Good day, ladies and gentlemen, and welcome to the MSCI First Quarter 20 16 Earnings Conference Call. As a reminder, this conference call is being recorded. I will now turn the call over to Mr. Stephen Davidson, Head of Investor Relations. You may
begin. Thank you, Kevin. Good day and welcome to the MSCI Q1 2016 earnings conference call. Earlier this morning, we issued a press release announcing our results for the quarter. 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 ks and our other filings with the SEC. 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 terms 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 28 to 32 of the earnings presentation. On the call today are Henry Fernandez, Chief Executive Officer Bob Cutoff, Chief Financial Officer and Rich Napolitano, Principal Accounting Officer. With that, let me now turn the call over to Mr. Henry Fernandez.
Henry? Thanks, Steve, and thanks everyone for joining us this morning. Before I go into prepared remarks, a couple of programming notes. This was supposed to be Bob Kukov's last earnings call. But unfortunately, he has developed severe back issues, so he's not able to deliver his prepared remarks.
Bob is joining us on the line. Bob?
Thanks, Henry. I can say I've never had back issues in my life and I tell you what, I hope I never have them again. But I really wanted to be on this final call and say thanks for the opportunity to work with all of you on the call. It's been an honor to be a part of the fantastic journey that MSCI is on and I'm really looking forward to the following successes to come. I'll miss the team at MSCI, but I'll tell you what, I'm really looking forward to spending more time with my family and without the back pain I hope.
Henry?
Thanks Bob and continue best wishes for recovery on a speedy basis. Given Bob's painful injury, Rich Napolitano, our Principal Accounting Officer will deliver Bob's prepared remarks. For the Q and A session, we'll have Rich and our colleague Andy Wieschmann who heads up our Corporate Development and Financial Planning and Analysis Group. I will leverage on both of them in responding to your questions. And if there are any specific questions for Bob, he will continue to be on the phone line.
As all of you know, Bob announced his retirement several months ago. And since then, we have been in the process of recruiting his successor. I would like to thank Bob for his many contributions to MSCI during what was a period of tremendous growth and change for the company. After a successful conclusion to this process, I am pleased to introduce Kathleen Winters, who will be joining MSCI as our new CFO officially this Monday, May 2. The press release went out last night and I thought it would be great to introduce Kathleen who's here with us this morning to this important group and have her say a few words.
Kathleen?
Thanks, Henry. This is a very exciting time for MSCI as the firm continues to expand and grow its products. I look forward to joining the firm's leadership team Monday and I look forward to meeting and working with all of you on the call as well. Thank you.
Thanks, Kathleen, and welcome aboard. Hopefully another fantastic journey like the one Bob had. Let us now turn to the results. I am pleased to share with you our Q1 2016 financial results that build on the strong momentum we established coming out of 2015. In my opening remarks, I will walk you through how we executed our strategy in the Q1, which resulted in growing revenues, making us more operationally efficient and optimizing our capital base.
I will provide a strategic update on each of our product segments and provide you with a sense of where we are in the cycle of investing for growth and profitability. Then given the market volatility we saw during the quarter, I will highlight how we are leveraging our research enhanced content at MSCI to create new analytic services that help our clients manage their portfolios through volatile times. I will walk you through a couple of slides that show the resiliency of our recurring subscription revenues and the resiliency of inflows into ETFs linked to MSCI indices. I will then conclude my remarks with an update on our capital return efforts and the underpinnings of our capital allocation strategy. Please turn to Slide 3 for a review of our financial results.
A 6% increase in revenue driven by double digit growth in index recurring subscriptions and accompanied by a 6% decline in adjusted EBITDA expenses drove a 24% increase in adjusted EBITDA. These strong operating results combined with a lower effective tax rate and a large number of share repurchases drove a 36% increase in adjusted EPS. First, let's talk a little bit about revenue growth. Our top line growth was dampened by the market volatility in the quarter, which led obviously to a decline in equity values and therefore AUMs of ETF linked to MSCI indices. It also dampened the top line growth was also dampened by the timing of revenues in our analytics product line, which we expect to be mitigated in the coming quarters.
We are continuing to invest and innovate across MSCI by leveraging the research enhanced content we have and creating new one that we can leverage to create new products and services and incremental layers of revenue growth. Turning to operational efficiency, we are relentless in our focus on ensuring that our cost base is right sized and aligned with the most attractive investment opportunities. We are gaining greater visibility and insight into the drivers of our cost base through our new segment reporting, our new activity costs and a large number of new operating and financial metrics that we are developing. For example, we're working hard to further break down our regional profitability and we're looking to analyze our sales to get insight into client profitability and client behavior. One of the byproducts of this initiative will be a more granular view for example of pricing or price increases and volume in our sales.
As a result of these efforts so far and the new initiatives, we believe that we're well positioned to achieve incremental operational efficiencies while at the same time maximizing growth. Our tax planning work is on track to deliver further improvement in our operating tax rate in the quarters ahead. Finally, in terms of capital optimization, we took advantage of the significant volatility in our stock price in the quarter to repurchase 4,900,000 shares at an average price of $68.45 for an aggregate amount of $333,000,000 On slide 4, we show how we delivered in the Q1 against our areas of focus in 2016. In our Index Products segment, we are hitting on all cylinders with strong execution against all the key opportunities in 2016. The one area where the metrics were not favorable was the equity market, which was obviously out of our control, but it has since recovered since the volatility in the Q1.
