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 June 30, 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 July 15, 2003 there were approximately 191.2 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 and
six month periods ended June 30, 2003 and 2002 4
Consolidated Balance Sheet at June 30, 2003,
December 31, 2002 and June 30, 2002 5-6
Consolidated Statement of Cash Flows for the six 7
months ended June 30, 2003 and 2002
Notes to Consolidated Financial Statements 8-12
Item 2. Management's Discussion and Analysis of Operating
------ Results and Financial Condition 13-21
Item 3. Quantitative and Qualitative Disclosures About
------ Market Risk 21
Item 4. Controls and Procedures 21
------
Part II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 22
------
Item 4. Submission of Matters to a Vote of Security Holders 22
------
Item 6. Exhibits and Reports on Form 8-K 22-30
------
<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 June 30, 2003, and the related consolidated statements of
income for the three and six month periods ended June 30, 2003 and 2002, and the
consolidated statements of cash flows for the six month periods ended June 30,
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
July 29, 2003
<page>
Part I
Financial Information
---------------------
Item 1. Financial Statements
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Income
--------------------------------
Periods Ended June 30, 2003 and 2002
------------------------------------
<caption>
Three Months Six Months
----------------- -------------------
2003 2002 2003 2002
--------- -------- --------- ---------
(in thousands, except per-share data)
Revenue (Note 3)
Product revenue $ 598,114 $ 602,843 $ 899,725 $ 912,209
Service revenue 592,364 572,429 1,137,296 1,093,606
---------- --------- --------- ----------
Total revenue 1,190,478 1,175,272 2,037,021 2,005,815
Operating expenses
Product 293,177 299,308 476,350 485,364
Service 206,523 199,644 399,820 405,789
--------- --------- --------- ---------
499,700 498,952 876,170 891,153
Selling and general expenses
Product 239,568 236,093 431,602 422,429
Service 200,823 193,177 395,447 367,026
--------- --------- --------- ---------
440,391 429,270 827,049 789,455
Depreciation 20,832 22,865 41,714 46,074
Amortization of intangibles 8,643 9,759 17,286 19,645
---------- --------- --------- ---------
Total expenses 969,566 960,846 1,762,219 1,746,327
Other income - net 7,213 9,346 16,650 16,487
---------- --------- --------- ---------
Income from operations 228,125 223,772 291,452 275,975
Interest expense 2,673 7,151 5,352 13,573
--------- --------- --------- ---------
Income from continuing operations
before taxes on income 225,452 216,621 286,100 262,402
Provision for taxes on income 83,417 81,233 105,856 98,401
--------- --------- --------- ---------
Income from continuing operations 142,035 135,388 180,244 164,001
Discontinued operations (Note 4):
Earnings from operations of
discontinued component(including
gain - 1,731 87,490 2,673
on disposal of $86,953 in 2003)
Income tax expense - 649 30,304 1,002
---------- --------- ---------- ----------
Earnings on discontinued operations - 1,082 57,186 1,671
---------- --------- ---------- ----------
Net income (Notes 1 and 2) $ 142,035 $ 136,470 $ 237,430 $ 165,672
========== ========= ========= =========
Basic earnings per common share
Income from continuing operations $ 0.75 $ 0.70 $ 0.95 $ 0.85
Net income $ 0.75 $ 0.71 $ 1.25 $ 0.86
Diluted earnings per common share
Income from continuing operations $ 0.74 $ 0.69 $ 0.94 $ 0.84
Net income $ 0.74 $ 0.70 $ 1.24 $ 0.85
Average number of common shares
outstanding: (Note 10)
Basic 189,830 193,267 190,458 193,026
Diluted 191,274 195,050 191,705 194,956
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
<caption>
June 30, Dec. 31, June 30,
2003 2002 2002
---------- ----------- ----------
(in thousands)
ASSETS
Current assets:
Cash and equivalents $ 94,820 $ 58,186 $ 50,518
Accounts receivable (net of allowance
for doubtful accounts and sales
returns) (Note 5) 931,100 991,806 1,010,259
Inventories (Note 5) 427,097 360,757 455,628
Deferred income taxes 167,039 169,829 218,964
Prepaid and other current assets
(Note 6) 114,066 93,729 108,467
---------- ---------- ----------
Total current assets 1,734,122 1,674,307 1,843,836
---------- ---------- ----------
Prepublication costs (net of
accumulated amortization) (Note 5) 520,761 534,835 565,269
Investments and other assets:
Investment in Rock-McGraw, Inc. - at
equity 127,582 119,442 111,692
Prepaid pension expense 274,494 261,243 239,178
Other 222,583 205,243 222,439
---------- ---------- ----------
Total investments and other assets 624,659 585,928 573,309
---------- ---------- ----------
Property and equipment - at cost 1,065,871 1,071,953 1,078,322
Less - accumulated depreciation 633,985 640,493 648,069
---------- ---------- ----------
Net property and equipment 431,886 431,460 430,253
Goodwill - net 1,294,170 1,294,831 1,246,205
Copyrights - net 259,954 272,243 339,809
Other intangible assets - net 226,212 238,578 225,897
---------- ---------- ----------
Total assets $5,091,764 $5,032,182 $5,224,578
========== ========== ==========
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Balance Sheet
--------------------------
<caption>
June 30, Dec. 31, June 30,
2003 2002 2002
---------- ----------- ----------
(in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $112,177 $119,414 $244,093
Accounts payable 309,174 303,354 296,874
Accrued liabilities 300,691 437,461 277,581
Income taxes currently payable 179,023 82,016 128,238
Unearned revenue 575,794 538,961 536,635
Other current liabilities (Note 6) 308,135 294,085 304,250
---------- ---------- ----------
Total current liabilities 1,784,994 1,775,291 1,787,671
---------- ---------- ----------
Other liabilities:
Long-term debt (Note 7) 421,277 458,923 919,367
Deferred income taxes 195,392 200,114 183,188
Accrued postretirement healthcare and
other benefits 170,929 172,067 174,583
Other non-current liabilities 259,927 259,965 234,345
---------- ---------- ----------
