MSCI Inc.
Q3 2015 Earnings Call Transcript

Published: 30 Oct 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the MSCI Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Stephen Davidson, Head of Investor Relations. Sir, you may begin.

[Stephen C. Davidson:]

Thank you, Shaniez. Good day and welcome to the MSCI third quarter 2015 earnings conference call. Earlier this morning, we issued a press release announcing our results for third quarter 2015. A copy of the release and a slide presentation that we have prepared for this call may be viewed at msci.com under the Investor Relations tab. These documents include our new segment reporting and activity costs and disclosures. Let me remind you that this call may contain forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made. For a discussion of additional risks and uncertainties, please see the risk factors and forward-looking statements in our most recent Form 10-K and our other filings with the SEC. During today's call, in addition to GAAP results, we also refer to non-GAAP measures, including adjusted EBITDA, adjusted EBITDA expenses, adjusted EPS and free cash flow. We believe our non-GAAP measures associate meaningful period-to-period comparisons and provide a baseline for the evolution of results. You'll find a reconciliation of the equivalent GAAP term in the earnings materials and an explanation of why we deem this information to be meaningful, as well as how management uses these measures on pages 32 to 40 of the earnings presentation. We have provided you with a lot of new disclosures this quarter. So to allow for more time for the Q&A, we'll try to limit the prepared remarks to incremental information not already included in our earnings release. On the call today are Henry Fernandez, Chief Executive Officer; and Bob Qutub, Chief Financial Officer. With that, let me now turn the call over to Mr. Henry Fernandez. Henry?

[Henry A. Fernandez:]

Thank you for joining us today. In my opening remarks, I plan to discuss some of the highlights from our strong third quarter, which builds upon the momentum that we have been developing over the last several quarters. Then I will like to share with you the bigger picture of MSCI. Our company's exciting strategies for the next several years is designed to lead to even greater revenue growth and profitability as well as increased cash flows. This strong financial performance should allow MSCI to continue its policy of returning significant capital to our shareholders. I am very excited to provide you with this look-ahead. But first our Q3 results, which start on slide three. As you saw from our press release, MSCI reported a strong third quarter. And one other thing, we delivered much higher levels of profitability, driven by solid revenue generation, and a strong cost discipline, resulting in double-digit growth in adjusted EBITDA and continued margin expansion. The highlights of Q3 include revenue growth of 7%, which combined with a 7% decline in adjusted EBITDA expenses drove a 740 basis point increase in margins to 48%, which is the highest margins reported by MSCI in almost three years. Total run rate growth was 6% and the recurring subscription run rate was up 8%, excluding the negative impact of foreign exchange. Net income was $64 million or $0.59 in diluted EPS. Adjusted net income was $66 million or $0.60 in adjusted EPS. Our business model continued to deliver a strong cash flow. Furthermore, our well-timed $800 million issuance of senior notes in early August, just before the spike in market volatility, positioned us to repurchase 8 million shares for a total value of approximately $480 million in the quarter and through October 14. Since December 2012, we have repurchased over 22 million shares. And with the completion of our $850 million share repurchase authorization, our board has approved a new $1 billion authorization. In summary, on the financial perspective, we are extremely pleased with MSCI's overall performance in the first three quarters of 2015. On the personnel front and to better position MSCI to achieve its strategic goals, we recently announced that Baer Pettit will assume the role of Chief Operating Officer and Diana Tidd has been appointed Head of Equity Index Products worldwide reporting to Baer. We are very pleased to have leaders like Baer and Diana to step into these important roles. Now I will turn our attention to a long-term target, which I have set for ourselves on slide four, taking you through each of our segments and the growth we aspire to for each of them over the longer term. This is the way we are running the company. And the segments will provide you with greater transparency and insight into our performance as we have promised earlier in the year. We believe we are a growth company with a strong recurring revenue model, aspiring to achieve double-digit revenue growth over time. We have, in our view, multiple levers to drive that future growth. In our Index segment where MSCI's global equity indices are considered the gold standard for global investing, it is our long-term goal to grow our revenue annually in the low double-digits, with adjusted EBITDA margin ranging from 68% to 72%. This range is below the margin level that we are reporting today for Q3. This is our long-term target, which reflects the impact of important investment that we may need to make to enhance and expand our market position and indices, just as we have done in the past by differentiating ourselves in new area, so just Factor Indexes. We're excited to report and we believe our Analytics segment is now on the path to both revenue growth and improved profitability as a result of the steps we have taken this year and the steps we will continue to take in 2016. It is our goal to move our revenue growth to the high single-digits over time. It is also our long-term goal to move adjusted EBITDA margins to the 30% to 35% range. Our clients rely on Analytics products to meet the demands of an increasingly complex and global multi-asset class investment world and, therefore, presenting us with significant opportunities to serve them and to grow our business. Lastly, in our All Other segment, which consist of our ESG and Real Estate products, we see high growth opportunities in our ESG products and the potential to achieve higher levels of growth and improved profitability for our Real Estate products. Our long-term goal is that the All Other segment will be an engine of future growth for the company and we hope to grow revenues in this segment in the low double-digits. And over the longer term, we also would like to move our adjusted EBITDA margin from negative levels today, given our significant investments in this area, to the range of about 15% to 20%. So having reviewed our financial targets for each of our segment, what does this all mean for MSCI as a whole? If we reach our long-term financial target, we believe that we'll be in an even more competitively advantageous position in the future and we'll be better positioned to deliver deeper insight and superior tools to the leading investors in the world. If we can grow at a faster pace, we believe we'll be in a position to solidify and enhance market leadership in all our products including indices, equity and multi-asset class Analytics, and ESG and private Real Estate products. From a financial perspective, it is our goal that the respective contribution from each of the segments will help us achieve our long-term goal of low double-digit revenue growth and EBITDA margin of over 50% for the whole company. The trajectory to our goal of 50% adjusted EBITDA margin will obviously not be a straight line. For example, even though we reached 48% margin in Q3, we expect Q4 to be lower by some 200 basis points to 300 basis points. However, please keep your focus on the destination of 50%. On the slide five, we provide you with more detail on how we intend to achieve the adjusted EBITDA target in the Analytics segment. As you know all too well, this is an area of key focus for us. The focus for Analytics in the near term will continue to be on improving profitability. We have started by reducing the cost structure. We have achieved over $10 million of cost reduction so far in 2015, which annualize to about $20 million of this $25 million to $30 million that we hope to achieve. We have, therefore, made significant headway already in 2015 in achieving our cost target for Analytics products. On the slide seven, we provide you with a sense of how much the new Analytics management team led by Peter Zangari has accomplished in the last six months. The team has put the segment on a path to improve profitability and subsequent revenue growth. Lastly, jumping to slide eight, we highlight for you the strong track record of capital returns that we have established for MSCI. From our early days of capital return in 2012 until the present, we have returned over $1.2 billion in capital to our shareholders. By repurchasing over 22 million shares at an average price of $51.34 and paying a cumulative dividend of $85 million. We certainly hope to continue our strong record of returning capital to our shareholders over the long term. Now, I'd like to turn over to Bob, who will walk us through to the third quarter results in more detail.

