McGraw Hill Responds to DOJ Lawsuit in Release, Suit is "Entirely Without Factual or Legal Merit"
The McGraw-Hill Companies (NYSE: MHP) today reported fourth quarter and full-year 2012 results. Because of the pending sale of McGraw-Hill Education, this business has been reclassified as a discontinued operation and its results are excluded from continuing operations. In addition, in anticipation of the formation of McGraw Hill Financial and the first full year of operation of the S&P Dow Jones Indices joint venture, the Company is reporting S&P Capital IQ and S&P Dow Jones Indices as distinct business segments beginning this quarter.
McGraw Hill Financial: The Company reported fourth quarter 2012 revenue of $1,226 million, an increase of 22% compared to the same period last year. Net income and diluted earnings per share from continuing operations were $190 million and $0.67, respectively. For the full year, revenue increased 13% to $4,450 million and net income and diluted earnings per share from continuing operations were $676 million and $2.37, respectively.
Excluding the impact of one-time costs related to the Growth and Value Plan, and a gain from modifications to the vacation policy, adjusted net income from continuing operations increased 52% to $205 million, and adjusted diluted earnings per share from continuing operations increased 56% to $0.72. For the full year, adjusted net income from continuing operations increased 24% to $783 million and adjusted diluted earnings per share from continuing operations increased 32% to $2.75.
"As we approach the successful completion of the Growth and Value Plan, I could not be more pleased with the execution of the Plan and the value it has unlocked for shareholders," said Harold McGraw III, chairman, president, and chief executive officer of The McGraw-Hill Companies. He continued, "The sale of McGraw-Hill Education is anticipated in the first quarter. Now we reflect on the tremendous opportunity both McGraw Hill Financial and McGraw-Hill Education have before them. In 2012, McGraw Hill Financial delivered 13% revenue growth and 32% diluted adjusted EPS from continuing operations growth. This performance demonstrates the growth potential of McGraw Hill Financial, with its market-leading positions providing essential intelligence to its customers."
The Outlook: The Company reported full-year 2012 revenue of $4,450 million and adjusted diluted EPS from continuing operations of $2.75. "This creates a baseline at McGraw Hill Financial for future comparisons," said Mr. McGraw. He added, "We are introducing 2013 revenue guidance of high single-digit growth and adjusted diluted EPS guidance of $3.10 to $3.20, approximately a 15% increase. This new company has the capability to deliver more pronounced growth for our shareholders and employees."
The Growth and Value Plan has delivered:
Separation: The sale of McGraw-Hill Education to Apollo Global Management was the cornerstone of the Growth and Value Plan. Its sale will be the culmination of this transformative initiative. Growth Investments: Focusing on innovative products and technologies, the Company executed several investments in 2012. The most visible has been the formation of the S&P Dow Jones Indices joint venture which combines some of the most widely followed and trusted brands in the index space. In addition, the Company completed acquisitions of QuantHouse, R2 Financial Technologies, Credit Market Analysis Limited, Coalition Development Ltd., and Kingsman SA. Cost Reductions: The Company approached $175 million in run-rate cost reductions exceeding its commitment of at least $100 million by the end of 2012. The principal elements of the cost reduction programs included select headcount reductions; the migration of numerous accounting work streams, human resource processes, and selected information technology support services to world-class partners that specialize in these operations; and redesigning the employee benefits plans, including a freeze of the U.S. pension plans. Approximately two-thirds of the savings benefited McGraw-Hill Education. The McGraw Hill Financial savings were partially offset by the impact of certain stranded costs driven by separation. Return of Capital: During 2011 and 2012, the Company returned $3.1 billion to shareholders. Aggregate share repurchases totaled approximately $1.8 billion. In addition, the Company distributed approximately $600 million in regular dividends and approximately $700 million through a special dividend of $2.50 per share paid in December 2012. Standard & Poor's Ratings Services: Driven by the continued low interest rate environment and elevated levels of refinancing activity, fourth quarter 2012 revenue increased 34% to $584 million and operating profit increased 67% to $246 million. Adjusted operating profit increased 63% to $254 million in the fourth quarter compared to a relatively weak fourth quarter in 2011. The adjusted operating profit margin increased to 43.6% in the quarter.
2012 revenue increased 15% to $2,034 million. Operating profit increased 18% to $849 million. Adjusted operating profit increased 19% to $865 million compared to 2011. For 2012, the adjusted operating profit margin increased 130 basis points to 42.5%.
