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Donald Rubin - SVP of IR

Terry McGraw - Chairman, President and CEO

Robert Bahash - CFO


Fred Searby - JP Morgan

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Michael Meltz - Bear Stearns

Karl Choi - Merrill Lynch

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McGraw-Hill Companies Inc. (MHP) Q3 2007 Earnings Call October 18, 1969 2:30 AM ET


Good morning, and welcome to the McGraw-Hill Companies’third quarter 2007 earnings call. At this time I would like to inform you thatthe call is being recorded for broadcast and that all participants are in alisten-only mode. At the request of the company, we will open the conference toquestions and answers after the presentation, and instructions will follow atthat time.

To enhance the call for today’s participants, McGraw-Hillhas made the presenter’s slides available on the internet. To do that, go to You will be prompted to enter you name. Thenet conference meeting number is PG5401565. The password is MCGRAW HILL, allcaps, with a space between MCGRAW and HILL, and the event type is conference.

This call is also being webcast live from McGraw-HillInvestors Relations web site and will be available for replay about two hoursafter this meeting ends, both by phone and on the web, for seven days.

If you need assistance at any time, including having yourvolume adjusted higher or lower, press star and zero, and I will assist youmomentarily.

I will now turn the conference over to Donald Rubin, SeniorVice President of Investor Relations for the McGraw-Hill Companies. Sir, youmay begin.

Donald Rubin

Thank you, and good morning. We thank you, everyone, forjoining us here for the McGraw-Hill Companies' third quarter 2007 earningsconference call. I’m Donald Rubin, Senior Vice President of Investor Relationsfor the McGraw-Hill Companies.

With me today are Harold McGraw III, Chairman, President andCEO; and Bob Bahash, Executive Vice-President and Chief Financial Officer.

This morning we issued a news release with our third quarter2007 results. We trust you have all had a chance to review the release. If youneed a copy of the release and financial schedules, they can be downloaded at

Before we begin this morning, I need to provide certaincautionary remarks about forward-looking statements. Except for historicalinformation, the matters discussed in the teleconference may containforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995, including projections, estimates anddescriptions of future events. Any such statements are based on currentexpectations and current economic conditions; and are subject to risks anduncertainties that may cause actual results to differ materially from resultsanticipated in these forward-looking statements.

In this regard, we direct listeners to the cautionarystatements contained in our form 10-K’s, 10-Q’s and other periodic reportsfiled with the US Securities and Exchange Commission.

We are aware that we do have some media representatives withus on the call. However, this call is for investors and we would ask thatquestions from the media be directed to Mr. Weiss in our New York office, at area code 212-512-2247, subsequent tothis call.

Today’s update will last approximately an hour. After thepresentations, the meeting will be open to questions and answers. Now, my please to introduce the Chairman, Presidentand CEO of McGraw-Hill Companies, Terry McGraw.

Terry McGraw

Okay. Thank you Don, and good morning everyone; and welcometo our review of the McGraw-Hill Companies’ third quarter earnings, and I thankyou all for joining us.

With me, as Don mentioned, is Bob Bahash, ExecutiveVice-President and Chief Financial Officer.

I’m going to start today’s session with a review of ouroperations and I’ll provide some comments on our prospects that are goingforward. Bob will than discuss some of the key financial information; and,after our presentation, as Don said, we’ll go in any direction any of you wouldlike to go, questions or comments about the companies.

Well, the third quarter is critically important to asuccessful year for the McGraw-Hill Companies because of obviously theseasonality of our business. In Education, we produced virtually all of ouroperating profits for the year in the third quarter. In 2007 we also faced anadditional challenge because of some of the difficult conditions in the creditmarkets. So I am especially pleased this morning with the results that we havejust announced for the third quarter.

Let me briefly re-cap some of the highlights. Diluted earnings per share increased 26.4% to$1.34, versus $1.06 last year. Diluted earnings per share in the third quarterof 2006 included a $0.03 charge for restructuring. Net income grew by 18.2% andrevenue increased 9.8% to $2.2 billion.

I’ll start this morning by reviewing how we achieved theseresults and then spend some time on the outlook for the McGraw-Hill Companiesand our guidance for 2007. But let me begin with our operations; and becauseeducation is such an important contributor to the third quarter, I’m going tostart the segment review with McGraw-Hill Education.

Double-digit growth in the elementary-high school market,and margin expansion for McGraw-Hill education in the most important quarter of the year, are key takeaways for thissegment. In the third quarter revenue increased 9.9%. Operating profit grew by 16.1%.That included a pre-tax gain of $4.1 million on the divestiture of product linefor our parochial schools. In 2006, there was a pre-tax restructuring charge of$5.6 million. The operating marginimproved to 35%, up from 33.1% for the same period last year.

Revenue for the McGraw-Hill School Education group grew at11.2%, and revenue for the McGraw-Hill Higher Education Professional andInternational group increased by 8.1%.

2007 is the first of four robust years in the state newadoption market. To improve our competitive position at the start of thiscycle, we reorganized our base of operations a little over a year ago; and wewanted to do that in order to strengthen our sales, marketing and productdevelopment initiatives.

We also stepped up our new product introductions, to takeadvantage of the new opportunities in an expanding market.

Those decisions are starting to pay off. You can see it inour performance in this year’s state new adoption market, which is growingfaster than our original forecast for the market. Some numbers will illustratemy point.

In 2006, our School Education Group participated in about80% of the state new adoption market, and that was worth about $685 million;and we took a 20% share. In 2007, ourreorganized School Education Group competed in virtually the entire state newadoption market, which is growing 14% to 20% and will be worth $780 million to$820 million this year. Our earlier forecast called for 10% to 15% growth and$750 million to $800 million range.

This year we are taking an industry-leading 32% market shareof this expanded market, and we are very pleased with those results.

To achieve these results, the school education group led allcompetitors in California and South Carolina for K-8 science and Grade 6 through 8 mathin Texas. We placed first in allsix states adopting music for the Elementary Grade. Treasures, which is our Kthrough 5 balanced basal reading program, led the market in Indianaand competed very well in Oregonand Tennessee.

It is also worth noting that we had a 30%+ capture rates inboth the K-5 and Grade 6 through 12 state new adoption markets, anotherimportant indicator of improved across-the-board performance achieved through areorganized and better-led team.

