S&P Global (SPGI) 10-Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

Commission File Number 1-1023

THE MCGRAW-HILL COMPANIES, INC.

(Exact name of registrant as specified in its charter)

New York	13-1026995
(State of other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1221 Avenue of the Americas, New York, N.Y.	10020
(Address of Principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code (212) 512-2000

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YESþ                      NOo

Indicate by check mark whether the Registrant is an accelerated filer.

YESþ                      NOo

On October 14, 2005 there were approximately 374.9 million shares of common stock (par value $1.00 per share) outstanding.

The McGraw-Hill Companies, Inc.

TABLE OF CONTENTS

	Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Report of Independent Registered Public Accounting Firm		3
Consolidated Statement of Income for the three and nine month periods ended September 30, 2005 and 2004		4
Consolidated Balance Sheet at September 30, 2005, December 31, 2004 and September 30, 2004		5
Consolidated Statement of Cash Flows for the nine months ended September 30, 2005 and 2004		7
Notes to Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		43
Item 4. Controls and Procedures		43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		44
Item 6. Exhibits		45
EX-12: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
EX-15: LETTER ON UNAUDITED INTERIM FINANCIALS
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32: CERTIFICATIONS
EX-99: AMENDMENT TO RIGHTS AGREEMENT

2

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
of The McGraw-Hill Companies, Inc.

We have reviewed the consolidated balance sheet of The McGraw-Hill Companies, Inc., as of September 30, 2005, and the related consolidated statements of income for the three-month and nine-month periods ended September 30, 2005 and 2004, and the consolidated statements of cash flows for the nine-month periods ended September 30, 2005 and 2004. These financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The McGraw-Hill Companies, Inc. as of December 31, 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended, not presented herein, and in our report dated February 22, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Ernst & Young LLP

October 26, 2005

3

Part I
Financial Information

Item 1. Financial Statements

The McGraw-Hill Companies, Inc.

Consolidated Statement of Income

Periods Ended September 30, 2005 and 2004

	Three Months				Nine Months
(in thousands, except per share data)	2005		2004		2005		2004
Revenue (Note 3)
Product	$	1,157,285	$	1,048,476	$	2,124,074	$	1,913,435
Service		819,756		674,400		2,338,250		1,975,270
Total revenue		1,977,041		1,722,876		4,462,324		3,888,705
Expenses
Operating related expense
Product		444,205		419,875		942,533		855,915
Service		277,798		229,288		784,638		674,047
Total operating related expense		722,003		649,163		1,727,171		1,529,962
Selling and general expense
Product		318,792		292,818		773,276		713,899
Service		294,312		232,618		809,020		681,632
Total selling and general expense		613,104		525,436		1,582,296		1,395,531
Depreciation		26,299		22,188		77,136		67,376
Amortization of intangibles		12,438		9,173		32,877		22,812
Total expenses		1,373,844		1,205,960		3,419,480		3,015,681
Other income-net		6,758		—		6,758		—
Income from operations		609,955		516,916		1,049,602		873,024
Interest expense		2,808		1,867		7,018		5,765
Income from continuing operations before taxes on income		607,147		515,049		1,042,584		867,259
Provision for taxes on income (Note 12)		225,858		190,568		387,590		300,886
Income from continuing operations		381,289		324,481		654,994		566,373
Discontinued operations (Note 4):
Juvenile retail publishing business		—		—		—		(931	)
Income tax benefit		—		—		—		(344	)
Loss from discontinued operations		—		—		—		(587	)
Net income (Notes 1 and 2)	$	381,289	$	324,481	$	654,994	$	565,786
Basic earnings per common share
Income from continuing operations	$	1.02	$	0.86	$	1.75	$	1.49
Net income	$	1.02	$	0.86	$	1.75	$	1.49
Diluted earnings per common share
Income from continuing operations	$	1.00	$	0.85	$	1.71	$	1.47
Net income	$	1.00	$	0.85	$	1.71	$	1.47
Average number of common shares outstanding: (Notes 7 and 9)
Basic		373,552		378,760		375,318		379,788
Diluted		381,163		384,112		382,615		385,522

See accompanying notes.

4

The McGraw-Hill Companies, Inc.

Consolidated Balance Sheet

	Sept. 30,		Dec. 31,		Sept. 30,
(in thousands)	2005		2004		2004
ASSETS
Current assets:
Cash and equivalents	$	466,635	$	680,623	$	423,763
Accounts receivable (net of allowance for doubtful accounts and sales returns) (Note 5)		1,361,530		1,002,408		1,178,500
Inventories (Note 5)		369,228		327,781		340,767
Deferred income taxes		267,867		258,157		241,272
Prepaid and other current assets		116,822		157,153		115,499
Total current assets		2,582,082		2,426,122		2,299,801
Prepublication costs (net of accumulated amortization) (Note 5)		422,376		428,205		399,756
Investments and other assets:
Prepaid pension expense (Note 10)		291,599		299,792		296,616
Other		187,656		220,611		216,543
Total investments and other assets		479,255		520,403		513,159
Property and equipment — at cost		1,266,248		1,195,792		1,164,650
Less — accumulated depreciation		752,918		682,726		677,731
Net property and equipment		513,330		513,066		486,919
Goodwill and other intangible assets (Note 4):
Goodwill — net		1,661,266		1,505,340		1,478,265
Copyrights — net		216,041		228,502		232,469
Other intangible assets — net		482,812		219,643		248,007
Net goodwill and intangible assets		2,360,119		1,953,485		1,958,741
Total assets	$	6,357,162	$	5,841,281	$	5,658,376

See accompanying notes.

5

The McGraw-Hill Companies, Inc.

Consolidated Balance Sheet

	Sept. 30,			Dec. 31,			Sept. 30,
(in thousands)	2005			2004			2004
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Notes payable	$	4,106		$	4,613		$	5,278
Accounts payable		263,068			318,301			266,984
Accrued royalties		102,221			103,844			95,573
Accrued compensation and contributions to retirement plans (Note 10)		428,960			411,330			366,344
Income taxes currently payable		222,008			78,776			222,590
Unearned revenue		816,794			719,948			659,408
Deferred gain on sale leaseback (Note 11)		7,516			7,516			7,516
Other current liabilities		331,247			302,626			331,004
Total current liabilities		2,175,920			1,946,954			1,954,697
Other liabilities:
Long-term debt (Note 6)		345			513			375
Deferred income taxes		321,572			232,081			181,360
Accrued postretirement healthcare and other benefits (Note 10)		160,938			164,021			165,398
Deferred gain on sale leaseback (Note 11)		191,603			197,267			199,179
Other non-current liabilities		343,197			315,932			287,364
Total other liabilities		1,017,655			909,814			833,676
Total liabilities		3,193,575			2,856,768			2,788,373
Commitments and contingencies (Note 13)
Shareholders’ equity (Notes 7 and 8):
Capital stock		411,709			205,855			205,854
Additional paid-in capital		2			113,843			113,610
Retained income		4,071,577			3,680,852			3,547,843
Accumulated other comprehensive income		(51,680	)		(32,255	)		(54,361	)
		4,431,608			3,968,295			3,812,946
Less — common stock in treasury-at cost		1,244,544			963,751			917,788
Unearned compensation on restricted stock		23,477			20,031			25,155
Total shareholders’ equity		3,163,587			2,984,513			2,870,003
Total liabilities and shareholders’ equity	$	6,357,162		$	5,841,281		$	5,658,376

See accompanying notes.

6

The McGraw-Hill Companies, Inc.

Consolidated Statement of Cash Flows

For the Nine Months Ended September 30, 2005 and 2004

(in thousands)	2005			2004
Cash flows from operating activities
Net income	$	654,994		$	565,786
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation		77,136			67,466
Amortization of intangibles		32,877			22,812
Amortization of prepublication costs		179,642			218,164
Provision for losses on accounts receivable		16,474			9,389
Other		9,805			6,624
Changes in assets and liabilities net of effect of acquisitions and dispositions:
(Increase) in accounts receivable		(373,412	)		(288,849	)
(Increase) in inventories		(41,952	)		(43,641	)
Decrease/(Increase) in prepaid and other current assets		48,146			(42,941	)
(Decrease) in accounts payable and accrued expenses		(51,263	)		(40,320	)
Increase in unearned revenue		82,639			65,759
Increase in other current liabilities		28,030			926
Increase in interest and income taxes currently payable		180,163			15,048
Net change in deferred income taxes		(6,050	)		(16,574	)
Net change in other assets and liabilities		60,041			13,557
Cash provided by operating activities		897,270			553,206
Investing activities
Investment in prepublication costs		(176,539	)		(162,038	)
Purchases of property and equipment		(72,684	)		(90,510	)
Acquisition of businesses and equity interests		(455,217	)		(298,896	)
Disposition of property, equipment and businesses		128,332			45,679
Additions to technology projects		(11,886	)		(8,589	)
Cash (used for) investing activities		(587,994	)		(514,354	)
Financing activities
(Payments) on short-term debt — net		(11,535	)		(21,698	)
Dividends paid to shareholders		(184,202	)		(171,138	)
Repurchase of treasury shares		(444,288	)		(269,088	)
Exercise of stock options		132,294			154,698
Other		(148	)		(239	)
Cash (used for) financing activities		(507,879	)		(307,465	)
Effect of exchange rate changes on cash		(15,385	)		(3,215	)
Net change in cash and equivalents		(213,988	)		(271,828	)
Cash and equivalents at beginning of period		680,623			695,591
Cash and equivalents at end of period	$	466,635		$	423,763

See accompanying notes.

7

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

1.	Basis of Presentation
	The financial information in this report has not been audited, but in the opinion of management all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly such information have been included. The operating results for the three and nine months ended September 30, 2005 and 2004 are not necessarily indicative of results to be expected for the full year due to the seasonal nature of some of the Company’s businesses. The financial statements included herein should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
	The Company’s critical accounting policies and estimates are disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Company’s annual report on Form 10-K for the year ended December 31, 2004. On an ongoing basis, the Company evaluates its estimates and assumptions, including those related to revenue recognition, allowance for doubtful accounts and sales returns, valuation of inventories, prepublication costs, valuation of long-lived assets, goodwill and other intangible assets, retirement plans and postretirement healthcare and other benefits and income taxes. Since the date of the annual report on Form 10-K, there have been no material changes to the Company’s critical accounting policies and estimates.
	Certain prior year amounts have been reclassified for comparability purposes.
	All share and per share figures have been restated to reflect the two-for-one stock split announced April 27, 2005. See Note 7 for further detail.
	In December 2002, The FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of SFAS No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation, and requires additional disclosures in interim and annual financial statements. The disclosure in interim periods requires pro forma net income and net income per share as if the Company adopted the fair value method of accounting for stock-based awards. Pro forma net income and earnings per share primarily reflecting compensation cost for the fair value of stock options were as follows:

	Three Months						Nine Months
(in thousands except earnings per share data)	2005			2004			2005			2004
Net income, as reported	$	381,289		$	324,481		$	654,994		$	565,786
Stock-based compensation cost included in net income, net of tax		9,154			9,046			17,812			15,345
Fair value of stock based compensation cost, net of tax		(20,766	)		(19,171	)		(54,358	)		(46,465	)
Pro forma net income	$	369,677		$	314,356		$	618,448		$	534,666
Basic earnings per common share as reported	$	1.02		$	0.86		$	1.75		$	1.49
Pro forma	$	0.99		$	0.83		$	1.65		$	1.41
Diluted earnings per common share as reported	$	1.00		$	0.85		$	1.71		$	1.47
Pro forma	$	0.97		$	0.82		$	1.62		$	1.39
Basic weighted average shares outstanding		373,552			378,760			375,318			379,788
Diluted weighted average shares outstanding		381,163			384,112			382,615			385,522

8

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

The weighted average fair value of options granted during the nine months ended September 30, 2005 and 2004 was $8.88 and $6.39, respectively. The fair value of each option grant was estimated on the date of the grant using a lattice option-pricing model in 2005 and the Black-Scholes option-pricing model in 2004, using the following assumptions:

	2005			2004
Risk free average interest rate		1.99 — 4.64	%		3.3	%
Dividend yield		1.6	%		1.6	%
Volatility		16 — 24	%		15.0	%
Expected life (years)		0.5 — 6.8			5.0

2.	Comprehensive Income
	The following table is a reconciliation of the Company’s net income to comprehensive income for the three and nine month periods ended September 30:

	Three Months				Nine Months
(in thousands)	2005		2004		2005			2004
Net income	$	381,289	$	324,481	$	654,994		$	565,786
Other comprehensive income / (loss):
Foreign currency translation adjustments		3,667		11,168		(19,425	)		15,163
Comprehensive income	$	384,956	$	335,649	$	635,569		$	580,949

3.

