MCGRAW HILL FINANCIAL INC 10-Q 2010
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2010
For the transition period from to
Commission File Number 1-1023
THE MCGRAW-HILL COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (212) 512-2000
(Former name, former address and former fiscal year, if changed since last report)
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and small reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ
On July 16, 2010 there were approximately 309.1 million shares of common stock (par value $1.00 per share) outstanding.
The McGraw-Hill Companies, Inc.
TABLE OF CONTENTS
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 June 30, 2010, and the related consolidated statements of income for the three-month and six-month periods ended June 30, 2010 and 2009, and the consolidated statements of cash flows for the six-month periods ended June 30, 2010 and 2009. These financial statements are the responsibility of the Companys 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, 2009, and the related consolidated statements of income, equity, and cash flows for the year then ended, not presented herein, and in our report dated February 24, 2010, we expressed an unqualified opinion on those consolidated financial statements.
/s/ ERNST & YOUNG LLP
July 23, 2010
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
See accompanying notes to the Consolidated Financial Statements.
See accompanying notes to the Consolidated Financial Statements.
See accompanying notes to the Consolidated Financial Statements.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in thousands, except per share amounts or as noted)
The following Management Discussion and Analysis (MD&A) provides a narrative of the results of operations and financial condition of The McGraw-Hill Companies, Inc. (together with its consolidated subsidiaries, the Company, we, us or our) for the three and six months ended June 30, 2010. The MD&A should be read in conjunction with the Consolidated Financial Statements, accompanying notes and MD&A included in our Annual Report on Form 10-K for the year ended December 31, 2009. The MD&A includes the following sections:
We are a leading global information services provider serving the education, financial services and business information markets with information products and services. Other markets include energy; automotive; construction; aerospace and defense; broadcasting; and marketing information services. The operations consist of three business segments: McGraw-Hill Education (MHE), Financial Services and Information & Media (I&M). As the customers of our businesses vary, we manage and assess the performance of our business based on the performance of our segments. Based on this approach and the nature of our operations, the discussion of results generally focuses around our three segments versus distinguishing between products and services.
Revenue increased at our MHE and Financial Services segments and declined at our I&M segment. Operating profit improved at our MHE and I&M segments and declined at our Financial Services segment.
Foreign exchange rates had favorable impacts of $3.4 million on revenue and $6.8 million on operating profit.
Revenue increased at our MHE and Financial Services segments and declined at our I&M segment. Operating profit/(loss) improved at all three of our segments.
Foreign exchange rates had favorable impacts of $21.3 million on revenue and $3.3 million on operating results.
Results of Operations Comparing Three and Six Months Ended June 30, 2010 and 2009
Product revenue and expenses consist of educational and information products, primarily books, magazine circulations and syndicated study programs in our MHE and I&M segments. Service revenue and expenses consist of our Financial Services segment, service assessment contracts in our MHE segment and information-related services and advertising in our I&M segment.
Product revenue increased primarily due to increases at MHE for both print and digital product in Higher Education and increases in the adoption states. Service revenue decreased slightly, primarily due to a decline in custom testing revenue at MHE due to the discontinuation of contracts. This was partially offset by increases in our index services, ratings services and growth at Capital IQ. The divestiture of BusinessWeek at I&M impacted both product and service revenue.
Product revenue increased primarily due to increases at MHE for both print and digital product in Higher Education and increases in the adoption states. Service revenue increased slightly, primarily due to growth in transaction revenues driven by high-yield corporate bond issuance, index services, credit-ratings related information products such as RatingsXpress and RatingsDirect, and Capital IQ. Increases for both product and service revenue were offset primarily by the divestiture of BusinessWeek at I&M.
Product and service operating expenses decreased primarily due to productivity improvements and cost-saving initiatives. Service operating expenses were also impacted by the divestiture of BusinessWeek at I&M.
Selling and general expenses increased slightly due to increased marketing costs at MHE, as well as higher stock-based compensation as compared to the prior year. This increase was partially offset by the benefits of cost-saving initiatives and the divestiture of BusinessWeek at I&M.
