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 March 31, 2003
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer.
X
---
On April 15, 2003 there were approximately 190.7 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
-------
Review Report of Independent Accountants 3
Consolidated Statement of Income for
the three months ended March 31, 2003 and 2002 4
Consolidated Balance Sheet at March 31, 2003,
December 31, 2002 and March 31, 2002 5-6
Consolidated Statement of Cash Flows for the three 7
months ended March 31, 2003 and 2002
Notes to Consolidated Financial Statements 8-12
Item 2. Management's Discussion and Analysis of Operating
------ Results and Financial Condition 13-18
Item 3. Quantitative and Qualitative Disclosures About
------ Market Risk 18
Item 4. Controls and Procedures 18
------
Part II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 19
------
Item 6. Exhibits and Reports on Form 8-K 19-27
------
<page>
Independent Accountant's Review Report
The Board of Directors and Shareholders
of The McGraw-Hill Companies, Inc.
We have reviewed the accompanying consolidated balance sheet of The
McGraw-Hill Companies, Inc., as of March 31, 2003, and the related consolidated
statement of income for the three-month periods ended March 31, 2003 and 2002,
and the consolidated statement of cash flows for the three-month periods ended
March 31, 2003 and 2002. These financial statements are the responsibility of
the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying consolidated financial statements referred to
above for them to be in conformity with accounting principles generally accepted
in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of The McGraw-Hill
Companies, Inc. as of December 31, 2002, 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 January 28, 2003, 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, 2002, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
Ernst & Young LLP
April 29, 2003
<page>
Part I
Financial Information
---------------------
Item 1. Financial Statements
---------------------
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Income
--------------------------------
Three Months Ended March 31, 2003 and 2002
------------------------------------------
<Caption>
2003 2002
---------- ----------
(in thousands, except per share data)
Revenue (Note 3)
Product revenue $ 301,611 $ 309,366
Service revenue 544,932 521,177
----------- -----------
Total revenue 846,543 830,543
Operating expenses
Product 183,173 186,056
Service 193,297 206,145
----------- -----------
376,470 392,201
Selling and general expenses
Product 192,034 186,336
Service 194,624 173,849
----------- -----------
386,658 360,185
Depreciation 20,882 23,209
Amortization of intangibles 8,643 9,886
----------- -----------
Total expenses 792,653 785,481
Other income - net 9,437 7,141
----------- -----------
Income from operations 63,327 52,203
Interest expense 2,679 6,422
----------- -----------
Income from continuing operations before taxes on
income 60,648 45,781
Provision for taxes on income 22,439 17,168
----------- -----------
Income from continuing operations $ 38,209 $ 28,613
Discontinued operations (Note 4):
Earnings from operations of discontinued component
(including gain on disposal of $86,953 in 2003) 87,490 942
Income tax expense 30,304 353
----------- -----------
Earnings on discontinued operations 57,186 589
----------- -----------
Net income (Notes 1 and 2) $ 95,395 $ 29,202
=========== ===========
Basic earnings per common share
Income from continuing operations $ 0.20 $ 0.15
Net income $ 0.50 $ 0.15
Diluted earnings per common share
Income from continuing operations $ 0.20 $ 0.15
Net income $ 0.50 $ 0.15
Average number of common shares outstanding: (Note 10)
Basic 190,933 192,889
Diluted 191,982 194,967
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
<caption>
March 31, Dec. 31, March 31,
2003 2002 2002
---------- ----------- ----------
(in thousands)
ASSETS
Current assets:
Cash and equivalents $ 96,053 $ 58,186 $ 20,782
Accounts receivable (net of allowance
for doubtful accounts and sales
returns) (Note 5) 716,945 991,806 826,056
Inventories (Note 5) 378,088 360,757 443,985
Deferred income taxes 167,354 169,829 218,795
Prepaid and other current assets (Note 6) 126,918 93,729 134,224
---------- ---------- ----------
Total current assets 1,485,358 1,674,307 1,643,842
---------- ---------- ----------
Prepublication costs (net of accumulated
amortization) (Note 5) 534,396 534,835 558,567
Investments and other assets:
Investment in Rock-McGraw, Inc. - at
equity 123,497 119,442 108,614
Prepaid pension expense 267,869 261,243 225,772
Other 221,810 205,243 224,412
---------- ---------- ----------
Total investments and other assets 613,176 585,928 558,798
---------- ---------- ----------
Property and equipment - at cost 1,055,810 1,071,953 1,078,312
Less - accumulated depreciation 635,059 640,493 639,656
---------- ---------- ----------
