標普全球 (SPGI) 2008 Q1 法說會逐字稿

Good morning and welcome to the The McGraw-Hill Companies first quarter 2008 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 listen-only mode. At the request of the Company, we will open the conference for questions and answers after the presentation and instruction will follow at that time. To enhance the call for today's participants, McGraw-Hill has made the presenter slides available on the internet. To do that go to http://www.mymeetings.com/mc/join. I will repeat the URL once more for those who would like to view the presenter slides online. It is http://www.mymeetings.com/mc/join. You will be prompted to enter your name. The net conference meeting number is P as in Paul, G as in good, 4193132. Passcode is McGraw-Hill, all caps with a space between McGraw and Hill. 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. (OPERATOR INSTRUCTIONS)

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

Thanks, and good morning. We are pleased that you all could join us this morning for The McGraw-Hill Companies first quarter earnings call. I am Donald Rubin, Senior Vice President of Investor Relations for The McGraw-Hill Companies. With me today are Harold McGraw III, Chairman, President and CEO, Robert Bahash, Executive Vice President and Chief Financial Officer, and Deven Sharma, President of McGraw-Hill Financial Services. This morning we issued a news release with our first quarter 2008 results. We hope you have all had a chance to review the release. If you need a copy of it and financial schedules, they can be downloaded at www.McGraw-Hill.com/investor_relations. Once again www.McGraw-Hill.com/investor_relations.

Before we begin this morning, I need to 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 meanings of the Private Securities Litigation Reform Act of 1995 with 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-Ks, 10-Qs and other periodic reports filed with the U.S. Securities and Exchange Commission. We are aware that we do have some media representatives with us on the call this morning. 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 area code 212-512-2247 subsequent to this call.

Today's update will last approximately an hour. After our presentation, we will open the meeting to questions and answers. It is now my pleasure to introduce the Chairman, President and CEO of The McGraw-Hill Companies, Terry McGraw.

Okay. Thank you very much, Don, and good morning, everyone. And, again, thank you for taking the time to be with us today for the review of The McGraw-Hill Companies first quarter earnings and our outlook for 2008. As Don was saying, joining me on the conference call beside Donald Rubin is Bob Bahash, our Exec. Vice President and CFO and also Deven Sharma, the head of our financial services segment, President of Standard & Poor's. I will begin the call by reviewing first our first-quarter results and some prospects for 2008. Bob will then review our financial performance. And obviously after that, we will go into any direction that you would like, any comments or questions that you have.

Earlier this morning, we released our first quarter results. Earnings per share were $0.25 compared to $0.40 last year and remember now, that that $0.40 included a $0.03 gain on the divestiture of a mutual fund data business. Revenue for the first quarter declined 6.1% to $1.2 billion. The slumping housing market remains the major negative factor for both the economy and the financial markets, and clearly, the credit crunch and the financial markets had an impact on our first-quarter results. Continued financial sector problems are expected to convince the Federal Reserve to cut interest rates tomorrow by probably 25 basis points. The Fed's fund rate is currently obviously at 2.25%.

David Weiss, the chief economist at Standard & Poor's says the first half of 2008 will be the toughest period for the economy and expecting the second half of the year to show some strength. He expects the tax rebate to help produce GDP growth of about 2.5% in the third quarter, maybe more. The business tax credits will provide a boost in the fourth quarter. With that as background, let's take a look at our first quarter performance and review our prospects for the balance of the year.

Let's begin with McGraw-Hill Education. Revenue declined 0.5%. We reduced the operating loss by 0.5%. The operating margin was unchanged from a year ago. And revenue for the McGraw-Hill School Education Group declined 4.8% to $138.8 million and revenue for the McGraw-Hill Higher Education Professional and International Group grew 2.9% to $191.4 million. First quarter results don't indicate much about what's ahead for our education business this year in a seasonally very low comparison. Obviously we run losses in the first quarter and you make your money in the third quarter.

In the elementary and high school market, first quarter revenue depends more on purchases of fill-in copies and supplemental materials more than new business. In higher education, first quarter revenue is primarily driven by ordering for the start of the new term, an echo of the ordering pattern established during the previous year's fourth quarter. But at the same time, we begin to get reports from the field on how our new products are being received in the marketplace. It is still early, but we are encouraged by the preliminary reports and our confidence in our forecast for the year is growing. Although North Carolina was the only adoption state to place substantial orders for newly adopted basal materials in the first quarter, we think the state new adoption market will meet our expectations by growing 10% to 15% this year.

In 2007, the state new adoption market was approximately $820 million. Our estimate for this market in 2008 is $900 million to $950 million. We still expect year-over-year industry revenue growth of about 1% to 2% in the open territory and again, that is a wild card for us. We think that after the last two years of it being fairly slow, that we might see some pick up there. We also look for 4% to 5% growth across the elementary, high school market as a whole.

In 2008, the McGraw-Hill School Education Group is focused on major opportunities in elementary reading and math, and on three big adoption states, Florida, Texas and California. In the Florida K-5 reading adoption, we are getting very encouraging reports on the performance of Treasures, which is our balance basal reading program, our alternative basal which is called Imagine It which is a revision of our open court reading, and also a direct instruction program called Reading Mastery. In the Texas K-5 math adoption, our new state-specific program is off to a very solid start. In California, we have sales opportunities in first-year math and second-year science. Our state-specific programs are competitive in both subjects at both the elementary and secondary levels and our alternative basal which is called Everyday Mathematics also looks very strong in California.