During the second quarter of 2009, we initiated a restructuring plan that included a realignment of select business operations within the MHE segment to further strengthen their position in the market by creating a market focused organization that enhances its ability to address the changing needs of their customers. Additionally, we continued to implement restructuring plans related to a limited number of our business operations to contain costs and mitigate the impact of the current and expected future economic conditions.
We recorded a pre-tax restructuring charge of $24.3 million, consisting primarily of employee severance costs related to a workforce reduction of approximately 550 positions. In addition, during the second quarter of 2009, we revised our estimate for previously recorded restructuring charges and reversed approximately $9.1 million. The net pre-tax charge recorded was $15.2 million ($9.7 million after-tax, or $0.03 per diluted share) and was classified as selling and general expenses within the Consolidated Statement of Income.
Net interest expense increased primarily due to a reversal of interest expense on uncertain tax positions in Germany that occurred in the three months ended June 30, 2009.
Product and service operating expenses decreased due to the factors noted above for the quarter.
Selling and general expenses decreased slightly as compared to the prior year as the benefits of cost-saving initiatives and the divestiture of BusinessWeek were partially offset by higher cost associated with increased sales as well as the restructuring costs as noted above for the quarter.
Net interest expense increased primarily due to the reversal of interest expense as noted above for the quarter, as well as lower international interest income from our investments.
In May 2009, we sold our Vista Research, Inc. business which was part of our Financial Services segment. During the second quarter of 2009, we recognized a pre-tax loss of $13.8 million ($8.8 million after-tax, or $0.03 per diluted share), recorded as other loss within the Consolidated Statement of Income. This business was selected for divestiture, as it no longer fit within our strategic plans. This divestiture enabled our Financial Services segment to focus on its core business of providing independent research, ratings, data indices and portfolio services. The impact of this divestiture on comparability of results is immaterial.
For the three and six months ended June 30, 2010 and 2009, the effective tax rate was 36.4%. We incurred transfer taxes of $35.4 million in the first quarter of 2010 resulting from a legal entity reorganization in our European operations to comply with recent regulation that will be offset in subsequent reporting periods and will not impact the effective tax rate. Therefore, we expect the effective tax rate to be at 36.4% for the remainder of the year absent the potential impact of numerous factors including intervening audit settlements, changes in federal, state or foreign law and changes in the geographical mix of our income.
Revenue and operating income for our MHE segment reflect the seasonal nature of some of our educational publishing businesses, with the first quarter being the least significant and the third quarter being the most significant.
Foreign exchange rates had favorable impacts of $3.3 million on revenue and $2.3 million on operating profit for the quarter, and a favorable impact of $9.1 million on revenue and an immaterial impact on operating loss for the six months.
Also impacting results was the restructuring plan initiated during the second quarter of 2009 that resulted in a net pre-tax restructuring charge recorded for the three and six months ended June 30, 2009 of $11.6 million.
School Education Group (SEG)
Revenue decreased compared to the prior year, primarily as the result of a decline in open territory sales and a decline in custom testing revenue due to the discontinuation of contracts for work in Arizona and Florida. Revenue in the current quarter was also impacted by revenue deferrals for Texas K-12 orders that will be shipped during the third quarter of 2010. Offsetting these decreases was an increase in revenue in the adoption states.
Revenue decreased compared to the prior year as declines in open territory sales and custom testing revenue which did not repeat due to the discontinuation of contracts in Florida, California and Arizona, were partially offset by increases in adoption state sales, as well as growth in revenue for the Acuity formative assessment program. Also contributing to the decrease were revenue deferrals as noted above for the quarter.
Higher Education, Professional and International
Higher Education increased for both print and digital products, driven by higher enrollments in the current academic year and by double-digit growth at three of our four subject-area imprints (Science, Engineering and Mathematics; Business and Economics; and Humanities, Social Science and Languages), while Career Education grew modestly.
