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The McGraw-Hill Companies, Inc. (MHP)

Q4 2006 Earnings Call

January 25, 2007 8:30 am ET

Executives

Harold McGraw, III - Chairman, President and CEO

Bob Bahash – EVP, CFO

Donald Rubin - IR

Analysts

Frederick Searby - JP Morgan

Peter Appert - Goldman Sachs

Brian Shipman - UBS

Lisa Monaco - Morgan Stanley

Michael Meltz - Bear Stearns

Brandon Dobell - Credit Suisse

Karl Choi - Merrill Lynch

Drew Crum - Stifel Nicolaus

William Bird - Citigroup

Steven Barlow - Prudential Equity Group

Presentation

Operator

Good morning and welcome to the McGraw-Hill Companies fourth quarter 2006 earnings call. (Operator Instructions) I will now turn the conference over to Donald Rubin, SVP of Investor Relations for the McGraw-Hill Companies. Sir, you may begin.

Donald Rubin

Thank you and good morning and thank everyone from around the world for joining us today at the McGraw-Hill Companies fourth quarter 2006 earnings conference call. I’m Donald Rubin, SVP for Investor Relations at the McGraw-Hill Companies. With me today are Harold McGraw III, Chairman, President and CEO and Robert Bahash, EVP and CFO of the corporation.

This morning the corporation issued a news release with fourth quarter 2006 results. We trust you’ve had a chance to review the release. If you need a copy of it and financial schedules, they can be downloaded at www.McGraw-Hill.com/investor_relations.

Before we begin this morning, I need to provide certain cautionary remarks about forward-looking statements. Except for historical information, the matters discussed in the teleconference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates, and descriptions of future events. Any such statements are based on current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward-looking statements. In this regard, we direct listeners to the cautionary statements contained in our Form 10-Ks, 10-Qs and other periodic reports filed with the U.S. SEC.

We’re 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 212-512-2247 subsequent to this call.

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

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Harold McGraw

Thank you, Don. Good morning and welcome. Thank you, everyone for being with us today to go through the review of the McGraw-Hill Companies’ fourth quarter and year end results. As Don said, joining me for today’s conference call is Bob Bahash, he’s our EVP and CFO of the companies.

We will start today by reviewing the performance of our business and the outlook for 2007. Bob will then review our financial performance and he’ll discuss some of our expectations for 2007 as well. When our presentation has concluded, obviously we’ll go in any direction any of you would like about the companies.

Earlier this morning, we announced full year and fourth quarter results for 2006. We reported that earnings per share increased 8.6% to $2.40 for 2006 and by 12% to $0.56 for the fourth quarter. Revenue grew by 4.2% for the year to $6.3 billion and 3.4% to $1.6 billion in the fourth quarter. The results include a number of charges largely due to the expenses for stock-based compensation, which are all carefully enumerated in the earnings release and the schedule that accompanies it. But I’ve also asked Bob Bahash to comment on them later in the call so that everybody has those exactly in perspective.

The bottom line is that we clearly have had a successful year, and we were also able to exceed our guidance for both 2006 and the fourth quarter and we’re pleased about that. With continued strength in financial services and a rebounding education market, we’re poised for double-digit earnings growth in 2007. All segments will contribute to this performance with improving operating margins. We are using $2.50 as the base for our double-digit earnings guidance for 2007. We arrived at this figure by adding back to GAAP earnings of $2.40 the non-recurring charges in 2006 of $0.04 for the elimination of the restoration stock option program and the $0.06 for restructuring; so $2.50, the base for the double-digit guidance for 2007.

Management is dedicated to creating total shareholder value. We’re very proud of the fact that our total return has outperformed the S&P 500 for each of the last ten, seven, three and one-year periods. As part of our commitment to advancing total shareholder value, we’ve been steadily returning more cash to shareholders, and that’s of course through stock buybacks and increased dividends. At the end of January, the board of directors at the regular monthly meeting on January 31st will review the dividend and the buyback programs. We bought back 28.4 million shares in 2006, cash dividends have increased at 10.3% compound annual growth rate since 1974. Obviously, we’ll have more to say about the dividend and the future buybacks in a few days.

As we look ahead, our economists believe slower economic growth should permit the Federal Reserve to lower interest rates around mid-year. The Fed has maintained the Fed funds rate at 5.25%, but could ease to around 4.5% by the end of 2007. Corporate cash flow is expected to remain strong, so will capital spending. State finances are in good shape, and of course that’s a plus for the education market.

With this background in mind, let’s take a look at the operations and why we’re optimistic about our growth prospects for 2007. Let me begin with McGraw-Hill Education. The bookings for education in 2006 were growth in the higher education, professional and international markets which produced 47% of the segment’s revenue in 2006; and a decline in the school education group, which is largely attributable to a weaker elementary/high school market and tough comparisons after a very successful 2005 performance.

Revenue for the segment declined in 2006 by 5.5%. Operating profit declined 19.8% and that includes incremental expenses of $19.6 million for stock-based compensation and a charge for the elimination of the restoration stock option program.

On a non-GAAP basis, the operating margin was 13.8% and that excludes the charge for the elimination of the restoration stock option program and restructuring charges of $16 million in the second half. Excluding taking those out and putting them back in, it would be 13%.

As part of the restructuring, we vacated some facilities and eliminated 450 positions. In a weaker year for state new adoptions, we reduced the segment’s costs and expenses by nearly 3%. Softer market conditions and challenging comparisons were most pronounced in the fourth quarter. The school education group’s revenue fell 30.2% in the fourth quarter and 12.4% for the year. In 2005 we received $44 million in late new adoption orders from Texas, which helped boost our fourth quarter revenue by 23.6% and so the comparison makes it difficult. In 2006 there was no major order from Texas and there was additional weakness in the testing business.

Our performance in the important state new adoptions in 2006 produced some outstanding successes and some disappointments. A 5% share for the Florida elementary science adoption, but a 39% share of the larger secondary market; a 15% share of the elementary social studies adoption in California, but a 32% share of the middle school and a 40% share of the high school market. These exceptional capture rates in the middle and the high school markets and our year-over-year increase in territory sales couldn’t offset the tough comparisons from 2005 and a 30% decline in the state new adoption opportunities in 2006.

We had expected the el-high market in 2006 to finish flat to down 4%. In fact, the market declined by 5.8% and even the industry’s open sales were off 0.3%, essentially flat in 2006, and of course this is all according to the AAP figures. Our school education group outperformed the competition in open territories, benefiting from a very strong showing from Treasures. That’s our new elementary reading basal. Although our secondary science and social studies programs were very successful, we underperformed in the state new adoption market.

