S&P Global Inc.
Q2 2011 Earnings Call Transcript

Published: 28 Jul 2011

[Operator:]

Good morning, and welcome to The McGraw-Hill Companies' Second Quarter 2011 Earnings Call. I'd like to inform you that this call is being recorded for broadcast. [Operator Instructions] To access the webcast and slides, go to www.mcgraw-hill.com, and click on the link for the earnings announcement conference call. At the bottom of the webcast page are 3 links. If you are listening by telephone, please select the first link for slides only. For both slides and audio via webcast, select the Windows Media link. [Operator Instructions] I'd now like to introduce Mr. Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. Sir, you may begin.

[Donald Rubin:]

Thank you, and good day to our worldwide audience. We thank everyone for joining us this morning for The McGraw-Hill Companies' Second Quarter 2011 Earnings Call. I'm Donald Rubin, Senior Vice President, Investor Relations for The McGraw-Hill Companies. With me today are Harold McGraw III, Chairman, President and CEO; and Jack Callahan, Executive Vice President and Chief Financial Officer. This morning, we issued a news release with our results. We trust you have all had a chance to review the release. If you need a copy of the release and financial schedules, they can be downloaded at www.mcgraw-hill.com. Once again, that's www.mcgraw-hill.com. In today's earnings release and during the conference call, we are providing adjusted revenue and free cash flow information. This information is provided to enable investors to make meaningful comparisons of the company's operating performance between periods and to view the company's business from the same perspective as management's. The earnings release contains exhibits that reconcile the differences between the non-GAAP measures and the comparable financial measures calculated in accordance with U.S. GAAP. Before we begin, 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 10-Ks, 10-Qs and other periodic reports filed with the U.S. Securities and Exchange Commission. We're 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 Jason Feuchtwanger in our New York office at area code [phone] subsequent to this call. Today's update will last approximately an hour. After the presentations, we will open the meeting to questions and answers. It's now my pleasure to introduce the Chairman, President and CEO of The McGraw-Hill Companies, Terry McGraw.

[Harold McGraw:]

Okay, thank you very much, Don. And good morning, everyone, and welcome to today's conference call. Besides Don, as Don mentioned, with me today is Jack Callahan, our Chief Financial Officer. He'll be providing a little bit more color to our financials in just a moment. We have 2 objectives for today's call. First, we want to review our encouraging second quarter results and share our perspective on the positive outlook that we have for the second half of this year. Second, we want to update you on our important strategic portfolio review, which is intended to accelerate global growth and unlock shareholder value. And as always, after our presentations, we'll be pleased to address any of your comments, questions or we can go any direction you'd like. I trust that you all had an opportunity to review our second quarter earnings release. If you recall, on our first quarter call in April, we said a promising year was off to a good start. Well, our second quarter results bear that out. Overall, our business is performing well. Earnings per share in the second quarter grew approximately 12% to $0.68 per share. Revenue grew more than 7% to $1.6 billion. We're very pleased with that. Our revenue growth for the first half is the best since 2007. First half revenue increased by 7.4% to $2.9 billion. Earnings per share grew by 14.4% to $1.07. Based on our solid start this year and a promising outlook for the second half, we now expect to achieve the top end of our 2011 diluted earnings per share guidance of $2.79 to $2.89. While we're encouraged by our first half results and prospects for the year, we are intent on growing faster and unlocking shareholder value by allocating our resources to support the best opportunities in growing global markets. That process is already well along. The most recent review of our businesses began with a decision to create McGraw-Hill Financial as a new segment for 2011. We reorganized and refocused this business and put it under separate leadership to leverage our intellectual property for new value creation. By integrating previously separate but strong and successful business lines into one scaled operation, McGraw-Hill Financial is delivering a growing array of innovative solutions and high-value content across all asset classes to financial professionals around the world. Our S&P Indices business and the new Integrated Desktop Solutions Group, which includes Capital IQ, continue to grow rapidly, driving year-over-year increases of 13.5% in revenue and 17.3% in operating profit in the second quarter. McGraw-Hill Financial is now actively reviewing opportunities for creating even more value through organic growth, strategic partnerships and acquisitions. But that's not the whole story. And so last month, we informed the market that a strategic review of the entire portfolio is underway. The goal, quite simply, is to increase shareholder value by building on the high-growth global brands at the core of our franchise. Many of you have asked what this review entails and what is our timeline. What we can tell you today is this

