Good day, and welcome, ladies and gentlemen, to the Moody's Corporation 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 Salli Schwartz, Global Head of Investor Relations. Please go ahead.
Thank you. Good morning, everyone, thanks for joining us on this teleconference to discuss Moody's second quarter results for 2012. I am Salli Schwartz, Global Head of Investor Relations. Moody's released its results for the second quarter 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. Raymond 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 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 31st, 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 Raymond McDaniel.
Thank you, Salli. Good morning, thank you to everyone for joining today's call. I'll begin by summarizing Moody's second quarter 2012 results. Linda will follow with additional financial detail on 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. Second quarter revenue of $641 million increased 6% over the prior year period, reflecting solid growth in public finance and structured finance, as well as continued strong results from Moody's Analytics. Expenses for the second quarter were $362 million, an 8% increase from the second quarter of 2011. Operating income for the second quarter was $279 million, a 3% increase from the prior year period.
Diluted earnings per share of $0.76 for the second quarter decreased $0.06 from the prior year period, which had included a $0.06 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-$2.72, and still expect to be toward the upper end of the range. Turning to the year-to-date performance, revenue for the first six months of 2012 was $1.3 billion, a 9% increase from the first half of 2011. Expenses were $740 million, up 12%, and operating income of $548 million increased 5% from the prior year period.
Diluted earnings per share of $1.52 for the first half of 2012 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 Investors Service for the first six months of 2012 was $894 million, an increase of 5% from a year ago. Moody's Analytics revenue of $394 million was 19% higher than the prior year period. 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 quarter increased 6%, $641 million. U.S. second quarter revenue increased 9% to $344 million, while revenue outside the U.S. grew 2% to $297 million and represented 46% of Moody's total revenue, down slightly from 48% in the year ago period. Recurring revenue of $338 million represented 53% of the total, up from 51% in the prior year period. Looking now at each of our businesses, Moody's Investors Service revenue for the quarter was $441 million, 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 second quarter declined 4% from the year ago period to $192 million. 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 second quarter was $91 million, 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 securities. International structured finance revenue was down 9%, reflecting issuance declines in European covered bonds and asset-backed securities. Global financial institutions revenue of $78 million decreased 2% from the same quarter of 2011.
U.S. revenue was essentially flat as compared to the second quarter of 2011, while non-U.S. revenue was down 3%.
Global revenue for the Public, Project and Infrastructure Finance business rose 12% year-over-year to $81 million. 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 for Moody's Analytics of $200 million was up 19% from the second quarter of 2011. Slightly more than half of growth was from the late 2011 acquisitions of Copal Partners and Barrie & Hibbert. Excluding the impact of foreign currency translation, revenue grew 21%. U.S. revenue grew by 23% year-over-year to $86 million. Non-U.S. revenue increased by 18% to $114 million and represented 57% of total Moody's Analytics revenue. Globally, revenue from research, data, and analytics of $121 million increased 9% from the prior year period and represented 61% of total MA revenue.
We continue to see demand for credit research via our CreditView offering and solid growth in data licensing arrangements. Revenue from Enterprise Risk Solutions of $52 million grew 24% from last year, reflecting the December 2011 acquisition of Barrie & Hibbert and growth in the base business. Due to the variable nature of project timing, Enterprise Risk Solutions revenue remains subject to quarterly volatility. Professional services revenue grew 84% to $27 million, reflecting the acquisition of a majority stake in Copal Partners in November 2011. Turning now to expenses. Moody's second quarter expenses were $362 million, an increase of 8% compared to second quarter 2011, or a 10% increase excluding the impact of 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%, down from 44.6% in the second quarter of 2011. Our effective tax rate for the quarter was 33.6%, compared with 27.8% 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 second quarter of 2012, Moody's repurchased 2.7 million shares at a total cost of $100 million and issued 0.3 million shares under employee stock-based compensation plans. Shares outstanding as of June 30th, 2012 totaled 222.3 million, representing a 3% decline from a year earlier.
