穆迪 (MCO) 2004 Q2 法說會逐字稿

Good afternoon and welcome, ladies and gentlemen, to the Moody's second quarter earnings release conference call.

At this time, I would like to inform you that this conference is being recorded, and that all participants are in a listen-only mode.

At the request of the Company, we will open the conference you will for question and answers after the presentation.

I will now turn the conference over to Michael Courtian, Vice President of Investor Relations and Corporate Finance.

Please go ahead, sir.

Thanks very much.

Good morning, everyone, and thank you for joining us on this teleconference to discuss Moody's results for the second quarter of 2004.

This is Michael Courtian, Vice President of Investor Relations and Corporate Finance.

Moody's released its results for the second quarter of 2004 this morning, and the earnings release is available at our website at ir.moodys.com.

John Rutherfurd, Jr., Chairman and Chief Executive Officer of Moody's Corporation will be leading this morning's teleconference.

Also on the call this morning are Ray McDaniel, Chief Operating Officer of Moody's Corporation and President of Moody's Investor Service; and Jeanne Dering, Chief Financial Officer of Moody's Corporation.

They will be available to answer your questions following John's remarks.

Before we get started, I would like to call your attention to the cautionary language set out at the end of our earnings release.

Certain statements my colleagues and I make today may be forward-looking within the spirit of the Private Securities Litigation Reform Act of 1995.

This Act provides the Safe Harbor for such forward-looking statements.

I would like to direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31st, 2003 and in our other filings made by the Company from time to time with the SEC.

I would also like to mint out the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995, contained in our press release issued this morning.

These set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements.

I should point out that some members of the media might be on the call this morning in a listen-only mode.

And I'm pleased to turn the call over to John Rutherfurd at this point.

Thank you, Michael and thank you all for joining us on today's call.

On this call, I will provide a summary of Moody's second quarter results and Ray will discuss our operating highlights in the quarter.

Following Ray's comments, I will provide some detail on the legacy tax provision we made in the quarter, give you an update on the regulatory environment, and discuss our share repurchase program.

I will conclude with Moody's outlook for 2004.

After the prepared comments, my colleagues and I will respond to questions.

Moody's reported good results for the second quarter of 2004.

Revenue rose to 358 million in the second quarter, 14% higher than in the same period of 2003.

Operating income was 200 million and increased 13% from the prior-year period.

Foreign currency exchange contributed about 130 basis points to the quarter's revenue growth, and had a minimal impact on operating income.

Diluted earnings per share per quarter were 68 cents, an increase of 3% over the second quarter of last year.

Second quarter EPS included a charge of $10 million, equivalent to 7 cents per diluted share, related to legacy income tax exposures that were assumed by Moody's in connection with its separation from Dun & Bradstreet in 2000.

In addition to the tax charge, earnings for the second quarter of 2004, including 7 million of pretax expense, related to stock options and other stock-based compensation plans equivalent to 3 cents per diluted share.

This compares with $3 million of similar expense or 1 cent per diluted share in the second quarter of 2003.

Now, I would like to ask Ray to provide a review of Moody's operating results for the quarter.

Thanks, John.

I will begin by discussing operating highlights for the U.S. business.

The Moody's Investors Service U.S. ratings and research business had 11% revenue growth for the quarter, with ratings revenue increasing 9%, and research revenue generating continued very strong growth of over 30%.

In the ratings business, U.S. structured finance achieved mid-teens percent revenue growth and was the largest contributor to growth on a dollar basis.

Moody's benefited from continued strength in residential mortgage and home equity loan securitizations and good growth in credit derivatives ratings.

Financial institutions ratings revenue increased more than 20%, although this was compared to a relatively weak second quarter of 2003.

U.S. corporate finance revenue grew in the low single digit percent range, despite lower issuance in the investment grade and high yield segments of the market, both from the second quarter of 2003 and sequentially from the first quarter of 2004.

Revenue growth was achieved largely from price increases related to the enhanced analysis initiative and from very strong revenue growth from bank loan ratings as a result of robust refinancing activities and growth in Moody's coverage in this sector.

Public finance ratings revenue declined 8% year-to-year in the quarter, as issuance declined due to higher interest rates and greater pay-as-you-go financing available to municipalities in a strengthening economy.

At Moody's KMV, U.S. revenue grew in the mid-teens percent in the quarter.

In total, Moody's U.S. revenue, including Moody's KMV, was $231 million for the second quarter and grew 12% year-over-year.

Moody's revenue continued to grow faster in international markets than in the U.S.

International revenue of $127 million in the second quarter, was 19% higher than in the prior-year period, and rose to 35% of Moody's total in the quarter from 34% a year ago.

Moody's international revenue growth continued to benefit from the favorable impact of currency translation.

For the Moody's Investors Service business, second quarter international revenue rose at a high teens percent rate from the prior-year period.

