S&P Global Inc.
Q4 2007 Earnings Call Transcript

Published: 24 Jan 2008

[Operator:]

Good morning, and welcome to McGraw-Hill Companies' fourth quarter 2007 earnings call. At this time, I'd like you inform you that the call is being recorded for broadcast and that all participants are in listen-only mode. At the request of the company, we will open the conference to questions and answers after presentation, and instructions will follow at that time. To enhance the call for today's participants, McGraw-Hill has made the presenters' slides available on the Internet. To do that, go to http

[Donald Rubin:]

Thank you and good morning. And thank everyone for joining us here at the McGraw-Hill Companies' fourth quarter earnings call. I'm Donald Rubin, Senior Vice President for Investor Relations at 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. This morning we issued a news release with our fourth quarter and full year 2007 results. We trust you've 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/Investor_Relations. Once again, that's www.McGrawHill.com/Investor_Relations. Before we begin this morning, I need to provide certain cautionary remarks about forward-looking statements. Except for historical information, the matters discussed in the 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 10Ks, 10Qs, and other periodic reports filed with the U.S. Securities and Exchange Commission. We are aware that we do have some media representatives with us on the call, however this call is for investors and we would ask that questions from the media be directed to Frank Briamonte in our New York office at area code 2125124145. 5124145. And do that subsequent to this call. Thank you. Today's update will last approximately an hour. After our 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, Terry McGraw.

[Harold McGraw III:]

Okay. Thank you very much, Don, and good morning, everyone. And again, thank you for taking time to be with us, and welcome to our review of the fourth quarter for the McGraw-Hill Companies and for the full year 2007. Joining me on the conference call will be Bob Bahash, who's our Executive Vice President and Chief Financial Officer. I'll begin by reviewing our results and the outlook for 2008, and then Bob will review our financial performance, and after his remarks, we'll be pleased to go in any direction anyone would like, any questions or comments about the McGraw-Hill Companies. Well, by now we all know that the Federal Reserve cut interest rates 75 basis points two days ago in an effort to make sure that the recession that many are so concerned about will be mild and will be brief, it if occurs at all. David Wyss, who is Standard & Poor's Chief Economist, currently thinks the odds of the U.S. economy slipping into a recession - a slight recession - are about 50

[Robert Bahash:]

Okay. Thank you, Terry. I'll begin this morning with an update on our share repurchase program. We continued our buyback program in the fourth quarter, purchasing 7 million shares at a cost of $322.7 million. This brings our full year total to 37 million shares for a cost of approximately $2.2 billion. Through a combination of share repurchases and an increased dividend, the McGraw Companies returned approximately $2.5 billion to shareholders in 2007, demonstrating management's commitment to increasing shareholder value. Since 1996, we have returned approximately $8.4 billion to shareholders through dividends and stock buybacks. Last October, the Board signalled its approval for the repurchase of the remaining 35 million shares over time from the 2007 repurchase program authorized by the Board of Directors. MHP purchased 7 million shares in the fourth quarter of 2007, as I previously stated, and we now start 2008 with 28 million shares remaining in this program. On January 30, the Board will review the cash dividend at its regularly monthly meeting. The Board has raised the cash dividend annually for the last 34 years. Since 1974, the dividend has grown at a compound rate of 10.4%. Now, share repurchases are impacting shares outstanding, debt and interest expense, so let's look at these items now. Because of the share buybacks, diluted weighted average shares outstanding declined in the fourth quarter to $330.8 million shares. This reflects a $7 million share decrease compared to the third quarter of 2007 and a 33.4 million share decrease compared to the same period last year. Our net debt position at the end of December was $801 million, down about $77 million from a net debt position of $879 million at the end of the third quarter. As of year end, on a gross basis our debt is approximately $1.2 billion offset by $396 million in cash, primarily in foreign holdings. This compares to 2006 when we were debt free and had a cash position of about $353 million. This change is primarily due to the share repurchases. The debt is comprised of $1.2 billion of unsecured senior notes issued in November of 2007 and is spread evenly across 5, 10 and 30-year tranches, adding term debt to our capital structure. We ended the year with no commercial paper outstanding, but we do plan to enter the commercial paper market in 2008 due to the seasonal nature of our businesses. Interest expense was $12 million in the fourth quarter compared to only $70,000 in the same period last year. For the full year, interest expense was $40.6 million. For 2008, we project interest expense in the range of $80 to $100 million. Let's now look at our corporate expenses. Corporate expenses increased $5.2 million or 12.6% to $46 million in the fourth quarter of 2007. The fourth quarter includes a pre-tax restructuring charge of $1.9 million for the elimination of 21 positions. For comparison purposes, the fourth quarter 2006 results included a $2.7 million pre-tax restructuring charge. The year-over-year increase is driven by increased incentive compensation as well as expenses related to our corporate program to improve operating efficiency, business process management or BPM. In addition to operating efficiency programs across the entire corporation, other programs include reviewing our digital publishing workflow systems, related offshoring activities, and other general business process improvements. For 2008, we expect a low single-digit increase. As Terry discussed, we expect operating profit at McGraw-Hill Education to grow in the low single digit range. I'd like to spend a few minutes elaborating on several of these factors. First, as a result of significant pre-publication investments, 2008 will incur a substantial increase of approximately $45 million in pre-publication amortization. Second, as Terry pointed out earlier, the digital transformation in education market requires increased investments in technology. The trends are unmistakable