[Jack Callahan:]

Thank you, Terry. It's a pleasure to review with you a very strong quarter and a strong first half to 2010 -- 2011. Let's start by providing additional detail on several items. Our solid organic revenue growth also benefited from acquisitions, as well as foreign exchange. In the second quarter, acquisitions completed over the past 12 months accelerated revenue growth by approximately 140 basis points, while the profit impact was modestly dilutive. Foreign exchange also positively impacted consolidated revenue results by approximately 160 basis points. Impact on the bottom line was minimal. Information & Media's Q2 segment expenses were impacted by a number of nonrecurring items, consisting of a write-off of deferred costs recorded in prior periods, largely offset by a gain on the sale of our interest in the LinkedIn Corporation. Corporate expense was $44 million in the quarter and increased by $6.6 million from the prior year. For the first half, corporate expense was $78.4 million, an increase of 6.9%. These increases were driven by a step-up in incentive compensation due to the timing of accruals as well as improved operating results. For the full year, we continue to expect corporate expense to increase in the mid-single-digit range versus 2010 adjusted corporate expense of $164 million. As a reminder, the 2010 expense exclude the one-time charge of $15.6 million related to subleasing excess space in the company's New York facilities. Net interest expense was $20 million in Q2, a modest decline of $1 million versus prior year. We still expect full year interest to be comparable to 2010, which was $82 million. Our effective tax rate was 36.4% in the second quarter, flat versus 2010. We expect our full year effective tax rate to remain in that range. Net income attributable to noncontrolling interests was $4.7 million, largely driven by CRISIL. Let me turn now to capital allocation. We spent $426 million on acquisitions and share repurchases in the first half, $126 million for acquisitions and $300 million for share repurchases. As Terry mentioned, the most notable acquisition was BENTEK Energy, which was acquired in the first quarter. Next, our acquisition of Steel Business Briefing Group closed on July 1 and will be included in our Q3 results. Both acquisitions added to Platts' growing platform, adding critical capability in the natural gas and iron ore markets. We continue to actively repurchase shares. In Q2, we repurchased 4.4 million shares, a step-up from Q1 repurchases of 3.3 million shares. For the first half, we repurchased 7.7 million shares for approximately $300 million, averaging $38.96 per share. Our diluted weighted average shares outstanding for the quarter was 309.2 million, a 4 million decrease from the prior year. The decline is due primarily to share repurchases, which more than offset equity-related awards. We continue to expect another year of strong cash flow. Before dividends, we expect to generate cash flow greater than $1 billion. After dividends, free cash flow is projected to be in excess of $700 million. Going forward, our robust free cash flow and strong balance sheet enable us to selectively add attractive, strategically-relevant businesses like BENTEK Energy and the Steel Business Briefing Group to the McGraw-Hill portfolio, while continue -- continuing to return cash to shareholders via share repurchases subject to market conditions. We are extremely well capitalized, with cash and short-term investments at quarter end of $1.3 billion. The $223 million decline in cash and short-term investments from year-end 2010 is due -- is primarily due to share repurchases in the acquisitions we've mentioned. Gross debt was approximately -- was comprised of approximately $1.2 billion in long-term unsecured senior notes. No commercial paper is outstanding. Turning to capital investments. We now expect prepublication investment to be below $200 million versus our previous guidance of roughly $200 million to $225 million. This decline is largely due to a rescoping of our new core reading program and some fine tuning overall financial requirements. Prepublication amortization for the full year is expected to be approximately $210 million, a $36 million decline from 2010, reflecting the recent reduced level of investment. Capital expenditures continue to be projected up to $150 million, driven in part by increased digital and technology investments. This compares to $115 million in 2010. In closing, the McGraw-Hill Companies is off to a solid start, and we are on track for a very good year. To reiterate several points made by Terry, our revenue growth for the first half is the best since 2007, and we now expect to achieve the top end of our 2011 diluted earnings per share guidance of $2.79 to $2.89. Now let me turn the call over to Donald Rubin for the Q&A session. Don?