In testing, we saw a continued decline in the sales of norm-referenced shelf tests which are being displaced by the state-specific standards-based assessments required under the Federal No Child Left Behind legislation. In the fourth quarter, volume from custom contracts declines as states reduced the scope of work on several of our continuing contracts. We’ve also discontinued some low-margin custom contracts, service revenue for state assessment contracts declined from $246.1 million in 2005 to $214.4 million in 2006.

The good news is that starting in 2007 the performance of our school education group will definitely improve. There are several reasons for this optimism. One is that we start with a growing market. The state new adoption market enters the first of three consecutive growth years and could increase by as much as 15% in 2007. We now expect open territory sales to grow in the low to mid single-digit range. That combination should lead the market growth to about 4% to 6% this year. We expect to outperform that. Clearly, year-over-year comparisons will be easier for our school education group in 2007.

We also expect to do better because the school education group will be participating in more of the addressable market in 2007 than it did in 2006. In most years, we participated in virtually the entire state new adoption market; but in 2006, for strategic reasons, we competed for about 80% of the available dollars in this state new adoption market. We captured about 25% of the market in which we competed, but only 20% of the total available state new adoption market, well below our usual capture rate which normally runs about 30%.

In 2007, we have timed the introduction and enhancements of new products to pursue bigger growth opportunities in a more robust market. In science, we have new elementary and secondary programs which have been customized for major adoption state. Real math, a skills-oriented elementary program, won a number of small and medium-size adoptions last year and is well-positioned for more growth in 2007 in both open territories and adoption states where it has been submitted.

Student tests were positive in schools that piloted the program last year and that will add to the momentum for this research-based program in 2007. Every Day mathematics, the best-selling program in the reform-oriented segment of the K-6 market, is continuing to win new business. We will extend the brand into the secondary grades with a new program in 2007. Reading with purpose for middle schools and the Readers Choice for high schools are a new series for the important secondary reading and literature market. We had some early success with these programs last year in the open territory and expect them to be very competitive in the state new adoption market in 2007.

Treasures, the new basal reading program for the elementary schools will build on the good start that it made in open territory last year. We are enhancing and expanding our line-up of products in reading and math for the fast-growing intervention market. For example, we’re adding middle school components to our successful Numbers World and Kaleidoscope programs; Jamestown Reading Navigator, a subscription-based reading program for grades 6 through 12 was piloted with more than 100,000 students in 2006. The new program had early adoptions last year in Massachusetts, Texas and Florida and recently won state level approval for purchase in 2007 by districts in California, Tennessee, and West Virginia.

We also entered 2007 with a stronger organization to compete in the core basal market. As you may recall, we combined our elementary and secondary basal publishing groups last year. That reorganization is now 100% complete. We believe that streamlining improves the sharing of resources -- very important -- the delivery of competitive pre-K through 12 solutions, our cost efficiencies from product development through sales and marketing, the growth of our top line and our return on sales.

We compete with a spectrum of products in the reading and math markets. This depth and breadth strategy encompasses the balanced basal segment in the middle and the progressive and skills-based market. That gives us an extraordinary range of options for meeting the needs of students and teachers in a very diverse marketplace.

We expect some improvement in the testing market as technology investments help us increase our efficiency. We will also be making new investments to improve our penetration of the rapidly growing formative testing market. This is the so-called low stakes market because educators use formative assessments during the school year, essentially to gauge how well students are prepared to take the summative or the high stakes tests at the end of the academic year.

With the No Child Left Behind Act’s emphasis on accountability for student performance, the market is looking for better ways to monitor and diagnose classroom progress. Teachers are realizing that there are issues with many of the homegrown assessment programs that they’ve been using. Most are not online, and the turnaround time is slow. Our new formative program is online and customized to meet state standards. It provides predictive and diagnostic tests to meet the market’s evolving demand for measurement-based formative assessment and we’re very encouraged by the initial response to the program.

We’re also expecting more improvement in 2007 from our higher education professional and international group. In 2006, our higher education and professional products grew both here and abroad. We had a strong finish in the international and professional markets. Our performance in the U.S. college market softened in the fourth quarter with only the business and economics imprints showing a gain for the period.

The best performance for the year was turned in by our science, engineering and math imprint which had solid growth. For 2006 it now looks like the U.S. college and university market grew about 3%, somewhat better than our performance. We expect the market to grow about 4% in 2007 and think our strong list of new products will give us an opportunity to do better. Higher education is expected to grow faster in international markets.

Our growing array of digital products and services contributed to growth in 2006 and will do so again in 2007. In the college and university market, we are getting some traction with Homework Manager and similar digital products in accounting, math and world languages. We’ve also introduced 40 new online courses for the college market and that should have a positive impact in 2007.

These online courses, incidentally, are finalists in two categories: one category the best education solution and the other category the best post-secondary course and content management solution for the prestigious COTY awards from the Software and Industry Association.

In the professional market, we will continue to add to our lineup of digital products for the medical professionals. We started with Access Medicine which is now used in more than 42 countries and by virtually all U.S. medical schools. Last July we launched Access Surgery. It follows the Access Medicine model and combines leading McGraw-Hill reference text with digital video. This month we will launch Access Emergency Medicine and at mid-year we plan to introduce Access Pharmacy. Other specialties will follow from that. And again, these are all subscription products that sell on a global basis.

Summing up then for McGraw-Hill Education, improved prospects and a growing elementary/high school market in 2007, a robust state new adoption market starting in 2007, a growing spectrum of products to serve a diverse el-high market, growing global growth prospects in higher education and professional markets, more growth in digital products as the convergence of technology and content increases the addressable market, and margin expansion in 2007.

With that, let’s turn over to the financial services segment and go through those results and prospects. This segment finished the year on an upswing with revenue improving 22.1% in the fourth quarter and with a good pipeline to start 2007. All the more impressive, since the hot U.S. residential mortgage-backed securities market started cooling down a bit in 2006.

Revenue in 2006 increased 14.4% but by 19.4% on a non-GAAP basis, and that’s reflecting the sale of Corporate Value Consulting in September of 2005. Operating profit increased by 18% and that is reflecting $30 million in incremental expenses for stock-based compensation and a one-time charge for the elimination of the restoration stock option program. The operating margin for the year was 43.8%, up from 42.5% in 2005. Solid growth in equity and fixed income information products and services produced new records at Standard & Poor’s for revenue, operating profit, and operating margins in 2006.

