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MSCI (NYSE:MSCI)

Q3 2013 Earnings Call

October 31, 2013 11:00 am ET

Executives

Edings Thibault

Robert Qutub - Chief Financial Officer and Principal Accounting Officer

Henry A. Fernandez - Chairman, Chief Executive Officer, President and Managing Director

Analysts

Georgios Mihalos - Crédit Suisse AG, Research Division

Kevin D. McVeigh - Macquarie Research

David Togut - Evercore Partners Inc., Research Division

Alex Kramm - UBS Investment Bank, Research Division

Christopher Shutler - William Blair & Company L.L.C., Research Division

Toni Kaplan - Morgan Stanley, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the MSCI Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Mr. Edings Thibault, Head of Investor Relations. Sir, you may begin.

Edings Thibault

Thank you, Sonya. Good morning, everyone, and thank you for joining our third quarter 2013 earnings call. Please note that earlier this morning, we issued a press release announcing our results for the third quarter and first 9 months of 2013. A copy of that release may be viewed at msci.com under the Investor Relations tab. You will also find on our website a slide presentation that we have prepared for this call.

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, which reflect management's current estimates, projections, expectations or beliefs and which are subject to risks and uncertainties that may cause actual results to differ materially.

For a description of additional risks and uncertainties that may affect MSCI's future results, please see the description of risk factors and forward-looking statements in our Form 10-K for the fiscal year ended December 31, 2012, today's earnings release and our other filings with the SEC.

Today's earnings call may also include a discussion of certain non-GAAP financial measures, including adjusted EBITDA and adjusted EPS. Adjusted EBITDA and adjusted EPS exclude the following: restructuring costs; the lease exit charge; the amortization of intangible assets and non-recurring stock-based expense. Adjusted EBITDA also excludes depreciation of amortization of property, equipment and lease hold improvements, while adjusted EPS also exclude the debt repayment and refinancing expenses and the income tax effect of the excluded items. Please refer to today's earnings release in pages 14 through 17 of the investor presentation for the required reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures and other related disclosures.

We will also be referring to run rate frequently in our discussion this morning, so let me remind you that our run rate is an approximation at a given point in time of the forward-looking revenues for subscriptions and product licenses that we will record over the next 12 months assuming no cancellations, new sales, changes in the assets and ETF licensed to our indices or changes in foreign currency rates. Please refer to Table 10 in our press release for a detailed explanation.

In our discussions of both revenue and run rate, we will also be referring to organic growth rates. As a reminder, organic growth calculations exclude the impact of the acquisitions of IPD and InvestorForce and the disposition of the CFRA product line.

With that, let me now turn the call over to Bob Qutub.

Robert Qutub

Thank you, Edings. Good morning, and thank you for joining us. I'd like to share some highlights from our third quarter 2013. But before we dive into the number zone, here are some key points. Revenues grew 10%, with that growth split between organic and acquisitions. Net income grew 15% and diluted EPS grew by 18%. Adjusted EBITDA grew 4% and adjusted EPS, assisted by lower debt costs and a lower share count, grew by 8%. On the operating side, we had a strong third quarter. Run rate grew by 12% to over $1 billion. Our growth was driven by a sharp increase in asset-based fee run rate and 10% growth in subscription run rate.

Our organic subscription run rate growth was 4% and retention rates increased to 92% where they've held all year.

MSCI continued to benefit from a strong demand for MSCI-linked ETFs. Asset-based revenues grew by 8%. On a run rate basis, where the comparisons have now lapped the impact of the Vanguard loss, ABF grew by 28%.

We continued to be active in managing the company's capital. MSCI repurchased a total of 2.7 million shares as part of the conclusion of the December 2012 accelerated share repurchase program and the opening of a second ASR in early August. We have also retained Morgan Stanley to help us explore strategic options for the Governance business, and Henry will have some additional comments on that decision later on the call.

As has been the case all year, we will highlight the effects of the acquisitions and the CFRA divestiture in the context of organic growth, as well as the continued impact FX has had an our run rate.

Now let's get into the numbers. MSCI reported third quarter revenues of $258 million, up 10% from third quarter 2012. Adjusted EBITDA was $113 million, an increase of 4% versus 2012, and adjusted EPS rose 8% to $0.53. Net income was $55 million and diluted EPS was $0.46, representing an increase of 15% and 18%, respectively, over the third quarter 2012.

Our third quarter revenue growth was led by the Performance and Risk segment, which reported revenue growth of $23 million or 11%, driven by higher growth in Index and ESG and RMA revenues partially offset by a decline in PMA. On an organic basis, Performance and Risk revenues rose by 4%.

Our Governance segment rose 7% on an organic basis. On a reported basis, however, Governance revenues declined 1% as a result of the divestiture of CFRA.

By revenue type. MSCI's total subscription revenue grew by 10% over the third quarter of 2012, driven primarily by the acquisitions of IPD and InvestorForce. On an organic basis, subscription revenues rose 4%. Asset-based fees rose 8% despite the impact of the Vanguard loss and nonrecurring revenues grew $1 million or 19%.