Within the ratings business, international corporate finance posted mid-20s percent revenue growth versus a weak second quarter in 2003, and was the largest dollar contributor to the quarter's growth.

Corporate ratings revenue was driven by robust issuance and new rating relationships in the European high yields sector, which more than offset the impact of lower issuance in the investment grade sector.

International structured finance revenue grew in the high single digit percent range.

The European business was marked by strong growth in credit derivatives, with revenue rising over 20% year-over-year after a relatively weak first quarter this year.

Growth was held down by declines securitization of consumer assets and commercial mortgage-backed securities.

The latter which included delays and issuance from the second and third quarter.

Japanese structured finance revenue was more than 60% higher than in the prior-year period.

Reflecting strong issuance volume, and coverage in residential and commercial mortgage-backed securities.

And Moody's research business continued its very good international performance with revenue rising more than 40% year-over-year.

On a global basis, our Moody's KMV business had strong results for the quarter.

Revenue reached $32 million, increasing 23% from the second quarter of 2003.

We continue to see good growth in revenue from subscriptions to Moody's KMV's quantitative credit risk assessment products.

The quarter's revenue growth also reflected unexpectedly strong sales of credit processing software to support commercial lending.

A portion of which had been anticipated later in the year.

During the second quarter, Moody's KMV also introduced its new Credit Edge Plus risk measurement and analysis product, which brings together information from the credit default swap, bond and equity markets.

One of several important products that we anticipate will support future growth.

Moody's operating margin for the second quarter was 56%, compared with 57% a year ago.

As was true in the first quarter, the second quarter margin remained above the full-year margin guidance we gave on our last conference call for a few reasons.

We have mentioned in the past that Moody's takes a conservative approach early in the year to spending for discretionary investment projects.

As a result, revenue in the second quarter, though growing at a slower rate in the first quarter, was still strong enough to generate a high margin.

As the year progresses and we continue to refine our full-year revenue outlook, we will then decide which projects we should fund.

The funding of discretionary projects, combined with an expected lower revenue growth rate over the second half of the year, which John will discuss, will result in a lower operating margin for the full year.

Expenses for the quarter were 16% higher than in the prior-year period on a reported basis, and 14% higher excluding currency impacts.

The largest contributor to expense growth was increases in staff and related expenses.

In addition, the $4 million year-to-year increase in stock-based compensation, which I noted a few minutes ago, also contributed to expense growth in the quarter.

This increase reflects both the phasing in of expense related to stock-based compensation over the current four-year option vesting period, and the effect of a higher share price on the value of our 2004 equity grants.

At this point, I will turn the call back to John.

Thanks, Ray.

I would like to provide some detail on the second quarter charge related to the legacy tax amount.

As we noted in this morning's press release, these results for the quarter included a charge of $10 million, equivalent to 7 cents per diluted share, related to legacy income tax exposures that we assumed in connection with our separation from Dun & Bradstreet in October of 2000.

There are 3 D&B legacy tax matters referred to in our Securities filings as, royalty expense deduction, amortization expense deductions and utilization of capital losses.

During the second quarter D&B and the IRS reached preliminary non-binding basis for settlement regarding the utilization of capital losses matter and a substantial portion of the royalty expense deductions matter.

Based on the terms of the tentative settlements, we would expect to make cash payments of about $26 million within the next several months.

And we have written off deferred tax assets of around $26 million.

So the expected cost of settling these 2 matters is just over $50 million, of which about a half will be a cash payment.

We were fortunate that the expected costs of settling these matters is not entirely a cash cause, that we have more certainty about the 2 matters than we did before.

However, I should caution you that the tentative settlement will not be binding until final settlement agreements are executed.

Based on these latest developments, we recorded a charge of $10 million in the quarter to reflect our current estimate of the probable exposure.

For complete disclosure related to these contingent liabilities, please refer to our 10-K for 2003, and our 10-Qs.

Our Form 10-Q for the second quarter of 2004, will include additional disclosure.

Please note also that our Security filings state that the probable exposure on these 3 legacy tax matters is less than the maximum exposure.

Now I would like to make a few comments on the ongoing regulatory review of the credit ratings industry in the United States and abroad.

In the United States, the SEC has not provided any public updates about the progress of its review of the role and function of the credit rating agencies, so there's nothing to report since our last conference call in April.

We continue to work with the commission to assist the process in any way we can.

As a reminder, the SEC has not announced a specific timetable for completing its work.

Outside the United States we also continue to speak with authorities who are studying credit rating agencies.

These authorities included national regulators and lawmakers, and international and regional organizations, such as the International Organization of Securities Commissions, IOSCO for short, the financial stability forum, European commission and the European parliament.

Upcoming reports and analysis about the credit rating agency include, first: Public release of a proposed code of conduct for credit rating agencies by IOSCO, is expected later this summer.

