S&P Global - 10-Q quarterly report FY

 

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On April 13, 2007 there were approximately 343.2 million shares of common stock (par value $1.00 per share) outstanding.

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, 2007, and the related consolidated statements of income for the three month periods ended March 31, 2007 and 2006, and the consolidated statements of cash flows for the three month periods ended March 31, 2007 and 2006. 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, 2006, 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 27, 2007, 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, 2006, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Ernst & Young LLP

April 25, 2007

Part I
Financial Information

See accompanying notes.

See accompanying notes.

See accompanying notes.

See accompanying notes.

Beginning in 1997, participants who exercised an option by tendering previously owned shares of common stock of the Company could elect to receive a one-time restoration option covering the number of shares tendered including any shares withheld for taxes. Restoration options were granted at fair market value of the Company’s common stock on the date of the grant, had a maximum term equal to the remainder of the original option term and were subject to a six-month vesting period. Effective March 30, 2006, the Company’s restoration stock option program was eliminated. Restoration options granted between February 3 and March 30, 2006 vested immediately and all restoration options outstanding as of February 3, 2006 became fully vested. During the three months ended March 31, 2006, the Company incurred a one-time charge of $23.8 million ($14.9 million after-tax or $0.04 per diluted share) related to the elimination of the restoration stock option program.

The number of common shares issued upon exercise of stock options and the vesting of restricted stock awards were as follows:

Commercial paper borrowings at March 31, 2007 totaled $604.8 million which is categorized as current debt and classified as notes payable. Certain share repurchases executed in March 2007 remained unsettled as of March 31, 2007. Accordingly, the Company has recorded a liability of $231.3 million, classified in Other current liabilities, to cover the settlement of these shares. There were no commercial paper borrowings as of March 31, 2006 and December 31, 2006. The commercial paper borrowings are supported by the revolving credit agreement described below.

The Company has a five-year revolving credit facility agreement of $1.2 billion that expires on July 20, 2009. The Company pays a facility fee of seven basis points on the credit facility agreement whether or not amounts have been borrowed, and borrowings may be made at a spread of 13 basis points above the prevailing LIBOR rates. This spread increases to

18 basis points for borrowings exceeding 50% of the total capacity available under the facility.

The amortization of prior service (credit)/cost and amortization of loss for the three months ended March 31, 2007, included in the above table, have been recognized in the net periodic benefit cost and included in other comprehensive income, net of tax.

In 2007, the expected rate of return on plan assets is 8.0% based on a market-related value of assets, which recognizes changes in market value over five years. The Company changed certain assumptions on its pension plans which became effective on January 1, 2007:

that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). SFAS No. 157 is effective for fiscal years that begin after November 15, 2007 which for the Company is January 1, 2008 and will be applied prospectively. The Company is currently evaluating the impact SFAS No. 157 will have on its Consolidated Financial Statements and is not yet in a position to determine what, if any, effects SFAS No. 157 will have on the Consolidated Financial Statements.

Results of Operations – Comparing Three Months Ended March 31, 2007 and 2006

In the first quarter of 2007 the Company achieved growth in revenue and operating profit of 13.7% and 71.0%, respectively. The increase in revenue is primarily attributable to growth in the Financial Services segment. The quarter reflects the seasonal nature of the Company’s educational publishing operations, with the first quarter being the least significant and the third quarter being the most significant. Foreign exchange rates positively impacted revenue growth by $11.6 million and had an immaterial impact on operating profit growth during the first quarter.

The Company implemented Financial Accounting Standard Board’s Statement No. 123-revised 2004, “Share Based Payment,” (“Statement No. 123(R)”) on January 1, 2006. Included in the 2006 stock-based compensation expense is a one-time charge of $23.8 million from the elimination of the Company’s restoration stock option program.

On March 16, 2007, the Company sold its mutual fund data business, which was part of the Financial Services segment. The sale resulted in a $17.3 million pre-tax gain ($10.3 million after-tax, or $0.03 per diluted share), recorded as Other income. The divestiture of the mutual fund data business is consistent with the Financial Services segment’s strategy of directing resources to those businesses which have the best opportunities to achieve both significant financial growth and market leadership. The divestiture will enable the Financial Services segment to focus on its core business of providing independent research, ratings, data, indices and portfolio services.

The transformation of Sweets to an internet-based sales and marketing solution benefited revenue and operating profit by $6.5 million and $5.8 million, respectively, in the quarter.

Product revenue increased 3.2% in the first quarter of 2007, due primarily to increases at McGraw-Hill Education.

Product operating-related expenses were flat, which include amortization of prepublication costs, primarily due to the growth in expenses at McGraw-Hill Education from the increase in direct expenses relating to product development, offset by cost containment. Amortization of prepublication costs increased by $5.6 million or 24.8%, as compared with the first quarter of 2006, as a result of product mix and adoption cycles.

Product related selling and general expenses increased 2.1%, primarily due to sales opportunities at McGraw-Hill Education. The product margin improved 2.9% mainly due to the improved opportunities at McGraw-Hill Education. The adoption market in 2007 is expected to be between $750 million and $800 million as compared with $685 million in 2006.

