標普全球 (SPGI) 2002 Q2 法說會逐字稿

Good morning, and welcome to the McGraw-Hill Companies 2nd quarter 2002 earnings call. At this time, I would like to inform you that the call is being recorded for rebroadcast, and all participants are in a listen only mode. At the request of the company, we will open the conference to questions and answers after the presentation, and instructions will follow at that time.

To enhance the call for today's telephone participants, McGraw-Hill has made presenter slides available on the internet. To do that, go to HTTP://WWW.my meetings.com/NC/join. I'll give the url once more for those that would like to view the slides online. It is HTTP://WWW.my meetings.com/NC/join. You will be prompted to enter your name, and the conference meeting number is P11818082. The password is McGraw-Hill, all caps, no spaces between McGraw and hill, and event type is conference.

This call is also being simultaneously webcast from from McGraw-Hill's investor relations website, and will be available for replay two hours after the meeting ends, both by phone and on the web.

If you need assistance at any time, including having your volume adjusted higher or lower, press star 0 and I will assist you momentarily.

I will now turn the conference over to Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. Sir, you may begin.

Thank you. And good morning, and thank everyone for joining us here at the McGraw-Hill building, and on the conference call, for this mornings announcement of McGraw-Hill Companies 2nd quarter earnings. I'm Donald Rubin, Senior Vice-president For Investor Realizations. With me today are Harold McGraw III, Chairman, President, and CEO, and Robert Bahash, Executive Vice President and Chief Financial Officer of the corporation.

This morning, we issued a news release with our 2nd quarter 2002 results. We trust you all have a chance to review that release. If you need a copy of the release and the financial schedules, they can be downloaded at WWW.McGraw-hill.com/investor_relations. I'll repeat that, WWW.McGraw-hill.com/investor_relations.

Before we begin, I need to provide certain cautionary remarks about forward-looking statements. Except for historical information, the matters discussed in this teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates and descriptions of future events. And these are based on current expectations and current economic conditions, and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looks statements. In this regard, we direct listeners to the cautionary statements contained in our form 10-K's, 10-Q's, and other periodic reports filed with the U.S. Securities and Exchange Commission.

We are also aware that we do have media representatives with us on the call. However, this call is for investors, and we would like that questions from the media be directed to Mr.Steve Weiss in our New York office at 212-512-2247, subsequent to this call. That's 212-512-2247.

Today's update will last approximately an hour. After our presentation we will open the meetings to questions and answer.

It's now my pleasure to introduce the Chairman, President and CEO of the McGraw-Hill Companies, Terry McGraw.

Thank you very much, Donald and let me add my own thank you for being here. Good morning and welcome to our view of the 2nd quarter earnings for the McGraw-Hill Companies. If you are joining us by phone or by webcast, we thank you also for your interest, and we welcome you.

After my review of the operations, I will ask Bob Bahash, our Chief Financial Officer, to look at some of the other important measures of our performance. And then we'll be glad to take any questions that you may have.

Earlier this morning we reported our 2nd quarter earnings. We beat the first call consensus by 3 cents. Earnings per share were 70 cents, an 18.6% increase when you exclude a 2 cent gain last year from one-time items. Both our results and the first call consequence census for the 2nd quarter include a four-cent benefit from the discontinuation of the good will amortization.

Revenue grew by 3.6% to $1.19 billion, and our operating margin improved 18.3%.

We are taking this opportunity to update our guidance. We're still on track for a double digit gain in earnings. That means we're looking for a double digit gain in the 3rd quarter, and a double digit gain for the full year.

We are using $1.22 for the 3rd quarter and $2.45 for the year as the basis for our guidance, and we are not including a 5-cent benefit for the 3rd quarter and a four-cent benefit in the 4th quarter from the discontinuation of good will amortization.

With that said, let's move to the operating segment. And let me begin with our financial services segment, which had another outstanding quarter. Revenue increased by 13.9%, operating profits grew 40.3%. The operating margin at 37% expanded by about 300 basis points over last year's 2nd quarter.

Now that margin expanded in the quarter because we kept a tight grip on cost both here and abroad. Infrastructure costs over access are growing more slowly now that the Financial Services Global Network is firmly established. Divestitures last year, and a shutdown of the Blue List, made comparisons easier in 2002. And since we priced for value, the robust growth in the more complex structured finance market again contributed to operating margin expansion.

If you look at new issuance in the U.S. bond market, the 2nd quarter is a repeat of the 1st quarter. Once again, a decline in corporate new issues pull down the total volume, which declined by about 5.7%.

For the first half, new issue volume is down 6.8%. But that figure disguises robust gains in both the first and second quarters in the structured finance, as well as the public finance sectors.

For the first half, mortgage backed dollar issuance is up 22.9%. Asset backed issuance are up 13.0%. And public finance is up 18.8%. And in Europe, over all bond issuance was down 17.4%, but our business showed strong growth.

Once again, the results at Standard & Poor's Credit Market Services illustrates that our mix of businesses can keep producing, even when a significant part of the market is in a slump.

