MSCI (MSCI) Henry A. Fernandez on Q4 2015 Results - Earnings Call Transcript

| About: MSCI, Inc. (MSCI)

MSCI, Inc. (NYSE:MSCI)

Q4 2015 Earnings Call

February 04, 2016 11:00 am ET

Executives

Stephen C. Davidson - Head of Investor Relations

Henry A. Fernandez - Chairman & Chief Executive Officer

Robert Qutub - Chief Financial Officer

Analysts

Alex Kramm - UBS Securities LLC

William A. Warmington - Wells Fargo Securities LLC

Toni M. Kaplan - Morgan Stanley & Co. LLC

Chris C. Shutler - William Blair & Co. LLC

Joseph Foresi - Cantor Fitzgerald Securities

Douglas Doucette - Keefe, Bruyette & Woods, Inc.

Hugh M. Miller - Macquarie Capital (NYSE:USA), Inc.

Keith M. Housum - Northcoast Research Partners LLC

Operator

Good day, ladies and gentlemen, and welcome to the MSCI Fourth Quarter and Full-Year 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 call is being recorded.

I would now like to turn the call over to Mr. Stephen Davidson, Head of Investor Relations. You may begin.

Stephen C. Davidson - Head of Investor Relations

Thank you, Katherine. Good day and welcome to the MSCI fourth quarter and full-year 2015 earnings conference call. Earlier this morning, we issued a press release announcing our results for the quarter. 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.

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 facilitate meaningful period-to-period comparisons and provide a baseline for the evolution of results. You'll find a reconciliation of the equivalent GAAP terms 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 26 to 29 of the earnings presentation.

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 - Chairman & Chief Executive Officer

Thanks, Steve, and thanks to all of you for joining us today. I am very pleased to share our strong fourth quarter and full-year 2015 financial results with you. In my opening remarks, I will provide an update on how we are executing our strategy by focusing on the levers that will grow revenues, make us more operationally efficient, and continue to return capital to our shareholders. I will also provide strategic update on each of our product segment and then focus on innovation, which is at the core of MSCI. I will then conclude my remarks with an update on our operational efficiency gains in 2015, and a summary of our capital return to-date.

If you turn to slide three for a review of our results, revenues increased 9% in the quarter and 8% for the whole year. These strong results were driven principally by Index products, which posted double-digit revenue increases in both subscription and ABF, both in the quarter and the whole year.

Innovation continue to be our focus across all of our product lines, with particular strength in Index. In Analytics, we continue to innovate in our core use cases of investment differentiation, operational efficiency, risk management and regulatory compliance. These are the most prevalent use cases that we're solving for in terms of the need that our clients have. We're also innovating by developing services to address new use cases that our clients face.

As ESG continues to move into the mainstream of investing, we are developing new products and services to meet that strong demand. In real estate, we're building out new products around global real estate market information and global real estate market risk and analytics and a new technology platform to deliver them to our clients more efficiently.

Turning to efficiency, cost discipline is a high priority at MSCI. We are ensuring that our cost base is rationalized and that we have that the right resources lined up against our fastest-growing, highest-return opportunities. We also deliver on our commitment to begin lowering our operating tax rate, which was reduced for 2015 by roughly 100 basis points compared to 2014.

And finally, capital, my favorite subject. MSCI continue to generate excellent cash flow, and we have strong growth prospects ahead that would only enhance our ability to create more value, whether it is from returning excess capital to shareholders, investing in organic growth opportunities or making small bolt-on acquisitions that complement the growth prospects that we have in our product line.

Our track record on returning capital to our shareholders is very strong. Since December 2012, we have acquired approximately 25 million shares of MSCI and returned $1.5 billion to our investors. In summary, we're pleased with MSCI's performance in the fourth quarter and the full-year of 2015. And we believe that the foundation continues to be set for further growth in 2016 and beyond.

Turning to slide four, we are providing you with a strategic update on our product line and the opportunity that we see for each of them in 2016. I'm not going to hit every item, but let me highlight the key takeaways for each segment.

In our Index product segment, we continue to drive adoption of our global investing framework. And our success is reflected in strong growth in small cap and customer Index products. In 2015, product development continue to be exceptional with a total of 56 new indexes and product enhancement, representing an increase of 14% over 2014.

ETFs based on our indexes, capture $88 billion of inflows in the year 2015, or 35% of the overall market, up from $49 billion a year earlier. Our development efforts have been focused on factor investing, where the estimated AUM linked to our factor indexes increased 17% to about $143 billion compared to $122 billion in 2014.

In 2016, we believe there are several growth levers in our Index products. The new product pipeline remains strong, and we continue our relentless effort on innovation to change the investment world. Factors and ESG continue to be incorporated into the mainstream investment process. The globalization and international investing trend is expanding. And lastly, we expect continued growth for exchange-traded MSCI-linked futures and options as demand for multi-country, multi-currency exposure (8:31) growth.

In Analytics, our team has done a great job in undertaking a major transformation of the product line across multiple dimensions, from strategy, product development to expense management to drive profitability. We're off to a strong start. We look forward to continue progress each quarter in this product line, and we will report accordingly.

MSCI won Market Risk Technology Product of the Year at the 2016 Risk Magazine Awards. Our liquidity metrics product, the first commercially available tool for measuring liquidity risk across asset classes, was cited as an important innovation by Risk Magazine.

The Analytics team will build on the successes of 2015 by creating new products and services that serve the operational and risk management use cases that we are seeing the most traction in with our clients around the world. The major data center migration we completed in the fall will bolster the capabilities we bring to our largest clients in processing their portfolios. Profitability will continue to be a focus as we reallocate resources to initiatives that drive future growth and profitability.

