MSCI's (MSCI) CEO Henry Fernandez on Q1 2016 Results - Earnings Call Transcript

| About: MSCI, Inc. (MSCI)

Msci Inc. (NYSE:MSCI)

Q1 2016 Results Earnings Conference Call

April 28, 2016 11:00 AM ET


Stephen Davidson - Head, IR

Henry Fernandez - Chairman & CEO

Bob Qutub - CFO

Rich Napolitano - Principal Accounting Officer

Kathleen Winters - New CFO

Andy Wichmann - Head, Strategy, Corporate Development & FP&A


Alex Kramm - UBS

Chris Shutler - William Blair

Hugh Miller - Macquarie Capital

Toni Kaplan - Morgan Stanley

Joseph Foresi - Cantor Fitzgerald Securities

Warren Gardiner - Evercore ISI

Keith Housum - Northcoast Research

Vincent Hung - Autonomous Research


Good day, ladies and gentlemen, and welcome to the MSCI First Quarter 2016 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 will now turn the call over to Mr. Stephen Davidson, Head of Investor Relations. You may begin.

Stephen Davidson

Thank you, Kevin. Good day and welcome to the MSCI First Quarter 2016 Earnings Conference Call. Earlier this morning, we issued a press release announcing our results for the quarter. A copy of the release and the slide presentation that we have prepared for this call may be viewed at 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 were made and are governed by the language on the second slide of today's presentation. For a discussion of additional risks and uncertainties, please see the Risk Factors on 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 to 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 28 to 32 of the earnings presentation.

On the call today are Henry Fernandez, Chief Executive Officer; Bob Qutub, Chief Financial Officer and Rich Napolitano, Principal Accounting Officer. With that, let me now turn the call over to Mr. Henry Fernandez. Henry?

Henry Fernandez

Thanks, Steve and thanks everyone for joining us this morning. Before I going into prepared remarks, a couple of programing notes. This was supposed to be Bob Qutub's last earnings call, but unfortunately he has developed severe back issues. So he's not able to deliver his prepared remarks, but Bob is joining on us on the line. Bob?

Bob Qutub

Thanks Henry. I can say I've never had back issues in my life and I'll tell you what, I hope I never have them again. But I really wanted be on this final call and say thanks for the opportunity to work with all of you on the call. It's been an honor to be a part of this fantastic journey that MSCI is on and I'm really looking forward to the following successes to come. I'll miss the team at MSCI but I'll tell you what, I'm really looking forward to spending more time with my family, without the back pain I hope. Henry?

A - Henry Fernandez

Thanks, Bob and continued best wishes for recovery on a speedy basis. Given Bob's painful injury, Rich Napolitano, our Principle Accounting Officer, will deliver Bob's prepared remarks. For the Q&A session, we'll have Rich and our colleague, Andy Wichmann, who heads up our Corporate Development and Financial Planning and Analysis Group. I will leverage on both of them in responding to your questions, and if there are any specific questions for Bob, he will continue to be on the phone line.

As all of you know, Bob announced his retirement several months ago, and since then, we have been in the process of recruiting his successor. I would like to thank Bob for his many contributions to MSCI during what was a period of tremendous growth and change for the Company. After a successful conclusion to this process, I am pleased to introduce Kathleen Winters, who will be joining MSCI as our new CFO officially this Monday, May 2. The press release went out last night, and I thought it would be great to introduce Kathleen, who's here with us this morning to this important group and have her say a few words. Kathleen?

Kathleen Winters

Thanks, Henry. This is a very exciting time for MSCI as the firm continues to expand and grow its products. I look forward to joining the firm's leadership team Monday, and I look forward to meeting and working with all of you on the call as well. Thank you.

Henry Fernandez

Thanks, Kathleen, and welcome aboard. Hopefully, another fantastic journey like the one Bob had. Let us now turn to the results. I am pleased to share with you our first quarter 2016 financial results, that build on the strong momentum we established coming out of 2015. In my opening remarks, I will walk you through how we executed our strategy in the first quarter, which resulted in growing revenues, making us more operationally efficient and optimizing our capital base. I will provide a strategic update on each of our product segments and provide you with a sense of where we are in the cycle of investing for growth and profitability. Then given the market volatility we saw during the quarter, I will highlight how we are leveraging our research enhanced content at MSCI to create new analytic services that help our clients manage their portfolios through volatile times. I will walk you through a couple of slides that show the resiliency of our recurring subscription revenues and the resiliency of inflows into ETFs linked to MSCI indices. I will then conclude my remarks with an update on our capital return efforts and the underpinnings of our capital allocation strategy.

Let's turn to Slide 3 for a review of our financial results; a 6% increase in revenue, driven by double-digit growth in Index recurring subscriptions and accompanied by a 6% decline in adjusted EBITDA expenses, drove a 24% increase in adjusted EBITDA. These strong operating results, combined with a lower effective tax rate and a large number of share repurchases drove a 36% increase in adjusted EPS.

First, let's talk a little bit about revenue growth. Our top line growth was dampened by the market volatility in the quarter, which led obviously to a decline in equity values, and therefore AUMs of ETF linked to MSCI indices. It also dampened -- the top line growth was also dampened by the timing of revenues in our Analytics product line, which we expect to be mitigated in the coming quarters. We are continuing to invest and innovate across MSCI by leveraging the research enhanced content we have, and creating new ones that we can leverage to create new products and services and incremental layers of revenue growth.

Turning to operational efficiency, we are relentless in our focus on ensuring that our cost base is right-sized and aligned with the most attractive investment opportunities. We are gaining greater visibility and insight into the drivers of our cost base through our new segment reporting, our new activity costs and a large number of new operating and financial metrics that we are developing.

