The Daily Magic Formula Stock for 01/09/2009 is McGraw-Hill Companies Inc. (The). According to the Magic Formula Investing Web Site, the ebit yield is 16% and the EBIT ROIC is >100%.
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The McGraw-Hill Companies, Inc. (The Registrant or the Company), incorporated in December 1925, is a leading global information services provider serving the financial services, education and business information markets with information products and services. Other markets include energy, construction, aerospace and defense, and medical and health. The Company serves its customers through a broad range of distribution channels, including printed books, magazines and newsletters, online via Internet websites and digital platforms, through wireless and traditional on-air broadcasting, and through a variety of conferences and trade shows.
The Registrantâ€™s 17,253 employees are located worldwide. They perform the vital functions of analyzing the nature of changing demands for information and of channeling the resources necessary to fill those demands. By virtue of the numerous copyrights and licensing, trade, and other agreements, which are essential to such a business, the Registrant is able to collect, compile, and disseminate this information. All book manufacturing and magazine printing is handled through a number of independent contractors. The Registrantâ€™s principal raw material is paper, and the Registrant has assured sources of supply, at competitive prices, adequate for its business needs.
Descriptions of the Companyâ€™s principal products, broad services and markets, and significant achievements are hereby incorporated by reference from Exhibit (13), page 19, containing textual material of the Registrantâ€™s 2004 Annual Report to Shareholders.
The Registrant has an investor kit available online and in print that includes the current (and prior years) Annual Report, Proxy Statement, 10-Q, 10-K, all filings through EDGAR with the Securities and Exchange Commission, the current earnings release and information with respect to the Dividend Reinvestment and Direct Stock Purchase Program. For online access go to www.mcgraw-hill.com/investor_relations and click on Digital Investor Kit. Requests for printed copies, free of charge, can be e-mailed to investor_relations@mcgraw -hill.com or mailed to Investor Relations, The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020-1095. You can call Investor Relations toll free at 866-436-8502.
The Registrant has adopted a Code of Ethics for the Companyâ€™s Chief Executive Officer and Senior Financial Officers that applies to its chief executive officer, chief financial officer, and chief accounting officer. To access such code, go to the Corporate Governance section of the Companyâ€™s Investor Relations website at www.mcgraw-hill.com/investor_relations. Any waivers that may in the future be granted from such Code will be posted at such website address. In addition to its Code of Ethics for the Chief Executive Officer and Senior Financial Officers noted above, the following topics may be found on the Registrantâ€™s website at the above website address:
â€˘ Code of Business Ethics for all employees;
â€˘ Corporate Governance Guidelines;
â€˘ Audit Committee Charter;
â€˘ Compensation Committee Charter; and
â€˘ Nominating and Corporate Governance Committee Charter.
The foregoing documents are also available in print, free of charge, to any shareholder who requests them. Requests for printed copies may be e-mailed to corporate_secretary@mcgra w-hill.com or mailed to the Corporate Secretary, The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020-1095.
You may also read and copy materials that the Company has filed with the Securities and Exchange Commission (SEC) at the SECâ€™s public reference room located at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for further information on the public reference room. In addition, the Companyâ€™s filings with the Commission are available to the public on the Commissionâ€™s web site at www.sec.gov. Several years of SEC filings are also available at the Companyâ€™s Investor Relation website. Go to www.mcgraw-hill.com/investor_relations and click on the SEC Filings link.
The Company has filed the required certifications under Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to our annual report on Form 10-K for the fiscal year ended December 31, 2004. After the 2005 Annual Meeting of Shareholders, the Company intends to file with the New York Stock Exchange the CEO certification regarding the Companyâ€™s compliance with the NYSEâ€™s corporate governance listing standards as required by NYSE rule 303A. 12. Last year, the Company filed this CEO certification with the NYSE on May 10, 2004.
Information as to Operating Segments
The relative contribution of the operating segments of the Registrant and its subsidiaries to operating revenue, operating profit, long-lived assets and geographic information for the three years ended December 31, 2004, are included in Exhibit (13), on pages 53 and 55 in the Registrantâ€™s 2004 Annual Report to Shareholders and is hereby incorporated by reference.
Douglas N. Daft , age 62, was Chairman of the Board and Chief Executive Officer of The Coca-Cola Company from 2000 to 2004. He served as President and Chief Operating Officer of The Coca-Cola Company from 1999 until 2000. He previously served as Senior Vice President of The Coca-Cola Company from 1991 until 1999. Mr. Daft worked at The Coca-Cola Company since 1969, and held various executive positions since 1984. Mr. Daft is a Director of Wal-Mart Stores, Inc. Mr. Daft is also an advisory board member for SISTEMA (the Russian Telecom Group) and Longreach, Inc. (a Japan-based private equity firm). He served on the Boards of the Boys and Girls Clubs of America, Catalyst, and a number of educational and professional associations. Mr. Daft was a Trustee of Emory University, the American Assembly, and the Center for Strategic & International Studies. He was also a member of The Business Council and The Business Roundtable. Mr. Daft has served as a Director of the Company since 2003 and is a member of the Audit and Compensation Committees.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations â€” Comparing Three Months Ended June 30, 2008 and 2007
The Segment Review that follows is incorporated herein by reference.
Revenue and Operating Profit
* Operating profit is income before taxes on income, interest expense and corporate expense.
In the second quarter of 2008 revenue and operating profit declined by 2.6% and 20.7%, respectively. The decrease in revenue and operating profit is primarily attributable to the decline in the Financial Services segment of 10.4% and 25.4%, respectively, primarily due to weakness in Credit Market Services. Partially offsetting the revenue decrease was an increase of 3.6% in the McGraw-Hill Education segment driven by the School Education Group and an increase of 6.8% in the Information & Media segment driven by the Business-to-Business Group. Lower 2008 incentive compensation helped mitigate the operating profit decline. Foreign exchange rates positively impacted both revenue and operating profit by $22.5 million and $7.8 million, respectively, during the second quarter of 2008.
In the second quarter of 2008, the Company restructured a limited number of business operations in its Financial Services and McGraw-Hill Education segments to more efficiently serve its markets and strengthen its long-term growth prospects. The Company incurred a pre-tax restructuring charge of $23.7 million ($14.8 million after-tax, or $0.05 per diluted share), which consisted primarily of severance costs related to a workforce reduction of 395 positions.
Product revenue increased 4.7% in the second quarter of 2008, due primarily to growth in the McGraw-Hill Education and Information & Media segments as compared to the second quarter of 2007.
Product operating-related expenses increased 4.9%, as compared to the second quarter of 2007, primarily due to the growth in expenses at McGraw-Hill Education related to major product launches in a strong 2008 state adoption market. Amortization of prepublication costs increased by $9.2 million or 16.2%, as compared with the second quarter of 2007, as a result of adoption cycles.
Product related selling and general expenses increased 10.1% and product margin decreased 2.2%, as compared to the second quarter of 2007, primarily due to the growth in expenses at McGraw-Hill Education related to major product launches in a strong 2008 state adoption market.
Service revenue decreased 6.6% in the second quarter of 2008 as compared to the same period in 2007, due primarily to a 10.4% decrease in Financial Services. Financial Services revenue decreased primarily due to Credit Market Services in light of the significant declines in the structured finance market resulting from the current credit problems experienced in the U.S. and in Europe, partially offset by growth in Investment Services. Additionally, growth in the Information & Media segment helped partially offset this revenue decline. The service margin decreased 5.3% to 31.3% for the second quarter of 2008 primarily due to the decline in Credit Market Services, partially offset by reduced 2008 incentive compensation expense.
Total expenses in the second quarter of 2008 increased $50.4 million or 4.0% as compared to the same period in 2007 driven by increased sales opportunities in the McGraw-Hill Education segment and the restructuring charge incurred by the Company in the second quarter of 2008.
Interest expense increased to $20.4 million in the second quarter of 2008, as compared with interest expense of $12.1 million for the second quarter of 2007. The increase was mainly driven by the impact of $1.2 billion in senior notes issued in the fourth quarter of 2007. Also included in the second quarter of 2008 and 2007 is interest income earned on investment balances.
For the quarters ended June 30, 2008 and 2007, the effective tax rate was 37.5%.
The Company expects the effective tax rate to be at 37.5% for the remainder of the year absent the impact of events such as intervening audit settlements, changes in federal, state or foreign law and changes in the geographical mix of the Companyâ€™s pre-tax income.
