UNITED STATES SECURITIES AND EXCHANGE COMMISSION
þ
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE | |
| SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2005
OR
o
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE | |
| SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 1-1023
THE MCGRAW-HILL COMPANIES, INC.
| New York | 13-1026995 | |
| (State of other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 1221 Avenue of the Americas, New York, N.Y. | 10020 | |
| (Address of Principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code (212) 512-2000
Not Applicable
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES þ NO o
Indicate by check mark whether the Registrant is an accelerated filer.
YES þ NO o
On April 11, 2005 there were approximately 187.3 million shares of common stock (par value $1.00 per share) outstanding.
The McGraw-Hill Companies, Inc.
TABLE OF CONTENTS
2
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
of The McGraw-Hill Companies, Inc.
We have reviewed the consolidated balance sheet of The McGraw-Hill Companies, Inc., as of March 31, 2005, and the related consolidated statements of income for the three-month periods ended March 31, 2005 and 2004, and the consolidated statements of cash flows for the three-month periods ended March 31, 2005 and 2004. These financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The McGraw-Hill Companies, Inc. as of December 31, 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended, not presented herein, and in our report dated February 22, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Ernst & Young LLP
April 26, 2005
3
Part I
Financial Information
Item 1. Financial Statements
The McGraw-Hill Companies, Inc.
Consolidated Statement of Income
Periods Ended March 31, 2005 and 2004
| Three Months | ||||||||
| (in thousands, except per-share data) | 2005 | 2004 | ||||||
Revenue (Note 3) |
||||||||
Product revenue |
$ | 328,846 | $ | 315,025 | ||||
Service revenue |
700,160 | 604,842 | ||||||
Total revenue |
1,029,006 | 919,867 | ||||||
Expenses
|
||||||||
Operating related expense
|
||||||||
Product |
203,975 | 182,147 | ||||||
Service |
226,752 | 204,213 | ||||||
Total operating related expense |
430,727 | 386,360 | ||||||
Selling and general expense
|
||||||||
Product |
200,799 | 191,165 | ||||||
Service |
238,674 | 222,233 | ||||||
Total selling and general expense |
439,473 | 413,398 | ||||||
Depreciation |
24,703 | 22,196 | ||||||
Amortization of intangibles |
8,429 | 6,865 | ||||||
Total expenses |
903,332 | 828,819 | ||||||
Income from operations |
125,674 | 91,048 | ||||||
Interest expense |
698 | 1,737 | ||||||
Income from continuing operations before taxes on
income |
124,976 | 89,311 | ||||||
Provision for taxes on income (Note 12) |
46,241 | 13,045 | ||||||
Income from continuing operations |
78,735 | 76,266 | ||||||
Discontinued operations (Note 4): |
||||||||
Juvenile retail publishing business |
— | (931 | ) | |||||
Income tax benefit |
— | (344 | ) | |||||
Loss from discontinued operations |
— | (587 | ) | |||||
Net income (Notes 1 and 2) |
$ | 78,735 | $ | 75,679 | ||||
Basic earnings per common share
|
||||||||
Income from continuing operations |
$ | 0.42 | $ | 0.40 | ||||
Net income |
$ | 0.42 | $ | 0.40 | ||||
Diluted earnings per common share
|
||||||||
Income from continuing operations |
$ | 0.41 | $ | 0.39 | ||||
Net income |
$ | 0.41 | $ | 0.39 | ||||
Average number of common shares
outstanding: (Notes 9 and 14)
|
||||||||
Basic |
189,415 | 190,581 | ||||||
Diluted |
193,300 | 193,490 | ||||||
See accompanying notes. |
||||||||
4
The McGraw-Hill Companies, Inc.
