Business context and reporting period
The McGraw-Hill Companies, Inc. (the company identified in the request as S&P Global) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. Its three reportable segments were McGraw-Hill Education, Financial Services (Standard & Poor’s), and Information & Media. Results are seasonal, particularly in education; interim results are not necessarily indicative of full-year performance. The independent accountant performed a review, not an audit, and reported no material modifications were needed for GAAP conformity.
Financial results and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $1,979.8 million | $1,875.9 million | $4,644.3 million | $4,489.3 million |
| Income from operations | $621.0 million | $556.0 million | $1,137.5 million | $976.6 million |
| Net income attributable to the company | $379.9 million | $336.1 million | $674.2 million | $563.2 million |
| Diluted EPS | $1.23 | $1.07 | $2.15 | $1.80 |
| Segment operating margin | 34.2% | 31.1% | 27.3% | 23.5% |
Revenue grew 5.5% in Q3 and 3.5% year to date; attributable net income rose 13.0% and 19.7%, respectively. Segment operating profit was $676.4 million for Q3 and $1,266.3 million year to date, up 15.8% and 20.2%. This segment measure precedes corporate expense and interest and is not the same as reported income from operations. Net interest expense was $19.3 million for Q3 and $62.2 million year to date. The effective tax rate was 36.4% in both comparative periods.
For the nine months, cash provided by operations was $1,053.3 million, versus $903.5 million; investing used $467.2 million, versus $167.4 million, largely reflecting acquisitions; and financing used $464.0 million, versus $277.0 million, primarily due to share repurchases. Cash and equivalents were $1,322.8 million at September 30, up $112.9 million from year-end 2009. Current assets were $3,178.7 million and current liabilities $2,587.7 million.
Long-term debt was $1,197.9 million, principally three senior-note issues due 2012, 2017, and 2037. The company reported access to a $1.2 billion commercial-paper program backed by a new $1.2 billion revolving credit facility maturing in July 2013; no borrowings were outstanding under the facility or commercial-paper program. The facility’s leverage covenant caps defined indebtedness to cash flow at 4:1, and the company said it had never exceeded it.
Material changes and segment performance
- Education: Q3 revenue increased 5.5% and operating profit 19.9%; nine-month revenue rose 3.7% and operating profit 43.2%. Adoption-state sales and Higher Education print and digital products helped; open-territory sales and discontinued custom-testing contracts were offsets. Lower prepublication amortization and inventory costs supported margins. The segment’s nine-month margin rose to 17.9% from 13.0%.
- Financial Services: Q3 revenue rose 9.5% and operating profit 6.6%; nine-month revenue rose 6.7% and operating profit 4.4%. Corporate high-yield issuance, ratings-related information products, index services, and Capital IQ contributed. Structured finance and investment research were weaker; incentive compensation, compliance, staffing, and acquisition costs weighed on profit. Segment margins declined to 39.2% from 40.2% in Q3 and 38.9% from 39.8% year to date.
- Information & Media: Q3 revenue fell 4.7% and nine-month revenue fell 6.0%, partly reflecting the 2009 BusinessWeek divestiture and construction weakness. Operating profit improved to $45.8 million in Q3 from $29.5 million and to $121.2 million year to date from $46.7 million, helped by the divestiture and growth in commodities products.
Other notable changes included a $11.1 million pretax gain in Q3 2010 from selling equity interests in India and the Australian secondary education business, compared with a $13.8 million pretax loss on the 2009 Vista Research sale. The company spent $325.0 million on acquisitions and related contingent payments in the first nine months of 2010, including the acquisition of TheMarkets.com. It repurchased 8.7 million shares for $255.8 million and raised its quarterly dividend to $0.235 per share from $0.225.
Outlook, risks, contingencies, and unusual items
- Management said its financial position and operating cash generation were expected to cover anticipated short-term operating requirements, while noting seasonal cash-flow swings. It projected 2010 prepublication investment of approximately $160 million and capital expenditures of $70–$80 million. It expected an effective tax rate of 36.4% for the remainder of 2010, absent specified tax-related changes or events. No consolidated earnings or revenue guidance was provided.
- Education results depend on adoption schedules and school budgets; the filing cited continuing budget pressure in districts and described a larger 2010 adoption opportunity than in 2009. Financial Services outlook depended on issuance volumes, credit-market conditions, securitization activity, and regulation. Management expected refinancing activity to continue in Q4, but noted uncertainty around new rules affecting securitization. Information & Media cited construction-market weakness and expected to invest in digital capabilities and selected markets.
- The Dodd-Frank Act was expected to increase credit-rating regulatory compliance costs and could increase litigation costs through changed pleading standards. Management said the full impact was difficult to predict and did not then expect a material adverse financial effect; future regulatory effects remained uncertain. Foreign-exchange movements also affected reported results; no material change in overall market-risk exposure was reported.
- Legal matters included the Parmalat rating litigation, where court-appointed experts issued a report critical of S&P’s ratings; S&P disputed its methodology and conclusions, and a hearing was scheduled for January 2011. Other updates concerned class-action appeals and the Reed Construction Data case. The filing did not provide a clear quantified estimate of potential loss for these matters.
- Other items to note: $35.4 million of transfer taxes incurred in Q1 2010 from a European legal-entity reorganization were expected to be recovered in later periods; pension benefit cost increased year to date, and the company expected approximately $8 million of additional required pension contributions in the remainder of 2010. The filing said disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether growth in Financial Services transaction revenue and education adoption sales persisted, and how segment margins developed after the seasonal Q3 period.
- Actual full-year cash generation, acquisition spending, prepublication investment, capital expenditures, pension contributions, and realization of the expected transfer-tax recovery.
- Debt, liquidity, and covenant headroom, including the availability and terms of commercial-paper and revolving-credit funding.
- The financial and operating effects of Dodd-Frank and other rating-agency regulation, securitization rule changes, and the identified legal proceedings.
- Comparability effects from BusinessWeek and Vista Research divestitures, 2010 disposition gains, share repurchases, and the 2009 restructuring and stock-compensation adjustments.