Moody’s Corporation Q2 2010 Earnings Call Transcript

| About: Moody's Corporation (MCO)

Moody’s Corporation (NYSE:MCO)

Q2 2010 Earnings Call Transcript

July 29, 2010 11:30 am ET

Executives

Liz Zale – VP, IR

Ray McDaniel – Chairman and CEO

Linda Huber – EVP and CFO

Mark Almeida – President of Moody's Analytics

Analysts

Peter Appert – Piper Jaffray

Michael Meltz – JP Morgan

Sloan Bohlen – Goldman Sachs

Craig Huber – Access 342

William Bird – Banc of America/Merrill Lynch

Operator

Good day and welcome, ladies and gentlemen, to the Moody's Corporation second quarter 2010 earnings conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company we will open the conference up for questions-and-answers following the presentation. I will now turn the conference over to Liz Zale, Vice President of Investor Relations. Please go ahead.

Liz Zale

Thank you. Good morning, everyone and thanks for joining us on this teleconference to discuss Moody's results for the second quarter of 2010. I am Liz Zale, Vice President of Investor Relations.

Moody's released its results for the second quarter of 2010 this morning. The earnings press release and a presentation to accompany this teleconference are both available on our website at IR.Moodys.com. Ray McDaniel, Chairman and Chief Executive Officer of Moody's Corporation will lead this morning's conference call. Also making prepared remarks on the call this morning is Linda Huber, Chief Financial Officer of Moody's Corporation.

Before we begin, I call your attention to the Safe Harbor language, which can be found toward the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the act, I also direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2009; our Form 10-Q for the period ended March 31, 2010, and in other SEC filings made by the company, which are available on our website and on the Securities and Exchange Commission’s website.

These, together with the Safe Harbor statement set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements. I should point out that members of the media may be on the call this morning in a listen-only mode.

I'll now turn the call over to Ray McDaniel.

Ray McDaniel

Thanks, Liz. Good morning and thank you to everyone for joining today's call. I'll begin our remarks this morning by summarizing Moody's second quarter and year-to-date 2010 results. Linda will follow with additional financial detail and operating highlights. I'll then speak to recent developments in the legislative and regulatory area and finish with comments on Moody's outlook for 2010. After our prepared remarks we'd be happy to respond to your questions.

Moody’s results for the second quarter were strong given the greater volatility in debt capital markets as compared to the first quarter. Total revenue was $478 million, up 6% from the second quarter of 2009, was largely driven by the resurgence of US-based bank loan activity for refinancing and LBO transactions, plus growth across Moody’s Analytics.

Operating income for the second quarter was $191 million, an increase of 2% year-over-year. Diluted earnings per share for the quarter were $0.51, 11% above the $0.46 in the prior year period. Excluding legacy tax and restructuring items in both years, diluted EPS for the quarter of $0.49 grew by 14% year-over-year.

Turning to year-to-date performance, revenue for the first six months of 2010 was $954 million, 11% increase from the first half of 2009. Expenses were $567 million, up 8% from the prior year period, and operating income of $387 million increased 15%.

Revenue at Moody’s Investors Service in the first six months of 2010 was $664 million, an increase of 14% from the prior year period. Moody’s Analytics revenue of $290 million was 4% higher than the prior year period. We’re reaffirming our full-year 2010 EPS guidance of $1.75 to $1.85 based on the sound first-half performance, but we expect the uneven credit market conditions will persist during the second half.

I will now turn the call over to Linda to provide further commentary on our results and other updates.

Linda Huber

Thanks, Ray. I’ll begin with revenue at the corporate level. As Ray mentioned Moody’s total revenue for the quarter was up 6% year-over-year. The impact of foreign currency translation on revenue was negligible. For the second quarter, US revenue increased 10% to $262 million; while revenue outside the US increased 1% to $215 million, representing 45% of Moody’s total revenue. Recurring revenue of $284 million represented 59% of total revenue compared to 61% in the prior year period.

