Item 1A. Risk Factors
Risk Factor Summary
Below is a summary of the principal risk factors that could impact our business, financial condition, or operating results. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found after this summary, and should be carefully considered.
•Risks Related to Our Business and Industry
◦Failing to maintain and protect our brand, independence, and reputation may harm our business
◦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
◦Prolonged volatility or downturns affecting the financial sector, global financial markets, and the global economy may impact our results
•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
◦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
•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
◦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 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
•Risks Related to Our Operations
◦Our future success depends on our ability to recruit, develop, and retain qualified employees
◦Our business, products and facilities are at risk of a number of material disruptive events, including an outage of our database, technology-based products and services or network facilities, which our operational risk management and business continuity programs may not be adequate to address
◦Today’s fragmented geopolitical, regulatory and cultural world could adversely affect our ability to maintain growth across our businesses
◦The continuing 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
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.
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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 that our reputation for integrity and high-caliber products and services is 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.
Our ESG offerings insert Morningstar publicly into the debate over a variety of non-financial issues surrounding climate, environment, social concerns, and corporate governance which we may be unsuited or unprepared to address. 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 of empowering investor success. Critiques of ESG research can become highly politicized and may reflect differences in societal norms and investor expectations in different areas of the world. New product offerings, such as Sustainalytics’ impact ratings, face a challenge to create objective, understandable methodologies in a rapidly developing field without widely accepted standards. 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.
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. In our index business, jointly developed products and beta indexes on which we earn a fee defy clean categorization under our historical policies that protect the integrity of our research and marketing efforts. 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 ratings business and Sustainalytics’ Sustainable Finance Solutions products we are participants in an issuer-pay business model under which we receive payments from issuers for our ratings rather than from the investors who consume such ratings. These payments may create the perception that our ratings and research in these areas are not independently determined or reliable. Undertaking proxy voting responsibilities for assets we manage risks a charge of politicizing our investing or false virtue if we don’t meet our customers’ expectations and exemplify their values.
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. Regardless of source, 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.
Our reputation may also be harmed by factors outside of our control, such as news reports about our clients, consultants, or suppliers or adverse publicity about certain types of investment and ratings products. Our reputation could also suffer if we fail to perform competitively in our investment management offerings. 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 efforts.
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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, institutional investors in the private capital markets, and participants in the fixed income 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 and advise participants in retirement plans on saving for retirement and choosing plan investments. 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 datasets, 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. There is also increased interest in alternative asset classes creating a need for applicable datasets and analytical expertise. 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 have greater breadth of product offerings or are able to successfully introduce innovative, proprietary research tools and software that gain attention from our clients. For example, our credit ratings business’ lack of presence in the CLO market represents a lost opportunity compared to our competitors. 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 many of the markets in which we operate. 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, at least on a going forward basis. 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.
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.
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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. For example, the adoption of ESG strategies across the financial adviser segment has been slower than we expected, impacting Sustainalytics’ products, and the reticence of some recordkeepers to embrace direct to plan participant sales and marketing efforts has impacted the pace of adoption of some of our retirement solutions offerings. 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.
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 which may be impacted by changes in interest rates, availability of credit, inflation rates, changes in laws, trade barriers, commodity prices, currency exchange rates and controls, and national and international political circumstances. Prolonged downturns, sustained volatility in the financial markets, interest and inflation rate fluctuations, 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 credit issuance or increases investor interest in non-traditional investment vehicles can put negative pressure on our credit ratings and investment management businesses, respectively. 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. The ascendence 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. A sustained global recession or other financial crisis would likely lead to material spending cutbacks among many of the companies to which we sell and longer sales cycles. 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 reduces 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 sustained pressure to reduce fees. As a result, 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. Changes in the nature of the financial advice delivered to investors or the manner of its delivery can also negatively affect our business. For instance, changes 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. 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 activities), PitchBook may also be subject to volatility based on the amount of activity and market interest in these areas.
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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, and the industrywide trend toward lower asset-based fees. 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 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. The introduction of non-traditional asset classes such as cryptocurrencies, private debt, real estate, structured products and collectibles, which lack a historical record of performance akin to traditional assets, into our investment research and strategies and managed assets may result in adverse outcomes and headline risk if they fail to perform in the manner that we anticipate.
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.
Our largest transaction-based business, the credit ratings 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. Ample market liquidity may be masking the true impact on credits as global economies emerge from the pandemic government support programs and central bank interventions. This makes it harder to explain our differentiated credit views and may produce a wave of negative publicity against the credit ratings business generally if an unanticipated wave of defaults result in conditions that reduce issuers’ ability or willingness to issue debt securities, such as market volatility, uncertainty in the outlook for 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 or hybrid events as the COVID-19 pandemic continued to restrict large gatherings during 2021 impacted our financial results for our Morningstar-sponsored investor conferences around the world. We are uncertain whether these trends will continue.
Our acquisitions and other investments may not be efficiently integrated or 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.
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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 entities 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. 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 extensive class action litigation, including one such proceeding involving us that was dismissed.
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. There is a need to continually invest in training to develop and maintain in-house expertise to manage these systems effectively.
We seek to constantly innovate and improve our retirement services offering, for example to add new capabilities in annuities, 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, more complex, versions and updates properly and understand the implications for their plan participants. More resources may also be required to continue to support legacy versions of the Wealth Forecasting Engine. 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.
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Our subsidiaries outside the U.S. that have investment advisory operations are subject to similar requirements. 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, conflict of interest monitoring, 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 negative publicity, 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.
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.For example, recent SEC amendments to the advertising and solicitation rule for registered investment advisers, resulted in costs to comply with new evaluation, implementation, and disclosure requirements in our investment management operations, as well as costs to modify software used by our unaffiliated registered investment adviser clients who must also comply with such amendments.
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.
