UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[ ] 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 (I.R.S. Employer
incorporation or organization) 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.
YES [X] NO [ ]
On October 15, 2001 there were approximately 193.3 million shares of common
stock (par value $1.00 per share) outstanding.
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
TABLE OF CONTENTS
-----------------
Page Number
-----------
PART I. FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
-------
Consolidated Statement of Income for
the three and nine month periods ended
September 30, 2001 and 2000 3
Consolidated Balance Sheet at September 30, 2001,
December 31, 2000 and September 30, 2000 4-5
Consolidated Statement of Cash Flow for the nine 6
months ended September 30, 2001 and 2000
Notes to Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Operating
------ Results and Financial Condition 13-18
Item 3. Quantitative and Qualitative Disclosures About
------ Market Risk 19
Part II. OTHER INFORMATION
---------------------------
Item 1 Legal Proceedings 19
------
Item 6. Exhibits 20-22
------
Part I
Financial Information
Item 1. Financial Statements
---------------------
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Income
-------------------------------
Periods Ended September 30, 2001 and 2000
------------------------------------------
Three Months Nine Months
------------------ -------------------
2001 2000 2001 2000
------ -------- -------- --------
(in thousands, except per-share data)
Operating revenue (Note 3) $1,535,100 $1,394,470 $3,530,967 $3,194,608
Expenses:
Operating 558,124 524,844 1,452,405 1,327,153
Selling and general 439,479 384,400 1,143,181 1,005,295
Depreciation and amortization 150,486 135,337 330,232 280,569
---------- ---------- ---------- ----------
Total expenses 1,148,089 1,044,581 2,925,818 2,613,017
Other income - net 15,959 15,734 37,907 48,886
---------- ---------- ---------- ----------
Income from operations 402,970 365,623 643,056 630,477
Interest expense - net 13,558 15,035 46,459 35,618
---------- ---------- ---------- ----------
Income before taxes on income 389,412 350,588 596,597 594,859
Provision for taxes on income 149,924 134,977 216,721 229,021
---------- ---------- ---------- ----------
Income before cumulative adjustment 239,488 215,611 379,876 365,838
Cumulative change in accounting,
net of tax (Note 10) - - - (68,122)
---------- ---------- ---------- ----------
Net income (Note 2) $239,488 $215,611 $379,876 $297,716
========== ========== ========== ==========
Earnings per common share:
Basic
-----
Income before cumulative adjustment $ 1.24 $ 1.11 $ 1.96 $ 1.88
Net Income $ 1.24 $ 1.11 $ 1.96 $ 1.53
Diluted
-------
Income before cumulative adjustment $ 1.22 $ 1.10 $ 1.93 $ 1.87
Net Income $ 1.22 $ 1.10 $ 1.93 $ 1.52
Average number of common shares
outstanding: (Notes 8 and 9)
Basic 193,892 194,488 194,281 194,194
Diluted 195,680 196,850 196,343 196,131
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
Sept. 30, Dec. 31, Sept. 30,
2001 2000 2000
---------- ----------- -----------
(in thousands)
ASSETS
Current assets:
Cash and equivalents $ 1,773 $ 3,171 $ 36,758
Accounts receivable (net of allowance
for doubtful accounts and sales
returns) (Note 4) 1,335,628 1,095,118 1,324,957
Inventories (Note 4) 437,494 388,947 419,993
Deferred income taxes 196,274 192,789 172,014
Prepaid and other current assets (Note 5) 109,146 121,665 98,840
---------- ---------- ----------
Total current assets 2,080,315 1,801,690 2,052,562
---------- ---------- ----------
Prepublication costs (net of accumulated
amortization) (Note 4) 510,888 518,031 463,615
Investments and other assets:
Investment in Rock-McGraw, Inc. - at
equity 103,272 95,862 92,811
Prepaid pension expense 198,883 159,598 147,303
Other 246,495 226,910 211,424
---------- ---------- ----------
Total investments and other assets 548,650 482,370 451,538
---------- ---------- ----------
Property and equipment - at cost 1,055,972 1,046,369 1,018,515
Less - accumulated depreciation 623,294 614,464 607,240
---------- ---------- ----------
Net property and equipment 432,678 431,905 411,275
Goodwill and other intangible assets - at
cost (net of accumulated amortization) 1,899,680 1,697,448 1,707,697
---------- ---------- ----------
Total Assets $5,472,211 $4,931,444 $5,086,687
========== ========== ==========
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
Sept. 30, Dec. 31, Sept. 30,
2001 2000 2000
---------- ----------- -----------
(in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ 268,483 $ 227,848 $265,140
Accounts payable 280,307 313,286 244,560
Accrued liabilities 345,309 358,274 343,961
Income taxes currently payable 238,436 55,388 126,549
Unearned revenue 484,988 475,559 446,914
Other current liabilities (Note 5) 341,338 350,430 366,618
---------- ---------- ----------
Total current liabilities 1,958,861 1,780,785 1,793,742
---------- ---------- ----------
Other liabilities:
Long-term debt (Note 6) 970,617 817,529 954,787
Deferred income taxes 169,828 163,231 178,949
Accrued postretirement healthcare and
other benefits 174,922 178,525 184,808
Other non-current liabilities 240,459 230,330 213,967
