MOODY'S CORPORATION
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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(Mark One) |
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended June 30, 2005 |
or |
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period
from to |
Commission file number 1-14037
Moodys Corporation
(Exact name of registrant as specified in its charter)
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Delaware
(State of Incorporation) |
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13-3998945
(I.R.S. Employer
Identification No.) |
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99 Church Street,
New York, N.Y.
(Address of Principal Executive Offices)
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10007
(Zip Code) |
Registrants telephone number, including area code:
(212) 553-0300
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Sections 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange
Act). Yes þ No o
Indicate the number of shares outstanding of each of the
issuers classes of common stock, as of the latest
practicable date:
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Title of Each Class |
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Shares Outstanding at June 30, 2005 |
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Common Stock, par value $0.01 per share |
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300.9 million |
MOODYS CORPORATION
INDEX TO FORM 10-Q
2
PART I. FINANCIAL INFORMATION
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Item 1. |
Financial Statements |
MOODYS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months | |
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Six Months Ended | |
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Ended June 30, | |
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June 30, | |
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2005 | |
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2004 | |
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2005 | |
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2004 | |
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(Amounts in millions, except per share data) | |
Revenue
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$ |
446.8 |
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$ |
357.6 |
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$ |
837.3 |
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$ |
688.8 |
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Expenses
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Operating, selling, general and administrative
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185.3 |
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149.4 |
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354.7 |
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289.4 |
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Depreciation and amortization
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8.7 |
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8.7 |
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17.3 |
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17.0 |
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Total expenses
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194.0 |
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158.1 |
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372.0 |
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306.4 |
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Operating income
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252.8 |
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199.5 |
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465.3 |
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382.4 |
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Interest and other non-operating expense, net
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(3.9 |
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(6.4 |
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(9.1 |
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(11.4 |
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Income before provision for income taxes
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248.9 |
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193.1 |
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456.2 |
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371.0 |
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Provision for income taxes
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103.5 |
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89.6 |
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192.1 |
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164.0 |
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Net income
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$ |
145.4 |
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$ |
103.5 |
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$ |
264.1 |
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$ |
207.0 |
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Earnings per share
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Basic
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$ |
0.48 |
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$ |
0.35 |
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$ |
0.88 |
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$ |
0.69 |
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Diluted
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$ |
0.47 |
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$ |
0.34 |
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$ |
0.86 |
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$ |
0.68 |
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Weighted average shares outstanding
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Basic
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300.4 |
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297.8 |
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299.7 |
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298.0 |
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Diluted
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307.7 |
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304.3 |
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306.9 |
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304.4 |
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The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
MOODYS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
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June 30, | |
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December 31, | |
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2005 | |
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2004 | |
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(Amounts in millions, | |
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except share and | |
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per share data) | |
ASSETS |
Current assets:
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Cash and cash equivalents
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$ |
930.8 |
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$ |
606.1 |
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Accounts receivable, net of allowances of $13.1 in 2005 and
$14.6 in 2004
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379.4 |
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371.7 |
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Other current assets
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60.5 |
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58.1 |
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Total current assets
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1,370.7 |
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1,035.9 |
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Property and equipment, net
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45.7 |
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45.2 |
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Prepaid pension costs
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58.0 |
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59.7 |
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Goodwill
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131.7 |
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131.7 |
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Intangible assets, net
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67.4 |
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70.7 |
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Other assets
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50.8 |
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46.1 |
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Total assets
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$ |
1,724.3 |
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$ |
1,389.3 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
Current liabilities:
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Notes payable
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$ |
300.0 |
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$ |
300.0 |
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Accounts payable and accrued liabilities
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251.7 |
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283.8 |
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Deferred revenue
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291.5 |
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266.7 |
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Total current liabilities
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843.2 |
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850.5 |
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Non-current portion of deferred revenue
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62.6 |
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54.4 |
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Other liabilities
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176.4 |
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166.9 |
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Total liabilities
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1,082.2 |
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1,071.8 |
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Contingencies (Note 8)
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Shareholders equity:
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Preferred stock, par value $.01 per share;
10,000,000 shares authorized; no shares issued
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Series common stock, par value $.01 per share;
10,000,000 shares authorized; no shares issued
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Common stock, par value $.01 per share;
1,000,000,000 shares authorized; 342,902,272 shares
issued at June 30, 2005 and December 31, 2004
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3.4 |
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3.4 |
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Capital surplus
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198.4 |
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142.3 |
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Retained earnings
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1,175.5 |
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939.3 |
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Treasury stock, at cost; 42,022,642 and 45,078,230 shares
of common stock at June 30, 2005 and December 31,
2004, respectively
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(737.4 |
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(777.2 |
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Accumulated other comprehensive income
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2.2 |
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9.7 |
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Total shareholders equity
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642.1 |
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317.5 |
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Total liabilities and shareholders equity
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$ |
1,724.3 |
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$ |
1,389.3 |
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The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
MOODYS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Six Months Ended | |
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June 30, | |
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2005 | |
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2004 | |
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(Amounts in millions) | |
Cash flows from operating activities
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Net income
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$ |
264.1 |
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$ |
207.0 |
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Reconciliation of net income to net cash provided by operating
activities:
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Depreciation and amortization
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17.3 |
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17.0 |
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Stock-based compensation expense
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29.2 |
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12.4 |
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Tax benefits from exercise of stock options
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33.4 |
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27.1 |
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Changes in assets and liabilities:
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Accounts receivable
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(9.6 |
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(24.1 |
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Other current assets
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(0.8 |
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(1.4 |
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Prepaid pension costs
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1.7 |
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0.3 |
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Other assets
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(6.5 |
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26.0 |
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Accounts payable and accrued liabilities
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(27.1 |
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(32.6 |
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Deferred revenue
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33.7 |
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40.0 |
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Other liabilities
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10.2 |
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(38.5 |
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Net cash provided by operating activities
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345.6 |
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233.2 |
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Cash flows from investing activities
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Capital additions
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(11.7 |
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(11.4 |
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Purchases of marketable securities
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(13.0 |
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(12.0 |
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Sales of marketable securities
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9.1 |
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8.3 |
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Net cash used in connection with investments in affiliates
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(3.9 |
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(3.1 |
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Net cash used in investing activities
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(19.5 |
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(18.2 |
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Cash flows from financing activities
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Proceeds from stock plans
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52.5 |
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57.2 |
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Cost of treasury shares repurchased
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(19.2 |
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(186.2 |
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Payment of dividends
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(27.8 |
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(22.4 |
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Payments under capital lease obligations
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(0.6 |
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(0.6 |
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Net cash provided by (used in) financing activities
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4.9 |
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(152.0 |
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Effect of exchange rate changes on cash and cash equivalents
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(6.3 |
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0.2 |
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Increase in cash and cash equivalents
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324.7 |
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63.2 |
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Cash and cash equivalents, beginning of the period
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606.1 |
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269.1 |
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Cash and cash equivalents, end of the period
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$ |
930.8 |
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$ |
332.3 |
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The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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1. |
DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION |
Moodys Corporation (Moodys or the
Company) is a provider of (i) credit ratings,
research and analysis covering fixed income securities, other
debt instruments and the entities that issue such instruments in
the global capital markets, and (ii) quantitative credit
assessment services, credit training services and credit
processing software to banks and other financial institutions.
Moodys operates in two reportable segments: Moodys
Investors Service and Moodys KMV. Moodys Investors
Service publishes rating opinions on a broad range of credit
obligations issued in domestic and international markets,
including various corporate and governmental obligations,
structured finance securities and commercial paper programs, as
well as rating opinions on issuers of credit obligations. It
also publishes investor-oriented credit research, including
in-depth research on major debt issuers, industry studies,
special comments and credit opinion handbooks. The Moodys
KMV business develops and distributes quantitative credit risk
assessment services and credit processing software for banks and
investors in credit-sensitive assets.
The Company operated as part of The Dun & Bradstreet
Corporation (Old D&B) until September 30,
2000 (the Distribution Date), when Old D&B
separated into two publicly traded companies
Moodys Corporation and The New D&B Corporation
(New D&B). At that time, Old D&B distributed
to its shareholders shares of New D&B stock. New D&B
comprised the business of Old D&Bs Dun &
Bradstreet operating company (the D&B Business).
The remaining business of Old D&B consisted solely of the
business of providing ratings and related research and credit
risk management services and was renamed Moodys
Corporation. The method by which Old D&B distributed
to its shareholders its shares of New D&B stock is
hereinafter referred to as the 2000 Distribution.
For purposes of governing certain ongoing relationships between
the Company and New D&B after the 2000 Distribution and to
provide for an orderly transition, the Company and New D&B
entered into various agreements including a Distribution
Agreement (the 2000 Distribution Agreement), Tax
Allocation Agreement, Employee Benefits Agreement, Shared
Transaction Services Agreement, Insurance and Risk Management
Services Agreement, Data Services Agreement and Transition
Services Agreement.
These interim financial statements have been prepared in
accordance with the instructions to Form 10-Q and should be
read in conjunction with the Companys consolidated
financial statements and related notes in the Companys
2004 annual report on Form 10-K filed with the Securities
and Exchange Commission on March 8, 2005. The results of
interim periods are not necessarily indicative of results for
the full year or any subsequent period. In the opinion of
management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of
financial position, results of operations and cash flows at the
dates and for the periods presented have been included. Included
in other current assets are short term investments of
$13.9 million and $7.3 million at June 30, 2005
and December 31, 2004, respectively. Included in accounts
payable and accrued liabilities are prepaid fees received in
advance of the issuance or monitoring of a rating. Such amounts
were $8.8 million and $13.3 million at June 30,
2005 and December 31, 2004, respectively. Certain prior
year amounts have been reclassified to conform to the current
year presentation.
In February 2005, Moodys Board of Directors declared a
two-for-one stock split to be effected as a special stock
distribution of one share of common stock for each share of the
Companys common stock outstanding, subject to stockholder
approval of a charter amendment to increase the Companys
authorized common shares from 400 million shares to
1 billion shares. At the Companys Annual Meeting on
April 26, 2005, Moodys stockholders approved the
charter amendment. As a result, stockholders of record as of the
close of business on May 4, 2005 received one additional
share of common stock for each share of the Companys
common stock held on that date. Such additional shares were
distributed on May 18, 2005. All prior period share and
option information have been restated to reflect the stock split.
6
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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2. |
STOCK-BASED COMPENSATION |
On January 1, 2003, the Company adopted, on a prospective
basis, the fair value method of accounting for stock-based
compensation under Statement of Financial Accounting Standards
(SFAS) No. 123. Therefore, employee stock
awards granted on and after January 1, 2003 are being
expensed by the Company over the vesting period (or sooner if
employees are at or near retirement eligibility) based on the
estimated fair value of the award on the date of grant. In
addition, shares issued to participants in the Companys
employee stock purchase plan are being expensed by the Company
based on the discount from the market price received by the
participants.
The condensed consolidated statements of operations include
pre-tax compensation expense of $12.3 million and
$29.2 million for the three and six month periods ended
June 30, 2005, respectively; and $7.2 million and
$12.4 million for the three and six month periods ended
June 30, 2004, respectively, related to stock awards
granted and stock issued under the employee stock purchase plan
since January 1, 2003. The 2005 amount includes
approximately $9.1 million pre-tax recorded in the first
quarter of 2005 relating to the accelerated expensing of equity
grants for employees who are at or near retirement eligibility
as defined in the related Company stock plans. The 2005 and 2004
expense is less than that which would have been recognized if
the fair value method had been applied to all awards since the
original effective date of SFAS No. 123 rather than
being applied prospectively. Had the Company determined such
stock-based compensation expense using the fair value method
provisions of SFAS No. 123 since its original
effective date, Moodys net income and earnings per share
would have been reduced to the pro forma amounts shown below.
The pro forma amounts for the six months ended June 30,
2005 include the effect of the $9.1 million charge
discussed above.
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Three Months | |
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Six Months | |
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Ended June 30, | |
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Ended June 30, | |
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2005 | |
|
2004 | |
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2005 | |
|
2004 | |
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(In millions, except | |
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(In millions, except | |
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per share data) | |
|
per share data) | |
Net income:
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As reported
|
|
$ |
145.4 |
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|
$ |
103.5 |
|
|
$ |
264.1 |
|
|
$ |
207.0 |
|
|
Add: Stock-based compensation expense included in reported net
income, net of tax
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|
7.7 |
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|
4.4 |
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|
17.7 |
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|
7.5 |
|
|
Deduct: Stock-based compensation expense determined under the
fair value method, net of tax
|
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|
(8.9 |
) |
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(7.6 |
) |
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(20.6 |
) |
|
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(13.9 |
) |
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Pro forma net income
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$ |
144.2 |
|
|
$ |
100.3 |
|
|
$ |
261.2 |
|
|
$ |
200.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported
|
|
$ |
0.48 |
|
|
$ |
0.35 |
|
|
$ |
0.88 |
|
|
$ |
0.69 |
|
|
Pro forma
|
|
$ |
0.48 |
|
|
$ |
0.34 |
|
|
$ |
0.87 |
|
|
$ |
0.67 |
|
Diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported
|
|
$ |
0.47 |
|
|
$ |
0.34 |
|
|
$ |
0.86 |
|
|
$ |
0.68 |
|
|
Pro forma
|
|
$ |
0.47 |
|
|
$ |
0.33 |
|
|
$ |
0.85 |
|
|
$ |
0.67 |
|
The pro forma disclosures shown above are not representative of
the effects on net income and earnings per share in future years.
7
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The fair value of stock options used to compute the pro forma
net income and earnings per share disclosures is the estimated
present value at grant date using the Black-Scholes
option-pricing model. The following weighted average assumptions
were used for options granted during the three and six months
ended June 30, 2005 and 2004.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months | |
|
Six Months | |
|
|
Ended June 30, | |
|
Ended June 30, | |
|
|
| |
|
| |
|
|
2005 | |
|
2004 | |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
| |
|
| |
Expected dividend yield
|
|
|
0.54 |
% |
|
|
0.46 |
% |
|
|
0.53 |
% |
|
|
0.46 |
% |
Expected stock volatility
|
|
|
23 |
% |
|
|
30 |
% |
|
|
23 |
% |
|
|
30 |
% |
Risk-free interest rate
|
|
|
4.29 |
% |
|
|
2.96 |
% |
|
|
4.07 |
% |
|
|
3.23 |
% |
Expected holding period
|
|
|
6 yrs |
|
|
|
5 yrs |
|
|
|
6 yrs |
|
|
|
5 yrs |
|
The estimated weighted average fair value of Moodys
options granted during the six months ended June 30, 2005
and 2004 was $12.50 and $9.98, respectively. The estimated
weighted average fair value of Moodys options granted
during the three months ended June 30, 2005 and 2004 was
$12.29 and $10.70, respectively.
At the Distribution Date, all unexercised Old D&B stock
options were converted into separately exercisable options of
Moodys and New D&B. The 2000 Distribution Agreement
provided that, for subsequent exercises of those options, the
issuer of the stock rather than the employer would be entitled
to the related tax deduction. Accordingly, from the Distribution
Date through the 2002 tax year, Moodys claimed tax
deductions when employees of New D&B exercised Moodys
stock options.
Beginning with stock option exercises in 2003, Moodys has
changed its tax deductions to conform to an IRS ruling, which
clarified that the employer should take the tax deduction for
option exercises rather than the issuer. The 2000 Distribution
Agreement entitles Moodys to reimbursement from New
D&B for the resulting loss of the issuer-based tax
deductions. Accordingly, Moodys has reflected a receivable
from New D&B within other current assets on the condensed
consolidated balance sheets in the amount of $19.5 million
and $23.3 million at June 30, 2005 and
December 31, 2004, respectively. This accounting had no
impact on the results of operations. The condensed consolidated
statement of cash flows for the six months ended June 30,
2004 has been reclassified to reflect this treatment.
In December 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 123 (Revised 2004)
Share-Based Payment
(SFAS No. 123R). Under this pronouncement,
companies are required to record compensation expense for all
share-based payment award transactions granted to employees,
based on the fair value of the equity instrument at the time of
grant. This includes shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation
rights. SFAS No. 123R eliminates the ability to
account for share-based compensation transactions using APB
Opinion No. 25, Accounting for Stock Issued to
Employees, which had been allowed in
SFAS No. 123 as originally issued. In April 2005, the
Securities and Exchange Commission (SEC) allowed
public companies to delay the implementation of SFAS 123R
until the first annual period beginning after June 15,
2005. The Company plans to implement this standard effective
January 1, 2006. Because the Company adopted the fair value
method provisions of SFAS No. 123 prospectively
beginning on January 1, 2003, it does not believe that the
impact of adoption will be material to its condensed
consolidated results of operations or financial position. The
Company currently is assessing the impact of the adoption on the
classification of tax benefits from exercise of stock options
between operating and financing activities on the consolidated
statement of cash flows. However, Moodys currently
anticipates that its 2006 stock compensation expense will be
higher than its 2005 expense, in part because the Company has
been phasing in the expensing of annual stock award grants
commencing in 2003 over the current four-year stock plan vesting
period.
8
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
3. |
RECONCILIATION OF WEIGHTED AVERAGE SHARES OUTSTANDING |
Below is a reconciliation of basic shares outstanding to diluted
shares outstanding (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months | |
|
Six Months | |
|
|
Ended June 30, | |
|
Ended June 30, | |
|
|
| |
|
| |
|
|
2005 | |
|
2004 | |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
| |
|
| |
Basic
|
|
|
300.4 |
|
|
|
297.8 |
|
|
|
299.7 |
|
|
|
298.0 |
|
Dilutive effect of shares issuable under stock-based
compensation plans
|
|
|
7.3 |
|
|
|
6.5 |
|
|
|
7.2 |
|
|
|
6.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
307.7 |
|
|
|
304.3 |
|
|
|
306.9 |
|
|
|
304.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase 0.3 million common shares for the three
and six month periods ended June 30, 2005 and
0.1 million and 3.0 million common shares,
respectively, for the three and six month periods ended
June 30, 2004 were outstanding but were not included in the
computation of diluted weighted average shares outstanding
because they were antidilutive.
In December 2001, the Company increased its investment in Korea
Investors Service (KIS) to just over 50%, at a cost
of $9.6 million with a contingent payment based on KIS net
income for the three-year period ended December 31, 2004.