Net property and equipment 420,751 431,460 438,656
Goodwill - net 1,285,588 1,294,831 1,229,838
Copyrights - net 265,240 272,243 346,458
Other intangible assets - net 228,765 238,578 224,855
---------- ---------- ----------
Total assets $4,833,274 $5,032,182 $5,001,014
========== ========== ==========
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
<caption>
March 31, Dec. 31, March 31,
2003 2002 2002
---------- ---------- ----------
(in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ 121,810 $ 119,414 $ 228,887
Accounts payable 247,683 303,354 289,428
Accrued liabilities 249,535 437,461 245,840
Income taxes currently payable 114,795 82,016 67,623
Unearned revenue 560,961 538,961 530,450
Other current liabilities (Note 6) 334,406 294,085 343,761
---------- ---------- ----------
Total current liabilities $1,629,190 $1,775,291 $1,705,989
---------- ---------- ----------
Other liabilities:
Long-term debt (Note 7) 469,842 458,923 856,410
Deferred income taxes 194,949 200,114 182,953
Accrued postretirement healthcare and
other benefits 171,552 172,067 175,213
Other non-current liabilities 246,488 259,965 221,960
---------- ---------- ----------
Total other liabilities 1,082,831 1,091,069 1,436,536
---------- ---------- ----------
Total liabilities 2,712,021 2,866,360 3,142,525
---------- ---------- ----------
Shareholders' equity (Notes 8 & 9):
Capital stock 205,854 205,853 205,852
Additional paid-in capital 81,526 79,410 66,836
Retained income 2,715,792 2,672,086 2,272,407
Accumulated other comprehensive income (102,399) (103,965) (130,977)
---------- ---------- ----------
2,900,773 2,853,384 2,414,118
Less - common stock in treasury-at cost 765,756 669,499 541,946
Unearned compensation on restricted stock 13,764 18,063 13,683
---------- ---------- ----------
Total shareholders' equity 2,121,253 2,165,822 1,858,489
---------- ---------- ----------
Total liabilities & shareholders'
equity $4,833,274 $5,032,182 $5,001,014
========== ========== ==========
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Cash Flows
------------------------------------
Three Months Ended March 31, 2003 and 2002
--------------------------------------------------
2003 2002
---------- ---------
Cash flows from operating activities (in thousands)
- ---------------------------------------------
Net income $95,395 $29,202
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation 21,159 23,684
Amortization of intangibles 8,675 9,933
Amortization of prepublication costs 31,648 33,069
Provision for losses on accounts receivable 10,092 6,720
Gain on the sale of S&P Comstock (86,953) -
Other (4,926) (3,075)
Changes in assets and liabilities net of effect of
acquisitions and dispositions:
Decrease in accounts receivable 255,934 199,907
Increase in inventories (17,743) (42,069)
Increase in prepaid and other current assets (36,388) (34,913)
Decrease in accounts payable and accrued expenses (237,892) (189,916)
Increase in unearned revenue 23,469 24,759
Increase in other current liabilities 29,438 1,809
Increase/(decrease) in interest and income taxes
currently payable 32,537 (6,317)
Net change in deferred income taxes 3,408 (1,365)
Net change in other assets and liabilities (19,726) (25,970)
- --------------------------------------------------- --------- ---------
Cash provided by operating activities 108,127 25,458
- --------------------------------------------------- --------- ---------
Investing activities
- -------------------------
Investment in prepublication costs (38,648) (34,853)
Purchases of property and equipment (13,150) (9,386)
Acquisition of businesses and equity interests - 3,299
Disposition of property, equipment and businesses 121,881 314
Additions to technology projects (7,742) (21,894)
- --------------------------------------------------- --------- ---------
Cash provided by / (used for) investing activities 62,341 (62,520)
- --------------------------------------------------- --------- ---------
Financing activities
- ----------------------------
Additions to short-term debt - net 13,496 29,099
Dividends paid to shareholders (51,691) (49,137)
Repurchase of treasury shares (103,074) (5,653)
Exercise of stock options 7,679 30,630
Other (124) (111)
- --------------------------------------------------- --------- ---------
Cash (used for)/provided by financing activities (133,714) 4,828
- --------------------------------------------------- --------- ---------
Effect of exchange rate fluctuations on cash 1,113 (519)
--------- ---------
Net change in cash and equivalents 37,867 (32,753)
Cash and equivalents at beginning of period 58,186 53,535
- --------------------------------------------------- --------- ---------
Cash and equivalents at end of period $96,053 $20,782
========= =========
</table>
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated 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 months ended March 31,
2003 and 2002 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, 2002.
