UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K/A
Amendment No. 1
x
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31,
2009
OR
o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
Commission File Number: 000-51280
MORNINGSTAR, INC.
(Exact Name of Registrant as Specified in its Charter)
Illinois
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36-3297908
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(State or Other Jurisdiction of
Incorporation or Organization)
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(I.R.S. Employer
Identification Number)
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22 West Washington Street
Chicago, Illinois
60602
(Address of Principal Executive Offices)
(312) 696-6000
(Registrants Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of
the Act:
Title of Each Class
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Name of Each
Exchange on Which Registered
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Common stock, no par value
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The NASDAQ Stock Market LLC
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Securities registered pursuant to Section 12(g) of
the Act:
None
Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act. Yes
o
No
x
Indicate
by check mark if the Registrant is not required to file reports pursuant to Section 13
or Section 15(d) of the Act. Yes
o
No
x
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 if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
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. (Check one):
Large
accelerated filer
x
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Accelerated filer
o
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Non-accelerated
filer
o
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Smaller reporting
company
o
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(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
The
aggregate market value of shares of common stock held by non-affiliates of the
Registrant as of June 30, 2009 was $848,941,450. As of February 22,
2010, there were 48,786,955 shares of the Registrants common stock, no par
value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain
parts of the Registrants Definitive Proxy Statement for the 2010 Annual
Meeting of Shareholders are incorporated into Part III of this Form 10-K.
EXPLANATORY NOTE
On March 1, 2010, Morningstar, Inc. (the Company)
filed its Annual Report on Form 10-K for the year ended December 31,
2009 with the Securities and Exchange Commission. The Company is providing
Item 1 of Part I and Item 7 of Part II of Form 10-K in this
Form 10-K/A filing to correctly reflect the total number of investments
covered in its database of approximately 350,000 and to revise the number of
database additions made during 2009 to more than 40,000. Except as set forth
herein, no other changes are made to the Companys Annual Report on
Form 10-K for the fiscal year ended December 31, 2009.
Part I
Item 1. Business
Morningstar is a leading provider of
independent investment research to investors around the world. Since our
founding in 1984, our mission has been to create great products that help
investors reach their financial goals. We offer an extensive line of data,
software, and research products for individual investors, financial advisors,
and institutional clients through our Investment Information segment. We also
provide asset management services for advisors, institutions, and retirement
plan participants through our Investment Management segment. In addition to our
U.S.-based products and services, we offer local versions of our products
designed for investors in Asia, Australia, Canada, Europe, Japan, and South
Africa. Morningstar serves approximately 7.4 million individual investors,
245,000 financial advisors, and 4,200 institutional clients. We have operations
in 20 countries and hold minority ownership positions in companies located in
two other countries.
We maintain a series of
comprehensive databases on many types of investments, focusing on investment
vehicles that are widely used by investors globally. After building these
databases, we add value and insight to the data by applying our core skills of
research, technology, and design. As of December 31, 2009, we provided
extensive data on more than:
·
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21,000
mutual fund share classes in the United States;
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·
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97,000
mutual funds and similar vehicles in international markets;
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·
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3,400
exchange-traded funds (ETFs);
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·
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1,800
closed-end funds;
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·
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28,000
stocks;
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·
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8,200
hedge funds;
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·
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7,200
separate accounts and collective investment trusts;
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·
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109,000
variable annuity/life subaccounts and policies;
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·
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46,000
insurance, pension, and life funds;
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·
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12,300
unit investment trusts;
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·
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85
state-sponsored college savings plans (commonly known as Section 529
College Savings Plans);
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·
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83
years of capital markets data capturing performance of several major asset
classes;
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·
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Extensive
cash flow, ownership, and biographical data on directors and officers;
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·
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Real-time
market data on more than 4 million exchange-traded equities, derivatives,
commodities, futures, foreign exchanges, precious metals, news, company
fundamentals, and analytics; and
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·
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Real-time price quotes for global foreign currencies.
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Our business model is based on
leveraging our investments in these databases by selling a wide variety of
products in multiple media to individual investors, financial advisors, and
institutions around the world.
Our data and proprietary analytical
tools such as the Morningstar Rating for mutual funds, which rates past
performance based on risk- and cost-adjusted returns, and the Morningstar Style
Box, which provides a visual summary of a mutual funds underlying investment
style, have become important tools that millions of investors and advisors use
in making investment decisions. Weve created other tools, such as the
Ownership Zone, Sector Delta, and Market Barometer, which allow investors to
see how different investments work together to form a portfolio and to
track its progress. We developed a popular Portfolio X-Ray tool that helps
investors reduce risk and understand the key characteristics of their
portfolios based on nine different factors.
2
We offer a variety of qualitative
measures such as Stewardship Grades, which help investors identify companies
and funds that have demonstrated a high level of commitment to shareholders and
stewardship of investors capital.
Since 1998, weve expanded our research
efforts on individual stocks and have worked to popularize the concepts of
economic moat, a measure of competitive advantage originally developed by
Warren Buffett; and margin of safety, which reflects the size of the discount
in a stocks price relative to its estimated value. The Morningstar Rating for
stocks is based on the stocks current price relative to our analyst-generated
fair value estimates, as well as the companys level of business risk and
economic moat.
In 2009, we began publishing credit
ratings and associated research on corporate debt issuers. We currently provide
ratings on approximately 120 companies. We also introduced comprehensive,
qualitative research and ratings for mutual funds based in Europe and Asia, a
new study comparing the mutual fund investor experience across 16 countries,
hedge fund operational risk flags, attribution analysis for equity funds and
funds of funds, a new equity fund classification structure, and a new series of
specialized, institutional-level investment benchmarks.
Weve also developed in-depth advice on
security selection and portfolio building to meet the needs of investors
looking for integrated portfolio solutions. We believe many investors rely on
these tools because they offer a useful framework for comparing potential
investments and making decisions. Our independence and our history of
innovation make us a trusted resource for investors.
Growth Strategies
In keeping with our mission, we are
pursuing five key growth strategies, which we describe below. We review our
growth strategies on a regular basis and refine them to reflect changes in our
business.
1. Enhance our position in each of our key
market segments by focusing on our three major Internet-based platforms.
We believe that individual investors,
financial advisors, and institutional clients increasingly want integrated
solutions as opposed to using different research tools for different parts of
their portfolios. To help meet this need, one of our key strategies is to focus
our product offerings on our three major platforms:
·
Morningstar.com for individual investors;
·
Morningstar Advisor Workstation for financial advisors;
and
·
Morningstar Direct for institutional professionals.
These products all include integrated
research and portfolio tools, allowing investors to use our proprietary
information and analysis across multiple security types. We believe we can
achieve deeper penetration of our current audiences with each of these
platforms, as well as extend their reach to new customers.
With Morningstar.com, were continuing
to expand the range of content and market updates on the site, including
third-party content. Weve also been focusing on mobile development and social
networking, as well as expanding data and functionality to increase the sites
value to both
3
registered users and Premium members.
With Advisor Workstation, we plan to build on our large installed base by
expanding our mid- and back-office capabilities, improving the products
interface and design, and integrating real-time data and other functionality.
With Morningstar Direct, were pursuing an aggressive development program to
provide data and analysis on securities and investments around the world. Were
adding third-party data and content and enhancing our technology to allow the
product to function as a purely web-based solution. We also plan to expand into
new global markets, enhance our capabilities in portfolio management and
accounting, and significantly increase the amount of equity research content
and functionality.
2. Become a global leader in fund-of-funds
investment management.
The large number of managed investment
products available has made assembling them into well-constructed portfolios a
difficult task for many investors. Consequently, fund-of-funds offerings have
seen strong growth within the mutual fund, variable annuity, and hedge fund
industries. Cerulli Associates estimates that global multimanager
assetsincluding publicly offered funds that invest in other funds as well as
investment vehicles managed by multiple subadvisorstotaled approximately $1.6
trillion in 2009. We believe assembling and evaluating funds of funds is a
natural extension of our expertise in understanding managed investment
products.
Our fund-of-funds programs combine
managed investment vehiclestypically mutual fundsin portfolios designed to
help investors meet their financial goals. When we create portfolios made up of
other funds, our goal is to simplify the investment process and help investors
access portfolios that match their level of risk tolerance, time horizon, and
long-term investment objectives. We draw on our extensive experience analyzing
funds to combine quantitative research with a qualitative assessment of manager
skill and investment style.
In June 2009, we expanded our
investment management business by acquiring Intech Pty Ltd, a leading provider
of multimanager and investment portfolio solutions in Sydney, Australia. Intech
(now doing business as Ibbotson Associates) manages the Intech Investment
Trusts, a range of single sector, alternative strategy, and diversified
investment portfolios.
We had a total of $61.4 billion in
assets under advisement in our Investment Consulting business as of December 31,
2009. Our consulting business focuses on relationships and agreements where we
act as a portfolio construction manager or asset allocation program designer
for a mutual fund or variable annuity and receive a basis-point fee. We plan to
continue building this business by expanding to reach new markets outside of
the United States, expanding our capabilities and products in new areas such as
alternative investment strategies, developing more ways to incorporate risk
protection and insurance, expanding to reach additional client segments, and
focusing on performance and client support.
We also offer managed retirement
account services through our Retirement Advice platform, which includes
Morningstar Retirement Manager and Advice by Ibbotson. We offer these services
for retirement plan participants who choose to delegate management of their
portfolios to our managed account programs, which are quantitative systems that
select investment options and make retirement planning choices for the
participants. We believe that retirement plan participants will continue to
adopt managed accounts because of the complexity involved in retirement
planning.
Morningstar Managed Portfolios is a
fee-based discretionary asset management service that includes a series of
mutual fund, exchange-traded fund, and stock portfolios tailored to meet
specific investment time horizons and risk levels. As of December 31,
2009, we had $2.1 billion in assets under management through Morningstar
Managed Portfolios and $15.6 billion in assets under management in our
managed retirement accounts.
4
3.
Continue
building thought leadership in independent investment research.
We believe that our leadership position
in independent investment research offers a competitive advantage that would be
difficult for competitors to replicate. Our goal is to continue producing
investment insights that empower investors and focus our research efforts in
four major areas:
·
Extend
leadership position in fund research to additional markets outside the United
States.
Over the past several years, we have expanded our analyst
coverage in fund markets outside of the United States. Weve built an
integrated team of locally based fund experts to expand our research coverage
in additional markets around the world. As of December 31, 2009, we had
about 80 fund analysts globally, including teams in North America, Europe,
Asia, and Australia. We currently produce qualitative analyst research on more
than 900 funds outside the United States and plan to continue building our
coverage of funds based in Europe and Asia.
·
Continue
leveraging our capabilities in stocks.
Our equity research complements our
approach to mutual fund analysis, where we focus on analyzing the individual
stocks that make up each funds portfolio. As of December 31, 2009, we
provided analyst research on approximately 2,000 companies.
From June 2004 through July 2009, we provided
research to six major investment banks under the terms of the Global Analyst
Research Settlement, which we describe in more detail on page 27. Although
the period covered by the Global Analyst Research Settlement expired in July 2009,
and the banks covered by it are no longer required to provide independent
investment research to their clients, we remain committed to maintaining the
broad, high-quality coverage weve become known for as one of the largest
providers of independent equity research. For further discussion about this
issue, see Item 1ARisk Factors.
Were working to expand distribution of our equity
research through a variety of other channels, including through financial
advisors
, buy-side firms, and companies outside of the United
States. We believe that investors increasing awareness of the value of
independent research will strengthen our business over the long term. Weve
also expanded our proprietary stock database, which we view as an important
complement to our analyst research.
·
Build
expertise in fixed-income credit research.
In 2009, we began publishing research
and ratings on corporate credit issuers. During the next year, we plan to
produce credit ratings for up to 1,000 companies currently covered by our
equity analyst team. We view credit ratings as a natural extension of the
equity research weve been producing for the past decade. We believe we have a
unique viewpoint to offer on company default risk that leverages our cash-flow
modeling expertise, proprietary measures like economic moat, and in-depth
knowledge of the companies and industries we cover.
Were including this research on our three major software
platforms to provide investors with an additional perspective on fixed-income
investments. We also plan to monetize the ratings through subscriptions to our
institutional equity research clients, who have access to the forecasts,
models, and scores underlying the ratings.
·
Enhance
our retirement income capabilities.
As the baby boom generation approaches retirement, we
believe many investors will need more information to help them manage income
during retirement. We believe this will lead to a greater need for information
and tools focusing on retirement income planning and long-term savings
strategies. In 2009, we introduced an advisory service for investors in
5
retirement through Morningstar
Retirement Manager. We currently offer Retirement Income Strategist, a
web-based financial planning tool that allows financial advisors to create
comprehensive income analyses for clients who are retired or approaching
retirement, as part of our Advisor Workstation platform. Weve developed
several retirement income services for institutional clients within our
Investment Consulting area, and we plan to incorporate additional retirement
income tools and services in other products over the next several years.
4.
Create
a premier global investment database.
Our goal is to continue building or
acquiring new databases for additional types of investments, including various
types of funds outside the United States and other widely used investment
products.
As detailed on page 2, we
currently provide extensive data on approximately 350,000 investments globally,
including managed investment products, individual securities, capital markets
data, real-time stock quotes from nearly all of the worlds major stock
exchanges, and a live data feed that covers exchange-traded equities,
derivatives, commodities, futures, foreign exchanges, precious metals, news,
company fundamentals, and analytics.
Our data is the foundation for all of
the products and services we offer. When we build investment databases, we
prefer to own the data and minimize
license agreements with outside data providers. We also focus on proprietary,
value-added data, such as our comprehensive data on current and historical
portfolio holdings for mutual funds and variable annuities. Within each database,
we continuously update our data to maintain timeliness and expand the depth and
breadth of coverage. Our strategy is to continuously expand our databases,
focusing on investment products that are widely used by large numbers of
investors. In particular, were focusing on expanding our fundamental equity
data. We also strive to establish our databases as the pre-eminent choice for
individual investors, financial advisors, and institutional clients around the
world, as well as continuing to invest in world-class data quality,
manufacturing, and delivery interfaces.
Over the past several years, weve
developed a series of proprietary indexes based on our investment data. The
Morningstar Indexes are rooted in our proprietary research and can be used for
precise asset allocation and benchmarking and as tools for portfolio
construction and market analysis. Weve significantly expanded the range of
indexes we offer and are working to expand our index business globally.
5.
Expand
our international brand presence, products, and services.
Our operations outside of the United
States generated $129.2 million in revenue in 2009 compared with $121.4 million
in 2008 and represent an increasing percentage of our consolidated revenue. Our
strategy is to expand our non-U.S. operations (either organically or through
acquisitions) to meet the increasing demand for wide-ranging, independent
investment insight by investors around the globe. Because more than half of the
worlds investable assets are located outside of the United States, we believe
there are significant opportunities for us there. Our strategy is to focus our
non-U.S. sales efforts on our major products, including Morningstar Advisor
Workstation and Morningstar Direct, as well as opportunities such as real-time data,
qualitative investment research and ratings, investment indexes, and
consulting. We also plan to explore new regions, such as Latin America, Eastern
Europe, and the Middle East; continue expanding our databases to be locally and
globally comprehensive; introduce new products in markets where we already have
operations; and expand our sales and product support infrastructure around the
world.
6
Acquisitions
Historically, the majority of our
long-term revenue growth has been driven by organic growth as weve introduced
new products and services and expanded our marketing efforts for existing
products. However, we have made and expect to continue making selective
acquisitions that support our five growth strategies. In reviewing potential
acquisitions, we focus on transactions that:
·
offer a good
strategic fit with our mission of creating great products that help investors
reach their financial goals;
·
help us build our
proprietary investment databases, research capabilities, technical expertise,
or customer base faster and more cost effectively than we could if we built
them ourselves; and
·
offer a good
cultural fit with our entrepreneurial spirit and brand leadership.
We paid approximately $74.2 million for
six acquisitions in 2009, as summarized in the table below.
Acquisition
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Description
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Date Completed
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Purchase Price*
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Global financial filings database business of Global
Reports LLC
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A leading provider of online financial and Corporate and
Social Responsibility reports for publicly traded companies around the world
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April 20, 2009
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Not separately disclosed
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Equity research and data business of C.P.M.S. Computerized
Portfolio Management Services Inc.
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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 earnings estimates for Canadian stocks
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May 1, 2009
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$13.9 million
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Andex Associates, Inc.
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Andex is known for Andex Charts, which illustrate
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
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May 1, 2009
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Not separately disclosed
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Intech Pty Ltd
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A leading provider of multimanager and investment
portfolio solutions in Sydney, Australia, Intech also manages a range of
single sector, alternative strategy, and diversified investment portfolios,
has one of the leading separately managed account databases in Australia, and
offers the Intech Desktop Consultant, a research software product for
institutions
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June 30, 2009
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Not separately disclosed
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Canadian Investment Awards and Gala
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Canadas marquee investment awards program, recognizing
excellence in products and firms within the financial services industry
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December 17, 2009
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Not separately disclosed
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Logical Information Machines, Inc.
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A leading provider of data and analytics for the energy,
financial, and agriculture sectors
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December 31, 2009
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$53.5 million
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*Total purchase price less cash
acquired.
For information about our previous
acquisitions, refer to Note 6 of the Notes to our Consolidated Financial
Statements.
7
Business Segments,
Products, and Services
We operate our business in two
segments:
·
Investment
Information, which includes all of our data, software, and research products
and services. These products are typically sold through subscriptions or
license agreements; and
·
Investment
Management, which includes all of our asset management operations, which
operate as registered investment advisors and earn more than half of their
revenue from asset-based fees.
The table
below shows our revenue by business segment for each of the past three years:
|
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2009
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2008
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2007
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Revenue by Segment
($000)
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Amount
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%
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Amount
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%
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Amount
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%
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Investment Information
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$
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386,642
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80.7%
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$
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390,693
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77.8%
|
|
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$
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327,372
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75.2%
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Investment Management
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92,354
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19.3
|
|
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111,764
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22.2
|
|
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107,735
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24.8
|
|
Consolidated revenue
|
|
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$
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478,996
|
|
100.0%
|
|
|
$
|
502,457
|
|
100.0%
|
|
|
$
|
435,107
|
|
100.0%
|
|
For information on segment
operating income (loss), refer to Note 4 of the Notes to our Consolidated
Financial Statements.
Investment Information
The largest products in this segment
based on revenue are Morningstar Licensed Data, a set of investment data
spanning all of our investment databases, including real-time pricing data, and
available through electronic data feeds; Morningstar Advisor Workstation, a
web-based investment planning system for independent financial advisors as well
as advisors affiliated with larger firms; Morningstar.com, which includes both
Premium Memberships and Internet advertising sales; Morningstar Direct, a
web-based institutional research platform; and Morningstar Principia, 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. Investors can access our equity research through the Premium
Membership service on Morningstar.com. In addition, we distribute our research
to several other companies that provide our analyst research to their
affiliated financial advisors or to individual investors. From June 2004
through July 2009, we distributed our equity research through six major
investment banks to meet the requirements for independent research under the
Global Analyst Research Settlement, which we describe in more detail on page 27.
We also offer a variety of financial
communications materials, real-time data, other investment software, and
investment indexes, as well as several print and online publications focusing
on stocks, mutual funds, personal finance, and other investing topics. In 2009,
we developed a beta version of Morningstar QuoteSpeed, a new web-based solution
that delivers real-time market data through a simplified desktop application.
In addition to real-time market information, QuoteSpeed provides users with
access to Morningstars fundamental data, news, analysis, and more. QuoteSpeed
will be available as a stand-alone application or as a module through platforms
such as Morningstar.com, Direct, Office, and Advisor Workstation. We also
created a
8
new Enterprise Data Management business
that helps institutions outsource certain business operations to Morningstar,
including creating investment profiles, aggregating account data, performance
reporting, and consolidating and managing data feeds from multiple sources.
With our purchase of Logical
Information Machines, Inc. (LIM) at the end of 2009, we added a new
analytical software application, which delivers a comprehensive, real-time
solution for research, analysis, and trading for institutional clients. LIM is
an analytical software service that aggregates financial and energy data from a
large number of sources. LIMs software lets clients query these multiple data
sets simultaneously. The majority of LIMs clients are in the energy and
commodities industries.
In 2009, about 31.6% of Investment
Information segment revenue was from outside of the United States.
Most of our products for individual
investors target experienced investors who are actively involved in the
investing process and want to take charge of their own investment decisions. We
also reach individuals who want to learn more about investing and investors who
seek out third-party sources to validate the advice they receive from brokers
or financial planners.
We sell our advisor-related products
both directly to independent financial advisors and through enterprise
licenses, which allow financial advisors associated with the licensing
enterprise to use our products. Our institutional clients include banks,
brokerage firms, insurance companies, mutual fund companies, media outlets, and
retirement plan sponsors and providers. We also have data reselling agreements
with third-party providers of investment tools and applications, allowing us to
increase the distribution of our data with minimal additional cost.
We believe the Investment Information
segment has a modest amount of seasonality. Weve historically had higher
revenue in the second quarter because we hold an investment conference then.
Sales for other products, such as Morningstar.com, tend to be slightly lower
over the spring and summer months. Other products in this segment generally
have not shown marked seasonality.
Our largest customer in the Investment
Information segment made up approximately 3% of segment revenue in 2009.
