The Daily Magic Formula Stock for 05/16/2008 is McGraw-Hill Companies Inc. According to the Magic Formula Investing Web Site, the ebit yield is 13% 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 a wide range of information products and services. Additional markets include energy, construction, aerospace and defense, and marketing information services. 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 21,171 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, trademark, and other agreements, which are essential to such a business, the Registrant is able to collect, compile, and disseminate this information. The Companyâ€™s books and magazines are printed by third parties. 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), pages 24 and 25, containing textual material of the Registrantâ€™s 2007 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, Form 10-Qs, Form 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. International callers may dial 212-512-2192.
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 Web site at www.mcgraw-hill.com/investor_relations. Any waivers that may in the future be granted from such Code will be posted at such Web site 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 Web site at the above Web site 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 (â€śSECâ€ť) 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 Relations Web site. 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 its annual report on Form 10-K for the fiscal year ended December 31, 2007. In addition the Company has filed the required certifications under Section 906 of the Sarbanes-Oxley Act of 2002 as Exhibit (32) to its annual report on Form 10-K for the fiscal year ended December 31, 2007. After the 2008 Annual Meeting of Shareholders, the Company intends to file with the New York Stock Exchange (â€śNYSEâ€ť) 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 17, 2007.
Sir Winfried Bischoff , age 66, has been Chairman of Citigroup, Inc. (â€śCitiâ€ť), a global financial services firm, since December 11, 2007. He served as acting Chief Executive Officer of Citi from November 4, 2007 through December 11, 2007 while maintaining his role of Chairman of Citi Europe, which he has been since 2000. Sir Winfried Bischoff was Chairman of Schroders plc, an international investment banking and asset management firm headquartered in Great Britain, from 1995 to 2000. Prior to that, Sir Winfried Bischoff was Chairman of J. Henry Schroder Co. (the London investment bank of Schroders plc) from 1983 to 1995 and Group Chief Executive of Schroders plc from 1984 to 1995. He is a Director of Eli Lilly and Company and Prudential plc. He was knighted in 2000 for his services to the banking industry. Sir Winfried Bischoff has served as a Director of the Company since 1999 and is Chair of the Financial Policy Committee and a member of the Executive and Compensation Committees.
Douglas N. Daft , age 65, was Chairman of the Board and Chief Executive Officer of The Coca-Cola Company from 2000 until his retirement from the company in 2004. Mr. Daft joined The Coca-Cola Company in 1969 in its Sydney, Australia office, and subsequently held various positions with the company throughout Asia. Mr. Daft moved to the companyâ€™s Atlanta, Georgia headquarters in 1991 to assume responsibility for the companyâ€™s Asia and Pacific regions and thereafter assumed responsibility for the companyâ€™s Middle East and African regions as well. Mr. Daft was appointed President and Chief Operating Officer of the company in 1999 and Chairman and Chief Executive Officer in 2000. Mr. Daft is a Director of Wal-Mart Stores, Inc. and Sistema-Hals (the Russian real estate, construction and development company). Mr. Daft is an advisory board member for Longreach, Inc. (a Japan-based private equity firm) and Thomas H. Lee Partners. Mr. Daft is also a member of the European Advisory Council for N.M. Rothschild & Sons Limited; an overseer board member for the International Business School of Brandeis University; a member of the Board of Governors of Thunderbird, The Garvin School of International Management in Arizona; Chairman of the Advisory Board for the Churchill Archives Center, Churchill College, Cambridge; a Patron of the American Australian Association; and a Trustee of the Cambridge Foundation. Mr. Daft has served as a Director of the Company since 2003 and is a member of the Audit and Compensation Committees.
Linda Koch Lorimer , age 56, has been Vice President and Secretary of Yale University since 1995, having returned to Yale as Secretary of the University in 1993. She was President of Randolph-Macon Womanâ€™s College from 1987 to 1993 and was Associate Provost of Yale University from 1983 to 1987. She is a Director of Sprint Nextel Corporation. Ms. Lorimer is the former Chairman of the Board of the Association of American Colleges and Universities and the Womenâ€™s College Coalition. Ms. Lorimer is a Director of Yale-New Haven Hospital and a Trustee of Hollins University. Ms. Lorimer has served as a Director of the Company since 1994 and is Chair of the Nominating and Corporate Governance Committee and a member of the Compensation and Executive Committees. She also serves as the Presiding Director of the Companyâ€™s Board of Directors.
