Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010
OR
o
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from
to
Commission File Number: 000-51280
MORNINGSTAR, INC.
(Exact
Name of Registrant as Specified in its Charter)
Illinois
|
|
36-3297908
|
(State
or Other Jurisdiction of
|
|
(I.R.S.
Employer
|
Incorporation
or Organization)
|
|
Identification
Number)
|
|
|
|
22 West Washington Street
|
|
|
Chicago, Illinois
|
|
60602
|
(Address
of Principal Executive Offices)
|
|
(Zip
Code)
|
(312) 696-6000
(Registrants
Telephone Number, Including Area Code)
Indicate by check mark whether the
Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes
x
No
o
Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site,
if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes
x
No
o
Indicate by check mark whether the
Registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act.
Large
accelerated filer
x
|
Accelerated
filer
o
|
Non-accelerated
filer
o
|
Smaller
reporting company
o
|
|
(Do not
check if a smaller reporting company)
|
|
Indicate by check mark whether the
Registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes
o
No
x
As of October 29, 2010, there
were 49,666,834 shares of the Companys common stock, no par value,
outstanding.
Table of
Contents
PART 1. FINANCIAL INFORMATION
Item 1.
Unaudited Condensed Consolidated Financial Statements
Morningstar, Inc.
and Subsidiaries
Unaudited
Condensed Consolidated Statements of Income
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
(in thousands except per share amounts)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
139,817
|
|
$
|
120,088
|
|
$
|
404,198
|
|
$
|
356,353
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expense (1):
|
|
|
|
|
|
|
|
|
|
Cost of
goods sold
|
|
40,713
|
|
31,954
|
|
114,767
|
|
92,900
|
|
Development
|
|
12,703
|
|
9,447
|
|
35,491
|
|
28,185
|
|
Sales
and marketing
|
|
22,881
|
|
17,730
|
|
69,877
|
|
53,276
|
|
General
and administrative
|
|
23,462
|
|
20,643
|
|
67,211
|
|
57,649
|
|
Depreciation
and amortization
|
|
9,897
|
|
6,631
|
|
28,082
|
|
23,347
|
|
Total
operating expense
|
|
109,656
|
|
86,405
|
|
315,428
|
|
255,357
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
30,161
|
|
33,683
|
|
88,770
|
|
100,996
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating
income, net:
|
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
512
|
|
572
|
|
1,692
|
|
2,314
|
|
Other income,
net
|
|
5,694
|
|
221
|
|
4,356
|
|
985
|
|
Non-operating
income, net
|
|
6,206
|
|
793
|
|
6,048
|
|
3,299
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes and equity in net income of unconsolidated entities
|
|
36,367
|
|
34,476
|
|
94,818
|
|
104,295
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
15,807
|
|
12,407
|
|
37,027
|
|
37,099
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in net income of unconsolidated entities
|
|
333
|
|
429
|
|
1,176
|
|
790
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
net income
|
|
20,893
|
|
22,498
|
|
58,967
|
|
67,986
|
|
|
|
|
|
|
|
|
|
|
|
Net
(income) loss attributable to noncontrolling interests
|
|
(106
|
)
|
22
|
|
10
|
|
40
|
|
|
|
|
|
|
|
|
|
|
|
Net
income attributable to Morningstar, Inc.
|
|
$
|
20,787
|
|
$
|
22,520
|
|
$
|
58,977
|
|
$
|
68,026
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share attributable to Morningstar, Inc.:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.42
|
|
$
|
0.46
|
|
$
|
1.19
|
|
$
|
1.42
|
|
Diluted
|
|
$
|
0.41
|
|
$
|
0.45
|
|
$
|
1.16
|
|
$
|
1.37
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
declared per common share
|
|
$
|
0.05
|
|
$
|
|
|
$
|
0.05
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
49,401
|
|
48,457
|
|
49,157
|
|
47,930
|
|
Diluted
|
|
50,544
|
|
50,048
|
|
50,453
|
|
49,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
(1) Includes
stock-based compensation expense of:
|
|
|
|
|
|
|
|
|
|
Cost of
goods sold
|
|
$
|
960
|
|
$
|
690
|
|
$
|
2,582
|
|
$
|
1,954
|
|
Development
|
|
517
|
|
410
|
|
1,359
|
|
1,177
|
|
Sales
and marketing
|
|
469
|
|
407
|
|
1,358
|
|
1,185
|
|
General
and administrative
|
|
1,799
|
|
1,356
|
|
5,038
|
|
4,340
|
|
Total
stock-based compensation expense
|
|
$
|
3,745
|
|
$
|
2,863
|
|
$
|
10,337
|
|
$
|
8,656
|
|
See notes to unaudited condensed
consolidated financial statements.
3
Table of Contents
Morningstar, Inc.
and Subsidiaries
Unaudited
Condensed Consolidated Balance Sheets
(in thousands except share amounts)
|
|
September 30
2010
|
|
December 31
2009
|
|
Assets
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash and
cash equivalents
|
|
$
|
175,872
|
|
$
|
130,496
|
|
Investments
|
|
163,469
|
|
212,057
|
|
Accounts
receivable, less allowance of $714 and $1,339, respectively
|
|
94,638
|
|
82,330
|
|
Deferred
tax asset, net
|
|
1,081
|
|
1,109
|
|
Income
tax receivable, net
|
|
9,554
|
|
5,541
|
|
Other
|
|
14,316
|
|
12,564
|
|
Total
current assets
|
|
458,930
|
|
444,097
|
|
Property,
equipment, and capitalized software, net
|
|
57,716
|
|
59,828
|
|
Investments
in unconsolidated entities
|
|
24,043
|
|
24,079
|
|
Goodwill
|
|
311,249
|
|
249,992
|
|
Intangible
assets, net
|
|
167,311
|
|
135,488
|
|
Other
assets
|
|
6,948
|
|
6,099
|
|
Total
assets
|
|
$
|
1,026,197
|
|
$
|
919,583
|
|
|
|
|
|
|
|
Liabilities and equity
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
Accounts
payable and accrued liabilities
|
|
$
|
37,504
|
|
$
|
29,901
|
|
Accrued
compensation
|
|
47,893
|
|
48,902
|
|
Deferred
revenue
|
|
135,843
|
|
127,114
|
|
Other
|
|
532
|
|
962
|
|
Total
current liabilities
|
|
221,772
|
|
206,879
|
|
Accrued
compensation
|
|
5,094
|
|
4,739
|
|
Deferred
tax liability, net
|
|
18,353
|
|
4,678
|
|
Other
long-term liabilities
|
|
25,552
|
|
26,413
|
|
Total
liabilities
|
|
270,771
|
|
242,709
|
|
|
|
|
|
|
|
Equity:
|
|
|
|
|
|
Morningstar, Inc.
shareholders equity:
|
|
|
|
|
|
Common
stock, no par value, 200,000,000 shares authorized, of which 49,658,633 and
48,768,541 shares were outstanding as of September 30, 2010 and
December 31, 2009, respectively
|
|
5
|
|
5
|
|
Treasury
stock at cost, 207,254 shares as of September 30, 2010 and 222,653
shares as of December 31, 2009
|
|
(2,913
|
)
|
(3,130
|
)
|
Additional
paid-in capital
|
|
448,485
|
|
432,052
|
|
Retained
earnings
|
|
303,196
|
|
246,745
|
|
Accumulated
other comprehensive income (loss):
|
|
|
|
|
|
Currency
translation adjustment
|
|
5,240
|
|
(337
|
)
|
Unrealized
gain on available-for-sale securities
|
|
413
|
|
370
|
|
Total
accumulated other comprehensive income
|
|
5,653
|
|
33
|
|
Total
Morningstar, Inc. shareholders equity
|
|
754,426
|
|
675,705
|
|
Noncontrolling
interest
|
|
1,000
|
|
1,169
|
|
Total equity
|
|
755,426
|
|
676,874
|
|
Total
liabilities and equity
|
|
$
|
1,026,197
|
|
$
|
919,583
|
|
See notes to unaudited condensed
consolidated financial statements.
4
Table of
Contents
Morningstar, Inc.
and Subsidiaries
Unaudited
Condensed Consolidated Statement of Equity
and
Comprehensive Income (Loss)
For the Nine
Months Ended September 30, 2010
|
|
Morningstar, Inc. Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
Additional
|
|
|
|
Comprehensive
|
|
Non
|
|
|
|
|
|
Shares
|
|
Par
|
|
Treasury
|
|
Paid-in
|
|
Retained
|
|
Income
|
|
Controlling
|
|
Total
|
|
(in thousands, except share amounts)
|
|
Outstanding
|
|
Value
|
|
Stock
|
|
Capital
|
|
Earnings
|
|
(Loss)
|
|
Interests
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of December 31, 2009
|
|
48,768,541
|
|
$
|
5
|
|
$
|
(3,130
|
)
|
$
|
432,052
|
|
$
|
246,745
|
|
$
|
33
|
|
$
|
1,169
|
|
$
|
676,874
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
58,977
|
|
|
|
(10
|
)
|
58,967
|
|
Unrealized gain on
available-for-sale investments, net of income tax of $28
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
|
43
|
|
Foreign currency translation
adjustment, net
|
|
|
|
|
|
|
|
|
|
|
|
5,577
|
|
57
|
|
5,634
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
58,977
|
|
5,620
|
|
47
|
|
64,644
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock related to
stock option exercises and vesting of restricted stock units, net
|
|
690,918
|
|
|
|
217
|
|
4,990
|
|
|
|
|
|
|
|
5,207
|
|
Stock-based compensation
restricted stock units
|
|
|
|
|
|
|
|
9,557
|
|
|
|
|
|
|
|
9,557
|
|
Stock-based compensation
restricted stock
|
|
199,174
|
|
|
|
|
|
780
|
|
|
|
|
|
|
|
780
|
|
Excess tax benefit derived from
stock option exercises and vesting of restricted stock units
|
|
|
|
|
|
|
|
4,885
|
|
|
|
|
|
|
|
4,885
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recognition of deferred tax
liability related to accretion of equity investment
|
|
|
|
|
|
|
|
(3,821
|
)
|
|
|
|
|
|
|
(3,821
|
)
|
Dividends declared common shares
outstanding
|
|
|
|
|
|
|
|
|
|
(2,484
|
)
|
|
|
|
|
(2,484
|
)
|
Dividends declared restricted
stock units
|
|
|
|
|
|
|
|
42
|
|
(42
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to noncontrolling
interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(216
|
)
|
(216
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of September 30, 2010
|
|
49,658,633
|
|
$
|
5
|
|
$
|
(2,913
|
)
|
$
|
448,485
|
|
$
|
303,196
|
|
$
|
5,653
|
|
$
|
1,000
|
|
$
|
755,426
|
|
See notes to unaudited condensed
consolidated financial statements.
5
Table of Contents
Morningstar, Inc.
and Subsidiaries
Unaudited
Condensed Consolidated Statements of Cash Flows
|
|
Nine months ended September 30
|
|
(in thousands)
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Operating activities
|
|
|
|
|
|
Consolidated
net income
|
|
$
|
58,967
|
|
$
|
67,986
|
|
Adjustments
to reconcile consolidated net income to net cash flows from operating
activities:
|
|
|
|
|
|
Depreciation
and amortization
|
|
28,082
|
|
23,347
|
|
Deferred
income tax (benefit) expense
|
|
5,659
|
|
(847
|
)
|
Stock-based
compensation expense
|
|
10,337
|
|
8,656
|
|
Provision
for bad debt
|
|
253
|
|
343
|
|
Equity
in net income of unconsolidated entities
|
|
(1,176
|
)
|
(790
|
)
|
Excess
tax benefits from stock option exercises and vesting of restricted stock
units
|
|
(4,885
|
)
|
(5,724
|
)
|
Holding
gain upon acquisition of additional ownership of equity method investments
|
|
(5,073
|
)
|
(352
|
)
|
Other,
net
|
|
724
|
|
(617
|
)
|
Changes
in operating assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
Accounts
receivable
|
|
(7,254
|
)
|
13,521
|
|
Other
assets
|
|
(2,508
|
)
|
2,206
|
|
Accounts
payable and accrued liabilities
|
|
2,025
|
|
(2,007
|
)
|
Accrued
compensation
|
|
(2,270
|
)
|
(41,794
|
)
|
Income
taxes payable
|
|
309
|
|
12,999
|
|
Deferred
revenue
|
|
(1,938
|
)
|
(8,974
|
)
|
Deferred
rent
|
|
442
|
|
(353
|
)
|
Other
liabilities
|
|
(1,384
|
)
|
(267
|
)
|
Cash
provided by operating activities
|
|
80,310
|
|
67,333
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
Purchases
of investments
|
|
(128,043
|
)
|
(111,603
|
)
|
Proceeds
from maturities and sales of investments
|
|
177,197
|
|
64,479
|
|
Capital
expenditures
|
|
(7,701
|
)
|
(10,286
|
)
|
Acquisitions,
net of cash acquired
|
|
(88,697
|
)
|
(19,315
|
)
|
Other,
net
|
|
830
|
|
623
|
|
Cash
used for investing activities
|
|
(46,414
|
)
|
(76,102
|
)
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
Proceeds
from stock option exercises
|
|
5,207
|
|
14,378
|
|
Excess
tax benefits from stock option exercises and vesting of restricted stock
units
|
|
4,885
|
|
5,724
|
|
Other,
net
|
|
(529
|
)
|
(305
|
)
|
Cash
provided by financing activities
|
|
9,563
|
|
19,797
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
1,917
|
|
4,481
|
|
Net
increase in cash and cash equivalents
|
|
45,376
|
|
15,509
|
|
Cash and
cash equivalentsbeginning of period
|
|
130,496
|
|
173,891
|
|
Cash and
cash equivalentsend of period
|
|
$
|
175,872
|
|
$
|
189,400
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow
information:
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
29,594
|
|
$
|
25,154
|
|
Supplemental information of non-cash
investing and financing activities:
|
|
|
|
|
|
Unrealized
gain (loss) on available-for-sale investments
|
|
$
|
71
|
|
$
|
(225
|
)
|
See notes to unaudited condensed
consolidated financial statements.
6
Table of
Contents
MORNINGSTAR, INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis
of Presentation of Interim Financial Information
The accompanying
condensed consolidated financial statements of Morningstar, Inc. and
subsidiaries (Morningstar, we, our, the Company) have been prepared to conform
to the rules and regulations of the Securities and Exchange Commission
(SEC). The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amount of assets,
liabilities, revenue, and expenses. Actual results could differ from those
estimates. In the opinion of management, the statements reflect all
adjustments, which are of a normal recurring nature, necessary to present
fairly our financial position, results of operations, equity, and cash flows.
These financial statements and notes should be read in conjunction with our
Consolidated Financial Statements and Notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2009, filed with
the SEC on March 1, 2010.
The acronyms that appear in the
Notes to our Condensed Consolidated Financial Statements refer to the
following:
ASC: Accounting Standards
Codification
ASU: Accounting Standards Update
EITF: Emerging Issues Task Force
FASB: Financial Accounting
Standards Board
SEC:
Securities and Exchange Commission
2.
Summary of Significant Accounting Policies
We discuss
our significant accounting policies in Note 2 of our Consolidated Financial
Statements included in our Annual Report on Form 10-K for the year ended
December 31, 2009, as filed with the SEC on March 1, 2010. In
addition, effective January 1, 2010, we adopted the following financial
accounting standards:
·
ASU No. 2009-16,
Transfers and Servicing
(Topic 860) and 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 FASB ASU No. 2009-16 consists of the
removal of the concept of a Qualifying Special-Purpose Entity (QSPE) from FASB
ASC 860,
Transfers and Services
. ASU No. 2009-17
addresses the effects of eliminating the QSPE concept from ASC 860 and responds
to concerns about the application of certain key provisions of FASB ASC 810,
Consolidation
, including concerns over the transparency of
enterprises involvement with Variable Interest Entities (VIEs). These
accounting pronouncements did not impact our Condensed Consolidated Financial
Statements.
·
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. ASU 2010-06 also clarifies 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. The additional disclosures
required by ASU No. 2010-06 appear in Note 6, in the Notes to our
Condensed Consolidated Financial Statements.
7
Table of Contents
3.
Acquisitions, Goodwill, and Other Intangible Assets
2010
Acquisitions
In the
first nine months of 2010, we completed six acquisitions, as follows:
Increased
Ownership Interest in Morningstar Danmark A/S (Morningstar Denmark)
In July 2010, we acquired an
additional 75% interest in Morningstar Denmark, increasing our ownership to
100% from 25%. Morningstar Denmarks main offering is the investment
information website for individual investors, Morningstar.dk, which provides
fund and ETF data, portfolio tools, and market analysis.
The total estimated fair value of
$20,665,000 includes $15,467,000 in cash paid to acquire the remaining 75%
interest in Morningstar Denmark. The following table summarizes our preliminary
allocation of the estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition:
|
|
($000)
|
|
Cash and
cash equivalents
|
|
$
|
915
|
|
Accounts
receivable and other current assets
|
|
771
|
|
Other
non-current assets
|
|
65
|
|
Intangible
assets
|
|
9,066
|
|
Goodwill
|
|
13,347
|
|
Deferred
revenue
|
|
(496
|
)
|
Deferred
tax liability
|
|
(2,307
|
)
|
Other
current and non-current liabilities
|
|
(696
|
)
|
Total
fair value of Morningstar Denmark
|
|
$
|
20,665
|
|
The
preliminary fair value allocation includes $9,066,000 of acquired intangible
assets, consisting primarily of customer-related assets and technology-based
assets, including software and databases. We recognized a deferred tax
liability of $2,307,000 mainly because the amortization expense related to
certain intangible assets is not deductible for income tax purposes.
Goodwill
of $13,347,000 represents the premium over the fair value of the net tangible
and intangible assets acquired with this acquisition. We paid this premium for
a number of reasons, including the opportunity to offer Morningstars full
suite of products and services to investors in Denmark, and further leveraging
Morningstars global reach, investment databases, and technology expertise.