Total other liabilities 1,047,525 1,091,069 1,511,483
---------- ---------- ----------
Total liabilities 2,832,519 2,866,360 3,299,154
---------- ---------- ----------
Shareholders' equity (Notes 8 & 9):
Capital stock 205,853 205,853 205,852
Additional paid-in capital 84,736 79,410 73,452
Retained income 2,806,242 2,672,086 2,359,387
Accumulated other comprehensive income (84,159) (103,965) (112,290)
---------- ---------- ----------
3,012,672 2,853,384 2,526,401
Less - common stock in treasury-at cost 727,968 669,499 576,956
Unearned compensation on restricted stock 25,459 18,063 24,021
---------- ---------- ----------
Total shareholders' equity 2,259,245 2,165,822 1,925,424
---------- ---------- ----------
Total liabilities & shareholders'
equity $5,091,764 $5,032,182 $5,224,578
========== ========== ==========
</table>
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Consolidated Statement of Cash Flows
------------------------------------
Six Months Ended June 30, 2003 and 2002
----------------------------------------
<caption>
2003 2002
--------- ---------
Cash flows from operating activities (in thousands)
- ---------------------------------------------------
Net income $237,430 $ 165,672
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation 41,989 47,040
Amortization of intangibles 17,318 19,740
Amortization of prepublication costs 101,036 104,797
Provision for losses on accounts receivable 18,548 16,197
Gain on the sale of S&P ComStock (86,953) -
Other (6,512) (4,550)
Changes in assets and liabilities net of effect of
acquisitions and dispositions:
Decrease in accounts receivable 48,954 13,730
Increase in inventories (64,107) (52,633)
Increase in prepaid and other current assets (20,851) (8,287)
Decrease in accounts payable and accrued expenses (128,484) (154,362)
Increase in unearned revenue 31,387 27,031
Decrease in other current liabilities (4,160) (46,475)
Increase in interest and income taxes
currently payable 96,860 57,547
Net change in deferred income taxes 3,602 (1,202)
Net change in other assets and liabilities (10,381) (12,502)
- --------------------------------------------------- --------- ---------
Cash provided by operating activities 275,676 171,743
- --------------------------------------------------- --------- ---------
Investing activities
- -------------------------
Investment in prepublication costs (89,666) (114,870)
Purchases of property and equipment (40,510) (26,865)
Acquisition of businesses and equity interests (1,878) (3,730)
Disposition of property, equipment and businesses 120,517 6,782
Additions to technology projects (12,744) (33,812)
Other - 3,299
- --------------------------------------------------- --------- ---------
Cash (used for) investing activities (24,281) (169,196)
- --------------------------------------------------- --------- ---------
Financing activities
- ----------------------------
(Reductions)/additions to short-term debt - net (45,156) 107,037
Dividends paid to shareholders (103,276) (98,629)
Repurchase of treasury shares (103,074) (63,787)
Exercise of stock options 29,295 45,667
Other (220) (218)
- --------------------------------------------------- --------- ---------
Cash (used for) financing activities (222,431) (9,930)
- --------------------------------------------------- --------- ---------
Effect of exchange rate fluctuations on cash 7,670 4,366
--------- ---------
Net change in cash and equivalents 36,634 (3,017)
Cash and equivalents at beginning of period 58,186 53,535
- --------------------------------------------------- --------- ---------
Cash and equivalents at end of period $94,820 $50,518
========= =========
</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
and six month periods ended June 30, 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 data):
<table>
<caption>
Three Months Six Months
----------------- ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income, as reported $142,035 $136,470 $237,430 $165,672
Stock-based compensation cost
included in net income 3,888 3,374 6,873 5,719
Fair value of stock based
compensation cost, net of tax (13,843) (17,335) (30,268) (29,688)
-------- -------- -------- --------
Pro forma net income $132,080 $122,509 $214,035 $141,703
Basic earnings per common share
As reported $ 0.75 $ 0.71 $ 1.25 $ 0.86
Pro forma $ 0.70 $ 0.63 $ 1.12 $ 0.73
Diluted earnings per common share
As reported $ 0.74 $ 0.70 $ 1.24 $ 0.85
Pro forma $ 0.69 $ 0.63 $ 1.12 $ 0.73
Basic weighted average shares
outstanding 189,830 193,267 190,458 193,026
Diluted weighted average shares
outstanding 191,274 195,050 191,705 194,956
</table>
2. The following table is a reconciliation of the Company's net income
to comprehensive income for the three and six month periods ended June 30:
<table>
<caption>
Three Months Six Months
2003 2002 2003 2002
--------- --------- --------- ---------
(in thousands)
Net income $ 142,035 $ 136,470 $ 237,430 $ 165,672
Other comprehensive income,
net of tax:
Foreign currency translation
adjustments 18,240 18,687 19,806 14,570
--------- --------- --------- ---------
Comprehensive income $ 160,275 $ 155,157 $ 257,236 $ 180,242
========= ========= ========= =========
</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 and six months ended June 30, 2003 and
2002 follows:
<table>
<caption>
2003 2002
-------------------- --------------------
Operating Operating
Revenue Profit Revenue Profit
---------- --------- ---------- ----------
Three Months (in thousands)
------------
McGraw-Hill Education $ 561,695 $ 54,420 $ 576,963 $ 64,042
Financial Services 439,365 171,557 400,586 152,714
Information and Media Services 189,418 24,443 197,723 26,556
------------------------------ ---------- --------- ----------- ---------
Total operating segments 1,190,478 250,420 1,175,272 243,312
General corporate expense - (22,295) - (19,540)
Interest expense - (2,673) - (7,151)
------------------------------ ---------- --------- ----------- ---------
Total Company $1,190,478 $ 225,452* $ 1,175,272 $216,621*
========== ========= =========== =========
</table>
*Income from continuing operations before taxes on income.
