標普全球 (SPGI) 2007 Q3 法說會逐字稿

Good morning, and welcome to The McGraw-Hill Companies third quarter 2007 earnings call. At this time, I would like to inform you that the call is being recorded for broadcast, and that 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 participants, McGraw-Hill has made the presenter's slides available on the internet. To do that, go to http://www.mymeetings.com/nc/join. I'll repeat the URL address once more for those who would like to view the presenter's slides online. It is http://www.mymeetings.com/nc/join. You will be prompted to enter your name. The net conference meeting number is P as in Paul, G as in good, 5401565. The password is McGraw-Hill, all caps with a space between McGraw and Hill, and the event type is conference. This call is also being webcast live from McGraw-Hill investor relations website and will be available for replay about two hours after this meeting ends, both by phone and on the web for seven days. If you need assistance at anytime, include having your volume adjusted higher or lower, press star then zero and I will assist you momentarily.

I will now turn the call 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 you, everyone, for joining us here for the McGraw-Hill's third quarter 2007 earnings conference call. I'm Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. With me today are Harold McGraw III, Chairman, President, CEO, and Robert Bahash, Executive Vice President and Chief Financial Officer. This morning, we issued a news release with our third quarter 2007 results. We trust you have all 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. Once again, that's www.mcgraw-hill.com/investor_relations.

Before we begin this morning, I need provide certain cautionary remarks about forward-looking statements. Except for historical information, the matters discussed in the 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. 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 U.S. Securities & Exchange Commission.

We're aware that we do have some media representatives with us on the call; however, this call is for investors and we would ask that questions from the media be directed to Mr. Steve [Weiss] in our New York office at 212-512-2247 subsequent to this call. Today's update will last approximately an hour. After the presentations, the meeting will be open to questions and answers. Now, my pleasure to introduce the Chairman, President and CEO of McGraw-Hill Companies, Terry McGraw.

Okay. Thank you, Don, and good morning everyone and welcome to your review of the McGraw-Hill third quarter earnings, and I thank you all for joining with us. With me, as Don mentioned, is Bob Bahash, Executive Vice President and Chief Financial Officer. I'm going to start today's session with a review of our operations, and I'll provide some comments on our prospects going forward. Bob will then discuss some of the key financial information and after our presentation, as Don said, we'll go in any direction any of you would like to go, questions or comments about the companies.

Well, the third quarter is critically important to a successful year for The McGraw-Hill Companies because obviously of the seasonality of our business. In education, we produce virtually all of our operating profits for the year in the third quarter. In 2007, we also faced an additional challenge because of some of the difficult conditions in the credit market. So, I'm especially pleased this morning with the results that we have just announced for the third quarter. And let me briefly recap some of the highlights. Diluted earnings per share increased 26.4% to $1.34 versus $1.06 last year. Diluted earnings per share in the third quarter of 2006 included a $0.03 charge for restructuring, net income grew by 18.2%, and revenue increased 9.8% to $2.2 billion.

Okay. I'll start this morning by reviewing how we achieved these results and then spend some time on the outlook for The McGraw-Hill Companies and our guidance for 2007. But, let me begin with our operations and, because education is such an important contributor to the third quarter, I'm going to start the segment review with McGraw-Hill Education. Double-digit growth in the elementary, high school market and margin expansion for McGraw-Hill Education in the most important quarter of the year are key takeaways for this segment. In the third quarter, revenue increased 9.9%, operating profit grew by 16.1%, and that included a pre-tax gain of $4.1 million on the divesture of product line for our parochial schools. In 2006, there was a pre-tax restructuring charge of $5.6 million. The operating margin improved to 35%, up from 33.1% for the same period last year. Revenue for the McGraw-Hill School Education Group grew at 11.2% and revenue for the McGraw-Hill Higher Education, Professional and International Group increased by 8.1%.

2007 is the first of four robust years in the state new adoption market. To improve our competitive position at the start of this cycle, we reorganized our basal operations a little over a year ago, and we wanted to do that in order to strengthen our sales, marketing, and product development initiatives. We also stepped up our new product introductions to take advantage of the new opportunities in an expanding market. Those decisions are starting to pay off. You can see it in our performance in this year's state new adoption market, which is growing faster than our original forecast for the market. Some numbers will illustrate my point. In 2006, our School Education Group participated in about 80% of the state new adoption market, and that was worth about $685 million, and we took a 20% share.

In 2007, our reorganized School Education Group competed in virtually the entire state new adoption market which is growing 14% to 20%, and will be worth $780 to $820 million this year, our earlier forecast called for 10% to 15% growth and $750 to $800 million range. This year, we're taking an industry-leading 32% market share of this expanded market. And we're very pleased with those results. To achieve these results, the School Education Group led all competitors in California and South Carolina for K-8 science and grades 6 through 8 math in Texas. We placed first in all six states adopting music for the elementary grades. Treasurs, which is our K through 5 balance basal reading program, led the market in Indiana and competed very well in Oregon and Tennessee.

It is also worth noting that we had a 30%-plus capture rate in both the K-5 and grades 6 through 12 state new adoption market, another important indicator of improved across the board performance achieved through reorganized and better-led team. The breadth of our product offering is another key to our success this year. In an education market that is not wedded to single instructional approach, we offer a spectrum of products. So, in addition to our success in Texas math with core basal programs, we took Share With Everyday Mathematics, a reform-based program, Everyday Math and took the leading share in New Mexico 's K through 5 math adoption and sold very well in the open territory, winning business in both urban and suburban markets. Offering a spectrum of products also means we compete in non-academic subjects.

In 2007, we captured significant business in small but very profitable markets such as health, business education, technical and vocational education, as well as family and consumer science. Even as we saw greater strength this year in the state new adoption market, we have seen a slower than expected growth in open territory. We have some anecdotal evidence for the slow down. Basically, it appears that non-discretionary costs in many districts are rising more rapidly than funding. For example, schools are seeing a substantial increase in fuel costs for transportation, heating and cooling. We're examining these trends in the open territory in more depth to gain greater understanding into changes that may be taking place there, but we do expect to see some improvement here.

