Good day, and welcome, ladies and gentlemen, to the Moody's Corporation 4th Quarter and Fiscal Year End 2016 Earnings Call. At this time, I'd 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 up the
I would now like to turn
the conference over to Ms. Sally Schwartz, Global Head of Investor Relations and Communications. Please go ahead.
Thank you. Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's Q4 and full year 2016 results as well as our outlook for full year 2017. I am Sallie Schwartz, Global Head of Investor Relations and Communications. This morning, Moody's released its results for the Q4 and full year 2016 as well as our outlook for full year 2017. The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com.
Ray McDaniel, Moody's President and Chief Executive Officer, will lead this morning's conference call. Also making prepared remarks on the call this morning is Linda Huber, Moody's Executive Vice President and Chief Financial Officer. During this call, we will be presenting non GAAP or adjusted figures. To view the nearest equivalent GAAP figures and a GAAP reconciliation, please refer to our earnings release that was filed this morning. 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 ks for the year ended December 31, 2015, 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 would also like to 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.
Thank you, Sally. Good morning and thank you to everyone for joining today's call. I'll begin by summarizing Moody's Q4 and full year 2016 financial results. Linda will follow with additional financial detail and operating highlights, and I will then conclude with comments on our outlook for 2017. After our prepared remarks, we will be happy to respond to your questions.
In the Q4, Moody's revenue of $942,000,000 increased 9% primarily as a result of higher issuance in global leverage finance, U. S. CLOs and U. S. Public and project finance, as well as continued strength from Moody's Analytics.
Many of Moody's other 4th quarter and full year 20 16 financial measures were impacted by the company's January 2017 agreement reached with the U. S. Department of Justice, 21 U. S. States and the District of Columbia to resolve pending and potential civil claims related to credit ratings assigned during the financial crisis era.
The agreement, while costly at $864,000,000 removed legacy legal risk as well as future costs and uncertainty. As such, we felt that putting these claims behind the company was in the best interest of Moody's, our employees and our shareholders. 4th quarter adjusted operating expense, which excludes the $864,000,000 settlement charge, was $551,000,000 up 3% from the Q4 of 2015. 4th quarter adjusted operating income, which excludes the settlement charge as well as depreciation and amortization, was $424,000,000 up 17% from the same period last year. The adjusted operating margin for the Q4 of 2016 was 45%, up 3 20 basis points from 41.8% in the Q4 of 2015.
Adjusted EPS for the quarter was $1.23 up 13% from $1.09 in the Q4 of 2015. Q4 2016 adjusted EPS excludes a $3.63 loss from the settlement charge and an $0.18 gain from a non cash foreign exchange benefit related to a subsidiary liquidation. Turning to full year performance. Against volatile market conditions, Moody's achieved 2016 revenue of $3,600,000,000 up 3% from 2015. Foreign currency translation unfavorably impacted Moody's revenue by 1%.
Moody's investor service record second half revenue overcame a very challenging first quarter, allowing MIS to record a 2% revenue increase to $2,400,000,000 The impact of foreign currency on MIS revenue was negligible. Moody's Analytics revenue surpassed $1,200,000,000 in 2016, a 7% increase over the prior year. Foreign currency translation unfavorably impacted MA revenue by 3 percent. Adjusted operating expense, which excludes the settlement charge and a $12,000,000 restructuring charge, was $2,100,000,000 up 4% from the prior year. Foreign currency translation favorably impacted expense by 2%.
Adjusted operating income, which excludes the settlement and restructuring charges as well as depreciation and amortization, was $1,600,000,000 up 3% from 2015. Moody's adjusted operating margin for 2016 was 45.5%, consistent with the prior year. Recognizing ongoing uncertain macroeconomic and geopolitical conditions, our 2017 outlook is for mid single digit percent revenue growth and EPS of $5.15 to $5.30 which includes an estimated $0.15 benefit from an accounting change related to equity compensation. I'll now turn the call over to Linda to provide further commentary on our financial results
and other updates. Thanks, Ray. I'll begin with revenue at the company level. As Ray mentioned, Moody's total revenue for the Q4 was $942,000,000 up 9% from the prior year period. U.
S. Revenue of $534,000,000 was up 11%. Non U. S. Revenue of $408,000,000 was up 6% and represented 43% of Moody's total revenue.
Foreign currency translation unfavorably impacted Moody's revenue by 2%. Recurring revenue of $472,000,000 was approximately flat to the prior year and represented 50% of total revenue. Looking now at each of our businesses, starting with Moody's Investor Service. Total MIS revenue for the quarter was $608,000,000 up 12% from the prior year period. U.
S. Revenue increased 11% to $376,000,000 Non U. S. Revenue of $232,000,000 was up 13% and represented 38% of total ratings revenue. The impact of foreign currency translation on MIS revenue was negligible.
Moving to the lines of business for MIS. 1st, global corporate finance revenue for the Q4 was $278,000,000 up 13% from the prior period. This result reflected increased levels of U. S. And European rated bank loan issuance as well as higher global speculative grade bond rating revenue.
U. S. And non U. S. Corporate finance revenues were up 6% and 28%, respectively.
2nd, global structured finance revenue for the 4th quarter was $131,000,000 up 14% from the prior year period. This result reflected increased deal activity in U. S. CLOs and CMBS and in European RMBS and CLOs. U.
S. And non U. S. Structured finance revenues were up 18% and 7% banking issuance. U.
S. Financial Institutions revenue was up 4%, while non U. S. Revenue was down 8 4th, global public project and infrastructure finance revenue of $103,000,000 was up 21% versus the prior year period, primarily driven by strong non U. S.
Infrastructure and U. S. Public finance issuance. U. S.
And non U. S. Public project and infrastructure finance revenues were each up 21%. MIS other, which consists of non rating revenue from ICRA in India and Korea Investor Service, contributed $8,000,000 to MIS revenue for the 4th quarter, up 10% from the prior year period. And turning now to Moody's Analytics, global revenue for MA of $334,000,000 was up 4% from the Q4 of 2015.
