Good morning, welcome to S&P Global's first quarter 2017 earnings conference call. I'd like to inform you that this call is being recorded for broadcast. All participants are in a listen-only mode. We will open the conference to questions and answers after the presentation, and instructions will follow at that time. To access the webcast and slides, go to investor.spglobal.com. That is investor.spglobal.com. Click on the link for the quarterly earnings webcast. If you need any additional technical assistance, please press star zero and I will assist you momentarily. I would now like to introduce Mr. Chip Merritt, Vice President of Investor Relations for S&P Global. Sir, you may begin.
Good morning, thank you for joining us on S&P Global's earnings call. Presenting on this morning's call are Doug Peterson, President and CEO, Ewout Steenbergen, Executive Vice President and Chief Financial Officer. This morning, we issued a news release with our first quarter 2017 results. If you need a copy of the release and financial schedules, they can be downloaded at investor.spglobal.com. In today's earnings release, during the conference call, we're providing adjusted financial information. This information is provided to enable investors to make meaningful comparisons of the corporation's operating performance between periods and to view the corporation's business from the same perspective as management's. The earnings release contains exhibits that reconcile the difference between the non-GAAP measures and the comparable financial measures calculated in accordance with US GAAP. Before we begin, I need to make certain cautionary remarks about forward-looking statements.
Except for historical information, the matters discussed in the teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates, and descriptions of future events. Any such statements are based on current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looking statements. In this regard, we direct listeners to the cautionary statements contained in our Forms 10-K, 10-Q, and other periodic reports filed with the U.S. Securities and Exchange Commission. I would also like to call your attention to a European regulation. Any investor who has or expects to obtain ownership of 5% or more of S&P Global should give me a call to better understand the impact of this legislation on the investor and potentially the company.
We're aware that we do have some media representatives with us on the call. However, this call is intended for investors, we would ask that questions from the media be directed to Jason Feuchtwanger at 212-438-1247. At this time, I would like to turn the call over to Doug Peterson. Doug?
Good morning. Thank you, Chip. Welcome, everyone, to the call. With a surge of bond issuance, healthy stock markets, recovering commodity markets, and improving global GDP, we're off to a great start in 2017. Let me begin with the first quarter highlights. We attained strong organic revenue growth in every segment. Ratings results were truly outstanding and were the highlight of the first quarter. We continued to improve margins and delivered 630 basis points of margin improvement and adjusted diluted EPS growth of 35%. We generated $306 million in free cash flow, and it was typically our weakest cash quarter due to payment of annual incentives. We returned $307 million to shareholders through share repurchases and dividends. We increased our adjusted diluted EPS guidance to a range of $6.00-$6.20.
Looking more closely at the financial results, the company reported 8% revenue growth and on an organic basis grew 18%. We frequently talk about the pull-through of revenue to adjusted operating profit being quite high. It's rather striking this quarter that the adjusted operating profit exceeded revenue growth. This can be primarily attributed to the markets and commodity segment, where divestitures drove revenue declines of $68 million, yet adjusted operating profit only declined $7 million. The company achieved a 630 basis point improvement in adjusted operating profit margin due to the sale of lower margin businesses, strong organic revenue growth, and productivity initiatives. Forex had an $8 million unfavorable impact on revenue with a $6 million unfavorable impact on adjusted operating profit. Ratings realized the majority of the impact. The progress we are making to build a cohesive set of high-value assets is paying off.
We were able to turn 18% organic revenue growth into 35% adjusted EPS growth through the combination of productivity improvements, share repurchases, and the inherent scalable nature of our businesses. In a moment, Ewout is going to discuss the results of each of our businesses in more detail. What I'd like to do is provide a bit more color on some of the current and future drivers of our businesses. Let me start with credit conditions. While GDP is the fundamental long-term driver of issuance, spreads can influence timing. This was clearly evident in the first quarter. High yield spreads contracted 400 basis points over the past year, making attractive entry point for issuers. During the same timeframe, investment-grade spreads contracted 74 basis points. We saw strong bank loan activity in the first quarter, partially as a result of the rate and spread environment.
Bank loan rating revenue has become an important part of our rating business over the past few years. This chart depicts the growth. First quarter 2017 bank loan rating revenue was particularly strong, increasing over 140% versus the first quarter of 2016. Bank loan ratings are primarily issued on leveraged loans, typically rated double B plus or lower. Both the volume of leveraged loans and the percent of leveraged loans rated by S&P have increased over the past few years. Leveraged loan growth has been supported by strong investor demand, with record inflows into retail loan funds and recovery in the issuance of CLOs since the financial crisis. In the first quarter, leveraged loan volumes were very strong, driven by tight spreads, driving borrowers to refinance their outstanding loans. We estimate that 47% of the global volume in the first quarter was for refinancing.
In addition, the percentage of leveraged loans rated by S&P surpassed 93% in the U.S. and 78% in Europe. While many of you track issuance, we always try to point out where issuance takes place, which type of issuance, and the size of issuance of the deals make a big difference in the revenue we realize. This was abundantly clear in the first quarter. Global issuance in the first quarter, excluding sovereign debt, increased 4%, yet high yield debt increased by over $100 billion, or 172%. Because very few high yield issuers are part of our frequent issuer program, this provided a tremendous amount of incremental revenue to the Ratings business. Geographically, issuance in the U.S. increased 23%, with investment grade increasing 15%, high yield soaring 115%, public finance decreasing 11%, and structured finance increasing 57%, due primarily to strength in CLOs, ABS, and RMBS.