Structured finance today is a global business, and we are benefiting from the worldwide growth in asset backed and mortgage backed securities. Both domestic and overseas ratings grew at double digit rates for the quarter, with international operations actually growing a little bit faster than domestic. More than 31% of our ratings revenue came from non U.S. sources in the 2nd quarter.

Public finance was also a strong contributor to our 2nd quarter success. Low interest rates and state municipal budget issues will keep the public finance market growing this year. For the McGraw-Hill Companies, a continued growth of the public finance market this year represents a real plus in our lineup for those who were concerned about state and local budgets, especially in the education area.

We expect continued robust growth in the structured finance market here and abroad. A further drop in interest rates could trigger still more growth in the issuance of residential mortgage back securities.

We're not counting on an upturn in the corporate market this year. But, we expect opportunistic financing to continue in the second half, and this again could be an area of an upside factor for us in the second half.

We expect more growth in our nontraditional services. For example, in the U.S. and Europe, we continue to see increased institutional participation in the bank loan rating market. In short, the outlook for ratings continues to be very strong.

In investment service. Revenues decline as the retail brokerage, foreign exchange and internet redistribution markets were all soft. But stringent cost control and growth in our higher margin businesses boosted profitability.

The index services market continues to grow. Assets under management, based on S&P indexes, at the end of the 2nd quarter reached $52.3 billion, a 32.4% increase over the same period a year ago.

With credit [INAUDIBLE] actively promoting the growth of the exchange traded fund based on the S&P Euro 350 index, we now have more assets under management than ETS based on either the [INAUDIBLE] or the MSCI European indexes. We continue to introduce new indexes and funds based on our new indexes.

In June, S&P launched the S&P ADR index with the assistance of J.P. Morgan. The index is designed to track the non U.S. portion of the S&P Global 1,200, with U.S. listed securities, primarily ADR's in New York.

A new exchange traded fund in Australia marks the first sector ATF in the Asia Pacific region.

And we spent the week last week in Asia. And we were in Hong Kong late last week, where we signed an agreement with the Hong Kong Stock Exchange. S&P will work with the Hong Kong Stock Exchange to create four co-branded indexes. There will be a large cap, a mid-cap, a small cap, and a composite of 3. They'll be known the S&P Hong Kong Exchange indexes, and they'll become available realtime in October.

It promotes benchmarks, it promotes new investment vehicles. It promotes simpler access to the region. It promotes transparency. And you'll see even more as the year unfolds.

We are also expanding our Corporate Value Consulting in a strategic expansion. CVC this summer will be adding 10 managing directors and 41 directors, managers, senior associates and others from Arthur Andersen. The additions enable CVC to expand it's national coverage, strengthen the corporate finance consulting, tax and financial reporting operations and enter the real estate valuations market with a scale required to be a player in this segment.

Let me be clear, we have not purchased any assets from Arthur Andersen. Instead, through a careful screening process, CBC senior management has recruited some seasoned and talented executives who will effectively contribute to our organizations growth.

With revenue of $42.5 million in the first half, CBC is off to a somewhat slower than expected start, largely due to the slower MNA actively. But we are on the right path, and very excited about our prospects here.

So, summing up for the financial services segment. Continued strong growth and ratings here and overseas. Structured finance and p[public debt markets will lead the way. More improvement in investment services, expansion at corporate value consulting, double digit top and bottom line growth for 2002, and expanding margins.

Now let's take a look at McGraw-Hill education. Revenue increased 1.9%. Operating profits declined by 5.8.

There two major units in the McGraw-Hill education. Buyer education professional and international group, and the school education group. Our higher ed group's revenue is up 10.9% for the 2nd quarter to $170.5 million. Our school groups revenue was off 1.4 to $406.5 million. Clearly our college and university business is off to a fine start and, we expect to continue double digit growth in this market.

We attribute our success in the higher education market to the way we are combining text and technology. Our digital solutions provide an interactive way for students to study. Course management systems for instructors and online assessments. The result is a better package for instructors and for students.

Our professional operations benefited from the publication of a new addition of the Encyclopedia of Science and Technology. This 22 volume work is now in it's ninth edition.

We've also added an important new module to our growing Access Medicine website. The Metabolic and Molecular Basis of Inherited Diseases has been the leading text in the field for more than 40 years. It is the core of the new offering on the web, with a promise of continually updated information, so the subscriber can keep pace with the strides being made in genetic research. It's the latest example of how we continue to use core text to create subscription based services that in this case offers researchers and physicians what is essentially a new global knowledge product with seven new sections on cancer, and fresh data on counseling and therapies for inherited diseases.

In our international market this quarter, solid secondary school sales in Mexico. Very pleased here. And a very good performance in Canada as well, were the key drivers.

Now let's take a look at our school education group. There are always questions at this time of the year about the outlook for the elementary high school market. But this year there seems to be even more questions than usual.

As we see it, there really four key questions. First, what is the impact of state funding on the education market? Second, will new Federal funds from the No Child Left Behind Act add incremental dollars to the market this year? Third, how much will the El-high industry grow in 2002? And fourth, how will the McGraw-Hill school education group perform in this environment? Let's look at each of these questions and provide some answers based on what we know today.