U. S. Revenue of $158,000,000 was up 11%. Non U. S.
Revenue of $176,000,000 was down 1% and represented 53% of total MA revenue. Foreign currency translation unfavorably impacted MA revenue by 4%. On a constant currency organic basis, MA revenue grew 5% in the Q4. And moving now to the lines of business for MA. 1st, Global Research Data and Analytics, or RD and A, revenue of 100 and $67,000,000 was up 3% from the prior year period and represented 50% of total MA revenue.
Growth was mainly driven by new sales and contract upgrades for credit research and ratings data feeds. US RD and A revenue was up 7%, while non U. S. Revenue was down 1%. Foreign currency translation unfavorably impacted RD and A revenue by 4%.
2nd, Global Enterprise Risk Solutions or ERS revenue of $130,000,000 was up 7% from last year. The growth was driven primarily by the March 2016 acquisition of GGY as well as an increase in software license revenue. U. S. ERS revenue was up 24%, while non U.
S. Revenue was down 1%. Foreign currency translation unfavorably impacted ERS revenue by 3%. Trailing 12 month revenue and sales for ERS increased 12% and 4%, respectively. Product sales were up 13%, while services declined 16%, reflecting our progress on shifting the mix of the ERS business to emphasize higher margin products.
3rd, global professional services revenue of $37,000,000 was down 3% from the prior year period. U. S. Professional services revenue was flat, while non U. S.
Revenue was down 4%. Foreign currency translation unfavorably impacted professional services revenue by 3%. Turning now to operating expense. Moody's 4th quarter adjusted operating expense, which excludes the settlement charge Ray mentioned earlier, was $551,000,000 up 3% from 2015. The increase was primarily attributable to increased incentive compensation, the March 2016 acquisition of GGY and annual merit increases, largely offset by management savings initiatives implemented in early 2016.
Foreign currency translation favorably impacted adjusted operating expense by 3%. As Ray mentioned, Moody's adjusted operating margin increased 320 basis points to 45% in the Q4. And now I'll provide an update on capital allocation. During the Q4 of 2016, Moody's repurchased 558,000 shares at a total cost of $60,000,000 or an average cost of $107.48 per share and issued 86,000 shares as part of its employee stock based compensation plans. Moody's returned $71,000,000 to its shareholders via dividend payments during the Q4 of 2016.
For full year 2016, Moody's repurchased 7,700,000 shares at a total cost of $739,000,000 or an average cost of $96.38 per share and issued 2,800,000 shares as part of its employee stock based compensation plan. Moody's returned $285,000,000 to its shareholders by dividend payments during 2016. The total capital returned to shareholders 2016 was $1,000,000,000 Additionally, on December 21, 2016, Moody's increased its quarterly dividend by 3% from $0.37 to $0.38 per common share of stock. Outstanding shares as of December 31, 2016 totaled 190,700,000, dollars down 3% from December 31, 2015. As of December 31, 2016, Moody's had approximately $700,000,000 of share repurchase authority remaining.
At year end, Moody's had $3,400,000,000 of outstanding debt and $1,000,000,000 of additional borrowing capacity under its commercial paper program, which is backstopped by an undrawn $1,000,000,000 revolving credit facility. Total cash, cash equivalents and short term investments at year end were $2,200,000,000 with approximately 78% held outside the U. S. Free cash flow in 2016 was $1,100,000,000 up 4% from 2015, primarily due to changes in working capital. And with that, I'll turn the call back over to Rick.
Okay. Thanks, Linda. I'll conclude this morning's prepared comments by discussing our full year guidance for 2017. A complete list of Moody's guidance is included in our Q4 and full year 2016 earnings press release, which can be found on the Moody's Investor Relations website at ir. Moodys.com.
Moody's outlook for 2017 is based on assumptions about many geopolitical conditions and macroeconomic and capital market factors, including interest rates, foreign currency exchange rates, corporate profitability and business investment spending, mergers and acquisitions, consumer borrowing and securitization and the amount of debt issued. These assumptions are subject to uncertainty and results for the year could differ materially from our current outlook. Our outlook does not include any estimated impact for potential changes in U. S. Tax laws or other possible policy or regulatory changes.
Our guidance assumes foreign currency translation at end of year exchange rates. Specifically, our forecast reflects exchange rates for the British pound of $1.24 to 1 pound and for the euro of $1.05 to 1 euro As I noted earlier, Moody's expects full year 2017 revenue to increase in the mid single digit percent range. Adjusted operating expense is expected to increase in the low single digit percent range from the 2016 adjusted operating expense of $2,100,000,000 On a constant dollar basis, the revenue growth rate would be approximately 120 basis points higher and the adjusted operating expense growth rate would be approximately 170 basis points higher. The company is projecting an operating margin of approximately 43%, up approximately 100 basis points compared to 20 sixteen's operating margin, excluding the settlement and restructuring charges of 42%. Adjusted operating margin is expected to be approximately 46%.
The effective tax rate is expected to be approximately 31% to 32% and reflects the U. S. Accounting change related to equity compensation as well as changes to U. K. Tax laws as noted in our earnings press release.
Full year 2017 EPS is expected to be $5.15 to $5.30 including the estimated $0.15 per share benefit resulting from the accounting change previously mentioned. Free cash flow is expected to be approximately $500,000,000 which includes the payment of the settlement charge recorded in the company's Q4 2016 financial results. Moody's expects share repurchases to be approximately $500,000,000 subject to available cash, market conditions and other capital allocation decisions. Capital expenditures are expected to be approximately $100,000,000 Depreciation and amortization expense is expected to be approximately $135,000,000 dollars For MIS, the company expects full year 2017 revenue to increase in the mid single digit percent range. Both U.
