標普全球 (SPGI) 2010 Q3 法說會逐字稿

Good morning. Welcome to The McGraw-Hill Companies third quarter, 2010, earnings call. (Operator Instructions) I'd now like to introduce Mr. Donald Rubin, Senior Vice President of Investor Relations for the McGraw-Hill Companies. Sir, you may begin.

Thank you. And good morning to our global audience and thank you for joining us for the McGraw-Hill Company's third quarter, 2010 earnings call. I am Donald Rubin, Senior Vice President, Investor Relations for 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 third quarter results. We trust you have all had a chance to review the release. If you need a copy of the release and financial schedules, they can be downloaded at www.mcgraw-hill.com. Once again, that is www.mcgraw-hill.com.

Before we begin, I need to provide certain cautionary remarks about forward-looking statements. Expect for historical information, the matters discussed in the teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Including projections, estimates and descriptions of future events.

Any such statements are based on current expectations, and current economic conditions, and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looking statements. In this regard, we direct listeners to the cautionary statements contained in our Form 10-K's, 10-Q's 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 and we would ask that questions from the media be directed to Jason [Fershwangler] in our New York office at 212-512-3151 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. Good morning, everyone. Welcome to our review of the third quarter earnings. As Don mentioned, with me this morning is Bob Bahash, he's our Executive Vice President and Chief Financial Officer. And I will start by reviewing the third quarter results, and our new guidance on earnings for 2010. After our presentations, obviously we will go in any direction you would like and answer any questions or take your comments about The McGraw-Hill Companies, Inc. and our prospects.

Earlier this morning we reported a 15% year-over-year increase in diluted earnings per share for the third quarter. Earnings per share of $1.23 -- now that included a $0.02 gain on some divestitures and $0.01 dilution on the acquisition of the markets.com. Revenue grew by 5.5% in the third quarter but increased 6.8% if you exclude the divestiture of Business Week. Based on that strong performance and the seasonally most important quarter of the year, we are increasing our guidance for 2010.

We now anticipate earnings per share this year in the $2.60 to $2.65 range, and we expect to achieve the high end of that range. The new guidance excludes the one time gain of $0.02 from divestitures but does include dilution of $0.02 from acquisitions. There were many contributor to our strong third quarter. We are very pleased to be firing on so many cylinders. This morning we will provide the details on how those results were achieved. Let's begin with a review of the financial services segment. The third quarter is normally the slowest each year in the ratings business, but not this year.

When S&P credit market services produced the most revenue in any quarter so far this year. It is also noteworthy that the growth is coming without the benefit of a recovery in the structured finance market, and despite a decline in European issuance. Revenue for S&P credit market services in the third quarter increased by 11.1%, based on strong performances in domestic markets. Domestic revenue grew about 20.9%. International revenue was up 0.9%. Revenue for S&P Investment Services grew by 6.3%. For Financial Services in the third quarter, revenue grew by 9.5%, including a $7.3 million pre-tax gain on divestitures, operating profit increased by 6.6%.

The operating margin was 39.2%, and it reflects the pre-tax gain on the divestitures and increases in incentive compensation, incremental cost for compliance and substantial staff increases overseas, basically and mainly in India. And the acquisition of TheMarkets.com. Our revenue growth was driven by increased refinancing activity, the investor search for yield, a robust bank loan market and recovery in the equity market which benefited S&P indices. Spreads, the excess interest rate over treasury bonds is a key factor in the level of issuance volume. The composite spread on speculative grade bonds hit a two-year low at the end of April at 553 basis points and then began widening. But spreads began tightening in September, and as our table shows, that trend has continued into October.

At S&P Credit Market Services, the global high yield new issue market took off in the third quarter. After a slight decline in new issuance in July, compared to the same period last year, the global high yield market started climbing in August and kept on climbing in September. The global high yield market has already produced more new issue dollar volume in nine months this year than it has in any previous single year. Companies are taking advantage of falling yields to refinance debt, and repair their balance sheets, as this S&P report shows, more than two-thirds of the high yield volume in the United States went for refinancing in the third quarter, and for the year-to-date.

High yield issuers are finding a receptive market, as investors search for yield at a time when cash is producing anemic returns. And as banks continue to deleverage, investment grade issuers are also stepping up their activity in the bond market to lock in low yields. The composite spread for investment grade bonds widened over the past month when it was 200 basis points. The spread in mid October of 203 basis points is still slightly above the five-year daily moving average of 198 basis points. Global bank loan ratings also soared in the third quarter, although the absolute volume is still on the low end of the historical averages.

Fundamentals remain strong, liquidy is good in the United States, and only slightly less so in Europe. There is usually a seasonal slowdown in the summer months in the municipal market, but while the dollar volume of public finance issue has declined in the third quarter, deal volume actually increased. It was fueled by refundings, which were up 11%, and the taxable Build America bond program. The taxable bond program which was launched last April has been a boon to municipality, taxable bond debt year-to-date accounts for 32% of the Muni market. The structured finance market is still struggling to recover.

The current residential mortgage-backed securities market cannot compete with the spreads on structured vehicles that benefit from explicit or implicit government support provided to Fannie Mae or Freddie Mac, or Ginnie Mae. Refinancing needs have been the source of securitizations for residential mortgage backed and commercial mortgage backed securities this year, but Re-REMIC activity declined in the third quarter and the residential mortgage backed market remains under pressure in the face of continued uncertainty over home prices and a sluggish economic recovery.