Service revenue increased 17.4% in the first quarter of 2007, due primarily to a 21.5% increase in Financial Services. Financial Services increased

primarily due to the performance of structured finance ratings and corporate (industrial and financial services) and government finance ratings. In the U.S., collateralized debt obligations (CDOs) drove growth in structured finance. The growth in corporate finance ratings was attributable to increases in industrials, driven by merger and acquisition activity, and public finance issuance, driven by refundings. The service margin increased to 32.3%.

Total expenses in the first quarter of 2007 increased 5.5% due primarily to the growth in Financial Services.

During 2006, the Company restructured a limited number of business operations to enhance the Corporation’s long-term growth prospects. As a result, in 2006, the Company recorded a restructuring charge of $31.5 million pre-tax, consisting mostly of vacant facilities and employee severance costs of $8.7 million for Information & Media, $16.0 million for McGraw-Hill Education, and $6.8 million for Corporate. The after-tax charge recorded was $19.8 million or $0.06 per share. For the three months ended March 31, 2007, the Company has paid approximately $4.7 million, consisting primarily of employee severance and benefit costs. The remaining reserve at March 31, 2007 was approximately $15.9 million.

In the first quarter of 2007, depreciation expense increased 4.9% to $28.9 million as a result of increased depreciation of technology related equipment and facilities. Amortization of intangibles decreased 2.6% to $11.6 million in the first quarter of 2007.

Interest expense increased to $1.2 million in the first quarter of 2007, compared with interest income of $2.5 million in 2006. Average commercial paper outstanding was $76.1 million for the quarter ended March 31, 2007. The average interest rate on commercial paper borrowings for the quarter ended March 31, 2007 was 5.3%. There was $604.8 million in commercial paper outstanding as of March 31, 2007. There was no commercial paper outstanding during the three months ended March 31, 2006. Included in the first quarter of 2007 and 2006 is approximately $2.2 million and $2.3 million, respectively, of interest expense related to the sale leaseback of the Company’s headquarters building in New York City (See Note 11). Also included in the first quarter of 2007 and 2006, is interest income earned on investment balances.

For the quarters ended March 31, 2007 and March 31, 2006 the effective tax rate was 37.7% and 37.2%, respectively in each year. Included in the effective tax rate is the impact of the divestiture of the mutual fund data business which added an incremental 0.2 percentage points to the effective tax rate. The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48) on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an increase in the liability for unrecognized tax benefits of approximately $5.2 million, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. The total amount of federal, state and local, and foreign unrecognized tax benefits as of January 1, 2007 was $75.1 million. Included in the balance at January 1, 2007, are $13.5 million of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. In addition to the unrecognized tax benefits, the Company had approximately $8.7 million, net of tax benefit, for the payment of interest and penalties accrued as of January 1, 2007.

The Company expects the effective tax rate to be at 37.5% for the remainder of the year absent the impact of numerous factors including intervening audit

settlements, changes in federal, state or foreign law and changes in the locational mix of the Company’s income.

Net income for the quarter increased 93.8% as compared with the first quarter of 2006. Diluted earnings per share were $0.40 as compared with $0.20 in 2006. Included in 2007 is the $0.03 after-tax impact of the divestiture of the Financial Services’ mutual fund data business. Included in 2006 is a $0.04 after-tax charge from termination of the Company’s restoration stock program.

Revenue for the McGraw-Hill Education (MHE) segment increased 5.6% over the prior year, while operating loss improved 6.6%. The quarter reflects the seasonal nature of the Company’s educational publishing operations, with the first quarter being the least significant, and the third quarter being the most significant. Foreign exchange rates positively impacted revenue growth by $2.1 million and had an immaterial impact on the operating loss improvement.

McGraw-Hill Education’s first quarter stock-based compensation expense for 2006 included a one-time charge of $4.2 million from the elimination of the Company’s restoration stock option program.

In the first quarter of 2007, revenue for the McGraw-Hill School Education Group (SEG) was flat as compared with the first quarter of 2006. The comparison reflects the fact that in early 2006 SEG had $9.0 million in Texas sales that had been delayed from the previous year owing to the state’s late funding of the 2005 adoption. Total U.S. PreK-12 enrollment for 2006-2007 is estimated at 55.0 million students, up 0.5% from 2005-2006, according to the National Center for Education Statistics (NCES). The total available state new adoption market in 2007 is estimated at between $750 million and $800 million compared with approximately $685 million in 2006.

The year’s key opportunities in the state new adoption market are primarily offered by math in Texas and science in California. Additionally, science in South Carolina and reading/literature in Tennessee and Indiana provide large opportunities for 2007. Other states, such as North Carolina, offer excellent opportunities in smaller curriculum areas where SEG has relatively little competition, including music, art, and vocational education. The pace of adoption decision-making varies from state to state, but early activity has been robust in North Carolina, Texas, and California. Based on preliminary announcements in the fastest-moving states, SEG anticipates significant market shares for math in Texas and New Mexico, science in California and South Carolina, and music in North Carolina. Sales campaigns will continue through June, with orders increasing in volume through the second and third quarters.

Although new basal adoption activity tends to start later in the open territory, several large districts, including New York City, Boston, Washington, DC, and Milwaukee, have already announced plans for major purchases in 2007. With new and revised programs across the curriculum, the Company is very well positioned to capitalize on these opportunities. New and

revised supplemental offerings contributed to first quarter results, especially Number Worlds and Science Snapshots.

