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, 2014
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. x
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, 2014 was $1.4 billion. As of February 20, 2015, there were 44,354,426 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 2015 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 250,000 financial advisors, 1,700 asset management firms, 24 retirement plan providers, 290,000 retirement plan sponsors, and 9.9 million individual investors. We have operations in 27 countries.
We build our own databases from the ground up, 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, 2014, we provided extensive data on approximately 500,000 investments, including mutual funds, stocks, exchange-traded funds (ETFs), closed-end funds, separate accounts, and variable annuities. We also track real-time market data on more than 14 million exchange-traded equities, derivatives, commodities, currencies, and other investments.
Our business model is based on leveraging our investments in these databases by selling a wide variety of products and services to financial advisors, asset managers, and retirement plan providers and sponsors, and individual investors around the world. Our goal is to help investors achieve better outcomes whether they make their own decisions or choose to outsource management of their portfolios
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 evaluate their portfolios and get a clear view of their underlying holdings.
We’ve been providing independent analyst research on mutual funds and other investment vehicles since the mid-1980s. To better represent the breadth and depth of their expertise, in 2014 we changed the name of our analyst team from fund research to manager research. Our analysts do more than rate and cover funds—they also specialize in analyzing the managers and firms that are running the funds.
We provide a forward-looking Morningstar Analyst Rating for funds, a global, qualitative measure based on our analyst research. We expanded the scope of our coverage in 2014 by launching in-depth fund analyst reports with Morningstar Analyst Ratings for approximately 1,500 funds available for sale in Europe, Asia, and other regions. We now provide research reports for approximately 4,200 funds globally, including active, passive, multi-asset, ETF, and closed-end fund strategies. We also offer qualitative research and ratings on alternative funds, state-sponsored college savings plan portfolios, and target-date funds.
In 2014, we added new strategic beta attributes to help investors better identify, compare, and analyze strategic beta investments, a broad and growing category of indexes and exchange-traded products that seek to enhance returns or minimize risk relative to a traditional market cap-weighted benchmark.
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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. We offer a variety of other 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.
Our analysts cover approximately 1,400 stocks, using a consistent, proprietary methodology that focuses on fundamental analysis, competitive advantage assessment, and intrinsic value estimation. In 2014, we published Why Moats Matter: The Morningstar Approach to Stock Investing, a book that explains how we use the concept of economic moats to identify great businesses that can fend off competition and earn high returns on capital for many years.
In addition to our analyst-driven coverage, we provide quantitative ratings and reports for nearly 50,000 companies globally. These equity ratings draw on the fundamental research of our equity analyst team and provide a forward-looking statistical view of the valuation, competitive advantage, and level of uncertainty for stocks that are often under-followed by other research firms.
Through our Morningstar Credit Ratings, LLC subsidiary, which is a Nationally Recognized Statistical Rating Organization (NRSRO), we provide new issue and surveillance ratings and analysis for commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS), as well as operational risk assessment services. We provide surveillance ratings and analysis on approximately 6,800 CMBS securities including the loans and properties securing them.
In addition, we publish credit ratings and associated research on corporate debt issuers. We currently provide ratings on about 600 issuers. Morningstar, Inc. is not an NRSRO, and our credit ratings on corporate issuers are not NRSRO credit ratings.
We've developed in-depth advice on asset allocation, portfolio construction, and security selection to meet the needs of investors and professionals looking for integrated portfolio solutions. We’ve developed research on "Gamma," an innovative measure that quantifies how much additional retirement income investors can generate by making better financial planning decisions. We use the concept of human capital—or potential future earning ability— to provide a more complete picture of an investor’s financial worth and optimize a portfolio’s asset mix. In 2014, we published new research extending this methodology to examine how job, home location, and pension benefits, such as Social Security, affect an investor’s optimal asset allocation.
We believe 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.
In 2014, we revised how we describe our three key objectives to better capture our major goals. We changed the description to emphasize that our investment data, research, and ratings are at the heart of our strategy, allowing us to help investors achieve better investment outcomes whether they make their own investment decisions or delegate management of their portfolios. We also revised the text of the first objective to focus on Morningstar Direct as our flagship decision support platform.
1. Develop Morningstar Direct as our flagship decision support platform.
We're currently building the next-generation version of Morningstar Direct, our institutional investment research platform.
The new software uses a design standard that’s more intuitive, elegant, and easy-to-use and will give users a more consistent, cohesive experience with a strong emphasis on Morningstar’s proprietary research and tools. It also has several technological advantages, including a more streamlined development process for commonly used Morningstar capabilities such as portfolio management tools.
The new software is fully web-based and will address our clients’ increasing preference for cloud-based deployment, which eliminates the need for desktop software installations and allows immediate access to new features. It will help us innovate more rapidly and more easily configure our software solutions to meet client needs. It also addresses the growing need for mobile-optimized capabilities to extend the desktop experience onto mobile devices.
Over time, we expect to migrate many of our core software capabilities to Morningstar Direct, which will serve as our main platform for clients looking for information to support the investment decisions they make on their own or validate investment recommendations from another party. Clients will benefit from cloud-based delivery, faster deployment, shorter upgrade cycles, and easier access to the latest versions of our proprietary tools and research.
We plan to introduce the next-generation version of Morningstar Direct in 2015, beginning with upgrades for many of our core capabilities. Over time, we expect the majority of our software to use this single technology platform. By moving many of our core research solutions to a common software platform, we'll be able to leverage our development resources, give our clients a more unified and consistent Morningstar experience, and better showcase our innovative research and analytical tools. We also plan to expand the user base for Morningstar Direct by enhancing workflow capabilities for our existing customer groups and adding additional workflows to reach new customers, such as financial advisors.
2. Produce the most effective investment data, research, and ratings to help investors reach their financial goals.
We believe our leadership position in independent investment research offers a competitive advantage that would be difficult for competitors to replicate. Our goal is to leverage our proprietary research and intellectual property to help investors with both decision support (via Morningstar Direct) and outsourced investment management (via our investment management business).
Our research is unique because we focus on building innovative solutions that help investors achieve better outcomes. We take a fundamental, bottom-up approach and focus on the long term. We foster a culture in which our analysts frequently challenge each other’s assumptions and speak freely and candidly about the investments they cover. We also emphasize innovation and strive to develop tools that help investors develop fresh insights on their portfolios.
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We’re focusing our research efforts on several different areas, as described below.
• | Manager research (including mutual funds, ETFs, separate accounts, and other vehicles) |
Our strategy for manager research is to leverage our leadership position to reach additional customer groups. We can help clients with every stage of the manager research workflow, including data, analytical tools, investor education, strategy research, platform approval, due diligence, lists of recommended funds, and portfolio management. In contrast to most of our competitors, we also integrate our manager research efforts with our software, which we believe is another competitive advantage.
In 2014, we launched Morningstar Manager Research Services, which combines our fund research reports, ratings, software, tools, and proprietary data with access to Morningstar’s manager research analysts. Having direct access to our analysts can help institutions complete their research and due diligence, select investments, and create portfolios. As institutional clients work to comply with an increasingly complex regulatory environment, we can help them supplement their own research and support their communication efforts with financial advisors and individual investors.
We've built an integrated team of locally based manager research experts to expand our research coverage in additional markets around the world. As of December 31, 2014, we had 110 manager research analysts globally, including teams in North America, Europe, Australia, and Asia.
• | Equity research |
Our equity research complements our approach to manager research, where we focus on analyzing the individual stocks that make up each fund's portfolio. As of December 31, 2014, we had more than 100 equity analysts globally, making us one of the largest providers of independent equity research. We believe our analysts’ long-term approach, deep industry knowledge, and focus on sustainable competitive advantage are important factors that set us apart and help investors achieve better investment outcomes.
Our equity research helps institutional investors and portfolio managers extend their internal research capabilities and support their investment decisions. They can also engage directly with our industry-focused equity and credit analysts to discuss company valuations, forecasts, industry dynamics, and competitive landscapes. We also provide our equity research to financial advisors, who can use our research reports either as a primary research source or to complement research generated in-house or by other firms. We deliver our equity research and ratings through a variety of platforms, including Morningstar Advisor Workstation as well as third-party providers.
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.
• | Credit research and ratings |
Morningstar Credit Ratings, LLC, our structured credit research and ratings subsidiary, is an NRSRO that has earned a reputation for innovation and excellence in the structured finance market. Our goal is to help institutional investors identify credit risk in structured finance investments. Our analytical approach stresses transparency of the ratings process, strong fundamental credit analysis, and comprehensive investor-focused reporting. We provide structured finance investors with access to high-quality ratings, investment research, surveillance services, data, and technology solutions.
Over the past several years, we have made substantial investments in building our credit ratings business. 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.
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Morningstar Credit Ratings recently applied to the Securities and Exchange Commission (SEC) to expand its NRSRO license to include credit ratings for corporate bonds and financial institutions. We’re applying to expand the NRSRO license because we believe we can make a difference in the market by bringing transparency, unique perspectives, and superior client service to all investors across the fixed-income markets.
• | Holistic advice methodologies (including our research on Gamma and the Total Wealth Approach) |
Over the past several years, we’ve developed new research tools that provide a more holistic approach to investing and asset allocation. Whereas traditional asset allocation methodologies focus solely on financial assets (such as stocks and bonds), we’ve developed methodologies that provide a more complete view of all sources of wealth, including financial capital, human capital, housing assets, and retirement and pension benefits. This Total Wealth Approach is the touchstone for our approach to asset allocation. Going forward, we plan to build on this research and incorporate it in more of our products and solutions.
3. Build world-class investment management solutions based on our proprietary research.
We leverage our innovative, proprietary research by building world-class investment management solutions that help investors achieve better outcomes. Our strategy is to connect our existing capabilities to create holistic solutions that help financial advisors, asset managers, and individual investors with portfolio construction, monitoring, security selection, and implementation.
Our Investment Advisory services combine managed investment vehicles—typically mutual funds—in portfolios designed to help investors meet their financial goals. When we create portfolios, 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 managed investment products and combine quantitative research with a qualitative assessment of manager skill and investment style. We had a total of $81.0 billion in assets under advisement in our Investment Advisory business as of December 31, 2014.