---------- ---------- ----------
Total other liabilities 1,555,826 1,389,615 1,532,511
---------- ---------- ----------
Total liabilities 3,514,687 3,170,400 3,326,253
---------- ---------- ----------
Shareholders' equity (Notes 7 & 8):
Capital stock 205,852 205,852 205,852
Additional paid-in capital 64,796 44,176 42,636
Retained income 2,342,402 2,105,145 2,044,650
Accumulated other comprehensive income (124,557) (110,358) (113,025)
--------- ---------- ----------
2,488,493 2,244,815 2,180,113
Less - common stock in treasury-at cost 508,155 470,903 404,112
Unearned compensation on
restricted stock 22,814 12,868 15,567
---------- ---------- ----------
Total shareholders' equity 1,957,524 1,761,044 1,760,434
---------- ---------- ----------
Total Liabilities & Shareholders'
Equity $5,472,211 $4,931,444 $5,086,687
========== ========== ==========
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Cash Flows
------------------------------------
For The Nine Months Ended September 30, 2001 and 2000
------------------------------------------------------
2001 2000
--------- ---------
(in thousands)
Cash flows from operating activities
---------------------------------------------
Net income $ 379,876 $ 297,716
Cumulative change in accounting principle - 68,122
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation 65,668 64,207
Amortization of goodwill and intangibles 67,222 45,583
Amortization of prepublication costs 197,342 170,779
Provision for losses on accounts receivable 39,302 34,341
Gain on sale of Tower Group - (16,587)
Gain on sale of Real Estate (6,925) -
Other (7,504) (6,109)
Changes in assets and liabilities net of effect of
acquisitions and dispositions:
Increase in accounts receivable (247,032) (302,434)
Increase in inventories (37,724) (60,006)
Decrease in prepaid and other current assets 13,651 20,062
Decrease in accounts payable, accrued
expenses and other current liabilities (56,639) (110,070)
Increase in unearned revenue 4,262 17,579
(Decrease)/increase in other current liabilities (13,264) 25,852
Increase in interest and income taxes
currently payable 201,138 74,759
Decrease/(increase) in deferred income taxes 347 (21,290)
Net change in other assets and liabilities (15,634) (14,052)
--------------------------------------------------- ---------- ----------
Cash provided by operating activities 584,086 288,452
---------------------------------------------------- ---------- ----------
Investing activities
Investment in prepublication costs (188,415) (163,464)
Purchases of property and equipment (69,921) (53,142)
Acquisition of businesses, net of cash acquired (332,957) (676,988)
Disposition of property, equipment and businesses 17,904 142,350
--------------------------------------------------- --------- ----------
Cash used for investing activities (573,389) (751,244)
--------------------------------------------------- --------- ----------
Financing activities
Net additions to commercial paper borrowings 194,064 683,925
Dividends paid to shareholders (142,619) (136,879)
Exercise of stock options 52,804 37,236
Repurchase of treasury shares (114,652) (85,635)
Other (278) (1,106)
--------------------------------------------------- ---------- ----------
Cash (used for)/provided by financing activities (10,681) 497,541
--------------------------------------------------- ---------- ----------
Effect of exchange rate fluctuations on cash (1,414) (4,480)
---------- ----------
Net change in cash and equivalents (1,398) 30,269
Cash and equivalents at beginning of period 3,171 6,489
--------------------------------------------------- ---------- ----------
Cash and equivalents at end of period $1,773 $36,758
========== ==========
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Financial Statements
-----------------------------
1. 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 month periods
ended September 30, 2001 and 2000 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, 2000.
Certain prior year amounts have been reclassified for comparability
purposes.
2. The following table is a reconciliation of the company's net income to
comprehensive income for the three-month and nine-month periods ended
September 30:
Three Months Nine Months
---------------------- ----------------------
2001 2000 2001 2000
--------- ---------- --------- ---------
(in thousands)
Net income $ 239,488 $ 215,611 $ 379,876 $ 297,716
Other comprehensive income,
net of tax: Foreign currency
translation adjustment 3,236 (7,521) (14,199) (25,294)
--------- --------- --------- ---------
Comprehensive income $ 242,724 $ 208,090 $ 365,677 $ 272,422
========= ========= ========= =========
3. The company has three reportable segments: McGraw-Hill Education, Financial
Services, and Information and Media Services. McGraw-Hill Education
provides educational and reference materials for all levels, from preschool
to lifelong learning, for students and professionals. The Financial
Services segment consists of Standard & Poor's operations, which provide a
wide range of financial information, credit ratings and analysis globally.
The Information and Media Services segment includes business and
professional media offering information, insight and analysis.