Consolidated Balance Sheet
| March 31, | Dec. 31, | March 31, | ||||||||||
| (in thousands) | 2005 | 2004 | 2004 | |||||||||
ASSETS |
||||||||||||
Current assets: |
||||||||||||
Cash and equivalents |
$ | 361,099 | $ | 680,623 | $ | 403,949 | ||||||
Accounts receivable (net of
allowance
for doubtful accounts and sales
returns) (Note 5) |
868,390 | 1,051,438 | 722,524 | |||||||||
Inventories (Note 5) |
378,464 | 300,459 | 316,034 | |||||||||
Deferred income taxes |
257,879 | 258,157 | 230,376 | |||||||||
Prepaid and other current assets |
150,221 | 157,153 | 135,804 | |||||||||
Total current assets |
2,016,053 | 2,447,830 | 1,808,687 | |||||||||
Prepublication costs (net of
accumulated amortization) (Note 5) |
452,164 | 428,205 | 461,525 | |||||||||
Investments and other assets: |
||||||||||||
Prepaid pension expense (Note 10) |
296,887 | 299,792 | 291,035 | |||||||||
Other |
226,212 | 220,611 | 222,549 | |||||||||
Total investments and other assets |
523,099 | 520,403 | 513,584 | |||||||||
Property and
equipment – at cost |
1,203,483 | 1,195,792 | 1,112,210 | |||||||||
Less – accumulated depreciation |
699,566 | 682,726 | 654,598 | |||||||||
Net property and equipment |
503,917 | 513,066 | 457,612 | |||||||||
Goodwill and other intangible assets: |
||||||||||||
Goodwill – net |
1,509,142 | 1,505,340 | 1,241,292 | |||||||||
Copyrights – net |
224,491 | 228,502 | 240,798 | |||||||||
Other intangible assets – net |
225,726 | 219,643 | 178,466 | |||||||||
Net goodwill and intangible assets |
1,959,359 | 1,953,485 | 1,660,556 | |||||||||
Total assets |
$ | 5,454,592 | $ | 5,862,989 | $ | 4,901,964 | ||||||
See accompanying notes. |
||||||||||||
5
The McGraw-Hill Companies, Inc.
Consolidated Balance Sheet
| March 31, | Dec. 31, | March 31, | ||||||||||
| (in thousands) | 2005 | 2004 | 2004 | |||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||||||
Current liabilities: |
||||||||||||
Notes payable |
$ | 3,064 | $ | 4,613 | $ | 5,523 | ||||||
Accounts payable |
273,543 | 318,301 | 257,304 | |||||||||
Accrued royalties |
51,115 | 125,552 | 46,808 | |||||||||
Accrued compensation and contributions to
retirement plans (Note 10) |
251,608 | 411,330 | 218,839 | |||||||||
Income taxes currently payable |
93,692 | 78,776 | 28,376 | |||||||||
Unearned revenue |
750,807 | 719,948 | 641,536 | |||||||||
Deferred gain on sale leaseback (Note 11) |
7,516 | 7,516 | 7,516 | |||||||||
Other current liabilities |
379,905 | 302,626 | 345,163 | |||||||||
Total current liabilities |
1,811,250 | 1,968,662 | 1,551,065 | |||||||||
Other liabilities: |
||||||||||||
Long-term debt (Note 6) |
357 | 513 | 385 | |||||||||
Deferred income taxes |
233,522 | 232,081 | 170,059 | |||||||||
Accrued postretirement healthcare and
other benefits (Note 10) |
162,919 | 164,021 | 167,413 | |||||||||
Deferred gain on sale leaseback (Note 11) |
195,401 | 197,267 | 202,937 | |||||||||
Other non-current liabilities |
307,971 | 315,932 | 267,530 | |||||||||
Total other liabilities |
900,170 | 909,814 | 808,324 | |||||||||
Total liabilities |
2,711,420 | 2,878,476 | 2,359,389 | |||||||||
Shareholders’ equity (Notes 7 & 8): |
||||||||||||
Capital stock |
205,855 | 205,855 | 205,854 | |||||||||
Additional paid-in capital |
127,585 | 113,843 | 99,278 | |||||||||
Retained income |
3,697,107 | 3,680,852 | 3,171,480 | |||||||||
Accumulated other comprehensive income |
(35,110 | ) | (32,255 | ) | (64,474 | ) | ||||||
| 3,995,437 | 3,968,295 | 3,412,138 | ||||||||||
Less – common stock in treasury-at cost |
1,236,748 | 963,751 | 858,056 | |||||||||
Unearned compensation on restricted stock |
15,517 | 20,031 | 11,507 | |||||||||
Total shareholders’ equity |
2,743,172 | 2,984,513 | 2,542,575 | |||||||||
Total liabilities & shareholders’
equity |
$ | 5,454,592 | $ | 5,862,989 | $ | 4,901,964 | ||||||
See accompanying notes. |
||||||||||||
6
The McGraw-Hill Companies, Inc.