Issuance increased 3% in Europe, with investment grade declining 1%, high yield rocketing 181%, and structured finance decreasing 21%, with weakness in covered bonds and RMBS. Issuance decreased 18% in Asia. The vast majority of Asian issuance is made up of local China debt that we don't rate. Ratings published its latest issuance forecast. For 2017, we expect an overall decrease in global issuance of 1%. This compares to the forecast of a 3% increase that we issued about three months ago. The most significant change is in international public finance, which had been forecast to increase 5% and is now forecasted to decrease 40%. It now appears that the 2016 issuance in international public finance was an aberration and that issuance will revert to historical norms. This is not a category that generates much revenue for our Ratings business.
When you look at the chart, you can see that the categories that are most impactful to our revenue, namely non-financial, financial services, structured and U.S. public finance, are collectively forecast to increase in 2017. Turning to S&P Dow Jones Indices. In February, we celebrated the 60th anniversary of the S&P 500. We often talk about the importance of benchmarks and the time it takes to build one. None is more iconic than the S&P 500. Originally known as the Standard 500, it was introduced at a luncheon for the press on February 27th, 1957, at the Lawyers Club in New York, with a turnout of 35 top financial writers. The initial 500 included 425 industrials, 25 railroads, and 50 utilities that were deemed most representative of the overall market. These 500 stocks accounted for 90% of the total U.S. market value.
The 500 is groundbreaking, not only for its breadth, but also because it could be calculated and distributed on an hourly basis. Today, the S&P 500 is the world's most followed stock market index, being calculated continuously. S&P Dow Jones Indices continued to build its business, several examples are listed in this slide. I'm only going to touch on the first item. The S&P Green Bond Select Index was created for market participants seeking to monitor developments in the critical areas of green finance. This pioneering index maintains stringent standards in order to include only those bonds whose proceeds are used to finance environmentally friendly projects. Platts is also actively expanding its business opportunities, two examples are listed here.
We believe the U.S. Gulf Coast is poised to become a key anchor for liquefied natural gas prices, and our customers require that the new flexible supply from the U.S. is underpinned by both price transparency and the means to hedge. In response to the growing U.S. LNG exports, ICE will launch LNG derivative contracts. These will be cash settled against the Platts LNG Gulf Coast Marker price assessment and use Platts-derived forward curves for daily settlement. The first OTC swap contract for Black Sea wheat traded with the Platts Black Sea wheat price assessment as a settlement price. This transaction is a significant step towards the emergence of a new regional futures market for Black Sea wheat. The Black Sea region is a major global wheat trading hub.
In spite of its size, this major trading hub has not had a dedicated derivatives market reflecting its own supply and demand dynamics. Turning to Market Intelligence. I thought it'd be instructive to provide a breakdown of the business by customer type. With investor concerns about the impact of the continued movement of assets from active to passive could have on Market Intelligence revenue, you can see that investment management makes up only about 25% of our customers' annualized contract value. In addition, our move to more enterprise-wide contracts should result in less customer volatility. As we look to the remainder of 2017, geopolitical risk and central bank actions may create volatility in the second half. There are a number of positive trends that we have identified, including expectations for slightly stronger GDP growth in the U.S., European GDP looking promising.
ECB continues with the quantitative easing program, strong global equity market so far in 2017, and a steady shift from active to passive investing. There is cause for caution, however, with a number of risks, including potential for U.S. Federal Reserve to initiate more frequent interest rate increases and begin unwinding its balance sheet, formal Brexit negotiations and upcoming elections in Europe, and continued devaluation of most currencies against the U.S. dollar. Finally, I want to share with you some significant changes planned for our board of directors. Sir Win Bischoff and Hilda Ochoa-Brillembourg, two longstanding directors who provided wise counsel and oversight over many years, are retiring. In the meantime, four new directors have been added in the past six months who bring a wealth of business acumen and experience to our board. With that, let me turn the call over to Ewout.
Thank you, Doug, and good morning to everyone on the call. This morning, I would like to discuss the first quarter results and then provide updated guidance for 2017. Doug already discussed the changes in revenue, organic revenue, and adjusted operating margin for the company. I would like to point out that the tax rate of 30.3% is below the anticipated full-year run rate of 31%, due primarily to the discrete tax benefit from stock option exercises through March. In addition, our ongoing share repurchase program led to a $6.4 million decrease, or 2%, in average diluted shares outstanding. I would like to echo Doug's comments that with a 35% increase in adjusted diluted EPS, we're off to a great start to 2017. Net of hedges, foreign exchange rates had a modest negative impact on the company's revenue and adjusted operating profit in the first quarter.
The bulk of the impact was in the Ratings segment, with a $6 million unfavorable impact on revenue and an $8 million unfavorable impact on adjusted operating profit due to weakness year-over-year in the British pound and euro. Let me turn to adjustments to earnings to help you better assess the underlying performance of the business. Pretax adjustments to earnings totaled to a loss of $41 million in the quarter, and included $15 million of acquisition and divestiture-related adjustments, a $2 million expense associated with an increase in financial crisis legal reserves, and $24 million in deal-related amortization. In the first quarter, every business segment contributed to gains in organic revenue, but the gains in Ratings were particularly noteworthy. The reported revenue decline in Market and Commodities Intelligence was due to several divestitures.
The adjusted operating profit growth varied by segment, with 50% at Ratings and 14% at S&P Dow Jones Indices. Once again, the impact from divestitures affected results with Market and Commodities Intelligence, adjusted operating profit declining 3% due to the sale of several businesses. Organic growth and synergies were able to make up much of this loss. Both Ratings and Market and Commodities Intelligence delivered remarkable adjusted operating margin improvements. Let me now turn to the individual segments' performance. As Doug discussed earlier, tight spreads drove high yield issuance and bank loan volume, and this resulted in a surge in high yield and bank loan ratings and propelled results for the Ratings segment. Revenue increased 29%, including a 1% unfavorable impact from Forex. 79% of the incremental revenue flowed through to adjusted operating profit, highlighting the scalable nature of the Ratings business.
