MORNINGSTAR, INC.
The discussion included in this section, as well as other sections of this
report, contains forward-looking statements as that term is used in the Private
Securities Litigation Reform Act of 1995. These statements are based on our
current expectations about future events or future financial performance.
Forward-looking statements by their nature address matters that are, to
different degrees, uncertain, and often contain words such as "may," "could,"
"expect," "intend," "plan," "seek," "anticipate," "believe," "estimate,"
"predict," "potential," or "continue." These statements involve known and
unknown risks and uncertainties that may cause the events we discuss not to
occur or to differ significantly from what we expect. For us, these risks and
uncertainties
include, among others:
• 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;
• liability related to cybersecurity and the protection of
confidential information, including personal information about
individuals;
• failing to differentiate our products and continuously create
innovative, proprietary research tools and financial advisor
software;
• inadequacy of our operational risk management and business
continuity programs in the event of a material disruptive event;
• failing to respond to technological change, keep pace with new
technology developments, or adopt a successful technology strategy;
• compliance failures, regulatory action, or changes in laws
applicable to our investment advisory or credit ratingsoperations; • volatility in the financial sector, global financial markets, and
global economy and its effect on our revenue from asset-based fees
and credit ratings business;
• trends in the asset management industry, including theincreasing
adoption of investment strategies and portfolios relying on
passively managed investment vehicles and increased industry
consolidation;
• liability relating to the collection or distribution ofinformation
and data we collect and produce, or errors included therein;
• an outage of our database, technology-based products and services,
or network facilities or the movement of parts of our technology and
data infrastructure to the public cloud and other outsourced
providers;
• the failure of acquisitions and other investments to be efficiently
integrated and produce the results we anticipate;
• the failure to recruit, develop, and retain qualified employees;
• challenges faced by our non-U.S. operations, including the concentration of data and development work at our offshore facilities inChina andIndia ; and • the failure to protect our intellectual property rights or claims of intellectual property infringement against us. A more complete description of these risks and uncertainties can be found in Item 1A-Risk Factors of this report. If any of these risks and uncertainties materialize, our actual future results may vary significantly from what we expect. We do not undertake to update our forward-looking statements as a result of new information or future events. This section includes comparisons of certain 2019 financial information to the same information for 2018. Year-to-year comparisons of the 2018 financial information to the same information for 2017 can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 . All dollar and percentage comparisons, which are often accompanied by words such as "increase," "decrease," "grew," "declined," "was up," "was down," "was flat," or "was similar" refer to a comparison with the prior year unless otherwise stated. 45
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Understanding Our Company
Key Business Characteristics
We offer an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors and other participants in the private capital markets. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.
Revenue
We generate revenue by selling a variety of investment-related products and services. We sell many of our products and services, including Morningstar Data, Morningstar Advisor Workstation, Morningstar Direct, and PitchBook, through license agreements. Our license agreements typically range from one to three years. We sell some of our other products, such as Premium Membership service on Morningstar.com, via subscriptions. These subscriptions are mainly offered for a one-year term, although we offer terms ranging from one month to three years. Our investment management products have multiple fee structures, which vary by client and region. In general, we seek to receive asset-based fees for any work we perform that involves managing investments or acting as a subadvisor to investment portfolios. For any individual contract, we may receive flat fees, variable asset-based fees, or a combination of the two. Some of our contracts include minimum fee levels that provide us with a flat payment up to a specified asset level, above which we also receive variable asset-based fees. In the majority of our contracts that include variable asset-based fees, we bill clients quarterly in arrears based on average assets for the quarter. Other contracts may include provisions for monthly billing or billing based on assets as of the last day of the billing period rather than on average assets. In our Workplace Solutions area, our contracts may include one-time setup fees, technology licensing fees, asset-based fees for managed retirement accounts, fixed and variable fees for advice and guidance, or a combination of these fee structures. We also offer plan sponsor advice and custom target-date consulting arrangements. Fees for these services may be based on the level of assets under advisement. We also generate transaction-based revenue, primarily from DBRS Morningstar and including the sale of advertising on our websites and sponsorship of conferences. For the six months endedDecember 31, 2019 , approximately 63% of the revenue generated by DBRS Morningstar came from one-time, transaction-based fees driven by our provision of ratings on newly-issued securities; whereas the remainder can be classified as transaction-related, with recurring annual fees tied to surveillance, credit research, or other services.
Deferred Revenue
We invoice some of our clients and collect cash in advance of providing services or fulfilling subscriptions for our customers. Deferred revenue totaled$282.3 million (of which$250.1 million was classified as a current liability with an additional$32.2 million included in other long-term liabilities) at the end of 2019. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our subscription agreements.
Significant Operating Leverage
Our business requires significant investments to create and maintain proprietary
software, databases, and content. While the fixed costs of the investments we
make in our business are relatively high, the variable cost of adding customers
is relatively low. This reflects our business focus on Internet-based platforms
and assets under management. At times, we may make investments in building our
databases and content that cause weaker short-term operating results. During
other periods, our profitability may improve because we're able to increase
revenue without increasing our cost base at the same rate. When revenue
decreases, however, we may not be able to adjust our cost base at a
corresponding rate.
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Operating Expense
We classify our operating expense into separate categories for cost of revenue, sales and marketing, general and administrative, and depreciation and amortization, as described below. We include stock-based compensation expense, as appropriate, in each of these categories. • Cost of revenue. This category includes compensation expense for employees who produce the products and services we deliver to our customers. For example, this category covers production teams and analysts who write investment research reports. It also includes compensation expense for programmers, designers, and other employees who develop new products and enhance existing products. In some cases, we capitalize the compensation costs associated with certain software development projects. This reduces the expense that we would otherwise report in this category. Cost of revenue also includes other expenses, such as third-party data purchases and data lines. • Sales and marketing. This category includes compensation expense for our sales teams, product managers, and marketing professionals. We also include the cost of advertising, direct mail campaigns, and other marketing and promotion efforts in this category. • General and administrative. This category includes compensation expense for our management team and other corporate functions, including employees in our compliance, finance, human resources, and legal departments. It also includes costs for corporate systems and facilities. • Depreciation and amortization. Our capital expenditures mainly relate to capitalized software development costs, information technology equipment, and leasehold improvements. We depreciate property and equipment using the straight-line method based on the useful lives of the assets, which range from three to seven years. We amortize leasehold improvements over the lease term or their useful lives, whichever is shorter. We amortize capitalized software development costs over their estimated economic life, generally three years. We also include amortization related to identifiable intangible assets, which is mainly driven by acquisitions, in this category. We amortize intangible assets using the straight-line method over their estimated economic useful lives, which range from one to 25 years. International Operations As ofDecember 31, 2019 , we had majority-owned operations in 26 countries outside ofthe United States (U.S. ) and included their results of operations and financial condition in our consolidated financial statements. We account for these investments outside of theU.S. and where we have significant influence, including Morningstar Japan K.K. (MJKK) andSustainalytics Holding B.V. (Sustainalytics), using the equity method of accounting.
