S&P Global Inc.
Q3 2012 Earnings Call Transcript

Published: 2 Nov 2012

[Operator:]

Good morning, and welcome to The McGraw-Hill Companies' Conference 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 third quarter earnings webcast. [Operator Instructions] I'd now like to introduce Mr. Chip Merritt, Vice President of Investor Relations for The McGraw-Hill Companies. Sir, you may begin.

[Robert S. Merritt:]

Good morning, and thank you for joining us for McGraw-Hill's Third Quarter 2012 Earnings Call. This morning, we issued a news release with our results. We trust you've all had a chance to review it. 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 financial information. This information is provided to enable investors to make meaningful comparisons of the corporation's operating performance between periods and to view the corporation'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. The results for the prior year quarter also reflect the reclassification of the Broadcasting Group as a discontinued operation. 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 are aware that we do have some media representatives with us on the call. However, this call is intended for investors, and we would ask that questions from the media be directed to Patti Rockenwagner in our New York office at [phone]. Now I would like to turn the call over to Harold McGraw III, Chairman, President and CEO of The McGraw-Hill Companies. Terry?

[Harold Whittlesey McGraw:]

Okay. Thank you very much, Chip. And good morning, everyone, and welcome to today's conference call. Joining me on today's conference call is Jack Callahan, our Chief Financial Officer. This morning, Jack and I will review our corporate results. We're going to provide an update on our Growth and Value Plan progress. We'll provide a detailed look at the segment results that make up what will be McGraw-Hill Financial and McGraw-Hill Education and then, provide an outlook for the balance of the year. Now, like many other New York companies, we delayed our earnings report from Wednesday to today to accommodate employees and shareholders impacted by Hurricane Sandy. And thankfully, all of our employees are safe, and our business continuity plans are operating effectively. Our employees have really stepped up to work through the many challenges, and I'm grateful to them and to the state and city workers who have done so much to help us over this past week. And I hope those of you on the phone affected by the storm are safe and starting the process to return to some state of normality as well. All right. Let me begin by saying that we are pleased by the success of our Growth and Value Plan and the strong results of the McGraw-Hill Financial businesses. Now while the Education company is facing some very tough current challenges in the U.S. education sector, we feel very excited by the promise of digital learning and by our new digital products and services, which are improving learning outcomes for students everywhere. And this digital transformation is gaining momentum, and we'll talk about that in just a little bit. During the third quarter, the company delivered a 2% increase in revenue. McGraw-Hill Financial, which realized a boost from the robust global issuance, delivered a 15% increase in revenue. Separately, McGraw-Hill Education delivered an 11% decrease in revenue as it managed the impact of the weakest level of state funding for K-12 textbooks in the past decade. Adjusted operating profit increased 3%, and due to our aggressive share repurchase program, we delivered 10% growth in adjusted diluted earnings per share, and Jack will provide a little additional financial detail on that in just a moment. A little over a year ago, we made a set of commitments in this Growth and Value Plan, and I'm proud of the substantial progress that our employees have made on each of these commitments. And let me take a moment and just walk through these different commitments and give you an update as to where we are. The first and most visible commitment is the separation of the company into 2 industry-leading companies, McGraw-Hill Financial and McGraw-Hill Education; and we are on track to do so. Amendment #2 to the Form 10 SEC Registration Statement for the potential spinoff of McGraw-Hill Education was filed with the Securities and Exchange Commission earlier this month, and we don't anticipate any substantial issues with that. In parallel with our efforts to spin off McGraw-Hill Education, we have undertaken a thorough evaluation process of numerous options, including the option to sell the business. This process is near its conclusion, and we expect to reach a decision in the coming weeks. Critical to this decision is ensuring that we choose the option that maximizes shareholder value. The timing of the ultimate separation will be dictated by which option is chosen. We have also committed to more than $100 million in run rate cost reductions by the end of the year. We're on track for this, and Jack will provide some color on this in just a moment. We committed to aggressively repurchasing shares, and after completing the $1.5 billion share repurchase program earlier this year, we reentered the market in the third quarter and purchased an additional $295 million of McGraw-Hill stock. Lastly, we committed to investing for growth. Earlier this year, we formed the S&P Dow Jones Indices joint venture. Importantly, this is the first quarter that we have managed and reported the combined results for some of the most widely followed and trusted brands in the index space. We believe this joint venture will prove to be a great value not only to our customers, but also our shareholders. In addition, earlier this year, the company acquired R2 Financial Technologies, QuantHouse, Credit Market Analysis Limited and Coalition Development Ltd. And most recently, we announced the acquisition of Kingsman SA, which I'll discuss in more detail in just a moment. So whether it's through the separation process, cost reductions, share repurchases or investing in growth, McGraw-Hill is meeting its Growth and Value Plan commitments and is on target and on track to do so. With that, let me now turn to the business results. McGraw-Hill Financial on a pro forma basis delivered a 15% increase in revenue and a 21% increase in adjusted operating profit during the quarter. Of the 15% revenue growth, 11% was organic and 4% was from the transactions that I just mentioned. While all 3 segments delivered revenue growth, it was Standard & Poor's Rating Services and Commodities & Commercial markets that provided the most impressive adjusted operating profit growth of 28% and 29%, respectively, as well as improved adjusted operating margins. McGraw-Hill Financial delivered 40% of its revenue from outside the United States during the third quarter. Domestic revenue growth of 17% outpaced International growth of 12%, which was impacted by adverse foreign exchange rates. Standard & Poor's Ratings continues to be the segment with the largest international presence, with 45% of its revenue coming from outside the United States. Standard & Poor's Ratings also delivered the largest revenue increase within McGraw-Hill Financial and delivered its strongest quarterly revenue since the third quarter of 2007. Revenue for this segment grew 22%, with a 33% increase in domestic revenue and a 12% increase in international revenue. The increase in international revenue occurred despite a 7% negative impact from foreign exchange rates. Adjusted segment operating profit increased 28%, and the corresponding operating margin increased almost 200 basis points. Actions during the quarter by both the European Central Bank, the ECB, and the Federal Reserve resulted in increased global bond issuance. The ECB's pledge to intervene in the sovereign bond markets and the Federal Reserves' Quantitative Easing 3 program caused global spreads to contract and fueled a surge in September bond issuance. These actions helped to drive U.S. speculative-grade corporate bond issuance to a record $85.4 billion in the third quarter. Transaction revenue increased 64% to $215 million. Recall that while issuance in the first half of 2011 was quite robust, it tapered off considerably in the second half of 2011, creating less difficult year-over-year comparisons in the second half of 2012. Nevertheless, the key drivers to the increase in transaction revenue were

