Moody’s Corporation — Q3 2016 Form 10-Q
Business context and reporting period. Moody’s provides credit ratings and related research, data, analytics, software, risk-management, and professional services. Its two reportable segments are Moody’s Investors Service (MIS) and Moody’s Analytics (MA). This unaudited filing covers the three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless stated otherwise. Dollar amounts are in millions except per-share data.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $917.1 | $834.9 | $2,662.1 | $2,618.6 |
| Operating income | $397.5 | $349.7 | $1,111.8 | $1,140.3 |
| Operating margin | 43.3% | 41.9% | 41.8% | 43.5% |
| Adjusted operating income (non-GAAP) | $438.6 | $378.0 | $1,217.6 | $1,225.1 |
| Adjusted operating margin (non-GAAP) | 47.8% | 45.3% | 45.7% | 46.8% |
| Net income attributable to Moody’s | $255.3 | $231.6 | $695.2 | $723.4 |
| Diluted EPS | $1.31 | $1.14 | $3.55 | $3.54 |
| Net interest expense | $35.4 | $25.8 | $103.8 | $87.0 |
Quarterly changes. Revenue rose 10%; MIS revenue increased 12% and MA revenue increased 6%. Higher high-yield corporate and bank-loan issuance, public finance activity, pricing and fee initiatives supported MIS. MA growth reflected RD&A subscriptions and ratings-data licensing, and ERS growth including GGY. Q3 operating income rose 14%, and diluted EPS increased 15%. The effective tax rate was 30.5%, versus 32.0%.
Nine-month changes. Revenue grew 2%, with MA up 8% and MIS down 1%. MIS faced weaker issuance and securitization activity earlier in the year amid elevated credit spreads, market volatility, and uncertainty over risk-retention requirements; stronger Q3 issuance partly offset those pressures. Operating income fell 2%, attributable net income fell 4%, and diluted EPS was nearly flat. The effective tax rate was 31.5%, versus 31.7%.
Cash flow and capital allocation. For the first nine months, operating cash flow was $856.6, down from $893.5; capital additions were $84.8, producing reported free cash flow of $771.8 versus $827.6. Investing activities used $2.4; financing activities used $882.6. Financing included $678.9 of treasury-share repurchases and $214.5 of dividends. The company expected approximately $750 of full-year 2016 repurchases, subject to cash availability, market conditions, and capital-allocation decisions; approximately $786.8 of authorization remained at September 30. The board declared a $0.37-per-share quarterly dividend payable December 12, 2016.
Balance sheet and debt. At September 30, cash and cash equivalents were $1,746.1 and short-term investments were $311.8, compared with $1,757.4 and $474.8, respectively, at year-end 2015. Total debt carrying value was $3,418.1, including $299.9 classified as current; shareholders’ deficit was $357.9. The company reported $2.1 billion in cash and short-term investments, approximately $1.7 billion held outside the U.S. It had no borrowings under its $1.0 billion commercial-paper program or $1.0 billion revolving facility and reported compliance with debt covenants. Management stated it had resources to meet cash requirements for the next 12 months.
Segment detail. Q3 MIS total segment revenue was $637.6 and operating income $338.1; MA total segment revenue was $309.0 and operating income $59.4. For the first nine months, MIS total segment revenue was $1,836.9 and operating income $941.8; MA total segment revenue was $908.9 and operating income $170.0. Segment totals include intersegment amounts and are not directly comparable to consolidated revenue.
Management commentary, outlook, and risks
- Restructuring: A September 2016 plan focused on headcount reductions in MIS and corporate overhead; actions represented approximately 1% of the workforce. Charges were $12.0 for the first nine months, with $9.6 remaining accrued and expected to be paid during 2016 and 2017.
- Acquisition: Moody’s acquired actuarial-software provider GGY on March 1, 2016 for total consideration of $86.5, funded with cash on hand. Goodwill assigned to MA was $59.4; management said the near-term operating and cash-flow impact was not material.
- Legal contingency: In a September 29, 2016 letter, the U.S. Department of Justice said it was preparing a civil complaint against Moody’s and MIS alleging violations of FIRREA related to pre-crisis RMBS and CDO ratings. The DOJ said its investigation remained ongoing and could expand. State attorneys general indicated they might pursue similar claims. Moody’s said it could not estimate a range of possible losses; outcomes, timing, and financial effects remain uncertain.
- Other risks: The filing describes ratings-related litigation, government inquiries, regulatory change, market and issuance volatility, foreign-exchange exposure, cybersecurity and operational risks, and tax audits. The company said it could not predict the outcome or potential impact of significant proceedings. No material changes to previously disclosed risk factors were reported.
- Outlook and accounting: Management gave no specific full-year revenue or EPS guidance in the supplied filing text. It cited improved Q3 issuance after difficult first-half conditions and stated its cash resources were adequate for the next 12 months. Moody’s intended to adopt the new revenue-recognition standard in 2018 and was assessing its impact, including potential changes in timing for certain software and ERS revenue and implementation costs.
- Additional disclosure: Approximately 95% of cash and short-term investments held in non-U.S. operations was at entities whose undistributed earnings were indefinitely reinvested; a future distribution or change in that assertion could create additional tax liabilities, which the company said it could not practicably estimate. Disclosure controls were deemed effective, with no material change in internal control over financial reporting reported.
Key facts investors should verify
- Whether subsequent MIS issuance trends sustained Q3’s recovery and offset first-half weakness, particularly in corporate debt, CLO, and CMBS markets.
- Whether MA growth, including GGY’s contribution, converts into improved margins as compensation and overhead costs rise.
- The status, scope, and potential financial exposure of the DOJ and state investigations and related ratings litigation; the filing provides no estimable loss range.
- The company’s ability to fund the 2017 $300.0 debt maturity, planned repurchases, dividends, and other obligations while preserving liquidity.
- The effect of the forthcoming revenue-recognition standard on MA revenue timing, ERS implementation costs, earnings, and cash flows.
- The sustainability of reported free cash flow and earnings, including the effects of working-capital movements, share repurchases, tax items, and restructuring charges.