穆迪 (MCO) 2005 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Moody's Corporation third-quarter 2005 results 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 up the conference for questions and answers following the presentation.

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

Please go ahead sir.

Thank you, Kelly.

Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's results for the third quarter of 2005.

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

Moody's released its results for the third quarter of 2005 this morning and the earnings release is available on our Website at IR.Moody's.com.

Ray McDaniel, Chairman and Chief Executive Officer of Moody's Corporation, will be leading this morning's conference call.

Also on the call this morning is Linda Huber, Chief Financial Officer of Moody's Corporation.

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 31, 2004 and in other filings made by the Company from time to time with the SEC.

I would also like to point out the Safe Harbor Statement in 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.

At this point, I am pleased to turn the call over to Ray McDaniel.

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

I will begin our prepared remarks this morning with a brief summary of Moody's third-quarter results;

Linda will then take you through the quarter's operating highlights, provide some commentary on revenue and expenses, and update you on our share repurchase program and debt refinancing.

I will then review developments in the legal and regulatory area and finish with Moody's revised outlook for 2005.

After that, we will be happy to respond to your questions.

Moody's reported solid growth again for the third quarter of 2005, including

(technical difficulty)

-- strength in our research business.

Operating income for the third quarter was $232 million and grew 17% year-over-year.

Foreign currency translation contributed approximately 50 basis points to the quarter's revenue growth and approximately 70 basis points to operating income growth.

With the dollar strengthening a bit, Moody's revenue growth received a smaller boost from foreign currency translation than it has in some recent quarters.

Diluted earnings per share of $0.48 for the quarter were 50% higher than in the prior year period.

Diluted EPS in the quarter included a $0.04 reduction in reserves related to legacy tax exposures assumed by Moody's in connection with its separation from The Dun & Bradstreet Corporation in 2000 and $0.02 per share of expense related to stock-based compensation.

Third-quarter 2004 diluted EPS of $0.32 per share included charges of $0.06 per share related to legacy tax exposures and $0.01 of expense related to stock-based compensation.

Our earnings release includes tables showing the non-GAAP financial measures that are derived after excluding adjustments to our legacy tax reserves and stock compensation expense from our 2004 and 2005 results.

At this point I will turn the call over to Linda, who will provide some more detail on revenue and expenses.

Thanks, Ray.

I'll provide some details for the quarter starting with our U.S. businesses.

Moody's U.S. revenue was 267 million in the third quarter, which was up 17% year-over-year.

First, I'll provide some details on Moody's Investors Service.

At Moody's Investors Service, U.S. ratings revenue rose 18% year-over-year and U.S. research revenue grew faster, rising at a 22% pace.

U.S. structured finance was once again the largest contributor to growth on both a dollar and percentage basis, with revenue increasing 25% compared with the prior year.

U.S. structured finance benefited from broad-based growth, including strong performance in the credit derivatives and commercial mortgage-backed securities segments of the business and solid growth from asset-backed and residential mortgage-backed securities, which by our definition includes home equity loan securitizations.

U.S. corporate finance revenue increased 10% from the prior year period, in part reflecting a recovery in rated speculative grade bond issuance.

U.S. financial institutions ratings revenue rose 11% compared with the prior year period, based on strong growth in issuance by insurance companies, particularly in the life sector, and moderate growth in the finance, securities and banking sector.

Finally, U.S. public finance revenue grew 8% compared with the third quarter of 2004, reflecting an increase in long-term issuance as issuers continued to take advantage of low, long-term interest rates and the narrow spread between long and short-term rates which has been favorable for advanced refundings.

Turning now to KMV, U.S. revenue at Moody's KMV rose 3% on a year-over-year basis in the third quarter.

This increase was driven by growth in subscription revenue from risk products, reflecting a larger book of business in Q3 2005 than in the previous year.

Now shifting the focus to the international front, Moody's continued to generate strong growth outside the U.S. with a percentage growth in revenue rising faster in international markets than domestically.

Total international revenue of 154 million in the third quarter was 19% higher than in the prior year period, with foreign currency translation accounting for approximately 150 basis points of this growth.

International revenue accounted for 37% of Moody's total in the quarter, up from 36% in the year-ago period.

Moody's Investors Service reported 16% growth in international revenue, with foreign currency translation contributing approximately 160 basis points of growth.

International structured finance ratings revenue grew 10% year-over-year, benefiting from very strong growth in the commercial mortgage-backed securities business and solid growth in residential mortgage-backed securities, which more than offset flat performance in international asset-backed securities and only modest growth in international derivatives revenue.