On a run rate basis, our subscription business grew by 10% to $879 million. On an organic basis, subscription run rate grew by 4%, led by a 9% increase in Index and ESG subscriptions, 6% growth in RMA and a 5% growth in Governance, partially offset by a decline in PMA. The growth in our rate was driven by an 11% increase in subscription sales, rising to $30 million this quarter. MSCI's retention rates increased over 2012 second quarter to a very strong 92% where it has held all year. Changes in foreign currency rates continued to have a negative impact on our year-over-year comparisons, lowering our run rate by $2 million versus the third quarter of 2012. However, they did have a positive impact on a sequential basis resulting in a $6 million benefit relative to the second quarter 2013.

Now let's turn to the performance of each of our 4 major product lines, starting with our index and ESG products where revenues grew by $22 million or 20% and by 9% organically.

Index and ESG subscription run rate grew by 23% to $360 million or 9% on an organic basis, driven by growth in Equity Index benchmark and data products. ESG products' run rate continued to grow at double-digit rates. The Index and ESG sales rose 21%, aided by acquisition, and retention rates remained strong at 95%. Changes in foreign currency lifted our run rate by $2 million sequentially, but only had a minimal impact versus third quarter 2012.

Let's take a look at our asset-based fees and the related run rate. The 22 Vanguard ETFs that switched their index benchmarks completed their transition during the second quarter, so this third quarter was the first full quarter without any impact from those funds.

We've been reporting to you for the past 2 quarters that the loss of those ETFs was clouding the strong growth in other MSCI-linked ETFs and that story became evident in this quarter's run rate comparison. Our ABF run rate rose 28% versus third quarter 2012 and that growth rate was in line with a 30% increase in the assets under management excluding those Vanguard ETFs. There was a total of $303 billion of assets under management at ETFs linked to MSCI indices at the end of September 2013. 1 year ago, if you exclude the Vanguard AUMs, that number was $233 billion, that's a $70 billion increase over the past year and $47 billion, or 2/3 of it, resulted from inflows into MSCI-linked ETFs with the remainder being accounted for by market appreciation of $23 billion.

Asset-based fee revenues grew 8% during the third quarter of 2012 driven by revenue growth from passive funds. Revenues from ETFs rose slightly as the loss of the revenues from the Vanguard ETFs was more than offset by an increase in revenues from other ETFs. The average basis point fee at the end of the third quarter was 3.7 points.

Turning to RMA. Revenues rose by 7% year-over-year and by 3% on an organic basis. Run rate of $288 million rose $27 million or 10% and by 6% organically. The increase was driven by a combination of robust organic growth, as well as contributions from InvestorForce. Organic sales growth in the Americas and in Asia Pacific was partially offset by lower sales in Europe. Notable sales during the quarter included a major U.S. pension fund and a large sovereign wealth fund. Retention rates remained a positive story rising to 92% from 89% 1 year ago. FX changes had a positive impact on the third quarter, lifting run rates sequentially by $2.5 million and by $1.3 million on a year-over-year basis.

Switching to PMA. Revenues fell 10% to $26 million and run rate also fell 10% to $105 million. PMA run rate did increase slightly from second quarter 2013 levels, with virtually all of that change driven by FX benefits.

Net sales were modestly positive during the quarter for the first time since the first quarter of 2012, as a result of higher sales and improved retention rates. Looking at the year-over-year decline in the PMA run rate of $11 million, just under a third of that was a result of changes in FX, an additional third was a result of products swaps and cancels on our Cosmos fixed-income product. Down [indiscernible] sales rather than client losses accounted for most of the remaining $3 million decline in run rate.

Now moving to Governance. Revenues rose by 7% on an organic basis. On a reported basis, revenues declined 1% to $30 million as a result of the sale of our CFRA product line at the end of the first quarter. Run rate rose 5% organically to $113 million, driven by higher sales of Executive Compensation Data and Analytics products and services, along with continued strength in retention rates.

Before we leave our discussion of operating results, let me remind you that while we are pleased with our year-to-date run rate, we have historically reported lower retention rates during the fourth quarter due to the timing of contract renewals.

Now let's turn to expenses. Our adjusted EBITDA expense rose by 14% to $145 million, with growth in both compensation and non-compensation expenses, driven primarily from acquisitions. Total compensation expenses, which excludes nonrecurring stock based compensation, rose 12% to $103 million. The growth in composition expense was driven largely by the acquisitions of IPD and InvestorForce, which were offset only partially by the sale of CFRA and lower severance. Our headcount rose 6% to 3,123 from the second quarter, as we continued to make organic investments in our client-facing activities, product development and infrastructure.

We continue to make progress in our efforts to leverage lower-cost centers, including Mumbai and Manila, the percentage of our workforce in those areas rose to 45% from 44% last year and 1 year ago -- last quarter and 1 year ago, which enabled us to keep our organic compensation cost below the rate of the increase in our organic headcount. Non-compensation expense, which excludes depreciation, amortization, the lease exit charge and restructuring costs, rose 21% in the third quarter 2013. The increase was driven by acquisitions and an increase in travel, marketing and recruiting costs, among other items. Adjusted EBITDA rose by 4% to $113 million in the third quarter of 2013.

Other expense of $6 million in the third quarter was down from $8 million 1 year ago, as a result of lower interest expense. Our tax rate was 39.9% in the third quarter and 32.8% for the first 9 months, reflecting the nature of how first quarter discrete items impact the rate over the remainder of the year. We continue to expect our full year tax rate to be approximately 34%, this means we expect our tax rate in the fourth quarter to be in the range of 37.5% to 38.5%.

