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EX-31.1 - EXHIBIT 31.1 - Morningstar, Inc.morn_exhibitx311x033115.htm
EX-10.1 - EXHIBIT 10.1 - Morningstar, Inc.morn_exhibitx101x033115.htm
EX-31.2 - EXHIBIT 31.2 - Morningstar, Inc.morn_exhibitx312x033115.htm
EX-32.2 - EXHIBIT 32.2 - Morningstar, Inc.morn_exhibitx322x033115.htm
EX-32.1 - EXHIBIT 32.1 - Morningstar, Inc.morn_exhibitx321x033115.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 

FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2015
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from         to
Commission File Number: 000-51280
 

MORNINGSTAR, INC.
(Exact Name of Registrant as Specified in its Charter) 
Illinois
 
36-3297908
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification Number)
 
 
 
22 West Washington Street
 
 
Chicago, Illinois
 
60602
(Address of Principal Executive Offices)
 
(Zip Code)
  (312) 696-6000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  o
Non-accelerated filer   o
Smaller reporting company  o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of April 24, 2015, there were 44.4 million shares of the Company’s common stock, no par value, outstanding.
 



MORNINGSTAR, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Income for the three months ended March 31, 2015 and 2014
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2015 and 2014
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2015 and December 31, 2014
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Equity for the three months ended March 31, 2015
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART 1.
FINANCIAL INFORMATION
Item 1.
Financial Statements

3


Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
 
 
Three months ended March 31
(in millions except per share amounts)
 
2015

 
2014

 
 
 
 
 
Revenue
 
$
189.8

 
$
181.2

 
 
 
 
 
Operating expense:
 
 
 
 
Cost of revenue
 
78.7

 
75.8

Sales and marketing
 
25.4

 
28.4

General and administrative
 
26.1

 
26.1

Depreciation and amortization
 
15.1

 
12.4

Total operating expense
 
145.3

 
142.7

 
 
 
 
 
Operating income
 
44.5

 
38.5

 
 
 
 
 
Non-operating income (expense):
 
 

 
 

Interest income, net
 
0.2

 
0.6

Other income (expense), net
 
(0.6
)
 
0.3

Non-operating income (expense), net
 
(0.4
)
 
0.9

 
 
 
 
 
Income before income taxes and equity in net income of unconsolidated entities
 
44.1

 
39.4

 
 
 
 
 
Equity in net income of unconsolidated entities
 
0.5

 
0.6

 
 
 
 
 
Income tax expense
 
14.8

 
13.7

 
 
 
 
 
Consolidated net income
 
29.8

 
26.3

 
 
 
 
 
Net (income) loss attributable to the noncontrolling interest
 
(0.1
)
 
0.1

 
 
 
 
 
Net income attributable to Morningstar, Inc.
 
$
29.7

 
$
26.4

 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 

 
 

Basic
 
$
0.67

 
$
0.59

Diluted
 
$
0.67

 
$
0.58

 
 
 
 
 
Dividends per common share:
 
 
 
 
Dividends declared per common share
 
$
0.19

 
$
0.17

Dividends paid per common share
 
$
0.19

 
$
0.17

 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
Basic
 
44.3

 
44.8

Diluted
 
44.5

 
45.1


See notes to unaudited condensed consolidated financial statements.


4


Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income

 
 
Three months ended March 31
(in millions) 
 
2015

 
2014

 
 
 
 
 
Consolidated net income
 
$
29.8

 
$
26.3

 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
Foreign currency translation adjustment
 
(19.8
)
 
2.5

Unrealized gains (losses) on securities, net of tax:
 
 
 
 
  Unrealized holding gains arising during period
 
0.1

 
0.1

  Reclassification of (gains) losses included in net income
 

 

Other comprehensive income (loss)
 
(19.7
)
 
2.6

 
 
 
 
 
Comprehensive income
 
10.1

 
28.9

Comprehensive (income) loss attributable to noncontrolling interest
 
(0.1
)
 
0.1

Comprehensive income attributable to Morningstar, Inc.
 
$
10.0

 
$
29.0


See notes to unaudited condensed consolidated financial statements.



5


Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
 
 
As of March 31
 
As of December 31
(in millions except share amounts)
 
2015

 
2014

Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
204.6

 
$
185.2

Investments
 
38.6

 
39.4

Accounts receivable, less allowance of $1.7 and $1.5, respectively
 
142.2

 
136.7

Deferred tax asset, net
 
10.8

 
9.0

Income tax receivable
 

 
6.9

Other current assets
 
22.3

 
22.6

Total current assets
 
418.5

 
399.8

Property, equipment, and capitalized software, less accumulated depreciation and amortization of $140.0 and $132.9, respectively
 
121.4

 
117.6

Investments in unconsolidated entities
 
29.3

 
28.8

Goodwill
 
359.8

 
370.1

Intangible assets, net
 
87.9

 
95.9

Other assets
 
8.9

 
7.1

Total assets
 
$
1,025.8

 
$
1,019.3

 
 
