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, 2018
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 every Interactive Data File required to be submitted 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 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | Emerging growth company o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 19, 2018, there were 42,660,038 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, 2018 and 2017 | ||||
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017 | ||||
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 | ||||
Unaudited Condensed Consolidated Statement of Equity for the nine months ended September 30, 2018 | ||||
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 | ||||
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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 millions, except per share amounts) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Revenue | $ | 261.3 | $ | 229.9 | $ | 757.2 | $ | 668.6 | ||||||||
Operating expense: | ||||||||||||||||
Cost of revenue | 100.0 | 90.9 | 302.2 | 283.2 | ||||||||||||
Sales and marketing | 35.8 | 31.1 | 113.7 | 100.2 | ||||||||||||
General and administrative | 35.4 | 33.3 | 103.6 | 93.2 | ||||||||||||
Depreciation and amortization | 24.7 | 21.8 | 71.2 | 64.8 | ||||||||||||
Total operating expense | 195.9 | 177.1 | 590.7 | 541.4 | ||||||||||||
Operating income | 65.4 | 52.8 | 166.5 | 127.2 | ||||||||||||
Non-operating income (expense), net: | ||||||||||||||||
Interest expense, net | (0.2 | ) | (0.9 | ) | (1.2 | ) | (2.6 | ) | ||||||||
Gain on sale of investments, reclassified from other comprehensive income | 0.3 | 0.3 | 0.9 | 1.1 | ||||||||||||
Gain on sale of business | — | — | — | 17.5 | ||||||||||||
Gain on sale of product line | — | — | 10.5 | — | ||||||||||||
Gain on sale of equity investments | 5.6 | — | 5.6 | — | ||||||||||||
Other income (expense), net | 1.6 | (1.4 | ) | 2.2 | (4.0 | ) | ||||||||||
Non-operating income (expense), net | 7.3 | (2.0 | ) | 18.0 | 12.0 | |||||||||||
Income before income taxes and equity in net income (loss) of unconsolidated entities | 72.7 | 50.8 | 184.5 | 139.2 | ||||||||||||
Equity in net income (loss) of unconsolidated entities | 0.3 | — | (1.6 | ) | (1.0 | ) | ||||||||||
Income tax expense | 16.1 | 16.9 | 42.3 | 40.2 | ||||||||||||
Consolidated net income | $ | 56.9 | $ | 33.9 | $ | 140.6 | $ | 98.0 | ||||||||
Net income per share: | ||||||||||||||||
Basic | $ | 1.33 | $ | 0.80 | $ | 3.30 | $ | 2.29 | ||||||||
Diluted | $ | 1.32 | $ | 0.79 | $ | 3.27 | $ | 2.28 | ||||||||
Dividends per common share: | ||||||||||||||||
Dividends declared per common share | $ | — | $ | — | $ | 0.50 | $ | 0.46 | ||||||||
Dividends paid per common share | $ | 0.25 | $ | 0.23 | $ | 0.75 | $ | 0.69 | ||||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 42.6 | 42.5 | 42.6 | 42.8 | ||||||||||||
Diluted | 43.1 | 42.8 | 43.0 | 43.1 | ||||||||||||
See notes to unaudited condensed consolidated financial statements.
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Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Consolidated net income | $ | 56.9 | $ | 33.9 | $ | 140.6 | $ | 98.0 | ||||||||
Other comprehensive (loss) income: | ||||||||||||||||
Foreign currency translation adjustment | (6.1 | ) | 10.0 | (20.2 | ) | 29.9 | ||||||||||
Unrealized gains (losses) on securities, net of tax: | ||||||||||||||||
Unrealized holding gains arising during period | 0.5 | 0.9 | 0.8 | 3.5 | ||||||||||||
Reclassification gains included in net income | (0.2 | ) | (0.3 | ) | (0.7 | ) | (0.8 | ) | ||||||||
Other comprehensive (loss) income | (5.8 | ) | 10.6 | (20.1 | ) | 32.6 | ||||||||||
Comprehensive income | $ | 51.1 | $ | 44.5 | $ | 120.5 | $ | 130.6 | ||||||||
See notes to unaudited condensed consolidated financial statements.
