MSCI's (MSCI) CEO Henry Fernandez on Q4 2016 Results - Earnings Call Transcript

| About: MSCI, Inc. (MSCI)
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MSCI, Inc. (NYSE:MSCI) Q4 2016 Earnings Conference Call February 2, 2017 11:00 AM ET

Executives

Stephen Davidson - Head of Investor Relations

Henry Fernandez - Chief Executive Officer

Kathleen Winters - Chief Financial Officer

Analysts

Alex Kramm - UBS

William Warmington - Wells Fargo

Toni Kaplan - Morgan Stanley

Mike Read - Cantor Fitzgerald

Keith Housum - Northcoast Research

Warren Gardiner - Evercore

Patrick Sanche - Raymond Jameson

Chris Shutler - William Blair

Operator

Good day, ladies and gentlemen, and welcome to the MSCI Fourth Quarter and Full Year 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 would now like to turn the call over to Mr. Stephen Davidson, Head of Investor Relations. You may begin.

Stephen Davidson

Thank you, Sonia. Good day and welcome to the MSCI fourth quarter and full year 2016 earnings conference call. Earlier this morning, we issued a press release announcing our results for the fourth quarter and fiscal year 2016. A copy of the release and the slide presentation that we have prepared for this call may be viewed at msci.com under the Investor Relations tab.

Let me remind you that this call may contain forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements which speak only as of the date on which they 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 and forward-looking statements in our most recent Form 10-K and our other SEC filings.

During today's call, in addition to GAAP results, we also refer to non-GAAP measures, including adjusted EBITDA, adjusted EBITDA expenses, adjusted EPS, and free cash flow. We believe our non-GAAP measures facilitate meaningful period-to-period comparisons and provide a baseline for the evolution of results.

You'll find a reconciliation of the equivalent GAAP measure 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 24 to 28 of the earnings presentation.

On the call today are Henry Fernandez, our Chief Executive Officer; and Kathleen Winters, our Chief Financial Officer.

With that, let me now turn the call over to Mr. Henry Fernandez. Henry?

Henry Fernandez

Thanks Steve and good day to everyone. As you have seen from the newswire this morning, we’ve been very busy and there is a lot to be excited about at MSCI. We are pleased share with you our fourth quarter and full year financial results.

We executed very well against our strategy and we continue to create new growth and services design to help our clients solve their most challenging investments problems and capitalize on their significant investment opportunities. As a result, MSCI is even more embedded in the fabric of the global investment process therefore creating a valuable network effect with our clients.

Please turn to Slide 4 for a review of our financial results for full year 2016. A 31% increase in adjusted EPS was driven by a 7% increase in operating revenue, a 2% decrease in adjusted EBITDA costs, an 18% increase in adjusted EBITDA, a lower effective tax rate, and a 12% decrease in our share count.

We have been to achieve these - strong results because the management team has been keenly focused on three areas as we have been reporting to you each quarter. We’re focused on investing in new products and services to drive our top line growth is driving from greater efficiency and productivity gains to create an even more efficient organization and ensuring the capital at MSCI is right sized and optimally deployed in the highest return opportunities to enhance shareholder returns.

First, in terms of revenue growth, we’re recorded a 7% increase in revenue driven principally by a 10% growth in Index revenue. Excluding the foreign exchange impact on subscription revenues, operating revenues would have been 8% higher. As we say would have been an increase of 8%.

This was a 12 consecutive quarter of year-over-year double digit growth in our Index subscription run rate which is a best demand to the strength of our Index franchise as well as the strong contribution from innovative new products.

Analytics revenue grew 3% on a reported basis or 5% on an FX adjusted basis. While 5% constant current revenue growth in Analytics in a challenging market environment is a solid performance, we are not satisfied with this growth rate and continue to take measures to improve it. We have successfully restructured the Analytics product line on the Peter’s and Gary’s leadership and now it is well positioned for the next phase which we hope will lead to increasing levels of revenue growth in line with our long term targets for this product line.

As announced earlier this morning, we’re very excited that Peter will be replacing Remy Briand as Global Head of Research and Product Development. As we will discuss in just a moment, this role is one of the most important ones at MSCI and it’s even more important now given our drive to accelerate the pace of innovation and growth.

Peter will be succeeded in his role as Head of Analytics by Jorge Mina, who has led Analytics in the Americas and has also led the business side of the development of our new Analytics platform. This move is just another example of our ability to tap a very deep bench of talent and deploy it to critical areas of focus at MSCI.

Revenue from our Other Product segment grew 7% on a reported basis or 13% excluding the impact of FX. ESG continues to register strong top line growth of approximately 20% on record sales in the quarter and record sales for the full year. The success in this product line has been driven by the increase in integration of ESG factors into the mainstream of the investment process, resulting in a strong sales and leveraging MSCI’s existing client base as well as some new clients.

This strong ESG sales mainly to existing MSCI plan demonstrate the power of the MSCI franchise with our clients as we are leveraging our brand and our existing relationships to sell ESG Reserves and Ratings at an accelerated pace.

In Real Estate, we realize our commitment to achieve profitability driven largely by discipline expense management. Real Estate is one of the largest and fastest growing asset classes in the world. So we believe that the restructuring of this product line that is underway will begin to pay dividend in the near future for us.

In summary, in the overall area of revenue growth, we are very focused on innovation and new products and services to accelerate the top line.

Turning to operational efficiency, the strong top line numbers we’re complemented by a 2% decrease in adjusted EBITDA expenses was flat versus the prior year on an FX adjusted basis. We’re able to achieve this strong performance because of our continued session with efficiency and our focus on redirecting capital to high return with initial investment.

We expect to see more improvements overtime in our operating tax rate, primarily driven by ongoing efforts to better outline our tax profile with our overall global operating footprint.

