UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K | ||||
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-51280
MORNINGSTAR, INC.
(Exact Name of Registrant as Specified in its Charter)
Illinois | 36-3297908 | |
(State or Other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification Number) | |
22 West Washington Street
Chicago, Illinois
60602
(Address of Principal Executive Offices)
(312) 696-6000
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common stock, no par value | The NASDAQ Stock Market LLC | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | ||
(Do not check if a smaller reporting company) | |||||
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of shares of common stock held by non-affiliates of the Registrant as of June 30, 2013 was $1.6 billion. As of February 21, 2014, there were 44,700,741 shares of the Registrant's common stock, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain parts of the Registrant's Definitive Proxy Statement for the 2014 Annual Meeting of Shareholders are incorporated into Part III of this Form 10-K.
Table of Contents
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Part I
Item 1. Business
Overview
Morningstar is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of products and services for financial advisors, asset managers, retirement plan providers and sponsors, and individual investors. In addition to our U.S.-based products and services, we offer local versions of our products designed for investors in Asia, Australia, Canada, Europe, Latin America, and South Africa. Morningstar serves approximately 260,000 financial advisors, 1,500 asset management firms, 26 retirement plan providers, 237,000 retirement plan sponsors, and 9.3 million individual investors. We have operations in 27 countries.
In the third quarter of 2013, we revised our segment reporting to reflect our shift to a more centralized organizational structure. We now report our results in a single reportable segment and have changed the presentation of our prior-period results to reflect our new segment structure.
We maintain a series of comprehensive databases on many types of investments, focusing on investment vehicles that are widely used by investors globally. After building these databases, we add value and insight to the data by applying our core skills of research, technology, and design. As of December 31, 2013, we provided extensive data on approximately 420,000 investments, including:
• | 155,000 open-end mutual funds globally; |
• | 10,700 exchange-traded funds (ETFs); |
• | 6,300 closed-end funds; |
• | 34,500 stocks; |
• | 5,800 hedge funds; |
• | 10,300 separate accounts and collective investment trusts; |
• | 115,400 variable annuity/life subaccounts and policies; |
• | 61,900 insurance, pension, and life funds; |
• | 14,000 unit investment trusts; and |
• | 4,600 state-sponsored college savings plan portfolios (commonly known as Section 529 College Savings Plans). |
Our investment database also includes:
• | 87 years of capital markets data capturing performance of several major asset classes; |
• | extensive cash flow, ownership, and biographical data on directors and officers; |
• | security-level identification information; |
• | regulatory documents, disclosure filings, and conference-call transcripts; |
• | real-time market data on more than 9 million exchange-traded equities, derivatives, commodities, futures, foreign exchanges, precious metals, news, company fundamentals, and analytics; and |
• | real-time price quotes for global foreign currencies. |
Our business model is based on leveraging our investments in these databases by selling a wide variety of products and services to individual investors, financial advisors, asset managers, and retirement plan providers and sponsors around the world.
Our data and proprietary analytical tools such as the Morningstar Rating for mutual funds, which rates past performance based on risk- and cost-adjusted returns, and the Morningstar Style Box, which provides a visual summary of a mutual fund's underlying investment style, have become important tools that millions of investors and advisors use in making investment decisions. We've created other tools, such as the Ownership Zone, Sector Delta, and Market Barometer, which allow investors to see how different investments work together to form a portfolio and to track its progress. Our popular Portfolio X-Ray tool helps investors reduce risk and understand the key characteristics of their portfolios based on nine different factors.
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In 2012, we published research on "Gamma," an innovative measure that quantifies how much additional retirement income investors can generate by making better financial planning decisions.
As part of our research efforts on individual stocks, we popularized the concepts of economic moat, a measure of competitive advantage originally developed by Warren Buffett, and margin of safety, which reflects the size of the discount in a stock's price relative to its estimated value. The Morningstar Rating for stocks is based on the stock's current price relative to our analyst-generated fair value estimates, as well as the company's level of business risk and economic moat. Our analysts cover approximately 1,600 stocks, using a consistent, proprietary methodology that focuses on fundamental analysis, competitive advantage assessment, and intrinsic value estimation. In 2013, 12 of our equity analysts were included in The Wall Street Journal’s 21st annual “Best on the Street” analysts survey.
In 2013, we significantly expanded our equity coverage with the launch of quantitative ratings and reports for 28,000 companies globally. These quantitative equity ratings are forward-looking and generated by a statistical model based on our analyst-driven equity ratings and quantitative statistics.
We offer a variety of qualitative measures such as Stewardship Grades, which help investors identify companies and fund firms that have demonstrated a high level of commitment to shareholders and stewardship of investors' capital. In 2012, we introduced a new global Stewardship Rating for stocks that places more emphasis on management decisions that directly improve returns on invested capital and shareholder investment. In 2011, we introduced our forward-looking Morningstar Analyst Rating for funds, a global, qualitative measure based on our analyst research. We also offer qualitative research and ratings on alternative funds, exchange-traded funds, closed-end funds, 529 plans, and target-date funds.
In addition, we publish credit ratings and associated research on corporate debt issuers. We currently provide ratings on about 600 issuers and also provide research and ratings on commercial mortgage-backed securities. In 2012, we began publishing analyst research on municipal bonds. Our fundamental municipal research is designed to assess relative credit quality and fiscal distress using a proprietary, analyst-driven methodology.
We've also developed in-depth advice on security selection and portfolio construction to meet the needs of investors and professionals looking for integrated portfolio solutions. We believe many investors rely on these tools because they offer a useful framework for comparing potential investments and making decisions. Our independence and our history of innovation make us a trusted resource for investors.
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Strategy and Key Objectives
Our strategy is to widen our economic moat, or sustainable competitive advantage, and build shareholder value by focusing on our three key objectives, which we describe in more detail below.
1. Develop the next-generation software for our investment research platforms, which will offer the most elegant and intuitive user experience for our customers.
We believe our customers’ technology needs are rapidly evolving, and our clients increasingly want integrated solutions as opposed to using different research tools for different parts of their portfolios. To meet this, we’re rebuilding our core software architecture to accelerate delivery of our products, allow us to innovate more rapidly, and drive rich web-based user experiences for our clients.
We're currently building the next-generation software architecture that will eventually underlie most of our software products. The new software architecture uses an underlying framework that allows us to create capabilities or tools that take our software to a much higher design standard that’s more intuitive, elegant, and easy-to-use and helps ensure a more consistent, cohesive “signature Morningstar” user experience. It also has several technological advantages, including a more streamlined design and development process for commonly used Morningstar capabilities such as portfolio management tools and a more consistent user experience across Morningstar's platforms.
The new software architecture will also address the growing need for mobile-optimized capabilities to extend the desktop experience onto mobile devices, as well as clients’ increasing preference for cloud-based deployment, which eliminates the need for desktop software installations and allows immediate access to new features. The new software framework will be easier for clients to implement and configure through seamless programming interfaces and web services. It will also allow us to innovate more rapidly and more easily configure our software solutions to meet client needs.
We plan to introduce this new architecture as part of Morningstar Direct in 2014, beginning with new versions of many of our core capabilities. Over time, we expect the majority of our software solutions to use this single technology architecture. By moving all of our core research products to a common software architecture, we'll be able to leverage our development resources, give our customers a more unified and consistent Morningstar experience, and better showcase our innovative research and analytical tools.
2. Deliver the most effective investment data, research, and ratings to help investors reach their financial goals.
We believe that our leadership position in independent investment research offers a competitive advantage that would be difficult for competitors to replicate. Our goal is to continue producing insights that empower investors and focus our research efforts in three major areas:
• | Extend leadership position in global fund research. In recent years, we have expanded our analyst coverage outside of the United States. We've built an integrated team of locally based fund experts to expand our research coverage in additional markets around the world. As of December 31, 2013, we had 105 fund analysts globally, including teams in North America, Europe, Asia, and Australia. We currently produce qualitative analyst research and Morningstar Analyst Ratings on about 4,000 funds around the world. We plan to continue expanding the number of funds that have Morningstar Analyst Ratings and in-depth qualitative research reports. |
• | Continue leveraging our capabilities in stocks. Our equity research complements our approach to mutual fund analysis, where we focus on analyzing the individual stocks that make up each fund's portfolio. As of December 31, 2013, we provided analyst research on about 1,600 companies globally. We also provide quantitative ratings and reports for approximately 28,000 companies globally. |
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We're committed to maintaining the broad, high-quality coverage we've become known for as one of the largest providers of independent equity research. We're working to expand distribution of our equity research through a variety of channels, including financial advisors, institutional investment firms, and companies outside of the United States. We believe that investors' increasing awareness of the value of independent research will strengthen our business over the long term. We've also expanded our proprietary stock database, which we view as an important complement to our analyst research.
• | Build business in credit research and ratings. We began publishing research and ratings on corporate credit issuers in 2009 and currently produce research and ratings on about 600 corporate credit issuers. In 2012, we began publishing research on more than 100 municipal bond issuers. We view credit ratings as a natural extension of the equity research we've been producing for the past decade. We believe we have a unique viewpoint to offer on company default risk that leverages our cash-flow modeling expertise, proprietary measures like economic moat, and in-depth knowledge of the companies and industries we cover. In 2013, we also published research reports analyzing pension plan assets and liabilities for pension plans administered by all 50 states and 25 major cities. |
We're including this research on our software platforms to provide investors with an additional perspective on fixed-income investments. We also plan to monetize the ratings through enterprise licenses and subscriptions to our institutional equity research clients, who have access to the forecasts, models, and scores underlying the ratings.
We also offer fixed-income capabilities through Morningstar Credit Ratings, LLC, a Nationally Recognized Statistical Rating Organization (NRSRO) that specializes in research and ratings on commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS). We believe investors are looking for better research on these securities and that we're well-positioned to meet this need.
3. Be a world-class investment management organization based on our proprietary research.
We believe assembling and evaluating multimanager portfolios is a natural extension of our expertise in understanding managed investment products. Our investment advisory programs combine managed investment vehicles—typically mutual funds—in portfolios designed to help investors meet their financial goals. When we create portfolios made up of other funds, our goal is to simplify the investment process and help investors access portfolios that match their level of risk tolerance, time horizon, and long-term investment objectives. We draw on our extensive experience analyzing funds and combine quantitative research with a qualitative assessment of manager skill and investment style. We had a total of $83.5 billion in assets under advisement in our Investment Advisory business as of December 31, 2013.
Our advisory business focuses on relationships and agreements where we act as a portfolio construction manager or asset allocation program designer for a mutual fund or variable annuity and receive a basis-point fee. We plan to further develop this business by expanding outside of the United States, building our capabilities in areas such as alternative investment strategies, developing more ways to incorporate risk protection and insurance, reaching additional client segments, and focusing on performance and client support.
We also offer managed retirement account services through our Retirement Solutions platform and had $31.7 billion in assets under management in our managed retirement accounts as of December 31, 2013. We offer these services for retirement plan participants who choose to delegate management of their portfolios to our managed retirement programs, which are based on quantitative systems that select investment options and make retirement planning choices for the participants. We believe retirement plan participants will continue to adopt managed accounts because of the complexity involved in retirement planning.
Morningstar Managed Portfolios is a fee-based discretionary asset management service that includes a series of mutual fund, ETF, and stock portfolios tailored to meet specific investment time horizons and risk levels. As of December 31, 2013, there were $7.3 billion in assets under management and advisement in Morningstar Managed Portfolios.
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Major Customer Groups
Given the core capabilities discussed above, we're focusing on four primary customer groups:
• | Advisor (including independent financial advisors as well as those affiliated with broker-dealers, other intermediaries, and retail brokerage firms); |
• | Asset management (including fund companies, insurance companies, and other companies that build and manage portfolios of securities for their clients); |
• | Retirement (including retirement plan providers and plan sponsors); and |
• | Individual investor. |
We describe each of these four customer groups in the section below.
Advisor
Financial advisors work with individual investors to help them reach their financial goals. This customer group includes several different types of advisors, including independent advisors at registered investment advisor (RIA) firms, advisors affiliated with independent broker-dealers, dually registered advisors, and “captive” advisors who are employees of a broker-dealer. Captive broker-dealers include wirehouses, regional broker-dealers, and banks. Cerulli Associates estimates there were approximately 300,000 financial advisors in the United States as of the end of 2013.
There has also been an industry-wide shift in favor of fee-based planning, as opposed to commission models. We add value by helping advisors make more efficient use of their time and deliver better investment outcomes for their clients. We also offer a comprehensive and integrated set of solutions, including proprietary investment methodologies, portfolio- and security-level research, and investment management. We believe our products and tools are deeply embedded in many portions of financial advisors’ daily workflow.
We sell our advisor-related solutions both directly to independent financial advisors and through enterprise licenses, which allow financial advisors associated with the licensing firm to use our products.
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To build this business, we plan to focus on helping advisors with a broad range of tasks, including investment decision-making, new client acquisition, client monitoring and reporting, and practice management. We're expanding our mobile solutions to reach advisors wherever they are—including at a desktop, on a mobile device, participating in social networking sites, or attending conferences and events. We plan to build comprehensive advisory solutions that incorporate both retirement and non-retirement assets and continue expanding our reach with both independent advisors and those affiliated with larger firms.
Our main products for financial advisors are Morningstar Advisor Workstation (including Morningstar Office), Morningstar Managed Portfolios, and Principia.
Asset management
Asset management firms create, market, and distribute investment portfolios. We estimate that there are approximately 2,700 asset management firms globally, ranging from large, global firms that each manage more than $1 trillion to firms with small fund lineups and operations in a single market or region. The asset management customer group includes individuals involved in sales, marketing, product development, and distribution, as well as investment management (the “buy side”), which includes portfolio management, research, and securities analysis.
Our asset management offerings help companies connect with investors by applying Morningstar’s intellectual capital and brand to reinforce the value propositions of their own financial products. We offer a global reach and have earned investors’ trust in our unbiased approach, investor-centric mission, thought leadership, and expertise in data and investment management.
Our strategy for the asset management customer group includes expanding the range of services we offer, driving our thought leadership, helping clients adapt to regulatory change, and tailoring our offerings to meet the needs of asset management firms of various sizes. We also plan to expand our offerings to meet the growing need for research, data, and tools related to ETFs and other passively managed portfolios, as well as enhancing our derivatives coverage and capabilities to help investors better analyze and understand the rapidly increasing universe of alternative investments.
For the buy side, we provide award-winning equity and credit research for active fundamental portfolio managers who want actionable, unbiased ideas that improve performance. We deliver focused ideas proven to drive long-term performance and consistent global research methodologies that can integrate with portfolio managers’ and analysts’ workflow.
Our goal is to expand the number of asset management firms and individuals at these firms who employ Morningstar’s research offerings to help them achieve better results for their clients. We also plan to incorporate our proprietary research methodologies in our data, analytics, and tools to continue developing differentiated software and data offerings.
The key products we offer for asset management firms include Morningstar Direct, Morningstar Data, Integrated Web Tools, Investment Profiles, and Investment Advisory services. For the buy side, key products include Morningstar Equity and Credit Research, Structured Credit Research and Ratings, Morningstar Data, and Morningstar Direct.
Retirement
In the retirement market, millions of investors are now charged with planning for their own retirement, as more companies have shifted from traditional pension plans to self-directed retirement plans such as 401(k) plans. Total assets in 401(k) plans have increased to $4.0 trillion as of September 30, 2013 based on data from the Investment Company Institute. In the wake of the financial crisis in 2008 and 2009, we believe individual investors, financial advisors, employers, and government organizations have all become more aware of the need for advice and guidance that helps individuals build assets for retirement and beyond.
Our retirement offerings help retirement plan participants of all ages plan and invest for retirement. We offer these services both through retirement plan providers (typically third-party asset management companies that offer proprietary mutual funds) and directly to plan sponsors (employers that offer retirement plans to their employees).
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We currently reach approximately 24 million plan participants through approximately 237,000 plan sponsors and 26 plan providers.
We help plan providers manage their risk and costs while differentiating themselves in an increasingly competitive market. We believe that we’re uniquely positioned as the only company that offers a full range of scalable, customizable retirement solutions driven by proprietary investment methodologies. We also help retirement plan sponsors enhance their investment lineups, meet their fiduciary obligations, and help their employees prepare for retirement.
We're continuing to enhance our managed retirement accounts, which is the largest and fastest-growing product offering within our Retirement Solutions business. We plan to continue improving our user interface, add solutions that allow investors to save for multiple goals, and incorporate a broader range of factors for retirement planning, such as health-care costs. We also plan to expand our offerings in select markets outside the United States.
Our major products for the retirement customer group are Retirement Solutions, Investment Advisory services, and Investment Profiles.