Harold McGraw III , age 59, has been Chairman of the Board since 2000 and President and Chief Executive Officer of the Company since 1998. Prior to that, Mr. McGraw had been President and Chief Operating Officer of the Company since 1993. He was Executive Vice President, Operations, of the Company from 1989 to 1993. Prior to that, he was President of the McGraw-Hill Financial Services Company, President of the McGraw-Hill Publications Company, Publisher of Aviation Week & Space Technology magazine and Vice President, Corporate Planning. Before joining the Company in 1980, he held financial positions at the GTE Corporation. Mr. McGraw serves on the Boards of Directors of ConocoPhillips and United Technologies Corporation. He is Chairman of The Business Roundtable and Chairman of the Emergency Committee for American Trade (ECAT). He is a member of The U.S. Trade Representativeâ€™s Advisory Committee for Trade, Policy and Negotiations (ACTPN) and The Business Council. He is Chairman of the Committee Encouraging Corporate Philanthropy and serves on the Board of the National Council on Economic Education and is on the Board of Trustees of Carnegie Hall as well as the Board of The New York Public Library. He also is a member of the Boards of the National Organization on Disability, The National Academy Foundation and Hartley House. Mr. McGraw has served as a Director of the Company since 1987 and is Chair of the Executive Committee. (a)
Sir Michael Rake , age 60, has been Chairman of BT Group plc (â€śBTâ€ť), one of the largest communications companies in the world, serving customers in more than 170 countries, since September 2007. Prior to being named Chairman of BT, he was Chairman of KPMG International, one of the worldâ€™s leading accounting organizations, with operations in 148 countries and more than 113,000 professionals working in member firms worldwide. After joining KPMG in 1972, he served the company in various capacities in Belgium, Luxembourg, the Middle East and London, and led a number of major global clientsâ€™ services teams. He joined the companyâ€™s UK Board in 1991, was elected UK Senior Partner in 1998 and named International Chairman in 2002. Sir Michael Rake is Chair of the Commission for Employment and Skills in the UK and a Vice President of the Royal National Institute for the Blind. He sits on the Board of the Financial Reporting Council and is a member of the DTI UK/US Taskforce on Regulation. He is a member of the Board of the TransAtlantic Business Dialogue, a member of the CBI International Advisory Board and the Advisory Board of the Judge Institute at the University of Cambridge. Educated at Wellington College, where he is a Governor, Sir Michael Rake is qualified as a UK chartered accountant. He was knighted in 2007 for his services to the accounting profession. Sir Michael Rake has served as a Director of the Company since December 2007 and is a member of the Audit Committee.
James H. Ross , age 69, was Deputy Chairman of National Grid Transco plc, a public UK company with interests in electricity and gas transmission and distribution in the United Kingdom, the United States, Argentina, Zambia and Australia, from 2002 to 2004. Prior to that, Mr. Ross was Chairman of National Grid Group plc from 1999 to 2002. From 1996 to 2002, Mr. Ross was Chairman of The Littlewoods Organisation, a private company in Great Britain operating in the retail home shopping and leisure businesses. Mr. Ross was Chief Executive and Deputy Chairman of Cable & Wireless plc, an international provider of telecommunications services, between 1992 and 1995. He was a Managing Director of British Petroleum plc, which engages in all phases of the petroleum business, from 1991 to 1992, and Chairman and Chief Executive Officer of BP America Inc., a subsidiary of British Petroleum plc, from 1988 to 1992. Mr. Ross is a Director of Prudential plc, Schneider Electric and Datacard Inc. He is also the Chairman of the Leadership Foundation for Higher Education in the United Kingdom. Mr. Ross has served as a Director of the Company since 1989 and is a member of the Audit and Nominating and Corporate Governance Committees.