How We Evaluate Our Business
When our analysts evaluate a stock, they focus on assessing the company's estimated intrinsic value, which is based on estimated future cash flows, discounted to their value in today's dollars. Our approach to evaluating our own business works the same way.
Our goal is to increase the intrinsic value of our business over time, which we believe is the best way to create value for our shareholders. We do not make public financial forecasts for our business because we want to avoid creating any incentives for our management team to make speculative statements about our financial results that could influence our stock price or take actions that help us meet short-term forecasts, but may not build long-term shareholder value.
We provide three specific measures that can help investors generate their own assessment of how our intrinsic value has changed over time:
• Revenue (including organic revenue);
• Operating income (loss) (including adjusted operating income); and
• Free cash flow.
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Organic revenue, adjusted operating income, and free cash flow are not measures of performance set forth underU.S. generally accepted accounting principles (GAAP). We define organic revenue as consolidated revenue excluding acquisitions, divestitures, adoption of accounting changes, and foreign currency translations. We present organic revenue because we believe it helps investors better compare our period-to-period results, and our management team uses this measure to evaluate the performance of our business. We exclude revenue from businesses acquired or divested from organic revenue for a period of 12 months after we complete the acquisition or divestiture. Organic revenue is not equivalent to any measure required under GAAP and may not be comparable to similarly titled measures reported by other companies. We define adjusted operating income as operating income excluding all mergers and acquisitions (M&A) related expenses and amortization. We present adjusted operating income because we believe it better reflects period-over-period comparisons and improves overall understanding of the underlying performance of the business absent the impact of M&A. We define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under GAAP and should not be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies. 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 actual revenue for the previous comparable fiscal period as the base rate for calculating the renewal percentage. The renewal rate excludes setup and customization fees, migrations to other Morningstar products, and contract renewals that were pending as ofJanuary 31, 2020 .
Regulatory Trends Affecting Our Business
In addition to the industry developments described under "Business - Trends Defining Our Business", there are several longer-term regulatory trends we consider relevant to our business, as outlined below.
General
With the passage of over ten years since the financial crisis of 2008 and 2009, the regulatory frameworks for financial services companies globally have generally become more settled. There has been a distinct shift from a period of intense regulatory redesign initiatives to a period where regulatory expectations revolve around how well organizations have implemented required regulatory change. For enterprises like ours that operate nationally and globally, we are experiencing increasingly fragmented regulatory activity as a period of global regulatory response and coordination is replaced by different jurisdictions and regulators reasserting their full control of their own regulatory agendas. The causes of this are varied, including the withdrawal of theUnited Kingdom (U.K. ) from theEuropean Union (EU) and the effect that may have on trans-European financial services providers, the federal gridlock inthe United States that has resulted in various states implementing divergent regulatory requirements in areas like data privacy and consumer protection, and the rise of disruptive technologies that permit greater personalization of interactions between financial services providers and their various customer bases. 48
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Many of the 2019 developments focus on certain themes globally, including access to financial services, the quality of advice and the value of the services provided, the protection of customer data and transparency around the uses of such data, the minimization of conflicts of interest, and improvements in corporate governance and risk management.
Brexit
TheU.K. withdrawal from the EU onJanuary 31, 2020 , has implications for certain Morningstar businesses, including investment management, credit ratings, and indexes. The full implications are unknown until theU.K. and EU finalize trade agreements, which may or may not be completed before the expiration of the current transition period that is currently set to expire at the end of 2020 but could be extended. In the meantime, the Withdrawal Agreement governs, and theU.K. effectively remains in the EU's customs union and single market. At least until the end of 2020, Morningstar's investment management (MIME) and credit rating operations (DBRS Morningstar) in both the EU andU.K. continue to be subject to the EU's laws and regulations governing EU investment managers and credit rating agencies (EU regime) and, in the case of DBRS Morningstar, supervision by theEuropean Securities and Markets Authority (ESMA). MIME is currently, and will continue to be, authorized and regulated by theFinancial Conduct Authority , but is expected to lose its "passporting" rights to deliver certain financial services across the EU. With respect to DBRS Morningstar'sU.K. operations, at the end of the transition period, it is expected that they will no longer be subject to the EU regime or ESMA supervision, but rather will become subject to theU.K. laws and regulations governingU.K. credit rating agencies (U.K. regime) and supervision by theU.K.'s Financial Conduct Authority (FCA). TheFCA has confirmed that DBRS Morningstar'sU.K. -based credit rating agency's current ESMA registration will convert to aU.K. registration at the expiration of the transition period. TheU.K. regime, adopted in 2019, largely mirrors the EU regime, which should minimize any significant change in DBRS Morningstar'sU.K. operations. However, over time, theU.K. may begin to make modifications to those laws and regulations. Similarly, theFCA may change its regulations over time so they are no longer the same as or equivalent to similar regulations in theU.K. to which MIME is subject.
