Item 1A. Risk Factors
You should carefully consider the risks and uncertainties described below and all of the other information included in this report when deciding whether to invest in our common stock or otherwise evaluating our business. If any of the following risks or uncertainties materialize, our business, financial condition, or operating results could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. Our operations could also be affected by other risks and uncertainties that are not presently known to us or that we currently consider to be immaterial to our operations.
Risks Related to Our Business and Industry
Failing to maintain and protect our brand, independence, and reputation may harm our business. Our reputation and business may also be harmed by allegations made about possible conflicts of interest, by other negative publicity or media reports, or by adverse outcomes in regulatory proceedings.
We believe that our brand is well recognized and highly regarded at both a corporate and product level among key decision makers at purchasers and users of our products and services. We also believe independence is at the core of our brand and business, and our reputation is one of our greatest corporate assets. We rely on our reputation for integrity and high-caliber products and services as a competitive advantage. Any failure to uphold our high ethical standards and ensure that our customers have a consistently positive experience with us could damage our reputation, either as an objective, honest, and credible source for investment and credit research and information or as a trusted solutions provider to our asset management and investment advisory customers, or both. Our ESG offerings insert Morningstar very publicly into the debate over a variety of non-financial issues around the environment, social concerns, and corporate governance, and our position as a leading source of ESG research and opinions may cause proponents of various causes to demand that we publicly take stands on a variety of controversial topics not directly related to our corporate mission. Allegations of improper conduct, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity or media reports about Morningstar, whether valid or not, may harm our reputation and damage our business. In addition, any failures by us to continue to instill effectively in our employees the non-negotiable expectation of independence and integrity may devalue our reputation over time. Morningstar’s corporate culture and reputation contribute to our ability to attract and retain talent, and reputational damage could negatively affect both our hiring and employee retention.
As our business has evolved, we have entered lines of business and business arrangements that may give rise to allegations of conflicts of interest or perceived failures of our independence. We provide ratings, analyst research, and investment recommendations on mutual funds and other investment products offered by our institutional clients. While we don’t charge asset management firms for their products to be rated, we do charge licensing fees for the use of our ratings. We also provide investment advisory and investment management services, including through our own series of mutual funds, which exposes us to the claim that we are acting as both a referee and a player in the investment management industry. In our credit rating business, which we significantly expanded through the purchase of DBRS, we are participants in an issuer-pay business model under which we receive payments from issuers for our credit ratings rather than from the investors who consume such ratings. An issuer pay model also applies to Sustainalytics’ Sustainable Finance Solutions business unit products and services. These payments may create the perception that our credit ratings and research are not independently determined or reliable. We evaluate the potential impact of ESG factors on other companies and risk a claim of hypocrisy if we take or fail to take corporate actions that are or seem inconsistent with our view of best corporate practices.
Our business expansion has also resulted in greater exposure to governmental regulation across our product lines. In some cases, such as with respect to our credit ratings business, interactions with regulators are extensive and continuous, raising the risk that they may result in enforcement investigations and proceedings. To the extent any of those investigations or proceedings result in a finding of misconduct or noncompliance, they could pose a significant reputational risk to us and negatively impact our business.
Our reputation may also be harmed by factors outside of our control, such as news reports about our clients, consultants, or partners or adverse publicity about certain investment and ratings products. Our reputation could also suffer if we fail to perform competitively in our investment management offerings.
30
Table of Contents
Prolonged volatility or downturns affecting the financial sector, global financial markets, and the global economy may impact our results, resulting in lower revenue from asset-based fees and credit ratings business, as well as other parts of our business to a lesser extent.
Our business results are partly driven by factors outside of our control, including general economic and financial market trends. Any unfavorable changes in the market environment in which we operate could cause a corresponding negative effect on our business results. As a result, we may experience lower revenue, operating income, and other financial results in the event of a market downturn.
For our licensed-based businesses, many of our customers are asset-management firms and other financial-services companies, which are also subject to external trends and changes. For example, the financial crisis of 2008 and 2009 led to sustained spending cutbacks among many of the companies to which we sell. Some institutional clients implemented additional review processes for new contracts or started providing certain services, such as investment management, in-house rather than hiring outside service providers. There is currently uncertainty regarding the duration and long-term economic and societal consequences of the COVID-19 pandemic, as well as the effects of unprecedented levels of fiscal and monetary stimulus, which may cause clients to modify spending decisions. Consolidation in the financial services sector has in the past, and may in the future, reduce the number of potential clients for our products and services. These trends could impact demand for our products and services or change the financial services landscape in which we operate.
Many companies in the financial services industry have also been subject to increasing government regulation and pressure to reduce fees. In turn, many of these firms have sought to reduce their operating costs by working with fewer service providers and/or negotiating lower fees for services they purchase.
Our PitchBook business may also be subject to cyclical trends specific to the private capital markets. Many of PitchBook's clients are investment banks and other participants in the capital and M&A markets, which are subject to periodic business downturns driven by changes in such markets. During these downturns, they often seek to reduce spending on third-party services, as well as the number of employees, which would directly affect the number of prospective clients for PitchBook. As a data and research provider focusing on the private capital markets (including venture capital, private equity, and M&A), PitchBook may also be subject to volatility based on the amount of activity and market interest in these areas.
The amount of asset-based revenue we earn primarily depends on the value of assets on which we provide advisory services, and the size of our asset base can increase or decrease along with trends in market performance. Our revenue from asset-based fees may be adversely affected by market declines, cash outflows from portfolios that we help manage, and the industrywide trend toward lower asset-based fees. Concerns about asset price bubbles, in particular in equities, have proliferated as the performance of the stock market appears disconnected from the real economy where the COVID-19 pandemic has had a greater negative impact on employment, spending, and general consumer economic activity.
Asset levels can also be affected if net inflows into the portfolios on which we provide investment advisory services drop or if these portfolios experience redemptions. A drop in net inflows or an increase in redemptions can result from a variety of factors, including overall market conditions and volatility or uncompetitive investment performance. If the level of assets on which we provide investment advisory or investment management services goes down, we expect our fee-based revenue to show a corresponding decline.
Our largest transaction-based business, the credit rating business, can be severely impacted by volatility in U.S. and international financial markets due to its dependence on the number and dollar volume of debt securities issued in the capital markets. Market disruptions and economic slowdowns have in the past negatively impacted, and may in the future negatively impact, the volume of debt securities issued in global capital markets and the demand for credit ratings.
31
Table of Contents
Conditions that reduce issuers’ ability or willingness to issue debt securities, such as market volatility, increasing inflation, declining growth, currency devaluations, or other adverse economic trends, reduce the number and value of debt issuances for which we provide credit ratings services and thereby adversely affect the fees we earn in our credit ratings business. Future debt issuances also could be negatively affected by increases in interest rates, widening credit spreads, regulatory and political developments, growth in the use of alternative sources of credit, and defaults by significant issuers. Our ability to reduce costs in the event of such adverse developments can be negatively impacted by, among other things, our obligations to monitor and maintain outstanding ratings. Declines or other changes in the markets for debt securities may materially and adversely affect our business, operating results, and financial condition.
Our transactional business results may also be hurt by negative trends in Internet advertising sales. Many advertisers have shifted some of their advertising spend to programmatic buying platforms that target users on other sites, which has from time to time had a negative effect on advertising revenue for our website for individual investors, Morningstar.com. The reliance on virtual events as the COVID-19 pandemic restricted large gatherings during 2020 impacted our financial results for our Morningstar-sponsored investor conferences around the world. We are uncertain whether these trends will continue.
Failing to differentiate our products and services and continuously create innovative, proprietary and insightful financial technology solutions may harm our competitive position and business results.
Our core competencies are around data and research, technology, and design. Morningstar deploys each of these to create unique intellectual property, products, and solutions that clearly convey complex investment information to investors of all kinds. Morningstar offers a suite of solutions that serve individuals, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the private capital markets. Morningstar also applies its long-term investing philosophy to managing assets for clients. Our customers have access to a wide selection of investment data, fundamental equity research, manager research, credit ratings, private capital markets research, and ESG data and research, directly on Morningstar’s proprietary desktop or web-based software platforms, or through subscriptions, data feeds, and third-party distributors. Our financial technology solutions also allow advisors to serve investors at all stages of the investing process. Morningstar’s managed portfolio offerings help advisors outsource investment selection and asset allocation through proprietary portfolio strategies based on Morningstar’s valuation-driven, fundamentals-based approach to investing. Applying its expertise in asset allocation, investment selection, and portfolio construction, our global investment team creates long-term investment strategies built on Morningstar’s data and ratings. We also help retirement plan sponsors build high-quality savings programs for employees. The breadth and depth of our service offerings set us apart from our competitors, which is a significant competitive advantage.
If we fail to continuously innovate and develop new research, methodologies, content or software to meet the needs of our customers, our competitive position and business results may suffer. In addition, our reputation could be harmed if we’re perceived as not moving quickly enough to meet the changing needs of investors or their financial advisors. These changing needs include a greater reliance on goals-based investing, the increased use of asset allocation portfolio models, and a significant emphasis on financial planning. Clients may also delay purchases of our currently offered research tools and software in anticipation of us offering new products or enhanced versions of existing products. Our competitive position and business results may also suffer if other companies are able to successfully introduce innovative, proprietary research tools and software that gain attention from our clients. We believe lower technology costs, the growth of open software platforms, and cloud computing technologies have lowered the barriers to entry for new competitors, making it easier for new players to enter the market. Smaller companies, including startup firms funded by private equity and venture capital, may be able to move more quickly than us to develop data sets, research, tools, and advisor software platforms that gain a wide following.
In addition, the value of our products and services may be negatively affected by the increasing amount of information and tools that are available for free, or at low cost, through Internet sources or other low-cost delivery systems, and by the ability of machine learning and other artificial intelligence systems to process and organize large data sets. Regulations, such as the SEC’s requirement that registered investment companies report their fund portfolio holdings publicly on Form N-PORT, may reduce demand for some of our data sets or make them more easily replicable. Although we believe our products and services contain value-added features and functionality that deeply embed them in our customers’ workflows, such developments may over time reduce the demand for, or customers’ willingness to pay for, certain of our products and services.
32
Table of Contents
If we fail to introduce innovative, proprietary research tools and frameworks or financial advisor software, we may not generate enough interest from potential clients to win new business. Consolidation within the financial services industry has provided our competitors resources to expand into adjacent business lines, often using our data in innovative ways or focusing on different client types or use cases. We cannot guarantee that we will successfully develop new product features and tools that differentiate our product offerings from those of our competitors.
In addition, we must make long-term investments and commit significant resources often before knowing whether such investments will result in products or services that satisfy our clients’ needs or generate revenues sufficient to justify such investments. In addition, from time to time, we also incur costs to transition clients to new or enhanced products or services. Such transitions can involve material execution risks and challenges. If we are unable to manage these investments and transitions successfully, our business, financial condition, and results of operations could be materially adversely affected.
Our results could suffer if fee compression within the asset and wealth management sectors continues, or if the financial industry continues to meaningfully consolidate.
Part of our growth since 1984 can be attributed to favorable industry trends as investors and their financial advisors embraced the need for complete, accurate, and timely research and data on investable securities. A significant portion of our research has historically focused on actively managed, equity-related funds. In 2019, the portion of assets invested in passively managed U.S. equity funds surpassed the assets invested in actively managed U.S. equity funds for the first time. Passively managed portfolios generally charge lower management fees than active strategies and lower management fees are a significant factor in investment recommendations of financial advisors and plan sponsors attempting to fulfill their fiduciary duties. However, the ascendance of passive strategies may affect both the profitability of asset managers, on whose success we in part depend, and the perceived value of our research regarding such strategies. In addition, the change in financial advisor activity away from security selection to goals-based asset allocation and portfolio construction and the increasing use of model portfolios, as well as the growth of online wealth management tools that provide automated, algorithm-based portfolio management advice, sometimes called robo-advice, may further reduce demand for our security-specific data and analyst research. In addition, as fee compression continues to affect recordkeepers, asset managers, and financial advisors, these customers for our software solutions and investment management and retirement solutions may seek price reductions and product enhancements to offset the effects of such compression on their businesses.
The growth of the mutual fund industry is also being affected by merger and acquisition activity within the asset management industry and brokerage and custodial distribution platforms, the pruning by some mutual fund and ETF platforms of the number of funds available for purchase, and the continuing impacts of regulation. This consolidation reduces the number of asset managers and platforms offering mutual funds and ETFs, reducing the number of potential customers in our traditional client base and increasing their relative bargaining power. With respect to regulation, the Markets in Financial Instruments Directive (MiFID II) in the EU, which requires that asset managers pay banks and brokers for investment research, has presented us with new business opportunities, but has also caused some of our clients to adapt their business practices and pricing models significantly to reflect or avoid these new costs, which may adversely affect their demand for our services. Industry consolidation also may reduce demand for our software products that support financial advisers and also gives the combined entities additional pricing power with respect to some of our investment products like Retirement Managed Accounts.
