Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31,
2009
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)
(312) 696-6000
(Registrants
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
o
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
o
|
Accelerated
filer
x
|
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 May 1,
2009, there were 47,686,546 shares of the Companys common stock, no par value,
outstanding.
Table of
Contents
PART 1. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Morningstar, Inc.
and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
|
|
Three Months Ended March 31
|
|
(in thousands except per share amounts)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
116,732
|
|
$
|
125,444
|
|
|
|
|
|
|
|
Operating expense
(1):
|
|
|
|
|
|
Cost of goods sold
|
|
30,252
|
|
32,938
|
|
Development
|
|
9,300
|
|
10,115
|
|
Sales and marketing
|
|
17,536
|
|
22,224
|
|
General and
administrative
|
|
17,153
|
|
19,325
|
|
Depreciation and
amortization
|
|
7,866
|
|
6,157
|
|
Total operating
expense
|
|
82,107
|
|
90,759
|
|
|
|
|
|
|
|
Operating income
|
|
34,625
|
|
34,685
|
|
|
|
|
|
|
|
Non-operating
income (expense):
|
|
|
|
|
|
Interest income,
net
|
|
978
|
|
1,519
|
|
Other income
(expense), net
|
|
(444
|
)
|
272
|
|
Non-operating
income, net
|
|
534
|
|
1,791
|
|
|
|
|
|
|
|
Income before
income taxes and equity in net income of unconsolidated entities
|
|
35,159
|
|
36,476
|
|
|
|
|
|
|
|
Income tax expense
|
|
10,668
|
|
13,504
|
|
|
|
|
|
|
|
Equity in net
income of unconsolidated entities
|
|
382
|
|
352
|
|
|
|
|
|
|
|
Consolidated net
income
|
|
24,873
|
|
23,324
|
|
|
|
|
|
|
|
Net (income) loss
attributable to the noncontrolling interest
|
|
89
|
|
(248
|
)
|
|
|
|
|
|
|
Net income
attributable to Morningstar, Inc.
|
|
$
|
24,962
|
|
$
|
23,076
|
|
|
|
|
|
|
|
Net income per
share attributable to Morningstar, Inc.:
|
|
|
|
|
|
Basic
|
|
$
|
0.53
|
|
$
|
0.51
|
|
Diluted
|
|
$
|
0.51
|
|
$
|
0.47
|
|
|
|
|
|
|
|
Weighted average
shares outstanding:
|
|
|
|
|
|
Basic
|
|
47,378
|
|
45,224
|
|
Diluted
|
|
49,167
|
|
49,010
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31
|
|
|
|
2009
|
|
2008
|
|
(1) Includes
stock-based compensation expense of:
|
|
|
|
|
|
Cost of goods sold
|
|
$
|
549
|
|
$
|
436
|
|
Development
|
|
354
|
|
321
|
|
Sales and marketing
|
|
356
|
|
345
|
|
General and
administrative
|
|
1,466
|
|
1,642
|
|
Total stock-based
compensation expense
|
|
$
|
2,725
|
|
$
|
2,744
|
|
See notes to
unaudited condensed consolidated financial statements.
3
Table of
Contents
Morningstar, Inc.
and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(in thousands except share amounts)
|
|
March 31
2009
|
|
December 31
2008
|
|
Assets
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
156,712
|
|
$
|
173,891
|
|
Investments
|
|
129,307
|
|
123,686
|
|
Accounts
receivable, less allowance of $640 and $466, respectively
|
|
88,165
|
|
89,537
|
|
Deferred tax asset,
net
|
|
3,660
|
|
3,538
|
|
Income tax
receivable
|
|
|
|
9,193
|
|
Other
|
|
13,212
|
|
13,891
|
|
Total current
assets
|
|
391,056
|
|
413,736
|
|
Property,
equipment, and capitalized software, net
|
|
60,104
|
|
58,822
|
|
Investments in
unconsolidated entities
|
|
20,661
|
|
20,404
|
|
Goodwill
|
|
186,292
|
|
187,242
|
|
Intangible assets,
net
|
|
113,915
|
|
119,812
|
|
Other assets
|
|
3,578
|
|
3,924
|
|
Total assets
|
|
$
|
775,606
|
|
$
|
803,940
|
|
|
|
|
|
|
|
Liabilities and equity
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
Accounts payable
and accrued liabilities
|
|
$
|
26,499
|
|
$
|
30,071
|
|
Accrued
compensation
|
|
16,524
|
|
73,012
|
|
Deferred revenue
|
|
133,071
|
|
130,270
|
|
Income taxes
payable
|
|
1,900
|
|
|
|
Other
|
|
5
|
|
88
|
|
Total current
liabilities
|
|
177,999
|
|
233,441
|
|
Accrued
compensation
|
|
3,971
|
|
3,611
|
|
Deferred tax
liability, net
|
|
6,062
|
|
7,531
|
|
Other long-term
liabilities
|
|
23,263
|
|
23,428
|
|
Total liabilities
|
|
211,295
|
|
268,011
|
|
|
|
|
|
|
|
Equity:
|
|
|
|
|
|
Morningstar, Inc.
shareholders equity:
|
|
|
|
|
|
Common stock, no
par value, 200,000,000 shares authorized, of which 47,564,595 and 47,282,958
shares were outstanding as of March 31, 2009 and December 31, 2008,
respectively
|
|
4
|
|
4
|
|
Treasury stock at
cost, 228,625 shares at March 31, 2009 and 233,332 at December 31,
2008
|
|
(3,214
|
)
|
(3,280
|
)
|
Additional paid-in
capital
|
|
396,345
|
|
390,404
|
|
Retained earnings
|
|
189,251
|
|
164,289
|
|
Accumulated other
comprehensive income (loss):
|
|
|
|
|
|
Currency
translation adjustment
|
|
(18,996
|
)
|
(16,366
|
)
|
Unrealized gain on
available-for-sale securities
|
|
613
|
|
481
|
|
Total accumulated
other comprehensive loss
|
|
(18,383
|
)
|
(15,885
|
)
|
Total
Morningstar, Inc. shareholders equity
|
|
564,003
|
|
535,532
|
|
Noncontrolling
interest
|
|
308
|
|
397
|
|
Total equity
|
|
564,311
|
|
535,929
|
|
Total liabilities
and equity
|
|
$
|
775,606
|
|
$
|
803,940
|
|
See notes to
unaudited condensed consolidated financial statements.
4
Table of
Contents
Morningstar, Inc.
and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity and Comprehensive
Income
(Loss)
For
the Three Months Ended March 31, 2009
|
|
Morningstar, Inc. Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
Additional
|
|
|
|
Comprehensive
|
|
Non-
|
|
|
|
|
|
Shares
|
|
Par
|
|
Treasury
|
|
Paid-in
|
|
Retained
|
|
Income
|
|
controlling
|
|
Total
|
|
(in thousands, except share amounts)
|
|
Outstanding
|
|
Value
|
|
Stock
|
|
Capital
|
|
Earnings
|
|
(Loss)
|
|
Interest
|
|
Equity
|
|
Balance as of December 31,
2008
|
|
47,282,958
|
|
$
|
4
|
|
$
|
(3,280
|
)
|
$
|
390,404
|
|
$
|
164,289
|
|
$
|
(15,885
|
)
|
$
|
|
|
$
|
535,532
|
|
Adoption of SFAS No. 160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
397
|
|
397
|
|
Balance as of January 1,
2009
|
|
47,282,958
|
|
4
|
|
(3,280
|
)
|
390,404
|
|
164,289
|
|
(15,885
|
)
|
397
|
|
535,929
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net income (loss)
|
|
|
|
|
|
|
|
|
|
24,962
|
|
|
|
(89
|
)
|
24,873
|
|
Unrealized gain on investments, net of income tax of $116
|
|
|
|
|
|
|
|
|
|
|
|
132
|
|
|
|
132
|
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
(2,630
|
)
|
|
|
(2,630
|
)
|
Total comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
24,962
|
|
(2,498
|
)
|
(89
|
)
|
22,375
|
|
Issuance of common stock related to stock option exercises
and vesting of restricted stock units, net
|
|
281,637
|
|
|
|
66
|
|
2.866
|
|
|
|
|
|
|
|
2,932
|
|
Stock-based compensation
|
|
|
|
|
|
|
|
2,725
|
|
|
|
|
|
|
|
2,725
|
|
Tax benefit derived from stock option exercises and
vesting of restricted stock units
|
|
|
|
|
|
|
|
350
|
|
|
|
|
|
|
|
350
|
|
Balance as of March 31,
2009
|
|
47,564,595
|
|
$
|
4
|
|
$
|
(3,214
|
)
|
$
|
396,345
|
|
$
|
189,251
|
|
$
|
(18,383
|
)
|
$
|
308
|
|
$
|
564,311
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to
unaudited condensed consolidated financial statements.
5
Table of
Contents
Morningstar, Inc.
and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
|
|
Three Months Ended March 31
|
|
(in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Operating activities
|
|
|
|
|
|
Consolidated net
income
|
|
$
|
24,873
|
|
$
|
23,324
|
|
Adjustments to
reconcile consolidated net income to net cash flows from operating
activities:
|
|
|
|
|
|
Depreciation and
amortization
|
|
7,866
|
|
6,157
|
|
Deferred income tax
expense (benefit)
|
|
(1,311
|
)
|
2,876
|
|
Stock-based
compensation expense
|
|
2,725
|
|
2,744
|
|
Provision for
(recovery of) bad debt
|
|
223
|
|
(27
|
)
|
Equity in net
income of unconsolidated entities
|
|
(382
|
)
|
(352
|
)
|
Excess tax benefits
from stock option exercises and vesting of restricted stock units
|
|
(350
|
)
|
(5,967
|
)
|
Other, net
|
|
409
|
|
24
|
|
Changes in
operating assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
Accounts receivable
|
|
169
|
|
(5,706
|
)
|
Other assets
|
|
351
|
|
(1,967
|
)
|
Accounts payable
and accrued liabilities
|
|
(4,111
|
)
|
2,770
|
|
Accrued
compensation
|
|
(55,039
|
)
|
(41,930
|
)
|
Income taxes
current
|
|
11,382
|
|
7,102
|
|
Deferred revenue
|
|
4,060
|
|
9,221
|
|
Deferred rent
|
|
(156
|
)
|
3,383
|
|
Other liabilities
|
|
969
|
|
(275
|
)
|
Cash provided by
(used for) operating activities
|
|
(8,322
|
)
|
1,377
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
Purchases of
investments
|
|
(22,403
|
)
|
(24,301
|
)
|
Proceeds from sale
of investments
|
|
16,752
|
|
43,951
|
|
Capital
expenditures
|
|
(4,590
|
)
|
(6,711
|
)
|
Acquisitions, net
of cash acquired
|
|
(60
|
)
|
(50,902
|
)
|
Other, net
|
|
98
|
|
|
|
Cash used for
investing activities
|
|
(10,203
|
)
|
(37,963
|
)
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
Proceeds from stock
options exercises
|
|
2,932
|
|
5,750
|
|
Excess tax benefits
from stock option exercises and vesting of restricted stock units
|
|
350
|
|
5,967
|
|
Other
|
|
(176
|
)
|
|
|
Cash provided by
financing activities
|
|
3,106
|
|
11,717
|
|
|
|
|
|
|
|
Effect of exchange
rate changes on cash
|
|
(1,760
|
)
|
1,230
|
|
Net decrease in
cash and cash equivalents
|
|
(17,179
|
)
|
(23,639
|
)
|
Cash and cash
equivalents beginning of period
|
|
173,891
|
|
159,576
|
|
Cash and cash
equivalents end of period
|
|
$
|
156,712
|
|
$
|
135,937
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
Cash paid for
income taxes
|
|
$
|
665
|
|
$
|
2,057
|
|
Supplemental information of non-cash investing and financing
activities:
|
|
|
|
|
|
Unrealized gain on
available-for-sale investments
|
|
$
|
248
|
|
$
|
294
|
|
See notes to
unaudited condensed consolidated financial statements.
6
Table of Contents
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) included herein have been
prepared to conform to the rules and regulations of the Securities and
Exchange Commission (SEC). The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amount of assets, liabilities, revenue, and expenses. Actual results could
differ from those estimates. In the opinion of management, the statements
reflect all adjustments, which are of a normal recurring nature, necessary to
present fairly our financial position, results of operations, equity, and cash
flows. These financial statements and notes should be read in conjunction with
our Consolidated Financial Statements and Notes thereto as of December 31,
2008 included in our Annual Report on Form 10-K filed with the SEC on March 5,
2009.
2.
Summary of Significant Accounting Policies
We discuss our
significant accounting policies in Note 2 of our Consolidated Financial
Statements included in our Annual Report on Form 10-K filed with the SEC
for the year ended December 31, 2008.
In addition, effective January 1, 2009, we adopted the following
financial accounting standards:
SFAS No. 160,
Accounting and Reporting of Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
Statement of
Financial Accounting Standards (SFAS) No. 160,
Accounting and Reporting of Noncontrolling Interests in Consolidated
Financial Statements, an amendment of ARB No. 51,
amends the
financial accounting and reporting of noncontrolling interests in consolidated
financial statements. A noncontrolling
interest is the portion of equity (net assets) in a subsidiary not
attributable, directly or indirectly, to the parent company. We conduct our business operations outside of
the United States through wholly owned or majority-owned operating subsidiaries. As a result of adopting SFAS No. 160,
the noncontrolling interest related to a majority-owned subsidiary is now
reported in our consolidated statement of financial position within equity,
separately from the shareholders equity attributable to Morningstar, Inc. In addition, the net income or loss and
comprehensive income or loss attributed to the Morningstar, Inc.
shareholders and the noncontrolling interest is presented in our Statements of
Income and Statement of Equity and Comprehensive Income.
