明晟 (MSCI) 2008 Q3 法說會逐字稿

Good day everyone and welcome to the MSCI Incorporated third quarter 2008 conference call. This call is being recorded and all callers are currently in a listen only mode. With us today from the company is the Chairman and Chief Executive Officer, Mr. Henry Fernandez; and Chief Financial Officer, Mr. Michael Neborak. At this time I would like to turn to call over to Mr. Michael Neborak. Please go ahead, sir.

Thank you, operator. Good morning, and thank you for joining us here for our third quarter 2008 earnings call. Please note that earlier this morning we issued a press release describing our results for the third quarter, 2008. A copy of that release can be reviewed on the company's website at MSCIBarra.com under Investor Relations.

This presentation 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 are made, which reflects management's current estimates, projections, expectations or beliefs and which are subject to risk and uncertainties that may cause actual results to differ materially. For a discussion of additional risks and uncertainties that may affect the future results of the company, please see the description of risk factors in forward-looking statements in our Form 10-K for our fiscal year ending November 30, 2007 and our quarterly filings and earnings releases for 2008.

Today's earnings call may also include discussion of certain non-GAAP financial measures. Please refer to today's earnings release for the required reconciliation of non-GAAP measures to the most directly comparable GAAP financial measures and other related disclosures.

Since we will be referring to run rates frequently in our discussion this morning, let me remind you that our run rate at a given point in time represents the forward-looking (inaudible) for prescriptions and product licenses that we will record over the next 12 months assuming no cancellations, new sales are changes in the asset and ETFs licensed to our indices. Please refer to table 2 in our press release for detailed explanation.

The agenda for today's call is as follows. First, Henry will summarize the third quarter. Second I will review third quarter financial results in detail. Following our formal remarks we will take questions. With that let me just turn to call over to Henry.

Thank you. In our third quarter, operating revenues increased almost 20% to a record $110 million and our adjusted EBITDA increased 27% to a record $51 million. We are particularly pleased with our adjusted EBITDA margin over 46% in the quarter despite incurring duplicative expenses to replace services currently provided by Morgan Stanley. This high level of profitability in our company highlights the significant positive operating leverage of our business.

Our record results continue to demonstrate the must have mission-critical nature of our products and services in the investment process. Our record results also demonstrate the balance and diversification of our revenue sources worldwide. Namely, we have a diverse product line ranging from performance benchmarks, performance and risk analytics to tools for total portfolio risk management.

We have a diverse plan based from not only asset managers to pension funds, Coverdell funds, broker-dealers, hedge funds worldwide. Our clients, over 3100 of them, are located all over the world from the US and Canada to Europe, the Middle East, Asia and Australia. A lot of these points are to reinforce the fact that we have a very diverse, a very balanced business that if one area of our business is not performing as well, the other one is.

While the ongoing turbulence within the financial markets have created headwinds for our asset base fees and our equity portfolio analytics products, sales of our equity and data subscription and our multi-asset class portfolio analytics remain strong, again demonstrating the balance in revenues in our business. Our run rate of $430 million in Q3 increased 15% year-over-year but was flat sequentially due to an 11% decline in our asset base fees -- mostly changed credit fund fees -- offset by a 2.5% increase in our subscription run rate.

On the second quarter call in July we cited several factors that weighed on our run rate. Those factors persisted during the quarter, the current quarter, and had an even more pronounced impact on our Q3 run rate. Let us go over those factors again.

First, market conditions. As we all know all too well, the conditions in the financial markets throughout the world deteriorated in recent months. The impact on our business is evident in our asset-based fees given the decline in the value of assets in ETFs linked to our indices. And the impact was also felt in our equity portfolio analytics as a result of the closure of a few qualitative funds among both hedge funds and loan only managers.

Secondly, the deferral of sales of our proprietary equity risk data, either sold directly to customers or bundled with our proprietary software Aegis, those products were -- some sales of those products were deferred ahead of the launch of our new and enhanced global equity risk model, GEM2.

Third, reallocation of resources. As we discussed on our second quarter call we believe new sales and new product development have been hampered by the reallocation of resources in our company towards the separation from Morgan Stanley. Therefore, we believe we have not operated at an optimal capacity and have not maximized the revenue opportunities available to us.

So for example, nearly 80 of the 96 new hires over the last year are focused on the replacement of Morgan Stanley services. In addition, over 60 existing full-time equivalent employees have been reassigned to work on these replacement efforts. All told, currently nearly 20% of our employees are currently working on the separation from Morgan Stanley. As these people free up over the next three to six months, they will return to focusing solely on growing our business. We therefore expect a positive impact on productivity starting in early 2009.

Let me now explain where we continue to be enthusiastic about our business. And we maintain our medium-term financial targets of revenue growth in the mid teens and adjusted EBITDA margin in the low 40s, even in this negative climate in the investment world.

First, our diverse product offering and global client base should help to insulate us from any particular segment of the financial market. For example, while the run rate for equity portfolio analytics slowed in Q3, our equity index data subscriptions accelerated and our multi-asset class portfolio analytics had another solid quarter.