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Morningstar, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions, except share amounts) | As of September 30, 2018 (unaudited) | As of December 31, 2017 | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 323.0 | $ | 308.2 | ||||
Investments | 43.7 | 45.1 | ||||||
Accounts receivable, less allowance of $4.5 and $3.2, respectively | 172.4 | 148.2 | ||||||
Income tax receivable | 7.8 | — | ||||||
Deferred commissions | 14.2 | — | ||||||
Other current assets | 22.8 | 28.3 | ||||||
Total current assets | 583.9 | 529.8 | ||||||
Property, equipment, and capitalized software, less accumulated depreciation and amortization of $333.1 and $284.7, respectively | 144.5 | 147.4 | ||||||
Investments in unconsolidated entities | 58.4 | 62.0 | ||||||
Goodwill | 559.2 | 564.9 | ||||||
Intangible assets, net | 79.3 | 95.4 | ||||||
Deferred commissions, non-current | 9.8 | — | ||||||
Other assets | 4.4 | 6.2 | ||||||
Total assets | $ | 1,439.5 | $ | 1,405.7 | ||||
Liabilities and equity | ||||||||
Current liabilities: | ||||||||
Accounts payable and accrued liabilities | $ | 42.5 | $ | 49.2 | ||||
Accrued compensation | 85.6 | 92.0 | ||||||
Deferred revenue | 189.0 | 171.3 | ||||||
Other current liabilities | 4.2 | 10.7 | ||||||
Total current liabilities | 321.3 | 323.2 | ||||||
Accrued compensation | 11.9 | 11.7 | ||||||
Deferred tax liability, net | 30.2 | 23.6 | ||||||
Long-term debt | 90.0 | 180.0 | ||||||
Deferred rent | 25.3 | 26.9 | ||||||
Deferred revenue, non-current | 14.6 | 14.2 | ||||||
Other long-term liabilities | 18.6 | 21.2 | ||||||
Total liabilities | 511.9 | 600.8 | ||||||
Equity: | ||||||||
Morningstar, Inc. shareholders’ equity: | ||||||||
Common stock, no par value, 200,000,000 shares authorized, of which 42,670,728 and 42,547,707 shares were outstanding as of September 30, 2018 and December 31, 2017, respectively | — | — | ||||||
Treasury stock at cost, 10,728,410 and 10,633,637 shares as of September 30, 2018 and December 31, 2017, respectively | (717.0 | ) | (708.2 | ) | ||||
Additional paid-in capital | 616.3 | 601.0 | ||||||
Retained earnings | 1,095.0 | 958.7 | ||||||
Accumulated other comprehensive loss: | ||||||||
Currency translation adjustment | (68.1 | ) | (47.9 | ) | ||||
Unrealized gain on available-for-sale investments | 1.4 | 1.3 | ||||||
Total accumulated other comprehensive loss | (66.7 | ) | (46.6 | ) | ||||
Total equity | 927.6 | 804.9 | ||||||
Total liabilities and equity | $ | 1,439.5 | $ | 1,405.7 | ||||
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, 2018
Morningstar, Inc. Shareholders’ Equity | |||||||||||||||||||||||||||
Accumulated Other Comprehensive Loss | |||||||||||||||||||||||||||
Common Stock | Additional Paid-in Capital | ||||||||||||||||||||||||||
(in millions, except share amounts) | Shares Outstanding | Par Value | Treasury Stock | Retained Earnings | Total Equity | ||||||||||||||||||||||
Balance as of December 31, 2017 | 42,547,707 | $ | — | $ | (708.2 | ) | $ | 601.0 | $ | 958.7 | $ | (46.6 | ) | $ | 804.9 | ||||||||||||
Cumulative effect of accounting change related to the adoption of ASU No. 2014-09 | 17.0 | 17.0 | |||||||||||||||||||||||||
Net income | — | — | — | 140.6 | — | 140.6 | |||||||||||||||||||||
Other comprehensive income (loss): | |||||||||||||||||||||||||||
Unrealized gain on available-for-sale investments, net of income tax of $0.1 | — | — | — | — | 0.8 | 0.8 | |||||||||||||||||||||
Reclassification of adjustments for gain included in net income, net of income tax of $0.2 | — | — | — | — | (0.7 | ) | (0.7 | ) | |||||||||||||||||||
Foreign currency translation adjustment, net | — | — | — | — | (20.2 | ) | (20.2 | ) | |||||||||||||||||||
Other comprehensive income (loss) | — | — | — | — | (20.1 | ) | (20.1 | ) | |||||||||||||||||||
Issuance of common stock related to option exercises and vesting of restricted stock units, net of shares withheld for taxes on settlements of restricted stock units | 232,310 | — | 1.7 | (13.1 | ) | — | — | (11.4 | ) | ||||||||||||||||||
Reclassification of awards previously liability-classified that were converted to equity | — | — | 4.5 | — | — | 4.5 | |||||||||||||||||||||
Stock-based compensation | — | — | 23.9 | — | — | 23.9 | |||||||||||||||||||||
Common shares repurchased | (109,289 | ) | — | (10.5 | ) | — | — | — | (10.5 | ) | |||||||||||||||||
Dividends declared | — | — | — | (21.3 | ) | — | (21.3 | ) | |||||||||||||||||||
Balance as of September 30, 2018 | 42,670,728 | $ | — | $ | (717.0 | ) | $ | 616.3 | $ | 1,095.0 | $ | (66.7 | ) | $ | 927.6 | ||||||||||||
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 millions) | 2018 | 2017 | ||||||
Operating activities | ||||||||
Consolidated net income | $ | 140.6 | $ | 98.0 | ||||
Adjustments to reconcile consolidated net income to net cash flows from operating activities: | ||||||||
Depreciation and amortization | 71.2 | 64.8 | ||||||
Deferred income taxes | 6.5 | 1.0 | ||||||
Stock-based compensation expense | 23.9 | 16.5 | ||||||
Provision for bad debt | 2.6 | 1.3 | ||||||
Equity in net loss of unconsolidated entities | 1.6 | 1.0 | ||||||
Gain on sale of business | — | (17.5 | ) | |||||
Gain on sale of product line | (10.5 | ) | — | |||||
Gain on sale of equity investments | (5.6 | ) | — | |||||
Other, net | (3.3 | ) | 2.9 | |||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (29.1 | ) | (0.3 | ) | ||||
Other assets | 8.8 | (3.0 | ) | |||||
Deferred commissions | 24.0 | — | ||||||
Accounts payable and accrued liabilities | 5.9 | (4.3 | ) | |||||
Accrued compensation | (31.6 | ) | 0.2 | |||||
Income taxes, current | (13.7 | ) | 1.6 | |||||
Deferred revenue | 21.0 | 6.2 | ||||||
Deferred rent | (1.4 | ) | (1.1 | ) | ||||
Other liabilities | (1.4 | ) | (2.6 | ) | ||||
Cash provided by operating activities | 209.5 | 164.7 | ||||||
Investing activities | ||||||||
Purchases of investments | (23.7 | ) | (22.7 | ) | ||||
Proceeds from maturities and sales of investments | 22.3 | 20.6 | ||||||
Capital expenditures | (55.2 | ) | (46.4 | ) | ||||
Acquisitions, net of cash acquired | — | (1.0 | ) | |||||
Proceeds from sale of a business | — | 23.7 | ||||||
Proceeds from sale of a product line | 10.5 | — | ||||||
Proceeds from sale of equity investments | 7.9 | — | ||||||
Purchases of equity investments | (0.5 | ) | (24.3 | ) | ||||
Other, net | (0.3 | ) | 0.6 | |||||
Cash used for investing activities | (39.0 | ) | (49.5 | ) | ||||
Financing activities | ||||||||
Common shares repurchased | (10.8 | ) | (41.3 | ) | ||||
Dividends paid | (31.9 | ) | (29.6 | ) | ||||
Repayment of long-term debt | (90.0 | ) | (45.0 | ) | ||||
Proceeds from stock-option exercises | 0.1 | 0.2 | ||||||
Employee taxes paid from withholding of restricted stock units | (11.5 | ) | (3.4 | ) | ||||
Other, net | (1.1 | ) | (0.4 | ) | ||||
Cash used for financing activities | (145.2 | ) | (119.5 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (10.5 | ) | 15.5 | |||||
Net increase in cash and cash equivalents | 14.8 | 11.2 | ||||||
Cash and cash equivalents—beginning of period | 308.2 | 259.1 | ||||||
Cash and cash equivalents—end of period | $ | 323.0 | $ | 270.3 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for income taxes | $ | 55.3 | $ | 37.5 | ||||
Cash paid for interest | $ | 2.7 | $ | 3.8 | ||||
Supplemental information of non-cash investing and financing activities: | ||||||||
Unrealized (loss) gain on available-for-sale investments | $ | (0.2 | ) | $ | 3.5 | |||
Software and equipment obtained under long-term financing arrangement | $ | — | $ | 3.1 | ||||
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 unaudited 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, 2017, filed with the SEC on March 1, 2018 (our Annual Report).
