Moody`s Corp (MCO) — Q4 2018 Earnings Call Transcript

Thank you. Good morning everyone. And thanks for joining us on this teleconference to discuss Moody's fourth quarter and full year 2018 results, as well as our current outlook for full year 2019. I am Salli Schwartz, Global Head of Investor Relations and Strategic Capital Management. This morning, Moody's released its results for the fourth quarter and full year 2018, as well as our current outlook for full year 2019. The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com. Ray McDaniel, Moody's President and Chief Executive Officer will lead this morning's conference call. Also making prepared remarks on the call this morning is 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 tables at the end of our earnings release filed this morning for a reconciliation between all adjusted measures mentioned during this call and GAAP. Before we begin, I call your attention to the Safe Harbor language, which can be found toward the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the Act, I also direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2017 and 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'll now turn the call over to Ray McDaniel.

Thank you, Salli. Good morning. And thank you to everyone for joining today's call. As we begin, I would like to note that we have revised our approach to our earnings call to focus more of our commentary on the factors underlying our financial results. We hope you will find this helpful and as always welcome your feedback. Additionally, we have changed our disclosure of certain guidance metrics in an effort to provide greater transparency in areas that are most relevant and predictable. Mark Kaye will go into greater detail about the guidance changes shortly. I will begin by summarizing Moody's full year and fourth quarter 2018 financial results. Mark will then follow with comments on our outlook for 2019. After our prepared remarks, we’ll be happy to respond to your questions. During full year 2018, Moody's achieved strong results, driven by robust performance of Moody's analytics, prudent expense management and the benefit of a lower effective tax rate offsetting weaker than expected global debt issuance in the fourth quarter. Full year 2018 adjusted operating margins increased across the corporation, including at both Moody’s Investor Service and Moody's Analytics. Adjusted diluted EPS grew 22% year-over-year. In the fourth quarter, Moody's total revenue declined 9%. As you're aware, we experienced a difficult issuance environment with high yield bond activity that was the weakest since the global financial crisis. MA revenue, which does not correlate with debt capital markets activity, grew 5% led by strong RD&A performance. Despite top-line softness in MIS, Moody's Corporation adjusted operating margin increased by 40 basis points for the quarter. Our improved operating leverage combined with a lower effective tax rate grew adjusted diluted EPS by 8% year-over-year. As you can see in the charts on Slide 7, adjusted operating margin increased in both MIS and MA by over 150 basis points in the fourth quarter of 2018. This was due to expense efficiency initiatives across both businesses, lower accruals for incentive compensation in MIS, and the roll-off of Bureau van Dijk's deferred revenue haircut in MA. On our last earnings call, we announced a restructuring plan. The restructuring charge we took in the fourth quarter of $49 million exceeded our previously announced range of $30 million to $40 million due to the acceleration of staff reductions and acquisition integration, which together also allowed for real estate rationalization. Our total restructuring program is now expected to be in the $70 million to $80 million range through the first half of 2019. We are increasing our anticipated annualized pretax savings to a range of $40 million to $50 million, which is $10 million higher than the range we previously announced. We will begin to realize the majority of the annualized run rate savings in the second half of 2019. These savings will create financial flexibility for various capital market conditions and provide options to reinvest in our business or bolster margins. We believe that the restructuring charge, acquisition synergies, and other cost management efforts will contribute to margin stability in full year 2019. After announcing the Bureau van Dijk acquisition, we focused on deleveraging and successfully reduced our net debt balance