Kurt L. Schmoke , age 58, has been the Dean of the Howard University School of Law since 2003. Prior to that, he was a partner at the Washington, D.C. based law firm of Wilmer Cutler & Pickering from 2000 through 2002. Mr. Schmoke served three terms as the Mayor of Baltimore from 1987 until 1999. Mr. Schmoke served as the Stateâ€™s Attorney for Baltimore City from 1982 until 1987. Mr. Schmoke is a Director of Legg Mason, Inc. He is a Trustee of The Carnegie Corporation of New York and Howard Hughes Medical Institute, a private philanthropic group. Mr. Schmoke is also a member of the Council on Foreign Relations. Mr. Schmoke was named to President Jimmy Carterâ€™s domestic policy staff in 1977. Mr. Schmoke has served as a Director of the Company since 2003 and is a member of the Financial Policy and Nominating and Corporate Governance Committees.
Sidney Taurel , age 59, has been Chairman and Chief Executive Officer of Eli Lilly and Company, a pharmaceutical company, since 1999. He was also its President from 1996 through 2005. Mr. Taurel joined Eli Lilly in 1971 and held management positions in the companyâ€™s operations in Brazil and Europe before becoming President of Eli Lilly International Corporation in 1986. He was elected a Director of Eli Lilly and Company in 1991, became Executive Vice President in 1993, and President and Chief Operating Officer in 1996. He has served as President and CEO since June 1998, adding the role of Chairman of the Board in January 1999. Mr. Taurel is a Director of IBM. He is a member of The Business Council and The Business Roundtable, and a Director of Pharmaceutical Research and Manufacturers of America. He is a Member of the Board of Overseers of the Columbia Business School, a founder of the International School of Indiana, and a Trustee of the Indianapolis Museum of Art. Mr. Taurel is also a Director of the RCA Tennis Championships. In February 2003, President Bush appointed Mr. Taurel to the Presidentâ€™s Export Council. Mr. Taurel has served as a Director of the Company since 1996 and is Chair of the Compensation Committee and a member of the Executive and Nominating and Corporate Governance Committees.
Pedro Aspe , age 57, has been since 2006 Co-Chairman of the Board of Evercore Partners, Inc., a leading investment banking boutique, and since 1996 Chairman of the Board and Chief Executive Officer of Protego Asesores, S.A. de C.V., a leading investment banking advisory firm in Mexico. From 1996 to 2000, Dr. Aspe was Chairman of the Board of Vector Casa de Bolsa, S.A. de C.V., an investment banking firm in Mexico. Dr. Aspe has been since 1995 a professor at the Instituto TecnolĂłgico AutĂłnomo de MĂ©xico located in Mexico City. Dr. Aspe has held a number of positions with the Mexican government and was the Secretary of Finance and Public Credit of Mexico from 1988 through 1994. Dr. Aspe is a Director of the Carnegie Corporation and of Televisa located in Mexico City. Dr. Aspe is a member of the Advisory Board of Stanford Universityâ€™s Institute of International Studies and the Visiting Committee of the Department of Economics of MIT. Dr. Aspe also sits on the Advisory Board of Marvin & Palmer. Dr. Aspe has served as a Director of the Company since 1996 and is a member of the Compensation and Financial Policy Committees.
Robert P. McGraw , age 53, has been Chairman and Chief Executive Officer of Averdale International, LLC since 1999. Prior to that, Mr. McGraw was Executive Vice President of the Professional Publishing Group of the Company from 1989 to 1998. He was Executive Vice President of the Healthcare Group from 1987 to 1989, and Group Vice President of that same group from 1985 to 1987. Prior to that, he served in several key positions in the Health Professions Division of the Company: General Manager from 1983 to 1985; Editorial Director from 1982 to 1983; and Editor from 1979 to 1982. He joined the Company in 1976 as a sales representative for McGraw-Hill Higher Education. Mr. McGraw has served as a Director of the Company since 1995 and is a member of the Financial Policy Committee. (a)
Hilda Ochoa-Brillembourg , age 63, is the founder and has been since 1987 the President and Chief Executive Officer of Strategic Investment Group, a group of affiliated investment management firms, and Director of Emerging Markets Investment Corporation and Emerging Markets Management, LLC. From 1976 to 1987, she was Chief Investment Officer of the Pension Investment Division at the World Bank. Prior to joining the World Bank, she served as an independent consultant in the fields of economics and finance, as a lecturer at the Universidad Catolica Andres Bello in Venezuela and as Treasurer of the C.A. Luz Electrica de Venezuela in Caracas. Ms. Ochoa-Brillembourg is a Director of General Mills, Inc., the World Bank/International Monetary Fund Credit Union and the Harvard Management Company, Inc. Ms. Ochoa-Brillembourg is Founding Chair of the Youth Orchestra of the Americas and a Trustee and Executive Committee member of the Washington National Opera. She is Vice Chairman, Group of 50, of the Carnegie Endowment for International Peace. She is also a Trustee and Co-Chair of the National Relations Committee of the National Symphony Orchestra and an Advisory Board member of the Rockefeller Center for Latin American Studies at Harvard University. Ms. Ochoa-Brillembourg has served as a Director of the Company since 2004 and is a member of the Audit and Financial Policy Committees.