<table>
<caption>
2003 2002
------------------- -------------------
Operating Operating
Revenue Profit Revenue Profit
-------- -------- -------- --------
Six Months (in thousands)
----------
McGraw-Hill Education $ 838,854 $ (18,385) $ 858,584 $ (7,768)
Financial Services 834,260 316,548 765,355 285,026
Information and Media Services 363,907 36,919 381,876 38,518
------------------------------- --------- --------- ----------- ---------
Total operating segments 2,037,021 335,082 2,005,815 315,776
General corporate expense - (43,630) - (39,801)
Interest expense - (5,352) - (13,573)
------------------------------- ---------- --------- ----------- ---------
Total Company $2,037,021 $ 286,100* $ 2,005,815 $262,402*
========== ========= =========== =========
*Income from continuing operations before taxes on income.
</table>
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
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 three months ended June 30, 2002 was
$16.1 million. The revenue recorded from ComStock for the six months
ended June 30, 2003 and June 30, 2002 was $11.1 million and $32.2
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.
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>
June 30, Dec. 31, June 30,
2003 2002 2002
---------- ---------- ----------
(in thousands)
Allowance for doubtful accounts $102,704 $105,532 $115,026
========== ========== ==========
Allowance for sales returns $ 88,325 $135,529 $ 88,230
========== ========== ==========
Inventories:
Finished goods $385,777 $314,420 $409,029
Work-in-process 14,986 18,128 20,236
Paper and other materials 26,334 28,209 26,363
---------- ---------- ----------
Total inventories $427,097 $360,757 $455,628
========== ========== ==========
Accumulated amortization of
prepublication costs $862,039 $924,867 $786,616
========== ========== ==========
</table>
<page>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
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 $400.0 million of matched purchase and sale
commitments at June 30, 2003. Only those transactions not closed at the
settlement date are reflected in the balance sheet as receivables and
payables.
<table>
<caption>
7. A summary of long-term debt follows:
June 30, Dec. 31, June 30,
2003 2002 2002
---------- ---------- ----------
(in thousands)
Commercial paper supported by
bank revolving credit agreements $420,880 $458,480 $898,160
Extendible commercial notes 20,000
Other 397 443 1,207
---------- ---------- ----------
Total long-term debt $421,277 $458,923 $919,367
========== ========== ==========
</table>
8. Common shares reserved for issuance for conversions and stock based
awards were as follows:
<table>
<Caption>
June 30, Dec. 31, June 30,
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 27,343,838 28,647,063 29,250,202
---------- ---------- ----------
27,343,838 28,647,063 29,267,732
========== ========== ==========
</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 $40.00 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 and six months
ended June 30, 2003 and 2002 were as follows:
Three Months Six Months
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
Common stock $0.270 $0.255 $0.540 $0.510
Preference stock - $0.300 - $0.600
<page>
<table>
The McGraw-Hill Companies, Inc.
-------------------------------
Notes to Consolidated Financial Statements
------------------------------------------
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 and six months ended June 30, 2003 and 2002 follows:
Three Month Period Six Month Period
2003 2002 2003 2002
------- ------- ------- -------
(in thousands)
Average number of common shares
outstanding 189,830 193,267 190,458 193,026
Effect of stock options and other
Dilutive securities 1,444 1,783 1,247 1,930
------- ------- ------- -------
Average number of common shares
outstanding including effect of
dilutive securities 191,274 195,050 191,705 194,956
======= ======= ======= =======
</table>
Restricted performance shares outstanding at June 30, 2003 of 471,000
were not included in the computation of diluted earnings per common
shares because the necessary vesting conditions have not yet been met.
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 for fiscal periods beginning after June 15,
2003 with early adoption permitted. Management is currently evaluating
the impact of this pronouncement and does not believe that this will
have a material impact on the Company's financial statements.
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin (ARB) No. 51. The
Interpretation introduces a new consolidation model, the variable
interests model, based on potential variability in gains and losses of
the entity being evaluated for consolidation. It provides guidance for
determining whether an entity lacks sufficient equity or the entity's
equity holders lack adequate decision-making ability. These entities,
variable interest entities (VIE), are evaluated for consolidation based
on their variable interests. Variable interests are contractual,
ownership or other interests in an entity that expose their holders to
the risks and rewards of the VIE. The Interpretation's provisions are
effective for variable interests in VIEs created after January 31,
2003, and for variable interests in VIEs created before February 1, no
later than the first reporting period beginning after June 15, 2003.
