Earnings Call Transcript - MCO Q1 2024

Operator, Operator

Good day, everyone, and welcome to the Moody's Corporation First Quarter 2024 Earnings Call. At this time, I would like to inform you that this conference is being recorded. Please refer to the Operator Instructions. I will now turn the call over to Shivani Kak, Head of Investor Relations. Please go ahead.

Shivani Kak, Head of Investor Relations

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 first 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 a reconciliation 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 & 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 on 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.

Robert Fauber, CEO

Thanks, Shivani. Good morning, and thanks, everybody, for joining today's call. Before I touch on a few key takeaways from our first quarter results, I'm going to start by saying how excited I am to be joined today by Noémie Heuland, who officially joined Moody's on April 1. As I mentioned on our last earnings call, Noémie brings almost 25 years of global financial and accounting leadership experience at some very large public companies with a real depth of experience in technology and software as a service. We’re really fortunate to have her as our Chief Financial Officer, and I look forward to all of you getting to know her in the coming weeks and months. So with that, let me turn to our first quarter results. We delivered an impressive 21% revenue growth, capitalizing on a strong issuance environment and continued demand for our leading risk assessment solutions. We delivered strong top-line performance and margin expansion in both businesses, resulting in adjusted diluted EPS of $3.37 for the quarter. Starting with MIS, it was a great quarter. Over the last several years, you have all heard me talk about the investments we have been making in analytical talent and technology enablement to ensure that we are the agency of choice for investors and issuers, and in turn, position us to capitalize on more robust issuance periods. In the first quarter, we did exactly that, showing the tremendous operating leverage in our business with the second highest quarterly revenue on record, up 35% year-over-year and an adjusted operating margin of 64.6%. Meanwhile, MA reported another quarter of 10% ARR growth, growing across all lines of business, including double-digit ARR growth in both Decision Solutions and Data & Information. During the quarter, we executed on our strategic investment roadmap across platforming, product innovation, and GenAI enablement. This quarter highlights the unique strength of our business model. We're tracking to our medium-term EPS target of low double-digit growth while funding this investment program that will drive future growth. We expect to return over $1.6 billion to stockholders this year through share repurchases and dividends. That is the power of the Moody's compounding machine. We're also updating a few of our guidance metrics, and Noémie will give some details on that a little later in the call. We've got our eye on the ball, we're looking ahead, and we're focused on our mission to be the leading source of insights on exponential risk. So with that, let's dive in a little more on the financial performance of our businesses this quarter and our latest expectations for the full year. As I said before, MIS really is one of the world's great business franchises. It's widely recognized as best in the industry with strong global coverage in cross-border and domestic debt markets, and it has a growing range of offerings to support growth areas like private credit and transition finance. Maintaining that leadership position is critical to capitalize on the resurgence and opportunistic issuance that we experienced during the first quarter. MIS delivered growth of 35% in the quarter, including 57% growth in transactional revenue. A key driver of this growth was the leveraged finance markets where revenue was up 144% versus the prior year quarter. We established a dedicated private credit team in MIS, which is paying dividends as we're better positioned to service the growth of the private credit markets. We are encouraged by interest in our transition finance offerings, which includes our second-party opinions and our new net-zero assessment. With discipline around expenses, MIS delivered an adjusted operating margin of almost 65%, again, demonstrating the tremendous operating leverage in this business. While the first quarter issuance was very robust, it is still early in the year and there are some uncertainties. We are a bit cautious regarding changes to our full-year outlook at this point in the year due to upcoming U.S. elections, ongoing tensions in the Middle East, and uncertainty around U.S. inflation and central bank rate cuts. Consequently, we have not changed our full-year issuance and revenue growth guidance targets but our updated outlook is now centered on the upper end of both ranges. The global economy has demonstrated resilience, reflective in declining high-yield default rates projected to range between 3% to 3.5% by year-end. We see investor demand for riskier assets keeping spreads tight. Notably, we're starting to see M&A activity pick up. Private equity funds are actively seeking exits and looking to deploy huge pools of capital. Again, we are keeping a close eye on this which we will discuss further in the Q&A. Now turning to Moody's Analytics (MA). MA continues to be a very consistent growth engine for us, achieving 65 consecutive quarters of revenue growth and now 6 consecutive quarters of double-digit ARR growth. Our retention rate has held steady at 94% for the last two years and again for Q1 2024. This is a testament to the stickiness of our solutions. As we look across our reported lines of business in MA, we can see our land-and-expand strategy in action. Starting with KYC, about a quarter of our 18% ARR growth in the first quarter is from new customer acquisitions. A notable percentage of our insurance ARR growth of 10% is from strong execution of our cross-sell strategy across our existing customer base. RMS is an important contributor to that, continuing to deliver against the targets we set back in 2021. Last year, we were starting to mobilize around GenAI without deploying our internal Copilot or announcing our partnership with Microsoft. A year later, we now have a framework for our suite of GenAI-enabled solutions that we're rolling out during 2024. We have categorized our capabilities into three primary buckets we call navigators, skills, and assistants. Each of these capabilities delivers increasing levels of value for our customers and will have some distinct economics. Navigators leverage an AI-powered natural language user interface to help our customers get the most out of our products. Almost all of our solutions will have some form of AI navigator or chat features, which are becoming table stakes for both our offerings and those of competitors in the near future. Skills represent specialized GenAI capabilities connecting to Moody's data, content, and analytics, and are designed to deliver automation while driving productivity and insights for our customers. We expect to release our planned QUIQMemo, an automated credit memo, and QUIQAlert, our surveillance and early warning system. We will also provide a set of assistants for major customer personas, which combine skills and prompt engineering relevant to their jobs. This go-to-market framework will address customer needs as they move up the GenAI adoption spectrum in their daily work processes. We have a pipeline coming to market in the coming weeks and months, expected to help drive our value proposition, retention rates, and opportunities to serve new users. On that note, I am very happy to hand it over to Noémie.