We also like our opportunities in K-5 reading in Oklahoma and Louisiana, our 6-12 literature in Alabama, Louisiana, and Oklahoma, our 6-12 science program in Georgia and in Kentucky, and our 6-12 social studies in Arkansas and Tennessee. Prospects also look very good for our fine arts, health, business and vocational lines in states adopting those subjects this year. Decision-making the open territory typically continues through the end of the second quarter and sometimes beyond, but we are encouraged by the opportunities our field staff has been tracking for this year. We will have more to give you on that in the next couple of months. We expect to benefit from the introduction of Math Connects which is our new national program for the K-5 market and Time Links, a new K-5 social studies program. We also anticipate continued gains in open territory market share for Treasures, the elementary reading program that we launched with great success last year.

In the supplemental market, there is a diminishing demand for traditional stand-alone products. Typically, these products are not clearly correlated to state standards or supported by research studies, criteria that are increasingly important in this age of accountability. And many supplements that used to be purchased separately are now unnecessary because of similar materials are provided in the ancillary packages that accompany today's more comprehensive basal programs. Sales are growing for our new print and digital intervention products which have been constructed around state standards and validated through research. In testing, we anticipate the strengthening of new revenues -- of a new revenue stream as formative assessment becomes more and more important in the instructional process.

The introduction of Acuity, our new informative testing system has enabled us to establish leadership in this market in a very short timeframe. In 2007, Acuity was selected for New York City's periodic assessment program which is the largest formative contract ever awarded at $80 million over five years. Acuity has been expanding its customer base at the school district level elsewhere in New York and in many other states. The system has also been adopted on a state-wide basis in Indiana and in West Virginia. Clearly activity is brisk despite concerns about the impact of a weakening economy on state and local budget. Budgets now under construction in 46 states that starts the new fiscal year on July 1.

In March, Standard & Poor's issued a report on how a weak economy will tax U.S. states 2009 budget. S&P pointed out that the budget proposals are showing substantial and broad-based reductions in spendings for most expense categories, except for education. In fact, the record of state support for education in this decade is remarkably consistent. According to statistics from the National Association of State Budget Officers Report, funding for education, aggregated across all 50 states, has increased every year since 2001. Clearly, education remains a priority for all state government. We will continue to monitor this situation obviously very carefully, but for now, it appears that the concern over state funding for education may be exaggerated.

The weakening economy could also benefit the college and university market. As this chart shows, there is a counter-cyclical aspect of the U.S. higher education market. In this decade, annual enrollments continue to grow as economic growth decline. In difficult times, more students stay in school longer while others return for more education to enhance their employability in a changing market. Even without the stimulus of a slowing economy, college enrollments are expecting to climb over the next decade based on demographic trends. The fastest growth will occur among women and members of minority groups, according to a recent report from the U.S. Department of Education's National Center for Educational Statistics. We expect the U.S. college and university market to grow in the range of 3% to 4% this year, and we still expect to outperform the market.

So let's sum up for the outlook of McGraw-Hill Education. Growing confidence in the forecast for industry growth and l-high and higher education market. Segment revenue growth of 6% to 8% and operating margin will probably decline 50 to 100 basis points due to stepped up investments in technology due to acceleration of improvements toward the digital transformation. Okay.

With that, let's go to the financial services segment. Here, product and geographic diversity and cost containment help cushion a steep decline in the structured finance area at financial services. In the first quarter, revenue declined 11.6%, operating profit was down 25.3%, and the operating margin was 40.4% down from 47.7% for the same period last year. But better than the 35.8% in the fourth quarter of '07, when restructuring charges cost 2.5 percentage points on the margin. In this environment, cost containment is clearly the top priority. We had the benefit of restructuring from the fourth quarter last year, and we will see the full impact of that action starting in the second quarter of this year. We strictly limited hiring, we cut back on discretionary expenses, and we reduced 2008 incentive compensation. We actually reduced year-over-year costs in the first quarter in financial services, and in just a moment, Bob Bahash will review those details for you.

In the face of challenging market conditions, we are currently considering more staff reductions. We have taken a measured approach as we carefully assess the operating environment. At this point, it is clear to me that we need to do more to lower costs and improve efficiency. We will have more to say about further reductions in the next several weeks, both at financial services and at McGraw-Hill Education. We also continue to focus on how best to grow our financial services business so we are in a good position to resume growth once the market regains its stride, as for sure it will.

Creating a diversified portfolio has long been a key strategic thrust at financial services. The growth at Standard & Poor's Investment Services is a key element in our effort to diversify within financial services. S&P Investment Services grew by 18% to $217 million in the first quarter and represented 34% of this segment's revenue. We expect double-digit revenue growth from this non-ratings business from the balance of the year. Our efforts to diversify are not limited to S&P Investment Services. For S&P credit marketing services, there is an ongoing effort to diversify by asset class, geography, product mix, and through the growth of annual fee and subscription revenue.

For the financial services segment, unearned revenue increased in the first quarter by 13.6% to $812 million or about 74% of the Corporation's total deferred revenue for the period. And we expect deferred revenue at financial services to continue growing this year. It contributed to the 11.2% growth of non-transaction revenue at S&P Credit Market Services which produced increases in subscriptions like Ratings Direct and Ratings Express, annual fees and surveillance revenue. Revenue from non-transaction sources was $309.1 million in the first quarter. International revenue for credit market services, and that was driven by favorable foreign exchange, grew by 5.8% in first quarter to $204.5 million or about 48% of the top line. That is very encouraging and telling.

CRISIL in India is an increasingly important contributor to our growth overseas and we continue to seek new opportunities to grow in international markets. In the first quarter, we added a new rating agency in Israel, S&P Malott and opened new branch operations in Dubai and Johannesburg, South Africa. Our strategy clearly buffered the segment and S&P Credit Market Services from the severity of the decline in the structured finance market in the first quarter. As this table shows, revenue for financial services declined 11.6% and S&P Credit Market Services was off 21.6%, while global new issue dollar volume fell 49.3% in the first quarter. S&P Credit Market Services international revenue increased 5.8% in the first quarter while international new issue dollar volume declined by 42.9%. Domestic revenue for the credit market services declined by 36.6% while total U.S. dollar volume fell by 55.5%.