Looking at each of our businesses, Moody’s Investors Service revenue for the quarter was $329 million, a 6% increase year-over-year. US revenue was up 12% over the prior year period; outside the US revenue declined 2% and represented 41% of total ratings revenue.

Global corporate finance revenue in the second quarter increased 19% from a year ago to $128 million. Revenue grew 30% in the US, primarily driven by strong activity and high yield bank loans, which more than offset reduced issuance of investment grade bonds.

Outside the US, revenue increased 1% from the prior year period, with strong issuance in Asia and Latin America, mostly offset by limited activity in Europe and Canada. Global structured finance revenue for the second quarter was $73 million, 2% below the prior year period.

In the US revenue declined 4% year-over-year with reduced activity in derivatives and asset backed commercial paper programs, partially offset by growth in commercial real estate finance issuance. Non-US structured finance revenue grew 1%, with improved European covered bond issuance, most offset by declines in other asset classes.

Global financial institutions revenue of $63 million decreased 6% from the second quarter of 2009 primarily due to issuance declines in the US and European insurance and banking sectors. US financial institutions revenue was down 9%, while outside US revenue declined 4%.

Global revenue for public, project and infrastructure finance business grew by 6% year-over-year to $64 million. Revenue increased 13% in the US, with higher revenue in the public and project finance sectors. Non-U.S. revenue declined 8% primarily due to lower issuance volumes in European infrastructure finance.

Turning now to Moody's Analytics, global revenue for is Moody's Analytics of $149 million was up 6% from the second quarter of 2009. US revenue grew by 6% year-over-year to $67 million. Non-US revenue increased by 7% to $82 million and represented 55% of total analytics revenue.

All lines of business grew over the prior year quarter led by risk management software, which generated the majority of the quarter’s revenue growth. Globally revenue from research, data and analytics of $105 million increased by 3% from the prior-year period and represented over 70% of total MA revenue. The return to growth for these businesses reflect further stabilization among our capital market customers, as disruption from the financial crisis recede.

In a more transaction sense of the businesses, revenue from risk management software of $39 million grew 16%, while revenue from professional services of $5 million, increased 14% from the prior year period. Growth rates in both of these business units are subject to significant quarter-to-quarter volatility due to the variable nature of project timing and the concentration of revenue in a relatively small number of engagements.

Turning now to expenses, Moody’s second quarter expenses were $287 million, an increase of 9% compared to the second quarter of 2009. The increase was primarily due to greater headcount and incentive compensation as well as higher spending related to legal and regulatory requirements.

Excluding minor restructuring related items from both periods, Moody’s second quarter 2010 expenses increased 10%. Excluding restructuring items in both periods, operating margin for the second quarter of 2010 was 39.9% compared to 42.2% in 2009.

Our effective tax rate for the quarter was 31.1% compared with 36.4% for the prior year period. The decrease was primarily due to a reduction in unrecognized tax benefits and other tax related liabilities resulting from the closing of the various tax audits, lower taxes on foreign income, and the favorable resolution of a legacy tax matter.

Now I would like to turn to an update on capital allocation and stock buybacks. During the second quarter of 2010, Moody’s repurchased 2.8 million shares at a total cost of $70 million and issued 0.1 million shares under employees stock-based compensation plan. Outstanding shares as of June 30, 2010, totaled 234 million, representing a 1% decline from the year earlier. As of June 30, 2010, Moody’s had 1.3 million of share purchase authority remaining under its current program.

At quarter-end, Moody's had $1.1 billion of outstanding debt and approximately $640 million of additional debt capacity available under its revolving credit facility. We used a portion of our cash flow to reduce total outstanding debt by $16 million during the second quarter. Net debt was potentially unchanged at approximately $620 million. We remain committed to using our strong cash flow to create value for shareholders, while maintaining sufficient liquidity.

In 2010, we expect to continue share repurchase at modest levels, subject to available cash flow, market conditions, and other ongoing capital allocation decisions.

And with that I will turn the call back over to Ray.

Ray McDaniel

Thanks, Linda. I’ll continue now with an update on legislative and regulatory developments.