Consolidated Statement of Cash Flows
For the Three Months Ended March 31, 2005 and 2004
| (in thousands) | 2005 | 2004 | ||||||
Cash flows from operating activities |
||||||||
Net income |
$ | 78,735 | $ | 75,679 | ||||
Adjustments to reconcile net income to
cash provided by operating activities: |
||||||||
Depreciation |
24,703 | 22,285 | ||||||
Amortization of intangibles |
8,429 | 6,865 | ||||||
Amortization of prepublication costs |
25,204 | 32,726 | ||||||
Provision for losses on accounts receivable |
5,595 | 6,630 | ||||||
Other |
(183 | ) | 2,865 | |||||
Changes in assets and liabilities net of effect of
acquisitions and dispositions: |
||||||||
Decrease in accounts receivable |
164,572 | 218,014 | ||||||
(Increase) in inventories |
(78,403 | ) | (47,683 | ) | ||||
Decrease/(Increase)in prepaid and other current
assets |
6,524 | (63,688 | ) | |||||
(Decrease)in accounts payable and accrued expenses |
(277,463 | ) | (251,918 | ) | ||||
Increase in unearned revenue |
33,856 | 46,601 | ||||||
Increase in other current liabilities |
8,099 | 17,626 | ||||||
Increase/(decrease) in interest and income taxes
currently payable |
26,178 | (201,459 | ) | |||||
Net change in deferred income taxes |
28 | (5,764 | ) | |||||
Net change in other assets and liabilities |
(10,020 | ) | (11,677 | ) | ||||
Cash provided by/(used for) operating activities |
15,854 | (152,898 | ) | |||||
Investing activities |
||||||||
Investment in prepublication costs |
(49,238 | ) | (35,877 | ) | ||||
Purchases of property and equipment |
(17,481 | ) | (17,428 | ) | ||||
Acquisition of businesses and equity interests |
(13,329 | ) | — | |||||
Disposition of property, equipment and businesses |
18,025 | 45,639 | ||||||
Additions to technology projects |
(1,001 | ) | (4,267 | ) | ||||
Cash (used for) investing activities |
(63,024 | ) | (11,933 | ) | ||||
Financing activities |
||||||||
Payments on short-term debt – net |
(1,732 | ) | (21,057 | ) | ||||
Dividends paid to shareholders |
(62,842 | ) | (57,394 | ) | ||||
Repurchase of treasury shares |
(249,256 | ) | (117,880 | ) | ||||
Exercise of stock options |
44,713 | 70,428 | ||||||
Other |
(55 | ) | (85 | ) | ||||
Cash (used for) financing activities |
(269,172 | ) | (125,988 | ) | ||||
Effect of exchange rate changes on cash |
(3,182 | ) | (823 | ) | ||||
Net change in cash and equivalents |
(319,524 | ) | (291,642 | ) | ||||
Cash and equivalents at beginning of period |
680,623 | 695,591 | ||||||
Cash and equivalents at end of period |
$ | 361,099 | $ | 403,949 | ||||
See accompanying notes. |
||||||||
7
The McGraw-Hill Companies, Inc.
Notes to Consolidated Financial Statements
1. Basis of Presentation
The financial information in this report has not been audited, but in the opinion of management all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly such information have been included. The operating results for the three months ended March 31, 2005 and 2004 are not necessarily indicative of results to be expected for the full year due to the seasonal nature of some of the Company’s businesses. The financial statements included herein should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
The Company’s critical accounting policies are disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Company’s annual report on Form 10-K for the year ended December 31, 2004. On an ongoing basis, the Company evaluates its estimates and assumptions, including those related to revenue recognition, allowance for doubtful accounts and sales returns, valuation of inventories, prepublication costs, valuation of long-lived assets, goodwill and other intangible assets, retirement plans and postretirement healthcare and other benefits and income taxes. Since the date of the annual report on Form 10-K, there have been no material changes to the Company’s critical accounting policies.