S. And non U. S. Revenues are expected to increase in the mid single digit percent range. On a constant dollar basis, the revenue growth rate for MIS would be approximately 100 basis points higher.
Corporate finance revenue, structured finance revenue and financial institutions revenues are all are each expected to increase in the mid single digit percent range. Public project and infrastructure finance revenue is expected to increase in the low single digit percent range. For Moody's Analytics, the company expects 2017 revenue to increase in the mid single digit percent range. US revenue is expected to increase in the low single digit percent range and non US revenue is expected to increase in the high single digit percent range. On a constant dollar basis, the revenue growth rate for MA would be approximately 180 basis points higher.
Research data and analytics revenue is projected to increase in the high single digit percent range. Enterprise Risk Solutions revenue is expected to increase in the mid single digit percent range, and professional services revenue is expected to increase in the low single digit percent range. This concludes our prepared remarks and joining Linda and me for the question and answer session are Mark Almeida, President of Moody's Analytics and Rob Sauber, President of Moody's Investor Service. We'll be pleased to take any questions you might have.
We'll go first to Alex Kramm
with UBS. Hey, hello everyone. I think my questions are mainly for Linda today. Starting with the expenses, I think the margin guidance was a nice surprise relative to what you've said before. Could you walk through the puts and takes a little bit more?
How should we think about what's driving the upside? Is it the way you've ended in terms of being soft on hiring this year? What about legal expenses that might be coming down post the settlement? And maybe any color on variable compensation, how we should be expecting there for the year? Thank you.
Hey, Alex. I'm glad you're happy and have a couple of points to make about that. We did do better in 20 16 due to some pretty rigorous expense control measures that we took back in February of last year. So we did better at the conclusion of 2016 even than we had expected. Those controls will continue going into 2017.
So we feel pretty good about guiding to approximately 100 basis points of margin expansion. Some of that does come from savings in legal costs, but the majority is what we're doing in terms of hiring. We have lowered the pace of hiring for the corporation. MA continues to move a little bit faster than the rating agency and shared services. Looking at 16 over 15, MIS is actually down in headcount and shared services is approximately flat.
So all those things have helped us just with good general housekeeping and some discipline. In terms of incentive compensation, let me find the right page here and we'll talk about that. As what sometimes happens, we noticed that in the Q4 because our performance was a good deal stronger in 2016, Alex, the quarters had gone in 2016 for incentive compensation about $32,000,000 $35,000,000 $42,000,000 And then as sometimes happens, the 4th quarter was $59,600,000 in incentive compensation. For 2017, probably the right thing to model there is somewhere between $40,000,000 $45,000,000 per quarter of incentive compensation. And does that hit most of what you wanted?
I think that got everything here. Secondly, similar on cash flow, I guess. How should we be thinking about the settlement and how you will actually end up paying for that and the timing of all of that. So if you can run through the kind of like the buybacks, are those going to be more 3rd quarter or Q4? How about are you going to draw on the revolver or the commercial paper program?
What's interest rate we should be thinking about? I don't think you've guided on interest expense. So just think about, Jacob, you have a lot of cash overseas. You generate decent cash here, but maybe not enough. So how should we be thinking about that?
And then maybe lastly related to that, how do you think about leverage in general? Because if you need to raise a little bit more debt for this, like I think you're hitting some of your initial targets. Are those targets changing? How do you think about it from being a rated company yourself? Anything we should be thinking about here?
Thank you.
Okay. Alex, that's about all the questions. Not at that. Let me try to start with the DOJ settlement. So the happy news is we're done or we're just about done.
The payments have been made. Those were largely completed. And the way we did that was cash on hand, U. S. Cash on hand.
You'll recall back in 2016, we reduced share repurchase guidance from $1,000,000,000 $750,000,000 And then also for those who have been paying close attention, we've reentered the commercial paper market. We have about $600,000,000 of commercial paper outstanding right now, about an average maturity of 60 days and we're paying about 1 point percent on that commercial paper. So we're very happy with the receptivity of the commercial paper markets and that's how we have financed the payment of the settlement. So again that's done. Going forward, we've got into about $500,000,000 of share repurchase for the rest of the year.
That's subject to many things as we've discussed already, but some of it is how cash flow comes in for the year for the company. So we'll see. As we announced the settlement, one of the other rating agencies that looked at us did provide a little bit more leverage room for us under its measure, which is now 1.5 times to 2 times rather than the 1.5 times that you had seen before. However, we very much like our rating category that we have right now and we don't like to run right up to the edge of our leverage level. So we feel that we have some dry powder.
We're happy about that. We have at least $500,000,000 of dry powder, something like that as we look at what we might want to do for 2017. So we like the leverage levels. We have a bit of room. Share repurchase about $500,000,000 And again, we just want to be thoughtful given everything that we've just to deal with and we don't like to be too close to the edge in terms of the leverage levels.
I don't know if Ray had anything else you wanted to add. I think that's most of it.
No, I just want to underscore both and this is implied both in the question and then addressed directly by Linda's answer. But between our cash on hand and our various borrowing options, we feel we have quite a bit of flexibility. And so we are going to be making decisions according to market conditions as we go through the year. And as I imagine you would expect, we're going to pay close attention to what we think are the best opportunities.
Alex, one final point, which may not have been taken into account in by everyone looking at their models. We did do some financing in 2016, excuse me. So you'll see in 2017 the roll forward effect of that interest expense. Secondly, we do have the $600,000,000 of CP and we are considering the term market at this time and we'll see what we decide to do about that. But again, if we take that 1.2% expense I'm sorry, the rate we're paying for the CP and we term that out, I think it'd be fair to say that we would expect that that interest expense would be a little bit heavier.
So we're considering that right now and that's one of the reasons why everything doesn't flow fully down to EPS.
Very helpful as usual. Thank you.