Individual investor
We also offer products for individual investors who invest to build wealth and save for other goals, such as retirement or college tuition. While the number of individual investors in the United States has declined from peak levels, Gallup’s annual Economics and Personal Finance Survey released in May 2013 found that approximately 52% of individuals in the United States invest in the stock market either directly or through mutual funds or self-directed retirement plans. On a global basis, McKinsey Global Institute estimates that households own approximately $85.2 trillion in financial assets, with approximately 28.1% invested in equities and 71.9% in other investments including cash, money-market funds, and fixed-income securities.
Most of our products for individual investors are designed for motivated people who are actively involved in the investing process and want to take charge of their own investment decisions. We also reach individuals who want to learn more about investing and investors who seek out third-party sources to validate the advice they receive from brokers or financial advisors. Our independent investment research, proprietary ratings, and proven portfolio strategies enable investors to make sensible plans, select investments to meet their needs, and monitor their portfolios through changing markets with more confidence and clarity.
We support our offerings for individual investors with a staff of analysts and investment strategists who continuously monitor, rate, and provide valuable perspective on stocks, funds, and other investments using a consistent, proven methodology. As an independent investment research provider, we’re uniquely positioned and trusted to support the needs of individual investors. Because many individual investors trust Morningstar’s research and tools, our extensive reach with individual investors also drives demand for our other customer groups.
Our main product for individual investors is Morningstar.com, which includes both paid Premium Memberships and free content available to registered users and visitors. We also reach investors through a series of investment newsletters, iPad and mobile applications, and through partnerships with other websites, such as Yahoo Finance, MSN Money, and Google Finance. We also reach millions of individual investors indirectly through our investment management offerings, including Investment Advisory, Retirement Solutions, and Morningstar Managed Portfolios.
Acquisitions and Divestitures
Since our founding in 1984, we have focused primarily on organic growth by introducing new products and services and expanding our existing offerings. From 2006 through 2010, we also completed 24 acquisitions to support our growth objectives (as detailed above). During the second quarter of 2013, we acquired an additional 76% interest in Morningstar Sweden AB to become sole owner.
For more information about the acquisitions and divestitures, refer to Notes 6 and 7 of the Notes to our Consolidated Financial Statements.
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Major Products and Services
The section below describes some of our major products and services (ranked in order of size based on their 2013 revenue).
Morningstar Data
Morningstar Data gives institutions access to a full range of investment data spanning numerous investment databases, including real-time pricing data and commodity data. We offer data packages that include access to our proprietary statistics, such as the Morningstar Style Box and Morningstar Rating, and a wide range of other data, including information on investment performance, risk, portfolios, operations data, fees and expenses, cash flows, and ownership. Institutions can use Morningstar Data in a variety of investor communications, including websites, print publications, and marketing fact sheets, as well as for internal research and product development. We deliver Morningstar Data through password-protected websites, data feeds, and software and provide daily updates to clients.
Morningstar Data for equities is used by many leading asset management firms, media companies, broker dealers, and other large institutions to support internal research functions, power investment tools, and deliver meaningful information and analysis to investors. Our continuously expanding global data services feature financial statement data, consolidated industry statistics, stock ownership information, and proprietary Morningstar statistics.
In 2013, our UK-based subsidiary, Morningstar UK Limited, received the Best Investment Data Provider award at the Professional Adviser Awards.
Also in 2013, the Financial Industry Regulatory Authority (FINRA) selected Morningstar to provide financial data, technology and design for the re-launch of FINRA's Market Data Center. FINRA's Market Data Center makes available to retail investors a wealth of information on a broad spectrum of financial instruments. We designed the new Market Data Center and provide comprehensive intra-day pricing and fundamental data for U.S. fixed income securities, equities, options, indexes, mutual funds and ETFs.
Pricing for Morningstar Data is based on the number of funds, market indexes, stocks, commodities, or other securities covered; the amount and depth of information provided for each security; and the number of users and level of distribution.
For Morningstar Data, our primary competitors are Financial Express, Informa Investment Solutions, and Thomson Reuters.
Morningstar Data was our largest product in 2013 and accounted for 18.5%, 17.5%, and 16.5% of our consolidated revenue in 2013, 2012, and 2011, respectively.
Morningstar Advisor Workstation
Morningstar Advisor Workstation, a web-based investment planning system, provides financial advisors with a comprehensive set of tools for conducting their core business—including investment research, planning, and presentations. It allows advisors to build and maintain a client portfolio database that can be fully integrated with the firm's back-office technology and resources. Moreover, it helps advisors create customized reports for client portfolios that combine mutual funds, stocks, separate accounts, variable annuity/life subaccounts, ETFs, hedge funds, closed-end funds, fixed-income securities, unit investment trusts, 529 plans, offshore funds, and pension and life funds.
As of December 31, 2013, approximately 170,000 advisors in the United States were licensed to use Advisor Workstation, which is available in two versions: Morningstar Office for independent financial advisors and an enterprise version for financial advisors affiliated with larger firms.
Morningstar Office is our complete practice and portfolio management system for independent financial advisors. This single, all-inclusive platform is designed to support the core aspects of an advisor’s practice. It features robust portfolio management and performance reporting, advanced research capabilities, sophisticated investment planning, and customer relationship management (CRM) tools for batch reporting and client communications.
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The enterprise version includes four core modules: Clients & Portfolios, Research, Sales/Hypotheticals, and Planning. We also offer a variety of other applications, including tools for defined contribution plans; Morningstar Document Library, which helps firms comply with pre- and post-sale document delivery requirements by providing access to prospectuses and supplements in HTML or PDF formats; Analyst Research Center, which complements the quantitative data in Advisor Workstation with independent, qualitative research on stocks, mutual funds, ETFs, and initial public offerings; and Presentation Library, which gives advisors access to compelling client presentation materials. These applications can be purchased as stand-alone products or combined as part of a full Workstation license.
In 2013, we completed the migration of all of our clients in the United States to Morningstar Advisor Workstation 2.0, a platform we launched in 2010 that incorporates significant technology upgrades along with interface and usability improvements. This migration will allow us to fully retire the previous version and enhance our efforts to simplify and consolidate our product lines. Pricing for Morningstar Advisor Workstation varies based on the number of users, as well as the level of functionality. We typically charge annual fees of about $3,400 per licensed user for a base configuration of Morningstar Advisor Workstation, but pricing varies significantly based on the scope of the license. For clients who purchase more limited tools-only licenses, the price per user is substantially less. We generally charge $5,700 per user for an annual license for Morningstar Office.
Major competitors for Morningstar Advisor Workstation and Morningstar Office include Advent Software, Charles Schwab, Standard & Poor's, SunGard, Tamarac (a division of Envestnet), and Thomson Reuters.
Morningstar Advisor Workstation is our second-largest product based on revenue and made up 13.3%, 13.1%, and 12.6% of our consolidated revenue in 2013, 2012, and 2011, respectively.
Morningstar Direct
Morningstar Direct is an institutional investment research platform that provides professionals with advanced analytical tools to perform research on the complete range of securities in Morningstar's global database, as well as privately held investments and data from third-party providers. This comprehensive platform empowers portfolio managers, investment consultants, financial product managers, wealth managers, and other finance professionals worldwide to develop, select, and monitor investments. These professionals use the qualitative and quantitative content available on Morningstar Direct—including data on current and historical performance data, operations, portfolio holdings, and asset flows—to conduct advanced performance comparisons and in-depth analyses of an investment's underlying investment style. Morningstar Direct also allows users to transform investment data into custom-branded reports and presentations to support internal audiences and marketing and sales groups.
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Over the past several years, we have expanded the range of third-party content included in Morningstar Direct, including indexes from all major providers and the HFR hedge fund database. We recently entered into an agreement to make separate account and hedge fund data from eVestment Alliance available to Morningstar Direct users. This database of more than 22,000 separate accounts and 23,000 hedge funds will be available for an additional annual fee to Morningstar Direct users in 2014.
Morningstar Direct's primary competitors are eVestment Alliance, FactSet Research Systems, and Thomson Reuters.
Morningstar Direct had approximately 8,500 licensed users worldwide as of December 31, 2013.
Pricing for Morningstar Direct is based on the number of licenses purchased. For clients in the United States, we generally charge an annual fee of $17,000 for the first user, $10,500 for the second user, and $9,000 for each additional user.
Morningstar Direct is our third-largest product based on revenue and accounted for 11.4%, 9.9%, and 8.3% of our consolidated revenue in 2013, 2012, and 2011, respectively.
Investment Advisory
Our Investment Advisory business provides institutional investment consulting, investment advisory, and management services for asset management firms, broker-dealers, and insurance providers. We offer Investment Advisory services through Morningstar Associates, Inc.; Morningstar Associates Korea Co., Ltd.; Morningstar Associates, LLC; Morningstar Investment Management Europe, Ltd; Ibbotson Associates, Inc.; Ibbotson Associates Australia Limited; Ibbotson Associates Japan KK; OBSR Advisory Services Limited; and Morningstar Investment Consulting France SAS (formerly Seeds Finance). All of these entities are wholly owned or majority-owned subsidiaries of Morningstar, Inc., and are authorized to provide investment advisory services by the appropriate regulatory agency in their applicable jurisdictions.
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Drawing on our proprietary research and methodologies, we deliver four core service offerings: asset allocation, manager evaluation, portfolio management, and 15(c) board consulting services. We focus on delivering customized solutions that improve the investor experience and help our clients build their businesses. Many of our Investment Advisory agreements focus on investment monitoring and asset allocation for multimanager portfolios made up of managed investment products, such as mutual funds, separate accounts, and variable insurance trusts. We focus on relationships where we're paid a fee expressed as a percentage of assets under management for ongoing investment management and advice, as opposed to one-time relationships where we're paid a flat fee.
We offer these advisory services to clients in most of our major operations globally, including insurance companies, investment management companies, mutual fund companies, and broker-dealers.
Our Investment Advisory business competes primarily with Mercer, Mesirow Financial, Russell Investments, Thomson Reuters, and Wilshire Associates, as well as some smaller firms in the retirement consulting business and various in-house providers of investment advisory services.
Pricing for our Investment Advisory is based on the scope of work, our degree of investment discretion, and the level of service required. In the majority of our contracts, we receive asset-based fees, reflecting our work as a portfolio construction manager or subadvisor for multimanager portfolios made up of managed investment products.
Investment Advisory was our fourth-largest product based on revenue in 2013 and accounted for 8.5%, 10.1%, and 11.3% of our consolidated revenue in 2013, 2012, and 2011, respectively.
Morningstar.com
Our largest website for individual investors is Morningstar.com in the United States. Revenue for this product offering includes both Premium Memberships (which made up about 60% of Morningstar.com's revenue base in 2013) and Internet advertising sales (which made up the remaining 40%). As of December 31, 2013, the free membership services offered through Morningstar.com had approximately 9.3 million registered users worldwide, who have access to comprehensive data on stocks, mutual funds, ETFs, closed-end funds, 529 plans, commodities, options, bonds, and other investments to help them conduct research and track performance. In addition, Morningstar.com features extensive market data, articles, proprietary portfolio tools, and educational content to help investors of all levels access timely, relevant investment information.
Morningstar.com has been named one of the best investing websites by publications such as Kiplinger's Personal Finance and The American Association of Individual Investors.
We also offer more than 40 regional investing websites customized to the needs of investors worldwide. Many of these sites feature coverage in local languages with tools and commentary tailored to specific markets. In 2013, the London Times included our UK-based site, Morningstar.co.uk, in its list of 50 top websites to help people save money.
We use our free content as a gateway into paid Premium Membership, which includes access to written analyst reports on more than 1,400 stocks, 1,200 mutual funds, 400 ETFs, and 120 closed-end funds, as well as our Portfolio X-Ray, asset allocation and portfolio management tools, proprietary stock data, Stewardship Grades and Ratings, and premium stock and fund screeners. We currently offer Premium Membership services in Australia, Canada, China, Italy, the United Kingdom, and the United States.
In 2013, we introduced Morningstar® for iPad, a comprehensive personal investing app that allows users to monitor the markets, evaluate their portfolios, and research securities. We believe this app sets a high standard for visual design, technology, and user experience.
Morningstar.com competes with The Motley Fool, Seeking Alpha, TheStreet.com, and Yahoo! Finance as well as other finance sites, such as AOL Money & Finance, Google Finance, Marketwatch.com, MSN Money, and The Wall Street Journal Online.
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As of December 31, 2013, we had approximately 124,000 paid Premium subscribers for Morningstar.com in the United States plus an additional 6,000 paid Premium subscribers in Australia, Canada, China, Italy, and the United Kingdom. We currently charge $23.95 for a monthly subscription, $199 for an annual subscription, $339 for a two-year subscription, and $439 for a three-year subscription for Morningstar.com's Premium Membership service in the United States. We also sell advertising on Morningstar.com.
Morningstar.com (including local versions outside of the United States) is our fifth-largest product based on revenue and accounted for 8.0% of our consolidated revenue in 2013, compared with 8.2% in 2012 and 8.9% in 2011.
Retirement Solutions
Our Retirement Solutions offerings help retirement plan participants plan and invest for retirement. We offer these services both through retirement plan providers (typically third-party asset management companies that offer proprietary mutual funds) and directly to plan sponsors (employers that offer retirement plans to their employees). Clients can select either a hosted solution or our installed software advice solution. We design these solutions to help retirement plan participants accumulate wealth, transition into retirement, and manage income during retirement.
Morningstar Retirement Manager is our advice and managed accounts program that helps plan participants with their retirement goals. It helps investors determine how much to invest and which investments are most appropriate for their portfolios. The program gives guidance explaining whether participants' suggested plans are on target to meet their retirement goals. As part of this service, we deliver personalized recommendations for a target savings goal, a recommended contribution rate to help achieve that goal, a portfolio mix based on risk tolerance, and specific investment recommendations. Participants can elect to have their accounts managed by us through our managed account service or build their own portfolios using our recommendations as a guide.
Morningstar Retirement Manager also helps plan sponsors meet their fiduciary obligations. Morningstar works with plan sponsors to help them better understand their fiduciary obligations and stay ahead of changes in the marketplace. We can act as an ERISA fiduciary by, for example, selecting and monitoring a broad range of diversified plan options. As part of this service, we can construct and monitor the investment lineup, document our investment process, create an Investment Policy Statement, and furnish the plan with detailed quarterly investment and performance reports.
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In 2013, we introduced the next-generation version of Morningstar Retirement Manager, which incorporates our latest institutional asset allocation methodologies. It also includes Income Secure, a program that provides individualized, tax-efficient retirement income drawdown advice.
We also entered into an agreement with Charles Schwab to add Morningstar to Schwab’s Index Advantage program, which uses low-cost investments (index funds or ETFs) with professional management from Morningstar to provide a low-cost, yet effective program to help participants prepare for retirement.
As of December 31, 2013, approximately 24 million plan participants had access to Retirement Solutions through approximately 237,000 plan sponsors and 26 plan providers. Pricing for Retirement Solutions depends on several different factors, including the level of services offered (including whether or not such services cause us to be an ERISA fiduciary), the number of participants, the level of systems integration required, and the availability of competing products.
In the retirement advice market, we compete primarily with Financial Engines and Guided Choice.
Morningstar Integrated Web Tools
Morningstar Integrated Web Tools is a set of tools and capabilities that help institutional clients build customized websites or enhance their existing solutions with Morningstar's online tools and components. We offer a series of components, editorial content, and reports that investment firms can license to build or enhance their websites for financial advisors and individual investors. Outside the United States, clients can customize our offerings with capabilities tailored to regional markets, multiple languages, and local currencies. Our suite of components can be customized to analyze sets of investments, focus on client-defined data points and methodologies, or perform calculations required by specific products or services. We also offer licenses for investment research, editorial content, and portfolio analysis and comparison tools that allow users to drill down into the underlying data when researching a potential investment.
Competitors for Integrated Web Tools include Advisor Software, Inc., Financial Express, Interactive Data Corporation, Markit on Demand, and Thomson Reuters.
Pricing for Integrated Web Tools consists of both ongoing license fees and one-time development fees and depends on the customer, the level of distribution, and the scope of information and functionality licensed.
Morningstar Managed Portfolios
We offer the Morningstar Managed Portfolios program through Morningstar Investment Services, Inc., a registered investment advisor, registered broker-dealer, member of the Financial Industry Regulatory Authority, Inc. (FINRA), and wholly owned subsidiary of Morningstar, Inc. The target customer for Morningstar Managed Portfolios is fee-based independent financial advisors. These advisors are often affiliated with the corporate registered investment arms of insurance companies and independent and registered broker-dealers.
