Moody’s Corporation — Q3 2012 Form 10-Q
Business context and reporting period. Moody’s provides credit ratings and related research, data, analytics, risk-management software, and professional services. Its reportable segments are Moody’s Investors Service (MIS) and Moody’s Analytics (MA). This unaudited filing covers the three and nine months ended September 30, 2012, compared with the corresponding 2011 periods. Unless noted otherwise, amounts are U.S. dollars.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $688.5M | $531.3M | $1,976.1M | $1,713.6M |
| Operating income | $269.7M | $196.1M | $817.2M | $716.3M |
| Operating margin | 39.2% | 36.9% | 41.4% | 41.8% |
| Adjusted operating income | $293.8M | $215.3M | $886.9M | $774.9M |
| Adjusted operating margin | 42.7% | 40.5% | 44.9% | 45.2% |
| Net income attributable to Moody’s | $183.9M | $130.7M | $529.9M | $475.2M |
| Diluted EPS | $0.81 | $0.57 | $2.34 | $2.06 |
Adjusted operating income and margin are non-GAAP measures that exclude depreciation and amortization and restructuring items.
- Revenue drivers: Q3 revenue increased 30%; MIS revenue rose 33% and MA revenue 20% (including intersegment amounts). MIS benefited from stronger debt issuance, especially U.S. corporate finance, as well as pricing and fee initiatives. MA growth included the late-2011 Copal and Barrie & Hibbert acquisitions, plus growth in risk solutions and research/data.
- Costs and margins: Q3 expenses rose 25%, reflecting incentive compensation, acquired businesses, staffing, IT investment, and higher legal-defense costs. Nine-month operating margin declined 0.4 percentage points despite higher revenue, as expenses grew 16%.
- Cash flow: Nine-month operating cash flow was $496.0M versus $666.3M; free cash flow was $460.8M versus $612.7M. Lower cash generation reflected tax-audit settlement payments, timing of tax payments, and higher receivables associated with increased billings; lower capital additions partly offset the decline. Capital additions were $35.2M.
- Balance sheet and liquidity: At September 30, cash and equivalents were $1,518.5M, short-term investments $22.7M, and total debt $1,707.5M, compared with $760.0M, $14.8M, and $1,243.8M at year-end 2011. Cash exceeded reported debt by approximately $189M. A $1.0B revolving facility, expiring in 2017, was undrawn; the company also had a $1.0B commercial-paper program. Moody’s reported compliance with debt covenants.
- Debt and capital returns: Moody’s issued $500M of 4.50% senior notes due 2022 in August 2012. Debt covenants generally include a maximum debt-to-EBITDA ratio of 4.0 to 1.0. Nine-month share repurchases were $125.1M and dividends paid were $107.3M. The Board declared a $0.16-per-share dividend payable in December 2012.
Material changes versus the prior comparable period
- Q3 revenue increased $157.2M and operating income increased $73.6M year over year. Nine-month revenue increased $262.5M and operating income increased $100.9M.
- Q3 MIS external revenue increased 35%; corporate finance revenue increased 71%. For the nine-month period, MIS external revenue grew 14%, with growth across all lines of business.
- MA external revenue increased 20% in Q3 and 19% for the nine months. Professional services growth was substantially acquisition-related; ERS growth included Barrie & Hibbert and organic growth.
- Operating cash flow and free cash flow fell year over year despite higher net income, principally because of tax payments and working-capital movements.
- Total debt increased by approximately $464M, primarily reflecting the new $500M notes, partly offset by term-loan repayments. The company changed its annual goodwill impairment assessment date from November 30 to July 31; management said the change did not defer or avoid impairment recognition.
Outlook, management commentary, risks, and unusual items
- 2012 guidance raised: GAAP diluted EPS guidance increased to $2.95–$3.05 from $2.76–$2.86. Pro forma EPS, excluding a $0.06-per-share legacy tax benefit, was projected at $2.89–$2.99. Management forecast mid-teens revenue and expense growth, an approximately 40% operating margin, approximately 43% adjusted operating margin, and an approximately 32% effective tax rate.
- Segment outlook: MIS revenue was expected to grow in the mid-teens, including low-20s growth in the U.S.; MA revenue was expected to grow in the high-teens. Management cited uncertainty in macroeconomic and capital-market assumptions, particularly in Europe, and assumed foreign exchange rates at quarter-end levels.
- Tax and other unusual items: Q3 included a $12.8M reversal of a legacy tax liability and a $4.4M accrued-interest reversal related to favorable resolution of legacy tax matters; management identified a $0.06-per-share benefit. Legacy tax liabilities recorded at quarter-end totaled $38.9M. Nine-month income-tax payments were $271.9M, including approximately $92M for audit settlements.
- Litigation and regulatory exposure: Moody’s described continuing investigations and litigation concerning ratings, with increased legal-defense costs. In the Cheyne SIV litigation, plaintiffs alleged approximately $713M in damages against all defendants; the filing says about $303M related to claims dismissed against Moody’s, while some claims and reconsideration motions remained. Rhinebridge plaintiffs alleged approximately $70M in damages. Management said it could not estimate a range of possible losses for certain pending matters. A shareholder derivative settlement requiring governance changes for two years received final judgment; the company agreed not to oppose fees and costs up to $4.95M.
- Other risks and items to monitor: The FSTC reporting unit was identified as most exposed to potential goodwill impairment if projections are missed; a 20% hypothetical fair-value reduction would produce a $17.0M deficit under the filing’s sensitivity analysis. A $1M impairment of certain FSTC customer lists was recorded; no goodwill impairment was recorded. The company also cited evolving credit-rating regulation, market issuance levels, foreign exchange, integration of acquisitions, and litigation outcomes as risks.
- Management expected positive operating cash flow over the next 12 months and said it had resources to meet cash requirements. Approximately $785M of cash was held outside the U.S., including about $712M in entities whose earnings were indefinitely reinvested; future distributions could create additional tax liabilities.
Important facts for investors to verify
- Whether improved ratings issuance and pricing persist, and how transaction-heavy revenue compares with recurring monitoring and subscription revenue.
- Whether the raised EPS outlook is achieved, including the effects of expenses, incentive compensation, foreign exchange, and the one-time legacy tax benefit.
- Whether operating cash flow recovers from the nine-month decline and whether receivables and tax-related payments normalize.
- Debt, cash deployment, and compliance with the 4.0-to-1.0 debt-to-EBITDA covenant; also monitor the Copal put/call obligation and other contractual commitments.
- Developments in Cheyne, Rhinebridge, tax audits, and credit-rating regulation, including any change in the currently unestimable potential litigation loss range.
- FSTC performance relative to forecasts and the assumptions supporting goodwill and intangible-asset valuations.