[John F. Callahan:]

Thank you, Terry. This morning, I want to discuss several topics

[Robert S. Merritt:]

Thanks, Jack. Just a couple of instructions. [Operator Instructions] And now, operator, we'll take our first question.

[Operator:]

Our first question comes from William Bird with Lazard.

[William G. Bird:]

Two questions. One, what is the drop-dead deadline for a decision on sale or spin of Education? And then, second, can you talk a bit about what's happening in the index business? I know the comp was really tough, but with assets under management up 40%, revenues down 7%, I was just wondering if you could elaborate on what's driving that and maybe just kind of the context around some of the issues at MSCI.

[Harold Whittlesey McGraw:]

Okay. Well, Bill, and look, as far as the separation process, we have been getting out an awful lot of information throughout the year as to where we are. We have literally worked tirelessly to look at all options in all of this, and we're coming to the conclusion, just like we said we would. And so literally, I think it would be inappropriate on my part to derail any element of the process at this point. But I will say that in the coming weeks, and, hopefully, sooner, we will have an announcement to make to you.

[William G. Bird:]

And then on the index business?

[Harold Whittlesey McGraw:]

Yes. We're so excited about this, because we wondered very hard whether or not we could actually pull this off on this one. But to put the S&P Indices, which are largely institutional indices, together with Dow Jones Indices, which are largely retail, is just a -- it's just a fabulous combination. And as we see more and more index behavior and the growth in exchange-traded funds, both in the United States and around the world, it gives us huge opportunities as a platform to expand. And I gave one example of the Brazilian component. But I can tell you the growth of S&P Dow Jones Indices is just going to be phenomenal. It's a wonderful platform, and we're going to be able to do a lot of other things to add to this platform to grow it even faster. So we're very excited about the combination, that it's under way and that the growth prospects are so high.

