標普全球 (SPGI) 2003 Q2 法說會逐字稿

Good morning, and welcome to the McGraw-Hill Companies second quarter 2003 earnings conference call. At this time, I would like to inform you the call is being recorded for broadcast 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 presentations and instructions will follow at that time. To enhance the call for today's telephone participants, McGraw-Hill has made the presenter slides available on the internet. To do that go to http:// www.mymeetings.com/nc/join. I will repeat the URL once more for those to present the slides. It is http:// www.mymeetings.com/ncjoin. You will be prompted to enter your name. The net conference meeting number is PG , 538-4160. The password is MCGRAWHILL, all caps, no spaces. The event type is conference. This call is also being simultaneously web cast for McGraw-Hill's investor relations web site and will be available for replay about two hours after this call ends, both by phone and on the web for seven days. If you need assistance at anytime, including having your volume adjusted higher or lower, press star zero and I will assist you momentarily. I would like to turn the call over to Donald Rubin, Senior Vice President of Investor Relations.

Thank you for joining us at the McGraw-Hill head quarters a well as on the phone for the companies' announcement of the 2003 second quarter earnings. I'm Donald Rubin, Senior Vice President of Investor Relations. With me are Terry McGraw III, our Chairman and CEO, and Robert Bahash, Executive Vice President and Chief Executive Officer. This morning we issued a news release with the second quarter 2003 results. We trust you had a chance to review the release. If you need a copy of the release and financial schedules they can be downloaded at www.mcgraw-hill.com/ investor_ relations.

Before I begin, I need to provide certain cautionary remarks about forward-looking statements. Except for historical information, the matters discussed in the teleconference may be contain forward-looking statements within the meaning of the private securities litigation reform act of 1995, including projections, estimates and descriptions of future events. Any such statements 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-looking statements. In this regard, we direct listeners to the cautionary statements contained in our Form 10-K, 10-Q and other periodic reports filed with the Securities and Exchange Commission. We're aware we do have some media representatives with us on the call. However, this call is for investors and we would ask questions from the media be directed to Steve Wise in our New York office at 212-512-2247 subsequent to this call. 212-512-2247. Today's update will last approximately an hour. After the presentation, we will open the meeting to questions and answers. It is my pleasure to introduce the president, CEO of McGraw-Hill, Terry McGraw.

Thank you very much, Donald. Good morning to all of you. Welcome to those of you who are here. Thank you. And those who have joined us by telephone or web cast, we appreciate your interest in the company. Thank you for joining us. This is the review today of the second quarter results. I will review the operating performance and the outlook for the McGraw-Hill Companies, and Bob Bahash, our Chief Financial Officer, will discuss some of the key aspects of the quarter. After the presentation, we will answer any questions you have about the McGraw-Hill Companies. With that, let's get started.

Earlier this morning, we announced second quarter results. Just to recap quickly, earnings per share from continuing operations increased 7.2% to 74 cents. Income from continues operations increased 4.9% to $142 million. Operating revenue grew by 1.3% to $1.2 billion. The second quarter finished more strongly than anticipated, particularly in the education area. We will discuss some of that. We have been concerned that timing issues in Texas might have an impact on the second quarter sales, and we so stated. The state's education budget was approved later than usual, and there were questions until very late in June about fulfilling orders promptly since Texas sends its own trucks to our warehouse to pick up the product. The process went smoothly, and we were able to meet the demands of the Texas schedule without letting second orders slip into the third quarter.

We were also very pleased with the strength of our College and University business in late June as well. In financial services, deal flow in structured finance favors the third month of each quarter, and late June was no exception at Standard & Poor's. Corporate issuance in Europe also closed very strongly. In looking ahead, we remain confidence in our guidance for the year. An increase in earnings per share from 7 to 9 percent which includes a 5-cent non-cash, non-operating change in pension accounting assumptions. We base some of our confidence from the accelerating second half recovery. Our economists forecast GDP on an annualized basis to grow 4% in the second half of this year, after, roughly, a 2% growth in the first half. We're seeing some very encouraging signs in the manufacturing sector that suggest pickup in capital spending for equipment. Corporate profits will continue to improve, growing at a did you double-digit rate, albeit the increase is coming off a low base.

The low interest environment favors continuation of the refinancing boom in the second half. An estimated 60% of the universe of the 30-year fixed mortgages are candidates for refinancing at lower rates. That's according to a CitiGroup survey issued to July 16th. The education market is in the midst of what we call a 60-day month, the crucial July and August period when the heavy seasonal ordering occurs. We are encouraged by our start. It is still too soon to predict how it will perform. Let's look at our operations in more detail. Let's start with the financial services segment. Financial services, revenue was up 9.7%. If you exclude MMS International which was divested in September 2002, it increased at a double digit rate. MMS reduced operating revenue by 2.5%.

Foreign exchange contributed $10.3 million to the growth in the second quarter. Operating profits increased 12.3% and the operating margin was over 39% which reflects the solid global growth of higher margin structured finance products in our mix as well as good cost containment. In short, a record quarter for revenue and operating profits, and we're very pleased with that. In the ratings area for the second quarter, we had strong growth overseas which provided under one-third of the revenue. We had even stronger growth domestically and nontraditional ratings, things like the corporate asset loan railings, rating value services and so forgot. Non-traditional ones grew faster. They represent about 20% of our revenue base. The structured finance market was very strong with our ratings at the forefront. Asset back alert, a news letter that tracks the market activity reported in its July 11 edition that after six month of this year that Standard & Poor is the market leader whether you measure by dollar volume or number of issues rated.

We rated this year 94.1% of the asset and mortgage back dollar value and issuance completed in the first half, compared to 93.7% for the same period last year. To quote the editors of the newsletters, we are, quote, on pace to win the rating agency rating for the sixth year in a row. We appreciate the comments. U.S. new issue market showed solid growth in the second quarter as dollar volume increased 23.3%. As we anticipated corporate issuance started to pick up in the second quarter. Very important. New dollar volume for corporate increased 23.8% in the second quarter, and finished up 7.8% for the first half. We saw a pick-up of investment grade issuance in the second quarter and a big jump in high yield issuance. It soared 161% and represented about 26% of the corporate dollar issuance in the second quarter, a pretty impressive number. Public finance grew as it increased 17.8% for the second quarter and 20% for the first half.