In analytics, we're launching new products and services and we are keenly focusing on profitability, while at the same time continuing to invest for growth. Price increases in the Alenx product line are having a positive impact on sales. At the same time, our retention rates are quite strong at 95%. Lastly, in our all other segment, in ESG in particular, a strong 20 plus percent revenue growth continues to be driven by the integration of ESG into the investment processes of mainstream asset manager. And in real estate, the work that we have done so far over the past few quarters is improving the performance of this product line with the transformation of the products and services and the launch of a new real estate analytics portal.
On Slide 5, we highlight where we are in terms of the cycle of investing for growth versus profitability. As our overall operating profit margins have expanded due to continued solid revenue growth and improved profitability in analytics, we are continuing to invest and innovate to drive future growth. Our long term targets for the company and each of the segments reflect a balanced level of investment that allow us to continue to innovate and sell our products and services and at the same time continue to deliver higher profitability to our shareholders. While we will increase investment for the remainder of 2016 relative to the quarterly run rate of the Q1. We're also focused on profitability as reflected in the lowering of our full year 2016 adjusted EBITDA expense range.
On Slide 6, we highlight just one example here of how we're innovating analytics to help our clients manage their portfolios through volatile times and market dislocations. We are continuing to address this client problem by generating research, models, methodologies that helps our clients think through the solutions to this problem that they're facing. Then we take that this research and the accompanying models and methodologies and commercializing it by creating new services like for example the macroeconomic stress testing that we launched in the quarter which lets our clients stress test their portfolios for events like a Fed tightening or a China slowdown or a downdraft in commodity prices etcetera. It is because of innovations like this that MSCI was awarded best sales side market risk product for risk manager in the 2016 Waters Technology Awards. Please turn to slide 7 where we highlight the resiliency of our recurring subscription model.
We did some analysis here to help you think through this and the conclusion that we reach is that the larger our clients get in terms of run rate with us, the stickier they get. So when we go through periods of significant volatility, we would expect high retention from our larger clients, which is the majority of our run rate and lower retention sometimes from a smaller client that make up say less than 10% of our overall subscription run rate. Not a bad position to be in. And of course as we develop and deepen our penetration with the larger clients hopefully this virtuous circle will continue. The challenging start to 2016 dampened the growth rate of our asset based fees as highlighted on Slide 8 by the daily progression of ETF AUMs linked to MSCI indices.
As this slide shows, it is the journey that counts, not the beginning point and the end point. Our revenues from the indices we license to ETF providers are based on the average of daily AUM over the course of each quarter. This chart illustrates how the daily AUM levels compared to the average of those daily AUM levels during the quarter during Q1 and through all the way to April 26. Due to the significant decline and subsequent recovery of daily AUM during the quarter, the average daily AUM for Q1 is lower, meaningfully lower than the starting level and the end level. Fortunately, given the recovery of the equity markets and the continued inflow into ETF linked to MSCI indices, in Q2 so far, our average daily AUM level is up significantly compared to Q1.
On slide 9, we highlight the resiliency of these inflows into ETFs linked to MSCI indices. We've done another amount of sharp work here to understand the behavior of this. Growth in revenue from the indices that we licensed to the ETF providers have been pretty resilient in periods of market decline because ETFs linked to MSCI indices have consistently captured positive cash flows. And the magnitude of those cash flows has far, far outweighed the negative impact from market declines. This chart illustrates the impact that cash flows and market movements on AUM in those ETFs linked to MSCI indices since 2012 and through the Q1 of 2016.
ETF linked to MSCI indices have captured positive cash flows in 15 out of the 17 quarters since 2012, including 5 out of the 7 quarters when the impact from market movement was negative, in some cases rather negative. As measured by dollars, the net impact from cash flows was 15 times greater than the net impact from market movement since 2012 or about $221,000,000,000 compared to $15,000,000,000 This strong trend can be attributed to the overall growth, secular growth of the equity ETF market combined with the strength of our indices, our brand, our client support, our relationship with ETF providers and of course the investment pattern of our clients. On slide 10, we have an update on our capital return efforts. Now that we have paid incentive compensation and taxes in the Q1 and excluding the outcome in dividend, we have approximately $200,000,000 in excess cash. We have delivered on our commitment to not store excess capital.
And as our cash balances have declined to more normal operating levels, we now have even more flexibility to be more opportunistic and discerning with our share repurchases. We expect to repurchase more shares at lower prices and less at higher prices as we have done before with a little more discerning to that effect. Capital deployment is a dynamic process that is constantly being evaluated with our Board against various competing uses. As we begin to explore the possibility of adding incremental leverage, giving our natural deleveraging as we grow and giving our target of leverage gross leverage of 3 to 3.5 times, we want to ensure that we maximize every dollar deployed and that we get an approximate return, an appropriate return and a high return for our shareholders on those dollars, all of which weigh above our cost of capital. Given all of this, please turn to slide 11, where we try to highlight the hierarchy of uses of capital that support our capital allocation framework.
Our first dollar typically goes to high return organic investments, followed by some inorganic investments if they exist, principally small bolt on acquisitions if they provide high returns. Next, we look at returning capital to our shareholders through the most efficient and accretive method. And lastly, we examine at times the repayment of debt if necessary or if appropriate given the cycle. Our Board of Directors is keenly focused on this capital allocation framework to ensure we achieve the highest return on our capital and equally the most optimal amount of capital base to support our business. So with all of that, I'd like to now pass it on to Rich Napolitano who will be stepping in for Bob.
Thank you, Henry. Please turn to Slide 13, where I will begin my overview of our financial results. Our results this quarter was solid with a 6% increase in revenue and a 6% decline in adjusted EBITDA expenses, driving a 24% increase in adjusted EBITDA and a 6 80 basis point increase in our adjusted EBITDA margin to 47.8%. Again, as a reminder, in the slides that follow, we provide the impact of foreign currency fluctuations on our subscription revenue and costs, but we do not provide the impact on foreign currency fluctuations on our asset base by the average AUM, of which approximately 2 thirds are invested in securities denominated in currencies other than the U. S.