SFAS No. 141(R),
Business
Combinations
SFAS No. 141(R),
Business Combinations
, modifies
the financial accounting and reporting of business combinations. For business
combinations which occur after January 1, 2009, SFAS No. 141(R) requires
the acquirer to recognize and measure the fair value of the acquired operation
as a whole, and the assets acquired and liabilities assumed at their full fair
values as of the date control is obtained, regardless of the percentage
ownership in the acquired operation or how the acquisition was achieved. In addition, under SFAS No.141 (R),
acquisition-related costs are expensed as incurred. Prior to the adoption of SFAS 141 (R), direct
costs incurred in connection with a business combination, such as finders
fees, advisory, accounting, legal, valuation, and other professional fees were
included as part of the cost of the acquired business. Restructuring costs are recognized separately
from the business combination accounting as post-combination expenses of the
combined entity unless the criteria of SFAS No. 146,
Accounting
for Costs Associated with Exit or Disposal Activities
, are met on
the acquisition date by the target entity. Prior to the adoption of SFAS No. 141
(R), restructuring costs such as severance and relocation of employees of the
acquired entity could be included in the purchase price allocation assuming
certain criteria were met.
7
Table of
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3.
Acquisitions, Goodwill, and Other Intangible Assets
We did not complete
any acquisitions in the first quarter of 2009.
In the first quarter of 2008, we acquired the Hemscott data, media, and
investor relations Web site businesses.
In addition, we completed 5 additional acquisitions throughout the
remainder of 2008.
The table below
summarizes the acquisitions completed during 2008. We did not make any
significant changes to the purchase price allocations compared with the
preliminary estimates existing at December 31, 2008. Additional information concerning these
acquisitions can be found in the Notes to our
Consolidated Financial Statements included in our Annual
Report on Form 10-K filed with the SEC on March 5, 2009.
Acquisition
|
|
Description
|
|
Date Completed
|
|
Purchase Price*
|
|
Hemscott data, media, and investor relations Web site
businesses
|
|
U.K.-based operation providing more than 20 years of
comprehensive fundamental data on publicly listed companies in the United
States, Canada, the United Kingdom, and Ireland; free and paid investment
research sites and data services; online investor relations services in the
United Kingdom
|
|
January 9, 2008
|
|
$51.3 million
|
|
Financial Computer Support, Inc. (FCSI)
|
|
Leading provider of practice management software for
independent advisors
|
|
September 2, 2008
|
|
$
4.9 million
|
|
Fundamental Data Limited (Fundamental Data)
|
|
Leading provider of data on closed-end funds in the United
Kingdom
|
|
October 2, 2008
|
|
$
18.6 million
|
|
10-K Wizard Technology, LLC (10-K Wizard)
|
|
Leading provider of SEC filing research and alert services
|
|
December 4, 2008
|
|
$
11.5 million
|
|
Tenfore Systems Limited (Tenfore)
|
|
Global provider of real-time market data and financial
data workstations based in the United Kingdom
|
|
December 17, 2008
|
|
$
19.2 million
|
|
InvestData (Proprietary) Limited (InvestData)
|
|
Leading provider of fund information in South Africa
|
|
December 29, 2008
|
|
Not disclosed
|
|
* Total purchase price less cash acquired
Goodwill
The following table
shows the changes in our goodwill balances from January 1, 2008 to March 31,
2009:
|
|
($000)
|
|
Balance as of
January 1, 2008
|
|
$
|
128,141
|
|
Acquisition of the
Hemscott data, media, and investor relations Web site businesses
|
|
35,683
|
|
Acquisition of
Fundamental Data
|
|
13,669
|
|
Acquisition of 10-K
Wizard
|
|
7,219
|
|
Acquisition of
Tenfore
|
|
13,916
|
|
Acquisition of FCSI
and InvestData
|
|
3,858
|
|
Other, primarily
currency translation
|
|
(15,244
|
)
|
Balance as of
December 31, 2008
|
|
187,242
|
|
Other, primarily
currency translation
|
|
(950
|
)
|
Balance as of
March 31, 2009
|
|
$
|
186,292
|
|
We did not record any
impairment losses in the first quarter of 2009 or 2008, respectively.
8
Table of
Contents
The following table
summarizes our intangible assets:
|
|
As of March 31, 2009
|
|
As of December 31, 2008
|
|
($000)
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net
|
|
Weighted
Average
Useful Life
(years)
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net
|
|
Weighted
Average
Useful Life
(years)
|
|
Intellectual
property
|
|
$
|
26,119
|
|
$
|
(9,078
|
)
|
$
|
17,041
|
|
10
|
|
$
|
26,198
|
|
$
|
(8,338
|
)
|
$
|
17,860
|
|
10
|
|
Customer-related
assets
|
|
66,915
|
|
(19,393
|
)
|
47,522
|
|
10
|
|
67,325
|
|
(17,620
|
)
|
49,705
|
|
10
|
|
Supplier
relationships
|
|
240
|
|
(51
|
)
|
189
|
|
20
|
|
240
|
|
(48
|
)
|
192
|
|
20
|
|
Technology-based
assets
|
|
34,763
|
|
(10,698
|
)
|
24,065
|
|
9
|
|
34,845
|
|
(9,525
|
)
|
25,320
|
|
9
|
|
Non-competition
agreement
|
|
810
|
|
(417
|
)
|
393
|
|
5
|
|
810
|
|
(375
|
)
|
435
|
|
5
|
|
Intangible assets
related to acquisitions of FCSI, Fundamental Data, Tenfore, 10-K Wizard, and
InvestData
|
|
26,549
|
|
(1,844
|
)
|
24,705
|
|
5
|
|
26,962
|
|
(662
|
)
|
26,300
|
|
5
|
|
Total intangible
assets
|
|
$
|
155,396
|
|
$
|
(41,481
|
)
|
$
|
113,915
|
|
9
|
|
$
|
156,380
|
|
$
|
(36,568
|
)
|
$
|
119,812
|
|
9
|
|
We amortize
intangible assets using the straight-line method over their expected economic
useful lives. Amortization expense was $5,121,000 and $4,022,000 for the three
months ended March 31, 2009 and March 31, 2008, respectively.
As of March 31,
2009, we estimate that aggregate amortization expense for intangible assets
will be $20,115,000 in 2009; $18,648,000 in 2010; $17,215,000 in 2011;
$16,564,000 in 2012; $14,430,000 in 2013; and $9,888,000 in 2014. Our estimates of
future amortization expense for intangible assets may be
affected by changes to the preliminary purchase price allocations.
4.
Income Per Share
The numerator for
both basic and diluted income per share is net income attributable to
Morningstar, Inc. The denominator for basic income per share is the
weighted average number of common shares outstanding during the period. For
diluted income per share, the dilutive effect of outstanding employee stock
options and restricted stock units is reflected in the denominator using the
treasury stock method. The following table shows how we reconcile our net
income and the number of shares used in computing basic and diluted income per
share:
|
|
Three Months Ended March 31
|
|
(in thousands, except per share amounts)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Basic income per share attributable to Morningstar, Inc.:
|
|
|
|
|
|
Net income
attributable to Morningstar, Inc.:
|
|
$
|
24,962
|
|
$
|
23,076
|
|
Weighted average
common shares outstanding
|
|
47,378
|
|
45,224
|
|
Basic net income
per share attributable to Morningstar, Inc.
|
|
$
|
0.53
|
|
$
|
0.51
|
|
|
|
|
|
|
|
Diluted income per share attributable to Morningstar, Inc.:
|
|
|
|
|
|
Net income
attributable to Morningstar, Inc.:
|
|
$
|
24,962
|
|
$
|
23,076
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
47,378
|
|
45,224
|
|
Net effect of
dilutive stock options and restricted stock units
|
|
1,789
|
|
3,786
|
|
Weighted average
common shares outstanding for computing diluted income per share
|
|
49,167
|
|
49,010
|
|
|
|
|
|
|
|
Diluted net income
per share attributable to Morningstar, Inc.
|
|
$
|
0.51
|
|
$
|
0.47
|
|
9
Table of
Contents
5.
Segment and Geographical Area Information
Beginning in 2009, we
changed our organizational structure and operating segments. Under the new
structure, Morningstar has two operating segments: Investment Information
and Investment Management. Previously, we organized our operations based on
three audience segments: Individual, Advisor, and Institutional. The new
structure organizes our operations according to product lines and growth
strategies rather than audience segments. Under the previous segment reporting,
we allocated costs for our corporate functions to each of the segments.
Beginning in 2009, we no longer allocate corporate costs to our business
segments. We have changed the
presentation of the prior years segment information to conform with the
current years presentation.
·
Investment Information
.
The Investment Information
segment includes all of our data, software, and research products and services.
These products are typically sold through subscriptions or license agreements.
The largest products
in this segment based on revenue are Licensed Data, Morningstar Advisor
Workstation, Morningstar.com, Morningstar Direct, and Morningstar Principia.
Licensed Data is a set of investment data spanning all of our investment
databases and available through electronic data feeds. Advisor Workstation is a
Web-based investment planning system for advisors. Advisor Workstation is
available in two editions: one for independent financial advisors and an
enterprise edition for financial advisors affiliated with larger firms.
Morningstar.com includes both Premium Memberships and Internet advertising
sales. Morningstar Direct is a Web-based institutional research platform.
Principia is our CD-ROM-based investment research and planning software for
advisors.
The Investment
Information segment also includes Morningstar Equity Research, which we
distribute through several channels. Our equity research is distributed through
six major investment banks to meet the requirements for independent research
under the Global Analyst Research Settlement, as well as to several other
companies that purchase our research for their own use or provide our research
to their affiliated financial advisors or to individual investors. This segment also includes a variety of
financial communications and newsletters, real-time data, and investment
indexes.
·
Investment Management
.
The Investment Management
segment includes all of our asset management operations, which operate as
registered investment advisors and earn the majority of their revenue from
asset-based fees.
The key products and
services in this segment based on revenue are Investment Consulting, which
focuses on investment monitoring and asset allocation for funds of funds,
including mutual funds and variable annuities; Retirement Advice, including the
Morningstar Retirement Manager and Advice by Ibbotson platforms; and
Morningstar Managed Portfolios, a fee-based discretionary asset management
service that includes a series of mutual fund and exchange-traded fund
portfolios tailored to meet a range of investment time horizons and risk levels
that financial advisors can use for their clients taxable and tax-deferred accounts.
Our segment
accounting policies are the same as those described in Note 2 to our
Consolidated Financial Statements included in our Annual Report on Form 10-K
as of December 31, 2008, except for the capitalization and amortization of
internal product development costs, amortization of intangible assets, and costs
related to corporate functions. We exclude these items from our operating
segment results to provide our chief operating decision maker with a better
indication of each segments ability to generate cash flow. This information is
one of the criteria used by our chief operating decision maker in determining
how to allocate resources to each segment. We include capitalization and
amortization of internal product development costs, amortization of intangible
assets, and costs related to corporate functions in the Corporate Items
category to arrive at the consolidated financial information. Our segment
disclosures include the business segment information provided to our chief
operating decision maker on a recurring basis, and therefore, we do not present
balance sheet information by segment. We disclose goodwill by segment in
accordance with the requirements of SFAS No. 142,
Goodwill and Other Intangible Assets
.
10
Table of
Contents
The following tables
show selected segment data for the three months ended March 31, 2009 and
2008:
|
|
Three months ended March 31, 2009
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Revenue
|
|
$
|
96,240
|
|
$
|
20,492
|
|
$
|
|
|
$
|
116,732
|
|
Operating expense,
excluding stock-based compensation expense, depreciation, and amortization
|
|
57,065
|
|
8,177
|
|
6,274
|
|
71,516
|
|
Stock-based
compensation expense
|
|
1,267
|
|
468
|
|
990
|
|
2,725
|
|
Depreciation and
amortization
|
|
1,071
|
|
20
|
|
6,775
|
|
7,866
|
|
Operating income
(loss)
|
|
$
|
36,837
|
|
$
|
11,827
|
|
$
|
(14,039
|
)
|
$
|
34,625
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
3,760
|
|
$
|
184
|
|
$
|
646
|
|
$
|
4,590
|
|
|
|
|
|
|
|
|
|
|
|
U.S. revenue
|
|
|
|
|
|
|
|
$
|
88,148
|
|
Non-U.S. revenue
|
|
|
|
|
|
|
|
$
|
28,584
|
|
|
|
As of March 31, 2009
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Goodwill
|
|
$
|
154,822
|
|
$
|
31,470
|
|
$
|
|
|
$
|
186,292
|
|
|
|
|
|
|
|
|
|
|
|
U.S. long-lived
assets
|
|
|
|
|
|
|
|
$
|
45,585
|
|
Non-U.S. long-lived
assets
|
|
|
|
|
|
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, 2008
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Revenue
|
|
$
|
96,506
|
|
$
|
28,938
|
|
$
|
|
|
$
|
125,444
|
|
Operating expense,
excluding stock-based compensation expense, depreciation, and amortization
|
|
60,895
|
|
13,122
|
|
7,841
|
|
81,858
|
|
Stock-based
compensation expense
|
|
1,289
|
|
504
|
|
951
|
|
2,744
|
|
Depreciation and
amortization
|
|
1,034
|
|
53
|
|
5,070
|
|
6,157
|
|
Operating income
(loss)
|
|
$
|
33,288
|
|
$
|
15,259
|
|
$
|
(13,862
|
)
|
$
|
34,685
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
5,380
|
|
$
|
1,032
|
|
$
|
299
|
|
$
|
6,711
|
|
|
|
|
|
|
|
|
|
|
|
U.S. revenue
|
|
|
|
|
|
|
|
$
|
95,163
|
|
Non-U.S. revenue
|
|
|
|
|
|
|
|
$
|
30,281
|
|
|
|
As of March 31, 2008
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Goodwill
|
|
$
|
125,192
|
|
$
|
31,470
|
|
$
|
|
|
$
|
156,662
|
|
|
|
|
|
|
|
|
|
|
|
U.S. long-lived
assets
|
|
|
|
|
|
|
|
$
|
14,354
|
|
Non-U.S. long-lived
assets
|
|
|
|
|
|
|
|
$
|
10,946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
Table of
Contents
6.
