MORNINGSTAR, INC., 10-Q filed on 11/3/2010
Quarterly Report
Condensed Consolidated Statements of Income (USD $)
In Thousands, except Per Share data
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
Revenue
$ 139,817 
$ 120,088 
$ 404,198 
$ 356,353 
Operating expense:
 
 
 
 
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 (in dollars per share)
0.42 
0.46 
1.19 
1.42 
Diluted (in dollars per share)
$ 0.41 
$ 0.45 
$ 1.16 
$ 1.37 
Dividends declared per common share
0.05 
 
0.05 
 
Weighted average shares outstanding:
 
 
 
 
Basic (in shares)
49,401 
48,457 
49,157 
47,930 
Diluted (in shares)
50,544 
50,048 
50,453 
49,623 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
In Thousands
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
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 
Condensed Consolidated Balance Sheets (USD $)
In Thousands
Sep. 30, 2010
Dec. 31, 2009
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 
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 
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
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 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Share data
Sep. 30, 2010
Dec. 31, 2009
Condensed Consolidated Balance Sheets
 
 
Accounts receivable, allowance (in dollars)
$ 714 
$ 1,339 
Common stock, no par value (in dollars per share)
 
 
Common stock, shares authorized
200,000,000 
200,000,000 
Common stock, shares outstanding
49,658,633 
48,768,541 
Treasury stock, shares
207,254 
222,653 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss)
In Thousands, except Share data
Common Stock
Treasury Stock
Additional Paid-in Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Non Controlling Interests
Comprehensive Income
Total
Balance at Dec. 31, 2009
(3,130)
432,052 
246,745 
33 
1,169 
 
676,874 
Balance (in shares) at Dec. 31, 2009
48,768,541 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
58,977 
 
(10)
58,967 
58,967 
Unrealized gain on available-for-sale investments, net of income tax of $28
 
 
 
 
43 
 
43 
43 
Foreign currency translation adjustment, net
 
 
 
 
5,577 
57 
5,634 
5,634 
Total comprehensive income
 
 
 
58,977 
5,620 
47 
64,644 
64,644 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net
 
217 
4,990 
 
 
 
 
5,207 
Issuance of common stock related to stock option exercises and vesting of restricted stock units, net (in shares)
690,918 
 
 
 
 
 
 
 
Stock-based compensation - restricted stock units
 
 
9,557 
 
 
 
 
9,557 
Stock-based compensation - restricted stock
 
 
780 
 
 
 
 
780 
Stock-based compensation - restricted stock (in shares)
199,174 
 
 
 
 
 
 
 
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 at Sep. 30, 2010
(2,913)
448,485 
303,196 
5,653 
1,000 
 
755,426 
Balance (in shares) at Sep. 30, 2010
49,658,633 
 
 
 
 
 
 
 
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss) (Parenthetical) (USD $)
In Thousands
9 Months Ended
Sep. 30, 2010
Condensed Consolidated Statement of Equity and Comprehensive Income (Loss)
 
Unrealized loss on available-for-sale investments, tax
$ 28 
Condensed Consolidated Statements of Cash Flows (USD $)
In Thousands
9 Months Ended
Sep. 30,
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 equivalents-beginning of period
130,496 
173,891 
Cash and cash equivalents-end 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)
Basis of Presentation of Interim Financial Information
Basis of Presentation of Interim Financial Information

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

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies

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.

Acquisitions, Goodwill, and Other Intangible Assets
Acquisitions, Goodwill, and Other Intangible Assets

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 Denmark’s 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 Morningstar’s full suite of products and services to investors in Denmark, and further leveraging Morningstar’s 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.

 

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 Realpoint’s 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

 

 

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.

 

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

 

Canada’s 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.

 

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

 

 

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.

Income Per Share
Income Per Share

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.

 

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

 

Segment and Geographical Area Information
Segment and Geographical Area Information

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.

 

·   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 segment’s 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 don’t 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

 

 

 

 

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

 

Investments and Fair Value Measurements
Investments and Fair Value Measurements

6. 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 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.

 

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.

Investments in Unconsolidated Entities
Investments in Unconsolidated Entities

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. MJKK’s 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 MJKK’s publicly quoted share price:

 

 

 

As of September 30
2010

 

As of December 31
2009

 

Morningstar’s approximate ownership of MJKK

 

34

%

34

%

 

 

 

 

 

 

Approximate market value of Morningstar’s 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.

Liability for Vacant Office Space
Liability for Vacant Office Space

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.

Stock-Based Compensation
Stock-Based Compensation

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.

 

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, Compensation—Stock 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 outstanding—December 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 outstanding—September 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.

 

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 outstanding—December 31, 2009

 

809,169

 

$

17.75

 

Canceled

 

(600

)

13.68

 

Exercised

 

(62,374

)

13.33

 

Options outstanding—September 30, 2010

 

746,195

 

18.70

 

 

 

 

 

 

 

Options exercisable—September 30, 2010

 

746,195

 

$

18.70

 

 

All Other Option Grants, Excluding Activity Shown Above

 

Underlying
 
Shares

 

Weighted
Average
Exercise
Price

 

Options outstanding—December 31, 2009

 

1,868,408

 

$

16.15

 

Canceled

 

(15,022

)

13.62

 

Exercised

 

(464,872

)

14.67

 

Options outstanding—September 30, 2010

 

1,388,514

 

16.99

 

 

 

 

 

 

 

Options exercisable—September 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