[Harold McGraw III:]

Okay. Thank you very much, Bob. Now obviously, we're pleased with the 22.5% EPS growth for 2007, albeit the slowdown in the U.S. structured finance market in particular in the fourth quarter. For 2008, it's going to be a first half, second half situation. The first half obviously is going to be slower, the second half picking up. But by the end of the full year, we're projecting EPS growth of 3% to 5% for the year. From an economy standpoint, it's very similar. We see a recession or recession-like environment in the first half improving in the second half. The housing recession will start to come to a conclusion. New housing starts will probably bottom out somewhere in the spring; a little bit more to go on housing prices to the fall as the equilibrium in terms of supply and demand of existing home sales works itself through, but a much better situation for the second half. So with that, let me turn it back to Don and then we'll go to anywhere you would like to go.

[Donald Rubin:]

Thank you, Terry. Just a couple of instructions for our phone participants. Please press star one to indicate you wish to enter the queue to ask a question. To cancel or withdraw your question, simply press star two. If you've been listening through a speaker phone but would now like to ask a question, we ask that you lift your handset prior to pressing star one and remain on the handset until your question has been answered. That'll ensure good sound quality for everyone. I think we're now ready for the first question.

[Operator:]

Thank you. Our first question comes from Michael Meltz with Bear Stearns. Please go ahead.

[Michael Meltz:]

Great. Thank you. I think I have two questions. Can you talk a little bit about your assumptions for S&P for the year? I think your slide said slower growth in the first half. Are you actually expecting revenue growth, S&P revenue to grow in the first half is my first question. And then related to that, what are you actually seeing thus far early in the year, in the first quarter here? And then second, Bob, on the shares out - the interest expense assumption of $80 to $100 million, how much buyback is in that number, and what does that imply for shares out? Thank you.

[Harold McGraw III:]

Thanks, Michael. Again, the first half, second half issue for S&P and especially for ratings, the first half is going to be down versus the first half of 2007, picking up in the second half and finishing on a stronger footing there. But again, at this point and in terms of looking at the first quarter, the situation that we saw in November and December is pretty much repeating itself in January. We are seeing there's some but not much. In terms of CDOs, residential mortgage-backed securities and the commercial mortgage-backed market, which we do expect to see some improvement in, still are very quiet on that part. And I think that reflects the current environment across the board for most people. As far as the share buyback, Bob?

[Robert Bahash:]

Terry, if I could just add to that point, and then I'll get to the share buyback, Michael, with regard to our first half, second half forecast with regard to new issuance volumes, clearly there's significant differences here. When we look at structured finance on the U.S. side  CMBS, CDOs, RMBS  all were anticipated down in the range of 60% to 70%, thereabouts. Asset backs down but not anywhere to that level. But somewhat of a rebound in the second half of the year, one in anticipation of simply a better economic environment, but also better comparables. CMBS could be soft pretty much for the full year. Europe, down in the first half of the year, those same key categories that I mentioned, but not at the same rates and coming back a little bit better. On the corporates and government side, pretty much a little bit down in the first half of the year - corporates and financials - but up in the second half. Europe, we're expecting corporates and financials down in the first half, up in the second half. That gives you some picture in terms of what we were thinking as we were building our plan. Now with regard to share buyback, clearly when we have our discussions with the Board, we tend to talk about our strategies on an annual basis, both for the dividend and for our share buybacks. As you know, the Board did authorize us to repurchase the full 35 million shares back in October, where we repurchased 7 million shares. But just as a matter of policy, we go back and talk to the Board about the specific amounts of authorization. And of course, given the tighter economic outlook, we have a picture in mind and obviously that's being reflected in the interest item, but I don't necessarily want to say exactly how much now until we get the authorization levels from the Board. But clearly, the share buyback program is a very important element to us. It's reflected in our outlook for the year in terms of interest and naturally in our lower shares outstanding as we're factoring in our figures for 2008, but we'll be in a better position following the January Board meeting to be very specific about that.

