MSCI Inc. F3Q08 (Qtr End 08/31/08) Earnings Call Transcript

MSCI Inc. (MXB)

F3Q08 Earnings Call

October 2, 2008 11:00 am ET

Executives

Michael K. Neborak - Chief Financial Officer

Henry A. Fernandez - Chairman and Chief Executive Officer

Analysts

Andrew Fones - UBS

Sara Gubins - Merrill Lynch

[Wally Pow] - KBW

John Neff - William Blair

Michael Weisberg - ING

Presentation

Operator

Welcome to the MSCI Inc. third quarter 2008 earnings conference call. (Operator Instructions) With us today from the company is the Chairman and Chief Executive Officer, Henry Fernandez and Chief Financial Officer, Michael Neborak.

Michael Neborak

Please note that earlier this morning we issued a press release describing our results for the third quarter 2008, a copy of that release can be reviewed on the company’s web site at mscibarra.com under investor relations.

This presentation 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 reflects 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 discussion of additional risks and uncertainties that may affect the future results of the company, please see the description of risk factors and forward-looking statements in our Form 10-K for our fiscal year ending November 30, 2007 and our quarterly filings and earnings releases for 2008.

Today’s earnings call may also include discussion of certain non-GAAP financial measures. Please refer to today’s earnings release for the required reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures and other related disclosures.

Since we will be referring to run rates frequently in our discussion this morning, let me remind you that our run rate at a given point in time represents the forward-looking seeds for subscription and product licenses that we will record over the next 12 months assuming no cancellations, new sales, or changes in the asset and ETF license to our indices. Please refer to table 2 in our press release for a detailed explanation.

The agenda for today’s call is as follows: first Henry will summarize the third quarter, second I will review third quarter financial results in detail. Following our formal remarks we will take questions.

Henry Fernandez

In our third quarter operating revenues increased almost 20% to a record $110 million and our adjusted EBITDA increased 27% to a record $51 million. We are particularly pleased with our adjusted EBITDA margin over 46% in the quarter despite incurring duplicative expenses to replace services currently provided by Morgan Stanley. This high level of profitability in our company highlights the significant positive operating leverage of our business.

Our record results continue to demonstrate the most have mission critical nature of our products and services in the investment process. Our record results also demonstrate the balance and diversification of our revenue sources worldwide; mainly we have a diverse product line ranging from performance benchmarks, performance, and risk analytics to tools for total portfolio risk management.

We have a diverse client base from loan only asset managers to pension funds, several world funds, broker dealers, hedge funds worldwide. Our clients, over 3,100 of them, are located all over the world from the US and Canada to Europe, the Middle East, Asia and Australia. A lot of these points are to reinforce the fact that we have a very diverse and very balanced business that if one area of our business is not performing as well, the other one is.

While the ongoing turbulence within the financial market has created headwinds for our asset based fees and our equity portfolio analytics products, sales of our equity and data subscription and our multi-asset classed portfolio analytic remains strong; again, demonstrating the balance in revenues in our business.

Our run rate of $430 million in Q3 increased 15% year-over-year, but went flat sequentially due to an 11% decline in our asset-based fees, mostly a changed credit fund fee, offset by a 2.5% increase in our subscription run rate.

On the second quarter call in July we cited several factors that weighed on our run rate. Those factors persisted during the current quarter and had an even pronounced impact on our Q3 run rate. Let us go over those factors again.

First, market conditions: as we all know all too well, the conditions in the financial market through out the world deteriorated in recent months. The impact on our business is evident in our asset-based fees, even the decline in the value of assets in ECS link to our indices. The impact was also felt in our equity portfolio analytics as a result of the closure of a few quantitative funds among both hedge funds and loan only managers.

Secondly, is the thorough [ph] of sales of our proprietary equity rich data either sold directly to customers or bundled with our proprietary software Aegis. Those products, where it affects some sales of those products were, to be fair, ahead of the launch of our new un-enhanced mobile equity risk model GEM2.

Third, reallocation of resources: as we discussed on our second quarter call, we believe new sales and new product development have been hampered by the reallocation of resources in our company towards the separation from Morgan Stanley. Therefore, we believe we have not operated at an optimal capacity and have not maximized the revenue opportunities available to us. For example, nearly 80 of the 96 new hires over the last year are focused on the replacement of Morgan Stanley services. In addition, over 60 existing full-time equivalent employees have been reassigned to work on these replacement efforts. All told, currently nearly 20% of our employees are currently working on the separation from Morgan Stanley. As these people r free up over the next three to six months they will return to focusing solely on growing our business. We therefore expect a positive impact on productivity starting in early 2009.

Let me now explain why we continue to be enthusiastic about our business and we maintain our medium term financial target of revenue growth in the mid-teens on adjusted EBITDA margin in the low 40s, even in this negative climate in the investment world.

First our diverse product offerings and global client base should help to insulate us from any particular segment of the financial market. For example, while the run rate for equity portfolio analytics slowed in Q3 our equity index data subscriptions accelerated and our multi-asset class portfolio had another solid quarter.