Net income for the quarter decreased 23.4% as compared with the second quarter of 2007. Diluted earnings per share decreased 16.5% to $0.66 from $0.79 in 2007. Included in the second quarter diluted earnings per share is the $0.05 after-tax impact of the restructuring charge.
In the second quarter of 2008, revenue for the McGraw-Hill Education (â€śMHEâ€ť) segment increased 3.6% or $23.5 million from the prior year, while operating profit decreased 13.5%. Foreign exchange rates favorably affected revenue by $5.3 million and had an immaterial impact on operating profit for the quarter.
During the second quarter of 2008, the MHE segment incurred a pre-tax restructuring charge of $8.5 million consisting primarily of employee severance costs related to the reduction of 149 positions, primarily in the assessment business, where MHE is taking steps to consolidate its resources, better leverage partnerships with key strategic suppliers, and facilitate a strategic shift toward increased investments in its digital and custom offerings. Across other parts of the segment, MHE is taking steps to enable greater efficiencies, better address new and existing revenue streams, and shift investments toward digital products.
In the second quarter of 2008, revenue for the McGraw-Hill School Education Group (â€śSEGâ€ť) increased 6.9% or $28.5 million compared with the second quarter of 2007. Strong basal sales of K-5 reading in Florida and K-5 math in Texas were partially offset by lower reorders of workbooks and other consumable reading materials in several states due to timing and budget concerns. Total U.S. PreK-12 enrollment for 2007-2008 is estimated at 56 million students, up 0.4% from 2006-2007, according to the National Center for Education Statistics (â€śNCESâ€ť). The total available state new adoption market in 2008 is estimated at between $900 million and $950 million compared with approximately $820 million in 2007.
The yearâ€™s key opportunities in the state new adoption market are primarily offered by K-5 reading in Florida, K-5 math in Texas, and K-8 math in California. Other opportunities for 2008 include science in California, reading in Alabama, Indiana, Louisiana, and Oklahoma, and social studies in Arkansas and Tennessee. With decision-making largely completed in the adoption states that are buying reading in 2008, the Company expects to capture a majority share of the important Florida K-5 market as well as a major share of the overall K-12 reading/literature state new adoption market. In the overall K-12 math state new adoption market, SEG projects a strong share based on solid results in the K-5 Texas adoption as well as announced K-8 decisions in California, where some sales activity may continue into the fall. Despite concerns about the economy in many areas, no state adoptions scheduled for purchasing in 2008 were cancelled and adoption activity remained brisk at the district level in most states within this market.
Open territory sales, which have remained flat over the past two years, are projected to increase modestly owing to pent-up demand for new instructional materials. Open territory net basal sales for the industry remained flat as compared to the prior year through May 2008, the most recent period for which detailed information is currently available. However, the bulk of open territory purchasing traditionally occurs in the third quarter. Despite budget pressures, most states have maintained or increased education funding levels in their new fiscal-year budgets.
According to statistics compiled by the Association of American Publishers (â€śAAPâ€ť), total net basal and supplementary sales of elementary and secondary instructional materials increased 1.5% through May 2008 compared to the same period in 2007. The supplementary market has been declining in recent years, in large part because basal programs are increasingly comprehensive, offering integrated ancillary materials that reduce the need for separate supplemental products. According to the AAP report, the industryâ€™s total basal sales increased by 6.0% through May 2008, driven by growth in the adoption states.
In the testing market, SEGâ€™s second-quarter non-custom or â€śshelfâ€ť testing revenue increased over the prior year primarily due to increased Acuity revenues in New York City and sales of the TABE series of assessments for adult learners and the LAS series for English-language learners, gains which more than offset declines in older products. Custom contract work decreased in 2008 compared to the same period last year primarily due to reductions in scope and price on contracts in Florida and Missouri, partially offset by an increase in scope on a West Virginia contract.
At the McGraw-Hill Higher Education, Professional and International Group (â€śHPIâ€ť), revenue decreased $5.0 million or 2.1% for the quarter compared to prior year. Foreign exchange rates favorably affected revenue by $5.3 million.
Higher Education revenue declined in comparison to the prior year, although the Career product line showed strong growth. A variation in bookstore ordering trends from June to July affected quarterly results. Key titles contributing to second-quarter performance included Thomson, Crafting an Executive Strategy, 16/e; Hill, International Business, 7/e; Silberberg, Chemistry , 5/e; Knorre, Puntos de partida, 8/e; and Ober, Keyboarding , 10/e.
Revenue in the professional market declined versus the prior-year quarter due to strong first-year sales of McGraw-Hill Encyclopedia of Science and Technology , which was published in May 2007, and overall softness in the market in 2008 as some retailers cut back on orders and reduced inventory through higher returns. Compared with the second quarter of 2007, HPIâ€™s overall international revenue increased in most regions, notably India, Asia, Canada, Latin America and the Middle East, partially offset by sales declines in Spain and Italy.
Financial Services revenue and operating profit for the second quarter of 2008 decreased 10.4% and 25.4%, respectively, from the second quarter of 2007. The revenue and operating profit declines from prior year are mainly due to lower revenue in Credit Market Services (â€śCMSâ€ť), partially offset by revenue growth in Investment Services (â€śISâ€ť). A reduction in 2008 incentive compensation helped mitigate the operating profit reduction. Foreign exchange positively impacted revenue by $16.8 million and operating profit by $7.9 million.
During the second quarter of 2008, the Financial Services segment incurred a pre-tax restructuring charge of $15.2 million consisting primarily of employee severance costs related to the reduction of 246 positions, driven by the current credit market environment as well as the consolidation of several support functions.
CMS revenue declined $127.8 million or 20.1% from prior year, primarily as a result of significant decreases in structured finance as well as decreases in corporate (industrial and financial services) ratings, partially offset by increases in public finance ratings and credit ratings-related information products such as RatingsXpress and RatingsDirect and credit risk evaluation products and services.
During the second quarter of 2008, significant decreases in issuance volumes in both the United States and Europe of residential mortgage-backed securities (â€śRMBSâ€ť), commercial mortgage-backed securities (â€śCMBSâ€ť), collateralized debt obligations (â€śCDOâ€ť) and asset-backed securities (â€śABSâ€ť) contributed to the decrease in revenue.
Total U.S. structured finance new issue dollar volume decreased 81.0% in the second quarter versus prior year. U.S. CDO issuance decreased 88.2%, according to Harrison Scott Publications and Standard & Poorâ€™s internal estimates (Harrison Scott Publications/S&P). The large decline in CDO issuance resulted from continued lack of investor appetite for the complex deal structures which were in demand in the second quarter of 2007 and secondary market trading liquidity concerns. Continued deterioration in the subprime mortgage market has significantly impacted dollar volume issuance in the U.S. RMBS market, which decreased 97.0% compared to prior year. U.S. CMBS issuance decreased 85.3% over the prior year due to the market dislocation attributed to high credit spreads resulting in high interest rates which are not economical to borrowers. U.S. ABS issuance decreased 19.1% compared to prior year. According to Thomson Financial, U.S. corporate issuance by dollar volume for the second quarter of 2008 decreased 15.1%, with investment grade down 7.2% and high yield issuance down 59.4%, driven by higher credit spreads and decreased merger and acquisition activity. The U.S. municipal market increased 18.7% resulting from issuance to refund existing debt, in addition to raise new money to fund infrastructure projects.
In Europe for the second quarter, structured finance issuance decreased 75.2% compared to the prior year and corporate and government issuance increased 8.6%. European RMBS issuance decreased 76.7%. European CDO and CMBS issuance declined 56.7% and 99.3%, respectively, which is primarily attributed to higher credit spreads. ABS issuance decreased 68.7% compared to the prior year.
IS revenue increased $42.3 million or 22.8%, driven by growth in index services and Capital IQ products. Revenue related to Standard & Poorâ€™s indices increased as assets under management for exchange-traded funds (â€śETFâ€ť) rose 15.5% from June 30, 2007 to $206.3 billion as of June 30, 2008 and license fee revenue increased. ETF assets under management at December 31, 2007 were $235.3 billion. The number of exchange-traded futures and option contracts based on S&P indices exhibited strong increases in the second quarter of 2008 compared to the same period of the prior year, thereby also contributing to the revenue growth. The number of Capital IQ clients increased 23% from the second quarter end of 2007 to second quarter end of 2008.