State funding for education has been a concern for sometime. 46 states each spring work on new budgets for a fiscal year that starts on July 1. For 40 of these states, budgeting for the new fiscal year became more complicated because tax receipts were coming in below forecast. Only six states reported that tax revenue beat their forecast for the January-April period this year.

Another complication is that some key states, like California, did not complete their budget deliberations by July 1. So there are still question marks out there.

But we do know that recent polls show education remains a top priority for the American public, particularly when it concerns instruction. That's why education is one of the few areas state legislators resist cutting. When reductions are made, they usually occur in new or peripheral programs, before and after school programs, in summer school and administration. Protecting instruction is the goal.

Many states and municipalities are using the so-called syntaxes on tobacco and gambling, tapping contingency funds, or even raising taxes to avoid major cuts in educational spending.

The only major instructional cut that we know about at this time may occur in California, where the revised budget currently provides $50 million less than the $523 million originally proposed. The lower amount still represents an 11.8% increase over the previous year.

In Florida the educational budget for the instructional materials in fiscal 2003 has been increased by 6.7% over last year.

In New York, the fiscal 2003 budget for education will increase less than 1% over fiscal 2002.

Illinois is reducing el-high funding by 1.3%, a cut from what is spent in the previous fiscal year. The cut is coming in grants and not in basic funding.

At this point, we still don't have all the facts on how much states will spend on educational materials in the new fiscal year. The National Conference of State Legislatures yesterday -- this report came out yesterday -- yesterday reported that 40 states have budgeted a 4.8% increase in K-12 education for the fiscal year starting in July. That includes, within that 40 states, 11 states planning cuts in K-12 education. And over all total spending, not just education, total spending in those 40 states we know about is budgeted to grow 1.6% for the new fiscal year.

So, based on what we are hearing, it seems fair to conclude overall state spending on educational materials is this new fiscal year still under pressure, but is showing more promise than some people thought.

The second question is about how fast federal dollars from the new No Child Left Behind Act will flow into the market this year. We have been watching this situation carefully. Right now it looks as if the loin's share of the authorized funding will be spent at the state and local level next year, even though the money is starting to flow now.

On June 25th, the Department of Education made the initial Reading First Grants under the HR 1 program, and let me give you the details we know at this time.

Alabama will receive $15.5 million this year and $102 million over the next six years.

Florida was granted $45.6 million this year, and nearly $300 million over the next six years.

And Colorado gets $9 million for the first year, and $89 million over a six-year period.

We know that 26 states, the District of Columbia, and Samoa have already applied for funding, so more announcements about the grants should be made throughout this summer. And we will keep that in front of us, so we all have that information.

When you examine the programs submitted by the states that have already received funding, it is clear that the first big wave of spending won't occur until next year.

Florida says it won't implement Reading First until next January, because educators need time to plan and train for the introduction of the new programs at the start of a new school year.

Colorado plans to give $7.2 million in grants to 45 schools in the spring of 2003.

Alabama will make subgrants of $12.5 million to 60 schools as early as December. Alabama officials also say that up to 80% of the total grant money will go directly to schools needing --

Hello?

What is that? [long pause]

Hello? Are any [INAUDIBLE] [long pause]

We had a little telecommunications blip there. I apologize, that must have been Alabama. [INAUDIBLE] Let's go back to Alabama.

Alabama will make subgrants of $12.5 million to 60 schools as early as December. Alabama officials also say that up to 80% of the total grant money will go directly to schools meeting Reading First eligibility requirements.

To receive a grant each Alabama school must employ a reading coach, Use research-based reading programs, use specific assessments, and spend $1,000 for every teacher in the school for professional development. Training started this very month.

Given the pressure on state and local education budgets, and the latest information on the timing of new federal money, it now appears that the el-high market will not reach the high end of our earlier 0-4% growth projection.

We knew that the adoption market this year would not match last year's. The big question then is the performance of the open territories in the 3rd quarter. This is a difficult area to call, and never more so than this year.

Funding allocations in the open territories generally occur at the local level, making them more difficult to quantify and to predict. And this year many schools delayed decision as they waited for guidance on Reading First requirements from their state and local education agencies. That means we will not have a clear picture of the open territories spending until well into the 3rd quarter.

The industry needs a solid performance in the open territories to stay on a growth plan for this year. Softness in the open territories will reduce or even create a downturn in el-high market sales for the year.

Even in this environment we expect to maintain share this year. Our 3rd quarter adoption sales are generally in line with our previous expectation. And we still expect to capture about 30% of the adoption market this year. Early signs in the open territories are very encouraging, but there too many uncertainties to predict the out come right now.

Summing up for the education segment. Another year of growth in the segment, strength in higher education, testing, supplementary reading and math, and secondary school markets will keep us moving ahead in 2002. We are still on track to achieve a 15% operating margin in the segment, and building from there.

Let's take a look at our information and media services segment. Revenue declined 9.1%. Operating profits were off 19.7%. We reduced cost by 7.2% for the quarter to shield some of that decline. And in fact, operating cost for the segment are down $20.9 million for the first half. So this management team has worked very effectively to hold the line under difficult circumstances.