Adjusted operating margin increased substantially to 53.1% due to strong revenue growth, partially offset by increased headcount and incentive compensation. Very strong transaction revenue fueled Ratings' first quarter revenue growth. Non-transaction revenue increased 4% from growth in surveillance fees, entity fees, intersegment royalties for Market Intelligence, and CRISIL. Transaction revenue increased 65%, primarily from a substantial increase in high yield bonds and bank loan ratings, as well as improved contract terms. If you look at Ratings revenue by its various markets, you can see that while all of these categories reported growth, the growth in corporates was exceptional. This is the category where the high-yield bonds and bank loans are recorded. Let me now turn to Market and Commodities Intelligence. This segment includes S&P Global Market Intelligence and S&P Global Platts. In the first quarter, reported revenue declined 10% due to recent divestitures.
Excluding these divestitures, organic revenue increased 7%. Adjusted operating profit was down due to the divestiture of several businesses. Despite these divestitures, adjusted operating profit only decreased by $7 million, as organic growth and synergies were able to make up much of this loss. Adjusted operating margin improved 270 basis points, primarily due to the sale of lower margin businesses, strong organic revenue growth, and SNL integration synergies. Let me add a bit more color on the first quarter. Recent divestitures mask solid organic growth of 9%. This was due in part to a 9% increase in the number of SNL, S&P Capital IQ, and RatingsDirect desktop users. One of the important milestones in the quarter was the launch of a unified S&P Capital IQ and SNL commercial organization. This is a critical step in harmonizing our product offering into cohesive enterprise commercial agreements and ultimately one product platform.
During the quarter, we also expanded our content quality reward program to include most of the Capital IQ content. Some of you may be familiar with this program as it awards $50 to those who find an error in our data. The final highlight of the quarter was the beginning of a strategic relationship with Kensho Technologies. If you're not familiar with Kensho, you should check them out. Kensho provides next-generation analytics, machine learning, and data visualization systems to Wall Street's premier global banks and investment institutions. We have agreed to a long-term commercial relationship, which will result in product and data collaboration. We have introduced a new disclosure here depicting market intelligence revenue by its three components. Risk Services delivered the strongest growth in market intelligence, thanks to mid-teens growth of RatingsXpress and high single-digit growth of RatingsDirect.
Enterprise Solutions revenue increased 7%, as demand for data feeds continued to be robust. Finally, our desktop products grew 8%, as the growth of the former SNL and S&P Capital IQ desktop products continues to roll out as one commercial offering. Finally, note that there was $38 million of revenue in the first quarter of 2016 from businesses that were divested. Platts delivered reasonable organic revenue growth as commodity markets recover. The OPEC production cuts have been very successful in increasing oil prices. Tensions remain as higher prices have encouraged new shale investments. According to rig data, North American rig counts have doubled since the low in May of 2016. First quarter revenue increased 10%. However, excluding revenue from recent acquisitions, organic revenue increased 4% due to modest growth in both subscriptions and global trading services.
The core subscription business delivered mid-single-digit revenue growth with similar gains across all commodity groups. Global trading services, low single-digit revenue increase was primarily due to the timing of revenue and strong trading volumes in petroleum, partially offset by weakness in metals. Of particular importance during the quarter was the announced inclusion of Norway's Troll as the latest additional crude grade in the Brent basket beginning January 2018. The makeup of the Brent oil benchmark has evolved over time as production changes have occurred. This latest change follows the addition of Forties and Oseberg in 2002, and Ekofisk in 2007. Here again, we have a new disclosure breaking out Platts revenue by four primary markets. You can see that petroleum and power and gas make up the majority of the business. The growth rates of each market are depicted on the slide.
During the first quarter, Platts delivered revenue growth in all but the metals and agriculture market due to lower metals revenues in global trading services. Please note that there was $11 million of revenue in the first quarter of 2017 from recent acquisitions. Let's turn to S&P Dow Jones Indices. Revenue increased 14%, mostly due to a surge in ETF assets under management. Adjusted operating profit increased 14%, primarily as a result of increased revenue. Adjusted operating margin increased 20 basis points to 67.9% as revenue gains were partially offset by increased headcount in commercial and operations to support future growth. Asset link fees experienced the greatest growth in the first quarter, rising 26%, driven by a 39% increase in average ETF AUM. Subscription revenue increased modestly due to growth in data subscriptions. Exchange-traded derivatives revenue declined 8%.
The trend of assets moving into passive investments was very strong in the first quarter. The exchange-traded products industry reached inflows of $189 billion, a new record for a first quarter, and it was two and a half times larger than the previous first-quarter record. The quarter-ending ETF AUM tied to our indices totaled $1,116 billion, up 35% versus the first quarter of 2016. As the chart shows, this was the result of $162 billion of inflows and $126 billion of market gains over the last 12 months. The $1,116 billion was a new record, surpassing the previous quarterly record of $1,023 billion set on December 31st, 2016. The first-quarter average AUM associated with our indices increased 39% year-over-year, this is a better proxy for revenue changes than the quarter-end figures. Exchange-traded derivatives faced a tough comparison to the first quarter of 2016, when market volatility was much higher.
Transaction revenue from exchange-traded derivatives declined due to a 10% decrease in average daily volume of products based on S&P DJI's indices, largely as a result of declines at the CME equity complex. Turning to our capital position. There was little change from the end of the fourth quarter. We continued to have $2.4 billion of cash and $3.6 billion of long-term debt. $1.8 billion of this cash was held outside the United States at the end of the first quarter. Our debt coverage, as measured by gross debt to adjusted EBITDA, was 1.3 times versus 1.4 times at the end of the fourth quarter. Free cash flow during the quarter was $306 million. To get a better sense of our underlying cash generation from operations, it is important to exclude activity associated with divestitures and the after-tax impact of legal settlements.