As of quarter end, Moody's had $800 million of share repurchase authority remaining under its current program. We still expect full-year 2012 share repurchases of approximately $200 million subject to available cash, market conditions, and other ongoing capital allocation decisions. As of June 30th, 2012, Moody's had $1.2 billion of outstanding debt and $1 billion of additional debt capacity available under our revolving credit facility. Cash and cash equivalents were $824 million as of June 30th, 2012, a decrease of $114 million from a year earlier. Approximately 85% 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. 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 publish its feasibility study on establishing an alternative system for allocating rating assignments for structured finance products by about the same time. Both banking and securities regulatory authorities continue to assess their use of ratings and regulation and are in the process of developing potential alternative measures as replacements. Turning to Europe, 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 III, 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 III would likely have significant negative implications for Europe's credit markets. Consequently, the debate among public policymakers in the private sector has focused on CRA III'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 and Council of Finance Ministers of the individual EU member states each produce its own version of the text and then enter into discussions with the Commission.
During these discussions, the three institutions seek to resolve any differences among their respective drafts. Once a compromised document is produced, it's put to a vote. In May and June of 2012, the Council and the Parliament respectively finalized their positions on CRA III. We expect the necessary compromise discussions to continue through the autumn months and for CRA III 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 align with the G20 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, business investment spending, merger and acquisition activity, consumer borrowing and securitization, and the amount of debt issued. There is an important degree of uncertainty surrounding these assumptions, especially as they relate to Europe. 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 of quarter exchange rates. As I mentioned earlier, we are reaffirming our 2012 EPS guidance range of $2.62-$2.72, still expect to be toward the upper end of the range. While we have reaffirmed our EPS guidance, certain components of 2012 guidance have been modified to reflect our current view of credit market conditions.
For Moody's overall, the company still expects full year 2012 revenue to grow in the low double-digit % range. Full year 2012 expenses are also still projected to increase in the low double-digit % range. Full year 2012 operating margin is still projected to be approximately 39%, including the full-year impact of our fourth quarter 2011 acquisitions. Our effective tax rate is still projected to be approximately 33%. As Linda mentioned earlier, we still expect full year 2012 share repurchase of approximately $200 million subject to available cash, market conditions, and other ongoing capital allocation decisions. Capital expenditures are still projected to be approximately $60 million-$70 million. We still expect approximately $100 million in depreciation and amortization expense. Incremental compliance and regulatory expense is still projected to be in the $10 million-$15 million range.
For the global MIS business, revenue for full year 2012 is still expected to increase in the mid to high single-digit % range. Within the U.S., MIS revenue is still expected to increase in the low double-digit % range, while non-U.S. revenue is still expected to increase in the low single-digit % range. Corporate finance revenue is now projected to grow in the high single to low double-digit % range. 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 expected to increase in the mid-teens % range. For MA, full year 2012 revenue is still expected to increase in the high teens % 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 % range. Revenue growth is still projected in the mid-single digit % range for research data and analytics, and in the low 20s % range for Enterprise Risk Solutions, reflecting the December 2011 acquisition of Barrie & 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, joining us for the question and answer session is Michel Madelain, President and Chief Operating Officer of Moody's Investors Service, and Mark Almeida, President of Moody's Analytics.
We'd be pleased to take any questions you might have.
Thank you. If you would like to ask a question, please signal by pressing the star key followed by the digit 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star 1 to ask a question. We'll go first to Peter Appert with Piper Jaffray.
Thanks. Good morning. Ray, just a couple of follow-up questions starting out on the regulatory environment. What's your thought in terms of the move to replace ratings in regulations in terms of the implications of that? Are you seeing any changes in the portion of debt securities that are issued that are rated versus not rated? That was part 1. Part 2, with regard to CRA III, 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. Frankly, the progress on that has not been particularly strong in my view. There have been probably as many changes in the use of ratings and regulation that would seek to increase the use of ratings as there are to decrease the use. 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 procyclicality that's associated with this, and we do have some views on how that can be done. 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. With respect to liability, yes, we are paying close attention to the discussions in Europe around liability, 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.
Again, there are ways for us to mitigate those risks, but we have to wait and see what the final conclusions are after these three-party discussions that go on in the fall.
You're assuming, right, that there will be higher level of liability in the final version of this thing?