in 2018. In December, we issued $800 million in bonds. The pie chart on the right shows that $450 million was used to pay down senior notes that were coming due in July 2019. A portion of the proceeds was also used to pay down our remaining outstanding term loan and commercial paper. As a result of this financing, we do not have further debt maturing until September 2020. In the fourth quarter of 2018, issuance was impacted by a variety of geopolitical and macroeconomic concerns, leading to market and interest rate volatility as well as widening spreads. Notably, there was no U.S. high yield bond issuance activity in December. Even with these challenges, economic fundamentals remain sound in developed markets with stable U.S. and European economic growth and unemployment rates at multi-year lows. The drop in global debt issuance of almost 30% in the fourth quarter of 2018 led to a smaller decline in MIS revenue of 18%, demonstrating the strength of the business model. MIS' revenue was buoyed through its recurring revenue base and was supported by increased monitoring fees from recent new mandates as well as pricing. For MA, total revenue grew 5% in the fourth quarter or 7% excluding the negative impact from foreign exchange. RD&A revenue grew 17% due to Bureau van Dijk strengthening the core business and contribution from the REE's acquisition. Bureau van Dijk added $90 million of revenue in the fourth quarter at a 48.2% adjusted operating margin. As expected, ERS revenue declined by 17% in the quarter as we continue to transition to a software-as-a-service or SaaS operating model. We anticipate ERS revenue growth to resume in 2019. I would like to provide additional details about our progress with SaaS transition and ERS. The chart on this slide illustrates the slight decline in total revenue in 2018 as 15% growth in subscription revenue was offset by a 28% decline in one-time revenue from software licenses and services. Due to the shift in product mix, recurring revenue as a share of total ERS business reached 77% in 2018, up from 69% at the end of 2017. The expansion of the recurring revenue base will drive ERS revenue growth in 2019 despite our expectation of a further contraction in one-time revenues. This year's revenue outlook is supported by 12% growth in 2018 sales of subscription products, which lifted aggregate ERS sales by 6% despite a 10% decline in sales of one-time software licenses and services. The acceleration in total ERS sales growth since early 2018 indicates that we've worked through the inflection point in the SaaS transition. Importantly, the expansion of our subscription business enhances the profitability of ERS, contributing to our expectation of further improvement in MA's adjusted operating margin in 2019. In terms of business fundamentals, our outlook for ERS reflects solid demand from banks and insurers for analytical tools that enable the adoption of new accounting standards and next-generation products that support automation trends. Before turning the call over to Mark to discuss our full year 2019 outlook, I'd like to take a moment to review Moody's ongoing strategic priorities. We continue to defend and enhance our core ratings and research businesses, while pursuing strategic growth opportunities, both down the corporate credit pyramid and across into new geographies and adjacent product areas. We are focused on providing information, insights, solutions, and standards to promote market transparency and fairness. Both are necessary conditions for market confidence, which in turn supports healthy financial markets over time. Underpinning these efforts, we are enhancing our technology infrastructure to enable automation, innovation, and efficiency and remain supportive of a diverse and inclusive workforce. Our recent acquisition of Reis, which closed on October 15, 2018 is a good example of expansion into adjacent product areas. Reis, a leading provider of U.S. Commercial Real Estate or CRE data, has built a unique data set over four years. We have observed growing demand from our asset management, banking, and insurance customers for a reliable source of integrated information and analytics to support management of their substantial exposures to CRE. By combining Reis proprietary data with MA's specialized expertise, Moody's is powerfully positioned to meet the need for standards that enhance operational efficiency and analytical precision in this market. I'll now turn the call over to Mark to review our outlook for 2019.