Noemie Heuland, CFO

Thank you, Rob. Let me start by saying that in my previous role as CFO of a public company, being here as Moody's CFO is both an honor and a thrill. Throughout the process, everyone I met mentioned what an exciting time it is to join the firm. Moody's has been a trusted source of financial insights through various economic cycles, and every actor in the global capital markets benefits from the value of Moody's products and services. The network effect is a hard competitive advantage to disrupt. My previous interactions with Moody's analysts and research teams left me impressed by their depth and rigor. Moody's Ratings is a powerful franchise with sustainable growth prospects, an unparalleled reputation, and impressive industry expertise. Moody's built great assets based on proprietary data that dates back over 100 years. The value of that historical data is unmatched. I strongly believe Moody's is well positioned to leverage GenAI capabilities across various use cases. I've spent over 15 years discussing the need for right data and analytics tools to make smart business decisions, and I can attest to the many use cases for Moody's Analytics solution set. As you'd expect, I studied Moody's financial profile before joining. From obvious attributes, it's a very profitable business, delivering 13% of adjusted diluted EPS growth in Q1 with high return on tangible assets and over 100% of free cash flow to net income conversion expected this year. This outstanding set of fundamentals provides flexibility for investing and innovating to fuel growth. Another CFO priority is execution on a disciplined capital allocation plan. I'm very impressed with our focus on results. We generated savings from resource redeployment and automation and redirected investment spending to enable us to deliver on our medium-term targets. We are also aiming to return around 80% of free cash flow to our shareholders in the form of dividends and buybacks this fiscal year. The operating leverage and track record of long-term sustainable growth are remarkable. I conclude, as a CFO, that I'm proud to be part of a team that puts risk management at the center of operations. The culture and intellect I have encountered here are special. As I turn to the first quarter results, we saw strong revenue growth of 21% and adjusted EPS growth of 13% compared to last year, leading to an adjusted operating margin expansion of 610 basis points to about 51%, translating into over 120% free cash flow conversion to GAAP net income. Our quarterly free cash flows of close to $700 million were the highest on record. Now let me touch on segment results. As Rob said, the issuance rebound led to MIS delivering its second highest quarter on record. We saw a strong start across all lines of business, driven by tightening spreads and strong investor demand for opportunistic issuance. Corporate Finance grew 49%, primarily from issuance by leveraged loan issuers and pull-forward activity. Financial Institutions issuance was the strongest since the financial crisis, leading to revenue growth of 37%. Regarding margins, the operating leverage of our ratings business, combined with our initiatives to drive operating efficiencies, allowed us to capture the significant rebound in issuance and expand the adjusted operating margin year-on-year by 780 basis points. Turning to Moody's Analytics, first-quarter revenue was up 8%, with strong demand in our Data & Information line of business growing 13% year-on-year and KYC and compliance solutions growth sitting at 24%. Research & Insights revenue grew by 3%, affected by the timing of revenue recognition and a modest but expected uptick in attrition from banks and asset managers. Overall, MA ended the first quarter with annualized recurring revenue of $3.1 