Moody’s Corporation — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods. Moody’s operates Moody’s Investors Service (MIS), its ratings business, and Moody’s Analytics (MA), its non-rating research, data, software, risk-management, training and outsourced-services businesses. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Revenue | $816.1 | $705.5 | $2,456.8 | $2,193.3 |
| Operating income | $349.7 | $291.5 | $1,094.4 | $922.7 |
| Operating margin | 42.9% | 41.3% | 44.5% | 42.1% |
| Net income attributable to Moody’s | $215.2 | $183.9 | $752.4 | $597.8 |
| Diluted EPS | $1.00 | $0.83 | $3.48 | $2.66 |
| Adjusted operating income | $372.9 | $314.9 | $1,163.0 | $992.8 |
| Adjusted operating margin | 45.7% | 44.6% | 47.3% | 45.3% |
Revenue grew 16% in Q3 and 12% year to date. Q3 growth reflected increases in both MIS and MA. MIS revenue by segment rose 14% in Q3 and 10% year to date; MA revenue rose 20% and 17%, respectively. In Q3, MA growth was strongest in Professional Services, which benefited from the Amba acquisition, and Enterprise Risk Solutions, which included WebEquity. Operating income growth outpaced revenue growth, and margins expanded.
Management’s non-GAAP diluted EPS was $0.97 for Q3 and $3.09 for the first nine months, excluding specified items. The nine-month GAAP EPS included a $0.36-per-share ICRA remeasurement gain and a $0.03 Legacy Tax benefit; 2013 included a $0.14-per-share litigation-settlement charge. Comparisons should account for these items.
Cash flow, balance sheet and capital allocation
- For the first nine months, operating cash flow was $709.8, versus $653.5 in 2013; free cash flow was $653.0, versus $622.5. Capital additions were $56.8.
- At September 30, cash and cash equivalents were $1,940.8 and short-term investments were $164.8. Long-term debt was $2,536.5, up from $2,101.8 at year-end 2013. The company reported $1.0 billion of undrawn capacity under its revolving facility and compliance with debt covenants.
- Approximately $1.4 billion of cash and short-term investments was held outside the U.S.; about 93% of non-U.S. balances were in entities whose earnings were considered indefinitely reinvested. A future distribution could create additional tax liability, which the company could not practicably estimate.
- Moody’s repurchased $780.2 of shares and paid $178.2 in dividends during the first nine months. It expected full-year 2014 repurchases of up to $1.25 billion, subject to cash availability and other considerations. A $0.28-per-share quarterly dividend was declared in October.
Material changes, outlook and risks
- Moody’s acquired a controlling 50.06% stake in ICRA in June, recognizing a $102.8 pre-tax gain ($78.5 after tax); ICRA’s balance sheet was consolidated at quarter-end, while its operating results were to be consolidated on a three-month lag. WebEquity was acquired in July for $130.6. Amba, acquired in December 2013, also contributed to MA growth.
- Q3 interest expense increased, including approximately $11 of net costs associated with early repayment of the 2005 notes. Moody’s issued $450 of five-year notes at 2.75% and $300 of 30-year notes at 5.25%, and used proceeds to repay the 2005 notes and for general corporate purposes.
- Full-year 2014 guidance was unchanged from the prior public outlook: revenue growth in the low-double-digit range; operating margin of 42%–43%; adjusted operating margin of 45%–46%; non-GAAP diluted EPS of $3.95–$4.05; and free cash flow of approximately $900. GAAP diluted EPS guidance was $4.34–$4.44, including the ICRA gain and Legacy Tax benefit. Guidance assumed quarter-end foreign exchange rates and depended on uncertain macroeconomic and capital-market conditions.
- Management cited issuance volumes, interest rates, market volatility, M&A activity and economic conditions as factors affecting results. Other risks include increased regulation and compliance costs, competition, litigation related to ratings, cybersecurity and operational risks, foreign-exchange movements, tax examinations, and integration of acquisitions.
- Legal claims and governmental inquiries concerning ratings remain ongoing. Moody’s said it could not estimate a range of possible losses for certain matters. In the CalPERS case, the California Supreme Court declined review in September 2014; the case returned to the trial court, with discovery expected to begin. Recorded Legacy Tax Matter liabilities were $10.8, and management warned ultimate liability could be higher. Tax audits and uncertain tax positions also remain.
- Management reported no material change in market-risk exposure or risk factors since year-end 2013, and said disclosure controls were effective with no material change in internal control over financial reporting.
Key facts for investors to verify
- How much of reported EPS growth reflects recurring operating performance versus the ICRA gain, tax benefit and prior-year litigation charge.
- Whether issuance activity, particularly CLOs and corporate debt, and recurring monitoring revenue can sustain MIS growth.
- Whether MA’s subscription and software growth offsets ERS project-revenue volatility, and how acquisitions affect margins and integration costs.
- Cash availability and tax implications of overseas balances, planned share repurchases, and the expected Copal Amba buyout, which carries a 25% premium to formulaic redemption value.
- Potential financial exposure from ratings litigation, regulatory developments, tax matters and goodwill sensitivity, particularly in FSTC and ERS.