IOSCO has been working to develop a code of conduct to help assure the quality and the integrity of the rating process, independence, and the avoidance of conflict of interest, and responsibilities of credit rating agencies to issuers and investors.

We understand that IOSCO has a goal of completing the code of conduct by the fall of this year.

We continue to be cautiously optimistic that the final IOSCO principles will be constructed and merit our support.

Second, an analysis and report of the issues relevant to the discussion of credit rating agencies is expected to be issued by the Committee of European Securities Regulators known as CESR, by December 15th, 2004.

Turning to Moody's share repurchase program.

Moody's is committed to returning its excess cash to shareholders via share repurchase.

We take an opportunistic approach to buybacks and use the discounted cash flow model with conservative assumptions to determine a range of fair values for the shares.

Our goal is to return capital to shareholders in a way that serves the interests of our long-term shareholders.

As a result, our share repurchase activity will vary from quarter to quarter.

During the second quarter of 2004, Moody's repurchased approximately 2.4 million shares at a total cost of $156 million.

Since becoming a public company in September 2000, and through the end of June 2004, Moody's has repurchased 25.9 million shares at a total cost of $1.1 billion.

Including 11.3 million shares repurchased to offset shares issued under employee stock plans.

At the end of the second quarter Moody's had approximately $330 million of cash on its balance sheet.

We are willing to let cash accumulate until we can repurchase shares at prices that we believe benefit our long-term shareholders, as well as those that are selling.

At quarter end we had $583 million of authorization remaining in our current $600 million share repurchase program.

Which is approved by our Board of Directors in May.

I would like to conclude my comments this morning by discussing our outlook for 2004.

Based on assumptions about many macroeconomic after-market factors including interest rates, consumer spending, corporate profitability, and business investment spending and capital market issuance activity.

There is an important degree of uncertainty surrounding these assumptions, and if actual conditions differ from these assumptions, Moody's results for the year may differ significantly from the current outlook.

In the United States, we expect low single-digit percent revenue growth for the ratings and research business for the full-year 2004.

The Federal Reserve has implemented the first of what is expected to be a series of increases to its target interest rate.

Years [ph] on benchmark instruments such as the ten-year U.S. treasury have increased in anticipation of further rate increases by the Federal Reserve.

We expect that higher borrowing costs, combined with high business profits from current production will reduce the need from corporations to fund business investments with debt.

Which, in turn, will continue to result in weak U.S. investment-grade corporate issuance.

Issuance in the high-yield market, though still strong, has slowed from the very strong levels of the second half of 2003, and the first quarter of 2004.

For the full-year 2004, we expect U.S. corporate finance and financial institution's revenue to grow modestly versus 2003.

Including the benefits of new products, particularly our enhanced analysis initiative.

In the U.S. structured finance market, revenue from rating residential mortgage and home equity securities has been stronger than last year and than we anticipated at the start of this year, due to both volumes and gains in our rating coverage; however, mortgage refinancings and originations have slowed recently, in response to rising interest rates and we expect revenue to slow in the second half of the year.

We should result in flat full-year 2004 revenues in this business segment, compared with 2003.

We expect credit card and vehicle securitization issuance in 2004, to be similar to that of 2003.

Which anticipates issuance increasing somewhat in the second half of the year, compared with the first.

Asked about commercial paper, we continue to show weakness, but we expect good growth in commercial mortgage-backed securities and credit derivatives.

Accordingly, for the full year we expect single-digit percent revenue growth in U.S. structured finance.

In U.S. public finance, we continue to expect a year-to-year revenue decline.

We are forecasting continued strong growth in the U.S. research business.

Outside the United States, we continue to expect low double-digit percent revenue growth in the combined corporate and financial institutions rating businesses.

We're also projecting high teens percent year-over-year revenue growth for international structured finance, due to good increases from rating European credit derivatives, European and Japanese residential and commercial mortgage-backed securities, and Japanese asset-backed securities.

We also expect the strong growth in international research revenue in the first half to continue.

These expectations, which include favorable foreign currency impacts, should produce high teens percent international ratings and research revenue growth in 2004.

Finally, we expect low teens percent revenue growth and be on a global basis.

This expectation is due -- is lower than MKMV's growth rate in the first half of the year, due to factors that include earlier-than-expected sales of credit process software and longer sales cycles than anticipated for new, more complex risk analysis products.

Moody's expenses for 2004 will likely reflect continued investment in the enhanced analysis initiative, and technology to support our growing research business.

And continued hiring to support growth areas of the business.

Moody's expects that the operating margin before the impact of expensing stock-based compensation to be flat to 100 basis points lower in 2004, compared with 2003.

This reflects the investments we are making and the faster growth of the lower margin KMV business.

Overall, for 2004, Moody's expects that year-over-year growth in revenue will be in the high single-digit percent range and that growth in diluted earnings per share will be in the high single-digit to low double-digit percent range.

