Moody`s Corp (MCO) — Q3 2018 Earnings Call Transcript

Thank you. Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's' third quarter 2018 results, as well as our current outlook for full year 2018. I am Steve Maire, Global Head of Investor Relations and Communications. This morning, Moody's released its results for the third quarter of 2018, as well as our current outlook for full year 2018. The earnings press release and the 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 Mark Kaye, Moody's Senior Vice President and Chief Financial Officer. During this call, we will also be presenting non-GAAP or adjusted figures. Please refer to the table at the end of our earnings press release that was filed this morning for a reconciliation of GAAP to all adjusted and organic measures mentioned during this call. I call your attention to the safe harbor language, which can be found toward the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the Act, I also direct your attention to the Management's Discussion and Analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2017, and in other SEC filings made by the company, which are available on our website and on the SEC's website. These, together with the safe harbor statements, 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 will now turn the call over to Ray McDaniel.

Thank you, Steve. Good morning and thank you to everyone for joining today's call. Before we begin, I am pleased to welcome Mark Kaye to his first earnings call. Mark joined Moody's on August 20 as Senior Vice President and Chief Financial Officer. I'll begin by summarizing Moody's third quarter and year-to-date 2018 financial results. Mark Kaye will then follow with additional third quarter financial details and operating highlights. I will conclude with comments on our current outlook for 2018. After our prepared remarks, we'll be happy to respond to your questions. In the third quarter, Moody's revenue of $1.1 billion was up 2% from the third quarter of 2017. This result reflected strong growth for Moody's Analytics, partially offset by a decline at Moody's Investors Service as non-financial corporate debt issuance slowed versus the record level in the prior year period. Operating expenses for the third quarter of 2018 totaled $614 million, approximately flat to the prior year period. Operating income was $467 million, up 4% from the third quarter of 2017. Adjusted operating income of $514 million was up 3%. Foreign currency translation had an immaterial impact on operating income and adjusted operating income. The operating margin was 43.2% and the adjusted operating margin was 47.6%. Moody's diluted EPS for the quarter was $1.59 per share, down 2% from the third quarter of 2017. Adjusted diluted EPS for the quarter was $1.69, up 11%, and excluded $0.10 per share related to amortization of acquired intangible assets. Third quarter 2017 adjusted diluted EPS excluded a $0.23 per share foreign currency hedge gain and $0.12 per share related to amortization of acquired intangible assets and acquisition-related expenses associated with the Bureau van Dijk acquisition. Turning to the year-to-date performance, Moody's revenue for the first nine months of 2018 was a record $3.4 billion, up 11% from the prior year period. U.S. revenue was $1.8 billion, up 3%; and non-U.S. revenue was $1.6 billion, up 23%. Foreign currency translation favorably impacted Moody's revenue by 1%. Moody's Investors Service revenue of $2.1 billion was up 3% from the prior year period. U.S. revenue was $1.3 billion, up 1%; and non-U.S. revenue was $848 million, up 8%. Foreign currency translation favorably impacted MIS revenue by 1%. Moody's Analytics revenue was $1.3 billion, a 28% increase from the prior year period. U.S. revenue of $513 million was up 9% and non-U.S. revenue of $752 million was up 45%. Foreign currency translation favorably impacted MA revenue by 2%. Organic MA revenue for the first nine months of 2018, which included Bureau van Dijk revenue as of August 11, was $1.1 billion, up 9% from the prior year period. Moody's Corporation operating expenses for the first nine months of 2018 were $1.9 billion, up 12% from the prior year period. This growth was primarily driven by the inclusion of Bureau van Dijk operating expenses as well as incremental compensation related to salary adjustments and hiring, partially offset by lower accruals for 2018 incentive compensation awards. Foreign currency translation unfavorably impacted expenses by 1%. Operating income was $1.5 billion, up 10% from the first nine months of 2017. Adjusted operating income of $1.6 billion was up 11%. Foreign currency translation favorably impacted operating income and adjusted operating income by 2% each. Moody's operating margin was 44.1%, and its adjusted operating margin was 48.5%. The effective tax rate for the first nine months of 2018 was 21%, down from 29% in the prior year period. The decline was primarily due to lower U.S. statutory tax rate and net uncertain tax position benefits related to a statute of limitations expiration and audit settlement. Primarily due to our expectation for continued lighter debt issuance into the fourth quarter, we are reducing our outlook for full year diluted EPS to a range of $6.95 to $7.10 and adjusted diluted EPS to a range of $7.50 to $7.65. In response, we intend to undertake cost management activities, which will result in a fourth quarter restructuring charge of $30 million to $40 million, and an aggregate charge through the first half of 2019 of $45 million to $60 million. We expect this to result in savings of $20 million to $25 million in 2019, and the aggregate annualized savings of $30 million to $40 million thereafter. I'll now turn the call over to Mark to provide further commentary on our financial results and other operating updates.