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 June 30, 2003 and 2002
- -------------------------------------------------------------------------
Consolidated Review
- -------------------
The Segment Review that follows is incorporated herein by reference.
Operating revenue for the second quarter increased by 1.3% to $1.2 billion, as
compared to the prior year's second quarter. The revenue increase is primarily
attributable to growth in the Financial Services segment. Foreign exchange
contributed to the growth in operating revenue and had a negligible impact on
income from continuing operations. Product revenue declined by $4.7 million as
compared to the prior year's second quarter, primarily due to a decrease in
revenue at McGraw-Hill Education. Service revenue increased to $592.4 million,
an increase of 3.5%, as compared to the prior year's second quarter, due
primarily to the growth in Financial Services. Other income decreased $2.1
million from $9.3 million in the second quarter of 2002. The decrease in other
income is attributed to a loss on foreign exchange.
Income from continuing operations increased $6.6 million to $142.0 million over
2002 second 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. Net income for the quarter increased $5.6
million over the comparable quarter in the prior year. Diluted earnings per
share for the quarter were $.74 versus $.70 in the prior year. In September
2002, the Financial Services segment divested MMS International, which had a
negligible effect on current quarter results.
Total expenses in the second quarter of 2003 increased only slightly due to cost
containment activities. Operating expenses include the amortization of
prepublication costs of $69.4 million for the second quarter 2003. Product
operating expenses declined 2.0% as compared to the prior year second quarter as
a result of a decline at McGraw-Hill Education. Service operating expenses
increased 3.4% due to growth in the Financial Services segment. Selling and
general product expenses increased $3.5 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
$2.3 million as compared with the second 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 rate assumptions for the Company's U.S.
retirement plans effective January 1, 2003 resulting in a decline in net pension
income for the second quarter 2003 as compared with 2002. For 2003, combined
printing, paper and distribution costs on product-related manufacturing items
are expected to decrease modestly.
Interest expense decreased 62.5% to $2.7 million from $7.2 million in the second
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 second
quarter of 2003 as compared to the same period in 2002. Average commercial paper
levels decreased from $1.1 billion for the second quarter of 2002 to $562.6
million for the second quarter of 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 $2.6 million of the decrease and lower average interest
rates for $1.0 million. Interest income on higher foreign cash levels
represented most of the remaining reduction in interest expense.
The provision for taxes as a percent of income before taxes is 37.0%, or 0.5%
less than the second quarter in 2002. The change in the effective tax rate is
primarily the result of the increase in foreign source income, taxed at lower
effective rates.
Segment Review
- --------------
McGraw-Hill Education's revenue and operating profit declined 2.6% and 15.0%,
respectively, as compared with the second quarter of 2002. The results reflect a
strong performance in the Texas middle and high school social studies adoption,
a large open territory adoption for elementary and middle school math programs
in New York City and growth in testing, which could not offset aging
supplemental lines and a disappointing performance in elementary social studies
in Texas. The segment's performance reflects the seasonal nature of the
business, with the first half being less significant. Expenditures related to
the Global Transformation Project of $7.7 million were expensed in the quarter.
The Global Transformation Project will support the segment's global growth
objectives, provide technological enhancements that support the infrastructure
of management information and customer-centric services, enable process and
production improvements throughout the organization, and position McGraw-Hill
Education to support the advancement of digital products as an emerging growth
opportunity.
<page>
The McGraw-Hill School Education Group's revenue declined 3.1% to $386.2
million. Increased sales of supplemental educational materials and niche basal
programs, such as Everyday Mathematics and Open Court Reading, could not offset
certain aging supplemental lines. Sales of children's supplemental educational
materials through the educational dealer and trade markets have been affected by
decreased 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 second quarter sales included coloring and activity books
and magazines, product lines which were discontinued in the latter part of 2001
with residual sales winding down in 2002. The School Education Group's major
adoption opportunity was Texas. The kindergarten through sixth grade sector also
experienced normal and expected revenue declines from lower reading, math and
language arts adoption opportunities as compared to the previous year. The
McGraw-Hill School Education Group took approximately a 26% to 27% share of the
kindergarten through twelfth grade Texas social studies adoption; in spite of a
lower than expected performance in the kindergarten through sixth grade social
studies adoption. Developmental Learning Materials performed well in the Texas
pre-kindergarten adoption. New York City adopted Everyday Mathematics and Impact
Mathematics which contributed positively to the School Education Group's open
territory sales. Custom contract testing grew in the second quarter, and the
School Education Group continues to invest in testing technology. Higher custom
contract revenue was driven by the Connecticut, New Mexico and West Virginia
programs.
McGraw-Hill Higher Education, Professional and International Group's revenue
decline by 1.7% to $175.5 million for the second quarter of 2003. The results
reflect the growth in the sales of higher education titles both domestically and
internationally, as well as the continued weakness in certain professional
titles. Despite state budget problems, growth in the higher education market
will be driven by continued enrollment increases. The sale of business and
economics and science, engineering and mathematics imprints increased in the
period. Key titles include Brealey, Principles of Corporate Finance, 7/e,
Garrison, Managerial Accounting, 10/e, Slater, Practical Business Math
Procedures, 7/e, Silberberg, Chemistry: The Molecular Nature of Matter and
Change, 3/e, Mader, Biology, 8/e, and Libby, Financial Accounting, 4/e.