For example, we're working hard to further break down our regional profitability, and we're looking to analyze our sales to gain insight into client profitability and client behavior. One of the byproducts of this initiative will be a more granular view, for example of pricing or price increases and volume in our sales. As a result of these efforts so far, on the new initiatives, we believe that we're well positioned to achieve incremental operational efficiencies, while at the same time, maximizing growth.

Our tax planning work is on track to deliver further improvement in our operating tax rate in the quarters ahead. Finally, in terms of capital optimization, we took advantage of the significant volatility in our stock price in the quarter to repurchase 4.9 million shares at an average price of $68.45 for an aggregate amount of $333 million.

On Slide 4, we show how we delivered in the first quarter against our areas of focus in 2016. In our Index product segment, we are hitting on all cylinders, with strong execution against all the key opportunities in 2016. The one area where the metrics were not favorable was the equity market, which was obviously out of our control, but it has since recovered, since the volatility in the first quarter.

In Analytics, we're launching new products and services and we are keenly focusing on profitability, while at the same time continuing to invest for growth. Price increases in the Analytics product line are having a positive impact on sales. At the same time, our retention rates are quite strong at 95%.

Lastly, in our All Other segment, in ESG in particular, a strong 20% plus revenue growth continues to be driven by the integration of ESG into the investment processes of mainstream asset managers. And in real estate, the work that we have done so far over the past few quarters is improving the performance of this product line with the transformation of the products and services and the launch of a new real estate analytics forum.

On slide 5, we highlight where we are in terms of the cycle of investing for growth versus profitability. As our overall operating profit margins have expanded due to continued solid revenue growth and improved profitability in Analytics, we are continuing to invest and innovate to drive future growth. Our long-term targets for the Company and each of the segments reflect a balanced level of investment that allow us to continue to innovate and sell our products and services and at the same time, continue to deliver higher profitability to our shareholders. While we'll increase investment for the remainder of 2016 relative to the quarterly run rate of the first quarter, we're also focused on profitability as reflected in the lowering of our full-year 2016 adjusted EBITDA expense range.

On Slide 6, we highlight just one example here of how we are innovating in Analytics to help our clients manage their portfolios through volatile times and market dislocations. We are continuing to address this client problem by generating research, models, mythologies that helps our clients think through the solutions to this problem that they are facing. Then we take this research and the accompanying models and mythologies and commercializing it by creating new services like, for example, the macroeconomic stress testing that we launched in the quarter which lets our client stress test their portfolios for events like a Fed tightening or a China slowdown or a downdraft in commodity prices, et cetera. It is because of innovations like this that MSCI was awarded Best Sell-Side Market Risk Product for RiskManager in the 2016 Waters Technology Awards.

Please turn to Slide 7, where we highlight the resiliency of our recurring subscription model. We did build some analysis here to help you think through this and the conclusion that we've reached is that the larger our clients get in terms of run rate with us, the secure they get. So when we gone through periods of significant volatility, we would expect high retention from our larger clients, which is the majority of our run rate and lower retention sometimes from the smaller clients that make up say less than 10% of our overall subscription run rate. Not a bad position to be in and of course, as we develop and deepen our penetration with the larger clients, hopefully, this virtuous circle will continue.

The challenging start to 2016 dampened the growth rate of our asset based fees as highlighted on Slide 8 by the daily progression of ETF AUMs linked to MSCI indices. As this slide shows, it is the journey that counts, not the beginning point or the end point. Our revenues from the indices we licensed to ETF providers are based on the average of daily AUM over the course of each quarter. This chart illustrates how the daily AUM levels compared to the average of those daily AUM levels during the quarter -- during Q1 and through all the way to April 26.

Due to the significant decline and subsequent recovery of daily AUM during the quarter, the average daily AUM for Q1 is lower -- meaningfully lower than the starting level and the end level. Fortunately, given the recovery of the equity markets and the continued inflow into ETF linked to MSCI indices, in Q2 so far, our average daily AUM level is up significantly compared to Q1.

On Slide 9, we highlight the resiliency of these inflows into ETFs linked to MSCI indices. We've done another amount of sharp work here to understand the behavior of this. Growth in revenue from the indices that we licensed to the ETF providers have been pretty resilient in periods of marketing decline because ETFs linked to MSCI indices have consistently capture positive cash flows, and the magnitude of those Cash flows has far outweighed the negative impact from market declines.

This chart illustrates the impact that cash flows and market movements on AUM in those ETFs linked to MSCI indices since 2012 and through the first quarter of 2016. ETFs linked to MSCI indices have captured positive cash flows in 15 out of the 17 quarters since 2012, including five out of the seven quarters when the impact from market movement was negative and in some cases, rather negative.

As measured by dollars, the net impact from cash flows was 15 times greater than the net impact from market movement since 2012 or about $221 billion compared to $15 billion. This strong trend can be attributed to the overall growth, secular growth of the equity ETF market combined with the strength of our indices, our brand, our client support, our relationship with ETF providers and of course, the investment pattern of our clients.

On slide 10, we have an update on our capital return efforts. Now that we have paid incentive compensation and taxes in the first quarter and excluding the upcoming dividend, we have approximately $200 million in excess cash. We have delivered on our commitment to not store excess capital and as our cash balances have declined to more normal operating levels, we now have even more flexibility to be more opportunistic and discerning with our share repurchases. We expect to repurchase more shares on lower prices and less at higher prices, as we have done before with a little more discerning to that effect.

Capital deployment is a dynamic process that is constantly being evaluated with our Board against various competing users. As we begin to explore the possibility of adding incremental leverage, given our natural de-leveraging as we grow, and given our target of gross leverage of 3.0 times to 3.5 times, we want to ensure that we maximize every dollar deployed and that we get an approximate return -- an appropriate return and a high return for our shareholders on those dollars, all of which way above our cost of capital.