And
we'll go next to Joseph Foresi with Cantor Fitzgerald.
Hi. My first question is just any thoughts on issuance given the new administration? I'm sure you're predicting that one. And what could that do to your current projections? Any internal scenarios you're setting up for?
Joe, what we'll do, I'll go through what we usually do regarding our views that we're hearing from the investment banks. And then we have an exciting new feature. Rob Falber is going to add a little bit of color in terms of what the rating agency is noting in the marketplace. So starting with the U. S.
View and again this is coming from the investment banks and it's sort of an averaging of what we're hearing from the different banks. Investment grade right now is running very, very strong. January was $200,000,000,000 in issuance. A strong month is $100,000,000,000 and this is record January supply. Financials had dominated as well as significant issuance from TMT Companies.
For the year, we're looking at about $1,200,000,000 of U. S. Investment grade issuance, that's about flat year over year. The pipeline is robust as corporates exit their blackout periods and potentially look to get ahead of Fed rate hikes later in the year, which might be June, could be March and then potentially again toward the end of the year. We note that many issuers we're hearing from the bank prefunded in favorable 2016 issuance environment that might serve as a bit of an offset to 2017.
And we're thinking about the M and A pipeline, which is bouncing around a bit. For U. S. High yield, dollars 35,000,000,000 issued so far, dollars 250,000,000,000 expected for the year, which is up 5% year over year. 2017 has started on a positive tone.
Large cash inflows to high yield, recovering commodity crisis and attractive yields are very constructive. More constructive default scenarios and energy price outlooks are helping with the backdrop and we think that will support 2017 high yield bond issuance. Leverage loans so far 120,000,000,000 dollars that is a torrid pace 400,000,000,000 expected this year. The year is expected to be down 15% year over year. But right now stability in the macro backdrop is aiding the leveraged loan market with potential interest rate increases.
The floating rate view is preferred for investors and we continue to have CLO formation and that will support leverage loan activity, not enough though to surpass the elevated levels of 20 16. Now moving to Europe, what we've heard from the banks, investment grade in Europe volumes were higher than usual in January as issuers took advantage of the good conditions and low rates. The ECB and Bank of England continue to buy bonds and support the market and there's a strong pipeline as issuers look to go to market ahead of key political events in Europe and potential ECB tapering. We're about 2 months away from the French election as the first major event. High yield in Europe and the leveraged loan market remain in robust shape.
ECB bond buying is indirectly supported to high yield market and should help maintain rates at all time lows. Macroeconomic and geopolitical risk continue to be key focus though in Europe particularly for the speculative grade market. And now I'll invite Rob to make any further comments that he might want to offer.
Linda, that pretty thorough. I don't have too much to add to that. I might just talk about a little bit of kind of the upsides and downsides in general and how we're thinking about issuance. Certainly, higher economic growth leading to more capital investment and in turn debt financing would be a positive. Some sort of infrastructure stimulus either privately funded or in the municipal market, more constructive M and A environment, certainly Linda touched on that.
And I think importantly, a pull forward of these 2019 through 2021 maturity walls. We think we're seeing some pull forward now, but if we see more pull forward, that could provide some upside. Things we're thinking about as potential headwinds, I think you mentioned potentially unfavorable tax changes. I know there's been a lot of discussion around that, around corporate interest, tax deductibility, repatriation of foreign cash. Interestingly, we did see in January some very large issuance from some big tech players who have large cash balances offshore.
And we're looking at trade developments that could disrupt market stall investment. Obviously watching the election calendar in the EU, strengthening of the U. S. Dollar would also be something that would have an impact on us as well.
And not that we're supposed to ask the questions, but Rob, you had mentioned one of the pieces of research we released last week on the refinancing loss.
Yes. I don't want to confuse people because I don't have the global numbers handy, but we just put out some research last week. I know in regards to the U. S. Spec grade maturity wall, we're looking at the 5 year maturity wall is now over $1,000,000,000,000 for the first time.
That's over that's up about $100,000,000,000 from the study this time last year.
Got it. So any color though on sort of real time what the clients are telling you given the new administration? Are you seeing a wait and see approach or any pull forwards? I'm just wondering if there's anything outside of kind of what you've laid out for me from the issuance side of things.
No. This is Ray. Obviously, conditions were very strong in January and the markets remain active in February. We really don't expect to see the January kind of numbers in the loan and high yield sectors continue at that pace, but market conditions remain good. All of that indicates that issuers are taking advantage of a tight spread environment.
They may be moving ahead of uncertainty later in this year, whether it's policy uncertainty here in the U. S. Or the potential implications of unexpected outcomes in the European election. So the pull forward is, I think, both a recognition of good market conditions and potential uncertainties later in the year.
Okay. And then the last one for me. On the regulatory side, we've heard about some repeal maybe at some large institutions. Just wondering if you had any thoughts about any of that impact on your analytics practice? Thanks.
Yes. I mean, I'll let Mark comment on how they're thinking about that and I'll add any color if appropriate. Yes. I'd say that we are not seeing any meaningful impact to any of the talk about pullback on banking regulation, for example. We're still seeing very good demand for our products, for regulatory requirements as well as some of the accounting rule changes that are coming through, both IFRS 9 and the current expected credit loss CECL program that's coming in, in the U.
S. So nothing meaningful from our standpoint.
Thank you.
And we'll go next to Bill Warmington with Wells Fargo.
Good morning, everyone, and congratulations on the strong quarter. Thanks. So first question on, I wanted to ask about new issuer rating mandates for 2016, how that's been trending versus previous years? Well, the
Q4 was up year on year. We had, I think, about 175 new rating mandates in Q4. So that's good looking forward into the new year. We are not at the peaks we were at back in 2013, 2014, but it has been a stable flow of new mandates at healthy levels, just off peak levels. Rob, I don't know if there's anything else worth adding on that.
I don't
think that's right.