Morningstar Managed Portfolios is a fee-based discretionary asset management service that includes a series of mutual fund, ETF, and stock portfolios tailored to meet specific investment time horizons and risk levels. This program is only available through financial advisors. Our team of investment professionals uses a disciplined process for asset allocation, security selection, and risk management. We complement these asset management services with online client-management functions such as risk profiling and access to client statements, transaction capabilities, and performance reports.
We had approximately $7.3 billion in assets under management with about 4,600 financial advisors using the service as of December 31, 2013. We charge asset-based fees for Morningstar Managed Portfolios. The management fee is typically based on a tiered schedule that depends on the client's average daily portfolio balance. Fees for our mutual fund and ETF portfolios generally range from 20 to 40 basis points. We charge 40 to 55 basis points for Select Stock Baskets, which is a managed account service that incorporates customizable stock portfolios based on Morningstar's proprietary equity research and indexes.
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For Morningstar Managed Portfolios, our primary competitors are Assetmark, Brinker Capital, Curian Capital, Envestnet PMC, Loring Ward, and SEI Investments. We also compete with in-house research teams at independent broker-dealers who build proprietary portfolios for use on brokerage firm platforms, as well other registered investment advisors that provide investment strategies or models on these platforms.
Other Products and Services
In addition to the products described above, we offer a variety of other products and services, including:
• | Equity and Credit Research: our fundamental research on approximately 1,600 companies worldwide plus credit ratings and analysis for about 600 of the largest corporate bond issuers worldwide; |
• | Structured Credit Ratings and Research, offered through Morningstar Credit Ratings, LLC, a Nationally Recognized Statistical Rating Organization (NRSRO) that provides timely new issue and surveillance ratings and analysis for commercial and residential mortgage-backed securities, as well as operational risk assessment services; |
• | Morningstar Investment Profiles: pre-made or custom-generated investment fact sheets institutions can use to help investors understand, compare, and differentiate investment offerings; |
• | Morningstar Commodity Data: high-quality market data and analytical products for energy data management systems, financial and agricultural data management, historical analysis, trading, risk management and forecasting; |
• | Principia: our CD-ROM-based investment research and planning software for financial planners; |
• | Morningstar Indexes: a comprehensive set of investment indexes that can be used to benchmark the market and create investment products; |
• | Financial Communications materials; |
• | Morningstar Enterprise Data Management: customized data aggregation and performance reporting solutions that help clients integrate data more effectively; |
• | Market data and desktop software; |
• | Other investment software for financial advisors and institutions; and |
• | Print and online publications. |
Marketing and Sales
We promote our products and services with a staff of sales and marketing professionals, as well as an in-house public relations team. Our sales team includes several strategic account managers who oversee all aspects of our largest institutional client relationships. We also have a sales operations staff, which focuses on tracking and forecasting sales and other tasks to support our sales team. We have a regional sales team responsible for expanding relationships for Morningstar Managed Portfolios. We also have a client solutions team responsible for developing a deep understanding of our customers and creating solutions to meet their needs. Across our business, we focus on high levels of customer support to help our clients use our products effectively. We had approximately 500 sales and marketing professionals on staff as of December 31, 2013.
We incurred approximately $6.9 million of advertising expense in 2013, including expenses incurred for various print and Internet ads, search engine fees, and direct mail campaigns.
International Operations
We conduct our business operations outside of the United States through wholly owned or majority-owned operating subsidiaries doing business in each of the following 26 countries: Australia, Brazil, Canada, Chile, Denmark, France, Germany, India, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, People's Republic of China (both Hong Kong and the mainland), Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, United Arab Emirates, and the United Kingdom. See Note 4 of the Notes to our Consolidated Financial Statements for additional information concerning revenue from customers and long-lived assets from our business operations outside the United States.
As of December 31, 2013, we also held a minority ownership position (approximately 34% of the outstanding shares) in Morningstar Japan K.K. (MJKK); this share had a market value of approximately $95 million. MJKK is publicly traded under ticker 4765 on the Osaka Stock Exchange “Hercules Market.” See Note 8 of the Notes to our Consolidated Financial Statements for information about our investments in unconsolidated entities.
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To enable these companies to do business in their designated territories, we provide them with the rights to the Morningstar name and logo and with access to certain of our products and technology. Each company is responsible for developing marketing plans tailored to meet the specific needs of investors within its country and working with Morningstar's data collection and development centers to create and maintain databases, develop new products, and enhance existing products.
See Item 1A—Risk Factors for a discussion of the risks related to our business operations outside of the United States.
Intellectual Property and Other Proprietary Rights
We treat our brand, product names and logos, software, technology, databases, and other products as proprietary. We try to protect this intellectual property by using trademark, copyright, patent and trade secrets laws; licensing and nondisclosure arrangements; and other security measures. For example, in the normal course of business, we only provide our intellectual property to third parties through standard licensing agreements. We use these agreements to define the extent and duration of any third-party usage rights and provide for our continued ownership in any intellectual property furnished.
Because of the value of our brand name and logo, we have tried to register one or both of them in all of the relevant international classes under the trademark laws of most of the jurisdictions in which we maintain operating companies. As we move into new countries, we consider adding to these registrations. We have registered the Morningstar name and/or logo in numerous countries and the European Union and have applied for registrations in various other countries. In some jurisdictions, we also register certain product names.
“Morningstar” and the Morningstar logo are registered marks of Morningstar in the United States and in certain other jurisdictions. The table below includes some of the trademarks and service marks that we use:
Ibbotson Associates ® | Morningstar Office SM | |
Morningstar ® Advisor Workstation SM | Morningstar ® Ownership Zone SM | |
Morningstar Analyst Rating TM | Morningstar ® Portfolio X-Ray ® | |
Morningstar ® Analyst Research Center SM | Morningstar ® Principia ® | |
Morningstar Direct SM | Morningstar Rating ™ | |
Morningstar ® Integrated Web Tools SM | Morningstar ® Retirement Manager SM | |
Morningstar® for iPad® | Morningstar ® Stewardship Grade SM | |
Morningstar ® Managed Portfolios SM | Morningstar Style Box ™ | |
Morningstar Market Barometer SM | Morningstar.com ® | |
In addition to trademarks, we currently hold several patents in the United States and Canada. We believe these patents represent our commitment to developing innovative products and tools for investors.
License Agreements
We license our products and/or other intellectual property to our customers for a fee. We generally use our standard agreements, whether in paper or electronic form, and we do not provide our products and services to customers or other users without having an agreement in place.
We maintain licensing agreements with all of our operating companies. We put these agreements in place so these companies can use our intellectual property, such as our products and trademarks, to market our products and develop and sell country-specific variants of products under the Morningstar name in their operating territories.
In the ordinary course of our business, we obtain and use intellectual property from a wide variety of sources, including licensing it from third-party sources, developing it internally, and obtaining it directly from public filings.
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Seasonality
We believe our business has a minimal amount of seasonality. Some of our smaller products, such as our Financial Communications materials and our annual investment conference in Chicago, generate the majority of their revenue in the first or second quarter of the year. We sell most of our products with subscription or license terms of at least one year, though, and we recognize revenue ratably over the term of each subscription or license agreement. This tends to moderate seasonality in sales patterns for individual products.
We believe market movements generally have more influence on our performance than seasonality. The revenue we earn from asset-based fees 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.
Largest Customer
In 2013, our largest customer accounted for less than 2% of our consolidated revenue.
Competitive Landscape
The economic and financial information industry has been marked by increased consolidation over the past several years, with the strongest players generally gaining market share at the expense of smaller competitors. Some of our major competitors include Bloomberg; Standard & Poor's, a division of McGraw Hill Financial; and Thomson Reuters. These companies have financial resources that are significantly greater than ours. We also have a number of smaller competitors, which we discuss in Major Products and Services above.
We believe the most important competitive factors in our industry are brand and reputation, data accuracy and quality, breadth of data coverage, quality of investment research and analytics, design, product reliability, and value of the products and services provided.
Research and Development
A key aspect of our growth strategy is to expand our investment research capabilities and enhance our existing products and services. We strive to rapidly adopt new technology that can improve our products and services. We have a flexible technology platform that allows our products to work together across a full range of investment databases, delivery formats, and market segments. As a general practice, we manage our own websites and build our own software rather than relying on outside vendors. This allows us to control our development and better manage costs, enabling us to respond quickly to market changes and to meet customer needs efficiently. As of December 31, 2013, our technology team consisted of approximately 900 programmers and technology and infrastructure professionals.
Government Regulation
United States
Investment advisory and broker-dealer businesses are subject to extensive regulation in the United States at both the federal and state level, as well as by self-regulatory organizations. Financial services companies are among the nation's most extensively regulated. The Securities and Exchange Commission (SEC) is responsible for enforcing the federal securities laws and oversees federally registered investment advisors and broker-dealers.
As of December 31, 2013, three of our subsidiaries, Ibbotson Associates, Inc., Morningstar Associates, LLC, and Morningstar Investment Services, Inc. are registered as investment advisors with the SEC under the Investment Advisers Act of 1940, as amended (Advisers Act). As registered investment advisors, these companies are subject to the requirements and regulations of the Advisers Act. Such requirements relate to, among other things, record-keeping, reporting, and standards of care, as well as general anti-fraud prohibitions. As registered investment advisors, all three subsidiaries are subject to on-site examination by the SEC.
In addition, because these three subsidiaries provide investment advisory services to retirement plans and their participants, they may be acting as fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA). As fiduciaries under ERISA, they 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.
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Morningstar Investment Services is a broker-dealer registered under the Securities Exchange Act of 1934 (Exchange Act) and a member of FINRA. The regulation of broker-dealers has, to a large extent, been delegated by the federal securities laws to self-regulatory organizations, including FINRA. Subject to approval by the SEC, FINRA adopts rules that govern its members. FINRA and the SEC conduct periodic examinations of the brokerage operations of Morningstar Investment Services. Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales, capital structure, record-keeping, and the conduct of directors, officers, and employees. Violation of applicable regulations can result in the revocation of a broker-dealer license, the imposition of censures or fines, and the suspension or expulsion of a firm or its officers or employees. Morningstar Investment Services is subject to certain net capital requirements under the Exchange Act. The net capital requirements, which specify minimum net capital levels for registered broker-dealers, are designed to measure the financial soundness and liquidity of broker-dealers.
Morningstar Credit Ratings, LLC is registered with the SEC as a Nationally Recognized Statistical Rating Organization (NRSRO) specializing in rating structured finance investments. As an NRSRO, Morningstar Credit Ratings, LLC is subject to the requirements and regulations under the Exchange Act. Such requirements relate to, among other things, record-keeping, reporting, governance, and conflicts of interest. As part of its NRSRO registration, Morningstar Credit Ratings is subject to annual examinations by the SEC.
Australia
Our subsidiaries that provide financial information services and advice in Australia, Morningstar Australasia Pty Limited and Ibbotson Associates Australia Ltd., are registered and hold an Australian Financial Services license and are subject to oversight by the Australian Securities and Investments Commission (ASIC). This license requires them to, among other things, maintain positive net asset levels and sufficient cash resources to cover three months of expenses and to comply with the audit requirements of the ASIC.
United Kingdom
Throughout 2013, Morningstar Investment Management Europe Limited and OBSR Advisory Services Limited were authorized and regulated by the Financial Conduct Authority (FCA) to provide advisory services in the United Kingdom. As authorized firms, these companies are subject to the requirements and regulations of the FCA. Such requirements relate to, among other things, financial reporting and other reporting obligations, record-keeping, and cross-border requirements. In February 2014, OBSR Advisory Services Limited submitted an application to the FCA to cancel its investment advice permission. If the FCA confirms the cancellation request, OBSR Advisory Services Limited will no longer be subject to FCA’s oversight, requirements, and regulations. Morningstar Investment Management Europe Limited will maintain its investment advice permission and remain subject to FCA’s oversight, requirements, and regulations.
Other Regions
We have a variety of other entities (including in Canada, Japan, Korea, Thailand, and France) that are registered with their respective regulatory bodies; however, the amount of business conducted by these entities related to the registration is relatively small.
Additional legislation and regulations, including those relating to the activities of investment advisors and broker-dealers, changes in rules imposed by the SEC or other U.S. or non-U.S. regulatory authorities and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may adversely affect our business and profitability. Our businesses may be materially affected not only by regulations applicable to it as an investment advisor or broker-dealer, but also by regulations that apply to companies generally.
Employees
We had approximately 3,565 employees as of December 31, 2013, including approximately 660 data analysts, 70 designers, 380 investment analysts (including consulting and quantitative research analysts), 900 programmers and technology staff, and 500 sales and marketing professionals. Our U.S.-based employees are not represented by any unions, and we have never experienced a walkout or strike.
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Executive Officers
As of February 28, 2014, we had 11 executive officers. The table below summarizes information about each of these officers.
Name | Age | Position | ||
Joe Mansueto | 57 | Chairman, Chief Executive Officer, and Director | ||
Stéphane Biehler | 46 | Chief Financial Officer | ||
Bevin Desmond | 47 | Head of Global Markets and Human Resources | ||
Catherine Gillis Odelbo | 51 | Head of Corporate Strategy and Partnerships | ||
Greg Goff | 42 | Chief Technology Officer | ||
Thomas Idzorek | 43 | President, Morningstar Investment Management | ||
Kunal Kapoor | 38 | Head of Information Products and Client Solutions | ||
Haywood Kelly | 45 | Head of Global Research | ||
Richard Robbins | 51 | General Counsel and Corporate Secretary | ||
James Tanner | 53 | Head of Global Business Development and Sales | ||
David W. Williams | 53 | Head of Design and Marketing | ||
Joe Mansueto
Joe Mansueto founded Morningstar in 1984. He has served as our chairman since our inception and as our chief executive officer from 1984 to 1996 and from 2000 to the present.
Joe holds a bachelor's degree in business administration from The University of Chicago and a master's degree in business administration from The University of Chicago Booth School of Business.
Stéphane Biehler
As chief financial officer, Stéphane Biehler is responsible for corporate finance, accounting, tax, and investor relations. He joined us in 2013 and previously served as executive vice president, chief accounting officer, and corporate controller for NYSE Euronext, a global operator of financial markets, since 2007. Before the 2007 merger between NYSE Group with Euronext to form NYSE Euronext and the 2006 merger of Archipelago Holdings with the New York Stock Exchange to form NYSE Group, he joined Archipelago Holdings as managing director and corporate controller in 2004.
Stéphane holds a master’s degree in international business from the University of Haute-Alsace in France.
Bevin Desmond
Bevin Desmond is head of global markets and human resources for Morningstar, a role she has held since 2010. She is responsible for identifying and developing new markets, managing and directing operations, and overseeing human resources functions for all of Morningstar’s global operations. Previously, she was head of international operations from 2001 until 2010. She joined Morningstar in 1993.
Bevin holds a bachelor's degree in psychology from St. Mary's College.
Catherine Gillis Odelbo
Catherine Gillis Odelbo is head of corporate strategy and partnerships, responsible for working with Morningstar’s senior management team on the company’s overall strategic planning process, mergers and acquisitions, and major partnerships. She has been in this role since 2012. Previously, she was president of equity and credit research from 2009 to 2012. Cathy joined Morningstar in 1988.
She holds a bachelor's degree in American history from The University of Chicago and a master's degree in business administration from The University of Chicago Booth School of Business.
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Greg Goff
Greg Goff is our chief technology officer and is responsible for Morningstar's global technology strategy. Before joining us in 2011, he was senior vice president of global platform technology for The Nielsen Company since 2009. He joined The Nielsen Company in 2004 as vice president of data warehousing. He has also worked for Accenture and BlueMeteor, Inc. in Chicago.
He holds a bachelor’s degree in electrical engineering from the University of Illinois at Urbana-Champaign.
Thomas Idzorek
Thomas Idzorek is president of Morningstar Investment Management. He is responsible for our global investment advice, consulting, retirement solutions, and index businesses. From 2006 until taking on his current role in May 2012, Tom was global chief investment officer for Morningstar Investment Management. Previously, he was director of research and product development for Ibbotson Associates, which we acquired in 2006. He began his career as a senior quantitative research for Zephyr Associates.
He holds a bachelor's degree in marketing from Arizona State University, a master's degree in business administration from Thunderbird School of Global Management, and the Chartered Financial Analyst (CFA) designation.
Kunal Kapoor
Kunal Kapoor is head of Information Products and Client Solutions. The Information Products group is responsible for product development, manufacturing, and innovation. Client Solutions is responsible for building deep client segment expertise and leading our efforts to bundle products and capabilities into solutions for our customers. Kunal became head of our global Client Solutions group starting in 2013 and took on additional responsibility for Information Products in February 2014. For part of 2013, he was president of our Data Division, and from 2010 until 2012, he was president of Equity and Market Data/Software. In 2009 and 2010, he was president of Individual Software. Kunal joined Morningstar in 1997.