[Robert Qutub:]

Thanks, Henry. And good morning to all of you on the phone. Now please turn to slide 10 where we'll begin my overview of our financial results. Our results this quarter were strong with a 7% increase in revenue and a 7% decline in adjusted EBITDA expenses. This drove a 26% increase in adjusted EBITDA and a 740 basis points increase in our adjusted EBITDA margins to 47.9%, including the impact of foreign exchange fluctuations. Just a couple of quick comments on the results. Our results include higher interest cost from our bond offerings in the fourth quarter of last year and August of this year. In our GAAP numbers, we recorded a $6.3 million gain on the sale of an investment, which is excluded from our adjusted EPS. The 7% decline in weighted shares outstanding over the year added about $0.04 to our adjusted EPS. We anniversaried GMI in August and, as of the third quarter, it is considered part of our organic revenue stream in ESG. And lastly, just a comment regarding our tax rate. We are now in the process of aligning our tax profile with our global operating footprint. We believe this project will reduce our effective tax rate by a number of percentage points over the coming years. As we move forward, we will update you on our progress. And with slides that follow, we adjust our reported results for foreign currency fluctuations on our subscription revenue and cost, but we do not provide the impact on foreign currency fluctuations on our asset-based fees tied to assets under management, of which approximately two-thirds are invested in securities denominated in currencies other than the U.S. dollar. Before I get into the results, let me talk for a moment on the changes in our disclosures. The disclosures of our product segments and the related profitability are in line with the commitment we made at the beginning of the year to provide this information in the second half of 2015. In line with these enhanced disclosures, we spend considerable time focusing on the activities that drive our costs. Those activities are now reflected in our income statement and show what we incur to, one, support our existing products and clients; expand and grow our client relationships; and finally, develop and build new products. We believe this increased transparency will provide you with more insight into MSCI. Now let's turn to slide 11 where we will provide you with a bridge for the year-over-year change in our revenues by segment and revenue type. Total revenues increased $17 million or 7% to $269 million, but declined slightly from the second quarter 2015. The year-over-year increase was driven by an increase of $14 million or 7% in recurring subscription revenues and an increase of $4 million or 9% in asset-based fees, partially offset by lower non-recurring revenue. Adjusting for the negative impact of FX, our subscription revenues, which includes recurring subscription and non-recurring revenue, would have increased 8% overall, and Index would have increased 10% and Analytics and All Other would have each increased 7%. The $4 million or 9% increase in asset-based fee revenue to $51 million was driven by $32 billion increase in average AUM and ETF linked to MSCI indices to $418 billion as well as growth in non-ETF institutional passive funds based on MSCI indices. On a linked quarter basis, asset-based fees declined slightly, driven by a 5% decline in average AUM and ETF linked to MSCI indices. The linked quarter decline was mitigated by higher revenue from non-ETF institutional passive funds linked to MSCI indices. Turning to slide 12, we provide you with the year-over-year adjusted EBIDA expense bridge. Third quarter adjusted EBITDA expenses decreased $10 million or 7% to $140 million and declined $12 million or 8% compared to the second quarter of 2015. The impact of 2014 hires and same-store inflationary compensation noted here on the chart as net carryover inflationary increase as well as incremental severance was more than offset by a $7 million benefit in foreign currency exchange fluctuations and cost savings of $12 million, driven primarily by lower compensation and benefits as head count was lower by 133 year-over-year. Lower non-compensation cost also contributed to this decline. Excluding the impact of foreign currency exchange fluctuation, our adjusted EBITDA expenses would have decreased $3 million or 2%. The decline on a linked quarter basis was driven entirely by lower compensation and benefit expenses, reflecting lower incentive compensation accruals, lower wages and lower severance related to our efficiency efforts, and higher capitalization of compensation related to various strategic projects underway. On slide 13, we provide the run rate bridge for the quarter. Our reported run rate increased 6% to $1.062 billion consisting of a 6% increase in subscription run rate to $874 million and a 6% ABF run rate to $188 million. Compared to the second quarter 2015, however, run rate was flat, driven by a 7% decline in asset-based fee run rate and a 5% decline in average AUM and ETF linked to MSCI indices. Adjusting for foreign currency fluctuations, subscription run rate grew 8% year-over-year. In