We believe there are more opportunities to achieve operating efficiencies at MSCI and we are only just getting started. Some of the areas that we are focused on include increased automation within our technology infrastructure, improved distribution of our products and services through our applications and that will allow our clients to a better access to our products which will result in operational efficiencies but would also result in higher growth of revenue.

Finally, in terms of capital optimization, we continue to be strategic investors in our stock, repurchasing 11.1 million shares for a total of approximately $844 million at an average price of about $74.18 throughout 2016 and through January 2017.

We have delivered in our commitment to optimize our balance sheet by increasing our gross leverage to levels that allow us to enhance shareholder returns but also maintain flexibility to pursue all our capital deployment options as our management onboard determined.

In summary, 2016 was a very strong year for MSCI. And we are very excited by the opportunities for growth and further efficiencies that lie ahead. In 2017, we will continue to be extremely focused on innovation and how we can accelerate the growth of the company. We will continue to be positioned - positioning ourselves to achieve superior operational efficiencies and again we will be focused on optimizing the deployment of capital, not just through dividends and share repurchases, but also across all capital deployment opportunities that will enhance our shareholder returns.

Please turn to Slide 5, which illustrates what we call the integrated franchise at MSCI that we bring to clients to help them capitalize under significant investment opportunities and so their most challenging investment problems. This franchise is the basis and a foundation for a partnership like relationship with our clients as oppose to a vendor like relationship.

We are very pleased of the investment community has embraced our segment reporting that we released in 2015. He has provided our investors and the analysts that follow us with a transparency they needed to give them the ability to track profitability and better value our asset. But it is absolutely critical to understand that MSCI is increasingly one integrated company. This integration is evident across several areas, including out approach to client relationships i.e. our go-to-market strategy, our product development efforts between various areas of the product line and the continent application combination the power the tools that we provide our clients.

Let me talk through each one of those areas briefly. First, in terms client relationships, we are taking an integrated approach by having a dedicated account manager for each of our top 100 clients. Each manager is responsible for core of the meeting or client interactions within MSCI. These account managers are focused on understanding our clients’ strategy, the various initiatives our clients have to drive those strategies and move the key individuals in the senior management team of our client they are responsible for this strategies, so that we can help them address those opportunities and those challenges that they have in their investment processes.

So in addition to the relationship that we have with those clients at the expert or user or product level, this overlay of the relationship allows us to apply a solutions approach that drive the interaction with us at a senior level between MSCI and decline organization, so that we become a partner in what the client goes and not just a vendor to the various experts in the organization.

Next MSCI is increasingly integrated at the product development level, where we use all of our different IP across the company to the lever complex solutions to our clients. Let me give you a few examples, just a few, there are many more, just a few.

For example in equity factor models and equity factors indexes which are critical collaborations between two product lines. We’ve talked about this extensively in the past. ESG Research and Rating and ESG Indexes provide our clients with an integrated perspective on the equity market opportunity with a view that cuts across market cap, factor weight and ESG factors.

So you get all these three combined, the market cap approach to indexes, you get the factor approach to the opportunity set and then you get the ESG factor approach in order to give our clients one view of the equity markets in which they can build their portfolios and it becomes very powerful in their search for alpha and differentiation.

Lastly in our Analytics product line, we have integrated our equity risk management products and services with our multi-asset class risk products and services and we are now in a further developing our fixed income risk products into one holistic view of risk of the total portfolio equity, fixed income and other asset classes and from the portfolio management part and the risk management approach in a holistic way.

The third area of integration with MSCI is between what we call content and applications are further illustrated in this slide. The most successful firms in our state will be those that master the integration of both the content i.e. the models and the methodologies and the right data, the algorithms or calculators, the content that we provide with the applications that are so critical and enabling that content for the maximum use and utility in investment processes of our clients.

The combination of content and application creates more value than some of the parts, because of the ability of using content and applications combined to address more use case and solve more problems and create more opportunities for our clients. So our goal is to be the best provider of content through either our clients’ applications, third party applications or our own applications, all of it as long as we get paid on their content.

So we are working on this integration as shows by our new Analytics platform which integrates data, analytical content and models and algorithms all in one platform.

The integrated franchise that we're building at MSCI is very powerful. It get some ways to go, there are long areas that we can continue to further integrate, but we believe that we're just getting started under the opportunity is massive.

As I travel around the world with seen our clients especially at the C-level, I hear more and more that they want those to do much more for them that they want us to become a partner to them in their investment process not just the vendor and therefore we can solve more and more use cases with our tools.

So we believe that this integrated solutions based approach in addition to what we have built on the user level will serve our client very well and will drive substantial value creation for our clients and our shareholders for a long time to come.

Before I turn the call over to Kathleen to go through the quarterly numbers and I would like to welcome Jacques Perold our new Independent Member of the Board, who will officially start with us on March 6, regional press release and an 8-K earlier this morning and we are absolutely thrilled to have someone of Jack’s deep experience in the asset management industry to join MSCI at this exciting time in the evolution of our firm. Kathleen?

Kathleen Winters

Thanks Henry, and hello to everyone on the call. I'll start on Slide 6 will take you through our fourth quarter results. We closed up the year with the very strong Q4. We delivered a 7% increase in revenue driven primarily by a 6% increase in recurring subscription revenue and an 11% increase in asset-based fee revenue.

Adjusting for the impact of foreign currency exchange rate fluctuations on subscription revenues, total operating revenue would have been increased 8%. As a reminder, we do not provide the impact of foreign currency fluctuations on our asset-based fee tied to average AUM of which approximately two thirds are invested in securities, denominators and currencies other than U.S. dollar.

On a reported basis, operating expenses increased 1% and adjusted EBITDA expenses were basically flat. Expenses that are supposed to foreign currency exchange rate fluctuations represented about 40% of adjusted EBITDA expenses in Q4 and the full year 2016. Excluding the impact of foreign currency exchange rate fluctuations, fourth quarter operating expenses and adjusted EBITDA expenses would have increased 3.5% and 2.7% respectively. The primary currency move that drove this benefit with the British pound, which was substantially weaker year-over-year.