 
 
 
Liabilities and equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable and accrued liabilities
 
$
35.8

 
$
34.3

Accrued compensation
 
41.3

 
80.5

Deferred revenue
 
160.2

 
146.0

Short-term debt
 
45.0

 
30.0

Income tax payable
 
6.1

 

Other current liabilities
 
4.8

 
3.0

Total current liabilities
 
293.2

 
293.8

Accrued compensation
 
8.1

 
7.9

Deferred tax liability, net
 
26.3

 
26.0

Deferred rent
 
26.2

 
26.4

Other long-term liabilities
 
11.0

 
10.8

Total liabilities
 
364.8

 
364.9

 
 
 
 
 
Equity:
 
 

 
 

Morningstar, Inc. shareholders’ equity:
 
 

 
 

Common stock, no par value, 200,000,000 shares authorized, of which 44,395,391 and 44,345,763 shares were outstanding as of March 31, 2015 and December 31, 2014, respectively
 

 

Treasury stock at cost, 8,289,240 shares as of March 31, 2015 and 8,257,214 shares as of December 31, 2014
 
(526.6
)
 
(524.3
)
Additional paid-in capital
 
568.3

 
561.1

Retained earnings
 
662.8

 
641.5

Accumulated other comprehensive income (loss):
 
 
 
 
    Currency translation adjustment
 
(44.9
)
 
(25.1
)
    Unrealized gain on available-for-sale investments
 
0.4

 
0.3

Total accumulated other comprehensive loss
 
(44.5
)
 
(24.8
)
Total Morningstar, Inc. shareholders’ equity
 
660.0

 
653.5

Noncontrolling interests
 
1.0

 
0.9

Total equity
 
661.0

 
654.4

Total liabilities and equity
 
$
1,025.8

 
$
1,019.3


See notes to unaudited condensed consolidated financial statements.

6


Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statement of Equity
For the three months ended March 31, 2015
 
 
 
Morningstar, Inc. Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
Other
Comprehensive
Income
(Loss)

 
 
 
 
 
 
Common Stock
 
 

 
Additional
Paid-in
Capital

 
 
 
 
Non-
Controlling
Interests

 
 
(in millions, except share amounts)
 
Shares
Outstanding

 
Par
Value

 
Treasury
Stock

 
 
Retained
Earnings

 
 
 
Total
Equity

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2014
 
44,345,763

 
$

 
$
(524.3
)
 
$
561.1

 
$
641.5

 
$
(24.8
)
 
$
0.9

 
$
654.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 

 

 

 
29.7

 


 
0.1

 
29.8

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale investments, net of income tax of $0.1
 
 
 

 

 

 

 
0.1

 

 
0.1

Reclassification of adjustments for losses included in net income, net of income tax of $0
 
 
 

 

 

 

 

 

 

Foreign currency translation adjustment, net
 
 
 

 

 

 

 
(19.8
)
 

 
(19.8
)
Other comprehensive loss, net
 
 
 

 

 

 

 
(19.7
)
 

 
(19.7
)
Issuance of common stock related to stock-option exercises and vesting of restricted stock units, net
 
81,654

 

 

 
1.8

 

 

 

 
1.8

Stock-based compensation
 
 
 

 

 
4.3

 

 

 

 
4.3

Excess tax benefit derived from stock-option exercises and vesting of restricted stock units
 
 
 

 

 
1.1

 

 

 

 
1.1

Common shares repurchased
 
(32,026
)
 

 
(2.3
)
 

 

 

 

 
(2.3
)
Dividends declared — common shares outstanding
 
 
 

 

 

 
(8.4
)
 

 

 
(8.4
)
Dividends declared — restricted stock units
 
 
 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2015
 
44,395,391

 
$

 
$
(526.6
)
 
$
568.3

 
$
662.8

 
$
(44.5
)
 
$
1.0

 
$
661.0

 
See notes to unaudited condensed consolidated financial statements.


7


Morningstar, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

 
 
 
 
 
Operating activities
 
 

 
 

Consolidated net income
 
$
29.8

 
$
26.3

Adjustments to reconcile consolidated net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
15.1

 
12.4

Deferred income taxes
 
(1.6
)
 
(2.3
)
Stock-based compensation expense
 
4.3

 
3.9

Provision for (recoveries of) bad debts
 
0.3

 
(0.3
)
Equity in net income of unconsolidated entities
 
(0.5
)
 
(0.6
)
Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
(1.1
)
 
(0.6
)
Other, net
 
0.6

 
(0.2
)
Changes in operating assets and liabilities, net of effects of acquisitions:
 


 


Accounts receivable
 
(8.6
)
 
(16.8
)
Other assets
 
(0.5
)
 
(3.3
)
Accounts payable and accrued liabilities
 
2.2

 
4.5

Accrued compensation
 
(36.4
)
 