We are seeing AAA rated three year spreads across major asset backed asset classes, and this would include auto, credit card receivables, student loans, and we are seeing these spreads continue to tighten. The asset backed securities markets has benefited all year from strong auto and student loan issuance, which helped offset a general slow down in credit card issuance. New regulatory requirements and higher capital costs of banks securitizations have tempered credit card issuance this year.

New issuance in the fourth quarter is off to a solid start for corporates and it appears that high yield issuers are continuing to find a receptive market and investment grade issuers are still taking advantage of attractive funding rates. We also expect cash to continue to pour into the leverage loan market filling the institutional pipeline. Favorable rates and heavy demand should continue to fuel this market. The structured finance market will also have to adjust to a number of new measures resulting from the Dodd Frank legislation, also new FDIC Safe Harbor rules and new SEC regulations that impose restrictions on sponsors of securitization and greater regulatory oversight on transactions.

Greater disclosure and transparency will benefit investors and, after a period of adjustment, S&P expects the use of securitization to be a significant funding tool for many issuers in the years ahead. In S&P Investment Services, growth at S&P Indices and expansion by Capital IQ were clearly third quarter highlights. Assets under management based on S&P indices and exchange traded funds set a new record at the end of September, $260.4 billion. That's a 17.9% year-over-year increase and a 12.9% sequential increase over the second quarter of 2010.

Growth in spiders and high shares in exchange traded funds were major contributor to the growth. 19 new exchange traded funds links to S&P indices were launched in the third quarter. That includes nine new vanguard exchange traded funds based on our core US indices including the S&P 500. So, in the aggregate now, there are 278 exchange traded funds based on S&P indices. There also was 7.3% growth in the average daily volume for major exchange traded derivatives, based on S&P indices. The daily average in the third quarter was 3.069 million. At the end of each quarterly report, you can expect more new indices from us. This quarter is no exception.

You can expect them in various asset classes including commodities, fixed income and equities. There was also an historic first for S&P indices in the third quarter. They licensed the Options Clearing Corporation to handle trades of over the counter S&P index based option contracts and to receive royalties. This is the first time S&P has licensed its indices to a clearing house for central counterparty clearing. Capital IQ continued its expansion in global markets with the acquisition in September of TheMarkets.com. The acquisition positions Capital IQ for significant growth on the buy side. There is only modest overlap between TheMarkets.com's more than 2000 clients and Capital IQ's 3300 clients.

We expect in the aggregate to add clients, add revenue, create cost synergies and grow in both domestic and international markets. With this acquisition, Capital IQ now has earnings models, estimates, fixed income research, that are all a part and a key part of the buy sides work flow. This diagram illustrates how the acquisition improves Capital IQ's competitive offering to the buy side. Private equity, venture capital, investor relations, as well as the business development departments at corporations. Those open circles indicate little or no availability.

This acquisition fills in -- and this acquisition fills in these circles with a complete investment research and analysis platform for asset managers worldwide based on contributions for more than 1,000 research and estimate contributors. On the regulatory front, a lot of the uncertainty is now behind us. S&P has filed its application as called for by the European regulations, which took affect on September 7. S&P expects to be registered later this year. S&P received its license in Japan as an approved agency before the October deadline and we are also discussing new regulatory proposals with Hong Kong, Canada and Taiwan. In the United States, SEC rule making will be required to implement many of the provisions of the new Dodd-Frank Act.

We continue to engage with the SEC and market participants as part of the rule making process. In anticipation of new regulations, S&P has made significant investments in technology platforms and staffing for quality, criteria, compliance, and risk management. We call this our QCCR framework, and again that's quality, criteria, compliance and risk, and these are four individual groups within S&P that perform these various functions. In 2009, S&P spent about $63 million for QCCR related items. This year spending will increase by about $15 million, mostly in the second half of this year. On a preliminary basis, incremental costs next year could be somewhere in the $12 million to $15 million range and we are still trying to narrow in on that.

Price increases have helped us to mitigate some of these costs, including the incremental expenses for QCCR related items. We expect that price increases will help us again next year. We also continue to monitor the impact of new regulations on bank lending. Regulators are forcing banks to shrink their balance sheets. It is already apparent that banks are retrenching and thinning out one of the busiest periods in the corporate bond market. With banks expected to keep more capital, it is inevitable that they will support less debt and reduced bank lending is obviously a plus for the public debt markets.

Our assessment of legal risks facing the corporation is low, and that remains unchanged. 15 of our motions to dismiss complaints have now been granted and five more cases have been withdrawn -- that's 20. Last Friday there was another favorable ruling in the case of Rice versus S&P and Moody's, a federal district court in California dismissed with prejudice a complaint concerning plaintiffs investments in Fannie Mae securities. There were some key points in this decision that are worth studying.

In dismissing the intentional misrepresentation claim, Judge Cormac Carney wrote, and I quote, Defendant's credit ratings are opinions of the future credit worthiness or value of companies, and therefore are not actionable unless plaintiffs can demonstrate the defendant's representatives who publish credit ratings actually knew that credit ratings were false or did not believe that the credit ratings were true at the time that each credit ratings was issued, closed quote.

The judge also recognized that a negligent misrepresentation claim concerning a professional opinion can only be stated by quote, A narrow and circumscribed group of persons to whom or for whom the misrepresentations were made. The rationale for limiting liability to a specific group of persons is to protect professionals who provide information from unlimited and uncertain liability, closed quote. In these important ways, this ruling recognizes limitations facing plaintiffs who seek to assert legal claims concerning S&Ps ratings. In Italy, there was a development earlier this month in the Parmalat litigation which got started in the fall of 2005.