The $3.9 million contingent payment, which was reflected in
goodwill and accrued liabilities as of December 31, 2004,
was paid in the second quarter of 2005 and is reflected in the
Condensed Consolidated Statement of Cash Flows for the six
months ended June 30, 2005.
|
|
5. |
GOODWILL AND OTHER INTANGIBLE ASSETS |
The following table summarizes the activity in goodwill for the
periods indicated (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2005 | |
|
Year Ended December 31, 2004 | |
|
|
| |
|
| |
|
|
Moodys | |
|
|
|
Moodys | |
|
|
|
|
Investors | |
|
Moodys | |
|
|
|
Investors | |
|
Moodys | |
|
|
|
|
Service | |
|
KMV | |
|
Consolidated | |
|
Service | |
|
KMV | |
|
Consolidated | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Beginning balance
|
|
$ |
7.6 |
|
|
$ |
124.1 |
|
|
$ |
131.7 |
|
|
$ |
2.3 |
|
|
$ |
124.1 |
|
|
$ |
126.4 |
|
Additions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.9 |
|
|
|
|
|
|
|
4.9 |
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.4 |
|
|
|
|
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance
|
|
$ |
7.6 |
|
|
$ |
124.1 |
|
|
$ |
131.7 |
|
|
$ |
7.6 |
|
|
$ |
124.1 |
|
|
$ |
131.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table summarizes intangible assets at the dates
indicated (in millions):
|
|
|
|
|
|
|
|
|
|
|
June 30, | |
|
December 31, | |
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Customer lists (11.3 year original weighted average life)
|
|
$ |
58.0 |
|
|
$ |
58.0 |
|
Accumulated amortization
|
|
|
(18.6 |
) |
|
|
(15.9 |
) |
|
|
|
|
|
|
|
Net customer lists
|
|
|
39.4 |
|
|
|
42.1 |
|
|
|
|
|
|
|
|
Other amortizable intangible assets (5.6 year original
weighted average life)
|
|
|
8.2 |
|
|
|
8.2 |
|
Accumulated amortization
|
|
|
(5.7 |
) |
|
|
(5.1 |
) |
|
|
|
|
|
|
|
Net other amortizable intangible assets
|
|
|
2.5 |
|
|
|
3.1 |
|
|
|
|
|
|
|
|
Total amortizable intangible assets
|
|
|
41.9 |
|
|
|
45.2 |
|
Indefinite-lived intangible assets (MKMV trade secrets)
|
|
|
25.5 |
|
|
|
25.5 |
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$ |
67.4 |
|
|
$ |
70.7 |
|
|
|
|
|
|
|
|
Amortization expense for the six month periods ended
June 30, 2005 and 2004 was $3.3 million and
$3.5 million, respectively.
Estimated future amortization expense for intangible assets
subject to amortization is as follows (in millions):
|
|
|
|
|
Year Ending December 31, |
|
|
|
|
|
2005 (after June 30)
|
|
$ |
3.2 |
|
2006
|
|
|
6.2 |
|
2007
|
|
|
5.5 |
|
2008
|
|
|
4.5 |
|
2009
|
|
|
4.2 |
|
Thereafter
|
|
|
18.3 |
|
|
|
6. |
PENSION AND OTHER POST-RETIREMENT BENEFITS |
Moodys maintains both funded and unfunded noncontributory
defined benefit pension plans in which substantially all
U.S. employees of the Company are eligible to participate.
The plans provide defined benefits using a cash balance formula
based on years of service and career average salary.
The Company also provides certain healthcare and life insurance
benefits for retired U.S. employees. The post-retirement
healthcare plans are contributory with participants
contributions adjusted annually; the life insurance plans are
noncontributory. The accounting for the healthcare plans
anticipates future cost-sharing changes to the written plans
that are consistent with the Companys expressed intent to
fix its share of costs and require retirees to pay for all
future increases in plan costs in excess of the amount of the
per person company contribution in the year 2005.
Moodys funded and unfunded pension plans, the
post-retirement healthcare plans and the post-retirement life
insurance plans described in the preceding two paragraphs are
collectively referred to herein as the Post-Retirement
Plans. Effective at the Distribution Date, Moodys
assumed responsibility for pension and other post-retirement
benefits relating to its active employees. New D&B has
assumed responsibility for the Companys retirees and
vested terminated employees as of the Distribution Date.
In May 2004, the FASB issued FASB Staff Position
(FSP) No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of
10
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2003 (the Act). The Act provides new
government subsidies for companies that provide prescription
drug benefits to retirees. In January 2005, the Centers for
Medicare and Medicaid Services published final regulations
implementing major provisions of the Act resulting in a
reduction of approximately $0.8 million to the
Companys accumulated post-retirement benefit obligation.
The adoption of FSP 106-2 and the final regulations had no
significant effects on the Companys net periodic
post-retirement expense for the six months ended June 30,
2005.
Following are the components of net periodic expense related to
the Post-Retirement Plans for the three and six months ended
June 30, 2005 and 2004 (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Plans | |
|
Other Post-Retirement Plans | |
|
|
| |
|
| |
|
|
Three Months Ended | |
|
Three Months Ended | |
|
Three Months Ended | |
|
Three Months Ended | |
|
|
June 30, 2005 | |
|
June 30, 2004 | |
|
June 30, 2005 | |
|
June 30, 2004 | |
|
|
| |
|
| |
|
| |
|
| |
Components of net periodic expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
|
$ |
2.4 |
|
|
$ |
2.0 |
|
|
$ |
0.1 |
|
|
$ |
0.1 |
|
Interest cost
|
|
|
1.5 |
|
|
|
1.4 |
|
|
|
0.1 |
|
|
|
0.1 |
|
Expected return on plan assets
|
|
|
(2.0 |
) |
|
|
(2.0 |
) |
|
|
|
|
|
|
|
|
Amortization of net actuarial loss from earlier periods
|
|
|
0.7 |
|
|
|
0.3 |
|
|
|
|
|
|
|
|
|
Amortization of unrecognized prior service costs
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic expense
|
|
$ |
2.7 |
|
|
$ |
1.7 |
|
|
$ |
0.2 |
|
|
$ |
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Plans | |
|
Other Post-Retirement Plans | |
|
|
| |
|
| |
|
|
Six Months Ended | |
|
Six Months Ended | |
|
Six Months Ended | |
|
Six Months Ended | |
|
|
June 30, 2005 | |
|
June 30, 2004 | |
|
June 30, 2005 | |
|
June 30, 2004 | |
|
|
| |
|
| |
|
| |
|
| |
Components of net periodic expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
|
$ |
5.0 |
|
|
$ |
4.1 |
|
|
$ |
0.3 |
|
|
$ |
0.3 |
|
Interest cost
|
|
|
3.1 |
|
|
|
2.6 |
|
|
|
0.2 |
|
|
|
0.2 |
|
Expected return on plan assets
|
|
|
(4.1 |
) |
|
|
(4.0 |
) |
|
|
|
|
|
|
|
|
Amortization of net actuarial loss from earlier periods
|
|
|
1.3 |
|
|
|
0.7 |
|
|
|
|
|
|
|
|
|
Amortization of unrecognized prior service costs
|
|
|
0.2 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic expense
|
|
$ |
5.5 |
|
|
$ |
3.5 |
|
|
$ |
0.5 |
|
|
$ |
0.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company made $0.2 million and $0.1 million of
contributions to its other post-retirement plans as of
June 30, 2005 and 2004, respectively. No significant
contributions to pension plans were made during the six month
periods ended June 30, 2005 and 2004. The Company presently
anticipates contributing $6.6 million to pension plans and
$0.1 million to its other post-retirement plans during the
remainder of 2005.
11
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Subsequent to June 30, 2005, the Company will record
additional pension expense of approximately $2.7 million in
the third quarter of 2005. The expense relates to the settlement
of an unfunded pension obligation associated with the election
of a lump sum payment of pension benefits.
On October 3, 2000 the Company issued $300 million of
notes payable (the Notes) in a private placement.
The Notes have a five-year term and bear interest at an annual
rate of 7.61%, payable semi-annually. In the event that
Moodys pays all or part of the Notes in advance of their
maturity (the prepaid principal), such prepayment
will be subject to a penalty calculated based on the excess, if
any, of the discounted value of the remaining scheduled
payments, as defined in the agreement, over the prepaid
principal. At June 30, 2005 and December 31, 2004, the
Notes have been classified as current liabilities since they
mature in September 2005. Management is in the process of
evaluating refinancing and repayment alternatives for the Notes.
Interest paid under the Notes was $11.4 million for each of
the six month periods ended June 30, 2005 and 2004.
On September 1, 2004, Moodys entered into a five-year
senior, unsecured bank revolving credit facility (the
Facility) in an aggregate principal amount of
$160 million that expires in September 2009. The Facility
replaced the $80 million 5-year facility that was scheduled
to expire in September 2005 and the $80 million 364-day
facility that expired in September 2004. Interest on borrowings
under the Facility is payable at rates that are based on the
London InterBank Offered Rate plus a premium that can range from
17 basis points to 47.5 basis points depending on the
Companys ratio of total indebtedness to earnings before
interest, taxes, depreciation and amortization (Earnings
Coverage Ratio), as defined in the related agreement. At
June 30, 2005, such premium was 17 basis points. The
Company also pays quarterly facility fees, regardless of
borrowing activity under the Facility. The quarterly fees can
range from 8 basis points of the Facility amount to
15 basis points, depending on the Companys Earnings
Coverage Ratio, and were 8 basis points at June 30,
2005. Under the Facility, the Company also pays a utilization
fee of 12.5 basis points on borrowings outstanding when the
aggregate amount outstanding under the Facility exceeds 50% of
the Facility. No interest was paid under the facilities for the
three and six month periods ended June 30, 2005 and 2004 as
no borrowings were outstanding during those periods.
The Notes and the Facility (the Agreements) contain
covenants that, among other things, restrict the ability of the
Company and its subsidiaries, without the approval of the
lenders, to engage in mergers, consolidations, asset sales,
transactions with affiliates and sale-leaseback transactions or
to incur liens, as defined in the related agreements. The
Agreements also contain financial covenants that, among other
things, require the Company to maintain an interest coverage
ratio, as defined in the related agreements, of not less than 3
to 1 for any period of four consecutive fiscal quarters, and an
Earnings Coverage Ratio, as defined in the related agreements,
of not more than 4 to 1 at the end of any fiscal quarter. At
June 30, 2005, the Company was in compliance with such
covenants. Upon the occurrence of certain financial or economic
events, significant corporate events or certain other events
constituting an event of default under the Agreements, all loans
outstanding under the Agreements (including accrued interest and
fees payable thereunder) may be declared immediately due and
payable and all commitments under the Agreements may be
terminated. In addition, certain other events of default under
the Agreements would automatically result in amounts outstanding
becoming immediately due and payable and all commitments being
terminated.
Moodys total interest expense was $5.8 million for
the three months ended June 30, 2005 and 2004 and
$11.5 million for each of the six month periods ended
June 30, 2005 and 2004. Total interest income on cash and
cash equivalents was $6.2 million and $1.1 million for
the three months ended June 30, 2005 and 2004,
respectively; and $10.7 million and $2.2 million for
the six months ended June 30, 2005 and 2004, respectively.
From time to time, Moodys is involved in legal and tax
proceedings, claims and litigation that are incidental to the
Companys business, including claims based on ratings
assigned by Moodys. Moodys is also
12
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
subject to ongoing tax audits in the normal course of business.
Management periodically assesses the Companys liabilities
and contingencies in connection with these matters based upon
the latest information available. For those matters where it is
both probable that a liability has been incurred and the
probable amount of loss can be reasonably estimated, the Company
believes it has recorded appropriate reserves in the condensed
consolidated financial statements and periodically adjusts these
reserves as appropriate. In other instances, because of the
uncertainties related to both the probable outcome and amount or
range of loss, management is unable to make a reasonable
estimate of a liability, if any. As additional information
becomes available, the Company adjusts its assessments and
estimates of such liabilities accordingly.
As a result of a recently completed tax audit by Japanese taxing
authorities, operating, selling, general and administrative
expenses for the quarter included a charge of $9.4 million
for the settlement of sales tax matters related to Moodys
operations in Japan from 2000 through June 30, 2005.
Based on its review of the latest information available, in the
opinion of management, the ultimate liability of the Company in
connection with pending legal and tax proceedings, claims and
litigation will not have a material adverse effect on
Moodys financial position, results of operations or cash
flows, subject to the contingencies described below.
On May 11, 2005, Moodys received a subpoena from the
New York Attorney Generals Office seeking documents and
other information regarding (i) securities offerings
Moodys rated or sought to rate that were backed by jumbo
mortgages from prime borrowers and (ii) credit enhancement
evaluations, during the period of June 30, 2000 through
June 30, 2003. The subpoena also seeks documents and other
information regarding Moodys credit policies and
procedures since January 1, 1999.
On July 13, 2005, Moodys received a subpoena from the
New York Attorney Generals Office seeking documents and
other information regarding (i) Moodys ratings of the
financial strength and subordinated debt of reinsurance
companies and (ii) Moodys policies and practices for
rating the financial strength and subordinated debt of
reinsurance companies, including ratings that were unsolicited
or in which the issuer did not participate in the rating
process, during the period since January 1, 1997.
Moodys is currently responding to these requests and
intends to continue cooperating with the New York Attorney
Generals Office inquiries. Moodys cannot predict the
outcome of these inquiries or any effect they may have on
Moodys financial position, results of operations, or cash
flows.
Moodys also has exposure to certain potential liabilities
assumed in connection with the 2000 Distribution. These
contingencies are referred to by Moodys as Legacy
Contingencies.
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|
Information Resources, Inc. |
The following is a description of an antitrust lawsuit filed in
1996 by Information Resources, Inc. (IRI). As more
fully described below, VNU N.V., a publicly traded Dutch
company, and its U.S. subsidiaries, VNU, Inc., ACNielsen
Corporation (ACNielsen), AC Nielsen (US), Inc.
(ACN (US)), and Nielsen Media Research, Inc.
(NMR) (collectively, the VNU Parties),
have assumed exclusive joint and several liability for any
judgment or settlement of this antitrust lawsuit. As a result of
the indemnity obligation, Moodys does not have any
exposure to a judgment or settlement of this lawsuit unless the
VNU Parties default on their obligations. However, in the event
of such a default, contractual commitments undertaken by
Moodys in connection with various corporate
reorganizations since 1996 would require the Company to bear a
portion of any amount not paid by the VNU Parties. Moreover, as
described below, on February 1, 2005, the
U.S. District Court for the Southern District of New York
entered a final judgment against IRI dismissing IRIs
claims with prejudice and on the merits. On February 2,
2005, the
13
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Court entered IRIs notice of appeal to the Second Circuit.
The parties have briefed the matter before the Court of Appeals
for the Second Circuit, but a date for oral argument has not yet
been set by the Court.
In July 1996, IRI filed a complaint, subsequently amended in
1997, in the U.S. District Court for the Southern District
of New York, naming as defendants the corporation then known as
The Dun & Bradstreet Corporation (now known as R.H.
Donnelley), A.C. Nielsen Company (a subsidiary of ACNielsen) and
IMS International, Inc. (a subsidiary of the company then known
as Cognizant). At the time of the filing of the complaint, each
of the other defendants was a subsidiary of the company then
known as The Dun & Bradstreet Corporation.
The amended complaint alleges various violations of United
States antitrust laws under Sections 1 and 2 of the Sherman
Act. The amended complaint also alleges a claim of tortious
interference with a contract and a claim of tortious
interference with a prospective business relationship. These
claims relate to the acquisition by defendants of Survey
Research Group Limited (SRG). IRI alleged SRG
violated an alleged agreement with IRI when it agreed to be
acquired by defendants and that defendants induced SRG to breach
that agreement.
IRIs antitrust claims allege that defendants developed and
implemented a plan to undermine IRIs ability to compete
within the United States and foreign markets in North America,
Latin America, Asia, Europe and Australia/ New Zealand through a
series of anti-competitive practices, including: unlawfully
tying/bundling services in the markets in which defendants
allegedly had monopoly power with services in markets in which
ACNielsen competed with IRI; entering into exclusionary
contracts with retailers in certain countries to deny IRIs
access to sales data necessary to provide retail tracking
services or to artificially raise the cost of that data;
predatory pricing; acquiring foreign market competitors with the
intent of impeding IRIs efforts to expand; disparaging IRI
to financial analysts and clients; and denying IRI access to
capital necessary for it to compete.
IRI claims damage in excess of $650 million, which IRI also
asked to be trebled. IRI has filed with the Court the report of
its expert who has opined that IRI suffered damages of between
$582 million and $652 million from the
defendants alleged practices. IRI also sought punitive
damages in an unspecified amount.
On June 21, 2004, pursuant to a stipulation between IRI and
defendants, the Court ordered that certain of IRIs claims
be dismissed with prejudice from the lawsuit, including the
claims that defendants tortiously interfered with the SRG
acquisition. The Company believes that the dismissal of the
tortious interference claims also precludes any claim for
punitive damages.
On December 3, 2004, the Court entered In limine Order
No. 1, which bars IRI from arguing that
Nielsens pricing practices or discounts were illegal or
anti-competitive unless it can prove they involved prices below
short-run average variable cost, calculated without the
inclusion of Nielsens Fixed Operations
costs. On December 17, 2004, IRI issued a press
release, which said in relevant part, Without this
evidence, IRI believes that little would be left of IRIs
case to take to trial. IRI asked the Court to enter a
final judgment against it, so that it could take an immediate
appeal to the Court of Appeals for the Second Circuit.
Defendants did not object to this request. On February 1,
2005 the Court entered a final judgment dismissing IRIs
claims with prejudice and on February 2, 2005, the Court
entered IRIs notice of appeal to the Second Circuit. The
parties have briefed the matter before the Court of Appeals for
the Second Circuit, but a date for oral argument has not yet
been set by the Court.
In connection with the 1996 Distribution, NMR (then known as
Cognizant Corporation), ACNielsen and R.H. Donnelley Corporation
(Donnelley) (then known as The Dun &
Bradstreet Corporation) entered into an Indemnity and Joint
Defense Agreement (the Original Indemnity and Joint
Defense Agreement), pursuant to which they agreed to:
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allocate potential liabilities that may relate to, arise out of
or result from the IRI lawsuit (IRI
Liabilities); and |
14
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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conduct a joint defense of such action. |
In 2001, ACNielsen was acquired by VNU N.V., which assumed
ACNielsens obligations under the Original Indemnity and
Joint Defense Agreement.
Under the terms of the 1998 Distribution, Old D&B assumed
all potential liabilities of Donnelley (then known as The
Dun & Bradstreet Corporation) arising from the IRI
action and agreed to indemnify Donnelley in connection with such
potential liabilities. Under the terms of the 2000 Distribution,
New D&B undertook to be jointly and severally liable with
Moodys for Old D&Bs obligations to Donnelley
under the 1998 Distribution, including for any liabilities
arising under the Original Indemnity and Joint Defense Agreement
and arising from the IRI action itself. However, as between New
D&B and Moodys, it was agreed that under the 2000
Distribution, each of New D&B and Moodys will be
responsible for 50% of any payments required to be made to or on
behalf of Donnelley with respect to the IRI action under the
terms of the 1998 Distribution, including legal fees or expenses
related to the IRI action.
On July 30, 2004, the VNU Parties, Donnelley, Moodys,
New D&B and IMS Health Incorporated (IMS Health)
entered into an Amended and Restated Indemnity and Joint Defense
Agreement (the Amended Indemnity and Joint Defense
Agreement).
Pursuant to the Amended Indemnity and Joint Defense Agreement,
any and all IRI Liabilities incurred by Donnelley, Moodys,
New D&B or IMS Health relating to a judgment (even if not
final) or any settlement being entered into in the IRI action
will be jointly and severally assumed, and fully discharged,
exclusively by the VNU Parties. Under the Amended Indemnity and
Joint Defense Agreement, the VNU Parties have agreed to, jointly
and severally, indemnify Donnelley, Moodys, New D&B
and IMS Health from and against all IRI Liabilities to which
they become subject. As a result, the cap on ACNielsens
liability for the IRI Liabilities, which was provided for in the
Original Indemnity and Joint Defense Agreement, no longer exists
and all such liabilities are the responsibility of the VNU
Parties pursuant to the Amended Indemnity and Joint Defense
Agreement.