billion, up 10% from the prior year. We also saw sequential acceleration of growth within our three lines of business. Decision Solutions ARR grew 12%, and Data & Information grew 11%, supported by higher retention rates among banks and public sector customers, representing about 71% of total ARR. Our retention rate remains best-in-class at 94%, demonstrating the stickiness of our solutions. In 2024, we commit to balancing strategic investments to drive future growth while maintaining operating efficiency initiatives. I'm pleased to report we delivered a 29.7% adjusted operating margin in the Moody's Analytics segment, an increase of 80 bps year-over-year. Now turning to our assumptions around issuance underpinning our fiscal year outlook. Our outlook of mid- to high single-digit growth accounts for a strong first half of the year. First-quarter issuance was robust across business lines but originated predominantly from Corporate Finance driven by refinancing activities. We are making modest revisions to select asset classes based on Q1 performance, expecting significant issuance to increase in the low single-digit percent range, driven by elevated infrequent issuer activity, while SFG is expected to grow in the high single-digit range. We maintain our guidance for first-time mandates in the range of 500 to 600 issuances. It remains early in the year, and our broader issuance outlook for 2024 remains largely unchanged. We are maintaining our MIS revenue guidance of high single-digit to low double-digit growth for the full year, incorporating macroeconomic assumptions detailed in our presentation. Our updated outlook for Moody's Analytics revenue is expected to increase in the high single-digit percent range, primarily reflecting the strengthening of the U.S. dollar. Our ARR growth expectation remains unchanged in the low double-digit range for fiscal year '24. We expect to maintain our full-year operating margin outlook for Moody's Analytics in the range of 30% to 31%. For MIS, we've maintained our full-year revenue outlook of high single-digit to low double-digit percent range, demonstrating our ability to capture increased issuance volume while expanding margins, raising MIS adjusted operating margin to a range of 56% to 58%. We are narrowing the adjusted diluted EPS range for the year to $10.40 to $11. That concludes our prepared remarks, and I'm happy to open the call for questions.

Operator, Operator

We'll take our first question from Heather Balsky at Bank of America.

Heather Balsky, Analyst

I was hoping you could dig in a little bit more on what you saw in MA during the quarter, particularly in terms of some of your customers where you said you saw pressure and how you're thinking about that. Is it Q1 specific? Is it part of the reason you reduced the guidance there?

Noemie Heuland, CFO

Yes, Heather, let me start with the Q1 revenue performance and what we're seeing for the rest of the year, and I'll pass it to Rob for additional insights on pipeline and sales. In Q1, we delivered revenue growth of 8% and ARR growth of 10%. We had strong demand for our data solutions and KYC. Those grew respectively by 13% and 24%. As I said, Research & Insights was unusual this quarter with revenue growth of 3%, affected by the mix between a lower share of on-premise transactions and a shift towards more SaaS subscriptions. However, our outlook for the full year for ARR growth remains high single-digit to low double-digit range, with the adjustments mainly for lower euro and GBP against the dollar. There's some seasonality in sales more towards the back half of the year driving a bit of the revenue upside in our updated outlook. Our retention rate remains strong at 94% and the ARR, which indicates the strength of our underlying business, remains solid.

