標普全球 (SPGI) 2009 Q2 法說會逐字稿

Good morning. Welcome to the McGraw-Hill Companies second quarter 2009 earnings call. I would like to inform you that the call is being recorded for broadcast, and that all participants are in a listen-only mode. We will open the conference to questions and answers after the presentation, and instructions will follow at that time.

To access the webcast and slides, go to www.mcgraw-hill.com, and click on the link for the earnings announcement conference call. At the bottom of the webcast page are three links. Click on Windows or Real Media if you want to access the slides and audio on your computer. If you only want to view the slides, and plan to remain on the telephone, click the third link with the telephone icon. (Operator Instructions).

I would now like to introduce Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. Sir, you may begin.

Thank you. Good morning to our worldwide audience. Thanks everyone for joining this morning for the McGraw-Hill Companies second quarter earnings call. I am Donald Rubin, Senior Vice President, Investor Relations at the McGraw-Hill Companies. With me this morning are Harold McGraw, III, Chairman, President, and CEO, and Robert Bahash, Executive Vice President and Chief Financial Officer.

This morning, the Company issued a news release with second quarter results. We trust you have all had a chance to review the release. If you need a copy of it, and financial schedules that can be downloaded at www.mcgraw-hill.com. Once again, that is www.mcgraw-hill.com.

Before we begin, 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 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-Ks, 10-Qs, and other periodic reports filed with the US Securities and Exchange Commission.

We are aware that we do have some media representatives with us on the call, however this call is for investors, so 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 updates will last approximately an hour. After our presentation, the meeting will be open to questions.

I am pleased now to introduce the Chairman, President and CEO of the McGraw-Hill Companies, Terry McGraw.

Thank you very much, Don. Good morning everyone. Thank you for joining us this morning. Welcome to our review of the second quarter earnings, and our outlook for the remainder of 2009. With me today besides Don is Bob Bahash, Executive Vice President and Chief Financial Officer. I will be starting off by reviewing our operating results, and Bob will provide in-depth outlook on our key financials. Of course as Don said, after our presentation, we will go in any direction that anybody would like to go with questions or comments.

Earlier today, we reported our second quarter results. Earnings per diluted share were $0.52, and that included $0.06 for a net restructuring charge, which was $0.03, and a loss on a divestiture, which was also $0.03 for the earnings, and revenue in the second quarter decreased 12.4% to 1.5 billion. At this point in the year, we still see challenges in the school marketplace as state budget pressures persist, but there are also signs that the economic activity has begun to recover. An improving flow of credit is helping to lay the groundwork for recovery.

In financial markets, spreads are narrowing, and should continue to tighten. Money managers and insurance companies are putting more money to work, and there is reviewed investor interest in the non-financial investment grade bonds, and even speculative grade instruments as well.

In the second quarter, we took some important steps to prepare for the future. First, we took a $0.03 restructuring charge for a workforce reduction of approximately 550 positions, about 2.5% of the total workforce. A key step in this restructuring was a reduction of approximately 340 positions at McGraw-Hill Education, as we combined our supplemental and basal operations. I will discuss this in a little more detail in a little bit. Secondly, we sold Vista Research, and that resulted in a pretax loss of $13.8 million, or $0.03 per diluted share. Thirdly, we announced that we are exploring strategic options for Business Week.

The take away is clear. In preparing for the future, this management team will continue to align resources with the Company's strategic outlook, and growth opportunities in the market. And with that as background, let's take a look at our segments and how they performed, and the prospects for the rest of the year, and how we are looking at 2010 in each of these markets as well.

For McGraw-Hill Education, this year is a tale of two markets. First is the declining sales and the elementary/high school market. The second one is the sustained growth in the US college and university market. Both trends were evident in the segment's second quarter performance, and undoubtedly will be factors in our second half results.

For the segment in the second quarter, revenue declined 17.2% reflecting a 22.7% falloff for the McGraw-Hill School Education Group, and a 6.9% decline for the McGraw-Hill Higher Education, Professional, and International group. Including a net pretax restructuring charge of $11.6 million, operating profit declined by 70.1%. The operating margin was 3.8%.

By now, everyone has probably heard about the challenges in this year's Elementary/High School market. State budgets for education are under pressure. There are substantial cutbacks in historic buying levels in the adoption states. Federal Stimulus funds are still trickling into the market, and with the sales opportunities shrinking this year in Florida and California, we are reducing our estimate for the 2009 state new adoption market to $500 million to $550 million.

Our new estimate includes some modest benefits from the Federal Stimulus funds that we have been able to identify. We had been originally forecasting $550 million to $600 million. Federal Stimulus funds are still the wild card in this year's market. Without the benefit of Stimulus funds, we still expect the el-hi market to decline by 15 to 20% this year. We don't expect more state level postponements, but there could be additional school district postponements in economically stressed states like California.

Although, the rate of purchasing is much lower than originally forecast, we expect to capture available business across a range of subjects. We should perform well in the following state new adoptions. Reading in California and Louisiana. Math in California, South Carolina, Kentucky, and Oregon. Science in Tennessee, Social Studies in Indiana. We now estimate a capture rate of 30% of the total available dollars in the state new adoption market for this year.

In Testing, our formative assessment program, we call it Acuity, continues to win new adoptions and renewals. These gains were offset by declines in custom and off-the-shelf products. The revenue outlook in higher education is very different. The US college and university market is off to a very strong start this year, and so are we.

As a result, we are increasing our forecast for the market in 2009. We now expect the US college market to grow between 5 and 7%. Previously, we had forecasted growth of 3 to 4%. We have a solid new publications list for all four imprints, successful new digital offerings, and the benefits of higher enrollments last fall, and again this spring. There are indications that enrollments will grow again in this semester, and that starts in the fall. But because of the softness in the el-hi market, we are reducing our revenue guidance for the segment. Previously we had a forecast of a decrease of 7 to 8% in 2009. We now expect the segment revenue in 2009 to decline by 8.5 to 9.5%.