We offer managed retirement account services through our Retirement Solutions platform and had $36.8 billion in assets under management in our managed retirement accounts as of December 31, 2014. We offer these services for retirement plan participants who choose to delegate management of their portfolios to us. We believe retirement plan participants will continue to adopt managed accounts because of the complexity involved in retirement planning.
Following our 2014 acquisition of HelloWallet Holdings, Inc., we plan to incorporate holistic advice to address the market need for a more comprehensive retirement offering. We believe there’s a significant opportunity in the retirement industry to develop a platform that can bring into focus a participant’s entire financial and investment picture and deliver a unique and highly personalized managed investment solution.
We believe financial advisors are increasingly turning to outsourced investment management as they seek to spend more time building client relationships and providing holistic advice. This trend includes both fully outsourced investment management through managed portfolios, as well as partially outsourced services for advisors who want to improve their efficiency and scale while maintaining a role in investment management.
We currently support the fully outsourced model through Morningstar Managed Portfolios, 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, 2014, we managed $9.3 billion in assets through this service.
In addition, we believe many financial advisors are seeking to provide holistic advice that incorporates all of their clients’ financial needs, including retirement assets. Over time, we plan to build more connections between our advisor software offerings and the Retirement Solutions platform to meet this emerging need.
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We also expect to expand the investment management solutions we offer through our index business. We currently offer more than 280 investment indexes that can be used for both benchmarking and product creation. We plan to create more indexes based on strategic beta, which refers to a broad and growing category of indexes and exchange-traded products that seek to enhance returns or minimize risk relative to a traditional market cap-weighted benchmark. We believe we’re uniquely positioned to deliver highly differentiated indexes based on our proprietary research. For example, our Wide Moat Focus Index includes 20 companies we believe have a sustainable competitive advantage and are trading at the highest ratio of estimated fair value compared with the stock price.
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. |
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 290,000 financial advisors in the United States as of the end of 2014.
We offer a comprehensive and integrated set of solutions, including proprietary investment methodologies, portfolio- and security-level research, and investment management. With our acquisition of ByAllAccounts, Inc. in 2014, we’re able to integrate positional and transactional assets that are “held away” from the advisor’s book of business at other banks, advisory firms, or online brokerages so advisors can build more comprehensive investment proposals and deliver more value to their clients. 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 expand the range of services we offer to help financial advisors with all aspects of their workflow, including investment decision-making, portfolio construction, client monitoring and reporting, practice management, portfolio rebalancing that connects with custodial and trading interfaces, and financial planning. We're expanding the outsourced investment management through Morningstar Managed Portfolios to help advisors save time and reduce compliance risk. We plan to add the data aggregation capabilities from ByAllAccounts to Morningstar Direct and Morningstar Advisor Workstation to give advisors a more complete view of their clients’ assets. In addition, we plan to build comprehensive advisory solutions that incorporate both retirement and non-retirement assets.
Our main products for financial advisors are Morningstar Advisor Workstation (including Morningstar Office) and Morningstar Managed Portfolios.
Asset management
Asset management firms manage and distribute investment portfolios. We estimate that there are more than 3,000 asset management firms globally, ranging from large, global firms 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 (often referred to as the “buy side”), which includes portfolio management, research, and securities analysis.
Our asset management offerings help companies connect with their clients because many individual investors are familiar with Morningstar's intellectual capital and brand. We offer a global reach and have earned investors’ trust in our unbiased approach, investor-centric mission, thought leadership, data, and investment research.
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 plan to expand our offerings to meet the growing need for research, data, and tools related to strategic beta portfolios and other ETFs, as well as enhancing our derivatives coverage and capabilities to help investors better analyze and understand alternative investments.
For the buy side, we provide award-winning equity research for active fundamental portfolio managers who want unbiased ideas that improve performance, as well as corporate credit research. We deliver focused ideas that can improve long-term performance and consistent global research methodologies that can integrate with the daily workflow for a portfolio manager or analyst.
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, Enterprise Components, and Investment Advisory services. For the buy side, key products include Morningstar Research, Morningstar Credit Ratings, Morningstar Data, and Morningstar Direct.
Retirement
In the retirement market, millions of investors are now charged with planning for their own retirement, mainly through self-directed retirement plans such as 401(k) plans. Assets in 401(k) plans totaled an estimated $4.4 trillion as of June 30, 2014 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 help plan providers manage their risks 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.
Following our June 2014 acquisition of HelloWallet Holdings, Inc., we plan to expand our retirement advice to include guidance on the saving and spending decisions that ultimately determine how much employees are able to invest for retirement. We plan to integrate HelloWallet’s capabilities with our retirement solutions during 2015.
We’re developing the next-generation version of our Retirement Manager platform, with an improved user interface, responsive design, and enhanced asset-allocation guidance for both retirement and non-retirement assets. We're continuing to enhance our managed retirement accounts, which is the largest and fastest-growing product offering within our Retirement Solutions business. We also plan to increase our market penetration with the custom models we offer directly to retirement plan sponsors and 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 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, a Gallup survey released in January 2014 found that approximately 54% 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.
We design most of our products for individual investors 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’re currently re-building the site with a more streamlined structure and a more elegant, intuitive user interface. Our goal is to set up the next-generation version of the website with a structure that allows individual investors to quickly and easily carry out specific tasks they’re trying to perform, such as finding new investment ideas, monitoring their portfolios, and staying up-to-date on the market. We also reach individual 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. In 2013, we acquired an additional 76% interest in Morningstar Sweden AB to become sole owner. We completed two acquisitions in 2014. In April, we acquired ByAllAccounts, Inc., and in June, we acquired an additional 81% interest in HelloWallet to become the sole owner.
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For more information about our acquisitions and divestitures, refer to Notes 8 and 9 of the Notes to our Consolidated Financial Statements.
Major Products and Services
The section below describes some of our major products and services (ranked in order of size based on each product's 2014 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 web-based interfaces, 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 2014, we added new strategic beta attributes to help investors better identify, compare, and analyze strategic beta investments, expanded our equity database coverage, added new sources to our real-time data feeds, and completed the roll-out of our Global Fund Reports with translated text available where applicable.
Pricing for Morningstar Data is based on the number of investment vehicles covered, the amount of information provided for each security, the frequency of updates, the method of delivery, the size of the licensing firm, and the level of distribution.
For Morningstar Data, our primary competitors include Bloomberg, FactSet, Financial Express, Interactive Data, Standard & Poor’s, and Thomson Reuters.
Morningstar Data was our largest product in 2014 and accounted for 18.1%, 18.5%, and 17.5% of our consolidated revenue in 2014, 2013, and 2012, 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 different types of investments.
Morningstar Advisor Workstation is available in two versions: Morningstar Office for independent financial advisors and an enterprise version for financial advisors affiliated with larger firms. As of December 31, 2014, approximately 4,300 financial advisors in the United States were licensed to use Morningstar Office, and approximately 180 companies held licenses for the enterprise version of Morningstar Advisor Workstation.
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.
The enterprise version includes four core modules: Clients & Portfolios, Research, Sales/Hypotheticals, and Planning. We also offer a variety of other applications, which can be purchased as stand-alone products or combined as part of a full Workstation license.
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In 2014, we added capabilities allowing advisors to view articles and analyst research reports in the context of a recommendation list or client portfolio. We announced integrations with Redtail CRM, eMoney Advisor’s wealth-planning platform, MoneyGuidePro, Schwab’s OpenView Gateway, and Advicent as part of our efforts to help advisors with all aspects of their daily workflow by creating connections between our products and these leading third-party applications. We continued migrating former Principia subscribers to Morningstar Advisor Workstation and are no longer selling new subscriptions for Principia.
Pricing for Morningstar Advisor Workstation varies based on the number of users, as well as the number of databases licensed and 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. We generally charge $6,000 per user for an annual license for Morningstar Office, as well as additional fees for Back Office Services.
Some of the main competitors for Morningstar Advisor Workstation and Morningstar Office include Advent Software, Charles Schwab, Envestnet, Standard & Poor's, and Thomson Reuters.
Morningstar Advisor Workstation is our second-largest product based on revenue and made up 13.4%, 13.3%, and 13.1% of our consolidated revenue in 2014, 2013, and 2012, respectively.
Morningstar Direct
Morningstar Direct is an institutional investment research platform that includes data and advanced analytical tools 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.
In 2014, we added new strategic beta data tabs to help wealth managers and asset managers easily identify and analyze this growing class of index funds that make active bets. We continued to enhance the product’s capabilities for asset allocation, portfolio analysis, and presentation, as well as improving integration with other Morningstar products, such as Morningstar Advisor Workstation.
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We’ve continued working on the next-generation version of Morningstar Direct, which will be fully web-based and will address our clients’ increasing preference for cloud-based deployment, which eliminates the need for desktop software installations and allows immediate access to new features. We plan to introduce the next-generation version of Morningstar Direct in 2015, beginning with upgrades for many of our core capabilities.
Morningstar Direct's primary competitors are Bloomberg, eVestment Alliance, FactSet Research Systems, and Thomson Reuters.
Morningstar Direct had approximately 10,100 licensed users worldwide as of December 31, 2014.
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 12.1%, 11.4%, and 9.9% of our consolidated revenue in 2014, 2013, and 2012, respectively.
Morningstar.com
Our largest website for individual investors is Morningstar.com. Revenue for this product offering includes both Premium Memberships (which made up about 54% of Morningstar.com's revenue base in 2014) and Internet advertising sales (which made up the remaining 46%). The site includes comprehensive data on mutual funds, stocks, ETFs, closed-end funds, bonds, 529 plans, and other investments to help investors conduct research and track performance. In addition, Morningstar.com features extensive market data, articles, proprietary portfolio tools, and educational content to help investors access timely, relevant investment information.
In addition to our U.S.-based site, we offer more than 30 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.
We also offer paid Premium Membership, which includes access to written analyst reports on stocks, mutual funds, ETFs, and 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 2014, we introduced new versions of our Morningstar for iPhone and Morningstar for Android apps with more data and richer content (including video).
Morningstar.com primarily competes with The Motley Fool, Seeking Alpha, TheStreet.com, and Yahoo! Finance as well as other finance sites.