[Michael Meltz:]

Okay. On your point about S&P in the first half, the Q4 trend is down about 7%. Is it fair to say you think it will be a little bit weaker than that in the early part of this year?

[Harold McGraw III:]

The Q4, the trend is - I mean directionally, it's in that same direction. The larger volume declines that we saw in RMBS, CMBS, CDOs and such will continue, but as you could also see from the attachments in the press release, we had very strong growth in the information products that, for the first time, as you can see, are broken out. And we expect that trend to continue so they will, because of the breadth of the portfolio that we have, will mute the overall decline. But clearly, it's going to be a very tough first half of the year.

[Michael Meltz:]

Okay, and last question. In the quarter, what was the foreign exchange benefit at S&P? You have the annual in there.

[Harold McGraw III:]

Yeah. I think it was about 1 percent point of gross approximately. Yeah, on the revenue side, it contributed about 1%.

[Michael Meltz:]

Okay. All right. Thank you for your time.

[Operator:]

Thank you. Our next question comes from Fred Searby with JP Morgan.

[Fred Searby:]

Thank you, Terry and Bob, Don. A question on the Education margins that I thought your guidance was very positive in light of what's been going on, except the Education margin kind of surprised me. You've been guiding obviously for an improvement and now you're saying the investment in digital - what are EBITDA margins so if we back out the pre-pub amortization, what would that core margin be before amortization? And where do you think you stand? I mean, if digital's only going to increase so does this put in jeopardy your longstanding goal of getting to 20% operating margins by 2010 in the Education business? Thanks.

[Harold McGraw III:]

Yeah, Fred, first of all, one of the things that we've been watching very carefully is the whole digital transformation component, and that in light of the ramp up in demand in terms of the new state adoption market. We made the decision to invest a little bit heavier, hence the pre-publication costs going up to make sure that we're in a good position for the 2009-2010 marketplace. The additional technology investment associated with that is part of it. We're also being very cautious at this point, too, in terms of the overall environment at this point. We have a very strong position, and we want to make sure that our market share gains are solid on that part, and we're watching very carefully state behavior as well. My sense of the state behavior question has to do with the fact that in terms of overall school budgets, it's the construction side that going to be more problematic than the content side because the results associated with student achievement are still the priority in getting that. Bob, do you want to add?

[Robert Bahash:]

Yeah, just two points. One, as I mentioned in my remarks that because of where we are right now, we do not expect to achieve the 20% margin in 2010, so I just want to emphasize that point. With regard to our margins, first of all, on operating profit for the year, when you exclude the restructuring activities and such we came in at 15.4%. This is on operating profit now compared to 13.8% last year. If you look at it excluding the amortization of pre-pub on that modified EBITDA multiple that you're thinking of, it's around 20%. But clearly the investments that we have been making over the past few years, because of the big opportunities we're seeing - which includes [inaudible] investments as well - is coming through in terms of higher amortization on an annualized basis. So that's certainly impacting our performance. As you know, in that first year of an adoption - and of course last year, as Terry pointed out, we had the market-leading 32% share - that first year of an adoption has the biggest impact on the bottom line because one, your amortization - and we used some of the [digital] amortization - is highest in Year 1. In addition, you have a higher level of complimentary copies to promote your products, and there's also the pressures of free with order. So that very first year has a number of additional cost elements that, once you secure that order, hopefully will dissipate during the course of the remaining years. As a rule of thumb, you could use a replacement figure of around 10% in Years 2, 3, 4, but Terry pointed out in his remarks some of the products that have higher level of consumables, the replacement amount might be a little bit higher. So hopefully, that gives a little bit different color.