Now let's turn to our balance sheet and cash flow. We finished the third quarter with total debt of $807 million and total cash position of $284 million, of which, $90 million is held offshore. During the third quarter, MSCI generated operating cash flow of $69 million, bringing our year-to-date total to $226 million. During the quarter, we spent $12 million in capital expenditures, repaid $11 million in debt and spent $100 million for the accelerated repurchase program.

As part of the ASR we put into place in August of 2013, with the inclusion of the December 2012 ASR, MSCI repurchased a total of 2.7 million shares. That brings the total number of shares we have repurchased as part of those ASRs to 4.9 million shares over the past 10 months. Share repurchase activity continued to -- contributed to a 2.3% decline in the number of diluted weighted average shares outstanding in the quarter.

The August 2013 ASR program remains in place and is expected to conclude in December 2013. And of course, let me remind you that we still have an additional $100 million remaining on our existing share repurchase program. And again, I just want to remind you on the tax rates in the -- this year, our tax rate was 35.9% in the third quarter and is 32.8% year-to-date and we're still anticipating a 34% rate for the full year, which means 37.5% to 38% is our range for the fourth quarter.

Now let me turn it over to Henry.

Henry A. Fernandez

Thank you, Bob. Good morning. As I have done over the past few quarters, I would like to provide a brief update on the current operating environment. I would also like to speak about our investment program and the positive impact of that program is having on our results. And finally, I would like to discuss our decision to explore strategic alternatives for the Governance business.

The operating environment has slowly improved in this past quarter. That improvement in tone has led to an increase in client activity, but it has not yet translated into significant improvement in sales. Broadly speaking, the tone from our asset manager and hedge fund clients in the Americas has brightened and they are feeling more optimistic. European asset managers and hedge funds remain cautious, though.

Our business in Asia is doing well. But I attribute that as much to the investments we have made in that region than to any broad recovery in business conditions. And importantly, our pipeline remains healthy.

In an operating environment in which our clients remain cautious, we have focused on innovation as a means of improving our growth. To support that innovation, we have invested and will continue to invest in our businesses. Since the beginning of 2012, or over 18 months or so, we have grown our headcount by 700 or about 30%, with more than half of that coming in the form of net new hires and the balance from our acquisitions. About half of our new hires have come in the form of sales and client service personnel and the rest have been split between new product development and technology.

These investments are starting to have a positive impact on our results. Over the past 2 years, we have opened new sales offices in markets like Canada, Korea, Taiwan, and have expanded our sales efforts in areas like Russia and Eastern Europe. That investment in those markets has led directly to an increase in sales from those regions.

We have also focused heavily on increasing our level of client service, which we see as an important differentiator. Those investments are helping to drive our retention rate to 92% for the first 3 quarters of the year, a level that in the past we would have considered much more aligned to a very strong market rather than the current environment that we're operating.

Our investment in new product development is also paying off. And I want to share a few examples with you from each of our major product lines.

In Index, we have talked a lot about our development of risk premia indices, which we are now calling MSCI Factor Indices. If you recall, we launched the first of this Factor Indices in 2008. As is often the case with our business, the initial progress appears slow. But over the last 2 years, these products have really started to generate significant momentum.

Asset owners, pension funds in particular, have embraced the use of this new indices. The assets under management in ETFs and all the passive funds in these indices have grown significantly. And our run rate tied to these indices has more than doubled since the beginning of the year to about $8 million now.

Institutional investors are now embracing this data and these indices to help them achieve their investment objectives at a lower overall cost of investing.

Encouraged by this trend, we at MSCI have continued to invest in these products so that we can extend our existing Factor Indices to cover more markets and to develop new indices in new areas.

In the RMA business, we saw some of the results of our investment come through in the form of new revenues. We have been focused on enhancing our client views of risks since we acquired RiskMetrics in 2010 and that focus has paid off with several new deals.

We continue to win business with regional banks in the U.S., seeking more visibility into counter-party risk. We also launched a new liquidity risk module during the third quarter and have recognized an early sale from that product as well.

Other investments, particularly in distributions of the RMA product line, have faster paybacks. Over the past 2 years, we have significantly increased our investment in Asia, adding senior management to the team there and a more dedicated sales focus. Our Risk Management Analytics business in Asia is now growing at a double-digit base.

In our PMA product line, total sales have exceeded our cancels for the first time since the beginning of 2012 and some of the currency pressures have also eased. While our sales numbers for this product line are not where we would like them to be, our new Japan Equity Model appears to be gaining some positive traction in the marketplace. This model is the first in a series that incorporates some truly differentiated and significant factors in the development of these risk models. So the level of interest in them bodes well for the additional models that we expect to launch over the next few months.

In addition, we contribute to our functionality to our Barra Portfolio Manager software and BPM has already started contributing in new sales to our overall market in PMA.

We have also invested in our senior management team, with the recent additions of a new Chief Information Officer and a new Chief Marketing Officer. Chris Corrado and Darla Hastings will help us continue to scale our infrastructure and deepen our relationship with our clients and develop further expertise in the way we market our products.