Asset backed issuance softened in the second quarter. It declined 3.7%. It is up 6.7% for the year. Mortgage backed issuance increased 53.1% for the second quarter and is up 45.9% for the first half, and these sources for these figures on U.S. issuance are coming from securities data and Harrison and Scott publication. European bond dollar volume, was strong as well, climbing 50.7% for the second quarter, and finishing up 47.5% for the first half. That's according to Bondware. In looking ahead, we see continued growth in the market for the balance of this year as interest rates remain low and the economic recovery takes hold. Most importantly, and something we've been saying over the last several months, investment grade corporate issuance will continue to grow.

We also expect an increase in the high yield issues driven by investors demand for higher returns. Public finance should show some growth in the second half, although not at first half rates. Notice for redemption for bonds maturing in this sector are at record levels. Many will be refunded with lower coupon debt. The structured finance market will remain strong globally. Mortgage refinancing will be a factor as long as interest rates stay at current level, and the federal reserve does not aggressively raise rates, which is not expected. In the mortgage-backed market, residential issuance is expected to remain strong for the balance of the year, although the growth rate may be somewhat slower in the second half in the United States than the first. In Europe, new issuers continue to enter this marketplace and volume is expected to pick up from existing issuers. The outlook for commercial mortgage-backed securities in the second half is promising and the pipeline for commercial mortgage backed securities transactions in Europe looks extremely good.

Asset backed issuance is expected to pick up in the second half. Auto and credit card issuance represent about 50% of the overall issuance in this sector. We expect a surge in the U.S. student loan market which could set a new record. The growth in student loans and the modest growth in credit card backed securities will more than offset declines expected in new issuance backed by housing and new auto loans. As a provider of independent research with 80 analysts covering 1400 stocks, we continue to work on the settlement procedure. Of the ten settlement firms, eight have already been the mandated independent consultant on board. We are in contact with all of them. We are responding to requests for information from them and their firms on items ranging from our stock selection process to how we use technology to create and deliver the information as to our procedures on compliance and so forth.

We have developed new prototypes of Equity Research report to meet the needs of the market. As you know, the federal district court in Manhattan delayed implementation of the settlements until the second quarter of 2004. We don't expect to see any financial settlement until next year. Don't be surprise if some of the settlement firms move quickly as an effort to rebuild customer confidence. In the meantime, our analyst stock selections continue to outperform the S&P 500. Our five star stock selections through June 27 beat the S&P 500 by 130 basis points. That would be 12.3% versus 11.0%. Our index services continue to produce solid results. At the end of the June, assets under management and exchange traded funds based on our industry hit $71.9 billion, an increase of 37.2% compared to a year ago.

Derivative contracts traded at the CBOE and CME continue to rise. For the first half, contract average 638,000 a day compared to 322,000 a day in the first half last year. We've seen good growth in the sale of analytical and qualitative services, including our GICS direct product which was launched about 18 months ago. The soft spot continues to be in the retail brokerage business which is a reflection of conditions on the street. Our valuation services increased sale as litigation support services offset some softness in the merger and acquisitions market, which has been a little bit soft. In winding up for the financial services segment, I would comment briefly on the SEC concept release Standard & Poor responded yesterday for commentary. Copies of our response are available on our web site. I'll give you that site. It is www.standardandpoors.com/special coverage/SEC.

The SEC asked many questions, but we believe the starting point is the recognition in the report of last January that ratings represent, and I quote, a rating agency's opinion as of a specific date of the credit worthiness of a particular company, security, or obligation, end quote. Because ratings are opinions, they are protected by the first amendment. That's critical to the rating process and, ultimately, the market. We believe that the best test of rating agency opinions should continue to be our track record over time and the market acceptance of such opinions. A government mandated regulatory procedures that produces a homogenize analysis would not serve the market. Independence, objectivity, transparency, reliability, integrity and quality are the hallmarks of our business. We look forward to working with the commission as it considers what actions may be appropriate. We propose a number of steps the commission could take to ensure a transparent designation process. The SEC will need time to evaluate our responses as well as others. That means we won't see a response until later this year.

So assuming up for the financial services, we are on track to produce a double top and bottom line. A 35% operating margin continues to be our benchmark for the year, continued strength in the structured finance market and a more promising outlook for the corporate market. Very important in terms of the recovery and what that portends. Solid prospects in international markets and Equity Research as part of the settlement and needs of the sell side and buy side institution.

With that, let's turn to the McGraw-Hill Education segment. The McGraw-Hill, revenue was off 2.6%. Operating profits declined 15%, and the operating margin was 9.7%. Revenue in this segment for the first half is off 2.3% with a seasonally most important part of the year still ahead of us. We are in that period, obviously, right now. As I pointed out earlier on, we call it the 60-day month, July and August. It is the peak ordering period each year for education.

Revenue for our higher education, professional and international group was flat as the second half got under way after a 1.7% decline in the second quarter. Our college and university business is growing around the globe, and we're very encouraged by the second half prospects for this group. In the United States, we expect to outperform the college and university market this year. We still expect the college market to grow somewhere in that 6% to 7% range. We've listed some of our best sellers from the new front list in the earnings release. I won't repeat them now. All of our key titles are supported by sophisticated software that enhances the value of the product for students as well as for instructors. One reason is ALEKS. ALEKS is our artificial intelligence based product offering. It has been expanded from introductory college math courses to statistics, business, and now into accounting. The success of Alex is building as instructors realize it provides their students completely individualized tutorial and study programs easily accessible over the web.