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Our Sustainalytics business could be negatively affected by increased regulation of ESG research and data. The European Commission’s legislative proposal for registering and supervising companies that act as external reviewers for green bonds aligned with the European Green Bond Standards (EuGBS) framework would require significant investments to build and maintain appropriate internal control and compliance processes for these teams.Similarly, the FCA and International Organization of Securities Commissions’ consultation papers on proposed ESG regulation of climate-related issuer disclosures and ESG rating and data providers prescribe governance policies, quality assurance and control programs, and standardized procedures and methodologies related to data collection and fees. We are also monitoring activities of regulators in North America and APAC that have announced that they are reviewing this topic and are preparing proposed legislation. Such regulatory regimes 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. With our acquisition of Moorgate Benchmarks, Morningstar has affiliates permissioned to act as a EU and U.K. benchmark administrator. While this cross-permissioning allows flows of U.K. benchmarks into the EU and vice versa, the benchmark administrator designation also has significant compliance responsibilities and costs. These compliance responsibilities include specified governance and oversight arrangements, outsourcing limitations, specified items in a code of conduct, key information disclosures, and systems and controls governing data, complaints and record-keeping. Supplemental regulations under the EU Benchmark Administration contain further operational and administrative requirements which may be costly to implement. Such regulations may create a competitive advantage for Morningstar by discouraging competitors but they may also lead to declining demand for indexes among market participants.
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.
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. Some of our intellectual property was obtained pursuant to a business or asset acquisition and the previous owners of the acquired business may not have taken similar measures to protect the acquired intellectual property. 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.
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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.
We may suffer malicious attacks by individuals or groups (including those sponsored by nation-states, terrorist organizations, or global corporations) seeking to attack our products and services or penetrate our network infrastructure to gain access to intellectual property, confidential or personal information, or to facilitate 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. Even if we are not directly impacted by an attack, time and effort must be spent confirming our status and communicating internally and with other stakeholders. 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. Furthermore, these security measures are less effective in situations where employees are utilizing personal devices and home networks while working remotely.
We may also be impacted by a cyberattack targeting one of our vendors or within our technology supply chain or infrastructure. 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. These risks may be heightened as we offer employees flexibility to work more frequently from remote work environments, our dependency on certain service providers, such as video conferencing and web conferencing services, has significantly increased. 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. As a result, inadequacies of our customers’ security technologies and practices introduce additional risk and cost of monitoring, and 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.
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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. Regulators and political leaders in various countries are increasingly interested in restricting cross-border data transfers that they perceive as problematic. 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 required practices 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.
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.
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 innovation in the financial technology landscape continues to accelerate. Developments in technology are fundamentally changing the ways investors, financial intermediaries, 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, the proliferation of machine learning and other artificial intelligence technologies, and the adoption of distributed ledger or “blockchain” technologies. These technological developments can render our existing products less competitive, obsolete or unmarketable. As a result, our future success will continue to depend upon our ability to identify and develop new products and enhancements that address the future needs of our target markets and to deliver them in ways that support our customers’ business models.
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. For example, the pandemic accelerated advisor and client demand for digital, friction-free technology and experiences with our turnkey asset management platform, shining a light on dated, legacy operational workflows. 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. We have a myriad of potential technology investments across our product lines and need to prioritize scarce technology resources to focus on products that best meet the needs and priorities of our customers.
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Our software development process is based on frequently rolling out new features so that we can quickly incorporate user feedback. However, at times adoption of new features or enhanced versions, for example of some of our workplace solutions products, is slowed by the significant client investment required for more advanced use cases. 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 multiple platforms over an extended period of time. Our competitive position depends on our execution speed and we regularly face new competitors from venture capital funded fintech firms that may be significantly more focused or nimble.
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. For example, in order to provide the personalized holistic advice that clients value, we need to collect, organize, and protect large, non-homogenous datasets and synthesize and effectively analyze the insights offered by this 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 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. Less significant errors could still require us to remove ratings, research, or data temporarily which could diminish the perceived value of the product or cause us to be deficient in our service-level agreements with clients that require us to meet certain obligations for delivering time-sensitive, up-to-date data and information.
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.
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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 private ratings or 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.
Risks Related to Our Operations
Our future success depends on our ability to recruit, develop, and retain qualified employees.
Our strategy envisions building and expanding our business which requires identifying, attracting, hiring, and on-boarding new qualified employees. Engineering, research, quantitative, fixed income data, credit analysis and ESG skill sets are particularly needed to capitalize on near-term growth opportunities. We experience competition for analysts, technology experts, data and software engineers, and other employees from other companies and organizations. While we have a geographically diversified workforce location strategy, building valued teams in a variety of locations around the globe, we experience recruiting challenges in nearly all our global locations. Such significant talent acquisition activities place a strain on our human resource management team. We must continue to refine and expand our recruiting capabilities, our systems and processes in order to meet this need in a highly competitive employment market.
The development, maintenance, and support of our products and services are also dependent upon the knowledge, skills, experience, and abilities of our existing employees. We invest in our employees’ continued development and growth through learning tools, educational stipends, speaker series, mentoring, and other resources to help them chart a fulfilling career at Morningstar. We are also thoughtful about employee engagement and communications to keep our staff focused and motivated by our mission. However, recent changes in labor markets such as the willingness of some employers to offer fully remote work and the so-called “Great Resignation” brought on, in part, by the COVID-19 pandemic, may make it more difficult for us to retain existing employees or maintain traditional workplace arrangements.
We believe the success of our business depends to a significant extent upon the continued service of our executives and other key employees. However, the talents and experience of these individuals make them attractive candidates to many of our peers, which are also experiencing significant business growth, as well as to early-stage companies that can offer the potential for outsize financial rewards if they are successful. Thus competition for these employees is intense and a high velocity of employee turnover creates a need to think strategically about the timing of new projects and initiatives to manage workloads. We may not be able to retain these employees or to develop and retain similar highly qualified personnel in the future.
In addition, we are exposed to overall rising wage scales in the employment markets in which many of our facilities are located, which negatively affects our ability to hire personnel generally without significantly increasing our compensation costs. Inflationary concerns, the recent strong stock performance in our sector and shortages of applicants with certain skills put upward pressure on wages. Shifting preferences regarding remote work flexibility and a backlog of immigration applications can further complicate employment offer negotiations with potential candidates and delay start dates.
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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 business, products and facilities are at risk of a number of material disruptive events, including an outage of our database, technology-based products and services or network facilities, 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 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. 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. 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.