Investments
We monitor the
concentration, diversification, maturity, and liquidity of our investment
portfolio, which is primarily invested in fixed-income securities. We classify
our investment portfolio as follows:
($000)
|
|
March 31
2009
|
|
December 31
2008
|
|
Available-for-sale
|
|
$
|
121,897
|
|
$
|
116,867
|
|
Held-to-maturity
|
|
4,204
|
|
3,497
|
|
Trading securities
|
|
3,206
|
|
3,322
|
|
Total
|
|
$
|
129,307
|
|
$
|
123,686
|
|
Held-to-maturity
investments include a $2,500,000 certificate of deposit held as collateral
against two bank guarantees for our office space lease in Australia.
7.
Fair Value Measurements
The fair value of our
assets subject to fair value measurements and the necessary disclosures are as
follows:
|
|
Fair Value
|
|
Fair Value Measurements as of March 31, 2009
|
|
|
|
as of
|
|
Using Fair Value Hierarchy
|
|
($000)
|
|
March 31, 2009
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Available-for-sale
investments
|
|
$
|
121,897
|
|
$
|
121,897
|
|
$
|
|
|
$
|
|
|
Trading securities
|
|
3,206
|
|
3,206
|
|
|
|
|
|
Total
|
|
$
|
125,103
|
|
$
|
125,103
|
|
$
|
|
|
$
|
|
|
|
|
Fair Value
|
|
Fair Value Measurements as of December 31, 2008
|
|
|
|
as of
|
|
Using Fair Value Hierarchy
|
|
($000)
|
|
December 31, 2008
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Available-for-sale
investments
|
|
$
|
116,867
|
|
$
|
116,867
|
|
$
|
|
|
$
|
|
|
Trading securities
|
|
3,322
|
|
3,322
|
|
|
|
|
|
Total
|
|
$
|
120,189
|
|
$
|
120,189
|
|
$
|
|
|
$
|
|
|
Level
1:
|
Valuations
based on quoted prices in active markets for identical assets or liabilities
that the Company has 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.
|
8.
Investments In Unconsolidated Entities
Our investments in
unconsolidated entities consist primarily of the following:
Morningstar
Japan K.K.
Morningstar
Japan K.K. (MJKK) develops and markets products and services customized
for the Japanese market. MJKKs shares are traded on the Osaka Stock Exchange, Hercules
Market, using the ticker 4765. As of March 31, 2009 and December 31,
2008, we owned approximately 34% of MJKK. We account for our investment in MJKK
using the equity method. The book value of our investment in MJKK totaled
$18,401,000 and $18,083,000 as of March 31, 2009 and December 31,
2008, respectively. The market value of our investment in MJKK was
approximately ¥2.7 billion (approximately U.S. $27,349,000) as of March 31,
2009 and ¥2.9 billion (approximately U.S. $32,536,000) as of December 31,
2008.
Morningstar
Korea, Ltd
. Morningstar
Korea provides financial information and services for investors in South Korea.
Our ownership interest and profit- and loss-sharing interest in Morningstar
Korea was 40% as of March 31, 2009 and December 31, 2008. We account
for this investment using the equity method. Our investment totaled $1,528,000
and $1,560,000 as of March 31, 2009 and December 31, 2008,
respectively.
Other
Investments in Unconsolidated Entities
. As of March 31, 2009 and December 31, 2008, the
book value of our other investments in unconsolidated entities totaled $732,000
and $761,000, respectively, and consist primarily of our investments in
Morningstar Danmark A/S (Morningstar Denmark) and Morningstar Sweden AB
(Morningstar Sweden). Morningstar Denmark and Morningstar Sweden develop and
market products and services customized for their respective markets. Our
ownership interest in both Morningstar Denmark and Morningstar Sweden was
approximately 25% as of March 31, 2009 and December 31, 2008. We
account for our investments in Morningstar Denmark and Morningstar Sweden using
the equity method.
12
Table of Contents
The
following table shows condensed combined financial information, a portion of
which is unaudited, for our investments in unconsolidated entities.
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Revenue
|
|
$
|
7,875
|
|
$
|
20,742
|
|
Operating income
|
|
$
|
791
|
|
$
|
1,626
|
|
Net income
|
|
$
|
641
|
|
$
|
1,129
|
|
In April 2008, MJKK sold one of its subsidiaries.
The information for the three months ended March 31, 2008 includes the
financial results of this subsidiary.
9. Stock-Based Compensation
Stock-Based Compensation Plans
In
November 2004, we adopted the 2004 Stock Incentive Plan. The 2004 Stock
Incentive Plan provides for grants of options, stock appreciation rights, restricted
stock units, and performance shares. All of our employees and our non-employee
directors are eligible for awards under the 2004 Stock Incentive Plan. Joe
Mansueto, our chairman and chief executive officer, does not participate in the
2004 Stock Incentive Plan or prior plans.
Since
the adoption of the 2004 Stock Incentive Plan, we have granted stock options
and, beginning in 2006, restricted stock units. Stock options granted under the
2004 Stock Incentive Plan generally vest ratably over a four-year period and
expire 10 years after the date of grant. Almost all of the options granted
under the 2004 Stock Incentive Plan have a premium feature in which the
exercise price increases over the term of the option at a rate equal to the
10-year Treasury bond yield as of the date of grant. Restricted stock units
represent the right to receive a share of Morningstar common stock when that
unit vests. Restricted stock units granted under the 2004 Stock Incentive Plan
generally vest ratably over a four-year period. For restricted stock units
granted through December 31, 2008, employees could elect to defer receipt
of the Morningstar common stock issued upon vesting of the restricted stock
unit. As of March 31, 2009, we had approximately 2,500,000 shares available
for future grants under our 2004 Stock Incentive Plan.
Prior
to November 2004, we granted stock options under various plans, including
the 1993 Stock Option Plan, the 2000 Morningstar Stock Option Plan, and the
2001 Morningstar Stock Option Plan (collectively, the Prior Plans). Options
granted under the Prior Plans generally vested over a four-year period and were
substantially all vested as of March 31, 2009; however, because the
options under these three plans expire 10 years after the date of grant, some
options granted under these plans remain outstanding as of March 31, 2009.
The 2004 Stock Incentive Plan amends and restates the Prior Plans. Under the
2004 Stock Incentive Plan, we will not grant any additional options under any
of the Prior Plans, and any shares subject to an award under any of the Prior
Plans that are forfeited, canceled, settled, or otherwise terminated without a
distribution of shares, or withheld by us in connection with the exercise of
options or in payment of any required income tax withholding, will not be
available for awards under the 2004 Stock Incentive Plan.
In
February 1999, we entered into an Incentive Stock Option Agreement and a
Nonqualified Stock Option Agreement under the 1999 Incentive Stock Option Plan
(the 1999 Plan) with Don Phillips, an officer of Morningstar. Under these
agreements, we granted Don options to purchase 1,500,000 shares of common stock
at an exercise price of $2.77 per share, equal to the fair value at the grant
date. These options were fully vested and expired in February 2009. The
30,576 options remaining as of December 31, 2008 were exercised prior to
the expiration date.
Accounting for Stock-Based Compensation Awards
In
accordance with SFAS No. 123 (R),
Stock
Based Compensation
, we estimate forfeitures of all employee
stock-based awards and recognize compensation cost only for those awards
expected to vest. We determine forfeiture rates based on historical
experience. Estimated forfeitures are adjusted to actual forfeiture
experience as needed.
The
following table summarizes stock-based compensation expense:
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Stock-based
compensation expense
|
|
$
|
2,725
|
|
$
|
2,744
|
|
|
|
|
|
|
|
|
|
The
income tax benefit related to the stock-based compensation expense above was
$867,000 and $891,000 for the three months ended March 31, 2009 and 2008,
respectively.
13
Table of Contents
Restricted Stock Units
We
measure the fair value of our restricted stock units on the date of grant based
on the closing market price of the underlying common stock on the day prior to
grant. We amortize that value to stock-based compensation expense, net of
estimated forfeitures, ratably over the vesting period. The total grant
date fair value of restricted stock units granted in the first quarter of 2009
was approximately $598,000. As of March 31, 2009, the total amount of
unrecognized stock-based compensation expense related to restricted stock units
was approximately $19,318,000. We expect to recognize this expense over an
average period of approximately 31 months.
The
following table summarizes restricted stock unit activity in the first three
months of 2009:
Restricted Stock Units (RSUs)
|
|
Unvested
|
|
Vested but
Deferred
|
|
Total
|
|
Weighted
Average
Grant Date Value
per RSU
|
|
RSUs
outstandingDecember 31, 2008
|
|
494,500
|
|
22,024
|
|
516,524
|
|
$
|
55.17
|
|
Granted
|
|
18,734
|
|
|
|
18,734
|
|
31.94
|
|
Vested
|
|
(11,089
|
)
|
|
|
(11,089
|
)
|
58.52
|
|
Forfeited
|
|
(3,303
|
)
|
|
|
(3,303
|
)
|
54.04
|
|
RSUs outstanding
March 31, 2009
|
|
498,842
|
|
22,024
|
|
520,866
|
|
53.90
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
The
following tables summarize stock option activity in the first three months of
2009 for our various stock option grants. The first table includes activity for
options granted at an exercise price below the fair value per share of our
common stock on the grant date; the second table includes activity for all
other option grants.
Options Granted At an Exercise Price Below the Fair Value Per Share on the Grant Date
|
|
Underlying
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Options outstandingDecember 31, 2008
|
|
1,110,652
|
|
$
|
15.33
|
|
Canceled
|
|
(50
|
)
|
14.70
|
|
Exercised
|
|
(211,666
|
)
|
9.92
|
|
Options
outstandingMarch 31, 2009
|
|
898,936
|
|
16.77
|
|
|
|
|
|
|
|
Options
exercisableMarch 31, 2009
|
|
898,911
|
|
$
|
16.77
|
|
All Other Option Grants, Excluding Activity Shown Above
|
|
Underlying
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Options outstandingDecember 31,
2008
|
|
2,942,706
|
|
$
|
15.14
|
|
Canceled
|
|
(1,267
|
)
|
23.22
|
|
Exercised
|
|
(61,355
|
)
|
13.22
|
|
Options outstandingMarch 31,
2009
|
|
2,880,084
|
|
15.23
|
|
|
|
|
|
|
|
Options exercisableMarch 31,
2009
|
|
2,662,639
|
|
$
|
14.55
|
|
The
total intrinsic value (difference between the market value of our stock on the
date of exercise and the exercise price of the option) of options exercised
during the three months ended March 31, 2009 and 2008 was $5,770,000 and
$41,636,000, respectively.
14
Table of Contents
The
table below shows additional information for options outstanding and options
exercisable as of March 31, 2009:
|
|
Options Outstanding
|
|
Options Exercisable
|
|
Range of Exercise Prices
|
|
Outstanding
Shares
|
|
Weighted
Average
Remaining
Contractual
Life (years)
|
|
Weighted
Average
Exercise
Price
|
|
Aggregate
Intrinsic
Value
($000)
|
|
Exercisable
Shares
|
|
Weighted
Average
Remaining
Contractual
Life (years)
|
|
Weighted
Average
Exercise
Price
|
|
Aggregate
Intrinsic
Value
($000)
|
|
$8.57 - $14.70
|
|
2,355,083
|
|
2.10
|
|
$
|
12.66
|
|
$
|
50,608
|
|
2,354,767
|
|
2.10
|
|
$
|
12.66
|
|
$
|
50,601
|
|
$17.54 - $39.83
|
|
1,423,937
|
|
5.96
|
|
20.41
|
|
19,888
|
|
1,206,783
|
|
5.92
|
|
19.84
|
|
17,506
|
|
$8.57 - $39.83
|
|
3,779,020
|
|
3.56
|
|
15.58
|
|
$
|
70,496
|
|
3,561,550
|
|
3.39
|
|
15.09
|
|
$
|
68,107
|
|
Vested or Expected to Vest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$8.57 - $39.83
|
|
3,759,085
|
|
3.54
|
|
$
|
15.54
|
|
$
|
70,277
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value, based on our closing stock price of $34.15 on March 31,
2009, which would have been received by the option holders had all option
holders exercised their options as of that date.
As
of March 31, 2009, the total amount of unrecognized stock-based
compensation expense related to non-vested stock options was approximately
$364,000. We expect to recognize this expense over a weighted average
period of approximately 5 months.
10. Related Party Transactions
In
1989, under our 1989 Nonqualified Stock Option Plan (the 1989 Plan), we granted
options to purchase 1,500,000 shares of common stock at an exercise price
of $0.075 per share, equal to the fair value at date of issue, to Don Phillips,
an officer of Morningstar. These options were not exercised and expired in February 1999.
In February 1999, in conjunction with the expiration of options granted
under the 1989 Plan, we entered into a Deferred Compensation Agreement (the
Agreement) with Don. Under the terms of the Agreement, on any date that Don
exercises the right to purchase shares under the 1999 Plan, we shall pay to him
$2.69 per share in the form of cash or, at our election, shares of common
stock. If on the date of purchase the fair value of Morningstars stock is below
$2.77 per share, the amount paid per share will be reduced based on the terms
of the Agreement. Our obligation to pay deferred compensation will not be
increased by any imputed interest or earnings amount.
As
of March 31, 2009 and December 31, 2008, our Condensed Consolidated
Balance Sheets include a liability of $27,000 and $82,000, respectively, for
the Agreement. The reduction in the liability since December 31, 2008
reflects amounts paid to Don in the first quarter of 2009 in accordance with
the Agreement.