In the first quarter, there was little difference as free cash flow on that basis was $307 million. As for return of capital, the company returned $307 million to shareholders in the first quarter, $201 million through repurchasing one and a half million shares and $106 million in dividends. I will review our updated 2017 guidance. Based upon a strong first quarter and our expectations for the remainder of 2017, we have made several changes to our original 2017 guidance. This slide depicts our GAAP guidance and the changes that we have made. Please keep in mind that our guidance reflects current spot market forex rates. This slide shows our updated adjusted guidance. The changes are highlighted on this slide.
I'm going to discuss the changes to our adjusted guidance, which were as follows: We have increased our organic revenue growth from mid-single digit to mid-to-high single-digit growth, with contributions by every business segment. We have lowered our unallocated expense from a range of $145 million-$150 million, down to a range of $130 million-$140 million. Corporate unallocated is expected to be lower, driven by continued cost discipline. We have changed our operating profit margin guidance, which had been for an increase of roughly 100 basis points to a range of 44.5%-45.5%. We hope that providing the margin percentage is more clear than merely providing the change in basis points. We have increased diluted EPS, which excludes deal-related amortization from a prior range of $5.90-$6.15, to a new range of $6-$6.20.
Free cash flow, excluding after-tax legal settlements and insurance recoveries, was $1.6 billion and now is greater than $1.6 billion. Our guidance does not take into consideration any potential policy changes from the new U.S. administration. Overall, this guidance reflects our expectation that 2017 will be another strong year for the company. With that, let me turn the call back over to Chip for your questions.
Thank you, Ewout. Just a couple of instructions for our phone participants. Please press star 1 to indicate that you wish to enter the queue to ask a question. To cancel or withdraw your question, simply press star 2. I would kindly ask you to limit yourself to two questions. That's two questions each in order to allow time for other callers during today's Q&A session. If you've been listening through a speakerphone but would now like to ask a question, we ask that you lift your handset prior to pressing star 1 and remain on the handset until your question has been answered. This will ensure better sound quality. Operator, we'll now take our first question.
Thank you. Our first question is from the line of Peter Appert of Piper Jaffray. Your line is now open.
Thanks. Good morning. Doug, the first quarter results, obviously very impressive. I'm wondering about your thought process on guidance. It seemed to imply that maybe some of the strength in the first quarter you're looking at is just pull forward. Can you talk to that issue?
First of all, thank you, Peter, for the comments. As we looked at guidance, we wanted to take into account this very robust first quarter issuance and take a look at the rest of the year, what we've forecast and what we've budgeted. If you look at a report that we issued called the Credit Trends in Global Issuance for 2017, as you can see, we looked at different categories. In my comments, I mentioned that international public finance was going to be dropping, and that was driving the overall 1% decrease. For the entire year, we're looking at industrials being up for about 5% issuance overall, financial services about a 3% range, structured finance about 4%, and then U.S. public finance down about 6%-7%. Those are kind of the underlying conditions we used for issuance for the rest of the year.
I wouldn't necessarily call it pull forward, but it was a very robust year. We also wanted to highlight this quarter bank loan ratings. We have never really given the kind of disclosure we gave before on the bank loan rating product. As you can see, it was also very strong in the first quarter, partially driven by the rate environment. The spreads have come down considerably as well as what I'd call a much more positive consumer outlook as well as corporate outlook for growth in the U.S. economy. As we've always said, GDP growth is the number one determinant of issuance. Spreads are also a part of that, but we're expecting the quarter as well as the rest of the year to play out, and that's what we use to build our guidance.
Understood. Thank you, Doug. Then secondly, and this might be for Ewout. The margin progress likewise has been very impressive. I'm just wondering how you think about where you are in that process, how far along we are, and how much more there is to come on the margin front beyond the guidance for this year.
Peter, thank you again for the compliment on the margin improvement. I think what you have seen is indeed margin improvement for each of the businesses on an organic basis if you take out the acquisitions and divestitures. If you look at the improvement of Market Intelligence, Market and Commodities Intelligence, what you clearly can see is there the growth of the business as well as the impact of the SNL synergies. This was in line with what we provided you in terms of guidance for 2017 with respect to the achievements and synergies and the run rate improvements we should see during 2017. Clearly, the margin improvement in Ratings was a result of the better top-line growth and modest expense increase. It shows the scalable nature of the Ratings business.
Obviously, this is not the level of margins we expect going forward as the new standard, but it's clearly a good improvement in terms of direction of the Ratings margins going forward. Lastly, with respect to the Indices business, margins, as you know, are already in the mid-60% range. This is a range where we are probably comfortable with respect to margins going forward. It's a very scalable business. The marginal expenses are relatively limited if we are able to add additional revenues to that business. That's why we are confident that margins should stay in that range going forward as well.
Peter, I want to add something. First of all, I think you know that we're committed to efficiency and improvement of our margins. The best way to improve them is through revenue growth. In addition to that, we're looking at other sorts of discipline on how we invest, where we invest our expenses, how we allocate. The overall aspirations are to get to a sustainable low 50% range in the Ratings business, and then the MCI, including Platts, aspiring to the mid to high 30% range. In Indices, as Ewout just said, we don't have any specific targets because we're already at such an attractive level, and we do want to keep investing in that business for growth.
Great. Thanks very much.
Thank you.
Thank you. Our next question is from the line of Joseph Foresi of Cantor Fitzgerald. Your line is now open.
Hello. Hey, this is Mike Reed on for Jill. Thanks for taking our call. Could you give us a little color on some of the progression from the index business outside of equities, including the custom indices, and maybe update on the Trucost and the ESG indices?