In addition, consolidation throughout the financial services industry among custodians, registered investment advisers, discount brokers, and record keepers provides surviving companies scale and resources to expand into adjacent service offerings which may compete with ours. For example, we have seen asset managers roll out model portfolios that compete with our managed portfolio offering. This trend requires us to continually expand and customize our service offerings and ensure that our products remain seamlessly integrated with our customers’ business processes and technology.
Prolonged downturns, sustained volatility in the financial markets, or a lack of investor confidence could reduce investor interest and investment activity and decrease demand for our software, data, and analyst research products. Intermittent volatility that reduces issuance or increased investor interest in other investment vehicles can put negative pressure on our credit ratings and investment management businesses.
33
Table of Contents
Our acquisitions and other investments may not produce the results we anticipate.
We have completed numerous acquisitions over the past 10 years, and we intend to continue to pursue selective acquisitions to support our business strategy. However, there can be no assurance we can identify suitable acquisition candidates at acceptable prices. In addition, each acquisition presents potential challenges and risks. We may not achieve the growth targets that we established for the acquired business at the time of the acquisition. The process of integration may require more resources than we expected or present challenges that were not foreseen.
We may assume unintended liabilities or experience operating difficulties or costs that we did not forecast. We may also fail to retain key personnel of the acquired business, which would make it difficult to follow through on our operating goals for the business. If an acquisition does not generate the results we anticipate, it could have a material adverse effect on our business, financial condition, and results of operations.
We also have, and intend to continue to make, various investments in companies where we do not have or obtain a controlling interest. Such investments are motivated both by their prospective financial return and the access they give us to certain new technologies, products, business ideas, and management teams. While we obtain various rights in connection with such investments, the future value of such investments is highly dependent on the management skill of the managers of those companies.
We expect to continue making acquisitions and establishing investments and joint ventures as part of our long-term business strategy. Acquisitions, investments, and joint ventures involve a number of risks. They can be time-consuming and may divert management’s attention from day-to-day operations, particularly if numerous acquisitions are in process at the same time. Financing an acquisition could result in dilution from issuing equity securities, reduce our financial flexibility because of reductions in our cash balance, or result in a weaker balance sheet from incurring debt.
Risks Related to Legal and Regulatory Matters
Our investment management operations may subject us to liability for any losses that result from a breach of our fiduciary duties or a failure to comply with our duties to clients under applicable securities laws.
Three of our subsidiaries, Morningstar Investment Management LLC, Morningstar Investment Services LLC, and Morningstar Research Services LLC, are registered as investment advisors with the SEC under the Advisers Act. As Registered Investment Advisors, these companies are subject to the requirements and regulations of the Advisers Act. These requirements primarily relate to record-keeping, reporting, and standards of care, as well as general anti-fraud prohibitions. The fiduciary duties of a Registered Investment Adviser to its clients include an obligation of good faith and full and fair disclosure of all facts material to the client’s engagement of the advisor, an obligation to provide investment advice suitable for the particular client, an obligation to have a reasonable, independent basis for investment recommendations, an obligation when directing client brokerage transactions to seek the best execution thereof, and an obligation to vote client proxies in the best interests of the client. As Registered Investment Advisors, these subsidiaries are subject to on-site examination by the SEC.
In addition, in cases where these subsidiaries provide investment advisory services to retirement plans and their participants, they may be acting as fiduciaries under ERISA. As fiduciaries under ERISA, they have obligations to act in the best interest of their clients. They also have duties of loyalty and prudence, as well as duties to diversify investments and to follow plan documents to comply with the applicable portions of ERISA.
Our subsidiaries outside the U.S. that have investment advisory operations are subject to similar requirements.
34
Table of Contents
We may face liabilities for actual or claimed breaches of our fiduciary duties, particularly in areas where we provide retirement advice and managed retirement accounts. In some of our retirement contracts, we act as an ERISA fiduciary by, for example, selecting and monitoring a broad range of diversified plan options. We also provide a managed account service for retirement plan participants who elect to have their accounts managed by our programs. Such activities have been the subject of increasing class action litigation in recent years. For example, in 2017, a participant in a pension plan filed a putative class action proceeding against us alleging that we, together with other defendant parties, violated the Racketeer Influenced and Corrupt Organizations Act by allegedly engaging in actions to steer plan participants into high-cost investments that pay unwarranted fees to the defendants. Our motion to dismiss that proceeding was granted, but there can be no assurance that other putative class action proceedings based on the same or other legal theories may not be brought against us in different contexts or, if brought, will be successfully dismissed. We could face substantial liabilities related to our management of assets in our managed retirement accounts.
We rely on automated investment technology for our retirement advice and managed retirement accounts services. The Wealth Forecasting Engine is our core advice and managed accounts engine that determines appropriate asset allocations for retirement plan participants and assigns individuals to portfolios. We also rely on automated portfolio construction tools. As these become more interconnected with other product offerings, including the technology of clients and other third parties, the increasing complexity of the technology requires more expertise and efforts to manage and test. Problems could arise if these programs do not work as intended, particularly if we failed to detect program errors over an extended period and are found to be a breach of our fiduciary duty or applicable law.
We seek to constantly innovate and improve our retirement services offering, and in doing so, we regularly release new versions of the technology and update our methodology. Additional customer support may be needed to ensure that clients implement the new versions and updates properly and understand the implications for their plan participants. If we make an error, we may be subject to potentially large liabilities for make-whole payments and/or litigation. We cannot quantify the potential size of these liabilities with any level of precision.
In addition, we may face other legal liabilities based on other theories of liability relating to various substantive requirements of the Advisers Act and other federal and state securities laws, even in the absence of an actual or claimed breach of fiduciary duty. We could face substantial liabilities related to the investment advisory and management services we provide.
Compliance failures, regulatory action, or changes in laws applicable to our credit ratings operations, investment advisory, ESG and index businesses could adversely affect our business.
DBRS Morningstar, our credit ratings business, operates in a highly regulated environment in Canada, the U.S., the U.K., and the EU. The laws and regulations governing credit ratings impose substantial ongoing compliance obligations and costs and subject DBRS Morningstar to regular regulatory examinations and occasional investigations, relating to the company itself or sometimes to the credit ratings industry as a whole. In operating under these laws and regulations, DBRS Morningstar can experience good faith uncertainty over the scope, interpretation, and administration of such laws and regulations. In addition, differences between the laws and rules governing credit rating agencies in Canada, the U.S., the U.K., and the EU can result in inconsistent regulatory requirements that it may not be possible to fully reconcile in a cost-efficient manner for a credit rating agency of DBRS Morningstar's size.
New laws, regulations and regulatory implementation guidance may also affect the day-to-day operation of the business of DBRS Morningstar, its customers, and users of its credit ratings, including by imposing new or expanded requirements on such matters as communications with issuers as part of the rating assignment process, the manner in which DBRS Morningstar’s ratings are developed and communicated, the manner in which customers may use credit ratings, and other aspects of the business model for credit rating agencies. Failures by DBRS Morningstar could lead to fines, settlements, and/or temporary or permanent operating restrictions. Further, many aspects of credit ratings agency policies and practices and their compliance with applicable law, regulations, contracts and license arrangements are not the subject of definitive regulatory guidance or case law.
35
Table of Contents
Our investment management operations are subject to complex securities laws and other laws in multiple jurisdictions. The activities of our investment advisory operations in the U.S. are subject to provisions of the Advisers Act, ERISA, and, in the case of our advisory relationship with the Morningstar Funds Trust, the Investment Company Act of 1940 and the Commodity Exchange Act. In addition, Morningstar Investment Services is a broker/dealer registered under the Exchange Act and is subject to the rules of FINRA. If we fail to comply with securities laws and other regulatory requirements, we may be subject to fines or other events that could have a negative effect on our business.
We also provide investment advisory services in other areas around the world, and our operations are subject to additional regulations in markets outside the U.S. In preparation for the end of the transition period following the U.K.’s exit from the EU, we restructured our European investment management operations. While we have been conditionally granted authorization for our French investment advisory subsidiary to continue to provide investment advisory services to those EU institutional clients previously serviced by our U.K. based investment advisory subsidiary, this process has been time consuming and has resulted in increased costs and duplication of functions. Furthermore, as there has not been an “equivalence” determination in terms of applicable regulations in the U.K. and the EU following Brexit, we anticipate ongoing costs to monitor and comply with potentially diverging legal and regulatory developments in each jurisdiction.
The Morningstar Funds Trust, a registered open-end mutual fund for which Morningstar Investment Management acts as investment advisor under an investment management agreement. The independent Board of Trustees of the Morningstar Funds Trust must annually approve the terms of the investment management agreement (including fees) and can terminate the agreement upon 60-days' notice. If we are no longer able to satisfy the Board of Trustees of our effective management of the Morningstar Funds Trust, the Board has authority to lower the fees that we receive or terminate our contract, which could have a material adverse effect on the revenues and net income of our investment advisory services.
Our Sustainalytics business could be negatively affected by increased regulation of ESG research and data. To date, regulatory activity, principally in the EU, has focused on new ESG disclosure requirements for publicly traded companies, and rules relating to the design, delivery and sale of financial services and products using ESG labels. Sustainalytics as a research and data provider has not been affected directly by this regulation. However, certain European regulators have proposed new legislation that would grant the European securities regulator, ESMA, supervisory powers over ESG data providers. ESG data providers would be required to disclose the sources of their data, their data collection processes, how missing data is estimated, and their data quality controls, among other things. ESG data providers would have to detail their governance and internal controls, their compliance practices for managing conflicts of interest, and their review functions for monitoring methodologies, models and key rating assumptions. The proposed regulation would require consistency of fees to ensure that the provision of sustainability-related products/services are not discriminatory. Such a regulatory regime could impose significant compliance burdens and costs on Sustainalytics and, as with all new regulation, could be subject to ambiguous interpretation that could result in inadvertent noncompliance. Furthermore, as our Sustainalytics business operates globally and we look to integrate ESG factors throughout our products, we may be subject to future regulation in multiple jurisdictions, which may be inconsistent.
Our index business could be negatively affected by increased regulation of benchmarks generally, which could increase the costs and risks of producing and administering indexes. For example, ESMA has proposed that it be granted the authority to require benchmark administrators to modify their benchmarks. Such regulations may discourage market participants from continuing to use, administer, or contribute to indexes, trigger changes in the rules or methodologies relating indexes, and/or lead to declining demand for indexes.
The laws, rules, and regulations, and their interpretations, applicable to our business may change in the future, and we may not be able to comply with these changes without extensive changes to our business practices. In the recent past, the scope and pace of global regulatory change has both increased and involved shorter compliance time frames, which has increased both the risk that we will properly identify and respond to regulatory changes applicable to our operations and the risk that we will implement such changes on a timely and complete basis. Regulations aimed at increasing transparency for investors or providing individuals greater control over their own data may devalue the investments we have made in our data sets or reduce their use cases. In addition, the broad scope of our business operations makes it more difficult to monitor areas that may be subject to regulatory and compliance risk. Developments, such as the National Security Law in Hong Kong which reduce press freedoms could impact the safety of our local employees and ultimately cause us to discontinue operations in that jurisdiction. If we fail to comply with any applicable law, rule, or regulation, we could be fined, sanctioned, or barred from providing certain products and services in the future, which could adversely affect our business.
36
Table of Contents
Failure to protect our intellectual property rights, or claims of intellectual property infringement against us, could harm our brand and ability to compete effectively.
The steps we have taken to protect our intellectual property may not be adequate to safeguard our proprietary information. We rely primarily on patent, trademark, copyright, and trade secret rights, as well as contractual protections and technical safeguards, to protect our intellectual property rights and proprietary information. Despite these efforts, third parties may still attempt to challenge, invalidate, or circumvent our rights or improperly obtain our proprietary information. Further, effective trademark, copyright, and trade secret protection may not be available in every country in which we offer our services. Failure to adequately protect our intellectual property could harm our brand, devalue our proprietary content, and affect our ability to compete in the marketplace.
From time to time, we encounter jurisdictions in which one or more third parties have a pre-existing trademark registration in certain relevant international classes that may prevent us from registering our own marks in those jurisdictions. Our continued ability to use the “Morningstar” name or logo, either on a stand-alone basis or in association with certain products or services, could be compromised in those jurisdictions because of these pre-existing registrations. Similarly, from time to time, we encounter situations in certain jurisdictions where one or more third parties are already using the Morningstar name, either as part of a registered corporate name, a registered domain name, or otherwise. Our ability to effectively market certain products and/or services in those locations could be adversely affected by these pre-existing usages.
We have from time to time been subject to claims by third parties alleging infringement of their intellectual property rights. Such claims can also be alleged against clients, customers, or distributors of our products or services whom we have agreed to indemnify against third party claims of infringement. The defense of such claims can be costly and consume valuable management time and attention. We may be forced to settle such claims on unfavorable terms, which can include the payment of damages, the entry into royalty or licensing arrangements on commercially unfavorable terms, or the suspension of our ability to offer affected products or services. If litigation were to arise from any such claim, there can be no certainty we would prevail in it. If any of these risks were to materialize, it could have a material adverse effect on our business, financial condition, or results of operations.