Before I conclude, I want to discuss our announcement about ISS. As stated in the press release, we have begun to explore our options for this business and we will update you when that process is completed. But for now, let me give you some context on how we came to this decision. Over the past 3 years, MSCI has worked hard to return ISS to growth. Our early investments were aimed at expanding the sales force, acquiring new clients, building a more competitive offering and building the voting platform. Once those steps were in place, our focus then turned to new products. First of those new products was an Executive Compensation Data Analytics product suite, which we launched in the middle of 2011. That product launch was among the most successful in ISS history and it remains one of the business's primary growth drivers today.

We're continuing to expand our capabilities in that area. And more recently, ISS launched QuickScore, a quantitative governance rating covering U.S. companies. We also bolstered the senior management team of ISS, naming one of our most seasoned executives, Gary Retelny, to head the business. Finally, we divested CFRA, which was the most challenged part of that unit. These investments have enabled us to put the Governance business on a more sustainable growth trajectory. During the third quarter, the Governance segment reported organic revenue growth of 7% and an EBITDA margin of 29%. So we think the time is right to explore our options.

I would like to add that we plan to retain the MSCI ESG business, which was also acquired as part of RiskMetrics group at that time and which is reported in our Index and ESG product line.

In summary, we are pleased that our previous strategic investments are driving strong results and are enabling us to position MSCI very well for an eventual full recovery in our marketplace. We remain excited about the many opportunities we see ahead of us.

With all of that, let me now pause, and we will be happy to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from George Mihalos of Credit Suisse.

Georgios Mihalos - Crédit Suisse AG, Research Division

I think, for the first time since I've been on these calls, I'll kick it off with the Governance business. Henry, you talked about the sustainability of the growth trajectory there. The margins have moved up fairly significantly year-over-year, I think you're right around 29% EBITDA margins right now. How sustainable is that and then should we be thinking about this business as being 30% EBITDA business going forward?

Henry A. Fernandez

So, George, I mean, we continue to remain very optimistic about this business. We have clearly done a great deal to position the business for this growth, spent a significant amount of time in the business with investments in sales, in client outreach in competitive offerings, pricing. We have invested in the technology, voting platform and the like. Even at the same time that we have increased the profit margins of it, so a quite successful effort of turning the business around from the quarterly declines that we saw back in 2010, 2011. We also feel that the opportunities here, in this business, are pretty large. Governance is something that everyone talks about every day. The end market of this product line is slightly recovering, like the end market of our Risk and Performance products. So I think the time is right now to be able to explore our options of separating this business from us. We don't know yet, obviously, what the ultimate outcome of all of that will be. But we feel pretty positive about the business and its prospects and where it can head.

Robert Qutub

George, one other comment I would add is, remember, when you're looking at this on a year ago, that included the CFRA margin and the margin now does not.

Georgios Mihalos - Crédit Suisse AG, Research Division

Got you. Got you. And then also the PMA business that seems to be stabilizing on a run rate basis. Obviously, some of the pressures on the FX side are dissipating. It sounded like you, guys, do feel better about that business and the prospects going forward. Am I interpreting that correctly?

Henry A. Fernandez

Yes we do. We definitely feel better about it in the last few months, a couple quarters. But we have also felt better in the past and there's been -- double dips are there. I think this time, we feel better for a variety of reasons: one, the market for quantitative asset managers has improved. From, basically, the beginning of this year, you've seen that many quantitative asset managers have been gathering asset inflows into them, they've been launching new products and the like, it's not a major quantum leap, but definitely a little more life into that market. Secondly, the fundamental managers that have client support have began to feel better about their business and have began to have dialogue with us about additional tools that they need, to provide that quantitative support to the fundamental managers, so that may bode well. Also, from our side, we have developed quite a lot of new models that have been introduced in the marketplace and a lot new models that will be introduced in the near future. And that has gotten the market pretty excited about new innovations that we're bringing. And the last piece for us has been the continued development of the software application that we couple, at times, with the content and the risk models. And we feel that we are at the kind of tail end or the lower -- the back end of being able to finish quite a lot of the functionality in BPM and make it a product that is pretty robust, compared to Aegis, and that is beginning to show in additional sales of BPM. Again, it's early days, we still have some way to go there, but we feel pretty good about that.

Georgios Mihalos - Crédit Suisse AG, Research Division

Okay, great. And just last question for me, the non-comp expense, I know it's up year-on-year because of the acquisition, but it also increased fairly substantially quarter-on-quarter, 2Q to 3Q, I think was up 16% in the SG&A segment. Can you talk a little bit about the drivers there and how we should be thinking about that now in the fourth quarter?

Robert Qutub

The sequential increase, George, was driven by, largely, some of the items I highlighted in my comments. We've had some more out of pocket costs as we expanded through our recruiting efforts. As Henry mentioned, we have made some investments in people, our global footprint has continued to broaden, going to 45%, up from 44%. We've made some investments in technology, the non-compensation side, that would reflect our ability to stay up to speed with our capacity, as well as our stability out there, as we continue to grow our client base. Occupancy has gone up a little bit too. So you're starting to see the benefit in terms of what we talked about in run rate, but it comes with some expansion in our capacity to support that.

Operator

Our next question comes from Kevin McVeigh of Macquarie.