We have been charting the decline in the U.S. new issue volume since the structured finance market started falling in 2007. As the orange bars in this slide show, the decline in the fourth quarter of 2007 accelerated in the first quarter of 2008, led by the plunge in U.S. structured finance new issue dollar volume which was down 69.4% in January, 84.7% in February, and 74.8% in March. We saw a similar pattern in the first quarter in the European structured finance market. The downturn hit residential mortgage-backed securities, the commercial mortgage-backed securities, and the collateralized debt obligations. Only the dollar volume issuance of asset-backed securities showed an increase in the first quarter in the United States and Europe. Without one private placement of $29 billion, new issue dollar volume of asset-backed securities in the U.S. would have been down slightly. As a result of the steep decline in the new issue markets, the transaction revenue for S&P Credit Market Services declined by 55.8% in the first quarter.

The outlook for financial services depends, in part, on the depth and duration of the downturn in the structured finance market. There is no question that there eventually will be a pick-up in the structured finance market. It is a question of timing that hinges on when investors believe most risks are transparent and out in the open. This slowdown in the U.S. economy and the tightening of residential mortgage lending standards will impact the level of lending in residential markets. In the commercial mortgage-backed market, cash bond spreads will have to tighten considerably. Forecasting CDO issuance remains difficult. In the asset-backed securities market, the non-mortgage ABS pipeline remains very healthy.

Credit card issuance got off to a strong start in the first quarter. Credit card asset-backed securities have been an attractive form of funding for the banks and we expect that trend to continue as banks try to preserve liquidity. The student loan sector is currently under some pressure. In the corporate market, both here and in Europe, investment grade issuance continues to attract investors. As a result, we have seen corporate treasures increase sales of long-term investment grade bonds for the first time in a decade. A shrinking commercial paper market and Federal Reserve rate cuts have helped the growth of investment grade bonds. A recovery in the high yield market rests clearly on the renewal of investor confidence.

In public finance, new money issuance comprised the bulk of that activity. Slower economic growth and the weakening housing sector will affect state and local governments, and could increase the demand for debt financing. In the past economic slowdowns, we have seen a shift to bonds instead of pay-as-you-go sources. At S&P Investment Services, we will benefit from the growth of our data and information businesses. Capital IQ continues to add new customers and there are now more than 2,300 which is a 24% increase compared to the first quarter last year. Capital IQ continues to upgrade its product line. Earlier this month, its latest release included content for more than 3,500 non-traditional media sources that improved download capabilities and improved charting functionality.

Our index service business is still growing and expanding. We saw more volume and exchange trade derivatives and a 23.1% year-over-year increase in assets under management in exchange traded funds based on S&P indices. Our data and custom index business also grew. In the first quarter, S&P indices were the basis of 13 new exchange-traded funds. There are now 157 exchange-traded funds based on S&P indices, and you can count on the fact there is going to be more. We have a variety of new indices in the pipeline for introduction shortly. Index services among the fastest-growing and most profitable at McGraw-Hill Financial Services.

To wrap up our review of financial service, I will comment briefly on the regulatory and legal outlook. A lot has been written, and even more has been said about the current problems in the financial markets. From the outset, S&P has been working to be a part of that solution. That is why in February of this year, S&P announced 27 leadership actions designed to strengthen the ratings process, increase transparency, and enhance its independence. S&P is focused on four key areas here. The categories are analytics, governance, information, and education. With analytics, it is to ensure that ratings' models, processes and analytical talent continue to be of the highest quality. In governance, to ensure transparency and maintain investor confidence. With information, to provide more insight into the ratings process and greater clarity about the risk that could cause ratings assumptions to change. And with investor education, to help market participants understand what a credit rating is and what it is not.

On April 10, S&P updated the market on the progress it is making in these key areas. These range from adding requirements for additional loan level data from issuers for new RMBS deals to the formation of a risk oversight committee and instituting an analyst rotation program. For a complete update, the best thing to do is to go to a website that we have put together here at www.spnewactions.com. That is www.spnewactions.com for a complete understanding of the 27 leadership actions that we have taken. The senior management team has been active both here and abroad reviewing these initiatives with regulators, legislators, and other policy makers. The response to the S&P initiatives has been very positive. In fact, many of our leadership actions are reflected in some of the recommendations that are beginning to emerge on how credit rating agencies should manage their processes.

This summer, we expect the SEC to report on its ongoing examination of the rating agency. We also expect the SEC to propose some new oversight rules at that time as well. We are committed to helping bring stability and transparency to capital markets, and look forward to continuing our dialog with regulators and policy makers, both here and importantly abroad as well. Based on what we know today, we do not believe any pending legal, governmental, or self-regulatory proceedings will result in a material adverse effect on our financial conditions or on the results of our operations.

So let's sum up for financial services. We expect double-digit growth for S&P Investment Services. Obviously, credit ratings markets faces continued uncertainty, although there are some signs of encouragement and I think in the second half, we will start to see more progress. But if the steep drop that we experienced in the first quarter in structured finance should continue for the rest of the year, revenue at financial services segment would decline 7% to 9% and we would expect a 500 to 600-point contraction in the operating margin. Now I must add that I don't think that is going to happen, but if that steep drop we are experiencing abroad should continue, then those results, I think would be prudent even though it is a very conservative approach to take.