The breadth of our product offering is another key to oursuccess this year. In an education market that is not wedded to a singleinstructional approach, we offer a spectrum of products. So, in addition to oursuccess in Texas Math, we had core basal programs, we took share with EverydayMathematics, at reform based program. Everyday Math took the leading share in New Mexico’s K through 5 math adoption and sold very wellin the open territory, winning business in both urban and suburban markets.

Offering this spectrum of products also means we compete innon-academic subjects. In 2007 we captured significant business in small, butvery profitable markets, such as health, business education, technical andvocational education, as well as family and consumer science.

Even as we saw greater strength this year in the state newadoption market, we’ve seen a slower than expected growth in open territory.

We have some anecdotal evidence for this slow-down.Basically, it appears that non-discretionary costs in many districts are risingmore rapidly than funding. For example, schools are seeing a substantialincrease in fuel costs for transportation and heating and cooling. We areexamining these trends in the open territory and in more depth, to gain greaterunderstanding into changes that may be taking place there.

But we do expect, you know, to see some improvement here.According to industry statistics, the open territory market is down 1.4% aftereight months. Orders in the fourth quarter, and there are some possibilitieshere, could produce an uptake this year.

The supplemental market has been soft all year. There isless demand for traditional stand-alone supplemental products, especially thosethat are not clearly correlated with state standards, because the new corecurriculum programs in science, social studies, math and reading, are far morerobust than ever before. These new basal programs are all standards-based andthey now provide extensive ancillary materials for practice, differentiatedinstruction and other classroom needs formerly met with supplemental titles.

However, there is a steady growing demand for well-designedsupplemental intervention programs. That is, they are using the programs forstudents that are performing below Grade level.

The schools are most interested in intervention programsthat can demonstrate their efficacy with research data. That’s why we arehaving good success with Kaleidoscope Literacy and Numbers World math programs.This is a promising development, and that will help us gain more traction inthe supplemental market.

Strength in the state new adoption market will help offsetsome of the softness in the non-adoption state, which has been expected to growabout 4% in 2007. Because of the softness in the open territory, it now appearsthat the total high market will grow in the 3% to 5% range this year, insteadof the 5% to 7% originally forecasted.

Our school education group is outpacing the competition inboth the state new adoption market and in the open territories, and expects tooutperform the market for the full year.

In testing, the performance in both custom and off-the-shelfmarkets has improved. We are seeing some encouraging developments in thismarket. In Indiana we recently won a one-year extension of our current Summit,those are the high stakes tests contract, plus a two-year contract beginning in2008 and a renewable for another two years.

We also won a five year renewal in West Virginia. We are seeing some promising gains in theformative, or the low stakes end of the market, for our new acuity product.This program recently won a five year contract valued at $80 million dollars,from New York City.

Earlier, I pointed out that the state new adoption marketlooks robust for the rest of the decade. Here’s our latest forecast for thestate new adoption market through 2010; and obviously, in 2007, we have uppedit from $780 million to $820 million. For 2008 it goes from $900 million to$950 million, 2009 $850 million to $900 million, and then in 2010, $900 millionto $950 million; the issue being that it is very strong for the next four yearsand we expect to do very, very well with that.

Our higher education professional and international groupcontinues to make good progress. In international markets we benefited fromstrong school sales in Canadaand in Spain,and a solid higher education selling season in Europe, Asiaand India.

In the US college and university market, our business andeconomics imprint set the pace in the third quarter, with solid gains in fourkey disciplines; accounting, economics, introduction to business, andmanagement.

We now think the UScollege and university market will grow between 5% and 6% in 2007; and weexpect to keep pace with the industry. Originally, we thought the market wouldgrow about 4% in 2007, and it’s a little bit strong than we had expected.

Digital products are contributing to that growth across allof our college and university imprints, and in professional markets.

We expect more growth in the digital world with a debut thisfall of CourseSmart. This is a new college publisher cooperative e-book ande-commerce web site; and this is something really, I believe, to pay attentionto. This is a really strong new endeavor. Instructors logging on to CourseSmartwill be able to evaluate textbooks and related material in one convenientlocation. For students, CourseSmart offers a lower cost alternative and all thefunctionality of a web application. Our higher end group is starting with 148e-books. Over time thousands of textbooks will be available on this commonplatform.

Our online product offerings for professionals continue togrow, both here and abroad. Two new subscription-based specialty sitesintroduced this year; one is called Access Emergency Medicine that was done inJanuary; and Access Pharmacy in April was there; and they’re off to very goodstarts with growing institutional sales.

Our professional books are also making the best-seller list.In September, one title, Rules for Renegades, a new title that made it ontofour best seller lists, was number 1 on USA Today’s business list, number 2 onWall Street Journal’s business list, number 14 on the Wall Street Journal’snon-fiction list, and number 4 on the New York Times hard cover advice list.

So, summing up for the McGraw-Hill Education, a solid thirdquarter performance, and market share gains in the elementary high schoolmarket. We’re very pleased with that performance. Good growth in highereducation, here and abroad. Digital products continue to gain traction inhigher education and professional market. We now expect the LI market to grow3% to 5% this year and 5% to 6% increase in the UScollege and university market; and operating margin for this segment willimprove for the full year.

Okay. With that, let’s go to the McGraw-Hill Financial Services.

The third quarter started strongly and softened inSeptember; but we still met our guidance for this period by a comfortablemargin. In the third quarter revenue grew by 12.5%, operating profits increasedby 17.3%, and the operating margin expanded to 45.7%, up from 43.8% last year. Allthis was accomplished, even though there was a decline in the US structuredfinance market in the third quarter.

Credit quality issue, and the re-pricing and there-evaluation of risk, due in part to the concerns regarding the performance ofsub-prime mortgages, all contributed to that decline. But what kept Standardand Poor’s growing in the third quarter was its resilient portfolio.

The strong performance included international creditratings, which grew at a double-digit rate and represented 41.6% of ratingsrevenue in the third quarter; non-traditional ratings in services, which alsogrew at a double-digit rate and now account for almost 26% of rating revenue;corporate and government ratings had solid performances; and financialinformation products and services also had very strong performance.

In short, the results underscore the successful action thatwe have taken over in the past several years, to strengthen Standard and Poor’sdiversification and resilience.

Although new issue volume is an imperfect measure of ourperformance in any one period, recent issuance does illustrate the trajectoryof business in the third quarter.