Edward B. Rust, Jr. , age 57, has been since 1987 Chairman of the Board and Chief Executive Officer of State Farm Insurance Companies, the largest insurer of automobiles and homes in the United States. Mr. Rust was also President of State Farm Insurance Companies from 1985 to 1998, and was re-elected President in 2007. Mr. Rust is a Director of Helmerich & Payne, an oil and gas drilling company, and Caterpillar Inc., a manufacturer of construction and mining equipment. Mr. Rust is a Trustee for Illinois Wesleyan University. Additionally, he was a member of President George W. Bushâ€™s Transition Advisory Team Committee on Education. Mr. Rust is Co-Chairman of The Business Roundtable. Mr. Rust has served as a Director of the Company since 2001 and is Chair of the Audit Committee and a member of the Executive and Compensation Committees.
What Are the Elements of Our Executive Compensation Program?
Our executive compensation program for our named executive officers consists of the following elements:
Annual cash incentives under our Key Executive Short-Term Incentive Compensation Plan;
Stock-based long-term incentives (Restricted Performance Shares and stock options) under our 2002 Stock Incentive Plan;
Retirement and other post-employment benefits under our tax-qualified and nonqualified retirement plans and our Senior Executive Severance Plan;
Health and welfare benefits under our group benefit plans and supplemental death and disability plans; and
Limited perquisites and other fringe benefits.
How Do We Use Market Data in Setting Compensation Levels?
In order to ensure that our salary ranges and incentive grant guidelines are aligned with general market practices, we use market data as reference points for competitive compensation paid in the external market place. In general, we design our executive compensation program to pay median levels of compensation for target levels of achievement, to pay below median for achievement below target, and to pay third quartile or above compensation for significantly higher levels of achievement versus target goals.
For purposes of setting the compensation of the named executive officers, a review is made of a third-party consultant survey of base salaries, annual incentive payments and equity awards within the publishing, information and media industries. For 2007, a total of 42 companies participated in the survey. For confidentiality reasons, the survey data provided to us by our third-party consultant does not identify the specific companies that reported compensation for each position.
Additionally, for purposes of setting the compensation of our CEO, CFO and General Counsel, a review is also made of the base salaries and annual and long-term incentive payments publicly reported by the companies included in the S&P 500 Financial Services Sector, a total of 93 companies for 2007.
How Do We Link Our Executives' Compensation to Our Performance?
A significant portion of the compensation paid to our named executive officers is aligned closely with shareholder interests since it is payable in equity and based on growth in earnings per share. Approximately 80% of our CEOâ€™s 2007 compensation opportunity was variable with the payment or value of the awards subject to the achievement of an annual double-digit earnings per share growth goal for the cash bonus opportunity; achievement of a three-year earnings per share growth goal for the Restricted Performance Share award; and, in the case of stock option grants, future increases in the Companyâ€™s stock price. For the other named executive officers, the variable percentages of 2007 compensation opportunities ranged from 67% to 71%. We believe that this incentive design provides strong motivation to focus on creating shareholder value.
What Compensation Did We Award to Our Named Executive Officers in 2006 and 2007?
The table below shows the 2006 and 2007 compensation amounts, including base salary, annual incentive payments and the value of the long-term incentive equity based awards for the named executive officers, as approved by the Compensation Committee. Not all of the amounts in this table coincide with amounts reported in the Summary Compensation Table on page 36 of this Proxy Statement.
What Individual Performance Factors Did We Apply for 2007?
With respect to the CEO, the following summarizes the specific performance factors that the Compensation Committee considered in determining compensation actions based on 2007 performance for purposes of his 2007 annual incentive payment, his 2008 base salary and his 2008 long-term incentive awards.