According to industry statistics, the open territory market is down 1.4% after eight months. Orders in the fourth quarter, and there are some possibilities here, could produce an uptick this year. The supplemental market has been soft all year. There is less demand for traditional stand-alone supplemental products, especially those that are not clearly correlated with state standards because the new core curriculum programs in science, social studies, math, and reading are far more robust than ever before. These new basal programs are all standards based, and they now provide extensitive ancillary materials for practice, differentiated instruction and other classroom needs formerly met with supplemental titles. However, there's a steady, growing demand for well-designed supplemental intervention programs, that is these are the programs for students performing below grade level.

The schools are most interested in intervention programs that can demonstrate their efficacy with research data. That's why we're having good success with Kaleidoscope Literacy and Numbers Worlds math programs. This is a promising development, and that will help us gain more traction in the supplemental market.

Strength in the state new adoption market will help offset some of the softness in the non-adoption states, which has been expected to grow about 4% in 2007. Because of the softness in the open territory, it now appears that the total el-hi market will grow in the 3 to 5% range this year instead of the 5 to 7% originally forecasted. Our School Education Group is out -- outpacing the competition in both the state new adoption market and in the open territories and expects to outperform the market for the full year.

In testing, the performance in both custom and off-the-shelf markets has improved. We're seeing some encouraging developments in this market. In Indiana, we recently won a one-year extension of our current summative; those are the high-stakes tests contract, plus a two-year contract beginning in 2008, and a renewable for another two years. We also won a five-year renewal in West Virginia. We're seeing some promising gains in the formative, or the low-stakes end of the market for our new Acuity product. This program recently won a five-year contract valued at $80 million from New York City. Earlier I pointed out that the state new adoption market looks robust for the rest of the decade. Here is our latest forecast for the state new adoption market through 2010. Obviously, in 2007 we have upped it from $780 to $820 million. For 2008 it goes from $900 to $950; 2009, $850 to $900; and then in 2010, $900 to $950 million. The issue being it that it is very strong for the next four years and we expect to do very, very well with that.

Our Higher Education, Professional and International Group continues to make good progress. In international markets, we benefited from strong school sales in Canada and in Spain, and a solid higher education selling season in Europe, Asia, and India.

In the U.S. college and university market, our business and economics imprint set the pace in the third quarter with solid gains in four key disciplines, accounting, economics, introduction to business, and management. We now think the U.S. college and university market will grow between 5% and 6% in 2007, and we expect to keep pace with the industry. Originally, we thought the market would grow about 4% in 2007, and it's a little bit stronger than we had expected. Digital products are contributing to that growth across all of our college and university imprints and in professional markets. We expect more growth in the digital world with a debut this fall of Course Smart. This is a new college publisher cooperative, E-book and E-commerce website, and this is something really I believe to pay attention to. This is a really strong, new endeavor. Instructors logging on to Course Smart will be able to evaluate textbooks and related material in one convenient location. For students, Course Smart offers a lower cost alternative and all of the functionality of a web application. Our higher ed group is starting with 148 E-books. Over time, thousands of textbooks will be available on this common platform.

Our online product offerings are for professionals continue to grow both here and abroad. Two new subscription-based specialty sites introduced this year, one is called Access Emergency Medicine and that was done in January, and Access Pharmacy in April, and they're off to very good starts with growing institutional sales.

Our professional books are also making best seller lists. In September, one title, Rules For Renegades, a new title that made it on to four best-seller lists. It was number one on USA Today's business list, number two on Wall Street Journal's business list, number 14 on the Wall Street Journal's nonfiction list, and number four on the New York Times hard cover advice list.

So, summing up for the McGraw-Hill Education a solid third quarter performance, and market share gains in the elementary-high school market and we're very pleased with that performance. Good growth in higher education here and abroad. Digital products continue to gain traction in higher education and professional markets, and we now expect the el-hi market to grow 3% to 5% this year, and 5% to 6% increase in the U.S. college and university market, and operating margin for this segment will improve for the full year.

Okay. With that, let's go to McGraw-Hill Financial Services. The third quarter started strongly and softened in September, but we still met our guidance for this period by a comfortable margin. In the third quarter, revenue grew by 12.5%, operating profits increased by 17.3%, and the operating margin expanded to 45.6% up from 43.8 last year. All of this was accomplished even though there was a decline in the U.S. structured finance market in the third quarter.

Credit quality issues and the repricing and re-evaluation of risks, due in part to the concerns regarding the performance of subprime mortgages, all contributed to that decline. But what kept Standard & Poor's growing in the third quarter was its resilient portfolio. The strong performers included international credit ratings, which grew at a double-digit rate and represented 46.1%. Non-traditional ratings and services which also grew at a double-digit rate, and now account for almost 26% of rating revenue. Corporate and government ratings had solid performances and financial information products and services also had very strong performances. In short, the results underscore the successful action that we have taken over in the past several years to strengthen Standard & Poor's diversification and resilience.

Although new issue volume is an imperfect measure of our performance in any one period, recent issuance does illustrate the trajectory of business in the third quarter. As this chart indicates, after a slow start in July, there was strong acceleration in new dollar issuance in the U.S. industrial market in August and September and obviously for the third quarter. There also was modest improvement in the public finance sector, which was encouraging, but we saw a sharp decline in new issuance dollar volume in the U.S. structured finance markets as the third quarter progressed. The following charts illustrate the pattern I have just described. You can see year-over-year volume plunging in September for the U.S. residential mortgage-backed securities, and also somewhat for the U.S. commercial mortgage-backed securities, and U.S. collateralized debt obligations, CDOs.

The activity that we're seeing in the U.S. structured finance so far in October is tracking the level of issuance we saw in September. We already pointed out that the year-to-year comparisons are challenging in the fourth quarter for structured finance. It is a large quarter seasonally for that business, and the revenue model is heavily transaction oriented. We now expect new issue dollar volume in the U.S. residential mortgage-backed securities market to decline by 70 to 75% in the fourth quarter versus last year, which obviously was robust. Declines of 85% to 90% are possible in the new issuance of U.S. CDOs, collateralized debt obligations, in the fourth quarter versus last year. As these charts illustrate, new issue dollar volume in the fourth quarter of 2006 actually surged in December for U.S. residential mortgage-backed securities, and collateralized debt obligations. The comparisons may not be quite as challenging for asset-backed securities, and possibly U.S. commercial mortgage-backed securities.