Dollar. On Slide 14, we show the positive impact on our adjusted EPS for the various levers we are pulling to create value for our shareholders. Adjusted EPS increased $0.18 or 36% compared to the Q1 of 2015. First, in terms of core growth, higher subscription revenues coupled with more muted ABF revenue growth as a result of the decline in equity values at the beginning of 2016 benefited EPS by $0.10 per share. Turning to operational efficiency, strong expense management and a lower effective tax rate contributed $0.05 per share.
And in terms of capital, the adjusted EPS benefit from share repurchases was partially offset by higher net interest expense, but resulted in accretion of $0.02 per share. And lastly, FX contributed about $0.02 to adjusted EPS, again excluding the impact of FX on our AUM. On Slide 15, we provide you with a bridge for the year over year change in our revenues by segment and by revenue type. Total revenues increased $16,000,000 or 6% to $279,000,000 year over year, driven by an increase of $13,000,000 or 6% in recurring subscription revenues, principally due to a 10% increase in index recurring subscription revenue and an increase of $3,000,000 or 6% in asset based fees. Currency fluctuations had a negligible impact on the recurring subscription revenues.
Turning to Slide 16, we provide you with the year over year adjusted EBITDA expense bridge. Overall, the combination of a 5% reduction in headcount, a $3,000,000 non cash charge in the prior year and strong expense management drove the year over year decline in our adjusted EBITDA expenses. 1st quarter adjusted EBITDA expenses decreased $9,000,000 or 6 percent to $146,000,000 and decreased slightly compared to the Q4 of 2015. Excluding a $4,000,000 benefit from foreign currency exchange fluctuations, our adjusted EBITDA expenses would have decreased $6,000,000 or 4% year over year. As shown in the upper chart, the non cash charge in the prior year was a significant driver of the year over year decline and is reflected in lower research and development costs, which we have shown in the lower chart.
While total research and development cost was down, we continue to invest in areas to support our growth strategy. The $7,000,000 decline in cost of revenues was broad based across client service and consultant, technology, data services, product management and research functions. On a linked quarter basis, costs were relatively flat as a reduction in technology related professional fees, stock based compensation and severance mostly offset 1st quarter seasonal increases in compensation and benefits. On Slide 17, we provide you the run rate bridge for the quarter. Our reported run rate increased 8% to $1,100,000,000 consisting of a 9% increase in subscription run rates to $913,000,000 and a 5% increase in ABF run rate to $199,000,000 dollars Over the past two quarters, we've been encouraged by the higher levels of new recurring subscription sales as well as higher non recurring sales, which has generated significantly higher levels of gross sales.
Strong recurring subscription sales combined with lower cancels resulted in net new recurring sales of $20,000,000 in the quarter, which is the highest level since 2,009. Our aggregate retention rate was a record 95% across MSCI in the quarter. While it is too early to call a change in the trend, we believe that many of our sales initiatives are beginning to take hold, so we are cautiously optimistic in the outlook. On Slides 18 through 22, I will walk you through our segment results. Let's begin with the Index segment on Slide 18.
Revenues for Index increased 8% on a reported basis. The double digit increase in recurring subscription revenue in the quarter was driven by strong double digit growth in revenue from developed and emerging marketsmallcap modules
and from
our custom factor, thematic and ESG based products. The adjusted margin, EBITDA margin for index was 69% compared to 70% in the prior year and 69% in the 4th quarter, which was in line with the guidance we provided on the Q4 earnings conference call. Decline in margin year over year was driven by higher research and development, selling and marketing as well as general and administrative costs. Index recurring subscription sales increased 14% driven by strong core benchmarking products. Cancels were in line with our expectations and we recorded very strong retention of 96%, just below the record 97% we set in the prior year.
On slide 18, we provide you with our leadership positions as an index provider to the ETF market in the Q1. On Slide 20, we provide you with detail around our asset based fees. Challenging market conditions early in the quarter dampened the growth of average ETF AUM linked to our indices. But this headwind reversed by the end of March and we ended the quarter at 438,000,000,000 in AUM with inflows of $7,000,000,000 in the quarter, which we show in the upper right chart. Turning to the upper left chart.
Overall asset base fee revenue increased $3,000,000 or 6% driven by a $2,000,000 or 20% increase in institutional passive of revenue as well as a $500,000 increase in revenue, contracts based on our indices. Average AUM and ETFs linked to our indices increased $15,000,000,000 year over year or 4%, but that increase was offset by a 4% decline in the average basis point fee as indicated in the lower right chart. The decline in the average basis point fee year over year was driven by mix due to the movement away from higher emerging market products to lower fee developed market products, including the U. S, which we show in the lower left chart, as well as a product mix within the developed market funds to lower fee products. On a linked quarter, asset base fee revenue declined approximately $2,000,000 or 3%, driven by a $2,000,000 or a 5% decline in ETF revenue.
This was partially offset by modestly higher revenue from institutional passive and exchange traded futures and options linked to our indices. Subsequent to year end I'm sorry, subsequent to quarter end and as of April 26, AUM and ETFs linked to our MSCI indices have increased to 450,000,000,000 on inflows of $3,000,000,000 and market appreciation of $9,000,000,000 which brings the Q2 to date average to $441,000,000,000 for AUM. We have continued to see strong inflows into iShares MSCI USA minimum volatility ETF. On Slide 21, we highlight the financials for the Analytics segment. Revenues for Analytics increased 3% on a reported basis and adjusted EBITDA margin increased to 28% compared to 13% from the prior year quarter.