(27.4
)
Income taxes—current
 
13.9

 
7.2

Deferred revenue
 
17.4

 
10.2

Deferred rent
 
0.1

 
(0.5
)
Other liabilities
 

 
(0.6
)
Cash provided by operating activities
 
35.0

 
11.9

 
 
 
 
 
Investing activities
 
 

 
 

Purchases of investments
 
(5.5
)
 
(1.7
)
Proceeds from maturities and sales of investments
 
5.9

 
73.7

Capital expenditures
 
(14.4
)
 
(20.8
)
Other, net
 
(0.1
)
 
0.2

Cash provided by (used for) investing activities
 
(14.1
)
 
51.4

 
 
 
 
 
Financing activities
 
 

 
 

Common shares repurchased
 
(2.3
)
 
(21.7
)
Dividends paid
 
(8.4
)
 
(7.6
)
Proceeds from short-term debt
 
15.0

 

Proceeds from stock-option exercises
 
1.8

 
1.3

Excess tax benefits from stock-option exercises and vesting of restricted stock units
 
1.1

 
0.6

Other, net
 
(0.2
)
 
(0.1
)
Cash provided by (used for) financing activities
 
7.0

 
(27.5
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(8.5
)
 
0.6

Net increase in cash and cash equivalents
 
19.4

 
36.4

Cash and cash equivalents—beginning of period
 
185.2

 
168.2

Cash and cash equivalents—end of period
 
$
204.6

 
$
204.6

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for income taxes
 
$
2.5

 
$
8.8

Supplemental information of non-cash investing and financing activities:
 
 
 
 
Unrealized gain (loss) on available-for-sale investments
 
$
0.2

 
$
0.2

Equipment obtained under long-term financing arrangement
 
$
1.3

 
$

 
See notes to unaudited condensed consolidated financial statements.

8


MORNINGSTAR, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. Basis of Presentation of Interim Financial Information
 
The accompanying condensed consolidated financial statements of Morningstar, Inc. and subsidiaries (Morningstar, we, our, the company) have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. In the opinion of management, the statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly our financial position, results of operations, equity, and cash flows. These financial statements and notes are unaudited and should be read in conjunction with our Audited Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on February 27, 2015.

The acronyms that appear in the Notes to our Unaudited Condensed Consolidated Financial Statements refer to the following:
 
ASC: Accounting Standards Codification
ASU: Accounting Standards Update
FASB: Financial Accounting Standards Board
 
2. Summary of Significant Accounting Policies

We discuss our significant accounting policies in Note 3 of our Audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on February 27, 2015.

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for us on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.


9


3. Credit Arrangements

In July 2014, the company entered into a one year, $75.0 million, single-bank revolving credit facility. The company drew $15.0 million on the credit facility during the first quarter of 2015 and had an outstanding principal balance of $45.0 million at an interest rate of LIBOR plus 100 basis points as of March 31, 2015, leaving borrowing availability of $30.0 million.

4. Acquisitions, Goodwill, and Other Intangible Assets

Acquisitions

In the first quarter of 2015, we finalized the purchase price allocation related to our 2014 acquisitions of ByAllAccounts, Inc. and HelloWallet Holdings, Inc. As a result, there were no adjustments to the balances reported as of December 31, 2014.

Goodwill
 
The following table shows the changes in our goodwill balances from December 31, 2014 to March 31, 2015:
 
 
 
(in millions)

Balance as of December 31, 2014
 
$
370.1

Foreign currency translation
 
(10.3
)
Balance as of March 31, 2015
 
$
359.8


We did not record any impairment losses in the first three months of 2015 or 2014. We perform our annual impairment reviews in the fourth quarter.

Intangible Assets

The following table summarizes our intangible assets: 
 
 
As of March 31, 2015
 
As of December 31, 2014
(in millions)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
 
Gross

 
Accumulated
Amortization

 
Net

 
Weighted
Average
Useful  Life
(years)
Intellectual property
 
$
28.6

 
$
(25.2
)
 
$
3.4

 
9
 
$
29.0

 
$
(25.0
)
 
$
4.0

 
9
Customer-related assets
 
137.5

 
(84.5
)
 
53.0

 
12
 
141.5

 
(83.6
)
 
57.9

 
12
Supplier relationships
 
0.2

 
(0.1
)
 
0.1

 
20
 
0.2

 
(0.1
)
 
0.1

 
20
Technology-based assets
 
87.8

 
(58.7
)
 
29.1

 
8
 
88.8

 
(57.4
)
 
31.4

 
8
Non-competition agreement
 
4.3

 
(2.0
)
 
2.3

 
5
 
4.4

 
(1.9
)
 
2.5

 
5
Total intangible assets
 
$
258.4

 
$
(170.5
)
 
$
87.9

 
10
 
$
263.9

 
$
(168.0
)
 
$
95.9

 
10
 
The following table summarizes our amortization expense related to intangible assets:
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Amortization expense
 
$
5.5

 
$
5.1

 
We amortize intangible assets using the straight-line method over their expected economic useful lives.