Professional products declined as the computer and technology imprints still
experienced softness due specifically to continued weakness in the global
technology sector. In 2002, the Group benefited from the release of The
McGraw-Hill Encyclopedia of Science and Technology, 9/e. Additionally, book
sales at retail outlets were depressed industry-wide through most of the
quarter.
Financial Services' revenue increased 9.7% to $439.4 million and operating
profit increased 12.3% to $171.6 million over 2002 second 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 2.5% decrease in revenue and a
negligible decrease in operating profit for the second quarter of 2003 as
compared to the second quarter of 2002. Overall, the segment experienced strong
growth in revenue globally. Foreign exchange contributed $10.3 million to
revenue growth with a negligible impact on operating profit.
The Financial Services segment increased revenue and operating profit due
primarily to the performance of structured finance, which represented
approximately 57.0% of the growth in revenue. Total U.S. structured finance new
issue dollar volume for the second quarter of 2003 increased 26.2%, driven
primarily by residential mortgaged-backed securities issuance, which grew 59.0%,
according to Harrison Scott Publications. Overall, new issue dollar volume in
the U.S. market was up 23.3% in the second quarter, according to Securities Data
and Harrison Scott Publications. U.S. new issue dollar volume for corporates for
the second quarter of 2003 increased 21.7% while public finance grew 17.8% and
financial institutions 27.2%. High yield issuance also picked up in the U.S.
increasing 234.9% according to Securities Data. European new issue dollar volume
rose 50.7% according to Bondware. An improving economic environment along with
the return of investor confidence, improving credit quality and low interest
rates, especially mortgage rates, should lead to continued growth in U.S.
issuance volumes in the second half of the year. Bank loan ratings and global
infrastructure ratings experienced higher growth rates than traditional ratings
products. The financial services industry, which has experienced adverse market
conditions and profit pressures, resulting in cost cutting initiatives,
including staff layoffs, is also showing some signs of improvement. While demand
for retail information and brokerage products remains weak, index-related
products and services continue to experience robust growth. Fund ratings, fund
information, and company-specific data sales performed well. Revenue related to
the Standard & Poor's indices increased as assets under management rose to $71.9
billion at June 30, 2003 from $52.4 billion at June 30, 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 revenue increased from the sale of non-valuation services, such as
litigation support. According to Bloomberg Mergers and Acquisitions Database of
June 2003, the dollar volume of announced deals involving a U.S. company was
down 9.4%, while the number of deals increased 1.4%, as compared to the second
quarter of 2002.
Information and Media Services' revenue decreased $8.3 million, or 4.2%, to
$189.4 million from 2002 second quarter results. Operating profit decreased $2.1
million, or 8.0%, to $24.4 million from 2002 second quarter results. Revenue
declined at the Business-to-Business Group by 4.7% and at Broadcasting by 1.2%.
Both groups were negatively impacted by the continued soft business-to-business
advertising market, which is now expected to pick up momentum in the Fall.
At BusinessWeek, advertising pages in the North American edition in the second
quarter were down by 15.3% according to the Publishers Information Bureau.
Weakness was experienced in BusinessWeek's other editions. The lack of targeted
BusinessWeek demographic editions, which were eliminated in the prior year,
negatively impacted the sales of the Business-to-Business Group. The Group
benefited from the Global Power conference which took place in the first quarter
of 2002 and in the second quarter of 2003. Advertising pages were up in the
power sector, with two more issues than in the prior year. The Paris Air Show
occurred in the second quarter of 2003 with no comparable show in the second
quarter of 2002. Due to political issues, the attendance at the Paris Air Show
was down versus the prior Paris Air Show of 2001. Sales to building product
manufacturers were up due to the Sweets CD being delayed into the second
quarter. Despite turmoil in the Aviation sector, advertising pages were ahead of
last year due to the timing of the Paris Air Show, while the Healthcare sector
experienced decreased pages. Sales to construction contractors and service
providers declined due to the weak commercial construction contractor sector.
The elimination of Dodge SCAN in the latter part of 2002 also created a negative
revenue comparison but improved margins. Competitive pressure and the weak
economy have negatively affected advertising page yields in the construction
publications. At Broadcasting, for the second quarter, the weak ratings position
of the ABC network and the general economic malaise, negatively impacted the
performance of the stations. The services and corporate products categories of
advertisers contributed to growth while the retailing and leisure time
categories remained weak.
Six Months
- -----------
Consolidated Review
- -------------------
The Segment Review that follows is incorporated herein by reference.
For the first six months of the year, operating revenue increased 1.6%, or $31.2
million to $2.0 billion, as compared to the six month period ended June 30,
2002. The revenue increase is primarily attributable to growth in the Financial
Services segment. Foreign exchange contributed to the growth in operating
revenue and had a negligible impact on income from continuing operations.
Product revenue declined 1.4% to $899.7 million as compared to the prior year's
first six months due primarily to decreases in revenue at McGraw-Hill Education.
