Scholastic Corp (SCHL) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Scholastic second-quarter fiscal 2003 earnings conference.

At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments along with the presentation.

It's now pleasure to hand the floor over to your host Mr. Ray Marchuck.

Sir you may begin.

Thank you, operator.

Welcome to Scholastic”s second quarter conference call.

I am Ray Marchuck, Senior Vice President of Finance and Investor Relations.

Before we begin, I'd like to read the following statement.

This conference contains certain forward-looking statements which are subject to various risks and uncertainties, including the conditions in the children's book and educational materials markets and other risks and factors which are identified from time to time with our filings with the Securities and Exchange Commission.

Actual results could differ materially from those currently anticipated.

To follow our slides on the internet, go to the investor relations section of Scholastic.com and you'll see a link.

And after 11:00 today, you can access a replay of our slides and audio on our website.

You can also access a telephone replay by calling either 877-519-4471 or 973-341-3080, and the pin number for that replay is 3614186.

Both replays will be available until January 10th.

Now I'd like to introduce Dick Robinson, the Chairman, President and CEO of Scholastic to review our second-quarter results

Good morning.

This is Dick Robinson.

Thank you for listening in on our conference.

With me are Kevin McEnery, CFO, Barbara Marcus, President of Children’s Book Publishing and Distribution, Margery Mayer, President of Scholastic Education and Beth Ford, Senior Vice President of Global Operations and Information Technology.

During the quarter, we delivered record results, with revenue up 4% and EPS up 9% to $1.85 per share.

This was our first -- our best quarter ever, with higher revenue, operating profit and margin in all four segments.

In children's book publishing, book fairs continue their growth pattern, while continuity has increased both revenue and profit.

In education, profit was up 40%, thanks in part to the continued success of read 180.

For the first time in years, international posted substantial growth, with profit up significantly.

Scholastic entertainment made a major contribution, with Clifford licensing and merchandising.

We achieved cost savings of $17 million year-to-date, putting us on track to reduce costs more than $35 million this year, exceeding our original target by more than $5 million and more than offsetting postage, healthcare and insurance and other cost increases.

In the five niche acquisitions we made last year -- babies first book club, klutz, teacher's friend, Tom Schneider productions and Heller associates -- were each modestly accretive.

While all this represents a significant achievement, continued economic weakness did affect our business, contributing to lower than expected revenue growth and EPS that was 6 cents below analyst consensus.

In this climate, our trade and club businesses performed below our expectations.

Looking ahead, we expect to receive the manuscript for the fifth Harry Potter book soon.

Given the five to six months it typically takes to edit and prepare the book, publication will move into early fiscal '04 but the move of Harry Potter 5 to next year, flat sales in clubs and lower than expected Harry Potter backlist sales we now see this year's EPS as approximating last year's level of 250 per share.

Harry Potter continues to be the world's best publishing property, at the top of current best-seller lists with more than $400 million in Scholastic sales since book 1 was first published in 1998.

In the year-ago quarter, the first Harry Potter movie gave an extraordinary lift to backlist sales.

While we expected somewhat lower sales this year, we and our trade customers had anticipated more of a lift than we saw from the second movie, which came out on November 15th.

Even though the film has been a success, we and our customers overestimated the impact of the second film on book sales.

As a consequence, we had net Harry Potter sales for the quarter of $25 million versus expectations of $35 million.

Year-to-date, we have recorded net Harry Potter sales of $40 million, as compared to $60 million last year in the first half, and we now anticipate $5 to $10 million in the second half versus $22 million last year.

We do expect improved sales of the back list when book 5 comes out in our fiscal '04 in what will surely be the publishing event of the year.

Our core book club business remains strong, but we attained revenues below expectations this fall.

We did successfully revitalize our school-based continuity's which are sold through clubs but accounted for separately, and these generated a 43% increase in revenue.

This was much better than expected, but surely took some growth away from the clubs.

While we expect revenues will be flat for the rest of the year, nonetheless, looking ahead, Barbara and her team are already revamping our program for next year.

In short, this quarter demonstrated the success of our efforts to improve underperforming areas of the business, to reduce costs, and to strengthen our core businesses.

We are taking actions now to deal with our club and trade issues which Barbara will discuss in a few minutes.

I will return at the end of the call and comment on next year.

Now, here is Kevin McEnery to give further detail on the quarter.

Thanks, Dick, and good morning.

To recap, revenue for the quarter increased 4% to $660 million.

Operating income increased 10% to $123 million, or 18.7% of revenue.

As compared to 17.6% of revenue last year.

And net income increased 13% to $75 million.

The quarter included $25 million of Harry Potter trade revenue as compared to last year's exceptional $45 million.

