Moody`s Corp (MCO) — Q3 2024 Earnings Call Transcript

Thank you. Good morning and thank you for joining us today. I'm Shivani Kak, Head of Investor Relations. This morning, Moody's released its results for the third quarter of 2024 as well as our revised outlook for select metrics for the full year 2024. The earnings press release and the presentation to accompany this teleconference are both available on our website at ir.moodys.com. During this call, we will also be presenting non-GAAP or adjusted figures. Please refer to the tables at the end of our earnings press release filed this morning for reconciliations between all adjusted measures referenced during this call in U.S. GAAP. I call your attention to the Safe Harbor language, which can be found towards the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the act, I also direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2023, and in other SEC filings made by the company, which are available on our website and the SEC'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 Rob.

Thanks, Shivani. Good morning or good afternoon. Thanks, everybody, for joining today's call. I'm really looking forward to discussing our third quarter results with you. We again delivered some impressive results with a 23% increase in revenue and an adjusted operating margin of approximately 48% and 32% growth in adjusted diluted EPS. One of the key drivers of these great results was our ratings business with a remarkable 41% increase in revenue versus the prior year period. September was a particularly strong month for issuance, which included a new record for weekly investment-grade activity with over $85 billion issued across 61 deals in the first week of September. Strength in first-time and infrequent issuers drove transactional revenue up by 70% for the quarter, outpacing global rated issuance growth of 51%. This growth, combined with ongoing cost discipline, delivered over 600 basis points in adjusted operating margin expansion compared to last year. This year has obviously been a very strong issuance environment; in fact, it's likely to be the second strongest on record. Amidst this strength, we see both cyclical and secular tailwinds that will drive future growth, including refunding walls, M&A, and other market trends that give us confidence in the medium-term outlook for our Ratings business. In MA, we delivered 7% overall revenue growth and 9% growth for both ARR and recurring revenue, both of which exclude one-time revenue that we're intentionally de-emphasizing. Year-to-date customer retention is 93%, and our adjusted operating margin for the quarter was in line with our expectations at 30.3%. Our Decision Solutions line of business, which includes banking, insurance, and KYC, continues to lead MA with almost $1.4 billion of ARR, growing at 12%. Last month, we marked the third anniversary of our RMS acquisition. I will spend a few minutes on today's call recapping our progress and performance there. When I finish, I'll turn it over to Noémie to provide more color on our numbers, including raises to several of our full year guidance metrics, including our outlook for adjusted diluted EPS. Before I move to MIS, I want to take a moment to acknowledge our third consecutive number one ranking in the Chartis RiskTech100. We're number one in 12 categories, a testament to the breadth and depth of our solutions, the strength of our competitive positioning, and the trust that our customers place in us. A big shout out to all my colleagues who contributed to this fantastic recognition. Now, moving to ratings, we feel good about the durable drivers of MIS growth as we look into the future, both cyclical and structural. The refunding walls are a key source of built-in growth. Last week, our analytical teams published their report on the nonfinancial corporate refi walls in both the US and EMEA, showing an 11% growth in the upcoming 4-year maturity walls, amounting to almost $5 trillion, a record high. Majority of this growth is coming from spec grade issuers. For the first time, forward maturity walls exceeded $2 trillion, up 19% from our last study, particularly true for the US market, where forward maturities are up 17% and spec-grade refi walls are up approximately 27%. This bodes well for future issuance, positively impacting our revenue mix. Activity in M&A has been well below historical levels, but we believe that is not sustainable given the needs for private equity sponsors to both exit and deploy capital, along with a more benign rate environment and improved macroeconomic conditions. We're also observing significant growth in private credit assets, which is expected to continue, further contributing to our revenue stream. Lastly, we're positioning our Ratings business for a world of digital finance, embracing blockchain and tokenization. While issuance volumes are modest, we want our ratings to play a crucial role in this evolving landscape. With that, I will hand it over to Noémie to provide more details on our numbers.