International financial institutions revenue grew 21% year-over-year, reflecting in part robust issuance amongst European banks and insurers and broad-based growth in new ratings relationships with issuers outside the U.S.

International corporate finance revenue rose 15%, led by solid performance in European investment-grade business augmented by good growth in Latin America and the Asian-Pacific region outside Japan.

Moody's research business continued its strong international performance with revenue rising 25% year-over-year.

Next, turning to Moody's KMV internationally.

Business generated 21 million of international revenue, up 39% compared to the third quarter of 2004.

The revenue growth reflected strong sales of credit decisioning software in Europe and in Asia, including revenue recognized from the completion of prior contractual commitments, as well as strong professional services revenue growth in Asia.

Now turning to operating expenses, Moody's operating expense for the quarter totaled 189 million, which was 18% higher than in the prior year period.

The quarter operating margin was 55%, roughly unchanged from the year ago.

Expenses this quarter included 13.3 million for stock-based compensation, compared with 6.7 million in the third quarter of 2004.

Next, I would like to change focus and make a few comments on capital allocation and stock buybacks.

Moody's remains committed to using its strong cash flow to create value for shareholders by investing in growing areas for our business or by making acquisitions in related businesses.

In addition, we are committed to returning cash -- excess cash to shareholders.

Our philosophy on returning excess cash continued to be to pay a modest dividend and to repurchase shares.

On our last earnings call, we announced plans to supplement our opportunistic approach to share repurchase with a systematic element.

During the third quarter of 2005, Moody's repurchased 6.3 million shares at a total cost of $309 million and we issued 0.9 million shares under employee stock comp plans.

The majority of these shares were repurchased under an SEC rule 10b5-1 program.

We are satisfied with the results of our systematic share repurchases thus far, and we expect to continue this effort under the Board's recently authorized new $1 billion share repurchase program, which will begin when the current program is completed.

Our aim is to continue reducing Moody's cash position to a level that still provides us financial flexibility given our business needs, the uncertainty in the operating environment and our desire to make acquisitions or to repurchase stock opportunistically at attractive valuations.

We anticipate that over time, systematic share repurchases generally will approximate free cash flow after dividends.

We also anticipate that Moody's quarterly share repurchase activity will continue to vary from quarter-to-quarter in response to business conditions and market opportunities.

And as a final item, I would like to point out that on September 30 we refinanced our $300 million debt private placement with a 10-year bullet maturity at a coupon rate of 4.98%.

And with that, I will turn the call back to Ray.

Thanks, Linda.

The period since our last earnings conference call has been relatively quiet in terms of developments in the legal and regulatory areas.

As we disclosed last quarter, Moody's received two subpoenas from the New York Attorney General's Office.

Moody's 10-Q for the second quarter of 2005 included disclosure on these matters.

Since then, we have continued to cooperate with the ongoing inquiries and we have no further material developments to report.

Moody's 10-Q for this quarter, which we expect to file at the beginning of November, will include a summary of what we have disclosed thus far regarding the subpoenas, and we'll provide an update if anything changes between now and then.

In June, Congressman Michael Fitzpatrick introduced a bill in the U.S.

House of Representatives titled the Credit Rating Agency Duopoly Relief Act of 2005.

Since then we are not aware of any developments in moving the bill forward.

The SEC is continuing to consider oversight of rating agencies, both in terms of a potential legislative framework and a voluntary industry framework.

The SEC submitted written comments to Congress in the form of technical assistance regarding issues to consider if a legislative framework for rating agencies were implemented.

Moody's submitted comments in response to the SEC's technical assistance, and these can be found on the Regulatory Affairs page of our Website.

We will continue to work constructively with legislators and regulators in the United States as they consider matters relating to rating agencies.

I'd like to conclude this morning's prepared comments by discussing Moody's outlook for 2005.

Moody's overall revenue and earnings per share growth rates for the first nine months of 2005 and our outlook for the remainder of the year suggest that growth for the full year will be modestly above the guidance we provided when we reported second-quarter results in July.

This adjustment to our guidance is in part based on stronger-than-expected growth in several businesses in the third quarter, partly offset by slower growth in others.

As a result, while we are making only a modest adjustment to our overall outlook for the full-year 2005, there are some significant changes to our forecasts for individual business lines.

Moody's outlook for 2005 is based on assumptions about many macroeconomic and capital market factors, including interest rates, corporate profitability and business investment spending, merger and acquisition activity, consumer spending, residential mortgage borrowing and refinancing activity, securitization levels and capital markets issuance.

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 from our current outlook.

In the U.S., we are now forecasting mid-teens percent revenue growth for the Moody's Investors Service ratings and research business for the full year 2005.