The quarter also included $17 million of revenue from acquisitions made last year.

Now, looking at our segments, in children's book publishing distribution, revenue in the quarter increased 3% to $438 million, and operating profit increased 8% to $111 million.

Revenue other than from Harry Potter and acquisitions was up 5% in that segment.

Revenue increases of 9% in continuities and 9% in schoolbook fairs more than offset the decline of 2% in book clubs and 5% in trade.

In the continuities channel, an addition of $7 million, or 43% increase in our school-based business, we continued to improve the direct to home business benefiting from lower return levels and a 2% lower bad debt expense and we also successfully integrated the babies first book club acquisition which added another $3 million in revenue.

In fairs, one of its larger revenue periods, the week after Thanksgiving, fell into the third fiscal quarter this year as compared to last year being in the second fiscal quarter.

Taking that into consideration, we are on our fair plan to date, and continue to track revenue growth of approximately 12% for the year.

Trade benefited from $10 million in revenue from the klutz books plus business, which we acquired in last year's fourth quarter, and from the increased revenue from Scholastic titles other than Harry Potter and klutz.

As Dick mentioned, our Harry Potter trade net revenue in the quarter was below our expectations and that of our retailers.

As most of you know, net trade revenue consists of sales value of the shipments made in the quarter, less a provision for anticipated returns.

Because of the lower than expected list in the retail sell-through resulting from the second Harry Potter movie, we have increased our returns provision as a percentage of shipment on the books that were delivered in the quarter, thus reducing our net sales by approximately $9 million.

This had an adverse EPS impact of approximately 7 to 8 cents per share.

As Barbara will discuss, we are working closely with our major trade customers, and believe that we are properly reserved for expected returns.

Turning now to educational publishing, that segment performed well in the quarter, with revenue increasing 3% to $77 million, and operating profit increasing more than 40% to $16 million.

Highlights include a 7% increase in curriculum revenue, largely reflecting strong read 180 sales, which more than offset lower literacy place sales of $4 million as compared to last year's $9 million.

We also realized a 10% increase in revenue from paperbacks and teaching resources, about half of which, or $1 million, came from teacher's friend, a business that we acquired last spring.

The Tom Schneider production supplemental software business, which was also acquired last year, added $2 million of revenue, which more than offset a modest decline in revenue from our library publishing group.

Overall, our margin expanded due to higher sales and read 180, which has a low variable cost, along with the benefits from our cost reduction programs.

The international segment continued to rebound, with revenues in the segment increasing 10% to $99 million and operating profit up 47% to $14 million.

Key factors included revenue gains in the Far East markets, as well as Canada, Mexico, and Australia, along with favorable currency exchange rates, which contributed to about 3 percentage points to the revenue growth.

Margin expanded due to a more favorable revenue mix combined with the benefits of our cost reduction program.

In the media licensing and advertising segment, which includes our internet operations, revenue increased slightly and operating profit was $300,000, as compared to last year's break-even.

Film production revenue related to delivery of the successful Clifford the big red dog TV show increased by more than $3 million, which more than offset a decline in CD-ROM sales.

The segment's operating profit reflected the higher margin in our Scholastic entertainment operations as well as cost reductions.

Overhead was up by about $7 million due to the anticipated increases in healthcare, general insurance, system investments, as well as facilities costs including the start-up costs of our new fulfillment center in Arkansas.

Depreciation and amortization included in the quarterly operating results was $10.7 million, as compared to $8.5 million last year.

In regards to the free cash flow from operations, we are on track to meet our goal of $50 million for fiscal '03, and that includes the impact of the $20 million that we are investing in the Arkansas facility.

That, at quarter end, was $23 million than that of last year, bringing our overall debt to capital ratio to 46%, as compared to last year's 56%.

Accounts receivable continued to perform well, as reflected by the DSOs which are consistent with last year's levels.

Looking forward, we expect the reduced profitability for the balance of the year, relative to the consensus estimates, will largely be reflected in the fourth quarter.

At this point, for the year, we anticipate that revenue will increase by about 7%, benefiting from the strong fair and continuity growth, and approximately a 2% benefit from last year's acquisitions.

And now, for more on children's book publishing and distribution, here is Barbara Marcus.

Thanks, Kevin.

In schoolbook clubs, our number of teacher renewal customers is strong.

But we did not attract quite as many new sponsors.

And Dick has discussed the balance between club revenue and the school-based continuities.

In response, we are testing product presentation and new approaches in promotion.

Looking to the second half, we are assuming flat revenue with higher margins.

Our initial plans for fiscal '04 are focused on making our offerings more dynamic to existing teacher sponsors and simpler to use for new teachers.