Licensed Data
Our Licensed Data service gives
institutions access to a full range of proprietary investment data spanning
numerous investment databases, including real-time pricing data. The data
packages we offer include proprietary statistics, such as the Morningstar Style
Box and Morningstar Rating, and a wide range of other data, including
information on investment performance, risk, portfolios, operations data, fees
and expenses, cash flows, and ownership. Institutions can use Licensed Data in
a variety of investor communications, including websites, print publications,
and marketing fact sheets, as well as for internal research and product
development. We deliver Licensed Data through electronic data feeds and provide
daily updates to clients. Pricing for Licensed Data is based on the number of
funds or other securities covered, the amount of information provided for each
security, and the level of distribution.
In 2009, we introduced a new
browser-based interface that allows clients who license proprietary data for
their marketing materials to access Morningstars proprietary statistics and
images in a format easily used by designers and web developers. We also added
interfaces that allow clients to view, search, and sort data on their desktops,
or export the data to their own applications. We launched an alert feed that
highlights relevant changes in a funds status and proprietary statistics, as
well as additional descriptive data on separate accounts. We introduced a
series of manager benchmarks based on our new institutional categories, as well
as other specialized
9
investment groupings and
client-customizable benchmarks. We continued to expand our fundamental data on
stocks around the world.
We rebranded Tenfore Systems Limited
(acquired in December 2008) as Morningstar Real-Time Data and integrated
many of Morningstars data sets, including fundamental equity data and
research. We also began providing 24-hour support to our Real-Time Data
clients.
We introduced a new Ownership Database
toward the end of the year, which provides security ownership information and
position changes on individual stocks. Following our acquisition of Fundamental
Data Limited in 2008, in 2009 we created a new Traded Funds Center, which
includes all global data on closed-end and exchange-traded funds. We also
launched the Morningstar Pension and Endowment Center, which provides insight
into the largest pensions and endowments and the underlying investments used in
these types of plans.
For Licensed Data, our primary
competitors are Bloomberg, FactSet Research Systems, Interactive Data
Corporation, Standard & Poors, and Thomson Reuters.
Licensed Data was our largest product
in 2009 and accounted for 19.1%, 15.6%, and 13.6% of our consolidated revenue
in 2009, 2008, and 2007, respectively.
Morningstar Advisor
Workstation
Morningstar Advisor Workstation, a
web-based investment planning system, provides financial advisors with a
comprehensive set of tools for conducting their core businessincluding
investment research, planning, and presentations. It allows advisors to build
and maintain a client portfolio database that can be fully integrated with the
firms back-office technology and resources. Moreover, it helps advisors create
customized reports for client portfolios that combine mutual funds, stocks,
separate accounts, variable annuity/life subaccounts, ETFs, hedge funds,
closed-end funds, 529 plans, offshore funds, and pension and life funds.
As of December 31, 2009, about
149,000 advisors in the United States were licensed to use Advisor Workstation,
which is available in two versions: Morningstar Office (formerly Advisor
Workstation Office Edition) for independent financial advisors and a
configurable enterprise version for financial advisors affiliated with larger
firms. Morningstar Advisor Workstation includes four core modules: Clients & Portfolios, Research,
Sales/Hypotheticals, and Planning. We also offer a variety of other
applications, including tools for defined contribution plans; Morningstar
Retirement Income Strategist, a financial planning application that helps
advisors create retirement income plans for their clients; Morningstar
Portfolio Builder, which helps advisors quickly produce sound client
portfolios; Morningstar Annuity Analyzer, which helps advisors screen and
analyze variable annuity contracts and subaccounts; and Morningstar
Hypothetical Illustrator. These applications can be purchased as stand-alone
products or combined as part of a full Workstation license.
Pricing for Morningstar Advisor
Workstation varies based on the number of users, as well as the level of
functionality offered. We typically charge about $3,100 per licensed user for a
base configuration of Morningstar Advisor Workstation, but pricing varies
significantly based on the scope of the license. For clients who purchase more
limited tools-only licenses, the price per user is substantially less. We
generally charge $5,400 per user for an annual license for Morningstar Office.
In 2009, we upgraded our defined
contribution module and alert capabilities, created a newer and more flexible
version of Hypothetical Illustrator, and launched a new version of Annuity
Analyzer.
We incorporated additional
functionality and content, including Target-Date Fund Series Reports, a
new version of the Analyst Research Center, and a Roth IRA calculator. We also
expanded our sales efforts for Portfolio Builder in several markets outside the
United States. With Morningstar
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Office, we introduced an enhanced
client web portal, added more investment data, and expanded back-office
services that handle daily importing and reconciliation of client accounts.
Major competitors for Morningstar
Advisor Workstation and Morningstar Office include Advanced Sales, Advent
Software, ASI, Junxure, MoneyGuide Pro, SunGard, and Thomson Reuters.
Morningstar Advisor Workstation is our
second-largest product based on revenue and made up 13.7%, 12.8%, and 12.5% of
our consolidated revenue in 2009, 2008, and 2007, respectively.
Morningstar.com
Our largest website for individual
investors is Morningstar.com in the United States, which includes both Premium Membership
revenue and Internet advertising sales. As of December 31, 2009, the free
membership services offered through Morningstar.com had more than
7.3 million registered users worldwide, who have access to comprehensive
data on stocks, mutual funds, exchange-traded funds, hedge funds, commodities,
options, bonds, and other investments to help them conduct research and track
performance. In addition, Morningstar.com features extensive market data,
articles, proprietary portfolio tools, and educational content to help
investors of all levels access timely, relevant investment information.
Morningstar.com also includes Portfolio X-Ray, which helps investors reduce
risk and understand key characteristics of their portfolios, and a variety of
other portfolio tools.
We also offer free local websites for
investors in 35 countries around the world, including new sites launched in
Estonia, India, Iceland, Ireland, Latvia, Lithuania, and Thailand in 2009.
We use our free content as a gateway
into paid Premium Membership, which includes access to written analyst reports
on more than 1,700 stocks, 1,700 mutual funds, and 300 exchange-traded
funds, as well as Analyst Picks and Pans, Stewardship Grades, and Premium Stock
and Fund Screeners. We currently offer Premium Membership services in
Australia, China, the United Kingdom, and the United States.
In 2009, we re-launched our site for
individual investors in Australia supported by a significant branding campaign.
The product integrates
Your Money Weekly
content with managed funds data and research. With the new site, we now offer
qualitative research that was previously available only to professionals to
individual investors in this market.
For Morningstar.com in the United
States, in 2009 we added real-time stock and ETF quotes, as well as expanded
market data. During the year we also doubled the number of free articles
published to about 40 per week and introduced a new mobile application for the
iPhone. In its December 2009 issue,
Kiplingers
Personal Finance
magazine named Morningstar.com as one of two best
investing websites.
In early 2010, we acquired the Footnoted.org website and the
Footnoted Pro service, which provide insight and analysis gathered from
corporate SEC filings. We plan to make some content from Footnoted.org
available on Morningstar.com.
Morningstar.com competes with the
personal finance websites of AOL Money & Finance, Google Finance, The
Motley Fool, MSN Money, Seeking Alpha, The Street.com, Yahoo! Finance, and The
Wall Street Journal Online.
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As of December 31, 2009, we had
150,473 paid Premium subscribers for Morningstar.com in the United States plus
an additional 16,000 paid Premium subscribers in Australia, the United Kingdom,
and China. We currently charge $19.95 for a monthly subscription, $179 for an
annual subscription, $299 for a two-year subscription, and $399 for a
three-year subscription for Morningstar.coms Premium service in the United
States. We also sell advertising space on Morningstar.com.
Morningstar.com (including local language
versions outside of the United States) is one of our five largest products
based on revenue and accounted for 8.2% of our consolidated revenue in 2009,
compared with 9.1% of our consolidated revenue in 2008 and 9.0% in 2007.
Morningstar Direct
Morningstar Direct is a web-based
institutional research platform that provides advanced research on the
complete range of securities in Morningstars global database. This
comprehensive research platform allows research and marketing
professionals to conduct advanced performance comparisons and in-depth analyses
of a portfolios underlying investment style. Morningstar Direct includes
access to numerous investment universes, including U.S. mutual funds; European
and offshore funds; funds based in most major markets around the world; stocks;
separate accounts; hedge funds; closed-end funds; exchange-traded funds; global
equity ownership data; variable annuity and life portfolios; and market
indexes.
In 2009, we made several key
enhancements to Morningstar Direct, including a new Presentation Studio that
allows clients to create reusable templates of customized presentations,
reports, and fact sheets; improved capabilities for performance attribution;
and expanded performance reporting, importing, and batch scheduling. We also
added new data on fund flows; descriptive text on separate accounts; Target
Date Fund Series Reports; more specialized fund categories; qualitative
analyst reports and ratings; and data on unit investment trusts. We introduced
local language versions of Morningstar Direct in China and Italy in 2009 and
plan to launch additional versions in Spain, France, and Germany in 2010.
For Morningstar Direct, our primary competitors are
eVestment Alliance, FactSet Research Systems, Markov Processes International,
Strategic Insight, Thomson Reuters, and Zephyr Associates in the United States,
and Europerformance, Feri, FinEx, Mercer, MoneyMate, and Style Research in
non-U.S. markets.
Morningstar Direct had 3,524 licensed
users worldwide as of December 31, 2009.
Pricing for Morningstar Direct is based
on the number of licenses purchased. We charge $16,000 for the first user,
$10,500 for the second user, and $8,000 for each additional user.
Morningstar Principia
Principia is our CD-ROM-based
investment research and planning software for financial planners and had 35,844
subscriptions as of December 31, 2009. The modules offered in Principia
provide data on mutual funds, stocks, separate accounts, variable annuity/life
subaccounts, closed-end funds, defined contribution plans, asset allocation,
presentations and education, and exchange-traded funds. Each module is
available separately or together and features searching, screening, and ranking
tools. Principia allows advisors to create integrated portfolios for clients
and offers three-page Portfolio Snapshot reports that provide a
comprehensive picture of the clients portfolio. The Snapshot report shows
overall style and sector weightings as well as the cumulative exposure to
individual stocks. The Snapshot report is among those approved by the
12
National Association of Securities
Dealers for financial advisors to distribute and review with their clients.
In 2009, we began offering electronic
delivery for Principia, which allows us to deliver data to customers faster and
at lower cost. We introduced a new CAMS (Client Account Manager Service) module
that incorporates the portfolio accounting and performance reporting
functionality we acquired through our purchase of Financial Computer Support, Inc.
in 2008. We also introduced new functionality for point-in-time historical
analysis, portfolio comparisons, and investment policy statements.
Principia prices generally range from
approximately $710 per year for monthly updates on one investment database to
$3,345 per year for monthly updates on the complete package spanning all
investment universes, or $7,535 for all investment universes plus additional
modules for asset allocation, defined contribution plans, and portfolio
management.
Major competitors for Principia include
Standards & Poors and Thomson Reuters.
Morningstar Site
Builder and Licensed Tools
We offer an extensive set of online
tools and editorial content that institutional clients can license to use in
their websites and software products. Within the United States, we offer
Morningstar Site Builder, a set of integrated tools, content, and reports that
investment firms can easily add to their existing advisor websites. Outside of
the United States, we offer Licensed Tools, which can be customized to meet the
needs of international audiences. Clients can select from more than 30
customizable investment tools for retail and advisor websites or purchase
modules focusing on screening and performance tools, editorial commentary and
educational articles, and goal planning and portfolio analysis. Site Builder
and Licensed Tools can be customized to analyze a set of investments, focus on
client-defined data points, or perform calculations required by specific
products or services. We also offer licenses for investment research and
portfolio analysis tools. Morningstar Site Builder and Licensed Tools can be
integrated with a clients existing website and allow users to drill down into
the underlying data when researching a potential investment.
In 2009, we added several new tools to
the Site Builder suite, including Portfolio Planner, Retirement Analyzer,
Watchlist, News, Ticker Tape, and IRA Calculators as well as a new
administrative tool. We have also launched new charting capabilities, market
monitoring tools, and real-time market data.
We also added several new tools to our
Licensed Tools offerings outside the United States, including Portfolio
Planner, Asset Allocator, real-time market data, and new equity tools,
including Stock Quickrank and Stock Reports.
Major competitors for Morningstar Site
Builder and Licensed Tools include Interactive Data Corporation, QuoteMedia,
Thomson Reuters, and Wall Street On Demand.
Pricing for Morningstar Site Builder
and Licensed Tools depends on the audience, the level of distribution, and the
scope of information and functionality licensed.
Newsletters and Other
Publications
We offer a variety of print and
electronic publications about investing. Some of these include
Morningstar Mutual Funds,
a reference
publication that features our signature one-page reports on approximately
1,500 mutual funds;
Morningstar
FundInvestor,
a monthly newsletter that provides information
and insight on 500 of the most popular mutual funds and a list of 150 Analyst
13
Picks;
Morningstar StockInvestor,
a monthly newsletter that focuses
on companies with strong competitive positions and stock prices that we believe
are low enough to provide investors with a margin of safety; and the
Ibbotson Stocks, Bonds, Bills, and Inflation
Yearbook,
a definitive study of historical capital markets data in
the United States. In addition, we offer several other investment
newsletters and a series of books about investing and personal finance,
which are available directly from us and in bookstores.
Our Investment Information segment also
includes several publications for investors in Australia, including
IFA Magazine,
Australias leading magazine
for independent financial advisors, and
Your
Money Weekly
, which focuses on investment recommendations and
portfolios ideas for companies listed in Australia.
In 2009, we created companion websites
for two of our publications. We also moved
Your
Money Weekly
in Australia
to
an online format that integrates content from the magazine with data and
research on managed investment funds.
Our print publications compete with
Agora Publishing, Forbes, InvestorPlace Media, The Motley Fool, and Value Line
in the United States and Intelligent Investor, InvestSmart, and The Rivkin
Report in Australia.
Morningstar Equity
Research
As of December 31, 2009, we
offered independent equity research on approximately 2,000 companies. Our
approach to stock analysis focuses on long-term fundamentals. Our analysts
evaluate companies by assessing each firms competitive advantage, analyzing the
level of business risk, and completing an in-depth projection of future cash
flows. For the companies we cover, our analysts prepare a fair value estimate,
a Morningstar Rating for stocks, a rating for business risk, and an assessment
of the companys economic moat. Economic moat is a concept originally developed
by Warren Buffett that describes a companys competitive advantage relative to
other companies. For the remaining stocks included in our database, we offer
quantitative grades for growth, profitability, and financial health, as well as
an explanation of the companys business operations. We currently deliver our
equity research to individual investors as part of our Premium Membership
service on Morningstar.com, as well as to several other companies who provide
our research to their affiliated financial advisors or to individual investors.
From June 2004 through July 2009,
we also provided independent equity research to six major investment banks
under the terms of the Global Analyst Research Settlement. For further
discussion about this issue, see Item 1A Risk Factors.
We currently provide analyst reports on
virtually all of the most widely held stocks in the S&P 500 index, as well
as numerous companies included in other major indexes. We had approximately 108
stock analysts around the world as of December 31, 2009, compared with 128
as of December 31, 2008.
In 2009, we entered into an agreement
with the NASDAQ OMX Group, Inc. to provide equity research profile reports
on more than 3,600 NASDAQ OMX-listed companies. In January 2010, we
announced an expanded agreement with NASDAQ OMX that gives NASDAQ-listed
companies the option of contracting with NASDAQ OMX for comprehensive analyst
research reports provided by Morningstar.
We also began publishing credit ratings
on 100 of the largest corporate issuers in 2009. In 2010, we plan to produce
credit ratings for up to 1,000 companies currently covered by our equity
analyst team. The ratings are available on Morningstar.com, and we offer
forecasts and scores underlying the ratings to our institutional equity
research clients.
14
Our Equity Research services compete
with The Applied Finance Group, Credit Suisse HOLT, Renaissance Capital,
Standard & Poors, Value Line, Zacks Investment Research, and several
smaller research firms. Competitors for our fixed-income credit research
include Credit Sights, Egan-Jones, Fitch, Gimme Credit, Moodys, and Standard &
Poors.
Pricing for Morningstar Equity Research
varies based on the level of distribution, the number of securities covered,
the amount of custom coverage required, and the length of the contract term.
Morningstar Indexes
We offer an extensive set of investment
indexes that can be used to benchmark the market and create investment
products. Our index family includes a series of U.S. equity indexes that track
the U.S. market by capitalization, sector, and investment style; a dividend
index; a focused stock index capturing performance of wide moat stocks with
the most attractive valuations; a series of bond indexes that track the U.S.
market by sector and term structure; global bond indexes; commodity indexes;
and asset allocation indexes. Investment firms can license the Morningstar
Indexes to create investment vehicles, including mutual funds, ETFs, and
derivative securities. We charge licensing fees for the Morningstar
Indexes, with fees consisting of an annual licensing fee as well as fees linked
to assets under management.
We currently license the Morningstar
Indexes to several institutions that offer exchange-traded funds or
exchange-traded notes based on the indexes, including Barclays Global
Investors, First Trust, and Merrill Lynch.
In 2009, we introduced a family of
asset allocation indexes that serve as benchmarks for target-date and
target-risk investments and expanded our family of commodity- and managed
futures- based indexes. We believe were the only index provider that offers
indexes spanning all asset categories, which allows us to develop indexes that
blend various asset classes.
Investment Management Segment
The largest 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, exchange-traded
fund, and stock 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 client base in this segment
includes banks, brokerage firms, insurance companies, mutual fund companies,
and retirement plan sponsors and providers. We currently offer investment
management services in the United States, Europe, Japan, and Australia. Our
license agreements in the Investment Management segment have an average
contract term of approximately three years, although some of our agreements
allow for early termination.
About 7.7% of Investment Management
segment revenue was from outside the United States in 2009.
Many of our largest customers are
insurance companies, including variable annuity providers, followed by mutual
fund companies and other asset management firms, retirement plan sponsors and
providers, broker-dealers, and banks. We plan to develop additional
distribution channels to reach other client types, including foundations and
endowments, defined contribution plans, defined benefit plans, and wealth
management firms. We also expect to continue expanding our Investment
Management business outside the United States.
15
For Morningstar Managed Portfolios, our
target audience consists of home offices of insurance companies,
broker-dealers, and registered investment advisors, as well as independent
financial advisors.
We market our Investment Management
services almost exclusively through our institutional sales team, including
both strategic account managers and sales representatives within each business
unit. We employ a consultative sales approach and often tailor customized
solutions to meet the needs of larger institutions. We have a regional sales
team responsible for expanding relationships for Morningstar Managed
Portfolios.
We believe our institutional clients
value our independence, breadth of information, and customized services; in
addition, we believe our research, tools, and advice reach many individual
investors through this channel. We also reach approximately 1,900 financial
advisors through our Managed Portfolios platform.
The Investment Management segment has
not historically shown seasonal business trends; however, business results for
this segment are typically more variable because of our emphasis on asset-based
fees, which change along with market movements and other factors.
Our largest customer in the Investment
Management segment made up approximately 9% of segment revenue in 2009.
Investment Consulting
Our Investment Consulting area provides
a broad range of services, many of which emphasize investment monitoring and
asset allocation for funds of funds, including mutual funds and variable
annuities. We offer Investment Consulting services through Morningstar
Associates, LLC, Morningstar Associates Europe, Ltd, Ibbotson Associates, Inc., Ibbotson
Advisors, LLC, and Intech Pty Ltd, which are registered investment advisors and
wholly owned subsidiaries of Morningstar, Inc. We emphasize contracts
where were paid a percentage of assets under management for ongoing investment
management and consulting, as opposed to one-time relationships where were
paid a flat fee.
Morningstar Associates generally
focuses on a small number of large relationships, focusing on customized
solutions that improve the investor experience and help our clients build their
businesses.
Our investment professionals evaluate
investment plans, recommend strategies, help set investment policies, develop
asset allocation programs, construct portfolios, and monitor ongoing
performance. We offer these consulting services to clients in the United
States, Asia, Australia, Canada, and Europe, including insurance companies,
investment management companies, mutual fund companies, and broker-dealers. We
also provide services for retirement plan sponsors and providers, including
developing plan lineups, creating investment policy statements, and monitoring
investment performance.
Our team of investment consultants
draws on both quantitative research tools and qualitative expertise to assess
investment programs, provide detailed analysis of performance and portfolio
characteristics, and make comprehensive recommendations for improvement. We
also offer investment manager search services. Our staff combines the depth of
Morningstars historical fundamental databases with detailed investment
knowledge and investment experience to recommend qualified candidates for
subadvisory firms, mutual fund managers, variable insurance trust managers, and
separate account managers. Our investment monitoring services include analyst
reports, customizable board reports, select lists, watch lists, and in-depth
attribution analysis.
16
In 2009, Morningstar Associates
introduced several new multimanager portfolios, including one incorporating a
risk management overlay and one using managed futures and foreign exchange managers
for distribution to accredited investors. We also developed a technology
solution that enables advisors or plan sponsors to create time, risk, or hybrid
models to select funds for defined contribution plan lineups.
In early 2010, Morningstar Associates
announced an agreement with Pax World Funds to create and manage a series of
four asset allocation portfolios featuring investment managers who incorporate
environment, social, and governance issues in their investment process.
Pax World is the investment advisor to
these portfolios, and Morningstar Associates is charged with manager selection,
asset allocation, and portfolio construction and monitoring. We invested $8
million as seed money in the portfolios in 2009.
We significantly expanded our Investment
Consulting area in 2006 when we acquired Ibbotson Associates, which has a
well-established consulting business that began in 1977. Ibbotsons Investment
Consulting unit is a leading authority on asset allocation and draws on its
knowledge of capital markets and portfolio building to construct portfolios
from the top down, starting at the asset class level. Ibbotson develops
customized asset allocation programs for mutual fund firms, banks,
broker-dealers, and insurance companies.