In the U.S. structured finance market, we now expect that revenue from rating residential mortgage-backed and home equity securities may rise more than 30% from the record level of 2004.

This is an important revision from our prior outlook which anticipated residential mortgage-backed and home equity securities revenue growing in the high-teens percent range.

We continue to expect good year-over-year growth in several other sectors of U.S. structured finance, including asset-backed securities, credit derivatives and commercial mortgage-backed securities.

We now expect total U.S. structured finance revenue to grow in the mid-20s% range, compared with our previous forecast which assumed revenue would grow in the mid-teens percent range.

In the U.S. corporate finance business, despite a recovery in third-quarter issuance in the speculative grade bond market following a weak first half, issuance remains uneven and will likely fall substantially below the volumes seen in 2004.

We believe that revenue weakness related to lower issuance in this business segment will be offset by modest growth from investment-grade ratings and price increases in connection with our Enhanced Analysis Initiative.

We now expect U.S. corporate finance revenue to grow in the low single-digit percent range for 2005, slower than we had previously forecast.

In the U.S. financial institution sector, we look for the impact of projected flat issuance volume to be offset by revenue related to price increases in connection with our Enhanced Analysis Initiative and from new rating relationships.

Together, we expect these to result in mid single-digit percent growth in this sector for 2005, slower than we had previously forecast.

Moody's U.S. public finance revenue growth for the quarter was roughly in line with our expectations.

As a result, our outlook for this business for the full year 2005 is essentially unchanged.

We continue to forecast public finance revenue for 2005 increasing in the low-teens percent range compared with 2004.

We also continue to forecast good growth in the U.S. research business.

Outside the U.S., we now expect growth in ratings and research revenue in the 20% range, with double-digit percent growth in all major business lines and regions assisted by favorable foreign currency impacts.

Our projection assumes continued strength in the corporate investment-grade business and good issuance growth in the European financial institution sector and several sectors of international structured finance, including commercial and residential mortgage-backed securities issuance.

In addition, we expect continued strong growth in international research revenue.

Finally, we continue to expect global growth at Moody's KMV to rise in the high single to low double-digit percent range, reflecting growth in both credit risk assessment subscription products and credit processing software products.

For Moody's overall, we expect revenue growth in the 15 to 18% range for the full year of 2005, including the positive impact of currency translation.

We expect the operating margin before the impact of expensing stock-based compensation to be flat to up by 100 basis points in 2005 compared with 2004.

This incorporates our modestly upgraded revenue outlook and investments we are continuing to make to expand geographically, improve our analytic processes, pursue ratings transparency and compliance initiatives, introduce new products and improve our technology infrastructure.

For 2005, we expect that year-over-year growth in pro forma diluted earnings per share will be in the 16 to 19% range.

This expected growth excludes the impacts of reserve adjustments related to legacy tax matters and the expensing of stock-based compensation in both 2005 and 2004.

The impact of expensing stock-based compensation is expected to be in the range of $0.11 to $0.12 per diluted share in 2005 compared to $0.06 per diluted share in 2004.

The estimated 2005 expense excludes the effects of adopting Statement of Financial Accounting Standards No. 123R, Share-based Payment, which Moody's will implement effective as of January 1, 2006.

That concludes our prepared remarks.

We would be pleased to take any questions you may have.

(OPERATOR INSTRUCTIONS).

Lauren Rich Fine, Merrill Lynch.

A couple of quick questions for you.

I'm just trying to understand the guidance on financial institutions.

And recognizing I might not have captured the right proportion of U.S. and international.

But it looks like you are suggesting a very weak quarter domestically, and I'm wondering if that is true and why.

And then, I guess on your margin guidance this has been a recurring area that has always perplexed me.

But if I look at your first three quarters excluding stock options, it would suggest just to get to the high-end of your margin guidance using the high-end of your revenue, a 250 basis point compression of margin in the fourth quarter.

What kind of spending are you expecting to come up with that kind of margin guidance?

Thank you very much, Lauren.

I will answer your first question and at least begin to comment on your second question, although Linda may have some additional thoughts.

With respect to the financial institutions area, you are correct that we do expect to have low single-digit growth in the fourth quarter in that business for the United States.

And that -- it reflects a couple of things.

Probably most importantly that many of our financial institutions rating relationships are frequent issuer pricing relationships, and those do cap out during the year.

And as a result, we do not recognize or realize the same kind of revenue alignment with volume activity late in the year that we do early in the year.