First, we are creating new promotions featuring the free books and teacher resources to help teachers cope with tight budgets.

Second, we are increasing the development of kits that are targeted to specific teacher ordering behavior.

Third, we are creating a program geared to educating new teachers about the value of clubs to their students.

Fourth, now that our on-line ordering service has proven effective, generating nearly 20% of orders in the second quarter, we are refining our offerings to drive higher revenue per order on-line, as well as convenience.

Over time, on-line will provide us with even more opportunities to customize promotions.

Looking at trade, while it is a difficult retail environment, we are still performing very well.

Harry Potter remains on the top of all best-seller lists, including "USA Today" and "The New York Times."

The hard covers of books 3 and 4 remain on the top 10 of the "New York Times" best-seller lists of children's chapter books and the soft covers of all four titles are at the top of the Times list of children's paperbacks.

We have developed a program which is being enthusiastically received by many of our trade customers providing favorable payment terms and a modest discount of 3 percentage points to support the sell-through of their -- of their current stock of Harry Potter books until next fiscal year, when book 5 will be released.

Turning to other Scholastic titles, those that performed particularly well included franchise properties such as Clifford, dear America, and Ricky Ricada.

Licensed properties such as Scooby-Doo, fiction such as the Thief Lord, picture books such as David gets in Trouble and reference titles such as the Scholastic dictionary.

Trade sales also benefited from expanded distribution into mass merchandisers and warehouse clubs.

To further this part of the business, last week we announced an agreement to become the primary publisher of books based on animated properties developed by Dreamworks.

We'll publish novels, coloring books and picture books in English and Spanish and in North and Latin America based on the studio's next five animated films starting with Shrek II in 2004.

In continuities, we were very pleased to see a significantly higher number of enrollments in response to our new school-based promotions featuring Spy University, Scooby-Doo, Nick Jr., and Hello Kitty.

The makeover we've been engineering in our continuities overall is moving along even better than expected.

The combination of these businesses enables us to reach a broad spectrum of parents, with baby's first book club focusing on parents of newborn children, direct to home focusing on parents of preschool children, and school-based focusing on parents of school-age children.

I'm very pleased to announce the schoolbook fairs are on plan.

Revenue per fair has been up approximately 7%, and as Kevin indicated, we continue to be on track for approximately 12% revenue growth, helped by about a 5% growth in the fair count.

Growth in revenue per fair reflects the continued success of our revenue-building programs, including more volunteer training, family nights, teacher wish lists, and community sponsorships.

Growth in fair count reflects an increase in the number of new school customers and the number of schools offering second fairs.

Now here is Margery Mayer to go into more detail on educational publishing.

Thanks, Barbara.

We had another strong quarter in educational publishing.

While schools are experiencing budget pressures, we're finding that they still have funds available for the critical job of improving reading scores.

Read 180 continues to be a major star in curriculum publishing which, excluding literacy place, generated $15 million in revenue this year versus $8 million last year.

Year-to-date, read 180 is up threefold in revenue.

Sales are coming from both new and existing customers, with big expansions in Palm Beach, Florida and Harrisburg, Pennsylvania, and new installations in Philadelphia, Patterson, New Jersey, and the Cook County Illinois juvenile detention center, just to name a few.

While most sales to date have been to middle schools, we have begun to see a significant uptick from elementary schools, and from our new product for high schools.

For example, the U.S.

Job Corps is putting read 180 high school version into many of its centers to raise literacy levels.

A new and upcoming curriculum product is the Scholastic early childhood reading and learning program.

During the quarter, the Texas state board of education adopted the program, and we are now marketing it to districts across the state.

Also, children's world learning centers purchased our program as their core curriculum.

Children's world is a leading provider of private daycare, preschool, and school-age programs, with more than 600 centers in 26 states.

The Scholastic guided reading program is another curriculum product that's doing well.

These are collections of Scholastic fiction and non-fiction books, grouped by reading levels, with instructional material from Dr. Gaysu Panell-ph of Ohio state University, a leading reading researcher.

Turning to paperbacks and professional resources, our 10% revenue growth includes our success in the growing parent/teacher store market.

As Kevin mentioned we have successfully integrated our acquisition of teacher's friend, which added a decorative business to our existing lines student lines of practice development materials.

In summary, the combination of our strategy, product mix and marketing, is proving effective in a challenging market, and we're working hard to maintain our momentum in the second half.

Now, here's Beth Ford for more detail on our cost-cutting efforts.

Thanks, Margery.

We achieved a major milestone in our cost reduction program this quarter that will benefit us this year and the years ahead.

Better than expected results in some areas have put us on track to deliver more than $35 million in new savings this fiscal year versus our original $30 million target.

