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Executives

Donald Rubin – SVP, IR

Harold McGraw III – Chairman, President and CEO

Robert Bahash – EVP and CFO

Analysts

Peter Appert – Piper Jaffray

Craig Huber – Barclays Capital

Michael Meltz – JP Morgan

Catriona Fallon – Citigroup

Marc Sugarman – Citigroup

Simon Wallace [ph] – ING [ph]

Edward Atorino – The Benchmark Company

Barry Lucas – Gabelli & Company

The McGraw-Hill Companies, Inc. (MHP) Q4 2008 Earnings Call Transcript January 27, 2009 8:30 AM ET

Operator

Good morning and welcome to McGraw-Hill Companies fourth quarter and full year 2008 earnings call. (Operator instructions) I would now like to introduce Donald Rubin, Senior Vice President of Investor Relations for McGraw-Hill Companies. Sir you may begin.

Donald Rubin

Thank you and good morning to our worldwide audience and thank everyone for joining us at The McGraw-Hill Companies fourth quarter earnings call. I’m Donald Rubin, Senior Vice President of Investor Relations at the McGraw-Hill Companies. With me this morning are Harold McGraw III, Chairman, President and CEO, and Robert Bahash, Executive Vice President and Chief Financial Officer.

This morning the company issued a news release with our fourth quarter 2008 results. We trust you have all had a chance to review the release. If you need a copy of the release and financial schedules, they can be downloaded at www.mcgraw-hill.com. Once again that is www.mcgraw-hill.com. Before we begin this morning, I need to provide certain cautionary remarks about forward-looking statements.

Except for historical information, the matters discussed in this teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates, and descriptions of future events. Any such statements are based on current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looking statements.

In this regard we direct listeners to the cautionary statements contained in our Form 10-Ks, 10-Qs, and other periodic reports filed with the US Securities and Exchange Commission. We are aware that we do have some media representatives with us on the call, however this call is for investors, and we would ask that questions from the media be directed to Mr. Steve Weiss in our New York office at area code 212-512-2247 subsequent to this call.

Today's update will last approximately an hour. After the presentation, we will open the meeting to questions and answers. It's now my pleasure to introduce the Chairman, President, and CEO of the McGraw-Hill Companies, Terry McGraw.

Harold McGraw III

Okay. Thank you very much Don and good morning to everyone and welcome to our review of the full year and fourth quarter earnings and the outlook for 2009. With me is Bob Bahash, our Executive Vice President and Chief Financial Officer.

On today’s call we will be providing information on our performance in 2008 and discuss our guidance for 2009. After my review of operations Bob will then provide a little bit more in-depth look at our strong financial condition as well as our outlook for free cash flow for 2009 and obviously after that we will take questions and comments and go in any direction you would like.

As Don said earlier this morning we announced results for the fourth quarter and for the full year. I’m very pleased to report that we delivered on the high end of our guidance for the fourth quarter and for the full year. Let us briefly recap those results.

For 2008, we reported 2008 diluted earnings per diluted share of $2.51 and that of course includes a $0.14 per share restructuring charge. Also revenue declined 6.2%.

For the fourth quarter of 2008, we reported diluted earnings per share of $0.37 and that included a $0.05 per share restructuring charge. Revenue declined by 9.8%. To help control expenses we reduced incentive compensation in 2008 by $273.7 million. The restructuring actions in 2008 resulted in a workforce reduction of 1045 positions.

Cost containment was a priority for us in 2008. And it’ll be the same again for this year. If more actions are necessary this year we’re prepared to take them. The challenge in the current environment is obviously is to manage for today while preparing for tomorrow. We will and we still must see how the massive recovery package coming from the Federal government will first one, stimulate the economy; second, relieve budget pressures on state and local government; three, help educational funding; and four, improve the sentiment in capital markets.

Slower economic growth and the weakened housing sector will affect the state and local tax base. At the same time, the demand for local government supported projects may lead to more debt financing. We’ve seen this trend before. Historically there is a clear inverse correlation between state and local operating balances and municipal debt issuance.

The changing financial landscape is both a source of new challenges and new opportunities. While circumstances are favorable, we have responded by investing in fast growing businesses at Standard & Poor’s, the confluence again of content, technology, and distribution is also creating opportunities to improve our potential by producing new digital products and services. For an audience eager to acquire 21st century skills, we’re doing so to maintain our leadership. In this environment we must also preserve and protect a very strong balance sheet.

A strong balance sheet has been the hallmark of this company and we plan to keep it that way. Our cash flow is more than sufficient to meet our requirements for operations, making investments, paying down debt, and returning cash to shareholders. We have paid a dividend every year since 1937. And we have increased it every year since 1974. That is 35 years of increasing the dividend. Few companies can match that record of consistency.

The next decision on the cash dividend will be made tomorrow at the board of directors regular monthly meeting and believe me, our board understands the importance here.

With that background let us review the operations and then 2009 guidance for each segment. And let us begin with Financial Services.

A resilient and diverse portfolio helped cushion the Financial Services segment in the midst of a credit crunch and very challenging comparisons with a very robust 2007. Revenue for S&P Credit Market Services in 2008 declined by 22.5% and by 24.5% in the fourth quarter.

Revenue for S&P Investment Services that is our non ratings business grew by 15% last year and by 7% in the fourth quarter. In 2007, S&P Investment Services produced about 26% of Financial Services revenue. In 2008 it rose to 34% of the total. Revenue for this segment declined by 12.9% for 2008 and by 15.4% in the fourth quarter.

In the face of adverse market conditions we continued to manage our costs diligently. After pre-tax restructuring charges of $25.9 million for a workforce reduction of approximately 340 positions and a $166.0 million decrease in incentive compensation, operating profit declined 22.4% in 2008.

In the fourth quarter, after a pre-tax restructuring charge of $6.6 million for a workforce reduction of approximately 50 positions and a reduction of $36.6 million in incentive compensation, operating profit declined 18.6%. All that effort enabled us to report a 39.8% operating margin for the year and a 34.4% operating margin in the fourth quarter.

The restructuring charges reduced the 2008 operating margin by 98 basis points for 2008 and by 105 basis points in the fourth quarter. The decline in new issue volume obviously had a major impact on 2008 results. As these bar charts illustrate, the decline in the U.S. structured finance new issuance dollar volume was pronounced all year. For 2008 U.S. structured finance new issuance dollar volume was off 79.9% and the weakest in the fourth quarter with an 89.4% decline.

Now corporate and public finance issuance fared better. U.S. corporate dollar volume issuance was up 33.8% for the year as the high-yield market dropped by 73.7%. In the fourth quarter U.S. corporate dollar volume issuance was down 39.3% as the high-yield market came to a virtual halt dropping by 96.3%. But while the new issue dollar volume last year was the weakest in the fourth quarter it is not the whole story for Standard & Poor’s.

As this table illustrates, the revenue performance for the segment and S&P Credit Markets Services did not come close to matching the fourth quarter decline in the U.S. or the global new issue dollar volume. A key to our resiliency in the ratings business is the non-transaction revenue. And that number grew by 5.2% in 2008 and represented 73.1% of S&P Credit Market Services revenue. In the fourth quarter, non-transaction revenue declined by 4.8% and accounted for 78.9% of rating revenue.

About 90% of the non-transaction revenue is reoccurring. And as you all know it comes from surveillance fees, annual contracts, subscriptions and so forth and the recurring – the reoccurring portion grew all year. Our non-transaction revenue also includes other services such as bank loan ratings, which are not reflected in the public bond issuance. A sharp decline in bank loan ratings was the key factor in the fourth quarter decline in non-transaction revenue.

We expect non-transaction revenue to grow in 2009. It’ll be helped by modest price increases, the majority of annually renewable contracts are with large investment grade companies, financial institutions, governments, and government related entities. These entities will continue to access the public debt markets.

Our subscription services, this would be RatingsDirect and RatingsXpress, provide vital information and this month we increased their value as a global credit portal to the market with major enhancements. Given all the uncertainty of current market conditions the outlook for transaction revenue is very hard to call. To be clear, we define transaction revenue as the new public issuance of corporate, public finance, and structured finance instruments. We expect new issuance to get off to a slower start this year but anticipate a better run rate in 2009 then we experienced in the fourth quarter of 2008. Still we don’t expect growth in new issuance in 2009. At best we think it could possibly be flat.