Investment Management and Indexes
In theU.S. , theSecurities and Exchange Commission (SEC) adopted Regulation Best Interest, which becomes effectiveJune 30, 2020 . The regulation will require brokers, who have previously been held to a suitability standard in relation to investment recommendations to their clients, to act in their clients' best interests when making an investment recommendation, by meeting four core obligations: providing certain prescribed disclosures before or at the time of a recommendation about the recommendation and the relationship between the retail customer and the broker; exercising reasonable diligence, care, and skill in making recommendations; establishing, maintaining, and enforcing policies and procedures reasonably designed to address conflicts of interest; and establishing, maintaining, and enforcing policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. We expect this regulation to increase demand for certain of our solutions that assist in demonstrating compliance with these obligations. In addition, in theU.S. , the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act, became law. The SECURE Act is likely to increase the number of participants in defined- contribution plans by, among other things, permitting "open" multiple-employer plans with unrelated plan sponsors, increasing the availability to small employers of safe harbor plans that automatically enroll employees, and including part-time workers as participants in plans. We expect this new law will present opportunities for our retirement solutions business. In theU.K. , regulators began reviews of the effects of the 2013 Retail Distribution Review (RDR), which emphasized increased regulation of advisory fees, higher professional standards for financial advisors, and "whole of market" investment solutions, and the 2016 Financial Advice Market Review (FAMR) which explored how the financial advice market could work better for all consumer demographics. Such reviews were initially expected to be completed in 2019 but are now expected in 2020. In the EU, market participants continue to adjust to the Markets in Financial Instruments Directive (MiFID II), which became effective inJanuary 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. 49
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With respect to indexes, European Union Benchmarks Regulation 2016/1011 came into force onJune 30, 2016 with a majority of its provisions having a compliance date ofJanuary 1, 2018 . 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. Under the regulation, third country index administrators like Morningstar were required to obtain recognition under the regulation byDecember 31, 2019 to continue offering their indexes in the EU. However, in 2019, theEuropean Commission agreed to an extension of this deadline untilDecember 31, 2021 . 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.The European Commission announced its Action Plan on Sustainable Finance inMay 2018 and theEuropean Securities and Market Authority published its technical advice on implementing the plan in the area of investment services inApril 2019 . These requirements would, among other things, modify MiFID II to require financial services providers to take into account environmental, social and governance (ESG) considerations when complying with existing requirements relating to the operation of their organizations, their product development and governance, and their assessment of the suitability of certain investments for certain clients. In addition to ESG regulation in the areas of investment management and advice, ESG regulations around disclosure and governance are increasing worldwide, but on a fragmentary basis. They include the EU's new regulation on disclosures, which should help align standards across investment, insurance, and retirement products, current and proposed rules inEurope and theU.K. requiring disclosure of how products weigh ESG considerations, as well as their policies in relation to the stewardship of investments, andSEC requirements around the disclosure of votes on shareholder resolutions, including ESG-related resolutions. InAustralia , theRoyal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry issued a final report onFebruary 1, 2019 . The commission did not recommend the elimination of vertically integrated wealth management business models but proposed a tighter set of rules around such vertical integration to make it more difficult to inappropriately incentivize the sale of financial products through aligned distribution channels. In particular financial advisers will be required to disclose to a client why they are not independent, impartial and unbiased before providing advice. The commission has also recommended a stronger regulatory presence with the imposition of more fines and an increase in enforcement litigation. 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 Vehicle Schemes allowing the regional offering of funds, the review of fees and costs disclosure for managed investment and superannuation funds, and a suite of seven new and updated regulatory guides for the fund management industry. Regulators in the financial services industry have indicated they are increasingly concerned by risk factors related to senior management accountability, data protection and privacy, and cybersecurity. For example, jurisdictions such asHong Kong , theU.K. ,Australia , andSingapore have adopted or are considering the adoption of more stringent rules that will require that specific individuals be identified as responsible for certain senior management functions and will hold a firm's senior management team personally accountable for their own and their firm's actions and conduct.
Other Regulation
Data privacy regulation continues to proliferate, as numerous national and state jurisdictions are considering new data privacy regulations.The EU's General Data Protection Regulation (GDPR) continues to be a major influence on the global privacy landscape. Many non-EU countries are following the EU's lead and implementing rules similar to GDPR in their jurisdictions in order to enable cross-border data exchange.Australia ,Brazil ,India , andKorea have all implemented or are moving to implement data privacy laws that resemble GDPR. In theU.S. , the California Consumer Privacy Act (CCPA) went into effect inJanuary 2020 . CCPA, heavily influenced by GDPR, is the first comprehensive data privacy law in theU.S. to date. Several other states are considering their own comprehensive privacy regulations. 50
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Congressional legislators have also acknowledged the insufficiency of the current privacy law landscape in the financial services field and are in the early stages of exploring new legislation in the financial technology space. Additionally, legislators have proposed dual proposals for a comprehensive consumer federal privacy law; however, adoption of a unified federal regulation in 2020 is unlikely until lessons from the CCPA can be consumed by federal regulators. Since operations in the financial services industry require the processing of significant amounts of personally identifiable information (PII), we believe the burdens of regulation, and possibly inconsistent regulation, will proliferate. In particular, the patchwork ofU.S. state laws creates complexity and ambiguity as to the application of such laws to particular persons, categories of personal information, or types of transactions. As a related matter, issues of cybersecurity as they relate to the identification and mitigation of system vulnerabilities also continue to grow in prominence and laws governing data breaches proliferate. In 2019,New York amended its cybersecurity regulations to place new burdens for companies handling client financial data. Financial regulators have also increased scrutiny on the data protection practices of the entities that they oversee. For example, theSEC's Office of Compliance Inspections and Examinations has indicated that its 2020 examination programs will continue to prioritize cybersecurity with an emphasis on, among other things, proper configuration of network storage devices and information security governance. 51
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Supplemental Operating Metrics (Unaudited) The tables below summarize our key product metrics and other supplemental data.