Ibbotson provides a range of consulting
services, including licensing its asset allocation models, providing consulting
services, and acting as a portfolio subadvisor. Ibbotson works with different
types of investment options, including mutual funds, variable annuities, and
exchange-traded funds, and provides both strategic and dynamic asset allocation
services. The group offers consulting services and fund-of-funds subadvisory
services, as well as tailored model portfolios, fund classification schemes,
and questionnaire design.
In 2009, Ibbotson Associates added
capabilities for forecasting and modeling the glide paths of target-maturity
funds; launched a lifetime financial advice solution that combines insurance
and annuities as part of investors portfolios over time; expanded its
target-maturity portfolio construction services to large plan sponsors; began
specifically incorporating an analysis of statistically unlikely (aka fat tail)
events in its portfolio construction process for some clients; and introduced
alternative investment strategy portfolios for clients in the United States.
Ibbotson is also developing active
investment management capabilities based on founder Roger Ibbotsons liquidity
methodology. We launched two seed portfolios in October 2009 with an investment
of $2 million to begin establishing a track record for this methodology.
As discussed on page 7, in June 2009
we acquired Intech Pty Ltd, a leading provider of multimanager and investment
portfolio solutions in Sydney, Australia, from IOOF Holdings Limited. Intech
manages the Intech Investment Trusts, a range of single sector, alternative
strategy, and diversified investment portfolios. In 2009, Intech launched
several additional unit trusts, including five multimanager solutions and two
trusts emphasizing different levels of growth and income. We rebranded Intech
under the Ibbotson name in February 2010.
Our Investment Consulting business
competes primarily with Mercer, Mesirow Financial, Russell Investments, Watson
Wyatt, and Wilshire Associates, as well as some smaller firms in the retirement
consulting business and various in-house providers of investment advisory
services.
Pricing for the consulting services we
provide through Morningstar Associates and Ibbotson Associates is based on the
scope of work and the level of service required. In the majority of our
contracts, we receive asset-based fees, reflecting our work as a portfolio
construction manager or subadvisor for a mutual fund or variable annuity.
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Investment Consulting was our
third-largest product based on revenue in 2009 and accounted for 13.3%, 15.5%,
and 17.4% of our consolidated revenue in 2009, 2008, and 2007, respectively.
Retirement Advice
We have two Retirement Advice offerings
that help retirement plan participants plan and invest for retirement:
Morningstar Retirement Manager (offered by Morningstar Associates) and Advice
by Ibbotson (offered by Ibbotson Associates).
Morningstar Retirement Manager is
designed to help retirement plan participants determine how much to invest and
which investments are most appropriate for their portfolios. It gives guidance
explaining whether participants suggested plans are on target to meet their
retirement goals. As part of this service, we deliver personalized
recommendations for a target savings goal, a recommended contribution rate to
help achieve that goal, a portfolio mix based on risk tolerance, and specific
fund recommendations. Morningstar Retirement Manager includes a managed account
service designed for plan participants who choose to delegate management of
their portfolios to Morningstars investment professionals. We offer these
services primarily through retirement plan providerstypically third-party
asset management companies or companies that offer administrative services to
retirement plans. These providers often offer proprietary mutual funds to
retirement plan sponsors and their participants.
In 2009, we introduced a new advisory
service for individuals in retirement that provides recommendations for drawing
down their portfolios to create sustainable income and managing their remaining
assets. We also created a custom models platform that enables retirement plan
sponsors and advisors to develop custom retirement date, lifestyle, or blended
portfolios using the plans investment lineup.
As of December 31, 2009,
approximately 11.2 million plan participants had access to Morningstar
Retirement Manager through approximately 83,000 plan sponsors and 16 plan
providers. Pricing for Morningstar Retirement Manager depends on the number of
participants, as well as the level of service we provide.
Advice by Ibbotson offers a set of
services and proprietary software to give retirement plan participants access
to investment education, self-service advice, and managed retirement accounts.
We offer these services mainly through retirement plan providers. The platform
includes installed software advice solutions that can be co-branded by
retirement plan sponsors and providers. Advice by Ibbotson combines asset
allocation and patented human capital methodologies that help participants
determine how to prepare for retirement based on their financial assets as well
as their future earnings and savings power. Advice by Ibbotsons customized software
can be integrated with existing systems to help investors accumulate wealth,
transition into retirement, and manage income during retirement.
In 2009, we launched our proprietary
Advice by Ibbotson technology platform serving defined contribution plan
providers; expanded the services available in Advice by Ibbotson to provide
financial advice to retirement plan participants through all stages of their
lives (including wealth accumulation, transition, and retirement); began
incorporating simulations of statistically unlikely (aka fat tail) events in
Advice by Ibbotsons wealth-forecasting process for defined contribution plans;
and enhanced our reporting capabilities for retirement-plan sponsors and plan
participants.
As of December 31, 2009, approximately
9.5 million plan participants had access to Advice by Ibbotson through
approximately 68,000 plan sponsors and seven plan providers. Pricing for Advice
by Ibbotson depends on the number of participants, as well as the level of
service we provide.
In the retirement advice market, we
compete primarily with Financial Engines, Guided Choice, and ProManage.
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Morningstar Managed
Portfolios
Morningstar Managed Portfolios is a
fee-based discretionary asset management service that includes a series of
mutual fund, ETF, and stock portfolios tailored to meet specific investment
time horizons and risk levels. This program is only available through financial
advisors. Our team of investment professionals uses a disciplined process for
asset allocation, fund selection, and portfolio construction. They actively
monitor the portfolios and make adjustments as needed. We complement these
asset management services with online client-management functions such as risk
profiling and access to client statements, transaction capabilities, and
performance reports.
We had approximately $2.1 billion
in assets under management with about 1,900 financial advisors using the
service as of December 31, 2009. We charge asset-based fees for
Morningstar Managed Portfolios. The management fee is based on a tiered
schedule that depends on the clients average daily portfolio balance.
Fees for our mutual fund and exchange-traded fund portfolios generally range
from 30 to 40 basis points. We charge 55 basis points for the Select Stock
Baskets, which are a managed account service consisting of individually
customized stock portfolios based on Morningstars proprietary indexes and
independent equity research.
In 2009, Morningstar Investment
Services introduced a series of Lifetime Wealth Portfolios in partnership with
Ibbotson Associates and a large insurance company. The Lifetime Wealth Portfolios
incorporate insurance as an integral part of an asset allocation. The solution
builds on Ibbotsons Human Capital concept, which models the value and risk
of an individuals human capital and recommends a face value of life insurance
(or an annuity) to hedge that capital. As a first-of-its-kind solution, the
portfolios help to define and contextualize an investors insurance needs
within a holistic financial plan.
For Morningstar Managed Portfolios, our
primary competitors are Brinker Capital, Curian Capital, Envestnet PMC,
FundQuest, and SEI Investments.
The Morningstar Managed Portfolios
program is offered through Morningstar Investment Services, Inc., a
registered investment advisor, registered broker-dealer, member of the
Financial Industry Regulatory Authority, Inc. (FINRA), and wholly owned
subsidiary of Morningstar, Inc.
Marketing and Sales
We promote our print, software,
web-based products and services, and consulting services with a staff of sales
and marketing professionals, as well as an in-house public relations team. Our
marketing staff includes both product specialists and a corporate marketing
group that manages company initiatives. Our sales team includes several
strategic account managers who oversee all aspects of our largest institutional
client relationships. We also have a sales operations staff, which focuses on
tracking and forecasting sales and other tasks to support our sales team.
Across our business, we emphasize high levels of product support to help our
customers use our products effectively and provide our product managers with
feedback from customers. We had approximately 400 sales and marketing
professionals on staff as of December 31, 2009.
International
Operations
We conduct our business operations
outside of the United States, which have been increasing as a percentage of our
consolidated revenue, through wholly owned or majority-owned operating
subsidiaries doing business in each of the following countries: Australia,
Canada, France, Germany, India, Italy, Japan, Korea, the Netherlands, New
Zealand, Norway, Peoples Republic of China (both Hong Kong and the mainland),
Singapore, South Africa, Spain, Switzerland, Taiwan, Thailand, and the United
Kingdom. See Note 4 of the Notes to our Consolidated
19
Financial Statements for additional
information concerning revenue from customers and long-lived assets from our
business operations outside the United States.
In addition, we hold minority ownership
positions in operating companies based in Denmark, Japan, and Sweden. As of December 31,
2009, we owned approximately 34% of the outstanding shares in Morningstar Japan
K.K. (Morningstar Japan) and our share had a market value of approximately
$28.5 million. Morningstar Japan is publicly traded under ticker 4765 on the
Osaka Stock Exchange Hercules Market. See Note 7 of the Notes to our
Consolidated Financial Statements for information on our investments in
unconsolidated entities.
To enable these companies to do
business in their designated territories, we provide them with the rights to
the Morningstar name and logo and with access to certain of our products and
technology. Each company is responsible for developing marketing plans tailored
to meet the specific needs of investors within its country and working with
Morningstars data collection and development centers to create and maintain
databases, develop new products, and enhance existing products.
See Item 1ARisk Factors for a
discussion of the risks related to our business operations outside of the
United States.
Intellectual Property
and Other Proprietary Rights
We treat our brand, product names and
logos, software, technology, databases, and other products as proprietary. We
try to protect this intellectual property by using trademark, copyright, patent
and trade secrets laws, licensing and nondisclosure arrangements, and other
security measures. For example, in the normal course of business, we only
provide our intellectual property to third parties through standard licensing
agreements. The purposes of these agreements are to both define the extent and
duration of any third-party usage rights and to provide for our continued
ownership in any intellectual property furnished.
Because of the value of our brand name
and logo, we have tried to register one or both of them in all of the relevant
international classes under the trademark laws of most of the jurisdictions in
which we maintain operating companies. As we move into new countries, we
consider adding to these registrations and, in some jurisdictions, register
certain product identifiers as well. We have registered our name and/or logo in
numerous countries and the European Union and have applied for registrations in
several other countries.
Morningstar and the Morningstar logo
are registered marks of Morningstar in the United States and in certain other
jurisdictions. The table below includes some of the trademarks or service marks
that we use:
Advice
by Ibbotson
®
|
|
Morningstar
®
Managed
Portfolios
SM
|
Hemscott
®
|
|
Morningstar
®
Managed
Portfolios
SM
Select
Stock Baskets
|
Ibbotson
Associates
®
|
|
Morningstar
Market Barometer
SM
|
Ibbotson
®
SBBI
®
|
|
Morningstar
®
Mutual
Funds
TM
|
Morningstar
®
Advisor
Workstation
SM
|
|
Morningstar
Office
SM
|
Morningstar
®
Advisor
Workstation
SM
Enterprise
Edition
|
|
Morningstar
®
Ownership
Zone
SM
|
Morningstar
®
Analyst
Research Center
|
|
Morningstar
®
Pension &
Endowment Center
SM
|
Morningstar
®
Annuity
Analyzer
SM
|
|
Morningstar
®
Portfolio
Builder
SM
|
Morningstar
®
Back
Office Services
SM
|
|
Morningstar
®
Portfolio
X-Ray
®
|
Morningstar
Direct
SM
|
|
Morningstar
®
Principia
®
|
Morningstar
®
Enterprise Data Management
|
|
Morningstar
Qualitative Rating
|
Morningstar
®
Equity
Research Services
SM
|
|
Morningstar
Rating
TM
|
Morningstar
®
Essentials
TM
|
|
Morningstar
®
Real-Time
Data
|
Morningstar
®
ETFInvestor
TM
|
|
Morningstar
®
Retirement
Income Strategist
SM
|
Morningstar
®
FundInvestor
TM
|
|
Morningstar
®
Retirement
Manager
SM
|
Morningstar
®
Global
Document Library
SM
|
|
Morningstar
®
Site
Builder
SM
|
Morningstar
®
Hypothetical
Illustrator
SM
|
|
Morningstar
®
Stewardship
Grade
SM
|
Morningstar
®
Institutional
Equity Research Services
SM
|
|
Morningstar
®
StockInvestor
TM
|
Morningstar
®
Investment
Guide
|
|
Morningstar
Style Box
TM
|
Morningstar
®
Investment
Profiles
TM
|
|
Morningstar
®
Traded
Fund Center
SM
|
Morningstar
®
Licensed
Data
SM
|
|
Morningstar
®
Wide
Moat Focus
SM
Index
|
Morningstar
®
Licensed
Tools and Content
|
|
Morningstar.com
®
|
In addition to trademarks, we currently
hold several patents in the United States, United Kingdom, and Canada. We are
in the process of registering another patent in the United States. We believe
these patents represent our commitment to developing innovative products and
tools for investors.
20
License Agreements
In the majority of our licensing
agreements, we license our products and/or other intellectual property to our
customers for a fee. We generally use our standard agreements, whether in paper
or electronic form, and we do not provide our products and services to
customers or other users without having an agreement in place.
We maintain licensing agreements with
each of our minority-owned operations. We put these agreements in place so
these companies can use our intellectual property, such as our products and
trademarks, to develop and market similar products under our name in their
operating territories.
In the ordinary course of our business,
we obtain and use intellectual property from a wide variety of sources. We
license some of this intellectual property from third parties and obtain other
portions of it directly from public filings.
Seasonality
We believe our business has a modest
amount of seasonality. Some of our smaller products, such as the
Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook
and one of our investment conferences, generate the majority of
their revenue in the first or second quarter of the year. Most of our products
are sold with subscription or license terms of at least one year, though, and
we recognize revenue ratably over the term of each subscription or license
agreement. This tends to moderate seasonality in sales patterns for individual
products.
We believe market movements generally
have more influence on our performance than seasonality. The amount of revenue
we earn from asset-based fees depends on the value of assets on which we
provide advisory services, and the size of our asset base can increase or
decrease along with trends in market performance.
Largest Customer
In 2009, our largest customer accounted
for less than 5% of our consolidated revenue.
Competitive Landscape
The economic and financial information
industry has been marked by increased consolidation over the past five years,
with the strongest players generally gaining market share at the expense of
smaller competitors. Some of our major competitors include Thomson Reuters;
Standard & Poors, a division of The McGraw-Hill Companies; Bloomberg;
and Yahoo!. These companies
21
have financial resources that are
significantly greater than ours. We also have a number of smaller competitors
in our two business segments, which we discuss in Business Segments, Products,
and Services above.
We believe the most important competitive
factors in our industry are brand and reputation, data accuracy and quality,
breadth of data coverage, quality of investment analysis and analytics, design,
product reliability, and value of the products and services provided.
Major Competitors by
Product
|
|
Licensed Data
|
|
Investment
Consulting
|
|
Morningstar
Advisor
Workstation
|
|
Morningstar.com
|
|
Principia
|
|
Morningstar
Direct
|
Advent Software
|
|
|
|
|
|
·
|
|
|
|
·
|
|
|
Bloomberg
|
|
·
|
|
|
|
|
|
·
|
|
|
|
·
|
eVestment Alliance
|
|
·
|
|
|
|
|
|
|
|
|
|
·
|
FactSet Research Services
|
|
·
|
|
|
|
|
|
|
|
|
|
·
|
Financial Express
|
|
·
|
|
|
|
·
|
|
|
|
|
|
|
Interactive Data Corporation
|
|
·
|
|
|
|
|
|
|
|
|
|
|
News Corporation*
|
|
|
|
|
|
|
|
·
|
|
|
|
|
Standard & Poors
|
|
·
|
|
|
|
·
|
|
|
|
·
|
|
|
Thomson Reuters**
|
|
·
|
|
|
|
·
|
|
|
|
·
|
|
·
|
Wilshire Associates
|
|
|
|
·
|
|
|
|
|
|
|
|
·
|
Yahoo!
|
|
|
|
|
|
|
|
·
|
|
|
|
|
Zephyr Associates
|
|
|
|
|
|
|
|
|
|
|
|
·
|
* News Corporation includes Dow Jones,
MarketWatch, and
SmartMoney
** Thomson Reuters includes
Lipper
Research and
Development
A key aspect of our growth strategy is
to expand our investment research capabilities and enhance our existing
products and services. We strive to rapidly adopt new technology that can
improve our products and services. We have also built a flexible technology
platform that allows our products to work together across a full range of
investment databases, delivery formats, and market segments. As a general
practice, we manage our own websites and build our own software rather than
relying on outside vendors. This allows us to control our development and
better manage costs, enabling us to respond quickly to market changes and to
meet customer needs efficiently. As of December 31, 2009, our technology
team consisted of approximately 500 programmers and technology and
infrastructure professionals.
In 2009, 2008, and 2007, our
development expense represented 8.0%, 8.0%, and 8.1%, respectively, of our
revenue. We expect that development expense will continue to represent a
meaningful percentage of our revenue in the future.
Government Regulation
United States
Investment advisory and broker-dealer businesses
are subject to extensive regulation in the United States at both the federal
and state level, as well as by self-regulatory organizations. Financial
services companies are among the nations most extensively regulated. The SEC
is
22
responsible for enforcing the federal
securities laws and oversees federally registered investment advisors and
broker-dealers.
As of December 31, 2009, four of
our subsidiaries, Ibbotson Associates, Inc., Ibbotson Associates Advisors,
LLC, Morningstar Associates, LLC, and Morningstar Investment Services, Inc.
are registered as investment advisors with the SEC under the Investment
Advisers Act of 1940, as amended (Advisers Act). As registered investment
advisors, these companies are subject to the requirements and regulations of
the Advisers Act. Such requirements relate to, among other things,
record-keeping, reporting, and standards of care, as well as general anti-fraud
prohibitions.
In addition, because these four
subsidiaries provide investment advisory services to retirement plans and
their participants, they may be acting as fiduciaries under the Employee
Retirement Income Security Act of 1974 (ERISA). As fiduciaries under ERISA,
they have duties of loyalty and prudence, as well as duties to diversify
investments and to follow plan documents to comply with the applicable portions
of ERISA.
We provide each of our investment
advisor companies with financial, operational, and administrative support.
However, each of them operates independently from each other and from other
areas of Morningstar, using separate personnel and supervisory structures and
making independent investment decisions.
Morningstar Investment Services is a
broker-dealer registered under the Securities Exchange Act of 1934 (Exchange
Act) and a member of FINRA. The regulation of broker-dealers has, to a large
extent, been delegated by the federal securities laws to self-regulatory
organizations, including FINRA. Subject to approval by the SEC, FINRA adopts rules that
govern its members. FINRA conducts periodic examinations of the operations of
Morningstar Investment Services. Broker-dealers are subject to regulations that
cover all aspects of the securities business, including sales, capital structure,
record-keeping, and the conduct of directors, officers, and employees.
Violation of applicable regulations can result in the revocation of a
broker-dealer license, the imposition of censures or fines, and the suspension
or expulsion of a firm or its officers or employees. Morningstar Investment
Services is subject to certain net capital requirements under the Exchange Act.
The net capital requirements, which specify minimum net capital levels for
registered broker-dealers, are designed to measure the financial soundness and
liquidity of broker-dealers.
Australia
Our subsidiaries that provide financial
information services in Australia, Morningstar Australasia Pty Limited and
Intech Fiduciaries Limited, must hold an Australian Financial Services License
and submit to the jurisdiction of the Australian Securities and Investments
Commission (ASIC). This license requires them to maintain positive net asset
levels and sufficient cash resources to cover three months of expenses and to
comply with the audit requirements of the ASIC.
United Kingdom
Morningstar Associates Europe Limited
is authorized and regulated by the U.K. Financial Services Authority as an
investment advisor. As an authorized firm, this company is subject to the
requirements and regulations of the Financial Services Authority. Such
requirements relate to, among other things, financial reporting and other
reporting obligations, record-keeping, and cross-border requirements.
Additional legislation and regulations,
including those relating to the activities of investment advisors and
broker-dealers, changes in rules imposed by the SEC or other U.S. or
non-U.S. regulatory authorities and self-regulatory organizations, or changes
in the interpretation or enforcement of existing laws and rules may adversely
affect our business and profitability. Our
23
businesses may be materially
affected not only by regulations applicable to it as an investment advisor or
broker-dealer, but also by regulations that apply to companies generally.
Employees
We had approximately 2,600 employees as
of December 31, 2009, including approximately 480 data analysts, 75
designers, 290 investment analysts (including consulting and quantitative
research analysts), 490 programmers and technology staff, and 400 sales and
marketing professionals. Our employees are not represented by any unions, and
we have never experienced a walkout or strike.
Executive Officers
As of February 26, 2010, we had 13
executive officers. The table below summarizes information about each of these
officers.
Name
|
|
Age
|
|
Position
|
Joe
Mansueto
|
|
53
|
|
Chairman,
Chief Executive Officer, and Director
|
Chris
Boruff
|
|
44
|
|
President,
Advisor Software
|
Peng
Chen
|
|
39
|
|
President,
Ibbotson Associates, Inc.
|
Scott
Cooley
|
|
41
|
|
Chief
Financial Officer
|
Bevin
Desmond
|
|
43
|
|
President,
International Division and Institutional Software
|
Catherine
Gillis Odelbo
|
|
47
|
|
President,
Equity Research
|
Tao
Huang
|
|
47
|
|
Chief
Operating Officer
|
Kunal
Kapoor
|
|
34
|
|
President,
Individual Investor Software
|
Elizabeth
Kirscher
|
|
45
|
|
President,
Data Services
|
Don
Phillips
|
|
47
|
|
President,
Fund Research and Managing Director
|
Patrick
Reinkemeyer
|
|
44
|
|
President,
Morningstar Associates LLC
|
Richard
Robbins
|
|
47
|
|
General
Counsel and Corporate Secretary
|
David W.