On EPS there is not much we can do in the near term to offset the impact from the decline to the values of assets in ETF linked to our indices. However, what we can do is to continue to work with our EPS managers to license indices for new EPS which will gather assets over time and mitigate, somewhat, the decline in assets in existing EPS. We also believe that we are well positioned to benefit from an up turn in the equity markets whenever they occur.

Third, on equity portfolio analytics we believe the recent launches of our second-generation global equity risk model GEM2, and the launch of Aegis 4.2 the analytic software which can be used to access GEM2, they should all contribute to an increase in subscriptions in the coming quarters. The launch of GEM2 data platform would also help accelerate the time to market of our new enhanced models to Europe, Australia, US, and other markets we plan to launch over the next year.

On investment initiative during Q3 we approved the hiring of approximately 100 people in the business, but not related to the replacement of Morgan Stanley services. These new hires, many of them in emerging market sensors, will help us accelerate our sales growth and instill new product introductions, or at a minimum, they will help us mitigate the impact of a slow down in new sales.

As previously discussed, we have been short staffed, especially in sales, in recent quarters and we are now taking very proactive steps to alleviate this resource constraint and try to minimize the many revenue opportunities we see in the market place today, while maintaining our EBITDA margin in the ranges that we have described before.

I will now turn to more details of our performance in pro-categories and in client segments during the quarter. In my remarks, when I discuss top line numbers, I will be referring only to run rate, while Mike will focus on accounting numbers later.

Run rates serves as a general and directional indication of future revenue, however I caution that they are only at snap shot of our business at a given point in time and do not have a corresponding one-to-one relationship with accounting revenues quarter-to-quarter. Please note that the run rate growth rates that I will refer to represent the percentage change from the run rate as of August 31, 2008, compared to the run rate as of August 31, 2007, unless otherwise specified.

In terms of major product categories the run rate and equity indices increased almost 20% year-over-year. Our equity data subscriptions had an excellent quarter. Our run rate grew 23.6% year-over-year and 5% sequentially from May 31, 2008.

We had a strong subscription sales across a broad range of products within our global invest able market index series and growth and usage fees for access to our index data as well. Growth was across all regions and particularly within our largest client segment, the loan only asset managers.

Equity in the asset based fees increased 11% year-over-year, but they decreased 11.6% sequentially due to a decline in the value of assets in ETFs linked to our indices. So in the third quarter nine new ETFs were launched, which brings the total for the first nine months of the year to 37, compared to 29 for all of ’07. Our pipeline of new ETFs remains full, although market conditions may impact the actual launch date in each particular ETF.

The run rate for equity portfolio analytics increased 10.5% year-over-year, but went flat sequentially. Excluding the negative impact of foreign currency translation during the quarter the run rate for equity portfolio analytics increased slightly to 0.7%. The run rate for Aegis within equity portfolio analytics declined 2.3% from Q2. Excluding the negative impact of foreign currency translation, the decline was a bit less at 1%. The run rate for equity risk data sold directly to customers increased 4.6%.

The closing of our BarraOne at some of our hedge fund clients and loan only clients during the quarter weigh on equity portfolio analytics results. As I said before, on the positive side we may see a gradual pick up in new sales in equity portfolio analytics in this next few quarters as a result of the launch of GEM2 an Aegis 4.2 last week. As previously discussed, new subscriptions in recent quarters have been negatively impacted by the deferral of purchases by our clients ahead of the launch of GEM2 and Aegis 4.2.

The run rate for multi-asset class analytics increased 22% year-over-year and 2.5% sequentially. Excluding the impact of foreign currency translation the sequential growth rate in multi-asset class analytics was a much higher 5.5%.

The run rate for BarraOne, the main component of multi-asset class analytics increased 39.4% year-over-year and 6.6% sequentially during the quarter. Again, excluding the negative impact from foreign currency translation the sequential growth rate of BarraOne during the quarter was a much higher 9.3%. About half of the sales of BarraOne are in currencies other than the US dollar.

We continue to add new BarraOne clients rapidly during the quarter including a flagship sale to the California State Teachers Retirement System.

In terms of our major client segment as in prior quarters we continued to grow our run rate by up selling to existing clients, adding new clients, and implementing some price increases even in this difficult environment. This quarter we added 65 net new clients for a total now, worldwide, of almost 3,100 clients.

Excluding asset based fees approximately 20% of our gross sales during the quarter came from new clients. This was a decrease from the 23% we experienced in the second quarter and a decrease also from ’07. We have seen a continued gradual decline in our gross sales to new clients as the shortage of staff in our sales force has forced them to constant trade on existing clients and therefore we intend to see an increase in this over the next few quarters. We intend to reverse this trend in the coming quarters as we add more staff to our sales and product management organization.

We saw growth in our run rate for all of our major client categories. Growth rates year-over-year were as follows: 11% to $288 million for asset managers; 28% to $45 million for broker/dealers; 27% to $22 million for hedge fund; 17% to $20 million for asset owners, mostly pension funds and several world funds; and 22% to $54 million for all other client categories.

In terms of the outlook, as I said at the beginning, we remain cautiously optimistic that our business model will hold up well despite a tremendous turmoil in financial markets worldwide. We are still comfortable with our medium term financial targets of revenue growth in the mid- teens and adjusted EBITDA in the low 40s. As previously noted, our level of profitability may fall within a range of 40% to 50% in any given quarter depending on the rate and the mix of revenue growth at a base of investment spending and the duplicative expenses that we’re incurring related to the replacement of services currently provided by Morgan Stanley.