Seeds
Group (Seeds)
In July 2010, we acquired
Seeds Group, a leading provider of investment consulting services and fund
research in France. Through its subsidiary Seeds Finance, Seeds provides
investment consulting services and specializes in asset liability management,
manager selection, plan construction, risk, and portfolio management in
alternative investments and active strategies. Its subsidiary,
Multiratings.com, provides a fund research and investment education website for
advisor groups and institutions. Terms were not disclosed. The acquisition did
not have a significant effect on our Condensed Consolidated Financial
Statements for the nine months ended September 30, 2010.
8
Table of Contents
Realpoint,
LLC
In May 2010,
we acquired Realpoint, LLC (Realpoint) a Nationally Recognized Statistical
Ratings Organization (NRSRO) that specializes in structured finance. Realpoint
offers securities ratings, research, surveillance services, and data to help
institutional investors identify credit risk in commercial mortgage-backed
securities. Institutional investment firms subscribe to Realpoints ratings and
analytics, including money managers who invest in commercial mortgage-backed
securities.
In
conjunction with this acquisition, we paid $38,423,000 in cash, net of cash
acquired, and issued 199,174 shares of restricted stock to the selling
employee-shareholders. As a result of the terms of the restricted share
agreements, in accordance with FASB ASC 805,
Business
Combinations
, we account for these grants as stock-based
compensation expense, and not as part of the acquisition consideration. See
Note 9 in the Notes to our Condensed Consolidated Financial Statements for
additional information concerning the accounting for this restricted stock.
The
following table summarizes our preliminary allocation of the purchase price to
the estimated fair values of the assets acquired and liabilities assumed at the
date of acquisition:
|
|
|
($000)
|
|
|
Cash and
cash equivalents
|
|
$
|
5,393
|
|
|
Accounts
receivable and other current assets
|
|
2,647
|
|
|
Other
non-current assets
|
|
227
|
|
|
Intangible
assets
|
|
19,959
|
|
|
Goodwill
|
|
24,259
|
|
|
Deferred
revenue
|
|
(7,316
|
)
|
|
Accounts
payable and accrued and other current liabilities
|
|
(1,353
|
)
|
|
Total
purchase price
|
|
$
|
43,816
|
|
The preliminary allocation includes
$19,959,000 of acquired intangible assets. These assets primarily include
customer-related assets and technology-based assets, including software and
databases.
Goodwill of $24,259,000 represents
the premium we paid over the fair value of the acquired net tangible and
intangible assets. We paid this premium for a number of reasons, including the
opportunity for Morningstar to enter into the structured finance ratings and
analysis business.
The value
assigned to goodwill, intangible assets, and restricted shares at the date of
grant are deductible for income tax purposes over a period of approximately 15
years from the acquisition date.
Old Broad Street Research
Ltd
In April 2010,
we acquired Old Broad Street Research Ltd. (OBSR) for $16,754,000 in cash, net
of cash acquired. OBSR is a premier provider of fund research, ratings, and
investment consulting services in the United Kingdom, and offers an array of
customized consulting services including model portfolios, advice on fund
construction, and corporate governance services, that are used by many of the
leading financial advisers and fund platforms.
The following table summarizes our
preliminary allocation of the purchase price to the estimated fair values of
the assets acquired and liabilities assumed at the date of acquisition. The
purchase price allocation is preliminary pending certain tax related matters,
including the valuation of deferred tax assets and liabilities at the date of
acquisition.
|
|
($000)
|
|
Cash and
cash equivalents
|
|
$
|
4,632
|
|
Accounts
receivable and other current assets
|
|
1,022
|
|
Other
non-current assets
|
|
449
|
|
Intangible
assets
|
|
9,312
|
|
Goodwill
|
|
11,396
|
|
Deferred
revenue
|
|
(1,557
|
)
|
Accounts
payable and accrued and other current liabilities
|
|
(1,169
|
)
|
Deferred
tax liability non-current
|
|
(2,621
|
)
|
Other non-current
liabilities
|
|
(78
|
)
|
Total
purchase price
|
|
$
|
21,386
|
|
9
Table of Contents
The preliminary allocation
includes $9,312,000 of acquired intangible assets. These assets primarily
include customer-related assets and technology-based assets, including software
and databases.
Goodwill
of $11,396,000 represents the premium we paid over the fair value of the
acquired net tangible and intangible assets. We paid this premium for a number
of reasons, including the strategic benefit of adding to our existing fund
research team in London and continuing to build our thought leadership in investment
research. OBSR will also help us expand our investment consulting presence in
the United Kingdom, where we already provide asset allocation, manager
selection, and portfolio construction services to institutions and
intermediaries. The goodwill we recorded is not considered deductible for
income tax purposes.
Aegis
Equities Research
In April 2010,
we acquired Aegis Equities Research, a leading provider of independent equity
research in Australia, for $10,717,000 in cash, net of cash acquired. The following
table summarizes our preliminary allocation of the purchase price to the
estimated fair values of the assets acquired and liabilities assumed at the
date of acquisition:
|
|
($000)
|
|
Cash and
cash equivalents
|
|
$
|
51
|
|
Investments
|
|
55
|
|
Accounts
receivable
|
|
229
|
|
Other
non-current assets
|
|
62
|
|
Intangible
assets
|
|
5,100
|
|
Goodwill
|
|
6,235
|
|
Deferred
revenue
|
|
(617
|
)
|
Other
current and non-current liabilities
|
|
(347
|
)
|
Total
purchase price
|
|
$
|
10,768
|
|
The preliminary allocation
includes $5,100,000 of acquired intangible assets. These assets primarily
include customer-related assets and technology-based assets, including software
and databases. Goodwill of $6,235,000 represents the premium we paid over the
fair value of the net tangible and intangible assets acquired with this
acquisition. We paid this premium for a number of reasons, including the
strategic benefits of creating a larger analyst team that will enable us to
expand our coverage of Australian-listed companies, provide Australian clients
with more robust independent research, and give us the potential to expand our
services in multiple delivery channels. We are in the process of determining
what portion of the value assigned to goodwill and intangible assets, if any,
is deductible for income tax purposes.
Footnoted
business of Financial Fineprint Inc.
In February 2010,
we acquired the Footnoted business of Financial Fineprint Inc. (Footnoted), a
blog for professional money managers, analysts, and individual investors.
Footnoted Pro, a service for institutional investors, provides insight on
actionable items and trends in SEC filings. The acquisition includes the
Footnoted.org website and the Footnoted Pro service. Terms were not disclosed.
The acquisition did not have a significant effect on our Condensed Consolidated
Financial Statements for the nine months ended September 30, 2010.
10
Table of Contents
2009
Acquisitions
The table
below summarizes the six acquisitions we completed in 2009:
Acquisition
|
|
Description
|
|
Date Acquired
|
|
Purchase Price*
|
Global
financial filings database business of Global Reports LLC
|
|
A
leading provider of online financial and Corporate and Social Responsibility
reports for publicly traded companies around the world
|
|
April 20,
2009
|
|
Not
separately Disclosed
|
Equity
research and data business of C.P.M.S. Computerized Portfolio Management
Services Inc.
|
|
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
|
|
May 1,
2009
|
|
$13.9
million
|
Andex
Associates, Inc.
|
|
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
|
|
May 1,
2009
|
|
Not
separately disclosed
|
Intech
Pty Ltd
|
|
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
|
|
June 30,
2009
|
|
Not
separately disclosed
|
Canadian
Investment Awards and Gala
|
|
Canadas
marquee investment awards program, recognizing excellence in products and
firms within the financial services industry
|
|
December 17,
2009
|
|
Not
separately disclosed
|
Logical
Information Machines, Inc. (LIM)
|
|
A
leading provider of data and analytics for the energy, financial, and
agriculture sectors
|
|
December 31,
2009
|
|
$53.5
million
|
* Total purchase price less cash acquired, subject to
post-closing adjustments.
As of September 30, 2010, we
did not make any significant changes to the purchase price allocations for the
acquisitions that occurred in 2009. Certain of these purchase price
allocations, primarily the purchase price allocation related to Logical
Information Machines, Inc. are preliminary, pending resolution of certain
tax and other matters. Additional information concerning the six acquisitions
completed in 2009 can be found in the Notes to our Consolidated Financial
Statements included in our Annual Report on Form 10-K filed with the SEC
on March 1, 2010.
11
Table of Contents
Pro Forma Information for
2010 and 2009 Acquisitions
The following unaudited pro forma
information presents a summary of our Condensed Consolidated Statements of
Income for the nine months ended September 30, 2010 and 2009 as if we had
completed the 2010 and 2009 acquisitions and had consolidated Morningstar Korea
and Morningstar Denmark, as of January 1 of each of these years. In
calculating the pro forma information below, we included an estimate of
amortization expense related to the intangible assets acquired.
|
|
Nine months ended September 30
|
|
Unaudited Pro Forma Financial Information (in thousands except per share amounts)
|
|
2010
|
|
2009
|
|
Revenue
|
|
$
|
414,208
|
|
$
|
397,680
|
|
Operating
income
|
|
$
|
88,210
|
|
$
|
100,916
|
|
Net
income attributable to Morningstar, Inc.
|
|
$
|
58,618
|
|
$
|
68,042
|
|
|
|
|
|
|
|
Basic
net income per share attributable to Morningstar, Inc.
|
|
$
|
1.19
|
|
$
|
1.42
|
|
Diluted
net income per share attributable to Morningstar, Inc.
|
|
$
|
1.16
|
|
$
|
1.37
|
|
Goodwill
The
following table shows the changes in our goodwill balances from
December 31, 2009 to September 30, 2010:
|
|
($000)
|
|
Balance as of December 31, 2009
|
|
$
|
249,992
|
|
Acquisition of Aegis
|
|
6,235
|
|
Acquisition of OBSR
|
|
11,396
|
|
Acquisition of Realpoint
|
|
24,259
|
|
Acquisition of Seeds Group
|
|
3,504
|
|
Acquisition of remaining ownership of Morningstar
Denmark
|
|
13,347
|
|
Other, primarily currency translation
|
|
2,516
|
|
Balance as of September 30, 2010
|
|
$
|
311,249
|
|
We did not
record any impairment losses in the third quarter or year-to-date periods ended
September 30, 2010 and September 30, 2009, respectively. We perform
our annual impairment reviews in the fourth quarter.
The
following table summarizes our intangible assets:
|
|
As of September 30, 2010
|
|
As of December 31, 2009
|
|
($000)
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net
|
|
Weighted
Average
Useful Life
(years)
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net
|
|
Weighted
Average
Useful Life
(years)
|
|
Intellectual
property
|
|
$
|
31,293
|
|
$
|
(14,804
|
)
|
$
|
16,489
|
|
10
|
|
$
|
28,472
|
|
$
|
(12,147
|
)
|
$
|
16,325
|
|
10
|
|
Customer-related
assets
|
|
111,935
|
|
(36,041
|
)
|
75,894
|
|
11
|
|
87,635
|
|
(27,405
|
)
|
60,230
|
|
10
|
|
Supplier
relationships
|
|
240
|
|
(69
|
)
|
171
|
|
20
|
|
240
|
|
(60
|
)
|
180
|
|
20
|
|
Technology-based
assets
|
|
60,302
|
|
(22,266
|
)
|
38,036
|
|
9
|
|
49,276
|
|
(16,694
|
)
|
32,582
|
|
9
|
|
Non-competition
agreement
|
|
849
|
|
(672
|
)
|
177
|
|
5
|
|
820
|
|
(547
|
)
|
273
|
|
5
|
|
Intangible
assets related to acquisitions with preliminary purchase price allocations
|
|
37,961
|
|
(1,417
|
)
|
36,544
|
|
10
|
|
26,129
|
|
(231
|
)
|
25,898
|
|
5
|
|
Total
intangible assets
|
|
$
|
242,580
|
|
$
|
(75,269
|
)
|
$
|
167,311
|
|
10
|
|
$
|
192,572
|
|
$
|
(57,084
|
)
|
$
|
135,488
|
|
9
|
|
12
Table of
Contents
The following table summarizes our
amortization expense related to intangible assets:
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Amortization
expense
|
|
$
|
6,219
|
|
$
|
3,130
|
|
$
|
17,535
|
|
$
|
13,793
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We amortize intangible assets
using the straight-line method over their expected economic useful lives.
Based on acquisitions completed
through September 30, 2010, we expect intangible amortization expense for
2010 and subsequent years as follows:
|
|
($000)
|
|
2010
|
|
$
|
24,054
|
|
2011
|
|
24,223
|
|
2012
|
|
22,973
|
|
2013
|
|
20,878
|
|
2014
|
|
19,925
|
|
2015
|
|
19,230
|
|
|
|
|
|
|
Our estimates of future
amortization expense for intangible assets may be affected by changes to the
preliminary purchase price allocations, additional acquisitions, and currency
translations.
4. Income Per
Share
We compute income per share based
on the two-class method, in accordance with FASB ASC 260-10-45-59A,
Participating Securities and the Two Class Method
.
In May 2010, we issued
restricted shares in conjunction with the Realpoint acquisition. Because the
restricted shares contain nonforfeitable rights to dividends, they meet the
criteria of a participating security. Under the two-class method, earnings are
allocated between common stock and participating securities. The two-class
method includes an earnings allocation formula that determines earnings per
share for each class of common stock according to dividends declared and
undistributed earnings for the period. We reduce our reported net earnings by
the amount allocated to participating securities to arrive at the earnings
allocated to common stock shareholders for purposes of calculating earnings per
share.
ASC 260-10-45-59A requires the
dilutive effect of participating securities to be calculated using the more
dilutive of the treasury stock or the two-class method. We have determined the
two-class method to be the more dilutive. As such, we adjusted the earnings
allocated to common stock shareholders in the basic earnings per share
calculation for the reallocation of undistributed earnings to participating
securities to calculate diluted earnings per share.
13
Table of Contents
The following table shows how we
reconcile our net income and the number of shares used in computing basic and
diluted income per share:
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
(in thousands, except per share amounts)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share attributable
to Morningstar, Inc.:
|
|
|
|
|
|
|
|
|
|
Net
income attributable to Morningstar, Inc.
|
|
$
|
20,787
|
|
$
|
22,520
|
|
$
|
58,977
|
|
$
|
68,026
|
|
Less:
Distributed earnings available to participating securities
|
|
(10
|
)
|
|
|
(10
|
)
|
|
|
Less:
Undistributed earnings available to participating securities
|
|
(73
|
)
|
|
|
(226
|
)
|
|
|
Numerator
for basic net income per share undistributed and distributed earnings
available to common shareholders
|
|
$
|
20,704
|
|
$
|
22,520
|
|
$
|
58,741
|
|
$
|
68,026
|
|
Weighted
average common shares outstanding
|
|
49,401
|
|
48,457
|
|
49,157
|
|
47,930
|
|
Basic
net income per share attributable to Morningstar, Inc.
|
|
$
|
0.42
|
|
$
|
0.46
|
|
$
|
1.19
|
|
$
|
1.42
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share attributable
to Morningstar, Inc.:
|
|
|
|
|
|
|
|
|
|
Numerator
for basic net income per share undistributed and distributed earnings
available to common shareholders
|
|
$
|
20,704
|
|
$
|
22,520
|
|
$
|
58,741
|
|
$
|
68,026
|
|
Add:
Undistributed earnings allocated to participating securities
|
|
73
|
|
|
|
226
|
|
|
|
Less:
Undistributed earnings reallocated to participating securities
|
|
(72
|
)
|
|
|
(221
|
)
|
|
|
Numerator
for diluted net income per share undistributed and distributed earnings
available to common shareholders
|
|
$
|
20,705
|
|
$
|
22,520
|
|
$
|
58,746
|
|
$
|
68,026
|
|
Weighted
average common shares outstanding
|
|
49,401
|
|
48,457
|
|
49,157
|
|
47,930
|
|
Net
effect of dilutive stock options and restricted stock units
|
|
1,143
|
|
1,591
|
|
1,296
|
|
1,693
|
|
Weighted
average common shares outstanding for computing diluted income per share
|
|
50,544
|
|
50,048
|
|
50,453
|
|
49,623
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net income per share attributable to Morningstar, Inc.
|
|
$
|
0.41
|
|
$
|
0.45
|
|
$
|
1.16
|
|
$
|
1.37
|
|
5. Segment and
Geographical Area Information
Morningstar has two operating
segments:
·
Investment Information
.
The Investment Information
segment includes all of our data, software, and research products and services.
These products are typically sold through subscriptions or license agreements.
The largest products in this
segment based on revenue are Licensed Data, Morningstar Advisor Workstation,
Morningstar.com, Morningstar Direct, and Morningstar Principia. Licensed Data
is a set of investment data spanning all of our investment databases, including
real-time pricing data, and is available through electronic data feeds. Advisor
Workstation is a web-based investment planning system for advisors. Advisor
Workstation is available in two editions: Morningstar Office 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. The period
covered by the Global Analyst Research Settlement expired at the end of July 2009.
The banks covered by it are no longer required to provide independent research
to their clients.
We also sell Equity Research to
other companies that purchase our research for their own use or provide our
research to their affiliated advisors or individual investor clients.
14
Table of Contents
·
Investment Management
.
The Investment Management segment
includes all of our asset management operations, which earn the majority of
their revenue from asset-based fees.
The key products and services in
this segment based on revenue are Investment Consulting, which focuses on
investment monitoring and asset allocation for funds of funds, including mutual
funds and variable annuities; Retirement Advice, including the Morningstar
Retirement Manager and Advice by Ibbotson platforms; and Morningstar Managed
Portfolios, a fee-based discretionary asset management service that includes a
series of mutual fund, exchange-traded fund, and stock portfolios tailored to
meet a range of investment time horizons, risk levels, and investment
strategies that financial advisors can use for their clients taxable and
tax-deferred accounts.