On ETFs, there is not much we can do in the near-term to offset the impact from the decline in the values of assets in ETFs linked to our indices. However, what we can do is continue to work with our ETF managers to license indices for new ETFs which will gather assets over time and mitigate somewhat the declines in assets in existing ETFs. We also believe that we're well positioned to benefit from an upturn in the equity markets whenever they occur.

Third, on equity portfolio analytics, we believe the recent launch is of our second generation global equity risk model, GEM2, and the launch of Aegis 4.2, the analytics software which can be used to access GEM2, they should all contribute to an increase in subscriptions in the coming quarters. The launch of GEM2 data platform would also help accelerate the time to market of our new enhanced models such as Europe, Australia, US small cap and other markets we plan to launch over the next year.

On investment initiatives, during Q3 we approved the hiring of approximately 100 people in the business but not related to the replacement of Morgan Stanley services. These new hires, many of them in emerging market centers, will help us accelerate our sales growth and speed new product introductions. Or at a minimum they will help us mitigate the impact of our slowdown in new sales.

As previously discussed we have been short staffed, especially in sales, in recent quarters and we are now taking very proactive steps to alleviate this resource constraint and strive to minimize the many revenue opportunities we see in the marketplace today while maintaining our EBITDA margin in the ranges that we have described before. I will now turn to more details of our performance in product categories and in client segments during the quarter.

In my remarks, when I discuss topline numbers I will be referring only to run rates while Mike will focus on accounting numbers later. Run rates serve as a general and directional indication of future revenues. However, I caution that they are only a snapshot of our business at a given point in time. And do not have a corresponding one-to-one relationship with accounting revenues quarter to quarter.

Please note that the run rate growth rates that I will refer to represent the percentage change from the run rate as of August 31, 2008 compared to the run rate as of August 31, 2007 unless otherwise specified. In terms of major product categories the run rate in equity indices increased almost 20% year-over-year. Our equity beta subscriptions had an excellent quarter. Our run rate grew 23.6% year-over-year and 5% sequentially from May 31, 2008.

We had strong subscription sales across a broad range of products within our global investable market index series and growth in usage fees for access to our index data as well. Growth was across all regions and particularly within our largest client segment, the loan only asset managers. Equity index asset based fees increased 11% year-over-year. But they decreased 11.6% sequentially due to a decline in the value of assets in ETFs linked to our indices.

During the third quarter nine new ETFs were launched, which brings the total for the first nine months of the year to 37, compared to 29 for all of '07. Our pipeline of new ETFs remains full although market conditions may impact the actual launch date in each particular ETF.

The run rate for equity portfolio analytics increased 10.5% year-over-year but was flat sequentially. Excluding the negative impact of foreign currency translation during the quarter, the run rate for equity portfolio analytics increased slightly to 0.7%. The run rate for Aegis within equity portfolio analytics declined 2.3% from Q2. Excluding the negative impact of foreign currency translation, this decline was a bit less at 1%. The run rate for equity risk data sold directly to customers (inaudible) increased 4.6%.

The closing of our (inaudible) fund at some of our hedge fund clients and loan only clients during the quarter weighed on equity portfolio analytics results. As I said before, on the positive side we may see a gradual pick up in new sales in equity portfolio analytics in the next few quarters as a result of the launch of GEM2 and Aegis 4.2 last week. As previously discussed, new subscriptions in recent quarters have been negatively impacted by the deferral of purchases by our client ahead of the launch of GEM2 and Aegis 4.2.

The run rate for multi-asset class analytics increased 22% year-over-year and 2.5% sequentially. Excluding the impact of foreign currency translation, this sequential growth rate in multi-asset class analytics was a much higher 5.5%.

The run rate for BarraOne, the main component of multi-asset class analytics, increased 39.4% year-over-year and 6.6% sequentially during the quarter. Again, excluding the negative impact from foreign currency translation the sequential growth rate of BarraOne during the quarter was a much higher 9.3%. About half of the sales of BarraOne are in currencies other than the US dollar. We continued to add new BarraOne clients rapidly during the quarter, including a flagship sale to the California State Teachers Retirement System.

In terms of our major client segment as in prior quarters, we continued to grow our run rate by outselling to existing clients, adding new clients, and implementing some price increases even in this difficult environment. This quarter we added 65 net new clients for a total now worldwide of almost 3100 clients. Excluding asset-based fees, approximately 20% of our gross sales during the quarter came from new clients. This was a decrease from the 23% we experienced in the second quarter and a decrease also from '07.

We have seen a continued decline -- gradual decline in our gross sales to new clients as the shortage of staff in our sales force has forced them to concentrate on existing clients. And therefore, we intend to see an increase in this over the next few quarters. We intend to reverse this trend in the coming quarters as we add more staff to our sales and product management organization.

We saw growth in our run rate for all of our major client categories. Growth rates year-over-year were as follows. 11% to $288 million for asset managers, 28% to $45 million for broker-dealers, 27% to $22 million for hedge funds, 17% to $20 million for asset owners -- mostly pension funds and some Coverdell funds, and 22% to $54 million for all other client categories.

