Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, for The McGraw-Hill Companies, Inc. (Note: The input metadata listed "S&P Global Inc.", but the filing text explicitly identifies the registrant as The McGraw-Hill Companies, Inc., which owns the Standard & Poor's brand). The company operates through three reportable segments: McGraw-Hill Education, Financial Services (Standard & Poor's), and Information & Media. The financial statements are unaudited but include normal recurring adjustments.
Key Financial Metrics
| Metric | Three Months Ended Sept 30, 2006 | Nine Months Ended Sept 30, 2006 |
|---|---|---|
| Total Revenue | $1,992.6 million | $4,660.8 million |
| Net Income | $382.3 million | $677.5 million |
| Diluted EPS | $1.06 | $1.84 |
| Operating Profit | $663.4 million | $1,214.3 million |
| Operating Margin | 33.3% | 26.1% |
| Cash and Equivalents | $309.7 million | (Balance Sheet Item) |
| Commercial Paper Borrowings | $232.8 million | (Balance Sheet Item) |
| Long-Term Debt | $0.3 million | (Balance Sheet Item) |
| Cash from Operating Activities | N/A | $950.8 million |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 0.8% for the quarter and 4.4% for the nine-month period compared to 2005. Growth was primarily driven by the Financial Services segment (up 11.4% for the quarter) and the acquisition of J.D. Power and Associates.
- Segment Performance:
- McGraw-Hill Education: Revenue decreased 6.3% (quarter) and 4.0% (nine months) due to a weaker state adoption market for K-12 textbooks, particularly in Texas and Louisiana.
- Financial Services: Revenue and operating profit increased significantly (11.4% and 17.3% respectively for the quarter) driven by strong issuance in structured finance (CDOs, CMBS) and corporate ratings.
- Information & Media: Revenue increased 8.0% (quarter) and 12.4% (nine months), aided by J.D. Power and Associates and favorable billing adjustments.
- Stock-Based Compensation: Expenses increased significantly due to the adoption of SFAS 123(R) on January 1, 2006. Total stock-based compensation was $29.2 million for the quarter and $106.2 million for the nine months, compared to $14.6 million and $28.3 million in the prior year periods.
- Restructuring Charges: The company recorded a $15.4 million pre-tax restructuring charge in Q3 2006, primarily for severance costs related to the reduction of approximately 600 positions.
- Divestiture Impact: Comparisons for the Financial Services segment are negatively impacted by the September 2005 divestiture of Corporate Value Consulting (CVC), which contributed $33.0 million to Q3 2005 revenue.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management anticipates the effective tax rate will remain at 37.2% for the remainder of the year. Capital expenditures for 2006 are expected to be approximately $150 million. Prepublication investment for 2006 is expected to be approximately $300 million.
- Restructuring: The company anticipates incurring an additional $16.0 million in pre-tax restructuring charges in Q4 2006, related to vacant facilities and the elimination of an additional 100 positions.
- Legal Proceedings (Parmalat): Standard & Poor's is facing a lawsuit in Milan, Italy, by the Parmalat Extraordinary Commissioner claiming damages of over €4 billion for allegedly assigning inflated ratings. Additionally, Italian prosecutors have issued a "Note of Completion" regarding an investigation into eight S&P analysts, though no formal charges have been filed. Management believes these claims lack merit.
- Regulatory Risks: The "Credit Rating Agency Reform Act of 2006" was signed into law, establishing a voluntary registration regime with the SEC. The company does not believe this will have a materially adverse effect.
- Accounting Changes: The company adopted SFAS 158 (pension accounting) effective for the fiscal year ending Dec 31, 2006, which is expected to reduce stockholders' equity by approximately $105 million but will not affect results of operations.
Investor Verification Checklist
- Verify the impact of the weaker K-12 textbook adoption cycle on the McGraw-Hill Education segment's future revenue streams.
- Monitor the status of the Parmalat litigation in Italy and the potential for financial exposure or reputational damage to the Financial Services segment.
- Assess the sustainability of the Financial Services segment's growth in structured finance ratings given potential market volatility in mortgage-backed securities.
- Review the execution of the $16.0 million additional restructuring charges anticipated in Q4 2006.
- Confirm the company's ability to maintain liquidity given the significant cash outflow ($1.4 billion) for share repurchases in the first nine months of 2006.