Because of the current credit market conditions, issuance levels deteriorated significantly across all asset classes. It is possible that the current market conditions and global issuance levels in structured finance could persist through 2008. The outlook for RMBS, CMBS and CDO asset classes as well as other asset classes is dependent upon many factors, including the general condition of the economy, interest rates, credit quality and spreads, and the level of liquidity in the financial markets.
The financial services industry is subject to the potential for increased regulation in the United States and abroad. The businesses conducted by the Financial Services segment are in certain cases regulated under the Credit Rating Agency Reform Act of 2006, U.S. Investment Advisers Act of 1940, the U.S. Securities Exchange Act of 1934 and/or the laws of the states or other jurisdictions in which they conduct business.
Standard & Poorâ€™s Ratings Services is a credit rating agency that is registered with the Securities and Exchange Commission (â€śSECâ€ť) as one of ten Nationally Recognized Statistical Rating Organizations, or NRSROs. The SEC first began designating NRSROs in 1975 for use of their credit ratings in the determination of capital charges for registered brokers and dealers under the SECâ€™s Net Capital Rule.
Credit rating agency legislation entitled â€śCredit Rating Agency Reform Act of 2006â€ť (the â€śActâ€ť) was signed into law on September 29, 2006. The Act created a new SEC registration system for rating agencies that volunteer to be recognized as NRSROs. Under the Act, the SEC is given authority and oversight of NRSROs and can censure NRSROs, revoke their registration or limit or suspend their registration in certain cases. The SEC is not authorized to review the analytical process, ratings criteria or methodology of the NRSROs. An agencyâ€™s decision to register and comply with the Act will not constitute a waiver of or diminish any right, defense or privilege available under applicable law. Pre-emption language is included in the Act consistent with other legal precedent. The Company does not believe the Act will have a material adverse effect on its financial condition or results of operations.
The SEC issued rules to implement the Act, effective June 2007. Standard & Poorâ€™s submitted its application on Form NRSRO on June 25, 2007. On September 24, 2007, the SEC granted Standard & Poorâ€™s registration as an NRSRO under the Act. In March 2008, S&P filed its first annual update of its registration with the SEC. The public portions of S&Pâ€™s Form NRSRO are available on S&Pâ€™s website.
On June 16, 2008, the SEC issued proposed rules that focus largely on NRSROsâ€™ structured finance ratings process. The proposed rules address a broad range of issues, including disclosure and management of conflicts related to the issuer-pays model, prohibitions against analystsâ€™ accepting gifts or making â€śrecommendationsâ€ť when rating a security, and limitations on analyst participation in fee discussions. Under the proposed rules, additional records of all rating actions must be created, retained and made public, and records must be kept of material deviations in ratings assigned from model outputs as well as complaints about analystsâ€™ performance. The proposals require more disclosure of performance statistics and methodologies, a new annual report by NRSROs of their rating actions to be provided confidentially to the SEC, and unless structured finance ratings are distinguished from other ratings, NRSROs will be required to issue a report describing the differences for each structured rating. The deadline for comments was July 25, 2008. S&P submitted comments on the proposals. The Company believes that some of the proposals raise serious legal issues. On July 1, 2008, the SEC also proposed changes to numerous SEC rules and forms that expressly utilize NRSRO ratings. The deadline for comments is September 5, 2008. S&P currently plans to submit comments on some of the SECâ€™s key proposals.
In the third quarter of 2007, rating agencies became subject to scrutiny for their ratings on structured finance transactions that involve the packaging of subprime residential mortgages, including residential mortgage-backed securities (â€śRMBSâ€ť) and collateralized debt obligations (â€śCDOsâ€ť).
On August 29, 2007, Standard & Poorâ€™s received a subpoena from the New York Attorney Generalâ€™s Office requesting information and documents relating to Standard & Poorâ€™s ratings of securities backed by residential real estate mortgages. Standard & Poorâ€™s has entered into an agreement with the New York Attorney Generalâ€™s Office which calls for S&P to implement certain structural reforms. The agreement resolves the Attorney Generalâ€™s investigation with no monetary payment and no admission of wrongdoing.
In September 2007, the SEC commenced an examination of rating agenciesâ€™ policies and procedures regarding conflicts of interest and the application of those policies and procedures to ratings on RMBS and related CDOs. Standard & Poorâ€™s is cooperating with the SEC staff in connection with this examination. The SEC issued its public Report on July 8, 2008. The SEC findings and recommendations addressed the following subjects: (a) the SEC noted there was a substantial increase in the number and complexity of RMBS and CDO deals since 2002, and some rating agencies appeared to struggle with the growth; (b) significant aspects of the rating process were not always disclosed; (c) policies and procedures for rating RMBS and CDOs could be better documented; (d) the implementation of new practices by rating agencies with respect to the information provided to them; (e) rating agencies did not always document significant steps in the ratings process and they did not always document significant participants in the ratings process; (f) the surveillance processes used by the rating agencies appear to have been less robust than their initial ratings processes; (g) issues were identified in the management of conflicts of interest and improvements could be made; and (h) internal audit processes. S&P has advised the SEC it will be taking steps to enhance S&Pâ€™s policies and procedures consistent with the SECâ€™s recommendations.
On October 16, 2007, Standard & Poorâ€™s received a subpoena from the Connecticut Attorney Generalâ€™s Office requesting information and documents relating to the conduct of Standard & Poorâ€™s credit ratings business. The subpoena appears to relate to an investigation by the Connecticut Attorney General into whether Standard & Poorâ€™s, in the conduct of its credit ratings business, violated the Connecticut Antitrust Act. Subsequently, a second subpoena dated December 6, 2007, seeking information and documents relating to the rating of securities backed by residential real estate mortgages, and a third subpoena dated January 14, 2008, seeking information and documents relating to the rating of municipal and corporate debt, were served. The Attorney Generalâ€™s Office has also indicated that its investigation is looking into whether Standard & Poorâ€™s may have violated the Connecticut Unfair Trade Practices Act. The Company is responding to the subpoenas.
On November 8, 2007, Standard & Poorâ€™s received a civil investigative demand from the Massachusetts Attorney Generalâ€™s Office requesting information and documents relating to Standard & Poorâ€™s ratings of securities backed by residential real estate mortgages. Standard & Poorâ€™s is responding to this request.
On April 22, 2008, the Senate Committee on Banking, Housing and Urban Affairs held a hearing on the role of rating agencies in U.S. credit markets. S&P participated in this hearing.
Outside the United States, particularly in Europe, regulators and government officials have reviewed whether credit rating agencies should be subject to formal oversight. In the past several years, the European Commission, the Committee of European Securities Regulators (â€śCESRâ€ť) which is charged with monitoring and reporting to the European Commission on rating agenciesâ€™ compliance with IOSCOâ€™s Code of Conduct (see below), and the International Organization of Securities Commissions (â€śIOSCOâ€ť) have issued reports, consultations and questionnaires concerning the role of credit rating agencies and potential regulation. In May 2008, IOSCO issued a report on the role of rating agencies in the structured finance market and related changes to its 2004 Code of Conduct Fundamentals for Credit Rating Agencies. IOSCOâ€™s report reflects comments received during a public consultation process. S&P and other global rating agencies contributed to this process. S&P has started to implement many of IOSCOâ€™s recommendations and expects to update its Code of Conduct as appropriate. In May 2008, CESR issued its second report to the European Commission on rating agenciesâ€™ compliance with IOSCOâ€™s original Code of Conduct, the role of rating agencies in structured finance and recommendations for, among other things, additional monitoring and oversight of rating agencies. CESR also requested public comments during a consultation period leading up to the final report. In June 2008, the European Securities Markets Expert Group (ESME), a group of senior practitioners and advisors to the European Commission, issued its report on the role of rating agencies and a separate set of recommendations. S&P engaged with ESME during its review process. The European review of rating agencies and potential additional oversight is expected to continue into the fall and, possibly, 2009.
Other regulatory developments include: a March 2008 report by the Presidentâ€™s Working Group on Financial Markets that includes recommendations relating to rating agencies; an April 2008 report by the Financial Stability Forum that recommends changes in the role and uses of credit ratings; and a July 2008 report by the Committee on the Global Financial System (Bank for International Settlements) on ratings in structured finance. S&P expects to continue to be involved in the follow up to these reports. In many countries, S&P is also an External Credit Assessment Institution (ECAI) under Basel II for purposes of allowing banks to use its ratings in determining risk weightings for many credit exposures. Recognized ECAIs may be subject to additional oversight in the future.