Spreads remain a key gain factor in S&P’s market. Firms are deleveraging and rationalizing balance sheets but a more substantial contraction in spreads probably won’t materialize until investors see clear signs that deleveraging has run its course. There are positive signs. Various Federal initiatives designed to improve liquidity have had some success at the short end of the market. That is a critical first step for spreads to tighten for long-term credit. Based on what issuers and investors are telling us, there are indications of pent up demand in the investment grade market. LIBOR spreads are the key cost of funds benchmark. So we’re watching them very closely. The rate has come down sharply in recent weeks and the three month LIBOR is currently approximately 1.15%.

A declining LIBOR rate obviously is an indication of lower perceived risk in the banking industry and helps facilitate more interbank lending, which is something that we need to see. We’re also looking for narrowing spreads on credit default swaps and improvement in spreads for both investment grade as well as in high-yield bonds. Stabilization of the housing market would be a big plus for everyone. Home prices on average have fallen 21% since July of 2006 and that is according to the Standard and Poor’s/Case-Schiller 20-city index and there is probably more to go. S&P’s chief economist, David Wyss, expects housing prices to bottom out probably around 30% peak to drop [ph] by the end of this year.

For S&P Investment Services tough comparisons. Revenue grew by 15.6% in the fourth quarter of 2007 and consolidations in the financial markets were factors in the lower rate of growth in the fourth quarter than in previous three quarters of 2008. Probably another factor here is the assets under management and exchange traded funds hit an all-time high of $235 billion at the end of 2007 and declined to $203.6 billion at the end of 2008, but a good year nonetheless.

Still we look forward for more improvement this year in our non-ratings business. In one of the worst years for equities since the 1930s our Index Services turned in an outstanding performance. We benefited from market volatility, which produced increased trading volume at derivatives based on S&P indices. In the fourth quarter alone there was nearly a 47% increase in the average daily volume on major exchange traded derivatives and these are all based on our indices. For more – more than 4.1 million contracts were traded daily in the fourth quarter of 2008 and that is versus just over 2.8 million in the fourth quarter of 2007 and of course Standard & Poor’s is paid every time a contract is traded.

Assets under management and exchange traded funds based on S&P indices declined year-over-year by 13.5% but we also saw new inflows to exchange traded funds creating a substantial increase in the number of shares invested in ETFs. That is a very positive development. We have also seen greater use of exchange traded funds as hedging tools.

We continue to find new opportunities to expand this market. In the fourth quarter 14 new exchange traded funds based on the S&P indices were introduced. For the year, 59 exchange traded funds were launched. There are now 203 exchange traded funds based on S&P indices and there is more in the pipeline.

New products, the growth in shares outstanding in ETS based on our indices, and the increasing diversity of our offerings should benefit us again in 2009. Despite the contraction in Wall Street, we continue to make progress with Capital IQ. Very pleased to hear, finishing the year with a client base of over 2600, a 19% increase for the year. At the end of the month, Capital IQ will add new data in functionality enhancements and a new portfolio attribution tool to combat the cutbacks and consolidation among financial firms, a key part of Capital IQ’s strategy is to add value with this new data offering and this improved functionality.

With litigation about S&P ratings in the news there was some confusion earlier this month when the European commission announced it was opening up formal proceedings with Standard & Poor’s and the matter raised some questions. So let me clarify that situation. First, the proceedings have nothing to do with ratings. Secondly, is that we are not dealing with a lawsuit or anything like that. It is only a review regarding our licensing practices. And third, the proceedings involved compliance against the CUSIP Service Bureau, which S&P operates on behalf of the American Bankers association. And as many of you know, CUSIP is the acronym for the Committee on Uniform Security Identification Procedures. This system started in 1968 when the American Bankers Association appointed Standard & Poor’s to develop and administer a system for uniquely identifying each U.S. stock and bond with a permanent nine digit code to facilitate the smooth settlement and clearance of security transactions.

For 30 years the CUSIP Service Bureau has been licensing commercial databases containing CUSIP numbers and associated descriptive data. Financial institutions seek access to these databases for a wide array of services purposes that go far beyond the clearance and settlement activities. So last summer the European Commission received a complaint from several associations representing financial institutions and asset managers that the CUSIP Service Bureau was allegedly abusing its position in the European market by requiring license fees for use in access to the CUSIP Service Bureau’s database of 12-digit ISIN numbers, which are derived from CUSIP and associated data.

They challenged the legal right of CUSIP Service Bureau to control access to its valuable and proprietary databases. These institutions wanted free access. In essence, the dispute is not about access to ISIN numbers for their primary purpose of settlement of cross border security transactions. These identifiers are available to market participants free of charge. Rather these Europeans have developed other uses for these identifiers such as the management of internal databases and demand free access for our commercial databases. The complaint is without merit. It misrepresents the licensing activities of the CUSIP Service Bureau and ignores the fact that our licensing practices and charges [ph] are wholly transparent and in line with industry practices.

There also is a new shareholder derivative lawsuit. As a shareholder the Teamsters Allied Benefit Funds is suing the board of directors and some corporate executives. The faulty premise of this complaint is that our Board of Directors and corporate executives allegedly knew there were problems with ratings, followed by purported misstatements in public filings on the results and operations of the S&P ratings business and again this suit is totally without merit.

On the regulatory front, there is more work to be done here and the outreach to key policy makers, regulators, politicians here and literally around the world is an ongoing process and we are very active here. In Europe we’re meeting with European members’ states and members of the European Parliament. We are participating in member states and pan-European meetings, Finance Ministers, Central Bank supervisors are all on the itinerary. In the United States, we are awaiting the publication of final NRSRO rules by the Securities and Exchange Commission. S&P continues to discuss global regulatory developments with the SEC and that is an ongoing issue. We believe that smart regulation will help strengthen financial markets and S&P is working very hard to be an integral part of that solution.

In this environment we also continue to strengthen our organization as a part of the leadership actions we appointed an ombudsman for Standard & Poor’s Credit Market Services effective February 16th. Ray Groves will be S&P’s first ombudsman. He was with Ernst & Young for 37 years. He served as the firm’s Chairman and Chief Executive Officer for 17 years until his retirement in 1994. The ombudsman will address concerns about conflicts of interest in analytical and governance issues raised inside and outside the company. The ombudsman reports directly to me and has accountability to the audit committee of the Board of Directors. He will also report annually to the public.

Now, many ideas have been suggested about the regulation of rating agencies and we think they should be thoroughly obviously explored. Managing the potential for conflicts of interest in the ratings process is a key issue, we agree. We have always agreed to that. We also believe that no system is completely free of conflict. But we do believe that conflict can and should be managed through greater transparency. In fact the key issue for financial markets is transparency. That is why Standard & Poor’s has taken 27 leadership actions. These are action steps to improve its process and procedures and that is forever an ongoing process. That is the reason for creating the office of the ombudsman and that is why Standard & Poor’s makes its ratings available at no charge to the market and in real time.

And because S&P’s opinions are freely available to everyone the market is free to assess our decisions and our business model makes this transparency possible.

Okay let us sum up then for the Financial Services segment. Growth in non-transaction revenue will help cushion the uncertainty in the new issue market in 2009 and we may start to see some pickup in new issuance especially in the second half. Growth in S&P Investment Services will continue and a slower start to 2009. Our guidance for 2009 for the Financial Services segment is low single digit revenue probably about 1.5% to 2% growth and a margin decline of 250 basis points to 300 basis points and that is excluding the 2008 restructuring charges.

Okay, let’s now take a look at McGraw-Hill Education. Gains in the U.S. higher education partially offset a decline in the elementary-high school market in 2008. The McGraw-Hill School Education Group’s revenue decreased by 5.4% in 2008 and by 18.6% in the fourth quarter compared to 2007.