Of note, we completed the first phase of our North American purchasing initiative, putting in place new vendor contracts that will significantly reduce our product and services spending in the U.S. and Canada, which is a major component of our overall cost reduction program.

In fiscal 2002, we reduced these costs by $9 million.

This year, we're on track to reduce them more than $15 million.

We've achieved this through a significant streamlining of our purchasing, channeling volume through 70% fewer vendors under multi-year contracts.

Second, we're obtaining better than expected cost reductions this year from consolidation and process re-engineering.

We're now targeting $11 million in savings in this area.

Two of the biggest items, consolidating the back office for home continuities and the distribution of library publishing into our national service organization, took place last year.

Now we're experiencing the benefits.

Third, we're finishing phase 1 of our inventory forecasting and planning initiative.

Phase 1 affects all U.S. operations other than book fairs.

Savings this year of $3 million will be realized from lower inventory and reduced out-of-stocks.

This translates into lower product, carrying, and shipping costs, and less inventory obsolescence.

We're currently working in Canada and the book fairs in phase 2 of this initiative.

Finally, we continue to be on track on our promotional cost savings of $6 million.

I'd like to point out that all the cost reduction initiatives the company is working on are not isolated projects.

They're part of a larger plan to optimize Scholastic's supply chain.

We've made great strides in digitizing our print and graphic assets.

This makes them easier and less expensive to use and reuse company-wide through an upgrade in our digital archive.

Our purchasing initiatives are developing closer links and better pricing with our vendors, enabling us to convert our creative assets into product more quickly and at less cost.

Operating groups are developing more targeted marketing driving down promotion costs as a percentage of revenue.

We also are reducing costs by consolidating and optimizing order processing and customer service and increasing efficiency in warehouse and distribution.

These efforts are being supported by our inventory forecasting and planning initiative, and ongoing improvements in our IT and distribution infrastructure.

The end result will be the optimization of Scholastic's supply chain, creating a resource that can produce, market, and distribute creative product to teachers, children, and parents faster, with great value and at improved margins.

With the lion's share of this year's operating improvements in place, we're on track to achieve more than $5 million more in savings than originally planned, and we have already begun working on next year's program.

Now, here's Dick Robinson to tell you about our continued rebound in our international segment and to wrap up.

Thank you, Beth.

We experienced another quarter of success with our turnaround plan and growth strategies in international, where we gained significantly in revenue and profitability.

In the U.K., we're re-engineering the business under the leadership of Ian Ronald, our new Managing Director there.

Our focus on adopting the U.S. book fair model, introducing klutz into the trade and revamping the school book clubs, have all had a positive impact, while our joint venture with the book people in the U.K. is off to a good start.

In Australia, the turnaround is continuing and that operation is improving nicely.

In southeast Asia, we're building on a strong base of operations we acquired in the Grolier-ph transaction, launching a book fair business in the Philippines, where there are 75 million English-speaking people and where our Grolier year operations have been doing business for 40 years and this is the model for going forward for our international operations in southeast Asia.

In Mexico during the quarter, our operation there realized its largest-ever sales to the government of books for school libraries, and our clubs and fairs were strong.

And in cost reduction, we're following the U.S. model in the U.K. this year, with planning underway to reduce costs in Australia gentleman next year.

In our call today, we discussed several basic themes.

While we are pleased to deliver record results in a challenging economic climate, we have reduced expectations for the year.

We are proud of our results so far this year in many areas, including fairs, continuities, international and media.

We are ahead of plan with our cost reduction program and expect more than $35 million of savings this year.

We are carefully monitoring all discretionary spending and hiring.

We're taking action in our club and trade businesses.

And building on the momentum we have established this year in fairs, international education and continuities and with Harry Potter 5, resumed growth in book clubs and continued focus on cost reduction, we anticipate strong profit growth in fiscal '04 and in the years to follow along with higher levels of free cash flow and increased shareholder value.

We look forward to your questions.

Operator, it's time for questions.

Thank you.

The floor is now open for questions.

If you do have a question or a comment, you could press 1, followed by 4, on your touch-tone phone.

If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key.

Once again, ladies and gentlemen, that's 1, followed by 4, on your touch-tone phone to ask a question.

Our first question or comment comes from Peter Aper of Goldman Sachs.

Your line is live.

Hi, good morning.

Dick or Barbara, maybe, I was just hoping you could help us understand better the revenue shortfall in the club business and specifically, I'm wondering, are you seeing resistance to pricing?

Are you seeing some changes in the competitive dynamic.

Maybe also in terms of the operating metrics in terms of average order size, if you could give us some help in that as well.

Barbara, I think you should take that one.

Sure.

Okay.

