7

---

 

MSCI INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The condensed consolidated statements of income reflect expense allocations for certain corporate functions historically provided by Morgan Stanley, including human resources, information technology, accounting, legal and compliance, corporate services, treasury and other services. These allocations are based on what the Company and Morgan Stanley considered reasonable reflections of the utilization levels of these services required in support of the Company’s business and are based on methods that include direct time tracking, headcount, inventory metrics and corporate overhead. Inter-company balances and transactions are eliminated in consolidation.

 

Certain prior period amounts have been reclassified to conform to current period presentations.

 

Change in Presentation

Effective June 1, 2008, the Company began presenting gains and losses resulting from foreign currency transactions as a component of other expense (income) in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 52, “Foreign Currency Translation” (“SFAS 52”).  Prior to June 1, 2008, the Company included such gains and losses as components of cost of services and selling, general and administrative.  The Company changed its presentation because foreign currency gains and losses are incidental to the business and not part of day to day operations. Prior period amounts have been reclassified to conform to current period presentation.  For the three months ended August 31, 2007, $72,000 and $338,000 recorded in cost of services and selling, general and administrative expenses, respectively, was moved to other expense (income).  For the nine months ended August 31, 2007, $65,000 and ($56,000) recorded in cost of services and selling, general and administrative expenses, respectively, was moved to other expense (income).

 

Concentration of Credit Risk

 

The Company licenses its products and services to investment managers primarily in the United States, Europe, Asia (Japan, Hong Kong and Singapore) and Australia. The Company evaluates the credit of its customers and does not require collateral. The Company maintains reserves for estimated credit losses.

 

Financial instruments that may potentially subject the Company to concentrations of credit risk consist principally of cash investments and short-term investments. Prior to July 1, 2008, excess cash was held on deposit with Morgan Stanley and was unsecured. The Company received interest at Morgan Stanley’s internal prevailing rates. At November 30, 2007, amounts held on deposit with Morgan Stanley were $137.6 million. On June 30, 2008, at MSCI’s instruction, Morgan Stanley transferred MSCI’s cash held on deposit to MSCI and following the transfer, the Company deposited the cash predominantly with Bank of America.

 

For the three months ended August 31, 2008 and 2007, Barclays PLC and its affiliates accounted for 11.7% and 14.3%, respectively, of the Company’s operating revenues.  For the nine months ended August 31, 2008 and 2007, Barclays PLC and its affiliates accounted for 11.9% and 13.0%, respectively, of the Company’s operating revenues.

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

 

In June 2007, the Emerging Issues Task Force (“EITF”) reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards ” EITF Issue No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units that are expected to vest be recorded as an increase to additional paid-in capital. The Company currently accounts for this tax benefit as a reduction to its income tax provision. EITF Issue No. 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007. As the Company currently has no plans to pay a dividend, the adoption of EITF Issue No. 06-11 is not expected to have an impact on the Company’s condensed consolidated financial statements.

 

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. SFAS

 

 

8

---

 

 

MSCI INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after December 1, 2009.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”). SFAS No. 162 identifies, within the accounting literature established by the FASB, the sources and hierarchy of the accounting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS No. 162 is effective 60 days following the Securities and Exchange Commission’s (“SEC’s”) approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The adoption is not expected to have an impact on the Company’s condensed consolidated financial statements.

3. EARNINGS PER COMMON SHARE

 

 

Basic and diluted earnings per common share (“EPS”) are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted weighted average common shares includes vested and unvested stock options and unvested restricted stock awards. No stock options or restricted stock awards were excluded from the calculation of diluted earnings per share for the three or nine months ended August 31, 2008 or 2007.