As this chart indicates, after a slow start in July, therewas strong acceleration in new dollar issuance in the USindustrial market in August and September, and obviously for the third quarter.There also was modest improvement in the public finance sector, which wasencouraging. But we saw a sharp declinein new issuance dollar volume in the USstructured finance markets as the third quarter progressed.

The following charts illustrate the pattern I’ve justdescribed. You can see year-over-year volume plunging in September for the USresidential mortgage backed securities, and also somewhat for the UScommercial mortgage backed security and US collateralized debt obligationsCEO’s.

The activity that we’re seeing in the US structured financeso far in October, is tracking the level of issuance we saw in September. Wehave already pointed out that the year-to-year comparisons are challenging inthe fourth quarter for structured finance. It is a large quarter seasonally forthat business, and the revenue model is heavily transaction-oriented.

We now expect new issue dollar volume in the USresidential mortgage backed securities market to decline by 70% to 75% in thefourth quarter versus last year, which obviously was robust.

Declines of 85% to 90% are possible in the new issuance ofUS CDO’s (collaterized debt obligations) in the fourth quarter versus lastyear. As these charts illustrate, newissue dollar volume in the fourth quarter of 2006 actually surged in Decemberfor USresidential mortgage backed security and collateralized debt obligations. Thecomparisons may not be quite a challenging for asset backed security andpossibly US commercial mortgage backed securities.

Despite market turbulence, S&B is encouraged about theprospects in the asset backed market. Credit card issuance continues to showstrength. Scheduled refinancing and increased credit card utilization byconsumers are reasons for optimism. Solid issuance of auto loans for theremainder of the year is also a possibility, as banks re-deploy capital tofixed-rate short term auto loans instead of mortgage products.

A pick-up in commercial mortgage backed securities is alittle bit problematic at this point. Commercial real estate fundamentalsremain very strong but activity has been chilled by the sub-prime problems inthe residential market. Widening spreads have kept many investors on thesideline, resulting in a reduction in the demand for new issuances. We reallybelieve that in the commercial mortgage backed market, this is a temporarysituation because it has been quite strong and we expect that to continue.

The weaker USstructured finance will be at least partially off-set by continuing strength ininvestment-grade corporates, international markets, non-traditional ratings andservices, annual contracts and surveillance fees, and financial informationproducts and services and vigorous expense management.

There is reason for optimism in the corporate market.Investment grade corporate issuance really has not faltered. In fact, it hasset new records. Industrial issuance will continue to be driven by favorablefinancing environment, M&A activity, and investments in capitalexpenditures.

Financial services issuance will be driven by many of thesame factors, including balance sheet restructuring activity. Spreads alsoremain historically tight and rates remain low. In addition, we expect a 10% to11% increase next year in potential refundings.

S&P anticipates that $47.9 billion of UScorporate debt to mature or be called in the fourth quarter of this year.Another $250 billion is potentially refundable in 2008, and that’s about an 11%increase over 2007 levels. The new issuance calendar also looks quite strongfor the coming months.

As I pointed out earlier, our diversification effortscontinue to contribute to growth and make our business more resilient; so wecontinue to expand our financial information and index services.

In the third quarter, trading started for six new exchangetraded funds based on S&P indices, including our first in the fixed incomespace. It’s the S&P national municipal bond index, sponsored by Barkley’sGlobal Investors.

Today there are 133 exchange-traded funds worldwide, basedon the S&P indices, and more are in the pipeline.

We are making good progress licensing some noteworthy clientsfor S&P GSCI index; that’s our commodities index, and that was acquiredfrom Goldman Sachs.

Dated information products are growing rapidly. The CapitalIQ product is adding new clients and expanding its base with existingcustomers. New modules, including portfolio management tools, are increasingdemand for the Capital IQ product. Expect more innovation here and moreexpansion into international markets.

Given all the uncertainty in the credit markets at thistime, it’s too soon to start making projections for 2008. Some observers feel acalm is returning to global credit markets and a fragile stability is startingto set in.

Going forward, there will be more, not less, focus on creditquality. Liquidity, worldwide, remains plentiful. We know that from thesurpluses from OPEC, Japan,China, Canada,Russia. Thebenefits of securitization, the liquidity, the economic capital reductions,tradability, will remain strong after the current turbulence has dissipated.

There are also questions about the timing of the nextinterest rate cut by the Federal Reserve. The changes of a rate cut later thismonth seem to have faded somewhat, with third quarter growth now appearing tobe stronger then expected.

David Weiss, who is S&P’s chief economist, now thinks wecould see a fed rate cut in December or, more likely, in January of ’08.

The housing recession still has a way to go. David Weissprojects that housing prices will fall nationally by 11% peak-to-trough, withprobably another 6% to 8% still to come. The difficult news is that no reboundis expected before the end of 2008, so we have a little bit more to go with thehousing recession.

Areas that experienced the greatest speculative run-up inprices, such as California, Florida, Nevada, Arizona; and states where theeconomy has been hardest hit by increasing unemployment, such as Michigan,Indiana, Ohio; could experience price declines of 15% or more.

On September 24, the Securities and Exchange Commissiongranted the registration of Standard & Poor’s as an NRSRO, and that wasunder the US Credit Rating Agency Reform Act of 2006.

September is also the month the SEC commenced an examinationof S&P and other rating agencies’ policy’s and procedures under the Act;and of course, as always, S&P is working with the SEC in connection withthis undertaking.

We will continue to work with the SEC, regulators in Europe,and we also work with regulators in Asia, as well as theUS Congress, to answer any questions about our policies and procedures; and weobviously welcome the opportunity to discuss any aspect of our business.Transparency, and increasing transparency, is always good.

Based on current information, we don’t believe any pendinglegal, governmental or self-regulatory proceeding will result in any materialadverse affect on our financial condition or our operations.

This is a challenging period for financial services but webelieve the issues are being addressed. Equally important, the favorablelong-term trends are clearly intact and will continue to drive our business forsome time to come.

So, let’s sum up our financial services; a solid performancein the third quarter, despite a tough market environment; worsening conditionsfor structured finance in the United Statesin the fourth quarter; but the rest of the business remains strong. A double-digittop and bottom line performance for the full year; and we will have, onceagain, margin expansion for the full year.