11. Income Taxes
The
following table shows our effective income tax rate for the three months ended March 31,
2009 and 2008:
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Income before
income taxes and equity in net income of unconsolidated entities
|
|
$
|
35,159
|
|
$
|
36,476
|
|
Equity in net
income of unconsolidated entities
|
|
382
|
|
352
|
|
Net (income) loss
attributable to the noncontrolling interest
|
|
89
|
|
(248
|
)
|
Total
|
|
$
|
35,630
|
|
$
|
36,580
|
|
Income tax expense
|
|
$
|
10,668
|
|
$
|
13,504
|
|
Effective income
tax expense rate
|
|
29.9
|
%
|
36.9
|
%
|
Our
effective tax rate declined by 7.0 percentage points in the first quarter of
2009. The first-quarter 2009 income tax
expense includes the impact of reversing a $1,420,000 reserve for uncertain tax
positions as a result of a lapse in the statute of limitations. This non-cash benefit contributed
approximately 4 percentage points of the decrease in the effective tax rate in
the quarter. In addition, the favorable, but variable, benefit from incentive
stock-option transactions contributed approximately 2 percentage points to the
decrease in the effective tax rate.
We
conduct business globally and as a result, we file income tax returns in U.S.
Federal, state, local, and foreign jurisdictions. In the normal course of
business we are subject to examination by tax authorities throughout the world.
The open tax years for our U.S. Federal tax return include the years 2005 to
the present. Most of our state tax returns have open tax years from 2005 to the
present. In
non-U.S.
jurisdictions, the statute of limitations generally extends to years prior to
2003.
15
Table of Contents
As of December 31, 2008, our Consolidated Balance Sheet
included a current liability of $3,983,000 and a non-current liability of
$3,756,000 for unrecognized tax benefits.
These amounts include interest and penalties, less any associated tax
benefits. Other than the impact of reversing the $1,420,000 reserve for
uncertain tax positions, there were no significant changes to uncertain tax
positions in the first quarter of 2009 as a result of other lapses of statutes
of limitation or audit activity. We are
currently under audit by the U.S. federal and various state and local tax
authorities in the United States. We are also under audit by the tax
authorities in certain non-U.S. jurisdictions. It is likely that the
examination phase of some of these U.S. federal, state, local, and non-U.S.
audits will conclude in 2009. It is not possible to estimate the impact of
current audits on previously recorded unrecognized tax benefits.
Our
effective income tax rate reflects the fact that we are not recording an income
tax benefit related to losses recorded by certain of our non-U.S. operations.
The net operating losses (NOLs) may become deductible in certain non-U.S.
tax jurisdictions to the extent these non-U.S. operations become profitable. In
the year certain non-U.S. entities record a loss, we do not record a
corresponding tax benefit, thus increasing our effective tax rate. For each of
our operations, we evaluate whether it is more likely than not that the tax
benefits related to NOLs will be realized. As part of this evaluation, we
consider evidence such as tax planning strategies, historical operating
results, forecasted taxable income, and recent financial performance.
Upon determining that it is more likely than not that the NOLs will be
realized, we reduce the tax valuation allowances related to these NOLs, which
results in a reduction to our income tax expense and our effective tax rate in
the period.
12.
Contingencies
NewRiver, Inc.
In January 2009, NewRiver, Inc. filed a lawsuit in
the Superior Court of the Commonwealth of Massachusetts against Morningstar, Inc.
alleging that Morningstar inappropriately accessed a database containing
SEC-filed mutual fund disclosure documents. In February 2009, the case was
removed to the United States District Court for the District of Massachusetts.
NewRiver seeks, among other things, a permanent injunction preventing
Morningstar from accessing NewRivers Prospectus Express Web-based data
warehouse, and unspecified damages. While Morningstar is vigorously contesting
the claims against it, we cannot predict the outcome of the proceeding.
Morningstar Associates, LLC Subpoenas from
the Securities and Exchange Commission, the New York Attorney Generals Office,
and the Department of Labor
Securities and Exchange Commission
In February 2005, Morningstar Associates, LLC, a wholly
owned subsidiary of Morningstar, Inc., received a request from the SEC for
the voluntary production of documents relating to the investment consulting
services the company offers to retirement plan providers, including fund lineup
recommendations for retirement plan sponsors. In July 2005, the SEC issued
a subpoena to Morningstar Associates that was virtually identical to its February 2005
request.
Subsequently, the SEC focused on disclosure relating to an
optional service offered to retirement plan sponsors (employers) that select
401(k) plan services from ING, one of Morningstar Associates clients. In
response to the SEC investigation, ING and Morningstar Associates revised
certain documents for plan sponsors to further clarify the roles of ING and
Morningstar Associates in providing that service. The revisions also help
reinforce that Morningstar Associates makes its selections only from funds
available within INGs various retirement products.
In January 2007, the SEC notified Morningstar
Associates that it ended its investigation, with no enforcement action, fines,
or penalties.
New York Attorney Generals Office
In December 2004, Morningstar Associates received a
subpoena from the New York Attorney Generals office seeking information and
documents related to an investigation the New York Attorney Generals office is
conducting. The request is similar in scope to the SEC subpoena described
above. Morningstar Associates has provided the requested information and documents.
In January 2007, Morningstar Associates received a
Notice of Proposed Litigation from the New York Attorney Generals office. The
Notice centers on the same issues that became the focus of the SEC
investigation described above. The Notice gave Morningstar Associates the
opportunity to explain why the New York Attorney Generals office should not
institute proceedings. Morningstar Associates promptly submitted its
explanation and has cooperated fully with the New York Attorney Generals
office.
16
Table of Contents
We cannot predict the scope, timing, or outcome of this
matter, which may include the institution of administrative, civil,
injunctive, or criminal proceedings, the imposition of fines and penalties, and
other remedies and sanctions, any of which could lead to an adverse impact on
our stock price, the inability to attract or retain key employees, and the loss
of customers. We also cannot predict what impact, if any, this matter
may have on our business, operating results, or financial condition.
United States Department of Labor
In May 2005, Morningstar Associates received a subpoena
from the United States Department of Labor, seeking information and documents
related to an investigation the Department of Labor is conducting. The
Department of Labor subpoena is substantially similar in scope to the SEC and
New York Attorney General subpoenas.
In January 2007, the Department of Labor issued a
request for additional documents pursuant to the May 2005 subpoena,
including documents and information regarding Morningstar Associates
retirement advice products for plan participants. Morningstar Associates
continues to cooperate fully with the Department of Labor.
We cannot predict the scope, timing, or outcome of this
matter, which may include the institution of administrative, civil,
injunctive, or criminal proceedings, the imposition of fines and penalties, and
other remedies and sanctions, any of which could lead to an adverse impact on
our stock price, the inability to attract or retain key employees, and the loss
of customers. We also cannot predict what impact, if any, these matters
may have on our business, operating results, or financial condition.
In addition to these proceedings, we are involved in legal
proceedings and litigation that have arisen in the normal course of our
business. Although the outcome of a particular proceeding can never be
predicted, we do not believe that the result of any of these other matters will
have a material adverse effect on our business, operating results, or financial
condition.
13. Subsequent Events
We completed the following three acquisitions
in April and May of 2009:
Global financial filings
database business of Global Reports LLC
: In April 2009, we acquired the global
financial filings database business of Global Reports LLC, a leading provider
of online financial and Corporate and Social Responsibility reports for
publicly traded companies around the world. Global Reports provides timely
online access to full-color financial filings from more than 37,000 publicly
traded companies in approximately 130 countries.
Equity research and data
business of C.P.M.S. Computerized Portfolio Management Services Inc.:
In May 2009, we acquired the equity research
and data business of C.P.M.S. Computerized Portfolio Management Services Inc.
(C.P.M.S.). C.P.M.S. tracks fundamental
equity data for approximately 4,000 securities in the United States and Canada
as well as tracks and provides brokerage earnings estimates for Canadian
equities.
Andex Associates Inc.
In May 2009, we acquired Andex Associates
Inc., based in Windsor, Ontario, Canada. The company is known for its Andex
Charts, individual graphic charts detailing historical market returns, stock
index growth, inflation rates, currency rates, and general economic conditions
for the United States dating back to 1926, and for Canada dating back to 1950.
The charts offer in-depth historical information to help investors understand
the context and propensity of market downturns and recoveries.
The combined purchase price for these three
acquisitions was approximately $18,000,000, subject to post-closing
adjustments.
14. Recently Issued Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board
(FASB) issued three Final Staff Positions (FSPs) intended to provide additional
application guidance and enhance disclosures regarding fair value measurements
and impairments of securities.
·
FSP FAS 157-4,
Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly
,
provides guidelines for making fair value measurements more consistent with the
principles presented in SFAS No. 157,
Fair Value Measurements
.
·
FSP FAS 107-1 and APB 28-1,
Interim
Disclosures about Fair Value of Financial Instruments
, enhances
consistency in financial reporting by increasing the frequency of fair value
disclosures.
·
FSP FAS 115-2 and FAS 124-2,
Recognition
and Presentation of Other-Than-Temporary Impairments
, provides
additional guidance designed to create greater clarity and consistency in
accounting for and presenting impairment losses on securities.
The FSPs are effective for interim and annual periods ending
after June 15, 2009. We are in the
process of determining the effect the adoption of these FSPs will have on our
Consolidated Financial Statements.
Also in April 2009, the FASB also issued an FSP to
amend and clarify SFAS No. 141 (revised 2007),
Business
Combinations
, to address application issues on initial recognition
and measurement, subsequent measurement and accounting, and disclosure of
assets and liabilities arising from contingencies in a business
combination. This FSP is effective for
assets or liabilities arising from contingencies in business combinations for
which the acquisition date is on or after January 1, 2009.
17
Table of Contents
Item 2.
Managements Discussion and Analysis of
Financial Condition and Results of Operations
The discussion included in this section,
as well as other sections of this Quarterly Report on Form 10-Q, contains
forward-looking statements as that term is used in the Private Securities
Litigation Reform Act of 1995. These statements are based on our current
expectations about future events or future financial performance.
Forward-looking statements by their nature address matters that are, to
different degrees, uncertain, and often contain words such as may, could, expect,
intend, plan, seek, anticipate, believe, estimate, predict, potential,
or continue. These statements involve known and unknown risks and
uncertainties that may cause the events we discuss not to occur or to differ
significantly from what we expect. For us, these risks and uncertainties
include, among others, general industry conditions and competition, including
the current global financial crisis that began in 2007; the impact of market
volatility on revenue from asset-based fees; damage to our reputation resulting
from claims made about possible conflicts of interest; liability for any losses
that result from an actual or claimed breach of our fiduciary duties; financial
services industry consolidation; a prolonged outage of our database and network
facilities; challenges faced by our non-U.S. operations; and the availability of
free or low-cost investment information.
A
more complete description of these risks and uncertainties can be found in our
other filings with the SEC, including our Annual Report on Form 10-K for
the year ended December 31, 2008. If any of these risks and uncertainties
materialize, our actual future results may vary significantly from what we
expect. We do not undertake to update our forward-looking statements as a
result of new information or future events.
All
dollar and percentage comparisons, which are often accompanied by words such as
increase, decrease, grew, declined, was up, was down, was flat,
or was similar refer to a comparison with the same period in the prior year
unless otherwise stated.
Understanding
our Company
Our
Business
Our mission is to create great products that help investors
reach their financial goals. We offer an extensive line of Internet, software,
and print-based products for individual investors, financial advisors, and
institutional clients. We also offer asset management services for advisors,
institutions, and retirement plan participants. Many of our products are sold
through subscriptions or license agreements. As a result, we typically generate
recurring revenue.
We emphasize a decentralized approach to running our
business to empower our managers and to create a culture of responsibility and
accountability. During 2008 and previous years, we operated our business in
three global segments: Individual, Advisor, and Institutional. Beginning in
2009, we changed our segment reporting to focus on two operating segments:
Investment Information, which includes all of our data, software, and research
products and services, and Investment Management, which includes our asset
management operations.
Historically, we have focused primarily on organic growth by
introducing new products and services and marketing our existing
products. However, we have made and expect to continue to make selective
acquisitions that support our five key growth strategies, which are:
·
|
|
Enhance our position in each of our key market segments by
focusing on our three major Internet-based platforms;
|
·
|
|
Become a global leader in funds-of-funds investment
management;
|
·
|
|
Continue building thought leadership in independent
investment research;
|
·
|
|
Create a premier global investment database; and
|
·
|
|
Expand our international brand presence, products, and
services.
|
Industry
Overview
We monitor
developments in the economic and financial information industry on an ongoing
basis and use these insights to help inform our company strategy, product
development plans, and marketing initiatives.
The U.S. equity
market continued its negative performance in the first quarter of 2009 despite
an upturn in March. Morningstars U.S. Market Index, a broad market benchmark,
was down 10.6% through March 31, 2009. Most global markets also
experienced losses during the quarter. Total U.S. mutual fund assets declined
to $9.2 trillion as of March 31,
18
2009, based on data
from the Investment Company Institute (ICI), compared with $11.7 trillion as of
March 31, 2008. Many stock and bond funds experienced net outflows in the
aftermath of the global financial turmoil that began in late 2007.
Market volatility
took a toll on alternative asset classes, such as hedge funds. In aggregate,
hedge funds included in Morningstars database, excluding funds of hedge funds,
experienced net outflows of about $31 billion through February 2009.
Assets in
exchange-traded funds (ETFs) also declined to $482 billion as of March 2009,
compared with $571 billion as of March 31, 2008, based on data from the
ICI.
Based on data from
Nielsen/Net Ratings, aggregate page views and unique users to financial
and investment sites were similar to levels shown in the first quarter of 2008,
and the number of pages viewed per person and pages viewed per visit
both increased over year-ago levels. We believe this indicates that while some
investors may be disengaged because of the market downturn, many people are
still interested in investment-related content.
Market weakness and
economic uncertainty continued to weigh on online ad spending. Although
advertisers have continued to shift spending from traditional media to the
Internet, growth in online spending slowed in 2008, based on reports published
by the Interactive Advertising Bureau and PricewaterhouseCoopers. Because of
the severe market downturn and declining asset levels, ad spending for
financial services firms declined 17% for full-year 2008 based on data from The
Nielsen Company. We believe that weakness in industry-wide ad spending
continued in the first quarter, and some industry surveys indicate that many
investment management firms have planned to continue reducing their marketing
budgets in 2009.
