Business context and reporting period
MSCI Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2013. MSCI provides investment decision-support tools, including indices, portfolio risk and performance analytics, and governance products. Its two segments are Performance and Risk and Governance. Results below compare Q3 and the first nine months of 2013 with the same 2012 periods; dollar amounts are in millions unless noted.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $258.2 | $235.4 | $768.0 | $703.1 |
| Operating income | $92.4 | $83.5 | $280.1 | $251.6 |
| Operating margin | 35.8% | 35.5% | 36.5% | 35.8% |
| Net income | $55.3 | $48.3 | $175.3 | $129.8 |
| Diluted EPS | $0.46 | $0.39 | $1.44 | $1.05 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $226.0 | $287.7 |
- Q3 revenue grew 9.7%; operating income rose 10.7% and net income rose 14.6%. For the nine months, revenue increased 9.2%, operating income 11.3% and net income 35.1%.
- Q3 segment revenue was $228.6 for Performance and Risk, up 11.3%, and $29.6 for Governance, down 1.4%. Nine-month segment revenue was $676.5, up 10.7%, and $91.5, down 0.5%, respectively. Performance and Risk growth included acquisitions; excluding IPD and InvestorForce, its revenue growth was 4.5% in Q3 and 3.7% year to date.
- Index and ESG revenue increased 20.1% in Q3 and 18.2% year to date. Portfolio management analytics revenue declined 10.0% and 8.7%, respectively. Governance growth excluding the sold CFRA product line was 7.4% in Q3 and 5.1% year to date.
- At September 30, cash and equivalents were $283.8, with no short-term investments; current assets were $590.1 and current liabilities $532.0. Total debt, net of discounts, was approximately $807.4 ($54.1 current and $753.3 long-term), versus $854.7 at December 31, 2012.
- Nine-month cash used in financing was $146.9, including $109.9 of treasury-share repurchases. Investing activities provided $24.9, including proceeds from matured investments, partly offset by the InvestorForce acquisition. Capital expenditures were $20.9 and capitalized software costs $1.8.
Material changes versus the prior comparable period
- Revenue gains were led by index and ESG subscriptions and asset-based fees, with additional contributions from IPD and InvestorForce, acquired in November 2012 and January 2013. Total Run Rate reached $1,025.8, up 12.1% year over year; excluding IPD, InvestorForce and CFRA effects, subscription Run Rate grew 4.4%.
- Average assets in MSCI-linked ETFs fell 17.0% in Q3 year over year, to $286.2, reflecting in part Vanguard ETF benchmark changes. Quarter-end ETF assets were $302.6, down 16.8% year over year but up 12.2% sequentially.
- Operating expenses rose 9.1% in Q3 and 8.1% year to date, mainly from compensation, staffing and acquisition costs. Cost of services increased faster than revenue, while lower intangible amortization and modest SG&A growth partly offset the expense increases.
- Nine-month operating cash flow declined $61.6 year over year, which management attributed primarily to the timing of receivable collections. Net income was higher, but working-capital movements affected cash conversion.
- Nine-month other expense, net, fell to $19.1 from $50.5. The 2012 comparison included $20.6 of refinancing-related fee expense; lower average debt and interest rates also reduced interest expense.
Outlook, commentary, risks and unusual items
- Management gave no specific numerical earnings or revenue guidance. It described continued investment in staff, technology, product development and global operations, while aiming over time to grow expenses more slowly than revenue and expand operating margins. It expects available liquidity to fund operating needs and scheduled debt payments for at least the next 12 months.
- On October 31, 2013, MSCI announced it had engaged Morgan Stanley to explore strategic alternatives for Governance, including a possible sale or separation. No transaction was assured; management noted a potential adverse outcome could result in impairment charges.
- The $880.0 term loan matures in May 2017 and carried a 2.18% rate at September 30. The company reported a 1.69x leverage ratio against a maximum of 3.25x and 23.00x interest coverage against a minimum of 5.00x. A hypothetical 100-basis-point LIBOR increase was estimated to add about $7.9 of annual interest expense.
- MSCI had $90.0 of cash held by foreign subsidiaries, some of which may face tax or legal restrictions on repatriation. The credit agreement restricts dividends and other payments; $355.7 was available for restricted payments at quarter end, subject to covenant terms and usage.
- Key exposures include foreign-exchange movements, market-driven and flow-driven changes in index-linked assets and fees, client cancellations, and portfolio analytics weakness. The filing also highlights possible regulation of benchmarks and proxy advisers, data privacy rules, and protection of index intellectual property.
- The company reported ongoing tax examinations in the U.S., U.K. and other jurisdictions. It considers its reserves adequate but said significant changes in unrecognized tax benefits may occur within 12 months; the amount and tax-rate impact could not be reasonably estimated. Management did not expect pending legal matters to have a material aggregate effect based on information then available.
- A $5.2 cumulative revenue reduction was recorded in 2012 to correct an immaterial revenue-recognition error for energy and commodity licenses; prior financial statements were not restated. MSCI also corrected a deferred-tax/goodwill allocation between segments in 2013 without an effect on consolidated results.
Most important facts for investors to verify
- Whether underlying subscription and index growth persists after excluding acquisitions, CFRA disposition effects and the Vanguard ETF transition.
- Whether portfolio management analytics revenue and retention stabilize; Q3 aggregate retention was 89.1% for that category versus 92.2% companywide.
- Progress and outcome of the Governance strategic-alternatives review, including any separation costs, impairment or transaction proceeds.
- Cash conversion and receivables collection trends, alongside the ongoing share repurchases and scheduled debt amortization.
- Potential effects of benchmark regulation, foreign-exchange movements, tax examinations and restrictions on foreign cash repatriation.