Accordingly, Moody's EPS outlook for the full-year 2004 is slightly improved from the previous guidance that we provided in April.

This expected EPS growth excludes the impact of the insurance gain in 2003, the legacy tax provisions in 2003 and 2004, and the expensing of stock-based compensation in both years.

The impact of expensing stock-based compensation is expected to be in the range of $25 million pretax in 2004, equivalent to 10 to 11 cents per diluted share, compared to $10.5 million or 4 cents per diluted share in 2003.

And that concludes Ray and my prepared remarks.

We'd be happy to address any questions that you may have.

Thank you, sir.

At this time the question-and-answer session will begin.

If you are using a speakerphone, please pick up the handset before pressing any numbers.

Should you have a question, please press star 1 on your push-button telephone.

If you would like to withdraw your question, please press star 2.

Your question will be taken in the order that it is received.

Please stand by for your first question.

Your first question is from Fred Searby of J.P. Morgan.

Please go ahead, sir.

Thank you.

Good afternoon.

My real question would be if I could see that DCF model and figure out what you are valuing it at, but I'm sure you won't want to share that with us.

But 2 questions, can you tell me what structured finance grew during the quarter if you back out the refi, the mortgage piece of the business and home equity?

And then secondly, obviously, there's very good growth prospects in Asia.

Can you drill down a little bit there and what you see in Asia ex-Japan and sort of what the growth and the issue relationships is, and what the trends are in that dynamic part of the world.

Sure.

On the question of what our structured growth was without the residential mortgage and home equity sectors, I think Jeanne is trying to compute that.

Do you have that number?

In the -- this is Ray.

In the U.S., absent what we call our residential mortgage business, which includes home equity, we had high single-digit growth for the remainder of the structured finance business.

Great.

Thank you.

Your next question is from Geoff Dunn of KBW.

Wait a moment, excuse me.

We didn't answer Fred's second question.

Is it okay to do that?

I apologize.

No problem.

Fred's second question was, well what do you see in Asia outside of Japan?

Ray, do you want to talk about that for Fred?

Sure.

The -- the growth in Asia ex-Japan and I will include Australia in that, has -- is, as you know, a relatively small part of our international revenue.

We have seen good growth in some parts of the structured finance business and we'd expect that to continue for the rest of the year.

In particular, the commercial mortgage-backed and residential mortgage-backed securities areas.

As far as -- as the remainder of the business lines, for the -- the full year, I think we would expect to see high single-digit growth for corporate finance.

Probably double-digit growth, low double-digit growth for the financial institutions area.

I just talked about structured finance, but I think we would expect that to be in the 15 to 20% range.

And the research business again, probably leading the way with mid-20s percent growth for the full year.

Is it just -- I don't know.

Can you all hear me?

Yes, we can.

Okay.

Thank you very much for answering the second part of my question.

So is it emerging with the same dynamic that it really is a 2-horse market with S&P and Moody's, obviously rating 94, 95% of the major deals and, you know, obviously it's a small part of your business, but I've got to imagine 10 years down the road you would imagine this will be a fairly large part of your business, so is that generally happening where you are building relationships with the major corporate clients who are based in China and some of the other emerging markets there?

I -- although I would not characterize it as a 2-horse market, I would characterize the development of that market as following similar lines that we've seen, certainly in Europe.

The one element I would add is that there has been attention paid on a regional basis to whether or not an Asian regional credit rating agency should be created.

That's not a new issue.

That's been going on for years, but those discussions continue among governments in Asia and regulatory authorities.

All right.

Thank you very much.

I would just like to add that, you know, we have offices in most of the the financial centers in Asia.

There are some areas where we do not have offices yet, and we are actively pursuing strategies to expand geographically into those important locations.

Great.

Thank you.

That was helpful.

Thank you.

Your next question come is from Geoff Dunn of KBW.

Please go ahead, sir.

Thanks.

Good morning.

First, could you give us an update on sort of the legislative picture in Europe, as far as favorable laws or developing laws to allow securitization and make that market more receptive to securitization growth going forward?

And then secondly, can you talk a little bit more in depth about the credit derivatives business and the ongoing growth there?

Is that growth just as the more traditional kind of CDO product gains broader geographies and broader issuers, or is is there a material amount of that growth coming from more the hybrid CDOs, like CDOs of CDOs, or CDOs of MBS?

Well, I don't think there's been a great deal of progress on the actual passage of the new securitization laws over the last year or so.

There is always a slow progress towards that in countries such as Germany, and Spain, but we have not seen actual new laws being passed and implemented at this point in time.

Secondly, the -- the growth of the credit derivatives business is very large.

There is a growth in single named credit default swaps.

There is a name -- there is growth on options and futures on credit default swaps.

There are growths of basket of credit default swaps, both first to default and second, third, et cetera, to default credit default swaps.

There's also been growth in various parts of the market for synthetic credit derivatives.