Thanks, Ray. I'll begin by reviewing third quarter 2018 revenue at the company level. As Ray mentioned, Moody's total revenue for the third quarter was $1.1 billion, up 2%. U.S. revenue of $560 million was down 5%. Non-U.S. revenue of $521 million was up 10% and represented 48% of Moody's total revenue. Recurring revenue of $619 million was up 16% and represented 57% of total revenue. The impact of foreign currency translation on Moody's revenue was negligible. Looking now at each of our businesses, starting with Moody's Investors Service. Total MIS revenue for the quarter was $645 million, down 7%. U.S. revenue decreased 10% to $385 million. Non-U.S. revenue of $260 million was down 2% and represented 40% of total MIS revenue. The impact of foreign currency translation on MIS revenue was negligible. Moving to the lines of business for MIS, first, corporate finance revenue for the third quarter was $296 million, down 15%. This result primarily reflected the decline in U.S. investment grade and global high-yield bond issuance activity. U.S. and non-U.S. corporate finance revenues were down 21% and 4%, respectively. Second, structured finance revenue totaled $125 million, down 2%. This result reflected lower U.S. CMBS rated issuance, partially offset by new CLO formation in EMEA and the U.S. U.S. structured finance revenue was down 9% while non-U.S. revenue was up 13%. Third, financial institutions revenue of $120 million was up 17%, driven by strong issuance activity, primarily from M&A-related financing in the U.S. insurance sector. U.S. financial institutions revenue was up 48% while non-U.S. revenue was down 3%. Fourth, public, project and infrastructure finance revenue of $99 million was down 9%, and primarily reflected a decline in global infrastructure and project finance issuance. U.S. and non-U.S. public, project and infrastructure finance revenues were down 7% and 13%, respectively. Turning now to Moody's Analytics. Total revenue for MA of $436 million was up 18%. U.S. revenue of $175 million was up 9%. Non-U.S. revenue of $261 million was up 26% and represented 60% of total MA revenue. Foreign currency translation had an unfavorable impact on MA revenue of 1 percentage point. Organic MA revenue for the third quarter of 2018, which included Bureau van Dijk revenue as of August 11 was $399 million, up 8% from the prior year period. Moving now to the lines of business for MA. First, research, data and analytics, or RD&A, revenue of $283 million was up 29%. U.S. and non-U.S. RD&A revenues were up 9% and 50%, respectively. Organic RD&A revenue, which included Bureau van Dijk revenue as of August 11, was $246 million, up 13%, driven by strength in sales of credit research and rating data feed. Second, enterprise risk solutions, or ERS, revenue of $113 million, was approximately flat to the prior year period. This result reflected strong growth in loan origination solution and the timing of revenue recognition under the new revenue accounting standard, ASC 606, offset by the decline in software license revenue as the business transitions to subscription-based product. U.S. ERS revenue was up 9% while non-U.S. revenue was down 4%. Trailing 12-month revenue and sales for ERS increased 6% and 4%, respectively. At the end of the third quarter of 2018, trailing 12-month subscription sales were up 9% versus the prior year period while one-time sales, inclusive of perpetual licenses and service fees, were down 11%. During the same 12 month period, ERS revenue from subscriptions was up 11% and one-time revenue was down 6%. Moving on to Professional Services, third quarter revenue of $40 million was up 7%. U.S. and non-U.S. professional services revenues were up 11% and 5%, respectively. Turning now to operating expenses. Moody's third quarter operating expenses were $614 million, approximately flat to the prior year period. This result reflected the inclusion of Bureau van Dijk operating expenses as well as incremental compensation related to salary adjustments and hiring, offset by lower accruals for 2018 incentive compensation awards. Foreign currency translation favorably impacted operating expenses by 1%. On January 1, 2018, the company adopted the new ASC 606 revenue accounting standard using the modified retrospective approach. We continue to expect the impact of the adoption to be immaterial to Moody's Corporation revenue and expenses for the full year of 2018. As Ray mentioned, Moody's operating margin was 43.2% and the adjusted operating margin was 47.6%. Moody's effective tax rate for the quarter was 24.4%, down from 31.4% in the prior year period. The decline primarily reflected a lower U.S. statutory tax rate. The third quarter 2018 effective tax rate included an increase in uncertain tax positions related to non-U.S. tax matters, offset by a decrease related to the transition tax liability, each being approximately $65 million. Now I'll provide an update on capital allocation. During the third quarter of 2018, Moody's repurchased approximately 400,000 shares at a total cost of $66 million or an average cost of $174.33 per share. Moody's also issued approximately 100,000 shares as part of its employee stock-based compensation plan. Moody's returned $84 million to its shareholders via dividend payments during the third quarter of 2018. And on October 22, the Board of Directors declared a regular quarterly dividend of $0.44 per share of Moody's common stock. This dividend will be payable on December 12, 2018, to stockholders of record at the close of business on November 21, 2018. Year-to-date, Moody's repurchased approximately 900,000 shares at a total cost of $147 million or an average cost of $168.37 per share, and issued a net 1.5 million shares as part of its employee stock-based compensation plan. The net amount includes shares withheld for employee payroll taxes. Moody's also returned $253 million to its shareholders via dividend payments during the first nine months of 2018. Outstanding shares as of September 30, 2018, totaled $191.6 million, approximately flat to a year ago. As of September 30, 2018, Moody's had approximately $380 million of share repurchase authority remaining. At quarter-end, Moody's had approximately $5 billion of outstanding debt and approximately $975 million of additional borrowing capacity under its revolving credit facility. Total cash, cash equivalents and short-term investments at quarter-end were $1.1 billion, down 3% since December 31, 2017, with approximately 87% held outside of the U.S. As of September 30, 2018, Moody's ratio of net debt to trailing 12 month adjusted operating income was 1.8x, down from 2.2x as of December 31, 2017. This reflected execution of management's commitment to delever post the Bureau van Dijk acquisition. Cash flow from operations for the first nine months of 2018 was $1.1 billion, an increase from $350 million in the first nine months of 2017. Free cash flow for the first nine months of 2018 was $1 billion, an increase from $280 million in the prior year period. These increases in cash flow were largely due to payments the company made in the first quarter of 2017, pursuant to its 2016 settlement with the Department of Justice and various State Attorneys General. And with that, I will turn the call back over to Ray.