In 2016, we believe there are several growth levers in Analytics, continued growth from our core use cases, developing new partnerships on products and services. We started a systematic program of price increases that reflect the increased value we're providing clients. And again, profitability will be a continued focus as we set the foundation for a stronger revenue growth after 2016.

Lastly, in our All Other segment, in ESG, we saw increasing interest from clients in the integration of ESG factors into the mainstream investment strategies. As the leading provider of ESG data, ratings, research and tools worldwide, MSCI is well positioned to continue to benefit from this trend in 2016.

In terms of growth levers for the year, product enhancements will be a driver of op sales, and we will continue to leverage our deep relationship with asset owners around the world to drive further adoption of ESG.

In real estate, we're strongly focused on realizing rapid improvements in this product line and are making changes in almost every area of the business. We completed the integration of the real estate sales team into MSCI's overall sales organization. We are accelerating development of the strategically important products, and we are moving operations head count to lower-cost centers. We expect this product line to go from a loss in 2015 to breakeven in 2016 and set the foundation to return to profitability beyond the year.

I'd like to spend a moment now discussing how MSCI leverages our content across our ecosystem. This is an important but at times misunderstood element of value creation in our business model.

On slide five, I can tell you that at the core of our company, MSCI is a content company that leverages and shares content across the entire MSCI ecosystem to innovate new products and services. The generation of that content starts with understanding the investment problems of our client, designing a solution to them in the form of a model of some kind. We call them methodologies and Index and models in Analytics. And then that model can be then turned into either data or analytical calculators such as performance attribution calculators, repayment models, pricing libraries and so on and so forth.

And in terms of the data, it could be equity in big data, equity risk model data, fix income risk model data, multi-asset class model data, and so on and so forth. We deliver our content to our clients, as I said, in the form of indexes, risk models, valuation models, ESG Research, real estate data or benchmarks. All of our content, our software applications and our services are designed to help our clients improve their overall investment processes and make better investment decisions.

Our content sits at the very center of our client's investment processes. It provides them with the insights and tools they need to build and manage their portfolios. A key part of my own job is to build senior-level relationship with our largest clients around the world. In my conversations with them, they tell me that the quality of our content is what sets MSCI apart. It is why they choose MSCI to help them with their biggest and most complex investment problems.

It is easy to look at our business in the way we present ourself in financial reporting, sort of broken out between Index and Analytics and ESG and real estate, et cetera. But content is a unifying element, and it will be our ability to integrate that content across all of our product lines that will unlock incremental levels of growth and profitability for MSCI in years to come.

On slide six is a concrete example of how we leverage this virtuous circle of content I just discussed within the MSCI ecosystem. The investments that we have made in the past several years, combined with the content that we have brought to Index from our other product areas, such as equity analytics and ESG and real estate and the like have positioned us to significantly grow not only in terms of AUM linked to global equity products, but also significantly in MSCI Factors, ESG and Thematic Indexes.

This growth has been at a rate that is about five times the growth of our core market cap franchise, which itself is growing at a very healthy base of around 15% CAGR. So this case study in innovation serves to diversify our franchise and represent another layer of growth for MSCI in the years to come.

Before moving to the next slide, let me take a moment to comment briefly on the market volatility that we're seeing as it relates to ETFs linked to MSCI indexes. Like all of you, we are continuing to monitor the market, but we're very pleased with the performance of ETF linked to MSCI indexes. Of the $34 billion plus in decline in AUM in MSCI-linked ETF since the beginning of the year, about 97%, 98% of that or about $33 billion plus of that decline is due to market depreciation and not outlooks.

As you all know, in your own businesses, outflows or inflows are the true measure of the health of an investment product, and therefore, we are pretty satisfied to see that we're holding up very well there, despite the decline in valuations.

As we highlight on slide seven, the innovation that I just discussed had led to a strong leadership position and Index provider to the ETF marketplace worldwide. The share of total equity ETF AUM linked to MSCI indexes increased to about 19% at the end of 2015 compared to 17% at the end of 2014, driven by strong inflows.

During the year, equity ETF linked to our indexes captured $88 billion in net cash inflows, up from $49 billion in the prior year. So the share of investment flows in ETF linked to our indexes increased from about 20% in 2014 to about 35% in 2015, making us the number one equity Index provider in 2015 by this measure.

We were also the Index leader for full-year 2015 in terms of net cash inflows to ETF based on currency-hedged indexes. Net cash flows in ETF linked to factor indexes, which increased almost three times compared to 2014 levels, and also our leadership position as number one in ETF – the launch of new ETF linked to equity indexes.

So, we're very pleased with the positioning of our Index franchise for ETF managers, and we're not resting on our laurels. We will continue to innovate and work to create the next wave of products that will drive our future growth.

On slide eight, we highlight our cost discipline. We saved $21 million of cost in 2015, which allow us to focus our resources on higher-growth, higher-return opportunities while keeping overall cost growth, including the impact of foreign exchange, within our 5% to 7% growth range. The key takeaway is our hitting the right balance between cost management and investing for the future.

Lastly, on slide nine, we highlight the strong capital return track record that we have established. As I said earlier, we returned $1.5 billion in capital to investors since late 2012, and we intend to keep returning capital to our shareholders over the longer term.

In summary, we registered strong growth in the quarter. We're continuing to focus on the levers that we believe will drive revenue growth, improvements in operational efficiency, and the continued optimization of our capital base with a strong capital return program.

With a relentless focus on these areas in the quarters and years to come, we believe we can enhance the growth and profitability of MSCI over the long term. All of us at MSCI believe that we're still on the ground floor of what is possible to achieve with this company.