Certain prior year amounts have been reclassified for comparability
purposes.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provision of
SFAS No. 123, Accounting for Stock Based Compensation, to stock based
employee compensation: (in thousands except earnings per share)
<table>
<caption>
Three Months Ended March 31,
2003 2002
-------- --------
Net income, as reported $ 95,395 $ 29,202
Stock-based compensation cost included in net
income 2,985 2,345
Fair value of stock based compensation cost, net of tax (16,425) (12,353)
-------- --------
Pro forma net income $ 81,955 $ 19,194
Basic earnings per common share
As reported $ 0.50 $ 0.15
Pro forma $ 0.43 $ 0.10
Diluted earnings per common share
As reported $ 0.50 $ 0.15
Pro forma $ 0.43 $ 0.10
Basic weighted average shares outstanding 190,933 192,889
Diluted weighted average shares outstanding 191,982 194,967
</table>
2. The following table is a reconciliation of the Company's net income to
comprehensive income for the three month period ended March 31:
<table>
<caption>
2003 2002
--------- ---------
(in thousands)
Net income $95,395 $29,202
Other comprehensive income, net of tax:
Foreign currency translation adjustments 1,566 (4,117)
--------- ---------
Total other comprehensive income 1,566 (4,117)
--------- ---------
Comprehensive income $96,961 $25,085
========= =========
</table>
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
3. 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. The Financial Services segment consists of Standard & Poor's
operations including ratings, indexes, related financial and investment
analysis and information, and corporate valuation services. The Information
and Media Services segment includes business and professional media
offering information, insight and analysis. In February 2003 the Company
divested S&P Comstock, which was formerly part of the Financial Services
segment. S&P Comstock is reflected as a discontinued operation on the face
of the income statement.
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 months ended March 31, 2003 and 2002 follows:
<table>
<caption>
2003 2002
------------------- -------------------
Operating Operating
Revenue Profit Revenue Profit
-------- -------- -------- --------
(in thousands)
McGraw-Hill Education $277,159 $(72,805) $281,621 $(71,810)
Financial Services 394,895 144,991 364,769 132,312
Information and Media Services 174,489 12,476 184,153 11,962
------------------------------ -------- -------- -------- --------
Total operating segments 846,543 84,662 830,543 72,464
General corporate expense - (21,335) - (20,261)
Interest expense - (2,679) - (6,422)
------------------------------ -------- -------- -------- --------
Total Company $846,543 $ 60,648* $830,543 $ 45,781*
======== ======== ======== ========
</table>
*Income from continuing operations before taxes on income.
4. Sale of S&P Comstock In February 2003, the Company divested S&P
Comstock(Comstock), the real-time market data unit of Standard & Poor's.
The sale resulted in a $56.8 million after-tax gain (30 cents per diluted
share), $87.0 million pre-tax, recorded as part of the discontinued
operations reflected on the face of the income statement. Comstock was
formerly part of the Financial Services segment. The sale of Comstock to
Interactive Data Corporation resulted in $115.0 million in cash acquired,
an after-tax cash flow impact of $78.7 million, and a reduction in net
assets of $28.0 million, which includes a reduction in net goodwill and
intangible assets of $14.3 million. The revenue recorded from Comstock for
the quarter ended March 31, 2003 and March 31, 2002 was $11.1 million and
$16.1 million, respectively. Under the agreement with Interactive Data
Corporation, the Company's Financial Services segment will continue to
feature Comstock market data in a variety of its products and services, and
Comstock will continue to serve as a distributor of Standard & Poor's
information.
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
Comstock provides market data to Institutional Investors, Retail Brokers,
Financial Advisors and other users. The decision to sell Comstock is
consistent with the Financial Services strategy of leveraging the strength
of its equity and fund research information to provide unique data and
analysis to investment managers and investment advisors. As a result of
this refined strategy, the market data ComStock provides fell outside the
core capabilities that Financial Services is committed to growing.
5. The allowance for doubtful accounts and sales returns, the components of
inventory and the accumulated amortization of prepublication costs were as
follows:
<table>
<caption>
March 31, Dec. 31, March 31,
2003 2002 2002
---------- ---------- ----------
(in thousands)
Allowance for doubtful accounts $100,134 $105,532 $146,172
========== ========== ==========
Allowance for sales returns $108,695 $135,529 $107,514
========== ========== ==========
Inventories:
Finished goods $340,567 $314,420 $392,518
Work-in-process 13,909 18,128 21,147
Paper and other materials 23,612 28,209 30,320
---------- ---------- ----------
Total inventories $378,088 $360,757 $443,985
========== ========== ==========
Accumulated amortization of
prepublication costs $792,100 $924,867 $740,878
========== ========== ==========
</table>
6. 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 $613.4 million of matched purchase and sale commitments at
March 31, 2003. Only those transactions not closed at the settlement date
are reflected in the balance sheet as receivables and payables.