Thanks, Mark. I'd like to provide some highlights on our progress with Bureau van Dijk integration and synergy activities. We are just over a year into the Bureau van Dijk acquisition, and the business continues to perform well. The revenue growth is on track to meet our 2018 forecast, while the direct adjusted operating margin for the third quarter and year-to-date was in line with historical business performance at 49% and 44.3%, respectively. We are particularly pleased with Bureau van Dijk's very strong sales results. On an FX-neutral basis, sales were up 14% year-to-date, with 21% growth in the third quarter. This acceleration reflects strong demand for Bureau van Dijk's product and the synergies that we're realizing as we drive distribution of Bureau van Dijk data to more customers and more markets. Importantly, our success in this area positions us for better revenue growth as we move into 2019. I'll now discuss certain components of our full year guidance for 2018. A complete list of Moody's guidance is included on Table 13 of our third quarter 2018 earnings press release, which can be found at Moody's Investor Relations website at ir.moodys.com. Moody's outlook for 2018 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 assumes foreign currency translation at end-of-quarter exchange rates. Specifically, our forecast reflects exchange rates for the British pound of $1.30 to £1; and for the euro, of $1.16 to €1. Moody's now expects full-year 2018 diluted EPS to be $6.95 to $7.10, including the amortization of all acquisition-related intangibles of approximately $0.40. The expected restructuring charge of $0.10 to $0.15 and the acquisition-related expenses of $0.02 to $0.03. Excluding these items, adjusted diluted EPS is now expected to be $7.50 to $7.65. Before turning to the Q&A, I would like to provide a few updates on recent acquisitions, investments and initiatives. On August 20, we announced the closing of the acquisition of Omega Performance, a leading provider of online credit training serving over 300 customers, ranging from large global banks to local lending solutions. Omega Performance will enhance MA as a worldwide market standard in credit proficiency for financial institutions that offer consumers, small business, and corporate lending. On August 30, we announced a definitive merger agreement to acquire Reis, a leading provider of U.S. commercial real estate, or CRE, data and commenced a tender offer on September 13 to acquire all issued and outstanding shares of Reis common stock at $23 per share. The tender offer and acquisition were successfully completed on October 15. The Reis acquisition contributes to MA's development of a comprehensive suite of CRE data and analytics solutions, positioning MA to become a leading data and analytics provider in the U.S. commercial real estate market, bringing efficiency to CRE analysis and enhance capital flows. We're very excited to welcome our new Omega Performance and Reis colleagues to Moody's and work together to achieve the synergies and commercial opportunities we have identified. On October 15, Mona Breed joined Moody's as Chief Information Officer. Ms. Breed will enhance Moody's technology infrastructure and programs, as we enhance our technology capabilities and leverage our investments. And on October 17, we appointed Derek Vadala as global head of a newly-formed cyber risk analytics group in MIS. This group will develop MIS's capabilities for evaluating cyber risk as it relates to operational and credit risk. Earlier this week, we announced an investment in a fund managed by Team8, a leading cybersecurity think tank and incubator that further supports our cyber analytics initiative. Finally, we recently announced our selection of the inaugural list of partners for Reshape Tomorrow, our global program to help owners of small and growing businesses overcome the challenges of expanding their enterprises. For more information on the programs and partners selected, please see the CSR press release we issued on October 24 or visit moodys.com/csr. This concludes our prepared remarks. And joining Mark and me for the question-and-answer session are Mark Almeida, President of Moody's Analytics; and Rob Fauber, President of Moody's Investors Service. We'd be pleased to take any questions you may have.

Can you hear me?

Yes.

On the $30 million to $40 million of cost savings, where is it coming from and what's the timing around that?