New legislation, regulations or judicial determinations applicable to credit rating agencies in the United States and abroad could affect the competitive position of Standard & Poorâ€™s Ratings Services; however, the Company does not believe that any new or currently proposed legislation, regulations or judicial determinations would have a materially adverse effect on its financial condition or results of operations.
The market for credit ratings as well as research and investment advisory services is very competitive. The Financial Services segment competes domestically and internationally on the basis of a number of factors, including quality of ratings, research and investment advice, client service, reputation, price, geographic scope, range of products and technological innovation. In addition, in some of the countries in which Standard & Poorâ€™s competes, governments may provide financial or other support to locally-based rating agencies and may from time to time establish official credit rating agencies, credit ratings criteria or procedures for evaluating local issuers.
A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) (collectively, â€śStandard & Poorâ€™sâ€ť) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the Tribunal of Milan, Italy by Enrico Bondi (â€śBondiâ€ť), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, â€śParmalatâ€ť). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poorâ€™s, which had issued investment grade ratings on Parmalat until shortly before Parmalatâ€™s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalatâ€™s business. Alleging joint and several liability, Bondi claims damages of euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poorâ€™s alleged complicity in aggravating Parmalatâ€™s financial difficulties and/or for having contributed in bringing about Parmalatâ€™s indebtedness towards its bondholders, and legal fees. The Company believes that Bondiâ€™s allegations and claims for damages lack legal or factual merit. Standard & Poorâ€™s filed its answer, counterclaim and third-party claims on March 16, 2006 and will continue to vigorously contest the action.
In a separate proceeding, the prosecutorâ€™s office in Parma, Italy is conducting an investigation into the bankruptcy of Parmalat. In June 2006, the prosecutorâ€™s office issued a Note of Completion of an Investigation (â€śNote of Completionâ€ť) concerning allegations, based on Standard & Poorâ€™s investment grade ratings of Parmalat, that individual Standard & Poorâ€™s rating analysts conspired with Parmalat insiders and rating advisors to fraudulently or negligently cause the Parmalat bankruptcy. The Note of Completion was served on eight Standard & Poorâ€™s rating analysts. While not a formal charge, the Note of Completion indicates the prosecutorâ€™s intention that the named rating analysts should appear before a judge in Parma for a preliminary hearing, at which hearing the judge will determine whether there is sufficient evidence against the rating analysts to proceed to trial. No date has been set for the preliminary hearing. On July 7, 2006, a defense brief was filed with the Parma prosecutorâ€™s office on behalf of the rating analysts. The Company believes that there is no basis in fact or law to support the allegations against the rating analysts, and they will be vigorously defended by the subsidiaries involved.
The Company learned on August 9, 2007 that a pro se action titled Blomquist v. Washington Mutual , et al., was filed in the District Court for the Northern District of California against numerous financial institutions, government agencies and individuals, including the Company and Mr. Harold McGraw III, the CEO of the Company, alleging various state and federal claims. The claims against the Company and Mr. McGraw concern Standard & Poorâ€™s ratings of subprime mortgage-backed securities. An amended Complaint was filed in the Blomquist action on September 10, 2007 which added two other rating agencies as defendants. On February 19, 2008 the Company was served with the Complaint and, on February 29, 2008, Mr. McGraw was served with the Complaint. On May 12, 2008, the Company and Mr. McGraw filed a motion to dismiss all claims asserted against them. Similar motions were filed by other defendants. Plaintiff filed papers opposing the motions on July 1, 2008. A hearing on the motions was held on July 11, 2008 and, by Order dated July 23, 2008, the Court dismissed all claims asserted against the Company and Mr. McGraw and denied plaintiff leave to amend as against them.
The Company also learned that on August 28, 2007 a putative shareholder class action titled Reese v. Bahash was filed in the District Court for the District of Columbia against Mr. Robert Bahash, the CFO of the Company, alleging claims under the federal securities laws and state tort law concerning Standard & Poorâ€™s ratings, particularly its ratings of subprime mortgage-backed securities. Mr. Bahash was not served with the Complaint. On February 11, 2008, the District Court in the Reese matter entered an order appointing a lead plaintiff in that action and permitting plaintiffs to amend the Complaint on or before April 16, 2008. On April 7, 2008, the District Court granted the application of the lead plaintiff to extend the deadline for its amendment of the Complaint to May 7, 2008. On May 7, 2008 an amended Complaint was filed alleging violations of the federal securities laws; the Company and Mr. McGraw were named as additional defendants. The amended Complaint asserts, among other things, that the defendants failed to warn investors that problems in the structured finance market, particularly the sub-prime lending market, would negatively affect the Companyâ€™s financial performance. Service of the amended Complaint was thereafter effectuated. On June 18, 2008, in response to a Consent Motion filed on behalf of the Company and Messrs. McGraw and Bahash, the District Court entered an Order transferring the action to the United States District Court for the Southern District of New York. A scheduling order has not yet been entered. The Company believes the litigation to be without merit and intends to vigorously defend against it.
Three actions were recently filed in New York State Supreme Court, New York County, naming The McGraw-Hill Companies, Inc. (â€śMcGraw-Hillâ€ť or the â€śCompanyâ€ť) as a defendant. The first case, brought by the New Jersey Carpenters Vacation Fund, on behalf of itself and all others similarly situated, was filed on May 14, 2008 and relates to certain mortgage-backed securities issued by various HarborView Mortgage Loan Trusts. The second, brought by the New Jersey Carpenters Health Fund, on behalf of itself and all others similarly situated, was filed on May 21, 2008 and relates to certain mortgage-backed securities issued by various NovaStar Mortgage Funding Trusts. The third case, brought again by the New Jersey Carpenters Vacation Fund, on behalf of itself and all others similarly situated, was filed on June 3, 2008 and relates to an October 30, 2006 offering by Home Equity Mortgage Trust 2006-5. The central allegation against the Company in each of these cases is that the Company issued inappropriate credit ratings on the applicable mortgage-backed securities in alleged violation of Section 11 of the Securities Exchange Act of 1933. In each, Plaintiff seeks as relief compensatory damages for the alleged decline in value of the securities, as well as an award of reasonable costs and expenses. Plaintiff has sued other parties, including the issuers and underwriters of the securities, in each case as well. All three cases were originally filed in New York State Supreme Court, New York County and have been subsequently removed to the United States District Court for the Southern District of New York. Plaintiff is seeking to remand in the three cases, and those motions are in the process of being briefed. The Company believes the litigations to be without merit and intends to defend against them vigorously.
On July 11, 2008, plaintiff Oddo Asset Management filed an action in New York State Supreme Court, New York County, against a number of defendants, including the Company. The action, titled Oddo Asset Management v. Barclays Bank PLC , arises out of plaintiffâ€™s investment in two structured investment vehicles, or SIV-Lites, that plaintiff alleges suffered losses as a result of violations of law by those who created, managed, arranged, and issued credit ratings for those investments. Plaintiff alleges various common law causes of action against the defendants. The central allegation against the Company is that it aided and abetted breaches of fiduciary duty by the collateral managers of the two SIV-Lites by falsely confirming the credit ratings it had previously given those investments. Plaintiff seeks compensatory and punitive damages plus reasonable costs, expenses, and attorneys fees. The Company believes the litigation to be without merit and intends to defend against it vigorously.
In addition, in the normal course of business both in the United States and abroad, the Company and its subsidiaries are defendants in numerous legal proceedings and are involved, from time to time, in governmental and self- regulatory agency proceedings, which may result in adverse judgments, damages, fines or penalties. Also, various governmental and self-regulatory agencies regularly make inquiries and conduct investigations concerning compliance with applicable laws and regulations. Based on information currently known by the Companyâ€™s management, the Company does not believe that any pending legal, governmental or self-regulatory proceedings or investigations will result in a material adverse effect on its financial condition or results of operations.
Good morning and thank everyone for joining us for the McGraw-Hill Companies third quarter earnings call. Iâ€™m Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. With me today are Harold McGraw III, Chairman, President and CEO, and Robert Bahash, Executive Vice President and Chief Financial Officer of the corporation.
This morning we issued a news release with our third quarter 2008 results. We trust you have all had a chance to review the release. If you need a copy of the release and financial schedules, they can be downloaded at www.mcgraw-hill.com. Before we begin this morning I need to provide certain cautionary remarks about forward-looking statements.
Except for historical information, the matters discussed in this teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates, and descriptions of future events. Any such statements are based on current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looking statements.