The increase in revenue was primarily driven by higher risk manager, Equity Models, Wealth Bench and Investor Force Products. While revenue grew 3%, run rate grew 7% year over year with the divergence reflecting when sales are booked and recorded in run rate versus when recognized in revenue. This divergence between revenue and run rate should close in the quarters ahead. The dramatic increase in margin year over year was driven by 14% increase I'm sorry, a 14% decrease in adjusted EBITDA expenses as the product area continues to transform and improve profitability, while at the same time investing in future growth opportunities. The margin was higher than guided on the 4th quarter call due to decreases in non compensation expenses, which more than offset seasonal increases in compensation and benefits.
While new recurring sales were softer in the quarter, driven by lower risk manager and equity model sales, Lower cancels more than offset the decline in recurring sales and retention increased to 95%, up from 93% in the prior year. And lastly for our segments, turning to slide 22, we have the All Other segment. Revenues for All Other increased 7% to $24,000,000 on a reported basis and grew 9% on an FX adjusted basis and adjusted EBITDA margin turned positive at 11%. First, in terms of ESG, a $2,000,000 or 21% increase in ESG revenue to $11,000,000 was due to strong sales driven by the increasing integration of ESG into our investment process, as Henry has mentioned, with approximately 40% of the sales coming from new clients. Run rate growth of 22% was driven primarily by growth in ESG ratings with particularly strong growth in ESG ratings in the Americas, which grew 39%.
Turning to Real Estate, a tough year over year comparison due to the early delivery of our PAS flagship reports in the prior year, partially was offset by higher market information product revenue in the current quarter, resulting in a slight decline in revenue to $13,000,000 Excluding the impact of FX, real estate revenue would have increased 1% compared to the Q1 last year. In the quarters ahead, we anticipate that the performance of real estate should continue to improve reflecting our restructuring efforts in the launch of our real estate analytics portal. On Slide 23, we provide our key balance sheet indicators. We ended the quarter with cash and cash equivalents $445,000,000 which includes $126,000,000 in cash held outside the United States and a domestic cash cushion of approximately $125,000,000 to $150,000,000 which as a general policy we maintain for operational purposes. Free cash flow in the quarter of $28,000,000 was below prior year levels due to timing of collections and higher interest payments and the decline compared to the Q4 was primarily due to the seasonal payment of our annual incentive compensation and bonuses.
On Slide 24, we highlight the progression of our full year 2016 adjusted EBITDA expense range. We now expect full year adjusted EBITDA expenses to come in between $600,000,000 615, dollars down from the range of $610,000,000 to $625,000,000 $3,000,000 of that $10,000,000 decline in the range was due to positive currency moves, but $7,000,000 is from savings from general expense management and corporate efficiency efforts. We expect that higher adjusted EBITDA expenses principally from technology related professional fees and information technology costs will flow through in the back half of twenty sixteen. With the introduction of our segments and activity costing, we are beginning to acquire better visibility into our expense base and opportunities to become more efficient are being identified. On Slide 25, we'd like to reiterate our guidance for full year 2016 with the only change being our full year adjusted expense I'm sorry, our full year adjusted EBITDA expense range, which I just discussed.
Lastly, we continue to work hard toward our long term targets. And with that, we'd like to open up the line
Our first question comes from Alex Karem with UBS.
Hey, good morning everyone. Good morning. Hey, I wanted to talk about the sales and in particular as it relates to pricing. I think in the last quarter, you alluded to the fact that in particular on the risk side, you were starting to take pricing for the first time in a while. Meanwhile though, the environment has certainly gotten a lot tougher, right?
So just wondering how those pricing discussions have gone, if you if a lot of the sale if you're seeing some of the impact already reflected here or if there's more to come and obviously how much pushback you're getting from clients? Thanks.
[SPEAKER JOSE RAFAEL FERNANDEZ:] Yes. So definitely we're on a journey to better match the pricing of our analytics product line to the value that we believe we're providing to our clients. And we've rolled out price increases pretty much across the board. Those discussions are going relatively well. Obviously, nobody wants to pay more for things and therefore there's always an element of that.
But they're going pretty well. They are we're making sure they go through and we're discussing with our clients and there is no we don't identify any fewer cancels at this point because of that. And people are beginning to understand that we got to invest in the product line. We got to do more things and we got to become more profitable as well. So they're going well and there is a little bit of that being reflected in the Q1.
I will say maybe 20% 25% of the sales in the quarter are price increases at this point, and we're going to continue to see that going through throughout the year.
Great. That's helpful. Thank you. And then just secondly, on the tax rate, you talked about continued efforts to bring that down. Can you just give us an update where you stand on that?
And maybe as part of the answer, there obviously has been some new guidance recently from the Treasury Department around all the earnings stripping and things like that that's going on. Is that going to hinder some of your journey there or it was that not or you think you can still bring that tax rate down materially with maybe some of the new rules here?
We are looking very closely at the new rules that are being proposed. And at this point, we're still standing firm with our guidance of 33% to 34% in our plan for this year. But at this point, we don't see this is going to materially change our goals.
But in terms of goals longer term, I mean any because I think you've done a ton of work for where you could go over the next couple of years. I mean is that kind of change anything or too early to tell?
Well, I think at this point we definitely would expect a gradual decline in the tax rate as we continue to do that work and execute on it. We have gone through a progression of a we had initially a cost plus model. We're going through we executed at the end of last year a process in which we're shifting the profits to better represent where the activity is being performed across the world and that has benefited us so far. Ultimately, we want to go to something that is called Principal Hub model. And that is probably at this point not going to be implemented until the end of this year.