Given all of this, please turn to slide 11, where we try to highlight the hierarchy of uses of capital that support our capital allocation framework. Our first dollar typically goes to a high return organic investment, followed by some inorganic investment if they exist, principally small bolt-on acquisitions if they provide high returns. Next, we look at returning capital to our shareholders through the most efficient and accretive method and lastly, we examine a time to repayment of debt if necessary or if appropriate given the cycles. Our Board of Directors is keenly focused on this capital allocation framework to ensure we achieve the highest return on our capital and equally the most optimal amount of capital base to support our business.

So, with all of that, I like to now pass it on to Rich Napolitano, who'll be stepping in for Bob.

Rich Napolitano

Thank you, Henry. Please turn to slide 13, where I will begin my overview of our financial results. Our results this quarter were solid, with a 6% increase in revenue and a 6% decline in adjusted EBITDA expenses, driving a 24% increase in adjusted EBITDA and 680 basis point increase in our adjusted EBITDA margin of 47.8%.

Again, as a reminder, in the slides that follow, we provide the impact of foreign currency fluctuation on our subscription revenue and cost, but we do not provide the impact of foreign currency fluctuations on our asset based [indiscernible] average AUM of which approximately two-thirds are invested in securities denominated in currencies other than the U.S. dollar.

On Slide 14, we showed a positive impact on our adjusted EPS from the various levers we're pulling to create value for our shareholders. Adjusted EPS increased $0.18 or 36% compared to the first quarter 2015. First, in terms of core growth, our subscription revenues coupled with more muted ETF revenue growth as a result of the decline in equity values at the beginning of 2016 benefited EPS by $0.10 per share.

Turning to operational efficiency, strong expense management and a lower effective tax rate contributed $0.05 per share. In terms of capital, the adjusted EPS benefit from share repurchases was partially offset by higher net interest expense but resulted in accretion of $0.02 per share. And lastly, FX contributed about $0.02 to adjusted EPS, again, excluding the impact of FX on our AUM.

On Slide 15, we provide you with a bridge for the year-over-year change in our revenues by segment and by revenue type. Total revenues increased $16 million or 6% to $279 million year-over-year, driven by an increase of $13 million or 6% in recurring subscription revenues principally due to a 10% increase in index recurring subscription revenue and an increase of $3 million or 6% in asset-based fees. Currency fluctuations had a negligible impact on the recurring subscription revenues.

Turning to Slide 16, we provide you with the year-over-year adjusted EBITDA expense bridge. Overall, the combination of a 5% reduction in headcount, a $3 million non-cash charge in the prior year and strong expense management drove the year-over-year decline in our adjusted EBITDA expenses. First quarter adjusted EBITDA expenses increased $9 million or 6% to $146 million and decreased slightly compared to the fourth quarter 2015. Excluding a $4 million benefit from foreign currency exchange fluctuations, our adjusted EBITDA expenses would have increased $6 million or 4% year-over-year.

As shown in the upper chart, the non-cash charge in the prior year was a significant driver of the year-over-year decline and is reflected in lower research and development cost which we have shown in the lower chart. While total research and development costs was down, we continue to invest in areas to support our growth strategy. The $7 million decline in cost of revenues was broad-based across client service and consultant, technology, data services, product management and research functions. On a linked quarter basis, costs were relatively flat as a reduction in technology related professional fees, stock-based compensation and severance mostly offset first quarter seasonal increases in compensation and benefits.

On Slide 17, we provide you the run rate bridge for the quarter. Our reported run rate increased 8% to $1.1 billion, consisting of a 9% increase in subscription run rate to $913 million, and a 5% increase in ABF run rate to $199 million. Over the past two quarters, we've been encouraged by the higher levels of new recurring subscription sales as well as higher non-recurring sales, which has generated significantly higher levels of gross sales.

Strong recurring subscription sales, combined with lower cancels resulted in net new recurring sales of $20 million in the quarter, which is the highest level since 2009. Our aggregate retention rate was a record 95% across MSCI in the quarter. While it is too early to call a change in the trend, we believe that many of our sales initiatives are beginning to take hold. So we are cautiously optimistic in the outlook.

On Slides 18 through 22, I will walk you through our segment results. Let's begin with the Index segments on Slide 18. Revenues for Index increased 8% on a reported basis. The double-digit increase in recurring subscription revenue in the quarter was driven by strong double-digit growth in revenue from developed and emerging markets small cap modules and from our innovative custom, factor, thematic and ESG-based products.

The adjusted margin -- EBITDA margin for Index was 69% compared to 70% in the prior year, and 69% in the fourth quarter, which was in line with the guidance we provided on the fourth quarter earnings conference call. The decline in margin year-over-year was driven by higher research and development, selling and marketing, as well as general and administrative costs. Index recurring subscription sales increased 14%, driven by strong core benchmarking products. Cancels were in line with our expectations, and we recorded very strong retention of 96%, just below the record 97% we set in the prior year.

On Slide 19, we provide you with our leadership position as an index provider to the ETF market in the first quarter. On Slide 20, we provide you with detail around our asset based fees. Challenging market conditions early in the quarter dampened the growth of average ETF AUM linked to our indices, but this headwind reversed by the end of March, and we ended the quarter at $438 billion in AUM with inflows of $7 billion in the quarter, which we show in the upper right chart.

Turning to the upper left chart, overall asset-based fee revenue increased $3 million or 6% driven by a $2 million or 20% increase in institutional passive revenue, as well as a $500,000 increase in revenue and a 47% increase in exchange traded future and option contracts based on our indices. Average AUM and ETFs linked to our indices increased $15 billion year-over-year or 4% but that increase was offset by a 4% decline in the average basis point fee as indicated in the lower right chart.

