Moody’s Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Moody’s operates through Moody’s Investors Service (MIS), principally credit ratings, and Moody’s Analytics (MA), covering research, data, software and risk-management services. Amounts below are in U.S. dollars unless noted.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $918.1 million | $873.5 million | $1,783.7 million | $1,640.7 million |
| Operating income | $419.3 million | $411.7 million | $790.6 million | $744.7 million |
| Operating margin | 45.7% | 47.1% | 44.3% | 45.4% |
| Adjusted operating income | $447.2 million | $434.0 million | $847.1 million | $790.1 million |
| Adjusted operating margin | 48.7% | 49.7% | 47.5% | 48.2% |
| Net income attributable to Moody’s | $261.7 million | $319.2 million | $491.8 million | $537.2 million |
| Diluted EPS | $1.28 | $1.48 | $2.39 | $2.47 |
| Interest expense, net | $31.9 million | $26.0 million | $61.2 million | $49.8 million |
| Effective tax rate | 30.4% | 33.1% | 31.5% | 31.5% |
Q2 revenue rose 5% reported and 10% excluding foreign-exchange translation effects. First-half revenue increased 9% reported and 14% on a constant-currency basis. In Q2, external MIS revenue grew 2% reported (7% constant currency); external MA revenue grew 12% (18% constant currency). MA’s ERS and RD&A businesses drove growth, while Professional Services revenue declined. U.S. revenue increased, while international revenue declined, notably in EMEA.
Q2 GAAP diluted EPS declined 14% year over year; the 2014 comparison included a $102.8 million pretax ($78.5 million after-tax) ICRA step-acquisition gain. Excluding that prior-year gain, Q2 2015 diluted EPS of $1.28 exceeded prior-year non-GAAP EPS of $1.12 by 14%. First-half EPS likewise declined against the ICRA gain; excluding it, management reported a $0.28 increase, supported in part by a 5% reduction in diluted weighted-average shares from repurchases.
Cash flow, liquidity and capital structure
- For the first half, operating cash flow was $594.4 million, versus $458.0 million; free cash flow, a non-GAAP measure defined as operating cash flow less capital additions, was $553.7 million, versus $419.2 million. Capital additions were $40.7 million.
- At June 30, cash and cash equivalents were $1,538.6 million and short-term investments were $508.9 million, totaling about $2.0 billion. Current assets were $3,064.0 million and current liabilities $1,124.8 million.
- Long-term debt was $3,106.1 million, up from $2,547.3 million at year-end 2014. Moody’s issued €500 million of 1.75% senior notes due 2027 in March. It also replaced its prior revolving facility with a five-year, $1 billion facility; no borrowings were outstanding under it at quarter-end. The company reported compliance with debt covenants and no cross-defaults.
- Shareholders’ equity was a deficit of $103.4 million, compared with positive equity of $42.9 million at December 31, 2014. First-half treasury-share repurchases were $600.7 million and dividends paid were $137.2 million. Moody’s had approximately $963 million remaining under its repurchase authorization at June 30.
- About $1.4 billion of cash and short-term investments was held outside the U.S.; approximately 95% of non-U.S. balances were at entities whose undistributed earnings were treated as indefinitely reinvested. A future distribution or change in that assertion could create additional tax liability; the amount was not practicably estimable.
Changes, outlook and management commentary
- Revenue growth reflected U.S. investment-grade corporate issuance, public-finance refundings, higher structured-finance activity, pricing and fee initiatives, and growth in MA. Acquisitions of ICRA, WebEquity and Lewtan contributed to results. A stronger U.S. dollar reduced reported revenue; management cited approximately $43 million of unfavorable FX impact in Q2 and $83 million in the first half.
- Expenses grew faster than revenue: total expenses increased 8% in Q2 and 11% in the first half. Management cited compensation and headcount growth, acquired operations, IT and infrastructure investment, and other operating costs. Margins contracted as Moody’s continued investing and integrated businesses with lower margins than its historical levels.
- For full-year 2015, management maintained mid-single-digit revenue and expense growth guidance; operating margin of about 43%, adjusted operating margin of about 46%, GAAP EPS of $4.55–$4.65, and effective tax rate of 31%–32%. It projected operating cash flow of about $1.1 billion, free cash flow of about $1 billion, capital expenditures of $100–$110 million and share repurchases of about $1 billion, subject to cash availability, market conditions and capital-allocation decisions.
- Segment outlook included mid-single-digit MIS global growth and mid-single-digit MA global growth. MIS U.S. growth was projected in the low double digits and non-U.S. approximately flat; MA U.S. growth was projected in the low double digits and non-U.S. in the low single digits. Management lowered the outlook for MIS non-U.S. and raised the outlook for PPIF compared with its May 1 guidance. ERS guidance was mid-single-digit growth; Professional Services was expected to decline in the high-single-digit range.
- Management’s outlook depends on uncertain capital-market and macroeconomic factors, including debt issuance, interest rates, FX, corporate activity and M&A. It warned actual results could differ materially from guidance.
Risks, contingencies and unusual items
- Moody’s faces ongoing litigation, governmental inquiries and regulatory scrutiny concerning ratings, including claims related to rated structured-finance securities. The filing says a loss range for certain matters cannot be estimated. In the Cheyne Finance matter, the New York Court of Appeals ruled in Moody’s favor on June 30, 2015; the appeal was returned to the Second Circuit for final disposition. CalPERS litigation remained pending, and a Pursuit Partners case was scheduled for trial in August 2015.
- Legacy tax matters carried recorded liabilities of $11.1 million. Total net long-term tax liabilities for unrecognized tax benefits and legacy tax matters were $217.9 million; expected payment timing could not be reasonably estimated. Tax audits may result in additional payments, adjustments or benefits.
- Regulatory changes in the U.S., EU and other jurisdictions may raise compliance costs, affect competition and pricing, or alter demand and practices for credit ratings. Other disclosed risks include litigation exposure, market and FX volatility, cyber and operational risks, acquisition integration and potential changes in debt issuance.
- Unusual comparison item: the 2014 ICRA step-acquisition produced a $102.8 million pretax gain, materially affecting year-over-year GAAP net income and EPS comparisons. Q2 2015 also included a lower effective tax rate following a state tax ruling and a New York City tax-law change relating to income apportionment.
Important facts for investors to verify
- Whether MIS issuance trends, particularly in EMEA and high-yield and bank-loan markets, support the company’s full-year revenue outlook.
- How much reported growth and future results depend on FX rates, acquisitions, pricing initiatives and transaction-based revenue.
- Whether expense growth moderates and margins recover as investment and acquisition-related costs are absorbed.
- Debt, interest costs, covenant headroom and the funding implications of planned repurchases and dividends; debt/EBITDA covenant maximum is 4 to 1.
- Developments in ratings-related litigation, regulatory proceedings and tax audits, for which certain possible losses or payment timing remain unestimable.
- Management’s non-GAAP measures and guidance reconciliations, including adjusted operating results, constant-currency growth and free cash flow, alongside GAAP results.