And that will help us lower the tax rate further. That's what we're looking to do and obviously operationally it's quite a lot of work to achieve all
of that.
And the current set of regulations by the Treasury doesn't seem to affect us at all. But you never know what new things get thrown at us by any one of the taxing authorities around the world.
That's fair enough. Thanks very much. Take care.
Our next question comes from Chris Shutler with William Blair.
Hey, guys. Good morning. On Slide 5, guys, that's where you're talking about striking the right balance of investing in margin with Q1 being tactical. So I'm just curious on in the back half of the year, where will spending go up? And can you be a little bit more specific?
I think you mentioned professional IT costs, but what exactly will you be spending on that would drive expenses higher? And will it be offset by other things they have in the works?
Well, the Q1 was a tad unusual in which when you see the average 1.57% here because we started the year with a lot of our budget and all our plans for continued investment and balancing out profitability versus investment. Now given the volatility that took place in the market at some point in the quarter, we decided to slow down certain investments because we didn't know, like most people, whether we were in a bear market, the beginnings of a bear market or whether it was just a nasty correction. We didn't want to be stranded with a lot of high cost if it was a protracted bear market for the balance of 2016. So we slowed down a few things. Some of them for example in the index coverage efforts and things like that.
So now that the market has recovered, we want to step up a little bit of that, but within the target of profitability that we talked about. None of it is in any way shape or form to dampen significantly or meaningfully our profit margins that we have for the year. But some of that needs to come back up. So there'll be investments in coverage, salespeople, client service, consultants. There will be investment in the back end in technology.
If you see, for example, capital expenditures, the average in the quarter was low. We need to step that up in order to achieve the targets we wanted to achieve. There have been similar declines in operating expenses in technology that we need to get back on track. But again, I want to emphasize that this back end and none of that will necessarily happen in the Q2 by the way. Q2 may end up being not largely dissimilar to the Q1, but we got to step it up at some point in order to continue to invest for future growth in the company in product management, in some of the technology efforts and the data efforts and in coverage.
Okay, thanks. And then a question on fixed income capabilities and within kind of the old what used to be the old RMA and also index. I think the thought for a while used to be that MSCI was a likely acquirer to build up your fixed income capabilities. Obviously, that hasn't transpired. So maybe just talk about your efforts to build out a more comprehensive fixed income offering as part of the multi asset class solutions you're offering?
And is that as important a goal today as it was a couple of years ago for MSCI?
[SPEAKER DANIEL MARTINEZ VALLE:] I think it's more important today than it was in the past. Underneath some of these efforts that you see in analytics, in the analytics product line, there is a meaningful amount of investment that is going on architecture and interface that we talked about, which we continue to develop and showcase it with clients. We haven't started really selling it, but we're beta testing it and things like that. And importantly, a meaningful amount of investment in fixed income analytics, both for multi asset class risk and performance and for portfolio management in fixed income in purely fixed income portfolios. We spent an inordinate amount of time since December in consultations with key clients around the world.
I think we've done 50 or so consultations as to what they would like to see in fixed income portfolio management analytics in our offering and therefore what investments we should do. So that continues. The way we have funded that has been by a relentless effort to look and relook and relook at the cost base of analytics and deprioritized things that were longer term and maybe didn't have as big of a payoff by reassigning creating efficiencies and the like in order to make room for these two meaningful investments in the product line, which is the new technology platform, the new software platform that will overlay on top of Risk Manager and ParaOne and PPM. And secondly, on a newer initiative is fixed income analytics. And we are heavily invested in that area in the context of these financials.
So I think the team in the LAX BOLA has done a marvelous job of trying to keep sales high if we can, retentions high, hammering and hammering at the cost structure and making room for investments while we keep an increase in profit margin.
All right. And last one, quick one. The, Henry, you called out earlier kind of rough 20% to 25% sales of sales or price increases. Was that specific to analytics of the business overall? And could you compare that to a year ago?
[SPEAKER JOSE RAFAEL FERNANDEZ:] Yes. Look that is roughly it's all analytics. That comment was all on analytics across the board. We no longer make a distinction, the old distinction that we have between RMA and PMA and all of that because we're trying to commingle all of it into a front to back offering of portfolio management and risk management. So it's all analytics across.
As you may remember, though, we had started taking steps to increase prices in portfolio management analytics, equity portfolio management analytics couple of years ago and we continue a bit last year on a smaller run rate of the old PMA product line. What we're now attacking in a big way is the right what is the right pricing, which has led to price increases versus the value of the multi asset class portfolio analytics and therefore risk manager and Barrow 1, managed services and all of that. And that's what we are rolling out and that was the comment I made at the beginning of the Q and A
question. But how did the 20% to 25% compared to a year ago in the analytics segment? So if you're at 12.4 $1,000,000 of recurring sales this Q1, dollars 13.5 last Q1?
No, it's much higher, much higher than
this
quarter last year. The comment I just made, right? If you look at the price increases we're doing on the OPMA, the OPMA run rate was 100 plus 1,000,000. The analytics, the multi asset class run rate was 300 plus 1,000,000. So those selected increases that were on PMA don't compare to the price increases in aggregate dollar to the price increases we're doing in the all multi asset class risk analytics.
Okay. Got it. Thank you, guys.
Sure.
Next question comes from Hugh Miller with Macquarie.
Hi, good morning. Thanks for taking my questions. Had a question as we look at the success that you guys have had with the margin growth in the other segment. Obviously, still below the longer term or medium to longer term target 15% to 20%. But as we consider kind of the returns in ESG versus real estate, how should we be thinking about product mix in those categories?