Now let's review our information & media segment. Let me just take a moment here, I've just been informed that -- we understand that some people cannot see the slides. We will be posting the slides immediately after this call on the investor relations website so that you can get them, but I hope you are able to see them. Again, let's review now the information and media segment. Growth in our information product and services again were key to the segment's improved results. In the first quarter, revenue increased 3.2%, operating profit increased 18.6%, and the operating margin improved to 4.8% from 4.2% last year. At the business-to-business group, revenue increased 3.5% to $219.7 million. Our value-added information for global markets is helping to produce the B-to-B growth.

Platts, Platt's news and pricing services for oil, natural gas, and power are all growing as volatile energy markets increase the demand for information. Platts continue to grow faster overseas than in North America by attracting new customers from emerging markets, like the former Soviet Republic and the Middle East. J.D. Power and Associates has also been growing in international markets. Last week, it was reported that China has passed Japan as the world's second largest car market behind the United States. That is good news for J.D. Power and Associates, which began its voice-of-the-customer research in China more than eight years ago. To take advantage of growing opportunities in China, J.D. Power in 2006 acquired Automotive Resources Asia, ARA, a leading source of market information and analysis for the Chinese market.

In 2007, the new capabilities enabled us to win a substantial contract, focusing on sales and service process improvement for the Chinese auto dealers who want to establish a competitive advantage based on superior customer satisfaction. Last week J.D. Power launched Power Circle Ratings on sina.com. That's SINA.com, the most recognized internet brand in China. The Power Circle Ratings are designed to help Chinese consumers make more informed decisions when shopping for new vehicles. To add to J.D. Powers' research capabilities, we acquired in April a company called Umbria ,Inc. This company which has (inaudible) and deriving market intelligence from online community adds an important new dimension to J.D. Powers voice-of-the-customer research.

Advertising is off to a slow start in the first quarter. At BusinessWeek, ad pages for the global edition were down 19.4% in the first quarter, and that's according to the Publishers Information Bureau. Broadcasting revenue of $23.7 million for the first quarter was flat compared to the prior year. Increases in political and local advertising were mostly offset by declines in national time sales. In our TV markets, the outlook for political advertising this year is very promising. In the next eight months, we will see three primary and national elections. Statewide primaries will be held in Indiana on May 6, in California on June 3, and in Colorado on August 12. State and local elections include a governor and a congressional seat in Indiana, the San Diego mayor, and a congressional seat in California, and a U.S. Senate and House race in Colorado.

So summing up for the information media services, more global growth for our information products, a promising outlook for political advertising later here, revenue growth of (inaudible ) percent for the segment, and improvement in operating margins. Okay. That completes the review of the operations and therefore, summing up for the Corporation.

Year-over-year comparisons get easier in the second half in financial services, so we haven't ruled out the possibility of finishing 2008 on an upswing. But again, if the current trends in the financial markets that we have seen in the first quarter of this year should continue for the balance of the year, then we would expect earnings per share in the $2.65 to $2.75-range in 2008. And again, I personally don't think that will take place, but I don't think given the uncertainty, it will make a more conservative posture in doing that. Now let's continue with our review in the financial results from our Chief Financial Officer, Bob Bahash. Bob?

Okay. Thank you, Terry. We have covered a lot of material this morning, so let's just take a moment to sum up the key points in our new guidance for 2008. For McGraw-Hill Education, guidance is unchanged. We continue to expect revenue growth of 6% to 8% and a 50 to 100-basis point decline in the operating margin due to stepped up technology investments and increased pre-publication costs. One additional item I would like to briefly mention is the transfer of our advanced placement courses from higher education to the school education group. These AP courses are taken by high school students for college credit and will now be sold by the sales team that directly serves the high school market. We have provided the reclassification of 2007 revenue by quarter in exhibit 3 of the earnings release. Due to the seasonality of the business, this transfer is not material to the two group's first-quarter revenue, but will be later in the year and as well as for the full-year results.

Guidance for information & media also remains unchanged. We continue to expect 6% to 8% revenue growth and improved margins. We are also maintaining our earlier forecast for double-digit growth at S&P Investment Services. However, as Terry indicated, there is little or no improvement in the financial markets this year. If there is, particularly in the structured finance area, we would expect the financial services segment's revenue to decline by 7% to 9% and the operating margin to be reduced by 500 to 600 basis points. Now if that's the case, our earnings per share in 2008 could range between $2.65 to $2.75 per share. Neither the benefits nor the associated termination costs of the actions, as Terry mentioned earlier, are reflected in this guidance.

Given the scenario of reduced earnings, there is a corresponding impact on our outlook for free cash flow. At first, let's be clear on how we define free cash flow. We start with our after-tax tax cash from operation, course after working capital and deduct investments and dividends. What's left is free cash flow, funds that we can use to repurchase stock, make acquisitions, or pay down debt. We started the year by forecasting free cash flow for 2008 in the range of $850 million to $900 million. Our new estimate for free cash flow this year is approximately $600 million, prior to any acquisitions or share repurchases. This new forecast is driven by reduced profits at financial services and the corresponding impact on working capital. These two factors will be partially mitigated by careful review of new investments in our businesses which I will discuss in a few moments.

Regarding acquisitions, we have spent about $34 million. Two in the first quarter, Malott, an Israeli securities ratings company that now becomes S&P Malott, the licensing rights to S&P/Case-Shiller home price indices, and Umbria in the second quarter, a marketing intelligence company specializing in social media and consumer-generated media research to enhance J.D. Power's voice-of-the-customer studies. Our reduced free cash flow, combined with these acquisitions, has implications for our stock buyback target. As you know, we began the year with 28 million shares remaining in the 2007 program authorized by the board of directors. We targeted 20 million shares for repurchase in 2008. In the first quarter, we repurchased 3.4 billion shares for a total cost of $134 million at an average price of $39.42 per share. With the reduction in available free cash flow, as well as our focus on maintaining net debt levels comparable to year-end 2007, our new target this year will be approximately 15 million shares.