Williams
|
|
49
|
|
Managing
Director, Design
|
Joe Mansueto
Joe Mansueto founded Morningstar in
1984. He has served as our chairman since our inception and as our chief
executive officer from our inception to 1996 and from 2000 to the present. He
holds a bachelors degree in business administration from The University of
Chicago and a masters degree in business administration from The University of
Chicago Booth School of Business. He is a member of the board of directors for
Trans Union LLC.
Chris Boruff
Chris Boruff has been the president of
our advisor business since 2000 and became president of our advisor software
business in 2009. He is responsible for overseeing strategy, development, and
marketing associated with our software for financial advisors. He joined us in
1996 as product manager for Principia, and from 1997 to 1998, he served as
senior product manager of advisor products. From 1999 to 2000, he served as
vice president of advisor products, where he was responsible for all marketing
related to financial advisors. He holds a bachelors degree in economics and
psychology from Northwestern University.
Peng Chen
Peng Chen has been president of
Ibbotson Associates, Inc. since August 2006. Prior to Morningstars
acquisition of Ibbotson in 2006, he served as Ibbotsons managing director and
chief investment officer. He joined Ibbotson in 1997 and played a key role in
the development of its investment consulting and 401(k) advice/managed
retirement account services. He received a
24
bachelors degree in industrial
management engineering from Harbin Institute of Technology and masters and
doctorate degrees in consumer economics from The Ohio State University.
Scott Cooley
Scott Cooley has been our chief
financial officer since August 2007. Before joining Morningstar in 1996 as
a stock analyst, he was a bank examiner for the Federal Deposit Insurance
Corporation (FDIC), where he focused on credit analysis and asset-backed
securities. From 1996 until 2003, he was an analyst, editor, and manager for
Morningstar.com,
Morningstar Mutual Funds
,
and other Morningstar publications. He became CEO of Morningstar Australia and
Morningstar New Zealand in 2003 and served as co-CEO of these operations
following our acquisition of Aspect Huntley in July 2006. He holds a
bachelors degree in economics and social science and a masters degree in
history from Illinois State University.
Bevin Desmond
Bevin Desmond has been president of our
international business since 2000. She is responsible for identifying and
developing our business in new countries, managing and directing operations,
and launching new products. In 2009, Bevin took on additional responsibilities
as president of institutional software, including oversight of Morningstar
Direct and other institutional software platforms. She joined us in 1993 and
was one of three employees who started our international business. From 1998 to
2000, she served as manager of all international ventures. She holds a bachelors
degree in psychology from St. Marys College.
Catherine Gillis
Odelbo
Catherine Gillis Odelbo was president of
our Individual segment from 2000 through 2008 and became president of our
equity research business in 2009. She joined us in 1988 as a mutual fund
analyst and from 1999 to 2000 served as senior vice president of content
development for the company, as well as publisher and editor of our stock and
closed-end fund research. She holds a bachelors degree in American history
from The University of Chicago and a masters degree in business administration
from The University of Chicago Booth School of Business.
Tao Huang
Tao Huang has been our chief operating
officer since 2000. He is responsible for corporate strategy and overseeing our
business results and day-to-day operations. He joined us in 1990 as a
software developer and from 1996 to 1998 served as chief technology officer.
From 1998 to 2000, he served as senior vice president of business development
and head of international operations. He holds a bachelors degree in computer
science from Hunan University in China, a masters degree in computer science
from Marquette University, and a masters degree in business administration
from The University of Chicago Booth School of Business.
Kunal Kapoor
Kunal Kapoor has been president of
individual investor software since 2009. He joined us in 1997 as a data analyst
and became a fund analyst in 1998. In 2001 he joined Morningstar Investment
Services as a senior research analyst. He was named editor of
Morningstar Mutual Funds
in 2003, and in
2004 was appointed director of mutual fund analysis. In 2006, he was named
director of business strategy for Morningstars international operations. He
became president and chief investment officer of Morningstar Investment
Services in 2007. Kunal holds a bachelors degree in economics and
environmental policy from Monmouth College and a masters degree in business
administration from The University of Chicago Booth School of Business. He also
holds the Chartered Financial Analyst (CFA) designation and is a member of the
Investment Analysts Society of Chicago.
25
Elizabeth Kirscher
Elizabeth Kirscher has been president
of our data services business since 2000. She is responsible for managing our
investment databases and related products. She joined us in 1995 as a major
accounts manager in our institutional sales area. From 1998 to 1999, she served
as international product manager and worked on the launch of Morningstar Japan.
From 1999 to 2000, she was director of sales and business development for
Morningstar.com and marketed Morningstar.com data and tools to other websites.
She holds a bachelors degree from Vassar College and a masters degree in
business administration from the Columbia Business School at Columbia
University.
Don Phillips
Don Phillips has been a managing
director since 2000 and in 2009 took on additional responsibilities as
president of fund research. He is responsible for overseeing our research on
mutual funds, exchange-traded funds, and alternative investments, as well as
our corporate communications area. He joined us in 1986 as our first analyst.
He served as our vice president and publisher from 1991 to 1996, as our
president from 1996 to 1998, and as our chief executive officer from 1998 to
2000. He has served on our board of directors since August 1999. He also
serves on the board of directors for Morningstar Japan. He holds a bachelors
degree from the University of Texas and a masters degree from The University
of Chicago.
Patrick Reinkemeyer
Patrick Reinkemeyer has been president
of Morningstar Associates, LLC since October 2004. He is responsible for
Morningstars Investment Consulting and Retirement Advice businesses. He joined
us in 1996 and directed our print and software variable annuity/life products
from 1996 to 1997. From 1998 until 2001, he was director of Morningstars
Investment Consulting business. From 2001 until October 2004, he served as
president of Investment Consulting. He holds a bachelors degree in
history from Middlebury College and a masters degree in business
administration from The University of Chicago Booth School of Business. He also
holds the Chartered Financial Analyst (CFA) designation and is a member of the
Investment Analysts Society of Chicago.
Richard Robbins
Richard Robbins has been our general
counsel and corporate secretary since August 2005. He is responsible for
directing Morningstars legal department and managing our relationships with
outside counsel. From May 1999 until he joined Morningstar, he was a
partner at Sidley Austin Brown & Wood LLP (now Sidley Austin LLP),
which he joined as an associate in August 1991. He holds bachelors and
masters degrees in computer science and electrical engineering from the
Massachusetts Institute of Technology and a juris doctor degree from The
University of Chicago Law School.
David W.
Williams
David W. Williams has been one of
our managing directors since 2000. He is in charge of design and its
application to brand identity, products, communications, and the workplace. He
joined us in 1993 and has been instrumental in establishing design as one of
our recognized core capabilities. He holds a bachelors degree in industrial
design from The Ohio State University and a masters degree in fine arts from
the Yale University School of Art.
Company Information
We were incorporated in Illinois on May 16,
1984. Our corporate headquarters are located at 22 West Washington Street,
Chicago, Illinois, 60602.
We maintain a website at
http://corporate.morningstar.com
. Our
Annual Report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to any of these documents are
available free of charge on this site as soon as reasonably practicable after
the reports are filed with or furnished to the SEC. We also post quarterly
press releases on our financial results and other documents containing
additional information related to our company on this site. We provide this
website and the information contained in or connected to it for informational
purposes only. That information is not part of this Annual Report on
Form 10-K.
26
Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations
The discussion included in this section, as well as other
sections of this Annual Report on Form 10-K, 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 current global financial uncertainty; 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 Item 1A Risk Factors of this Annual Report on Form 10-K.
If any of these risks and uncertainties materialize, our actual future results
may vary significantly from what we expected. 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
mission is to create great products that help investors reach their financial
goals. We offer an extensive line of data, software, and research 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.
Morningstar
has two operating segments: Investment Information and Investment Management.
The 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 our asset management operations, which operate as registered
investment advisors and earn more than half of their revenue from asset-based
fees. We emphasize a decentralized approach to running our business to empower
our managers and to create a culture of responsibility and accountability.
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 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.
Key Business Characteristics
Revenue
We
generate revenue by selling a variety of investment-related products and
services. We sell many of our offerings, such as newsletters, Principia
software, and Premium service on Morningstar.com, via subscriptions. These
subscriptions are mainly offered for a one-year term, although we also offer
terms ranging from one month to three years. We also sell advertising on our
websites throughout the world. Several of our other products are sold through
license agreements, including Morningstar Advisor Workstation, Morningstar
Equity Research, Morningstar Direct, Retirement Advice, and Licensed Data. Our
license agreements typically range from one to three years.
For
some of our other institutional services, mainly Investment Consulting, we
generally base our fees on the scope of work and the level of service we
provide and calculate them as a percentage of assets under advisement. We also
earn fees relating to Morningstar Managed Portfolios and the managed retirement
accounts offered through Morningstar Retirement Manager and
27
Advice
by Ibbotson that we calculate as a percentage of assets under management.
Overall, revenue tied to asset-based fees accounted for about 12% of our
consolidated revenue in 2009.
Deferred Revenue
We
frequently invoice our clients and collect cash in advance of providing
services or fulfilling subscriptions for our customers. As a result, we use
some of this cash to fund our operations and invest in new product development.
The businesses we acquired over the past several years have similar business
models, and as a result, we acquired their deferred revenue. Deferred
revenue is the largest liability on our Consolidated Balance Sheets and totaled
$127.1 million as of December 31, 2009 and $130.3 million as of December 31,
2008. We expect to recognize this deferred revenue in future periods as we
fulfill the service obligations under our subscription, license, and service
agreements.
Significant Operating Leverage
Our
business requires significant investments to create and maintain proprietary
databases and content. We strive to leverage these costs by selling a wide variety
of products and services to multiple investor segments, through multiple media,
and in many geographic markets. In general, our businesses have high fixed
costs, and we expect our revenue to increase or decrease more quickly than our
expenses. We believe that while the fixed costs of the investments in our
business are relatively high, the variable cost of adding customers is
considerably lower, particularly as a significant portion of our products and
services focus on Internet-based platforms and assets under management. At
times, we will make investments in building our databases and content that will
hurt our short-term operating results. During other periods, our profitability
will improve because were able to increase revenue without increasing our cost
base at the same rate. When revenue decreases, however, the significant
operating leverage in our business may reduce our profitability.
Operating Expense
We
classify our operating expense into separate categories for cost of goods sold,
development, sales and marketing, general and administrative, and depreciation
and amortization, as described below. We include stock-based compensation
expense, as appropriate, in each of these categories.
·
Cost of goods
sold.
This category includes compensation expense for employees who
produce the products and services we deliver to our customers. For example,
this category covers production teams and analysts who write investment
research reports. Cost of goods sold also includes other expense such as postage,
printing, and CD-ROM replication, as well as shareholder servicing fees for
Morningstar Managed Portfolios.
·
Development.
This
category includes compensation expense for programmers, designers, and other
employees who develop new products and enhance existing products. In some
cases, we capitalize the compensation costs associated with certain development
projects. This reduces the expense that we would otherwise report in this
category. We amortize these capitalized costs over the estimated economic life
of the software, which is generally three years, and include this expense in
depreciation and amortization.
·
Sales and
marketing.
This category includes compensation expense for our sales
teams, product managers, and other marketing professionals. We also include the
cost of advertising, direct mail campaigns, and other marketing programs to
promote our products.
·
General and
administrative.
This category consists mainly of compensation
expense for each segments management team, as well as human resources,
finance, and support employees for each segment. The category also includes
compensation expense for senior management and other corporate costs, including
corporate systems, finance and accounting, legal, and facilities expense.
·
Depreciation
and amortization.
Our capital expenditures consist of computers,
leasehold improvements, and capitalized product development costs related to
certain software development projects. We depreciate property and equipment
primarily using the straight-line method based on the useful life of the asset,
which ranges from three to seven years. We amortize leasehold improvements over
the lease term or their useful lives, whichever is shorter. We amortize
capitalized product development costs over their estimated economic life, which
is generally three years. We also include amortization related to intangible
assets, which is mainly driven by acquisitions, in this category. We amortize
intangible assets using the straight-line method over their estimated economic
useful lives, which range from one to 25 years.
28
International Operations
We have
majority-owned operations in 19 countries outside of the United States and
include these in our consolidated financial statements. We account for our
minority-owned investments in Japan, Denmark, and Sweden using the equity
method.
How We Evaluate Our Business
When
our analysts evaluate a stock, they focus on assessing the companys estimated
intrinsic valuethe value of the companys future cash flows, discounted to
their worth in todays dollars. Our approach to evaluating our own business
works the same way. Our goal is to increase the intrinsic value of our business
over time, which we believe is the best way to create value for our
shareholders.
We do
not make public financial forecasts for our business because we want to avoid
creating any incentives for our management team to make speculative statements
about our financial results that could influence the stock price, or to take
actions that help us meet short-term forecasts but may not be in the long-term
interest of building shareholder value.
We
provide three specific measures that can help investors generate their own
assessment of how our intrinsic value has changed over time:
·
Revenue
(including organic revenue);
·
Operating
income (loss); and
·
Free
cash flow, which we define as cash provided by or used for operating activities
less capital expenditures.
Organic
revenue is considered a non-GAAP financial measure under Securities and
Exchange Commission (SEC) regulations. We define organic revenue as
consolidated revenue excluding acquisitions and foreign currency translations.
We present organic revenue because we believe it helps investors better compare
our period-to-period results, and our management team uses this measure to
evaluate the performance of our business.
Free
cash flow is also considered a non-GAAP financial measure. We present this
measure as supplemental information to help investors better understand trends
in our business results over time. Our management team uses free cash flow to
evaluate the performance of our business. Free cash flow is not equivalent to
any measure of performance required under U.S. generally accepted accounting
principles (GAAP) and should not be considered an indicator of our overall
financial performance or liquidity. Moreover, the free cash flow definition we
use may not be comparable to similarly titled measures reported by other
companies.
To evaluate
how successful weve been in maintaining existing business for products and
services that have renewable revenue, we calculate a retention rate. We use two
different methods for calculating retention. For subscription-based products
(including our print newsletters, Morningstar.com Premium Membership service,
and Principia software), we track the number of subscriptions retained during
the year. For products sold through contracts and licenses, we use the contract
value method, which is based on tracking the dollar value of renewals compared
with the total dollar value of contracts up for renewal during the period. We
include changes in the contract value in the renewal amount, unless the change
specifically results from adding a new product that we can identify. We also
include variable-fee contracts in this calculation and use the previous quarters
actual revenue as the base rate for calculating the renewal percentage. The
retention rate excludes setup and customization fees, migrations to other Morningstar
products, and contract renewals that were pending as of January 31, 2010.
The Year 2009 in Review
Industry Overview
We
monitor developments in the economic and financial information industry on an
ongoing basis. We use these insights to help inform our company strategy,
product development plans, and marketing initiatives.
Following
the severe market downturn in 2008, the U.S. market rebounded sharply by the
end of 2009. Despite continued negative performance in the first quarter of
2009, the equity market gained 28.5% for the year as measured by Morningstars
U.S. Market Index, a broad market index. Global markets also rallied, as did
most fixed-income investments.
Total
U.S. mutual fund assets rose to $11.1 trillion as of December 31, 2009, compared
with $9.6 trillion as of December 31, 2008, based on data from the
Investment Company Institute (ICI). Although aggregate cash flows to mutual
funds were strong for the year, investors continued to show caution by heavily
favoring fixed-income funds rather than equity funds. U.S. stock funds had
negative net cash flows for the year, although less so than in 2008. Global
mutual fund assets showed a similar trend, with total assets rising after 2008s
decline, but asset flows weighted toward fixed-income portfolios.
29
The
downturn in 2008 also led to contraction in the number of funds. The number of
mutual funds in the United States fell to about 7,700 in 2009 (excluding
multiple share classes) from 8,000 in 2008, based on data from the ICI. Global
mutual funds also contracted, with the number of funds totaling 66,000 as of September 30,
2009, compared with more than 69,000 as of September 30, 2008, based on
ICI data.
Despite strong market performance in
2009,
we estimate that hedge funds
included in Morningstars database had about $55 billion in net outflows
through December 31, 2009, compared with about $57 billion for the same
period in 2008. However, many hedge-fund categories had positive inflows later
in the year.
Exchange-traded funds continued to
increase in popularity relative to traditional mutual funds. The U.S. ETF
industry closed out 2009 with $784.9 billion in assets under management based
on Morningstars data, up from $533.4 billion at the end of 2008.
Based on data from Nielsen/Net
Ratings, aggregate page views and the number of unique users for financial
and investment sites in 2009 both declined by about 5% to 10% compared with
2008, while the amount of time spent per visit was down more. We attribute
these trends to the unusual level of market volatility in 2008, which increased
investor interest in financial and investment sites in the year-ago period.
Although unique users and page views for Morningstar.com also declined
during 2009, the site continued to perform well based on metrics such as pages viewed
per visit and time spent per visit.
Economic uncertainty continued to
weigh on the global advertising market. Magna, a division of Interpublic Group,
estimates that industry-wide revenue for online advertising was down about 3%
in 2009. Although online advertising has held up better than other areas as
advertisers have continued to shift spending from traditional media to the
Internet, we believe that spending in the financial services area remains under
pressure. Following 2009s downturn in advertising sales, several surveys
conducted by the American Marketing Association and other organizations have
projected moderate increases in overall ad spending for 2010.
Asset managers and other financial
services firms continued to consolidate in the wake of the global financial
crisis. If one of our clients is acquired, w
e may lose business if were not able to continue providing services or
expand our business with the combined organization.
The financial crisis of 2009 and
2008 caused sharp cutbacks in investment research spending by institutional
clients and financial advisors, many of whom had staff layoffs or other
reductions in spending. We believe individual investors also reduced discretionary
spending because of the weak economic environment in 2009.
Despite spending pressures, we
believe our clients continue to find value in our services. Some of our
products allow clients to streamline the number of third-party applications they
use and save money. Weve also created a new Enterprise Data Management
business that offers back-office service bureau and performance reporting
operations to financial advisors. By outsourcing these services, clients can
leverage our infrastructure and capabilities to offload non-core tasks and save
money.
The global financial crisis has led
to increased regulatory scrutiny of financial services around the world. In
Germany and France, for example, independent financial advisors have been under
pressure to provide more written evidence for their advice to clients. Hong
Kong regulators recently implemented increased regulatory requirements for risk
disclosure to retail clients.
The United Kingdoms Retail
Distribution Review (RDR), which emphasizes increased regulation of advisory
fees, higher professional standards for financial advisors, and an emphasis on whole
of market investment solutions, is scheduled to come into effect at the end of
2012. Because advisors will be obligated to give clients a choice of all
investment vehicles (including funds, ETFs, and structured products) and
demonstrate that they consider different investment options without bias, we
believe it may increase the business need for investment information on
multiple investment types, which we offer through products such as Morningstar
Direct and Morningstar Advisor Workstation.
The Obama administration has
proposed numerous financial regulatory reforms. We dont believe the majority
of these reforms would have a direct impact on our business, although they will
likely impact many of our clients. Several proposed regulations may also impact
investment advice and retirement plans, including additional regulations on
asset custody, privacy, and other investor protection issues. We continue to
monitor the potential impact of these proposed regulations on our business.
30
Overall, we remain cautious because
of the difficult market environment, which persisted in the wake of the
financial crisis that began in 2007. Despite the recent upturn in the U.S.
equity market, we believe asset management firms and other financial services
companies continue to carefully scrutinize their spending levels, creating
additional pricing pressure and increasing the time required to close new
business and renewals. On the positive side, however, we believe some of the
uncertainty in the financial services sector began easing during 2009, with
business trends improving toward the end of the year. As discussed in more
detail in the Consolidated Operating Income section below, in early 2010 we
began phasing in some of the benefits and other compensation-related expenses
we previously reduced.
Performance Summary
The list below summarizes the key
accomplishments and challenges that our management team has highlighted related
to our 2009 performance:
Accomplishments
·
We completed
six acquisitions, four of which were outside the United States. These
acquisitions represent approximately $38 million in annual revenue. We
increased our ownership interest in Morningstar Korea, making it one of our
majority-owned operations. We also integrated many capabilities from previous
acquisitions.
·
We continued
investing in our three key web-based platforms, Morningstar.com, Morningstar
Advisor Workstation, and Morningstar Direct. Licensed Data had strong renewal
rates and ranks as our largest product by revenue. Morningstar Direct continued
its strong growth and now ranks as our fifth-largest product by revenue.
·
We expanded
our research offerings, including the launch of corporate credit ratings on 100
public companies; basic profile reports for NASDAQ-listed companies;
target-date fund series ratings and research reports for 20 of the largest fund
series; qualitative research and ratings for more than 830 European and Asian
funds; and a Global Fund Investor Experience study across 16 countries.
·
In our
Investment Management segment, we continued our work in custom target-date
funds and lifetime financial advice and expanded our consulting services
internationally.
·
We added
database coverage of more than 40,000 securities and expanded our fundamental
data on global stocks and exchange-traded funds.
·
We created a
new Enterprise Data Management business that offers back-office service bureau
and performance reporting operations to financial advisors.