In conclusion and in summary, while the turmoil in the financial market creates headwinds for us, we believe the company is very well positioned for the future and the investments we’re currently making to help us to offset and mitigate the impact on our business from the current financial turmoil.

Michael Neborak

I am going to discuss, in more detail, our financial performance. Please note that unless otherwise specified the fed change figures represents the comparison between Q3 2008 and Q3 2007.

First our operating revenues: For the third quarter 2008 operating revenues increased 19.5% to $110.4 million. Assuming exchange rates are unchanged from Q3 2007, Q3 2008 operating revenues increased 17.9%. The performance was led by a 21.4% increase in our subscription revenues. Growth in asset based fee revenues was 10.8%.

Now I will comment on some specifics around revenue performance by products.

Revenues from equity indices, our largest product category, this is approximately 56% of our total revenues, increased 24.1% to $62 million.

Within equity indices, revenues from equity index data subscription, this is about 4% of our revenue base, were up 30.7% to $43.7 million, reflecting growth in subscriptions across a broad range of products within our global invest able market index series.

Revenues attributable to equity index asset based fee products, this is about 17% of our total revenues, increased 10.8% to $18.3 million in the third quarter of 2008. In the third quarter 2008 approximately 78% of the revenues included in this product category relate to exchange traded funds. The other 22% includes fees on institutional index funds, transaction volume based fees for futures and options traded on certain MSCI indices and other of structured products.

Compared to the second quarter of 2008 equity index asset based fee revenue was flat at $18.3 million, reflecting a 1% decline in our ETF asset based fee revenues, which was offset by an increase in fees from other products in this category. The average value of assets in ETF linked MSCI equity indices was $178.3 billion for the third quarter 2008 compared to $184.4 billion for the second quarter of 2008.

At August 31, 2008 the value of assets in ETF linked MSCI equity indices was $166.3 billion. US lifted ETF accounted for 85% of our AUM balance, a difference of between 185% was ETFs primarily listed in Europe.

As disclosed in the earnings release we did experience a $2.1 billion decrease in AUMs in the quarter attributable to asset out flows. While this is the first time we experienced a net asset out flow in a quarter, we believe the $2.1 billion figure is quite modest in the context of the equity market turmoil we experienced recently. The out flows were most significant in EFA and emerging market ETFs.

We believe we remain well positioned within the global ETF industry. Our market share remains in the mid-20s. We currently have 156 ETFs including 32 with AUM balances greater than $1 billion licensed to our indices.

Our second largest product revenue category is equity portfolio analytics; this is about 31% total revenues. Revenues for this category increased 14.3% to $33.7 million. The year-over-year increase reflects new subscriptions to our proprietary equity risk data accessed directly and followed with Aegis.

Multi asset-backed portfolio analytics had another strong quarter. Revenues increased 33.8% to $8.9 million. The year-over-year increase is largely attributable to strong new subscriptions to BarraOne.

Before I talk about expenses I am going to talk a little bit more about foreign currency and how that impacted our quarter number 3 results.

First is our run rate: When comparing our run rate on August 31, 2008 to our run rate on May 31, 2008 currency had a negative $3.3 million impact due to the depreciation of the tower during the quarter. Please note that approximately $62 million or 14% of our run rate on August 31 was nominated in non-US dollars.

In terms of accounting revenues, when comparing our quarter #3 2008 accounting revenues to the same quarter in 2007, currency was a positive $1.4 million dollars due primarily to the depreciation of the dollar versus the euro, between the third quarter 2007 and the end of the third quarter 2008. Approximately $15 million or 14\% of our Q3 revenues are denominated in non-US dollars.

On the expense side, when you compare our quarter #3 2008 expenses to Q3 2007, currency increased our expected $151.4 million primarily due to the depreciation of the dollar versus the Swiss frank, between the third quarter of 2007 and the third quarter of 2008. Approximately $20 million or 27% of our third quarter 2008 expenses were denominated in non-US dollars. And, on the balance sheet, the re-measurement of our balance sheet at the end of the third quarter 2008 versus the second quarter of 2008 resulted in a foreign currency loss of $3 million due to the strengthening of the US dollar which is recognized in the non-operating other expense line.

Operating expenses increased 23.2% to $72.9 million. This increase is primarily due to two factors: Founders grant expenses and set up in duplicate costs related to the replacement of services provided by Morgan Stanley; if we exclude the founders grant expense of $5.8 million, operating expenses increased by 14.2% to $67.5 million. If we take this one step further and strip out transition expenses that we incurred in the quarter equal to $7.8 million, now again this relates to the replacement of Morgan Stanley services, and we also strip out the Morgan Stanley allocation in the quarter of $3.9 million and we strip $7 million out in the third quarter of 2007, expenses were up 7% compared to the third quarter of 2007.

Our head count was 723 people at the end of the quarter representing an increase of 96 or 15.15 from the end of the third quarter of 2007.

On August 31 2008 approximately 26% of our employees were located in emerging market centers, which is up from 185 at the beginning of the fiscal year.