Furthermore, instructors can use ALEKS to monitor progress of individual students or an entire class from any web enabled computer. In terms of higher Ed discipline, we expect growth in science, engineering math, business and economics to be the key drivers in this market. Higher education in international markets continues to show improvement. Enrollments are growing as education has become a key to greater economic achievement. Our export texts are traveling well and the same technology enhancement and wrap-around software we provide students and instructors in North America are producing increased sales overseas. Our focused publishing program in selected market overseas is also producing good results. Professional publishing has been the soft spot in this group in the second quarter, and the first half reflecting problems at retail and the slump in the worldwide sale of computer titles. We've consolidated our computer publishing operations going from three groups to one and we're reducing the number of titles we planned to publish in that sector.

A sign of improvement in the professional group is the growth of the online information services, AccessScience signed a consortium of Ohio libraries to a five-year subscription. That means the service is available to all Ohio Net public schools and university libraries across the state. We're pursuing other statewide adoptions as well. Our school education group has shown areas of strength and pockets of weakness. Revenue was off 3.1% and off 3.9% the first half. In assessing our prospects here, we have been closely monitoring the impact of state budgets on educational pending. A lot of ink has been spilled on the fiscal problems of the state but there has been no reporting on what the year-over-year changes will be. Late last week, the National Conference of State Legislatures provided some facts. What has emerged from the head line noise about budget cuts is a modest increase of 1.9% for elementary, high school spending for the new fiscal year that just got under way. That report is based on information from 38 states, six states, including California, Connecticut, and Pennsylvania have not enacted budgets.

The no child left behind and the national conference of state legislature which tracks state spending in four key categories, K-12 education where the el-hi had budget and general fund is up 1.5% and total el-hi funding is expected to grow 1.9%. They also track higher Ed spending which will decline by 2.0%. Corrections will decline 1.1% and Medicaid which is expected to grow at 4.6%. In 38 states that reported, general fund spending is expected to grow 1%. I think it is worth noting that state revenues are projected to increase 4.3% for the new fiscal year that ends next June. That information is based on data from 43 states. Closing budget gaps has not been easy. States have increased taxes, cut spending, reduced the workforce, frozen hiring and salaries, and they capped reserves and tobacco settlement funds. 11 states made targeted cuts in elementary, high school education and 13 in higher education. In the next few weeks we will see how it plays out in the open territory. It is already clear that budget issues have some impact on the timing of orders.

We expect a mid-single digit increase in the new adoption market for this year, and as we reported this morning, our middle and high school social studies program has led the all-important Texas market with a 38% share. It is expected to turn in solid gains in Indiana, North Carolina, and Virginia. In general, we expect another good year in the middle and high school market. The elementary school social studies program is not meeting our expectation. Its performance in the key Texas adoption was disappointing. While the capture rate in other adoption states is better, the results are still short of our expectations. Supplemental sales have been lagging in the educational, dealer, home, and school markets, a reflection of decreased traffic in retail and specialty stores and a weaker economy in the first half. The skills oriented products such as the James town remedial product line are doing very well.

Early childhood market is showing promise. We captured 35% of this year's Texas pre-K adoption with one of our products. To increase the efficiency and strength of operations in the supplemental market, we formed a new group last month. The McGraw-Hill learning group which will combine SRA McGraw-Hill, Wright McGraw-Hill and McGraw-Hill/Con- temporary for K-12 alternative basal and supplemental publishing, a very important area that's getting a lot of attention, especially in the urban education market. We think this step will improve our ability to perform in this market place. One of our alternative basal products, Everyday Math , helped us set a record open territory adoption of mathematics of 20 million. New York City purchased Everyday Math for the elementary grade and purchased our Impact Mathematics for the middle school grades.

We're continue to closely monitor the allocation and expenditure of reading first response. We have been informed by the department of education that all 50 states and five territories have applied for funding and that every plan should be approved by September. At this point, 35 states have received $669.1 million in first-year funding for reading first programs. There's no doubt that the reading first pipeline is starting to fill, and it will lead to sales in the second half of this year. The opportunity will be even bigger in 2004. There is considerable variation among and within states on how and when the funds will be spent. In general, we estimate that about 20% to 25% of those funds will be spent on instructional materials. Another 20% to 25% on assessment, and the remainder on professional development. There are opportunity in all three areas for McGraw-Hill Education.

We learned that our Insight product will be used exclusively for professional development statewide as part as of Wisconsin reading first grant. The testing market is already active as states compete and complete the designs for their assessment programs to meet the federal requirements. Our test revenue grew in the second quarter driven by increases in custom contracts. Connecticut, New Mexico, and West Virginia had programs that contributed to this growth. Prospects in this market should continue to improve throughout the second half and into 2004. As state standards are set for measuring adequately yearly progress, local school district will begin to see formative tests to help students pass summative(ph) test. So summing up for education, solid prospects for growth in higher education in the United States and in the international markets. Improving prospects for testing, a modest overall improvement in state funding for the ELHI education for the current fiscal year. Lagging sale in some supplementary areas but promising growth in early childhood education and a new unit that will lead to better performance in this supplemental market and solid middle and high school performance with some disappointment in the elementary area.

Let's turn now to our third segment, Information and Media Services. Here revenue declined 4.2% operating profit decreased 8%, operating margin was 12.9%. A soft advertising market is still evident in our second quarter results, although June was the first positive month for Business Week since January. Second quarter ad pages were off 15.3%. That's according to Publisher's Information Bureau, PIB. For the first half, business week ad pages declined by 8.5%. After four issues in July, we're off 6.4%. The BIP figures included a fifth issue last year. The PIB reports a 31.9% decline in July because of one less issue this year. We're still expecting a significant pickup in the second half as the economy strengthens. Our advanced bookings are bearing that out. There is no doubt we will have the benefit of easier comparisons in the second half. The ad page count in the third quarter last year was up 0.3%, versus the previous year and up by 6.3% in the fourth quarter of 2002. Circulation on a very important figure to watch continues to grow. Business Week improved its market share in the first half. I believe that we're well very positioned to benefit from this coming recovery.