[Donald Rubin:]

Thank you, Jack. [Operator Instructions]

[Operator:]

Our first question comes from Sloan Bohlen from Goldman Sachs.

[Sloan Bohlen:]

First question for Terry. I imagine you know this is the one that's coming. I wonder if you could give us some color around what significant changes you may proceed with regard to one, kind of give us an idea of the scope of some G&A cuts that you could make; and then second to that, what areas of the business you think you could make changes in.

[Harold McGraw:]

Okay, Sloan, help me with that last part of your question. What kind of support we can do in terms of the businesses overall, what was that?

[Sloan Bohlen:]

So just trying to get a sense of what that means. Is it -- Does it mean additional investment in businesses? Does it mean divestiture of businesses? Kind of give us a sense of what your portfolio review entails?

[Harold McGraw:]

Okay, all right. Well, actually, Sloan, as you know, this all started in 2010. We had to make sure some of the bigger issues that were influencing the corporation in terms of things like legal and regulatory and the Structured Finance revenues and some of the funding issues from state, we needed to get those sorted through. And so as we progressed in 2010, we really focused on getting those behind us and sharpening on the expectation for execution, and that's why you saw some of the management changes and so forth. As part of all that, we also then began to look really hard at the overall portfolio in terms of where we ought to be allocating a lot of the capital and given some of the cash generation and so forth. One is that we wanted to really reinvigorate a commitment that we've always had to share repurchase, and then as well as to the dividend situation. But that also led then to the whole issue of McGraw-Hill Financial. McGraw-Hill Financial is a completely different business than Standard & Poor's. It needs its own management structure, it's an own design. It needs its own growth pattern and so forth. So integrating those businesses became a priority. And so as we got into 2011, we needed to be running McGraw-Hill Financial,I think. And we're really, really pleased with the results in the first half of this year and what the prospects for McGraw-Hill Financial are. The second one was then starting to look at some more non-core assets, and that's what led us to the Broadcasting piece. Some of the things that we've talked about in terms of focusing on more core properties led us to really, really strengthening our initiatives on Platts, and that led to the BENTEK Energy acquisition and the Steel Business Briefing that we just announced on that one. We need to accelerate aggressively the digital transformation at the education side, and clearly, we're seeing it at the higher ed, professional, international, and we're now beginning to see it again on the K-12 side. We have to deal, obviously, with the state funding issues. And obviously, for this year, Texas, as we've said, was going to be the wildcard in all of this. The good news is that they are funding. The issue is it didn't come in May, June or July. It's going to be into the third quarter, and so we look to benefit nicely from that part. In terms of other aspects of the portfolio, the only thing that I really would say at this point, Sloan, is that again, everything is being looked at. There is an awful lot of things that are on the table right now, from a timing standpoint. I look to the second half of this year to be making some pretty significant action statements, on that part. But again, overall, we've got a very strong cash and balance sheet position. The share repurchase and dividend, we're going to continue to emphasize. We've had a strong first half. We're going to have a very strong second half, on that part. But it gives us an opportunity, having all of that, to be able to make some changes and focusing more on some of the core assets that we have. So other than saying that there's going to be more actual statements coming relatively soon, we feel very excited about the portfolio review that we've done, and it will continue, on that part. Does that -- without going into any other specifics, I mean, the actions we're taking on this one, more to come.

