McGraw Hill Financial, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2014. The company provided ratings, benchmarks and analytics through S&P Ratings, S&P Capital IQ, S&P Dow Jones Indices, and Commodities & Commercial Markets. The interim financial statements were reviewed by Ernst & Young, not audited.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $1,263 million (+10%) | $1,152 million | $3,761 million (+8%) | $3,496 million |
| Operating profit | $366 million (-8%) | $395 million | $1,261 million (+16%) | $1,087 million |
| Operating margin | 29% | 34% | 34% | 31% |
| Income from continuing operations | $215 million | $258 million | $793 million | $691 million |
| Diluted continuing-operations EPS | $0.68 | $0.82 | $2.59 | $2.20 |
| Net income attributable to company | $190 million | $215 million | $731 million | $1,204 million |
| Diluted net EPS | $0.69 | $0.77 | $2.64 | $4.29 |
Nine-month 2013 net income included a $592 million after-tax gain on the sale of McGraw-Hill Education; the comparison therefore does not represent continuing operations alone. Continuing-operations EPS increased year over year over nine months.
- Segment trends: Q3 revenue rose across all four segments. S&P Ratings revenue increased 12%, but operating profit fell 21%; Capital IQ revenue and profit increased 6% and 29%; Indices increased 15% and 12%; C&C revenue increased 7%, while profit fell 18%. For nine months, segment revenue grew 8% at Ratings, 6% at Capital IQ, 14% at Indices, and 6% at C&C.
- Cash flow: Nine-month cash from continuing operations was $820 million, versus $476 million. Capital expenditures were $52 million; company-defined free cash flow was $737 million, versus $365 million. Operating cash flow benefited mainly from tax-payment timing and a tax refund, partly offset by higher incentive payments.
- Liquidity and debt: Cash and equivalents were $1.918 billion at September 30, 2014; current assets were $3.188 billion and current liabilities $2.384 billion. Long-term debt was $799 million, with no commercial paper outstanding. A $1.0 billion credit facility supported the commercial-paper program; the company reported compliance with its 3.25-to-1 debt-to-cash-flow covenant. Cash was held approximately half domestically and half abroad.
- Capital returns: Nine-month shareholder dividends were $245 million in cash; declared dividends were $0.30 per share for Q3. The company repurchased 4.6 million shares for $362 million in cash during the first nine months; no shares were purchased under the program in Q3.
Material changes and unusual items
- Q3 selling and general expense included a $60 million charge for regulatory matters and restructuring costs. The company recorded $50 million in charges under its 2014 restructuring plan during Q3; its nine-month restructuring expense disclosure also cites $46 million. These costs, increased legal and compensation costs, and prior-year comparison items contributed to lower Q3 operating profit.
- Nine-month operating profit growth partly reflected lower unallocated expenses than in 2013, which included $64 million of McGraw-Hill Education separation and cost-reduction costs and approximately $77 million of legal settlements.
- Effective tax rates on continuing operations were 39.2% for Q3 and 35.1% for nine months, compared with 32.4% and 33.6%, respectively, in 2013. The company attributed the increases principally to the assumed tax treatment of regulatory charges.
- On September 22, 2014, the company agreed to sell McGraw Hill Construction for $320 million in cash and expected closing in Q4, subject to regulatory approval and customary conditions. The business was presented as discontinued operations and held for sale.
- Q3 and nine-month revenue growth reflected demand for corporate bond ratings, subscriptions and Platts content, and higher assets under management tied to indices. Ratings issuance trends varied by product and region; management cited weaker U.S. corporate issuance in Q3 and structured-finance weakness earlier in the year.
Outlook, commentary and risks
Management described its financial position as strong and said cash, operating cash flow and available credit were expected to meet operating and recurring cash needs into the foreseeable future. It identified growth and performance as strategic priorities but gave no specific earnings or revenue guidance. The company expected to contribute approximately $10 million more to retirement plans in the remainder of 2014. It noted that index over-the-counter derivative volumes would be adversely affected for the remainder of 2014 by the expiration of a commodities-index license arrangement.
Material legal and regulatory uncertainties include the U.S. Department of Justice structured-finance ratings case, state attorneys-general litigation, and a July 2014 SEC Wells Notice concerning 2011 commercial mortgage-backed securities ratings and related disclosures. The SEC staff could seek penalties, disgorgement, a cease-and-desist order, or NRSRO registration restrictions. The company recorded a $60 million charge for regulatory matters but said it could not reasonably estimate potential additional amounts. Other disclosed matters include an Italian government claim described as not less than €234 billion and Italian criminal proceedings; the filing reported indictments issued October 28, 2014. The company stated it could not predict outcomes or assure that these matters would not materially affect its business, financial condition or cash flows.
Other risks identified include changing regulation, litigation, credit and capital-market conditions, ratings demand, competition, M&A activity, commodities and automotive markets, foreign exchange, cybersecurity and business continuity. Management reported no material change in previously disclosed risk factors or market-risk exposure. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Whether and on what terms the $320 million McGraw Hill Construction sale closed, and the final proceeds and discontinued-operation effects.
- Resolution and potential additional cost or operational impact of the SEC, DOJ, state, and Italian legal or regulatory matters, including any effect on S&P Ratings’ registration.
- Underlying operating trends excluding the $60 million regulatory charge, restructuring expenses, and prior-year gains or charges.
- Cash generation sustainability, cash held abroad and potential repatriation taxes, and capital allocation among dividends, repurchases, acquisitions and debt.
- Reliability of index-related revenue estimates and the effect of the expired commodities-index license on subsequent results.