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
SAB: Staff Accounting Bulletin
2. Summary of Significant Accounting Policies
Significant changes to our accounting policies as a result of adopting ASU 2014-09, Revenue from Contracts with Customers, are discussed below. We discuss our other significant accounting policies in Note 2 of our Audited Consolidated Financial Statements included in our Annual Report.
Recently adopted accounting pronouncements
Revenue Recognition: On May 28, 2014, the FASB issued ASU No. 2014-09 (Topic 606), 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 original effective date for ASU 2014-09 would have required us to adopt it beginning on January 1, 2017. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers—Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 for one year and permitted early adoption as early as the original effective date. We elected the deferral, and the new standard was effective for us on January 1, 2018. We also adopted ASU No. 2016-08, ASU No. 2016-10, ASU No. 2016-11, ASU No. 2016-12, and ASU No. 2016-20 on January 1, 2018.
We adopted Topic 606 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Upon adoption, we recognized the cumulative effect of adopting this guidance as an adjustment to our opening balance of retained earnings. Prior periods were not retrospectively adjusted.
The impact to revenue as a result of applying Topic 606 was an increase of $1.7 million and $5.0 million for the three and nine months ended September 30, 2018, respectively, and relates to a change in presentation of revenue and costs associated with third-party content and data. Such revenue and costs were presented on a net basis prior to the adoption of Topic 606 and are now presented on a gross basis.
We also changed our accounting for expenses related to our sales commission plans as a result of adopting Topic 606. Due to our method of adoption, we recorded a deferred commission asset, and related deferred tax liability, as of January 1, 2018 for sales commissions that were expensed in prior periods. This change resulted in an opening net adjustment to retained earnings of $17.0 million, with an offsetting increase to our deferred commissions and deferred income tax liabilities relating to prior periods.
9
The following table summarizes the cumulative effect of the changes to our unaudited condensed consolidated balance sheet as of January 1, 2018 from the adoption of Topic 606:
(in millions) | Balance at December 31, 2017 | Adjustments due to Topic 606 | Balance at January 1, 2018 | |||||||||
Assets: | ||||||||||||
Deferred commissions, current and non-current | $ | — | $ | 22.7 | $ | 22.7 | ||||||
Liabilities: | ||||||||||||
Deferred income tax liability | $ | — | $ | 5.7 | $ | 5.7 | ||||||
Equity: | ||||||||||||
Retained earnings | $ | — | $ | 17.0 | $ | 17.0 | ||||||
The following table illustrates the impact that adopting Topic 606 has had on our reported results in the unaudited condensed consolidated balance sheet as of September 30, 2018 and the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2018:
As of September 30, 2018 | ||||||||||||
(in millions) | As Reported | Impact of adopting Topic 606 | Balances without adoption of Topic 606 | |||||||||
Balance Sheet: | ||||||||||||
Accounts receivable, less allowance | $ | 172.4 | $ | — | $ | 172.4 | ||||||
Deferred commissions, current and non-current | 24.0 | 24.0 | — | |||||||||
Deferred revenue, current and non-current | 203.6 | — | 203.6 | |||||||||
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2018 | 2018 | |||||||||||||||||||||||
(in millions) | As Reported | Impact of adopting Topic 606 | Balances without adoption of Topic 606 | As Reported | Impact of adopting Topic 606 | Balances without adoption of Topic 606 | ||||||||||||||||||
Income Statement: | ||||||||||||||||||||||||
Revenue | $ | 261.3 | $ | 1.7 | $ | 259.6 | $ | 757.2 | $ | 5.0 | $ | 752.2 | ||||||||||||
Cost of revenue | 100.0 | 1.7 | 98.3 | 302.2 | 5.0 | 297.2 | ||||||||||||||||||
Sales and marketing | 35.8 | 1.5 | 37.3 | 113.7 | 1.7 | 115.4 | ||||||||||||||||||
Operating income | 65.4 | (1.5 | ) | 63.9 | 166.5 | (1.7 | ) | 164.8 | ||||||||||||||||
We recognize revenue by applying the following five-step model to each of our customer arrangements:
1.Identify the customer contract
2.Identify the performance obligations in the contract
3.Determine the transaction price
4.Allocate the transaction price to the performance obligations
5.Recognize revenue when (or as) performance obligations are satisfied
10
Revenues are recognized when (or as) performance obligations are satisfied by transferring a promised product or service to the customer. Products or services are transferred when (or as) the customer obtains control of the product or service. The transaction price for a customer arrangement is the amount we expect to be entitled to in exchange for transferring the promised product or service. The transaction price may include fixed amounts, variable amounts, or both. Amounts invoiced in excess of the revenue recognized for the services transferred during the period will result in an increase to deferred revenue. The timing of cash payments is typically thirty to sixty days after the performance obligation has been satisfied and these payments reduce our outstanding accounts receivable.