[Sloan Bohlen:]

Okay. And Terry, maybe I'd just add one follow-up to kind of piece out some detail. The idea that there's significant changes potentially in the second half suggests that things are in the work. Is that incremental to the sale of the broadcasting unit? Can we expect that there's things beyond that, that will be announced in the second half?

[Harold McGraw:]

I think you can infer that, yes.

[Sloan Bohlen:]

Okay. And then maybe just one question on how we should think about the pace of share repurchase activity going forward. Is the pace that's been set out in the first half of this year a good run rate going forward? Or in the past, I know you guys have been more opportunistic given where the stock is. But maybe just give us a sense.

[Harold McGraw:]

Sloan, we've got to take a look at what conditions, and all of that. The answer to your question is yes. It is to say that the step up in the first half is more of what we're looking at in the second half. But again, we will take a look at conditions as they exist, and if we think it's necessary to accelerate, we will.

[Operator:]

Our next question comes from Michael Meltz, JPMorgan.

[Michael Meltz:]

I appreciate the -- what you said about the portfolio review at the outset. Can you tell us though -- Terry, I think you said you have different work streams and I guess folks looking at things internally. Is this also -- have you engaged consultants or bankers as well with the broader analysis? That's my first question.

[Harold McGraw:]

Well, the answer is yes. I mean, when we look at things, we're looking to get as much intelligence and support as we can. And so the answer is yes.

[Michael Meltz:]

Okay. And does it also -- besides the portfolio review, which -- I think that at the end of the quarter, you had net cash of over $1 billion. Is there -- are you reassessing your comfort level with the balance sheet and maybe having a set leverage target of some sort?

[Harold McGraw:]

Yes. I mean, again, dependent upon conditions and the like, I mean, those things are on constant review on this part. Making sure that -- going back to our first premise always, as we came out of 2010 and a lot of the external market factors that were influencing things and moving beyond that. The question is, is

[Michael Meltz:]

Okay. And then a question for you on the guidance. I believe -- I got to look back but I believe last quarter, you had -- or previously, you've been giving pretty specific segment guidance. And while you're pointing to the high end of EPS range, can you tell us what the x revenue growth expectation is for the 3 segments versus the prior -- I guess, for the 4 segments versus what you had previously been pointing to?

[Harold McGraw:]

No. I mean, I think that the issue for us is that the first half showed us the revenue growth expectations that we wanted. We were hoping to get to the double-digit growth. Now in all 3 segments, with the exception of Education, which is under a different kind of pressure, issues in terms of revenue growth, we saw the double-digit growth that we wanted.

[Jack Callahan:]

Yes, let me give specifics by segments. There's no real change in our overall segment guidance at this point in time. So from McGraw-Hill Financial, that would be double-digit growth. Although double-digit growth for S&P, there would be high single-digit growth. Now obviously, there's always could be some potential volatility in the capital markets. Information & Media, more in the sort of the mid-single, a bit better there but we'd hold to the mid-single for right now. And then MHE is low-single digit guidance for the full year. Obviously, that would require a pretty significant Q3 given where we are so far within the year. But we'd stand with that initial guidance right now.

[Harold McGraw:]

And the other aspect here, Michael, is that again, everything is relative to the environments in which we operate. And so as we were putting numbers together last year, we thought the $2.79, $2.89 was a very responsible platform for what we were seeing. Clearly, given the strength of the first half and some of our expectations, we can now say the upper end of that, on that part. But again, it's one that, relative to environment conditions, we want to be able to operate at the highest level we possibly can. And if it's doing better, we'll do it better.

[Michael Meltz:]

Okay. And then one clarification for me, please. Terry, I think to the last question -- last questioner, you had said to get to this review, you had to assess the legal situation and some of the other things that were happening. Is that meaning -- just to understand -- to get some of the dismissals out of the way? Or is there -- to the extent you look to spin off some things or do something more significant, you might be restricted because of lawsuits that are still outstanding? I don't...