We delivered a 17% increase in operating income and a 16% increase in adjusted EBITDA with an adjusted EBITDA margin of 50.2%. Our effective tax rate was 29.7% in line with the 29.8% effective tax rate in prior year Q4. The 2015 fourth quarter tax rate benefited primarily from higher net tax benefits mainly associated with various research and production related credits and deductions. These benefits impacted Q4 2015 adjusted EPS by $0.04.

The current quarter's tax rate benefited from higher 2016 profits recorded in lower tax jurisdictions than previously estimated, as well as several favorable discrete items including the settlement of tax audit and a recent taxable change. These benefits increased fourth quarter 2016 of adjusted EPS by $0.04 per share.

Diluted EPS and adjusted EPS increased 28% and 23% respectively. Free cash flow increased over 100% to $127 million in fourth quarter 2016.

In summary, Q4 with a great performance capital of a strong year, as we continue to execute very well against our strategy.

On Slide 7, you can see the different drivers of EPS growth in Q4. Adjusted EPS increased 23% from $0.66 per share to $0.81 per share. Strong revenue growth from both subscription and asset-based fees contributed $0.15 per share. Investments net of efficiencies in our product segments and operations we used earnings by $0.04.

In terms of capital optimization, share repurchases benefit EPS as well. We reduced our average weighted diluted share count by 9% which benefited adjusted EPS by $0.08 with a partial offset from higher net interest expense to net $0.03 per share benefit.

And lastly, FX had a net $0.01 per share positive impact due to the impact of currency moves primarily the pound on adjusted EBITDA expenses.

On Slide 8, we highlight our record fourth quarter sales. We delivered record sales this quarter despite the continuing challenging market headwinds that select client segment have been experiencing as reflected in the higher level of cancels and Analytics over the past three quarters, which I will address in an upcoming slide.

The record growth sales of $50 million represents an increase of 21% and was driven by strong growth across all regions and product segments with particular strength in Asia with growth sales were up 45%. The growth in Asia was driven by a broad mix of new client acquisition and module of sales in Index as well as strong growth in Analytics especially in Greater China and Japan. We believe that this strong sales performance in a challenging market is a reflection of our ability to identify new and innovative used cases that leverage our product and service offerings for our clients.

Strong recurring index sales up 26% were complemented by strong Analytics recurring sales which were up 13% driven by strength in the banking client segment and higher sales of RiskManager and Equity Model.

We also had record ESG sales with recurring sales up 54%, driven primarily by ESG Ratings sales leveraging both MSCI existing client base as well new client growth. These record sales help to offset higher levels of cancels resulting in a 37% increase in net new recurring subscriptions. We’re maintaining a high level of retention at approximately 93% on a much larger book of business. Our pipeline remains strong and we remain optimistic, but cautious as we move into 2017.

On Slide 9 through 2014, I’ll walk you through our segment results. Let’s begin with the Index segment on Slide 9 through Slide 11. Revenues for Index increased 11% on a reported basis, driven primarily by a 9% increase in recurring subscriptions. We saw growth in benchmark and data products broadly with growth in core products, factor and thematic products, usage fees and custom products. Additionally, we saw a 1% increase in asset-based fee revenue.

In terms of our operating metrics, record quarterly sales were driven by record recurring subscription sales of $17 million. Aggregate retention rate remained high and partially 93% in the quarter and 95% from the full year in line with the prior year period.

Index run rate grew by $54 million or 9% compared to December 31st, 2015. This was driven by an increase and subscription run rate of $38 million or 10% and $16 million or 8% increase in asset-based fee run rate. The adjusted EBITDA margin for Index was 71.1% versus 68.9% in Q4 2015.

Turning to Slide 10, detail on our asset-based fee. Starting with the upper left hand chart, overall asset-based fee revenue increased $6 million or 11%, driven by a $3 million or 26% increase in revenue from non-ETF passive funds and $2 million or 5% increase in revenue from ETF linked to MSCI indexes, I mean a 11% increase in average AUM.

The strong revenue generation from non-ETF passive funds was primarily driven by higher revenue from new product launches including increases in higher fee products.

In the upper right hand chart, we ended the fourth quarter with $481 billion in ETF AUM linked to MSCI indexes, driven by cash inflows of $15 billion, partially offset by market depreciation of $9 billion.

For the full year, ETF AUM linked to MSCI indexes increased $48 billion or 11% on inflows of $37 billion and market appreciation of $11. From January 1st, 2017 through January 31st, 201, ETF AUM linked to MSCI indexes has increased to $509 billion, driven by $13 billion in inflows and $15 billion in market depreciation. We hit an all-time high of $511 billion on the 27th January. More equity ETF track MSCI indexes than any other provider.

As shown in the lower left hand chart, quarter end AUM by market exposure ETF linked to MSCI indexes reflected the decline in EM after the U.S. Presidential Election, which was accompanied by increases in developed market. EM however remains well above prior year levels.

Lastly, on the lower right hand chart, you can see the year-over-year decline in the average run rate basis point fee from 3.32 to 3.1. The decline in the average basis point fee is primarily due to cash flow statement lower fee segments of the ETF market. However, we’ve experienced a stabilization of the average basis point fee over the last three quarters and it has continued through January 2017.

On Slide 11, we provide you with the AUM of ETF linked through our indexes classified in three discrete components illustrating our differentiated index licensing strategy. This strategy is linked to further expand our index licensing franchise for the ETF market beyond our flagship indexes increasing the adoption of new index family and U.S. segment index families.