Despite market turbulence S&P is encouraged about the prospects in the asset-backed market. Credit card issuance continues to show strength. Scheduled refinancing and increased credit card utilization by consumers are reasons for optimism. Solid issuance of auto loans for the remainder of the year is also a possibility as banks redeploy capital to fixed-rate, short-term auto loans instead of mortgage products. A pick up in commercial-mortgage-backed securities is a little bit more problematic at this point. Commercial real estate fundamentals remain very strong, but activity as been chilled by the subprime problems in the residential market. Widening spreads have kept many investors on the sideline, resulting in a reduction in the demand for new issuance. We really believe that in the commercial mortgage-backed market this is temporary situation because it has been quite strong and we expect that to continue.

The weaker U.S. structured finance will be at least partially offset by continuing strength in investment-grade corporates, international markets, non-traditional ratings and services, annual contracts and surveillance fees, and financial information products and services and vigorous expense management.

There is reason for optimism in the corporate market. Investment grade corporate issuance really has not faltered. In fact, it has set new records. Industrial issuance will continue to be driven by a favorable financing environment, M&A activity, and investments in capital expenditures. Financial services issuance will be driven by many of the same factors, including balance sheet restructuring activity. Spreads also remain historically tight and rates remain low. In addition, we expect a 10% to 11% increase next year in potential refundings. S&P anticipates that $47.9 billion of U.S. corporate debt to mature or be called in the fourth quarter this year. Another $250 billion is potentially refundable in 2008, and that's about an 11% increase over 2007 levels. The new issuance calendar also looks quite strong for the coming months.

As I pointed out earlier, our diversification efforts continue to contribute to growth and make our business more resilient, so we continue to expand our financial information and index services. In the third quarter, trading started for six new exchange-traded funds based on S&P indices, including our first in the fixed-income space, its the S&P national municipal bond index sponsored by Barclays Global Investors. Today, there are 133 exchange-traded funds worldwide based on S&P indices and more are in the pipeline. We're making good progress licensing some noteworthy clients for S&P GSCI index, that's our commodities index and that was acquired from Goldman Sachs.

Data and information products are growing rapidly. The Capital IQ product is adding new clients and expanding its base with existing customers, new modules including portfolio management tools are increasing demand for the Capital IQ product. Expect more innovation here and more expansion into international markets.

Given all the uncertainty in the credit market at this time, it is too soon to start making projections for 2008. Some observers feel a calm is returning to global credit markets and a fragile stability is starting to set in. Going forward, there will be more, not less, focus on credit quality. Liquidity worldwide remains plentiful, we know that from surpluses from OPEC, Japan, China, Canada, Russia. The benefits of securitization, the liquidity, the economic capital reductions, tradeability will remain strong after the current turbulence has dissipated. There are also questions about the timing of the next interest rate cut by the Federal Reserve. The chances of a rate cut later this month seemed to have faded somewhat with third quarter growth now appearing to be stronger than expected.

David Wyss, who is S&P's chief economist, now thinks we could see a Fed rate cut in December or more likely in January of '08. The housing recession still has a way to go. David Wyss predicts that housing prices will fall nationally by 11% peak to trough, with probably another 6 to 8% still to come. The difficult news is that no rebound is expected before the end of 2008, so we have a little bit more to go with the housing recession. Areas that experienced the greatest speculative run up in prices, such as California, Florida, Nevada, Arizona, and states where the economy has been hardest hit by increasing unemployment such as Michigan, Indiana, Ohio could experience price declines of 15% or more.

On September 24, the Securities and Exchange Commission granted the registration of Standard & Poor's as an NRSRO, and that was under the U.S. Credit Agency Reform Act of 2006.

September is also the month the SEC commenced an examination of S&P and other rating agencies policies and procedures under the Act and, of course, as always, S&P is working with the SEC, regulators in Europe, we also work with regulators in Asia as well as the U.S. Congress to answer any questions about our policies and procedures, and we obviously welcome the opportunity to discuss any aspect of our business. Transparency and increasing transparency is always good. Based on current information, we don't believe any pending legal, governmental or self -regulatory proceeding will result in any material adverse effect on our financial condition or our operations.

This is challenging period for Financial Services, but we believe the issues are being addressed. Equally important the favorable long-term trends are clearly intact and will continue to drive our business for some time to come.

So, let's sum up for Financial Services, a solid performance in the third quarter despite a tough market environment. Worsening conditions for structured finance in the United States in the fourth quarter, but the rest of the business remains strong. A double-digit top and bottom-line performance for the full year, and we will have, once again, margin expansion for the full year.

Now, let's review the Information & Media segment. For the third quarter, revenue increased 2.1% and operating profit grew by 35.8%. In the third quarter last year, there was a pre-tax restructuring charge of $5.8 million. The operating margin was 7.4%, up from 5.5% last year. This segment is in transition as we work to overcome the softness in advertising with increased sales of higher value information products and services delivered to customers online.

A weak advertising market was certainly a factor in the third quarter.

Revenue in the Broadcasting Group for the third quarter declined by 7.8% and revenue for the Business-to -Business group was up 3.2% even though Business Week's ad pages were off 24.6% in the third quarter. The Business to Business Group's growth came from information products and services. Clearly, the strong performances came from pricing in news for oil and natural gas and power from Platts, expansion of our international research and proprietary studies under the J.D. Power and Associates brand, products and services delivered online to the construction industry -- which is virtually a 24/7 online network now.