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As of December 31, 2014, the free membership services offered through Morningstar.com had approximately 9.9 million registered users worldwide. We also had approximately 123,000 paid Premium subscribers for Morningstar.com in the United States plus an additional 16,000 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 fourth-largest product based on revenue and accounted for 7.6% of our consolidated revenue in 2014, compared with 8.0% in 2013 and 8.2% in 2012.
Retirement Solutions
Our Retirement Solutions service helps 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 an advice and managed accounts program that helps plan participants with 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. We do not hold assets in custody for the managed retirement accounts we provide.
Morningstar Retirement Manager also helps plan sponsors meet their fiduciary obligations. 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.
In 2014, we became the first managed accounts provider to manage more than 1 million retirement accounts for 401(k) plan participants. In June, we acquired HelloWallet Holdings, Inc., which provides personalized financial guidance to U.S. workers and their families through their employer benefit plans. HelloWallet helps employees build a strong financial foundation by providing them with tools for emergency savings, debt management, and budgeting. We plan to integrate HelloWallet’s capabilities with our retirement solutions during 2015.
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.
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Our main competitors for Retirement Solutions are Financial Engines and Guided Choice.
Retirement Solutions is our fifth-largest product based on revenue and accounted for 7.5% of our consolidated revenue in 2014, compared with 6.5% in 2013 and 5.8% in 2012.
Investment Advisory
Our Investment Advisory business provides institutional investment advisory and management services for asset management firms, broker-dealers, and insurance providers. We offer Investment Advisory services through a variety of registered entities in Australia, Dubai, France, Hong Kong, India, Japan, Korea, South Africa, the United Kingdom, and the United States. 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.
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. 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 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. We do not hold assets in custody in our investment advisory business.
Our Investment Advisory business competes primarily with Callan, Mercer, and Wilshire Associates, as well as some smaller firms in the retirement consulting business and various in-house providers of investment management services.
We base our pricing for our Investment Advisory services 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.
Morningstar Enterprise Components (formerly Integrated Web Tools)
Morningstar Enterprise Components is a set of tools and capabilities that help institutional clients build customized websites or enhance their existing solutions. 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. 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.
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For Enterprise Components, our primary competitors include Advisor Software, Inc., Financial Express, Interactive Data Corporation, Markit on Demand, and Thomson Reuters.
Pricing for Enterprise Components 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
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. We offer this service 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. We offer Morningstar Managed Portfolios mainly to 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.
We had approximately $9.3 billion in assets under management with about 5,300 financial advisors using the service as of December 31, 2014. We charge asset-based fees for Morningstar Managed Portfolios. We typically base our management fee 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. We use third-party custodians for Morningstar Managed Portfolios and do not hold the assets in custody.
For Morningstar Managed Portfolios, our primary competitors are 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.
Morningstar Research (formerly Morningstar Equity and Credit Research)
Morningstar Research includes both Equity Research Services and Manager Research Services. We offer equity research to institutional investors who use it to supplement their own research, as well as to broker-dealers who provide our research to their affiliated financial advisors or individual investor clients. We also deliver our equity research through several other Morningstar products, including Morningstar Direct, Morningstar Advisor Workstation, and our Premium Membership service on Morningstar.com.
We’ve provided independent research on mutual funds and other managed investment products since the mid-1980s. In 2014, we introduced Morningstar Manager Research Services, a new service designed to help institutional investors evaluate funds, investment strategies, and asset management firms. Morningstar Manager Research Services combines our fund research reports, ratings, software, tools, and proprietary data with access to Morningstar’s manager research analysts. It complements internal due diligence functions for institutions such as banks, wealth managers, insurers, sovereign wealth funds, pensions, endowments, and foundations.
Our Equity Research services compete with Credit Suisse HOLT, Ford Equity Research, Ned Davis Research Group, Standard & Poor’s, Zacks Investment Research, and several smaller research firms. For institutional clients, we compete with sell-side firms, internal providers, and smaller boutique firms. Our Manager Research services mainly compete with Mercer, Towers Watson, and Wilshire. Competitors for our credit research include Credit Sights, Fitch, Gimme Credit, Moody’s, and Standard & Poor’s.
Pricing for Morningstar Research varies based on the level of distribution, the type of investors who are using our research, the number of securities or investment strategies covered, the amount of custom coverage and client support required, and the length of the contract term.
Morningstar Credit Ratings
Morningstar Credit Ratings, LLC is an NRSRO that provides timely new issue and surveillance ratings and analysis for structured credits, as well as operational risk assessment services.
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We recently developed a rating methodology for residential mortgage-backed securities. This service will provide institutional investors with cutting-edge analytics, Morningstar’s monthly DealView Credit Analysis, and timely letter ratings on thousands of secondary market RMBS transactions.
In addition, we offer operational risk assessments that evaluate mortgage servicers, loan originators, and third-party service providers. These assessments focus on non-credit-related operational risks and the likelihood of maintaining current performance levels given ongoing market conditions.
In 2014, we introduced new ratings on single family rental securities and have now rated 16 transactions in this emerging asset class. We also launched our asset-backed securities (ABS) initiative, our ABS rating methodology, and secured our first ABS ratings assignment. In June, the National Association of Insurance Commissioners (NAIC) voted to extend Morningstar Credit Ratings, LLC’s designation on the NAIC Credit Rating Provider (CRP) list to all mortgage-backed securities and asset-backed securities. Previously, the designation only covered commercial mortgage-backed securities.
During 2014, we made our credit ratings and research more broadly available through several channels. Our CMBS surveillance reports for new issues we were selected to rate are now available to all investors, portfolio managers, analysts, and traders at our credit rating website, https://ratingagency.morningstar.com. We also began providing ratings and research to Bloomberg and reached an agreement with Trepp, a leading provider of CMBS analytical services, to distribute our CMBS ratings analysis to Trepp customers.
Morningstar Credit Ratings recently applied to the SEC to expand its NRSRO license to include corporate credit ratings and financial institution credit ratings.
This business competes with several other firms, including Dominion Bond Rating Services (DBRS), Fitch, Kroll Bond Ratings, Moody’s, and Standard & Poor’s.
We charge annual fees for our subscription-based CMBS Surveillance Workstation and data services, which are paid for by the user. For new-issue ratings, we charge one-time fees to the issuer based on the type of security, the size of the transaction, and the complexity of the issue. Our new-issue ratings services also include annual surveillance monitoring fees that continue until the securities mature.
Morningstar Indexes
We offer an extensive set of investment indexes that can be used to benchmark the market and create investment products, including indexes that track the U.S. market by capitalization, sector, and investment style; dividend indexes; active equity indexes based on Morningstar’s equity research; bond indexes; commodity indexes; hedge fund indexes; and asset allocation indexes.
In 2014, we introduced a family of more than 60 new global equity indexes, providing investors with comprehensive view of worldwide markets. Our index family now spans 45 countries in both developed and emerging markets. The new indexes provide investors with tools for benchmarking the performance of equity markets worldwide and will serve as the foundation for our next generation of proprietary strategic beta indexes.
We currently license the Morningstar Indexes to numerous institutions that offer ETFs and exchange-traded notes based on the indexes. Firms can license Morningstar Indexes for both product creation (where we typically receive the greater of a minimum fee or basis points tied to assets under management) and data licensing (where we typically receive annual licensing fees). In both cases, our pricing varies based on the level of distribution, the type of user, and the specific indexes licensed.
Major competitors for the Morningstar Indexes include FTSE, MSCI, S&P Dow Jones Indices (offered through McGraw Hill Financial), and Research Affiliates.
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Other Products and Services
We offer a variety of other products and services, including:
• | Morningstar Investment Profiles: pre-made or custom-generated investment fact sheets institutions can use for investor communications; |
• | 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; |
• | Print and online publications; |
• | Investment conferences; |
• | ByAllAccounts, which provides innovative data aggregation technology for financial applications; |
• | Morningstar Enterprise Data Management: customized data aggregation and performance reporting solutions that help clients integrate data more effectively; |
• | Market data and desktop software; and |
• | Other investment software for financial advisors and institutions. |
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 global sales team is responsible for selling most of our products and services, but we also have several specialist sales teams supporting products such as Morningstar Managed Portfolio, Commodity Data, online advertising, and Morningstar Credit Ratings. We have a sales operations staff that supports our sales teams by managing our sales forecasts, pipeline, and incentives. Our client solutions team is 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 get the most out of our solutions. We had approximately 500 sales and marketing professionals as of December 31, 2014.
We incurred approximately $7.5 million of advertising expense in 2014, including expenses 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 based in each of the following 26 countries: Australia, Brazil, Canada, Chile, Denmark, France, Germany, India, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, People's Republic of China (both Hong Kong and the mainland), Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, United Arab Emirates, and the United Kingdom. See Note 6 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, 2014, we also held a minority ownership position (approximately 34% of the outstanding shares) in Morningstar Japan K.K. (MJKK) with a market value of approximately $61 million. MJKK is publicly traded under ticker 4765 on the Tokyo Stock Exchange. See Note 10 of the Notes to our Consolidated Financial Statements for information about our investments in unconsolidated entities.
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.
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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 referenced in this report:
HelloWallet® | Morningstar OfficeSM | |
Ibbotson Associates® | Morningstar® Ownership ZoneSM | |
Morningstar® Advisor WorkstationSM | Morningstar® Portfolio X-Ray® | |
Morningstar Analyst RatingTM | Morningstar® Principia® | |
Morningstar® ByAllAccounts® | Morningstar Rating™ | |
Morningstar® Data | Morningstar® Retirement ManagerSM | |
Morningstar DirectSM | Morningstar® Stewardship GradeSM | |
Morningstar® Enterprise ComponentsSM | Morningstar Style Box™ | |
Morningstar® Managed PortfoliosSM | Morningstar.com® | |
Morningstar Market BarometerSM | ||
In addition to trademarks, we currently hold several patents in the United States, including patents held by our Ibbotson Associates subsidiary for lifetime asset allocation and asset allocation with annuities.
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 most of our larger 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 recording it based on information found in public filings.
Seasonality
We believe our business has a minimal amount of seasonality. Some of our smaller products, such as 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.
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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 2014, 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 main 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 compete with a variety of other companies in specific areas of our business. We discuss the most relevant competitors in each area in the Major Products and Services section of this report.
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, 2014, our technology team consisted of approximately 1,100 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 SEC is responsible for enforcing the federal securities laws and oversees federally registered investment advisors and broker-dealers.