Before I end, I want to offer my personal appreciation to Bob Qutub for his years of service to the company during a time of tremendous growth and change. As we announced a couple of weeks ago, Bob has decided to retire from MSCI to spend a bit more time with his young family and consider a new opportunity in the future.

I am pleased Bob will be with us until we on-board his successor to ensure a smooth transition. Bob?

Robert Qutub - Chief Financial Officer

Thanks, Henry, for the kind words. It's been a tremendous pleasure to work with MSCI teams, the board and our investors, but let's get into the results here. So, let's turn to slide 11 where I'll begin my overview of our financial results. Our results this quarter were strong with a 9% increase in revenue and a 1% decline in adjusted EBITDA expenses, driving a 22% increase in adjusted EBITDA and a 500 basis point increase in our adjusted EBITDA margin, 46.5%, including the impact of foreign currency exchange fluctuations.

Just a quick couple comments on the results. We closed the acquisition of Insignis in the fourth quarter and the contribution to revenues and expenses was negligible. So we're not adjusting our numbers to derive an underlying organic growth. Our results also include higher interest cost from our bond offerings in November 2014 and August of 2015. As we stated last quarter, we're in the process of aligning our tax profile with our global operating footprint. And I am pleased to report that we're already seeing benefits, which are reflected in the decline of our operating tax rate for the full-year 2015.

On that note, tax benefits in the quarter contributed $0.04 to adjusted EPS, which includes the impact of discrete items from prior periods, as well as a positive impact on our 2015 operating rate, which was 34.8%. The 9% decline in the weighted average shares outstanding year-over-year added about $0.06 to our adjusted EPS. Again, as a reminder in the slides that follow, we provide the impact of foreign currency fluctuations on our subscription revenue and costs, but we do not provide the impact of foreign currency fluctuations on our asset-based fees tied to average AUM, of which approximately two-thirds are invested in securities denominated in currencies other than the U.S. dollar.

Turning to slide 12, we provide you with a bridge for the year-over-year change in our revenues by segment and revenue type. Total revenues increased $22 million or 9% to $273 million year-over-year, driven by an increase of $15 million or 7% in recurring subscription revenues, an increase of $5 million or 10% in asset-based fees and a $2 million increase in non-recurring revenue.

Currency fluctuations had about a $2 million negative impact on our overall subscription revenues, which includes recurring subscription in non-recurring revenue. And this negative impact was mostly split between the Analytics and All Other product areas. Excluding the impact of FX, subscription revenue would have increased 9%.

The $5 million or 10% increase in asset-based fee revenue to $50 million was driven primarily by $50 billion increase in average AUM in ETFs linked to MSCI indexes to $423 billion, as well as a growth in non-ETF institutional passive funds linked to MSCI indexes and the growth in trading volumes in exchange-traded futures and options contracts linked to MSCI indexes.

Turning to slide 13, we provide you with year-over-year adjusted EBITDA expense bridge. Fourth quarter adjusted EBITDA expenses decreased $1 million or 1% to $146 million, but increased $6.1 million or 4% compared to third quarter 2015. Excluding the impact of foreign currency exchange fluctuations, our adjusted EBITDA expenses would have increased $4 million or 3% year-over-year and 5% for the full-year 2015 compared to full year 2014.

The increase in cost on a linked-quarter basis was driven by higher general and administrative compensation and benefits, increased development costs, as well as higher selling and marketing costs. Shown in the lower half of the chart, we registered decreases of 7% and 2% in cost of revenues in selling and marketing respectively, partially offset by increases in general and administrative and research costs.

Lower cost of revenues was primarily driven by lower head count, generally across the board, reflecting a more efficient management of our product set. Lower marketing costs contributed to the decline in selling and marketing.

On slide 14, we provide the run rate bridge for the quarter. Our reported run rate increased 8% to $1.1 billion, consisting of a 7% increase in subscription run rate to $888 million, and a 15% increase in ABF run rate to $201 million. Adjusting for foreign currency fluctuations, subscription run rate grew 8% year-over-year. We were pleased by the growth – by the record growth in new recurring sales for the full-year 2015 and the fourth quarter. While sales in the quarter were stronger, the net new recurring declined slightly, due to higher levels of cancellations.

Price increases represented a larger percentage of recurring sales, up from prior periods, driven primarily by price increases and Analytics. Cancellations in the quarter were higher primarily due to an increase in closures and strategy changes. Based on the dialogue that we're having with our clients, the uptick in cancellations above the seasonal norms does not appear to be carrying over into the first quarter and our pipeline of deals remain strong.

While we are pleased with the strong sales in the quarter, it is too early to determine if this quarter represents the beginning of a new trend in sales. For MSCI overall, aggregate retention dipped, as is customary in the fourth quarter, to 90%, but the full-year retention of 93% was in line with full-year 2014.

On slides 15 through 18, I will walk you through our segment results. Let's begin with Index on slide 15. Revenues for Index increased 11% on a reported basis with negligible impact from FX. The double-digit increases in subscription and ABF revenue in the quarter were driven by strong sales from our market cap products and continued fast growth in our innovative factor, ESG, and thematic products throughout 2015 and strong inflows into ETFs linked to MSCI indexes.

The adjusted EBITDA margin for Index was 69%. The decline in the adjusted EBITDA margin compared to the third quarter 2015 was due to three factors. One, higher incentive compensation; two, higher severance cost; and three, higher corporate allocations of professional fees primarily related to corporate tax planning. Excluding discrete items in these areas, Index margin would have been approximately 70%.