I will talk a little bit now about our capital structure. Because we achieved certain leverage thresholds defined in our credit agreement, the LIBOR spreads on both our term loan A and term loan B debt stepped down another 25 basis points during the third quarter. The LIBOR spread on our term A loan is now at 200 basis points, down from 225 basis points and the LIBOR spread on our term loan B decreased to 250 basis points from 275 basis points.

For the quarter ended August 31, 2008 our effective all in interest rate, including our interest rates locked, was approximately 5.16%. For the fourth quarter we expect our effective all in interest rate to be between 5.1% and 5.15%.

Please note that the net income EPS for the third quarter in 2008 are not comparable to the third quarter 2007, primarily because of founders grant expense and changes in our capital structure as well as our initial public offering.

Net income in the third quarter 2008 declined 11.7% to $18.9 million from the third quarter of 2007. The decline primarily reflects founders grant expense and higher interest expense offset in part by the increase in adjusted EBITDA.

On a diluted EPS basis for the third quarter of 2008 that figure was $0.19, a decline of 24% from the third quarter of 2007, reflecting a higher number of shares outstanding.

Adjusted EBITDA increased 26.9% to $51.3 million for the third quarter of 2008. I refer you to Table 9 in our press release for the reconciliation of adjusted EBITDA to net income, an adjusted EBITDA margin expanded to 46.4% in the third quarter of 2008 from 43.7% in the third quarter of 2007. The increase reflects the positive operating leverage in the business.

Our cash earnings for the third quarter 2008 were $26.7 million or $0.26 on a diluted per share basis compared to $25.7 million or $0.31 per diluted share in the third quarter of 2007. The decline in cash EPS reflects a lack of comparability due to the increase in the number of shares outstanding resulting from our IPO and the increase in interest expense resulting from changes in our capital structure during 2007. We calculate cash earnings of $26.7 million by taking our net income for the quarter, which is $18.9 million and adding back the after tax impact of the founders grant and that after tax figure is $3.3 million and then adding back the after tax impact of amortization of intangibles, that figure is $4.5 million.

We have already touched on a number of our operating metrics, the details of which can be seen in Table 2 of the press release. I did want to however, provide a little bit more color around our retention rate.

Our aggregate retention rate was unchanged at 92% for the third quarter 2008 compared to the third quarter of 2007, however our full retention rate, which eliminates product slots, declined to 94% from 95% in the third quarter of 2007. This decline was largely attributable to lower retention in Barra Aegis and in the total risk component of multi-asset class.

I am going to spend a little bit of time now talking about the transition away from Morgan Stanley services.

In the third quarter of 2008 the allocation of these costs from Morgan Stanley declined by $1.9 million to $3.9 million from the $5.8 million figure that we incurred in quarter 2, 2008 and this was principally because we took over certain administrative HR and finance functions and we continue to do that. As I have said before, our goal is to be self sufficient for a vast majority of all the services that we received from Morgan Stanley, by the end of this fiscal year, and with the profits fully completed by May 2009.

We expect the allocations in the fourth quarter to be largely from IT as the allocations were HR, finance, and other corporate functions run off during the fourth quarter. As such we expect the Morgan Stanley allocations to decline by approximately $0.5 million in the fourth quarter to about $3.4 million. In fiscal 2009 we expect the Morgan Stanley allocation to be approximately $6 million, largely reflecting IT expenses. Again, we expect Morgan Stanley charges to peak after May 2009.

For the full year fiscal 2008 we expect the Morgan Stanley allocation to total approximately $19 million. That compares to $26.4 million of allocation expense in fiscal 2007. In the third quarter 2008 the initial set up costs as well as duplicate costs we incurred related to establishing the infrastructure to replace these Morgan Stanley services totaled $7.8 million, including approximately $2.3 million of non-recurring expenses. For the full year 2008 these duplicate transition expenses should total approximately $21 to $22 million.

In summary, if you take the total cost of the Morgan Stanley allocation and the duplication transition expenses that we expect for all of 2008, the total of those two items should be approximately $40 to $42 million. The equivalent expense for 2007 was $28 million.

Let me touch a little bit on capital expenditures. Capital expenditures for the third quarter totaled $13.5 million, including approximately $4 million paid to Morgan Stanley for assets purchased such as leasehold improvement to our offices, PCs and other communication equipment and office furniture. Excluding the payment to Morgan Stanley, capital expenditures year-to-date were $15 million.

We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Andrew Fones - UBS.

Andrew Fones - UBS

I was wondering if you could tell us where your ETF assets were at the end of September.

Michael Neborak

This is the figure as of last Friday, approximately $156 billion. That is down from the $166 billion at the end of August.

Andrew Fones - UBS

In terms of the compensation I saw that you were able to manage that extremely well. Can you, I think the accruals in Q2 were about $12 to $13 million. Can you give us what the compensation accruals were in Q3?

Michael Neborak

I’m not quite sure, Andrew, I follow the question in terms of the compensation. The compensation in Q2 total was about $36, $37 million and in Q3 was between $37 and $38 million in terms of the compensation part of the expense line.

Andrew Fones - UBS

Sorry, I was looking at the cash flow statement. I was just looking for kind of the bonus accruals; I think it was at $12.5 million in Q2. I was wondering if you have that number for Q3.