How was the breakdown between Europe and U. S?
I don't have that number in front of me. Rob telling me it was skewed towards the U. S, at least in the Q4.
Okay. And then on the Moody's Analytics side, just wanted to ask how things were looking at RD and A in terms of how the retention rates have been holding up, how the pricing realization has been?
It continues to be strong on both fronts. We're running in the mid-90s on customer retention. Pricing is solid. We're seeing good upgrade activity. So that's all strong.
I mean any softness we see in the RD and A numbers for the quarter really are down to currency. I mean, we really took it on the chin on currency translation in Europe. So it's hit us pretty hard, but the underlying business is as strong as it's been in over the last couple of years.
Okay. Then last question on ERS. You had mentioned the GGY acquisition, which you're going to be anniversarying and then also some what look like very strong software license revenue. So I was going to ask for some help in terms of modeling that out for the rest of the year, how we should think about that?
Yes. Well, you're right. We had a good year in 2016 because we had very good performance in the business. We also had help from the GGY acquisition. So that was all good.
Linda also referred to the fact that we are making good progress on our transition in the mix of the business as we've been talking about for a while. We are deemphasizing the services piece of the business and focusing much more heavily on sales of products that are much more scalable and therefore much more profitable. So the impact of that will flow through to 2017 revenue in the sense that we had a revenue a deliberate revenue decline in the services segment of the business. And so you're going to see that flowing through to revenue growth in 2017. So we're guiding toward mid single digit revenue growth in ERS.
And I think the way to think about that is think about 2017 in terms of ERS revenue growth as sort of a transition year as we shift the mix of the business away from services and focus more heavily on products, which we think will drive a much stronger P and L over the coming years.
Got it. Thank you very much.
And we'll go next to Manav Patnaik with Barclays.
Yes. Hi, good
afternoon. Linda, just to follow-up on the expense commentary, could you give us the ramp that you usually guide us to from now to the Q4? And also, how much of that 100 basis points is coming from the Moody's Analytics side? Maybe you could just update us on the efforts for the margin improvement there?
Sure. Manav, the first question is a little bit easier and maybe I'll let Mark think a little bit about what he wants to say on your second question. This year, we're hoping that the ramp will be a little bit flatter than it's been in previous years. So to give you somewhere to start, I think I've got this right. We're looking at about $532,000,000 for the Q1 budget for expenses in 2017.
And we're looking at the ramp going up $20,000,000 to $25,000,000 from the Q1 to the 4th quarter. Now I'll give the same warning that I give every year. That includes the view that incentive compensation lays out pretty evenly for the year. We haven't had that sort of performance recently in 2016. You'll note incentive comp went way up in the 4th quarter because of the strong performance.
But all things being equal, you want to start with $532,000,000 or so and take it up $20,000,000 to $25,000,000 Now, we've had pretty significant margin work in MIS and pretty strong cost controls in shared services in 2016. That reduces the kind of the run rate increase for 2017. And Mark's continuing to focus on margin by looking at its higher margin businesses as we said in the prepared remarks. I don't know Mark if you want to make any other comments on your thoughts.
Yes. I mean I would only observe consistent with what we've said before that I think we are making good progress with the MA margin. The challenge that we have is it's difficult for you to see that because of the way that we allocate overhead expense to the 2 operating businesses. MA as it's been growing faster than MIS over the last couple of years is attracting more overhead. So that's sort of offsetting the work that we're doing in the business itself.
So it's difficult for you to see it because of that. It's difficult for you to see it because of the impact on the margin, at least in the short run with some of the acquisitions we've made. So we believe we're making good progress. We think that progress is only going to get better over the coming years. But it is going to be difficult to see it on the MA standalone P and L just given the way we treat overhead expense.
So is the target still mid-20s over several years?
Yes.
Okay. All right. And then just one on the rating side, maybe Rob can add some color here. But I think you guys have put out some pieces around tax reform and the impact on issuance. I mean, it sounds like for Moody's company specifically, obviously, the lower tax and repatriation are positive.
But just on the broader tax reform piece, I mean, I guess it sounds like the view is it should be a negative, but how should we think about timing and how that impacts issuance and the company's decision making? Any help or color there would be helpful.
Well, this is Ray. When we look at potential changes in taxes, it's really there are a number of puts and takes. Certainly to the extent that there are impacts from changes in interest deductibility, you have to count that as negative. But to the extent that debt financing is still a low cost form of financing, you would have companies that have more available cash. It would probably be a stimulus for economic growth, and so there I would hope and anticipate we would see more new money borrowing.
So the quantification of whether it ends up being a net negative or a net positive is difficult to assess without having more detail about what the actual changes in tax law would be. And as we see that, we will obviously communicate it.
Got it.
All right. Thanks a lot guys.
And we'll go next to Toni Kaplan with Morgan Stanley.
Hi, good morning. Good morning. 2016, in 2016, your transactional revenue ratings revenue growth was up about 0.5%, while your biggest competitor was up about 6% in transactional ratings. What do you think the key drivers are that explain the delta there, just given that historically you've been a little bit more in terms of transactional mix shift. And so just wanted to figure out what we should be thinking about?
Tony, it's Linda. This is one of the most calculation for our competitor calculation for our competitor. It makes it pretty hard for us to judge. I'll ask Rob if he wants to make any other comments on this. But that wouldn't we don't have as much clarity on that as you might think, and it's a little hard for us to parse.
Rob?
Yes. The only thing I think I could surmise was there would be some sort of shift in the mix. Yes.
And just to add on to that, our transaction versus recurring revenue splits remained fairly constant in 2016 versus 2015. So we didn't see any big shifts there.
Okay, great. And so and I guess related, can you just talk about sort of the pricing environment within MIS?
Sure. It's Linda. We had spoken about at Investor Day back in 2016 that we felt pretty good about the pricing environment. I think that continues. I think I had noted then that we expected to be closer to the 4% end of the range we had said of 3% to 4%.