You may have heard of the single tranche credit derivative market which essentially enables dealers to provide a customized product to investors without funding and selling all of or most all of the credit risk associated with the credit default swap.

We see these business growing very rapidly, we believe that we are getting our normal share of both the credit rating part of that business, which obviously we're getting through our Moody's Investors Service activity, but it's also the reason why, in our KMV business, we're introducing the product that Ray talked about, which provides information from both the bond and the credit default swap market, the 2 investors and brokers.

Great.

Thank you very much.

Thank you.

The next question is from Michael Meltz of Bear Stearns.

Please go ahead, sir.

Hi.

I'm going to ask Kevin's question about compensation as a percent of total expenses in the quarter, as well as incentive comp as a percent of comp?

And secondly, can you talk a bit about international structure during the quarter?

The high single-digit growth it seems like something was holding that back, and I understand you had a tough comp, but can you just elaborate a bit on that?

Thanks.

Jeanne, do you want to answer Kevin's traditional question?

Sure.

In honor of Kevin, we'll answer that another time.

The compensation expense, as you know, Michael, is generally about 2/3 of total expense, and in the quarter, the incentive compensation part of that was in the range of 20% of the expense.

Okay.

Ray, do you want to talk about structure or --

I'm sorry, can you --

Well, I -- yeah.

Basically, the -- if you look at the June quarter, versus the prior-year quarter, and you focus on -- you focus on Europe, what Ray said was that we had essentially good growth in the derivative area, and that the overall growth rate was held back by declines in other areas.

Ray also noted -- and those areas would obviously be asset-backed, residential mortgage, and commercial mortgage securitizations.

Ray also noted that some of the commercial mortgage issuance that we have been working on during the quarter was pushed out to the third quarter.

So we don't expect the -- the decline in commercial mortgage-backed securities to be permanent in any way.

Let me -- let me just add a couple of things, now that I've gotten my notes and -- and can amplify on John's comments.

In the commercial mortgage-backed area, we -- we saw, as John mentioned, a timing where some of the business was pushed out to the third quarter but we also saw smaller deals in the second quarter, and that was a factor in reducing our revenue.

In the residential mortgage area, we had revenue growth that was lower than volume growth in the market, and that was because of capping on the deal prices in a number of instances.

And finally in the ABS area, there were a fewer number of complex deals which obtained premium pricing, compared to the prior year.

I also want to correct a statement I made at the beginning where I said that U.S. structured finance issuance ex the RMBS home equity sector was high single -- or revenue growth was high single-digit, it was mid.

I have checked my math.

So I want to make sure that I get that corrected.

Mid-single-digit growth.

Great.

Thank you.

Thank you.

The next question is from Steven Eiseman of Front Point Partners.

Please go ahead, sir.

I'm a little bit new to the Company.

If I could understand the guidance a little bit.

Is the base off of which you are working $2.47, and then the -- when you say a high single digit -- double single digit, very low double digit, let's say that would be 10%, I would then add 10% to 247, would I then subtract 10 to 11 cents for stock options and another 7 cents for legacy taxes.

Is that how it works?

Jeanne, do you have anything we'll add to that.

Okay, I will try to address that question.

I think the base for 2003, which would exclude the insurance recovery, the legacy tax provision, and the stock option expense would be $2.48.

And I think there's a table in the back of our earnings release that will give you the reconciliation from the GAAP EPS number to this non-GAAP financial measure.

And in looking at the 2004 outlook, as you indicated, that guidance does exclude the legacy tax provision, which was, I believe, 7 cents in the second quarter, and the stock option expense, which we're estimating -- or the stock compensation expense which we're estimating will be 10 to 11 cents for the full year.

So the guidance of, let's say it's 10%, do I multiply that times $2.48 and then subtract the 10 to 11 cents for the stock options or the 7 cents for the legacy or does the 10% assume that already in it.

No, if you were using 10% as your assumed growth rate, then I think the -- the math that you set out in the first instance would be the -- the correct math, $2.48 times your 10% growth assumption, and then to get as-reported earnings per share from that, you would subtract the tax provision and then subtract the stock compensation expense.

Thank you very much.

That clarified things.

Great.

Thank you.

The next question is from Brandon Dobell of CSFB.

Please go ahead, sir.

Hi.

Thanks.

I wonder if I could get a little bit, maybe some detail or some color on the relative size internationally between, let's say Europe and Japan or Asia ex-Japan in terms of revenue contribution or maybe in terms of professionals.

And then kind of a follow-on to that, looking at international finance structured finance this quarter, I guess a little bit lower in terms of growth than we've seen in some previous quarters, particularly last year.

I want to get your sense on what you think kind of the near term, let's say in the next, you know, 12 to 24 or 36 months would look like for structured finance, and if there's any material difference from what you would expect in Europe versus Japan, for example.

Sure.

Why don't I take at least the first part of that.