The year was marked by solid contributions from rating services, data and information products, and index services. We have said that before and we are confident that we will say it again in 2007. Clearly, the solid and growing line-up at S&P continues to contribute to the sustainability of its performance, while reducing dependence on any single product or asset class.

In ratings, we grew solidly domestically and abroad. In the fourth quarter, the share of revenue from international ratings and services topped the 40% mark for the first time in S&P’s history and that was accounting for 41.8% of its revenue, versus 38.4% for the same period last year.

For the full year, international produced 38.6% of ratings revenue and that’s up from 37% in 2005. The structured finance market continues to be a strong driver. In the fourth quarter, structured finance’s performance was primarily attributable to growth in the collateralized debt obligations and the commercial mortgage-backed securities market.

In the CDO market there was strong investor demand in cash flow and synthetic sectors as well as increases in collateralized loan obligations which benefited from the growth and leveraged loans stimulated by merger and acquisition activity. Asset-backed alert on industry newsletter reported on January 19th that in 2006 S&P, for the ninth straight year, rated more asset mortgage-backed securities than any other agency. The measures are S&P’s ratings of dollar volume issuance and the number of deals.

S&P also benefited from a substantial pickup in the corporate market in the fourth quarter. Public finance issuance also finished the year strongly. Some, but not all, of the strength was captured by the quarterly flow by new dollar volume issuance this year. As this bar chart shows, U.S. corporate dollar volume issuance grew year over year in each quarter of 2006 and finished with a surge in the fourth quarter. For the year, U.S. corporate issuance was up 43.8% as investment grade and high yield issuance both set records.

Public finance issuance was off about 7% in 2006, but produced a gain of nearly 17% in the fourth quarter as December volume soared. This was the most active December market in public finance since 1985. Seven of the 14 largest deals of the year were sold in the fourth quarter.

The U.S. residential mortgage-backed securities market rose at the start of 2006, but dollar volume issuance started declining in the third quarter. That trend continued into the fourth quarter, but thanks to the strong start in 2006, the U.S. residential mortgage-backed securities issuance of the year finished ahead by about 1.4%.

In Europe, the residential mortgage-backed securities market dollar issuance was up for most of the year and was exceptionally strong in the fourth quarter. For the year, European issuance in this asset class was up 58.9%.

The commercial mortgage-backed securities market produced year-over-year gains and dollar volume issuance for each quarter of 2006 and surged dramatically in the fourth quarter. As you may recall, we started talking about this issuance demand starting to pick up in early 2005 and it has and it is steadily increasing. For the year, commercial mortgage-backed securities dollar volume issuance was up 27.6% in 2006.

The commercial market was also very strong in Europe, and especially in the second half as issuance continued to build. For 2006, the commercial mortgage-backed security issuance in Europe was up 37.3%. Asset-backed dollar volume issuance in the United States showed year-over-year gains in the first and the third quarters but ended the year off 4.4%.

The market was also strong for ratings and services that are not directly tied to new issuance. These services accounted for 24.5% of ratings in the fourth quarter and 23.9% for the year. We expect revenue in this area to increase again in 2007. These are bank loan ratings, counterparty credit ratings, financial strength ratings, credit estimates. These will all lead to growth. In fact, we expect growth in all asset classes in 2007 except for the U.S. residential mortgage-backed securities where issuance will probably decline around 10% or 15%.

International growth will be strong again in 2007, with all regions expected to produce increases for the year. We’ve also worked very hard in recent years to reduce our dependence on transaction revenue through the growth of frequent issuer and surveillance programs. A measure of our success is the growth of unearned revenue. The corporation’s unearned revenue grew by more than 15% last year to $983.2 million. The increase is primarily attributable to financial services ratings products.

In equity markets, S&P continues to expand and grow. Assets under management and exchange-traded funds based upon S&P indices increased 19.3% in 2006 to $161.2 billion. We will continue to expand and add index services in new asset classes such as real estate. Our goal is to provide an index for every type of investment style.

In the fourth quarter, ten new exchange-traded funds based upon S&P indices were introduced bringing the year’s total of new exchange-traded funds to 35. All told, there are now 87 exchange traded funds worldwide using S&P indices and we anticipate 13 more exchange-traded funds will be launched in the first quarter of 2007.

There is continuing global demand for our equity and fixed income information products and services. Since we acquired Capital IQ in 2004 the client base has doubled to more than 1,700. Last fall, we added data from S&P ratings to the Capital IQ offering, leveraging and extracting greater value from S&P’s content is a key strategy here and we are pleased with the progress that we’re making.

Summing up for financial services, continued strength in ratings, solid growth in international markets, excellent growth in data and information and indices, another year of double-digit top and bottom line growth in 2007, and more margin expansion.

With that, let’s turn now to the information and media segment. As we know, this is a segment in transition as we take advantage of new opportunities to deliver information and analytics over the Internet to our customers in the B2B markets. We’re also very pleased with the performance of JD Power and Associates, and you may recall we acquired that in April of 2005.

These factors contributed to the 5.7% increase in revenue for the year and the 17.6% decline in operating profit and an operating margin of 5.1%. Operating profit included $14.1 million in incremental expenses for stock-based compensation and a one-time charge for the elimination of the restoration stock option program. It also included restructuring charges of $8.7 million for the employee severance cost for the reduction of approximately 150 positions. It also included a change in revenue recognition for the transformation of suites from primarily a print catalog to a bundled print and online service. As a result of this change, there were reductions of $23.8 million in revenue and $21.1 million in operating profit in the fourth quarter.

Favorable developments over certain disputed billings also benefited segment comparisons by $8.3 million. There was also the impact of eliminating Business Week’s European and Asian editions. They produced approximately $26 million in revenue in 2005.

The year in advertising was mixed. Political advertising at our broadcasting group was extremely strong in the fourth quarter and for the year. The races for the governor in California and Indiana; there were also contests for the House of Representatives in Denver and Indianapolis; and, you had the issue and the proposition advertising in California. These were all factors in producing more than $16.8 million in political advertising in 2006. Some of that gain was offset by the loss of Monday Night Football at all our ABC affiliates and a decision not to renew the Oprah Winfrey Show in two of our markets, San Diego and Denver.