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Financial Statements
-----------------------------
Operating profit by segment is the primary basis for the chief operating
decision maker of the company to evaluate the performance of each segment. A
summary of operating results by segment for the three months and nine months
ended September 30, 2001 and 2000 follows:
2001 2000
---------------------- ----------------------
Operating Operating
Revenue Profit Revenue Profit
--------- ---------- --------- ---------
(in thousands)
Three Months
------------
McGraw-Hill Education $998,776 $ 305,124 $847,710 $257,714
Financial Services 349,992 109,896 321,341 99,712
Information and Media Services 186,332 8,292 225,419 32,681
------------------------------ ---------- ---------- --------- ---------
Total operating segments 1,535,100 423,312 1,394,470 390,107
General corporate expense - (20,342) - (24,484)
Interest expense - net - (13,558) - (15,035)
------------------------------ ---------- ---------- ---------- ---------
Total company $1,535,100 $ 389,412* $1,394,470 $350,588*
========== ========== ========== =========
*Income before taxes on income.
2001 2000
---------------------- ----------------------
Operating Operating
Revenue Profit Revenue Profit
--------- ---------- --------- ---------
(in thousands)
Nine Months
------------
McGraw-Hill Education $1,872,684 $315,284 $1,531,806 $270,444
Financial Services 1,060,954 326,555 941,953 283,892
Information and Media Services 597,329 55,036 720,849 140,567
------------------------------ ---------- ---------- ---------- ----------
Total operating segments 3,530,967 696,875 3,194,608 694,903
General corporate expense - (53,819) - (64,426)
Interest expense - net - (46,459) - (35,618)
------------------------------ ---------- ---------- ---------- ----------
Total company $3,530,967 $596,597* $3,194,608 $594,859*
========== ========== ========== ==========
*Income before taxes on income.
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Financial Statements
-----------------------------
4. The allowance 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,
2001 2000 2000
---------- ---------- ----------
(in thousands)
Allowance for doubtful accounts $144,848 $137,741 $132,974
========== ========== ==========
Allowance for sales returns $136,201 $118,522 $128,283
========== ========== ==========
Inventories:
Finished goods $365,042 $324,852 $327,357
Work-in-process 29,970 24,231 53,901
Paper and other materials 42,482 39,864 38,735
---------- ---------- ----------
Total inventories $437,494 $388,947 $419,993
========== ========== ==========
Accumulated amortization of
prepublication costs $866,736 $757,034 $738,991
========== ========== ==========
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Financial Statements
-----------------------------
5. A subsidiary of J.J. Kenny Co. acts as an undisclosed agent in the purchase
and sale of municipal securities for broker-dealers and dealer banks and
the company had $337.1 million of matched purchase and sale commitments at
September 30, 2001. Only those transactions not closed at the settlement
date are included in Other Current Assets and Other Current Liabilities on
the balance sheet.
6. A summary of long-term debt follows:
Sept. 30, Dec. 31, Sept. 30,
2001 2000 2000
---------- ---------- ----------
(in thousands)
Commercial paper supported by
bank revolving credit agreement $789,085 $815,600 $949,840
Extendible Commercial Notes 180,000 - -
Other 1,532 1,929 4,947
---------- ---------- ----------
Total long-term debt $970,617 $817,529 $954,787
========== ========== ==========
Extendible Commercial Notes (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.
On August 14, 2001, the company's existing $625 million 364-day revolving credit
facility ("Existing 364-day Facility") expired and was replaced with a new $650
million 364-day revolving credit facility ("New 364-day Facility"). On October
10, 2001, an additional $25 million was added to the New 364-day Facility. The
New 364-day Facility agreement provides that the company may borrow until August
13, 2002, on which date the facility commitment terminates and the maturity of
such borrowings may not be later than August 13, 2003. The company pays a
facility fee of 5 basis points on the New 364-day Facility (whether or not
amounts have been borrowed) and borrowings may be made at a range of 15 to 20
basis points above LIBOR at the company's current credit rating. The New 364-day
Facility contains certain covenants, and the only financial covenant requires
that the company not exceed an indebtedness to cash flow ratio, as defined, of 4
to 1 at any time. This restriction, which was also in place under the Existing
364-day Facility, has never been exceeded. At September 30, 2001, there were no
borrowings under this facility or the company's existing 5-year facility.
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Financial Statements
-----------------------------
7. Common shares reserved for issuance for conversions and stock based awards
were as follows:
Sept. 30, Dec. 31, Sept. 30,
2001 2000 2000
---------- ---------- ----------
$1.20 convertible preference stock
at the rate of 13.2 shares for each
share of preference stock 17,530 17,530 17,530
Stock based awards 21,454,232 23,474,142 23,879,053
---------- ---------- ----------
21,471,762 23,491,672 23,896,583
========== ========== ==========
8. Cash dividends per share declared during the periods were as follows:
Three Months Nine Months
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
Common stock $.245 $.235 $.735 $.705
Preference stock $.300 $.300 $.900 $.900
9. A reconciliation of the number of shares used for calculating basic
earnings per common share and diluted earnings per common share for the
three months and the nine months ended September 30, 2001 and 2000 follows:
Three month period 2001 2000
------------------ ---------- ----------
(thousands of shares)
Average number of common shares outstanding 193,892 194,488
Effect of stock options and other dilutive securities 1,788 2,362
---------- ----------
195,680 196,850
========== ==========
Nine month period 2001 2000
---------------- ---------- ----------
(thousands of shares)
Average number of common shares outstanding 194,281 194,194
Effect of stock options and other dilutive securities 2,062 1,937
---------- ----------
196,343 196,131
========== ==========
Restricted performance shares outstanding at September 30, 2001 of 674,000
were not included in the computation of diluted earnings per common
shares because the necessary vesting conditions have not occurred.