Is one product meaningfully more profitable than the other?
Yes, surely. At this point, that segment or other is composed of 2 product lines, the ESG product line and the real estate product line. The ESG product line is red hot, red hot, right? I mean it's as Rich indicated, revenues grew 21% from last Q1 last year. Run rate grew 22%.
We are capitalizing enormously on the relationships that MSCI, the other parts of MSCI have with the big mainstream asset managers in order to penetrate to have this product be penetrated in those mainstream asset managers as they are beginning to look at investing on the basis of ESG criteria. So that is done well. The profitability of that product line has increased meaningfully. It was say losing money 2, 3 years ago. It got to breakeven a couple of years ago.
And now it's got a little bit of a profit margin. I think the trade off there on ESG is that we've got to continue to invest. This is a very large opportunity in the world. And you've got to invest in products. You've got to invest in coverage, in sales and so on and so forth.
So that's the trade off we try to do. So we but we want to do it in a disciplined way. So we've asked the team to show up with more profitability, to good discipline and create more operational efficiencies so that we can continue to reinvest back into the product line. Now real estate is in a different state of development, which is when we bought this business, we knew we needed to do a radical surgery to it in order to prepare it for a global footprint and global expansion and all of that. We needed to run the product line, automate the data processes, create new technology, create better delivery systems to our clients through this new real estate portal and the like relocate the vast majority of the staff from the U.
K. To emerging market, especially India. So major, major transformation of that product line. And I think we are we probably have the worst over in that process and in terms of the financials. And now we're continuing to see improvement.
The product line got obviously hit by the fact that a lot of the sales are in pounds because this originally was largely a U. K. Business. So those translate into dollars. So meaningful decline in growth rates.
But they continue to grow and the profitability has increased dramatically from a loss to a little bit of a profit hopefully this year. And we want to continue on that growth. So as I've said before, one of our goals is to across the company is to maintain the profitability that we have in index, was to increase significantly the profitability of analytics, which we have achieved and obviously have more work to do. And this incubator of new businesses and new product lines, which the all other segment to get it to a position that it contributes meaningfully to the profit margin of the company. But we got to be realistic that this is an area where investment is needed and therefore we're going to overweight investment versus profitability.
And we'll see better profitability, but it's not going to yet get to levels similar to the other businesses.
That's helpful. Thank you very much. And I guess as we think about operational efficiency, obviously you guys have made great strides in automating process and kind of limiting growth in headcount. But we've also seen kind of a shift towards headcount in emerging markets and it gets up to 53% of the total versus closer to 50% a year ago. Should we continue to see that happening?
Do you have a target in the next maybe 3 to 5 years as to the amount of headcount you probably see in emerging markets relative to developed?
Yes. We definitely want to continue on all of the above for sure. I think at this point, you'll see that EMC, DMC split continue to each upward. Not yet clear where the targets are. Obviously, we're pushing as hard as we can to make it higher.
I think once you start getting into the 60s, you may start getting to the limit. And a lot of it is because you got to have a lot of our sort of senior product people, our coverage people, our consultants in big financial centers of the world, which is where our biggest clients are in New York, London, Boston, Chicago, the major European capitals and Tokyo, Hong Kong, all centers that obviously are more expensive than in emerging markets. And that makes you got to have people there and a lot of people in order to service the client base. So that's kind of where we are. Now importantly, take this opportunity to say that a lot of the last 2, 3 years we've embarked on a process of really pulling out as many metrics, operating metrics, financial metrics, putting the financial software systems to be able to automate those and then hire finance directors that we couple with business people and engrain it in the culture so that the whole company is being managed by metrics, by daily metrics in financial metrics, operating metrics and all that.
We're in a journey. We're probably a third of the way in that journey. And that's why the comment that I made and the comment that Rich made is that it makes us cautiously optimistic that as we develop deeper and deeper metrics that the that's going to help us make better understanding of the cost and how do we squeeze it. It's going to be better understanding of profitability and how to go to the profitability and how to go to the places where it's higher. How do we understand the value proposition to our client versus the pricing and so on and so forth and therefore makes us hopeful that this operational efficiency will continue.
This increase in revenues will continue from being smart about how you allocate it and on top of that the investments in new products.
Got it. Okay. Thank you very much.
Our next question comes from Toni Kaplan with Morgan Stanley.
Hi, good morning. Focusing on the asset based fee business for a second, you highlighted that the fee rate ticked down because of the mix shift between EM and developed. So just putting that aside, in terms of contract renewals, in that business, can you talk directionally about how the fee rate is trending? And also have you been gaining market share of U. S.
Flows or was it more just market shift more market driven And is gaining U. S. Flows a strategic priority right now?
[SPEAKER JEAN FRANCOIS PRUNEAU:] So one, the sort of bouncing around a little bit of the bps is totally, totally mix driven, totally, which is totally out of our control, right? Secondly, no change whatsoever on the renewal of contracts and the fees and all of that compared to all the practices that we have had. So basically zero change there. And then 3, yes, given the factor investing huge push that we're making is allowing us to be more to launch a lot of domestic products with indices and license it to our ETF clients. And that has that's a priority of ours.
That's a good way for us to be domestically relevant in many of the big markets. So when you look at the MSCI, iShare or the iShare MSCI minimum volatility ETF has been capturing significant amount of flows. And that's great because it's all a domestic product with good fees and good revenues for iShares for us and it's a win win and it makes us much more relevant in the domestic market.
Okay, great. And just another question on the higher level of investment for the remainder of this year. Is that going to be focused more on some certain segments? I know analytics margins have been a little bit higher than the 25% that you've been talking about as like a normalized level. Like is that 25% still the right normalized number to think about?