Our segment accounting policies
are the same as those described in Note 2 to our Consolidated Financial
Statements included in our Annual Report on Form 10-K as of
December 31, 2009, except for the capitalization and amortization of
internal product development costs, amortization of intangible assets, and
costs related to corporate functions. We exclude these items from our operating
segment results to provide our chief operating decision maker with a better
indication of each segments ability to generate cash flow. This information is
one of the criteria used by our chief operating decision maker in determining
how to allocate resources to each segment. We include capitalization and
amortization of internal product development costs, amortization of intangible
assets, and costs related to corporate functions in the Corporate Items
category to arrive at the consolidated financial information. Our segment
disclosures are consistent with the business segment information provided to
our chief operating decision maker on a recurring basis; for that reason, we
dont present balance sheet information by segment. We disclose goodwill by
segment in accordance with the requirements of FASB ASC 350-20-50,
Intangibles - Goodwill - Disclosure.
The following tables show selected
segment data for the three and nine months ended September 30, 2010 and
2009:
|
|
Three months ended September 30, 2010
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
External
revenue
|
|
$
|
112,055
|
|
$
|
27,762
|
|
$
|
|
|
$
|
139,817
|
|
Operating
expense, excluding stock-based compensation expense, depreciation, and
amortization
|
|
75,129
|
|
13,670
|
|
7,215
|
|
96,014
|
|
Stock-based
compensation expense
|
|
2,326
|
|
525
|
|
894
|
|
3,745
|
|
Depreciation
and amortization
|
|
1,789
|
|
44
|
|
8,064
|
|
9,897
|
|
Operating
income (loss)
|
|
$
|
32,811
|
|
$
|
13,523
|
|
$
|
(16,173
|
)
|
$
|
30,161
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
revenue
|
|
|
|
|
|
|
|
$
|
99,933
|
|
Non-U.S.
revenue
|
|
|
|
|
|
|
|
$
|
39,884
|
|
|
|
Three months ended September 30, 2009
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
External
revenue
|
|
$
|
95,410
|
|
$
|
24,678
|
|
$
|
|
|
$
|
120,088
|
|
Operating
expense, excluding stock-based compensation expense, depreciation, and
amortization
|
|
59,122
|
|
9,755
|
|
8,034
|
|
76,911
|
|
Stock-based
compensation expense
|
|
1,429
|
|
484
|
|
950
|
|
2,863
|
|
Depreciation
and amortization
|
|
1,561
|
|
48
|
|
5,022
|
|
6,631
|
|
Operating
income (loss)
|
|
$
|
33,298
|
|
$
|
14,391
|
|
$
|
(14,006
|
)
|
$
|
33,683
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
revenue
|
|
|
|
|
|
|
|
$
|
85,548
|
|
Non-U.S.
revenue
|
|
|
|
|
|
|
|
$
|
34,540
|
|
15
Table of Contents
|
|
Nine months ended September 30, 2010
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
External
revenue
|
|
$
|
324,600
|
|
$
|
79,598
|
|
$
|
|
|
$
|
404,198
|
|
Operating
expense, excluding stock-based compensation expense, depreciation, and
amortization
|
|
217,559
|
|
36,768
|
|
22,682
|
|
277,009
|
|
Stock-based
compensation expense
|
|
5,926
|
|
1,557
|
|
2,854
|
|
10,337
|
|
Depreciation
and amortization
|
|
5,016
|
|
136
|
|
22,930
|
|
28,082
|
|
Operating
income (loss)
|
|
$
|
96,099
|
|
$
|
41,137
|
|
$
|
(48,466
|
)
|
$
|
88,770
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
4,953
|
|
$
|
58
|
|
$
|
2,690
|
|
$
|
7,701
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
revenue
|
|
|
|
|
|
|
|
$
|
291,529
|
|
Non-U.S.
revenue
|
|
|
|
|
|
|
|
$
|
112,669
|
|
|
|
Nine months ended September 30, 2009
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
External
revenue
|
|
$
|
289,389
|
|
$
|
66,964
|
|
$
|
|
|
$
|
356,353
|
|
Operating
expense, excluding stock-based compensation expense, depreciation, and
amortization
|
|
173,957
|
|
26,058
|
|
23,339
|
|
223,354
|
|
Stock-based
compensation expense
|
|
4,222
|
|
1,469
|
|
2,965
|
|
8,656
|
|
Depreciation
and amortization
|
|
3,833
|
|
157
|
|
19,357
|
|
23,347
|
|
Operating
income (loss)
|
|
$
|
107,377
|
|
$
|
39,280
|
|
$
|
(45,661
|
)
|
$
|
100,996
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
8,872
|
|
$
|
679
|
|
$
|
735
|
|
$
|
10,286
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
revenue
|
|
|
|
|
|
|
|
$
|
262,982
|
|
Non-U.S.
revenue
|
|
|
|
|
|
|
|
$
|
93,371
|
|
|
|
As of September 30, 2010
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Goodwill
|
|
$
|
269,042
|
|
$
|
42,207
|
|
$
|
|
|
$
|
311,249
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
long-lived assets
|
|
|
|
|
|
|
|
$
|
40,257
|
|
Non-U.S.
long-lived assets
|
|
|
|
|
|
|
|
$
|
17,459
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2009
|
|
($000)
|
|
Investment
Information
|
|
Investment
Management
|
|
Corporate Items
|
|
Total
|
|
Goodwill
|
|
$
|
217,758
|
|
$
|
32,234
|
|
$
|
|
|
$
|
249,992
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
long-lived assets
|
|
|
|
|
|
|
|
$
|
42,884
|
|
Non-U.S.
long-lived assets
|
|
|
|
|
|
|
|
$
|
16,944
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
Table of Contents
6. Investments
and Fair Value Measurements
We account for our investments in
accordance with FASB ASC 320,
InvestmentsDebt and
Equity Securities.
We classify our investments in three categories:
available-for-sale, held-to-maturity, and trading. We monitor the
concentration, diversification, maturity, and liquidity of our investment
portfolio, which is primarily invested in fixed-income securities, and classify
our investment portfolio as shown below:
($000)
|
|
As of September 30
2010
|
|
As of December 31
2009
|
|
Available-for-sale
|
|
$
|
150,516
|
|
$
|
197,306
|
|
Held-to-maturity
|
|
8,759
|
|
10,588
|
|
Trading
securities
|
|
4,194
|
|
4,163
|
|
Total
|
|
$
|
163,469
|
|
$
|
212,057
|
|
The following table shows the
cost, unrealized gains (losses), and fair values related to investments
classified as available-for-sale and held-to-maturity:
|
|
As of September 30, 2010
|
|
As of December 31, 2009
|
|
($000)
|
|
Cost
|
|
Unrealized
Gain
|
|
Unrealized
Loss
|
|
Fair
Value
|
|
Cost
|
|
Unrealized
Gain
|
|
Unrealized
Loss
|
|
Fair
Value
|
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Government
obligations
|
|
$
|
101,260
|
|
$
|
94
|
|
$
|
(11
|
)
|
$
|
101,343
|
|
$
|
174,433
|
|
$
|
439
|
|
$
|
(50
|
)
|
$
|
174,822
|
|
Corporate
bonds
|
|
36,609
|
|
78
|
|
(27
|
)
|
36,660
|
|
12,268
|
|
44
|
|
(1
|
)
|
12,311
|
|
Equity
securities
|
|
3,921
|
|
346
|
|
|
|
4,267
|
|
2,013
|
|
188
|
|
(28
|
)
|
2,173
|
|
Mutual
funds
|
|
8,063
|
|
183
|
|
|
|
8,246
|
|
8,000
|
|
|
|
|
|
8,000
|
|
Total
|
|
$
|
149,853
|
|
$
|
701
|
|
$
|
(38
|
)
|
$
|
150,516
|
|
$
|
196,714
|
|
$
|
671
|
|
$
|
(79
|
)
|
$
|
197,306
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates
of deposit
|
|
$
|
8,759
|
|
$
|
|
|
$
|
|
|
$
|
8,759
|
|
$
|
10,588
|
|
$
|
|
|
$
|
|
|
$
|
10,588
|
|
As of September 30, 2010 and December 31,
2009, investments with unrealized losses for greater than a 12-month period
were not material to the Condensed Consolidated Balance Sheets and were not
deemed to have other than temporary declines in value.
The table below shows the cost and
fair value of investments classified as available-for-sale and held-to-maturity
based on their contractual maturities as of September 30, 2010 and December 31,
2009. The expected maturities of certain fixed-income securities
may differ from their contractual maturities because some of these
holdings have call features that allow the issuers the right to prepay
obligations without penalties.
|
|
As of September 30, 2010
|
|
As of December 31, 2009
|
|
($000)
|
|
Cost
|
|
Fair Value
|
|
Cost
|
|
Fair Value
|
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
|
Due in
one year or less
|
|
$
|
59,078
|
|
$
|
59,091
|
|
$
|
161,453
|
|
$
|
161,817
|
|
Due in
one to three years
|
|
78,791
|
|
78,912
|
|
25,248
|
|
25,316
|
|
Equity
securities and mutual funds
|
|
11,984
|
|
12,513
|
|
10,013
|
|
10,173
|
|
Total
|
|
$
|
149,853
|
|
$
|
150,516
|
|
$
|
196,714
|
|
$
|
197,306
|
|
|
|
|
|
|
|
|
|
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
|
Due in
one year or less
|
|
$
|
8,754
|
|
$
|
8,754
|
|
$
|
10,587
|
|
$
|
10,587
|
|
Due in
one to three years
|
|
5
|
|
5
|
|
1
|
|
1
|
|
Total
|
|
$
|
8,759
|
|
$
|
8,759
|
|
$
|
10,588
|
|
$
|
10,588
|
|
Held-to-maturity investments
include a $1,600,000 certificate of deposit held as collateral against two bank
guarantees for our office lease in Australia.
17
Table of Contents
The following table shows the
realized gains and losses arising from sales of our investments classified as
available-for-sale recorded in our Condensed Consolidated Statements of Income:
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Realized
gains
|
|
$
|
17
|
|
$
|
|
|
Realized
losses
|
|
(3
|
)
|
|
|
Realized
gains, net
|
|
$
|
14
|
|
$
|
|
|
The following table shows the net
unrealized gains (losses) on trading securities as recorded in our Condensed
Consolidated Statements of Income:
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Unrealized
gains (losses), net
|
|
$
|
(75
|
)
|
$
|
1,026
|
|
|
|
|
|
|
|
|
|
The fair value of our assets
subject to fair value measurements and the necessary disclosures are as
follows:
|
|
Fair Value
|
|
Fair Value Measurements as of
|
|
|
|
as of
|
|
September 30, 2010 Using Fair Value Hierarchy
|
|
($000)
|
|
September 30, 2010
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Available-for-sale
investments
|
|
|
|
|
|
|
|
|
|
Government
obligations
|
|
$
|
101,343
|
|
$
|
101,343
|
|
$
|
|
|
$
|
|
|
Corporate
bonds
|
|
36,660
|
|
36,660
|
|
|
|
|
|
Equity
securities
|
|
4,267
|
|
4,267
|
|
|
|
|
|
Mutual
funds
|
|
8,246
|
|
8,246
|
|
|
|
|
|
Trading
securities
|
|
4,194
|
|
4,194
|
|
|
|
|
|
Total
|
|
$
|
154,710
|
|
$
|
154,710
|
|
$
|
|
|
$
|
|
|
|
|
Fair Value
|
|
Fair Value Measurements as of
|
|
|
|
as of
|
|
December 31, 2009 Using Fair Value Hierarchy
|
|
($000)
|
|
December 31, 2009
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Available-for-sale
investments
|
|
|
|
|
|
|
|
|
|
Government
obligations
|
|
$
|
174,822
|
|
$
|
174,822
|
|
$
|
|
|
$
|
|
|
Corporate
bonds
|
|
12,311
|
|
12,311
|
|
|
|
|
|
Equity
securities
|
|
2,173
|
|
2,173
|
|
|
|
|
|
Mutual
funds
|
|
8,000
|
|
8,000
|
|
|
|
|
|
Trading
securities
|
|
4,163
|
|
4,163
|
|
|
|
|
|
Total
|
|
$
|
201,469
|
|
$
|
201,469
|
|
$
|
|
|
$
|
|
|
Level 1:
|
Valuations based on quoted
prices in active markets for identical assets or liabilities that we have the
ability to access.
|
Level 2:
|
Valuations based on quoted
prices in markets that are not active or for which all significant inputs are
observable, either directly or indirectly.
|
Level 3:
|
Valuations based on inputs that
are unobservable and significant to the overall fair value measurement.
|
We did not transfer any
investments between levels of the fair value hierarchy in the first nine months
of 2010 or 2009. Based on our analysis of the nature and risks of our
investments in equity securities and mutual funds, we have determined that
presenting these investment categories each in the aggregate is appropriate.
18
Table of Contents
7. Investments in
Unconsolidated Entities
Our investments in unconsolidated
entities consist primarily of the following:
($000)
|
|
As of September 30
2010
|
|
As of December 31
2009
|
|
Investment
in MJKK
|
|
$
|
18,821
|
|
$
|
18,413
|
|
Other
equity method investments
|
|
107
|
|
577
|
|
Investments
accounted for using the cost method
|
|
5,115
|
|
5,089
|
|
Total
investments in unconsolidated entities
|
|
$
|
24,043
|
|
$
|
24,079
|
|
Morningstar
Japan K.K.
Morningstar
Japan K.K. (MJKK) develops and markets products and services customized
for the Japanese market. MJKKs shares are traded on the Osaka Stock Exchange, Hercules
Market, using the ticker 4765. We account for our investment in MJKK using the
equity method. The following table summarizes our ownership percentage in MJKK
and the market value of this investment based on MJKKs publicly quoted share
price:
|
|
As of September 30
2010
|
|
As of December 31
2009
|
|
Morningstars
approximate ownership of MJKK
|
|
34
|
%
|
34
|
%
|
|
|
|
|
|
|
Approximate
market value of Morningstars ownership in MJKK:
|
|
|
|
|
|
Japanese
yen (¥000)
|
|
¥
|
3,068,300
|
|
¥
|
2,600,000
|
|
Equivalent
U.S. dollars ($000)
|
|
$
|
36,697
|
|
$
|
28,507
|
|
Other
Equity Method Investments
. As
of September 30, 2010 and December 31, 2009, other equity method
investments include our investment in Morningstar Sweden AB (Morningstar
Sweden). Morningstar Sweden develops and markets products and services
customized for their respective market. Our ownership interest in Morningstar
Sweden was approximately 24% as of September 30, 2010 and December 31,
2009.
As of December 31,
2009, other equity-method investments also included our investment in
Morningstar Danmark A/S (Morningstar Denmark). Our ownership interest and
profit-and loss-sharing interest in Morningstar Denmark was 25% at that date.
In July 2010, we acquired an additional 75% ownership in Morningstar
Denmark, increasing our ownership interest to 100%. Upon acquiring the majority
ownership, we recorded a preliminary holding gain of $5,073,000. This gain
represents the difference between the estimated fair value and the book value
of our investment in Morningstar Denmark at the date of acquisition. Because
Morningstar Denmark is now a wholly-owned subsidiary, we no longer account for
our investment using the equity method. Beginning in July 2010, we
consolidate the assets, liabilities, and results of operations of Morningstar
Denmark in our Condensed Consolidated Financial Statements.
Cost
Method Investments.
As of September 30,
2010 and December 31, 2009, our cost method investments consist mainly of
minority investments in Pitchbook Data, Inc. (Pitchbook) and Bundle
Corporation (Bundle). Pitchbook offers detailed data and information about
private equity transactions, investors, companies, limited partners, and
service providers. Bundle is a social media company dedicated to helping people
make smarter spending and saving choices. Its website, Bundle.com, features a
money comparison tool that shows spending trends across the United States,
along with a range of information on saving, investing, and budgeting. We did
not record any impairment losses on our cost method investments in the first
nine months of 2010 and 2009, respectively.
8. Liability for Vacant
Office Space
The following table shows the
change in our liability for vacant office space from December 31, 2009 to September 30,
2010:
Liability for vacant office space
|
|
($000)
|
|
Balance
as of December 31, 2009
|
|
$
|
3,815
|
|
Increased
liability for vacant office space
|
|
1,390
|
|
Reduction
of liability for lease payments
|
|
(1,550
|
)
|
Other, net
|
|
(1,151
|
)
|
Balance
as of September 30, 2010
|
|
$
|
2,504
|
|
In the first nine months of 2010,
we increased our liability for vacant office space for the former Ibbotson
headquarters because we finalized sub-lease arrangements for a portion of this
space. In addition, we increased our liability for vacant office space related
to the equity research and data business acquired from C.P.M.S. We recorded the
increases in the liability as an operating expense in the first nine months of
2010.
19
Table of Contents
9. Stock-Based
Compensation
Stock-Based
Compensation Plans
In November 2004, we adopted
the 2004 Stock Incentive Plan. The 2004 Stock Incentive Plan provides for
grants of options, stock appreciation rights, restricted stock units, and
performance shares. All of our employees and our non-employee directors are
eligible for awards under the 2004 Stock Incentive Plan. Joe Mansueto, our
chairman and chief executive officer, does not participate in the 2004 Stock
Incentive Plan or prior plans.
Since the adoption of the 2004
Stock Incentive Plan, we have granted stock options and, beginning in 2006,
restricted stock units.
Restricted stock units represent
the right to receive a share of Morningstar common stock when that unit vests.
Restricted stock units granted under the 2004 Stock Incentive Plan generally
vest ratably over a four-year period. For restricted stock units granted through
December 31, 2008, employees could elect to defer receipt of the
Morningstar common stock issued upon vesting of the restricted stock unit.
Stock options granted under the 2004 Stock Incentive Plan generally vest
ratably over a four-year period and expire 10 years after the date of grant.
Almost all of the options granted under the 2004 Stock Incentive Plan have a
premium feature in which the exercise price increases over the term of the
option at a rate equal to the 10-year Treasury bond yield as of the date of
grant.