The first component of the strategy primarily reflects the licensing to ETF provider of our flagship indexes. In other words, market cap indexes focused mainly on exposures outside of the U.S. with exposure to large and midcap stocks only. This component represents the majority of ETF AUM linked to MSCI indexes. As well as most of the approximately 10 trillion benchmark to MSCI indexes overall. This category of licensing we include EAFE, EM and our single-country market cap indexes. The ETF AUM linked to these indexes has been growing at a three year CAGR of approximately 6% and pricing have been steady.

The next component of our strategy is the licensing of indexes which primarily include non-U.S. exposure to large, mid and small cap stock, which include indexes that are used as a basis of the U.S. listed iShares or core series in the USA factor indexes such as the MSCI, USA minimum volatility index.

The assets in this component represent roughly 10% of total AUM and have been growing at a CAGR of over 90% over the last three years. Generally, the pricing for these products is lower than ETF that licensed our flagship indexes.

The third component of our strategy is a licensing of more segmented U.S. indexes including sector and REAT indexes. AUM has been growing at a CAGR of approximately 30% over the past three years and represents about 15% of overall AUM. The pricing in this component is generally lower than ETF licensed or flagship in new index family.

So you can see our strategy is to diversify our licensed ETF franchise in maximized revenue. This differentiates strategy has been successful as evidenced by the strong growth in AUM and revenue. Even now the faster growth in the lower fee product areas has contributed to a lower overall average basis point fee based on run rate. While, we expect our periods were product mix will impact the average fee we earn through a differentiated licensing strategy, we look to maximize the price volume trade-off over the long term.

Resilient pricing in our flagship bonds with strong AUM growth but more than offset pricing declined and fast growing lower fee ETF.

On Slide 12, we highlight the financials for the Analytics segment. Revenues for Analytics increased 3.4% to $114 million on a reported basis, which includes $2.4 million negative impact from FX. Excluding the impacted FX, Analytics revenue increase 5.6%. The increase in revenue was primarily driven by higher revenues from RiskManager, Equity Models and BarraOne.

We have a strong increase in recurring sales which were 13% higher compared to the prior year fourth quarter, due to higher equity model and RiskManager sales.

Gross sales which include non-recurring sales were up $2.9 million or 15.1%. We did however see elevated cancels in Q4, due to seasonality driven by a higher number of contracts up for renewal in the fourth quarter as well as continued challenging market conditions in some client segments.

Analytics run rate at December 31st, 2016 grew by $15 million or 3% to $452 million and would have increased 4% excluding the impact of FX.

Adjusted EBITDA margin was 29.1%, up from 27.9% in the prior year, notably approaching our long term margin target range for this segment.

Turning to Slide 13, this provides you with sales and cancels history for the Analytics segment. The chart shows gross sales and cancels for Analytics over the last three years. The higher level sales in 2016 broke us out of the $60 million range of the previous two years, driven by strong RiskManager and Equity Model sales.

Over the past several quarters, we’ve seen hiking cost pressures and budgetary constraints among our bank and bank-owned asset and wealth management clients which resulted in a $10 million or 34% increase in cancels for Analytics in 2016. Roughly $5 million of the $10 million increase came from 2 clients in the second half of the year. These cancels have been primarily in the U.S. but we’ve also experienced higher levels in Europe principally in a RiskManager product area. Approximately 70% of the cancels for 2016 are principally related to closures, changes in strategy and cost pressures. So market factor is beyond our control.

So while we’re disappointed with the increase in cancels and selected clients segments, we’re very pleased with our strong sales numbers in the quarter, specifically in the bank segment where RiskManager growth those were up 138% and the pipeline remains strong.

Turning to Slide 14, we show results for the All Other segment. Revenues for all other increased 4% to $19 million reported basis and grew 15% after adjusting the disposal of Occupiers and the impact of FX. First, in terms of ESG, a $2 million or 20% increase in ESG revenue to $12 million due to strong ESG rating revenue with record ESG recurring sales in the quarter which increase 54%.

Growth in ESG continues to be driven by the increasing integration of ESG in to the mainstream of the investment partner and leveraging the existing MSCI client base as well as new client acquisitions.

Real Estate revenues decreased $1 million or 13% to $8 million on a reported basis. Excluding any impact of foreign currency and sale of Occupiers business, Real Estate revenues increased 10%. The All Other adjusted EBITDA margin was 2.3% up from a negative 16.1% in the prior year.

The increase in the adjusted EBITDA margin was driven by continued strong growth in ESG revenue as well as lower Real Estate costs, primary due to a reduction in headcount and strong cost management as we make progress towards improved profitability in our Real Estate product area.

Turning to Slide 15, you have an update on our capital return activity. We continue to return substantial amount of capital to investors. In Q4 and through January 27th, we repurchased and settled total of 4.2 million shares at an average price of $80.27 for a total value of $339.7 million.

Since 2012, we’ve returned almost 2.3 billion for shares repurchase and dividends and we’ve repurchased 35 million shares for the company. There was an $806 million remaining on our outstanding repurchase authorization as of January 27th, 2017.

On Slide 16, we provide our key balance sheet indicators. We ended the quarter with cash and cash equivalents of $792 million. This includes a $208 million of cash held outside the United States and domestic cash cushion of approximately $125 million to $150 million which is a general policy we maintained for operational purposes.

We continue to repurchase shares in January and above over $60 million. Furthermore, we pay our annual cash incentive compensation in the first quarter. As a result of this coupled with interests, dividends and tax payments, CapEx disbursement and the aforementioned buyback, our deployable cash balance in Q1 2017 will be lower than what was available as to 12-31-16.

Our growth leverage was 3.7 times at the end of the quarter down from 3.8 times at the end of the third quarter 2016. Over time we expect that we will return to our stated range of three to and three and half times as our adjusted EBITDA growth.

