Moody’s Corporation — Q1 2015 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three months ended March 31, 2015, compared with Q1 2014. Moody’s operates two reportable segments: Moody’s Investors Service (MIS), principally credit ratings, and Moody’s Analytics (MA), which provides research, data, software, risk-management and professional services.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $865.6 million | $767.2 million | +13% |
| Operating income | $371.3 million | $333.0 million | +12% |
| Operating margin | 42.9% | 43.4% | Down 0.5 percentage point |
| Adjusted operating income (non-GAAP) | $399.9 million | $356.1 million | +12% |
| Adjusted operating margin (non-GAAP) | 46.2% | 46.4% | Down 0.2 percentage point |
| Net income attributable to Moody’s | $230.1 million | $218.0 million | +6% |
| Diluted EPS | $1.11 | $1.00 | +11% |
| Net cash from operating activities | $261.8 million | $177.2 million | +$84.6 million |
| Free cash flow (non-GAAP) | $242.8 million | $158.1 million | +$84.7 million |
- Segments: MIS external revenue was $602.3 million, up 14%; MA external revenue was $263.3 million, up 11%. MA operating income was $44.0 million, up 4%, while its operating margin declined to 16.5% from 17.6%. MIS operating income rose 13% to $327.3 million; its operating margin was 52.4%, down from 52.8%.
- Cash and liquidity: Cash and cash equivalents were $1.510 billion and short-term investments were $485.5 million at March 31, 2015, totaling about $2.0 billion. Approximately $1.3 billion was held outside the U.S.; management said about 96% of non-U.S. cash and short-term investments was held by entities with indefinitely reinvested earnings.
- Debt: Long-term debt carrying value was $3.095 billion, up from $2.547 billion at year-end 2014. Moody’s issued €500 million of 1.75% senior notes due 2027 in March. It had $1.0 billion available under its revolving credit facility, was in compliance with debt covenants and reported no cross-defaults.
- Capital returns: Moody’s repurchased $365.8 million of treasury shares and paid $68.7 million in dividends during the quarter. The Board declared a subsequent quarterly dividend of $0.34 per share. The company projected approximately $1 billion of 2015 repurchases, subject to cash availability, market conditions and capital-allocation decisions.
Material changes and management commentary
- Revenue growth reflected higher corporate and speculative-grade debt issuance, U.S. public-finance refundings, ICRA’s contribution, pricing and fee initiatives, and growth in MA’s ERS and RD&A businesses. The 2014 WebEquity and Lewtan acquisitions also contributed to MA growth.
- Foreign exchange was a significant offset: management estimated unfavorable translation effects of about $29 million on MIS revenue and $12 million on MA revenue. FX also reduced operating income by approximately 7% versus the prior-year quarter.
- Total expenses increased $60.1 million, principally from compensation, incentive compensation, higher headcount, IT and operational projects, and acquired businesses. Operating margin slipped despite higher revenue and operating income.
- The effective tax rate rose to 32.9% from 28.9%, primarily because Q1 2014 benefited from reversal of uncertain tax positions following resolution of international tax matters. Higher interest expense also weighed on earnings.
- Operating cash flow improved, partly due to the timing of tax payments; management also cited higher net income. Free cash flow is a company-defined non-GAAP measure.
- Shareholders’ equity attributable to Moody’s was a deficit of $373.7 million at March 31, versus a deficit of $187.8 million at year-end. The filing reports substantial treasury-stock purchases and a $109.4 million pre-tax foreign-currency translation loss in other comprehensive income during the quarter.
Guidance, risks and unusual items
- 2015 consolidated outlook: Guidance was unchanged from February 25: revenue and operating-expense growth in the mid-single-digit range; operating margin about 43%; adjusted operating margin about 46%; effective tax rate about 32%–33%; GAAP EPS of $4.55–$4.65; capital expenditures of about $110–$115 million; free cash flow of about $1 billion; and share repurchases of about $1 billion, subject to stated conditions.
- Segment guidance changes: MIS U.S. revenue growth was raised to high-single digits from mid-single digits, while MIS non-U.S. was lowered to low-single digits from mid-single digits. SFG and FIG were each lowered to low-single-digit growth from mid-single digits. MA U.S. was raised to low-double-digit growth from approximately 10%, while MA non-U.S. was lowered to low-single digits from mid-single digits. PS guidance changed from approximately flat to a low-single-digit decline. Other listed segment guidance was unchanged.
- Management cautioned that the outlook depends on uncertain macroeconomic and capital-market assumptions, including interest rates, FX, debt issuance, corporate profitability, M&A activity and securitization. ERS revenue is subject to quarterly volatility from project timing and concentration of implementation and license revenue.
- Material risks include extensive and evolving U.S. and international regulation of credit-rating agencies, litigation and governmental investigations related to ratings, market issuance cycles, competition, FX movements, cybersecurity and operational risks, and acquisition integration. The filing says a range of possible losses for certain legal matters cannot currently be estimated.
- Notable proceedings include the CalPERS structured-finance ratings case, where discovery had begun, and the Pursuit Partners case, where a motion to dismiss was denied and trial was scheduled for August 2015 if Moody’s did not prevail on summary judgment. A legal question in the Commerzbank appeal was scheduled for argument in June 2015. Moody’s reported $11.0 million of liabilities for Legacy Tax Matters; net long-term tax liabilities of $233.6 million were excluded from the contractual-obligations schedule because payment timing could not be reasonably estimated.
- Moody’s identified potential effects from the new revenue-recognition standard, including accounting for contract implementation costs, advance ratings-monitoring fees, certain MA license and maintenance revenue, some ERS arrangements and contract acquisition costs. The company was evaluating the impact.
Most important facts for investors to verify
- Whether debt issuance, ratings demand and public-finance refinancing support the 2015 revenue outlook, particularly alongside the lower non-U.S., SFG and FIG growth forecasts.
- Whether expense growth, acquisition costs and FX pressure continue to weigh on margins, especially in MA.
- Whether the $4.55–$4.65 EPS, approximately $1 billion free-cash-flow and approximately $1 billion repurchase outlooks remain achievable; these are forward-looking estimates and repurchases are conditional.
- The amount and timing of potential legal, regulatory and tax exposures: the filing does not provide a clear loss range for certain proceedings, and the $233.6 million of net long-term tax liabilities has no estimable payment schedule.
- The implications of foreign cash concentration and indefinitely reinvested earnings, including possible tax costs if funds are repatriated or the reinvestment assertion changes.