[Fred Searby:]

That helps. Can I have just one follow-up question on what I was saying? Terry, historically you have positioned the digital transformation as a great opportunity and that it was going to reinvigorate the Education business and make it a growth business. In the near term it looks like it's just depressing margins, so do you think this is a temporary kind of transition and you'll start to see better revenue growth or better profitability beyond this transitional period?

[Harold McGraw III:]

Yeah. Fred, I mean, without question. I mean, we're seeing it in a big way at the higher ed level and certainly in the professional markets. The digital transformation in the K-12 space has been a lot slower than we anticipated, but we're starting to see more and more signs that that's afoot and that there is going to be more change. So there's no question in my mind that when you start talking about customization, you start talking about individual instruction, you start talking about ways to improve broad-based student achievement, it has to come in the online environment. And so we're very excited about that. We're going to continue to invest on that, and I think and hopefully we will start to see more results in the marketplace as that transition takes place.

[Fred Searby:]

Thank you, guys.

[Operator:]

Thank you. Our next question comes from Peter Appert with Goldman Sachs. Please go ahead.

[Peter Appert:]

Thank you. Terry or Bob, are you getting any indications back from your sales guys in the field on the education side that deferrals are in the works in terms of adoptions in the 08 cycle?

[Harold McGraw III:]

Peter, no, we're not. I just came from a sales convention, and they are extremely upbeat and the opportunities for this year are very significant, as you know, with Texas, California and Florida all participating. And we're excited about that, and we hopefully will have a record at the end of the year in terms of market share that is on the 2007 level.

[Peter Appert:]

Right. So in Texas specifically, where there have been issues in the past, the funding looks relatively secure?

[Harold McGraw III:]

Yes, it does, on that one. Now again, there's noise factors here. We've all heard the noise from the governor in California and elsewhere, whatever, but again, my other prior comment. Usually in a more temporary kind of situation, you're going to see more cutbacks if there are cutbacks on the construction side rather than the content side because that's where they're going to be able to get the results in terms of the student achievement goals that they have. Now, another interesting one is that - and Bob alluded to this in talking about first half, second half ratings revenue - we're seeing some pretty good strength in the public finance market. And my sense of it is that given the fact that we have a recession-like environment as a mild and a brief issue with an uptick in the second half of the year, that what you might see is more states taking care of any gap that may exist in tax receipts through debt financing. [inaudible] So we're watching that one very carefully as well, but at this point we're excited about 2008 and the state adoption market and we like our opportunities.

[Peter Appert:]

Okay, and then not to beat this too hard but on the 20% margin target, should we assume that that is sort of off the table permanently or do you think that is a realistic objective still on a longer-term basis? And I guess the issue, following on what Fred had said, is there just a permanent diminution in profitability in this business in the context of the higher spending levels you're required to make to remain competitive?

[Harold McGraw III:]

No. I think it is a more temporary situation, and I think that the digital transformation, especially in the K-12 space, is taking a little longer to get adopted into the marketplace. And there's several reasons for that, but it's not because of the fact that it's not going to be a stronger part of what curriculum is all about in the education space. On the margin goals, Peter, absolutely not. I mean, we still have very much thinking here of getting to the 20%, and as you know that in the digital transformed environment, given some of the costs that go away, we're looking for even more than that. But we've got to get to 20 on that part, and that is the mantra here. And as Bob was saying, we think that given some of these increased investments, getting there by 2010 is not realistic so we want to say that, but that is very much the goal that we have in mind, and we're going to do everything we possibly can to continue to improve those margins.

[Peter Appert:]

All right. Okay, great. Thank you. And last thing, Bob, are you comfortable taking the leverage ratios up from where they are currently, factoring in the seasonal CP you'll take on to fund repurchases or other activities, or should we assume the repurchases in '08 have to be primarily funded from internal free cash flow.

[Robert Bahash:]

I think there'll be more of a timing thing there, Peter, than anything else. As you know, the first half of the year - just from normal operations, it's the lighter part of the year - we're making more off our investments. So, like peak to trough, you can think of roughly $150 million is the variability between first half, second half with regard to our cash needs. But I think what you'll see is most likely the repurchase program will be spread across the year, so we'll simply be building up the CP program and then paying it down during the second half of the year. That's the expectation that we have right now.

[Peter Appert:]

Which would imply that year-end debt will be similar '08 to '07.

[Robert Bahash:]

It will be in that similar range, yeah.

[Peter Appert:]

All right. Okay. Thank you.