Broadcasting revenue is off 1.2% for the second quarter and only 0.8% for the first half. Broadcasting faces tougher comparisons in the second half since last year benefited from the elections and political advertising. We will have to see what the effort in California to recall the governor means to our stations this year. The results in our verticals, construction, energy, aviation and health care were mixed. Let's sum up the Information and Media Services, continued emphasis on cost controls. We continue to expect the pickup in advertising as we get into the second half. That's the outlook for each of the three operating segments.

Therefore, summing up for the corporation, the strength of the product lineup, the overall business portfolio is evident in the first half results. We will continue to keep a tight grip on costs and we're still on track to achieve our full year guidance of 7% to 9% EPS growth which, again, including a 5-cent non-cash, non-operating change in our pension accounting assumptions. With that, let me stop there and turn it over to Bob Bahash, our Chief Financial Officer to go over some of the financial aspects.

Thank you, Terry. The company continues to maintain a strong financial position. Let's start this morning by reviewing some of the key factors that contribute to the strength. Total debt at the end of the second quarter was $533 million. Now, that's $45 million lower than 2002 year-end debt and $630 million lower than debt at the end of June of last year. Now, furthermore, when you look at that decrease, especially the $45 million for the first six months of 2003, that compare to an increase of $107 million in the first six months of 2002 or a relative decrease of $152 million in 2003. Contributing to that performance is the proceeds from the divesture of Comstock which was completed earlier this year. We have kept our debt and commercial papers to take advantage of low interest rates. As a result, interest expense decreased 62% to $2.7 million in the second quarter from $7.2 million in the second quarter of 2002. That reflects 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. Our average interest rate and commercial paper borrowings for 2003 so far is 1.3%.

That's a decrease from last year's rate of 1.9%. Corporate expenses increased $2.8 million or 14.1% in the second quarter over the comparable quarter last year. The increase is primarily due to occupancy cost increases. Regarding manufacturing expenses, at the start of the year, we expected a modest increase. We're now expecting a decrease. This decline is the result of successful negotiations with suppliers for both printing and paper. We continue to benefit from improvements made from the collection process due to best practice initiatives. As a result, cash provided by the decrease in accounts receivable in the first half of 2003 is $35 million, more than the same period last year. You may remember that last year was a very solid year as well.

As we discussed last quarter, our blended tax rate for 2003 is 37%, which is a half point less than 2002. You should anticipate this rate for the remainder of the year. The primary reason for the change in the effective tax rate was an increase in foreign source income, which is taxed at rates lower than a combined federal and state rates in the U.S. In the second quarter, the translation of foreign currency resulted in a favorable impact from operations mainly from financial services. As Terry pointed out earlier, foreign exchange contributed $10.3 million to the revenue growth and financial services in the second quarter. The impact of the currency translation had a negligible impact on operating profit and he earning per share growth because of increased cost due to currency as well as losses from foreign exchange transactions. The increase in the loss from foreign exchange transactions resulted from the revaluation of U.S. dollar based financial assets mainly held by European operations. Now, these financial assets would mainly be accounts receivable.

Let's look at capital it capital expenditures in the second quarter. Three ingredients to capital expenditures. One, purchase of property and equipment which we routinely categorize as CAPEX. The publication expenses and additions to technology projects. Let's look at them. CAPEX, what we spend for property and equipment came in at $27.3 million or almost $10 million above the same level of last year. Spending in this category will be higher for the balance of the year, as we prepare to occupy our new building in Canary wharf in London. Construction is being completed and we expect to start moving employees into the new facility at the beginning of next year. With the expected $50 million to$ 55 million required for the Canary Wharf build out we expect capital expenditure to reach $175 million for the year. That's what we forecasted for the year. Publication costs for the second quarter were $51 million, down $29 million for the same period last year. We're running a bit lower for the year end now and we expect to spend $260 million to $270 million for the year, which is down from the earlier forecast of $285 million.

Now, a few reasons for the lower forecast for 2003. With the continuing softness in the computer and technology book sales worldwide, we are cutting back on the publishing program in this area. As you know, we consolidated three computer book publishing operation into one. Also, the increased use of technology in creating our products in helping to decrease costs here and, also, there is a timing factor as we regularly assess programs as well as our schedules. Additions to technology projects for the second quarter was $5 million, down from $11.9 million in the second quarter last year. Based on lower spending in the first half, the full-year estimate for deferred spending on additions to technology projects is now estimated to be $60 million to $65 million instead of the original forecast of $75 million. We are investing in these projects to improve business efficiency and enable new business opportunities. In the second quarter, total spending of $7.7 million to GTP was expensed. For the first half we expensed $15.3 million and our full-year estimate is for $20 million of expense for GTP.

The education global transformation project will provide enhanced features for customer self-service, the development of electronic business to business catalog and new and enhanced features for the global warehouse. These are among the many features that will improve efficiencies and provide the basis for increased revenue. We anticipate the enhanced project will continue to cost roughly $180 million. As we previously reported, our current schedule call for a rollout in the U.S. school units in 2004, and higher education and professional publishing units in 2005. The international units will be completed during the 2005-2006 period, at which time we'll begin to realize the benefits from implementing the system on a global basis. Let's look at some non-cash items. Pre-pub amortization decreased $2.3 million in the second quarter to $69 million. Last year was approximately $72 million. Depreciation for the second quarter was $20.8 million, down from almost $23 million a year ago, and amortization for intangibles for the second quarter was $8.6 million, down from almost $10 million last year. Free cash flow continues to be strong, and we expect another good, solid year. As usual, it is back-end weighted to the second half of the year. Finally, an update on the share buyback program. No purchases were made in the second quarter. For the first half of 2003 we repurchased 1,584,000 shares for $84.8 million at an average price of $53.57 per share. We are ahead of 2002's pace. We bought back 965,000 shares at an average price of $61.43. We will continue to be optimistic in our pricing and for the full year we expect to repurchase roughly 3 million to 3.5 million shares. Thank you. Now back to Terry.