Michael Neborak

I don’t have that number right now.

Andrew Fones - UBS

I was just wondering if you have any update in terms of how Morgan Stanley may be looking at the kind of the store ownership piece coming up here in mid-November on your first anniversary of the IPO.

Henry Fernandez

I think the masses have not really changed at all. Morgan Stanley has publicly expressed their objective of selling their entire stake in MSCI over time and I think what has always been a question is the timing and the exact nature of those sales over time. So I think nothing has changed from that perspective. We really have not announced at this moment any additional sales [inaudible] Morgan Stanley, so the timing and the nature of the subsequent sales is to be determined by them.

I think one other important point to also indicate is that as you all know the shares that Morgan Stanley own, which is about 27.7 million shares right now out of a total of about 100. They carry super votes, you know it is five votes per share to the [inaudible] shares, which is one vote per chair and as long as Morgan Stanley sells those shares to a non-affiliated entity those shares revert back to one vote per share, they convert from class B to class A and therefore go from five votes per share to one vote per share.

Operator

Your next question comes from Sara Gubins - Merrill Lynch.

Sara Gubins - Merrill Lynch

Could you talk about trends that you’ve seen over the past month in terms of demand for index subscriptions, equity analytics, and the multi-asset classed products. Is there any either decrease or pick-up in that?

Henry Fernandez

I cannot address in a few moments what has happened the last two or three days. Our business continues to be fine, but over the course of September, let me back up a little. The third quarter of a year is not our easiest quarter, because in the northern hemisphere, where we sell most of our products, we have the summer, you know we have July and August and therefore it has typically been a major effort by our sales people to ensure that there is enough focus on the part of the client under the [inaudible] makers within the client to make the final decisions about purchases of our products and the like.

In this past third quarter that was particularly more acute because people in our client base, have been distracted by the problems in the financial market. So coming into September, excluding the last couple weeks, which that is not to say that we have or have not done well in the last couple weeks, last couple days, I’m sorry., but just excluding that, in most of September we saw a very meaningful pick-up in activity in our client base in terms of wanting to make official, deciding on probes, planning in sales and the like, so we were getting very cautiously optimistic that things will pick up in the balance of the year and that is not unusual, because to some extent the new year in a lot of organizations really begins in September rather than January. They make a lot of purchases around that time, etc… etc…

Now the last few days and depending on what happens in the environment here, will dictate what will happen for the balance of the quarter.

In an environment like this, relative asset managers tend to hog their benchmarks. They want to be very, very close to the benchmark. They want to understand what they are over weighting, what they are under weighting and in many instances many of those relative performance managers are as close to the benchmark weight as possible, because they don’t want to either be left out, if there is a rally in the market, and they don’t get a significant benefit by spending cash for those managers in the event of a decline.

Therefore, there is a natural tendency for a lot of inquiry and a lot of questions and potential interest in subscribing more to our equity index data. That obviously gets mitigated by the fact that sometimes the budgets are tight. So similarly in equity portfolio analytics in an environment like this there are a lot of organizations out there that want to understand what is happening with their portfolios on a quantitative basis, but again that gets mitigated and sometimes more than mitigated by the fact that it is a time easier to not spend money on quantitative tools for the grunt [ph] in the middle office.

Under the [manicorp] multi-asset class risk is strong in an environment like this because a lot of patient funds are lower and the managers want to understand what is happening in their total portfolio correlated to one another what the exposure to the value of the firm is or to the value of the portfolio in the case of a pension fund.

Sara Gubins - Merrill Lynch

I have one other question on the cost side. Your operating costs have been fairly flat on a sequential basis this year and I am wondering if that is a trend that we can see continue into the fourth quarter or if we just start to see the ramped up hiring move those costs up?

Michael Neborak

To the latter part of your question, in general you will see a progressive increase versus what you’ve seen year-to-date in terms of the percent changes that you’re referring to. I would say that what you’re seeing, in terms of the lower than you might otherwise expect growth in our expense base is due primarily to the movement of head count to emerging market centers.

Sara Gubins - Merrill Lynch

Can you give us an update on your plans to hire in 2009 and maybe talk about how many people you’re planning to add?

Henry Fernandez

Back in the summer we initially had a pretty robust plan to add head count in ’09, mostly in sales and product management and to alleviate certain bottlenecks that we have had on our data factory. A lot of those hires are planned to be in emerging market centers with the idea that we want to reach two objectives. One is to have fairly significant rates of investment in our business so we can either grow faster or mitigate a slow-down and then secondly preserve or enhance our EBITDA margins.

Clearly in the next few weeks and through the balance of the quarter we are going to reassess what the operating environment is to ensure that the scale of our operation and the scale of our head count is commensurate with the operating environment that we see day-to-day in our business.

We basically like to expand in environments like this, because it is a lot easier to find the people. You find a lot of talented people on a lower cost then would otherwise be the case and as you know, people are the main part of our business. So the bias would be to do more than less, but we for sure want to ensure that we scale the organization correctly and preserve or enhance our margin.

Operator

Your next question comes from [Wally Pow] - KBW.