McGraw-Hill higher education, professional and international group’s revenue increased by 1% in 2008 and declined by 2% in the fourth quarter. This group accounted for 48% of the entire segment revenue in 2008. Revenue for this segment declined by 2.5% for the year and 8% in the fourth quarter. Cost cutting was a priority for this segment as market conditions softened during the year. Including pre-tax restructuring charges of $25.3 million for a workforce reduction of approximately 455 positions and a $29.3 million decrease in incentive compensation, operating profits declined by 20.9% in 2008.

In the fourth quarter including a pre-tax restructuring charge of $11.4 million for a workforce reduction of approximately 215 positions and a $7.8 million decline in incentive compensation this segment had an operating loss of $14.3 million.

The operating margin for 2008 was 12%. The restructuring charge reduced the operating margin for the year by 96 basis points.

For the most part, the fourth quarter in education is not seasonally significant except in some years for the U.S. College and university business. December is traditionally the key month of the fourth quarter for higher education and that certainly proved true again in 2008.

A late surge in sales enabled higher education to finish the year on an upswing and in a good position for 2009. Still we didn’t quite match the U.S. college markets’ estimated 3% sales gain in 2008. Our performance in 2008 resulted primarily from the fact that we published fewer major titles in 2008 than we did in 2007. With a more robust list for the New Year, we expect to stay in step with the industry in 2009. We also will benefit from a growing lineup of new digital offerings that include individualized online tutoring, a lecture capture service that gives students access to course critical lectures, and an assessment placement tool to build that enables schools to determine the most appropriate courses for entering students and that we are developing off of our (inaudible) artificial intelligence base capability.

For 2009, we’ve also launched a new generation of homework managers. Already our best selling digital product line in the higher education market, these subject-specific platforms allow instructors to organize all of their course assignments, and add their assessments for online use by students. Our robust new platform, which we’re calling McGraw-Hill Connect, offers many more features for both faculty and students. Available initially for 12 different disciplines the McGraw-Hill Connect product line will be promoting – be promoted with a tag line; connect, learn, and succeed.

At year end we also had 741 titles live on CourseSmart, that is the industry’s e-book web site. And we think the college and universities sales market could grow 3% to 4% in 2009. Historically higher education has been a countercyclical market during economic downturns post-secondary enrollments tend to increase as unemployed workers return to school to upgrade their skills and current students remain in school longer to become more competitive in a tight job market.

Our sales of professional books were hurt by weakness at the retail as consumers cut back spending. In 2009, we will be launching key titles in the scientific, technical, and medical market which are less vulnerable to economic downturns than the general retail market. Our digital products and services enjoyed solid growth in 2008 and we will continue to build on that success in 2009.

In the first quarter, we will launch three major new digital projects for professionals; JAMAevidence, access anesthesiology [ph], and access engineering [ph]. Very quickly on those three, JAMAevidence, it was developed jointly with the Journal of the American Medical Association. It provides subscribers with the fundamental tools for applying the medical literature to clinical diagnosis. It also includes a full text access to two of our major references, the Users' Guides to the Medical Literature and the newly published Rational Clinical Examination.

Access anesthesiology is a comprehensive online resource covering pain management, critical care, and perioperative medicine. It takes the subscriber from the reference desk into the anesthesiologist’s workflow.

Access engineering features fully searchable content from hundreds of our publications including such classics as Perry's Chemical Engineering – Engineers' Handbook. Users can customize access engineering for their own projects and for their own individual studies. What I am really describing are outstanding examples of the convergence again of content and technology. It takes knowledge, creativity, and innovation to leverage our content and create such products. Professionals around the world recognize the value proposition because they require 21st century skills to succeed. That is why our digital products are growing globally and at a very good pace. We’re seeing a steady increase in new subscriptions from around the world and the renewals a strong. We also expect more growth overseas in higher education and professional markets.

The challenge in 2009 obviously will be the elementary-high school market, where we now anticipate, and we’ll have to see, but we now anticipate a 10% to 15% decline in the industry sales after a decrease of approximately 4% in 2008. It is a market in which we capture approximately 30% of available state new adoption dollars. That market topped $980 million, exceeding our earlier projections of $925 million to $950 million.

In 2009, the state new adoption calendar is simply not as robust. The upturn in state new adoption starts in 2010 and carries into 2011. We currently estimate the 2009 state new adoption market at $675 million to $725 million down from an earlier estimate of $850 million to $900 million.

State and local budgets are obviously under pressure and funding concerns could affect the outlook in two of this year’s key adoption states, California and Florida. Both states are grappling with deficits that could affect the purchase of instructional materials. Florida has already eliminated the call for a K-12 Music Adoption. Only the 6-12 literature adoption will be funded this year. And many districts may elect to postpone purchasing until next year or even 2011. We just don’t know.

We have a strong program entered in the California K-5 reading [ph] market this year, appropriately the program is called California Treasures. We also are very well positioned for the second year of the math adoption in California particularly with the Los Angeles Unified School District. But here too there is budget pressure and the situation is highly fluid.

The budget pressures are also evident in our testing business. Revenue for custom contracts was off for the year and the fourth quarter as well due to lower volume of work on several contracts and the discontinuation of two contracts that produced income in 2008. Replacing that revenue with newer expanded contract work became increasingly difficult as state budgets tightened in the second half of the year last year. There is some good news in testing. Despite state and district budget pressures, Acuity, that is our formative testing program is adding new districts and retaining current customers. Renewals continue to be strong. We are benefiting from interest at the district level for technically sound classroom assessment.

And let us not forget the testing is still a required part of state education programs and a focus of districts seeking to move schools ahead and accurately measure achievement and growth. We anticipate that grants to states for Summative, that is the highest exam of testing under the No Child Left Behind Act will probably be funded at or near the 2008 level about $410 million in the new education budget.

At the end of December 41 states – at the end of December 41 states in the District of Columbia reported budget deficits for their current fiscal years, which end in most cases June 30. Of the top 16 states in terms of instructional materials purchasing, 5 had already enacted mid-year cuts in their educational budgets totaling about $370 million and cuts from additional states are expected.

On a macro level, it is not possible to quantify possible reductions in the purchasing of instruction materials based on reductions in overall education budgets because there are so many variations in funding practices across the state, but it seems prudent to assume that some budget cuts will affect purchasing by schools in the first half of 2009.

There also is some concern about budgets for the fiscal year but we’re not likely to have much clarity on the 2009, 2010 state education funding until May or just a little bit after that. When the spring tax revenue comes in and legislatures begin to complete budgets for the new fiscal year.

A new Federal education budget from the Obama administration has been promised for February. It may contain an increase in Title 1 Grants to districts with high numbers of disadvantaged students. These funds can be used for the purchase of instructional materials along for – along with other purposes. More immediately, any funding for school infrastructure improvement included in the general economic stimulus package would benefit education and the industry indirectly by freeing up more state and local education allocations for instructional related expenses.

This week as we all are watching the U.S. House Of Representatives is scheduled to vote on a stimulus bill which will send $41 billion to local school districts. It also includes $79 billion in state fiscal relief. The effort to prevent cutbacks in key state services provides $39 billion to local school districts and public colleges and universities. All told there is $140 billion in this stimulus package for education. A stimulus bill from the senate is in the works. It will include tax credits for tuition fees and for the first time the purchase of course materials.

Congress is on track to pass the economic stimulus package before adjourning on February 13th for President’s Day. Clearly there are many developments that could influence prospects this year in the school market. We’re following these developments closely and obviously we’ll keep you posted of how we are seeing it. None of the current proposed stimulus is in our financials.

Let us some up for McGraw-Hill Education. Federal funds may help alleviate pressure on state and local funding for education, a 10% to 15% decline in the elementary-high school market in 2009 and growth of 3% to 4% in the U.S. higher education market and for this segment a low-single digit revenue decline and the 300 basis points to 400 basis points decline in the operating margin excluding the 2008 restructuring charges.

And finally now let us review the Information & Media segment. Growth in business to business markets and a record year in political advertising in broadcasting were key factors in this segment’s performance in face of weakness for print advertising. Revenue for the business to business group increased by 4.1% for 2008 and by 0.2% in the fourth quarter. Revenue for the broadcasting group increased by 4% for 2008 and by 11.3% in the fourth quarter. This segment’s revenue increased by 4.1% for 2008 and 1.3% in the fourth quarter including pre-tax restructuring charges of $19.2 million for a workforce reduction of approximately 210 positions and a $22.6 million decrease in incentive compensation. Operating profit increased by 45% in 2008.