Segment and Related Information

The Company has three reportable segments: McGraw-Hill Education, Financial Services, and Information and Media Services. McGraw-Hill Education is one of the premier global educational publishers serving the elementary and high school, college and university, professional and international markets. In January 2004, the Company divested Landoll, Frank Schaffer and related juvenile retail publishing businesses, which were part of the McGraw-Hill Education segment. In accordance with SFAS No. 144, the Company reflected the results of these businesses as discontinued operations as of December 31, 2003 (See Note 4). The Financial Services segment operates under the Standard & Poor’s brand and provides credit ratings, evaluation services, and analyses globally on corporations, financial institutions, securitized and project financings, and local, state and sovereign governments. Financial Services provides a wide range of analytical and data services for investment managers and investment advisors globally. In September 2005, the Company divested its Corporate Value Consulting (CVC) business, which was formerly part of the Financial Services segment (see Note 4). During the first nine months of 2005, the Company acquired Vista Research and an additional 49.07% investment in CRISIL Limited. The assets of these acquisitions total approximately $115 million. These acquisitions are included as part of the Financial Services segment. The assets of these acquisitions are not considered material to the Company. The Information and Media Services (IMS) segment includes business and professional media offering information, insight and analysis. Included in the results of the IMS segment are the results of J.D. Power and Associates which was acquired on April 1, 2005 (see Note 4). The assets acquired in this acquisition

9

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

totaled approximately $520 million. J.D. Power and Associates assets are not considered material to the Company.

In accordance with Emerging Issues Task Force Issue 00-10, “Accounting for Shipping and Handling Fees and Costs,” all amounts billed to customers in a sales transaction for shipping and handling are classified as revenue. All prior periods have been reclassified to comply with the classification guidelines of this issue.

Operating profit by segment is the primary basis for the chief operating decision maker of the Company, the Executive Committee, to evaluate the performance of each segment. A summary of operating results by segment for the three and nine months ended September 30, 2005 and 2004 follows:

	2005					2004
(in thousands)			Operating					Operating
Three Months	Revenue		Profit			Revenue		Profit
McGraw-Hill Education	$	1,142,331	$	380,847		$	1,032,318	$	323,255
Financial Services		605,751		251,945			502,799		202,022
Information and Media Services		228,959		12,437			187,759		23,808
Total operating segments		1,977,041		645,229			1,722,876		549,085
General corporate expense		—		(35,274	)		—		(32,169	)
Interest expense		—		(2,808	)		—		(1,867	)
Total Company	$	1,977,041	$	607,147	*	$	1,722,876	$	515,049	*

*   Income from continuing operations before taxes on income.

	2005					2004
(in thousands)			Operating					Operating
Nine Months	Revenue		Profit			Revenue		Profit
McGraw-Hill Education	$	2,078,278	$	373,764		$	1,866,193	$	311,514
Financial Services		1,750,398		732,743			1,463,906		590,066
Information and Media Services		633,648		30,791			558,606		62,300
Total operating segments		4,462,324		1,137,298			3,888,705		963,880
General corporate expense		—		(87,696	)		—		(90,856	)
Interest expense		—		(7,018	)		—		(5,765	)
Total Company	$	4,462,324	$	1,042,584	*	$	3,888,705	$	867,259	*

*   Income from continuing operations before taxes on income.

4.	Acquisitions and Dispositions
	Acquisitions:During the first nine months of 2005, the Company paid approximately $455.0 million for several acquisitions principally Vista Research, Inc. and J.D. Power and Associates and an additional 49.07% investment in CRISIL Limited. The excess of the purchase price over the net assets acquired for these acquisitions was preliminarily allocated to goodwill and other intangibles in the amount of $244.1 million and $288.8 million, respectively. These acquisitions are discussed in further detail below.
	On June 1, 2005, the Company became the majority shareholder of CRISIL Limited (CRISIL), a leading provider of credit ratings, financial news and risk and policy advisory services in India.

10

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

During the Company’s recent tender offer, it received valid acceptances for 3,120,948 shares, representing 49.07% of CRISIL. When combined with its existing interest, the Company now owns 3,720,948 shares, or 58.5% of CRISIL. CRISIL’s operations will be integrated with the Financial Services segment and will allow the Company to leverage opportunities in India. CRISIL is now part of the Financial Services segment.

On April 1, 2005, the Company acquired Vista Research, Inc., a leading provider of primary research. Vista will enhance the growth prospects of the Financial Services segment’s research product suite by providing clients with access to professionals with direct experience in industries such as technology, media, telecommunications and healthcare.

Vista’s network of industry practitioners is able to offer investors fresh, field-level insights about issues and conditions affecting companies and sectors. Vista Research, Inc. is now part of the Financial Services segment.

On April 1, 2005, the Company acquired J.D. Power and Associates. J.D. Power and Associates, founded in 1968 by J.D. Power III, is a leading provider of marketing information services for the global automotive industry and has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy. Its customer satisfaction ratings and market research are recognized worldwide as benchmarks for quality and independence.

The acquisition enhances our growth prospects for our core business information platform by providing a new direct link to consumers, while also providing new collaborative opportunities with our leading franchises includingBusinessWeek, Platts, McGraw-Hill Construction and Aviation Week. J.D. Power and Associates is now part of the Information and Media Services (IMS) segment.

Dispositions:On September 30, 2005, the Company sold its Corporate Value Consulting (CVC) business, the valuation services unit of the Financial Services segment. This business was selected for divestiture as it no longer fit within the Company’s strategic plans. The divestiture of CVC will enable the Financial Services segment to focus on its core business of providing independent research, ratings, data indices and portfolio services. The Company recognized a pre-tax gain of $6.8 million ($4.2 million after-tax, or 1 cent per diluted share).

In January 2004, the Company sold the juvenile retail publishing business, which was part of the McGraw-Hill Education segment’s School Education Group. The juvenile retail publishing business produced consumer-oriented learning products for sale through educational dealers, mass merchandisers, bookstores and e-commerce. This business was selected for divestiture as it no longer fit within the Company’s strategic plans. The market was considered to have limited future growth potential, unique sales channels and low profit margins and would have required significant investment to achieve the limited growth potential.

As of December 31, 2003, in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviewed the carrying value of the juvenile retail publishing business’s net assets and adjusted the net assets to their fair market value less cost to sell. Accordingly, the Company recognized impairments to the carrying value of these net assets of approximately $75.9 million ($54.1 million after-tax, or 28

11

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

	cents per diluted share) in 2003. Approximately $70.1 million of that charge was a write-off of goodwill and intangibles.
	As a result of the Company’s disposition of the juvenile retail publishing business, the results of these businesses are reflected as discontinued operations for all periods presented. For the nine months ended September 30, 2004, the juvenile retail publishing business generated revenue of approximately $3.9 million and had an immaterial impact on operating profit.
5.	Allowances, Inventories and Accumulated Amortization of Prepublication Costs
	The allowances for doubtful accounts and sales returns, the components of inventory and the accumulated amortization of prepublication costs were as follows:

	Sept. 30,		Dec. 31,		Sept. 30,
(in thousands)	2005		2004		2004
Allowance for doubtful accounts	$	76,299	$	80,570	$	85,001
Allowance for sales returns	$	202,216	$	178,128	$	201,846
Inventories:
Finished goods	$	337,198	$	292,693	$	312,841
Work-in-process		15,822		15,255		7,792
Paper and other materials		16,208		19,833		20,134
Total inventories	$	369,228	$	327,781	$	340,767
Accumulated amortization of prepublication costs	$	960,014	$	1,074,645	$	1,040,433

6.	Debt
	A summary of long-term debt follows:

	Sept. 30,		Dec. 31,		Sept. 30,
(in thousands)	2005		2004		2004
Total long-term debt	$	345	$	513	$	375

There were no commercial paper borrowings as of September 30, 2005 and 2004.

The Company has a five-year revolving credit facility agreement of $1.2 billion that expires on July 20, 2009. The Company pays a facility fee of seven basis points on the credit facility agreement whether or not amounts have been borrowed, and borrowings may be made at a spread of 13 basis points above the prevailing LIBOR rates. This spread increases to 18 basis points for borrowings exceeding 50% of the total capacity available under the facility.

On July 5, 2005, the Company amended its credit facility to implement a materiality threshold for determining whether the effects of acquisitions and dispositions are included in the financial calculations for covenant reporting. The amended facility contains certain covenants

12

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

	and the only financial covenant requires that the Company not exceed indebtedness to cash flow ratio, as defined of 4 to 1 at any time. This restriction has never been exceeded. There were no borrowings under the amended facility as of September 30, 2005 and 2004.
7.	Capital Structure
	On April 27, 2005, the Company’s Board of Directors approved a two-for-one stock split of the Company’s common stock to be effected in the form of a 100 percent stock dividend to shareholders of record as of May 6, 2005. On May 17, 2005, the Company’s shareholders received one additional share for each share in their possession on the date of record. This did not change the proportionate interest a shareholder maintains in the Company.
	The number of common shares reserved for issuance for employee stock plan awards and under the Director Deferred Stock Ownership Plan, were as follows:

	Sept. 30,		Dec. 31,		Sept. 30,
(in thousands)	2005		2004		2004
Stock based awards		62,601		64,396		65,356
The number of common shares issued upon exercise of stock based awards were as follows:
(in thousands)
Stock based awards exercised		6,170		10,176		6,404

8.	Cash Dividends
	Cash dividends per share have been restated to reflect the two-for-one stock split announced April 27, 2005 and effective May 17, 2005 to shareholders of record on May 6, 2005.
	Cash dividends per share declared during the three and nine months ended September 30, 2005 and 2004 were as follows:

	Three Months				Nine Months
	2005		2004		2005		2004
Common stock	$	0.165	$	0.150	$	0.495	$	0.450

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The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

9.	Common Shares Outstanding
	A reconciliation of the number of shares used for calculating basic earnings per common share and diluted earnings per common share for the three and nine months ended September 30, 2005 and 2004 follows:

	Three Months				Nine Months
(in thousands)	2005		2004		2005		2004
Average number of common shares outstanding		373,552		378,760		375,318		379,788
Effect of stock options and other diluted securities		7,611		5,352		7,297		5,734
Average number of common shares outstanding including effect of dilutive securities		381,163		384,112		382,615		385,522

	Restricted performance shares outstanding at September 30, 2005 and 2004 of 1,444,000 and 1,528,000 were not included in the computation of diluted earnings per common share because the necessary vesting conditions have not yet been met.
10.	Retirement Plans and Postretirement Healthcare and Other Benefits
	A summary of net periodic benefit cost for the Company’s defined benefit plans and postretirement healthcare and other benefits for the three and nine months ended September 30, 2005 and 2004 is as follows:

(in thousands)	Three Months						Nine Months
Defined Benefit Plans	2005			2004			2005			2004
Service cost	$	12,222		$	10,365		$	36,667		$	31,796
Interest cost		15,010			13,817			45,029			41,132
Expected return on plan assets		(22,167	)		(24,346	)		(66,502	)		(73,409	)
Amortization of prior service cost		83			117			250			281
Recognized net actuarial loss		1,422			131			4,265			391
Net periodic benefit cost	$	6,570		$	84		$	19,709		$	191

(in thousands)	Three Months						Nine Months
Postretirement Healthcare and Other Benefits	2005			2004			2005			2004
Service cost	$	541		$	641		$	1,491		$	1,786
Interest cost		1,787			1,951			6,435			7,467
Amortization of prior service cost		(350	)		(594	)		(882	)		(1,781	)
Net periodic benefit cost	$	1,978		$	1,998		$	7,044		$	7,472

Effective January 1, 2005 the Company changed its expected rate of return on plan assets to 8.0% from 8.75% for its U.S. retirement plans. The expected rate of return on plan assets is based on a market-related value of assets, which recognizes changes in market value over five years. Additionally, effective January 1, 2005, the Company changed its