Service revenue increased to $1.1 billion, an increase of 4.0%, as compared to
the prior year's first six months. The growth in service revenue is primarily
attributable to the growth in the Financial Services segment. Other income
increased $0.2 million to $16.7 million for the six months ended June 30, 2003
as compared with the same period in 2002. The increase in other income is
attributed to an increase in income from equity investments.
Income from continuing operations increased $16.2 million to $180.2 million over
2002 six months 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 period increased $71.8 million over the comparable six months in the
prior year. Diluted earnings per share for the six month period were $1.24
versus $0.85 in the prior year. In September 2002, the Financial Services
segment divested MMS International, which had a negligible effect on current
period results.
Total expenses in the first six months of 2003 increased only slightly due to
cost containment activities. Operating expenses include the amortization of
prepublication costs of $101.0 million for the six month period in 2003.
Amortization of prepublication costs decreased by $3.8 million as compared with
the first six months period of 2002. Product operating expenses declined
slightly as compared with the prior year six month period due primarily to cost
containment at McGraw-Hill Education. Service operating expenses decreased 1.5%
primarily due to cost containment efforts at Information and Media Services.
Selling and general product expenses increased 2.2% because of technology
spending. Selling and general service expenses increased 7.7% primarily from the
growth of the Financial Services segment. 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 rate assumptions for the Company's U.S. retirement plans
effective January 1, 2003 resulting in a decline in net pension income for the
first half of 2003 as compared with the first half of 2002. For 2003, combined
printing paper and distribution prices on product-related manufacturing items
are expected to decrease modestly.
Interest expense decreased 60.3% to $5.4 million from $13.6 million reported in
the first six months 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 six month period in 2003 as compared to the same period in 2002.
Average commercial paper levels decreased from $1.0 billion for the first six
months of 2002 to $550.1 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 $4.8 million of the decrease and lower average
interest rates for $1.7 million. Interest on higher foreign cash levels
represented most of the remaining reduction in interest expense.
The provision for taxes as a percent of income before taxes is 37.0%, 0.5% less
than the first six months of 2002. The change in the effective tax rate is
primarily the result of the increase in foreign source income.
Segment Review
- --------------
McGraw-Hill Education's revenue and operating profit declined $19.7 million and
$10.6 million, respectively, as compared with the first half of 2002. The
results reflect the weak economic conditions impacting the School Education
Group as well as a strong performance in the Texas middle and high school social
studies adoption, a large open territory adoption for elementary and middle
school math programs in New York City and growth in testing, which could not
offset aging supplemental lines and a disappointing performance in elementary
social studies in Texas. The segment's performance reflects the seasonal nature
of its business, with the first half being less significant. Expenditures
related to the Global Transformation Project of $15.3 million were expensed in
the period.
The McGraw-Hill School Education Group's revenue declined 3.9% to $514.1
million. Economic conditions negatively impacted adoption and open territory
opportunities early in the year. Increased sales of supplemental educational
materials and niche basal programs, such as Everyday Mathematics and Open Court
Reading, could not offset certain aging supplemental lines. Sales of children's
supplemental educational materials through the educational dealer and trade
markets have been affected by decreased 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 half sales included coloring
and activity books and magazines, product lines which were discontinued in the
latter part of 2001 with residual sales winding down in the latter part of 2002.
The kindergarten through sixth grade sector also experienced normal and expected
revenue declines from lower reading, math and language arts adoption
opportunities as compared to the previous year. The School Education Group's
major adoption opportunity was in Texas. The McGraw-Hill School Education Group
took approximately a 26% to 27% share of the kindergarten through twelfth grade
Texas social studies adoption in spite of a lower than expected performance in
the kindergarten through sixth grade social studies adoption. Developmental
Learning Materials performed well in the Texas pre-kindergarten adoption. New
York City adopted Everyday Mathematics and Impact Mathematics which contributed
positively to the School Education Group's open territory sales. Custom contract
testing increased in the period, and the School Education Group continues to
invest in testing technology. Higher custom contract revenue was driven by the
Connecticut, Kentucky, New Mexico and West Virginia programs.
McGraw-Hill Higher Education, Professional and International Group's revenue
increase by $1.2 million to $324.8 million for the first half of 2003. The
results reflect the growth in the sales of higher education titles both
domestically and internationally, as well as the continued weakness in certain
professional titles. Despite state budget problems, growth in the higher
education market will be driven by continued enrollment increases. The sales of
business and economics and science, engineering and mathematics imprints
increased in the period. Key titles include Brealey, Principles of Corporate
Finance, 7/e, Garrison, Managerial Accounting, 10/e Slater, Practical Business
Math Procedures, 7/e, Silberberg, Chemistry: The Molecular Nature of Matter and
Change, 3/e, Mader, Biology, 8/e, and Libby, Financial Accounting, 4/e.
Professional products declined as the computer and technology imprints still
experienced softness due specifically to continued weakness in the global
technology sector. For the first half 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 half of 2003.
Financial Services' revenue increased 9.0% to $834.3 million and operating
profit increased 11.1% to $316.5 million over 2002 six months 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 2.7% decrease in revenue and a
negligible decrease in operating profit for the first half of 2003 as compared
to the first half of 2002. Foreign exchange contributed $18.3 million to revenue
growth with a negligible impact to operating profit.