Certain prior year amounts have been reclassified for comparability purposes.
In December 2002, The FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of SFAS No. 123.” This statement amends SFAS No. 123, ”Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation, and requires additional disclosures in interim and annual financial statements. The disclosure in interim periods requires pro forma net income and net income per share as if the Company adopted the fair value method of accounting for stock-based awards. Pro forma net income and earnings per share primarily reflecting compensation cost for the fair value of stock options for the three months ended March 31, 2005 and 2004 were as follows:
(in
thousands, except earnings |
||||||||
per
share data) |
2005 | 2004 | ||||||
Net income, as reported |
$ | 78,735 | $ | 75,679 | ||||
Stock-based compensation cost
included in net income, net of tax |
3,559 | 2,965 | ||||||
Fair value of stock based
compensation cost, net of tax |
(15,586 | ) | (13,711 | ) | ||||
Pro forma net income |
$ | 66,708 | $ | 64,933 | ||||
Basic earnings per common share
as reported |
$ | 0.42 | $ | 0.40 | ||||
Pro forma |
$ | 0.35 | $ | 0.34 | ||||
Diluted earnings per common share
as reported |
$ | 0.41 | $ | 0.39 | ||||
Pro forma |
$ | 0.34 | $ | 0.33 | ||||
Basic weighted average shares
outstanding |
189,415 | 190,581 | ||||||
Diluted weighted average shares
outstanding |
193,300 | 193,490 | ||||||
8
The McGraw-Hill Companies, Inc.
Notes to Consolidated Financial Statements
The fair value of each option grant was estimated on the date of the grant using a lattice option-pricing model in 2005 and the Black-Scholes option-pricing model in 2004, using the following assumptions:
| 2005 | 2004 | |||||||
Risk free average interest rate |
1.99-4.64 | % | 2.9 | % | ||||
Dividend yield |
1.6 | % | 1.6 | % | ||||
Volatility |
16-23 | % | 17.0 | % | ||||
Expected life (years) |
0.5-6.8 | 5.0 | ||||||
2. Comprehensive Income
The following table is a reconciliation of the Company’s net income to comprehensive income for the three month period ended March 31:
| (in thousands) | 2005 | 2004 | ||||||
Net income |
$ | 78,735 | $ | 75,679 | ||||
Other comprehensive (loss)/income: |
||||||||
Foreign currency translation adjustments |
(2,855 | ) | 5,050 | |||||
Comprehensive income |
$ | 75,880 | $ | 80,729 | ||||
3. Segment and Related Information
The Company has three reportable segments: McGraw-Hill Education, Financial Services, and Information and Media Services. McGraw-Hill Education is one of the premier global educational publishers serving the elementary and high school, college and university, professional and international markets. In January 2004, the Company divested Landoll, Frank Schaffer and related juvenile retail publishing businesses, which were part of the McGraw-Hill Education segment. In accordance with SFAS No. 144, the Company reflected the results of these businesses as discontinued operations as of December 31, 2003 (See Note 4). The Financial Services segment operates under the Standard & Poor’s brand and provides credit ratings, evaluation services, and analyses globally on corporations, financial institutions, securitized and project financings, and local, state and sovereign governments. Financial Services provides a wide range of analytical and data services for investment managers and investment advisors globally. The Financial Services segment is also a leading provider of valuation and consulting services. The Information and Media Services segment includes business and professional media offering information, insight and analysis.
Operating profit by segment is the primary basis for the chief operating decision maker of the Company, the Executive Committee, to evaluate the performance of each segment. A summary of operating results by segment for the three months ended March 31, 2005 and 2004 follows:
9
The McGraw-Hill Companies, Inc.