I also urge you to take a look at the newly-redesigned BusinessWeek starting with the October 22 issue. The relaunch of BusinessWeek is the product of 18 months of research among readers and non-readers to gain a better understanding of today's business information consumers. Editor in Chief, Steve Adler, has reconceived the publication and in the spirit of the new Internet age will direct his editorial team to sort, to clarify, to illuminate the important developments for an audience of more than 4.8 million readers each week. That means offering other smart perspectives from around the world, along side stories developed by BusinessWeek in a multi-channel endeavor. The goal is to solidify BusinessWeek's leadership as a multi-platform global business media organization and build on healthy circulation statistics.

Newsstand sales, a key indicator of editorial vitality, are up 25% in the first half. The average price per subscriber is up 1%. Overall, circulation is very steady.

So, summing up for Information & Media, a segment in transition, advertising remains soft, but growth and online information products will continue to be the focus and the push on that.

That completes our review of the operation. Let me now address some of the guidance issues here. I want to spend a few minutes updating our guidance for the full year as well as for the fourth quarter. We are still on course to produce double-digit earnings per share growth for the full year, for 2007. For the full year, we expect improved operating margins at McGraw-Hill Education and McGraw-Hill Financial Services; no change there. Our guidance excludes the following items: A $0.04 charge for the elimination of the restoration stock option program in the first quarter of 2006, a $0.06 charge for restructuring in the second half of 2006, and a $0.03 gain from the divestiture of a mutual fund data business at Financial Services in the first quarter of 2007. On that basis, after nine months of solid achievement, we have already earned nearly as much as we did for all of 2006.

Now, given those charges and gains, on a GAAP basis inclusive of these items, the 2007 earnings growth would be even stronger. But I believe that the non-GAAP financial measures, and excluding those items, provide more useful information to investors due to the unusual nature of those excluded items.

Now, let's review the outlook for the fourth quarter. In the fourth quarter, Financial Services faces the toughest comparisons of the year. Last year, revenue for this segment grew at 22.1% in the fourth quarter. For the fourth quarter this year, we expect a high single-digit decline in revenue and some margin contraction because of the challenging conditions in the U.S. structured finance market. For McGraw-Hill Education in the seasonally very, very small fourth quarter, we expect a slight decline in operating profit and some margin compression. As a consequence, the corporations' revenue and earnings in the fourth quarter will not match last year's results.

So, summing up for the corporation, first of all, double-digit earnings growth for the full year, even though revenue in earnings will be reduced in the fourth quarter versus last year, and margin expansion for the year in Financial Services at McGraw-Hill Education.

Okay. With that, let me hold it there, and let me turn it over to Bob Bahash, our Chief Financial Officer and he'll go through some and then we'll go to your questions and comments. Bob.

Okay. Thank you, Terry. I'll begin this morning with an update on our share repurchase program. We planned to repurchase up to 30 million shares this year. We achieved that goal in the third quarter by buying back 10.5 million shares for $616 million. The company has spent $1.9 billion this year for the 30 million shares. That averages to $63 per share. Since 1996, the corporation has returned $8 billion in cash to shareholders through share repurchases and dividends, including more than $2.1 billion in the first nine months of 2007. There are 35 million shares remaining in the 2007 repurchase program that was authorized by the board of directors last January.

As a result of share repurchase activity, the diluted weighted average shares outstanding declined in the third quarter to 337.7 million shares. This reflects a 12.6 million share decrease compared to the second quarter of 2007 and a 23.2 million share decrease compared to the same period last year.

We have ramped up our borrowings to fund the additional share repurchases. At the end of September, we had a net debt position of $879 million, which is up from a net debt position of $636 million at the end of the second quarter. As of September 30, our -- on a gross basis, our debt is approximately $1.3 billion, which is offset by $453 million in cash, primarily in foreign holdings. The current debt reflects a mix of short-term borrowings, primarily in commercial paper, with the balance in extendible commercial notes and money market loans. As a result of increased borrowings, interest expense was $15.4 million in the third quarter, which is more than double the $7.5 million in the same period last year. For the full year, we now expect interest expense in the range of $39 to $41 million, which is slightly lower than our previously estimate of $40 to $42 million.

Let us now look at our corporate expenses. Corporate expenses decreased $9.5 million, or 20.1%, in the third quarter as compared to a year ago, but corporate expenses in the third quarter of 2006 included a $4.1 million charge for restructuring. Excluding this charge, corporate expenses decreased $5.4 million in the third quarter compared to a year ago, and the decrease is primarily driven by lower incentive compensation accruals versus the prior year, and a one-time gain from the sale of an equity investment. Regarding operating segment performance, there are two items that influenced year to year comparisons in the third quarter. So, in the third quarter of 2007 we sold a non-strategic product line, Terry mentioned that, within our K to 12 business that resulted in a pre-tax gain of $4.1 million, and in the third quarter of 2006, we incurred pre-tax restructuring charges of $15.4 million, or $0.03 per share. That was primarily for employee severance in McGraw-Hill Education, Information & Media, and at corporate.

The effective tax rate in the third quarter was 37.5%, compared to 37.2% in the same period last year.

Let's take a look at our capital expenditures, which include prepublication investments and purchases of property and equipment. Prepublication investments were $77 million compared to 64 million for the same period last year. For 2007, we continue to project that prepub investments will be about $310 million.

Purchases of property and equipment were $63 million in the third quarter compared to only $25 million for the same period last year and this is, of course, being driven by the construction of our new data center which is underway and expected to be completed in the first half of 2008, along with technology investments we are making to digitize our products and services. We continue to project $250 million for 2007.

Now, for some of the non-cash items. Amortization of prepublication costs was $110 million in the third quarter, compared to $103 million in the same period last year. We now expect to be about at a level of $250 million in 2007, which is down slightly from our previous estimate of $260 million.

Depreciation was $26 million in the third quarter, that compares to $27 million in the same period last year, virtually flat. We now expect it to be $120 million in 2007, again this is also down slightly from our previous estimate of $130 million due to a change in the timing of capital expenditures in 2007.

Amortization of intangibles was $12 million; that's also flat with last year, and we expect 2007 to be about $50 million.

Finally, unearned revenue was just over $1 billion in the third quarter, which is up from $884 million from the same period last year. This reflects a $121 million or 14% year-over-year growth. This revenue will be largely recognized over the next 12 months. As Terry pointed out, with a softer revenue forecast, it's likely that it will impact some of the growth related to unearned revenue for the fourth quarter. Thank you now, and back to Terry.