We are very interested in providing appropriate value for what we do and we think that we've made some significant investments in what the team has been able to do in terms of ease of use and otherwise very strong value proposition, which I'll let Rob talk about. But we're feeling okay about pricing. Rob, anything else you want mention?
No, I think that's it.
Okay, great. And then your long term framework calls for EPS growth in the teens. This coming year, you're expecting a mid single digit MIS growth environment. Why only 5% on the EPS increase excluding the tax benefit? I think you did mention perhaps the higher interest expense before rolling into 2017 from the actions you took in 2016.
But are there other pieces that we should be thinking about as well?
Tony, you might want to note the new accounting provision is helpful to us, but the UK has a couple of laws that's going to limit the interest deductibility piece to 30% of EBITDA and that is costing us about 100 and 60 basis points on the tax line. The tax line is in this climate one of the more challenging things for us predict. If we do see a change in tax policy, I would note which might be helpful to you that a 1% change in the ETR, that's 100 basis points, gives us $0.07 to $0.08 in EPS, which is a lot. So we're quite sensitive to what happens to that tax line, but you know that we've guided to $0.31 to $0.32 We'll see what happens with that. And there's obviously some variability around it.
So we're taking a prudent view on this given what we know now. And if we have adjustments, we'll be happy to discuss those with you on future calls. Brad, do you want
to The only other thing I would direct you to is fact that we do have higher financing costs this year than we did last year. Part of that is the roll forward of financing that we did during the year last year, and part of it is the fact that we've done some financing and we'll continue to do some financing as a result of the settlement with the Department of Justice and the payments that were made there. So that's just giving us an increase in that line that we normally wouldn't see.
Thanks a lot.
We'll go next to Warren Gardiner with Evercore.
Great. Thanks. On the margin in analytics in the quarter, it sounds like there were a couple of moving parts there with GGY and some FX. I mean, any sense you could kind of parse that out for us and give us what you kind of think the, I guess, core margin would be
for that business? Well, I can tell you that if we ignore the additional overhead expense that we absorbed and we ignore the impact of the acquisition for the quarter, the margin would have been flat to 2015. I should also note that we've got a couple of $1,000,000 of we had a couple of $1,000,000 of non recurring expense in the Q4 of 2016 that we won't have going forward. And so you probably if you want to look at on a run rate basis, you want to back out a couple of $1,000,000 for that as well. Okay.
I guess then on expenses overall for Linda maybe, in the past you guys have and this has kind of been asked a little bit, but in the past you guys have given us a sense of what you might have to kind of pull back on if things got choppy. Any sense of that level of flexibility would be for 2017?
Yes. I think I'd stick to what we said in 2016. We always tell you guys we can achieve $50,000,000 of expense savings and voila, we achieved $50,000,000 of expense savings. So there's probably another $50,000,000 in there across the company. I would note that we are being very thoughtful about expenses.
We note that both operating expenses and CapEx, CapEx is looking to be up about $100,000,000 as we go through 2017. We've had a little bit of lightening up in terms of our real estate projects. We've taken 2 floors in 1 World Trade Center in 2016. And as you know, we're making some investment in our technology, but we expect that to lighten up a little bit in 2017. So we're guiding to $100,000,000 as we had said.
So just across the board, we're just being really careful with what we're doing and considering every cost. We do have a procurement group that's done a really nice job in some of our expenses such as T and E. And we're managing very, very closely. So we'll think about maybe flexibility for another $50,000,000 for 'seventeen. Got it.
Okay.
Makes sense. Thanks a lot.
Next to Andre Benjamin with Goldman Sachs.
Thanks and good afternoon. I guess I wanted to come back to the ERS growth and the assumed deceleration in mid single digits from double digits the last 3 years. I know you called out the mix shift of going towards products away from services. One, I just want to confirm just for similar, I guess, offering that it the implication is that it's lower priced. So I just want to confirm if that's right for 1.
And then 2 is that how much of it is that versus just you being conservative the last couple of years? I think you've guided to mid single digits and put up something much healthier than that.
Yes. Andre, a couple of things. First, as Linda said earlier, she noted that trailing 12 month sales in ERS are up 4% and then she decomposed that. She said that product sales again, trailing 12 months, product sales are up 13% and services are down 16%. So if you just start with the trailing 12 month sales for ERS up 4%, that sort of flows through to our mid single digit revenue guidance for 2017, right, because we've got sort of the lag on revenue recognition.
So that's sort of how we get to the guidance. The mix shift again is designed to deliver more margin. I think you're right in talking about fees. You're right in the sense that over the last number of years, we've done some very large projects for customers where we charged many 1,000,000 of dollars for the services work that we did. So in that respect, that not doing projects of that scale and charging those kinds of fees for services we'll put some we'll put a bit of a drag on top line growth.
But we think that because the product is more mature, it is more scalable, it meets more needs for more customers, we think we'll be able to sell more. But I guess what I'm saying is we're going to make it up to some degree, we're going to make it up on volume. So we'll be able to as we get through this transition, we'll be able to get to a very a better growth rate over time. And then the other thing to keep in mind here is that decline, that 16% decline in services sales in 2016 was kind of a one time phenomenon. Our expectation is that we'll hold that line flat going forward.
So you won't see a big contraction there. We'll be holding that flat while the product line continues to grow at a double digit rate. So we'll think we're going to get to on balance, we'll get to a much healthier overall growth rate ERS, which is why I say it's healthy to think or helpful to think of 2017 as a transition year for the business.
Okay. That's helpful. And then I guess just a follow-up on the margin question that a couple other people asked. Definitely makes sense that you're getting more overhead. You've been talking about that for a while now.
It's just explicitly to make sure we model it right. Should we assume that margins for that business are up next year as you work through this transition? Or is getting to the mid-20s more back end loaded?