Kevin D. McVeigh - Macquarie Research

I just want to make sure I understand the mechanics of that. It sounds like we've repurchased about 2.7 million shares, bringing the total to 4.9 million, and it's over $200 million. How does it work with kind of the remaining incremental $100 million under the ASR, what's the potential there? And then, ultimately, for the additional $100 million out other, should we think about that as another kind of ASR or just kind of more general market?

Robert Qutub

Let me -- this is Bob, Kevin. We look at the 2.7 million in 2 tranches: 1.7 million of that was the close out the ASR that we started in December of last year, where we had an initial delivery of 2.2 million shares and as the purchase program was completed, we received an additional 0.7 million. So that first program gave us 2.9 million shares. With this program we've got just under, the first tranche, we got just under 2 million shares in August, so that's where the third quarter number gets to 2.7 million. We still have to finish the program out through the end of the year. So there could be some shares potentially delivered to us and there could be -- we'd never be in a situation where we'd have to give any back, the way the deal is structured. And with respect to our -- the remaining $100 million on the shelf, glad you pointed that out, that still is out there and we'll be in this market here through the end of the year. And come the first of the year, we'll be talking to our board about 2014 and '15.

Kevin D. McVeigh - Macquarie Research

Got it. And then, Bob, as we think about kind of potential proceeds from the Governance business, should we think about that in terms of capital returns to organic growth or as that kind of comes clear into focus?

Robert Qutub

Well, let me say. Our capital -- basically, our capital strategy has remained unchanged. I mean our investment strategy is around organic investments and bolt-on investments where we can make -- help facilitate capabilities that we need or expedite capabilities or gain capabilities that we need to get. We maintain a balance on that. With our buyback program, we still have $100 million on the shelf, and with respect to whatever happens with ISS it's really just too early to tell.

Kevin D. McVeigh - Macquarie Research

Okay. And then just, if I could, the retention rates, seems like they picked up nicely, there may be some seasonality in Q4. How should we think about that into Q4, and then a bit longer term too, as we about 2014?

Robert Qutub

I'll take you back to Henry's comments. I mean, we've made a lot of investment on our client side and coverage side to really focusing in on our clients staying with us. I wouldn't say we're defying gravity, but I think that we're feeling pretty strong about how we approach our clients. Our retention rate's at 92%, all 3 quarters is very strong. Now having said that, about 1/3 of our contracts, give or take, renew in the fourth quarter, so you get a higher proportion of them in the fourth quarter. And if you look back, over time, we tend to see a little more volatility in the fourth quarter. Now remember, the retention rate construct is a in-quarter number annualized. So it tends to get sort of exacerbated in the quarter. And why it's, looking at it over a full year, I think it is much better perspective in taking that -- 2/3 of our contracts this year have renewed at 92% retention rates.

Operator

Our next question comes from David Togut of Evercore.

David Togut - Evercore Partners Inc., Research Division

Do you expect to generate operating margin expansion in 2014? And if you could walk us through some of the puts and takes.

Robert Qutub

It's -- we're in this business to grow. The best indicator I can provide for you in that, because we generally don't give guidance on that, but take a look at our key operating metric and our discussions around the growth in our run rate on a year-over-year basis. That really gives you a window out there on the forward-looking 12 months in terms of what we would be bringing in terms of driving up revenue growth. As always, we continue to maintain discipline on non-compensation. We have taken a step up in non-compensation expenses that I mentioned earlier. And we will continue to make some organic investments, which will require investments, but we need to balance that out and make sure we turn profitability. Balancing out our whole capital process that I mentioned earlier to Kevin.

David Togut - Evercore Partners Inc., Research Division

I think the revenue side is pretty clear just from the run rate, but think, I guess, I still have a question about spending for next year and thinking about whether you're going to get operating leverage. Is there anything you can add to kind of clarify possible margin trends looking out beyond Q4?

Henry A. Fernandez

Kevin, this is Henry -- I'm sorry. David, this is Henry. The -- I think it's important to recognize that away from the volatility that could exist with the asset-based fee business in which if the markets rally, we get showered by a lot of cash flow that drops to the bottom line or -- and if the market turns negative, obviously it declines. So if you put that aside because that's an element that is, even though secularly improving for our business on a cyclical basis or a seasonal business, sometimes they're not controllable, I think that we are of the view that we are at the beginning of a very gradual recovery in the investment universe of the world, in which you're seeing better tone, better momentum in asset managers, hedge funds, pension funds in the U.S. You're seeing a bit of that in Japan and Australia. You're seeing a tad of that in Asia, x those countries. Obviously, Europe is still a little bit challenged, but we're hoping that, over time, that we're going to see a gradual recovery there. And our clients are asking us to anticipate that recovery and invest in the business. So I think our best view to you is that away from the volatility that could be provided by the asset-based fee business, which we don't control, we're not likely to see an expansion of the margin. We're not likely to see operating leverage in the business because we would want to continue to position the company for that upturn and the demand that we see -- that we're beginning to see, reflected in the tone of the dialogue and the actual dollars and cents that clients want to spend with us.

David Togut - Evercore Partners Inc., Research Division

That's very helpful. Just a quick, related question. Do you have an early read on headcount, a target for 2014?

Henry A. Fernandez

Not at the moment. Not at the moment. We haven't finalized our plans for 2014.