Under the circumstances, some are starting to question prospects for education in 2010. We expect the outlook for education to improve for several reasons. One, the comparisons will get easier. Another is that the benefits of our recent restructuring will be realized. We also expect to operate more efficiently, and lower development costs. A growing lineup of digital products will produce more growth. Federal Stimulus funds will make a difference. The state new adoption calendar improves in 2010, and there will be more students, enrollments are still growing.

Let's look now at how these reasons are compelling to the market, and let's look at them in a little bit more detail. The first one would be comparisons will get easier. Revenue for McGraw-Hill School Education Group is off by 20.1% for the first half, and while we expect the rate of decline to diminish in the second half, there is no doubt we will be cycling against easier comparisons in 2010.

Second, we will begin to see the benefits of the restructuring of our elementary high school business in the second half, with more to be realized in 2010. We recently announced the combination of our basal and supplemental school operations, in a new streamlined Pre-K to 12 organization. As a result, we took a net restructuring charge of $11.6 million for this segment, as approximately 340 positions were eliminated.

Third, lowering development costs and reducing time to market are key objectives for the new organization. By increasing our focus on growth areas, such as intervention and college and career readiness, and by streamlining our product creation in four learning solution centers, we are improving our operating efficiencies and revenue potential.

Fourth, the integration of content, technology, and distribution, offers significant opportunities for growth. We will be increasingly digital in the school market in testing, in higher education, and in the professional markets. To create the same digital environment in the elementary and secondary classroom, that is emerging outside the school, we recently created the McGraw-Hill Education Center for Digital Innovation, and we did this out in Bothell, Washington. It is focused on developing digital platforms. It is why we could introduce CINCH mathematics, an all-digital curriculum that combines online capabilities with the power of interactive White Boards.

In Testing, we just introduced Acuity UnWired, a version of our formative assessment system, that permits students to respond by using wireless hand-held devices. By the way, Acuity recently won the prestigious CODiE Award from the Educational Software Association for the 'Best Student Assessment System.' Online study tools are rapidly gaining traction in the college and the university market, as we find new ways to incorporate the printed page into our dynamic online learning environment.

Fifth, the potential impact of the Federal Stimulus package remains difficult to gauge at this time, but the Title I funds for schools serving disadvantaged students, and the IDA funds for Special Education programs, could make a meaningful difference in some states. Some product categories in the second half. There are a total of $25.2 billion available for Title I and IDEA Special Education funds in the system.

Federal Stimulus money is moving into the states, but with few exceptions, it is moving very slowly into districts. As of July 24, 44 states, the District of Columbia, and Puerto Rico have been approved for about $29 billion in funding. Six states have applications pending. It is widely expected that the first wave of stabilization funding would be used by state and districts, to cover shortfalls and save teaching jobs in 2009, rather than to initiate new purchases.

We expect to have a solid list of Stimulus-funded adoptions to report at the end of the third quarter. We also expect to see some fourth quarter sales activity as well. The Administration's focus on realtime assessments and multiple measures, combined with Stimulus money, and state and local interest and formative assessments, will also provide new opportunities for Acuity. Undoubtedly, the Stimulus package will have greater impact in 2010 than in 2009 on the elementary/high school market.

Also, don't overlook the fact that Federal Stimulus package contains several provisions, with positive implications for post-secondary education. That includes increases in the maximum Pell grants, and increased support for work study programs.

Sixth, we still expect to see an improved state new adoption calendar for next year. We currently estimate approximately $950 million to $1 billion for state new adoptions in 2010. The market should benefit from the increased availability of Stimulus funds, the implementation of 2009 postponements in 2010, and the return of Texas to the market for K-12 Reading, literature, and that adoption. That program has already been funded by the Texas state legislature. The opportunity in Florida for K-12 math in 2010 also looks solid. The state needs new textbooks, so math can be taught according to the newly revised state standards.

Seven. Enrollments are growing across the entire Pre-K to 16 student population. According to the latest projections from the National Center for Education Statistics, by the way that is a very good web site to monitor. According to the latest projections from the National Center for Education Statistics, there will be 56.4 million students enrolled in elementary and secondary institutions next year, and 18.6 million in US higher education.

So summing up for the segment, before the benefits of the Federal Stimulus package, 15 to 20% decline in the el-hi market, 5 to 7% increase in the US college and university market, and for the segment in 2009, 8.5 to 9.5% decline in revenue, 300 to 400 basis point decline in the operating margin. That is excluding the 2008-2009 restructuring charges, and implies an operating margin of 9 to 10%. All right.

Let's move to the McGraw-Hill Financial Services segment. In Financial Services, growth in the industrial sector here and abroad, another decline in structured finance, and some softness in the indexed services were important factors in the second quarter performance. For the segment in the second quarter, revenue was off 8.4%, and that is reflecting a 9.9% decline at the S&P Credit Market Services, and a 4.9% decline at S&P Investment Services.

Including a pretax loss of $13.8 million from the divestiture of Vista Research, and a pretax net benefit of $400 [thousand] (corrected by company after the call) from restructuring charges, operating profit declined by 8.8%. The operating margin was 41%. Two things are not immediately apparent from these results. First, comparisons were especially challenging, because the second quarter in 2008 was the biggest revenue and profit producer last year for Financial Services. And second, there were signs of a thaw in the credit markets in this year's second quarter.

One of the keys to thawing the credit markets, has been the ability of the banks in the second quarter, to issue debt without government guarantees. In the first quarter, guaranteed debt accounted for more than 80% of the financial sector issuance. It has now fallen to less than 50%. As the capital base of banks improves, there is a renewed ability to attract capital from the private sector.

Liquidity has also improved. One sign is the bank's decreasing demand for short-term funding from Federal programs. The sharp drop in LIBOR, indicates that banks are more comfortable getting funds from each other. The spread, and this is important, the spread between the three-month LIBOR and the Fed's overnight rate, a gauge of how banks assess the riskiness of lending to one another, is down to approximately 0.4%.

There is a greater willingness of investors to take on some risks. That trend undoubtedly contribute to the 82.6% increase in US speculative grade issuance in the second quarter. Much of the issuance was used to refinance bonds and loans. There remains a significant need for speculative grade companies to raise cash, especially those looking to shift debt, from short-term loans into longer term maturities.