Professional increased slightly over the comparable prior-year period due to increases in net book publishing sales as actual returns were significantly lower than the comparable prior-year quarter. Growth in digital revenue, primarily from digital subscription products, also contributed to the increase.
International increased slightly over the comparable prior-year period, driven by the favorable impact of foreign exchange rates. Also contributing to the increase were higher sales in Asia as a result of Higher Education sales in Southeast Asia and Korea, and in Latin America as a result of growth in Mexico.
Higher Education increased for both print and digital products, driven by higher enrollments in the current academic year and by strong publication lists and attractive new digital offerings at all four subject-area imprints. Digital growth was driven by the continued success of the Homework Management product line, which included new releases on the improved and enhanced Connect platform. E-book revenue also increased over the comparable prior-year period.
Professional increased slightly over the comparable prior-year period due to the factors noted above for the quarter.
International increased over the comparable prior-year period, driven by the favorable impact of foreign exchange rates. The increase was also a result of gains in the Middle East and Africa from large orders placed by international non-profit organizations, and in Asia as noted above for the quarter. These gains were offset by declines in other international markets.
In the second quarter of 2010, operating profit for MHE improved, primarily due to the strong growth in Higher Education sales combined with lower expenses at SEG due to productivity improvements, cost-saving initiatives and reduced plant amortization. The realignment of several business operations within the segment that occurred during the second quarter of 2009 also contributed to the increase.
In the first six months of 2010, operating loss for MHE improved, primarily due to the increase in Higher Education sales combined with lower expenses at SEG due to productivity improvements, cost-saving initiatives and the realignment of several business operations within the segment as noted above.
Industry Highlights and Outlook
According to statistics compiled by the Association of American Publishers, total net sales of elementary and secondary instructional materials increased by 5.3% through May 2010 compared to the same period in 2009. Sales in adoption states for the industry increased by 8.7% compared to the prior year, while sales in open territory states increased by 2.6%. Beginning in 2010, basal and supplemental sales are no longer being reported separately due to the increasing overlap between these types of products and their markets.
The environment for 2010 is positive as the total available state new adoption market in 2010 is currently estimated at between $825 million and $875 million, depending on state funding levels, compared to approximately $500 million in 2009. In addition, total U.S. PreK-12 enrollment for 2009-2010 is estimated at nearly 56 million students, up slightly from 2008-2009, according to the National Center for Education Statistics.
The key adoption opportunities in 2010 are K-12 reading and literature in Texas and K-12 math in Florida. Although spending levels remain uncertain given the states budget issues, second-year purchasing of K-8 reading and literature and third-year purchasing of K-8 math in California are also anticipated.
Foreign exchange rates had an immaterial impact on revenue and a favorable impact of $5.2 million on operating profit for the quarter, and favorable impacts of $11.6 million on revenue and $5.0 million on operating profit for the six months.
Credit Market Services
Credit Market Services revenue was relatively flat compared to the prior year as increases in corporate industrial ratings and credit ratings-related information products were partially offset by declines in structured finance. Corporate industrial ratings increased primarily due to growth in transaction revenue driven by increased bank loan ratings and robust high-yield corporate bond issuance in the beginning of the quarter. The decrease in financial institution ratings resulted primarily from reduced debt issuance. Structured finance decreased in both the U.S. and Europe as both issuers and investors contemplate the market impact of pending changes in the regulatory environment. In addition, there were a reduced number of restructurings of existing mortgage-backed securities (re-REMIC transactions) and lower issuance in the U.S. of asset-backed securities. Also, the European sovereign debt crisis impacted market liquidity and there was a decline in central bank sponsored repurchase agreement activity.
Revenue derived from non-transaction related sources decreased slightly compared to the second quarter of 2009. Offsetting the decrease were increases in credit ratings-related information products such as RatingsXpress and RatingsDirect, which continue to have strong growth in the quarter as compared to the prior year. Non-transaction related revenue represented 67.1% of total Credit Market Services revenue for the second quarter of 2010, down slightly from 67.9% for the second quarter of 2009.