With respect to the margin, I think you certainly know because you have been following us for a while that we spend -- we try to spend conservatively early in the year before we have as much clarity as we do later in the year on growth and our ability to make investment spending decisions.

So, the fourth quarter has traditionally had relatively higher expense associated with investments.

And that will continue this year as well.

As I mentioned in the prepared comments, this includes in particular this year areas such as our ratings compliance activities, where we are making investments both in headcount and in preparation with our advisors for a more robust compliance and reporting regime in 2006.

And it also reflects continuing investment in technology infrastructure which we will be pursuing, I think, really as aggressively as we prudently can in the fourth quarter.

I don't know if Linda has any other comments.

She is shaking her head no.

We will leave it at that.

Actually I do have a couple of quick ones for Linda, which is just on the tax rate.

The underlying recurring rate was higher in the third quarter.

I'm wondering if you can give us any idea of what you think the fourth-quarter rate will be.

And then also, the other line -- could you break that out between interest expense, interest income and other?

Sure, Lauren.

Let us look up the breakout there.

But I think the tax rate in this quarter as you saw, we are moving forward to deal with these legacy tax issues.

And we dealt with one piece of that in the third quarter given a settlement that we saw on part of one of the legacy matters that we have.

Going forward, I think our tax rate will continue to be in the same neighborhood that we are seeing right now without any particularly radical changes.

And the breakout on the other expense, we see interest income at 8.6 million for the quarter, interest expense at 5.7 million, and other expense at 0.2 million, for a net of 2.7 million.

Back on the tax rate, I guess what I was trying to suggest is even without the legacy adjustment, it looked like the recurring rate was higher than it had been.

It that the right rate to pull forward, the underlying recurring rate of the third quarter?

Ray is going to comment on that.

I was going to say that at least a part of that may be attributable to our expense assumptions for New York State.

And we have increased our assumptions for New York State taxes that may be due.

Douglas Arthur, Morgan Stanley.

I think Lisa has got a couple of questions.

But, Ray, could you just clarify the trends in the high-yield market in the U.S., realizing that's a pretty profitable part of the business?

And it looks like it was strong in Q3.

What's the pipeline look like going into Q4?

Thanks.

And then Lisa has got a follow-up.

Sure, Doug.

Roughly, the issuance-related revenue in the third quarter for our corporate finance business globally was about 36% of total corporate finance ratings revenue.

And of that 36%, it was roughly split evenly between the high-yield sector and the investment-grade sector.

We did see a recovery, a good recovery in high-yield issuance in the third quarter, compared to really a very weak first half.

That activity, though, was not materially above what we saw in the prior year period.

And the issuance activity has been uneven throughout the year.

And we do expect that if there are rising rates, if the rising rates continue on the long end, and particularly if spreads widen that we will perhaps have seen the recovery in Q3 not be replicated in Q4.

Okay.

Here's Lisa.

Ray, can you just elaborate on your comments in international structured finance about the modest increase in asset-backed securities in the derivative -- I think you said flattish -- and what occurred in the quarter and what you see going forward?

Thanks.

Sure.

The asset-backed sector was volume related.

We did not see a strong growth in issuance volume in the asset-backed sector, and I think that largely tells the story there.

On the credit derivatives side, there are a couple of things happening.

And I think really the story for the modest growth in that area really relates to some pricing changes that we made in the synthetic market beginning in the fourth quarter last year, but they gave us some difficult comparisons with some lower pricing going from Q3 '04 to Q3 '05.

Fred Searby, JP Morgan.

A bunch of questions.

But share repurchase -- you were a heavy repurchaser of your shares.

I think it was $300 million.

And in the past you have said you were waiting for an entry point that you thought yielded a higher return for shareholders.

What was the change in thinking?

It doesn't appear that the trends in issuance (indiscernible) business are accelerating, so why now given the stock is not meaningfully down?

I think it's even probably even up since then.

And then just some other -- the other income or in the interest expense, what -- the gain you booked this quarter.

I don't have the press release in front of me, but off the top of my head I think it was $2.8 million.

What drove that?

And then, I wondered if you could give us some sense of what your provision is for incentive comp and where you see hiring looking out into 2006?

Fred, it's Linda.

Let me tackle the share repurchase question first.

As we had said on last quarter's call, we were moving to implement a systematic share repurchase program, basically a change in strategy as to how we were going to alter the mix to return value to shareholders.

So, as we said, we started that beginning in the third quarter and we have moved through that.

We have been very happy with it.

And you are correct; we spent about $300 million in the quarter.

We repurchased 6.3 million shares.

And as you saw, the Board of Directors has approved authorization for another $1 billion in share buybacks, which as we stated in the press release will likely run through the first half of 2007.