According to statistics compiled by the Association of American Publishers (AAP), total net basal and supplementary sales of elementary and secondary instructional materials were down by 13.8% through February 2007 compared to the same two-month period in 2006. The numbers are not considered predictive of full-year results because very little new basal purchasing occurs during the first quarter.

In the testing market, SEG’s first-quarter custom testing contracts increased over the prior year due to additional work related to the statewide assessment programs in Florida, Indiana, Colorado and Missouri as well as new work in Georgia. This increase was partially offset by lower volumes on custom contracts in New York and cancelled contracts in Kentucky and Pennsylvania. SEG continued to invest in technology to improve efficiencies in developing, delivering, and scoring custom assessments. The non-custom or “shelf” test products volume was flat in the first quarter of 2007 compared to the same period in 2006.

At the McGraw-Hill Higher Education, Professional and International Group (HPI), revenue increased $19.2 million or 11.5% compared to prior year.

For higher education all three imprints, Science, Engineering and Mathematics (SEM), Humanities, Social Science and Languages (HSSL) and Business and Economics (B&E) performed well, with SEM experiencing the highest gain of the three imprints. Key titles contributing to first quarter performance included Wild, Fund Accounting Principles, 18/e; Stevenson, Operations Management, 9/e; Lucas, The Art of Public Speaking, 9/e; Brinkley, American History: A Survey, 12/e; Saladin,Anatomy and Physiology, 4/e; and Mader, Biology, 9/e.

Professional backlist titles in the medical and technical product lines fell short of prior year levels.

Custom school products sold well in Mexico and a United Nations Educational, Scientific and Cultural Education (UNESCO) order of approximately $1.0 million for international schools across the Middle East benefited HPI. Special school funding in British Columbia and Ontario, Canada, which occurred in 2006 did not recur in 2007, affecting comparisons.

Financial Services revenue and operating profit increased substantially over first quarter 2006 results. Foreign exchange positively impacted revenue growth by $9.5 million and had an immaterial impact on operating profit growth.

The Financial Services’ first quarter stock-based compensation expense in 2006 included a one-time charge of $2.1 million from the elimination of the Company’s restoration stock option program.

On March 16, 2007, the Company sold its mutual fund data business to Morningstar, Inc. The sale resulted in a $17.3 million pre-tax gain.

The Financial Services segment’s increase in revenue and operating profit was due to the performance of structured finance and corporate (industrial and financial services) and government ratings, which represented approximately

40.8% and 34.3%, respectively, of the growth in revenue. In the U.S., collateralized debt obligations (CDOs) drove growth in structured finance. The growth in corporate finance ratings was attributable to industrials, driven primarily by bond and loan issuance related to acquisition financing. Public finance also performed well in the quarter with issuance driven primarily by refundings.

Total U.S. structured finance new issue dollar volume increased 17.2% in the first quarter versus prior year. U.S. CDO issuance increased 153.6%, according to Harrison Scott Publications and Standard & Poor’s internal estimates (Harrison Scott Publications/S&P). Growth in the U.S. CDO market continues to be driven by new structures (hybrids) and arbitrage opportunities within the cash flow and synthetic sectors; however, in the first quarter issuance volumes were also favorably impacted by concerns about widening spreads resulting from credit quality deterioration in the subprime mortgage market. U.S. commercial mortgage-backed securities (CMBS) issuance increased 34.9% over the prior year due to the historically low interest rate environment and strong commercial real estate fundamentals, which are driving commercial originations and the refinancing of maturing deals as well as rising property values. U.S. residential mortgage-backed securities (RMBS) issuance decreased 10.8%, driven primarily by declines in the subprime and affordability products and home equity sectors. According to Thomson Financial, U.S. corporate issuance by dollar volume for the first quarter of 2007 increased 42.9%, with investment grade up 40.9% and high yield issuance up 56.9%, driven by continued robust merger and acquisition activity and opportunistic financing as issuers took advantage of favorable market conditions. The U.S. municipal market grew 46.8%, coming off a slow first quarter 2006, reflecting increased levels of refunding due to favorable interest rates. Bank loan ratings, derivative ratings as well as rating evaluation services all showed strong growth in the quarter.

In Europe for the first quarter, structured finance issuance grew 160.9% as all structured finance asset classes experienced growth, with CDOs and RMBS being particularly strong. CDO issuance was driven by a surge in cash CDO deals and a robust market for collateralized loan obligations (CLOs). A stable economic backdrop combined with moderate home price growth in most European countries fueled demand for mortgage credit and RMBS volumes picked up as new and existing issuers took advantage of tight spreads. European corporate issuance was up in the first quarter due primarily to solid growth in the financial services sector.

Standard & Poor’s is a leading provider of data, analysis and independent investment advice and recommendations. Securities information products such as RatingsXpress and RatingsDirect performed well as customer demand for fixed income data increased. CUSIP issuance volume also increased. The Capital IQ product showed growth with the number of clients increasing 32.7% over prior year. Market conditions continued to be challenging in equity research.

Revenue related to Standard & Poor’s indices increased as assets under management for exchange-traded funds (ETFs) rose 23.7% from March 31, 2006 to $170.3 billion as of March 31, 2007. ETF assets under management at December 31, 2006 were $161.2 billion.