We also saw an increase in dollar volume issuance in the industrial sector in the second quarter, and it was up 2.1% in the US, and 34.8% in Europe. Issuance has risen because issuers turned to the public markets, to avoid refinancing risks over the next 18 months. At the same time, low short-term interest rates, and an aversion to equity and structured finance risk, had channeled investors toward industrial bonds.

Even though the structured finance market declined again in the United States and in Europe, the impact of the corporate activity on S&P's credit market services transition revenue was significant. In the second quarter, we saw a 31.6% sequential increase in transaction revenue. Compared to the biggest quarter of 2008, transaction revenue was down year-over-year by 21.6%.

The outlook for structured finance for the rest of the year remains uncertain. The US residential mortgage backed securities market has benefited in the short term, from increase RE-REMIC issuance. But the longer term outlook for this market and the European Residential Mortgage Backed securities market, is dependent upon a recovery in the housing market.

The majority of the European structured finance transaction revenue, continues to be derived from the government and central bank liquidity programs. In both Europe and the United States, the markets for the commercial mortgage-backed securities and the collateralized debt obligations, continued to experience very little issuance, and very low trading volume in the secondary markets.

The TALF program has stimulated new activity in the asset backed securities market, but year-over-year new issuance declined by 25.8% in the second quarter of 2009. Since the beginning of this year, there has been a substantial tightening of spreads in three important consumer asset classes. Certainly autos, credit cards, and student loans. And we anticipate further recovery in the asset-backed securities sector, an important factor for '09, but also as we go into 2010.

The new activity in the bond market is encouraging. A continuation of this trend will favorably impact transaction revenue in the second half, as our year-over-year comparisons obviously get much easier. As a result, we are changing our forecast for transaction revenue for the year. We had expected a 10 to 12% decline in transaction revenue in 2009. We now expect a mid-single digit decline in transaction revenue for the year, a very encouraging and very good sign.

Nontransaction revenue was off 3.1% in the second quarter. The primary reason was a reduction in fees earned for work on canceled transactions, or breakup fees, breakage fees, and the impact of foreign exchange. Nontransaction revenue is derived from annual contracts, surveillance fees, and subscription services, and produced a 67.9% of Standard & Poor's Credit Market Services revenue in the second quarter.

Unlike transaction revenue, nontransactions are a resilient source of revenue. For the first half of 2009, nontransaction revenue represented 69.6% of S&P Credit Market Services total revenue. We still expect only a slight decline for the year in nontransactional revenue, primarily because of less breakage fees in 2009 versus 2008, and again the impact of foreign exchange. International revenue at S&P Credit Market Services declined by $24 million in the second quarter, but $21 million of that decrease can be attributed to foreign exchange rates.

Rates moved strongly in the second half of 2008, so they probably will be less of a factor in the upcoming 2009 comparisons. For the year, we continue to expect low-single digit revenue decline in S&P Credit Market Services in 2009. The near term outlook is somewhat mixed for S&P Investment Services.

Revenue declined 4.9% in the second quarter, and we now expect a low single-digit decrease for the year. The sale of Vista Research in May is a contributing factor. At the end of July, the settlement contracts with the investment banks expire for our equity research products. There are currently nine firms purchasing independent research from S&P. The good news is that we are going to retain some of these clients, and we are negotiating with these firms. Some will continue stock coverage, and purchase other products as well. We have already signed a new agreement with Citibank, and more are in the works.

Indexed Services experienced a decline in the second quarter primarily driven by a reduction in asset-based fees from exchange traded funds, and a drop in over-the-counter derivatives trading, all linked to various S&P indices. Assets under management and exchange traded funds based on S&P indices fell by 8% to $189.8 billion at the end of the second quarter, versus the same period last year.

As the market rebounds, we also saw a sequential improvement over the first quarter which had ended at $158.6 billion. We did see an increased purchasing of our data and growth in the custom index business as well. 11 new exchange traded funds based on S&P indices were launched in the second quarter. There are now a total of 209 exchange traded funds based on S&P indices. We have more indices in the pipeline, to help our clients accumulate assets.

Capital IQ continues to attract new clients, finishing the second quarter with more than 2,800, an increase of 5.2% since the end of 2008. Capital IQ is continuing to expand overseas, and benefit from international growth in the second quarter.

Let's spend now a few minutes on the regulatory outlook for credit rating agencies. In the United States, we are working with the Securities and Exchange Commission, the White House, the Treasury Department, and the Congress on proposed new legislation. In Europe, we are working with CESR, these are the security regulators. The European Commission, IOSCO, as well as others. We will continue to work with IOSCO, and are reaching out to regulators and policymakers in Japan, Australia, and Canada. In short, we are touching all of the bases, as we work for globally consistent oversight, analytical independence, and a level playing field for everyone.

A lot has changed at Standard & Poor's, especially on the credit rating side. This is in the last two years. And we were using all of the means at our disposal, to convey how our internal initiatives complement proposed new regulations, both here and abroad. We are focused on measures in four key areas. Obviously, quality, secondly, prevention of conflicts, three, increased transparency, and four, accountability. We continue to work in all four areas and communicate our commitment to improvement to policymakers, legislators, regulators, to help restore confidence in the credit markets.

The latest effort in our global outreach was an ad on Standard & Poor's commitment to reform. It ran in 'The Financial Times,' 'The Wall Street Journal,' 'The New York Times,' 'The Washington Post' and others. You can find the full text of that comment at www.standardandpoors.com. Which addresses the changes S&P has made in it's business in the last two years.

The timeline on the regulatory framework remains fluid. In the United States, we hope the legislative process will be completed by the end of the year, but depending on, obviously Congressional priorities, it may not be finished until 2010, but we really believe it is a 2009 action. In Europe, we expect the new European Union legislation on credit rating agencies to be formally adopted this fall. The effective date for rating agencies to be in compliance is expected to be by mid-2010, and we will be ahead of that, in terms of initiatives.

In this period, we will continue to deal with the issues as they arise. There is, for example, the misleading notion that S&P Credit Market Services not change it's practice, in light of recent market difficulties. It is not subject to meaningful regulatory oversight. The fact that S&P Credit Market Services is a now a highly regulated business, doesn't seem to get much recognition from these critics.