He holds a bachelor's degree in economics and environmental policy from Monmouth College and a master's degree in business administration from The University of Chicago Booth School of Business. He also holds the Chartered Financial Analyst (CFA) designation.
Haywood Kelly
Haywood Kelly is head of global research for Morningstar and oversees our global fund, equity, and credit research and data operations. Before taking on his current role in January 2014, he was head of equity and credit research since 2009 and took on additional responsibility for equity data in 2013. Haywood joined Morningstar in 1991.
He holds a bachelor’s degree in economics from the University of Chicago, where he graduated as a member of Phi Beta Kappa. He also holds the CFA designation.
Richard Robbins
Richard Robbins is our general counsel and corporate secretary. He is responsible for directing Morningstar's legal department and managing our relationships with outside counsel. He also oversees our compliance and corporate communications departments. From 1999 until he joined Morningstar in 2005, he was a partner at Sidley Austin Brown & Wood LLP (now Sidley Austin LLP), which he joined as an associate in 1991.
He holds bachelor's and master's degrees in computer science and electrical engineering from the Massachusetts Institute of Technology and a juris doctor degree from The University of Chicago Law School.
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James Tanner
James Tanner is head of global business development and sales for Morningstar. He joined us in January 2013. Previously he served as vice chairman of business development for Markit On Demand, an Internet technology company he founded as Wall Street On Demand in 1991. In addition to his role as CEO, he also served in various roles for firms that have owned Wall Street On Demand, including head of sales for eBridge and head of distribution and vice chairman of business development for Markit, a UK-based global financial information company.
Jim holds a bachelor’s degree in Russian language and literature from Haverford College and a master’s degree in business administration from Harvard University.
David W. Williams
David W. Williams is head of design and marketing for Morningstar. He is responsible for corporate design and its application to brand identity, products, communications, and the workplace. He joined us in 1993 and has been instrumental in establishing design as one of our recognized core capabilities.
David holds a bachelor's degree in industrial design from The Ohio State University and a master's degree in fine arts from the Yale University School of Art.
Company Information
We were incorporated in Illinois on May 16, 1984. Our corporate headquarters are located at 22 West Washington Street, Chicago, Illinois, 60602.
We maintain a website at http://corporate.morningstar.com. Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to any of these documents are available free of charge on this site as soon as reasonably practicable after the reports are filed with or furnished to the SEC. We also post quarterly press releases on our financial results and other documents containing additional information related to our company on this site. We provide this website and the information contained in or connected to it for informational purposes only. That information is not part of this Annual Report on Form 10-K.
1A. Risk Factors
You should carefully consider the risks described below and all of the other information included in this Form 10-K when deciding whether to invest in our common stock or otherwise evaluating our business. If any of the following risks materialize, our business, financial condition, or operating results could suffer. In this case, the trading price of our common stock could decline, and you may lose all or part of your investment.
Our investment advisory operations may subject us to liability for any losses that result from a breach of our fiduciary duties.
Three of our subsidiaries, Ibbotson Associates, Inc., Morningstar Associates, LLC, and Morningstar Investment Services, Inc. are registered as investment advisors with the SEC under the Investment Advisers Act of 1940, as amended (Advisers Act). As registered investment advisors, these companies are subject to the requirements and regulations of the Advisers Act. Such requirements relate to, among other things, record-keeping, reporting, and standards of care, as well as general anti-fraud prohibitions. As registered investment advisors, all three subsidiaries are subject to on-site examination by the SEC.
In addition, because these three subsidiaries provide investment advisory services to retirement plans and their participants, they may be acting as fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA). As fiduciaries under ERISA, they have obligations to act in the best interest of their clients. They also have duties of loyalty and prudence, as well as duties to diversify investments and to follow plan documents to comply with the applicable portions of ERISA.
Our subsidiaries outside the United States that have investment advisory operations are subject to similar requirements.
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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. As part of this service, we can construct and monitor the investment lineup, document our investment process, create an Investment Policy Statement, and furnish the plan with detailed quarterly investment and performance reports. We also provide a managed account service for retirement plan participants who elect to have their accounts managed by our programs. As of December 31, 2013, we had $31.7 billion in assets under management in our managed retirement accounts.
We rely on automated investment technology for our retirement advice and managed retirement accounts services. The Wealth Forecasting Engine is our core advice and managed accounts engine that determines appropriate asset allocations for retirement plan participants and assigns individuals to portfolios. We also rely on automated portfolio construction tools. Problems could arise if these programs assigned retirement plan participants to the wrong portfolios, particularly if we failed to detect program errors over an extended period. We may not be able to prevent clients from taking legal action against us for an actual or claimed breach of a fiduciary duty. If we make an error, we may be subject to potentially large liabilities for make-whole payments and/or litigation. We cannot quantify the potential size of these liabilities with any level of precision.
In addition, we may face other legal liabilities based on the quality and outcome of our investment advisory recommendations, even in the absence of an actual or claimed breach of fiduciary duty. In total, we provided investment advisory and management services on nearly $160 billion in assets as of December 31, 2013. We could face substantial liabilities related to our work on these assets.
Failing to differentiate our products and continuously create innovative, proprietary research tools may harm our competitive position and business results.
We attribute much of our company's success over the past 29 years to our ability to develop innovative, proprietary research tools, such as the Morningstar Rating, Morningstar Style Box, Ownership Zone, and Portfolio X-Ray. We believe these proprietary tools continue to provide us with a competitive advantage, but if tools similar to them become available through other channels, our competitive position and business results may suffer. Our competitive position and business results may also suffer if other companies are able to successfully introduce innovative, proprietary research tools that gain a wide following. We believe lower technology costs and the growth of open software platforms have lowered the barriers to entry for new competitors, making it easier for new players to enter the market. Smaller companies may be able to introduce new research tools that gain a wide following. If we fail to introduce innovative, proprietary research tools at the same rate as in the past, we may not generate enough enthusiasm with potential clients to win new business. We cannot guarantee that we will continue to successfully develop new product features and tools that differentiate our product offerings from those of our competitors.
Failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy may negatively affect our competitive position and business results.
We believe the technology landscape has been changing at an accelerating rate over the past several years. Changes in technology are fundamentally changing the ways investors access data and content. Examples include the shift from local network to computing to cloud-based systems, the proliferation of wireless mobile devices, and rapid acceleration in the use of social media platforms. We are in the process of building the next-generation software architecture that will eventually underlie of our investment research platforms, but we have not yet incorporated this software in our products. 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. We believe our history of rapid technological innovation and expertise in technology have historically given us a competitive advantage. As mentioned above, though, we believe that lower technology costs and growth in open software platforms have lowered barriers to entry for new competitors. Our competitors may also be able to introduce new technology more rapidly than we are to meet changing market needs. Our competitive position and business results may suffer if we fail to develop new technologies to meet client demands, or if we adopt a technology strategy that doesn't align with changes in the market.
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An outage of our database and network facilities could result in reduced revenue and the loss of customers.
The success of our business depends upon our ability to deliver time-sensitive, up-to-date data and information. We rely on our computer equipment, database storage facilities, and other network equipment, much of which is geographically concentrated in our Chicago headquarters and other backup locations in the United States. We also have extensive information systems outside the United States. Our mission-critical databases and networks are increasingly complex and interdependent. Many of our client contracts contain service-level agreements that require us to meet certain obligations for delivering time-sensitive, up-to-date data and information. We may not be able to meet these obligations in the event of failure or downtime in our information systems. Our operations and those of our suppliers and customers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, Internet failures or disruptions, 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 maintain off-site back-up facilities for our database and network equipment, but we cannot guarantee that these facilities will operate as expected during an interruption that affects our headquarters. 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.
Our business relies heavily on electronic delivery systems and the Internet. Any failures or disruptions could result in reduced revenue and the loss of customers.
Most of our products and services depend heavily on our electronic delivery systems and the Internet. Our ability to deliver information using the Internet 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 our 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 could face liabilities and/or damage to our reputation as a result of some of our currently pending litigation.
From time to time, we are subject to legal or regulatory proceedings in the ordinary course of our business. These include proceedings relating to aspects of our businesses that are specific to us and proceedings that are typical in the asset management and financial information businesses in which we operate.
We are currently defendants in two cases that we describe in Item 3—Legal Proceedings of this Annual Report on Form 10-K. The plaintiffs are seeking large and/or indeterminate amounts of damages. Litigation is inherently unpredictable, and the outcome of any particular proceeding can never be predicted with certainty. An adverse litigation outcome could have a materially adverse effect on our financial condition.
In addition to its potential financial impact, litigation can have a significant adverse reputational impact. We depend to a large extent on our reputation for integrity and high-caliber professional services. Allegations of improper conduct made by private litigants or regulators, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, whether valid or not, may harm our reputation, which may be damaging to our business.
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We could face liability related to our storage of personal information about our users.
Customers routinely enter personal investment and financial information, including portfolio holdings and credit card information, on our websites. We also handle an increasing volume of personally sensitive information through our Portfolio Management Service, Enterprise Data Management, managed retirement accounts, and other areas of our business. Contractual commitments to customers as well as laws and industry regulations related to data protection, system availability, and privacy require us to safeguard critical data. We are also required to take appropriate steps to safeguard credit card numbers, social security numbers, and other personally identifiable information. We may suffer malicious attacks seeking to penetrate our network and databases to gain access to personal data. We could be subject to liability if we were to inappropriately disclose any user's personal information or if third parties were able to penetrate our network security or otherwise gain access to any user's name, address, portfolio holdings, or credit card information.
Downturns in the financial sector, global financial markets, and global economy may adversely impact our business.
We believe ongoing economic weakness continues to cause uncertainty and pressure on consumer discretionary spending. The financial crisis of 2008 and 2009, as well as more recent financial and economic uncertainty, has led to spending cutbacks among asset management firms and other financial services companies, which make up a large percentage of our client base. Some institutional clients have also implemented additional review processes for new contracts or began to provide certain services, particularly investment advisory services, in-house rather than hiring outside service providers. Some institutional clients have also reduced the scope of their operations. For example, several large insurers withdrew from the variable annuity market in recent years, while others curtailed their new sales efforts. This has had a negative effect on the services we provide to institutional clients that offer variable annuities.
In 2010 and 2011, rising government debt levels around the world as well as downgrades in sovereign debt issues for some European countries led to market fears about a potential crisis in global sovereign debt. Some European countries have been unable to successfully refinance their debts, leading European finance officials to take measures during 2010 and 2011 to stabilize financial conditions across Europe. While conditions in Europe have improved, many European countries have continued to experience weak economic growth. In addition, many companies in the financial services industry have been subject to increasing government regulation, which may increase their operating costs and cause them to reduce spending in other areas.
In addition, if financial markets around the world experience negative performance and volatility, demand for our products and services may decline, and our revenue, operating income, and other financial results could suffer. Our business results may also be hurt by negative trends in Internet advertising sales. Our structured credit rating business is subject to volatility from trends in new issuance of commercial mortgage-backed securities and other structured credits. The financial markets and many businesses operating in the financial services industry are highly volatile and are affected by factors, such as U.S. and foreign economic conditions and general trends in business and finance, that are beyond our control.
Our revenue from asset-based fees may be adversely affected by market declines as well as the effect of cash outflows from portfolios that we help manage.
In 2013, revenue from asset-based fees made up approximately 13% of our consolidated revenue and a greater percentage of our operating income. The amount of revenue we earn from asset-based fees 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. The value of assets under advisement may show substantial declines during periods of significant market volatility. The size of these portfolios can also be affected if net inflows into the portfolios on which we provide investment advisory services drop or if these portfolios experience redemptions. If the level of assets on which we provide investment advisory services goes down, we expect our fee-based revenue to show a corresponding decline.
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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.
We believe that independence is at the core of our business, and our reputation is our greatest corporate asset. We offer products and services to our institutional clients, which include banks, brokerage firms, insurance companies, mutual fund companies, media outlets, and retirement plan providers and sponsors. Our institutional clients have generated a significant percentage of our consolidated revenue in recent years. We provide ratings, analyst research, and investment recommendations on mutual funds and other investment products offered and securities issued by our institutional clients. We also provide investment advisory and investment management services. The fact that our institutional clients pay us for certain products and services, as well as the fact that in some cases we make investment recommendations within the framework of client constraints, may create the perception that our ratings, research, and recommendations are not impartial.
This perception may undermine the confidence of our customers and potential customers in our reputation as a provider of independent research. Any such loss of confidence or damage to our reputation could hurt our business.
Any failure to uphold our high ethical standards and ensure that our customers have a consistently positive experience with us (either intentionally or inadvertently) could damage our reputation as an objective, honest, and credible source for investment research and information.
Our reputation may also be harmed by factors outside of our control, such as news reports about our clients or adverse publicity about certain investment products.
Changes in laws applicable to our investment advisory or credit rating operations, compliance failures, or regulatory action could adversely affect our business.
Our investment advisory operations are a growing part of our overall business. The securities laws and other laws that govern our activities as a registered investment advisor are complex. The activities of our investment advisory operations are primarily subject to provisions of the Investment Advisers Act of 1940 (the Advisers Act) and the Employee Retirement Income Security Act of 1974 (ERISA). In addition, Morningstar Investment Services is a broker-dealer registered under the Securities Exchange Act of 1934 (the Exchange Act) and is subject to the rules of FINRA. We also provide investment advisory services in other areas around the world, and our operations are subject to additional regulations in markets outside the United States. If we fail to establish required licenses or regulatory approvals for our investment advisory operations, we may be subject to fines or other events that could have a negative effect on our business.
Over the past several years, we have also made significant investments in our credit rating business. We began publishing credit ratings and associated research on corporate debt issuers in 2009. Although our corporate credit rating business is not currently regulated as a Nationally Recognized Statistical Rating Organization (NRSRO), credit rating and research providers have been under increasing regulatory scrutiny. We cannot predict the future impact of potential future regulatory changes on our corporate credit rating business.
We also expanded our credit rating business operations with our May 2010 acquisition of Realpoint, LLC (now known as Morningstar Credit Ratings, LLC), an NRSRO that specializes in structured finance. As an NRSRO, Morningstar Credit Ratings is subject to various requirements and regulations under the Exchange Act relating to, among other things, record-keeping, reporting, governance, and conflicts of interest. As part of its NRSRO registration, Morningstar Credit Ratings is subject to annual examination by the SEC.
It is difficult to predict the future effect of the broad and expanding legislative and regulatory requirements affecting our business. The laws, rules, and regulations applicable to our business may change in the future, and we may not be able to comply with any such changes. If we fail to comply with any applicable law, rule, or regulation, we could be fined, sanctioned, or barred from providing investment advisory or credit rating services in the future, which could materially adversely affect our business, operating results, or financial condition.
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Competition could reduce our share of the investment research market and hurt our financial performance.
We operate in a highly competitive industry, with many investment research providers competing for business from individual investors, financial advisors, and institutional clients. We compete with many different types of companies that vary in size, product scope, and media focus, including large and well-established distributors of financial information, such as Bloomberg; Standard & Poor's, a division of McGraw Hill Financial; and Thomson Reuters. We compete with a variety of other companies in different areas of our business, which we discuss in greater detail in the Major Products and Services section in Item 1—Business.
Many of our competitors have larger customer bases and significantly greater resources than we do. This may allow them to respond more quickly to new technologies and changes in demand for products and services, devote greater resources to developing and promoting their services, and make more attractive offers to potential clients, subscribers, and strategic partners. They may also be able to offer better customer service and support. Industry consolidation may also lead to more intense competition. Increased competition could result in price reductions, reduced margins, or loss of market share, any of which could hurt our business, operating results, or financial condition.
The investment information industry is dominated by a few large players, and industry consolidation has increased in the past several years. If providers of data and investment analysis continue to consolidate, our competitive position may suffer.
Our results could suffer if the mutual fund industry continues to experience slower growth, or if actively managed equity funds continue to attract less investor attention.
We generate a significant portion of our revenue from products and services related to mutual funds. The mutual fund industry has experienced substantial growth over the past 30 years, but suffered along with the market downturn in 2008 and early 2009. Since then, fund assets have increased, but at a slower rate than in previous years. Based on Morningstar's estimates for U.S. mutual fund asset flows, long-term open-end funds had positive net inflows of approximately $270 billion in 2013.
A significant portion of our fund research has historically focused on equity-related funds. In addition, we are best-known for our data and analyst research on actively managed equity funds. Over the past several years, passively managed index funds have seen greater investor interest. This trend continued in 2013, as passively managed vehicles (both mutual funds and ETFs) had about $300 billion in net inflows, compared with $150 billion of net inflows for active products. Overall, we estimate that passively managed assets now account for more than one-fourth of combined mutual fund and ETF assets.