Year Ended December 31, 2019
(in millions) 2019 2018 2019 Change
Revenue by type (1)
License-based (2) $ 812.7 $ 751.6 8.1 %
Asset-based (3) 211.6 200.4 5.6 %
Transaction-based (4) 154.7 67.9 127.8 %
Key product area revenue (1)
Morningstar Data $ 196.8 $ 185.2 6.3 %
Morningstar Direct 148.6 137.9 7.8 %
PitchBook 148.4 99.6 49.0 %
DBRS Morningstar (5) 127.6 36.3 251.5 %
Morningstar Investment Management 115.9 111.2 4.2 %
Morningstar Advisor Workstation 88.5 90.0 (1.7 )%
Workplace Solutions 78.4 75.3 4.1 %
As of December 31,
2019 2018 2019 Change
Select business metrics
Morningstar Direct licenses 15,903 15,033 5.8 %
PitchBook Platform licenses 36,695 22,979 59.7 %
Advisor Workstation clients (U.S.) 163 171 (4.7 )%
Morningstar.com Premium Membership subscriptions (U.S.) 109,967 116,402 (5.5 )%
As of December 31,
Assets under management and advisement (approximate)
($bil) (6) 2019 2018 2019 Change
Workplace Solutions
Managed Accounts (7) $ 74.8 $ 58.2 28.5 %
Fiduciary Services 49.3 41.0 20.2 %
Custom Models 35.3 29.0 21.7 %
Workplace Solutions (total) $ 159.4 $ 128.2 24.3 %
Investment Management
Morningstar Managed Portfolios $ 48.6 $ 41.7 16.5 %
Institutional Asset Management 16.0 16.8 (4.8 )%
Asset Allocation Services 8.9 6.5 36.9 %
Investment Management (total) $ 73.5 $ 65.0 13.1 %
Asset value linked to Morningstar Indexes ($bil) 67.7 46.8 44.7 %
Our employees (approximate)
Worldwide headcount 6,737 5,416 24.4 %
Average assets under management and advisement ($bil) $ 214.0
(1) Revenue by type and key product area revenue includes the effect of foreign currency translations. For the year endedDecember 31, 2019 , Morningstar Data, Morningstar Direct, andMorningstar Investment Management increased revenue by 8.4%, 9.5%, and 5.7%, respectively, whereas Advisor Workstation revenue declined by 1.5% when excluding the impact of foreign currency. 52
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(2) License-based revenue includes Morningstar Data, Morningstar Direct, Morningstar Advisor Workstation, PitchBook, and other similar products. License-based revenue during 2018 included a$10.5 million revenue benefit related to an amended license agreement. Excluding the non-recurring revenue benefit from the license amendment in the prior period results, license-based revenue grew 10.0% during 2019. (3) Asset-based revenue includesMorningstar Investment Management , Workplace Solutions, and Morningstar Indexes. (4) Transaction-based revenue includes DBRS Morningstar, Internet advertising sales, and conferences. (5) Revenue for the twelve months endedDecember 31, 2018 reflects Morningstar Credit Ratings. Revenue for the first six months of 2019 includes revenue from Morningstar Credit Ratings while revenue for the third and fourth quarters of 2019 includes revenue from DBRS Morningstar, the newly combined credit ratings operations. For the six months ended 2019, transaction-based revenue, derived primarily from one-time ratings fees was 63% of such revenue. Recurring revenue from surveillance, research, and other services comprised the remainder in such period. (6) 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. Excluding changes related to new contracts and cancellations, changes in the value of assets under advisement can come from two primary sources: gains or losses related to overall trends in market performance, and net inflows or outflows caused when investors add to or redeem shares from these portfolios. Aside from Morningstar Managed Portfolios, it's difficult for our Investment Management business to quantify these cash inflows and outflows. The information we receive from most of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot specify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations. (7) Many factors can cause changes in assets under management and advisement for our managed retirement accounts, including employer and employee contributions, plan administrative fees, market movements, and participant loans and hardship withdrawals. The information we receive from the plan providers does not separately identify these transactions or the changes in balances caused by market movement. Consolidated Results Key metrics (in millions) 2019 2018 Change Revenue$ 1,179.0 $ 1,019.9 15.6 % Operating income 189.6 215.8 (12.1 )% Operating margin 16.1 % 21.2 % (5.1)pp Cash used for investing activities$ (746.3 ) $ (49.9
) 1,395.6 %
Cash provided by (used for) financing activities
Cash provided by operating activities$ 334.4 $ 314.8 6.2 % Capital expenditures (80.0 ) (76.1 ) 5.1 % Free cash flow$ 254.4 $ 238.7 6.6 %
____________________________________________________________________________________________
pp - percentage points
Consolidated Revenue (in millions) 2019 2018 Change Consolidated revenue$ 1,179.0 $ 1,019.9 15.6 %
In 2019, our consolidated revenue rose
We experienced strong revenue growth across all revenue types during 2019.
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License-based revenue, which represents subscription services available to customers, increased 8.1% during 2019 driven by demand for license-based products, such as PitchBook, Morningstar Data, and Morningstar Direct. PitchBook exhibited strong levels of both new account sales as well as existing client renewals and upgrades, which resulted in an increase in revenue of$48.8 million during 2019. The number of PitchBook Platform licenses increased to 36,695 at the end of 2019, compared with 22,979 at the end of 2018. Strong contributions from international markets helped to drive revenue growth of$11.6 million and$10.7 million for both Morningstar Data and Morningstar Direct, respectively. Asset-based revenue increased 5.6% during 2019, primarily driven by Morningstar Managed Portfolios, Morningstar Indexes, and Workplace Solutions. Morningstar Managed Portfolios revenue increased$7.7 million , primarily driven by the gross revenue contribution of Morningstar Funds Trust of$9.5 million , which largely offset ongoing fee compression resulting from a shift in the asset mix to lower-fee strategies. Total assets linked to Morningstar Indexes grew 44.7% over the prior year period, which contributed to revenue growth. Workplace Solutions revenue increased$3.0 million due to asset growth in managed accounts, custom models, and fiduciary services. Average assets under management and advisement (calculated based on available average quarterly or monthly data) were approximately$214.0 billion in 2019, compared with$200.1 billion in 2018. Transaction-based revenue grew 127.8% during 2019, driven by the$127.6 million revenue contribution of DBRS Morningstar. Excluding the impact of the combined credit ratings contribution, transaction-based revenue declined$4.5 million , or 14.2%, due to decreases in advertising revenue on Morningstar.com.
Organic revenue
Organic revenue (revenue excluding acquisitions, divestitures, adoption of accounting changes, 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. To allow for more meaningful comparisons of our results in different periods, we provide information about organic revenue, which reflects our underlying business excluding acquisitions, divestitures, adoption of accounting changes, and the effect of foreign currency translations. We exclude revenue from acquired businesses from our organic revenue growth calculation for a period of 12 months after we complete the acquisition. For divestitures, we exclude revenue in the prior period for which there is no comparable revenue in the current period. The combination of DBRS and Morningstar'sU.S. -based credit ratings operations in 2019 makes it difficult to ascribe the origin of revenue growth to either entity. As such, revenue from the entire credit ratings operation will be excluded from the reporting of organic revenue growth through the second quarter of 2020. Prior period results have been adjusted to conform to this presentation.
Organic revenue increased 8.4% in 2019. PitchBook, Morningstar Data, and
Morningstar Direct were the main drivers of the increase in organic revenue
during 2019. Excluding the
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[[Image Removed: a0510k19contributorsrevgrowt.jpg]]
The tables below reconcile consolidated revenue with organic revenue:
(in millions) 2019 2018 Change
Consolidated revenue $ 1,179.0 $ 1,019.9 15.6 %
Less: acquisitions (107.8 ) (20.2 ) 433.7 %
Less: divestitures - - - %
Less: adoption of accounting changes - - - %
Effect of foreign currency translations 12.3 - NMF
Organic revenue $ 1,083.5 $ 999.7 8.4 %
____________________________________________________________________________________________
NMF - Not meaningful
Revenue by geographical area
Year ended December 31
(in millions) 2019 2018 Change
United States $ 866.4 $ 764.2 13.4 %
Asia 27.9 24.5 13.9 %
Australia 39.5 40.9 (3.4 )%
Canada 56.9 30.7 85.3 %
Continental Europe 88.0 81.2 8.4 %
United Kingdom 93.9 72.4 29.7 %
Other 6.4 6.0 6.7 %
Total International 312.6 255.7 22.3 %
Consolidated revenue $ 1,179.0 $ 1,019.9 15.6 %
International revenue comprised approximately 27% of our consolidated revenue in
2019, compared with 25% in 2018. Approximately 58% of international revenue is
generated by Continental Europe and the U.K. Revenue from international operations increased
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International organic revenue
International organic revenue (international revenue excluding acquisitions, divestitures, adoption of accounting changes, and the effect of foreign currency translations) is considered a non-GAAP financial measure. The definition of international organic revenue we use may not be the same as similarly titled measures used by other companies. International organic revenue should not be considered an alternative to any measure of performance as promulgated under GAAP.