Risks Related to Our Information Technology and Security
We could face significant reputational and financial consequences relating to cybersecurity and the protection of confidential information, including personal information about individuals.
Our business requires that we securely collect, process, store, and transmit confidential information, including personal information, relating to our operations, customers, employees, and other third parties. We continuously invest in systems, processes, controls, and other security measures to guard against the risk of improper access to or release of such information. However, these measures do not guarantee absolute security, and improper access to or release of confidential information may still occur through employee error or malfeasance, system error, other inadvertent release, failure to properly purge and protect data, or cyberattack. Furthermore, these security measures are less effective in situations where employees are utilizing personal devices and home networks while working remotely.
We may suffer malicious attacks by individuals or groups (including those sponsored by nation-states, terrorist organizations, or global corporations seeking to illicitly obtain technology or other intellectual property) seeking to attack our products and services or penetrate our network infrastructure to gain access to confidential information, including personal information, or to launch or coordinate distributed denial of service attacks. While we have dedicated resources responsible for maintaining appropriate levels of cybersecurity and implemented systems and processes intended to help identify cyberattacks and protect and remediate our network infrastructure, these attacks have become increasingly frequent, sophisticated, and difficult to detect. Our measures may not be adequate for all eventualities and may be vulnerable to circumvention of security systems, denial of service attacks or other cyberattacks, hacking, “phishing” attacks, computer viruses, ransomware or malware, employee or insider error, employee or vendor malfeasance, social engineering, physical breaches or other malicious actions.
37
Table of Contents
We may also be impacted by a cyberattack targeting one of our vendors or within our technology supply chain or infrastructure. Recent well-publicized security breaches at government agencies and other companies have led to enhanced government and regulatory scrutiny of the measures taken by companies to protect against cyberattacks and may in the future result in heightened cybersecurity requirements, including additional regulatory expectations for oversight of customers, vendors, and service providers. Our information technology systems interact with those of customers, vendors, and service providers and collect an increasing amount of data as we expand our product and service offerings, for example in financial planning. Our contracts with those parties typically require them to implement and maintain adequate security controls, but we may not have the ability to effectively monitor the security measures of all our customers, vendors, and service providers. These risks may be heightened in connection with employees working from remote work environments occasioned by the COVID-19 pandemic as our dependency on certain service providers, such as video conferencing and web conferencing services, has significantly increased. In a number of cases, our customers build and host their own web applications and access our solutions through our APIs. In these cases, additional risks reside in the customer’s system with respect to security and preventive controls. As a result, inadequacies of our customers’ security technologies and practices may only be detected after a security breach has occurred.
Any failure to safeguard confidential information or any material cybersecurity failures or incidents in our systems (or the systems of a customer, vendor, or service provider which stores or processes confidential information for which we are responsible) could cause us to experience reputational harm, loss of customers, regulatory actions, sanctions or other statutory penalties, litigation, or financial losses and increased expenses related to addressing or mitigating the risks associated with any such material failures or incidents.
In addition to the risks above related to general confidential information, we may also be subject to specific obligations relating to personal information and personal financial information. Our products and websites in certain cases collect, store, process, and transmit personal information about an individual, including personally identifiable information and personal financial information such as portfolio holdings, account numbers, and credit card information. Our business also operates across national borders and routinely moves personal information from one jurisdiction to another. We and our customers are often subject to federal, state, and foreign laws relating to privacy, cybersecurity, and data protection. The scope of the laws that may be applicable is often uncertain and may be inconsistent with laws of other jurisdictions. Consequently, our business is subject to a variety of continuously evolving and possibly conflicting regulations and customer requirements. Our compliance with these changing and increasingly burdensome regulations and requirements may cause us to incur substantial costs or require us to change our business practices which may impact financial results. If we fail to comply with these regulations or requirements, we may be exposed to litigation expenses and possible significant liability, fees, or fines. For example, in the EU, noncompliance with the General Data Protection Regulation (GDPR) requirements could result in penalties of up to 4% of worldwide revenues.
Additionally, we make disclosures and statements regarding our use of personal information through our privacy policies and statements covering our products and websites as required by privacy or data protection regulation. One of Morningstar’s core strengths is the ability to collect data and enrich it with data from another part of the business to provide valuable information and insights to investors. As data is accessible across our products, consistent data privacy practices and disclosure becomes more important and challenging. Failure to comply with our public statements or to adequately disclose our privacy or data protection practices could result in costly investigations by governmental authorities, litigation, and fines as well as reputational damage and customer loss.
We also from time to time acquire other companies that collect and process personal information. While we perform extensive due diligence on the technology systems and practices of these companies, there can be no assurance that such companies have not suffered data breaches or system intrusions prior to or continuing after our acquisition for which we may be liable. Acquired businesses may not have invested as heavily in such security measures or data privacy controls and they introduce additional cybersecurity and data privacy risk as their systems are integrated with ours.
While we maintain insurance coverage that is intended to address certain aspects of cybersecurity and data protection risks, such coverage may not be sufficient to cover all or the majority of the costs, losses, or types of claims. Our insurance coverage would not extend to any reputational damage, loss of customers, or required improvements to our systems.
38
Table of Contents
Failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy may negatively affect our competitive position and business results.
We believe the technology landscape has been changing at an accelerating rate over the past several years. Changes in technology are fundamentally changing the ways investors, issuers and other market participants access data and content. Examples include the shift from local network computing to cloud-based systems, the proliferation of wireless mobile devices, rapid acceleration in the use of social media platforms, the dissemination of data through application programming interfaces that permit real-time updating rather than raw data feeds, and the proliferation of machine learning and other artificial intelligence technologies. As our customers further automate their business processes, their need for our products may change and the technological flexibility and interoperability of our systems may become more important. In addition, there has been an increasing focus on technology not merely supplying additional tools for users, but also offering solutions to specific client problems.
Our software development process is based on frequently rolling out new features so that we can quickly incorporate user feedback. While some changes in technology may offer opportunities for Morningstar, we cannot guarantee that we will successfully adapt our product offerings to meet evolving customer needs or that the transition to such new offerings will be seamless. If we fail to develop and implement new technology rapidly enough, we may sacrifice new business opportunities or renewals from existing customers. We may also incur additional operating expense if major software projects take longer than anticipated or if clients decline to migrate to new systems and we must support two platforms over an extended period of time. Our technology is also heavily dependent on the quality and comprehensiveness of our data and our ability to successfully build analytics, research, and other intellectual property around that data. We are investing significant resources in consolidating our various data assets and improving their usability and deliverability across our platform of products. Our competitive position and business results may suffer if we fail to develop new technologies to meet client demands, if our execution speed is too slow, if we adopt a technology strategy that doesn't align with changes in the market, or if we fail to realize the value and potential of our data assets.
Finally, we rely on technology for our own internal business operations and must continually evaluate these tools to ensure they are sufficient for our expanding needs. If we are unable to develop or purchase technology to support our finance, legal, compliance, audit, human resources, and other corporate teams, these functions may operate inefficiently, at higher cost, or with greater risks than is necessary.
We could face liability for the information and data we collect, store, use, create, and distribute or the reports and other documents we publish or that are produced by our software products.
We may be subject to claims for securities law violations, defamation (including libel and slander), negligence, or other claims relating to the information we publish, including our research and credit ratings. For example, investors may take legal action against us if they rely on published information that contains an error, or a company may claim that we have made a defamatory statement about it or its employees. In addition, in our credit ratings business, we have access to significant amounts of material nonpublic information on issuers of securities, the inadvertent disclosure of which, or the misappropriation by employees or others, could expose us to various liabilities under securities and other laws.
Some of our products support the investment processes or the client account reporting practices and other activities of our clients who manage significant assets of other parties. Use of our products as part of such activities creates the risk that clients, or the parties whose assets are managed by our clients, may pursue claims against us for losses that may have some connection to our products, and we may be subject to investigation of our products and their use by government regulators who regulate the business of our clients. In the case of software products, even though most of our contracts for such products contain limitations of our liability in such cases, we may be required to make such clients or their customers whole for any losses in order to maintain our business relationships. We could also be subject to claims based on the content that is accessible from our website through links to other websites.
We rely on a variety of outside parties as the original sources for the information we use in our published data. These sources include securities exchanges, fund companies, hedge funds, transfer agents, issuers, and other data providers. We also incorporate data from a variety of third-party sources for many of our products including PitchBook. Accordingly, in addition to possible exposure for publishing incorrect information that results directly from our own errors, we could face liability based on inaccurate data provided to us by others. For example, our Sustainalytics business is reliant on self-reported information for some of its issuer focused ESG ratings and analysis. We also face the risk that a significant data source terminates its distribution of the data to us, which could impact our products, research, or other calculations that utilize that information.
39
Table of Contents
We could be subject to claims by providers of data and information we compile from websites and other sources that we have improperly obtained that data in violation of the source’s copyrights or terms of use. We could also be subject to claims from third parties, such as securities exchanges from which we license and redistribute data and information, that we have used or redistributed the data or information in ways not permitted by our license rights or that we have inadequately permissioned our clients to use such data. The agreements with such exchanges and other data providers give them extensive data use audit rights, and such audits can be expensive and time consuming and potentially result in substantial fines. We could also be subject to claims from regulators that we have mishandled nonpublic data and information, in particular in our credit ratings business. These regulatory bodies have audit rights regarding our data use which could have similar adverse consequences in terms of time, expense, or fines. Defending claims based on the information we publish could be expensive and time-consuming and could adversely impact our business, operating results, and financial condition.
Finally, our global business regularly seeks to optimize our data storage in order to improve information accuracy and streamline the technology, which supports our business operations. These efforts are constrained by data privacy legislation, such as GDPR, which defines standards for storage, transfer, and use of certain personal information from and about individuals. Legislation aimed at protecting material nonpublic information or mitigating potential conflicts of interest further define how certain information can be accessed and retained which may result in less efficient or higher cost technological processes and infrastructure.
An outage of our database, technology-based products and services or network facilities could result in reduced revenue and the loss of customers, and our movement of parts of our technological and data infrastructure to the public cloud and other outsourced providers could expose us to various third party provider risks.
The success of our business depends upon our ability to deliver time-sensitive, up-to-date data and information that meets client expectations and contractual requirements. We rely extensively on our computer systems, database storage facilities, and other network infrastructure, which is located across multiple facilities in the U.S. and globally. Our mission-critical databases and networks are complex and interdependent, which increases the risk of failure. As we grow through acquisitions, the newly acquired businesses may not have invested in technological infrastructure and disaster recovery to the same extent as we have. As their systems are integrated into ours, a vulnerability could be introduced, which could impact our platforms across the company. Problems in our network systems may lead to cascading effects involving product downtime, overloading of third-party data centers, and other issues that may affect our clients. Many of our client contracts contain service-level agreements that require us to meet certain obligations for delivering time-sensitive, up-to-date data and information. We may not be able to meet these obligations in the event of failure or downtime in our information systems.
Our operations and those of our suppliers and customers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, computer viruses, and other events beyond our control. Our database and network facilities may also be vulnerable to external attacks that misappropriate our data, corrupt our databases, or limit access to our information systems. To defend against these threats, we implement a series of controls focusing on both prevention and detection, including firewalls, intrusion detection systems, automated scanning and testing, server hardening, antivirus software, training, and patch management. We make significant investments in servers, storage, and other network infrastructure to prevent incidents of network failure and downtime, but we cannot guarantee that these efforts will work as planned.
Most of our products and services depend heavily on our electronic delivery systems and the Internet, although we are shifting the storage of our data and delivery of several of our products and services to cloud-based delivery systems. We rely on cloud providers and other vendors to maintain, service, and improve our technological infrastructure, which underpins and protects our data, research, and other products and services. In addition, in the remote work environments occasioned by the COVID-19 pandemic, the daily activities and productivity of our work force is now closely tied to key vendors, such as video conferencing services, consistently delivering their services without material disruption. Our ability to deliver information using the Internet and to operate in a remote working environment may be impaired because of infrastructure failures, service outages at third-party Internet providers, malicious attacks, or other factors. If disruptions, failures, or slowdowns of these electronic delivery systems or the Internet occur, our ability to distribute our products and services effectively and to serve our customers may be impaired.
40
Table of Contents
We maintain off-site backup facilities for our data, but we cannot guarantee that these facilities will operate as expected during an interruption that affects our primary facility. There may be single points of failure that affect our core databases, data transfer interfaces, or storage area networks. We may not be able to fully recover data or information lost during a database or network facility outage. Any losses, service disruption, or damages incurred by us could have a material adverse effect on our business, operating results, or financial condition.
Risks Related to Our Operations
The current COVID-19 pandemic may have material and adverse impacts on our business, financial condition, and results of operations, the nature and extent of which continue to be uncertain and unpredictable.