On Slide 17, we highlight the key drivers of the outperformance for the full year 2016 free cash flow generation. Free cash flow increased 53% to $392 million for the full year versus 2015. The outperformance was driven primarily by two factors. First, we saw strong customer collections in Q4 with some clients even paying early therefore, we experienced a pull forward of about $20 million in collection into 2016. Next, we benefited from a combination of tax refund and discrete cash tax benefits of about $40 million.

Normalized free cash flow would have been approximately $330 million for the full year 2016. For 2017, we are guiding to free cash flow of $310 million to $370 million reflecting ongoing strong cash generation in 2016 partially offset by incremental interest payments, cash taxes and lower collections due to the full power.

Lastly, before we open the line for Q&A, on Slide 18, we’re providing you with our full year 2017 guidance. Operating expenses are expected to be in the range of $690 million to $705 million. And adjusted EBITDA expenses are expected to come in between $605 million and $620. FX part rates at the end of 2016 are the bases for this expense guidance.

In 2017, we're expecting at roughly half of the $32 million year-over-year increase. And adjusted EBITDA expenses will be from carryover and inflationary increases. The other half of the increased will be investments in the sales, marketing and products and services. We expect the full year 2017 adjusted EBITDA margin in analytics to be flat or slightly better than the 4Q exit margin for the product area.

Interest expense is expected to be approximately $116 million. Net cash provided by operating activities is expected in the range of $360 million to $410 million. CapEx is expected to be in the range of $40 million to $50 million in line with 2016.

Free cash flow is expected to come in between $310 million and $370 million below the free cash flow generated this year because of the items I discussed earlier. Effective tax rate is expected to come in between 31.5% and 32.5%.

In the first quarter of 2017, we were adopting the new accounting guidance related to employee share based compensation under the new standard, all share compensation excess tax benefits and tax short falls will be recognized in income taxes in the statement of income as discrete items in the reporting period in which they occur. Previously they were recognized as a component of stockholders equity. We expect the impact assuming current stock price levels and based on the stock investing and option expiration timetables to result in a tax benefit of approximately $3.5 million for the full year of 2017.

Given that the majority of our stocks were the best in the first quarter of each year, we expect about two thirds of this estimate to occur in the first quarter.

Please note the impact of this change is just an estimate which could change significantly based on changes in MSCI’s stock price, employees and when employees elect to exercise options. We're reaffirming our dividend payout ratio of 30% to 40% of adjusted EPS and are objective to maintain growth leverage in the range of three to three and half time.

Also beginning with Q1 2017, adjusted EPS will include amortization expense associated with internally developed capitalized software on a perspective basis. The impact of prior periods was not material. We're making this change because internally developed capitalized software will become a more meaningful component over time as we continue to invest. We believe that only intangible amortization related to acquisitions to be excluded from the adjusted EPS calculation.

For modeling purposes amortization of internally developed capitalized software that will be included in adjusted EPS is expected to be between $5 million and $6 million in 2016.

Lastly, as a follow-up to the issuance of our long term targets in 2015, we are reaffirming those targets as of this call.

In summary, we executed well throughout the quarter and the year, and we're very pleased with our strong results. We are continuing to invest in and innovate with new products that will position MSCI to continue to grow in the quarters and years ahead.

With that we’ll open the lines to take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Alex Kramm of UBS. Your line is now open.

Alex Kramm

Hey, good morning everyone. Maybe just starting with the environment and the outlook a little bit clearly that cancels are still elevated in the year, but the sales were really, really strong. So what are you seeing out there, I guess particularly on holiday to maybe to some degree on index in terms of confidence level that the sales can remain elevate or increase, so what are you seeing out there, we also while also selling I mean and the cancellation side do you feel like a lot of the kind a one time or such done now or when you look at the customer base there are there still some areas that you think should be struggling so we might continue to see some of these elevated levels? Thank you.

Henry Fernandez

Yes, so the pipeline remains pretty solid going to 2017 and in January. So that we remain cautiously optimistic about the prospects of gross sales, and return sales this year. I think the environment I mean we have obviously very strong financial result despite the - our end client environment, we sell quite a lot to active managers you know around the world that's a lot of our subscription business is based on that clearly asset based fee business that based on passive managers.

And that you know client base the active management client base is suffering from two areas, cyclical pressures, the value stop thinking is last when you have you know sort of asset prices being determine by monetary policy around the world. And you have secular issues such as you know passive management of grudging a lot in what they do. So throughout the year all the way through to December those trends have continues to the extent that the new environment that we're seeing of higher growth around the world the U.S. or Europe or Asia more emphasis on deficit spending or system policy rather than the monetary policy, higher inflation.

So our end client base can benefit from that and the prospects will get better than what we are currently seeing. Too early to tell at this moment clearly there was a big run up of banks and asset managers, and insurance companies, and the like from November to December someone that some of it has been reversed in January.

But again it's too early to tell, we tried not to count on that or focus on that, but we try to do is we extremely focused on understanding the client or what the client is facing positively or negatively and try to help them with that. So with respect to cancel, I think it's hard to say, clearly we have high sales, because of all the efforts we’re doing and the new product and the newer services, the new approach to go to market, the solutions that we're trying to come to our clients with it, all of that has benefited the gross sales.

I think they will continue to be some level of evaluated cancels given the structural changes that are going on maybe they get a little lower because of less pressure on the cyclical changes but again is too early to tell. And therefore the conclusion from our part is the pipeline where executing well against that, we hope to continue our piece and pace of sales but again I don’t know it will do every quarter with the last quarter. We are assuming that the cancels will continue to be elevated at some level given the environment on as an environment turns.

Alex Kramm

Very helpful, thank you. And then just I need to address of course the asset-based tied in terms of ETF fees and other index fees I mean thanks for the color in terms of the mix. But obviously when you think about your biggest customer BlackRock, you saw some of the moves that they just made on the custody side moving $1 trillion over to it to J.P. Morgan from State Street and I think in the process they also said that they are getting more conscious with some of their vendors. So when you combine that and you see other moves like swap for example lowering fees aggressively for their index products even on the index mutual fund side like it just seems like the fee pressure is still out there. So any updated thoughts on how that how you fit in and if there could be anything coming out if your discussed that change with some of the customers of yourself? Thank you.

