Scholastic Corp (SCHL) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Scholastic fourth quarter year-end Earnings Conference Call. At this time all participants have been placed in a listen-only mode and the floor will be open for questions and comments following the presentation. I'd now like to turn the floor over to your host Ray Marchuk, SVP of Finance and Investor Relations. Sir, the floor is yours.

Thank you. Welcome to Scholastic's Annual Conference for shareholders and analysts. Before we begin, I'd like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the conditions of the children's book and instruction material markets, and other risks and factors identified from time to time with the Securities and Exchange Commission. Actual results could differ materially from those currently anticipated. Now I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic to begin the presentation.

Good morning and thank you all for coming this morning and for those of you on the phone. When I was talking to some of the people here before we started our presentation, he said, what are you going to be talking about today and he was looking rather intently at me. So I said: You see, this forehead where normally you would see the Harry Potter mark, right, you're going to hear about improving our core operations, improved profitability and margin and greater free cash flow. OK. So it's written right here on our forehead. I'm very happy to say that we're joined here today by our shareholders, analysts, and our Scholastic staff. From the management group are here to hear our presentation and take part in this opportunity for us to communicate with our shareholders and investors.

And I wanted to thank all of you who were here for the support that you've given the company for your role in helping the company improve from its current position and for the support you've given to this family of Scholastic. Like me, not an altogether happy family, but I think one that's pulling together to move our great company forward. It's really no small feat to build our wonderful proprietary channels, our great content, like Harry Potter, and also our educational brands, as well as our other wonderful content products. We do need to tighten up our management to improve our core businesses and move ahead through improving profitability and cash. And this is what we'll be talking about today.

Fiscal 2003 was difficult and disappointing year for Scholastic. We did miss our plan and our profit fell significantly. And this has caused some of you to question where the company is heading. Today we'll discuss why we missed expectations in the quarter and the year, what we've done to identify and fix the problems, how we plan to improve profitability and cash flow, and why Scholastic remains a fundamentally strong company with strong channels and strong content. As you know already, fiscal 2003 was a difficult year. At $1.26 per share our earnings last year were 21 cents below our revised guidance for the year.

First, let's look at last quarter's results compared to the guidance provided last March. As we noted in our press releases, the two major reasons for our miss against expectations were disappointing results in our ride and in our schoolbook fair businesses. First we expected fourth quarter results in trade to rebound from a poor third quarter. This turned out to be wrong. Both our sales and the industry sales suffered in our fourth quarter. As children's book revenues for all publishers were down in a sort of unbelievable 17 % during the May 2002 to -- December 2002 to the May 2002 period. The shortfall in trade and the accompanying reduction in variable profit was the primary factor in our earnings miss.

The second largest cause of our last year's earnings shortfall occurred in schoolbook fairs. After three-quarters of growth, fourth quarter book revenue was down 1 % relative to prior year, and this was caused by lower revenue per fair, which we've had an excellent record in building revenue per fair until that time. This was the result of the very weak book-selling environment in the spring, as we were affected in fairs by the same sort of malaise that was going on in the retail selling, as well as by some of our own execution issues. This unexpected weakness in our second largest quarter for fairs was a cost largely fixed for the spring season, directly affected operating income. Other parts of the company performed in line with our expectations, with those performing somewhat better offset by smaller misses in other areas. In the wake of the shortfall the operating and financial teams have undertaken a comprehensive review of forecasting processes and we are taking a conservative look at our business going forward.

Fiscal 2003's operating results are particularly disappointing because they did interrupt what had been our consistent record of growing profit and improving margin. We have identified and are addressing the key factors behind these results. Let's look at what these factors were in fiscal 2003.