The new regulations were recently described in the press as mostly 'innocuous.' An observation that fails to appreciate the depth and breadth of the regulatory scheme under which we operate. The Credit Rating Agency Reform Act of 2006 gave the SEC a significant amount of regulatory authority, and I can assure you that it is being exercised vigorously, and on a regular basis.

Earlier this year, new wide-ranging SEC rules took effect. They include measures related to disclosure, and management of potential conflicts related to the issuer pay model, a ban an certain conduct involving gifts and fee discussions with analysts, increased recordkeeping requirements for material deviations, a sign from model outputs, and complaints about analyst performance, just to name a few. More new rules will be coming, and that is according to the SEC. And in short it is quite clear that S&P Credit Market Services is, and I can assure you will continue to be, subject to robust regulatory oversight, and we will work with that.

Accountability is another issue. In addition to our daily accountability to the market, which is the most important check on our rating business, we are accountable to the SEC, and subject to private litigation. Like all other participants in the financial markets, we can be sued for securities fraud. While courts have recognized that ratings opinions' are entitled to First Amendment protection against certain claims, it is important to state clearly that the First Amendment provides no exemption from potential liability for intentionally misleading or defrauding investors. That fundamental legal point, seems to have alluded some of our critics. We have approximately three dozen lawsuits from plaintiffs and their counsels, who clearly think they have stated causes of action against S&P, notwithstanding the First Amendment.

On the litigation front, the newest lawsuit was filed by Calpers, and has gained a fair bit of attention. Calpers says it purchased without due diligence, $1.3 billion of securities based solely on ratings opinions issued by S&P, Moody's, and Fitch. And that is notwithstanding our clear and long standing public disclosure, that a rating is not a recommendation to buy, to sell, or hold. Some in the media have expressed surprise that a sophisticated institutional investor like Calpers, would make such a significant investment decision like this, without conducting it's own firsthand analysis. We think the lawsuit is totally without merit, and we intend to defend against it vigorously.

Summing up then for the Financial Services for 2009, a slight decline in revenue. Margin decline at 225 to 275 basis points, excluding 2008 and 2009 restructuring charges, and the loss on Vista. Low single-digit growth and expenses, implied operating margin of approximately 39%.

And finally now, let's take a look at the Information and Media Segment. The continuing weakness in the advertising market was a key factor in the performance of this segment. For the second quarter, revenue declined 11.5%, reflecting a 23.1% decrease at broadcasting, and a 10.2% falloff in the Business-to-Business group. Including a pretax charge of $4 million, the operating profit declined by 41.8%, and the operating margin was 6.1%.

In broadcasting, we experienced declines in national and local time sales, softness in auto advertising was clearly a contributor to this picture. The absence of political advertising after last year's strong performance is obviously a factor in 2009, in comparison to 2008. Print advertising is also soft across the board in the Business-to-Business group. That includes our publications in the construction and aviation markets, as well as BusinessWeek. Advertising pages in BusinessWeek's global edition were off 34.3% in the second quarter, and that is according to the Publisher's Information Bureau, PIB.

During the second quarter, oil prices have more than doubled, since hitting a low of $33.98 a barrel on February 12. That volatility also contributes to the strong performance of Platts, our global energy information service. Platts is growing in the petroleum, natural gas, nuclear, and the metal markets.

Summing up then for Information and Media. In view of continued weakness in advertising, we are reducing revenue guidance, we now expect a decline of 8 to 9%. Previously, the forecast called for decrease of 5 to 6%, and a 300 to 400 basis point decline in the operating margin, excluding the 2008 and 2009 restructuring charges. Therefore, finally summing up for the corporation, a revenue decline of 5.5 to 6.5% for the year, excluding the second quarter restructuring charge and divestiture of Vista, our guidance for 2009 earnings per share of $2.20 to $2.25, although it appears that we will come in at the low end of the range on that one.

But have I to say that our prospects on the second half begin to appear much more promising, especially on the education front, and in terms of some of the improvement on the financial service side. So we will see as we go. That wraps up the review of the operations, especially for the second quarter, for the remainder of the year.

As we are starting to look at 2010, let's hear now from Bob Bahash, our Chief Financial Officer on the financial results. Bob?

Thanks, Terry. The key to the year is our second half performance. So I want to focus this morning on factors that will influence results during this crucial period. The obvious one, of course, is the seasonality of our education business, which makes the third quarter the biggest earnings contributor each year. But there are other influences that will be important as well.

If you do the math, on our full-year revenue guidance, and I am sure you will, it will be apparent that we expect the rate of decline we saw in our revenue in the first half, it was up 9.6%, to diminish in the second half. This is also true for expenses. In the first half, they are down 7.1%. For the full year, excluding restructuring charges in 2008 and 2009, and the loss on the divestiture of Vista in 2009, we expect consolidated expenses to decline in the low single-digit range, implying minimal growth in expenses in the second half.

Now let's review some other factors that influenced the first half performance, and expectations for the second half, including restructuring, the impact of foreign exchange on revenue and expense, and incentive compensation. In doing so I hope three things become clear. First, we have been able to mitigate the revenue decline in the first half, through stringent expense controls, and we are not going to let up in the second half. Second, the Company's financial position is strong, and will remain so. Third, the actions we have taken leave us well-positioned when economic conditions improve.

In the second quarter, we took a restructuring charge of $24.3 million, relating to the reduction of approximately 550 positions. This is partially offset by a reversal of $9.1 million, related to prior restructuring initiatives, resulting in a net charge of $15.2 million pretax, or approximately $0.03 per diluted share of second quarter earnings.

The majority of the restructuring charge related to our decision to combine our core basal publishing operations with our alternative basal and supplemental publishing operations. Due to the timing of the actions as well as the implementation costs, the costs of benefits of this combination will largely be realized in 2010. The reversal of $9.1 million related to prior restructuring initiatives is primarily due to two factors. One, instances where we eliminated the position, but were able to place affected employees in open positions within some of our faster growing businesses. And two, lower than anticipated severance payments.

