S&P Global Inc. (then The McGraw-Hill Companies, Inc.) — Q3 2011 Form 10-Q
Business context and period. This filing covers the three and nine months ended September 30, 2011. At the time, the company reported four segments: Standard & Poor’s (S&P), McGraw-Hill Financial, McGraw-Hill Education, and Information & Media. Interim statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $1,908.0 million | $1,956.2 million | $4,726.4 million | $4,576.6 million |
| Operating income | $606.8 million | $630.0 million | $1,180.1 million | $1,145.4 million |
| Operating margin | 31.8% | 32.2% | 25.0% | 25.0% |
| Net income attributable to company | $365.6 million | $379.9 million | $696.6 million | $674.2 million |
| Diluted EPS | $1.21 | $1.23 | $2.27 | $2.15 |
Q3 revenue declined 2.5% and operating income declined 3.7%; nine-month revenue rose 3.3% and operating income rose 3.0%. Q3 diluted EPS fell 2.0%, while nine-month diluted EPS increased 5.2%. Q3 service revenue increased 7.8%, but product revenue fell 11.1%; for the nine months, service revenue rose 11.4% and product revenue declined 8.0%.
- Segment trends: Q3 revenue and operating income declined at S&P (1.8% and 9.7%) and Education (11.1% and 12.0%); both increased at McGraw-Hill Financial (18.4% and 31.2%) and Information & Media (11.9% and 17.1%). For the nine months, all segments except Education reported revenue growth; Education revenue declined 8.3% and operating income 19.0%.
- Cash flow: Nine-month cash from operations was $1,037.6 million, versus $1,053.3 million in 2010. Investing used $366.2 million and financing used $752.9 million. Company-defined free cash flow, after prepublication investment, capital expenditures, and dividends, was $627.3 million, down from $650.6 million.
- Liquidity and debt: September 30 cash and equivalents were $1,437.6 million; current assets were $3,389.5 million and current liabilities $2,760.2 million. Long-term debt was $1,198.0 million, essentially unchanged from year-end 2010. The company had an unused $1.2 billion credit facility available through July 2013; its stated leverage covenant was not exceeded.
- Capital returns: Nine-month shareholder dividends paid were $224.7 million. The company repurchased 16.7 million shares for approximately $655 million in the nine-month period, and declared a quarterly dividend of $0.25 per share, increased from $0.235.
Material changes, outlook, and commentary
- Management projected 2011 free cash flow of approximately $750 million, prepublication investment of approximately $175 million, and capital expenditures of approximately $125 million. Interest expense was expected to be relatively flat versus 2010. The filing provides no consolidated revenue or EPS forecast.
- Management attributed S&P’s Q3 weakness mainly to sharply lower high-yield issuance and declines in structured-finance and public-finance activity amid market volatility and European sovereign-debt concerns. It expected corporate issuance to remain subdued until market conditions improved.
- Education results weakened amid lower adoption-state and open-territory sales and continued investment in digital products. Financial and Information & Media benefited from subscription, data, index, and commodities-related demand. Management noted that education publishing is seasonal, so interim results may not indicate full-year performance.
- On September 12, 2011, the board approved a plan to separate the company into McGraw-Hill Markets and McGraw-Hill Education, with a proposed tax-free education spin-off targeted by the end of 2012. Completion depended on final board approval, an IRS tax ruling, and other conditions; execution and separation risks were disclosed.
- On October 3, 2011, after the quarter, the company announced an agreement to sell its Broadcasting Group for approximately $212 million cash, subject to regulatory approval and customary conditions. The business was presented as discontinued operations and held for sale. It generated $66.8 million of revenue and a $1.7 million after-tax loss for the first nine months of 2011.
- Unusual items included a $13.2 million pretax gain on the sale of the company’s LinkedIn investment during the first nine months. Segment results also included other nonrecurring items, including a deferred-cost write-off and insurance recoveries; the filing does not give a clear combined amount for those items.
Risks and contingencies
- S&P received an SEC staff Wells Notice concerning ratings for the 2007 Delphinus CDO 2007-1 offering. The notice was not a formal allegation or finding; S&P submitted its response. The company also disclosed numerous ratings-related lawsuits, investigations, and government inquiries. Management said it would defend the matters and did not expect currently pending matters to have a material adverse effect, while noting outcomes and potential losses could not be predicted with confidence.
- Other disclosed matters included the Reed litigation and an EC investigation into CUSIP pricing. The Parmalat court dismissed the main damages claim but ordered S&P to pay approximately €784,000 plus interest and limited costs; appeal timing remained open.
- Management identified economic, financial-market, regulatory, foreign-exchange, education-funding, issuance-volume, and technology-related uncertainties. Spin-off risks included delays, costs, operational disruption, and potentially greater volatility for the less diversified standalone companies.
- Cash held abroad was $569.6 million and was generally intended for international operations or reinvestment abroad; repatriation to the U.S. could trigger taxes. The filing reported no significant change in market-risk exposure and only an immaterial amount of currency forwards.
Most important facts to verify
- Whether the projected 2011 free cash flow of approximately $750 million was achieved, and how the company’s free-cash-flow definition compares with other issuers’ measures.
- Subsequent performance in Education and S&P, particularly adoption sales, bond issuance activity, and the effect of market volatility on ratings revenue.
- Completion, timing, tax treatment, and costs of the proposed education spin-off, including the required IRS ruling and final approvals.
- Closing proceeds and conditions for the Broadcasting Group sale, and the final accounting for the discontinued operation.
- Developments and financial exposure from the SEC Wells Notice, ratings-related litigation and investigations, and the CUSIP inquiry.
- Share-repurchase pace, liquidity needs, and the upcoming 2012 senior-note maturity.