Credit Market Services revenue increased compared to the prior year, primarily due to growth in transaction revenues driven by robust high-yield corporate bond issuance and increases in credit ratings-related products, partially offset by decreases in structured finance.
Revenue derived from non-transaction related sources increased compared to the first six months of 2009, primarily as a result of growth in annual fees and subscription revenue. Credit ratings-related information products such as RatingsXpress and RatingsDirect, had strong growth in their subscription base in the first half of 2010 as compared to prior year. Non-transaction related revenue represented 67.0% of total Credit Market Services revenue for the first six months of 2010 down from 69.6% for the first half of 2009 due to transaction revenue growing at a higher rate than non-transaction revenue in the first half of 2010.
Investment Services revenue increased compared to the prior year, primarily driven by increases in our index services and growth at Capital IQ, partially offset by declines in investment research products. Specifically, index services increased mainly due to growth in exchange traded derivatives resulting from higher trading volumes and growth in exchange-traded fund (ETF) products as 32 new ETFs were launched in the quarter. Capital IQ continues to grow the number of new clients and their cancellations have decreased. The number of Capital IQ clients at June 30, 2010 increased 13.9% from the comparable prior-year period. Offsetting these increases were decreases in investment research products, primarily resulting from the expiration of the Independent Equity Research settlement at the end of July 2009.
Investment Services revenue increased slightly compared to the prior year due to the factors noted above for the quarter. Revenue was also impacted by the divestiture of Vista Research in May 2009.
Operating profit decreased for the second quarter of 2010, primarily due to declines in structured finance as noted above.
Operating profit increased for the first six months of 2010, primarily due the growth in transaction revenue and increases in our index services, partially offset by declines in structured finance and investment research products as noted above.
We monitor issuance volumes as an indicator of trends in transaction revenue streams within Credit Market Services. The following tables depict changes in issuance levels as compared to the prior year, based on Thomson Financial, Harrison Scott Publications and Standard & Poors internal estimates.
Industry Highlights and Outlook
Activity in the first half of 2010 has been driven by refinancing as companies are exhibiting prudent capital management and are taking advantage of low underlying interest rates and increased investor demand for new issues. Corporate issuance levels in the second half of 2010 will depend on re-establishing stability in the wake of the European sovereign debt crisis, which has reduced the number of opportunistic financings experienced earlier this year. However, a significant amount of debt maturities in 2010 remain to be refinanced by companies in the second half of the year. In addition, mergers and acquisition activity is projected to recover somewhat and the overall cost of financing should remain at attractive levels for most of the year.
Global new issue credit spreads increased during the second quarter as the result of the market conditions in Europe. As the market conditions stabilize and spreads tighten, it will be more attractive for issuers to access the capital markets. The Federal Reserve noted in June of 2010 that it will continue to keep interest rates exceptionally low for an extended period, which should keep the current liquidity conditions intact in the corporate credit market.
Although the ABS market continued to strengthen during the first half of 2010, this trend may slow as the year progresses as the market adjusts to new and proposed rules and regulations from the Federal Deposit Insurance Corporation (FDIC), Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC), which may increase the cost of securitization for issuers going forward.
In addition, we anticipate slow and gradual improvement among the RMBS and CMBS asset classes as we progress throughout 2010, as long as the economic recovery remains on track and the capital markets remain stable.
The following amends the Legal and Regulatory Environment disclosure for our Financial Services segment in our Annual Report on Form 10-K for the year ended December 31, 2009.
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) which, among other things, will impose new requirements and standards on credit rating agencies, including NRSROs, which may result in an increase in the Companys costs for regulatory compliance. The Act also amends the law that establishes pleading standards in securities fraud suits brought against credit rating agencies under the Securities Exchange Act of 1934. The change in the pleading standards may result in increased litigation costs for the Company; however, the law does not amend the liability standard in such lawsuits which continues to be the same standard applicable to all defendants.