On October 1, two court appointed experts, both accountants, filed a report that was critical of the ratings assigned to Parmalat by S&P during the time frame of 2000 to 2003. The S&P expert disputed the methodology, findings and conclusions of the accountants' report which as a matter of law is not binding in court. The judge who appointed the two accountants to assist her in her determination has scheduled a hearing in early January. We continue to believe that the outcome of this litigation against two subsidiaries of The McGraw-Hill Companies, should not have any material adverse affect on our condition.

Let's sum up for financial services. We expect revenue growth in the mid single digits. We had expected a 100 basis point decline in the operating margin. We now expect 150 basis point decline in the operating margin, primarily due to the acquisition of Markets.com.

Okay. With that, let's move over to McGraw-Hill Education operations. In the seasonally most important quarter of the year for education, we grew both in the elementary/high school market, and in the US higher education markets. We did so with an operating margin of 33.9% for the segment. This includes a 40 basis points from a gain on the divestiture. That still makes this year's third quarter performance by McGraw-Hill Education the best since 2007 when an operating margin of 35.0% was reported. For McGraw-Hill Education in the third quarter, revenue increased 5.5%.

Operating profit, including a $3.8 million pre-tax gain on a divestiture grew by 19.9%. The operating margin of 33.9% compares to 29.8% for the same period last year. Control of costs and expenses and improved results in the elementary/high school market, and the US higher education market contributed to this performance. Revenue for the McGraw-Hill School Education Group increased by 6.7%. Revenue for the McGraw-Hill higher education, professional and international grew by 4.3%. As we had expected, state new adoptions were key to the performance in this year's el-hi market.

We are on track to capture about 30% of this year's state new adoption market at $825 million to $875 million this year. The state new adoption market will grow 65% to 75% over last year. This increased spending is the prime reason why we expect the el-hi market to grow 4% to 6% this year. According to the most recent AAP, that is the Association of American Publishers report. Sales in the el-hi market were up 8% through August because of 24.7% increase in state adoption sales. Open territory sales after eight months were down 7.3%. These nonadoption states represented 44.8%, roughly 45% of this year's revenue.

Based on the August results, the el-hi market could hit the high end of our 4% to 6% growth forecast if industry sales remain flat with the last four months of 2010. As this chart shows, industry sales grew in each of the last four months of 2009, so achieving that level of growth will be challenging. September results for the industry are not yet available, but indications are that overall sales slowed during the month, adding to the challenge. For McGraw-Hill, however, September was another strong month, especially in adoption states.

Reading, literature and math represented the biggest revenue opportunities in this year's state new adoption market. The McGraw-Hill School Education Group did particularly well in the very large K-5 reading market, with strong performances in Texas and California. The school group expects to capture about 45% of the K-5 reading market, and approximately 32% of the K-12 reading and literature opportunity. The school group's K-5 treasures program is a key to its success in reading. In math, the school group expects to win more than 40% of the secondary school market with programs in Florida, California, Indiana, West Virginia, and Oklahoma. But under performance in Florida's K-5 math adoption will probably hold our overall capture rate in K-12 math to about 28%. Open territory sales were down in the third quarter for us as well as for the industry. A reflection of budget pressures in such states as New Jersey, Michigan, Illinois and Missouri.

In testing, the third quarter is normally slow and this year we had the additional impact of the planned phase-out of custom contracts in Florida, California and Arizona. Procedural delays in signing some important contracts were also a factor, but those issues will be settled in the fourth quarter, a seasonally important period in the testing market. A really fine year is taking shape in the US higher education market. For this second year in a row, the US higher education market is benefiting from increased enrollments, an important driver is the federal government's huge step-up in the student aid area. Under the new administration, spending on student aid has increased by nearly 50% to $145 billion. We think increased aid is reflected in the growing higher education enrollments that we are seeing at the start of the new school year.

Preliminary information indicates that fall enrollments at colleges and universities grew by 4% to 5% this year, an increase we had not anticipated at the beginning of 2010. Enrollments in the fall of 2009 grew by 7% to 8%. All of our major product lines produced year-over-year growth in the higher education market in the critical third quarter, and there is added impetus from the double-digit growth from digital products and services. Our line up of homework management, assessment and tutoring products for college and university students is gaining traction and expanding the addressable market. Through September, registrations for these products have grown to 1.9 million, a 26% year-over-year increase.

McGraw-Hill Connect, that is our all digital teaching and learning platform, is our leader in this rapidly growing market and we continue to strengthen it. That is why we recently acquired Tegrity, whose scalable automated lecture capture service has become a core feature of McGraw-Hill Connect since it was introduced last fall. Lecture capture gives students the ability to review material presented in the classroom, any time, anywhere, for replay online or on any mobile device. That is a powerful tool for studying and learning. More than 200 educational institutions already use the Tegrity cloud based service. We have also launched McGraw-Hill Create. It is a Google-like search engine that enables instructors to customize quality content for their courses. They can draw on 4,000 McGraw-Hill textbooks, 5500 articles, 11,000 literature, philosophy and humanity readings, and 25,000 business case studies from such providers as the Harvard Business School.

Once a customized text has been developed on Create, the instructor can get a digital review copy in less than an hour. Printed review copies will be delivered in only three to five days. Students can purchase McGraw-Hill Create E-books through the McGraw-Hill E-bookstore or by printed copies at the campus bookstore. And through the recently announced partnership with Blackboard, instructors will have access to the full suite of McGraw-Hill Create content through their Blackboard accounts. If you are looking for a window into our future in digital and international markets, take a look at this next slide.