With costs tied down so tightly, we substantially improved our leverage, and any improvement in advertising is going to show up on the bottom line. Our situation is starting to look better.

As you know, Business Week ad pages were off 33.4% in the 1st quarter of this year, and 20.4% in the 2nd quarter. But, Business Week is starting the 3rd quarter on a positive note. And after five issues in July, Business Week ad pages are up 4.6% according to the Publisher's Information Bureau.

This battle is won a week at a time, but we want to see a pick up in capital spending and continued business spending activities, so we know the pick up is sustainable.

Of course, we are also benefiting from easier comparisons. In the 3rd quarter last year, Business Week ran 772 advertising pages, a drop of 40% versus the same period in the year 2000. Business Week experienced another 40% drop in the 4th quarter of last year, following the terrorist attack of September 11th.

The ad picture is also brightening in our broadcasting operation. For the first time this year, broadcasting has a positive pacing at the start of the quarter. Right now the broadcasting group is up mid-single digits for the 3rd quarter.

The Aviation Week market. Our magazine here faced tough comparisons in the 2nd quarter, because the Paris Air Show was held at that time last year. This year, we are looking forward to the Farmbourough Air Show in Great Britain in the 3rd quarter.

In the energy markets. Platts, our global energy brand, continues to benefit from the acquisition of FT Energy.

And in the construction market, tight expense controls allows us to have increased operating profitability.

So, summing up for the information and media services segment. Tight expense controls will improve our leverage, and advertising will be able to drop to the bottom line. Signs of positive improvement in advertising are also at foot.

There you have the current picture for the corporation. And in summarizing now for the corporation, continued strength in financial services and margin expansion.

A double digit gain in higher education will help offset slower expected growth in the el-high market.

Improving prospects in advertising, continued emphasis on cost and expenses.

A double digit increase in earnings per share in the 3rd quarter, and for the full year.

Simply stated, we are on target. I appreciate that. Thank you. And I would now like to ask Bob Bahash, the Chief Financial Officer, to give you additional performance indicators.And then we'll take questions, and go in any direction you would like.

Okay. Thank you, Terry. The corporation continues to maintain a strong financial position. We completed the first half with our debt at $1 billion, 163 million. That's $133 million lower than it was for the same period last year, but $107 million higher than it was at year end. Now, our debt level reflects the normal, usual seasonal ramp up in borrowing, because of our investments in the education market.

Virtually all of our debt is in regulated commercial paper at favorable rates. The average interest rate on commercial paper borrowing has declined from 5.6% last year to 1.9% this year. At the end of June, our outstanding commercial paper had a weighted average maturity of 62 days.

We continue to benefit from lower interest costs. Interest expenses were down 55.4% for the 2nd quarter, and almost 59% for the first half. We paid $13.6 million this year in the first half, versus $32.9 million last year.

Given the low interest rate environment, and debt levels that have already peaked this year, we expect favorable comparisons for the remainder of the year.

As part of a world wide restructuring program announced last fall, we planned a work force reduction of 925 positions. At the end of the 1st quarter, 348 had been terminated. For the first half, the figure has grown to 773. We expect to complete this program by the end of the year.

In the restructuring, we were closing out our business training course ware operations. In June, we sold selected course waer, technology , and E-learning assets from this unit to the Thompson Corporation.

Also, we divested a unit of the McGraw-Hill Construction area in June.

Cap, a space planning and specification software company for the contract office furniture industry, was sold to 20-20 Technologies. Cap was headquartered in Grand Rapids, Michigan.

Cost containment measures are always important, so it's worth noting that our cost and expenses for the first half are virtually flat. Lower manufacturing costs played a key role in our ongoing containment efforts.

Last year, combined printing, paper and distribution expenses accounted for 23% of our operating expenses. Through various actions we expected a 3% decrease in these expenses this year. But recent successful negotiations with suppliers have enabled us to roll back printing and paper costs some more. As a result, we now expect to reduce manufacturing expenses by 3.8% this year.

Now let's look at some other costs. Prepublication costs still represent our biggest single biggest investment each year. We spent $80 million in the 2nd quarter, and $114.9 million for the first half. We are still expecting to spend about $300 million for the year.

Our capital expenditures for the 2nd quarter came in at $17.5 million, and $26.9 million for the first half. And that's down 34.6% from last year. We expect to end the year substantially under last year's total of $116.9 million.

I also want to point out a new line in the cash flow statement for technology projects. For the first half we spent $33.8 million on these technology projects. The differed project requires development to make it productive, which is why we don't include them as capital expenditure items. The new Global Transformation Product from McGraw-Hill education is a major undertaking, and accounts for most of the dollars in this category.

To simplify our business processes for the entire McGraw-Hill education group, we are reengineering our systems for customer services, production, inventory, and data management. Working with Oracle and Ecentric, we are successfully piloting this project in Canada. On June 3 we went live. We successfully closed the 2nd quarter books for the first time in Canada, using the Oracle 11I software.