Well, again, we don't give specific margin guidance by line of business. But I will tell you again that if we were to you ignore the GGY acquisition, you ignore the additional overhead that we attracted in 2016, and if you ignore that couple of $1,000,000 that I mentioned, that non recurring expense that we had in the Q4, we would have seen over 100 basis points of margin expansion in MA from 'fifteen to 'sixteen. So and I would expect that trend to continue. Okay. Thanks.
We'll go next to Peter Appert with Piper Jaffray.
Thanks. Ray, what's left on the legal front?
Fortunately, not much. If we step back and look at all of the crisis era litigation, we've now disposed of better than 90% of what we were facing globally. So very little left in terms of numbers.
And then Linda, I understand their rationale in terms of lower pace of share repurchase in 2017. Should we anticipate then that in 2018 maybe you get back to more of the $1,000,000,000 kind of run rate you've been doing in recent years?
Peter, it's hard for us to guide that far ahead in terms of share repurchase. We do look at market conditions. We do want to reinvest in our businesses. And share repurchase oftentimes is sort of the last number that we look at given that we thought it was best to be prudent for this year. Yes, we would like to return to more vigorous share repurchase, but we're going to have to see.
It's too early to tell where that will go.
I think the fairest thing we could say looking out that far is we believe we would certainly have the capacity to do so, and we'd make those decisions near to date.
Got it. And then lastly, Rob, just on the trends in the structured finance market, which seems like it's basically come back to life. Any commentary in terms of changes you're seeing in the market that might give you more confidence in the sustainability volumes there? And any commentary on competitive dynamics? Because it does seem like there is more competitive pressures in that market than you see elsewhere.
Thanks.
Yes. Maybe I'll focus primarily on the U. S, obviously the largest market. So in the ABS sector, got off to a bit of a subdued start as folks were still adapting to the Reg A B2 loan level reporting requirements. But the pipeline is certainly heating up and activity is heating up in February on some very strong demand there.
In terms of CMBS, we saw a very weak start. That was due to a pull forward of deals from the risk retention deadline at the end of the Q4 of 'sixteen. I would say that CMBS hasn't weathered risk retention quite as well as the CLO market. So we've only seen 2 risk retention compliant deals get printed since the deadline at the end of December. That said, there is a pipeline building in CMBS.
And then CLO, we've seen some very strong issuance continuing into the Q1 of 'seventeen. So obviously, you saw in our results there was a very strong issuance in the Q4 due to a real pull forward from 2017 into '16 in advance of that risk retention deadline. I would note that much of the early volume in the Q1 in CLOs is refi as spreads have come in. We are starting to see some new CLO formation come into the March pipeline as CLO the CLO market seems to have found some structures that work within the risk retention framework. Just in terms of from a competitive standpoint, our coverage continues to be strong, and we actually have seen some nice gains in our coverage in Europe.
Thank you.
And we'll go to Tim McHugh with William Blair and Company.
Yes, thanks. Just on the margin question, obviously, 2017 is better, I guess. Are you finding things that you didn't expect? Or are we seeing some of the expected margin expansion that you talked about at the Investor Day in terms of the path towards 45% just come faster than you would have otherwise expected?
Yes. I think it's a couple of things. We have taken actions in 2016 that were somewhat accelerated against our original expectations and we're getting the benefits of those. We've also got a little bit, as you might imagine, better position on the legal side now than we had last year. We are still anticipating that we can move to the mid-40s percent margin.
Overall, again subject to the mix of the 2 different businesses. But so yes, you've got an acceleration of what we were identifying earlier in the year last year. Linda, I don't know if there's anything else you wanted to add
to that. Yes. We're very pleased with the progress we made in 2016. I think we even surprised ourselves, frankly, Tim. We did a $12,000,000 restructuring charge.
The genesis of that was split sort of half and half between the rating agency and shared services. We're being very careful with what we're doing in headcount. And in shared services, we're very thoughtful about our use of lower cost
locations and those are our
own employees that we're using in down and we're very happy about that and we're being really careful about what we do going forward. So I think it's good housekeeping and Ray and I encouraged our colleagues to think hard about the margin line and everybody really got the message and did a great job and we expect that that will continue. We run the business in a very disciplined way. We've been very careful in terms of adding new headcounts and even backfilling. So we're pleased with what we're seeing and we're doing a little bit better than we even thought.
So very happy with all that. There's no magic to it. It's just day to day hard work and good discipline.
Okay, great. Thanks. And just a follow-up on the tax benefits from the new stock comp rules, I guess. Is that caused more seasonality in the tax rate that we should expect? Because I know there's timing differences sometimes and when you'll recognize the benefit associated with that part of it.
I don't know if the UK rule has similar.
Yes, sure. So the U. S. Rule probably will see seasonal effects and we've estimated about $0.15 but there are a number of factors that go into that which could move around. So we would urge everybody to think about that as an approximation.
A lot of that might come into the Q1 when our restricted stock awards vest. And there are a bunch of factors there. One is, what is the exercise price? 2nd is, what is the pace of that exercise pricing, the timing, the number and any number of other factors. So we would expect that that effect might be heavier in the Q1, particularly given very happily where the stock price is right now.
So we'll see how that lays out. This is new to us and we'll give more information as we see what we get in the Q1.
Okay. Thank you.
And we'll go next to Craig Huber with Huber Research Partners.
Great. Thank you. I have just a broad question on the tax policy potential changes we heard out of Washington. If they do get rid of interest expense deductibility in the U. S.
As part of overall tax reform, is your guys base case that would hurt potentially high yield issuance much more so than investment grade issuance? That's my first question.
I think it would probably have more of an impact on high yield. Again, though, just trying to weigh the puts and takes on that, it's also high yield companies that are going to probably want to take most advantage of having additional cash on hand. And so that gives them more flexibility. It might cause them to engage in different behaviors, whether it's from an M and A standpoint or business expansion. So I do think the premise of your question probably leans against high yield more than it leans against investment grade, but there's pluses and minuses in both cases.
