Moody’s Corporation — Q3 2010 Form 10-Q
Business context and reporting period. Moody’s provides credit ratings and related research, data, analytics, risk-management software and services through Moody’s Investors Service (MIS) and Moody’s Analytics (MA). This unaudited filing covers the quarter and nine months ended September 30, 2010; comparisons are with the same 2009 periods unless noted. Dollar amounts are in millions except per-share data.
Financial performance and liquidity
- Third quarter: Revenue rose 14% to $513.3; operating income increased 10% to $188.9 (36.8% operating margin, versus 38.2%); net income attributable to Moody’s increased 35% to $136.0; diluted EPS was $0.58, up from $0.42. The 2010 tax rate was 24.4%, including a $17.6 tax benefit, or about $0.07 per diluted share, on foreign earnings deemed indefinitely reinvested.
- Nine months: Revenue increased 12% to $1,467.7; operating income rose 13% to $576.2 (39.3% margin, versus 38.8%); net income attributable to Moody’s was $370.4, up 23%; diluted EPS was $1.56, versus $1.26. The effective tax rate was 30.9%, compared with 36.6%.
- Segments: Q3 MIS revenue grew 17% to $373.7 and operating income grew 16% to $158.8. MA revenue grew 6% to $155.1, but operating income fell 15% to $30.1 as expenses rose faster than revenue. For nine months, MIS revenue increased 15% to $1,068.6 and operating income increased 18% to $481.3; MA revenue increased 5% to $445.4 while operating income declined 6% to $94.9.
- Cash flow: Nine-month operating cash flow was $474.7, versus $456.6. Investing used $55.0, including $54.6 of capital additions; financing used $104.7. Cash increased $319.8 to $793.7.
- Balance sheet and debt: At September 30, cash and cash equivalents were $793.7; current assets were $1,301.4 and current liabilities $792.6. Total debt was $1,260.0, up from $1,193.7 at year-end 2009; commercial paper was $15.0, down from $443.7. The company issued $500 of 5.50% senior notes due 2020. Shareholders’ deficit was $297.6.
- Capital returns: Moody’s repurchased shares for $119.6 during the first nine months and paid $74.1 in dividends. The board declared a quarterly dividend of $0.105 per share for payment in December 2010.
Material changes versus the prior comparable period
- Q3 ratings growth was led by corporate finance, particularly speculative-grade debt and bank-loan issuance; banking and public finance also grew. Structured-finance revenue declined 11% in Q3 and 5% for nine months.
- MA growth came mainly from risk-management software; management attributed quarterly RMS growth in part to final delivery and client acceptance of software licenses and implementations. Recurring revenue represented 86% of Q3 MA revenue, versus 88% a year earlier.
- Higher compensation, headcount, technology investment and legal/litigation costs contributed to expense growth. Q3 SG&A increased 22% to $152.2. Prior-year restructuring charges were substantially absent in the nine-month 2010 comparison.
- Q3 transaction revenue increased to 45% of consolidated revenue from 37%; MIS transaction revenue was 58% of MIS revenue versus 50%.
Outlook, risks and unusual items
- 2010 outlook: Moody’s raised full-year diluted EPS guidance to $1.90–$1.96. It expected revenue growth in the high-single- to low-double-digit range, expenses to rise in the low-double-digit range, operating margin in the high-thirties range, and an effective tax rate of 33%–34%. MIS revenue was forecast to grow in the low-double-digit range; MA revenue in the mid-single-digit range. Forecasts depend on macroeconomic and capital-market conditions and assume foreign-exchange translation at end-of-quarter rates.
- Management estimated incremental costs from new regulation at approximately $15 for 2010 and $15–$25 for 2011. Share repurchases were expected to continue subject to cash flow and capital-allocation decisions; $1.3 billion of authorization remained at quarter-end.
- The Dodd-Frank Act and evolving U.S. and international CRA rules could increase compliance costs, change rating practices or demand, and raise litigation exposure. The filing noted that much of the U.S. rulemaking was still pending.
- Moody’s reported ongoing investigations and litigation concerning ratings and related conduct. The SEC had completed its investigation related to MIS’s initial NRSRO application and stated it would take no enforcement action, while a report of investigation was to be issued. Management said other pending matters were not likely to materially affect consolidated financial position, but could materially affect results in an individual period.
- Legacy tax matters: Recorded liabilities totaled $58.1, including $56.2 related to potential repayment to New D&B. The company warned the ultimate liability could exceed the recorded amount and materially affect future results, financial position or cash flows. Net long-term tax liabilities of $227.4 were excluded from the contractual-obligations schedule because payment timing could not be reasonably estimated.
- The filing states the company was in compliance with debt covenants at September 30. Its $1.0 billion revolving facility expires in September 2012; debt agreements generally include a maximum Debt/EBITDA covenant of 4.0 to 1.0 and cross-default provisions.
Most important facts for investors to verify
- Whether the improved ratings-issuance environment and 2010 EPS guidance were sustained, particularly given structured-finance weakness and market sensitivity.
- How much of earnings growth reflects recurring operating performance versus the $17.6 tax benefit and other tax-related items.
- Whether MA can convert revenue growth into improved operating income and margins as investment, compensation and compliance costs rise.
- The ultimate cost and business impact of Dodd-Frank implementation, other CRA regulation, investigations and ratings-related litigation.
- Potential cash requirements from the $58.1 Legacy Tax Matters liability and the broader $227.4 of net long-term tax liabilities, alongside debt service, leases and share repurchases.