Vince, thank you for the question. We have undertaken a careful review of our expense infrastructure to identify opportunities for efficiency. The cost management activities will primarily come from two separate and distinct areas. First, reducing, exiting, and/or subleasing certain real estate property; and second, a targeted reduction in headcount with an emphasis on streamlining our operations, eliminating redundancies, and meeting regulatory expectations. We anticipate that the restructuring charge of $30 million to $40 million in the fourth quarter of 2018 and the additional $10 million to $15 million in the first half of 2019 will result in an annualized pretax benefit of $30 million to $40 million once complete, and that the net pretax benefit for 2019 on a standalone basis is estimated between $20 million and $25 million.

Got it. And just to follow up, when we think about expenses, long term is there anything else you can do beyond that?

Yes. The business is actually undertaking a number of initiatives at the moment with respect to automation and technology to address costs. As we said before, we are first focusing on having the right people doing the right jobs in the right location. And since 2015, over half of our headcount adds have been at our support center in India. We have now opened our hub in Costa Rica and are working with other locations, specifically related to the MIS business. We are also investing in major programs, specifically in MIS, around the workflow system and analytics system that we believe can provide simplification around the MTN ratings process and add additional efficiency gains to our staff.

Ray, just I think in your comments, you talked about the slowdown that you expect in the fourth quarter to be temporary. And I was hoping you and maybe Rob could just elaborate on that a bit and just explain why you are confident that it's only temporary and not maybe the start of something?

Sure, I'll let Rob share his insights as well. I didn’t mention that the situation is temporary, but we are assessing various headwinds and tailwinds. It’s challenging to predict which will have a greater impact as we move into 2019 and beyond. However, we are currently in a rising interest rate environment that is linked to robust economic growth. As I mentioned earlier, this scenario encourages business expansion, investment spending, and merger and acquisition activities. We believe that the overall market conditions are likely more significant than the interest rates themselves. Rising rates in a strong economy, with tight spreads, is not necessarily negative. Conversely, a stagflation situation would be concerning. If we were to see a rise in interest rates that doesn’t reflect underlying business strength, it would be a different story. I don’t anticipate that to be the case at this stage, which is why my previous comments may have seemed to indicate a temporary slowdown. Rob, feel free to add anything else.

No, I think that covers it, Ray.

And Mark, welcome to the call, but just in terms of the cost actions, how much of this was driven by, obviously, the slowdown you expect in the fourth quarter versus how much of it was a fresh set of eyes from your end, and thinking that there's more room to be taken out here?

Manav, thank you, and certainly, very pleased to be a part of the Moody's management team. I think the restructuring program was really driven by a combination of factors, and I can really think of the three primary ones. First is the expected continuation of the relatively soft issuance environment through year end. Secondly is an opportunity to rationalize our real estate footprint, specifically to include synergies from some of our recent acquisitions. And then third, let's say, it allows us to give a continued focus on optimizing our global sourcing operations for greater efficiency, including some of the geographic rebalancing that I spoke about earlier.

Yes. I would like to add that while it's beneficial to bring in a new perspective on the company's operations, the timing is also significantly tied to the completion of two recent acquisitions and some geographic rebalancing we are undertaking, partly in response to regulatory expectations.

So just, okay I guess following up on Manav's first question, in terms of the environment in the 2019 outlook, I know this is not a guidance call for next year, but your competitor, S&P, as they laid out their initial issuance outlook, calling for kind of 1% of growth overall, corporates fell down 4%. So curious if you could comment on that a little bit in terms of your own outlook or anything that you're seeing that may be different. In particular, these guys called out the repatriation is still being something that is going to weigh on the outlook. So maybe some color there would be really helpful, how much of that will be an impact for your business.

Sure. I'll let Rob comment on this, and you're right, we're not going to be offering a full outlook for 2019 on this call. But I know Rob does have some thoughts and perspectives on the environment.

Yes, right. Thanks, Ray. So we'd like to get to the end of the year where we can see where issuance ends up and then be able to triangulate both our bottom-up forecast with what we're also seeing from the Street. But that's to give you a little feel for how we're looking at it. I mean overall, we still have economic growth, we saw today the U.S. GDP trend for the third quarter at 3.5%, expectations for U.S. GDP growth of close to 3% next year and the major economies in Europe in the 1.5% to 2% range. So continuing to see economic growth. And Ray always talks about that, that's a key driver to issuance. I'd say modest geopolitical risks, we've got, I think, continued healthy investor demand, and we're seeing that now with pretty constructive market conditions albeit with some volatility and gradual rate increases. And again, that's the key here, is that they are gradual and well telegraphed. And we think also a strong M&A outlook going into next year. We've got a lot of LBO-driven M&A activity now in the market, and you can see that in the bank loan space. We think that's going to continue as well as some of the jumbo M&A. We've also expect default rates, particularly spec-grade default rates to remain low next year, that should contain spreads and then we balance that against, I would acknowledge that we're seeing both a combination of rates moving and I'd say in some cases relatively liquid issuers, which I do think is weighed on some opportunistic supply and we've seen that in the third quarter. We're going to have to look at the sustainability of the bank loan supply if spreads are not further tightening. And I think all in all, that translates into a corporate issuance outlook that's roughly in line with 2018, and we may see a modest rebound in U.S. high yield after a pretty sharp decline. And then maybe just touching on securitization. I think the trend there remains favorable or steady. It's a highly competitive market, but we do expect to see some growth on the back of again, economic growth and consumer sentiment that will be supporting securitization markets. Maybe just in terms of first-time mandates, I think, in our view is that, that's going to continue to provide some support for revenues going forward. So a lot of health warnings on that, we will tighten that up and be able to talk more about it on the next call.