Now let’s review the information and media segment. For thethird quarter, revenue increased 2.1% and operating profit grew by 35.8%. Inthe third quarter last year there was a pre-tax restructuring charge of$5.8 million. The operating margin was7.4%, up from 5.5% last year. This segment is in transition, as we work toovercome the softness in advertising with increased sales of higher valueinformation products and services delivered to customers on-line.

A weak advertising market was certainly a factor in thethird quarter. Revenue in the broadcasting group for the third quarter declinedby 7.8%; and revenue for the business-to-business group was up 3.2%, eventhough Business Week’s ad pages were off 24.6% in the third quarter.

The business-to-business group’s growth came frominformation products and services. Clearly, the strong performances came frompricing to news for oil and natural gas and power from plats. Expansion of ourinternational research and proprietary studies under the JD Power &Associates brand; products also, and services delivered on-line to theconstruction industry, which is virtually a 24/7 on-line network now.

I also urge you to take a look at the newly redesignedBusiness Week, starting with the October 22nd issue. The re-launch of theBusiness Week is the product of 18 months of research among readers andnon-readers, to gain a better understanding of today’s business informationconsumers. Editor-in-chief, Stephen Adler, has reconceived the publication;and, in the spirit of the new internet age, will direct his editorial team tosort, to clarify, to illuminate the important developments for an audience ofmore than 4.8 million readers each week. That means offering other smartperspectives from around the world alongside stories developed by Business Weekin a multi-channel endeavor.

The goal is to solidify Business Week’s leadership as a multi-platformglobal business media organization and build on healthy circulation statistics.News stand sales, a key indicator of editorial vitality, are up 25% in thefirst half. The average price for subscribers is up 1%. Overall circulation isvery steady.

So, summing up our information and media segment, advertisingremains soft but growth in on-line information product will continue to be, youknow, the focus and the push on that.

That completes our review of the operation; and let me nowaddress some of the guidance issues here; and I want to spend a few minutesupdating our guidance for the full year, as well as for the fourth quarter.

We are still on course to produce double-digit earnings forshare growth for the full year, for 2007. For the full year, we expect improvedoperating margins at McGraw-Hill Education and McGraw-Hill Financial Services,no change there.

Our guidance excludes the following items: a $0.04 chargefor the elimination of the restoration stock option program in the firstquarter of 2006; a $0.06 charge for restructuring in the second half of 2006;and a $0.03 gain from the divestiture of a mutual fund data business at FinancialServices in the first quarter of 2007. On that basis, after nine months of solid achievement we have alreadyearned nearly as much as we did for all of 2006.

Now, given those charges and gains, on a GAAP basisinclusive of these items, the 2007 earnings growth would be even stronger. But I believe that the non-GAAP financialmeasures, and excluding those items, provide more useful information toinvestors due to the unusual nature of those excluded items.

Now let’s review the outlook for the fourth quarter. In the fourth quarter, Financial Servicesfaces the toughest comparisons of the year. Last year revenue for this segment grew at 22.1% in the fourthquarter.

For the fourth quarter this year, we expect a high single-digitdecline in revenue and some margin contraction because of the challengingconditions in the U.S.structured finance market.

For McGraw-Hill Education, in a seasonally very, very smallfourth quarter, we expect a slight decline operating profit and some margincompression. As a consequence, thecorporation’s revenue and earnings in the fourth quarter will not match lastyear’s results.

So summing up for the corporation, first of all double-digitearnings growth for the full year, even though revenue and earnings will bereduced in the fourth quarter versus last year; and margin expansion for theyear in Financial Services and McGraw-Hill Education.

With that let me hold it there, and let me turn it over toBob Bahash, our CFO, and he will go through some, and then we will go to yourquestions and comments.

Robert Bahash

Thank you, Terry. Iwill begin this morning with an update on our share repurchase program. We planned to repurchase up to 30 millionshares this year. We achieved that goalin the third quarter by buying back 10.5 million shares for a $616million. The company has spent $1.9billion this year for the 30 million shares. That averages to $63 per share. Since 1996, the corporation has returned $8 billion in cash toshareholders through share repurchases and dividends including more than $2.1billion in the first nine months of 2007.

There are 35 million shares remaining in the 2007 repurchaseprogram. That was authorized by theboard of districts last January. As aresult of share repurchase activity, the diluted weighted average sharesoutstanding declined in the third quarter to 337.7 million shares. This reflects a 12.6 million share decreasecompared to the second quarter of 2007, and a 23.2 million share decreasecompared to the same period last year.

We ramped up our borrowings to fund the additional sharerepurchases. At the end of September, wehad a net debt position of $879 million which is up from a net debt position of$636 million at the end of the second quarter.

As of September 30, on a gross basis our debt isapproximately $1.3 billion, which is offset by $453 million in cash, primarilyin foreign holdings. The current debtreflects a mix of short-term borrowings, primarily in commercial paper, withthe balance in extendable commercial notes and money market loans.

As a result of increased borrowings, interest expense was$15.4 million in the third quarter, which is more than double the $7.5 millionin the same period last year. For the fullyear, we now expect interest expense in the range of $39 million to $41million, which is slightly lower than our previous estimate of $40 million to$42 million.

Let’s now look at our corporate expenses. Corporate expenses decreased $9.5 million or20.1% in the third quarter, as compared to a year ago. Corporate expenses in the third quarter of2006 included a $4.1 million charge for restructuring. Excluding this charge, corporate expensesdecreased $5.4 million in the third quarter compared to a year ago. The decrease is primarily driven by lowerincentive compensation versus the prior year, and a one-time gain from the saleof an equity investment.

Regarding operating segment performance, there are two itemsthat influence year to year comparisons in the third quarter. In the third quarter of 2007 we sold anon-strategic product line -- Terry mentioned that -- within our K-12 businessthat resulted in a pre-tax gain of $4.1 million. And in the third quarter of 2006, we incurredpre-tax restructuring charges of $15.4 million or $0.03 per share. That was primarily for employee severance inMcGraw-Hill Education, information and media, and at corporate.

The effective tax rate in the third quarter was 37.5%compared to 37.2% in the same period last year.

Let’s take a look at our capital expenditures, which includeprepublication investments and purchases of property and equipment. Prepublication investments were $77 million,compared to $64 million for the same period last year. For 2007, we continued to project thatpre-pub investments will be about $310 million.