David Togut - Evercore Partners Inc., Research Division

Got it. And then 2 quick housekeeping questions, Bob. Do you have a share count at the end of the quarter? And just a read on 4Q and 2014 tax rate.

Robert Qutub

Let me get back to you on the exact share count, that's going to be on our Form 10-Q that we'll file later this week. Okay?

David Togut - Evercore Partners Inc., Research Division

Okay. And tax rate?

Robert Qutub

Tax rate is the guidance that we talked about.

David Togut - Evercore Partners Inc., Research Division

For 2014?

Robert Qutub

No, we don't have guidance on that yet. But I just talked about what we'll -- 34% is what we expect for the full year. We maintain an aggressive approach, focused approach, on how we can optimize our global tax rate. And as we continue to grow more and more internationally, we should see some benefit of that.

Operator

Our next question comes from Alex Kramm of UBS.

Alex Kramm - UBS Investment Bank, Research Division

Just -- sorry to come back on the expenses one more time. But it seems, Bob, you talked about what drove it higher in the third quarter. I think, for the most recent question you talked a little bit about next year and the longer-term outlook, which, I think, can be appreciated. But can you just talk very specifically about the fourth quarter again? Like was there some seasonality in the third quarter in terms of the recruiting? Is the run rate a pretty good run rate to use now or are some employees coming on late that will drive this even higher? Is there a lot of hiring that you're doing in the fourth quarter? So just a little bit more specific on the fourth quarter, if you may.

Robert Qutub

On the fourth quarter, or more of the third quarter, Alex?

Alex Kramm - UBS Investment Bank, Research Division

No, no. On the fourth quarter, in terms of expectations for, in particular, SG&A.

Robert Qutub

I mean, we've -- our headcount coming on board tends to slow down in the fourth quarter. Obviously, the second and third quarter are your strongest times in which you get people in your seats and where you make a lot of your hirings, it's the most economically -- the most efficient, so you kind of take us -- you couple that with related costs that would be around recruiting and things of that sort. We've had some internal onetime items that have occurred, nothing significant, Alex. But again, we maintain a tight discipline on costs into the fourth quarter.

Alex Kramm - UBS Investment Bank, Research Division

Okay, good. And secondly, I think, good color again on the selling environment, I guess, improving. Can you be a little bit more specific in terms of how that is manifesting itself? Is the pipeline of new sales shortening? Is the -- are pricing discussions getting -- are there lower pricing discussion? Are people not pushing back as much? Are you seeing less from -- on the competitive side? So a little bit more color on what's happening on the sales side here.

Robert Qutub

Starting with pricing, we remain strong in our pricing and our index product. RMA, we're maintaining our pricing. PMA, we still have some competition out there. That's, really, as I mentioned earlier, a lot of the decline in our run rate has not come from lost clients, it's come, largely, from that third, is coming from repricing of the products that have been out there, driven by competition. Again, RMA product, Governance products, Index products remain strong and, to a certain extent, Index has continued to maintain its pricing strength. With respect to the pipeline, the pipeline, as Henry said, remains healthy. And that's the tone that we've held out there for the last couple, 3 quarters. In fact, the tone, that's something we introduced into our conversation last quarter and we maintain that. There's a lot more active conversation and we have seen some 2-way movements in the pipeline. What I mean by that is up and back. Though in the past we see -- we saw more deals pushed out, but we have had discussions about trying to pull some deals in. So the active conversation is really important. It's around the conversations that we're having with them and the real key is manifesting those into sales.

Alex Kramm - UBS Investment Bank, Research Division

And so the sales cycle itself seems to be kind of, it goes back and forth, it's fairly unchanged on average, I guess. Is that what you're trying to say?

Henry A. Fernandez

Yes. Let me add to what Bob said. The -- what was happening for about, say, 6, 7 quarters, starting back in the spring of 2011, was that every -- taking seasonality away or putting that aside, every quarter, there will be a very slight deterioration of the operating environment and that was manifested into items in the pipeline, not necessarily leaving but more and more items in the pipeline being pushed to the next quarter and the next quarter. And more approvals by clients, more debate and discussion about whether they should buy the product or not and the like. And it was also manifested in a bit more cost-consciousness and price pressures because our client is reporting to their own internal people were under a huge amount of pressure to contain costs. What we began to see about 1 quarter or 2 ago, let's say 2 quarters ago, is that, that gradual deterioration, that was happening quarter after quarter after quarter, began to ease. So it wasn't that it was improving, it was that the deterioration was less 2 quarters ago, slightly less last quarter and that, therefore, the items that would otherwise have been pushed to the next quarter, some of them were staying in the current quarter. And then secondly, that the number of approvals began to decrease a little bit and the willingness of clients to try to get the deal done and close and move on, increased. And the overall tone of the discussion, the overall tone of trials and show me new things, show me new ideas, show me the new things, the dialogue has improved in the U.S. and in Asia, a little less so in Europe. So that makes us cautiously, very cautiously optimistic, that we're beginning to see a gradual, very gradual sort of return to a more active dialogue, less deterioration of the pipeline, quarter-to-quarter. As we said, the pipeline remains healthy and, right now, we have helped all of these by creating new products. Because when you have a new product, the client wants to engage. The client wants to have a discussion and sometimes the clients creates budget when they have a new product that they think is going to differentiate them in their investment process. So the Factory Indices have been an extremely important dialogue with a lot of our clients. The liquidity metrics and the counter-party risk has been a good dialogue with our clients. And the OTC market moving to centrally-cleared products, the margining and the products that we can offer on margining has been a good dialogue with our clients. In PMA, the new Japan model, we had a roadshow in Japan, very well attended, people are interested. Then we have a new Korea model coming out, a lot of our Korean clients are interested in that. And we're rolling out a whole series of models. We're in more active dialogue on BPM, because now the software is much more completed, complete than it was a couple quarters ago. So overall, it feels better. And therefore, this makes us feel that we got to continue to progress in the pace of investments in the business, back into the business in order to continue to capitalize on those trends. And if those trends accelerate, accelerate the level of investment. So that's where we are in that gradual, small recovery process.