This was most pronounced at some of our international locations. Country rules vary significantly making estimating international severance a little challenging. Our estimates turned out to be conservative. Foreign exchange will be a factor in our results of the year. In the first and secretary quarters, foreign exchange significantly reduced revenue. It reduced second quarter revenue by $37.2 million, increasing the revenue decline by 220 basis points.

In the first half, foreign exchange reduced revenue by $74.6 million, increasing the revenue decline here by 260 basis points. Based on current rates, we anticipate the impact on revenue to lessen in the second half. Foreign exchange reduced segment expenses by $32.4 million in the second quarter, and by $82 million in the first half. Excluding restructuring charges in 2008 and 2009, and the loss on the divestiture of Vista, segment expenses would have declined 7.6% in the second quarter at constant currencies, versus the reported 10.1% decline.

Year-to-date expenses would have declined 3.8%, versus the reported 7.4% decline. Based on current rates, we expect the impact on foreign exchange on expenses to lessen in the second half. In the first half, the impact to operating profit from foreign exchange was a benefit of $7.3 million. These different top and bottom line outcomes occurred because we primarily bill in Euros and US dollars, while significant expenses are denominated in currencies such as the British pound, which has significantly weakened compared to the US dollar.

Changing levels of incentive compensation were a factor in the first half, and will be even more significant in the second half. In the second quarter, we benefited from a $23 million decline in incentive compensation for the segments, as well as corporate. For the first half, the benefit was approximately $29 million. In our year end call, I indicated that we expected full-year incentive compensation to increase $110 million. We have refined our estimates taking into account current projections, as well as the impact of restructuring actions.

We now believe that the full-year increase will be approximately $90 million. That implies a $119 million increase in incentive compensation in the second half, because we have reduced our long-term and short-term accruals in the second half of the 2008, particularly in the third quarter. As a result, we had negative stock-based compensation of $39 million in the third quarter of 2008.

Our cost containment initiative should enable to us reduce expenses in two of our thee segments, even as revenue declines. At McGraw-Hill Education, as Terry indicated, we now expect revenue to decline 8.5 to 9.5% versus the previous guidance of a 7 to 8% decrease. We also anticipate a mid-single digit decline in expenses, versus our previous estimate of a low-single digit decline. On that basis, we are maintaining our margin guidance of 300 to 400 basis point decline. Excluding the 2008 and 2009 restructuring charges.

Expenses were down 11.7% year-over-year in the second quarter, and 10% in the first half excluding the restructuring actions in both years. At constant currencies, first half expenses were down 7.1%, benefiting from prior restructuring actions, lower cost of goods sold given the lower revenue, and lower sales and marketing costs, which in some cases will shift to the third quarter of 2009. In the Financial Services segment, Credit Market Services transaction revenue is down 20% in the first half, but we expect strong growth in the second half, as comparisons particularly in the fourth quarter, get significantly easier due to the depressed issuance in 2008.

Credit Market Services nontransaction revenue increased from $280 million in the first quarter, to $311 million in the second quarter. Part of the reason for this sequential increase is the fact that the first quarter was depressed due to the timing of renewals for certain contracts. Due to tight expense controls, we now expect margins for the segment to decline 225 to 275 basis points, versus our previous margin guidance of a 250 to 300 basis point decline. This implies a low-single digit increase in expenses, and a modest improvement from our previous guidance.

For the second quarter, expenses were down 8%, excluding restructuring charges in 2008 and 2009, and the loss on the Vista divestiture. Adjusting for currency, expenses were down $15.2 million, or 3.6%. This decrease was primarily driven by reduced incentive compensation, and restructuring benefits from previous actions. And we also benefited from the divestitures of Vista, and CRISIL's Gas Strategies Group.

For the first half, expenses were down 4 .4%, at constant currencies they were up 1.3%. Second half comparisons are more difficult given increased incentive compensation, and the reduced impact of foreign exchange. Partially offsetting these are the benefits of previous restructuring actions. In Information and Media, Compass, an online reporting and analytical tool, recently introduced by JD Power, is having a significant impact on segment revenue and profits.

As I have indicated previously, the segment results for the year will be adversely affected by the noncash accounting impact, of converting studies onto this online platform. Revenue previously recognized at the time of syndicated studies release, will now be recognized ratably over the 12-month life of the subscription. This is similar to the Sweets transition in 2006.

For the full year we now expect a $12 million decrease in revenue, and a $7 million decrease in profit, due to the impact of Compass, versus our previous guidance of a $15 million decline in revenue, and a $10 million decline in profit. The revised estimate is due to changes in the scope and timing of conversions. For the second quarter, the Compass conversion resulted in a $3.4 million decrease in revenue, and a $2.9 million decrease in profit.

And for the first half, the figures would be an $8.1 million decrease in revenue, and $5.2 million in profits. Due to the additional revenue decline we are projecting for the segment, partially mitigated by our continued cross-containment initiatives, we now are forecasting a 300 to 400 basis point decline in margins, excluding the 2008 and 2009 restructuring charges, versus our previous forecast of a 200 to 300 basis point decline. This essentially implies a mid-single digit decline in expenses for the year, versus our previous guidance of a low-single digit decline.

Corporate expenses in the second quarter were $29.3 million, a $4.2 million decline from the same period last year, largely due to reduced stock-based compensation. Second half comparisons particularly in third quarter, becomes significantly more challenging reflecting the increased stock based and short-term incentive compensation that I previously mentioned.

We continue to expect that corporate expenses will increase this year by $25 million to $30 million, due to the increased incentive compensation. The Company's effective tax rate was 36.4% in the second quarter, versus 37% in the same period last year. We expect the full year 2009 tax rate to be 36.4%, an approximate 60 basis point decline from 2008.

Let's now review free cash flow. To calculate free cash flow, we start with after-tax cash from operations, and deduct investments and dividends, as well as working capital. What is left is free cash flow, funds use to repurchase stock, make acquisitions, or pay down debt. Our free cash flow guidance previously did not reflect any pension plan contributions, although we indicated that there could be a contribution in the second half.