Overall, we believe
the disruption in the financial markets continues to cause widespread investor
uncertainty and spending cutbacks among asset management firms and other
financial services companies. We remain cautious because of the difficult and
uncertain market environment. On the positive side, however, we believe some of
the uncertainty in the financial services sector began easing to some extent
along with the market upturn toward the end of the first quarter.
Three Months Ended March 31, 2009 vs. Three
Months Ended March 31, 2008
First-Quarter
Highlights
Consolidated
Results
|
|
Three Months Ended March 31
|
|
Key Metrics ($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Revenue
|
|
$
|
116,732
|
|
$
|
125,444
|
|
(6.9
|
)%
|
Operating income
|
|
34,625
|
|
34,685
|
|
(0.2
|
)%
|
Operating margin
|
|
29.7
|
%
|
27.6
|
%
|
2.1
|
pp
|
|
|
|
|
|
|
|
|
Cash used for
investing activities
|
|
$
|
(10,203
|
)
|
$
|
(37,963
|
)
|
(73.1
|
)%
|
Cash provided by
financing activities
|
|
3,106
|
|
11,717
|
|
(73.5
|
)%
|
|
|
|
|
|
|
|
|
Cash provided by
(used for) operating activities
|
|
$
|
(8,322
|
)
|
$
|
1,377
|
|
NMF
|
Capital
expenditures
|
|
(4,590
|
)
|
(6,711
|
)
|
(31.6
|
)%
|
Free cash flow
|
|
$
|
(12,912
|
)
|
$
|
(5,334
|
)
|
142.1
|
%
|
pp
percentage points
We define free cash
flow as cash provided by or used for operating activities less capital
expenditures. We present free cash flow solely as supplemental disclosure to
help you better understand how much cash is available after we spend money to
operate our business. Our management team uses free cash flow to evaluate the
performance of our business. Free cash flow is not a measure of performance set
forth under U.S. generally accepted accounting principles (GAAP). Also, the
free cash flow definition we use may not be comparable to similarly titled
measures used by other companies.
Because weve made
several acquisitions in recent years, comparing our financial results from year
to year is complex. To make it easier for investors to compare our results in
different periods, we provide information on both organic revenue, which reflects
our underlying business excluding acquisitions, and revenue from acquisitions.
We include an acquired operation as part of our revenue from acquisitions for
12 months after we complete the acquisition. After that, we include it as part
of our organic revenue.
19
Table of
Contents
Consolidated organic
revenue (revenue excluding acquisitions and the impact of foreign currency
translations) is considered a non-GAAP financial measure. The definition of
organic revenue we use may not be the same as similarly titled measures used by
other companies. Organic revenue should not be considered an alternative to any
measure of performance as promulgated under GAAP.
The table below shows
the period in which we included each acquired operation in revenue from
acquisitions.
Acquisition
|
|
Revenue from Acquisitions
|
|
|
|
Hemscott data,
media, and investor relations Web site businesses
|
|
January 1 through
January 8, 2009
|
Financial Computer
Support, Inc.
|
|
January 1
through March 31, 2009
|
Fundamental Data
Limited
|
|
January 1
through March 31, 2009
|
10-K Wizard
Technology, LLC
|
|
January 1
through March 31, 2009
|
Tenfore Systems
Limited
|
|
January 1
through March 31, 2009
|
InvestData
(Proprietary) Limited
|
|
January 1
through March 31, 2009
|
Consolidated
Revenue
In the first quarter
of 2009, our consolidated revenue decreased 6.9% to $116.7 million. The
majority of the revenue decline was driven by our Investment Consulting
business, which suffered because of continued negative market conditions as
well as the impact of one client not renewing when its contract expired in the
fourth quarter of 2008. Currency movements also had a significant negative
effect as the U.S. dollar appreciated against most other major currencies
during the quarter, offsetting the positive impact of additional revenue from
acquisitions. While acquisitions contributed about five percentage points to
our consolidated revenue growth, the impact of foreign currency translations
reduced revenue by nearly the same amount.
The table below
reconciles consolidated revenue with organic revenue (revenue excluding
acquisitions and the impact of foreign currency translations):
|
|
Three Months Ended March 31
|
|
|
|
($000)
|
|
2008
|
|
2007
|
|
Change
|
|
Consolidated
revenue
|
|
$
|
116,732
|
|
$
|
125,444
|
|
(6.9
|
)%
|
Less: acquisitions
|
|
(5,928
|
)
|
|
|
NMF
|
|
Unfavorable impact of foreign currency translations
|
|
5,697
|
|
|
|
NMF
|
|
Organic revenue
|
|
$
|
116,501
|
|
$
|
125,444
|
|
(7.1
|
)%
|
The table below shows
our consolidated revenue by segment for the three months ended March 31,
2009 and March 31, 2008:
|
|
Three Months Ended March 31
|
|
|
|
2009
|
|
2008
|
|
Revenue by Segment ($000)
|
|
Amount
|
|
% of total
|
|
Amount
|
|
% of total
|
|
Investment Information
|
|
$
|
96,240
|
|
82.4
|
%
|
$
|
96,506
|
|
76.9
|
%
|
Investment
Management
|
|
20,492
|
|
17.6
|
|
28,938
|
|
23.1
|
|
Consolidated
revenue
|
|
$
|
116,732
|
|
100.0
|
%
|
$
|
125,444
|
|
100.0
|
%
|
As previously announced, Morningstar now has two operating
segments: Investment Information and Investment Management. Previously, we
organized our operations based on three audience segments: Individual, Advisor,
and Institutional. The changes were effective January 1, 2009. The new
Investment Information segment includes all of our data, software, and research
products and services. These products and services are typically sold through
subscriptions or license agreements. The Investment Management segment includes
all of our asset management operations, which operate as registered investment
advisors and earn about half of their revenue from asset-based fees.
While revenue for the
Investment Information segment was consistent with the year-ago quarter,
revenue in the Investment Management segment was down about 29%. Investment
Consulting was by far the most significant driver behind the revenue decline.
We had lower revenue from asset-based fees as assets under advisement declined
to $63.3 billion from $95.8 billion. The lower level of assets reflects both
negative performance in the market and the impact of the client non-renewal
mentioned above.
20
Table of Contents
Revenue from
international operations decreased $1.7 million, or 5.6%, to $28.6 million in
the first quarter of 2009. Acquisitions contributed $4.0 million of additional
revenue outside the United States, but that was offset by the unfavorable
impact of foreign currency translations, which reduced international revenue by
$5.7 million. Excluding acquisitions and the impact of foreign currency
translations, our non-U.S. revenue increased approximately 0.2%.
International organic revenue (international revenue
excluding acquisitions and the impact of foreign currency translations) is
considered a non-GAAP financial measure. The definition of international
organic revenue we use may not be the same as similarly titled measures used by
other companies. International organic revenue should not be considered an alternative
to any measure of performance as promulgated under GAAP. The tables below
present a reconciliation from international revenue to international organic
revenue (international revenue excluding acquisitions and the impact of foreign
currency translations):
|
|
Three Months Ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
International
revenue
|
|
$
|
28,584
|
|
$
|
30,281
|
|
(5.6
|
)%
|
Less: acquisitions
|
|
(3,952
|
)
|
|
|
NMF
|
|
Unfavorable impact
of foreign currency translations
|
|
5,697
|
|
|
|
NMF
|
|
International organic
revenue
|
|
$
|
30,329
|
|
$
|
30,281
|
|
0.2
|
%
|
Consolidated
Operating Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Operating expense
|
|
$
|
82,107
|
|
$
|
90,759
|
|
(9.5
|
)%
|
% of revenue
|
|
70.3
|
%
|
72.4
|
%
|
(2.1
|
)pp
|
|
|
|
|
|
|
|
|
|
|
In the first quarter
of 2009, our consolidated operating expense decreased $8.7 million, or 9.5%. To
better align operating expense with revenue in this challenging business
environment, we took a number of steps to reduce costs beginning in 2008, with
the largest cutbacks effective January 1, 2009. We changed our bonus plan
in 2009 to reduce bonus expense, our single largest discretionary cost. About
80% of the decline in operating expense stems from lower bonus expense accrued
during the quarter.
We also suspended
matching contributions to our 401(k) program in the United States, which
reduced operating expense by about $2.8 million. In addition, we reduced
discretionary spending in advertising and marketing as well as travel.
Advertising and marketing costs declined by $2.3 million in the first quarter
of 2009 compared with the same period a year ago, primarily because of reduced
spending for direct mail campaigns for books and newsletters, including three
investing guides that were no longer publishing. In addition, travel costs were
about $0.8 million lower, partly because we cancelled our annual global sales
forum usually held in the first quarter.
Partially offsetting
these operating expense reductions were additional costs related to
acquisitions, including a $1.1 million increase in amortization expense. We
completed five acquisitions in the second half of 2008. Because of the timing
of these acquisitions, our first-quarter 2009 results include operating expense
that did not exist in the same period last year. Headcount and salary expense
also increased year over year, partly because of incremental employees added
through acquisitions. We had approximately 2,370 employees worldwide as of March 31,
2009, a 16% increase from the same period a year ago and about in line with December 31,
2008.
Cost
of Goods Sold
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Cost of goods sold
|
|
$
|
30,252
|
|
$
|
32,938
|
|
(8.2
|
)%
|
% of revenue
|
|
25.9
|
%
|
26.3
|
%
|
(0.4
|
)pp
|
Gross profit
|
|
$
|
86,480
|
|
$
|
92,506
|
|
(6.5
|
)%
|
Gross margin
|
|
74.1
|
%
|
73.7
|
%
|
0.4
|
pp
|
Cost of goods sold is
our largest category of operating expense, accounting for more than one-third
of our total operating expense in both the first quarter of 2009 and 2008. Our
business relies heavily on human capital, and cost of goods sold includes the
compensation expense for employees who produce our products and services.
21
Table of Contents
Cost of goods sold
was down $2.6 million in the first quarter of 2009, with the entire decline
driven by lower bonus expense.
Our gross margin in
the first quarter of 2009 increased slightly to 74.1%, compared with 73.7% in
the first quarter of 2008.
Development
Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Development expense
|
|
$
|
9,300
|
|
$
|
10,115
|
|
(8.1
|
)%
|
% of revenue
|
|
8.0
|
%
|
8.1
|
%
|
(0.1
|
)pp
|
|
|
|
|
|
|
|
|
|
|
Development expense
decreased $0.8 million in the first quarter of 2009. While compensation expense
rose because of higher headcount, that increase was more than offset by lower
bonus expense. As a percentage of revenue, development expense declined
modestly in the first quarter of 2009.
Sales
and Marketing Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Sales and marketing
expense
|
|
$
|
17,536
|
|
$
|
22,224
|
|
(21.1
|
)%
|
% of revenue
|
|
15.0
|
%
|
17.7
|
%
|
(2.7
|
)pp
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing
expense decreased $4.7 million in the first quarter of 2009. About half of the
decline reflects lower spending on advertising and marketing, which we reduced
from higher levels in 2008 because of the challenging business environment. In
2009, we also discontinued three of the publications we previously published in
the first quarter of each year: the
Morningstar
Funds 500
,
Morningstar Stocks
500
, and
Morningstar ETFs 150
and therefore didnt
incur costs to promote these publications. Lower bonus expense and other
compensation costs also contributed to lower sales and marketing expense in the
first quarter.
As a percentage of
revenue, sales and marketing expense decreased 2.7 percentage points compared
with the first quarter of 2008.
General
and Administrative Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
General and
administrative expense
|
|
$
|
17,153
|
|
$
|
19,325
|
|
(11.2
|
)%
|
% of revenue
|
|
14.7
|
%
|
15.4
|
%
|
(0.7
|
)pp
|
|
|
|
|
|
|
|
|
|
|
General and
administrative expense decreased $2.1 million in the first quarter of 2009.
Most of the decline reflects lower bonus expense. Decreases in other
compensation costs, travel, and other general and administrative costs also
contributed to lower expense in this area, but to a lesser extent.
As a percentage of
revenue, general and administrative expense dropped 0.7 percentage points in
the first quarter of 2009 compared with the same period in 2008.
Depreciation
and Amortization Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Depreciation
expense
|
|
$
|
2,745
|
|
$
|
2,135
|
|
28.6
|
%
|
Amortization
expense
|
|
5,121
|
|
4,022
|
|
27.3
|
%
|
Total depreciation
and amortization expense
|
|
$
|
7,866
|
|
$
|
6,157
|
|
27.8
|
%
|
% of revenue
|
|
6.7
|
%
|
4.9
|
%
|
1.8
|
pp
|
Depreciation and
amortization expense rose $1.7 million in the first quarter of 2009 primarily
from incremental amortization expense of intangible assets related to
acquisitions made in 2008. As a percentage of revenue, this category of expense
increased by 1.8 percentage points.
22
Table of
Contents
We expect that
amortization of intangible assets will be an ongoing cost for the remaining
life of the assets. Based on acquisitions completed through March 31,
2009, we estimate that aggregate amortization expense for intangible assets
will be $20.1 million in 2009. Our estimates of future amortization expense for
intangible assets may be affected by changes to the preliminary purchase price
allocations associated with our 2008 acquisitions.
Stock-Based
Compensation Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Stock-based
compensation expense
|
|
$
|
2,725
|
|
$
|
2,744
|
|
(0.7
|
)%
|
% of revenue
|
|
2.3
|
%
|
2.2
|
%
|
0.1
|
pp
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation expense remained relatively flat in the first quarter of 2009 and
increased slightly as a percentage of revenue compared with the same period in
2008.
We include stock-based compensation expense in each of our
operating expense categories. We began granting restricted stock units (RSUs)
in May 2006 and made additional grants in 2007 and 2008, primarily in the
second quarter of each year. We recognize the expense related to RSUs over the
vesting period, which is generally four years.
We determine stock-based compensation expense in accordance
with Statement of Financial Accounting Standards (SFAS) No. 123 (Revised
2004),
Share-Based Payment
(SFAS No. 123(R)). We
record stock-based compensation expense only for those awards that ultimately
vest. As a result, the stock-based compensation expense reflects an estimate of
an expected forfeiture rate.