Challenges
·
Despite an
upturn in the market, revenue declined for the second time in our history, and
operating income fell 10%. Many of our clients were cutting budgets, reducing
staff, and experiencing the effects of industry consolidation, all of which had
a direct impact on our business.
·
We had lower
revenue for Investment Consulting because one client did not renew its contract
in the fourth quarter of 2008 and another client did not renew its contract in
May 2009.
·
The
independent equity research we provided to six banks under the terms of the
Global Analyst Research Settlement ended in July 2009. As a result, equity
research revenue was $9.4 million lower in 2009 versus 2008.
·
Internet
advertising sales were down sharply, Premium Membership subscriptions for
Morningstar.com fell 15%, and revenue for Morningstar Principia was down for
the year.
·
Our 2009
results include a total of $9.5 million in operating expense related to two
unanticipated matters. We recorded a $6.1 million operating expense related to
adjusting the tax treatment of some stock options that were originally
considered incentive stock options, and we incurred $3.4 million in operating
expense for penalties related to the timing of deposits for taxes withheld on
stock option exercises from 2006 through 2009.
Consolidated Results
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
2009 Change
|
|
2008 Change
|
|
Revenue
|
|
$
|
478,996
|
|
$
|
502,457
|
|
$
|
435,107
|
|
(4.7)%
|
|
15.5%
|
|
Operating income
|
|
125,320
|
|
139,119
|
|
117,254
|
|
(9.9)%
|
|
18.6%
|
|
Operating margin
|
|
26.2%
|
|
27.7%
|
|
26.9%
|
|
(1.5)pp
|
|
0.8pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash used for investing activities
|
|
$
|
(174,675
|
)
|
$
|
(179,124
|
)
|
$
|
(102,838
|
)
|
(2.5)%
|
|
74.2%
|
|
Cash provided by financing
activities
|
|
30,394
|
|
47,630
|
|
52,465
|
|
(36.2)%
|
|
(9.2)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash provided by operating
activities
|
|
$
|
96,182
|
|
$
|
152,446
|
|
$
|
112,368
|
|
(36.9)%
|
|
35.7%
|
|
Capital expenditures
|
|
(12,372
|
)
|
(48,519
|
)
|
(11,346
|
)
|
(74.5)%
|
|
327.6%
|
|
Free cash flow
|
|
$
|
83,810
|
|
$
|
103,927
|
|
$
|
101,022
|
|
(19.4)%
|
|
2.9%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
pppercentage point(s)
As noted in
How We
Evaluate Our Business
, we define free cash flow as cash provided by
or used for operating activities less capital expenditures. Please refer to the
discussion on page 43 for more detail.
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 revenue from acquisitions and organic revenue, which
reflects our underlying business excluding revenue from acquisitions and the
impact of foreign currency translations. 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.
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.
31
The table below shows the periods in which we included each
acquired operation in revenue from acquisitions:
Consolidated Revenue
In 2009, our consolidated revenue decreased 4.7% to $479.0 million.
We had about $29.6 million in incremental revenue from acquisitions during the
year, mainly reflecting additional revenue from Tenfore Systems Limited
(Tenfore), as well as 10-K Wizard Technology, LLC (10-K Wizard), the equity
research and data business from C.P.M.S. (CPMS), Intech Pty Limited (Intech),
Fundamental Data Limited (Fundamental Data), and others. However, this was more
than offset by lower organic revenue, largely reflecting a drop in revenue from
Investment Consulting as well as lower Equity Research revenue related to the
Global Analyst Research Settlement. Investment Consulting revenue declined
because two clients did not renew their contracts, one in October 2008 and
the other in May 2009. The Global Analyst Research Settlement period
expired in July 2009.
Our 2009 results also suffered because of the continuing
effects of the severe market downturn in 2008, which put pressure on client
budgets and led to consolidation among some of our clients. Our organic growth
rate decelerated during 2008 because of these adverse market conditions and
continued deteriorating during the first half of 2009. While our organic
revenue was down for the year, we believe the trend in the second half is
encouraging. Our organic revenue fell 10.2% in the third quarter of 2009, but
only 6.6% in the fourth quarter.
32
Our consolidated revenue increased 15.5% to $502.5 million
in 2008, reflecting positive organic growth for the year as well as new revenue
from acquisitions, with the majority driven by the Hemscott businesses we
acquired in January 2008. Acquired operations contributed $27.1 million of
revenue and represented 6 percentage points of our consolidated revenue growth
in 2008.
The tables below reconcile consolidated revenue with organic
revenue (revenue excluding acquisitions and the impact of foreign currency
translations):
2009 vs. 2008 ($000)
|
|
2009
|
|
2008
|
|
Change
|
|
Consolidated revenue
|
|
$
|
478,996
|
|
$
|
502,457
|
|
(4.7)%
|
|
Revenue from acquisitions
|
|
(29,590
|
)
|
|
|
NMF
|
|
Unfavorable impact of foreign
currency translations
|
|
8,987
|
|
|
|
NMF
|
|
Organic revenue
|
|
$
|
458,393
|
|
$
|
502,457
|
|
(8.8)%
|
|
2008 vs. 2007 ($000)
|
|
2008
|
|
2007
|
|
Change
|
|
Consolidated revenue
|
|
$
|
502,457
|
|
$
|
435,107
|
|
15.5%
|
|
Revenue from acquisitions
|
|
(27,125
|
)
|
|
|
NMF
|
|
Favorable impact of foreign
currency translations
|
|
(1,850
|
)
|
|
|
NMF
|
|
Organic revenue
|
|
$
|
473,482
|
|
$
|
435,107
|
|
8.8%
|
|
2007 vs. 2006 ($000)
|
|
2007
|
|
2006
|
|
Change
|
|
Consolidated revenue
|
|
$
|
435,107
|
|
$
|
315,175
|
|
38.1%
|
|
Revenue from acquisitions
|
|
(44,226
|
)
|
|
|
NMF
|
|
Favorable impact of foreign
currency translations
|
|
(3,808
|
)
|
|
|
NMF
|
|
Organic revenue
|
|
$
|
387,073
|
|
$
|
315,175
|
|
22.8%
|
|
While organic revenue and acquisitions had the most
significant impact on revenue in 2009 and 2008, we also enjoyed a benefit from
foreign currency translations because of the weakness in the U.S. dollar during
2007 and the first half of 2008. Late in 2008, the currency trend reversed. As
a result, foreign currency translations reduced revenue by nearly $9.0 million
in 2009.
Revenue for our Investment Information segment, which
accounts for about 81% of company-wide revenue, declined by 1% in 2009, as the
lower revenue across various product lines was partially offset by revenue from
acquisitions. Acquisitions contributed $25.9 million to segment revenue in
2009.
Investment Management segment revenue was down 17.4% in
2009, driven by the two Investment Consulting non-renewals mentioned above.
Combined, these contracts represented about $17 million of revenue in 2008.
Acquisitions contributed $3.7 million to segment revenue in 2009.
In 2008, Investment Information segment revenue rose 19.3%.
Acquisitions contributed $27.1 million to segment revenue for the year.
Software products, including Morningstar Advisor Workstation and Morningstar
Direct, were the largest drivers behind the revenue increase. Licensed Data was
another significant contributor to revenue growth, and investment research
revenue also rose for the year.
Investment Management segment revenue rose 3.7% in 2008.
Total assets under advisement for Investment Consulting declined approximately
32%, partly driven by the market downturn as well as the impact of one client
not renewing its contract. New client wins for Ibbotson Associates partly
offset the impact of these factors.
Revenue from international operations increased as a
percentage of total revenue in 2009 and 2008. Our non-U.S. revenue increased to
27.0% of consolidated revenue in 2009, compared with 24.2% in 2008 and 20.6% in
2007. Several of our recent acquisitions have extensive operations outside the
United States. The majority of our international revenue is from Europe,
Australia, and Canada. Acquisitions contributed $23.4 million to international
revenue in 2009 and $19.4 million in 2008.
33
Foreign currency translations reduced revenue by
approximately $9.0 million in 2009, reversing the trend from 2008, when foreign
currency translations had a positive impact of $1.9 million. Excluding
acquisitions and the impact of foreign currency translations, our non-U.S.
revenue declined 5.5% in 2009 and increased 11.7% in 2008.
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:
2009 vs. 2008 ($000)
|
|
2009
|
|
2008
|
|
Change
|
|
International revenue
|
|
$
|
129,160
|
|
$
|
121,436
|
|
6.4%
|
|
Revenue from acquisitions
|
|
(23,371
|
)
|
|
|
NMF
|
|
Unfavorable impact of foreign
currency translations
|
|
8,987
|
|
|
|
NMF
|
|
International organic revenue
|
|
$
|
114,776
|
|
$
|
121,436
|
|
(5.5)%
|
|
2008 vs. 2007 ($000)
|
|
2008
|
|
2007
|
|
Change
|
|
International revenue
|
|
$
|
121,436
|
|
$
|
89,680
|
|
35.4%
|
|
Revenue from acquisitions
|
|
(19,426
|
)
|
|
|
NMF
|
|
Favorable impact of foreign
currency translations
|
|
(1,850
|
)
|
|
|
NMF
|
|
International organic revenue
|
|
$
|
100,160
|
|
$
|
89,680
|
|
11.7%
|
|
2007
vs. 2006 ($000)
|
|
2007
|
|
2006
|
|
Change
|
|
International revenue
|
|
$
|
89,680
|
|
$
|
44,276
|
|
102.5%
|
|
Revenue from acquisitions
|
|
(31,690
|
)
|
|
|
NMF
|
|
Favorable impact of foreign
currency translations
|
|
(3,808
|
)
|
|
|
NMF
|
|
International organic revenue
|
|
$
|
54,182
|
|
$
|
44,276
|
|
22.4%
|
|
Our five largest products based on revenueLicensed Data,
Investment Consulting, Morningstar Advisor Workstation, Morningstar.com, and
Morningstar Directmade up about 61% of consolidated revenue in 2009. While the
percentage of revenue made up by our top five products has remained relatively
consistent over the past three years, the relative size of products within the top
five has changed each year. Licensed Data became our largest product in 2008
and continued increasing as a percentage of revenue in 2009, partly because of
incremental revenue from Tenfore, 10-K Wizard, and Fundamental Data. Investment
Consulting moved down to become the third-largest product in 2009, while
Morningstar Direct moved up to become the fifth-largest product because of
continued license growth.
In 2009, as a part of the changes to our organizational
structure with a focus on our global product lines, we no longer include
Morningstar Site Builder as part of Morningstar Advisor Workstation. Site
Builder consists of a set of integrated tools, content, and reports that
investment firms can seamlessly add to their existing advisor websites. In addition,
were continuing to globalize the Premium subscriptions and advertising revenue
generated by Morningstar.com websites, which operate in a variety of markets.
As a result, we now include advertising revenue for all non-U.S. sites as part
of Morningstar.com and have reclassified prior-year product revenue for
consistency with current-year presentation. These reclassifications did not
have any impact on the order of our top five products in 2008 or 2007.
34
Top Five Products (Segment) 2009
|
|
Revenue
($000)
|
|
% of
Consolidated
Revenue
|
|
Licensed Data (Investment
Information)
|
|
$
|
91,524
|
|
19.1%
|
|
Morningstar Advisor Workstation
(Investment Information)
|
|
65,673
|
|
13.7%
|
|
Investment Consulting (Investment
Management)
|
|
63,748
|
|
13.3%
|
|
Morningstar.com (Investment
Information)
|
|
39,454
|
|
8.2%
|
|
Morningstar Direct (Investment
Information)
|
|
29,968
|
|
6.3%
|
|
|
|
|
|
|
|
|
Top Five Products (Segment) 2008
|
|
Revenue
($000)
|
|
% of
Consolidated
Revenue
|
|
Licensed Data (Investment
Information)
|
|
$
|
78,329
|
|
15.6%
|
|
Investment Consulting (Investment
Management)
|
|
77,757
|
|
15.5%
|
|
Morningstar Advisor Workstation
(Investment Information)
|
|
64,222
|
|
12.8%
|
|
Morningstar.com (Investment
Information)
|
|
45,684
|
|
9.1%
|
|
Principia (Investment Information)
|
|
27,791
|
|
5.5%
|
|
|
|
|
|
|
|
|
Top Five Products (Segment) 2007
|
|
Revenue
($000)
|
|
% of
Consolidated
Revenue
|
|
Investment Consulting (Investment
Management)
|
|
$
|
75,595
|
|
17.4%
|
|
Licensed Data (Investment
Information)
|
|
59,207
|
|
13.6%
|
|
Morningstar Advisor Workstation
(Investment Information)
|
|
53,755
|
|
12.4%
|
|
Morningstar.com (Investment
Information)
|
|
39,367
|
|
9.0%
|
|
Principia (Investment Information)
|
|
28,760
|
|
6.6%
|
|
|
|
|
|
|
|
|
As discussed in
How We
Evaluate Our Business
, we calculate retention and renewal rates to
help measure how successful weve been in maintaining existing business for
products and services that have renewable revenue. The following graph
illustrates these two metrics over the past five years:
In 2009, we estimate that our retention rate for
subscription-based products, such as Principia, Morningstar.com Premium
Membership service, and print and online newsletters, was on the higher end of
the range between 55% and 60%, down from 60% to 65% in 2008. For contract-based
products and services, we estimate that our weighted average renewal rate was
on the low end of the range between 80% and 85% and was down about 9.5
percentage points from our renewal rate in 2008. The decline in renewal rates
in 2009 was largely driven by the end of the Global Analyst Research Settlement
period. Excluding this factor, the 2009 renewal rate declined about 3
percentage points from 2008. This decline reflects lower renewal rates for
several product lines, including Investment Consulting, institutional software,
and advisor software. Many of our clients were cutting budgets, reducing staff,
and experiencing the effects of industry consolidation during 2009. The figure
for contract-based products includes the impact of price changes and changes to
the contract value upon renewal, as well as changes in the value of
variable-fee contracts.
Consolidated Operating Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Operating expense
|
|
$
|
353,676
|
|
$
|
363,338
|
|
$
|
317,853
|
|
% change
|
|
(2.7)%
|
|
14.3%
|
|
33.7%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
73.8%
|
|
72.3%
|
|
73.1%
|
|
Change
|
|
1.5pp
|
|
(0.8)pp
|
|
(2.3)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
Our consolidated operating expense decreased $9.6 million,
or 2.7%, in 2009. To better align operating expense with revenue in a
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. As a result, bonus expense was down about $28.9 million in
2009. The significant reduction in bonus expense also reflects a slowdown in
our financial performance in 2009 compared with 2008.
35
We also suspended matching contributions to our 401(k) program
in the United States, which reduced operating expense by about $6.6 million. In
addition, we reduced discretionary spending in travel, advertising, and
marketing. Travel costs were about $4.5 million lower in 2009. Advertising and
marketing costs declined by $4.3 million in 2009. Weve been carefully
evaluating spending in this area and cutting back on programs with lower
returns. In addition, we discontinued three publications previously published,
which contributed to lower marketing expense in 2009.
The positive impact of these cost reductions was partially
offset by incremental costs from acquisitions. We completed six acquisitions in
2009 and six in 2008. Because of the timing of these acquisitions, our 2009
results include operating expense that did not exist in 2008. Headcount and
salary expense increased year over year, partly because of incremental
employees added through acquisitions. We had approximately 2,605 employees
worldwide as of December 31, 2009, a 9.7% increase, from 2,375 employees
as of December 31, 2008. We added approximately 170 employees through
acquisitions over the 12 months ending December 31, 2009. The remainder of
the increase in headcount reflects continued hiring for our development center
in China.
The cost reductions were further offset by a total of $9.5
million of operating expense for two separate matters. First, we recorded a
$6.1 million operating expense related to adjusting the tax treatment of
certain stock options that were originally considered incentive stock options (ISOs).
In 1998, 1999, and 2000, we granted ISOs to many employees. Upon exercise, ISOs
typically have a favorable tax treatment for the employee relative to the tax
treatment for non-qualified stock options (NQSOs). In 2009, we determined that
certain ISOs granted to one former and two current executives should have been
treated as NQSOs for the executives and our income tax purposes. As a result,
Morningstar will pay these individuals a total of $4.9 million to compensate
for the difference in tax treatment. We also recorded $1.2 million, primarily
for potential penalties related to this matter. This $6.1 million expense is
included in our operating expenses as a general and administrative expense.
Second, we recorded an operating expense of $3.4 million for
penalties related to the timing of deposits for taxes withheld on stock option
exercises. The expense impacted each of our operating expense categories, with
approximately half recorded as general and administrative expense. For some
companies, including Morningstar, it is common practice for taxes withheld on
stock-based compensation to be paid with the companys regularly scheduled
payroll deposit. This approach, however, does not technically comply with
Internal Revenue Service (IRS) guidelines concerning deposits of taxes withheld
in connection with stock-based compensation, which generally require that if a
companys cumulative deposit liability for all compensation exceeds $100,000,
the tax withholding must be deposited by the following business day.
Transactions related to stock-based compensation frequently cause companies to
exceed this threshold outside of their regularly scheduled payroll cycles, thus
triggering the accelerated deposit rules. The subject of tax deposit penalties
was part of an IRS audit that began in 2009 and concluded in early 2010. We
have concluded the matter with the IRS and have increased the frequency of
deposits for taxes withheld on stock option exercises.
Our operating expense in 2009 also includes additional rent
expense of $2.7 million to increase a liability related to vacant office space,
primarily for the former Ibbotson headquarters. We increased the liability
because we anticipate receiving lower sublease income and expect it will take
more time than previously estimated to identify a tenant.
Despite significant reductions to bonus expense, operating
expense as a percentage of revenue increased 1.5 percentage points in 2009,
mainly driven by the $9.5 million of incremental operating expenses described
above and other expense increases.
In 2008, our consolidated operating expense increased $45.4
million, or 14.3%. Compensation-related expense, excluding bonuses, accounted
for two-thirds of the increase in 2008, mainly because of a 38% increase in
worldwide headcount and higher sales commission expense. Lower bonus expense
partially offset these increases. We had approximately 2,375 employees
worldwide as of December 31, 2008, compared with 1,720 as of December 31,
2007. Approximately half of the growth in headcount was from
acquisitions. In addition, in 2008 we hired 50 employees for the
Morningstar Development Program, a two-year rotational training program for
entry-level college graduates. Bonus expense declined $2.1 million because of
lower growth in our financial performance compared with the previous year.
Excluding compensation-related expense and bonus expense,
operating expense increased $18.5 million in 2008. About one-third of this
operating expense increase was from higher lease expense for our new headquarters
and other global offices. During 2008, we recorded lease expense for our new
headquarters as well as for our former headquarters, which was occupied until December 2008.
Depreciation and amortization rose $4.7 million in 2008, and we incurred additional
costs across all operating expense categories from acquisitions. Higher costs
in these areas were partially offset by lower legal and professional fees,
which declined $2.1 million. In 2007, we recorded $0.9 million in expense
related to the settlement of litigation in Australia. In addition, we had about
$1.6 million in product implementation costs for Advice by Ibbotson in 2007
that did not recur in 2008.
As a percentage of revenue, operating expense in 2008
declined 0.8 percentage points.
36
Cost of Goods Sold
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Cost of goods sold
|
|
$
|
128,616
|
|
$
|
130,085
|
|
$
|
113,777
|
|
% change
|
|
(1.1)%
|
|
14.3%
|
|
30.8%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
26.9%
|
|
25.9%
|
|
26.1%
|
|
Change
|
|
1.0pp
|
|
(0.2)pp
|
|
(1.5)pp
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
350,380
|
|
$
|
372,372
|
|
$
|
321,330
|
|
% change
|
|
(5.9)%
|
|
15.9%
|
|
40.8%
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
73.1%
|
|
74.1%
|
|
73.9%
|
|
Change
|
|
(1.0)pp
|
|
0.2pp
|
|
1.5pp
|
|
Cost of goods sold is our largest category of operating
expense, accounting for more than one-third of our total operating expense over
the past three years. Our business relies heavily on human capital, and cost of
goods sold includes the compensation expense for employees who produce our
products and services.
Cost of goods sold decreased $1.5 million in 2009, with the
majority of the decline driven by lower bonus expense and lower fulfillment
expense, partially offset by incremental costs from acquisitions.
Cost of goods sold increased $16.3 million in 2008.
Three-quarters of the increase was driven by higher compensation expense,
excluding incentive compensation, which was partly offset by a reduction in
product implementation expense. In 2007, we recorded $1.6 million for
outsourced product implementation expense associated with the Advice by
Ibbotson service. These costs did not recur in 2008. Incremental costs from
acquisitions contributed to the higher compensation expense, and were the
largest contributor to the remainder of the cost increases. Incentive
compensation in 2008 was about the same as in 2007.
Gross margin declined by about one percentage point in 2009,
reversing the trend in the two previous years.
Development Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Development expense
|
|
$
|
38,378
|
|
$
|
40,340
|
|
$
|
35,116
|
|
% change
|
|
(4.9)%
|
|
14.9%
|
|
19.1%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
8.0%
|
|
8.0%
|
|
8.1%
|
|
Change
|
|
|
|
(0.1)pp
|
|
(1.3)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
Development expense decreased $1.9 million in 2009, mainly
because of lower bonus expense, which was partially offset by incremental
compensation costs from acquisitions. Development expense as a percentage of
revenue in 2009 was consistent with 2008 and 2007.