7. A summary of long-term debt follows:
<table>
<caption>
March 31, Dec. 31, March 31,
2003 2002 2002
---------- ---------- ----------
(in thousands)
Commercial paper supported by
bank revolving credit agreements $469,440 $458,480 $854,960
Other 402 443 1,450
--------- --------- ---------
Total long-term debt $469,842 $458,923 $856,410
========= ========= =========
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
8. Common shares reserved for issuance for conversions and stock based awards
were as follows:
March 31, Dec. 31, March 31,
2003 2002 2002
---------- ---------- ----------
$1.20 convertible preference stock
at the rate of 13.2 shares for
each share of preference stock - - 17,530
Stock based awards 28,339,922 28,647,063 20,278,945
---------- ---------- ----------
28,339,922 28,647,063 20,296,475
========== ========== ==========
</table>
In the third quarter of 2002 the Company redeemed all of the outstanding
shares of $1.20 convertible preference stock. The redemption price of $40
per share, as provided by the terms of the preference stock, became payable
to holders, who did not otherwise convert their shares into the Company's
common stock, on September 1, 2002. Most holders elected conversion prior
to redemption. None of the convertible preference shares provided a
beneficial conversion feature at the time they were originally issued.
9. Cash dividends per share declared during the three months ended March 31,
2003 and 2002 were as follows:
2003 2002
---- ----
Common stock $.270 $.255
Preference stock - $.300
10. 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 ended March 31, 2003 and 2002 follows:
<table>
2003 2002
---------- ----------
(in thousands)
Average number of common shares outstanding 190,933 192,889
Effect of stock options and other dilutive
securities 1,049 2,078
---------- ----------
Average number of common shares outstanding
including effect of dilutive securities 191,982 194,967
========== ==========
</table>
Restricted performance shares outstanding at March 31, 2003 of 480,000 were
not included in the computation of diluted earnings per common shares
because the necessary vesting conditions have not yet been met.
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
11. In November 2002, the Emerging Issues Task Force ("EITF") reached consensus
on EITF 00-21, Accounting for Revenue Relationships with Multiple
Deliverables. This pronouncement addresses how to account for
multiple-element revenue arrangements and focuses on when a revenue
arrangement should be separated into components or deliverables, or
alternatively, when smaller deliverables or elements should be combined for
purposes of recognizing revenue. The final consensus is applicable to
agreements entered into in fiscal periods beginning after June 15, 2003
with early adoption permitted. Management does not believe that this will
have a material impact on the Company's financial statements.
<page>
Item 2. Management's Discussion and Analysis of Operating Results and
- ------- -------------------------------------------------------------
Financial Condition
-------------------
Operating Results - Comparing Three Months Ended March 31, 2003 and 2002
- ----------------------------------------------------------------------------
Consolidated Review
- -------------------
The Segment Review that follows is incorporated herein by reference.
Operating revenue for the first quarter increased slightly, 1.9%, to $846.5
million, as compared to the prior year's first quarter. The revenue increase is
primarily attributable to growth in the Financial Services segment. Product
revenue declined by 2.5% to $301.6 million as compared to the prior year's first
quarter. Service revenue increased to $544.9 million, an increase of 4.6% as
compared to the prior year's first quarter. Other income increased to $9.4
million from $7.1 million in the first quarter of 2002. The increase in other
income is attributed to a gain in foreign exchange and an increase in income
from equity investments.
Income from continuing operations increased $9.6 million to $38.2 million
over 2002 first quarter results. Excluded from the results of continuing
operations is Comstock, which was disposed of in February 2003. Comstock was
formerly part of the Financial Services segment. The disposition contributed
$87.5 million pre-tax and $57.2 million after-tax or 30 cents per diluted share.
Net income for the quarter increased $66.2 million over the comparable quarter
in the prior year. Diluted earnings per share for the quarter were $0.50 versus
$0.15 in the prior year. In September 2002, the Financial Services segment
divested MMS International, which accounted for a 1.2% decrease in revenue and a
1.0% decrease in operating profit for the first quarter of 2003 as compared to
the first quarter of 2002.
Total expenses in the first quarter of 2003 increased slightly due to cost
containment activities. Operating expenses include the amortization of
prepublication costs of $31.6 million for the first quarter 2003. Product
operating expenses remained relatively flat with the comparable prior year first
quarter. Service operating expenses decreased 6.2% due to cost containment
efforts. Selling and general product expenses increased $5.7 million because of
technology spending. Selling and general service expenses increased primarily
from the growth of the Financial Services segment. Amortization of
prepublication costs decreased by $1.4 million as compared with the first
quarter of 2002. The decline in stock market performance for the last three
years has negatively impacted the return on the Company's pension assets.
Additionally, the Company has changed its investment return and discount
assumptions for the Company's U.S. retirement plans effective January 1, 2003
resulting in a decline in net pension income for the first quarter 2003 as
compared with 2002.
Interest expense decreased 58.3% to $2.7 million from $6.4 million in the
first quarter of 2002. The primary reasons for the decrease are the reduced
average debt outstanding and the reduction in the average interest rate for the
first quarter of 2003 as compared to the same period in 2002. Average commercial
paper levels decreased from $995.7 million for the first quarter of 2002 to
$537.5 million in 2003. The average interest rate on commercial paper borrowings
decreased from 1.9% in 2002 to 1.3% in 2003. Lower average debt levels accounted
for $2.2 million of the decrease and lower average interest rates for $0.8
million.