Purchases of property and equipment were $63 million in thethird quarter, compared to only $25 million for the same period last year. This is of course being driven by the constructionof our new data center which is underway and expected to be completed in thefirst half of 2008, along with technology investments we are making todigitalize our products and services. Wecontinue to project $250 million for 2007.

Now for some of the non-cash items. Amortization of prepublication costs was $110million in the third quarter, compared to $103 million in the same period lastyear. We now expect to be about at alevel of $250 million in 2007, which is down slightly from our previousestimate of $260 million. Depreciationwas $26 million in the third quarter, that compares to $27 million in the sameperiod last year, virtually flat. We nowexpect it to be $120 million in 2007; again this is also down slightly from ourprevious estimate of $130 million due to a change in the timing of capitalexpenditures in 2007.

Amortization of intangibles was $12 million, that’s alsoflat with last year. We expect 2007 tobe about at $50 million.

Finally unearned revenue was just over $1 billion in thethird quarter, which is up from $884 million for the same period lastyear. This reflects a $121 million or14% year-over-year growth. This revenuewill be largely recognized over the next 12 months.

As Terry pointed out, with a softer revenue forecast it islikely that it will impact some of the growth related to unearned revenue forthe fourth quarter.

Thank you. Now back to Terry.

Terry McGraw

Thank you, Bob. Thatcompletes our review. Let me just sayagain, I am very pleased with the solid results for the third quarter, coupledwith the very strong results in the first half of this year. In Education, we delivered in the mostseasonally obviously important quarter of the year. I’m very pleased with the McGraw-Hill SchoolEducation Group that we reorganized a year ago. For them to come out with such a strong performance and a 32% share inthe new adoption market, we were pleased with that.

In Financial Services again, another very strong performancein a lot of areas, although we are facing obviously some very challengingmarket conditions in the U.S.structured finance market. We understandthe issues here, and trust me, we are riveted on those issues and we will bedoing everything we can to bring that back to an acceptable level for us. The long-term trends though in the market areso strong, and are obviously very intact and we are buoyed by that. So again, we will deal with whateverchallenging market conditions and we feel very good about our overall positionin the portfolio.

With that, let me turn it over to Don Rubin and we will goto your questions and comments.

Donald Rubin

Thank you. Just acouple of instructions for our telephone participants. (Caller Instructions) We are now ready totake our first question.



Your first question comes from Fred Searby - JP Morgan.

Fred Searby - JPMorgan

Congratulations on the quarter. Can you give us some sense of what percent ofS&P’s revenues were non-rating business and how fast they were growing inthe quarter?

Can you also give us a sense, it looks like some of theissuance from 2Q spilled over into 3Q and that’s why there is partiallyprecipitous fallout expected in the fourth quarter. Can you confirm that or just give us somecolor around that?

Terry McGraw

Thanks, Fred. As youknow, in terms of Standard & Poor’s we don’t break out the individualcomponents on that. The financial information and services side is strong anddoing quite well. Also on the fixedincome information side coming out of ratings as well, with RatingsDirect andRatingsXpress and things like that.

No question everything was impacted by the U.S.structured finance market, most notably the residential mortgage-backed market andthe collaterized debt obligation markets. It had a little bit of effect on other issuance as well as I thinkeverybody that started took a little bit of a pause. But the corporate and government side isquite strong, and we are already seeing significant pickup in opportunitiesthere. Again, for the obvious reasons, because of M&A activity and capitalexpenditures and so forth on that part.

Also, as we were saying, the non-traditional areas and theinternational side has not abated. Ijust came back from an Asian trip and they are not experiencing any of thesekinds of issues. So it has had an effectfor sure, but for the quarter, July and August were quite strong and Septemberis where it really had its effect. Itwill have an effect going forward into the fourth quarter, but we see thatturning around and it is too early to start to get into 2008 projections. We will see. We will see how some of this unfolds. But at this point anyway, that’s how we are looking at it.


Your next question comes from Craig Huber - LehmanBrothers.

Craig Huber - LehmanBrothers

What do you think the average maturity is of the stuff yourate on the structured side versus the investment grade leveraged loans and syndicatedloans, all of that. What’s the averagematurity on both sides?

Terry McGraw

Craig, I think I better get some better information for youthan what I currently have. For the mostpart we are seeing most things with intermediate terms on that one; ten years,in that area. When you start talkingabout specific instruments, obviously it would all be different in theresidential mortgage-backed depending upon whether it was fixed or whether itwas adjustable and all those kind of things. Those are all packaged loans. SoI don’t want to give you an answer that I’m not comfortable with, so we willget back to you with more information on that. I would be thinking more inintermediate terms.

Craig Huber - LehmanBrothers

What I’m getting at here is because this is perhapsuncharted territory, the so-called bubble on the structured side. What happens here if it takes multiple yearsfor structured finance to level off and start growing again? Because then you are not replenishing thestuff that’s already matured. If thisgoes on for a few years so the surveillance fee would start to take a little hitand that has been a nice buffer for you guys. If this thing drags on long term, is that going to be a problem here?

Terry McGraw

Well, we are into subjective territory, Craig. My opinion is just one. I personally don’t think a two-year timeframefor a credit crunch in the structured finance market to return isrealistic. We are already seeing signsof things like the commercial mortgage-backed market starting to pick up againand I think it was just a pause that has been taken there because we had seen,since early 2005 that market do very well.

I think we have to assume that there is going to be somesoftness, certainly with CDOs and residential mortgage-backed securities, goingforward here. I don’t think that we are going to see anextended credit crunch. I think thatwould have implications on the economy overall, and I don’t think that would bein the best interests of the major lending institutions either. So I just don’t see that taking place.

There is an enormous liquidity, as you know, that stillexists in the system because of all the worldwide surpluses and that still hasto be employed. So I see this as moretemporary in nature rather than long-term in nature.

Craig Huber - LehmanBrothers

Can you just talk a little bit about your cost based withinFinancial Services? What kind of flexibility you have there for next year ifthis does drags on into next year in terms of the bonus accruals you could playwith, head count et cetera. I know it is largely fixed costs but what can youdo on the cost side next year on financial services?

Terry McGraw

As you know, in terms of the rapid growth that we have hadin areas like the U.S. structured finance market, what we have done is developed lots ofcross-training programs and the like because you just don’t want to be hiringand hiring and hiring and then all of a sudden, things like this happen and thenall of a sudden you are doing a lot of changes on that.