Revenue from contracts with customers is derived from license-based arrangements, asset-based arrangements, and transaction-based arrangements.
License-based revenue is generated through subscription contracts with our customers of Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, Morningstar Enterprise Components, PitchBook Data, and other similar products. Our performance obligations under these contracts are typically satisfied over time, as the customer has access to the product or service during the term of the subscription license and the level of service is consistent during the contract period. Therefore, we recognize revenue for these performance obligations on a straight-line basis, typically over terms of 12 to 36 months.
Asset-based revenue is generated through consulting service contracts with our customers of Morningstar Investment Management, Workplace Solutions, and Morningstar Indexes. Our performance obligations under these contracts are satisfied over time as the customer receives continuous access to a service for the contract term. We recognize revenue over the contract term based on the value of assets under management and a tiered fee agreed to with the customer (typically in a range of 30-55 basis points of the customer’s average daily portfolio balance). Asset-based arrangements typically have a term of 12 to 36 months. The fees from such arrangements represent variable consideration, and the customer does not make separate purchasing decisions that result in additional performance obligations. Significant changes in the underlying fund assets, or significant disruptions in the market, are evaluated to determine if revisions on estimates of earned asset-based fees for the current quarter are needed. An estimate of variable consideration is included in the initial transaction price only to the extent it is probable that a significant reversal in the amount of revenue recognized will not occur. Estimates of asset-based fees are based on the most recently reported quarter, and, as a result, it is unlikely a significant reversal of revenue would occur.
Transaction-based revenue is generated through contracts with our customers for Internet advertising, Morningstar Conferences, and Morningstar Credit Ratings. Our performance obligations for Internet advertising and Morningstar Conferences are satisfied as the service is delivered, and therefore we recognize revenue when the performance obligation is satisfied (as the customer’s advertisements are displayed and at the completion of the Morningstar Conference). Our performance obligations for Morningstar Credit Ratings include the issuance of the rating, and may include surveillance services for a period of time as agreed with the customer. We allocate the transaction price to the deliverables based on their relative selling price, which is generally based on the price we charge when the same deliverable is sold separately. Our performance obligation for the issuance of the rating is satisfied when the rating is issued, which is when we recognize the related revenue. Our performance obligations for surveillance services is satisfied over time, as the customer has access to the service during the surveillance period and the level of service is consistent during the contract period. Therefore, we recognize revenue for this performance obligation on a straight-line basis.
Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its estimated standalone selling price. We generally determine standalone selling prices based on prices charged to customers when the same performance obligation is sold separately.
Our contracts with customers may include third-party involvement in providing goods or services to the customer. The inclusion of third-party content does not result in separate performance obligations because is it not delivered separately from the other license obligations. In these arrangements, the customer has contracted to receive a single, bundled solution with third-party and Morningstar content delivered via Morningstar’s subscription services. Revenue and related costs of revenue from third-party content is presented on a gross basis within the condensed consolidated interim financial statements.
11
Sales Commissions: We capitalize sales incentive compensation costs (sales commissions), which are considered directly attributable to obtaining a customer contract. Such costs are capitalized using a portfolio approach that aggregates these costs by legal entity within their geographical regions. Capitalized sales commissions are amortized using the straight-line method over a period that is consistent with the transfer of the products or services to the customer to which the sales commission relates. The period of transfer for each portfolio is the shorter of the weighted-average customer life, or the economic life of the underlying technology that delivers the products or services. As of September 30, 2018, the period of transfer was determined to be two to three years. Discretionary amounts which are added to sales commission payments are expensed as incurred, as they are not considered to be directly attributable to obtaining a customer contract.
Financial Instruments: On January 5, 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The new standard was effective for us on January 1, 2018. The adoption of ASU No. 2016-01 on January 1, 2018 had no impact on our consolidated financial statements and related disclosures.
Statement of Cash Flows: On August 26, 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, which reduces diversity in practice of how certain transactions are classified in the statement of cash flows. The new guidance clarifies the classification of cash activities related to debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate and bank-owned life insurance policies, distributions received from equity-method investments, and beneficial interests in securitization transactions. The guidance also describes a predominance principle in which cash flows with aspects of more than one class that cannot be separated should be classified based on the activity that is likely to be the predominant source or use of cash flow. The new standard was effective for us on January 1, 2018. The adoption of ASU No. 2016-15 on January 1, 2018 had no impact on our consolidated financial statements and related disclosures.
Business Combinations: On January 5, 2017, the FASB issued ASU No. 2017-01, Business Combinations: Clarifying the Definition of a Business, which revises the definition of a business. When substantially all of the fair value of gross assets acquired is concentrated in a single asset (or a group of similar assets), the assets acquired would not represent a business. To be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs. The new guidance provides a framework to evaluate when an input and substantive process are present (including for early-stage companies that have not generated outputs). To be a business without outputs, there will now need to be an organized workforce. The new guidance also narrows the definition of the term outputs to be consistent with how it is described in Topic 606, Revenue from Contracts with Customers. The new standard was effective for us on January 1, 2018. The adoption of ASU No. 2017-01 on January 1, 2018 had no impact on our consolidated financial statements and related disclosures.
Compensation—Stock Compensation: On May 10, 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation: Scope of Modification Accounting, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The new standard was effective for us on January 1, 2018. The adoption of ASU No. 2017-09 on January 1, 2018 had no impact on our consolidated financial statements and related disclosures.