Yeah, let me take that. First of all, as you know, over time, we've been looking at growing our index business in different types of asset classes. We have investments around the globe that we've made with international exchanges to help them professionalize their index markets, as well as have distribution of U.S. indices and other international indices we have into those markets. That's one of our diversification strategies. Another one has been on different types of asset classes that are smart beta or different ways to weight indices. One of the most important growth factors that we have is ESG. We're seeing very high demand on environmental, social, and governance factors used by investors around the globe. Asset owners are increasingly demanding more and more information, as well as benchmarking to ESG factors. That's one of the reasons we bought Trucost.
Trucost comes with a phenomenal set of data and analytics, but more importantly, a really high-quality team. We've integrated them very quickly into our business. One of the beauties of Trucost isn't just that we're able to develop new funds and launch funds. We're up over 100 ESG funds already. That Trucost also benefits all of our divisions across the company. We didn't highlight it, but we've been launching some green bond assessments as well as ESG products in the ratings business, and we're looking at ways that we can incorporate more ESG factors and climate factors into market intelligence data as well. The Trucost has been a fantastic acquisition for us. We see a lot of synergies across the entire group for that acquisition.
Okay, great. Do you have any more commentary on the outlook for possible tax reform and impact to issuance, or is it still too uncertain to really give any more color on that?
Last quarter, we gave you a view of what we thought at the time. There hasn't been enough of a change yet for us to update any of our thinking around that. As the new tax proposals evolve, we will provide more guidance on that and more of our views as more comes out.
Okay, great. Thanks, guys.
Thank you.
Bye.
Thank you. The next question is from the line of James Friedman of Susquehanna Financial Group. Your line is now open.
Doug, in your prepared remarks, you called out some of the opportunities in the high yield market and how that may have helped propel the quarter. I thought you also mentioned about your mind share and market share. If you could elaborate on that opportunity going forward, that would be helpful.
Yeah. First of all, as I mentioned, the high yield market has been one that we've been able to benefit from. I've always talked every quarter. We always talk about the importance of understanding the mix of issuance. This quarter, the mix, including a large component of leverage loan refinancing as well as high yield bond financing, was something that benefits us on the top line because they're the types of organizations and companies we don't have frequent issuer programs with. At the same time, while we benefited from that type of issuance overall, if you went back to slide 10 in our materials, what you'd see is that we've also been able to increase our market share of the leverage loan issuers over the last few years.
What we see is that investors demand the opinions and the evaluations from S&P Global Ratings when they look at loans. We've been able to benefit from that in a robust market. Because of our increasing market share, we've benefited with the increase in volume.
Okay, thanks for that. My follow-up. Ewout, I think you called out some headcount growth in indices. Doug, I realize you're trying to discipline the margins there. That's my question. I think you said that it was commercial-related. How should we be thinking about the revenue growth relative to the headcount growth?
Thank you for that question, James. I think overall, if you look at the expense development in the indices business relative to the revenue growth, what you see is a couple of step-up expenses that we are incurring compared to a year ago that should stay more or less flat going forward again. To give you a little bit more details on that, we had the inclusion of Trucost. Doug already just gave you some further explanation of the importance strategically of Trucost and how it is benefiting the whole company from an ESG capability perspective. That is a step-up cost that we didn't incur a year ago and that you see in the expense base of the indices business. We had also the launch of a third data center during 2016.
That is another step-up cost that we are incurring now in the first quarter of 2017 that you don't see in a comparable period of last year. We had some people and capability investments, which we think is important because we further want to expand this business. It's a business, as you are very much aware of, that has really a great perspective given the changes in the asset management world and the very large shift from active to passive management.
We look at these expenses more at step-up expenses, and the margin increase and expense increase from here should not be too much affected by those expenses going forward again.
Got it. Thank you for taking my questions.
Thank you. Our next question is from the line of Warren Gardiner of Evercore ISI. Your line is now open.
Great, thanks. There were some headlines during the quarter around some potential M&A in the index business. Would just be curious to get your thoughts on that, and then maybe also give us a sense about how you guys think about M&A, what qualitative and quantitative hurdles kind of need to be met maybe beyond one-year accretion and being a benchmark-type asset.
First of all, as you know, we wouldn't comment at all on any kind of market speculation and market rumors. We do evaluate, obviously, opportunities in the marketplace. As you saw, that we announced this quarter that we have set up a strategic relationship and alliance with Kensho. It's not an acquisition, just in terms of the sorts of valuations that we're always doing in the market, looking for financial as well as strategic fit. We're always looking to improve our portfolio in the parameters and bounds of what we've defined as a markets-oriented data ratings benchmark organization. Let me hand it off to Ewout to give you some thoughts about the second part of your question.
What I would like to say is that as a company, we are disciplined in every way how we utilize our capital. If it's organic, inorganic, as well as other ways we can use capital, for example, the most optimal way to return capital to shareholders. With respect to using capital for M&A, we are looking at a couple of key metrics. Accretion of EPS is an important element. Discounted cash flow methodology is a second important element. The third important metric we are looking at, and actually, I'm a very big believer of the importance of this, is return on invested capital. We are very much measuring if M&A is ultimately hitting our hurdle rates and cost of capital over a couple of years in the future. Of course, you have to also take into consideration the strategic importance of acquisitions over time.
Those are, in terms of framework, the ways how we measure and assess M&A opportunities in the market.
Great. Thank you. That's really helpful. I guess in my one other question there, obviously, really nice quarter in the ratings business. How much of that 29% year-over-year gain would you kind of attribute to improved contract terms, and where are you guys in terms of what inning you're kind of in terms of capturing that opportunity?
Well, in general terms, we don't give that breakdown. We cannot give you a specific answer. Directionally, what we can say is that the largest part of that was volume driven, and contract terms is only a smaller part of the contribution of the 29% increase in revenues.
The other thing we can add is that, as we think about the inning of where we're at with this contract work, we probably got about half that in 2016. We'll probably get about the other half in 2017. Maybe it'll trickle forward after that. Really largely in 2016 and 2017.