International organic revenue increased 8.1% during 2019 primarily driven by Morningstar Data and Morningstar Direct.
The tables below present a reconciliation from international revenue to international organic revenue:
(in millions) 2019 2018 Change International revenue$ 312.6 $ 255.7 22.3 % Less: acquisitions (48.5 ) - - % Less: divestitures - - - Less: adoption of accounting changes - - - % Effect of foreign currency translations 12.3 - NMF International organic revenue$ 276.4 $ 255.7 8.1 % 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 our retention metrics over the past five years for all of our contract-based products and services, which are primarily weighted toward Morningstar Data, Morningstar Direct, PitchBook, Morningstar Advisor Workstation, and Morningstar Office Cloud. [[Image Removed: a910k19renewalratesbw02.jpg]] For these contract-based products and services, we estimate that our weighted average annual renewal rate was approximately 102% in 2019, compared with 100% in 2018. 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%. 56
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Consolidated Operating Expense
(in millions) 2019 2018 Change Cost of revenue$ 483.1 $ 411.1 17.5 % % of revenue 41.0 % 40.3 % 0.7 pp Sales and marketing 177.9 148.5 19.8 % % of revenue 15.1 % 14.6 % 0.5 pp General and administrative 210.7 147.8 42.6 % % of revenue 17.9 % 14.5 % 3.4 pp
Depreciation and amortization 117.7 96.7 21.7 %
% of revenue 10.0 % 9.5 % 0.5 pp Total operating expense$ 989.4 $ 804.1 23.0 % % of revenue 83.9 % 78.8 % 5.1 pp In 2019, operating expense increased$185.3 million , or 23.0%. DBRS Morningstar contributed 10.9% to operating expense growth, including deal-related amortization and integration expenses as well as costs related to a pending legal settlement. Operating expenses for the remainder of Morningstar increased 12.1% as we continue to invest for growth in the business. Foreign currency translations increased our operating expense by$11.3 million in 2019. Compensation expense (which primarily consists of salaries, bonus, and other company-sponsored benefits) increased$80.3 million in 2019. The addition of approximately 504 employees from the DBRS acquisition contributed$45.3 million of the total increase in compensation expense. The remaining increase reflects investments in headcount related to roles in data collection and analysis, product and software development, and sales and service support. Production expense increased$16.3 million , mainly due to the fees paid to sub-advisors and other costs related to the Morningstar Funds Trust as well as cloud computing costs. Amortization expense increased$15.8 million primarily from additional amortization related to intangibles from the acquisition of DBRS. Rent expense increased$13.6 million during 2019 in connection with planned expansion and office lease renewals in certain geographies. Stock-based compensation expense also increased$12.6 million in 2019, primarily resulting from continued achievement of incentive targets under the PitchBook management bonus plan. We had 6,737 employees worldwide at the end of 2019, compared with 5,416 in 2018. This increase reflects continued investment in resources to support our key growth initiatives, including operations inIndia andthe United States . This increase also includes approximately 504 employees who joined Morningstar as a result of the DBRS acquisition inJuly 2019 .
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$72.0 million , or 17.5%, in 2019. Higher compensation expense of$46.9 million was the largest contributor to the increase. DBRS Morningstar contributed$31.9 million of the increase in compensation expense. Higher production expense of$16.3 million also contributed to the unfavorable variance in this category, mainly due to$9.5 million in fees paid to sub-advisors and other costs related to the Morningstar Funds Trust as well as cloud computing costs. Continuous focus on development of our major software platforms, in addition to bringing new products and capabilities to market, resulted in a slight increase in capitalized software development over the prior period, which in turn reduced operating expense. In 2019, we capitalized$53.8 million in costs associated with software development activities, mainly related to enhanced capabilities in our products, internal infrastructure, and software compared with$53.5 million in 2018. 57
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Sales and marketing
Sales and marketing expense increased$29.4 million , or 19.8%, in 2019, reflecting a$16.5 million increase in compensation expense, which was partially driven by additional headcount from the DBRS acquisition. Sales commission expense was higher by$3.9 million due to strong PitchBook sales performance. Advertising and marketing spend increased$3.0 million due to higher levels of spend on advertising and promotional materials. Stock-based compensation also increased$2.0 million , primarily driven by the continued achievement of incentive targets under the PitchBook management bonus plan.
General and administrative
General and administrative expense increased$62.9 million , or 42.6%, during 2019. Compensation expense increased$16.8 million , of which DBRS Morningstar accounted for$8.6 million . Rent expense increased$13.6 million in connection with planned expansion and office lease renewals in certain geographies. Professional fees increased$9.7 million during 2019 primarily due to acquisition-related expenses for DBRS. Stock-based compensation was higher by$9.4 million primarily driven by continued achievement of incentive targets under the PitchBook management bonus plan.
Depreciation and amortization
Depreciation and amortization increased
Depreciation expense rose$5.2 million in 2019, mainly driven by depreciation expense related to capitalized software development incurred over the past several years. Intangible amortization expense increased$15.8 million in 2019, primarily from additional amortization related to intangibles generated by the acquisition of DBRS. Amortization of intangible assets will be an ongoing expense. We estimate that this expense will total approximately$53.5 million for the twelve months endedDecember 31, 2020 . Our estimates of future amortization expense for intangible assets may be affected by additional acquisitions, divestitures, changes in the estimated average useful lives, and foreign currency translation.
Consolidated Operating Income and Operating Margin
(in millions) 2019 2018 Change Operating income$ 189.6 $ 215.8 (12.1 )% Operating margin 16.1 % 21.2 % (5.1) pp Consolidated operating income decreased$26.2 million in 2019, reflecting an increase in operating expenses of$185.3 million , which was partially mitigated by an increase in revenue of$159.1 million . Operating margin was 16.1%, a decrease of 5.1 percentage points compared with 2018. 58
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We reported adjusted operating income, which excludes M&A related expenses and
amortization expense, of $233.3 million in 2019. Adjusted operating income is a
non-GAAP financial measure; the table below shows a reconciliation to the most
directly comparable GAAP financial measure.