So, with 70% as an exit rate and factoring in the lower expected asset-based fees due to the decline in equity values, as well as the seasonal first quarter increases in compensation and benefits, we would expect to begin 2016 with margins around fourth quarter levels.

We ended the full year with adjusted EBITDA margin at 70%, which is in line with our target. Index ended 2015 with a very strong retention rate of 95% and in line with the full-year 2014.

On slide 16, we provide you with detail around our asset-based fee. First, in terms of revenue from ETFs linked to MSCI indexes, a 13% in average ETF AUM drove a 9% increase in ETF revenue with the increase AUM offset by a decline in average basis points as shown in the lower-right chart.

Inflows in the quarter were very strong at $29 billion, and while the start of 2016 has been rocky, we are pleased with our overall performance. The decline in average basis points year-over-year and quarter-over-quarter was due to two factors. First, the movement away from higher fee emerging market products to lower fee developed market products, including the U.S., as illustrated in the lower-left chart, as well as mix shift within developed markets to lower fee products.

And second, there was some erosion due to total expense ratio changes by several clients which impacted our average fee. These same drivers offset the 1% increase in AUM linked to MSCI indexes on a linked-quarter basis. In terms of weighting these two drivers, the vast majority of the change was due to mix. Institutional passive revenues are up year-over-year but declined on a linked-quarter basis.

Lastly, in terms of futures and options linked to MSCI indexes, increasing levels of adoption and an increase in market volatility in the second half of 2015 has driven increases in trading volumes with average daily volume of 200,000 contracts in the second half of 2015. That's up 29% compared to the second half of 2014. And the year ended with 1.5 million contracts at open interest, up 20% versus year-end 2014.

Turning to slide 17, we highlight the financials for the Analytics segment. With the consolidation of product groups within Analytics segment and the focus on solving client use cases, the legacy product lines of portfolio management analytics and risk management analytics no longer reflect how the segment is being managed. As a result, we are no longer breaking out the results for that segment in these two legacy product lines.

Revenues for Analytics increased 5% on a reported basis and on an FX-adjusted basis and the adjusted EBITDA margin increased to 28% and compared to 19% for the quarter of prior year. The increase was primarily driven by higher risk manager, equity models and InvestorForce revenues.

Higher-than-anticipated margin relative to the guidance provided in the third quarter was driven primarily by higher-than-anticipated non-recurring revenue and the reversal of prior period accruals for long-term incentive compensation related to the departure of a senior executive.

Adjusting for these items, the normalized Analytics margin would have been 25%, which is in line with the guidance we provided, and we believe is a good exit rate for 2015. Then you can factor in customary first quarter seasonal impact of higher comp and benefits. Adjusted EBITDA margin was 22% for the full-year 2015. And at the end of 2015, Analytics retention was 93%, up from 92% in 2014.

And lastly, for our Other segment on slide 18, we have the All Other. Revenues for All Other increased 14% to $19 million on a reported basis and grew 17% on an FX-adjusted basis. And the adjusted EBITDA margin continued to improve. First, in terms of ESG, a $1 million or 15% increase in ESG revenue to $10 million was driven by record sales for ESG research.

In terms of ESG sales, it was a very strong quarter, especially for the Americas. Run rate growth in the U.S. of 17% year-over-year surpassed EMEA growth of 15%. This is the first time since 2011 that this has happened and reflects the mainstreaming of ESG into the investment process. Growth in ESG continues to be fueled by the addition of new clients.

Now turning to real estate, a $1 million or 14% increase in real estate revenue to $9 million was driven by a strong increase in custom data reports for clients. Excluding the impact of FX, real estate revenue would have increased 20% compared to fourth quarter last year and would have been up slightly for the full-year 2015 compared to full-year 2014. And beginning in the first quarter of 2016, we will consolidate ESG and real estate in our reporting, but we will continue to provide you with color on the performance of each product within the segment.

On slide 19, we provide our key balance sheet indicators. We ended the quarter with cash and cash equivalents of $778 million, which includes cash held outside of the U.S. of $128 million. And as a general policy, we maintain a domestic cash cushion of approximately $150 million for operational purposes.

Free cash flow was up slightly for the year with higher cash from stronger operating results, partially offset by higher interest and cash taxes. As a reminder, interest payments on our outstanding debt are paid quarterly in February, May, August, and November.

Just a quick refresh on leverage. Our goal is maintain gross leverage between 3.0 and 3.5 with the only constraint for net leverage not equaling gross leverage being the cash we hold offshore and for domestic operating purposes of totaling approximately $275 million at this time. In full-year 2015, we paid out 35% of our adjusted EPS as a dividend and it's at the midpoint of our payout range.

On slide 20, we have our new guidance for the full-year 2016. We expect adjusted EBITDA expense to come in between $610 million and $625 million, and this implies a year-over-year increase in cost of approximately 4% using the midpoint of the 2016 range. FX spot rates at the end of 2015 are the basis for rates in this expense guidance.

Interest expense is expected to be approximately $92 million. CapEx is expected to be in the range of $40 million to $50 million. And free cash flow is expected to come in between $270 million and $310 million. And lastly, the effective tax rate is expected to come in between 33% and 34%. And in terms of our financial policies, we are reaffirming our dividend payout ratio of 30% to 40% of adjusted EPS. And lastly, as a follow-up to the issuance of our long-term targets last October, we are reaffirming those targets as of this call.

And with that, I would now like to open up the line for your questions.

Question-and-Answer Session

Operator

Thank you. And our first question comes from Alex Kramm from UBS.