Great. Thanks a lot.
Thank you. Our next question is from the line of Vincent Hung of Autonomous. Your line is now open.
Hi. You recently invested in Kensho. Could you talk about what this investment gives you, and also touch more broadly on how you're thinking about the changing technological landscape impacting your business?
First of all, we have been looking at ways to enhance our analytical capabilities that move into new areas like machine learning and artificial intelligence and cognitive learning programs. Obviously, we try to do some of that on our own, and there are ways that we can have task force or special labs or initiatives, as well as embedding things into our own workspace. In addition, there are companies like Kensho, which are on the cutting edge, that we felt like it was valuable for us to build this connection with them, to get access to people who are building new products and services that we hope can enhance what we do, that we can learn from them, as well as build products and services together.
This was definitely done with that in mind to the kernel of your question, which is that as the world changes, we believe we need to get on with it and move ahead with it, and that we need a combination of internal as well as external sources for that kind of innovation.
If I could add just a couple things. We will be providing them with some data, and they in turn, will be providing us with some of their capabilities and will be offered on our market intelligence platforms.
My next question is, can you give us an update on where we are on the Project Simplify initiative in the ratings agency?
Let me give you a quick update on that. First of all, for those of you that don't know what Project Simplify is, over the last five or six years, we have put in place a whole set of new policies and procedures and processes around improving our controls, implementing new approaches to criteria, how we deal with documentation in our organization, and ensuring that we're operating at the highest quality and control standards for best practices, as well as to comply with the regulations that have been implemented around the globe, especially in Europe, overseen by ESMA, in the U.S., overseen by the SEC. As we put in place all those approaches to managing and controlling our business. We added on a lot of layers of activities and processes.
Project Simplify, for those of you that don't know then, is an approach to take a step back and re-engineer and reformulate our processes with many more of them being automated, as well as eliminating duplication, et cetera. We're probably, as Chip's using baseball analogies this morning, we're probably in the third inning. We have a ways to go. We're just moving from the design phase into the piloting phase. The project is going very well. I'm pleased with the progress. I know that it's going to require some change, but net-net, we think it will continue to allow us to move improvement in our margins and decrease some of our expenses. More importantly, it will improve our workflow and our quality and allow us to invest also for other growth.
Thanks.
Thanks, Joseph.
Thank you. Our next question is from the line of Toni Kaplan of Morgan Stanley. Your line is now open.
Good morning. This is actually Josh Goldstein on for Toni. You had mentioned that part of the benefit you received from high yield issuing strength was because not many high yield issuers are on the frequent issuer program. Can you just talk a little bit about your target mix within ratings between transactional and recurring revenue? Are you just comfortable with your roughly 55 to 45 subscription to transactional mix, or would you look to alter that mix based on your issuance outlook at any given point in time?
We don't target the right kind of a mix. If I went back a few years, what I would tell you is that we needed to look at a program where we were ensuring that we're getting the right kind of contract realization from our frequent issuer program. If there's been any major change over the last few years, it's that we started looking at ways to ensure that we were having the right approach to our discounting policies on the frequent issuer programs. We don't have a targeted mix. We obviously want to grow the non-transactional revenue. It's valuable to have a more stable subscription-like approach to our business. In addition to surveillance fees, entity fees, the royalties we get, and the basic frequent issuer program, the non-transaction revenue, having that in our overall program it's a good base to have.
We don't have a specific target overall for that. Just to remind everybody on slide 25, for this quarter, we did have a 65% increase in transaction revenue. It was principally driven by the high yield bond and bank loan ratings, as well as some of the improved contract terms. We had a 4% increase in non-transaction revenue.
Okay. That's helpful. Then just at the time of the SNL acquisition, you had provided some interesting data on the margin differential between established businesses that were in kind of the 30%+ range and still some unprofitable businesses like metals and mining and financial institution software. I was just hoping you could provide an update on some of these developing businesses and if you expect them to contribute to profits this year.
I'm a little bit scratching my head because I don't have that data in front of me. I'm looking around if we have the specific answer to your question. What I can tell you is that philosophically, we have continued to manage all of our businesses for a combination of growth. We do have, as Dave laid out to you a few minutes ago, we do have programs where we like to invest, and we like to manage our investments and track them. That's one of the nice disciplines that the SNL team brought as well, is their approach towards opening new businesses and managing them for growth and investment. I don't have the specific margins. Chip has more to say.
Yeah, we're not going to share the margins, one of the things we said at the time, the new businesses were, like you mentioned, in the metals and mining space and the international FIG product, that were losing money because they were just plain new. We can say that the international FIG product is probably ahead of our plans or projections, and the metals and mining is behind our projections from a revenue perspective. That's really going to lead your margin because you're just talking about incremental margins on the revenue. Hopefully that's helpful that one's doing a little better, one's a little worse. Together, we're doing a little bit better than our models had expected.
That's helpful. Thanks.
Thank you. Our next question is from the line of Alex Kramm of UBS. Your line is now open.
Yeah. Hey, good morning, everyone. Want to start with something a little bit bigger picture around the stock and the valuation. Obviously stock has been strong this year, if you look at the valuation on PE or EBITDA, it's still below, at least on my numbers, your primary ratings peer. More importantly, when you look at some of your other businesses and look at the comps there, like the index businesses, some of the data businesses that are out there, it seems like the stock is trading at a pretty big discount. Just wondering how you and the board thinks about this. Is there something missing, or I know you've talked about the business mix and how committed you are to the different businesses, but do you feel like there's actually the opportunity if these businesses weren't together to really realize the value here?
Just wondering how you and the board think about the value that may be left on the table here, maybe because people are not understanding the businesses.