And then Ray, I assume you'd say that probably even more so if the interest expense deductibility was limited to only up to 30% of EBITDA, similarly you talked about in the UK, I guess Germany has as well as opposed to getting rid of the 100%.
Yes. And again, it's there's what it does in an absolute sense, but then it's also relatively what is still the more or less attractive ways to raise capital. And so even if it's less attractive, if it's still the most attractive, you expect firms would make rational economic decisions.
And then Ray, as a follow on to that, if you just isolate, I know this is hard, but if you just isolate, if the corporate tax rate of the U. S, federal rate goes from 35% to 15% or 20% or thereabouts, what is your general sense on what that could do to debt issuance in terms of I mean, obviously, it should be more pro growth out there.
So what
do you think it would do from debt issuance from an M and A perspective and investing back in companies, etcetera? Yes. I To debt issuance?
I mean, I don't have a quantification of that for you, Craig. But again, the pluses and minuses that we've outlined in a couple of our comments throughout the call indicate that we don't expect dramatic change in what is happening around our business. But it's going to have some impact, whether it's at 15% or 20% or 25%, and we're just going to have to see.
Linda, a couple of quick housekeeping questions. What maybe I missed this, what percent of your cash hoard is outside the U. S. Right now, if you would please?
78% is offshore now, Craig. The numbers are U. S. Is roughly $500,000,000 International is roughly $1,700,000,000 That totals to 2 $200,000,000 a little bit more, but 78% overseas. And that's because we used some of the U.
S. Cash as we dealt with the DOJ situation. But as we noted, the very vast majority of the settlement payments have already been made.
And as has been the case in the past, a substantial fraction of our foreign cash is also held in U. S. Dollars.
Okay. And then lastly, Linda, if I could just ask, just given the concerns ongoing concerns around Brexit, for your ratings business, was your revenues out of the U. K. For full year 2016 roughly 7%, 8% of your ratings revenue again? Is that a fair number to think about?
Offshore offhand, excuse me, Craig, I'm not certain. We're sort of puzzling and looking at Rob to see if he has any further information.
Yes, it's not as straightforward as you might hope, Craig, because we do both UK entity based ratings out of the UK, but we also do European based ratings, EU based ratings out of the UK. And so, and the companies that are issuing into the EU may be followed from any one of a number of offices. So both how the revenue gets apportioned and then how the expense base supporting that revenue gets apportioned are subject to some interpretations of what's in and what's out. The U. K.
Is not a large part of our overall European business, but I don't have a fraction I can give you.
Okay. Thank you. And we'll go next to Jeff Silber with Bank of Montreal.
Hey, good morning, guys. It's Henry Chien calling for Jeff. I just had a question on MIS. Just curious from a commercial sales perspective now with the business stabilizing, are there any new markets or geographies that you're looking at to potentially expand your coverage in?
Yes. In terms of markets that we are looking to expand in, we have been active, as you have seen in emerging markets, including India, increasing our stake in Korea. Growing business coming out of China has been growing very nicely. With the liberalization that is being proposed and discussed in the Chinese market, we would anticipate that that should create some opportunities. We've also been concentrating on building out the business in Latin America and Middle East.
So Rob, I don't know if there's anything else you wanted to add to that.
Yes, we opened an office last year in Sweden. So we've been building out a presence as well in the Nordic region.
Got it. Okay. Yes, that's helpful. And just on MIS, just as a follow-up. In terms of the different products, I'd say, are there any margin changes when one sort of increases as a percentage of the whole, let's say like structured increases as a percentage?
Does that sort of impact the margins of the business?
Business? The margins in the MIS business for all of the fundamental areas are roughly the same. The structured finance margin is more variable. It's a more transactionally oriented business. And so in periods of high volume, you get higher margins and low volume, lower margins.
It's also susceptible to how intense the monitoring activity has to be in periods of greater stress. There is greater allocation of resource to having to be on top of the monitoring, simply because in periods of stress, there are more assets that have to be scrutinized more closely. And so you get some swings there as well. So that's the only line of business that I would say has substantial variability in margin.
Yes. The monitoring for the structured or just overall?
Monitoring for structured in particular, because of the large number of assets that underlie those pools.
Got it. Okay, great. Thanks so much.
And we'll go next to Patrick O'Shaughnessy with Raymond James.
Hey, good afternoon. A quick CLO question for you. Does the CLO refinancing create the same sort of revenue opportunity for you guys as a CLO issuance?
No, new issuance would be a higher revenue opportunity than refi.
Got it. And then follow-up question. The acquisition that you just announced the other day, this structured finance data and analytics of SCDM, is that going within research data and analytics? And if so, can you talk about how much of the high single digit revenue growth the target for that segment in 2017 is going to come from the acquisition?
The answer to your first question is yes, it is part of our DNA, but it is a very, very small acquisition. I mean, it's a good acquisition. It makes a ton of sense. We've done this a number of times before where we've acquired businesses, where in this case, we didn't acquire any people. We essentially bought a product that is very similar to an existing product of ours.
We're going to transition their customers from the legacy product to our product. So essentially we bought that business without buying any expense frankly that would come along with it. So it's I think it's a very good transaction for us, but it is honestly, it's tiny. Yes. It's strategically, it's a nice fit, but it's not going to turn the dial on financial performance for RD and A in 2017.
Got you. So smaller than the GGY acquisition of last year?
That's correct. Significant.
Okay, great. Thank you.
And we have no further questions at this time. I'd like to turn the conference back over to Mr. Ray McDaniel for closing comments.
Okay. Thank you all for joining the call today and we look forward to speaking with you again after the Q1. Thanks.
This concludes Moody's 4th quarter fiscal year end 2016 earnings call. As a reminder,