the quarter a combined $3 million increase in Index and record ESG sales was offset by a $4 million decline in Analytics and Real Estate sales. Lower Analytics cancellations, however, helped mitigate the decline in Analytics gross sales and aggregate retention rates increased to a record 95.3%. Overall, retention remained very strong at 95%. On slides 14 through 18, I'll walk you through our segment results. Let's begin with Index on slide 14. Revenues for Index increased 9% on a reported basis and the recurring subscription portion of Index revenues increased 11% on an FX-adjusted basis. The adjusted EBITDA margin for Index increased to 73%. We saw a continued strong growth in our core market cap Index products, factor and thematics, and derivatives as this growth continues to be supported by a growing pipeline of new products. Our core market cap Index products, factors and thematics and derivatives recorded strong year-over-year results and run rate growth. Growth in factors and thematic is helping to diversify our revenue base and is driving growth in both subscription and ABF revenue types. Open interest in MSCI Index-based futures and options increased to 1.6 million contracts, up 29% year-over-year. In terms of new products in the quarter, we launched three new Index families and we expanded 20 Index families, mostly factors. Year-to-date, we have launched 15 new Index families and 44 Index families have been expanded compared to 22 in the prior period. In the third quarter, ETF providers launched 47 ETFs based on MSCI indices compared to 19 in the prior year. Lastly, on the client side, we are continuing to focus on diversifying our client base and growing the new client base. On slide 15, we provide you with some detail around our asset-based fees. In the upper left chart, despite the spike in market volatility in August, our asset-based fee revenue remained fairly stable on a linked quarter basis due to higher revenue from non-institutional passive funds linked to MSCI indices. As shown in the upper right corner, third quarter inflows into ETFs remain positive in the quarter, despite depreciation of $48 million. As shown in the lower left corner, we have seen significant declines in emerging markets related AUM both year-over-year and quarter-over-quarter and while developed markets AUM is up year-over-year but declined on a linked quarter basis. Turning to lower right, the reported average basis points fee for ETF AUM linked to MSCI indices was 3.40 basis points at the end of the third quarter, down from the 3.51 basis points reported at the end of the third quarter and down slightly from the second quarter of this year. The decline year-over-year and quarter-on-quarter was driven by fee structure as well as the negative mix shift I mentioned earlier and assets that moved out of emerging markets and moved into developed market ETFs. On slide 16, we highlight our position as a leading index provider in ETF markets where we are number one year-to-date globally in terms of new assets gathered. Net flows in the ETFs through MSCI indices were $3 billion during the third quarter, down from $24 billion in the second quarter. Year-to-date ETFs linked to MSCI indices captured $59 billion in net flows. Number one new assets in currency-hedged indices. Assets in ETFs linked to MSCI currency-hedged indices have more than doubled year-to-date, growing from $17 billion to $41 billion as of the end of the third quarter. Number one in new assets linked to factors. Despite lower assets in equity factor ETFs generated during the quarter, mainly due to negative market movement, there was positive demand for ETF linked to MSCI Factor Indexes. Assets in ETFs linked to MSCI Factor Indexes were $21.8 billion at the end of the third quarter, up $1.6 billion from the end of the second quarter. Year-to-date, ETFs linked to MSCI Factor Indexes have captured $9.1 billion of net flows. And lastly, we were number one in the total number of equity ETFs with 774. On slide 17, we highlight the financials for the Analytics segment. Revenues for Analytics increased 5% on a reported basis and 7% on an FX-adjusted basis and the adjusted EBITDA margin increased to 27%. To reiterate what Henry mentioned earlier, we expect that higher cost across all segments in the fourth quarter will lower the Analytics margin in a range of 24% to 26% in the fourth quarter. Now, the three primary use cases around which we are focusing our products and services in Analytics are, one, clients looking to differentiate themselves; two, operations in risk management infrastructure; and three, regulation. As we think about these use cases, what we are seeing from our clients is that they are spending to save money and they are spending to comply with the increasingly complex regulatory environment. Given this, the sales dialogue with most of our clients is focused on the operations and risk management use case as well as the regulatory use case. The federal banks with comprehensive capital analysis and reviewing on the CCAR and the proposed liquidity rules for asset managers by the SEC are the primary drivers of the regulatory chill in dialogue (26