[John F. Callahan:]

And then, Bill, the one thing I'd also add, and it's really a third quarter issue, largely for the base S&P Indices business, is the comp versus a year ago was really difficult, largely driven because of the extensive activity in exchange-traded derivatives from a year ago. I think Terry had a chart on that during his comments. And that overlap is less onerous as we get into the fourth quarter. So I think we're more -- we think that's an easier overlap for us to manage as we head into the balance of the year.

[William G. Bird:]

So just to be clear, there's been a lot written just about the fee war going on in the ETF industry. I just wanted to get a sense of what you're seeing on pricing.

[Harold Whittlesey McGraw:]

At this point, and I don't want to comment on MSCI, that's theirs to do, but we are not seeing that kind of pressure at this point. So from our standpoint, we're not overly concerned by that. And again, Bill, again, the quality of brands and the recognition of those trusted brands is really, really important on that one. And again, when you have markets that have a lot of uncertainty built into it, those trusted brands take on a lot more import.

[Operator:]

Our next question comes from Manav Patnaik with Barclays.

[Manav Patnaik:]

First quick question on Platts. I guess what was the acquisition contribution for the Platts line item from BENTEK's steel business? And also, just maybe a little more color there, I mean I guess it was a little tougher comp, but it seemed like the growth decelerated a bit from the 20% in the first half of the year.

[Harold Whittlesey McGraw:]

No, actually the Platts business has been strong all year, and the Kingsman acquisition, I think you're referring to, gives us strength in terms of a brand-new sector. They expanded into the agricultural markets, not only from biofuels, but also in terms of expanding in the commodity platform. But from our standpoint, Platts has exceeded its plans and is doing extremely well, and we expect that to hold up.

[John F. Callahan:]

And back to the acquisition impact, so just keep in mind, the BENTEK deal closed early in 2011, and the SPD deal closed early in the third quarter of last year. So essentially, the third quarter, it's really apples to apples. So it's really -- it's year-on-year comparisons are now -- have the acquisition in it, and the only new piece is the Kingsman acquisition. But obviously, that just closed yesterday so that's more of a fourth quarter impact. I can tell you, at least within BENTEK, we're seeing double-digit growth for that enterprise, and we're quite excited about what that's adding to the portfolio.

[Manav Patnaik:]

All right. And then one more question, I guess, on the ratings side. Did the trial date, I guess the Abu Dhabi trial, get pushed to May? I guess that trial was initially Feb. And then just around the trial front, can you give us an update on how the Australia trial went or what the pending status there is?

[Harold Whittlesey McGraw:]

Okay. Well, first of all, in terms of Abu Dhabi, we're actually quite pleased with the situation as it's unfolding. We have eliminated several components, and it's scheduled for trial in May of next year, and we'll see how that goes. But we're not concerned at all. As far as the Australian CPDO situation, we're waiting to hear the result on that. And from our standpoint, again, we feel very -- we feel like we're in a very good position. But we should get a result any day on that, and we'll be reporting that as others will as well. But again, the overall legal situation, Manav, has been one of you've got so much wait in these things. As you know, in the United States, we do everything at the federal court level. And literally, because of all the litigation out there, not just ours, I mean, all of the litigation out there, it takes 2, 2.5 years to get before a federal judge, and so you have to wait. And one of the things that we have said, and we're encouraged by the results, is that in many cases, once it gets before a judge, it's the same day that these cases get dismissed on all that. So we are -- we think that we're in a very good position. We're obviously well advised, and it's a wait-and-see game. But to date, with the 30 cases that have been dismissed, the number of cases that have been reaffirmed to be dismissed at the higher-court level over a lower-court decision, all of those kinds of things, you have to be focused on all of these kinds of things. But we think the risk here in terms of legal aspects are low.