The financial services industry is subject to the potential for increasing regulation in the United States and abroad. The businesses conducted by the Financial Services segment are in certain cases regulated under the Credit Rating Agency Reform Act of 2006, U.S. Investment Advisers Act of 1940, the U.S. Securities Exchange Act of 1934, the National Association of Securities Dealers and/or the laws of the states or other jurisdictions in which they conduct business.

Standard & Poor’s Ratings Services is a credit rating agency that has been designated as one of five Nationally Recognized Statistical Rating Organizations, or NRSROs, by the Securities and Exchange Commission (SEC). The SEC first began designating NRSROs in 1975, for use of their credit ratings, in the determination of capital charges for registered brokers and dealers under the SEC’s Net Capital

Rule. During the last five years, the SEC has been examining the purpose of and the need for greater regulation of NRSROs. During this period, the SEC issued several documents. A 2003 report discussed the role and function of credit rating agencies in the operation of the securities markets. In June 2003, the SEC solicited comments on a concept release that questioned: (a) whether the SEC should continue to designate NRSROs for regulatory purposes and, if so, what the criteria for designation should be; and (b) the level of oversight that the SEC should apply to NRSROs. Additionally in 2005, the SEC issued a rule proposal to define NRSROs.

Credit rating agency legislation entitled “Credit Rating Agency Reform Act of 2006” was signed into law by President Bush on September 29, 2006. The legislation creates a new SEC registration system for rating agencies that want to be treated as NRSROs. Eligible agencies include those with business models different from the existing NRSROs, including Standard & Poor’s. Registrants, including existing NRSROs, will need to submit policies, methodologies, performance data and other materials the SEC will require under new rules to be issued this year. New firms must provide evidence that certain capital market participants regard them as issuers of quality credit opinions. The SEC will have a limited time to deny an application. Registered NRSROs will need to certify annually as to the accuracy of application materials and list material changes. The SEC is given new, expansive authority and oversight of NRSROs and will be able to censure NRSROs, revoke their registration or limit or suspend their registration in certain cases. The SEC is not supposed to be injected into the analytical process, ratings criteria or methodology. Importantly, an agency’s decision to register and comply with the law will not constitute a waiver of or diminish any right, defense or privilege available under applicable law. Pre-emption language is included consistent with other legal precedent. The law is effective the earlier of 270 days from enactment (June 26, 2007) or when the SEC issues final rules required by the law. The Company does not believe this legislation will have a material adverse effect on its financial condition or results of operations.

On February 5, 2007, the SEC issued proposed rules to implement the 2006 legislation and a draft Form NRSRO for applicants to complete in registering with the SEC. Public comments were due by March 12^th. Standard & Poor’s submitted comments on March 12th and submitted a second set of comments on March 26^th. Standard & Poor’s plans to submit an application on Form NRSRO, when finalized, by the June 26^th deadline.

The legal status of rating agencies has also been addressed by courts in the United States in various decisions and is likely to be considered and addressed in legal proceedings from time to time in the future.

Outside the United States, particularly in Europe, regulators and government officials also have reviewed whether credit rating agencies should be subject to formal oversight. In December 2005, the European Commission issued a report endorsing earlier advice by the Committee of European Securities Regulators (CESR) that rating agencies should be subject to market-based oversight based on compliance with the IOSCO Code described below.

The International Organization of Securities Commissions (IOSCO), a global group of securities commissioners, reviewed the role of rating agencies and their processes. This review culminated in December 2004 with IOSCO’s publication of its Code of Conduct Fundamentals for rating agencies. Standard & Poor’s worked closely with IOSCO in its drafting of the code and earlier principles on which the code was based. In October 2005, Standard & Poor’s replaced its existing code of practices and procedures with a new Ratings Services Code of Conduct which is consistent with the IOSCO Code. In February 2006, Standard & Poor’s Ratings Services published a report concerning implementation of its Code ofConduct. Standard & Poor’s met with representatives of CESR in June 2006 to discuss the Ratings Services Code of Conduct and Implementation Report. In July 2006, CESR published a questionnaire for comment on rating agencies’ codes of conduct and implementation. CESR published the comments it received this fall. In December 2006, pursuant to a request by the European Commission, CESR issued its first annual report to the European Commission on compliance by credit rating

agencies with the IOSCO Code. CESR concluded that the four agencies it reviewed (Standard & Poor’s Ratings Services, Moody’s Investors Service, Fitch Ratings and Dominion Bond Rating Service) are largely compliant with the IOSCO Code. CESR noted areas for improvement and plans to review these areas in 2007. CESR stated it will also assess in its next report the impact of the new U.S. law and SEC rules on the ratings industry in Europe.

IOSCO conducted a similar review of rating agencies’ implementation of IOSCO’s model Code of Conduct and issued a draft report earlier this year. IOSCO’s draft conclusions on implementation by the major rating agencies are positive overall. Comments on IOSCO’s draft are due by mid-May.

New legislation, regulations or judicial determinations applicable to credit rating agencies in the United States and abroad could affect the competitive position of Standard & Poor’s ratings services; however, the Company does not believe that any new or currently proposed legislation, regulations or judicial determinations would have a materially adverse effect on its financial condition or results of operations.