So we do a lot of cross-training so that we can move peoplearound to the other areas and so we haveanalysts that are being redeployed into the corporate and government area orinto some of the other international opportunities. We have latitude on this one. But I can guarantee you that everything isbeing looked at. We will takeappropriate action as we size the revenue opportunities.


Our next question comes from Michael Meltz - BearStearns.

Michael Meltz - BearStearns

I have three questions. Can I just get a better sense as to theguidance for the fourth ? quarter? About a month ago you were guiding toroughly flat or flat to slightly down in financial services and now you aresaying down high single-digits. Can you justtalk a little bit about what has changed in your expectations? It sounds likestructured finance; what are magnitude you are thinking about now?.

Secondly, implicit in your guidance are you expectinginternational revenues to be up double-digits still?

Thirdly, at the Education Group your margin was prettystrong in the quarter, but your pointing to decline year-over-year in thefourth quarter. Can you talk a littlebit about what is going on with the expenses there?

Terry McGraw

Really, in terms of the guidance or the fourth quarter, weare trying to give you the best look that we have on it. When we were doing the second quarterearnings and when we updated our guidance -- I think it was September 18th-- we were looking at a situation that was evolving at that point. So we were saying it looked to us at thatpoint that the fourth quarter would probably be flat for FinancialServices.

Clearly given the September results and what we are seeingin October, the residential market and the CDO market has really come to agrinding halt. I don’t think that isgoing to last a long time, but it is certainly there.

What we are giving you is an extrapolation of what we areseeing right now; if there is some upside to that, great. But at this point, we are just extrapolatingout what the current environment is giving us. We are buoyed by the fact that the corporate and governments is doingwell and that international side is also doing well.

Now, on the international, double-digit on that one; again,we are going to have to see what effect -- the Asian markets are not affectedat all in this area, or for the most part, at all on that one. The European markets are affected somewhat onthat one. Again, what creates a creditcrunch in that one is more of an uncertainty and almost a panic to say hey listen, let’s just lay low for a whileuntil we see what activity takes place. We are already seeing a pick up in activity in certain areas. Our thinking is that things are starting tocalm down a little bit in all of that. But in terms of projections so that youhave got the best possible information from us, we are extrapolating out whatwe are seeing in September and October to date.

On the Education side, and on the expense side, we are very,very tough on that it. We watch thatvery, very carefully. The fourth quarteris so small for Education, the third quarter is where it’s at. There are alwaystiming issues. Do sales orders coming inrun over between the end of September,into October and all of those kind of things. Sometimes there are those kind of issues. But the third quarter needed to be verystrong, and it was and we were very pleased with that. The fourth quarter, it is just, it’s reallyvery small. From an expense standpoint we are always watching that verycarefully.

Michael Meltz - BearStearns

Terry, so just to put parameters around it. To understand the high single-digit revenuedecline, can you put parameters around what you are expecting out of your StructuredFinance business?

Terry McGraw

Well again, in terms of specific again, guidance on anyonecomponent, we are not. But you can go toyour own CDO desk and mortgage backed area and you know that the activity rightnow is obviously very light on that one. I think that will probably remainthat way at least until the end of the year.

It is the U.S.structured finance part of the market that is being impacted.

Michael Meltz - BearStearns

Do you think your international structured finance businesscan grow in that environment?

Terry McGraw

Well again, we will see. It has not been impacted at the same extent that it has been here in theU.S. but again weare in real-time now and we are monitoring activities just like you are. Will somebody come back into the market morerapidly in the European markets than here? Don’t know on that part. But weare obviously monitoring it, and I would think that, but until we get a littlebetter evidence… again, as we start looking at early ‘08 and all those kinds ofthings, I need to see what the activities over the next six weeks is to be ableto started making any kind of predictions on that.

Robert Bahash

Michael, if I could just add a couple of points here. With regard to the fourth quarter and how weconstructed our guidance here, as Terry pointed out it is an extension ofreally what occurred in September and what we are experiencing here in October;but when we look at external data as we gather market volume forecasts lookingat Thomson Financial Securities data, Harrison Scott data, et cetera, when welook at the U.S. RMBS and CDO forecast there are declines on a year-over-yearbasis because last year was so strong, in the 70% to 80% range. Europe on the otherhand is not as dramatic but there are declines especially in RMBS and CMBS inthe 30% range. That was the basis inguidance we used to instruct our forecast in the guidance we gave to you.


Your next question comes from Karl Choi - MerrillLynch.

Karl Choi - MerrillLynch

I also have three questions. First regarding structuredfinance revenues, I think Terry you mentioned that is mostly transactiondriven. I believe that Moody’s talkedabout 25% of restructured finance revenues coming from annual fees. Can you give us a sense of a similarpercentage at S&P? Is it similar, higher or lower?

A second question is related to the supplementals. It sounds like from the trends you talkedabout, does it mean the supplemental softness can actually continue into 2008?

Bob, can you give us the basic shares outstanding at the endof the quarter?

Terry McGraw

Yes, in the structured finance area, as you know again, andespecially towards the end of the year, it is more transaction driven on thatone. Everything that we do is we try andpush things towards a broader surveillance there. I would say and I will get you a number onthat, but I would say that we are higher than the 25%. But again, right now given the fall off, atthis point of the year it is more transaction-focused. On a yearly basis, we would be much heaviertowards surveillance on a fee basis. Butat this point in time it is going to be more transaction driven.

On the supplemental part, what we are seeing is a little bitof a mix change between the basal side and the new adoption market and thesupplemental market. With big programsnow and especially focused on social studies, math and science, reading, therequirements that are coming from the State are inclusive of a lot of differentadd-on products; online products, assessment products, all sorts ofthings. What we are seeing is a littlebit of a shift this year towards the bigger programs, the adoptionprograms.

The supplemental market is an important market, and it’sreally focused on the sort of alternative basal, or the intervention and remedialkind of products that support the adoption market. We are seeing that as a focus in ‘07 morethan we saw that before.

So we are picking it up and that’s why we saw the State newadoption monies. We were talking about $750million to $800 million. We upped it to $780million to $820 million because some of those monies that were in thealternative area we are moving into the new adoption market.

So the total opportunity is not going away. It is a mix shift. Supplemental is going to be very important tous. We will continue to focus on theremedial intervention there.