Henry Fernandez

I think the first think that we are trying to do best that we could to provide you kind of an insight look of how we view our licensing strategy and done with the comments by Kathleen. The flagship, product line, the new index families they were launching that of course have less value at the moment than the flagship one that are been around for about 20, 30 years and then the domestic one U.S. domestic one that have a fairly different competitive dynamics than the prior tool right. So a lot of what we’re going in is like we know we just want to rest on the flagship product line and the wonderful things that we’ve done there, we want to continue to expand dramatically into all areas of the ETF marketplace regardless of the competitive dynamics good or bad as long as we - is a good return on our capital and on the effort. So that’s what we trying to simplify here in as good of a way as we could.

I think that the BlackRock is an example of that on the partnership approach that we take in with our largest client and which we together trying to optimize the revenue for them and consequently the revenue to us, was in the same way, we do it with a lot of other clients on the active side and on the passive side, I suppose to just being a vendor and just being the lowest cause vendor to them.

So we believe that there are segments of the market like flagship indexes that will have less cost pressure or less pressure, because there is unique IP there, and unique properties. But there are other segments of the market that we have more fee pressure. And I’m not afraid of going into them towards, it’s not a question of fees, the question already return on our capital, return on our efforts. And we have great returns and all built upon already low cost, marginal low very low marginal costs infrastructure, we are going to be in all those places.

Kathleen Winters

So you’re look at the space, going to continue to grow and gather substantial net of assets overtime right. And we’re focused on how we capture that market share through new product innovation and our differentiated licensing strategy. Over the long term, we’re pretty confident that the volume price trade-off makes sense for us.

Alex Kramm

All right. Very good. Thanks again.

Operator

Thank you. And our next question comes from Bill Warmington of Wells Fargo. Your line is now open.

William Warmington

Good morning, everyone.

Henry Fernandez

Good morning.

Kathleen Winters

Good morning.

William Warmington

So a question for you also on the Analytic side that’s an area where you guys have been putting through some price increases and so even though you had elevated attrition there, margins were still up 120 basis points on a year-over-year basis and even 30 basis points on a sequential basis. So was it just that some low margin clients left or are you taking more of up and out up or out I should say for some of the more marginal clients?

Henry Fernandez

No, no. I think overall Bill, the approach has been how do we take a very aggressive and proactive management of the product line or no last picks of it, or last pick. So we started by saying what is the value of this products to our clients and how does that value compared to the price. They were charging and we - so and realize that some of these flow coming credible value. Clients are running their entire infrastructure in many cases on this and therefore dividing immense value and the price they were paying was lower.

So we said okay, you know overtime, we got to try to equate value and price on that. So that you know the genesis of the price increases and things like that right. The price increases have not driving the cancellation by any meaningful or way at all.

William Warmington

Got it.

Henry Fernandez

So that they know sounds one approach. The second approach is that we look at all of our activities, so Analytics is composed to a lot of different activities and a lot of different products, insight that we say what, how much capital, how much and expenses or capital will be flowing to one area versus another area versus another area and we started cutting back significantly the effort on the capital in some area in order to deployed into higher yielding opportunities and alike.

So that yield is a significant kind of demand of savings and we’ve put a lot of that in the margins. But reportedly very specifically a meaningful part of the savings are being deployed on our on what I mentioned briefly our efforts on fixed income analytics, fixing income risk and fixed income analytics and we’ve been able to sell fund. That significant effort last year and in the coming years out of that and it’s still be on our way to achieve those targets.

So if you were to think about it, it’s almost like management one-on-one right. Understand your value proposition and the price that you are charging and what clients are you doing it and understand your how you deploying your people internally and what activities and what cost and we’re very pleased with what we’ve done, but we believe we also believe in recognize that we have we still have a long way go to yield even better financial results.

And as we said, couple of years ago, when we launched this whole program of restructuring and reengineering and transformation of analytics, we knew that the first half of the program was going to be margin expansion and the second half has to be revenue growth and that’s what we’re focused on, on the revenue growth.

William Warmington

One more if am I might on leverage you pointed out the on Slide 16, the gross leverage at 3.7 times which is you know - sorry above the targeted at 3, 3.5, but really what stands out is the net leverage at 2.3 times which would tend to bring in the comment there you’ve got a fortress balance way overcapitalized, a high class problem of course. But are you thinking - you’ve got a lot of cash there, so are you thinking about doing some M&A or you are going to be more aggressive on the buyback?

Henry Fernandez

So I think the way to think about it is clearly the excess capital or excess cash and if the growth numbers look big and all of that but when you take the money that is outside of the U.S. which you can bring it unless there is some tax.

Kathleen Winters

Unless there is tax reformers opportunities.

Henry Fernandez

Plus $200 million that is kind of locked away right. And then the money that in the U.S. 500 plus million and you got to have operating cash to run in the business so that roughly at the moment gives you 400 plus or so million in that and we haven't yet paid the cash and the dividend payment this quarter and tax interest payments and all of that. So we are - we're getting close to kind of steady state in which we're setting up the excess capital and excess cash. And as we do we will continue in the same path of what we've done in next two, three years, mostly organic growth and mostly sort of return of capital for dividend and buyback with then occasionally acquisition here and there. But the less excess cash on your balance, it makes you to be even more opportunistic and discriminating on the purchase of your shares. So we’ll continue to it, but in this far way.

William Warmington

Well, thank you very much.

Operator

Thank you. And our next question comes from Toni Kaplan of Morgan Stanley. Your line is now open.

Toni Kaplan

Hi good morning.

