10-K 1 morn_10kx12312017.htm 10-K Document

 
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, 2017

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)
mornlogoreda04.jpg
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.


(Check one):
Large accelerated filer  x
Accelerated filer ¨
 
Non-accelerated filer  ¨
 
Smaller reporting company  ¨
Emerging growth company  o
 
 
 
(Do not check if a smaller reporting company)
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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, 2017 was $1.4 billion. As of February 16, 2018, there were 42,498,136 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 2018 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, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the private capital markets.
We currently serve approximately 255,000 financial advisors, 1,500 asset management firms, 31 retirement plan providers, 285,000 retirement plan sponsors, and 11.9 million individual investors. We also provide data on the private capital markets to approximately 2,700 institutional clients.

Our data and research are core assets that we seek to leverage to build Morningstar's long-term value. Morningstar provides extensive data and research insights on a wide range of investment offerings, including managed investment products, publicly listed companies, fixed income securities, private capital markets, and real-time global market data.

We’ve been providing independent analyst research on mutual funds and other investment vehicles since the mid-1980s. We use this analyst research to provide a qualitative, forward-looking Morningstar Analyst Rating for funds. We now provide research reports and Morningstar Analyst Ratings for approximately 5,100 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, target-date funds, and ETFs. 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. Other tools, such as the Ownership Zone, Sector Delta, and Market Barometer, allow investors to see how different investments work together to form a portfolio and to track its progress.

The Morningstar Sustainability Rating helps investors evaluate funds based on environmental, social, and governance (ESG) factors. Morningstar now provides Sustainability Ratings for approximately 36,000 investment vehicles. Sustainability ratings for mutual funds and ETFs encompass $21 trillion in assets under management, or more than half of fund assets globally.

As part of our research efforts on individual stocks, we popularized the concepts of economic moat, a measure of competitive advantage originally developed by Warren Buffett, and margin of safety, which reflects the size of the discount in a stock's price relative to its estimated value. The Morningstar Rating for stocks is based on the stock's current price relative to our analyst-generated fair value estimates, as well as the company's level of business risk and economic moat. Our analysts cover approximately 1,500 stocks using a consistent, proprietary methodology that focuses on fundamental analysis, competitive advantage assessment, and intrinsic value estimation.

In addition to our analyst-driven coverage, we provide quantitative ratings and reports for approximately 56,000 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.

PitchBook, which we acquired in December 2016, provides venture capital and private equity firms, corporate development teams, investment banks, limited partners, lenders, law firms, and accounting firms with a robust, all-in-one workstation that focuses on private capital markets. Morningstar’s in-depth public company fundamental data and institutional equity research were integrated into the platform in 2017, allowing institutional investors to better capitalize on opportunities in both public and private markets.


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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), residential mortgage-backed securities (RMBS), and other types of asset-backed securities. In 2017, the National Association of Insurance Commissioners (NAIC) extended Morningstar Credit Ratings’ designation on its NAIC Credit Rating Provider list to include financial institutions, brokers, and dealers, as well as corporate issuers. Morningstar Credit Ratings also announced the launch of its Real Estate Investment Trust (REIT) ratings initiative in 2017.

In our investment management business, 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 published 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.

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.

1. Produce the most effective investment data, research, and ratings to help investors reach their financial goals.

We believe the quality and scope of our 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 PitchBook) and outsourced investment management.

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 goal for manager research is to improve investor outcomes through ratings efficacy, coverage expansion, and innovation. Our analyst team qualitatively assesses thousands of managed investments using a structured and uniform approach. With the release of the Morningstar Quantitative Rating for Funds in the U.S., we have used machine-learning techniques to extend the qualitative Analyst Rating to thousands of funds that our analysts don’t cover. In addition, our analysts contribute to research and data innovations that we surface in the products and services we offer and oversee other ratings systems and tools that we offer to help investors make more-informed decisions when selecting securities, constructing portfolios, or measuring risk.

As of December 31, 2017, we had about 120 manager research analysts, including teams in North America, Europe, Australia, and Asia.
 
Equity research


Our analysts follow a rigorous methodology that emphasizes a bottom-up, long-term, fundamentals-based valuation approach. We believe that our deep industry knowledge and Economic MoatTM Ratings, which identify sustainable competitive advantages, differentiate our equity research and help investors achieve better investment outcomes.

As of December 31, 2017, we had about 100 equity analysts globally, making us one of the largest providers of independent equity research.

Credit ratings

Morningstar Credit Ratings, LLC, our credit ratings subsidiary, is a Nationally Recognized Statistical Rating Organization (NRSRO) that is focused on structured finance and credit ratings for corporate issuers and financial institutions. We bring transparency, unique perspectives, and superior client service to investors across the fixed-income markets.

As of December 31, 2017, we had about 100 credit analysts globally.


Portfolio 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.



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2. Develop Morningstar Direct and PitchBook as our key decision support platforms.

In 2017, we continued to develop the next-generation version of Morningstar Direct, our institutional investment research platform.

The new software is designed to be more intuitive, elegant, and easy-to-use. It provides a more consistent, cohesive experience with a strong emphasis on Morningstar’s proprietary research and tools. We also improved the underlying technology, including a more streamlined development process for commonly used Morningstar capabilities such as portfolio management tools.

The new software is fully web-based, which eliminates the need for desktop software installations and allows immediate access to new features. It allows to 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 the past several years, we've started migrating many of our core software capabilities to Morningstar Direct, which will serve as our main platform for clients seeking information to support the investment decisions they make on their own or to validate investment recommendations from another party. We're also continuing to expand the user base for Morningstar Direct by enhancing capabilities for our existing asset management clients and adding workflows for new types of clients, such as financial advisors.

The PitchBook Platform is an all-in-one web-based research and analysis workstation centered on the private capital markets, including venture capital, private equity, and mergers and acquisitions. The PitchBook Platform also offers a mobile application, Excel plug-in, Chrome extension and optional CRM integrations, all designed to help users source deals, raise funds, build buyer lists, create benchmarks, network, and more. 

In 2017, we introduced several high-impact data and technology enhancements. Morningstar’s in-depth public company fundamental data and institutional equity research were integrated into the platform, which when combined with PitchBook’s best-in-class private market data, offers seamless access to cross-market insights, allowing institutional investors to better capitalize on opportunities in both public and private markets. We also doubled our private European company coverage.

In 2017, PitchBook also launched a new interface and user experience, creating a more scalable product and helping users quickly uncover trends and opportunities. For example, the new Chrome extension allows users to instantly view hard-to-find company data while browsing other web content, thereby creating efficiency and value for users in their research. 

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. Leveraging our existing capabilities, we create holistic solutions that help financial advisors, asset managers, and individual investors with portfolio construction, monitoring, security selection, and implementation.

Our investment management solutions include Morningstar Managed Portfolios, which had $39.8 billion in assets under management and advisement as of December 31, 2017, and Workplace Solutions (formerly Retirement Solutions), which had a total of $128.1 billion in assets under management and advisement.

We also expect to expand the investment management solutions we offer through our index business. We currently offer more than 580 investment indexes that can be used for both benchmarking and product creation.


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Major Customer Groups

Given the core capabilities discussed above, we're focusing on five primary customer groups:

Advisor (including independent financial advisors as well as those affiliated with broker-dealers or other intermediaries);
Asset management (including fund companies, insurance companies, and other companies that build and manage portfolios of securities for their clients);
Workplace/retirement (including retirement plan providers and plan sponsors);
Individual investor; and
Institutional investor.

Advisor

Financial advisors work with individual investors to help them reach their financial goals. This customer group includes 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. Such broker-dealers include wirehouses, regional broker-dealers, and banks. The advisor landscape is broad in both the United States, and in other parts of the world where we focus. The U.S. is our largest market, and in total, Cerulli Associates estimates there were approximately 313,000 financial advisors in the U.S. as of the end of 2017.

We believe our deep understanding of individual investors’ needs allows us to work with advisors to help them make more efficient use of their time and deliver better investment outcomes for their clients. Our advisor solutions also draw on Morningstar’s proprietary investment research methodologies and research insights.

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.

We're expanding the range of services we offer to help financial advisors with all aspects of their daily workflow needs, including investment decision-making, portfolio construction, client monitoring and reporting, practice management, portfolio rebalancing that connects with custodial and trading interfaces, and financial planning. Because advisors are increasingly outsourcing investment management, we're continuing to enhance Morningstar Managed Portfolios to help advisors save time and reduce compliance risk.

Our main products for financial advisors are Morningstar Advisor Workstation (including Morningstar Office) and Morningstar Managed Portfolios.


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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 and research.

Our asset management offerings help companies connect with their clients because of Morningstar’s strong brand presence with both financial advisors and individual investors. We offer a global reach and have earned investors’ trust in our unbiased approach, investor-centric mission, and thought leadership.

The key products we offer for asset management firms include Morningstar Direct, Morningstar Data, and Morningstar Indexes. For the buy side, key products include Morningstar Research, Morningstar Credit Ratings, Morningstar Data, and Morningstar Direct.

Workplace/retirement

In the U.S. workplace (also known as 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 in the United States. Assets in 401(k) plans totaled an estimated $5.6 trillion as of December 31, 2017, based on data from Cerulli Associates. In the wake of the financial crisis of 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 provide administrative and record-keeping services) and directly to plan sponsors (employers that offer retirement plans to their employees).

Our main product offerings for the workplace/retirement customer group include retirement advice and managed accounts, fiduciary services, and custom models.

Individual investor

We offer products for individual investors who invest to build wealth and save for other goals, such as retirement or college tuition. A Gallup survey released in April 2017 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.

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 or want to validate the advice they receive from brokers or financial advisors.

Our main product for individual investors is Morningstar.com, which includes both paid Premium Memberships and free content available to registered users and visitors. We also reach individual investors through investment newsletters, iPad and mobile applications, and through licensing our content to other websites, such as Yahoo Finance, MSN Money, and Google Finance.

Institutional investor

Through PitchBook Data, Inc. (PitchBook), which we acquired in December 2016, we reach approximately 2,700 investment and research firms and their service providers, including venture capital and private equity firms, corporate development teams, investment banks, limited partners, lenders, law firms, and accounting firms. These clients use PitchBook’s platform to access data, discover new connections, and conduct research on potential investment opportunities.

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PitchBook covers the full lifecycle of venture capital, private equity, and mergers and acquisitions (M&A), including the limited partners, investment funds, and service providers involved. Our main product for this customer group is the PitchBook Platform, an all-in-one research and analysis workstation for sophisticated investment and business professionals.

Acquisitions and Divestitures

Since our founding in 1984, we've supported our organic growth by introducing new products and services and expanding our existing offerings. From 2006 through 2017, we also completed 30 acquisitions to support our growth objectives. In July 2017, we acquired a minority stake in Sustainalytics Holding B.V., an independent ESG and corporate governance research, ratings, and analysis firm supporting investors around the world with the development and implementation of responsible investment strategies. In June 2017, we sold HelloWallet.

For more information about our acquisitions, refer to Note 7 of the Notes to our Consolidated Financial Statements.
For more information about our investments in unconsolidated entities, refer to Note 9 of the Notes to our Consolidated Financial Statements. For more information about our divestiture, refer to Note 8 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 2017 revenue).

Morningstar Data

Morningstar Data gives institutions access to a full range of investment data spanning numerous investment databases, including real-time pricing and market data. We offer licenses and data feeds for 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 also offer Morningstar Data for equities, including financial statement data, consolidated industry statistics, stock ownership information, and proprietary Morningstar statistics.

In 2017, we added several new sets of data to our suite of offerings, including the expansion of our equity data, which added over 1,000 new data elements. We also advanced our fixed income capabilities, expanding portfolio level data and new analytics for funds. We’ve continued developing our data delivery platforms, including application programming interfaces (APIs), which allow for faster and more flexible client access to large groups of data files. We’ve expanded the number of data sets that are available through APIs and expanded the scope of data provided at the request of our clients.

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.

Our main competitors for Morningstar Data include Activ Financial, Bloomberg, FactSet, Financial Express, Interactive Data, S&P Global, Thomson Reuters, and Xignite.

Morningstar Data is our largest product based on revenue and accounted for 17.9%, 19.0%, and 18.3% of our consolidated revenue in 2017, 2016, and 2015, respectively.


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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. It helps portfolio managers, investment consultants, financial product managers, wealth managers, and other professionals develop, select, and monitor investments. Users can create advanced performance comparisons and in-depth analyses of an investment's underlying investment style, as well as custom-branded reports and presentations.

In 2017, we further developed Morningstar Direct Cloud (the next-generation version of Morningstar Direct). These ongoing development efforts include rebuilding the platform to make it purely web-based and retooling existing capabilities to support users' daily workflow needs.

We also enhanced the data and research capabilities offered in Morningstar Direct during the year. For example, we expanded the Morningstar Sustainability Rating for funds, which helps investors evaluate mutual funds and ETFs based on how well the companies held in their portfolios are managing their environmental, social, and governance (ESG) risks and opportunities. We also introduced a new Global Risk Model into Direct Cloud, which helps investors understand and visualize the underlying factors that can drive the risk of a stock or portfolio and run scenario analysis to analyze returns.