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. Our data collection, technology, and operational center in Mumbai, India is also a significant location where employees maintain and update our equity database and PitchBook's data and research operations, and provide shared services to many of our 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. We engage third party vendors in several locations, including Colombia, India, and Ukraine, which provide contract labor in support of our operations. If a pandemic, war, natural disaster, violent incident, or another dangerous emergency significantly impacted the safety or communication connectivity of people living in and around these locations, we might not be able to continue business operations at an acceptable level that would meet all our legal and contractual commitments. Each of these locations has experienced various types of geopolitical risks and changes in laws and regulations relating to data privacy, security, protection of intellectual property rights, and acceptable telecommunication infrastructure which create uncertainty regarding our long-term operations there. Any extended disruptions to our operations in these locations would make it difficult for us to meet our operating goals.
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. 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. 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. 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.
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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. Some of these providers have recently experienced widely reported service disruptions that affected numerous customers including ourselves. In addition, as we offer our employees opportunities to work from remote environments more frequently, 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.
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.
Today’s fragmented geopolitical, regulatory, and cultural world could adversely affect our ability to maintain growth across our businesses.
Morningstar’s strategy for growth involves, in part, continuous expansion into new and adjacent product lines to anticipate and meet our customers’ needs. Our ability to realize those opportunities in one of our businesses, however, may be hindered by regulatory requirements governing a different business within the Morningstar group. In certain cases, regulatory sanctions against one of our businesses could affect our ability to continue to operate in unrelated regulated areas. In addition, the day-to-day sharing and optimization of the value of our intellectual property across our product lines can be affected by regulatory concerns. For example, in response to regulatory requirements we are evaluating our implementation of information barriers to segregate the data and research accessible by some members of our credit ratings team from those involved in investment management. Similarly, differences in data privacy regimes and governmental surveillance rights applicable in specific countries significantly affect our workforce location strategy and technology infrastructure in relation to cross-border processing of personally identifiable information of customers, employees and other third parties. Such limitations, which seem likely to proliferate as global consensus regarding regulatory principles wanes, may impact our ability to maintain growth across our businesses.
The dynamics of today’s geopolitical discourse may also impact business growth across different markets. It has been our experience that adoption of many ESG focused products has been more rapid in European countries than in other parts of the world, and there is more agreement on ESG taxonomies, methodologies, and acceptable sources of data in that market. Customer opinions about such products, or preferences regarding their methodology or approach, are at times impacted by regional or national political trends which may differ significantly. Preferred terminology and information sources may similarly differ from place to place. In such an environment, Morningstar may struggle to maintain its reputation for methodological transparency and consistency which underpins the value and reputation of our research.
Morningstar’s growth also places increasing demands on our functional resources to scale and optimize globally and to balance global consistency with local flexibility. Our sales and marketing teams are focused on multi-product based strategies to bring the breadth of our offerings and the full value of our intellectual property to our customers. However, such sales efforts can breed customer confusion, implicate regulatory limits on how certain products or services can be sold and by whom in certain jurisdictions, and if coupled with misaligned incentive structures, can create opportunities for misconduct or excessive risk taking. Additional complexity also creates a need for clear responsibilities and ownership across various global teams within Morningstar. A higher velocity of hiring and turnover in the competitive talent acquisition environment also creates challenges for cross-company collaboration. Morningstar is fortunate to have many opportunities for global growth in its strategic plan, however, we cannot be certain that further growth or profitability will be at the same or higher levelgiven the headwinds of deglobalization and political, regulatory, and cultural fragmentation. Accordingly, an inability to maintain growth, or an inability to effectively manage growth, could have an adverse effect on our business, financial condition and results of operations.
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The continuing 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 continuing 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 periods of 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 2021, 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 2022 as specific variants of the virus and concerns over the adoption and efficacy of mitigants, such as vaccines and other treatments, compel certain governments to again impose travel limitations, lockdowns and curfews, and other business and personal restrictions. Our approach to preventative and protective actions has remained similarly flexible and, based on the guidelines of local authorities and our own safety standards, we have re-opened certain offices and will continue to do so. Many of our customers, vendors, and data suppliers continue to operate under remote working or voluntary attendance arrangements, which may interfere with 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. When health and safety conditions allow, we are encouraging or requiring collaborative teams to begin returning to our offices on a regular schedule and employees have been cleared to resume travel for approved business purposes in jurisdictions permitting such travel. 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 2021 saw growth in many financial markets, the speed and extent to which governments and central banks withdraw fiscal and monetary stimulus, and other 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 and subscription businesses, could materially deteriorate, which could result in lower demand, cancellations, price reductions, or delays in implementation for our products and services.
Other macroeconomic trends reflecting consumer and business reactions to the COVID-19 pandemic could also have a lasting impact on our cost profile and long-term profitability. Given the nature of our business, global supply chain disruptions have had little impact on us but could impact the availability of certain IT infrastructure over time. Certain long-term effects of the efforts of monetary authorities and governments to ameliorate the impacts of the pandemic are potentially starting to become evident, including both price and wage inflation as well as increased competition for workers. We have noted these effects in our business related to the mobility of employees between jobs and the wage levels needed to hire or retain employees. While our annual bonus programs are designed to reward exceptional business performance and so a portion of our compensation expense is aligned with overall growth, other components of compensation expense are relatively fixed which may impact profitability. 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.
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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. Travel restrictions put in place in various countries in response to the continuing COVID-19 pandemic and administrative delays at government immigration offices 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.
During 2021, we did not 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. We monitor our financial performance on a global basis and may look to enter into derivatives from time to time to reduce or control risk for known exposures.
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, any borrowings under our current credit facility bear interest at fluctuating interest rates based on the London interbank offered rate (LIBOR) for deposits of U.S. dollars. In May 2021, the FCA (the authority that regulates LIBOR) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR for the U.S. dollar LIBOR tenors relevant to the company after June 30, 2023. The industry is in a period of transition and both Secured Overnight Financing Rate (SOFR) and Short-Term Bank Yield Index (BSBY) have emerged as potential alternatives to USD LIBOR. SOFR is a broad measure of the cost of borrowing overnight collateralized by U.S. Treasury securities. BSBY represents the average cost at which large, global banks access USD unsecured wholesale funding, and has characteristics similar to USD LIBOR. We continue to monitor the relative merits of these options and expect to effect the necessary administrative changes in advance of June 2023. It is not possible to predict the effect of these changes on our borrowing costs over time or the availability to us of credit.