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 (Advisers Act). As registered investment advisors, these companies are subject to the requirements and regulations of the Advisers Act. These 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 certain requirements and regulations under the Exchange Act. These 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 examination 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
Morningstar Investment Management Europe Limited is authorized and regulated by the Financial Conduct Authority (FCA) to provide advisory services in the United Kingdom. As an authorized firm, Morningstar Investment Management Europe Limited is 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.
Other Regions
We have a variety of other entities (including in Canada, France, Hong Kong, Japan, Korea, South Africa, and Thailand) 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 business 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 3,760 employees as of December 31, 2014, including approximately 780 data analysts, 70 designers, 430 investment analysts (including consulting and quantitative research analysts), 1,100 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 27, 2015, we had 12 executive officers. The table below summarizes information about each of these officers.
Name | Age | Position | ||
Joe Mansueto | 58 | Chairman, Chief Executive Officer, and Director | ||
Stéphane Biehler | 47 | Chief Financial Officer | ||
Bevin Desmond | 48 | Head of Global Markets and Human Resources | ||
Catherine Gillis Odelbo | 52 | Head of Corporate Strategy and Partnerships | ||
Greg Goff | 43 | Chief Technology Officer | ||
Kunal Kapoor | 39 | Head of Products and Client Solutions | ||
Haywood Kelly | 46 | Head of Global Research | ||
Daniel E. Needham | 36 | President and Chief Investment Officer, Morningstar Investment Management | ||
Rob Pinkerton | 45 | Chief Marketing Officer | ||
Richard Robbins | 52 | General Counsel and Corporate Secretary | ||
James Tanner | 54 | Head of Global Business Development and Sales | ||
David W. Williams | 54 | Head of Design | ||
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 of 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 was managing director and corporate controller for Archipelago Holdings, which he joined 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, a role she has held since 2010. She is responsible for identifying, developing, managing and directing international 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.
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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.
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, a global information and measurement 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.
Kunal Kapoor
Kunal Kapoor is head of products and client solutions. The products group is responsible for product development, manufacturing, and innovation. Client solutions is responsible for building a deep understanding of our customers 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 the products group 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.
Daniel E. Needham
Daniel Needham is president and chief investment officer (CIO) of Morningstar Investment Management and is responsible for building world-class investment management solutions based on our proprietary research. Before taking on his current role in February 2015, he served as CIO for Morningstar Investment Management, and was previously managing director and CIO for Morningstar Investment Management’s Asia-Pacific Operations. He joined our company when Morningstar acquired Intech Pty Ltd (now Ibbotson Associates Australia) in 2009, where he served as chief investment officer. Before joining Intech in 2002, Daniel worked for Zurich Financial Services in Sydney.
He holds a bachelor's degree in commerce with a major in finance and economics from the University of Sydney. He also holds the CFA designation.
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Rob Pinkerton
Rob Pinkerton is our chief marketing officer and is responsible for overseeing our global marketing organization and corporate communications. He joined Morningstar through our June 2014 acquisition of HelloWallet, where he served as chief marketing officer. Before joining HelloWallet in 2012, Rob was a senior director for Adobe Systems, a computer software company, beginning in 2007. He previously served in executive marketing and product roles with LexisNexis and Siebel Systems (which was acquired by Oracle).
He holds a bachelor’s degree in economics, political science, and history from the University of Richmond, a juris doctor degree from the University of Baltimore School of Law, and a master’s degree in business administration with concentrations in information technology management, marketing, and strategy from Carnegie Mellon University.
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 department. 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 electrical engineering and computer science from the Massachusetts Institute of Technology and a juris doctor degree from The University of Chicago Law School.
James Tanner
James Tanner is head of global business development and sales for Morningstar. He joined us in January 2013. Previously he served as CEO of Markit On Demand, an Internet technology company he founded as Wall Street On Demand in 1991.
In addition to his role as founder and CEO of Wall Street On Demand, he served in various roles for the firms that have owned Wall Street On Demand, including vice chairman for business development for Markit in 2012, head of distribution for Markit in 2010 and 2011, and division head for Goldman Sachs from 2006 to 2010.
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 for Morningstar. He is responsible for corporate design and its application to brand identity, products, communications, and the workplace. He also oversees all aspects of Morningstar's design as it relates to our other core capabilities in research and technology. He joined us in 1993.
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.
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Item 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 management 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. As registered investment advisors, these companies are subject to the requirements and regulations of the Advisers Act. These 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. 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.
We may face liabilities for actual or claimed breaches of our fiduciary duties, particularly in areas where we provide retirement advice and managed retirement accounts. In some of our retirement contracts, we act as an ERISA fiduciary by, for example, selecting and monitoring a broad range of diversified plan options. We also provide a managed account service for retirement plan participants who elect to have their accounts managed by our programs. As of December 31, 2014, we had $36.8 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. Clients may take 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 approximately $170 billion in assets as of December 31, 2014. We could face substantial liabilities related to our work on these assets.
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 independence is at the core of our business, and our reputation is our greatest corporate asset. We depend to a large extent on our reputation for integrity and high-caliber products and services. Any failure to uphold our high ethical standards and ensure that our customers have a consistently positive experience with us (either intentionally or not) could damage our reputation as an objective, honest, and credible source for investment research and information. Allegations of improper conduct, 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 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.
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. Our reputation could also suffer if we fail to produce competitive performance in our investment management offerings.
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 30 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 more widely available, 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 for Morningstar Direct and other products, 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 ability to develop innovative technology has historically given us a competitive advantage. As mentioned above, though, we believe 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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We could face liability related to our storage of personal information about individuals as well as portfolio and account-level information.
Customers routinely enter personal investment and financial information, including portfolio holdings, account numbers, and credit card information, on our websites. We also handle an increasing volume of personally identifiable information through Morningstar Office (including Back Office Services), Morningstar Direct, Enterprise Data Management, managed retirement accounts, and other areas of our business. In 2014, we acquired HelloWallet, which provides personalized financial guidance to individuals through their employer benefit plans. Through HelloWallet's website and mobile applications, employees enter their goals and priorities and add their financial information, including income, bank accounts, credit cards, retirement plans, insurance, and investments. We also acquired ByAllAccounts, which uses technology to collect, consolidate, and transform financial account data and deliver it to any platform. Both HelloWallet and ByAllAccounts handle a large volume of personally identifiable information as part of their normal business operations.
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 information about individuals or their accounts. 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, Social Security number, account numbers, portfolio holdings, credit card information, or other personal information.
Compliance failures, regulatory action, or changes in laws applicable to our investment advisory or credit rating operations could adversely affect our business.
Our investment management operations are a growing part of our overall business. The securities laws and other laws that govern our investment advisory activities are complex. The activities of our investment advisory operations are subject to provisions of the Advisers Act and ERISA. In addition, Morningstar Investment Services is a broker-dealer registered under 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. Our Morningstar Credit Ratings, LLC subsidiary is 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.
We also publish credit ratings and research on corporate debt issuers and recently applied to expand our NRSRO license to include corporate credit ratings and financial institution credit ratings. Credit rating and research providers have been under increasing regulatory scrutiny, and we cannot predict the effect of potential future regulatory changes on our corporate credit rating business.
The laws, rules, and regulations applicable to our business may change in the future, and we may not be able to comply with these 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 adversely affect our business.
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Downturns in the financial sector, global financial markets, and global economy may adversely impact our business.
The financial crisis of 2008 and 2009, along with more recent events, 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 implemented additional review processes for new contracts or started providing certain services, such as investment management, 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.
Many companies in the financial services industry have also been subject to increasing government regulation, which may increase their operating costs and cause them to reduce spending in other areas.
If financial markets around the world experience downturns or 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 2014, revenue from asset-based fees made up approximately 12% 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. Asset levels can also be affected if net inflows into the portfolios on which we provide investment advisory services drop or if these portfolios experience redemptions. If the level of assets on which we provide investment advisory or investment management services goes down, we expect our fee-based revenue to show a corresponding decline.
An outage of our database, technology-based products and services, or 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, 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.
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.
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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.
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 840 employees working in our data and technology development center in Shenzhen, China, or about one-fourth of our total workforce. We rely on these employees to maintain and update our mutual fund database and work on other projects. Because China has a restrictive government under centralized control, our operations are subject to political and regulatory risk, which is inherently unpredictable. 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 continuing to operate our development center in China may harm our business and have a negative impact on the products and services we provide.
We have approximately 430 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.
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.
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 15 years, passively managed index funds have seen greater investor interest, and this trend was more dramatic in 2014. Net inflows for passively managed vehicles were in excess of $400 billion, compared with only $40 billion of net inflows for active products (both mutual funds and ETFs). Actively managed U.S. equity funds had net outflows of nearly $100 billion for the year. Overall, we estimate that passively managed portfolios now account for more than 30% 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 involve additional challenges that we may not be able to meet.
Our operations outside of the United States generated $209.3 million in revenue in 2014, 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.
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.
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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 structured and 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.
From time to time, we encounter jurisdictions in which one or more third parties have a pre-existing trademark registration in certain relevant international classes that may prevent us from registering our own marks in those jurisdictions. Our continued ability to use the “Morningstar” name or logo, either on a stand-alone basis or in association with certain products or services, could be compromised in those jurisdictions because of these pre-existing registrations. Similarly, from time to time, we encounter situations in certain jurisdictions where one or more third parties are already using the Morningstar name, either as part of a registered corporate name, a registered domain name or otherwise. Our ability to effectively market certain products and/or services in those locations could be adversely affected by these pre-existing usages.
Control by a principal shareholder could adversely affect our other shareholders.
As of December 31, 2014, 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.
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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 employee salaries and benefits, 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 granted stock 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, 2014, our employees and non-employee directors held options to acquire 169,810 shares of common stock, 154,864 of which were exercisable at a weighted average price of approximately $38.53 per share. As of December 31, 2014, there were 670,712 restricted stock units outstanding, which have an average remaining vesting period of 32 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 when 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.