We have reviewed the new laws, regulations and rules which have been adopted and have implemented, or are planning to implement, changes as required. Although it is difficult to predict the full impact of the Act, we do not currently believe that the Act or other adopted laws, regulations or rules will have a materially adverse effect on the Companys financial condition or results of operations. Other laws, regulations and rules relating to credit rating agencies are being considered by local, national, foreign and multinational bodies and are likely to continue to be considered in the future. The impact on us of the adoption of any such laws, regulations or rules remains uncertain.
See Note 12 Commitments and Contingencies to our unaudited Consolidated Financial Statements for legal proceedings disclosure that amends the disclosure in our Annual Report on Form 10-K for the year ended December 31, 2009.
Information & Media
Foreign exchange rates had an immaterial impact on revenue and an unfavorable impact of $0.7 million on operating profit for the quarter, and a favorable impact of $0.6 million on revenue and an unfavorable impact of $1.6 million on operating profit for the six months.
Also impacting results was the restructuring plan initiated during the second quarter of 2009 that resulted in a net pre-tax restructuring charge recorded for the three and six months ended June 30, 2009 of $4.0 million.
In the second quarter of 2010, Business-to-Business revenue decline was driven primarily by the divesture of BusinessWeek in December 2009. Offsetting this decline was continued revenue growth in our global commodities products, primarily related to oil and natural gas, as continued volatility in crude oil and other commodity prices drove the need for market information. Also offsetting the decline was an increase in non-auto sectors due to growth in syndicated research studies.
In the first six months of 2010, Business-to-Business revenue decline was driven primarily by the divesture of BusinessWeek in December 2009 and decreases in our construction business as market declines have slowed revenue growth. Offsetting these declines was continued revenue growth in our global commodities products as described above for the quarter.
Broadcasting revenue for the second quarter and first six months of 2010 increased primarily due to increases in both political and base advertising, as automotive and other categories have shown growth as compared to the comparable prior-year period.
The Business-to-Business group was the key driver for operating profit in the segment for the second quarter and first six months of 2010, which was positively impacted by the divesture of BusinessWeek and growth in our global commodities products.
Industry Highlights and Outlook
I&M expects to invest in digital capabilities and further expand our presence in selected markets in order to drive growth in 2010.
Liquidity and Capital Resources
We continue to maintain a strong financial position and expect this position to be sufficient to, at a minimum, meet our anticipated short-term operating requirements. Our primary source of funds for operations is cash generated by operating activities. We also use our cash for making ongoing investments in our businesses, strategic acquisitions and share repurchases. Our core businesses have been strong cash generators. However, income and, consequently, cash provided from operations during the year are significantly impacted by the seasonality of our businesses, particularly educational publishing. This seasonality also impacts cash flow and related borrowing patterns as investments are typically made in the first half of the year to support the strong selling period that occurs in the third quarter. As a result, our cash flow is typically negative in the first half of the year and turns positive during the third and fourth quarters. Debt financing is used as necessary for our seasonal fluctuations in working capital.
Cash Flow Overview
Cash and cash equivalents were $1.1 billion on June 30, 2010, a decrease of $92.1 million from December 31, 2009, and consist of domestic cash and cash held abroad. Typically, cash held outside the U.S. is anticipated to be utilized to fund international operations or to be reinvested outside of the U.S., as a significant portion of our opportunities for growth in the coming years are expected to be abroad.
Cash provided by operations increased $65.4 million to $359.5 million for the first six months of 2010, mainly due to an increase in operating results, lower accrued expenses and growth in unearned revenue.
As of June 30, 2010, accounts receivable increased $42.4 million from the prior year-end, primarily due to an increase at MHE resulting from increased sales outpacing cash collections, partially offset by decreases at our Financial Services and I&M segments due to strong cash collections during the first half of 2010. This compares to an increase of $1.4 million in the first half of 2009. The number of days sales outstanding for operations have improved by 2 days, primarily due to revenue growth in our Financial Services and MHE segments, and strong cash collections across our Financial Services and I&M segments.
Accounts payable and accrued expenses decreased $141.9 million over the prior year-end, primarily due to incentive compensation and royalty payments. This decrease compares to a $207.2 million decrease in the first six months of 2009.