 

The following table sets forth the computation of earnings per share:

 

		Three Months Ended August 31,								Nine Months Ended August 31,
		2008				2007				2008				2007
		(in thousands, except per share data)								(in thousands, except per share data)
Net income		$	18,878			$	21,379			$	55,443			$	62,872
Basic weighted average common shares outstanding			100,052				83,900				100,020				83,900
Basic weighted average common shares outstanding			100,052				83,900				100,020				83,900
Effect of dilutive securities:
Stock options and restricted stock units			1,646				—				1,216				—
Diluted weighted average common shares outstanding			101,698				83,900				101,236				83,900
Earnings per basic common share		$	0.19			$	0.25			$	0.55			$	0.75
Earnings per diluted common share		$	0.19			$	0.25			$	0.55			$	0.75

 

4. COMPREHENSIVE INCOME

 

The components of comprehensive income are as follows:

 

 

9

---

 

 

MSCI INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

		Three Months Ended August 31,							Nine Months Ended August 31,
		2008			2007				2008			2007
		(in thousands)							(in thousands)
Net income		$	18,878		$	21,379			$	55,443		$	62,872
Other comprehensive income, net of tax:
Net changes in unrealized (losses) gains on cash flow hedges			(858	)		—				1,305			—
Foreign currency translation adjustments			(1,095	)		(2,846	)			(164	)		(1,506	)
Comprehensive income		$	16,925		$	18,533			$	56,584		$	61,366

 

5. RELATED PARTY TRANSACTIONS

 

Cash Deposits, Receivables from Related Parties and Interest Income. Prior to July 1, 2008, the Company deposited most of its excess funds with Morgan Stanley. Related party receivables consist of amounts due to the Company for sales of products and services to Morgan Stanley. The Company received interest at Morgan Stanley’s internal prevailing rates on its cash deposits and related party receivables. Related party receivables as of August 31, 2008 were approximately $5.7 million. On June 30, 2008, at MSCI’s instruction, Morgan Stanley transferred MSCI’s cash held on deposit to MSCI and following the transfer, the Company deposited the cash predominately with Bank of America. Interest earned on both cash on deposit with Morgan Stanley and related party receivables for the three months ended August 31, 2008 and 2007 totaled approximately $0.9 million and $1.1 million, respectively. Interest earned on both cash on deposit with Morgan Stanley and related party receivables for the nine months ended August 31, 2008 and 2007 totaled approximately $5.3 million and $11.6 million, respectively.

 

Revenues. Morgan Stanley or its affiliates subscribe to, in the normal course of business, certain of the Company’s products. Revenues recognized by the Company from subscription to the Company’s products by Morgan Stanley for the three months ended August 31, 2008 and 2007 were $2.9 million and $3.3 million, respectively. For the nine months ended August 31, 2008 and 2007, revenues of $9.1 million and $10.3 million, respectively, were from Morgan Stanley and from Capital Group International, which is not a related party for the three or nine months ended August 31, 2008.

 

Administrative Expenses. Morgan Stanley affiliates have invoiced administrative expenses to the Company relating to office space, equipment and staff services. The amounts invoiced by Morgan Stanley affiliates for staff services for the three months ended August 31, 2008 and 2007 were $3.9 million and $7.0 million, respectively. The amounts invoiced by Morgan Stanley affiliates for staff services for the nine months ended August 31, 2008 and 2007 were $16.0 million and $19.8 million, respectively.

 

Payables to Related Parties. Current payables to related parties consist principally of amounts due to Morgan Stanley affiliates for services provided to the Company and state income taxes. Historically, payables to related parties consisted of amounts due to Morgan Stanley affiliates for the Company’s expenses, income taxes and prepayments for the Company’s services. The amounts outstanding are unsecured, bear interest at Morgan Stanley’s internal prevailing rates and are payable on demand. Amounts payable to related parties as of August 31, 2008 were $15.2 million. Interest expense on these payables for the three months ended August 31, 2008 and 2007 was less than $0.1 million and $1.3 million, respectively. Interest expense on these payables for the nine months ended August 31, 2008 and 2007 was $0.4 million and $1.6 million, respectively.