[Operator:]

Thank you. Our next question comes from Lucas Binder with UBS. Please go ahead.

[Lucas Binder:]

Hi, guys. Thank you very much. A couple of quick questions. On the slides you talk about the decline in revenue, and Terry, you highlighted how issuance, global issuance, is down, but revenues were not down as much. Can you talk about how that works? How is that, for instance, international revenues were down 4% or 5% in the fourth quarter, but issuance was down quite a bit more than that? What are the different contributing factors to that, and is that a way to look at it going into 2008, especially with deferred revenue contributing?

[Harold McGraw III:]

That's exactly right. Bob, go ahead.

[Robert Bahash:]

Yeah, why don't I jump in here? There's several components when you look at the overall performance. First of all we have the high level or relationship fees, surveillance fees. Then we have our data products, that being Rating Express, Ratings Direct, which are very nice products and they're growing rather rapidly. The $790 million relating to deferred revenue, which has grown 10% during 2007, we expect to grow modestly in 2008, but nevertheless we're expecting growth so these are elements that offset the transaction nature that you're looking at. So the issuance numbers would be more reflective in large part to the transaction side, but there are recurring revenue streams and there are the non-traditional, non-transaction revenues that also counterweight that. When you look at total Financial Services, roughly 25% or thereabouts relates to information-based products, and you could see from Slide 4 on the press release, they were growing double digit and we expect very significant growth going out into 2008. So I think all these are contributing factors to our overall performance.

[Lucas Binder:]

The final question, then, would be if we see issuance down substantially in 2008, could the impact to deferred revenue be more a 2009-2010 phenomenon? Or is it like you said, that's going to continue to grow at a more modest pace, but still grow?

[Harold McGraw III:]

Where we expect the issuance figures to decline more rapidly would be in the structured areas - RMBS, CMBS, CDOs, et cetera. The main contributor, the larger contributor, to the deferred revenue side would be in corporates, financial institutions, public finance, that side of the house. So we don't see a similar decline in deferred revenue as you might see in issuance volumes.

[Lucas Binder:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next question comes from Craig Huber with Lehman Brothers. Please go ahead.

[Craig Huber:]

Yes, good morning. Thank you. On this up 2% to 4% Financial Service revenue guidance for the year, obviously to build up to that you had to think about how you thought the quarters were going to progress. What I'm curious about is you talk about January being down similar in terms of the new issued dollar volume down in January similar to November and December. It sounds like then that you're assuming first quarter revenue from Financial Services down worse than roughly the 7% number you had in the fourth quarter. Is that fair?

[Robert Bahash:]

I'm not - no, we're not necessarily projecting and we're not going to project revenue by quarter because that's obviously much more difficult. But I think the important element here is that the issuance volumes that we saw in terms of the rather significant declines in the fourth quarter are continuing into the first quarter, and whether that continues out into the second quarter, we're not sure. Because clearly the visibility is not like it had been in the past. Things are very different. But on the other hand, we do have those other elements of revenue that I just mentioned that will continue - relationship revenues that we'll be recognizing, surveillance fees, contract revenue relating to ratings, express ratings, direct products, like that. And then you get into the information products that, again, we expect to grow in the double-digit category during the course of the year. So to be precise in terms of where the revenue decline overall will be is a little bit difficult at this point in time, but nevertheless, I think the patterns are somewhat similar to what we experienced in the fourth quarter. But we're not going to be projecting quarterly revenue guidance. We really want to look at first half, second half. Hopefully that gives you some help here.

[Harold McGraw III:]

Yeah. And Craig I think that, again, we've got, as Bob says, a fair bit of uncertainty as to how some of these instruments are going to return or where some of the categories of investment pickup is going to come from. In the meantime, we're going to be obviously bears on cost, and we are going to be able to be in this position, I think, to benefit when this starts to come back.

[Craig Huber:]

In talking about costs on the Financial Services side, do you have any plans to do another restructuring charge, perhaps later in the spring if things don't materialize as you expect to face the next four or five months?

[Harold McGraw III:]

Craig, the restructuring charge we took was a second tier step compared to the cost controls we put into place in the fourth quarter of 2007. We believe that relative to the revenue projections we have, that is a very good response to that. Given the uncertainty down the pike, that would be all hypothetical, but we'll do whatever it takes to be able to make sure that our cost structure is equivalent to the revenue generation capabilities we have. So we're going to - we continue to look at this every day and all of that. But in this kind of environment, you've got to make sure that you're doing everything you possibly can to watch that expense base. But we'll be watching the revenue projection side very hard, too, as well.