(in millions) 2019 2018 Change
Operating income $ 189.6 $ 215.8 (12.1 )%
Add: all intangible amortization expense 36.5 20.7 76.3 %
Add: all M&A-related expenses 7.2 - NMF
Adjusted operating income $ 233.3 $ 236.5 (1.4 )%
We reported an adjusted operating margin, which excludes M&A-related expenses
and amortization expense, of 19.8% in 2019. Adjusted operating margin is a
non-GAAP financial measure; the table below shows a reconciliation to the most
directly comparable GAAP financial measure.
2019 2018 Change
Operating margin 16.1 % 21.2 % (5.1) pp
Add: all intangible amortization expense 3.1 % 2.0 % 1.1 pp
Add: all M&A-related expenses 0.6 % - % 0.6 pp
Adjusted operating margin 19.8 % 23.2 % (3.4) pp
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Non-Operating Income, Equity in Net Loss of Unconsolidated Entities, and Effective Tax Rate and Income Tax Expense
Non-Operating Income
The following table presents the components of non-operating income, net:
(in millions) 2019 2018 Interest income$ 2.4 $ 2.3 Interest expense (11.1 ) (4.1 )
Gain on sale of investments, net 1.2 1.0 Gain on sale of product line
- 10.5
Gain on sale of equity investments 19.5 5.6
Other (expense) income, net (3.1 ) 1.8
Non-operating income, net $ 8.9 $ 17.1 Interest income reflects interest from our investment portfolio. Interest expense mainly relates to the outstanding principal balance under the prior credit facility and the new senior credit agreement, which we entered into during the third quarter of 2019 to fund the acquisition of DBRS.
The gain on sale of equity investments in 2019 relates to the sale of our equity ownership in one of our equity method investments during the third quarter of 2019. Other (expense) income, net primarily includes foreign currency exchange gains and losses resulting from theU.S. dollar denominated short-term investments held in non-U.S. jurisdictions.
Equity in Net Loss of Unconsolidated Entities
(in millions) 2019 2018
Equity in net loss of unconsolidated entities
Equity in net loss of unconsolidated entities primarily reflects income from Morningstar Japan K.K. (MJKK) offset by losses in our other equity method investments.
We describe our investments in unconsolidated entities in more detail in Note 10 of the Notes to our Consolidated Financial Statements.
Effective Tax Rate and Income Tax Expense
The following table summarizes the components of our effective tax rate: (in millions)
2019 2018
Income before income taxes and equity in net loss of unconsolidated entities
$ 198.5 $ 232.9 Equity in net loss of unconsolidated entities (0.9 ) (2.1 ) Total$ 197.6 $ 230.8 Income tax expense$ 45.6 $ 47.8 Effective tax rate 23.1 % 20.7 % Our effective tax rate in 2019 was 23.1%, an increase of 2.4 percentage points compared with 20.7% in 2018, primarily due to minimum taxes and non-deductible expenses in 2019. 60
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Liquidity and Capital Resources
As ofDecember 31, 2019 , we had cash, cash equivalents, and investments of$367.5 million , down$28.4 million from the end of 2018. The decrease reflects cash provided by operating activities and proceeds from long-term debt of$610.0 million , partially offset by$681.9 million of cash paid for the acquisition of DBRS and AdviserLogic,$165.6 million of repayments of long-term debt,$80.0 million of capital expenditures, dividends paid of$47.8 million , and$15.2 million for employee taxes paid from withholding of restricted stock units. We also used$4.9 million to repurchase common stock under our share repurchase program, of which$0.3 million was repurchased in the fourth quarter of 2018, but was settled and paid for inJanuary 2019 . Purchases of equity-method investments of$1.5 million also offset the cash inflows. [[Image Removed: a1110k19cashequivbw03.jpg]] Cash provided by operating activities is our main source of cash. In 2019, cash provided by operating activities was$334.4 million , reflecting$292.9 million of net income, adjusted for non-cash items and$41.5 million in positive changes from our net operating assets and liabilities. OnJuly 2, 2019 , we entered into a new senior credit agreement (the Credit Agreement), the initial borrowings under which were made to finance the DBRS acquisition, and repaid all outstanding obligations under the prior credit facility. The Credit Agreement provides the company with a five year multi-currency credit facility with an initial borrowing capacity of up to$750.0 million , including a$300.0 million revolving credit facility and a term loan facility of$450.0 million . We had an outstanding principal balance of$513.1 million as ofDecember 31, 2019 and a revolving credit facility borrowing availability of$230.0 million . The Credit Agreement also contains financial covenants under which we: (i) may not exceed a maximum consolidated leverage ratio of 3.50 to 1.00 (or 3.75 to 1.00 for the four fiscal quarters following any material acquisition (as defined in the Credit Agreement)) and (ii) are required to maintain a minimum consolidated interest coverage ratio of not less than 3.00 to 1.00. We were in compliance with the financial covenants as ofDecember 31, 2019 . See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our new Credit Agreement. [[Image Removed: a1010k19debtbw02crpped.jpg]] 61
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We believe our available cash balances and investments, along with cash generated from operations and the borrowing capacity under our Credit Agreement, will be sufficient to meet our operating and cash needs for at least the next 12 months. We invest our cash reserves in cash equivalents and investments and maintain a conservative investment policy. We invest most of our investment balance (approximately$32.0 million , or 95.8% of our total investments balance as ofDecember 31, 2019 ) in stocks, bonds, options, mutual funds, money market funds, or exchange-traded products that replicate the model portfolios and strategies created by Morningstar. These investment accounts may also include exchange-traded products where Morningstar is an index provider. Approximately 70% of our cash, cash equivalents, and investments as ofDecember 31, 2019 was held by our operations outside theU.S. , up from about 67% as ofDecember 31, 2018 . The amount of accumulated undistributed earnings of our foreign subsidiaries was approximately$240.5 million as ofDecember 31, 2019 . We have not recorded deferred income taxes on the$240.5 million primarily because most of these earnings were previously subject to the one-time deemed mandatory repatriation tax under the Tax Cuts and Jobs Act of 2017. InFebruary 2019 , we repatriated approximately$45.8 million of our foreign earnings to theU.S. Otherwise, we generally consider ourU.S. directly-owned foreign subsidiary earnings to be permanently reinvested.
We intend to use our cash, cash equivalents, and investments for general corporate purposes, including working capital and funding future growth.