Well, first of all, thank you for the question. We don't comment about the market and market price and valuation, but we do obviously look at it. It's something that we pay attention to and look at. What we can control is the quality of our businesses, the quality of our execution, the top-line growth, the improvement in margins over time, and that's how we value our performance, and that's also how we get paid. It's important that people like you are helping understand the business and communicating to the market the quality of the businesses and how we're performing. As to the actual A stock price itself and the valuation and multiples, it's not something that I can comment on. That's something the street actually has to comment on.
All right. Fair enough, I guess. Then just secondly, some small here on the index side, I don't think you commented on the subscription side of the business. I know it was up 3%, but if you think about that number relative to pricing power, it seems a little bit softer than what we would have expected. Was there some one-timers maybe in the fourth quarter, or also is the end market maybe a little bit tougher given what's going on in the active management space? Just seems like some of your peers are doing better there, so maybe a little bit more color on the subscription side and index.
Alex, this is Ewout. First of all, I think if you look at that line, that will fluctuate a bit quarter-to-quarter. There's some custom kind of products that you see there that are fluctuating over periods, as well as we had a $2 million correction during the quarter in that line, a one-time item of $2 million that should not recur during the next quarters again. I think those are the main drivers why you saw a slight weakness in the line of the data subscriptions in the indices for this quarter.
All right. Very helpful. Thank you.
Thank you. Our next question is from the line of Hamzah Mazari of Macquarie Research. Your line is now open.
Good morning. Thank you. The first question is just on how many of your customers right now are on enterprise-wide contracts and any future impact you can share around the SNL and Capital IQ commercial organization. Is that in your synergy numbers already? Is that upside? Thank you.
I do not have the actual detail on how many people moved to enterprise-wide contracts, it is the direction we're going. Think of it this way, that the SNL contracts were principally on enterprise-wide contracts. Capital IQ were principally on per seat contracts, and we've been steadily moving the Capital IQ into enterprise-wide contracts. That's actually the goal of our new and recent sales force reengineering and launch of a whole new approach to how we're managing an integrated sales force. One of the things that we've done, and we had a brief comment about it in the prepared remarks, was to put in place a unified sales force for Market Intelligence, which is, as you know, the Capital IQ and SNL sales forces. It's built in a way that we have a combination of relationship managers who are managing relationships for the long term. They're identifying opportunities.
We have a sales force. We have an excellent high-quality sales services organization and post-sale support group. That's where we're now launching and leveraging the compatibility and the quality of both platforms to build out this sales approach. What we're doing there is also moving more and more of our contracts to enterprise-wide pricing as part of that process. Our salespeople have incentives to upsell, to get deeper penetration, as well as to move to enterprise-wide contracts.
Great. That's very helpful. Just a follow-up question, just on issuance. I'm just curious if you guys view issuance as less cyclical relative to past cycles, either because there are secular drivers around European bank disintermediation, or maybe refinancing is a bigger piece. Just curious how you think about cyclicality of issuance relative to past cycles, if anything has changed. Thanks.
If you look over a long period, let's say 15 years, and we have a chart which we typically have in our investor materials, not necessarily in quarter materials. You can see over the last 15 years, there's been a very steady year-by-year increase in total issuance, with the exception of 2008, when there was a significant drop, in particular in structured finance issuance, and that structured finance issuance has never actually recovered from the bubble that it had reached in 2006 and 2007. If you look at corporate issuance and sovereign issuance, financial institutions issuance, it's been also a very steady underlying growth with the only year that it dropped was 2008, which was the global recession. We look at it overall, it's a steady growth. That's the way we plan around it.
That doesn't mean that quarter by quarter, month by month, that mix and issuance is going to be the same. We need to look at overall GDP growth. As I mentioned in my remarks, just some of the factors with U.S. economy growing at higher levels than we saw it, with the EU starting to recover, with emerging markets like Brazil that's coming off of a very deep recession into mild growth, and other countries in Latin America improving. China's growth is a little bit more robust than we expected. Those are all very good factors for us to look at shorter-term issuance. Longer-term issuance, we look at on a steady path tied to overall GDP growth as well as capital markets development around the globe.
Thank you.
Thanks, Hamzah.
Thanks.
Thank you. Our next question is from the line of Timothy McHugh of William Blair. Your line is now open.
Yes. Thanks. I understand the strong revenue obviously probably helped your Ratings margins this quarter. Market Intelligence is there I guess, is there any reason why this isn't a level that should be sustainable? I guess, if so, I think it's at the higher end of kind of the medium-term targets you set for that segment.
I would say, this is Ewout talking. Good morning, Tim. I would say that if you look at the margin in Market Intelligence, there were no particular items this quarter that jump out, that drove the margin higher or lower than what you should expect directionally in the future. You have seen a significant step-up of 270 basis points compared to the previous period of last year. We are seeing the benefit of some of the divestitures and those were businesses with lower margin. We see the benefit of the organic revenue improvements, and we're very pleased to see that this business is doing very well. Just want to point out one data point again, 9% increase in desktop users compared to a year ago. 9%, which is of course, a very good result to see that the top line is growing so fast.
We see the benefit of the SNL synergies coming in. We gave you guidance on that, and insight on that last quarter. We will give you an update later this year. The SNL synergies are of course, helping the margin improvement as well. Ending up at 37.6% margin for the first quarter, that's indeed in line with our longer-term guidance mid to higher 30% range for this business.
Okay, thanks. Just the total margin guidance that you changed from kind of giving us a basis point increase to a absolute number. Just is that a increase in your guidance or your expectation for the year? Is it because the change in kind of the format, just want to understand whether you kept your assumptions the same or increased them.
Yes. That was an increase from our previous guidance. Let me explain that to you a bit. The previous guidance was 100 basis points improvement of the margin during 2017, and that was measured from the base margin during 2016. That margin was 42.9%, so at 100 basis points, you are at 43.9%. The new guidance is 44.5%-45.5%, so 60-160 basis points higher than the prior guidance we have given to you in terms of margins. What you should read out of that is clearly a high level of comfort that we're on the right path with respect to the performance of the business. We are having a, of course, a great start of 2017, and therefore we have raised our margin guidance for this year compared to the prior guidance.