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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, 2021, Joe Mansueto, our Executive Chairman and Chairman of the Board, owned approximately 41.6% 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. For example, if the U.S. economy were to enter a prolonged inflationary period, increased compensation and other expenses could impact our operating results in the short term. Uncertainty regarding inflation could also impact our ability to forecast costs, which inform our longer-term budget and capital allocation decisions. 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.
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 11, 2022, we leased approximately 511,000 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 648,000 square feet of office space in 26 other countries around the world, including approximately 220,000 square feet in Mumbai, India and 80,000 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 15 of the Notes to our Consolidated Financial Statements contained in Part II, Item 8 of this report.
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Item 4. Mine Safety Disclosures
Not applicable.
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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 11, 2022, there were 728 shareholders of record of our common stock.
We paid four dividends during 2021. In the fourth quarter of 2021, we increased our quarterly cash dividend from 31.5 cents per share to 36 cents per share. While subsequent dividends will be subject to board approval, we expect to pay a regular quarterly dividend of 36 cents per share in 2022.
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 4, 2020, to repurchase up to $400.0 million in shares of the company's outstanding common stock, effective January 1, 2021. This authorization will expire on December 31, 2023.
The following table presents information related to repurchases of common stock we made during the three months ended December 31, 2021:
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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 February 1, 2022:
During the fourth quarter of 2021, the previously disclosed Rule 10b5-1 plan for Steve Kaplan completed in accordance with its terms.
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(1)This column reflects an estimate of the number of shares each identified director and executive officer will beneficially own following the sale of all shares under the Rule 10b5-1 sales plan. This information reflects the beneficial ownership of our common stock on December 31, 2021 and includes shares of our common stock subject to options that were then exercisable or that will have become exercisable by March 1, 2022 and restricted stock units that will vest by March 1, 2022. The estimates do not reflect any changes to beneficial ownership that may have occurred since December 31, 2021. 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) This plan is entered into by Bevin Desmond’s spouse.
(3) The number of shares to be sold under this plan is estimated using a 40% withholding tax rate.
(4) The projected beneficial ownership is estimated based on the estimated number of shares to be sold under the Plan using a 40% withholding tax rate.
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Item 6. [Reserved]
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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--Regulatory Trends Affecting 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 related to cybersecurity and the protection of confidential information, including personal information about individuals;
•liability for any losses that result from an actual or claimed breach of our fiduciary duties or failure to comply with applicable securities laws;
•compliance failures, regulatory action, or changes in laws applicable to our credit ratings operations, or our investment advisory, ESG, and index businesses;
•failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy;
•the failure to recruit, develop, and retain qualified employees;
•inadequacy of our operational risk management and business continuity programs in the event of a material disruptive event, including an outage of our database, technology-based products and services or network facilities;
•failing to differentiate our products and services and continuously create innovative, proprietary, and insightful financial technology solutions;
•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;
•failing to maintain growth across our businesses in today's fragmented geopolitical, regulatory and cultural world;
•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;
•the failure of acquisitions and other investments to be efficiently integrated and produce the results we anticipate;
•the impact of the current COVID-19 pandemic and government actions in response thereto on our business, financial condition, and results of operations;
•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 2021 financial information to the same information for 2020. Year-to-year comparisons of the 2020 financial information to the same information for 2019 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, 2020.
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.
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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, PitchBook, and Sustainalytics, 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 most 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. Firms license Morningstar Indexes for both product creation (where we typically receive the greater of a minimum fee or basis points tied to assets under management) and data licensing (where we typically receive annual licensing fees).
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, 2021, 65.7% of the revenue generated by DBRS Morningstar came from one-time, transaction-based fees driven by ratings on newly-issued securities; the remainder can be classified as transaction-related, with 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 subscription services to our customers. Deferred revenue totaled $413.8 million (of which $377.4 million was classified as a current liability with an additional $36.4 million included in other long-term liabilities) at the end of 2021. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our license and subscription agreements.
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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.
• 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 as well as professional fees for third-party development activities.
• Sales and marketing. This category includes compensation expense for our sales teams, product managers, and marketing professionals. We also include the cost of advertising, digital marketing 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 amortize capitalized software development costs over their estimated economic life, generally three years. 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 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, 2021, 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 the following 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);
• Operating margin (including operating margin); and
• Free cash flow.
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Organic revenue, adjusted operating income, adjusted operating margin, and adjusted net income per share, 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 define adjusted operating margin as operating margin excluding all M&A-related expenses and amortization. We present these measures because we believe they better reflect 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, 2022.
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 the global markets.
While the business environment in most of the jurisdictions in which we operate continues to move toward a state resembling pre-pandemic conditions, the long-term impact of the COVID-19 pandemic on our ongoing business, results of operations, and overall future financial performance continues to be difficult to reasonably estimate at this time. The threat of new variants of the virus and concerns over the adoption and efficacy of mitigants, such as vaccines and other treatments, continue to affect historical commercial and work patterns, although not with any significant impact on any of our sources of revenue during 2021.
Based on the guidelines of local authorities and our own safety standards, we have re-opened certain offices and will continue to do so. We continue to provide work flexibility for employees with a focus on health and safety while at the same time encouraging or requiring collaborative teams to begin returning to our offices on a regular schedule. Employees have been cleared to resume travel for approved business purposes in jurisdictions permitting such travel. Given the nature of our business, global supply chain disruptions have had little impact on the company, but could impact the availability of certain IT infrastructure over time. While 2021 saw growth in many financial markets, the speed and extent to which governments and central banks withdraw fiscal and monetary stimulus, and other national and global political conditions may undermine or reverse such growth. Certain long-term effects of the efforts of monetary authorities and governments to ameliorate the impacts of the pandemic are potentially starting to become evident, including both price and wage inflation as well as the competition for workers. We have noted these effects in our business related to the mobility of employees between jobs and the wage levels needed to hire or retain employees.
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Accordingly, the situation surrounding the COVID-19 pandemic remains fluid. We continue to actively manage our response and have assessed potential impacts to our financial position and operating results related to our consolidated financial statements during 2021. We remain focused on maintaining a strong balance sheet and liquidity position. At December 31, 2021, our cash, cash equivalents, and investments totaled $546.1 million and we had full availability of our $300.0 million revolving credit facility.