In addition, the Amended Indemnity and Joint Defense Agreement
provides that if it becomes necessary to post any bond pending
an appeal of an adverse judgment, then the VNU Parties shall
obtain the bond required for the appeal and shall pay the full
cost of such bond.
In connection with entering into the Amended Indemnity and Joint
Defense Agreement, Donnelley, Moodys, New D&B and IMS
Health agreed to amend certain covenants of the Original
Indemnity and Joint Defense Agreement to provide operational
flexibility for ACNielsen going forward. In addition, the
Amended Indemnity and Joint Defense Agreement includes certain
amendments to the covenants of ACNielsen (which, under the
Amended Indemnity and Joint Defense Agreement, are now also
applicable to ACN (US), which the Company understands holds
ACNielsens operating assets), which are designed to
preserve such parties claims-paying ability and protect
Donnelley, Moodys, New D&B and IMS Health. Among other
covenants, ACNielsen and ACN (US) agreed that neither they
nor any of their respective subsidiaries will incur any
indebtedness to any affiliated person, except indebtedness which
its payment will, after a payment obligation under the Amended
Indemnity and Joint Defense Agreement comes due, be conditioned
on, and subordinated to, the payment and performance of the
obligations of such parties under the Amended Indemnity and
Joint Defense Agreement. VNU N.V. has agreed to having a process
agent in New York to receive on its behalf service of any
process concerning the Amended Indemnity and Joint Defense
Agreement.
As described above, the VNU Parties have assumed exclusive
responsibility for the payment of all IRI Liabilities. However,
because liability for violations of the antitrust laws is joint
and several and because the rights and obligations relating to
the Amended Indemnity and Joint Defense Agreement are based on
contractual relationships, the failure of the VNU Parties to
fulfill their obligations under the Amended Indemnity and Joint
Defense Agreement could result in the other parties bearing all
or a portion of the IRI Liabilities. Joint and several liability
for the IRI action means that even where more than one defendant
is
15
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
determined to have been responsible for an alleged wrongdoing,
the plaintiff can collect all or part of the judgment from just
one of the defendants. This is true regardless of whatever
contractual allocation of responsibility the defendants and any
other indemnifying parties may have made, including the
allocations described above between the VNU Parties, Donnelley,
Moodys, New D&B and IMS Health.
Accordingly, and as a result of the allocations of liability
described above, in the event the VNU Parties default on their
obligations under the Amended Indemnity and Joint Defense
Agreement, each of Moodys and New D&B will be
responsible for the payment of 50% of the portion of any
judgment or settlement ultimately paid by Donnelley (which is a
defendant in the IRI action), which can be as high as all the
IRI Liabilities.
The Company is unable to predict the outcome of the IRI action
(including the appeal), or the financial condition of any of the
VNU Parties or the other defendants at the time of any such
outcome and hence the Company cannot estimate their ability to
pay potential IRI Liabilities pursuant to the Amended Indemnity
and Joint Defense Agreement or the amount of the judgment or
settlement in the IRI action. However, provided that the VNU
Parties fulfill their obligations under the Amended Indemnity
and Joint Defense Agreement, the Company believes that the
resolution of this matter, irrespective of the outcome of the
IRI action, should not materially affect Moodys financial
position, results of operations and cash flows. Accordingly, no
amount in respect of this matter has been accrued in the
Companys condensed consolidated financial statements. If,
however, IRI were to prevail in whole or in part in this action
and if Moodys is required to pay, notwithstanding such
contractual obligations, a portion of any significant settlement
or judgment, the outcome of this matter could have a material
adverse effect on Moodys financial position, results of
operations, and cash flows.
Old D&B and its predecessors entered into global tax
planning initiatives in the normal course of business, including
through tax-free restructurings of both their foreign and
domestic operations. These initiatives are subject to normal
review by tax authorities.
Pursuant to a series of agreements, as between themselves, IMS
Health and NMR are jointly and severally liable to pay one-half,
and New D&B and Moodys are jointly and severally
liable to pay the other half, of any payments for taxes,
penalties and accrued interest resulting from unfavorable IRS
rulings on certain tax matters as described in such agreements
(excluding the matter described below as Amortization
Expense Deductions for which New D&B and Moodys
are solely responsible) and certain other potential tax
liabilities, also as described in such agreements, after New
D&B and/or Moodys pays the first $137 million,
which amount was paid in connection with the matter described
below as Utilization of Capital Losses.
In connection with the 2000 Distribution and pursuant to the
terms of the 2000 Distribution Agreement, New D&B and
Moodys have, between themselves, agreed to each be
financially responsible for 50% of any potential liabilities
that may arise to the extent such potential liabilities are not
directly attributable to their respective business operations.
Without limiting the generality of the foregoing, three specific
tax matters are discussed below.
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Royalty Expense Deductions |
During the second quarter of 2003, New D&B received an
Examination Report from the IRS with respect to a partnership
transaction entered into in 1993. In this Examination Report,
the IRS stated its intention to disallow certain royalty expense
deductions claimed by Old D&B on its tax returns for the
years 1993 through 1996 (the Royalty Report). In the
first quarter of 2004, New D&B received a similar
Examination Report (the Second Royalty Report)
relating to the first quarter of 1997.
16
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
During the second quarter of 2003, New D&B also received an
Examination Report that had been issued by the IRS to the
partnership, stating the IRS intention to ignore the
partnership structure that had been established in 1993 in
connection with the above transaction, and to reallocate to Old
D&B income and expense items that had been reported in the
partnership tax return for 1996 (the Reallocation
Report). New D&B also received a similar Examination
Report (the Second Reallocation Report) issued to
the partnership with respect to the first quarter of 1997.
In June 2004, New D&B and the IRS conducted a mediation of
these issues, at which they reached a basis for settlement with
regard to the Royalty Report for 1995 and 1996, the Reallocation
Report, and certain tax refund claims made by Old D&B
related to 1995 and 1996 (the Preliminary
Settlement). The Preliminary Settlement was subject to the
execution of a formal settlement agreement. In addition, the IRS
reasserted its position that certain tax refund claims made by
Old D&B related to 1993 and 1994 may be offset by tax
liabilities relating to the above mentioned partnership formed
in 1993. New D&B disagrees with the position taken by the
IRS for 1993 and 1994 and Moodys understands that New
D&B plans to file a protest with the IRS Appeals Office. If
the protest is unsuccessful New D&B can either:
(1) abandon its tax refund claims; or (2) challenge
the IRS claim in U.S. District Court or the U.S. Court
of Federal Claims. Moodys estimates that its exposure for
the write-off of deferred tax assets related to these tax refund
claims could be up to $9 million.
As of June 30, 2004, Moodys had adjusted its reserves
for the Royalty Expense Deductions matter to $42 million to
reflect the Companys estimates of probable exposure for
the Preliminary Settlement and the other matters discussed in
the preceding paragraph. In accordance with the 1996
Distribution Agreement, New D&B was required to obtain the
consent of Moodys, IMS Health and NMR as a condition to
executing the formal settlement agreement. However, New D&B
was unable to obtain consent from IMS Health and NMR and
accordingly, New D&B and the IRS were unable to agree on the
terms of a formal settlement agreement by the November 1,
2004 deadline imposed by the IRS. As a result, the IRS withdrew
the Preliminary Settlement and Moodys had increased its
reserves for this matter in 2004 to reflect its updated
estimates of probable exposure.
As a result of continuing its dialogue with the IRS to settle
the Royalty Report and the Reallocation Report matters, in the
second quarter of 2005 New D&B agreed to a basis for
settlement on essentially the same terms as reached in the 2004
mediation. Moodys, IMS Health and NMR each consented to
the terms of the settlement and in July New D&B submitted a
closing agreement to the IRS for signature based upon these
terms. The Company will reevaluate its reserves for the Royalty
Expense Deductions at the time the IRS signs the closing
agreement.
The Company believes that, in accordance with the 1996
Distribution Agreement, if the IRS does not sign the closing
agreement, IMS Health and NMR would be contractually responsible
to pay any excess amounts above the Preliminary Settlement that
may ultimately be owed with respect to tax years 1995 and 1996.
IMS Health has alleged various breaches of New D&Bs
obligations under the 1996 Distribution Agreement related to New
D&Bs management and attempted settlement of this
matter. If the parties were to fail to resolve any dispute,
Moodys understands that New D&B would anticipate
commencing arbitration proceedings against IMS Health and NMR.
Based on our current understanding of the positions which New
D&B and IMS Health may take, the Company believes it is
likely that New D&B should prevail, but we cannot predict
with certainty the outcome.
In addition, the Second Royalty Report and the Second
Reallocation Report, which were not part of New D&Bs
preliminary settlement with the IRS, have not been resolved.
Moodys estimates that its share of the potential required
payment to the IRS for this matter is $0.1 million
(including penalties and interest, and net of tax benefits).
17
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Moodys estimates that its share of the potential liability
for the Royalty Expense Deductions matter could be up to
$115 million, which takes into consideration: (1) the
Royalty Reports and the Reallocation Reports discussed above
(for which the Companys share of the required payments to
the IRS could be up to $106 million, including penalties
and interest, and net of tax benefits); and (2) the
potential write-off of deferred tax assets (for which the
Companys exposure could be up to $9 million as
discussed above). Moodys could also be obligated for
future interest payments on its share of such liability.
Moodys believes that the positions taken by the IRS in the
Royalty Reports and the Reallocation Reports discussed above are
inconsistent with each other. While it is possible that the IRS
could ultimately prevail in whole or in part on one of such
positions noted above, Moodys believes that it is unlikely
that the IRS will prevail on both.
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Amortization Expense Deductions |
In April 2004, New D&B received Examination Reports (the
April Examination Reports) from the IRS with respect
to a partnership transaction. This transaction was entered into
in 1997 and has resulted in amortization expense deductions on
the tax returns of Old D&B since 1997. These deductions
could continue through 2012. In the April Examination Reports,
the IRS stated its intention to disallow the amortization
expense deductions related to this partnership that were claimed
by Old D&B on its 1997 and 1998 tax returns. New D&B
disagrees with the position taken by the IRS and can either:
(1) accept and pay the IRS assessment; (2) challenge
the assessment in U.S. Tax Court; or (3) challenge the
assessment in U.S. District Court or the U.S. Court of
Federal Claims, where in either case payment of the disputed
amount would be required in connection with such challenge. IRS
audits of Old D&Bs or New D&Bs tax returns
for years subsequent to 1998 could result in the issuance of
similar Examination Reports, in which case New D&B would
also have the aforementioned three courses of action.
Should any such payments be made by New D&B related to
either the April Examination Reports or any potential
Examination Reports for future years, including years subsequent
to the separation of Moodys from New D&B, then
pursuant to the terms of the 2000 Distribution Agreement,
Moodys would have to pay to New D&B its 50% share. In
addition, should New D&B discontinue claiming the
amortization deductions on future tax returns, Moodys
would be required to repay to New D&B an amount equal to the
discounted value of its 50% share of the related future tax
benefits. New D&B had paid the discounted value of 50% of
the future tax benefits from this transaction in cash to
Moodys at the Distribution Date. Moodys estimates
that the Companys current potential exposure could be up
to $98 million (including penalties and interest, and net
of tax benefits). This exposure could increase by approximately
$3 million to $6 million per year, depending on
actions that the IRS may take and on whether New D&B
continues claiming the amortization deductions on its tax
returns.
In the April Examination Reports, the IRS also stated its
intention to disallow certain royalty expense deductions claimed
by Old D&B on its 1997 and 1998 tax returns with respect to
the partnership transaction. In addition, the IRS stated its
intention to disregard the partnership structure and to
reallocate to Old D&B certain partnership income and expense
items that had been reported in the partnership tax returns for
1997 and 1998. New D&B disagrees with the positions taken by
the IRS and can take any of the three courses of action
described in the first paragraph of this Amortization
Expense Deductions section. IRS audits of Old
D&Bs or New D&Bs tax returns for years
subsequent to 1998 could result in the issuance of similar
Examination Reports for the subsequent years. Should any such
payments be made by New D&B related to either the April
Examination Reports or any potential Examination Reports for
future years, then pursuant to the terms of the 2000
Distribution Agreement, Moodys would have to pay to New
D&B its 50% share of New D&Bs payments to the IRS
for the period from 1997 through the Distribution Date.
Moodys estimates that its share of the potential exposure
to the IRS for the potential disallowance of royalty expense
deductions could be up to $131 million (including penalties
and interest, and net of tax benefits). Moodys also could
be obligated for future interest payments on its share of such
liability.
18
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
New D&B had filed protests with the IRS Appeals Office
regarding the April Examination Reports. In September 2004, the
IRS Appeals Office remanded the case to the IRS examination
office for further development of the issues. New D&B has
reopened discussion of the issues with the examination office.
On May 6, 2005 New D&B received a Notice of Proposed
Adjustment (Notice) from the IRS for the 1999-2002
tax years which 1) disallows amortization expense
deductions allocated from the partnership to Old D&B on its
1999 and 2000 tax returns and to New D&B on its 2000, 2001
and 2002 tax returns and 2) disallows certain royalty
expense deductions claimed by Old D&B on its 1999 and 2000
tax returns and by New D&B on its 2000, 2001 and 2002 tax
returns. Moodys is in the process of assessing the
potential exposure related to the Notice. Currently, the Company
does not expect that this Notice will have a material impact on
the legacy tax reserves and the potential future outlays related
to legacy tax matters that are discussed below in Summary
of Moodys Exposure to Three Legacy Tax Matters.
Moodys believes that the IRS proposed assessments of
tax against Old D&B and the proposed reallocations of
partnership income and expense to Old D&B are inconsistent
with each other. Accordingly, while it is possible that the IRS
could ultimately prevail in whole or in part on one of such
positions, Moodys believes that it is unlikely that the
IRS will prevail on both.
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Utilization of Capital Losses |
The IRS has completed its review of the utilization of certain
capital losses generated by Old D&B during 1989 and 1990. On
June 26, 2000, the IRS, as part of its audit process,
issued a formal assessment with respect to the utilization of
these capital losses.
On May 12, 2000, an amended tax return was filed by Old
D&B for the 1989 and 1990 tax years, which reflected
$561.6 million of tax and interest due. Old D&B paid
the IRS approximately $349.3 million of this amount on
May 12, 2000; 50% of such payment was allocated to
Moodys and had previously been accrued by the Company. IMS
Health informed Old D&B that it paid to the IRS
approximately $212.3 million on May 17, 2000. The
payments were made to the IRS to stop further interest from
accruing, and on September 20, 2000, Old D&B filed a
petition for a refund in the U.S. District Court.
In July 2004, New D&B and the IRS reached a basis for
settlement of all outstanding issues related to this matter and
in December 2004 executed a formal settlement agreement. New
D&B received two assessments on this matter during the first
quarter of 2005, and expects to receive the third and final
assessment in the third quarter of 2005. Moodys paid its
allocated share of the first two assessments to New D&B
consisting of cash payments of $12.8 million
($8.1 million net of expected tax benefits) and the
write-off of deferred tax assets of approximately
$9 million. Moodys remaining liability at
June 30, 2005 was approximately $0.3 million. The
amounts paid by Moodys included its share of approximately
$4 million that Moodys and New D&B believe should
have been paid by IMS Health and NMR, but were not paid by them
due to their disagreement with various aspects of New
D&Bs calculation of their respective shares of the
payments. If New D&B fails to resolve this dispute with IMS
Health and NMR, Moodys understands that New D&B
anticipates commencing arbitration proceedings against them.
Moodys believes that New D&B should prevail in its
position, but the Company cannot predict with certainty the
outcome. In the first quarter of 2005, Moodys had
increased its reserves by $2.7 million due to this
disagreement.
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Summary of Moodys Exposure to Three Legacy Tax
Matters |
The Company considers from time to time the range and
probability of potential outcomes related to the three legacy
tax matters discussed above and establishes reserves that it
believes are appropriate in light of the relevant facts and
circumstances. In doing so, Moodys makes estimates and
judgments as to future events and conditions and evaluates its
estimates and judgments on an ongoing basis.
19
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
In the first quarter of 2005, the Company recorded
$2.7 million of additional reserves relating to the
Utilization of Capital Losses matter described above. For the
first six months the Company has recorded $3.0 million of
interest expense related to its legacy tax reserves. At
June 30, 2005, Moodys total net legacy tax reserves
were $133 million (consisting of $149 million of tax
liabilities, partially offset by the expected utilization of
$16 million of deferred tax assets). The $133 million
of expected cash payments consists of $46 million of
current liabilities (reflecting the estimated cash payments
related to the Royalty Expense Deductions and Utilization of
Capital Losses matters that are expected to be made over the
next twelve months) and $87 million of non-current
liabilities.
It is possible that the legacy tax matters could be resolved in
amounts that are greater than the amounts reserved by the
Company, which could result in additional charges that may be
material to Moodys future reported results, financial
position and cash flows. Although Moodys does not believe
it is likely that the Company will ultimately be required to pay
the full amounts presently being sought by the IRS, potential
future outlays resulting from these matters could be as much as
$345 million and could increase with time as described
above. In matters where Moodys believes the IRS has taken
inconsistent positions, Moodys may be obligated initially
to pay its share of related duplicative assessments. However,
Moodys believes that ultimately it is unlikely that the
IRS would retain such duplicative payments.
Total comprehensive income was as follows:
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Three Months | |
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Six Months | |
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Ended June 30, | |
|
Ended June 30, | |
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| |
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2005 | |
|
2004 | |
|
2005 | |
|
2004 | |
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| |
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(In millions) | |
|
(In millions) | |
Net income
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|
$ |
145.4 |
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|
$ |
103.5 |
|
|
$ |
264.1 |
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|
$ |
207.0 |
|
Other comprehensive loss foreign currency
translation adjustment
|
|
|
(5.8 |
) |
|
|
(1.6 |
) |
|
|
(7.5 |
) |
|
|
(0.8 |
) |
Other comprehensive loss additional minimum pension
liability
|
|
|
|
|
|
|
(0.3 |
) |
|
|
|
|
|
|
(0.3 |
) |
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|
|
|
|
|
|
|
Total comprehensive income
|
|
$ |
139.6 |
|
|
$ |
101.6 |
|
|
$ |
256.6 |
|
|
$ |
205.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Moodys operates in two reportable segments: Moodys
Investors Service and Moodys KMV. The Company reports
segment information in accordance with SFAS No. 131,
Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 131 defines operating
segments as components of an enterprise for which separate
financial information is available that is evaluated regularly
by the chief operating decision-maker in deciding how to
allocate resources and in assessing performance.
Moodys Investors Service consists of four rating
groups structured finance, corporate finance,
financial institutions and sovereign risk, and public
finance that generate revenue principally from the
assignment of credit ratings on issuers and issues of
fixed-income obligations in the debt markets, and research,
which primarily generates revenue from the sale of
investor-oriented credit research, principally produced by the
rating groups. Given the dominance of Moodys Investors
Service to Moodys overall results, the Company does not
separately measure or report corporate expenses, nor are they
allocated to the Companys business segments. Accordingly,
all corporate expenses are included in operating income of the
Moodys Investors Service segment and none have been
allocated to the Moodys KMV segment.
Moodys KMV develops and distributes quantitative credit
assessment services for banks and investors in credit-sensitive
assets and credit processing software. Assets used solely by
Moodys KMV are separately
20
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
disclosed within that segment. All other Company assets,
including corporate assets, are reported as part of Moodys
Investors Service. Revenue by geographic area is generally based
on the location of the customer. Inter-segment sales are
insignificant and no single customer accounted for 10% or more
of total revenue.