In terms of the outlook, I said at the beginning we remain cautiously optimistic that our business model will hold up well despite the tremendous turmoil in financial markets worldwide. We're still comfortable with our medium-term financial targets of revenue growth in the mid teens and adjusted EBITDA in the low 40s. As previously noted, our level of profitability may fall within a range of 40% to 50% in any given quarter depending on the rate and the mix of revenue growth, the pace of investments pending and the duplicative expenses that we are incurring related to the replacement of services currently provided by Morgan Stanley.

In conclusion and in summary, while the turmoil in the financial market creates headwinds for us, we believe the company is very well positioned for the future. And the investments we're currently making to help us to offset and mitigate the impact on our business from the current financial turmoil. Let me now turn the presentation over to Mike.

Thank you, Henry. I'm going to describe in more detail our financial performance. Please note that unless otherwise specified, percent change figures represent the comparison between Q3 2008 and Q3 2007.

First, our operating revenues. For the third quarter 2008 operating revenues increased 19.5% to $110.4 million. Assuming exchange rates are unchanged from Q3 2007, Q3 2008 operating revenues increased 17.9%. Performance was led by a 21.4% increase in our subscription revenues. Growth in asset-based fee revenues was 10.8%.

Now [some] product specifics around the revenue performance by product. Revenues from equity indices, our largest product category -- this is approximately 56% of our total revenues -- increased 24.1%, $[52] million. Within equity indices, revenues from equity index data subscriptions -- this is about 4% of our revenue base -- were up 30.7%, $43.7 million, reflecting growth in subscription across a broad range of products within our global investable market index series.

Revenues attributable to equity index asset-based fees products -- this is about 17% of our total revenues -- increased 10.8% to $18.3 million in the third quarter of 2008. In the third quarter of 2008, approximately 78% of the revenues included in this product category were related to exchange traded funds. The other 22% includes fees on institutional index funds, transaction volume based fees for futures and options traded on certain MSCI indices, and other structure products.

Compared to the second quarter 2008 equity index asset-based fee revenue was flat at $18.3 million, reflecting a 1% decline in our ETF asset-based fee revenues which was offset by an increase in fees from other products in this category. The average value of assets in ETFs linked to MSCI equity indices was $178.3 billion for the third quarter of 2008 compared to $184.4 billion for the second quarter of 2008.

At August 31, 2008 the value of assets in ETFs linked to MSCI equity indices were $166.3 billion. US listed ETFs accounted for 85% of our [AUM] balance. The difference between 100 and 85% was ETFs primarily listed in Europe.

As disclosed in the earnings release, we did experience a $2.1 billion decrease in AUM during the quarter attributable to asset outflows. While this is the first time we experienced a net asset outflow in a quarter, we believe the $2.1 billion figure is quite modest in the context of the equity market turmoil we have experienced recently. The outflows were most significant in [EFA] and emerging market ETFs.

We believe we remain well positioned within the global ETF industry. Our market share remains in the mid-20s. We currently have 156 ETFs, including 32 with AUM balances greater than $1 billion licensed to our indices.

Our second-largest product revenue category is equity portfolio analytics. This is about 31% of total revenues. Revenues for this category increased 14.3% to $33.7 million. The year-over-year increase reflects new subscriptions to our proprietary equity risk data accessed directly and bundled with Aegis.

Multi-asset class portfolio analytics had another strong quarter. Revenues increased 33.8%, to $8.9 million. The year-over-year increase is largely attributable to strong new subscriptions to BarraOne.

Before I talk about expenses, I want to talk a little bit more about foreign currency and how that impacted our quarter number three results. First is our run rate. When comparing our run rate on August 31, 2008 to our run rate on May 31, 2008, currency had a negative $3.3 million impact due to the appreciation of the dollar during the quarter. Please note that approximately $62 million or 14% of our run rate on August 31 was denominated in non-US dollars.

In terms of accounting revenues when comparing our quarter number three 2008 accounting revenues to the same quarter in 2007, currency was a positive $1.4 million dollars due primarily to the depreciation of the dollar versus the Euro between the third quarter of 2007 and the end of the third quarter of 2008. Approximately $15 million or 14% of our Q3 revenues are denominated in non US dollars.

On the expense side when you compare our quarter number three 2008 expenses to Q3 2007, currency increased our expenses by $1.4 million primarily due to the depreciation of the dollar versus the Swiss Frank between the third quarter of 2007 and the third quarter of 2008. Approximately $20 million or 27% of our third quarter 2008 expenses were denominated in non US dollars.

And on the balance sheet, the re-measurement of our balance sheet at the end of the third quarter 2008 versus the second quarter 2008 resulted in a foreign currency loss of $3 million due to the strengthening of the US dollar in the third quarter 2007, primarily because of founder's grant expense, changes in our capital structure, as well as our IPO.

Net income in the third quarter 2008 declined 11.7% to $18.9 million from the third quarter of 2007. The decline primarily reflects founder's grant expense and higher interest expense offset in part by the increase in adjusted EBITDA.

On a diluted EPS basis, for the third quarter of 2008 that figure was $0.19, a decline of 24% from the third quarter of 2007, reflecting a higher number of shares outstanding. Adjusted EBITDA increased 26.9% to $53.1 million for the third quarter of 2008. I refer you to table nine in our press release for the reconciliation of adjusted EBITDA to net income.