Henry Fernandez

Good morning.

Kathleen Winters

Good morning.

Toni Kaplan

You mentioned some cash collections that were expected in fiscal 2017 that were received in the fourth quarter and so I was wondering if that dynamic impacted your new sales level during the quarter as well?

Kathleen Winters

Well, you know if you look at those two events are data points and look we had strong sales in the quarter, we’re very happy with that. Actually in the second half of the year sales were quite strong. And then we had the really healthy cash collections which is an interesting thing to see, you don’t often you see that where clients are actually paying ahead of the due date.

So optimistically like to think that okay the environment looks pretty healthy, right clients have incremental cash are paying early but yet still we look at the overall environment, we look at some of our client segments that have been challenged over the last several quarters. So we're still a little bit cautious, but yes you're point too good data points there.

Toni Kaplan

Okay. And you've mentioned a couple of times the tax initiatives this year that will impact next year's tax rate by about 200 basis points by sort of positioning your business mark globally from a tax perspective. And so would potential tax reform in the United States if there were to be a reduction to a federal level of call it 20% would that impact your strategy or what you would do going forward for achieving your tax initiatives?

Kathleen Winters

Yeah, well, so first of all there are a lot of unknowns with regard to tax reforms in terms of what it looks like, when it takes place, when in effective. So we're waiting to see how that plays out, we’re watching that very closely. You know it depends on what form it takes right. Reduced corporate tax rate obviously would be beneficial, but then there are other considerations to an unknown like what happens with interest deductibility.

So we're watching to see how that plays out, but generally the work we've done on the tax side really just aligned our tax structure with our operating structure, so where we employ our people, where we're generating our assets, where our clients are located. So all of that makes sense and we're waiting to see what any incremental changes might be with tax reform.

Toni Kaplan

Thank you.

Operator

Thank you. And our next question comes from Joseph Foresi of Cantor Fitzgerald. Your line is now open.

Mike Read

Hi guys this is Mike Read on for Joe, thanks for taking my question. Just could you go into a little bit what do you think other impacts from the new administration could be outside of possible tax reform that you might expect to see?

Henry Fernandez

I think the more the bigger one for us were obvious one would be to the - what I said before to the extent that there is higher growth in the U.S. may potentially be higher growth we're seeing the higher growth in Europe in the last few days, few weeks. More emphasis on fiscal policy rather than monetary policy there are more inflation all of that will be very beneficial to our client base, asset managers, hedge managers, banks, wealth managers, et cetera, and that will have two effects, they will buy more products from us, they wanted to buy, but the budgets are being constrained and then maybe less you know less slashing and burning cost basis. You can see that our major weakness, not major weakness, but a relative weakness in our - when you look at our councils has been the bank on asset managers, especially in Europe it bank on wealth managers. Even the bank balance sheet themselves well in the last quarter but in general the banks have been clearly slashing and burning expenses.

So to the extent they feel better about trading to expand the asset managers feel better about flows and feel better about stop thinking and all of that that can potentially have a very leverage of bull effect on us, because we are right there, we’re the partners, we're helping them in a lot of things so you may have a two side of benefit, higher sales and lower councils and that will be highly leverage for us. But it is too early to tell, because that may be cope with your political risk or trade risk and things so that. So we’re cautiously optimistic, but we have to wait and see how it all being travel.

Mike Read

Okay, thanks. And then just switching over to the margin side after the strong expense in the last few years in the overall company even a margin kind of runway and do you see left in the medium and longer term for overall company margins?

Henry Fernandez

Well I mean we continue with the same policies that we have outlined so far, so very slow change from that.

Mike Read

Okay, thanks guys.

Operator

Thank you. And our next question comes from Keith Housum of Northcoast Research. Your line is now open.

Keith Housum

Good morning guys, thanks for taking my call. Just want to clarify on the tax rate guidance, 31.5% to 32.5% that includes the stock base compensation change in the first quarter?

Kathleen Winters

Yes, Keith it does include that.

Keith Housum

Okay and I think also just a follow-up question that in terms of the cash collections. I guess how to understand the logic about why would customers pay early because obviously people like to further hold their cash and then obviously they pay for it to do it otherwise, so why people pay early here in the fourth quarter?

Kathleen Winters

That's a really good question.

Henry Fernandez

We don’t know.

Kathleen Winters

We asked ourselves that question that we were happy to take the $20 million.

Keith Housum

Well if this guy came to you and said they can fairly.

Kathleen Winters

They send it to us.

Keith Housum

All right, thanks. Appreciated.

Operator

Thank you. And our next question comes from Warren Gardiner of Evercore. Your line is now open.

Warren Gardiner

Yes, thanks. I actually just on our last question to, so was that - did it impact growth sales, in the fourth quarter just to clarify that?

Kathleen Winters

No.

Warren Gardiner

Like would have been in 1Q you had on the cash payment, the growth sales?

Kathleen Winters

If I have not come in Q4 that cash would have come in Q1 and that cash was across the pretty broad group of clients, so there’s no at one client or two clients, there was quite a number of clients that for sure.

Henry Fernandez

And by the way this is all in the - in our normal qualitative of cash collections, so there were no incentives for them to pay as earlier or anything like that or some people to discount or whatever it’s zero, I mean it was all in the normal course of collecting cash.

Warren Gardiner

So what is the - with sales of the gross sales number would that have been many different, I guess was more?

Kathleen Winters

No.

Warren Gardiner

Okay, thank you. And then my other question was you know on the index subscription basis a really nice quarter for growth again. So obviously I like around right there, but I do want to ask because you've seen the growth in the number of kind of non-U.S. mutual funds kind of slow pretty significantly recently. So I mean how do you guys thinking about that trend maybe impacting that gross sales outlook for the index subscription basis. I mean obviously there are some other stuff that's gone pretty well in custom and factor, but just kind of thinking about the legacy sort of active mutual fund manager with emerging market mutual fund or just do you know anything on those things?

