MSCI Inc. — Q3 2018 Form 10-Q
Business context and period. MSCI provides investment indexes, analytics and risk-management tools, ESG research and ratings, and real estate data and services. This unaudited quarterly report covers the three and nine months ended September 30, 2018; comparisons are with the same 2017 periods unless noted. MSCI adopted ASC 606 on January 1, 2018 using the modified retrospective method.
Financial performance
| Metric | Q3 2018 | Nine months 2018 |
|---|---|---|
| Operating revenue | $357.9 million, up 11.1% | $1,072.3 million, up 14.1% |
| Operating income / margin | $176.4 million / 49.3%; margin was 46.2% in Q3 2017 | $517.1 million / 48.2%; margin was 45.3% in 2017 |
| Adjusted EBITDA / margin | $195.5 million, up 15.9% / 54.6% versus 52.4% | $582.7 million, up 19.9% / 54.3% versus 51.7% |
| Net income | $123.8 million, up 45.4% | $355.8 million, up 48.6% |
| Diluted EPS | $1.36, versus $0.93 | $3.87, versus $2.61 |
| Operating cash flow | Not presented for the quarter in the filing text | $439.6 million, versus $261.0 million |
Revenue mix and segments. Q3 recurring subscription revenue was $267.4 million, up 9.9%; asset-based fees were $82.0 million, up 12.6%; and non-recurring revenue was $8.6 million, up 46.6%. Index revenue grew 13.9% to $210.2 million, Analytics grew 4.3% to $119.9 million, and All Other grew 23.6% to $27.8 million. Growth in All Other was led by ESG. MSCI-linked ETF AUM was $765.5 billion at quarter-end, up 13.5% year over year.
Cash, liquidity and debt. Cash and equivalents were $1.398 billion at September 30, up from $889.5 million at December 31, 2017. Nine-month investing cash outflow was $5.2 million and financing cash inflow was $80.6 million. Capital expenditures and capitalized software costs totaled $26.2 million. Long-term debt was $2.575 billion, representing $2.6 billion principal of senior notes; approximate net debt was $1.18 billion. The $250 million revolving facility was undrawn. The company reported leverage of 3.20x against a maximum covenant of 4.25x and interest coverage of 7.20x against a minimum of 4.00x.
Material changes and unusual items
- Growth and margins: Revenue and Adjusted EBITDA growth outpaced expense growth, lifting margins. Index results benefited from subscriptions and asset-based fees; ESG also expanded strongly.
- Tax: The effective tax rate was 15.7% in Q3 and 19.6% year to date, versus 29.5% and 29.6%, respectively, in 2017. Lower rates reflected Tax Reform and discrete benefits, including an $7.8 million valuation-allowance release in Q3 tied to the InvestorForce sale agreement. The 2018 year-to-date rate also included $8.8 million of excess stock-compensation tax benefits and an $11.8 million valuation-allowance release.
- Divestitures: MSCI sold Financial Engineering Associates (FEA) on April 9 for $21.0 million and recorded a $10.6 million gain. InvestorForce was classified as held for sale at quarter-end; its sale closed October 12 for $62.8 million cash. MSCI estimated a pretax gain of about $47 million and after-tax gain of about $41 million, subject to working-capital adjustments.
- Revenue accounting: ASC 606 changed the timing of revenue recognition and increased receivables and deferred revenue. Its reported impact through September 30 was to increase nine-month revenue and net income by $5.5 million and $4.4 million, respectively, relative to the former standard. The transition also included a $16.1 million increase to opening retained earnings. Comparisons with prior periods therefore are not fully on the same accounting basis.
- Capital returns and borrowing: Nine-month share repurchases were $269 million at an average $149.82 per share; dividends declared were $1.34 per share. MSCI issued $500 million of 5.375% notes due 2027 in May, using proceeds for general corporate purposes, including potential buybacks and acquisitions. A further $119.6 million of repurchases occurred through October 31.
Outlook, commentary and risks
No quantified financial guidance is provided in the supplied filing text. Management reported total Run Rate of $1.435 billion at September 30, up 10.0% year over year, and said cash, operating cash flows, available credit and market access should be sufficient for operating needs and commitments for at least the next 12 months. Run Rate is a management operating metric, not a forecast; realized revenue may differ due to renewals, asset levels, market movements, trading volumes, pricing, currency and revenue-recognition timing.
- Foreign-currency exposure remains relevant: 12.9% of nine-month revenue was subject to FX risk, and about 40.5% of operating expenses were denominated in foreign currencies. MSCI uses currency forwards to manage some exposure.
- BlackRock represented 12.2% of consolidated revenue for the first nine months of 2018, up from 11.1% in the comparable period, and 20.7% of Index revenue.
- Tax accounting for Tax Reform remained provisional; tax examinations include U.S. and foreign jurisdictions. The company said significant changes in unrecognized tax benefits were reasonably possible within 12 months, but could not estimate the amount.
- Management said pending legal matters were not expected to have a material effect based on currently available facts; it also noted that contingencies could affect results in a particular period. No material changes to disclosed risk factors were reported.
- The quarterly financial statements received a limited review by PwC, not an audit. Management stated that disclosure controls were effective and there were no material changes to internal control over financial reporting during the quarter.
Key facts investors should verify
- How much of reported earnings growth reflects underlying operations versus lower taxes, discrete tax benefits and the FEA gain.
- Whether subscription growth, retention and Run Rate growth persist; Q3 total Retention Rate was 95.0%, while the year-to-date rate was 94.5%.
- How market returns, net flows and product mix affect asset-based fees; Q3 average ETF AUM was up 15.5% year over year, while the reported basis-point fee rate declined.
- Debt, repurchases and dividends relative to cash generation, covenant headroom and the company’s capital-allocation priorities.
- Final InvestorForce sale proceeds and gain, final Tax Reform accounting, and any developments in tax examinations or legal contingencies.