We are very pleased with the results of this.

We're serious about returning value to shareholders.

And we are quite pleased with the way that the program has been working.

Again, we prefer the systematic view.

We don't think we're smarter than the market and we would prefer to do this on a systematic way, systematic basis, so that we can be more orderly in the way that we are able to execute this.

Could you help me with understanding systematic, then?

So, I mean, the 300 million even with the $1 billion authorization -- I shouldn't assume -- that sounds awfully heavy or above what you are expecting.

That would be about 1.2 billion a year.

So, what does systematic really mean?

I don't think you should consider -- as we said, given changing conditions and as the situation warrants we're going to be doing both systematic and opportunistic if it appears that that is attractive.

But our overall philosophy, Fred, is that we want to get our cash balance to a place where we are comfortable with it.

Frankly, at, I believe, $970 million of cash at the end of the second quarter -- we thought that that was just a bit high.

So, we are looking to find a comfortable level of cash balance for us which is prudent given the activity in our business, some of the other things that we want to do.

And in the future going forward, we are looking to match free cash flow net of dividends to our share buyback amount.

So, that's sort of what we are looking to do.

And you can work with those numbers and sort of see where we are looking to do.

The 10b5-1 program has the benefit of our being able to be in the market on many more days and gives us some flexibility through some of our blackout periods, which is what makes it more attractive.

On some of your other questions, the other income of 2.7 million was primarily interest income.

We have moved into a short-term investment on auction rate certificates.

We have had a pickup of about 16 basis points on those, so those have contributed a bit to our other income.

And then, I think you had one other question which I may have missed.

It was provision for incentive comp.

You have had another spectacular year -- what your thinking is there.

And about hiring, I guess, in the newspaper (indiscernible) FTs.

But just looking at what we should think of in terms of hiring for 2006, because you're -- I'm sure you're in the process of doing that now.

Our hiring growth had been -- I believe it was 8% year-over-year last year, and we are looking quite hard, obviously, at our hiring plans for next year.

Obviously, we need to match our compensation to our results.

And as you'll see, our allocation for our compensation has moved up.

And that is one of the main things that has increased our expenses for this quarter.

So, obviously, we accrue our compensation in line with our profitability.

Just one final Piggly Wiggly;

I will squeeze one more in.

Private ratings.

Since we can't track that, can you give us some color in terms of that, some of the things that we're not picking up, and what percent -- how meaningful that was in terms of your overall ratings business in the quarter?

Sure.

I'll turn that one back to Ray.

I think the primary area for private market activity that we are involved in is in the European credit derivatives market and synthetic market.

As you know, the European credit derivatives portion of our European structured finance business has been the largest piece of that market.

I don't have the breakout between the private market and public market revenue generation from that business.

And because of the private nature, it is in fact quite difficult to tell what overall market volumes are on the private side.

But that is where you should be thinking in terms of private market activity.

On the corporate side, the ratings on private placements are a very modest portion of our overall revenue.

And I don't think you would find those to be especially material.

Steven Barlow, Prudential Equity Group.

Linda, could you give us help here on what compensation is as a percent of total (technical difficulty).

Secondly, you've talked in the past about (technical difficulty) in Germany, in particular the Landesbanks.

Just give us an update on what is going on there, whether that's driving some of your results or whether there's any countries that would have similar capital requirement for their banks to adhere to.

And then lastly, do you have a forecast of what year you would have 40% of your revenue coming from the international side?

I will take the first one statement, Steven, and then I will turn over the other two to Ray since we try to be equitable regarding these questions.

Our compensation expenses including option expense of the third quarter of 2005 are 70% of our overall expense.

And to follow-up on the question that Fred had previously, if you look at page three of the earnings release, the quarter's comp expenses included 13.3 million related to stock-based compensation plans, which is up from 6.7 million last year.

So, you can see that detail there in the earnings release.

And regarding Germany, since Ray was the last one to Europe, we will let him tackle that one.

You are correct.

We, at least in previous quarters, had identified activity coming from the Landesbanks ahead of the July deadline for the recognition of support for those banks, governmental support, as being a driver for the growth in the market.

That was not, in our opinion, a driver in the third quarter now.

And rather, European bank issuance activity was related more to the attractive interest rate and spread environment for financial institutions (technical difficulty) attractive then for the corporate sector and encouraged bank borrowing.

And in turn, that fed through to bank loan ratings in the corporate sector, which although it's a small part of our business, did have very good growth in Europe in the third quarter.

With respect to when international might be 40% of our total revenue, you probably know my track record for forecasting, so take this with caution.