[Operator:]

Our next question comes from Peter Appert with Piper Jaffray.

[George K. Tong:]

This is George Tong for Peter Appert. Cost growth continued to slow in the Commodities & Commercial segment in the third quarter, which helped you generate some pretty good margins. Should that pattern replay, you think, in the fourth quarter and heading into 2013?

[Harold Whittlesey McGraw:]

Well, George, again, I don't want to speculate here and other thing. But I have to tell you that given the strength of the digital offering and the subscription growth, our hope is that continued emphasis on the cost reduction part is doable. But I would just say at this point that we're very pleased with the results for year-to-date and for the third quarter, and you have my assurances that every focus is on continuing to find ways to reduce those costs. But we're very excited about the revenue growth here. It's a good picture, and it's getting better.

[John F. Callahan:]

As you saw last quarter, we had some pretty good margins in the segment, and I think we'll be around sort of this high-20s -- mid- to high-20s range sort of going forward, nice margins in Platts. And we have, as Terry mentioned, a great year for J.D. Power and a stabilizing across the balance of the Commercial platform. So we should be in this range for the fourth quarter.

[Harold Whittlesey McGraw:]

And by the way, George, having just come back from Beijing on a quick trip, J.D. Power's business ought to do really well. I've never seen so many cars in my entire life and traffic jams to go with them.

[George K. Tong:]

That's very helpful. Could you give us some -- sort of switching gears a bit. Could you give us some additional detail on your outlook for the Education business and when you might expect an inflection point in spending and budgets to occur?

[Harold Whittlesey McGraw:]

Wow. I wish I could do so with some accuracy here. Look, the Education business, whether we're talking Higher Ed, whether we're talking Professional, International or the all-important K-12, these are essential businesses. I mean, you're talking about educating your future workforce. And the unfortunate part, we have seen in the United States a significant deterioration in educational funding, which has very dire consequences for student achievement and all of those kind of thing. We've got to get back onto that track. Now if your -- if everything is essentially based on property tax structures at local and state municipalities and all that, and you put the longest housing recession that we've ever seen together with that, you've got a very bad combination, plus the fact that you have so many states that are in deficit and all of those thing. Those aren't excuses. Those are realities and everything. So one, on improving housing market, getting states out of deficit positions and getting growth again is going to help this situation. But literally -- and this won't last. I mean, it can't. But this is the worst K-12 environment in a decade. And I think it should be, obviously, an outrage to everyone, but it won't last. And second part is, coupled with that environment, the positive here is the speed of the digital transformation part. We are seeing increased activity across the board here. We have been -- whether we're working with certain manufacturer -- device manufacturers or whether we're working with partners in terms of developing digital solution, we've been working aggressively on this for some time, and the receptivity of it is just moving at a very fast pace now. And so that's very encouraging. That's got serious implications for cost reduction, but also, very, very strong positives for our revenue growth on that part. But it's an essential business, it's our future workforce, and the Education agenda should be a priority for any country.

[Operator:]

Our next question comes from Craig Huber with Huber Research Partners.

[Craig Huber:]

Just a few questions. Terry, first, on the cost-cutting front, you talked of this $100 million annualized goal you're looking to get by end of this year. Can you -- I'm just curious. Why is that number at the end of the day not going to potentially be 2x to 3x that? I ask that in the context, last year, as you know, you had -- I think you had $4.8 billion costs to your company. Why only $100 million, my first question, please?

[John F. Callahan:]

This is a Jack. Craig, look, what's unique about this situation is we're talking about cost reduction in the context of separation. I think there's very few companies that have ever talked about both of those things at the same time, and we're trying to put an end date on this cost program, because once we get into the early part of next year, these are 2 separate entities. Then it'll be my accountability to come back and talk what would the cost outlook is for McGraw-Hill Financial, and it'll be Patrick Milano's to do the same for McGraw-Hill Education. And I think it's, kind of given the separation right ahead of us now, it's premature to kind of go past that. But we certainly acknowledge that there's opportunity here, and I think some of the foundational things we have done this year give us opportunities to kind of extend some of the cost programs once we move into 2 separate entities. So more to come.