It is a custom site for the Arab Academy for Science, Technology and Maritime Transport in Egypt. It is hosted on McGraw-Hill Education's international create E-bookstore which is now live around the world. McGraw-Hill Create E-bookstore made it possible to deliver 36 titles to this Egyptian institution for students to use in their new semester. The customer selection of 36 titles underscores the scope of McGraw-Hill's global content creation. The list includes titles drawn from US McGraw-Hill higher education, our US professional catalog, as well as original titles published by our subsidiaries in India and in Europe. Because of the capabilities of McGraw-Hill Create, 30 of the titles will be delivered directly to students, using institutionally purchased access codes.

At the school's request, six titles will be delivered as E-books for testing the student experience and Tourage -- that's the EDGE trademark, it's a new E-reader. Another site has been established at the Rotterdam School of Business in Netherlands. Using McGraw-Hill Create that microsite will host 29 custom E-books from our catalog for student purchases. One more observation about using McGraw-Hill Creates delivery content. In this world we are not supplying physical products. That means no printing, no binding cost, no inventory or warehousing costs, no shipping charges, no returns and no used books.

Clearly connecting content and managing digital assets globally is a powerful combination that is creating new opportunities as we shift away from our Legacy model to an interactive and digital model. The same transition is taking place in professional markets. Here, we are seeing an acceleration in the online ordering of hard copies, and a huge increase in the sale of E-books. Since the beginning of the year, our E-book sales through the major E-book retailers to consumers have nearly tripled.

Our best selling E-books in the third quarter range from the presentation secrets of Steve Job, to the famous Graham and Dodd work Security Analysis. We have more than 5000 professional titles available as E-books. Even with the continued rapid growth of digital products and services, the fourth quarter this year will be challenging. Last year we had a significant upswing in operating profits based on the surge in the second quarter semester orders in the US higher education market and improved results in the professional and international markets. The bulk of second semester ordering in higher education sometimes occurs in December. And in other years it comes in January. Complicating the balancing between the fourth quarter forecasting in this market. The US higher education market is forecasted to grow 8% to 10% this year.

There is pent-up demand in the el-hi market, but budget pressures are continuing to constrain school district spending in many regions,, the arrival of new federal funds could be a positive factor, however. The McGraw-Hill School Education Group sales teams are still working on a number of large Basel adoptions in the open territories, as well as some excellent fourth quarter opportunities for intervention products across the country. Federal funding will clearly play a part in some of these purchases, but in other cases it will be harder to identify because large district orders tend to be paid for through a blend of funding sources, so it is difficult to predict what will materialize.

So, with that, let's sum up the McGraw-Hill Education. Revenue, we still expect a low single digit increases. Operating margin. We had be forecasting flat margins. We now expect an improving of 200 basis points to 14% for 2010. Okay.

Let's move over to review out third segment, and that is the information and media segment. Key contributors to this segments third quarter performance were the continued solid growth of our global energy information business, an increase in television advertising and the effect of the Business Week divestiture. In the third quarter, revenue declined by 4.7%, but excluding Business Week, it actually grew by 5.1%. Operating profit increased by 55.1%, or $16.3 million. The operating margin was 20.1%, up from 12.4% for the same period last year. The business to business groups revenue declined by 7.1%. But excluding Business Week, increased by 3.3%.

In volatile energy markets the demand for Platts data and information products continues to drive strong growth in both the United States and international markets. And, incidently, more than 60% of Platts revenue comes from outside of the United States. Platts is growing rapidly across a number of commodities. It is continuing to expand its coverage of the refined petroleum markets in the United States, Europe and Asia, with new price assessments in gasoline, fuel oil, naphtha -- naphtha being the raw material for gasoline. Platts expanded its suite of daily spot price assessments to include alumina, that is a mineral produced from Bauxite ore that is used to make aluminum.

The new price assessments, the world's first daily price references for alumina address the needs of miners, smelters, refiners and traders for an independent source of open market spot prices to better determine valuations for short and long term contracts. Platts also began producing new price assessments in the India coal market. India's thermal coal imports are changing trade flows radically and increasing the need for expanded, more frequent and transparent price information.

These new assessments address the needs of power producers, coal traders and ship brokers for an independent source of India-related open market spot prices, making Platt even more relevant in this growing market. There was some softness in construction, particularly among smaller regional contractors who have been hardest hit by the declining activity in this market. Weakness in the global automotive business offset improvements in the nonauto parts of the market at J.D. Power and Associates. Revenue for the Broadcasting Group increased by 23.5% to $23.6 million. A combination of political advertising and improved local and national time sales accounted for the increase. In this political season, the contest for Governor, a heated race for a Senate seat, and issue-related advertising in Colorado are attracting significant ad dollars. Therefore, summing up for Information & Media, there is no change in our revenue guidance. We still expect a revenue decline in the midsingle digits. But midsingle digit growth excluding Business Week. We now expect the operating margin in the mid to high teens. We had anticipated an operating margin in the mid-teens, and now we are addressing that upwards a little.

That concludes our review of the operations and therefore summing up for the corporation. We anticipate earnings per share in the $2.60 to $2.65 range and expect to achieve the high end of that range. The new guidance excludes $0.02 of the one-time gain from divestiture, but includes dilution of $0.02 from acquisitions. Okay. Let's hold it there. With that, let me turn it over to Bob Bahash, our Chief Financial Officer for his results.