Based on grants made
through March 31, 2009, we anticipate that stock-based compensation
expense will be $9.6 million in 2009. This amount is subject to change
based on additional equity grants or changes in our estimated forfeiture rate
related to these grants. We usually make this adjustment in the second quarter,
which is when most of our larger equity grants typically vest.
Bonus
Expense
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Bonus expense
|
|
$
|
5,190
|
|
$
|
12,537
|
|
(58.6
|
)%
|
% of revenue
|
|
4.4
|
%
|
10.0
|
%
|
(5.6
|
)pp
|
|
|
|
|
|
|
|
|
|
|
Bonus expense, which we include in each of our operating
expense categories, declined $7.3 million in the first quarter of 2009. Most of
this reduction reflects the changes we made to our bonus program for 2009 as
part of our efforts to better align our cost structure with revenue in the
challenging business environment. The significant reduction in bonus expense
also reflects a slowdown in our financial performance in 2009 compared with
2008.
Changes in the size of our bonus pool vary each year based
on a number of items, including changes in full-year operating income growth
relative to the previous year and other factors. We review and update our
estimates and the bonus pool size quarterly. We record bonus expense throughout
the year and pay out annual bonuses to employees in the first quarter.
As a percentage of
revenue, bonus expense declined by 5.6 percentage points in the first quarter
of 2009.
Consolidated
Operating Income
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Operating income
|
|
$
|
34,625
|
|
$
|
34,685
|
|
(0.2
|
)%
|
% of revenue
|
|
29.7
|
%
|
27.6
|
%
|
2.1
|
pp
|
|
|
|
|
|
|
|
|
|
|
Consolidated
operating income remained relatively flat, as it decreased $0.1 million in the
first quarter of 2009, reflecting the impact of cost savings measures
implemented in 2009. Even though revenue declined in the first quarter, we were
able to reduce costs in all operating expense categories except depreciation
and amortization, which rose because of additional amortization costs for
acquisitions made in 2008. The margin improvement was primarily the result of
operating expense reductions, which exceeded the decline in revenue.
23
Table of Contents
With
operating expense declining more than revenue, our operating margin increased
2.1 percentage points in the first quarter of 2009.
Consolidated Free Cash Flow
Historically,
free cash flow has been lower in the first quarter compared with the other
three quarters of the year because of the timing of our annual bonus payments.
We typically pay bonuses in the first quarter, and these payments reduce our
cash flow from operations.
Free
cash flow in the first quarter of 2009 was negative $12.9 million, reflecting
cash used for operating activities of $8.3 million and capital expenditures of
$4.6 million. We made bonus payments of $58.9 million in the first quarter of
2009, compared with $49.3 million in the first quarter of 2008. Bonuses paid in the first quarter of 2009
included $10.0 million in payments deferred from 2007. We revised our bonus
program in January 2009 and no longer defer payment of a portion of bonuses
recorded in the prior year.
Compared
with the prior-year period, free cash flow decreased by approximately $7.6
million, reflecting a $9.7 million decrease in operating cash flow partially
offset by a decrease in capital expenditures of $2.1 million.
The
increase of $9.6 million for bonus payments was the primary factor contributing
to the decline in operating cash flow. In addition, in the first quarter of
2008, operating cash flow included a $3.4 million benefit from tenant
improvement allowances related to the construction of our new corporate
headquarters. This benefit did not recur in the first quarter of 2009. These
items, which contributed to the decline in operating cash flow, were partially
offset by higher net income adjusted for non-cash items. Excess tax benefits
have a positive impact on cash provided by financing activities with an equal,
but offsetting, impact on cash from operations. Excess tax benefits declined
$5.6 million in the quarter, primarily reflecting lower average stock prices on
the exercise dates and a reduction in the number of options exercised.
Capital
expenditures decreased $2.1 million for the quarter mainly because of the
timing of payments related to our new corporate headquarters.
To
provide investors with additional insight into our financial results, we
provide a comparison between the increase in consolidated net income and the
change in operating cash flow:
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Consolidated net
income
|
|
$
|
24,873
|
|
$
|
23,324
|
|
$
|
1,549
|
|
Adjustments to
reconcile consolidated net income to net cash flows from operating
activities:
|
|
|
|
|
|
|
|
Excess tax
benefits in accordance with SFAS No. 123(R)
|
|
(350
|
)
|
(5,967
|
)
|
5,617
|
|
Depreciation and
amortization expense
|
|
7,866
|
|
6,157
|
|
1,709
|
|
Stock-based
compensation expense
|
|
2,725
|
|
2,744
|
|
(19
|
)
|
All other non-cash
items included in net income
|
|
(1,061
|
)
|
2,521
|
|
(3,582
|
)
|
Changes in
operating assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
Cash paid for
bonuses
|
|
(58,867
|
)
|
(49,253
|
)
|
(9,614
|
)
|
Cash paid for
income taxes
|
|
(665
|
)
|
(2,057
|
)
|
1,392
|
|
Accounts
receivable
|
|
169
|
|
(5,706
|
)
|
5,875
|
|
Deferred revenue
|
|
4,060
|
|
9,221
|
|
(5,161
|
)
|
Income taxes
current
|
|
12,047
|
|
9,159
|
|
2,888
|
|
Accrued
compensation
|
|
3,828
|
|
7,323
|
|
(3,495
|
)
|
Deferred rent
|
|
(156
|
)
|
3,383
|
|
(3,539
|
)
|
Other assets
|
|
351
|
|
(1,967
|
)
|
2,318
|
|
Accounts payable
and accrued liabilities
|
|
(4,111
|
)
|
2,770
|
|
(6,881
|
)
|
All other
|
|
969
|
|
(275
|
)
|
1,244
|
|
Cash provided by
(used for) operating activities
|
|
$
|
(8,322
|
)
|
$
|
1,377
|
|
$
|
(9,699
|
)
|
24
Table of Contents
Despite the $1.6 million increase in
net income, operating cash flow decreased $9.7 million. The gap between net income and operating cash
flow primarily reflects the $9.6 million increase in bonuses paid in the first
quarter of 2009. The tenant improvement
allowance of $3.4 million received in connection with the build-out of our new
headquarters was a benefit to cash flow in the first quarter of 2008, but did
not recur in the current year. The tenant improvement allowance received in
2008 is being amortized as a reduction in office lease expense over the lease
term and will be deducted from net income to arrive at cash flow provided by
(used for) operating activities.
Segment Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31
|
|
Key Metrics ($000)
|
|
2009
|
|
2008
|
|
% Change
|
|
Revenue
|
|
|
|
|
|
|
|
Investment
Information
|
|
$
|
96,240
|
|
$
|
96,506
|
|
(0.3
|
)%
|
Investment
Management
|
|
20,492
|
|
28,938
|
|
(29.2
|
)%
|
Consolidated
revenue
|
|
$
|
116,732
|
|
$
|
125,444
|
|
(6.9
|
)%
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
|
|
|
|
|
Investment
Information
|
|
$
|
36,837
|
|
$
|
33,288
|
|
10.7
|
%
|
Investment
Management
|
|
11,827
|
|
15,259
|
|
(22.5
|
)%
|
Intangible
amortization and corporate depreciation expense
|
|
(6,775
|
)
|
(5,070
|
)
|
33.6
|
%
|
Corporate
unallocated
|
|
(7,264
|
)
|
(8,792
|
)
|
(17.4
|
)%
|
Consolidated
operating income
|
|
$
|
34,625
|
|
$
|
34,685
|
|
0.2
|
%
|
|
|
|
|
|
|
|
|
Operating margin
|
|
|
|
|
|
|
|
Investment Information
|
|
38.3
|
%
|
34.5
|
%
|
3.8
|
pp
|
Investment
Management
|
|
57.7
|
%
|
52.7
|
%
|
5.0
|
pp
|
Consolidated
operating margin
|
|
29.7
|
%
|
27.6
|
%
|
2.1
|
pp
|
Investment Information Segment
The
Investment Information segment includes all of our data, software, and research
products and services. These products are typically sold through subscriptions
or license agreements.
The
largest products in this segment based on revenue are Licensed Data,
Morningstar Advisor Workstation, Morningstar.com, Morningstar Direct, and
Morningstar Principia. Licensed Data is a set of investment data spanning all
of our investment databases and available through electronic data feeds.
Advisor Workstation is a Web-based investment planning system for advisors.
Advisor Workstation is available in two editions: one for independent financial
advisors and an enterprise edition for financial advisors affiliated with
larger firms. Morningstar.com includes both Premium Memberships and Internet
advertising sales. Morningstar Direct is a Web-based institutional research
platform. Principia is our CD-ROM-based investment research and planning
software for advisors.
The
Investment Information segment also includes Morningstar Equity Research, which
we distribute through several channels. Our equity research is distributed
through six major investment banks to meet the requirements for independent
research under the Global Analyst Research Settlement, as well as to several
other companies that purchase our research for their own use or provide our
research to their affiliated financial advisors or to individual investors.
In 2003 and 2004, 12 leading Wall Street investment banks
agreed to a $1.5 billion settlement (the Global Analyst Research Settlement)
with the Securities and Exchange Commission (SEC), the New York Attorney
General, and other securities regulators to resolve allegations of undue
influence of investment banking interests on securities research. Approximately
$450 million of the $1.5 billion in fines that the investment banks agreed to
pay in the settlement has been designated for independent research over a
period of five years, with the independent research to be provided by companies
that are not engaged in the investment banking industry. Each firm involved in
the settlement is required to provide research from at least three providers of
independent research that are not engaged in the investment banking industry.
The period covered by the Global Analyst Research Settlement will expire in July 2009.
After the settlement period expires, the companies covered by it will no longer
be required to provide independent investment research to their clients. For
further discussion about this issue, see Item 1A Risk Factors in our 10-K
report for the year ended December 31, 2008.
We
also offer a variety of financial communications and newsletters, real-time
data, and investment indexes.
25
Table of Contents
In
the first quarter of 2009 and 2008, this segment represented 82.4% and 76.9%,
respectively, of our consolidated revenue.
|
|
Three months ended March 31
|
|
Key Metrics ($000)
|
|
2009
|
|
2008
|
|
% Change
|
|
Revenue
|
|
$
|
96,240
|
|
$
|
96,506
|
|
(0.3
|
)%
|
Operating income
|
|
$
|
36,837
|
|
$
|
33,288
|
|
10.7
|
%
|
Operating margin
(%)
|
|
38.3
|
%
|
34.5
|
%
|
3.8
|
pp
|
In the first quarter
of 2009, revenue decreased slightly to $96.2 million. Acquisitions contributed
$5.9 million of revenue. Excluding the impact of acquisitions, revenue declined
$6.2 million, primarily reflecting the unfavorable impact of currency
translation.
One
of the primary drivers of the decline in organic revenue was the decline in
Internet advertising related to Morningstar.com. Negative trends in Internet
advertising drove all of the decrease in this products revenue due to the
markets downturn. Subscriptions for Morningstar.com Premium service declined
by 13,521, to 168,257 as of March 31, 2009, compared with 181,778 as of March 31,
2008. Subscriptions declined by 9,261 in the quarter compared with 177,518 as
of December 31, 2008 as general market weakness affected subscriber growth
and new trials. However, consistent with the trend over the past few years, we
moderately increased subscription prices for Premium Membership in both January 2009
and 2008. Revenue growth therefore outweighed the decline in subscriptions.
Revenue from our Investment
Research products was also down in the first quarter of 2009, primarily from
our publications, including newsletters and books. In the first quarter of
2009, we discontinued three of the print publications we previously published
in the first quarter of each year: the
Morningstar
Funds 500
,
Morningstar Stocks
500
, and
Morningstar ETFs 150
. Slightly offsetting
this decrease was revenue from Morningstar Equity Research, which primarily
includes revenue related to the Global Analyst Research Settlement. Revenue
related to the Global Analyst Research Settlement accounted for approximately
6% of our Investment Information segment revenue and 5% of our consolidated
revenue in the first quarter of 2009. As mentioned above, the period covered by
the Global Analyst Research Settlement will expire in July 2009. After the
settlement period expires, the banks covered by it will no longer be required
to provide independent research to their clients. We expect our post-settlement
equity research revenue to be significantly lower beginning in the second half
of 2009. For further discussion, see
Item 1ARisk Factors in our 10-K filed with the SEC on March 5, 2009.
Revenue growth in Advisor
Software products partially offset these revenue declines discussed above. The
growth was primarily from Morningstar Advisor Workstation, slightly offset by a
decline in Principia revenue. The number of U.S. licenses for Morningstar Advisor
Workstation increased to 194,857 as of March 31, 2009 compared with
190,267 as of December 31, 2008 and 178,619 as of March 31, 2008. The
growth in users primarily reflects a new client contract that began in the
first quarter. Principia revenue was down in the first quarter of 2009. The
number of subscriptions for Principia was 40,993 as of March 31, 2009, a
12.2% decrease, from 46,690 as of March 31, 2008. The decline in the
number of subscriptions partly reflects clients migrating from Principia to Advisor
Workstation, but also reflects a lower retention rate as the economic
environment weakened during the latter part of 2008 and continued in the first
quarter of 2009.
Revenue from our data products,
primarily Licensed Data, also increased in the first quarter of 2009, although
by a smaller amount. This product continued to benefit from expanded sales
efforts in Europe and other markets outside the United States, as well as
continued strength in the United States. The number of licenses for Morningstar
Direct increased 23.2% to 3,033 worldwide as of March 31, 2009, compared
with 2,461 as of March 31, 2008.
In
the first quarter of 2008, operating income for the Investment Information
segment increased $3.5 million, or 10.7%, as operating expense declined more
than revenue.
Operating expense decreased $3.8
million in the first quarter of 2009, as cost reductions for discretionary
expense such as bonuses, advertising, and marketing were partially offset by
additional operating expense from acquisitions. Lower bonus expense accounted
for approximately one-third of the decrease in operating expense excluding
acquisitions. Most of this reduction reflects the changes we made to our bonus
program for 2009 as part of our efforts to better align our cost structure with
revenue in the challenging business environment. Excluding acquisitions, other
compensation-related expense was down, primarily because we suspended matching
contributions to our 401(k) plan in the United States, reducing operating
expense by about $1.6 million in this segment.