[Harold Whittlesey McGraw:]

And Craig, I'd just echo that. Again, the most important thing in terms of separation is making sure that we've got the right options and we're on track and on target and all of those kind of thing. At the same time, as you start to decouple the shared services and all the other kind of capabilities to that, there's lots of opportunities here in all that. But I think to do, as Jack said, the separation correctly and to put out a $100 million number is very responsible. But we think that there's a lot more opportunity, and we look forward to, once the separation is completed, coming back with you with another number.

[Craig Huber:]

Okay. And my second question, please, if you think about the backlogs in your Ratings business for the next 2 to 3 months, what are they looking like right now, and how much risk do you think there is just given the federal debt ceiling has to get raised? We know how that went 1.5 years ago, terrible. Secondly, also with the fiscal cliff issue for January 1 [ph] is that going to put issuers on hold here for a while? What do you think there, please?

[Harold Whittlesey McGraw:]

Okay. Well, look. First of all, and not to talk about just the fourth quarter, to talk about the next 3, 5, 10 years, the capital demand needs are huge. And if you talk about infrastructure financing alone, between now and 2030, you're talking some $70 trillion. You're talking about $1 trillion of infrastructure financing in India alone over the next 5 years. The study that I gave you was on just refunding between now and 2016 of $8 trillion. So the demand here is absolutely huge on that part. So I'm not -- I mean, any given time, you're going to have some slowness or some pickup or whatever, but the overall demand for capital is only going to go up, and banks are not going to be able to satisfy all that kind of demand. And in fact, the reason that the capital markets and fixed income markets in particular are doing so well is because now the banks, in many ways, are stalled and the largest portion of the capital demand has got to come from the capital markets on that one. So from a backlog standpoint, we're doing really well. Now the second part to that question is, look, obviously, the European Central Bank made a decision that they were going to intervene in the sovereign bond market and provide a level of support. That, obviously, created some activity. When Ben Bernanke came out with the QE3, the real question was, "Is there going to be a QE4?" and anything. I don't know and all of that, but both of those caused global spreads to contract and, obviously, fueled a surge in September bond issuance. So then I get questions like, "Okay, well, is that just bringing moneys forward that were in the fourth quarter or the first quarter for next year or something like that?" How do I know and all of that, and we'll just have to wait and see what the facts are. But the capital demand load is huge on that one and it's worldwide on that part. And again, with 45% of our revenues coming from outside the United States, we're in a terrific position to be able to deal with that.

[Craig Huber:]

And also, Terry, if I could ask, once you sell or spin off your Education, if you do actually sell it, would you use those proceeds most likely to buy back stock? Of course, a small piece of the refinancing you talked about, given your [ph] style to do large acquisitions, of course.

[Harold Whittlesey McGraw:]

Yes. Well, first of all, I don't want to get ahead of ourselves, here. But let me give you 2 facts on that one that Jack was talking about. One, we are an extremely dividend-friendly company, and we have been since we created a dividend in 1936 and have been increasing it every year since '74. And so there's going to be no letup on that side. Number two, in terms of share repurchase, I think our track record is out there, and it's pretty solid. We're a very share-repurchase-friendly company. And we do anticipate we're back in the market in the third quarter. We bought back $295 million. We did the accelerated share repurchase of $1.5 billion last year, and I expect to have a strong share repurchase program going forward. But I think it's a little premature to talk about what level or all of those kind of things. But from a financial engineering standpoint, I think our track record is pretty solid.

[Operator:]

The next question comes from David Reynolds with Jefferies.

[David Reynolds:]

David Reynolds here from London. Just to say it's great to see New York is back on track, and our thoughts are with you. A question, though, just -- and I don't mean to labor the point, but if I can just address the coming decision process around the Education asset, and clearly, you've talked about it being on a timescale of the coming weeks. Are you able to describe what kind of decision you are now going through? Is it one of having received the bids, you're determining whether a price is acceptable? I know it's a difficult area to talk about, but if you could shed some light on that, that would be helpful

[Harold Whittlesey McGraw:]

Okay. Thanks, David, and thanks for your comments about New York . I mean, as you know, from your own associates, I mean, it has really been hard hit, and it's probably going to be weeks in terms of getting total business continuity going again and all of that. But thanks for the comments on that. Now as far as the separation process and all that, look, we said from the very beginning that we're going to look at every single aspect in all of this, and that's exactly what we've done. We've given out timelines, and we are coming to a conclusion. And again, I think to skew this in any way is not appropriate from my standpoint at this point. So the best color I can give you is that you're not talking a long time frame here. You're talking, literally, coming weeks and maybe sooner.