Okay. Thank you, Bob. That completes our second quarter results and review. Again, given all the conditions that we face coming into this year, geopolitical, economic, and so forth, I'm quite pleased with the results and the way the overall portfolio has behaved. We're going into the second half now, which is the largest percentage of our earnings of the year, and I think we're going in with some very good prospects for the environment overall, as well as our individual market. We look forward to being able to report those to you at the right time. So, with that, let's go to questions. Don, if you'll take us there.

Thank you. A couple instructions for our guests here. Please use the microphone when asking the questions so our phone participants can hear the question. Please be sure to state your name and company. You may signal Sam when he has a question so he can bring the microphone to you. For our phone participants, when your turn comes, please press star one to indicate you wish to enter the queue to ask a question. To cancel or withdraw your question, press star two. If you have been listening through a speaker phone but would like to ask a question, we ask you lift your handset and remain on the handset until your question has been answered. That will ensure good, sound quality. Let's start with any questions in the room.

Good morning, Terry. Given the confusion in the school market, could you review your outlook for the school publishing for the year. Could you talk about how you see the roughly $700 million of the reading first money? Does that get stretched out and into all four. Thirdly, a question for Bob. McGraw-Hill is really becoming a money machine. Just on the -- you will be piling up a lot of cash. Any dividend payout or what would do you when you get a lot of cash in the bank?

Okay. Thanks, Ed. First on El-high (ph). Let's talk about what we know. In terms of coming into this year, in terms of total adoption dollars, we said that 2002 is going to complete somewhere around $670 million. A few restatements coming in from the states. That turned out to be $690 million for 2002. We were looking at adoption sales for this year, somewhere around $732 million, and that number now, through restatements has gone up. That number right now, our best guess, is about $745 million for this year. So from our stand point, now the question becomes one of waiting on the open territories. Clearly some of the noise that we've all seen in terms of state funding and some of the budgetary problems, you know, probably aren't going to go away as we go into next year, but, again, if we take a look at some of the progress we have made already this year of the adoption states, I don't think it is going to be as dire as some have made it. I don't think it will be robust, but I think it will grow nicely on that part. 2004 is a little far out on that one.

When we look at the adoption dollars on the schedule is not as strong as 2003. That was not a strong one either. So if you had to make a guess, my guess is that total adoption dollars will probably come in somewhere around 2002 levels, which is about $690 million. But it's, again, too early to tell. One thing we do know is that math is going to be extremely important in 2004, which is where we're a market leader, both the middle and high school level. We're a leader in alternative bay sill with Everyday Math and impact Mathematics. We have a brand new program at the elementary level we are excited about. That's where we are at this point. Do you want to follow up on that, Ed?

Some of it is this year. Does it get spent in '04 or stretched out?

Here is what we see with the reading first. It is not at the federal level. The funding has already taken place. The question is, is the allocation and the speed at the state level. In some cases the states are holding back some of the funds and are slow in terms of allocating that. That's why we see we will see more of that money into the second half of this year and into next year. At this point it is at the state level. Again, by agreement with the department of education, 20% of those funds can be held back for administrative purposes at the state level. 80% has to be distributed to the various districts. So that's the part that has us on that.

Yes, Ed. With regard to the dividend, we look at the total return to shareholders. As you know, we in roughly the mid-1990, '95, '96, '97 began a share repurchasing program. The total cash return to the shareholder has exceeded 15% compounded during that period of time. It is a combination of an attractive yield to the shareholder, those individual that is are locking for yield or return as well as the share repurchase which enhances the overall capital return to the individual. So we're looking at the combination as being very attractive to the diversified shareholder base that we have.

Good morning. Alistair McCloud from ABN. A question on the reading first program. To get color on your 60-day month. Have you seen any tangible evidence coming through yet for that money or do you have expectation for how much substitution will be going on versus new money and, finally, on the supplementary weakness. Are you expecting this to continue into the second half?

I'm sorry. The last part.

The supplementary material softness. Are you expecting that to continue into the second half?

Let's go to reading first again. Again, the issue is at the state level and the allocation process on that. We have already seen a fair bit of activity that has focused for us in the alternative base on supplementary area, things like the SRA McGraw-Hill in terms of our Open Court phonics based program, Everyday Mathematics. So we're seeing those dollars spent. Those are reading first initiatives. Are those funds coming from general education spending funds or federal? It really doesn't matter at this point. I think there could be some supplanting going on. The factor is it will be monitored by the department of education, and they're going to have to be held accountable for the results. There could be some supplanting but, over time, that should work itself through. So I do expect the second half of this year to show some significant pickup in terms of the use of those kind of funds.

In terms of the supplementary area, yes, I do. I expect to see that. With the focus especially coming out of the No Child Left Behind Bill on urban education. As more of those get a lot more focused, what you're going to see is more effort put into the early childhood learns, which is a major initiative. It was major in terms of the drafting of the legislation, but, also, the president has been very strong in terms of his focus on that one. He's currently working now on this head start reform package which will be a benefit in this as well. The focus being on early childhood and urban. For our alternative basal, that will benefit nicely.

Our first question will come from Peter Appert from Goldman Sachs.

Hi, Terry. Good morning. A couple follow-up questions on the education side. With regard to Texas, did you end up getting 100% of the shipments done in the second quarter, or will there be some spillover into the second quarter?