Morningstar Direct's primary competitors are Bloomberg, eVestment Alliance, FactSet Research Systems, Thomson Reuters, and Zephyr Associates.

Morningstar Direct had approximately 13,900 licensed users worldwide as of December 31, 2017.
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 $18,000 for the first user, $11,500 for the second user, and $9,800 for each additional user.

Morningstar Direct is our second-largest product based on revenue and accounted for 13.6%, 13.8%, and 12.9% of our consolidated revenue in 2017, 2016, and 2015, respectively.

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Morningstar Investment Management

This product line includes several different offerings, including Morningstar Managed Portfolios, as well as services for institutional asset management, asset allocation, and manager selection.


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Morningstar Managed Portfolios are widely available as strategist models on third-party managed account platforms and through a fee-based discretionary asset management service also known as a turn-key asset management program (TAMP). In the United States, we offer this service through Morningstar Investment Services LLC, a registered investment advisor, registered broker/dealer, member of the Financial Industry Regulatory Authority, Inc. (FINRA), and wholly owned subsidiary of Morningstar, Inc. Our portfolios are built using mutual funds, ETFs, and equities and tailored to meet specific investment time horizons, risk levels, and outcomes. We offer Morningstar Managed Portfolios mainly through fee-based independent financial advisors. These advisors are often affiliated with independent or insurance-related broker-dealers. Morningstar Managed Portfolios are also available in Australia, South Africa, and the United Kingdom.
We also provide other institutional asset management services for asset management firms, broker-dealers, and insurance providers, which we offer through a variety of registered entities in Australia, Canada, Dubai, France, Hong Kong, India, Japan, 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.

These services include institutional asset management, asset allocation, and manager selection services, which are investment recommendations delivered as select lists, based on a process that draws on our rated universe and manager selection methodology.

In 2017, we continued migrating functionality to the new Morningstar Managed Portfolios website from our legacy platform. We also launched a new portfolio series, U.S. Real Return, as part of our outcome-based lineup. These diversified, multi-asset portfolios align their valuation-driven and best-ideas investment approach with the investors’ financial planning needs and goals.

We charge asset-based fees for Morningstar Managed Portfolios, which are typically based on the type of service (i.e., TAMP vs. strategist models) and the products contained within the portfolios. Fees for our mutual fund and ETF portfolios generally range from 20 to 40 basis points. We charge 40 to 55 basis points for Equity Portfolios, which are customizable stock portfolios based on Morningstar's proprietary equity research. We use third-party custodians for Morningstar Managed Portfolios and do not hold the assets in custody.
We base pricing for our other investment management 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.

For Morningstar Managed Portfolios offered through our TAMP, our primary competitors are AssetMark, Brinker Capital, and SEI Investments. Our primary strategist offering competitors are Blackrock, Vanguard, Envestnet PMC and Russell. 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. In our other investment management services, we compete with consulting firms such as Mercer, Callan, and Wilshire Associates, as well as various in-house providers of investment management services.

Morningstar Investment Management is our third-largest product based on revenue and made up 11.6%, 12.3%, and 12.5% of our consolidated revenue in 2017, 2016, and 2015, 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, 2017, 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.


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In 2017, we continued to enhance integrations with several leading third-party platforms to help advisors with all aspects of their daily workflows. We advanced Morningstar Office CloudSM, our cloud-based practice and portfolio management platform for advisors. We also launched our Best Interest Scorecard, a solution designed to help advisors act as fiduciaries for their clients.

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 $3,500 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 $8,000 per firm, on average, for an annual license for Morningstar Office. This average includes a mix of "per account" and "per seat" pricing for access. With the release of our cloud-based platform, we will be more focused on pricing on an account basis versus pricing per user.

Competitors for Morningstar Advisor Workstation and Morningstar Office include Black Diamond, Envestnet, Orion Advisor Services, S&P Global, and Thomson Reuters.

Morningstar Advisor Workstation is our fourth-largest product based on revenue and made up 9.6%, 10.3%, and 10.3% of our consolidated revenue in 2017, 2016, and 2015, respectively.




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Workplace Solutions

This product line includes several different offerings, including retirement advice and managed accounts, fiduciary services and custom models.

Our advice and managed accounts program, delivered primarily through Morningstar Retirement Manager, helps retirement 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 build their own portfolios based on our recommendations or elect to have their accounts managed by us through our managed retirement account offering. We also offer Advisor Managed Accounts, a program that allows financial advisors to specify the portfolios that are used in an employer's managed account offering. We do not hold assets in custody for the managed retirement accounts we provide.


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In our fiduciary services offering, we work with retirement plan providers and sponsors to help them meet their fiduciary obligations by selecting and monitoring a broad range of diversified plan options. With our custom models, we work with retirement plan providers to design solutions for their investment lineups, including target maturity models and risk-based models.

We also serve as a non-discretionary subadvisor and index provider for the Morningstar Lifetime Allocation Funds, a series of target-date collective investment trust funds (CITs) offered by UBS Asset Management to retirement plan sponsors. Retirement plan sponsors can select a conservative, moderate, or growth version of the funds based on the needs of participants in the plan.

In 2017, we further redesigned the user interface of Retirement Manager and transitioned many of our provider clients to the new version.

Pricing for Workplace Solutions depends on several different factors, including the level of services offered (including whether the services involve acting as a fiduciary under the Employee Retirement Income Security Act, or ERISA), the number of participants, the level of systems integration required, and the availability of competing products.

Our main competitors for Workplace Solutions are Financial Engines and Guided Choice as well as companies that provide automated investment advice, such as Betterment and Wealthfront. For the Lifetime Allocation Funds, we compete with other providers of target-date funds, such as Vanguard, Fidelity, and T. Rowe Price.
    
Workplace Solutions is our fifth-largest product based on revenue and made up 8.1% of revenue in 2017, compared with 8.9% in 2016 and 8.4% in 2015.

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PitchBook Data

PitchBook Data, Inc., which Morningstar acquired in December 2016, provides data, research, and technology covering the private capital markets, including venture capital, private equity, and M&A. PitchBook's main product is the PitchBook Platform, an all-in-one research and analysis workstation for sophisticated investment and research professionals. Close to 14,000 professionals use this software to source deals, raise funds, build buyer lists, create benchmarks, network, and more. To accommodate their diverse needs, the platform offers advanced search functionality, a fully customizable dashboard and email alerts that help users discover and monitor relevant information.

PitchBook also offers a mobile application, Excel plug-in, data feeds, and flexible, à la carte data solutions that allow clients to access a variety of data points on demand.


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In 2017, we integrated Morningstar’s in-depth fundamental data and equity research into PitchBook and we now provide comprehensive data coverage and information for publicly traded companies worldwide. PitchBook also significantly expanded its European data sets, doubling private European company coverage to over 340,000 companies. We also launched a new interface for the platform, creating a more scalable and intuitive product to enhance the user experience.

PitchBook's main competitors are CB Insights, Dow Jones VentureSource, Prequin, S&P Capital IQ, and Thomson Reuters.

Pricing for the PitchBook Platform is based on the number of seats, with the standard base license generally priced at $32,500 for the first five seats, and pricing for additional seats generally priced at $6,500 per user, with customized prices for large enterprises, boutiques, and startup firms.

PitchBook is our sixth-largest product based on revenue and made up 7% of revenue in 2017, compared with 0.5% in 2016. Because the PitchBook acquisition closed in December, PitchBook contributed approximately one month of revenue in 2016.

Morningstar.com

Our largest website, Morningstar.com, helps individual investors discover, evaluate, and monitor stocks and funds; build and monitor portfolios; and monitor the markets. Revenue is generated from paid memberships through Morningstar Premium and Internet advertising sales, which respectively made up approximately 53% and 47% of Morningstar.com’s total revenue in 2017.

Our Morningstar Premium offering is focused on bringing clarity and confidence to investment decisions. Members have access to proprietary Morningstar research, ratings, data and tools, including analyst reports, portfolio management tools (such as Portfolio X-Ray), and premium stock and fund screeners.

We currently offer Premium Membership services in Australia, Canada, Italy, the United Kingdom, and the United States.

In 2017, we continued to build out and optimize our redesigned site. The site features a new user interface focused on helping individual investors select and monitor investments. We plan to complete the rollout of the new site during 2018, including a new fund report page and new portfolio and screener experiences.

Morningstar.com primarily competes with The Motley Fool, Seeking Alpha, TheStreet.com, and Yahoo! Finance, as well as other finance and brokerage sites.

As of December 31, 2017, Morningstar.com had about 11.9 million registered free members worldwide. We also had approximately 118,000 paid Premium members in the United States plus an additional 11,000 Premium members across other global markets. 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.



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Morningstar Enterprise Components

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 API 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.

In 2017, we continued to roll out the new Morningstar Developer platform, now known as Morningstar as a Service, which provides clients with direct access to our tools, components, data, calculation engines, and APIs. The site empowers clients by giving them the flexibility to develop their own solutions using Morningstar components.

For Enterprise Components, our primary competitors include Factset, 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 solution being offered, the number of users and level of distribution, and the amount of client integration involved.

Morningstar Research

We offer Morningstar Research, including Equity Research and Manager Research, through Morningstar Research Services LLC and a variety of other subsidiaries outside the United States. 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. Our Manager Research services help institutional investors and manager research due diligence teams evaluate funds, investment strategies, and asset management firms.

During 2017, we continued to evolve our manager research solutions, which help wealth management firms evaluate managed investments and perform due diligence on the products they offer to clients. We also progressed our Morningstar Quantitative Rating, a forward-looking rating assigned by a model that is designed to estimate what the Morningstar Analyst Rating would be on managed products not covered by our manager research analysts.

Our Equity Research services compete with CFRA Research (formerly S&P Capital IQ Equity Research) and Zack's Investment Research, as well as sell-side firms, internal providers, and smaller boutique firms. Our Manager Research services mainly compete with Mercer, Willis Towers Watson, and Wilshire Associates.

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.


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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. We provide ratings on a broad range of structured finance securities, including commercial mortgage-backed securities, residential mortgage-backed securities, single-family rental securities, and asset-backed securities. We also provide ratings for corporate issuers and financial institutions.

In 2017, we expanded our research and ratings, most notably in asset-backed securities, which had a positive impact on financial performance.

Our business competes with several other firms, including DBRS, Fitch, Kroll Bond Ratings, Moody’s, and S&P Global Ratings.

We charge annual fees for our subscription-based CMBS surveillance software and data services, which are paid for by the user. Pricing for these services varies depending on the solution and the level of access within a client organization. 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. In addition to the initial rating fee, clients pay annual surveillance 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 global equity markets, sector, and investment style; strategic beta indexes; dividend indexes; active equity indexes based on Morningstar’s equity research; bond indexes; commodity indexes; hedge fund indexes; asset allocation indexes; and a family of sustainability indexes.

In 2017, we globalized our strategic beta indexes, which included a family of dividend-based indexes and moat-focused indexes that draw upon our proprietary research. We also further developed our Global Sustainability Indexes, which incorporate environmental, social and governance factors into the investment process.

We expanded the Morningstar Open Indexes Project, offering asset managers and other firms the ability to benchmark their investments against more than 100 Morningstar global equity indexes for free. The goal of the project is to lower benchmarking costs for the industry and improve outcomes for investors in response to the escalating cost of market-cap-weighted equity indexes. Participants receive price return, total return, net return, and month-end constituent data for indexes included in the project.

We currently license Morningstar Indexes to numerous institutions that offer ETFs and exchange-traded notes based on the indexes. Firms license Morningstar Indexes for both product creation (where we typically receive the greater of a minimum fee or basis points tied to assets under management) and data licensing (where we typically receive annual licensing fees). In both cases, our pricing varies based on the level of distribution, the type of user, and the specific indexes licensed.

Major competitors for Morningstar Indexes include FTSE Russell, MSCI, and S&P Dow Jones Indices (offered through S&P Global).

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 5 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.


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Intellectual Property and Other Proprietary Rights

We treat our brand name and logo, product names, databases and related content, software, technology, know-how, and the like as proprietary. We seek to protect this intellectual property by using: (i) trademark, copyright, patent and trade secrets laws; (ii) licensing and nondisclosure agreements; and (iii) other security and related technical measures designed to restrict unauthorized access and use. For example, we generally provide our intellectual property to third parties through the use of standard licensing agreements, which 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 generally seek to register one or both of them as trademarks in all relevant international classes in any jurisdiction in which we have business offices or significant operations. We have registered the Morningstar name and/or logo in approximately 50 jurisdictions, including the European Union, and currently have registrations pending in several others. In some jurisdictions, we may also choose to register one or more product names. 