First, trade revenue was down 3 % for the year, significantly below our expectations. And in part as we said due to a very difficult book selling environment. Within trade, there was also a change in our revenue mix. And I think this is really the key issue for why the profitability of the company dropped. There was a change in our revenue mix. Higher margin backlist Harry Potter revenues declined by approximately $33 million relative to the prior year. Partially offset by $31 million in lower margin revenues, largely from Klutz. Now, does this mean that Harry Potter is good and Klutz is not good? No. It's really the incremental profit from increased Harry sales or the incremental or the lack of incremental profit from sales that dropped below expectations that caused this rather significant change in profitability. Klutz is profitable and it's an excellent operation. And it has equal margins with the rest of the industry. But it doesn't match up with the, improve the variable profit gain or loss improved in Harry Potter sales.

We expect trade to be strong in this fiscal year with 40 to 50 % revenue growth. We've already shipped more than 9 million copies of Harry Potter and the Order of the Phoenix. And as you know we were achieving high sell through. This will significantly increase earnings in fiscal 2004. Besides Harry Potter we also have a strong trade list for the year, which Barbara will tell you about.

While fiscal '04 trade revenue will be up significantly, this does highlight the volatility for trade to the key issue in looking at the company. And of course that is typical in the industry.

Second key factor behind last year's results was the decline in growth in our school distribution channels. School book clubs were down 2% for the year on somewhat lower orders. School book fairs were up 5 % for the year, on lower 3 only 5% for the year and lower revenue per fair, particularly late in the year. This drop from expectations was partly due to shortages is from advertise titles in our fairs as well as the weak book selling environment. By correcting these factors, which cause short falls in fiscal 2003, for '04 we have an improved outlook expecting mid to upper single digit growth over all in our school channel. With simplified ordering more focused offers and enhanced teachers benefits we expect a turn around in our book clubs in school fairs we're focused on revenue per fair and are focusing product availability issues among other initiatives and we're working there to lower cost and improve margins. We expect these channels to continue to be very important consistent sources of our future growth. And they have done extremely well over a long period of time and will continue to do so.

Last year's operating margins were impacted by anticipated increases in the cost of postage, IT, insurance, facilities and depreciation. As well as both expected and unexpected costs increased costs in healthcare costs. These increases more than offset the benefit of our very successful cost savings program, and Kevin will go into that in more detail in a few moments.

As part of our effort to increase margins, we've expanded our cost reduction efforts for '04 to more than 40 million. This includes the effect of the reduction forest announced in May, which will safe more $15 million in this fiscal year. Additionally we're sharing more healthcare costs with our staff, and we don't expect an increase in postage rates this year.

The significant factor in last year's lower cash flow levels besides lower operating income was continued high level of capital expenditures. And in recent years we have made major investments to expand and improve our distribution infrastructure, in our facilities as well as to integrate the Internet throughout our business and distribution channels. And these investments have used cash but in fact they have strengthened our business for the long-term. But this period of heavy investment is largely behind us. And while we'll continue to make necessary investments, we expect to reduce capital expenditures by more than $25 million in fiscal 2004. Combined with working capital management and improved operating income, we expect this reduction in Capex to result in a substantial improvement in cash flow. Obviously we take last year's results very seriously and our plan for this year is a direct response to some of the issues that we encountered in that year.

To summarize, we've identified the problems and we're fixing them. This includes our review of our forecasting processes. Second, we've implemented a significant reduction in force and have expanded our cost savings plan to resume growth in our operating margins. Third, we anticipate that our cash flow will be boosted by reduced Capex. And cash flow is a priority for the company in this year and upcoming years. Fourth, we continue to focus on profitably growing our business. Based on all of this, we are estimating earnings per share to be between $1.95 and $2.35 on revenue between $2.1 and $2.2 billion and cash flow between $40 and $50 million, as Kevin will describe in greater detail.

For the remainder of this presentation, CFO Kevin McEnery will provide detailed financial results from last year and from the last quarter, as well as further guidance for fiscal '04. Barbara Marcus, President of Children's Book Publishing and Distribution will speak about Scholastic's outlook for '04. I will then come back and talk about our outlook for other segments of the business. And we're also joined here by other members of our executive team who are available for questions at the end of this presentation. Kevin, shall we move on to our fourth quarter '03 and -- '03 full year results.

