Moody’s Corporation — Q2 2013 Form 10-Q
Business context and reporting period. Moody’s provides credit ratings and financial research, data, analytics, software, risk-management, and professional services. Its reportable segments are Moody’s Investors Service (MIS) and Moody’s Analytics (MA). This unaudited filing covers the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $756.0 million | $640.8 million | $1,487.8 million | $1,287.6 million |
| Operating income | $350.8 million | $278.5 million | $631.2 million | $547.5 million |
| Operating margin | 46.4% | 43.5% | 42.4% | 42.5% |
| Adjusted operating income | $373.9 million | $300.6 million | $677.9 million | $593.1 million |
| Adjusted operating margin | 49.5% | 46.9% | 45.6% | 46.1% |
| Net income attributable to Moody’s | $225.5 million | $172.5 million | $413.9 million | $346.0 million |
| Diluted EPS | $1.00 | $0.76 | $1.83 | $1.52 |
| Net interest expense | $21.7 million | $16.6 million | $43.7 million | $26.9 million |
Revenue and segment drivers. Q2 revenue rose 18%; growth was reported across all lines of business in both segments. MIS external revenue increased 22% to $537.3 million, led by corporate finance (up 37%) as high-yield, bank-loan, and investment-grade issuance grew. MA external revenue rose 10% to $218.7 million, with growth in research/data/analytics, enterprise risk solutions, and professional services. For the first half, MIS external revenue increased 18% to $1,058.5 million and MA external revenue increased 9% to $429.3 million. Transaction revenue represented 52% of consolidated revenue in Q2 versus 47% a year earlier.
Q2 operating margin improved as revenue growth outpaced expense growth. For the first half, reported operating margin was essentially flat and adjusted margin declined, reflecting litigation-settlement costs and higher compensation and other expenses. The filing defines adjusted operating income and margin as non-GAAP measures; adjusted income excludes depreciation and amortization.
Cash flow and liquidity. First-half operating cash flow was $369.1 million, versus $235.5 million; free cash flow, a company-defined non-GAAP measure, was $351.0 million versus $213.6 million. Capital additions were $18.1 million. Cash and cash equivalents were $1.633 billion at June 30, including approximately $1 billion held outside the U.S. Total debt was $1.605 billion, all classified as long-term; the $63.8 million 2008 term loan was repaid during the half. Moody’s had no commercial paper outstanding and had $1 billion of available capacity under its revolving credit facility, which expires in 2017. The company reported compliance with debt covenants and no cross-defaults.
Financing cash outflow was $426.2 million, including $350.4 million of share repurchases and $89.1 million of dividends paid. At June 30, $1.3 billion of repurchase authorization remained. Current assets were $2.443 billion and current liabilities $897.1 million. Management said it expected positive operating cash flow over the next twelve months and believed available financial resources were sufficient for cash requirements.
Changes, outlook, and management commentary
- First-half revenue rose 16%, while Moody’s-attributable net income rose 20% and diluted EPS rose 20%. Q2 diluted EPS increased 32% year over year.
- Expenses increased with headcount, compensation and incentive costs, IT investment, legal costs, and first-quarter settlements of the Abu Dhabi and Rhinebridge litigation matters. First-half GAAP diluted EPS included a $0.14 per-share litigation-settlement impact; excluding it, non-GAAP EPS was $1.97.
- Interest expense increased, primarily reflecting the 2012 Senior Notes issued in 2012. First-half other non-operating income included approximately $13 million of foreign-exchange gains, mainly associated with euro strength against the pound.
- 2013 guidance was maintained: GAAP diluted EPS of $3.35–$3.45, including the $0.14 settlement impact; non-GAAP EPS of $3.49–$3.59; high-single-digit revenue growth; mid-single-digit expense growth; 41%–42% operating margin and 44%–45% adjusted operating margin. The effective tax rate was expected to be approximately 32%.
- Management expected approximately $1 billion of 2013 share repurchases, including about $650 million in the second half, approximately $50 million of capital expenditures, and about $850 million of free cash flow. It raised the annualized dividend to $1.00 per share; a $0.25 quarterly dividend was declared for payment in September 2013.
- Business outlook depends on uncertain macroeconomic and capital-market conditions, including interest rates, debt issuance, corporate activity, consumer borrowing, and securitization. MIS guidance included low-single-digit declines in structured finance revenue and high-single-digit growth overall. MA revenue was expected to grow at a high-single-digit rate.
Risks, contingencies, and unusual items
- Litigation and investigations: Moody’s described ongoing securities-related litigation, government inquiries, and regulatory scrutiny of rating agencies. The Abu Dhabi and Rhinebridge matters were settled confidentially in April 2013. Two plaintiffs in the Abu Dhabi matter appealed; the filing cites approximately $76 million in claimed compensatory damages for those claims. The company stated it could not estimate a range of possible losses for certain pending matters.
- Tax exposures: Recorded Legacy Tax Matter liabilities were $39.8 million; management cautioned that ultimate liability could be higher and future charges could be material. The filing also reports $222.7 million of net long-term liabilities for uncertain tax positions and legacy tax matters excluded from the contractual-obligations schedule because payment timing could not be estimated. Tax audits were ongoing.
- Goodwill and operating risks: Moody’s reported no goodwill impairment in the first half of 2013 but warned that failure of MA’s FSTC reporting unit to meet projections could cause a future impairment. Enterprise risk solutions revenue may fluctuate with project timing and customer concentration.
- Regulation: New EU CRA3 rules became effective June 20, 2013, adding requirements concerning sovereign ratings, liability, rotation, ownership, and pricing. Further implementation and rulemaking were expected. Regulatory changes could raise costs, affect competition, or alter demand for ratings.
- Other exposures: Approximately $920 million of foreign cash was in entities whose earnings were indefinitely reinvested; a future distribution or change in that assertion could create additional tax liability. The company identified market conditions, litigation, regulation, currency movements, cybersecurity, key employees, and acquisition integration among forward-looking risks.
Important facts for investors to verify
- Whether strong corporate-finance issuance and growth in MA products continue, and how transaction-dependent revenue evolves.
- Progress against 2013 EPS, margin, cash-flow, repurchase, and revenue guidance; distinguish GAAP from company-defined non-GAAP measures.
- Cash deployment, especially planned repurchases, dividend payments, and the impact on cash and debt.
- Developments in pending litigation, regulatory inquiries, tax audits, and the potential amount and timing of related liabilities.
- Whether MA’s FSTC unit meets forecasts and whether any goodwill impairment indicators arise.
- Foreign-cash repatriation and tax implications, and compliance with debt covenants and the 4-to-1 maximum debt-to-EBITDA covenant.