10. In June 2001, the FASB issued FAS No. 143, Accounting for Asset
Retirement Obligations. FAS No. 143 requires that the fair value of
the liability for an asset retirement obligation be recognized in the
period which it is incurred if a reasonable estimate of fair value can
be made. The associated asset retirement costs are capitalized as part
of the carrying amount of the long-lived assets. This statement is
effective January 1, 2003. The company is currently evaluating this
pronouncement and does not believe it will have a material impact on
its financial statements.
In June 2001, the FASB issued FAS No. 141, Business Combinations, and
FAS No. 142, Goodwill and Other Intangible Assets. FAS No. 141 prohibits
the use of the pooling-of-interest method of business combinations
initiated after June 30, 2001. FAS No. 142 institutes new requirements
for testing goodwill and indefinitely lived intangible assets for
impairment instead of amortizing them. The effective date of this
pronouncement is January 1, 2002. Goodwill amortization for the nine
month periods ended September 30, 2001 and 2000 was approximately $51
million and $31 million, respectively.
The company adopted Staff Accounting Bulletin No.101 (SAB 101), Revenue
Recognition in Financial Statements, effective January 1, 2000. In
consideration of the views expressed in SAB 101, the company modified
its revenue recognition policies for various service contracts. Under
SAB 101, the company recognizes revenue relating to agreements where
it provides more than one service based upon the fair value to the
customer rather than recognizing revenue based on the level of service
effort to fulfill such contracts. The cumulative impact of the
accounting change at January 1, 2000 was $68.1 million, net of tax of
$46.7 million. The total amount of this cumulative adjustment that was
recognized for the nine months ended September 30, 2001 is $1.2
million.
Item 2. Management's Discussion and Analysis of Operating Results and
-------------------------------------------------------------
Financial Condition
-------------------
Operating Results - Comparing Periods Ended September 30, 2001 and 2000
-----------------------------------------------------------------------
Three Months
------------
Consolidated Review
-------------------
The Segment Review that follows is incorporated herein by reference.
Operating revenue for the quarter increased $140.6 million or 10.1% over the
prior year's quarter to $1.5 billion. This increase was due to growth in the
McGraw-Hill Education segment and continuing strong growth at Standard & Poor's
Credit Market Services in the Financial Services segment, offset somewhat by the
decline in advertising revenue in the Information and Media Services segment.
Included in the results of the McGraw-Hill Education segment are the results for
the acquisitions of Frank Schaffer Publications in late May 2001, Mayfield
Publishing in January 2001 and Tribune Education Company and Landoll, Inc.
(Tribune Education) in September 2000. Included in the Financial Services
segment are the results from the acquisition of PricewaterhouseCoopers' U.S.
Corporate Value Consulting business as of September 4, 2001. Included in the
Information and Media Services segment is the acquisition of Financial Times
Energy which was acquired on September 4, 2001.
Net income for the quarter increased $23.9 million, or 11.1% over the comparable
quarter in the prior year. Diluted earnings per share for the quarter were $1.22
versus $1.10 in the prior year, a 10.9% increase. Negatively affecting operating
results is the economic impact of the September 11th terrorist attacks.
Total expenses increased 9.9% due to normal recurring expenses, and the
introduction of new services and products.
Net interest expense decreased $1.5 million, 9.8%, as compared to the third
quarter in the prior year, primarily due to reduced interest rates. The average
interest rate on commercial paper borrowing for the quarter decreased from 6.6%
in 2000 to 3.8% in 2001.
The provision for taxes as a percent of income before taxes was 38.5%, the same
level as the third quarter of 2000.
Segment Review
--------------
McGraw-Hill Education's revenue increased 17.8% over the prior year third
quarter to $998.8 million. The segment's operating results include performances
by Frank Schaffer Publications, Mayfield Publishing and Tribune Education,
acquired in May 2001, January 2001 and September 2000, respectively.
SRA/McGraw-Hill performed well with its Open Court Reading program in North
Carolina and the open territories. The Wright Group contributed positively to
growth in the segment but not to the degree anticipated due to short-term
issues. Macmillan/McGraw-Hill had a strong performance from its reading program
in the Southeast and Midwest states. Macmillan/McGraw-Hill's elementary math
program did not perform as well as anticipated in California.