Good morning. Thank you, Dick. Scholastic's revenue for the quarter increased to $557 million as compared to last year's $541 million. For the full fiscal year, the revenue increased to $1,958,00,00,00 as compared to last year's $1,917,00,00,00. Our net income for the quarter decreased to $29 million equivalent to 72 cents a share as compared to last year's income of $52 million or $1.28 per share. Now for the full fiscal year 2003, our net income decreased to $59 million, or $1.46 per share. That compares to 93 million last year, which was equivalent to $2.38 per share.

As Dick noted, there were some special items included in the fiscal years both '02 and '03 that I'd like to mention. The most significant is a severance charge of $10.9 million that was recorded during the last quarter. This had an EPS effect of about 17.5 cents. The majority of this charge was recorded in the individual operating segments, and you'll see that in a few moments as we review the operating segment results. We also had charges last year in -- we also had charges for unrelated litigation settlements in the first quarter of fiscal '03 and the last quarter of fiscal '02.

In the third quarter of fiscal '03 we benefited from the sale of an investment and in the fourth quarter of fiscal '02 we had a write off of an equity investment. Fiscal '02 also saw a change of accounting for motion pictures as mandated by the FASB. Now as discussed in last night's press release, Scholastic's Internet activities have moved from a developmental stage to the operational stage. As a result, we have reallocated the Internet-related revenues and expenses that were previously recorded in the media segment. This had no effect on the company's overall revenue or cost either in fiscal '03 or '02. We will be providing the adjusted quarterly figures by segment on our investor Web site later today. Dick has already described the major factors impacting the results for the quarter and in the year for children's book publishing and distribution. In particular, a drop in operating income on slightly higher revenue. In addition to trade, school book clubs and book fairs, this segment also includes continuity programs where operating income is lower with school-based gains more than offset by lower direct-to home results.

In educational publishing last year, revenue grew by 3%, in spite of a difficult school-funding environment. Growth in our reading intervention program, Read 180, offset declines in revenue from library publishing and Scholastic literacy place, which we stopped investing over two years ago.

The segment's operating income for the year was down $2 million, primarily due to the special charge for severance. International's revenue grew by 6% last year, primarily reflecting the benefits of higher foreign exchange rates. However, operating income was down by $6 million, mostly due to a $4 million charge for severance and reduced results from export.

Revenue in media, licensing and advertising was down 5% last year, due primarily to reduced software and advertising revenue, and after the reallocation of Internet costs, the segment recorded an operating loss of about $4 1/2 million as compared to a break-even last year. In the year, rather, in the quarter, corporate overhead increased by about $3 million, and it increased by about $14 million for the year. The increase for the year primarily reflects the higher costs of benefits, particularly healthcare, facilities and depreciation, offset in part by the elimination of the management incentive bonuses for fiscal '03.

In the second half of fiscal '02, we made four acquisitions of note. Klutz, which is now included in our trade operations, babies first book club, which is included in our direct to home continuity program, teacher's friend which is in our educational segment, and Tom Snyder productions, parts of which are in the educational segment as well as the media licensing and advertising segment.

Now, we are pleased with the results of these acquisitions and the success of their integration in fiscal '03. Last year these acquisitions generated total revenue of $71 million and were accretive to earnings. And we believe that this contribution will grow in fiscal '04.

As Dick mentioned, the significant decline in last year's operating income, in spite of a slight increase in revenue, is attributable to a number of factors. First and most importantly, there was an adverse change in our revenue mix. We experienced declines in high margin product revenue, especially in Harry Potter and the Scholastic literacy place. At the same time, we saw increases in lower margin product revenue, largely from the prior year acquisitions. The net of this resultant in a reduction of approximately $44 million in profit margin. Second year -- secondly, last year's cost reduction program yielded a bit more than $35 million of overall savings, exceeding our initial targets. However, as Dick mentioned, we had significant and largely anticipated cost increases in areas such as healthcare, postage, facilities and depreciation, which totaled approximately $41 million. Along with other increases of $6 million, these expenses were more than offset -- more than offset the benefits of the cost reduction program.