Sales and Marketing Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Sales and marketing expense
|
|
$
|
71,772
|
|
$
|
81,651
|
|
$
|
68,835
|
|
% change
|
|
(12.1)%
|
|
18.6%
|
|
36.0%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
15.0%
|
|
16.3%
|
|
15.8%
|
|
Change
|
|
(1.3)pp
|
|
0.5pp
|
|
(0.3)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing expense decreased $9.9 million in
2009. Lower bonus expense and advertising and marketing were the two largest
factors driving this change, with each contributing about 40% of the decline.
We reduced advertising and marketing 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
Morningstar Funds 500
,
Morningstar Stocks 500
,
and
Morningstar ETFs 150
and therefore didnt
incur costs to promote these publications. Reduced spending on travel,
training, and conferences also contributed to the decrease, but to a lesser
extent.
37
Sales and marketing expense increased $12.9 million in 2008.
Higher compensation expense, including sales commissions, was the main
contributor to the change. In addition, we had incremental costs from
acquisitions because of growth in headcount and the number of products and
services sold.
As a percentage of revenue, sales and marketing expense
decreased about 1 percentage point in 2009, following a slight increase in
2008.
General and Administrative Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
General and administrative expense
|
|
$
|
82,949
|
|
$
|
85,266
|
|
$
|
78,868
|
|
% change
|
|
(2.7)%
|
|
8.1%
|
|
41.9%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
17.3%
|
|
17.0%
|
|
18.1%
|
|
Change
|
|
0.3pp
|
|
(1.1)pp
|
|
0.5pp
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative (G&A) expense decreased $2.3
million in 2009. Most of the decline reflects lower bonus expense included in
this category. Decreases in travel, training, and conferences also contributed
to lower expense in this area, but to a lesser extent.
These cost reductions were partially offset by the $6.1
million operating expense related to adjusting the tax treatment of certain
stock options originally considered incentive stock options as well as an
operating expense for the deposit penalty, which contributed $1.8 million to
general and administrative expense in 2009. We discuss both of these matters in
more detail in the Consolidated Operating Expense section, on page 50.
G&A expense increased $6.4 million in 2008 as lease
costs grew. In 2008, lease costs rose because we recorded lease expense for our
new Chicago headquarters as well as for the office space we occupied until December 2008.
Compensation expense also increased, but was offset by the favorable impact of
lower bonus expense. Increases in this cost category were also offset by a $2.1
million reduction in legal and professional fees.
As a percentage of revenue, G&A expense increased 0.3
percentage points in 2009.
Depreciation and Amortization Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Depreciation expense
|
|
$
|
12,998
|
|
$
|
9,348
|
|
$
|
8,488
|
|
Amortization expense
|
|
18,963
|
|
16,648
|
|
12,769
|
|
Total depreciation and
amortization expense
|
|
$
|
31,961
|
|
$
|
25,996
|
|
$
|
21,257
|
|
% change
|
|
22.9%
|
|
22.3%
|
|
41.9%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
6.7%
|
|
5.2%
|
|
4.9%
|
|
Change
|
|
1.5pp
|
|
0.3pp
|
|
0.1pp
|
|
Deprecation expense rose $3.7 million in 2009, primarily
from higher depreciation expense associated with our new corporate
headquarters. Amortization expense increased $2.3 million in 2009 and $3.8
million in 2008, reflecting amortization of intangible assets related to
acquisitions.
As a percentage of revenue, depreciation and amortization
increased 1.5 percentage points in 2009.
We expect that amortization of intangible assets will be an
ongoing cost for the remaining life of the assets. Based on acquisitions
completed through December 31, 2009, we estimate that aggregate amortization
expense for intangible assets will be $23.4 million in 2010. Our estimates of
future amortization expense for intangible assets may be affected by changes to
the preliminary purchase price allocations associated with our 2009
acquisitions.
38
Stock-Based Compensation Expense
Stock-based compensation expense is included in each of our
operating expense categories, as shown below:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Cost of goods sold
|
|
$
|
2,666
|
|
$
|
2,058
|
|
$
|
1,706
|
|
Development
|
|
1,570
|
|
1,402
|
|
1,256
|
|
Sales and marketing
|
|
1,587
|
|
1,449
|
|
1,397
|
|
General and administrative
|
|
5,770
|
|
6,372
|
|
6,619
|
|
Stock-based compensation expense
|
|
$
|
11,593
|
|
$
|
11,281
|
|
$
|
10,978
|
|
% change
|
|
2.8%
|
|
2.8%
|
|
28.0%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
2.4%
|
|
2.2%
|
|
2.5%
|
|
Change
|
|
0.2pp
|
|
(0.3)pp
|
|
(0.2)pp
|
|
Our stock based compensation expense mainly relates to
grants of restricted stock units, and to a lesser extent, to stock options
granted in previous years:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Restricted stock units
|
|
$
|
10,591
|
|
$
|
7,571
|
|
$
|
4,503
|
|
Stock options
|
|
1,002
|
|
3,710
|
|
6,475
|
|
Stock-based compensation expense
|
|
$
|
11,593
|
|
$
|
11,281
|
|
$
|
10,978
|
|
We began granting restricted stock units (RSUs) in May 2006
and made additional grants in 2007, 2008, and 2009, typically in the second
quarter of each year. We recognize the expense related to RSUs over the vesting
period, which is generally four years. We estimate forfeitures of all
stock-based awards and typically adjust the estimated forfeitures to actual
forfeiture experience in the second quarter, which is when most of our larger
equity grants typically vest. In the second quarters of 2009, 2008, and 2007,
we recorded approximately $0.2 million, $0.2 million, and $0.8 million,
respectively, of additional stock-based compensation expense as a result of
these adjustments.
Our stock-based compensation expense related to RSUs has
increased over the past three years, reflecting the additional RSU grants. In
contrast, the stock-based compensation expense related to stock options has
declined over the past three years reflecting no stock option grants in 2009
and 2008, a small grant in 2007, and that stock options granted prior to 2007
were fully expensed by 2009.
As discussed above, in 2009 we adjusted the tax treatment of
certain stock options that were originally considered incentive stock options.
This change did not impact the amount of stock-based compensation expense we
recorded related to these stock options.
Based on grants made through December 31, 2009, we
anticipate that stock-based compensation expense will be $10.3 million in
2010. This amount is subject to change based on additional equity grants
or changes in our estimated forfeiture rate related to these grants.
Bonus Expense
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Bonus expense
|
|
$
|
21,019
|
|
$
|
49,912
|
|
$
|
52,014
|
|
% change
|
|
(57.9)%
|
|
(4.0)%
|
|
35.7%
|
|
|
|
|
|
|
|
|
|
% of revenue
|
|
4.4%
|
|
9.9%
|
|
12.0%
|
|
Change
|
|
(5.5)pp
|
|
(2.1)pp
|
|
(0.2)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonus expense, which we include in each of our operating
expense categories, declined $28.9 million in 2009. This reduction reflects
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. Overall, bonus expense as a
percentage of revenue declined about 5.5 percentage points in 2009.
In 2008, bonus expense declined about $2.1 million, or 4.0%.
Bonus expense declined to 9.9% of revenue in 2008, compared with 12.0% in 2007,
reflecting the lower operating income growth in 2008 compared with 2007.
39
The amount of bonus expense is not a fixed cost. Instead,
the size of the bonus pool varies each year based on a number of items,
including changes in full-year operating income 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 of the following year.
Consolidated Operating Income
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Operating income
|
|
$
|
125,320
|
|
$
|
139,119
|
|
$
|
117,254
|
|
% change
|
|
(9.9)%
|
|
18.6%
|
|
51.2%
|
|
|
|
|
|
|
|
|
|
Operating margin
|
|
26.2%
|
|
27.7%
|
|
26.9%
|
|
Change
|
|
(1.5)pp
|
|
0.8pp
|
|
2.3pp
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income decreased $13.8 million in
2009, as the $23.5 million decline in revenue was partially offset by a $9.7
million reduction in operating expense. We took a number of steps to reduce our
cost structure in 2009mainly by reducing employee benefit costs and bonus
expense. While cost reductions began in 2008, the largest reductions were
effective January 1, 2009. We reduced our single largest discretionary
cost, bonus expense, by $28.9 million, with changes to the bonus plan in 2009.
We also suspended matching contributions to our 401(k) program in the
United States, which accounted for about $6.6 million of expense in 2008. In
addition, 2008 lease-related costs incurred in the fourth quarter of 2008 did
not recur in 2009 because we no longer incur lease costs for both our new and
former corporate headquarters in Chicago.
Although we reduced operating expense in several areas with
the cost-savings initiatives implemented at the beginning of 2009, we recorded
a total of $9.5 million of unanticipated expense for two separate matters,
including $6.1 million of operating expense related to adjusting the tax
treatment of incentive stock options granted in previous years and $3.4 million
of operating expense for penalties related to the timing of deposits for taxes
withheld on stock option exercises.
Because operating expense declined at a slower pace than
revenue, the 2009 operating margin was down about 1.5 percentage points from
2008s operating margin. The $9.5 million of operating expense described above
represented about 2 percentage points of the margin decline.
In 2010, we began phasing in some of the benefits we
temporarily suspended in 2009. Were now matching 50% of employee contributions
(up to 7% of salary) to our 401(k) plan in the United States, compared
with a full match up to 7% of salary before 2009. We kept salary levels flat
for nearly all of our employees in 2009, but expect to make some moderate
compensation increases later in 2010. Weve also been hiring for some
previously unfilled positions.
Consolidated operating income increased $21.8 million in
2008. In 2008, the operating margin increased by 0.8 percentage points partly
because of lower bonus expense and legal expense as a percentage of revenue, as
well as the $1.6 million decline in product implementation expense associated
with the Advice by Ibbotson service. Higher lease expense as a percentage of
revenue offset these positive factors and contributed to the lower operating
margin growth compared with the two previous years. Incremental costs added by
acquisitions, such as amortization of intangible assets and higher compensation
costs, also contributed to slower growth in the operating margin.
Importantly, the 2008 annual operating margin reflects a mix
of higher operating margins early in the year and lower margins in the latter
part of the year, which worsened as the business environment became more
challenging. Our operating margin was 24.1% in the fourth quarter of 2008,
compared with 28.2% in fourth quarter of 2007.
40
Consolidated Free Cash Flow
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 investors 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 GAAP. Also, the free cash
flow definition we use may not be comparable to similarly titled measures used
by other companies.
We generated positive free cash flow in 2009, 2008, and 2007
as our cash provided by operating activities has consistently exceeded our
level of capital expenditures, as shown below:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
2009 Change
|
|
2008 Change
|
|
Cash provided by operating
activities
|
|
$
|
96,182
|
|
$
|
152,446
|
|
$
|
112,368
|
|
(36.9)%
|
|
35.7%
|
|
Capital expenditures
|
|
(12,372
|
)
|
(48,519
|
)
|
(11,346
|
)
|
(74.5)%
|
|
327.6%
|
|
Free cash flow
|
|
$
|
83,810
|
|
$
|
103,927
|
|
$
|
101,022
|
|
(19.4)%
|
|
2.9%
|
|
Free cash flow fell $20.1 million in 2009, reflecting a
$56.2 million decrease in cash provided by operating activities, which was
partially offset by a $36.1 million decrease in capital expenditures. Free cash
flow increased $2.9 million in 2008, reflecting a $40.1 million increase in
cash flow provided by operating activities, which was offset by a $37.2 million
increase in capital expenditures.
Cash provided by operating activities
: Cash
provided by operating activities decreased $56.2 million in 2009. The decline
in cash provided by operating activities reflects a lower cash benefit from
accrued compensation as well as an increase of $9.6 million for bonus payments.
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. In addition, cash provided by
operating activities in 2008 included a $16.3 million benefit from deferred
rent, primarily for tenant improvement allowances related to the construction
of our new corporate headquarters. This benefit did not recur in 2009. Excess
tax benefits declined $9.8 million in 2009 because of a reduction in the number
of options exercised and lower average stock prices on the exercise dates.
Cash provided by operating activities increased $40.1
million in 2008 compared with 2007. The increase resulted from the positive
impact of higher net income (adjusted for non-cash items) of $43.0 million and
an increase in deferred rent of $16.0 million. These increases were offset by
the impact of higher cash paid for bonuses of $14.0 million and a decrease in
the impact of accrued income taxes and accrued compensation. Deferred rent
includes the tenant improvement allowance received in connection with the
build-out of our new headquarters. The tenant improvement allowance will be
amortized over the lease term as a reduction in office lease expense.
41
To provide investors with additional insight into our
financial results, we provide a comparison between the change in consolidated
net income and the change in cash provided by operating activities:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
2009
Change
|
|
2008
Change
|
|
Consolidated net income
|
|
$
|
82,324
|
|
$
|
92,929
|
|
$
|
73,922
|
|
$
|
(10,605
|
)
|
$
|
19,007
|
|
Adjustments to reconcile
consolidated net income to net cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
Excess tax benefits from stock
option exercises and vesting of restricted stock units
|
|
(13,767
|
)
|
(23,531
|
)
|
(30,428
|
)
|
9,764
|
|
6,897
|
|
Depreciation and amortization
expense
|
|
31,961
|
|
25,996
|
|
21,257
|
|
5,965
|
|
4,739
|
|
Stock-based compensation expense
|
|
11,593
|
|
11,281
|
|
10,978
|
|
312
|
|
303
|
|
All other non-cash items included
in net income
|
|
(1,537
|
)
|
8,889
|
|
(3,214
|
)
|
(10,426
|
)
|
12,103
|
|
Changes in operating assets and
liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for bonuses
|
|
(58,867
|
)
|
(49,253
|
)
|
(35,269
|
)
|
(9,614
|
)
|
(13,984
|
)
|
Cash paid for income taxes
|
|
(38,009
|
)
|
(19,782
|
)
|
(27,795
|
)
|
(18,227
|
)
|
8,013
|
|
Accounts receivable
|
|
12,364
|
|
(658
|
)
|
(11,723
|
)
|
13,022
|
|
11,065
|
|
Deferred revenue
|
|
(8,704
|
)
|
(1,595
|
)
|
8,401
|
|
(7,109
|
)
|
(9,996
|
)
|
Income taxescurrent
|
|
49,685
|
|
41,860
|
|
53,024
|
|
7,825
|
|
(11,164
|
)
|
Accrued compensation
|
|
32,138
|
|
46,920
|
|
58,387
|
|
(14,782
|
)
|
(11,467
|
)
|
Deferred rent
|
|
(790
|
)
|
16,346
|
|
380
|
|
(17,136
|
)
|
15,966
|
|
Other assets
|
|
2,521
|
|
1,573
|
|
(3,536
|
)
|
948
|
|
5,109
|
|
Reduction of Australian litigation
reserve
|
|
|
|
|
|
(2,091
|
)
|
|
|
2,091
|
|
Accounts payable and accrued
liabilities
|
|
(3,654
|
)
|
3,008
|
|
2,729
|
|
(6,662
|
)
|
279
|
|
All other
|
|
(1,076
|
)
|
(1,537
|
)
|
(2,654
|
)
|
461
|
|
1,117
|
|
Cash provided by operating
activities
|
|
$
|
96,182
|
|
$
|
152,446
|
|
$
|
112,368
|
|
$
|
(56,264
|
)
|
$
|
40,078
|
|
In 2009, the decline in cash provided by operating
activities was greater than the decline in consolidated net income, reflecting
the difference in timing between cash receipts or disbursements and when these
items are recognized in revenue or expense. Deferred rent of $16.3 million,
primarily for tenant improvement allowances received in connection with the
build-out of our new headquarters benefited cash flow in 2008, but did not
recur in 2009. 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 provided by operating activities.
The $18.2 million increase in tax payments as well as the $9.6 million increase
in bonuses paid in 2009 compared with 2008 also contributed to the difference
between net income and cash provided by operations. A lower cash flow benefit
from accrued compensation, primarily reflecting the reduction in the 2009 bonus
expense, also contributed to the difference between net income and cash from
operations.
The $40.1 million increase in cash provided by operating
activities in 2008 outpaced the $19.0 million increase in consolidated net
income. The tenant improvement allowance of $16.3 million received in
connection with the build-out of our new headquarters represented a significant
benefit to cash flow in 2008. Non-cash items included in net income were a
primary driver of the difference between net income and cash provided by
operations in 2008.
FASB ASC 718,
Compensation Stock Compensation
,
requires that we classify excess tax benefits as a financing activity, which
contributes to the difference between net income and cash from operations. In
2009, 2008, and 2007 we classified $13.8 million, $23.5 million, and $30.4
million of excess tax benefits, respectively, as financing activities. We
describe these excess tax benefits in the Liquidity and Capital Resources
section.
Capital expenditures
: Capital
expenditures decreased $36.1 million in 2009 mainly because of the timing of
payments related to our new corporate headquarters in Chicago. In 2008, capital
expenditures were $48.5 million, an increase of $37.2 million from 2007. The
2008 increase was almost entirely driven by capital expenditures for our new
headquarters.
42
Segment Results
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
2009
Change
|
|
2008
Change
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
Investment Information
|
|
$
|
386,642
|
|
$
|
390,693
|
|
$
|
327,372
|
|
(1.0)%
|
|
19.3%
|
|
Investment Management
|
|
92,354
|
|
111,764
|
|
107,735
|
|
(17.4)%
|
|
3.7%
|
|
Consolidated revenue
|
|
$
|
478,996
|
|
$
|
502,457
|
|
$
|
435,107
|
|
(4.7)%
|
|
15.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
|
|
|
|
|
|
Investment Information
|
|
$
|
138,576
|
|
$
|
138,902
|
|
$
|
114,948
|
|
(0.2)%
|
|
20.8%
|
|
Investment Management
|
|
52,889
|
|
60,396
|
|
55,395
|
|
(12.4)%
|
|
9.0%
|
|
Intangible amortization and
corporate depreciation expense
|
|
(26,349
|
)
|
(20,550
|
)
|
(18,522
|
)
|
28.2%
|
|
10.9%
|
|
Corporate unallocated
|
|
(39,796
|
)
|
(39,629
|
)
|
(34,567
|
)
|
0.4%
|
|
14.6%
|
|
Consolidated operating income
|
|
$
|
125,320
|
|
$
|
139,119
|
|
$
|
117,254
|
|
(9.9)%
|
|
18.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
margin
|
|
|
|
|
|
|
|
|
|
|
|
Investment Information
|
|
35.8%
|
|
35.6%
|
|
35.1%
|
|
0.2pp
|
|
0.5pp
|
|
Investment Management
|
|
57.3%
|
|
54.0%
|
|
51.4%
|
|
3.3pp
|
|
2.6pp
|
|
Consolidated operating margin
|
|
26.2%
|
|
27.7%
|
|
26.9%
|
|
(1.5)pp
|
|
0.8pp
|
|
Investment Information Segment
The Investment Information segment includes all of our data,
software, and research products and services, which are typically sold through
subscriptions or license agreements.
The largest products in this segment based on revenue are
Morningstar 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, including real-time
pricing data, 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. From June 2004
through July 2009, our equity research was distributed through six major
investment banks to meet the requirements for independent research under the
Global Analyst Research Settlement (GARS). The period covered by GARS expired
at the end of July 2009. The investment banks covered by it are no longer
required to provide independent investment research to their clients. For
further discussion about this issue, see Item 1ARisk Factors.
We also sell equity research 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.
We also offer a variety of financial communications and
newsletters, other investment software, and investment indexes.
This segment represented 80.7%, 77.8%, and 75.2% of our
consolidated revenue in 2009, 2008, and 2007, respectively.
Revenue
Revenue for our Investment Information segment declined $4.1
million in 2009. Acquisitions contributed $25.9 million to segment revenue in
2009, partially offsetting the decline across a number of our product lines. Revenue
from our investment research products was down 24.1%, mainly reflecting the end
of GARS and, to a lesser extent, lower revenue from investment newsletters.
Organic revenue for software product lines was down about 2.2%, driven by
declines in the U.S. version of Morningstar.com and, to a much lesser extent,
advisor software. These declines were partly offset by higher revenue for
institutional software and data-related products and services.
43
As mentioned above, the period covered by GARS expired at
the end of July 2009, and as previously disclosed, our post-settlement
equity research revenue was significantly lower in 2009. GARS revenue was $12.5
million in 2009, compared with $21.9 million in 2008. We entered into new
equity research contracts with two of the banks that were clients under GARS;
however, these contracts only represent about 10% of the previous annual GARS
revenue. In addition, were continuing to provide broad equity coverage to
individual investors, financial advisors, and institutions through a variety of
other channels. For further discussion about this issue, see Item 1ARisk
Factors.
Revenue from our other investment research products declined
in 2009 primarily because of lower revenue from 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:
Morningstar Funds 500
,
Morningstar Stocks
500
, and
Morningstar
ETFs 150
. Lower advertising revenue from publications sold in
Australia and lower revenue from the annual Morningstar Investment Conference
held in the second quarter also contributed to the decline.
The U.S. version of Morningstar.com, which includes Internet
advertising sales and Premium Membership subscriptions, was the second-largest
driver behind the revenue decline in the segment. Negative trends in Internet
advertising drove most of the decrease. In addition, subscriptions for the
Morningstar.com Premium service fell by 15.2% to 150,473 as of December 31,
2009, compared with 177,518 as of December 31, 2008 because of negative
trends in subscriber growth and new trials. However, we moderately increased
subscription prices for Premium Membership in both January 2009 and 2008,
which partially offset lower revenue from the subscription decline.
Advisor software revenue was down in 2009, reflecting lower
Principia revenue partially offset by higher revenue for Advisor Workstation
and other products. Principia subscriptions totaled 35,844 as of December 31,
2009, a 16.7% decrease from 43,019 as of December 31, 2008. The decline
partly reflects clients migrating from Principia to Advisor Workstation, but
also reflects a lower retention rate as the economic environment weakened.