The market for credit ratings as well as research, investment advisory and broker-dealer services is very competitive. The Financial Services segment competes domestically and internationally on the basis of a number of factors, including quality of ratings, research and investment advice, client service, reputation, price, geographic scope, range of products and technological innovation. In addition, in some of the countries in which Standard & Poor’s competes, governments may provide financial or other support to locally-based rating agencies and may from time to time establish official credit rating agencies, credit ratings criteria or procedures for evaluating local issuers.

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) (collectively, “Standard & Poor’s”) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the Tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings on Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit. Standard & Poor’s filed its answer, counterclaim and third-party claims on March 16, 2006 and will continue to vigorously contest the action.

In a separate proceeding, the prosecutor’s office in Parma, Italy is conducting an investigation into the bankruptcy of Parmalat. In June 2006, the prosecutor’s office issued a Note of Completion of an Investigation (“Note of Completion”) concerning allegations, based on Standard & Poor’s investment grade ratings of Parmalat, that individual Standard & Poor’s rating analysts conspired with Parmalat insiders and rating advisors to fraudulently or negligently cause the Parmalat bankruptcy. The Note of Completion was served on eight Standard & Poor’s rating analysts.

While not a formal charge, the Note of Completion indicates the prosecutor’s intention that the named rating analysts should appear before a judge in Parma for a preliminary hearing, at which hearing the judge will determine whether there is sufficient evidence against the rating analysts to proceed to trial. No date has been set for the preliminary hearing. On July 7, 2006, a defense brief was filed with the Parma prosecutor’s office on behalf of the rating analysts. The Company believes that there is no basis in fact or law to support the

allegations against the rating analysts, and they will be vigorously defended by the subsidiaries involved.

In addition, in the normal course of business both in the United States and abroad, the Company and its subsidiaries are defendants in numerous legal proceedings and are involved, from time to time, in governmental and self-regulatory agency proceedings, which may result in adverse judgments, damages, fines or penalties. Also, various governmental and self-regulatory agencies regularly make inquiries and conduct investigations concerning compliance with applicable laws and regulations. Based on information currently known by the Company’s management, the Company does not believe that any pending legal, governmental or self-regulatory proceedings or investigations will result in a material adverse effect on its financial condition or results of operations.

In the first quarter 2007, revenue grew by 4.1% or $9.4 million over the prior year while operating profit increased $8.2 million. During 2006, the Sweets building products database was integrated into the McGraw-Hill Construction Network, providing architects, engineers and contractors a powerful new search function for finding, comparing, selecting and purchasing products. This integration transformed Sweets from a primarily print catalog to a bundled print and online service. Historically, Sweets file sales were recognized in the fourth quarter of each year when catalogs were delivered to its customers. Online service revenue is recognized as the service is provided. Sales of the bundled product will be recognized ratably over the service period, primarily 2007. $6.5 million of revenue and $5.8 million of operating profit were recorded in the Business-to-Business Group in the first quarter of 2007 related to the Sweets transformation. In Broadcasting, comparisons to first quarter 2006 are driven by the loss of the Super Bowl on ABC and declines in local and national advertising, particularly in the automotive sector. Foreign exchange rates had an immaterial impact on revenue growth and a negative impact of $1.2 million on segment operating profit growth.

Information & Media’s first quarter 2006 stock-based compensation expense included a one-time charge of $2.7 million from the elimination of the Company’s restoration stock option program.

At the Business-to-Business Group, revenue in the first quarter increased 7.5% compared to prior year due to growth in oil, natural gas and power news and pricing products and the Sweets transformation. According to the Publishing Information Bureau (PIB), BusinessWeek’s advertising pages in the global edition for the first quarter were down 3.0%, with comparable number of issues year to year for PIB purposes and revenue recognition purposes.

BusinessWeek.com continues to improve its performance with increases in both advertising and unique visitors compared with the first quarter 2006. The Company continues to make investments in the BusinessWeek.com brand.

Oil, natural gas and power news and pricing products experienced growth as a result of the increased need for market information as the price of crude oil continued to be volatile.

The release of new automobile and healthcare studies as well as increased penetration of existing studies, positively influenced growth for the Business-to-Business Group in the first quarter of 2007 over the first quarter of 2006.

As of March 2007, total U.S. construction starts were down 15% versus prior year. Most of the decline was due to a sharply reduced amount of residential building, reported at 29% below first quarter 2006. Nonresidential building was down a slight 1% from its elevated activity a year ago, while nonbuilding construction registered a 7% gain.

Broadcasting revenue for the quarter declined by 18.8% in 2007 compared to the first quarter of the prior year. Broadcasting benefited in 2006 from ABC’s airing of the Super Bowl and political advertising in 2006 which included proposition advertising in Indiana and Colorado and a special election in California. No such comparable events occurred in 2007. Additionally, the Group’s decision not to renew the Oprah Winfrey Show for the San Diego and Denver ABC affiliates negatively impacted growth. Local and national advertising declined primarily due to the automotive and services categories.

The Company continues to maintain a strong financial position. The Company’s primary source of funds for operations is cash generated by operating activities. The Company’s core businesses have been strong cash generators. Income and consequently cash provided from operations during the year are significantly impacted by the seasonality of businesses, particularly educational publishing. This seasonality also impacts cash flow and related borrowing patterns. The Company’s cash flow is typically negative to neutral in the first half of the year and turns positive during the third and fourth quarters. Debt financing is used as necessary for acquisitions and for seasonal fluctuations in working capital. Cash and cash equivalents were $429.6 million at March 31, 2007, an increase of $76.1 million from December 31, 2006. Most of the cash and equivalents as of March 31, 2007 are held outside the United States. The Company’s subsidiaries maintain cash balances at financial institutions located throughout the world. These cash balances are subject to normal currency exchange fluctuations. Typically, cash held outside the U.S. is anticipated to be utilized to fund international operations or to be reinvested outside the U.S. as a significant portion of the Company’s opportunities for growth in the coming years are expected to be abroad.