The provision for taxes as a percent of income before taxes is 37.0%, 0.5%
less than the first quarter in 2002. The change in the effective tax rate is
primarily the result of the increase in foreign source income.
<page>
Segment Review
- --------------
McGraw-Hill Education's revenue and operating profit declined slightly as
compared with the first quarter of 2002. The results reflect the weak economic
conditions impacting the School Education Group partially offset by solid
revenue results in McGraw-Hill Higher Education, Professional and International
Group (HPI). The segment's performance reflects the seasonal nature of its
business, with the first quarter the least significant. To support the segment's
global growth objectives, the Global Transformation Project is expanding in
scope and complexity. The enhanced project is anticipated to cost $180.0
million, up from $140.0 million. The increase in spending is the result of the
customization of software and the enhancement of features, which include
customer self-service, the development of a business-to-business web catalog,
and a global data warehouse. These and other features will improve efficiencies
and provide the basis for increased revenues.
The McGraw-Hill School Education Group's revenue declined 6.3% to $127.9
million, as economic conditions negatively impacted sales of supplemental
educational materials and adoption and open territory opportunities. The
supplemental education market is particularly vulnerable to economic conditions
that can have an impact on such discretionary spending. Sales of children's
supplemental educational materials through the educational dealer and trade
markets have been affected by decreased foot traffic in retail and specialty
stores, as consumers react to a struggling economy and an uncertain economic
future by reducing purchases. In addition, prior year first quarter sales
include coloring and activity books and magazines, product lines which were
discontinued in the latter part of 2002. Sales of supplemental educational
materials to U.S. school systems are dependent on grant and supplemental
funding. States grappling with the sluggish economy and the subsequent budget
shortfalls have postponed purchases of supplemental materials in favor of
required texts. This, however, may be a temporary reaction. As states and school
districts sort through the budget issues and full year 2004 budgets are
approved, it is possible that additional funds will become available,
particularly through the No Child Left Behind Act, or that some schools will
decide it is preferable to delay large purchases of text books while filling the
gap with smaller purchases of supplemental learning materials. State budgetary
gaps are also negatively impacting the School Education Group's adoption and
open territory opportunities. Initially the industry was anticipated to grow
2-4% in 2003. During January and February, state budget gaps grew by 50% and the
latest National Conference of State Legislatures survey reports that two-thirds
of the states must reduce their budgets by nearly $26 billion between now and
June 30, when most states fiscal years end. Kentucky responded to fiscal
pressure by postponing this year's elementary math adoption. In Texas there is a
proposal that would shift several grade adoptions for social studies from 2003
to 2005 and conceivably shift or eliminate 2004 adoptions of business, family,
consumer and technical education. We also know that, as of April 28, 2003, 30
states have already received $541 million in Reading First grants from the
Department of Education. Based on these developments, we still expect the K-12
market to show improvement in 2003 after a 5% decline in 2002. Everyday Math
performed well in the first quarter of 2003 due to sales in Arizona,
Pennsylvania and South Carolina. Direct Instruction also had increased
year-over-year sales in South Carolina. New York City has adopted Everyday
Mathematics and Impact Mathematics which will contribute positively to the
School Education Group's open territory capture. Custom contract testing saw
delays into the second quarter, but the School Education Group continues to
invest in testing technology.
<page>
McGraw-Hill Higher Education, Professional and International Group had
revenue increase by 2.9% to $149.3 million for the first quarter of 2003.
Despite state budget problems, growth in the higher education market will be
driven by continued enrollment increases. Professional trade and reference
products performed well, especially in academic markets. Scientific, technical
and medical sales also increased over the prior year first quarter. The computer
and technology imprints still experienced softness. Higher education titles
performed well internationally, and only the Ibero region experienced weakness.
For the first quarter of 2002 the states mandate of a new graduate equivalency
test resulted in increased sales of study materials. No such comparable event
occurred for the first quarter of 2003.
Financial Services' revenue increased 8.3% to $394.9 million and operating
profit increased 9.6% to $145.0 million over 2002 first quarter results. In
February 2003, Comstock was disposed of and this divestiture is reflected as a
discontinued operation. In September 2002, the Financial Services segment
divested MMS International, which accounted for a 2.8% decrease in revenue and a
0.5% decrease in operating profit for the first quarter of 2003 as compared to
the first quarter of 2002.