Broadcasting revenue increased 7.5% to $120.6 million for the year and 3.5% in the fourth quarter to $33.6 million. Off a small base, revenue at BusinessWeek.com grew by 45.7% last year, and we are looking for more growth in 2007. Business Week’s ad pages were essentially flat in 2006 and up 1.6% in the fourth quarter. We expect some improvement at Business Week this year. In total, advertising contributed slightly less to the corporation’s revenue in 2006, about 5.3% of our revenues is in advertising, and that compares to 5.6% of the total revenues in 2005.

In looking ahead, we expect our information products and services to drive improvement in this segment. We will be delivering higher value-added information to readers and advertisers by focusing on a few areas: news and information in text, audio and video formats; data and analytics and work flow tools and services; search advertising and lead generation and online community portals producing user-generated content. Construction will obviously benefit from the pickup in suites as revenue for the bundled print and online services will be recognized as earned in 2007. This is a significant transformation for a 100-year-old service.

JD Power and Associates had a solid gain in the fourth quarter and is poised for another very good year in 2007 and more global expansion. We’re seeing strength in the non-auto segment. Financial services, insurance, real estate and construction all showed gains. As this graph shows, the outlook for the global automotive market over the next several years is very strong, particularly in the Asia Pacific region. In China alone, auto sales are expected to rise in seven years from 6.7 million to 12.9 million units. Given the complex and fast-changing nature of the Chinese automotive market, solid information on industry and customers is critical. That’s why JD Power and Associates last September acquired Automotive Resources Asia which has been specializing in the Asian car markets since 1993.

The combination with JD Power which has been providing voice of the customer information in China’s auto market since 2000, adds a whole new dimension to our services for the fast-growing region and enhances our prospects.

Additionally, news about oil and pricing in the volatile market will also continue to drive demand for [Platt’s] products and services and we’re pleased with the performance in ‘06 and expect more in ‘07.

Let’s sum up for the information and media segment then: expanding services in a digital world, growth in higher value-added information products and margin expansion in 2007.

For the corporation in 2007, we look for double-digit earnings growth, another year of double-digit top and bottom line growth at financial services, solid gains in our school education business, good growth in the global higher education market, more progress in information and media and margin expansion in all three segments.

With that, let me turn it over to Bob Bahash and Bob will talk a little bit about our financial performance and our strength there.

Bob Bahash

Thank you, Terry. As part of the McGraw-Hill’s Companies commitment to produce total shareholder value, we have been returning cash to shareholders through increased dividends and share repurchases. We’ve built on that record again in 2006 by returning $1.8 billion to shareholders in this manner. In fact, since 1996 dividends and share repurchases have returned $5.9 billion to McGraw-Hill shareholders.

As Terry mentioned earlier, the board of directors reduced the dividend and the share repurchase program at its January meeting which takes place next Wednesday. This morning, I’m going to discuss our strong financial condition at the end of 2006 and provide some indication of what to expect for 2007.

We are debt-free. Our cash position at the end of 2006 was $353 million which is $395 million lower than the year end 2005 balance and consists primarily of our foreign holdings. I’ll speak to the specifics of key components of cash flow in detail, but it’s important to note that our strong cash flow for the year, along with our beginning cash balance, was sufficient to fund all operating investments, capital expenditures, pre-publication investments and our return to shareholders in the form of dividends and increased share repurchases, net of option exercise proceeds.

We achieved our previously announced 28.4 million share repurchase target for 2006 by repurchasing 2.4 million shares in the fourth quarter. We repurchased the 28.4 million shares at an average price of $54.23 per share, totaling approximately $1.5 billion. 20 million shares remain from the 45 million share repurchase program approved by the board in January of 2006. The fully diluted weighted average shares outstanding -- or WASO, and I am going to refer to this a couple of times, WASO -- for 2006 was 366.9 million shares. That’s a 15.7 million share decrease compared to the full year 2005.

The decrease is primarily driven by the weighted impact of the 28.4 million shares repurchased during 2006, partially offset by stock option activity and the 31.7% increase in our stock price in 2006. In the fourth quarter, WASO actually increased 3.4 million shares compared to the third quarter and was influenced by the three factors mentioned above:

  1. A 17% increase in the stock price for the fourth quarter, resulting in more in the money stock options;
  2. Increased option exercise activity; and
  3. There were no share repurchases in the third quarter.

Now hopefully this illustrates how these factors can influence the WASO calculation using the required treasury stock method of determining outstanding shares.

Net interest expense was $14 million for 2006 which is slightly lower than we had projected. This declined to only $70,000 in the fourth quarter, a seasonally strong period of free cash flow as the interest income earned on investments from excess cash balances offset the fixed components of interest expense relating to bank fees, deferred compensation, and the accounting for the Rock-McGraw sale leaseback transaction that occurred in December of 2003.

For 2007, we expect the full year of interest expense to range between $16 million and $18 million. This is higher than 2006 as we begin this year with $395 million less cash than the same period last year. 2007 interest includes the same fixed items as 2006 with the largest component being the $9 million for accounting relating to the Rock-McGraw transaction.

Now, there are a number of ins and outs affecting 2006 and 2005 for both the full year and the quarter, so I want to point them out now to you. The earnings released this morning reviewed the 2006 earnings results of $2.40 per share. The results include a one-time charge of $0.04 for the elimination of the restoration stock option program; $0.11 for incremental stock-based compensation; and $0.06 in charges for restructuring started in the third quarter and completed in the fourth quarter.

The restructuring eliminated approximately 700 positions across the company. The action brought our total restructuring charge for the year to $31.5 million. Now, that compares to 2005’s EPS of $2.21 and that included a $0.04 restructuring charge for employee severance costs related to the reduction of approximately 500 positions across the corporation in the fourth quarter of 2005; and, a $0.03 increase in income taxes on the repatriation of funds made possible by the American Jobs Creation Act and a $0.01 gain on the sale of corporate value consulting.

Now looking at the quarter. For the fourth quarter of 2006, diluted earnings per share increased 12% to $0.56 compared to the same period last year. These results include $0.01 for the incremental stock-based compensation; $0.03 restructuring charge for positions eliminated in the fourth quarter; and a $0.04 for a change in revenue recognition, the transformation of suites that we discussed at previous meetings.

That compares to 2005’s fourth quarter EPS of $0.50 which included the two items I just mentioned for the full year 2005 EPS, $0.04 restructuring charge and $0.03 increase in income taxes for the repatriation of funds.