10


We expect intangible amortization expense for the remainder of 2015 and subsequent years as follows:
 
 
(in millions)

Remainder of 2015 (from April 1 through December 31)
 
$
16.0

2016
 
17.0

2017
 
12.7

2018
 
10.5

2019
 
7.8

Thereafter
 
23.9

 
Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, divestitures, changes in the estimated average useful life, and currency translations.

5. Income Per Share 

The following table shows how we reconcile our net income and the number of shares used in computing basic and diluted income per share:

 
 
Three months ended March 31
(in millions, except per share amounts)
 
2015

 
2014

 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.:
 
 

 
 

Net income attributable to Morningstar, Inc.:
 
$
29.7

 
$
26.4

Less: Distributed earnings available to participating securities
 

 

Less: Undistributed earnings available to participating securities
 

 

Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
29.7

 
$
26.4

 
 
 
 
 
Weighted average common shares outstanding
 
44.3

 
44.8

 
 
 
 
 
Basic net income per share attributable to Morningstar, Inc.
 
$
0.67

 
$
0.59

 
 
 
 
 
Diluted net income per share attributable to Morningstar, Inc.:
 
 
 
 
Numerator for basic net income per share — undistributed and distributed earnings available to common shareholders
 
$
29.7

 
$
26.4

Add: Undistributed earnings allocated to participating securities
 

 

Less: Undistributed earnings reallocated to participating securities
 

 

Numerator for diluted net income per share — undistributed and distributed earnings available to common shareholders
 
$
29.7

 
$
26.4

 
 


 


Weighted average common shares outstanding
 
44.3

 
44.8
Net effect of dilutive stock options, restricted stock units, and performance share awards
 
0.2

 
0.3

Weighted average common shares outstanding for computing diluted income per share
 
44.5

 
45.1

 
 


 
 
Diluted net income per share attributable to Morningstar, Inc.
 
$
0.67

 
$
0.58



11


The following table shows the number of restricted stock units and performance share awards excluded from our calculation of diluted earnings per share because their inclusion would have been anti-dilutive:

 
 
Three months ended March 31
(in thousands)
 
2015

 
2014

Weighted average restricted stock units
 
32

 
6

Weighted average performance share awards
 
18

 
9

Total
 
50

 
15


Stock options and restricted stock could be included in the calculation in the future.

6. Segment and Geographical Area Information
 
Segment Information

We report our results in a single reportable segment, which reflects how our chief operating decision maker allocates resources and evaluates our financial results.

Because we have one reportable segment, all required financial segment information can be found directly in the Unaudited Condensed Consolidated Financial Statements.

The accounting policies for our single reportable segment are the same as those described in “Note 3. Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2014. We evaluate the performance of our reporting segment based on revenue and operating income.

Geographical Area Information

The tables below summarize our revenue and long-lived assets by geographical area:

External revenue by geographical area
 
 
 
 
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

United States
 
$
140.9

 
$
130.0

 
 
 
 
 
United Kingdom
 
14.6

 
15.3

Continental Europe
 
14.3

 
15.6

Australia
 
7.7

 
8.2

Canada
 
7.0

 
7.7

Asia
 
4.4

 
3.7

Other
 
0.9

 
0.7

Total International
 
48.9

 
51.2

 
 
 
 
 
Consolidated revenue
 
$
189.8

 
$
181.2



12


Long-lived assets by geographical area
 
 
 
 
 
 
As of March 31
 
As of December 31
(in millions)
 
2015

 
2014

United States
 
$
102.7

 
$
98.1

 
 
 
 
 
United Kingdom
 
8.4

 
8.1

Continental Europe
 
1.8

 
2.1

Australia
 
0.7

 
0.8

Canada
 
0.8

 
0.9

Asia
 
6.9

 
7.5

Other
 
0.1

 
0.1

Total International
 
18.7

 
19.5

 
 
 
 
 
Consolidated property, equipment, and capitalized software, net
 
$
121.4

 
$
117.6


7. Investments and Fair Value Measurements
 
We account for our investments in accordance with FASB ASC 320, Investments—Debt and Equity Securities. We classify our investments into three categories: available-for-sale, held-to-maturity, and trading securities. Our investment portfolio is primarily invested in proprietary Morningstar portfolios, exchange-traded funds that seek to track the performance of certain Morningstar proprietary indexes, and various mutual funds. We classify our investment portfolio as shown below:
 
 
 
As of March 31
 
As of December 31
(in millions)
 
2015

 
2014

Available-for-sale
 
$
13.4

 
$
13.2

Held-to-maturity
 
16.8

 
17.9

Trading securities
 
8.4

 
8.3

Total
 
$
38.6

 
$
39.4


The following table shows the cost, unrealized gains (losses), and fair value of investments classified as available-for-sale and held-to-maturity:
 
 
 