Alex Kramm - UBS Investment Bank, Research Division

That's very helpful. Just one quick last one here. One of the things we're hearing more and more in our business is that I think we have the best start-up phase for new hedge funds than we've seen in, like, 10, 12 years or so. So not sure if this is a big focus for you, or how material it can be. But are these guys just not big enough yet or are you actually focusing on new sales into that channel as these guys are starting up and, obviously, need a lot of tools to run their business?

Henry A. Fernandez

We definitely have seen, year-over-year, a marked improvement in our dialogue on activity with hedge funds that are particularly in the U.S. A bit less in Europe. And we have heard and seen clients leaving -- personnel, leaving from one to another to set up new hedge funds, and we're in active dialogue with many of them. That has not, though, yet translated into significant sales to those potentially new startups. I think that they are potentially in fund-raising mode at the moment. So remember there's always a lag. If you have somebody who wanted to start a hedge fund, they may leave, they might put a business plan in place, but they've got to go raise the money and that may take 3, 6, 9 months. So we're seeing some of that, but it hasn't translated into them purchasing the tools at this point.

Operator

Our next question comes from Chris Shutler of William Blair.

Christopher Shutler - William Blair & Company L.L.C., Research Division

I wanted to focus for a second on the headcount growth. So 6% growth sequentially, 29% growth over the last 12 months, the top line over that time is growing at 10%. So just thinking about it rationally, does that mean that you're going to potentially hire considerably fewer people over the next 12 months than you have over the prior 12 months, I guess x acquisitions?

Robert Qutub

Chris, let me -- you got the 6% correct, but the 29%, remember, goes back to the beginning of 2012. So that's over a 2-year period. You got to remember of that 700, half of that was through acquisitions, so that growth has been recent in terms of what we've been picking up, but the acquisition contributed to more than half of it. The important thing that we highlighted, and that Henry talked about, is half of those hires, nearly half of those hires, came in the form of client-facing and getting out on the street, working with the clients, as well us on the retention side too. So retention is a really valuable investment payoff for us and staying at 92% means it's 1 less sale we have to make to retain the run rate. So that we find as very important. The other thing I'll make and, Henry, you can throw in a couple things here, is that our organic growth is built on people. Our organic growth is built on capability in the most efficient way we can. And the comment that was made that while we have grown our headcount organically, we've grown our compensation costs, related to that headcount growth, less. And that's by focusing in on lower-cost centers that are out there and continuing to drive that from 44% to 45%, both on a linked-quarter and year-over-year. And if you remember, last year-over-year, we didn't have the impact of IPD and InvestorForce, we've actually brought that down in the interim quarters. So we continue to push out on that capability because we have to have the innovation, and the innovation comes from people to be able to build the products that Henry was talking about so we can sell into this gradual recovery we're seeing out there.

Henry A. Fernandez

The other point I would add is to say that we're very much focused on meeting the current demand from our clients and anticipating the immediate demand the 6, 9 months, 10 months from our clients, with existing products and new products. And when you work backwards from there, you then need to make incremental investments to position yourself for that demand and that -- hopefully increasing revenue growth. And investment to us is all people, so mostly people. There are some technology investments in the space and all, but people or people-related things. And therefore, we say, "How do we make those investments in a way that there's balance and in a way that doesn't meaningfully handicap our profitability?" And that's why we rely heavily on our emerging market centers. The next phase that we do is how do we make those investments in a way that are balanced, that let's make the investments have a quicker payback first. So just new sales in markets where we see demand and so just client-servicing and solutions personnel that we see continued improvement in retention rates and renewal rates. So about half of the past investments have gone into that. The next layer that we're focused on is, okay, we now have to enhance products or create new products. How do we balance that out? How do we make some incremental, prudent investments to invest in those products and the like? So that's what we've done. Where we are right now is that we're saying that's what we've done in the last 1.5 years, almost 2 years, since the beginning of 2012. We anticipate that, that is the philosophy we're going to continue to have going into 2014, because it's working, the paybacks of those investments has generated incremental revenue and run rate we actually have seen in RMA and Factory Indices and PMA, slowing down the decline there, and Governance and the like. And not only that, but we're -- if we see further improvement in the tone, further improvement in the sales effort, we want to make sure we capitalize on them.