In this regard we direct listeners to the cautionary statements contained in our Form 10-Ks, 10-Qs, and other periodic reports filed with the US Securities and Exchange Commission. We are aware that we do have some media representatives with us today on the call, however this call is for investors, and we would ask that questions from the media be directed to Mr. Steve Weiss in our New York office subsequent to this call.
Today's update will last approximately an hour. After the presentations we will open the meeting to questions and answers. It's now my pleasure to introduce the Chairman, President, and CEO of the McGraw-Hill Companies, Harold McGraw.
Thank you very much Donald, good morning everyone and welcome to our review of the McGraw-Hill Companies third quarter results and the outlook for the remainder of 2008 and as Donald mentioned joining me today on this call is Robert Bahash, Executive Vice President and Chief Financial Officer.
On todayâ€™s call we will be reviewing the third quarter earnings and our guidance for 2008 and then Robert will provide an in depth look at our financial condition which is strong, and we aim to keep it that way. At the conclusion of Robertâ€™s presentation as always we will be pleased to take any comments or questions that you may have about the companies.
Earlier this morning we announced third quarter results; letâ€™s get started with a quick recap on that. We took a pre-tax restructuring charge of $23.4 million for a workforce reduction of approximately 270 positions. Thatâ€™s a $14.6 million after-tax or $0.05 per share.
Including the restructuring charge then, earnings per share was $1.23 and revenue declined 6.4% to $2 billion. Restructuring charges in the second and third quarter represent pre-tax charges of $47.1 million or $29.4 million after-tax and a workforce reduction of approximately 670 positions this year.
We have been taking action since late last year, including the staff reductions announced in the fourth quarter of 2007 we have eliminated approximately 1,275 positions. In this environment we will continue to monitor our situation very carefully and I can assure you that we will take more steps if warranted.
In the face of continued economic weakness we have seen more efforts by the US government to support the financial sector and restore confidence in credit markets. US Treasury Secretary Hank Poulson recently provided more details on the bank recapitalization measures and Fed Chairman Ben Bernanki, is supporting another stimulus package.
Additional rate cuts with the Fed Funds going down to 1% later this year now seem very likely and thatâ€™s according to our economists. The rate cuts by the Federal Reserve and other major central banks have already set the stage for further stimulus. Another Fed rate cut could come this week.
Housing has been in recession for three years now. David Weiss our chief economist doesnâ€™t expect housing prices to hit bottom until late in 2009 so we have a little bit more to go there. The housing recession and the credit crunch in the financial markets continue to have an impact on our results.
In the face of challenging conditions we are now forecasting earnings per share of $2.63 to $2.65 for this year. The projection for 2008 excludes the restructuring charges but includes the associated benefits. The forecast assumes earnings per share of $0.40 to $0.42 in the fourth quarter.
Alright, with this as background letâ€™s examine in more detail the performance and the outlook for our three operating segments and letâ€™s begin because of the third quarter and the education quarter, letâ€™s begin with McGraw-Hill education which in the third quarter produced some expected successes and also experienced some unexpected softness.
In the third quarter revenue declined by 3.8% as an increase of 3.7% for higher education, professional and international group partially offset a decrease of 9.1% at the school education group.
Including a pre-tax restructuring charge of $5.4 million operating profit was off 14.5% and the operating margin was 31.1%. After nine months this year revenue is off 1% including restructuring, operating profit is 17.5% and the operating margin is 15.5%.
To contain costs we took pre-tax restructuring charges in the second and third quarters. For McGraw-Hill education that totaled $13.9 million and represented the reduction of approximately 240 positions.
The most important 60 days of the sales year in the education market normally occur in July and August. Through July the industry was off to a pretty good start. According to reports from the Association of American Publishers industry sales in July were up 5% but as we cautioned investors at a conference in September, the situation suddenly began to change in early August.
Our concern was validated when the Association of American Publishers, AAP, subsequently released sales figures for August and September. Industry sales in August dropped by 16.6%, results that turned the markets 3.9% gain after seven months into a 1.7% decline after eight months.
In September industry sales fell by 17.6% and the market is down 3.3% after nine months. The reversal of the positive trend that we saw earlier in the year has led us to conclude that sales for the elementary/high school market will now decline about 3% to 4% in 2008 however we expect to gain share in this very difficult market.
Historically residual sales are heaviest in the third quarter, but in August we witnessed and unprecedented slow down in residual sales and as many of you know residual sales are sales of previously adopted materials. These include hardbound text that are needed by the schools for new enrollments, or to replace lost of damaged books.
More importantly residuals include workbooks, lab manuals and other consumable softbound materials that support texts. These are designed for students to write in so they are normally replaced every year. Residual sales represent a significant percentage of all publishersâ€™ revenues in any given year.
Along with the decline in residual sales, we also a decrease in the volume of new textbook business. The decrease was most pronounced in the open territory states which are mainly in the northern and central regions. Open territory school districts are more dependent on local property tax revenues and more likely to face higher fuel costs for bus transportation, heating in the new school year and so forth.
When it comes to purchasing new textbook programs, open territory districts are also more independent then adoption state districts where there are directives on how budget allocations must be spent but all school districts face increased costs for personnel including salaries, health care and pensions which are frequently indexed to the rate of inflation.
On average the state education budgets that went into the effect for the fiscal year starting on July 1 were not sufficient to cover these inflationary increases. As a result all expenses that might be considered discretionary became low priority items.
Unfortunately in many districts the purchase of instructional materials fell into this category. For many large urban districts this situation was aggravated by the cutback in this yearâ€™s Federal Reading First bonds which dropped from more then $1 billion last year to only $383 million this year.
The supplemental market has always been very sensitive to discretionary funding constraints because most purchases are made at the school building or classroom level. It is disappointing but not surprising that this market has been slow all year.
To reduce costs some districts are buying newly adopted programs for only a few grades intending to add more grades in the future. We have also seen more buying of classroom sets that are used by successive classes throughout the day as opposed to purchases that would provide one book per student.
As schools have reduced their orders for consumable materials we have also seen more copying of workbooks particularly in grades K through two. These short-term measures are not sustainable. Enrollments in many places are growing and schools will face shortages as standards align materials which are so important in preparing students to meet the accountability requirements of No Child Left Behind which remain in force and which have actually become more stringent in the current academic year.
Photocopying workbooks which many financially strapped districts are doing, is an illusionary savings. It happens because the expense of photocopying is spread over several months and is charged to a different cost center. In reality it is more cost effective to order new workbooks then to copy old ones but for the time being the cost of copying shows up in somebody elseâ€™s budget and so therefore there is an appearance of savings.
In the state new adoption market we have delivered on our forecast. As we had expected the school education group captured approximately 31% of the total available dollars in the state new adoption market and it was propelled by strong performances in K-5 reading and mathematics.
These programs also produced sales gains in the open territory. In the Florida K-5 reading adoption we expect to capture more than 70% of the market; an outstanding achievement. We also expect to take about 40% of the K-12 reading literature state new adoption market. In mathematics we project that 31% capture rate in the Texas K-market, a state specific version of Math Connects has also done very well in the first year of the California math adoption and Everyday Mathematics has also won some good adoptions in California.
We led the first year science adoption in California in 2007 and a second year sales are following that positive trend and our music, fine arts, health, business and vocational lines have also performed very well in all states adopting in these categories.
In assessment and reporting the third quarter is typically a seasonally slow period. Revenue for custom tests declined due to reductions in the volume of work performed for Indiana and Missouri and the expiration of contracts in Mississippi and Tennessee.
But we continue to make progress with acuity which is our new formative testing program Lost Links, our assessment for English language learners and TABE which is our suite of assessments and structural resources for adult students.
In the higher education, professional, and international group we also saw a shift this year in historical ordering patterns. In the US college and university market the peak ordering period normally occurs in July and August. This year we experienced a surge in September as college and retail stores waited to gauge student demand. We still expect the total market to grow 4% to 6% this year but our own higher education group will underperform the industry in 2008.
All our main academic higher education imprints achieved good growth in the third quarter, thatâ€™s in business and economics, science, engineering and mathematics, and humanities, social sciences, and languages.
But 2008 is also a low point or an off cycle year for revisions of our traditional best sellers in these disciplines and that will dampen our performance a little bit in 2008.
Our career education product line produced a very strong gain. We have strengthened our position in the allied health market and the computer information technology markets with products like Computers in the Medical Office.