“Morningstar” and the Morningstar logo are both registered marks of Morningstar in the United States. The table below includes some of the trademarks and service marks referenced in this report:
Morningstar® Advisor Workstation SM
 
Morningstar® Portfolio X-Ray®
Morningstar Analyst Rating TM
 
Morningstar Rating™
Morningstar® ByAllAccounts®
 
Morningstar® Retirement Manager SM
Morningstar® Data
 
Morningstar® Stewardship Grade SM
Morningstar Direct SM
 
Morningstar Style Box™
Morningstar® Enterprise Components SM
 
Morningstar Sustainability Rating™
Morningstar® Managed Portfolios SM
 
Morningstar.com®
Morningstar Market Barometer SM
 
PitchBook®
Morningstar Office SM
 
 

In addition to trademark registrations, we currently hold several patents in the United States, including a recently issued patent for a coordinate-based document processing system and several patents held by our wholly owned subsidiary, Morningstar Investment Management LLC, for lifetime asset allocation and asset allocation with annuities.

License Agreements

We license our products and related intellectual property to our customers, generally for a fee. As a rule, we use our standard agreement forms 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 Morningstar operating companies around the world to allow them to access and use our intellectual property, including, without limitation, our products, trademarks, databases and content, technology, and know-how. We put these agreements in place to allow our operating companies to both market standard Morningstar products and services in their operating territories and to develop and sell territory-specific variants of those products under the Morningstar name in their specific 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 providers, developing it internally, and gathering it through publicly available sources (e.g., regulatory 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 offset most of the seasonality in our business.

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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 2017, our largest customer accounted for less than 2% of our consolidated revenue.

Competitive Landscape

The economic and financial information industry includes a few large firms as well as numerous smaller companies, including startup firms. Some of our main competitors include Bloomberg, S&P Global, 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 some of the key 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, technology, 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 adopt new technology that can improve our products and services. 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 technology development and better manage costs, enabling us to respond quickly to market changes and to meet customer needs efficiently. As of December 31, 2017, our technology team consisted of approximately 1,310 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, Morningstar Investment Management LLC, Morningstar Investment Services LLC, and Morningstar Research Services LLC, 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, these subsidiaries are subject to on-site examination by the SEC.

In addition, in cases where these subsidiaries provide investment advisory services to retirement plans and their participants, they may be acting as fiduciaries under 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.

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.


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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. As a registered broker-dealer, Morningstar Investment Services is subject to certain net capital requirements under the Exchange Act. These requirements are designed to regulate 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, corporate credit issuers, and financial institutions. As an NRSRO, Morningstar Credit Ratings 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 Morningstar Investment Management Australia Ltd., are registered under 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.

In addition, our index business, as a non-European Union administrator of indexes, will be seeking recognition from the FCA under EU benchmark regulations that have recently become effective to administer indexes in the EU. Morningstar Investment Management Europe Limited will act as our legal representative for this purpose in the EU. Compliance with these regulations will require us to, among other things, comply with the IOSCO Principles for Financial Benchmarks and related certification requirements.
   
Other Regions

We have a variety of other entities (including in Canada, France, Hong Kong, India, Japan, Korea, and South Africa) 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.

Employees

We had 4,920 employees globally as of December 31, 2017, including approximately 1,050 data analysts, 80 designers, 460 investment analysts (including consulting and quantitative research analysts), 1,310 programmers and technology staff, and 530 sales and marketing professionals. Our U.S.-based employees are not represented by any unions, and we have never experienced a walkout or strike.

Executive Officers

As of March 1, 2018, we had nine executive officers. The table below summarizes information about each of these officers.

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Name
 
Age
 
Position
Joe Mansueto
 
61
 
Executive Chairman
Kunal Kapoor
 
42
 
Chief Executive Officer
Jason Dubinsky
 
44
 
Chief Financial Officer
Bevin Desmond
 
51
 
Head of Talent and Culture
Danny Dunn
 
42
 
Chief Revenue Officer
Haywood Kelly
 
49
 
Head of Global Research
Pat Maloney
 
60
 
General Counsel
Daniel Needham
 
39
 
President and Chief Investment Officer, Investment Management
Tricia Rothschild
 
51
 
Chief Product Officer

Joe Mansueto

Joe Mansueto founded Morningstar in 1984 and became executive chairman in 2017. He has served as chairman of the board since the company's inception. He served as our chief executive officer from 1984 to 1996 and again from 2000 to 2016.

Under Joe’s leadership, Morningstar has been named twice to Fortune magazine’s “100 Best Companies to Work For” list, in 2011 and 2012. The Chicago Tribune recognized Morningstar as one of the top 100 workplaces in the Chicago area in 2010, 2011, and 2012, and Crain’s Chicago Business listed Morningstar in its Fast Fifty feature in 2007, 2008, 2009, and 2011. Morningstar won the 2010 AIGA Chicago Chapter Corporate Design Leadership Award, which recognizes forward-thinking organizations that have advanced design by promoting it as a meaningful business policy.

In December 2016, InvestmentNews named Joe to its list of 20 Icons & Innovators. MutualFundWire.com recognized Joe as one of the 10 most influential individuals in the mutual fund industry in 2015, and he was the recipient of PLANSPONSOR’s Lifetime Achievement Award in 2013. In 2010, Joe received the Tiburon CEO Summit award, MutualFundWire.com named him ninth on its list of the 100 Most Influential People of the year, and Chicago magazine listed Joe among its top 40 Chicago pioneers over the past four decades. In 2007, SmartMoney magazine recognized him in the “SmartMoney Power 30,” its annual list of the 30 most powerful forces in business and finance. He received the Distinguished Entrepreneurial Alumnus Award from the University of Chicago Booth School of Business in 2000.

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.

Kunal Kapoor

Kunal Kapoor is chief executive officer of Morningstar and a member of our board of directors. Before assuming his current role in 2017, he served as president, responsible for product development and innovation, sales and marketing, and driving strategic prioritization across the firm.

Before becoming president in 2015, Kunal was head of global products and client solutions. Kunal became head of our global client solutions group 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.


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Jason Dubinsky

Jason Dubinsky is chief financial officer for Morningstar, responsible for controllership, tax, treasury, internal audit, financial planning and analysis, and investor relations.

Before joining Morningstar in 2017, Jason served as senior vice president and chief financial officer of planning and central operations for Walgreens Boots Alliance, Inc., where he was responsible for accounting and shared service functions for Walgreens' U.S. operations and led the financial planning and analysis function for the global business. Prior to the merger of Walgreens and Alliance Boots in 2014, he was Walgreens' vice president of finance and treasurer, with responsibility for business unit finance, treasury operations, risk management, and investor relations. Before joining Walgreens in 2009, he served as vice president of investment banking at Goldman Sachs and Lehman Brothers, where he led mergers and acquisitions and corporate finance activity for clients across various industries.

Jason holds a bachelor's degree in business administration from the University of Michigan and a master’s degree in business administration from New York University's Stern School of Business.

Bevin Desmond

Bevin Desmond is head of talent and culture, a role she has held since 2010. She is responsible for overseeing talent and culture for all of Morningstar’s global operations. Previously, she was head of global markets from 2010 to 2017 and 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.

Danny Dunn

Danny Dunn is chief revenue officer for Morningstar. He is responsible for sales philosophy, strategy, and execution in order to drive revenue growth.

Before joining Morningstar in 2016, Danny was vice president of the Midwest enterprise unit for IBM, a global information technology firm. He was responsible for marketing, strategy, sales, channels, and customer service for the complete IBM portfolio, including Cloud, Software, Services, Systems, and IBM Credit, LLC in the region. Prior to that, he was regional director for IBM's Chicago enterprise unit in 2013 and 2014, territory director for IBM's Wisconsin business unit from 2011 until June 2013, and territory sales leader for IBM Global Services from 2009 until July 2011. Before joining IBM in 2007, he led sales, account management, and client service at Neology, a software and technology consulting division of SmithBucklin Corporation.

Danny holds a bachelor’s degree from the University of Vermont and a master’s degree in business administration, with concentrations in marketing, strategy, and managerial economics, from the Kellogg School of Management at Northwestern University.

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.

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Pat Maloney

Pat Maloney is general counsel for Morningstar. He is responsible for directing Morningstar’s legal department and managing its relationships with outside counsel. He also oversees Morningstar’s compliance department.

Before joining Morningstar in June 2016, Pat was a partner at Sheppard Mullin Richter & Hampton LLP from July 2012 through April 2016 in the firm’s corporate and securities practice. Previously, he was a partner at K&L Gates LLP and its legacy predecessor firm, Bell, Boyd & Lloyd LLP. Early in his career, he was an associate with the New York law firm of Dewey Ballantine and an Assistant General Counsel with the Prudential Insurance Company of America.

Pat holds a bachelor’s degree with honors from The University of Chicago and a juris doctor degree with honors from The University of Chicago Law School. He is admitted to practice law in Illinois and New York.
Daniel 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.

Tricia Rothschild

Tricia Rothschild is chief product officer for Morningstar. She is responsible for product strategy, innovation, development, and execution for the solutions delivered to clients.

Before taking on her current role in January 2017, Tricia was head of global advisor solutions for Morningstar, setting the strategic direction for our wealth management and online brokerage business and overseeing priorities for this customer group. From September 2012 until February 2013, Tricia was senior vice president of advisor software for Morningstar. Previously, she served as senior vice president for Morningstar's equity research business and held a variety of research and product management roles after joining Morningstar in 1993.

Tricia holds a bachelor’s degree from Northwestern University and a master’s degree in Russian and Central European economics from Indiana University. She also holds the CFA designation.

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://www.morningstar.com/company. 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, Morningstar Investment Management LLC, Morningstar Investment Services LLC, and Morningstar Research Services LLC, 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, these subsidiaries are subject to on-site examination by the SEC.

In addition, in cases where these subsidiaries provide investment advisory services to retirement plans and their participants, they may be acting as fiduciaries under 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. Such activities have been the subject of increasing class action litigation in recent years. For example, in 2017, a participant in a pension plan filed a putative class action proceeding against us alleging that we, together with other defendant parties, violated the Racketeer Influenced and Corrupt Organizations Act by allegedly engaging in actions to steer plan participants into high-cost investments that pay unwarranted fees to the defendants. We are vigorously contesting this proceeding, which is described in more detail in Item 3 of this Form 10-K under Legal Proceedings. As of December 31, 2017, we had $57.6 billion in assets under management in our managed retirement accounts. We could face substantial liabilities related to our management of these assets.

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, or based on our investment management fees and expenses. In total, we provided investment advisory and management services on approximately $195 billion in assets as of December 31, 2017. We could face substantial liabilities related to our work on these assets.


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Failing to maintain and protect our brand, independence, and reputation may harm our business. Our reputation and business may also be harmed by allegations made about possible conflicts of interest or by other negative publicity or media reports.

We believe independence is at the core of our business, and our reputation is our greatest corporate asset. We rely 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 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 any negative publicity or media reports about Morningstar, whether valid or not, may harm our reputation and damage our business. For instance, in October 2017, The Wall Street Journal ran an article critical of our fund star and analyst ratings. We publicly and comprehensively disputed the assertions made in the article, but the publication of such an article illustrates the risks of negative publicity to our business.
 
We provide ratings, analyst research, and investment recommendations on mutual funds and other investment products offered by our institutional clients. We also provide investment advisory and investment management services. In some cases, we make investment recommendations (such as Select Lists) within the framework of client constraints. While we don’t charge asset management firms for their products to be rated, we do charge licensing fees for the use of our ratings. We also receive payments from issuers for our new-issue ratings on various types of asset-backed securities and corporate bond issues. These payments 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 34 years to our ability to develop innovative, proprietary research tools, such as the Morningstar Rating, Morningstar Style Box, Ownership Zone, and Portfolio X-Ray. More recently, we’ve developed unique concepts and tools such as the Wealth Forecasting Engine, Gamma, Total Wealth Approach, and Best Interest Scorecard. We believe these innovations set us apart because most of our competitors focus on providing data or software rather than creating their own proprietary research frameworks. We also believe our ability to develop innovative, proprietary research tools is at the core of what drives Morningstar’s value for all of our customer groups.

If we fail to continuously innovate and develop new tools to meet the needs of our customers, our competitive position and business results may suffer. In addition, our reputation could be harmed if we’re perceived as not moving quickly enough to meet the changing needs of investors. Clients may also delay purchases of our currently offered research tools in anticipation of us offering new products or enhanced versions of existing products. Our competitive position and business results may also suffer if other companies are able to successfully introduce innovative, proprietary research tools that gain attention from our clients. We believe lower technology costs, the growth of open software platforms, and cloud computing technologies have lowered the barriers to entry for new competitors, making it easier for new players to enter the market. Smaller companies, including startup firms funded by private equity and venture capital, may be able to move more quickly to develop research and tools that gain a wide following.

In addition, the value of our data, research and software tools may be negatively affected by the increasing amount of information and tools that are available for free, or at low cost, through internet sources or other low-cost delivery systems. Although we believe our products and services contain value-added features and functionality that deeply embed them in our customers’ workflows, such developments may over time reduce the demand for, or customers’ willingness to pay for, certain of our products and services.

If we fail to introduce innovative, proprietary research tools and frameworks, we may not generate enough interest from potential clients to win new business. We cannot guarantee that we will successfully develop new product features and tools that differentiate our product offerings from those of our competitors.

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In addition, we must make long-term investments and commit significant resources often before knowing whether such investments will result in products or services that satisfy our clients’ needs or generate revenues sufficient to justify such investments. In addition, from time to time, we also incur costs to transition clients to new or enhanced products or services. Such transitions can involve material execution risks and challenges. If we are unable to manage these investments and transitions successfully, our business, financial condition, and results of operations could be materially adversely affected.

