MSCI Inc. — Q1 2014 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2014; unaudited results are compared with Q1 2013. MSCI provides investment indexes, ESG products, and portfolio risk and performance analytics. Following its agreement to sell Institutional Shareholder Services (ISS), MSCI classified ISS and the previously disposed CFRA product line as discontinued operations and now reports one continuing business segment. The ISS sale closed April 30, 2014, after quarter-end.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Continuing operating revenue | $239.7 million | $219.5 million; up 9.2% |
| Operating income / margin | $79.5 million / 33.2% | $82.9 million / 37.8% |
| Continuing net income | $47.1 million | $53.0 million; down 11.0% |
| Discontinued-operations income, net | $33.3 million | $6.0 million |
| Net income / diluted EPS | $80.4 million / $0.68 | $58.9 million / $0.48 |
| Cash from operating activities | $25.2 million | $71.0 million |
| Cash and cash equivalents, March 31 | $260.5 million | $358.4 million at Dec. 31, 2013 |
| Long-term debt, including current maturities | $802.8 million | $807.8 million at Dec. 31, 2013 |
Index and ESG revenue rose 13.9% to $138.2 million; risk management analytics grew 7.3% to $75.6 million; portfolio management analytics fell 6.4% to $25.9 million. Recurring subscription revenue increased 8.5% to $195.0 million. Total Run Rate was $955.3 million, up 9.5% year over year. Aggregate retention was 92.8%, versus 92.4%.
Operating cash flow declined year over year amid higher expenses, income-tax payments, and payments of previously accrued compensation. Investing activities used $10.1 million, including $8.5 million of capital expenditures and $1.6 million of capitalized software costs. Financing activities used $109.3 million, primarily reflecting $107.2 million of treasury-share repurchases. The $100 million February accelerated repurchase had delivered 1.7 million shares by quarter-end; final settlement was expected by May.
Debt bore interest at 2.15% at March 31 and matures in December 2018; the scheduled final payment is $658.1 million, assuming no further prepayments. Credit-facility leverage and interest-coverage ratios were 1.89x and 21.57x, respectively, against limits of 3.25x maximum leverage and 5.00x minimum coverage. The facility restricts dividends and other restricted payments; $482.0 million was available for restricted payments at quarter-end, subject to the agreement’s terms.
Material changes and unusual items
- Revenue grew, but operating expenses rose 17.3% to $160.2 million; management cited investment in product development, sales, client service, and infrastructure. Operating income declined 4.1% and operating margin contracted 4.6 percentage points.
- Q1 2014 discontinued-operations income included a $30.6 million deferred-tax benefit related to ISS’s tax and book basis difference. This substantially boosted reported net income; the benefit was expected to be realized upon the sale closing. Q1 2014 effective tax rate on continuing operations was 35.9%, versus 28.6% a year earlier.
- ISS assets of $415.7 million and liabilities of $128.2 million were classified as held for sale at March 31. The April 30 sale price was approximately $367.4 million, subject to final working-capital adjustments. MSCI expected to record a gain in Q2 2014 and did not expect cash tax on the sale proceeds.
- BlackRock accounted for 10.4% of Q1 2014 operating revenue; no customer reached 10% in Q1 2013.
Outlook, risks, and contingencies
Management expected 2014 spending increases in sales, client service, IT, and product development to exceed revenue growth and slow operating-profit growth, while anticipating that these investments would support higher medium-term revenue and operating-profit growth. MSCI stated that existing cash and expected cash flows should fund operations and commitments for at least the next 12 months. The filing gives no specific revenue or earnings guidance.
Risks include market movements and fund flows affecting index-linked asset fees, foreign-exchange movements, variable-rate debt exposure, and elevated operating-cost growth. A hypothetical 100-basis-point LIBOR increase for one year was estimated to add about $8.0 million of interest expense. Foreign subsidiaries held $61.5 million of cash, some of which could face tax or local-law restrictions on repatriation. Management said pending legal matters were not expected to have a material effect based on currently available facts, while noting outcomes remain uncertain. Tax examinations are ongoing; significant changes in unrecognized tax benefits within 12 months were possible but not reasonably estimable.
Most important facts for investors to verify
- Q2 recognition of the ISS sale gain, final working-capital adjustment, and realization of the deferred-tax benefit.
- Whether revenue and Run Rate growth can continue while expense growth moderates and operating margins recover.
- Trends in index-linked assets, fund flows, asset-based fees, and the portfolio management analytics decline.
- Cash conversion, the effect of seasonal compensation and tax payments, and cash remaining after repurchases.
- Debt amortization and the large December 2018 final payment, covenant headroom, and restrictions on repurchases or dividends.
- Customer concentration, foreign-currency exposure, and outcomes of tax examinations and other contingencies.