This innovative program combines software and print to give medical assistance students practical, hands-on experience as well as permanent on the job reference materials.
Digital products grew rapidly in the third quarter with study guide products like homework manager leading the way. Students are embracing this generation of digital products because they provide course critical content that helps them study and prepare for exams more efficiently.
We continued to make headway, good headway with ebooks. Currently our higher education group has 618 titles on Course Smart and thatâ€™s the industryâ€™s ebook website. New functionality permits sales representatives to provide samples to instructors directly from Course Smart. Sampling instructors electronically not only offers some cost savings but it also represents a cost effective strategy for increasing awareness of ebook availability among student customers.
To facilitate the sale of ebooks to students, Course Smart now has partnerships with about 50 campuses in conjunction with a Nebraska book company, a textbook retailer and wholesaler, and a significant new agreement the university system of Ohio will link to Course Smart through its own textbook site which is available to all students enrolled in the stateâ€™s private as well as public colleges.
Digital subscriptions and licensing also had a favorable impact in our professional market but could not offset softness at retail as bookstores cut back on orders and reduced inventory in face of economic conditions.
In international markets Harrisonâ€™s Principals of Internal Medicine continued to perform well in both the English and Spanish editions released in recent months. Higher education products sold well in Europe, The Middle East, and India. In the third quarter we also benefited from back to school sales in Spain, and in Mexico.
So letâ€™s sum up for the McGraw-Hill education, growth in higher education markets here and abroad here in the third quarter, digital revenue that continued to grow rapidly in higher education and professional markets, a strong performance in the state new adoption market with a 31% capture rate, a slowdown in the elementary/high school market in August and September that signals a 3% to 4% decline in industry sales for the full year.
Growth in the college market of 4% to 6% and an expectation to increase share in the elementary/high school market and to underperform slightly in the US college and university market.
As we enter a seasonally slow fourth quarter for education we are adjusting the 2008 outlook for this segment. We now expect revenue in 2008 to decrease 1% to 2% with an operating margin decline of 300 to 350 basis points.
Okay letâ€™s turn now to financial services, in a challenging period for credit markets the diversity of our portfolio helped cushion the downturn at Standard & Poor's Credit Market Services, thatâ€™s the rating portion of Standard & Poor's.
For the financial services segment in the third quarter revenue declined by 14.2% as an increase of 13.5% for Standard & Poor's investment services, helped offset a fall off of 24.2% for the S&P credit market services including a pre-tax restructuring charge of $4.1 million operating profit decreased by 18.8% and the operating margin was 43.2%.
After nine months this year revenue is off 12% including restructuring charges, operating profit is down 23.3% and the operating margin is 41.4%. We continue to watch costs closely and we took restructuring charges in the second and the third quarters to contain costs and to mitigate the impact of economic conditions.
For financial services that totaled $19.3 million and represented the reduction of approximately 290 positions. The reduction climbs to 460 positions when you include the cutbacks announced for the fourth quarter of 2007.
The restructuring charges taken this year reduced the operating margin by 64 basis points and thatâ€™s in the third quarter and by 95 basis points for the nine months.
As we all know turbulence in the credit markets continued into the third quarter. The charts illustrate quarterly new issuance dollar volume this year for residential mortgage-backed securities, commercial mortgage-backed securities, and collateralized debt obligations and asset-backed securities in the US market.
In looking at these bar charts its readily apparent that the third quarter is the weakest of the year for new issuance. You can also see that in most cases the structured finance market volume continued to decline in the fourth quarter of 2007.
Structured finance dollar volume issuance in the United States was off 78.3% in the third quarter. In this environment a 2.6% decline for asset backed securities issuance is as good as it gets. US public finance dollar volume issuance was off 1.8% and corporate declined by 65.8%.
But new issue volume is not the whole story in financial services, as this next chart shows global new issuance dollar volume declined 44.2% in the third quarter but revenue was off 14.2% for financial services and 24.2% at credit market services.
International revenue for S&P credit market services declined 11.6% in the third quarter while non-US issuance fell 21.0%. Domestic revenue for S&P credit market services was off 33% but total US new issuance fell 61.6%.
Clearly steps we have taken to diversify our portfolio in both S&P credit market services and in S&Pâ€™s investment services is providing some shelter in this storm. Reducing S&P credit market services dependence on the new issue market and expanding internationally were important initiative that continue to benefit us in turbulent times and those will continue.
International ratings accounted for 47.9% of S&Pâ€™s credit market services revenue in the third quarter, up from 41% of the comparable quarter last year. In Europe we saw a substantial drop in structured finance issuance resulting from widening spreads and a decline in fundamentals. There was also some issuance softness in the Asia Pacific region, [Cresol] our ratings operation in India continues to post solid gains.
We are actively exploring more opportunities to expand our international footprint and weâ€™ll be back to you with more on that. The continued growth of non-transaction revenue is another measure of our diversification strategy. Non-transaction revenue grew by 2.3% in the third quarter and up 8.9% after nine months.
Non-transaction revenue includes surveillance fees, annual contracts, subscriptions, all three categories grew in the third quarter. Deferred revenue for this segment also increased in the third quarter. It grew by 7.2% to just over $8.5 million at the end of the third quarter. Sequentially that represents a decline from the second quarter. The slower growth reflects the seasonality of our revenue as well as a decline in ratings activity.
We are pleased with another quarter of double-digit growth from S&Pâ€™s investment services. Our non-ratings businesses, Capital IQ, and Index services were key contributors to this performance. Capital IQ has added new customers all year, now with more than 2,500 customers. Capital IQâ€™s base has grown by 22.2% in the past 12 months. Capital IQ also continues to expand its product offering and improve the functionality.
To accelerate Capital IQâ€™s own estimates database project, and launch into an alternative research marketplace we recently acquired a copy of Reuterâ€™s estimates and the Reuterâ€™s research on demand databases. The acquisition adds another piece to the comprehensive global analytical solutions offered by Capital IQ.
In index services we benefited from higher volume for exchange-traded derivatives, an increase in assets under management and exchange traded funds based on S&P indices and growth in our data and custom indices. Assets under management and exchanged traded funds grew to $223.5 billion and that was by the end of the third quarter.
Thatâ€™s a gain of 6.7%. We believe the increase is in part due to the use of exchange-traded funds for hedging as well as the asset class mix acting as a natural hedge. Daily volume for major exchange traded derivatives based on S&P indices averaged 3.7 million contracts, a year-over-year increase of 27%.
We also continue to expand in index services, in the past nine months of this year S&P has launched 45 new exchange traded funds based on its indices compared to 46 for all of 2007. There are now 189 new exchange traded funds based on S&P indices around the world.
Building on its family of fixed income indices, S&P in October launched the S&P LSTA US levered loan 100 index. It is a market value weighted index designed to measure the performance of the US levered loan market.
LSTA is short for Loan Syndications and Trading Association. Earlier this month S&P introduced the S&P US commercial paper index. It consists of commercial paper with one to three month maturities issued by financial and non-financial corporate issuers.
In September S&P signed an agreement with a Korean exchange to develop a new set of indices to meet the needs of Asian investors. S&P already signed its first exchange partnership in the year 2000 with the Australian stock exchange. Today we have partnerships with primary exchanges in Tokyo, Milan, Toronto, Moscow, Hong Kong, India, and so forth and there is more in the pipeline this year from index services.
Earlier in this presentation we showed charts indicating that new issue market for most asset classes continued to soften in 2007. That means that S&P faces the easiest comparisons of the year in the fourth quarter of 2008. But some improvement obviously hinges on the start of a market recovery in the fourth quarter.
At this point visibility on the extent and speed of the recovery remains low. There is growing concern about the economy and the markets are assessing the new rescue program from the Federal government and how to respond to various fiscal stimulus packages.
The infusion of capital into the banks should help return confidence and credit to the market. Recently weâ€™ve seen a decline in the key London inter bank offer rate or LIBOR, a sign that credit markets may be on the mend. There are indications that investors now are on the sidelines and they are ready to move once markets begin to stabilize.
When investors do return it will be back to basics, less leverage, less risk, and more plain vanilla securities. Our assessment of the outlook for financial services this year assumed that the level of activity in the structured finance market would remain at low levels.
For 2008 we now anticipate revenue for the financial services segment will decrease by approximately 11% to 12%. We have also changed our forecast on the operating margin, originally we expected a decline of 500 to 600 basis points, now we anticipate only a 425 to 475 basis point decline in the operating margin for this year.