The current COVID-19 pandemic and the governmental and societal responses to it worldwide have the potential to materially and adversely affect our business, financial condition, and results of operations in ways that continue to be uncertain and unpredictable. The COVID-19 pandemic has created significant public health concerns, as well as significant volatility, uncertainty, and economic disruption in most countries in which we operate. While we have taken numerous steps to respond to this changing environment, there can be no assurance that such steps will be successful or that our business, financial condition, and results of operations will not be materially and adversely affected by the consequences of the pandemic.
Throughout 2020, we saw fluctuations of government-mandated COVID-19-related restrictions on the physical movement and gathering of people in certain geographies, dependent upon the local extent and severity of COVID-19 infections and other factors. Those fluctuations have continued into 2021 as certain governments, such as the United Kingdom, have again imposed comprehensive lockdowns. Our approach to preventative and protective actions has remained similarly flexible and, although a significant portion of our workforce continues to work from remote work environments, we have been able to bring back some employees to office locations on a volunteer-only basis. Many of our customers, vendors, and data suppliers continue to operate under similar arrangements, which may interfere with attendance or productivity. While our business continuity plans have permitted remote working arrangements without material interruption, prolonged periods of virtual collaboration may have an impact on innovation, productivity, and culture over time. Our management is focused on mitigating the effects of the COVID-19 pandemic on our business, which has required and may continue to require a substantial investment of their time and may delay other strategic activities.
In the longer term, the adverse effects of the COVID-19 pandemic on the world’s economies and financial markets may be significant, with unpredictable effects on the overall demand and pricing environment for our products and services. While 2020 saw periods of growth in many financial markets and our business showed resiliency, uncertainty around the continuing extent and severity of the COVID-19 pandemic, the willingness of governments and central banks to continue fiscal and monetary stimulus, and national and global political conditions may undermine or reverse such growth. If that turns out to be the case, our asset management businesses could be affected by declines in assets under management and advisement resulting from any prolonged downturn in financial markets and a concomitant decline of broad-based investment activity, while our credit ratings business could suffer from a decline in new issuance activity resulting from a decline in the availability of credit. The financial performance of our customers, including those of our license businesses, could materially deteriorate, which could result in lower demand, cancellations, price reductions, or delays in implementation for our products and services. The uncertainty surrounding the duration and the effects of the COVID-19 pandemic in the countries in which we operate could impede our business planning and coordination. In addition, the availability of credit could become constrained even to financially strong companies.
41
Table of Contents
Our business, products and facilities are at risk of a number of material disruptive events which our operational risk management and business continuity programs may not be adequate to address.
Our business and major products are dependent on our ability to provide data, software applications, and other products and services on a current and time-sensitive basis. We are at risk of disruptions from numerous factors, including pandemic, violent incident, natural disaster, power loss, telecommunications and Internet failures, civil unrest, cybersecurity attacks and breaches, and other events beyond our reasonable control. We are also subject to potential shortcomings in our own business resilience practices, such as failures to fully understand dependencies between different business processes across the locations in which they are performed, inadequate vendor risk assessment and management processes and critical vendor dependencies, concentration of certain critical activities in areas of geopolitical risk, concentration of certain skills and know-how with small groups of key employees, and possibly ineffective location recovery strategies in the event of a location disruption. We continue to develop processes to support our employees working remotely, but we remain exposed to disruptive events at our significant office locations.
Our corporate headquarters in Chicago, Illinois is the home office for a significant number of our employees including most of our executive leadership team, as well as substantial numbers of employees involved in the delivery of most of our major products and services. If a pandemic, natural disaster, a violent incident, or another dangerous emergency significantly impacted the safety or communication connectivity of people living in and around Chicago, we might not be able to continue business operations at an acceptable level that would meet all our legal and contractual commitments. Civil unrest in downtown Chicago caused us to close our headquarters office several times during 2020, disrupting workflow for local employees and requiring agility from our facilities and other teams focused on ensuring the safety and security of our business operations.
We also have a substantial number of employees working in our data and technology development center in Shenzhen, China. We rely on these employees to maintain and update our mutual fund database and work on other projects. Because China has a restrictive government under centralized control and the relationship between the U.S. and China is experiencing a period of increased political, military, trade, and other commercial tensions, our operations are subject to political and regulatory risk, which is inherently unpredictable. Laws and regulations relating to data privacy, security, protection of intellectual property rights, and acceptable telecommunication infrastructure in China, as well as the enforcement environment for such laws and regulations, are in certain cases uncertain and evolving. In addition, this facility is subject from time to time to extreme weather events, which has limited employees' access to our offices. The concentration of certain types of development and data work carried out at this facility also involves operational risks for parts of our network infrastructure. While we have short-term backup plans in place, it would be difficult for us to maintain and update our mutual fund database if we were unable to maintain the continuity of our Shenzhen operations for an extended period of time. Any difficulties that we face in continuing to operate our development center in China may harm our business and have a negative impact on the products and services we provide.
Our data collection, technology, and operational center in Mumbai, India is also a significant location with many of our employees. These employees maintain and update our equity database and PitchBook's data and research operations, and provide shared services to many of our operations. This location is subject to extreme weather events and political unrest, including public protests that can disrupt transportation and make it difficult for employees to commute to and from work. The electrical infrastructure of Mumbai is also subject to more frequent interruptions than are experienced at our other major facilities. In addition, Mumbai has experienced and may in the future experience terrorist attacks. While we have short-term backup plans in place to address such business continuity issues, it would be challenging for us to maintain and update our equity database or continue to provide certain shared services to our worldwide operations if we were unable to maintain the continuity of our Mumbai operations for an extended period of time.
We engage third party vendors in several locations, including Colombia, India, and Ukraine, which provide contract labor in support of our operations. Each of these locations has experienced various types of geopolitical risks and the labor force at those locations may be subject to instructions from the third party vendors in the case of a disruptive event that might need to take into consideration priorities different from our own. Any extended disruptions to our contract operations in these locations would make it difficult for us to meet our operating goals.
42
Table of Contents
Our future success depends on our ability to recruit, develop, and retain qualified employees.
The development, maintenance, and support of our products and services are dependent upon the knowledge, skills, experience, and abilities of our employees. Accordingly, we believe the success of our business depends to a significant extent upon the continued service of our executives and other key employees. We experience competition for analysts, technology experts, data and software engineers, and other employees from other companies and organizations. Competition for these employees is intense, and we may not be able to retain our existing employees or be able to recruit and retain other highly qualified personnel in the future. In addition, we are exposed to overall rising wage scales in the employment markets in which some of our facilities are located, such as our development center in China, which negatively affects our ability to hire personnel generally without significantly increasing our compensation costs. In China, we believe our ability to hire qualified personnel is also being negatively impacted by the preference of job candidates to work for Chinese companies, as opposed to multinationals, in a period of increasing international tensions.
Our future success also depends on the continued service of our executive officers, including Joe Mansueto, our Executive Chairman and Chairman of the Board and largest shareholder, and Kunal Kapoor, our Chief Executive Officer. The loss of Mansueto, Kapoor, or other executive officers could hurt our business, operating results, or financial condition. We do not have employment agreements, noncompete agreements, or life insurance policies in place with any of our executive officers. They may leave us and work for our competitors or start their own competing businesses.
Our operations outside of the U.S. involve additional challenges that we may not be able to meet.
Our operations outside of the U.S. constitute a significant portion of our consolidated revenue. There are risks inherent in doing business outside the U.S., including challenges in reaching new markets because of established competitors and limited brand recognition; difficulties in staffing, managing, and integrating non-U.S. operations; difficulties in coordinating and sharing information globally; differences in laws and policies from country to country, including in relation to employment terms and conditions; exposure to varying legal standards, including intellectual property protection laws; potential tax exposure related to transfer pricing and other issues; heightened risk of fraud and noncompliance in some jurisdictions; and currency exchange rates and exchange controls.
In addition, new risks have arisen from the assertion by various national governments of greater control over the movements of people and information across national borders. For example, changes to immigration policy in the U.K. as a result of Brexit and in the U.S. as a result of continued restrictive immigration enforcement could adversely affect our ability to attract and retain talent from other countries. In addition, China’s government has backed various measures that could compromise the privacy and security of our proprietary information or information concerning our customers, including a ban on nonstate sanctioned virtual private networks and requirements that multinational firms acquire and use equipment from Chinese telecom suppliers, while recent court decisions in the EU have raised questions about the ability of multinational companies to process personally identifiable information of EU residents outside of the EU. These risks could hamper our ability to expand around the world, which may hurt our financial performance and ability to grow.
We don't engage in currency hedging or have any positions in derivative instruments to hedge our currency risk. Our reported revenue could suffer if certain foreign currencies decline relative to the U.S. dollar, although the impact on operating income may be offset by an opposing currency impact on locally based operating expense.
43
Table of Contents
Risks Related to Ownership of Our Common Stock
Our indebtedness could adversely affect our cash flows and financial flexibility. Our variable rate indebtedness could subject us to interest rate risk, which could cause our debt service obligations to increase significantly.
For an overview of our current outstanding indebtedness, refer to Item 7 — Management's Discussion and Analysis of Financial Condition and Results of Operations— Liquidity and Capital Resources below. While our business has historically generated strong cash flow and interest rates on corporate indebtedness are at historically low levels, we cannot provide assurance that we will generate and maintain cash flows sufficient to permit us to service our indebtedness. Our ability to make payments on indebtedness and to fund planned capital expenditures depends on our ability to generate and access cash in the future, which, in turn, is subject to general economic, financial, competitive, regulatory and other factors, many of which are beyond our control. If we cannot refinance or otherwise pay our obligations as they mature and fund our liquidity needs, our business, financial condition, results of operations, cash flows, liquidity, ability to obtain financing and ability to compete in our industry could be materially adversely affected.
In addition, a portion of our long-term indebtedness currently bears interest at fluctuating interest rates based on the London interbank offered rate (LIBOR) for deposits of U.S. dollars. During 2017, the U.K.’s Financial Conduct Authority (the authority that regulates LIBOR) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021, though certain USD LIBOR tenors are now expected to be published through mid-2023. It appears as though Secured Overnight Financing Rate (SOFR) is emerging as the preferred alternative to US Dollar LIBOR. SOFR is a broad measure of the cost of borrowing overnight collateralized by US Treasury securities. It is not possible to predict the effect of these changes on our borrowing costs over time or the availability to us of credit.
Furthermore, the terms of our debt agreements include restrictive covenants that limit, among other things, our and our subsidiaries’ financial flexibility. If we are unable to comply with the restrictions and covenants in our debt agreements, there could be a default that, in some cases, if continuing, could result in the accelerated payment of our debt obligations or the termination of borrowing commitments on the part of the lenders under our Credit Agreement. Refer to Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources for a description of the restrictive covenants in our debt agreements.
Control by a principal shareholder could adversely affect our other shareholders.
As of December 31, 2020, Joe Mansueto, our Executive Chairman and Chairman of the Board, owned approximately 45.5% of our outstanding common stock. As a result, he has the practical ability to control substantially all matters submitted to our shareholders for approval, including the election and removal of directors and any merger, consolidation, or sale of our assets. This concentration of ownership may delay or prevent a change in control, impede a merger, consolidation, takeover, or other business combination involving Morningstar, discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of the company, or result in actions that may be opposed by other shareholders.
Fluctuations in our operating results may negatively affect our stock price.
We believe our business has relatively large fixed costs and low variable costs, which magnify the impact of revenue fluctuations on our operating results. As a result, a decline in our revenue may lead to a larger decline in operating income. In addition, because we manage our business with a long-term perspective, we generally don’t make significant adjustments to our strategy or cost structure in response to short-term factors. As a result, our operating results may suffer in the short term. In addition, we do not provide earnings guidance or hold one-on-one meetings with institutional investors and research analysts. Because of this policy and limited analyst coverage on our stock, our stock price may not always reflect the intrinsic value of our business and assets. If our operating results or other operating metrics fail to meet the expectations of outside research analysts and investors, the market price of our common stock may decline.
44
Table of Contents
The future sale of shares of our common stock may negatively affect our stock price.
If our significant shareholders sell substantial amounts of our common stock, the market price of our common stock could fall. A significant reduction in ownership by Joe Mansueto or any other large shareholder could cause the market price of our common stock to fall. Our directors and officers may adopt written plans, known as Rule 10b5-1 plans, in which they may contract with a broker to sell shares on a periodic basis. In addition, the average daily trading volume in our stock is relatively low. The lack of trading activity in our stock may lead to greater fluctuations in our stock price. Low trading volume may also make it difficult for shareholders to make transactions in a timely fashion.
Item 1B. Unresolved Staff Comments
We do not have any unresolved comments from the Staff of the SEC regarding our periodic or current reports under the Exchange Act.
Item 2. Properties
As of February 12, 2021, we leased approximately 527,000 square feet of office space for our U.S. operations, with approximately half of the space for our corporate headquarters located in Chicago, Illinois. We also lease another 626,000 square feet of office space in 27 other countries around the world, including approximately 163,000 square feet in Mumbai, India and 121,000 square feet in Shenzhen, China. We believe that our existing and planned office facilities are adequate for our needs and that additional or substitute space is available to accommodate growth and expansion.