14

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

	discount rate assumptions on its U.S. retirement plans to 5.75% from 6.25% in 2004. The effect of these changes on pension expense for the three and nine months ended September 30, 2005 was an increase in expense of $3.8 million pretax and $11.3 million pretax, respectively. On a post-split basis, the per share impact for the quarter was approximately a half cent per diluted share, and for the nine months ended September 30, 2005, the increase in expense was approximately two cents per diluted share. There has been no significant change in the Company’s required contributions to the above plans from what was disclosed in the Company’s 2004 consolidated financial statements.
11.	Sale Leaseback Transaction
	In December 2003, the Company sold its 45% equity investment in Rock-McGraw, Inc. Rock-McGraw, Inc. owns the Company’s headquarters building in New York City. The transaction was valued at $450.0 million, including assumed debt. Proceeds from the disposition were $382.1 million. The sale resulted in a pre-tax gain of $131.3 million and an after-tax benefit of $58.4 million, or 15 cents per diluted share (post-split) in 2003.
	The Company remains an anchor tenant of what continues to be known as The McGraw-Hill Companies building and will continue to lease space from Rock-McGraw, Inc., under an existing lease. As of December 31, 2004, the Company had a lease for approximately 17% of the building space for approximately 15 years, which is being accounted for as an operating lease. Pursuant to sale leaseback accounting rules, as a result of the Company’s continued involvement, a gain of approximately $212.3 million ($126.3 million after-tax) was deferred and will be amortized over the remaining lease term as a reduction in rent expense. Information relating to the sale-leaseback transaction for the three and nine months ended September 30, 2005 and 2004 is as follows:

	Three Months						Nine Months
(in millions)	2005			2004			2005			2004
Reduction in rent expense	$	(4.2	)	$	(4.3	)	$	(12.6	)	$	(12.9	)
Interest expense		2.3			2.5			7.0			7.3

12.	Income Taxes
	In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon the facts and circumstances known. The Company’s effective tax rate is based on expected income, statutory tax rates and permanent differences between financial statement and tax return income applicable to the Company in the various jurisdictions in which the Company operates.
	Significant judgment is required in determining the Company’s effective tax rate and in evaluating the Company’s tax position. The Company establishes reserves when, despite its belief that the tax return positions are meritorious, it believes that it is probable that certain positions may be challenged and if challenged, may have to be compromised or could result in assessments. Based on an evaluation of the Company’s tax positions, the Company believes that it is appropriately accrued under SFAS No. 5, “Accounting for Contingencies” for all probable and estimable expenses. All periods presented utilized these same basic assumptions. The Company adjusts these reserves in light of changing facts and circumstances. The effective tax rate includes the impact of reserve provisions and changes to reserves that the Company considers appropriate.

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The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

	The effective tax rate for the first nine months of 2005 of approximately 37.2% is a weighted blend of the rates for the first, second and third quarters of 2005; 37.0%, 37.2% and 37.2% respectively. The Company has completed various federal, state and local, and foreign tax audit cycles and, in the first quarter of 2004, accordingly removed approximately $20.0 million from its accrued income tax liability accounts. This non-cash item resulted in a reduction to the overall effective tax rate for continuing operations for the first nine months of 2004 from 37.0% to 34.7%. The Company remains subject to federal audits for 2002 and subsequent years, and to state and local and foreign tax audits for a variety of open years dependent upon the jurisdiction in question.
13.	Commitments and Contingencies
	A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Registrant) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Registrant believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.
14.	Recently Issued Accounting Standards
	On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (Statement 123(R)), which replaces Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123(R) requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value and recognize the cost in the financial statements beginning with the first interim or annual reporting period that begins after June 15, 2005. The pro forma disclosures previously permitted under Statement 123 will no longer be an alternative to financial statement recognition. This statement applies to all awards granted after the date of adoption and to awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying Statement 123(R), if any, is recognized as of the date of adoption.
	On April 14, 2005, the Securities and Exchange Commission announced that it would provide for a phased-in implementation process for FASB Statement No. 123(R), “Share-Based Payment”. The SEC now requires that registrants adopt Statement 123(R)’s fair value method of accounting for share-based payments to employees no later than the beginning of the

16

The McGraw-Hill Companies, Inc.

Notes to Consolidated Financial Statements

first fiscal year beginning after June 15, 2005. The Company is required to adopt Statement 123(R) beginning January 1, 2006.

The Company is required to apply Statement 123(R) using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the date of adoption for the portion of outstanding awards, for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for pro forma disclosures. For periods before the date of adoption, the Company may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by Statement 123. The Company has elected to implement Statement 123(R) prospectively and is currently evaluating the impact of the statement.

On December 21, 2004, the FASB issued FASB Staff Position (FSP) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (FSP 109-2). FSP 109-2 provides guidance under FASB Statement No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the Jobs Act) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB Statement No. 109. The Company is considering the repatriation of foreign earnings in the fourth quarter. This repatriation of funds is presently estimated to be between $200 million and $230 million. The Company expects that the incremental income tax on the repatriation will be approximately $10 million and dilute earnings per share by approximately $0.03 in the fourth quarter of 2005. As the Company has not yet fully completed evaluating the impact of the repatriation provisions, as provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability.

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\

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations — Comparing Three Months Ended September 30, 2005 and 2004

Consolidated Review

The Segment Review that follows is incorporated herein by reference.

Revenue and Operating Profit

	Third					Third
	Quarter			%		Quarter
(millions of dollars)	2005			Increase		2004
Revenue	$	1,977.0			14.8	$	1,722.9
Operating profit*		645.2	(a)		17.5		549.1
% Operating margin		32.6					31.9

*	Operating profit is income from continuing operations before taxes on income, interest expense and corporate expense.
(a)	Includes a $6.8 million pre-tax gain on the sale of Corporate Value Consulting

In the third quarter of 2005, the Company achieved growth in revenue and operating profit of 14.8% and 17.5%, respectively. The increase in revenue is primarily attributable to growth in the McGraw-Hill Education and Financial Services segments, which contributed $110.0 million and $103.0 million to the growth in revenue, respectively. The acquisition of J.D. Power and Associates also contributed $51 million to revenue growth. The quarter reflects the seasonal nature of the Company’s educational publishing operations, with the third quarter being the most significant. Foreign exchange rates contributed $3.5 million to revenue and negatively impacted income from continuing operations by $2.7 million during the third quarter.

On September 30, 2005, the Company sold its Corporate Value Consulting (CVC) business, the valuation services unit of the Financial Services Segment. The sale resulted in a $6.8 million pre-tax gain, 1 cent per diluted share. The divestiture of CVC is consistent with the Financial Services segment’s strategy of directing resources to those businesses which have the best opportunities to achieve both significant financial growth and market leadership. The divestiture will enable the Financial Services segment to focus on its core business of providing independent research, ratings, data, indices and portfolio services.

During 2005 and the last half of 2004 the Company made several acquisitions to add new capabilities. These acquisitions which are discussed in further detail in Footnote 4 of the Consolidated Financial Statements are as follows:

• CRISIL Limited: The Company acquired a majority ownership of CRISIL Limited (CRISIL), a leading provider of credit ratings, financial news and risk and policy advisory services in India on June 1, 2005. CRISIL is now part of the Financial Services segment.

• Vista Research, Inc: The Company acquired Vista Research, Inc., a leading provider of primary research on April 1, 2005. Vista Research, Inc. is now part of the Financial Services segment.

• J.D. Power and Associates (JDPA): The Company acquired JDPA, a leading provider of marketing information services for the global automotive industry that has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy on April 1, 2005. JDPA is now part of the Information and Media Services segment.

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• Capital IQ: The Company acquired Capital IQ, a leading provider of high-impact information solutions to the global investment and financial services communities on September 17, 2004. Capital IQ is now a unit of the Financial Services segment.

• The Grow Network:The Company acquired The Grow Network, a leading provider of assessment reporting and customized content for states and large school districts across the country on July 16, 2004. The Grow Network is now part of the School Education Group.

During the third quarter of 2005, these acquisitions diluted earnings per share by one cent. The Company expects that these acquisitions will negatively affect diluted earnings per share in 2005 by $0.06 to $0.07 per share.

In 2005, the Company paid approximately $455 million for several acquisitions primarily, Vista Research, Inc., JDPA and a 49.07% additional investment in CRISIL Limited.

Product revenue increased 10.4% in the third quarter of 2005, due primarily to an increase in revenue in the School Education Group (SEG) as the Group benefited from the success of elementary and secondary products in the state adoption market. The quarter also reflects the seasonal nature of the Company’s educational publishing operations, with the third quarter being the most significant. Product operating margins increased 2.1 percentage points to 34.1% primarily due to product mix in SEG. Total product expenses increased only 7.1% on a 10.4% increase in revenue. Product operating related expenses, which include amortization of prepublication costs, increased only 5.8%. Amortization of prepublication costs decreased by $13.8 million or 12.2%, as compared with the third quarter of 2004, as a result of product mix and adoption cycles. Product related selling and general expenses increased only 8.9%, primarily due to increased selling and marketing costs associated with the School Education Group for major adoption opportunities in 2005 and 2006.

Service revenue increased 21.6% in the third quarter of 2005, due primarily to a 20.5% increase in revenue in the Financial Services segment and the acquisition of JDPA which contributed $51.0 million of revenue. Financial Services increased primarily due to the performance of structured finance ratings, corporate finance (corporate finance and financial services) ratings, and acquisitions which contributed 29.2%, 17.6% and 28.1% to the growth respectively. Strong growth in structured finance reflects continued favorable global market conditions, including a low interest rate environment. Corporate finance ratings growth is attributable to increases in revenue from customers on annual fee arrangements, recurring fees for surveillance activities and transaction revenue from improving high-yield issuance and in financial services, primarily in the insurance sector. Service operating margins decreased slightly to 30.2% due to the acquisition of JDPA. Total service related expenses increased 23.9% on revenue growth of 21.6%. Financial Services segment expenses increased only 20.0% on a revenue increase of 20.5%. JPDA contributed 43.8% to the growth in service related expenses.

Total expenses in the third quarter of 2005 increased 13.9%. A significant portion of both operating related and selling and general expense is compensation expense, which increased approximately 20.0% in 2005, primarily as a result of an increase in the employee base. The employee base increased approximately 7.3%. Increases were primarily due to acquisitions and the timing of new hires, which occurred in the first half of 2005. Increases in the employee base were required in SEG’s editorial, production and sales

19

groups to develop and market new products for increased opportunities in the K-6 and secondary markets in 2005 and beyond. Also contributing to the increase in compensation expense is the increase in pension expense from the Company’s U.S. retirement plans. Effective January 1, 2005, the Company changed its U.S. retirement plans’ discount rate assumption to 5.75% from 6.25% in 2004. Additionally, effective January 1, 2005, the Company changed its expected rate of return on plan assets to 8.0% from 8.75%. The effect of these changes resulted in an increase in pension expense for the quarter ended September 30, 2005 of $3.8 million pre-tax, or approximately a half a cent per diluted share on a post-split basis.

In the third quarter of 2005, depreciation expense increased 18.5% to $26.3 million as a result of acquisitions and increased depreciation of technology related equipment. Amortization of intangibles increased 35.6% to $12.4 million in the third quarter of 2005 due to acquisitions.

Other income for the third quarter of 2005 includes a $6.8 million pre-tax gain from the disposition of CVC.

Interest expense increased to $2.8 million in the third quarter of 2005. The primary reason is due to an increase in average commercial paper borrowings to $155.9 million. There was no commercial paper outstanding for the three months ended September 30, 2004. The average interest rate on commercial paper borrowings for the three months ended September 30, 2005 was 3.3%. This increase was partially offset by an increase in interest income attributed to higher average invested cash levels in the Company’s European operations. For the third quarter, European investments were $203.9 million at an average rate of 3.0% in 2005 compared to $104.6 million at a comparable rate in 2004. Included in the third quarter of 2005 and 2004 is approximately $2.3 million and $2.5 million, respectively, of interest expense related to the sale leaseback of the Company’s headquarters building in New York City (See Note 11).

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.

For the quarter ended September 30, 2005 the effective tax rate was 37.2% compared to 37.0% in the prior period. This minor increase is due to changes in foreign tax laws. The Company expects the effective tax rate to remain at 37.2% for the remainder of the year; however, this is subject to the impact of numerous factors including the absence of intervening audit settlements, changes in federal, state or foreign law, changes in the locational mix of the Company’s income and the repatriation of funds (Note 14).

20

Net income for the quarter increased 17.5% over the comparable quarter in the prior year. Diluted earnings per share on net income were $1.00 versus $0.85 on a post-split basis in the prior year. All prior year earnings per share have been adjusted to reflect the two-for-one stock split effective to shareholders of record on May 6, 2005.

Segment Review

McGraw-Hill Education

	Third				Third
	Quarter		%		Quarter
(millions of dollars )	2005		Increase		2004
Revenue
School Education Group	$	685.0		18.9	$	576.1
Higher Education, Professional and International		457.3		0.2		456.2
Total revenue		1,142.3		10.7		1,032.3
Operating profit	$	380.8		17.8	$	323.3
% Operating margin		33.3				31.3

Revenue for the McGraw-Hill Education segment increased 10.7%, while operating profit increased 17.8% over the prior year. The quarter reflects the seasonal nature of the Company’s educational publishing operations, with the first quarter being the least significant, and the third quarter being the most significant. Foreign exchange rates benefited revenue by $3.7 million and had a slightly negative impact on operating profit. Operating margin improved over the prior year primarily as a result of product mix.