InDecember 2017 , the board of directors approved a share repurchase program that authorizes the company to repurchase up to$500.0 million in shares of the company's outstanding common stock, effectiveJanuary 1, 2018 . The authorization expires onDecember 31, 2020 . We have repurchased a total of 244,180 shares for$25.6 million throughDecember 31, 2019 and had approximately$474.4 million available for future repurchases as ofDecember 31, 2019 . In 2019, we also paid dividends of$47.8 million . InFebruary 2020 , our board of directors declared a quarterly dividend of30 cents per share. The dividend is payable onApril 30, 2020 to shareholders of record as ofApril 3, 2020 . While subsequent dividends will be subject to board approval, we expect to make regular quarterly dividend payments of30 cents per share in 2020. We expect to continue making capital expenditures in 2020, primarily for computer hardware and software provided by third parties, internally developed software, and leasehold improvements for new and existing office locations. We continue to adopt more public cloud and software as a service applications for new initiatives and are in the process of migrating relevant parts of our data centers to the public cloud over the next several years. During this migration, we expect to run certain applications and infrastructure in parallel. These actions will have some transitional effects on our level of capital expenditures and operating expenses.
We also expect to use a portion of our cash and investments balances in the
first quarter of 2020 to make annual bonus payments of approximately
Consolidated Free Cash Flow
As described in more detail above, we define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow solely as supplemental disclosure to help investors better understand how much cash is available after we spend money to operate our business. Our management team uses free cash flow to evaluate our business. Free cash flow is not a measure of performance. Also, the free cash flow definition we use may not be comparable to similarly titled measures used by other companies. (in millions) 2019 2018 Change Cash provided by operating activities$ 334.4 $ 314.8 6.2 % Capital expenditures (80.0 ) (76.1 ) 5.1 % Free cash flow$ 254.4 $ 238.7 6.6 % 62
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We generated free cash flow of$254.4 million in 2019, an increase of$15.7 million compared with 2018. The change reflects a$19.6 million increase in cash provided by operating activities as well as a$3.9 million increase in capital expenditures. Acquisitions We paid a total of$683.3 million , less cash acquired, related to acquisitions over the past three years. We describe these acquisitions in Note 8 of the Notes to our Consolidated Financial Statements. We paid a total of$33.7 million related to purchasing additional investments in unconsolidated entities over the past three years. We describe these investments in Note 10 of the Notes to our Consolidated Financial Statements.
Divestitures
We sold our 15(c) board consulting services product line in 2018 and received a total of$10.5 million related to this sale. We sold HelloWallet in 2017 and received a total of$23.7 million related to this sale. For more information, please see Note 9 of the Notes to our Consolidated Financial Statements.
Application of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with GAAP. We discuss our significant accounting policies in Note 2 of the Notes to our Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires our management team to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense, and related disclosures included in our Consolidated Financial Statements. We continually evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe are reasonable. Based on these assumptions and estimates, we make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results could vary from these estimates and assumptions. If actual amounts are different from previous estimates, we include revisions in our results of operations for the period in which the actual amounts become known. We believe the following critical accounting policies reflect the significant judgments and estimates used in the preparation of our Consolidated Financial Statements: Revenue Recognition Most of our revenue comes from the sale of subscriptions for data, software, and Internet-based products and services. We recognize this revenue in equal amounts over the term of the subscription or license, which generally ranges from one to three years. We also provide research, investment management, retirement advice, and other services. We recognize this revenue when the service is provided or during the service obligation period defined in the contract. We make significant judgments related to revenue recognition, including identifying the transaction price in a contract. For contracts that combine multiple products and services or other performance obligations, we make judgments regarding the value of each obligation in the arrangement based on selling prices of the items as if when sold separately. We recognize revenue as we satisfy our performance obligations under the terms of the contracts with our customers. If arrangements include an acceptance provision, we begin recognizing revenue upon the receipt of customer acceptance.
We make judgments at the beginning of an arrangement regarding whether or not collection of the consideration to which we are entitled is probable. We typically sell to institutional customers with whom we have a history of successful collections and assess the probability of collection on a customer-by-customer basis.
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Deferred revenue is the amount collected in advance for subscriptions, licenses, or services that has not yet been recognized as revenue. Deferred revenue totaled$282.3 million at the end of 2019 (of which$250.1 million was classified as a current liability with an additional$32.2 million included in other long-term liabilities). We expect to recognize this deferred revenue in future periods as we fulfill our service obligations under our subscription and service agreements. The amount of deferred revenue may increase or decrease based on the mix of contracted products and services and the volume of new and renewal subscriptions. The timing of future revenue recognition may change depending on the terms of the applicable agreements and the timing of fulfilling our service obligations. To the extent that there are material differences between our determination of deferred revenue and its expected realization and actual results, our financial condition or results of operations may be affected. Acquisitions,Goodwill , and Other Intangible Assets We generally acquire businesses which are accounted for as business combinations. Our financial statements reflect the operations of an acquired business starting from the completion of the transaction. We record the estimated fair value of assets acquired and liabilities assumed as of the date of acquisition. To account for each business combination, we utilize the acquisition method of accounting which requires the following steps (1) identifying the acquirer, (2) determining the acquisition date, (3) recognizing and measuring identifiable assets acquired and liabilities assumed and (4) recognizing and measuring goodwill or a gain from a bargain purchase. Regardless of whether an acquisition is considered to be a business combination or an asset acquisition, allocating the purchase price to the acquired assets and liabilities involves management judgment. We base the fair value estimates on available historical information and on future expectations and assumptions that we believe are reasonable, but these estimates are inherently uncertain. Determining the fair value of intangible assets requires significant management judgment in the following areas: • Identify the acquired intangible assets: For each acquisition, we identify
the intangible assets acquired. These intangible assets generally consist
of customer relationships, trademarks and trade names, technology-related
intangibles (including internally developed software and databases), and
in certain acquisitions, noncompete agreements.
• Estimate the fair value of these intangible assets: We may consider
various approaches to value the intangible assets. These include the cost
approach, which measures the value of an asset based on the cost to
reproduce it or replace it with another asset of like utility by applying
the reproduction cost method or replacement cost method; the market
approach, which values the asset through an analysis of sales and
offerings of comparable assets which can be adjusted to reflect
differences between the investment or asset being valued and thecomparable investments or assets, such as historical financial condition
and performance, expected economic benefits, time and terms of sale,
utility, and physical characteristics, and the income approach, which
measures the value of an asset based on the present value of the economic
benefits it is expected to produce utilizing inputs such as estimated
future cash flows based on forecasted revenue growth rates and EBITDA
margins, estimated attritions rate and weighted average cost of capital
and discount rate assumptions.