Alex Kramm - UBS Securities LLC

Hey. Good morning, everyone. Can you – I guess both of you made some quick comments on the sales environment. So, maybe you can go back that a little bit and provide a little bit more detail, and clearly, your core customer base is probably suffering a little bit so far this year over the last few months. So, what are your hearing from clients in terms of willingness to buy new products. And also pricing I believe is going to be a big component on the Analytics side this year. So, what's the push back you're hearing on that in particular? Thanks.

Henry A. Fernandez - Chairman & Chief Executive Officer

So, Alex, first of all, the market volatility that we've seen has not had any impact on our pipeline. Our pipeline continues to be healthy and solid and no impact on that.

Secondly is that we have started rolling out price increases on Analytics and it's gone fairly well. So, we do not anticipate for now any kind of pushback by our clients. We did have very strong sales quarter both in one-time sales and also in recurring sales in the fourth quarter, which are focus there of that range of sales that we have had for quite a few quarters. And it's too early to tell whether that break is sustainable. We did well, but it's too early to tell and therefore, we feel good about the quarter. But we got to execute this quarter and the future quarters to see if we can break out of that range-bound that we have had for some time.

In an environment of significant volatility, it's actually sometimes a positive environment for us, even though our clients are not feeling well because there's a lot of focus on risk, there is a lot of focus on understanding the performance of portfolios, there is a meaningful amount of money that flows into passive investments from active that we benefit and the like. And obviously, on the other side, budget gets a little more tight, approvals get longer and the like, but on balance, it has not affected us.

And the last thing that I will say, Alex, is that we are typically a very a light indicator of any of this. It typically takes several quarters before any meaningful market volatility affects us on the subscription business. We obviously have seen the decline in values in ABF, but fortunately, not any meaningful amount of outflows.

Alex Kramm - UBS Securities LLC

Okay. Great. That's helpful. Then I guess maybe secondly, just for Bob real quick on the tax rates, obviously, a nice guide down on the year-over-year perspective. Is that a good – at the midpoint, is that a good point to use for the full quarter – I'm sorry, for the full year every quarter? Or do you think it's actually going to trickle down throughout the year as you get, I guess, smarter with the tax rate? And then, related to that, what are your current thinking as we exit 2016 and look forward to 2017, 2018, 2019, as you probably do a little bit more aggressive tax planning?

Robert Qutub - Chief Financial Officer

We have been focused on the operating rate, Alex. And we did see some benefits, as I talked in my comment. We did also get some benefits from discrete items that we went back and actually got some deductions from prior periods and that got all reflected here, so it magnified the effect on the effective tax rate. But we are guiding down, it's safe to say generally, when we give you a range, we like to look at the midpoint. And that's what we expect our rate to be next year plus or minus discrete items if they come through.

We have more certainty in our planning this year than we did last year. For example, the R&D credit is now permanent, so that helps us a lot. So, I feel that's a pretty sustainable rate throughout the year. There are things that can change it, Alex, the mix of international profits and things like that. But right now based on what we're seeing, we will look at 33% to 34% and if things change, we'll let you know appropriately, but we feel comfortable at this point right now.

Alex Kramm - UBS Securities LLC

And no comments on ongoing work to reduce it even further beyond 2016?

Robert Qutub - Chief Financial Officer

We'll always – we're going to continue to focus. We see more upside out there, but as some of the work that we need to is more extensive and requires a lot more work with our advisors, but we continue to press on. It's not something we're going to take our eye off the ball. And if we have positive surprises – positive developments not surprises, we'll update you accordingly.

Alex Kramm - UBS Securities LLC

All right. Fair enough. Thank you.

Operator

Thank you. Our next question comes from Bill Warmington with Wells Fargo. Your line is open.

William A. Warmington - Wells Fargo Securities LLC

Good morning, everyone.

Henry A. Fernandez - Chairman & Chief Executive Officer

Good morning.

William A. Warmington - Wells Fargo Securities LLC

I wanted to ask about the Index business, specifically. It looked like the sales had been strong on a year-over-year basis, but also the cancellations were up. You had mentioned this in your comments. I just wanted to see if we could get a little bit more color there. Fortunately, it was offset by some improvement in Analytics, but I thought we should start out with Index.

Henry A. Fernandez - Chairman & Chief Executive Officer

Yes, Bill, there is – with respect to cancels, right, there is absolutely nothing to read into these numbers in the fourth quarter. There are times in which you pick up a little, cancel here and there and it exacerbates the numbers. So, we are not concerned about it.

We don't think this is a trend. We think these are just sort of quarter-to-quarter variations and the like. And we continue to be positive about the continued growth of the subscription business on, what we call, the market data, the market capitalization indexes and are very focused on the incremental growth of the franchise into new areas such as the factor indexes, the ESG indexes, the thematic indexes, the custom indexes.

We're also very focused on the expansion of the futures and options franchise linked to MSCI indexes that we did well. We think we're going to continue to do well given the market volatility that is happening and the like. So, the franchise is – continues to be very strong, and I would not read too much into those numbers.

William A. Warmington - Wells Fargo Securities LLC

Well, you really touched on my second question, which was going to be about the futures and options opportunity for you. I know that, with some other indexes, some of your competitors, they have a higher percentage of revenue coming in from these types of products. And the challenge, it seemed to be, at least initially, that it was a more complex product, meaning that you were going across multiple currencies. And so maybe you could talk a little bit about how you solved that problem and what you think the opportunity is. How big is it now in terms of what you are doing, and how fast is it growing?

Henry A. Fernandez - Chairman & Chief Executive Officer

Yeah. So the – most listed futures and options in equity indexes around the world are national, so meaning single-country, single-currency or multi-country, but single-currency like in continental Europe with the EURO STOXX 50.