On July 16, 2004, the Company acquired The Grow Network, a privately held company. The Grow Network is a leading provider of assessment reporting and customized content for states and large school districts across the country. The acquisition supports McGraw-Hill Education’s strategy to provide a full range of customized education solutions to help improve teaching and learning. On August 1, 2005, the Company acquired TurnLeaf Solutions Inc. TurnLeaf Solutions Inc. is a national provider of customized online reporting and data analysis. TurnLeaf helps administrators and teachers track progress toward school districts’ Adequate Yearly Progress goals, a key provision in the No Child Left Behind law. TurnLeaf Solutions Inc. is now part of the School Education Group and will become part of The Grow Network.

The McGraw-Hill School Education Group’s revenue increased 18.9% in the third quarter of 2005, benefiting from the success of elementary and secondary school products in the state adoption market. The 2005 state new adoption market is favorable not only because of its size but also because the schedule affords opportunities in a range of subject areas, allowing SEG to leverage the breadth and depth of its product offerings. The state new adoption market for 2005 is projected to increase to between $900 million and $950 million. Social studies represents the year’s largest subject-area market, and strong performances in Florida and Alabama have positioned SEG to lead the high-volume secondary portion of that market. SEG has also performed well in health in Texas, Indiana and California, where the Los Angeles Unified School District (LAUSD) chose McGraw-Hill programs for use at both the elementary and middle school grades. The LAUSD also adopted the Group’s reading intervention program,Kaleidoscope, in 2005. The Group captured a large share of science in Indiana and also in North Carolina, where the state’s largest district, Charlotte-Mecklenburg, selected the McGraw-Hill elementary program.

The Group captured leading shares in the fine arts (art/music) and health adoptions in Texas when school districts made their selections earlier in the

21

year. Although the state legislature adjourned without appropriating funds for Proclamation 2002 purchasing, in mid-August the governor authorized the Texas Education Agency (TEA) to open its ordering system and allow the districts to place their orders. The governor instructed the TEA to transfer $294.5 million from other existing appropriations to fund Proclamation 2002 textbooks with the understanding that the state will provide the necessary funding through budget execution. Proclamation 2002 covers world languages as well as health and fine arts.

Although TEA guidelines limited the number of health and fine arts textbooks that schools can buy with state funds, the Group’s success in these subjects is expected to produce excellent revenue results. The Group recognized $37.5 million in revenue related to Proclamation 2002 during the quarter. Because of the funding delay, some revenue related to orders shipped in the third quarter will be recognized in the fourth quarter, and many additional Proclamation 2002 orders will be fulfilled before the end of the year. The Company continues to monitor the situation regarding the Texas textbook funding for fine arts (music/art), world languages, and health (Proclamation 2002). The group also benefited in the third quarter from sales of vocational and technical products that were adopted in 2004 under Proclamation 2001 but were not funded for purchase until this year.

As a result of recent hurricanes in the Gulf States, Mississippi has postponed its 2006 language arts and health adoption, and Louisiana is expected to delay its 2006 social studies adoption. In addition, Mississippi has invoked a partial termination of the statewide testing contract during the 2005-2006 school year. Although purchasing by Alabama, Mississippi, and Louisiana represented approximately $84 million or 9% of the total state new adoption market in 2005, the Group’s sales of state-adopted materials were not affected as product had been shipped to the region prior to the hurricanes. The full impact of the hurricanes cannot be estimated at this time. However, we anticipate that any 2006 shortfalls resulting from the postponed adoptions will be partially offset by sales of replacement inventories in the Gulf States and of additional materials for students who have relocated to other states.

In open territories, major adoptions announced to date includeEveryday Mathematicsin Washington, DC, Hartford, CT, and El Paso, TX;Open Court Readingin Baltimore; and Direct Instruction in Minneapolis and St. Louis.

Compared to 2004, reading and math opportunities were lower in 2005 due to the state adoption cycle. The Group’s alternative basal program,Open Court Reading,and reading intervention program,Kaleidoscope, both performed well, but they did not entirely offset the decline in Direct Instruction and certain aging supplemental products. In the third quarter of 2004,Everyday Mathematics, a reform-based elementary program, contributed positively to open territory results by winning major sales in New York City, negatively affecting comparisons in 2005.

According to the Association of American Publishers’ year-to-date statistics through August 2005, net adoption and open territory sales of basal and supplementary materials for grades K-12, excluding testing, increased by 6.6% for all publishers surveyed.

Custom contract testing grew in the third quarter, contributing to the segment’s revenue growth. Higher custom contract revenue was driven by the Arizona, Florida, Massachusetts, and New York programs. Expenses related to the increased scoring costs of certain contracts in 2004 did not recur in 2005. SEG continues to invest in technology to improve its efficiency and the effectiveness of custom contract delivery. Sales of “shelf” or norm-referenced tests were lower than prior year due to an ongoing shift, driven by

22

the No Child Left Behind law, to state-specific custom assessments, which have lower margins. Assessment reporting and the expansion of the Group’s personalized study guide business also contributed favorably to results.

McGraw-Hill Higher Education, Professional and International Group’s (HPI) revenue was flat compared to prior year. Higher education products performed well in both the domestic and international markets on a gross sales basis, but all three major product categories experienced higher return rates than in 2004. The three major categories: Science, Engineering, and Mathematics (SEM); Business and Economics; and Humanities, Social Science, and Languages benefited from the success of new and revised titles in 2005. SEM also benefited from strong sales in Applied Biology and Allied Health. Key titles contributing to the third-quarter performance include:

• Silberberg,Chemistry, 4/e

• McConnell and Brue,Economics, 16/e; and

• Knorr,Puntos de Partida,7/e

The U.S. college new textbook market is expected to grow 5% to 6% this year, the Company anticipates that its college product sales will match the industry.

In the professional Science, Technical, and Medical (STM) marketplace, the release ofHarrison’s Principles of Internal Medicine, 16/e, in the third quarter of 2004 and a strong response to a backlist promotion in 2004 negatively affected year-over-year comparisons. However, the introduction ofPearls of Wisdom, a 35-title series of study guides for medical board exams, contributed favorably to 2005 results. Internationally, third-quarter STM sales benefited from the release ofHarrison’s Principles of Internal Medicine, 16/e, in Spanish and Portuguese translations. Trade products experienced strong growth, and several titles reached best-seller status, includingWooden on Leadership; The Millionaire Real Estate Investor; The Millionaire Real Estate Agent; andCrucial Conversations: Tools for Talking When Stakes Are High.Softness continued in the professional technology sector. Overall, international sales improved over last year’s results for the same period due to a strong mix of new products for the educational, professional, and trade markets.

Financial Services

	Third					Third
	Quarter			%		Quarter
(millions of dollars)	2005			Increase		2004
Revenue	$	605.8			20.5	$	502.8
Operating profit		251.9	(a)		24.7		202.0
% Operating margin		41.6					40.2

(a) Includes a $6.8 million pre-tax gain on the sale of Corporate Value Consulting

Financial Services revenue and operating profit dramatically increased over 2004 third quarter results. Foreign exchange rates had no material effect on revenue and had a negative impact on operating profit of $2.6 million.

On September 30, 2005, the Company sold its Corporate Value Consulting (CVC) business, the valuation services unit of the Financial Services segment. The sale resulted in a $6.8 million pre-tax gain. This disposition did not materially impact the segment results for the quarter-ended September 30, 2005.

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The Financial Services segment’s increase in revenue and operating profit is due to the performance of structured finance ratings and corporate finance (corporate finance and financial services) ratings, which represented approximately 29.2% and 17.6% of the growth in revenue, respectively. Growth was experienced in all asset classes within structured finance. The continuing favorable interest rate environment led to strong growth in the issuance of U.S. residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDOs). The growth in corporate finance ratings is attributable to increases in revenue from customers on annual fee arrangements, recurring fees for surveillance activities and transaction revenue from improving high yield issuance and financial services, primarily in the insurance sector.

Over the past twelve months, the Financial Services segment made several acquisitions primarily, Vista Research, Capital IQ and a majority interest in CRISIL Limited. These acquisitions represented approximately 28.1% of the growth in revenue, and had no material impact on operating profit for the quarter. These acquisitions are discussed in further detail in the Consolidated Review and Footnote 4 of the Consolidated Financial Statements for the period ended September 30, 2005.

Total U.S. structured finance new issue dollar volume increased 35.7%; with solid growth experienced across all asset classes. U.S. CDO issuance increased 120.6% according to Harrison Scott Publications. The U.S. CDO market was driven by favorable spreads, stable credit quality and continuing demand by investors seeking higher yields. U.S. CMBS issuance increased 96.9% over the prior year primarily due to the favorable interest rate environment, which spurred a record level of originations. U.S. RMBS issuance increased 27.0% according to Harrison Scott Publications. Issuance in this asset class continues to benefit from the low interest rate environment, continuing appreciation in home prices, as well as a shift from agency to private origination associated with the prevalence of affordability products such as hybrid ARMs, negative amortization loans, interest only mortgages and silent seconds. Although U.S. RMBS issuance volumes have been strong overall, the number of issues increased only moderately leading to issue sizes that are substantially larger than last year. Asset-backed issuance was up benefiting from growth in credit card, commercial revolving credit and aircraft leasing deals. According to Securities Data, U.S. new issue dollar volume for corporates for the third quarter of 2005 decreased 12.2% with high yield dollar volume issuance declining 3.7%. Corporations continue to generate strong cash flows and maintain high cash balances and excess production capacity. The high level of refinancing activity, which took place in 2004, has also lessened the need for new debt financing in 2005. Public finance issuance increased due to accelerated refundings by municipalities as they took advantage of a flattening yield curve. In Europe, issuance levels declined in the quarter driven by a decrease in corporates, primarily financial services. Issuance in financial services was down in Europe during the third quarter as pre-funding occurred in the first half of the year in part due to the expiration of the Pfandbrief in Germany and the introduction of new filing regulations. European CDO issuance also decreased largely due to the effect of the Ford and General Motors downgrades on the synthetic CDO market, followed by the tightening of spreads, which reduces arbitraging opportunities. Declines in RMBS issuance in Europe were partially offset by strong issuance in CMBS.

Revenue related to Standard & Poor’s indices increased as assets under management for Exchange-Traded Funds rose 28.9% from September 30, 2004 to $119.1 billion as of September 30, 2005. Assets under management at December 31, 2004 were $113.7 billion.

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The financial services industry is subject to the potential for increasing regulation in the United States and abroad. The businesses conducted by the Financial Services segment are in certain cases regulated under the U.S. Investment Advisers Act of 1940, the U.S. Securities Exchange Act of 1934, the National Association of Securities Dealers and/or the laws of the states or other jurisdictions in which they conduct business.

Standard & Poor’s Ratings Services is a credit rating agency that has been designated as one of five Nationally Recognized Statistical Rating Organizations, or NRSROs, by the SEC. The SEC first began designating NRSROs in 1975, for use of their credit ratings, in the determination of capital charges for registered brokers and dealers under the SEC’s Net Capital Rule. During the last three years, the SEC has been examining the purpose of and the need for greater regulation of NRSROs. In January 2003, the SEC issued a report on the role and function of credit rating agencies in the operation of the securities markets. The report addressed issues that the SEC was required to examine under the Sarbanes-Oxley Act of 2002, as well as other issues arising from the SEC’s own review of credit rating agencies. In June 2003, the SEC solicited comments on a concept release that questioned: (1) whether the SEC should continue to designate NRSROs for regulatory purposes and, if so, what the criteria for designation should be; and (2) the level of oversight that the SEC should apply to NRSROs. In February 2005, Standard & Poor’s and other NRSROs’ representatives testified before the Senate Committee on Banking, Housing and Urban Affairs at a hearing to examine the role of credit rating agencies. In March 2005, SEC Chairman Donaldson also testified before the Senate Committee on Banking, Housing and Urban Affairs. He raised an issue about the SEC’s current authority to oversee NRSROs and referred to a voluntary framework for oversight that the NRSROs have been discussing with the SEC staff. The Chairman noted that the question of whether to impose a regulatory regime raises important issues that need to be examined, including the First Amendment. The legal status of rating agencies has also been addressed by courts in the United States in various decisions and is likely to be considered and addressed in legal proceedings from time to time in the future.