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, 2014, we leased approximately 397,000 square feet of office space for our U.S. operations, primarily for our office located in Chicago, Illinois. We also lease approximately 366,000 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
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 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:
2014 | 2013 | |||||||||||||
High | Low | High | Low | |||||||||||
First Quarter | $ | 84.05 | $ | 73.97 | $ | 71.14 | $ | 61.31 | ||||||
Second Quarter | 80.00 | 67.77 | 77.83 | 63.01 | ||||||||||
Third Quarter | 72.76 | 66.30 | 80.00 | 74.19 | ||||||||||
Fourth Quarter | 71.08 | 61.03 | 85.97 | 73.40 | ||||||||||
As of February 20, 2015, the last reported sale price on the Nasdaq Global Select Market for our common stock was $77.13 per share, and there were 1,433 shareholders of record of our common stock.
The following table shows dividends declared and paid for the periods indicated:
2014 | 2013 | |||||||||||||
Dividends declared | Dividends paid | Dividends declared | Dividends paid | |||||||||||
First Quarter | $ | 0.170 | $ | 0.170 | $ | 0.125 | $ | — | ||||||
Second Quarter | 0.170 | 0.170 | 0.125 | 0.125 | ||||||||||
Third Quarter | 0.170 | 0.170 | — | 0.125 | ||||||||||
Fourth Quarter | 0.190 | 0.170 | 0.295 | 0.125 | ||||||||||
We paid four dividends during 2014. While subsequent dividends will be subject to board approval, we expect to pay a regular quarterly dividend of 19.0 cents per share in 2015.
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 13 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, 2014 and during the three months ended December 31, 2014:
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, 2014 | 7,691,658 | $ | 64.43 | 7,691,658 | $ | 204,367,514 | ||||||||
October 2014 | 197,318 | 67.10 | 197,318 | $ | 191,123,032 | |||||||||
November 2014 | 253,034 | 69.69 | 253,034 | $ | 173,484,274 | |||||||||
December 2014 | — | — | — | $ | 173,484,274 | |||||||||
Total | 8,142,010 | $ | 64.65 | 8,142,010 | ||||||||||
_________________________________________________
* 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) | We have an ongoing authorization, originally approved by our board of directors in September 2010, and subsequently amended, to repurchase up to $700 million in shares of our outstanding common stock. The authorization expires on December 31, 2015. |
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 20, 2015:
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 20, 2015 | Projected Beneficial Ownership (1) | ||||||||||
Don Phillips Managing Director and Director | 11/24/2014 | 11/17/2015 | 26,862 | Shares to be sold under the plan if the stock reaches specified prices | 2,000 | 163,952 | ||||||||||
During the fourth quarter, the previously disclosed Rule 10b5-1 plans for Cheryl Francis, Steve Kaplan, Jack Noonan, and Richard Robbins completed or expired in accordance with their terms.
_______________________________
(1) This column reflects an estimate of the number of shares Don will beneficially own following the sale of all shares under the Rule 10b5-1 sales plan. This information reflects the beneficial ownership of our common stock on December 31, 2014, and includes shares of our common stock subject to options that were then exercisable or that will have become exercisable by March 1, 2015 and restricted stock units that will vest by March 1, 2015. The estimates do not reflect any changes to beneficial ownership that may have occurred since December 31, 2014. Don 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, 2014, 2013, and 2012 and Consolidated Balance Sheet Data as of December 31, 2014 and 2013 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, 2011 and 2010 and Consolidated Balance Sheet Data as of December 31, 2012, 2011, and 2010 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) | 2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||
Revenue | $ | 555,351 | $ | 631,400 | $ | 658,288 | $ | 698,266 | $ | 760,071 | |||||||||||
Operating expense | 434,292 | 492,985 | 507,620 | 527,612 | 654,477 | (1) | |||||||||||||||
Operating income | 121,059 | 138,415 | 150,668 | 170,654 | 105,594 | (1) | |||||||||||||||
Non-operating income, net | 6,732 | 1,709 | 2,957 | 7,356 | 8,304 | ||||||||||||||||
Income before income taxes and equity in net income of unconsolidated entities | 127,791 | 140,124 | 153,625 | 178,010 | 113,898 | ||||||||||||||||
Equity in net income of unconsolidated entities | 1,422 | 1,848 | 2,027 | 1,428 | 39 | ||||||||||||||||
Income tax expense | 42,756 | 43,658 | 52,878 | 56,031 | 35,678 | ||||||||||||||||
Consolidated net income from continuing operations | 86,457 | 98,314 | 102,774 | 123,407 | 78,259 | ||||||||||||||||
Gain on sale of discontinued operations, net of tax | — | — | 5,188 | — | — | ||||||||||||||||
Consolidated net income | 86,457 | 98,314 | 107,962 | 123,407 | 78,259 | ||||||||||||||||
Net (income) loss attributable to noncontrolling interests | (87 | ) | 43 | 117 | 122 | 42 | |||||||||||||||
Net income attributable to Morningstar, Inc. | $ | 86,370 | $ | 98,357 | $ | 108,079 | $ | 123,529 | $ | 78,301 | |||||||||||
Net income per share attributable to Morningstar, Inc.: | |||||||||||||||||||||
Basic: | |||||||||||||||||||||
Continuing operations | $ | 1.75 | $ | 1.96 | $ | 2.12 | $ | 2.68 | $ | 1.75 | |||||||||||
Discontinued operations | — | — | 0.11 | — | — | ||||||||||||||||
Total | $ | 1.75 | $ | 1.96 | $ | 2.23 | $ | 2.68 | $ | 1.75 | |||||||||||
Diluted: | |||||||||||||||||||||
Continuing operations | $ | 1.70 | $ | 1.92 | $ | 2.10 | $ | 2.66 | $ | 1.74 | |||||||||||
Discontinued operations | — | — | 0.10 | — | — | ||||||||||||||||
Total | $ | 1.70 | $ | 1.92 | $ | 2.20 | $ | 2.66 | $ | 1.74 | |||||||||||
Dividends per common share: | |||||||||||||||||||||
Dividends declared per common share | $ | 0.050 | $ | 0.250 | $ | 0.425 | $ | 0.545 | $ | 0.700 | |||||||||||
Dividends paid per common share | $ | — | $ | 0.200 | $ | 0.525 | $ | 0.375 | $ | 0.680 | |||||||||||
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Weighted average common shares outstanding: | |||||||||||||||||||||
Basic | 49,249 | 50,032 | 48,497 | 46,158 | 44,675 | ||||||||||||||||
Diluted | 50,555 | 50,988 | 49,148 | 46,491 | 44,901 | ||||||||||||||||
Other Consolidated Financial Data ($000) | 2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||
Cash provided by (used for) investing activities (2) | $ | (87,949 | ) | $ | (110,767 | ) | $ | 80,192 | $ | (14,861 | ) | $ | (31,216 | ) | |||||||
Cash provided by (used for) financing activities (3) | $ | 12,525 | $ | (32,596 | ) | $ | (265,176 | ) | $ | (166,372 | ) | $ | (71,679 | ) | |||||||
Cash provided by operating activities | $ | 123,416 | $ | 164,976 | $ | 145,996 | $ | 186,658 | $ | 132,221 | (1) | ||||||||||
Capital expenditures | (14,771 | ) | (23,322 | ) | (30,039 | ) | (33,583 | ) | (58,320 | ) | |||||||||||
Free cash flow (4) | $ | 108,645 | $ | 141,654 | $ | 115,957 | $ | 153,075 | $ | 73,901 | (1) | ||||||||||
Consolidated Balance Sheet Data | |||||||||||||||||||||
As of December 31 ($000) | 2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||
Cash, cash equivalents, and investments | $ | 365,416 | $ | 470,192 | $ | 321,418 | $ | 298,567 | $ | 224,572 | |||||||||||
Working capital | 254,556 | 341,400 | 217,245 | 177,348 | 106,014 | ||||||||||||||||
Total assets | 1,086,302 | 1,172,084 | 1,041,952 | 1,030,668 | 1,019,281 | ||||||||||||||||
Deferred revenue (5) | 146,267 | 155,494 | 146,015 | 149,225 | 145,979 | ||||||||||||||||
Long-term liabilities | 52,153 | 44,435 | 57,692 | 69,833 | 71,124 | ||||||||||||||||
Total equity | 781,425 | 857,016 | 726,895 | 691,290 | 654,398 | ||||||||||||||||
(1) Operating income and free cash flow for 2014 include a $61.0 million litigation settlement expense and corresponding cash outflow.
(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 our revolving credit facility, 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.
(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 maintain and protect our brand, independence, and reputation; |
• | failing to differentiate our products and continuously create innovative, proprietary research tools; |
• | failing to respond to technological change, keep pace with new technology developments, or adopt a successful technology strategy; |
• | liability related to the storage of personal information related to individuals as well as portfolio and account-level information; |
• | compliance failures, regulatory action, or changes in laws applicable to our investment advisory or credit rating operations; |
• | downturns in the financial sector, global financial markets, and global economy; |
• | the effect of market volatility on revenue from asset-based fees; |
• | a prolonged outage of our database, technology-based products and services, or network facilities; |
• | challenges faced by our non-U.S. operations, including the concentration of data and development work at our offshore facilities in China and India; and |
• | trends in the mutual fund industry, including the increasing popularity of passively managed investment vehicles. |
A more complete description of these risks and uncertainties can be found in 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.
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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 2013, we revised our segment reporting 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.
Revenue
We generate revenue by selling a variety of investment-related products and services. We sell many of our products and services, including Morningstar Data, Morningstar Advisor Workstation, Morningstar Direct, and Morningstar Research, 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 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 credit research and rating business, we generate transaction-based revenue for our ratings on new issues of commercial mortgage-backed securities and other structured credits.
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. 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 could be detrimental to our competitive position. We disclose changes in the 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 consolidated 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 40 to 50 basis points for our Select Stock Baskets.
Deferred Revenue
We invoice some of 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 $146.0 million at the end of 2014 and $149.2 million at the end of 2013. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our subscription, license, and service agreements.
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In recent years, our deferred revenue balance has increased at a more moderate rate, partly because we've been issuing more quarterly and monthly invoices versus up-front, annual invoices. In addition, as we’ve migrated some Principia subscribers to Morningstar Advisor Workstation and other products that meet their needs, we have less subscription-based revenue contributing to the deferred revenue balance.
