Moody’s Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; compared with Q1 2015. Moody’s operates through Moody’s Investors Service (MIS), its ratings business, and Moody’s Analytics (MA), which provides research, data, software, risk-management and professional services.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $816.1 million | $865.6 million | Down 6%; down 4% excluding FX |
| Operating income / margin | $304.1 million / 37.3% | $371.3 million / 42.9% | Income down 18% |
| Adjusted operating income / margin (non-GAAP) | $334.0 million / 40.9% | $399.9 million / 46.2% | Income down 16% |
| Net income attributable to Moody’s | $184.4 million | $230.1 million | Down 20% |
| Diluted EPS | $0.93 | $1.11 | Down 16% |
| Operating cash flow / free cash flow (non-GAAP) | $237.3 million / $211.0 million | $261.8 million / $242.8 million | FCF down $31.8 million |
- Segment results: MIS external revenue fell 13% to $525.1 million; ratings revenue declined across most lines, particularly corporate finance (down 20%), amid market volatility and weaker high-yield, investment-grade and securitization issuance. MA external revenue rose 11% to $291.0 million (13% excluding FX), led by RD&A (up 10%) and ERS (up 16%).
- Costs and margins: Total expenses rose 4% to $512.0 million. Higher compensation, headcount, acquisition-related costs, legal fees and occupancy costs were partly offset by lower incentive compensation in some areas. Company operating margin contracted 5.6 percentage points.
- Other income and tax: Net interest expense increased to $34.1 million from $29.3 million, mainly reflecting additional notes issued in 2015. The effective tax rate was 32.3%, versus 32.9%, primarily due to lower state taxes and a New York City tax-law change.
Financial position and capital allocation
- At March 31, cash and cash equivalents were $1,576.1 million and short-term investments were $490.6 million. Total current assets were $3,085.3 million against current liabilities of $1,151.9 million.
- Long-term debt carrying value was $3,428.6 million; total liabilities were $5,466.4 million. Moody’s reported a shareholders’ deficit of $351.5 million. It had $1.0 billion available under its revolving credit facility and was in compliance with debt covenants.
- Operating cash flow declined $24.5 million year over year. Investing cash outflow was $108.4 million, including $75.9 million net cash paid for the GGY acquisition. Financing used $339.2 million, including $262.1 million for share repurchases and $72.1 million in dividends.
- Moody’s repurchased $262.1 million of shares in Q1. Management expected approximately $1 billion of full-year 2016 repurchases, subject to cash availability, market conditions and capital-allocation decisions. A $0.37-per-share quarterly dividend was declared for payment in June 2016.
Changes, outlook and risks
- Q1 revenue weakness primarily reflected MIS ratings activity; growth in MA partly offset the decline. Transaction revenue represented 45% of total company revenue, down from 51% a year earlier. MA recurring revenue was 76% of its total, versus 77%.
- Moody’s acquired Gilliland Gold Young, an actuarial software provider, on March 1, 2016. Total consideration was $86.9 million; $58.8 million of goodwill was allocated to MA.
- Management said it expected positive operating cash flow over the next 12 months and believed available financial resources would meet cash requirements. The filing gives no explicit revenue, earnings or EPS guidance.
- Key exposures include volatile capital-market issuance, economic and credit conditions, FX movements, competition, cybersecurity and operational risks, and evolving regulation of credit rating agencies. The company noted ongoing governmental inquiries and litigation, including claims related to ratings; it could not estimate a range of possible losses for certain matters. The CalPERS case settled and was dismissed with prejudice without negative financial impact. Commerzbank’s appeal in the Cheyne matter was dismissed in February 2016.
- Tax authorities were examining several U.S., New York and U.K. tax years. Management said it believed provisions for open tax years were adequate, but audit outcomes and timing were uncertain. Net long-term tax liabilities of $211.6 million were excluded from the contractual-obligations schedule because payment timing could not be reasonably estimated.
- The company was evaluating new accounting standards, including revenue recognition. Management anticipated effects on certain MA software subscription and ERS revenue arrangements and on contract-related costs, but had not quantified the overall impact.
Most important facts for investors to verify
- Whether MIS issuance and transaction volumes recover, particularly in corporate finance, CMBS and CLOs, and how market volatility affects ratings revenue.
- Whether MA growth—especially ERS and RD&A—continues and whether GGY contributes as anticipated, including the effect of acquisition-related costs.
- Whether revenue and margin pressure persists as expenses and headcount grow; distinguish reported results from non-GAAP adjusted measures.
- Cash conversion, debt maturities and liquidity, and whether planned share repurchases and dividends remain consistent with management’s cash-flow expectations.
- Developments in ratings-related litigation, regulatory requirements and tax audits, including any material financial or operational consequences.