Advisor Workstation revenue increased in 2009 because of
higher revenue in the first half of the year. The number of U.S. licenses for
Morningstar Advisor Workstation decreased to 148,392 as of December 31,
2009 compared with 151,874 as of December 31, 2008. The decrease reflects
clients migrating to Site Builder and a change in the scope of some licenses,
partially offset by new contracts in 2009. In 2009, as a part of the changes to
our organizational structure with a focus on our global product lines, we no
longer include Morningstar Site Builder as part of Morningstar Advisor
Workstation. Site Builder consists of a set of integrated tools, content, and
reports that investment firms can seamlessly add to their existing advisor
websites. The number of Advisor Workstation licenses reported in 2008 has been
adjusted to reflect this change.
Higher revenue from our institutional software and data
product lines partially offset the declines in individual and advisor software.
Institutional software revenue increased mainly because of Morningstar Direct.
The number of licenses for Morningstar Direct grew 19.0% to 3,524 worldwide as
of December 31, 2009, compared with 2,961 as of December 31, 2008.
Revenue from Licensed Data also increased in 2009.
In 2008, revenue from the Investment Information segment
increased $63.3 million. Acquisitions contributed approximately $27.1 million
of revenue. Excluding acquisitions, the 2008 revenue expansion was driven by
Morningstar Advisor Workstation, Licensed Data, Morningstar Direct, and
Morningstar.com.
The number of U.S. licenses for Morningstar Advisor
Workstation increased to 151,874 as of December 31, 2008 compared with
150,505 as of December 31, 2007. The revenue growth reflects new client
contracts as well as additional users and functionality for existing clients. Part of
this growth reflects expansions in the scope of some contracts to full-site
licenses (where we include all eligible advisors in our total license count),
from tools-only licenses (where we include a smaller number of advisors based
on actual usage).
Licensed Data was also a major contributor to organic
revenue growth in this segment in 2008, as demand for data feeds and other
services remained strong for most of the year. Morningstar Direct also had a
positive impact, as the number of licenses for Morningstar Direct totaled 2,961
worldwide as of December 31, 2008, up 32.8% compared with 2,229 as of December 31,
2007.
Morningstar.com Premium Membership and Internet advertising
sales contributed to organic revenue growth in 2008, but slowed throughout the
year. Subscriptions for Morningstar.com Premium service fell slightly to
177,518 as of December 31, 2008 compared with 180,366 as of December 31,
2007 as general market weakness affected subscriber growth and new trials. In
addition, we moderately increased subscription prices for Premium Membership in
January 2008. As a result, revenue grew despite the decline in the number
of subscriptions.
44
Operating Income
In 2009, operating income for the Investment Information
segment was $138.6 million, a slight decrease compared with 2008, as the $4.1
million decline in revenue was partially offset by lower operating expense.
Operating expense decreased $3.8 million in 2009 as cost
reductions for discretionary expense such as bonuses, other compensation
expense, and advertising and marketing were partially offset by additional
operating expense from acquisitions. Bonus expense declined $11.0 million in
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. The reduction in bonus expense also reflects a slowdown in our
financial performance in 2009 compared with 2008. 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 $4.3
million in 2009.
Sales and marketing costs decreased $8.3 million in 2009.
Most of the decline reflects lower spending on advertising and marketing
(primarily direct mail expense) and lower travel costs, which we pared back
because of the challenging business environment. As mentioned above, we
discontinued three of the publications we previously published in the first
quarter of each year, and therefore didnt incur costs to promote these
publications in 2009.
Our Investment Information segment operating margin improved
slightly in 2009 because of operating expense reductions partially offset by
the impact of acquisitions in 2009.
Operating income for the segment increased $24.0 million in
2008. Operating expense increased $39.3 million, with compensation-related
expense generating most of the increase. Incremental costs added from acquired
businesses also accounted for a portion of the increase across all cost
categories. The operating margin in 2008 grew modestly, up 0.5 percentage
points, because operating expense grew at a slower rate than revenue.
Investment Management Segment
The Investment Management segment includes all of our asset
management operations, which operate as registered investment advisors and earn
more than 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. Acquisitions, primarily the Intech
acquisition in Australia, contributed revenue of $3.7 million to this segment
in 2009.
This segment represented 19.3%, 22.2% and 24.8% of our
consolidated revenue in 2009, 2008, and 2007, respectively.
Revenue
Although revenue declined across all products in the
Investment Management segment, Investment Consulting, which has been a leading
contributor to revenue growth in previous years, accounted for about
three-fourths of the segments revenue decline in 2009 and was relatively flat
year over year in 2008. Our Investment Consulting business suffered in 2009
because one client did not renew its contract when it expired in the fourth
quarter of 2008 and another client did not renew its contract in May 2009.
Combined, these contracts represented about $17 million of revenue in 2008.
We provided advisory services on approximately $61.4 billion
in assets as of December 31, 2009, compared with approximately $66.2
billion as of December 31, 2008 and approximately $97.5 billion as of December 31,
2007. These asset totals include relationships for which we receive basis-point
fees, including consulting and agreements where we act as a portfolio
construction manager for a mutual fund or variable annuity. We also provide
Investment Consulting services for some assets under management for which we
receive a flat fee; these assets are not included in the total assets reported
above. Excluding changes related to contract wins or cancellations, changes in
the value of assets under advisement can come from two primary sources: gains
or losses related to overall trends in market performance, and net inflows or
outflows caused when investors add to or redeem shares from these portfolios.
45
Total assets under advisement for Investment Consulting as
of December 31, 2009 declined approximately 7.3% compared with December 31,
2008, as assets under advisement from Morningstar Associates declined 27.4%,
which was partially offset by assets under advisement from Ibbotson Associates,
which increased about 9.0%. The majority of the asset decline in 2009 reflects
the loss of one of the contracts discussed above, partially offset by positive
market performance, and, to a lesser extent, from net inflows and new client
wins in assets under advisement.
Total assets under advisement for Investment Consulting
declined approximately 32% as of December 31, 2008 compared with December 31,
2007. In 2008, the U.S. stock market fell about 37% and was the main factor
behind the decline in assets for most portfolios. The reduction in assets under
advisement compared with 2007 also reflects the client non-renewal in the
fourth quarter of 2008. As a result, assets under advisement for Morningstar
Associates declined more than the market for the year.
|
|
|
|
|
|
|
|
As of December 31
|
|
|
|
Assets under advisement for Investment Consulting ($ billions)
|
|
2009
|
|
2008
|
|
2007
|
|
Ibbotson Associates
|
|
$
|
39.9
|
|
$
|
36.6
|
|
$
|
40.9
|
|
Morningstar Associates
|
|
21.5
|
|
29.6
|
|
56.6
|
|
Total
|
|
$
|
61.4
|
|
$
|
66.2
|
|
$
|
97.5
|
|
In addition, total assets under management for Intech (now
doing business as Ibbotson Associates) were $3.4 million as of December 31,
2009.
Retirement Advice revenue was also down in 2009, although
less than Investment Consulting. We primarily earn license-based fees for the
advice and guidance services we provide through our Retirement Advice platform,
and revenue for these services declined because of several smaller client
nonrenewals in 2009. Assets under management for Retirement Advice increased to
$15.7 billion as of December 31, 2009, compared with $11.0 billion as of December 31,
2008 and $13.7 billion as of December 31, 2007. In 2008, Retirement Advice
revenue was up slightly compared with 2007.
|
|
|
|
|
|
|
|
As of December 31
|
|
|
|
Assets under management for
managed retirement accounts ($ billions)
|
|
2009
|
|
2008
|
|
2007
|
|
Advice by Ibbotson
|
|
$
|
14.2
|
|
$
|
10.0
|
|
$
|
12.7
|
|
Morningstar Retirement Manager
|
|
1.5
|
|
1.0
|
|
1.0
|
|
Total
|
|
$
|
15.7
|
|
$
|
11.0
|
|
$
|
13.7
|
|
The tables below show the breakdown of retirement plan
participants who had access to the services offered through Morningstar
Retirement Manager and Advice by Ibbotson, as well as the number of plan
sponsors and plan providers that provide this access.
|
|
|
|
|
|
|
|
As of December 31
|
|
|
|
Plan
Participants (millions)
|
|
2009
|
|
2008
|
|
2007
|
|
Advice by Ibbotson
|
|
9.5
|
|
8.9
|
|
6.6
|
|
Morningstar Retirement Manager
|
|
11.2
|
|
8.3
|
|
8.8
|
|
Total
|
|
20.7
|
|
17.2
|
|
15.4
|
|
|
|
|
|
|
|
|
|
Plan
Sponsors (approximate)
|
|
2009
|
|
2008
|
|
2007
|
|
Advice by Ibbotson
|
|
68,000
|
|
68,000
|
|
60,000
|
|
Morningstar Retirement Manager
|
|
83,000
|
|
72,000
|
|
75,000
|
|
Total
|
|
151,000
|
|
140,000
|
|
135,000
|
|
|
|
|
|
|
|
|
|
Plan Providers
|
|
2009
|
|
2008
|
|
2007
|
|
Advice by Ibbotson
|
|
7
|
|
7
|
|
8
|
|
Morningstar Retirement Manager
|
|
16
|
|
17
|
|
22
|
|
Total
|
|
23
|
|
24
|
|
30
|
|
46
Morningstar Managed Portfolios also contributed to the
segments revenue decline in 2009, although to a much lesser extent than
Investment Consulting. The lower revenue mainly reflects lower average asset
levels during 2009 compared with the same period in 2008. Assets under
management for Morningstar Managed Portfolios regained asset levels observed in
previous years, ending at $2.1 billion as of December 31, 2009 compared
with $1.6 billion as of December 31, 2008 and $2.2 billion as of December 31,
2007. Revenue for Morningstar Managed Portfolios was flat in 2008 compared with
2007.
Operating Income
Operating expense in the segment decreased $11.9 million, or
23.2%, in 2009. The decrease was primarily because of lower bonus and other
compensation-related expense, partially offset by the additional operating
expense related to the Intech acquisition. Bonus expense declined $10.4 million
in 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. The reduction in bonus expense also reflects a slowdown in our
financial performance in 2009 compared with 2008. 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 $1.3 million
in 2009. A slight reduction in product implementation fees related to our
Advice by Ibbotson service also contributed to the decrease.
Operating margin was 57.3% in 2009, an increase of 3.3
percentage points over 2008. Lower bonus expense as a percentage of revenue was
the main driver of the margin improvement. The decrease in other
compensation-related expense also contributed to the margin improvement,
although to a much lesser extent. These factors were offset by incremental
costs from the Intech acquisition and higher compensation expense as a
percentage of revenue.
Operating expense decreased $1.0 million in 2008, driven by
lower bonus expense and a reduction in product implementation fees related to
our Advice by Ibbotson service. The 2008 expense decrease was partially offset
by an increase in compensation expense, excluding bonus.
Operating margin was 54.0% in 2008 compared with 51.4% in
2007. Product implementation fees related to our Advice by Ibbotson service
represented 1.6% of revenue in 2007, but were significantly lower in 2008.
Lower bonus expense as a percentage of revenue also had a favorable impact on
the margin.
Corporate Items
This category includes corporate costs, which we do not
allocate to our business segments. The corporate items category also includes
amortization expense related to intangible assets recorded for acquisitions.
The table below shows the components of corporate items that impacted our
consolidated operating income:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Amortization expense
|
|
$
|
18,963
|
|
$
|
16,648
|
|
$
|
12,769
|
|
Depreciation expense
|
|
7,386
|
|
3,902
|
|
5,753
|
|
Corporate unallocated
|
|
39,796
|
|
39,629
|
|
34,567
|
|
Corporate items
|
|
$
|
66,145
|
|
$
|
60,179
|
|
$
|
53,089
|
|
% change
|
|
9.9%
|
|
13.4%
|
|
29.3%
|
|
Amortization of intangible assets increased $2.4 million in
2009 and $3.8 million in 2008. We paid $240.1 million for acquisitions during
the past three years. As of December 31, 2009 and December 31, 2008,
respectively, we had $135.5 million and $119.8 million recorded for net
intangible assets. We amortize these intangible assets over their estimated
lives, ranging from one to 25 years. Based on acquisitions completed through December 31,
2009, we estimate that aggregate amortization expense for intangible assets
will be $23.4 million in 2010. Some of the purchase price allocations are
preliminary, and the values assigned to intangible assets and the associated
amortization expense may change in future periods.
Depreciation expense for corporate departments increased
$3.5 million in 2009. We relocated to our new corporate headquarters in the
fourth quarter of 2008, resulting in higher depreciation expense. Depreciation
expense included in this category declined in 2008 because computer equipment
and internal product development costs capitalized in previous years were fully
depreciated.
Corporate unallocated increased $0.2 million in 2009. In
2009, this category includes $6.1 million of operating expense related to
adjusting the tax treatment of certain stock options originally considered
incentive stock options, as well as an operating expense for the deposit
penalty of $3.4 million. This category also includes a $2.7 million expense to
increase lease vacancy reserves, primarily for the former Ibbotson
headquarters. These additional costs were almost entirely offset by lower bonus
expense and other compensation-related expense, as well as lower travel
expense.
47
Corporate unallocated increased $5.0 million in 2008,
primarily because of higher lease expense. Lease costs rose because we recorded
lease expense for our new headquarters as well as for the former headquarters space
we occupied until December 2008. The higher lease expense was partially
offset by a decrease in professional fees. We recorded an expense of $0.9
million related to settling our Australian litigation in 2007, but this expense
did not recur in 2008 or 2009.
Equity in Net Income of Unconsolidated
Entities, Non-Operating Income, and Income Tax Expense
Equity in Net Income of Unconsolidated
Entities
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Equity in net income of
unconsolidated entities
|
|
$
|
1,165
|
|
$
|
1,321
|
|
$
|
1,694
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in net income of unconsolidated entities includes our
portion of the net income (loss) of Morningstar Japan K.K. (MJKK), Morningstar
Danmark A/S, Morningstar Sweden AB, and Morningstar Korea Co., Ltd. In 2009, 2008, and 2007, equity in net income
of unconsolidated entities was primarily from our position in MJKK. In 2009, we
acquired an additional 40% ownership interest in Morningstar Korea, increasing
our ownership percentage to 80%. As a result of the majority ownership, we no
longer account for our investment in Morningstar Korea using the equity method.
Beginning in September 2009, we consolidate the assets, liabilities, and
results of operations of this operation in our Consolidated Financial
statements. We describe our investments in unconsolidated entities in more
detail in Note 7 of the Notes to our Consolidated Financial Statements.
Non-Operating Income
The following table presents the components of net
non-operating income:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Interest income, net
|
|
$
|
3,016
|
|
$
|
5,687
|
|
$
|
7,134
|
|
Other expense, net
|
|
(82
|
)
|
(1,435
|
)
|
(905
|
)
|
Non-operating income, net
|
|
$
|
2,934
|
|
$
|
4,252
|
|
$
|
6,229
|
|
Net interest income mainly reflects interest from our
investment portfolio. Net interest income decreased $2.7 million in 2009 and
$1.4 million during 2008. The decrease in both years reflects lower returns on
our invested balances during the year.
Other expense, net, mainly reflects 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. In 2009, this category
includes a holding gain of approximately $0.4 million resulting from the
difference between the fair value and the book value of our investment in
Morningstar Korea.
The larger expense in 2008 was influenced primarily by
foreign currency exchange losses in the fourth quarter driven by a
significantly stronger U.S. dollar.
Income Tax Expense
The following table summarizes our effective tax rate:
($000)
|
|
2009
|
|
2008
|
|
2007
|
|
Income before income taxes and
equity in net income of unconsolidated entities
|
|
$
|
128,254
|
|
$
|
143,371
|
|
$
|
123,483
|
|
Equity in net income of
unconsolidated entities
|
|
1,165
|
|
1,321
|
|
1,694
|
|
Net (income) loss attributable to
noncontrolling interests
|
|
132
|
|
(397
|
)
|
|
|
Total
|
|
$
|
129,551
|
|
$
|
144,295
|
|
$
|
125,177
|
|
Income tax expense
|
|
$
|
47,095
|
|
$
|
51,763
|
|
$
|
51,255
|
|
Effective tax rate
|
|
36.4%
|
|
35.9%
|
|
40.9%
|
|
For a reconciliation of the U.S. federal tax rate to our
effective income tax rate, refer to Note 14 of the Notes to our Consolidated
Financial Statements.
In 2009, our effective tax rate increased by 0.5 percentage
points compared with 2008, reflecting the net impact of a number of items.
State income taxes represented 2.7 percentage points of our effective tax rate
compared with 1.5 percentage points in 2008, due to a favorable impact from reducing
accruals for state income taxes in 2008 that did not recur in 2009.
48
Second, in 2009, we recorded an operating expense of $3.4
million for penalties related to the timing of deposits for taxes withheld on
stock option exercises. This penalty is not deductible for income tax purposes
and increased our effective tax rate by 1.1 percentage points.
A third item that increased the effective tax rate in 2009
relates to disqualifying dispositions of incentive stock options. A
disqualifying disposition occurs when the option holder sells shares within one
year of exercising an incentive stock option. We receive a cash tax benefit
when a disqualifying disposition occurs. A portion of this tax benefit is recorded
as a reduction to income tax expense in our Statement of Income, reducing our
effective income tax rate. In 2009, we adjusted the amount of the tax benefit
recognized in our previous years Statements of Income related to disqualifying
dispositions. While this adjustment did not impact the amount of cash tax
benefit we received for the disqualifying dispositions, it increased our
effective tax rate by 1.4 percentage points in 2009. As of December 2009,
all incentive stock options have been exercised, and therefore we do not expect
that disqualifying dispositions will impact our effective tax rate in the
future.
The $6.1 million of operating expense related to adjusting
the tax treatment of stock options originally considered incentive stock
options increased the effective tax rate by 0.8 percentage points, as these
operating expenses are subject to deduction limitations for income tax
purposes.
The above items, which increased our effective tax rate,
were partially offset by three primary items. First, research and development
and foreign tax credits, some from previous years, reduced the 2009 effective
tax rate by 2.5 percentage points. A
reversal of reserves for uncertain tax positions, primarily as a result of a
lapse in the statute of limitations, also reduced our effective tax rate by 1.4
percentage points in 2009. Lastly, our
income tax expense included a non-cash tax benefit of $1.3 million related to
adjusting the treatment of stock options that were originally considered ISOs.
This tax benefit lowered the effective tax rate by 1 percentage point.
In 2008, our effective tax rate declined 5.0 percentage
points. The 2008 effective tax rate reflects the favorable, but variable,
benefit from incentive stock-option transactions and a decrease in our U.S.
state tax rate following a 2007 change in state tax law. These reductions were
partially offset by an increase in liabilities for certain tax positions in the
companys U.S. and non-U.S. operations.
As of December 31, 2009, we had net operating loss
(NOL) carryforwards of $50.6 million related to our non-U.S. operations and
have recorded a valuation allowance against all but $4.4 million of these NOLs.
Because of the historical operating losses for certain non-U.S. operations, a
valuation allowance is required because we do not believe that we will be able
to use all of our non-U.S. NOLs.
Certain positions we have taken or intend to take on our
U.S. and non-U.S. tax returns may be reviewed by tax authorities in the
jurisdictions in which we operate. As of December 31, 2009, we had
approximately $6.1 million of gross unrecognized tax benefits, of which $5.3
million, if recognized, would reduce our effective income tax rate and decrease
our income tax expense by $4.7 million. In 2010, we expect changes to our
liability for uncertain tax positions of approximately $0.8 million for
settlements with tax authorities. It is not possible to estimate the impact of
current audits on previously recorded unrecognized tax benefits.
We anticipate that our effective income tax rate may
continue to fluctuate related to the creation or reversal of valuation
allowances for our non-U.S. operations as well as to changes in 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, emphasizing principal preservation, and invest a portion of these
assets in municipal securities with high-quality stand-alone credit
ratings. 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.
Over the past three years, we
invested $240.1 million for acquisitions, less cash acquired, with internally
generated funds.
49
Cash, Cash Equivalents, and Investments
As of December 31, 2009, we had cash, cash equivalents,
and investments of $342.6 million, an increase of $45.0 million compared with December 31,
2008. This increase mainly reflects cash provided by operating activities and
proceeds received from employee stock option exercises, partially offset by
payments for acquisitions and capital expenditures.
We used a portion of our cash and investments balances in
the first quarter of 2010 to make annual bonus payments of approximately $21
million. In addition, in the first quarter of 2010, we paid $4.9 million to one
former and two current executives, related to adjusting the tax treatment of
certain stock options originally considered incentive stock options. We expect
that this payment will be partially offset by a cash tax benefit in the future.
Cash Provided by Operating Activities
Our main source of capital is cash generated from operating
activities.
In 2009, cash provided by operating
activities was $96.2 million driven by $110.6 million of net income (adjusted
for non-cash items) partially offset by $14.4 million in changes from our net
operating assets and liabilities, mainly driven by bonus payments. We paid $58.9 million for bonuses in 2009,
including $10.0 million in deferred payments from 2007. The cash flow impact of
these payments was partially offset by the cash flow benefit from accrued
compensation for the 2009 bonuses.
In 2008, cash provided by operating activities was $152.4
million, driven by $115.5 million of net income (adjusted for non-cash items)
and $36.9 million of changes in our net operating assets and liabilities.
