic useful lives.
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We expect intangible amortization expense for 2014 and subsequent years as follows:
($000) | ||||
2014 | $ | 22,059 | ||
2015 | 22,251 | |||
2016 | 17,693 | |||
2017 | 13,145 | |||
2018 | 10,965 | |||
Thereafter | 33,885 | |||
Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, divestitures, changes in the estimated average useful life, and currency translations.
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6. 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 September 30 | Nine months ended September 30 | |||||||||||||||
(in thousands, except per share amounts) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Basic net income per share attributable to Morningstar, Inc.: | ||||||||||||||||
Net income attributable to Morningstar, Inc.: | $ | 30,180 | $ | 31,463 | $ | 46,787 | $ | 92,202 | ||||||||
Less: Distributed earnings available to participating securities | (1 | ) | — | (6 | ) | (5 | ) | |||||||||
Less: Undistributed earnings available to participating securities | (4 | ) | (11 | ) | (4 | ) | (29 | ) | ||||||||
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders | $ | 30,175 | $ | 31,452 | $ | 46,777 | $ | 92,168 | ||||||||
Weighted average common shares outstanding | 44,734 | 46,080 | 44,763 | 46,293 | ||||||||||||
Basic net income per share attributable to Morningstar, Inc. | $ | 0.67 | $ | 0.68 | $ | 1.04 | $ | 1.99 | ||||||||
Diluted net income per share attributable to Morningstar, Inc.: | ||||||||||||||||
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders | $ | 30,175 | $ | 31,452 | $ | 46,777 | $ | 92,168 | ||||||||
Add: Undistributed earnings allocated to participating securities | 4 | 11 | 4 | 29 | ||||||||||||
Less: Undistributed earnings reallocated to participating securities | (4 | ) | (11 | ) | (4 | ) | (29 | ) | ||||||||
Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders | $ | 30,175 | $ | 31,452 | $ | 46,777 | $ | 92,168 | ||||||||
Weighted average common shares outstanding | 44,734 | 46,080 | 44,763 | 46,293 | ||||||||||||
Net effect of dilutive stock options and restricted stock units | 155 | 439 | 227 | 342 | ||||||||||||
Weighted average common shares outstanding for computing diluted income per share | 44,889 | 46,519 | 44,990 | 46,635 | ||||||||||||
Diluted net income per share attributable to Morningstar, Inc. | $ | 0.67 | $ | 0.68 | $ | 1.04 | $ | 1.98 | ||||||||
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The following table shows the number of restricted stock units and performance share awards excluded from our calculation of diluted earnings per share because their inclusion would have been anti-dilutive:
Three months ended September 30 | Nine months ended September 30 | |||||||||||
(in thousands) | 2014 | 2013 | 2014 | 2013 | ||||||||
Weighted average restricted stock units | 83 | 1 | 34 | 19 | ||||||||
Weighted average performance share awards | 9 | — | 7 | — | ||||||||
Total | 92 | 1 | 41 | 19 | ||||||||
Stock options and restricted stock could be included in the calculation in the future.
7. 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 September 30 | Nine months ended September 30 | |||||||||||||||
($000) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Investment information | $ | 152,252 | $ | 137,216 | $ | 443,049 | $ | 412,332 | ||||||||
Investment management | 40,854 | 36,266 | 120,607 | 105,434 | ||||||||||||
Consolidated revenue | $ | 193,106 | $ | 173,482 | $ | 563,656 | $ | 517,766 | ||||||||
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Geographical Area Information
The tables below summarize our revenue and long-lived assets by geographical area:
External revenue by geographical area | ||||||||||||||||
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
($000) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
United States | $ | 141,276 | $ | 124,998 | $ | 407,681 | $ | 372,746 | ||||||||
United Kingdom | 15,190 | 14,148 | 46,071 | 41,316 | ||||||||||||
Continental Europe | 15,562 | 14,666 | 47,109 | 41,826 | ||||||||||||
Australia | 8,866 | 8,041 | 26,267 | 26,569 | ||||||||||||
Canada | 7,391 | 7,603 | 22,599 | 23,151 | ||||||||||||
Asia | 3,950 | 3,363 | 11,547 | 10,236 | ||||||||||||
Other | 871 | 663 | 2,382 | 1,922 | ||||||||||||
Total International | 51,830 | 48,484 | 155,975 | 145,020 | ||||||||||||
Consolidated revenue | $ | 193,106 | $ | 173,482 | $ | 563,656 | $ | 517,766 | ||||||||
Long-lived assets by geographical area | ||||||||
As of September 30 | As of December 31 | |||||||
($000) | 2014 | 2013 | ||||||
United States | $ | 94,103 | $ | 84,321 | ||||
United Kingdom | 6,994 | 6,873 | ||||||
Continental Europe | 1,410 | 1,873 | ||||||
Australia | 926 | 1,051 | ||||||
Canada | 926 | 1,275 | ||||||