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 computing to cloud-based systems, the proliferation of wireless mobile devices, and rapid acceleration in the use of social media platforms.

Our software development process is based on frequently rolling out new features so that we can quickly incorporate user feedback. While some changes in technology may offer opportunities for Morningstar, we cannot guarantee that we will successfully adapt our product offerings to meet evolving customer needs. If we fail to develop and implement new technology rapidly enough, we may sacrifice new business opportunities or renewals from existing customers. We may also incur additional operating expense if major software projects take longer than anticipated. Our competitive position and business results may suffer if we fail to develop new technologies to meet client demands, if our execution speed is too slow, or if we adopt a technology strategy that doesn't align with changes in the market.

Our results could suffer if the mutual fund industry continues to experience slower growth, if actively managed equity funds continue to attract less investor attention, or if the industry continues to meaningfully consolidate.

We generate a significant portion of our revenue from products and services related to mutual funds, and part of our growth since 1984 can be attributed to favorable industry trends. The mutual fund industry has experienced substantial growth over the past 30 to 40 years, but suffered during the market downturn of 2008 and 2009. Since then, fund assets have increased, but at a slower rate than in previous years. Some of that slower growth is attributable to the growth of ETFs as a mutual fund alternative, and we have accordingly expanded our research coverage and analyst ratings to include ETFs. However, ETFs generally track passive investing strategies and charge lower management fees than active strategies, which may affect both the profitability of asset managers, on whose success we in part depend, and the perceived value of our research regarding ETFs.

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 has accelerated in recent years. In 2017, actively managed mutual funds suffered about $7 billion in net outflows, compared with net inflows of more than $690 billion for passively managed funds. Overall, we estimate that passively managed portfolios now account for more than one-third of combined mutual fund and ETF assets. The growth of online wealth management tools that provide automated, algorithm-based portfolio management advice, sometimes called robo-advice, may further accelerate the adoption of passively managed portfolios and reduce demand for our data and analyst research.

The growth of the mutual fund industry is also being affected by increasing merger and acquisition activity within the asset management industry, which is reducing the number of asset managers offering mutual funds and ETFs, the pruning by some mutual fund and ETF platforms of the number of funds available for purchase, and the continuing impacts of regulation, such as MiFID II’s requirement that asset managers pay banks and brokers for investment research, which may be a competitive advantage for larger asset managers better able to absorb such costs.
Prolonged 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, including our software, data, and analyst research.


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Our business continuity program may not be adequate in the event of a material emergency affecting one or more of our United States or offshore business centers or adverse political or regulatory developments in countries in which we have significant data and development operations.

We have approximately 1,360 employees working at our corporate headquarters in Chicago, Illinois. These include most of our executive leadership team as well as substantial numbers of employees involved in the delivery of most of our major products and services. If our headquarters were to become unusable due to a natural disaster, a violent incident or another dangerous emergency, we might not be able to continue business operations at an acceptable level that would meet all our legal and contractual commitments. Our failure to successfully implement and deploy a business continuity plan, either at an enterprise level or with respect to particular business centers, could materially affect our business operations and have a material adverse effect on our financial condition and results of operations.

We now have approximately 950 employees working in our data and technology development center in Shenzhen, China. We rely on these employees to maintain and update our mutual fund database and work on other projects. Because China has a restrictive government under centralized control and the relationship between the United States and China is experiencing a period of increased political, military, and commercial tensions, our operations are subject to political and regulatory risk, which is inherently unpredictable. Laws and regulations relating to data privacy, security, and protection of intellectual property rights in China, as well as the enforcement environment for such laws and regulations, are in certain cases uncertain and evolving. In addition, this facility is subject from time to time to extreme weather events. The concentration of certain types of development and data work carried out at this facility also involves operational risks for parts of our network infrastructure. While we have short-term backup plans in place, it would be difficult for us to maintain and update our mutual fund database if we were unable to access our Shenzhen operations for an extended period of time. Any difficulties that we face in continuing to operate our development center in China may harm our business and have a negative impact on the products and services we provide.

We have approximately 935 employees who work at our data collection, technology and operational center in Mumbai, India. These employees maintain and update our equity database and provide shared services to many of our operations. This location is subject to extreme weather events and political unrest, including public protests which can disrupt transportation and make it difficult for employees to commute to and from work. The electrical infrastructure of Mumbai is also subject to more frequent interruptions than are experienced at our other major facilities. In addition, Mumbai has experienced and may in the future experience terrorist attacks. While we have short-term backup plans in place to address such business continuity issues, it would be challenging for us to maintain and update our equity database or continue to provide certain shared services to our worldwide operations if we were unable to access our Mumbai operations for an extended period of time.

PitchBook, which we acquired in December 2016, has approximately 230 contract employees based in Calcutta and Pune, India who support its data and research operations and approximately 100 contract employees based in Ukraine who work on software development. Ukraine has been subject to significant political unrest and military incursions. Any disruption to PitchBook's contract operations in these locations would make it difficult for PitchBook to meet its operating goals.

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. In addition, we handle increasing amounts of personally identifiable information in areas such as Morningstar Retirement Manager, Morningstar Managed Portfolios, ByAllAccounts, Morningstar Office, Enterprise Data Management, and Morningstar.com. ByAllAccounts uses technology to collect, consolidate, and transform financial account data and deliver it to any platform, and accordingly handles a large volume of personally identifiable information as part of its normal business operations.


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Any failure to safeguard this information could damage our reputation and business results. We must continuously invest in systems, processes, and controls to guard against the risk of improper access to this information, which could be disclosed through employee errors, other inadvertent release, social engineering, failure to restrict access, or failure to properly purge and protect data. We may suffer malicious attacks by individuals or groups seeking to attack our products and services or penetrate our network and databases to gain access to personal data or to launch or coordinate distributed denial of service attacks. These attacks have become increasingly frequent, sophisticated, and difficult to detect.

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. In the European Union, the General Data Protection Regulation (GDPR), which will become effective in May 2018, will among other things impose stringent additional requirements regarding the information to be provided to, and the consents required from, individuals to justify a business using their personal data, as well as new rights of data subjects to be forgotten, data portability rights and the right to object to certain automated decision-making processes. Given the growing concern over data privacy and identity theft, we have been and expect to continue to be subject to increased scrutiny by clients and regulators. We could be subject to liability if we were to inappropriately collect, retain, or 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. We could also be subject to liability if we fail to meet the requirements of laws and regulations such as the GDPR, which contemplate substantial enterprise-level penalties for non-compliance, in a timely or thorough manner.

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 comply with securities laws and other regulatory requirements, we may be subject to fines or other events that could have a negative effect on our business.

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, corporate credit issuers, and financial institutions. Credit rating and research providers continue to be subject to intensive regulatory scrutiny. 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, as well as periodic investigations by the SEC and other governmental authorities relating to matters of regulatory interest such as industry practices and personnel matters. The cost and management distraction resulting from such examinations and investigations may have a negative effect on our credit rating business.

Our index business could be negatively affected by increased regulation of benchmarks generally, which could increase the costs and risks of producing and administering indexes. Such regulations may discourage market participants from continuing to use, administer or contribute to indexes, trigger changes in the rules or methodologies relating indexes, and/or lead to declining demand for indexes.

The laws, rules, and regulations, and their interpretations, applicable to our business may change in the future, and we may not be able to comply with these changes without extensive changes to our business practices. In addition, the broad scope of our business operations makes it more difficult to monitor areas that may be subject to regulatory and compliance risk. If we fail to comply with any applicable law, rule, or regulation, we could be fined, sanctioned, or barred from providing investment advisory, credit rating or index services in the future, which could adversely affect our business.


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An outage of our database, technology-based products and services, or network facilities could result in reduced revenue and the loss of customers, and our movement of parts of our technological infrastructure to the public cloud could expose us to various third party provider risks

The success of our business depends upon our ability to deliver time-sensitive, up-to-date data and information. We rely primarily on our computer equipment, database storage facilities, and other network equipment, which is located across multiple facilities in the United States. We also have extensive information systems outside the United States. Our mission-critical databases and networks are complex and interdependent, which increases the risk of failure. Problems in our network systems may lead to cascading effects involving product downtime, overloading of third-party data centers, and other issues that may affect our clients. Many of our client contracts contain service-level agreements that require us to meet certain obligations for delivering time-sensitive, up-to-date data and information. We may not be able to meet these obligations in the event of failure or downtime in our information systems.

Our operations and those of our suppliers and customers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, computer viruses, and other events beyond our control. Our database and network facilities may also be vulnerable to external attacks that misappropriate our data, corrupt our databases, or limit access to our information systems. To defend against these threats, we implement a series of controls focusing on both prevention and detection, including firewalls, intrusion detection systems, automated scanning and testing, server hardening, anti-virus software, training, and patch management. We make significant investments in servers, storage, and other network infrastructure to prevent incidents of network failure and downtime, but we cannot guarantee that these efforts will work as planned.

Most of our products and services currently depend heavily on our electronic delivery systems and the Internet, although we are shifting the delivery of several of our products and services to cloud-based delivery systems. Our ability to deliver information using the Internet may be impaired because of infrastructure failures, service outages at third-party Internet providers, malicious attacks, or other factors. If disruptions, failures, or slowdowns of our electronic delivery systems or the Internet occur, our ability to distribute our products and services effectively and to serve our customers may be impaired.

We maintain off-site back-up facilities for our data, but we cannot guarantee that these facilities will operate as expected during an interruption that affects our headquarters. There may be single points of failure that affect our core databases, data transfer interfaces, or storage area networks. We may not be able to fully recover data or information lost during a database or network facility outage. Any losses, service disruption, or damages incurred by us could have a material adverse effect on our business, operating results, or financial condition.

Our gradual movement of parts of our technological infrastructure to the public cloud and software as a service (SaaS) solutions presents a variety of additional risks, including risks relating to sharing the same computing resources with other users, the use by cloud and SaaS providers of virtualization products and various security issues relating thereto, reliance on cloud and SaaS providers’ authentication, authorization and access control mechanisms, a lack of control over cloud and SaaS providers’ redundancy systems and fault tolerances, and a reduced ability to directly address client concerns over data security and privacy. Any disruption of or interference with our use of the public cloud or SaaS solutions, or any information security breach at any cloud or SaaS provider, could materially impact our operations and have an adverse effect on our business. Over time, a growing dependence of our technology infrastructure on the public cloud and SaaS solutions also risks us becoming overly dependent on particular suppliers, which could adversely affect the pricing we receive from such suppliers and limit our ability to transition away from such suppliers in the event of service-quality issues.

Downturns in the financial sector, global financial markets, and global economy may hurt our results, resulting in lower revenue from asset-based fees, transaction-based revenue, or other parts of our business.

Our business results are partly driven by factors outside of our control, including general economic and financial market trends. Any unfavorable changes in the environment we operate in could cause a corresponding negative effect on our business results. As a result, we may experience lower revenue, operating income, and other financial results in the event of a market downturn.


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Many of our customers are asset management firms and other financial services companies, which are also subject to external trends and changes. For example, the financial crisis of 2008 and 2009 led to spending cutbacks among many of the companies to which we sell. 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, and merger and acquisition activity in the asset management sector has in the past, and may in the future, reduce the number of potential asset management clients.

Many companies in the financial services industry have also been subject to increasing government regulation and pressure to reduce fees. In turn, many of these firms have sought to reduce their operating costs by working with fewer service providers and/or negotiating lower fees for services they purchase.

In addition, our revenue from asset-based fees may be adversely affected by market declines, cash outflows from portfolios that we help manage, and the industry-wide trend toward lower asset-based fees.

In 2017, asset-based revenue made up approximately 21% of our consolidated revenue. The amount of asset-based revenue we earn primarily depends on the value of assets on which we provide advisory services, and the size of our asset base can increase or decrease along with trends in market performance. In 2017, the U.S. and many international markets experienced substantial valuation increases. These market trends were highly favorable in terms of the value of assets we have under management or advisement, but there can be no assurance that these trends will continue and, if they do not, our asset-based revenue may be negatively affected.

Asset levels can also be affected if net inflows into the portfolios on which we provide investment advisory services drop or if these portfolios experience redemptions. A drop in net inflows or an increase in redemptions can result from a variety of factors, including overall market conditions and volatility or a decline in investment performance. If the level of assets on which we provide investment advisory or investment management services goes down, we expect our fee-based revenue to show a corresponding decline.

Our business results may also be hurt by negative trends in Internet advertising sales, which made up about 3% of consolidated revenue in 2017. Many advertisers have shifted some of their advertising spend to programmatic buying platforms that target users on other sites, which has from time to time had a negative effect on advertising revenue for our website for individual investors, Morningstar.com. We are uncertain whether this trend will continue.

Our structured credit rating business, which made up about 3% of consolidated revenue in 2017, is subject to volatility from trends in new issuance of commercial mortgage-backed securities and other structured credits. If industry-wide issuance for such securities declines, our revenue associated with this line of business may also go down. We have also expanded our coverage to include corporate credit issuers and financial institutions, which are also subject to volatility in issuance patterns based on market conditions.