Below are financial information by segment, Moodys
Investors Service revenue by business unit and consolidated
revenue information by geographic area, each for the three and
six month periods ended June 30, 2005 and 2004, and total
assets by segment as of June 30, 2005 and December 31,
2004 (in millions). Certain prior year amounts have been
reclassified to conform to the current presentation.
Financial Information by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2005 | |
|
Three Months Ended June 30, 2004 | |
|
|
| |
|
| |
|
|
Moodys | |
|
|
|
Moodys | |
|
|
|
|
Investors | |
|
Moodys | |
|
|
|
Investors | |
|
Moodys | |
|
|
|
|
Service | |
|
KMV | |
|
Consolidated | |
|
Service | |
|
KMV | |
|
Consolidated | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Revenue
|
|
$ |
416.2 |
|
|
$ |
30.6 |
|
|
$ |
446.8 |
|
|
$ |
326.3 |
|
|
$ |
31.3 |
|
|
$ |
357.6 |
|
Operating, selling, general and administrative expenses
|
|
|
158.9 |
|
|
|
26.4 |
|
|
|
185.3 |
|
|
|
125.4 |
|
|
|
24.0 |
|
|
|
149.4 |
|
Depreciation and amortization
|
|
|
4.6 |
|
|
|
4.1 |
|
|
|
8.7 |
|
|
|
4.6 |
|
|
|
4.1 |
|
|
|
8.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
252.7 |
|
|
|
0.1 |
|
|
|
252.8 |
|
|
|
196.3 |
|
|
|
3.2 |
|
|
|
199.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other non-operating expense, net
|
|
|
|
|
|
|
|
|
|
|
(3.9 |
) |
|
|
|
|
|
|
|
|
|
|
(6.4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
248.9 |
|
|
|
|
|
|
|
|
|
|
|
193.1 |
|
|
Provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
103.5 |
|
|
|
|
|
|
|
|
|
|
|
89.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
$ |
145.4 |
|
|
|
|
|
|
|
|
|
|
$ |
103.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2005 | |
|
Six Months Ended June 30, 2004 | |
|
|
| |
|
| |
|
|
Moodys | |
|
|
|
Moodys | |
|
|
|
|
Investors | |
|
Moodys | |
|
|
|
Investors | |
|
Moodys | |
|
|
|
|
Service | |
|
KMV | |
|
Consolidated | |
|
Service | |
|
KMV | |
|
Consolidated | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Revenue
|
|
$ |
775.4 |
|
|
$ |
61.9 |
|
|
$ |
837.3 |
|
|
$ |
629.7 |
|
|
$ |
59.1 |
|
|
$ |
688.8 |
|
Operating, selling, general and administrative expenses
|
|
|
304.2 |
|
|
|
50.5 |
|
|
|
354.7 |
|
|
|
241.9 |
|
|
|
47.5 |
|
|
|
289.4 |
|
Depreciation and amortization
|
|
|
9.0 |
|
|
|
8.3 |
|
|
|
17.3 |
|
|
|
8.7 |
|
|
|
8.3 |
|
|
|
17.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
462.2 |
|
|
|
3.1 |
|
|
|
465.3 |
|
|
|
379.1 |
|
|
|
3.3 |
|
|
|
382.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other non-operating expense, net
|
|
|
|
|
|
|
|
|
|
|
(9.1 |
) |
|
|
|
|
|
|
|
|
|
|
(11.4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
456.2 |
|
|
|
|
|
|
|
|
|
|
|
371.0 |
|
|
Provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
192.1 |
|
|
|
|
|
|
|
|
|
|
|
164.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
$ |
264.1 |
|
|
|
|
|
|
|
|
|
|
$ |
207.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Moodys Investors Service Revenue by Business Unit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months | |
|
Six Months | |
|
|
Ended June 30, | |
|
Ended June 30, | |
|
|
| |
|
| |
|
|
2005 | |
|
2004 | |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
| |
|
| |
Ratings revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Structured finance
|
|
$ |
192.4 |
|
|
$ |
135.0 |
|
|
$ |
330.9 |
|
|
$ |
251.0 |
|
|
Corporate finance
|
|
|
79.1 |
|
|
|
75.2 |
|
|
|
159.4 |
|
|
|
148.5 |
|
|
Financial institutions and sovereign risk
|
|
|
65.6 |
|
|
|
51.8 |
|
|
|
131.3 |
|
|
|
104.3 |
|
|
Public finance
|
|
|
26.2 |
|
|
|
21.9 |
|
|
|
49.4 |
|
|
|
42.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total ratings revenue
|
|
|
363.3 |
|
|
|
283.9 |
|
|
|
671.0 |
|
|
|
545.8 |
|
Research revenue
|
|
|
52.9 |
|
|
|
42.4 |
|
|
|
104.4 |
|
|
|
83.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Moodys Investors Service
|
|
$ |
416.2 |
|
|
$ |
326.3 |
|
|
$ |
775.4 |
|
|
$ |
629.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Revenue Information by Geographic Area
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months | |
|
Six Months | |
|
|
Ended June 30, | |
|
Ended June 30, | |
|
|
| |
|
| |
|
|
2005 | |
|
2004 | |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
| |
|
| |
United States
|
|
$ |
281.8 |
|
|
$ |
231.0 |
|
|
$ |
523.9 |
|
|
$ |
442.9 |
|
International
|
|
|
165.0 |
|
|
|
126.6 |
|
|
|
313.4 |
|
|
|
245.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
446.8 |
|
|
$ |
357.6 |
|
|
$ |
837.3 |
|
|
$ |
688.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2005 | |
|
December 31, 2004 | |
|
|
| |
|
| |
|
|
Moodys | |
|
|
|
Moodys | |
|
|
|
|
Investors | |
|
Moodys | |
|
|
|
Investors | |
|
Moodys | |
|
|
|
|
Service | |
|
KMV | |
|
Consolidated | |
|
Service | |
|
KMV | |
|
Consolidated | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets by segment
|
|
$ |
1,481.5 |
|
|
$ |
242.8 |
|
|
$ |
1,724.3 |
|
|
$ |
1,123.5 |
|
|
$ |
265.8 |
|
|
$ |
1,389.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11. |
RECENTLY ISSUED ACCOUNTING STANDARDS |
As discussed in Note 6, in May 2004, the FASB issued FASB
Staff Position (FSP) No. FAS 106-2,
Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of
2003 (the Act). The Act provides new
government subsidies for companies that provide prescription
drug benefits to retirees. Moodys has incorporated the
effects of the Act into the measurement of plan assets and
obligations as of December 31, 2004. In January 2005, the
Centers for Medicare and Medicaid Services published final
regulations implementing major provisions of the Act resulting
in a $0.8 million reduction to the Companys
accumulated post-retirement benefit obligation. The adoption of
FSP 106-2 and the final regulations had no significant effects
on the Companys net periodic post-retirement expense for
the six months ended June 30, 2005.
In December 2004, the FASB issued FSP No. 109-2,
Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs
Creation Act of 2004, which provides guidance under
SFAS No. 109, Accounting for Income Taxes,
with respect to recording the potential impact of the
repatriation provisions of the American Jobs Creation Act of
2004 (the Jobs Act). The Jobs Act provides for a
special one-time tax deduction relating to a portion of certain
foreign earnings that are repatriated in 2004 or 2005. The
Company plans to repatriate a portion of foreign earnings in
2005 and continues to evaluate the effects of the Jobs Act on
its consolidated results of operations and financial position.
22
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
As discussed in Note 2, in December 2004, the FASB issued
SFAS No. 123R. Under this pronouncement, companies are
required to record compensation expense for all share-based
payment award transactions granted to employees, based on the
fair value of the equity instrument at the time of grant. This
includes shares issued under employee stock purchase plans,
stock options, restricted stock and stock appreciation rights.
SFAS No. 123R eliminates the ability to account for
share-based compensation transactions using APB Opinion
No. 25, Accounting for Stock Issued to
Employees, which had been allowed in
SFAS No. 123 as originally issued. In March 2005, the
SEC issued Staff Accounting Bulletin No. 107
(SAB 107). SAB 107 expresses views of the
SEC staff regarding the interaction between this statement and
certain SEC rules. In April 2005, the SEC allowed public
companies to delay the implementation of SFAS No. 123R
until the first annual period beginning after June 15,
2005. The Company plans to implement this standard effective
January 1, 2006. Because the Company adopted the fair value
method provisions of SFAS No. 123 prospectively
beginning on January 1, 2003, it does not believe that the
impact of adoption will be material to its condensed
consolidated results of operations or financial position. The
Company currently is assessing the impact of the adoption on the
classification of tax benefits from exercise of stock options
between operating and financing activities on the consolidated
statement of cash flows. However, Moodys currently
anticipates that its 2006 stock compensation expense will be
higher than its 2005 expense, in part because the Company has
been phasing in the expensing of annual stock award grants
commencing in 2003 over the current four-year stock plan vesting
period.
In March 2005, the FASB issued FSP No. 46(R)-5,
Implicit Variable Interests under FASB Interpretation
No. 46 (revised December 2003), Consolidation of Variable
Interest Entities (FSP 46(R)-5), which
provides guidance for a reporting enterprise on whether it holds
an implicit variable interest in a variable interest entity
(VIE) or potential VIE when specific conditions
exist. FSP 46(R)-5 is effective as of the first reporting period
beginning after March 3, 2005 and, accordingly, was adopted
by the Company on April 1, 2005. The adoption did not have
a material impact on the Companys consolidated results of
operations and financial position.
In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections
(SFAS 154) which replaces Accounting Principles
Board Opinion No. 20 Accounting Changes and
SFAS No. 3, Reporting Accounting Changes in
Interim Financial Statements An Amendment of APB
Opinion No. 28. SFAS 154 provides guidance on
the accounting for and reporting of accounting changes and error
corrections. It establishes retrospective application, or the
latest practicable date, as the required method for reporting a
change in accounting principle and the reporting of a correction
of an error. SFAS 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after
December 15, 2005 and, accordingly, is required to be
adopted by the Company on January 1, 2006. The Company does
not expect that the adoption of SFAS 154 will have a
material impact on its consolidated results of operations and
financial position.
In July 2005, the FASB issued FSP No. APB 18-1,
Accounting by an Investor for Its Proportionate Share of
Accumulated Other Comprehensive Income of an Investee Accounted
for under the Equity Method in Accordance with APB Opinion
No. 18 upon a Loss of Significant Influence
(FSP APB 18-1), which provides guidance on how
an investor should account for its proportionate share of an
investees equity adjustments for other comprehensive
income (OCI) upon a loss of significant
influence. FSP APB 18-1 requires that an investors
proportionate share of an investees equity adjustments for
OCI should be offset against the carrying value of the
investment at the time significant influence is lost. FSP
APB 18-1 is effective as of the first reporting period
beginning after July 12, 2005 and, accordingly, will be
adopted by the Company on October 1, 2005. The adoption of
this FSP is not expected to have a material impact on the
Companys consolidated results of operations and financial
position.
23
MOODYS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On July 12, 2005, the Board of Directors of the Company
approved a quarterly dividend of $0.055 per share of
Moodys common stock, payable on September 10, 2005 to
shareholders of record at the close of business on
August 20, 2005.
24
|
|
Item 2. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |
This discussion and analysis of financial condition and results
of operations should be read in conjunction with the
Moodys Corporation condensed consolidated financial
statements and notes thereto included elsewhere in this
quarterly report on Form 10-Q.
This Managements Discussion and Analysis of Financial
Condition and Results of Operations contains Forward-Looking
Statements. See Forward-Looking Statements on
page 46 for a discussion of uncertainties, risks and other
factors associated with these statements.
The Company
Except where otherwise indicated, the terms
Moodys and the Company refer to
Moodys Corporation and its subsidiaries. Moodys is a
provider of (i) credit ratings, research and analysis
covering fixed income securities, other debt instruments and the
entities that issue such instruments in the global capital
markets, and (ii) quantitative credit assessment services,
credit training services and credit processing software to banks
and other financial institutions. Moodys operates in two
reportable segments: Moodys Investors Service and
Moodys KMV (MKMV).
Moodys Investors Service publishes rating opinions on a
broad range of credit obligors and credit obligations issued in
domestic and international markets, including various corporate
and governmental obligations, structured finance securities and
commercial paper programs. It also publishes investor-oriented
credit research, including in-depth research on major issuers,
industry studies, special comments and credit opinion handbooks.
The Moodys KMV business develops and distributes
quantitative credit assessment products and services for banks
and investors in credit-sensitive assets and credit processing
software.
Critical Accounting Estimates
Moodys discussion and analysis of its financial condition
and results of operations are based on the Companys
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires Moodys to make estimates and judgments that
affect reported amounts of assets and liabilities and related
disclosures of contingent assets and liabilities at the dates of
the financial statements and revenue and expenses during the
reporting periods. These estimates are based on historical
experience and on other assumptions that are believed to be
reasonable under the circumstances. On an ongoing basis,
Moodys evaluates its estimates, including those related to
revenue recognition, accounts receivable allowances,
contingencies, goodwill, pension and other post-retirement
benefits and stock-based compensation. Actual results may differ
from these estimates under different assumptions or conditions.
Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations, in the
Companys annual report on Form 10-K for the year
ended December 31, 2004, includes descriptions of some of
the judgments that Moodys makes in applying its accounting
estimates in these areas. Since the date of the annual report on
Form 10-K, there have been no material changes to the
Companys critical accounting estimates.
Operating Segments
The Moodys Investors Service business consists of four
rating groups structured finance, corporate finance,
financial institutions and sovereign risk, and public
finance that generate revenue principally from the
assignment of credit ratings on issuers and issues of
fixed-income obligations in the debt markets, and research,
which primarily generates revenue from the sale of
investor-oriented credit research, principally produced by the
rating groups. Given the dominance of Moodys Investors
Service to Moodys overall results, the Company does not
separately measure or report corporate expenses, nor are such
expenses allocated between the Companys business segments.
Accordingly, all corporate expenses are included in operating
25
income of the Moodys Investors Service segment and none
have been allocated to the Moodys KMV segment.
The Moodys KMV business develops and distributes
quantitative credit assessment products and services for banks
and investors in credit-sensitive assets and credit processing
software.
In February 2005, Moodys Board of Directors declared a
two-for-one stock split to be effected as a special stock
distribution of one share of common stock for each share of the
Companys common stock outstanding, subject to stockholder
approval of a charter amendment to increase the Companys
authorized common shares from 400 million shares to
1 billion shares. At the Companys Annual Meeting on
April 26, 2005, Moodys stockholders approved the
charter amendment. As a result, stockholders of record as of the
close of business on May 4, 2005 received one additional
share of common stock for each share of the Companys
common stock held on that date. Such additional shares were
distributed on May 18, 2005. All prior period share
information has been restated to reflect the stock split.
Certain prior year amounts have been reclassified to conform to
the current presentation.
Results of Operations
|
|
|
Three Months Ended June 30, 2005 Compared With Three
Months Ended June 30, 2004 |
Moodys revenue for the second quarter of 2005 was
$446.8 million, an increase of $89.2 million or 24.9%
from $357.6 million for the second quarter of 2004.
Moodys achieved strong revenue growth in several business
sectors, including global structured finance, European financial
institutions, global research and U.S. public finance.
Revenue in the United States was $281.8 million for the
second quarter of 2005, an increase of $50.8 million or
22.0% from $231.0 million in the second quarter of 2004.
Approximately 80% of the U.S growth was driven by
structured finance, reflecting especially strong growth in the
residential mortgage-backed and home equities securities area,
as well as in commercial mortgage-backed securities and
collateralized debt obligations (CDOs). The
U.S. financial institutions, public finance and research
areas contributed to year-to-year growth as well.
Moodys international revenue was $165.0 million in
the second quarter, an increase of $38.4 million or 30.3%
over $126.6 million in the second quarter of 2004.
International ratings revenue grew $32 million versus the
prior year, with 80% of the growth related to Europe, where
increased issuance contributed to approximately $13 million
of growth in structured finance and approximately
$11 million of growth in financial institutions. The latter
business also benefited from new ratings relationships. European
corporate finance and research contributed to growth as well.
Foreign currency translation accounted for approximately
$5 million of reported international revenue growth.
Operating, selling, general and administrative expenses were
$185.3 million in the second quarter of 2005, an increase
of $35.9 million or 24.0% from $149.4 million in the
second quarter of 2004. The largest contributor to this increase
was growth in compensation and benefits expense of
$22 million, reflecting compensation increases, increased
staffing, and higher stock-based compensation expense.
Moodys global staffing of about 2,600 employees at
June 30, 2005 was approximately 7% higher than in the
quarter ended June 30, 2004, and reflected hiring primarily
in the U.S. and European ratings businesses to support business
growth, and additional staff in the Companys finance and
technology support functions. Stock-based compensation expense
increased $5.1 million quarter over quarter. As more fully
discussed in Note 2 to the condensed consolidated financial
statements, the Company adopted the fair value method provisions
of SFAS No. 123 prospectively beginning on
January 1, 2003. The quarter over quarter increase in
expense reflects the phasing in of expense over the current
four-year equity plan vesting period and the effects of a higher
share price on the value of the 2005 equity grants. As a result
of a recently completed tax audit by Japanese taxing
authorities, expenses for the quarter included a charge of
$9.4 million for the settlement of
26
sales tax matters related to Moodys operations in Japan
from 2000 through June 30, 2005. In addition, foreign
currency translation accounted for approximately $2 million
of the year-to-year expense growth.
Second quarter operating income of $252.8 million rose
$53.3 million or 26.7% from $199.5 million in the same
period of 2004. Foreign currency translation contributed
approximately $3 million to operating income growth.
Moodys operating margin for the second quarter of 2005 was
56.6% compared to 55.8% a year earlier.
Moodys reported $3.9 million of interest and other
non-operating expense, net for the second quarter of 2005
compared with $6.4 million for the same period of 2004.
Interest expense was $5.8 million for the three months
ended June 30, 2005 and 2004 and was principally related to
Moodys $300 million of private placement debt.
Interest income was $6.2 million in the second quarter of
2005 compared to $1.1 million in the second quarter of
2004. The increase was due to a higher average investment
balance as well as an increase in the weighted average yield.
Foreign exchange losses were $3.8 million and
$1.0 million in the second quarter of 2005 and 2004,
respectively.
Moodys effective tax rate was 41.6% in the second quarter
of 2005 compared to 46.4% in the second quarter of 2004. The
second quarter of 2004 included the impact of a
$10.0 million charge related to the legacy income tax
exposures that were assumed by Moodys in connection with
the separation from the Dun & Bradstreet Corporation in
2000.
Segment Results
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Moodys Investors Service |
Revenue at Moodys Investors Service for the second quarter
of 2005 was $416.2 million, up $89.9 million or 27.6%
from $326.3 million in the second quarter of 2004. Ratings
revenue accounted for $79.4 million of the growth with
approximately 85% of that growth coming from global structured
finance and European financial institutions. Good growth was
also achieved in the smaller public finance business as well as
in research. Issuance volume, price increases and new rating
relationships were all contributors to year-to-year growth in
reported revenue. Additionally, foreign currency translation
accounted for approximately $5 million of reported revenue
growth.
Global structured finance revenue was $192.4 million for
the second quarter of 2005, an increase of $57.4 million or
42.5% from $135.0 million in the same period of 2004.