The Financial Services segment increased revenue and operating profit due
primarily to the performance of structured finance, which represented
approximately 64.0% of the growth in revenue. New issue dollar volume in the
U.S. market was up 11.1% in the first quarter, according to Securities Data and
Harrison Scott Publications. European new issue dollar volume rose 39.2%
according to Bondware. U.S. new issue dollar volume for corporates for the first
quarter of 2003 decreased 5.2% while public finance grew 21.0%. Total U.S.
structured finance new issue dollar volume for the first quarter of 2003
increased 28.4%, driven by mortgaged-backed and asset-backed securities
issuance, which grew 38.8% and 21.1%, respectively, according to Harrison Scott
Publications. Bank loan ratings, counterparty credit ratings, public finance
financial strength ratings and global infrastructure ratings all experienced
higher growth rates than traditional ratings products. The financial services
industry overall continues to experience adverse market conditions and profit
pressures have resulted in various cost cutting actions by financial services
firms, including laying off staff. This has led to decreased demand for
information products and services, especially in the retail brokerage sector.
Despite the decline in demand for information products, managed fund ratings
performed well and index related products and services continue to experience
robust growth. Revenue related to the Standard & Poor's indices increased as
assets under management rose to $60.4 billion at March 31, 2003 from $51.5
billion at March 31, 2002. Assets under management at December 31, 2002 were
$63.2 billion. The lack of merger and acquisition activity continued to
negatively impact the sale of valuations, although volume increased from the
sale of non-valuation services, such as litigation support. According to
Bloomberg Mergers and Acquisitions Database as of March 2003, the dollar volume
and the number of announced deals involving a U.S. company each declined 8% as
compared to the first quarter of 2002.
Information and Media Services' revenue decreased $9.7 million, or 5.2% to
$174.5 million from 2002 first quarter results. Operating profit increased $0.5
million, or 4.3%, to $12.5 million from 2002 first quarter results. Revenue
declined at the Business-to-Business Group by 6.0% and remained flat at
Broadcasting. Both groups were negatively impacted by the continued soft
advertising market and the impact of the war with Iraq.
<page>
At BusinessWeek, advertising pages in the first quarter were up 2.2%
according to the Publishers Information Bureau, with one more issue published
than in 2002, but with the same number of issues for revenue recognition
purposes. Weakness was experienced in the international editions. Also in the
Business-to-Business Group, the Global Power conference took place in the first
quarter of 2002 and will take place in the second quarter of 2003. Advertising
pages were down in the energy, oil and power sectors as well as the aviation
sector. The Singapore Air Show which occurred in the first quarter of 2002 did
not occur in the first quarter of 2003. Sales to building product manufacturers
were flat due to the Sweets CD being delayed into the second quarter. Sales to
construction contractors and service providers declined due to the weak economy.
The elimination of Dodge Scan in the latter part of 2002 also created a negative
revenue comparison but improved margins. At Broadcasting, for the first quarter,
national gross time sales were up a total of 2%, while local gross time sales
were down approximately 8% year-over-year. The airing of the Super Bowl during
the first quarter of 2003 offset the lack of political advertising. The weak
ratings position of the ABC network, as well as pre-emption caused by war
coverage and general economic malaise, negatively impacted the performance of
the stations. All groups within Information and Media Services contained costs.
Financial Condition
- -------------------
The Company continues to maintain a strong financial position. Cash flow
from operations of $108.1 million increased by $82.6 million in 2003 compared
with $25.5 million for the quarter ended March 31, 2002. The increase in cash
provided by operating activities primarily relates to the improvement in the
management of accounts receivable and increases in taxes payable. Total debt
increased by only $13.3 million since year-end, reflecting increased share
repurchases as well as improved asset management and the impact of dispositions.
The Company's strong presence in the school and higher education markets
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.
Commercial paper borrowings at March 31, 2003 totaled $586.8 million, an
increase of $13.7 million from December 31, 2002. The Company's $675 million,
364-day revolving facility agreement, entered into on July 23, 2002 allows the
Company to borrow until July 22, 2003, on which date the facility agreement
terminates and the maturity of such borrowings may not be later than July 22,
2004. The Company pays a facility fee of five basis points on the 364-day
facility (whether or not amounts have been borrowed) and borrowings may be made
at 15 basis points above LIBOR. The commercial paper borrowings are also
supported by a $625 million, 5-year revolving credit facility. The Company pays
a facility fee of seven basis points on the 5-year credit facility whether or
not amounts have been borrowed, and borrowings may be made at 13 basis points
above LIBOR. All of the facilities contain 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. At March 31, 2003 there were no borrowings under any of the
facilities. Eighty percent or $469.4 million of the commercial paper borrowings
outstanding are classified as long-term.
In the third quarter of 2002 the Company redeemed all of the outstanding
shares of $1.20 convertible preference stock. The redemption price of $40 per
share, as provided by the terms of the preference stock, became payable to
holders, who did not otherwise convert their shares into the Company's common
stock, on September 1, 2002. Most holders elected conversion prior to
redemption. None of the convertible preference shares provided a beneficial
conversion feature at the time they were originally issued.