Continued downturns or volatility in the financial markets, increased investor interest in other investment vehicles, or a lack of investor confidence could continue to reduce investor interest and investment activity. In addition, a continued lessening of investor interest in actively managed equity funds could decrease demand for our products.
Our operations outside of the United States are expanding and involve additional challenges that we may not be able to meet.
Our operations outside of the United States generated $197.5 million in revenue in 2013, or about 28% of our consolidated revenue. There are risks inherent in doing business outside the United States, 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; 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; and currency exchange rates and exchange controls. These risks could hamper our ability to expand around the world, which may hurt our financial performance and ability to grow.
As our non-U.S. revenue increases as a percentage of consolidated revenue, fluctuations in foreign currencies present a greater potential risk. We don't engage in currency hedging or have any positions in derivative instruments to hedge our currency risk. Our reported revenue could suffer if certain foreign currencies decline relative to the U.S. dollar, although the impact on operating income may be offset by an opposing currency impact on locally based operating expense. In addition, because we use the local currency of our subsidiaries as the functional currency, our financial results are affected by the translation of foreign currencies into U.S. dollars.
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The concentration of data and development work carried out at our offshore facilities may have a negative effect on our business operations, products, and services.
We now have approximately 900 employees working in our data and technology development center in Shenzhen, China, or about one-fourth of our total workforce. Because China has a restrictive government under centralized control, we cannot predict the level of political and regulatory risk that may affect our operations. The concentration of development and data work carried out at this facility also involves operational risks for our network infrastructure. Any difficulties that we face in successfully maintaining our development center in China may harm our business and have a negative impact on the products and services we provide, particularly because we rely on employees in this facility to maintain and update our mutual fund database.
We have approximately 360 employees who work at our data collection facility in Mumbai, India, which may also be subject to regulatory and political risk (including potential terrorist acts). Like the Shenzhen operation, these facilities also involve operational risks for our network infrastructure.
We could face liability for the information we publish, including information based on data we obtain from other parties.
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 ratings on corporate credit issuers. 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. 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, and other data providers. 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. 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.
Our future success depends on our ability to recruit and retain qualified employees.
We experience competition for analysts and other employees from financial institutions and financial services organizations. These organizations generally have greater resources than we do and therefore may be able to offer significantly more attractive compensation packages to potential employees. Competition for these employees is intense, and we may not be able to retain our existing employees or be able to recruit and retain other highly qualified personnel in the future.
Our future success also depends on the continued service of our executive officers, including Joe Mansueto, our chairman, chief executive officer, and controlling shareholder. Joe is heavily involved in our day-to-day operations, business strategy, and overall company direction. The loss of Joe or other executive officers could hurt our business, operating results, or financial condition. We do not have employment agreements, non-compete 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.
Failure to protect our intellectual property rights 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. Further, effective trademark, copyright, and trade secret protection may not be available in every country in which we offer our services. Our continued ability to market one or more of our products under their current names could be adversely affected in those jurisdictions where another person registers, or has a pre-existing registration on one or more of them. Failure to adequately protect our intellectual property could harm our brand, devalue our proprietary content, and affect our ability to compete in the marketplace.
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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. It is possible that 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.
Control by a principal shareholder could adversely affect our other shareholders.
As of December 31, 2013, Joe Mansueto, our chairman and chief executive officer, owned approximately 55% of our outstanding common stock. As a result, he has the 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. He also has the ability to control our management and affairs. 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. A substantial portion of our operating expense is related to personnel costs, marketing programs, office leases, and other infrastructure spending, which generally cannot be adjusted quickly. Our operating expense levels are based on our expectations for future revenue. If actual revenue falls below our expectations, or if our expenses increase before revenues do, our operating results would be materially and adversely affected. 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 be volatile. 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 shareholders sell substantial amounts of our common stock, the market price of our common stock could fall. A reduction in ownership by Joe Mansueto or any other large shareholder could cause the market price of our common stock to fall. 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.
Our shareholders may experience dilution in their ownership positions.
In the past, we've granted options to employees as a significant part of their overall compensation package. In 2006, we began granting restricted stock units to our employees and non-employee directors. As of December 31, 2013, our employees and non-employee directors held options to acquire 433,531 shares of common stock, 399,008 of which were exercisable at a weighted average price of approximately $27.91 per share. As of December 31, 2013, there were 696,684 restricted stock units outstanding, which have an average remaining vesting period of 33 months. Generally speaking, the company issues a share of stock when a restricted stock unit vests. To the extent that option holders exercise outstanding options to purchase common stock and we issue shares with the vesting of restricted stock units vest, there will be further dilution. Future grants of stock options or restricted stock units may also result in dilution. We may raise additional funds through future sales of our common stock. Any such financing would result in additional dilution to our shareholders.
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Stock option exercises, share repurchases, and other factors may create volatility in our cash flows.
Part of our cash provided by financing activities consists of proceeds from stock option exercises and excess tax benefits related to stock option exercises and vesting of restricted stock units. Excess tax benefits occur at the time a stock option is exercised if the intrinsic value of the option (the difference between the exercise price of the option and the fair value of our stock on the date of exercise) exceeds the fair value of the option at the time of grant. Similarly, excess tax benefits are generated upon vesting of restricted stock units when the market value of our common stock at vesting is greater than the grant price of the restricted stock units. These excess tax benefits reduce the cash we pay for income taxes in the year they are recognized. It is not possible to predict the timing of stock option exercises or the intrinsic value that will be realized. Because of this uncertainty, there may be additional volatility in our cash flows from financing activities.
In addition, our board of directors has authorized a share repurchase program allowing for the repurchase of up to $700 million of our outstanding common stock, of which approximately $230 million remains available for future repurchases as of February 21, 2014. We may repurchase shares from time to time at prevailing market prices on the open market or in private transactions in amounts that management deems appropriate. Changes in the amount of repurchase activity from period to period may also cause volatility in our cash flows.
Item 1B. Unresolved Staff Comments
We do not have any unresolved comments from the Staff of the Securities and Exchange Commission regarding our periodic or current reports under the Exchange Act.
Item 2. Properties
As of December 31, 2013, we leased approximately 334,000 square feet of office space for our U.S. operations, primarily for our office located in Chicago, Illinois. We also lease approximately 357,000 square feet of office space in 26 other countries around the world, including 141,000 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.
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Item 3. Legal Proceedings
Life's Good S.T.A.B.L. Hedge Fund
In September 2011, three individual investors in Life's Good S.T.A.B.L. Mortgage hedge fund (LG), Marta Klass, Gregory Martin, and Richard Roellig, filed a complaint in the United States District Court for the Eastern District of Pennsylvania against LG, its principal Robert Stinson, and several other parties, including Morningstar, Inc. (the Klass Matter). The plaintiffs claim that Morningstar committed fraud and aided and abetted the other defendants' breach of fiduciary duty through the 5-star rating LG obtained from Morningstar. The plaintiffs seek unspecified damages. Hedge fund managers self-report their performance data to Morningstar. More than a year before the Klass Matter, in June 2010, the SEC filed suit against LG and other entities claiming they were part of a Ponzi scheme operated by Stinson. As a result, LG and the other entities were placed in court-appointed receivership. Morningstar was not part of the SEC suit or receivership. Since that time, the Receiver, as part of his duties, has been investigating whether to assert claims against third parties. Morningstar is aware of 14 lawsuits filed by the Receiver seeking to recover money for the fund.
In November 2011, Morningstar filed a motion to dismiss the Klass Matter. On behalf of the entities in receivership, the Receiver filed a motion to stay the proceedings because the Receivership Order does not permit suits against the entities in receivership without court permission. The court granted the Receiver's motion and stayed the Klass Matter. In April 2012, the Receiver filed a complaint against Morningstar, in which the Receiver claims that Morningstar is liable for contribution and aiding and abetting Stinson's breach of fiduciary duty and fraud through the 5-star rating LG obtained from Morningstar. The same day the Receiver filed his complaint, Morningstar sought leave from the court to file a counter suit against Stinson and two of his entities-Keystone State Capital Corporation and LG for, among other things, fraud, misrepresentation, and breach of user agreements. In June 2012, the court denied Morningstar's motion for leave to file suit. The court took no position on the merits of Morningstar's claims, and did not preclude us from renewing our motion to file a complaint at a later time, but deferred to the Receiver's request not to subject the receivership estate to additional litigation at this early point in the receivership. A bench trial related to the Receiver’s claims against Morningstar was held between January 13 and January 28, 2014. At trial, the Receiver claimed that Morningstar is liable under a contribution theory for all or part of a $14.5 million disgorgement judgment that the SEC obtained against the entities and individuals in receivership. Morningstar contested liability and damages at trial and believes it is not liable for any amount. The parties will file post-trial proposed findings of fact and conclusions of law in early March 2014. It is not known when the court will issue its decision.
We believe the allegations against Morningstar by the Klass plaintiffs and the Receiver have no legal or factual basis and we plan to continue to vigorously contest the claims. We also intend to refile our affirmative claims against Stinson, Keystone, and LG at a later time consistent with the court's order. We cannot predict the outcome of the proceedings.
We have not provided an estimate of loss or range of loss in connection with this matter because no such estimate can reasonably be made.
Business Logic Holding Corporation
In November 2009, Business Logic Holding Corporation filed a complaint in the Circuit Court of Cook County, Illinois against Ibbotson Associates, Inc. and Morningstar, Inc. relating to Ibbotson's prior commercial relationship with Business Logic. Business Logic is alleging breach of contract and trade secret misappropriation in connection with Ibbotson's development of a proprietary web-service software and user interface that connects plan participant data with the Ibbotson Wealth Forecasting Engine. Ibbotson and Morningstar answered the complaint, and Ibbotson asserted a counterclaim against Business Logic alleging trade secret misappropriation and breach of contract, also seeking damages and injunctive relief. Business Logic filed a motion for summary judgment on its breach of contract claim, which was denied on October 1, 2013.
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Business Logic's complaint seeks, among other things, compensatory damages, punitive damages, attorneys' fees, and injunctive relief. With regard to compensatory damages, based on the analysis of Ibbotson's retained damages expert (who has assumed, solely for purposes of his analysis, that Business Logic will prevail with regard to the issue of liability), and recognizing the uncertainty inherent in litigation and our intention to continue to vigorously defend the claims made by Business Logic, our best estimate of the range of possible loss is between $0 and $5.4 million, excluding punitive damages or attorneys' fees, both of which are recoverable in certain circumstances under the Illinois Trade Secrets Act. Business Logic's retained damages expert (who has also assumed for purposes of her estimate that Business Logic will prevail with regard to the issue of liability) has, however, estimated compensatory damages of $84 million, excluding punitive damages or attorneys' fees. We dispute the conclusions reached and the methods employed by Business Logic's expert.
With regard to Business Logic's claim for injunctive relief, no reasonable estimate of loss or range of loss is possible.
Morningstar and Ibbotson continue to vigorously contest all the claims against them in this matter. We cannot, however, predict the outcome of the proceeding.
In addition to these proceedings, we are involved in legal proceedings and litigation that have arisen in the normal course of our business. Although the outcome of a particular proceeding can never be predicted, we do not believe that the result of any of these other matters will have a material adverse effect on our business, operating results, or financial position.
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.”
The following table shows the high and low price per share of our common stock for the periods indicated, as reported on the Nasdaq Global Select Market:
2013 | 2012 | |||||||||||||
High | Low | High | Low | |||||||||||
First Quarter | $ | 71.14 | $ | 61.31 | $ | 63.25 | $ | 56.23 | ||||||
Second Quarter | 77.83 | 63.01 | 63.57 | 54.71 | ||||||||||
Third Quarter | 80.00 | 74.19 | 63.08 | 56.35 | ||||||||||
Fourth Quarter | 85.97 | 73.40 | 65.62 | 60.69 | ||||||||||
As of February 21, 2014, the last reported price on the Nasdaq Global Select Market for our common stock was $83.15 per share, and there were 1,412 shareholders of record for our common stock.
The following table shows dividends declared and paid for the periods indicated:
2013 | 2012 | |||||||||||||
Dividends declared | Dividends paid | Dividends declared | Dividends paid | |||||||||||
First Quarter | $ | 0.125 | $ | — | $ | 0.10 | $ | 0.10 | ||||||
Second Quarter | 0.125 | 0.125 | 0.10 | 0.10 | ||||||||||
Third Quarter | — | 0.125 | 0.10 | 0.10 | ||||||||||
Fourth Quarter | 0.295 | 0.125 | 0.125 | 0.225 | ||||||||||
We paid three dividends during 2013 as we opted to pay our January 2013 dividend in December 2012. While subsequent dividends will be subject to board approval, we expect to pay a regular quarterly dividend of 17.0 cents per share in 2014.
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.
See Note 11 of the Notes to our Consolidated Financial Statements for a description of our equity compensation plans.
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Issuer Purchases of Equity Securities*
The following table presents information related to repurchases of common stock we made through September 30, 2013 and during the three months ended December 31, 2013:
Period: | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced programs (1) | Approximate dollar value of shares that may yet be purchased under the programs (1) | ||||||||||
Cumulative through September 30, 2013 | 5,885,886 | $ | 60.99 | 5,885,886 | $ | 140,936,469 | ||||||||
October 1, 2013 - October 31, 2013 | 152,139 | 74.75 | 152,139 | $ | 129,560,608 | |||||||||
November 1, 2013 - November 30, 2013 | — | — | — | $ | 129,560,608 | |||||||||
December 1, 2013 - December 31, 2013 | 1,029,981 | 77.01 | 1,029,981 | $ | 250,216,174 | |||||||||
Total | 7,068,006 | $ | 63.62 | 7,068,006 | ||||||||||
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* 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.
(1) | In September 2010, our board of directors approved a share repurchase program that authorized the purchase of up to $100 million of the outstanding common stock with an expiration date of December 31, 2012. In December 2011, the board approved a $200 million increase to this program. In December 2012, the board authorized the company to repurchase up to an additional $200 million in shares of our outstanding common stock and extended the expiration date of the program to December 31, 2014. In December 2013, the board approved another $200 million increase in the program. |
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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 15, 2014:
Name and Position | Date of Plan | Plan Termination Date | Number of Shares to be Sold under the Plan | Timing of Sales under the Plan | Number of Shares Sold under the Plan through February 15, 2014 | Projected Beneficial Ownership (1) | ||||||||||
Jack Noonan Director | 11/15/2012 | 5/2/2015 | 24,000 | Shares to be sold under the plan if the stock reaches specified prices | 13,000 | 58,232 | ||||||||||
David W. Williams Head of Design and Marketing | 11/25/2013 | 4/1/2015 | 7,500 | Shares to be sold under the plan if the stock reaches specified prices | — | 36,943 | ||||||||||
During the fourth quarter, the previously disclosed Rule 10b5-1 sales plans for Bevin Desmond and her spouse, Steve Kaplan, Richard Robbins, and David W. Williams completed or expired in accordance with their terms.
_______________________________
(1) This column reflects an estimate of the number of shares each identified director and executive officer will beneficially own following the sale of all shares under the Rule 10b5-1 sales plans identified above. This information reflects the beneficial ownership of our common stock on December 31, 2013, and includes shares of our common stock subject to options that were then exercisable or that will have become exercisable by March 1, 2014 and restricted stock units that will vest by March 1, 2014. The estimates do not reflect any changes to beneficial ownership that may have occurred since December 31, 2013. Each director and executive officer identified in the table may amend or terminate his Rule 10b5-1 sales plan and may adopt additional Rule 10b5-1 plans in the future.
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Item 6. Selected Financial Data
The selected historical financial data shown below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and related notes included elsewhere in this Annual Report on Form 10-K. We have derived our Consolidated Statements of Income Data and Consolidated Cash Flow Data for the years ended December 31, 2013, 2012, and 2011 and Consolidated Balance Sheet Data as of December 31, 2013 and 2012 from our audited Consolidated Financial Statements included in this Annual Report on Form 10-K. The Consolidated Statements of Income Data and Consolidated Cash Flow Data for the years ended December 31, 2010 and 2009 and Consolidated Balance Sheet Data as of December 31, 2011, 2010, and 2009 were derived from our audited Consolidated Financial Statements that are not included in this Annual Report on Form 10-K.