Unearned revenue increased $42.8 million over the prior year-end primarily resulting from increases in our MHE segment related to deferrals for Texas K-12 orders that will be shipped during the third quarter of 2010 as well as our Financial Services segment. This increase compares to a $6.6 million decrease in the first half of 2009.
Cash used for investing activities was $100.9 million and $99.8 million in the first six months of 2010 and 2009, respectively. The increase is due primarily to increased capital spending in the first half of 2010, the impact of the disposition of Vista Research, Inc. in 2009 and an acquisition related contingent payment made in 2010. These increases were partially offset by decreased investment in prepublication costs.
Net prepublication costs decreased $35.4 million from December 31, 2009 to $425.4 million, as amortization outpaced spending. Prepublication investment in the current year totaled $60.0 million, $25.1 million less than the same period in 2009. In 2010, as a result of the larger state adoption opportunities, we expect prepublication investments in the range of $195 million to $205 million versus $177 million in 2009. In 2010, we are projecting capital expenditures in the range of $90 million to $100 million largely due to increased technology spending.
Cash used for financing activities was $321.5 million through June 30, 2010 compared to $120.1 million in 2009. The difference is primarily attributable to cash used to repurchase shares. On January 31, 2007 the Board of Directors approved a stock repurchase program authorizing the purchase of up to 45.0 million shares, which was 12.7% of the total shares of our outstanding common stock at that time. During the second quarter of 2010, we repurchased 6.5 million shares under the 2007 repurchase program for $186.9 million. As of June 30, 2010, 10.6 million shares remained available under the 2007 repurchase program. The repurchase program has no expiration date. The repurchased shares may be 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. Purchases under this program may be made from time to time on the open market and in private transactions, depending on market conditions.
On January 20, 2010, the Board of Directors approved an increase in the quarterly common stock dividend from $0.225 to $0.235 per share.
Currently, we have the ability to borrow additional funds through our commercial paper program, which is supported by our credit facility. Historically, we have also had the ability to borrow additional funds through Extendible Commercial Notes (ECNs) and a promissory note. However, in the current credit environment the market for ECNs and financing through our promissory note are not available and, as such, we have no short-term plans to utilize these sources for additional funds. As of June 30, 2010 and December 31, 2009, we have not utilized any of these sources for additional funds. As of June 30, 2009, we have only borrowed under the commercial paper program.
Commercial Paper Program
The size of our total commercial paper program is $1.2 billion and is supported by the revolving credit agreements described below. Commercial paper borrowings outstanding at June 30, 2009 totaled $89.6 million, with an average interest rate and average term of 0.2% and 13 days, respectively. These borrowings are classified as current notes payable in the consolidated balance sheet as of June 30, 2009.
Our credit facility serves as a backup facility for short-term financing requirements that normally would be satisfied through the commercial paper program. Our combined credit facility totals $1.2 billion and consists of two separate tranches, a $433.3 million 364-day facility that will terminate on August 13, 2010 and a $766.7 million 3-year facility that will terminate on September 12, 2011. Based on our credit rating, we currently pay a commitment fee of 12.5 basis points for the 364-day facility and a commitment fee of 10 basis points for the 3-year facility, whether or not amounts have been borrowed. The interest rate on borrowings under the credit facility is, at our option, based on (i) a spread over the prevailing London Inter-Bank Offer Rate (LIBOR) that is based on our credit rating (LIBOR loans) or (ii) on the higher of (a) the prime rate, which is the rate of interest publicly announced by the administrative agent (b) 0.5% plus the Federal funds rate, or (c) LIBOR plus 1% (ABR loans).
We have the option at the termination of the 364-day facility to convert any revolving loans outstanding into term loans for an additional year. Term loans can be LIBOR loans or ABR loans and would carry an additional spread of 1.0%.
The credit facility contains certain covenants. The only financial covenant requires that we not exceed indebtedness to cash flow ratio, as defined in the credit facility, of 4 to 1, and this covenant has never been exceeded.