Robert Bahash

Basic shares outstanding at the end of the quarter was 329million.

Karl Choi - MerrillLynch

I believe testing revenues last year was down around13%. Can you give us a sense what yourexpectation is for this year?

Robert Bahash

Well, we honestly don’t break out, Karl, the testingrevenues per se but in talking in general about our testing business, we arevery excited about some of the shelf revenues. Obviously we gained somesignificant share on custom contract revenue with some of the wins that Terryhad pointed out. But the Acuity productis very exciting for us, and we are seeing significant growth in that category. We don’t break that area out in particular,but we are really excited about the web-based Acuity offering that we have.

Terry McGraw

Karl as you know, we have been spending a lot of investmenton this area and it’s very encouraging to go see the results that we aregetting here. As you know, we were ahigh stakes testing business, and the growth is all in the low stakes or the formativeside and Acuity product, as Bob said, is doing really well. We are building more enhancements onthat.

Testing assessment is going to be an importantcomponent. We are on the right trackwith that.


Your next question comes from Edward Atorino - The BenchmarkCo.

Edward Atorino - TheBenchmark Co.

The press release talks about weak revenues and softness ineducation. You went down in education inthe fourth quarter. Why would that be?

Terry McGraw

Ed, as you know, you know, the fourth quarter is relativelyvery small. The third quarter is whereit’s at. The upside that we are lookingfor is on the higher education side because that is obviously a more globalbusiness and we’ll see from that.

But it is just that in terms of K-12, we did extremely wellin the third quarter. I don’t see anyreal timing issues here that it is into the third quarter and there won’t bemuch spillover on that one. So we arejust saying that it’s in a very small quarter for education. We are not goingto see a lot of upside. Where we arelooking for, and it’s not in the numbers, is higher education. Higher education could be some upside for usin the fourth quarter.

Robert Bahash

Let me clarify one point here. The guidance called for a decline in revenuefor the corporation, really much driven by financial services. As Terry pointsout it is a relatively weaker quarter for MAG.

Edward Atorino - TheBenchmark Co.

It is softness in education?

Robert Bahash

Revenue, we are projecting revenue will increase. But it is really driven the profit pressuresare driven by digital products and services.


Your next question comes from Peter Appert - GoldmanSachs.

Peter Appert -Goldman Sachs

Terry, you are seeing in ‘07 obviously some impressiveimprovement in the profitability within the education segment. I’mwondering if in ‘08 do we see another equally dramatic step-up in profitabilityin the context of the revenue expectations you have outlined, or will thespending requirements for the new products mute the margin gains next year?

Terry McGraw

Again, it is a little early to start getting into ‘08 but itis a little bit clearer on the education side because the new adoption marketopportunity is big. As you know, nextyear we have got science, we have got reading, we have got mathematics. We have got California,we have got Texas. You have some huge opportunities outthere.

The important thing to us about ‘08 is how we perform in‘07. Because of the restructuring of theSchool Education Group, we needed to see strong, strong performance. With the 32% market share and leading everystate that we are in, we are very upbeat about that. As you know, the investment in ‘08 product ishas already taken place. I would expectto continue to build on that in next year and that will be an important partfor us.

Robert Bahash

Peter, one of the influencing factors that we are going toexperience next year in 2008, as I mentioned earlier, we will have completedthe construction of our new data center, which will house -- it is reallycritical for us in terms of the movement to our digital product offerings. The migration of our products and services,and all the platforms from the existing data center to the new data center willoccur throughout pretty much part of the first quarter, second, third andfourth quarters of next year. Those willbe additional costs.

We are really looking at them as one-time costs that willinfluence obviously performance next year. But it helps us to establish the right kind of platforms for our 24/7delivery across all our product lines. That’s the only extenuating item that would influence our forecast fornext year.

But again it is early on, as Terry pointed out. We are not really into the budgeting processbut I wanted to point out that is one item we are looking at for next year.

Peter Appert -Goldman Sachs

How big would that item be?

Robert Bahash

Again we are not really into the budgeting side of things,but you are migrating all of the systems that exist for education, for the mostpart, are being migrated to the new center. So we will be incurring duplicate application costs, duplicate equipmentcosts as we do that migration and wind out of some of those leases that is wemay have when we complete that effort. So we were’ formulating that now, but it is a one-time item that we aregoing to be faced with next year.

Terry McGraw

There are offsets to that and there will be savingsassociate associated as well.

Peter Appert -Goldman Sachs

The capital spending obviously has taken a big step up in‘07. Do you have a thought in terms ofwhat the run rate should look like on a go-forward basis in cap spending?

Robert Bahash

The big step up this year, of course, was driven by the datacenter getting up to 250 million so would I tend to think that next year,absent the data center, we are back down to the, most likely the $120 million to$140 million range.


Your next question comes from Ben [Slater] - Glenview Capital.

Ben [Slater] - Glenview Capital

I was hoping you could provide a little more color on theguidance in Q4 for higher education versus K-12, and what sort of growth in highereducation is coming from price versus volume?

Terry McGraw

Again, the higher education side is a more steady. The contribution quarter by quarter byquarter is more steady than it is in the K-12 area. In the K-12 area, as you know, the firstquarter you are reflecting all the investments and that’s why you are recordinglosses and you have to make it up in the third quarter.

What we have seen is a very obviously strong third quarter forK-12. The upside for us is on the education,the higher education side. And we areseeing a stronger market this year than we had forecasted coming into themarket.

So again, it is early on. If there is upside on the education side in the fourth quarter it isgoing to come from the higher education piece. And again, that’s both price and volume.

Ben [Slater] - Glenview Capital

Is it fair to say that your guidance for the educationsegment in total relates more to the K-12 segment and is due to timing morethan underlying weakness in the actual market?

Terry McGraw

Again, what we saw was mix shifts in the education thisyear. The strong, strong new adoptionmarket in the K-12 side, we did very well with. We saw some softness in this supplemental area. We picked that up in the new adoptionmarket.

Also, the other one that we are watching very careful, are theopen territories. The open territorieshave not grown over the last several years anywhere near where we think theyshould be. We think that’s going to beupside for ‘08. But right now we alsoexpect that we might get a little uptick in the fourth quarter from the openterritories side.

It is still very big; you are talking about almost $2billion that is being spent. The question is, is the growth on that? Again, that’s why we said 3% to 5% growth forthe market and we will do a lot better than that.