The decline in the average basis point fee year-over-year was driven by mix due to the movement away from higher emerging market products to lower fee developed market products, including the U.S., which we show on the lower left chart, as well as a product mix within the developed market funds to lower fee products.

On a linked-quarter, asset-based fee revenue declined approximately $2 million or 3% driven by a $2 million or 5% decline in ETF revenue. This was partially offset by modestly higher revenue from institutional passive and exchange traded future and options linked to our indices. Subsequent to quarter-end and as of April 26, AUM and ETFs linked to our MSCI indices have increased to $450 billion on inflows of $3 billion and market appreciation of $9 billion, which brings the second quarter to date average to $441 billion for AUM. We have continued to see strong inflows into high shares MSCI USA minimum volatility.

On Slide 21, we highlight the financials in the Analytics segment. Revenues for Analytics increased 3% on a reported basis and adjusted EBITDA margin increased to 28% compared to 13% from the prior year quarter. The increase in revenue was primarily driven by higher RiskManager, equity models, WealthBench, and InvestorForce products.

While revenue grew 3%, run rate grew 7% year-over-year with the divergence reflecting when sales were booked and recorded in run rate versus when recognizing in revenue. This divergence between revenue and run rate should close in the quarters ahead. The dramatic increase in margin year-over-year was driven by a 14% decrease in adjusted EBITDA expenses as the product area continues to transform and improve profitability, while at the same time investing in future growth opportunities.

The margin was higher than guided on the fourth quarter call due to decreases in non-compensation expenses, which more than offset seasonal increases in compensation and benefits. While new recurring sales were soft during the quarter, driven by lower RiskManager and equity model sales, lower cancels more than offset the decline in recurring sales and retention increased to 95%, up from 93% in the prior year.

And lastly, for our segments, turning to Slide 22, we have the all other segment. Revenues for all other increased 7% to $24 million on a reported basis and grew 9% on an FX adjusted basis and adjusted EBITDA margin turned positive at 11%. First, in terms of ESG, $2 million or 21% increase in ESG revenue to $11 million was due to strong sales, driven by the increasing integration of ESG into our investment process, as Henry has mentioned, with approximately 40% of the sales coming from new clients. Run rate growth of 22% was driven primarily by growth in ESG ratings, with particularly strong growth in ESG ratings in the Americas, which grew 39%.

Turning to real estate, a tough year-over-year comparison due to the early delivery of our PAS flagship reports in the prior year, partially was offset by higher market information, product revenue in the current quarter, resulting in a slight decline in revenue to $13 million. Excluding the impact of FX, real estate revenue would have increased 1%, compared to the first quarter last year. In the quarters ahead, we anticipate that the performance of real estate should continue to improve, reflecting our restructuring effort and the launch of our real estate analytics portal.

On slide 23, we provide our key balance sheet indicators. We ended the quarter with cash and cash equivalents of $445 million which includes $126 million in cash held outside the United States and a domestic cash cushion of approximately a $125 million to $150 million, which as a general policy, we maintain for operational purposes. Free cash flow in the quarter of $28 million was below prior year levels due to the timing of collections and higher interest payments and the decline compared to the fourth quarter was primarily due to the seasonal payment of our annual incentive compensation and bonus.

On Slide 24, we highlight the progression of our full year 2016 adjusted EBTIDA expense range. We now expect full-year adjusted EBITDA expenses to come in between $600 million and $615 million, down from a range of $610 million to $625 million. $3 million of that $10 million decline in the range was due to positive currency moves, but $7 million is from savings from general expense management and corporate efficiency efforts.

We expect that higher adjusted EBITDA expenses, principally from technology related professional fees and information technology costs will flow through in the back half of 2016. With the introduction of our segments and activity costing, we are beginning to acquire better visibility into our expense base, and opportunities to become more efficient are being identified.

On Slide 25, we'd like to reiterate our guidance for full-year 2016, with the only change being our full-year adjusted EBITDA expense range, which I just discussed. Lastly, we continue to work hard toward our long-term targets, and with that, we'd like to open up the line for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Alex Kramm with UBS.

Alex Kramm

Wanted to talk about the sales, and in particular, as it relates to pricing, I think in the last quarter, you alluded to the fact that in particular on the risk side, you were starting to take pricing for the first time in a while. Meanwhile, though the environment has certainly gotten a lot tougher, right? So just wondering how those pricing discussions have gone. If you're seeing some of the impact already reflected here, or if there is more to come and obviously, how much push back you're getting from [indiscernible]

Henry Fernandez

Yes, so definitely, we're on a journey to better match the pricing of our Analytics product line to the value that we believe we're providing to our clients and we've rolled out price increases pretty much across the board. Those discussions are going relatively well. Obviously, nobody wants to pay more for things and therefore, there's always an element of that but they're going pretty well. We're making sure they go through and we're discussing with our clients and there is no -- we don't identify any fear or cancels at this point because of that and people are beginning to understand that we got to invest in the product line, we got to do more things and we got to become more profitable as well. So, they're going well and there is a little of that being reflected with first quarter. I will say maybe 20% to 25% of the sales in the quarter are price increases at this point and we are going to continue to see that going through throughout the year.

Alex Kramm

Great. That's helpful. Thank you. And then just secondly, on the tax rate, you talked about continued efforts to bring that down. Can you just give us an update where you stand on that and maybe as part of the answer, there obviously has been some new guidance recently from the Treasury Department around all the earnings stripping and things like that, that's going on. Is that going to hinder some of your journey there or you think you can still bring that tax rate down materially with maybe some of the new rules here?