Cash Flow

Operating Activities: Cash provided by operations was $128.7 million for the first three months of 2007, as compared to $20.3 million of cash used for operations in 2006. The change in cash from operating activities is primarily the result of growth in income from operations and strong cash collections.

Accounts receivable (before reserves) decreased $262.1 million from the prior year-end, primarily due to the seasonality of the educational business and by strong cash collections. This decrease compares to a $226.9 million decrease in 2006 from the prior year-end. Year-to-date, the number of day’s sales outstanding for operations have improved by 5 days year over year. Inventories increased by $61.9 million from the end of 2006 as the Company’s education business prepares for its selling season. The increase in inventories over the prior year is primarily the result of the stronger adoption opportunities in 2007 compared with 2006.

Accounts payable and accrued expenses decreased by $323.8 million over the prior year-end primarily due to the timing of first quarter performance based compensation payments. This decrease compares to a $371.4 million decrease in 2006. Deferred taxes reduced cash from operations by $39.0 primarily as a result of deferred tax assets relating to the accounting of share-based compensation in accordance with Statement No. 123(R).

Investing Activities: Cash used for investing activities was $27.4 million and $63.9 million in the first three months of 2007 and 2006, respectively. The change over the prior year is primarily due to the disposition of the mutual fund data business.

Purchases of property and equipment totaled $22.7 million in the first three months of 2007 compared with $11.6 million in 2006. For 2007, capital expenditures are expected to be approximately $250 million and primarily relate to increased investment in the Company’s information technology data centers and other technology initiatives, a well as the new McGraw-Hill Education facility in Iowa.

Net prepublication costs increased $29.8 million to $537.7 million from December 31, 2006, as spending outpaced amortization. Prepublication investment in the current year totaled $57.4 million as of March 31, 2007, $4.2 million less than the same period in 2006. Prepublication investment for 2007 is now expected to be approximately $310 million, reflecting the significant adoption opportunities in key states in 2007 and beyond.

Financing Activities: Cash used for financing activities was $26.1 million as of March 31, 2007 compared to $485.3 million in 2006. The difference is primarily attributable to the increased borrowings of commercial paper. In 2007, cash was utilized to repurchase approximately 9.5 million shares for $611.1 million on a settlement basis. An additional 3.7 million shares were repurchased in the first quarter of 2007, that settled in April 2007 bringing the total repurchase to 13.2 million shares for $842.4 million on a trade date basis. On a settlement basis, cash was utilized to repurchase approximately 10 million shares for $525.7 million in the first quarter of 2006. An additional 8.4 million shares were repurchased on March 30, 2006 and that transaction settled on April 5, 2006 bringing the total repurchase to 18.4 million shares for $994.7 million on a trade date basis. Shares repurchased under the repurchase program were used for general corporate purposes, including the issuance of shares for stock compensation plans and to offset the dilutive effect of the exercise of employee stock options.

There were $604.8 million in commercial paper borrowings outstanding as of March 31, 2007. There were no commercial paper borrowings as of March 31, 2006. Commercial paper borrowings are supported by the Company’s five-year revolving credit facility agreement of $1.2 billion which expires on July 20, 2009. The Company pays a facility fee of seven basis points on the credit facility whether or not amounts have been borrowed, and borrowings may be made at a spread of 13 basis points above the prevailing LIBOR rates. This spread increases to 18 basis points for borrowings exceeding 50% of the total capacity available under the facility. The facility contains certain covenants, and the only financial covenant requires that the Company not exceed indebtedness to cash flow ratio, as defined, of 4 to 1 at any time. This restriction has never been exceeded. There were no borrowings under this agreement as of March 31, 2007 and 2006.

The Company also has the capacity to issue Extendible Commercial Notes (ECNs) of up to $240 million. ECNs replicate commercial paper, except that the Company has an option to extend the note beyond its initial redemption date to a maximum final maturity of 390 days. However, if exercised, such an extension is at a higher reset rate, which is at a predetermined spread over LIBOR and is related to the Company’s commercial paper rating at the time of extension. As a result of the extension option, no backup facilities for these borrowings are required. As is the case with commercial paper, ECNs have no financial covenants. There were no ECNs outstanding at March 31, 2007 and 2006.

On April 19, 2007, the Company signed a promissory note with one of its providers of banking services to enable the Company to borrow additional funds, on an uncommitted basis, from time to time to supplement its commercial paper borrowings. The specific terms (principal, interest rate and maturity date) of each borrowing governed by this promissory note will be determined on the borrowing date of each loan. There are no borrowings outstanding under this promissory note.

Under the shelf registration that became effective with the Securities and Exchange Commission in 1990, an additional $250 million of debt securities can be issued.