[Wally Pow]- KBW

When I look at the run rate, I know you talked about the run rate revenues, when I look at the equity and this is a subscription business, the run rate revenue growth is expected to be 24%, just you know, it’s 24% loss over what you had in the last quarter and I’m just trying to understand, obviously the operating environment continued to get more challenging last quarter.

I am just trying to understand, you know given the challenging environment, revenue in run rate revenue growth is holding up pretty well and would you say that is a function of new managers, new money wanting to benchmark the portfolios as, Henry, you alluded to and not wanting to be left behind, or what is really kind of helping your run rates hold up at 24%?

Henry Fernandez

I think when equity index data subscriptions, I would say the 24% or even the 5% which annualized would be about 20%, 55% [ph] sequentially, which when annualized would about 20%, is higher than we can consistently do across cycles. We believe that equity index data subscriptions can grow in the high teens across cycles and I think what you’re seeing here is probably a spur of growth associated with the ripple effect of the introduction of a lot of new products within the global equity index, the global invest able marketable indices last year, that will probably continue for some time. That is one point.

The second point is that typically in a down market like this, clearly there is more need for this data in order to ensure that everyone in the investment organization of a client is following very closely the benchmarks and the weights of the benchmarks on controlling the risk of their portfolios, but as I said it gets mitigated by the budgets being pretty tight.

Consistently these entire down cycles we have seen that there is growth. There are new managers out there, but there is also growth within our existing managers for making the data available in more locations, more counting of the data to more users etc… But as I said, I think the run rate growth in the 20% to 24% is probably not sustainable. I would rather have you think that in the continuation of a market like this, it is probably mid-to-high teens.

[Wally Pow]- KBW

Also, when I look at the adjusted EBITDA margin that improved very nicely in the quarter and I would have thought in the ETF acid based revenues, that was kind of pressured given the environment, and my expectation was that’s probably a higher margin business and with that main pressure, I was kind of a little bit surprised at the EBITDA margin investment has been dead. Could you talk a little bit about that?

Henry Fernandez

There are two or three points there. Number one is that a lot of people do sell those ETF margins, incremental margins coming from ETF are very, very large and therefore they represent a meaningful part of EBITDA and we’ll say yes, that is absolutely right, but what is also right is that the incremental margin of a lot of our all in probe [ph] is also extremely high. You know incremental margin extremely high, so I am inputting the date on equity risk data that is probably in the high 80s or low 90s is the only cost is the cost of selling, right? So therefore that represents a significant part of EBITDA.

Therefore when people look at the margin, it is all a question of where do we attribute the cost of creating the equity in the data? Do you apply it to the extreme, do you apply it all to the ETFC and therefore the margins are a lot more or do you apply it all to the equity in the data. Right, so the vast majority of our business has incremental of our product has incremental margins very, very high there.

That is one concept. The second one is that what happens, what you see in an environment like this and why our margins have held back and in this case maybe the margin went up higher than our target is because you have a couple of things going on. One is we never planned to take a lot of the incremental margin and ETF into our investment plan. We don’t assume that that money will be here, we assume that that money will be there next year, but not this year, so it doesn’t affect our investment plans and therefore if it is a spur of ETFCs you hold it down to the margin and vice versa.

Secondly there is a huge amount of positive operating leverage in the business from the subscription business that I mentioned before and that has an upward pressure on EBITDA margin and number three, we are very disciplined in our cost management in all aspects of our business, non-compensation and in the case of compensation we purely have a target of growing most of our new head count in emerging market centers so that we can do a lot of investing with out a commensurate increase in cost.

[Wally Pow]- KBW

You previously mentioned what the ETS assets were at the end of September, but could you tell us what the flows were in September?

Michael Neborak

We don’t have that data available right here with us. It is quite an exercise to go through and to figure that out so that’s why we don’t have it.

[Wally Pow]- KBW

Okay and in terms of the equity portfolio analytics business you did see some cancellations in the quant managers and that kind of is reflected in the run rate kind of slowing down. I mean, where do you think that is in terms of playing out, the thing that the quant managers, we have seen some pressures in terms of the quant funds for a while now. Do you think that has kind of played itself out or do you think there is a little bit more to be played out on that front?

Henry Fernandez

I think there is clearly pressure on the quantitative portfolio managers, but remember also that the majority of our sales go to the quant office from the mid portfolio managers, not just the quantitative portfolio managers. So there is clearly pressure on budgets all around. I think we didn’t grow as fast maybe as some of our competitors in equity portfolio analytics for a variety of reasons. One we were short staffed in the area that was most acute in our sales organization, one in equity portfolio analytics.

Secondly we had told the market that we were working on a number of different models, including GEM2 and the European model and therefore that creates a tendency for customers to wait until the new model comes in before they subscribe to those.

Thirdly, in the case of equity portfolio analytics, I think about ¼ if I remember correctly of the revenues are in currencies older than the dollar, about ¼ in currencies older than the dollar and therefore when you have a rapid appreciation of the dollar like we saw in August, which actually was reversed in September, but we saw it in August, that impacts the net run rate that you see in the numbers here. So we are hoping that, obviously things may get a bit worse before they get better given the environment, but we are hoping that some mediation to the continents [ph] of the run rate on equity analytics will come from, we are now focused on putting a lot more sales people on this category and there is money to be had there that we are leaving on the table.