That's great color. And just one more quickly I think on the same topic. As you're thinking to the remainder of the year, if I look at your updated guidance for the, I guess, implied guidance for the fourth quarter, if I'm correct for the corporate side, I think you're assuming a pretty big ramp in the fourth quarter, maybe something like 15% or so. It will be a very big ramp by historical standards, and I know the third quarter was soft. But I think some people called your guidance this morning still fairly aggressive in that area. So maybe just commenting on that real quick in terms of the more near-term assumptions, what could still go wrong here?

Yes. So you can see where we are in terms of year-to-date growth. I would say that we are expecting 4Q to show some sequential growth, certainly from 3Q '18, and that's the resumption of that more typical sawtooth pattern that we have typically seen except for last year. This year we saw that typical summer slowdown. Last year, you remember, every quarter saw sequential growth. So we think we're back to that sawtooth pattern. And think that 4Q '18 will be up on 3Q '18. We've got again, the technical issuance backdrop is good. I think our pipelines look generally healthy, the loan market is active, M&A inquiries are active. But we will need to see some degree of improvement and opportunistic issuance in 4Q versus 3Q to hit our outlook. And I would also note that we're not looking for the same levels of opportunistic issuance in 4Q that we saw in the first half of 2018, but certainly, a pick up from the third quarter. And the last thing I want to point out is, 4Q is going to be a tough comp, 4Q '18, tough comp to 4Q '17. You might remember we benefited from some of that pull forward in U.S. PMG, we saw some late jumbo investment-grade issuance and we put up something close to 20% revenue growth. So an acceleration, a pick up of revenue from 3Q into 4Q, but a deceleration of that kind of year-to-date growth rate, and that's how we got to our guide.

Also I wanted to ask on MIS. In terms of just the recent weakness in issuance, I know that you could attribute part of it to rates. But do you also attribute part of it to tax reform? And when you do think about, if so, when you do think about tax reform's impact on issuance, do you see it as more of an ongoing phenomena since companies would be paying less tax and have more cash on the balance sheet? Or would you think about it as, this is a short-term impact because of the repatriation aspect, so there's less of an issue right now, and so therefore, maybe it's a little bit more temporarily. So I just wanted to talk about what you think is driving the recent weakness in addition to rates.

I would emphasize the significance of repatriation, particularly from the tech sector. We previously identified this as a known challenge earlier this year. However, this challenge is somewhat concentrated because the substantial repatriation amounts are mainly linked to large technology companies. A considerable portion of the corporate debt market, especially in our business within the speculative-grade sector, does not have significant offshore cash reserves. Therefore, I believe the recent slowdown in speculative-grade bonds is more related to the rising interest rate environment, with bank loans being preferred over speculative-grade bonds, rather than tax reform impacting this situation. However, companies with substantial overseas cash that can be repatriated will likely continue to have cash available for repatriation in 2019. I don't anticipate this being a short-lived or isolated occurrence specific to 2018.

Great. And just despite the top line weakness in ratings, the margins and MIS held up well. I guess, what were some of the levers you able to pull in the quarter? I assume incentive comp was probably one of them. So it'd be helpful to hear what that was during the quarter. And also, I think that last quarter, wouldn't have the incentive comp number for 2Q. So if you could give 3Q and 2Q incentive comp, that'd be helpful.

Morning, Toni. The second quarter 2018 incentive comp number was $51.3 million. The third quarter number is $43.3 million. In terms of the MIS margins, quarter-over-quarter, the increase is approximately 140 basis points, and we do however, like to look at margins on a trailing 12 months basis. And there you'll see the increase is approximately 40 basis points. The difference is really due to the normalization of the incentive compensation and ongoing cost control measures within MIS.

I was wondering what would be the company's response to prolonged issuance slowdown. Do you expect to protect profitability in that scenario? And how much flexibility do you think you have there?

In terms of what protects the business model and business performance in a negative environment, there's a number of things to look at. On the revenue side, look to the steady growth in recurring revenue versus transaction revenue at MIS. Pricing opportunities where we are providing particular value. The going forward benefit of new rating mandates that we have picked up in 2018, 2017, which translate into maintenance and monitoring fees on a going-forward basis. And of course, Moody's Analytics, which is not a capital market sensitive business and has a very heavy waiting to recurring revenue. As far as expenses are concerned, there is the formulaic flex in our incentive compensation that responds to what's happening with revenue and operating income. We can also modulate the pace of investments, and those are a variety of different investments whether they're technology-related or otherwise. But I would underscore that we think there are some very important opportunities for the company that we do want to put investment against. And so for short-term cyclical variations in market conditions, we're going to continue to invest even as we pull on these other levers to make sure that the business model is resilient.