Okay. Thank you, Bob. Well that completes our review. I'm -- let me just say again, I'm -- I'm very pleased with the solid results for the third quarter coupled with the very strong results in the first half of this year. In Eeducation, we delivered in the most seasonally, obviously important, quarter of the year, and I'm very pleased with the McGraw-Hill School Education Group that we reorganized a year ago. And for them to come out with such a strong performance and a 32% share in the new adoption market, we were pleased with that.

In Financial Services, again another very strong performance in -- in a lot of areas, although we are facing some obviously very challenging market conditions in the U.S. structured finance market. We understand the issues here and, trust me, we are riveted on those issues and we will be doing everything we can to bring that back to an acceptable level for us. The long-term trends, though, in the market are so strong and are obviously very intact and we're buoyed by that. So, again, we will deal with whatever challenging market conditions and we feel very good about our overall position in the portfolio. So, okay. With that, let me turn it over to Don Rubin and we'll go to your questions and comments.

Thank you. Just a couple of instructions for our telephone participants. (PHONE INSTRUCTIONS)

Thank you, this question comes from Fred Searby with J.P. Morgan. You may ask your question.

Hi, thank you. Congratulations, Terry, on the quarter. A couple questions. Can you give us some sense of what percent of S&P's revenues were -non rating business and how fast they were growing in the quarter? And then, can you also give us a sense -- it looks like some of the issuance from 2Q spilled over into 3Q, and that's why there's partially precipitous fallout expected in the fourth quarter. Can you confirm that or give us color around that? Thank you.

Yes. Thanks, Fred. As you know, that in terms for Standard & Poor's we don't break out the individual components on that the financial information and services side is strong and doing quite well. Also, on the fixed-income information side coming out of ratings as well with Ratings Direct and Ratings Express and things like that. There -- no question, everything was impacted by the structured finance market, the U.S. structured finance market. Most notably, the residential mortgage-backed market and the collateralized debt obligation markets and it had a little bit of effect on -- on -- on other issuance as well as I think everybody sort of took a little bit of a pause, but the corporate and government side is quite strong and we're already seeing significant pickup in opportunities there and, again, for the obvious reasons, because of M&A activity and capital expenditures and so forth on that part.

Also a lot of the -- as we were saying , the non-traditional areas and the international side has not abated. I just came back from an Asia trip and -- and there they aren't experiencing obviously any of these kinds of issues. So, it's had an effect for sure, but for the quarter, July and August, we're quite strong and September is where it really had its effect, and it will have an effect going forward in to the fourth quarter, but we see that turning around and it's too early to start to get in to 2008 projections, but, we'll see. We'll see how some of this unfolds but, at this point anyway, that's how we're looking at

Okay. Thank you.

Thanks, Fred.

Thank you. Our next question comes from Craig Huber with Lehman Brothers. You may ask your question.

Yes, good morning. Curious to know, what do you think the average maturity is of the stuff you rate on the structure side versus the investment-grade, leveraged loans, syndicated loans, all that? What's the average maturity on both sides?

Well, let's see. I'm -- you know, Craig, I think I better get some better information for you than what I currently have. For the most part we're seeing most things with intermediate terms. On that one, 10 years in that area. When you start talking about specific instruments, obviously we'd all be different. In the residential mortgage backed, depending on whether it was fixed or whether it was adjustable and all of those kinds of things, those are all packaged loans. So, I don't want to give you an answer on that that I'm not comfortable with, so we'll get back to you with more information on that, but I would be thinking more in the intermediate terms.

Okay. I appreciate that. What I'm sort of getting here is because it's perhaps uncharted territory, the so-called bubble may be coming off on the structured side. What -- what happens here if it takes multiple years, say, for structured finance to level off and start growing again? Because then you are not replenishing the stuff that has already matured. This goes on for a few years. So, the surveillance fee side would start to take a real hit because that's been a nice buffer for you guys, but if this thing drags on a long time, isn't it going to be a problem here?

Well, we're in to subjective territory, Craig. My opinion is just one. I personally don't think a two-year timeframe for a credit crunch in the structured finance market to return is realistic. We're already seeing signs of things like the commercial mortgage-backed market starting to pick up again, and I think it was just a pause it had taken there because we had seen since early 2005 that market do very well. But, I think we have to assume that there's going to be some softness, certainly with CDOs and residential mortgage-backed securities going forward here, but I don't think we're going to see an extended credit crunch. I think that would have implications on the economy overall, and I don't think that would be in the best interest of the major lending institutions either, so I just don't see that taking place. There is enormous liquidity that still exists in the system because of all of the worldwide surpluses and that still has to be employed. So, I see this as more temporary in nature rather than long-term in nature.

And my other question, please, can you just talk a little bit about your cost base within Financial Services, what kind of flexibility you have there for next year if this does drag on to next year, in terms of the bonus accruals you could play with, head count, the variability of any costs, I know it's largely fixed cost, but what can you do on a cost side next year?

In terms of the rapid growth that we have had in areas like the U.S. structured finance market what we have done is developed lots of cross-training programs and the like because you just don't want to be hiring and hiring and hiring and then all of a sudden things like this happen and then all of a sudden you are doing a lot of changes on that. So, we do a lot of cross-training so that we can move people around to the other areas, so we have analysts that are being redeployed into the corporate or government area or into some of the other international opportunities. So, we have latitude on this one, but I can guarantee you that everything is being looked at, and we'll take appropriate action as we -- as we size the revenue opportunities.

Great. Thank you.

Thanks, Craig.

Thank you. Our next question comes from Michael Meltz with Bear Stearns. One moment, and I'll open your line.