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.
Specifically, though, are you seeing a change in the percentage of publicly issued debt securities that are rated versus unrated?
No. Except to the extent that there are 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. For both the existing issuer base and for most of the new issues that are coming to market, we continue to provide very comprehensive coverage.
Mm-hmm. Okay. Linda, one other thing. Could you just talk a little bit about the pipeline in terms of what you guys are seeing currently in terms of issuance? On the cost dynamics, the cost growth slowed considerably on a year-to-year basis in the second quarter versus the first. What's the differential?
Sure. Peter, let me take the pipeline question first. The information that I'm quoting here is coming from Morgan Stanley. Let me talk first about investment-grade.
Oh, how insulting that you're quoting them.
Sorry about that. Investment-grade issuance first, Peter, then high yield. Year-to-date investment grade volume here in the U.S. is $512 billion, which is up 6% from 2011. First-half volume, $469 billion. It's the largest first half on record, 5% more than the first half of 2008, which was a recent high, and 6% more than the first half of 2011. The month-to-date volume has been $51 billion and close to the July 2010 record amount of $59 billion. We may surpass 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 10-year's at 1.42, so we're sort of back to Eisenhower levels long-term rates. That is helpful to the pipeline. On high yield, year-to-date volume is $187 billion. That's down 13% versus 2011.
The first half volume is $162 billion, which is down 25% from the first half of last year. Leveraged loans year-to-date volume, $136 billion, which is down 30% from 2011 year-to-date. First half volume was $123 billion, which is down 31% from the first half. High yield market is grinding tighter. We saw a little bit more activity recently. The pipeline seems to be pretty well constrained right now, looking at about $10 billion of visible high yield issuance in the pipeline and $13 billion in leverage loans in the pipeline. Again, that's one view. You're going to see a little bit of movement, depending on who you source for information. Generally, again, high yield pipeline limited, investment-grade pipeline pretty strong. On cost, Peter, you're correct. We did move down from the first quarter to the second quarter.
A couple of things going on there. The first quarter had some unusually high expenses in it. Our big comp quarter is the first quarter, and the second quarter had some reductions in that. First quarter obviously was stronger, so we had higher incentive compensation amount, and the second quarter was a little bit more reasonable. 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.
It seems like debt issuance in Europe looked pretty weak in the second quarter year-over-year, and I think European MIS revenues were down about 5%, which seems rather stable. Can you maybe just talk about what are some of the drivers behind this trend that you guys saw in the revenues in Europe in MIS?
Sure. Yes, Europe was softer in the second quarter. There were a number of lines that saw year-on-year quarterly decreases. This was mitigated by the fact that 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. 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.
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. That is transaction-based revenue for the most part.
Okay. In terms of the structured finance products, can you just talk about the profitability of those deals? Are they higher than from the corporate side?
It's similar. There are not market differences in profitability, subject to cyclical upturns and downturns. We have a downturn in structured finance and an upturn in another area that obviously will be more profitable. Looking through those cycles, I wouldn't identify any significant differences.
Okay. Just have one more on the expense side. I think from the first quarter, you mentioned you spent some ramp in expenses throughout the year to the tune of about $40 million. Is that still your expectation, looking at the full year now? If so, just wondering how much flexibility you have in that, just because it seems like in the second quarter, you weren't able to manage expenses down quite a bit.
Right. Jen, it's Linda. Let me talk about the back half of the year as compared to the first half of the year. Let me start by saying that we don't give quarterly guidance, 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 year, 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. The split on that we're thinking is about 52% first half, 48% back half. We do, at this point, expect revenue in the second half of the year to be a little bit slower. On the expense side, you're right.
We had talked about a $40 million ramp coming off our $377 million first quarter expense number. We did do better in the second quarter. We do expect $40 million expense ramp from that $377 million as we get to the fourth quarter. Obviously, that would result in a tick-up in expenses in the third quarter and another move up in the fourth quarter. 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, they are changes to existing systems which have to be expensed as opposed to building new systems, which are, of course, capitalized.