But the contribution of international to Moody's overall revenue has been continuing to grow, although at a more modest pace than in some prior years, really related to strength in the U.S. business.

We expect, however, that the U.S. business will be more subject to a cyclical downturn in a rising rate environment, particularly on the long rates.

And if house price appreciation and consumer borrowing for residential mortgages, home equity, and consumer finance slows down and a slower business environment.

And so, I would expect the pace at which the international contribution grows to pick up in 2006 and 2007.

Whether we get to the 40% number in 2006 or not, I don't know.

But I would expect at least by 2007 we would be in the 40% range.

A more precise estimate of that will have to come after we finalize our operating plan outlook and outlook for 2006, which we are in the process of doing, but we have not finished that.

Michael Meltz, Bear Stearns.

Ray, I think Doug asked about the high-yield trend.

Have you actually seen a slowdown in your structured products in the quarter thus far?

That's my first question.

Linda, regarding the repurchase, understanding you repurchased 6 million shares, it looks like shares out were actually flat compared to the second quarter.

What was behind that?

And then two just data questions.

What was the cash balance at the end of the quarter and what was actual -- the actual number?

What were you accruing incentive comp as a percent of comp?

Michael, I will address the first while Linda does a little work on your other questions.

With respect to structured finance in the fourth quarter, we currently have a pretty good pipeline in the businesses that were strong in the third quarter going into the fourth quarter.

This would include the residential mortgage and home equity sector, as well as asset-backed derivatives and commercial mortgage-backed securities.

I think that our caution on the fourth quarter in structured finance as a result has less to do with the pipeline than the effect (technical difficulty)

Hello?

Sorry -- and potentially tighter credit conditions in the fourth quarter might have on issuance activity.

So, rates and spreads as well as the credit conditions.

The higher short-term rates that we have seen have begun to translate into some higher long-term rates.

There's about a 50 basis point increase in the 10-year treasury since the beginning of September.

And if that also has an impact on mortgage rates, it could affect the desire to securitize instruments that are in the pipeline.

Although it probably will not be a big factor in the fourth quarter, we also are looking at the slowing of home price appreciation and declining pool performance.

As more of the mortgages and home equity instruments that are being made available in the market are more speculative, those have an influence on our credit enhancement levels.

And since they have an influence on the credit enhancement levels, we may be more conservative than our competitors for example.

That could have an influence on the market share that we have in these sectors.

So, we are certainly not expecting a big fall-off in activity in the mortgage sector, but we do see some reasons to be cautious.

I would also just add -- and for those of you who have listened on these calls before -- we tend to have less visibility on the structured finance market than we do in some of the other lines of business, particularly the company ratings business.

And so, that lower visibility in terms of potential revenue growth should be factored in.

Michael, you had asked a couple of questions.

You had asked first about the share count, you had asked about cash balance, and then the percentage of incentive comp as a percentage of expenses.

I would call your attention to the new and exciting exhibit on page 10 of the earnings release.

We anticipated this question and we have provided selected consolidated balance sheet data which probably would be helpful to you.

So, if you look at page 10, at the end of the quarter, you will see that we have 736.7 million of cash.

And then in short-term investments, those auction rate certificates, as I had spoken about before -- of most of that, the 81.7 is those.

Probably the reason why you are a bit confused or not clear on the number of shares -- on that page 10 you'll see the shares outstanding as of September 30 were 295.4 million.

That is a point-in-time view.

And in some of the other pages of our document here, we have weighted average.

So, you might want to try to reconcile those, which would help you move through it.

But you're correct; in the third quarter we repurchased 6.3 million shares at a cost of $309 million.

So, if you look at the difference between the spot and the weighted average, I think you will be able to work it out.

So, that provides the information on the shares and the cash balances at the end of the quarter.

Incentive comp was 17% of our expenses.

And if you want some more detail on that, perhaps we could catch up after the call.

That's fine.

I apologize for asking that cash question.

But on the shares, that's a diluted count at the end of the quarter.

Is that what you are saying? 295?

That is not diluted.

That's a basic count, everyone is telling me.

And then some of the other measures in here which are weighted average on page eight, for example, is a weighted average measure.

At the bottom of page eight you'll see 299.6, and then diluted is 307.7 million shares.

So, you're saying you bought back a lot of shares late in the quarter?

You could infer that, yes.

John Neff, William Blair.

A question about the systemic share repurchase.

And Linda, I thought I heard you say on the call that you were going to dedicate free cash flow less dividends to the systemic -- or systematic share repurchase.

Did I hear you correctly?

And if so, what does that leave for the opportunistic buyback?