[David Reynolds:]

That's great. And perhaps just one follow-up, obviously, we noted your increase in the full year '12 guidance. Intuitively, that feels relatively conservative. Would you agree with that?

[Harold Whittlesey McGraw:]

David, you're a great guy. Look, I thought the range $3.25 to $3.35 was a really, really solid number and range for us for 2012. The facts that things were a little bit better, that our cost reduction programs came in, all of those kinds of things, we started in the midyear giving guidance that it was more like $3.30 and maybe closer as we got on towards the upper end of the range. But given the third quarter and all of that and the way we expect to finish 2012, we think that improving the guidance from $3.35 to $3.40 is a good step. I mean, it's really there. Now would I like to be able to give more -- I'll get into a wrestling match with Jack here in a minute and all of that. But we're pleased with that guidance, and if things go the way we like it, we'll be very pleased.

[John F. Callahan:]

We're pretty focused on delivering on the commitments that we make. But -- and then we're hopeful that we'll finish the year nicely to position us well for next year.

[Operator:]

We will now take our final question from Bill Warmington with Raymond James.

[William A. Warmington:]

A question for you on how many cases are still outstanding for Standard & Poor's? And then, finally, when do you start to bump up against some of the statute of limitations for these claims?

[Harold Whittlesey McGraw:]

Let's see. In terms of the outstanding issue, it's -- I'd have to get the exact number for you, but it's a few dozen. If you call Chip, he can get the exact number for you, but it's way down, obviously. But since the downturn in the markets and all of those kind of thing, it's been a solid 4-plus years in all of that. So the expectations that we had in terms of there's no merit to some of these and all of that has borne out to be true and all of that. But we've got a few dozen left.

[William A. Warmington:]

All right. And then for the EPS guidance for 2012, does that include the impact of the $200 million of share repurchases you're planning to do in the fourth quarter?

[John F. Callahan:]

It's a consideration. But by the time we average those in, it's not going to have a big impact. As you saw in the third quarter, it's hard to predict what's going to happen with stock option exercises. So I wouldn't view our guidance as dependent on it at this point in time, but it's probably -- it'll have a bigger impact as we get into next year.

[Harold Whittlesey McGraw:]

And again, based on market conditions and all of those kind of things, we'll keep everybody updated on exactly what we're doing.

[John F. Callahan:]

One other point in your first question on the legal situation is I can tell you sort of our legal expense on a run-rate basis is coming down a bit. So I think we're -- so I think if that's any indicator of some of the issues facing the company, that is one thing we are looking at.

[William A. Warmington:]

Excellent. And then if you could comment on the competitive environment for Capital IQ, especially in light of Bloomberg putting through a 6% price increase. That would seem like it would be a positive for you.

[Harold Whittlesey McGraw:]

Well, again, I don't want to talk about any of the other competitors. That's for them. We feel very, very good about where Capital IQ is. We talked about the addition of 4,400 clients and 55,000 subscribers and all of that. Our growth plan for Capital IQ is on target. And I think the other thing to focus in on at Capital IQ is the customization aspect of this, that we can -- we have multiple abilities to put more content packages together to create customized platforms for customers, and that's what we're focused on doing. But Capital IQ is on target.

[Operator:]

That concludes this morning's call. A PDF version of the presenters' slides is available now for downloading from www.mcgraw-hill.com. A replay of this call, including the Q&A session, will be available in about 2 hours. The replay will be maintained on McGraw-Hill's website for 12 months from today and for 1 month from today by telephone. On behalf of The McGraw-Hill Companies, we thank you for participating and wish you good day.