[Craig Huber:]

And then lastly if I could, on the Education front here, if we are in a recession or we go into recession here over the first, say, six to nine months this year, how confident are you that the elementary-high school, you know, overall Education revenues will be up 6% to 8% this year in that sort of environment? Or do you think it's actually - it just gets delayed with the fallout in tax revenues and it therefore actually hurts 2009 Education numbers as opposed to this year?

[Harold McGraw III:]

Craig, when we make our revenue projections like this, we take into account the environment that we're going to be in. Again, any special event or event risk factor that could take place we'll be watching very hard. But again, remember in terms of overall school budgets, which have to do with construction, with teachers, with materials, all of those kind of factors, the area that usually gets affected in the short term is the construction side. Again, governors are measured on their student achievement scores, and therefore content is usually the last thing to be cut.

[Craig Huber:]

But again, would you be more nervous about 2009, then, on the Education revenue side as opposed to 2008, then, having said that?

[Harold McGraw III:]

Everything that we've talked about in terms of - and we're talking K12 now - in the marketplace, 2009, 2010, and really 2011 if you take into account Texas, are going to be very good years for us. The opportunities are going to be there, and we're gearing up now for those markets. As you know, two, three years out, we're developing the products on that. So no, we feel very good about that.

[Craig Huber:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from Karl Choi with Merrill Lynch. Please go ahead.

[Karl Choi:]

Hi, good morning. I have two questions. First, I want just to go back to the S&P assumption. Since ratings were still around 74% of your total segment revenues for the year, even if I assume 15%, 20% growth for the Investment Services, that seems to imply that you think ratings will be basically flat to down, maybe 5% for the whole year. And that seems to imply pretty significant recovery in the second half. Just want to sort of check that assumption and my interpretation and see if there's anything - if that's sort of in line with what you're thinking. And I guess the second question is similar. In terms of Education, given your outlook for industry growth, you seem to be implying a 6% to 8% growth will be quite a bit higher than the industry growth. Is it just coming from market share gains, or is it going to be made up from growth in international or professional? If you can give some more color, that'd be great.

[Harold McGraw III:]

All right. On the S&P ratings side, as Bob said, the first half of this year is going to be down. This is where diversity counts. And all of the other factors, the nontraditional ratings, all of the other information and content services are going to be a player here. In addition, as I was talking in my remarks, the S&P Investment Services, which is now 26% of total Financial Services revenue, is also scheduled for some good growth here as well. But there is no question that the U.S. structured finance market in particular is hard hit, and you can go to your own desk and you can see the level of activity - it's not very high on that one. Will that come back quickly? Will that come back - I don't know. At this point, our best thinking is that we're going to start to see growth again towards the second half of this year, and we're going to benefit from that. We're going to position ourselves to do that, but it's going to be a tougher first half in terms of ratings revenue, and therefore revenue will be coming from other sources. Bob?

[Robert Bahash:]

Yeah, I think the ratings forecast that you said, around flat or thereabouts, is a reasonable projection for the year where we are. The first half of the year, clearly much weaker, but when we get into the second half of the year, two elements. One, we're anticipating somewhat of a recovery in terms of whether we're in a recession, a mild one but at least starting a bouncing back. But again, the comparables as well will be much better for us going into the second half of the year. So weighted for the full year, a weak first half; a better situation for the second half for the two reasons I said. But overall, around flat. But that's a reasonable place to look at the ratings side, and we're expecting growth from the information products, as Terry mentioned.

[Karl Choi:]

And on Education?

[Harold McGraw III:]

I'm sorry, what was that one, Karl?

[Karl Choi:]

Sure. Given your outlook for industry growth for el-high, 4 to 5 for college in the U.S. and 3 to 4 in your overall growth for the segment of 68. Just want to see where the discrepancy comes in. Is it purely from market share gains that you're expecting or from the other businesses within the segment such as professional and international?

[Harold McGraw III:]

Well, it is clearly going to be from good execution and good performance. Again, we were very pleased with the 32% market share that we took this year. We're looking for further gains in terms of market share support. We're also looking at a strong higher education market, and we anticipate to do better than the industry averages there as well.

[Karl Choi:]

Is testing included in your 3% to 4% - sorry, in your 4% to 5% growth estimate for the industry for El-High?