Or is it a little bit higher than that in analytics?
Yes. On analytics, I on analytics, the last two quarters have been great positive surprises, clearly, for us and for you. And a lot of it is because we keep hammering and hammering away of the allocation of cost and investments and all of that and that has yielded positive results. But the product line needs investment. This new architecture is hugely important in order to not only create the platform for higher growth of the product line, but also making us even more efficient because we have so many platforms that we got to maintain, right?
So and now with this new initiative since the Q4 on fixed income analytics, again, we're incubating that initiative by growing Peter to pay Paul, so to speak. But at some point, as we see the development of revenues in that initiative, we'll have to fund it additionally. So that's why I think that we got to be realistic and I think 25% is not a bad number to use.
Okay, great. And then just lastly regarding M and A, can you just give us some color on the pipeline? And are there any areas that you're more focused on right now? Thanks.
[SPEAKER DANIEL
MARTINEZ VALLE:] Yes.
I think, Darren, in M and A, I mean, we obviously, the last 10 years, we made the big acquisitions we wanted to make to position the company well. We're not really looking for any kind of bigger type of acquisitions unless they're blatant. They're right in our mainstream and they create significant amount of shareholder returns. If not, will pass, right? So we are focused on trying to look for bolt ons at this point.
And those are opportunistic and they come sometimes they don't. But in all of these things, we're here to create value and therefore the discipline of the returns, high returns is dogmatic and obsessive.
Thanks a lot.
Our next question comes from Joseph Foresi with Cantor Fitzgerald.
Hi. Can you talk about the improvements in your go to market in light of the kind of new subscription sales number that you've talked about? What particular business lines do you feel like you're having the most success there?
Look, Lorenzo here, our Global Head of Coverage, Client Coverage is sitting here next to me and smiling, right? He joined us, I don't know, 16 months ago, 15 months ago and he's done an incredible job in revamping the go to market strategy in a variety of ways. We've changed dramatically the compensation system. We launched that at the beginning of this year to a much more incentivized system. So far so good, early days, but so far very good.
We can attribute some of the success on the Q4 and the first quarter through that incentive plan. 3, we've streamlined a lot of the efforts there. We've drove out lower performers, focused on the higher ones, make sure we're focused on the right territories and so on and so forth. We've had we put a lot of effort into the senior account managers in order to go to the C level of our clients and in addition to the bottom up selling, the top down selling and those are beginning produce some great results. So I think that across the board, not just in one product line, across we by the way, we merge all the we brought out there Laurent's leadership, all of the product lines from real estate to ESG to that.
We regionalized them under the leadership of the various regional managers. We have a complete team among the regional managers. He and his finance team have done an incredible job building out all the metrics. So we're looking at managing the whole coverage effort by metrics every place. So all of that is yielding great results and it's all across the board and more to come.
[SPEAKER JOSE RAFAEL FERNANDEZ:]
Got it. And maybe we could delve a little bit more to analytics. How sensitive is that business to market volatility? I think you mentioned maybe some delays in 1Q because of what we saw there. And where do you stand from a progression standpoint in improving the overall portfolio?
Like what inning do you think you're in from that perspective? [SPEAKER DANIEL
MARTINEZ VALLE:] Yes. Look, I think there are 2 kind of conflicting trends in market volatility with analytics. On one hand, when volatility increases a lot, the product is more badly needed. People want to focus on risk and where the performance is coming from and all of that. So the theoretical demand goes up.
On the other hand, sometimes some clients some types of clients get a little bit itchy and they slow down the decision making process and therefore the pipeline slows. We don't tend to see things coming out of the pipeline. Honestly, what we just tend to see is that, gee, we were hoping to sign it this quarter and just slip to the 1st few weeks of the next quarter and therefore that makes the sales a little more volatile sometimes. So that's now where we are, I think that I'm going to say something that sometimes people I think analytics over time over a 10 year period could potentially surpass the size of the index business. And the reason is that there are a lot more use cases that you can apply this to around the world.
There are so many asset managers and asset owners that need a platform to be able to understand performance and risk and portfolio construction and asset allocation. And I think we're only in the early innings of providing that. But it's a new industry. It's a new process. It's a new this where we're largely it.
We're at the forefront of all of that. And obviously, we are doing it with legacy systems and legacy products. And we're trying to break out of that problem in order to grow faster and be more profitable. But I think this is a tremendous opportunity for somebody, and I hope that is that turns out to be for MSCI.
Got it. And last one for me real quickly. Can you talk about other opportunities for potential cost containment? Obviously, you're going through the portfolio and you talked about being a third through the journey of understanding the cost. But are there any particular areas that you're focused on examining the cost structures right now and think that there may be more opportunities?
Thanks.
I think it's blocking and tackling. We're focused intensely on performance of people, so that if somebody giving them a chance, not performing, we upgrade and therefore create more productivity at a fixed cost. Secondly, this whole metric that I'm talking about is huge. It's huge. I mean, we always had good instincts and good gut feelings and the like and we make great decision.
We're trying to improve that decision making process dramatically by preaching to the same thing that we tell our clients, manage our portfolios with quantitative tools, right? So manage our decisions by metrics. And that has a lot of improvement, improvement in figuring out the cost and what the payback of those costs, figuring out in the investment, what the returns of those investments are, put the money where it's a higher multiple evaluation rather than a lower multiple evaluation and not every dollar or EBITDA is valued the same and so on and so forth. So as I said, we're in the early innings of that and I think that will yield a lot of results over time.
Thank you. Our next question comes from Warren Gardner with Evercore.