Significant Operating Leverage
Our business requires significant investments to create and maintain proprietary software, databases, and content. We believe that while the fixed costs of the investments in our business are relatively high, the variable cost of adding customers is lower, partly because many 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 cause weaker short-term operating results. During other periods, our profitability may improve because we're able to increase revenue without increasing our cost base at the same rate. When revenue decreases, however, we may not be able to adjust our cost base, which would reduce profitability.
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 as well as development expense.
• 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 includes compensation expense for our management team and other corporate functions, including employees in our compliance, finance, human resources, and legal departments. It also includes costs for corporate systems and facilities.
• Depreciation and amortization. Our capital expenditures 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 range from three to seven 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, 2014, 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 investment in Morningstar Japan K.K. (MJKK) 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 is based on estimated future cash flows, discounted to their value in today's dollars. Our approach to evaluating our own business works the same way.
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Our goal is to increase the intrinsic value of our business over time, which we believe is the best way to create value for our shareholders. We do not make public financial forecasts for our business because we want to avoid creating any incentives for our management team to make speculative statements about our financial results that could influence our stock price or take actions that help us meet short-term forecasts but may not build long-term shareholder value.
We provide three specific measures that can help investors generate their own assessment of how our intrinsic value has changed over time:
• Revenue (including organic revenue);
• Operating income (loss); and
• Free cash flow, which we define as cash provided by or used for operating activities less capital expenditures.
Organic revenue and free cash flow are not measures of performance set forth under GAAP (generally accepted accounting principles).
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.
We present free cash flow as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under GAAP and should not be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.
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, 2015.
The Year 2014 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 higher volatility and growing investor concerns about global economic growth and the effect of falling oil prices near the end of the year, the U.S. stock market was relatively strong in 2014. Morningstar's U.S. Market Index, a broad market benchmark, ended the year up 12.9%. Global markets were weaker, though; Morningstar’s Global Markets ex-U.S. Index finished the year down 3.2%.
The fund industry showed moderate growth in 2014, thanks in part to a generally favorable market. Total U.S. mutual fund assets rose to $15.9 trillion as of December 31, 2014, compared with $15.0 trillion as of December 31, 2013, 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 $280 billion in 2014, up from about $220 billion in 2013.
Investors have also continued to favor passively managed index funds rather than actively managed portfolios--a trend that was more pronounced in 2014. In 2014, passively managed vehicles had more than $400 billion in net inflows, compared with only $40 billion net inflows for active products (both mutual funds and ETFs). Actively managed U.S. equity funds had net outflows of nearly $100 billion for the year.
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The number of mutual funds in the United States rose slightly to about 7,900 in 2014 (excluding multiple share classes), compared with about 7,700 in 2013 based on ICI data. The number of global mutual funds rose to about 78,900 as of September 30, 2014, up from about 75,300 as of September 30, 2013, based on ICI data.
ETFs continued to increase in popularity relative to traditional mutual funds. The U.S. ETF industry closed out 2014 with nearly $2 trillion in assets under management based on ICI data, up from about $1.7 trillion as of December 2013.
Based on data from ComScore, aggregate page views to financial and investment sites were down about 6% in 2014, while the number of unique users decreased a similar amount. The number of pages viewed per visit and time spent per visit both increased modestly. For Morningstar.com, metrics such as unique users and aggregate page views both increased for the year.
Amid these trends, we believe online advertising spending by financial services companies rose moderately in 2014. Magna Global, a division of Interpublic Group, estimates that global online advertising revenue rose about 17% across all industries in 2014, and we believe advertising spending in the financial services industry also increased versus 2013.
In addition to industry developments in 2014, there are several longer-term trends we consider relevant to our business, as outlined below.
In the wake of the financial crisis of 2008 and 2009, regulators have continued to implement new frameworks for financial services companies globally. Many of these rules 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 "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.
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 fact sheet that replaces the Simplified Prospectus. We use our data and production capabilities to help fund companies produce and distribute these documents.
The European Securities and Markets Authority (ESMA) published its final Technical Advice on MIFID (Market in Financial Instruments Directive) and issued a draft version of regulatory technical and implementing standards, which is currently open for comment. The new regulatory framework would go into effect in January 2017 and aims to ensure that secondary markets are fair, transparent, and safe. It also seeks to ensure that investors’ interests are safeguarded when being sold investment products. The main proposals include, among other things, limits on portfolio managers' use of third-party research, quality and organizational rules regarding the provision of advice, additional governance requirements for the manufacturing and distribution of financial instruments and structured deposits, requirements for firms to provide clients with details of all costs and charges related to their investments, and new rules for disclosing the cumulative effect of costs on investor returns.
In Australia, the government has continued to implement the series of Future of Financial Advice reforms that began in July 2013. Several measures that were previously identified for removal were ultimately retained, including requirements relating to annual fee disclosure and compensation structures for financial advisors. In response, we believe financial advisors have become more focused on client engagement to demonstrate the value of the services they provide.
During 2014, the Australian Prudential Regulation Authority increased its level of surveillance on superannuation funds (a type of pension plan for employees to use in saving for retirement) with additional quarterly reporting requirements regarding assets held. We've expanded our data collection and distribution services to help asset management firms and superannuation funds meet these additional requirements.
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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 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 don't believe Dodd-Frank and related regulations will have a significant effect on other areas of Morningstar, we continue to monitor the potential effect 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 (DOL) has proposed a similar plan that would only apply to advisors working with defined contribution plans and individual retirement accounts. President Obama recently endorsed the DOL proposal and encouraged the DOL to move ahead with new rules that would require a fiduciary standard for financial advisors providing retirement advice. We believe the increased regulatory scrutiny of advisors may lead to an expanding need for independent advice, tools, and solutions.
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 caused lower margins for some 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.
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Supplemental Operating Metrics
The tables below summarize our key product metrics and other supplemental data.
As of December 31, | |||||||||||||||||
Our business | 2014 | 2013 | 2012 | 2014 change | 2013 change | ||||||||||||
Morningstar.com Premium Membership subscriptions (U.S.) | 123,274 | 124,027 | 123,899 | (0.6 | )% | 0.1 | % | ||||||||||
Morningstar.com registered users (U.S.) | 8,189,569 | 7,848,057 | 7,521,043 | 4.4 | % | 4.3 | % | ||||||||||
Advisor Workstation clients (U.S.) (1) | 181 | 162 | 149 | 11.7 | % | 8.7 | % | ||||||||||
Morningstar Office licenses (U.S.) (1) | 4,268 | 4,073 | 3,803 | 4.8 | % | 7.1 | % | ||||||||||
Principia subscriptions (2) | 8,178 | 19,206 | 26,807 | (57.4 | )% | (28.4 | )% | ||||||||||
Morningstar Direct licenses (3) | 10,055 | 8,514 | 7,388 | 18.1 | % | 15.2 | % | ||||||||||
Assets under management and advisement (approximate) ($bil) | |||||||||||||||||
Investment Advisory services (4) | $ | 81.0 | $ | 83.5 | $ | 94.3 | (3.0 | )% | (11.5 | )% | |||||||
Retirement Solutions | |||||||||||||||||
Managed retirement accounts (5) | $ | 36.8 | $ | 31.7 | $ | 25.1 | 16.1 | % | 26.3 | % | |||||||
Plan sponsor advice | 26.7 | 22.9 | 17.7 | 16.6 | % | 29.4 | % | ||||||||||
Custom models | 13.3 | 11.0 | 4.4 | 20.9 | % | 150.0 | % | ||||||||||
Retirement Solutions (total) | $ | 76.8 | $ | 65.6 | $ | 47.2 | 17.1 | % | 39.0 | % | |||||||
Morningstar Managed Portfolios | $ | 9.3 | $ | 7.3 | $ | 4.7 | 27.4 | % | 55.3 | % | |||||||
Ibbotson Australia | $ | 3.0 | $ | 3.0 | $ | 3.3 | — | % | (9.1 | )% | |||||||
Average assets under management and advisement ($bil) | $ | 166.3 | $ | 161.6 | $ | 181.0 | 2.9 | % | (10.7 | )% | |||||||
Number of commercial mortgage-backed securities (CMBS) new-issue ratings completed | 52 | 38 | 19 | 36.8 | % | 100.0 | % | ||||||||||
Asset value of CMBS new-issue ratings ($bil) | $ | 33.7 | $ | 24.5 | $ | 15.4 | 37.6 | % | 59.1 | % | |||||||
Our employees (approximate) | |||||||||||||||||
Worldwide headcount | 3,760 | 3,565 | 3,495 | 5.5 | % | 2.0 | % | ||||||||||
Number of equity and credit analysts | 172 | 165 | 155 | 4.2 | % | 6.5 | % | ||||||||||
Number of manager research analysts | 100 | 105 | 110 | (4.8 | )% | (4.5 | )% | ||||||||||
Year ended December 31, | |||||||||||||||||
Key product revenue ($000) | 2014 | 2013 | 2012 | 2014 change | 2013 change | ||||||||||||
Morningstar Data (3) | $ | 137,408 | $ | 129,262 | $ | 115,273 | 6.3 | % | 12.1 | % | |||||||
Morningstar Advisor Workstation (3) | 101,689 | 93,059 | 86,048 | 9.3 | % | 8.1 | % | ||||||||||
Morningstar Direct (3) | 91,829 | 79,358 | 65,279 | 15.7 | % | 21.6 | % | ||||||||||
Morningstar.com | 58,122 | 55,637 | 53,671 | 4.5 | % | 3.7 | % | ||||||||||
Retirement Solutions | 57,252 | 45,536 | 38,085 | 25.7 | % | 19.6 | % | ||||||||||
(1) Beginning in the second quarter of 2014, we changed our reporting to show the number of enterprise clients for Morningstar Advisor Workstation instead of individual licenses. We believe this is a better way to capture underlying business trends because per-user pricing varies significantly depending on the scope of the license. We also began disclosing the number of licenses for Morningstar Office as a separate line item.
(2) We no longer offer new Principia subscriptions and are transitioning subscribers to Morningstar Advisor Workstation and other Morningstar products.
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(3) We revised our revenue by product structure in 2013 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 for 2012 to reflect these changes. We also made minor corrections to the total number of licenses for Morningstar Direct in 2012.
(4) The decline in assets under advisement 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 $2.5 billion in 2014 and $10.8 billion in 2013.
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.
Because we don't have custody of the underlying assets, it's difficult for us to quantify cash inflows and outflows for these portfolios. The information we receive from most of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot specify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations.