Item 3. Legal Proceedings
We incorporate by reference the information regarding legal proceedings set forth in Note 16 of the Notes to our Consolidated Financial Statements contained in Part II, Item 8 of this report.
Item 4. Mine Safety Disclosures
Not applicable.
45
Table of Contents
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the Nasdaq Global Select Market under the symbol "MORN".
As of February 12, 2021, there were 787 shareholders of record of our common stock.
We paid four dividends during 2020. In the fourth quarter of 2020, we increased our quarterly cash dividend from 30 cents per share to 31.5 cents per share. While subsequent dividends will be subject to board approval, we expect to pay a regular quarterly dividend of 31.5 cents per share in 2021.
Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent upon our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law, and other factors deemed relevant by the board of directors. Future indebtedness and loan facilities could also prohibit or restrict our ability to pay dividends and make distributions to our shareholders.
Issuer Purchases of Equity Securities
Subject to applicable law, we may repurchase shares at prevailing market prices directly on the open market or in privately negotiated transactions in amounts that we deem appropriate.
We have an ongoing authorization, most recently approved by the board of directors on December 8, 2017, to repurchase up to $500.0 million in shares of the Company's outstanding common stock. The authorization expired on December 31, 2020. On December 4, 2020, the board of directors approved a new share repurchase program that authorizes the company to repurchase up to $400.0 million in shares of the Company's outstanding common stock, effective January 1, 2021. The new authorization expires on December 31, 2023.
The following table presents information related to repurchases of common stock we made during the three months ended December 31, 2020:
46
Table of Contents
Rule 10b5-1 Sales Plans
Our directors and executive officers may exercise stock options or purchase or sell shares of our common stock in the market from time to time. We encourage them to make these transactions through plans that comply with Exchange Act Rule 10b5-1(c). Morningstar will not receive any proceeds, other than proceeds from the exercise of stock options, related to these transactions. The following table, which we are providing on a voluntary basis, shows the Rule 10b5-1 sales plans entered into by our directors and executive officers that were in effect as of January 29, 2021:
During the fourth quarter of 2020, the previously disclosed Rule 10b5-1 sales plans for Gail Landis and Bill Lyons completed in accordance with their respective terms.
_______________________________
(1)This column reflects an estimate of the number of shares each identified director and executive officer will beneficially own assuming the sale of all shares under the Rule 10b5-1 sales plan. This information reflects the beneficial ownership of our common stock on December 31, 2020 and includes shares of our common stock subject to options that were then exercisable or that will have become exercisable by March 1, 2021 and restricted stock units that will vest by March 1, 2021. The estimates do not reflect any changes to beneficial ownership that may have occurred since December 31, 2020. Each director and executive officer identified in the table may amend or terminate his or her Rule 10b5-1 sales plan and may adopt additional Rule 10b5-1 plans in the future.
(2) The number of shares to be sold under this plan represent approximately 40% of the gross shares vesting on May 15, 2021 and May 15, 2022.
(3) Based on the terms of Caroline Tsay's existing grants 1,165 shares will vest on May 15, 2021 resulting in the sale of 466 shares under the plan. The number of shares to be sold pursuant to grants vesting on May 15, 2022 and the projected beneficial ownership is dependent, in part, upon future share prices and is not reasonably estimable.
47
Table of Contents
Item 6. Selected Financial Data
The selected historical financial data shown below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and related notes included elsewhere in this report. We have derived our Consolidated Statements of Income Data and Consolidated Cash Flow Data for the years ended December 31, 2020, 2019, and 2018 and Consolidated Balance Sheet Data as of December 31, 2020 and 2019 from our audited Consolidated Financial Statements included elsewhere in this report. The Consolidated Statements of Income Data and Consolidated Cash Flow Data for the years ended December 31, 2017 and 2016 and Consolidated Balance Sheet Data as of December 31, 2018, 2017, and 2016 were derived from our audited Consolidated Financial Statements that are not included in this report.
48
Table of Contents
Consolidated Statements of Income Data
Net income per share:
Dividends per common share:
Weighted average common shares outstanding:
Consolidated Balance Sheet Data
49
Table of Contents
(1) On January 1, 2018, we adopted ASC Topic 606 using the modified retrospective transition method. Beginning on January 1, 2018, results are presented in accordance with this new accounting standard, while prior period amounts are not adjusted and continue to be reported in accordance with our historical policies.
(2) Revenue, operating income, and free cash flow in 2018 includes a $10.5 million revenue benefit related to an amended license agreement and the corresponding favorable cash impact.
(3) Non-operating income in 2017 included a $16.7 million gain related to the sale of HelloWallet. Non-operating income in 2018 included a $10.5 million gain related to the sale of our 15(c) board consulting services product line. Non-operating income in 2019 included a $19.5 million gain on the sale of our equity ownership in one of equity method investments. Non-operating income in 2020 included a $50.9 million holding gain on our previously held equity interest in Sustainalytics and a $30.0 million gain on the sale of our equity ownership in two of our equity method investments.
(4) Free cash flow is considered a non-GAAP financial measure under SEC regulations. We present this measure as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required to be reported under GAAP, nor should this data be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.
(5) Cash used for investing activities consists primarily of cash used for acquisitions, purchases of investments, net of proceeds from the sale of investments, capital expenditures, purchases of equity and cost-method investments, and proceeds from the sale of businesses, product lines, and equity investments. The level of investing activities can vary from period to period depending on the level of activity in these categories. Refer to Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources for more information concerning cash used for investing activities.
(6) Cash provided by (used for) financing activities consists primarily of cash used to make repayments on our credit facility, repurchase outstanding common stock through our share repurchase program, and dividend payments. These cash outflows are partially offset by proceeds from our revolving credit facility and stock option exercises. Refer to Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources for more information related to cash used for financing activities.
(7) We frequently invoice or collect cash in advance of providing services or fulfilling subscriptions for our customers and record these balances as deferred revenue. These amounts represent both current and non-current deferred revenue.
(8) Long-term liabilities in 2016, 2017, 2018, 2019, and 2020 include $250.0 million, $180.0 million, $70.0 million, $502.1 million, and $449.1 million of long-term debt, respectively.
50
Table of Contents
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion included in this section, as well as other under "Business--Our Strategy," "Business--Trends Defining Our Business" and sections of this report, 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:
•failing to maintain and protect our brand, independence, and reputation;
•liability for any losses that result from an actual or claimed breach of our fiduciary duties or failure to comply with applicable securities laws;
•liability related to cybersecurity and the protection of confidential information, including personal information about individuals;
•compliance failures, regulatory action, or changes in laws applicable to our credit ratings operations, investment advisory, ESG, and index businesses;
•prolonged volatility or downturns affecting the financial sector, global financial markets, and global economy and its effect on our revenue from asset-based fees and credit ratings business;
•the impact of the current COVID-19 pandemic on our business, financial condition, and results of operations;
•inadequacy of our operational risk management and business continuity programs in the event of a material disruptive event;
•failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy;
•failing to differentiate our products and services and continuously create innovative, proprietary, and insightful financial technology solutions;
•liability relating to the information and data we collect, store, use, create, and distribute or the reports that we publish or are produced by our software products;
•trends in the financial services industry, including fee compression within the asset and wealth management sectors and increased industry consolidation;
•an outage of our database, technology-based products and services, or network facilities or the movement of parts of our technology and data infrastructure to the public cloud and other outsourced providers;
•the failure of acquisitions and other investments to be efficiently integrated and produce the results we anticipate;
•the failure to recruit, develop, and retain qualified employees;
•challenges faced by our non-U.S. operations, including the concentration of data and development work at our offshore facilities in China and India;
•our indebtedness could adversely affect our cash flows and financial flexibility; and
•the failure to protect our intellectual property rights or claims of intellectual property infringement against us.
A more complete description of these risks and uncertainties can be found in Item 1A—Risk Factors of this report. If any of these risks and uncertainties materialize, our actual future results and other future events 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.
This section includes comparisons of certain 2020 financial information to the same information for 2019. Year-to-year comparisons of the 2019 financial information to the same information for 2018 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
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 prior year unless otherwise stated.
51
Table of Contents
Understanding Our Company
Key Business Characteristics
We offer an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors and other participants in the private capital markets. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.
Revenue
We generate revenue by selling a variety of investment-related products and services. We sell many of our products and services, including Morningstar Data, Morningstar Advisor Workstation, Morningstar Direct, and PitchBook, through license agreements. Our license agreements typically range from one to three years. We sell some of our other products, such as Premium Membership service, which represents subscription services available to customers and not a license under the accounting guidance, on Morningstar.com via subscriptions. These subscriptions are mainly offered for a one-year term, although we offer terms ranging from one month to three years.
Our investment management products have multiple fee structures, which vary by client and region. In general, we seek to receive asset-based fees for any work we perform that involves managing investments or acting as a subadvisor to investment portfolios. For any individual contract, we may receive flat fees, variable asset-based fees, or a combination of the two. Some of our contracts include minimum fee levels that provide us with a flat payment up to a specified asset level, above which we also receive variable asset-based fees. In the majority of our contracts that include variable asset-based fees, we bill clients quarterly in arrears based on average assets for the quarter. Other contracts may include provisions for monthly billing or billing based on assets as of the last day of the billing period rather than on average assets.
In our Workplace Solutions area, our contracts may include one-time setup fees, technology licensing fees, asset-based fees for managed retirement accounts, fixed and variable fees for advice and guidance, or a combination of these fee structures. We also offer plan sponsor advice and custom target-date consulting arrangements. Fees for these services may be based on the level of assets under advisement.
We also generate transaction-based revenue, primarily from DBRS Morningstar and from the sale of advertising on our websites and sponsorship of our conferences. For the year ended December 31, 2020, approximately 59.9% of the revenue generated by DBRS Morningstar came from one-time, transaction-based fees driven by our provision of ratings on newly-issued securities; whereas the remainder can be classified as transaction-related, with recurring annual fees tied to surveillance, credit research, or other services.
Deferred Revenue
We invoice some of our clients and collect cash in advance of providing services or fulfilling subscriptions for our customers. Deferred revenue totaled $340.3 million (of which $306.8 million was classified as a current liability with an additional $33.5 million included in other long-term liabilities) at the end of 2020. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our license and subscription agreements.
Significant Operating Leverage
Our business requires significant investments to create and maintain proprietary software, databases, and content. While the fixed costs of the investments we make in our business are relatively high, the variable cost of adding customers is relatively low. This reflects our business focus on Internet-based platforms and assets under management. At times, we may make investments in building our databases and content that cause weaker short-term operating results. During other periods, our profitability may improve because we're able to increase revenue without increasing our cost base at the same rate. When revenue decreases, however, we may not be able to adjust our cost base at a corresponding rate.
52
Table of Contents
Operating Expense
We classify our operating expense into separate categories for cost of revenue, sales and marketing, general and administrative, and depreciation and amortization, as described below. We include stock-based compensation expense, as appropriate, in each of these categories.
• Cost of revenue. This category includes compensation expense for employees who produce the products and services we deliver to our customers. For example, this category covers production teams and analysts who write investment research reports. It also includes compensation expense for programmers, designers, and other employees who develop new products and enhance existing products. In some cases, we capitalize the compensation costs associated with certain software development projects. This reduces the expense that we would otherwise report in this category. Cost of revenue also includes other expenses, such as third-party data purchases and data lines.
• Sales and marketing. This category includes compensation expense for our sales teams, product managers, and marketing professionals. We also include the cost of advertising, direct mail campaigns, and other marketing and promotion efforts in this category.
• General and administrative. This category includes compensation expense for our management team and other corporate functions, including employees in our compliance, finance, human resources, and legal departments. It also includes costs for corporate systems and facilities.
• Depreciation and amortization. Our capital expenditures mainly relate to capitalized software development costs, information technology equipment, and leasehold improvements. We depreciate property and equipment using the straight-line method based on the useful lives of the assets, which range from three to seven years. We amortize leasehold improvements over the lease term or their useful lives, whichever is shorter. We amortize capitalized software development costs over their estimated economic life, generally three years. We also include amortization related to identifiable intangible assets, which is mainly driven by acquisitions, in this category. We amortize intangible assets using the straight-line method over their estimated economic useful lives, which range from one to twenty years.
International Operations
As of December 31, 2020, we had majority-owned operations in 28 countries outside of the U.S. and included their results of operations and financial condition in our consolidated financial statements. We also have investments outside of the U.S., and where we have significant influence, including MJKK, we apply the equity method of accounting.
How We Evaluate Our Business
When our analysts evaluate a stock, they focus on assessing the company's estimated intrinsic value, which is based on estimated future cash flows, discounted to their value in today's dollars. Our approach to evaluating our own business works the same way.
Our goal is to increase the intrinsic value of our business over time, which we believe is the best way to create value for our shareholders. We do not make public financial forecasts for our business because we want to avoid creating any incentives for our management team to make speculative statements about our financial results that could influence our stock price or take actions that help us meet short-term forecasts, but may not build long-term shareholder value.