Our PitchBook Data business may also be subject to cyclical trends. Many of PitchBook's clients are investment banks and other participants in the capital and merger and acquisition markets, which are subject to periodic business downturns driven by changes in such markets. During these downturns, they often seek to reduce spending on third-party services as well as the number of employees, which would directly affect the number of prospective clients for PitchBook. As a data and research provider focusing on the private capital markets (including venture capital, private equity, and M&A), PitchBook may also be subject to volatility based on the amount of activity and market interest in these areas.

Our acquisitions and other investments may not produce the results we anticipate. We have also incurred debt in connection with acquisitions, which may limit our financial flexibility.

We've completed numerous acquisitions over the past 10 years. In 2016, we acquired PitchBook. This acquisition presents several potential challenges and risks. We may not achieve the growth targets that we established for PitchBook at the time of the acquisition. The process of integration may require more resources than we anticipated. We may assume unintended liabilities or experience operating difficulties or costs that we did not anticipate. We may also fail to retain key personnel of the acquired business, including PitchBook founder and chief executive officer John Gabbert, which would make it difficult to follow through on our operating goals for the acquisition. If our acquisition of PitchBook does not generate the results we anticipate, it could have a material adverse effect on our business, financial condition, and results of operations. We may also fail to generate enough revenue or profits from this acquisition to earn a positive return on the associated purchase price.

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To fund this acquisition, we increased the principal amount available for borrowing under our existing revolving credit facility to $300.0 million and extended the term of this facility to three years. Under the terms of our agreement with the lender, we are now subject to certain restrictions and financial covenants, which may limit our financial flexibility. As of December 31, 2017, borrowings in the principal amount of $180.0 million remain outstanding under such facility.

In 2017, we purchased a 40% interest in Sustainalytics Holding B.V. (Sustainalytics), a leading global provider of environmental, social and governance (ESG) research and ratings. While we obtained various rights in connection with that investment, including representation on Sustainalytics’ Board of Directors, we do not own a controlling interest in Sustainalytics and the future value of our investment is highly dependent on the management skill of the managers of Sustainalytics.

We expect to continue making acquisitions and establishing investments and joint ventures as part of our long-term business strategy. Acquisitions, investments, and joint ventures involve a number of risks. They can be time-consuming and may divert management’s attention from day-to-day operations, particularly if numerous acquisitions are in process at the same time. Financing an acquisition could result in dilution from issuing equity securities, reduce our financial flexibility because of reductions in our cash balance, or result in a weaker balance sheet from incurring debt.

Our future success depends on our ability to recruit, develop, and retain qualified employees.

We experience competition for analysts, technology experts, and other employees from other companies and organizations. Competition for these employees is intense, and we may not be able to retain our existing employees or be able to recruit and retain other highly qualified personnel in the future.

Our future success also depends on the continued service of our executive officers, including Joe Mansueto, our executive chairman and controlling shareholder. At the end of 2016, Joe changed his role to focus less on our day-to-day business operations, but he remains heavily involved our strategy and overall company direction. The loss of Joe, our chief executive officer, Kunal Kapoor, 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.

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 $224.7 million in revenue in 2017, or about 25% 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 or the reports and other documents produced by our software products, including information, reports and documents 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 issuers of structured credits and corporate credits. 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. Clients of our software products used by advisors or asset managers or governmental regulation of such clients may make claims against us based on software or data errors that affect investment reporting or client billing. Even though most of our contracts for such products contain limitations of our liability in such cases, we may be required to make such clients or their customers whole for any losses in order to maintain our business relationships. We could also be subject to claims based on the content that is accessible from our website through links to other websites.

We rely on a variety of outside parties as the original sources for the information we use in our published data. These sources include securities exchanges, fund companies, hedge funds, transfer agents, and other data providers. We also incorporate data from a variety of third-party sources for PitchBook Data. 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.

We could be subject to claims by providers of publicly available data and information we compile from websites and other sources that we have improperly obtained that data in violation of the source’s copyrights or terms of use, or based on the provisions of new legislation such as GDPR that limits the bases on which businesses can collect personal information from and about individuals. We could also be subject to claims from third parties from which we license data and information that we have used or re-distributed the data or information in ways not permitted by our license rights. 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.

Failure to protect our intellectual property rights, or claims of intellectual property infringement against us, could harm our brand and ability to compete effectively.

The steps we have taken to protect our intellectual property may not be adequate to safeguard our proprietary information. We rely primarily on patent, trademark, copyright and trade secret rights, as well as contractual protections and technical safeguards, to protect our intellectual property rights and proprietary information. Despite these efforts, third parties may still attempt to challenge, invalidate or circumvent our rights or improperly obtain our proprietary information. Further, effective trademark, copyright, and trade secret protection may not be available in every country in which we offer our services. Failure to adequately protect our intellectual property could harm our brand, devalue our proprietary content, and affect our ability to compete in the marketplace.

From time to time, we encounter jurisdictions in which one or more third parties have a pre-existing trademark registration in certain relevant international classes that may prevent us from registering our own marks in those jurisdictions. Our continued ability to use the “Morningstar” name or logo, either on a stand-alone basis or in association with certain products or services, could be compromised in those jurisdictions because of these pre-existing registrations. Similarly, from time to time, we encounter situations in certain jurisdictions where one or more third parties are already using the Morningstar name, either as part of a registered corporate name, a registered domain name or otherwise. Our ability to effectively market certain products and/or services in those locations could be adversely affected by these pre-existing usages.

We have from time to time been subject to claims by third parties alleging infringement of their intellectual property rights. Such claims can also be alleged against clients, customers, or distributors of our products or services whom we have agreed to indemnify against third party claims of infringement. The defense of such claims can be costly and consume valuable management time and attention. We may be forced to settle such claims on unfavorable terms, which can include the payment of damages, the entry into royalty or licensing arrangements on commercially unfavorable terms, or the suspension of our ability to offer affected products or services. If litigation were to arise from any such claim, there can be no certainty we would prevail in it. If any of these risks were to materialize, it could have a material adverse effect on our business, financial condition or results of operations.


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Control by a principal shareholder could adversely affect our other shareholders.

As of December 31, 2017, Joe Mansueto, our executive chairman, owned approximately 57% of our outstanding common stock. As a result, he has the ability to control substantially all matters submitted to our shareholders for approval, including the election and removal of directors and any merger, consolidation, or sale of our assets. He also has the ability to control our management and affairs. This concentration of ownership may delay or prevent a change in control; impede a merger, consolidation, takeover, or other business combination involving Morningstar; discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of the company; or result in actions that may be opposed by other shareholders.

Fluctuations in our operating results may negatively affect our stock price.

We believe our business has relatively large fixed costs and low variable costs, which magnify the impact of revenue fluctuations on our operating results. As a result, a decline in our revenue may lead to a larger decline in operating income. In addition, because we manage our business with a long-term perspective, we generally don’t make significant adjustments to our strategy or cost structure in response to short-term factors. As a result, our operating results may suffer in the short term. In addition, we do not provide earnings guidance or hold one-on-one meetings with institutional investors and research analysts. Because of this policy and limited analyst coverage on our stock, our stock price may not always reflect the intrinsic value of our business and assets. If our operating results or other operating metrics fail to meet the expectations of outside research analysts and investors, the market price of our common stock may decline.

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.


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, 2017, we leased approximately 457,000 square feet of office space for our U.S. operations, primarily for our corporate headquarters located in Chicago, Illinois. We also lease another 435,000 square feet of office space in 26 other countries around the world, including approximately 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.

Item 3. Legal Proceedings
 
Michael D. Green
In August 2017, Michael D. Green, individually and purportedly on behalf of all others similarly situated, filed a complaint in the United States District Court for the Northern District of Illinois. The complaint names as defendants Morningstar, Inc., Prudential Investment Management Services LLC, and Prudential Retirement Insurance and Annuity Co., and contains one count alleging violation of the Racketeer Influenced and Corrupt Organizations Act (RICO). Plaintiff, a participant in a pension plan, alleges that the defendants engaged in concerted racketeering actions to steer plan participants into high-cost investments that pay unwarranted fees to the defendants. The complaint seeks unspecified compensatory damages for plaintiff and the members of the putative class, treble damages, injunctive relief, costs, and attorneys’ fees. Morningstar has filed a motion to dismiss the complaint, which is fully briefed and under advisement by the court. Although Morningstar is vigorously contesting the claim asserted, we cannot predict the outcome of the proceeding.


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Other Matters
We are involved from time to time in legal proceedings and litigation that arise in the normal course of our business. While it is difficult to predict the outcome of any particular proceeding, we do not believe 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:
 
 
 
2017

 
 
2016

 
 
High

Low

 
High

Low

First Quarter
 
$
81.97

$
72.85

 
$
88.66

$
74.78

Second Quarter
 
79.55

68.43

 
89.44

76.57

Third Quarter
 
85.58

77.46

 
85.49

73.84

Fourth Quarter
 
99.11

82.64

 
79.30

67.74


As of February 16, 2018, the last reported sale price on the Nasdaq Global Select Market for our common stock was $96.55 per share, and there were 1,164 shareholders of record of our common stock.

See Note 12 of the Notes to our Consolidated Financial Statements for a description of our equity compensation plans.
 
The following table shows dividends declared and paid for the periods indicated:
 
 
 
2017

 
 
2016

 
 
Dividends declared

Dividends paid

 
Dividends declared

Dividends paid

First Quarter
 
$
0.23

$
0.23

 
$
0.22

$
0.22

Second Quarter
 
0.23

0.23

 
0.22

0.22

Third Quarter
 

0.23

 
0.22

0.22

Fourth Quarter
 
0.48

0.23

 
0.23

0.22


We paid four dividends during 2017. Due to timing, we declared two dividends during the fourth quarter of 2017, one at 23 cents per share and one at 25 cents per share. While subsequent dividends will be subject to board approval, we expect to pay a regular quarterly dividend of 25 cents per share in 2018.

Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent upon our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law, and other factors deemed relevant by the board of directors. Future indebtedness and loan facilities could also prohibit or restrict our ability to pay dividends and make distributions to our shareholders.

Issuer Purchases of Equity Securities
 
Subject to applicable law, we may repurchase shares at prevailing market prices directly on the open market or in privately negotiated transactions in amounts that we deem appropriate.

We had an ongoing authorization, originally approved by our board of directors in September 2010, and subsequently amended, to repurchase up to $1.0 billion in shares of our outstanding common stock. The authorization expired on December 31, 2017. On December 8, 2017, the board of directors approved a new share repurchase program that authorizes the company to repurchase up to $500.0 million in shares of the company's outstanding common stock, effective January 1, 2018. The authorization expires on December 31, 2020.


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The following table presents information related to repurchases of common stock we made during the three months ended December 31, 2017:

Period:
 
Total number
of shares
purchased

 
Average
price paid
per share

 
Total number
of shares
purchased as
part of publicly
announced
programs 

 
Approximate
dollar value of
shares that
may yet be
purchased
under the
programs

October 1, 2017 - October 31, 2017
 

 
$

 

 
$
286,469,896

November 1, 2017 - November 30, 2017
 

 

 

 
$
286,469,896

December 1, 2017 - December 31, 2017
 
13,361

 
96.62

 
13,361

 
$

Total
 
13,361

 
$
96.62

 
13,361

 
 


Rule 10b5-1 Sales Plans

Our directors and executive officers may exercise stock options or purchase or sell shares of our common stock in the market from time to time. We encourage them to make these transactions through plans that comply with Exchange Act Rule 10b5-1(c). Morningstar will not receive any proceeds, other than proceeds from the exercise of stock options, related to these transactions. The following table, which we are providing on a voluntary basis, shows the Rule 10b5-1 sales plans entered into by our directors and executive officers that were in effect as of February 15, 2018:
Name and Position
 
Date of
Plan
 
Plan Termination Date
 
Number of
Shares
to be
Sold under
the Plan

 
Timing of Sales under the Plan
 
Number of Shares Sold under the Plan through February 15, 2018

 
Projected
Beneficial
Ownership (1)

 
Gail Landis Director
 
11/3/2017
 
5/1/2019
 
1,531

 
Shares to be sold under the plan if the stock reaches specified prices

 

 
3,172

 

During the fourth quarter of 2017, the previously disclosed Rule 10b5-1 sales plan for Steven Kaplan, Gail Landis, and Jack Noonan completed in accordance with their terms.
_______________________________
(1) This column reflects an estimate of the number of shares Gail Landis 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, 2017, and includes shares of our common stock subject to options that were then exercisable or that will have become exercisable by March 1, 2018 and restricted stock units that will vest by March 1, 2018. The estimates do not reflect any changes to beneficial ownership that may have occurred since December 31, 2017. Gail may amend or terminate her Rule 10b5-1 sales plan and may adopt additional Rule 10b5-1 plans in the future.