Approximately $41 million of the increase was in the U.S.,
with residential mortgage-backed (including home equity)
securities, commercial mortgage-backed securities and CDOs
contributing approximately 90% to this amount. Continuing low
mortgage interest rates and rising home values drove growth in
mortgage re-financings, new mortgages and home equity borrowing.
A strong supply of corporate loans and structured finance
securities available for securitization coupled with tight
spreads on CDOs have driven growth. International structured
finance revenue grew approximately $17 million
year-to-year, with Europe contributing approximately
$13 million based on strong issuance of asset-backed
securities and in the commercial and residential mortgage-backed
securities sectors. Foreign currency translation also
contributed $2 million to growth in international
structured finance revenue.
Revenue in the corporate finance group was $79.1 million
for the second quarter of 2005, up $3.9 million or 5.2%
from $75.2 million in the second quarter of 2004. Revenue
was essentially flat in the U.S., as issuance and price-related
revenue growth in investment grade bond ratings and bank loan
ratings was largely offset by a large decline in high yield
issuance, resulting in a 38% decline in high yield revenue. High
yield bond issuance declined in part because issuers shifted to
the leveraged loan markets for financing needs. International
corporate finance revenue increased approximately
$4 million or approximately 17%, mainly driven by increased
corporate bond issuance in Asia. Price increases also
contributed to year-to-year growth in global corporate finance
revenue.
Financial institutions and sovereign risk revenue was
$65.6 million for the second quarter of 2005, an increase
of $13.8 million or 26.6% from $51.8 million in the
second quarter of 2004. In the U.S., revenue grew approximately
$3 million, principally reflecting growth in non-issuance
related revenues and new ratings relationships. Internationally,
revenue grew approximately $11 million compared to the
prior year period,
27
primarily due to increased issuance in the banking and insurance
sectors, coupled with new ratings relationships in Europe. Price
increases also contributed to year-to-year growth in global
financial institutions revenue.
Public finance revenue was $26.2 million for the second
quarter of 2005, an increase of $4.3 million or 19.6% from
$21.9 million for the same period in 2004. Dollar issuance
in the municipal bond market increased approximately 7% versus
the same period in 2004, in part as issuers accelerated
borrowings in anticipation of higher interest rates later in the
year. Revenue growth has outpaced issuance growth primarily
because of a higher revenue yield on overall market issuance and
increased market coverage. Refinancings represented 43% of total
dollar issuance in the second quarter of 2005, versus 31% in the
same period of 2004.
Research revenue of $52.9 million for the second quarter of
2005 was $10.5 million or 24.8% higher than the
$42.4 million reported in the second quarter of 2004.
Revenue grew by approximately $4 million in the U.S. and
about $6 million internationally with Europe accounting for
around three-quarters of international growth. Credit research,
primarily on corporates and financial institutions, together
with sales of analytics and data services, accounted for
approximately $7 million of global revenue growth.
Licensing of Moodys data to customers for internal and
external use accounted for about $3 million of revenue
growth. Foreign currency translation and price increases also
contributed to year-to-year growth in reported revenue.
Moodys Investors Service operating, selling, general and
administrative expenses, including corporate expenses, were
$158.9 million for the second quarter of 2005, an increase
of $33.5 million or 26.7% from $125.4 million in the
second quarter of 2004. Compensation and benefits expense
accounted for $22 million of the expense growth. This
increase included $4.7 million related to stock-based
compensation, as discussed above. The growth also reflected
compensation increases, staffing growth primarily in the U.S.
and European ratings businesses to support business growth, and
additional staff in finance and technology support functions. As
a result of a recently completed tax audit by Japanese taxing
authorities, expenses for the second quarter of 2005 included a
charge of $9.4 million for the settlement of sales tax
matters related to Moodys operations in Japan from 2000
through June 30, 2005. Foreign currency translation
contributed approximately $2 million to year-to-year growth
in reported expenses.
Moodys Investors Service operating income of
$252.7 million for the second quarter of 2005 was up
$56.4 million or 28.7% from $196.3 million in the
second quarter of 2004. Foreign currency translation contributed
approximately $3 million to the year-to-year growth in
operating income.
Moodys KMV revenue of $30.6 million for the second
quarter of 2005 declined $0.7 million or 2.2% from
$31.3 million for the same period in 2004. MKMVs
global revenue decline was primarily due to the deferral of
revenue associated with certain contractual commitments for
future software delivery. Subscriptions revenue related to
credit risk assessment products grew by 6% more than the prior
year driven by 36% growth of MKMVs private firm product
(RiskCalctm),
but was tempered by client attrition significantly affected by
bank consolidations in both Europe and North America. In the
second quarter, international revenue accounted for 54% of
global revenue.
MKMVs operating, selling, general and administrative
expenses were $26.4 million for the second quarter of 2005,
an increase of $2.4 million or 10% from $24.0 million
in the second quarter of 2004. Second quarter 2005 expenses
included $1.2 million for stock-based compensation expense,
which was $0.4 million higher than the prior year.
Depreciation and amortization expense was $4.1 million for
the second quarter of 2005 and 2004. MKMV operating income was
$0.1 million for the second quarter of 2005 compared with
$3.2 million in the second quarter of 2004. Currency
translation did not have a significant year-to-year impact on
MKMV results.
28
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Six Months Ended June 30, 2005 Compared With Six
Months Ended June 30, 2004 |
Moodys revenue for the six months ended June 30, 2005
was $837.3 million, an increase of $148.5 million or
21.6% from $688.8 million for the first half of 2004.
Moodys achieved strong revenue growth in several business
sectors, including global structured finance, European financial
institutions, global research and public finance.
Revenue in the United States was $523.9 million for the
first half of 2005, an increase of $81.0 million or 18.3%
from $442.9 million in the first half of 2004.
Approximately 77% of the U.S. growth was driven by structured
finance, reflecting strong issuance in residential and
commercial mortgage-backed securities and CDOs.
U.S. financial institutions, research and public finance
contributed to year-to-year growth as well.
Moodys international revenue was $313.4 million in
the first half of 2005, an increase of $67.5 million or
27.5% over $245.9 million in the first half of 2004.
International ratings revenue grew approximately
$52 million versus the prior year, with approximately 85%
of the growth related to Europe where increased issuance and new
ratings relationships contributed to the approximately
$22 million of growth in financial institutions revenue.
European corporate finance, structured finance and research
contributed to growth as well. Foreign currency translation
accounted for approximately $11 million of reported
international revenue growth.
Operating, selling, general and administrative expenses were
$354.7 million in the first half of 2005, an increase of
$65.3 million or 22.6% from $289.4 million in the
first half of 2004. The largest contributor to this increase was
growth in compensation and benefits expense of $49 million,
reflecting compensation increases, increased staffing, and
higher stock-based compensation expense. Moodys global
staffing of about 2,600 employees at June 30, 2005 was
approximately 8% higher than in the six months ended
June 30, 2004, and reflected hiring in the U.S. and
European ratings businesses to support business growth, and
additional staff in finance and technology support functions.
Stock-based compensation expense increased $16.8 million
year-to-year. As more fully discussed in Note 2 to the
condensed consolidated financial statements, the Company adopted
the fair value method provisions of SFAS No. 123
prospectively beginning on January 1, 2003. The
year-to-year increase in expense reflects the phasing in of
expense over the current four-year equity plan vesting period as
annual equity grants are made, the effects of a higher share
price on the value of the 2005 equity grants versus 2004, and
approximately $9.1 million recorded in the first quarter of
2005 related to the accelerated expensing of equity grants for
employees at or near retirement eligibility. As a result of a
recently completed tax audit by Japanese taxing authorities,
expenses for the six months included a charge of
$9.4 million for the settlement of sales tax matters
related to Moodys operations in Japan from 2000 through
June 30, 2005. In addition, foreign currency translation
accounted for approximately $4 million of the year-to-year
expense growth.
First half operating income of $465.3 million rose
$82.9 million or 21.7% from $382.4 million in the same
period of 2004. Foreign currency translation contributed
approximately $7 million to operating income growth.
Moodys operating margin for the first half of 2005 was
55.6% compared to 55.5% a year earlier.
Moodys reported $9.1 million of interest and other
non-operating expense, net for the first half of 2005 compared
with $11.4 million for the same period of 2004. Interest
expense was $11.5 million for the six months ended
June 30, 2005 and 2004 and was principally related to
Moodys $300 million of private placement debt.
Interest income was $10.7 million in 2005 compared to
$2.2 million in 2004. The increase was due to a higher
average investment balance as well as an increase in the
weighted average yield. Foreign exchange losses were
$7.5 million and $1.5 million in the first half of
2005 and 2004, respectively.
Moodys effective tax rate was 42.1% in the first half of
2005 compared to 44.2% in the first half of 2004. The 2004 tax
expense included the impact of a $10.0 million charge
related to the legacy income tax exposures that were assumed in
connection with the separation from the Dun &
Bradstreet Corporation in 2000.
29
Segment Results
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Moodys Investors Service |
Revenue at Moodys Investors Service for the first half of
2005 was $775.4 million, up $145.7 million or 23.1%
from $629.7 million in the first half of 2004. Ratings
revenue accounted for $125.2 million of growth with
approximately 82% of that growth coming from global structured
finance and European financial institutions. Good growth was
also achieved in public finance as well as in research. Foreign
currency translation accounted for approximately
$11 million of reported revenue growth. Price increases
also contributed to year-to-year growth in reported revenue.
Global structured finance revenue was $330.9 million for
the first half of 2005, an increase of $79.9 million or
31.8% from $251.0 million in the same period of 2004.
Approximately $62 million of the increase was in the U.S.,
with residential and commercial mortgage-backed securities and
CDOs contributing approximately 93% of this amount. Continuing
low mortgage interest rates and rising home values drove growth
in mortgage re-financings, new mortgages and home equity
borrowing. A strong supply of corporate loans and structured
finance securities available for securitization coupled with
tight spreads on CDOs have driven growth. Record issuance drove
strong revenue growth in commercial mortgage-backed securities
during the first half of the year. International structured
finance revenue grew approximately $18 million
year-to-year, with Europe contributing approximately
$15 million of which $7 million related to commercial
mortgage-backed securities. Foreign currency translation also
contributed $4 million to growth in international
structured finance revenue.
Corporate finance revenue was $159.4 million for the first
half of 2005, up $10.9 million or 7.3% from
$148.5 million in the first half of 2004. Revenue was
essentially flat in the U.S., as 15% growth in investment-grade
issuance and growth in bank loan ratings revenue was largely
offset by a 31% decline in high yield issuance. High yield bond
issuance declined as issuers shifted to the leveraged loan
markets for financing needs while numerous large
investment-grade deals came to market in the transportation,
energy, and technology sectors. International corporate finance
revenue increased approximately $11 million or 25% mainly
due to increased corporate bond issuance. Price increases also
contributed to year-to-year growth in global corporate finance
revenue.
Revenue in the financial institutions and sovereign risk group
was $131.3 million for the first half of 2005, an increase
of $27.0 million or 25.9% from $104.3 million in the
first half of 2004. In the U.S., revenue grew approximately
$4 million, principally due to strength in insurance and
real estate sectors. Internationally, revenue grew approximately
$23 million compared to the prior year period, primarily
due to increased issuance and new ratings relationships in
Europe. European issuance was particularly strong in the
banking, insurance and sub-sovereign sectors. Price increases
also contributed to year-to-year growth in global financial
institutions revenue.
Public finance revenue was $49.4 million for the first half
of 2005, an increase of $7.4 million or 17.6% from
$42.0 million for the same period in 2004. Dollar issuance
in the municipal bond market was approximately
$209 billion, or 10% more than the same period in 2004, as
issuers accelerated borrowings in anticipation of higher
interest rates later in the year. Revenue growth outpaced
issuance largely due to a higher revenue yield on overall market
issuance as well as increased market coverage. Refinancings
represented 46% of total dollar issuance in the first half of
2005, versus 36% in the same period of 2004.
Research revenue of $104.4 million for the first half of
2005 was $20.5 million or 24.4% higher than the
$83.9 million reported in the first half of 2004. Revenue
grew by approximately $9 million in the U.S. and about
$12 million internationally with Europe accounting for 70%
of international growth. Credit research, primarily on
corporates and financial institutions, together with sales of
analytics and data services, accounted for approximately
$14 million of global revenue growth. Revenue growth from
the licensing of Moodys information to financial customers
for internal use and redistribution was $23 million in the
first half, an increase of $6 million, or 35% higher than
the prior year. Foreign currency translation and price increases
also contributed to year-to-year growth in reported revenue.
30
Moodys Investors Service operating, selling, general and
administrative expenses, including corporate expenses, were
$304.2 million for the first half of 2005, an increase of
$62.3 million or 25.8% from $241.9 million in the
first half of 2004. Compensation and benefits expense accounted
for $49 million of the expense growth. This increase
included $16.3 million related to stock-based compensation,
as discussed above. The growth also reflected compensation
increases, staffing growth in the U.S. and European ratings
businesses to support business growth, and additional staff in
finance and technology support functions. As a result of a
recently completed tax audit by Japanese taxing authorities,
expenses for the first half of 2005 included a charge of
$9.4 million for the settlement of sales tax matters
related to Moodys operations in Japan from 2000 through
June 30, 2005. Foreign currency translation contributed
approximately $4 million to year-to-year growth in reported
expenses.
Moodys Investors Service operating income of
$462.2 million for the first half of 2005 was up
$83.1 million or 21.9% from $379.1 million in the
first half of 2004. Foreign currency translation contributed
approximately $7 million to the year-to-year growth in
operating income.
Moodys KMV revenue of $61.9 million for the first
half of 2005 was $2.8 million or 4.7% more than the same
period in 2004. MKMVs revenue growth decelerated in the
second quarter due to the deferral of revenue associated with
certain contractual commitments for future software delivery.
Growth in subscriptions revenue related to credit risk
assessment products was 7% more than prior year led by 41%
growth in
RiskCalctm,
MKMVs private firm product, but was moderated by client
attrition and bank consolidations in Europe and North America.
In the first half, international revenue accounted for 55% of
global revenue.
MKMVs operating, selling, general and administrative
expenses were $50.5 million for the first half of 2005, an
increase of $3.0 million or 6.3% from $47.5 million in
the first half of 2004. First half 2005 expenses included
$2.1 million for stock-based compensation expense, which
was $0.5 million higher than the prior year. Depreciation
and amortization expense was $8.3 million for the first
half of 2005 and 2004. MKMV operating income was
$3.1 million for the first half of 2005 compared with
$3.3 million in the first half of 2004. Currency
translation did not have a significant year-to-year impact on
MKMV results.
Liquidity and Capital Resources
The Company is currently financing its operations and capital
expenditures through cash flow from operations. Net cash
provided by operating activities was $345.6 million and
$233.2 million for the six months ended June 30, 2005
and 2004, respectively.
Moodys net cash provided by operating activities in 2005
increased by $112.4 million compared with 2004.
Contributing to this growth was the increase in net income of
$57.1 million, higher non-cash stock-based compensation
expense of $16.8 million, higher tax benefits from exercise
of stock options of $6.3 million, and the accrual for the
settlement of Japanese sales tax of $9.4 million, as
discussed above in Results of Operations Total
Company Results. In addition, timing of quarterly federal,
state and international income tax payments and growth in the
tax provision in the first half of 2005 compared with 2004
contributed $29.5 million to year-to-year growth in cash
provided by operating activities. Partially offsetting this
benefit was the payment of $12.8 million related to the
settlement of legacy matters, as discussed below in
Contingencies Legacy Tax Matters.
Net cash used in investing activities was $19.5 million for
the six months ended June 30, 2005 compared with
$18.2 million for the same period of 2004. Spending for
property and equipment and for development costs for MKMVs
software products totaled $11.7 million for the first half
of 2005 compared with $11.4 million in the first half of
2004. Net investments in marketable securities totaled
$3.9 million for the first half of 2005 compared with
$3.7 million in the first half of 2004. The 2005 spending
on investments in affiliates related to the $3.9 million
contingent payment made in the second quarter related to Korea
Investors Service.
31
Net cash provided by (used in) financing activities was
$4.9 million for the six months ended June 30, 2005
compared to ($152.0) million for the six months ended
June 30, 2004. Proceeds from exercises of stock options
were $52.5 million in the 2005 period and
$57.2 million in the 2004 period. These amounts were offset
by $19.2 million and $186.2 million used for share
repurchases in the first half of 2005 and 2004, respectively,
and dividends paid of $27.8 million and $22.4 million
in the first half of 2005 and 2004, respectively.
Moodys currently expects to fund expenditures as well as
liquidity needs created by changes in working capital from
internally generated funds. The Company believes that it has the
financial resources needed to meet its cash requirements for the
next twelve months and expects to have positive operating cash
flow for fiscal year 2005. Cash requirements for periods beyond
the next twelve months will depend among other things on the
Companys profitability and its ability to manage working
capital requirements.
The Company currently intends to use a portion of its cash flow
to pay dividends, of which the Board of Directors declared a
quarterly amount of $0.055 per share on July 12, 2005
payable on September 10, 2005 to shareholders of record at
the close of business on August 20, 2005. The continued
payment of dividends at this rate, or at all, is subject to the
discretion of the Board of Directors.
The Company also currently intends to use a majority of its
remaining cash flow provided by operating activities to continue
its share repurchase program. The Company is in the process of
implementing a systematic share repurchase program which will
constitute a portion of the potential repurchase activity, as
Moodys wants to continue to be able and prepared to act
opportunistically when conditions warrant. This move to initiate
a systematic element to repurchase activities will be conducted
within the existing $600 million repurchase authorization,
of which $528 million remains. The Companys goal is
to return capital to shareholders in a way that serves their
long-term interests. As a result, Moodys share repurchase
activity will continue to vary from quarter to quarter.
In addition, the Company will from time to time consider cash
outlays for acquisitions of or investments in complementary
businesses, products, services and technologies. The Company may
also be required to make future cash outlays to pay to New
D&B its share of potential liabilities related to the legacy
tax and legal contingencies that are discussed in this
Managements Discussion and Analysis of Financial Condition
and Results of Operations under Contingencies. In
addition, management is currently evaluating refinancing and
repayment alternatives for its $300 million of notes
payable outstanding, which mature in September 2005. It is
possible that the Company may not immediately refinance these
notes when they mature, in which case their repayment would
substantially reduce the Companys cash balance. These
potential cash outlays could be material and might affect
liquidity requirements, and they could cause the Company to
pursue additional financing. There can be no assurance that
financing to meet cash requirements will be available in amounts
or on terms acceptable to the Company, if at all.
At June 30, 2005 and 2004, the Company had outstanding
$300 million of notes payable. The Company also had in
place at June 30, 2005 a $160 million bank revolving
credit facility, which replaced two $80 million facilities
that were in place at June 30, 2004. There were no
borrowings under the revolving credit facilities during 2005 or
2004.
On October 3, 2000 the Company issued $300 million of
notes payable (the Notes) in a private placement.
The Notes have a five-year term and bear interest at an annual
rate of 7.61%, payable semi-annually. In the event that
Moodys pays all or part of the Notes in advance of their
maturity (the prepaid principal), such prepayment
will be subject to a penalty calculated based on the excess, if
any, of the discounted value of the remaining scheduled
payments, as defined in the agreement, over the prepaid
principal. Management is in the process of evaluating
refinancing and repayment alternatives for the Notes when they
mature in September 2005. At June 30, 2005 and
December 31, 2004, the Notes have been classified as a
current liability.