We provide three specific measures that can help investors generate their own assessment of how our intrinsic value has changed over time:
• Revenue (including organic revenue);
• Operating income (loss) (including adjusted operating income); and
• Free cash flow.
53
Table of Contents
Organic revenue, adjusted operating income, and free cash flow are not measures of performance set forth under U.S. generally accepted accounting principles (GAAP).
We define organic revenue as consolidated revenue excluding acquisitions, divestitures, adoption of new accounting standards, and foreign currency translations. We present organic revenue because we believe it helps investors better compare our period-to-period results, and our management team uses this measure to evaluate the performance of our business. We exclude revenue from businesses acquired or divested from organic revenue for a period of 12 months after we complete the acquisition or divestiture. Organic revenue is not equivalent to any measure required under GAAP and may not be comparable to similarly titled measures reported by other companies.
We define adjusted operating income as operating income excluding all M&A-related expenses and amortization. We present adjusted operating income because we believe it better reflects period-over-period comparisons and improves overall understanding of the underlying performance of the business absent the impact of M&A.
We define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under GAAP and should not be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.
We calculate revenue renewal rates to evaluate how successful we've been in maintaining existing business for products and services that have revenue associated with periodic renewals. We use the annual contract value method, which is based on tracking the dollar value of renewals compared with the total dollar value of contracts up for renewal during the period. We include changes in the contract value in the renewal amount. We also include variable-fee contracts in this calculation and use the actual revenue for the previous comparable fiscal period as the base rate for calculating the renewal percentage. The renewal rate excludes setup and customization fees and contract renewals that were pending as of January 31, 2021.
COVID-19 Update
We continue to closely monitor the impact of the COVID-19 pandemic on all aspects of our business and in the geographies in which we operate, including how it affects team members, customers, suppliers, and global markets.
Given the dynamic nature of these circumstances, the long-term impact of the COVID-19 pandemic on our ongoing business, results of operations, and overall future financial performance cannot be reasonably estimated at this time. While the recurring nature of our licensed-based revenue showed continued resilience throughout 2020, a prolonged economic downturn caused by the COVID-19 pandemic could lead clients to adjust purchasing decisions or product and service implementations, or may cause them to cancel or reduce spending with us. Our asset-based revenue is subject to global market conditions and client investment decisions, although the structure of certain contracts and timing of client asset reporting may cause certain impacts to be reflected in results with a lag. Transaction-based revenue primarily includes DBRS Morningstar, which is dependent on overall credit market conditions and debt issuance levels. We continued to benefit from strong Canadian corporate issuances. Nevertheless, credit market conditions remain sensitive to the overall global economic environment.
54
Table of Contents
Our operations also continue to be affected by a range of external factors related to the COVID-19 pandemic that are not within our control. For example, many jurisdictions continue to impose a wide range of restrictions on the physical movement of our employees and vendors to limit the spread of COVID-19. We have taken numerous steps, and will continue to take further actions, in our approach to addressing the COVID-19 pandemic. We continue to evolve our business continuity plans and our incident management team is in place to respond to changes in our global environment quickly and effectively. To protect the health and safety of our team members, we continue to conduct business with a large portion of our global workforce in remote work environments, which has had relatively little impact on the productivity of our employees, including our ability to gather data. Based on the guidelines of local authorities and our own safety standards, we continued to re-open certain offices on a limited capacity basis and will continue to do so to provide flexibility for employees with a focus on social distancing and safety. We are also working closely with our clients to support them as they implement their own contingency plans, helping them access our products and services remotely. To date, there have been minimal interruptions in our ability to provide our products, services, and support to our clients.
The situation surrounding the COVID-19 pandemic remains fluid, and we continue to actively manage our response and assess potential impacts to our financial position and operating results. This includes the continued evaluation and implementation of certain cost control efforts to help us mitigate the impact that reduced revenues may have on our financial results. We are focusing on maintaining a strong balance sheet and liquidity position. On October 26, 2020, we completed the issuance and sale of $350.0 million aggregate principal amount of 2.32% senior notes due October 26, 2030 in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. Our cash, cash equivalents, and investments totaled $464.2 million at December 31, 2020, and we had $350.0 million of availability under our $350.0 million revolving credit facilities. At December 31, 2020, we remain in compliance with our financial covenants under these facilities.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. The CARES Act provides a substantial stimulus and assistance package intended to address the impact of the COVID-19 pandemic, including tax relief and government loans, grants, and investments. On December 27, 2020, an additional stimulus was approved as part of the Consolidated Appropriations Act, 2021 (CAA). Many of the more recent coronavirus relief provisions are extensions and modifications of CARES Act provisions. The CARES Act and CAA had no impact on our consolidated financial statements for the year ended December 31, 2020. We continue to monitor any effects that may result from the CARES Act, CAA, and other similar legislation or governmental actions in geographies in which our business operates.
Regulatory Trends Affecting Our Business
In addition to the industry developments described under "Business - Trends Defining Our Business", there are several longer-term regulatory trends we consider relevant to our business, as outlined below.
General
2020 was a year of extensive disruption and adaptation for all businesses. Due to the global pandemic, businesses were required to rapidly adopt remote working arrangements and the increased use of online and digital communications technologies. The demand also increased for firms to adopt ESG-related business and operational risk strategies. These developments will have long term impacts on our delivery of products and services, customer interactions, physical operations, technology systems, and dependencies on third parties. In this environment, regulators are expected to more closely scrutinize the change management processes of regulated entities like Morningstar to ensure they comply with laws and regulations and to assess whether they are based on sound internal governance principles and structures. Given more intense regulatory scrutiny and the novelty of some of the issues presented, the possibilities for inadvertent noncompliance with regulation have increased.
55
Table of Contents
In addition, the trend towards increasingly fragmented regulatory activity as a period of global regulatory response and coordination has been replaced by different jurisdictions and regulators reasserting their full control of their own regulatory agendas is continuing. The causes of this trend are varied, including the change of administrations in the United States and the likely end to a period of more relaxed financial regulatory activity, the end of the transition period for the withdrawal of the U.K. from the EU and the effect on trans-European financial services providers, the lack of federal legislation in the United States in important areas like data privacy and consumer protection that has resulted in various states implementing divergent regulatory requirements, and the rise of disruptive technologies worldwide that permit greater personalization of interactions between financial services providers and their various customer segments.
The COVID-19 pandemic influenced the regulatory focus of 2020 as governments around the world tried to support users of financial services, and particularly those suffering serious detrimental impact from the pandemic. Many regulators, such as the FCA, made it clear that regulated firms must provide appropriate support to consumers facing financial difficulties. Even with these dramatic changes due to the pandemic, regulators globally have continued to focus on certain recurrent themes, including access to financial services, the quality of advice and the value of the services provided, the protection of customer data and transparency around the uses of such data, the minimization of conflicts of interest, and improvements in corporate governance and risk management.
Set forth below is a description of recent and prospective developments in regulation affecting each of our regulated lines of business as well as our business generally.
Investment Management
The U.K./EU Trade and Cooperation Agreement that was agreed on December 24, 2020 provides no new transition period for financial services, nor any new arrangements to replace the existing “passporting” regime. This leaves both the U.K. and EU to address matters of access in financial services through unilateral declarations of equivalence under existing equivalence regimes and through domestic laws. Morningstar Investment Management Europe Limited has lost the associated passporting rights required to deliver certain financial services across the EU and is operating under the temporary arrangements that the U.K. and certain EU-based state regulators have made. In anticipation of these developments, Morningstar Investment Consulting France SAS (MICF) applied for and has received provisional approval for categorization as a Markets in Financial Instruments Directive (MiFID) investment firm, permitted to provide investment advice as it pertains to certain types of securities across the EU. Authorization is expected once several related conditions are met.
In the U.S., the SEC's Regulation Best Interest became effective on June 30, 2020. The regulation requires brokers, who have previously been held to a suitability standard in relation to investment recommendations to their clients, to act in their clients’ best interests when making an investment recommendation. We have found this regulation to increase demand for certain of our solutions that assist brokers in demonstrating compliance with these obligations.
As in the U.S., recent regulations and guidance reports in places like Australia and New Zealand have focused on investment management compliance practices such as conflicts of interest and fee disclosures. The increased complexity and extent of regulatory change globally is a challenge for both Morningstar and its clients and we continue to expend resources to remain in compliance.
Retirement Solutions
On October 30, 2020, the U.S. Department of Labor (DOL) adopted amendments to the “Investment duties” regulation under Title I of ERISA, to confirm that ERISA requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action. While this regulation could have adverse effects on demand for our ESG-related retirement solutions, we anticipate that the DOL’s policy or enforcement priorities may change with the new administration in the U.S.
56
Table of Contents
Other recent regulatory developments in the U.S. are likely to have a positive impact on our Retirement Solutions business. For example, the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act, became effective in 2020 and is likely to increase the number of participants in defined- contribution plans increasing demand for our services. Also, the DOL announced a new prohibited transaction exemption that expands the scope of fiduciary investment advice to include rollover recommendations. While we do not anticipate any of Morningstar’s businesses will need to avail themselves of the exemption, we provide tools and other resources designed for financial institutions and investment professionals to help clients make an informed decision on possible rollover options that may be impacted by the change.
Indexes
The primary regulation concerning our index business is the EU Benchmarks Regulation, which seeks to ensure the use of benchmarks are free of conflicts of interest, are used appropriately, and reflect the actual market or economic reality they are intended to measure. Morningstar, Inc. received confirmation in August 2020 from the U.K. FCA that it was authorized to act as a third country benchmark administrator, within the EU, on a recognition basis.Morningstar Investment Management Europe Limited is currently appointed as the EU-based legal representative, but as this entity is domiciled in the U.K. and following the withdrawal of the U.K. from the EU, a different EU-based subsidiary will need to be qualified to act in this capacity. The EU has extended the associated benchmarks regulation transition period until the end of 2023.
Credit Ratings
On January 4, 2021, ESMA withdrew the registrations of all U.K.-based credit rating agencies, including DBRS Ratings Limited. Accordingly, all ratings of DBRS Ratings Limited will now require the endorsement of its EU-based credit ratings affiliate, DBRS Ratings GmbH. At present, the U.K. credit rating agency regulatory regime and the EU regime largely mirror each other, which should minimize any significant change in our overall operations. However, over time, either ESMA or the FCA may begin to make inconsistent modifications to those laws and regulations, which would increase the cost and complexity of regulatory compliance for our credit ratings business.
ESG
The EU has similarly taken the lead with respect to regulation of ESG. In July 2020, an EU-wide taxonomy (or combined glossary and classification system) of environmentally sustainable activities, as well as new disclosure requirements for certain financial services firms and large public interest entities was adopted. Portions of the regulation relating to climate change mitigation and adaptation are expected to become effective in January 2022 with the full regulation to become effective in January 2023. Also, an EU regulation on sustainability-related disclosures will take effect on March 10, 2021. The regulation will require various investment market participants to implement policies and make certain disclosures with regards to sustainability risks and sustainability factors relevant to their investment activities. ESMA has also proposed to the European Commission that legislation should be adopted regulating providers of ESG ratings and assessment tools, including by adopting a regulatory model similar to that in place with respect to credit rating agencies.
Regulators in other jurisdictions as diverse as China and the UAE have also begun to work on ESG-disclosure related frameworks. While green bond issuances are on the rise in the U.S., there is no set framework or statutory definition in the U.S. for such financings. While legal authority to regulate sustainable investing and finance exists in the U.S., there has not yet been systemic consideration of the regulation of sustainable finance in the U.S.
Data Privacy and Cybersecurity
Data privacy regulation continues to proliferate, as numerous national and state jurisdictions are considering new data privacy regulations. The GDPR continues to be a major influence on the global privacy landscape. Many non-EU countries are following the EU’s lead and implementing rules similar to GDPR in their jurisdictions to enable cross-border data exchange. Australia, Brazil, China, India, and Korea have all implemented, or are moving to implement, data privacy laws that resemble GDPR in certain respects. A recent decision from the Court of Justice of the EU has called in to question common practices regarding international data flows and the use of data transfer mechanisms, causing us, our clients and companies across the financial services industry, to reconsider our compliance practices.
57
Table of Contents
In the U.S., the California Consumer Privacy Act (CCPA) went into effect in January 2020. CCPA, heavily influenced by GDPR, is the first comprehensive data privacy law in the U.S. to date. In November 2020, California voters adopted the California Privacy Rights Act (CPRA), which adds additional privacy requirements, such as rights of correction and rights to opt out of automated decision-making technologies and expanded opt out and data portability rights. CPRA is expected to become effective on January 1, 2023. Several other states have adopted or are considering the adoption of privacy regulations.
With the new U.S. administration and control by one party of both houses of Congress, 2021 is thought by some observers to be a year in which comprehensive Federal privacy regulation could be successfully adopted.Regardless, since operations in the financial services industry require the processing of significant amounts of personally identifiable information, we believe the burdens of regulation, and possibly inconsistent regulation, will proliferate, particularly in the application of such laws and regulations to particular persons, categories of personal information, or types of transactions.