In March 2005, the SEC voted to issue a rule proposal to define NRSROs. The SEC issued its proposed rule for public comment on April 19^th. Standard & Poor’s submitted its comments on June 9^th, largely supporting a more formal designation process and clear criteria, but without involving the SEC in the substance of the ratings process or in second-guessing rating opinions. In April 2005, Annette Nazareth, then Director of the SEC’s Division of Market Regulation, testified before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the House Financial Services Committee on the SEC’s proposed rule and on the oversight framework. She also raised questions on the SEC’s authority over NRSROs. Following this hearing, Rep. Kanjorski asked the SEC to provide technical assistance on the specific authority the SEC would need to effectively oversee rating agencies. In June 2005, the SEC submitted an outline to Rep. Kanjorski of key issues to be addressed if Congress proceeds with legislation (Legislative Framework). Also in June 2005, Standard & Poor’s testified before the same House Subcommittee on H.R.2990, the “Credit Rating Agency Duopoly Relief Act”. This bill, proposed by Rep. Fitzpatrick on June 20^th, would set up a mandatory licensing regime with the SEC for credit rating agencies. Standard & Poor’s objected to the bill for legal and policy reasons. In August 2005, Standard & Poor’s submitted comments on the Legislative Framework to Rep. Kanjorski at his request.

Outside the United States, the European Parliament has adopted resolutions requiring the European Commission to analyze the desirability of registering credit rating agencies in Europe and the need for registration criteria. The European Commission, through the Committee of European Securities Regulators

25

(CESR), solicited comments on these issues from regulators and the public, including rating agencies, and in late March, CESR issued its final advice to the European Commission. CESR recommended that rating agencies should not be regulated but should implement and enforce internally a code of conduct and other policies to address key issues.

In addition, European Union member states are in the process of implementing the European Commission’s Market Abuse Directive which, depending on how the Directive is implemented, could affect rating agencies’ communications with issuers as part of the rating process. Local, national and multinational bodies have considered and adopted other legislation and regulations relating to credit rating agencies from time to time and are likely to continue to do so in the future.

The International Organization of Securities Commissions (IOSCO), a global group of securities commissioners, has also been reviewing the role of rating agencies and their processes. In September 2003, IOSCO published a set of principles relating to rating agencies’ processes and procedures. On December 23, 2004, it published its Code of Conduct Fundamentals for rating agencies that builds upon the 2003 principles. Standard & Poor’s worked closely with IOSCO in its drafting of both the principles and the code. In September 2004, Standard & Poor’s also published its own code of practices that is broadly consistent with IOSCO’s code and represents a compilation of existing policies and procedures around key aspects of the ratings process.

New legislation, regulations or judicial determinations applicable to credit rating agencies in the United States and abroad could affect the competitive position of Standard & Poor’s ratings; however, the Company does not believe that any new or currently proposed legislation, regulations or judicial determinations would have a materially adverse effect on its financial condition or results of operations.

The market for credit ratings as well as research, investment advisory and broker-dealer services is very competitive. The Financial Services segment competes domestically and internationally on the basis of a number of factors, including quality of ratings, research and investment advice, client service, reputation, price, geographic scope, range of products and technological innovation. In addition, in some of the countries in which Standard & Poor’s competes, governments may provide financial or other support to locally-based rating agencies and may from time to time establish official credit rating agencies, credit ratings criteria or procedures for evaluating local issuers.

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.

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Information and Media Services

	Third		%			Third
	Quarter		Increase/			Quarter
(millions of dollars)	2005		(Decrease)			2004
Revenue
Business-to-Business	$	201.4		25.3		$	160.8
Broadcasting		27.6		2.2			27.0
Total revenue		229.0		21.9			187.8
Operating profit	$	12.4		(47.8	)	$	23.8
% Operating margin		5.4					12.7

In the third quarter of 2005, revenue grew by 21.9% or $41.2 million over the prior year. Operating profit decreased 47.8%. J.D. Power and Associates (JDPA), which was acquired on April 1, 2005, contributed $51.0 million in revenue to the Business-to-Business Group and had no material impact on the segment’s operating profit. The Business-to-Business Group was negatively impacted by the continued soft advertising market. In Broadcasting, the improved ratings position of the ABC network and ballot issues in California helped offset the decline in political advertising from last year’s national elections. Foreign exchange rates had no significant impact on revenue and contributed $0.6 million to operating profit.

On April 1, 2005, the Company acquired JDPA, a privately held company. JDPA, founded in 1968 by J.D. Power III, is a leading provider of marketing information services for the global automotive industry and has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy. Its customer satisfaction ratings and market research are recognized worldwide as benchmarks for quality and independence.

The acquisition enhances the Company’s growth prospects for its core business information platform by providing a new direct link to consumers, while also providing new collaborative opportunities with the Company’s leading franchises includingBusinessWeek, Standard & Poor’s, Platts, McGraw-Hill Construction and Aviation Week.

Revenue increased at the Business-to-Business Group compared to prior year due primarily to the acquisition of JDPA. Revenue growth in JDPA was driven by its U.S. client services business primarily in homebuilders, telecommunications, utilities, and finance and insurance sectors. According to the Publishers Information Bureau (PIB),BusinessWeek’sadvertising pages in the North America edition for the third quarter were down 8.3%, with the same number of issues for PIB purposes. There was one less issue for revenue recognition purposes in the third quarter of 2005. The third quarter of 2004 included a special 75th Anniversary double issue ofBusinessWeek, which was the largest issue since 2000, with 252 total pages in the North American edition. Advertising pages were also down in the Europe and Asia editions in the third quarter of 2005. According to the PIB, advertising pages declined in the five book competitive set.BusinessWeek Online continues to perform well as advertising and unique visitors continue to increase.

Platts’ news and pricing products experienced growth as a result of the increased need for market information as the price of crude oil rose as a result of supply disruptions in the Gulf of Mexico caused by the recent hurricanes and the resulting increase in supply risk. Increased customer demand for news and pricing products added to the subscriber base. The

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resulting revenue is recognized over the life of the related product subscriptions. In the Aviation industry, the Farnborough Air Show occurred in the third quarter 2004, with no comparable event in 2005.

As of September 2005, total U.S. construction starts were up 8% versus prior year. Both residential building (up 13%) and non-building construction (up 8%) were higher than prior year, while U.S. nonresidential building was flat compared to the prior year. New McGraw-Hill Construction publications such asConstructormagazine andMy Housecontributed to growth. In the third quarter of 2005, the Business-to-Business Group continued to make investments in the McGraw-Hill Construction Network to strengthen its effectiveness and efficiency and increase customer satisfaction.

At the Broadcasting Group revenue in the third quarter increased 2.2% compared to prior year. The improved ratings position of the ABC network helped to offset the loss of political advertising in the third quarter of 2005. A strong political issue advertising market in California helped offset the loss of prior year political advertising in other markets. Local advertising remained strong. The service, automotive, leisure time and retailing categories of advertisers contributed to growth while the consumer products category was weak.

NINE MONTHS

Consolidated Review

The Segment Review that follows is incorporated herein by reference.

Revenue and Operating Profit

	Nine Months			%		Nine Months
(millions of dollars)	2005			Increase		2004
Revenue	$	4,462.3			14.8	$	3,888.7
Operating profit*		1,137.3	(a)		18.0		963.9
% Operating margin		25.5					24.8

*	Operating profit is income from continuing operations before taxes on income, interest expense and corporate expense.
(a)	Includes a $6.8 million pre-tax gain on the sale of Corporate Value Consulting

In the first nine months of 2005, the Company achieved growth in revenue and income from continuing operations. Revenue growth of 14.8% resulted in an 18.0% increase in operating profit. The increase in revenue is primarily attributable to growth in the Financial Services segment of $286.5 million and the McGraw-Hill Education segment of $212.1 million. The acquisition of J.D. Power and Associates also contributed $84.6 million to revenue growth. Foreign exchange rates contributed $16.7 million to revenue and $2.8 million to income from continuing operations.

On September 30, 2005, the Company sold its Corporate Value Consulting (CVC) business, the valuation services unit of the Financial Services Segment. The sale resulted in a $6.8 million pre-tax gain, 1 cent per diluted share. The divestiture of CVC is consistent with the Financial Services segment’s strategy of directing resources to those businesses which have the best opportunities to achieve both significant financial growth and market leadership. The divestiture will enable the Financial Services segment to focus on its core business of providing independent research, ratings, data, indices and portfolio services.

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During 2005 and the last half of 2004 the Company made several acquisitions to add new capabilities. These acquisitions which are discussed in further detail in Footnote 4 of the Consolidated Financial Statements are as follows:

• CRISIL Limited: The Company acquired a majority interest in CRISIL Limited (CRISIL), a leading provider of credit ratings, financial news and risk and policy advisory services in India on June 1, 2005. CRISIL is now part of the Financial Services segment.

• Vista Research, Inc: The Company acquired Vista Research, Inc., a leading provider of primary research on April 1, 2005. Vista Research, Inc. is now part of the Financial Services segment.

• J.D. Power and Associates (JDPA): The Company acquired JDPA, a leading provider of marketing information services for the global automotive industry that has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy on April 1, 2005. JDPA is now part of the Information and Media Services segment.

• Capital IQ: The Company acquired Capital IQ, a leading provider of high-impact information solutions to the global investment and financial services communities on September 17, 2004. Capital IQ is a unit of the Financial Services segment.

• The Grow Network:The Company acquired The Grow Network, a leading provider of assessment reporting and customized content for states and large school districts across the country on July 16, 2004. The Grow Network is now part of the School Education Group.

For the nine months ended September 30, 2005, these acquisitions diluted earnings per share by $0.05. The Company expects that these acquisitions will negatively affect diluted earnings per share in 2005 by $0.06 to $0.07 per share.

In 2005, the Company paid approximately $455 million for several acquisitions primarily, Vista Research, Inc., JDPA, and a 49.07% additional investment in CRISIL Limited.

Product revenue increased 11.0% in the first nine months of 2005, due to an increase in revenue in the School Education Group (SEG) as the Group benefited from the success of elementary and secondary products in the 2005 new state adoption market. Product operating margins increased 1.2 percentage points to 19.2%, primarily due to product mix in SEG. Product expenses increased only 9.3% on an 11.0% increase in revenue. Product operating related expenses, which include amortization of prepublication costs, increased only 10.1%. Amortization of prepublication costs decreased, by 17.6% over prior year as a result of product mix and adoption cycles. Product related selling and general expenses increased 8.3%, primarily due to an increase in selling and marketing costs associated with major adoption opportunities in 2005 and 2006 in the School Education Group.

Service revenue increased 18.4% in the first nine months of 2005, due primarily to an increase in revenue in the Financial Services segment of $286.5 million and the acquisition of JDPA which contributed $84.6 million of revenue. Financial Services revenue increased due to the strong performance of structured finance ratings and corporate finance ratings (corporate finance and financial services). Strong growth in structured finance reflects continued favorable global market conditions, including a low interest rate environment. Growth in corporate finance ratings is attributable primarily to

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revenues from recurring fees for surveillance activities and customers on annual fee arrangements. Service operating margins increased slightly to 31.8%. Total service related expenses increased 17.6% on revenue growth of 18.4%. The acquisition of JDPA negatively impacted operating margins as a result of increased acquisition costs. Financial Services segment expenses increased only 16.9% on a revenue increase of 19.6%.

Total expenses for the first nine months of 2005 increased 13.4%. A significant portion of both operating related and selling and general expense is compensation expense, which increased approximately 18.0% in 2005, primarily as a result of an increase in the employee base. The employee base increased approximately 7.3% year over year. Increases were primarily due to acquisitions and the timing of new hires, which occurred in the first half of 2005. Increases in employee base were required in SEG’s editorial, production, and sales groups to develop and market new products for increased adoption opportunities in 2005 and 2006. Also contributing to the increase in compensation expense is the increase in pension expense from the Company’s U.S. retirement plans. Effective January 1, 2005, the Company changed its U.S. retirement plans’ discount rate assumption to 5.75% from 6.25% in 2004. Additionally, effective January 1, 2005, the Company changed its expected rate of return on plan assets to 8.0% from 8.75%. The effect of these changes resulted in an increase in pension expense for the nine months ended September 30, 2005 of $11.3 million pre-tax, or approximately two cents per diluted share on a post-split basis.

In the first nine months of 2005, depreciation expense increased 14.5% to $77.1 million as a result of acquisitions and increased depreciation of technology related equipment. Amortization of intangibles increased 44.1% to $32.9 million as of September 30, 2005 due to acquisitions.

Other income includes a $6.8 million pre-tax gain from the disposition of CVC on September 30, 2005.

