Good day, and welcome, ladies and gentlemen, to the Moody's Corporation's Second Quarter 2012 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 Sallie Schwartz, Global Head of Investor relations. Please go ahead.
Thank you. Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's 2nd quarter results for 2012. I am Sally Schwartz, Global Head of Investor Relations. Moody's released its results for the Q2 of 2012 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, President 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 towards 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, 2011, 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 2nd quarter 2012 results. Linda will follow with additional financial detail and operating highlights. I will then speak to recent regulatory developments and finish our comments with our outlook for 2012.
After our prepared remarks, we'll be happy to respond to your questions. 2nd quarter revenue of $641,000,000 increased 6% over the prior year period, reflecting solid growth in public finance Structured Finance as well as continued strong results from Moody's Analytics. Expenses for the 2nd quarter were $362,000,000 an 8% increase from Operating income for the 2nd quarter was $279,000,000 a 3% increase from the prior year period. Diluted earnings per share of $0.76 for the 2nd quarter decreased 0 point 0 $6 from the prior year period, which had included a favorable tax impact related to a foreign tax ruling and a $0.03 legacy tax benefit. Though market conditions remain volatile, We are reaffirming our 2012 EPS guidance range of $2.62 to $2.72 and still expect to be toward the upper end of the range.
Turning to the year to date performance, revenue for the 1st 6 months of 2012 was $1,300,000,000 a 9% increase from the first half of twenty eleven. Expenses were $740,000,000 up 12 percent and operating income of $548,000,000 increased 5% from the prior year period. Diluted earnings per share of $1.52 for the first half of twenty twelve increased $0.03 from the prior year period, which again had included a $0.06 favorable tax impact related to a foreign tax ruling and a $0.03 legacy tax benefit. Revenue at Moody's Investor Service for the 1st 6 months of 2012 was $894,000,000 an increase of 5% from a year ago. Moody's Analytics revenue of $394,000,000 was 19% higher than the prior year period.
I'll now turn the call over to Linda 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 quarter increased While revenue outside the U. S. Grew 2 percent to $297,000,000 and represented 46% of Moody's total revenue, down slightly from 48% in the year ago period.
Recurring revenue of $338,000,000 represented 53% of the total, up from 51% in the prior year period. And looking now at each of our businesses, Moody's Investor Service revenue for the quarter was $441,000,000 about flat to prior year period. Foreign currency translation unfavorably impacted MIS revenue by 3%. U. S.
Revenue for MIS increased 5% over the prior year period, while revenue outside the U. S. Decreased 5% and represented 42% of total ratings revenue. Global Corporate Finance revenue in the 2nd quarter declined 4% from the year ago period to $192,000,000 Revenue was down 4% year over year, both inside and outside the U. S.
The decline in Global Corporate Finance revenue reflected weaker speculative grade bond and bank loan issuance against a near record prior year period. Investment grade issuance for non financial corporates was higher year on year, reflecting continued historically low borrowing rates. Global structured finance revenue for the Q2 was $91,000,000 5% above prior year period. In the U. S, revenue increased 22% year over year, primarily due to strength in ratings of collateralized loan obligations and asset backed International structured finance revenue was down 9%, reflecting issuance declines in European covered bonds and asset backed securities.
Global Financial Institutions revenue of $78,000,000 decreased 2% from the same quarter of 2011. U. S. Revenue was essentially flat as compared to the Q2 of 2011, while non U. S.
Revenue was down 3%. Global revenue for the Public Project and Infrastructure business rose 12% year over year to $81,000,000 Revenue was up 19% in the U. S, primarily due to gains in ratings for regional governments and higher education, while non U. S. Revenue declined 3%.
Turning now to Moody's Analytics. Global revenue from Moody's Analytics of $200,000,000 was up 19% from the Q2 of 2011. Slightly more than half of the growth was from the late 2011 acquisitions of Copel Partners and Berry and Hibbard. Excluding the impact of foreign currency translation, revenue grew 21%. U.
S. Revenue grew by 23% year over year to 8%. Non U. S. Revenue increased by 15% to $114,000,000 and represented 67% of total Moody's Analytics revenue.
Globally, revenue from research, data and analytics of $121,000,000 increased 9% from the prior year period and represented 61% of total MA revenue. We continue to see demand for Credit research via our credit view offering and solid growth in data licensing arrangements. Revenue from Enterprise Risk Solutions, dollars 52,000,000 grew 24% from last year, reflecting the December 2011 acquisition of Barry and Hibbard and growth in the base business. Due to the variable nature of project Enterprise Risk Solutions revenue remains subject to quarterly volatility. Professional services revenue grew 84% to $27,000,000 reflecting of a majority stake in Copal Partners in November 2011.