[Harold McGraw:]

No, no, no. It's a very different situation. Obviously, given the turmoil in the financial markets and all of those kind of things, we were clearly influenced and clearly the stock was influenced with some of the uncertainty and the regulatory and legal situation and the like. Today, what we said -- and by the way, what we said from the very beginning is being reaffirmed, is that it's a vastly different legal and regulatory environment. We have -- we don't have anywhere near the uncertainty in the regulatory issue that you had a year ago. Both the United States, Europe, Japan, Canada, Australia have all completed those kinds of forms. Now, by the way, one that we're pushing very aggressively on and why we're focused on the G20 coming up at the end of the year is that there still needs to be an effort, and hopefully, led by the United States, to harmonize some of the financial regulation. They're not all in compliance with each other, so we need to push very aggressively on that. But the regulatory environment is vastly improved in terms of certainty and those kind of things. The legal issue, we said from the very beginning that the overall legal situation is low in all of that but you have to bear it out. Today, 30 suits have been dismissed or dropped, and we see that continuing. Most importantly, the categories that those suits were in, underwriter suits, stock drop suits and things like that, the courts have all set precedents now that those are not germane. So we don't see any additional activity on those things. But as those dark clouds go away and the earnings power and the execution capability is there, what we're focusing on now from a strategic standpoint is where we want that capital allocation to go in terms of the core assets and how we can expand faster.

[Operator:]

Our next question comes from Peter Appert from Piper Jaffray.

[Peter Appert:]

So Terry, you mentioned that perhaps you're seeing a little bit of market share pressure at S&P, and I was just hoping you might give us a little color on where you're seeing that pressure and how significantly you take that in terms of something that requires action.

[Harold McGraw:]

Well, it doesn't. I mean, this is day-to-day, everyday business conditions, and you watch it, all of it, very carefully. Sometimes, in terms of how you establish criteria, what the -- who's financing what, what capabilities it takes on. There are shifts back and forth in all of that. We want to make sure that from a clarity standpoint that we're as transparent as we possibly can be about what the criteria we establish for certain instruments is and that we apply it in such a way that it's coherent to the marketplace on that part. From time to time, you'll see some share gains or reverse in all of that. But that's just normal operating conditions. The most important thing is that people have a very clear understanding of how we are viewing and assessing any particular instrument, and that they see a very clear application of that.

[Peter Appert:]

Okay. And then, Terry, with regard to the margin expectations for S&P. I mean, given the, I think, a broad expectation that revenue growth would certainly have to slow in the second half, are you confident that you can see year-to-year margin improvement at S&P in the second half, even in the context of what would likely be, I would imagine, significantly slower revenue growth?

[Harold McGraw:]

Let me put it -- flip it around on that one. Given some of the cost pressures that we talked about and whether it be foreign exchange or some of the others that we've dealt with, I am personally very pleased with the margin level that we're running at right now. Quite frankly, my expectation was not where it is right now on this one. So I would say to you without getting into forecasting margin levels or whatever, you can assume that margin level that we achieved in the first half, we should be able to at least match in the second half. And obviously, everything we're looking at is trying to improve that. But I think that for Standard & Poor's, that is a pretty good level relative to some things that we faced.

[Peter Appert:]

Okay, fair enough. And then based on that Terry, should we anticipate that the current level of margins are sort of around on the 44% level, I guess, is what you would view as an appropriate level going forward?

[Harold McGraw:]

No, I wouldn't forecast yet on that part. I mean, again, as markets recover and as this business is getting all the attention that it's getting in all of that, obviously, we want to try and improve upon that. But I wouldn't forecast anything yet. I think where we are right now, I'm pleased in the first half. We're going to do everything we can to build on that.