Number two, is it possible to give us any quantification of the savings impact or the margin impact we could expect to see from the global transformation project

Okay. All right. As far as Texas is concerned, again, it was an improved situation. What we were looking at with the budget discussions in April or May and what we reported was the prospect for some significant ordering delays. Obviously, once they got through the budget resolution, they started immediately in sending their trucks and starting to ship on that one, which surprised us a little bit in terms of their responsiveness on that one. Therefore, we were able to take advantage of that. That was one of the factors in the second quarter results. It was not 100%, however. There is some spillover effect. We will see that in the July, August period as well. As far as margin improvement with the global transformation project, again, you know, we have to get through implementation and as Bob was saying, we are still looking at the spring of 2004 for the rollout in the United States and then into higher education in '05 and international in '05-'06. It's going to take some time. At this point, as we've taken a lock at it, we believe there should be at least 2%, 3% percentage points of margin improvement associated with that. As it rolls out, as we implement it, we will be looking hard at that and give you better information as we get into next year

May I ask a follow-up, Terry. I know this is very early to ask. With regard to '04 broadly, you've acknowledged tough comps in the education business. S&P comps will be difficult. Is it realistic to stick with the earnings target for '04?

Our aspiration is always double, Peter. And it's early, in December we'll probably put out guidance on the full year '04. That would be our aspiration. We'll see how things come together. I would take issue just a little bit, though, Peter on that one. Even though the K-12 will have some softness next year, just in terms the overall agenda, you'll still see a very strong testing market. You will see strong alternative basal and supplementary and focus on the early childhood learning.

Also, college and university should also continue to grow, probably I guess -- we'll get into those projections a little later on in the year. Probably somewhere around where it is from a market stand point this year, which we fully expect to outperform. It is early to get into that part of the guidance. On the financial side, Peter, we see continued strength. This structured finance market has surprised us a little bit in terms of its strength and its momentum. That will continue. We talked a little bit about the credit card and the auto loans and student loans and so forth where we see some of that coming, but it's still very robust, not only here in the states, but in Europe and parts of Asia as well. Public finance should continue to do quite well, and the all-important area, which is in the corporate market. If one assumes that the recovery takes shape the way we talked about it, you're going to see business continue to assume additional risk and, therefore, they will be tapping into those capital markets and we would expect a stronger corporate market. We also expect some contribution coming into next year from our independent Equity Research. So I think, you know, as we look out -- again, it is a little early to do that. I think that with those factors and an improved advertising environment, it could be a better year.

Great. Thanks, Terry.

Thanks, Peter.

Thank you. Our next question will come from Carl Choi (ph) from Merrill Lynch.

Hi. Good morning. I want to follow up on Ed's question. If you put everything together, do you expect the El-High education to be up and do you expect McGraw-Hill to -- given the adoption in Texas. Second if you could isolate how college did in the first half and how that stacks up against your expectation of 6% to 7% industry growth for the year. Thanks

Karl, taking the collage and university market, we said it was going to grow about 6% to 7% this year. I think that's about right. We're going to outperform it. We have a very good front list. We're selling very will outside the United States as well. That's helping to support those numbers. We don't break out specifics within that segment. Clearly, the professional group that we talked about has softness, especially with the computer books, and why we have reorganized that into a single from three divisions. That will focus a lot on non-U.S. sales where computer book titles do extremely well.

If I got it right, Karl, on the K-12 again, and for the remainder of the year, it is a little early to be talking about how we're going to finish up in the third and fourth, given the open territory sales. We have to see for T-12 that activity. We've seen some very good, positive signs. Again, I think to connect the dots at this point just isn't sound at this point. We will know, obviously, at the end of August a good deal more where we are, and we can give you better information at that point. You know, this is the 60-day month. It is strong on that part. Again, in forecasting what the full year would be looking like, I think it's a little early for us to be there

Okay. Thank you.

Thank you. Our next question will come from Brandon Dobell from Credit Suisse First Boston.

Good morning. A quick one. On the financial services business on the ratings side, if you can give us -- historically you talk about the mix between transaction revenues and retainer subscription revenues. Maybe in the context of structured finance and how strong that's been, has that mix changed at all? Do you expect to go away from your target? Historical has been 60% to 70% retainer revenues. Trying to get a feel for that as well as on the media side, so far the first half of the year going into July, what do your TV pacing look like? Do you see any kind of momentum there, up or down? Thanks.

Brandon, on the transaction and volatility side for credit market services, we use 60-40. We have protected 60% of the volatility of that through, again, surveillance fees, global, no traditional products and so forth. It allows us to extend into new nontraditional areas doing more products and service for that existing customer. So 60-40, there's no change in that. That's a good rule of thumb. At any given time, however, that with fluctuate a little bit, as it did last year, when you have such strong new dollar issuance volume in any one particular area. So without having a hard number in front of me at this point, my guess is that, you know, it probably is a little lower right now, that it would probably be somewhere in the mid-50s or something. We'll have to see how the year completes to see exactly where that number will come in. But depending on any given time, that number will fluctuate. The 60-40 rule of thumb, I think, is one that, over time, you can feel comfortable with.

On the advertising side, it is a slow start to this recovery. We started to see some progress in advance bookings in June, which we've talked about for the second half. Then it got a little soft again, and how it is picking up again on this one. So I think that, you know, there's no change in our guidance that, you know, from an advertising recovery standpoint, we fully expect, given the indicators we watch that influence us, such as growth and corporate profits and things like that, that we clearly are going to benefit in the second half, and the advanced bookings that we're seeing now for the September, October, November time frame in particular, you know, are starting to show good promise. Again, we have to see that continue. This is a soft period traditionally in July and early August, but as we start to gear up for September, we're starting to see some progress on that part. Broadcasting has done even better. We started to see, with national sales starting to increase, the auto advertising. That's very important in our market. That has continued, and we expect to see continued pickup there as well.

Okay. Thanks a lot

You bet.

Thank you. Our next question will come from Douglas Arthur from Morgan Stanley.

Terry, on the second half outlook for ratings, you sound a little bit more optimistic based on what you're talking about, structured finance and international. Is it fair to assume, from our comments, that ratings could grow almost as fast in the second half as it did in the first? A follow-up, if you look at the whole lineup of products in the non-ratings side of financial services, can you just sort of give an overall growth rate for that expectation for '03? Thanks.