Based on current expectations, we plan to make a pension contribution of approximately $25 million in the third quarter. We have now incorporated this into our free cash flow projections. Even with the pension contribution, we continue to expect free cash flow for the year to be in the range of $430 million to $450 million. That is the guidance that we had previously given, although most likely at the low end of the range. This is approximately equal to last year, despite lower profits, due to continuing working capital improvements and our focus on cross containment, and prudent investments.

In the first half of 2009, free cash flow improved by $337 million versus the prior year. In the first half, free cash flow is generally negative due to the seasonality of our businesses. As we had anticipated, it was substantially higher than the previous year, driven by a significant reduction in cash incentive compensation payments, and continuing working capital improvements, particularly for inventories and Accounts Receivable. Second half comparisons will be more difficult, given anticipated receipts, lower anticipated receipts.

The corporation's financial position remains strong. Net debt decreased to $731 million, down $130 million versus the first quarter, and $65 million versus year end. We continue to have access to the commercial paper market at very low rates. On a gross basis, total debt at the end of the quarter was $1.3 billion. It is comprised of $1.2 billion in unsecured senior notes, as well as about $90 million in commercial paper. This is offset by $556 million in cash, primarily foreign holdings.

The first long-term debt payment is not due until the end of 2012, so we are in a comfortable position in terms of managing maturities. Our diluted weighted average shares outstanding were 313 million in the second quarter, an 8.1 million share decline versus the same period last year. That is roughly flat compared to the first quarter of 2009. The year-over-year decline is primarily due to the 2008 share repurchases, and to a lesser extent the decline in our stock price. Fully diluted shares at the end of the quarter were approximately 313 million. Interest expense was $18.5 million in the second quarter, a $2 million decline from the prior year.

For the full year, we expect interest expense to be roughly comparable with 2008. In today's challenging environment, we are continuing to manage investments prudently without hurting the enterprise. New efficiencies and softening market conditions, will result in more reductions this year in prepublication costs, and a cutback in the purchase of property and equipment. Prepublication investments were $42.3 million in the second quarter, a decrease of $23 million compared to the second quarter of 2008.

For the year, we now expect prepub investments of approximately $200 million, which is down from our previous guidance of $225 million, and $254 million that we invested last year. Prepub costs are being reduced because in the current economic environment, the scope of some programs is being reduced. There is a change in the timing of some programs, and we continue to realize benefits of offshoring and other efficiencies.

Purchases of property and equipment were $9 million in the second quarter, compared to $25 million in the same period last year, reflecting year-over-year reductions in technology spend and real estate improvements. We now anticipate full-year expenditures of approximately $75 million to $80 million, versus our previous estimate of $90 million.

Now let's review our noncash items. Amortization of prepub costs in the second quarter were $71 million, versus $66 million in the prior year. For the full year, we continue to expect prepub amortization of $275 million to $280 million, versus $270 million in 2008. Depreciation was $28.8 million in the second quarter. That is $1.6 million lower than the same period last year, and we are still forecasting approximately $130 million for the full year. Amortization of intangibles was $11.4 million for the quarter, versus $13 million for the same period last year.

And for the full year, we expect approximately $50 million, versus our previous estimate of $55 million. I will conclude with a comment on our growth in unearned revenue, which ended the second quarter of 2009 at $1.1 billion. It is roughly flat with the prior year in the first quarter, but in constant currencies it grew 2.6% versus the prior year. At the end of the second quarter, Financial Services represented approximately 75% of the corporation's total unearned revenue. We still expect unearned revenue to grow slightly in 2009.

Thanks. And back to Terry.

Okay. Thanks, Bob. Before I turn it back to Don, overall we are encouraged by some of the improvement in the conditions during the second quarter. And certainly we are encouraged by the earnings results, given the performance in June. But as I said at the end of the first quarter earnings call, we really saw at that point, the fourth quarter of 2008 and the first quarter of this year, as being the bottom in the market. And we really feel substantiated on that.

And we have started to see an improvement in conditions in the second quarter, leading us to believe that the second half is going to be a lot better, obviously than the first half on that one. But there is an awful lot going on in our various markets that we can take advantage of. As we return from an economic standpoint to a healthier situation, we are in a very, very good position, to take advantage of some of those opportunities, and we talked about some of them. We can talk about them in any questions or comments that you have.

So let me turn it at this point, back to Don. Don?

Thank you Terry. Just a couple of instructions for our phone participants. (Operator Instructions). We are now ready for questions.

Thank you. The first question comes from Peter Appert of Piper Jaffray. Your line is open. You may ask your question.

Thanks. Terry, based on the AAP data, it does look like you're losing relatively significant market share in the K-12 business. Can you comment on that in terms of specific areas where you think that might be occurring, and why that might imply that you might continue to see challenging revenue trends next year as well?

Well, again, good morning, Peter. And again, as we were saying in the remarks, the K-12 market is obviously under a lot of pressure, and it is really dependent right now on Stimulus money coming into the market. It has been extremely slow, as we try and monitor where that Stimulus money is. There are some issues coming out of the Federal government with it. There are also some issues in terms of state administration of those kind of funds, and getting the funds to the district. Also we are seeing some of the pullback and postponements in terms of some of the adoption areas.

So at this point it is a timing issue. We are taking advantage of some of the Title I and some of the IDEA special education funds, and we think that in the second half of this year, that we are going to be able to pick up some at that pace. So I don't look at it as losing share, or those kind of things.

Right now it is a very fluid situation. It is a timing issue. And I think that we are going to finish up a little better than where we are projecting, but I think it is safe to say that until we see more Stimulus money into the marketplace, that the 15 to 20% decline that we talked about, is a very prudent place to be. And we hope to do better than that.

Okay. Thanks, Terry. That helps. Then second question, wondering how you are feeling about just the strategic appeal of the whole information media segment, in terms of what clearly has been operating results that have weighed on your performance for the last several years, and exacerbated this year by the challenges in the ad business, which don't look like they are going to be getting any better. You have made a step with the decision to divest BusinessWeek. Does it make sense to go further than that within that info media segment?