Robert Fauber, CEO

Yes, Heather, just to double-click on your mention of retention. We're seeing very strong overall retention at the MA portfolio level. However, we are noticing some pressure from banks and asset managers. As Noémie indicated, we've seen some mild uptick in our research business. Nonetheless, we continue to witness some improved retention in other areas. More broadly, the sales pipeline remains robust at this point, with no elongation of sales cycles. We see power from the underlying drivers for our products surrounding digitization and automation, fueled further by GenAI and the 360-degree view of risk. Thus, the sales pipeline supports our confidence in the ARR guidance for the year.

Manav Patnaik, Analyst

Could you help us with some of your end market exposures in MA concerning client pressures? We understand other financial information service companies are calling out pressures from both buy-side and sell-side. Any insights on this going forward?

Robert Fauber, CEO

Yes, Manav. To reiterate, while there are certainly cost pressures at financial institutions, our clients remain focused on maintaining disciplined expenses. However, there are also important demand drivers. Financial institutions, in particular, are emphasizing digitization and automation across their enterprises. Institutions have been transitioning these transformation programs over the past several years and now they are looking at GenAI as a way to accelerate and derisk these endeavors. Therefore, we're having promising discussions around that front. The value proposition for our solutions remains compelling amid client cost pressures.

Toni Kaplan, Analyst

You raised FIG and structured marginally while keeping corporate the same. You're also calling out improved M&A activity, and you're guiding towards the high end of the range. What gives you reservation about not fully raising the MIS guide? You mentioned election uncertainty and rate uncertainty later in the year; can you elaborate?

Robert Fauber, CEO

Yes, Toni. Part of this is about recognizing it's only Q1. While we're centering on the higher end of the guide, we do have some pull-forward. There are two types of pull-forward happening here: one is the issuance that issuers were planning for later in the year, and banks are advising clients to bring that forward into the first half while markets remain supportive. The second is pull-forward from maturity walls and refinancing, and while there have been positive economic indicators, we’re still assessing how the back half will pan out with elections and geopolitical tensions. Therefore, it leads us to exercise some caution regarding the guidance.

Ashish Sabadra, Analyst

Can we better understand the refinancing wall for 2025 and 2026? What are your assumptions for M&A as a percentage of overall issuance this year? How does that compare to an average year?

Robert Fauber, CEO

Yes, Ashish. We'll have more insight later in the year when we publish our updated maturity refinancing study. But many issuers are tackling upcoming maturities, especially in loans—not significantly to worry about, just some refinances that need addressing this year. For M&A, while we have not modified our outlook, we've observed green shoots indicating improved strategic deals and sponsor-backed transactions leading us to expect a modest recovery in 2024, which is a wildcard but shows promise.

Andrew Nicholas, Analyst

You mentioned the AI framework on the presentation. Could you elaborate on monetization strategies across the different buckets? How could that impact both in 2024 and in future years?

Robert Fauber, CEO

Certainly. We aimed to have a structured framework as innovation flourishes. Our strategy spans delivering GenAI-enabled workflow software to those utilizing our software, whilst also integrating our GenAI APIs into clients' workflows or raw data feeds. Navigators, skills, and assistants will visualize our offerings, expanding our product usability. We expect to scale up the client experience by delivering AI-enabled efficiencies that streamline operations for our customers and yield improved retention. Ultimately, our monetization model will be diversified, reflecting these strategies.

Noemie Heuland, CFO

It's worth mentioning that as we engage customers, they are keen on partnering with firms that prioritize data integrity and analytics. They seek reliable vendors in the GenAI realm, which is where we excel given our strong reputation and foundational work.

Scott Wurtzel, Analyst

Can you provide insights on margins? Given the performance in Q1 and the context of reiterating total operating margins, is there an element of reinvestment plans keeping that stable or is it related to expected deceleration in MIS revenue?