The roll out to U.S. divisions will start next year, followed by international locations. A substantial share of the investment in the Global Transformation Project has been made in the last 18 months. These projects are amortized as they come online.

Depreciation for the 2nd quarter was $23.4 million, and $47 million for the first half. An increase of 3.7%.

Amortization of prepub costs rose $71.7 million for the 2nd quarter, and $104.8 million for the 1st half. An increase of 16.9%. We expect to hit roughly $300 million this year.

Amortization of [INAUDIBLE] and intangibles of course declined, because of FAB-142, by 58% to $9.8 million in the 2nd quarter, and $19.7 million for the first half, which is a 55.8% decline. For the year we expect basically amortization of intangibles to [INAUDIBLE] in about $38 million.

Starting in the 2nd quarter we began to repurchase shares. So far this year, we've bought back 965,000 shares, and we do plan to repurchase between 3 and 3.5 million this year.

Finally, lets spend a moment on the outlook for our free cash flow. Cash provided by operating activities for U.S. GAAP for the first half of the year was $171.7 million. We described free cash flow in a broader fashion going beyond operating cash flow.

We define free cash as what's left after working capitol needs, internal investments-- including prepublication costs and capital expenditures -- interest expense, and the $196 million that we annually spend for dividends, but before one-time real estate projects. Free cash available -- free cash is available to repurchase stock, make acquisitions, and repay debt.

Based on normalized free cash flow of $331 million from last year, we are still on track to produce a year of double digit gains.

Thanks, and back to Terry.

Okay, there you go. And thank you very much, Bob. Now we can go in any direction you want. We are obviously very pleased with the overall environment with the 2nd quarter results. We are very excited about the completion of this year, and the guidance we have been able to give you, both for the 3rd quarter and the 4th quarter of double digit earnings.

So with that, we can go in any direction you would like. Back to you, Don.

Thank you, Terry. We will start with questions online, and turn it over to the operator for the first question.

At this time we will be in the question and answer session. If you like to answer a question, press star 1 to indicate that you wish to enter the queue and ask a question. To cancel or withdraw your question, simply press star 2. Once again, that is star 1 to ask a question, and star 2 to cancel or withdraw a question. One moment while the questions are registered.

Your first question comes from Peter Appert of Goldman Sachs.

Thanks you. Good morning, Terry. You've had spectacular results from the stuctured finance efforts at S&P for a couple of years now. I wonder if you can speak to the issue of what's happened in that market to drive the growth, and if it's truly sustainable, or if we're looking at just a cyclical key [INAUDIBLE] right now that might come and bite us in the rear end next year.

Thank you, Peter. Now the structured finance market has gained strength, and it's going to continue to remain strong for sometime. It is a global market place. It is accelerated in terms of its participation not only in the asset backed area, but increasingly in the mortgage-backed area and the residential mortgage-backed area, as housing becomes an obviously bigger and bigger issue, especially outside the United States.

In the 2nd quarter, the structured finance deals, and this is going to public information, S&P rated about 89% of the dollar volume, versus about 80% last year. We were quite pleased with that. We expect for the remainder of this year and into next year that this growth will continue at a very good pace.

So it's a -- it's gained strength. But because of the growth, in particular with the mortgage-backed area, and picking up in terms of new issue volume numbers, it's going to be a lucrative market for sometime.

Okay. Unrelated that that. The CVC business, you mentioned, was off to a slightly slower start than expected. What's going on there?

You're talking about CTB McGraw-Hill testing?

No, CVC. Corporate Value Consulting.

Oh, I'm sorry, CVC. Corporate Value Consulting is being impacted, Peter, a little bit on the M&A activity, or absence of M&A activity. But it's been giving us an opportunity too, to strengthen our over valuation capabilities. And we talked about some of the things, with Arthur Andersen and the numbers to date, that we have been able to achieve.

We are excited about this platform. A very similar business to some of our other S&P businesses. We are right on track. We are a little behind because of the M&A activity. But we fully expect to have a good year. And '03 and '04 should be another strong complimentary capability for them.

Okay. Last thing, Terry. The -- in the context of the current market environment, would you think about getting more aggressive in terms of the share repurchase program?

Let me just say that Peter, we are very active on our share repurchase. As Bob was saying, even though we are a little under a million shares this year, we fully plan to do at least 3, 3.5 million total. And dependent upon conditions, we could do more. but at this point we will hold to the 3, 3.5. We are obviously watching that like everybody else is, very, very carefully.

Alright. Thank you Terry.

Thanks, Peter.

Our next question comes from William Burke of Soloman Smith Barney. Sir, you may ask your question.

Hi Terry. I was wondering if you can talk a little bit about potential annualized cost savings from the Global Transformation Project.

Also, do you have any plans to fix your debt?

And third, I was wondering if you can talk specifically to the new issue pipeline for S&P Q3.

I'm sorry Bill, on that last one? What was that again?

The last question was if you can discuss specifically how the new issue pipeline looks for S&P in Q3.

Okay. First, Global Transformation Project. We are obviously well underway. As we told you in June, we were going to out the Global Transformation Project in Canada. That is going extremely well, and we are very, very pleased. And now starting to work on the plans for the phase in here in the States, which we expect to be completed in '03, and then off into outside there, probably late '03 and into '04.