In terms of the percentage breakout of the business regionally, about 2/3 of the revenue is from the U.S., and then about 34%, 33, 34% is outside the U.S., with 24% being from Europe and 10% being elsewhere internationally.

Most of that coming from Asia.

Great.

Thanks.

The second part of the question, I actually forgot answering the first part of the question.

So if you could repeat that, that would be helpful.

No problem at all.

Just comparing, looking at Europe versus Japan or Asia, I'm trying to get a sense of relative opportunity there.

Growth rates and structured finance, is there anything that would make a longer term growth profile different in Europe than Japan or could we expect about the same type of growth in structured finance in those 2 areas?

And I guess beyond structured finance in general, should they grow about the same or differently?

This is Ray.

I guess -- I guess I would say broadly that we would expect to see similar growth in Europe, as in Asia.

A positive on the European side would be that with European Union, I think we -- we do have more confidence in the economic convergence of the multiple jurisdictions, and that should help harmonize laws, legislation that support structured finance.

That we may see less of that in Asia, where -- where just because of the lack of convergence of the region, as a region, we may see slower development.

That being said, Japan is -- is so important in the Asian region and such a leader, as far as the development of the structured finance that the business may be copied elsewhere or the development business may be copied elsewhere within the region.

So I -- I think on balance, I would at least expect to see relatively consistent rates of growth between Europe and Asia.

Great.

Thanks.

Very helpful.

And I think if you look beyond that to some underlying factors it really depends on what is the growth of consumer spending in Europe, versus the growth of consumer spending in Asia?

The European consumers have historically been high savers, especially on the Continent.

We have seen growth of good spending patterns in countries like Korea, in countries like Thailand, and, you know, there are important internal structured finance markets in India and they certainly could develop some in China.

So in the longer term, I think there's a tremendous amount of opportunity in Asian structured based on growth of consumer assets.

Thank you.

Your next question is from John Neff of William Blair.

Hi, guys.

Question for you on the legacy tax reserve.

You mentioned, I think in the prepared remarks that you are expecting that the current tentative settlement earned a total of about$52 million, and you mentioned something about the significance of it being a cash payment.

I was wondering if you could just repeat that.

And also, last I saw in the last queue, you had $127 million in reserves set aside for this exposure.

The 52 million or so that you outlined as being a possible payment, obviously less of that.

Might we see a possible reversal of that -- of those reserves at some point down the road depending how things shake out obviously.

I will let Jeanne answer that one.

Okay, thanks, John.

First of all, to -- just to clarify the comment that John Rutherfurd made before, out of the 52 million of expected costs for the 2 matters that John talked about, roughly half of that is expected to be a cash payment.

And the other half would be writeoffs of deferred tax assets that we had on our balance sheet.

In terms of the reserve level, during the quarter, I think John mentioned that during the quarter we recorded an additional expense of $10 million to cover what is our current estimate on the probable exposure on the 3 legacy tax matters.

So if you think about a $127 million reserve at the end of the first quarter that means that the reserve, speaking holistically, went up by $10 million in the second quarter.

But the reserve that we have is now distributed between deferred tax writeoffs -- deferred tax asset writeoffs and then liabilities to represent estimated cash payments.

So our overall estimate of the exposure in the quarter, the probable exposure went up by $10 million.

Great.

John, did that answer your question or do you have a follow-on question?

A follow-on question, unrelated.

Ray, I think was mentioning some of the laws and sort of the -- I guess the regulatory structure that supports the development of structured finance markets.

I was wondering if you comment on what some of those laws -- give some examples of that kind of a structure, that is conducive to the development of structured finance.

Sure.

Just by way of illustration, the ability to transfer assets, without, for example, the permission of the borrower, the ability to add assets into securitizations without that circumventing privacy laws, are the kinds of issues that we've seen both in Europe, and in Japan.

In addition, to the extent that cross border markets within Europe develop legislation that creates more homogeneous asset types, that is very beneficial.

In terms of common mortgage -- common mortgage structure, common consumer loans, so that they may be more efficiently put into pools of assets because they can be analyzed on a common basis, that's very helpful to the development of the structured finance market as well.

Great.

Very helpful.

Thank you.

The next question is from Douglas Arthur of Morgan Stanley.

Please go ahead, sir.

Yeah, Ray, I'm wondering if you can -- I know you touched on it numerous times here, but the international structured finance grew in the mid-20s in the first quarter, it grew in the high single-digit level in Q2.

Is that -- is that mostly attributable to the slowdown in RMBSs in the quarter?

And in addition, I think at the end of the first quarter you guys were looking for overall global revenue growth of 20%, you are now saying high teens.

What's the reason for the delta?

And then I have a follow-up on -- on Q3 trends.

Sure.

What we have seen, particularly in Europe, between Q1 and Q2, is a very different set of drivers in terms of the asset classes.