As of March 31, 2015
 
As of December 31, 2014
(in millions)
 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

 
Cost

 
Unrealized
Gain

 
Unrealized
Loss

 
Fair
Value

Available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Equity securities and exchange-traded funds
 
$
11.5

 
$
0.9

 
$
(0.3
)
 
$
12.1

 
$
11.4

 
$
0.8

 
$
(0.3
)
 
$
11.9

Mutual funds
 
1.2

 
0.2

 
(0.1
)
 
1.3

 
1.2

 
0.2

 
(0.1
)
 
1.3

Total
 
$
12.7

 
$
1.1

 
$
(0.4
)
 
$
13.4

 
$
12.6

 
$
1.0

 
$
(0.4
)
 
$
13.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Certificates of deposit
 
$
16.8

 
$

 
$

 
$
16.8

 
$
17.9

 
$

 
$

 
$
17.9

 

13


As of March 31, 2015 and December 31, 2014, 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 March 31, 2015 and December 31, 2014. 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 March 31, 2015
 
As of December 31, 2014
(in millions)
 
Cost

 
Fair Value

 
Cost

 
Fair Value

Available-for-sale:
 
 

 
 

 
 

 
 

Equity securities, exchange-traded funds, and mutual funds
 
$
12.7

 
$
13.4

 
$
12.6

 
$
13.2

    Total
 
$
12.7

 
$
13.4

 
$
12.6

 
$
13.2

 
 
 
 
 
 
 
 
 
Held-to-maturity:
 
 

 
 

 
 

 
 

Due in one year or less
 
$
16.8

 
$
16.8

 
$
17.9

 
$
17.9

Due in one to three years
 

 

 

 

Total
 
$
16.8

 
$
16.8

 
$
17.9

 
$
17.9

 
As of March 31, 2015 and December 31, 2014, held-to-maturity investments included a $1.5 million certificate of deposit held primarily as collateral against bank guarantees for our office leases, primarily in Australia.

The following table shows the realized gains and losses arising from sales of our investments classified as available-for-sale recorded in our Condensed Consolidated Statements of Income: 

 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Realized gains
 
$
0.2

 
$
0.2

Realized losses
 
(0.2
)
 
(0.2
)
Realized gains (losses), net
 
$

 
$

 
We determine realized gains and losses using the specific identification method.

The following table shows the net unrealized gains on trading securities as recorded in our Condensed Consolidated Statements of Income:
 
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Unrealized gains, net
 
$
0.1

 
$
0.1



14


The table below shows the fair value of our assets subject to fair value measurements that are measured at fair value on a recurring basis using the fair value hierarchy and the necessary disclosures under FASB ASC 820, Fair Value Measurement:
 
 
 
Fair Value
 
Fair Value Measurements as of March 31, 2015
 
 
as of
 
Using Fair Value Hierarchy
(in millions)
 
March 31, 2015
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Equity securities and exchange-traded funds
 
$
12.1

 
$
12.1

 
$

 
$

Mutual funds
 
1.3

 
1.3

 

 

Trading securities
 
8.4

 
8.4

 

 

Cash equivalents
 
0.5

 
0.5

 

 

Total
 
$
22.3

 
$
22.3

 
$

 
$

 
 
 
Fair Value
 
Fair Value Measurements as of December 31, 2014
 
 
as of
 
Using Fair Value Hierarchy
(in millions)
 
December 31, 2014
 
Level 1

 
Level 2

 
Level 3

Available-for-sale investments:
 
 

 
 

 
 

 
 

Equity securities and exchange-traded funds
 
$
11.9

 
$
11.9

 
$

 
$

Mutual funds
 
1.3

 
1.3

 

 

Trading securities
 
8.3

 
8.3

 

 

Cash equivalents
 
0.5

 
0.5

 

 

Total
 
$
22.0

 
$
22.0

 
$

 
$

 
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.

Based on our analysis of the nature and risks of our investments in equity securities and mutual funds, we have determined that presenting each of these investment categories in the aggregate is appropriate.

We measure the fair value of money market funds, mutual funds, equity securities, and exchange-traded funds based on quoted prices in active markets for identical assets or liabilities. We did not hold any securities categorized as Level 2 or Level 3 as of March 31, 2015 and December 31, 2014.

8. Stock-Based Compensation
 
Stock-Based Compensation Plans
 
Our shareholders approved the Morningstar 2011 Stock Incentive Plan (the 2011 Plan) on May 17, 2011. As of that date, we stopped granting awards under the Morningstar 2004 Stock Incentive Plan (the 2004 Plan). The 2004 Plan amended and restated the Morningstar 1993 Stock Option Plan, the Morningstar 2000 Stock Option Plan, and the Morningstar 2001 Stock Option Plan.

The 2011 Plan provides for a variety of stock-based awards, including, among other things, stock options, performance share awards, restricted stock units, and restricted stock. We granted stock options, restricted stock units, and restricted stock under the 2004 Plan.