Turning now to expenses, Moody's 2nd quarter expenses were 3 to foreign currency translation. Compensation expense accounted for over half of the year on year expense increase and was due to increased headcount from the acquisitions in late 2011 and from growth in our existing business. Incremental non compensation expense was driven by higher information technology expenses, supporting business growth and regulatory initiatives as well as purchase price amortization associated with acquisitions. Moody's reported operating margin for the quarter was 43.5 percent, down from 44.6 percent in the Q2 of 2011. Our effective tax rate for the quarter was 33.6% compared with 27.8 percent for the prior year period.
The increase in effective tax rate was primarily due to lower taxes in 2011, resulting from a favorable foreign tax ruling. Now I'll provide an update on capital allocation. During the Q2 of 2012, Moody's repurchased 2,700,000 shares at a total cost of $100,000,000 and issued 300,000 shares under employee stock based compensation plans. Shares outstanding as of June 30, 2012, totaled 222,300,000, representing a 3% decline from a year earlier. As of quarter end, Moody's had $800,000,000 of share repurchase authority remaining under its current program.
We still expect full year $200,000,000 subject to available cash, market conditions and other ongoing capital allocation decisions. As of June 30, 2012, Moody's had $1,200,000,000 of outstanding debt and $1,000,000,000 of additional debt capacity available under our revolving credit facility. Cash and cash equivalents were $824,000,000 as of June 30, 2012, a decrease of $114,000,000 from a year earlier. Approximately 85 percent of our cash holdings are maintained outside the U. S.
We remain committed to using our strong cash flow to create value for shareholders while maintaining sufficient liquidity. And with that, I'll turn the call back to Ray.
Thanks, Linda. I'll continue with an update on regulatory developments, first in the U. S. We continue to expect the SEC will adopt final rules relevant to nationally recognized credit rating agencies by year end 2012 and published its feasibility study on establishing an alternative system for allocating rating For structured finance products by about the same time. Both banking and securities regulatory authorities continue to assess Moody's was registered in the European Union in late October 2011 and our European operations are under the full examination and oversight authority of the European Securities and Markets Authority or ESMA.
As discussed on previous calls, in November 2011, The European Commission released new regulatory reform proposals for the rating agency industry, commonly referred to as CRA 3, that seek to address among other ideas the use of ratings and regulation, business models, competition, rotation of rating agencies and liability. If implemented as originally proposed by the commission, many believe CRA 3 would likely have significant negative implications for Europe's credit markets. Consequently, the debate among public policymakers and the private sector has focused on CRA3's potential damaging impact on the broader European economy and European issuers' access to debt markets. The European legislative process requires that the European Parliament During these discussions, the 3 institutions seek to resolve any differences among their respective drafts and once a compromised document is produced, put to a vote. In May June of 2012, the Council and the Parliament, respectively, finalized their positions on CRA 3.
We expect the necessary compromise discussions to continue through the autumn month and for CRA 3 to be finalized before year end 2012. It is still too early to assess what the likely outcome of these deliberations will be. As always, we will continue to advocate for globally consistent approaches that are in line with the G20's statements and directives. I'll conclude this morning's prepared comments by discussing our full year guidance. Moody's outlook for 2012 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 amount of debt issued.
There's an important degree of uncertainty surrounding these assumptions, especially as they relate to Europe. And if actual conditions differ from these assumptions, Moody's results for the year may differ materially from the current outlook. Our guidance assumes foreign currency translation at end quarter exchange rates. As I mentioned earlier, we are reaffirming our 2012 EPS guidance range of $2.62 to $2.72 and still expect to be toward the upper end of the range. While we have reaffirmed our EPS guidance, certain components of Full year 2012 operating margin is still projected to be approximately 39%, including the full year impact of our 4th quarter Our effective tax rate is still projected to be approximately 33%.
As Linda mentioned earlier, we still Full year 2012 share repurchase of approximately $200,000,000 subject to available cash, market conditions and other ongoing capital allocation decisions. Capital expenditures are still projected to be approximately $60,000,000 to $70,000,000 We still expect approximately $100,000,000 in depreciation and amortization Incremental compliance and regulatory expense is still projected to be in the $10,000,000 to $15,000,000 range. For the global MIS business, Revenue for full year 2012 is still expected to increase in the mid to high single digit percent range. Within the U. S, MIS revenue is still expected to increase in the low double digit percent range, while non U.