Including the $12 million in net higher special items in fiscal '03 relative to fiscal '02, predominantly the severance including in fiscal '03, this explains a $68 million decrease in operating income this year.

This slide provides an expanded breakout of our income statement. Our costs of sales was up slightly, more than revenue, reflecting the adverse change in our revenue mix mentioned previously, partially offset by lower product costs and cost reductions from reengineering. You'll note that the costs of SG&A grew faster than revenue due to the higher costs we mentioned in the healthcare facilities and some other expenses discussed previously. Bad debt expense largely pertains to our continuity programs and this 4% increase actually reflects a slight improvement in bad debt experiences in the area, which had revenue increases over the year of 7%.

Depreciation and amortization reflects the cost increases of the new facilities with systems come on stream, and during the year the interest expense was largely flat and our effective tax rate improved slightly to 35% from 35.6% last year, reflecting a slightly lower effective tax rate in our international subsidiaries.

Now, moving on to the balance sheet. As you may recall, we elected to pre-fund the $125 million worth of senior debt that is coming due this December. And as a result we had approximately $59 million of cash and cash equivalents, mostly in the form of interest-bearing deposits on the balance sheet as of May 31, '03. This compares to about $11 million in May '02. Accounts receivable year over year were up by about $22 million, of which about a third is related to the increased U.S. dollar value of our international receivables. An examination of the DSOs on an individual segment basis shows that they're basically in line with that of the prior year. We're particularly pleased with the results of our Harry Potter back list inventory management program, the payments which have been deferred or paid as of May 31 in the Harry Potter return rate has been at expected levels. Inventory year over year was up by about $23 million, and approximately $9 million of that is due to the foreign exchange effects. And 7 million pertains to the increased stock held in preparation of the release of Harry Potter 5 in June. We also had inventory that related to product acquired in anticipation of some large educational orders that were shipped in June and July of this year.

Accounts payable was relatively consistent year over year and debt was up by 87 million, in large part due to the pre-funding, I mentioned previously, and this was partly offset by the $48 million of cashier over year.

In spite of our lower operating results, cash provided by operations improved to 181 million as compared to 165 million in fiscal '02. This was due to improved working capital.

Our capital expenditures increased slightly in the year, due to the acquisition of a new warehouse and fulfillment center in Mammal Arkansas and our pre-publication and production costs also increased slightly reflecting in part the costs for the Clifford TV show. Royalty advances in fiscal '03 were slightly lower than that of fiscal '02. This resulted in free cash flow defined as net cash provided by operating activities less spending on PP and E, prepublication and printing cost and royalty advances of negative $4 million last year. While this improved modestly over fiscal '02 we recognized a need for and are committed to further improvements in this area as Dick described.

For the year we expect our operating margin to between 7.5% and 8%. And with the benefit of the release of Harry Potter 5, we expect that our seasonal first quarter loss, while significant, will be reduced relative to last year's loss, and that this reduction will represent a significant amount of this year a expected earnings improvement. Non-cash expenses from depreciation and amortization are planned to rise in the current year. And as Dick mentioned we are targeting free cash flow in fiscal '04 of between $40 and $50 million. This is based on anticipated net cash provided by operations of 215 to 230 million. A reduction in capital expenditures of more than 25 million to between 55 and 60 million. Relatively flat royalty advances of between 30 and 35 million. These improvements in cash flow factors are expected to be partly offset by higher prepublication and costs which are expected to rise between $15 and $20 million.

In part due to the production expenses associated with the Clifford TV episodes and the movie as well as the Mia and Miguel TV episodes. These costs will be largely offset by future payments from networks. Now I'd like to introduce Barbara Marcus, our president of Children's Publishing.. Book Publishing and Distribution. Thank you.