Glencoe/McGraw-Hill was negatively impacted by funding cuts in Alabama,
Mississippi, South Carolina and Virginia, as a result of the economic slowdown.
Its literature program performed well in Texas and Oklahoma. Glencoe/McGraw-Hill
also had less than anticipated results in California for its math and science
programs although it performed well in other adoption states. CTB/McGraw-Hill
had excellent growth primarily from custom contracts, particularly in Indiana,
Maryland, Mississippi and New York City. Children's Publishing/McGraw-Hill
benefited from the acquisition of Frank Schaffer Publications in May 2001, but
was negatively impacted by a weak economic environment, deep discounting and
order fulfillment integration issues. The Higher Education Group had strong
frontlist sales. Important revised titles included Mader, Biology, 7/e; Bluman,
Elementary Statistics, 4/e; Libby, Financial Accounting, 3/e; Thompson,
Strategic Management, 12/e. Continued softness in computer and trade titles
negatively impacted the Professional Book operation, which was selling in a
difficult economic environment. International Publishing showed growth in
Canada, Australia, and Asia Pacific, which was more than offset by declines,
primarily in Latin America. Operating profit for McGraw-Hill Education segment
increased 18.4% to $305.1 million, reflecting the acquisitions and the seasonal
nature of the businesses. Educational Publishing will have slower growth in 2002
as there are lighter adoptions in 2002 than 2001.
Financial Services' revenue increased 8.9% to $350.0 million and operating
profit increased 10.2% to $109.9 million as compared to third quarter 2000
results. Included in the results is the acquisition of PricewaterhouseCoopers'
U.S. Corporate Value Consulting (CVC) business on September 4, 2001. CVC
provides valuation and value analysis to major U.S. companies for financial
reporting, tax, business combinations, corporate restructurings, capital
allocation and capital structure purposes. Following the attack on the World
Trade Center, the shutdown of the financial markets resulted in reduced
transaction revenue for the Financial Services segment. Standard & Poor's Credit
Market Services' revenue and operating profit experienced double digit
increases, as new issues dollar volume in the U.S. bond market increased 13.8%
despite European bond issuance decreases of 25.5%. Strong growth in Structured
Finance, Corporate Finance, Financial Services and Public Finance contributed to
the results. Non-traditional products, particularly those internationally, grew
at a faster rate than the domestic business. About 30% of Standard & Poor's
Credit Market Services' revenue was generated in international markets for the
third quarter. Standard & Poor's Information Services' revenue and operating
profits were up slightly as growth in index services, portfolio services and the
sale of content and quote feeds to financial websites and Internet
redistributors was somewhat offset by shortfalls in the secondary municipal
markets, services for foreign exchange markets and continued investment in new
products and services.
Information and Media Services' revenue decreased $39.1 million, or 17.3%, to
$186.3 million as compared to the 2000 third quarter results. Operating profit
decreased $24.4 million, or 74.6% to $8.3 million as compared to the third
quarter of 2000. A slowdown in the advertising market, intensified after the
September 11th attacks, negatively impacted both the Business-to-Business Group
and Broadcasting. This weak environment is anticipated to exist for the next two
quarters. At BusinessWeek, advertising pages in the third quarter were off 40.1%
according to the Publishers Information Bureau. Aviation Week was negatively
impacted by the economic slowdown and by comparison to the prior year which
included the biennial Farnborough Air Show. Platts' revenue benefited from the
acquisition of Financial Times Energy, a provider of energy information,
research and consulting services from Pearson plc on September 4, 2001. Platts
was negatively effected by declines in advertising, acquisition costs and
increased technology investments. The Construction Information Group benefited
from revenue gains at Sweet's and cost savings, particularly at F.W. Dodge,
however, advertising declined at Engineering News Record. The Healthcare
Information Group showed declines due to reduced advertising spending.
Broadcasting showed declines due to the lack of political advertising in 2001,
the effects of post September 11th news coverage pre-emption of regular
programming and declines in advertising due to the weak economy. National and
local time sales were down.
Nine months
-----------
Consolidated Review
-------------------
The Segment Review that follows is incorporated herein by reference.
For the first nine months of the year, revenue increased 10.5%, or $336.4
million, to $3.5 billion. The revenue increase reflects the growth and
acquisitions in the McGraw-Hill Education segment and the solid growth at
Standard & Poor's Credit Market Services, somewhat offset by declines in
advertising revenue. All segments reflect the negative economic impact of the
September 11th attacks. Net income was $379.9 million, an increase of $82.2
million over the nine month period ended September 30, 2000. In May 2001, the
company purchased Frank Schaffer Publications, in January 2001, Mayfield
Publishing, and in September 2000 Tribune Education Company and Landoll, Inc.