Asia | 8,138 | 9,479 | ||||||
Other | 87 | 114 | ||||||
Total International | 18,481 | 20,665 | ||||||
Consolidated property, equipment, and capitalized software, net | $ | 112,584 | $ | 104,986 | ||||
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8. 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 into three categories: available-for-sale, held-to-maturity, and trading. Our investment portfolio is primarily invested in proprietary Morningstar portfolios, exchange-traded funds that seek to track the performance of certain Morningstar proprietary indexes, and various mutual funds. We classify our investment portfolio as shown below:
As of September 30 | As of December 31 | |||||||
($000) | 2014 | 2013 | ||||||
Available-for-sale | $ | 12,226 | $ | 91,461 | ||||
Held-to-maturity | 18,059 | 31,214 | ||||||
Trading securities | 8,205 | 7,732 | ||||||
Total | $ | 38,490 | $ | 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 September 30, 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 | $ | — | $ | — | $ | — | $ | — | $ | 19,693 | $ | 8 | $ | (3 | ) | $ | 19,698 | |||||||||||||||
Corporate bonds | — | — | — | — | 49,913 | 22 | (124 | ) | 49,811 | |||||||||||||||||||||||
Foreign obligations | — | — | — | — | 505 | — | (2 | ) | 503 | |||||||||||||||||||||||
Commercial paper | — | — | — | — | 9,482 | 7 | — | 9,489 | ||||||||||||||||||||||||
Equity securities and exchange-traded funds | 6,499 | 477 | (81 | ) | 6,895 | 8,872 | 1,011 | (141 | ) | 9,742 | ||||||||||||||||||||||
Mutual funds | 5,097 | 372 | (138 | ) | 5,331 | 2,095 | 221 | (98 | ) | 2,218 | ||||||||||||||||||||||
Total | $ | 11,596 | $ | 849 | $ | (219 | ) | $ | 12,226 | $ | 90,560 | $ | 1,269 | $ | (368 | ) | $ | 91,461 | ||||||||||||||
Held-to-maturity: | ||||||||||||||||||||||||||||||||
Certificates of deposit | $ | 18,059 | $ | — | $ | — | $ | 18,059 | $ | 31,214 | $ | — | $ | — | $ | 31,214 | ||||||||||||||||
As of September 30, 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 September 30, 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 September 30, 2014 | As of December 31, 2013 | |||||||||||||||
($000) | Cost | Fair Value | Cost | Fair Value | ||||||||||||
Available-for-sale: | ||||||||||||||||
Due in one year or less | $ | — | $ | — | $ | 45,486 | $ | 45,402 | ||||||||
Due in one to two years | — | — | 34,107 | 34,099 | ||||||||||||
Equity securities, exchange-traded funds, and mutual funds | 11,596 | 12,226 | 10,967 | 11,960 | ||||||||||||
Total | $ | 11,596 | $ | 12,226 | $ | 90,560 | $ | 91,461 | ||||||||
Held-to-maturity: | ||||||||||||||||
Due in one year or less | $ | 18,054 | $ | 18,054 | $ | 31,210 | $ | 31,210 | ||||||||
Due in one to three years | 5 | 5 | 4 | 4 | ||||||||||||
Total | $ | 18,059 | $ | 18,059 | $ | 31,214 | $ | 31,214 | ||||||||
As of September 30, 2014 and December 31, 2013, held-to-maturity investments included a $1.5 million 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 September 30 | Nine months ended September 30 | |||||||||||||||
($000) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Realized gains | $ | 158 | $ | 94 | $ | 731 | $ | 2,320 | ||||||||
Realized losses | — | (136 | ) | (226 | ) | (1,214 | ) | |||||||||
Realized gains (losses), net | $ | 158 | $ | (42 | ) | $ | 505 | $ | 1,106 | |||||||
We determine realized gains and losses using the specific identification method.
The following table shows the net unrealized gains (losses) on trading securities as recorded in our Condensed Consolidated Statements of Income:
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
($000) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Unrealized gains (losses), net | $ | 272 | $ | (741 | ) | $ | 117 | $ | (468 | ) | ||||||
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The table below shows the fair value of our assets subject to fair value measurements 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:
Fair Value | Fair Value Measurements as of September 30, 2014 | |||||||||||||||
as of | Using Fair Value Hierarchy | |||||||||||||||
($000) | September 30, 2014 | Level 1 | Level 2 | Level 3 | ||||||||||||
Available-for-sale investments: | ||||||||||||||||
Government obligations | $ | — | $ | — | $ | — | $ | — | ||||||||
Corporate bonds | — | — | — | — | ||||||||||||
Foreign obligations | — | — | — | — | ||||||||||||
Commercial paper | — | — | — | — | ||||||||||||
Equity securities and exchange-traded funds | 6,895 | 6,895 | — | — | ||||||||||||
Mutual funds | 5,331 | 5,331 | — | — | ||||||||||||
Trading securities | 8,205 | 8,205 | — | — | ||||||||||||
Cash equivalents | 428 | 428 | — | — | ||||||||||||
Total | $ | 20,859 | $ | 20,859 | $ | — | $ | — | ||||||||
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 | $ | — | ||||||||