The project right now is running in excess of roughly $90 million. And in terms of the benefits, that those would be phased in over the approximate period of time that it is being implemented.

So, we are very pleased with it, it's on track. And the first big task was obviously Canada, and we are doing well. We are pleased, and the phase in for the U.S. for the remainder -- coming towards the end of this year and into '03, is on track there.

Bob, do you want to add anything more on the global transformation project?

No, you're doing fine Terry.

Good. Okay.

Fixed debt. I will give you my stab on it, and then we'll give it over to Bob as well. We are very pleased with where the interest rate environment is right now. We're benefiting nicely from that. It has been a strategy that we have imposed for sometime now. We see no reason at this point to make any changes in that.

So, you can fully expect that given the current interest rate environment, and our expectations for this environment that, we are going to continue to impose the strategy we have.

Bob, do you want to add anything to that?

The only thing I would add is Bill, as you know, we are expecting that our end of year debt levels will be [INAUDIBLE] under a billion dollars, probably in the range of $900 million, absent acquisitions. We have the ability to pay that off relatively quickly.

So right, now with the environment as it is, there is no pressing need for us to extend out maturities. And we're just going to continue with the position that we have.

And Bill, on your final question on new issue volume for the 3rd and 4th quarter of the second half, obviously we expect here to see continued strength. The structured finance market is going to show continued strength not only here, but abroad. We are also going to be able to see the public finance market continue to show growth.

And one that we are watching very carefully is the whole corporate area, which is obviously down. We have been talking about how we will see some financing here. I think this could be one that could turn very positive and surprise us a little bit. Given this environment that we are in, and that we may see pick up by the end of the year. We're not writing that in and counting on it, but it could be an upside for us.

The insurance markets are still showing growth. Overseas we are doing well, especially in the bank loan market. We are doing well in Asia, especially in Japan with a securitized market, and we continue to focus on that one..

So, the second half for S&P in the credit rating side looks very positive to us. We expect that to continue in terms of the kind of growth that we have seen in the first half.

Is it fair to say that Q2 S&P ratings revenue growth is probably in excess of 20%?

We don't break that down, Bill, as you know. Obviously given the kind of numbers that we are talking about and the kind of performance we saw in terms of deals that we rated, it was quite strong.

Thank you.

You bet.

Our next question comes from Lauren Fine from Merrill Lynch. You may ask your question.

Thank you. A couple of quick questions. On financial ratings, I'm wondering if you can tell us what proportion of revenues were nontraditional versus traditional, or transaction versus nontransaction.

Okay.

And then I have a follow-up.

Okay. The nontraditional ratings over all is a smaller number, obviously. But a growing number. It roughly represents -- and it fluctuates at any given time. but given the strength of the bank loan markets, and our ability to serve that market both here and abroad, we have done very well. Those numbers are about roughly around 20%. That's of the total.

In terms of transaction, Lauren again, in looking at any one specific period is kind of tough. but given the new issue dollar volume in the structured and public finance market, obviously there is a little bit of a skew towards the transaction side. But again, because of our fee-based model, and our surveillance fee arrangement, we would be deffering some of that revenue recognition into the later periods.

Okay. I'm not sure I understood. In that last market, you would have a choice to defer the revenues?

I'm sorry.

I don't -- I guess I didn't understand that last part of your remark about deferring the revenues.

Oh no, no. Again, I'm just saying as you know with our surveillance fee arrangements, we would be obviously deferring portions of those out, so that the transaction portion in a given period would have less of an effect.

Okay. In the education area, one of the thing that is continually confusing me is there has been a lot of discussion about how budgets are determined usually by July 1. If that's the same every year, I'm not sure why that would cause delays.

Maybe what I'm trying to get a stab at is how much of a fiscal year budget at state level is spent in the current calendar year versus the next calendar year.

Well, let me try, Lauren. We have been watching and we are become state budget experts. We have a long ways to go.

In terms of watching how the states come about their budgets, it has gotten more difficult obviously in the last year. From our standpoint, the educational part of the budget they have spent, and therefore getting those kind of materials -- and again, expenditures for instructional material is the critical part. If they are making postponments or cuts, they're coming from other areas.

So, we are seeing those kinds numbers, and they are spending those monies in the current period. What we were watching for is in terms of some of the federal dollars, whether or not they were supplanting some of the short gap they have or looking at alternative means.

One of the pieces of information we were able to achieve yesterday came from this conference of state legislatures, where they were showing the expenditures. And they were up in the 40 states that have reported so far. Quite significantly for K-12 education. Especially given the fact that total spending for that same 40 was at 1.6% versus 4.8% for the K-12.

So I think that, from a local standpoint, those dollars are being spent in the current period. And the question is that given tougher times, how they are going to be able to rectify some of that short gap. And we're seeing a whole host of things, from tax schemes to additional fundings. To be able to do that.

So again, I think it's an encouraging picture of what we heard on this. We want to watch this very carefully, especially as we see the completion in the 3rd quarter of the open territories. And if there are going to be budgetary concerns that states are going to have, and will they flow through to those. So we're watching that very carefully.