The following table summarizes the
number of shares available for future grants under our 2004 Stock Incentive
Plan:
(000)
|
|
As of September 30
2010
|
|
As of December 31
2009
|
|
Shares
available for future grants
|
|
1,814
|
|
2,143
|
|
Prior to November 2004, we
granted stock options under various plans, including the 1993 Stock Option
Plan, the 2000 Morningstar Stock Option Plan, and the 2001 Morningstar Stock
Option Plan (collectively, the Prior Plans). The 2004 Stock Incentive Plan
amends and restates the Prior Plans. Under the 2004 Stock Incentive Plan, we
will not grant any additional options under any of the Prior Plans, and any
shares subject to an award under any of the Prior Plans that are forfeited,
canceled, settled, or otherwise terminated without a distribution of shares, or
withheld by us in connection with the exercise of options or in payment of any
required income tax withholding, will not be available for awards under the
2004 Stock Incentive Plan.
All options granted under the 2004
Stock Incentive Plan and the Prior Plans were vested as of January 1,
2010; however, because the options under these plans expire 10 years after the
date of grant, some options granted under these plans remain outstanding as of September 30,
2010.
Restricted Stock
In conjunction with the Realpoint
acquisition in May 2010, we issued 199,174 shares of restricted stock to
the selling employee-shareholders. The restricted stock vests ratably over a
five-year period from the acquisition date and may be subject to forfeiture if
the holder terminates his or her employment during the vesting period. Because
of the terms of the restricted share agreements, in accordance with ASC 805,
Business Combinations
, we account for these grants as
stock-based compensation expense, and not as part of the acquisition
consideration. See Note 3, in the Notes to our Condensed Consolidated Financial
Statements, for additional information concerning the Realpoint acquisition.
20
Table of Contents
Accounting for
Stock-Based Compensation Awards
The following table summarizes our
stock-based compensation expense and the related income tax benefit we recorded
in the three and nine months ended September 30, 2010 and 2009:
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Restricted
stock units
|
|
$
|
3,277
|
|
$
|
2,781
|
|
$
|
9,557
|
|
$
|
7,686
|
|
Restricted
stock
|
|
468
|
|
|
|
780
|
|
|
|
Stock
options
|
|
|
|
82
|
|
|
|
970
|
|
Total
stock-based compensation expense
|
|
$
|
3,745
|
|
$
|
2,863
|
|
$
|
10,337
|
|
$
|
8,656
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit related to the stock-based compensation expense
|
|
$
|
973
|
|
$
|
881
|
|
$
|
2,874
|
|
$
|
2,714
|
|
In accordance with FASB ASC 718,
CompensationStock Compensation
, we estimate forfeitures of
employee stock-based awards and recognize compensation cost only for those
awards expected to vest. Because our largest annual equity grants typically
have vesting dates in the second quarter, we adjust the stock-based
compensation expense at that time to reflect those awards that ultimately
vested and update our estimate of the forfeiture rate that will be applied to
awards not yet vested. In the second quarter of 2010 and 2009, we recorded
approximately $228,000 and $299,000, respectively, of additional stock-based
compensation expense as a result of these adjustments.
Restricted Stock
Units
We measure the fair value of our
restricted stock units on the date of grant based on the closing market price
of the underlying common stock on the day prior to grant. We amortize that
value to stock-based compensation expense, net of estimated forfeitures,
ratably over the vesting period. The following table summarizes restricted
stock unit activity during the first nine months of 2010:
Restricted Stock Units (RSUs)
|
|
Unvested
|
|
Vested but
Deferred
|
|
Total
|
|
Weighted
Average
Grant Date Value
per RSU
|
|
RSUs
outstandingDecember 31, 2009
|
|
681,425
|
|
39,594
|
|
721,019
|
|
$
|
46.99
|
|
Granted
|
|
362,387
|
|
|
|
362,387
|
|
47.63
|
|
Vested
|
|
(212,356
|
)
|
|
|
(212,356
|
)
|
48.11
|
|
Vested
but deferred
|
|
(15,996
|
)
|
15,996
|
|
|
|
|
|
Issued
|
|
|
|
(11,153
|
)
|
(11,153
|
)
|
49.29
|
|
Forfeited
|
|
(32,392
|
)
|
|
|
(32,392
|
)
|
46.16
|
|
RSUs
outstandingSeptember 30, 2010
|
|
783,068
|
|
44,437
|
|
827,505
|
|
46.99
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2010, the
total amount of unrecognized stock-based compensation expense related to
restricted stock units was approximately $29,516,000. We expect to recognize
this expense over an average period of approximately 34 months.
Restricted Stock
We measured the fair value of the
restricted stock on the date of grant based on the closing market price of our
common stock on the day prior to the grant. We amortize this value to
stock-based compensation expense ratably over the vesting period. We have
assumed that all of the restricted stock will ultimately vest, and therefore we
have not incorporated a forfeiture rate for purposes of determining the
stock-based compensation expense.
As of September 30, 2010, the
total amount of unrecognized stock-based compensation expense related to
restricted stock was approximately $8,583,000. We expect to recognize this
expense over 55 months, from October 2010 through April 2015.
21
Table of Contents
Stock Option
Activity
The following tables summarize
stock option activity in the first nine months of 2010 for our various stock
option grants. The first table includes activity for options granted at an
exercise price below the fair value per share of our common stock on the grant
date; the second table includes activity for all other option grants.
Options Granted At an Exercise Price Below the Fair Value Per Share on the Grant Date
|
|
Underlying
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Options
outstandingDecember 31, 2009
|
|
809,169
|
|
$
|
17.75
|
|
Canceled
|
|
(600
|
)
|
13.68
|
|
Exercised
|
|
(62,374
|
)
|
13.33
|
|
Options
outstandingSeptember 30, 2010
|
|
746,195
|
|
18.70
|
|
|
|
|
|
|
|
Options
exercisableSeptember 30, 2010
|
|
746,195
|
|
$
|
18.70
|
|
All Other Option Grants, Excluding Activity Shown Above
|
|
Underlying
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Options
outstandingDecember 31, 2009
|
|
1,868,408
|
|
$
|
16.15
|
|
Canceled
|
|
(15,022
|
)
|
13.62
|
|
Exercised
|
|
(464,872
|
)
|
14.67
|
|
Options
outstandingSeptember 30, 2010
|
|
1,388,514
|
|
16.99
|
|
|
|
|
|
|
|
Options
exercisableSeptember 30, 2010
|
|
1,388,514
|
|
$
|
16.99
|
|
The following table summarizes the
total intrinsic value (difference between the market value of our stock on the
date of exercise and the exercise price of the option) of options exercised:
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Intrinsic
value of options exercised
|
|
$
|
17,094
|
|
$
|
31,302
|
|
|
|
|
|
|
|
|
|
All outstanding options were
vested and exercisable as of January 1, 2010. The table below shows
additional information for options outstanding and exercisable as of
September 30, 2010:
|
|
Options Outstanding and Exercisable
|
|
Range of Exercise Prices
|
|
Number of Options
|
|
Weighted
Average
Remaining
Contractual
Life (years)
|
|
Weighted
Average
Exercise
Price
|
|
Aggregate
Intrinsic
Value
($000)
|
|
$8.57 -
$14.70
|
|
844,935
|
|
1.56
|
|
$
|
11.36
|
|
$
|
28,056
|
|
$18.74 -
$42.48
|
|
1,289,774
|
|
4.42
|
|
21.67
|
|
29,522
|
|
$8.57 -
$42.48
|
|
2,134,709
|
|
3.29
|
|
17.59
|
|
$
|
57,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value in
the table above represents the total pretax intrinsic value all option holders
would have received if they had exercised all outstanding options on September 30,
2010. The intrinsic value is based on our closing stock price of $44.56 on that
date.
As of September 30, 2010, there
was no unrecognized stock-based compensation expense related to stock options.
22
Table of
Contents
Excess Tax Benefits Related
to Stock-Based Compensation
FASB ASC 718,
CompensationStock
Compensation,
requires that we classify the cash flows that result
from excess tax benefits as financing cash flows. Excess tax benefits
correspond to the portion of the tax deduction taken on our income tax return
that exceeds the amount of tax benefit related to the compensation cost
recognized in our Statement of Income. The following table summarizes our
excess tax benefits for the three and nine months ended September 30, 2010
and 2009:
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Excess
tax benefits related to stock-based compensation
|
|
$
|
680
|
|
$
|
1,180
|
|
$
|
4,885
|
|
$
|
5,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10. Related Party
Transactions
In 2009, we determined that
certain incentive stock options (ISOs) granted to one former and two current
executives, including Tao Huang, our chief operating officer, should have been
treated as non-qualified stock options (NQSOs) for the executives and our
income tax purposes. In the fourth quarter of 2009, we recorded an operating
expense of $4,887,000 related to adjusting the tax treatment of these stock
options that were originally considered ISOs. In the first quarter of 2010, we
paid these individuals $4,887,000 to compensate for the difference in tax
treatment.
11. Income Taxes
The following table shows our
effective income tax rate for the three and nine months ended
September 30, 2010 and 2009:
|
|
Three months ended September 30
|
|
Nine months ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Income
before income taxes and equity in net income of unconsolidated entities
|
|
$
|
36,367
|
|
$
|
34,476
|
|
$
|
94,818
|
|
$
|
104,295
|
|
Equity
in net income of unconsolidated entities
|
|
333
|
|
429
|
|
1,176
|
|
790
|
|
Net
(income) loss attributable to noncontrolling interests
|
|
(106
|
)
|
22
|
|
10
|
|
40
|
|
Total
|
|
$
|
36,594
|
|
$
|
34,927
|
|
$
|
96,004
|
|
$
|
105,125
|
|
Income
tax expense
|
|
$
|
15,807
|
|
$
|
12,407
|
|
$
|
37,027
|
|
$
|
37,099
|
|
Effective
tax rate
|
|
43.2
|
%
|
35.5
|
%
|
38.6
|
%
|
35.3
|
%
|
Our effective tax rate increased
7.7 percentage points in the third quarter of 2010 and 3.3 percentage points
for the year-to-date period. Income tax expense in the quarter includes
$5,773,000 of non-cash income tax expense, including $1,883,000 related to the preliminary
gain we recorded upon the acquisition of Morningstar Denmark and $3,890,000 of
non-cash income tax expense for prior periods related to Morningstars share of
earnings in equity method investments, primarily MJKK. These items increased
the effective tax rate by approximately 11 percentage points in the quarter and
4 percentage points for the year-to-date period. In the third quarter of 2010
we also recorded a $3,821,000 deferred tax liability, and a corresponding
reduction to additional paid-in capital related to our investment in MJKK. The
deferred tax liability arises from the difference between the book basis and
tax basis of our investment in MJKK. This adjustment did not impact our effective
tax rate for either period in 2010.
Our effective tax rates for the
third quarter and nine-month periods in 2009 were favorably affected by a
variety of items that did not recur in 2010. In the third quarter of 2009, we
recognized $2,100,000 of tax credits from previous years. These tax credits
reduced our tax rate by approximately 6 percentage points in the third quarter
and 2 percentage points in the first nine months of 2009. The effective tax
rate for the first nine months of 2009 also reflects the favorable impact of
reversing $2,145,000 in reserves for uncertain tax positions. These items were
partially offset by the impact of the non-deductible deposit penalty expense,
which increased our year-to-date effective tax rate by approximately 1.3
percentage points.
We conduct business globally and
as a result, we file income tax returns in U.S. Federal, state, local, and
foreign jurisdictions. In the normal course of business we are subject to
examination by tax authorities throughout the world. The open tax years for our
U.S. Federal tax return include the years 2007 to the present. Most of our
state tax returns have open tax years from 2006 to the present. In non-U.S.
jurisdictions, the statute of limitations generally extends to years prior to
2003.
There were
no significant changes to uncertain tax positions in the third quarter of 2010
as a result of other lapses of statutes of limitation or audit activity. As of December 31,
2009, our Condensed Consolidated Balance Sheet included a current liability of
$981,000 and a non-current liability of $5,369,000 for unrecognized tax
benefits. These amounts include interest and penalties, less any associated tax
benefits.
23
Table of
Contents
We are
currently under audit by various state and local tax authorities in the United
States. We are also under audit by the tax authorities in certain non-U.S.
jurisdictions. It is likely that the examination phase of some of these state,
local, and non-U.S. audits will conclude in 2010. It is not possible to
estimate the impact of current audits on previously recorded unrecognized tax
benefits.
Our effective tax rate reflects
the fact that we are not recording an income tax benefit related to losses
recorded by certain of our non-U.S. operations. The net operating losses (NOLs)
may become deductible in certain non-U.S. tax jurisdictions to the extent
these non-U.S. operations become profitable. In the year certain non-U.S.
entities record a loss, we do not record a corresponding tax benefit, thus
increasing our effective tax rate. For each of our operations, we evaluate
whether it is more likely than not that the tax benefits related to NOLs will
be realized. As part of this evaluation, we consider evidence such as tax
planning strategies, historical operating results, forecasted taxable income,
and recent financial performance. Upon determining that it is more likely
than not that the NOLs will be realized, we reduce the tax valuation allowances
related to these NOLs, which results in a reduction to our income tax expense
and our effective tax rate in the period.
12. Contingencies
Egan-Jones Rating Co.
In
June 2010, Egan-Jones Rating Co. filed a complaint in the Court of Common
Pleas of Montgomery County, Pennsylvania against Realpoint LLC and
Morningstar, Inc. in connection with a December 2007 agreement
between Egan-Jones and Realpoint for certain data sharing and other services.
In addition to damages, Egan-Jones filed a petition seeking an injunction to
temporarily prevent Morningstar from offering corporate credit ratings. In September 2010,
the court denied Egan-Joness request for a preliminary injunction against
Morningstars corporate credit ratings business. Realpoint and Morningstar
continue to vigorously contest liability on all of Egan-Jones claims for
damages. We cannot predict the outcome of the proceeding.
Aloft Media, LLC
In June 2010,
Aloft Media, LLC filed a complaint in the United States District Court for the
Eastern District of Texas against Morningstar, Inc. and several other
companies alleging that each defendant infringes U.S. Patent No. 7,593,910
and 7,596,538 which purports to relate to a computer-based platform that
supports a decision making process. In October 2010, Morningstar and Aloft
Media entered into a license agreement covering, among other things, those
patents. The license agreement resolves the litigation. All other settlement
terms are confidential.
Business Logic Holding Corporation
In
November 2009, Business Logic Holding Corporation filed a complaint in the
Circuit Court of Cook County, Illinois against Ibbotson
Associates, Inc. and Morningstar, Inc. relating to Ibbotsons prior
commercial relationship with Business Logic. Business Logic is alleging that
Ibbotson Associates and Morningstar violated Business Logics rights by using
its trade secrets to develop a proprietary web-service software and user interface
that connects plan participant data with the Ibbotson Wealth Forecasting
Engine. Business Logic seeks, among other things, injunctive relief and
unspecified damages. Ibbotson and Morningstar answered the complaint, and
Ibbotson asserted a counterclaim against Business Logic alleging trade secret
misappropriation and breach of contract, seeking damages and injunctive relief.
While Morningstar and Ibbotson Associates are vigorously contesting the claims
against them, we cannot predict the outcome of the proceeding.
Online News Link LLC
In
October 2009, Online News Link LLC filed a complaint in the United States
District Court for the Eastern District of Texas against Morningstar, Inc.
and several other providers of online information alleging that each defendant
infringes U.S. Patent No. 7,508,789, which relates to ways for delivering
online information. In July 2010, Morningstar and Online News Link entered
into a license agreement covering patents relating to, among other things, the
delivery of news content via electronic mail with links to additional content.
The license agreement resolves the litigation. All other settlement terms are
confidential.
Morningstar Associates, LLC Subpoena from the New York Attorney Generals
Office
In
December 2004, Morningstar Associates, LLC, a wholly owned subsidiary of
Morningstar, Inc., received a subpoena from the New York Attorney Generals
office seeking information and documents related to an investigation the New
York Attorney Generals office is conducting. The subpoena asks for documents
relating to the investment consulting services the company offers to retirement
plan providers, including fund lineup recommendations for retirement plan
sponsors. Morningstar Associates has provided the requested information and
documents.
24
Table of
Contents
In 2005,
Morningstar Associates received subpoenas seeking information and documents
related to investigations being conducted by the SEC and United States
Department of Labor. The subpoenas were similar in scope to the New York
Attorney General subpoena. In January 2007 and September 2009,
respectively, the SEC and Department of Labor each notified Morningstar
Associates that it had ended its investigation, with no enforcement action,
fines, or penalties.
In
January 2007, Morningstar Associates received a Notice of Proposed
Litigation from the New York Attorney Generals office. The Notice centers on
disclosure relating to an optional service offered to retirement plan sponsors
(employers) that select 401(k) plan services from ING, one of Morningstar
Associates clients. The Notice gave Morningstar Associates the opportunity to
explain why the New York Attorney Generals office should not institute
proceedings. Morningstar Associates promptly submitted its explanation and has
cooperated fully with the New York Attorney Generals office.
We cannot
predict the scope, timing, or outcome of this matter, which may include
the institution of administrative, civil, injunctive, or criminal proceedings,
the imposition of fines and penalties, and other remedies and sanctions, any of
which could lead to an adverse impact on our stock price, the inability to
attract or retain key employees, and the loss of customers. We also cannot
predict what impact, if any, this matter may have on our business,
operating results, or financial condition.
In
addition to these proceedings, we are involved in legal proceedings and
litigation that have arisen in the normal course of our business. Although the
outcome of a particular proceeding can never be predicted, we do not believe
that the result of any of these other matters will have a material adverse
effect on our business, operating results, or financial condition.
13.
Quarterly Dividend and Share Repurchase Programs
In September 2010,
our board of directors approved a regular quarterly cash dividend of 5 cents
per share. The first quarterly dividend will be payable on January 14,
2011 to shareholders of record on December 31, 2010. As of September 30,
2010, we recorded a dividend payable of $2,484,000.
In
addition, the board of directors approved a share repurchase program that
authorizes the repurchase of up to $100 million in shares of our outstanding
common stock. We may repurchase shares from time to time at prevailing market
prices on the open market or in private transactions in amounts that we deem
appropriate. As of September 30, 2010, we had not repurchased any of our
outstanding common stock under this repurchase program.
14.