Rich Napolitano

We are looking very closely at the new rules that are being proposed. At this point, we are still standing firm with our guidance of 33% and 34% in our plant for this year, but at this point, we don't see this is going to materially change our goals.

Alex Kramm

But in terms of goals longer term, any -- I think you've done a ton of work for where you could go over the next couple of years. Is that going to change anything or too early to tell?

Henry Fernandez

Well, I think at the point now, we definitely would expect a gradual decline in the tax rate as we continue to do the work and execute on it. We've gone through a progression of a -- we have initially a cost plus model. We executed at the end of last year a process in which we're shifting the profits to better represent where the activity is being performed across the world, and that has benefited us so far.

Ultimately, we want to go something that is called principal-hub model, and that is probably at this point not going to be implemented until the end of this year, and that would help us lower the tax rate further. That's what we're looking to do and obviously, operationally, it's quite a lot of work to achieve all of that and the current set of regulations by the Treasury doesn't seem to affect us at all, but you never know when new things get thrown at us by any one of the taxing authorities around the world.


Our next question comes from Chris Shutler with William Blair.

Chris Shutler

On Slide 5, guys, that's where you're talking about striking the right balance and investing in margin with Q1 being tactical. So just curious on -- in the back half of the year, where will spending go up and can you be a little bit more specific, I think you mentioned professional IT costs, but what exactly will you be spending on that would drive expenses higher? And will it be offset by other things that you have in the works?

Henry Fernandez

Well, the first quarter was a tad unusual in which when you see the average $145.7 million here, because we started the year with a lot of our budget and lot of our plans for continued investments and balancing out profitability versus investments. Now during the volatility that took place in the market, at some point in the quarter, we decided to slow down certain investments because we didn't know like most people whether we were in a bear market -- the beginnings of a bear market or whether it was just a nasty correction and we didn't want to be stranded with a lot of high cost if it was a protracted bear market for the balance of 2016.

So we slowed down a few things. Some of them, for example, in the Index coverage efforts and things like that. So now that the market has recovered, we want to step up a little bit of that but within the target of profitability that we talked about. None of this is in any way, shape or form to dampen significantly or meaningfully our profit margins that we have for the year, but some of that needs to come back up. So there'll be investments in coverage, sales people, client service, consultant. There will be investment in the back-end in technology. If you see, for example, capital expenditures, the average in the quarter was low. We need to step that up in order to achieve the targets we wanted to achieve. There are similar -- there have been similar declines in operating expenses in technology that we need to get back on track, but again, I want to emphasize that this back-end -- and none of that will necessarily happen in the second quarter by the way. Second quarter may end up being not largely dissimilar to the first quarter, but we got to step it up at some point in order to continue to invest for future growth in the Company in product management, in some of the technology efforts and in data efforts and in coverage.

Chris Shutler

Okay, thanks. And then a question on fixed income capabilities and within kind of the old -- what used to be the old RMA and also Index, I think the thought for a while used to be that MSCI was a likely acquirer to build up your fixed income capabilities. Obviously, that hasn't transpired. So maybe just talk about your efforts to build out a more comprehensive fixed income offering as part of the multi-asset class solutions you're offering, and is that as important a goal today as it was a couple years ago for MSCI?

Henry Fernandez

I think it's more important today than it was in the past. Underneath some of this efforts that you see in Analytics -- in the Analytics product line, there is a meaningful amount of investment that is going on, on both -- the new architecture and interface that we've talked about, which we continue to develop and showcase it with clients. We haven't started really selling it, but we're beta testing it and things like that.

And importantly, a meaningful amount of investment in fixed income analytics, both for multi-asset class risk, performance and for portfolio management in fixed income -- in purely fixed income portfolios, we spend an inordinate amount of time since December in consultations with key clients around the world. I think we've done 50 or so consultations, as to what they would like to see in fixed income portfolio management and analytics, in our offering and therefore what investments we should do. So that continues -- the way we have funded that has been by a relentless effort through look and re-look, and re-look at the cost base of analytics, and the prioritizing were longer-term and maybe they have a [indiscernible] by reassigning and reallocating and creating efficiencies, and the like in order to make room for these two meaningful investments in the product line, which is the newer technology platform, the new software platform that we'll overlay on top of RiskManager and BarraOne and TTM [ph] and secondly, the newer initiative is fixed income analytics, and we are heavily invested in that area in the context of these financials. So I think the team in the average phones has done a marvelous job of trying to keep sales high if we can, retentions high, hammering and hammering at the cost structure and making room for investments, while we keep increased profit margin.

Chris Shutler

Last one, quick one. Henry, you called out earlier kind of rough 20% to 25% of sales or price increases. Is that specific to analytics or the business overall and could you compare that to a year ago?

Henry Fernandez

Yes, look, that is roughly -- it's all Analytics. That comment was all on Analytics across the board. We no longer make a distinction; the old distinction that we have between RMA and PMA and all that, because we're trying to comingle all of it into a front to back offering of portfolio management and risk management. So, it's all analytics across. As you may remember, we had started taking steps to increase prices in portfolio management analytics, equity portfolio management analytics a couple of years ago and we continued a bit last year on a smaller run rate of the overall PMA product line.

What we're now attacking in a big way is what is the right pricing which has led to price increases versus the value of the multi-asset class portfolio analytics, and therefore RiskManager and BarraOne, managed services and all of that, and that's what we are rolling out and that was the comments I made at the beginning of the Q&A, of course.

Chris Shutler

How did 20% to 25% compare to a year ago in the analytic segment? So if you're at $12.4 million of recurring sales this is the first quarter, $13.5 million last first quarter?