(5) Many factors can cause changes in assets under management and advisement for our managed retirement accounts, including employer and employee contributions, plan administrative fees, market movements, and participant loans and hardship withdrawals. The information we receive from the plan providers does not separately identify these transactions or the changes in balances caused by market movement.
Consolidated Results
Key Metrics ($000) | 2014 | 2013 | 2012 | 2014 Change | 2013 Change | ||||||||||||||
Revenue | $ | 760,071 | $ | 698,266 | 658,288 | 8.9 | % | 6.1 | % | ||||||||||
Operating income | $ | 105,594 | (1) | $ | 170,654 | 150,668 | (38.1 | )% | 13.3 | % | |||||||||
Operating margin | 13.9 | % | 24.4 | % | 22.9 | % | (10.5 | ) | pp | 1.5 | pp | ||||||||
Cash provided by (used for) investing activities | $ | (31,216 | ) | $ | (14,861 | ) | 80,192 | NMF | NMF | ||||||||||
Cash used for financing activities | $ | (71,679 | ) | $ | (166,372 | ) | (265,176 | ) | (56.9 | )% | (37.3 | )% | |||||||
Cash provided by operating activities | $ | 132,221 | (1) | $ | 186,658 | 145,996 | (29.2 | )% | 27.9 | % | |||||||||
Capital expenditures | (58,320 | ) | (33,583 | ) | (30,039 | ) | 73.7 | % | 11.8 | % | |||||||||
Free cash flow | $ | 73,901 | (1) | $ | 153,075 | $ | 115,957 | (51.7 | )% | 32.0 | % | ||||||||
____________________________________________________________________________________________
pp — percentage points
NMF — Not meaningful
(1) Operating income and free cash flow for 2014 include a $61.0 million litigation settlement expense and corresponding cash outflow.
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.
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Consolidated Revenue
($000) | 2014 | 2013 | 2012 | 2014 Change | 2013 Change | ||||||||||||||
Revenue | |||||||||||||||||||
Investment information | $ | 597,046 | $ | 555,642 | $ | 526,147 | 7.5 | % | 5.6 | % | |||||||||
Investment management | 163,025 | 142,624 | 132,141 | 14.3 | % | 7.9 | % | ||||||||||||
Consolidated revenue | $ | 760,071 | $ | 698,266 | $ | 658,288 | 8.9 | % | 6.1 | % | |||||||||
In 2014, our consolidated revenue rose 8.9%. Some of the main contributors to the increase were Morningstar Direct, Morningstar Retirement Solutions, Morningstar Managed Portfolios, and Morningstar Credit Ratings. Positive results for these products were partially offset by a $9.1 million decline for Principia, as we've been migrating some Principia clients to Morningstar Advisor Workstation and other products. Revenue for Investment Advisory services was down $2.3 million, reflecting the ongoing effect of clients moving to in-house management for fund-of-funds portfolios in the variable annuity industry.
In 2013, our consolidated revenue increased 6.1%. 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 the main contributors to revenue growth in 2013.
Investment information revenue
Investment information products, which make up about 80% of our consolidated revenue, rose $41.4 million, or 7.5%, in 2014 and $29.5 million, or 5.6%, in 2013. Morningstar Direct was the biggest contributor to growth in this product group in both 2014 and 2013, with revenue increasing by $12.5 million in 2014 and $14.1 million in 2013. The number of licenses for Morningstar Direct increased to about 10,000 worldwide at the end of 2014, compared with about 8,500 at the end of 2013 and 7,400 at the end of 2012, with strong growth in both the United States and internationally. Growth in Morningstar Direct reflects additional licenses for both new and existing clients.
Morningstar Advisor Workstation was the second-largest contributor to growth in this product group in 2014 with an additional $8.6 million of revenue, mainly reflecting additional enterprise clients. These positive growth trends were offset by lower revenue for Principia, which was down $9.1 million in 2014 and $4.8 million in 2013. We're no longer selling new subscriptions to Principia, and we’ve been transitioning some Principia subscribers to Morningstar Advisor Workstation and other Morningstar products that meet their needs.
Revenue for Morningstar Credit Ratings rose $8.4 million, reflecting both higher industry-wide new issuance volume in structured credits and growth in our market share for CMBS new-issue ratings versus other rating agencies.
Revenue for Morningstar Data increased $8.1 million, reflecting strong renewal rates and new client contracts for managed products data.
Investment management revenue
Investment management revenue, which represents about 20% of consolidated revenue, was up $20.4 million, or 14.3%, in 2014, driven by higher revenue for Morningstar Retirement Solutions and Morningstar Managed Portfolios. Revenue for Morningstar Retirement Solutions was up $11.7 million year over year, reflecting strong asset growth from both new and existing clients. Revenue for Morningstar Managed Portfolios increased $8.5 million, driven by net inflows and positive market returns over the past 12 months.
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, revenue for our Investment Advisory services was down about $2.3 million year over year, and assets under advisement were down $2.5 billion over the same period.
Because the variable annuity industry, which accounted for approximately 2% of consolidated revenue in 2014 and 2013, continues to face challenges, we expect there will be further pressure on revenue from variable annuity clients.
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Investment management revenue increased $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. 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.
The asset-based fees we earn are generally based on average asset levels during each quarter. Average assets under management and advisement (calculated based on available average quarterly or monthly data) were approximately $166.3 billion in 2014, compared with $161.6 billion in 2013 and $181.0 billion in 2012. We had $94.1 million in revenue from asset-based fees in 2014, an increase of $5.5 million compared with $88.6 million in 2013. In 2012, revenue from asset-based fees was $81.4 million. Revenue from asset-based fees made up approximately 12.4% of consolidated revenue in 2014, down slightly from 12.7% in 2013.
Organic revenue
To make it easier to compare 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. In April 2014, we acquired ByAllAccounts, Inc. (ByAllAccounts) and in June 2014, we acquired an additional 81.3% interest in HelloWallet Holdings, Inc. (HelloWallet) to become the sole owner. During the second quarter of 2013, we acquired an additional 76% interest in Morningstar Sweden AB to become the sole owner.
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 2014, we had $11.4 million in incremental revenue from acquisitions, primarily from ByAllAccounts and HelloWallet. In addition, currency translations reduced revenue by about $2.5 million in 2014, mainly because of the weaker Australian dollar and Canadian dollar, partially offset by the stronger British pound. Excluding acquisitions, divestitures, and foreign currency translations, organic revenue was up 7.6% in 2014.
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.
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The tables below reconcile consolidated revenue with organic revenue (revenue excluding acquisitions, divestitures, and the effect of foreign currency translations):
2014 vs. 2013 ($000) | 2014 | 2013 | Change | ||||||||
Consolidated revenue | $ | 760,071 | $ | 698,266 | 8.9 | % | |||||
Less: acquisitions | (11,397 | ) | — | ||||||||
Less: divestitures | — | — | |||||||||
Unfavorable effect of foreign currency translations | 2,459 | — | |||||||||
Organic revenue | $ | 751,133 | $ | 698,266 | 7.6 | % | |||||
2013 vs. 2012 ($000) | 2013 | 2012 | Change | ||||||||
Consolidated revenue | $ | 698,266 | $ | 658,288 | 6.1 | % | |||||
Less: acquisitions | (3,746 | ) | — | ||||||||
Less: divestitures | — | (4,144 | ) | ||||||||
Unfavorable effect of foreign currency translations | 3,575 | — | |||||||||
Organic revenue | $ | 698,095 | $ | 654,144 | 6.7 | % | |||||
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.
Revenue by region
Year ended December 31 | ||||||||||||||||||
($000) | 2014 | 2013 | 2012 | 2014 Change | 2013 Change | |||||||||||||
United States | $ | 550,740 | $ | 500,730 | $ | 466,947 | 10.0 | % | 7.2 | % | ||||||||
United Kingdom | 61,844 | 56,298 | 56,794 | 9.9 | % | (0.9 | )% | |||||||||||
Continental Europe | 62,677 | 57,580 | 49,844 | 8.9 | % | 15.5 | % | |||||||||||
Australia | 34,977 | 35,289 | 38,229 | (0.9 | )% | (7.7 | )% | |||||||||||
Canada | 30,790 | 31,845 | 30,664 | (3.3 | )% | 3.9 | % | |||||||||||
Asia | 15,830 | 13,860 | 13,765 | 14.2 | % | 0.7 | % | |||||||||||
Other | 3,213 | 2,664 | 2,045 | 20.6 | % | 30.3 | % | |||||||||||
Total International | 209,331 | 197,536 | 191,341 | 6.0 | % | 3.2 | % | |||||||||||
Consolidated revenue | $ | 760,071 | $ | 698,266 | $ | 658,288 | 8.9 | % | 6.1 | % | ||||||||
International revenue made up about 28% of our consolidated revenue in 2014, 2013, and 2012. 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 6.0% in 2014. Excluding acquisitions and foreign currency translations, revenue from international operations increased 6.2%. Our operations in Continental Europe were the main contributors to the increase, followed by the United Kingdom and Australia.
In 2013, revenue from international operations rose 3.2%, as our operations in Continental Europe enjoyed stronger product sales, but this growth was partly offset by negative currency movements (mainly the weaker Australian dollar).
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The tables below present a reconciliation from international revenue to international organic revenue (international revenue excluding acquisitions, divestitures, and the effect of foreign currency translations):
($000) | 2014 | 2013 | Change | ||||||||
International revenue | $ | 209,330 | $ | 197,536 | 6.0 | % | |||||
Less: acquisitions | (1,949 | ) | — | ||||||||
Less: divestitures | — | — | |||||||||
Unfavorable effect of foreign currency translations | 2,459 | — | |||||||||
International organic revenue | $ | 209,840 | $ | 197,536 | 6.2 | % | |||||
($000) | 2013 | 2012 | Change | ||||||||
International revenue | $ | 197,536 | $ | 191,341 | 3.2 | % | |||||
Less: acquisitions | (3,746 | ) | — | ||||||||
Less: divestitures | — | (3,814 | ) | ||||||||
Unfavorable effect of foreign currency translations | 3,575 | — | |||||||||
International organic revenue | $ | 197,365 | $ | 187,527 | 5.2 | % | |||||
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.