• Estimate the remaining useful life of the assets: For each intangible
asset, we use judgment and assumptions to establish the remaining useful
life of the asset. For example, for customer relationships, we determine
the estimated useful life with reference to observed customer attrition
rates. For technology-related assets such as databases, we make judgments
about the demand for current data and historical metrics in establishing
the remaining useful life. For internally developed software, we estimate
an obsolescence factor associated with the software.
We record any excess of the purchase price over the estimated fair values of the
net assets acquired as goodwill, which is not amortized. Instead, it is subject
to an impairment test annually or whenever indicators of impairment exist. We
review the carrying value of goodwill for impairment at least annually based on
our assessment of impairment indicators. If impairment indicators exist, we
reduce the goodwill balance to reflect the revised fair value.
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We believe the accounting estimates related to purchase price allocations and subsequent goodwill impairment testing are critical accounting estimates because changes in these assumptions could materially affect the amounts and classifications of assets and liabilities presented in our Consolidated Balance Sheets, as well as the amount of amortization and depreciation expense, if any, recorded in our Consolidated Statements of Income. Stock-Based Compensation We include stock-based compensation expense in each of our operating expense categories. Our stock-based compensation expense primarily reflects grants of restricted stock units, performance share awards, and market stock units. We measure stock-based compensation expense at the grant date based on the fair value of the award and recognize the expense ratably over the award's vesting period. We measure the fair value of our restricted stock units on the date of grant based on the market price of the underlying common stock as of the close of trading on the day before the grant. We estimate expected forfeitures of stock-based awards at the grant date and recognize compensation cost only for those awards expected to vest. We later adjust this forfeiture assumption to the actual forfeiture rate. Therefore, changes in the forfeiture assumptions do not change the total amount of expense ultimately recognized over the vesting period. Instead, different forfeiture assumptions would only affect the timing of expense recognition over the vesting period.
We adjust the stock-based compensation expense to reflect those awards that ultimately vested and update our estimate of the forfeiture rate that will be applied to awards not yet vested.
Income Taxes
Our effective tax rate is based on the mix of income and losses in ourU.S. and non-U.S. operations, statutory tax rates, and tax-planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required to evaluate our tax positions. Because of timing differences required by tax law, the effective tax rate reflected in our Consolidated Financial Statements is different from the tax rate reported on our tax return (our cash tax rate). Some of these differences, such as expenses that are not deductible in our tax return, are permanent. Other differences, such as depreciation expense, reverse over time. These timing differences create deferred tax assets and liabilities. We determine our deferred tax assets and liabilities based on temporary differences between the financial reporting and the tax basis of assets and liabilities. As ofDecember 31, 2019 , we had gross deferred tax assets of$46.0 million and gross deferred tax liabilities of$128.0 million . The deferred tax assets include$4.5 million of deferred tax assets related to$21.4 million of net operating losses (NOLs) of our non-U.S. operations. In assessing the realizability of our deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. We have recorded a valuation allowance against all but approximately$11.7 million of the non-U.S. NOLs, reflecting the likelihood that the benefit of the NOLs will not be realized. We have not recorded a valuation allowance against theU.S. federal NOLs of$0.8 million because we expect the benefit of theU.S. federal NOLs to be fully utilized before expiration. In assessing the need for a valuation allowance, we consider both positive and negative evidence, including tax planning strategies, projected future taxable income, and recent financial performance. If we determine a lower allowance is required at some point in the future, we would record a reduction to our tax expense and valuation allowance. These adjustments would be made in the same period we determined the change in the valuation allowance was needed. This would cause our income tax expense, effective tax rate, and net income to fluctuate. We use judgment to identify, recognize, and measure the amounts of uncertain tax positions to be recorded in the financial statements related to tax positions taken or expected to be taken in a tax return. We recognize liabilities to represent our potential future obligations to taxing authorities for the benefits taken in our tax returns. We adjust these liabilities, including any impact of the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. A number of years may elapse before a particular matter for which we have established a reserve is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. 65
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We use judgment to classify unrecognized tax benefits as either current or noncurrent liabilities in our Consolidated Balance Sheets. Settlement of any particular issue would usually require the use of cash. We generally classify liabilities associated with unrecognized tax benefits as noncurrent liabilities. It typically takes several years between our initial tax return filing and the final resolution of any uncertain tax positions with the tax authority. We recognize favorable resolutions of tax matters for which we have previously established reserves as a reduction to our income tax expense when the amounts involved become known. Assessing the future tax consequences of events that have been recognized in our Consolidated Financial Statements or tax returns requires judgment. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.
Contingencies
We are subject to various claims and contingencies related to legal proceedings and regulatory investigations. These legal proceedings and regulatory investigations involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties, and government actions. Assessing the probability of loss for such contingencies and determining how to accrue the appropriate liabilities requires judgment. If actual results differ from our assessments, our financial position, results of operations, or cash flows would be affected.
Recently Issued Accounting Pronouncements
Refer to Note 18 of the Notes to our Consolidated Financial Statements for
recently adopted accounting pronouncements and recently issued accounting
pronouncements not yet adopted as of
Contractual Obligations
The table below shows our known contractual obligations as ofDecember 31, 2019 , and the expected timing of cash payments related to these contractual obligations: (in millions) 2020 2021 2022 2023 2024 Thereafter Total Minimum commitments on non-cancelable operating lease obligations (1)$ 41.7 $ 37.9 $ 25.4 $ 22.9 $ 17.7 $ 55.7 $ 201.3 Minimum payments related to long-term financing agreements 1.1 - - - - - 1.1 Minimum payments on Credit Agreement (2) 11.3 14.1 22.5 22.5 444.1 - 514.5 Unrecognized tax benefits (3) 10.8 - - - - - 10.8 Total$ 64.9 $ 52.0 $ 47.9 $ 45.4 $ 461.8 $ 55.7 $ 727.7
(1) The non-cancelable operating lease obligations are mainly for office space.
(2) The minimum payments on the term facility and revolving credit facility
reflect outstanding principal balance of
(3) Represents unrecognized tax benefits (including penalties and interest, less the impact of any associated tax benefits). The amount included in the table represents items that may be resolved through settlement of tax audits during 2020. The table excludes$3.0 million of unrecognized tax benefits, included as a long-term liability in our Consolidated Balance Sheet as ofDecember 31, 2019 , for which we cannot make a reasonably reliable estimate of the period of payment. 66
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