Subsequent Event
In November 2010,
we acquired the annuity intelligence business of Advanced Sales and Marketing
Corp., based in Illinois. The purchase price is $14.1 million, subject to
post-closing adjustments. We acquired the Annuity Intelligence Report (AI
Report), a web-based service that helps broker-dealers, insurers, and the
financial professionals they support better understand and more effectively
present variable annuity products to their clients. The AI Report service
leverages a proprietary database of more than 1,000 variable annuities that
includes plain-English translations of complex but important information found
in prospectuses and other public filings.
15. Recently
Issued Accounting Pronouncements
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 and also does 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.
25
Table of Contents
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 entities to disclose information in the Level 3
rollforward about purchases, sales, issuances, and settlements on a gross
basis. For Morningstar, the requirement to separately disclose purchases, sales,
issuances, and settlements in the Level 3 rollforward will be effective for our
2011 Consolidated Financial Statements. We are in the process of determining
the impact, if any, this accounting pronouncement will have on our Consolidated
Financial Statements.
26
Table of Contents
Item 2.
Managements Discussion and Analysis of
Financial Condition and Results of Operations
The discussion
included in this section, as well as other sections of this Quarterly Report on
Form 10-Q, contains forward-looking statements as that term is used in the
Private Securities Litigation Reform Act of 1995. These statements are based on
our current expectations about future events or future financial performance.
Forward-looking statements by their nature address matters that are, to
different degrees, uncertain, and often contain words such as may, could, expect,
intend, plan, seek, anticipate, believe, estimate, predict, potential,
or continue. These statements involve known and unknown risks and
uncertainties that may cause the events we discuss not to occur or to differ
significantly from what we expect. For us, these risks and uncertainties
include, among others:
·
general industry conditions and
competition, including 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 our other filings
with the Securities and Exchange Commission (SEC), including our Annual Report
on Form 10-K for the year ended December 31, 2009. If any of these
risks and uncertainties materialize, our actual future results may vary
significantly from what we expect. We do not undertake to update our
forward-looking statements as a result of new information or future events.
All dollar and
percentage comparisons, which are often accompanied by words such as increase,
decrease, grew, declined, was up, was down, was flat, or was
similar refer to a comparison with the same period in the prior year unless
otherwise stated.
Understanding our
Company
Our Business
Our
mission is to create great products that help investors reach their financial
goals. We offer an extensive line of Internet, software, and print-based products
for individual investors, financial advisors, and institutional clients. We
also offer asset management services for advisors, institutions, and retirement
plan participants. Many of our products are sold through subscriptions or
license agreements. As a result, we typically generate recurring revenue.
We
emphasize a decentralized approach to running our business to create a culture
of responsibility and accountability. Our company has two operating segments:
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 all of our asset management operations, which are registered
investment advisors and earn more than half of their revenue from asset-based
fees.
Historically,
we have focused primarily on organic growth by introducing new products and
services and expanding our existing products. However, we have made and expect
to continue to make selective acquisitions that support our five key growth
strategies, which are:
·
Enhance our position in each of our key market segments by focusing on
our three major Internet-based platforms;
·
Become a global leader in fund-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.
27
Table of
Contents
Industry Overview
We monitor
developments in the economic and financial information industry on an ongoing
basis and use these insights to help inform our company strategy, product
development plans, and marketing initiatives.
Despite
mixed economic data, the U.S. stock market was up strongly in the third
quarter. Morningstars U.S. Market Index, a broad market benchmark, rose 11.6%
during the quarter and was up 11.1% for the 12-month period ending in
September. Total U.S. mutual fund assets increased to $11.3 trillion as of September 30,
2010, based on data from the Investment Company Institute (ICI), up from $10.8
trillion as of September 30, 2009.
Despite
the more positive market environment, alternative asset classes, such as hedge
funds, had mixed results in terms of cash flows. In aggregate, hedge funds
included in Morningstars database, excluding funds of hedge funds, experienced
small net outflows for the year-to-date period through August 31, 2010.
Assets in
exchange-traded funds (ETFs) increased to $883 billion as of September 30,
2010, compared with $693 billion as of September 30, 2009, based on data
from the ICI.
Based on
data from Nielsen/Net Ratings, aggregate page views, unique users, pages per
visit, and time spent per visit for financial and investment sites all
decreased compared with the third quarter of 2009. Overall, page views to
finance and investment sites were about 25% lower year over year, based on
Nielsens data. We attribute this trend to individual investors lower level of
engagement with investing-related topics in a period of continued economic
weakness. Although our investment website, Morningstar.com, continued to
perform well versus competing sites based on time spent per visit, some metrics
such as unique visitors and pages viewed per visit declined according to
Nielsens data.
Following
the industry-wide downturn in global advertising sales in 2009, we began seeing
stronger growth in online advertising spending in 2010. During the second
quarter of 2010, industry publication eMarketer increased its forecast for U.S.
online advertising spending, which is based on data from the Interactive
Advertising Bureau and PricewaterhouseCoopers. The revised forecast projects an
increase of 11% to $25.1 billion in 2010, following a 4.6% decline in 2009.
Overall,
we believe that business conditions in the financial services sector have
continued improving in recent months, although some areas, such as consumer
discretionary spending, remain under pressure.
Three and Nine
Months Ended September 30, 2010 vs. Three and Nine Months Ended
September 30, 2009
Consolidated
Results
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
Key Metrics ($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Revenue
|
|
$
|
139,817
|
|
$
|
120,088
|
|
16.4
|
%
|
$
|
404,198
|
|
$
|
356,353
|
|
13.4
|
%
|
Operating
income
|
|
30,161
|
|
33,683
|
|
(10.5
|
)%
|
88,770
|
|
100,996
|
|
(12.1
|
)%
|
Operating
margin
|
|
21.6
|
%
|
28.0
|
%
|
(6.4
|
)pp
|
22.0
|
%
|
28.3
|
%
|
(6.3
|
)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
used for investing activities
|
|
(20,862
|
)
|
(39,247
|
)
|
(46.8
|
)%
|
(46,414
|
)
|
(76,102
|
)
|
(39.0
|
)%
|
Cash
provided by financing activities
|
|
1,503
|
|
3,778
|
|
(60.2
|
)%
|
9,563
|
|
19,797
|
|
(51.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
provided by operating activities
|
|
$
|
35,280
|
|
$
|
36,066
|
|
(2.2
|
)%
|
$
|
80,310
|
|
$
|
67,333
|
|
19.3
|
%
|
Capital
expenditures
|
|
(3,862
|
)
|
(3,518
|
)
|
9.8
|
%
|
(7,701
|
)
|
(10,286
|
)
|
(25.1
|
)%
|
Free
cash flow
|
|
$
|
31,418
|
|
$
|
32,548
|
|
(3.5
|
)%
|
$
|
72,609
|
|
$
|
57,047
|
|
27.3
|
%
|
28
Table of Contents
We define free cash flow as cash
provided by or used for operating activities less capital expenditures. We
present free cash flow solely as supplemental disclosure to help you better
understand how much cash is available after we spend money to operate our
business. Our management team uses free cash flow to evaluate our business.
Free cash flow is not equivalent to any measure required to be reported under
U.S. generally accepted accounting principles (GAAP). Also, the free cash flow
definition we use may not be comparable to similarly titled measures used by
other companies.
Because weve made several
acquisitions in recent years, comparing our financial results from year to year
is complex. To make it easier for investors to compare our results in different
periods, we provide information on both organic revenue, which reflects our
underlying business excluding acquisitions, and revenue from acquisitions. We include
an acquired operation as part of our revenue from acquisitions for 12 months
after we complete the acquisition. After that, we include it in 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.
The table below shows the period
in which we included each acquired operation in revenue from acquisitions.
Acquisition
|
|
Date of Acquisition
|
|
Nine months ended September 30, 2010
|
Global
financial filings database business of Global Reports LLC
|
|
April 20, 2009
|
|
January 1 through
April 19, 2010
|
Equity
research and data business of C.P.M.S. Computerized Portfolio Management
Services Inc.
|
|
May 1, 2009
|
|
January 1 through
April 30, 2010
|
Andex
Associates, Inc.
|
|
May 1, 2009
|
|
January 1 through
April 30, 2010
|
Intech
Pty Ltd
|
|
June 30, 2009
|
|
January 1 through
June 30, 2010
|
Canadian
Investment Awards and Gala
|
|
December 17, 2009
|
|
January 1 through September 30,
2010
|
Logical
Information Machines, Inc.
|
|
December 31, 2009
|
|
January 1 through September 30,
2010
|
Footnoted
business of Financial Fineprint Inc.
|
|
February 1, 2010
|
|
February 1 through
September 30, 2010
|
Aegis
Equities Research
|
|
April 1, 2010
|
|
April 1 through
September 30, 2010
|
Old
Broad Street Research Ltd.
|
|
April 12, 2010
|
|
April 12 through
September 30, 2010
|
Realpoint,
LLC
|
|
May 3, 2010
|
|
May 3 through
September 30, 2010
|
Seeds
Group
|
|
July 1, 2010
|
|
July 1 through
September 30, 2010
|
Morningstar Danmark A/S (Morningstar Denmark)
|
|
July 1, 2010
|
|
July 1 through
September 30, 2010
|
Consolidated
Revenue
In the third quarter of 2010, our
consolidated revenue increased 16.4% to $139.8 million. Revenue for the first
nine months of the year rose 13.4% to $404.2 million. We had $12.0 million in
incremental revenue from acquisitions during the third quarter, which
contributed about 10 percentage points to our consolidated revenue growth.
Currency movements had a slight negative effect in the third quarter, but a
larger positive impact in the year-to-date period.
Excluding acquisitions and the
impact of foreign currency translations, consolidated revenue increased by
about $7.9 million, or 6.6%, in the third quarter of 2010. Higher revenue from
Licensed Data, Morningstar Direct, and Internet advertising were the main
drivers behind the revenue increase. These positive factorsas well as smaller
contributions from advisor software and our Investment Management
productshelped offset the loss of revenue associated with the Global Analyst
Research Settlement (GARS), which ended in July 2009. We had equity
research revenue of $1.5 million related to GARS in the third quarter of 2009
and $12.5 million in the first nine months of 2009 that did not recur in 2010.
29
Table of Contents
The table below reconciles
consolidated revenue with organic revenue (revenue excluding acquisitions and
the impact of foreign currency translations):
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Consolidated
revenue
|
|
$
|
139,817
|
|
$
|
120,088
|
|
16.4
|
%
|
$
|
404,198
|
|
$
|
356,353
|
|
13.4
|
%
|
Less:
acquisitions
|
|
(11,964
|
)
|
|
|
NMF
|
|
(34,386
|
)
|
|
|
NMF
|
|
Less:
impact of foreign currency translations
|
|
183
|
|
|
|
NMF
|
|
(4,219
|
)
|
|
|
NMF
|
|
Organic
revenue
|
|
$
|
128,036
|
|
$
|
120,088
|
|
6.6
|
%
|
$
|
365,593
|
|
$
|
356,353
|
|
2.6
|
%
|
International revenue continues to
increase as a percentage of our consolidated revenue and made up about 28.5% of
our consolidated revenue in the third quarter of 2010. Revenue from
international operations rose $5.3 million, or 15.5%, to $39.9 million for the
third quarter. Acquisitions contributed $3.5 million of additional revenue
outside the United States, and foreign currency translations had a slightly
negative effect. Excluding acquisitions and the effect of foreign currency
translations, non-U.S. revenue rose 6.0%, reflecting stronger product sales in
Europe.
Revenue from international operations
rose $19.3 million, or 20.7%, to $112.7 million in the first nine months of
2010. Acquisitions contributed $12.7 million of additional revenue outside the
United States, and foreign currency translations had a positive effect of $4.2
million. Excluding acquisitions and the impact of foreign currency
translations, non-U.S. revenue rose 2.6%.
International
organic revenue (international revenue excluding acquisitions and the impact of
foreign currency translations) is considered a non-GAAP financial measure. The
definition of international organic revenue we use may not be the same as
similarly titled measures used by other companies. International organic
revenue should not be considered an alternative to any measure of performance
as promulgated under GAAP. The tables below present a reconciliation from
international revenue to international organic revenue (international revenue
excluding acquisitions and the impact of foreign currency translations):
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
International
revenue
|
|
$
|
39,884
|
|
$
|
34,540
|
|
15.5
|
%
|
$
|
112,669
|
|
$
|
93,371
|
|
20.7
|
%
|
Less:
acquisitions
|
|
(3,470
|
)
|
|
|
NMF
|
|
(12,691
|
)
|
|
|
NMF
|
|
Less:
impact of foreign currency translations
|
|
183
|
|
|
|
NMF
|
|
(4,219
|
)
|
|
|
NMF
|
|
International
organic revenue
|
|
$
|
36,597
|
|
$
|
34,540
|
|
6.0
|
%
|
$
|
95,759
|
|
$
|
93,371
|
|
2.6
|
%
|
Consolidated
Operating Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Operating
expense
|
|
$
|
109,656
|
|
$
|
86,405
|
|
26.9
|
%
|
$
|
315,428
|
|
$
|
255,357
|
|
23.5
|
%
|
% of
revenue
|
|
78.4
|
%
|
72.0
|
%
|
6.4
|
pp
|
78.0
|
%
|
71.7
|
%
|
6.3
|
pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the third quarter of 2010, our
consolidated operating expense increased $23.3 million, or 26.9%. For the first
nine months of 2010, operating expense increased $60.0 million, or 23.5%. We
completed six acquisitions in 2009 and six in the first nine months of 2010.
Because of the timing of these acquisitions, our third-quarter and year-to-date
results include operating expense that did not exist in the same periods last
year. Incremental operating expense from acquired businesses represented
approximately half of the operating expense increase in both periods.
Higher salary expense represented
approximately 40% of the total operating expense increase, reflecting higher
headcount from acquisitions and filling open positions, as well as salary
increases that were effective in July 2010, following generally flat
salary levels in 2009.
30
Table of Contents
Higher incentive compensation and
employee benefit costs represented approximately one-third of the overall operating
expense increase in the quarter. In early 2010, we began phasing in some of the
benefits and other compensation-related expense we reduced in 2009. As a
result, bonus expense increased $3.6 million in the third quarter and $11.6
million in the first nine months of 2010. Matching contributions to our 401(k) plan
in the United States increased $0.9 million in the third quarter and $2.7
million for the year-to-date period because we partially reinstated this
employee benefit in 2010. Sales commissions increased $1.4 million in the
quarter and $5.9 million in the first nine months of 2010, reflecting improved
sales activity compared with the first nine months of 2009 as well as a change
to one of our commission plans. In addition, healthcare benefit costs rose $0.5
million in the third quarter of 2010 and $2.1 million in the first nine months
of 2010, mainly because of some unusually high medical claims.
Intangible amortization expense
increased $3.1 million compared with the prior-year period. The expense recorded
in the third quarter of 2009 reflected a $1.7 million reduction of previously
recorded intangible amortization expense. The remaining increase reflects
amortization expense from recent acquisitions.
In the third quarter of 2009, we
recorded an expense of $2.4 million to increase our liability for vacant office
space, primarily for the former Ibbotson headquarters. This expense did not
recur in 2010, partially offsetting the increase in operating expenses in the
quarter.
In the first nine months of 2009,
we recorded a $3.5 million operating expense for estimated penalties related to
the timing of deposits for taxes withheld on stock-option exercises from 2006
through 2009. The expense affected each of our operating expense categories,
with approximately half recorded as general and administrative expense. This
expense did not recur in 2010.
Headcount and salary-related
expense increased year over year, partly because of acquisitions. We had
approximately 3,165 employees worldwide as of September 30, 2010, up 21.7%
from December 31, 2009, and a 25.3% increase from the same period a year
ago. We added about 185 employees through acquisitions over the 12 months
ending September 30, 2010. The remainder of the increase in headcount
mainly reflects continued hiring for our development centers in China and
India.
Cost of Goods
Sold
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Cost of
goods sold
|
|
$
|
40,713
|
|
$
|
31,954
|
|
27.4
|
%
|
$
|
114,767
|
|
$
|
92,900
|
|
23.5
|
%
|
% of
revenue
|
|
29.1
|
%
|
26.6
|
%
|
2.5
|
pp
|
28.4
|
%
|
26.1
|
%
|
2.3
|
pp
|
Gross
profit
|
|
$
|
99,104
|
|
$
|
88,134
|
|
12.4
|
%
|
$
|
289,431
|
|
$
|
263,453
|
|
9.9
|
%
|
Gross
margin
|
|
70.9
|
%
|
73.4
|
%
|
(2.5
|
)pp
|
71.6
|
%
|
73.9
|
%
|
(2.3
|
)pp
|
Cost of goods sold is our largest
category of operating expense, accounting for more than one-third of our total
operating expense. 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 rose $8.7
million in the third quarter and $21.9 million in the first nine months of
2010. Approximately half of the increase was related to recent acquisitions.
Higher salaries, bonus expense and other compensation-related expense also
contributed to the increase.
Our gross margin in the third
quarter of 2010 was down 2.5 percentage points to 70.9%, compared with 73.4% in
the third quarter of 2009. The year-to-date gross margin also declined by 2.3
percentage points.
31
Table of Contents
Development
Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Development
expense
|
|
$
|
12,703
|
|
$
|
9,447
|
|
34.5
|
%
|
$
|
35,491
|
|
$
|
28,185
|
|
25.9
|
%
|
% of
revenue
|
|
9.1
|
%
|
7.9
|
%
|
1.2
|
pp
|
8.8
|
%
|
7.9
|
%
|
0.9
|
pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Development expense increased $3.3
million in the third quarter of 2010 and $7.3 million in the first nine months
of 2010, mainly because of higher salaries, bonus, and compensation-related
expense for our development teams. Development expense from recent acquisitions
also contributed to the increase, but to a lesser extent. As a percentage of
revenue, development was up slightly from the same periods in 2009.