Net debt at the end of the first quarter was $1.2 billion. This reflects the $400-million increase versus year-end 2007 and is driven primarily by seasonal cash requirements in the first quarter, as well as funding for share repurchases. As of March 31 on a gross basis, the total debt is comprised of $1.2 billion of unsecured senior notes and $396.2 million in commercial paper outstanding. This is offset by $396.7 million in cash, which is primarily in foreign holdings. As a result of the lower share repurchase target, we now expect net interest expense in the range of $75 million to $85 million. That is down from our initial forecast of $80 million to $100 million for 2008.

The first quarter of 2008, net interest expense was $18 million compared to only $1.2 million in the same period last year. Now let's look at our diluted weighted average shares outstanding or WASO. For the first quarter, WASO was 323.4 million share, a 38.1 million share decrease compared to the first quarter of 2007, and a 7.4 million share decrease compared to the fourth quarter of 2007. Corporate expenses decreased $1.2 million in the first quarter to $33.9 million versus the same period last year. This is primarily driven by lower incentive compensation accruals as a result of our financial performance. For 2008, we now expect a mid single-digit decrease in corporate expenses versus our previous guidance of a low single-digit increase. This change is driven primarily by reduced incentive compensation as well as stringent expense controls.

I would like to take a few moments to discuss the impact of incentive compensation on McGraw-Hill's first quarter results, as well as a general comment on expenses. The Company's results benefited from decreased incentive compensation, including stock-based compensation. That benefit was most pronounced at S&P, which saw a $40-million decrease year-over-year. If the financial markets don't recover, we would expect the year-over-year decline in incentive compensation expense to continue throughout the year. Although it will not be as significant in the second half of 2008 due to the slowdown that we did experience in the second half of 2007, and then impact of that was the corresponding lower incentive compensation accruals last year.

Regarding expenses, in particular at financial services, we are balancing prudent investments while keeping a watchful eye on costs. That means investing in businesses that are growing, such as index services and Capital IQ, as well as recent acquisitions including I Make and Clarify in 2007 and Malott in early 2008. We are making these investments while also maintaining strict expense controls at credit market services, including decisions related to new hires. As you know, included in the expense category is other income from gains from divestitures. Included in your exhibit, Exhibit 2 reflects revenue by operating segment, costs and expense by operating segment, net profit. So imbedded within the expense categories would be any gains from divestitures or gains from sale of assets.

The first quarter of 2007, as you know, included a gain from the divestiture of the mutual fund data business that Terry mentioned. That was $17.3 million, partially offset by operating expenses for this business prior to the divestiture. Also, expenses for 2008 include costs for the acquisitions that I previously mentioned that were not in 2007. The reported change in expense which is shown on Exhibit 2, is an increase of almost 1%, 0.9%. In order to make the year-over-year comparisons more meaningful, I have adjusted for the net gain in 2007 for the mutual fund data business and acquisition operating costs for 2008. As a result, expenses actually declined in the first quarter of 2008, compared to 2007 by $16 million or 4% versus the reported expense increase of 0.9%.

In addition, we continue to make investments for a number of our growing businesses such as index services, cap like, Hue and CRISIL. But another important measure in to compare expenses in the first quarter of 2008 to the fourth quarter of 2007. The sequential quarter comparison reflects a $70 million or 15.4% decline in expenses from the fourth quarter, and that excludes the restructuring charge taken in the fourth quarter. Lower incentive compensation is certainly a key driver, but not as significant as the Q1 2008 to Q1 2007 comparison as we also reduced incentive compensation in the fourth quarter of 2007. We are benefiting from our focus on expense management, hiring delays and curtailments, as well as the fourth quarter restructuring actions.

I'll now review unearned revenue, which was $1.1 billion at the end of the first quarter and reflects an 11.5% year-over-year increase. Excluding foreign exchange currency gains here, the increase is 9.7%. For 2008, we continue to expect that growth will moderate given the forecast for slower revenue growth. In terms of our effective tax rate, we expect the rate to be 37.5% in 2008, approximately the same rate as 2007 on a full-year basis.

Let's now look at capital expenditures which include pre-publication investments and purchases of property and equipment. In the first quarter, our pre-publication investments were $67 million, compared to $57 million in the same period last year. We were projecting $300 million to $310 million in pre-pub investments for the year. We now expect $290 million for 2008, which reflects prudent investments and continued offshoring efficiencies. Purchases of property and equipment were $24 million in the first quarter, compared to $23 million in the same period last year. For 2008, we now expect lower CapEx, which is projected to be about $160 million for normal replacement expenditures, additional purchases of software and technology equipment for the new data center in the first half of 2008, and continued investments in technology.

Finally now, for some noncash items. Amortization of prepublication costs is $28 million for both years. For 2008, we continue to expect amortization to increase $45 million to $285 million. This is driven by significant pre-publication investments to take advantage of opportunities in the L-high market, which as Terry mentioned, is expected to grow 10 to 15% this year. Depreciation was $27.5 million compared to $29 million in the same period last year. We still expect it to be approximately $125 million in 2008, reflecting the completion of the data center, the purchase of new technology equipment for the data center, and then other increases in capital expenditures.

Finally, amortization of intangibles were $14 million compared to $12 million in the same period last year. For 2008, we expect approximately $52 million. Now, thank you, and back to Terry.

