Moody’s Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods. Amounts are in millions of U.S. dollars unless otherwise stated. Moody’s operates Moody’s Investors Service (MIS), its ratings business, and Moody’s Analytics (MA), its non-rating businesses.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $640.8 | $605.2 | $1,287.6 | $1,182.3 |
| Operating income | $278.5 | $270.1 | $547.5 | $520.2 |
| Operating margin | 43.5% | 44.6% | 42.5% | 44.0% |
| Net income attributable to Moody’s | $172.5 | $189.0 | $346.0 | $344.5 |
| Diluted EPS | $0.76 | $0.82 | $1.52 | $1.49 |
| Net cash from operating activities | — | — | $235.5 | $445.9 |
- Revenue and segments: Q2 revenue rose 6%; six-month revenue rose 9%. Q2 MIS revenue was $458.7, up 1%, while MA revenue was $202.5, up 19%. For the first half, MIS revenue was $928.5, up 5%, and MA revenue was $399.6, up 19%. MA growth included Copal and Barrie & Hibbert, acquired in late 2011.
- Expenses and margins: Q2 operating income rose 3%, but margin declined 1.1 percentage points. First-half operating income rose 5%, while margin fell 1.5 points. Higher compensation, acquisition-related costs, technology investment, and regulatory and compliance spending contributed to expense growth.
- Taxes and earnings: Effective tax rates were 33.6% for Q2 and 32.9% for the first half, versus 27.8% and 30.4% a year earlier. Prior-year results benefited from a foreign tax ruling and favorable legacy-tax resolutions; these comparisons materially affected reported earnings and EPS.
- Cash flow: First-half operating cash flow fell $210.4, mainly reflecting tax-audit settlement payments, higher prepaid taxes, increased receivables, and pension contributions. Capital additions were $21.9; operating cash flow less capital additions was approximately $213.6. Cash increased to $824.1 from $760.0 at year-end.
- Liquidity and debt: Current assets were $1,519.4 and current liabilities $995.2. Total debt was $1,238.3, including $127.5 current and $1,110.8 long-term; cash was below gross debt by approximately $414.2. Moody’s had an undrawn $1 billion revolving facility and reported compliance with debt covenants. The facility’s maximum Debt/EBITDA covenant is 4.0-to-1.
- Capital returns: First-half share repurchases were $100.0 and dividends paid were $71.6. The board approved a quarterly dividend of $0.16 per share for payment in September 2012. Approximately $773.8 of share-repurchase authorization remained at June 30.
Material changes versus the prior comparable period
- Q2 revenue growth was led by MA, while MIS grew modestly; within MIS, public finance and structured finance gains were partly offset by weaker corporate finance issuance, including high-yield debt and bank loans.
- MA’s Q2 professional services revenue increased 84%, with growth substantially reflecting Copal; ERS revenue increased 24%, including Barrie & Hibbert. MA revenue growth also included stronger research and data sales.
- Foreign-exchange translation reduced Q2 revenue by approximately $18 million and operating income by approximately $11 million. For the first half, FX reduced revenue by approximately $22 million and operating income by approximately $12 million.
- Q2 attributable net income fell 9% and diluted EPS fell from $0.82 to $0.76. Management said EPS excluding the prior-year $0.03-per-share legacy-tax benefit declined $0.03; the prior-year period also included a separate foreign-tax benefit.
- First-half attributable net income was broadly flat and diluted EPS increased from $1.49 to $1.52. Excluding the prior-year legacy-tax benefit, management said first-half diluted EPS increased $0.06.
- Operating cash flow declined sharply from the prior year, despite higher earnings, primarily because of tax payments and working-capital movements.
Outlook, commentary, risks and unusual items
- 2012 outlook reaffirmed: Full-year diluted EPS guidance was $2.62–$2.72, with results expected toward the upper end. Moody’s continued to expect low-double-digit revenue growth, low-double-digit expense growth, an operating margin of approximately 39%, and an effective tax rate of approximately 33%.
- Segment outlook: MIS revenue was expected to grow mid- to high-single digits; MA revenue high-teens. Management projected MA professional services growth of approximately 75%, including Copal, and noted uncertainty around macroeconomic and capital-market assumptions, particularly in Europe.
- Litigation and regulatory exposure: Moody’s described ongoing investigations and litigation relating to ratings. Plaintiffs in Cheyne-related litigation asserted approximately $811 million in compensatory damages; Rhinebridge plaintiffs asserted approximately $70 million. These are claimants’ allegations, not management’s loss estimates. The company said it could not estimate a range of possible losses for significant matters. A shareholder derivative settlement received preliminary court approval after quarter-end; proposed terms include two years of governance changes and fees and costs of up to $4.95 million, subject to final approval.
- Tax contingencies: Recorded liabilities for legacy tax matters totaled $55.8 million. The company cautioned that ultimate liability could exceed recorded amounts. It also reported $185.8 million of net long-term tax liabilities for uncertain tax positions and legacy matters, whose payment timing could not be reasonably estimated.
- Other risks and items: Proposed European rules could add procedural, liability, pricing, rotation, and other requirements for credit rating agencies. Management cited sensitivity to debt issuance and market conditions, foreign exchange, competition, litigation, regulation, tax matters, and integration of acquired businesses. Moody’s changed its annual goodwill impairment assessment date from November 30 to July 31, prospectively, and reported no goodwill or intangible-asset impairment in the periods presented.
Important facts for investors to verify
- Whether full-year guidance, particularly the expectation of results toward the upper end of the $2.62–$2.72 EPS range, remained achievable given European uncertainty and issuance trends.
- How much MA’s growth reflects acquired revenue versus underlying organic growth, and whether acquisition-related costs and project-based revenue volatility affect margins.
- Whether cash conversion improves after the substantial first-half decline in operating cash flow, including the effects of tax settlements, receivables, and prepaid taxes.
- Developments in ratings-related litigation, investigations, proposed EU regulation, and any eventual change in the company’s ability to estimate or record losses.
- Debt maturities, covenant headroom, the Copal put/call arrangement and related contingent obligations, and the extent to which cash held overseas is available for U.S. capital needs.