In the fourth quarter of 2008 including a pre-tax restructuring charge of $5.3 million for a work force reduction of approximately 70 positions and a $6.4 million decrease in incentive compensation expense the operating profit increased 61.7%. The operating margin was 8.7% for the year and 11.4% for the fourth quarter. Restructuring charges reduced the operating margin by 181 basis points for the year and 186 basis points for the fourth quarter.

Volatility in energy markets increased the demand for information and we clearly benefited in 2008. Platts' news, pricing and conference businesses produced solid results all year. We look forward to solid results again in 2009. J.D. Power and Associates benefited from strong results in the Asia Pacific market primarily automotive in China for the year but experienced some softness in the fourth quarter.

McGraw-Hill Construction again in our project news network was offset by softness at suites and a fall off in the media advertising and advertising pages at BusinessWeek were down 16.1% for the year and 19.6% in the fourth quarter.

Political advertising was another story. Our broadcasting group had a record year in political advertising with more than half of it coming in the fourth quarter. Total revenue from political advertising topped $27 million in 2008. A recessionary environment and a year without significant elections will challenge the advertising market here obviously in 2009.

Problems in the automotive market will be an issue for advertising and J.D. Power and Associates in 2009. Another factor in our revenue picture is a shift to online services at J.D. Power which impacts the timing of revenue recognition. Bob will have a few more details on that in his presentation.

So summing up for the Information & Media segment, a low-single digits decline in revenue, 200 basis points to 300 basis points reduction in the margin and that is excluding 2008 restructuring charges.

And therefore summing up for The McGraw-Hill Companies, 2009 will be another challenging year, tight credit markets, budget pressures on state and local governments will affect some spending on education and some softness in advertising. Obviously there is a great deal of uncertainty in this environment but we’re encouraged by yesterday’s USAToday’s new economic survey of 52 top economists and prospects for the second half of this year. Growth in U.S. GDP products resumes in the third quarter of 2009 and expands in the fourth quarter and according to these median estimates encouraging but we will have to see how this stimulus package impacts our markets. That is hard to predict. So we have not factored it again into any aspects of our forecast. At this point in the year, we expect consolidated 2009 revenue to decline 1% to 2% compared to 2008 and earnings per share in a range from $2.20 to $2.30 and we’ll have to see it from there.

Okay, with that let me now turn it over to Bob and Bob is going to provide a little bit more granularity about our performance and some of the key assumptions underpinning our guidance that are baked into our overall plans in terms of budget considerations for 2009. So Bob?

Donald Rubin

Okay, thank you Terry. Today I'm going to focus most of my remarks this morning on providing guidance for 2009. But before I get to this discussion I will mention some key points as to how we finished 2008. The environment clearly continues to be challenging but as Terry pointed out we did achieve $2.65 per share excluding restructuring charges, which is at the high end of our guidance.

Our cash flow under our definition which is after all investments and a dividend came in at $455 million. Share repurchases which mainly occurred in the earlier part of the year totaled 10.9 million shares resulting in a cash outflow of $447 million.

Now to the fourth quarter operating performance highlights and we’ll start with Financial Services. Credit Market Services revenue declined 24.5% and as debt issuance was minimal during the difficult months of October and November. As you know December started to show some signs of life particularly in the U.S. investment grade issuance.

Investment Services revenue grew 7% but clearly at a slower rate than in the first three quarters which were double digits from the weakness that was felt in the banking and investment services sectors. Expenses continue to be prudently managed. However,

fourth quarter margins at 35.5% versus 38.3% in the prior year excluding restructuring charges were clearly influenced by softer revenue as Credit Markets Services revenue was the lowest of all four quarters for 2008.

For – now for McGraw-Hill Education, higher education, professional and international group’s revenues declined 2% influenced by currency of course. Solid performance in the U.S. College and university market was offset by a challenging retail environment for professional as well as weaker overseas sales due to the strengthening dollar and weakening economic conditions in our Spanish language markets.

Softness in the supplemental market and residual sales contributed to an 18.6% revenue decline at School Education Group. A 4.8% decline in expenses, excluding restructuring charges in both years, could not offset the impact of the revenue decline for the quarter.

Now for Information & Media, revenue grew 1.3% driven by broadcasting strong political sales in the Denver market, continued growth from Platt’s news and pricing services. Offsetting this growth was softness in broadcasting’s local and national advertising revenue as well as declines in advertising revenue from BusinessWeek. The expenses here were managed effectively and coupled with the revenue growth resulted in margins expanding to 13.3% excluding restructuring charges.

There were significant restructuring actions during 2008. So I would like to take a moment to provide an update on employee headcount. Total number of employees ending 2008 was 21,649. This reflects an increase of 478 employees compared to year-end 2007. This is net of the restructuring actions taken during the past year and keep in mind that the most recent fourth quarter action relates to terminations that will mainly occur in 2009.

The net increase in headcount is due to higher financial services primarily – particularly internationally to support our fast growing data and information business as well as CRISIL's rapidly growing ratings equity research services outsourcing support businesses located in India. In fact employment has grown only in our overseas markets as it declined in the U.S.

Now let us move to 2009 and of course there is a great deal of uncertainty that we’re facing and this guidance will give you broad parameters on how we have built that plan. So for the company as Terry pointed we expect revenue to decline 1% to 2%. So I’ll begin with Financial Services. Our guidance of 1.5% to 2% revenue growth for Financial Services in 2009 is a blend of high-single digit growth in Investment Services with a slight decline at Credit Markets Services. And as you know, Credit Markets Services is approximately 66% of total Financial Services’ revenue.

Our guidance is based on current foreign exchange rate projections, which clearly influences growth as the strengthening dollar will negatively impact this growth in 2009.

On a constant currency basis revenue is projected to grow approximately 5% to 6% for this segment. Investment Services revenue is primarily billed in U.S. dollars. So foreign exchange largely impacts Credit Markets Services revenue. Credit Markets Services revenue will benefit from growth of 1% to 2% in non-transaction revenue which is recurring in nature such as relationship fees, surveillance fees, and subscriptions that Terry discussed.

Modest price increases will help as well. The reason we’re able to forecast growth in 2009 is because certain nonrecurring items that showed significant declines in 2008 such as bank loan ratings should not hamper us in 2009. We expected 10% to 12% decline in transaction revenue. This is based on better comparables and some recovery in the latter part of the year following a 55% decline in 2008. While transaction revenue was particularly depressed in the fourth quarter the month of December as a previously indicated showed improvement. While our projections do not anticipate any meaningful uptick in new issuance volume particularly in non-investment grade issuance we do expect that December will be a better proxy for 2009 with some potential market pickup in the second half. This should help transaction revenue.

While Investment Services fourth quarter revenue grew 7% year-over-year as I mentioned earlier it did decline sequentially compared to the third quarter. Their customer base is facing challenges and growth in index services in the quarter was hampered by a significant market declines. However ETF assets inflows continued to grow strongly which leaves us well positioned when the market rebounds. As a result we expect high single digit revenue growth in 2009 for Investment Services based on continued growth for indices, sales of new products and services, particularly Capital IQ and benefits from modest price increases.

As Terry indicated, we are projecting 250 basis points to 300 basis points margin decline at Financial Services in 2009. This guidance implies that expenses will increase approximately 6% for an operating margin in the range of 37.7% to 38.2%. On a constant currency basis we expect expenses to increase approximately 10% reflecting the full year impact of 2008 hires particularly our investment services. Most improvements were added oversees that I pointed out earlier and continued investments in our fast growing businesses although at a reduced pace as well as increased stock based compensation.

Partly offsetting these are the benefits of our restructuring actions. I will provide more detail on the impact of incentive compensation later. Finish off [ph] with one final comment on margins. While we’re projecting margin contraction at Financial Services for the full year we do expect margins to improve from the 35.5% margin IN the fourth quarter of 2008 which excludes restructuring charges. The fourth quarter’s margins were depressed since it was the lowest revenue producing quarter of the year. This is primarily driven by the fact that the fourth quarter revenues particularly transaction revenues were depressed in light of the low debt issues particularly in October and November. As a result they had a more pronounced impact given the high fixed cost of the business.