Thank you, Rob, and good morning, everyone. Q3 was a record quarter, the highest third-quarter revenue performance in Moody's history, with strong growth across revenue and profitability metrics driving 32% adjusted diluted EPS growth and a free cash flow conversion rate of over 100% of net income. We delivered $1.8 billion of revenue, a 23% increase compared to last year, with Moody's ratings growing transactional revenue by 70%, well above the 51% growth in global issuance. This demonstrates the impressive strength of our ratings franchise. We executed very well across all sectors, with the corporate finance, investment-grade transaction revenue growth exceeding 137%, supported by sustained levels of infrequent issuer activity as well as jumbo deals over the summer. In addition, leveraged finance transaction revenue grew 67%, approximately $80 million, driven by the favorable spread environment. These elements contributed to the largest third quarter for corporate finance revenue on record. The level of infrequent issuer activity, which was the strongest in over a decade, also helped drive favorable revenue mix in FIG, where transaction revenue grew 77%, outpacing issuance growth of 18%. In Moody's Analytics, revenue grew by 7%, including 1 point of growth from FX. Recurring revenue, now at 95% of the segment revenue, grew by 9%, aligning with our ARR growth. As Rob mentioned earlier, our year-to-date retention rate is 93%, illustrating the stickiness of our solution. Revenue growth was driven by recurring revenue in Decision Solutions, which is over 40% of our total revenue, delivering 12% year-on-year ARR growth. Banking revenue grew 3%, balancing double-digit decline in low-margin transactional revenue against flat growth in on-prem sales year-over-year. Continued investment in the banking platform and focus on driving recurring revenue growth yielded a 10% increase in Q3. In insurance, revenue grew 7%, fueled by 11% recurring revenue growth. Our KYC segment delivered 19% recurring revenue growth. We are actively investing to scale this growth level as we enhance solutions for compliance, supply chain, and trade credit workflows. Outside Decision Solutions, research and insights and data information businesses grew by 6% and 7% respectively. Overall, this was an exceptionally strong quarter, achieved a 320 basis-point improvement in the total company adjusted operating margin, and over 100% of net income conversion to free cash flow year-to-date. MIS achieved 59.6% adjusted operating margin, including adjustments for increased incentive compensation accruals, while MA delivered 30.3% adjusted operating margin, a sequential improvement of 180 bps from Q2. With a record third quarter and continued market strength, we are updating our guidance for full year ratings revenue, underpinned by revised global issuance growth assumptions for the full year. We expect issuance will continue to be supported by opportunistic activity in the fourth quarter as issuers take advantage of lower rates, high spreads, and strong investor demand. We also expect sustained activity levels from first-time mandates, which we forecast will revert close to pre-pandemic levels. Our revised guidance now implies mid-30s percentage range issuance growth for the full year, suggesting a mid-single-digit decline in global issuance for Q4, an improvement from an expected decline in mid-teens back in July. We are raising our guidance for MIS revenue growth to the high 20s percentage range, which at the higher end of the range translates into increased Q4 ratings revenue expectations versus prior guidance. We're raising MIS adjusted operating margin to a range of 59% to 60%, up by 100 basis points from previous guidance. The upward revision to our guidance range accounts for the adjustments to our incentive compensation and includes approximately 50 basis points of headwind from a regulatory settlement recorded and disclosed in Q2. For MA, we're maintaining guidance across all metrics. In summary, we now expect Moody's revenue to grow in the high teen percentage range, expenses to increase by approximately 10%, and adjusted operating margin in the range of 47% to 48%. We are also updating free cash flow guidance to approximately $2.3 billion and narrowing adjusted diluted EPS guidance to $11.90 to $12.10, an $0.80 increase at the midpoint and growth of approximately 21% versus prior year. I'm very proud of our team's performance this quarter, and Rob and I cannot thank our colleagues enough for their hard work and dedication. That concludes our prepared remarks, and operator, we will open the line for Q&A.

Thanks so much. I wanted to pick up on the data and information, ARR slowdown from last quarter. I think, Noémie, you mentioned the government contracts renewing at a lower value. Was this reduction in the number of products being purchased, or was it pricing or something else? And maybe just what percentage of revenues related to government? Was this federal government? And are there any more renewals with government coming up? Thanks.

Yes, thanks. We had signaled this in the last earnings call, where we had some large federal government contracts up for renewal in the second half of the year. In data and information, we had a lower renewal with one of our large federal government contracts, which has to do with their spending patterns. As you know, we're in an election year, and they are reevaluating their overall contract space. This has affected the renewals, but we've accounted for those in the third quarter and do not expect any large renewals to affect the remainder of the year. Additionally, the ARR growth this quarter was strained by some customers transitioning to MSCI for their sustainability content, impacting some existing renewals.

Thank you.

Thanks for taking my question. Rob, thanks for flagging both the near and midterm secular and cyclical tailwinds for issuance. But, as you mentioned, it was also the second strongest issuance year. So, can you help us understand if these near-term issuance tailwinds can offset the headwinds from tougher comps and the pull forward, as well as the revenue tailwinds from the infrequent issuers? Or do we need to normalize before we can start to grow off those levels? Thanks.

Ashish, are we talking about Q4? Are you looking towards 2025?

More 2025. Thanks.