(Tribune Education). The results of these operations are reflected in the
McGraw-Hill Education segment. On September 4, 2001, the company purchased
Corporate Value Consulting (CVC) from PricewaterhouseCoopers and its results are
accounted for in the Financial Services segment. As part of a restructuring
initiative, in early May 2001, the company divested DRI, which resulted in a
$26.3 million after tax gain (13 cents per diluted share, $8.8 million pretax),
recorded within the Financial Services segment. Also included in net income in
the Financial Services segment is the write-down of certain assets, the shutdown
of the Blue List and the contribution of Rational Investor to mPower.com in
exchange for an equity position in the online investment advisory service for
the retirement market. The total charge for these items was $21.9 million after
tax, (11 cents per diluted share, $22.8 million pretax). On September 4, 2001,
the company purchased Financial Times Energy (FT Energy) from Pearson plc, and
its results are recorded in the Information and Media Services segment. Net
income also includes $6.9 million pretax, 2 cents per diluted share, related to
a gain on the sale of real estate in the first quarter of 2001, which was
recorded as other income in the consolidated statement of income. In February
2000, Tower Group International was divested, and an after-tax gain of $10.2
million, or 5 cents per diluted share, was recorded in the Information and Media
Services segment. In January 2000, the company adopted Staff Accounting Bulletin
No. 101 (SAB101), Revenue Recognition in Financial Statements, and recognized a
cumulative adjustment of $68.1 million, net of tax, or 35 cents per diluted
share.
Total expenses increased 12.0% due to new and acquired products and services and
increases in normal recurring expenses, somewhat offset by cost containment
activities.
Net interest expense increased 30.4% to $46.5 million from $35.6 million for the
comparable period in 2000. The primary reason for the increase is higher debt
levels due to acquisitions, primarily Tribune Education, somewhat offset by a
decrease in interest rates. The average interest rate for commercial paper
borrowing decreased from 6.3% in 2000 to 5.0% in 2001.
The provision for taxes as a percent of income before taxes was 36.3%, 2.2% less
than the first nine months of 2000. The change in the effective tax rate is
primarily the result of the additional tax benefit from the DRI divestiture.
Segment Review
--------------
McGraw-Hill Education's revenue increased 22.2% to $1.9 billion over the same
nine months of 2000. Operating profits climbed 16.6% over the comparable period
in 2000 to $315.3 million. The segment's operating results include those of
Frank Schaffer Publications, Mayfield Publishing, and Tribune Education,
acquired in May 2001, January 2001, and September 2000, respectively.
SRA/McGraw-Hill performed well with its Open Court Reading program in North
Carolina, California, Florida and the open territories. The Wright Group
contributed positively to the growth of the segment, but not to the degree
anticipated due to short-term issues. Macmillan/McGraw-Hill performed well with
its social studies program. Its reading program had a strong performance in the
Southeast and Midwest states. Macmillan/McGraw-Hill's results for its elementary
math program in California were less than anticipated. Glencoe/McGraw-Hill was
negatively impacted by funding cuts in South Carolina, Alabama, Mississippi and
Virginia, as a result of the economic slowdown. Glencoe/McGraw-Hill also had
less than anticipated results in California for its math and science programs.
CTB/McGraw-Hill had an excellent nine months with its custom contracts.
Children's Publishing/McGraw-Hill benefited from the acquisition of Frank
Schaffer Publications in May 2001, but was negatively impacted by a weak
economic environment, discounting and order fulfillment integration issues. The
Higher Education Group had strong frontlist and backlist sales. The Professional
Book operation grew revenue in part from the introduction of the 15th edition of
Harrison's Principles of Internal Medicine. International Publishing showed
growth in Canada, Europe and Asia Pacific, which was more than offset by
declines, primarily in Latin America. Educational Publishing will have slower
growth in 2002 as there are lighter adoptions in 2002 than 2001.
Financial Services' revenue increased $119.0 million to $1.1 billion for the
first nine months as compared to the same period in 2000. Included in the
results is the acquisition of PricewaterhouseCoopers' U.S. Corporate Value
Consulting (CVC) business as of September 4, 2001. CVC provides valuation and
value analysis to major U.S. companies for financial reporting, tax, business
combinations, corporate restructurings, capital allocation and capital structure
purposes. The segment results were negatively impacted by the shut down of the
financial markets subsequent to the September 11th attacks, which resulted in a
reduction in transactional volume. As part of a restructuring initiative in the
second quarter of 2001, the divestiture of DRI negatively impacted the revenue
comparison by $20.2 million. Standard & Poor's Credit Market Services' revenue
and operating profit experienced double-digit increases as new issue dollar
volume in the U.S. bond market increased 47.0% and European bond issuance
increased 3.3%. Strong performances at Structured Finance, Corporate Finance,
Financial Services and Public Finance contributed to the results.
Non-traditional products, particularly internationally, grew at a faster rate
than the domestic, traditional business. Standard & Poor's Information Services
showed an increase in revenue from retail markets, index and portfolio services
and Compustat. Operating profit declined primarily due to continued investment
in fund services and softness in the foreign exchange and the secondary
municipal markets. Included in the Financial Services' results is the gain on
the sale of DRI for $8.8 million pretax ($26.3 million after tax, 13 cents per
diluted shares). Also impacting Financial Services' results is the write-down of
selected assets, the shutdown of the Blue List and the contribution of Rational
Investor to mPower.com in exchange for an equity position in the online
investment advisory service for the retirement market. The total charge for
these items was $22.8 million pretax ($21.9 million after tax, 11 cents per
diluted share).