Transaction revenue increased 97% to $292 million during the quarter, compared to what was a relatively weak period last year, and was driven by a doubling of U.S. corporate issuance and a 74% increase in European corporate issuance. Worldwide structured issuance decreased 4%. U.S. structured finance issuance increased 104% off a small base and was driven by strength in commercial mortgage-backed securities, asset-backed securities, and collateralized loan obligations. The growth was offset by a 45% decline in European structured finance issuance due to a decrease in residential mortgage-backed securities and covered bond activity.
Non-transaction revenue increased 2% in the fourth quarter and represented 50% of Standard & Poor's Ratings' total revenue compared to 66% for the same period last year.
Domestic revenue increased 46% in the fourth quarter, outpacing a 23% increase in international revenue. Foreign exchange rates negatively impacted international revenue by $4 million. International revenue represented 46% of Standard & Poor's Ratings' total fourth quarter revenue.
S&P Capital IQ: Revenue increased 8% to $290 million in the fourth quarter of 2012. Organic growth accounted for 5% and new revenue from the acquisitions of QuantHouse, R2 Financial Technologies, and Credit Market Analysis Limited accounted for the balance. Quarterly operating profit decreased 10% to $48 million. Adjusted operating profit decreased 1% to $53 million.
Full-year 2012 revenue increased 9% to $1,124 million. Organic growth accounted for 7% and new revenue from the acquisitions of QuantHouse, R2 Financial Technologies, and Credit Market Analysis Limited accounted for the balance. Operating profit decreased 3% to $208 million. Adjusted operating profit increased 6% to $228 million.
The business enjoyed high single-digit adjusted operating profit in the first half of the year. In the second half of the year, profits declined modestly as the acquisitions were supplemented with additional investments to further develop the newly acquired technologies into innovative products and services.
Two key offerings, S&P Capital IQ (within Desktop Solutions) and Global Data Solutions (within Enterprise Solutions), both delivered solid growth despite continued layoffs within the financial industry. TheMarkets.com is being successfully integrated into S&P Capital IQ's platform and users are migrating to S&P Capital IQ service. Collectively, the number of S&P Capital IQ users increased 7% over the past year to more than 71,000.
S&P Dow Jones Indices: Revenue increased 38% to $110 million in the fourth quarter of 2012. Excluding the revenue associated with the Dow Jones Indexes, revenue increased 5% to $84 million. Quarterly operating profit increased 48% to $64 million. Adjusted operating profit attributable to the Company increased 16% to $50 million.
2012 revenue increased 20% to $388 million. Excluding the revenue associated with the Dow Jones Indexes, full-year revenue increased 3% to $332 million. Operating profit increased 12% to $212 million. Adjusted operating profit attributable to the Company increased 5% to $198 million.
Because the S&P Dow Jones Indices joint venture is a majority-owned entity, 100% of its revenue and expenses are consolidated into the Company's financial statements. In accordance with U.S. GAAP, 27% of the net income that is not owned by the Company is removed from the Company's income statement in the "net income attributable to noncontrolling interests" line.
Assets under management in exchange-traded funds based on S&P's indices increased 28% to $402 billion at the end of the fourth quarter. Including the Dow Jones Indexes, assets under management increased 27% to $466 billion. This was driven by record industry inflow of $191 billion into ETFs in the quarter.
The revenue benefit of increased assets under management was partially offset by a 12% decline in the average daily volume of exchange-traded derivative contracts based on S&P's indices, as well as a 27% decline in over-the-counter derivative revenue due to concerns among European banks with credit risk and the general economic slowdown.
Commodities & Commercial Markets: Revenue increased 9% to $260 million and operating profit increased 31% to $54 million in the fourth quarter of 2012. Adjusted operating profit increased by 27% to $59 million in the fourth quarter, compared to the same period last year.
For 2012, revenue increased 9% to $973 million. Operating profit increased 38% to $248 million. Adjusted operating profit increased by 40% to $260 million.
Platts topped off an already strong year with 15% revenue growth at Commodities to $129 million for the fourth quarter. Petroleum product subscriptions, licensing of its price assessments to derivative exchanges, and metals products and services all contributed to their double-digit growth.
Commercial Markets' revenue increased 4% for the quarter as a record year at J.D. Power and Associates was offset by a modest decline at Construction.