[Jack Callahan:]

The flat outlook for the balance of the year is prudent. Also, I'd just -- and even we -- the expense comparisons in the back half are a bit more favorable for us relative to last year than they were in the first half of this year. So and it's still too early to comment on next year.

[Peter Appert:]

Okay. And then one last thing. Terry, you said participation in 70% of adoptions this year. And I think that's sort of a strategic change because in the past, I believe you've been very broad-based in terms of your participation.

[Harold McGraw:]

Yes, you're exactly right, Peter. You should think and given the fact that states have been healthier in the past and funding is more predictable and all of those kind of thing, we tend to have been in near 100%, 95% to 100% anyway, of the market opportunity. This year, and this came out a part of the strategic study that was initiated last year, our decision is that on some of the smaller disciplines, that we were not going to participate, and we're not just going to be in every single thing. Getting -- making sure that in terms of reading, math, science, those are very core disciplines that you have to have high competency in. And some of the others, we'll be very selective in terms of where we're going to allocate capital.

[Operator:]

. Our next question comes from Craig Huber, Access 342.

[Craig Huber -:]

My first question just on education. What is your outlook? Just to elaborate a little bit further here, for the open territories for this full year? And can you talk a little bit further about -- on the adoption market you're expecting there?

[Harold McGraw:]

Well, the good picture overall, Craig, is that the comment that we made coming in into this year, is that we thought the state adoption market -- I mean, and I think a good story, is that the state adoption market would equal or do a little bit better than 2010, and that all was dependent upon obviously Texas being the biggest part of this year. When we saw the state legislature in Texas wandering a little bit in terms of funding initiatives, it concerned us obviously, on that part. The fact that they have now come out and are going to fund and fund at the levels that they're funding and into the third quarter, that makes this a much better year. So last year, the $858 million, $875 million range, I think we'll definitely do that, and we might even do better than that. Open territory is again spotty. I mean, it's sort of like looking at numbers for the EU or something. You've got so many different countries with different growth prospects. You can come up with an average but some states are doing a little bit better in the open territory area, but then you have some outliers as well. But overall, I would say the situation is clearly improving.

[Craig Huber -:]

And also on the S&P ratings front, I mean, given how poor public finance debt issuance has been in the first 6 months of the year, are you expecting that to materially pick up here in the back half of the year?

[Harold McGraw:]

That's -- obviously, that is one that we're watching very carefully because of the health of the states and the influences, lots of other decisions as well. I mean, in terms of activity levels, we're starting to see some activity on this. But I'm still a little bit guarded on that. I wish we were seeing a little bit more at this point. But I would certainly hope that the second half and certainly 2012 begins to show a very different picture than what we saw in the first half of this year.

[Jack Callahan:]

Yes. To be specific on this year, our outlook is fairly conservative for the balance of the year. We're not banking on any material improvements relative to our outlook right now.

[Harold McGraw:]

Yes, but Craig, that's one for all of us, that we need to see some improvement.

[Craig Huber -:]

Also Terry, if I could ask, your outlook for the Structured Finance market, what signs are you looking for to potentially help that out here off of a very low base?

[Harold McGraw:]

Well, this is one that's definitely improving, on that one. We have seen a little bit more strength, obviously in more of the plain vanilla side of the structured market in terms of asset-backed securities. We're seeing more activity in Europe. We're seeing the commercial mortgage-backed market showing some signs. So it's definitely improving. I mean, if anybody wants to talk about the residential mortgage-backed market, no, you're not seeing any pickup in activity there. But in terms of ABS and CMBS and so on , yes, you're starting to see some here and in Europe.

[Operator:]

That was our final question. That concludes this morning's call. A PDF version of the presenter's slides is available now for downloading from www.mcgraw-hill.com. A replay of this call will be available in about 2 hours. Please note that a replay of this call, including Q&A, will be maintained on McGraw-Hill's website for 12 months from today and for one month from today by telephone. On behalf of The McGraw-Hill Companies, we thank you for participating and wish you good day.