Harold McGraw III, Chairman, President and Chief Executive Officer:
Led the Company to strong full year results:
Reported 2007 diluted EPS grew by 22.5% over 2006;
Revenue grew by 8.3% over 2006;
Reported net income grew by 14.9% over 2006;
Initiated and directed comprehensive review of corporate business portfolio and planning for future business opportunities, including investment in digital media and global expansion;
Sponsored and directly engaged in a business process management initiative companywide to identify productivity opportunities and drive margin expansion;
Demonstrated strong personal commitment to leadership and development of high potential employees and broad based talent development initiatives; and
Promoted Company reputation by performing highly visible roles as Chairman of The Business Roundtable and Chairman of the Emergency Committee for American Trade.
With respect to the named executive officers reporting to the CEO, the following summarizes the specific performance factors considered in determining compensation actions based on their individual 2007 performance in addition to the Companyâ€™s 2007 financial performance referred to above for purposes of their 2007 annual incentive payment, their 2008 base salary and their 2008 long-term incentive awards.
Robert J. Bahash, Executive Vice President and Chief Financial Officer:
Enhanced efficiencies in corporate information management and reduced unit costs;
Created a global technology infrastructure to enable the introduction of new revenue generating digital products;
Realized significant savings by selecting high quality/low cost suppliers in India, China and Latin America; and
Increased accuracy of cash flow forecasting models to improve cash management efficiency.
David Murphy, Executive Vice President, Human Resources:
Launched upgraded human resource, payroll and benefits systems and global managerial and employee self-service applications;
Continued strong focus on global talent development initiatives including Key Leadership Education, Talent Councils, Accelerated Development Programs, Womenâ€™s High Potential Initiative and Diversity commitment;
Provided strategic leadership direction to Global Real Estate and Facilities development needs; and
Launched web based on demand learning management system providing enhanced development opportunities for our global workforce.
Kenneth M. Vittor, Executive Vice President and General Counsel:
Led the Companyâ€™s response to Credit Rating Agency Reform Act and SEC Oversight Rules;
Led the Companyâ€™s responses to significant litigation matters;
Coordinated the Companyâ€™s initiatives and responses concerning corporate governance; and
Led the Companyâ€™s initiatives on global security and crisis management.
Peter Davis, Executive Vice President, Global Strategy:
Developed a comprehensive portfolio review for each of the Companyâ€™s businesses;
Identified growth opportunities in several adjacent markets, including new business models;
Developed a framework for expansion of new domestic and international business opportunities; and
Completed key acquisition and divestiture activities and identified potential future transactions.
How Do We Set Base Salaries?
The base salaries of our named executive officers are reviewed on an annual basis with median marketplace compensation survey data for comparable positions. Increases to base salary are based on an assessment of the executivesâ€™ individual performance evaluated under our Performance Management Process, and the increase guidelines established for merit increases.
We use a global Performance Management Process that measures performance against goals, behaviors and competencies to determine individual performance ratings. Those rated at lower levels are not eligible for base salary increases or annual incentive payments unless and until performance improves to meet their managerâ€™s expectations.
The base salary increases for our CEO and our other named executive officers are effective on January 1 of each year. The Compensation Committee evaluates the performance of our CEO and reports its findings and recommendations to the independent members of the Board of Directors in executive session each December. Base salary merit increases for our other named executive officers are recommended annually by the CEO and are reviewed and approved by the Compensation Committee.
In formulating his base salary recommendations for our other named executive officers for the following year, the CEO reviews the named executive officersâ€™ current year base salary, individual achievements and contributions, financial results, the competitive market data described above and his expectations for the named executive officers for the year. The criteria used to evaluate financial performance include, among other things, our earnings per share growth, net income growth and revenue growth. The CEO makes his recommendations for adjustments to the other named executive officersâ€™ base salaries for the following year based on this assessment and the annual base salary merit increase guidelines that are established by the Compensation Committee for the following year. For 2007 and 2008, the merit budget for Corporate employees was set at 3.6% of the prior yearâ€™s annual base salaries. The individual guidelines for our named executive officers were in a range between 0 and 10%.
Independently, the Compensation Committee determines the CEOâ€™s annual base salary adjustment for each year. These decisions are made in executive session with input from Frederic W. Cook & Co. The CEO position is not included in the salary bands that cover other senior executives. Instead, the Compensation Committee establishes his base salary so that, together with his target annual incentive and stock-based awards, his compensation is competitive in total against market reference points for the publishing, information, media and financial services industries, taking into account differences in pay mix and his individual performance for the applicable year.