The adjusted EBITDA margin expanded to 46.4% in the third quarter of 2008 from 43.7% in the third quarter of 2007. The increase reflects the positive operating leverage in the business.

Our cash earnings for the third quarter 2008 were $26.7 million or $0.26 on a diluted per share basis compared to $25.7 million or $0.31 per diluted share in the third quarter of 2007. The decline in cash EPS reflects the lack of comparability due to the increase in the number of shares outstanding resulting from our IPO, and the increase in interest expense resulting from changes in our capital structure during 2007.

We calculate cash earnings of $26.7 million by taking our net income for the quarter, which is $18.9 million, and adding back the after-tax impact of the founder's grant. And that after-tax figure is $3.3 million, and then adding back the after-tax impact of amortization of intangibles. That figure is $4.5 million.

We have already touched on a number of our operating metrics, the detail of which can be seen in table 2 of the press release. I did want to, however, provide a little bit more color around the retention rate.

Our aggregate retention rate was unchanged at 92% for the third quarter 2008 compared to the third quarter of 2007. However, our core retention rate which eliminates product swaps declined to 94% from 95% in the third quarter of 2007. This decline is largely attributable to lower retention in Barra Aegis and the TotalRisk component of multi-asset class.

Let me spend a little bit time now talking about the transition away from Morgan Stanley's services. So in the third quarter of 2008 the allocation for these costs from Morgan Stanley declined by $1.9 million to $3.9 million from the $5.8 million figure that we incurred in the quarter two 2008. This is principally because we took over certain administrative, HR and finance functions and we continue to do that.

As I said before our goal is to be self-sufficient for a vast majority of all the services that we have historically received from Morgan Stanley by the end of this fiscal year and with the process fully completed by May, 2009. We expect the allocations in the fourth quarter to be largely from IT as the allocations for HR, finance and other corporate functions runoff during the fourth quarter. As such we expect the Morgan Stanley allocation to decline by approximately $0.5 million in the fourth quarter to about $3.4 million.

In fiscal 2009 we expect THE Morgan Stanley allocation to be approximately $6 million largely reflecting IT expenses. Again, we expect Morgan Stanley charges to cease after May, 2009. For the full-year fiscal 2008 we expect the Morgan Stanley allocation to total approximately $19 million. That compares to $26.4 million of allocation expense in fiscal 2007.

In the third quarter 2008, the initial setup costs as well as duplicate costs and we incurred related to establishing the infrastructure to replace these Morgan Stanley services totaled $7.8, million including approximately $2.3 million of non-recurring expenses. For the full-year 2008 these duplicate transition expenses should total approximately $21 million to $22 million.

So in summary if you take the total cost of the Morgan Stanley allocation and the duplicate transition expenses that we expect, for all of 2008, the total of those two items should be approximately $40 million to $42 million. The equivalent expense for 2007 was $28 million.

Let me touch a little bit on capital expenditures. Capital expenditures for the third quarter totaled $13.5 million including approximately $4 million paid to Morgan Stanley for assets purchased, such as leasehold improvements in our offices, PCs and other communication equipment and office furniture. Excluding the payment to Morgan Stanley, capital expenditures year-to-date were $15 million. With that we will turn it over to the operator for questions. Operator?

(Operator Instructions). Andrew Fones, UBS.

I was wondering if you could tell us where your ETF-based assets were at the end of September.

Yes -- this is a figure as of last Friday approximately $156 billion. So that's down from the $166 billion at the end of August.

Okay, thank you. And then in terms of compensation I saw that you were able to manage that extremely well. Can you -- I think the accruals in Q2 were about $12 million to $13 million. Can you give us what the compensation accruals were in Q3?

I'm not quite sure I followed the question in terms of compensation accrualized. Compensation in Q2 total was about $36 million, $37 million. And then Q3 it was between $37 million and $38 million in terms of the compensation part of the expense line.

Sorry, I was looking at the cash-flow statement. I was just looking for kind of the bonus accruals. I think it was at $12.5 million in Q2. I was wondering if you have that number for Q3.

I don't have that number right now.

Okay. And then I was just wondering if you have any update in terms of how Morgan Stanley may be looking at kind of the stub ownership piece? You know we're coming up I guess here in mid-November, I mean first anniversary of the IPO. Thanks.

I think the message has not really changed at all. Morgan Stanley has [boldly] expressed their objective of selling their entire stake in MSCI over time. And I think what has always been a question is the timing and the exact nature of those sales over time.

So I think nothing has changed from that perspective. We clearly are not having announced at this moment any of additional sales by Morgan Stanley, so the timing and the nature of the subsequent sales is to be determined by them.

I think another important point to also indicate is that as you all know the shares that Morgan Stanley owns, which is about 27.7 million shares right now out of a total of about 100, they carry super votes. It is five votes per share compared to the Class A shares, which is one vote per share. And when Morgan -- as long as Morgan Stanley sells those shares to a nonaffiliated entity, those shares revert back to one vote per share. They convert from Class B to Class A and therefore go from five votes per share to one vote per share.