I will now turn to McGraw-Hill Education. Terry covered most of their revenue issues but there are a couple of items I like to address. For higher education, professional and international the U.S. college market is expected to grow 3% to 4% and we expect to grow in line with the market. However growth in the overall HPI group will be negatively impacted by a very challenging professional market and the impact of the stronger dollar on overseas sales. And to underscore Terry’s point about the weakening state new adoption market in 2009 I will point out that California makes up approximately one-third of the total new adoption market and this naturally bears watching [ph].

.

We expected a 300 basis points to 400 basis point decline in this segment’s margin for 2009. This implies a 9% to 10% margin. Expenses are expected to be roughly flat despite plant amortization increasing $15 million and increased investments at higher education and with it greater emphasis on digital products. This segment will benefit from restructuring actions taken in 2008, the completion of the data center moves, and lower marketing costs due to reduced opportunities in the adoption markets.

For Information & Media, we expect revenue to decline in the low single digits. We expect continued growth for energy information from Platt’s, however, this growth will not be enough to offset the loss of political advertising in a nonpolitical year, an extremely challenging advertising environment, and turmoil in the automotive market. Additionally, our results for the year will be adversely impacted by a non cash accounting change at J.D. Power relating to the introduction of COMPASS [ph] a more robust reporting and analytical tool for our clients.

Revenue previously recognized at the point of syndicated studies release will now be recognized ratably over a 12-month life of the subscription. Now this is similar to the suite’s transition that we had talked about back in 2006.

Now for 2009, this will result in a $15 million revenue decline and a $10 million decline in profits. This migration will also impact 2010 and 2011 but to a lesser degree. Our guidance for Information & Media margin is a 200 basis point to 300 basis point decline. This essentially implies a 7.5% to 8.5% margin with expense growth flat, largely due to restructuring actions taken in 2008.

Now for the impact of incentive compensation. As Terry discussed in his remarks incentive compensation was reduced by approximately $274 million in 2008. There will be some incentives being reinstated in 2009 but in the amount of approximately $110 million across all segments in corporate.

Corporate expenses in 2009 will increase $25 million to $30 million and this largely reflects increased stock-based and short-term incentive compensation. The data center construction was largely completed and virtually all of the applications, systems and equipment migrations were finished in 2008. A little bit carried over into January. Now the migration cost totaled $31 million and was $10 million in the fourth quarter.

McGraw-Hill Education represented about half of the migration effort in order to support their full range of digital offerings for the elementary, high school, college, and professional and college markets. The migration effort in fact was completed during this past weekend. And these costs are minimal in 2009.

Regarding the company’s effective tax rate, we expect a lower effective tax rate for 2009. It will be approximately 37% which is lower than the 37.5% rate to 2008. Two changes in our business are influencing this decline. The continued higher growth in our international operations has a favorable impact on the rate. Also we recently formed Standard & Poor’s Financial Services LLC, a Delaware limited liability company. In addition to operational benefits we expect this new structure to be more tax efficient.

Let us now review free cash flow. We continued to generate sizable free cash flow in 2008 despite a challenging environment. As you can see from the table cash provided by operations per US GAAP was $1.2 billion for 2008. We then subtract the following items; prepublication investments, purchases of property and equipment, additions to technology projects, and dividends paid to shareholders. The result is free cash flow that is available to the company for share repurchases, acquisitions, and to pay down debt.

Free cash flow for 2008 was $455 million. The strengthening dollar reduced the value of our overseas cash balances by approximately $50 million and this change is reflected in our free cash flow. Based on our operating guidance for 2009, we anticipate free cash flow in the range of $430 million to $450 million. Despite our projections for lower operating results this level of free cash flow is comparable to 2008 and is the result of easier working capital comparison as well as reduced investments that I will discuss in just a moment.

An item that we have not factored into the free cash flow guidance is the potential for any pension plan contributions. The U.S. plan is now in an underfunded position following last year’s significant market declines. We continued to follow the guidance we are receiving from the government agencies regarding contribution formula changes. Based on what we are now seeing we may have no funding requirement in 2009 or if one is required it could be in the range of $30 million to $50 million. And if it is required it will would not be payable until the second half of the year.

Now let me recap the corporation’s strong financial position. On a gross basis, total debt at year end was $1.27 billion. It is comprised of $1.2 billion in unsecured senior notes that we issued in 2007 as well as $70 million in commercial paper. This is offset by $472 million in cash. We did repatriate cash from overseas in the fourth quarter. However, our cash balance still consists largely of foreign cash plus some cash held in the U.S. for operational purposes.

Our net debt at the end of December was $796 million in down from $801 million last year or virtually flat. We do not plan – we do plan to access the commercial paper market in early 2009 as we do each year due to the seasonal nature of our educational businesses.

As I mentioned at the start of my remarks, we did repurchase 10.9 million shares in 2008 for a cost of $447.2 million at an average price of $41.03 per share. 17.1 million shares remain in the 2007 program authorized by the Board Of Directors. Given our desire to maintain debt levels comparable to year-end 2007, we did not make any additional share repurchases in the fourth quarter.

Our diluted weighted average shares outstanding was $312.8 million in the fourth quarter a 17.9 million shares decline versus the same period last year and a 4.4 million share decline from the third quarter of 2008. The sequential decline was minimal since we did not repurchase shares in the fourth quarter.

Year-end WASO or weighted average shares outstanding was 318.7 million shares, a 26.1 million share year-over-year decline. The figure for fully diluted shares at the end of the year was 315 million.

Interest expense was $15.4 million in the fourth quarter compared to $12 million in the same period last year. For the full year interest expense was $75.6 million compared to $40.6 million in 2007 and we expect 2009 to be roughly comparable to 2008.

We are also focusing on our investments and our capital expenditures will decline in 2009. Prepublication investments for 2009 are expected to be $225 million versus $254 million in 2008. This lower spend level is due to reduced investment revenue opportunities in 2009 as well as prudent investments and continued offshoring benefits.

Purchases of property and equipment for 2009 are projected at approximately $90 million versus $106 million in 2008. This $16 million decline is largely due to reduced technology spending.

Let us now look at some non-cash items. For 2009, we expect amortization of prepublication costs to be $285 million versus $270 million in 2008. This increase reflects the higher level of investments made in 2007 and 2008. We expect depreciation to grow to $130 million in 2009 versus $120 million in 2008. Amortization of intangibles was $17.9 million for the fourth quarter of 2008 due to the acceleration of the amortization of certain acquired intangibles. This brought the total for 2008 to $58.5 million. For 2009, we expect it to be approximately $55 million.

I will end with a recap of growth and unearned revenue. Unearned revenue ended 2008 at $1.1 billion, which is up 1.3% from the prior year. At constant foreign currency exchange rates it actually grew 3.8%. Financial Services makes up 74% of the corporation’s total unearned revenue. Financial Services’ unearned revenue grew 2.7% driven by strong growth for subscription products including RatingsDirect.

At constant foreign currency exchange rates, Financial Services unearned revenue increased 6.1%. For 2009, we expect low-single digit growth in unearned revenue. Thank you and now back to Terry.

Harold McGraw III

Okay. Thank you Bob and Don you want to start us off.

Question-and-Answer Session

Donald Rubin

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

Operator

Our first question comes from Peter Appert with Piper Jaffray. Please go ahead.

Peter Appert – Piper Jaffray

Thank you, good morning. First question I think is for Bob. Bob on the incentive comp decline of $274 million; can you help me understand how much of that is reversible per year of accruals versus a year-to-year reduction in ‘08 from ’07?

Robert Bahash

Okay, yes Peter not to enter specifics about the specific amounts but the incentive compensation decline consists of really two components, one is lower, short-term annual incentive compensation just driven by the overall performance but also as you point out, there is a reversal of accruals relating to our three-year grant program which really deals with 2007 and 2006 grants and certain accruals that were restarted in the beginning of the year for 2008 grants that were reversed. So there is a much larger change that occurred in 2008 than you would normally see. So it is a combination of lower, short-term incentive compensation relating to the specific year as well as reversals of accruals that were put on the books for the three-year long-term plans in the previous couple of years.