Great. Thanks. Good morning. So you guys gave us a lot of good sort of updates on the level of price increases you guys have been able to kind of pass along on across the index side and the analytics side, I think over the past year. But could you kind of give us a sense of maybe where or how much of kind of current subscription run rate is yet to be repriced for both of those areas?
Well, look, one thing that is important to keep in mind is that we are in the middle of a lot of work in understanding the pricing and the level of price increases in renegotiations of contracts versus the volume versus volume, how much of the run rate is subject to this, how much of it is not and all of that. And we're giving you directional comments because we're not yet in a position to give you very specific metrics. And this is part of the metrics work hopefully in the next couple of quarters we'll be able to give you very specific things with a high degree of confidence. I mean we know a lot, but we want to double check and triple check all of those numbers. At this point, quite a lot of the multi asset class risk management analytics run rate is not yet priced at a level that is commensurate to the value that it provides.
Okay. Fair enough. And then I guess with some of the M and A or I guess proposed M and A out there, I mean are you guys seeing any signs of increased opportunity for index switches on the ETF side at all?
We are and we're seeing a major differentiation those index providers that are revenue centers to the client like we are versus those that are cost centers. So we're seeing a bit more pressure by ETF sponsors to rotate out of those that are at a lower cost if they don't add a great deal of value. The benefit of MSCI is that given our $10,000,000,000,000 of client assets that are benchmarked to MSCI, a lot of ETF launches are option contracts, so to speak, call on that money to be invested in those ETFs. So we become a revenue center for our clients. So we are constantly in dialogue with our clients to see what do they have in their portfolio that it is managed against an index that is not giving them what they want.
But we want to be in the areas where we add a lot of value and we have a premium pricing and we want we do not want to be in those areas that we're competing on cost.
Thank you. Our next question comes from Keith Hulson with Northcoast Research.
Good morning, gentlemen. Thanks for taking my question. A question for you around the cash flow. Obviously, that number is lower than it was Q1 2015. I think you cited the incentive compensation accruals and timing of payments.
Can you provide us a little bit more color on, I guess, the decline in the year over year decline in free cash flow for the Q1?
Yes. I mean,
mainly just as we indicated, it was due to timing, right. So essentially when you look year over year, we've had a substantial growth in our business including our invoicing and a lot of that invoicing happened later in the quarter. Therefore, some of the collections that we had expected in the Q1 get actually moved to the Q2. Plus, in terms of interest expense, with the 2 new debt offerings that we have, we now actually make an interest payment every quarter, right? So we have 2 debt offerings, they pay semiannually, but the way it works out is every quarter we'll have one interest payment roughly in the $20,000,000 to $25,000,000 range.
Got you. Okay. Appreciate that. And a follow-up question if I could. You guys talked about being 1 third of the way through in terms of your cost containment initiatives.
Can you perhaps just drill down a little bit further on and how you're doing that? Are you guys putting in an SAP system that's giving you better visibility? Or how are you guys doing your performance metrics? I guess, is there a tool you're using to do that? [SPEAKER J.
PATRICK O'SHAUGHNESSY:]
Patrick Gallagher:] Yes. So let me just say and Rich will answer that well is that look when you look at the G and A line, you see meaningful increases year over year which are not the way typically we want to run the company. A lot of those increases have to do with the fact that we're putting a significant amount of resources on the financial technology that underpins the operations of the company including SAP and we clearly are putting a lot of money in the tax projects. So Rich? Yes.
I mean overall internally we call it our business intelligence initiative which as Henry mentioned is the ultimate goal to provide very transparent, timely decisions support information to all the business heads. And it's not just about SAP, right. That's one tool in a portfolio of tools that we've been investing in. And we're investing in SAP to do a lot of the and the general ledger functions. We're using other tools like Clarity to do project management, workforce management as well as activity based costing.
We use Workday and Concur for either people management or expenses. And what we're doing is basically linking all these tools together into what we're calling this new business information platform. Again, along that journey, we still got some time to get there. But every quarter we pump out better and better information as Henry has mentioned to help us manage.
Great. Thank you.
Our next question comes from Vincent Huang with Autonomous.
Hey, how's it going?
On Slide 7, on the client side, those greater than EUR 1,000,000, how many clients does that relate to?
You have a guess, Rich?
It's probably in the well, it's probably in the more than 3 quarters of our clients probably. So we look at our clients two ways kind of at a low parent child relationship where as we've disclosed we have about 6,500 clients. When you kind of aggregate that at a parent level, we have about 3,800 clients and I would say about 3 quarters of those clients fall in that range.
Okay. And we talked a lot about analytics and maybe I missed this. And I found your longer term outlook on analytics pretty interesting. Can you provide any insights into the competitive environment currently for our business? [SPEAKER JOSE RAFAEL FERNANDEZ:]
Yes. The competitive environment hasn't really changed that much. There's definitely all of our product lines will increasingly become more competitive. And therefore the name of the game is not to have competition, it is to compete and win. And we're shaping up the company to do that.
So not a lot of change. I mean there are only 2 or 3 providers of multi asset class risk analytics depending on the space, depending on what the client segment type, asset owners or asset managers or hedge funds. And there are 2 or 3 that provide equity portfolio management analytics. Obviously, we're trying to enter in a big way the fixed income portfolio management analytics space. There are other providers in there, but we're trying to do it in a way that is congruent and attached to the work that we do on equity portfolio analytics and multi asset class risk analytics for those clients.
Thank you. And there are no further questions at this time.
Thank you very much for your time. We went over a bit, but we wanted to get to everyone on the line. So we will talk to everyone soon. Thank you.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful