gregdevittdesign client job date comments/rationale McGraw-Hill Ryerson MHR Annual Report 2006 cvr December 1, 2006 Cover No. b LEARNING. THE JOURNEY TO SUCCESS. McGraw-Hill Ryerson Annual Report 2006 Company Profile McGraw-Hill Ryerson Limited has a long and illustrious history. It is built on the solid foundations of two respected publishing companies: McGraw-Hill Book Company, now known as The McGraw-Hill Companies, Inc., and The Ryerson Press. In 1944, the McGraw-Hill Book Company, which had begun publishing in the United States in 1909, bought the Embassy Book Company of Toronto, incorporating it as a franchised distributor for McGraw-Hill, Inc. in Canada. It was called the Embassy Book Company Limited until 1947 when it was then established as a wholly-owned subsidiary of the parent company and renamed the McGraw-Hill Company of Canada Limited. In 1829, the Methodist Church established the Methodist Book and Publishing House, the very first publishing company in Canada. Egerton Ryerson, known as the father of Ontario’s public school system, was given the responsibility of founding the press and took it from religious publishing into the area of secular books. In 1919, the press took on his name and continued to publish in many areas: religious, educational, and trade. In December 1970, the McGraw-Hill Company of Canada Limited bought The Ryerson Press from the United Church of Canada and in 1971, the company became McGraw-Hill Ryerson Limited (sometimes referred to herein as “MHR” or “McGraw-Hill Ryerson” or the “Company”). The Company publishes and distributes educational and professional products in both print and non-print media. These products are designed to fulfill the individual needs of customers by providing effective and innovative educational and learning solutions. Product offerings include text and professional reference books, multimedia tools, and teaching, assessment, support, and monitoring solutions. The Company is committed to providing Canadians with material of the highest quality for their education and enjoyment. The Company is structured on a market-focused basis and operates in three primary market areas through the following revenue divisions: • Higher Education Division: post-secondary education, including universities, community, and career colleges • School Division: secondary and elementary schools • Professional Division: general interest, non-fiction, general reference, business, and computer disciplines, training and professional development, and medical. Table of Contents McGraw-Hill Ryerson is a public company, operated independently, in close cooperation with various divisions and international subsidiaries of its majority shareholder, The McGraw-Hill Companies, Inc. Through this cooperation the Company benefits from its access to the significant product, market, and operational expertise of The McGraw-Hill Companies, Inc. Company Profile: Who and What McGraw-Hill Ryerson Limited Is 1 McGraw-Hill Ryerson at a Glance • A quick look at McGraw-Hill Ryerson’s three business segments, including: key markets, primary programs, key issues and trends, and outlook 2 Vision, Mission, Culture, and Values Statements 3 1 • Professional Division • Chenelière/McGraw-Hill (“DLC”) • Major Support Initiatives 8 9 10 Management’s Discussion and Analysis of Operating Results and Financial Position 11 Financial Statements • McGraw-Hill Ryerson’s 2006 financial statements and notes 16 Dividend Policy 26 Message to the Shareholders 5 • A letter to McGraw-Hill Ryerson’s shareholders from H. Ian Macdonald, Chairman, reviewing the Company’s performance and looking to the future 2006 Corporate Contribution Programs 27 Corporate Governance and Management Team 28 Shareholder and Corporate Information 30 An Overview of McGraw-Hill Ryerson’s Business Units and Markets • Higher Education Division • School Division International Affiliates 31 Financial Highlights 4 • A look at McGraw-Hill Ryerson’s financial performance 6 7 McGraw-Hill Ryerson Higher Education Division McGraw-Hill Ryerson Annual Report 2006 at a Glance PRIMARY PROGRAMS KEY ISSUES AND TRENDS Universities, Community Colleges, Career Colleges Business Economics Computer and Information Technologies Science Engineering English Psychology Social Sciences E-Services Nationally, enrollments are increasing slightly. Growing interest in “custom” solutions. Growth in technology-enabled and web-based teaching and learning solutions. Mixed-mode educational models dominate. Growing interest in assessment applications. Secondary Schools, Elementary Schools Mathematics Science & Health Social Studies Literacy English Social Sciences Technology Education Marginal decline in student enrollment. Flat government spending on education. Focus on requirement to improve standards of academic achievement and accountability. Curriculum renewal cycles varying by province. Booksellers, Distributors, Libraries, Direct to Professionals, Medical Schools Business General Interest Scientific Technical Medical Language Computer Dominance of major bricks and mortar and online book retailers. Growth in medical student enrollment. Competition from online retailers. Growth in professional digital products and services. Chenelière/ McGraw-Hill Professional Division School Division 2 KEY MARKETS By publishing under a joint imprint, McGraw-Hill Ryerson Limited and Les Éditions de la Chenelière are able to concurrently publish French and English editions of secondary and post-secondary titles. Vision To be recognized as a leading Canadian publisher of educational Mission To be a Canadian leader in developing and marketing quality infor- resources, information products, and services for lifelong learning and enjoyment. mation products and services to selected educational, professional, and consumer markets through innovation and teamwork. We will provide exceptional value to customers, growth and recognition Values Culture to our shareholders. At McGraw-Hill Ryerson, we will work together to: • strive to exceed our customers’ expectations, by recognizing and anticipating their needs • meet challenging but achievable company objectives and financial goals, with well-planned and clearly communicated strategies • continually improve MHR’s image in the marketplace, through the promotion of creative ideas, and the development of targeted, innovative products • encourage a winning spirit and a positive working environment through the development of supportive, appreciative, and rewarding working relationships • create a market-driven organization • reward creativity, innovation, and risk-taking • recognize diversity by treating individuals with respect and dignity Customer focus Profitability (short-term and long-term) Innovation and improvement of products and systems Commitment to quality Employee development/lifelong learning Employee recognition Teamwork (collaboration, shared decision making within and between divisions) Integrity, honesty, ethical behaviour Respect for individuals and their differences; high quality of work life McGraw-Hill Ryerson Annual Report 2006 opportunities for employees, and outstanding financial performance 3 Financial Highlights (In Thousands of Dollars, except Per Share Data) 2006 2005 2004 2003 2002 $92,878 $81,746 $ 7,006 $87,707 $78,490 $ 5,829 $89,226 $78,458 $ 7,023 $89,564 $79,838 $ 6,104 $96,757 $87,500 $ 6,156 $16,546 $ 1,011 $ 6,305 $15,454 $ 377 $ 5,710 $ 7,190 $ 659 $ 44 $13,891 $ 436 $ 7,331 $ 5,602 $ 4,058 $(7,186) $76,498 $95,211 $71,139 $87,684 $69,833 $87,372 $64,218 $86,881 $59,402 $95,406 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Revenue and Earnings McGraw-Hill Ryerson Annual Report 2006 Revenue Expenses Net income 4 Cash Flow Cash provided by operating activities Additions to capital assets Net increase/(decrease) in cash during the year Closing Financial Position Total shareholders’ equity Total assets Per Common Share Basic – net income per share for the year Dividends Book value Market value at December 31 3.51 0.825 38.31 43.29 2.92 2.265 35.63 39.25 3.52 0.705 34.98 35.50 3.06 0.645 32.16 37.50 3.08 0.60 29.76 33.25 Financial Ratios Net Income/Average Assets Net Income/Total Revenue 7.7% 7.5% 6.7% 6.6% 8.1% 7.9% 6.7% 6.8% 6.8% 6.4% 11,132 92,878 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 Message to the Shareholders After two years of minor sales decline, McGraw-Hill Ryerson reported an aggregate sales increase of 5.6% for 2006. Given the modest industry-wide growth figures reported in the Higher Education and Trade/Professional markets in particular, this is a significant accomplishment for the Company. Our Higher Education Division, which serves the post-secondary market for English-language titles, reported a 2.4% sales growth, relatively consistent with industry-wide sales in this segment. This Division continues to innovate in the development of digital products, which has helped us become a market leader in this area. Our School Division reported a substantial 8.1% sales increase. This division has expanded its Canadian publishing program aggressively in response to curriculum revisions in several of its largest regions. Through this program, we have published several titles in 2005 and 2006 that are proving to be very popular with teachers and administrators. This, combined with government funding for textbooks in Ontario