So, I think – so that has been the nature of the listed futures and options industry. And you require typically a very healthy amount of listed futures and options to develop a large structure of product, structure-derivative product business because related products are the ones that are used to hedge the positions in the structured products.

So, that's a business that many – some of our competitors who are more – who have developed more into national Index businesses have benefited from. We have been hard at work on developing with our partners, the industry of multi-country, multi-currency futures. We started with the New York Stock Exchange life exchange that was acquired by ICE, so we're working pretty close with ICE now in the U.S. to develop that. The volumes on the MSCI emerging market Index futures and the MCSCI EAFE futures trading in New York have been increasing rapidly and steadily. So, we like that. We're trying to see if we can do the same in Europe and Asia as well. So, this is an area of good growth in double digits, but it is from a very small base at the moment. And it's not going to be a huge growth driver immediately, but it's a steady – it will be a steady build. And as I said in the past, there are always three big legs that you can build on equity index franchise around, there is the active leg, which is what we call subscription. There's the passive leg, which is institutional passive and ETF, and then there is the hedging or exposure leg, which is futures and options and other forms of structured products.

So, we've been very good in the first two, and we're now really attacking with a hard drive, the third leg, to see if we can capitalize on the breakthroughs that have been made in the creation of multi-currency futures.

William A. Warmington - Wells Fargo Securities LLC

Okay. Well, thank you very much.

Operator

Thank you. Our next question comes from Toni Kaplan from Morgan Stanley. Your line is open.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Good morning. Analytics margins, the margins in Analytics were extremely strong in this quarter and, I think, above what you had previously been guiding to. It sounds like FX was a contributor. But is there anything else to call out? And, really, if I look at that segment, the first half and second half were so different in terms of the margin profile. So how should we think about 2016 for Analytics margins?

Robert Qutub - Chief Financial Officer

Yeah. I'll try to – that's a good question, Toni. We tried to address that, and we were fully cognizant of the margin came in a little different than we had guided in the third quarter. Two things, on a top line, sales again were very strong in the fourth quarter as you saw both recurring and non-recurring totaling $40 million in aggregate. So, we did have one-time sales came in, in Q4 that helped the Analytics that we weren't anticipating, which is – that's a good thing.

Secondly, I did refer to the reversal of an incentive compensation have closed significant for senior executive that left in the fourth quarter after our call. And then we did file an 8-K on that in Q4. Those were two of the principal drivers, there were a few one-times in there. But we knew about most of them. But I would say, those two items really steered the margin the other way.

Having said that, I tried to give you the normalization of around 25% as we enter into 2016, for Q1, adjusted for some tax inflationary costs related to compensation. Hopefully that helps a little bit, Toni.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Yes. It does. Thank you. And you have been doing a number of repurchases, especially in the second half of last year. How should we think about pacing of buybacks in 2016? And if you could just remind us, how should we think about repurchases as a percentage of free cash flow, just on a normal sort of policy basis? Thanks.

Henry A. Fernandez - Chairman & Chief Executive Officer

I think the way to think about it, Toni, one is, we are not in the mood or desire to restore excess capital in the company or in the balance sheet, right? So, to begin with. Secondly, we want to be opportunistic with our repurchases, which – at higher share prices we do less but we still do – we'll do some and at lower share prices, we do more, the volume. And therefore, every quarter is going to be different, depending on where our share price is trading, and what the volumes are because, obviously, we want to do this in a way that we're not impacting the natural demand-supply and price discovery in the stock. So that's kind of the balancing act that we have, but we've done well so far, right? We've done really well in the last six, nine months or so with this strategy. And we definitely intend to continue to do that if we can.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Thank you.

Operator

Thank you. Our next question comes from Chris Shutler with William Blair. Your line is open.

Chris C. Shutler - William Blair & Co. LLC

Hey, guys. Good morning.

Henry A. Fernandez - Chairman & Chief Executive Officer

Good morning.

Robert Qutub - Chief Financial Officer

Hi, Chris.

Chris C. Shutler - William Blair & Co. LLC

On the EBITDA expense guidance for 2016, what exchange rates have you used for the pound and euro and what would cause you guys to be at the low end versus the high end?

Robert Qutub - Chief Financial Officer

We used the – same as last year, we use the spot rates of December 31 to convert all of our currencies. So, we're really starting out fresh. That was the basis for $610 million to $625 million. So, that's something you can get pretty easily. I don't have it here in front of me, but we've got those for you.

And regarding the – I think as Henry talked about, we remain vigorously addressing our cost base, making sure we're as efficient as we can to provide ourselves opportunities that are out there. And as with all the years, Chris, we're going to one times, but we still want to stay whole and true to our 5% to 7% and 4% is guiding to our midpoint. That gives us room if need be, but we're going keep our eye on the markets along with a question that Alex dropped in the first part of his call here.

So, again, right now, $610 million to $625 million as we move through the year, similar to last year, we'll definitely steer you on a tighter path.

Henry A. Fernandez - Chairman & Chief Executive Officer

The other thing is, if you sit back and look at the totality of the company, right, in terms of cash flows and balance sheet and all of that, if you put aside for a minute the ABF, which I'll comment on in a second, but if you put aside the ABF, our revenues are largely in the hard currencies. Obviously, most of them are in dollars, in euros, in pounds, and in yens, right? And our cost is also in those hard currencies, but is also a meaningful amount of the cost is in the soft currencies of various emerging markets. So, on a net-net basis, a stronger dollar ends up being mildly positive for us. And particularly the way it has evolved, which has become strong relative to the hard currencies, but not as strong as comparing to the appreciation relative to the weaker currencies, the soft currencies. So...

