S&P Global Inc. (then The McGraw-Hill Companies, Inc.) — Q1 2011 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2011, compared with Q1 2010. The company reported four segments: Standard & Poor’s (S&P), McGraw-Hill Financial, McGraw-Hill Education (MHE), and McGraw-Hill Information & Media (I&M). The interim financial statements received an accountant’s review, not an audit; the reviewer reported no material modifications needed for GAAP conformity.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $1,281.9 million | $1,190.4 million | +7.7% |
| Operating income | $214.4 million | $190.3 million | +12.7% |
| Operating margin | 16.7% | 16.0% | +0.7 percentage points |
| Net income attributable to the company | $120.0 million | $103.3 million | +16.2% |
| Diluted EPS | $0.39 | $0.33 | +18.2% |
| Cash provided by operations | $49.3 million | $106.4 million | −53.7% |
| Free cash flow, company-defined non-GAAP | $(74.1) million | $(12.8) million | Lower by $61.3 million |
Service revenue grew 11.9% to $984.2 million, while product revenue declined 4.2% to $297.7 million. Total expenses rose 6.7% to $1,067.5 million; net interest expense fell 13.6% to $19.1 million. The effective tax rate was 36.4% in both periods.
At March 31, 2011, cash and equivalents were $1,269.6 million, short-term investments $28.5 million, and total debt approximately $1,198.3 million, principally long-term notes. The company had $1.2 billion of unused capacity under its commercial paper program and supporting credit facility; it reported compliance with the facility’s financial covenant. Cash decreased $256.0 million during the quarter. Operating cash flow was pressured by payments of accounts payable and accrued expenses and increased inventory purchases. Investing cash outflow was $179.0 million, including $126.2 million for acquisitions; financing cash outflow was $150.9 million, including $123.6 million of share repurchases and $76.7 million of shareholder dividends.
Segment performance and material changes
- S&P: Revenue rose 10.4% to $442.9 million, but operating profit increased just 0.8% to $190.4 million; margin declined to 43.0% from 47.0%. Record global high-yield issuance and increased U.S. bank-loan ratings aided revenue; higher foreign-exchange, compliance, regulatory, and personnel costs weighed on profit.
- McGraw-Hill Financial: Revenue increased 16.2% to $324.0 million and operating profit 35.3% to $96.3 million. Growth reflected ETFs, Capital IQ and other subscriptions, Global Credit Portal, Global Data Solutions, and the acquisition of TheMarkets.com.
- MHE: Revenue declined 4.6% to $302.7 million and operating loss widened to $75.5 million from $61.8 million. Lower open-territory and custom-testing sales and increased digital-development investment contributed to the deterioration. The company cautioned that education results are seasonal and Q1 is typically the least significant quarter.
- I&M: Revenue increased 10.3% to $227.5 million and operating profit 34.5% to $37.4 million, supported by Platts, automotive research and consulting, broadcasting, and lower compensation costs following restructuring. Construction remained weak.
Overall revenue and operating profit improved, led by Financial and I&M, while MHE weakened and S&P’s higher revenue did not translate into material profit growth. Foreign exchange benefited revenue by $5.3 million but reduced operating profit by $9.9 million, according to management.
Outlook, risks, and unusual items
- Management expected 2011 prepublication investment of $200–$225 million, capital expenditures of approximately $150 million, and full-year free cash flow above $700 million; interest expense was expected to be relatively flat versus 2010. These are forward-looking estimates, not guarantees.
- Management expected modest growth in S&P issuance activity, continued demand for Financial data and analytics, and ongoing digital investment. S&P structured-finance surveillance revenue was expected to remain under pressure. Education funding, adoption activity, and market conditions remained important uncertainties.
- Risks cited include weaker education funding or spending, credit-market difficulties, regulatory changes, foreign-exchange volatility, competition, and economic and market conditions. Management noted that S&P and the company faced numerous lawsuits and government inquiries related to ratings activity, including novel securities-law claims; outcomes and potential losses could not be predicted. The company stated that pending matters were not expected, based on then-current knowledge, to have a material adverse effect.
- Q1 acquisitions totaled approximately $126 million and included Bookette Software and Bentek Energy; none was considered material individually or in aggregate. The company repurchased 3.3 million shares for $123.6 million at an average $37.44 per share. The quarterly dividend was increased to $0.25 per share from $0.235.
- Cash-flow seasonality is significant, with publishing investments generally made in the first half and stronger cash generation typically in the second half. The company also disclosed $58.4 million of unrecognized tax benefits at quarter-end and $15.0 million of related accrued interest and penalties.
Most important facts for investors to verify
- Whether full-year free-cash-flow guidance above $700 million is achievable given Q1 negative free cash flow and the seasonal working-capital pattern.
- Whether Financial and I&M growth can continue and whether S&P can convert higher revenue into improved operating profit and margins.
- Whether MHE’s revenue and operating-loss deterioration persists, including the effects of education budgets, adoption cycles, and digital investment.
- The trajectory and potential financial impact of ratings-related litigation, regulatory inquiries, and uncertain tax positions.
- The full-year spending and return profile for acquisitions, prepublication investment, capital expenditures, dividends, and share repurchases.