and B.C., has contributed to the strong sales and bottom line results in the School Division. Our Professional Division (previously referred to as Trade, Professional, and Medical) reported a substantial 9.3% sales increase as well. Several key titles, including A Thousand Barrels a Second and Blue Ocean Strategy, sold very well during 2006. This Division also reported strong results from its Language and General Reference titles. During the year management worked hard to strengthen our retail partnerships, and to analyze detailed product sales data to drive bottom-line profitability. Process improvements across our supply chain departments have allowed us to become more efficient while keeping a consistent level of inventory. We are particularly proud of this achievement in a year with substantial revenue growth which, combined with strong cash collection results, has helped to drive our cash balances to record levels. As a result, we were pleased to be able to increase our quarterly dividend payment to shareholders for the fifth year in a row. Our quarterly dividend payments have now more than doubled since 1998. We would like to thank all of the employees of McGraw-Hill Ryerson Limited for their contribution in 2006, and through their continued dedication we anticipate much success in 2007. H. Ian Macdonald, O.C., LL.D.,D.UNIV.D.LITT, FCOL David L. Swail Chairman of the Board of Directors President and Chief Executive Officer McGraw-Hill Ryerson Annual Report 2006 The markets for our products in 2006 varied considerably across each of the three segments we serve. Overall market spending for Higher Education titles was up marginally for the year. One-time government funding for learning resources helped drive the overall School market up by 12% while the Trade/Professional market was relatively flat. 5 McGraw-Hill Ryerson Annual Report 2006 H I G H E R E D U C AT I O N D I V I S I O N 6 This Division’s Canadian Publishing Program continued its growth in 2006. Titles in areas such as international business, sociology, and English composition are examples of new areas of publication. New projects were also signed in subjects such as management, corporate finance, accounting, marketing, anthropology, criminology, and psychology. The Media Technology Group continued its growth in the McGraw-Hill Homework Management arena with new products in accounting, finance, and economics, and has expanded content and service offering new delivery platforms such as the iPod. Overall, 41 titles were published in 2006 and projects worth an estimated $19 million in projected first year sales were signed. Key Titles for 2006 were as follows: 1. Garrison, Managerial Accounting 7/e 2. Crane, Marketing 6/e 3. McShane, Canadian Organizational Behaviour 6/e 4. Ross, Fundamentals of Corporate Finance 5/e 5. Myers, Social Psychology 3/e 6. Libby, Financial Accounting 2/e 7. Schwind, Canadian Human Resource Management 7/e 8. Mader, Inquiry into Life 11/e 9. Nicholson, Linear Algebra with Applications 5/e 10. Beechy, Intermediate Acct. Vol. 1 3/e Research indicates that students continued to find and use substitutions for textbooks. The continued presence of copyright infringement (photocopying, online piracy, and peer-to-peer sharing) all contributed to slower growth in all markets across the country in 2005 and 2006. To combat this, McGraw-Hill Ryerson continues to work with faculty to offer flexible, high-value solutions to students, using both traditional and online content, as well as leading-edge technology. The School Division’s 2006 publishing program continued to build on its long-term strategy of targeting Grades 7 – 12 mathematics, science, and social studies courses for university, college, and workplace-bound students. Publication of MHR Mathematics 7: Focus on Understanding under contract to the Nova Scotia Department of Education is the second in a three-title series from Grades 7 – 9; MHR Principles of Mathematics 9, designed for university-bound students, is the third title in a new series of mathematics resources to be published for the revised Ontario Mathematics curriculum. British Columbia Science 8 is the first in a series of three titles to support new Grades 8 – 10 science curricula in British Columbia. The publication of Inquiry into Biology and Inquiry into Chemistry launches the School Division into the Grades 11/12 university-bound science market in Alberta and builds on our success in the Alberta Grades 7 – 10 science market. This year also saw the launch of the School Division into the Ontario college-bound social studies market with the publication of Canadian History: A Sense of Time and Canadian Geography: A Sense of Place. The School Division also continues to engage in market research into the role and value of technology-enabled teaching and learning solutions in Grade 7 – 12 classrooms. Key titles in the School Division for 2006: 1. Sandner et al., BC Science 8 7. Mason et al., BC Science 6 2. Speijer et al., Principles of Mathematics 9 8. Gini-Newman et el., Canadian History: A Sense of Time 3. Speijer et al., McGraw-Hill Ryerson Mathematics 7 4. Knill et al., MATHPOWER 9 Western Edition 9. Witte et al., Food for Today 1/e 10. Mason et al., BC Science 7 5. Knill et al., MATHPOWER 7 Western Edition 6. Knill et al., MATHPOWER 8 Western Edition Total funding for learning resources in 2007 is expected to be relatively consistent with 2006. In 2006 a one-time textbook and learning resource allotment in British Columbia and Ontario respectively drove industry performance 12% higher than the prior year. The key elements of unpredictability lie in last-minute political decisions affecting the timing of curriculum implementation and release of funding. McGraw-Hill Ryerson Annual Report 2006 SCHOOL DIVISION 7 McGraw-Hill Ryerson Annual Report 2006 PROFESSIONAL DIVISION 8 The Professional Division concentrates on marketing and distributing products from The McGraw-Hill Companies Inc., as well as from several agencies, including Harvard Business School Press. Sales in 2006 were driven primarily through national chains and online retailers, which both saw outstanding point of sale improvements, reduced returns, and overall improved inventory management. Strategic partnerships with key customers resulted in new opportunities, which helped drive sales and market share advancements. Growth occurred across most product categories and backlist sales rose through all channels. Key Professional Products in 2006: 1. Tertzakian, A Thousand Barrels a Second 2. DiPiro et al., Pharmacotherapy 6/e 3. Wolff et al., Color Atlas and Syn. Clinical Dermatology 5/e 4. Chan and Mauborgne, Blue Ocean Strategy 5. Lowndes, How to Talk to Anyone 6. Tintinalli et al., Emergency Medicine Study Guide 6/e 7. Kirsch, Ultimate New York Diet Plan 8. Kasper et al., Harrison’s Principles of Internal Medicine 16/e 9. Crocker, Schaum’s Outline of French Grammar 10. Harrap, Harrap’s French/English Dictionary Several factors may impact this Division in 2007 and beyond. Customers may continue to diversify how they obtain product as they search for content from a multitude of other sources and locations. Also, new competitors continue to enter the marketplace as retailers are now developing their own publishing programs. These new sources of product may compete directly with traditional publishers in an already mature and established publishing industry. Chenelière/McGraw-Hill (“DLC”) Best-selling titles for 2006: 1. Mason et al., Sciences 6 – Colombie Britannique 2. Mason et al., Sciences 7 – Colombie Britannaique 3. Sandner et al., Sciences 8 – Colombie Britannique 4. Ainslie et al., Mathematiques 9 – Nouvelle-Ecosse 5. Stevenson, La gestion des opérations, produits et services 2/e 6. Lind, Méthodes statistiques pour les sciences de la gestion 7. Hilton, Comptabilité financière avancée 3/e 8. Gray, Management de projet In 2007, DLC's Higher Education and School divisions will be publishing many new translations of McGraw-Hill Ryerson titles. In Higher Education, DLC expects successful launches of the new edition of Marketing by Berkowitz, Accounting by Larson, Organizational Behaviour by McShane, and Fundamentals of Financial Accounting by Libby. As for the School Division, titles will include Biology for Grades 11 and 12-Alberta, Science for Grade 9-British Columbia, Principles of Mathematics for Grade 9-Ontario and Mathematics for Grade 7-Nova Scotia. While the warehousing contract between McGraw-Hill Ryerson and DLC expired at the end of 2005, agreements covering the joint imprint and translation rights remain firmly in place. McGraw-Hill Ryerson Annual Report 2006 By publishing under a joint imprint, McGraw-Hill Ryerson and Les Éditions de la Chenelière (“DLC”) are able to concurrently publish French and English editions of secondary and post-secondary titles. Chenelière/McGraw-Hill enjoyed an excellent year in 2006 with French translations of successful titles from McGraw-Hill Ryerson. DLC and McGraw-Hill Ryerson are working together to develop English and French proposals simultaneously to fit various calls for resources across Canada. 