But you know, our sense is that local market and state spending levels that have been allocated have been spent.

Okay, thank you.

And our next question comes from Douglas Arthur from Morgan Stanley. You may ask your question.

Yeah, a couple of questions. One, could you comment on potential political advertising on TV in the second half?

Two. Just a little elaboration on why you are so confident in double digit earnings growth [INAUDIBLE] 3rd quarter, given the caveats on particularly things like the open territories [INAUDIBLE].

And third, any comments on potential acquisitions in the higher end market. Obviously, there are some assets available on the market here. Is that an area you might look at? Thanks.

Thanks, Doug. Political advertising is going to probably accelerate as we get into the 3rd quarter. We have seen it a little softer than expected, and I goes with the times a little bit. We do expect that to pick up, especially given the very close California race. So again, it's difficult to tell at this point, but I think somewhere in the range of 6-8 million is probably a fairly good estimate at that point.

The double digit in the 3rd quarter is a function of some strength across-the-board, not only in financial services where we see continued growth and we see continued impact on profitability, but also in the investment services area with some of the index and portfolio management service.

Also we will be getting continued contribution out of higher education, as well as the international publishing operations. We expect to get some continued growth out of such areas as our energy markets, especially with the Platts brand, and in the Aviation Week market.

Any advertising pick up, and any easing of comparisons here year over year, will certainly also benefit that. And that was because of the cost controls, it would drop right to the bottom line. So we are very comfortable with that guidance for the 3rd quarter.

Doug, in the acquisition area. As you well know, we don't talk about specific acquisitions. But the higher education area is a very attractive area. It's one where we have grown and put a lot of emphasis on. And we are obviously continuing to look how to further growth and further development that. So that's a priority for us as well.

great, thanks.

Our next question comes from Brian Shipman from UBS Warburg. You may ask your question

Thank you, good morning. The question on the higher ed professional international portion of education. Up 10, almost 11%, sounds like professional is still struggling a bit. International is still in a bit of a turn around, but it [INAUDIBLE] higher ed specifically may be up in the mid-teens. Can you talk about how that compares to the competition in higher ed, and also talk about why higher ed is holding up so much more nicely than say the el-high category.

Thanks, Brian. Obviously, in the latter part of that question, the higher education market is a very different marketplace than the -- than the elementary high school market. The influences, the assumptions, and the indicators that we would watch are very different on that one. So, we are not obviously subjected to state funding kinds of issues, or other kinds of shifts associated with federal dollars or anything like that.

Where as we are excited about those aspects, especially towards the latter part of this year and get into '03, in a better adoption market. The higher education market is benefiting obviously from the continued ability to sell outside the United States, with core disciplines in the maths and sciences and engineering and business and so forth. It's an area we have spent a lot of time on. The management team there is quite strong. In a market that's growing about 5% on an annual basis, we are growing at a double digit rate, and therefor taking share. To the previous question from Doug Arthur. Obviously, we will be taking a look, Brian, on how we can continue to build on that platform. International is also doing very well. We spent a lot of time on this. I'm very pleased with the results coming out of Mexico. Mexico is doing very well. Also out of Canada. But increasingly, you -- we expect more contribution here.

The higher education market is doing very well. Enrollments are solid, and we expect to continue to be able to explode non U.S. markets, as well as getting share domestically, to do that double digit gain.

Can you talk about the profit margin between higher ed and maybe el-high?

Sure. In fact, let me turn that over to Bob. Bob?

Okay. Just on the last question, I had two points. One within the professional publishing area. We had good strong performance from the launch of the Encyclopedia of Science and Technology in the 2nd quarter. So that benefited us

And also, just to add to Terry's comments on the higher education side, we really are a leader in the technology offerings with regard to our products. The wrap around pieces, the compliments from web-based product offerings, I think has really helped to separate our position in many cases.

With regard to the margins, clearly there is a differential in margins in our different businesses. Higher education margins, when you think back prior to the acquisition of the Times-Mirror businesses, when we swapped that -- our Shepherds business for that, we were at roughly a 10% margin. And we had indicated that we would reach -- our objective was to reach a 20% margin. And clearly, we have reached that, and we have exceeded that. In large part because of the revenue gains, but also the technology components added there as well. So that segment, that piece of the education area has the higher margins driven in large part by higher education.

So when you look at the other side of the house, there are many different components. The secondary markets, those fitting in with the Glenco offerings, have very significant margins, as well as our suplimentary, with our SRA.

But the areas that require the largest investment, that being our K-6 business offerings, the school divisions, have the lower margins. And that's what differentiates the margins between K-12 and higher education.

Great. Thank you very much.

Thanks Brian.

And our next question comes from Brandon [Doleman] from Credit Suisse First Boston. You may ask your question.

Good morning.

Good morning.

I have a couple questions on education. You mentioned the strength in the testing market, a lot of good wins there. I wonder if you can detail for us what opportunities are left in that market relative to the testing [INAUDIBLE] that are going down the pipe.