<page>
Under a shelf registration that became effective with the Securities and
Exchange Commission in 1990, an additional $250 million of debt securities can
be issued. Debt could be used to replace a portion of the commercial paper
borrowings with longer-term securities if and when market conditions warrant.
Gross accounts receivable of $925.8 million decreased $307.1 million from
the end of 2002 primarily from the seasonality of the educational publishing
business. Inventory increased $17.3 million from the end of 2002 to $378.1
million as the Company prepares for its selling season.
Additions to technology projects were $7.7 million in the first quarter of
2003 versus $21.9 million for the first quarter of 2002. Additions to technology
projects for 2003 are now expected to approximate $75.0 million.
Net prepublication costs were consistent with the end of 2002 at $534.4
million, as spending on school and higher education titles continued.
Prepublication cost spending in the first three months of 2003 totaled $38.6
million which was $3.8 million more than the spending for the same period of
2002. Prepublication cost spending is expected to increase over the remainder of
the year totaling an estimated $285.0 million for the full year. Purchases of
property and equipment were $13.2 million, $3.8 million higher than the prior
year. Spending is expected to be higher than the comparative prior year period
for the remainder of the year due to the Canary Wharf real estate project in
London, England.
The Board of Directors approved a 5.9% increase in the quarterly common
stock dividend to 27.0 cents per share in January 2003. In 1999, the Board of
Directors authorized a stock repurchase program of up to 15 million shares. 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. Approximately 14.3
million shares have been repurchased under this program through March 31, 2003.
During 2003, a total of 1.6 million shares were repurchased at an average price
of $53.57 per share. On January 29, 2003 the Board of Directors approved a new
stock repurchase program authorizing the purchase of up to 15 million additional
shares. In addition, there remains available 0.7 million shares under the
original stock repurchase program.
Market Risk
- -----------
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. 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 naturally hedged positions in most countries with a local currency
perspective and asset and liability offsets. The gross amount of the Company's
foreign exchange positions is $139.7 million, and management has estimated using
a value at risk analysis with 90% certainty that based on the historical
volatilities of the portfolio that the foreign exchange gains and losses will
not exceed $14.7 million over the next year. The Company's interest expense is
sensitive to changes in the general level of U.S. interest rates. Based on
average debt outstanding over the past three months, the following is the
projected impact on interest expense on current operations:
- -------------------------------------------------------------------------
Percent change in interest rates Projected impact on operations
(+/-) (millions)
- -------------------------------------------------------------------------
1% $5.4
- -------------------------------------------------------------------------
<page>
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act
- --------------------------------------------------------------------------
of 1995
- -------
The foregoing sections, as well as other portions of this document,
includes certain forward-looking statements about the Company's business, new
products, sales, expenses, cash flows, spending, and operating and capital
requirements. Such forward-looking statements include, but are not limited to:
Educational Publishing's level of success in 2003 adoptions and open
territories; the level of educational funding; the strength of higher education,
professional and international publishing markets; the level of interest rates
and the strength of profit levels and the capital markets in the U.S. and abroad
with respect to Standard & Poor's Credit Market Services; the strength of the
domestic and international advertising markets; Broadcasting's level of
advertising; and the level of future cash flow, debt levels, product related
manufacturing increases, pension income, capital and other expenditures and
prepublication cost investment.
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 and political conditions, currency and
foreign exchange volatility, the health of capital and equity markets, including
future interest rate changes, the level of funding in the education market (both
domestically and internationally), the pace of recovery of the economy and in
advertising, 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, 2002.
Please see the financial condition section in Item 2 of this Form 10-Q for
additional market risk disclosures.
Item 4. Controls and Procedures
- ------ -----------------------
As of March 31, 2003, 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. 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 March 31, 2003. There have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect internal controls subsequent to March 31, 2003.
<page>
Part II
Other Information
Item 1. Legal Proceedings
- ------ -----------------
While the Registrant and its subsidiaries are defendants in numerous legal
proceedings in the United States and abroad, neither the Registrant nor its
subsidiaries are a party to, or any of their properties subject to, any known
material pending legal proceedings which the Registrant believes will result in
a material adverse effect on its financial statements or business operations.