In the US, last week the president signed into law the Dodd-Frank Wall Street Reform Act, which establishes a revised legal and regulatory infrastructure for the US financial system. We believe that regulatory reform is healthy for the markets, and we’re committed to implementing the provisions that are specific to our industry as quickly and effectively as possible.

The intent of the law regarding credit rating agencies is increased transparency and accountability through a number of measures. The majority of the provisions seek to enhance the regulatory environment for Nationally Recognized Statistical Rating Organizations, or NRSROs, and will be implemented through rule-making by the SEC.

Certain of provisions, however are effective immediately, including the revised litigation pleading standard provided for by section 933 and the rescission of rule 436 G. Section 933 provides that the initial complaint in a Federal securities fraud case against a credit rating agency will be sufficient if a plaintiff adequately alleges that the rating agency knowingly or recklessly either failed to conduct a reasonable investigation of factual elements relevant to the rating, or failed to obtain independent third party verification of factual material relied upon for the rating.

This provision changes only the pleading standard for bringing a case, not the liability standard that sets forth what a plaintiff will ultimately be required to prove. Moody’s analysts have always investigated the factual elements relevant to our ratings, including in many instances a review of information that has been verified by independent third parties.

In response to the revised pleading standard however, we are undertaking certain processes and operational changes, which include enhanced documentation of some of our existing processes, and seeking additional third-party verification where appropriate. We are also considering other possible actions that may help mitigate some of the financial risks of this revised pleading standard.

Regarding the other litigation related provision, as a result of the rescission of SEC rule 436 G, if an NRSRO provides consent for a rating to be included in the 1933 Act registration statement or prospectus. The NRSRO is subject to expert liability. Moody’s like several other NRSROs has stated that we are not able to provide that consent without further study of the legal consequences.

However, this is no way limits our rating activity of the public availability of Moody’s ratings through our website or press releases or other multi-uses of our ratings in the offering process. While the rescission of 436 G is applicable to US public securities offerings, it does not cover securities offered outside the US, or US private placements or municipal bonds. It is most relevant to limited sectors of the market where there is a regulatory requirement to include ratings in a registration statement or prospectus.

As we have discussed for more than a decade, Moody’s support through removal of ratings from regulations, and believes it is in the best interests of all market participants. In Europe, as noted on previous calls, we are in the process of implementing the new European Union credit rating agency regulation, and continue to communicate with national and regional authorities charged with providing guidance and oversight for this regulation.

We are completing our application to register under the new EU regulatory regime for credit rating agencies, and anticipate that additional European regulatory review will be ongoing during the second half of the year. Finally, as regulatory reviews and activity occur in other jurisdictions, we will continue to advocate for globally consistent approaches that align with the G-20 statements.

I would like to conclude this morning’s prepared remarks by discussing our full year guidance. Moody's outlook for 2010 is based on assumptions about many macroeconomic and capital market factors, including interest rates, corporate profitability and business investment spending, merger and acquisition activity, consumer borrowing and securitization, and the eventual withdrawal of government-sponsored economic stabilization initiatives. There is an important degree of uncertainty surrounding these assumptions and, if actual conditions differ, Moody's results for the year may differ materially from our current forecast.

As I mentioned earlier, we are reaffirming our full-year 2010 EPS guidance in the range of $1.75 to $1.85; however, certain components of 2010 guidance have been modified to reflect our current view of credit market conditions and implications for the company. My comments will primarily focus on those components that have been revised, and we refer you to our earnings release for a full review of our guidance.

Our full-year outlook assumes foreign currency translation at exchange rates as of the end of a second quarter. For Moody’s Corporation we now expect revenue to grow in the mid-single-digit percent range and expenses to increase in the mid- to high-single-digit range. As previously discussed, we expect operating expenses to increase throughout the year, and we continue to believe incremental compliance costs related to new regulation will be approximately $15 million for this year and $15 million to $25 million for next year.