Thanks, Kevin. While clubs fair and trade were disappointing last year, we believe that there are continuing growth opportunities in the $4 billion market for children's books even in the current difficult economic environment. Children's books meet the needs of a constantly renewing marketplace and our unique distribution channels give us unrivaled access to these customers, children, parents and teachers which in turn enables us to consistently publish quality best selling titles. We believe our channels and our publishing assets and brands continue to offer a strong, long-term opportunity to grow. I'd like to lay out our plan for this year to regain growth in the core businesses.

Turning to our goal of increasing revenue in the book club, we are implementing the following focused plan. One, we have improved and simplified teacher benefits to boost excitement among our sponsors. Two, we have simplified our product selection, allowing us to better promote our offers. Three, we have refined our mail plan and enhancing promotion of our on-line ordering, also known as Cool, where we expect to receive over 25 % of book club orders this year. Four, we are increasing our presence in the value segment of the school book club market by creating a new Carnival Troll Club based on rights and assets we acquired from Troll. As a result of these actions we expect mid to upper single digit percent revenue growth in clubs this year with some improvement in margin.

Our primary focus in fairs this year is on boosting revenue per fair. To accomplish this, we are first addressing the availability problems of certain advertised titles last year with better inventory management and purchasing. We are also expanding our support of book fair chair people, helping them to better promote fairs in advance and improving the merchandising in their fairs. Our general managers and sales staff are dedicated to driving revenue per fair increases. At the same time, we are continuing to improve efficiencies and productivity with better fair packing and routing and additional trapped operational metrics. Overall we expect mid to upper single digit percent revenue growth in fairs this year with margin improvement. In continuity our top priority continues to be increasing enrollment. This year our focus is on further developing our customer acquisitions through direct mail, the Internet and the school market, where, in particular, we saw strong growth last year as well as exploring new ways to increase our customer base. This is partially a continued response to the federal and state do not call (inaudible).

Complimenting our customer acquisition initiative this year we're launching new product in the school market and to the home, including Nick, Jr. and Disney Princess Club. We're also excited about continuing to grow babies first book club now in its second year post acquisition.

Overall in continuity we expect mid single digit percent revenue growth this year. Of course, the highlight in trade this year is Harry Potter and the Order of the Phoenix, which we launched June 21st. After an initial print run of 8.5 million copies, the largest in history, five million copies were sold in the first day. And as Dick said earlier, we've shipped more than nine million copies to date. Sales continue to be strong and based on feedback from our book sellers, we expect there to be net sales of more than ten million copies of Harry Potter and the Order of the Phoenix this fiscal year.

As for Harry Potter back list sales, they have certainly picked up since the launch. Though much of that demand is being met with books on hand in advance of the publication date. We expect net sales of the Harry Potter back list to be approximately 10 to 20 million this year, versus $49 million last year. Based on these assumptions, we expect at least 150 to 175 million in total Harry Potter net sales this year, the majority falling in our first quarter. While Harry Potter and the Order of the Phoenix will be very important this year, we have also worked very hard to create a strong, broad trade program apart from Harry. This includes new titles from best selling Scholastic authors and franchises like ink cart by [inaudible] author of the best selling the Thief Lord.

Two, new captain underpants titles by Dave Pilke, as well as Clifford's puppy days title. We're also re-launching the best selling goose bumps series and have exciting licensing deals for Schrek II, Spiderman II, (inaudible) new properties from the creators of the Bob the builder. Overall we expect a very strong year in trade with sales up 40-50% over last year driven by the success of the Harry Potter and the Order of the Phoenix these customers through unrivaled distribution channels. We now have proprietary reach through our school book clubs, our school book fairs, and our direct to the home business, which is the largest in children's publishing. And we also of course use the trade distribution channel.