Henry Fernandez

No, it's much higher, much higher than first quarter last year. The comment I've just made, right, if you look at the price increases we are doing on the old PMA run rate was $100 plus million. With the analytics, the multi-asset class run rate was $300 million plus. So those selected price increases that were on PMA don't compare to the price increases in aggregate dollar to the price increases we're doing in the all multi-asset class risk analytics.


Our next question comes from Hugh Miller with Macquarie.

Hugh Miller

I had a question. As we look at the success that you guys have had with the margin growth in the other segment, obviously still below the longer term or medium to longer-term target of 15% to 20%, but as we consider the returns in ESG versus real estate, how should we be thinking about product mix in those categories? Is one product meaningfully more profitable than the other?

Henry Fernandez

Yes, surely. At this point, that segment All Other, is composed of two product lines, the ESG product line and the real estate product line. The ESG product line is red hot. It's -- as Rich indicated, revenues grew 21% from first quarter last year. Run rate grew 22%. We are capitalizing enormously on the relationships that MSCI -- the old parts of the MSCI have with the big mainstream asset managers in order to penetrate -- to have this product be penetrated in those main stream asset managers as they are beginning to look at investing on the basis of ESG criteria. So that has doing well.

The profitability of that product line has increased meaningfully. It was losing money two, three years ago. We got to breakeven a couple of years ago and now it's got a little bit of a profit margin. I think the trade-off there on ESG is that [indiscernible] to invest, this is a very large opportunity in the world, and you got to invest in products, you got to invest in coverage, in sales and so on and so forth. So that's the trade-off we try to do. So we want to do in a discipline way. So we've asked the team to show up with more profitability. It's a good discipline and create more operational efficiencies so that we continue to reinvest back into the product line.

Now real estate is in a different state of development, which is when we bought this business, we knew we needed to do a radical surgery to it in order to prepare it for global foot print in a global expansion and all of that. We needed to revamp the product line, automated data processes, create new technology, create better delivery systems to our clients through this new real estate portal and the like, relocate the vast majority of the staff from the UK to emerging market, especially India, major transformation of that product line.

And I think we probably have the worst order in that process and in terms of the financials and now we'll continue to see improvement. The product line got obviously hit by the fact that a lot of the sales are in pounds because this originally was largely a UK business. So those translated into dollars. So meaningful a decline in growth rates, but they continued to grow and the profitability has increased dramatically from a loss to a little bit of a profit, hopefully this year and we want to continue on that growth.

So as I said before, one of our goals across the Company is to maintain the profitability that we have in Index, was to increase significantly the profitability of analytics which we have achieved and obviously have more work to do, and this incubator of new businesses and new product lines with the All Other segment, to get it to a position that it contributes meaningfully to the profit margin of the Company, but we got to be realistic that this is an area where investment is needed and therefore we're going to overweight investment versus profitability, we'll see better profitability, but it's not going to yet get to levels similar to the other businesses.

Hugh Miller

That's helpful. Thank you very much. And I guess, as we think about operational efficiency, obviously, you guys have made great strides in automating process and limiting growth in headcount, but we've also seen a shift towards headcount in emerging markets. I think it's up to 53% of the total versus closer to 50% a year ago. Should we continue to see that happening? Do you have a target in the next maybe three to five years as the amount of headcount you'll probably see in emerging markets relative to developed?

Henry Fernandez

Yes, we definitely want to continue on all of the above for sure. I think, at this point, you'll see that EMC, DMC split continue to inch upward. Not yet clear where the targets are. Obviously, we're pushing as hard as we can to make it higher. I think once you start getting into the 60s, you may starting get into the limit and a lot it is because you're going to have a lot of -- a lot of our senior product people, our coverage people, our consultants in big financial centers of the world, which is where our biggest clients are, in New York, London, Boston, Chicago, the major European capitals, and Tokyo, Hong Kong, all centers that obviously are more expensive than in emerging market, and that makes -- you get our people there and a lot of people in order to serve as a client base. So that's where we are.

Now importantly, take this opportunity to say that a lot of -- in the last two, three years, we embarked on a process of really pulling out as many metrics, operating metrics, financial metrics, putting the financial software systems to be able to automate those and then hire finance directors that we couple with business people and engrain that in the culture, so that the whole Company is being managed by metrics, by daily metrics, financial metrics, operating metrics and all of that.

We're in a journey. We're probably a third of the way in that journey and that's why the comments that I made and the comment that Rich made is that it makes us cautiously optimistic that as we develop deeper and deeper metrics, that the -- that's going to help us make better understanding of the cost and how to squeeze it, it's going to be better understanding of profitability and how to go to the places where its higher, how do we understand the value proposition to our client versus the pricing and so on and so forth, and therefore makes us hopeful that this operational efficiency will continue, this increase in revenues will continue from being smart about how you allocate it and on top of that, the investments in new products.


And our next question comes from Toni Kaplan with Morgan Stanley.

Toni Kaplan

Focusing on the asset-based fee business for a second, you highlighted that the fee rate ticked down because of the mix shift between EM and developed. So just putting that aside, in terms of contract renewals in that business, can you talk directionally about how the fee rate is trending? And also, have you been gaining market share of U.S. flows or was it more market-driven and is gaining U.S. flows a strategic priority right now?

Henry Fernandez

So, one, the sort of bouncing around a little bit of the bps is totally mix-driven, totally, which is totally out of our control. Secondly, no change whatsoever on the renewal of contracts and fees and all of that compared to all the practices that we have had. So basically zero change there.

And then three, yes, given the factor investing -- huge push that we're making is allowing us to launch a lot of domestic products with indices and licenses to our EPF clients and that's a priority of ours. That's a good way for us to be domestically relevant in many of the big markets. So when you look at the MSCI iShares or the iShares MSCI minimum volatility ETF, it has been capturing significant amount of flows and that's great because it's all a domestic product with good fees and good revenues for iShares, for us and it's a win-win and it makes us much more relevant in the domestic market.