The company still projects the full-year 2010 operating margin in the high-30% range and now expects the effective tax rate in the range of 34% to 35%. At Moody’s Investors Service, we expect global revenue growth in the mid-single digit percent range. Reduced issuance activity and challenging credit market conditions in some key markets abroad are expected to continue going forward.

In the US, we expect MIS revenue to increase in the low double-digit percent range, while non-U.S. revenue is expected to decline in the low single digit percent range. Corporate finance revenue is projected to increase in the high teens to low 20s percent range, structured finance revenue is expected to decline in the high single to low double-digit percent range, while revenue from financial institutions is expected to be relatively flat.

Revenue from public, project and infrastructure finance is projected to increase in the mid-single digit percent range. At Moody’s Analytics, we continue to expect full-year 2010 revenue to increase from the mid-single digit percent range. Revenue in the US is now expected to grow in the mid-single digit percent range, the same rate of growth as outside the US. We continue to project revenue growth in the low single digit percent range for research data and analytics, while growth for risk management software is now expected to be in the low double digit percent range. Professional services is expected to grow in the mid-single digit percent range.

That concludes our prepared remarks and joining us for the question-and-answer section are Michel Madelain, Chief Operating Officer, Moody's Investors Service; and Mark Almeida, President of Moody's Analytics. We will be pleased to take any questions you may have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will take our first question from Peter Appert of Piper Jaffray.

Peter Appert – Piper Jaffray

Thanks. Ray, I think it is noteworthy that your revenue performance in the ratings business is quite a bit better than both S&P and Fitch. I understand there is differences in terms of mix from a transaction versus relationship based pricing model. Do you feel that perhaps you're gaining market share?

Ray McDaniel

I mean, it is certainly possible Peter, but I don’t think that one quarter’s performance is really sufficient for us to make a strong statement about that. As you say, it could be some timing differences. We also had a strong quarter from the rating of bank loans in the US in particular, and that is a more transaction-based part of our business, and accounted for a lot of the strength.

Peter Appert – Piper Jaffray

This is, actually, Ray, your second quarter of outperformance, so I think it's an emerging trend perhaps. How about, Ray, on pricing strategy, you have talked in the past about the possibility of being a little more aggressive in the context of the higher costs you're facing with the new regulations, any further thoughts on that?

Ray McDaniel

Yes, as we have said before, there are certainly additional costs that we are dealing with this year and that we expect to deal with next year – we do anticipate that pricing increases will be appropriate in some areas of our business as they have been this year. And so, yes, we will price where we have additional cost, but as we always are most interested in aligning price with the value creation, and that is going to be the primary focus.

Peter Appert – Piper Jaffray

Okay. And then just one last thing, you're offering somewhat more cautionary guidance from a revenue standpoint here for the back half. Does this imply you're seeing something in terms of issuance activity near term that drives that, or is there something else we should be thinking about?

Ray McDaniel

No, actually I think the market tone both in the US and in Europe has been better in July, certainly than it was in May and the early part of June. But we have experienced a couple of months this year, whether the markets have turned pessimistic and spreads have widened. We saw that in February, we saw it in May, and the early part of June and issuance declined.

And we are anticipating that they are going to continue to be these periods of pessimism from time to time given the degree of uncertainty, and somewhat the degree of fragility that we have seen in the debt capital markets.

Peter Appert – Piper Jaffray

Okay. Thanks, Ray.

Ray McDaniel

Thank you, Peter.

Operator

Our next question comes from Michael Meltz of JP Morgan.

Michael Meltz – JP Morgan

Thank you. Two questions. Ray, clearly the issuance data that we all look at, I don't think it's ever really tracked all that well to your revenues and this quarter especially, so the bank loan or syndicated debt portion of your business, can you talk about trends specifically there? How did you exit – was it just a really strong start to the period or how did you exit? And then I have a follow-up.

Ray McDaniel

Well, the bank loan issuance activity was stronger in the second quarter than in the first quarter. And to some extent bank loan activity and speculative grade bond activity offset each other. So, we see strength in one versus the other at different points in time. But the loan activity was a combination of corporations finding the opportunity to refinance, and because there was more LDO activity recently than we had seen for a while, and so that was driving the bank loans. And again particularly this was true in the United States.