The content and distribution builds on each other. In the end, the strategy of putting unrivaled content through strong proprietary distribution channels creates the opportunity for stronger customer relationships and important higher margin sales that as you can add a distribution margin to a content or publishing margin, then you get a higher margin business, which has been the secret to our success in our children's book publishing growth over the past 20 years. This stronger customer relationship, of course, helps our consumer brands like Clifford, Captain Underpants, I Spy and Harry Potter but also our educational brands such as Read 180. I believe this year's plan while focused on the basics of returning our core businesses to growth and profitability, improving cash flow and continuing and returning to upgraded margins, that this year's plan focused on those basics, nonetheless also advances our long-term strategy across the business.

Scholastic fundamentals remain strong. As the global leader or the global leader in children's books, education and media, we stand to benefit from continued spending to help children read and learn around the world. In our brands and distribution channels, with the disciplined financial plan, we'll bring continued growth in earnings and cash flow. Clearly given last year's results our first burden is to demonstrate that we can manage our business predictably and profitably, yet even as we regain the confidence of our shareholders, we remain focused on our long-term strategies of content, distribution, to grow our business and improve and build shareholder value.

Thank you for listening to our presentation. I now would like to invite questions from analysts, fellow investors and stockholders. We do have microphones for the people here and we'll hope to use those, because there are many people on the phone and they need to hear your questions. We'll take some of those questions first then we'll turn to people on the phone.

Questions from investors and shareholders and friends here this morning? Yes.

Dick , it looked like last year, without the acquisitions, your overall revenue would have been down. Could you address the overall 7 to 12 % revenue growth, what's organic and what's coming from acquisitions?

Kevin, the answer to the first question is yes, it would have been down, because I think we talked about $51 million worth of acquisitions, and probably more than our overall revenue growth for the year, which was about 40 something. So it's a small net. Obviously there's a tough year and we were facing some strong economic pressures. Next year we expect -- I think your question is what will those same acquisitions produce in the upcoming year?

Well, in terms of the increment, that was your these customers through unrivaled distribution channels. We now have proprietary reach through our school book clubs, our school book fairs, and our direct to the home business, which is the largest in children's publishing. And we also of course use the trade distribution channel.

The content and distribution builds on each other. In the end, the strategy of putting unrivaled content through strong proprietary distribution channels creates the opportunity for stronger customer relationships and important higher margin sales that as you can add a distribution margin to a content or publishing margin, then you get a higher margin business, which has been the secret to our success in our children's book publishing growth over the past 20 years. This stronger customer relationship, of course, helps our consumer brands like Clifford, Captain Underpants, I Spy and Harry Potter but also our educational brands such as Read 180. I believe this year's plan while focused on the basics of returning our core businesses to growth and profitability, improving cash flow and continuing and returning to upgraded margins, that this year's plan focused on those basics, nonetheless also advances our long-term strategy across the business.

Scholastic fundamentals remain strong. As the global leader or the global leader in children's books, education and media, we stand to benefit from continued spending to help children read and learn around the world. In our brands and distribution channels, with the disciplined financial plan, we'll bring continued growth in earnings and cash flow. Clearly given last year's results our first burden is to demonstrate that we can manage our business predictably and profitably, yet even as we regain the confidence of our shareholders, we remain focused on our long-term strategies of content, distribution, to grow our business and improve and build shareholder value.

Thank you for listening to our presentation. I now would like to invite questions from analysts, fellow investors and stockholders. We do have microphones for the people here and we'll hope to use those, because there are many people on the phone and they need to hear your questions. We'll take some of those questions first then we'll turn to people on the phone. Questions from investors and shareholders and friends here this morning? Yes.

Dick , it looked like last year, without the acquisitions, your overall revenue would have been down. Could you address the overall 7 to 12 % revenue growth, what's organic and what's coming from acquisitions?

Kevin, the answer to the first question is yes, it would have been down, because I think we talked about $51 million worth of acquisitions, and probably more than our overall revenue growth for the year, which was about 40 something. So it's a small net. Obviously there's a tough year and we were facing some strong economic pressures. Next year we expect -- I think your question is what will those same acquisitions produce in the upcoming year?