Great. Thank you. I think I have three questions. Can I just get a better sense as to the guidance for the fourth quarter, about a month ago you were guiding to roughly flat -- or flat to slightly down in Financial Services and now you are saying down high single digits. Can you just talk a little bit about what has changed in your expectations and if it sounds like structured finance, exactly what magnitude you're thinking about now? Secondly, are -- are you implicit in your guidance are you expecting international revenues to be up double digits still? And, thirdly, at the Education Group, your margin was -- was pretty strong in the quarter, but you're pointing to decline year-over-year in the fourth quarter. Can you talk a little bit about what is going on with the expenses there?

Sure. Thanks, Michael. Yes. I mean really in terms of the guidance of the fourth quarter we're trying to give you the best look that we have on it. When we were doing the second quarter earnings and when we updated our guidance, I think it was September 18, Don? We were -- we were looking at a situation that was evolving at that point.

So, we were saying it looked to us at that point that the fourth quarter would probably be flat for Financial Services. Clearly given the September results and -- and what we're seeing in October the residential market and the CDO market has really come to a grinding halt. I don't think that is going to last a long time, but it is certainly there. And so what we're giving you is an extrapolation of what we're seeing right now, and if there is some upside to that, great; but at this point, we're just extrapolating out what the current environment is giving us. We're buoyed by the fact that the corporates and governments are doing well and that the international side is also doing well.

Now, on the international double-digit on that one, again, we're going to have to see what effect, the Asian markets aren't affected at all in this area or for the most part at all. The European markets are affected somewhat on that one, and again, what creates a credit crunch in that one is more of an -- an uncertainty and sort of a -- almost a panic to say that, hey, listen, let's just lay low for a while until we see what activity takes place. We're already seeing pickup in activity in certain areas, and so our thinking is -- is that things are starting to calm down a little bit in all of that. But, in terms of projections, so that you've got the best possible information from us, is we're extrapolating out what we're seeing in September and October to date.

On the education side and on the expense side, we're very, very -- you know, very tough on that and we watch that very, very carefully. The fourth quarter is so small for education. The third quarter is where it's at. There's always timing issues. Does it run over? Do sales orders coming in run over between the end of September into October and all of those kind of things and sometimes there's those kind of issues, but the third quarter needed to be very strong and it was, and we were -- we were very pleased with that. The fourth quarter it's just -- it's really very small, and from an expense standpoint, we're always watching that very carefully.

And Terry, just to put parameters around it, so to understand the high single-digit revenue decline, can you put parameters around what you are expecting out of your structured finance business?

Well, again, in terms of specific guidance on any one component, we're not. But, I mean, you can go to your own CDO desk and mortgage-backed area and you know the activity right now is obviously very light on that one, and I think that will probably remain that way at least through the end of the year, and so, you know, it is the U.S. structured finance part of the market that is being impacted.

Do you think your international structured finance market can grow in that environment?

Well, again we'll see. It has not been impacted at the same extent that it has been here in the U.S., but again we're in real time now. And we're monitoring activity just like you are, and so will somebody come back in to the market more rapidly in the European markets than here? Don't know on that part. But, we're obviously monitoring it and I would think that, but until we get a little bit evidence to do it and, again, as we start looking at early '08 and all of those kind of things, I need to see what the activities over the next six weeks, say, to be able to start making any kind of predictions on that.

Okay. Thank you for your time.

Thanks, Michael.

Michael, if I could just add a couple of points here, with regard to the fourth quarter and how we constructed our guidance here. As Terry pointed out, it's an extension of really what occurred in September and what we're experiencing here in October, but when we look at external data as we gather market volume forecast, looking at Thompson Financial Securities data, Harrison Scott data, et cetera, when we look at the U.S., RMBS, and CDO forecast their declines on a year-to-year basis because last year was so strong, are in the 70 to 80% range. Europe, on the other hand, is not as dramatic but there are declines, especially in RMBS and CMBS in the 30%-ish range. That was the basis in guidance that we used to construct our forecast and the guidance that we gave to you.

Okay. Thank you both.

Thank you. Our next question comes from Karl Choi with Merrill Lynch. You may ask your question.

Hi, good morning. I also have three questions. First of all, regarding structured finance revenues, I think, Terry, you mentioned that is mostly transaction driven. I believe at Moody's they've talked about 25% of their structured finance revenues every year come from annual fees. Can you give us a sense of a similar percentage at S&P? Is it similar, higher or lower? And, second question is related to the supplementals. It sounds like from what the trend set, Terry, you talked about. Does it mean that supplemental softness can actually continue into 2008? And last question, if Bob can give us the basic shares outstanding at the end of the quarter. Thanks.

Terrific. Thanks, Karl. Yes. In a structured finance area, again and especially towards the end of the year, it's more transaction driven on that one. Everything that we do is -- we try and push things towards a broader surveillance on there. I would say that -- and I'll get you a number on that, but I would say that we're higher than the 25%, but right now, given the fall off, at this point of the year it's more transaction focused. On a yearly basis we would be much, much heavier towards surveillance-fee basis, but at this point in time, it's going to be more transaction driven.

On the supplemental part, I mean what we're seeing is a little bit of mix change between the basal side and the new adoption market and the supplemental market, and with big programs now and especially focused on social studies, math, science, reading, the requirements that are coming from the state are inclusive of a lot of different add-on products--o online products, assessment products, all sorts of things. And so what we're seeing is a little bit of a shift this year towards the -- the bigger programs, and the adoption programs. The supplemental market is an important market and it is really focused on the sort of alternative basal or the intervention and remedial kind of products that support the adoption market and we're seeing that as a focus more in '07 more than we saw that before. So, we're picking it up, and that's why we saw the -- the state new adoption monies. We were talking about $750 to $800 million. We upped it to $780 to $820, because some of those monies that were in the alternative area were moving in to the new adoption market, so the total opportunity isn't going away. It's a mix shift and supplemental is going to be very important to us, and so we'll -- we'll continue to focus on the remedial intervention there. Bob, shares --

Yes. Basic shares outstanding, Karl, at the end of the quarter was 329 million.

Actually, one last question. I believe testing revenues last year was down around 13%. Can you give us a sense of what your expectation is for this year?

13% of what?