Changes in our operating assets and liabilities mainly benefited from a $16.3
million increase in deferred rent related to tenant improvement allowances
received in connection with the build-out of our new headquarters, a $46.9
million increase in accrued compensation, and a $41.9 million increase in
income taxes payable. Bonus payments of approximately $49.3 million and tax
payments of $19.8 million offset these cash flow benefits.
In 2007, cash provided by operating activities was $112.4
million, driven by net income (adjusted for non-cash items) of $72.5 million,
and changes in our net operating assets and liabilities of $39.9 million.
Changes in net operating assets mainly benefited from a $58.4 million increase
in accrued compensation and a $53.0 million increase in income taxes payable.
These benefits were offset by bonus payments of $35.3 million and tax payments
of $27.8 million.
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
maturity or sale of investments), and capital expenditures. The level of cash
used for investing activities can vary from period to period depending on the
level of activity in these three categories. Cash used for investing activities
was $174.7 million in 2009, $179.1 million in 2008, and $102.8 million in 2007.
Cash used for acquisitions in 2009, net of cash acquired,
was $74.2 million. We completed six acquisitions in 2009. The majority of the
cash used for acquisitions was related to our purchase of Logical Information
Machines, Inc. and our acquisition of the equity research and data
business of C.P.M.S. Computerized Portfolio Management Services, Inc. In
2008, cash used for acquisitions, net of cash acquired, of $105.4 million. The
majority of this amount pertains to our acquisition of the Hemscott data,
media, and investor relations website businesses and Tenfore Systems Limited.
Cash used for acquisitions in 2007, net of cash acquired, was $60.5 million,
primarily related to our acquisition of the fund data business from Standard &
Poors.
Purchases of investments, net of proceeds from the maturity
or sale of investments, were $83.9 million, $24.9 million, and $31.0 million in
2009, 2008, and 2007, respectively. As of December 31, 2009 and 2008, we
had investments, consisting primarily of fixed-income securities, of $212.1
million and $123.7 million, respectively. As of December 31, 2009, our
investments represented approximately 62% of our total cash, cash equivalents,
and investments, up 20 percentage points compared with December 31, 2008,
primarily due to the significant cash outflow for the purchase of Logical
Information Machines, Inc. on December 31, 2009.
Capital expenditures were $12.4 million, $48.5 million, and
$11.3 million in 2009, 2008, and 2007, respectively. Capital expenditures
peaked in 2008 when we paid for the build-out of our new headquarters in
Chicago. Some of the cash outlay for this investment continued into 2009.
Capital expenditures in 2009 also include investment for a couple of our office
locations in Europe. Tenant improvement allowances of $16.3 million, which are
included in cash provided by operating activities, reduced the total amount of
cash we paid for the build-out in 2008. We expect to make capital expenditures
of approximately $16 million in 2010, primarily for leasehold improvements and
computer equipment.
50
In 2009, we used cash of approximately $4.2 million to
acquire minority equity stakes in Pitchbook Data, a private equity data
provider, and Bundle Corporation, a start-up company dedicated to helping
people make smarter spending and saving choices. This amount also includes the
cash we paid to increase our ownership interest in Morningstar Korea, making it
one of our majority-owned operations.
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, the vesting of restricted stock
units generates excess tax benefits 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 that 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 10 in the Notes to
our Consolidated Financial Statements includes additional information
concerning stock options and restricted stock units outstanding as of December 31,
2009.
In 2009, cash provided by financing activities was $30.4
million. Proceeds from stock option exercises totaled $16.4 million and excess
tax benefits related to stock option exercises and vesting of restricted stock
units totaled $13.8 million. In 2009, cash provided by financing activities
decreased by $17.2 million, or 36.2%, compared with 2008, driven mostly by a
$9.8 million decline in excess tax benefits, and to a lesser extent by a $7.0
million decline in proceeds from stock option exercises. The decrease mainly
reflects a lower average stock price at the time the stock options were
exercised and a decrease in the number of options exercised.
In 2008, cash provided by financing activities was $47.6
million. Proceeds from stock option exercises totaled $23.4 million and excess
tax benefits related to stock option exercises and vesting of restricted stock
units totaled $23.5 million. In 2008, cash provided by financing activities
decreased by $4.8 million, or 9.2%, compared with 2007, driven mostly by a $6.9
million decline in excess tax benefits. The decrease was due primarily to a
lower average stock price at the time the stock options were exercised.
Employees exercised approximately 1.4 million, 2.4 million,
and 2.5 million stock options in 2009, 2008, and 2007, respectively. The total
intrinsic value of options exercised during 2009, 2008, and 2007 was $37.4
million, $113.6 million, and $133.5 million, respectively.
Acquisitions
We invested a total of $240.1 million, less cash acquired,
related to acquisitions over the past three years. We describe these
acquisitions, including purchase price and product offerings, in Note 6 of the
Notes to our Consolidated Financial Statements.
Subsequent Event
See Note 16 in the Notes to our Condensed Consolidated
Financial Statements for information on events subsequent to December 31,
2009.
Application of Critical Accounting Policies
and Estimates
Our discussion and analysis of our financial condition and
results of operations are based on our Consolidated Financial Statements, which
have been prepared in accordance with GAAP. We discuss our significant
accounting policies in Note 2 of the Notes to our Consolidated Financial
Statements. The preparation of financial statements in accordance with GAAP
requires our management team to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenue, expense, and related
disclosures included in our Consolidated Financial Statements.
We evaluate our estimates on an ongoing basis. We base our
estimates on historical experience and various other assumptions that we
believe are reasonable. Based on these assumptions and estimates, we make
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Our actual results could vary from these
estimates and
51
assumptions. If actual amounts are different from previous
estimates, we include revisions in our results of operations for the period in
which the actual amounts become known.
We believe the following critical accounting policies
reflect the significant judgments and estimates used in the preparation of our
Consolidated Financial Statements:
Revenue Recognition
Much of our revenue comes from the sale of subscriptions or
licenses for print publications, software, and Internet-based products and
services. We recognize this revenue in equal amounts over the term of the
subscription or license, which generally ranges from one to three years. We
also provide analysis, consulting, retirement advice, and other services. We
recognize this revenue when the service is provided or during the service
obligation period defined in the contract.
We make significant judgments related to revenue
recognition, including whether fees are fixed or determinable and whether the
collection of payment is probable. For contracts that combine multiple products
and services, we make judgments regarding the value of each element in the
arrangement based on selling prices of the items when sold separately. Delivery
of our products and services is a prerequisite to the recognition of
revenue. If arrangements include an acceptance provision, we begin
recognizing revenue upon the receipt of customer acceptance.
Deferred revenue is the amount invoiced or collected in
advance for subscriptions, licenses, or services that has not yet been
recognized as revenue. As of December 31, 2009, our deferred revenue was
$127.1 million. We expect to recognize this deferred revenue in future
periods as we fulfill our service obligations. The amount of deferred revenue
may increase or decrease primarily based on the mix of contracted products and
services and the volume of new and renewal subscriptions. The timing of future revenue
recognition may change depending on the terms of the license agreements and the
timing of fulfilling our service obligations. We believe that the estimate
related to revenue recognition is a critical accounting estimate, and to the
extent that there are material differences between our determination of
deferred revenue and actual results, our financial condition or results of
operations may be affected.
Purchase Price Allocation
Over the past several years, we have acquired several
companies that complement our business operations. Over the past three years,
the total cash paid for acquisitions, less cash acquired, was $240.1 million.
For each acquisition, we allocate the purchase price to the
assets acquired, liabilities assumed, and goodwill in accordance with FASB ASC
805,
Business Combinations
. We
recognize the assets and liabilities acquired related to these acquisitions at
their estimated fair values. As of December 31, 2009, we allocated $192.6
million of gross value to intangible assets, primarily for customer-related
assets, technology-based assets, and intellectual property. The estimated
useful lives of the intangible assets range from one to 25 years. As of December 31,
2009, we also have recorded $250.0 million of goodwill arising from acquisitions.
Management judgment is required in allocating the purchase
price to the acquired assets and liabilities. We use judgment to:
·
identify the
acquired assets,
·
estimate the fair
value of these assets,
·
estimate the useful
life of the assets; and
·
assess the
appropriate method for recognizing depreciation or amortization expense over
the assets useful life.
We believe that the accounting estimates related to purchase
price allocations are critical accounting estimates because the assumptions
impact the amounts and classifications of assets and liabilities presented in
our Consolidated Balance Sheets, the amount of amortization and depreciation
expense, if any, recorded in our Consolidated Statements of Income, and the
impairment testing performed in subsequent periods.
Goodwill
Goodwill recorded on our Consolidated Balance Sheet as of December 31,
2009 was $250.0 million. In accordance with FASB ASC 350,
Intangibles Goodwill and
Other
, we do not amortize goodwill. Instead, it is subject to at
least an annual test for impairment, or whenever indicators of impairment
exist, based on a discounted cash-flow model. An impairment would occur if the
carrying amount of a reporting unit, including goodwill, exceeded the fair
value of that reporting unit.
52
The process of evaluating the potential impairment of
goodwill is subjective and requires significant judgment. In estimating the
fair value of the reporting units, we make estimates and judgments about the
future cash flows of the reporting unit. These estimates include assumptions
about future market growth and trends, forecasted revenue and costs, capital
investments, appropriate discount rates, and other variables that can
significantly affect the value of the reporting unit.
Although our cash flow forecasts are based on assumptions
that are consistent with plans and estimates we use to manage the underlying
business, there is significant judgment in determining the cash flows
attributable to these businesses over a long-term horizon. We update these
assumptions and cash flow estimates at least annually.
We believe that the accounting estimate related to goodwill
impairment is a critical accounting estimate because the assumptions used are highly
susceptible to changes in the operating results and cash flows of the reporting
units included in our segments. If actual results differ from our estimates,
future tests may indicate an impairment of goodwill. This would result in a
non-cash charge, adversely affecting our results of operations.
Impairment of Long-Lived Assets
Our Consolidated Balance Sheet as of December 31, 2009
includes property, equipment, and capitalized software, net of accumulated
depreciation, of $59.8 million and intangible assets, net of accumulated
amortization, of $135.5 million. In accordance with FASB ASC 360-10-35
, Subsequent
MeasurementImpairment or Disposal of Long-Lived Assets
, we
review our property, equipment, capitalized software, and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Such events or changes may include
deterioration in the business climate for a specific product or service. If the
total of projected future undiscounted cash flows is less than the carrying
amount of an asset, we may need to record an impairment loss based on the
excess of the carrying amount over the fair value of the assets.
Estimates of future cash flows and the estimated useful
lives associated with these assets are critical to the assessment of
recoverability and fair values. They are susceptible to change from period to
period because of the requirement to make assumptions about future cash flows
generated over extended periods of time. Changes in these estimates could
result in a determination of asset impairment, which would result in a
reduction to the carrying value and could adversely affect our operating
results in the related period.
Stock-Based Compensation
We include stock-based compensation expense in each of our
operating expense categories. Over the past three years, we have mainly granted
restricted stock units (RSUs) to employees. Because of these additional RSU
grants, stock-based compensation expense related to RSUs has increased over the
past three years. In contrast, stock-based compensation expense related to
stock options has declined over the past three years reflecting no stock option
grants in 2009 and 2008, a small grant in 2007, and that stock options granted
prior to 2007 were fully expensed by the end of 2009.
Under FASB ASC 718
, Compensation Stock
Compensation
, stock-based compensation expense is measured at the
grant date based on the fair value of the award, and the cost is recognized as
expense ratably over the awards vesting period. We measure the fair value of
our restricted stock units on the date of grant based on the market price of
the underlying common stock as of the close of trading on the day prior to
grant. For stock options, we measured the fair value on the date of grant using
a Black-Scholes option-pricing model. We estimate expected forfeitures of
stock-based awards at the grant date and recognize compensation cost only for
those awards expected to vest. We ultimately adjust this forfeiture assumption
to the actual forfeiture rate. Therefore, changes in the forfeiture assumptions
do not impact the total amount of expense ultimately recognized over the
vesting period. Instead, different forfeiture assumptions would only impact the
timing of expense recognition over the vesting period.
Because our largest annual equity grants typically have
vesting dates in the second quarter of the year, we adjust the stock-based
compensation expense at that time to reflect those awards that ultimately
vested. In addition, we update our estimate of the forfeiture rate that will be
applied to awards not yet vested. In 2009 and 2008, we recorded
approximately $0.2 million of additional stock-based compensation expense
related to these changes in estimates.
We believe that the estimates related to stock-based
compensation expense are critical accounting estimates because the assumptions
used could significantly impact the timing and amount of stock-based
compensation expense recorded in our Consolidated Financial Statements.
53
Income Taxes
Our effective tax rate is based on the mix of income and
losses in our U.S. and non-U.S. operations, statutory tax rates, and
tax-planning opportunities available to us in the various jurisdictions in
which we operate. Significant judgment is required to evaluate our tax
positions.
Tax law requires us to include items in our tax return at
different times from when these items are reflected in our Consolidated Income
Statement. As a result, the effective tax rate reflected in our Consolidated
Financial Statements is different from the tax rate reported on our tax return
(our cash tax rate). Some of these differences, such as expenses that are not
deductible in our tax return, are permanent. Other differences, such as
depreciation expense, reverse over time. These timing differences create
deferred tax assets and liabilities. We determine our deferred tax assets and
liabilities based on temporary differences between the financial reporting and
the tax basis of assets and liabilities. The excess tax benefits
associated with stock option exercises and vesting of restricted stock units
also create a difference between our cash tax rate and the effective tax rate
in our Consolidated Income Statement.
As of December 31, 2009, we had gross deferred tax
assets of $48.9 million and gross deferred tax liabilities of $39.6 million.
The deferred tax assets include $14.0 million of deferred tax assets related to
$50.6 million of NOLs of our non-U.S. operations. Because of the historical
operating losses of certain of the non-U.S. operations that generated these
NOLs, we have recorded a valuation allowance against all but approximately $4.4
million of the NOLs, reflecting the likelihood that the benefit of the NOLs
will not be realized. In assessing the realizability of our deferred tax
assets, we consider whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized.
In assessing the need for a valuation allowance, we consider
both positive and negative evidence, including tax-planning strategies,
projected future taxable income, and recent financial performance. If we
determine a lesser allowance is required at some point in the future, we would
record a reduction to our tax expense and valuation allowance. These
adjustments would be made in the same period we determined the change in the
valuation allowance was needed. This would cause our income tax expense,
effective tax rate, and net income to fluctuate.
We assess uncertain tax positions in accordance with FASB ASC 740
,
Income Taxes.
We use judgment to identify, recognize, and
measure the amounts to be recorded in the financial statements related to tax
positions taken or expected to be taken in a tax return. We recognize
liabilities to represent our potential future obligations to taxing authorities
for the benefits taken in our tax returns. We adjust these liabilities,
including any impact of the related interest and penalties, in light of changing
facts and circumstances such as the progress of a tax audit. A number of years
may elapse before a particular matter for which we have established a reserve
is audited and finally resolved. The number of years with open tax audits
varies depending on the tax jurisdiction.
We use judgment to classify unrecognized tax benefits as
either current or noncurrent liabilities in our Consolidated Balance Sheets.
Settlement of any particular issue would usually require the use of cash. We
generally classify liabilities associated with unrecognized tax benefits as
noncurrent liabilities. It typically takes several years between our initial
tax return filing and the final resolution of any uncertain tax positions with
the tax authority. We recognize favorable resolutions of tax matters for
which we have previously established reserves as a reduction to our income tax
expense when the amounts involved become known.
Assessing the future tax consequences of events that have
been recognized in our Consolidated Financial Statements or tax returns
requires judgment. Variations in the actual outcome of these future tax
consequences could materially impact our financial position, results of
operations, or cash flows.
Contingencies
We are subject to various claims and contingencies related
to legal proceedings and investigations, which we describe in Note 15 of the
Notes to our Consolidated Financial Statements. These legal proceedings involve
inherent uncertainties including, but not limited to, court rulings,
negotiations between affected parties, and government actions. Assessing the
probability of loss for such contingencies and determining how to accrue the
appropriate liabilities requires judgment. If actual results differ from our
assessments, our financial position, results of operations, or cash flows would
be impacted.
Recently Issued Accounting Pronouncements
In June 2009, the FASB issued Accounting Standards
Update (ASU) No. 2009-16
, Transfers and Servicing
(Topic 860): Accounting for Transfers of Financial Assets
and ASU No. 2009-17,
Consolidations (Topic 810): Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities.
These accounting pronouncements change the way entities
account for transfers of financial assets and determine what entities must be
consolidated. The most significant amendment resulting from ASU No. 2009-16
consists of the removal of the concept of a Qualifying Special-Purpose Entity
(QSPE) from ASC 860,
Transfers and Services
. ASU No. 2009-17 addresses the effects of
54
eliminating the QSPE concept from ASC 860,
Transfers and Services,
and responds to concerns about the
application of certain key provisions of ASC 810,
Consolidation
,
including concerns over the transparency of enterprises involvement with Variable
Interest Entities (VIEs). We adopted ASU No. 2009-16 and ASU No. 2009-17
effective January 1, 2010 and do not anticipate any impact on our
Consolidated Financial Statements.
In October 2009, the FASB issued ASU No. 2009-13,
Revenue Recognition (Topic 605): Multiple-Deliverable Revenue
Arrangements.
ASU 2009-13 supersedes EITF Issue 00-21,
Revenue Arrangements with Multiple Deliverables
. ASU 2009-13
establishes the accounting and reporting guidance for arrangements when a
vendor performs multiple revenue-generating activities, addresses how to
separate deliverables, and how to measure and allocate arrangement
consideration. Vendors often provide multiple products or services to
customers. Because products and services are often provided at different points
in time or over different time periods within the same contractual arrangement,
this guidance enables vendors to account for products or services separately
rather than as a combined unit.
Also in October 2009, the FASB issued ASU No. 2009-14,
Software (Topic 985): Certain Revenue Arrangements
That Include Software Elements,
and affects vendors that sell or
lease tangible products in an arrangement that contains software that is more
than incidental to the tangible product as a whole. ASU No. 2009-14 does
not affect software revenue arrangements that do not include tangible products.
They also do not affect software revenue arrangements that include services if
the software is essential to the functionality of those services.
For Morningstar, ASU No. 2009-13 and ASU No. 2009-14
will be effective prospectively for revenue arrangements entered into from January 1,
2011. Early adoption is permitted. We are in the process of determining the
impact, if any, these accounting standard updates will have on our Consolidated
Financial Statements.
In January 2010, the FASB
issued ASU No. 2010-06,
Fair Value Measurements
and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements
.
ASU No. 2010-06 requires additional disclosures regarding fair value
measurements. The amended guidance requires entities to disclose additional
information regarding assets and liabilities that are transferred between
levels of the fair value hierarchy. Entities are also required to disclose
information in the Level 3 rollforward about purchases, sales, issuances and
settlements on a gross basis. In addition to these new disclosure requirements,
ASU 2010-06 also amends Topic 820 to further clarify existing guidance
pertaining to the level of disaggregation at which fair value disclosures
should be made and the disclosure requirements regarding the valuation
techniques and inputs used in estimating Level 2 and Level 3 fair value
measurements.
For Morningstar, the requirement to disclose additional
information regarding assets and liabilities that are transferred between
levels of the fair value hierarchy will be effective beginning with our 2010
Consolidated Financial Statements. The requirement to separately disclose
purchases, sales, issuances, and settlements in the Level 3 rollforward will be
effective beginning with our 2011 Consolidated Financial Statements. We are in the process of determining the
impact, if any, these accounting pronouncements will have on our Consolidated
Financial Statements.
55
Contractual Obligations
The table below shows our known contractual obligations as
of December 31, 2009 and the expected timing of cash payments related to
these contractual obligations:
($000)
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
Thereafter
|
|
Total
|
|
Minimum commitments on
non-cancelable operating lease obligations (1)
|
|
$
|
17,107
|
|
$
|
15,446
|
|
$
|
12,572
|
|
$
|
10,538
|
|
$
|
10,792
|
|
$
|
74,044
|
|
$
|
140,499
|
|
Unrecognized tax benefits (2)
|
|
981
|
|
|
|
|
|
|
|
|
|
|
|
981
|
|
Total
|
|
$
|
18,088
|
|
$
|
15,446
|
|
$
|
12,572
|
|
$
|
10,538
|
|
$
|
10,792
|
|
$
|
74,044
|
|
$
|
141,480
|
|
(1)
|
|
The non-cancelable operating lease obligations are mainly
for lease commitments for office space.
|
|
|
|
(2)
|
|
Represents unrecognized tax benefits (including penalties
and interest, less the impact of any associated tax benefits) recorded in
accordance with FASB ASC 740,
Income Taxes
. The
amount included in the table represents amounts we anticipate may be settled
in 2010. The table excludes $5.4 million of unrecognized tax benefits,
included as a long-term liability in our Consolidated Balance Sheet as of
December 31, 2009, for which we cannot make a reasonably reliable
estimate of the period of payment.
|
There are no purchase commitments as of December 31,
2009 that we believe would have a significant impact on our financial position
or cash flows.
56
Signatures
Pursuant to the requirements of Section 13 or
15(d) 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 on March 19, 2010.
|
MORNINGSTAR, INC.
|
|
|
|
By: /s/ Richard E. Robbins
|
|
Name: Richard E. Robbins
|
|
Title: General Counsel and Corporate Secretary
|
57
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