Sales and
Marketing Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Sales
and marketing expense
|
|
$
|
22,881
|
|
$
|
17,730
|
|
29.1
|
%
|
$
|
69,877
|
|
$
|
53,276
|
|
31.2
|
%
|
% of
revenue
|
|
16.4
|
%
|
14.8
|
%
|
1.6
|
pp
|
17.3
|
%
|
15.0
|
%
|
2.3
|
pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing expense
increased $5.2 million in the third quarter of 2010 and $16.6 million in the
first nine months of 2010. These increases include higher sales commission
expense, which rose $1.4 million in the third quarter and $5.9 million in the
first nine months of 2010. This increase partly reflects improved sales
activity. In addition, we recognized more expense in the third quarter because
of a change in our U.S. sales commission structure. Under this new commission
plan, we record the entire commission expense in the quarter in which it is
incurred. Under the previous commission structure, we recognized the commission
expense over the term of the customer contract. Other costs in this category,
including salaries, bonuses, and travel, also increased. Approximately
one-fourth of the increase in sales and marketing expense was related to recent
acquisitions.
As a percentage of revenue, sales
and marketing expense increased 1.6 percentage points in the third quarter and
2.3 percentage points in the first nine months of 2010.
General and
Administrative Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
General
and administrative expense
|
|
$
|
23,462
|
|
$
|
20,643
|
|
13.7
|
%
|
$
|
67,211
|
|
$
|
57,649
|
|
16.6
|
%
|
% of
revenue
|
|
16.8
|
%
|
17.2
|
%
|
(0.4
|
)pp
|
16.6
|
%
|
16.2
|
%
|
0.4
|
pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
(G&A) expense rose $2.9 million in the third quarter and $9.6 million in
the first nine months of 2010.
For the quarter, the majority of
the increase results from higher salaries, bonus, and other
compensation-related expense. Higher professional fees, mainly
related to acquisitions, also contributed to the increase, but to a lesser
extent. In the third quarter of 2009, we recorded an expense of $2.4
million to increase our liability for vacant office space, primarily for
the former Ibbotson headquarters. This expense did not recur in 2010, partially
offsetting the increase in operating expenses.
For the year-to-date period,
G&A expense included $1.3 million of expense to increase liabilities for
vacant office space. In the first quarter of 2010, we increased our liability
for vacant office space for the former Ibbotson headquarters when we finalized
sub-lease arrangements for a portion of the space. In the second quarter of
2010, we increased our liability for vacant office space related to the
acquisition of the equity research and data business from C.P.M.S. in Canada.
Higher travel, professional, and legal fees, partly related to acquisitions,
also contributed to the expense growth.
G&A expense in the first nine
months of 2009 included $1.8 million for the estimated tax deposit penalty
discussed in more detail on page 28. This expense did not recur in 2010.
As a percentage of revenue G&A
expense decreased 0.4 percentage points in the third quarter of 2010 and
increased 0.4 percentage points in the first nine months of 2010.
32
Table of Contents
Depreciation and
Amortization Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Depreciation
expense
|
|
$
|
3,678
|
|
$
|
3,501
|
|
5.1
|
%
|
$
|
10,547
|
|
$
|
9,554
|
|
10.4
|
%
|
Amortization
expense
|
|
6,219
|
|
3,130
|
|
98.7
|
%
|
17,535
|
|
13,793
|
|
27.1
|
%
|
Total depreciation and amortization expense
|
|
$
|
9,897
|
|
$
|
6,631
|
|
49.3
|
%
|
$
|
28,082
|
|
$
|
23,347
|
|
20.3
|
%
|
% of
revenue
|
|
7.1
|
%
|
5.5
|
%
|
1.6
|
pp
|
6.9
|
%
|
6.6
|
%
|
0.3
|
pp
|
Depreciation expense was up
slightly in the third quarter and rose $1.0 million in the first nine months of
2010. Amortization expense increased $3.1 million in the third quarter and $3.7
million in the first nine months of 2010. Part of this increase reflects lower expense levels in 2009, as
the expense recorded in the third quarter of 2009 included a $1.7 million
reduction of previously recorded intangible amortization expense. The remaining
increase in 2010 reflects amortization expense from recent acquisitions.
We expect that amortization of
intangible assets will be an ongoing cost for the remaining life of the assets.
Based on acquisitions completed through September 30, 2010, we estimate
that aggregate amortization expense for intangible assets will be approximately
$24 million in 2010 and 2011. Our estimates of future amortization expense for
intangible assets may be affected by changes to the preliminary purchase price
allocations associated with the acquisitions we made in 2009 and 2010,
additional acquisitions, and currency translations.
As a percentage of revenue,
depreciation and amortization was up in both the third quarter and first nine
months of 2010.
Stock-Based
Compensation Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Restricted stock units
|
|
$
|
3,277
|
|
$
|
2,781
|
|
17.8
|
%
|
$
|
9,557
|
|
$
|
7,686
|
|
24.3
|
%
|
Restricted stock
|
|
468
|
|
|
|
NMF
|
|
780
|
|
|
|
NMF
|
|
Stock options
|
|
|
|
82
|
|
(100
|
)%
|
|
|
970
|
|
(100
|
)%
|
Total
stock-based compensation expense
|
|
$
|
3,745
|
|
$
|
2,863
|
|
30.8
|
%
|
$
|
10,337
|
|
$
|
8,656
|
|
19.4
|
%
|
% of
revenue
|
|
2.7
|
%
|
2.4
|
%
|
0.3
|
pp
|
2.6
|
%
|
2.4
|
%
|
0.2
|
pp
|
Stock-based compensation expense,
which we include in each of our operating expense categories, increased $0.8
million in the third quarter of 2010 and $1.6 million in the first nine months
of 2010 and remained relatively flat as a percentage of revenue compared with
the same periods in 2009.
Our stock-based compensation
expense mainly relates to grants of restricted stock units (RSUs) and, in the
first nine months of 2009, to stock-option grants made in previous years. We
began granting RSUs in May 2006 and make additional grants each year,
primarily in the second quarter. We recognize the expense related to RSUs over
the vesting period, which is generally four years.
Beginning in the second quarter of
2010, we began recording expense related to restricted stock issued in
conjunction with the acquisition of Realpoint, LLC. In May 2010, we issued
199,174 shares that will vest over five years from the date of grant. This
grant resulted in an expense of $0.5 million in the third quarter and $0.8 million
in the first nine months of 2010.
All outstanding stock options were
vested as of January 1, 2010. As a result, we did not record any
additional stock-based compensation expense in the first nine months of 2010
for stock options granted in previous years.
We estimate forfeitures of these
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 quarter of 2010 and 2009, we recorded
approximately $0.2 million and $0.3 million, respectively, of additional
stock-based compensation expense when we made these adjustments.
Based on grants of RSUs and
restricted stock made through September 30, 2010, we anticipate that stock-based
compensation expense will be $14.1 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.
33
Table of
Contents
Bonus Expense
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Bonus
expense
|
|
$
|
8,833
|
|
$
|
5,200
|
|
69.9
|
%
|
$
|
25,534
|
|
$
|
13,938
|
|
83.2
|
%
|
% of
revenue
|
|
6.3
|
%
|
4.3
|
%
|
2.0
|
pp
|
6.3
|
%
|
3.9
|
%
|
2.4
|
pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonus
expense, which we include in each of our operating expense categories,
increased $3.6 million in the third quarter of 2010 and $11.6 in the first nine
months of 2010. We reduced our bonus expense in 2009 as part of our efforts to
better align our cost structure with revenue in the challenging business
environment. In 2010, we reinstated a portion of the bonus expense that was
previously reduced. Bonus expense for newly acquired operations also
contributed to the increase, but to a lesser extent.
The size of our 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 annual bonuses to employees in the first quarter of
the following year.
As a percentage of revenue, bonus
expense increased by 2.0 percentage points in the third quarter and 2.4
percentage points in the first nine months of 2010.
Consolidated
Operating Income
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Operating
income
|
|
$
|
30,161
|
|
$
|
33,683
|
|
(10.5
|
)%
|
$
|
88,770
|
|
$
|
100,996
|
|
(12.1
|
)%
|
% of
revenue
|
|
21.6
|
%
|
28.0
|
%
|
(6.4
|
)pp
|
22.0
|
%
|
28.3
|
%
|
(6.3
|
)pp
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income fell
$3.5 million in the third quarter and $12.2 million in the first nine months of
2010. Although revenue increased in both periods, our cost base rose more, leading
to lower operating income in both periods. The decline was driven by
incremental costs from acquisitions, modest compensation increases, and
reinstating some of the employee benefits and other expenses we reduced in
2009. For both the third quarter and first nine months of 2010, costs rose
across all of our operating expense categories.
We made significant cost
reductions early in 2009 in anticipation of a tough economic environment. Those
cost reductions improved our margin in the third quarter and first nine months
of 2009. In 2010, we began phasing in some of the benefits we suspended in
2009, such as a partial reinstatement of matching contributions to our 401(k) plan
in the United States, which represented approximately $0.9 million of expense
in the third quarter and $2.7 million in the first nine months of 2010.
We made some moderate compensation
increases in July 2010 after keeping salary levels flat for nearly all
employees in 2009. Higher bonus expense across all expense categories also
contributed to the decline in operating income.
With operating expense increasing
more than revenue, our operating margin was 6.4 percentage points lower in the
third quarter of 2010 and 6.3 percentage points lower in the first nine months
of 2010. The margin decline mainly reflects higher salaries, bonuses, sales
commissions, and employee benefits as a percentage of revenue. The loss of
revenue from GARS also had a negative effect on margins.
34
Table of Contents
Consolidated Free
Cash Flow
As described in more detail above,
we define free cash flow as cash provided by or used for operating activities
less capital expenditures.
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Cash provided by operating activities
|
|
$
|
35,280
|
|
$
|
36,066
|
|
(2.2
|
)%
|
$
|
80,310
|
|
$
|
67,333
|
|
19.3
|
%
|
Capital expenditures
|
|
(3,862
|
)
|
(3,518
|
)
|
9.8
|
%
|
(7,701
|
)
|
(10,286
|
)
|
(25.1
|
)%
|
Free
cash flow
|
|
$
|
31,418
|
|
$
|
32,548
|
|
(3.5
|
)%
|
$
|
72,609
|
|
$
|
57,047
|
|
27.3
|
%
|
We generated positive free cash
flow in both the third quarter and year-to-date periods of 2010 and 2009. Free
cash flow declined $1.1 million in the third quarter, but increased $15.6
million in the first nine months of 2010. The decline in free cash flow in the
quarter primarily reflects a reduction in cash provided by operating
activities. The year-to-date increase primarily reflects lower bonus payments
made in the first quarter of 2010.
Cash provided by
operating activities:
Cash
provided by operating activities decreased $0.8 million in the third quarter of
2010, as a reduction in cash flow generated from accounts receivable and other
operating assets and liabilities was partially offset by an increase in net
income adjusted for non-cash items.
Cash provided by operating activities
increased $13.0 million in the first nine months of the year. Bonuses paid in
the first quarter of 2010 were $37.5 million less than the amount paid in the
previous year. We made bonus payments of $21.4 million in the first quarter of
2010, compared with $58.9 million in the first quarter of 2009, including $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 the bonus. The cash flow impact of
a lower bonus payment was partially offset by an increase of $4.4 million in
cash paid for income taxes in the first nine months of the year as well as a
payment of $4.9 million we made to one former and two current executives
related to adjusting the tax treatment of certain stock options originally
considered incentive stock options (ISOs). We recorded the operating expense
related to this matter in the fourth quarter of 2009. We expect that the
payment will be partially offset by a cash tax benefit in the future.
35
Table of Contents
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 operating cash flow:
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Consolidated
net income
|
|
$
|
20,893
|
|
$
|
22,498
|
|
$
|
(1,605
|
)
|
$
|
58,967
|
|
$
|
67,986
|
|
$
|
(9,019
|
)
|
Adjustments
to reconcile consolidated net income to net cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Holding
gain upon acquisition of additional ownership of equity method investments
|
|
(5,073
|
)
|
(352
|
)
|
(4,721
|
)
|
(5,073
|
)
|
(352
|
)
|
(4,721
|
)
|
Deferred
income tax (benefit) expense
|
|
6,671
|
|
109
|
|
6,562
|
|
5,659
|
|
(847
|
)
|
6,506
|
|
Depreciation
and amortization expense
|
|
9,897
|
|
6,631
|
|
3,266
|
|
28,082
|
|
23,347
|
|
4,735
|
|
Stock-based
compensation expense
|
|
3,745
|
|
2,863
|
|
882
|
|
10,337
|
|
8,656
|
|
1,681
|
|
Excess
tax benefits from stock option exercises and vesting of restricted stock
units
|
|
(680
|
)
|
(1,180
|
)
|
500
|
|
(4,885
|
)
|
(5,724
|
)
|
839
|
|
All
other non-cash items included in net income
|
|
(1,098
|
)
|
(138
|
)
|
(960
|
)
|
(199
|
)
|
(1,064
|
)
|
865
|
|
Changes
in operating assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for bonuses
|
|
|
|
|
|
|
|
(21,360
|
)
|
(58,867
|
)
|
37,507
|
|
Cash
paid for income taxes
|
|
(3,198
|
)
|
(11,002
|
)
|
7,804
|
|
(29,594
|
)
|
(25,154
|
)
|
(4,440
|
)
|
Cash
paid related to adjusting the tax treatment of certain stock options
originally considered incentive stock options
|
|
|
|
|
|
|
|
(4,887
|
)
|
|
|
(4,887
|
)
|
Accounts
receivable
|
|
(639
|
)
|
4,209
|
|
(4,848
|
)
|
(7,254
|
)
|
13,521
|
|
(20,775
|
)
|
Deferred
revenue
|
|
(9,115
|
)
|
(9,780
|
)
|
665
|
|
(1,938
|
)
|
(8,974
|
)
|
7,036
|
|
Income
taxes current
|
|
7,762
|
|
13,605
|
|
(5,843
|
)
|
29,903
|
|
38,153
|
|
(8,250
|
)
|
Accrued
compensation
|
|
8,884
|
|
3,637
|
|
5,247
|
|
23,977
|
|
17,073
|
|
6,904
|
|
Deferred
rent
|
|
522
|
|
(67
|
)
|
589
|
|
442
|
|
(353
|
)
|
795
|
|
Other
assets
|
|
(1,997
|
)
|
1,865
|
|
(3,862
|
)
|
(2,508
|
)
|
2,206
|
|
(4,714
|
)
|
Accounts
payable and accrued liabilities
|
|
(834
|
)
|
4,005
|
|
(4,839
|
)
|
2,025
|
|
(2,007
|
)
|
4,032
|
|
All
other
|
|
(460
|
)
|
(837
|
)
|
377
|
|
(1,384
|
)
|
(267
|
)
|
(1,117
|
)
|
Cash
provided by operating activities
|
|
$
|
35,280
|
|
$
|
36,066
|
|
$
|
(786
|
)
|
$
|
80,310
|
|
$
|
67,333
|
|
$
|
12,977
|
|
In the third quarter of 2010, the
decline in cash provided by operations was less than the decline in net income,
primarily because of the timing of cash paid for income taxes and a reduction
in the cash flow benefit from operating assets and liabilities. For the
year-to-date period, while consolidated net income declined, cash flow from operations
increased. The $37.5 million decrease in bonuses paid in the first quarter of
2010 was the primary contributor to the difference between the changes in net
income and cash provided by operations.
FASB ASC 718,
CompensationStock
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 the first nine months of 2010 and 2009, we classified
$4.9 million and $5.7 million of excess tax benefits, respectively, as
financing activities. We describe these excess tax benefits in the Liquidity
and Capital Resources section.
Capital
expenditures:
We spent $3.9 million for capital expenditures in the third
quarter of 2010 and $7.7 million in the first nine months of 2010, primarily
for computer hardware and software and, to a lesser extent, leasehold
improvements. Year to date, capital expenditures decreased $2.6 million
primarily as a result of lower first-quarter spending compared with the same
period in 2009. The 2009 capital expenditures included spending for our new
corporate headquarters in Chicago.
36
Table of Contents
Segment Results
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
Key Metrics ($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
Information
|
|
$
|
112,055
|
|
$
|
95,410
|
|
17.4
|
%
|
$
|
324,600
|
|
$
|
289,389
|
|
12.2
|
%
|
Investment
Management
|
|
27,762
|
|
24,678
|
|
12.5
|
%
|
79,598
|
|
66,964
|
|
18.9
|
%
|
Consolidated
revenue
|
|
$
|
139,817
|
|
$
|
120,088
|
|
16.4
|
%
|
$
|
404,198
|
|
$
|
356,353
|
|
13.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
Information
|
|
$
|
32,811
|
|
$
|
33,298
|
|
(1.5
|
)%
|
$
|
96,099
|
|
$
|
107,377
|
|
(10.5
|
)%
|
Investment
Management
|
|
13,523
|
|
14,391
|
|
(6.0
|
)%
|
41,137
|
|
39,280
|
|
4.7
|
%
|
Intangible
amortization and corporate depreciation expense
|
|
(8,064
|
)
|
(5,022
|
)
|
60.6
|
%
|
(22,930
|
)
|
(19,357
|
)
|
18.5
|
%
|
Corporate
unallocated
|
|
(8,109
|
)
|
(8,984
|
)
|
(9.7
|
)%
|
(25,536
|
)
|
(26,304
|
)
|
(2.9
|
)%
|
Consolidated
operating income
|
|
$
|
30,161
|
|
$
|
33,683
|
|
(10.5
|
)%
|
$
|
88,770
|
|
$
|
100,996
|
|
(12.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
Information
|
|
29.3
|
%
|
34.9
|
%
|
(5.6
|
)pp
|
29.6
|
%
|
37.1
|
%
|
(7.5
|
)pp
|
Investment
Management
|
|
48.7
|
%
|
58.3
|
%
|
(9.6
|
)pp
|
51.7
|
%
|
58.7
|
%
|
(7.0
|
)pp
|
Consolidated
operating margin
|
|
21.6
|
%
|
28.0
|
%
|
(6.4
|
)pp
|
22.0
|
%
|
28.3
|
%
|
(6.3
|
)pp
|
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 and available through electronic data feeds. Advisor Workstation is a
web-based investment planning system for advisors. Advisor Workstation is
available in two editions: Morningstar Office 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 ended in July 2009. The banks covered by it are no
longer required to provide independent research to their clients. For further
discussion about this issue, see Item 1ARisk Factors, included in our Annual
Report on
Form 10-K filed with the SEC on March 1, 2010. 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, real-time data, and investment
indexes.