All of our employees and our non-employee directors are eligible for awards under the 2011 Plan.


15


Grants awarded under the 2011 Plan or the 2004 Plan that are forfeited, canceled, settled, or otherwise terminated without a distribution of shares, or shares withheld by us in connection with the exercise of options, will be available for awards under the 2011 Plan. Any shares subject to awards under the 2011 Plan, but not under the 2004 Plan, that are withheld by us in connection with the payment of any required income tax withholding will be available for awards under the 2011 Plan.

The following table summarizes the number of shares available for future grants under our 2011 Plan:
 
 
 
As of March 31

(in millions)
 
2015

Shares available for future grants
 
4.2

 
Accounting for Stock-Based Compensation Awards
 
The following table summarizes our stock-based compensation expense and the related income tax benefit we recorded:
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Restricted stock units
 
$
4.0

 
$
3.7

Restricted stock
 
0.1

 
0.1

Performance share awards
 
0.1

 

Stock options
 
0.1

 
0.1

Total stock-based compensation expense
 
$
4.3

 
$
3.9

 
 


 


Income tax benefit related to the stock-based compensation expense
 
$
1.2

 
$
1.1

 
The following table summarizes the stock-based compensation expense included in each of our operating expense categories:
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Cost of revenue
 
$
2.0

 
$
1.7

Sales and marketing
 
0.5

 
0.5

General and administrative
 
1.8

 
1.7

Total stock-based compensation expense
 
$
4.3

 
$
3.9


The following table summarizes the amount of unrecognized stock-based compensation expense as of March 31, 2015 and the expected number of months over which the expense will be recognized:
 
 
Unrecognized stock-based compensation expense (in millions)

 
Expected amortization period (months)
Restricted stock units
 
$
29.1

 
30
Restricted stock
 

 
1
Performance share awards
 
4.2

 
32
Stock options
 
0.1

 
4
Total unrecognized stock-based compensation expense
 
$
33.4

 
30


16


In accordance with FASB ASC 718, Compensation—Stock Compensation, we estimate forfeitures of employee stock-based awards and recognize compensation cost only for those awards expected to vest. Our largest annual equity grants typically have vesting dates in the second quarter. We adjust the stock-based compensation expense annually in the third quarter to reflect those awards that ultimately vested and update our estimate of the forfeiture rate that will be applied to awards not yet vested.
 
Restricted Stock Units
 
Restricted stock units represent the right to receive a share of Morningstar common stock when that unit vests. Restricted stock units to employees vest ratably over a four-year period. Restricted stock units granted to non-employee directors vest ratably over a three-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.

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 the 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 three months of 2015:
Restricted Stock Units (RSUs)
 
Unvested

 
Vested but
Deferred

 
Total

 
Weighted
Average
Grant Date Value
per RSU

RSUs outstanding—December 31, 2014
 
655,934

 
14,778

 
670,712

 
$
67.51

Granted
 

 

 

 

Dividend equivalents
 
595

 
42

 
637

 
56.40

Vested
 
(123
)
 

 
(123
)
 
57.07

Issued
 

 

 

 

Forfeited
 
(10,812
)
 

 
(10,812
)
 
68.23

RSUs Outstanding - March 31, 2015
 
645,594

 
14,820

 
660,414

 
$
67.50

 
Restricted Stock
 
In conjunction with the 2010 Realpoint acquisition, we issued shares of restricted stock to the selling employee-shareholders which vest 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.
 
Performance Share Awards

In 2014, we introduced a long-term incentive award program consisting of performance shares. In March 2015, executive officers, other than Joe Mansueto, and certain other employees, were granted performance share awards. These awards entitle the holder to a number of shares of Morningstar common stock equal to the number of notional performance shares that become vested. Each award specifies a number of performance shares that will vest if pre-established target performance goals are attained. The number of performance shares that actually vest may be more or less than the specified number of performance shares to the extent Morningstar exceeds or fails to achieve, respectively, the target performance goals over a three-year performance period.

We base the grant date fair value for these awards on the closing market price of the underlying common stock on the day prior to the grant date. We amortize that value to stock-based compensation expense ratably over the vesting period based on the satisfaction of the performance condition that is most likely to be satisfied over the three-year performance period.


17


The table below shows target performance share awards granted and shares that would be issued at current performance levels for performance share awards granted as of March 31, 2015:
 
 
As of March 31, 2015

Target performance share awards granted
 
75,947

Weighted average fair value per award
 
$
76.33

Number of shares that would be issued based on current performance levels
 
64,105

Unamortized expense, based on current performance levels (in millions)
 
$
4.2


Stock Options

Stock options granted to employees vest ratably over a four-year period. Grants to our non-employee directors vest ratably over a three-year period. All grants expire 10 years after the date of grant. Almost all of the options granted under the 2004 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. Options granted under the 2011 Plan have an exercise price equal to the fair market value on the grant date.