Now obviously no discussion of financial services would be complete these days without a review of the regulatory and legal situations. Weâ€™ve now embarked on another round of new congressional hearings on the rating agencies.
Last week as many of you know Deven Sharma our President of Standard & Poor's, testified before the US House of Representatives Committee on over side and government reform, these are Congressman [Waxmanâ€™s] committee.
It was a long day but there seemed to be three basic charges against the rating agencies that came out of that. One was structured finance ratings were not objective, another one was that S&Pâ€™s only concern was for profit, the business model, the third one, is prone to conflict.
Those seemed to be the three pieces that came out of that. In a rush to judgment it can be difficult to be heard. But Deven refuted these charges and we donâ€™t have time this morning to go through all of it but I do urge you to read his complete testimony and that you can get at www.standardandpoors.com. I think youâ€™ll get a good sense of how he positioned it and how we feel about it.
He pointed out in his remarks that S&Pâ€™s ratings business has strong policies against analysts structuring transaction that S&P rates and that it does not provide consulting services to issuers, that it does not give higher ratings based on how its paid but it does make its ratings criteria and methodologies available and open to market comment.
But letâ€™s be clear, no business model is without potential for conflict but a reasonable organization like S&P has policies and procedures in place to manage them. Our professionals have never been compensated upon the amount of revenue they generate. Credit analysts do not negotiate fees. Rating decisions are always made by a committee and not by individuals. And we have a team of quality officers to promote analytical rigor and the safeguard of the ratings process. The compliance process is very strong and very clear.
A thorough examination by the SEC recently found â€śthere is no evidence that decisions about rating methodology or models we attracting or losing market share.â€ť Under the issuer pays model S&P makes all its ratings public, free of charge in real time, higher transparency which is the order of the day.
Credit ratings are not investment advice or recommendations to buy, sell, or hold a security. Credit ratings primarily address the likelihood that an obligation will be repaid on time with interest. Ratings are also not static. S&P recognizes the seriousness of the current dislocation in the capital markets and that not all of the forecasts used in its ratings analysis have been borne out, even though historical events going back 75 years to the Great Depression were included in our stress tests.
S&P is committed to constant improvement, greater transparency, and independence. Thatâ€™s why earlier this year after consulting with policy makers and regulators both here and abroad, around the world, S&P announced 27 actions on its own to enhance the ratings process and promote confidence.
And you can get an update on the S&Pâ€™s 27 leadership actions in four categories by visiting S&Pâ€™s website. And you can get some additional perspective by looking at S&Pâ€™s record in rating AAA US structured finance securities. The default rate on US structured finance securities rated AAA by S&P between January of 1978 and October 13, 2008 is only one-quarter of 1%; 0.28%.
We expect to learn more about regulatory initiatives next month, sometime in November the SEC could issue new rules for rating agencies. As we now know on November 12 the European commission is expected to issue its proposals on rating agencies and those will be out for public comment and we will work through that process.
There is a little doubt that more regulation is coming but we will continue to work with policy makers, regulators and others to assure some global consistency. We believe global consistency should be based on IOSCOs, those are the security commissioners out of Madrid recently revised Code of Conduct for rating agencies.
Basically not a lot has changed on the legal front since we reviewed the situation at an Investor Conference on September 18. A new lawsuit was filed at the end of September against the Federal National Mortgage Association and a number of defendants, class action suit, and included in that was the McGraw-Hill Companies. The central allegation is that the company issued inappropriate credit ratings on certain securities issued by the Federal National Mortgage Association.
We believe strongly that the litigation is without bearing. We continue to believe that any pending legal, governmental, or self-regulatory proceedings or investigation, will not result in a material adverse effect on the financial condition or results of our operations.
Letâ€™s sum up for financial services, revenue will decline 11% to 12% in 2008, the operating margin will decline 425 t0 475 basis points this year, better then we thought, low visibility in credit markets and double-digit growth for S&P investment services in 2008.
Now letâ€™s review our third segment, information, and media, where business-to-business products and services again drove the results. In the third quarter revenue increased 5.3% as the business-to-business group grew by 5.4% and broadcasting was up 4.4% including a pre-tax restructuring charge of $13.9 million, operating profit increased 22.6%.
The operating margin was 8.6% and the restructuring charge for the workforce cutback reduced the operating margin by 523 basis points in the third quarter. After nine months revenue is up 5.1% including the restructuring charge, operating profit is up 37.3% and the operating margin is 7.7%.
The key revenue driver this year continues to be Platts. It was true again in the third quarter. Platts is a leading provider of global energy information as well as on other commodities to customers in more then 160 countries. With continued volatility in crude oil and other commodity prices these customers increasingly depend on our news and pricing information to help with decision making in uncertain times.
Thatâ€™s what happens when your information becomes imbedded in customersâ€™ workflow. This is a global phenomenon, growth at Platts is coming both in North America as well as overseas and as you know we headquarter it in three locations; Singapore, New York, and London.
Aviation Week benefited from the timing of a major international air show in the UK. Thatâ€™s the [Farmboro] air show which is held every other year in the third quarter. Advertising pages for Business Weekâ€™s global edition was down 13.9% in the third quarter and even in this environment Business Week continues to attract new subscribers and improve its renewal rate.
Business Week also took an important step in September by launching the Business Exchange. This enables users to create topics around business issues that matter to them and connect with Business Weekâ€™s community. In a short period of time more then 500 topics have been created on the Business Exchange, which is a very nice start.
The introduction of social media in the business spaces will create an opportunity to leverage context and content for users and advertisers. We are enhancing the Business Exchange with two important partnerships, Linked In and Federation Media, which taps the blogs sphere.
The partnership with Linked In helps Business Week readers network with others that provides Linked In users with broader access to content; over 30 million professionals use Linked In. For the broadcasting group a solid increase in political advertising offset softness in local and national advertising in the third quarter.
In the Denver market we benefited from Coloradoâ€™s status as the swing state in the Presidential election. Advertising by candidate for the US Senate and House and significant spending on issues and propositions.
Spending has also been strong in Indiana because of the Governorâ€™s race and the Presidential contest as well. So summing up for information and media, more progress this year with our business-to-business group, solid growth in political advertising for broadcasting and revenue growth of 4% of 6%, an improvement in the operating margin for this segment.
So therefore for the corporation overall, summing for the McGraw-Hill Companies, we now are forecasting earnings per share of $2.63 to $2.65 for 2008 and the projection excludes the restructuring charge but includes the associated benefits.
The forecast assumes earnings per share of $0.40 to $0.42 for the fourth quarter. We have started work on our budgets for 2009 but until that process is completed weâ€™re not in a position to make a forecast for next year.
We already know the state new adoption market will not match this yearâ€™s total. Texas is not scheduled for a new adoption in 2009 and that always makes a difference in the market. The good news is that the state adoption market calendar improves sharply in 2010. We also know the college and university market is counter cyclical in times of economic difficulty in enrollment increase. In financial markets visibility is low and it will be important to see when various stimulus packages and other government led programs begin to have an impact.
In this environment we are very focused on managing costs and maintaining liquidity. So this would be the best time to turn it over to Robert and to hear about that part of it.
Thank you Harold, as we began to feel the full force of the decline of the credit markets last year, revenue for S&P credit market services dropped in the fourth quarter of 2007 by 14.1%, and the financial services segment was off by 7.2%.
But while we were looking at easier comparisons for financial services during the fourth quarter of this year the rate of decline has been steeper and thatâ€™s reflected in our guidance for this segment. We donâ€™t expect a pick up in credit market services and we have seen a sequential decline in the revenue growth at Standard & Poor's investment services.
Growth will probably slow again in the fourth quarter for S&P investment services although it will still grow by double-digits this year. For McGraw-Hill education the fourth quarter is seasonally slow. In the elementary/high school market we may realize some sales from postponements earlier this year but that is hard to call in this environment.
In the US college and university market we will be introducing some new titles in the fourth quarter but the timing of any pick up is difficult to gauge. Sometimes [inaudible] materialize in December and in other years they donâ€™t show up fully until January.
Under these circumstances we continue to take a very hard look at our costs and expenses. As Harold discussed we recorded a restructuring charge of $23.4 million in the third quarter primarily for severance costs related to a workforce reduction of approximately 270 positions to contain costs and mitigate the impact of current and future economic conditions.