9 Major Support Initiatives McGraw-Hill Ryerson Annual Report 2006 2003 EDITORIAL, DESIGN, AND PRODUCTION DEPARTMENT 10 McGraw-Hill Ryerson’s Editorial, Design, and Production (EDP) Department provides project management, technical production, and manufacturing services for a wide variety of product offerings. In 2006, EDP oversaw the production of more than 130 new titles and supplements and 350 reprints. Business alliances with key vendors in Canada, the U.S., and overseas allow for competitive pricing and ensure the highest quality of materials for McGraw-Hill Ryerson’s products. These alliances help to facilitate the timely delivery of products to the Company’s warehouse for distribution to customers. In addition, a close working relationship with our majority shareholder, The McGraw-Hill Companies, Inc., provides McGraw-Hill Ryerson with the opportunity to leverage buying power and establish best practices of a multi-billion dollar corporation. INFORMATION SYSTEMS AND TECHNOLOGY (IS&T) In our ongoing commitment to support the Company’s business strategy and goals, the IS&T group focused efforts on evolving our e-commerce capabilities, achieving greater automation in our business processes, and supporting the dynamic needs of our customers. This year, the Company launched Ecommerce Services for business-to-business (B2B) and business-to-consumer (B2C), introduced a sales force automation tool for the School Division, automated our corporate process improvement program, and invested in the development of analytics tools. In 2007 we will build on the foundations of our work in 2006, as we develop digital workflows and enhance our customers’ experience through improved electronic services. CUSTOMER SATISFACTION DIVISION The Customer Satisfaction Division provides customer service and logistical support to ensure a high level of service to our customers. Building on the success of improvements implemented in 2005, additional process and quality initiatives were undertaken in 2006. Efforts were focused on simplifying and strengthening internal processes and resulted in improved operating efficiencies and expanded operating capacities. These results have contributed to improved performance standards and support our continuing effort to provide service levels that exceed customer expectations. HUMAN RESOURCES There was extensive support of productivity improvements across the Company in 2006. This resulted in improved workflows, and more engaged employees. There has also been a greater emphasis on succession plans for key positions within the organization and developing high-potential employees for promotion and retention. Our progressive Human Resource policies, programs, and benefit plans (including a bonus plan covering all employees, flexible health benefits, and a Company pension plan) have helped us attract and retain a very strong and loyal employee workforce. This management's discussion and analysis (“MD&A”) provides a detailed analysis of McGraw-Hill Ryerson's business and compares its 2006 financial results with those of the previous year. In order to better understand the MD&A, it should be read in conjunction with the Financial Statements for the year ended December 31, 2006 and its related notes. The Company prepares and files its financial statements and MD&A using Canadian dollars and in accordance with Canadian generally accepted accounting principles (“GAAP”). The financial statements and MD&A, as well as additional information regarding McGraw-Hill Ryerson, including the Annual Information Form, are available at www.sedar.com. This MD&A is made as of February 2, 2007. PROFILE McGraw-Hill Ryerson Limited (the “Company”) was incorporated in 1944 and has been listed on the Toronto Stock Exchange since 1971. The Company is operated independently, in close cooperation with various divisions and international subsidiaries of its majority shareholder, The McGraw-Hill Companies, Inc. The Company’s strategy is to be a Canadian leader in developing and marketing quality information products and services to select educational, professional, and consumer markets through innovation and teamwork. The Company publishes and distributes educational and professional products in both print and non-print media. These products are designed to fulfill the individual needs of customers by providing effective and innovative educational and learning solutions. Product offerings include text and professional reference books, multimedia tools, and teaching, assessment, support, and monitoring solutions. The Company is structured on a market-focused basis and operates in three primary market areas. The largest division is the Higher Education Division which serves post-secondary education institutions, including universities, community colleges and career colleges. The second largest division is the School Division which services secondary and elementary schools. The third division is the Professional Division which sells general interest, non-fiction, general reference, business, and computer disciplines, training and professional development and medical books. Selected Annual Financial Results (In Thousands of Dollars). Comparative numbers are restated. 2006 2005 2004 2003 2002 Net Sales % increase/(decrease) 90,343 5.6% 85,557 (1.9)% 87,223 (0.5)% 87,693 (7.4)% 94,693 7.8% % of Net Sales Higher Education sales School sales Professional sales Other sales 60.0% 26.1% 12.0% 2.0% 61.8% 25.5% 11.6% 1.1% 59.7% 28.0% 11.1% 1.1% 58.2% 29.0% 11.9% 0.9% 49.8% 36.7% 12.0% 1.5% % of Net Sales Imported product sales Canadian and adaptation sales Agency sales Other 49.9% 48.1% 1.0% 1.0% 51.2% 46.9% 0.8% 1.1% 50.9% 46.7% 1.3% 1.1% 51.0% 46.3% 1.8% 0.9% 53.2% 43.8% 1.5% 1.5% Total revenue % increase/(decrease) 92,878 5.9% 87,707 (1.7%) 89,226 (0.4%) 89,564 (7.4%) 96,757 7.5% Total expenses % of Total revenue 81,746 88.0% 78,490 89.5% 78,458 87.9% 79,838 89.1% 87,500 90.4% Net income Net income/Total revenue Net income per share 7,006 7.5% $3.51 5,829 6.6% $2.92 7,023 7.9% $3.52 6,104 6.8% $3.06 6,156 6.4% $3.08 Total assets Net income/Average assets 95,211 7.7% 87,684 6.7% 87,372 8.1% 86,881 6.7% 95,406 6.8% Cash dividend payments 1,647 4,523 1,408 1,288 1,198 McGraw-Hill Ryerson Annual Report 2006 Management’s Discussion and Analysis of Operating Results and Financial Position 11 DISCLOSURE CONTROLS AND INTERNAL CONTROLS OVER FINANCIAL REPORTING McGraw-Hill Ryerson Annual Report 2006 The Company’s management is responsible for establishing and maintaining the Company’s disclosure controls and procedures and internal control over financial reporting to ensure that information used internally and disclosed externally is accurate and reliable. The Company’s management has evaluated the effectiveness of the Company’s disclosure controls and procedures, and based on such evaluation has concluded that their design and operation are adequate and effective as of the end of the fiscal year ended December 31, 2006. There have been no changes in the Company’s internal controls over financial reporting during the year ended December 31, 2006 that have materially affected or are reasonably likely to materially affect the internal controls over financial reporting. 12 REVENUE The Company’s net sales increased in 2006 by 5.6%, with sales of $90.3 million, compared to $85.6 million in 2005. For the twelfth consecutive year, the Higher Education Division succeeded in increasing sales. Sales increased by 2.4% compared to 2005. Growth in the Higher Education industry was 3.6% in 2006 (industry-wide annual sales growth, based on results provided by the Canadian Publishers Council). The strength of the entire Higher Education team continued in 2006, with success across many disciplines, especially in biology, chemistry and math. Custom publication sales were up 10% over 2005. This increase is a reflection of both the need for customized solutions and the ability of McGraw-Hill Ryerson to meet customer demands. Our Faculty Services team continued to grow and was leveraged in new sales of approximately 110,000 units. McGraw-Hill Ryerson held a successful Educational Conference series reaching approximately 1,250 educators. With this focus on faculty development, we continue to offer our customers an opportunity to learn and grow. With product offerings such as the McGraw-Hill Homework Manager, iStudy and online course content, faculty were able to integrate new technologies into their teaching strategies and offer students a dynamic learning environment in combination with our leading textbooks. The School Division’s sales increased by 8.1% compared to the prior year. The largest increase was in our local publishing program where both our 2006 and 2005 publications exceeded sales targets. This growth is a reflection of the implementation of selected new core Grades 7 – 12 science, mathematics and social studies curricula in combination with the market place success of our list. Sales growth also occurred in the Glencoe/McGraw-Hill list, reflecting an ongoing interest in resources to support non-core curricula. Overall industry growth of 11.8% (based on Canadian Education Resource Council information) was driven by significant government funding released in British Columbia and Ontario in early 2006. The Company benefited from this funding, as sales to schools and school boards in British Columbia more than doubled in 2006 compared to 2005. The Professional Division experienced impressive sales growth in 2006 despite the industry’s modest gains. While the Canadian trade book market was stable, the Professional Division saw a 9.3% revenue increase over the prior year. Ongoing improvements in product development and support from The McGraw-Hill Companies Inc. helped spearhead sizeable market share gains in categories like languages, reference, business, and digital. The Professional Division continued to drive sales in the foreign language market by focusing on key brands, such as the growing Harraps line, which now encompasses French and Spanish dictionaries, as well as ongoing sales from the Teach Yourself language learning series. Harraps French and Spanish dictionaries are now well established best sellers in the Canadian trade book market. Business sales were also strong in 2006 as this division saw significant gains from both the McGraw-Hill and Harvard Business School Press lines. Growth was spurred by key business publications such as A Thousand Barrels a Second, Chasing Daylight, and Blue Ocean Strategy, as well as ongoing solid category performance within our key channels. Medical sales declined by 9% in 2006, mainly from a reduction in key title publications. Digital sales continued to see impressive gains as spending for digital content increased and our subscription business grew. Sales for Access Science remained stable while Access Medicine and Digital Engineering Library grew in 2006. Canadian publications increased from 46.9% in 2005 to 48.1% of total sales in 2006 as a result of the growth in Higher Education and School Divisions’ publishing programs. On average, the Company earns higher margins on Canadian publications than on imported product or agency product. Sales of product imported from The McGraw-Hill Companies, Inc. decreased to 49.9% of total sales compared to 51.2% in 2005. Agency sales increased marginally to 1.0% of total sales in 2006 from 0.8% in 2005. Other revenue, consisting of rental revenue from the tenant at the Company’s owned headquarters facility in Whitby, Ontario, interest on investments, and copyright/licensing fees, increased to $2.5 million in 2006 ($2.2 million in 2005). Total revenue increased from $87.7 million last year to $92.9 million in 2006, a 5.9% increase. EXPENSES In 2006, total expenses increased to $81.7 million over the prior year’s $78.5 million. Operating expenses, comprised of cost of product and royalties, increased to $41.3 million from $39.5 million. This 4.5% increase is consistent with the sales increase. Operating expenses as a percentage of net sales has improved this year (45.7% of sales in 2006 compared to 46.2% in 2005). This is mainly a function of the change in product mix (Canadian vs. imported product). Editorial, selling, general, and administrative expenses increased 7.2% to $33.5 million from $31.3 million in 2005. The results in 2005 included a $0.9 million restructuring charge included in editorial, selling, general, and administrative expenses. Additional expenses were expected in 2006 as a result of the costs to support the expanding publishing program in the School Division, and the discontinuation of the Company’s warehousing contract with Les Éditions de la Chenelière at the end of 2005, which had offset expenses in 2005 by $1.4 million. These expenses as a percentage of sales have increased to 37.1% from 36.6%. Amortization of prepublication costs decreased 13.6% to $5.4 million from $6.2 million in the prior year because of the small number of titles published in the School Division in 2003 to 2005, when provincial funding was focused away from the secondary school LIQUIDITY AND FINANCIAL RESOURCES Cash and cash equivalents at December 31, 2006 have increased to $33.5 million from $27.2 million in 2005 because of increased sales, strong cash collection results, and the Company’s continued emphasis on inventory management. The accounts receivable balance increased slightly to $17.9 million from $17.5 million in as a result of higher sales in the fourth quarter of 2006 compared to 2005. The Company's collection performance is closely monitored in accordance with credit terms and industry standards. Inventory levels remained relatively consistent with the prior year at $8.1 million versus $8.0 million in 2005. The Company’s efforts to improve distribution processes led to improved inventory turnover results. Prepublication investment increased from $4.8 million in 2005 to $7.6 million, reflecting the expanded publishing program within the School Division for 2006 and 2007 titles. Capital asset purchases of $1.0 million in 2006 (mainly for warehouse and facility improvements) are higher than the $0.4 million in 2005. These purchases support the process improvements implemented throughout the Company during the year. The Company has entered into operating leases, primarily for automobiles, for which the estimated future minimum annual lease payments are $0.3 million in 2007 and $0.1 million in 2008. The Company has future purchase commitments with a vendor for printing/copying costs. The minimum annual commitments are $0.4 million in 2007 and $0.1 million thereafter. The Company's cash flow is cyclical during the year reflecting our sales cycle, with high cash balances in the first and fourth quarters. During the low-cash phase of the cycle, in the second and third quarters, the Company has a line of credit available to meet forecasted needs. The line of credit was not used in 2006 or 2005. The Company generated significant cash from operations in 2006. TRANSACTIONS WITH RELATED PARTIES The Company is a subsidiary of The McGraw-Hill Companies, Inc. which owns 70.1% of the outstanding common shares. Under longstanding arrangements, the Company purchases books and educational materials from the parent company and various international subsidiaries of The McGraw-Hill Companies, Inc. Inventory purchases from the parent company in 2006 were $31.8 million, down from $32.9 million in 2005. In addition, the Company pays royalties to the parent company for any titles that have been adapted to the Canadian market. Royalty payments in 2006 were $1.5 million compared to $1.1 million last year. The Company also sells books and educational materials to various international subsidiaries of The McGraw-Hill Companies, Inc. These purchases and sales are recorded at the exchange rates in effect at the time of the transaction. In the normal course of business, the Company reimburses (and is reimbursed) for common expenses shared with other McGraw-Hill entities. All such reimbursements are done at cost, using exchange rates in effect at the time of the transactions. Common expenses reimbursed to The McGraw-Hill Companies, Inc. are expected to increase by $0.7 million in 2007 as a result of information systems and support charges. The Company owed related parties $7.3 million at the end of 2006, compared with $6.2 million at December 31, 2005, and was owed $1.8 million by the related parties at the end of 2006, down from $2.6 million at the end of 2005. DIVIDENDS For the fifth year in a row, the Company increased its quarterly dividend payment. The quarterly dividend payment is $0.21 per share at the end of 2006 ($0.195 at the end of 2005). Total dividends paid were $1.6 million in 2006 compared to $4.5 million in 2005. In 2005, the Company declared and paid a special dividend of $3.0 million ($1.50 per share). Liquidity and Financial Resources (In Thousands of Dollars—except Per Share Data) 2006 2005 As at December 31, Cash and cash equivalents 33,511 27,206 Total assets 95,211 87,684 Working capital 45,658 42,338 Accounts receivable 17,948 17,503 Inventory 8,066 8,006 2004 2003 2002 21,496 87,372 39,188 17,231 11,543 21,452 86,881 31,505 14,991 11,483 14,121 95,406 23,881 18,372 15,227 For the 12 Months Ended December 31 Cash flow from operations Prepublication investment Capital asset additions Dividends paid per share 7,190 5,079 659 0.705 13,891 4,836 436 0.645 5,602 7,532 4,058 0.60 16,546 7,583 1,011 0.825 15,454 4,844 377 2.265 McGraw-Hill Ryerson Annual Report 2006 market. Capital asset amortization has decreased 1.9% in 2006 as a result of minimal capital investment in recent years. The Company incurs foreign exchange gains and losses throughout the year as a result of the significant volume of related party transactions, most of which are denominated in U.S. dollars. The foreign exchange loss of $0.2 million is slightly higher than the $0.1 million exchange loss in 2005. The Company continues to employ policies to minimize the impact of currency fluctuations. The effective tax rate increased to 37.1% [2005 – 36.8%]. This minor rate increase reflects future tax rate changes. 