In the first nine months of 2010
and 2009, this segment represented 80% and 81%, respectively, of our
consolidated revenue.
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
Key Metrics ($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Revenue
|
|
$
|
112,055
|
|
$
|
95,410
|
|
17.4
|
%
|
$
|
324,600
|
|
$
|
289,389
|
|
12.2
|
%
|
Operating
income
|
|
$
|
32,811
|
|
$
|
33,298
|
|
(1.5
|
)%
|
$
|
96,099
|
|
$
|
107,377
|
|
(10.5
|
)%
|
Operating
margin (%)
|
|
29.3
|
%
|
34.9
|
%
|
(5.6
|
)pp
|
29.6
|
%
|
37.1
|
%
|
(7.5
|
)pp
|
37
Table of Contents
Revenue
In the third quarter of 2010, Investment
Information segment revenue increased $16.7 million, or 17.4%, to $112.1
million. Acquisitions contributed $10.7 million of revenue in the quarter.
Excluding acquisitions, higher revenue in our software, investment research,
and data products and services more than offset the loss of $1.5 million of
revenue from GARS, which expired at the end of July 2009. In the first
nine months of 2010, revenue increased $35.2 million, or 12.2%, to $324.6
million, with acquisitions contributing $28.3 million. GARS revenue was $12.5
million in the first nine months of 2009.
As disclosed in the third quarter
of 2009, 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 in our Annual Report on Form 10-K for
the year ended December 31, 2009.
In December 2009, we began
publishing research and ratings on corporate credit issuers. We entered into
our first credit research agreement with a major financial services firm to
provide credit ratings and research to its 18,000 financial advisors beginning
in the third quarter of 2010. The firms internal credit research team also has
access to Morningstar Select, our institutional credit research platform.
Although the revenue impact in the quarter was not significant, we believe this
credit research agreement gives us an important foothold in this new area.
Revenue for Morningstar.com, which
includes Internet advertising sales and Premium Membership subscriptions,
increased in both the third quarter and first nine months of 2010. Positive
trends in Internet advertising sales were partially offset by a decline in
Premium Membership revenue in the United States. Subscriptions for the U.S.
version of Morningstar.com Premium service declined to 140,118 as of September 30,
2010 compared with 150,473 as of December 31, 2009 and 155,200 as of September 30,
2009. Subscriptions fell partly because of continued weakness in new trial
memberships. However, consistent with the trend over the past few years, we
moderately increased subscription prices for U.S. Premium Membership in both January 2010
and 2009, which partly offset the revenue decline associated with lower
subscription levels.
Advisor software revenue also increased
in the third quarter and first nine months of 2010, as higher revenue from
Advisor Workstation, SiteBuilder, and Profiles and Guides more than offset
lower Principia revenue. The number of U.S. licenses for Morningstar Advisor
Workstation increased slightly to 154,403 as of September 30, 2010
compared with 148,392 as of December 31, 2009, and 153,603 as of September 30,
2009. Principia subscriptions totaled 33,252 as of September 30, 2010,
down from 35,844 as of December 31, 2009 and 37,365 as of September 30,
2009.
Higher
revenue from Morningstar Direct also contributed to the revenue increase in the
quarter and year-to-date periods. The number of licenses for Morningstar Direct
increased to 4,403 worldwide, compared with 3,329 as of September 30, 2009,
with particularly strong growth from outside the United States. The growth in
licenses reflects additional licenses for both new and existing clients, as
well as client migrations from Institutional Workstation to Morningstar Direct.
Higher revenue from Licensed Data
contributed to the revenue increase in the third quarter and first nine month
of 2010, reflecting strong renewal rates and new client contracts. 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.
Operating
Income
In the third quarter of 2010,
operating income for the Investment Information segment decreased $0.5 million,
or 1.5%. Segment operating income decreased $11.3 million, or 10.5%, in the
first nine months of 2010, as operating expense increased more than revenue.
38
Table of Contents
Operating
expense increased $17.1 million in the third quarter of 2010 and $46.5 million
in the first nine months of 2010. Additional costs from acquisitions contributed
approximately half of the increase. Higher salaries, reflecting expanded
headcount and incentive compensation, including bonus and sales commission
expense, also contributed to the increase. An increase in employee benefits
expense, including employee healthcare benefits and the partial reinstatement
of matching contributions to our 401(k) plan in the United States, also
contributed to the increase, but to a lesser extent.
Our Investment Information segment operating margin declined
5.6 percentage points in the third quarter and 7.5 percentage points in the
first nine months of 2010. Approximately 4 percentage points of the margin
decline in the quarter reflects higher compensation-related expense as a percentage
of revenue, with the remainder reflecting recent acquisitions.
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, exchange-traded fund, and stock portfolios tailored to
meet a range of investment time horizons, risk levels, and investment
strategies that financial advisors can use for their clients taxable and
tax-deferred accounts.
In the first nine months of 2010
and 2009, this segment represented 20% and 19%, respectively, of our
consolidated revenue.
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
Key Metrics ($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Revenue
|
|
$
|
27,762
|
|
$
|
24,678
|
|
12.5
|
%
|
$
|
79,598
|
|
$
|
66,964
|
|
18.9
|
%
|
Operating
income
|
|
$
|
13,523
|
|
$
|
14,391
|
|
(6.0
|
)%
|
$
|
41,137
|
|
$
|
39,280
|
|
4.7
|
%
|
Operating
margin (%)
|
|
48.7
|
%
|
58.3
|
%
|
(9.6
|
)pp
|
51.7
|
%
|
58.7
|
%
|
(7.0
|
)pp
|
Revenue
Investment
Management segment revenue increased $3.1 million in the third quarter and
$12.6 million year to date. Acquisitions contributed $1.3 million of revenue in
the third quarter, primarily from the acquisition of Old Broad Street Research
Ltd. (OBSR), and $6.1 million in the first nine months of 2010, primarily from
the OBSR and Intech Pty Ltd (Intech) acquisitions.
Excluding
acquisitions, revenue increased across all revenue categories in the quarter
and year-to-date periods. Retirement
Advice and Investment Consulting were the primary drivers of the revenue
increase. Managed Portfolios also contributed to the increase, but to a lesser
extent.
Within the Investment Management
segment, revenue from asset-based fees made up approximately 61% of segment
revenue in the first nine months of 2010 and 2009. For the majority of our
contracts that include variable asset-based fees, we bill clients quarterly in
arrears based on average assets for the quarter. The method of calculation
varies by client; some contracts include provisions for calculating average
assets based on daily data, while others use weekly or monthly data. Other
contracts may include provisions for monthly billing or billing based on assets
as of the last day of the billing period rather than on average assets.
Our Investment Consulting business
has multiple fee structures, which vary by client. In general, we seek to
receive asset-based fees for any work we perform that involves investment
management or acting as a subadvisor to investment portfolios. For any
individual contract, we may receive flat fees, variable asset-based fees, or a
combination of the two. Some of our contracts include minimum fee levels that
provide us with a flat payment up to a specified asset level, above which we
also receive variable asset-based fees.
39
Table of Contents
In our Retirement Advice business,
our contracts may include fixed fees for advice and guidance, one-time setup
fees, technology licensing fees, asset-based fees for managed retirement
accounts, or a combination of these fee structures.
Assets under Advisement for
Investment Consulting
|
|
As of September 30
|
|
Assets under advisement for Investment Consulting ($ billions)
|
|
2010
|
|
2009
|
|
Ibbotson
Associates
|
|
$
|
45.3
|
|
$
|
48.0
|
|
Morningstar
Associates
|
|
56.0
|
|
20.2
|
|
Total
|
|
$
|
101.3
|
|
$
|
68.2
|
|
We provided Investment Consulting
advisory services on approximately $101.3 billion in assets as of September 30,
2010 compared with approximately $61.4 billion as of December 31, 2009 and
approximately $68.2 billion as of September 30, 2009. The asset totals
include relationships for which we receive basis-point fees, including
consulting arrangements and other 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; we do not include these assets in the total reported above.
Excluding changes related to new contracts and 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.
Total assets under advisement as
of September 30, 2010 includes approximately $35 billion related to a new
fund-of-funds program that began in May 2010 for an existing Morningstar
Associates client. Previously, we created model portfolios for the same client,
so the increase in assets represents incremental growth in an existing revenue
stream. Excluding assets from the new fund-of-funds program, assets under
advisement for Investment Consulting declined slightly compared with the prior
year, reflecting a client non-renewal that occurred in the fourth quarter of
2009, partially offset by net inflows and new client wins.
We cannot quantify cash inflows
and outflows for these portfolios because we do not have custody of the assets
in the majority of our investment management businesses. The information we
receive from our clients does not separately identify the impact of cash
inflows and outflows on asset balances for each period. We also cannot
precisely quantify the impact of market appreciation or depreciation because
the majority of our clients have discretionary authority to implement their own
portfolio allocations.
Assets
under Management for Managed Retirement Accounts
|
|
As of September 30
|
|
Assets under management in managed retirement accounts ($ billions)
|
|
2010
|
|
2009
|
|
Advice
by Ibbotson
|
|
$
|
16.0
|
|
$
|
13.2
|
|
Morningstar
Retirement Manager
|
|
1.8
|
|
1.4
|
|
Total
|
|
$
|
17.8
|
|
$
|
14.6
|
|
Assets
under management for Retirement Advice increased to $17.8 billion as of September 30,
2010 compared with $15.7 billion as of December 31, 2009 and $14.6 billion
as of September 30, 2009.
There are several factors that
affect assets under management for our managed retirement accounts. These
factors include employer and employee contributions, plan administrative fees,
market movements, and participant loans and hardship withdrawals. We cannot
quantify the effect of these other factors because the information we receive
from the plan providers does not separately identify these transactions or the
changes in balances caused by market movement.
40
Table of Contents
Morningstar Managed
Portfolios
Morningstar Managed Portfolios
also contributed to the segments revenue increase in the third quarter and
first nine months of 2010. The higher revenue mainly reflects higher average
asset levels during the first nine months of 2010 compared with the same period
in 2009. Assets under management for Morningstar Managed Portfolios rose to
$2.5 billion as of September 30, 2010, from $1.9 billion as of September 30,
2009, reflecting positive equity market returns and net inflows.
Operating
Income
Operating income for the
Investment Management segment declined $0.9 million, or 6.0%, in the third
quarter and increased $1.9 million, or 4.7%, in the first nine months of 2010.
Operating expense in the segment
rose $4.0 million, or 38.4%, in the third quarter of 2010 and $10.8 million, or
38.9%, in the first nine months of the year.
Higher salaries and incentive
compensation, including bonuses and sales commissions, contributed
approximately two-thirds of the operating expense increase. Bonus expense rose
$0.9 million in the third quarter and $2.8 million in the first nine months of
2010. Sales commissions increased $0.4 million in the third quarter and $1.1
million in the first nine months of 2010. Employee benefits, including employee
healthcare benefits and matching contributions to our 401(k) plan in the
United States, also increased, but to a lesser extent. Approximately one-third
of the quarters operating expense increase reflects recent acquisitions.
Operating margin declined 9.6
percentage points in the third quarter of 2010 and 7.0 percentage points in the
first nine months of 2010. The margin decline mainly reflects higher bonus and
sales commission expense as a percentage of revenue. Acquisitions also
contributed to the margin decline, but to a lesser extent.
Corporate Items
We do not allocate corporate costs
to our business segments. The corporate items category also includes
amortization expense related to intangible assets recorded when we allocate the
purchase price of acquisitions. The table below shows the components of
corporate items that impacted our consolidated operating income:
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
Key Metrics ($000)
|
|
2010
|
|
2009
|
|
Change
|
|
2010
|
|
2009
|
|
Change
|
|
Amortization
expense
|
|
$
|
6,219
|
|
$
|
3,130
|
|
98.7
|
%
|
$
|
17,535
|
|
$
|
13,793
|
|
27.1
|
%
|
Depreciation
expense
|
|
1,845
|
|
1,892
|
|
(2.5
|
)%
|
5,395
|
|
5,564
|
|
(3.0
|
)%
|
Corporate
unallocated
|
|
8,109
|
|
8,984
|
|
(9.7
|
)%
|
25,536
|
|
26,304
|
|
(2.9
|
)%
|
Corporate
items
|
|
$
|
16,173
|
|
$
|
14,006
|
|
15.5
|
%
|
$
|
48,466
|
|
$
|
45,661
|
|
6.1
|
%
|
Amortization of intangible assets
increased $3.1 million in the third quarter of 2010 and $3.7 million in the
first nine months of 2010, mainly reflecting incremental amortization expense
related to acquisitions completed in 2009 and 2010. As of September 30,
2010, we had $167.3 million of net intangible assets. We amortize these
intangible assets over their estimated lives, ranging from one to 25 years.
Based on acquisitions completed through September 30, 2010, we estimate
that aggregate amortization expense for intangible assets will be approximately
$24.0 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 did not change significantly in the quarter or year-to-date
periods.
Corporate unallocated expense
decreased $0.9 million in the third quarter of 2010 and $0.8 million in the
first nine months of 2010. In the third quarter of 2009, we recorded a $2.4
million expense to increase lease vacancy reserves, primarily for the former
Ibbotson headquarters. The corporate unallocated expense for the nine months
ended September 30, 2009 also included a $3.5 million operating expense
for estimated penalties related to the timing of deposits for taxes withheld on
stock-option exercises from 2006 through 2009. These expenses did not recur in
2010. This expense decline in both the quarter and year-to-date periods was
partially offset by incremental expense from acquisitions, higher
compensation-related and bonus expense, and higher professional fees.
41
Table of Contents
Equity in Net
Income of Unconsolidated Entities, Non-Operating Income, and Income Tax Expense
Equity in Net
Income of Unconsolidated Entities
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Equity
in net income of unconsolidated entities
|
|
$
|
333
|
|
$
|
429
|
|
$
|
1,176
|
|
$
|
790
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in net income of
unconsolidated entities includes our portion of the net income (loss) of
Morningstar Japan K.K. (MJKK) and Morningstar Sweden AB. In the first six
months of 2010, this category also included our portion of the net income
(loss) of Morningstar Denmark. In 2009, this category also included our portion
of the net income (loss) of Morningstar Denmark and Morningstar Korea. Equity
in net income of unconsolidated entities is primarily from our position in
MJKK.
In July 2010, we acquired an
additional 75% ownership interest in Morningstar Denmark, increasing our
ownership percentage to 100%. As a result, we no longer account for our
investment in Morningstar Denmark using the equity method. Beginning in the
third quarter of 2010, we consolidate the assets, liabilities, and results of
operations of Morningstar Denmark in our Consolidated Financial Statements.
In 2009, we acquired an additional
40% ownership interest in Morningstar Korea, increasing our ownership
percentage to 80%. As a result, we no longer account for our investment in
Morningstar Korea using the equity method. In September 2009, we began
consolidating the assets, liabilities, and results of operations of Morningstar
Korea in our Consolidated Financial Statements.
We describe our investments in
unconsolidated entities in more detail in Note 7 of the Notes to our Unaudited
Condensed Consolidated Financial Statements.
Non-Operating
Income
The following table presents the
components of net non-operating income:
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Interest
income, net
|
|
$
|
512
|
|
$
|
572
|
|
$
|
1,692
|
|
$
|
2,314
|
|
Other
income, net
|
|
5,694
|
|
221
|
|
4,356
|
|
985
|
|
Non-operating
income, net
|
|
$
|
6,206
|
|
$
|
793
|
|
$
|
6,048
|
|
$
|
3,299
|
|
Interest income, net mainly
reflects interest from our investment portfolio. Net interest income was
essentially flat in the third quarter of 2010 and decreased $0.6 million in the
first nine months of 2010. The year-to-date decline reflects lower returns on
our investment balances.
Other income, net primarily
represents foreign currency exchange gains and losses arising from the ordinary
course of business related to our U.S. and non-U.S. operations. It also
includes royalty income from MJKK and realized gains and losses from our
investment portfolio. In the third quarter of 2010, we recorded a preliminary holding
gain of approximately $5.1 million. This gain represents the difference between
the estimated fair value and the book value of our investment in Morningstar
Denmark at the date of acquisition. In the third quarter of 2009, we recorded a
holding gain of approximately $0.4 million when we increased our ownership in
Morningstar Korea.
42
Table of Contents
Income Tax
Expense
The following table summarizes the
components of our effective tax rate:
|
|
Three Months Ended September 30
|
|
Nine Months Ended September 30
|
|
($000)
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
Income
before income taxes and equity in net income of unconsolidated entities
|
|
$
|
36,367
|
|
$
|
34,476
|
|
$
|
94,818
|
|
$
|
104,295
|
|
Equity
in net income of unconsolidated entities
|
|
333
|
|
429
|
|
1,176
|
|
790
|
|
Net (income)
loss attributable to the noncontrolling interest
|
|
(106
|
)
|
22
|
|
10
|
|
40
|
|
Total
|
|
$
|
36,594
|
|
$
|
34,927
|
|
$
|
96,004
|
|
$
|
105,125
|
|
Income
tax expense
|
|
$
|
15,807
|
|
$
|
12,407
|
|
$
|
37,027
|
|
$
|
37,099
|
|
Effective
tax rate
|
|
43.2
|
%
|
35.5
|
%
|
38.6
|
%
|
35.3
|
%
|
Our effective tax rate increased
7.7 percentage points in the third quarter of 2010 and 3.3 percentage points
for the year-to-date period. Income tax expense in the quarter includes $5.8
million of non-cash expense, including $1.9 million related to the gain we
recorded upon the acquisition of Morningstar Denmark and $3.9 million for prior
periods related to Morningstars share of earnings in equity method
investments, primarily MJKK. These items increased the effective tax rate by
approximately 11 percentage points in the quarter and 4 percentage points year
to date.