Based on the individual achievements described above and in recognition of their leadership and expertise in their respective areas of responsibility, our named executive officers were granted salary increases for 2008. The amount of each executive's increase for 2008 was generally consistent with the increases the executive received in 2007, but adjusted downward in recognition of the challenging 2008 economic environment.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations â€” Comparing Three Months Ended March 31, 2008 and 2007
In the first quarter of 2008 revenue and operating profit declined by 6.1% and 32.1%, respectively. The decrease in revenue and operating profit is primarily attributable to the decline in our Financial Services segment of 11.6% and 25.3%, respectively, primarily due to weakness in Credit Market Services. Partially offsetting the revenue decrease was an increase of 3.2% in the Information & Media segment primarily driven by the Business-to-Business Group. Revenue at the McGraw-Hill Education segment was essentially flat. Lower 2008 incentive compensation helped mitigate the operating profit decline. The quarter reflects the seasonal nature of the Companyâ€™s educational publishing operations, with the first quarter being the least significant and the third quarter being the most significant. Foreign exchange rates positively impacted both revenue and operating profit by $19.6 million and $3.2 million, respectively, during the first quarter of 2008.
In March 2007, the Company sold its mutual fund data business, which was part of the Financial Services segment. The sale resulted in a $17.3 million pre-tax gain ($10.3 million after-tax, or $0.03 per diluted share), recorded as other income. The divestiture of the mutual fund data business was consistent with the Financial Services segmentâ€™s strategy of directing resources to those businesses which have the best opportunities to achieve both significant financial growth and market leadership. The divestiture will enable the Financial Services segment to focus on its core business of providing independent research, ratings, data, indices and portfolio services.
Product revenue increased 1.7% in the first quarter of 2008, due primarily to growth in the Information & Media segment driven by increased sales in the Business-to-Business Group as compared to the first quarter of 2007.
Product operating-related expenses increased 6.5%, as compared to the first quarter of 2007, primarily due to the growth in expenses at McGraw-Hill Education from the increase in direct expenses relating to product development, royalties and manufacturing costs. Also contributing to this increase were increases in editorial costs partially offset by cost containment. Amortization of prepublication costs was in line with the first quarter of 2007.
Product related selling and general expenses decreased 3.3%, primarily due to cost containment at McGraw-Hill Education. The product margin improved 0.6% mainly due to increased product sales at McGraw-Hill Education and cost containment.
Service revenue decreased 8.5% in the first quarter of 2008 as compared to the first quarter of 2007, due primarily to an 11.6% 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 4.4% to 27.8% for the first quarter of 2008 primarily due to the decline in Credit Market Services, partially offset by reduced 2008 incentive compensation expense.
Total expenses in the first quarter of 2008 decreased $11.3 million or 1.0% as compared to the same period in 2007 driven by reductions in incentive compensation for 2008, partially offset by increases in salaries and wages and increases in rent expense.
Interest expense increased to $17.8 million in the first quarter of 2008, as compared with interest expense of $1.2 million for the first 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 first quarter of 2008 and 2007 is interest income earned on investment balances.
For the quarters ended March 31, 2008 and 2007, the effective tax rate was 37.5% and 37.7%, respectively. The minor decrease in the effective tax rate for the period ended March 31, 2008, compared with the prior period, is primarily attributable to the impact of the 2007 divestiture of the mutual fund data business.
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 43.6% as compared with the first quarter of 2007. Diluted earnings per share decreased 37.5% to $0.25 from $0.40 in 2007. Included in the 2007 diluted earnings per share is the $0.03 after-tax favorable impact of the divestiture of the Financial Servicesâ€™ mutual fund data business.
The Company is currently considering further staff reductions related to a limited number of business operations in the Financial Services and McGraw-Hill Education segments to gain efficiencies and reflect current business conditions. As a result, the Company anticipates having a plan and recording a restructuring charge during the second quarter of 2008. The Company is unable to estimate the amount of this restructuring charge at this time.