32
On September 1, 2004, Moodys entered into a five-year
senior, unsecured revolving credit facility (the
Facility) in an aggregate principal amount of
$160 million that expires in September 2009. The Facility
replaced the $80 million 5-year facility that was scheduled
to expire in September 2005 and the $80 million 364-day
facility that expired in September 2004. Interest on borrowings
under the Facility is payable at rates that are based on the
London InterBank Offered Rate plus a premium that can range from
17 basis points to 47.5 basis points, depending on the
Companys ratio of total indebtedness to earnings before
interest, taxes, depreciation and amortization (Earnings
Coverage Ratio), as defined in the related agreement. At
June 30, 2005, such premium was 17 basis points. The
Company also pays quarterly facility fees, regardless of
borrowing activity under the Facility. The quarterly fees can
range from 8 basis points of the Facility amount to
15 basis points, depending on the Companys Earnings
Coverage Ratio, and were 8 basis points at June 30,
2005. Under the Facility, the Company also pays a utilization
fee of 12.5 basis points on borrowings outstanding when the
aggregate amount outstanding under the Facility exceeds 50% of
the Facility.
Management may consider pursuing additional long-term financing
when it is appropriate in light of cash requirements for share
repurchase and other strategic opportunities, which would result
in higher financing costs.
The Notes and the Facility (the Agreements) contain
covenants that, among other things, restrict the ability of the
Company and its subsidiaries, without the approval of the
lenders, to engage in mergers, consolidations, asset sales,
transactions with affiliates and sale-leaseback transactions or
to incur liens, as defined in the related agreements. The
Agreements also contain financial covenants that, among other
things, require the Company to maintain an interest coverage
ratio, as defined in the related agreements, of not less than 3
to 1 for any period of four consecutive fiscal quarters, and an
Earnings Coverage Ratio, as defined in the related agreements,
of not more than 4 to 1 at the end of any fiscal quarter. At
June 30, 2005, the Company was in compliance with such
covenants. Upon the occurrence of certain financial or economic
events, significant corporate events or certain other events
constituting an event of default under the Agreements, all loans
outstanding under the Agreements (including accrued interest and
fees payable thereunder) may be declared immediately due and
payable and all commitments under the Agreements may be
terminated. In addition, certain other events of default under
the Agreements would automatically result in amounts outstanding
becoming immediately due and payable and all commitments being
terminated.
Off-Balance Sheet Arrangements
At June 30, 2005, Moodys did not have any
relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as special
purpose or variable interest entities where Moodys is the
primary beneficiary, which would have been established for the
purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. As such, Moodys
is not exposed to any financing, liquidity, market or credit
risk that could arise if it had engaged in such relationships.
Contractual Obligations
As of June 30, 2005, there had not been any material
changes outside the normal course of business in Moodys
contractual obligations as presented in its annual report on
Form 10-K for the year ended December 31, 2004.
Dividends
On July 12, 2005, the Board of Directors of the Company
approved a quarterly dividend of $0.055 per share of
Moodys common stock, payable on September 10, 2005 to
shareholders of record at the close of business on
August 20, 2005.
Outlook
Moodys overall revenue and earnings growth rates for the
period were significantly above the full year growth rate
guidance the Company provided when Moodys reported first
quarter results in April. While the
33
Company does not believe the growth rates achieved in the second
quarter will be sustained through the remainder of the year,
Moodys has made a number of revisions to the outlook for
the year.
Moodys 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, Moodys
results for the year may differ from the current outlook.
In the U.S., the Company expects low to mid-teens percent
revenue growth for the ratings and research business for the
full year 2005. In the U.S. structured finance market,
Moodys now expects that revenue from rating residential
mortgage-backed and home equity securities will rise in the high
teens percent range from the record level of 2004. This is a
significant revision from the prior outlook, which anticipated
residential mortgage-backed and home equity securities revenue
declining in the high teens to twenty percent range. The Company
continues to expect good year-over-year growth in several other
sectors of U.S. structured finance, including asset-backed
securities, CDOs and commercial mortgage-backed securities, and
Moodys has trimmed expectations for asset-backed
commercial paper, where the Company now forecasts a modest
decline. Moodys now expects total U.S. structured
finance revenue to grow in the mid-teens percent range, compared
with previous forecasts which assumed revenue would decline
slightly from 2004.
In the U.S. corporate finance business, issuance in the
speculative grade bond market remains weak and will likely fall
substantially below the volume seen in 2004. The Company expects
this shortfall to be offset by stronger than expected growth in
investment grade and bank loan ratings and by revenue related to
the Enhanced Analysis Initiative, resulting in high single-digit
percent revenue growth.
In the U.S. financial institutions sector, Moodys
continues to expect that the impact of expected flat issuance
volume will be offset by revenue related to the Enhanced
Analysis Initiative and from new rating relationships, providing
low double-digit percent growth in this sector in 2005.
Based on a strong second quarter in U.S. public finance,
the Company has revised the revenue outlook for this business.
Moodys now expects public finance revenue for 2005 to
increase in the low teens percent range compared with 2004. The
Company continues to forecast strong growth in the
U.S. research business.
Outside the U.S. Moodys expects growth in ratings and
research revenue in the high teens percent range, with
double-digit percent growth in all major business lines and
regions, assisted by favorable foreign currency impacts. The
Companys projection assumes improved corporate issuance in
Europe after a relatively weak 2004 and good issuance growth in
the European financial institutions sector and several sectors
of structured finance in Europe and Japan. In addition,
Moodys expects continued strong growth in international
research revenue.
Finally, the Company expects global revenue at Moodys 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 Moodys overall, the Company expects revenue growth in
the 13% to 16% range for the full year 2005, including the
positive impact of currency translation. Moodys expects
the operating margin to be lower by up to 150 basis points
in 2005 compared with 2004. This reflects higher revenue growth
in 2005 than originally expected, offset by higher stock-based
compensation expense in 2005 compared to 2004, and by
investments the Company is continuing to make to expand
geographically, improve its analytic processes, pursue ratings
transparency and compliance initiatives, introduce new products,
and improve technology infrastructure.
For 2005, Moodys expects that year-over-year growth in
diluted earnings per share will be in the 17% to 21% range. This
expected growth includes the impacts of legacy tax provisions
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 $0.10 $0.11 per
diluted share in 2005, compared to $0.06 per
34
diluted share in 2004. The estimated 2005 expense excludes the
effects of adopting Statement of Financial Accounting Standards
No. 123R, Share-Based Payment, which
Moodys will implement effective as of January 1, 2006
based on the Securities and Exchange Commissions recent
rule allowing deferral of the implementation date.
Recently Issued Accounting Standards
In May 2004, the FASB issued FASB Staff Position
(FSP) No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (the
Act). The Act provides new government subsidies for
companies that provide prescription drug benefits to retirees.
Moodys has incorporated the effects of the Act into the
measurement of plan assets and obligations as of
December 31, 2004. In January 2005, the Centers for
Medicare and Medicaid Services published final regulations
implementing major provisions of the Act resulting in a
$0.8 million reduction to the Companys accumulated
post-retirement benefit obligation. The adoption of FSP 106-2
and the final regulations had no significant effects on the
Companys net periodic post-retirement expense for the six
months ended June 30, 2005.
In December 2004, the FASB issued FSP No. 109-2,
Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs
Creation Act of 2004, which provides guidance under
SFAS No. 109, Accounting for Income Taxes,
with respect to recording the potential impact of the
repatriation provisions of the American Jobs Creation Act of
2004 (the Jobs Act). The Jobs Act provides for a
special one-time tax deduction relating to a portion of certain
foreign earnings that are repatriated in 2004 or 2005. The
Company plans to repatriate a portion of foreign earnings in
2005 and continues to evaluate the effects of the Jobs Act on
its consolidated results of operations and financial position.
In December 2004, the FASB issued SFAS No. 123
(Revised 2004) Share-Based Payment
(SFAS No. 123R). Under this pronouncement,
companies are required to record compensation expense for all
share-based payment award transactions granted to employees,
based on the fair value of the equity instrument at the time of
grant. This includes shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation
rights. SFAS No. 123R eliminates the ability to
account for share-based compensation transactions using APB
Opinion No. 25, Accounting for Stock Issued to
Employees, which had been allowed in
SFAS No. 123 as originally issued. In March 2005, the
SEC issued Staff Accounting Bulletin No. 107
(SAB 107). SAB 107 expresses views of the
SEC staff regarding the interaction between this statement and
certain SEC rules. In April 2005, the SEC allowed public
companies to delay the implementation of SFAS No. 123R
until the first annual period beginning after June 15,
2005. The Company plans to implement this standard effective
January 1, 2006. Because the Company adopted the fair value
method provisions of SFAS No. 123 prospectively
beginning on January 1, 2003, it does not believe that the
impact of adoption will be material to its condensed
consolidated results of operations or financial position. The
Company currently is assessing the impact of the adoption on the
classification of tax benefits from exercise of stock options
between operating and financing activities on the consolidated
statement of cash flows. However, Moodys currently
anticipates that its 2006 stock compensation expense will be
higher than its 2005 expense, in part because the Company has
been phasing in the expensing of annual stock award grants
commencing in 2003 over the current four-year stock plan vesting
period.
In March 2005, the FASB issued FSP No. 46(R)-5,
Implicit Variable Interests under FASB Interpretation
No. 46 (revised December 2003), Consolidation of Variable
Interest Entities (FSP 46(R)-5), which
provides guidance for a reporting enterprise on whether it holds
an implicit variable interest in a variable interest entity
(VIE) or potential VIE when specific conditions
exist. FSP 46(R)-5 is effective as of the first reporting period
beginning after March 3, 2005 and, accordingly, was adopted
by the Company on April 1, 2005. The adoption did not have
a material impact on the Companys consolidated results of
operations and financial position.
In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections
(SFAS 154) which replaces Accounting Principles
Board Opinion No. 20 Accounting Changes and
SFAS No. 3, Reporting Accounting Changes in
Interim Financial Statements An Amendment of APB
35
Opinion No. 28. SFAS 154 provides guidance on
the accounting for and reporting of accounting changes and error
corrections. It establishes retrospective application, or the
latest practicable date, as the required method for reporting a
change in accounting principle and the reporting of a correction
of an error. SFAS 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after
December 15, 2005 and, accordingly, is required to be
adopted by the Company on January 1, 2006. The Company does
not expect that the adoption of SFAS 154 will have a
material impact on its consolidated results of operations and
financial position.
In July 2005, the FASB issued FSP No. APB 18-1,
Accounting by an Investor for Its Proportionate Share of
Accumulated Other Comprehensive Income of an Investee Accounted
for under the Equity Method in Accordance with APB Opinion
No. 18 upon a Loss of Significant Influence
(FSP APB 18-1), which provides guidance on how
an investor should account for its proportionate share of an
investees equity adjustments for other comprehensive
income (OCI) upon a loss of significant
influence. FSP APB 18-1 requires that an investors
proportionate share of an investees equity adjustments for
OCI should be offset against the carrying value of the
investment at the time significant influence is lost. FSP
APB 18-1 is effective as of the first reporting period
beginning after July 12, 2005 and, accordingly, will be
adopted by the Company on October 1, 2005. The adoption of
this FSP is not expected to have a material impact on the
Companys consolidated results of operations and financial
position.
Contingencies
From time to time, Moodys is involved in legal and tax
proceedings, claims and litigation that are incidental to the
Companys business, including claims based on ratings
assigned by Moodys. Moodys is also subject to
ongoing tax audits in the normal course of business. Management
periodically assesses the Companys liabilities and
contingencies in connection with these matters based upon the
latest information available. For those matters where it is both
probable that a liability has been incurred and the probable
amount of loss can be reasonably estimated, the Company believes
it has recorded appropriate reserves in the condensed
consolidated financial statements and periodically adjusts these
reserves as appropriate. In other instances, because of the
uncertainties related to both the probable outcome and amount or
range of loss, management is unable to make a reasonable
estimate of a liability, if any. As additional information
becomes available, the Company adjusts its assessments and
estimates of such liabilities accordingly.
As a result of a recently completed tax audit by Japanese taxing
authorities, operating, selling, general and administrative
expenses for the quarter included a charge of $9.4 million
for the settlement of sales tax matters related to Moodys
operations in Japan from 2000 through June 30, 2005.
Based on its review of the latest information available, in the
opinion of management, the ultimate liability of the Company in
connection with pending legal and tax proceedings, claims and
litigation will not have a material adverse effect on
Moodys financial position, results of operations or cash
flows, subject to the contingencies described below.
On May 11, 2005, Moodys received a subpoena from the
New York Attorney Generals Office seeking documents and
other information regarding (i) securities offerings
Moodys rated or sought to rate that were backed by jumbo
mortgages from prime borrowers and (ii) credit enhancement
evaluations, during the period of June 30, 2000 through
June 30, 2003. The subpoena also seeks documents and other
information regarding Moodys credit policies and
procedures since January 1, 1999.
On July 13, 2005, Moodys received a subpoena from the
New York Attorney Generals Office seeking documents and
other information regarding (i) Moodys ratings of the
financial strength and subordinated debt of reinsurance
companies and (ii) Moodys policies and practices for
rating the financial strength and subordinated debt of
reinsurance companies, including ratings that were unsolicited
or in which the issuer did not participate in the rating
process, during the period since January 1, 1997.
Moodys is currently responding to these requests and
intends to continue cooperating with the New York Attorney
Generals Office inquiries. Moodys cannot predict the
outcome of these inquiries or any effect they may have on
Moodys financial position, results of operations, or cash
flows.
36
Moodys also has exposure to certain potential liabilities
assumed in connection with the 2000 Distribution. These
contingencies are referred to by Moodys as Legacy
Contingencies.
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Information Resources, Inc. |
The following is a description of an antitrust lawsuit filed in
1996 by Information Resources, Inc. (IRI). As more
fully described below, VNU N.V., a publicly traded Dutch
company, and its U.S. subsidiaries, VNU, Inc., ACNielsen
Corporation (ACNielsen), AC Nielsen (US), Inc.
(ACN (US)), and Nielsen Media Research, Inc.
(NMR) (collectively, the VNU Parties),
have assumed exclusive joint and several liability for any
judgment or settlement of this antitrust lawsuit. As a result of
the indemnity obligation, Moodys does not have any
exposure to a judgment or settlement of this lawsuit unless the
VNU Parties default on their obligations. However, in the event
of such a default, contractual commitments undertaken by
Moodys in connection with various corporate
reorganizations since 1996 would require the Company to bear a
portion of any amount not paid by the VNU Parties. Moreover, as
described below, on February 1, 2005, the
U.S. District Court for the Southern District of New York
entered a final judgment against IRI dismissing IRIs
claims with prejudice and on the merits. On February 2,
2005, the Court entered IRIs notice of appeal to the
Second Circuit. The parties have briefed the matter before the
Court of Appeals for the Second Circuit, but a date for oral
argument has not yet been set by the Court.
In July 1996, IRI filed a complaint, subsequently amended in
1997, in the U.S. District Court for the Southern District
of New York, naming as defendants the corporation then known as
The Dun & Bradstreet Corporation (now known as R.H.
Donnelley), A.C. Nielsen Company (a subsidiary of ACNielsen) and
IMS International, Inc. (a subsidiary of the company then known
as Cognizant). At the time of the filing of the complaint, each
of the other defendants was a subsidiary of the company then
known as The Dun & Bradstreet Corporation.
The amended complaint alleges various violations of United
States antitrust laws under Sections 1 and 2 of the Sherman
Act. The amended complaint also alleges a claim of tortious
interference with a contract and a claim of tortious
interference with a prospective business relationship. These
claims relate to the acquisition by defendants of Survey
Research Group Limited (SRG). IRI alleged SRG
violated an alleged agreement with IRI when it agreed to be
acquired by defendants and that defendants induced SRG to breach
that agreement.
IRIs antitrust claims allege that defendants developed and
implemented a plan to undermine IRIs ability to compete
within the United States and foreign markets in North America,
Latin America, Asia, Europe and Australia/ New Zealand through a
series of anti-competitive practices, including: unlawfully
tying/bundling services in the markets in which defendants
allegedly had monopoly power with services in markets in which
ACNielsen competed with IRI; entering into exclusionary
contracts with retailers in certain countries to deny IRIs
access to sales data necessary to provide retail tracking
services or to artificially raise the cost of that data;
predatory pricing; acquiring foreign market competitors with the
intent of impeding IRIs efforts to expand; disparaging IRI
to financial analysts and clients; and denying IRI access to
capital necessary for it to compete.
IRI claims damage in excess of $650 million, which IRI also
asked to be trebled. IRI has filed with the Court the report of
its expert who has opined that IRI suffered damages of between
$582 million and $652 million from the
defendants alleged practices. IRI also sought punitive
damages in an unspecified amount.
On June 21, 2004, pursuant to a stipulation between IRI and
defendants, the Court ordered that certain of IRIs claims
be dismissed with prejudice from the lawsuit, including the
claims that defendants tortiously interfered with the SRG
acquisition. The Company believes that the dismissal of the
tortious interference claims also precludes any claim for
punitive damages.
On December 3, 2004, the Court entered In limine Order
No. 1, which bars IRI from arguing that
Nielsens pricing practices or discounts were illegal or
anti-competitive unless it can prove they involved prices
37
below short-run average variable cost, calculated without the
inclusion of Nielsens Fixed Operations
costs. On December 17, 2004, IRI issued a press
release, which said in relevant part, Without this
evidence, IRI believes that little would be left of IRIs
case to take to trial. IRI asked the Court to enter a
final judgment against it, so that it could take an immediate
appeal to the Court of Appeals for the Second Circuit.
Defendants did not object to this request. On February 1,
2005 the Court entered a final judgment dismissing IRIs
claims with prejudice and on February 2, 2005, the Court
entered IRIs notice of appeal to the Second Circuit. The
parties have briefed the matter before the Court of Appeals for
the Second Circuit, but a date for oral argument has not yet
been set by the Court.
In connection with the 1996 Distribution, NMR (then known as
Cognizant Corporation), ACNielsen and R.H. Donnelley Corporation
(Donnelley) (then known as The Dun &
Bradstreet Corporation) entered into an Indemnity and Joint
Defense Agreement (the Original Indemnity and Joint
Defense Agreement), pursuant to which they agreed to:
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allocate potential liabilities that may relate to, arise out of
or result from the IRI lawsuit (IRI
Liabilities); and |
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conduct a joint defense of such action. |
In 2001, ACNielsen was acquired by VNU N.V., which assumed
ACNielsens obligations under the Original Indemnity and
Joint Defense Agreement.
Under the terms of the 1998 Distribution, Old D&B assumed
all potential liabilities of Donnelley (then known as The
Dun & Bradstreet Corporation) arising from the IRI
action and agreed to indemnify Donnelley in connection with such
potential liabilities. Under the terms of the 2000 Distribution,
New D&B undertook to be jointly and severally liable with
Moodys for Old D&Bs obligations to Donnelley
under the 1998 Distribution, including for any liabilities
arising under the Original Indemnity and Joint Defense Agreement
and arising from the IRI action itself. However, as between New
D&B and Moodys, it was agreed that under the 2000
Distribution, each of New D&B and Moodys will be
responsible for 50% of any payments required to be made to or on
behalf of Donnelley with respect to the IRI action under the
terms of the 1998 Distribution, including legal fees or expenses
related to the IRI action.