Income Taxes: On March 13, 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, which allowed SEC registrants to record provisional amounts in earnings for the year ended December 31, 2017 due to the complexities involved in accounting for the enactment of the Tax Reform Act. We recognized the estimated income tax effects of the Tax Reform Act in our Audited Consolidated Financial Statements included in our Annual Report in accordance with SEC Staff Accounting Bulletin No. 118 (SAB 118). Refer to Note 10 for further information regarding the provisional amounts that we recorded as of December 31, 2017.
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Recently issued accounting pronouncements not yet adopted
Leases: On February 25, 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will require lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability. The new standard is effective for us on January 1, 2019. The new standard required the use of a modified retrospective approach upon adoption. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842) -Targeted Improvements, which allows an additional transition method to adopt the new lease standard at the adoption date, as compared to the beginning of the earliest period presented, and recognize a cumulative-effect adjustment to the beginning balance of retained earnings in the period of adoption. We plan to elect this transition method at the adoption date of January 1, 2019. We continue to evaluate the effect that ASU No. 2016-02 will have on our consolidated financial statements and related disclosures. We are progressing on our project plan and achieving project milestones related to our comprehensive review of our lease portfolio, including identification of all leases where the company is either a lessor or lessee. We are implementing processes and lease accounting software to assist in our ongoing lease data collection and analysis, and updating our accounting policies and internal controls that would be impacted by the new guidance, to ensure readiness for adoption in the first quarter of 2019.
Intangibles—Goodwill and Other: On January 26, 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other, which simplifies the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. The new standard is effective for us on January 1, 2020. The new standard is required to be applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. We are evaluating the effect that ASU No. 2017-04 will have on our consolidated financial statements and related disclosures.
Income Statement-Reporting Comprehensive Income: On February 14, 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, to address a specific consequence of the Tax Cuts and Jobs Act (the Tax Reform Act) by allowing a reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from the Tax Reform Act’s reduction of the U.S. federal corporate income tax rate. The new standard is effective for us on January 1, 2019 and is to be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Reform Act is recognized. Early adoption is permitted. We are evaluating the effect that ASU No. 2018-02 will have on our consolidated financial statements and related disclosures.
Compensation—Stock Compensation: On June 20, 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718) - Improvements to Nonemployee Share-Based Payment Accounting, which aligns the accounting for share-based payment awards issued to employees and nonemployees. Under ASU No. 2018-07, the existing employee guidance will apply to nonemployee share-based transactions (as long as the transaction is not effectively a form of financing), with the exception of specific guidance related to the attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an expected term in the option-pricing model for nonemployee awards. The new standard is effective for us on January 1, 2019. Early adoption is permitted, including in interim periods, and should be applied to all new awards granted after the date of adoption. We are evaluating the effect that ASU No. 2018-07 will have on our consolidated financial statements and related disclosures.
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Cloud Computing: On August 29, 2018, the FASB issued ASU No. 2018-15, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which helps entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (CCA) by providing guidance for determining when an arrangement includes a software license and when an arrangement is solely a hosted CCA service. Under ASU No. 2018-15, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. The new guidance also prescribes the balance sheet, income statement, and cash flow classification of the capitalized implementation costs and related amortization expense, and requires additional quantitative and qualitative disclosures. The new standard is effective for us on January 1, 2020. Early adoption is permitted, including adoption in any interim period for which financial statements have not been issued. Entities can choose to adopt the new guidance prospectively to eligible costs incurred on or after the date this guidance is first applied or retrospectively. We are evaluating the effect that ASU No. 2018-15 will have on our consolidated financial statements and related disclosures.
3. Credit Arrangements
We are party to a credit agreement that provides us with a three-year credit facility expiring in November 2019 with a borrowing capacity of up to $300.0 million. The credit agreement also provides for issuance of up to $25.0 million of letters of credit under the revolving credit facility.
The interest rate applicable to any loan under the credit agreement is, at our option, either: (i) the applicable London interbank offered rate (LIBOR) plus an applicable margin for such loans, which ranges between 1.00% and 1.75%, based on our consolidated leverage ratio or (ii) the lender's base rate plus the applicable margin for such loans, which ranges between 2.00% and 2.75%, based on our consolidated leverage ratio.
The credit agreement also contains financial covenants under which we: (i) may not exceed a maximum consolidated leverage ratio of 3.00 to 1.00 and (ii) are required to maintain a minimum consolidated interest coverage ratio of not less than 3.00 to 1.00. We were in compliance with the financial covenants as of September 30, 2018.
Our outstanding principal balance was $90.0 million at a one-month LIBOR interest rate plus 100 basis points as of September 30, 2018, leaving borrowing availability of $210.0 million.
4. Goodwill and Other Intangible Assets
Goodwill
The following table shows the changes in our goodwill balances from December 31, 2017 to September 30, 2018:
(in millions) | ||||
Balance as of December 31, 2017 | $ | 564.9 | ||
Foreign currency translation | (5.7 | ) | ||
Balance as of September 30, 2018 | $ | 559.2 | ||
We did not record any impairment losses in the first nine months of 2018 and 2017. We perform our annual impairment reviews in the fourth quarter and when triggering events are identified.