[Operator:]

Thank you. [Operator Instruction] Our first question comes from the line of Toni Kaplan with Morgan Stanley. Your line is now open.

[Toni M. Kaplan:]

Thank you. And thanks for providing the additional disclosure, especially on the margins of the segments. I am going to skip over Index just because that was a really strong number and in line with the target anyway. Just on Analytics, just the run rate in the quarter ticked down a little bit on a constant currency basis, so I just wanted to know, if you could remind us of some of the initiatives that will drive you to the higher growth rate that you're looking for?

[Henry A. Fernandez:]

Yeah. Toni, it's Henry. We had a slightly soft quarter in Analytics sales, but it is just a quarter – there was clearly a lot of volatility in the market. And when that happens, clients are focused intensely on the volatility and so transform our decisions about budget and closure of contracts and the like slow down a little bit. Our pipeline of Analytics is actually pretty extensive. And therefore that gives us optimistic caution or cautiously optimistic that what our sales pace will pick up. In terms of what are we doing to drive that even higher structurally, not just with the existing product line, there is a slew of new product development that has taken place in Analytics from the launch of a lot of new models in the equity risk model area to particularly the revamping of our applications with a new interface and new layer of application on top of some of our other applications. We are hoping that we can launch that in a selective basis in the first quarter of 2016 and over time we hope that that's going to drive Analytics higher. One other key area that we have been focusing on in the last six months with the management team Analytics is how do we really look at use cases in our client and drive strong sales efforts in each one of these use cases. And I think as Bob mentioned, we are very much focused on investment differentiation. So you go to a client and say our tools are going to help you build better performance. The second one is operational efficiencies, the complexity and global nature on multi-asset class nature of portfolios are creating significant complexity in our clients operationally and we want to drive our products to help them reduce that complexity and create efficiencies. And the third one is surely regulatory compliance. So all of those efforts – so I gave you a little bit of an answer on the short term in terms of the sales and the pipeline and longer-term why we are very optimistic about the sales this product.

[Toni M. Kaplan:]

Okay, great. And then in All Other, it looks they are non-recurring revenues and sort of a drag there on the growth rate, can you just remind us what's included in that non-recurring part? It looks like the run rate trend has been sort of low double-digits on a constant currency basis. Thanks.

[Robert Qutub:]

In the Other side, when we have ESG and Real Estate, and the Real Estate tends to dominate the one-times, and we've spent a lot of time trying to move those more into recurring and we have seen some tapering off, but with the platform we're expecting us to be able to generate more product capabilities across the regions that are out there, but most of those are coming out of the Real Estate segment. And they tend to be one-time sales, one-time subscriptions that are out there.

[Toni M. Kaplan:]

Okay, great. And just lastly, just wanted to see if you have any updated thoughts on capital deployment, now that you have almost $1 billion cash on hand, so is there any areas of M&A that you are more focused on? Thanks.