The first quarter for the credit derivatives sector was actually quite slow for us, and particularly, the early part of the quarter.

It picked up later in the quarter.

But the first quarter had a lot of strength and -- in all the other asset classes, which includes commercial mortgage-backed securities, residential, asset-backed.

The second quarter we saw strength in the derivatives market.

There was a bit of spread widening.

We'd released some new analytic product into the market place, which made it easier to contribute assets and analyze assets that were put into credit derivatives, and on the other hand, we saw the commercial and residential mortgage-backed sectors and asset-backed sectors slow down compared to the first quarter, for the reasons that I briefly outlined before.

For the full year, I think that we are going to see less of those extremes, either way, and I think we would expect to see the -- the European business growing at a high-teens rate, based on double-digit growth really across all of the asset classes.

And the other international business, I think, which has had more consistent growth by asset class reflecting that.

So I think -- I think what happened in Q1, Q2 is going to settle down in Europe and that's going to allow for the high-teens growth.

In terms of the 20% versus high teens, that's not a -- a large shift in our estimate for any single asset class, just a bit more caution in terms of whether spreads are going to be beneficial for contribution of assets in the credit derivatives area, and whether we are going to see as much activity in some of the smaller but growing asset classes.

Not a big change.

Okay.

Great.

And then, John, I'm wondering if you could just make any comment on what you are seeing backlog or any otherwise in the market right now and in July?

And what it's telling you about early Q3 trends?

Well, I think we see a -- generally a continuation in July of the sorts of things that we saw in the second quarter; that is, there has been some decline, but also -- also some strength in the residential mortgage area.

There have been continuations of strength in things like bank loans, so that -- I suppose the real question is: You know, did the egg fall off the shelf in July?

And the answer is no.

It has not fallen off the shelf in July.

So -- okay.

That's great.

Thank you.

Thank you.

The next question is from William Bird from Smith Barney.

Yes, just 2 quick questions.

One, as you look at the second half, will caps come into play in certain asset classes?

And second, bigger picture, John, I'm just curious about your thoughts on light corporate capital investment and your general point of view whether this rising rate cycle could be different.

Thanks.

As far as caps, I assume that the question referred to our annual fee caps, which are applicable in the financial institutions corporate finance area.

Yeah, that's right.

Yeah.

Okay.

We will see caps coming into play.

We do every year.

They will come later in the year for a number of corporate finance issuers than occurred the last couple of years, just because issuance activity has been lighter.

But the financial institutions sector has continued to be relatively strong on the first half of the year, and so I expect that we are going to see more capping earlier in that sector.

I think that the broad thing that we see is profits from current production are very, very high percent of business investment spending.

That's been true for a number of quarters.

It is the result of tremendous increases in productivity in the U.S. economy, and that does not suggest a -- an important rise in long -- business investment financed by long-term debt.

It's very hard to predict M&A activity.

That could offset it a little bit, but I don't think it's something that you can count on.

By the same token, I don't see any signs at this point, and releveraging of corporate balance sheets.

I see the opposite.

So it's going to take a while for those fundamentals to turn around in our opinion.

Thank you.

The next question is from Joe LaManna of William Blair & Company.

Please go ahead, sir.

Yes, I just have 1 question.

Do you have any update you can provide us on changes in your pricing for any of your products during the past quarter?

In the past quarter?

No.

I don't think we had any material changes in pricing.

Okay.

Thank you.

Thank you.

The next question is from Peter Sakowski of Goldman Sachs.

Please go ahead, sir.

Good afternoon.

Just a couple of quick questions.

One, on the EAI product, if you could talk a little bit about the revenue run rate on that business and then whether or not it's profitable at this point from an earnings standpoint?

And what you think going forward?

And then just the second follow-up is, on the FTEs if you could give it at the end of the quarter, I would appreciate it.

Okay.

This is Ray.

Let me take the EAI question.

We continue to expect that our enhanced analysis initiative in the corporate and the financial institutions area will produce about $11 million in revenue in 2004, about $10 million of that would be incremental, above 2003.

The -- it is not expected to be profitable this year.

It is expected to be profitable by next year.

Although the expense that we now associate with 2004 is probably going to be a bit less for this than we thought earlier in the year, simply because of timing of some of the hires, not a reduction in the number of hires.

Okay.

And this is Jeanne Dering.

I will address the issue of head count.

At the end of the second quarter we had almost 2,300 people and that's an increase of close to 200 from the prior year second quarter, and I should point out that those numbers exclude headcount attributable to our joint ventures, which would add about another 100 people.

Great.

Thank you.

The next question is from Jim Baker of Neuberger Berman.

Please go ahead, sir.

Yes, good afternoon, everyone.

I actually had a few questions.

Jeanne, first on the tax rate, you know, that's down to 41.5 for the first 6 months.

It was 41.8 in the first quarter.

Is 41.5 a number that that you would use for the full year now?