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Intangible Assets
The following table summarizes our intangible assets:
As of September 30, 2018 | As of December 31, 2017 | |||||||||||||||||||||||||||
(in millions) | Gross | Accumulated Amortization | Net | Weighted Average Useful Life (years) | Gross | Accumulated Amortization | Net | Weighted Average Useful Life (years) | ||||||||||||||||||||
Intellectual property | $ | 31.4 | $ | (29.1 | ) | $ | 2.3 | 9 | $ | 31.5 | $ | (28.9 | ) | $ | 2.6 | 9 | ||||||||||||
Customer-related assets | 154.4 | (111.4 | ) | 43.0 | 12 | 156.6 | (108.1 | ) | 48.5 | 12 | ||||||||||||||||||
Supplier relationships | 0.3 | (0.2 | ) | 0.1 | 20 | 0.2 | (0.1 | ) | 0.1 | 20 | ||||||||||||||||||
Technology-based assets | 127.1 | (93.5 | ) | 33.6 | 7 | 127.9 | (84.2 | ) | 43.7 | 7 | ||||||||||||||||||
Non-competition agreements | 2.4 | (2.1 | ) | 0.3 | 5 | 2.5 | (2.0 | ) | 0.5 | 5 | ||||||||||||||||||
Total intangible assets | $ | 315.6 | $ | (236.3 | ) | $ | 79.3 | 10 | $ | 318.7 | $ | (223.3 | ) | $ | 95.4 | 10 | ||||||||||||
The following table summarizes our amortization expense related to intangible assets:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Amortization expense | $ | 5.2 | $ | 5.5 | $ | 15.7 | $ | 18.1 | ||||||||
We amortize intangible assets using the straight-line method over their expected economic useful lives.
We expect intangible amortization expense for the remainder of 2018 and subsequent years as follows:
(in millions) | ||||
Remainder of 2018 (from October 1 through December 31) | $ | 4.9 | ||
2019 | 19.1 | |||
2020 | 16.2 | |||
2021 | 12.9 | |||
2022 | 5.1 | |||
Thereafter | 21.1 | |||
Our estimates of future amortization expense for intangible assets may be affected by acquisitions, divestitures, changes in the estimated average useful lives, and foreign currency translation.
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5. Income Per Share
The following table shows how we reconcile our net income and the number of shares used in computing basic and diluted net income per share:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions, except per share amounts) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Basic net income per share: | ||||||||||||||||
Consolidated net income | $ | 56.9 | $ | 33.9 | $ | 140.6 | $ | 98.0 | ||||||||
Weighted average common shares outstanding | 42.6 | 42.5 | 42.6 | 42.8 | ||||||||||||
Basic net income per share | $ | 1.33 | $ | 0.80 | $ | 3.30 | $ | 2.29 | ||||||||
Diluted net income per share: | ||||||||||||||||
Consolidated net income | $ | 56.9 | $ | 33.9 | $ | 140.6 | $ | 98.0 | ||||||||
Weighted average common shares outstanding | 42.6 | 42.5 | 42.6 | 42.8 | ||||||||||||
Net effect of dilutive stock options, restricted stock units, performance share awards, and market stock units | 0.5 | 0.3 | 0.4 | 0.3 | ||||||||||||
Weighted average common shares outstanding for computing diluted income per share | 43.1 | 42.8 | 43.0 | 43.1 | ||||||||||||
Diluted net income per share | $ | 1.32 | $ | 0.79 | $ | 3.27 | $ | 2.28 | ||||||||
The number of weighted average restricted stock units, performance share awards, and market stock units excluded from our calculation of diluted earnings per share, as their inclusion would have been anti-dilutive, was immaterial during the periods presented.
6. Revenue
Disaggregation of Revenue
The following table presents our revenue disaggregated by revenue type. Sales and usage-based taxes are excluded from revenue.
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
License-based | $ | 196.7 | $ | 169.5 | $ | 559.5 | $ | 492.9 | ||||||||
Asset-based | 50.5 | 46.2 | 149.9 | 134.0 | ||||||||||||
Transaction-based | 14.1 | 14.2 | 47.8 | 41.7 | ||||||||||||
Consolidated revenue | $ | 261.3 | $ | 229.9 | $ | 757.2 | $ | 668.6 | ||||||||
License-based performance obligations are generally satisfied over time as the customer has access to the product or service during the term of the subscription license and the level of service is consistent during the contract period. License-based agreements typically have a term of 12 to 36 months. License-based revenue includes Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, Morningstar Enterprise Components, Morningstar Research, PitchBook Data, and other similar products.
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Asset-based performance obligations are satisfied over time as the customer receives continuous access to a service for the term. Asset-based arrangements typically have a term of 12 to 36 months. The asset based fees represent variable consideration and the customer does not make separate purchasing decisions that result in additional performance obligations. Significant changes in the underlying fund assets, or significant disruptions in the market, are evaluated to determine if revisions of estimates of earned asset-based fees are needed for the current quarter. An estimate of variable consideration is included in the initial transaction price only to the extent it is probable that a significant reversal in the amount of the revenue recognized will not occur. Estimates of asset based fees are based on the most recently completed quarter and as a result, it is unlikely a significant reversal of revenue would occur. Asset-based revenue includes Morningstar Investment Management, Workplace Solutions, and Morningstar Indexes.
Transaction-based performance obligations are satisfied when the product or service is completed or delivered. Transaction-based revenue includes Morningstar Credit Ratings, Internet Advertising Sales, and Conferences. Morningstar Credit Ratings may include surveillance services, which are recognized over time, as the customer has access to the service during the surveillance period.
Contract liabilities
Our contract liabilities represent deferred revenue. We record contract liabilities when cash payments are received or due in advance of our performance, including amounts which are refundable. The contract liabilities balance for the nine months ended September 30, 2018 had a net increase of $18.1 million, primarily driven by cash payments received or due in advance of satisfying our performance obligations. We recognized $153.6 million of revenue in the nine-month period ended September 30, 2018 that was included in the contract liabilities balance as of December 31, 2017.
We expect to recognize revenue related to our contract liabilities for the remainder of 2018 and subsequent years as follows:
(in millions) | As of September 30, 2018 | |||
Remainder of 2018 (from October 1 through December 31) | $ | 137.6 | ||
2019 | 246.7 | |||
2020 | 69.9 | |||
2021 | 17.4 | |||
2022 | 8.9 | |||
Thereafter | 37.5 | |||
$ | 518.0 | |||
The aggregate amount of revenue we expect to recognize for the remainder of 2018 and subsequent years is higher than our contract liability balance of $203.6 million as of September 30, 2018. The difference represents the value of performance obligations for signed contracts where we have not yet begun to satisfy the performance obligations, partially satisfied performance obligations, or have not yet billed the customer.