Consolidated Statements of Income Data | ||||||||||||||||||||
(in thousands except per share amounts) | 2009 | 2010 | 2011 | 2012 | 2013 | |||||||||||||||
Revenue | $ | 478,996 | $ | 555,351 | $ | 631,400 | $ | 658,288 | $ | 698,266 | ||||||||||
Operating expense | 354,323 | 434,292 | 492,985 | 507,620 | 527,612 | |||||||||||||||
Operating income | 124,673 | 121,059 | 138,415 | 150,668 | 170,654 | |||||||||||||||
Non-operating income, net | 2,934 | 6,732 | 1,709 | 2,957 | 7,356 | |||||||||||||||
Income before income taxes and equity in net income of unconsolidated entities | 127,607 | 127,791 | 140,124 | 153,625 | 178,010 | |||||||||||||||
Equity in net income of unconsolidated entities | 1,165 | 1,422 | 1,848 | 2,027 | 1,428 | |||||||||||||||
Income tax expense | 46,775 | 42,756 | 43,658 | 52,878 | 56,031 | |||||||||||||||
Consolidated net income from continuing operations | 81,997 | 86,457 | 98,314 | 102,774 | 123,407 | |||||||||||||||
Gain on sale of discontinued operations, net of tax | — | — | — | 5,188 | — | |||||||||||||||
Consolidated net income | 81,997 | 86,457 | 98,314 | 107,962 | 123,407 | |||||||||||||||
Net (income) loss attributable to noncontrolling interests | 132 | (87 | ) | 43 | 117 | 122 | ||||||||||||||
Net income attributable to Morningstar, Inc. | $ | 82,129 | $ | 86,370 | $ | 98,357 | $ | 108,079 | $ | 123,529 | ||||||||||
Net income per share attributable to Morningstar, Inc.: | ||||||||||||||||||||
Basic: | ||||||||||||||||||||
Continuing operations | $ | 1.71 | $ | 1.75 | $ | 1.96 | $ | 2.12 | $ | 2.68 | ||||||||||
Discontinued operations | — | — | — | 0.11 | — | |||||||||||||||
Total | $ | 1.71 | $ | 1.75 | $ | 1.96 | $ | 2.23 | $ | 2.68 | ||||||||||
Diluted: | ||||||||||||||||||||
Continuing operations | $ | 1.65 | $ | 1.70 | $ | 1.92 | $ | 2.10 | $ | 2.66 | ||||||||||
Discontinued operations | — | — | — | 0.10 | — | |||||||||||||||
Total | $ | 1.65 | $ | 1.70 | $ | 1.92 | $ | 2.20 | $ | 2.66 | ||||||||||
Dividends per common share: | ||||||||||||||||||||
Dividends declared per common share | $ | — | $ | 0.05 | $ | 0.25 | $ | 0.425 | $ | 0.545 | ||||||||||
Dividends paid per common share | $ | — | $ | — | $ | 0.20 | $ | 0.525 | $ | 0.375 | ||||||||||
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Weighted average common shares outstanding: | ||||||||||||||||||||
Basic | 48,112 | 49,249 | 50,032 | 48,497 | 46,158 | |||||||||||||||
Diluted | 49,793 | 50,555 | 50,988 | 49,148 | 46,491 | |||||||||||||||
Other Consolidated Financial Data ($000) | 2009 | 2010 | 2011 | 2012 | 2013 | |||||||||||||||
Stock-based compensation expense (1): | ||||||||||||||||||||
Restricted stock units | $ | 10,591 | $ | 12,545 | $ | 12,765 | $ | 13,451 | $ | 14,163 | ||||||||||
Restricted stock | — | 1,248 | 2,196 | 5,013 | 388 | |||||||||||||||
Stock options | 1,002 | — | 342 | 441 | 492 | |||||||||||||||
Total stock-based compensation expense | $ | 11,593 | $ | 13,793 | $ | 15,303 | $ | 18,905 | $ | 15,043 | ||||||||||
Cash provided by (used for) investing activities (2) | $ | (174,675 | ) | $ | (87,949 | ) | $ | (110,767 | ) | $ | 80,192 | $ | (14,861 | ) | ||||||
Cash provided by (used for) financing activities (3) | $ | 25,320 | $ | 12,525 | $ | (32,596 | ) | $ | (265,176 | ) | $ | (166,372 | ) | |||||||
Cash provided by operating activities | $ | 101,256 | $ | 123,416 | $ | 164,976 | $ | 145,996 | $ | 186,658 | ||||||||||
Capital expenditures | (12,372 | ) | (14,771 | ) | (23,322 | ) | (30,039 | ) | (33,583 | ) | ||||||||||
Free cash flow (4) | $ | 88,884 | $ | 108,645 | $ | 141,654 | $ | 115,957 | $ | 153,075 | ||||||||||
Consolidated Balance Sheet Data | ||||||||||||||||||||
As of December 31 ($000) | 2009 | 2010 | 2011 | 2012 | 2013 | |||||||||||||||
Cash, cash equivalents, and investments | $ | 342,553 | $ | 365,416 | $ | 470,192 | $ | 321,418 | $ | 298,567 | ||||||||||
Working capital | 236,595 | 254,556 | 341,400 | 217,245 | 166,602 | |||||||||||||||
Total assets | 919,083 | 1,086,302 | 1,172,084 | 1,041,952 | 1,030,668 | |||||||||||||||
Deferred revenue (5) | 127,114 | 146,267 | 155,494 | 146,015 | 149,225 | |||||||||||||||
Long-term liabilities | 45,792 | 52,153 | 44,435 | 57,692 | 59,087 | |||||||||||||||
Total equity | 665,789 | 781,425 | 857,016 | 726,895 | 691,290 | |||||||||||||||
(1) We account for our stock-based compensation expense in accordance with FASB ASC 718, Compensation—Stock Compensation. Our stock-based compensation expense reflects grants of restricted stock units, restricted stock, and stock options. Please see Note 11 of the Notes to our Consolidated Financial Statements for more information on our stock-based compensation.
(2) Cash provided by (used for) investing activities consists primarily of cash used for acquisitions, purchases of investments, net of proceeds from the sale of investments, capital expenditures, purchases of equity and cost- method investments, and proceeds from the sale of businesses. The level of investing activities can vary from period to period depending on the level of activity in these categories. Refer to Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources for more information concerning cash used for investing activities.
(3) Cash provided by (used for) financing activities consists primarily of cash used to repurchase outstanding common stock through our share repurchase program and dividend payments. These cash outflows are offset by proceeds from stock-option exercises and excess tax benefits. Refer to Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources, for more information concerning cash provided by financing activities.
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(4) Free cash flow is considered a non-GAAP financial measure under SEC regulations. We present this measure as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required to be reported under GAAP, nor should this data be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.
(5) We frequently invoice or collect cash in advance of providing services or fulfilling subscriptions for our customers. These amounts are recorded as deferred revenue on our Consolidated Balance Sheets.
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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 sections of this Annual Report on Form 10-K, contains forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. These statements are based on our current expectations about future events or future financial performance. Forward-looking statements by their nature address matters that are, to different degrees, uncertain, and often contain words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue.” These statements involve known and unknown risks and uncertainties that may cause the events we discuss not to occur or to differ significantly from what we expect. For us, these risks and uncertainties
include, among others:
• | liability for any losses that result from an actual or claimed breach of our fiduciary duties; |
• | failing to differentiate our products and continuously create innovative, proprietary research tools; |
• | failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy |
• | a prolonged outage of our database and network facilities; |
• | any failures or disruptions in our electronic delivery systems and the Internet; |
• | liability and/or damage to our reputation as a result of some of our pending litigation; |
• | liability related to the storage of personal information about our users; |
• | general industry conditions and competition, including global financial uncertainty, trends in the mutual fund industry, and continued growth in passively managed investment vehicles; |
• | the impact of market volatility on revenue from asset-based fees; |
• | failing to maintain and protect our brand, independence, and reputation; |
• | changes in laws applicable to our investment advisory or credit rating operations, compliance failures, or regulatory action; and |
• | challenges faced by our non-U.S. operations, including the concentration of development work at our offshore facilities in China and India. |
A more complete description of these risks and uncertainties can be found in Item 1A—Risk Factors of this Annual Report on Form 10-K. If any of these risks and uncertainties materialize, our actual future results may vary significantly from what we expected. We do not undertake to update our forward-looking statements as a result of new information or future events.
All dollar and percentage comparisons, which are often accompanied by words such as “increase,” “decrease,” “grew,” “declined,” “was up,” “was down,” “was flat,” or “was similar” refer to a comparison with the same period in the prior year unless otherwise stated.
Understanding Our Company
Key Business Characteristics
Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of products and services for financial advisors, asset managers, retirement plan providers and sponsors, and individual investors. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.
In the third quarter of 2013, we revised our segment structure to reflect our shift to a more centralized organizational structure. We now report our results in a single segment, which is consistent with how management allocates resources and evaluates our financial results.
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Revenue
We generate revenue by selling a variety of investment-related products and services. We sell most of our investment information products and services, including Morningstar Data, Morningstar Advisor Workstation, Morningstar Direct, Morningstar Equity Research, Retirement Solutions, and some of our structured credit research and ratings offerings, 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 on Morningstar.com, Principia software, and newsletters, via subscriptions. These subscriptions are mainly offered for a one-year term, although we also offer terms ranging from one month to three years. We also sell advertising on our websites throughout the world. In our structured credit research and rating business, we generate transaction-based revenue for our ratings on new issues of commercial mortgage-backed securities.
Our investment management business has multiple fee structures, which vary by client. In general, we seek to receive asset-based fees for any work we perform that involves managing investments or acting as a subadvisor to investment portfolios. For any individual contract, we may receive flat fees, variable asset-based fees, or a combination of the two. Some of our contracts include minimum fee levels that provide us with a flat payment up to a specified asset level, above which we also receive variable asset-based fees. In the majority of our contracts that include variable asset-based fees, we bill clients quarterly in arrears based on average assets for the quarter. The method of calculation varies by client; some contracts include provisions for calculating average assets based on daily data, while others use weekly or monthly data. Other contracts may include provisions for monthly billing or billing based on assets as of the last day of the billing period rather than on average assets.
In our Retirement Solutions business, 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. Our Retirement Solutions business also includes plan sponsor and custom target-date consulting arrangements. Fees for these services may be based on the level of assets under advisement.
We do not disclose a fee range for our Investment Advisory Services and Retirement Solutions businesses because our fee structures vary by client. In addition, we believe disclosing a fee range would be detrimental to our competitive position. We disclose changes in the nature of the underlying services we provide or their associated fee structures (for example, a change from flat fees to asset-based fees) in our SEC filings to the extent that they are material to our financial results.
For Morningstar Managed Portfolios, we charge asset-based fees, which are based on a tiered schedule that depends on the client’s account balance. Fees for our mutual fund and ETF portfolios generally range from 20 to 40 basis points. We charge fees of 55 basis points for our customized stock portfolios.
Deferred Revenue
We frequently invoice our clients and collect cash in advance of providing services or fulfilling subscriptions for our customers. As a result, we use some of this cash to fund our operations and invest in new product development. Deferred revenue is the largest liability on our Consolidated Balance Sheets and totaled $149.2 million at the end of 2013 and $146.0 million at the end of 2012. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our subscription, license, and service agreements.
Significant Operating Leverage
Our business requires significant investments to create and maintain proprietary databases and content. We strive to leverage these costs by selling a wide variety of products and services to multiple customer groups, through multiple media, and in many geographical markets. In general, our businesses have high fixed costs, and we expect our revenue to increase or decrease more quickly than our operating expense. We believe that while the fixed costs of the investments in our business are relatively high, the variable cost of adding customers is considerably lower, particularly as a significant portion of our products and services focus on Internet-based platforms and assets under management. At times, we may make investments in building our databases and content that will hurt our short-term operating results. During other periods, our profitability may improve because we are able to increase revenue without increasing our cost base at the same rate. When revenue decreases, however, the operating leverage in our business may reduce our profitability.
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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. We include stock-based compensation expense, as appropriate, in each of these categories.
• Cost of revenue. This category includes compensation expense for employees who produce the products and services we deliver to our customers. For example, this category covers production teams and analysts who write investment research reports. It also includes compensation expense for programmers, designers, and other employees who develop new products and enhance existing products. In some cases, we capitalize the compensation costs associated with certain software development projects. This reduces the expense that we would otherwise report in this category. Cost of revenue also includes other expense such as third-party data purchases and data lines. We now include development expense in the cost of revenue category, which we previously referred to as cost of goods sold. We have reclassified development expense to include it in cost of revenue for all periods presented.
• Sales and marketing. This category includes compensation expense for our sales teams, product managers, and other marketing professionals. We also include the cost of advertising, direct mail campaigns, and other marketing programs to promote our products in this category.
• General and administrative. This category consists mainly of compensation expense for our management team, as well as corporate functions (including employees in our human resources, finance, and legal departments). The category also includes compensation expense for senior management and other corporate costs, including corporate systems, finance and accounting, legal, compliance, and facilities expense.
• Depreciation and amortization. Our capital expenditures primarily consist of information technology equipment, leasehold improvements, and capitalized software development costs. We depreciate property and equipment primarily using the straight-line method based on the useful lives of the assets, which range from three to seven years. We amortize leasehold improvements over the lease term or their useful lives, whichever is shorter. We amortize capitalized software development costs over their estimated economic life, which is generally three years. We also include amortization related to 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 25 years.
International Operations
As of December 31, 2013, we had majority-owned operations in 26 countries outside of the United States and included their results of operations and financial condition in our consolidated financial statements. We account for our minority-owned investments in Japan and Sweden using the equity method.
How We Evaluate Our Business
When our analysts evaluate a stock, they focus on assessing the company's estimated intrinsic value, which represents the company's 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 to take actions that help us meet short-term forecasts but may not be in the long-term interest of building shareholder value.
We provide three specific measures that can help investors generate their own assessment of how our intrinsic value has changed over time:
• Revenue (including organic revenue);
• Operating income (loss); and
• Free cash flow, which we define as cash provided by or used for operating activities less capital expenditures.
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Organic revenue is considered a non-GAAP financial measure under Securities and Exchange Commission (SEC) regulations. We define organic revenue as consolidated revenue excluding acquisitions, divestitures, 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.
Free cash flow is also considered a non-GAAP financial measure. We present this measure as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under U.S. generally accepted accounting principles (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.
To evaluate how successful we've been in maintaining existing business for products and services that have renewable revenue, we calculate a retention rate. We use two different methods for calculating retention. For subscription-based products (including our print newsletters, Morningstar.com Premium Membership service, and Principia software), we track the number of subscriptions retained during the year. For products sold through contracts and licenses, we use the 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, unless the change specifically results from adding a new product that we can identify. We also include variable-fee contracts in this calculation and use the previous quarter's actual revenue as the base rate for calculating the renewal percentage. The retention rate excludes setup and customization fees, migrations to other Morningstar products, and contract renewals that were pending as of January 31, 2014.
The Year 2013 in Review
We monitor developments in the economic and financial information industry on an ongoing basis. We use these insights to help inform our company strategy, product development plans, and marketing initiatives.
Despite a temporary government shutdown and periodic concerns about the Federal Reserve tapering off its efforts to stimulate the economy, the U.S. stock market showed unusually strong gains in 2013. Morningstar's U.S. Market Index, a broad market benchmark, ended the year up 33.1%. Global markets also closed out the year with strong returns; Morningstar’s Global Markets ex-U.S. Index posted a 16.1% gain for the year.
The fund industry enjoyed healthy growth in 2013 as a slowly improving global economy help lead to more positive investor sentiment. Total U.S. mutual fund assets rose to $15.0 trillion as of December 31, 2013, compared with $13.0 trillion as of December 31, 2012, based on data from the Investment Company Institute (ICI). Based on Morningstar’s analysis of fund flow trends, equity mutual funds had estimated net inflows of about $220 billion in 2013, up from about $100 billion in 2012. In contrast to the past several years, when investors heavily favored bond funds, some fixed-income fund categories experienced net outflows as rising interest rates led to negative total returns. Global mutual fund assets showed a similar trend.
Investors have also continued to favor passively managed index funds rather than actively managed portfolios. In 2013, passively managed vehicles had more than $300 billion in net inflows, compared with about $150 billion of net inflows for active products (both mutual funds and ETFs).
The number of mutual funds in the United States rose slightly to about 7,700 in 2013 (excluding multiple share classes), compared with about 7,600 in 2012 based on ICI data. The number of global mutual funds rose to about 75,300 as of September 30, 2013, up from about 73,500 as of September 30, 2012, based on ICI data.
ETFs continued to increase in popularity relative to traditional mutual funds. The U.S. ETF industry closed out 2013 with about $1.7 trillion in assets under management based on ICI data, up from about $1.3 trillion at the end of 2012.
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Based on data from ComScore, aggregate page views to financial and investment sites rose about 9% in 2013, while the number of unique users was up about 11%. The number of pages viewed per visit and time spent per visit increased by about 17% and 21%, respectively. We believe these trends reflect a higher level of interest in financial- and investment-related content among individual investors as the market rose during 2013. For Morningstar.com, metrics such as unique users and aggregate page views were up slightly for the year, while pages viewed per visit and time spent per visit showed a more significant increase.