Robert Qutub - Chief Financial Officer

Yeah. And maybe just on that point, just to give you something concrete, in terms of subscription revenues, our billable in dollars for our revenues is 83% in dollars, so that leaves 17% for non-dollars. And those exposures are euro, yen and sterling on an absolute basis.

On expenses, our billable currency other than the U.S. dollar has increased slightly to 44%. We've talked about that being 40% in the past. And our larger exposures are sterling, but then again that gets offset by the revenue. So, really our net exposure on EBITDA and revenues for subscription revenues would be – mainly euro would be our biggest one out there. Having said that, we don't factor in the AUM, although two-thirds of those are denominated in other currencies than the U.S. dollar.

Henry A. Fernandez - Chairman & Chief Executive Officer

And that's kind of clearly the issue that's always hard, right, because a lot of the AUM is in non-dollar in the passive products. And so when the dollar strengthen against that, you see an immediate weakening of those AUM levels, but typically more assets flow into those because of the exchange rate and, over time, they kind of come back up to prior levels. So, that's always harder to do that.

But net-net, we're not worried at all about the strength of the dollar because it's a mild positive and we're not worried of a reversal of the strength of the dollar because it's not a big impact on us. We're largely hedged, not totally, but we're largely hedged.

Chris C. Shutler - William Blair & Co. LLC

All right. Great. Then can I just ask a question on Analytics. Maybe – you've talked a lot about this in the past, but can you just flesh out some of the – you talked about opportunities for 2016 in Analytics, whether it be core use cases, new partnerships, pricing, et cetera. Can you just flesh some of that out a little bit more? And I also was hoping to get an update on the technology platform that you guys have talked about in the past. Thanks.

Henry A. Fernandez - Chairman & Chief Executive Officer

Yeah. So, on Analytics, we are trying to gradually transform the product line from selling risk models and software applications and things like that to understanding very specific client needs, and then offering them a solution to that client need by packaging our content and our applications. Not on a bespoke or customized basis, but just with certain adjustments, but addressing specifically a client need.

The four client needs that we're very focused on is a lot of our clients, particularly active managers, are very intent of creating differentiation in their performance and showing that differentiation to their own clients. So, that's one.

Another one is, a lot of our clients are under cost pressures and profit pressures and, therefore, they're trying to reduce costs. So, a lot of what we do it creates transparency, efficiencies and therefore reduction of costs. So, many of our clients are tackling the issue of how do they deal with risk and how do they report risk and how do they manage risk. So, that's another one.

And lastly, huge amount of regulatory burden on all forms of clients from asset managers to hedge funds to banks and the like. So, we go to them and say, let's fully understand what the regulators are asking for from you and how do we help you create the content and the reports that help you with that.

So, very much – and that has resonated very well with our clients. And we're trying to push that mode of service at them. So – and we continue to clearly innovate in terms of new risk models, new performance contribution models and so on and so forth. So we can spend more time on that offline. Now, all this content that we create has to be enabled by applications.

Pretty much everything we do at MSCI has to be enabled by applications, but especially a lot of the Analytics content, a lot of the models have to be enabled by, what I call, workflow applications. So, you got to think BarraOne, and RiskManager, and BPM as kind of workflow applications. But then they're not the only ones. There are also – we also give the content to our clients and they use their own applications, particularly the large passive managers. Many of the – some of the hedge funds and the like, so we work with them on that.

And lastly, we would – and this is where the partnerships come in, is that we're trying to work with other providers of workflow applications of different types to put our content in them to serve the needs of the client. And therefore, is either in areas that we do and we also compete with, or in areas that we don't do, so how do we put our applications side-by-side with OMS applications, for example, or for an office applications that could be helpful to the client. So we're working on that in order to, again, facilitate the serving of the needs of the clients.

And lastly on – we are – the difficulty we've had in this product line and a part of the lower profitability on this product line is because given the nature of the way we grew, which was by acquisitions, we still have quite a lot of legacy applications that are all similar to one another, built in different languages and different use, different interfaces and all of that. So that – maintaining – first of all innovating on them and maintaining them is costly and that it's a way – a meaningful amount on the profit margin on our content.

So, what we're doing is building an overlay application, which we call, new interface, new architecture, an overlay application that we put on top of this with a user interface, so that's what the client eventually sees. And therefore, we then go to the engine room and link the current applications and make the current applications more of engine to that. So, we're going to be launching the first release of that next quarter, which is still – obviously it doesn't have everything, but it's just step-by-step. And we're going to start signing up clients on that. But we're still going to sell the existing applications because that's what we have today.

Chris C. Shutler - William Blair & Co. LLC

All right. Thank you.

Operator

Thank you. Our next question comes from Joseph Foresi with Cantor Fitzgerald. Your line is open.

Joseph Foresi - Cantor Fitzgerald Securities

Hi. Good morning. I was wondering if you could tell us or maybe give us some detail around how the increase in custom indexes is impacting the business. Is there a different go-to-market for it and how you sort of see that playing out?

Henry A. Fernandez - Chairman & Chief Executive Officer

This is an area of double-digit growth for us and has always been from a couple of decades and what it is, is that we have the off-the-shelf market capitalization indexes or factor indexes or the other ones and therefore, people come to us and say we want to be benchmarked with something that is worth targeting to what our investment objectives are. Can you help us with that? And the easy part, which is we repackage the countries in a different way or repackage industries in a different way or exclude a number of industries that they're concerned about or, in the case of ESG, exclude a different number of companies that are not compliant to what they believe to be a secret area.

So, this is an area that we have created an industrial strength organization from the understanding of the client needs to looking at the methodology, to the production environment, which is pretty critical because you cannot have thousands of these indexes and all in a manual way. So, we are very well set to continue to grow here. And we see this as a way of the future in which clients will want to rifle-shoot their investment goals and have a benchmark that is tailoring to them.