Well, in terms of the increment, that was your question, increment year-over-year nearly all the growth will be organic, obviously helped substantially by Harry Potter 5. We didn't really have any acquisitions in this past fiscal year. So on a year-over-year basis it should be consistent. Last year the acquisitions, as the slide, indicated generated about $70 million in this past fiscal year and we expect that would modestly increase in this next fiscal year.

Can you give us some sense of how quickly you can get costs better in line with revenues? It seems in the quarter there was a great misalignment, how quickly should we expect to see progress in that regard?

Well, our problem for this past year was we clearly anticipated a year when we would grow revenues and we didn't. And we build the cost base of the company for increased revenues which didn't materialize. We realized this during the year, and to some extent we were, we had our wonderful cost savings program, which continues. But this was offset, as we pointed out, by some both anticipated and unanticipated increased costs. But the key issue was that we built our infrastructure a little bit too big for the level of revenues that came in during the year. When we did realize this during the year, we started to chip away at our expenditures and cut back discretionary spending fairly substantially, but more important we knew we had to trim our staff. That was an unhappy situation, but we, as you know, we reduced about 400 jobs out of mainly middle management and upper management ranks and this will produce a $15 million cost reduction in our base for this coming year. And we're looking at costs throughout the organization in that context.

Beth, do you want to talk a little bit more about some of those cost reductions that we're planning this coming year?

Sure. I mean we've actually had tremendous success over the last three years taking costs out on efficiencies, engineering, purchasing, the core areas of operating in the business. We actually drive a very nice variable cost structure in our distribution. We are able to go through layoffs during the summer then staff up again in the fall and -- because we are a seasonal business. We'll continue to focus on those areas this next fiscal year, I think the slide showed $25 million of additional savings this next fiscal year from purchasing savings and from efficiencies and infrastructure consolidation. So we are always looking at our cost structure and the base operations trying to optimize the supply chain and will continue to do so.

I think the key point you made is that we know that our SG&A is too high, and part of that is because we anticipated a higher level of revenue and during the year we knew that that level of revenue wasn't coming in, we started to work down those costs and we're continuing that in the current fiscal year, but longer term we were holding the SG&A, moving it down as a way of improving margin. Yes.

I was just wondering what kind of economic scenario you built into your forecast, to what extent it's sensitive to the economics scenario that may develop in the next year, is it possible that the economy does improve that you do actually better than your guidance or are you conservative?

We're trying to be conservative in our forecasting, having been, having had several misses this past year and that has been a source of concern both within the company and among our shareholders and analysts. We're not anticipating any particularly great revenue or economic increases in the upcoming year. We are turning around our core businesses. We're expecting a better, slightly better book selling environment, and that's already taken place with the tremendous success of Harry Potter, which not only accounted for a significant amount of Barnes and noble and Borders revenue by itself but also helped lift the book selling revenues for other books in those chains as already announced. So we're seeing a little bit of benefit there. We know that international is already improving in Asia, as SARS proceed. So there's a better, somewhat better environment but we're not counting on any rising tied lifting all both Scenario we're counting on. We're doing a better job in a slightly better book-selling environment. Yes.

In the context of the book fairs, you mentioned increased benefits to teachers. I'm wondering what these incentives involve, how they might affect margins and if you can tell me what they are in dollar terms.

The book club business is the one in which we're improving teacher incentives. We're offsetting slightly reduced kid mailings, which is our promotion pieces, with improved benefits for the teachers, which are generally in terms of free books, bonus points, classroom materials, the ability to select professional materials with bonus points. And we're tipping the balance between promotion, kid mailings and teacher incentives more to the teacher incentive side. And we believe that will help and we know from focus group research and discussions with the marketplace that this is something that teachers are looking forward to. There should be no -- it should be a complete offset between reduced kids mailings and increased teacher benefits. So no impact on margins, although we expect better sales and therefore better profitability out of that segment book club.

Is there any way to quantify the shortages in titles that hurt the fairs last year? You mentioned that a couple times that you didn't have the titles that you had advertised and marketed, any way to quantify that?