I think what we were trying to say in the call was that if we had put in the incredible fix and increase in revenue in our school-based continuities which is run through our clubs, our club business in the fall would be up around 2%.

And so we do feel that, you know, the two metrics that we look at -- revenue per order -- would have -- you know, was impacted by the school-based continuites, which as -- if you recall, we were struggling with last year, and we fixed them.

They obviously had -- had an impact this year on our -- on our revenue per order.

On the other -- and so then that's -- that is what we feel.

On the order -- order area, I think that generally -- and this is not for the quarter -- generally we feel that we are actually up in our renewals and our strong -- strong large base of teachers, where we had some softness is in what we call new sponsors, which are teachers who haven't ordered from us previously and some new teachers, and that's where we see some -- some softness.

And so we really do feel that those are the two reasons that impacted our club revenue this quarter.

Do you think the failure to sign up the new sponsors is a function of the lower promotional spending or increased activity by your competition in that market?

I don't think -- I don't see competition as being our issue here.

Though, you know, they -- they were in the marketplace.

And maybe we should look at them closely.

I think we're looking at our -- our -- competing with ourselves in some way in the mechanism this -- this quarter.

So -- and I think for -- you know, again, since we have such a strong core of teachers who order from us, I think that maybe we were addressing them more than we were addressing teachers who have either infrequent or have had not a contact with us over -- you know, over a number of years and the number of new teachers coming into the market.

I think if we wanted to look at that, I think that is maybe the place where we feel we -- we were a little short.

Uh-huh, uh-huh.

Okay.

Thanks.

And just one follow-up.

I guess for Margery.

The operating margin improvement, or the operating income improvement in the educational publishing segment was quite extraordinary and I'm wondering if you could just help us understand better what drove that, and is there any ongoing accounting issue related still to the sell-in of literacy place that perhaps is distorting the profitability.

You know, Peter, I'm going to handle this over to Kevin.

Uh-huh.

Peter, the profitability increase we saw in education was a function basically of two things.

Read 180 did very nicely and read 180 has a relatively low variable cost.

It is, in many regards, a software based product and it's -- and it's priced very nicely.

Secondly, within the education group, the group -- and Margery in particular -- has been very focused on ways to reduce the operating costs and some of the purchasing initiatives that Beth spoke about have also manifested themselves in reducing our product cost.

So I think it's largely a combination of low incremental variable cost on the revenue, plus the benefits of the cost reduction efforts

uh-huh.

Okay.

Thank you.

Thank you.

Our next question comes from William Byrd of Salomon Smith Barney.

Your line is live.

Hi.

I was just wondering if you could discuss actual Harry Potter return trends versus your reserve for returns, and really, you know, was wondering if you think, you know, the $9 million of incremental that you discussed is enough.

And also, you know, how -- if you -- I was wondering if you could just discuss a little bit some of what Barbara alluded to in distribution.

That is, I was wondering what percentage of children's book distribution is now through mass merchandisers and warehouse clubs and where you expect that to go in the next couple years.

Thanks.

Let me take the questions on the returns, Bill.

The actual returns that we've seen from Harry Potter have been very consistent with our expectations, you know, over the past -- over the past year.

No surprises there.

The group, the trade group, had an extensive survey of the retailers and discussed with them the status of sell-through and their inventory stocks, and we feel that the incremental $9 million that we took as an incremental reserve is adequate and appropriate.

To anticipate the returns.

Barbara, do you want to --

I just want to sort of continue on that note.

I think what we are feeling is that -- that this still -- Harry Potter is still an incredibly important and best-selling franchise for our customers, and obviously for Scholastic, but for our customers.

And I think they are working with us and are looking at their sell-through and merchandising the books.

It is still on -- you know, on the top of the best-seller lists.

It is still their best selling brand and they are -- are -- you know, they want to sell those books.

They're merchandising them to sell those books.

So I think that that sort of works for us with whatever program we are working with them today and will continue to work with them.

As far as the mass merchants and -- and sort of what we call sort of the more mass accounts, we sort of look at them and we don't exactly have the number, so I'm going to give sort of a range of about 10 to 15%.

And I think that they will continue to grow modestly as we more change our formats and publish more into the mass color and activity area, less so than trying to put more of our trade books into that market.

It will be a function about our growing of that end of our publishing program.

Thank you.

Thank you.

Our next question comes from Lauren Fine of Merrill Lynch.

Your line is live.

Thank you.

A couple of quick ones and then another question.

I just want to make sure.

The $25 million of Harry Potter is already net of the $9 million?

Yes, that is.

That's actually net of the normal reserves plus the additional 9 million.

Okay, okay.

And then the tax rate in the quarter was actually down versus where you have been, and that seems to have helped the bottom line.