Yes, we expect the continued expense ramp. We expect that revenue may weaken a bit. Traditionally, our pattern has been that the third quarter is the most challenged on the revenue side. That might make for a little bit of a tougher situation in the third quarter. That's how we see it laying out at this point.
Okay. Thank you.
As a reminder, it is star one to signal for a question. We'll go next to Craig Huber with Huber Research Partners.
Yes. Hi, thank you. First couple cost questions. What was incentive compensation expense in a quarter?
Sure, Craig. I think it's $27.5 million.
It's basically flat with the first quarter, correct?
That's right. Last year, just interestingly, Craig, last year we had a different pattern. Last year we had in first quarter $29.4 million and ramping up to $35 million in the second quarter because, of course, second quarter was very strong last year. As you said, this year, $27.5 is flat first quarter to second quarter.
Also back on the overall second quarter cost. Remembering your remarks from three months ago about how you thought the cost pattern would go, also looking at history here, based on what I can see here, over the last 10 plus years, you've never had a quarter where costs in the second quarter were down from the first quarter like we had here sequentially. What changed in your mind versus your original budget you talked about three months ago that costs are actually down versus the first quarter?
Sure. Of course, we're looking to accrue incentive compensation based on how we do against our forecast. In the first quarter, we put up heavier incentive compensation view because we had a greater amount of completion. In the second quarter, that was a little bit lighter. We also had some other issues involving FX, which were a little bit better for us in the second quarter. 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. 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. I think those would be the main drivers. I'd ask Ray if he had any further comments he'd like to make about that.
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 as much as it's explained by Q2 because we did have the higher incentive accruals in the first quarter 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.
Yeah. No, exactly.
Okay. Then let me ask some questions here. Within your four main segments within ratings, can you break out, if you would, Linda, the transaction % versus non-transaction across the four segments, please?
Sure. For Corporates, Craig, we'll do as usual, transaction first and relationship second. For CFG, we're running 70/30 transaction relationship. Structured is 57/43. FIG is 35/65. PPIF is 62/38. Total for the rating agency is 60/40. MA is the reverse, 20% transaction revenue and 80 relationship. Total for MCO is 47 transaction and 53 relationship.
Also breaking out the revenues differently. Could you do the similar percentages like within corporate finance, high yield bank loans, investment grade, and then that monitoring CP, medium-term notes, do that for all four segments?
Yeah, sure.
Thanks.
Starting with corporate finance, Craig Huber. The total number for corporate finance dollar amount for the second quarter is $191.5 million. Investment grade made up 22% of that revenue in the second quarter. High yield made up 17% of the revenue, bank loans 18%, and other accounts 43%. Going on to FIG revenues, a total amount of $77.8. Again, FIG is pretty consistent quarter-over-quarter. Banking, 67% of that revenue, insurance 27%, and managed investments 7%. Going on to PPIF, the total number was $81.2 million, and 54% of that came from public finance and sovereigns. Again, that was an increase from what we usually see. Munis at 6%, project and infrastructure at 40%, and again, $81.2 million was the total. I think we missed structured. Total number of $90.7 million. Asset-backed securities, 32% of that. Residential mortgage-backed securities, 24%, commercial real estate 20%, and derivatives 24%.
Great. Thank you.
We'll go next to Douglas Arthur with Evercore.
Yeah, Ray, just on amplifying on international trends. If Europe stays choppy for the balance of the year, can you talk about trends outside of Europe in emerging markets, Asia, Latin America, and how if those strengthen or continue to be strong or how significant that could be to your MIS international revenues?
Sure. We are expecting the international business outside of EMEA to be relatively stronger than Europe or EMEA. 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. Frankly, that's a tough call to make. We think that other international is 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. I will ask Michel Madelain 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. We see that as much more stable and robust than we see the choppiness we see in Europe today.
Yeah.
Can you put a ballpark range around the scale relative to Europe?
Yeah. Of overall Moody's Corporation business, Europe represents about 30%, 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 Raymond 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 12th 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 website, ir.moodys.com. Thanks a lot for joining the call today, and we look forward to seeing many of you in September.
This concludes Moody's third quarter earnings call. As a reminder, a replay of this call will be available after 4:00 P.M. Eastern Time on Moody's website. Thank you.