[Robert Qutub:]

We look at – we try to bring it down to where our cash is now. Obviously, we continue to deploy cash. All the way past through the quarter end, we used the rest of our $800 million authorization. We got about $600 million cash on our balance sheet that's available. Acquisitions are obviously a good deployment of capital that can be done either synergistically or they can be done to filling gaps or they can be done to excel capabilities like most recently we have had a few. But we still – we're looking for the highest return and we have been deploying capital through buyback. With the $1 billion authorization, as I indicated earlier, we intend to continue to buy that back until opportunities come up our way that are different, but the highest and best deals is what we're focused on.

[Toni M. Kaplan:]

Thanks a lot, guys.

[Operator:]

Our next question comes from the line of Chris Shutler with William Blair. Your line is now open.

[Chris C. Shutler:]

Hey, guys. Good morning. On the new $1 billion buyback plan, what are your thoughts on timeline there? Is there a date that you have to complete a buy or just what – how fast do you think that that will get deployed?

[Robert Qutub:]

We're going to – we kept it open and we're committed to returning. It's just we're going to basically face ourselves over the course of the next few periods. As I said, Chris, we're way ahead of our original commitment of returning the $1 billion. We are 96% on that initial $1 billion and we remain committed to returning that and using our recently issued debt to the highest and best use.

[Chris C. Shutler:]

Okay. I mean, I'm just thinking through this bottoming. If it was going to be longer-term in terms of the timeline for usage, why would you raise $800 million of debt, given that you could buy back that $1 billion over a period of year or a little bit over a year with free cash and revolver, which probably would be a lot cheaper?

[Robert Qutub:]

Well, it goes back to when you look at our balance sheet, and when we talked about at the second quarter working with the board, we felt the more appropriate level of leverage was 3 times to 3.5 times was better matched our cash flows. And we had a great opportunity to raise $800 million, as Henry mentioned, extremely efficiently in the first part of August before the volatility struck. And we've always remain committed, Chris, that we are not here to store cash. We are here to deploy it as efficiently and effectively as we can. And I think our record in the third quarter here shows that we did deploy a lot of capital as the market moved and the volatility enhanced, we were able to efficiently buyback a lot of shares, 8 million shares to be specific since the beginning of the third quarter.

[Henry A. Fernandez:]

And also look as Bob indicated – our plan is to try to be in a market with lower levels of share price and be in the market that did less with higher levels of share price. So I think the pace which we affect our program will depend quite a lot on where things turn out.

[Chris C. Shutler:]

Okay, thanks. And then, just a couple more quick ones, on – Bob, did you give the ETF yield in the asset base fees?

[Robert Qutub:]

Yeah, 3.4 basis points which was down and 3.43 basis points and 3.51 basis points year before on a linked and year-over-year basis.

[Chris C. Shutler:]

Okay.

[Robert Qutub:]

It's on the slides too, Chris.

[Chris C. Shutler:]

Okay, perfect. Thank you. And then, on Index, just what kind of investments do you guys need to make there to enhance and expand, as you said, margin targets there just given where you are at seem relatively conservative, so just want to understand the incremental investments.

[Henry A. Fernandez:]

I don't know, I mean, 70-plus% EBITDA margins don't seem conservative to me. I think that – if you look – I think that we have a phenomenal franchise in Index, phenomenal. And honestly, I mean, as management and shareholders, you got two choices, you either melt the franchise and over time you reduce your market leadership or you invest in new franchise and you continue to feel this revenue growth and this level of profitability. We are in the latter camp which is a balance between how much you won and can invest on annual basis. But there is still – if you think about there are three areas where equity indices are – can be very profitable for active management, passive management and derivatives. So in active management, you have to reach out more and more customers, deeper into the market cap areas, so for example into small cap indices, you want to reach into new territories like China and Saudi Arabia and other places like that. As they open up to global investing. On passive management, in addition to the market capital indices, you want to invest in factor indices and thematic, which is a big revolution we are at the forefront of that. You got to put some investments in there. And thirdly, an area that it's been small for us is derivatives, listed futures and options around the world. We feel extremely excited about that area over time from a small base, because we have demonstrated in the last few years that the market for multi-currency Index underlying futures contracts has – it can be very successful. And we did that obviously with our partners at ICE with the emerging market Index futures and the EAFE futures and in Europe with our partners at EUREX with the world futures and the likes of what – we would like to make some investments in there to see if we can build a fairly large third leg of revenue and profitability for our business.

[Chris C. Shutler:]

All right. Thank you.

[Operator:]

Our next question comes from line of Alex Kramm with UBS. Your line is now open.