Okay. Thank you, Terry. It has been an active and productive third quarter. So, this morning I'm going to focus on strategic acquisitions, divestitures, share buybacks, improved outlook for cash flow and expenses. Now, we recently announced three acquisitions. The research and estimates business of TheMarkets.com for Capital IQ. Tegrity which becomes part of the McGraw-Hill Higher Education, Professional and International Group and Pipal Research by CRISIL. The acquisition of Tegrity closed in October and Pipal Research is expected to close in the fourth quarter.

We expect to spend approximately $360 million on these acquisitions, and the recent equity investment in AMBO Education, a leading provider of educational and career enhancement services in China. The most significant of these acquisitions, of course, is TheMarkets.com. It diluted earnings per share by $0.01 in the third quarter and will do so again in the fourth quarter. In 2011 TheMarkets.com acquisition is expected to generate approximately $60 million in revenues and despite an anticipated $15 million in intangible amortization, the acquisition will be both accounting and cash flow accretive in 2011.

We also had three divestures in the third quarter. A small secondary school business in Australia which generated a $3.8 million pre-tax gain and two by CRISIL. They are a 7% equity interest in the National Commodity and Derivatives Exchange of India. We continue to maintain a 5% ownership. The divestiture of the 7% was required to comply with local regulations regarding foreign ownership rules. Also, CRISIL's remaining 10% interest in Gas Strategies Group, the 90% interest we had sold that back in December of 2008. The two CRISIL divestitures this year generated $7.3 million in pre-tax gains. Because CRISIL is a non-wholly owned subsidiary, part of the gain is deducted for purposes of calculating EPS and is shown as a component of net income attributable to non-controlling interest. This was $2.3 million, which represents the post-tax portion of the gain attributable to the minority owners of CRISIL.

In addition to the acquisitions, we continue to actively repurchase shares. In the third quarter, we repurchased 2.2 million shares, for a total cost of $69 million, at an average price of $31.14 per share. Year-to-date, we repurchased 8.7 million shares, for $255.8 million, averaging $29.37 per share. 8.4 million shares remain in the 2007 program authorized by the Board. Our diluted weighted average shares outstanding was 309.3 million in the third quarter, a $4.4 million decrease versus the previous year, due primarily to the full year impact of the second quarter share repurchases. Diluted weighted average shares outstanding declined 3.9 million for the second quarter, reflecting the full impact of second quarter share repurchases, as well as the weighted impact of third quarter share repurchases.

Fully diluted shares at the end of the quarter were approximately 308 million. We continue to be well capitalized with net cash and short term investments as of September 30, of $158 million. The shift to a net cash position from a net debt position of $53 million at the end of the second quarter is driven primarily by strong free cash flow, partially offset by funding for acquisitions and share repurchases. Cash and short term investments at the end of the quarter totaled $1.356 billion, while gross debt was comprised of approximately $1.2 billion in senior notes. Our debt is entirely in long term unsecured senior notes. No commercial paper is outstanding. The outlook for free cash flow continues to improve. To calculate free cash flow we start with our after tax cash from operations, and deduct working capital, investments and dividends.

What's left is free cash flow. Funds we can use to repurchase stock, make acquisitions or pay down debt. During the third quarter, our seasonally strongest quarter, we generated free cash flow of $552 million. Year-to-date in 2010 we generated free cash flow of $651 million versus $507 million in the same period last year, for an increase of $144 million. The improvement is due primarily to stronger operating results and a continuing focus on asset management. We now expect free cash flow this year to be clearly in excess of $700 million, versus our previous guidance of $600 million to $650 million. The improvement is driven by stronger operating results, reduced capital investment projections and more favorable working capital than previously anticipated. Just as a reminder free cash flow last year was $770 million. Regarding our US pension plan, we made a $14 million discretionary contribution in the third quarter, and we anticipate making an additional discretionary payment in the fourth quarter, potentially in the range of $50 million, and that is factored into the free cash flow projections.

Now, let's look at expenses. As a reminder, I will speak to adjusted expense growth, which represents expense growth excluding 2009 restructuring charges, as well as 2009 and 2010 gains and losses on divestitures. So, let's start with education. Third quarter adjusted expenses were roughly flat, declining 0.1%. Year-to-date adjusted expenses declined 1.3%. Contributing to the lower expense levels were two key decisions last year.

The first was to combine the core Basel publishing operations with our alternative Basel and supplemental publishing operations. The second was the planned phase out of statewide low margin custom test contracts in California, Florida and Arizona. A $15 million decline in amortization of prepublication costs also benefited third quarter results. Increases in selling and marketing costs for the robust state new adoption opportunities and continued digital investments partially offset these savings. As Terry has indicated, we now expect margin improvement, approximately 200 basis points, versus our previous guidance of flat margins.

For Financial Services, adjusted expenses increased 13.3% in the third quarter, and 12.8% at constant currencies. Year-to-date adjusted expenses increased 10.1%, and 9.3% at constant currencies. The growth in expenses in the third quarter and year-to-date was driven by increased salaries and occupancy costs, primarily for international hires and higher incentive compensation. Third quarter expenses were also impacted by TheMarkets.com acquisition. That resulted in an incremental $5 million in expense. There also was $5.4 million in additional costs related to our regulatory and compliance initiatives. Taken together, these increased total financial services expense by 2.7%.