Regulatory Trends Affecting Our Business
In addition to the industry developments described under "Business - Our Strategy", there are several longer-term regulatory trends we consider relevant to our business, as outlined below.
General
With the continuing impact of the COVID-19 pandemic throughout 2021, businesses relied on remote working arrangements and increased their use of online and digital communications technologies. Demand by investors, regulators and other interested parties for firms to adopt environmental, social, and governance (ESG) related business and operational risk strategies persists. 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 scrutinize the change management processes of regulated entities, like Morningstar, more closely 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.
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 current administration in the United States (U.S.) signaling stricter financial regulatory activity, the end of the transition period for the withdrawal of the United Kingdom (U.K.) from the European Union (EU) and the effect on trans-European financial services providers, the lack of federal legislation in the U.S. 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.
Even in its fragmented state, regulators globally have continued to focus on certain recurring 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. Other themes have emerged globally, with increased attention to corporate ethics, in areas such as human rights and modern slavery, which impact not just financial service providers, like Morningstar, but all companies of a commensurate size.
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.
Credit Ratings
On January 4, 2021, the European Securities and Markets Authority (ESMA) withdrew the registrations of all U.K.-based credit rating agencies, including DBRS Ratings Limited. Accordingly, all ratings of DBRS Ratings Limited require the endorsement of its EU-based credit ratings affiliate, DBRS Ratings GmbH, for regulatory use in the EU. At present, the U.K. credit rating agency regulatory regime and the EU regime largely continue to mirror each other, which minimize any significant change in our overall operations. However, over time, either ESMA or the U.K. Financial Conduct Authority (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.
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Investment Management
In the U.S., on December 22, 2020, the SEC adopted amendments to its investment adviser advertising and cash solicitation fee rules under the Advisers Act. The rule replaces the current advertising rule’s broadly drawn limitations with principles-based provisions designed to accommodate the continual evolution and interplay of technology and advice and includes tailored requirements for certain types of advertisements. The amendments create a single rule that replaces the current advertising and cash solicitation rules. The final rule, which comes into effect on November 4, 2022, is designed to comprehensively and efficiently regulate investment advisers’ marketing communications. Morningstar is reviewing its use of hypothetical performance information in its adviser software products to align with the updated requirements and generally working with its adviser customers to prepare for the new regime. Morningstar Investment Management is also working on changes to its policies and practices to comply with the new rule.
In the U.K. and Europe, Morningstar continues to navigate the equivalence regimes and domestic laws governing matters of access in financial services post-Brexit. Morningstar Investment Consulting France SAS received its authorization as a Markets in Financial Instruments Directive (MiFID) investment firm in early 2021. This initiative enables Morningstar Investment Management to continue provision of related services to EU-based clients, post Brexit.In addition, the Investment Firms Regulation and Directive in the EU and the equivalent Investment Firms Prudential Regime in the U.K. have had an impact on the regulatory requirements for Morningstar Investment Management Europe Limited and Morningstar Investment Consulting France SAS. We have taken steps to ensure these entities remain in compliance with these regulations’ requirements in matters such as capital adequacy, liquid assets, risk management, regulatory reporting and remuneration.
Similarly, in other parts of the world, recent regulations and other guidance in jurisdictions, like Australia and New Zealand, have focused on investment management compliance practices, such as design and distribution obligations, 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.
Workplace 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 had some adverse effects on demand for Morningstar’s ESG-related retirement solutions, DOL has since changed course as we anticipated. DOL announced on March 10, 2021 the agency would not enforce the regulation. On October 14, 2021, DOL proposed a new rule that would encourage plan sponsors to consider ESG information when evaluating investments. We expect the revised rule will be finalized in 2022.
Other recent regulatory developments in the U.S. are likely to have a positive impact on our Workplace Solutions business. DOL finalized a new prohibited transaction exemption that expands the scope of fiduciary investment advice to include rollover recommendations and will start to enforce all its requirements after June 30, 2022. While we do not anticipate any of Morningstar’s businesses will need to avail themselves of the exemption, Morningstar provides tools and other resources designed for financial institutions and investment professionals to provide clients analysis on rollover recommendations, which is now required for some advisors.
ESG
While the EU has generally taken the lead with respect to regulation of ESG products and services, other jurisdiction have also adopted or begun to work in this area. In July 2019, ESMA issued Guidelines on the disclosure of ESG factors in credit rating agency (CRA) press releases. Pursuant to the Guidelines, the CRAs are expected to indicate within EU credit ratings public press releases when ESG factors are a key driver behind a change to a credit rating or rating outlook. The Guidelines began to apply on March 30, 2020. DBRS Morningstar evaluates and incorporates ESG risks in the assessment of its credit ratings globally and provides transparency in its rating action press releases in situations where one or more ESG factor(s) are associated key rating drivers, as applicable.
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The Sustainable Finance Disclosure Regulation came into effect in the EU on March 10, 2021. The regulation requires various investment market participants to implement policies and make certain disclosures with regards to sustainability risks and sustainability factors relevant to their investment activities. Portions of the regulation relating to climate change mitigation and adaptation came into effect in January 2022 with the full regulation expected to become effective in January 2023. We do not expect this disclosure requirement will have a material adverse effect on our business, operating results, or financial position.
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. In July 2021, the European Commission released its EuGBS proposal that, among other things, would set up a system for registering and supervising companies that act as external reviewers for green bonds aligned with the EuGBS Regulation framework. If adopted, the EuGBS Regulation would contain a suite of requirements covering the governance of external reviewers, as well as general principles requiring the external reviewer to employ appropriate systems, resources and procedures and to monitor and evaluate at least annually, the adequacy and effectiveness of its systems and internal control mechanisms and arrangements. Sustainalytics currently offers external reviews of green bonds that we expect may be in scope for the EuGBS Regulation. We understand that ESMA’s current timeline is to require registration of external reviewers in 2022-2023. We are currently undertaking an internal review of appropriate measures and an assessment of the need for additional resources that may be required to comply with such regulation. Furthermore, ESMA has 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. Morningstar is familiar with this regulatory model on account of DBRS Morningstar.