S. Revenue is still expected to increase in the low single digit percent range. Corporate finance revenue is now projected to grow in the high single to low double digit Revenue from each of structured finance and financial institutions is still projected to be flat to slightly up, while public project and infrastructure finance revenue is still For MA, full year 2012 revenue is still expected to increase in the high teens percent range. Within the U. S, MA revenue is now expected to increase in the high teens to 20% range, while non U.
S. Revenue is still expected to increase in the high teens percent range. Revenue growth is still projected in the mid single digit percent range for research, data and analytics and in the low 20s percent range for enterprise risk solutions, reflecting the December 2011 acquisition of Berry and Hibbert as well as growth in the base business. Professional services revenue is now projected to grow by approximately 75%, inclusive of revenue from the late 2011 acquisition of a majority stake in Copal Partners and growth in MA's existing Financial Training and Certification business. This concludes our prepared remarks.
And joining us for the question and answer session is Michel Madeline, President and Chief Operating Officer of Moody's Investor Service And Mark Ameda, President of Moody's Analytics, would be pleased to take any questions you might have.
We'll go first to Peter Appert with Piper Jaffray.
Thanks. Good morning. So Ray, just a couple of Follow-up questions starting out on the regulatory environment. So that what's your thought in terms of the move To replace ratings and regulations in terms of the implications of that, are you seeing any changes in the A portion of debt securities that are issued that are rated versus not rated. That was part 1.
And then part 2, with regard to CRA 3, The liability issue seems like it might be the bugaboo. What's your read on how that's going to play out? Thanks. Okay.
On the ratings and regulation or reliance on ratings, there have been efforts Both in the U. S. Under Dodd Frank and as part of some of the European proposals and discussions to reduce or eliminate The use of ratings and regulation, I think from prior calls, you know that we are very supportive of that. But Frankly, the progress on that has not been particularly strong in my view. And there have been Probably as many changes in the use of ratings and regulation that would seek to increase the use of ratings So, net net, I don't think there's been a lot of change.
If nothing else, What we would argue for is at least to reduce the mechanistic use of ratings and regulation. So it reduces some of the cliff risk or pro cyclicality that's associated with this and we do have some views on how that can be done. So As I said, we're supportive of the overall effort even if it has not made a lot of progress and we don't see it having a negative impact on our business. And then with respect to liability, yes, we are paying close attention to the discussions in Europe And obviously, we will accommodate our business to make sure that we have the maximum protections we can have Depending on what kind of liability regime the Europeans determine for our business. And there are Again, there are ways for us to mitigate those risks, but we have to wait and see what the final conclusions are After these 3 party discussions to go on in the fall.
So you're assuming right that there will be higher level of liability
I think there's a good chance that there will be. The question really is the degree and what we will do operationally to manage that risk back down.
And then specifically though, are you seeing a change in the percentage of publicly issued debt securities that are rated versus unrated?
No. It's I mean, except to the extent that there are So issues coming in domestic markets that might have previously not been issuers, That's where we have to make sure we continue to provide coverage. But for both the existing issuer base And for most of the new issues that are coming to market, we are providing we continue to provide very comprehensive coverage.
Okay. And then Linda, one other thing, in terms of could you just talk a little bit about the pipeline in terms of what you guys are seeing currently in terms of issuance? And then on Cost dynamics, the cost growth slowed considerably on a year to year basis in the Q2 versus the first. What's The differential.
Sure. Peter, let me take the pipeline question first. And the information that I'm quoting here is coming from Morgan Stanley. Let me talk first about investment grade.
How insulting that you're
quoting them.
Sorry about that. Investment grade issuance first seater and then high yield. Year to date, investment grade volume here in the U. S. Is $512,000,000,000 which is up 6% from 2011.
First half volume $469,000,000,000 It's the largest first half on record, 5% more than the first half of 2,008, which was a recent high and more than the first half of twenty eleven. The month to date volume has been $51,000,000,000 And close to the July 2010 record amount of $59,000,000,000 we may have surpassed that. The last week has been okay and the pipeline looks reasonably good. Right now, we have historically low interest rates. I just saw before coming up here the tenure is at 1.42, so we're sort of back to Eisenhower level Long term rate, so that is helpful to the pipeline.
On high yield, year to date volume is $187,000,000,000 that's down 13% versus 2011. The first half volume is $162,000,000,000 which is down 25% from the first half of last year. Leveraged loans year to date volume $136,000,000,000 which is down 30% from 2011 year to date. And first half volume was $123,000,000,000 which is down 31% from the first half. Now high yield market is grinding tighter.