Okay. Thank you, Bob. And again, in a difficult first quarter, we were pleased to do $0.25, especially given the steep decline in the structured finance area. As we said at the beginning of the year, we see that we are going to be impacted in the first half of this year, and especially given the strength of the comparisons from last year. But we do see substantive improvement for the second half. I also again, was given a note that some people were having difficulty seeing the slides. And again, they will be posted on our investor relations website at the conclusion of this meeting. Let me go back now to Don Rubin, head of investor relations.

Thank you, Terry. Just a couple of instructions for our phone participants. (QUESTION-AND-ANSWER INSTRUCTIONS) We are now ready for our first question. Thank you.

Our first question comes from Peter Appert with Goldman Sachs. Your line is open.

Thank you. Terry, two questions please. The investment services unit with 18% revenue gain is quite impressive in the context of the market backdrop. Can you talk a little bit about what is driving that and how important pricing is for that gain? And then, the second question is, just on the indication of potentially more staffing cuts, should we read that to be an indication that maybe the second quarter in particular, is off to a relatively soft start or pace of business maybe has gotten a little bit worse? Thank you.

Okay. Thanks, Peter. First of all, in investment services, as you know, we have been increasingly building on that. On the index services side has been very, very strong, but the overall portfolio services and the equity research side has also shown significant gain. The third part is Capital IQ. Not only are we gaining on customer penetration, you are also starting to see, because of all of the product enhancements and the -- and things like the charting functionality and things like that, that we think that's going to lead to even more revenue enhancement there. As far as, cost containment or any kind of -- that becomes -- Peter obviously, when you have a significant revenue shortfall as we do in the structured finance area, until we start seeing any kind of meaningful pickup in activity, we are going to be very, very tough on those expenses.

I think that, as we have said, from the very beginning, we are going to do it in staged phases. We did the first phase when we first started getting faced with some of these issues in the fourth quarter of last year. We did another phase in the beginning of this year. And I think that what we are examining and what we are looking at now is another phase of this kind of activity. I do believe that in the structured finance area, we are seeing very, very low volumes in the first quarter, very similar to the fourth quarter of last year. I think even though we are starting to see some activity, that the first half of the year will be impacted by that. But if we start to see increased activity on this one, I think the second half is going to be a very different picture, much more positive picture to us, and position us better for 2009. At this point, we will continue to be very, very strict on costs, and you will be seeing more activity associated with that.

How about on the education side specifically, Terry. I think you indicated some more cuts there. What's driving that?

There for the most part is the emphasis on the digital transformation. We are shifting from some of the legacy products to some of the educational services, and some of of the digital product enhancement. We are starting to see more market demand and therefore, we are responding to that part of it. Bob talked about where we are in terms of some of the pre-pub costs. We have been able to cut back on some of those pre-pub costs. At the same time that we are increasing the investment on the digital side. We are pleased by that. We want to see more progress in terms of that transformation.

Great. Thanks, Terry.

Thanks, Peter

Our next question comes from Craig Huber, Lehman Brothers. You may ask your question.

Yes, good morning. A couple of questions. Can you talk a little bit about your recurring fees for the rest of the year? They are up 50% in the first quarter. Do you expect that to be up for the remainder of the year? I am particularly concerned about when you get roughly the fourth quarter this year, when your transaction base was down significantly a year ago. Should we see the recurring fees down at that point? Or no?

Yes. Bob?

Yes. I think, as I pointed out, the unearned revenue, when you think about that growth, it was 11% and after currency was about 9.5%. But as I mentioned, with the slower revenue growth during the course of the year, you will see a corresponding slower growth in revenue from unearned revenue during the course of the year. Those numbers will start to slowly decline, but we are expecting growth, just not at the same pace that we have been experiencing over the past several years.

Just to be clear, even if you take your conservative case of market conditions continuing as they are for the rest of the year, you would still expect your recurring fee, surveillance, annual contract subscriptions to be up year-over-year for the remainder of the year?

Yes, we do because a fair amount of that recurring revenue is coming from the corporate and government side. As you probably know, investment-grade issuance was pretty darn strong in the month of April. Some pretty good G.E. credit went out. You've got Bristol-Myers, you've got Monsanto, a number of big issuers are hitting the marketplace, and that's where we're seeing some of those recurring fees. All be it at a slower growth rate, but nevertheless we are going to be experiencing growth during the course of the year.

Can you give us a sense out of that roughly $200 million that's recurring fees, what rough percentage of that would be surveillance fees?

No, we really can't break it down that finally, but you are really talking about program fees, annual fees. We are talking about general relationship fees, frequent issuer fees. There is a number of different categories that we have within there. We really can't break it down that finally, but there is a number of ways that we characterize it to cover all the various markets. I really couldn't break it down that finally for you.

Yes, but Craig, the other aspect of that is that it is still a significant factor for us. Even though the growth rate will decline a little bit, it will still be at a very healthy rate. As things start to improve I think we will start to see that number go back up as well. But it is still at a very healthy double-digit rate.

My second question, please. What is the average length, in terms of number of years, of the stuff you guys actually rate? Eight to ten years roughly? The average length of stuff you guys rate?

It -- that's an issue that differs by asset class. Let me ask Deven Sharma. Deven, do you want to comment?

In the structured areas, certainly shorter time frames. And in the corporate instruments, it is somewhere between 5 to 8 to 10 years.

Okay. Then my last question, as you guys look out here over the next year or so, what asset class of fixed income would you advise investors to focus on that you think would come back first, the investment grade municipals or the higher grade stuff?

Well -- all right, I better be careful giving investment advice on this one, but certainly at this point, as we were commenting, the attention is really to investment grade at this point. When you start talk about the high yield markets and you start talking about some parts of the structured finance market, it will be a little bit more slow in coming and I think there will be a -- obviously a bias towards quality. You will see more plain vanilla issuance from that standpoint. But clearly, there is a bias to quality that this point.