Michael Meltz – JP Morgan

A question for you on legal and D&O. I mean, we have seen a lot of reaction from your firm and competitors now that the reform went into effect. How have your discussions gone with your insurers? Any update you can give us on that?

Ray McDaniel

We don’t discuss our discussions with other insurers, but as we have said before, we think we carry very appropriate levels of insurance and will continue to do so.

Michael Meltz – JP Morgan

Okay. Thank you.

Operator

Our next question comes from Sloan Bohlen of Goldman Sachs.

Sloan Bohlen – Goldman Sachs

Hi, good afternoon. First a question for Ray and Mark on the Moody's Analytics side, the growth that we're seeing in the recovery value products, is that mostly just sort of demand for the products? Are you actually starting to see some growth from new hiring at financial institutions and new seats being added?

Ray McDaniel

Yes, let me ask Mark to comment on that.

Mark Almeida

No, we are really not seeing any material increase in staffing at our customer accounts. So that is not really driving our revenue growth. What is driving our revenue growth is good, not extraordinary, but good demand for our products and services and very clear stabilization in the customer base and higher customer retention.

We had a problem with customer retention when we were in the throes of the financial crisis, and that situation has improved a lot since the middle and end of last year.

Sloan Bohlen – Goldman Sachs

I guess, for that customer retention, are you finding that new customers are looking for those products as well as certain of those types of assets are coming back to trade in the market?

Mark Almeida

Yes, yes we are seeing good demand from new customers and good demand from existing customers as well.

Sloan Bohlen – Goldman Sachs

Okay. And then just a question for Linda on the buyback, I just wanted to get a sense of how the size of the buyback was determined and then maybe a comment on timing relative to when Fin Reg was passed.

Linda Huber

Sure. We determined our size by looking at our financial ratios and making sure that we had an appropriate amount of money to spend in keeping with our modest guidance and we handle these things systematically Sloan. And so there isn’t much to say in terms of timing with financial regulation.

Sloan Bohlen – Goldman Sachs

Okay. Fair enough. Thanks.

Operator

Our next question comes from Craig Huber of Access 342.

Craig Huber – Access 342

Yes, good morning. My typical question first, if I could, could you break down, if you would, the breakdown of your revenues transaction versus non-transaction across your four broad categories? And I have a follow up.

Linda Huber

Yes, I certainly could Craig. Let me see here, we will do transaction and then relationships. For structured finance, transaction revenues were 40% and relationship revenues were 60%. For corporate finance CFG, 70% transaction, 30% relationship; FIG with 32% transaction and 68% relationship, and PPIF with 58% transaction and 42% relationship.

For MIS as a whole we were at 54% and 46%, and for Moody’s Analytics 12% transaction, 88% relationship and for the Corporation as a whole 41% transaction, and 59% relationship.

Craig Huber – Access 342

And then my other housekeeping question, if I could, could you further breakdown your revenues within corporate finance of the four main categories, high yield, bank loans, investment grade, et cetera? (inaudible)

Linda Huber

For…

Craig Huber – Access 342

I know it is a lot of numbers. Thank you.

Linda Huber

Okay. For corporate finance for the second quarter, investment-grade was 16% of our revenues and again in total corporate finance revenues were 127.9 million. So, 16% of that was investment grade, 22% of that was speculative grade, 20% of it was bank loans, and 43% of that was other. Anything else?

Craig Huber – Access 342

Yes, if you could just do the other three broad categories too, structured finance, finance institutions, PPIF.

Linda Huber

Sure. Let me do structured, total structured revenue was $73.1 million, and asset-backed category was 31%, residential mortgage-backed securities was 22%, commercial real estate 18%, and derivatives 29%. And do you want PPIF or FIG?

Craig Huber – Access 342

Yes, both please.