In the beginning of 2006, we indicated we were transforming suites. The McGraw-Hill Construction Group’s popular Building Products Database from a print catalog to a bundled print and online service. This move resulted in a change in our revenue recognition for the suites product sales. Accounting standards require us to recognize revenue for subscription products over the contract period, rather than solely in the fourth quarter which was how we recognized suites revenue in the past when only the standalone print product was delivered to customers in December. The shift reduced Suites’ fourth quarter 2006 revenue by $23.8 million and operating profit by $21.1 million, or $0.04 per share. The difference between the revenue and operating profit impact is due to the deferral of $2.7 million in related expenses that will be recognized in 2007.

In 2006, the company incurred incremental stock-based compensation expense of $85 million, which includes a one-time charge of $23.8 million from the elimination of the company’s restoration stock option program. The $85 million expense represents $0.11 per share for the incremental expensing plus an additional $0.04 one-time charge for the elimination of the restoration program.

Now, looking at how this all breaks down between the segments and corporate, McGraw-Hill Education had incremental expenses of $19.6 million for stock-based compensation which includes $4.2 million for the one-time charge. Financial Services had incremental expenses of $30 million for stock-based comp, including $2.1 million for the one-time charge. Information and media, incremental expenses of $14.1 million; that includes $2.7 million for the one-time charge. And finally, for the corporate areas the incremental expenses of $21.4 million, that includes $14.7 million for the one-time charge.

Now, let’s take a look at corporate expense. Corporate expense increased $38 million to $163 million for 2006. It includes, of course, the $21.4 million incremental stock-based comp I just mentioned. The full year amount also includes a portion of the restructuring charge of $6.8 million versus $2.8 million of restructuring charges in 2005, as well as a revaluation charge for certain equity venture investments.

In 2006, we had dilution of $0.05 from the acquisitions made in 2004 and 2005. In 2007, we expect they will be cash positive. The company, of course, did not make any material acquisition or dispositions in 2006.

The effective tax rate in the fourth quarter was 37.2%. The blended effective income tax rate for 2006 was also 37.2%. For 2007, we expect the rate to be approximately the same as 2006 on a full-year basis.

Let’s take a look now at capital expenditures which include prepublication investments and the purchases of property and equipment. Prepublication investments were $87 million in the fourth quarter and $277 million for 2006. This is $19 million higher than in 2005, but lower than our original projection for 2006 due to timing, as well as some efficiencies from our global resource management program.

For 2007, our prepublication investments will be about $330 million. As Terry mentioned earlier, we compete with a spectrum of products in the key reading and math markets and these investments are targeted to these opportunities. This level of investment is driven mainly for products we are currently developing to realize significant opportunities in the el-high market in 2007 through 2009.

Purchases of property and equipment were $70 million in the fourth quarter and $127 million for the year, which is $6 million higher than in 2005. As we mentioned during the last call, the primary construction phase for our new data center has shifted to 2007. In addition, we anticipate increased technology investments due to the continuing digitization of our products and services. As a result, we project $250 million for 2007 which is a $123 million increase compared to 2006.

Now, for some non-cash items. Depreciation was $113 million in 2006; for 2007 we expect $130 million, reflecting the higher level of capital expenditures in 2007 and the full year of depreciation from CapEx made in 2006. Amortization of prepublication costs was $228 million in 2006. For 2007 we expect $260 million, as a result of the new el-high programs we’re publishing to take advantage of the strong adoption opportunities.

Amortization of intangibles was $48 million in 2006. We’re expecting $50 million in 2007, virtually flat with the previous year. That brings me to free cash flow. In defining free cash flow, we start with operating cash flow and reduce that amount by certain cash outflows for investing and financing activities that are more reoccurring by nature. As you see from the table, cash provided by operations per GAAP was $1.5 billion for 2006. We then subtract the following which we’ve already talked about. Investments and prepublication costs of $277 million; purchases of property and equipment, $127 million; additions to technology projects, $23 million; and dividends paid to shareholders, $260 million.

Under this definition, free cash flow for 2006 was $825 million versus $896 million for 2005. That’s an 8% decrease due to increased investments and a return to a more normalized level of working capital. For 2007, we anticipate free cash flow in the range of $700 million to $750 million, primarily reflecting higher investment spending. We have ample cash and borrowing capacity for dividends, share repurchases, strategic acquisitions and to meet our requirements for internal investments.

Thank you and now back to Terry.

Terry McGraw

Thanks, Bob. Again, as we entered 2006 we did so knowing that we were going to have a slower education market and we needed to reflect all of the expensing of stock-based compensation. But with all of that, we’re very pleased with how we completed 2006 and we’re pleased that we were able to outperform the guidance that we gave for the full year and for the fourth quarter.

Now, that we’re in 2007 and we obviously have a much better look for all of our businesses, we look for the double digit earnings growth for the corporation, another year of double-digit top and bottom for financial services, we’re looking for solid gains in our school education business -- again, good growth in higher education and more progress and information. And again, margin expansion across the board.

So with that let me turn it back to Don – and again, one other aspect again. We’re using $2.50 as the base for our double-digit earnings guidance for 2007, and again, we arrived at that figure by taking the GAAP earnings at $2.40 and adding to that the nonrecurring charges in 2006 of $0.04 for the elimination of the stock restoration program and $0.06 for restructuring, so $2.50 is the base line for that.

Now, back to Don.

Donald Rubin

Thank you. Just a couple of instructions for phone participants. (Caller Instructions) We are now ready to take the first question.

Question-and-Answer Session

Operator

Your first question comes from Peter Appert - Goldman Sachs.

Peter Appert - Goldman Sachs

Thank you, good morning. Terry or Bob, can you talk please about the operating margin performance in the financial services segment? You had shown some fairly impressive year-to-year gains in the first three quarters, the margin down in the fourth quarter. Anything particularly we should note that's driving that?

Harold McGraw

Well, Peter, good morning. Even with a softer residential mortgage-backed market the pipeline has just been very strong. And again, the shift in leadership between some of the structured market asset classes as well as impressive buildup on the corporate and government side has allowed us to grow a little quicker. Also, as I mentioned in the remarks, the non-traditional products and services also contributed, as well as the growth on the data and information side and on the indices.

So it was just across the board a very good year for S&P and we expect a very good year in 2007. Bob, do you want to add anything?

Bob Bahash

If could I add two points there: one, because of the very strong performance year there was a true-up in incentives for the various businesses as well. And last year, Peter, we had divested CVC in the third quarter so that comparison then therefore is now out. It was in the comparison on the year-to-year basis for the first three quarters, not in there for the fourth quarter. That also influenced the comparisons.