DOJ Lawsuit: The Company believes the Department of Justice civil lawsuit filed last week is entirely without factual or legal merit and that the Company has very strong defenses against this and all pending litigation. S&P has a record of successfully defending these types of cases, with 41 cases dismissed outright or voluntarily withdrawn.
The DOJ lawsuit disregards the central fact that S&P's CDO ratings were made in good faith through its committee-based system and were fully consistent with the views of many other institutions at the time, including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained.
The cherry-picked emails, selectively chosen from 20 million emails and documents, do not disprove this central fact. They display a culture of vigorous debate but not of wrongdoing. Claims that S&P deliberately kept ratings high when it knew they should be lower are simply not true as an objective assessment of all of the evidence will prove.
The DOJ also cites the fact that S&P personnel discussed proposed rating criteria with market participants although, under certain recent regulations, S&P is required to do just that.
The fact is, before 2007, and increasingly during 2007, S&P downgraded a record number of U.S. residential mortgage-backed securities (RMBS) and repeatedly warned of deteriorating conditions in the housing market and potential downgrades to come. (See list of published documents from this time on website listed below.) Between February and July of 2007 alone, S&P took 637 negative actions on ratings on 2006 vintage subprime RMBS. S&P downgraded more underlying U.S. RMBS than any other rating agency and did so sooner — a year and a half before the Lehman bankruptcy. These negative rating actions had a direct and automatic impact on S&P's CDO ratings. If the RMBS that was put on CreditWatch, or downgraded, was in a CDO, or was being considered for a new CDO, S&P's CDO rating took that negative status into account and required additional protection for the CDO.
Unfortunately, these actions turned out to be insufficient in anticipating the severity of the housing crisis that ultimately came to pass. However, the Company does not believe the Department of Justice can prove that this failure — common to nearly everyone at the time — was the product of intentional misconduct by anyone at S&P.
Additional information is available at www.standardandpoors.com/response
Unallocated Expense: Unallocated expense includes corporate functions and centrally managed costs. Adjusted unallocated expense increased 7% to $62 million in the fourth quarter, largely driven by increased incentives.
Non-GAAP Adjustments to Continuing Operations: During the fourth quarter, there were $77 million of one-time charges related to the Growth and Value Plan, which includes restructuring charges. Approximately $44 million was related to professional fees and approximately $29 million was related to restructuring actions. Also during the quarter, the vacation policy was changed resulting in a $52 million gain. These items are excluded from the adjusted results.
Return of Capital: During 2012, share repurchases totaled approximately $300 million, regular quarterly dividends totaled approximately $300 million, and the Company paid approximately $700 million for a special dividend of $2.50 per share in December.
In 2013, the Company anticipates continuing its share repurchase program, subject to market conditions, once the funds from the sale of McGraw-Hill Education are received. As a reminder, the Company currently has 16.9 million shares remaining under the existing authorization from the Board of Directors. The 2013 EPS guidance includes a positive impact from this anticipated share repurchase activity.
Balance Sheet and Cash Flow: Cash and short-term investments at the end of the fourth quarter were $761 million, down from $864 million at the end of 2011. During the fourth quarter the Company paid down approximately $400 million of 5.375% Senior Notes and paid the special dividend. To help fund these transactions, the Company utilized its commercial paper program and had $457 million outstanding at year end. 2012 free cash flow from continuing operations (see exhibits 3 and 11) was $626 million, a decrease of $183 million from the same period in 2011. This was due primarily to the one-time costs associated with the Growth and Value Plan and a $150 million fourth quarter pension contribution.
The McGraw-Hill Companies:
Discontinued Operations: With the pending sale of the McGraw-Hill Education business, the results were classified as a discontinued operation. Net loss from discontinued operations in the fourth quarter and full year were $(406) million and $(239) million, respectively. These losses include intangible asset impairments of $497 million that consisted of goodwill, prepublication investment, and inventory assets at McGraw-Hill Education's School Education Group. Adjusted net income from discontinued operations for the fourth quarter and full year were $9 million and $196 million, respectively.
On a consolidated basis, which includes McGraw Hill Financial and McGraw-Hill Education, adjusted diluted earnings per share for the fourth quarter and the full year were $0.75 and $3.44, respectively. This exceeded the Company's most recent 2012 guidance of $3.35 to $3.40 per share.
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