Interest expense increased to $7.0 million in the first nine months of 2005. The primary reason is an increase in average commercial paper borrowings to $172.8 million. Average commercial paper outstanding during the nine months ended September 30, 2004 was $4.7 million at a rate of 1.1%. The average interest rate on commercial paper borrowings for the nine months ended September 30, 2005 was 3.1%. This increase was partially offset by an increase in interest income due to higher interest rates on higher average cash levels in the Company’s European operations. For the first nine months of 2005, average domestic investments were $186.8 million at an average interest rate of 1.9%, compared to $403.0 million at an average rate of 1.0% in 2004. European investments averaged $197.1 million for the first nine months of 2005 at an average rate of 3.0%. Comparable figures for 2004 were average investments of $115.1 million at an average rate of 2.8%. Included in the nine months ended September 30, 2005 and 2004 is approximately $7.0 million and $7.3 million, respectively, of interest expense related to the sale leaseback of the Company’s headquarters building in New York City (See Note 11).

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and

30

negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.

In the first quarter of 2004, the Company completed various federal, state and local, and foreign tax audit cycles and accordingly removed approximately $20.0 million from its accrued income tax liability accounts. This non-cash item resulted in a reduction to the overall effective tax rate for continuing operations in the first nine months of 2004 from 37.0% to 34.7%. The effective tax rate for the first nine months of 2005 is 37.2%. The Company expects the effective tax rate to remain at 37.2% for the remainder of the year; however, this is subject to the impact of numerous factors including the absence of intervening audit settlements, changes in federal, state or foreign law, changes in the locational mix of the Company’s income and the repatriation of funds (Note 14). The Company remains subject to federal audits for 2002 and subsequent years, and to state and local and foreign tax audits for a variety of open years depending upon the jurisdiction in question.

The loss on discontinued operations relates to the disposition of Landoll, Frank Schaffer and the related juvenile retail publishing businesses (juvenile retail publishing business), which was disposed of during January 2004. The juvenile retail publishing business was part of the McGraw-Hill Education segment. The revenue impact for the first nine months of 2004 for the juvenile retail publishing business was $3.9 million. Loss from discontinued operations for the period ended September 30, 2004 was $0.6 million.

Net income for the first nine months of 2005 increased 15.8% over the comparable period in the prior year. Diluted earnings per share from continuing operations as well as from net income for the first nine months of 2005 were $1.71 versus $1.47 in the prior year. All prior year earnings per share have been adjusted to reflect the two-for-one stock split effective to shareholders of record on May 6, 2005. Included in 2004 is a $0.05 benefit from the reversal of $20.0 million in accrued tax liabilities following the completion of various federal, state and local, and foreign tax audit cycles in the first quarter of 2004.

Segment Review

McGraw-Hill Education

	Nine Months		%		Nine Months
(millions of dollars)	2005		Increase		2004
Revenue
School Education Group	$	1,247.5		17.5	$	1,061.8
Higher Education, Professional and International		830.8		3.3		804.4
Total revenue		2,078.3		11.4		1,866.2
Operating profit	$	373.8		20.0	$	311.5
% Operating margin		18.0				16.7

Revenue for the McGraw-Hill Education segment increased over the prior year primarily due to improvement at the School Education Group (SEG). Operating profit increased 20.0% over the prior year. Foreign exchange rates benefited

31

revenue by $8.8 million and had a negative impact of $1.4 million on operating results. Operating margin improved over the prior year primarily as a result of product mix.

On July 16, 2004, the Company acquired The Grow Network, a privately held company. The Grow Network is a leading provider of assessment reporting and customized content for states and large school districts across the country. The acquisition supports McGraw-Hill Education’s strategy to provide a full range of customized education solutions to help improve teaching and learning. On August 1, 2005, the Company acquired TurnLeaf Solutions Inc. TurnLeaf Solutions Inc. is a national provider of customized online reporting and data analysis. TurnLeaf helps administrators and teachers track progress toward school districts’ Adequate Yearly Progress goals, a key provision in the No Child Left Behind law. TurnLeaf Solutions Inc. is now part of the School Education Group and will become part of The Grow Network.

The McGraw-Hill School Education Group’s revenue increased 17.5% for the nine months ended September 30, 2005, benefiting from the success of elementary and secondary school products in the state adoption market. The 2005 new state adoption market is favorable not only because of its size but also because the schedule affords opportunities in a range of subject areas, allowing SEG to leverage the breadth and depth of its product offerings. The new state adoption market for 2005 is projected to increase to between $900 million and $950 million. Social studies represents the year’s largest subject-area market, and strong performances in Florida and Alabama have positioned SEG to lead the high-volume secondary portion of that market. SEG has also performed well in health in Texas, Indiana and California, where the Los Angeles Unified School District (LAUSD) chose McGraw-Hill programs for use at both the elementary and middle school grades. The LAUSD also adopted the Group’s reading intervention program,Kaleidoscope, in 2005. The Group captured a large share of science in Indiana and also in North Carolina, where the state’s largest district, Charlotte-Mecklenburg, selected the McGraw-Hill elementary program.

The Group captured leading shares in the fine arts (art/music) and health adoptions in Texas when school districts made their selections earlier in the year. Although the state legislature adjourned without appropriating funds for Proclamation 2002 purchasing, in mid-August the governor authorized the Texas Education Agency (TEA) to open its ordering system and allow the district to place their orders. The governor instructed the TEA to transfer $294.5 million from other existing appropriations to fund Proclamation 2002 textbooks with the understanding that the state will provide the necessary funding through budget execution. Proclamation 2002 covers world languages as well as health and fine arts. Although TEA guidelines limited the number of health and fine arts textbooks that schools can buy with state funds, the Group’s success in these subjects is expected to produce excellent revenue results.

The Group recognized $37.5 million in revenue related to Proclamation 2002 textbooks during the third quarter. Because of the funding delay, some revenue related to orders shipped in the third quarter will be recognized in the fourth quarter, and many additional Proclamation 2002 orders will be fulfilled before the end of the year. The Company continues to monitor the situation regarding the Texas textbook funding for fine arts (music/art), world languages, and health (Proclamation 2002). The Group also benefited from sales of vocational and technical products as a result of Texas funding that were adopted in 2004 under Proclamation 2001 but were not funded for purchase until this year.

As a result of recent hurricanes in the Gulf States, Mississippi has postponed its 2006 language arts and health adoption, and Louisiana is expected to delay

32

its 2006 social studies adoption. In addition, Mississippi has invoked a partial termination of the statewide testing contract during the 2005-2006 school year. Although purchasing by Alabama, Mississippi, and Louisiana represented approximately $84 million or 9% of the total state new adoption market in 2005, the Group’s sales of state-adopted materials were not affected as product had been shipped to the region prior to the hurricanes. The full impact of the hurricanes cannot be estimated at this time. However, we anticipate that any 2006 shortfalls resulting from the postponed adoptions will be partially offset by sales of replacement inventories in the Gulf States and of additional materials for students who have relocated to other states.

In open territories, major adoptions announced to date includeEveryday Mathematicsin Washington, DC, Hartford, CT, and El Paso, TX;Open Court Readingin Baltimore, MD; and Direct Instruction in Minneapolis, MN and St. Louis, MO. In the open territories, elementary sales across the curriculum benefited from a $29 million state textbook fund in Illinois that supplemented local purchasing of materials for grades K-4 in 2005. In 2004, funding was provided for grades 9-12. The Group’s music program also performed well in the open territories.

Compared to 2004, reading and math opportunities were lower in 2005 due to the state adoption cycle. The Group’s alternative basal program,Open Court Reading,and reading intervention program,Kaleidoscope, both performed well, but they did not entirely offset the decline in Direct Instruction and certain aging supplemental products. In the first nine months of 2004,Everyday Mathematics, a reform-based elementary program, contributed positively to open territory results by winning major sales in New York City, negatively affecting comparisons in 2005.

According to the Association of American Publishers’ year-to-date statistics through August 2005, net adoption and open territory sales of basal and supplementary materials for grades K-12, excluding testing, increased by 6.6% for all publishers surveyed.

Custom contract testing grew in the first nine months, contributing to the segment’s revenue growth. Higher custom contract revenue was driven by contract wins in Arizona, Massachusetts and Florida, the timing of custom contracts in the Connecticut and Missouri programs and by the expansion of programs in New York, Indiana, Oklahoma, and the State of Qatar’s National Assessment Program. SEG continues to invest in technology to improve its efficiency and the effectiveness of custom contract delivery. Expenses related to the increased scoring costs of certain contracts in 2004 did not recur in 2005. Sales of “shelf” or norm-referenced tests were lower than prior year due to an ongoing shift, driven by the No Child Left Behind law, to state-specific custom assessments, which have lower margins. Assessment reporting and the expansion of the Group’s personalized study guide business also contributed favorably to results.

McGraw-Hill Higher Education, Professional and International Group’s (HPI) revenue increased by 3.3% to $830.8 million for the first nine months of 2005. Higher education products performed well in both the domestic and international markets on a gross sales basis, but all three major product categories experienced higher return rates than in 2004. The three major categories: Science, Engineering, and Mathematics (SEM); Business and Economics; and Humanities, Social Science, and Languages benefited from the success of new and revised titles in 2005. Key titles contributing to the performance in the first nine months of 2005 include:

• Silberberg,Chemistry, 4/e

33

• McConnell and Brue,Economics, 16/e; and

• Knorr,Puntos de Partida,7/e

The U.S. college new textbook market is expected to grow 5% to 6% this year, the Company anticipates that its college product sales will match the industry.

In the professional Science, Technical and Medical (STM) marketplace, the release ofHarrison’s Principles of Internal Medicine, 16/e, in the third quarter of 2004 and a strong response to a backlist promotion in 2004 negatively affected year-over-year comparisons. However, the introduction ofPearls of Wisdom, a 35-title series of study guides for medical board exams, contributed favorably to 2005 results.AccessMedicinean online product that was launched in November 2004 also performed well. Internationally, STM products benefited from the release ofHarrison’s Principles of Internal Medicine, 16/e, in Spanish and Portuguese translations during 2005. Trade products experienced strong growth, and several titles reached best-seller status, includingWooden on Leadership, The Millionaire Real Estate InvestorandCrucial Conversations: Tools for Talking When Stakes Are High.Softness continued in the professional technology sector. Internationally, the Group also benefited significantly from increased sales of English Language Training materials, which have been especially successful in the Middle East and Asia.

Financial Services

	Nine Months			%		Nine Months
(millions of dollars)	2005			Increase		2004
Revenue	$	1,750.4			19.6	$	1,463.9
Operating profit		732.7	(a)		24.2		590.1
% Operating margin		41.9					40.3

(a) includes a $6.8 million pre-tax gain on the sale of Corporate Value Consulting

Financial Services revenue and operating profit increased dramatically over 2004 results. Foreign exchange rates contributed $7.9 million to revenue and had a positive impact on operating profit of $4.2 million.

On September 30, 2005, the Company sold its Corporate Value Consulting (CVC) business, the valuation services unit of the Financial Services segment. The sale resulted in a $6.8 million pre-tax gain. This disposition did not materially impact the segment results for the nine months ended September 30, 2005.

The Financial Services segment’s increase in revenue and operating profit for the first nine months of 2005 is due primarily to the strong performance of structured finance ratings and corporate finance (corporate finance and financial services) ratings, which represented approximately 33.5% and 14.1% of the growth in revenue, respectively. Growth was experienced in all asset classes within structured finance. The continuing favorable interest rate environment led to strong growth in the issuance of U.S. residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDOs). The growth in corporate finance ratings is attributable primarily to revenues from recurring fees for surveillance activities and customers on annual fee arrangements.

Over the past twelve months, the Financial Services segment made several acquisitions primarily, Vista Research, Capital IQ and a majority interest in CRISIL Limited. These acquisitions represent approximately 20.6% of the growth in revenue, and had no material impact on operating profit for the

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period. These acquisitions are discussed in further detail in the Consolidated Review and Footnote 4 of the Consolidated Financial Statements for the period ended September 30, 2005.