I think that in terms of activity, we are seeing still a very healthy asset-backed market, both in terms of credit card receivables and in terms of some of the auto loans area. Also, I would look to the commercial mortgage-backed market to come back a little bit quicker on this. Right now, what you are seeing is some of those deals being done through levered loans, but I think you will see more activity from that standpoint. Also in terms of the municipal market, that you will see a healthier situation there. Overall, I think what we are seeing is obviously the credit crunch is having its effect. It is contained in the structured finance market. As that starts to unwind, you are going to start to see improvement. We are looking into the second half of this year to start to see some of that.

Terry, if I could add to that. April is a very, very busy month for investment grade. Just to give you an example, GE did a three-traunched deal, $8.5 billion. Oracle, a $5 billion, three-traunched deal. $4 billion, three-traunched transaction from Verizon. Bristol-Myers just this week, a $600-million transaction. Same with Monsanto. We are seeing a fair amount of really key activity, as rates are where they are, from very significant investment-grade properties, as the spreads to treasuries are starting to come in. Hopefully, that will bode well for the balance of the year.

Great. Thank you.

Thanks, Craig.

Our next question comes from Barton Crockett, J.P. Morgan. You may ask your question.

Okay. Great. Thanks for taking my question. I wanted to zero in a little bit more on -- the trend that you are seeing in the financial services top line. You had given kind of a range of revenue. I mean we saw the 12% or so decline in the first quarter and you are saying 7% to 9% decline for the year. Can you give us a sense of whether the second quarter is pacing within that range or outside of it, the up side or the down side, in terms of the aggregate top line that you see right now?

I am sorry, Barton, I didn't get all of your question. But in terms of the revenue for the second quarter, again, we are not looking at -- we don't forecast quarterly performance. But clearly, what we want to see is continued improvement in some of the categories of structure. Commercial, mortgage-backed is still soft. Residential mortgage-backed obviously, is dormant right now. But the asset-backed area is showing signs of improvement and we want to continue to see that side of it. As Bob was saying, that corporates and government side is showing a healthy increase in terms of corporate treasures starting to finance more in terms of long bonds versus commercial paper or other kinds of issues. The second quarter is going to be still affected by the current conditions that we are facing here, but through very strong product diversity, geographic expansion, and cost containment, we will be hopeful that we will be able to have a stable position on that. The second half is where we are going to start to see, hopefully, the improvement.

Okay. And then I think everybody would agree that your businesses is obviously, cyclical issues but a lot of this will come back as the market normalizes. But some portions of it may not come back or may come back at levels, nothing like what we saw before. Can you give us your take on where you would see that what portion of the issuance market and how large you might size the portion of that market that may not come back? I am thinking about some of the more exotic structure finance products or maybe residential mortgage-backed securities where the agencies have raised the conforming loan limits.

Yes. I think that clearly, the structured finance market is going to come back more gradually. Again, you are going to see more of a flight to quality. You are going to see less of an appetite for high yield or a high risk kind of instrument. Again, as confidence comes back into the market, we will see that increase. Do I believe that we will get back to levels that we saw in the past? I think, yes. I mean, because I believe that the securitization process is a fundamental driver in the investment community. And institutional investors love that product and they have so much mobility with that product in terms of all the things that they can do with it. It will come back. It is just going to take a little time to restore the confidence and trust in the system, and to understand and make sure that people understand the risks associated with that kind of product. It is really a timing question.

Okay, great. I will leave it there. Thanks a lot

Your next question comes from Catriona Fallon with Citi. Your line is open.

Yes, good morning. Could you give us an update on where you are on the announced headcount reductions from early January? So what was the change in headcount for the quarter?

Okay. Deven, do you want --

We have completed our headcount reduction in financial services that we had announced in December. And Bob and Terry for education, and --

The education and corporate areas had also announced some downsizings, have all been completed as well. I think in all categories, though, individuals remained under peril during a portion of the first quarter. We will really start to see the benefits come more dramatically in the second quarter and beyond.

And again, one of the things that we have done is we talked about stage, and three stages. The first one was that once we saw the situation, we did go into a hiring freeze. Then we announced the restructuring charge for the second stage relative to the lack of activity. Given the first quarter and steep decline in structured finance equal to what we saw in the fourth quarter, we are examining, another stage at this point. But we want to be very measured, relative to the activity levels. As we start to see things start to improve, we want to be measured in terms of how we respond to that. Again, when we especially talked about the structured finance area, these are very, very talented people. Therefore in terms of making some of those kind of cuts, you want to be very measured in doing that, but we are examining now another component of that. But you also want to make sure that, in terms of the ongoing business that you have in the surveillance area, that your staff is able to do that. But we are examining another stage.

Okay, great. And then, just quickly on the education business. It seems that your competitor, Pearson, is looking for a lower growth rate in the elementary, high school area. Can you help us understand what gives you more confidence that this growth is actually higher than kind of the low single-digits for that category?

Well, there are two areas here. In the L-high area you have got both the adoption market and you have got the open territory market. You also have major states in play with California, Texas, and Florida. You have got significant opportunities there. You also have a significant increase in the state adoption monies, 10 to 15%. We are looking at $900 to $950 million there, and we fully expect to take share here.

In the open territory, we have been very conservative in saying that after the last two years, the numbers are -- we are saying 1% to 2% because one, we don't know, and secondly, it is almost untenable that you won't see growth in these markets. Some of these states are already behind. Given the fact that education is a priority in all of these states and the funding level seems to be very healthy, we would expect to see open territory growth here as well. From our standpoint, the 6% to 8% growth for the segment reflects a pretty good situation for the L-high market, but also for the higher-end market as well.