The following table summarizes stock option activity in the first three months of 2015 for our various stock option grants:
 
 
Underlying
Shares

 
Weighted
Average
Exercise
Price

Options outstanding—December 31, 2014
 
169,810

 
$
40.20

Granted
 

 

Canceled
 

 

Exercised
 
(81,579
)
 
29.32

Options outstanding—March 31, 2015
 
88,231

 
$
50.53

 
 
 
 
 
Options exercisable—March 31, 2015
 
73,285

 
$
49.11

 
The following table summarizes the total intrinsic value of options exercised, which reflects the difference between the market value of our stock on the date of exercise and the exercise price of the option:
 
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Intrinsic value of options exercised
 
$
3.7

 
$
2.5

 

The table below shows additional information for options outstanding and exercisable as of March 31, 2015:
 
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number of  Options

 
Weighted
Average
Remaining
Contractual
Life (years)
 
Weighted
Average
Exercise
Price

 
Aggregate
Intrinsic
Value
(in millions)

 
Exercisable Shares

 
Weighted Average Remaining Contractual Life (years)
 
Weighted Average Exercise Price

 
Aggregate Intrinsic Value (in millions)

$27.81
 
19,300

 
0.09
 
$
27.81

 
$
0.9

 
19,300

 
0.09
 
$
27.81

 
$
0.9

$40.88 - $51.58
 
5,256

 
0.67
 
49.84

 
0.1

 
5,256

 
0.67
 
49.84

 
0.1

$57.28 - $59.35
 
63,675

 
6.26
 
57.48

 
1.1

 
48,729

 
6.26
 
57.47

 
0.9

$57.28 - $59.35
 
88,231

 
4.58
 
$
50.53

 
$
2.1

 
73,285

 
4.24
 
$
49.11

 
$
1.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested or Expected to Vest
 
 
 
 
 
 
 
 
 
 
 
 
 
$27.81 - $59.35
 
88,231

 
4.58
 
$
50.53

 
$
2.1

 
 
 
 
 
 
 
 

18


 
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 March 31, 2015. The intrinsic value is based on our closing stock price of $74.91 on that date.

Excess Tax Benefits Related to Stock-Based Compensation
 
FASB ASC 718, Compensation—Stock 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 Condensed Consolidated Statements of Operations. The following table summarizes our excess tax benefits:
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Excess tax benefits related to stock-based compensation
 
$
1.1

 
$
0.6




19


9. Income Taxes

Effective Tax Rate

The following table shows our effective tax rate for the three months ended March 31, 2015 and March 31, 2014:
 
 
 
Three months ended March 31
(in millions)
 
2015

 
2014

Income before income taxes and equity in net income of unconsolidated entities
 
$
44.1

 
$
39.4

Equity in net income of unconsolidated entities
 
0.5

 
0.6

Net (income) loss attributable to the noncontrolling interest
 
(0.1
)
 
0.1

Total
 
$
44.5

 
$
40.1

Income tax expense
 
$
14.8

 
$
13.7

Effective tax rate
 
33.3
%
 
34.1
%
 
Our effective tax rate in the first quarter of 2015 was 33.3%, a decrease of 0.8 percentage points compared with 34.1% in the prior-year period. The effective tax rate decrease primarily reflects unrecognized tax benefits that were recorded in the prior-year period.

Unrecognized Tax Benefits

The table below provides information concerning our gross unrecognized tax benefits as of March 31, 2015 and December 31, 2014, as well as the effect these gross unrecognized tax benefits would have on our income tax expense, if they were recognized.
 
 
As of March 31
 
As of December 31
(in millions)
 
2015

 
2014

Gross unrecognized tax benefits
 
$
11.6

 
$
11.9

Gross unrecognized tax benefits that would affect income tax expense
 
$
11.6

 
$
11.9

Decrease in income tax expense upon recognition of gross unrecognized tax benefits
 
$
10.2

 
$
10.6


Our Condensed Consolidated Balance Sheets include the following liabilities for unrecognized tax benefits. These amounts include interest and penalties, less any associated tax benefits.

 
 
As of March 31
 
As of December 31
Liabilities for Unrecognized Tax Benefits (in millions)
 
2015

 
2014

Current liability
 
$
5.0

 
$
5.1

Non-current liability
 
6.6

 
6.6

Total liability for unrecognized tax benefits
 
$
11.6

 
$
11.7



20


We conduct business globally and, as a result, we file income tax returns in U.S. federal, state, local, and foreign jurisdictions. We are currently under audit by federal and various state and local tax authorities in the United States, as well as tax authorities in certain non-U.S. jurisdictions. It is possible, though not likely, that the examination phase of some of these audits will conclude in 2015. It is not possible to estimate the effect of current audits on previously recorded unrecognized tax benefits.