Joseph Foresi - Cantor Fitzgerald Securities

Okay. And maybe you could just talk about if you've seen any changes at all in the competitive environment either on custom indexes or in other areas. And any updates you could provide on sort of sales force additions would be great as well. Thanks.

Henry A. Fernandez - Chairman & Chief Executive Officer

Not a lot competitive changes from last year at all. If anything, some of the types of acquisitions and mergers that have taken place have created openings for us to go out and insert ourselves, and that's been beneficial to our business. And now, the factor investing area is an area that we're leading, but is – we're very subject to clearly more competition at this moment. Quite a lot of the competition is not coming from traditional sources but more from asset managers that have fund teams that build these factor models. For example – and therefore, they don't make them available to everyone like we do, but they go to the client and offer the product sometimes in competition with our indexes.

But we believe that given the huge expertise that we have on equity risk models, the Barra risk models, and the know-how that we have, Barra practically invented equity risk models and factor investing starting from the mid-1970s, so we have huge competitive advantage in having leadership in this area.

Joseph Foresi - Cantor Fitzgerald Securities

Thank you.

Operator

Thank you. Our next question comes from Doug Doucette with KBW. Your line is open.

Douglas Doucette - Keefe, Bruyette & Woods, Inc.

Good morning, guys. Thanks for squeezing me in. Just one question, wondering if you could give us any sense of the timeline on reaching the 15% to 20% margin target for the Other segment in light of your commentary about the real estate segment reaching breakeven this year.

Henry A. Fernandez - Chairman & Chief Executive Officer

Well, these are longer-term targets, right, but we clearly are intent on getting there sooner than later, right? We feel pretty good about the ESG product line. If anything, that's a product line that we can accelerate dramatically, higher profits, but it's a huge growth area, huge. It's at a $40 million-plus run rate and quite a lot of demand. So, we are balancing out the increasing of profit relative to investments that we want to make, so that we are – we continue to be the leader there.

And, as we said, in real estate, we hope to breakeven next year, or maybe single-digit margins, and then we want to accelerate from there. But we can't tell you yet what the trajectory is, but we are fully intent on achieving those margins over a few years.

Douglas Doucette - Keefe, Bruyette & Woods, Inc.

All right. Thanks.

Operator

Thank you. Our next question comes from Hugh Miller with Macquarie. Your line is open.

Hugh M. Miller - Macquarie Capital (USA), Inc.

...for squeezing me in as well. Just had one question on the Index retention. I know you guys had mentioned that some closures and strategy changes had weighed on 4Q and that it was kind of more of an anomaly. How comfortable are you guys with kind of the historical retention of 95%-ish as we think about 2016?

Henry A. Fernandez - Chairman & Chief Executive Officer

For the full year, we're comfortable. We don't – there is no evidence of any meaningful change to that at this point. I know there would always be variations from quarter-to-quarter. So, there is no – we were not thinking about it any differently.

Robert Qutub - Chief Financial Officer

And Q4 is always one – you got to put that in context. It tends to be seasonally, where a lot of clients will renew their contracts. We see it drop a little bit in Q4.

Hugh M. Miller - Macquarie Capital (USA), Inc.

Understood. Thank you. And then the other was just I appreciate the insight on the Analytics margins and stuff like that and you guys mentioning the potential to raise prices and not getting a lot of pushback from clients on that. Can you just help us – give us a sense of what type of level of price increases are you guys striving for, for 2016?

Robert Qutub - Chief Financial Officer

Well, we've pushed in 2015, in our repriceable portfolio on Index, we did 5% to 7%. And we look at that as the opportunity for 2016. Again, on Analytics, the emphasis there is it was really just starting in late 2015 and we were starting to push the price increases on that portfolio.

We expect that to be a good piece of the growth that we're going to see in 2016 over 2015. And we'll update you more each quarter as we get into the year and we start realizing those price increases.

Hugh M. Miller - Macquarie Capital (USA), Inc.

Okay. That's helpful. I mean – but do you still also feel confident about your ability to maybe take share and grow the client base as well or is it more a function of just kind of adding value to the current client base and being able to charge more for that?

Henry A. Fernandez - Chairman & Chief Executive Officer

All of the above.

Robert Qutub - Chief Financial Officer

All of the above. Yeah.

Hugh M. Miller - Macquarie Capital (USA), Inc.

Okay. Thank you.

Operator

Thank you. And we have a question from Keith Housum with Northcoast Research. Your line is open.

Keith M. Housum - Northcoast Research Partners LLC

Thanks, gentlemen. One question for you in terms of the Indexes and the asset-based fees. The pressure that ETFs are getting just from competitive stance in terms of lower – having to lower their fees, how tied is their reduction fees to what you guys recognize for under your fees for assets under management?

Henry A. Fernandez - Chairman & Chief Executive Officer

Yeah. So, the way a lot of our fees are structured is that our fee is a percentage of the management fee but (70:17) and it has a cap. So, if we're operating at the high end of that range and the manager lowers their fee, we come down with that lowering of the fee. But if we're at the lower end of the cap, which is where the largest of our funds are, then any lowering of the fee hits the floor.

Keith M. Housum - Northcoast Research Partners LLC

Okay. Thank you.

Operator

Thank you. And I am showing no further questions at this time. I would like to turn the call back to Steve Davidson for any closing remarks.

Stephen C. Davidson - Head of Investor Relations

Thanks for your time this morning and we look forward to speaking with you all soon.

Henry A. Fernandez - Chairman & Chief Executive Officer

Thank you.

Operator

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

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