Additionally we took a significant reduction in both long-term and short-term incentive compensation at all segments as well as at corporate. The year-over-year decline of $117 million was comprised of $71 million decline in stock-based compensation, the remainder being short-term incentive compensation. We lowered accruals for long-term awards due to reduced operating results.
This resulted in a negative $39 million for stock-based compensation in the third quarter. As mentioned previously the cash savings from reducing our short-term incentives in 2008 will not be realized until the awards are paid out in March of 2009.
The impact of reduced incentive compensation as noted in the earnings release is as follows. McGraw-Hill education $15.9 million; financial services $60 million; information and media $12.4 million; and corporate $29.1 million.
Iâ€™d like to take a few moments to discuss expenses at financial services, McGraw-Hill education and corporate. At financial services expenses decreased $43 million or 10.4%. Excluding the $4 million pre-tax restructuring charge in the third quarter expenses decreased $47 million or 11.5%.
This year-over-year expense comparison benefits from a $60 million reduction in incentive compensation. This is up from a $30 million year-over-year reduction in incentive compensation in the second quarter primarily due to the negative stock-based compensation I previously mentioned.
Expenses also benefit from savings from restructuring actions taken in the fourth quarter of 2007 and the second quarter of 2008 as mentioned earlier. These expense savings were partially offset by the impact of acquisitions and investments in our fast growing areas such as [Cresol], Capital IQ and index services.
Financial services sequential third quarter expenses decreased $66 million or 15.2% versus the second quarter as reported. The primary contributors to this expense decrease are a $46 million decrease in incentive compensation, a reduction in third quarter versus second quarter restructuring charges of $11 million, and savings from restructuring actions.
McGraw-Hill education reported expense growth of 2% or $15 million. Excluding the restructuring charge of $5.4 million expense growth was 1.3% or $9.6 million. The minimal expense growth at education is driven by a $14 million increase in pre-publication amortization, increased costs related to strong state new adoption opportunities, and investments in technology including $4 million in data center migration costs.
This is offset by a $15.9 million decline in incentive compensation as well as lower cost of goods sold due to the reduction in revenue. The migration to our new data center is nearly complete. In the third quarter the migration cost was $8 million. For the nine-month period it was $21 million.
Now that weâ€™re nearing the end of the project we expect the overall cost will be around $30 million to $35 million for 2008 which is $5 million to $10 million lower then our original forecast.
We expect McGraw-Hill education to represent about half of the total cost as the segment continues to deliver more digital content and services. Corporate expenses were $9.7 million in the third quarter, a $28 million or 74% decrease versus the same period last year.
This overall decrease is driven by a $29 million reduction in incentive compensation accruals for the quarter and of course excluding the incentive comp accruals, expenses were about flat with last year.
We had previously forecasted a mid single-digit decrease in corporate expenses for 2008. Due to the reduction in incentive compensation we now expect corporate expenses to be down about $50 million and this would imply an approximate $10 million decline in corporate expenses in the fourth quarter.
Now let me recap the corporationâ€™s strong financial position, net debt as of September 30 was $1 billion, this is down approximately $349 million from the end of the second quarter as a result of free cash flow generated in the third quarter.
The second half is when we generally generate the majority of our free cash flow primarily due to the seasonality of our education business. As of September 30 on a gross basis, total debt was $1.5 billion and is comprised of $1.2 billion of unsecured senior notes that we issued in 2007 and $307 million in commercial paper outstanding.
This is offset by $485 million in cash primarily in foreign holdings. The outstanding commercial paper is supported by a $1.15 billion credit facility which was renewed in the third quarter. Our commercial paper rating F1/P1 from the key credit rating agencies of Moodyâ€™s and Fitch.
Given the current liquidity issues in the CP market, being a Tier 1 issuer is very important not only for pricing but also for availability. We plan to reduce commercial paper outstanding through the balance of the year with our seasonal cash inflows.
As discussed previously our objective is to maintain a net debt level comparable to year-end 2007. As we typically do at this time of year weâ€™re evaluating repatriating cash from overseas which is primarily invested in money market instruments.
Obviously repatriation does not impact net debt but causes swings between where cash is held and the level of commercial paper outstanding. Regarding net interest expense in the third quarter we had $22 million compared to $15 million in the same period last year.
We expect interest expense in the fourth quarter to be roughly comparable with the third quarter resulting in a full year interest expense of approximately $80 million.
Letâ€™s now review free cash flow, as a reminder of our free cash flow calculation, we start with after-tax cash from operations which is after working capital and deduct pre-publication investments, CapEx and dividends. Whatâ€™s left is free cash flow, funds that we can use to repurchase stock, make acquisitions, or pay down debt.
Despite a challenging 2008 we continued to generate free cash flow. Third quarter free cash flow was approximately $500 million which is roughly flat with last year. As we indicated on the second quarter earnings call free cash flow as of June 30 was approximately $300 million lower then the year before while third quarter free cash flow performance was comparable to the prior year given the reduction in third quarter revenue and its impact on cash collections in the fourth quarter, we now project free cash flow to be approximately $500 million for 2008 versus the $600 million forecast we provided during our second quarter earnings call in July.
To help offset the lower operating cash flow weâ€™re carefully managing costs and capital investments while continuing to invest in fast growing areas such as [Cresol], Capital IQ and index services. Given the uncertain economic environment we will continue to monitor our investment priorities this year.
Iâ€™ll discuss capital expenditures in greater detail shortly, but will now recap our acquisition and share repurchase activities. For the first nine months we spent approximately $40 million on acquisitions. On October 7 of this quarter we announced that we had acquired a copy of the Reuterâ€™s estimates and Reuterâ€™s research on demand databases to enhance Capital IQâ€™s data offering.
In the third quarter we repurchased 3.5 million shares for a total cost of $142.4 million at an average price of $40.70 per share. That brings the year-to-date repurchases to 10.9 million shares for a cost of $447.2 million at an average price of $41.03 per share.
A total of 17.1 million shares remain in the 2007 program authorized by the Board of Directors. Given our new forecast for reduced free cash flow and our desire to maintain debt levels comparable to year-end 2007 weâ€™re currently evaluating the extent of our share repurchases for the fourth quarter.
We remain committed to returning cash to shareholders through dividend payments and share repurchases but it is important to balance this while maintaining appropriate liquidity during this difficult credit environment.
Our diluted weighted average shares outstanding declined in the third quarter to 317.2 million shares. This reflects a 20.5 million share decrease compared to the third quarter of 2007 and a 3.9 million share decrease compared to the second quarter of 2008.
Our fully diluted shares at the end of the third quarter were approximately 315 million shares. Iâ€™ll now review unearned revenue which ended the quarter at approximately $1.1 billion, a 6.4% year-over-year increase.
Financial services unearned revenue grew 7.2% versus the prior year. The year-over-year revenue declined for credit market services primarily structured finance accounts for the slower growth in unearned revenue.
Financial services represents three-quarters of our unearned revenue balance and with the reduced revenue guidance for financial services we now expect minimal growth in the corporationâ€™s unearned revenue for 2008.
Our effective tax rate was 37.5% in the third quarter and we expect it to be approximately at the same level for the full year. Letâ€™s now look at capital expenditures, which include pre-publication investments and purchases of property and equipment.
In the third quarter our pre-publication investments were $65 million compared to $77 million in the same period last year. We continue to expect $270 million for 2008. Purchases of property and equipment were $18 million in the third quarter compared to $63 million in the same period last year and this was of course higher last year because of the building of our new data center.
In light of slower operating free cash flow as well as the uncertain economic environment, weâ€™re delaying a number of capital projects. We now project CapEx will be $115 million for 2008 versus our previous forecast of $160 million.
Iâ€™d like to wrap up with a quick review of non-cash items, amortization of pre-publication costs was $125 million compared to $110 million last year. For 2008 we continue to expect it to be about $275 million. Depreciation was $30 million compared to $26 million in the same period last year. We still expect it to be approximately $125 million in 2008 primarily due to the completion of the data center as well as the purchase of new technology equipment.
Amortization of intangibles was $14 million compared to $12 million in the same period last year and for 2008 we expect it to be approximately $52 million. So letâ€™s sum up, weâ€™re taking a hard line on company expenses while prudently managing investments to support areas of high growth potential.
In short, weâ€™re making every effort to protect the companyâ€™s strong financial position in a very difficult environment. Our priorities are clear, reduce expenses, ensure we have the resources to fund our growth and maintain liquidity.
We are now ready for your questions.