Okay, great. Thank you.
Tim.
Thank you. Our next question is from the line of Manav Patnaik of Barclays. Your line is now open.
Yeah, good morning, gentlemen. Congratulations on the quarter. My first question is just on the guidance. I think you said that all areas of all your businesses were contributing to the increased guidance. The range still seems wide and still probably conservative. Is it fair to say that most of that is just that, the ratings conservative, you guys typically assume early in the year?
I would say, we are very confident by the first quarter results. We are not providing quarterly guidance. This is yearly guidance. We have raised the bottom end of the EPS range by $0.10 and the top end by $0.05. What you should read out of that is a good start of the year. Again, we are not providing quarterly guidance. From our perspective, this is the most reasonable middle-of-the-road guidance we can provide to you. It's neither conservative nor aggressive.
Okay. Then, just your earlier comments around capital allocation and ROIC and so forth. I mean, that disciplines sounds really good, if it's not M&A, the balance sheet still is really underutilized in our view. You've talked about how your ratings business has obviously benefited from people trying to take advantage of spreads and ahead of rates and so forth. The buybacks felt a little light this quarter, too. Just curious on, should we be expecting action one way or the other in the next quarter or two?
Manav, let me say it in the following way. We believe that there's an opportunity to provide more specifics in terms of our capital management targets and capital allocation targets for the company. Today, we don't have very specific targets. There is a limit, particularly on the debt level. There is a limit. We want to stay in the investment grade space. Where exactly in the spectrum of investment grade, we haven't specified. What we expect is that later this year, we will be able to come back to you with more specific and concrete targets with respect to our capital management strategy. It's a little bit too early now, I cannot give you more specifics at this point in time. Later this year, we will come back with more specifics on that.
Okay, that's helpful. Thanks a lot, guys.
Thank you.
Thank you. Our next question is from the line of Jeffrey Silber of BMO Capital Markets. Your line is now open.
Thanks so much. I know it's late. I'm not sure if anybody asked the pricing pressure question that you typically get on each quarter's call. If they haven't, if you could answer that for me.
Pricing pressure in any particular category, or?
I guess both in Market and Commodities, then maybe fee pressures on the Indices side.
Let me take that question. On the Market Intelligence, as you know, our shift to an enterprise-wide model allows us to model very carefully the value that we provide to our customers and the kind of service that we're delivering. It allows us to have a very good conversation about price, and it's not necessarily tied to a price per user as we've had sometimes in the past with Capital IQ. We look at that very carefully. It's a value-driven approach to how we deliver that value and the kind of contract that we're able to sign. I wouldn't say there's necessarily pressure there because we're able to negotiate that well. When it comes to the fee structures in Indices, we wouldn't necessarily talk about specific customer pricing actions.
We do have excellent margins, we're looking very carefully at penetration, at new products, new services, et cetera, as a way to grow our top-line growth. We're very pleased with where we are in that business.
Okay, great. On the diluted EPS guidance for the year of $6-$6.20, what share count is embedded in that guidance?
We cannot give you those specifics because then we would implicitly tell you what is the level of share buybacks we're aiming for during this year. I can just say that share buybacks, the company has a track record. We are a believer in buybacks, that it is a good and value-enhancing way to return capital to shareholders. You may expect the company to continue with our track record going forward.
Thanks.
Thanks, Jeff.
Thank you. Our final question is from the line of Craig Huber of Huber Research. Your line is now open.
Yes, thank you. Doug, a question for you here. This whole interest expense deductibility issue in Washington, D.C., Paul Ryan's tax plan. Are you aware of any country around the world of any significance that's gone from allowing full interest expense deductibility to none in one fell swoop? I'm not, but are you?
No, we're not. There's Spain, Germany, the U.K. They have different aspects of how it's implemented. I don't know of any place where they've actually implemented in one fell swoop.
Do you sort of think then, Doug, along those lines that maybe a middle ground is something like a Germany, as you say, where they allow only interest expense deductibility up to about 30% of EBITDA? Is that sort of the middle ground maybe here in the U.S.? Something like that.
You know what? I don't know. There's been some interesting research and advocacy that's been coming out recently on what the impact would be beyond just the real estate industry, on other industries that use debt. In particular, community banks are very worried about what the impact would be if their borrowers on SME-type activities are not able to deduct interest and what that means both for SMEs as well as for the small community banks that provide that kind of debt. There's a lot of different angles coming out as this is being discussed more thoroughly. We're watching very carefully what all the different arguments are. I don't want to predict where it will end up. I do know that there's going to be a lot of arguments that are going to be surfacing on this.
My other unrelated question, please, Doug. On average, what should investors expect for pricing increases this year across your portfolio? Is there any wide disparity between the segments?
No. We never give any kind of specific pricing guideline, especially for future pricing. It's something that we wouldn't be able to give you at this point in time.
Thank you.
Thanks, Craig.
Thank you. As everybody closes and we hang up on the call, I do want to thank everyone for your questions. Very importantly, I want to thank the team at S&P Global for excellent performance in the first quarter. We do know that we've had great momentum from how we started the year, there are some potential upsides as well as some potential clouds out there. We're very, very pleased with how we've begun the year across the board. Thank you very much, everybody, for joining the call this morning.
That concludes this morning's call. A PDF version of the presenter slides is available now for downloading from investor.spglobal.com. A replay of this call, including the Q&A session, will be available in about two hours. The replay will be maintained on S&P Global's website for 12 months from today and for one month from today by telephone. On behalf of S&P Global, we thank you for participating and wish you a good day.