On July 30, 2004, the VNU Parties, Donnelley, Moodys,
New D&B and IMS Health Incorporated (IMS Health)
entered into an Amended and Restated Indemnity and Joint Defense
Agreement (the Amended Indemnity and Joint Defense
Agreement).
Pursuant to the Amended Indemnity and Joint Defense Agreement,
any and all IRI Liabilities incurred by Donnelley, Moodys,
New D&B or IMS Health relating to a judgment (even if not
final) or any settlement being entered into in the IRI action
will be jointly and severally assumed, and fully discharged,
exclusively by the VNU Parties. Under the Amended Indemnity and
Joint Defense Agreement, the VNU Parties have agreed to, jointly
and severally, indemnify Donnelley, Moodys, New D&B
and IMS Health from and against all IRI Liabilities to which
they become subject. As a result, the cap on ACNielsens
liability for the IRI Liabilities, which was provided for in the
Original Indemnity and Joint Defense Agreement, no longer exists
and all such liabilities are the responsibility of the VNU
Parties pursuant to the Amended Indemnity and Joint Defense
Agreement.
In addition, the Amended Indemnity and Joint Defense Agreement
provides that if it becomes necessary to post any bond pending
an appeal of an adverse judgment, then the VNU Parties shall
obtain the bond required for the appeal and shall pay the full
cost of such bond.
In connection with entering into the Amended Indemnity and Joint
Defense Agreement, Donnelley, Moodys, New D&B and IMS
Health agreed to amend certain covenants of the Original
Indemnity and Joint Defense Agreement to provide operational
flexibility for ACNielsen going forward. In addition, the
Amended Indemnity and Joint Defense Agreement includes certain
amendments to the covenants of ACNielsen (which, under the
Amended Indemnity and Joint Defense Agreement, are now also
applicable to ACN (US), which the Company understands holds
ACNielsens operating assets), which are designed to
preserve such parties claims-paying ability and protect
Donnelley, Moodys, New D&B and IMS Health. Among other
38
covenants, ACNielsen and ACN (US) agreed that neither they
nor any of their respective subsidiaries will incur any
indebtedness to any affiliated person, except indebtedness which
its payment will, after a payment obligation under the Amended
Indemnity and Joint Defense Agreement comes due, be conditioned
on, and subordinated to, the payment and performance of the
obligations of such parties under the Amended Indemnity and
Joint Defense Agreement. VNU N.V. has agreed to having a process
agent in New York to receive on its behalf service of any
process concerning the Amended Indemnity and Joint Defense
Agreement.
As described above, the VNU Parties have assumed exclusive
responsibility for the payment of all IRI Liabilities. However,
because liability for violations of the antitrust laws is joint
and several and because the rights and obligations relating to
the Amended Indemnity and Joint Defense Agreement are based on
contractual relationships, the failure of the VNU Parties to
fulfill their obligations under the Amended Indemnity and Joint
Defense Agreement could result in the other parties bearing all
or a portion of the IRI Liabilities. Joint and several liability
for the IRI action means that even where more than one defendant
is determined to have been responsible for an alleged
wrongdoing, the plaintiff can collect all or part of the
judgment from just one of the defendants. This is true
regardless of whatever contractual allocation of responsibility
the defendants and any other indemnifying parties may have made,
including the allocations described above between the VNU
Parties, Donnelley, Moodys, New D&B and IMS Health.
Accordingly, and as a result of the allocations of liability
described above, in the event the VNU Parties default on their
obligations under the Amended Indemnity and Joint Defense
Agreement, each of Moodys and New D&B will be
responsible for the payment of 50% of the portion of any
judgment or settlement ultimately paid by Donnelley (which is a
defendant in the IRI action), which can be as high as all the
IRI Liabilities.
The Company is unable to predict the outcome of the IRI action
(including the appeal), or the financial condition of any of the
VNU Parties or the other defendants at the time of any such
outcome and hence the Company cannot estimate their ability to
pay potential IRI Liabilities pursuant to the Amended Indemnity
and Joint Defense Agreement or the amount of the judgment or
settlement in the IRI action. However, provided that the VNU
Parties fulfill their obligations under the Amended Indemnity
and Joint Defense Agreement, the Company believes that the
resolution of this matter, irrespective of the outcome of the
IRI action, should not materially affect Moodys financial
position, results of operations and cash flows. Accordingly, no
amount in respect of this matter has been accrued in the
Companys condensed consolidated financial statements. If,
however, IRI were to prevail in whole or in part in this action
and if Moodys is required to pay, notwithstanding such
contractual obligations, a portion of any significant settlement
or judgment, the outcome of this matter could have a material
adverse effect on Moodys financial position, results of
operations, and cash flows.
Old D&B and its predecessors entered into global tax
planning initiatives in the normal course of business, including
through tax-free restructurings of both their foreign and
domestic operations. These initiatives are subject to normal
review by tax authorities.
Pursuant to a series of agreements, as between themselves, IMS
Health and NMR are jointly and severally liable to pay one-half,
and New D&B and Moodys are jointly and severally
liable to pay the other half, of any payments for taxes,
penalties and accrued interest resulting from unfavorable IRS
rulings on certain tax matters as described in such agreements
(excluding the matter described below as Amortization
Expense Deductions for which New D&B and Moodys
are solely responsible) and certain other potential tax
liabilities, also as described in such agreements, after New
D&B and/or Moodys pays the first $137 million,
which amount was paid in connection with the matter described
below as Utilization of Capital Losses.
In connection with the 2000 Distribution and pursuant to the
terms of the 2000 Distribution Agreement, New D&B and
Moodys have, between themselves, agreed to each be
financially responsible for 50% of any potential liabilities
that may arise to the extent such potential liabilities are not
directly attributable to their respective business operations.
39
Without limiting the generality of the foregoing, three specific
tax matters are discussed below.
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Royalty Expense Deductions |
During the second quarter of 2003, New D&B received an
Examination Report from the IRS with respect to a partnership
transaction entered into in 1993. In this Examination Report,
the IRS stated its intention to disallow certain royalty expense
deductions claimed by Old D&B on its tax returns for the
years 1993 through 1996 (the Royalty Report). In the
first quarter of 2004, New D&B received a similar
Examination Report (the Second Royalty Report)
relating to the first quarter of 1997.
During the second quarter of 2003, New D&B also received an
Examination Report that had been issued by the IRS to the
partnership, stating the IRS intention to ignore the
partnership structure that had been established in 1993 in
connection with the above transaction, and to reallocate to Old
D&B income and expense items that had been reported in the
partnership tax return for 1996 (the Reallocation
Report). New D&B also received a similar Examination
Report (the Second Reallocation Report) issued to
the partnership with respect to the first quarter of 1997.
In June 2004, New D&B and the IRS conducted a mediation of
these issues, at which they reached a basis for settlement with
regard to the Royalty Report for 1995 and 1996, the Reallocation
Report, and certain tax refund claims made by Old D&B
related to 1995 and 1996 (the Preliminary
Settlement). The Preliminary Settlement was subject to the
execution of a formal settlement agreement. In addition, the IRS
reasserted its position that certain tax refund claims made by
Old D&B related to 1993 and 1994 may be offset by tax
liabilities relating to the above mentioned partnership formed
in 1993. New D&B disagrees with the position taken by the
IRS for 1993 and 1994 and Moodys understands that New
D&B plans to file a protest with the IRS Appeals Office. If
the protest is unsuccessful New D&B can either:
(1) abandon its tax refund claims; or (2) challenge
the IRS claim in U.S. District Court or the U.S. Court
of Federal Claims. Moodys estimates that its exposure for
the write-off of deferred tax assets related to these tax refund
claims could be up to $9 million.
As of June 30, 2004, Moodys had adjusted its reserves
for the Royalty Expense Deductions matter to $42 million to
reflect the Companys estimates of probable exposure for
the Preliminary Settlement and the other matters discussed in
the preceding paragraph. In accordance with the 1996
Distribution Agreement, New D&B was required to obtain the
consent of Moodys, IMS Health and NMR as a condition to
executing the formal settlement agreement. However, New D&B
was unable to obtain consent from IMS Health and NMR and
accordingly, New D&B and the IRS were unable to agree on the
terms of a formal settlement agreement by the November 1,
2004 deadline imposed by the IRS. As a result, the IRS withdrew
the Preliminary Settlement and Moodys had increased its
reserves for this matter in 2004 to reflect its updated
estimates of probable exposure.
As a result of continuing its dialogue with the IRS to settle
the Royalty Report and the Reallocation Report matters, in the
second quarter of 2005 New D&B agreed to a basis for
settlement on essentially the same terms as reached in the 2004
mediation. Moodys, IMS Health and NMR each consented to
the terms of the settlement and in July New D&B submitted a
closing agreement to the IRS for signature based upon these
terms. The Company will reevaluate its reserves for the Royalty
Expense Deductions at the time the IRS signs the closing
agreement.
The Company believes that, in accordance with the 1996
Distribution Agreement, if the IRS does not sign the closing
agreement, IMS Health and NMR would be contractually responsible
to pay any excess amounts above the Preliminary Settlement that
may ultimately be owed with respect to tax years 1995 and 1996.
IMS Health has alleged various breaches of New D&Bs
obligations under the 1996 Distribution Agreement related to New
D&Bs management and attempted settlement of this
matter. If the parties were to fail to resolve any dispute,
Moodys understands that New D&B would anticipate
commencing arbitration proceedings against IMS Health and NMR.
Based on our current understanding of the positions which New
D&B and IMS Health may take, the Company believes it is
likely that New D&B should prevail, but we cannot predict
with certainty the outcome.
40
In addition, the Second Royalty Report and the Second
Reallocation Report, which were not part of New D&Bs
preliminary settlement with the IRS, have not been resolved.
Moodys estimates that its share of the potential required
payment to the IRS for this matter is $0.1 million
(including penalties and interest, and net of tax benefits).
Moodys estimates that its share of the potential liability
for the Royalty Expense Deductions matter could be up to
$115 million, which takes into consideration: (1) the
Royalty Reports and the Reallocation Reports discussed above
(for which the Companys share of the required payments to
the IRS could be up to $106 million, including penalties
and interest, and net of tax benefits); and (2) the
potential write-off of deferred tax assets (for which the
Companys exposure could be up to $9 million as
discussed above). Moodys could also be obligated for
future interest payments on its share of such liability.
Moodys believes that the positions taken by the IRS in the
Royalty Reports and the Reallocation Reports discussed above are
inconsistent with each other. While it is possible that the IRS
could ultimately prevail in whole or in part on one of such
positions noted above, Moodys believes that it is unlikely
that the IRS will prevail on both.
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Amortization Expense Deductions |
In April 2004, New D&B received Examination Reports (the
April Examination Reports) from the IRS with respect
to a partnership transaction. This transaction was entered into
in 1997 and has resulted in amortization expense deductions on
the tax returns of Old D&B since 1997. These deductions
could continue through 2012. In the April Examination Reports,
the IRS stated its intention to disallow the amortization
expense deductions related to this partnership that were claimed
by Old D&B on its 1997 and 1998 tax returns. New D&B
disagrees with the position taken by the IRS and can either:
(1) accept and pay the IRS assessment; (2) challenge
the assessment in U.S. Tax Court; or (3) challenge the
assessment in U.S. District Court or the U.S. Court of
Federal Claims, where in either case payment of the disputed
amount would be required in connection with such challenge. IRS
audits of Old D&Bs or New D&Bs tax returns
for years subsequent to 1998 could result in the issuance of
similar Examination Reports, in which case New D&B would
also have the aforementioned three courses of action.
Should any such payments be made by New D&B related to
either the April Examination Reports or any potential
Examination Reports for future years, including years subsequent
to the separation of Moodys from New D&B, then
pursuant to the terms of the 2000 Distribution Agreement,
Moodys would have to pay to New D&B its 50% share. In
addition, should New D&B discontinue claiming the
amortization deductions on future tax returns, Moodys
would be required to repay to New D&B an amount equal to the
discounted value of its 50% share of the related future tax
benefits. New D&B had paid the discounted value of 50% of
the future tax benefits from this transaction in cash to
Moodys at the Distribution Date. Moodys estimates
that the Companys current potential exposure could be up
to $98 million (including penalties and interest, and net
of tax benefits). This exposure could increase by approximately
$3 million to $6 million per year, depending on
actions that the IRS may take and on whether New D&B
continues claiming the amortization deductions on its tax
returns.
In the April Examination Reports, the IRS also stated its
intention to disallow certain royalty expense deductions claimed
by Old D&B on its 1997 and 1998 tax returns with respect to
the partnership transaction. In addition, the IRS stated its
intention to disregard the partnership structure and to
reallocate to Old D&B certain partnership income and expense
items that had been reported in the partnership tax returns for
1997 and 1998. New D&B disagrees with the positions taken by
the IRS and can take any of the three courses of action
described in the first paragraph of this Amortization
Expense Deductions section. IRS audits of Old
D&Bs or New D&Bs tax returns for years
subsequent to 1998 could result in the issuance of similar
Examination Reports for the subsequent years. Should any such
payments be made by New D&B related to either the April
Examination Reports or any potential Examination Reports for
future years, then pursuant to the terms of the 2000
Distribution Agreement, Moodys would have to pay to New
D&B its 50% share of New D&Bs payments to the IRS
for the period from 1997 through the Distribution Date.
Moodys estimates that its share of the potential exposure
to the IRS for the potential disallowance of royalty expense
deductions could be up to $131 million (including penalties
and interest, and net of tax benefits). Moodys also could
be obligated for future interest payments on its share of such
liability.
41
New D&B had filed protests with the IRS Appeals Office
regarding the April Examination Reports. In September 2004, the
IRS Appeals Office remanded the case to the IRS examination
office for further development of the issues. New D&B has
reopened discussion of the issues with the examination office.
On May 6, 2005 New D&B received a Notice of Proposed
Adjustment (Notice) from the IRS for the 1999-2002
tax years which 1) disallows amortization expense
deductions allocated from the partnership to Old D&B on its
1999 and 2000 tax returns and to New D&B on its 2000, 2001
and 2002 tax returns and 2) disallows certain royalty
expense deductions claimed by Old D&B on its 1999 and 2000
tax returns and by New D&B on its 2000, 2001 and 2002 tax
returns. Moodys is in the process of assessing the
potential exposure related to the Notice. Currently, the Company
does not expect that this Notice will have a material impact on
the legacy tax reserves and the potential future outlays related
to legacy tax matters that are discussed below in Summary
of Moodys Exposure to Three Legacy Tax Matters.
Moodys believes that the IRS proposed assessments of
tax against Old D&B and the proposed reallocations of
partnership income and expense to Old D&B are inconsistent
with each other. Accordingly, while it is possible that the IRS
could ultimately prevail in whole or in part on one of such
positions, Moodys believes that it is unlikely that the
IRS will prevail on both.
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Utilization of Capital Losses |
The IRS has completed its review of the utilization of certain
capital losses generated by Old D&B during 1989 and 1990. On
June 26, 2000, the IRS, as part of its audit process,
issued a formal assessment with respect to the utilization of
these capital losses.
On May 12, 2000, an amended tax return was filed by Old
D&B for the 1989 and 1990 tax years, which reflected
$561.6 million of tax and interest due. Old D&B paid
the IRS approximately $349.3 million of this amount on
May 12, 2000; 50% of such payment was allocated to
Moodys and had previously been accrued by the Company. IMS
Health informed Old D&B that it paid to the IRS
approximately $212.3 million on May 17, 2000. The
payments were made to the IRS to stop further interest from
accruing, and on September 20, 2000, Old D&B filed a
petition for a refund in the U.S. District Court.
In July 2004, New D&B and the IRS reached a basis for
settlement of all outstanding issues related to this matter and
in December 2004 executed a formal settlement agreement. New
D&B received two assessments on this matter during the first
quarter of 2005, and expects to receive the third and final
assessment in the third quarter of 2005. Moodys paid its
allocated share of the first two assessments to New D&B
consisting of cash payments of $12.8 million
($8.1 million net of expected tax benefits) and the
write-off of deferred tax assets of approximately
$9 million. Moodys remaining liability at
June 30, 2005 was approximately $0.3 million. The
amounts paid by Moodys included its share of approximately
$4 million that Moodys and New D&B believe should
have been paid by IMS Health and NMR, but were not paid by them
due to their disagreement with various aspects of New
D&Bs calculation of their respective shares of the
payments. If New D&B fails to resolve this dispute with IMS
Health and NMR, Moodys understands that New D&B
anticipates commencing arbitration proceedings against them.
Moodys believes that New D&B should prevail in its
position, but the Company cannot predict with certainty the
outcome. In the first quarter of 2005, Moodys had
increased its reserves by $2.7 million due to this
disagreement.
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Summary of Moodys Exposure to Three Legacy Tax
Matters |
The Company considers from time to time the range and
probability of potential outcomes related to the three legacy
tax matters discussed above and establishes reserves that it
believes are appropriate in light of the relevant facts and
circumstances. In doing so, Moodys makes estimates and
judgments as to future events and conditions and evaluates its
estimates and judgments on an ongoing basis.
In the first quarter of 2005, the Company recorded
$2.7 million of additional reserves relating to the
Utilization of Capital Losses matter described above. For the
first six months the Company has recorded $3.0 million of
interest expense related to its legacy tax reserves. At
June 30, 2005, Moodys total net legacy tax reserves
were $133 million (consisting of $149 million of tax
liabilities, partially offset by the expected
42
utilization of $16 million of deferred tax assets). The
$133 million of expected cash payments consists of
$46 million of current liabilities (reflecting the
estimated cash payments related to the Royalty Expense
Deductions and Utilization of Capital Losses matters that are
expected to be made over the next twelve months) and
$87 million of non-current liabilities.
It is possible that the legacy tax matters could be resolved in
amounts that are greater than the amounts reserved by the
Company, which could result in additional charges that may be
material to Moodys future reported results, financial
position and cash flows. Although Moodys does not believe
it is likely that the Company will ultimately be required to pay
the full amounts presently being sought by the IRS, potential
future outlays resulting from these matters could be as much as
$345 million and could increase with time as described
above. In matters where Moodys believes the IRS has taken
inconsistent positions, Moodys may be obligated initially
to pay its share of related duplicative assessments. However,
Moodys believes that ultimately it is unlikely that the
IRS would retain such duplicative payments.
Regulation
In the United States, Moodys Investors Service voluntarily
registers as an investment adviser under the Investment Advisers
Act of 1940, as amended. Moodys has also been designated
as a Nationally Recognized Statistical Rating Organization
(NRSRO) by the U.S. Securities and Exchange
Commission (SEC). The SEC first applied the NRSRO
designation in 1975 to companies whose credit ratings could be
used by broker-dealers for purposes of determining their net
capital requirements. Since that time, Congress (including in
certain mortgage-related legislation), the SEC (including in
certain of its regulations under the Securities Act of 1933, as
amended, the Securities Exchange Act of 1934, as amended and the
Investment Company Act of 1940, as amended) and other
governmental and private bodies have used the ratings of NRSROs
to distinguish between, among other things, investment
grade and non-investment grade securities.
Over the past several years, U.S. regulatory and
congressional authorities have questioned the suitability of
continuing to employ ratings in federal securities laws; and, if
so, the potential need for altering the regulatory framework
under which rating agencies operate. Following is a summary of
some recent developments in the U.S.