Sales
and marketing costs decreased in the first quarter of 2009. Most of the decline
reflects lower spending on advertising and marketing and lower travel costs,
which we pared back because of the challenging business environment. In 2009,
we also discontinued three of the publications we previously published in the
first quarter of each year: the
Morningstar
Funds 500
,
Morningstar Stocks
500
, and
Morningstar ETFs 150
and therefore didnt
incur costs to promote these publications.
26
Table of Contents
Our Investment
Information segment operating margin improved 3.8 percentage points. Operating
expense reductions including lower bonus expense, advertising, and marketing as
a percentage of revenue, outpaced the revenue decline. This margin expansion
was partially offset by the impact of acquisitions in the quarter.
Investment Management Segment
The
Investment Management segment includes all of our asset management operations,
which operate as registered investment advisors and earn about half of their
revenue from asset-based fees.
The
key products and services in this segment based on revenue are Investment
Consulting, which focuses on investment monitoring and asset allocation for
funds of funds, including mutual funds and variable annuities; Retirement
Advice, including the Morningstar Retirement Manager and Advice by Ibbotson
platforms; and Morningstar Managed Portfolios, a fee-based discretionary asset
management service that includes a series of mutual fund and exchange-traded
fund portfolios tailored to meet a range of investment time horizons and risk
levels that financial advisors can use for their clients taxable and
tax-deferred accounts.
In
the first quarter of 2009 and 2008, this segment represented 17.6% and 23.1%,
respectively, of our consolidated revenue.
|
|
Three Months Ended March 31
|
|
Key Metrics ($000)
|
|
2009
|
|
2008
|
|
% Change
|
|
Revenue
|
|
$
|
20,492
|
|
$
|
28,938
|
|
(29.2
|
)%
|
Operating income
|
|
$
|
11,827
|
|
$
|
15,259
|
|
(22.5
|
)%
|
Operating margin
(%)
|
|
57.7
|
%
|
52.7
|
%
|
5.0
|
pp
|
Although revenue declined across
all products in the Investment Management segment, Investment Consulting, which
has been a leading contributor to revenue growth in recent years, declined
significantly in the first quarter of 2009. Approximately one-third of the
decline in the Investment Management segments revenue resulted from a
Morningstar Associates client that did not renew an Investment Consulting
contract in the fourth quarter of 2008. Also, in the first quarter of 2009, we
did not reach agreement on renewal terms with another consulting client. This
contract, which represented approximately 8% of the Investment Management segments
revenue in the first quarter of 2009, expires on May 1, 2009. Combined,
these contracts represented about $17 million of revenue in 2008.
We provided advisory services on
approximately $63.3 billion in assets as of March 31, 2009, compared with
approximately $66.2 billion as of December 31, 2008 and approximately
$95.8 billion as of March 31, 2008. These totals include consulting
relationships as well as agreements where we act as a portfolio construction
manager for a mutual fund or variable annuity and receive a basis-point fee. We
also provide Investment Consulting services for some assets under management
for which we receive a flat fee.
Total assets under advisement for
Investment Consulting declined approximately 33.9% compared with March 31,
2008, as assets under advisement from Morningstar Associates declined 47.9% and
assets under advisement from Ibbotson Associates decreased about 16.3%. Excluding changes related to contract
cancellations or renewals, changes in the value of assets under advisement can
come from two primary sources: gains or losses related to overall trends in
market performance, and net inflows or outflows caused when investors add to or
redeem shares from these portfolios. In the first quarter of 2009, the
continuing losses in the U.S. stock market were the main factor behind the
decline in assets for most portfolios. In addition, during the second quarter
of 2008, an Investment Consulting client informed us that it was not planning
to renew its contract in the fourth quarter of 2008. As a result, assets under
advisement for Morningstar Associates declined more than the market compared
with the prior-year period.
Retirement Advice revenue was
also down in the first quarter of 2009, although to a lesser extent. Assets under
management for Retirement Advice declined to $10.2 billion, compared with $11.0
billion at December 31, 2008 and $13.2 billion in the same period a year
ago.
|
|
As of March 31
|
|
Assets under advisement for Investment Consulting ($ billions)
|
|
2009
|
|
2008
|
|
Ibbotson
Associates
|
|
$
|
35.5
|
|
$
|
42.4
|
|
Morningstar
Associates
|
|
27.8
|
|
53.4
|
|
Total
|
|
$
|
63.3
|
|
$
|
95.8
|
|
27
Table of Contents
|
|
As of March 31
|
|
Assets under management in managed retirement accounts ($ billions)
|
|
2009
|
|
2008
|
|
Advice by Ibbotson
|
|
$
|
9.3
|
|
$
|
12.1
|
|
Morningstar
Retirement Manager
|
|
0.9
|
|
1.1
|
|
Total
|
|
$
|
10.2
|
|
$
|
13.2
|
|
Morningstar Managed Portfolios
revenue was down in the first quarter of 2009 and was another factor that
contributed to the revenue decline. Assets under management for Morningstar
Managed Portfolios fell to $1.4 billion as of March 31, 2009, compared
with $1.6 billion as of December 31, 2008 and $2.1 billion as of March 31,
2008, resulting from general market weakness.
Operating expense in
the segment decreased $4.9 million, or 36%, primarily because of lower bonus
and other compensation-related expenses, mainly as a result of suspending our
401(k) matching contributions in the United States.
Operating margin was
57.7% in the first quarter of 2009, compared with 52.7% in the prior-year
period. Lower bonus expense and compensation-related expenses, as a percentage
of revenue, contributed to the margin improvement.
Corporate Items
Under our new segment structure,
we no longer allocate corporate costs to our business segments. This category
also includes amortization expense related to intangible assets recorded when
we allocate the purchase price of acquisitions. The table below shows the
components of corporate items that impacted our consolidated operating income:
|
|
Three Months Ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
% Change
|
|
Amortization
expense
|
|
$
|
5,121
|
|
$
|
4,022
|
|
27.3
|
%
|
Depreciation
expense
|
|
1,654
|
|
1,048
|
|
57.8
|
%
|
Corporate
unallocated
|
|
7,264
|
|
8,792
|
|
(17.4
|
)%
|
Corporate items
|
|
$
|
14,039
|
|
$
|
13,862
|
|
1.3
|
%
|
Amortization
of intangible assets increased $1.1 million in the first quarter of 2009,
reflecting incremental amortization expense of intangible assets related to our
2008 acquisitions. Based on acquisitions completed through December 31,
2008, we estimate that aggregate amortization expense for intangible assets
will be $20.1 million in 2009. Some of the purchase price allocations are
preliminary, and the values assigned to intangible assets and the associated
amortization expense may be affected by changes to these preliminary purchase
price allocations.
Depreciation expense
increased $0.6 million in the first quarter of 2009. In the fourth quarter of
2008, we relocated to our new corporate headquarters, resulting in higher
depreciation expense compared with the prior-year period.
Corporate unallocated decreased
$1.5 million in the first quarter of 2009. Lower bonus expense and other
compensation-related expenses drove the decrease in this category.
Equity in Net Income of Unconsolidated Entities,
Non-Operating Income, and Income Tax Expense
Equity in Net Income of Unconsolidated Entities
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Equity in net
income of unconsolidated entities
|
|
$
|
382
|
|
$
|
352
|
|
|
|
|
|
|
|
|
|
Equity
in net income of unconsolidated entities includes our portion of the net income
(loss) of Morningstar Japan K.K. (MJKK), Morningstar Korea, Ltd., Morningstar
Danmark A/S, and Morningstar Sweden AB. In the first quarter of 2009 and 2008,
equity in net income of unconsolidated entities was primarily from our position
in MJKK. We describe our investments in unconsolidated entities in more detail
in Note 8 of the Notes to our Unaudited Condensed Consolidated Financial
Statements.
Non-Operating Income
The
following table presents the components of net non-operating income:
28
Table of Contents
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Interest income,
net
|
|
$
|
978
|
|
$
|
1,519
|
|
Other income
(expense), net
|
|
(444
|
)
|
272
|
|
Non-operating
income, net
|
|
$
|
534
|
|
$
|
1,791
|
|
Net
interest income mainly reflects interest from our investment portfolio. Net
interest income decreased $0.5 million in the first quarter of 2009 as a result
of lower returns on our investment balances.
Other
income (expense) primarily represents foreign currency exchange gains and
losses arising from the ordinary course of business related to our U.S. and
non-U.S. operations. It also includes royalty income from MJKK and realized
gains and losses from our investment portfolio. The large expense in the first
quarter of 2009 was driven by a net foreign currency exchange loss from the
stronger U.S. dollar.
Income Tax Expense
The
following table summarizes the components of our effective tax rate:
|
|
Three months ended March 31
|
|
($000)
|
|
2009
|
|
2008
|
|
Income before
income taxes and equity in net income of unconsolidated entities
|
|
$
|
35,159
|
|
$
|
36,476
|
|
Equity in net
income of unconsolidated entities
|
|
382
|
|
352
|
|
Net (income) loss
attributable to the noncontrolling interest
|
|
89
|
|
(248
|
)
|
Total
|
|
$
|
35,630
|
|
$
|
36,580
|
|
Income tax expense
|
|
$
|
10,668
|
|
$
|
13,504
|
|
Effective tax rate
|
|
29.9
|
%
|
36.9
|
%
|
Our
effective tax rate declined by 7.0 percentage points in the first quarter of
2009. Lower income tax expense in the first quarter of 2009 includes the impact
of reversing a $1.4 million reserve for uncertain tax positions as a result of
a lapse in the statute of limitations. This non-cash credit contributed
approximately 4 percentage points of the decrease in the effective tax rate. In
addition, the favorable, but variable, benefit from incentive stock-option
transactions contributed approximately 2.0 percentage points to the decrease in
the effective tax rate.
As
of December 31, 2008, our Consolidated Balance Sheet included a current
liability of $3,983,000 and a non-current liability of $3,756,000 for unrecognized
tax benefits. These amounts include interest and penalties, less any associated
tax benefits. Other than the impact of reversing the $1.4 million reserve for
uncertain tax positions, there were no significant changes to uncertain tax
positions in the first quarter of 2009 as a result of other lapses of statutes
of limitation or audit activity. We are currently under audit by the U.S.
federal and various state and local tax authorities in the United States. We
are also under audit by the tax authorities in certain non-U.S. jurisdictions.
It is likely that the examination phase of some of these U.S. federal, state,
local, and non-U.S. audits will conclude in 2009. It is not possible to
estimate the impact of current audits on previously recorded unrecognized tax
benefits.
Liquidity and Capital Resources
We believe our available cash
balances and investments, along with cash generated from operations, will be
sufficient to meet our operating and cash needs for the foreseeable future. We
invest our cash reserves in cash equivalents and investments, consisting
primarily of fixed-income securities. We maintain a conservative investment
policy for our investments and invest a portion of these assets in municipal
securities with high-quality stand-alone credit ratings. The ongoing financial
crisis, which accelerated during the latter half of 2008 and continued during
the first quarter of 2009, has heightened our application of a conservative
investment policy, emphasizing principal preservation. Despite adverse
conditions in the credit markets, which have also adversely affected
traditionally safe investments such as money market funds and high-grade
commercial paper, we believe our investment portfolio remains marketable.
Investments in our portfolio have a maximum maturity of two years; the weighted
average maturity is approximately one year.
We intend to use our cash, cash
equivalents, and investments for general corporate purposes, including for
working capital and for funding future growth. To date we have not needed to
access any significant commercial credit and have not attempted to borrow or
establish any lines of credit.
29
Table of Contents
Cash
and Cash Equivalents
As of March 31,
2009, we had cash, cash equivalents, and investments of $286.0 million, a
decrease of $11.6 million compared with December 31, 2008. This decline
mainly reflects cash used for operating activities and capital expenditures,
partially offset by the proceeds received from employee stock option exercises.
Cash
Provided by Operating Activities
Our main source of
capital is cash generated from operating activities. We typically pay bonuses
in the first quarter of the year. As a result, cash flow from operations in the
first quarter tends to be lower compared with subsequent quarters.
In the first quarter
of 2009, cash used for operating activities was $8.3 million, a decrease of
$9.7 million, compared with cash provided by operating activities of $1.4
million in the first quarter of 2008. Changes in our net operating assets and
liabilities reduced the cash flow benefit from net income (adjusted for
non-cash items) by $15.0 million, primarily as a result of an increase of $9.6
million in bonus payments and a $3.5 million reduction in cash received for
tenant improvement allowances. Net
income (adjusted for non-cash items) increased $5.3 million, partially
offsetting the change in operating assets and liabilities.
We paid $58.9 million
in annual bonus payments in the first quarter of 2009, compared with $49.3
million in the prior-year period. The
bonuses paid in 2009 included approximately $48.9 million of bonus expense
recorded in 2008 and approximately $10.0 million of bonus payments deferred
from 2007. In accordance with bonus program revisions adopted in January 2009,
we are not deferring payments on any bonus expense recorded for 2008.
The $5.3 million
increase in net income (adjusted for non-cash items) is primarily related to a
lower impact related to excess tax benefits on operating cash flows. Excess tax benefits have a positive impact on
cash provided by financing activities with an equal, but offsetting, impact on
cash from operations. Excess tax benefits declined $5.6 million in the quarter,
primarily reflecting lower average stock prices on the exercise dates and a
reduction in the number of options exercised.
Cash
Used for Investing Activities
Cash used for
investing activities consists primarily of cash used for acquisitions;
purchases of investments, net of proceeds from the sale of investments; and
capital expenditures. The level of investing activities can vary from period to
period depending on the level of activity in these three categories. In the first quarter of 2009, cash used for
investing activities was $10.2 million, compared with $38.0 million in the
first quarter of 2008.
We did not complete
any acquisitions in the first quarter of 2009. In comparison, cash used for
acquisitions, net of cash acquired, was $50.9 million in the first quarter of
2008. In January 2008, we acquired the Hemscott data, media, and investor
relations Web site businesses.