Our effective tax rates for the
third quarter and nine-month periods in 2009 were favorably affected by a
variety of items that did not recur in 2010. In the third quarter of 2009, we
recognized $2.1 million of tax credits from previous years. These tax credits
reduced our tax rate by approximately 6 percentage points in the quarter and 2
percentage points in the first nine months of 2009. The effective tax rate for
the first nine months of 2009 also reflects the favorable impact of reversing
approximately $2.2 million in reserves for uncertain tax positions. These items
were partially offset by the impact of the non-deductible deposit penalty
expense, which increased our year-to-date effective tax rate by approximately
1.3 percentage points.
There were no significant changes
to uncertain tax positions in the first nine months of 2010 as a result of
other lapses of statutes of limitation or audit activity. As of December 31,
2009, our Consolidated Balance Sheet included a current liability of $1.0
million and a non-current liability of $5.4 million for unrecognized tax
benefits. These amounts include interest and penalties, less any associated tax
benefits.
We are currently under audit by
various state and local tax authorities in the United States, as well as tax
authorities in certain non-U.S. jurisdictions. It is likely that the
examination phase of some of these state, local, and non-U.S. audits will
conclude in 2010. It is not possible to estimate the impact of current audits
on previously recorded unrecognized tax benefits.
Liquidity and
Capital Resources
We believe our available cash
balances and investments, along with cash generated from operations, will be
sufficient to meet our operating and cash needs for the foreseeable future. We
invest our cash reserves in cash equivalents and investments, consisting
primarily of fixed-income securities. We maintain a conservative investment
policy for our investments and invest a portion of these assets in municipal securities
with high-quality stand-alone credit ratings. 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.
43
Table of Contents
We expect
to make a recurring quarterly dividend payment of 5 cents per share. Our first
dividend will be paid in January 2011 to shareholders of record as of December 31,
2010, with an estimated payment amount of $2.5 million. In September 2010,
our board of directors also approved a share repurchase program that authorizes
a repurchase of up to $100 million of our outstanding common stock. From time
to time we may repurchase shares at prevailing market prices on the open market
or in private transactions in amounts that we deem appropriate.
Cash and Cash
Equivalents
As of September 30, 2010, we
had cash, cash equivalents, and investments of $339.3 million, a decrease of
$3.3 million compared with December 31, 2009. The decrease reflects cash
used for acquisitions and capital expenditures of $96.4 million, partially
offset by $80.3 million of cash provided by operating activities, cash flows
from stock-option exercises, and a positive effect of foreign currency
translations.
Cash Provided by
Operating Activities
Our main source of capital is cash
generated from operating activities. We typically pay bonuses in the first
quarter of the year. As a result, cash flow from operations in the first
quarter tends to be lower compared with subsequent quarters.
In the first nine months of 2010,
cash provided by operating activities was $80.3 million, an increase of $13.0
million compared with cash provided for operating activities of $67.3 million
in the first nine months of 2009. The increase primarily reflects the lower
bonus payments in 2010, which we reduced in response to the difficult operating
environment experienced in 2009.
We paid $21.4 million in annual
bonus payments in the first quarter of 2010, compared with bonus payments of
$58.9 million in the prior-year period. The bonuses paid in 2009 included
approximately $48.9 million of bonus expense recorded in 2008 and approximately
$10.0 million of bonus payments deferred from 2007. In accordance with bonus
program revisions adopted in January 2009, we no longer defer payment of a
portion of the bonus from prior years.
In addition, in the first nine
months of 2010, we paid $4.9 million to one former and two current executives
to adjust the tax treatment of certain stock options originally considered
incentive stock options. We expect this payment to be partially offset by a
cash tax benefit in the future.
Cash Used for
Investing Activities
Cash used for investing activities
consists primarily of cash used for acquisitions, purchases of investments less
proceeds from the maturity or sale of investments, and cash used for capital
expenditures. The level of investing activities can vary from period to period
depending on the level of activity in these three categories. In the first nine
months of 2010, cash used for investing activities was $46.4 million, compared
with cash used for investing activities of $76.1 million in the same period of
2009.
Cash used for acquisitions, net of
cash acquired, was $88.7 million in the first nine months of 2010. We completed
six acquisitions in the first nine months of 2010. In comparison, cash used for
acquisitions, net of acquired cash, was $19.3 million in the first nine months
of 2009. We completed four acquisitions in the first nine months of 2009 and
increased our investment in Morningstar Korea.
In the first nine months of 2010,
proceeds from the maturity and sale of investments exceeded the purchases of
investments by $49.2 million. We transferred funds from our investment
portfolio to cash and cash equivalents to pay for acquisitions made in the
first nine months of 2010. In contrast, in the first nine months of 2009,
purchases of investments, net of proceeds from the maturity or sale of
investments, were $47.1 million. As of September 30, 2010 and December 31,
2009, we had investments, consisting primarily of fixed-income securities, of
$163.5 million and $212.1 million, respectively. As of September 30, 2010,
our investments represented approximately 48% of our total cash, cash
equivalents, and investments, a decrease of approximately 14 percentage points
compared with December 31, 2009.
Capital expenditures were $7.7
million in the first nine months of 2010, a decrease of $2.6 million compared
with $10.3 million in the first nine months of 2009. We expect to make capital
expenditures of approximately $18 to $20 million in 2010 compared with $12.4 million
in 2009. The 2010 capital expenditures include spending for a new office space
in Shenzhen, China.
44
Table of Contents
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 9 in the Notes to our
Unaudited Condensed Consolidated Financial Statements includes additional
information concerning stock options and restricted stock units outstanding as
of September 30, 2010.
Cash provided by financing
activities was $9.6 million in the first nine months of 2010. Proceeds from
stock-option exercises totaled $5.2 million, while excess tax benefits related
to stock-option exercises and vesting of restricted stock units totaled $4.9
million. In the first nine months of 2010, cash provided by financing
activities decreased by $10.2 million, driven by a decrease in proceeds from
stock-option exercises.
Employees exercised approximately
0.5 million and 1.2 million stock options in the first nine months of 2010 and
2009, respectively. The total intrinsic value (the difference between the
market value of our stock on the date of exercise and the exercise price of the
option) of options exercised during the first nine months of 2010 and 2009 was
$17.1 million and $31.3 million, respectively.
45
Table of
Contents
Acquisitions
In 2010, we announced the
following acquisitions:
Acquisition
|
|
Description
|
|
Date of Acquisition
|
|
Purchase Price*
|
Footnoted
business of Financial Fineprint Inc.
|
|
Footnoted
is a highly regarded blog for professional money managers, analysts, and
sophisticated individual investors. Footnoted Pro, a service for
institutional investors, provides insight on actionable items and trends in
SEC filings.
|
|
February 1,
2010
|
|
Not
separately disclosed
|
Aegis
Equities Research
|
|
A
leading provider of independent equity research in Sydney, Australia.
|
|
April 1,
2010
|
|
$10.7
million
|
Old
Broad Street Research Ltd.
|
|
A
premier provider of fund research, ratings, and investment consulting
services in the United Kingdom.
|
|
April 12,
2010
|
|
$16.8
million
|
Realpoint,
LLC
|
|
A
Nationally Recognized Statistical Ratings Organization (NRSRO) that
specializes in structured finance.
|
|
May 3,
2010
|
|
$38.4
million in cash and 199,174 shares of restricted stock (valued at
approximately $10 million as of the date the acquisition was announced in
March 2010)
|
Morningstar Danmark A/S (Morningstar Denmark)
|
|
Acquisition
of the 75% ownership interest not previously owned by Morningstar, bringing
our ownership to 100%.
|
|
July 1,
2010
|
|
$14.6
million
|
Seeds
Group
|
|
A
leading provider of investment consulting services and fund research in
France.
|
|
July 1,
2010
|
|
Not
separately disclosed
|
Annuity intelligence
business of Advanced Sales and Marketing Corp.
|
|
The annuity
intelligence business provides a web-based service that leverages a
proprietary database of more than 1,000 variable annuities that includes
plain-English translations of complex but important information found in
prospectuses and other public filings.
|
|
November 1,
2010
|
|
$14.1
million
|
* Total purchase price, less cash acquired, subject to post
closing adjustments.
Subsequent Events
See Note 14 in the Notes to our
Unaudited Condensed Consolidated Financial Statements for events subsequent to September 30,
2010.
46
Table of Contents
Reclassifications
Beginning in 2010, we include
revenue from Ibbotsons plan sponsor advice service as Retirement Advice
revenue. Previously, we included this revenue in Investment Consulting. We have
reclassified the prior-year information for consistency with the current-year
presentation. This reclassification did not have any effect on the order of our
top five products in 2009 or 2008, as presented in the two tables below.
Top Five Products 2009
|
|
Reclassified for
Consistency with
2010 Product
Revenue
($000)
|
|
As Reported
Revenue ($000)
|
|
Licensed
Data
|
|
$
|
91,524
|
|
$
|
91,524
|
|
Advisor
Workstation
|
|
65,673
|
|
65,673
|
|
Investment
Consulting
|
|
62,531
|
|
63,748
|
|
Morningstar.com
|
|
39,454
|
|
39,454
|
|
Morningstar
Direct
|
|
29,968
|
|
29,968
|
|
|
|
|
|
|
|
|
|
Top Five Products 2008
|
|
Reclassified for
Consistency with
2010 Product
Revenue
($000)
|
|
As Reported
Revenue ($000)
|
|
Licensed
Data
|
|
$
|
78,329
|
|
$
|
78,329
|
|
Investment
Consulting
|
|
76,150
|
|
77,757
|
|
Advisor
Workstation
|
|
64,222
|
|
64,222
|
|
Morningstar.com
|
|
45,684
|
|
45,684
|
|
Principia
|
|
27,791
|
|
27,791
|
|
|
|
|
|
|
|
|
|
Application of
Critical Accounting Policies and Estimates
We discuss our critical accounting
policies and estimates in Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations, included in our Annual Report on
Form 10-K filed with the SEC for the year ended December 31, 2009. In
addition, effective January 1, 2010, we adopted the following financial
accounting standards:
·
Accounting
Standards Update (ASU) No. 2009-16,
Transfers and Servicing
(Topic 860) and 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 FASB ASC 860,
Transfers and Services
. ASU No. 2009-17 addresses the
effects of eliminating the QSPE concept from FASB ASC 860 and responds to
concerns about the application of certain key provisions of FASB ASC 810,
Consolidation
, including concerns over the transparency of
enterprises involvement with Variable Interest Entities (VIEs). These
accounting pronouncements did not impact our Unaudited Condensed Consolidated
Financial Statements.
·
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.
ASU 2010-06 also clarifies 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. The additional
disclosures required by ASU No. 2010-06 appear in Note 6, in the Notes to
our Unaudited Condensed Consolidated Financial Statements.
47
Table of Contents
Recently Issued
Accounting Pronouncements
In October 2009, the
Financial Accounting Standards Board (FASB) issued ASU No. 2009-13,
Revenue Recognition (Topic 605): Multiple-Deliverable
Revenue Arrangements.
ASU 2009-13 supersedes Emerging Issues Task
Force (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 and also does 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 entities to disclose
information in the Level 3 rollforward about purchases, sales, issuances, and
settlements on a gross basis. For Morningstar, the requirement to separately
disclose purchases, sales, issuances, and settlements in the Level 3
rollforward will be effective for our 2011 Consolidated Financial Statements.
We are in the process of determining the impact, if any, this accounting
pronouncement will have on our Consolidated Financial Statements.
48
Table of Contents
Rule 10b5-1 Sales
Plans
Our
directors and executive officers may exercise stock options or purchase or
sell shares of our common stock in the market from time to time. We encourage
them to make these transactions through plans that comply with Exchange Act
Rule 10b5-1(c). Morningstar will not receive any proceeds, other than
proceeds from the exercise of stock options, related to these transactions. The
following table, which we are providing on a voluntary basis, shows the
Rule 10b5-1 sales plans entered into by our directors and executive
officers that were in effect as of November 1, 2010:
Name and Position
|
|
Date of
Plan
|
|
Plan
Termination
Date
|
|
Number of
Shares
to be
Sold under
the Plan
|
|
Timing of Sales under the Plan
|
|
Number of
Shares
Sold under
the Plan through
November 1,
2010
|
|
Projected
Beneficial
Ownership (1)
|
|
Cheryl
Francis
Director
|
|
08/11/09
|
|
12/17/10
|
|
12,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
6,002
|
|
31,047
|
|
Steve
Kaplan
Director
|
|
05/5/10
|
|
12/31/10
|
|
8,001
|
|
Shares
to be sold under the plan on specified dates
|
|
4,001
|
|
57,225
|
|
Liz
Kirscher
President, Data Services
|
|
11/23/09
|
|
12/31/10
|
|
25,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
|
|
111,167
|
|
Cathy
Odelbo
President, Equity Research
|
|
08/13/08
|
|
12/31/11
|
|
100,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
|
|
77,635
|
|
Patrick
Reinkemeyer
President, Morningstar Associates
|
|
05/13/10
|
|
03/05/11
|
|
50,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
13,000
|
|
269,545
|
|
Richard
Robbins
General Counsel and Corporate Secretary
|
|
11/11/09
|
|
12/31/10
|
|
5,000
|
|
Biweekly
increments of up to 500 shares
|
|
|
|
27,784
|
|
David
Williams
Managing Director, Design
|
|
09/10/08
|
|
12/31/10
|
|
20,000
|
|
Shares
to be sold under the plan if the stock reaches specified prices
|
|
|
|
88,141
|
|
During the
third quarter, Joe Mansueto terminated his previously disclosed Rule 10b5-1
sales plan, and Peng Chens previously disclosed Rule 10b5-1 sales plan
completed in accordance with its terms.
(1)
This column reflects an estimate of the number of shares each identified
director and executive officer will beneficially own following the sale of all
shares under the Rule 10b5-1 sales plans identified above. This
information reflects the beneficial ownership of our common stock on September 30,
2010, and includes shares of our common stock subject to options that were then
exercisable or that will have become exercisable by November 29, 2010 and
restricted stock units that will vest by November 29, 2010. The
estimates do not reflect any changes to beneficial ownership that may have
occurred since September 30, 2010. Each director and executive
officer identified in the table may amend or terminate his or her
Rule 10b5-1 sales plan and may adopt additional Rule 10b5-1 plans in
the future.
49
Table of
Contents
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Our
investment portfolio is actively managed and may suffer losses from fluctuating
interest rates, market prices, or adverse security selection. Our investment
portfolio is mainly invested in high-quality fixed-income securities. We do not
have any direct exposure to sub-prime mortgages. As of September 30, 2010,
our cash, cash equivalents, and investments balance was $339.3 million. Based
on our estimates, a 100 basis-point change in interest rates would impact the
fair value of our investment portfolio by approximately $0.8 million.
As our
non-U.S. revenue increases as a percentage of our consolidated revenue,
fluctuations in foreign currencies present a greater potential risk. To date,
we have not engaged in currency hedging, and we do not currently have any
positions in derivative instruments to hedge our currency risk. Our results
could suffer if certain foreign currencies decline relative to the U.S. dollar.
In addition, because we use the local currency of our subsidiaries as the functional
currency, we are affected by the translation of foreign currencies into U.S.
dollars.
Item 4.
Controls and Procedures
(a) Evaluation
and Disclosure Controls and Procedures
Disclosure controls and procedures
are designed to reasonably assure that information required to be disclosed in
the reports filed or submitted under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in the SECs
rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to reasonably assure that
information required to be disclosed in the reports filed under the Exchange
Act is accumulated and communicated to management, including the chief
executive officer and chief financial officer, as appropriate, to allow timely
decisions regarding required disclosure.
We carried
out an evaluation, under the supervision and with the participation of our
management, including our chief executive officer and chief financial officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as of September 30, 2010. Based on that
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are effective to provide reasonable
assurance that information required to be disclosed in the reports we file or
submit under the Exchange Act is recorded, processed, summarized, and reported
as and when required and is accumulated and communicated to management,
including the chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure.
(b) Changes
in Internal Controls Over Financial Reporting
There were no changes in our
internal controls over financial reporting during the quarter ended September 30,
2010 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART 2
OTHER
INFORMATION
Item
1. Legal Proceedings
We incorporate by reference the
information regarding legal proceedings set forth in Note 12, Contingencies, of
the Notes to our Unaudited Condensed Consolidated Financial Statements contained
in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Item
1A. Risk Factors
There have been no material
changes to the risk factors disclosed in Item 1ARisk Factors in our Annual
Report on Form 10-K for the year ended December 31, 2009.
50
Table of Contents
Item 6.
Exhibits
(a) Exhibits
Exhibit No
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Description of Exhibit
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31.1
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Certification of Chief Executive
Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the
Securities Exchange Act of 1934, as amended
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31.2
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Certification of Chief Financial
Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the
Securities Exchange Act of 1934, as amended
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32.1
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Certification of Chief Executive
Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
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32.2
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Certification of Chief Financial
Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
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101*
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The following financial
information from Morningstar Inc.s Quarterly Report on Form 10-Q for
the quarter ended September 30, 2010, filed with the SEC on
November 3, 2010, formatted in XBRL: (i) Condensed Consolidated
Statements of Income, (ii) Condensed Consolidated Balance Sheets,
(iii) Condensed Consolidated Statement of Equity and Comprehensive
Income (Loss), (iv) Condensed Consolidated Statements of Cash Flows and
(v) the Notes to Unaudited Condensed Consolidated Financial Statements,
tagged as blocks of text
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*
Users of this data are advised pursuant to Rule 406T of
Regulation S-T that this interactive data file is deemed not filed or part of a
registration statement or prospectus for purposes of sections 11 or 12 of the
Securities Act of 1933, is deemed not filed for purposes of section 18 of the
Securities Exchange Act of 1934, and otherwise is not subject to liability
under these sections
SIGNATURE
Pursuant to the requirements of
the Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned thereunto duly authorized.
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MORNINGSTAR, INC.
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Date: November 3, 2010
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By:
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/s/ Scott Cooley
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Scott Cooley
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Chief Financial Officer
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51
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