13 Quarterly Income Statement ($000—except Per Share Data) Quarter Ended Quarter Ended March 31 June 30 2006 2005 2006 2005 Quarter Ended Sept. 30 2006 2005 Quarter Ended Dec. 31 2006 2005 2006 2005 Total Revenue 12,691 8,595 18,083 17,414 37,572 37,751 24,532 23,947 92,878 87,707 Net Income (Loss) for the period (1,239) (2,759) (28) 719 5,923 6,317 2,350 1,552 7,006 5,829 Net Income (Loss) per share $(0.62) $(1.38) $(0.01) $0.36 $2.97 $3.16 $1.18 $0.78 $3.51 $2.92 McGraw-Hill Ryerson Annual Report 2006 QUARTERLY RESULTS 14 The Company's sales are based on the education industry's school terms for the School and Higher Education Divisions and are therefore cyclical. As a result, the Company earns a significant amount of its total sales in the third and fourth quarters of each year. In the fourth quarter of 2006, total revenue increased 2.4% compared to the prior year, driven by improved results within the Higher Education and Professional Divisions. Net income increased by $0.8 million, caused mainly by reduced editorial, selling, general, and administrative expenses and lower amortization. Editorial, selling, general, and administrative expenses in the fourth quarter of 2005 included a $0.9 million restructuring charge. CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in accordance with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. The critical accounting estimates included in the financial statements are as follows: • • • The inventory obsolescence reserve is based upon management's assessment of the marketplace of products in demand as compared to the number of units currently on hand. This calculation is completed for each title. Should the estimate for inventory obsolescence vary by one percentage point, it would have an approximate $0.1 million impact on operating profit. The allowance for doubtful accounts is calculated by reviewing any specifically identified aged accounts plus a general provision for the balance of the accounts. The impact on operating profit for a one percentage point change in the allowance for doubtful accounts rate is $0.3 million. The estimate for sales return reserve is calculated using the forecasted rate of returns in future periods. This forecast is calculated separately for each segment, and is based on the average rate of returns over the past three years. Should the estimate for sales returns vary by one percentage point, it would have an approximate $0.5 million impact on operating profit. Full Year PRESIDENT AND CHIEF EXECUTIVE OFFICER David Swail was appointed President and Chief Executive Officer during the second quarter of 2006. He succeeded John Dill, who retired effective December 31, 2005. OTHER The number of common shares outstanding as of December 31, 2006 was 1,996,638. RISKS AND UNCERTAINTIES Educational Funding Constraints and Curriculum Revisions in the School Market Educational funding varies from year to year depending on the current government’s mandate in each jurisdiction. The annual provincial government mandates affect both the funding levels and curriculum revision cycles. The funding levels and curriculum revision cycles have an immediate and on-going impact on the performance of the Company’s School Division. Format and Delivery of Future Learning Resources Changing media technology continues to affect the publishing industry in several ways: sales of non-print materials have begun to increase as a percentage of total sales; there has been an increase in electronic piracy over the Internet; and, most important, the format of future learning resources remains uncertain. While the Company is working on leveraging the opportunities arising from these developments, there can be no assurances that one or more of these developments will not have a permanent and long-term impact on markets for the Company’s products. Competition from Foreign-Based Online Bookstores The advent of online bookstores in the U.S. and other countries has created an avenue for Canadian consumers and students to purchase published product directly from foreign retailers, thus eliminating the Canadian marketers and distributors of the product. In particular, students are able to access a very large source of second-hand product. Sustained increases in market penetration by foreign-based virtual bookstores could adversely impact the Company’s market share and financial performance. 2004 2005 2006 Dec. 31 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31 "likely", "project", "intend", "plan", "forecast", "expects", "believes", "anticipates", "could", and similar expressions and statements related to matters that are not historical facts, constitute forwardlooking information within the meaning of securities laws. Such forward-looking information, particularly with respect to the Company’s future plans, costs, objectives, or economic performance, reflects what we believe in good faith to be reasonable assumptions, expectations, and intentions based on information that is currently available. Although we believe these underlying assumptions, expectations, and intentions to be reasonable, forward-looking information is not a guarantee of future performance, and involves risks and uncertainties, many of which are beyond our control and which may cause actual results, events, or actions to differ materially from those expressed or implied in such forward-looking information. These risks and uncertainties include, but are not limited to, changes in customer markets, changes in demand for the Company’s products, changes in technology, changes in educational funding by governments, curriculum changes in the School market, other government policy changes, changes to the format and delivery of future learning resources, competition from foreign-based virtual bookstores, changes to copyright law and the ability to protect the Company’s content under copyright law, currency fluctuations, and general economic conditions. The factors and assumptions that were applied in reaching the forward-looking information included herein include, but are not limited to, the assumptions: Exchange Rate 0.815 0.853 0.859 • Court rulings in Canada have reinforced user rights. As media technology continues to evolve, publishers may find it more difficult to protect their content effectively. These factors may impact the Company's future sales and royalties from copyright collectives. Dependency on Retail National Accounts While national accounts comprise a small portion of the Company’s total business, their significant influence in the marketplace can increase the volatility of sales and returns and lead to less favourable commercial terms as a result of their negotiating power. In addition, some national accounts have introduced in-house publishing programs that may potentially compete with the Company’s publishing program. Labour Disruptions in the Education Sector A labour disruption in the School or Higher Education market can have a significant impact on the purchasing behaviour within these markets, depending on timing and duration of the disruption. Foreign Exchange The following table sets forth, for each period indicated, the exchange rate for Canadian dollars expressed in U.S. dollars at the end of that period. 0.898 0.893 0.858 A significant portion of the Company’s purchases is incurred in U.S. dollars, while all of its revenues are incurred in Canadian dollars and its financial results are reported in Canadian dollars. As a result, major exchange-rate fluctuations between the Canadian and U.S. dollar will either positively or negatively affect net income. The Company is employing policies to minimize the impact of these currency fluctuations. • • OUTLOOK • Fiscal 2007 is expected to be a year of modest sales growth for the Company. Demand for the Higher Education Division's industryleading products and services will drive modest growth in that division. The Professional Division is also forecasting a year with minor revenue growth as a result of strong downward pressure on pricing in 2007. The School Division forecasts further sales increases in 2007 as a result of continuing curriculum revisions in several provinces. The bottom-line impact of the forecasted overall sales increase will, however, be offset by increased editorial, selling, general, and administrative expenses. These expenses will increase as a result of costs to support the expanding publishing program in the School Division, as well as increased information systems and support costs across all divisions. • Cautionary Note Regarding Forward-Looking Statements Certain statements contained in this Annual Report and MD&A, including statements which may contain the words "may", "will", that curriculum revisions in several provinces will take place as anticipated and that our newly published products will meet the requirements of those curriculum revisions; that enrollment at elementary schools, secondary schools, and colleges/universities is consistent with our expectations. Nationally, we expect a minor decline in enrolment at the elementary/secondary school level and a minor increase at the college/university level; that demand for the Higher Education Division’s technologybased products and services continues to grow; that provincial funding for educational resources will proceed as anticipated; and that Retail and Medical national accounts will maintain their stable purchasing and returns patterns. Although we have attempted to identify and describe above under the heading “Risks and Uncertainties” important risks and factors which may cause actual results to differ materially from those described in any forward-looking information, there may be other risks and factors that cause results, events, or actions to differ materially from those anticipated, estimated, or intended. Accordingly, readers should not place undue reliance on forwardlooking information contained in this report. Any forward-looking information contained herein is expressed as of the date of this report and, except as required by law, the Company does not undertake any obligation to update or revise such forward-looking information to reflect subsequent information, events or