Linda Huber

Okay. Getting to the right page here, in case of FIG, total revenue was $63.2 million, banking was 70% of that, insurance was 23% of that, and managed investments was 7% of that, and I got to find PPIF.

And let me see, for that total of $64.4 million, public finance and sovereign was 52% of revenue, municipal structured finance was 8%, and project and infrastructure was 40% of total revenue. I think that is all of them.

Craig Huber – Access 342

Yes, that's all of them. And then, could you also speak about the debt maturities you're looking at, I guess on a worldwide basis for 2011 and what you think could be a pull forward effect of some refinancing into the fourth quarter, and how you're thinking about that versus your guidance?

Ray McDaniel

Yes, I mean, I think we have certainly seen pulled forward already. And there remains a significant amount of debt that needs to be refinanced, not just in 2011, but 2012, and 2013 as well. So, I guess I’m less sensitive to whether there is a pull forward into later this year with 2011 debt, because of the amount of debt that is still outstanding, maturing in 2012 and 2013. And so as a result, it looks very opportunistic at this point. Spreads come in and issuance activity is substantial, but when spreads widen out as they did in May, there is not much activity because the debt is not due now. It is being pulled forward.

Craig Huber – Access 342

And then lastly, you touched on briefly your thoughts on the European regulations. If they do open up, the European regulations for the credit rating companies again further, what would you expect them to focus on here?

Ray McDaniel

I would expect that the focus affected that their focus on many of the things that they either looked at before, or that have been looked at in the US in terms of managing conflicts of interest, looking at the business model, the transparency, the accountability reporting. And I hope, although I don’t know this, but I would hope that we would also see – look at harmonization, because again even if we are dealing with a more intensive regulatory environment, it is helpful if that environment is one that we can operate in a consistent manner globally.

Craig Huber – Access 342

Great. Thank you.

Operator

(Operator instructions) Our next question comes from William Bird of Banc of America/Merrill Lynch.

William Bird – Banc of America/Merrill Lynch

Thanks. I was wondering if you could tell us what the incentives comp accrual was in the quarter.

Linda Huber

I can tell you the percentages, here, Bill, which is how we prefer to do it. Total comp expense for the second quarter was $176 million. Of that 10% was incentive compensation, and about 7% stock based compensation, and the rest salaries and benefits made up about 82% of compensation, and that is approximately how we have been running, and how we expect to run for 2010.

William Bird – Banc of America/Merrill Lynch

And can you also just talk about the tax rate? Does the 34% to 35% for the full year, does that include the legacy tax item, and where do you expect the sustainable tax rate to be beyond 2010?

Linda Huber

Sure, the 34% to 35% would include what we see for the rest of the year going forward. We have a very good quarter regarding the tax rate. Obviously, we had some beneficial one-off situations, and then we also work hard on making sure that we are providing the correct tax structure for the corporation, given that in general 50% of our revenues are now oversees. So we worked hard on our strategy, and then also we have been fortunate this quarter to have a few things that have worked our way in terms of closing certain audits that were outstanding and so on.

So 34% to 35% is our best thought going forward. Bill, I would not be as brave as to venture anything for 2011. We have got an administration in the Congress, which is considering some pretty major changes to tax legislation and for us to give any guidance at this time I think would be a guess at best, and perhaps a bit irresponsible. So let us see where the politicians do and we will update you when we do next year’s guidance.

William Bird – Banc of America/Merrill Lynch

So, just to clarify this 34% to 35%, it sounds like it includes the legacy tax item?

Linda Huber

Yes, we can be certain on when legacy tax items are going to see results, but from what we can see for this year that is what we have in there.

William Bird – Banc of America/Merrill Lynch

Thank you.

Operator

And at this time, there are no further questions. I will turn the call back to Ray McDaniel for any closing remarks.

Ray McDaniel

Okay. I just want to thank everyone for joining the call today, and we look forward to speaking with you again in October. Thanks.

Operator

And this concludes the Moody’s second quarter earnings call. As a reminder, a replay of this call will be available after 4 P.M. Eastern Time on Moody’s web site. Thank you.

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