On April 11, 2006, The Company announced it terminated the restoration feature of its stock option program on March 30, 2006. The Board of Directors voted to eliminate restoration stock options in an effort to reduce future expenses the Company will incur under Statement No. 123(R). Additionally, the Company has reshaped its long-term incentive compensation program to emphasize the use of restricted performance stock over employee stock options.

On January 24, 2006, the Board of Directors approved a stock repurchase program authorizing the purchase of up to 45 million additional shares, which was approximately 12.1% of the total shares of the Company’s outstanding common stock. The repurchased shares may be used for general corporate purposes, including the issuance of shares in connection with the exercise of employee stock options. Purchases under this program may be made from time to time on the open market and in private transactions depending on market conditions. At December 31, 2006, authorization for the repurchase of 20 million shares remained under the 2006 program. On January 31, 2007, the Board of Directors approved a new stock repurchase program (2007 program) authorizing the repurchase of up to 45 million additional shares. The Company repurchased 13.2 million shares (on a trade date basis) from the 2006 program during the first quarter of 2007 for $842.4 million at an average price of $63.81 per share. During the remainder of 2007, the Company expects to repurchase up to an additional 1.8 million shares from the 2006 program, subject to market conditions.

On January 31, 2007, the Board of Directors approved an increase of 12.9% in the quarterly common stock dividend from $0.1815 to $0.2050 per share.

The Company is exposed to market risk from changes in foreign exchange rates. The Company has operations in various foreign countries. The functional currency is the local currency for all locations, except in the McGraw-Hill Education segment, where operations that are extensions of the parent have the U.S. dollar as the functional currency. For hyper-inflationary economies, the functional currency is the U.S. dollar. In the normal course of business, these operations are exposed to fluctuations in currency values. The Company does not generally enter into derivative financial instruments in the normal course of business, nor are such instruments used for speculative purposes. The Company has no such instruments outstanding at this time.

The Company has naturally hedged positions in most countries from a local currency perspective with offsetting assets and liabilities. The gross amount of the Company’s foreign exchange balance sheet exposure from operations is $188.1 million as of March 31, 2007. Management has estimated using an undiversified value-at-risk analysis with 95% certainty that the foreign exchange gains and losses should not exceed $20.3 million over the next year based on the historical volatilities of the portfolio.

The Company’s net interest expense is sensitive to changes in the general level of U.S. and foreign interest rates. Based on average debt and investments outstanding over the past three months, the following is the projected annual impact on interest expense on current operations:

In February 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) to provide companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective for fiscal years that begin after November 15, 2007 which for the Company is January, 1 2008 and will be applied prospectively. The Company is currently evaluating the impact SFAS No. 159 will have on its Consolidated Financial Statements and is not yet in a position to determine what, if any, effects SFAS No. 159 will have on the Consolidated Financial Statements.

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”) to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). SFAS No. 157 is effective for fiscal years that begin after November 15, 2007 which for the Company is January 1, 2008 and will be applied prospectively. The Company is currently evaluating the impact SFAS No. 157 will have on its Consolidated Financial Statements and is not yet in a position to determine what, if any, effects SFAS No. 157 will have on the Consolidated Financial Statements.

In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”) which became effective for and was adopted by the Company as of January 1, 2007. FIN 48 clarifies the accounting and reporting for uncertainties in income taxes and prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. For further information regarding the effects of adopting FIN 48 see Note 12.

In June 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF No. 06-3”) which became effective for the Company as of January 1, 2007. EITF No. 06-3 provides that taxes imposed by a governmental authority on a revenue producing transaction between a seller and a customer should be shown in the income statement on either a gross or a net basis, based on the entity’s accounting policy, which should be disclosed pursuant to Accounting Principles Board (“APB”) Opinion No. 22, “Disclosure of Accounting Policies.” The Company will continue to present taxes within the scope of EITF No. 06-3 on a net basis. As such, the adoption of EITF No. 06-3 did not have a material effect on the Company’s consolidated financial statements.

Since the date of the annual report, there have been no other material changes to the Company’s critical accounting policies.

This section, as well as other portions of this document, includes certain forward-looking statements about the Company’s businesses, new products, sales, expenses, tax rates, cash flows and operating and capital requirements. Such forward-looking statements include, but are not limited to: the strength and sustainability of the U.S. and global economy; Educational Publishing’s level of success in 2007 adoptions and enrollment and demographic trends; the level of educational funding; the level of education technology investments; the strength of Higher Education, Professional and International publishing markets and the impact of technology on them; the level of interest rates and the strength of the economic recovery, profit levels and the capital markets in the U.S. and abroad; the level of success of new product development and global expansion and strength of domestic and international markets; the demand and market for debt ratings, including mortgage and asset-backed securities; the regulatory environment affecting Standard & Poor’s; the level of merger and acquisition activity in the U.S. and abroad; the strength of the domestic and international advertising markets; the volatility of the energy marketplace; the contract value of public works, manufacturing and single-family unit construction; the level of political advertising; and the level of future cash flow, debt levels, product-related manufacturing expenses, pension expense, distribution expenses, postal rates, prepublication, amortization and depreciation expense, income tax rates, capital, technology, restructuring charges and other expenditures and prepublication cost investment.