The table above does not include variable consideration for unsatisfied performance obligations related to certain of our asset-based and transaction-based contracts as of September 30, 2018. We are applying the optional exemption as the variable consideration relates to these unsatisfied performance obligations being fulfilled as a series. The performance obligations related to these contracts are expected to be satisfied over the next 12 to 36 months as services are provided to the client. For asset-based contracts, the consideration received for services performed is based on future asset values, which will be known at the time the services are performed. The variable consideration for this revenue can be affected by changes in the underlying value of fund assets due to client redemptions, additional investments, or significant movements in the market. For transaction-based contracts such as Internet advertising, the consideration received for services performed is based on the number of impressions, which will be known once impressions are created. The variable consideration for this revenue can be affected by the timing and quantity of impressions in any given period.
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The table above does not include revenue for unsatisfied performance obligations related to certain of our license-based and transaction-based contracts as of September 30, 2018. We are applying the optional exemption as the performance obligations for such contracts have an expected duration of one year or less. For certain license-based contracts, the remaining performance obligation is expected to be less than one year based on the corresponding subscription terms. For transaction-based contracts such as new credit rating issuances and the Morningstar conference, the related performance obligations are expected to be satisfied within the next twelve months.
Contract Assets
Our contract assets represent accounts receivable, less allowance and deferred commissions. We did not record any impairment losses on receivables or deferred commissions in the first nine months of 2018.
The following table summarizes our contract assets balance:
(in millions) | As of September 30, 2018 | As of December 31, 2017 | ||||||
Accounts receivable, less allowance | $ | 172.4 | $ | 148.2 | ||||
Deferred commissions | 14.2 | — | ||||||
Deferred commissions, non-current | 9.8 | — | ||||||
Total contract assets | $ | 196.4 | $ | 148.2 | ||||
The following table shows the change in our deferred commissions balance from January 1, 2018 to September 30, 2018:
(in millions) | ||||
Balance as of January 1, 2018 | $ | 22.7 | ||
Commissions earned and capitalized | 13.8 | |||
Amortization of capitalized amounts | (12.5 | ) | ||
Balance as of September 30, 2018 | $ | 24.0 | ||
7. Segment and Geographical Area Information
Segment Information
We 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 the Audited Consolidated Financial Statements and Notes thereto included in our Annual Report. We evaluate the performance of our reporting segment based on revenue and operating income.
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Geographical Area Information
The tables below summarize our revenue and long-lived assets by geographical area:
Revenue by geographical area | ||||||||||||||||
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
United States | $ | 198.7 | $ | 171.8 | $ | 566.0 | $ | 503.4 | ||||||||
United Kingdom | 17.9 | 17.0 | 54.6 | 47.5 | ||||||||||||
Continental Europe | 20.1 | 18.2 | 60.3 | 51.0 | ||||||||||||
Australia | 9.9 | 8.8 | 31.2 | 25.5 | ||||||||||||
Canada | 7.4 | 7.5 | 22.6 | 22.0 | ||||||||||||
Asia | 5.9 | 5.3 | 18.1 | 15.7 | ||||||||||||
Other | 1.4 | 1.3 | 4.4 | 3.5 | ||||||||||||
Total International | 62.6 | 58.1 | 191.2 | 165.2 | ||||||||||||
Consolidated revenue | $ | 261.3 | $ | 229.9 | $ | 757.2 | $ | 668.6 | ||||||||
Long-lived assets by geographical area | ||||||||
(in millions) | As of September 30, 2018 | As of December 31, 2017 | ||||||
United States | $ | 128.4 | $ | 131.9 | ||||
United Kingdom | 4.3 | 6.0 | ||||||
Continental Europe | 1.3 | 1.7 | ||||||
Australia | 5.1 | 2.3 | ||||||
Canada | 0.3 | 0.2 | ||||||
Asia | 5.1 | 5.2 | ||||||
Other | — | 0.1 | ||||||
Total International | 16.1 | 15.5 | ||||||
Consolidated property, equipment, and capitalized software, net | $ | 144.5 | $ | 147.4 | ||||
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8. Investments and Fair Value Measurements
We classify our investments into three categories: available-for-sale, held-to-maturity, and trading securities. Our investment portfolio consists of stocks, bonds, options, mutual funds, money market funds, or exchange-traded products that replicate the model portfolios and strategies created by Morningstar. These investment accounts may also include exchange-traded products where Morningstar is an index provider. We classify our investment portfolio as shown below:
(in millions) | As of September 30, 2018 | As of December 31, 2017 | ||||||
Available-for-sale | $ | 23.1 | $ | 21.5 | ||||
Held-to-maturity | 18.8 | 21.9 | ||||||
Trading securities | 1.8 | 1.7 | ||||||
Total | $ | 43.7 | $ | 45.1 | ||||
The following table shows the cost, unrealized gains (losses), and fair value of investments classified as available-for-sale and held-to-maturity:
As of September 30, 2018 | As of December 31, 2017 | |||||||||||||||||||||||||||||||
(in millions) | Cost | Unrealized Gain | Unrealized Loss | Fair Value | Cost | Unrealized Gain | Unrealized Loss | Fair Value | ||||||||||||||||||||||||
Available-for-sale: | ||||||||||||||||||||||||||||||||
Equity securities and exchange-traded funds | $ | 18.5 | $ | 2.5 | $ | (0.8 | ) | $ | 20.2 | $ | 17.1 | $ | 2.4 | $ | (0.6 | ) | $ | 18.9 | ||||||||||||||
Mutual funds | 2.8 | 0.2 | (0.1 | ) | 2.9 | 2.4 | 0.2 | — | 2.6 | |||||||||||||||||||||||
Total | $ | 21.3 | $ | 2.7 | $ | (0.9 | ) | $ | 23.1 | $ | 19.5 | $ | 2.6 | $ | (0.6 | ) | $ | 21.5 | ||||||||||||||
Held-to-maturity: | ||||||||||||||||||||||||||||||||
Certificates of deposit | $ | 18.8 | $ | — | $ | — | $ | 18.8 | $ | 19.9 | $ | — | $ | — | $ | 19.9 | ||||||||||||||||
Convertible note | — | — | — | — | 2.0 | — | — | 2.0 | ||||||||||||||||||||||||
Total | $ | 18.8 | $ | — | $ | — | $ | 18.8 | $ | 21.9 | $ | — | $ | — | $ | 21.9 | ||||||||||||||||
As of September 30, 2018 and December 31, 2017, investments with unrealized losses for greater than a 12-month period were not material to the Unaudited 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, 2018 and December 31, 2017.