Peter Appert – Piper Jaffray

Right. So would incentive comp in total then be a zero or negative number in ’08?

Robert Bahash

Say that, I am not sure I understood that.

Peter Appert – Piper Jaffray

I am wondering if the reversal of prior year accruals exceeded the short-term incentive comp accruals in ’09.

Robert Bahash

No. Okay, the answer to that is no. There is a combination here. First of all, let’s say, there are certain businesses that did achieve their targets or achieved within the bands [ph] and short-term incentive compensation was paid to some of those businesses. In addition there is the component of the long-term incentive award that is stock-based compensation and as you know, you are recording an accrual for the stock-based compensation regardless of what happens at the end. So the answer to that is it would not be zero. I think the key point here is that as I mentioned in my remarks, there are certain accruals that we were making or planning for 2009 totaling $110 million but that is at targets that are a bit lower than we normally would be – than a normal year. So we are anticipating lower payouts for certain types of awards.

Peter Appert – Piper Jaffray

Okay. One more thing then I will get off this topic, what was the actual then incentive comp expense side in ’08?

Robert Bahash

For the whole company?

Peter Appert – Piper Jaffray

Yes.

Robert Bahash

I don’t have that number handy Peter but I think the easiest way to describe is for the corporate side it was zero with the exception of the accrual for stock options. For Education it was minimal, for Information & Media certain businesses achieved their targets and for Financial Services there is a combination of normal short-term incentives that kick in a target and there is also the portion of profit sharing contribution incentive compensation amount which is similar to Financial Services. So there is a payout based on lower percentages. That gives you an idea there were certainly payouts in certain businesses but at much lower rates than we had experienced.

Peter Appert – Piper Jaffray

Okay, and then one other thing for Bob or Terry, on the S&P margins I guess I am somewhat surprised to see you budgeting for a 10% increase in costs next year and the contacts and all the staff reductions you have done can you help me I guess better understand what is driving those cost pressures?

Harold McGraw III

Well there are a number of factors there, on the S&P Investment Services side, they are growing very nicely and we are continuing to invest there. We also, in terms of a non-transaction revenue, are maintaining very strong surveillance staff on that part and we certainly do anticipate at some point here some pick up and so our expenses at this point are reflecting the growth on the Investment Services side as well as some of the surveillance capabilities on non-transaction revenue.

Peter Appert – Piper Jaffray

And Terry have you really thought your expectations in terms of where you think the longer term margins that S&P can be sustained?

Harold McGraw III

Well, again, you know we are in the toughest period right now. I think that when we look back at some point, the fourth quarter of ’08 and the first quarter of ’09 is going to be the bottom point and so again you are dealing with a fair bit of uncertainty and talking about when new issuance volume starts to pick up and in what areas and the like. Clearly we would like to get back to a much higher level on this one. Do you have increased legal cost? Do you have increased compliance cost? The question is yes, but I differ at this point, clearly we guide to get well back into the 40s on that one and we will watch it together as we go.

Peter Appert – Piper Jaffray

Great. Thanks Terry.

Harold McGraw III

Thanks Peter.

Operator

Thank you. Our next question comes from Craig Huber with Barclays Capital. Please go ahead.

Craig Huber – Barclays Capital

My question is mainly about regulation here in the States, you mentioned Terry in your speech back at the media conference earlier this year, you talked the regulatory issues in the US would drag into 2010, could you elaborate on that further. And most importantly, what are you expecting with the new administration here, a more democratic congress and obviously seems like a very tough person now running the SEC, what sort of changes do you expect in the regulatory front in the S&P ratings business this year, thanks.

Harold McGraw III

Thanks Craig. Craig, you know, I am feeling more sanguine about all of that. As I told you that on the regulatory basis, I have risks to the business as relatively low, it is in our best interest to have very strong regulation that brings more clarity and simplifies the process and that is something that we took on as an initiative earlier on in terms of the voluntary oversight frameworks in Europe with both the Commission, IOSCO and CESR the Regulators and we were less successful in bringing that a part of the SEC. When Chairman Frank insisted upon going that direction, most of what we had gotten in those frameworks we got into the Credit Rating Agency Reform Act of ’06 and so we were pleased with that part of it. We are going to see some here in the States, I think there is going to be a lot taking place in the first half of this year. We think that you are going to see some enhanced NRSRO rules on that one. We have already opined on them and pushed back. We think that they strengthen the current condition, they are not overbearing and onerous and we think that in Europe we are going to see a conclusion, and again we are guessing now, probably in the April/May timeframe that it is going to very consistent in the end with US regulatory policy. So I think it is going to bring a lot more simplicity, a lot more transparency and we are very supportive. So I don’t see an environment, with the Obama administration, that is going to be more intrusive on that one. Chairman Shapiro I think has been very forthright. She has a terrific track record and we look forward to working with her and the staff making sure that the SEC is doing really well on the regulatory front is I think is a part of what we have to be about and we are going to do everything we can to make the regulation successful and that is where we have got to be.

Craig Huber – Barclays Capital

On a totally separate matter, are you seeing anything on your transaction-based business here early first quarter that gives you any sort of hope that things are starting to turn here particularly if you maybe look at the investment grade market from the issuance?

Harold McGraw III

I have always been more optimistic in whatever so I better be careful here; but you know, I really look at 2009 as the first half, second half year. I think we are going to see – we have to see what the stimulus package does, what the effect of some of that is on the state and local government, but I think that with some of the infrastructure projects and the like, I think we are going to see some additional public financing. I think corporates and governments are going to show some pickup. The real question is going to be are we going to see any pickup in the structured area and I certainly think that in some of the assets backed area, collateralized loan obligation, some of those kind of markets, the question mark is in the mortgage-backed securities and it is very hard to see new growth there yet. But I think we might surprise ourselves especially in the second half of this year.

Craig Huber – Barclays Capital

Now I will turn back to my first question, can you just explain to us why you don’t think that the SEC may look real hard at changing how you get paid on your issuance in terms of maybe going back how it was 30 or 35 years ago when investors used to pay for the ratings?

Harold McGraw III

Yes, we are going to get into that as we have in a very big way. I mean, there are multiple business models that you could look. You could look at an issuer pay, you could look at an investor pay, you could look at a subscription base, you could look at a whole host of things. On every single business model that you come up with is going to have conflicts or potential conflicts inherent in it and you are going to always have to have a very clear process and a very compliant process to be able to deal with those kinds of conflicts. The question really ends up, as we were saying before, what is it you are trying to solve the equation for? If you are trying to solve the equation for a higher transparency which is what is foremost on everybody’s mind, then the issuer-pay model gets you closest to that because of the fact that the issuer pays. We disseminate all that data free of charge worldwide and so that is where we have come down. We have looked at the pros and cons of other kinds of models and we look forward to working with the SEC in addressing that but when you take a look at the pros and cons of each of the business models, if you are starving for higher transparency, it is more the issuer pay. Now making sure that you are managing those conflicts and that there is very clear process on that is also very, very important and that is one of the things that – things like some of the 27 leadership actions like the ombudsman and other kinds of things that we think is very important as part of the process so that it is very clear, but that is the approach we are taking.

Craig Huber – Barclays Capital

Great, thank you.

Harold McGraw III

Thanks Craig.

Operator

Thank you. Our next question comes from Michael Meltz with JP Morgan. Please go ahead.

Michael Meltz – JP Morgan

Thank you. One comment there, I don’t know if you want to answer this or not but on that question it is not quite clear to me through all my research if the SEC even has the authority to try to change your revenue model. That is just a comment on my part, if you want to answer it, fine, if not, that is okay. Secondly, on S&P trends, I don’t know if Vicky is there or Deven, but can you talk a little bit exactly what you have seen in the past three weeks, my understanding is there has been a pickup in high-yield deals, we have seen some of these drive-by type of transactions, there has been a couple of CLOs that in fact your comment about a slow start to ’09, there has been a lot more activity of late than what we did see in Q4 and then I have a follow-up.