Henry Fernandez

Well, I think the value of our benchmarking product line to mutual funds all over the world dramatically increased in the last few years, the value because on an average of general basis mutual funds used to be sort of largely benchmark to indices but doing whatever they wanted, with the pressure intense pressure by passive investing which is obviously did benchmark replicated in the benchmark, the mutual funds have to spend a lot more time understanding the benchmark which is some respects the competition, because that's where passive is coming from.

Really establishing a lot more discipline on whether they overweight, whether they underweight if they run a little more concentrated portfolio what the exact risks are you know all that and so on and so forth, so that add to the input of our clients subscribing more to our information in more locations, with more people, with more intensity, and all of that.

Secondly we don't - we typically constantly put more and more data, more and more new things into the same modules to the same packages of data. So the client is constantly getting an upgrade product so if you say, if do not price increases the product is a lot big bigger to a lot more valuable for the prices remained the same. So if you're basically have increased the price you want to think about it that way.

So that's what has added significant interest and potential to what we learn in the third element is obviously the subscription here is catch subscriptions to market indices, but also add subscription to factor indices, factor indices are not just being used for passive, we have clients subscribing to fact indices in the benchmarking product line and is dramatic indices and the ESG indices and all of that, so all of that is expanding our relationship with our clients and our value added to our client.

Despite the headwind that pretty much every mutual fund in the world has clearly with a lot stronger in the U.S. getting stronger in Europe, best strong in Asia, Asia is much more mutual fund driven at this point, so different dynamic and different regions of the world.

Warren Gardiner

Thank you.

Operator

Thank you. And our next question comes from Patrick Sanche of Raymond Jameson. Your line is now open.

Patrick Sanche

Hey, good afternoon, I guess. First question just a little bit of housekeeping, the incremental $5 million to $6 million expenses you capitalized or you amortize your capitalized software in 2017, is that incremental the $5 million to $6 million versus 2016 if I recall correctly said it was basically nominal this past year?

Kathleen Winters

No it’s not incremental, is $5 million to $6 million in 2017, but it was a pretty small number, couple of million in 2016.

Patrick Sanche

All right thank you. That's helpful. And then my follow-up, curious if you can share any thoughts on that Morningstar open indexes initiative that they talked about last I think it's December or November. It kind of interesting from the perspective that know there's a handful of buy side firms expressed displeasure with their indices licensing fees and certainly the initiative would be seeming to come after you a little bit, so curious about your thoughts on that?

Henry Fernandez

Yes, so first of all there's always been competition and new entrance I mean it running the company for 21 years there's always been so many creating another formally or globally indices, if you're going to look around there you could look at three, four, five branded indices providers or one category or another who have international indices, well all over in the world right. So that’s not new, I mean there’s always been those offerings throughout the last 20 years. I think is that, it's very hard, I mean - our value proposition is to be a standard of communication and a standard of comparisons, communication between the asset owner and the asset manager and a standard of comparison across investment products and across different entities.

So that the throwing at standard like that is very hard, because then you lose that standard being issues here, if you say okay, English is the language of the world, and you say now okay, now we're going to speak here, only three of us, well the mark right because the standard is English, right. So that's pretty hard to this on. The third element already that we are high value added and obviously premium product line will that standard it continuously innovating, continuously renovating the indices and the benchmark and all of that continuously evolving, so I’ll mix it also harder to catch up with that process as well.

Patrick Sanche

Great thank you.

Operator

Thank you. And our next question comes from Chris Shutler of William Blair. Your line is now open.

Andrew Nicholas

Hi this is Andrew Nicholas filling in for Chris. Just on the net sales front in the analytics segment. Obviously those were solid numbers in the quarter, but it does look like constant currency run rate growth continues to decelerate, just wondering if you can help me better understand what's driving that dynamic?

Kathleen Winters

Yeah there was a slight FX impact on the run rate. I don't have that number in my fingertips right now we can get that for you Andrew. But I think the key point here is that if you look at the sales numbers for really the second half of the year we've seen pretty healthy sales numbers in analytics in the Q4 30% and Q3 the recurring sales number was 26%. So even despite the cancels which are really isolated to those specific client segment that we referred to earlier. We’re pretty happy with overall performance.

Andrew Nicholas

Okay, thank you.

Kathleen Winters

Yeah I'm just checking the run rate numbers here, 3.4% on a reported basis, 3.8% at FX.

Andrew Nicholas

Right, right. It's just little bit down from second and third quarter. So that's why I was looking for a little more color.

Kathleen Winters

Yeah.

Andrew Nicholas

And then the second question I think you provided a little bit of guidance segment margins for analytics, if I'm not mistaken just curious if you could talk a little bit more about maybe segment targets for 2016 in the other segments and how that is kind of relative to your long term goals? Thanks.

Kathleen Winters

Yeah, so just to reiterate the long term target, right, index 68% to 72% margin target you know we're in that range that expect to continue to execute and stay within that range. Analytics are margin rate - our exit margin rate at the end of the year is almost that the long term target range of 30% to 35% so that’s a sustainable margin rate from our perspective and there is more improvement, more margin expansion to come to get strongly into that 30% to 35%. We do of course had a little bit of lumpiness from quarter-to-quarter sometimes, but when you thing about annual margin rate we’re pretty confident and continue to progression there and then or other segment we’ve made great progress with regard to restructuring in the real estate on product and we expect that progress to continue as well.

Andrew Nicholas

Okay thank you.

Operator

Thank you. And ladies and gentleman this does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Stephen Davidson for any further remarks.

Stephen Davidson

Thanks everyone for your time and have a great afternoon. Thank you.

Operator

So ladies and gentlemen thank you for participating in today's conference. This concludes today’s program. You may all disconnect. Everyone have a great day.

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