We have not provided federal and state income taxes on accumulated undistributed earnings of certain foreign subsidiaries because these earnings have been permanently reinvested. Approximately 56% of our cash, cash equivalents, and investments balance as of March 31, 2015 was held by our operations outside of the United States. We believe that our cash balances and investments in the United States, along with cash generated from our U.S. operations, will be sufficient to meet our U.S. operating and cash needs for the foreseeable future, without requiring us to repatriate earnings from these foreign subsidiaries. It is not practical to determine the amount of the unrecognized deferred tax liability related to the undistributed earnings.
 
Certain of our non-U.S. operations have incurred net operating losses (NOLs) which may become deductible to the extent these operations become profitable. 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. In the year that certain non-U.S. operations record a loss, we do not recognize a corresponding tax benefit, thus increasing our effective tax rate. 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.

10. Contingencies

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 the result of any of these matters will have a material adverse effect on our business, operating results, or financial position.


11. Share Repurchase Program
 
We have an ongoing authorization, originally approved by our board of directors in September 2010, and subsequently amended, to repurchase up to $700.0 million in shares of our outstanding common stock. The authorization expires on December 31, 2015. 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 March 31, 2015, we had repurchased a total of 8,174,036 shares for $528.9 million under this authorization, leaving approximately $171.1 million available for future repurchases.


21


Item 2.
Management’s 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:

liability for any losses that result from an actual or claimed breach of our fiduciary duties;
failing to maintain and protect our brand, independence, and reputation;
failing to differentiate our products and continuously create innovative, proprietary research tools;
failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy;
liability related to our storage of personal information related to individuals as well as portfolio and account-level information;
compliance failures, regulatory action, or changes in laws applicable to our investment advisory or credit rating operations;
downturns in the financial sector, global financial markets, and global economy;
the effect of market volatility on revenue from asset-based fees;
a prolonged outage of our database, technology-based products and services, or network facilities;
challenges faced by our operations outside the United States, including the concentration of data and development work at our offshore facilities in China and India; and
trends in the mutual fund industry, including the increasing popularity of passively managed investment vehicles.

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, 2014. 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 previous year unless otherwise stated. 



22


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 products and services for financial advisors, asset managers, retirement plan providers and sponsors, and individual investors. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

Industry Overview
 
We monitor developments in the financial information industry to help inform our company strategy, product development plans, and marketing initiatives.
 
Global markets were generally off to a positive start in 2015. After posting double-digit gains in 2014, the Morningstar U.S. Market Index, a broad market benchmark, was up 1.8% for the first quarter of 2015, while the Global Ex-U.S. Index finished the quarter up 3.7%.
 
U.S. mutual fund assets stood at $16.1 trillion as of March 31, 2015, based on data from the Investment Company Institute (ICI), compared with $15.3 trillion as of the same date in 2014. Based on Morningstar's estimated asset flow data, investors added about $147.9 billion to long-term open-end and exchange-traded funds (ETFs) during the first three months of 2015, compared with $127.8 billion in the first quarter of 2014. Fund flows to equity funds were slightly negative in the quarter.
 
Assets in exchange-traded funds rose to $2.1 trillion as of March 31, 2015, compared with $1.7 trillion as of the same date in 2014, based on data from the ICI.

Despite generally positive market trends, we believe the business environment for the financial services industry remains mixed. While equity market returns have generally been positive, asset management firms have been facing increasing regulatory burdens, which are leading to higher costs and more cautious spending in other areas.



23


Supplemental Operating Metrics

The tables below summarize our key product metrics and other supplemental data.
 
 
 
As of March 31
 
 
 
2015

 
2014

 
Change
 
Our business
 
 
 
 
 
 
 
Morningstar.com Premium Membership subscriptions (U.S.)
 
123,563

 
123,777

 
(0.2
)%
 
Morningstar.com registered users (U.S.)
 
8,294,274

 
7,945,324

 
4.4
 %
 
Advisor Workstation clients (U.S.) (1)
 
187

 
168

 
11.3
 %
 
Morningstar Office licenses (U.S.) (1)
 
4,321

 
4,137

 
4.4
 %
 
Morningstar Direct licenses
 
10,413

 
8,858

 
17.6
 %
 
Assets under advisement and management (approximate) ($bil)
 
 
 
 
 
 
 
 
Investment Advisory services (2)
 
$
84.5

 
$
84.8

(4)
(0.4
)%
 
 
Retirement Solutions
 
 
 
 
 
 
 
 
    Managed Accounts (3)
 
$
38.7

 
$
32.8

 
18.0
 %
 
 
Plan Sponsor Advice
 
28.1

 
24.2

 
16.1
 %
 
 
Custom Models
 
15.2

 
11.0

 
38.2
 %
 
 
Retirement Solutions (total)
 
$
82.0

 
$
68.0

 
20.6
 %
 
 
Morningstar Managed Portfolios
 
$
12.8

 
$
11.0

(4)
16.4
 %
 
 
 
 
 
 
 
 
 
 
Our employees (approximate)
 
 
 
 
 
 
 
Worldwide headcount
 
3,750