Harold McGraw III

Thanks Michael. On the SEC side, we are regulated by the SEC and it is in our best interest. We do everything we can to make the process a success and that is what we are going to do in all of that and so we will have those discussions. As far as pickup to the beginning of the year, you know Michael; it is just – there is just so much uncertainty in here. Clearly we have seen an improvement, if you call it that, from the fourth quarter of last year. I still think that when we look back in terms of economic growth and things like that, the first quarter and the fourth quarter of last year are going to be the bottom part; it is going to be the worst. Now what we have got to see is in terms of business activity, in terms of how states are going to finance some of their issues and like. We have got to see where the new activity is. So, yes we see some spots here and there and I think that hopefully that part will start to build but we have got to get a little bit more evidence before we start saying that we think that in any particular category new issuance is starting to really pick up. I think we are really talking about ups and downs a little bit in the first half, I am hopeful that by the time we get into the second half, we are going to see some change but we have to see some evidence of that.

Michael Meltz – JP Morgan

Okay. Bob, another question for you on the incentive compensation, I just don’t think I understand what your guidance implies, if the mid-point of EPS guidance is down 15% year-over-year and I guess you are implying EBIT declines, what are you modeling for incentive comps to increase year-over-year? I don’t think I understand what you are saying.

Robert Bahash

Yes, the comment that I made is that incentive compensation, there is a decline, let’s work off the decline in 2008 which was $274 million. The budget calls for – what we are carrying in the budget is an increase of $110 million which is spread across the corporation. For the most part the incentive payments and I did mention on Peter’s comments that there are incentive payments that occur in the Standard & Poor’s business based on what is more like a profit sharing model. There is a very modest growth in that incentive pool planned for 2009. There are other areas that basically paid out nothing so there is some reinstatement and there is also an accrual based on the long-term incentive compensation which saw a couple of years of reversals. So net/net there is an increase in incentive compensation across the corporation for short-term incentive compensation as well as stock-based and long-term compensation of $110 million.

Michael Meltz – JP Morgan

Okay. And Peter’s question, I think for us it is kind of hard to assess what that means if we don’t know the base level for ’08 it would be helpful to get the number of what incentive comp was in ’08 so we can truly analyze the increase. I have one follow-up question, in terms of your revenue guidance for education, if I listened what you are saying about HPI, you are saying the college market is up 3% to 4%, total HPI will be up less because of some of the other businesses there but you are pointing to total revenue for the group down just I think low-single digits and I think that if I back into it you are saying K-12 will do better or school will do better than the 10 of the 10% to 15% for the market, am I missing something here, can you talk a little bit more about that please?

Robert Bahash

Well 10% to 15% Michael is a pretty good spread. Again, the uncertainty levels given some of the state and local pressures are there. That was our best guess coming out of the fourth quarter on this one. We will have to see what some of the stimulus initiatives are going to do at the state and local level and what the willingness is going to be to spend. Certainly I think education is going to be a priority for most states and obviously $140 billion of stimulus is got to be spent somewhere and so we will see as we get into the year on those things but at this point I think that to be very conservative I think we should stay with our 10% to 15% down for K-12 and we will see.

Michael Meltz – JP Morgan

Okay. Alright, thank you.

Operator

Thank you. Our next question comes from Catriona Fallon with Citigroup. Please go ahead.

Catriona Fallon – Citigroup

Good morning, thanks for taking the question.

Harold McGraw III

Hi Catriona.

Catriona Fallon – Citigroup

Hi. On the Education business, this past year I think some of the margin decline was due to investing in digital products and it seems that next year some of the decline is really due to the fact that elementary-high is going to be weak and Education revenue was down, can you tell us a little bit more about the margins on the digital products and how we should be thinking about the Education margin longer term?

Robert Bahash

Okay, you know nobody mostly me is happy with the margin levels here. The push and the aggressiveness on the digital product and offerings I think is a unique opportunity that is starting to materialize in a much broader way especially at the higher education and increasingly at K-12. And we are going to push aggressively on that and those are higher margin businesses and we are going to work as part of some of these new initiatives too aggressive on that. So we will just have to keep that in front of us but obviously we have never retreated, it has only been timing and then the turmoil of ’08 and where we are in ’09 but we want to get to that 20% and there is no let up on that part of it and digital has to be a very strong component of that and that part will continue.

Catriona Fallon – Citigroup

Can you give us some color as to the percent of revenue in education that is due to digital products?

Robert Bahash

The percentage of digital is right now very modest. In the higher education professional side, there is a mixture. There is very little coming from our international side. Our professional publishing and Terry mentioned a number of product offerings there albeit the smallest of the three businesses we are seeing a greater penetration of digital coming out of professional with renewal rates on that revenue up in the 90% range. So we are seeing here the signs of what we expect to see hopefully at the higher education side. The higher education penetration is very, very small at this point in time.

Catriona Fallon – Citigroup

Okay great. Now, I will just switch gears quickly to Financial Services, can you give us a little bit of color on some of the areas within Credit Market Services where you saw improvement in debt issuance in December and then specifically what did you see from mortgage-backed securities in December?

Robert Bahash

The latter one is the easiest that was very low. There is some very small activity but that is virtually flat. Where we saw some activities obviously is on the corporate governments as well as some public finance on that one. As Michael had suggested as well, we saw some pickup in some issuance in terms of asset-based securities, some collateralized loan obligations but the structured area has been very impacted on this. We need to see some additional life to that but at this point corporates public financing governments is carrying that.

Catriona Fallon – Citigroup

Okay and then just a quick last question, once we do get through this downturn in the market what do you think the credit market services can grow at on a longer term basis?

Robert Bahash

Well, as you know from historical rates, again if the economy is growing and the sectors are participating, you are going to see obviously a return to very good growth and I think we are in the closer to the ending process of unwinding some of that. We need to see the credit markets be more accommodating as that starts to take place I think that we are going to see certainly a return on the high-yield side, more activities on the corporates and I think you are going to see a resumption maybe not on the residential mortgage-backed side but maybe on the commercial mortgage-backed side and some of that activity and you are going to start to see that come again and I am hoping by the second-half of this year.

Catriona Fallon – Citigroup

Okay, sorry I do have one more question, just in the month of December we were seeing a little bit of issuance in Europe on the structured side, maybe not as much on the NBA [ph] side but banks were pledging and building up collaterals for loans basically from the government and I am just wondering if you saw ratings revenue for any of that activity?

Robert Bahash

Again, in terms of an economic environment, I think the United States is probably somewhere around, I don’t know, six months ahead of Europe. I think Europe has a little bit more to go in all of this and therefore we will be watching that kind of activity but certainly in terms of bank loan ratings, in terms of some of the core financing there the extent to which there is growth activity, I think that we will see that pick up but probably more slowly than we will see here.

Catriona Fallon – Citigroup

Okay thanks.

Operator

Thank you. Our next question comes from Marc Sugarman with Citigroup. Please go ahead.

Marc Sugarman – Citigroup

Good morning.

Harold McGraw III

Good morning Marc.

Marc Sugarman – Citigroup

Two quick questions on education. The first on college you talked about, I think you talked about 3% to 4% growth for college especially the international and you said that it was after a currency drag, I just wondered how much of a currency impact is in that number and could you also split out college within that as well. And then secondly, on schools, I think at the Arizona Conference you hosted a couple of weeks back, you were talking about the adoption market being 725 to 775, so you brought that down a little bit which I guess is the Florida Music Adoption that you mentioned but you have not changed the overall range of schools being down 10% to 15%, I was wondering if you could just square that circle.

Harold McGraw III

Tell you, I will give you the latter one and Bob you can go on the currency with education. When we were out there again we were, I mean 10% to 15% down is a pretty safe conservative view because we just don’t know. We do know that because of some of the cutbacks and some of the state views of this especially in the open territory there is a lot of concern and there is going to be some pullbacks. Florida and California represent almost half of the opportunities in this year’s state new adoption market and K-5 math and reading are going to very, very important. The good thing is we are very strong in both of those capabilities. So we have to see what they are going to do in all of this. So I think it is safe to say that we brought the state new adoption number down a little bit because we have seen some cutbacks. The bottom line is we are very uncertain as to what the stimulus is going to do at the state level. The $140 billion going through the states on education is a sizeable, sizeable number and I don’t know if that is going to have people re-think and influence. So I think at this point we need to be pretty conservative. We are looking at a big number for 2010 and 2011 now because you are not only picking up some of the ’08 and ’09 cutbacks or whatever but you are also into big, big major recycles in the business in all that and we are more investing obviously in that product sometimes these big programs are two-and-a-half years developed. So we are in an active mode on those and getting ready for that but we will have to see what exactly takes place in ’09 but I think staying with the 10% to 15% at this point and the state new adoption level is where we are is a good number.