I'm wondering if you could discuss, you know, why that occurred and what we should expect for the remainder of the year.

And then -- well, go ahead.

You can answer that and I'll ask my last question.

Okay.

The tax rate in the quarter was about 35%, and that was a little bit better than we had last year.

We were realizing some benefits internationally in terms of some tax rate differentials.

So that is sustainable?

We expect to sustain that for the rest of the year, yes.

Okay.

And then my last question, my memory in the club business was when the year starts out weak, it's difficult to turn it, and most of your comments would suggest that you've conceded that, that you have to focus on next year.

When you look historically, have there ever been two weak back-to-back years or have you typically had success in the past turning it around?

We -- we have had -- you know, my recollection, 19 years, is that we have turned it around the following year.

Kevin is nodding vigorously next to me.

But that is -- you know, we usually -- we can pinpoint the issues and we are pinpointing them and then we turn around and create programs which -- which really sort of fix whatever we -- we've identified.

But is there any reason that you couldn't attack it now and turn it around midyear through increased promotions?

We -- of course we'll attempt to do that, but I think we're being realistic based on our history of what usually happens in the -- in the club business, and, you know, unfortunately we have a huge lead time.

Our promotions for the spring are already printed and ready to go, so we will try and add on top of that, but, you know, modestly.

But they're done.

They're cooked, as we say.

Okay.

Thank you.

Thank you.

Our next question comes from Shawn Chatburn of CSFB.

Your line is live.

Hi, guys.

Good morning.

I just want to revisit a topic from a few months ago with regard to your equity investment in the book people.

I just want to find out how that's proceeding, if you're seeing any benefit from that.

I think the last time we talked about this, profitability from the U.K. was -- was sub-par, and are you seeing any improvements in profitability in the U.K. from -- from your investment?

Well, right now -- right now, it's too soon for the equity investment of the book people to kick in.

We have a program where we're both working together on two clubs, one direct to the home and one through the schools that children's books and family books sold through the schools.

Those are both doing well.

But it's -- it's too soon to see any -- any profit improvement based on those.

In terms of the U.K. turnaround overall, we -- it's proceeding well.

It's not having an immediate effect on the bottom line, but all the trends are very favorable, and things are improving rapidly in several of our businesses and we expect I think that by the end of the year we would see some uptick in the international -- in the U.K. profit results.

Very good.

Just one quick follow-up question.

What was the actual cost savings that were realized in the -- in the second quarter?

In the quarter, we had cost savings realized of about $17 million.

I mean, I'm sorry -- I'm sorry.

That -- Beth has corrected me.

That is half the year.

Yeah.

So within the quarter is about $12 million.

12 million in the quarter.

Okay.

Thanks, guys.

Thank you.

Our next question comes from Shawn Daniel of Blackburn.

Your line is live.

Yes.

Quick question.

I got on the call late.

Did you give any kind of breakdown or can you give a breakdown on the cost and expense line between COGS and SG&A?

At this present time, we don't have that available right now.

We'll be filing that with the Q.

Okay.

Thank you.

Thank you.

Our next question comes from Robert Back of SNC capital.

Your line is live.

Yes.

Could you comment briefly on the future of the Harry Potter franchise, the next three years when the next release comes?

I'll take it, Dick, and then maybe you want to -- if you want to add something.

We -- we -- again, I -- I -- I do keep saying this and I believe it in my heart of hearts.

This -- and our retailers believe it.

That this book -- these books were published, they're critically reviewed, we see them as modern classics, as going to be around well, well after all of us are sitting here, and they are currently selling very well.

We -- we see them selling well for a very, very long time.

Our booksellers, they are the biggest -- even at our -- the lower number that we have reported today, they are still seeing -- they are still, you know, seeing incredible volume and sales at our bookstores and we -- we will continue to see them be at the top of the best-selling lists and the top of our retailers' sales.

And we believe that.

When book 5 comes out, we will see an increase in sales and book 5 will be very successful.

And she is committed to doing the rest of the books.

I -- I would not even begin -- begin to even discuss where and when those will happen, but -- this is a -- this is a property that will exist for a very long time.

And what is the impact of the movie?

The movie is -- as you know, is doing very well, and we have seen a ramp in sales in our books -- in our book chains, in our book retailers and our mass merchandise.

It just was not at the level which we had all anticipated, but we definitely did see an increase in sales.

Thank you.

Our next question comes from Steven Barlow of Prudential Securities.

Your line is live.

Good morning.

With the 250 EPS goal, revenue up, will actual dollar cash costs -- or I guess really accounting cost that we're dealing with be down in fiscal '03?

Secondly, can you give us some indication on 3Q EPS?

Obviously you had the bad debt change last year.