All right. Let me just tackle some early thoughts on 2025 and the headwinds and tailwinds we might see. We don’t know exactly how the year will end, but I believe that the balance of tailwinds and headwinds for issuance next year is probably leaning towards the tailwinds. We know this has been a huge issuance year, and while there have been some pull forwards, this is likely going to be the second biggest year for issuance on record. That creates tough comparisons for next year, but there are constructive issuance conditions likely to remain. First, the spec-grade default rate has been declining and is expected to decline further into next year. That should keep spreads tight, which are near their all-time lows. We expect lower interest rates moving forward, combining with tight spreads, creating a favorable environment for new issuance and refi activity. Then we have refunding walls, measuring nearly $5 trillion over the next four years, and M&A activity is also modestly increasing. More significant drivers include private credit and transition finance as we shift toward a cleaner energy economy. The market remains data-dependent, and macroeconomic factors could create volatility, but overall, we remain cautiously optimistic.

That's great color. Thanks, Rob.

Good morning. Thanks for taking my questions. I wanted to stick on the topic of issuance here. Rob, could you share where we are with debt velocity? I know it's been strong this quarter for issuance, but on balance, where we are with debt velocity? Thanks.

Yes. Debt velocity has generally been improving due to the strength of the issuance environment. If you look back to this year, we're likely to finish just under $6 trillion in issuance. Historically, from 2012 onward, you’d see something like a 3.5% CAGR in the growth of issuance. However, the total stock of nonfinancial corporate debt has grown around 7% during that same period, meaning debt velocity has been below historical averages. Currently, debt velocity is around 12% for fiscal '24, which indicates tailwind potential for growth.

Great, very helpful. Thank you.

Hi, good morning. I wanted to ask about research and insight. Last quarter, you indicated your expectation that ARR growth would accelerate in the back half of the year due to new products. It seems we did not see that in Q3. Could you unpack that for this line, particularly around the monetization of Gen AI related tools so far this year? Thank you.

Yes, I'm happy to take that. Research and Insight for Q3 grew 6% ARR, slightly lower than our previous sustained performance of 10% preceding this. There remains some pressure from stress in the banking sector. We are investing in the research assistant; we have solid pipeline growth as we enter the largest quarter of the year. We also have positive usage stats and customer satisfaction indicating a strong foundation for pipeline growth. However, larger financial institutions may be adopting Gen AI capabilities at a slower pace due to their internal governance requirements.

Noémie, to clarify, we had expected some acceleration in the second half of the year, and while we still expect modest acceleration, we may see ARR in the lower end of high single-digit growth rather than at the higher end for Q4.

And Rob, is that research and insights or MA as a whole, just to be clear?

That was specifically referring to Research and Insights.

Okay. Understood. Thank you.

Just to stick on MA. The revenue versus ARR growth keeps widening, and I was hoping you could help level set why that is today, and how that flows into 2025 would be helpful.

On revenue growth, we focus on recurring revenue. If you look at recurring revenue for Decision Solutions, Research & Insights, and Data & Information, they move closely to ARR growth. Revenue grew 7% on a reported basis in Q3; recurring revenue, which is 95% of the total revenue grew by 9%, closely aligning with the ARR. The main driver of the discrepancy stems from declining training and service revenues, which are in double digits, while revenue from multiyear on-prem software remained stable, influenced by renewal timing. In Decision Solutions, recurring revenue grew 13% during Q3, while KYC solutions and others have been in line with ARR, and Data & Information revenue grew 7%. We expect significant prospects in the pipeline moving forward.

I mean you touched on it just that there's the transactional one-time revenue and the recurring revenue. For fiscal 2023, that one-time revenue grew, and this year we see a decline in comparison, resulting in some widening.

Thank you.

Hi, good afternoon. Thank you for taking my question. I know we have touched on private credit before, but the narrative of public-private market convergence is expanding. Rob, you discussed Apollo Investor Day, and they highlighted standardized credit ratings. Could you please discuss the appetite for investment-grade issuers to wade that directly from these PE firms and bypass Moody's ratings, or is the value of credit ratings too significant to bypass?

Yes, Owen, I appreciate the question. I’ve engaged extensively with senior players in this market throughout the year, and while we may have talked defensively historically, there is now a real opportunity and need for independent third-party credit assessment, whether through ratings or other tools. When engaging with large players like Apollo and Blackstone, there’s consensus on the significance of credit rating agencies, providing the data, analytics, and ratings essential for understanding risks across both public and private credit. As private credit continues to grow, investors are demanding the clarity and independence that quality ratings provide. That said, there will be increasing revenue from our FIG franchise, linked to BDCs and fund financing instruments. Again, we’re starting to see more demand for these independent credit assessments.