Peter Appert - Goldman Sachs

Wouldn't that have a positive impact, though, on margin performance in the fourth quarter versus a year ago?

Bob Bahash

The CVC, when you look at our performance each quarter this year, of course it was down; if you are comparing to last year, because CVC's margins were lower than the total, last year's margins would have been lower for the first three quarters. Now you are getting more to a normalized margin for the businesses in the fourth quarter. So the comparison obviously would be tighter.

Peter Appert - Goldman Sachs

Even so, the incremental margin doesn't look that impressive versus what you have been doing. You mentioned specifically the true-up in bonuses. Would that be enough to account for the year-to-year differential in margin or are there some other mix issues?

Bob Bahash

There's nothing out of the ordinary, or nothing unusual, but the incentive true-up clearly was part of that, but there's nothing unusual in terms of the overall mix of different businesses, different activities.

Peter Appert - Goldman Sachs

One last thing and I'll let go of this. For '07 then would you expect the operating margin in the financial services segment to be roughly flat on a year-to-year basis?

Bob Bahash

Again, the way we're looking at it at this point, I think from a guidance standpoint Peter, we're saying that we expect margin improvement. At this point of the year, I think that's a good place to leave it. But we expect more margin improvement.

Peter Appert - Goldman Sachs

Thank you.

Operator

The next question is from David Lewis - JP Morgan.

David Lewis - JP Morgan

Quick question, can you guys elaborate on the international pipeline for issuance and just related to that, an update on some of the emerging opportunities? For example, CRISIL, how that's progressing? Thanks.

Harold McGraw

Sure. First of all, again, as you can see in the numbers and as the percent of international revenues is increasing, that number will continue. What we have said is that we think that probably by 2010, about half of ratings revenue will be coming from outside the United States and I think that's a pretty good benchmark at this point. So it's very strong.

It's very strong across the board. It's strong on the corporate side but it's also strong increasingly on the structured finance side. As some of the new issuance numbers, the residential mortgage-backed market is benefiting nicely both in Europe and in parts of Asia, also in parts of Latin America; Mexico as well, on that one. So the international pipeline is strong and we'll continue to gain strength on that one.

CRISIL is a wonderful example. CRISIL is a terrific example of what we're able to do when markets change and markets grow. India is gaining a lot of strength, it's growing quite well on the financial services side and is benefiting nicely from that, and so are we. CRISIL has been a wonderful addition and not just on the ratings side. As important as that is, it is also expanding in terms of all of the information and data services as that market begins to show more development. So we're very, very pleased with where CRISIL is and we expect a fair bit of growth coming out of India for 2007.

Operator

Your next question comes from Steven Barlow - Prudential.

Steve Barlow - Prudential

Good morning. There's been a lot of focus on the adoption states. Could you talk about what the market and what you feel the open territories can grow in the education business in 2007?

To drill down a little bit on Capital IQ, you talk about being pleased with the operation so far. Is there a way to quantify that a bit? Margins doubled since you bought it, margins are now in the low double-digits, the high double-digits, any particular metrics you can give us on that business? Thanks.

Harold McGraw

Steve, obviously the state adoption market for 2007 is going to be a much better opportunity than it was last year. We are looking at somewhere around a 15% increase in the addressable market and we expect to do well. You are going to have programs like K-12 science in California, you are going to have reading and literature in Indiana for the elementary and middle school, you've got Georgia elementary and middle school math; you've got Florida is coming out with K-12 health and world languages. Texas has got middle school and secondary school math. So you have got a very, very good schedule and you have got good breadth in terms of state adoption monies.

Obviously at this time of the year the open territories number is a difficult one to project. It was essentially flat in 2006, so we're looking for an increase here. I would say mid single-digits is probably a good estimate for right now. I think by the time we get through March and April we'll probably have a better indication of whether to strengthen that or not, but at this point I'd say about 5%.

On Capital IQ, again, the focus here, Steve, has all been on the revenue-generating side. Customer expansion, content expansion, and building out on this platform. We are very excited about their role as a platform and a data aggregator, and its competitive posture in the market. We are with some 1,700 clients now, that's double where we were when we acquired it, and we will do everything we can to continue that customer expansion, and at the same time, investing in building out on the content side. As we talked about a little bit earlier, some of the other S&P information that we have added to that content, but you will see more on that side. So the revenue growth is quite strong and we're pleased with that, but that's where our focus is at this point in terms of building out on it.

Steve Barlow - Prudential

Would it be fair to say then if the number of clients is double that your revenue has potentially doubled since you bought it?

Harold McGraw

Yes.

Operator

The next question is from Lisa Monaco - Morgan Stanley.

Lisa Monaco - Morgan Stanley

Hi, yes. Two questions. Just first financial, I think in the press release you gave some color on the increase in financial services segment. It looks like 75% was from structured finance and corporate and munis. Can we take away from that potentially that the non-ratings businesses in financial services, the growth was more subdued in the fourth quarter versus earlier in the year?

Harold McGraw

No.

Lisa Monaco - Morgan Stanley

Can you elaborate on that?

Harold McGraw

Again, you've got several components here. You are quite right in terms of the emphasis was on the structured finance market. That has been going on and will continue to go on for sometime. Again, it's not only the breadth of the structured market but it's also the geographic expansion as capital market growth really wants to go in that direction.

When you start taking a look at the other components, the non-traditional ratings business, when you start taking a look at the data information and the indices, those are all quite strong. All at a time when we're spending a lot of investment also in building out as we were just talking about the Capital IQ platform, on that one. So again, we have seen a nice contribution across the board, but obviously led by the very strong performance in structured.

Bob, do you want to add anything?

Bob Bahash

We had very good performance when you were earlier referring to the non-ratings side and the growth rates that we had been experiencing for some of the different segments, data and information, some of those particular product and services, as well as our index services, continued to be very, very strong or double-digit growth rates.

Lisa Monaco - Morgan Stanley

Just on this issue and then I will move on, can you say whether the growth in the ratings business was higher or lower than in the non-ratings business?

Harold McGraw

Higher.

Lisa Monaco - Morgan Stanley

Higher. Okay. And then just on education: in '06, you guys spoke about some areas of disappointment in California and Florida. At what point did you get the sense that expectations were a little bit too high and the year was not going to come in as expected? Where I'm going with this is how much you have a visibility in terms of new state adoptions.