Thanks, Doug. Second half ratings, when we put our forecast together and when we look at the market conditions in '02 coming into '03, we gave what we thought was a very straight accounting of what we thought was going to happen. Some people called it too optimistic, and we had one competitor that was talking the market down a little bit. We did not see any reason for that aspect. We thought the markets would perform in a much healthier way. The facts are, at this point, that's exactly what has happened. The structured finance market, you know, did not slow down. It picked up. It was quite strong, both in terms of asset backed and mortgage backed securities. In pact, at the time, we were talking about residential mortgage backed securities slowing down by mid-year and just the opposite has taken place there. That will increase, and now what we're saying it's going to be for the full year, for the complete year. Public finance market, you know, after 2.5 good years on that market, the notion was that was going to slow down on that one. It has been -- it has been just the opposite. We said early on we thought we were going to see significant double digit growth in that market. That has taken place. I believe that will continue.

The wild card in all of this really happens in the non-U.S. part and also with corporate. We believe that in terms of the recovery and if some of the geopolitical events of February through June subsided, some of the pressure of those subsided, that in accordance with the recovery, you are going to see an emerging corporate market. That is exactly what happened. As we said, the corporate market was up 24% in the second quarter. The interesting part here has been the strength in the high yield market. We saw interest in the high yield market at the end of the first quarter, continue in the second quarter. Right now it counts for about a quarter of all corporate new issuance, which is a pretty healthy number at this point in the recovery, which suggests that the recovery is definitely under way, and that we're going to see some momentum there. So what some people have thought of being more optimistic is very realistic, and we don't see any change in those assumptions going into the second half. So I wouldn't want to give you a number, but I would watch the corporate new issue volume very carefully as a telltale for that kind of strength. The non-U.S. part, Europe and Japan have also been very healthy components there. So our forecast that we came into this year with and have updated with you stands. We think it is a very healthy picture.

Let's see. Non-rating. It is a little -- with regard to the non-rating side, Doug, as you know, we report the financial services as one single segment. Terry talks about different products within the financial services area, both ratings products, index products, and when you look at those which are non-rating, obviously, our index businesses are doing pretty darn good, and those products and services that we provide to the financial services community, just simply because of the pressure that they are under, are not performing as well. We do not break out the component growth rates between those two areas

Yeah. Doug, the only area we did talk about was on some of the retail side. You know, indicative of some of the pressure that the retail side of the market is under. We've had some softness there.

Thank you.

You bet.

Thank you. Our next question will come from Steven Barlow with Prudential.

Good morning

Good morning, Steve

Terry, in your remarks at the mid-year review, you said the El-high market would be at the lower end of the 2% to 4% growth rate. Is that the forecast or are we at a 0 to 2? The next question is on the financial services margins, 39% is high compare to what you've done in the past. You are saying 35% for the year. I guess the question is are you sand bagging us for the second half of the year on the financial services margin? Thanks

Nice to hear from you, Steve. Let me address the last one, seriously, first. We try and call them right. We're not trying to sand bag you. Starting with the margins at S&P, the second quarter margin of a little over 39%, obviously, we are very pleased with. That is a reflection of the strength in the structured market in particular and in the areas we have already talked about, and as that volume came through and those are higher priced components, we were able to do a little better. I think, at this point, again, as we moved up to a 35% margin, in taking advantage of some of the investment that is we already made and benefiting from that, I think that's a pretty good benchmark number at this point. If we see things significantly stronger than they already are, I'd be back to you and giving you some indication. I think for where we are right now and how we see things, I think holding that as a benchmark is pretty good.

On the Elementary, High School market growth rate, as we came into this year, we did not think that there was going to be as much pressure as some thought given some of the state problems on education material spending, and that's born itself out. Even with the cutbacks and deficit financing, people have to make sure they have got the right kinds of materials in order to get the results they're being held accountable to on that part. We talked, again, about the national conference on state legislatures and the numbers we have now, about 1.9%. We feel good on that part. A lot of things had to go right, given a limited schedule, to get into the -- into mid--single digits. We didn't think that was appropriate. So much noise in the system, we thought 2 to 4 was pretty good, and it was clear that given some of the problems in California and Texas, even though California doesn't have a robust schedule for this year and next, that the lower end of that range was more appropriate. I have to see, you know, how the 60-day month goes, you know, before I would alter that. I still would say that, you know, it's somewhere around there. It's really guesswork, and if it came in at just under 2, I wouldn't be surprised. If it was a little higher, I wouldn't be surprised either

Thanks. On the NCSL number, is that for instructional materials from the state governments, or is that total spending?

Total.

Thank you.

You bet.

Thank you. Our next question will come from Kevin Gruneich with Bear Stearns.

Great. Thank you. Three quick questions. I was wondering, first of all, whether the corporate expense run rate is a good quarterly run rate going forward. Secondly, the data that the AAP has released on college book sales and I understand you're not providing college revenues and I understand the seasonal factors. It looks like book returns are swamping sales in the college sector so for this year. I was wondering your experience. Finally, with reviewing the national council of what state legislature said a year ago, they were at plus 4.8% for K-12. I think it came in down mid-to single digits. Could you are reflect or review what happened last year at this time?

Okay. Let's see where we go. Bob, why don't you start off with corporate expense

Sure. The 14% increase, or $2.8 million in total, that was a little bit higher than we anticipated for the quarter. We expect that the run rate, as you look out into the third and fourth quarters, to be in the single digit range, most likely in the, probably 5% to 7% range. That's what you can expect for the balance of the year.

Okay. Again, you know, you're right, Kevin. In terms of AAP statistics, I see those as well. Again, there are a number of vagaries in all of that. I'm not sure who is skewing some of the numbers. We are not having a returns problem. In fact, it is more at a normal level. Even though we're in a finishing of a selling season now, we're still seeing some very real strength there. So there's some inconsistency between ourselves and what we're seeing in the AAP numbers. Bob, do you want to add anything?

Yeah. The returns were coming in faster than we anticipated in the earlier part of the year but have slowed down dramatically. As Terry points out, when you look at the six-month period in terms of overall returns, we're tracking right where we expected to track and, also, tracking with last year. In terms of the beginning of the year, we were running a little bit faster but slowed down appreciably the last couple months.