That's a good question, John.

Directionally, I think you have it right.

It would be free cash flow which would be net of dividends, and any other extraordinary opportunities that we see to invest back in the business.

Opportunistic share repurchases, of course, would be driven by market conditions.

If the market we see as being extraordinary and presenting a great opportunity, we will go back in and buy opportunistically. (technical difficulty) as sort of the meat and potatoes of the program.

So, if you want to think of it that way, that will sort of be the base loading of what we are looking to do.

John, I would just add that we fully intend to maintain a healthy cash balance, so that if we do see a good opportunity for opportunistic share repurchase, we are going to be able to act on that.

And John, as we would also point out to you, we rolled our $300 million of debt.

And with that we also have that capacity.

Does that help?

It does.

I apologize;

I may have to follow back up.

The call cut out on me there for a second.

I think I got the jest of it.

Is this a little bit of a shift from -- I think last quarter when you were talking about this, the idea was that there were going to be -- that the systematic repurchase was going to be a minority component of your overall repurchase activity.

But it seems to have shifted.

Would that be fair to say?

John, I don't think that would be fair to say.

I'd encourage you to go back and look at our comments that we made at the end of the second quarter.

I think we said we were adding a systematic component to our share repurchases.

I do not believe we ever inferred, nor did we intend to infer that that would ever be a minority component.

(OPERATOR INSTRUCTIONS).

Brandon Dobell, Credit Suisse.

Sorry;

I heard some hold music there.

I thought I got put into a different call.

Ray, just a couple of quick questions on KMV.

From a pricing perspective, I just want to get a flavor for what is going on there, what is driving some of the activity.

And then secondly, maybe some color on that business by, I guess, vertical is the best way to think about it -- banks versus funds and commercial versus investment -- getting a sense for where your exposure is and the different types of buyers you might have.

Sure.

First of all with respect to pricing, price changes were not a material component of third-quarter performance at KMV.

The pricing for that business is largely subscription-based, and so we are recognizing revenue for sales in the subscription part of business over the previous 12-month period.

But we did not engage in any significant pricing adjustments in the third quarter for that business.

In terms of the business by verticals, I think you know that the bank sector of that business, particularly the large bank sector, has been -- in the U.S. has been the historical core of that business.

And that's actually part of the reason why you see the difference in U.S. growth versus international growth.

The penetration of the U.S. market is more mature in the banking sector.

And there has also been some merger and acquisition activity throughout 2005, and that has resulted in once the banks merge and cancellation of two subscriptions in favor of one subscription.

It also, I think importantly, explains the growth that we had internationally, because we have been able to expand the business into the large and medium-sized banks internationally, which was not as heavily penetrated.

And in addition, we have found a good appetite for purchase of the credit decisioning software, credit processing software for banks internationally.

And this includes both Europe and Asia.

Maybe a follow-up on the pricing question.

That business -- I would imagine the renewals are somewhat spread out through the year.

The opportunity to raise prices upon the renewal date or at renewal time, or even off cycle renewals -- how should we think about that as we look into Q4 or into '06 for you guys?

Frankly, I think the ability to generate a lot of growth out of price increases in that sector is probably limited.

And there are certainly some areas of the business where we think the value proposition is sufficiently strong where we do see opportunities, but that is not a statement that I think would be fair to apply across the board or to the majority of the outstanding subscriptions.

And then a final question on kind of comparative momentum if you look at the first three or four weeks of this quarter versus standing in the same spot last quarter.

If there is a way you can characterize your level of confidence looking at the pipeline of deals or issuance thus far.

I'm just trying to get a sense of visibility as you start the quarter, relative to where you have been at similar points in the past.

I attempted to get in this a little bit before, but I'll take another stab at it.

The visibility is better on the company ratings side of the business.

And it also -- we do not tend to see the kind of uplift from issuance activity late in the year that we might early in the year because of capping under our frequent issuer pricing programs in both the corporate sector and particularly in the financial institutions sector.

So, we are less volume-sensitive in those sectors, particularly as we move through the year and hit price caps for large active issuers.

In the structured finance business, again, the pipeline is really pretty good right now.

It is off the peaks that we saw in the residential mortgage and home equity sector, but it is still strong.

And it is strong in commercial mortgage-backed securities and derivatives.

I hope that what we are seeing in the pipeline in fact moves through into the market as rates slowly move upward, but we will have to see.

(OPERATOR INSTRUCTIONS).

Jim Baker, Neuberger Berman.

I just had a couple of quick ones.

One, on the dividend versus share repurchase policy, I was just wondering if you could inform us a little bit as to the board's thinking on that matter.

