Moody’s Corporation — Q2 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2016, compared with the same 2015 periods. Moody’s operates Moody’s Investors Service (MIS), its ratings business, and Moody’s Analytics (MA), which provides research, data, software, risk-management and related services. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial results and liquidity
- Second quarter: Revenue was $928.9, up 1% year over year. Operating income was $410.2, down 2%; operating margin was 44.2%, versus 45.7%. Adjusted operating income, a non-GAAP measure, was $441.4, down 1%, with a 47.5% margin versus 48.7%. Net income attributable to Moody’s was $255.5, down 2%; diluted EPS rose 2% to $1.30, supported by a 4% decline in diluted weighted-average shares.
- First six months: Revenue was $1,745.0, down 2%. Operating income fell 10% to $714.3, and operating margin declined to 40.9% from 44.3%. Adjusted operating income declined 8% to $775.4, with adjusted margin of 44.4% versus 47.5%. Net income attributable to Moody’s was $439.9, down 11%; diluted EPS fell 6% to $2.24.
- Segment trends: Q2 MIS revenue declined 2%, while MA revenue rose 9%. For the first half, MIS revenue declined 7% and MA revenue grew 10%. MIS weakness reflected lower corporate debt issuance and U.S. securitization activity; MA growth came chiefly from research/data and enterprise risk solutions, including GGY acquisition revenue.
- Cash flow: First-half operating cash flow was $528.8, down from $594.4. Free cash flow, defined by the company as operating cash flow less capital additions, was $474.5 versus $553.7. Capital additions were $54.3. Cash and cash equivalents were $1,674.3 at June 30, compared with $1,757.4 at year-end 2015.
- Liquidity and debt: Short-term investments were $352.5, bringing cash and short-term investments to approximately $2.0 billion. Long-term debt carrying value was $3,420.4, compared with $3,380.6 at year-end; the company reported $1.0 billion of additional capacity under its revolving credit facility. It was in compliance with debt covenants and reported no cross-defaults. Total shareholders’ deficit was $369.5.
- Other metrics: The effective tax rate was 31.9% in Q2 and 32.1% for the first half, higher than the comparable 2015 periods due mainly to a favorable prior-year state tax ruling. The declared quarterly dividend was $0.37 per share. First-half share repurchases totaled $485.9.
Material changes and management commentary
- Q2’s 1% revenue growth reflected MA expansion offsetting a modest MIS decline. MIS cited weak U.S. CLO and RMBS activity, lower U.S. high-yield issuance and lower Asia-Pacific investment-grade issuance. Pricing initiatives, fee mix and infrastructure-finance revenue partly offset the pressure.
- For the first half, market volatility—especially in Q1—reduced corporate debt and U.S. CLO and CMBS activity. MIS also cited uncertainty around regulatory requirements affecting securitization markets.
- Higher compensation expense, headcount growth and GGY-related costs weighed on margins. Cost-reduction initiatives and lower incentive compensation partly offset expense growth. Management attributed MA margin pressure in part to a larger allocation of shared overhead costs.
- Moody’s acquired 100% of actuarial software provider Gilliland Gold Young (GGY) on March 1 for total consideration of $86.9, funded with cash on hand. Goodwill associated with the acquisition was assigned to MA.
Outlook, risks and contingencies
- Management expected positive operating cash flow over the next 12 months and said it believed available financial resources were sufficient for cash requirements. It expected approximately $1 billion of full-year 2016 share repurchases, subject to cash availability, market conditions and capital-allocation decisions. No specific revenue or earnings guidance is provided in the supplied filing text.
- The board declared a $0.37-per-share quarterly dividend payable in September 2016; future dividends remain at the board’s discretion.
- Risks include sensitivity of ratings revenue to debt issuance and capital-market volatility; evolving U.S. and international regulation; litigation and government inquiries relating to ratings; competition, cybersecurity and operational risks; foreign-exchange exposure; and uncertainty following the U.K. referendum to leave the EU. Management said the referendum had not changed MIS’s regulatory framework at the filing date.
- The company was involved in legal proceedings, investigations and inquiries, including matters related to ratings. For some matters, management could not estimate a range of possible losses or predict outcomes and timing. The filing also describes ongoing federal, state, local and U.K. tax examinations; management said it could not estimate possible changes to unrecognized tax benefits.
- Approximately $1.6 billion of cash and short-term investments was held outside the U.S.; most of the cash and investments in non-U.S. operations was associated with earnings treated as indefinitely reinvested. A future distribution or change in that position could result in additional tax liability, which the company said was not practicable to estimate.
Important facts for investors to verify
- Whether MIS issuance and securitization trends, particularly U.S. CLO and CMBS activity, recovered or continued to pressure revenue after Q2.
- How much MA growth was organic versus attributable to GGY, and whether MA expense growth and overhead allocations continued to constrain margins.
- Whether operating cash flow and free cash flow improved, and whether the planned 2016 buybacks and dividend remained consistent with liquidity and debt priorities.
- Developments in ratings-related litigation, government inquiries and tax audits, including any material change in expected exposure.
- The eventual financial-statement effects of new accounting standards, especially revenue recognition and share-based payment changes; the company was still assessing impacts.