Morningstar is additionally monitoring proposed legislation in the EU relevant to its ESG business activities. In June 2021, the FCA and the International Organization of Securities Commissions (IOSCO) published consultation papers on the proposed regulation of climate-related issuer disclosures and the governance policies, quality assurance and control programs, data collection procedures and methodologies, and fee payment models of ESG rating and data product providers. In November 2021, IOSCO published its related final report that include several recommendations addressed to regulators, ESG ratings and data product providers and users of ESG ratings and data products.
Regulators in other jurisdictions including Canada, China, India, Japan, and the UAE have also adopted or begun to work on frameworks related to ESG-disclosure and registration requirements applicable to ESG rating providers or green bond verifiers. 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. Similarly, there has not yet been systemic consideration of the regulation of sustainable finance in the U.S. Morningstar continues to monitor these developments closely.
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. With our acquisition of Moorgate Benchmarks, Morningstar’s affiliates, Moorgate Benchmarks Limited and Moorgate Benchmarks GmbH, are permissioned to act as an U.K. and EU benchmark administrator, respectively. As such, Morningstar is well positioned for continued cross-border provision of indexes within the combined EU/U.K. markets even after the associated benchmarks regulation transition period ends in 2023. The potential for U.S. authorities to introduce a regulatory regime specific to index providers remains uncertain.
Data Privacy and Cybersecurity
Data privacy regulation continues to proliferate, as numerous national and state jurisdictions are considering new data privacy regulations. The General Data Protection Regulation (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.
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The expansion of international data transfer rules has caused Morningstar and other global companies to reconsider offshoring and compliance practices. In 2021, China, the EU, New Zealand, and the U.K. promulgated rules governing the transfer of personal data across international borders. EU cross-border transfer rules require companies to evaluate their ability to protect personal data transferred outside of the European Economic Area considering importing countries’ laws and surveillance practices. In addition to increased compliance costs, these rules have increased the risk of regulatory enforcement and business disruption associated with processing personal data in certain countries.
In the U.S., the growing number of state privacy laws and the absence of a comprehensive federal privacy law have contributed to a challenging compliance environment. In 2021, Colorado and Virginia enacted comprehensive consumer privacy laws scheduled to become effective in 2023. Several other states have adopted or are considering the adoption of privacy regulations. Additionally, the California Privacy Rights Act, which expands upon the California Consumer Privacy Act, goes into effect on January 1, 2023. State privacy laws typically adopt similar themes as GDPR, limiting companies’ ability to process certain categories of personal data and extending to customers the right to control their data. These laws may provide obligations inconsistent with other state or global privacy regulations and impose additional compliance costs. 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 regarding information security, outsourcing and the use of cloud-based services. In the U.S., the SEC has stated that is focused on cybersecurity issues involving four groups of entities: registered financial sector participants such as broker dealers and registered investment advisers; public companies; service providers that work with financial sector registrants but are not registered themselves; and the SEC itself. The SEC is focused on cybersecurity hygiene and preparedness, cyber incident reporting to the government, and in certain circumstances, disclosure to the public. This focus has the potential to impact not only Morningstar’s regulated businesses, but also those of its customers who may potentially need to implement increasing scrutiny of their service providers and commercial counterparties.
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Supplemental Operating Metrics (Unaudited)
The tables below summarize our key product metrics and other supplemental data.
Year ended December 31,
Revenue by type
Key product area revenue
Morningstar Advisor Workstation 91.9 87.2 5.4 % 4.8 %
As of December 31,
Select business metrics
Advisor Workstation clients (U.S. and Canada) 232 244 (7) (4.9) %
Morningstar.com Premium Membership subscriptions (U.S.) 115,541 113,320 2.0 %
As of December 31,
Workplace Solutions
Investment Management
Morningstar Managed Portfolios $ 32.4 $ 28.6 13.3 %
Institutional Asset Management 11.8 11.2 (10) 5.4 %
Asset Allocation Services 8.0 6.9 15.9 %
Investment Management (total) $ 52.2 $ 46.7 11.8 %
Asset value linked to Morningstar Indexes ($bil) 147.0 80.6 82.4 %
Our employees (approximate)
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(1) Organic revenue excludes acquisitions, divestitures, adoption of new accounting standards, and the effect of foreign currency translations.
(2) License-based revenue includes PitchBook, Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, Sustainalytics, and other similar products.
(3) Asset-based revenue includes Investment Management, Workplace Solutions, and Morningstar Indexes.
(4) Transaction-based revenue includes DBRS Morningstar, Internet advertising, and Morningstar-sponsored conferences.
(5) For the years ended December 31, 2021 and 2020, DBRS Morningstar recurring revenue derived primarily from surveillance, research, and other transaction-related services was 34.3% and 40.1%, respectively.
(6) Investment Management revenue includes the contribution of the Morningstar Funds Trust, which records revenue as well as sub-advisory fees on a gross basis. For the full year 2021 and 2020, this contribution represented $21.5 million and $17.3 million, respectively.
(7) Revised to reflect updated enterprise client reporting for Advisor Workstation to include clients in Canada.
(8) The asset totals shown below (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) Revised to reclass CIT assets previously reported in Institutional Asset Management to Custom Models/CIT.
Consolidated Results
Key metrics (in millions) 2021 2020 Change
Cash provided by operating activities $ 449.9 $ 384.3 17.1 %
Cash used for investing activities $ (167.7) $ (123.8) 35.5 %
Cash used for financing activities $ (211.8) $ (182.2) 16.2 %
___________________________________________________________________________________________
pp — percentage points
Consolidated Revenue
In 2021, our consolidated revenue rose $309.8 million, or 22.3%. Foreign currency movements increased revenue by $26.7 million in 2021.
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We experienced strong revenue growth across all revenue types during 2021.