circumstances. McGraw-Hill Ryerson Annual Report 2006 Copyright Law 15 Management Report To the Shareholders of McGraw-Hill Ryerson Limited The financial statements and all the information in this Annual Report were prepared by the management of McGraw-Hill Ryerson Limited, which is responsible for their integrity and objectivity. McGraw-Hill Ryerson Annual Report 2006 These financial statements—prepared in conformity with appropriately chosen Canadian generally accepted accounting principles, and including amounts based on management’s best estimates and judgments—present fairly McGraw-Hill Ryerson’s financial condition and the results of the Company’s operations. Other financial information given in this report is consistent with these financial statements. McGraw-Hill Ryerson’s management maintains a system of internal accounting controls designed to provide reasonable assurance that the financial records accurately reflect the Company’s operations and that the Company’s assets are protected against loss. Consistent with the concept of reasonable assurance, the Company recognizes that the relative cost of these controls should not exceed the expected benefits in maintaining these controls. These controls further assure the quality of the financial records in several ways: the careful selection and training of management personnel; maintaining an organizational structure that provides an appropriate division of financial responsibilities; and communicating financial and other relevant policies through the Company. 16 McGraw-Hill Ryerson’s Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the financial statements. The Board carries out this responsibility principally through its Audit Committee, which meets periodically with management and the independent auditors to ensure that each group is carrying out its respective responsibilities. In addition, the independent auditors have full and free access to the Audit Committee and meet with it with no representatives from management present. The financial statements in this report have been audited by Ernst & Young LLP, Chartered Accountants, in accordance with Canadian generally accepted auditing standards. The independent auditors were retained to express an opinion on the financial statements, which appears on page 17. David L. Swail President and Chief Executive Officer Gordon Dyer Executive Vice President and Chief Financial Officer Auditors’ Report To the Shareholders of McGraw-Hill Ryerson Limited We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Toronto, Canada, January 19, 2007 Chartered Accountants McGraw-Hill Ryerson Annual Report 2006 We have audited the balance sheets of McGraw-Hill Ryerson Limited as at December 31, 2006 and 2005, and the statements of income and retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. 17 Balance Sheets (In Thousands of Dollars) As at December 31 2006 2005 33,511 27,206 17,948 1,792 8,066 355 — 2,485 64,157 18,359 12,695 95,211 17,503 2,638 8,006 407 190 2,535 58,485 18,716 10,483 87,684 10,697 511 7,291 18,499 214 18,713 9,966 — 6,181 16,147 398 16,545 1,997 74,501 76,498 95,211 1,997 69,142 71,139 87,684 McGraw-Hill Ryerson Annual Report 2006 Assets 18 Current Cash and cash equivalents Accounts receivable [net of allowance for book returns of $7,013; 2005 - $6,801] [note 8] Due from parent and affiliated companies [note 2] Inventories Prepaid expenses and other Income taxes receivable Future tax assets [note 6] Total current assets Capital assets, net [note 4] Other assets, net [note 5] Liabilities and Shareholders’ Equity Current Accounts payable and accrued charges Income taxes payable Due to parent and affiliated companies [note 2] Total current liabilities Future tax liabilities [note 6] Total liabilities Commitments [note 7] Shareholders’ Equity Share capital Authorized 5,000,000 common shares Issued and outstanding 1,996,638 common shares Retained earnings Total shareholders' equity (See accompanying Notes.) On behalf of the Board H. Ian Macdonald, O.C., LL.D., Director David L. Swail, Director Statements of Income and Retained Earnings (In Thousands of Dollars—except Per Share Data) Years ended December 31 2006 2005 90,343 2,535 92,878 85,557 2,150 87,707 41,285 33,546 5,371 1,368 176 81,746 11,132 39,496 31,296 6,214 1,395 89 78,490 9,217 4,260 (134) 4,126 7,006 3,951 (563) 3,388 5,829 69,142 (1,647) 74,501 67,836 (4,523) 69,142 $3.51 $3.51 $2.92 $2.92 Revenue Sales, less returns Other Operating [note 2] Editorial, selling, general and administrative [note 3 and 11] Amortization – Prepublications Costs Amortization – Capital Assets Foreign exchange loss Income before income taxes Provision for (recovery of) income taxes [note 6] Current Future Net income for the year McGraw-Hill Ryerson Annual Report 2006 Expenses 19 Retained earnings, beginning of year Dividends paid to shareholders [$0.825 per share; 2005 - $2.265 per share] Retained earnings, end of year Earnings per share Basic Diluted (See accompanying Notes.) Statements of Cash Flows (In Thousands of Dollars) Years ended December 31 2006 2005 Operating Activities McGraw-Hill Ryerson Annual Report 2006 Net income for the year Add (deduct) non-cash items Amortization – Prepublication Costs Amortization – Capital Assets Future income taxes 7,006 5,829 5,371 1,368 (134) 13,611 6,214 1,395 (668) 12,770 2,935 16,546 2,684 15,454 (7,583) (1,011) (8,594) (4,844) (377) (5,221) Dividends paid to shareholders Cash used in financing activities (1,647) (1,647) (4,523) (4,523) Net increase in cash during the year Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year 6,305 27,206 33,511 5,710 21,496 27,206 Net change in non-cash working capital balances related to operations [note 10] Cash provided by operating activities Investing Activities Pre-publications costs Additions to capital assets Cash used in investing activities Financing Activities 20 (See accompanying Notes.) Notes to Financial Statements Foreign exchange translation 1 Summary of Significant Accounting Policies The accompanying financial statements of McGraw-Hill Ryerson Limited [the "Company"] have been prepared in accordance with Canadian generally accepted accounting principles. The most significant accounting policies are summarized as follows: Cash and cash equivalents The Company considers all highly liquid instruments with a maturity date of ninety days or less at the date of acquisition to be cash equivalents. Allowance for doubtful accounts and sales returns The accounts receivable reserve methodology is based on historical analysis and a review of outstanding balances. A significant estimate for the Company is the allowance for sales returns, which is based on the historical rate of return and current market conditions. Foreign cash balances and amounts receivable from or payable to foreign affiliates are translated into Canadian dollars at the rates of exchange prevailing at year end. Transactions denominated in foreign currencies are translated into Canadian dollars at the exchange rates at the date of the transactions. Any resulting gains or losses are included in net income for the year. Revenue recognition The Company recognizes revenue for product sales, net of estimated returns, when the products are shipped to customers, which is also when title passes to the customer. Other revenue is comprised mainly of rental income, interest, and other miscellaneous income, and is recognized as earned on a monthly basis. Pension costs The Company has a defined contribution pension plan for all employees for which the Company's contributions are expensed as incurred. Total pension expense for this plan during the year is $725 [2005-$703]. Inventories Inventories are stated at the lower of cost, on a first-in, first-out basis, and net realizable value. A significant estimate for the Company is the reserve for inventory obsolescence. The reserve is based upon management's assessment of the marketplace of products on demand as compared to the number of units currently on hand. Capital assets Capital assets are recorded at cost less accumulated amortization. Amortization is provided on a straight-line basis at the following annual rates: Building Computer equipment Furniture, fixtures and equipment 40 years 3 to 7 years 5 to 10 years Pre-publication costs Pre-publication costs include third party services, preparation, and plate costs, which are amortized from the year of publication over the lesser of five years and the expected sales life of the related publication using either an accelerated or straight-line method. The Company periodically evaluates the remaining lives and recoverability of such costs, which is sometimes dependent upon program acceptance by provincial authorities, based on expected undiscounted cash flows. Goodwill Effective January 1, 2002, goodwill is no longer amortized but is subject to an annual review for impairment, which consists of a comparison of the fair value of the assets to their carrying value. Based on the annual impairment review for 2006, the Company determined that no provision for impairment was required. The Company also has a supplemental employee retirement plan [“SERP”] for certain executives. They are entitled to additional pension payments upon retirement or end of services to the Company determined primarily based on the executives’ salaries and years of service. Total SERP