So a question for Mark Almeida. Number one, the BvD momentum, very impressive here in terms of the acceleration in quarterly revenue growth. So I was hoping you just give us more color on what's driving that and the sustainability of that. And then I'll get my follow-up, and in advance, on the ERS business, just any color in terms of progress in improving profitability there.

Sure, Peter. BvD is performing exceptionally well, and we're very satisfied with the current state of the business. We're witnessing strong demand from various sources and across multiple use cases for the BvD product. Additionally, we're gaining solid momentum as we start to cross-sell the BvD product to our traditional Moody's Analytics customer base. Overall, we feel confident about our performance, especially in terms of sales with Bureau van Dijk. This strong sales growth is expected to translate into significant revenue generation in the upcoming quarters. Regarding ERS, things are progressing as anticipated. The business is undergoing a significant transition, and we are seeing that unfold as expected. Last year, ERS achieved about 7% revenue growth, and in the first half of this year, the growth was 6%. However, we were flat in this last quarter for ERS. Our full-year guidance suggests a slight decline, indicating that the fourth quarter is likely to be down for ERS. It's essential to focus on the details Mark provided earlier. He mentioned that total ERS sales have increased by 4% over the past 12 months, which is noteworthy because the trailing 12-month sales in ERS were flat in the first two quarters of this year. This suggests we are beginning to turn a corner, transitioning from a traditional software licensing and project business to a genuine Software-as-a-Service model, where we are selling on a subscription basis. I believe the business performance is heading in the right direction, which will lead to improved profitability in ERS. You are starting to see this impact the MA margin overall. We experienced significant margin expansion in MA this past quarter and continue to see positive margin growth on a trailing 12-month basis. This is largely due to the high-margin BvD business as well as the beneficial work we are doing within the legacy MA businesses, which is primarily an ERS initiative.

If I look at your MIS business and I look at the types of clients that you develop ratings for, where do you get the most incremental margins? And if you may, can you rank order them that would be helpful.

Yes. I mean, the new rating mandates are certainly a very attractive source of revenue because they establish new relationships that we would expect would be very stable over time. That being said, that is not the highest margin business. New customers, new rating relationships require additional analytical capacity and analytical support capacity. So I think you can understand that, that where we have an established relationship and that entity decides to reenter the debt markets, that is a profitable opportunity for us because we already have the cost base installed in terms of our workforce that follows the company or the municipality. And we are earning incremental revenue off of the additional issuance. Rob, you want to add anything to that?

Yes, that makes sense. The balance between first-time mandates and refinancing activity was already addressed since we were rating these companies. If we look at it from a sector perspective, there seems to be a connection to complexity. In areas with greater analytical complexity, we typically see that reflected in the financial outcomes, particularly in sectors like leveraged finance, CLOs, and CMBS.

The guidance does include the impact of Reis and Omega. The expectation in terms of an adjusted EPS impact for 2018, that would be $0.02, consistent with the earlier release. And then in terms of the guidance around share repurchase or interest expense, we don't provide that.

A couple of questions. The first one, Ray, as you think out to next year, can you just walk us through sort of preliminary basis, some of the factors that may be more positive next year, less of a headwind next year versus what you're dealing with this year on the debt issuance side of your ratings business? And I have a follow-up.

Yes, absolutely. A gradual and anticipated shift in the interest rate environment would be more advantageous than any sudden or overly aggressive changes. As we've mentioned, linking this to GDP growth is essential. Additionally, we expect default rates to remain low and even decrease, which should help maintain tight spreads. Therefore, the key question for 2019 will be whether policy actions are anticipated, and if so, whether we will see an M&A and investment environment that fosters debt issuance to support that expansion.

Then maybe one area to add to. We saw, 2017, we saw a lot of issuance out of the greater China region. This year, with some of the volatility we've seen that slow down. But we believe there's a pretty big backlog of issuance out of China. So I think there's some potential upside to see that come back into the market in 2019.

And as I think about it, looking for upside as well, if, in Europe in particular, if some of the things that people are worried about in terms of BREXIT and whether there's a hard BREXIT, the Italian budget situation, if those are resolved in a relatively more benign rather than less benign manner, there's certainly going to help with our confidence and business expansion on the European side.

So the first question for you is to ask about how new mandates are doing? And whether they're holding up in 3Q and into 4Q?