Yeah, Jim, I think that would be more representative of the full-year rate.

I think that the rate for the full year will be certainly a little bit less than we had in the first quarter.

And I guess part of that is with your forecast basically say, you know, the U.S. slows down a fair amount in terms of revenue growth, international not slowing down as much.

So it's even conceivable, I guess that that could drop lower if those forecasts play out; is that correct?

Yeah, I think, Jim, you are right in pointing out that the growth in international generally helps us to reduce our tax rates across our tax rate on earnings from New York City and New York state is very high.

So if our international growth were substantially higher than what we're forecasting at the moment, that could certainly have a small positive impact on the tax rate.

I don't think it would be large enough to make a big difference for the year.

Okay.

And the second question I wanted to ask is for the quarter, could you give us the numbers?

I know they will be eventually in the 10-Q, but for operating income for MIS and MKMV for the second quarter, just a break down.

And, obviously, MIS is the overwhelming majority of it.

Let me just quickly give you the MKMV numbers.

Okay.

That's good enough.

The MIS would be by subtraction and that includes -- the MIS numbers include corporate expenses.

Right.

We don't allocate them on the 2 [inaudible] units.

Okay.

So for MKMV in the second quarter, the operating income on the reported basis was about $3.1 million.

That includes the stock compensation expense and it also includes the amortization of the purchase price of KMV.

Okay.

And could you remind me how much those 2 factors were, those latter 2 that you mentioned?

Yes, the stock compensation expense for MKMV was roughly $800,000 in quarter and the purchase accounting amortization related to KMV, I believe on a full-year basis is about $8.5 million.

So it would be say, 2.1, 2.2 million per quarter.

Okay, that's great.

And then really, the last question I had was just if you could, there's a line in the income statement, interest and other non-operating expense, if you could just give us the breakdown, the interest and then other non-operating within that.

Okay.

For the second quarter, the interest we generally have about $5.8 million of interest expense each quarter on the $300 million of notes.

Right.

And then we had interest income of about $1.1 million.

The rest of the number is a combination of foreign exchange effects, and the effects of recognizing income and losses, or income and minority interest for our various joint ventures and consolidated subsidiaries where we don't own 100%.

So the foreign exchange part of that, I think, was a little bit unfavorable to the prior quarter essentially because the pound and the Euro, while still stronger than last year, weakened quarter-to-quarter.

So we had a larger foreign exchange loss on the assets and the liabilities that are denominated in foreign currencies.

I see.

Because I noticed you said in the press release, you said that, yeah, you know, foreign currency helped revenues a little bit, but they really didn't help operating income materially in the second quarter.

Was hedging part of the reason for that or is it more of a cost base that you had?

No, it's actually more of the latter.

It's the relative cost base that we have in non-U.S. dollars versus the relative revenue base, and a larger portion of our expenses are in pound sterling compared with our revenue.

So you have to look at the way that the rates moved year-to-year on a relative basis.

Okay.

That's terrific.

Thank you very much.

Thank you.

The next question is from David Dusenbury of INS Capital.

My questions have been asked.

Thank you very much.

Your next question is from Douglas Arthur of Morgan Stanley.

Hi, it's Lisa.

Ray or John, could you just elaborate kind of on your comments for your investment spending for the second half of the year?

I know you guys have margins flat to down for the year.

And, Ray, I believe you made some comment about, you know, in the second half of the year, if the revenue is slow, you can kind of decide what investment spending you will pursue?

And also, can you quantify in the quarter, what were kind of one-off investment spending for projects?

Thanks.

Well, we have investment spending for financial infrastructure, that we have been pursuing this year.

We have investment spending for, essentially a much more complete disaster recovery site.

We have had a variety of investment spending projects to make it easier for us to produce new products, particularly in our research business.

So there -- I can't completely explain these things, but we're going from a -- a 2-tiered product generation architecture, to a 3-tiered product generation architecture with middleware and we're spending quite a little money on that, but we believe that it will be -- it will enable us to produce products much more rapidly than in the past.

We also have a variety of new products in the research business where we need to populate them, they've been quite successful as you can see by the growth in our research business, and some of those are in our credit policy area, things like our market-implied ratings products.

Others of them are our new data products in public finance, financial institutions, and corporate.

So this gives you a flavor for some of the things that we're doing.

I would say that the 2 broad categories would be infrastructure, both financial infrastructure and information technology infrastructure and then specific products to support the growth of the research business.

Thank you.

As a reminder, ladies and gentlemen, should you have you a question, please press star 1 on your push-button phone at this time.

If there are no further questions, I will turn the call back to Mr. Rutherfurd to conclude.

Well, I would like to thank everybody for joining us today.

And, again, I would like to thank you all for your support of Moody's.

Have a good day.

Ladies and gentlemen, this concludes our conference for today.

Thank you all for participating.

Have a nice day.

All parties may now disconnect.