Toni Kaplan

Okay, great. And just another question on higher level of investment for the remainder of this year. Is that going to be focused more on some certain segments. I know Analytics margins have been a little bit higher than the 25% that you've been talking about as like a normalized level. Like is that 25% still the right normalized number to think about, or is it a little bit higher than that in Analytics?

Henry Fernandez

Yes, on Analytics, the last two quarters have been great positive surprises, clearly for us and for you and a lot of it is because we keep hammering and hammering away of the allocation of cost and investments and all of that, and that has yielded positive results. But the product line needs investment. This new architecture is hugely important in order to not only create the platform for higher growth of the product line, but also making us even more efficient, because we have so many platforms that we had to maintain, right. And now with this new initiative since the fourth quarter on fixed income analytics, again, we're incubating that initiative by [indiscernible] to pay full. So if they put at some point as we see the development of revenues, then that initiative will have to fund it additionally. So that's why I think that we got to be realistic and I think 25% is not a bad number to use.

Toni Kaplan

Okay, great. And then just lastly, regarding M&A, can you just give us some color on the pipeline and are there any areas that you're more focused on right now?

Henry Fernandez

Yes. I think that -- in M&A, obviously, the last 10 years, we've made the big acquisitions we wanted to make to position the Company well. We're not really looking for any bigger type of acquisitions unless they're blatant and they're right in our mainstream and they create significant amount of shareholder returns. If not, we'll pass, right? So we are focused on trying to look for bolt-on at this point, and those are opportunistic and they come sometimes, they don't. But in all of this thing, we're here to create value and therefore the discipline of the returns -- high returns is still valid, automatic and obsessive].


Our next question comes from Joseph Foresi with Cantor Fitzgerald.

Joseph Foresi

Can you talk about the improvements in your go-to-market in light of new subscription sales number that you've talked about? What particular business lines do you feel like you're having the most success there?

Henry Fernandez

Laurent Seyer, our Global Head of Client Coverage is sitting here next to me and smiling. He joined us 16 months ago, 15 months ago, and he's done an incredible job in revamping the go-to-market strategy in a variety of ways. We've changed dramatically the compensation system. We launched that at the beginning of this year to a much more incentivized system. So far so good, early days, but so far very good. We can attribute some of the success on the fourth quarter and first quarter through that incentive plan.

Three, we have streamlined a lot of the efforts there. We drove out lower performers, focused on the higher ones, made sure we're focused on the right territories and so on and so forth. We've put out lot of effort into the senior account managers in order go to sea level of our clients, and in addition to the bottom up selling, the top down selling and those are beginning to produce some great results.

So I think that across the board, not just in one product line -- by the way, we merged all the -- we brought out there, Laurent's leadership, all of the products lines from real estate to ESG to that. We regionalized them under the leadership of the various regional managers. We have a complete team among the regional managers. He and his finance team have done an incredible job building out all the metrics. So we are looking at managing the whole coverage effort by metrics that we place. So all of that is yielding great results and is all across the board and more to come.

Joseph Foresi

Got it. And maybe we could delve a little bit more to Analytics. How sensitive is that business to market volatility? I think you mentioned maybe some delays in 1Q because of what we saw there? And where do you stand from a progression standpoint in improving the overall portfolio? Like what inning do you think you're in from an average perspective?

Henry Fernandez

Yes, look, I think there are two conflicting trends in market volatility with Analytics. On one hand, when volatility increases a lot, the product is more badly needed. People want to focus on risk and where the performance is coming from and all of that. So radical demand goes up. On the other hand, sometimes top suppliers get a little bit itchy and they slowdown the decision making process, and therefore the pipeline slows. We don't tend to see the things coming out of the pipeline. Honestly, what we just tend to see is that we were hoping post some sign this quarter and it just slipped to the first few weeks of the next quarter and therefore that makes the sales a little more -- little more volatile sometimes.

So that's -- now where we are, I think that I'm going to say something that sometimes people -- I think Analytics over time, over a 10-year period, could potentially surpass the size of the Index business. And the reason is that there are a lot more use cases that you can this to around the world. There are so many asset managers and asset owners that need a platform to be able to understand performance and risk and portfolio construction and asset allocation, and I think we're only in the early innings of providing that but it's a new industry, it's a new process, it's a new -- this, we're largely it, we're at the forefront of all of that and obviously, we're doing it with legacy systems and legacy products and we're trying to break out of that problem in order to grow faster and be more profitable. But I think this is a tremendous opportunity for somebody and I hope that it turns out to be for MSCI.

Joseph Foresi

Got it. And last one for me real quickly, can you talk about other opportunities for potential cost containment? Obviously, you're going through the portfolio and you talked about being a third through the journey of understanding the costs. But are there any particular areas that you're focused on, examining the cost structures right now, and think that there may be more opportunities?

Henry Fernandez

I think it's blocking and tackling. We're focused intensely on performance of people, so that if somebody given them a chance, they're performing, we upgrade and therefore create more productivity at a fixed cost. Secondly, this whole metric that I'm talking about is huge, is huge. We always had good instincts and good gut feelings and the like and we've made great decision.

We're trying to improve that decision making process dramatically by preaching the same thing that we tell our clients, manage their portfolios with quantitative tools, right. So manage our decisions by metrics and that has a lot of improvement. Improvement in theory out of the cost and when the payback of those costs in the investment, what the returns of those investments are, put the money where it's a higher multiple evaluation rather than a lower multiple evaluation and not every dollar EBITDA -- the value are the same, and so on and so forth. So, as I said, we're in the early innings of that and I think that will yield lot of results over time.