Purchases of
investments, net of proceeds from the sale of investments, were $5.6 million in
the first quarter of 2009 as we transferred cash balances excess to our
immediate needs into investments with longer maturities. In contrast, in the
first quarter of 2008, the proceeds from the sales of investments exceeded the
purchases of investments by $19.7 million. As of March 31, 2009 and December 31,
2008, we had investments, consisting primarily of fixed-income securities, of
$129.3 million and $123.7 million, respectively. As of March 31, 2009, our
investments represented approximately 45% of our total cash, cash equivalents,
and investments, up approximately 4 percentage points compared with December 31,
2008.
Capital expenditures
were $4.6 million in the first quarter of 2009, a decrease of $2.1 million,
compared with $6.7 million in the first quarter of 2008. In both periods,
the amounts were almost entirely composed of capital expenditures for our new
headquarters in Chicago.
Cash
Provided by Financing Activities
Cash provided by financing activities consists primarily of
proceeds from stock option exercises and excess tax benefits related to stock
option exercises and vesting of restricted stock units. Excess tax benefits
occur at the time a stock option is exercised when the intrinsic value of the
option (the difference between the fair value of our stock on the date of
exercise and the exercise price of the option) is greater than the fair value
of the option at the time of grant. Similarly, excess tax benefits are
generated upon vesting of restricted stock units when the market value of our
common stock on the vesting date exceeds the grant price of the restricted
stock units. These excess tax benefits reduce the cash we pay for income taxes
in the year they are recognized. It is not possible to predict the timing of
stock option exercises or the intrinsic value which will be achieved at the
time options are exercised or upon vesting of restricted stock units. As a
result, we expect cash flow from financing activities to vary over time. Note 9
in the Notes to our Consolidated Financial Statements includes additional
information concerning stock options and restricted stock units outstanding as
of March 31, 2009.
30
Table of
Contents
Cash provided by
financing activities was $3.1 million in the first quarter of 2009, consisting
mainly of proceeds from stock option exercises of $2.9 million and excess tax
benefits of $0.4 million. In 2009, cash provided by financing activities
decreased by $8.6 million, or 73.5%, compared with the first quarter of 2008,
driven mostly by a $5.6 decline in excess tax benefits and a $2.9 million
reduction in proceeds from stock option exercises. The decrease was due
primarily to a lower average stock price at the time the stock options were
exercised and a fewer number of options being exercised.
Employees exercised
approximately 273,000 and 738,000 stock options in the first quarters of 2009
and 2008, respectively. The total intrinsic value (the difference between the
market value of our stock on the date of exercise and the exercise price of the
option) of options exercised during the first quarter of 2009 and 2008 was $5.8
million and $41.6 million, respectively.
Subsequent Events
We
completed the following three acquisitions in April and May of 2009:
Global financial filings database business of Global Reports LLC
: In April 2009, we acquired the global
financial filings database business of Global Reports LLC, a leading provider
of online financial and Corporate and Social Responsibility reports for
publicly traded companies around the world. Global Reports provides timely
online access to full-color financial filings from more than 37,000 publicly
traded companies in approximately 130 countries.
Equity research and data business of C.P.M.S. Computerized Portfolio
Management Services Inc.:
In May 2009, we
acquired the equity research and data business of C.P.M.S. Computerized Portfolio
Management Services Inc. (C.P.M.S.). C.P.M.S. tracks fundamental equity data
for approximately 4,000 securities in the United States and Canada as well as
tracks and provides brokerage earnings estimates for Canadian equities.
Andex Associates Inc.
In May 2009, we
acquired Andex Associates Inc., based in Windsor, Ontario, Canada. The company
is known for its Andex Charts, individual graphic charts detailing historical
market returns, stock index growth, inflation rates, currency rates, and
general economic conditions for the United States dating back to 1926, and for
Canada dating back to 1950. The charts offer in-depth historical information to
help investors understand the context and propensity of market downturns and
recoveries.
The
combined purchase price for these three acquisitions was approximately $18.0
million, subject to post-closing adjustments.
Application
of Critical Accounting Policies and Estimates
Our critical
accounting policies and estimates are discussed in the Managements Discussion
and Analysis section of our Annual Report on Form 10-K filed with the
Securities and Exchange Commission (SEC) for the year ended December 31,
2008. In addition, effective January 1,
2009, we adopted the following financial accounting standards:
SFAS No. 160,
Accounting and Reporting of Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
Statement of
Financial Accounting Standards (SFAS) No. 160,
Accounting
and Reporting of Noncontrolling Interests in Consolidated Financial Statements,
an amendment of ARB No. 51,
amends the financial accounting and
reporting of noncontrolling interests in consolidated financial
statements. A noncontrolling interest is
the portion of equity (net assets) in a subsidiary not attributable, directly
or indirectly, to the parent company. We
conduct our business operations outside of the United States through wholly
owned or majority-owned operating subsidiaries.
As a result of adopting SFAS No. 160, the noncontrolling interest
related to a majority-owned subsidiary is now reported in our consolidated
statement of financial position within equity, separately from the shareholders
equity attributable to Morningstar, Inc.
In addition, the net income or loss and comprehensive income or loss
attributed to the Morningstar, Inc. shareholders and the noncontrolling
interest is presented in our Statements of Income and Statement of Equity and
Comprehensive Income.
SFAS No. 141(R),
Business Combinations
SFAS No. 141(R),
Business Combinations
, modifies the
financial accounting and reporting of business combinations. For business combinations which occur after January 1,
2009, SFAS No. 141(R) requires the acquirer to recognize and measure
the fair value of the acquired operation as a whole, and the assets acquired
and liabilities assumed at their full fair values as of the date control is
obtained, regardless of the percentage ownership in the acquired operation or
how the acquisition was achieved. In addition,
under SFAS No. 141 (R), acquisition-related costs are expensed as
incurred. Prior to the adoption of SFAS
141 (R), direct costs incurred in connection with a business combination, such
as finders fees, advisory, accounting, legal, valuation, and other
professional fees were included as part of the cost of the acquired
business. Restructuring costs are
recognized separately from the business combination accounting as
post-combination expenses of the combined entity unless the criteria of SFAS No. 146
are met on the acquisition date by the target entity. Prior to the adoption of SFAS No. 141
(R), restructuring costs such as severance and relocation of employees of the
acquired entity could be included in the purchase price allocation assuming certain
criteria were met.
Recently
Issued Accounting Pronouncements
In
April 2009, the Financial Accounting Standards Board (FASB) issued three Final
Staff Positions (FSPs) intended to provide additional application guidance and
enhance disclosures regarding fair value measurements and impairments of
securities.
·
|
FSP
FAS 157-4,
Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly
, provides guidelines
for making fair value measurements more consistent with the principles
presented in SFAS No. 157,
Fair Value Measurements
.
|
|
|
·
|
FSP
FAS 107-1 and APB 28-1,
Interim Disclosures
about Fair Value of Financial Instruments
, enhances consistency in
financial reporting by increasing the frequency of fair value disclosures.
|
|
|
·
|
FSP
FAS 115-2 and FAS 124-2,
Recognition and
Presentation of Other-Than-Temporary Impairments
, provides
additional guidance designed to create greater clarity and consistency in accounting
for and presenting impairment losses on securities.
|
31
Table of Contents
The
FSPs are effective for interim and annual periods ending after June 15,
2009. We are in the process of determining the effect the adoption of these
FSPs will have on our Consolidated Financial Statements.
In April 2009,
the FASB also issued an FSP to amend and clarify SFAS No. 141 (revised
2007),
Business Combinations
, to address
application issues on initial recognition and measurement, subsequent
measurement and accounting, and disclosure of assets and liabilities arising
from contingencies in a business combination.
This FSP is effective for assets or liabilities arising from
contingencies in business combinations for which the acquisition date is on or
after January 1, 2009.
Rule 10b5-1
Sales Plans
Rule 10b5-1 Plans
Our directors and executive officers may exercise stock
options or purchase or sell shares of our common stock in the market from time
to time. We encourage them to make these transactions through plans that comply
with Exchange Act Rule 10b5-1(c). Morningstar will not receive any
proceeds, other than proceeds from the exercise of stock options, related to
these transactions.
The
following table, which we are providing on a voluntary basis, shows the Rule 10b5-1
sales plans entered into by our directors and executive officers that were in
effect as of May 1, 2009:
Name and Position
|
|
Date of
Plan
|
|
Plan
Termination
Date
|
|
Number of
Shares
to be
Sold under
the Plan
|
|
Timing of Sales under the Plan
|
|
Number of
Shares
Sold under
the Plan through
May 1,
2009
|
|
Projected
Beneficial
Ownership (1)
|
|
Joe
Mansueto
Chairman and
Chief Executive
Officer
|
|
08/13/08
|
|
12/31/09
|
|
1,075,000
|
|
Shares
to be sold ratably over the course of the plan
|
|
325,016
|
|
25,851,246
|
|
Chris
Boruff
President,
Advisor Software
|
|
05/12/08
|
|
11/15/09
|
|
80,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
12,000
|
|
91,180
|
|
Tao
Huang
Chief Operating
Officer
|
|
02/24/09
|
|
05/31/10
|
|
470,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices beginning
May 5, 2009
|
|
|
|
497,179
|
|
Elizabeth
Kirscher
President, Data
Services
|
|
05/22/08
|
|
06/30/09
|
|
100,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
|
|
90,564
|
|
Catherine
Odelbo
President, Equity
Research
|
|
08/13/08
|
|
12/31/09
|
|
28,165
|
|
Weekly
increments of up to 3,500 shares
|
|
|
|
148,000
|
|
Don
Phillips
President, Fund
Research and
Managing
Director
|
|
05/09/06
|
|
12/01/09
|
|
1,506,097
|
|
Weekly
increments of up to 17,500 shares
|
|
1,297,251
|
|
439,506
|
|
Patrick
Reinkemeyer
President,
Morningstar
Associates, LLC
|
|
09/10/08
|
|
10/31/09
|
|
15,000
|
|
Weekly
increments of up to 1,000 shares
|
|
|
|
318,495
|
|
Richard
Robbins
General Counsel
and Corporate
Secretary
|
|
08/15/08
|
|
06/30/09
|
|
7,061
|
|
Biweekly
increments of up to 500 shares
|
|
2,061
|
|
17,435
|
|
David
Williams
Managing
Director,
Design
|
|
09/10/08
|
|
09/30/09
|
|
10,000
|
|
Weekly
increments of up to 2,500 shares
|
|
|
|
100,362
|
|
32
Table of Contents
(1) This column reflects an estimate of the
number of shares each identified director and executive officer will
beneficially own following the sale of all shares under the Rule 10b5-1
sales plans identified above. This information reflects the beneficial
ownership of our common stock on March 31, 2009, and includes shares of
our common stock subject to options that were then exercisable or that will
have become exercisable by May 30, 2009 and restricted stock units that
will vest by May 30, 2009. The estimates do not reflect any changes
to beneficial ownership that may have occurred since March 31, 2009. Each
director and executive officer identified in the table may amend or terminate
his or her Rule 10b5-1 sales plan and may adopt additional Rule 10b5-1
plans in the future.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our investment portfolio is actively managed and may suffer
losses from fluctuating interest rates, market prices, or adverse security
selection. Our investment portfolio is mainly invested in high-quality
fixed-income securities. We do not have any direct exposure to sub-prime
mortgages. As of March 31, 2009, our cash, cash equivalents, and
investments balance was $286.0 million. Based on our estimates, a 100
basis-point change in interest rates would impact the fair value of our
investment portfolio by approximately $0.9 million.
As our non-U.S. revenue increases as a percentage of our
consolidated revenue, fluctuations in foreign currencies present a greater
potential risk. To date, we have not engaged in currency hedging, and we do not
currently have any positions in derivative instruments to hedge our currency
risk. Our results could suffer if certain foreign currencies decline relative
to the U.S. dollar. In addition, because we use the local currency of our
subsidiaries as the functional currency, we are affected by the translation of
foreign currencies into U.S. dollars.
Item 4. Controls and Procedures
(a) Evaluation
and Disclosure Controls and Procedures
Disclosure controls
and procedures are designed to reasonably assure that information required to
be disclosed in the reports filed or submitted under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in the SECs rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to reasonably assure that
information required to be disclosed in the reports filed under the Exchange
Act is accumulated and communicated to management, including the chief
executive officer and chief financial officer, as appropriate, to allow timely
decisions regarding required disclosure.
We
carried out an evaluation, under the supervision and with the participation of
our management, including our chief executive officer and chief financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 12a-15(e) and 15d-15(e) of
the Securities Exchange Act of 1934, as of March 31, 2009. Based on that
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are effective to provide reasonable
assurance that information required to be disclosed in the reports we file or
submit under the Exchange Act is recorded, processed, summarized, and reported
as and when required and is accumulated and communicated to management,
including the chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure.
(b) Changes
in Internal Controls Over Financial Reporting
There were no changes
in our internal controls over financial reporting during the quarter ended March 31,
2009 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART 2
OTHER INFORMATION
Item 1. Legal Proceedings
We incorporate by
reference the information regarding legal proceedings set forth in Note 12, Contingencies,
of the Notes to our Unaudited Condensed Consolidated Financial Statements
contained in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
There have been no
material changes to the risk factors disclosed in Item 1A Risk Factors in our
Annual Report on Form 10-K for the year ended December 31, 2008.
33
Table of
Contents
Item 6.
Exhibits
(a) Exhibits
Exhibit No
|
|
Description of Exhibit
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of
the Securities Exchange Act of 1934, as amended
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of
the Securities Exchange Act of 1934, as amended
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
|
34
Table of
Contents
SIGNATURE
Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
|
|
|
|
MORNINGSTAR,
INC.
|
|
|
|
|
|
Date: May 6,
2009
|
|
|
By:
|
/s/ Scott
Cooley
|
|
|
|
|
Scott
Cooley
|
|
|
|
|
Chief
Financial Officer
|
35
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