Secondly, we did launch the global equity model and we are launching a number of other models in the next few quarters, so that may mitigate some of that impact. There is nothing we can do about the foreign exchange rate, right, that goes up and down and the benefits you adhere to depending on which way it goes.

[Wally Pow]- KBW

Lastly, with the stock trading at the levels it’s staying in right now, any thoughts on share repurchases?

Michael Neborak

That’s a great point. Under our credit facility we are not permitted at the present time to do share repurchases. Also the other, which will go away, while mortgage innings [ph] in our capital structure, we are also not doing any share repurchases, but it’s really limited right now by our credit facility.

Operator

Your next question comes from John Neff - William Blair.

John Neff - William Blair

The asset based revenue was a little better than expected this quarter despite a lower average daily ETF level than we had calculated and I remember last quarter some of the weakness, despite better than expected average, was due to things like index replicating on some assets there. Can you talk about some of the other moving parts besides ETF that contributed to the asset-based revenue?

Henry Fernandez

What happens is, you always keep in mind is that exchange credit funds are on a secular growth even within in a cyclical downturn and therefore contrary to a lot of equity mutual funds in the United States that have been meaningful redemptions, you won’t necessarily see a significantly meaningful amount of out flows in equity administrative funds across the world. We attribute that to the fact that there is an underlying set of demand for these products that is secular that is not going away.

But you see that most of the impact is the asset deprecation. There are outlooks of course, but the asset depreciation is in the probe.

Secondly, as I said before, in turmoil markets like this one, a lot of people want to exactly replicate the benchmark; they don’t want to be making a lot of bets one way or the other, it is actually bar bets. Some people end up being a stock market of people calling and either being cash or just in a concentrated portfolio that they know well that is defensive or alternatively they just want to know exactly what is in there portfolio and they make their own decision separately as to whether to put things in cash or not. So these ETFs are very, very good ways to do that.

Another aspect is that ETFs are used for over lay strategies by people and that helps as well to go long or short. As far as I know many of these ETFs are not part of any of the shortly [ph] that are anywhere in the world, so that is a component.

Another thing that is more specific to us is that we are launching products out there and in the past we have said that new products, the assets accumulated in new products and therefore the revenue coming from that in a rapidly escalating market like last year, they were not a meaningful part of our revenue. But, if you had declines in existing products and you are introducing new products, those revenues do help mitigate the downturn in assets and in revenues.

We are seeing some of our closest ETF sponsors or managers taking this market down turn as an opportunity to be more aggressive in launching products and gaining market share as the markets recover and therefore we are likely to see more and more EFT launches in the coming quarters.

John Neff - William Blair

Again sort of picking up on the notion of how flat the cash operating expenses have been sequentially, the question is what are you cutting expense wise as you are adding head count? Is the reason for the flatness in the cash operating expenses due to the lower cost to replicate the Morgan Stanley services as you move those in house? How should we think about that?

Michael Neborak

I think a lot of it is we have had a number of head count reductions in rather considered to be developed market centers that we haven’t replaced and we’ve not replaced that headcount or if we have replaced the head count it’s been two merging market centers, so there is a lower cost. So that mitigates against having higher cash expense growth. So I think I would attribute it to that as well as just really tight, tight, management around our expenses, especially in a non compensation area where we are very diligent constantly in terms of keeping those costs low in terms of travel and items like that that really make a difference.

John Neff - William Blair

The FX loss in the quarter of $3 million due mainly to changes in the non-US dollar cash balances. Why is that simply not a balance sheet item?

Michael Neborak

Because basically that takes place at a level, you mean balance sheet item in terms of otherwise being recorded into other [interposing].

John Neff - William Blair

Yes why doesn’t it simply affect the dollar value of the cash balance as opposed to being run through the P&L?

Michael Neborak

Because those cash balances are held in non-US subsidiary’s so it’s in a level of our functional currency. So when that originating currency and functional currency are kind of valued at the end of the quarter that goes through the P&L. What won’t go through the P&L is when we convert functional currency like our UK company up to the US company, that basically will go through OCI, so it is a little bit complicated.

We have a triple ledger system, so we have originating currency, a functional currency, and then a reporting currency. When you go from origination currency to functional currency, that difference there at the end of the balance sheet period goes to the P&L and to other operating income and then from a functional currency up to reporting currency. So the UK company converted up to reported currency was US dollars, that difference there will go into other comprehensive income, but the balance sheet item does not go through the P&L.

John Neff - William Blair

Is there a way to just sort of think about our rule of thumb in terms of say a 10% appreciation in the US dollar versus the basket of currencies you are dealing with? What does that do, how should we think about that in terms of impact on the P&L?

Michael Neborak

The largest component, we had at the end of August about the equivalent of $60 million US dollars in non-dollar currencies; that is a mix between the pound, which is probably the largest component there and the yen and then the euro. So for example of that $60 million at the end of August, probably $30, $35 million was in pounds. So you could think about it in that context.

Then I will also say that there are other monetary assets that are on the balance sheet of the functional currency companies down below, for example receivables and payables between the companies, that could also impact it, but it is basically our non-cash balances which, as I mentioned, at the end of August our non-US dollar cash balances were about $50 million.