We saw a little bit more activity recently. But the pipeline seems to be pretty well constrained right now, looking at about $10,000,000,000 of visible high yield issuance in the pipeline and 13,000,000,000 In leveraged loans in the pipeline. And again, that's one view. You're going to see a little bit of movement depending on who you source for information. But generally, again, high yield pipeline, limited investment grade pipeline, pretty strong.
Now on Cost, Kieran, you're correct. We did move down from the Q1 to the Q2. A couple of things going on there. The Q1 had some unusually high Our big comp quarter is the Q1, and the 2nd quarter had some reductions in that. 1st quarter, obviously, was stronger, so we had higher incentive compensation amount and the 2nd quarter was a little bit more reasonable.
And so that basically is the main driver of what's happened with the quarter over quarter expenses.
Got it. Thanks, Linda.
We'll go
next to Jennifer Wong with UBS.
Hi. Thanks for taking the question. So it seems like debt issuance in Europe Looked pretty weak in the Q2 year over year. And I think European MIS revenues were down about 5%, which seems Rather stable. So can you maybe just talk about what are some of the drivers behind the strength that you guys saw in the revenues in Europe in MIS.
Sure. Yes, Europe was Softer in the second quarter and there were a number of lines that saw Year on year quarterly decreases. But this was mitigated by the fact We do have a large number of frequent issuer pricing agreements in Europe, and those provide a steadier base of revenue. What we're missing though is the growth opportunity in Europe that comes from issuance and that's why we would look for Whether market tone and sentiment improves in the second half or remains as volatile and choppy as it has been in the first half Because that would bring more of the speculative grade credits to market and those are The credits that are less likely to be under frequent issuer pricing agreements and would increase our transaction based revenue. Also to the extent that there's a strengthening in market tone in Europe, I would expect that that's Going to be good news for structured finance issuance, so we would have to keep a close eye on that and that is transaction based revenue for the most part.
Okay. And then in terms of the structured finance products, can you just talk about the profitability of those deals? Are they still I mean, are they higher than on the corporate side?
It's similar. There are not market differences in profitability subject to cyclical upturns and downturns. And so we have a downturn in structured finance and an upturn in another area that obviously will be more profitable. But looking through those cycles, I wouldn't identify any significant differences.
Okay. And then just have one more on the expense side. So I think from the last from the Q1, you mentioned you expect some ramp in expenses throughout the year to the tune of about 40,000,000. Is that still your expectation looking at the full year now? And if so, just wondering how much Flexibility you have in that is just because it seems like in the second quarter, you weren't able to manage expenses down quite a bit.
Hi, Jen, it's Linda. Let me talk about the back half of the year as compared to the first half of the year. And let me start by saying that we don't give quarterly guidance, so you're going to have to do the math on some of this. On the revenue side, we expect that our revenue pattern will lay out approximately like it did last With our revenue coming in, with a balance toward the first half of the year with a little bit of weakening, toward the second half of the year. So The split on that we're thinking is about 52% first half, 48% back half.
So we do, at this point, expect Revenue in the second half of the year to be a little bit slower. Now on the expense side, you're right. We had talked about a $40,000,000 ramp coming off our $377,000,000 first quarter expense number. We did do better in the second quarter. We do expect $40,000,000 expense ramp from that $377,000,000 as we get to the 4th quarter.
And That would result in a tick up in expenses in the Q3 and another move up in the Q4. Now the reason for that is we have more headcount coming on In the second half of the year, we also have raises that come into play in the back half of the year And some other expenditures that we have to make in terms of IT, particularly to get ready for Dodd Frank compliance, Many of those are expensed items, so they are changes to existing systems, which have to be expensed as opposed to building new systems, which are, of course, capitalized. So yes, we expect the continued expense ramp. We expect that revenue may weaken a bit. And traditionally, our pattern has been that the Q3 is the most challenged on the revenue side.
So that might make for a little bit of a tougher situation in the Q3. So that's how we see it laying out at this point.
Okay. Okay. Thank you.
We'll go next to Craig Huber with Huber Research Partners.
Yes. Hi. Thank you. First couple of cost questions. What was incentive compensation expense in the quarter?
Sure, Craig. I think it's $27,500,000
So it was basically flat with the Q1, correct?
That's right. Now last year just interestingly, Craig, last year, we had a different pattern. Last year, we We had in Q1 $29,400,000 and ramping up to $35,000,000 in the second quarter because, of course, second quarter was very strong last year. So as you said, this year, dollars 27.5 is flat Q1 to Q2.