Christopher Shutler - William Blair & Company L.L.C., Research Division

Okay, makes sense, guys, I appreciate it. And then just one more, on the CIO and CMO hires, just -- can you talk about each of those a little bit more and why was now the right time to make those hires as opposed to 6 or 12 months ago?

Henry A. Fernandez

Yes. On the CIO, we are a technology company as you all know very well. Big parts of our business rely heavily on technology. The Index business, which is mostly a content business, relies heavily on technology and the manufacturing of the data, so to speak, the production of the data and the distribution of the data. And our Analytics business do the same, but not only that, our product is actually a software program that we run 4 people in our ASP SaaS solutions. So we have been discussing over the last 12 months, how do we continue to improve, scale up and make sure we have a very strong foundation to continue to go to clients and perform for them highly mission-critical processes. Coupled with that is that a few clients have come to us and have asked us to take significantly more of their internal mission-critical processing in risk management and in performance. And therefore, we felt that the strengthening our technology organization would be prudent in order to begin to plan for those potential sales. So that was the reason we hired a CIO and that's the reason we're going to add a few more senior people in that area. On marketing, we've grown significantly. We have now $1 billion in run rate, we have some 8,000 clients in 85 countries. We have a multi-product line. We reach out to many corners of the world. And in the past, we've done it kind of the old-fashioned way, which is one client at a time, one person at a time, talking to people and the like. I think the time has come that we develop MSCI into a very marketing-focused organization that we figure out what are the most effective and efficient means to reach out to clients. How do we develop stronger client relationship at all levels of organization? How do we use branding as a way to deliver our messages? How do we use advertising? Which we've been doing in the U.S. to deliver our message to the financial advisory community so that they can buy MSCI-linked products and the like. So there is a lot of areas that I think that, with Darla Hastings now as the CMO, she can help us become much better as a marketing company and, hopefully, expand our reach, expand our product line and make it a more coherent whole.

Operator

Our next question comes from Toni Kaplan of Morgan Stanley.

Toni Kaplan - Morgan Stanley, Research Division

Just a quick one for me. With regard to IPD and InvestorForce, are there any opportunities to cut costs out of those businesses going forward?

Robert Qutub

With respect to IPD, there were -- the merger was not really -- a lot of flare on synergies, but yes, definitely, there are some synergies, especially as we combine a lot of the infrastructure and modernize a lot of the data capabilities that they have. InvestorForce, less so. InvestorForce is really a client and revenue play, from that perspective, and that was very easily bolted on to our existing infrastructure with -- not really designed for cost savings.

Henry A. Fernandez

That will be, though -- Toni, the plan will be, though, that whatever significant reductions in costs we have on IPD, we would want to reinvest back into the business. The reason is, we believe we're in a cyclical -- sorry, in a secular upswing in real estate across the world, both in terms of the market appreciation, with limited supply in many markets around the world. Secondly, the increasing institutionalization of the real estate asset class. And lastly, an increasing globalization of the investment in real estate. So we bought this business in order to create what we believe to be a very large presence in risk and performance in real estate around the world. We are, right now, pretty big in Europe. We are taking steps to increase significantly our presence in the U.S. and in Japan and in other markets in Asia. And therefore, that's going to require continued investment that we plan to make from the cost savings that we have, not necessarily, obviously, dropping profitability of the business.

Toni Kaplan - Morgan Stanley, Research Division

Great. And also just with regard to those 2 acquisitions, are there any areas where you've had either upside or downside surprises? Maybe additional clients that you wouldn't have necessarily thought would want to cross sell in something. Any sort of surprising either to the upside or downside of those?

Henry A. Fernandez

I think the positive surprise have been that: one, the business have not been really -- the business have not really focused significantly on asset owners around the world, pension plans and sovereign wealth funds and the like. So we have started hiring and putting a dedicated team to do that and it has began to pay off well in the last 2 quarters. So that's been pretty good. Secondly, is that our footprint, the core MSCI footprint, in many markets where IPD didn't have the time or the resources or the headcount to go out and sell, has been beneficial to them. So we've opened a lot of doors for IPD in Korea, for example. Some of these other sovereign wealth funds in the Middle East and in Asia. And, clearly, our relationship with many of the pension plans in the U.S. have helped open the doors. And lastly, we are in the early stages of a major dialogue with clients, especially asset owner clients, about the incorporation of the real estate asset class in the total portfolio of the fund, what are the diversification benefits, what are the risk issues associated with them and the like, in order to see if we can become a catalyst for the further institutionalization and globalization of real estate investment by institutional investors. Early days, because that takes time, but we have a number of research papers, we have research conferences going on and the like, that are attacking that and that's one MSCI team of research people from the performance side, the risk side and the real estate side. I think, on the negative surprises, so to speak, has been we have started to transform the IPD business into the way we look at the world in terms of recognition of revenues and in terms of run rates and the capturing of those rates and the like. And those have been a little bit of the volatility that you've seen in the last 2 quarters or 3 quarters in the ups and downs of the revenue on IPD.

Operator

And at this time, I'm not showing any further questions. I'd like to turn the call back to management for any closing remarks.

Edings Thibault

Thank you, Sonya, I appreciate it. Well, just want, before we close, to remind everyone to please feel free to call me if you have any questions on the quarter. We want to thank you for your interest in MSCI, and thank you especially for your ownership of our shares. Thanks.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.

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