37


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, 2017, 2016, and 2015 and Consolidated Balance Sheet Data as of December 31, 2017 and 2016 from our audited Consolidated Financial Statements included elsewhere 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, 2014 and 2013 and Consolidated Balance Sheet Data as of December 31, 2015, 2014, and 2013 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 millions except per share amounts)
 
2013

 
2014

 
2015

 
2016

 
2017

 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
698.3

 
$
760.1

 
$
788.8

 
$
798.6

 
$
911.7

 
Operating expense
 
527.6

 
654.5

(1)
598.2

 
617.8

 
741.9

 
Operating income
 
170.7

 
105.6

(1)
190.6

 
180.8

 
169.8

 
Non-operating income, net
 
7.3

 
8.4

 
3.1

 
44.1

(2)
11.3

(2)
Income before income taxes and equity in net income of unconsolidated entities
 
178.0

 
114.0

 
193.7

 
224.9

 
181.1

 
Equity in net income (loss) of unconsolidated entities
 
1.4

 

 
1.8

 
(0.2
)
 
(1.3
)
 
Income tax expense
 
56.0

 
35.7

 
62.7

 
63.7

 
42.9

 
Consolidated net income
 
123.4

 
78.3

 
132.8

 
161.0

 
136.9

 
Net (income) loss attributable to noncontrolling interests
 
0.1

 

 
(0.2
)
 

 

 
Net income attributable to Morningstar, Inc.
 
$
123.5

 
$
78.3

 
$
132.6

 
$
161.0

 
$
136.9

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per share attributable to Morningstar, Inc.:
 
 
 
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
2.68

 
$
1.75

 
$
3.00

 
$
3.74

 
$
3.21

 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
2.66

 
$
1.74

 
$
3.00

 
$
3.72

 
$
3.18

 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends per common share:
 
 
 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.545

 
$
0.700

 
$
0.790

 
$
0.890

 
$
0.940

 
Dividends paid per common share
 
$
0.375

 
$
0.680

 
$
0.760

 
$
0.880

 
$
0.920

 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Basic
 
46.2

 
44.7

 
44.2

 
43.0

 
42.7

 
Diluted
 
46.5

 
44.9

 
44.3

 
43.3

 
43.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

38


Consolidated Cash Flow Data (in millions)
 
2013

 
2014

 
2015

 
2016

 
2017

 
 
 
 
 
 
 
 
 
 
 
 
 
Cash provided by operating activities
 
$
192.6

 
$
136.6

(1)
$
241.5

 
$
213.7

 
$
250.1

 
Capital expenditures
 
(33.6
)
 
(58.3
)
 
(57.3
)
 
(62.8
)
 
(66.6
)
 
Free cash flow (3)
 
$
159.0

 
$
78.3

(1)
$
184.2

 
$
150.9

 
$
183.5

 
 
 
 
 
 
 
 
 
 
 
 
 
Cash provided by (used for) investing activities (4)
 
$
(14.9
)
 
$
(31.2
)
 
$
(79.5
)
 
$
(274.2
)
 
$
(60.8
)
 
Cash provided by (used for) financing activities (5)
 
$
(172.3
)
 
$
(76.1
)
 
$
(127.5
)
 
$
123.7

 
$
(157.5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
 
As of December 31 (in millions)
 
2013

 
2014

 
2015

 
2016

 
2017

 
 
 
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, and investments
 
$
298.6

 
$
224.6

 
$
248.6

 
$
304.0

 
$
353.3

 
Working capital
 
173.5

 
97.0

 
105.5

 
177.1

 
206.6

 
Total assets
 
1,026.8

 
1,010.3

 
1,029.0

 
1,350.9

 
1,405.7

 
Deferred revenue (6)
 
149.2

 
146.0

 
152.0

 
179.5

 
185.5

 
Long-term liabilities
 
66.0

 
62.1

 
84.0

 
359.2

(7)
277.6

(7)
Total equity
 
691.3

 
654.4

 
640.6

 
696.8

 
804.9

 

(1) Operating income and free cash flow for 2014 included a $61.0 million litigation settlement expense and corresponding cash outflow.

(2) Non-operating income in 2016 included a $37.1 million holding gain related to the purchase of the remaining ownership interest in PitchBook, which was previously a minority investment. Non-operating income in 2017 includes a $16.7 million gain related to the sale of HelloWallet.

(3) 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.

(4) 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.

(5) 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 partially 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 used for financing activities.

(6) We frequently invoice or collect cash in advance of providing services or fulfilling subscriptions for our customers and record these balances as deferred revenue. These amounts represent both current and non-current deferred revenue.

(7) Long-term liabilities in 2016 and 2017 includes $250.0 million and $180.0 million of long-term debt, respectively.


39


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;
trends in the asset management industry, including the increasing popularity of passively managed investment vehicles;
inadequacy in our business continuity program in the event of a material emergency or adverse political or regulatory developments;
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;
an outage of our database, technology-based products and services, or network facilities or the movement of parts of our technology infrastructure to the public cloud;
downturns in the financial sector, global financial markets, and global economy;
the effect of market volatility on revenue from asset-based fees;
the failure of acquisitions and other investments to produce the results we anticipate;
the failure to recruit, develop, and retain qualified employees;
challenges faced by our non-U.S. operations, including the concentration of data and development work at our offshore facilities in China and India;
liability relating to the acquisition or redistribution of data or information we acquire or errors included therein; and
the failure to protect our intellectual property rights or claims of intellectual property infringement against us.

A more complete description of these risks and uncertainties can be found in Item 1A—Risk Factors of this 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. 


40


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 individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the private capital markets. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

Revenue

We generate revenue by selling a variety of investment-related products and services. We sell many of our products and services, including Morningstar Data, Morningstar Advisor Workstation, Morningstar Direct, Morningstar Research, and PitchBook Data, 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, via subscriptions. These subscriptions are mainly offered for a one-year term, although we offer terms ranging from one month to three years. We also sell advertising on our websites throughout the world. In our credit ratings 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 and region. In general, we seek to receive asset-based fees for any work we perform that involves managing investments or acting as a subadvisor to investment portfolios. For any individual contract, we may receive flat fees, variable asset-based fees, or a combination of the two. Some of our contracts include minimum fee levels that provide us with a flat payment up to a specified asset level, above which we also receive variable asset-based fees. In the majority of our contracts that include variable asset-based fees, we bill clients quarterly in arrears based on average assets for the quarter. Other contracts may include provisions for monthly billing or billing based on assets as of the last day of the billing period rather than on average assets.

In our Workplace Solutions area, our contracts may include one-time setup fees, technology licensing fees, asset-based fees for managed retirement accounts, fixed and variable fees for advice and guidance, or a combination of these fee structures. We also offer plan sponsor advice and custom target-date consulting arrangements. Fees for these services may be based on the level of assets under advisement.
 
For Morningstar Managed Portfolios, we charge asset-based fees, which are based on a tiered schedule that depends on the client’s account balance.

Deferred Revenue

We invoice some of our clients and collect cash in advance of providing services or fulfilling subscriptions for our customers. 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, at the end of 2017, totaled $185.5 million (of which $171.3 million was classified as a current liability with an additional $14.2 million included in other long-term liabilities). At the end of 2016, the amount of deferred revenue was $179.5 million (of which $165.4 million was classified as a current liability with an additional $14.1 million included in other long-term liabilities). We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our subscription, license, and service agreements.

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 discontinued some subscription-based products, we have less subscription-based revenue contributing to the deferred revenue balance. Our acquisition of PitchBook in 2016 also contributed to the increase in deferred revenue.

41


Significant Operating Leverage

Our business requires significant investments to create and maintain proprietary software, databases, and content. While the fixed costs of the investments we make in our business are relatively high, the variable cost of adding customers is relatively low. This reflects our business focus on Internet-based platforms and assets under management. At times, we may make investments in building our databases and content that cause weaker short-term operating results. During other periods, our profitability may improve because we're able to increase revenue without increasing our cost base at the same rate. When revenue decreases, however, we may not be able to adjust our cost base at a corresponding rate.

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.

Sales and marketing. This category includes compensation expense for our sales teams, product managers, and marketing professionals. We also include the cost of advertising, direct mail campaigns, and other marketing and promotion efforts in this category.

General and administrative. This category includes compensation expense for our management team and other corporate functions, including employees in our compliance, finance, human resources, and legal departments. It also includes costs for corporate systems and facilities.

Depreciation and amortization. Our capital expenditures are mainly for capitalized software development costs, information technology equipment, and leasehold improvements. 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, generally three years. We also include amortization related to identifiable intangible assets, which is mainly driven by acquisitions, in this category. We amortize intangible assets using the straight-line method over their estimated economic useful lives, which range from one to 25 years.

International Operations

As of December 31, 2017, 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 certain minority-owned investments, including 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.

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.


42


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

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 exclude revenue from businesses acquired or divested from organic revenue for a period of 12 months after we complete the acquisition or divestiture. Organic revenue is not equivalent to any measure required under GAAP and may not be comparable to similarly titled measures reported by other companies.

We define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under GAAP and should not be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.

To evaluate how successful we've been in maintaining existing business for products and services that have renewable revenue, we calculate retention and renewal rates using two different methods. For subscription-based products, we calculate a retention rate based on the number of subscriptions retained during the year as a percentage of the number of subscriptions up for renewal. 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 renewal rate excludes setup and customization fees, migrations to other Morningstar products, and contract renewals that were pending as of January 31, 2018.

The Year 2017 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.

2017 was a strong year for equities. With the bull market in U.S. equities fast approaching its nine-year anniversary, we’ve seen a growing tendency for diversification outside of the United States. Morningstar's U.S. Market Index, a broad market benchmark, ended the year with a robust 21.5% gain; however, international equities as a group fared slightly better. Morningstar’s Global Markets ex-U.S. Index finished the year up 28.0%, with the Developed Markets ex-U.S. Index up 25.5% and the Emerging Markets Index up almost 36.0%.

The Federal Reserve raised short-term interest rates three times in 2017. However, all bond categories were still able to deliver healthy returns because the long end of the yield curve was relatively flat in the last year.

Based on Morningstar Asset Flows data, total U.S. mutual fund assets edged up to $18.1 trillion as of December 31, 2017, compared with $15.1 trillion as of December 31, 2016. ETFs continued to increase in popularity relative to traditional mutual funds. The U.S. ETF industry closed out 2017 with $3.4 trillion in assets under management based on Morningstar Asset Flows data, up from about $2.5 trillion as of December 2016.

Based on our analysis of fund flow trends, long-term mutual funds and exchange traded products had aggregate net inflows of about $680 billion in 2017, up significantly from about $160 billion in 2016, and outpacing the most recent record of $460 billion set in 2014. Net outflows in actively managed mutual funds slowed to $7 billion in 2017 versus $340 billion in 2016. Nevertheless, the overall decline remains consistent with the trend of investor preference for passively managed funds, which experienced over $690 billion in net inflows in 2017.


43


Longer-Term Trends and Regulatory Environment

In addition to industry developments in 2017, 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. The RDR also restricted the use of commission payments for products sold to individual investors, although UK regulators are reportedly considering changes to this restriction. The UK regulator is monitoring the implementation of RDR and is scheduled to publish a review of its findings in 2019. In addition to the RDR, the UK regulator and Her Majesty's Treasury (HMT) launched the Financial Advice Market Review (FAMR) in 2015 in light of concerns that the market for financial advice was not working well for consumers. FAMR aimed to explore ways in which the government, industry, and regulators could take collective steps to stimulate the development of a market which delivers affordable and accessible financial advice and guidance to everyone. FAMR's final report, published in March 2016, set out 28 recommendations intended to tackle barriers to consumers accessing advice. The FCA and HMT will review the outcomes of FAMR in 2019.

In the European Union, the new version of the Markets in Financial Instruments Directive, also known as MiFID II, became effective in January 2018. The main provisions 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.

With respect to indexes, European Union Benchmarks Regulation 2016/1011 came into force on June 30, 2016 with a majority of its provisions having a compliance date of January 1, 2018. The principal objective of the Regulation is to ensure benchmarks used in financial instruments and financial contracts or to measure the performance of investment funds (e.g., a tracking index of a ETF) are free of conflicts of interest, are used appropriately and reflect the actual market or economic reality they are intended to measure. This Regulation applies to Morningstar’s index group as a result of making available its indexes to European investable product sponsors (e.g., ETF sponsors) as the tracking index for their investable product.  

In Australia, in an effort to improve trust and confidence in the financial services industry, the government has announced many regulatory reforms and inquiries ranging from enhanced enforcement powers for the Australian Securities and Investments Commission (ASIC), new reforms to significantly raise the professional, educational and ethical standards of financial advisors, and a Royal Commission into the alleged misconduct of Australia's banks and other financial services entities with broad terms of reference and the potential to impact many aspects of the financial services industry. ASIC has been actively enforcing the Future of Financial Advice reforms that began in July 2013 with actions against financial advisors who failed to act in the best interest of clients and a review of the five largest vertically integrated financial institutions and their management of conflicts of interest. The fund management industry also continues to be an area of regulatory reform with the introduction of the Asia Region Funds Passport and Corporate Collective Investment Schemes, the implementation of new costs and fee disclosure for managed investment and superannuation funds, and a proposed update and overhaul of regulatory guidance for fund managers.