Marc Sugarman – Citigroup

Is your participation pretty much the same in ’09 as in ’08?

Harold McGraw III

Yes. Again, our expectation always is that capture rates of 30% is where we need to be and if it is in a very strong weaning cycle or math cycle we fully expect to do better than that.

Robert Bahash

Let me respond to your question on the higher education side. There are two parts to this. The 3% to 4% reference related to the US higher education market there is much better data to measure here. So Terry’s comments focused specifically on the US higher education piece of HPI where we expect to grow in line with the market. On an overall basis for HPI where we are forecasting to be off around 1% currency clearly has an impact here. If you exclude the currency impact, the growth rate is in the 3% range for all of HPI.

Marc Sugarman – Citigroup

Just one question, given that December saw quite a big pickup in college and you know the point that Terry made on counter-cyclicality you go into the market in 2008 with 3% I was surprised that you would not expect it to be a little bit stronger in 2009?

Robert Bahash

Again, I am with your sentiment, I am hoping on this one but I think given the uncertainty and the conditions and state tuitions and all that 3% to 4% is probably a good number at this point.

Marc Sugarman – Citigroup

Thanks very much.

Robert Bahash

Thanks.

Operator

Thank you. Our next question comes from Simon Wallace [ph] with ING [ph]. Please go ahead.

Simon Wallace – ING

Good morning, thanks for taking my questions.

Robert Bahash

Good morning Simon.

Simon Wallace – ING

Good morning. A couple on market share. The first following up with the last question on higher education, you are growing in a way 1% versus roughly 3% for the market, can you comment on competitive pressures from Pearson, maybe some of the other competitors like Cengage and also on the schools market, I think you are modeling about 30% capture rate for ’09, do you have an idea what your capture rate was for ’08 please?

Harold McGraw III

Okay, Bob will give you the latter one. In terms of competitive pressures, it really depends on your current offering level. This was a lower year for us in terms of revision of major titles and that influenced some of the mix. From a competitive standpoint I think no change. The only thing that in terms of Cengage there was a very, very aggressive price increase that they put through and I think they captured a little more from that – in all that but I see no significant change in that. We are going to have a bigger cycle this year as we put out the earnings release in terms of major title revisions as well as some new entries and so I think at this point the market is 3% to 4% and we look to match that and hopefully improve on that.

Simon Wallace – ING

Are you happy with your kind of digital products Harold, is that kind of fully competitive with some of the competitors?

Harold McGraw III

Again, it is in different areas and Bob was talking about where we are on the professional side but the higher education side is very aggressive and you are going to see continued focus on that. College students today on average are taking one course online. We see that accelerating. We think that with the counter-cyclicality in terms of some of the unemployment that you are going to see more online activity necessary and we are just going to continue on that path.

Robert Bahash

Just on the comment that you raised with regard to the 2008 growth rates for higher education, again I need to break that apart a bit, the higher education professional international group grew by just under 1%, was influenced by currency when you take currency out the overall group which includes the US Higher Education business, Professional and the International Publishing would have grown 1.5%. Now we look at the US Higher Education, I think that was the thrust of your question the US Higher Education market. As I indicated yes, we did not – we did not grow in line with the market but the growth rate there was a little under 2.5% so figures were a little bit better than you were thinking here.

Simon Wallace – ING

(inaudible).

Robert Bahash

I am sorry, repeat that one for me, would you?

Simon Wallace – ING

Just to understand what you think your market share was in ’08, am I right thinking you are basing your ’09 guidance on that 30% capture rate.

Robert Bahash

Yes, the capture rate for the new adoptions was 30% and based on the data that we have been receiving from the AAP on an overall basis which takes into account often territories, residual sales and such, we have slightly – we have performed slightly better than the market. That is the basis for our guidance into 2009 as well. We feel we have excellent product offerings for the new adoption marketplace and we are looking at capturing share on the other side as well.

Simon Wallace – ING

Great, thank you.

Operator

Thank you. Our next question comes from Edward Atorino with The Benchmark Company. Please go ahead.

Edward Atorino – The Benchmark Company

Hi Terry, on education, was any of the ’08 strengths sort of let’s spend the rest of the budget because we are not going to have anything in ’09 on sort of a borrowing from ’09 number one. Number two, would you see any change in the ordering – timing of orders in ’09 due to budgetary pressures might they come earlier whilst schools have the money or later when they find out how much money they have?

Robert Bahash

Good morning Ed.

Edward Atorino – The Benchmark Company

Good morning.

Robert Bahash

Yes, I think that you are probably going to see a little bit more of delay. I think that given the state economic conditions you know that they are going to be looking for the stimulus and how quickly the stimulus is going to be getting out. And so I think that is going to be a little bit of a whole impact. I don’t think anybody is trying to borrow from one year to the next to the like. They are really trying to fully fund their requirements and they are postponing or they are splitting up into a one-year or two-year buy in certain programs. But the emphasis on this year is a lower state adoption market than we had anticipated in a large part because of the state conditions but California and Florida are the ones to watch and the core capabilities for this year are going to be K-5 math, K-5 reading and 6-12 literature and those are all areas of strength for us and so we are hoping that that is where we are going to be able to benefit.

Edward Atorino – The Benchmark Company

Could you sort of flush out your comments on 2010 to 2011. You said recycle, are these going to be sort of the big year levels and any major programs that are sort of on the horizon?

Robert Bahash

You know we have – because of the conditions in the latter part of ’07 and certainly ’08, we have seen cycles elongated here. You are running into some very core discipline programs coming up. You are talking about reading math, social studies, you are talking about literature, all of the core disciplines coming up, you are talking about state new adoption markets somewhere in the billion dollar range for 2010 and probably for 2011 and with a much improved economic condition hopefully and with less funding pressures I think we are going to get back to what you would consider some of the bigger years. We will see in all of this and there are some unknowns right now in terms of obviously stimulus but we will see but right now 2010 and 2011 are looking to be the years that we had hoped that 2008 and 2009 were going to be.

Edward Atorino – The Benchmark Company

Great, thanks a lot.

Robert Bahash

Yes.

Operator

Thank you. Our next question comes from Barry Lucas with Gabelli & Company. Please go ahead.

Barry Lucas – Gabelli & Company

Good morning, thanks for taking the question. Terry, I want to come to the comments that Bob made on of projecting free cash flow of around flattish $450 million for 2009 and how do you prioritize the use of that with the stock sitting kind of at a ten-year low and the balance sheet in awfully good shape, debt under $1 billion and so share repurchases, the dividend payments you alluded to earlier and M&A activities are opportunities that may come your way because of your strong financial position.

Harold McGraw III

Barry, good morning and thanks. But you know, again, uses of that free cash flow taking into account exactly what you were saying across the board. I think that there are going to be acquisition opportunities. I do think that there are going to be a host of portfolio considerations that could be beneficial to us. At this point we have to make sure that the organic growth stays strong and then we are investing from that standpoint and I am very eager to get back as conditions improve to a strong share repurchase program in August. At this point we need to think to settle a little bit before we do that but organic growth, acquisition, share repurchase just like in the better times – just the way, we were performing that way and we want to get back to that mode but portfolio considerations are certainly on the table.

Barry Lucas – Gabelli & Company

Thank you.

Operator

Thank you. Our final question comes from Michael Meltz with JP Morgan.

Michael Meltz – JP Morgan

No marks for me, I will follow up with Don, thank you.

Donald Rubin

Yes thanks Michael on that one.

Harold McGraw III

Okay, if that is it, thank you all very much. We will see you as the year progresses and we certainly will be giving you everything that we have as we go but we are hoping for a better ’09. Thank you.

Operator

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

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Source: The McGraw-Hill Companies, Inc. Q4 2008 Earnings Call Transcript
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