Notes to Consolidated Financial Statements
| 2005 | 2004 | |||||||||||||||
| Operating | Operating | |||||||||||||||
| (in thousands) | Revenue | Profit | Revenue | Profit | ||||||||||||
McGraw-Hill Education |
$ | 307,300 | ($78,674 | ) | $ | 286,489 | $ | (68,796 | ) | |||||||
Financial Services |
547,281 | 222,512 | 456,635 | 173,839 | ||||||||||||
Information and Media
Services |
174,425 | 4,746 | 176,743 | 13,651 | ||||||||||||
Total operating segments |
1,029,006 | 148,584 | 919,867 | 118,694 | ||||||||||||
General corporate expense |
— | (22,910 | ) | — | (27,646 | ) | ||||||||||
Interest expense |
— | (698 | ) | — | (1,737 | ) | ||||||||||
Total Company |
$ | 1,029,006 | $ | 124,976 | * | $ | 919,867 | $ | 89,311 | * | ||||||
| * | Income from continuing operations before taxes on income. |
4. Acquisitions and Dispositions
Acquisitions: On February 21, 2005, the Company acquired Assirt, a leading provider of fund data, ratings and portfolio services to the Australian investment marketplace. Assirt is now part of the Financial Services segment.
On April 1, 2005, the Company acquired Vista Research, Inc., a leading provider of primary research. Vista will enhance the growth prospects of the Financial Services segment’s research product suite by providing clients with access to professionals with direct experience in industries such as technology, media, telecommunications and healthcare. Vista’s network of industry practitioners is able to offer investors fresh, field-level insights about issues and conditions affecting companies and sectors. Vista Research, Inc. is now part of the Financial Services segment.
On April 1, 2005, the Company acquired J.D. Power and Associates, a privately held company. J.D. Power and Associates, founded in 1968 by J.D. Power III, is the leading provider of marketing information services for the global automotive industry and has established a strong and growing presence in several other important industries, including finance and insurance, healthcare, home building, telecommunications and energy. Its customer satisfaction ratings and market research are recognized worldwide as benchmarks for quality. The company, which includes the Power Information Network, LLC, has 787 employees, and operates globally in 12 locations.
The acquisition will enhance our growth prospects for our core business information platform by providing a new direct link to consumers, while also providing new collaborative opportunities with our leading franchises including BusinessWeek, Platts, McGraw-Hill Construction, Aviation Week and healthcare. J.D. Power and Associates is now part of the Information and Media Services (IMS) segment.
The Company paid approximately $420.0 million for the acquisitions of Assirt, Vista Research, Inc. and J.D. Power and Associates. The Company expects that these acquisitions will negatively affect diluted earnings per share in 2005 by $0.06 to $0.07 per share.
10
The McGraw-Hill Companies, Inc.
Notes to Consolidated Financial Statements
Dispositions: In January 2004, the Company sold the juvenile retail publishing business, which was part of the McGraw-Hill Education segment’s School Education Group. The juvenile retail publishing business produced consumer-oriented learning products for sale through educational dealers, mass merchandisers, bookstores and e-commerce. This business was selected for divestiture as it no longer fit within the Company’s strategic plans. The market was considered to have limited future growth potential, unique sales channels and low profit margins and would have required significant investment to achieve the limited growth potential.
As of December 31, 2003, in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviewed the carrying value of the juvenile retail publishing business’s net assets and adjusted the net assets to their fair market value less cost to sell. Accordingly, the Company recognized impairments to the carrying value of these net assets of approximately $75.9 million ($54.1 million after-tax, or 28 cents per diluted share) in 2003. Approximately $70.1 million of that charge was a write-off of goodwill and intangibles.
As a result of the Company’s disposition of the juvenile retail publishing business, the results of these businesses are reflected as discontinued operations for all periods presented. For the three months ended March 31, 2004, the juvenile retail publishing business generated revenue of approximately $3.9 million and had an immaterial impact on operating profit.
5. Allowances, Inventories and Accumulated Amortization of Prepublication Costs
The allowances for doubtful accounts and sales returns, the components of inventory and the accumulated amortization of prepublication costs were as follows:
| March 31, | Dec. 31, | March 31, | ||||||||||
| (in thousands) | 2005 | 2004 | 2004 | |||||||||
Allowance for doubtful
accounts |
$ | 75,608 | $ | 80,570 | $ | 94,399 | ||||||
Allowance for sales returns |
$ | 94,220 | $ | 129,098 | $ | 103,495 | ||||||
Inventories: |
||||||||||||
Finished goods |
$ | 336,500 | $ | 265,371 | $ | 285,114 | ||||||
Work-in-process |
17,657 | 15,255 | 11,473 | |||||||||