Yes, this is Rob. I’ll address that question. There was a slight deceleration in the third quarter, which aligns with the slowdown in the leverage finance markets, but overall, we are still on track for a very strong year. We secured over 200 first-time mandates in the third quarter, which is a decrease from the second quarter and last year's quarter. However, we have more than 800 first-time mandates for the year so far, and we still expect to exceed 1,000 mandates by the end of the year. Last year, we were slightly above that figure, around 1,040. It’s important to mention that we also have several unpublished mandates, especially in China, with some awaiting regulatory approval and others pending better pricing conditions due to market volatility. This has created a significant backlog that hasn’t yet entered the market. Notably, first-time mandate growth has been strongest in the U.S. this year, showing substantial growth compared to last year, and we have a solid pipeline there.

And I'd just add, that the numbers that we're seeing in Q3 are as expected, and going into Q4, we did not anticipate. As I think everyone knows from our second quarter outlook, we do not anticipate the third quarter of 2018 behaving like the third quarter of 2017. Just a very unusual quarter, that not only affected issuance, it affected new mandates, et cetera. It just drove an unusual performance profile last year that we've normalized back to typical market performance in 2018.

Well, I certainly continue on the path of introducing and encouraging the team to implement difference and more automated digital approaches. That's how we think about finance and how finance function interacts with the business itself. We did spend some time with our Board talking about that in our October meeting, and they are supportive of what we're trying to do here. On the restructuring, I do view this as an opportunity for us to create capacity, both to expand margins and to be able to reinvest back into the business. I think, from my perspective, it's important to keep the investment at a level that's sustainable, but also to add value over the long term.

Just going to ask on ERS. I noticed the description of kind of where the growth came from is more the loan origination side of the products side. I guess, can you talk at all about I guess, the regulatory related solutions and what you're seeing from the client? And has, I guess, where the growth is coming from shifted a lot versus 2 to 3 years ago for ERS?

Yes, Tim. The landscape has changed significantly. We've previously discussed this, but looking back a few years, demand was primarily driven by post-crisis regulations like Basel rules and stress-testing protocols applied to banks in both the U.S. and Europe. That regulatory-driven demand has shifted to banks seeking more efficiency and streamlined processes, which has positively impacted our loan origination product. Many banks are competing to make faster and more efficient credit and lending decisions, especially in the midsized and small corporate lending market. It's a highly competitive field, and automating the decision-making process is increasingly crucial. We're observing substantial investments from banks in this area. Additionally, we see demand related to new accounting standards, though not strictly regulatory. We've been addressing IFRS 9 for several years outside the U.S., which aligns well with our strengths and has generated significant business. Now, with the introduction of a U.S. variant of IFRS 9 called CECL in 2020, we are seeing considerable demand for our solutions, particularly from smaller institutions, and we're performing well there. Another noteworthy area is the accounting-driven requirement for insurance companies known as IFRS 17, which will be implemented in the next couple of years. This aligns with our analytical capabilities, and we've developed a solution for it that is attracting a lot of interest. So, these are the main factors driving current demand for our ERS solutions.

Are you retaining, I guess, the legacy regulatory type of subscriptions or licenses? Or do you see clients drop those? Just trying to understand if you're declining on one part and growing at the other, or I guess, what the underlying dynamics are?

No. Most of the regulations are still in place, and financial institutions must continue to adhere to these rules, whether they relate to Basel or stress testing primarily conducted with larger institutions. These larger institutions remain under those regulations, even though some smaller institutions in the U.S. have experienced relaxed rules. Therefore, we do not observe any loss of customers or products due to the changes in regulation volume. It’s more about the flow of regulation rather than its stock. In other words, the overall amount of regulation remains unchanged; we are just witnessing a decrease in new regulatory initiatives that create new demand.

Okay. And then on BvD, just on the new sales. I'm recognizing since it's a sales number rather than a revenue number that can bounce around, and I guess, you're comparing it to the year-ago quarter when there's maybe some disruption I guess, because of the closing of the merger. Can you, I guess, address that? Just how steady has that sales number growth been? And so just trying to understand how outside the norm a 21% growth rate is for BvD? Or if it's been volatile?

As Ray said, we had 21% sales growth in Q3. But I think the more useful number, frankly, is the 14% year-to-date sales growth number that he cited. And then again, those are, both of those are at constant FX rates, so you don't have any currency noise in there. But the 14% rate, again, I think is a good reflection of the underlying performance of the business. The 21% Q3, frankly, reflected a bit of catch-up that we had from some operational issues that we talked about in the first quarter. But 14%'s a good number, and that's meaningfully stronger than where the business was performing when we acquired it. So we feel very good about that, and we are optimistic about being able to sustain that.

I want to focus a little bit on the RD&A business. It seems like from the guidance that you're expecting something like a $25 million sequential ramp in revenue. Where is that coming from? And if it's coming from the BvD business, it seems that the BvD business, when you gross up for deferred revenue, was actually down over just over $1 million sequentially. If you can kind of put that in context?