In the United States, the U.S. Department of Labor (DOL) published a final version of a new fiduciary standard that would expand the definition of a fiduciary for certain financial advisors who provide advice related to retirement planning. The new rule was previously scheduled to go into effect in April 2017. Parts of the rule went into effect in June 2017 but full implementation of the rule has been pushed back to July 2019. The SEC is also considering possible rulemaking in this area. In December 2017, the SEC released its updated agenda of regulatory priorities in 2018 and beyond, which listed rulemaking regarding a Personalized Investment Advice Standard of Conduct (i.e., a fiduciary standard) as being at the shorter-term proposed rulemaking stage. 


44


Despite this uncertainty, we believe recent shifts, such as a greater emphasis on serving investors’ interests and lowering fees, are fundamental changes that will continue. We've introduced several new product offerings and bundled solutions to help financial advisors determine, demonstrate, and document that their advice is in the best interest of the investor. We believe Morningstar is well-positioned to help our clients adapt to this new landscape and have had many positive discussions with financial advisors and asset managers about the solutions we can provide. In particular, we’ve increased our manager research coverage in response to growing demand for information that helps financial advisors show investors the thought process behind their investment recommendations.



45


Supplemental Operating Metrics (Unaudited)

The tables below summarize our key product metrics and other supplemental data.
 
 
 
As of December 31,
 
 
 
 
 
 
 
2017

 
2016

 
2015

 
2017 Change

 
2016 Change

Our business
 
 
 
 
 
 
 
 
 
 
Morningstar.com Premium Membership subscriptions (U.S.)
 
118,462

 
118,339

 
120,557

 
0.1
 %
 
(1.8
)%
Morningstar.com average monthly unique users (U.S.)
 
9,829,527

 
8,892,203

 
8,529,792

 
10.5
 %
 
4.2
 %
Advisor Workstation clients (U.S.)
 
182

 
175

 
189

 
4.0
 %
 
(7.4
)%
Morningstar Office licenses (U.S.)
 
4,330

 
4,286

 
4,342

 
1.0
 %
 
(1.3
)%
Morningstar Direct licenses
 
13,884

 
12,492

 
11,428

 
11.1
 %
 
9.3
 %
PitchBook Platform licenses
 
13,908

 
9,723

(1)
6,700

(1)
43.0
 %
 
45.1
 %
Assets under management and advisement (approximate) ($bil) (2)
 
 
 
 
 
 
 
 
 
 
 
Workplace Solutions (Retirement)
 
 
 
 
 
 
 
 
 
 
 
    Managed Accounts (3)
 
57.6

 
46.9

 
40.3

 
22.8
 %
 
16.4
 %
 
Fiduciary Services (4)
 
42.5

 
34.3

 
30.7

 
23.9
 %
 
11.7
 %
 
Custom Models
 
28.0

 
23.2

 
18.7

 
20.7
 %
 
24.1
 %
 
Workplace Solutions (total)
 
$
128.1

 
$
104.4

 
$
89.7

 
22.7
 %
 
16.4
 %
 
Morningstar Investment Management
 
 
 
 
 
 
 
 
 
 
 
Morningstar Managed Portfolios
 
39.8

 
30.2

(5)
25.8

 (5)
31.8
 %
 
17.1
 %
 
Institutional Asset Management
 
17.6

(6)
58.0

 
59.4

 
(69.7
)%
 
(2.4
)%
 
Asset Allocation Services
 
9.5

 
7.2

 
7.6

 
31.9
 %
 
(5.3
)%
 
Manager Selection Services
 
1.4

 
1.2

 
2.1

 
16.7
 %
 
(42.9
)%
 
Morningstar Investment Management (total)
 
$
68.3

 
$
96.6

 
$
94.9

 
(29.3
)%
 
1.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Average assets under management and advisement ($bil)
 
$
207.9

 
$
192.8

 
$
179.9

 
7.8
 %
 
7.2
 %
 
Number of new-issue ratings completed (7)
 
97

 
70

 
90

 
38.6
 %
 
(22.2
)%
 
Asset value of new-issue ratings ($bil) (7)
 
$
39.0

 
$
30.7

 
$
59.8

 
27.0
 %
 
(48.7
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Our employees (approximate)
 
 
 
 
 
 
 
 
 
 
 
Worldwide headcount
 
4,920

 
4,550

(8)
3,880

(8)
8.1
 %
 
17.3
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

46


 
 
 
Year ended December 31,
 
 
 
 
 
(in millions)
 
2017

 
2016

 
2015

 
2017 Change

 
2016 Change

 
Key product and investment area revenue (9)
 
 
 
 
 
 
 
 
 
 
 
Morningstar Data
 
$
162.9

 
$
152.1

 
$
144.5

 
7.2
 %
 
5.3
 %
 
Morningstar Direct
 
124.4

 
110.5

 
101.7

 
12.6
 %
 
8.7
 %
 
Morningstar Investment Management
 
106.0

 
98.4

 
98.8

 
7.7
 %
 
(0.4
)%
 
Morningstar Advisor Workstation
 
87.3

 
82.4

 
81.4

(10)
6.0
 %
 
1.2
 %
 
Workplace Solutions
 
73.5

 
71.3

 
66.6

 
3.2
 %
(11)
7.0
 %
 
PitchBook Data
 
63.6

 
4.1

 

 
1,447.9
 %
 
NMF

 
Morningstar Credit Ratings
 
31.4

 
26.4

 
37.7

 
18.8
 %
 
(30.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue by Type (9)
 
 
 
 
 
 
 
 
 
 
 
License-based (12)
 
$
662.9

 
$
573.4

 
$
552.3

 
15.6
 %
 
3.8
 %
 
Asset-based (13)
 
187.3

 
169.8

 
163.6

 
10.3
 %
 
3.8
 %
 
Transaction-based (14)
 
61.5

 
55.4

 
72.9

 
11.1
 %
 
(24.1
)%

(1) Included for informational purposes only; Morningstar did not acquire full ownership of PitchBook until December 2016.

(2) The asset totals shown above (including assets we either manage directly or for which we provide consulting or subadvisory work) only include assets for which we receive basis-point fees. Some of our client contracts include services for which we receive a flat fee, but we do not include those assets in the total reported 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.

Except for Morningstar Managed Portfolios, it's difficult for our Investment Management business to quantify these cash inflows and outflows. The information we receive from most of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot specify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations.

(3) 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.

(4) Formerly Plan Sponsor Advice.

(5) Revised to include assets from South Africa.

(6) Decline due to client losses related to a strategic shift away from our customized investment management offerings to Managed Portfolios.

(7) Includes commercial mortgage-backed securities, residential mortgage-backed securities, other asset-backed securities, and corporate and financial institutions.

(8) Revised to exclude temporary employees and part-time employees who work less than 30 hours a week.

(9) Key product and investment area revenue and revenue by type includes the effect of foreign currency translations.

(10) Revised to exclude Morningstar Office.

(11) Excluding the negative 6.5 percentage point impact of the HelloWallet divestiture, revenue increased by 9.7% for the full year.


47


(12) License-based revenue includes Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, Morningstar Enterprise Components, Morningstar Research, PitchBook Data, and other similar products.

(13) Asset-based revenue includes Morningstar Investment Management, Workplace Solutions, and Morningstar Indexes.

(14) Transaction-based revenue includes Morningstar Credit Ratings, Internet advertising sales, and Conferences.


 

48


Consolidated Results
Key Metrics (in millions)
 
2017

 
2016

 
2015

 
2017 Change

 
2016 Change

 
Revenue
 
$
911.7

 
$
798.6

 
$
788.8

 
14.2
 %
 
1.2
 %
 
Operating income
 
$
169.8

 
$
180.8

 
$
190.6

 
(6.0
)%
 
(5.2
)%
 
Operating margin
 
18.6
%
 
22.6
%
 
24.2
%
 
(4.0
)
pp
(1.6
)
pp
 
 
 
 
 
 
 
 
 
 
 
 
Cash used for investing activities
 
$
(60.8
)
 
$
(274.2
)
 
$
(79.5
)
 
(77.8
)%
 
244.9
 %
 
Cash provided by (used for) financing activities
 
$
(157.5
)
 
$
123.7

 
$
(127.5
)
 
(227.3
)%
 
197.0
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash provided by operating activities
 
$
250.1

 
$
213.7

 
$
241.5

 
17.0
 %
 
(11.5
)%
 
Capital expenditures
 
(66.6
)
 
(62.8
)
 
(57.3
)
 
6.1
 %
 
9.6
 %
 
Free cash flow
 
$
183.5

 
$
150.9

 
$
184.2

 
21.6
 %
 
(18.1
)%
 
 
____________________________________________________________________________________________
pp — percentage points

We define free cash flow as cash provided by or used for operating activities less capital expenditures. Please refer to the discussion in How We Evaluate our Business for more detail.
 
Consolidated Revenue
(in millions)
 
2017

 
2016

 
2015

 
2017 Change

 
2016 Change

 
Consolidated revenue
 
$
911.7

 
$
798.6

 
$
788.8

 
14.2
%
 
1.2
%
 
 
In 2017 and 2016, our consolidated revenue rose 14.2% and 1.2%, respectively. Our acquisition of PitchBook Data, Inc. (PitchBook) in December 2016 contributed $57.2 million of revenue growth during 2017. Foreign currency movements had no net material impact on revenue in 2017 and reduced revenue by $9.5 million in 2016.

We experienced strong revenue growth across all revenue types during 2017.

License-based revenue grew 15.6% during 2017. We experienced stronger growth rates for license-based products such as Morningstar Direct and Morningstar Data. Revenue from Morningstar Direct was the biggest contributor to growth in both 2017 and 2016, with revenue increasing by $13.9 million in 2017 and $8.8 million in 2016. The number of licenses for Morningstar Direct increased to 13,884 worldwide at the end of 2017, compared with 12,492 at the end of 2016 and 11,428 at the end of 2015, with modest growth in both the United States and internationally. Growth in Morningstar Direct reflects additional licenses for both new and existing clients.

Morningstar Data revenue increased $10.9 million in 2017, mainly reflecting new contracts and renewals for managed products data and our market data business.

Asset-based revenue increased 10.3% during 2017. Morningstar Managed Portfolios and Workplace Solutions were the primary drivers of the increase. 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 $207.9 billion in 2017, compared with $192.8 billion in 2016 and $179.9 billion in 2015.

Transaction-based revenue grew 11.1% during 2017. Revenue from Morningstar Credit Ratings (our structured credit ratings business) increased $5.0 million during the year, primarily due to new-issue growth in asset-backed securities partially offset by a slight decrease in ratings on commercial mortgage-backed securities.

Some of the main contributors to the 2016 revenue increase were Morningstar Direct, Morningstar Data, and Workplace Solutions. Positive results for these products were partially offset by decreases in Morningstar Credit Ratings and Internet advertising sales on Morningstar.com.

49


In December 2016, we acquired the remaining interest in PitchBook, which contributed $4.1 million of revenue during the one-month period that PitchBook was included in our consolidated results for 2016.

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 2017, we divested HelloWallet and did not make any acquisitions. During 2016, we acquired Requisight, LLC (RightPond), InvestSoft Technology, Inc. (InvestSoft), and PitchBook Data, Inc. (PitchBook). We did not divest any businesses in 2016.

We exclude revenue from acquired businesses from our organic revenue growth calculation for a period of 12 months after we complete the acquisition. Contribution from PitchBook was treated as acquired revenue through November 2017 and was incorporated into organic growth statistics after December 1, 2017. For divestitures, we exclude revenue in the prior period for which there is no comparable revenue in the current period. Because HelloWallet was divested in the second quarter of 2017, we excluded HelloWallet's last six months of 2016 revenue from our organic revenue growth calculation.

In 2017, we had $57.5 million in incremental revenue from acquisitions, primarily from PitchBook. Revenue in 2016 included $4.4 million of revenue from HelloWallet, which we divested in the second quarter of 2017, and that did not recur in the second half of 2017. In addition, foreign currency translations had no net material impact on revenue in 2017. Excluding acquisitions, divestitures, and foreign currency translations, organic revenue was up 7.6% in 2017.