As of September 30, 2018 | As of December 31, 2017 | |||||||||||||||
(in millions) | Cost | Fair Value | Cost | Fair Value | ||||||||||||
Available-for-sale: | ||||||||||||||||
Equity securities, exchange-traded funds, and mutual funds | $ | 21.3 | $ | 23.1 | $ | 19.5 | $ | 21.5 | ||||||||
Total | $ | 21.3 | $ | 23.1 | $ | 19.5 | $ | 21.5 | ||||||||
Held-to-maturity: | ||||||||||||||||
Due in one year or less | $ | 18.6 | $ | 18.6 | $ | 19.7 | $ | 19.7 | ||||||||
Due in one to three years | 0.2 | 0.2 | 2.2 | 2.2 | ||||||||||||
Total | $ | 18.8 | $ | 18.8 | $ | 21.9 | $ | 21.9 | ||||||||
The following table shows the realized gains and losses arising from sales of our investments classified as available-for-sale recorded in our Unaudited Condensed Consolidated Statements of Income:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Realized gains | $ | 0.5 | $ | 0.4 | $ | 1.4 | $ | 1.3 | ||||||||
Realized losses | (0.2 | ) | (0.1 | ) | (0.5 | ) | (0.2 | ) | ||||||||
Realized gains, net | $ | 0.3 | $ | 0.3 | $ | 0.9 | $ | 1.1 | ||||||||
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 Unaudited Condensed Consolidated Statements of Income:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Unrealized gains, net | $ | — | $ | — | $ | — | $ | 0.1 | ||||||||
The table below shows the fair value of our assets subject to fair value measurements on a recurring basis using a fair value hierarchy:
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. |
Fair Value | Fair Value Measurements as of September 30, 2018 | |||||||||||||||
as of | Using Fair Value Hierarchy | |||||||||||||||
(in millions) | September 30, 2018 | Level 1 | Level 2 | Level 3 | ||||||||||||
Available-for-sale investments: | ||||||||||||||||
Equity securities and exchange-traded funds | $ | 20.2 | $ | 20.2 | $ | — | $ | — | ||||||||
Mutual funds | 2.9 | 2.9 | — | — | ||||||||||||
Trading securities | 1.8 | 1.8 | — | — | ||||||||||||
Cash equivalents | 0.5 | 0.5 | — | — | ||||||||||||
Total | $ | 25.4 | $ | 25.4 | $ | — | $ | — | ||||||||
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Fair Value | Fair Value Measurements as of December 31, 2017 | |||||||||||||||
as of | Using Fair Value Hierarchy | |||||||||||||||
(in millions) | December 31, 2017 | Level 1 | Level 2 | Level 3 | ||||||||||||
Available-for-sale investments: | ||||||||||||||||
Equity securities and exchange-traded funds | $ | 18.9 | $ | 18.9 | $ | — | $ | — | ||||||||
Mutual funds | 2.6 | 2.6 | — | — | ||||||||||||
Trading securities | 1.7 | 1.7 | — | — | ||||||||||||
Cash equivalents | 0.5 | 0.5 | — | — | ||||||||||||
Total | $ | 23.7 | $ | 23.7 | $ | — | $ | — | ||||||||
Based on our analysis of the nature and risks of our investments in equity securities and mutual funds, we 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. We did not hold any securities categorized as Level 2 or Level 3 as of September 30, 2018 and December 31, 2017.
9. Stock-Based Compensation
Stock-Based Compensation Plans
All of our employees and our non-employee directors are eligible for awards under the Morningstar 2011 Stock Incentive Plan, which provides for a variety of stock-based awards, including stock options, restricted stock units, performance share awards, market stock units, and restricted stock.
The following table summarizes the stock-based compensation expense included in each of our operating expense categories:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Cost of revenue | $ | 3.1 | $ | 2.2 | $ | 9.0 | $ | 6.6 | ||||||||
Sales and marketing | 0.8 | 0.7 | 2.5 | 2.1 | ||||||||||||
General and administrative | 3.4 | 2.6 | 12.4 | 7.8 | ||||||||||||
Total stock-based compensation expense | $ | 7.3 | $ | 5.5 | $ | 23.9 | $ | 16.5 | ||||||||
As of September 30, 2018, the total unrecognized stock-based compensation cost related to outstanding restricted stock units, performance share awards, and market stock units expected to vest was $44.2 million, which we expect to recognize over a weighted average period of 32 months.
22
10. Income Taxes
Effective Tax Rate
The following table shows our effective tax rate for the three and nine months ended September 30, 2018 and September 30, 2017:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Income before income taxes and equity in net income (loss) of unconsolidated entities | $ | 72.7 | $ | 50.8 | $ | 184.5 | $ | 139.2 | ||||||||
Equity in net income (loss) of unconsolidated entities | 0.3 | — | (1.6 | ) | (1.0 | ) | ||||||||||
Total | $ | 73.0 | $ | 50.8 | $ | 182.9 | $ | 138.2 | ||||||||