expense during the year is $98 [2005 - $171] and the SERP liability as at December 31, 2006 is $783 [2005 - $546]. The SERP obligation is unfunded and is included in accrued charges on the Company’s balance sheet. Income taxes The Company uses the liability method of accounting for income taxes. Under the liability method, future tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are measured using the substantively enacted tax rates and laws that will be in effect when the differences are expected to reverse. Earnings per share The weighted average number of common shares used in the computation of both basic and diluted earnings per share for 2006 is 1,996,638 [2005 - 1,996,638]. Use of estimates The preparation of financial statements in accordance with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. McGraw-Hill Ryerson Annual Report 2006 (Amounts are in Thousands of Dollars) 21 2 Related Party Transactions The Company is a subsidiary of The McGraw-Hill Companies, Inc. which owns 70.1% of the outstanding common shares. Transactions with related parties are as follows: The Company also, in the normal course of business sells books and educational materials to various international subsidiaries of The McGraw-Hill Companies, Inc. Under long-standing arrangements, the Company, in the normal course of business, purchases books and educational materials from the parent company and various international subsidiaries of The McGraw-Hill Companies, Inc. The Company reimburses (and is reimbursed) for common expenses shared with other McGraw-Hill entities [note 3]. The Company pays royalties to the parent company for any U.S. titles that have been adapted to the Canadian market. Terms of payment vary from 50 to 90 days [2005 - 50 to 90 days], net from the transaction date, and all amounts are non-interest bearing. McGraw-Hill Ryerson Annual Report 2006 Amounts due from parent and affiliated companies consist of the following: 22 Parent Common-controlled enterprises 2006 784 1,008 1,792 2005 1,228 1,410 2,638 2006 7,243 48 7,291 2005 6,127 54 6,181 2006 2005 31,767 210 32,905 181 1,435 62 625 242 1,129 50 243 246 Amounts due to parent and affiliated companies consist of the following: Parent Common-controlled enterprises Related party transactions with parent and affiliated companies consist of the following: Inventory purchases from Parent Common-controlled enterprises Royalties paid to parent Parent Common-controlled enterprises Common expenses paid to parent Common expenses reimbursed from parent 3 STOCK-BASED COMPENSATION The parent company has granted certain employees of the Company stock options to purchase common stock of the parent and/or restricted stock of the parent, collectively referred to as awards [note 2]. The fair values of these awards are charged to the Company by the parent and are recorded as compensation expense by the Company over their respective vesting periods with a corresponding increase in due to parent company. For the year ended December 31, 2006, editorial, selling, general, and administrative expenses include stock-based compensation of $172 [2005 – nil]. CAPITAL ASSETS 4 Capital assets consist of the following: Land Building Computer equipment Furniture, fixtures and equipment Cost 2006 Accumulated amortization Net book value Cost 3,598 18,017 5,839 5,146 32,600 — 6,819 4,785 2,637 14,241 3,598 11,198 1,054 2,509 18,359 3,598 17,967 5,710 4,314 31,589 2005 Accumulated amortization — 6,366 4,293 2,214 12,873 Net book value 3,598 11,601 1,417 2,100 18,716 Other assets consist of the following: 2006 12,332 363 12,695 Net book value, prepublication costs Goodwill 2005 10,120 363 10,483 Prepublication costs consist of the following: Beginning balance Additions Amortization Write off of fully amortized titles Ending balance Prepublication Costs 41,967 7,583 — (74) 49,476 Accumulated Amortization 31,847 — 5,371 (74) 37,144 Net Book Value 10,120 7,583 5,371 — 12,332 There is $3,842,000 of prepublication costs on unpublished titles not being amortized as of December 31, 2006. 6 Income Taxes Under the liability method, future tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities. Significant components of the Company's future tax assets and liabilities are as follows: 2006 Current future tax assets Allowance for book returns and other items Other 2005 2,474 11 2,485 2,406 129 2,535 2,546 (2,198) (134) 214 2,906 (2,366) (142) 398 2006 2005 Tax at combined federal and provincial rates 4,021 3,329 Manufacturing and processing profits reduction (102) (80) 63 — 144 139 4,126 3,388 Non-current future tax liabilities (assets) Capital assets Prepublication costs Other The reconciliation of the provision for income taxes computed at the statutory tax rates is as follows: Decrease in future income taxes resulting from statutory tax rate change Other McGraw-Hill Ryerson Annual Report 2006 Other Assets 5 23 7 Commitments The Company has entered into operating leases, primarily for automobiles, for which the estimated future minimum annual lease payments are as follows: The Company has future purchase commitments with a vendor for printing/copying costs and as a result of an agency relationship. The future minimum annual commitments are as follows: 2007 $299 2008 $109 Thereafter $ 17 $425 2007 2008 2009 $ 447 $ 48 $ 32 $ 527 McGraw-Hill Ryerson Annual Report 2006 The Company has a $22 [2005 – $22] contingent letter of credit to secure the release of goods from customs prior to payment of duties at the Canadian border. 8 Financial Instruments 9 The Company's financial instruments consist of cash and cash equivalents, accounts receivable, due from/to parent and affiliated companies, accounts payable and accrued charges, and income taxes payable/receivable. At December 31, 2006 and 2005, the fair value of the Company's financial instruments approximates their carrying values due to the short-term maturity of these instruments. Segmented Disclosure The Company is structured on a market-focus basis and operates in three primary market areas: post-secondary education, including universities and community colleges, and proprietary colleges ["Higher Education"]; secondary and elementary schools ["School"] and trade, professional and medical, including retailers, distributors, libraries, non-traditional booksellers, direct marketing, and the medical sector ["Professional "]. Included in Warehouse Support and Other Sales are freight charged to customers and sales to French institutions mostly in Quebec. The accounting policies of these operating segments are the same as those described in the summary of significant accounting policies. The Company's five largest customers make up approximately 29% [2005- 30%] of the accounts receivable balance and approximately 14% [2005 - 15%] of net sales. 24 2006 2005 Warehouse, Higher Support, Education School Professional & Other Total Sales, less returns Amortization – Prepublication Costs Amortization – Capital Assets Income (loss) before income taxes Provision for income taxes Total expenditures for additions to capital assets Segment assets Higher Education School Warehouse, Support, Professional & Other Total 54,209 23,551 10,821 1,762 90,343 52,913 21,779 9,899 966 85,557 2,679 2,692 0 0 5,371 2,848 3,366 0 0 6,214 83 42 14 1,229 1,368 116 44 19 1,216 1,395 14,140 6,069 2,183 (11,260) 11,132 13,196 4,840 1,965 (10,784) 9,217 — — — 4,126 4,126 — — — 3,388 3,388 59 21,293 42 12,307 5 5,519 905 18,079 1,011 57,198 32 20,214 27 11,349 26 4,908 292 18,406 377 54,877 Reconciliations 2006 Segment assets 2005 $57,198 $54,877 33,511 27,206 1,792 2,638 — 190 225 238 2,485 2,535 Total Assets 95,211 87,684 Segment sales, less returns 90,343 85,557 2,535 2,150 $92,878 $87,707 Unallocated assets Cash and cash equivalents Due from parent and affiliated companies Income taxes recevable Prepaid expenses and other (445) (272) McGraw-Hill Ryerson Annual Report 2006 Future tax assets Due from parent and affiliated companies 846 138 25 Inventories (60) 3,537 52 (79) Income taxes receivable/payable 701 (643) Accounts payable and accrued charges 731 2,557 Due to parent and affiliated companies 1,110 (2,554) 2,935 2,684 Income taxes refunded (478) (87) Income taxes paid 3,990 4,832 Other revenue Total Revenue 10 Statements of Cash Flows The net change in non-cash working capital balances related to operations consists of the following: 2006 Accounts receivable Prepaid expenses and other 2005 Supplemental cash flow information 11 Editorial, Selling, General, and Administrative Expenses In 2005, the Company restructured some business operations to enhance the Company’s long-term growth prospects. The realignment cost of $900 consisted of employee termination and severance costs and is included in the editorial, selling, general, and administrative expenses. No further costs related to the realignment are anticipated. There was no restructuring charge in 2006. Dividend Policy At their meeting held on April 27, 2006, the Board of Directors approved an increase in the quarterly dividend from 19.5¢ per share to 21.0¢ per share to shareholders of record as at May 17, 2006. This dividend increase took effect with the payment of the first quarter dividend on June 1, 2006. In 2005, The Company declared and paid a one-time special dividend of $1.50 per share to shareholders. The determination to declare or pay dividends