Total U.S. structured finance new issue dollar volume increased 44.4%; solid growth was experienced across all asset classes. U.S. CDO issuance increased 113.1% according to Harrison Scott Publications. The U.S. CDO market was driven by stabilization of the asset class, improving credit quality, strong investor demand as well as an increase in new structures (customizations) and arbitrage opportunities. CMBS issuance through September 2005 was at record levels, up 79.5%, driven by low interest rates and refinancing opportunities. U.S. RMBS issuance increased 41.4% according to Harrison Scott Publications with the growth driven by the low interest rate environment, rising home values as well as a proliferation of non-agency (non-conforming) mortgage products, which are comprising an increasing share of total mortgage originations. Although U.S. RMBS issuance volumes have been strong overall, the number of issues increased only moderately leading to issue sizes that are substantially larger than last year. The Company had originally anticipated that RMBS issuance would decline approximately 15%-20% in 2005. Assuming no change in current market conditions such as a large and sudden rise in interest rates, issuance should meet last year’s levels. Issuance of asset-backed securities grew, driven by growth in credit cards and auto and student loans. According to Securities Data, U.S. new issue dollar volume for corporate issuers for the nine months ended September 30, 2005 decreased 10.7%, with investment grade issuance down 7.8% and high yield issuance down 24.7%. Strong cash flows, high cash balances, excess production capacity and the high level of refinancing activity which took place in 2004, have lessened the need for new debt financing. Public finance issuance increased due to accelerated refundings by municipalities as they took advantage of rising short-term rates coupled with stable long-term rates. Refundings are up nearly 55% over prior year, while new money issuance is down slightly. Despite a decline in the third quarter, year to date international issuance growth remains strong as the favorable trends of securitization, disintermediation and privatization continue. In Europe, issuance levels rose in the first nine months of 2005, primarily driven by strong corporate issuance in the first half of the year. Corporate issuance in Europe was up year-to-date reflecting strength in financial services primarily due to pre-funding that occurred in the first half of the year partly as a result of the expiration of the Pfandbrief in Germany and the introduction of new filing regulations. Also, structured finance experienced strong issuance in the first half driven primarily by growth in mortgage-backed securities and CDO issuance.

Revenue related to Standard & Poor’s indices increased as assets under management for Exchange-Traded Funds rose 28.9% from September 30, 2004 to $119.1 billion as of September 30, 2005. Assets under management at December 31, 2004 were $113.7 billion.

The financial services industry is subject to the potential for increasing regulation in the United States and abroad. The businesses conducted by the Financial Services segment are in certain cases regulated under the U.S. Investment Advisers Act of 1940, the U.S. Securities Exchange Act of 1934, the National Association of Securities Dealers and/or the laws of the states or other jurisdictions in which they conduct business.

Standard & Poor’s Ratings Services is a credit rating agency that has been designated as one of five Nationally Recognized Statistical Rating Organizations, or NRSROs, by the SEC. The SEC first began designating NRSROs in 1975, for use of their credit ratings, in the determination of capital charges for registered brokers and dealers under the SEC’s Net Capital Rule. During the last three years, the SEC has been examining the purpose of and the need for greater regulation of NRSROs. In January 2003, the SEC issued a

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report on the role and function of credit rating agencies in the operation of the securities markets. The report addressed issues that the SEC was required to examine under the Sarbanes-Oxley Act of 2002, as well as other issues arising from the SEC’s own review of credit rating agencies. In June 2003, the SEC solicited comments on a concept release that questioned: (1) whether the SEC should continue to designate NRSROs for regulatory purposes and, if so, what the criteria for designation should be; and (2) the level of oversight that the SEC should apply to NRSROs. In February 2005, Standard & Poor’s and other NRSROs’ representatives testified before the Senate Committee on Banking, Housing and Urban Affairs at a hearing to examine the role of credit rating agencies. In March 2005, SEC Chairman Donaldson also testified before the Senate Committee on Banking, Housing and Urban Affairs. He raised an issue about the SEC’s current authority to oversee NRSROs and referred to a voluntary framework for oversight that the NRSROs have been discussing with the SEC staff. The Chairman noted that the question of whether to impose a regulatory regime raises important issues that need to be examined, including the First Amendment. The legal status of rating agencies has also been addressed by courts in the United States in various decisions and is likely to be considered and addressed in legal proceedings from time to time in the future.

In March 2005, the SEC voted to issue a rule proposal to define NRSROs. The SEC issued its proposed rule for public comment on April 19^th. Standard & Poor’s submitted its comments on June 9^th, largely supporting a more formal designation process and clear criteria, but without involving the SEC in the substance of the ratings process or in second-guessing rating opinions. In April 2005, Annette Nazareth, then Director of the SEC’s Division of Market Regulation, testified before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the House Financial Services Committee on the SEC’s proposed rule and on the oversight framework. She also raised questions on the SEC’s authority over NRSROs. Following this hearing, Rep. Kanjorski asked the SEC to provide technical assistance on the specific authority the SEC would need to effectively oversee rating agencies. In June 2005, the SEC submitted an outline to Rep. Kanjorski of key issues to be addressed if Congress proceeds with legislation (Legislative Framework). Also in June 2005, Standard & Poor’s testified before the same House Subcommittee on H.R.2990, the “Credit Rating Agency Duopoly Relief Act”. This bill, proposed by Rep. Fitzpatrick on June 20^th, would set up a mandatory licensing regime with the SEC for credit rating agencies. Standard & Poor’s objected to the bill for legal and policy reasons. In August 2005, Standard & Poor’s submitted comments on the Legislative Framework to Rep. Kanjorski at his request.

Outside the United States, the European Parliament has adopted resolutions requiring the European Commission to analyze the desirability of registering credit rating agencies in Europe and the need for registration criteria. The European Commission, through the Committee of European Securities Regulators (CESR), solicited comments on these issues from regulators and the public, including rating agencies, and in late March, CESR issued its final advice to the European Commission. CESR recommended that rating agencies should not be regulated but should implement and enforce internally a code of conduct and other policies to address key issues.

In addition, European Union member states are in the process of implementing the European Commission’s Market Abuse Directive which, depending on how the Directive is implemented, could affect rating agencies’ communications with issuers as part of the rating process. Local, national and multinational bodies have considered and adopted other legislation and regulations relating to credit rating agencies from time to time and are likely to continue to do so in the future.

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The International Organization of Securities Commissions (IOSCO), a global group of securities commissioners, has also been reviewing the role of rating agencies and their processes. In September 2003, IOSCO published a set of principles relating to rating agencies’ processes and procedures. On December 23, 2004, it published its Code of Conduct Fundamentals for rating agencies that builds upon the 2003 principles. Standard & Poor’s worked closely with IOSCO in its drafting of both the principles and the code. In September 2004, Standard & Poor’s also published its own code of practices that is broadly consistent with IOSCO’s code and represents a compilation of existing policies and procedures around key aspects of the ratings process.

New legislation, regulations or judicial determinations applicable to credit rating agencies in the United States and abroad could affect the competitive position of Standard & Poor’s ratings; however, the Company does not believe that any new or currently proposed legislation, regulations or judicial determinations would have a materially adverse effect on its financial condition or results of operations.

The market for credit ratings as well as research, investment advisory and broker-dealer services is very competitive. The Financial Services segment competes domestically and internationally on the basis of a number of factors, including quality of ratings, research and investment advice, client service, reputation, price, geographic scope, range of products and technological innovation. In addition, in some of the countries in which Standard & Poor’s competes, governments may provide financial or other support to locally-based rating agencies and may from time to time establish official credit rating agencies, credit ratings criteria or procedures for evaluating local issue.

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.

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Information and Media Services

			%
	Nine Months		Increase/			Nine Months
(millions of dollars)	2005		(Decrease)			2004
Revenue
Business-to-Business	$	553.9		15.7		$	478.9
Broadcasting		79.7		—			79.7
Total revenue		633.6		13.4			558.6
Operating profit	$	30.8		(50.6	)	$	62.3
% Operating margin		4.9					11.2

In the first nine months of 2005, revenue grew by 13.4% or $75.0 million over the prior year. Operating profit decreased 50.6% compared to 2004. J.D. Power and Associates (JDPA), which was acquired on April 1, 2005, contributed $84.6 million in revenue to the Business-to-Business Group and decreased the segment’s operating profits by $8.8 million for the nine month period ended September 30, 2005, primarily due to acquisition related costs. The Business-to-Business Group was negatively impacted by the continued soft advertising market. At the Broadcasting Group, the improved ratings position of the ABC network offset the loss of political advertising in the first nine months of 2005. Foreign exchange rates had no significant impact on revenue or operating profit.

On April 1, 2005, the Company acquired JDPA, a privately held company. JDPA, founded in 1968 by J.D. Power III, is a leading provider of marketing information services for the global automotive industry and has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy. Its customer satisfaction ratings and market research are recognized worldwide as benchmarks for quality and independence.

The acquisition enhances the Company’s growth prospects for its core business information platform by providing a new direct link to consumers, while also providing new collaborative opportunities with the Company’s leading franchises includingBusinessWeek, Standard & Poor’s, Platts, McGraw-Hill Construction and Aviation Week.

Revenue increased at the Business-to-Business Group compared to prior year primarily due to the acquisition of JDPA. Revenue growth in JDPA was driven by its U.S. client services businesses in the telecommunications and insurance sectors. According to the Publishers Information Bureau (PIB),BusinessWeek’sadvertising pages in the North America edition for the first nine months of 2005 were down 9.6%, with the same number of issues. There was one less issue for revenue recognition purposes for the first nine months of 2005. The prior year included a special 75th Anniversary double issue ofBusinessWeekwhich was the largest issue since 2000, with 252 total pages in the North American edition. Advertising pages were also down in the Europe and Asia editions in the first nine months of 2005. According to the PIB, advertising pages declined in the five book competitive set.BusinessWeek Onlinecontinues to perform well as advertising and unique visitors continue to increase. During the first nine months of 2005, the Group also benefited fromBusinessWeekSmallBiz, which was launched in the second quarter of 2004.

Platts’ news and pricing products experienced growth as a result of the increased need for market transparency due to the increase in crude oil prices and as U.S. energy markets continued to be affected by natural gas supplies. Increased customer demand for news and pricing products added to the subscriber base. The resulting revenue is recognized over the life of the related product subscriptions. Advertising in Aviation publications were down

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due to an absence of events compared to the prior year. The Singapore Air Show and Farnborough Air Show occurred in 2004, and the Paris Air Show occurred in 2005.

As of September 2005, total U.S. construction starts were up 8% versus prior year. Both residential building (up 13%) and non-building construction (up 8%) were higher than prior year, while U.S. nonresidential building was flat compared to the prior year. Display advertising pages in the construction publications increased. New McGraw-Hill Construction publications such asConstructor magazine andMy Housecontributed to growth. In the first nine months of 2005, the Business-to-Business Group continued to make investments in the McGraw-Hill Construction Network to strengthen its effectiveness and efficiency. Increased competitive pressures negatively impacted Sweets file sales.

At the Broadcasting Group, the improved ratings position of the ABC network offset the loss of political advertising in the first nine months of 2005. A strong political issue advertising market in California helped offset the loss of prior year political advertising in other markets. Local advertising was strong. The service, automotive, leisure time and retailing categories of advertisers contributed to growth while the consumer products category was weak. The Broadcasting Group was also negatively impacted by a reduction in network compensation as a result of the renegotiation of affiliation agreements with the ABC network in the second quarter of 2005.

Liquidity and Capital Resources

The Company continues to maintain a strong financial position. The Company’s primary source of funds for operations is cash generated by operating activities. The Company’s core businesses have been strong cash generators. Income and consequently cash provided from operations during the year are significantly impacted by the seasonality of businesses, particularly educational publishing. This seasonality also impacts cash flow and related borrowing patterns. The Company’s cash flow is typically negative to neutral in the first half of the year and turns positive during the third and fourth quarters. Debt financing is used as necessary for acquisitions and for seasonal fluctuations in working capital. Cash and cash equivalents were $466.6 million at September 30, 2005, a decline of $214 million from December 31, 2004. The Company’s subsidiaries maintain cash balances at several financial institutions located throughout the world. These cash balances are subject to normal currency exchange fluctuations. At September 30, 2005 and 2004, the Company’s overseas cash balances totaled $339.6 million and $171.3 million, respectively. As a result of the American Jobs Creation Act of 2004, which was enacted on October 22, 2004, the Company is considering the repatriation of foreign earnings in the fourth quarter of 2005. This repatriation of funds is presently estimated to be between $200 million and $230 million. The Company expects that the incremental income tax on the repatriation will be approximately $10 million and dilute earnings per share by approximately $0.03 in the fourth quarter of 2005. (see Note 14).

Cash Flow

Operating Activities: Cash provided by operations was $897.3 million for 2005, as compared to $553.2 million in 2004. The change in cash provided from operating activities is primarily from strong operating results as well as an increase in income taxes payable as a result of tax payments in 2004. Prepaid assets increased in 2004 as a result of a tax receivable which was received in 2005.