Well we don't necessarily break out, Karl, the testing revenues per se, but in talking in general about our testing business, we're very excited about some of the shelf revenues. Obviously, we gained some significant share on custom contract revenue with some of the wins that Terry had pointed out. But the Acuity product is very exciting for us, and we're seeing significant growth in that category. We don't break that area out in particular, but we're really excited about the web-based Acuity offering that we have.

Yes, we have been -- and -- Karl, as you know, we have been spending a lot of investment on this area, and it's very encouraging to see the results that we're getting here. As you know, we were a high-stakes testing business, and the growth is all in the low-stakes or the formative side, and the Acuity product, as Bob said, is doing really well, and we're building more enhancements on that. Testing assessment is going to be an important component, and we're on the right track with that.

Great. Thank you.

Thank you. The next question comes from Edward Atorino from Benchmark. You may can your question.

Hi. The press release talks about weak revenues and softness in education -- down education in the fourth quarter and why would that be?

Ed, as you know, the fourth quarter is relatively very small. The third quarter is where it's at. And it's just the upside that we're looking for is on the higher education side because that is obviously a more global business and we'll see from that. But, it's just that in terms of K-12 we did extremely well in the third quarter. I don't see any real timing issues here that it is into the third quarter and there won't be much spillover on that one. So, we're just saying that it's in a very small quarter for education, it's -- we're not going to see a lot of upside. Where we're looking for, and it's not in the numbers, is higher education. Higher education could be some upside for us in the fourth quarter.

Okay.

Let me clarify one point here. The -- the guidance called for a decline in revenue for the corporation.

Oh, okay.

Okay.

I understand.

Really driven by financial services.

Gotcha.

As Terry points out, it is a relatively weaker quarter for MHE.

Softness in education --

Yes. Revenue, we're projecting that revenue will increase, but it's really driven -- the profit pressures are driven by expense for digital products and services --

I understand. I just was looking at the syntax.

Okay. Yes.

Thank you, our next question comes from Peter Appert with Goldman Sachs. You may ask your question.

Thanks. Terry, you are seeing in '07 obviously some impressive improvement in the profitability within the education segment. I'm wondering if in '08 do we see another equally dramatic step-up in profitability in the context of the revenue expectations you've outlines or will the spending requirements for the new products mute the margin gains next year?

Okay. Thanks, Peter, it's -- again it's a little early to start getting in to '08, but it's a little bit clearer on the education side because the new adoption market opportunity is big. As you know, next year, we've got science, we've got reading, we've got mathematics, we've got California. We've got Texas. You have got some huge opportunities out there.

The important thing to -- to us about '08 is how we perform in '07. Because of the restructuring of the School Education Group, we needed to see strong, strong performance. And with the 32% market share and leading every state that we are in, we're very -- we're very upbeat about that. So, I would expect, and as you know, the investment in '08 product has already taken place. So, I would expect to continue to build on that in -- in -- next year and that will be an important part for us.

Peter, one of the influencing factors that we're going to experience next year in 2008, as I mentioned earlier, we will have completed the construction of our new data center which will house -- it's really critical for us in terms of the movement to our digital product offerings. The migration of our products and services in all of the platforms from the existing data center to the new data center will occur throughout pretty much part of the first quarter, second, third, and fourth quarters of next year. Those will be additional costs.

We're really looking at them at one-time costs. That will influence obviously performance next year, but it helps us to establish the right kind of platforms for our 24/7 delivery across all of our product lines. So, that's the only extenuating item that would influence our forecast for next year. But, again, it's early on. As Terry pointed out, we're not really in to the budgeting process, but I just wanted to point out that is one item that we're looking at for next year.

How big will that item be, Bob?

Again, we're not really in to the budgeting side of things, but you are migrating all of the systems that exist for Education, for the most part, are being migrated to the new center. There's -- so we will be incurring duplicate application costs, duplicate equipment costs as we do that migration and wind out some of those leases that we may have when we complete that effort. So, we're formulating that now, but it's -- it's a one-time item that we're going to be faced with next year.

Yes, and there's offsets to that, and there will be savings associated as well.

Bob, one follow-on the capital spending obviously has taken a big step up in '07. Do you have a thought in terms of what the run rate should look on a go-forward basis in cap spending?

Yes. The big step up this year, of course, was driven by the data center, getting up to $250 million, so I would tend to think that next year absent the data center, we're back down to the -- most likely, the $120 to $140 million range.

Great. Thank you.

Thank. Our next question comes in Ben [Sader-Ratner] with Glenview Capital. You may ask your question.

Hi, thanks for taking my call. I was hoping you could provide a little more color on the guidance in Q4 for higher education versus K-12 and what sort of growth in higher education is coming from price versus volume.

Okay. Thanks, Ben. Yes. Again, the higher education side is a more steady -- the contribution quarter by quarter by quarter is more steady than in it is in the K-12 area. In the K-12 area, as you know, the first quarter you're reflecting all the investments and that's why your recording losses and you have to make it up in the third quarter, and what we've seen is a very obviously strong third quarter for K-12. The up side for us is on the education -- on the higher education side, and we're seeing a stronger market this year than -- than we had forecasted coming in to the market. So, you know, again it's early on. If there's upside on the education side in the fourth quarter, it's going to come from the higher education piece. And, again, that's -- that's both price and volume.

Got it. So, it is fair to say that your guidance for the education segment in total relates more to the K through 12 segment and is due to timing more than underlying weakness in the actual market?

Yes -- no -- I think that again what we saw was mix shifts in the education this year. The strong, strong new adoption market in the K-12 side, we did very well with. We saw some softness in the supplemental area, and that we picked up in the new adoption market. Also, the other one that we're watching very carefully are the open territories. And the open territories have not grown over the last several years anywhere near where we think they should be, and we think that's going to be upside for '08, but right now we also expect that we might get a little uptick in the fourth quarter from the open territory side. It's still very big. You are talking about almost $2 billion that is being spent, but the question is, is the growth on that. And, again, that's why we said 3% to 5% growth for the market. We'll do a lot better than that. And on the higher ed side, it is a little bit stronger than we expected, so we moved that up to 5% to 6% for the market.

Thank you.