is entirely at the discretion of the Board of Directors of the Company, based upon recommendations from the Finance Committee of the Board of Directors, and will depend upon the Company's financial condition, results of operations, capital requirements, and such other factors the Board of Directors and Finance Committee consider relevant. McGraw-Hill Ryerson Annual Report 2006 $45.00 26 $40.00 $35.00 $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 $(5.00) $(10.00) $5.00 $0.00 $(5.00) Share price Net Profit Per Share Dividend per share McGraw-Hill Ryerson’s 2006 Corporate Contribution Programs McGraw-Hill Ryerson Limited believes Canadians will flourish in communities that are healthy, well educated, culturally rich, and socially secure. The Company will support programs that increase the abilities of people in our communities to learn, grow intellectually, master new skills, and maximize their individual talents for school, work, and community. The Company will match any employee's financial gift to any non-profit Canadian organization that supports education, learning, and literacy, up to a maximum of $1,000 per institution per year. In 2006, there were 2 matches totaling $700, not including the United Way donations. United Way Program McGraw-Hill Ryerson will match any employee's United Way contribution. When an employee contributes a day's pay to the United Way, he or she may take a paid day off work to perform volunteer work to support the activities of any non-profit organization or a worthy project in the community. In 2006, the Company matched employee contributions of $11,289. Employee Volunteer Support Program When an employee participates, on a regular basis for a year or more, in a qualified program of volunteer support through schools and non-profit organizations (education, health or fitness, and social services) and has an ongoing commitment of at least fifty hours a year, McGraw-Hill Ryerson will support the program with a $300 contribution. In 2006, the Company supported two organizations for a total of $600. McGraw-Hill Ryerson Annual Report 2006 Matching Gift Program 27 Corporate Governance A primary concern of the Company’s Board of Directors has been, and will continue to be, the effective governance of McGraw-Hill Ryerson Limited on behalf of all shareholders. The Company’s Corporate Governance Committee meets regularly to review corporate governance matters. Directors McGraw-Hill Ryerson Annual Report 2006 1. Robert J. Bahash 28 Executive Vice President and Chief Financial Officer, The McGraw-Hill Companies, Inc. since 1988 Joined McGraw-Hill in 1974 Became a Director in 1988 Member of the Finance Committee Previous posts at The McGraw-Hill Companies, Inc. include: Senior Vice President, Finance and Manufacturing Senior Vice President, Corporate Financial Operations 2. Susan Armstrong, C.A. Corporate Director Became a Director in 2005 Chairman of the Audit Committee Current Posts include: Vice-Chair of the Board of Directors of The George Hull Centre for Children and Families Member of the Audit Committee and Resources Committee of the Board of Directors of Trillium Health Centre Member of the Governance Committee of the Board of Directors of Toronto Rehabilitation Institute Previous Posts include: Senior Vice-President, Swiss Reinsurance Company Canada Senior Vice-President and Chief Financial Officer, CIBC Insurance Vice-President and Chief Financial Officer, The Dominion of Canada General Insurance Company 3. J. Mark DesLauriers Partner Osler, Hoskin & Harcourt LLP Joined Osler in 1983 Became a Director in 2001 Chairman of the Compensation Committee Member of the Executive Committee 4. David L. Swail President and Chief Executive Officer McGraw-Hill Ryerson Limited Joined McGraw-Hill Ryerson in 2006 Became a Director in 2006 Member of the Executive Committee and the Finance Committee Previous positions include: Vice-President, Operations – Sun Media Vice President, Operations and Planning – CanWest 5. Brian D. Heer Senior Vice President Special Projects The McGraw-Hill Companies, Inc. Joined The McGraw-Hill Companies, Inc. in 1999 Became a Director in 2001 Member of the Corporate Governance and Nominating Committee Previous positions include: Group President, McGraw-Hill Higher Education, Professional and International Publishing President, International Publishing Group President, Prentice Hall Canada 6. Hendrik Kranenburg Group President, McGraw-Hill Higher Education, Professional and International Publishing, The McGraw-Hill Companies, Inc., since August 2005 Joined The McGraw-Hill Companies, Inc. in 1980 Became a Director in 2005 Member of the Executive Committee and the Compensation Committee Previous positions at Standard & Poor’s, a dvision of The McGraw-Hill Companies Inc., include: Executive Vice President, Investment Services Executive Vice President, Global Ratings Development Executive Vice President/Managing Director, Ratings Services (International) 7. H. Ian Macdonald, O.C., LL.D., D.UNIV.D.LITT, FCOL Chairman of the Board of Directors of McGraw-Hill Ryerson Limited since 1996 Became a Director in 1985 Chairman of the Finance Committee Member of the Executive Committee, the Corporate Governance and Nominating Committee, the Audit Committee, and the Compensation Committee President Emeritus and Professor of Economics and Public Policy at York University Officer of the Order of Canada Past Chairman of the Board of Governors of The Commonwealth of Learning 8. Manon R. Vennat, CM Principal of Manon Vennat & Associates Member of the Bar of Quebec Member of the Order of Canada Became a Director in 1988 Chairman of the Corporate Governance and Nominating Committee Member of the Audit Committee, and the Compensation Committee Previous positions include: Chairman, SpencerStuart in Montreal Vice President, Managing Director, SpencerStuart in Montreal Management Team President and Chief Executive Officer Joined the management team in 2006 See Biography in Directors Marshall I. Morris Executive Vice President Customer Satisfaction Joined the management team in 1996 Prior Employment: various management positions at Canadian Tire Corporation Gordon K. Dyer Executive Vice President, Chief Financial Officer and Secretary-Treasurer Joined the management team in 2003 Prior Employment: Vice President, Finance at Teletech Canada Inc. Claudio Pascucci President Professional Division Joined the management team in 2006 Prior Employment: Director of Sales, McGraw-Hill Ryerson, Professional Division Cathy Efremidis-Koop Vice President Information Services and Productivity Joined the management team in 2005 Prior Employment: Director of Information Services and Productivity Carl Posluns Executive Vice President Human Resources Joined the management team in 1994 Prior Employment: Vice President, Human Resources, Smithbooks (FICG Inc.) Patrick Ferrier President Higher Education Division Joined the management team in 2005 Prior Employment: Vice President and Publisher, McGraw-Hill Ryerson, Higher Education Division Nancy L. Gerrish President President School Division Joined the management team in 1999 Prior Employment: Director of Sales and Marketing, McGraw-Hill Ryerson, School Division Clive Powell Executive Vice President Editorial, Design, and Production Joined the management team in 1997 Prior Employment: Director of Production, McGraw-Hill Ryerson McGraw-Hill Ryerson Annual Report 2006 David L. Swail 29 Shareholder and Corporate Information Executive Offices Registrar and Transfer Agent McGraw-Hill Ryerson Limited 300 Water Street Whitby, Ontario L1N 9B6 Telephone: (905) 430-5000 Facsimile: (905) 430-5020 http://www.mcgrawhill.ca Investors are encouraged to contact our Transfer Agent and Registrar, CIBC Mellon Trust Company, for information regarding their security holdings. They can be reached at: McGraw-Hill Ryerson Annual Report 2006 Corporate and Shareholder Information 30 Gordon Dyer Secretary-Treasurer Telephone: (905) 430-5032 Annual Meeting of Shareholders McGraw-Hill Ryerson Limited 300 Water Street Whitby, Ontario Wednesday, June 6, 2007 at 11:00 a.m. Exchange Listings The Toronto Stock Exchange Stock Symbol: MHR Outside Legal Counsel Osler, Hoskin & Harcourt LLP Barristers & Solicitors Toronto Auditors Ernst & Young LLP Chartered Accountants Toronto Bankers Citibank Canada CIBC Mellon Trust Company P.O. Box 7010 Adelaide Street Postal Station Toronto, Ontario M5C 2W9 AnswerLine™ (416) 643-5500 or 1-800-387-0825 (Toll Free throughout North America) Facsimile: (416) 643-5501 Web site: www.cibcmellon.ca E-mail: [email protected] Recycling This report has been printed on recyclable acid-free papers. International Affiliates New York, New York McGraw-Hill Australia Pty. 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Mexico, D.F., Mexico McGraw-Hill/Interamericana de Espana, S.A. Madrid, Spain McGraw-Hill International Enterprises, Inc. Kowloon, Hong Kong McGraw-Hill International Enterprises, Inc. Taipei, Taiwan McGraw-Hill International Enterprises, Inc. Bangkok, Thailand McGraw-Hill Interamericana do Brasil Ltda. Sao Paulo, Brazil The McGraw-Hill Companies, GmbH Frankfurt, Germany The McGraw-Hill Companies, S.A. Paris, France McGraw-Hill Ryerson Annual Report 2006 The McGraw-Hill Companies, Inc. 31 LEARNING. THE JOURNEY TO SUCCESS. www.mcgrawhill.ca
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