The Financial Services segment increased revenue and operating profit were due
primarily to the performance of structured finance, which represented
approximately 60.0% of the growth in revenue. Total U.S. structured finance new
issue dollar volume for the first six months of 2003 increased 27.4%, driven by
residential and commercial mortgaged-backed and asset-backed securities
issuance, which grew 48.4%, 30.0% and 6.7%, respectively, according to Harrison
Scott Publications. New issue dollar volume in the U.S. market overall was up
17.6% in the first six month period, according to Securities Data and Harrison
Scott Publications. U.S. new issue dollar volume for corporates for the first
six month of 2003 decreased 3.6% while public finance grew 20.0% and financial
institutions grew 24.7%. European new issue dollar volume rose 47.5% according
to Bondware. The return of investor confidence, improving credit quality and low
interest rates, especially mortgage rates, should lead to continued growth in
U.S. issuance volumes in the second half of the year. Bank loan ratings,
counterparty credit ratings, and global infrastructure ratings all experienced
higher growth rates than traditional ratings products. The overall financial
services industry, which experienced adverse market conditions and profit
pressures during most of the six month period ended June 30, 2003, is now
showing modest improvement. These market conditions 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 $71.9 billion at June 30, 2003 from $52.4
billion at June 30, 2002. Assets under management at December 31, 2002 were
$63.2 billion. Although valuations were negatively impacted by the lack of
merger and acquisition activity, revenue increased from the sale of
non-valuation services, such as litigation support. According to Bloomberg
Mergers and Acquisitions Database as of June 2003, the dollar volume of
announced deals involving a U.S. company declined 8.1%, and the number of deals
decreased 2.4%, as compared to the first six months of 2002.
Information and Media Services' revenue decreased $18.0 million, or 4.7%, for
the first six months of 2003 as compared to the first six months of 2002.
Operating profit decreased $1.6 million, or 4.2%, to $36.9 million for the
comparable period. Revenue declined at the Business-to-Business Group by 5.3%
and at Broadcasting by 0.8%. Both groups were negatively impacted by the
continued soft advertising market and the impact of the war with Iraq. The
business-to-business advertising market continues to be soft, and is now
expected to pick up momentum in the Fall.
At BusinessWeek, advertising pages, in the North American edition for the first
half were down 8.5% in 2003 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 North American and
International editions related to international advertisers, particularly
European advertisers. The lack of targeted BusinessWeek demographic editions,
which were discontinued in the prior year, negatively impacted the sales of the
Business-to-Business Group. Advertising pages were down in the power sector,
with two more issues than in the prior year. U.S. power markets were negatively
impacted by the fallout from Enron. The turmoil in the Aviation industry has
resulted in decreased advertising pages, but increased page yields. The
Healthcare sector saw decreased pages and page yields. The Singapore Air Show
which occurred in the first half of 2002 did not occur in 2003, while the Paris
Air Show occurred in the first half of 2003 and did not occur in 2002. Due to
geopolitical tensions, the Paris Air Show was a much smaller show than previous
Paris events. Sales to construction contractors and service providers declined
due to the weak commercial contractor sector. The elimination of Dodge SCAN in
the latter part of 2002 also created a negative revenue comparison but improved
margins. Competitive pressure and the weak economy have negatively affected page
yields for the construction publications. At Broadcasting, for the first half of
2003, the airing of the Super Bowl during the first quarter of 2003 helped to
somewhat offset the lack of political advertising. The weak ratings position of
the ABC network, pre-emptions caused by war coverage and the general economic
malaise negatively impacted the performance of the stations. The services and
corporate products categories of advertisers contributed to growth while the
retailing and leisure time categories remained weak.
Financial Condition
- -------------------
The Company continues to maintain a strong financial position. Cash flow from
operations of $275.7 million increased by $104.0 million in 2003 compared with
$171.7 million for the period ended June 30, 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 decreased by
$44.9 million since year-end reflecting improved asset management and the impact
of dispositions, offset by increased share repurchases and dividends. 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 June 30, 2003 totaled $526.1 million, a decrease
of $47.0 million from December 31, 2002. The Company's $675 million, 364-day
revolving facility agreement, entered into on July 23, 2002 expired on July 22,
2003. On July 22, 2003, the Company replaced this credit facility with a new
364-day credit facility of $575 million that allows it to borrow until July 20,
2004, on which date the facility agreement will terminate and the maturity of
such borrowings may not be later than July 20, 2005. The Company continues to
pay 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, which expires August 15, 2005. 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 June 30, 2003 there were no borrowings under any of the facilities.
Eighty percent or $420.9 million of the commercial paper borrowings outstanding
are classified as long-term.
<page>
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.
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 $1.1 billion decreased $110.7 million from the end
of 2002 primarily from the seasonality of the educational publishing business
and improved asset management. Inventory increased $66.3 million from the end of
2002 to $427.1 million as the Company prepares for its selling season.
Additions to technology projects were $12.7 million in the first half of 2003
versus $33.8 million for the first half of 2002. Additions to technology
projects for 2003 are expected to approximate $60 million to $65 million.