Thank you. Our next question comes from Warren Gardiner with Evercore.

Warren Gardiner

So you guys gave us a lot of good sort of updates on the level of price increases you guys have been able to pass along on across the Index side and the Analytics side I think over the past year. But could you give us a sense of maybe where or how much of the current subscription run rate is yet to be repriced for both of those areas?

Henry Fernandez

One think that is very important to keep in mind is we are in the middle of a lot of work in understanding the pricing and the level of price increases and renegotiations of contracts versus the volume versus volume, how much of the run rate is subject to this, how much of it is not and all of that and we're giving you directional comments because we're not yet in a position to give you very specific metrics. And this is part of the metrics where hopefully in the next couple of quarters we'll be able to give you very specific things with a high degree of confidence. We know a lot but we want to double check and triple check fully those numbers. At this point a lot of the multi-asset class risk management analytics run rate is not yet priced at a level that is commensurate to the value that it provides.

Warren Gardiner

Okay. Fair enough. And I guess, with some of the M&A or I guess, proposed M&A out there, are you guys seeing any signs of increased opportunity for index switches is on the ETF side at all?

Henry Fernandez

We are and we're seeing a major differentiation between those index providers that are revenues centers to the client like we are versus those that are cost centers. So we're seeing a bit more pressure by ETF sponsors to rotate out of those that are lower cost if they don't add a great deal of value. The benefit of MSCI is that given our $10 trillion plus of client assets that are benchmarked to MSCI, a lot of ETF launches are option contracts, so to speak, on a call on that money to be invested in those ETFs. So we become a revenue center for our clients. So we are constantly in dialogue with our clients to see what do they have in their portfolio that it is managed against an index that is not giving them what they want, but we want to be in the areas where we add a lot of value and we have a premium pricing and we do not want to be in those areas that we're competing on cost.


Thank you. Our next question comes from Keith Housum with Northcoast Research.

Keith Housum

Question for you around the cash flow. Obviously, that number is lower than it was first quarter 2015 and I think you cited the incentive compensation accruals and timing of payments. Can you provide just a little bit more color on I guess, the decline in the year-over-year decline of free cash flow for the first quarter?

Henry Fernandez

Mainly, just as we indicated due to timing. So, essentially, when you look year-over-year, we've had a substantial growth in our business, including our invoicing. And a lot of that invoicing happened later in the quarter. Therefore, some of the collections that we had expected in the first quarter get actually moved to the second quarter. Plus, in terms of interest expense, with the two new debt offerings that we have, we now actually make an interest payment every quarter, right. So we have two debt offerings, they pay semi-annually, but the way it works out is every quarter we'll have one interest payment, roughly in the $20 million to $25 million range.

Keith Housum

Got you, okay. Appreciate that. And a follow-up question, if I could. You guys talked about being a one-third way through in terms of your cost containment initiatives. Can you perhaps just drill down a little bit further on in how you're doing that? Are you guys putting in a SAP system that's giving you better visibility or, how are you guys doing your performance metrics, I guess? Is there a tool that you're using to do that?

Stephen Davidson

Yes, so let me just say, and Rich will answer that as well, is that, look, when you look at the G&A line, you see meaningful increases year-over-year, which are not the way typically we want to run the Company. A lot of those increases have to go with the fact that we're putting a significant amount of resources on the financial technology that underpins the operations of the Company, including SAP and we clearly are putting a lot of money in the tax projects. So, Rich?

Rich Napolitano

Overall, internally, we call it our business intelligence initiative, which as Henry mentions is the ultimate goal to provide very transparent timely decisions support information to all the business heads. And it's not just about SAP, right, that's one tool and a portfolio tool that we've been investing in. And we're investing in SAP to do a lot of the ERM and the general ledger functions. We're using other tools like Clarity to do project management, workforce management, as well as activity-based costing. We use Workday and Concur for either people management or expenses. And what we're doing is basically linking all these tools together into what we are calling this new business information platform. Again, we're along that journey. We still got some time to get there, but every quarter, we pump out better and better information as Henry has mentioned to help us manage.


Our next question comes from Vincent Hung with Autonomous.

Vincent Hung

On Slide 7, on the client side, those greater than $1 million, how many clients does that relate to?

Andy Wichmann

It's probably in the -- more than three quarters of our clients, probably. So we look at our clients two ways. In a low parent child relationship where as we've disclosed we have about 6,500 clients, when of aggregate that at a parent level, we have about 3,800 clients and I would say about three quarters of those clients fall in that range.

Vincent Hung

Okay. And we talked a lot about Analytics and maybe I missed this. As far as your longer term outlook on Analytics, pretty interesting. Can you provide any insights into the competitive environment currently in that business?

Rich Napolitano

Yes, the competitive environment hasn't really changed that much. This definitely -- all our product lines will increasingly become more competitive and therefore, the name of the game is not to have competition. It is to compete and win and we're shaping up the Company to do that. So not a lot of change.

There are only two or three providers on multi-asset class risk analytics, depending on the space, depending on what the client segment type, asset owners or asset managers of hedge funds, and there are two or three that provide equity portfolio management analytics. Obviously, we're trying to enter in a big way the fixed income portfolio management analytics space. There are other providers in there but we're trying to do it in a way that is congruent and attached to the work that we do on equity portfolio analytics and multi-asset class risk analytics for those clients.


Thank you. And there are no further questions at this time.

Henry Fernandez

Thank you very much for your time. We went over a bit, but we wanted to get to everyone on the line. So we will talk to everyone soon. Thank you.


Well, ladies and gentleman, that concludes today's presentation. You may now disconnect and have a wonderful day.

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