Moody’s Corporation (MCO) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial figures are in millions except per-share amounts. Moody’s operates Moody’s Investors Service (MIS), its ratings business, and Moody’s Analytics (MA), its data, research, software and risk-solutions business.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Change | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|---|
| Revenue | $1,356 | $1,240 | 9% | $4,081 | $3,596 |
| Operating income | $642 | $549 | 17% | $1,944 | $1,494 |
| Operating margin | 47.3% | 44.3% | +300 bps | 47.6% | 41.5% |
| Adjusted operating income | $721 | $614 | 17% | $2,136 | $1,732 |
| Adjusted operating margin | 53.2% | 49.5% | +370 bps | 52.3% | 48.2% |
| Net income attributable to Moody’s | $467 | $380 | 23% | $1,464 | $1,062 |
| Diluted EPS | $2.47 | $1.99 | 24% | $7.73 | $5.54 |
| Adjusted diluted EPS | $2.69 | $2.15 | 25% | $8.24 | $6.29 |
Q3 MIS external revenue rose 11% to $825; MA external revenue increased 7% to $531. MIS growth was led by corporate finance, while structured finance declined. MA growth reflected RD&A and ERS demand, including KYC/compliance, research and data feeds, and risk solutions. Nine-month MIS external revenue grew 19% to $2,557; MA external revenue rose 6% to $1,524. MA organic revenue growth was 9% in Q3 and 8% year to date.
Q3 total operating and SG&A expenses were $635, down 1% year over year. Revenue growth and cost discipline lifted margins. Diluted EPS also benefited from lower share count; diluted weighted-average shares fell to 189.3 million in Q3 from 191.1 million.
Cash flow, balance sheet and debt
- For the first nine months, operating cash flow was $1,488, versus $1,196 in 2019. Free cash flow, a non-GAAP measure defined as operating cash flow less capital additions, was $1,405 versus $1,135. Capital additions were $83.
- Investing cash use was $853, principally reflecting $699 of net acquisition payments. Financing cash flow was positive $3, compared with cash use of $1,517 in the prior-year period.
- At September 30, cash and cash equivalents were $2,492 and short-term investments were $96. Long-term debt carrying value was $6,363; total debt principal was $6,365. Cash and short-term investments exceeded current liabilities of $1,721, though debt substantially exceeded cash.
- Debt increased from $5,581 at year-end 2019. Moody’s issued $1,491 of notes during the nine months and repaid $800 of notes, including early repayment of $300 of 2018 notes and $500 of 2017 notes. It reported compliance with debt covenants and no cross-defaults at quarter-end; approximately $1 billion of CP-program capacity was available, and all CP outstanding had been repaid.
- Dividends paid in the first nine months totaled $315. Share repurchases were suspended from late Q1 through Q3 to preserve liquidity; management anticipated resuming them in Q4. The board declared a $0.56-per-share dividend payable in December 2020.
Material changes and unusual items
- Corporate finance issuance drove much of MIS growth: issuers took advantage of favorable borrowing costs for refinancing, liquidity and M&A. Conversely, structured finance revenue fell 16% in Q3 and 17% year to date, including weaker CLO activity and, year to date, lower U.S. CMBS activity.
- MA’s reported comparisons include acquisitions, notably Regulatory DataCorp (RDC), acquired for approximately $702 in February 2020, as well as ABS Suite and RiskFirst. The 2019 divestiture of MAKS also affects comparisons. RDC goodwill was preliminarily recorded at $494; the purchase-price allocation remained subject to final valuation.
- Q3 restructuring charges were $23, primarily non-cash impairments of leased-office right-of-use assets and leasehold improvements under the 2020 program. The program is expected to generate $5–$6 of annualized savings, with total pretax charges estimated at $25–$35. Management expected most office exits to be completed in the first half of 2021.
- The effective tax rate was 22.0% in Q3 and 20.0% year to date, below the comparable 2019 rates of 25.3% and 21.4%. The decrease primarily reflected a tax benefit from a non-U.S. corporate reorganization; year-to-date results also included excess stock-compensation tax benefits and reductions in tax positions.
- Interest expense increased in Q3, including a $16 early-redemption penalty, partly offset by a $17 benefit from fair-value hedge adjustments. Year-to-date operating cash flow also reflected a $99 pension contribution and the $68 settlement payment on treasury-rate locks.
Outlook, commentary and risks
The filing provides no specific full-year revenue or EPS guidance. Management said COVID-19’s duration and severity made its near- and long-term financial impact difficult to predict, but stated that Moody’s had adequate liquidity to operate with minimal disruption and remain compliant with debt covenants. The company reduced discretionary spending and used additional borrowing to bolster liquidity.
Management identified potential pressure on MIS from market volatility, moderation in corporate issuance after unusually strong activity, and possible declines in leveraged-loan issuance and CLO activity. For MA, risks included customer spending reductions, delayed software sales and longer sales cycles, postponed compliance deadlines, and higher attrition or lower renewal yields. COVID-19 could also contribute to lower revenue and cash flow, additional receivable credit losses, asset impairments and changes in pension-plan funded status. Moody’s recorded a $31 net provision for expected credit losses during the first nine months, with the increase primarily attributed to estimated COVID-19 effects.
Other disclosed uncertainties include regulatory and litigation exposure for ratings activities, tax audits, foreign-exchange and interest-rate risks, and potential goodwill impairment. ICRA faced ongoing inquiries and an increased SEBI penalty; Moody’s could not estimate any financial impact, and an unfavorable outcome could affect ICRA results or lead to impairment. The company reported no material change to previously disclosed risk factors. A subsequent event was the October 2020 acquisition of Acquire Media for an undisclosed, non-material purchase price.
Key facts for investors to verify
- Whether corporate debt issuance and refinancing activity remain strong, and whether bank-loan, CLO and CMBS weakness deepens.
- Whether MA’s organic growth, subscription renewals and sales conversion offset acquisition-related comparisons and any customer spending or compliance delays.
- COVID-19 effects on receivables, cash flow, restructuring costs and pension funding; compare actual 2020 restructuring charges and savings with management’s estimates.
- Debt and liquidity developments, planned share-repurchase resumption, and the effect of repurchases and dividends on cash and leverage.
- Final RDC purchase accounting and subsequent goodwill or intangible-asset impairment assessments, including developments at ICRA and Reis.
- Tax-audit outcomes, ratings-related regulatory or litigation matters, and the assumptions underlying non-GAAP adjusted results.