In 2016, we had $5.5 million in incremental revenue from acquisitions, primarily from PitchBook. In addition, foreign currency translations reduced revenue by about $9.5 million in 2016, mainly because of the weaker British pound and Canadian dollar. Excluding acquisitions, divestitures, and foreign currency translations, organic revenue was up 1.7% in 2016.

a0710k17contribrevgrowth02.jpg

50


The tables below reconcile consolidated revenue with organic revenue (revenue excluding acquisitions, divestitures, and the effect of foreign currency translations): 
2017 vs. 2016 (in millions)
 
2017

 
2016

 
Change

Consolidated revenue
 
$
911.7

 
$
798.6

 
14.2
%
Less: acquisitions
 
(57.5
)
 

 
NMF

Less: divestitures
 

 
(4.4
)
 
NMF

Effect of foreign currency translations
 

 

 

Organic revenue
 
$
854.2

 
$
794.2

 
7.6
%
2016 vs. 2015 (in millions)
 
2016

 
2015

 
Change

Consolidated revenue
 
$
798.6

 
$
788.8

 
1.2
%
Less: acquisitions
 
(5.5
)
 

 
NMF

Less: divestitures
 

 

 

Unfavorable effect of foreign currency translations
 
9.5

 

 
NMF

Organic revenue
 
$
802.6

 
$
788.8

 
1.7
%
____________________________________________________________________________________________
NMF — Not meaningful

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
 
 
 
 
(in millions)
 
2017

 
2016

 
2015

 
2017 Change

 
2016 Change

United States
 
$
687.0

 
$
590.5

 
$
585.1

 
16.3
%
 
0.9
 %
 
 
 
 
 
 
 
 
 
 
 
United Kingdom
 
64.7

 
61.1

 
64.2

 
5.9
%
 
(4.8
)%
Continental Europe
 
69.9

 
62.6

 
58.8

 
11.7
%
 
6.5
 %
Australia
 
34.6

 
32.2

 
30.5

 
7.5
%
 
5.6
 %
Canada
 
29.4

 
28.2

 
27.9

 
4.3
%
 
1.1
 %
Asia
 
21.2

 
20.0

 
18.5

 
6.0
%
 
8.1
 %
Other
 
4.9

 
4.0

 
3.8

 
22.5
%
 
5.3
 %
Total International
 
224.7

 
208.1

 
203.7

 
8.0
%
 
2.2
 %
 
 
 
 
 
 
 
 
 
 
 
Consolidated revenue
 
$
911.7

 
$
798.6

 
$
788.8

 
14.2
%
 
1.2
 %

International revenue made up about 25% of our consolidated revenue in 2017, compared with 26% in both 2016 and 2015. 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 increased $16.6 million, or 8.0%, in 2017 and international organic revenue increased 8.0%.

In 2016, revenue from international operations increased 2.2% and international organic revenue increased 6.8%.


51


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):

2017 vs. 2016 (in millions)
 
2017

 
2016

 
Change

International revenue
 
$
224.7

 
$
208.1

 
8.0
%
Less: acquisitions
 

 

 

Less: divestitures
 

 

 

Effect of foreign currency translations
 

 

 

International organic revenue
 
$
224.7

 
$
208.1

 
8.0
%

2016 vs. 2015 (in millions)
 
2016

 
2015

 
Change

International revenue
 
$
208.1

 
$
203.7

 
2.2
%
Less: acquisitions
 

 

 

Less: divestitures
 

 

 

Unfavorable effect of foreign currency translations
 
9.5

 

 
NMF

International organic revenue
 
$
217.6

 
$
203.7

 
6.8
%

International revenue as a percentage of consolidated revenue has been relatively flat the past few years, partly reflecting negative effects of foreign currency translations.

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 graph below illustrates these two metrics over the past five years:

a0810k17renewalretention02.jpg


52


For contract-based products and services (such as Morningstar Data including PitchBook, Investment Advisory services, Morningstar Direct, and Morningstar Advisor Workstation), we estimate that our weighted average annual renewal rate was approximately 102% in 2017, compared with 96% in 2016. The increase mainly reflects higher renewal rates for some larger products, including Morningstar Direct, Morningstar Investment Management, Workplace Solutions, Morningstar Research, and PitchBook. The figure for contract-based products includes the effect of price changes; increasing client bases upon contract renewal; changes to the contract value upon renewal (such as increased users); and changes in the value of variable-fee contracts. These factors, therefore, can lead to a renewal rate percentage over 100%.

In 2017, we estimate that our annual retention rate for subscription-based products, including Morningstar.com's Premium Membership service, Morningstar Office, and newsletter products, was approximately 66%, which was unchanged from 2016.


Consolidated Operating Expense
  
 
 
 
 
 
(in millions)
 
2017

 
2016

 
2015

 
2017 Change

 
 
2016 Change

 
Cost of revenue
 
$
386.6

 
$
344.3

 
$
330.1

 
12.3
%
 
 
4.3
 %
 
  % of revenue
 
42.4
%
 
43.1
%
 
41.9
%
 
(0.7)
pp
 
1.2

pp
Sales and marketing
 
134.3

 
97.6

 
96.6

 
37.6
%
 
 
1.0
 %
 
  % of revenue
 
14.7
%
 
12.2
%
 
12.2
%
 
2.5

pp
 

pp
General and administrative
 
129.8

 
105.2

 
107.1

 
23.3
%
 
 
(1.7
)%
 
  % of revenue
 
14.2
%
 
13.2
%
 
13.6
%
 
1.0
pp
 
(0.4)
pp
Depreciation and amortization
 
91.2

 
70.7

 
64.4

 
28.9
%
 
 
9.9
 %
 
  % of revenue
 
10.0
%
 
8.9
%
 
8.2
%
 
1.1
pp
 
0.7
pp
Total operating expense
 
$
741.9

 
$
617.8

 
$
598.2

 
20.1
%
 
 
3.3
 %
 
  % of revenue
 
81.4
%
 
77.4
%
 
75.8
%
 
4.0
pp
 
1.6
pp

In 2017, our operating expense was up $124.1 million, or 20.1%. Foreign currency translations reduced our operating expense by $0.6 million in 2017.

Our acquisition of PitchBook contributed $76.0 million of operating expense, primarily for salaries, amortization expense, professional fees, commission expense, and management bonus expense during the year. PitchBook expenses exceeded revenue in 2017, primarily due to $10.6 million of deal-related intangible amortization and $7.9 million of vesting of performance share awards associated with the acquisition. PitchBook also had $4.6 million of capitalized labor during 2017.

The remaining increase was primarily a result of higher compensation expense (including salaries, bonus, and other company-sponsored benefits), depreciation expense, professional fees, and production expense, which includes third-party data and infrastructure hosting.

Excluding PitchBook, compensation expense (including salaries and other company-sponsored benefits) increased $16.2 million in 2017. Bonus expense also increased $14.5 million in 2017. Bonus expense was higher due to stronger performance against our internal targets.

Depreciation expense in 2017 includes a $4.1 million impairment charge for certain software licenses due to a shift toward a cloud-based strategy.

Partially offsetting our total operating expense increase was an increase in internally developed capitalized software. We have accelerated development of our major software platforms, resulting in an increase in capitalized software development, which reduced operating expense. In 2017, we capitalized $41.7 million, which excludes the PitchBook capitalized labor noted above, associated with software development activities, mainly related to Morningstar Data, Workplace Solutions, and additional enhancements to reporting, financial planning, and other capabilities in our products. In comparison, we capitalized $28.2 million of software development expense in 2016.


53


We had approximately 4,920 employees worldwide at the end of 2017, compared with 4,550 in 2016. This increase reflects continued investment in our key growth initiatives, including data operations in India and China and PitchBook in the United States and Europe.

In 2016, our operating expense was up $19.6 million, or 3.3%. Due to the strength of the U.S. dollar, foreign currency translations reduced our operating expense by $11.5 million in 2016.

Compensation expense (including salaries and other company-sponsored benefits) increased $26.2 million in 2016. We had approximately 4,550 employees worldwide at the end of 2016, compared with 3,880 in 2015. This increase reflects continued investment in our key growth initiatives and mainly includes technology, sales, and analyst roles in the United States, India, and China. The growth in compensation expense was partially offset by a $13.1 million reduction in bonus expense during 2016 compared to 2015. Bonus expense was lower mainly because we did not meet our internal targets for revenue growth during 2016.

Depreciation expense, professional fees, and production expense also increased during 2016 as we continued to invest in our business. We have also accelerated development of our major software platforms and therefore had an increase in capitalized software development, which reduced operating expense.

In 2016, we capitalized $28.2 million of software development expense for ongoing enhancements of key platforms and new development of upgraded software platforms. In comparison, we capitalized $21.8 million of software development expense in 2015.

Sales commission expense decreased $2.8 million in 2016, reflecting declines in new sales closed.

Our acquisition of PitchBook contributed $7.5 million of operating expense, primarily for salaries, professional fees, and amortization expense during the one-month period that PitchBook was included in our consolidated results for 2016.

Cost of revenue

Cost of revenue is our largest category of operating expense, representing about one-half of our total operating expense. Our business relies heavily on human capital, and cost of revenue includes the compensation expense for employees who produce our products and services. We include compensation expense for approximately 80% of our employees in this category.

Cost of revenue increased $42.3 million, or 12.3%, in 2017. Our acquisition of PitchBook contributed $14.0 million of operating expense in this cost category, primarily for professional fees, salary expense, and capitalized labor during 2017. The remaining increase was largely due to higher salary expense of $13.6 million, mainly driven by additional headcount. Higher bonus expense, professional fees, and production expense also contributed to the increase in this category.

Partially offsetting these increases was an increase in internally developed capitalized software. We have accelerated development of our major software platforms, resulting in an increase in capitalized software development, which reduced operating expense. During 2017, we capitalized $41.7 million, which excludes the PitchBook capitalized labor noted above, associated with software development activities, mainly related to Morningstar Data, Workplace Solutions, and additional enhancements to reporting, financial planning, and other capabilities in our products. In comparison, we capitalized $28.2 million in 2016.

Cost of revenue increased $14.2 million in 2016. Higher salary expense of $19.9 million was the largest contributor to the increase and was mainly driven by additional headcount. Higher company-sponsored benefits and software subscriptions also contributed to the growth in this category.

Partially offsetting these increases was a $9.1 million decrease in bonus expense, as well as an increase in capitalized software development. As mentioned above, we capitalized $28.2 million associated with software development activities in 2016, compared with $21.8 million included in 2015.

PitchBook contributed $1.3 million of operating expense in this cost category, primarily for salary expense during the one-month period that PitchBook was included in our consolidated results for 2016.


54


As a percentage of revenue, cost of revenue decreased 0.7 percentage points in 2017 and increased 1.2 percentage points in 2016.

Sales and marketing

Sales and marketing expense increased $36.7 million, or 37.6%, in 2017. Our acquisition of PitchBook contributed $34.9 million of operating expense in this cost category, primarily for salary and sales commission expense in 2017.
The remaining increase was due to an increase in sales commission expense of $3.7 million, partially offset by decreases in compensation expense (including salaries and other company-sponsored benefits), advertising and marketing spend, and professional fees.

Sales and marketing expense increased $1.0 million in 2016, reflecting a $2.7 million increase in compensation expense (including salaries and other company-sponsored benefits) and a $1.0 million increase in advertising and marketing spend. Partly offsetting these increases were decreases in sales commission expense of $1.9 million and bonus expense of $1.0 million.

Our acquisition of PitchBook contributed $2.7 million during the one-month period that PitchBook was included in our consolidated results for 2016.

As a percentage of revenue, sales and marketing expense increased 2.5 percentage points in 2017 and was unchanged in 2016 compared to 2015.

General and administrative

General and administrative expense increased $24.6 million, or 23.3%, during 2017. Our acquisition of PitchBook contributed $16.1 million of operating expense in this cost category, primarily for management bonus plan expense and salary expense during 2017. Bonus expense, software subscriptions, and rent expense contributed to the remaining increase in 2017.

General and administrative expense decreased $1.9 million in 2016, mainly because of a $3.0 million decline in bonus expense and a $2.0 million decline in stock-based compensation expense. Partially offsetting these decreases was an increase of $3.8 million in professional fees in connection with legal and compliance and other company initiatives. Compensation expense (including salaries and other company-sponsored benefits) also increased $0.9 million.

PitchBook contributed $2.5 million in 2016, primarily for salary expense, professional fees, and management bonus plan expense during the one-month period that PitchBook was included in our consolidated results for 2016.

General and administrative expense as a percentage of revenue was up 1.0 percentage points in 2017 and down 0.4 percentage points in 2016.

Depreciation and amortization

Overall, depreciation and amortization increased $20.5 million, or 28.9%, in 2017 and $6.3 million, or 9.9%, in 2016.

Our acquisition of PitchBook contributed $11.0 million of operating expense in this cost category in 2017 and $0.9 million in 2016, primarily for intangible amortization expense related to the acquisition.

Depreciation expense rose $16.3 million in 2017, mainly driven by depreciation expense related to capitalized software development and computer equipment incurred over the past several years. Depreciation expense during 2017 also includes a $4.1 million impairment charge for certain software licenses due to a shift toward a cloud- based strategy. Intangible amortization expense increased $4.2 million in 2017 due to additional amortization expense for the intangible assets of PitchBook offset by certain intangible assets from some previous acquisitions that are now fully amortized.

Depreciation expense rose $8.9 million in 2016, mainly driven by higher capital expenditures for computer equipment and additional depreciation expense for capitalized software development. Intangible amortization expense decreased $2.6 million in 2016 as certain intangible assets from some previous acquisitions are now fully amortized.

55


We expect that amortization of intangible assets will be an ongoing cost. We estimate that this expense will total approximately $20.7 million in 2018. Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, divestitures, changes in the estimated average useful lives, and foreign currency translation.

Consolidated Operating Income and Operating Margin
 
(in millions)
 
2017

 
2016

 
2015

 
Operating income
 
$
169.8

 
$
180.8

 
$
190.6

 
% change
 
(6.0
)%
 
(5.2
)%
 
80.5
%