Also in education, if you can give us an idea of what potentially could be the upside and the downside with the open territories? As you look at that, kind of 0 to 4% range in el-high, or in elementary, where would that range go if the open territories came in strong or very week [INAUDIBLE] your expectations. Thanks.

You bet. First of all, on testing. Testing in general, the appetite for testing materials in terms of the development of low stakes tests, both in the very local markets and the districts, is very strong. We expect to see continued participation there, and very solid growth.

In the high stakes area as well, certainly it's going to become even more important as a lot of the expenditures associated with some the federal dollars get into the system, and the desire to make sure that there is compliance to the accountability measure that have been established.

So, the strength in testing will continue for sometime. Right now, we are seeing a tremendous benefit, especially in the low stakes area.

In the open territories, in the up and down, some of the similar things that are influencing the adoption markets, state funding kind of pressures, and federal dollars, and all of those are also being watched carefully. I am very encouraged however, especially with the latest report from the Conference on State Legislatures, that the spending increases out of those 40 state that we do know ,and where they are. And therefore, it's just a little too early to get too specific about a number.

Again, we are encouraged in what we see at this point that open territory spending could be a much bigger portion, and therefore a good contributor. We were looking at, coming into this year, at that open territories would be about 55% of the opportunity versus about 45% for adoptions.

And of course, we would need to see that number strengthen as well. Any softness or weakness in those numbers obviously is going to make it very difficult to show a year over year market gain on that.

It's just a little too early to tell. We will keep that in front of us.

Thanks. One quick follow-up for Bob. The tax rate in the quarter. As we model out the rest of the year, is that going to be sustainable, or should we model something different?

The effective tax rate of 37.5% will hold for the balance of the year.

Okay. Thanks.

You bet.

We will now take our final question from Kevin [Grid] from Bear Stearns. Sir, you may ask your question.

Thanks. Just a couple of questions, and a follow-up, if I could. First of all, I was wondering if you can tell how much Fred Shaffer incremented revenues in the [INAUDIBLE] business. And secondly, on the transformation projects that Bob -- [INAUDIBLE, audio breaking up]

Okay. I'm sorry. You were coming across broken up on that, but let me take a stab, and then you can sort of guide us here. We didn't quite get all the Global Transformation Project question.

Let me start with Frank Schaefer. The children's publishing area is an area we wanted to put some very strong emphasis on. Of course this acquisition helped us there. We don't break out the specifics of a particular unit that way, but children's publishing is having a very good start to the year. We are very pleased with that. Frank Schaefer obviously is adding to that.

On the Global Transformation Project. As you know, it has been all expenses, and we are roughly running about $90 million in terms of the project. We announced the June start in Canada as the first part of the phase in. Therefore that is going very well. Now we are making the plans for the implementation of the phase in for the end of this year and '03 for the U.S.

I'm not sure again, with it being garbled, but Bob, why don't you take a crack. And then guide us if we need to get somewhere closer.

kevin, I think I got your question. You asked specifically where were the GTP deferred project costs in 2001, since they are broken out this year. The costs in 2001 they were modest. That's why when you look at the cash flow schedule, they were in the other category. Now, as they got to be a much larger item, we broke out as a separate line item. And as Terry pointed out, a large portion of that $90 million expense item will be incurred this year. But obviously with the roll out going out through 2003, you will still see a fair amount of cost coming through in 2003 as well.

Bob, just a follow-up on that. Would you expect the second half to be in line with the first half? in terms of transformation costs?

Yeah. I think, Kevin, most likely it would be in that range, because we're -- we have rolled out Canada, we're putting ourselves in a position to start the process with some of the other businesses. We are just going to be a little bit too tight with some of the year end business activities to move. Most likely we will not move for the roll out in the fall.

Generally it probably will be a roll out of a couple of businesses in generally the February and March period, prior to the major selling season in the summer. And then most likely -- [INAUDIBLE] we would look at higher education and those businesses after the major selling season next fall.

Got it. And then, just one follow-up. That's on the lifetime warranty business that you sold to Thompson. I understand this is a small divestiture. Wasn't that business written down back in 2001, and where is that transaction accounted for in Q2 of '01? I guess I'd throw the Cap divestiture in there too.

Unfortunately those are very small. Those businesses that were sold to Thompson, as we mentioned earlier, were part of the restructuring actions that were taken last December. Both of those transactions were very small. Just simply pointing out that we did sell those assets, but we got very modest proceeds. The Cap deal, that was a small business to start with. It's one that did not fit strategically. It was very, very specific in terms of the office furniture marketplace. We had an opportunity to sell it and we did. But both of those transactions were very modest, Kevin.

Okay. So no gain or loss on either of those?

No. Especially since we wrote the business off. It's a very, very modest gain, unfortunately. I wish there was something more to say on that.

Thank you.

You bet, Kevin. Okay, does that do it? Again, we thank you all for your participation. We are excited about the 2nd quarter and the completion of the full year. Again, our guidance of double digit earnings for the third and the full year. Thanks for being with us.

That concludes this is morning's call. On behalf of McGraw-Hill Companies, we thank you for participating, and wish you a good day.