 

 

 

10

---

 

MSCI INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

6. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Property, equipment and leasehold improvements at August 31, 2008 and November 30, 2007 consisted of the following:

		As of
		August 31,				November 30,
		2008				2007
Computer & related equipment		$	19,376			$	7,598
Furniture & fixtures			2,332				1,520
Leasehold improvements			10,479				8,532
Work-in-process			2,829			─
Subtotal			35,016				17,650
Accumulated depreciation and amortization			(13,039	)			(13,404	)
Property, equipment and leasehold improvements, net		$	21,977			$	4,246

Depreciation and amortization expense of property, equipment and leasehold improvements was $1.3 million and $0.4 million for the three months ended August 31, 2008 and 2007, respectively.  Depreciation and amortization expense of property, equipment and leasehold improvements was $2.3 million and $1.5 million for the nine months ended August 31, 2008 and 2007, respectively.

 

7. INTANGIBLE ASSETS

 

The Company amortizes definite-lived intangible assets over their estimated useful lives. Amortizable intangible assets are tested for impairment when impairment indicators are present, and, if impaired, written down to fair value based on either discounted cash flows or appraised values. No impairment of intangible assets has been identified during any of the periods presented. The Company has no indefinite-lived intangibles.

 

Amortization expense related to intangible assets for the three months ended August 31, 2008 and 2007 was approximately $7.1 million and $6.7 million, respectively. Amortization expense related to intangible assets for the nine months ended August 31, 2008 and 2007 was approximately $21.4 million and $19.2 million, respectively.

 

The gross carrying amounts and accumulated amortization totals related to the Company’s identifiable intangible assets are as follows:

 

		Gross Carrying Value				Accumulated Amortization				Net Carrying Value
		(in thousands)
As of August 31, 2008
Technology/software		$	140,800			$	(84,631	)		$	56,169
Trademarks			102,220				(20,669	)			81,551
Customer relationships			25,880				(10,568	)			15,312
Non-competes			50				(50	)			—
Total		$	268,950			$	(115,918	)		$	153,032

 

 

 

We do not have any off-balance sheet arrangements as of August 31, 2008.

 

 

33

---

 

 

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

 

Foreign Currency Risk

 

We have exposures to currency exchange fluctuation risk—revenues from index-linked investment products, such as exchange traded funds, non-U.S. dollar invoiced revenues and non-U.S. dollar operating expenses.

 

Revenues from equity index-linked asset based fee products represented approximately $18.3 million and $56.2 million, or 16.6% and 17.4%, of our operating revenues for the three and nine months ended August 31, 2008, respectively. While our fees for index-linked investment products are generally invoiced in U.S. dollars, the fees are based on the investment product’s assets, substantially all of which are invested in securities denominated in currencies other than the U.S. dollar. Accordingly, declines in such other currencies against the U.S. dollar will decrease the fees payable to us under such licenses. In addition, declines in such currencies against the U.S. dollar could impact the attractiveness of such investment products resulting in net fund outflows, which would further reduce the fees payable under such licenses.

 

We generally invoice our clients in U.S. dollars; however, we invoice a portion of clients in Euros, pounds sterling, Japanese yen and a limited number of other non-U.S. dollar currencies. Approximately $15.2 million and $46.2 million, or 13.7% and 14.3% of our revenues for the three and nine months ended August 31, 2008, respectively, are denominated in foreign currencies, of which the majority are in Euros, pounds sterling and Japanese yen.

 

We are exposed to additional foreign currency risk in certain of our operating costs. Although our expenses are generally in U.S. dollars, some of our expenses are incurred in non-U.S. dollar denominated currencies. Approximately $19.9 million and $52.6 million, or 27.3% and 24.1% of our expenses for the three and nine months ended August 31, 2008, respectively, were denominated in foreign currencies, the significant majority of which were denominated in Swiss francs, pounds sterling, Hong Kong dollars, Euros and Japanese yen. Expenses paid in foreign currency may increase as we expand our business outside the U.S. and replace services provided by Morgan Stanley internationally for which we currently pay Morgan Stanley in U.S. dollars.

 

In addition, a significant number of our senior personnel are compensated in U.S. dollars as opposed to the local currency of their respective locations. This exposes us to employee turnover in periods of U.S. dollar weakness.