Yes. Thanks, Peter. And it is not fair to comment more broadly on that, other than to say what I have said all along, is that in conditions like this in particular, everything in the portfolio gets scrutinized.

And we are looking for future growth paths and the like, and the extent to which we see limitations on it, we are going to deal with it. And therefore, that is why I made the comment that we are exploring this strategic options, but obviously anything in the portfolio, in terms of growth implication is also being scrutinized as well.

Okay. And last thing, Terry, in terms of the litigation, you guys are not make anything reserves, correct, in terms of possible settlements?

No. I don't want to comment on that part, Peter. I would say though, that in terms of the legal suits, and as you know, we have got them categorized essentially in three buckets, there is a whole group in what we call the underwriting class, that says S&P was an underwriter of securities, which is absolutely false. We are not. We have got good defenses on that one.

The second one is a category of stock drop suits, that the stock dropped, because we failed to say something, or tell or inform the market or something. That is just not the case. We will defend those. The third is in the state municipality area, where some think ratings are too low, and therefore, their interest payments are too high. We will defend those as well.

So in every case, we are eager to get to briefs, because as soon as you get through briefs then we can go for early dismissal, and we expect to see some movement fairly soon on the early release of some of these. I think that will quell that situation a little bit. But we have got to get through that process. I mean, to say that we are a litigious society is an understatement. There are so many suits out there, not ours, but so many out there, getting before a judge is one. And then getting a judgment is a second one. So we are hoping that we are getting close to getting some early dismissal judgments.

Great, thanks, Terry.

Thanks, Peter.

Thank you. Our next question is from Michael Meltz of JPMorgan.

I think I have three questions. First off, at S&P, can you give us an update on the search there for new head of S&P ratings? Just walk us through exactly what you are doing, and the timeline. Terry, I think the last time around it took about two years to fill the spot? What is the expected timeline? And then I have two follow-ups.

Okay. Obviously in any kind of situation, but especially now, when things are a little bit more difficult, everything, as I was saying to Peter, comes under review. And we constantly are looking at our leadership and our talent management, and constantly trying to figure out how we train, develop, nurture, or replace in all of that. And nothing is new, that is what we are doing. With Vickie Tillman taking on the new position for sustainability, which is a neat opportunity, and a revenue generating opportunity for us. It gives us an opportunity to examine the leadership structure there.

And I would expect, and by the way, there is a lot of talent in the universe right now. And therefore, we are looking at that, and I think that without putting undue expectation out there, I think that we have got a more immediate situation on that one. But we feel very comfortable, very good, and I would also add on the talent leadership coming out of Europe, very strong. And so we have taken this opportunity to upgrade in some areas, and we will continue to do that. That is a management thing.

Okay. Within Education, can you talk a little about the HPI segment? You are talking about college being very strong. You were down, I think 2 to 3%, in the quarter excluding currency. How bad is retail? How bad is international ex-currency? For the year, if I back into your guidance for segment growth, are you saying HPI total segment up modestly? Is that what it implies?

Well, we said, Michael, that the growth for this year, we are upgrading from the 3 to 4% that we said, to 5 to 7%, and we are certainly going to match that. We will see as we get through the all-important third quarter, what upside to that there may be. But I think seeing that at the very least, we are going to match the 5 to 7% is where we ought to be.

There are timing issues here obviously in the market, some discount programs from competitors have inflated, maybe some results in June. We will see by the end of the third quarter where, from a marketplace, this all rests out. But we are very encouraged. Of course, as you know, the higher education in particular is a countercyclical business. Given the downturn, enrollments are way up and doing well. So we are very encouraged about this whole area.

Internationally, they are influenced as well, in terms of the economic downturn. But it is countercyclical that way. We fully expect that to continue as you say, ex foreign currency to perform well. So we are very encouraged about this area.

My question, though, Bob, I don't know if you have the data. Does your guidance for the year imply that HPI group in total opt modestly? Is that the guidance?

Yes. Let me just give a little bit further color to Terry's answer here. Clearly the US higher education business is growing strongly, and we expect it to do very well for the balance of the year. The professional publishing piece, I am not breaking out specific pieces, but it is the smallest of the three. We are looking at the US higher education, professional publishing, and international. Professional is the smallest of the total, but clearly, the retail chains have been hit very, very hard. So the performance here is down pretty dramatically.

On the international side excluding currency, we are influenced somewhat by a decision that we made last year, to discontinue certain K-12 operations in one of our particular markets. So we had revenue from that particular business last year, which we don't have this year which is influencing it. But I think the second half on average is going to be about flat to up modestly, ex currency.

Okay. And then on investment, S&P investment services, can you talk a little bit more about what exactly your expectations are for that business going forward? I think it was the second quarter it has disappointed relative to your expectations, what exactly are you seeing there? I don't think you gave specific guidance for the year. I think if I back into your numbers, you are saying down modestly, is that correct?

Yes. I think that is probably, going to be the result there, Michael. But I am not discouraged on investment services at all. In fact, it is just the opposite. It is representing about 40% of the revenues now of S&P. It has got an absolutely super management team, and we have got terrific prospects here. I think the comparisons compared to last year are a little difficult, but the Indexed Services is extremely strong, it defines a high margin business. Capital IQ and Compustat continue to gain client traction, up to over 2,800 clients there and still growing. Compared to other trading platforms, where you are seeing decline, we are growing there.

Equity Research is going to have a little bit of an issue, given the curtailment of the settlement dollars, but we are working very hard, as we said, on retaining those customers that we have, and I have a good promise on that. So in terms of data information, the analytics, the Capital IQ, the Indexed Services, no, no, very strong, and I think that, we might surprise in the second half. I don't know on this one. So slightly down, I think, would be a good forecast for now.

Michael, our guidance here specifically is a low-single digit decline. Just the points that Terry made are appropriate here. Indexed services we are seeing some pressure where we are seeing movement out of the large cap stocks, into some of the smaller mid-cap stocks, not fully offsetting some of the movements out as well, actually, the impact on the overall market decline, and what that does to your assets under management.

Also we are influenced in the second half of the year by the loss of the revenue from Vista and CRISIL's Gas Strategies Group, which is part of the investment services segment. Not big, but it does influence the growth.