Right. In terms of the national conference on state legislatures, again, it depends when you're getting that data, and who is included in that. In talking about the numbers, we keep telling you how many states are included and which states are not included. They change rapidly as some of the larger states put those numbers in. The only thing I can say is it depends on when, you know, we got that number and who was included in it. The number that we have now is based on 38 states and is our best thinking -- or their best thinking of those expenditures. You have a number of budgets that aren't in that at this point.

Terry, I think the year ago number -- and this was provided a year ago on the conference call -- was for 40 states. I guess I'm not talking so much this year but reviewing back on what happened last year

Okay. Again, I'll see if I can get you even a better answer. My guesstimate at this point is, certainly, even though education material spending is growing, it's growing at a slower rate, you know, this year than it was at that point, and that would be reflective, obviously, of their conditions and their ability. It is still growing. It is at a slower rate.

Okay. Thanks.

You bet.

Thank you. Our next question will come from Derrick Krebbs from Glenview Capital.

Hi. I wanted to clarify a couple numbers on the education segment. How much is EL-high down on the year, on the six-month number?

Are you referring to the segment, El-high segment?

Yes. Sales. The same question for Higher Ed.

On higher education, professional and international, and we reported in those groupings, David, it is flat coming into the second quarter. It was modestly down in the first quarter. Now, that's being influenced by, in large part, by the professional area, and, in particular, the computer book field. College and university sales are growing nicely.

Right. So it is flat for the first half of the year, but we're projecting 6% to 7% growth for the full year?

for the market, that's correct. We expect to outperform that.

Okay. And my other -- my next question is on Texas. I think you said that --

Derrick hold on a second. Let me get Bob on K-12

The school education group for the second quarter is off roughly 3%

And for the year-to-date?

Off 6% for the first quarter but a lower base. So weighted it is a little bit over 4% or so.

Okay. And on Texas you had said the social studies adoption didn't go as well as you hoped_--

The elementary. We're the market leader in the middle school and the high school level with a 38% capture rate. It was the elementary side that was softer and below the expectations.

Who gained share in that adoption?

On the elementary side, I would have to say it was Pearson (ph)

My last question is, will education spending overall be up next year or down next year?

Well, that's again by segment in -- you know, that's a number that I wouldn't give guidance on at this point. The components we did talk about earlier, I fully expect the College and University market to grow somewhere around where it is this year, and we would expect to outperform that. We'll give that guidance when we get into December as we get closer to that. The number we did talk about, David, was, you know, adoption sales. As we look at the schedule for '04, it is lighter than '03. The numbers that we're using is for adoption state spending with $690 million in 2002. We're currently guesstimating about $745 million for 2003, and, again, a rough guess. I think that total expenditures on adoption state spending would probably be somewhere around 2002 levels. That is around $690 million. It is a little early to go there. That would be our thinking. Open territory still is the wild card

Okay. Thank you very much.

You bet.

Thank you. We will now take our final question from Richard Fiery(ph) from Delhi Management.

On the financial services side, I know you talked a little bit about your performance earlier. There's a question. Have you modeled in what will happen to that business and the various parts of it if rates start going back up? I know that ten-year treasury has been recently. What modeling have you done there?

Obviously, we watch anything that influences the environment very carefully. We don't, in our thinking, expect any interest rate increases until sometime into next year. Now, let me put a different component on. A rising interest rate does not hurt our business on that one. It depending on overall demand and where that demand is coming from. If interest rates were rising, I think that would be a rather positive notion given where we are in the current recovery and what our expectations are because it would be suggesting that the economy is starting to pick up and is doing better, and we would fully expect that the corporate market, as well as public finance and construction, would continue to benefit nicely from that. If interest rates started to move, which, again, we're not expecting this year, you know, I think that would probably be given where we are in current conditions a positive situation for us

All right. I think that's all I have. Thank you.

You're very welcome. We have a question right here

A couple questions for Robert. CAPEX next year has to be down, right?

That's right. We're spending roughly $50 million to $55 million for Canary Wharf. There might be a few hanging over. In the range of $120 million is a good working number for next year.

Secondly, I don't think you mentioned the annual '03 estimates for pre-pub amortization you gave the second quarter number but I don't think you...

The annual would be, roughly, $280 million.

And, lastly, on the global tech projects. The total project would cost you $180 million

That's correct.

$65 million of it is this year, right? Roughly $60 million, $65 million. How much will have been invested by the end of this year and, secondly, if you are expensing $20 million of the $65 million through the income statement, then I would think that as these projects come online, that expensing in the income statement would jump dramatically in '04 and '05 from the $20 million you are expensing this year.

First off, the $60 million to $65 million is not global transformation. There is, roughly, ten projects in the education segment and within the financial services segment that comprised the $60 million to $65 million. It is not one project. When we go live with these projects, generally the amortization period is a shorter life cycle. As you know, we have done these projects over the years. We have broken them out separately simply because of the size of the global transformation project. We are not -- we were not required to break it out but we elected to because of the size. When we go live, we amortize those for what we identify the recoverability period which is generally shorter than the life of the project. It could be three to five years of the amortization period that we amortize those over. With regard to global transformation, a major portion of the investment will be completed by the end of this year because the core shell of what it is we're building as we go live for these new projects, especially the school education group, will be the shell for the entire project. So a good portion of the investment will be made between last year and this year as well.

The expense number will jump next year. (Inaudible)

You're only amortizing as the particular element comes on live. We're only bringing on live a portion of school publishing in the beginning of the year. Only a portion of the amortization will kick in 2004. A larger amortization will kick in 2005. The bulk of the amortization, coupled with the bulk of the savings, will come on board in 2006.

Okay. That concluding our second quarter review. Thank you all very much for joining us.

on behalf of the McGraw-Hill Companies, we thank you for participating and wish you a good day.--- 0