License-based revenue, which represents subscription services available to customers, increased 21.1% during 2021 driven by demand for license-based products, such as PitchBook, Sustainalytics, and Morningstar Data. Licensed-based organic revenue grew 15.4%. PitchBook revenue increased 44.3% during 2021, highlighting ongoing expansion of existing client relationships along with growth in new users. The number of PitchBook Platform licenses increased to 73,940 at the end of 2021, compared with 52,288 at the end of 2020. During 2021, significant investments in PitchBook's data, research, and product capabilities enhanced the workflows of PitchBook's core clients, expanded private markets coverage in the European region, and launched new functionality for alternative asset investors. Sustainalytics revenue grew 168.1%, or 44.4% on an organic basis, to $78.9 million on strong demand from both investor and corporate clients. Morningstar Data revenue grew 13.2% as a result of expansion of data use cases, ongoing demand for data to support regulatory needs, and growing demand for fund-level sustainability data as core client segments respond to increasing investor interest in ESG.
Asset-based revenue increased 18.4% during 2021, primarily from Workplace Solutions, Morningstar Indexes, and Investment Management. Workplace Solutions revenue growth of 23.6% was bolstered by higher market performance and higher assets under management in Morningstar Retirement Manager from both new and existing plans. Morningstar Indexes revenue increased 59.3%, driven by higher index data licensing sales and strong asset flows and market growth for investable products linked to Morningstar Indexes. Investment Management revenue grew 6.1% in 2021, as stronger year-over-year inflows and market performance more than offset the negative impact of previously-disclosed client losses. Average assets under management and advisement (calculated based on available average quarterly or monthly data) were approximately $249.4 billion in 2021, compared with $211.6 billion in 2020.
Transaction-based revenue increased 31.2% during 2021, primarily driven by the contribution of DBRS Morningstar. DBRS Morningstar revenue grew 30.8%, primarily from robust commercial and residential mortgage-backed securities (CMBS and RMBS) issuance following muted 2020 volumes. Revenue growth from fundamental ratings accelerated throughout 2021 as DBRS Morningstar continued to successfully expand its presence in the U.S. and European corporate middle markets alongside outsized issuance in Canadian non-bank financials. Annual fees tied to surveillance, research, and other services represented 34.3% 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 Sustainalytics revenue in our organic revenue calculation in the third quarter of 2021. As such, organic revenue for the year-ended December 31, 2021 only includes Sustainalytics revenue for the last six months of 2021.
Excluding revenue from acquisitions and the impact of foreign currency translations, organic revenue increased 17.6% in 2021. PitchBook, DBRS Morningstar, Morningstar Data, Workplace Solutions, and Sustainalytics were the main drivers of the increase in organic revenue during 2021.
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The tables below reconcile consolidated revenue with organic revenue:
Less: acquisitions (37.9) — NMF
Effect of foreign currency translations (26.7) — NMF
____________________________________________________________________________________________
NMF — Not meaningful
Revenue by geographical area
Year ended December 31
International revenue comprised approximately 30% of our consolidated revenue in both 2021 and 2020. Approximately 57% of international revenue is generated from Continental Europe and the U.K.
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Revenue from international operations increased $96.3 million, or 23.0%, in 2021. Over half of the increase in 2021 is due to our acquisition of Sustainalytics, which has a revenue base in Europe, and DBRS Morningstar, which has a significant revenue base in Canada and Europe. Acquisitions and foreign currency translations had a favorable impact of $27.0 million and $26.7 million, respectively, on international revenue in 2021.
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%.
Our revenue renewal rate calculation includes only those products that we consider to be license-based. These are primarily weighted toward PitchBook, Morningstar Data, Morningstar Direct, and Morningstar Advisor Workstation, but also includes other license-based products and services across Morningstar. For these license-based products and services, we estimate that our annual renewal rate was approximately 104% in 2021 versus 99%, with the year-over-year increase largely driven by PitchBook. Sustainalytics' revenue renewal rate is excluded from our calculation because fiscal year 2021 included only six months of organic revenue contribution.
Consolidated Operating Expense
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In 2021, operating expense increased $268.0 million, or 22.8%. Higher compensation expense, sales commissions, professional fees, and advertising and marketing costs were the key contributors to operating expense growth during 2021. Foreign currency translations had an unfavorable impact of $22.6 million on operating expense in 2021.
Compensation expense (which primarily consists of salaries, bonus, and other company-sponsored benefits) increased $177.4 million in 2021. Higher salary and bonus expense, which reflect increased headcount, merit raises, and higher bonus accruals driven by the company's strong financial performance, were the primary drivers of increased compensation expense during 2021.
Sales commissions also grew $23.3 million largely due to strong PitchBook sales performance and additional headcount under sales commission plans throughout the organization. Professional fees increased $18.2 million during 2021 related to ongoing M&A integration products and third-party contractors assisting with software development and technology improvements. Advertising and marketing costs increased $10.6 million in 2021 due to an increase in paid-search advertising and branded partnership campaigns at PitchBook, as well as the return to hybrid and in-person Morningstar conferences.
An increase of $16.1 million in capitalized software development related to accelerated product development efforts for our key product areas also reduced operating expense during 2021.
We had 9,556 employees worldwide at the end of 2021, compared with 7,979 at the end of 2020, which reflects further investments across many areas including data collection and analysis, product and software development, and sales and service to support our growth objectives.
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 $142.0 million, or 25.5%, in 2021. Higher compensation expense of $124.0 million was the largest contributor to the increase, largely reflecting additional salary and bonus expense. Professional fees increased $9.4 million during 2021 related to ongoing M&A integration projects and third-party contractors assisting with software development and technology improvements. Growth in mutual fund operating costs of $4.6 million also contributed to the unfavorable variance in this category, mainly due to fees paid to sub-advisors and other costs related to the Morningstar Funds Trust. These increases were partially mitigated by higher capitalized software expense of $16.1 million.
Continuous focus on the development of our major software platforms for our key product areas, in addition to bringing new products and capabilities to market, resulted in an increase in capitalized software development over the prior year period, which in turn reduced operating expense. In 2021, we capitalized $79.0 million in costs associated with software development activities, mainly related to enhanced capabilities in our products, internal infrastructure, and software compared with $62.9 million in 2020.
Sales and marketing
Sales and marketing expense increased $68.4 million, or 33.1%, in 2021, reflecting a $33.8 million increase in compensation expense. Sales commission expense was higher by $20.6 million largely due to strong PitchBook sales performance and additional headcount under sales commission plans throughout the organization. Advertising and marketing costs increased $10.6 million due to an increase in paid search advertising for PitchBook and Morningstar.com.