Harold McGraw

The issue again was in the elementary side of Florida, and on California, both were very different issues. In the science adoption on elementary in Florida, because of the overall opportunity and the size of the opportunity, we decided not to go with a rigid state-specific offering. It was state-specific, but it was coming off of a very successful national science program and that was the issue there. Again, in the middle school and the secondary school, those were very, very strong performances, and it carried the aggregate capture rate up.

In California with social studies, it was a very different issue. California was looking for a very rigid state-specific offering which we complied with. At the end of the day, because of the fact that it wasn't being tested and the emphasis was on reading and math, that California wanted to go with a much diluted version rather than a hard state-specific.

There were very different issues. It's not in terms of the quality of the program it is about markets conditions on those. Again, the middle school on social studies was quite strong on that part. So overall, it's just the elementary side and we have taken a lot of pains to fix that, and that was a part of the reorganization that we talked about last year, and they're out, and we fully expect to get back to the capture rates that we anticipate for planning purposes every year.

Bob Bahash

Lisa, with regard to the specific timing of when we had indications, different districts, some of the larger ones -- Dade and such -- they are making their calls at different times. So you are getting indications, I guess probably in the February/March period, but in terms of when we really had a pretty good handle on where we were coming out, it's really into about the middle of the second quarter that you have a pretty good idea where your won-loss rate is coming out.

Operator

The next question is from Michael Meltz - Bear Stearns.

Michael Meltz - Bear Stearns

Thank you. I think I have three questions. Bob, just following-up on Peter's question that incentive true-up that you referred to for bonuses, can you quantify that? Is that closer to $1 million or is that a $10 million type of number? Then I have a follow-up.

Bob Bahash

Mike, that's not something that I could actually quantify or that I really care to quantify. This is a business that has performed extremely well and we want to make certain that we first of all, reward the employee population in the best manner and be very, very competitive and we make certain that our total pay package, including incentives and such is going to be very attractive to maintain the best quality. So it's not $1 million, let's put that it way.

Michael Meltz - Bear Stearns

Fair enough. On your guidance just a clarification, you have said margins up at all three segments this year, and you have said financial services revenue is up over 10%. Is it fair to say you're looking for mid single-digit revenue growth at the other two segments?

Bob Bahash

We're not forecasting, at this point in time, revenue for the other businesses. What we're comfortable in talking about is revenue for financial services, operating profits for financial services, both double-digit; EPS growth double-digit for the corporation and margin improvement for all three segments.

Harold McGraw

Michael, obviously with the base in '06, we're looking for a very good performance on the education side.

Michael Meltz - Bear Stearns

With that suites transformation, that $24 million does, is that fully incremental in '07?

Bob Bahash

It moves from 2006 to 2007. I'm not sure what you mean.

Michael Meltz - Bear Stearns

So that boosts up your growth rate by a couple hundred basis points?

Bob Bahash

Yes. Well, you're coming off a year where we didn't have it. So clearly that's going to be an additional element. It's simply a shift, as I mentioned earlier. We had always recognized that revenue in December. Now, with the print and online versions, you're taking effectively that same amount of money that would have been recognized in December of 2006 and is being recognized over 2007.

Michael Meltz - Bear Stearns

Thank you, and I have one last question. You mentioned on the testing business, I think you said revenues were down 13% last year. Can you just talk a little bit about profitability of that unit, perhaps relative to the rest of the education business?

Harold McGraw

Yes, Michael, we don't break that one out specifically. But again, this is a business that is in transformation. Again, we were very, very strong as a high-stakes tester, the summative testing market. Where the market is going is obviously into the formative side of assessment. The production infrastructure for the high stakes is different than it is for the low stakes testing, or the formative side because of the fact that speed and customization are the requirements and therefore, the investment that we're making on the technology side is having an impact on the testing business at this point.

Michael Meltz - Bear Stearns

Thank you for your time.

Operator

The next question is from Drew Crum - Stifel Nicolaus.

Drew Crum - Stifel Nicolaus

Good morning, guys. Terry, I wonder if you could fist start to talk about some of the keys to reversing the margin erosion you experienced in education? What are some of the swing factors you look at for '07 to boosting margins for that business?

Harold McGraw

Well, there's a number of things in all of that. Certainly, a lot of the structuring issues that we have taken place, we're looking for more of response on. We talked about that in terms of combining the elementary and the high school operations and those centers of excellence.

You're also going to benefit from the global transformation project in terms of the efficiency of the order to cash methodology. You're also going to have some impact on the global resource management as we have outsourced some of those capabilities, but also, Drew, you've got the top line opportunity. With a much bigger addressable market, we fully expect to get back to the capture rates that we expect and I think that's going to have an impact as well.

Drew Crum - Stifel Nicolaus

Fair enough. Terry, is it possible to quantify the cost savings associated with the elimination of the 700 positions?

Harold McGraw

It will have some impact.

Drew Crum - Stifel Nicolaus

Shifting gears to the financial services business, obviously some strength, surprisingly strength in the public finance realm in the fourth quarter. Can you maybe talk about what the contributing factors were to that and what you're likely or expecting to see into '07?

Harold McGraw

Yes, I think that overall, I would say from a state standpoint the financial picture is quite bright. Budgets are very strong. We saw in the '05/'06 period a real slowdown in the new issuance market, reflective of that kind of strength. What we're seeing now is a little bit more aggressive budget as people are dealing with things like education reform and the like, and you're seeing some financing starting to pick up.

I would not look for robust growth here but certainly coming off of a very quiet '06, I think you're going to see a nice gain here.

Drew Crum - Stifel Nicolaus

Thanks, guys.

Operator

The next question is from Brandon Dobell - Credit Suisse.

Brandon Dobell - Credit Suisse

Thanks. In education, Terry, you talked a little bit about the textbook market for options, a little about open territories. What about the supplemental market? How should we think about the performance there in '06 and your expectations or your assumptions for '07 in terms of revenue growth or market share?

Harold McGraw

Brandon, the alternative basal or supplemental market has been a huge component for us because it's an area that allows us, obviously, to be able to address more and more of a particular market. It used to be that the lion's share was through a basal program, and now with the alternative basal and getting into reform and skill-based areas, having offerings in all of those areas gives us quite a leg up.

We expect growth in this area, and we expect the continuation of strength in some of the areas that we talked about in the remarks having to do with the mathematics with Everyday Mathematics and Impact Mathematics and the continuance of the very, very strong phonics-based Open Reading, and some of our new products in that area. So that will be an important part.