And then also back on the overall Q2 costs, Remember in your remarks from 3 months ago about how you thought the cost pattern would go and also looking at history here, based on what I can see here over the last 10 plus years, you've never Quarter where costs in the Q2 were down from the Q1 like we had here sequentially. What changed in your mind Your original budget, you talked about 3 months ago that costs are actually down versus the Q1.
Sure. Of course, we're looking to accrue incentive compensation based on how we do against our forecast. And in the Q1, we put out Heavier incentive compensation view because we had a greater amount of completion. For the Q2, that was a little bit lighter. We also had some other Issues involving FX, which were a little bit better for us in the Q2.
But generally, we are being careful with expenses. We're being careful with Hiring, we're being very thoughtful about how we're managing the business. And with the market outlook being as choppy as it is, we have to be very thoughtful about what we're doing and how we're doing it. So I think those would be the main drivers. And I'd ask Ray if he had any further comments he'd like to make
No. Just to emphasize that, I think part of the pattern that you're seeing that's different in Q1 to Q2 is really explained by Q1 1, as much as it's explained by Q2 because we did have the higher incentive accruals in the Q1 based on the strength of the markets At that time.
Versus your budget you're saying because it's the same number both quarters of course.
Yes. No, exactly, exactly. Okay.
And then let me ask some questions. Within your 4 main segments within Radiance, can you break out if you would lend to the transaction percentage Versus non transaction across the 4 segments, please?
Sure. For corporates, Craig, we'll do a digital transaction first and relationship second. For CFG, we're running seventy-thirty. Transaction relationship structured is 57.43. SIG is 35.65 and PPIF is 62.38.
Total for the rating agency is 60.40. MA is the reverse, 20 percent transaction revenue and 80 relationship. Total for MCO is 47 Transaction at 53 relationship.
And then also breaking out the revenues differently due to similar percentages like within corporate finance, high yield bank loans, That's been great in the net monitoring CP medium term notes below for all 4 segments.
Yes, sure. Starting with Corporate Finance, Craig, the total number for Corporate Finance Dollar amount for the 2nd quarter is $191,500,000 Investment grade made up 22% of that revenue in the 2nd quarter. High yield made up 17% of the revenue bank loans 18% and other accounts 43%. Going on to FIG revenues, total amount of $77,800,000 Again, FIG is pretty consistent quarter over quarter Banking, 67% of that revenue Insurance, 27% and Managed Investments, 7%. Going on To CPIF, the total number was $81,200,000 and 54% of that came from Public Finance and Sovereigns.
Again, that was an increase in what we usually see. Munis at 6%, Project and Infrastructure at 40% and again $81,200,000 was the total. And then I think we restructured Total number of $90,700,000 asset backed securities, 32 excuse me, 32 percent of that Residential mortgage backed securities, 24%, commercial real estate, 20% and derivatives, 24%.
Great. Thank you.
And we'll go next to Doug Arthur with Evercore.
Yes. Ray, just on amplifying on international trends. If Europe stays choppy for the balance of the year, can you talk about trends side of Europe and emerging markets Asia, Latin America and how if those Strengthened or continue to be stronger with how significant that could be to your MIS International revenues?
Sure. We are expecting the international business of EMEA to be relatively stronger than Europe or EMEA. And the concern will be the extent of any contagion from Europe and what that might do to business confidence and business expansion in other international markets. And Frankly, that's a tough call to make. So we think that other international It's going to perform reasonably well for the second half.
It is smaller than our European business, But it's subject to at least some of the choppiness and volatility risks that we see in Europe. And I will ask Michel Madeline if he has any additional comments he'd like to make on that. Thank you, Ray. No, I think the scale of the business obviously is quite different in Asia and Latin America compared to Europe. And But we see that as much more stable and robust than we see what the choppiness we've seen here have to say.
Can you put a ballpark range around the scale relative to Europe?
Yes. The Europe of overall Moody's Corporation business, Europe represents about 30% and Asia represents about half of that, Asia and Latin America.
Okay, great. Thank you.
Okay. That
concludes today's question and answer session. At this time, I will turn the conference over to Ray McDaniel for any additional or closing remarks.
Okay. Before we end the call, I just want to announce that Moody's will host its Investor Day on Wednesday, September 12 in New York City. Attendance is by invitation only and the event will be webcast and further details will be provided on our Investor Relations
This concludes Moody's 3rd quarter earnings call. As a reminder, a replay of this call will be available after 4 pm Eastern Time on Moody's website. Thank you.