Yes, sure. I mean first, as we just discussed, there is strong underlying growth in the BvD business, and that acceleration in sales growth that we've talked about, that's going to start flowing through to the P&L, and it'll start hitting the top line. And so that's certainly contributing to a good strong fourth quarter that we expect. I think you've done the math correctly, Shlomo. The other thing you need to keep in mind is, you mentioned it, you've got the haircut going away, there was $22 million of haircut in the fourth quarter last year. We don't have that problem this year in the fourth quarter. And you've also got Reis coming in to the results this next quarter. So you've got those three things, strong underlying growth in BvD, the reversal of the haircut if you want to put it that way, and then Reis coming in, in addition to what I would characterize as very solid performance in the rest of the business.

Got it. And then, I just want to ask in terms of the issuance commentary. S&P noted yesterday that they thought that the refi wall would be more meaningful in the second half of '19 as they look towards kind of pacing on the refis. Are you guys seeing that in the numbers that you're looking at as well?

Yes. When we examine the refinancing schedule, it is actually increasing each year through 2022. This makes it reasonable to expect that refinancing may rise later in the year, particularly since the refinancing from 2020 and 2021 is approaching the latter part of next year. However, a lot of this depends on the mindset of the companies and the expectations of Chief Financial Officers and Treasurers regarding future rates and spreads, which can influence when refinancing occurs. Looking ahead, the amount that needs to be refinanced over the coming years is substantial, but accurately predicting the specific quarters when this will happen is more challenging.

I was going to ask about the refinancing wall as well, so that question was already covered a bit. But to dig a little deeper, is there anything about the refinancing wall that stands out upon closer examination? Looking ahead over the next few years, do you anticipate that refinancing might not occur as frequently? For instance, are there many issuers who might have utilized that capital for synthetic repatriation and may not choose to refinance when the time comes? Are you hearing from companies that acknowledge the upcoming deadlines but are now focused on deleveraging? Is there anything that suggests the refinancing wall will appear different compared to previous years?

I mean, I think an important thing to keep in mind is that when we talk about opportunistic refinancing and the refinancing walls, we are largely talking about the U.S. speculative-grade sector. The investment-grade sector refinances on a much more regular basis, steady basis year on year on year. And international companies, both investment grade and speculative-grade, have a history of refinancing on a more regular basis. The opportunistic refinancing comes out of U.S. spec grade, and those aren't companies that have a lot of overseas cash, as we've talked about before. So I don't think that's going to be an important factor. You could certainly have companies deciding that they wish to deleverage. But again, the ability to deleverage across the speculative grade universe and the desire to delever across the speculative-grade universe, I think is reasonably low. So yes, I can think of circumstances where refinancing may decline, but I don't think that's the central case.

All right, great. And the last one, real quick for Mark Almeida, that is, follow-up on the BvD question, on the growth there. I think someone decided, quarter-over-quarter, but I think year-over-year, if my numbers are correct, that growth was pretty soft as well. I get to maybe like 3%, 4%, 5%. So is there anything else going on other than the disruption, like any sort of customer loss or anything else that may weigh on that growth even going forward? Or you think we're now through this and some of the sales growth can actually translate into real revenue growth in the high single, low double-digit growth, just to circle back here.

Yes. The short answer, Alex, is no. We feel the business is performing very well. As I said, better than it was performing pre-acquisition. We're executing on our synergies, we're building momentum in sales production, which will manifest in good, solid revenue growth. So we feel very good about what's going on there. And we view the numbers, all very positive.

Hi, some phone issues earlier. But how sensitive is BvD and Reis to an economic slowdown? How tied are they discretionary spending in the real estate market?

I will talk about Bureau van Dijk first. It does not seem to be influenced by macroeconomic conditions, similar to the rest of Moody's Analytics. Historically, we have not observed much correlation between economic trends and our business performance, whether positive or negative. Generally, we experience steady growth regardless of the macro environment, except in extreme cases like the financial crisis in 2009. Bureau van Dijk has shown resilience during challenging times, performing above average, though not extraordinarily. We don't find it to be highly sensitive to economic fluctuations. As for the Reis business, we have only owned it for under two weeks, so our experience is limited. However, it seems similarly stable and not particularly affected by macroeconomic conditions during typical economic cycles.

And I would just add, Joe, for the Reis business in particular, we're looking at a business that is assessing, collecting data and with our analytics, assessing risk in the commercial real estate sector, which actually may be in more demand in a more distressed environment. So we're new to Reis, and we'll need some time to sort through this, but that would be one of the things I would be looking for.

I just had a follow-up. Ray or Rob, do you get any sense from any of your clients in the U.S. for example, that are thinking or starting to act on, lock in some of these low rates, or took out all these massive amount of spec rate bank loans in the last few years. Were any of them in waves, here? Just give me a sense of a lock in high-yield bond market here, just kind of think out over the next year. Is that a strategy you think might get deployed more and more here?

Yes. I mean, it's something we are certainly going to be watching for, to see whether a floating rate converts back over to fixed rate. And in looking at that, obviously, we would also be looking at the yield curve itself and how attractive longer-term debt fixed-rate paper is, based on spreads in the yield curve itself. So it's a good area to pay attention to, I agree.

Just wanted to thank everyone for joining the call today, and we look forward to speaking to you again in the New Year. Thanks.