As a related matter, issues of cybersecurity as they relate to the identification and mitigation of system vulnerabilities also continue to grow in prominence and laws governing data breaches continue to proliferate globally. Financial regulators have also increased scrutiny on the data protection practices of the entities, such as Morningstar, that they oversee. Several countries including Singapore, Hong Kong, and Australia have shown increasing sensitivity in regard to information security, outsourcing and the use of cloud based services.For example, the SEC's Office of Compliance Inspections and Examinations prioritized cybersecurity during its 2020 examination programs with an emphasis on, among other things, proper configuration of network storage devices and information security governance.
58
Table of Contents
Supplemental Operating Metrics (Unaudited)
The tables below summarize our key product metrics and other supplemental data.
Revenue by type
Key product area revenue
Morningstar Advisor Workstation 87.2 88.5 (1.5) % (1.3) %
As of December 31,
Select business metrics
Advisor Workstation clients (U.S.) 187 (7) 185 (7) 1.1 %
Morningstar.com Premium Membership subscriptions (U.S.) 113,320 109,967 3.0 %
As of December 31,
Workplace Solutions
Investment Management
Morningstar Managed Portfolios $ 28.6 $ 48.6 (41.2) % (10)
Asset Allocation Services 6.9 8.9 (22.5) %
Investment Management (total) $ 47.9 $ 72.4 (33.8) %
Asset value linked to Morningstar Indexes ($bil) 80.6 67.7 19.1 %
Our employees (approximate)
59
Table of Contents
(1) Organic revenue excludes acquisitions, divestitures, adoption of new accounting standards, and the effect of foreign currency translations.
(2) License-based revenue includes Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, PitchBook, Sustainalytics, and other similar products.
(3) Asset-based revenue includes Morningstar Investment Management, Workplace Solutions, and Morningstar Indexes.
(4) Transaction-based revenue includes DBRS Morningstar, Internet advertising sales, and Morningstar-sponsored conferences.
(5) For the year ended December 31, 2020 and for the six months ended December 31, 2019, transaction-based revenue, derived primarily from one-time ratings fees was 59.9% and 63.0%, respectively, of such revenue. Recurring revenue from surveillance, research, and other services comprised the remainder in such periods.
(6) Revenue from DBRS Morningstar is excluded from the reporting of organic revenue growth through the second quarter of 2020.
(7) Revised to reflect updated enterprise client reporting for Advisor Workstation.
(8) The asset totals shown above (including assets we either manage directly or for which we provide consulting or subadvisory work) only include assets for which we receive variable fees based on basis-points of asset balances. Some of our client contracts include services for which we receive a flat fee, but we do not include those assets in the total reported.
Excluding changes related to new contracts and cancellations, changes in the value of assets under advisement can come from two primary sources: gains or losses related to overall trends in market performance and net inflows or outflows caused when investors add to or redeem shares from these portfolios.
Aside from Morningstar Managed Portfolios, it's difficult for our Investment Management business to quantify these cash inflows and outflows. The information we receive from most of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot specify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations.
(9) Many factors can cause changes in assets under management and advisement for our managed retirement accounts, including employer and employee contributions, plan administrative fees, market movements, and participant loans and hardship withdrawals. The information we receive from the plan providers does not separately identify these transactions or the changes in balances caused by market movements.
(10) The decline in Morningstar Managed Portfolios assets was largely attributed to a TD Ameritrade contract change from a variable to fixed-fee arrangement. Excluding the assets from this contract in the prior-year period, assets in Morningstar Managed Portfolios increased 1.8%. TD Ameritrade subsequently canceled its contract in the fourth quarter as a result of its completed merger with Charles Schwab. The cancellation will not impact future asset reporting, but will begin to impact Investment Management revenue growth in the first quarter of 2021.
(11) Revised to reflect updated asset reporting.
(12) The decline in Institutional Asset Management assets was attributed to the non-renewal of a client contract in the third quarter of 2020.
Consolidated Results
Key metrics (in millions) 2020 2019 Change
Cash used for investing activities $ (123.8) $ (746.3) (83.4) %
Cash provided by (used for) financing activities $ (182.2) $ 373.7 (148.8) %
Cash provided by operating activities $ 384.3 $ 334.4 14.9 %
Capital expenditures (76.7) (80.0) (4.1) %
____________________________________________________________________________________________
pp — percentage points
60
Table of Contents
Consolidated Revenue
In 2020, our consolidated revenue rose $210.5 million, or 17.9%. Foreign currency movements decreased revenue by $2.1 million in 2020.
We experienced strong revenue growth across all revenue types during 2020.
License-based revenue, which represents subscription services available to customers, increased 15.0% during 2020 driven by demand for license-based products, such as PitchBook, Sustainalytics, Morningstar Data, and Morningstar Direct. Licensed-based revenue grew 10.4%, when excluding Sustainalytics and other acquisitions and foreign currency translations. PitchBook exhibited strong levels of both new account sales as well as existing client renewals and upgrades, which resulted in an increase in revenue of $52.7 million during 2020. The number of PitchBook Platform licenses increased to 52,288 at the end of 2020, compared with 36,695 at the end of 2019. Continued global demand for our data and research helped to drive revenue growth of $18.3 million and $9.5 million for Morningstar Data and Morningstar Direct, respectively. Morningstar Data and Morningstar Direct reported positive and balanced revenue contribution across geographies, with higher growth rates in Europe and Asia, during the year.
Asset-based revenue increased 5.8% during 2020, primarily driven by Workplace Solutions, Morningstar Managed Portfolios, and Morningstar Indexes. Positive market performance, growth in managed retirement accounts, and strong demand for the new advisor-based platform contributed to 7.8% growth in Workplace revenue compared to the prior-year period. Investment Management revenue grew 2.1% in 2020, as market performance and the gross contribution of Morningstar Funds Trust within Managed Portfolios offset the negative impact of an Institutional Asset Management client loss and soft net flows. Morningstar Indexes experienced growth of assets under management linked to investment products, driven by market gains, ongoing demand for strategic-beta and market-cap weighted indexes, and rising interest in ESG indexes. Average assets under management and advisement (calculated based on available average quarterly or monthly data) were approximately $211.4 billion in 2020, compared with $213.4 billion in 2019.
Transaction-based revenue grew 49.2% during 2020, primarily driven by the contribution of DBRS Morningstar. Strong Canadian corporate credit issuances primarily drove DBRS Morningstar's revenue growth for the year. Recurring annual fees tied to surveillance, research, and other services represented 40.1% of credit ratings revenue.
Organic revenue
Organic revenue (revenue excluding acquisitions, divestitures, adoption of new accounting standards, and the effect of foreign currency translations) is considered a non-GAAP financial measure. The definition of organic revenue we use may not be the same as similarly titled measures used by other companies. Organic revenue should not be considered an alternative to any measure of performance as promulgated under GAAP.
We present organic revenue because we believe it helps investors better compare our period-to-period results, and our management team uses this measure to evaluate the performance of our business. We exclude revenue from acquired businesses from our organic revenue growth calculation for a period of 12 months after we complete the acquisition. For divestitures, we exclude revenue in the prior period for which there is no comparable revenue in the current period.
We began including DBRS Morningstar revenue in our organic revenue calculation in the third quarter of 2020. As such, organic revenue for the year-ended December 31, 2020 only includes DBRS Morningstar revenue for the last six months of 2020 and Sustainalytics for the last six months of 2020.
Excluding revenue from acquisitions and the impact of foreign currency translations, organic revenue increased 8.2% in 2020. PitchBook, Morningstar Data, and Morningstar Direct were the main drivers of the increase in organic revenue during 2020.
61
Table of Contents
The tables below reconcile consolidated revenue with organic revenue:
Less: acquisitions (132.9) (20.1) NMF
Effect of foreign currency translations (2.1) — NMF
____________________________________________________________________________________________
NMF — Not meaningful
Revenue by geographical area
Year ended December 31
International revenue comprised approximately 30% of our consolidated revenue in 2020, compared with 27% in 2019. Approximately 55% of international revenue is generated within Continental Europe and the U.K.
62
Table of Contents
Revenue from international operations increased $106.1 million, or 33.9%, in 2020. The increase in 2020 is primarily due to our acquisition of DBRS, which has a significant revenue base in Canada and Europe, and our acquisition of Sustainalytics, which has a revenue base in Europe.
International organic revenue
International organic revenue (international revenue excluding acquisitions, divestitures, adoption of new accounting standards, and the effect of foreign currency translations) is considered a non-GAAP financial measure. The definition of international organic revenue we use may not be the same as similarly titled measures used by other companies. International organic revenue should not be considered an alternative to any measure of performance as promulgated under GAAP.
International organic revenue increased 8.3% during 2020 primarily driven by Morningstar Data and Morningstar Direct across all geographies.
The tables below present a reconciliation from international revenue to international organic revenue:
Less: acquisitions (78.1) — NMF
Effect of foreign currency translations (2.1) — NMF
International organic revenue $ 338.5 $ 312.6 8.3 %
Revenue Renewal Rates
As discussed in How We Evaluate Our Business, we calculate revenue renewal rates to help measure how successful we've been in maintaining existing business for products and services that have renewable revenue.The figures for license-based products includes the effect of price changes; increasing client bases upon contract renewal; changes to the contract value upon renewal (such as increased users); and changes in the value of variable-fee contracts. These factors, therefore, can result in a renewal rate percentage greater than 100%.
In 2020, we modified our revenue renewal rate calculation to include only those products that we consider license-based. These are primarily weighted toward Morningstar Data, Morningstar Direct, PitchBook, and Morningstar Advisor Workstation, but also includes other license-based products and services across Morningstar. In 2020, we did not include Sustainalytics in our calculation. For these license-based products and services, we estimate that our annual renewal rate was approximately 99% in 2020.
63
Table of Contents
Consolidated Operating Expense
% of revenue 10.0 % 10.0 % — pp
In 2020, operating expense increased $184.9 million, or 18.7%. The increase primarily reflects the inclusion of Sustainalytics' purchase accounting and operating expenses for both DBRS Morningstar and Sustainalytics. Excluding the impacts from DBRS Morningstar and Sustainalytics, operating expenses for the remainder of Morningstar increased 3.2%. Throughout 2020, we implemented measures to better manage costs amidst the uncertain environment, which led to lower growth rates in compensation and benefits and decreases in certain discretionary spending categories. Certain other corporate expense categories, like travel, decreased as global restrictions took effect and employees adapted to a virtual work environment. Foreign currency translations had an unfavorable impact of $1.5 million on operating expense in 2020.
Compensation expense (which primarily consists of salaries, bonus, and other company-sponsored benefits) increased $136.8 million in 2020, with the acquisition of DBRS and Sustainalytics contributing $68.6 million of the increase and $27.8 million due to M&A-related earn-outs. See Note 8 of the Notes to our Consolidated Financial Statements for additional information. The remaining increase reflects additional headcount in data collection and analysis, product and software development, and sales and service support.
Professional fees increased $25.7 million during 2020 related to third-party contractors assisting with software development and technology improvements as well as costs for third-party assistance with regulatory matters and M&A-related activity. In addition, DBRS Morningstar contributed $6.9 million of the professional fee increase. Amortization expense increased $22.3 million primarily from additional amortization related to new intangibles from the acquisition of DBRS and Sustainalytics. Production expense increased $11.3 million during 2020, primarily from fees paid to sub-advisors and other costs related to the Morningstar Funds Trust, as well as cloud-based computing costs. Rent expense increased $10.3 million in connection with lease expansion in certain geographies as well as the addition of Sustainalytics' leases. Sales commissions also grew $7.8 million largely due to strong PitchBook sales performance and additional headcount under the sales commission plans throughout the organization.
These increases were partially mitigated by lower spend in categories directly impacted by the COVID-19 pandemic, such as employee travel-related expense, which decreased $15.3 million during 2020. An increase of $9.1 million in capitalized software development also reduced operating expense during 2020.
In addition, stock-based compensation expense declined $7.7 million due to PitchBook’s management bonus plan, which features lower incentive targets in years one and two compared with year three, and was renewed in 2020. Given 2019 was year three of the prior PitchBook management bonus plan, stock-based compensation expense was lower in 2020, which is year one of the new plan, compared with 2019.
We had 7,979 employees worldwide at the end of 2020, compared with 6,737 at the end of 2019. This increase reflects continued investment in resources to support our key growth initiatives, including operations in India and the U.S. This increase also includes approximately 750 employees who joined Morningstar as a result of the Sustainalytics acquisition in July 2020.
64
Table of Contents
Cost of revenue
Cost of revenue is our largest category of operating expense, representing about one-half of our total operating expense. Our business relies heavily on human capital, and cost of revenue includes the compensation expense for employees who produce our products and services. We include compensation expense for approximately 80% of our employees in this category.