[Alex Kramm:]

Yeah, hey, good morning everyone. And again thanks for all the disclosures. I actually want to go back to page 5 and the Analytics long-term target. I think some of this was mentioned already, but maybe you can flush it out a little bit more. First of all, when you talk about long-term target, what are the timelines of some of these buckets here in particular when it comes to the cost savings, I mean, are those very near-term what's a little bit more backward loaded? And then coming back to, I think something that was asked earlier, how confident do you feel about the ability to drive that incremental growth at the same time as you are cutting costs? Thank you.

[Henry A. Fernandez:]

Yeah. Well, look we purposely left the timeline a bit flexible because clearly nobody has a crystal ball, right, as to what the future can predict and the pace by which we can achieve things. The second important component of this slide is that, it starts with the restructuring of the costs, the efficiencies of the product line and therefore you noticed that the first column on the slide on the left is long-term cost savings, which we are very much on our way to achieve. We already are on an annualized $20 million cost savings. We got $5 million to $10 million to go. And those are the things we have identified for now and clearly but the management team Analytics is also not going to stop there, it's going to keep tightening and tightening in a way that creates further efficiencies. Then on the right-hand side, as you see, we put the incremental revenue target up there which we think are going to take a little longer than the cost savings. But we're confident that at least from today's vantage point that this – as I mentioned earlier that a significant amount of new product development and repositioning of the product and utilization of the use cases and the like can help was achieve these kinds of revenue profiles to get to an EBITDA – to say think about it a steady state from today's vantage point, EBITDA margins in the 30s%. Once we achieve those, it doesn't mean that's where we end. We then will have to reassess. Is that an appropriate margin? Can we do better? Can we not? I don't know, it's clearly too early to tell. Right now what we can give you is what we see in the horizon and then reassess when we get there as to what else can be done.

[Alex Kramm:]

Great. Maybe just to follow-up quickly on this one as well, you mentioned earlier kind of like the use cases and more focus on that, but I think what's been noted a couple of times is that the sales growth is still lagging in that segment. So maybe just getting beyond some of these use cases, what would you say is like the biggest thing that's missing and if its macro that's fine too, but what do you think is really the one component that you need to accelerate that sales growth?

[Henry A. Fernandez:]

Yeah, I think the -- first of all, I honestly want to ensure that I point out again that the softness in any particular quarter should not be a cause for alarm. And it's something that if we have a blow out quarter unless we tell you otherwise should not be a cause for euphoria. And so and we will be guiding you through that given the segment reporting on a quarter-to-quarter basis. So I will not – if I were you, I would not read that much into the softness of this quarter. Remember, we had a huge amount of volatility. In the U.S. Labor Day was a week later and then so September was really three weeks to close a lot of deals. So the distraction by our clients and the late return of people from vacation and all of that may have caused some of the things to slip. And overall, for example, I mean, going into the final week of the quarter, there was like $4 million – this is not just in Analytics, but overall there was like $4 million that could have closed in the quarter. And that slipped into the final end quarter and that was about a 100% higher than in prior quarters. So that tells you a little bit of the some of this artificial sort of lines that we put into quarters. What is very important is that the pipeline is pretty good, so we feel very good about the pipeline. Now, the timing of closing all of that again is a question of working with our clients and getting approval for their purchases and so on and so forth. So we feel pretty good now. My keen focus – and the team's keen focus on the various use cases is so that we rally the resources of the firm to achieve the objectives of the client. Said it differently, instead of selling products and features and applications and models and the like we're trying to flip a lot of that completely and say solve use cases. So, okay, a client wants 10% better cost efficiencies in the way they are managing their risk – their risk management effort, how do we achieve that with our tools, let's work backwards from that. Our client is looking for a 50 basis point or better improvement in their portfolios, what can the tools do to achieve that and so on and so forth. Or worse yet, right, the clients are with a huge deadline by regulators to provide certain reports and the like, how can we rally our resources to achieve that. So all of that gives us a good amount of optimism. But again, this revenue, the sale process and the revenue process initially will be slow and we hope that after a few quarters, it accelerates and over time it begins to move certainly more rapidly. But again, we have to see how it all goes in all of this. I want to make sure our expectations are right that we're really focusing on profitability first and launching the products that we – and utilizing the benefit of all the products that we have launched and the ones that were coming out and then focusing on increasing sales.

[Alex Kramm:]

All right, great. And I think people have been asking more than two questions, so I'm going to squeeze one more in, if that's cool. But, Bob, real quick on the tax rate, you gave us a little bit of a teaser on looking to reduce that. Can you also talk a little bit about the, A, the timeline and then, B, the kind of things that you're thinking about? Because I think there's been some things thrown around like moving the IP of indices and some things that sound a little bit more complex than other things I have seen in the past. So maybe give us a little bit more color about timeline and what you're actually trying to do here.