The fourth quarter is expected to show a comparable increase in costs related to our regulatory and compliance efforts. We are still projecting additional full year costs of approximately $15 million as Terry stated. One last comment on financial services third quarter expense growth in the beginning of the third quarter -- of the year, I indicated that total stock-based compensation from McGraw-Hill was expected to increase roughly $30 million versus 2009 due to the three year earnings investment period which is off a depressed base due to stronger operating results we now expect an increase of roughly $40 million. The majority of this increase, as anticipated, was realized in the third quarter due to particularly depressed levels in the third quarter of 2009. As a result, financial services had a $10.6 million increase in stock-based compensation for the quarter. As Terry indicated, we now expect Financial Services margins to decline by approximately 150 basis points, which implies expenses will increase roughly 9% to 10%, versus our previous guidance of 7% to 8% and the increase is largely driven by TheMarkets.com acquisition.

At information and media, third quarter and year-to-date adjusted expenses declined 13.1% and 17.4% respectively. The divestiture of Business Week reduced third quarter revenue by $22 million and expenses by $32 million for a positive profit impact of roughly $10 million for the quarter. Year-to-date, the divestiture of Business Week reduced revenue by $78 million and expenses by $111 million, for a positive profit impact of $33 million. And, of course, for the fourth quarter, the divestiture of Business Week is expected to reduce revenue by $22 million and expense by $27 million. The positive impact here is $5 million. This will result in full year savings of $38 million.

For 2010 we expect adjusted expense to decline in the mid-teens, versus a previous guidance of a decline in the low teens. Corporate expense in the third quarter is $44.4 million, a $16.5 million increase versus the prior year. The increase was primarily driven by increased incentive compensation, compared to lower levels in 2009, as well as normal increases due to the stronger operating results. Increased excess vacant space was also a contributor to increased corporate costs.

We are making progress in reducing excess space. We finalized one agreement to sublease some excess space in New York this month, and have received several promising inquiries regarding additional space. Because we are subleasing this space at lower rates than what we are currently paying, the accounting rules require us to take a one-time charge for the difference between the present value of the payments we will receive, versus the payments we will have to make over the term of the lease. Our new earnings per share guidance excludes this one time charge since we are still finalizing accounting for this charge. Excluding the charge, we now expect full year 2010 corporate expense to increase $30 million to $35 million, versus our previous guidance of an increase of $25 million to $30 million due to additional incentive compensation accruals. Net interest expense was $19.3 million in the third quarter, compared to about $18 million in the same period last year, and $21 million in the second quarter of 2010. We continue to expect full year interest to be roughly comparable to 2009, which was roughly $76.9 million. The Company's effective tax rate in the third quarter and year-to-date was 36.4%, which is unchanged from 2009. We expect a comparable rate for the full year.

Now, let's turn to investments. The publication investments were $39.3 million in the third quarter. $5.4 million lower than last year. Year-to-date prepub investments were $99.3 million, a $30.4 million decrease versus the prior year. For the year, we now expect pre-pub investments of approximately $160 million, and that's versus our previous estimate of $195 million to $205 million. Now, the reduction in our pre-pub investment estimate is due to several factors. First, the timing of the adoption of common course standards by various states. To date, 36 states and the District of Columbia have adopted the standards for K-12 math, reading and language arts.

Also, we continue to re-evaluate several programs to enhance our digital offerings. These actions have caused timing delays for a number of our pre-pub investments. In addition, we continue to realize savings from combining the core Basel publishing operations with our alternative Basel and supplemental publishing operations.

Now, purchases of property and equipment were $16.6 million in the third quarter, about $1 million higher than last year. And year-to-date purchases were approximately $39 million. We now expect on a full year basis, the expenditures to be in the $70 million to $80 million range, versus the previous estimate of $90 million to $100 million. This compares to $68.5 million in 2009. Now, let's take a look at some of the non-cash items. Amortization of prepublication costs was $112 million in the third quarter, a $15 million decrease versus the third quarter of 2009. For the full year, we now expect $245 million to $250 million, versus the previous estimate of $260 million to $265 million. This compares to $270 million in 2009.

The decrease reflects the recent lower level of investments. Depreciation was $25 million in the third quarter, compared to $26 million last year. We now expect full year depreciation to be slightly below last year which was $113 million. Amortization of intangibles was $9 million for the third quarter of 2010 and $32 million for the first nine months. Reflecting the impact of our recent acquisitions, we now expect it to be closer to $50 million for the full year versus our previous estimate or $40 million.

Our unearned revenue continues to grow. We ended the quarter at $1.1 billion, up 4.2% from the prior year. At constant foreign currency exchange rates excluding the impact of acquisitions and divestitures, growth was approximately 5%. Financial services represented 74% of the corporations total unearned revenue. It grew in the low single digits driven by strong growth in ratings related information products, S&P indices and Capital IQ. While still small, unearned revenue at McGraw-Hill Education is showing strong growth due to sales of digital products. For 2010 we continue to expect midsingle digit growth in unearned revenue. Thank you, and now back to Terry.

Thank you. This is Don Rubin again with just a couple of instructions for our phone participants. (Operator Instructions) We are now ready for questions. One moment, please. We will start with the questions very shortly.

Our first question comes from the line of Brian Shipman of Jefferies. Your line is open.

Thank you. A couple of questions. First on education. I was wondering if you could take a stab at sizing the 2011 new adoption market for us. Second, on S&P business, you saw the new issuance pick up late in Q3 but comparisons are very tough in the fourth quarter, having grown 63% in the year ago quarter. So, can transaction revenue continue to accelerate here from the third quarter trend into the fourth quarter of 2010 or will growth be tough to attain here in the coming fourth quarter? Thank you.