On the higher ed side, it is a little bit stronger than weexpected, and so we moved that up to 5% to 6% for the market.


Your next question comes from David Einhorn - Greenlight Capital.

David Einhorn - GreenlightCapital

As you look at the structured finance market, are thereparts of it that you feel, looking back, it is not a question that there is atemporary issue but maybe some of this just wasn’t such a good idea to beginwith?

Second, I’m wondering how you view Standard & Poor’sfrom a brand and what might be happening to the brand as a result of what’sgone on in the structured finance market. Thanks so much.

Terry McGraw

David, the market is what the market is and what we do isprovide access to the capital markets and provide, in the structured area, creditratings that relate to the risk a particular instrument has in terms ofdefaulting on its interest or on its principal payments.

The structured finance market is a market that institutionalinvestments like, and a lot. The reasonis because with structured product, you can divide them up into tranches andyou can get just the risk/reward characteristics or attributes that you arelooking for in terms of your own portfolio construction on that one.

If the market wants those kind of products and theinstitution investors want those products, then we move with the market and weare going to rate whatever on that part. Given the current environment, I think what you are going to see is moreof a flight to quality and less to speculative grade on that. We are reflectingthat now.

In terms of Standard & Poor’s as a brand, no; I mean, youare constantly growing, you are constantly learning, you are constantlyinvolved in not only the ratings side of the market but providing thetransparency in terms of all the financial information products.

We take that responsibility very seriously and thecredibility that S&P has as a brand in terms of serving the markets in alot of areas, here and around the world, is only going to grow with the growthof the capital markets. The long-termtrends here -- privatization, securitization, the whole global movement, thedisintermediation away from the banks into the capital market -- those trendsare undeniable. That’s what is growingthis. That is why the markets are extremely sophisticated and solid, and so too are theEuropean markets and the Asian markets.

Those trends are what are driving it and we are acenterpiece right in the middle of all that.


Your next question comes from Katrina Fallin - Citi.

Katrina Fallin - Citi

I was hoping you could broaden your comments a little bitabout your buyback plans. With 35million shares left in the ‘07 program, what’s your philosophy around continuedbuybacks? Should we expect a similar pace of buybacks in Q4 that we saw in Q3?

Terry McGraw

When we start talking about share repurchase now, this is aboard of directors’ authorization and that’s where it that is to come. I can give you my own sentiments that I thinkthat in terms of what we see, in terms of our growth trends and ouropportunities going forward, I think they are solid, they are strong. We very much like a share repurchaseprogram. We have completed ourauthorized portion so far in ‘07. We havea board meeting coming up and I guess that might get discussed.

Katrina Fallin - Citi

Just one further question on the ETF on S&Pindices. Nice growth there, $209billion. How much of that is through organicgrowth of the funds versus acquired growth through some of the new indices thatyou purchased? What are your thoughtsaround additional opportunities for acquisitions there?

Terry McGraw

Well again, most of what we do is organic. We are constantly developing thosecapabilities. Where we can acceleratethat through an acquisition such as the Goldman Sachs indices on commodities andso forth, we will do that.

So most of it is organic. It is a wonderful area and whatyou are doing is you are creating investable benchmarks and there are endlesspermutations to the type of benchmarks that you can develop.

So here, around the world, that effort will continue and weare working with lots of different exchanges and large institutional investorsto develop whatever they want in that area. Because you can measure things in any dimension; so again, withbenchmarks you can go in a lot of directions. Most of that is organic.

Katrina Fallin - Citi

Do you give any color around the contribution margin forthat business?

Terry McGraw

Yes. It is high.


Your final question comes from Michael Meltz - BearStearns.

Michael Meltz - BearStearns

Bob, I think you said the corporate line benefited from aone-time equity gain. What was that, andcan you size that? Following up onPeter’s question, this is, I think, the first time I’ve heard about theseredundant costs next year. Understandingthey are one-time, it would be helpful if at this point you could put it into context. Is this a $10 million charge or is this a $50million type of hit?

Terry McGraw

First off, it was an equity investment that we had. I’m not going to go any further than that.But it was roughly $3.6 million was the gain that is embedded within corporateexpense. We have been talking about theconstruction of the new data center now for the past year or so. Obviously coming with a new data center is,implicit in that is the movement and shifting of all our technicalcapabilities, our applications and such, fitting it with hardware, moving itinto that. That’s simply a bigprocess.

I’m simply highlighting that there is an item here. This is not something that is astronomicaland is going to influence the overall performance of the enterprise. It is just something that I’m just pointingout. We will size that for you as we gofurther in the course of the year, but just simply pointing out that this is aneffort that’s going to go on next year and it is the transition costs that areone-time. That’s all I’m referring to.

Michael Meltz - BearStearns

Your comment on shares out, the 329 million, was that adiluted or basic number at the end of the quarter?

Terry McGraw

That was a basic number.


We do have another question from Karl Choi - Merrill Lynch.

Karl Choi - MerrillLynch

Just within Financial Services, wondering if there was anyreversal in incentive compensation accrual in the quarter?

Bob, if you have a figure for how much headcount would be upyear-over-year in the fourth quarter for Financial Services?

Robert Bahash

With regard to incentive compensation, an influencing factor-- without getting into how much -- was simply because of the performance andthe outlook for the year as it relates to last year, you may remember last yearwas very, very strong and the expectation was for a very strong fourthquarter. We were building incentiveaccruals as we went through the course of the year.

Now this year, with the weaker performance in September andthe outlook going forward, the incentive accruals are lower. So that influenced the overallperformance. I’m not going to get intothe specifics of numbers. But it didinfluence the performance and did influence the fact that our margin was higherare on a year to year basis.

With regard to headcount, as Terry pointed out, we arelooking very, very hard at the organization, but keeping in mind that we have aresponsibility to provide quality products and services. We have surveillance that we are going to beadhering to. But we are looking acrossother parts of the lines to be certain that we are staffed accordingly, basedon what we are facing in the next six to nine months.

Terry McGraw

Karl the other aspect is the whole cross-training initiativewithin the ratings division. They move things around depending upon where therevenue growth is but everything is being looked at.


Thank you. This does conclude this morning’s call. On behalfof McGraw-Hill Companies we thank you for participating and wish you a goodday.

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