MSCI

MSCI Inc. 10-Q Summary: Quarter Ended May 31, 2008

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended May 31, 2008, and the six-month period ended on the same date. MSCI Inc. is a leading provider of investment decision support tools, including equity indices (MSCI brand) and portfolio analytics (Barra brand). The company operates as a single segment and is currently in a transition phase following its November 2007 IPO, moving from reliance on administrative services provided by its majority shareholder, Morgan Stanley, to independent operations.

Key Financial Metrics

Note: Total cash includes $203.3 million deposited with related parties (Morgan Stanley) as of May 31, 2008.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 21.9% year-over-year for the quarter and 21.2% for the six-month period. Growth was driven by equity index subscriptions (+26.0%) and asset-based fees (+25.0% for the quarter), alongside a 94.6% surge in multi-asset class portfolio analytics revenue.
• Expense Increases: Total operating expenses rose 20.4% for the quarter. Selling, general, and administrative (SG&A) expenses jumped 47.6%, primarily due to $6.9 million in "founders grant" stock-based compensation (non-existent in the prior year) and costs associated with replacing Morgan Stanley services ($5.1 million).
• Net Income Decline: Despite revenue growth, net income decreased 6.1% for the quarter and 11.9% for the six-month period. This was largely due to increased interest expense from the $500 million credit facility established in late 2007 and the aforementioned stock-based compensation costs.
• Interest Expense: Interest income (expense) and other, net, swung from a $5.0 million gain in Q2 2007 to a $3.1 million expense in Q2 2008, reflecting higher debt service costs.

Outlook, Risks, and Management Commentary

• Run Rate: The company's "Run Rate" (forward-looking fees for the next 12 months) increased 21.4% year-over-year to $430.3 million as of May 31, 2008, indicating strong underlying demand.
• Retention Rates: The Aggregate Retention Rate was 91% for the quarter (down from 94% prior year), impacted by the cancellation of a TotalRisk subscription as the company transitions clients to the BarraOne platform. The Core Retention Rate was 92%.
• Transition Costs: Management expects operating expenses to remain elevated in the near term due to "initial set-up costs and overlaps" as the company replaces services previously provided by Morgan Stanley (IT, HR, legal, etc.).
• Liquidity: The company maintains a $500 million credit facility with $413.9 million outstanding. It entered into interest rate swaps in February 2008 to hedge floating-rate debt risk. Cash deposited with Morgan Stanley ($203.3 million) was transferred to MSCI and redeposited with Bank of America on June 30, 2008.
• Risks: Key risks include dependency on third-party data suppliers (e.g., potential disputes with the Korea Exchange), foreign currency fluctuations affecting asset-based fees, and the ability to successfully transition away from Morgan Stanley services without significant disruption.

Investor Verification Checklist

• Run Rate Sustainability: Verify if the 21.4% growth in Run Rate translates to sustained revenue growth given the recent decline in ETF asset values post-May 31.
• Expense Normalization: Monitor the trajectory of SG&A expenses to determine when the "overlap" costs of replacing Morgan Stanley services will cease and margins can expand.
• Stock-Based Compensation: Confirm the remaining amortization schedule for the $68 million founders grant to understand future earnings pressure.
• Data Supplier Relations: Assess the status of negotiations with key data providers, specifically the Korea Exchange, to ensure no disruption to index data feeds.
• Debt Service: Review the impact of interest rate fluctuations on the variable-rate portion of the credit facility, despite the hedging in place.