Information & Media Services' revenue decreased $123.5 million, or 17.1%, to
$597.3 million for the first nine months as compared to the same period in 2000.
Operating profit decreased $85.5 million, or 60.8%, for the first nine months as
compared to the same period in 2000. The segment, which was already experiencing
a slowdown in the advertising market, was negatively impacted by the September
11th attacks. This weak environment is anticipated to exist for the next two
quarters. Included in the results is the impact of the acquisition of Financial
Times Energy (FT Energy) by Platts. Included in 2000 revenue was $18.7 million
from Tower Group International, which negatively impacted the year-to-year
growth comparison by 2.2%. Included in the operating profit for the segment for
2000 was the gain on the sale of Tower Group International representing $16.6
million ($10.2 million after tax, or 5 cents per diluted share). The divestiture
of Tower Group International also negatively impacted operating profit by 7.4%.
At BusinessWeek advertising pages year-to-date were off 35.1% according to the
Publishers Information Bureau. Aviation Week benefited from the Paris Air Show,
but was negatively impacted by the lack of the Farnborough Air Show, which
occurred in the third quarter of 2000. Construction Information Group was up
year-to-date as compared to the same period for 2000 as cost savings initiatives
out weighed declines in revenue at F.W. Dodge and at Engineering News Record.
The Healthcare Information Group showed declines due to reduced advertising
spending. Broadcasting had a difficult comparison to 2000 due to the lack of
political advertising and the lack of the Super Bowl in 2001. National and local
time sales were down as well.
Financial Condition
-------------------
The company continues to maintain a strong financial position. Cash provided by
operating activities for the first nine months totaled $584.1 million compared
to $288.5 million for the same period in the prior year. Total debt increased
$193.7 million since year-end, primarily due to the acquisitions made by the
company in 2001. The company's strong presence in school and higher education
publishing significantly impacts the seasonality of its earnings and borrowing
patterns during the year, with the company borrowing during the first half of
the year and generating cash in the second half of the year, particularly in the
fourth quarter.
Commercial paper borrowings at September 30, 2001 totaled $986.4 million, a
decrease of $33.1 million from December 31, 2000. The commercial paper
borrowings were supported through August 14, 2001 by two revolving credit
agreements, each with the same domestic and international banks, consisting of a
$625 million, five-year revolving credit facility and a $625 million, 364-day
revolving credit facility ("Existing 364-day Facility"). On August 14, 2001 the
company obtained a new 364-day credit facility for $650 million, ("New 364-day
Facility") as the company's Existing 364-day Facility expired. On October 10,
2001 an additional $25 million was added to the New 364-day Facility. The New
364-day Facility agreement provides that the company may borrow until August 13,
2002, on which date the facility commitment terminates and the maturity of such
borrowings may not be later than August 13, 2003. The New 364-day Facility is
with predominately the same group of banks as the Existing 364-day Facility. The
company pays a facility fee of 5 basis points on the New 364-day Facility
(whether or not amounts have been borrowed) and borrowings may be made at a
range of 15 to 20 basis points above LIBOR at the company's current credit
rating. The New 364-day Facility contains certain covenants, and the only
financial covenant requires that the company not exceed an indebtedness to cash
flow ratio, as defined, of 4 to 1 at any time. This restriction, which was also
in place under the Existing 364-day Facility, has never been exceeded. At
September 30, 2001, there were no borrowings under any of these facilities.
The company also has $225.0 million of extendible commercial notes (ECNs)
outstanding as of September 30, 2001. Eighty percent or $789.1 million, of the
commercial paper borrowings and $180.0 million of the ECNs outstanding are
classified as long-term. 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.
Under a shelf registration that became effective with the Securities and
Exchange Commission in 1990, the company can issue an additional $250 million of
debt securities. The new debt could be used to replace a portion of the
commercial paper borrowings with longer-term securities when and if interest
rates are attractive and markets are favorable.
Gross accounts receivable of $1.6 billion increased from year-end due primarily
to seasonality of the education business and the acquisition of Frank Schaffer
Publications, Mayfield Publishing, the U.S. Corporate Value Consulting of
PricewaterhouseCoopers and Financial Times Energy. Inventories increased $48.6
million from the end of 2000 because of the anticipated higher sales in
education in its selling season and as a result of acquisitions.
Net prepublication cost decreased $7.1 million from the end of 2000 to $510.9
million, as amortization expense exceeded spending. Prepublication cost spending
in the third quarter totaled $72.8 million, an increase of $13.8 million over
last year's third quarter spending, which did not include Frank Schaffer
Publications, Mayfield Publishing or two months of Tribune Education.
Prepublication cost spending through the third quarter totaled $188.4 million,
an increase of $25.0 million over last year's spending for the same period.