Okay thanks. That was really helpful and great job guys.

Sarah Gubins, Merrill Lynch.

Could you talk about trends that you have seen over the past months in terms of demand for index subscriptions, equity analytics and the multi-asset class products? Any either decrease or pick up in that?

Let me address that. We -- I cannot address purely this morning what has happened in the last two days, or two or three days. Since Monday I think our business continued to be fine. But over the course of September -- well, let me back up a little bit. Typically, the third quarter of a year is not our easiest year -- our easiest quarter, because in the Northern Hemisphere, where we sell most of our products, we have -- when we have the summer, we have July and August. And therefore it has typically been a major effort by our salespeople to insure that there is enough focus on the part of the client, and the decision-makers within the client, to make the final decisions about purchases of our products and the like.

In this past third quarter, that was particularly more acute because people have been, in our client base, distracted by the financial markets -- the problems in the financial markets.

So coming into September, excluding the last couple of weeks, which -- that is not to say that we have done well are not done well the last couple weeks -- these last of the days; I'm sorry. But just excluding that, in most of September we saw a very meaningful pick up in activity in our client base in terms of one thing -- to make decisions, deciding on products, and in sales and the like. So we were getting very cautiously optimistic that things will pick up during the balance of the year.

And that is not unusual because to some extent the new year in a lot of organizations really begin in September rather than January. They make a lot of purchases around that time etc., etc. So now, the last few days, and depending on what happens in the next -- in the environment here, will dictate what will happen for the balance of the quarter.

Okay. (multiple speakers)

Actually, let me add something else also. In environments like this, relative asset managers tend to hog their benchmarks. They want to be very, very close to the benchmarks. They want to understand what they are overweighting, what they are underweighting. And in many instances, many of those relative performance managers are as close to the benchmark weight as possible, because they do not want to either be left out if there is a rally in the market, and they don't get a significant benefit by spending cash for those managers, in the event of a decline. So they stay -- so therefore there is a natural tendency for a lot of inquiry and a lot of questions and potential interest in subscribing more to our equity index data.

That obviously gets mitigated by the fact that sometimes the budgets are tight. So similar in equity portfolio analytics, in an environment like this there are a lot of organizations out there that want to understand what is happening with their portfolios on a quantitative basis.

But again, that gets mitigated, and sometimes more than mitigated, by the fact that it is at times easier to not spend money on quantitative tools for the [quant] in the middle office. And the demand for multi-asset class risk is strong in an environment like this because a lot of pension funds and a lot of asset managers want to understand what is happening in their total portfolio, how they are correlated to one another, what the exposure to the value of the firm is, or to the value of the portfolio in the case of a pension fund.

Thank you. One other question on the cost side -- you're operating costs has been fairly flat on a sequential basis this year. I'm wondering if that is a trend that we could see continue into the fourth quarter, or if we should start to see the ramped up hiring move those costs up?

Well, I would say to the latter part of your question, in general you will see a progressive increase versus what you have seen year-to-date in terms of the percent of changes that you're referring to. But I will say that what you are seeing in terms of the lower than you might otherwise expect growth in our expense statement is due primarily to the movement of head count to emerging market centers.

Okay great. And then just last, can you give us an update on your plans to hire in 2009, and maybe talk about how many people you are planning to add?

I think you know we initially, back in the summer, had a pretty robust plan to add head count in '09 in mostly sales and product management, and to alleviate certain bottlenecks that we have had on our data factory. And a lot of those hires are planned to be in emerging market centers with the idea that we want to reach two objectives -- one, have fairly significant rates of investment in our business so we can either grow faster or mitigate a slowdown, and then secondly, preserve or enhance our EBITDA margins.

Clearly, in the next few weeks and through the balance of the quarter, we're going to reassess what the operating environment is to insure that our -- the scale of our operation and the scale of our head count is commensurate with the operating environment that we see day to day in our business.

We typically like to expand in environments like this because it's a lot easier to find the people. You find a lot of talented people and at a lower cost than would otherwise be the case. And as you know, people is the main part of our business. So the bias will be to do more than less, but we for sure want to insure that we scale the organization correctly and preserve or enhance our margins.

Murali Gopal, KBW.

A couple of quick questions. When I look at the [earmark] rate -- I know you've talked about the run-rate revenues. When I look at the equity in this as a subscription business, the run-rate revenue growth has been expected to be 24%, which is just pretty -- it's 24% worse, what you had in the last quarter. I'm just trying to understand.

Obviously the environment, operating environment, continued to get more challenging last quarter. I'm just trying to understand, given the challenging environment, revenue, and run-rate revenue growth is holding up pretty well. Would you say, is that a function of new managers, new money wanting to benchmark the portfolio, as Henry, you alluded to, and not wanting to be left behind? Or what is really kind of helping you -- the run rate hold up at 24%?

Yes. Let me -- I don't see this necessarily -- ah, the 24%. I see it now.

Yes. I think on equity indices, equity index data subscriptions, I would say that the 24%, or even the 5% which annualized will be about 20% -- the 5% sequential, right, which annualized would be about 20% -- is higher than we can consistently do cross cycles.