Also, Michael, even with all that is going on in the comparisons that the second quarter of last year, we did launch 11 new exchange-traded funds in the quarter. We are very pleased with that. You are going to see the continuation of that pipeline.

Let me tack on one more. I am sorry to be a glutton here. On the lawsuits you mentioned here were mentioned in 'The Times,' of the 35 or 36 lawsuits, can you just in kind of Lehman's terms, say how many of those do you think, are I guess I would classify as real lawsuits, versus stock drops lawsuits, versus mortgage pass-through co-defendant type of lawsuits?

Michael, in the three categories that I gave you, we sort of lumped them together as underwriter suits, stock drop suits, and then state municipalities on that one. Obviously there are quite a few in the stock drop area, and once those start to get dismissed, and go, I think it is sort of like pulling the plug on a number of them. We are going to be very aggressive

I have told people that, well, especially on the legal risk, that I have it in my own mind as relatively low in all of that. It is your opinion, and whatever, but once we start getting the early releases from these, I think a lot of the pressure, in terms of thinking about them goes away.

Okay. Thank you for your time.

Thanks.

Thank you. Our next question is from Carl Herman. You may ask your question. Mr. Herman, your line is open. Please turn off your mute button, or pick up your handset.

Carl?

We will go to the next question. From Edward Atorino of Benchmark.

Hi, good morning. I was asking the same questions as Peter asked, so I will pass, thanks.

Thanks, Ed.

Our next question will be from Craig Hubert, Barclays Capital. Your line is open.

Yes, good morning. A few questions. Let's take them one at a time if I could. Could you talk briefly about potential regulatory change, outside of US and outside of Europe, is there anything dramatically changing up in the regulatory front outside of those two areas?

Good morning, Craig. I think it is a very encouraging picture. We were very pleased coming out of the G-20 in London, that they agreed upon a regulatory format within the financial markets, but also with respect to credit rating agencies. That was very appropriate, and one that we can work with. And I think that the issue here is, we have to see globally consistent regulation, because to your point, when you get beyond Europe, you get into the Asian markets, you get into the Middle East. As capital markets continue to grow and flourish, you are going to have to have regulatory schemes, and you can't keep coming up with all of these individual schemes, and therefore, there has to be some sort of framework in terms of this.

I think what is going to come out of this, between the United States and Europe, is going to be a very consistent picture, which others are going to be able to adopt to. That is important because there is no global body, if you will, to arbitrate these. Coming now the out of G-20, and we have a G-20 coming up in Pittsburgh in September, which will be important as well. I think it is very important not just in this area but in other areas as well, that there is consistency across the board on that front. I see it as an encouraging development.

Europe is essentially complete, not implemented but complete, and I think that by the end of this year, we probably should be complete here in the United States, and of course the Senate Banking Committee and the House Financial Service Committee are weighing in. We have seen the Administration's White Paper on this one. And I think that, there is a lot of discussion going on. And once we get through the August recess, I think we will get it completed this year. That will be a good thing. Globally consistent regulation is what we have got to search for.

And then a totally separate question. How many analysts do you have in your S&P ratings business, and the second part to that question, when new issuance does pick up on a sustained basis, do your analysts have enough bandwidth to absorb the significant higher issuance levels, that they are waiting to work? Do they have enough bandwidth, or do you have to go out and hire a ton of people here, do you think?

We roughly have at this point about 1,200 analysts. And it might be a little bit higher than that, and I am thinking fast here on the European and Middle East front. But I would say about 1,200 on that one. As things pick up, yes, you will see a modest pickup in some of that analyst activity. But what we have done is we have cross-trained a lot of our analysts in areas, so that there is a little bit of fungibility here. You can move people over to areas that are showing a little bit more strength. The corporate and government areas are doing quite well. Some of the structured analysts that are on the residential and CDO issuance area, have been moved over to some of those areas.

So we have been able to protect a fair bit of our talent. Albeit, we have had to cut back in certain areas, because of the conditions. So there will be a modest pickup in that, but for the most part, our strongest talent has been protected. We will be fine going forward.

Then my other question, in your outlook here for S&P ratings, what specifically is it your personal outlook for your asset-backed issuance revenues for the full year? A very important category for you. What is your outlook for the percent change?

That is a good question, Craig. I mean it is a fluid situation. Obviously, when people talk about structured finance and they talk about how is it going to come back, and all of those kind of things, clearly, we hadn't expected in the first quarter to see some asset-backed deals. And it continued with some strength in the second quarter. So both on credit card receivables and student loans, but also a little bit of pickup on the auto side. So I am sort of guessing.

I think that we are going to see continued buildup on that side, and it is more the plain vanilla structured finance instrumentation, that you would expect to see coming back. It is a little bit of a fluid situation. Mine is, that I am pleasantly surprised to see what we have. If that continues in the third quarter, that could have a nice influence for the structured market going forward.

On the residential and the commercial mortgage backed side, Craig as you know, it is very soft. There is no movement there. And we are going to need to see, as we were saying in the remarks, the housing recovery, which we expect, home prices to bottom out by the end of this year, and maybe into next year, but I think by the end of this year. That could have a nice influence on those markets. So it is still a very fluid situation, so of the activity that exists, to your point, asset backed is showing a little bit of movement.

Lastly, if I could, for nontransaction revenues in the second quarter as you mentioned up roughly 10% from the first quarter, was that partly because of the currency swing, but also because of annual contracts that got signed in the second quarter, and weren't in the numbers for the first quarter? Or are there some other reasons still?

Yes. That is exactly right. And as you would expect, the quarter over quarter nontransaction revenue is off a little bit, because of the strength that it had in the first half of last year, but no, nontransaction revenue is still quite strong, as surveillance fees and such continue.

And the timing of some of the annual contracts also influence the difference between the first quarter and second quarter.

Great. Thank you very much.

Thanks, Craig.

There are no further questions. That concludes this morning's call.

The presenter slides will be available now for downloading from mcgraw-hill.com, and a replay of this call will be available in about two hours. On behalf of the McGraw-Hill Companies, we thank you for participating, and wish you a good day.