Critical Accounting Estimates
Our accounting policies are described in Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2009. As discussed in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report, we consider an accounting estimate to be critical if it required assumptions to be made that were
uncertain at the time the estimate was made and changes in the estimate or different estimates could have a material effect on our results of operations. These critical estimates include those related to revenue recognition, allowance for doubtful accounts and sales returns, prepublication costs, valuation of inventories, valuation of long-lived assets, goodwill and other intangible assets, pension plans, income taxes, incentive compensation and stock-based compensation. We base our estimates on historical experience, current developments and on various other assumptions that we believe to be reasonable under these circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that cannot readily be determined from other sources. There can be no assurance that actual results will not differ from those estimates. Since the date of the Annual Report, there have been no changes to our critical accounting estimates.
Recently Issued or Adopted Accounting Standards
Refer to Note 14 to the unaudited Consolidated Financial Statements for a discussion of certain accounting standards that have been adopted during 2010 and certain accounting standards which we have not yet been required to adopt and may be applicable to our future Consolidated Financial Statements results.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This section, as well as other portions of this document, includes certain forward-looking statements about our businesses and our prospects, new products, sales, expenses, tax rates, cash flows, prepublication investments 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; the duration and depth of the current recession; Educational Publishings level of success in 2010 adoptions and in open territories and enrollment and demographic trends; the level of educational funding; the strength of School Education including the testing market, Higher Education, Professional and International publishing markets and the impact of technology on them; the level of interest rates and the strength of the economy, 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 corporate issuance, CDOs, residential and commercial mortgage and asset-backed securities and related asset classes; the continued difficulties in the credit markets and their impact on Standard & Poors and the economy in general; the regulatory environment affecting Standard & Poors; the level of merger and acquisition activity in the U.S. and abroad; the strength of the domestic and international advertising markets; the strength and the performance of the domestic and international automotive 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, manufacturing expenses, distribution expenses, 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 debt and equity markets, including interest rates, credit quality and spreads, the level of liquidity, future debt issuances including, corporate issuance, residential and commercial mortgage-backed securities and CDOs backed by residential mortgages, related asset classes and other asset-backed securities; the implementation of an expanded regulatory scheme affecting Standard & Poors 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, automotive, 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
There have been no significant changes in our exposure to market risk during the six months ended June 30, 2010 from December 31, 2009. Our exposure to market risk includes changes in foreign exchange rates. We have operations in various foreign countries where the functional currency is primarily the local currency. For international operations that are determined to be extensions of the parent company, the U.S. dollar is the functional currency. We typically have naturally hedged positions in most countries from a local currency perspective with offsetting assets and liabilities. As of June 30, 2010, we have entered into an immaterial amount of foreign exchange forwards to hedge the effect of adverse fluctuations in foreign currency exchange rates. We have not entered into any derivative financial instruments for speculative purposes.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed with the Securities and Exchange Commission (SEC) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.
As of June 30, 2010, an evaluation was performed under the supervision and with the participation of management, including the CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the U.S. Securities Exchange Act of 1934). Based on that evaluation, management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of June 30, 2010.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal controls over financial reporting during the most recent quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
See Note 12 Commitments and Contingencies to our unaudited Consolidated Financial Statements for legal proceedings disclosure that amends the disclosure in our Annual Report for the year ended December 31, 2009.
Item 1a. Risk Factors
There have been no material changes to the risk factors we have previously disclosed in Item 1a-Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On January 31, 2007 the Board of Directors approved a new stock repurchase program authorizing the purchase of up to 45.0 million shares, which was 12.7% of the total shares of our outstanding common stock at that time. During the second quarter of 2010, we repurchased 6.5 million shares under the 2007 repurchase program. As of June 30, 2010, 10.6 million shares remained available under the 2007 repurchase program. The repurchase program has no expiration date. The repurchased shares may be 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. 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 second quarter of 2010 pursuant to the stock repurchase program authorized by the Board of Directors on January 31, 2007 (column c). In addition to purchases under the 2007 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:
Item 6. Exhibits
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.