General and administrative
General and administrative expense increased $46.4 million, or 17.1%, during 2021. Compensation expense increased $19.6 million. Professional fees increased $8.4 million related to ongoing M&A integration projects and third-party contractors assisting with software development and technology improvements.
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Depreciation and amortization
Depreciation and amortization increased $11.2 million, or 8.0%, in 2021 primarily due to depreciation expense.
Depreciation expense increased $6.9 million in 2021, driven mainly by depreciation expense related to capitalized software development incurred over the past several years.
Consolidated Operating Income and Operating Margin
Consolidated operating income increased $41.8 million in 2021, reflecting an increase in operating expense of $268.0 million, which was more than offset by an increase in revenue of $309.8 million. Operating margin was 15.1% in 2021, a decrease of 0.4 percentage points compared with 2020.
In 2021, we reported adjusted operating income of $363.4 million, which excludes intangible amortization expense and M&A-related expenses (including M&A-related earn-outs). 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 62.0 58.8 5.4 %
Add: M&A-related earn-outs 27.0 27.8 (2.9) %
In 2021, we reported an adjusted operating margin of 21.3%, which excludes intangible amortization expense and M&A-related expenses (including M&A-related earn-outs). Adjusted operating margin is a non-GAAP financial measure; the table below shows a reconciliation to the most directly comparable GAAP financial measure.
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Add: intangible amortization expense 3.6 % 4.2 % (0.6) pp
Add: M&A-related expenses 1.0 % 1.1 % (0.1) pp
Add: M&A-related earn-outs 1.6 % 2.0 % (0.4) pp
Adjusted operating margin 21.3 % 22.8 % (1.5) pp
Non-Operating Income (Expense), Net, Equity in Net Income (Loss) of Unconsolidated Entities, and Effective Tax Rate and Income Tax Expense
Non-Operating Income (Expense), Net
The following table presents the components of non-operating income, net:
Interest income $ 1.7 $ 1.6
Realized gains on sale of equity method investments 0.9 30.0
Holding gain on previously held equity interest — 50.9
Other expense, net (3.7) (5.7)
Non-operating income (expense), net $ (6.5) $ 67.8
Interest income reflects interest from our investment portfolio. Interest expense primarily relates to the outstanding principal balance under our Credit Agreement and the $350.0 million aggregate principal amount of the 2.32% senior notes due October 26, 2030 (2030 Notes).
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 our previously held equity interest relates to the purchase of the remaining interest in Sustainalytics in July 2020.
Other expense, net primarily includes foreign currency losses.
Equity in Net Income of Unconsolidated Entities
Equity in net income of unconsolidated entities $ 5.4 $ 0.3
Equity in net income of unconsolidated entities primarily reflects income and losses from certain of our
unconsolidated entities.
We describe our investments in unconsolidated entities in more detail in Note 9 of the Notes to our Consolidated Financial Statements.
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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 5.4 0.3
Income tax expense $ 62.6 $ 59.7
Effective tax rate 24.5 % 21.1 %
Our effective tax rate in 2021 was 24.5%, an increase of 3.4 percentage points, compared with 21.1% in 2020. The increase was primarily attributable to minimum taxes and non-deductible expenses.
Liquidity and Capital Resources
As of December 31, 2021, we had cash, cash equivalents, and investments of $546.1 million, up $81.9 million from the end of 2020. The increase reflects higher cash provided by operating activities of $449.9 million offset by $101.8 million of capital expenditures, $90.0 million of net repayments of long-term debt, dividends paid of $54.2 million, $34.4 million for the payment of acquisition-related earn-outs included in financing activities, $29.8 million for purchases of equity method investments, and $24.8 million for acquisitions, net of cash acquired in investing activities.
Cash provided by operating activities is our main source of cash. In 2021, cash provided by operating activities was $449.9 million, reflecting $386.3 million of net income, adjusted for non-cash items and $63.6 million in positive changes from our net operating assets and liabilities. Cash provided by operating activities increased $65.6 million, or 17.1%, in 2021, primarily due to higher cash earnings.
On July 2, 2019, we entered into a senior credit agreement (the Credit Agreement). 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 $11.0 million on the term facility and borrowing availability on the revolving credit facility of $300.0 million as of December 31, 2021. See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our Credit Agreement.
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On June 30, 2020, we entered into a senior credit agreement that provides us with a $50.0 million 364-day senior revolving credit facility. The 364-Day Revolving Credit Facility expired on June 29, 2021 and we chose not to renew the facility upon expiration.
On October 26, 2020, we completed the issuance and sale of 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, 2021, our total outstanding debt, net of issuance costs, under the 2030 Notes was $348.4 million. See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our 2030 Notes.
Each of the Credit Agreement 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, 2021.
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 are focused on maintaining a strong balance sheet and liquidity position. We hold 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.
Approximately 57% of our cash, cash equivalents, and investments as of December 31, 2021 was held by our operations outside the U.S., down slightly from about 60% as of December 31, 2020. 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 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 authorization expires on December 31, 2023. As of December 31, 2021, we repurchased a total of 4,900 shares for $1.3 million under this authorization.
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In 2021, we also paid dividends of $54.2 million. Subsequent dividends will be subject to board approval and we expect to make regular quarterly dividend payments of 36 cents per share in 2022.
We expect to continue making capital expenditures in 2022, 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 continue to 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 2022 to make annual bonus payments of approximately $141.5 million related to the 2021 bonus program compared to $85.9 million in 2020.
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 $ 449.9 $ 384.3 17.1 %
We generated free cash flow of $348.1 million in 2021, an increase of $40.5 million compared with 2020. The change reflects a $65.6 million increase in cash provided by operating activities as well as a $25.1 million increase in capital expenditures. Cash provided by operating activities increased primarily due to higher earnings and the timing of working capital. Capital expenditures increased due to higher capitalized software development. Excluding $16.6 million of M&A-related earn-out payments, operating cash and free cash flow would have grown by 21.4% and 18.6%, respectively.
Acquisitions
We paid a total of $774.5 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 $38.0 million related to additional investments in unconsolidated entities over the past three years. We describe these investments in Note 9 of the Notes to our Consolidated Financial Statements.
Divestitures
We had no divestitures in 2021, 2020, or 2019.
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.
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