Thank you, our next question comes from David Einhorn from Greenlight Capital.

Oh, thanks for taking my question as well. My question is, as you look at the structured finance market, are there parts of that it you feel, looking back -- it's not a question that they -- there's a temporary issue, but maybe some of this just wasn't such a good idea to begin with? And, second, I'm wondering how you view Standard & Poor's from a brand, and what might be happening to the brand as a result of what's gone on in the structured finance market? Thanks so much.

Yes, David, the market is what the market is, and what we do is provide access to the capital markets, and provide in the structured area, credit ratings that relate to the risk a particular instrument has in terms of defaulting on its interest or on its principal payment. So, the structured finance market is a -- is a market that institutional investors like, and a lot. The reason is, is because with structured product you can -- you can divide them up in to tranches and you can get just the risk reward characteristics or attributes that you are looking for in terms of your own portfolio construction on that one. So, if the market wants those kinds of products, and the institutional investors want those products, then we move with the market and we're going to rate whatever on that part.

Give even the current environment I think what you are going to see is more of a flight to quality, and -- and less to speculative grade on that, and -- and we're reflecting that now. In terms of Standard & Poor's as a brand, no. I mean, your constantly growing. You're constantly learning. You're constantly involved in not only the rating side of the market, but providing the transparency in terms of all of the financial information products. And we are -- we take that responsibility very seriously, and the credibility that S&P has as a brand, in terms of serving the markets in a lot of areas here and around the world, is only going to grow with the growth of the capital markets.

The long-term trend here, privatization, securitization, the whole global movement, the disintermediation away from the banks in to the capital market, those trends are undeniable. I mean, that's what's growing this. That why the U.S. capital markets are extremely sophisticated and solid, and so too are the European markets and the Asian markets, and those trends are what are driving it, and we're a centerpiece right in the middle of all of that.

Thanks so much.

Thanks, David.

Thank you. Our next question comes from Catrina Fallon with City. You may ask your question.

Hi good morning. I was hoping you could just broaden your comments a little bit about your buy-back plans. With 35 million shares left in the '07 program, what's your philosophy around continued buybacks? So should we expect a similar pace of buybacks in Q4 that we saw in Q3?

Okay. When we start talking about share repurchase, this is a Board of Directors authorization and that's is where it has to come. I can give you my own sentiments. I think that in terms of what we see, in terms of our growth trends, and our opportunities going forward, I think they are solid. They are strong. And -- and we -- we very much like a share repurchase program. We have completed our authorized portion so far in '07. We -- we have a board meeting coming up, and I guess that might get discussed.

Great. And then just one further question on the ETF -- on -- on S&P indices. Nice growth there, $209 billion. How much of that is through organic growth of the funds versus acquired growth through some of the new indices that you purchased, and what is your thought around additional opportunities for acquisitions there?

Well, again, most of what we do is organic and we're constantly developing those capabilities and where we are can accelerate that through an acquisition such as the Goldman Sachs indices on commodities and so forth, we will do that. So, most of it is organic, but it's -- it's a wonderful area, and what you're doing is you're creating investable benchmarks and there are endless permutations to the type of benchmarks that you can develop. So, here around the world that effort will continue and we're working with lots of different exchanges and large institutional investors to develop whatever they want in that area. Because you can measure things in any in any dimension so, again, with benchmarks you can go in a lot of directions, so most of that's organic.

Yes. Do you give any color around the contribution margin from that business?

Yes, it's high.

Thank you very much.

Thanks.

Thank you. Thank you. We will now take our final question from Michael Meltz with Bear Stearns. You may ask your question.

Thanks. Two follow-ups. Bob, I think you said the corporate line benefited from a one-time equity gain. What was that and can you size that? And then following up on Peter's question, this is the - I think - the first time I've heard about these redundant costs next year. Understanding they're one time, it would be helpful if at this point if you could put it in context. Is this a $10 million charge or is this a $50 million type of hit?

Okay. First off, the -- it was an equity investment that we had. I'm not going to go any further in that, but it was roughly $3.6 million was the gain that is embedded within corporate expense. We've been talking about the construction of the new data center now for the past year or so and obviously coming with a new data center implicit in that is the movement in shifting of all our technical capabilities, our applications and such, fitting it with hardware, moving it into there, and that's simply a big process. I'm simply highlighting that there's an item here. This is not something that is astronomical and is going to influence the overall performance of the enterprise, it's just something that I'm just pointing out, and we'll size that for you as we go further in the course of the year, but just simply pointing out that this is an effort that is going to go on next year and it's the transition costs that is one time, and that's what I'm referring to.

Okay. And then, your comment on shares out of the $329 million, was that a diluted or basic number at the end of the quarter?

That was a basic number.

Okay. Thank you.

Thanks, Michael.

We do have another question from Karl Choi with Merrill Lynch. You may ask your question.

Yes. Just within Financial Services, just wondering if there was any reversal in terms of compensation accrual in the quarter and, Bob, if you can -- if you have a figure for how much head count would be up EOB in the fourth quarter for Financial Services.

With regard to incentive compensation, an influencing factor, without getting in to how much, was simply because of the performance and the outlook for the year as it relates to last year. You may remember last year was very, very strong and the expectation was for a very strong fourth quarter. We were building incentive accruals as we went through the course of the year. Now, this year with the weaker performance in September and the outlook going forward, the incentive accruals are lower, so that influenced the overall performance. I'm not going to get into the specifics in numbers, but it did influence the performance and did influence the fact that our margin was higher on a year-to-year basis.

With regard to head count, as Terry pointed out, we're looking very, very hard at the organization, but keeping in mind that we have a responsibility to provide quality products and services. We have surveillance that we're going to be adhering to, but we are looking across other parts of the lines to be certain that we're staffed accordingly based on what we're facing in the next 6 to 9 months.

Yes, and, Karl, the other aspect is the whole cross-training initiative within the ratings division. They move things around depending upon where the revenue growth is, but everything is being looked at.

Great. Thank you.

Thank you, and this does conclude this morning's call. On behalf of The McGraw-Hill Companies, we thank you for participating and wish you a good day.