Revenue for the McGraw-Hill Education (â€śMHEâ€ť) segment decreased 0.5% from the prior year, while its operating loss improved 0.5%. The quarter reflects the seasonal nature of the Companyâ€™s educational publishing operations, with the first quarter being the least significant, and the third quarter being the most significant. Foreign exchange rates positively impacted revenue by $4.4 million and had an immaterial impact on the improvement in operating loss.
In the first quarter of 2008, revenue for the McGraw-Hill School Education Group (â€śSEGâ€ť) decreased 4.8% or $7.0 million compared with the first quarter of 2007. A shift in adoption opportunities from K-5 to 6-12 in North Carolina and a decline in supplemental sales contributed to SEGâ€™s revenue decrease. 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 in math in Texas and California and reading in Florida. Other opportunities for 2008 include science in California, reading in Alabama, Louisiana, and Oklahoma, and social studies in Tennessee. Early activity indicates solid results for the SEG in the Florida K-5 reading adoption as well as good second-year wins in California K-8 science and first-year wins in California K-8 math. Despite concerns about the economy in many areas, adoption activity remained brisk at the district level in all states within this market, and there has been no cancellation or significant delay in state adoptions scheduled for purchasing in 2008.
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. There is a possibility that open territory spending in 2008 will be affected by limited increases in federal funding and pressures on local and state budgets as problems in the housing sector cause tax revenues to decline. However, open territory sales for the industry increased by 4% through February 2008, the most recent period for which detailed information is currently available, and a number of large districts have announced that they will be purchasing new materials in the second or third quarter.
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 were down by 0.9% through February 2008 compared to the same two-month period in 2007. The numbers are not considered predictive of full-year results because very little new basal purchasing occurs during the first quarter.
In the testing market, SEGâ€™s first-quarter non-custom or â€śshelfâ€ť testing revenue increased over the prior year primarily due to increased sales in New York City. The acceleration of some custom contract work into the fourth quarter of 2007 was the principal reason for a decrease in this revenue category during the first quarter of 2008 compared to the same period last year.
At the McGraw-Hill Higher Education, Professional and International Group (â€śHPIâ€ť), revenue increased $5.4 million, including the positive impact of foreign exchange, or 2.9% compared to prior year.
Higher Education revenue increased modestly during the quarter, which is seasonally small in this market. Growth in the Business and Economics (â€śB&Eâ€ť), Science, Engineering and Math (â€śSEMâ€ť), and Career product lines was partially offset by a slight decline in Humanities, Social Sciences and Languages (â€śHSSLâ€ť). Key titles contributing to first-quarter performance included McConnell, Economics , 17/e; Nickels, Understanding Business , 8/e; Garrison, Managerial Accounting , 12/e; Bentley, Traditions and Encounters, 4/e; and Wardlaw, Contemporary Nutrition , 7/e.
Revenue in the professional market was flat with the prior-year quarter as growth contributed by frontlist titles and digital subscription products was offset by sales declines in some backlist categories. However, the release of the new, seventeenth edition of Harrisonâ€™s Principles of Internal Medicine in mid-March benefited both domestic and international sales at HPI during the quarter and will have a positive impact on results throughout the remainder of the year. Compared with the first quarter of 2007, HPIâ€™s overall international revenue, including the positive impact of foreign exchange rates, increased slightly as sales declines in Latin America were offset by improved sales of higher education, professional, and English-language training products in India, Korea, China, and Thailand.
Financial Services revenue and operating profit for the first quarter of 2008 decreased 11.6% and 25.3%, respectively, from the first 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 $14.8 million and operating profit by $6.5 million.
In March 2007, the Company sold its mutual fund data business, which resulted in a $17.3 million pre-tax gain ($10.3 million after-tax, or $0.03 per diluted share). Included in Investment Services in the first quarter of 2007 was $7.8 million of revenue relating to this mutual fund data business, with no comparable amount in the first quarter of 2008.
CMS revenue declined $117.7 million or 21.6% from prior year, primarily as a result of significant decreases in structured finance. Also contributing to the decrease was a decrease in corporate ratings partially offset by increases in credit ratings-related information products such as RatingsXpress and RatingsDirect and credit risk evaluation products and services.
During the first quarter of 2008, significant decreases in issuance volumes in both the United States and Europe for residential mortgage backed securities (â€śRMBSâ€ť), commercial mortgage backed securities (â€śCMBSâ€ť) and Collateralized Debt Obligations (â€śCDOâ€ť) contributed to the decreases in revenue.