Net prepublication costs decreased $14.1 million from the end of 2002 to $520.8
million, due to timing of spending. Prepublication cost spending is expected to
increase over the remainder of the year totaling an estimated $260.0 million to
$270.0 million for the full year. Prepublication cost spending in the first six
months of 2003 totaled $89.7 million which was $25.2 million less than the
spending for the same period of 2002. Purchases of property and equipment were
$40.5 million, $13.6 million higher than the first half of 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 June 30, 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. For hyperinflationary economies, such as Venezuela,
the functional currency is the U.S. dollar. In the normal course of business,
these operations are exposed to fluctuations in currency values. The Company
does not generally enter into derivative financial instruments in the normal
course of business, nor are such instruments used for speculative purposes. The
Company has naturally hedged positions in most countries with a local currency
perspective and asset and liability offsets. The gross amount of the Company's
<page>
foreign exchange positions is $136.2 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 $15.8 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 six months, the following is the
projected impact on interest expense on current operations:
- ------------------------------------------------------------------------------
Percent change in interest rates Projected impact on operations
(+/-) (millions)
- ------------------------------------------------------------------------------
1% $5.5
- ------------------------------------------------------------------------------
"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 territory sales; the
level of educational funding; the strength of higher education, professional and
international publishing markets; the level of interest rates and debt issuance
and 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; Broadcasting's level of advertising; and the
level of future cash flow, debt levels, product related manufacturing expenses,
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 domestic and
international economies 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 June 30, 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 June 30, 2003. There have been no significant changes in
the Company's internal controls over financial reporting during the most recent
quarter that have materially affected, or are reasonably likely to materially
affect, the Company's internal controls over financial reporting.
<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 4. Submission of Matters to a Vote of Security Holders
- ------ ---------------------------------------------------
(a) The 2002 Annual Meeting of Shareholders of the Registrant was held on
April 30, 2003.
(b) The following nominees, having received the FOR votes set forth
opposite their respective names, constituting a plurality of the votes
cast as the Annual Meeting for the election of Directors, were duly
elected Directors of the Registrant:
DIRECTOR FOR WITHHOLD AUTHORITY
Douglas N. Daft 144,471,673 8,508,142
Vartan Gregorian 142,673,274 10,306,541
James H. Ross 146,404,925 6,574,890
Kurt L. Schmoke 148,273,954 4,705,861
Sidney Taurel 142,707,974 10,271,841
The terms of office of the following directors continued
after the meeting:
Pedro Aspe, Sir Winfried Bischoff, Linda Koch Lorimer,
Harold W. McGraw III, Robert P. McGraw and Edward B. Rust,
Jr.
(c) Shareholders ratified the appointment of Ernst & Young LLP as
independent auditors for the Registrant and its subsidiaries for
2003. The vote was 145,431,933 shares FOR and 5,309,759 shares
AGAINST, with 2,238,124 shares abstaining and no broker non-votes.
Item 6. Exhibits and Reports on Form 8-K Page Number
- ------ -------------------------------- -----------
(a) Exhibits
(12) Computation of Ratio of Earnings to Fixed Charges. 24
(15) Letter on Unaudited Interim Financial Information 25
(99.1) Quarterly Certification of the Chief Executive
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. 26-27
(99.2) Quarterly Certification of the Chief Financial
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. 28-29
(99.3) Quarterly Certification of the Chief Executive
Officer and the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. 30
(b) Reports on Form 8-K. A Form 8-K was filed on,
and dated, (i) April 29, 2003 with respect to
Item 9 (and furnished pursuant to Item 12) of said
Form, and (ii) May 5, 2003 with respect to Item 9 of
said Form.
<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: July 31, 2003 By
-----------/s/-----------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
Date: July 31, 2003 By
------------/s/----------------
Kenneth M. Vittor
Executive Vice President
and General Counsel
Date: July 31, 2003 By
-----------/s/----------------
Talia M. Griep
Senior Vice President
and Corporate Controller
<page>
Exhibit (12)
The McGraw-Hill Companies, Inc.
-------------------------------
Computation of Ratio of Earnings to Fixed Charges
-------------------------------------------------
<table>
<caption>
June 30, 2003 June 30, 2002
------------------ -------------
Six Twelve Six
Months Months Months
-------- -------- --------
(in thousands)
Earnings
Earnings from continuing operations
before income tax expense (Note) $ 277,959 $ 904,046 $ 256,248
Fixed charges 36,249 74,939 37,404
--------- --------- ---------
Total Earnings $ 314,208 $ 978,985 $ 293,652
========= ========= =========
Fixed Charges (Note)
Interest expense $ 6,576 $ 17,153 $ 14,427
Portion of rental payments deemed
to be interest 29,673 57,786 22,977
--------- --------- ---------
Total Fixed Charges $ 36,249 $ 74,939 $ 37,404
========= ========= =========
Ratio of Earnings to Fixed Charges 8.7x 13.1x 7.9x
</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 six and twelve
month periods ended June 30, 2003 and the six month period ended
June 30, 2002 are $8.1 million, $15.9 million and $6.2 million,
respectively. "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 June 30, 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 July 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 June 30, 2003.
ERNST & YOUNG LLP
New York, New York
July 31, 2003
<page>
Exhibit (99.1)
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 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report
based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
<page>
Exhibit (99.1)
Quarterly Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: July 31, 2003
-----------/s/--------------
Harold W. McGraw III
Chairman, President and
Chief Executive Officer
<page>
Exhibit (99.2)
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 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report
based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
<page>
Exhibit (99.2)
Quarterly Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: July 31, 2003
-------------/s/---------------
Robert J. Bahash
Executive Vice President
and Chief Financial Officer
<page>
Exhibit (99.3)
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 June 30, 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: July 31, 2003
------------/s/----------------
Harold W. McGraw III
Chairman, President and
Chief Executive Officer
Dated: July 31, 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.