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Accounts receivable (before reserves) increased $373.4 million from the prior year-end primarily from the seasonality of the educational business. This increase compares to a $288.9 million increase in 2004 from the prior year-end. The increase in accounts receivable over the prior year is primarily attributable to the increase in adoption opportunities. Year-to-date, the number of days sales outstanding for continuing operations was consistent year over year. Inventories increased by $42.0 million from the end of 2004, primarily from the seasonality of the educational business. The increase in inventories and accounts receivable over prior year is primarily from the increase in adoption opportunities in 2005.

Income taxes payable increased by $180.2 million over the prior year-end. This increase compares to a $15.0 million increase in 2004 as a result of higher-than-usual tax payments made in the first quarter of 2004, but accrued at December 31, 2003. These payments are attributable to the gain on the sale of the Company’s 45% equity investment in Rock-McGraw, Inc. and a large international tax payment. Also included in the operating cash flow for the nine months ended September 30, 2004 is a $20.0 million non-cash reduction of the Company’s accrued income tax liability (see Note 12). The increase in 2005 income taxes payable is primarily due to the increase in the provision of taxes payable on income from continuing operations.

Investing Activities: Cash used for investing activities was $588.0 million in the first nine months of 2005, compared to $514.4 million in 2004. The change over the prior year is primarily due to an increase in the number and size of acquisitions in 2005 versus 2004. Proceeds received from dispositions increased primarily due to the disposition of Corporate Value Consulting on September 30, 2005.

Purchases of property and equipment totaled $72.7 million in 2005 compared with $90.5 million in 2004. 2005 spending primarily relates to investments in the Company’s distribution centers and facilities and technology related equipment. Included in 2004 purchases is the purchase of a corporate aircraft for approximately $32.8 million. The Company invested in a corporate aircraft shifting from the current charter aircraft approach to an ownership approach due in part to extensive international travel, as a result of the Company’s continued global expansion. For 2005, capital expenditures are expected to be approximately $130 million.

Additions to technology projects totaled $11.9 million in the first nine months of 2005 compared with $8.6 million in 2004. For 2005, additions to deferred technology projects are expected to be approximately $30 million.

Net prepublication costs decreased by $5.8 million from December 31, 2004, as amortization outpaced spending. Prepublication investment totaled $176.5 million as of September 30, 2005, $14.5 million more than the same period in 2004 reflecting the significant adoption opportunities in 2005 and beyond. Prepublication spending for 2005 is now expected to increase to approximately $250 million reflecting the significant adoption opportunities in key states in 2005 and beyond. The reduction in spending is the result of cost efficiencies.

Financing Activities: Cash used for financing activities was $507.9 million as of September 30, 2005 compared to $307.5 million in 2004. The difference is primarily attributable to the increase in the repurchase of treasury shares. On a settlement basis, cash was utilized to repurchase approximately 10 million of treasury shares for $444.3 million in 2005. In 2004, cash was utilized to repurchase approximately 7.1 million of treasury shares for $269.1 million on a settlement basis. Shares repurchased under the repurchase program were used for general corporate purposes, including the issuance of shares for stock compensation plans and to offset the dilutive effect of the exercise of employee stock options.

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There were no commercial paper borrowings as of September 30, 2005 and 2004. The Company has a five-year revolving credit facility agreement of $1.2 billion that expires on July 20, 2009. The Company pays a facility fee of seven basis points on the credit facility whether or not amounts have been borrowed, and borrowings may be made at a spread of 13 basis points above the prevailing LIBOR rates. This spread increases to 18 basis points for borrowings exceeding 50% of the total capacity available under the facility. On July 5, 2005, the Company amended its credit facility to implement a materiality threshold for determining whether the effects of acquisitions and dispositions are included in the financial calculation for covenant reporting. The amended facility contains certain covenants, and the only financial covenant requires that the Company not exceed indebtedness to cash flow ratio, as defined, of 4 to 1 at any time. This restriction has never been exceeded. There were no borrowings under this agreement as of September 30, 2005 and 2004.

The Company also has the capacity to issue Extendible Commercial Notes (ECNs) of up to $240 million. ECNs replicate commercial paper, except that the Company has an option to extend the note beyond its initial redemption date to a maximum final maturity of 390 days. However, if exercised, such an extension is at a higher reset rate, which is at a predetermined spread over LIBOR and is related to the Company’s commercial paper rating at the time of extension. As a result of the extension option, no backup facilities for these borrowings are required. As is the case with commercial paper, ECNs have no financial covenants. There were no ECNs outstanding at September 30, 2005 and 2004.

Under the shelf registration that became effective with the Securities and Exchange Commission in 1990, an additional $250 million of debt securities can be issued.

On April 27, 2005, the Company’s Board of Directors approved a two-for-one stock split of the Company’s common stock that was effected in the form of a 100 percent stock dividend to shareholders of record on May 6, 2005. The Company’s shareholders received one additional share for each share in their possession on that date. This did not change the proportionate interest a shareholder maintains in the Company. The additional shares were distributed on May 17, 2005.

On January 26, 2005, the Board of Directors approved an increase of 10% in the quarterly common stock dividend from $0.15 to $0.165 per share on a post-split basis.

On January 29, 2003, the Board of Directors approved a new share repurchase program authorizing the purchase of up to 30 million additional shares (post-split), which was approximately 7.8% of the total shares of the Company’s outstanding common stock. The repurchased shares may be used for general corporate purposes, including the issuance of shares in connection with the exercise of employee stock options. Purchases under this program may be made from time to time on the open market and in private transactions depending on market conditions. On January 26, 2005, the Company announced it would repurchase 6 to 10 million of its shares during 2005. On a trade date basis, the Company repurchased 10 million shares for $443.5 million in 2005 at an average price of approximately $44.35 per share on a post-split basis. Approximately 22.2 million shares on a post-split basis have been repurchased for $920.8 million at an average price of $41.39 under this program through September 30, 2005. On October 26, 2005, the Board of Directors approved the repurchase of up to 7.8 million additional shares which are the total number of shares remaining in the 30 million share repurchase program. The Company will purchase the shares over the coming months subject to market conditions.

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Quantitative and Qualitative Disclosure about Market Risk

The Company is exposed to market risk from changes in foreign exchange rates. The Company has operations in various foreign countries. The functional currency is the local currency for all locations, except in the McGraw-Hill Education segment, where operations that are extensions of the parent have the U.S. dollar as the functional currency. For hyper-inflationary economies, the functional currency is the U.S. dollar. In the normal course of business, these operations are exposed to fluctuations in currency values. The Company does not generally enter into derivative financial instruments in the normal course of business, nor are such instruments used for speculative purposes. The Company has no such instruments outstanding at this time.

The Company has naturally hedged positions in most countries with a local currency perspective with offsetting assets and liabilities. The gross amount of the Company’s foreign exchange balance sheet exposure from operations is $214.3 million as of September 30, 2005. Management has estimated using an undiversified value at risk analysis with 95% certainty that the foreign exchange gains and losses should not exceed $22.4 million over the next year based on the historical volatilities of the portfolio.

The Company’s net interest expense is sensitive to changes in the general level of U.S. interest rates. Based on average debt and investments outstanding over the past nine months, the following is the projected annual impact on interest expense on current operations:

Percent change in interest rates	Projected annual impact on operations
(+/-)	(millions)
1%	$2.24

Recently Issued Accounting Standards

See Note 14 to the Company’s Consolidated Financial Statements for disclosure of the impact that recently issued accounting standards will have on the Company’s financial statements.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995

This section, as well as other portions of this document, includes certain forward-looking statements about the Company’s businesses, new products, sales, expenses, cash flows and operating and capital requirements. Such forward-looking statements include, but are not limited to: the strength and sustainability of the U.S. and global economy; Educational Publishing’s level of success in 2005 adoptions and enrollment and demographic trends; the level of educational funding; the level of education technology investments; the strength of Higher Education, Professional and International publishing markets and the impact of technology on them; the level of interest rates and the strength of profit levels and the capital markets in the U.S. and abroad; the level of success of new product development and global expansion and strength of domestic and international markets; the demand and market for debt ratings, including mortgage and asset-backed securities; the regulatory environment affecting Standard & Poor’s; the strength of the domestic and international advertising markets; the volatility of the energy marketplace; the contract value of public works, manufacturing and single-family unit construction; the level of political advertising; and the level of future cash flow, debt levels, product-related manufacturing expenses, pension expense, distribution expenses, postal rates, amortization and depreciation expense, income tax rates, capital, technology and other expenditures and prepublication cost investment.

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Actual results may differ materially from those in any forward-looking statements because any such statements involve risks and uncertainties and are subject to change based upon various important factors, including, but not limited to, worldwide economic, financial, political and regulatory conditions; currency and foreign exchange volatility; the health of capital and equity markets, including future interest rate changes; the implementation of an expanded regulatory scheme affecting Standard & Poor’s ratings and services; the level of funding in the education market (both domestically and internationally); the pace of recovery of the economy and in advertising; continued investment by the construction, computer and aviation industries; the successful marketing of new products, and the effect of competitive products and pricing.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

The Company has no material changes to the disclosure made on this matter in the Company’s report on Form 10-K for the year ended December 31, 2004. Please see the financial condition section in Item 2 of this Form 10-Q for additional market risk disclosures.

Item 4.Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed with the Securities and Exchange Commission (SEC) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.

As of September 30, 2005, an evaluation was performed under the supervision and with the participation of the Company’s management, including the CEO and CFO, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under the U.S. Securities Exchange Act of 1934). Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2005.

Other Matters

There have been no changes in the Company’s internal controls over financial reporting during the most recent quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II
Other Information

Item 1.Legal Proceedings

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of Euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit and intends to vigorously contest the action.

In addition, in the normal course of business both in the United States and abroad, the Company and its subsidiaries are defendants in numerous legal proceedings and are involved, from time to time, in governmental and self-regulatory agency proceedings, which may result in adverse judgments, damages, fines or penalties. Also, various governmental and self-regulatory agencies regularly make inquiries and conduct investigations concerning compliance with applicable laws and regulations. Based on information currently known by the Company’s management, the Company does not believe that any pending legal, governmental or self-regulatory proceedings or investigations will result in a material adverse effect on its financial condition or results of operations.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

The following table provides information on purchases made by the Company of its outstanding common stock during the third quarter of 2005 pursuant to the stock repurchase program authorized on January 29, 2003 by the Board of Directors (column c). The stock repurchase program authorizes the purchase of up to 30 million additional shares (post-split), which was approximately 7.8% of the total shares of the Company’s outstanding common stock as of January 29, 2003. The repurchase program has no expiration date. The repurchased shares may be used for general corporate purposes, including the issuance of shares in connection with the exercise of employee stock options. Purchases under this program may be made from time to time on the open market and in private transactions, depending on market conditions. In addition to purchases under the 2003 stock repurchase program, the number of shares in column (a) include; 1) shares of common stock that are tendered to the Registrant to satisfy the employees’ tax withholding obligations in connection with the vesting of awards of restricted performance shares (such shares are repurchased by the Registrant based on their fair market value on the vesting date), and 2) shares of the Registrant deemed surrendered to the Registrant to pay the exercise price and to satisfy the employees’ tax withholding obligations in connection with the exercise of employee stock options.

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There were no other share repurchases during the quarter outside the stock repurchases noted below:

					(c)Total Number of		(d)Maximum Number
					Shares Purchased as		of Shares that may
	(a)Total Number of				Part of Publicly		yet be Purchased
	Shares Purchased		(b)Average Price		Announced Programs		Under the Programs
Period	(in millions)		Paid per Share		(in millions)		(in millions)
(July  1 — July 31, 2005)		—		—		—		8.6
(Aug. 1 — Aug. 31, 2005)		0.1	$	47.29		—		8.6
(Sept. 1 — Sept. 30, 2005)		1.6	$	47.62		0.8		7.8
Total — Qtr		1.7	$	47.58		0.8		7.8

Item 6.Exhibits

(12)	Computation of Ratio of Earnings to Fixed Charges
(15)	Letter on Unaudited Interim Financials
(31.1)	Quarterly Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(31.2)	Quarterly Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(32)	Quarterly Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(99)	Amendment to Rights Agreement, dated as of July 27, 2005, by and between the Registrant and The Bank of New York, as Rights Agent, incorporated by reference from Form 8-A/A filed August 3, 2005

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	THE MCGRAW-HILL COMPANIES, INC.
Date: October 28, 2005	By	/s/ Robert J. Bahash
		Robert J. Bahash Executive Vice President and Chief Financial Officer
Date: October 28, 2005	By	/s/ Kenneth M. Vittor
		Kenneth M. Vittor Executive Vice President and General Counsel
Date: October 28, 2005	By	/s/ Talia M. Griep
		Talia M. Griep Corporate Controller and Senior Vice President, Global Business Services

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