Brian, thanks. First of all, it is a little early to be focusing on 2011. We clearly, obviously, look at the schedule very hard. The calendar is very full. It is going to be a science year next year. And, so, if you look at the calendar and just take it from that standpoint, our guesstimate at this point is that we will be at or a little better than 2010 state adoption levels on that one. But we have got to also see what the affect of common course standards are going to be and if there is going to be changes from that standpoint. So it is a little bit early. If you look just at the calendar, at or above 2010 is what we are thinking on that one. New issuance, Brian, as you know, coming off of a softer second quarter, really ramped up. Especially the high yield market. Again, the big number that we watch is the refinancing numbers out through 2014. Still is about $2 trillion in terms of maturities coming due on that part. Of course, there was a lot of refinancing or refundings in the third quarter. A lot of the new issuance that way. We have seen a continued strong corporate market here. Issuance a little softer in Europe, but, again, one would think that it should be still fairly strong. We have evidence of that at this point. We will have to see as we get into November and early December. But, so far, it is pretty good.

Okay. Just a quick follow-up, if I may. Are you seeing any sign of federal money affecting the el-hi market, at all? Thank you.

In the el-hi market, yes, you are seeing some on that one. It is hard, as we are saying, it is hard to trace. Funding is coming from various levels, but from what we are hearing from both ends, both the state side and the federal level, both are talking about funds coming into the market.

Thank you very much.

Thanks, Brian.

Our next question comes from the line of Peter Appert, of Piper Jaffray. Your line is open.

Thank you. So, Terry, the emergence at S&P obviously come a little bit year-to-year, even in the context of the better revenues and explain where the incremental costs are coming from. I am wondering, over the next couple of years, how do you think about the potential for margin improvement in the context of a fairly robust debt market. Do you think margins are at best flat from here going forward?

As you know -- and I will get Bob to get on this -- we reported 39.2%. Then when you take out the gains, it gets down to 38.1%. And, then, if in between -- what is it, Bob -- between foreign exchange?

Yes. If you adjust for the unfavorable impact of foreign exchange in the quarter, as well as the impact one month worth of Markets.com, the apples to apples margin would be 39.6%.

That gets us back to the 40% range. And I think what we are going to see, especially in terms of some of the QCCR compliance network costs, we are going to start to see that abate. The hope would be, then, that we would be able to translate that into margin improvement on that part. So, no, we are not -- we are pleased with where we are relative to the costs associated, but we will be looking for margin improvement.

Do you think low to mid-40s is a reasonable expectation over the next several years?

Well, again, there is a lot of uncertainties in what the pipeline would be like and what any additional regulatory issues and compliance costs and all of that. That would certainly be the hope, Peter, but I think we just better take it as it comes right now just so that we -- we want to keep expectations to where they are.

Got it. Then one last thing, Terry, on the margin front. The education segment obviously doing quite a bit better than expected this year with the leverage from the revenue upside. How do you think about the sustainability of margins of education going into 2011 in the context of what presumably will be a tougher year from a revenue standpoint?

Well, again, one of the questions is, we want to take a good, hard look at the student aid -- the federal government student aid program. That clearly has helped enrollments. That is why we made the adjustment from higher ed growing from 5% to 7% up to 8% to 10%. It's really going to trigger on enrollments there and if enrollments stay strong, then I think -- we will continue to benefit from that and therefore margins will be reflective of that.

And the K-12 business you think is sustainable margin-wise from the context of how you see revenues going up.

I think we got to see what the impact of common core standards are going to be on that part. And my opinion between that and digital it can only help.

Thanks, Terry.

Thanks.

Our next question comes from Craig Huber, of Access 342. You may ask your question.

Yes. Good morning, thanks for taking my questions. Let's just stick with education for a second, if I could. What percent of your elements of high school revenues come from digital and what percent of your college revenues are from digital for the first nine months? I have some follow-ups, thank you.

Craig, at this point, on the higher end professional side, we are seeing 15% and growing very rapidly, so we are pleased with that. On the elementary, high school side, it is smaller than that. We are benefiting at the higher ed side with McGraw-Hill Connect now and all the related pieces to that. We don't break that out as such, but it would be a smaller number than the 15%.

If I ballparked it around 5%, would that be reasonable, you think?

I would say somewhere probably a little higher than that. Probably somewhere in the neighborhood of 6% to 8%.

Okay. And also, can you size for us in the US this year the open territories in residual sales. What percent declined most likely this year are you expecting for the whole market?

Well, again, the open territory market has been problematic, really, for the last four years. We are looking to see more progress in that area. That will be a big piece of future growth. That is roughly 45% of the whole opportunity on that part. But at this point, we still see it as a hold-back.

Just to -- our current thinking in terms of where we are and how we factor into our outlook for the full year for all of K-12, is that for residual sales we're looking at a decline on a full year basis in the high single digits. And for open territory, declines in more midsingle digits, maybe 3% to 5%. But declines in both areas.

Okay. Can you help us understand better the opportunity here on the digital front as you migrate away from print. What, on average, printing costs, binding costs, warehousing costs, postage costs, all that. What percent of cash cost is that for your print operations in education do you end up saving as things transition over to digital?

About 25%.

What?

It is about 25%.