[Robert Qutub:]

The timeline is immediate. We have already started to take advantage of our global footprint and realigning where our leadership is, all aligned with what the tax and where we think the value is. In terms of selling IP and moving IP, that's a different conversation. Obviously, you want to explore that. But really, right now, it's really aligning where the value is on our footprint. And that will happen probably you will see it in our operating rate, it is actually pretty strong. We had some discrete items this quarter reflective of state items that could benefit on the sale of our investment to offset that, but we did inside of the tax rate have some benefit in the third quarter and will be continuing ongoing as it becomes more meaningful. When we talk about guidance next year, we will talk more about what we think those rates should be.

[Operator:]

Our next question comes from the line of Vincent Hung with Autonomous. Your line is now open.

[Vincent Hung:]

Hi. It's Vincent Hung from Autonomous. Few questions. Just first, maybe I've missed this. Can you talk through the path to the higher margins in the All Other segment please?

[Robert Qutub:]

In terms of the margins in the Other segment, the direction of them? Vincent, I am sorry, I just want to make sure – we didn't hear you well, Vincent.

[Vincent Hung:]

How do you expect to get to the 15% to 20% from where you are now?

[Robert Qutub:]

There's two factors. I will start up and Henry can finish it. You can see that we were actually moving in that direction. You can see – and the best way to look at the Other segment, Vincent, in my view, is look at it on a year-to-date basis. You can see that the revenues on an absolute basis grew about 2.6% or about $1.6 million. But what we saw was efficiencies that I referred to on the Real Estate expenses actually on a year-to-date basis has declined, driving the margin to coming more towards a breakeven and, as I talked about, ESG is growing significantly. Obviously, the reported run rates in ESG are obviously down because now we have annualized GMI, so you're starting to see them in the high-teens, closer to 20%. That's one factor. The other factor that help drive the growth is the platform I referred to on Real Estate and not only will provide a better client experience, it will provide more efficiency as well as a platform to grow on. That's what we see going forward.

[Vincent Hung:]

Okay. Thanks. And then second question. Just curious on the segment reporting methodology you put out today. So you've chosen to allocate shared cost as opposed to splitting them out. How much did you have in terms of these indirect or shared costs?

[Robert Qutub:]

I think – let me – the question is, when we went through all of the cost base, we had several dedicated costs. More than half of our costs tend to be dedicated and aligned around the products, we tend to become more corporate and share a lot of the infrastructure costs, but we see it (54

[Operator:]

Our next question comes from line of Keith Housum with Northcoast Research. Your line is now open.

[Keith M. Housum:]

Good morning, gentlemen. Thanks for taking my question. As we look at the long-term guidance and long-term target out there, I know you have, well, let's say, a year on that. But should we be thinking about that as a two-year or three-year target or just more of a 10-year target that you guys are thinking of in your heads?

[Henry A. Fernandez:]

Well, Keith, I mean, 10 year is an eternity for us. So we're for sure not focused on that. So we're growing closer to the first range. But again, we left it totally flexible at this point because we can't tell you how all of this will evolve. We can't tell you how market conditions and how product development efforts and so on and so forth. So again, we – it's not clear if it was that we have a specific set of targets and – I mean we – a timing on the targets. What we have is target that we want to achieve. And if it takes a while, it take a while. If they come sooner, they come sooner. But we don't have a specific timeframe set where we're going to hurry, but we don't want a specific timeframe, so we can't provide that to you.

[Robert Qutub:]

And also, you can see we demonstrated some immediate action on the cost, as Henry referred to about what we've done in Analytics.

[Keith M. Housum:]

Yeah. Okay. And then as I think about the All Other segment, I guess, is that the area where you have the most opportunity for improvement? It sounds like your Index and Analytics segments, it's operating as expected or perhaps even better than you're planning on perhaps even a year ago. But in the All Other, especially in the Real Estate area, something you're perhaps lagging there where you're hoping to be? And, I guess, is there any acquisition you're going to make in the area or is that an area you just need some more time and effort be able to get there?