Any guidance on that particular number for the third quarter?

And in '04, do you have any anticipation of Harry revenue?

Thanks.

Starting with the last one, in -- in the second half of the year, we're expecting to have, you know, roughly 5 to $8 million worth of Harry Potter revenue, and that would probably be mostly in the fourth quarter.

In regards to the third quarter, I think last year we had a 31 EPS.

We had the benefit of a -- of a true-up on the bad debt reserve of 10 cents.

I think that any adjustments that that we're foreseeing in the second half due to our revised guidance would probably roll more into the fourth quarter than the third quarter.

If that gives you any help.

Steve, I didn't quite get your first question, though, about the accounting cash or accounting costs.

If you could repeat that.

I guess I'm trying to figure out that if revenue is up in '03, and you're going to earn flat EPS, you've been busy on the expense side.

Will the dollar amount of expenses be down in fiscal '03?

Well, as we've said, we're going to be -- we're anticipating a positive cash -- free cash flow of about $50 million, and that is net of the expenditures that we're making in the new Arkansas facility, so we do expect that our free cash flow actually to increase in -- in '03 as a result of the operations.

Okay.

I guess I'm trying to come at it a different way in that you always talk about savings that you're not -- really the savings or money that you're not spending that you would have if you hadn't instituted these programs.

Right, right.

I look at it differently, I guess a little bit.

I want to know what expenses are going up or down.

Okay.

Just the raw number.

Because it's hard to figure out what you didn't spend.

Last year, or in July when we talked about our plan, we identified a number of items that were going to be incremental year over year.

One of the major things was postage.

Postage, year over year, was up about 8-and-a-half million dollars.

Health and property insurance was up about $8 million as well.

The facilities costs, including some of the start-up investment and costs that we were incurring in Arkansas, was up about $6 million.

So those -- those were costs that -- and there were a few others, but those were costs that actually weighed against some of the cost savings that we were able to implement.

Postage being implemented in July by the, you know, 13% across-the-board increase.

So I think if I'm answering your question, I think those were some of the major uncontrollable costs that were factored into our -- our plan earlier this year.

Okay.

Thanks.

Thank you.

Our next question comes from Abe Bennett of CitiGroup.

Your line is live.

Our next question comes from Sugno Young-ph of Gemco Capital.

Your line is live.

Good morning.

Just had additional questions about Harry Potter.

I understood that your original guidance had some room for Harry Potter this year, so there was a 30-cent difference between the low end and the high end of the guidance.

Given the recent development, are you still comfortable that the 30 cents is merely pushed back to 2004, or do you have a revised view on that forecast?

Thank you.

Well, at this point in time, we don't typically give any specific guidance for -- for '04.

We're in the process of beginning our planning, and then budgeting efforts, for fiscal '04, which starts in the -- in June 1st.

But I think as you -- as you look forward to '04, you should anticipate we would see an increase, and I think, you know, some analysts have speculated it was in that area, and -- but we're not giving any guidance on that at the present time.

Thank you.

Our next question comes from Justin Moore of Lord Abbott.

Your line is live.

Good morning, guys.

A couple of housekeeping things.

On the reserve of $9 million, does that include the 3% discount that you indicated you're going -- you offer to the retailers?

Yes, it does.

It does.

Okay.

And then just on the mass business, it doesn't sound like it would be a meaningful change of percentage of the business there, but how do you guys go to -- do you guys go to market differently there versus the traditional retailers, or does it still go through distributors?

And the reason I ask, is there any opportunity, as you sell those guys more over time, to leverage the size of those retailers to make it more meaningful to you guys at margin?

At this point, we -- we still do deal primarily with distributors, and I don't see that changing in the near future.

That is the way that those books are distributed.

So there should be no profit enhancement from selling that channel.

It's just another distribution channel that you're selling to?

Yes.

Okay.

Thank you.

Thank you.

Our next question comes from Andrew Horowitz of Horowitz and Company.

Your line is live.

Good morning.

Thank you.

Just a question on this whole issue of Harry Potter.

It seems that for the most part, for the last -- some time, you've been hanging your hat or wand, so to speak on this -- you know, on the Harry Potter franchise being so popular.

As a shareholder and -- you know, tell us how we can become comfortable with the fact that, you know, if the product doesn't continue to move as it has, where your diversification as a company is going, and, you know, what other offerings do you see in the future as significant drivers to earnings?

We've spent a lot of time on that question.

Actually, Harry Potter at this point is a small percentage of our total revenues.

We're anticipating around $45 million this year.

It's about 2-and-a-half percent of our total revenues this year.

It was higher in the preceding two years, of course.