Thank you. As I alluded to you at an industry conference call in late 2018, we are enhancing the transparency around certain of our guidance metrics while at the same time curtailing other metrics where we feel there is less value in providing them, or they are inherently difficult to accurately predict. For 2019, we have added MIS and MA adjusted operating margin segment guidance, as well as net interest expense guidance. We removed Reis revenue guidance at the sub-segment or line of business level. I want to emphasize that our reporting of actual results will remain unchanged. And in particular, we will keep reporting sub-segment revenue results every quarter in our earnings press releases and in our SEC filings. Moody's outlook for 2019 is based on assumptions about many geopolitical conditions and macroeconomic factors, including but not limited to, interest and foreign currency exchange rates, corporate profitability and business investment spending, mergers and acquisitions, and the level of debt capital markets activity. These assumptions are subject to uncertainty and results for the year could differ materially from our current outlook. Our guidance assumes foreign currency translation at the end of the fourth quarter 2018 exchange rates. Specifically, our full cost reflects exchange rates for the British pound of $1.27 and for the euro of $1.14. Slide 18 outlines a variety of drivers we considered when setting up the 2019 guidance. I will mention a few key items now. For MIS, we believe that stable economic fundamentals of GDP growth of 2% to 3% in the U.S. and 1% to 2% in Europe will underpin global debt issuance activity. However, market volatility may moderate the pace of new mandates and their ability in annual global debt issuance. For MA, product innovations will enable sustained core RD&A growth. ERS revenue growth should resume as the transition from licenses and services to SaaS-based products has passed the inflection point. We remain on track to achieve our Bureau van Dijk run rate synergy targets of approximately $45 million by year-end 2019. As Ray outlined earlier, company-wide, annualized pretax savings as a result of our restructuring activities are now anticipated to be in the range of $40 million to $50 million with an estimated pretax savings of $30 million to $35 million in 2019. We will continue to strategically manage our real estate footprint and hiring activities. As you can see from this slide, we have been able to achieve high-single-digit revenue growth over the last four years and concurrently grow the adjusted operating margin by 170 basis points. This has allowed us to generate incremental free cash flow. For 2019, we are forecasting revenue growth in the mid-single-digit percent range and adjusted operating margin of approximately 48%, and free cash flow in the range of $1.6 billion to $1.7 billion despite our flat to down issuance outlook. Listed here are additional items for Moody's guidance in 2019. A complete list of Moody's guidance is included in table 13 of our fourth quarter 2018 earnings press release, which can be found in Moody’s Investor Relations website at IR.moodys.com. In 2019, we forecast global debt issuance to be flat to down 5% driven by volatility and spread widening relative to 2018. We also expect moderating M&A, new CLO formations, and refinancing of leverage debt. The chart on the right shows our forecast for a slower pace of the new mandates in 2019 relative to the past two years. These headwinds will be partially offset by an expanding global economy, deployment of investor cash balances, and low credit defaults. Upcoming refinancing needs and the already announced 2019 M&A transactions provide a base for upcoming issuance activity. For MIS, we expect total revenue to increase in the low single-digit percent range as we execute on our ability to grow revenue despite the issuance headwinds I just spoke about. We project that capital market conditions will be more constructive than in the fourth quarter of 2018, but believe that the full year 2019 market environment will be more difficult on average than 2018. Overall, we see positive economic fundamentals, moderating declines in M&A activity, and refinancing activity. Tighter investment grade and speculative rate spreads along with still low, although slightly rising default rates should support more constructive issuance markets in the second half of the year. In the last few weeks, issuance markets have improved following the Federal Reserve's recent announcement. We have seen healthy U.S. investment grade issuance activity and the return of U.S. speculative grade issuers to the markets following a historically slow December month. We will continue to monitor monetary policy along with other macro and geopolitical factors affecting the credit market. We expect MIS adjusted operating margin to be approximately 58% in 2019. We will manage our expense base and implement technology to increase efficiency in our ratings processes. However, we also have to account for a reset of the incentive compensation pulled back to 100%, assuming of course we meet our full-year operation targets. We are investing in the MIS business to support our strategy of expansion into the Chinese and Latin American markets, pursuing opportunities in adjacency and enhancing our technology infrastructure. For MA, we expect total revenue to increase in the low double-digit percent range, underpinned by strong sales growth in the second half of 2018. We anticipate broad-based strength across all product areas and businesses. The drag from FX will be offset by the acquired growth from Omega Performance and Reis, thus constant dollar organic growth is also projected to increase in the low double-digit percent range. We anticipate MA adjusted operating margin increasing 250 to 350 basis points, to the 29% to 30% range in 2019. This improvement has several primary drivers, including a combination from strong sales growth of Bureau van Dijk and the ERS transition to more SaaS-based offerings, which improves both recurring revenue and earnings predictability. Ongoing discipline in expense management further underpins MA margin expansion, which is bolstered by the roll-off of Bureau van Dijk's deferred revenue haircut. In 2019, we plan to return capital through $1 billion of share repurchases and an annualized dividend of $2 per share. Today, Moody’s is pleased to announce a $500 million accelerated share repurchase program that will be completed during the second quarter of 2019. In addition, on February 12th, Moody's Board of Directors declared a regular quarterly dividend of $0.50 per share of Moody's common stock, a 14% increase from the prior quarterly dividend of $0.44 per share. This dividend will be payable on the 18th of March to stockholders of record at the close of business on the 25th of February. This increased dividend is in line with our target dividend payout ratio of 25% to 30% of adjusted net income. Before turning to Q&A, I would like to note a few principal takeaways. We are confident in Moody's ability to deliver revenue growth and drive productivity gains to support strong margins in 2019 despite the relatively weakened global debt issuance outlook. We continue to invest in custom offerings of information, insights, solutions, and standards that enhance market transparency. Finally, we will maintain our disciplined and thoughtful approach to capital management.

Thank you, Mark. 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.

Okay. Just want to thank everyone for joining us on the call today and we look forward to speaking to you again in the spring. Thank you.