[Harold McGraw III:]

No.

[Karl Choi:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from Catriona Fallon - Citi. Please go ahead.

[Catriona Fallon:]

Good morning. Thanks for taking my question. So specifically I'm looking at the levers that you have to pull to get your S&P guidance of operating margin down 125 to 225 basis points, so specifically what kind of variability is there in incentive compensation within the S&P - what percentage of expenses there are compensation, and of that, how much of that is an incentive or a variable comp? And then secondly, about pricing power, what type of pricing power do you have on new issuance? Is there any movement there? And then on your relationship-based revenue, how do those relationships change on an annual basis? Is it typically a flat fee or is there some movement there based on size of company or expected debt issuance, et cetera?

[Harold McGraw III:]

Well, number one, when we start talking about - and you're focused on the ratings side of S&P - it's for the most part all people costs. And certainly the incentive, part of that is part of this and it's affected on that part. And I'll let Bob - you want to comment on that?

[Robert Bahash:]

Yeah. There's a couple elements within the incentive programs. We have multiple incentive programs within ratings. Some of those programs are clearly performance-based programs, and others are sort of like a quasi-performance, profit sharing. You could think of it in that regard. So there are variable elements to it, and there's also more of a steady state side of it. As we look at our overall - and not to go into the specifics, but nevertheless in our factoring of where we're going to be for the year and the outlook for the first half, second half, et cetera, we've factored in those various components into our equation. As Terry pointed out, we took certain actions in the fourth quarter with the announcement. There's also been a significant amount of staffing delays and nonhirings of positions that have been on the Board but simply have not been filled and we'll be receiving those benefits throughout the course of the year. So those are some very significant elements that I think will help to contribute to our projection of a decline of 125 to 225 basis points. But you also have the other side of the house, the information products and services that are going to be growing really well. Margins have been improving on that side. The margin contribution is different clearly between ratings and nonratings, but nevertheless, the margins have been steadily improving over the past couple of years. With regard to pricing power, clearly there's limited pricing power as we're moving into this particular year. And the relationship fee side, there's several elements there, but the relationship fees are negotiated at the beginning of each year with the major issuers. It's based on the expectation of issuance going out into the next year, the size of those issuance and such, and the relationship fee structure that existed in the previous year. I think what we'll see is probably in a lot of cases flat projections with regard to our relationship fees, and in some cases for some of the perhaps financial institutions that have been focusing more on improving their capital structure by equity than anything else, we might see some fee renegotiations. But we've factored that into our thinking.

[Harold McGraw III:]

I would also mention the fact that over 40% now of [inaudible] revenue is coming from outside the United States. And here, where the opportunities are, as I mentioned, you know, we are investing in those opportunities - the new offices in Johannesburg and Tel Aviv and Dubai - and also the new operations in Turkey are also representing opportunities. But the structured finance market in Europe and in Asia is behaving somewhat differently than it is here. The large problem is the U.S. structured finance market, so in terms of some of that growth, we're going to benefit from that. But as Bob said, there's very little variability in the prices in the relationship part. Those are pretty constant. The issue in terms of pricing, obviously it's higher when you're talking about larger, more complex instruments like CDOs and RMBS and CMBS and the like, and so with more growth coming from the corporate side and the government side, we'll be looking at that as well.

[Catriona Fallon:]

Great. Thank you. And just kind of a broad picture question, then, on your view on the federal funds rate cuts, and what type of improvement in liquidity do you think we'll see in the next month or so following the recent cuts? And is there any sensitivity around how quickly the financial services have reacted in your experience or rebounded in relation to the pace of additional cuts? Like would that give a change to your outlook at all if rate cuts come quicker than what you said in March or April?

[Harold McGraw III:]

Yeah. Well, first of all and again, our sense of this - and David Wyss, our Chief Economist, said and he's very much on top of this - our feeling was that the 75 basis point move was extraordinary, and that there are going to be further moves. The thinking that we had prior to the 75 point move was that there was going to be movement in January, there'd be a rate cut in March, and there'd be a rate cut in April, and we'd be down to 3.5% in April. Well, we're at 3.5% now, and clearly, in terms of dealing with liquidity, the monetary policy is the best stimulus package, and we're going to probably see more cuts. David Wyss thinks that when all is said and done, we're going to be down to a 2.5% fed funds rate. So that would give us a full percentage point to go, and my guess is that we're going to see it sooner rather than later on that part. As far as a stimulus package, the president's plan was $145 billion. Democrats were talking about even going higher, to $200 billion, in terms of some of the pushback, and the president has not disagreed with that. The question is how quickly are you going to be able to get it out, and my guess is that they're going to do everything they possibly can to do it in the next several months.