Okay. Just quickly. On the guidance, it seems that that's assuming essentially the market that we were experiencing at the end of March. And since then, we have seen CMBS spreads come in. We have seen agency spreads and corporate spreads also come in, and you have made some comments that corporate activity is already up in April. Do you you think that from what you have seen in the month of April that you are more than likely to come in above that guidance even if structured finance is down? Some of the other categories are already seeing strength.

Well, yes. Again, we are still in a soft period, and it is very uncertain. What we tried to do with giving some guidance was to put some boundaries here. If the first-quarter activity levels, like the fourth-quarter levels, continue, then the forecasted down 7% to 9% of financial services and 500 basis points or so in margin, would be probably more appropriate. I personally don't think that that is going to happen, but what I think doesn't matter. We need to see some of the activity level.

We are starting to get a little encouraged by some of the things that we are seeing. But I would say overall, that even though the corporates and governance area is showing some really good upside that Bob was talking about, in terms of treasures going into investment-grade long-term quality on that part. That's there. I think the structured finance market is going to be a gradual recovery on that part. But we are seeing some upside, and we will keep giving you the best guidance we have got as we go. I do think the second half is going to be a much different situation than the first half of this year.

Thank you so much.

Thanks.

Your next question comes from Michael Meltz, Bear Stearns. You may ask your question.

Thank you. Two questions and then a follow-up. Bob, can you give us at financial services, what was the contribution from acquisitions on the top line in the quarter? And then on your -- I guess quasi guidance for segment margin for the year, the down 500 to 600 basis points, what are you using as the '07 number? Because it was -- it had a divestiture and it had a charge in there for '07. I want to make sure I have the right reference point and then I have a follow-up.

Let's talk first with the impact of the acquisition revenue on the first quarter. It was relatively small. It is about roughly 7/10 of 1%. More importantly, I think the impact on currency benefited the financial services segment by about 1.4 percentage points as well.

Okay. Okay. Then that margin? Year-ago margin?

Now, could you repeat that again please?

What are you using as the margin in '07 that you think it could go down to -- down 500 to 600 basis points from in '08?

In financial services?

Yes.

Okay. 44.7%.

Okay. You made -- my question is now on the cost side, it would seem -- if I run that through, it would seem you are modeling costs up low single-digits at financial services in '08. Which I say flattish to up low single-digits which would seem kind of odd given what you did in the first quarter and you are talking about additional benefit coming forward and perhaps some more cost takeouts. Is there some seasonality there? Is there another factor? If I just take the run rate for the quarter, it is well below that number.

Yes. The quarter benefited significantly from lower incentive compensation. Now, there are two drivers there. First is the short-term incentive compensation that is based on the current year performance, and there is another element relating to our three-year long-term incentive, which based on the forecast that we are going with, we have just adjusted those as well. There are two significant adjustments making up that $40 million, affecting the financial services segment in the quarter. Now last year 2007, we started to make adjustments to the incentive compensation accruals in the third quarter and in the fourth quarter last year. You may recall first and second quarters were very strong. We had built our incentive accruals based on an expectation that the year was going to continue going that way. As it started to decline, we pulled back incentive accruals a bit in the third quarter as well as in the fourth quarter. When you look at the lower incentive, just using that as a basis, the run rate will be at a lower rate going forward.

In addition, there are some other significant parts of the business that Terry mentioned. While we look at Capital IQ, the data and information side, equity research, we look at our acquisitions that the acquisition of a few years ago, CRISIL and growth rates we are seeing in CRISIL, as well as the acquisitions we have made this year. We are making investments in those businesses, we are adding people to those businesses to drive that top-line double-digit revenue growth that we are forecasting. We are looking at a blended rate in terms of the overimpact on expense. Clearly as Terry pointed out and Deven pointed out, we are focusing very strongly on being sure that we have right-sized the credit market services business, based on the environment that we are in, as well as making certain that we have the appropriate talent in-house to do the appropriate levels of surveillance that is necessary to meet market needs. Hopefully, that gives you an idea or flavor, where we are going.

Yes. Mike, I will only add to that how important the global side of this is. Again, both in terms of the Asian markets, as well as the parts of the European and -- those are very important. We are very excited about the operations out of Dubai and the work we are doing there. These will increasingly be very, very important areas as both China and India, the Middle East, and also the African markets. Right now in South Africa, but also in terms of some of the urbanization and the infrastructure development there as well.

Yes, yes. One last question from me. Can you -- I know it is not a simple question, but can you give us some type of bridge to get from your prior free cash flow guidance to the new $600 million number? I guess I am just struggling to see how the number got -- the components of that decline. Bob, is there any way you can walk us through that?

Yes. I will do it in general terms, not to be very specific. But first of all, it is our projection of the impact of the $2.65 and $2.75. What that does to our lower overall net income. Also there is the -- a couple of items that influence our cash. As an example with regard to our data center, we had accrued certain construction costs at the end of the year 2007, but we made payments of about $30 million associated with that this year. Also our profit-sharing contribution, we shifted the payment into the first -- into January of 2008 for 2007. We had not done that in previous years. We had an opportunity to do that, so we did do that.

Also, we have basic payments for the incentive compensation for 2007. Those payments need to be made by March roughly of 2008. We don't have the corresponding accruals built for this particular year. That gives you a general idea, but that generally walks down from the $900 million to the $600 million.

That's very helpful. Okay. Thank you.

We will now take our final question from Edward Atorino, Benchmark. You may ask your question.

I will pass. It has been asked. Thanks.

Thanks, Ed. Again in terms of the slides, for those people who were not able to see the slides, there are they are now available on the investor relations website for downloading on that one. Again, thank you for attending and thank you.

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