We believe that equity index data subscriptions can grow in the high teens across cycles. And I think what you're seeing here is probably a spurt of growth associated with the ripple effect of the introduction of a lot of new products within the global equity index, the global investable market indices last year. That will probably continue for some time. So that is one point.

The second point is that typically in a down market like this, clearly there is more needs for these data in order to insure that everyone in the investment organization of our clients is following very closely the benchmarks and the weights of the benchmarks, and controlling the risks, the tracking error risks, of their portfolios.

But as I said, it gets mitigated by the budgets being pretty tight. But consistently, at least in prior down cycles, we have seen that there is growth, either new managers out there, but there's also growth within our existing managers for making this data available in more locations, more content of the data, to more users, etc. But as I said, I think the run-rate growth in the 20% to 24% is probably not sustainable. I would rather have you think that in a continuation of a market like this, it is probably mid to high teens.

Okay, that is helpful. Also, when I look at the adjusted EBITDA margins that improved very nicely in the quarter, and I would have thought the ETF asset-based revenues -- that was kind of pressured given the environment. And my expectation was, that's probably a higher-margin business. And with that being pressured, I was kind of a little surprised the EBITDA margin improved as much as it did. Would you talk a little bit about that?

Yes. I think just two -- there are two or three points there. Point number one is that a lot of people do tell us, look, your ETF margins are -- incremental margins coming from ETFs are very, very large, and therefore they represent a minimal -- a meaningful part of EBITDA. And we say, yes, that is absolutely right.

But what is also right is that the incremental margin of a lot of our other products is also extremely high -- incremental margin extremely high. So on equity index data, on equity risk data it's probably in the high 80s or low 90s. The only cost is the cost of selling. Right?

Right.

So -- and therefore that represents a significant part of EBITDA. So when people look at the -- therefore at the margin, it's all a question of where do we attribute the cost of creating the equity index data. Do you apply it to -- at the extreme, do you apply it all to be ETF fees, and therefore the margins are a lot lower? Or do you apply it all to the equity index data? So the vast majority of our business has incremental -- of our products have incremental margins very, very high. So that is one concept.

The second one is that what happens -- what you see in an environment like this, and why our margins have held up -- and in this case the EBITDA margin went up higher than our target -- it is because you have a couple of things going on. One is we never planned to take a lot of the incremental margin in ETF into our investment plan. We don't assume that that money will be here. We assume that that money will be there next year, but not this year. So it does not affect our investment plans, and therefore if it is a spurt of ETF fees, it all goes down to the margin, and vice versa.

Secondly, there is a huge amount of operating leverage, positive operating leverage, in the business from the subscription business that I mentioned before, and that has an upward pressure on the EBITDA margin.

And number three is we are very disciplined, extremely disciplined in our cost management in all aspects of our business non compensation. And in the case of compensation, we clearly have a target of growing most of our new head count in emerging market centers so that we can do a lot of investing without a commensurate increase in cost.

Okay. I note you previously didn't mention what the ETF assets were at the end of September. But could you tell us what the flows were in September?

We do not have that data available right here with us. It is quite an exercise to go through and to figure that out. So that is why we don't have it.

Okay. And I know in terms of the equity portfolio analytics business, you did see some cancellations of quant managers, and that kind of is reflected in the run rate kind of slowing down. Where do you think that is in terms of playing out? Do you think that the quant managers -- have you seen some pressure in terms of the quant funds? For a while now, you'd think that has kind of played out itself, or you think there's a little bit more to be played out on that front?

I think clearly there is pressure on the quantitative portfolio managers. But remember also that the majority of our sales go to the quant's office, the quant middle office of fundamental portfolio managers, not just the quantitative portfolio managers. So there is clearly pressure on budgets all around.

I think we did not grow as fast maybe as some of our competitors in equity portfolio analytics for a variety of reasons. One, we were short staffed, and the area that it was most acute in our sales organization was an equity portfolio analytics.

Secondly, we had told the market that we were working on a number of different models including GEM2 and the European model, and therefore that creates a tendency for customers to wait until the new model comes in before they subscribe to those.

And then thirdly, in the case of equity portfolio analytics, I think about one quarter, Mike, if I remember correctly, of the revenues are in currencies other than the dollar, about a quarter in currencies other than the dollar. And therefore when you have a rapid appreciation of the dollar like we saw in August, which actually was reversed in September -- but we saw it in August, that impacts the net run rate that you see in the numbers here.

So we're hoping that -- obviously, things may get a bit worse before they get better, given the environment. But we're hoping that some mitigation to the flatness of the run rate on equity analytics will come from -- we're now focused on putting a lot more salespeople on this category, and there is money to be had there that we're leaving on the table.

Secondly, we did launch this product -- the global equity model. And we are launching a number of other models in the next few quarters. So that may mitigate some of that impact. Nothing we can do about the foreign exchange, right. That goes up and down, and it benefits you or hurts you depending on which way it goes.

Okay. And lastly, with the slot trading at the levels it's sustaining right now, any thoughts on share repurchases?