Okay, thanks. One last question, if I can sneak it in. Can you just talk a little bit further about the backlog here for your ratings business for the fourth quarter. What material changes are you seeing there versus the trend you saw here in the third quarter? Thank you.

Craig right now, as we were saying, especially in terms of corporate governments in that category, we are starting to see still strong transaction growth. A little bit less in Europe on that part. But, so far, it is looking promising. We will be watching it together. And all of that. But from a pipeline standpoint, it is looking good right now. And, again, the bigger number Is the $2 trillion worth of refinancings that have to take place between now and 2014. That should keep some pretty good activity in that part of the market.

Craig, let me just expand on your previous question. The paper, print, bind, postage elements, of course, are variable costs. So, if you elect not to print a product, and you move to a digital offering those costs go away. You also mentioned warehouse and of course, that 's not a variable cost. You are still going to be in an avenue where we are going to be producing product for a period of time. Maybe our warehousing structure over time could be reduced, but that is clearly not a variable cost in the short term.

Great. Thank you.

Next question comes from Michael Meltz, of JPMC. You may ask your question.

Thank you. Three questions for you. The 2011 education question was asked a few different ways. Let me try it another way here. At this point, do you think you can grow your total education segment revenues in 2011, just with K-12 trends as well as what is happening on the higher ed side with the for profit guides? That is the first question. Then I have two follow-ups, please.

Well, Michael, it is a bit little early to be forecasting that. I think that what we have done is we have taken a look at where we are in terms of what we are going to be submitting, and we've taken a look at the calendar, and just have done some rough estimating. That is why we say at or above 2010 levels in all this. But, I don't want to mislead. We have to see what common core standards are going to do. So it is a little premature to come in with a harder number.

On the college side, what about the potential headwind on the for-profit or that portion of the market?

Enrollments, the number we are watching there is clearly enrollments. As we said, the student aid program has been very robust and very helpful, to that part of it. That is why we have increased our projections on that. That is the number we are going to be looking at. If we have a decent enrollment number, you can anticipate a commensurate year.

Okay. Two other questions for you. On the liability side at S&P, it would seem that that recent ruling is another nice win for you, that Rice ruling you mentioned. There has been some talk in the trades pubs recently about S&P losing some mandates versus Moody's and Fitch perhaps because of tougher stance on liability provisions in documents. Can you talk a little bit about that, please?

Well, I think it depends on the area and the like. That is why in the QCCR area, we break out both the quality assurance aspect, the criteria the compliance and the risk areas on that part. And we manage the criteria side very hard on that one, making sure that it is as strong and solid and as appropriate to any particular issue. If there is a particular area where our criteria is a little tougher or a little more stringent than somebody else, I think it balances out through the number of issues. But there could be some that way on that part. We are also are saying very clearly to any issuer, that if you are supplying to us with information, that is going to go into part of the determination of a rating, then, hey, you have to be accountable to make sure that the dated information that you are providing us is reliable in all that. Now, we're going to test, and all those kinds of things, but again, all we are saying is that you have got to be very accountable that the information you are giving us that is going to help determine a credit rating is reliable. That is what we are saying.

Okay. And last question for me. In terms of free cash flow priorities, you did TheMarkets.com acquisition, which is while not all that big, it's one of your biggest in a couple years. Can you talk about your priorities in terms of M&A versus repurchase, please?

Both are very viable in all of that. In fact, also in terms of organic growth, a lot of the digital components, like McGraw-Hill Create and Connect and those kinds of things, those are very strong organic programs. You can count on the fact that of the four uses, dividends, share repurchase, organic and acquisition, all are active and continue. Now, again, when you go through the latter part of 2008 and into 2009, activity levels in terms of acquisitions and some of those projects were softer in all of that. Obviously the focus then was on share repurchase and dividend in all of that. Now, given the strength of the free cash flow and improved markets and the like, you can see activity in all four areas.

Okay. Thank you for your time.

Thanks.

Our next question comes from of [Doug Arthur], Evercore. You may ask your question.

Terry, you may have answered this. I got distracted for a second. But the 4.3% increase in higher ed professional and international, that seems light to me in light of your dominance, your strength in college, and the fact that you raised expectations for the industry. So, what were the offsets there?

International. The international side was a little softer than we had anticipated. But, the higher ed side, in particular, is clearly going to come in in terms -- or in line with our expectations and maybe even better on that part. But it was the international side that was softer.

And in terms of the market growth of 8% to 10%, are you going to meet share or gain share?

We will see. At the very least we will meet share. Hopefully we do a little better. At this point I think it is safe to say we will meet.

Great. Thanks.

Thanks, Doug.

Our final question comes from Edward Atorino, Benchmark.

I had the same question Doug did on the higher ed. One other one. Terry, given what I thought was a surprisingly school growth, with all of the budgetary best pressures, et cetera are books sort of, I don't want to say immune, but they are a pretty small slice of the budget? It seems they are holding their own in a very difficult environment. Would you discuss -- are the cuts not hitting the book area?

No. I think again you still have pent-up demand. Remember. When we talk about the state adoption market, it was half or a little more than half of what it was last year. And, so the increase of 65% to 75% in the state new adoption market, and some of the growth in the intervention market I think has been a little bit of a surprise and has held up. Even though at one point we were thinking $875 million to $925 million for the state new adoption market, in the second quarter we came back to $825 million, $875 million. I think that is going to be a pretty good range for this year and we clearly are benefiting from that.

Thank you.

Thanks, Ed.

That concludes this morning's call. The presenter slides will be available soon for downloading from www.mcgraw-hill.com. 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.