John Neff - William Blair

Then the $7.8 million in Morgan Stanley replacement costs, how much of that, or if any, is one time?

Michael Neborak

Of that $2.3 million, $2.4 million, is one time, $2.3 is one time.

John Neff - William Blair

You talked about 100 new hires during the quarter. How many of those are in sales and what is the total coverage head count at this point versus last quarter or a year ago?

Henry Fernandez

The action that we took in early June was to alleviate the acute pay of shortage of stock in the company and therefore the effective of sales and products in the light, we authorized the hiring of 100 people in the ensuing six to twelve months from June of this year.

Secondly, on a net basis, almost all of those 100 people will be hiring emergent market senators. What that means is that there are some that are in developed markets for sure, but when there is attrition in the developed markets we will be moving some of those functions to emergent markets. So that is what, 100 on a net basis is mostly in emergent market centers.

The other more direct answer to your question is about 40 to 50 of those people will go in what we call the client organization which are about half of those will be sales and the other half will be client support. So if you think about in orders of magnitude of 100 people, 25 going to sales, another 25 going into sales support functions to support the maintenance of run rate and a new sales for client but without paying ¼ carrying sales people and the other 50 or so out of the 100 will go into product management functions that are going to obviously support the sales effort; the bulk of those 50 will go into production functions, which is our beta factory and the IT infrastructure to support the data factory in order to break down some of the bottleneck that has prevented us, in the past, from speeding up new product introductions.

John Neff - William Blair

Can you talk a little bit about acquisitions? Is it a good opportunity to be looking at acquisitions and can you discuss your ability to pursue acquisitions as long as Morgan Stanley owns a big portion of your stock?

Henry Fernandez

We continuously review acquisitions. In an environment like this we will tend to think that acquisitions are more practical in evaluation perspectives, but there is also a lot less liquidity, a lot less flow of companies, because they are waiting to see if the markets will go down, the evaluations will go down and stay there or whether there is a recuperation of the value lost and so there is not a lot of liquidity. We continuously look at it.

I think any large acquisition for equity or debt is not likely while Morgan Stanley is in the capital structure because they will not want to be diluted and they may not want to pay for the discount that is typically associated in the stock in an acquisition when you are paying a premium for the target.

So, if we do anything at this point it will likely be in a forecast in a smaller way. Again, that is just a guideline. If something comes up that is very attractive, we should really have we will be talking to Morgan Stanley to see if we can get done.

Operator

Your final question comes from Michael Weisberg - ING.

Michael Weisberg – ING

The $3 million on the balance sheet related charge, is that a pre-tax charge?

Michael Neborak

That’s pre-tax yes.

Michael Weisberg – ING

When you talk about all the new hires, you mention that ex the Morgan Stanley’s transition, your expenses were running up about 7%, I think you said, year-to-year in the third quarter?

Michael Neborak

I said ex if you take out the founders grant, you take out the transition expenses that we’re incurring and then you eliminate the allocation for Morgan Stanley from both the third quarter 2008 and the third quarter of 2007 then you get about 7% expense growth.

Michael Weisberg – ING

With the announced hiring of, which you’re in transition of of 100 people, is that going to cause that number to go up as we move into ’09 or not? Or can you maintain it where it was?

Henry Fernandez

We guesstimate as we are hiring these people, remember these people are max, you know max 100 in emergent market sensors. Some in developed markets and some relocation of functions based on attrition to emergent market, the compensation expense of that is say $10 to $12 million run rate that will start running through the P&L just before hire, which is a very modest investment in our minds given the profitability of the business and the expanding margins of the business.

You know when you hear a company of 700 people hiring 100 people all in arms, bells go off that, that is going to have a significant and material impact on costs and the margins are going to go down and the light. Based on the comment that I just made our goal right now, as far as we can see, is to maintain the margin in the business that we have been accustomed to for as long as we can. Now if the environment over a year period turns extremely negative, we will be talking to all of you about whether that is maintainable or not, but that is the intent.

Our goal is to make significant investments in the business, which typically means people, to do it in a way that it is very cost effective, and maintain and enhance the margins of the business.

Michael Weisberg – ING

You mentioned the high growth in the equity index business. It is now 20%, in the 20% growth range is not sustainable. You also mentioned new products. Is recognizing it’s a mid high-teens growth business longer term, is that 20% plus kind of growth sustainable as we move into 2009?

Henry Fernandez

As we move into 2009 I would, as I said before, I would be more comfortable in the equity index data subscription to be in the high-teens, not in the 20% to 25% category. Based on what we know today, again, we are in uncertain markets, so if you extrapolate the last five days or two weeks and assume that all of our money is going to be like this, we will be talking about maybe being more realistic about those growth rates right? And assuming some return to normalcy, meaning like the summer, not assuming a major conflagration here the equity markets, we feel pretty comfortable that those equity index data subscriptions can grow in the mid to high-teens.

Operator

There are no further calls.

Henry Fernandez

Thank you again for participating. As we said we have very record results here and we have work to do to make sure that our run rate goes back to a level that is more commensurate to what we’ve been accustomed to and we are doing everything we can to do that; we will be updating everyone as we go through that.

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