Actual results may differ materially from those in any forward-looking statements because any such statements involve risks and uncertainties and are subject to change based upon various important factors, including, but not limited to, worldwide economic, financial, political and regulatory conditions; currency and foreign exchange volatility; the health of capital and equity markets, including future interest rate changes; the implementation of an expanded regulatory scheme affecting Standard & Poor’s ratings and services; the level of funding in the education market (both domestically and internationally); the pace of recovery in advertising; continued investment by the construction, computer and aviation industries; the successful marketing of new products, and the effect of competitive products and pricing.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company has no material changes to the disclosure made on this matter in the Company’s report on Form 10-K for the year ended December 31, 2006. Please see the financial condition section in Item 2 of this Form 10-Q for additional market risk disclosures.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed with the Securities and Exchange Commission (SEC) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.

As of March 31, 2007, an evaluation was performed under the supervision and with the participation of the Company’s management, including the CEO and CFO, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under

the U.S. Securities Exchange Act of 1934). Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2007.

There have been no changes in the Company’s internal controls over financial reporting during the most recent quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 1. Legal Proceedings

A writ of summons was served on The McGraw-Hill Companies, SRL and on The McGraw-Hill Companies, SA (both indirect subsidiaries of the Company) (collectively, “Standard & Poor’s”) on September 29, 2005 and October 7, 2005, respectively, in an action brought in the Tribunal of Milan, Italy by Enrico Bondi (“Bondi”), the Extraordinary Commissioner of Parmalat Finanziaria S.p.A. and Parmalat S.p.A. (collectively, “Parmalat”). Bondi has brought numerous other lawsuits in both Italy and the United States against entities and individuals who had dealings with Parmalat. In this suit, Bondi claims that Standard & Poor’s, which had issued investment grade ratings of Parmalat until shortly before Parmalat’s collapse in December 2003, breached its duty to issue an independent and professional rating and negligently and knowingly assigned inflated ratings in order to retain Parmalat’s business. Alleging joint and several liability, Bondi claims damages of euros 4,073,984,120 (representing the value of bonds issued by Parmalat and the rating fees paid by Parmalat) with interest, plus damages to be ascertained for Standard & Poor’s alleged complicity in aggravating Parmalat’s financial difficulties and/or for having contributed in bringing about Parmalat’s indebtedness towards its bondholders, and legal fees. The Company believes that Bondi’s allegations and claims for damages lack legal or factual merit. Standard & Poor’s filed its answer, counterclaim and third-party claims on March 16, 2006 and will continue to vigorously contest the action.

In a separate proceeding, the prosecutor’s office in Parma, Italy is conducting an investigation into the bankruptcy of Parmalat. In June 2006, the prosecutor’s office issued a Note of Completion of an Investigation (“Note of Completion”) concerning allegations, based on Standard & Poor’s investment grade ratings of Parmalat, that individual Standard & Poor’s rating analysts conspired with Parmalat insiders and rating advisors to fraudulently or negligently cause the Parmalat bankruptcy. The Note of Completion was served on eight Standard & Poor’s rating analysts.

While not a formal charge, the Note of Completion indicates the prosecutor’s intention that the named rating analysts should appear before a judge in Parma for a preliminary hearing, at which hearing the judge will determine whether there is sufficient evidence against the rating analysts to proceed to trial. No date has been set for the preliminary hearing. On July 7, 2006, a defense brief was filed with the Parma prosecutor’s office on behalf of the rating analysts. The Company believes that there is no basis in fact or law to support the allegations against the rating analysts, and they will be vigorously defended by the subsidiaries involved.

In addition, in the normal course of business both in the United States and abroad, the Company and its subsidiaries are defendants in numerous legal proceedings and are involved, from time to time, in governmental and self-regulatory agency proceedings, which may result in adverse judgments, damages, fines or penalties. Also, various governmental and self-regulatory agencies regularly make inquiries and conduct investigations concerning compliance with

applicable laws and regulations. Based on information currently known by the Company’s management, the Company does not believe that any pending legal, governmental or self-regulatory proceedings or investigations will result in a material adverse effect on its financial condition or results of operations.

On January 24, 2006, the Board of Directors approved a stock repurchase program authorizing the purchase of up to 45 million additional shares, which was approximately 12.1% of the total shares of the Company’s outstanding common stock as of January 24, 2006. As of December 31, 2006, 20 million shares remained available under the 2006 repurchase program. On January 31, 2007 the Board of Directors approved a new stock repurchase program authorizing the purchase of up to 45 million additional shares, which was approximately 12.7% of the total shares of the Company’s outstanding common stock as of January 31, 2007. The repurchase programs have no expiration date. The repurchased shares may be used for general corporate purposes, including the issuance of shares in connection with the exercise of employee stock options. Purchases under this program may be made from time to time on the open market and in private transactions, depending on market conditions.

The following table provides information on purchases made by the Company of its outstanding common stock during the first quarter of 2007 pursuant to the stock repurchase program authorized by the Board of Directors on January 24, 2006 (column c). In addition to purchases under the 2006 stock repurchase program, the number of shares in column (a) include: 1) shares of common stock that are tendered to the Registrant to satisfy the employees’ tax withholding obligations in connection with the vesting of awards of restricted performance shares (such shares are repurchased by the Registrant based on their fair market value on the vesting date), and 2) shares of the Registrant deemed surrendered to the Registrant to pay the exercise price and to satisfy the employees’ tax withholding obligations in connection with the exercise of employee stock options. There were no other share repurchases during the quarter outside the stock repurchases noted below:

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.