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:
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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 approximately 95% in 2014, compared with 94% in 2013. Many of our products have shown positive trends in renewal rates over the past three years, which was partially offset by lower renewals for variable annuity clients for Investment Advisory services. 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 2014, 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 approximately 69% in 2014, down from 71% in 2013. The decline was mainly driven by subscription losses from Principia.
Consolidated Operating Expense
($000) | 2014 | 2013 | 2012 | 2014 Change | 2013 Change | |||||||||||||||
Cost of revenue | $ | 318,638 | $ | 271,437 | $ | 246,783 | 17.4 | % | 10.0 | % | ||||||||||
% of revenue | 41.9 | % | 38.9 | % | 37.5 | % | 3.0 | pp | 1.4 | pp | ||||||||||
Sales and marketing | 111,088 | 103,614 | 108,884 | 7.2 | % | (4.8 | )% | |||||||||||||
% of revenue | 14.6 | % | 14.8 | % | 16.5 | % | (0.2) | pp | (1.7) | pp | ||||||||||
General and administrative | 108,865 | 106,868 | 108,857 | 1.9 | % | (1.8 | )% | |||||||||||||
% of revenue | 14.3 | % | 15.3 | % | 16.5 | % | (1.0) | pp | (1.2) | pp | ||||||||||
Depreciation and amortization | 54,886 | 45,693 | 43,096 | 20.1 | % | 6.0 | % | |||||||||||||
% of revenue | 7.2 | % | 6.5 | % | 6.5 | % | 0.7 | pp | 0.0 | pp | ||||||||||
Litigation settlement | 61,000 | — | — | 100.0 | % | — | % | |||||||||||||
% of revenue | 8.0 | % | — | — | 8.0 | pp | 0.0 | pp | ||||||||||||
Total operating expense | $ | 654,477 | $ | 527,612 | $ | 507,620 | 24.0 | % | 3.9 | % | ||||||||||
% of revenue | 86.1 | % | 75.6 | % | 77.1 | % | 10.5 | pp | (1.5) | pp | ||||||||||
Note: Following our change to a more centralized structure during 2013, we refined the classification of employees within operating expense categories. As a result, approximately 180 net positions shifted from the general and administrative and sales and marketing categories to cost of revenue starting in the second half of 2013. These changes added approximately $14 million of compensation expense to cost of revenue in 2014 versus 2013 as well as in 2013 versus 2012, and reduced the compensation expense included in the sales and marketing and general and administrative categories by approximately $8 million and $6 million in each of these periods, respectively. These changes did not affect total operating expense or operating income for any of the periods presented.
In 2014, our operating expense was up $126.9 million, or 24.0%. We settled a dispute with Business Logic during the second quarter of 2014 for $61.0 million, which contributed nearly half of this increase. Higher compensation expense (including salaries, bonus, and other company-sponsored benefits) also contributed to the change. We had approximately 3,760 employees worldwide at the end of 2014, compared with 3,565 at the end of 2013--an increase of approximately 200 employees. About half of the change reflects new employees added with the ByAllAccounts and HelloWallet acquisitions. We also added product and technology roles in the United States as well as equity data analysts in India.
Commission expense rose $10.0 million in 2014, mainly because we changed to a new sales commission structure that requires a different accounting treatment. We now expense commissions as incurred instead of amortizing them over the term of the underlying contracts. However, we continued to amortize the prepaid commission balance from our previous commission plan during 2014.
Depreciation expense was up $8.4 million in 2014, mainly reflecting additional capitalized software development and computer software purchases for our U.S. operations.
Production expense was up $6.7 million in 2014, mainly reflecting higher costs for information technology maintenance agreements and infrastructure, as well as an unrealized loss on some of our model portfolios.
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This expense growth was partially offset by an increase in capitalized software development, which reduced operating expense. In 2014, we capitalized $18.8 million of software development costs for ongoing enhancements as well as new development of upgraded software platforms, compared with $8.1 million in 2013.
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.
Depreciation expense increased $5.1 million during 2013, mainly reflecting additional capitalized software development and computer software purchases for our U.S. operations. Professional fees were up $5.0 million in 2013, primarily reflecting higher legal expense.
Total operating expense also includes bonus expense and stock-based compensation expense, which we include in each of the cost categories shown in the table above. Bonus expense was $48.1 million in 2014, compared with $40.9 million in 2013 and $36.2 million in 2012.
Stock-based compensation expense was $17.6 million in 2014, compared with $15.0 million in 2013 and $18.9 million in 2012.
Overall, operating expense as a percentage of revenue increased 10.5 percentage points in 2014, mainly because of the $61.0 million litigation settlement expense. Operating expense as a percentage of revenue was down 1.5 percentage points in 2013.
Cost of revenue
Cost of revenue is our largest category of operating expense, representing about one-half of our total operating expense.
In both 2014 and 2013, the $14 million of additional expense from the shift in employee cost categories discussed above was a major factor behind the growth in cost of revenue. In 2014, other increases in salary expense, bonus, and other compensation costs--which totaled about $44.4 million--also contributed to growth in this category. Production expense was up $6.7 million in 2014, mainly reflecting higher costs for information technology maintenance agreements and infrastructure, as well as an unrealized loss on some of our model portfolios.
These increases were partially offset by a higher level of capitalized software development in 2014. We capitalized $18.8 million of software development in 2014, compared with $8.1 million in 2013 and $8.5 million in 2012.
As a percentage of revenue, cost of revenue increased by about 3.0 percentage points in 2014 and 1.4 percentage points in 2013, with approximately 2 percentage points of the change in both years driven by the shift in expense categories.
Sales and marketing
As discussed above, the shift in employee cost categories reduced sales and marketing expense by approximately $8 million in both 2014 and 2013. Despite this reduction, total sales and marketing expense was still up $7.5 million in 2014, mainly because of higher sales commission costs following the change in commission plan discussed above. Additional costs for advertising and marketing also contributed to this increase, but to a lesser extent. This expense growth was partly offset by lower costs for travel, training, and conferences.
Sales and marketing expense was down $5.3 million in 2013, mainly driven by the shift in expense categories discussed above. Higher sales commissions of $2.6 million partly offset this decrease.
As a percentage of revenue, sales and marketing expense was down 0.2 percentage points in 2014 and 1.7 percentage points in 2013, mainly because of the shift in expense categories.
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General and administrative
The shift in employee cost categories discussed above reduced general and administrative (G&A) expense by approximately $6 million in both 2014 and 2013. Despite this reduction, total G&A expense still increased by $2.0 million in 2014. Rent and facilities costs were up $2.8 million versus 2013, mainly because we expanded our office space in the United States. This additional expense was partially offset by a $1.5 million credit we recorded for damages received in connection with a legal matter in the first quarter of 2014, which partially offset growth in legal and other professional fees.
G&A expense was down $2.0 million in 2013. There were three main items that contributed to the decline. First, G&A expense in 2012 included $3.2 million for accelerated vesting of restricted stock issued to a former executive in a business we acquired. 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, the shift in expense categories discussed above partially offset growth in salary, benefits, and other compensation expense.
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 as a percentage of revenue was down 1.0 percentage points in 2014 and 1.2 percentage points in 2013, mainly because of the shift in expense categories.
Depreciation and amortization
Intangible amortization expense increased $0.8 million in 2014 and $2.5 million in 2013, as additional amortization expense for the intangible assets of HelloWallet and ByAllAccounts was largely offset by the completed amortization of intangible assets from some previous acquisitions. However, depreciation expense rose $8.4 million in 2014, mainly because of higher capital expenditures for computer software and a higher level of capitalized software development for our operations in the United States. Depreciation expense increased $5.1 million in 2013, mainly because of additions to capitalized software development and purchases of computer software.
We expect that amortization of intangible assets will be an ongoing cost for the remaining lives of the assets. We estimate that this expense will total approximately $21.9 million in 2015. 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 increased $9.2 million in 2014 and $2.6 million in 2013.
Litigation settlement
We recorded a $61.0 million litigation settlement expense in the second quarter of 2014 related to our agreement with Business Logic. This settlement contributed nearly half of the increase in operating expense in 2014.
Consolidated Operating Income
($000) | 2014 | 2013 | 2012 | ||||||||||
Operating income | $ | 105,594 | $ | 170,654 | $ | 150,668 | |||||||
% change | (38.1 | )% | 13.3 | % | 8.9 | % | |||||||
Operating margin | 13.9 | % | 24.4 | % | 22.9 | % | |||||||
Change | (10.5 | ) | pp | 1.5 | pp | 1.0 | pp | ||||||
Consolidated operating income decreased $65.1 million in 2014 as our revenue increased $61.8 million and operating expense rose by $126.9 million. Operating margin was 13.9%, a decrease of 10.5 percentage points compared with 2013.
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The $61.0 million settlement was the biggest contributor to the decline in operating income and operating margin in 2014. We also had higher salary and other compensation-related expense from additional
headcount, reflecting both new hires and employees added with the ByAllAccounts and HelloWallet acquisitions.
Excluding the settlement, we reported adjusted operating income of $166.6 million in 2014, a decrease of 2.4% compared with 2013. Adjusted operating income is a non-GAAP measure; the table below shows a reconciliation to the comparable GAAP measure.
We present adjusted operating income (operating income excluding the settlement) to show the effect of this charge, better reflect period-over-period comparisons, and improve overall understanding of our current and future financial performance.
($000) | 2014 | 2013 | 2012 | 2014 Change | 2013 Change | |||||||||||||
Operating income | $ | 105,594 | $ | 170,654 | $ | 150,668 | (38.1 | )% | 13.3 | % | ||||||||
Less: litigation settlement | 61,000 | — | — | 100.0 | % | — | % | |||||||||||
Adjusted operating income | $ | 166,594 | $ | 170,654 | $ | 150,668 | (2.4 | )% | 13.3 | % | ||||||||
Excluding the settlement, we reported an adjusted operating margin of 21.9% in 2014, a decrease of 2.5 percentage points. Adjusted operating margin is a non-GAAP measure; the table below shows a reconciliation to the comparable GAAP measure.
We present adjusted operating margin (operating margin excluding the settlement) to show the effect of this charge, better reflect period-over-period comparisons, and improve overall understanding of our current and future financial performance.
($000) | 2014 | |||||||||||||||