Amid these trends, we believe online advertising spending by financial services companies rose moderately in 2013. Although Magna Global, a division of Interpublic Group, estimates that global online advertising revenue rose about 16% across all industries in 2013, we believe spending in the financial services industry rose at a more moderate pace.
In the wake of the financial crisis of 2008 and 2009, regulators have continued to implement new rules for financial services companies globally. Many of these relate to financial advisor compensation, fees and expenses, investor disclosure, and the use of hedge funds and alternative investments. In the United Kingdom, for example, the Retail Distribution Review (RDR), which emphasizes increased regulation of advisory fees, higher professional standards for financial advisors, and an emphasis on "whole of market" investment solutions, became effective in January 2013. Advisors are now required to give clients a choice of all investment vehicles (including funds, ETFs, and other products) and demonstrate that they consider different investment options without bias. Financial advisors are also required to fully disclose and have clients agree on fees for advice and charge separately for any funds or investments. Beginning in April 2014, online investment platforms will also be required to charge separate fees for investors who make transactions through them and provide additional disclosures about the fees they charge.
In the European Union, Undertakings for Collective Investments in Transferable Securities (UCITS) is a set of directives designed to enable funds to operate across the region based upon authorization from one state regulator. UCITS IV, which came into effect in July 2011, included requirements for a new Key Investor Information Document (KIID), an easy-to-read annual factsheet that replaces the Simplified Prospectus. Every UCITS fund that is promoted to retail investors is now required to produce a KIID and issue an updated copy each year. We use our data and production capabilities to help fund companies produce and distribute these documents.
In Australia, the government has introduced a series of Future of Financial Advice reforms. Mandatory implementation of these reforms began in July 2013. Many of these related to fiduciary standards and compensation structures for financial advisors.
In the United States, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) into law in July 2010. Dodd-Frank creates a number of new regulatory, supervisory, and advisory bodies and touches on the regulation of virtually every aspect of U.S. financial markets and activities. Dodd-Frank also left numerous matters to be addressed through rulemaking and other regulatory action, giving the regulators significant discretion in many areas. As a result, the final shape and effect of the legislation are continuing to emerge.
In 2013, various regulatory agencies approved provisions of the "Volcker Rule," which would prevent banks from engaging in some types of proprietary trading and more speculative investments. The Volcker Rule is scheduled to go into effect in April 2014.
Dodd-Frank included a number of corporate governance and disclosure requirements that apply to publicly traded companies generally. It also included changes to the regulatory framework for credit rating agencies granting the SEC more oversight over Nationally Recognized Statistical Rating Organizations (NRSROs), including our Morningstar Credit Ratings subsidiary. While we believe Dodd-Frank and related regulations will not have a significant effect on other areas of Morningstar, we continue to monitor the potential impact on our clients.
The U.S. Securities and Exchange Commission has been considering rules that would impose a fiduciary standard for financial advisors, which would require them to act in the best interest of clients when making investment recommendations instead of the looser “suitability” standards currently in place. The Department of Labor has proposed a similar plan that would only apply to advisors working with defined contribution plans and individual retirement accounts. We believe the increase regulatory scrutiny of advisors may lead to an expanding need for independent advice, tools, and solutions.
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In July 2013, the United States Department of Labor (DOL) revised the definition of "Rating Agency" in its amended requirements for the Exemption From Certain Prohibited Transaction Restrictions of the Employee Retirement Income Security Act of 1974 (ERISA) to eliminate any specific reference to a particular credit rating agency. The amended exemption increases the ability of employee benefit plans to invest in structured credit securities that carry ratings issued by Morningstar Credit Ratings.
Despite generally positive market trends, we believe the business environment for the financial services industry remains challenging. Asset management firms have been facing increasing regulatory burdens, which are leading to higher costs and more cautious spending in other areas. Further, the historically low interest rate environment has put significant pressure on the margins of many firms, most notably those in the variable annuity space. As a result, we expect there will be further pressure on revenue from clients in this area.
Supplemental Operating Metrics
The tables below summarize our key product metrics and other supplemental data.
As of December 31, | |||||||||||||||||
Our business | 2013 | 2012 | 2011 | 2013 change | 2012 change | ||||||||||||
Morningstar.com Premium Membership subscriptions (U.S.) | 124,027 | 123,899 | 130,354 | 0.1 | % | (5.0 | )% | ||||||||||
Registered users for Morningstar.com (U.S.) | 7,848,057 | 7,521,043 | 6,891,458 | 4.3 | % | 9.1 | % | ||||||||||
U.S. Advisor Workstation and Morningstar Office licenses | 169,592 | 162,904 | 160,287 | 4.1 | % | 1.6 | % | ||||||||||
Principia subscriptions | 19,206 | 26,807 | 31,270 | (28.4 | )% | (14.3 | )% | ||||||||||
Morningstar Direct licenses (3) | 8,514 | 7,388 | 6,134 | 15.2 | % | 20.4 | % | ||||||||||
Assets under advisement and management (approximate) ($bil) | |||||||||||||||||
Investment Advisory services (1) | $ | 83.5 | $ | 94.3 | $ | 137.5 | (11.5 | )% | (31.4 | )% | |||||||
Retirement Solutions | |||||||||||||||||
Managed retirement accounts (2) | $ | 31.7 | $ | 25.1 | $ | 19.9 | 26.3 | % | 26.1 | % | |||||||
Other assets | $ | 33.9 | $ | 22.1 | $ | 17.5 | 53.4 | % | 26.3 | % | |||||||
Total for Retirement Solutions | $ | 65.6 | $ | 47.2 | $ | 37.4 | 39.0 | % | 26.2 | % | |||||||
Morningstar Managed Portfolios | $ | 7.3 | $ | 4.7 | $ | 3.1 | 55.3 | % | 51.6 | % | |||||||
Ibbotson Australia | $ | 3.0 | $ | 3.3 | $ | 2.9 | (9.1 | )% | 13.8 | % | |||||||
Number of commercial mortgage-backed securities (CMBS) new-issue ratings completed | 38 | 19 | 13 | 100.0 | % | 46.2 | % | ||||||||||
Rated balance for CMBS new-issue ratings ($bil) | $ | 24.5 | $ | 15.4 | $ | 13.3 | 59.1 | % | 15.8 | % | |||||||
Our employees | |||||||||||||||||
Worldwide headcount (approximate) | 3,565 | 3,495 | 3,465 | 2.0 | % | 0.9 | % | ||||||||||
Number of worldwide equity and credit analysts (approximate) | 165 | 155 | 140 | 6.5 | % | 10.7 | % | ||||||||||
Number of worldwide fund analysts (approximate) | 105 | 110 | 105 | (4.5 | )% | 4.8 | % | ||||||||||
Key product revenue ($000) | 2013 | 2012 | 2011 | 2013 change | 2012 change | ||||||||||||
Morningstar Data (3) | $ | 129,262 | $ | 115,273 | $ | 103,996 | 12.1 | % | 10.8 | % | |||||||
Morningstar Advisor Workstation (3) | 93,059 | 86,048 | 79,664 | 8.1 | % | 8.0 | % | ||||||||||
Morningstar Direct (3) | 79,358 | 65,279 | 52,185 | 21.6 | % | 25.1 | % | ||||||||||
Investment Advisory (3) | 59,187 | 66,369 | 71,465 | (10.8 | )% | (7.1 | )% | ||||||||||
Morningstar.com | 55,637 | 53,671 | 56,352 | 3.7 | % | (4.8 | )% | ||||||||||
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(1) The decline in assets under advisement in 2012 and 2013 reflects difficult market conditions for companies that offer variable annuities. Some of our clients have been managing their funds-of-funds portfolios in-house instead of using outside subadvisors. Because of this trend, assets under advisement were down $10.8 billion in 2013 and $43.2 billion in 2012. The asset change in 2012 reflects both the loss of business from a large client and a change in the scope of services provided to another client.
The asset totals include relationships for which we receive basis-point fees, including consulting arrangements and other agreements where we act as a portfolio construction manager for a mutual fund or variable annuity. We also provide Investment Advisory services for some assets for which we receive a flat fee; we do not include these assets in the total reported above.
Excluding changes related to new contracts and cancellations, changes in the value of assets under advisement can come from two primary sources: gains or losses related to overall trends in market performance, and net inflows or outflows caused when investors add to or redeem shares from these portfolios.
We cannot separately quantify cash inflows and outflows for these portfolios because we do not have custody of the assets in the majority of our investment management businesses. The information we receive from many of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot precisely quantify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations.
(2) We cannot separately quantify the factors affecting assets under management and advisement for our managed retirement accounts. These factors primarily consist of employer and employee contributions, plan administrative fees, market movements, and participant loans and hardship withdrawals. We cannot quantify the impact of these other factors because the information we receive from the plan providers does not separately identify these transactions or the changes in balances caused by market movement.
(3) Beginning with the third quarter of 2013, we revised our segment structure to reflect our shift to a more centralized organizational structure. In addition, we took this opportunity to revise our revenue by product structure to better represent how management internally reviews and evaluates product revenue and performance. The most significant revision is that Morningstar Data now excludes Morningstar Commodity Data. We have reclassified the prior-year information to reflect these changes. We also made minor corrections to the total number of licenses for Morningstar Direct in 2012 and 2011.
Consolidated Results
Key Metrics ($000) | 2013 | 2012 | 2011 | 2013 Change | 2012 Change | ||||||||||||||
Revenue | $ | 698,266 | $ | 658,288 | 631,400 | 6.1 | % | 4.3 | % | ||||||||||
Operating income | $ | 170,654 | $ | 150,668 | 138,415 | 13.3 | % | 8.9 | % | ||||||||||
Operating margin | 24.4 | % | 22.9 | % | 21.9 | % | 1.5 | pp | 1.0 | pp | |||||||||
Cash provided by (used for) investing activities | $ | (14,861 | ) | $ | 80,192 | (110,767 | ) | NMF | NMF | ||||||||||
Cash used for financing activities | $ | (166,372 | ) | $ | (265,176 | ) | (32,596 | ) | (37.3 | )% | 713.5 | % | |||||||
Cash provided by operating activities | $ | 186,658 | $ | 145,996 | 164,976 | 27.9 | % | (11.5 | )% | ||||||||||
Capital expenditures | (33,583 | ) | (30,039 | ) | (23,322 | ) | 11.8 | % | 28.8 | % | |||||||||
Free cash flow | $ | 153,075 | $ | 115,957 | $ | 141,654 | 32.0 | % | (18.1 | )% | |||||||||
____________________________________________________________________________________________
pp — percentage points
NMF — Not meaningful
We define free cash flow as cash provided by or used for operating activities less capital expenditures. Please refer to the discussion in How We Evaluate our Business for more detail.
Consolidated Revenue
($000) | 2013 | 2012 | 2011 | 2013 Change | 2012 Change | |||||||||||
Revenue | ||||||||||||||||
Investment information | 555,642 | 526,147 | 498,265 | 5.6 | % | 5.6 | % | |||||||||
Investment management | 142,624 | 132,141 | 133,135 | 7.9 | % | (0.7 | %) | |||||||||
Consolidated revenue | 698,266 | 658,288 | 631,400 | 6.1 | % | 4.3 | % | |||||||||
In 2013, our consolidated revenue rose 6.1% compared with the previous year. Although our Investment Advisory revenue was down about $7.2 million compared with 2012, most of our other major products performed well. Morningstar Direct, Morningstar Data, Morningstar Managed Portfolios, and Morningstar Retirement Solutions were some of our major growth drivers in 2013.
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In 2012, our consolidated revenue increased 4.3%. Morningstar Direct was the main contributor to revenue growth, followed by Morningstar Data. Morningstar Advisor Workstation and Integrated Web Tools also made positive contributions, although to a lesser extent. These factors helped offset the loss of business from a large variable annuity client in our Investment Advisory business. Because this client began managing several fund-of-funds portfolios in-house in April 2012, we recognized $3.8 million in associated revenue in 2012, down from $12.4 million in 2011.
Investment information revenue
Investment information products, which make up about 80% of our consolidated revenue, rose $29.5 million, or 5.6%, in 2013 and $27.9 million, or 5.6%, in 2012. Morningstar Direct was the biggest contributor to growth in this product group in both 2013 and 2012, with revenue increasing by $14.1 million in 2013 and $13.1 million in 2012. The number of licenses for Morningstar Direct increased to about 8,500 worldwide in 2013, compared with about 7,400 at the end of 2012 and 6,100 at the end of 2011, with strong growth in both the United States and internationally. Growth in Morningstar Direct reflects additional licenses for both new and existing clients, and, to a lesser extent, client migrations from both Institutional Workstation and Morningstar EnCorr to Morningstar Direct.
Morningstar Data was the second-biggest contributor to growth in this product group in both 2013 and 2012, reflecting strong renewal rates and new client contracts for managed products data. Morningstar Data gives institutions access to a full range of proprietary investment data spanning numerous investment databases, including real-time pricing data, fundamental equity data, and managed investment product data. The data packages we offer include proprietary statistics, such as the Morningstar Style Box and Morningstar Rating, and a wide range of other data, including information on investment performance, risk, portfolios, operations data, fees and expenses, cash flows, and ownership.
Morningstar Advisor Workstation (mainly Morningstar Office) had moderately positive revenue growth in both 2013 and 2012. The number of U.S. licenses for Morningstar Advisor Workstation increased to about 170,000 in 2013, compared with 163,000 at the end of 2012 and 160,000 at the end of 2011. These positive growth trends were partially offset by lower revenue for Principia, which was down $4.8 million in 2013 and $1.8 million in 2012. During the first quarter of 2013, we announced that we are no longer selling new subscriptions to Principia, and we’ve begun migrating Principia clients to Morningstar Advisor Workstation and other Morningstar products that meet their needs. We expect to continue supporting clients on Principia until the end of 2014. Morningstar.com was up slightly in 2013, but declined by $2.7 million in 2012. Revenue was down in 2012 because of declining paid Premium Membership subscriptions (mainly in the United States) and a difficult advertising sales market.
Investment management revenue
Investment management revenue, which represents about 20% of consolidated revenue, was up $10.5 million, or 7.9%, in 2013, as positive trends in assets under management for Retirement Solutions and Morningstar Managed Portfolios more than offset lower revenue for Investment Advisory services. Companies that offer variable annuities have continued to face difficult market conditions, which has prompted some of our clients to begin managing their fund-of-funds portfolios in-house instead of using outside subadvisors. Because of this trend, our Investment Advisory revenue was about $7.2 million lower in 2013 versus 2012, and assets under advisement for these services were down $10.8 billion over the same period.
Investment management revenue decreased $1.0 million, or 0.7%, in 2012. The loss of some business from a large client in the variable annuity industry was the main reason for this decline. Excluding the loss of this business, Investment Advisory revenue was up $3.4 million in 2012. Revenue for Morningstar Managed Portfolios, and to a lesser extent, Retirement Solutions, also rose in 2012, partially offsetting negative trends in Investment Advisory.
The asset-based fees we earn are primarily based on average asset levels during each quarter. Average assets under advisement and management (calculated based on available average quarterly or monthly data) were approximately $161.6 million in 2013, compared with $181.0 million in 2012 and $165.3 million in 2011. We had $88.6 million in revenue from asset-based fees in 2013, an increase of $7.2 million compared with $81.4 million in 2012. In 2011, revenue from asset-based fees was $81.7 million. Revenue from asset-based fees made up approximately 12.7% of consolidated revenue in 2013, up slightly from 12.4% in 2012.
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The variable annuity industry, which accounted for approximately 2% and 3% of consolidated revenue in 2013 and 2012, respectively, continues to face challenges. Accordingly, we expect there will be further pressure on revenue from variable annuity clients.
Organic revenue
To allow for more meaningful comparisons of our results in different periods, we provide information about organic revenue, which reflects our underlying business excluding acquisitions, divestitures, and the effect of foreign currency translations. During the second quarter of 2013, we acquired an additional 76% interest in Morningstar Sweden AB to become the sole owner. We divested several smaller business lines during 2012.
We exclude revenue from businesses acquired or divested from organic revenue for a period of 12 months after we complete the acquisition or divestiture.
In 2013, the net effect of acquisitions and divestitures was essentially neutral, as we had $3.7 million in incremental revenue from our acquisition of the remaining ownership interest in Morningstar Sweden, which was offset by the loss of $4.1 million in revenue from business lines we divested in 2012. In addition, currency translations reduced revenue by about $3.6 million in 2013, mainly because of the weaker Australian dollar. Excluding acquisitions, divestitures, and foreign currency translations, organic revenue was up 6.7% in 2013.
In 2012, currency translations reduced revenue by about $4.6 million. The euro, and to a lesser extent, the British pound, were the primary reasons for the negative currency effect. Divestitures reduced revenue by an additional $1.1 million in 2012, and we had no incremental revenue from acquisitions. Excluding acquisitions, divestitures, and foreign currency translations, organic revenue was up 5.2% in 2012.