Well, that is a great point. Under our credit facility, we're not permitted at the present time to do share repurchases. And also the other -- which will go away. While Morgan Stanley is in our capital structure, we are also not doing any share repurchases. But it is really limited right now by our credit facility.

Thank you very much. That's very helpful.

John Neff, William Blair.

The asset-based revenue was a little better than expected this quarter, despite a lower average daily ETF level than we had calculated. I remember last quarter some of the weakness despite better than expected average was due to things like index replicating funds and assets there. Can you talk about some of the other moving parts besides ETFs that contributed to the asset-based revenue?

Yes, John. See what happens is -- I think the first thing to always keep in mind is that exchange credit funds are on a secular growth even within a cyclical downturn. And therefore, you -- let's say, contrary to a lot of equity mutual funds in the United States that have seen meaningful redemptions, you don't necessarily see a significant or meaningful amount of outflows in equity exchange traded funds across the world. And therefore -- and we attribute that to the fact that there is an underlying set of demand for these products that is secular that is not going away. So what you see is that most of the impact is the asset depreciation. There are outlooks of course, but the asset depreciations are in the product.

But secondly, as I said before, in markets like this one -- in turmoil markets like this, a lot of people want to exactly replicate the benchmark. They don't want -- they want us -- they don't want to be making a lot of bets one way or another. It is actually bar bells. Some people end up taking -- being a stock picking market, as some people call it, and either being cash or just in a concentrated portfolio that they know well that is defensive.

Or alternatively, they just want to know exactly what is in their portfolio, and they make their own decision separately as to whether to put things in cash or not. So these ETFs are a very good way to do that.

Another aspect is that ETFs are used for overlay strategies by people, and that helps as well to go along or short. And as far as I know, many of these ETFs or not part of any of the short lists that are anywhere in the world. So that's a component.

Another thing that is more specific to us is that we are launching products out there, and in the past we have said that new products, the assets accumulated in new products and therefore the revenue coming from that in a rapidly escalating market like last year, they were not a meaningful part of our revenue. But if you have declines in existing products and you are introducing new products, those revenues do help mitigate the downturns in assets and in revenues.

We're seeing some of our closest ETF sponsors or managers taking this market downturn as an opportunity to have -- to be more aggressive in launching products and gain market share as the markets recover. So -- and therefore, we're likely to see more and more ETF launches in the coming quarters.

Thank you. And then a question probably for Mike. Again, sort of picking up on the notion of how flat the cash operating expenses have been sequentially, the question is, what are you cutting expense-wise as you're adding head count? Is the reason for the flatness in the cash operating expenses due to the lower-cost to replicate the Morgan Stanley services as you move those in-house? How should we think about that?

So I think a lot of it is we have had a number of head-count reductions in what I would consider to be developed market centers, that we have not replaced. And we have either not replaced that head count, or if we have replaced the head count, it has been to emerging market centers, so there is a lower cost. So that's a mitigating against having higher cash expense growth. So I think I would attribute it to that, as well as just really tight, tight management around our expenses, especially in the non-compensation area, where we are very diligent constantly in terms of keeping those costs low in terms of T&E, and travel, and items like that, that really make a difference.

Great. And then probably Mike, another couple of questions for you would be -- the FX loss in the quarter of $3 million due mainly to changes in the non-US dollar cash balances. Why is that simply not a balance-sheet item?

Because basically that takes place at a level -- you mean balance-sheet item in terms of otherwise being recorded into other (multiple speakers) comprehensive income?

Yes. Why doesn't it simply affect the dollar value of the cash balance, as opposed to being run through the P&L?

Because those cash balances are held in non-US subsidiaries, so it is at a level of our functional currency. So when that originating currency and functional currency are valued at the end of the quarter, that goes through the P&L.

What will not go through the P&L is when we convert functional currency like our UK company up to the US company. That basically will go through OCI. So it's a little bit complicated. We have a triple-ledger system, so we have originating currency, a functional currency, and then a reporting currency. When you go from originating currency to functional currency, that difference there at the end of a balance-sheet period goes to the P&L into other operating income, and then from a functional currency up to reporting currency. So when the UK company converted up to the reporting currency with US dollars, that difference there will go into other comprehensive income. It's a balance-sheet item and does not go through the P&L.

Okay. Okay, that is great. Is there a way to just sort of think about -- or rule of thumb in terms of say a 10% appreciation in the US dollar versus the basket of currencies you're dealing with? What does that do -- how should we think about that in terms of impact on the P&L?

Well, the largest component we had at the end of August, about the equivalent of $50 million in non-dollar currencies. So -- and that is a mix between the pound, which is probably the largest component there, and the Yen, and then the Euro.

So for example, out of that $50 million, at the end of August probably 30, 35 million was in pounds. So you could think about it in that context. And then I will also say that there are other monetary assets that are on the balance sheets of the functional currency companies down below, for example, receivables and payables between the companies. That could also impact it. But it is basically our non-cash balances, which as I mentioned, at end of August our non-US-dollar cash balances, which at the end of August were about $50 million.

And then the $7.8 million in Morgan Stanley replacement costs, how much of that, if any, is one-time?

$2.3 million, $2.4 million is one-time; $2.3 is one-time.