Cost of revenue increased $73.3 million, or 15.2%, in 2020. Higher compensation expense of $60.1 million was the largest contributor. Professional fees increased $12.5 million during 2020 related to third-party contractors assisting with software development and technology improvements. Higher production expense of $11.3 million also contributed to the unfavorable variance in this category, mainly due to $5.2 million in fees paid to sub-advisors and other costs related to the Morningstar Funds Trust, as well as cloud-based computing costs. These increases were offset by higher capitalized software expense due primarily to an increase in development activity in key growth areas, as well as a decrease in employee travel-related expenses of $7.7 million, resulting from the impact of the COVID-19 pandemic.
Continuous focus on development of our major software platforms, in addition to bringing new products and capabilities to market, resulted in an increase in capitalized software development over the prior year, which in turn reduced operating expense. In 2020, we capitalized $62.9 million in costs associated with software development activities, mainly related to enhanced capabilities in our products, internal infrastructure, and software compared with $53.8 million in 2019.
Sales and marketing
Sales and marketing expense increased $28.5 million, or 16.0%, in 2020, reflecting a $27.5 million increase in compensation expense. Sales commission expense was higher by $7.4 million largely due to strong PitchBook sales performance and additional headcount under sales commission plans throughout the organization. The increases in compensation and sales commission expense were partially mitigated by lower spend in certain expense categories impacted by the COVID-19 pandemic, such as employee travel-related expense and marketing expense for Morningstar-sponsored conferences, which decreased $5.4 million and $1.3 million, respectively, during 2020.
General and administrative
General and administrative expense increased $61.3 million, or 29.1%, during 2020. Compensation expense increased $49.1 million with over half of the increase due to M&A-related earn-outs.See Note 8 of the Notes to our Consolidated Financial Statements for additional information. Rent expense also increased $10.3 million during 2020 in connection with lease expansion in certain geographies as well as the addition of Sustainalytics' leases during the third quarter of 2020. Professional fees increased $12.5 million during 2020, primarily due to third-party assistance with regulatory matters and M&A-related activity. Stock-based compensation decreased $7.4 million as a result of PitchBook's management bonus plan, which features lower incentive targets in years one and two compared with year three, and was renewed in 2020. Given 2019 was year three of the prior PitchBook management bonus plan, stock-based compensation expense was lower in 2020, which is year one of the new plan.
Depreciation and amortization
Depreciation and amortization increased $21.8 million, or 18.5%, in 2020.
Depreciation expense declined $1.1 million in 2020, mainly due to timing of fixed assets being placed into service. Intangible amortization expense increased $22.3 million in 2020, primarily from additional amortization related to intangibles generated by the acquisitions of DBRS and Sustainalytics.
Amortization of intangible assets will be an ongoing expense. We estimate that this expense will total approximately $61.1 million for the year ending December 31, 2021. Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, divestitures, changes in the estimated average useful lives, impairments, and foreign currency translation.
65
Table of Contents
Consolidated Operating Income and Operating Margin
Consolidated operating income increased $25.6 million in 2020, reflecting an increase in operating expense of $184.9 million, which was more than offset by an increase in revenue of $210.5 million. Operating margin was 15.5% in 2020, a decrease of 0.6 percentage points compared with 2019.
We reported adjusted operating income, which excludes intangible amortization expense and M&A-related expenses (including M&A-related earn-outs), of $316.7 million in 2020. Adjusted operating income is a non-GAAP financial measure; the table below shows a reconciliation to the most directly comparable GAAP financial measure.
Add: intangible amortization expense 58.8 36.5 61.1 %
Add: M&A-related earn-outs 27.8 — NMF
We reported an adjusted operating margin, which excludes intangible amortization expense and M&A-related expenses (including M&A-related earn-outs), of 22.8% in 2020. Adjusted operating margin is a non-GAAP financial measure; the table below shows a reconciliation to the most directly comparable GAAP financial measure.
Add: intangible amortization expense 4.2 % 3.1 % 1.1 pp
Add: M&A-related expenses 1.1 % 0.6 % 0.5 pp
Add: M&A-related earn-outs 2.0 % — % 2.0 pp
Adjusted operating margin 22.8 % 19.8 % 3.0 pp
66
Table of Contents
Non-Operating Income, Net, Equity in Net Income (Loss) of Unconsolidated Entities, and Effective Tax Rate and Income Tax Expense
Non-Operating Income, Net
The following table presents the components of non-operating income, net:
Interest income $ 1.6 $ 2.4
Gain on sale of equity method investments 30.0 19.5
Holding gain on previously held equity interest 50.9 —
Other expense, net (5.7) (3.1)
Non-operating income, net $ 67.8 $ 8.9
Interest income reflects interest from our investment portfolio. Interest expense mainly relates to the outstanding principal balance under our credit facilities.
The gain on sale of equity method investments in 2019 relates to the sale of our equity ownership in one of our equity method investments during the third quarter of 2019. The gain on sale of equity method investments in 2020 relates to the sale of our equity ownership in two of our equity method investments during the fourth quarter of 2020.
The holding gain on previously held equity interest relates to our purchase of the remaining interest in Sustainalytics in July 2020.
Other expense, net primarily includes foreign currency losses.
Equity in Net Income (Loss) of Unconsolidated Entities
Equity in net income (loss) of unconsolidated entities $ 0.3 $ (0.9)
Equity in net income (loss) of unconsolidated entities primarily reflects income from MJKK offset by losses in our other equity method investments.
We describe our investments in unconsolidated entities in more detail in Note 10 of the Notes to our Consolidated Financial Statements.
67
Table of Contents
Effective Tax Rate and Income Tax Expense
The following table summarizes the components of our effective tax rate:
Equity in net income (loss) of unconsolidated entities 0.3 (0.9)
Income tax expense $ 59.7 $ 45.6
Effective tax rate 21.1 % 23.1 %
Our effective tax rate in 2020 was 21.1%, a decrease of 2.0 percentage points, compared with 23.1% in 2019. The decrease was primarily attributable to the non-taxable holding gain on the previously held equity interest in Sustainalytics offset by the M&A-related earn-outs that are not deductible for tax purposes.
Liquidity and Capital Resources
As of December 31, 2020, we had cash, cash equivalents, and investments of $464.2 million, up $96.7 million from the end of 2019. The increase reflects higher cash provided by operating activities offset primarily by $76.7 million of capital expenditures, $67.8 million of cash paid for the acquisitions, primarily for the acquisition of Sustainalytics, net debt repayments of $63.4 million, dividends paid of $51.4 million, and $41.9 million to repurchase common stock under our share repurchase program.
Cash provided by operating activities is our main source of cash. In 2020, cash provided by operating activities was $384.3 million, reflecting $345.4 million of net income, adjusted for non-cash items and $38.9 million in positive changes from our net operating assets and liabilities. Cash provided by operating activities increased $49.9 million, or 14.9%, in 2020.
68
Table of Contents
On July 2, 2019, we entered into a new senior credit agreement (the Credit Agreement), the initial borrowings under which were made to finance the DBRS acquisition, and repaid all outstanding obligations under the prior credit facility. The Credit Agreement provides the Company with a five year multi-currency credit facility with an initial borrowing capacity of up to $750.0 million, including a $300.0 million revolving credit facility and a term loan facility of $450.0 million. We had an outstanding principal balance of $100.8 million as of December 31, 2020 and a revolving credit facility borrowing availability of $300.0 million. See Note 3 of the Notes to our Consolidated
Financial Statements for additional information on our Credit Agreement.
On June 30, 2020, we entered into a new senior credit agreement that provides us with a $50.0 million 364-day senior revolving credit facility. This 364-day revolving facility was undrawn as of December 31, 2020.
On October 26, 2020, we completed the issuance and sale of $350.0 million aggregate principal amount of 2.32% senior notes due October 26, 2030 (the 2030 Notes), in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. Proceeds were primarily used to pay off a portion of the Company's outstanding debt under its Credit Agreement. Interest on the 2030 Notes will be paid semi-annually on each October 30 and April 30 during the term of the 2030 Notes and at maturity, with the first interest payment date occurring on April 30, 2021. As of December 31, 2020, our total outstanding debt (net of issuance costs) under the 2030 Notes was $348.3 million. See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our 2030 Notes.
Each of the Credit Agreement, the 364-Day revolving credit facility, and the 2030 Notes include customary representations, warranties, and covenants, including financial covenants, that require us to maintain specified ratios of consolidated earnings before interest, taxes, depreciation, and amortization (EBITDA) to consolidated interest charges and consolidated funded indebtedness to consolidated EBITDA, which are tested on a quarterly basis. We were in compliance with these financial covenants as of December 31, 2020.
We believe our available cash balances and investments, along with cash generated from operations and our Credit Agreement, will be sufficient to meet our operating and cash needs for at least the next 12 months. We invest our cash reserves in cash equivalents and investments and maintain a conservative investment policy. We invest most of our investment balance in stocks, bonds, options, mutual funds, money market funds, or exchange-traded products that replicate the model portfolios and strategies created by Morningstar. These investment accounts may also include exchange-traded products where Morningstar is an index provider.
69
Table of Contents
Approximately 60% of our cash, cash equivalents, and investments as of December 31, 2020 was held by our operations outside the U.S., down from about 70% as of December 31, 2019. The amount of accumulated undistributed earnings of our foreign subsidiaries was approximately $243.5 million as of December 31, 2020. We have not recorded deferred income taxes on the $243.5 million primarily because most of these earnings were previously subject to the one-time deemed mandatory repatriation tax under the Tax Cuts and Jobs Act of 2017 (Tax Reform Act). In February 2019, we repatriated approximately $45.8 million of our foreign earnings to the U.S. Otherwise, we generally consider our U.S. directly-owned foreign subsidiary earnings to be permanently reinvested.
We intend to use our cash, cash equivalents, and investments for general corporate purposes, including working capital and funding future growth.
In December 2017, the board of directors approved a share repurchase program that authorizes the Company to repurchase up to $500.0 million in shares of the Company's outstanding common stock. The authorization expired on December 31, 2020.
As of December 31, 2020, we repurchased a total of 559,105 shares for $67.5 million under this authorization. On December 4, 2020, the board of directors approved a new share repurchase program that authorizes the Company to repurchase up to $400.0 million in shares of the Company's outstanding common stock, effective January 1, 2021. The new authorization expires on December 31, 2023.
In 2020, we also paid dividends of $51.4 million. In February 2021, our board of directors declared a quarterly dividend of 31.5 cents per share. The dividend is payable on April 30, 2021 to shareholders of record as of April 9, 2021. While subsequent dividends will be subject to board approval, we expect to make regular quarterly dividend payments of 31.5 cents per share in 2021.
We expect to continue making capital expenditures in 2021, primarily for computer hardware and software provided by third parties, internally developed software, and leasehold improvements for new and existing office locations. We continue to adopt more public cloud and software-as-a-service applications for new initiatives and are in the process of migrating relevant parts of our data centers to the public cloud over the next several years. During this migration, we expect to run certain applications and infrastructure in parallel. These actions will have some transitional effects on our level of capital expenditures and operating expenses.
We also expect to use a portion of our cash and investments balances in the first quarter of 2021 to make annual bonus payments of approximately $86.7 million related to the 2020 bonus compared to $83.4 million in 2019.
Consolidated Free Cash Flow
As described in more detail above, we define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow solely as supplemental disclosure to help investors better understand how much cash is available after we spend money to operate our business. Our management team uses free cash flow to evaluate our business. Free cash flow is not a measure of performance. Also, the free cash flow definition we use may not be comparable to similarly titled measures used by other companies.
Cash provided by operating activities $ 384.3 $ 334.4 14.9 %
Capital expenditures (76.7) (80.0) (4.1) %
We generated free cash flow of $307.6 million in 2020, an increase of $53.2 million compared with 2019. The change reflects a $49.9 million increase in cash provided by operating activities as well as a $3.3 million decrease in capital expenditures. Cash provided by operating activities increased primarily due to higher cash earnings in 2020 compared to 2019.
70
Table of Contents
Acquisitions
We paid a total of $750.1 million, less cash acquired, related to acquisitions over the past three years. We describe these acquisitions in Note 8 of the Notes to our Consolidated Financial Statements.
We paid a total of $15.6 million related to additional investments in unconsolidated entities over the past three years. We describe these investments in Note 10 of the Notes to our Consolidated Financial Statements.
Divestitures
We sold our 15(c) board consulting services product line in 2018 and received a total of $10.5 million related to this sale. For more information, please see Note 9 of the Notes to our Consolidated Financial Statements.
Application of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with GAAP. We discuss our significant accounting policies in Note 2 of the Notes to our Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires our management team to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense, and related disclosures included in our Consolidated Financial Statements.
We continually evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe are reasonable. Based on these assumptions and estimates, we make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results could vary from these estimates and assumptions. If actual amounts are different from previous estimates, we include revisions in our results of operations for the period in which the actual amounts become known.
We believe the following critical accounting policies reflect the significant judgments and estimates used in the preparation of our Consolidated Financial Statements:
Revenue Recognition