Thanks for the color, Rob.

Hi, thank you so much. So I wanted to ask about Moody's Analytics again in relation to your medium-term targets. I know you referred to them previously as aspirational. I'm curious if you have an update on that, given there has been a little bit of deceleration this year. Could you highlight which areas excite you the most and your expectation for acceleration moving into 2025 and beyond?

Yes, great question. We plan to update our medium-term targets annually and be prepared to discuss them in our February earnings call. For now, I can share some areas of opportunity we're targeting to achieve these goals. We have relationships with several thousand banks and around 1,000 insurers, providing a solid customer base for expansion strategies. The opportunity exists to do much more for these clients and increase the number of products used. For corporates, a land strategy can be more beneficial, utilizing one of the world's largest company databases for various interconnected use cases. Implementing these factors will help drive our margin expansion and the attainment of our medium-term targets.

Hey, thanks. Good afternoon. Rob, could you provide an updated view on the pull-forward that has taken place this year, especially in Q3 specifically, and whether that has lowered your expectations for issuance growth in 2025?

Yes, David, welcome to the call. It's interesting; the pull forward has varied between investment-grade and spec-grade issuers. While 2025 investment-grade maturities have grown by about 9%, we’ve seen more pull forward from spec-grade issuers who are more sensitive to market conditions. Spec-grade pull forward this year has been more pronounced than our historical averages. However, any upcoming maturities for investment-grade are still higher than this time last year, so the annualized pull forward is in line with historical averages. The potential for a declining rate environment could lead to further refi activity in the future, resulting in tailwinds for our business.

Can you talk about the spread between the 70% transaction revenue growth in ratings vs. the 51% growth in global issuance in the quarter? Then, Noémie, could you throw in the incentive compensation in the third quarter and outlook for Q4?

We had a favorable mix driven primarily by strong investment-grade issuance. We had significant volume from infrequent issuers along with increased leverage finance growth. In addition, first-time mandates created fee opportunities and our consistent pricing initiatives contributed to favorable revenue mix relative to issuance.

In Q3 of 2024, we recorded an adjustment to incentive compensation accruals to reflect updated revenue outlook specifics to MIS. Incentive compensation was about $150 million in Q3, representing a 54% increase year-over-year. We expect overall incentive compensation for the full year to be approximately $490 million, translating to about $120 million for Q4.

Great. Thank you.

Hi, thanks. Good afternoon. I wanted to dive more into your ratings outlook. You mentioned that the pull forward is showing historical averages, but the updated guide implies about mid-single-digit MIS revenue growth in Q4, even though comps don’t appear tougher. Can you discuss why you think Q4 issuance growth will moderate? How do you see that influencing 2025 MIS growth?

We believe issuance will decline in Q4 due to intra-year pull forward and discussions among banks encouraging issuers to take action before any potential election uncertainty. We also anticipate strength in issuance through Q4, which is supported by the upward revision to our outlook. We expect a low-single-digit percent revenue growth rate over last year’s quarter due to that favorable contribution of issuance mix.

Got it. Very helpful. Thank you.

Hi, thank you very much. Rob, could you give an update on progress concerning your AI products? You mentioned Navigator skills assistance. Can you discuss where you are both in development and adoption? There has been a bit of a slower adoption cycle with clients setting up their frameworks. Are you expecting that to change?

Regarding AI development, our suite, termed Navigator, has rolled out across key products, enhancing customer experience and retention. Research assistant, our initial market product, is leading to promising customer satisfaction scores. Larger financial institutions are adopting at a slower pace due to establishing governance requirements for technology deployment. However, we remain optimistic as we see strong engagement and potential outcomes.

Thank you so much. In reviewing your guidance for the year and backing into the implied guidance for Q4 adjusted EPS, it appears that you're guiding it to be flat or potentially down. Are you being overly conservative? Or is there something specific going on?

We are guiding for an adjusted diluted EPS range of $11.90 to $12.10 for the full year, reflecting a 21% growth at the midpoint driven by MIS performance. The midpoint implies Q4 EPS growth that remains flat compared to the prior period and down approximately 30% sequentially from Q3 aligning with top line performance.

Are there any specific margin concerns for the fourth quarter that we should focus on?

For Q4, margin implications reflect the updated top line outlook I discussed. The impact from incentive compensation adjustments in Q3 already accounts for anticipated margins in Q4. Outside of that, we expect no other significant changes.

Generally, for MIS margin, we anticipate it to be lower, reflecting revenue figures. The subsequent weeks leading up to November will offer insights on issuance trends that may impact our guidance.

Thank you for the questions. We look forward to talking with you again on the fourth quarter earnings call. Until then, take care.