The Company has certain balances denominated in currencies other than local functional amounts and when these assets and liabilities were remeasured into their local functional currency, a loss resulted from the devaluation of the value of the functional currency.  As a result of these positions, we recognized foreign currency exchange losses of $3.0 million for both of the three and nine months ended August 31, 2008.  These losses on foreign currency exchange were primarily due to the strengthening of the US dollar ("USD") in August. Although the company does not currently hedge the foreign exchange risk of assets and liabilities denominated in currencies other than the functional currency, it is looking to minimize exposure by reducing the value of the assets and liabilities in currencies other than the functional currency of the legal entity in which they reside.

 

To the extent that our international activities recorded in local currencies increase in the future, our exposure to fluctuations in currency exchange rates will correspondingly increase. Generally, we do not use derivative financial instruments as a means of hedging this risk; however, we may do so in the future. Foreign currency cash balances held overseas are generally kept at levels necessary to meet current operating and capitalization needs.

 

Interest Rate Sensitivity

 

We had unrestricted cash and cash equivalents totaling $246.5 million at August 31, 2008 and $33.8 million at November 30, 2007. These amounts were held primarily in checking money market accounts in the countries where we maintain banking relationships. Prior to July 1, 2008, the majority of excess cash was deposited with Morgan Stanley. At November 30, 2007, amounts held with Morgan Stanley were $137.6 million. On our Condensed Consolidated Statement of Financial Position, these amounts are shown as cash deposited with related parties. We

 

 

34

---

 

 

received interest at Morgan Stanley’s internal prevailing rates on these funds. The unrestricted cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. We believe we do not have any material exposure to changes in fair value as a result of changes in interest rates. Declines in interest rates, however, will reduce future interest income.

 

Borrowings under the Credit Facility accrued interest at a variable rate equal to LIBOR plus a fixed margin subject to interest rate step-downs based on the achievement of consolidated leverage ratio conditions (as defined in the Credit Facility.)  On July 8, 2008, we met certain conditions as defined in the Credit Facility and qualified for a tier change, resulting in a decrease in the LIBOR fixed margin to 2.00% for the term loan A facility and 2.50% for the term loan B facility. We expect to pay down the Credit Facility with cash generated from our ongoing operations.

 

On February 13, 2008, we entered into interest rate swap agreements effective through the end of November 2010 for an aggregate notional principal amount of $251.7 million. By entering into these agreements, we reduced interest rate risk by effectively converting floating-rate debt into fixed-rate debt. This action reduces our risk of incurring higher interest costs in periods of rising interest rates and improves the overall balance between floating and fixed rate debt. The effective fixed rate on the notional principal amount swapped was approximately 5.25% for the three months ended August 31, 2008. On August 31, 2008, the effective fixed rate on the notional principal amount swapped was 5.15%.  These swaps are designated as cash flow hedges and qualify for hedge accounting treatment under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.

 

Changes in LIBOR will affect the interest rate on the portion of our credit facilities which have not been hedged by the interest rate swaps and, therefore, our costs under the credit facilities.  Assuming an average of $160.0 million of variable rate debt outstanding, a hypothetical 100 basis point increase in LIBOR for a one year period would result in approximately $1.6 million of additional interest rate expense.

 

We recorded a pre-tax loss in other comprehensive income of $1.4 million ($0.9 million after tax) for the three months ended August 31, 2008 and a pre-tax gain of $2.2 million ($1.3 million after tax) for the nine months ended August 31, 2008 as a result of the fair value measurement of these swaps. The fair value of these swaps is included in other accrued liabilities on our Condensed Consolidated Statement of Financial Position.

 

Item 4.    Controls and Procedures

 

Our Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, the “Exchange Act”) and have concluded that these disclosure controls and procedures are effective as of August 31, 2008 These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

There were no changes during the three months ended August 31, 2008 in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

35

---

 

 

Part II

 

Item 1.    Legal Proceedings

 

From time to time we are party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, operating results, financial condition or cash flows.

Item 1A.