For three years, we've been working on our cost reduction program, understanding that Harry Potter was -- was going to not continue at the rate that it was selling in the year 2000, and that we -- I think we believe that that was a smart thing to do and we're continuing to do that.

At the same time, Scholastic is really about distribution and we have a tremendous range of different distribution vehicles within the company.

We've talked about our schoolbook clubs, we've talked about our schoolbook fairs, we're expanding our continuity and direct to the home business.

We have -- we're expanding our international operations.

So Harry Potter does help the incremental profits a lot when it's doing extremely well, but we're -- we're planning, over time, to increase the profits of other areas of the business and reducing our -- you know, the impact of Harry Potter as Harry Potter -- as Harry Potter wanes a bit in revenues and profits.

But we -- we do want to emphasize that Harry Potter is the world's greatest publishing property, and it's going to continue for many years, and there's -- even at current levels, which are a little bit down from the preceding two years, it's still one of the great book publishing franchises of all times.

So we're very glad to have it, but at the same time, we don't think of it as the centerpiece of the company.

The company is a distribution company, a publishing company, an education company, an international company, and in all those ways, we're expanding revenues and profits and we will -- whereas we also hope to be the publisher of a very successful Harry Potter franchise over time.

Yeah the reason I ask obviously is almost in every publication, you see, Harry Potter is the centerpiece of the discussion of earnings moving forward.

Yes.

And it's kind of concerning that it's such a for example.

Well, as I say, it tends to have a significant incremental profit, and if -- when it falls short, it does affect our -- our forecasts and our bottom line.

But it's -- as a percentage of the company going forward, we're looking for our profit growth from other -- from other activities.

Okay.

Thank you.

Dick, if I could just add that, you know, Harry Potter is a phenomenon, and so in the world, it is talked about a lot, and so I think we get sort of mixed into that.

And number two, we have -- you know, Harry Potter sales will vary as new books come and go in the Harry Potter franchise.

And finally, I think in just our publishing area, which is -- is not our distribution area, we have -- we are working and continue to work very hard to create not -- you know, not expecting Harry Potter numbers but great new franchises and great new areas of publishing such as we announced today with our Dreamworks and our whole mass market publishing focus and -- and many other new things that we hope to build into strong franchises as well.

Thank you.

Thank you.

Our final question comes from Neil Godsey of Think Equity Partners.

Your line is live.

Hi, good morning.

A couple of questions for Kevin and then one for Margery.

Kevin, on the corporate overhead line on the income statement, could you give us what the company's expectations are for the third and the fourth quarter?

And then secondly, on the cash flow statement, can you provide any more detail as to what cash flow from operations was in the quarter and also what capex was in the quarter?

And then for Margery, just wondering if you could provide any commentary on what you're seeing in the marketplace with respect to spending levels at the state level, given, you know, what's going on with lower than expected tax receipts and then also if you're seeing any -- any impact yet from federal dollars coming in from some of the new programs.

Thanks.

Margery, why don't you go first on this one, okay?

Yeah.

Neil, it -- when you talk to educators out there, they're definitely feeling pressure on state funding, and I think you probably are monitoring what's going on in California where -- which is probably the most dramatic example of pressure on state funds.

In terms of the federal funding, there is federal money flowing into the states now, and I think that part of the way that schools are financing read 180 is using federal funds from many different categories.

Not from reading first, but from title 1 and other grant and funding sources.

Okay.

Does that answer your question?

Yes, it does.

Do you see the federal dollars rolling in more significantly in the first -- say the first quarter of '03, calendar '02?

You know, Neil, I can't give you a really good answer on that.

I'm really not sure.

Uh-huh.

I'm sorry.

Okay.

Thanks.

Neil, in terms of the cash expenditures, I'm -- I'm going to give you the six-month figures.

That will incorporate, obviously, the first quarter.

In terms of some of the major expenditures, it was capital -- capital expenditures was about $45 million.

That included the -- a significant expenditure for the Arkansas facility.

Pre-pub was pretty close, maybe a little bit lower than last year.

It was about 20, $22 million.

So those seem to be tracking, you know, fairly closely to where we were last year.

I think as I mentioned, year over year, debt is down.

It's down to 650 as compared to where it was a year ago.

It's down $23 million.

In terms of the overhead, I guess looking forward, in view of some of the -- those costs that I referred to before, the healthcare as well as the insurance costs, you should be expecting the overhead to grow in the third and fourth quarter maybe 10 to 12% vis-a-vis that of last year.

Okay.

Thanks.

Mr. Marchuck, I'd like to turn the the floor back over to you for any closing comments.

Well, we thank you all for your attention and for your continued support of Scholastic.

Thank you very much.

Thank you.

This does conclude today's teleconference.

Please disconnect your lines at this time and have a wonderful weekend.