It's very commendable, I think, that you're doing this systematic share repurchase.

But, I am wondering whether -- two questions on the dividend.

Why are you paying one at all -- it's so nominal -- if you are really sort of favoring share repurchase much more?

Or B., could this -- maybe the uncertainty about the future tax law -- is that affecting your thinking?

That's question number one.

Also, could you give a segment breakdown among the KMV and research and ratings segments for operating profit for the third quarter of '05 and '04?

And finally, you do have a foreign exchange gain in this quarter that I think you have been racking up losses there with your hedging programs.

It looks like you might have had a gain this quarter.

So, that's it.

Jim, it's Linda.

Let me take the dividend question first and then I will flip it back over to Ray for the KMV information, and then I'll come back and answer you on the FX issue.

We have thought quite a bit about the interplay of share repurchase and dividend.

We have a couple of thoughts regarding why we have chosen to keep the dividend where it is.

First of all, it is important that we pay a dividend so that different types of funds are able to invest in Moody's stock.

So, it's important that we pay at least some nominal dividend.

(technical difficulty)

-- and we don't get quite the difficulty in constantly having to ask to change programs as we would with a dividend.

Secondly, you are right; it's very hard to tell in 2008 what will happen with the tax rate on dividends.

From what we can see from our advisors, that may change.

And, obviously, to raise your dividend in the face of more prohibitive tax rates would probably not be a good thing to do.

So, again, the goal here is to get the value back to the shareholders in the most efficient way possible.

We think that is best performed through repurchases.

And as a growth stock -- and we think we have been a pretty highly-performing growth stock -- we think that our nominal dividend suits us just fine.

So, I hope that answers your question there.

And I will flip it over to Ray for KMV.

Sure.

I think as you know, the KMV business operates at a far lower margin than the Moody's Investors Service ratings and research business, so we have encouraged KMV to invest for top-line growth.

So, our preference would be to see top-line growth in that business if we can get it rather than focusing on the bottom-line.

Although if top-line growth slows beyond a point where we don't think further investments will be (technical difficulty) for that, we certainly will pay more attention to the bottom-line.

So with that introductory comment, in terms of operating income, the Moody's KMV business is really just a low single-digit percent contributor to overall operating growth for Moody's Corporation.

Okay.

I think last year you had about -- if memory serves -- about $500,000 of operating profit at KMV.

What would it have been this year in the third quarter?

For the third quarter it would be about $4 million.

So that's quite an improvement then.

Yes.

To what would you attribute that, Ray?

It's still small, but it's quite an improvement, yes.

What would you attribute that to?

Do you think maybe you're getting some operating leverage in some of the past investments?

Well, that and I guess as I implied without saying directly in my introductory comment, to the extent that we are not getting the top-line growth from KMV that we would have anticipated in prior years, we are paying relatively more attention to the bottom-line.

And we want to make sure that we are satisfied with the business' ability to contribute to Moody's financial performance, ideally on the top-line and the bottom-line, but we have more control over the bottom-line and we're managing those expenses.

I see.

That makes sense and that is good to hear.

Just lastly on that foreign exchange issue.

Jim, I think we would call your attention to page two of the earnings release where we say that the favorable impact of currency translation mainly due to the strength of the Euro, that contributed 60 basis points to revenue growth, 70 basis points to operating growth in the quarter.

We are quite clear, though, that should the situation change we may not face a gain situation, and may in fact move into a slight loss situation for the fourth quarter.

I think we had mentioned perhaps a few million dollars that we might be harmed by changes in currency movements.

Also as a point of clarification, we do not at this point hedge our foreign currency exposure, though that is something that we have to study up on a bit more as we become more international in nature.

I guess I -- maybe you misunderstood the -- I had a -- I was really referring to the foreign exchange gain or loss that you record within other income and expense below the line, which maybe is translation;

I don't know what generates that.

But it's been showing a loss in the first couple of quarters.

I think I have a sense that maybe that was a gain this quarter.

You know what I'm referring to?

Yes.

We -- in fact, I'm sorry if I more fully answered your question than perhaps I should have.

But we had a loss, yes, of $3.8 million previously.

And in fact (technical difficulty) but in the third quarter we have shown a gain of $400,000.

And we will delve a bit more into exactly where that is coming from, and happy to get back to you after the call.

There appear be no further questions.

I'll turn things back to you, Mr. McDaniel, for closing remarks.

I just want to thank everyone for joining us and we look forward to speaking to you at year-end again.

Thank you.

Thanks.

That will conclude today's conference call.

You may now disconnect at this time.