In February 2005, Moodys participated in a hearing held by
the United States Senate Committee on Banking, Housing and Urban
Affairs (the Banking Committee) on Examining the
Role of Credit Rating Agencies in the Capital Markets. Primary
areas of inquiry by Senators on the Banking Committee included
(i) potential conflicts of interest affecting credit rating
agencies and how those conflicts can be avoided or properly
managed, and (ii) the degree of competition in the credit
ratings industry and how competition might be increased.
Moodys written statement submitted to the Committee can be
found on the Regulatory Affairs page of the
Companys website at www.moodys.com.
In March 2005, the SEC disclosed that in considering the
oversight of NRSROs, it may pursue a voluntary compliance and
oversight framework for rating agencies that are designated as
NRSROs, or it could seek legislative authority for formal
compliance and oversight for NRSROs. In April 2005, the SEC
released for public comment a Proposed Rule on the
Definition of Nationally Recognized Statistical Rating
Organization. The proposed definition of the term NRSRO is
an entity that: (i) issues publicly available credit
ratings that are current assessments of the creditworthiness of
obligors with respect to specific securities or money market
instruments; (ii) is generally accepted in the financial
markets as an issuer of credible and reliable ratings, including
ratings for a particular industry or geographic segment, by the
predominant users of securities ratings; and (iii) uses
systematic procedures designed to ensure credible and reliable
ratings, manage potential conflicts of interest, and prevent the
misuse of nonpublic information, and has sufficient financial
resources to ensure compliance with those procedures. Numerous
market participants, including Moodys, responded to the
request for comment. Moodys response can be found on the
Regulatory Affairs page of the Companys website. In
addition, in June 2005 the SEC produced technical assistance
pursuant to a Congressional request, relating to the statutory
authority the SEC may need if Congress determines that it is
appropriate to create a comprehensive oversight regime for
credit rating agencies.
43
In June 2005, U.S. House Representative Michael Fitzpatrick
(R-PA) introduced H.R. 2990, the Credit Rating Agency
Duopoly Relief Act of 2005. In June the House of
Representatives Financial Services Subcommittee on Capital
Markets held a hearing on H.R. 2990, at which several interested
parties testified. The next steps in the process have not been
announced.
At present, Moodys is unable to assess the likelihood of
any regulatory or legislative changes that may result from
ongoing reviews, nor the nature and effect of any such
regulatory changes.
Internationally, several regulatory developments have occurred:
In December 2004, the Technical Committee of the International
Organization of Securities Commissions (IOSCO)
published the Code of Conduct Fundamentals for Credit Rating
Agencies (the IOSCO Code). The IOSCO Code is the
product of approximately two years of deliberations and market
consultation by IOSCO, and incorporates provisions that address
three broad areas:
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The quality and integrity of the rating process; |
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Credit rating agency independence and the avoidance of conflicts
of interest; and, |
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Credit rating agency responsibilities to the investing public
and issuers. |
The IOSCO Code is not binding on credit rating agencies. It
relies on voluntary compliance and public disclosure of areas of
non-compliance by credit rating agencies so that users of credit
ratings can better assess rating agency behavior and
performance. Moodys endorsed the IOSCO Code and in June
2005 published its Code of Professional Conduct (the
Moodys Code) pursuant to the IOSCO Code. The
Moodys Code can be found on the Regulatory Affairs
page of the Companys website.
In April 2005, IOSCO held its annual meeting, which included a
panel discussion on whether the adoption of the IOSCO Code by
rating agencies was sufficient or whether such adoption should
be supplemented through regulation. John Rutherfurd, Jr.,
Chief Executive Officer of Moodys Corporation at the time
of the meeting, was a panelist on behalf of Moodys. His
written statement prepared in connection with the panel
discussion can be found on the Regulatory Affairs page of
the Companys website.
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2) Committee of European Regulators |
In July 2004, the European Commission, as requested by the
European Parliament, mandated the Committee of European
Securities Regulators (CESR) to conduct a review of
the credit rating agency industry and provide the European
Commission with advice by April 1, 2005 on the following
four general areas:
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potential conflicts of interest within rating agencies, such as
between advisory services and direct rating activities; |
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transparency of rating agencies methodologies; |
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legal treatment of rating agencies access to inside
information; and |
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concerns about possible lack of competition in the market for
provision of credit ratings. |
In late 2004 CESR published, and in early 2005 received,
comments on a consultation document about the credit ratings
industry, which addressed areas including: the competitive
structure of the industry and competition issues; registration
of credit rating agencies; potential barriers to entry;
potential rules of conduct for the industry; and regulatory
options to address these areas. Moodys written comments
can be found on the Regulatory Affairs page of the
Companys website. In addition, CESR held an open hearing
on these topics, in which Moodys participated. CESR
followed these activities with its technical advice to the
European
44
Commission in March 2005, in which it offered the European
Commission two possible regulatory alternatives:
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|
The European Commission could take a wait and see
approach, whereby rating agencies that operate in the European
Market would be given an opportunity to implement the IOSCO Code
and report on their implementation periodically to the
market; or |
|
|
|
The European Commission could take a light touch
regulation approach, whereby it would essentially regulate into
legislation the IOSCO Code. |
In its discussion, CESR further noted that the majority of
market participants who commented during CESRs
consultation process, as well as the majority of European
regulatory authorities, have indicated a preference for the
wait and see approach. The European Commission is
expected to publish and forward to the European Parliament in
October 2005 its suggested regulatory approach for rating
agencies. At present, Moodys cannot predict whether
voluntary standards will prevail, or whether regulation or
legislation will be enacted in the European Union (the
EU).
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3) Market Abuse Directive |
Implementation guidelines proposed by CESR under the European
Commissions Market Abuse Directive are, absent exemption,
applicable to all participants in the European capital markets.
Credit rating agencies are excluded from control under the
guidelines. However, depending on the form in which the
implementation guidelines are ultimately adopted by national
regulators or lawmakers, such guidelines could include controls
over credit rating agencies in some EU countries. If so, the
guidelines could, among other things, alter rating
agencies communications with issuers as part of the rating
assignment process and increase Moodys cost of doing
business in Europe and the legal risk associated with such
business.
In June 2004, the Basel Committee on Banking Supervision
published its new capital adequacy framework
(Basel II) to replace its initial 1988
framework. Under Basel II, ratings assigned by designated
credit rating agencies (called External Credit Assessment
Institutions) would be an alternative available to banks to
determine the credit risk weights for many of their
institutional credit exposures. Such designated rating agencies
could be subject to a broader range of oversight. It is
anticipated that Basel II will be implemented by national
regulatory authorities by January 2007. The European Commission
has created the Committee of European Banking Supervisors
(CEBS), comprised of European banking regulators, to
advise it on the implementation of Basel II in Europe. In
June 2005, CEBS released its proposed Guidelines for a
common approach to the recognition of External Credit Assessment
Institutions within the European Union and has requested
comments by September 30, 2005. Moodys is in the
process of reviewing the proposal and intends to submit comments.
At this time Moodys cannot predict the long-term impact of
Basel II on the manner in which the Company conducts its
business. However, Moodys does not currently believe that
Basel II will materially affect its financial position or
results of operations.
Finally, Moodys is subject to regulation in certain
non-U.S. jurisdictions in which it operates. Some
regulatory actions outside the United States are noted below:
As a consequence of the 2003 French Securities Law, Loi de
Sécurité Financiére (the LSF),
rating agencies operating in France are subject to a document
retention obligation. Moreover, the newly formed French
regulatory authority, LAutorité des Marchés
Financiers (AMF), is required to publish an
annual report on the role of rating agencies; their business
ethics, the transparency of their methods, and the impact of
their activity on issuers and the financial markets.
Moodys submits responses to questions posed by the AMF in
accordance with this mandate. The AMF released its first report
on the rating agency industry in January 2005. It concluded that
while there was no evidence of wrong-doing or inappropriate
behavior in the industry,
45
and that some sort of regulatory framework at the European level
may be suitable. For that, the AMF deferred to the CESR process.
In April 2005, the Italian Parliament passed the EU Law 2004,
which is Italys implementing legislation for the EU Market
Abuse Directive. The legislation makes the Market Abuse
Directive applicable to rating agencies in the Italian market.
It requires: (1) the Italian securities regulator,
Commissione Nazionale per la Società e la Borsa
(CONSOB), to recognize and register rating
agencies in the Italian market; (2) recognized rating
agencies to adopt and implement the IOSCO Code; and
(3) issuers of bonds in the Italian market to obtain
ratings from recognized rating agencies. The legislation
requires that CONSOB provide the appropriate regulatory
framework. However, the Italian Senate attached a resolution to
the legislation (Ordine del Giorno) recommending that the
Italian Government:
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adopt a contrary position and interpret the legislation to
acknowledge the special and different treatment of rating
agencies within Italian regulations for disclosure obligations
that will be implemented by CONSOB; and |
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|
consider the possibility of recognizing the self-regulation and
control procedures for rating agencies already developed in
Europe. |
In May 2005, the CONSOB published for comment the regulatory
framework as required by the implementation statute for the
Market Abuse Directive. The CONSOB took note of the Ordine
del Giorno, and proposed endorsing and adopting the IOSCO
Code of Conducts self-regulatory approach vis-à-vis
rating agencies. Moodys comments on CONSOBs proposal
can be found on the Regulatory Affairs page of the
Companys website.
At present, Moodys is not able to assess either the
likelihood of any regulatory changes that may result in Italy or
the nature and effect of any such regulatory changes.
Other legislation and regulation relating to credit rating and
research services has been considered from time to time by
local, national and multinational bodies and is likely to be
considered in the future. In certain countries, governments may
provide financial or other support to locally-based rating
agencies. In addition, governments may from time to time
establish official rating agencies or credit ratings criteria or
procedures for evaluating local issuers. If enacted, any such
legislation and regulation could significantly change the
competitive landscape in which Moodys operates. In
addition, the legal status of rating agencies has been addressed
by courts in various decisions and is likely to be considered
and addressed in legal proceedings from time to time in the
future. Management of Moodys cannot predict whether these
or any other proposals will be enacted, the outcome of any
pending or possible future legal proceedings, or the ultimate
impact of any such matters on the competitive position,
financial position or results of operations of Moodys.
Forward-Looking Statements
Certain statements contained in this quarterly report on
Form 10-Q are forward-looking statements and are based on
future expectations, plans and prospects for the Companys
business and operations that involve a number of risks and
uncertainties. Such statements involve estimates, projections,
goals, forecasts, assumptions and uncertainties that could cause
actual results or outcomes to differ materially from those
contemplated, expressed, projected, anticipated or implied in
the forward-looking statements. Those statements appear at
various places throughout this quarterly report on
Form 10-Q, including in the sections entitled
Outlook and Contingencies under
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations, commencing
at page 25 of this quarterly report on Form 10-Q, and
elsewhere in the context of statements containing the words
believe, expect, anticipate,
intend, plan, will,
predict, potential,
continue, strategy, aspire,
target, forecast, project,
estimate, should, could,
may and similar expressions or words and variations
thereof relating to the Companys views on future events,
trends and contingencies. We caution you not to place undue
reliance on these forward-looking statements. The
forward-looking statements and other information are made as of
the
46
date of this quarterly report on Form 10-Q, and the Company
undertakes no obligation (nor does it intend) to publicly
supplement, update or revise such statements on a going-forward
basis, whether as a result of subsequent developments, changed
expectations or otherwise. In connection with the safe
harbor provisions of the Private Securities Litigation
Reform Act of 1995, the Company is identifying examples of
factors, risks and uncertainties that could cause actual results
to differ, perhaps materially, from those indicated by these
forward-looking statements. Those factors, risks and
uncertainties include, but are not limited to, changes in the
volume of debt and other securities issued in domestic and/or
global capital markets; changes in interest rates and other
volatility in the financial markets; market perceptions of the
utility and integrity of independent agency ratings; possible
loss of market share through competition; introduction of
competing products or technologies by other companies; pricing
pressures from competitors and/or customers; the potential
emergence of government-sponsored credit rating agencies;
proposed U.S., foreign, state and local legislation and
regulations, including those relating to Nationally Recognized
Statistical Rating Organizations; possible judicial decisions in
various jurisdictions regarding the status of and potential
liabilities of rating agencies; the possible loss of key
employees to investment or commercial banks or elsewhere and
related compensation cost pressures; the outcome of any review
by controlling tax authorities of the Companys global tax
planning initiatives; the outcome of those tax and legal
contingencies that relate to Old D&B, its predecessors and
their affiliated companies for which the Company has assumed
portions of the financial responsibility; the outcome of other
legal actions to which the Company, from time to time, may be
named as a party; the ability of the Company to successfully
integrate the KMV and MRMS businesses; a decline in the demand
for credit risk management tools by financial institutions.
These factors, risks and uncertainties as well as other risks
and uncertainties that could cause Moodys actual results
to differ materially from those contemplated, expressed,
projected, anticipated or implied in the forward-looking
statements are described in greater detail in the Companys
annual report on Form 10-K and in other filings made by the
Company from time to time with the Securities and Exchange
Commission or in materials incorporated herein or therein. You
should be aware that the occurrence of any of these factors,
risks and uncertainties may cause the Companys actual
results to differ materially from those contemplated, expressed,
projected, anticipated or implied in the forward-looking
statements, which could have a material and adverse effect on
the Companys business, results of operations and financial
condition. New factors may emerge from time to time, and it is
not possible for the Company to predict new factors, nor can the
Company assess the potential effect of any new factors on it.
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Item 3. |
Quantitative and Qualitative Disclosures about Market Risk |
There was no material change in the Companys exposure to
market risk from December 31, 2004 to June 30, 2005.
For a discussion of the Companys exposure to market risk,
refer to Item 7A, Quantitative and Qualitative
Disclosures about Market Risk, contained in the
Companys annual report on Form 10-K for the year
ended December 31, 2004.
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Item 4. |
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures: The Company
carried out an evaluation, as required by Rule 13a-15(b)
under the Securities Exchange Act of 1934, as amended (the
Exchange Act), under the supervision and with the
participation of the Companys management, including the
Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the
Companys disclosure controls and procedures as of the end
of the period covered by this report (the Evaluation
Date). Based on such evaluation, such officers have
concluded that, as of the Evaluation Date, the Companys
disclosure controls and procedures are effective in alerting
them on a timely basis to material information relating to the
Company (including its consolidated subsidiaries) required to be
included in the Companys periodic filings under the
Exchange Act.
In addition, the Companys management, including the
Companys Chief Executive Officer and Chief Financial
Officer, has determined that there were no changes in the
Companys internal control over financial reporting that
have materially affected, or are reasonably likely to materially
affect, these internal controls over financial reporting during
the period covered by this report.
47
PART II. OTHER INFORMATION
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Item 1. |
Legal Proceedings |
From time to time, Moodys is involved in legal and tax
proceedings, claims and litigation that are incidental to the
Companys business, including claims based on ratings
assigned by Moodys. Management periodically assesses the
Companys liabilities and contingencies in connection with
these matters, based upon the latest information available. For
those matters where it is both probable that a liability has
been incurred and the probable amount of loss can be reasonably
estimated, the Company believes it has recorded appropriate
reserves in the condensed consolidated financial statements and
periodically adjusts these reserves as appropriate. In other
instances, because of the uncertainties related to both the
probable outcome and amount or range of loss, management is
unable to make a reasonable estimate of a liability, if any. As
additional information becomes available, the Company adjusts
its assessments and estimates of such liabilities accordingly.
The discussion of the legal matters under Part I,
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
Contingencies, commencing at page 36 of this
quarterly report on Form 10-Q, is incorporated into this
Item 1 by reference.
Based on its review of the latest information available, in the
opinion of management, the ultimate liability of the Company in
connection with the pending legal and tax proceedings, claims
and litigation described above will not have a material adverse
effect on Moodys financial position, results of operations
or cash flows, subject to the contingencies described in
Part I, Item 2. Managements Discussion and
Analysis of Financial Condition and Results of
Operations Contingencies.
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Item 2. |
Unregistered Sales of Equity Securities and Use of
Proceeds |
MOODYS PURCHASES OF EQUITY SECURITIES
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Total Number of Shares |
|
Approximate Dollar Value of |
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Purchased as Part of |
|
Shares that May yet be |
|
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Total Number of |
|
Average Price |
|
Publicly Announced |
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Purchased Under the |
Period |
|
Shares Purchased |
|
Paid per Share |
|
Program |
|
Program(1) |
|
|
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|
|
|
|
|
|
April 1-30
|
|
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422,112 |
(2) |
|
$ |
40.3088 |
|
|
|
422,000 |
|
|
$ |
530,641,473 |
|
May 1-31
|
|
|
66,402 |
(2) |
|
$ |
40.4846 |
|
|
|
55,600 |
|
|
|
528,389,694 |
|
June 1-30
|
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|
|
|
|
|
|
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|
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|
|
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528,389,694 |
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Total
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488,514 |
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477,600 |
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(1) |
As of the last day of each of the months. On May 24, 2004,
the Company announced that its Board of Directors had authorized
an additional $600 million share repurchase program, which
includes both special share repurchases and systematic share
repurchases to offset shares issued under Moodys
stock-based compensation plans. There is no established
expiration date for this authorization. |
|
(2) |
Includes the surrender to the Company of 112 shares in
April and 10,802 shares in May of common stock to satisfy
tax withholding obligations in connection with the vesting of
restricted stock issued to employees. |
Moodys issued 1.2 million shares of common stock
under employee stock compensation plans during the second
quarter of 2005. Since becoming a public company in October 2000
and through the second quarter of 2005, Moodys has
repurchased 53.5 million shares at a total cost of
$1.1 billion, including 29.7 million shares to offset
issuances under employee stock plans.
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Item 4. |
Submission of Matters to a Vote of Security Holders |
Previously reported in the Companys Form 10-Q for the
quarter ended March 31, 2005.
48
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Exhibit No. |
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Description |
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3 |
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ARTICLES OF INCORPORATION AND BY-LAWS |
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1 |
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Restated Certificate of Incorporation of the Registrant dated
June 15, 1998, as amended effective June 30, 1998, as
amended effective October 1, 2000, and as further amended
effective April 26, 2005 (incorporated by reference to
Exhibit 3.1 to the Report on Form 8-K of the
Registrant, file number 1-14037, filed April 27, 2005). |
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2 |
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Amended and Restated By-laws of the Registrant (incorporated by
reference to Exhibit 3.2 of the Registrants
Registration Statement on Form 10, file number 1-14037,
filed June 18, 1998). |
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31 |
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CERTIFICATIONS PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002 |
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1* |
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Chief Executive Officer Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
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2* |
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Chief Financial Officer Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
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32 |
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CERTIFICATIONS PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002 |
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1* |
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Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. (The Company has furnished this certification and does
not intend for it to be considered filed under the Securities
Exchange Act of 1934 or incorporated by reference into future
filings under the Securities Act of 1933 or the Securities
Exchange Act of 1934.) |
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2* |
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Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. (The Company has furnished this certification and does
not intend for it to be considered filed under the Securities
Exchange Act of 1934 or incorporated by reference into future
filings under the Securities Act of 1933 or the Securities
Exchange Act of 1934.) |
49
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
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Linda S. Huber |
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Executive Vice President and Chief Financial Officer |
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(principal financial officer) |
Date: July 29, 2005
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Joseph McCabe |
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Vice President and Corporate Controller |
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(principal accounting officer) |
Date: July 29, 2005
50