Okay, great. And then you mentioned -- I think, Henry, you talked about 100 new hires during the quarter. How many of those are in sales, and what is the total coverage head count at this point versus last quarter or a year ago?

Yes. We -- the action that we took in early July -- June was to alleviate the acute state of shortage of staff in the Company and therefore the effect on sales of products and the like. We authorized the hiring of 100 people in the ensuing six to 12 months, from June of this year.

Secondly, on a net basis, almost all those 100 people will be hired in emerging market centers. What that means is that there are that are in developed markets for sure, but when there is attrition in the developed markets, we will be moving some of those functions to emerging markets. So that is what -- 100 on a net basis is mostly in emerging market centers.

The other more direct answer to your question is, about 40 to 50 of those people will go in what we call the client organization, which are -- about half of those will be sales and another half will be client support. So if you think about in orders of magnitude of 100 people, 25 going to sales, another 25 going to sales support functions to support the maintenance of run rate and new sales for clients but without being quota-carrying salespeople, and the other 50 or so out of the 100 will go into product management functions that are going to obviously support the sales effort, some of those.

And then the bulk of those 50 will go into product production functions, which is our data factory, and the IT infrastructure to support the data factory in order to break down some of the bottlenecks that have prevented us in the past from speeding up new product introductions.

Last question, and I will just get back in the queue, is can you talk a little bit about acquisitions? Is it a good opportunity to be looking at acquisitions? And can you discuss your ability to pursue acquisitions as long as Morgan Stanley owns a big slug of your stock?

Sure. Yes. We continue to continuously review acquisitions. In environments like this you would tend to think that acquisitions are clearly more attractive from the valuation perspective, but there is also a lot less liquidity, a lot less flow of companies because they are waiting to see if the markets will go down or their valuations will go down and stay there, or whether there is a recuperation of the value lost. So there's not a lot of liquidity.

We continuously look at it. I think any large acquisition for equity or debt is not likely while Morgan Stanley is in the capital structure, because they will not want to be diluted, and they may not want to pay for the discount that is typically associated in the stock in an acquisition when you're paying a premium for the target.

So if we do anything at this point, it will likely be for cash in a smaller way. But again, that is just a guideline. If something comes up that is very attractive and we should not really pass, obviously we will be talking to Morgan Stanley to see if we can get done.

Michael Weisberg, ING.

A couple of things, if I could. The $3 million charge on the -- the balance-sheet related charge, is that a pretax charge?

That's pretax, yes.

Pretax, got it. Great. When you talk about all the new hired, you mentioned that, ex the Morgan Stanley transition, your expenses were running up about 7%, I think you said, year to year in the third quarter?

I said ex -- if you take out the founders grant, you take out the transition expenses that we are incurring, and then you eliminate the allocation from Morgan Stanley from both the third quarter 2008 and the third quarter 2007, then you get about 7% expense growth.

Great. I guess with the announced hiring of -- which you're in transition of -- of 100 people, is that going to cause that number to go up as we move into '09 or not? Or can you maintain it where it was?

Yes. We guestimate as we are hiring these people -- remember, these people are net 100 in emerging markets centers, some in developed markets and some relocation of functions based on attrition to emerging markets.

The compensation expense of that is say $10 million to $12 million. The run rate that will start obviously is running through the P&L as those people are hired, which is a very modest investment in our mind given the profitability of the business and the expanding margins of the business.

I would like to repeat, when you hear a company of 700 people hiring 100 people, all alarm bells go off that, gee, that's going to have a significant and immaterial impact on cost, and the margins are going to go down, and the lights. Based on the comment I just made, we -- our goal right now as far as we can see, is to maintain the margins in the business that we have been accustomed to for as long as we can.

Now, if the environment over a year or two-year period turns extremely negative, we will be talking to you about -- to all of you about whether that is maintainable or not, but that is the intent. So our goal is to make significant investments in the business, which typically means people; to do it in a way that it is very cost-effective; and maintain and enhance the margins of the business.

Okay great. Now, could you also -- you mentioned the high growth in the equity index business. And it's now 20% and the 20% growth range is not sustainable. You also mentioned your products. Is -- recognizing it is a mid high-teens growth business longer-term, is that 20%-plus kind of growth sustainable as we move into 2009?

Well, as we move into 2009, as I said before, I will be more comfortable in the equity index data subscription to be in the high teens, not in the 20% to 25% category, based on what we know today. Again, we are in an uncertain market. So if you extrapolate the last five days or two weeks and assume that all of '09 is going to be like this, we will be talking about maybe me being more realistic about those growth rates, right.

But assuming some return to normalcy, meaning like the summer, not assuming a major conflagration here in the equity market, we feel pretty comfortable that those equity index data subscriptions can grow in the mid to high teens.

Thanks a lot, Henry.

That does conclude the question-and-answer session. I will turn the call back over to Management for additional or closing remarks.

Well, thank you again for participating. We -- as we said, we have very record results here, and we have work to do to make sure that our run rates go back to a level that is more commensurate to what we have been accustomed to, and we are doing everything we can to do that, and we will be updating everyone as we go on through that.

Thank you.

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may disconnect at this time.