Item 6. Exhibits and Reports on Form 8-K Page Number
- ------ -------------------------------- -----------
(a) Exhibits
(12) Computation of ratio of earnings to fixed charges 25
(15) Letter on Unaudited Interim Financial Information 26
(99) Quarterly Certification of the Chief Executive
Officer and the Chief Financial
Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 27
(b) Reports on Form 8-K
No reports were filed during the period covered
by this report
<page>
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: May 2, 2003 By:-----------/s/-----------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
Date: May 2, 2003 By:----------/s/-----------------
Kenneth M. Vittor
Executive Vice President
and General Counsel
Date: May 2, 2003 By:---------/s/-------------------
Talia M. Griep
Senior Vice President
and Corporate Controller
<page>
Quarterly Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Harold W. McGraw III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The McGraw-Hill
Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and
procedures to ensure that material information
relating to the registrant, including its
consolidated subsidiaries, is made known to us
by others within those entities, particularly
during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our
conclusions about the effectiveness of
the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or
operation of internal controls which could
adversely affect the registrant's ability to
record, process, summarize and report financial
data and have identified for the registrant's
auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that
involves management or other employees who have
a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 2, 2003
------------/s/----------------
Harold W. McGraw III
Chairman, President and
Chief Executive Officer
<page>
Quarterly Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Robert J. Bahash, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The McGraw-Hill
Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and
procedures to ensure that material information
relating to the registrant, including its
consolidated subsidiaries, is made known to us
by others within those entities, particularly
during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our
conclusions about the effectiveness of
the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or
operation of internal controls which could
adversely affect the registrant's ability to
record, process, summarize and report financial
data and have identified for the registrant's
auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that
involves management or other employees who have
a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 2, 2003
-----------/s/----------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
<page>
<table>
Exhibit (12)
The McGraw-Hill Companies, Inc.
-------------------------------
Computation of Ratio of Earnings to Fixed Charges
-------------------------------------------------
Periods Ended March 31, 2003
-----------------------------
March 31, 2003 March 31, 2002
-------------------- ---------------
Three Twelve Three
Months Months Months
-------- -------- --------
(in thousands)
Earnings
Earnings from continuing operations
before income tax expense (Note) $ 56,593 $ 896,224 $ 42,704
Fixed charges 17,444 75,346 18,192
-------- ---------- ---------
Total Earnings $ 74,037 $ 971,570 $ 60,896
======== ========== =========
Fixed Charges (Note)
Interest expense $ 3,315 $ 21,417 $ 6,902
Portion of rental payments deemed to be
interest 14,129 53,929 11,290
--------- --------- ---------
Total Fixed Charges $ 17,444 $ 75,346 $ 18,192
========= ========= =========
Ratio of Earnings to Fixed Charges 4.2x 12.9x 3.3x
</table>
(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, primarily
the Company's earnings in its 45% interest in Rock-McGraw, Inc. Rock-McGraw
earnings for the three and twelve months periods ended March 31, 2003, are
$4.1 million and $14.9 million, respectively. Rock-McGraw earnings for the
three month period ended March 31, 2002 were $3.0 million. "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 tax expense for the
twelve month period ended March 31, 2003 includes a $14.5 million pre-tax
loss on the disposition of MMS International.
<page>
Exhibit (15)
The Board of Directors and Shareholders of
The McGraw-Hill Companies, Inc.
We are aware of the incorporation by reference in the Registration
Statement on Form S-3 (No. 33-33667) pertaining to the Debt Securities of The
McGraw-Hill Companies, Inc. and in the Registration Statements on Form S-8
pertaining to the 1983 Stock Option Plan for Officers and Key Employees (No.
2-84058), the 1987 Key Employee Stock Incentive Plan (No. 33-22344), the 1993
Employee Stock Incentive Plan (No. 33-49743, No. 33-30043 and No. 33-40502), the
2002 Stock Incentive Plan (No. 33-92224), the Director Deferred Stock Ownership
Plan (No. 33-06871) and The Savings Incentive Plan of McGraw-Hill, Inc. and its
Subsidiaries, The Employee Retirement Account Plan of McGraw-Hill, Inc. and its
Subsidiaries, The Standard & Poor's Savings Incentive Plan for Represented
Employees, The Standard and Poor's Employee Retirement Account Plan for
Represented Employees and The Employee's Investment Plan of McGraw-Hill
Broadcasting Company, Inc. and its Subsidiaries (No. 33-50856) of our report
dated April 29, 2003 relating to the unaudited consolidated interim financial
statements of The McGraw-Hill Companies, Inc. that are included in its Form 10-Q
for the quarter ended March 31, 2003.
ERNST & YOUNG LLP
New York, New York
May 2, 2003
<page>
Exhibit (99)
Quarterly Certification Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each of
the undersigned officers of The McGraw-Hill Companies, Inc. (the "Company"),
does hereby certify, to such officer's knowledge, that:
The quarterly report on Form 10-Q for the quarter ended March 31, 2003 of
the Company fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 and information contained in the Form 10-Q
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Dated: May 2, 2003 ------------/s/---------------
Harold W. McGraw III
Chairman, President and
Chief Executive Officer
Dated: May 2, 2003 ------------/s/---------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
A signed original of this written statement required by
Section 906 has been provided to The McGraw-Hill Companies
and will be retained by The McGraw-Hill Companies and
furnished to the Securities and Exchange Commission or its
staff upon request.