[Henry A. Fernandez:]

So the way to think about the enterprise is that we are already at a steady state of EBITDA margin in Index. It will go up and down, obviously, within the range and beyond depending on certain conditions. We are ramping up the margin on Analytics and the milestone is in the 30s% at some point and to what happens after that. And then thirdly, this Other area, Other product category that's out where we're putting a lot of our new investments that we think will have a high revenue growth, but we need to have meaningful investments in them and, at the beginning, we will run them out of deficit. But over time, we want to make sure they're breakeven and then contribute to the overall profitability of the firm. So, therefore, where we're focused on in efficiencies and profitability are in Analytics is to get to where we want to be. And within the Other category is the Real Estate because it's an area that we've been investing and restructuring and reengineering the whole product line after the acquisition so we can bring it back to a positive contribution to profitability of the firm. Acquisitions, they can happen in any one of our businesses, and we look at them all the time, for sure, especially smaller acquisition, but I think I want to emphasize that the footprint that we have at MSCI is enough for now to make us focus on organic growth. So the vast majority of our efforts at MSCI are organic growth with selective bolt-on expansion acquisitions. That's where we are right now. Obviously, if anything change, then we will report that.

[Keith M. Housum:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Joel Jeffrey with KBW. Your line is now open.

[Joel Jeffrey:]

Hi. Good afternoon, guys. Looking at the P&L and the R&D expense line, I mean, it's up about 10% year-to-date, but certainly down meaningfully quarter-to-quarter and year-on-year in the third quarter. Just wondering how to think about that going forward? I mean, was there just an acceleration of development cost in the first half of the year and should we be thinking about sort of the remainder of the year being similar to what we saw in the third quarter?

[Robert Qutub:]

A couple of things. One is R&D is what we're spending on for the future, okay, as opposed to cost of revenues to support the existing book of business, and selling and marketing to grow the existing clients and new clients acquisition. Here, two things. In the first half of the year, recall we talked about the technology project associated with RMA that we decided to spend away from because the benefits that we had initially identified had diminished and we had a write-off of about $3.5 million to $4 million in the first quarter, which would have inflated the first quarter, and you can see that in historical results and also that inflates it on the year-to-date basis. I did talk about the linked quarter decline coming down significantly. And one of the components was deferred software, which is on catch-up basis in the third quarter that would actually have deep – just sort of depress the expense or reduce the expense for the linked quarter. So you would see that come back up slightly in the fourth quarter. One of the contributing factors that we referred to is slightly increasing costs in the fourth quarter.

[Joel Jeffrey:]

Okay.

[Robert Qutub:]

When you think about that, it's just under 6% of revenues. I would say on a more normalized basis, that probably would be higher – slightly higher, closer to the 6.5%, 7% that you've seen historically once it gets full up and running.

[Joel Jeffrey:]

Great. That's helpful. And then just looking back a couple or thinking back a couple of years ago, I know you guys talked about the investment that you needed to make in the business to kind of ensure that you saw sustainable revenue growth going forward. And that was one of the reasons that margins had come down at levels that they hadn't. Sort of that in prior year before that, you were less focused on that, and that's the reason you saw the margins are actually at current levels about now. Just wondering how we think about this going forward and in terms of the need for increased spend and the ability to drive those margins up to that 50% level that you talked about longer term?

[Henry A. Fernandez:]

Yeah. If you think about the investment plan that we went through in 2013 and 2014, which was very important to us, we needed some investment, catch-up or step-up investments in Index, which we achieve and you noted in the segment and, therefore, the EBITDA margins in Index went down to about 64%, 69% because we needed that. We definitely needed a meaningful amount of investments, particularly on our data centers and our sort of running of the infrastructure of the applications that we provide in Analytics. There were investments there in significantly upgrading the leadership of the technology team in all aspects of that and, obviously, a lot of investment in capital expenditure with the data centers and software and things like that and new applications that we're building. So we're benefiting from that investment in this space right now. There were significant investment in servicing our entire client base around the world, so there was a step-up for that. So as we look at that period, that's a period that has benefited us in getting the retentions rate so high and in stabilizing and now growing the Analytics product line and in maintaining our leadership in the Index franchise. So where we are now is at a point in which that step-up of investment has served us well. And we are now on a normal step-up basis as opposed to a big step-up, a normal cadence every quarter every year, which tells us that this is pretty sustainable for a period of time. Now if there were to be a different perspective of that and we need another rash of investments in the future, which we don't see in the immediate future or medium term future, we'll come back to you, but we feel pretty good about what we did. It was painful, obviously, and describing it all to you, and the share price did not benefit from that and the like, but there are times in which you got to do that in order to make sure that the long-term value proposition of this business to our client is great and to our shareholders and continue to drive shareholder value.

[Operator:]

And at this time, I am showing no further questions. I would now like to turn the call back over to Stephen Davidson for closing remarks.

[Stephen C. Davidson:]

Thank you very much for your time today, your interest in MSCI, and we look forward to speaking with you soon. Have a good day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.