Purchases of property and equipment were $69.9 million, $16.8 million higher
than the prior year comparable period.
The Board of Directors approved a 4.3% increase in the quarterly common stock
dividend to $0.245 per share in January 2001. In 1999, the Board of Directors
authorized a stock repurchase program of up to 15 million shares. The
repurchased shares will be used for general corporate purposes, including the
issuance of shares for the exercise of employee stock options. Purchases under
this program may be made from time to time on the open market in private
transactions depending on market conditions. Approximately 8.1 million shares
have been repurchased under this program.
"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 business, new products, sales,
expenses, cash flows, and operating and capital requirements. Such
forward-looking statements included, but are not limited to: McGraw-Hill
Education's level of success in adoptions and the level of educational funding;
the strength of higher education, professional and international publishing
markets; the strength of profit levels and the capital markets in the U.S. and
abroad with respect to Standard & Poor's; the strength of the domestic and
international advertising markets; the level of future cash flow, debt levels,
capital expenditures and prepublication cost investment; the level of success in
new product development; and the expected financial impact of the Tribune
Education acquisition on the company's financial condition.
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 on various important factors, including but not limited
to: worldwide economic and political conditions, the health of capital and
equity markets, currency and foreign exchange volatility, continued state and
local funding for educational matters, expenditures for advertising, the
successful marketing of new products, 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, 2000.
Part II
Other Information
Item 1. Legal Proceedings
-----------------
In Registrant's Form 10-Q for the quarter ended June 30, 2001, Registrant
reported that a summons was served on June 20, 2001 in an action brought by
L'Association Francaise des Porteurs d'Emprunts Russes (AFPER) against Standard
& Poor's SA (an indirect subsidiary of the Registrant) in the Court of First
Instance of Paris, France. In this suit, AFPER, a group of holders of
pre-Revolutionary Russian bonds, makes claims against Standard & Poor's and
another rating agency for lack of diligence and prudence in their ratings of
Russia and Russian debt. AFPER alleges that, by failing to take into account the
post-Revolutionary repudiation of pre-Revolutionary Czarist debt by the Soviet
government in rating Russia and new issues of Russian debt beginning in 1996,
the rating agencies enabled the Russian Federation to issue new debt without
repaying the old obligations of the Czarist government. Alleging joint and
several liability, AFPER seeks damages of 17.85 billion francs (approximately
$2.49 billion), plus 50,000 francs (approximately $7,000) under certain
provisions of the French Code of Civil Procedure and legal costs. The Registrant
believes that the allegations lack legal or factual merit and intends to
vigorously contest the action. During the period covered by this Report on Form
10-Q, no material developments occurred in this litigation.
Item 6. Exhibits and Reports on Form 8-K Page Number
-------------------------------- -----------
(a) Exhibits
(10) 364-Day Credit Agreement dated as of August 14,
2001 among the Registrant, the lenders listed
therein, and The Chase Manhattan Bank, as
administrative agent, incorporated by reference
from the Registrant's Form 8-K dated August 17,
2001.
(12) Computation of Ratio of Earnings to Fixed Charges; 22
(b) Reports on Form 8-K.
A Form 8-K was filed on, and dated, August 17, 2001,
with respect to item 5 of said Form.
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: By
-------------------- -------------/s/-----------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
Date: By
-------------------- -------------/s/-----------------
Kenneth M. Vittor
Executive Vice President
and General Counsel
Date: By
-------------------- -------------/s/-----------------
Talia M. Griep
Senior Vice President
and Corporate Controller
Exhibit (12)
The McGraw-Hill Companies, Inc.
-------------------------------
Computation of Ratio of Earnings to Fixed Charges
-------------------------------------------------
Periods Ended September 30, 2001
--------------------------------
Nine Twelve
Months Months
--------- ---------
(in thousands)
Earnings
Earnings from continuing operations
before income tax expense and
extraordinary item (Note) $ 589,187 $ 758,619
Fixed charges 79,131 106,112
---------- ----------
Total Earnings $ 668,318 $ 864,731
========== ==========
Fixed Charges (Note)
Interest expense $ 48,620 $ 66,369
Portion of rental payments deemed to be
interest 30,511 39,743
---------- ----------
Total Fixed Charges $ 79,131 $ 106,112
========== ==========
Ratio of Earnings to Fixed Charges 8.4x 8.1x
<FN>
(Note) For purposes of computing the ratio of earnings to fixed charges,
"earnings from continuing operations before income taxes" excludes
undistributed equity in income of less than 50%-owned companies.
"Fixed charges" consist of (1) interest on debt, and (2) the portion of
the company's rental expense deemed representative of the interest
factor in rental expense.
Earnings from continuing operations before income taxes for the nine
month and twelve month periods ended September 30, 2001 includes a
$6.9 million pretax gain on the sale of real estate, a one-time
gain on the sale of DRI ($8.8 million pretax), the write-down of
selected assets, the shutdown of the Blue List and the contribution of
Rational Investor to mPower.com ($22.8 million pretax).
</FN>