Risk Factors

 

For a discussion of the risk factors affecting the company, see “Risk Factors” in Part I, Item 1A of our Form 10-K for the fiscal year ended November 30, 2007 as updated by “Risk Factors” in Part II, Item 1A of our Form 10-Q for the quarter ended May 31, 2008.

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

There have been no unregistered sales of equity securities.

 

The table below sets forth the information with respect to purchases made by or on behalf of the Company of its common shares during the quarter ended August 31, 2008.

Issuer Purchases of Equity Securities

Period	Total Number of Shares Purchased	Average Price Paid Per Share	Total Number of Shares Purchased As Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
Month #1 (June 1, 2008-June 30, 2008)      Employee Transactions(1)	282	$36.32	N/A	N/A
Month #2 (July 1, 2008-July 31, 2008)      Employee Transactions(1)	609	$30.69	N/A	N/A
Month #3 (August 1, 2008-August 31, 2008)      Employee Transactions(1)	-	-	-	-
Total      Employee Transactions(1)	891	$32.47	N/A	N/A

(1) Includes shares withheld to offset tax withholding obligations that occur upon vesting and delivery of outstanding shares underlying restricted stock units and/or upon the exercise of employee stock options. The value of the shares withheld were valued using the fair market value of the Company’s class A common shares on the date of withholding, using a valuation methodology established by the Company.

 

 

36

---

 

 

Item 3.    Defaults Upon Senior Securities

 

None.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

None.

Item 5.    Other Information

 

None.

 

Item 6.    Exhibits

 

An exhibit index has been filed as part of this Report on page E-1.

 

 

37

---

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: October 3, 2008

 

MSCI INC. (Registrant)
By:	/s/ Michael K. Neborak
	Michael K. Neborak
	Chief Financial Officer
	(Principal Financial Officer)

 

38

---

 

EXHIBIT INDEX

 

MSCI INC.

 

QUARTER ENDED AUGUST 31, 2008

 

		3.1		Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Company’s Form 10-K (File No. 001-33812), filed with the SEC on February 28, 2008)
		3.2		Amended and Restated By-laws (filed as Exhibit 3.2 to the Company’s Form 10-K (File No. 001-33812), filed with the SEC on February 28, 2008)
		10.1		MSCI Inc. Amended and Restated 2007 Equity Incentive Compensation Plan (filed as Annex B to the Company’s Proxy Statement on Schedule 14A (File No. 001-33812), filed with the SEC on February 28, 2008)
		10.2		MSCI Inc. Performance Formula and Incentive Plan (filed as Annex C to the Company’s Proxy Statement on Schedule 14A (File No. 001-33812), filed with the SEC on February 28, 2008)
*		10.3		Amended and Restated Shareholder Agreement, dated as of July 21, 2008, between Morgan Stanley and MSCI Inc.
*		10.4		Amendment No. 1 to the Intellectual Property Agreement, dated as of July 21, 2008, between Morgan Stanley and MSCI Inc.
*		10.5		Amendment No. 1 to the Services Agreement, dated as of July 21, 2008, between Morgan Stanley and MSCI Inc.
*		10.6		Amendment No. 1 to the Trademark License Agreement, dated as of July 21, 2008, between Morgan Stanley and MSCI Inc.
*		10.7		Asset Purchase Agreement, dated as of July 22, 2008, between Morgan Stanley and MSCI Inc.
		11		Statement Re: Computation of Earnings Per Common share (The calculation per share earnings is in Part I, Item I, Note 3 to the Condensed Consolidated Financial Statements (“Earnings Per Common Share”) and is omitted in accordance with Section (b)(11) of Item 601 of Regulation S-K.)
*		15		Letter of awareness from Deloitte & Touche LLP, dated October 3, 2008, concerning unaudited interim financial information
**		31.1		Rule 13a-14(a) Certification of the Chief Executive Officer
**		31.2		Rule 13a-14(a) Certification of the Chief Financial Officer
**		32.1		Section 1350 Certification of the Chief Executive Officer and the Chief Financial Officer

________________

*	Filed herewith

 

**	Furnished herewith

 

 

E-1

---