[Catriona Fallon:]

Great. Thank you so much.

[Operator:]

Thank you. Our next question comes from Edward Atorino with Benchmark. Please go ahead.

[Edward Atorino:]

Hi. Bob, could you - Peter's question on the debt, you're raising your interest expense dramatically, but did I understand you're going to end up the year with the same debt you have now? It doesn't quite equate.

[Robert Bahash:]

Well, Peter, we issued our senior notes - as I mentioned earlier, we ended 2006, entering 2007, with no debt, so during the course of the year, as we repurchased shares, we only began to build debt. We got ourselves up to a level of about $1.2 billion really by the end of the third quarter, where we converted that commercial paper - which was commercial paper outstanding - into the senior notes - 5s, 10s, 30, $1.2 billion - so there was a build up of debt during the course of the year.

[Edward Atorino:]

Okay, yeah.

[Robert Bahash:]

We will have that debt outstanding for the balance of 2008.

[Edward Atorino:]

Gotcha. Okay.

[Robert Bahash:]

In addition, we will be using our leverage with regard to commercial paper to one, fund our working capital needs - and there will be an anticipation of share repurchases as well, not being specific in terms of how much until we have that meeting with the Board - so there's a partial year in 2007 and a full-year impact in 2008.

[Edward Atorino:]

Okay. Thanks.

[Operator:]

Thank you. Our next question comes from Ken Silver with RBS Greenwich Capital. Please go ahead.

[Ken Silver:]

Hi. Good morning. Thanks for taking the call. A couple questions about your higher education business. Can you just maybe give more color as to why the - hello?

[Harold McGraw III:]

Ken, are you there?

[Ken Silver:]

Yeah, can you hear me?

[Harold McGraw III:]

Yeah. Go ahead.

[Ken Silver:]

On higher education, why was revenue growth in the fourth quarter - I think it was 3.4% - why was that so much lower than the rest of the year, which was 7% and, you know, the third quarter, which was 8%? And then the other question I had was if I heard you correctly in your prepared remarks you were only expecting revenue growth in the domestic higher education market to be 3% to 4% next year, which I think is quite a bit lower than '07. If you could just talk about those two things?

[Harold McGraw III:]

Yeah. First of all, from a timing standpoint, the seasonality of the higher ed flows would, if you've got as strong a third quarter as we did, you're probably pulling some timing issues out of the fourth quarter, and that was the case here. Also international was a little softer than we had anticipated. And usually the flow back from international operations would take place in the fourth quarter, and that was that effect. But we were very pleased with the higher ed performance, and clearly it's a very strong third quarter business and less so in the fourth.

[Ken Silver:]

Okay. And then the forecast for the industry only to grow 3% to 4% next year? I mean, that's lower than in '07, right?

[Harold McGraw III:]

Yeah, it is. Again, that's the best guess that we have at this point from what we're seeing in terms of the market activity. We fully expect, as we indicated, that we're going to do better now.

[Ken Silver:]

But could you just give us more color as to why? I mean, I think it was 5% to 6% at least, and you were up 7% this year. Why do you think it's going to be so much weaker next year? What are you hearing?

[Harold McGraw III:]

Well, it's not such much what I'm hearing. I mean, in terms of the kinds of programs that we're dealing with and the projections that we make, it's coming in more like 3%, 4%. So it is a market projection rather than any particular factor. Again, we look at that. But from the markets that we are going to participate in and the programs that we have, those titles look to us to be a lot more exciting in terms of their promises or prospects than the market.

[Ken Silver:]

Any in particular that you think are - which programs, I mean.

[Harold McGraw III:]

Oh, straight across the board. Our Economics in Business segment is doing exceptionally well. The humanities areas, languages are going to do very well. But no, we're very - we think we have really good programs and they're in the right places, and we expect to participate.

[Ken Silver:]

Okay. Thanks a lot. I appreciate it.

[Operator:]

Thank you, and I show no further questions at this time. That does conclude today's morning conference call. On behalf of McGraw-Hill Companies, we thank you for participating and wish you a good day.