Brandon Dobell - Credit Suisse

As we look at the adoption cycle in the next couple of years, we've talked about this in previous calls, but is there any trend in any of the major states to not do away with the formal textbook as the center of the learning, but to go towards more of a supplemental outlook for the teachers to use, not quite the same rigid philosophy, textbook centric? I'm trying to get a feel for the market share between supplemental and textbook, especially in the bigger states?

Harold McGraw

It all depends on how people are addressing the intervention and remedial markets. States are doing that in a different way. Ours is to have a very strong alternative basal and a strong basal program and therefore make it fungible. We can go in any direction to build on the solution that they are looking for. I do think and we work very hard in terms of anticipating direction in the market that you are seeing, like we faced in social studies in California, an emphasis on certain areas and a de-emphasis on some and how to respond to some of those. I think the quicker we get to an online environment for some of those it's going to make it easier, and certainly I think the financials will reflect that as well.

But we work on that state by state but, yes, I think that everybody is looking at alternative ways of building content and how to do things or connect assessment into the content and the curriculum, and we will continue to work with states to do that. But you are not going to replace the textbook as the core component at this point. What you are going to do is you're going to be able to expand online participation in those markets.

Brandon Dobell - Credit Suisse

One final one. Moody's has talked this past year or so about catching up on staff, especially international markets to keep up with the growth in structured products. Maybe if you could give us some color on staffing levels within the ratings business and how you see those progressing? Do you think you've got the right people in the right places to keep up with the strong growth in some of those complex products?

Harold McGraw

I won't address Moody's, I'll let them do that. But from our standpoint, remember, as part of the global expansion what we have done is developed capabilities in specific markets, and therefore as you do so, initially your margins are going to be a little bit lower until you can get to a level of revenue base to get you to margin levels that we see domestically, and that will continue.

We are very competitive around the world, and we have people in those markets. So I don't see a huge ramping up for these activities. Another thing that's very, very important and one of the things that we do a lot of is a lot of cross-training, such that as you have shifts in the marketplace i.e. from let's say residential mortgage-backed securities to commercial mortgage-backed securities, that we can move staff around easily so that we can pick up some of that transaction capability.

So again, you have to have a very strong training and development function. We have very, very strong representation in specific markets, so that we can pick up on that demand.

Brandon Dobell - Credit Suisse

Great, thanks a lot.

Operator

The next question is from William Bird - Citigroup.

William Bird - Citigroup

Terry, I was wondering if you could talk about your current thoughts on acquisitions and also you have laid out a goal of education margin of 20% in 2010. That would imply about 160 basis points a year improvement. Just wondering if you expect even progress or some different pattern? Thank you.

Harold McGraw

Well, again, on the acquisition market, as Bob said and as we've said before, we were a little quieter in 2006. Some of the valuations that we saw and some of the things that we would like to do were in our opinion, too rich. When you're seeing certain kind of acquisitions at four, five, six times revenues, you can't get adequate returns on that, and therefore we think that in terms of use of free cash flow, going for a higher share repurchase and dividend made a lot more sense, provided that we're maintaining the organic growth investment required to be competitive in our market. So there was a bit of a shift on that one.

We'll see, as we get into this year, certainly I think that the 17 rate hikes last year are certainly going to slow down growth and by the time we get into, I don't know, somewhere mid-year, I think the Federal Reserve again will reflect that slowdown in growth and will start cutting interest rates.

As you take out some of the excess liquidity in the market, I think that valuations could become better on that one. So we're very active. We've got a pipeline there and we continue to monitor things, and where they make sense strategically, either from a platform standpoint or a component standpoint we'll address that. But we need to see valuations that are more conducive to the kinds of returns that we expect to get.

On the education market, again, the 20% goal by 2010 there's no change in that. We certainly realize that we have a bit of a hill to climb here in all of this. 2006 was an unusual year and 2007, 2008, and 2009 are going to be quite strong and given some of the things that we've talked about before in terms of GDP and global resource management that push to online the higher contributions and the higher ed in international and professional, we will definitely be making significant improvement on that part.

Now again, when you start projecting 2010 a lot of factors between now and then and will take place. But we expect significant margin gain and having a goal of 20% by 2010 I think is a responsible thing.

Bob Bahash

If I could just add to that, Bill. Your suggestion of a linear approach there would be nice, but that's not going to happen.

With regard to the opportunities coming up in 2007, they are significant. As Terry pointed out, in addition to the global resource management, global transformation project, outsourcing, offshoring activities like that, it's capture rates on the top line which is going to be critical, but as you know, for some of these major adoptions coming up in these various states there's a fair amount of upfront marketing costs in terms of promotion, free with order, sampling costs, and things like that. Of course, your amortization costs are higher in that first year. So that has to be reflected in.

When you look at the life cycle of an adoption and the significant capture rates one achieves, the profitability really flows in in the later years because that's when you basically don't have your marketing costs, your amortization costs are much lower and with the higher capture rates you're now filling replacement orders at a pretty higher rate.

So those are just some of the factors. So you shouldn't be thinking of this from a standpoint of a linear approach, because we have big adoptions coming up, some bigger upfront costs to address, but we're looking at some significant capture rates because we're excited about the programs that we have.

Operator

We will now take our final question from Karl Choi - Merrill Lynch.

Karl Choi - Merrill Lynch

Good morning. I just wanted to get back to the testing market for a second. Terry, you sound a little bit more optimistic about the outlook for testing in '07, but you also mentioned that you discontinued some lower margin contracts. I just wonder, do you think that testing revenues could actually be up in 2007?

Harold McGraw

Yes, thanks, Karl. We broke that out to show the investment as well as the shifts in the marketplace. I would expect, obviously coming off of a lower '06 I would have a higher expectation for revenue growth in '07. But again, this is a market that is in transformation. It's a critical piece of the market because of the No Child Left Behind standards. You're adding science testing in '07. So the market opportunities start to expand; but again, the investment is on being able to develop a fast, customized, formative product into the market which would be state-specific and it requires a technology base that allows you to customize and to have that instant return in terms of the test grading on that part.

So this will be a business that will continue to require investment and it will put pressure obviously on margins but the revenue opportunity is a growing one.

Karl Choi - Merrill Lynch

Thank you.

Operator

That concludes this morning's call. On behalf of the McGraw-Hill Companies, we thank you for participating and wish you a good day.

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