Noemie Heuland, CFO

The MIS adjusted operating margin outlook has been increased by 50 bps for the full year while we are holding MA adjusted operating margin steady despite some revenue headwinds. We're strategically investing while also embedding efficiencies into our operations. Overall, our outlook at the consolidated level has not changed significantly, retaining within previously communicated range.

Faiza Alwy, Analyst

I want to revisit MA and the change in the revenue guide. Is the change entirely FX-driven? How much FX impacted MA this quarter?

Noemie Heuland, CFO

On first-quarter results, we didn't see any material impact on FX. The update in MA revenue outlook primarily reflects FX changes. The strengthening U.S. dollar impacts our future guidance. There is a slight impact from sales seasonality towards the year’s latter half, but we maintain our ARR outlook.

Jeff Silber, Analyst

I'd like to focus on Research & Insights. You've seen some deceleration in ARR growth, and what is causing the expected acceleration in the second half of the year?

Robert Fauber, CEO

ARR growth in Research & Insights has slowed slightly. We've been focusing on two enhancements: the Research Assistant and unrated coverage expansion. While it will take time to see substantial results, we expect growth in the second half driven by these enhancements and an uptick in engagements. Positive indications of increasing user interaction on the platform bolster our confidence.

George Tong, Analyst

Can you elaborate on the issuance pull-forward? How much opportunistic issuance may have been pulled forward into the quarter, and what does that imply for non-refinancing commercial issuance moving forward?

Robert Fauber, CEO

The majority of issuance this quarter was refinancing, but there was some pull forward of new money transactions as well. To have confidence that this trend persists, we need to see the mix shift towards non-refinancing transactions as the year progresses. M&A activity will be key for that, with private equity firms actively looking to deploy capital in the public markets.

Craig Huber, Analyst

Noémie, what are your thoughts on improving the company moving forward? Do you see potential for capital allocation tweaks in light of recent cash position and whether you could position for acquisitions?

Noemie Heuland, CFO

On capital allocation, we are focused on balancing investments to drive future growth while maintaining healthy returns. The recent share buyback was in line with our planned cadence, and I intend to uphold that strategy. It's too early to identify changes in cash balance strategies or plans for acquisitions, but we will continue evaluating all options.

Owen Lau, Analyst

Could you provide more details on the seasonality of MIS and MA margins throughout this year?

Noemie Heuland, CFO

For MIS, we expect the margin to evolve in line with revenue expectations. The adjusted operating margin of 64.6% in Q1 implies average adjusted margins of 53% to 56% for the remainder of the year, with Q2 expected to be slightly higher than the upper range of fiscal year guidance before gradually declining. For MA, margins will likely trend similarly, expecting an uptick towards 30% to 31% in the latter part of the year.

Craig Huber, Analyst

Could we discuss expectations for the company's cost ramp for the remaining quarters in context of your guidance?

Noemie Heuland, CFO

We recorded $105 million in incentive compensations for Q1. The second and third quarters should average about $100 million, with a slight increase in the fourth quarter. We expect expenses will remain flat sequentially in Q2, then gradually increase by $20 million to $30 million in Q3 and $15 million to $25 million in Q4 reflecting our strategic investments and growth alignment.

Shlomo Rosenbaum, Analyst

Rob, can you comment on KYC growth? It's accelerating significantly but ARR seems consistent. What's driving that discrepancy?

Robert Fauber, CEO

KYC's revenue growth is robust driven by understanding whom clients are doing business with, extending beyond traditional definitions. Our investments in KYC solutions have led to notable customer wins and broader demand. The ARR figure is indicative of solid performance, but we believe it will align with revenue as the market continues growing.

Operator, Operator

That does conclude the Q&A session. I'll turn the conference back over to Rob for any closing remarks.

Robert Fauber, CEO

Thank you, everyone, for your questions. I appreciate you joining the call, and we'll talk to you next quarter. Have a great day.

Noemie Heuland, CFO

Thank you.

Operator, Operator

This concludes the Moody's Corporation First Quarter 2024 Earnings Call. A replay will be available after the call on the Moody's IR website. Thank you.