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The tables below reconcile consolidated revenue with organic revenue (revenue excluding acquisitions, divestitures, and the effect of foreign currency translations):
2013 vs. 2012 ($000) | 2013 | 2012 | Change | ||||||||
Consolidated revenue | $ | 698,266 | $ | 658,288 | 6.1 | % | |||||
Less: acquisitions | (3,746 | ) | — | NMF | |||||||
Less: divestitures | — | (4,144 | ) | NMF | |||||||
Unfavorable effect of foreign currency translations | 3,575 | — | NMF | ||||||||
Organic revenue | $ | 698,095 | $ | 654,144 | 6.7 | % | |||||
2012 vs. 2011 ($000) | 2012 | 2011 | Change | ||||||||
Consolidated revenue | $ | 658,288 | $ | 631,400 | 4.3 | % | |||||
Less: acquisitions | — | — | NMF | ||||||||
Less: divestitures | — | (1,057 | ) | NMF | |||||||
Unfavorable effect of foreign currency translations | 4,620 | — | NMF | ||||||||
Organic revenue | $ | 662,908 | $ | 630,343 | 5.2 | % | |||||
Organic revenue (revenue excluding acquisitions, divestitures, 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.
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Revenue by region
Year ended December 31 | ||||||||||||||||||
($000) | 2013 | 2012 | 2011 | 2013 Change | 2012 Change | |||||||||||||
United States | $ | 500,730 | $ | 466,947 | $ | 446,470 | 7.2 | % | 4.6 | % | ||||||||
United Kingdom | 56,298 | 56,794 | 53,427 | (0.9 | )% | 6.3 | % | |||||||||||
Continental Europe | 57,580 | 49,844 | 49,507 | 15.5 | % | 0.7 | % | |||||||||||
Australia | 35,289 | 38,229 | 39,761 | (7.7 | )% | (3.9 | )% | |||||||||||
Canada | 31,845 | 30,664 | 27,808 | 3.9 | % | 10.3 | % | |||||||||||
Asia | 13,860 | 13,765 | 13,188 | 0.7 | % | 4.4 | % | |||||||||||
Other | 2,664 | 2,045 | 1,239 | 30.3 | % | 65.1 | % | |||||||||||
Total international | 197,536 | 191,341 | 184,930 | 3.2 | % | 3.5 | % | |||||||||||
Consolidated revenue | $ | 698,266 | $ | 658,288 | $ | 631,400 | 6.1 | % | 4.3 | % | ||||||||
International revenue made up about 28% of our consolidated revenue in 2013, 2012, and 2011. About 60% of our international revenue is from Continental Europe and the United Kingdom. We also have a fairly large revenue base in Australia and Canada.
Revenue from international operations rose 3.2% in 2013, as our operations in Continental Europe enjoyed stronger product sales, but this growth was partly offset by the negative effect of foreign currency translations (mainly the weaker Australian dollar).
In 2012, international revenue was up 3.5%, mainly because of stronger product sales in Europe and Canada, partially offset by lower revenue in Australia. Divestitures had a slight negative effect on international revenue in 2012, while foreign currency translations decreased revenue by $4.6 million, mainly because of the euro, and to a lesser extent, the British pound.
The tables below present a reconciliation from international revenue to international organic revenue (international revenue excluding acquisitions, divestitures, and the impact of foreign currency translations):
($000) | 2013 | 2012 | Change | ||||||||
International revenue | $ | 197,536 | $ | 191,341 | 3.2 | % | |||||
Less: acquisitions | (3,746 | ) | — | NMF | |||||||
Less: divestitures | — | (3,814 | ) | NMF | |||||||
Unfavorable effect of foreign currency translations | 3,575 | — | NMF | ||||||||
International organic revenue | $ | 197,365 | $ | 187,527 | 5.2 | % | |||||
($000) | 2012 | 2011 | Change | ||||||||
International revenue | $ | 191,341 | $ | 184,930 | 3.5 | % | |||||
Less: acquisitions | — | — | NMF | ||||||||
Less: divestitures | — | (982 | ) | NMF | |||||||
Unfavorable effect of foreign currency translations | 4,620 | — | NMF | ||||||||
International organic revenue | $ | 195,961 | $ | 183,948 | 6.5 | % | |||||
International organic revenue (international revenue excluding acquisitions, divestitures, and the effect of foreign currency translations) is considered a non-GAAP financial measure. The definition of international organic revenue we use may not be the same as similarly titled measures used by other companies. International organic revenue should not be considered an alternative to any measure of performance as promulgated under GAAP.
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Retention and Renewal Rates
As discussed in How We Evaluate Our Business, we calculate retention and renewal rates to help measure how successful we've been in maintaining existing business for products and services that have renewable revenue. The following graph illustrates these two metrics over the past five years:
For contract-based products and services (such as Morningstar Data, Investment Advisory services, Morningstar Direct, and Morningstar Advisor Workstation), we estimate that our weighted average annual renewal rate was between 90% and 95% in 2013, within the same range as 2012. The figure for contract-based products includes the effect of price changes and changes to the contract value upon renewal, as well as changes in the value of variable-fee contracts.
In 2013, we estimate that our annual retention rate for subscription-based products, such as Principia, Morningstar.com's Premium Membership service, and print and online newsletters, was between 65% and 70%, within the same range as 2012.
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Consolidated Operating Expense
($000) | 2013 | 2012 | 2011 | 2013 Change | 2012 Change | |||||||||||||||
Cost of revenue (1) | $ | 271,437 | $ | 246,783 | $ | 235,289 | 10.0 | % | 4.9 | % | ||||||||||
% of revenue | 38.9 | % | 37.5 | % | 37.3 | % | 1.4 | pp | 0.2 | pp | ||||||||||
Sales and marketing | 103,614 | 108,884 | 106,699 | (4.8 | )% | 2.0 | % | |||||||||||||
% of revenue | 14.8 | % | 16.5 | % | 16.9 | % | (1.7) | pp | (0.4) | pp | ||||||||||
General and administrative | 106,868 | 108,857 | 108,084 | (1.8 | )% | 0.7 | % | |||||||||||||
% of revenue | 15.3 | % | 16.5 | % | 17.1 | % | (1.2) | pp | (0.6) | pp | ||||||||||
Depreciation and amortization | 45,693 | 43,096 | 42,913 | 6.0 | % | 0.4 | % | |||||||||||||
% of revenue | 6.5 | % | 6.5 | % | 6.8 | % | 0.0 | pp | (0.3) | pp | ||||||||||
Total operating expense (2) (3) | $ | 527,612 | $ | 507,620 | $ | 492,985 | 3.9 | % | 3.0 | % | ||||||||||
% of revenue | 75.6 | % | 77.1 | % | 78.1 | % | (1.5) | pp | (1.0) | pp | ||||||||||
(1) We now include development expense in the cost of revenue category, which we previously referred to as cost of goods sold. We have reclassified development expense to include it in cost of revenue for all periods presented. We previously reported development expense as a separate operating expense category.
Separately, as a result of our recent reorganization (including new positions created, changes in focus for some existing roles, and the refinement of employee cost categorizations as we moved to a more centralized structure), approximately 180 net positions shifted from the general and administrative and sales and marketing categories to cost of revenue. For the year ended December 31, 2013 as compared with 2012 and 2011, changes related to our more centralized organizational structure added approximately $14 million of compensation expense to cost of revenue, and reduced the compensation expense in our sales and marketing and general and administrative expense categories by approximately $8 million and $6 million, respectively. These changes did not affect our total operating expense or operating income for any of the periods presented.
(2) Includes stock-based compensation expense of:
($000) | 2013 | 2012 | 2011 | ||||||||||
Stock-based compensation expense | $ | 15,043 | $ | 18,905 | $ | 15,303 | |||||||
% of revenue | 2.2 | % | 2.9 | % | 2.4 | % | |||||||
(3) Includes bonus expense of:
($000) | 2013 | 2012 | 2011 | ||||||||||
Bonus expense | $ | 40,930 | $ | 36,241 | $ | 42,621 | |||||||
% of revenue | 5.9 | % | 5.5 | % | 6.8 | % | |||||||
In 2013, our operating expense was up $20.0 million, or 3.9%, mainly because of higher salary expense, depreciation expense, professional fees, and bonus expense. Salary expense rose $6.3 million for the year, primarily because of pay raises made in July 2013. In addition, while headcount was down in the first nine months of the year, we hired about 75 net new employees during the fourth quarter. By the end of 2013, we had about 3,565 employees worldwide, compared with 3,495 at the end of 2012 and 3,465 at the end of 2011.
Depreciation increased $5.1 million, mainly reflecting additional capitalized software development and computer software purchases for our U.S. operations.
Professional fees were up $5.0 million in 2013, mainly reflecting higher legal expense.
Bonus expense rose $4.6 million in 2013. We review our estimates for the size of the bonus pool quarterly and make adjustments based on our expectations for full-year revenue and operating income relative to internal targets.
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In 2012, operating expense rose $14.6 million or 3.0%, mainly because of a $14.0 million increase in salary expense. Salary expense was up because of the full-year effect of regular pay raises and market adjustments made in July 2011, as well as regular pay raises made in July 2012. New hires in 2011 and 2012 also contributed to the growth in salary expense.
Higher professional fees, production expense, company-sponsored benefits (including matching contributions to our 401(k) plan for U.S. employees), and stock-based compensation expense also added to our expense base in 2012, although to a lesser extent than the salary costs discussed above. Stock-based compensation expense in 2012 included $3.2 million for accelerated vesting of restricted stock issued to a former executive in our structured credit research unit when we acquired the business. Additional data purchases contributed to the $3.8 million growth in production expense.
Operating expense as a percentage of revenue was down 1.5 percentage points in 2013 and 1.0 percentage point in 2012.
Cost of revenue
Cost of revenue (which we previously referred to as cost of goods sold) is our largest category of operating expense, representing about one-half of our total operating expense. Our business relies heavily on human capital, and we include compensation costs for the employees who produce our products and services in cost of revenue. We now include development expense in this category and have reclassified development expense to include it in cost of revenue for all periods presented.
Cost of revenue was up $24.7 million, or 10.0%, in 2013. Higher compensation expense of $14.0 million (mainly because of the shift in expense categories discussed above) was the main contributor to the increase. We included compensation expense in this category for approximately 2,880 employees as of December 31, 2013 (about 80% of our total employees), compared with approximately 2,585 as of December 31, 2012 (about 75% of our total employees).
We capitalized $8.1 million of compensation expense related to software development activities in 2013, reducing cost of revenue. For comparison, we capitalized $8.5 million of expense in this category in 2012.
Cost of revenue rose $11.5 million in 2012. Higher salary expense contributed about $10.4 million of this increase, mainly because of additional headcount. We also had higher production expense of $3.8 million because of additional data purchases for our operations in the United States and Europe. Other compensation-related expense (mainly for employee benefits) was another factor behind higher cost of revenue in 2012. We capitalized $8.5 million of operating expense in 2012 compared with $5.3 million in 2011 for software development, reducing the expense that we would otherwise report in this category.
Our gross margin declined by about 1.4 percentage points and 0.2 percentage points in 2013 and 2012, respectively. In 2013, about 2 percentage points of the decline resulted from the shift in expense categories discussed above.
Sales and marketing
Sales and marketing expense was down $5.3 million in 2013. Lower salary-related and bonus expense of $6.4 million (including approximately $8 million from the shift in expense categories as a result of our recent reorganization), was the main reason for the decline. We included compensation expense in this category for approximately 290 employees as of December 31, 2013 compared with approximately 350 as of December 31, 2012. Higher sales commissions of $2.6 million partly offset this decrease.
Sales and marketing expense rose $2.2 million in 2012. Salary expense increased $4.1 million and bonus expense was up $1.5 million, but these were partially offset by lower costs for advertising, marketing, and commissions. Full-year bonus expense included in this category was flat in 2012; however, in the first quarter of 2012, we paid a greater portion of the 2011 bonus to employees in this category compared with our initial estimate, contributing $1.0 million to the bonus expense recorded in 2012.
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As a percentage of revenue, sales and marketing expense was down 1.7 percentage points in 2013 and 0.4 percentage points in 2012, mainly because of lower salary expense as a percentage of revenue in both years. In 2012, advertising and marketing and commissions also declined as a percentage of revenue. In 2013, 1.1 percentage points of the decline was driven by the shift in expense categories discussed above.
General and administrative
General and administrative (G&A) expense was down $2.0 million in 2013. There were three main items that contributed to the decline in G&A expense in 2013. First, G&A expense in 2012 included $3.2 million for accelerated vesting of restricted stock issued to a former executive in the structured credit research unit when we acquired the business. This expense did not recur in 2013. Second, we had an additional $1.6 million of combined expense in 2012 for an impairment charge for one of our smaller products and a litigation settlement. This expense did not recur in 2013, either. Third, salary expense was down about $0.9 million (including a reduction of approximately $6 million from the shift in expense categories as a result of our recent reorganization). We included compensation expense in this category for approximately 395 employees as of December 31, 2013, compared with approximately 560 as of December 31, 2012.
Higher professional fees of $3.6 million partially offset the decline in G&A expense in 2013. In addition, our 2012 results included a benefit of approximately $1.0 million for the resolution of a prior-year business tax expense matter. This benefit did not recur in 2013.
G&A expense rose $0.8 million in 2012. Higher professional fees and higher stock-based compensation expense contributed to the total increase in G&A. As mentioned above, stock-based compensation expense in 2012 included $3.2 million for accelerated vesting of restricted stock. Lower bonus expense of $5.7 million in 2012 partially offset the increase. Current-year bonus expense was down $2.8 million. In addition, in the first quarter of 2011, we paid a greater portion of the 2010 bonus to employees in this category compared with our initial estimate, contributing $2.6 million to the bonus expense recorded in 2011.
G&A expense in 2012 included about $1.6 million of expense for a litigation settlement and an impairment charge for one of our smaller products. However, as mentioned above, our 2012 results included a benefit of approximately$1.0 million from the resolution of a prior-year business tax expense matter. Conversely, our results for 2011 included $1.4 million of expense related to this business tax. G&A expense in 2011 also included $3.2 million for the separation agreement with our former chief operating officer. This expense did not recur in 2012.
G&A expense as a percentage of revenue was down 1.2 percentage points in 2013 and 0.6 percentage points in 2012. In 2013, 0.9 percentage points of the decline was driven by the shift in expense categories discussed above.
Depreciation and amortization
Intangible amortization expense decreased $2.5 million in 2013 and $3.3 million in 2012, mainly because some of the intangible assets from some of our previous acquisitions are now fully amortized. Amortization expense was also down in 2012 because of a favorable comparison with 2011, when our results included $1.6 million of expense for the accelerated amortization of certain trade names and the impairment of one trade name. However, depreciation expense rose $5.1 million in 2013, mainly because of additions to capitalized software development and purchases of computer software for our U.S. operations. Depreciation expense rose $3.5 million in 2012, mainly driven by an increase in capital spending for our U.S. operations.
We expect that amortization of intangible assets will be an ongoing cost for the remaining lives of the assets. We estimate that total amortization expense for intangible assets will be approximately $20.5 million in 2014. Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, dispositions, changes in the estimated average useful lives, and currency translations.
Overall, depreciation and amortization was unchanged in 2013 and decreased slightly as a percentage of revenue in 2012.
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Consolidated Operating Income
($000) | 2013 | 2012 | 2011 | ||||||||||
Operating income | $ | 170,654 | $ | 150,668 | $ | 138,415 | |||||||
% change | 13.3 | % | 8.9 | % | 14.3 | % | |||||||
Operating margin | 24.4 | % | 22.9 | % | 21.9 | % | |||||||
Change | 1.5 | pp | 1.0 | pp | 0.1 | pp | |||||||
Consolidated operating income increased $20.0 million in 2013 as our revenue increased $40.0 million and operating expense rose by $20.0 million. Operating margin was 24.4%, an increase of 1.5 percentage points compared with 2012, mainly reflecting higher operating margins for the first three quarters of the year.
Lower salary expense as a percentage of revenue contributed approximately 1.0 percentage points to the margin improvement in 2013; lower stock-based compensation expense and amortization expense as a percentage of revenue also had favorable effects of 0.7 percentage points and 0.5 percentage points, respectively. On the negative side, professional fees and depreciation expense as a percentage of revenue were both up 0.6 percentage points, and bonus expense as a percentage of revenue rose 0.4 percentage points.
In 2012, consolidated operating income rose $12.3 million, and our margin was up 1.0 percentage points. Our revenue growth of $26.9 million outpaced the increase in our costs of $14.6 million.