Total U.S. structured finance new issue dollar volume decreased 76.3% in the first quarter versus prior year. U.S. CDO issuance decreased 91.1%, according to Harrison Scott Publications and Standard & Poorâ€™s internal estimates (Harrison Scott Publications/S&P). The large decline in CDO issuance resulted from lack of investor appetite for the complex deal structures which were in demand in the first 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 95.1% compared to prior year. U.S. CMBS issuance decreased 90.8% 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. Asset Backed Securities (â€śABSâ€ť) issuance increased 42.1% compared to prior year, driven by a large private placement of $29 billion. Excluding the impact of this private placement deal, U.S. ABS was slightly down as compared to the same period in 2007. According to Thomson Financial, U.S. corporate issuance by dollar volume for the first quarter of 2008 decreased 37.1%, with investment grade down 29.5% and high yield issuance down 87.8%, driven by higher credit spreads and decreased merger & acquisition activity. The U.S. municipal market declined 24.7% mostly reflecting comparisons to the very strong issuance levels experienced in 2007.
In Europe for the first quarter, structured finance issuance declined 61.0% compared to the prior year and corporate and government issuance declined 41.0%, contributing to the revenue decline in CMS. RMBS issuance in Europe declined 68.7% compared to prior year as the result of high credit spreads which have led prime lenders to utilize other sources of more economical funding. European CDO and CMBS issuance declined 69.9% and 91.1% respectively, which is also primarily attributed to higher credit spreads. ABS issuance increased 48.2% compared to the prior year.
IS revenue increased $33.1 million or 18.0%, 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 23.1% from March 31, 2007 to $209.7 billion as of March 31, 2008. 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 first quarter of 2008 compared to the same period of the prior year, thereby also contributing to the revenue growth. In the first quarter of 2008 the number of Capital IQ clients increased 24% as compared to the first quarter of 2007.
Because of the current credit market conditions, issuance levels deteriorated significantly across all asset classes except for ABS. 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 nine 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 want to be recognized as NRSROs. Registrants, including existing NRSROs, are required to submit policies, methodologies, performance data and other materials. Registered NRSROs are required to certify annually as to the accuracy of application materials and list material changes. 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 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 is responding to this request.
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.
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 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.
The legal status of rating agencies has also been addressed by courts in the United States in various decisions and is likely to be considered and addressed in legal proceedings from time to time in the future.
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) 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. IOSCOâ€™s first review culminated in December 2004 with its Code of Conduct Fundamentals for rating agencies. Standard & Poorâ€™s worked closely with IOSCO in drafting the Code and, in October 2005, Standard & Poorâ€™s issued a new Credit Market Services Code of Conduct, which was updated in June 2007 that is consistent with the IOSCO Code.
CESR has been charged by the European Commission with monitoring and reporting to the Commission on rating agenciesâ€™ compliance with their IOSCO-based codes of conduct. CESR held its first annual compliance review in 2006 and, in December 2006, issued its first annual report. CESR concluded that Standard & Poorâ€™s and the three other agencies it reviewed are largely compliant with the IOSCO Code. CESR noted areas for improvement and in June 2007, CESR published a questionnaire for public comment concerning structured finance ratings and processes and asked the rating agencies for additional information in the fall. Standard & Poorâ€™s participated in this process. CESR plans to issue its 2007 report in mid-2008. CESR stated it will also assess in its next report the impact of the new U.S. law and SEC rules on the ratings industry in Europe.
In 2006, IOSCO conducted a similar review of rating agenciesâ€™ implementation of IOSCOâ€™s model Code of Conduct and issued a report for public consultation in February 2007. IOSCOâ€™s draft conclusions concerning implementation by the major rating agencies were positive overall. As part of its ongoing review and in response to developments in the U.S. housing market, in September 2007, IOSCO convened a meeting of rating agency task force members and representatives from the then seven NRSROs to discuss structured finance rating issues. IOSCO may modify its model Code of Conduct following its review of agenciesâ€™ structured finance rating processes. IOSCOâ€™s work is expected to conclude in mid-2008.
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. The current time to respond to the Complaint is May 12, 2008. In addition, the Company has 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 has not been 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 to add additional defendants. 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. The Company believes both Complaints to be without merit and intends to vigorously defend against them.
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.