I'll turn this to Barbara in a second, but we put out a promotion to book fair schools and we produced a great big new book fair news, let's say, which gets sent home to kids in advance of the fairs and builds their anticipation of what's going to be in the fair. And in that list we have a group of somewhere around 50 titles that we think are going to really drive revenue, and those are what we call advertised titles. And those are ones that we want to have in the book fairs when the kids arrive, because they're the ones that are being promoted in which they're looking forward to. In some cases this year, that did not happen. Do you want to amplify?

Sure. I don't think -- to quantify it, we do believe there's the mix between the economy where we definitely anecdotally felt that there were less dollars and I guess less adults spending money at the fairs. On the other hand, on the advertised titles, we felt there was sort of a narrowing of interest. We had many many titles at our fairs, but the advertised titles seemed to, I think for two reasons, I think there was sort of less of an amalgam of best selling titles so the marketplace sort of focused on these advertised titles. And we forecasted but did not forecast totally accurately based on this and had less of them than we would have liked. And as a result we feel both those factors delivered a lower revenue per fair this quarter.

We have another couple of questions from the audience then we'll turn to the phone. Steve. Steve Barlow from Prudential.

Thanks Dick. I wondered if you could talk about moral a little bit in the organization. The first time I guess in memory that you've let go a lot of people, I guess the understanding I've got from just talking to people in New York is that moral is pretty poor right now. How are you combating that and any relative -- related question is you talked about options. My guess is -- you tell me, what percentage of options do you have outstanding and underwater and how is that affecting moral, and what is your bonus plan for '04?

Yeah, key question here is the people in this room that are, the staff and the rest of the thousands of people who are not in this room, how are they feeling about the business and how do they, what's their level of confidence going forward. So I think that's a very important thing for us to address. I think first of all, people are very aware that we missed our forecast and they're very concerned about this. So I think there's a level of concern and a little bit dampening of animal spirits within the staff because of the misting of the forecast and the little bit of remaining sadness about losing some colleagues and friends from the company. So I'm not surprised of your report and we feel that we need to work on improving people's outlook and feeling about the business.

On the other hand, one of the strengths of Scholastic has always been the tremendous pride that people take in what we do as a business and the fact that they know that they're helping children's lives and supporting kids reading and learning. And that's a key ingredient and everybody in the company from the people who are creating product to the people who are picking and packing books feel they're doing something valuable for a small child in first grade by picking and packing the right books. So we overall our mission drives a lot of pride and belief in the company in what it does. Obviously right now there's a little bit concern about, we've had a miss on what's going to happen. It's mixed with very great enthusiasm about the wonderful success of Harry Potter.

So it's a little bit complicated, but I think basically as we start to and this is true of a company overall, it's true of you, it's true of other shareholders in this room, people feel a little bit concerned about the fact that we didn't do as well this year as we normally have in the past five years we've met all of our targets as you and I were discussing before. And this year we didn't. So people think, well, is something wrong or what's going to happen or we let people go. So there's a little bit of concern of what's going to happen, our performance. I believe and certainly the members of management who are here with me believe that we have addressed these problems, we're turning them around.

Our business is very, is fundamentally strong. We're serving our customers. We're reaching our market, particularly effective way, in a number of different areas and that this will, with a focus on better management, and returning the core business to profitability is going to have a good effect on our upcoming year. And with that we'll come back -- the staff reductions will be viewed as a necessary thing that had to be done in the context of a bad year and lowering our cost base. In respect to options and bonuses, of course these are important tools for any company to give people participation in the success of the business. The underwater options, probably half to two-thirds of them would be half or underwater. That's -- I'm sure that people are -- actually, I believe they think they're going to, over a long year period they're going to be fine.

So I don't think there's that much anxiety about the underwater option. These are options that have six years left to run and our company is going to do great over that six-year period. We still believe that options are an important tool for our company. We still believe we're a growth company and we believe options have played an important part in the incentive that's driven the growth of the company over the past 20 years, especially over the past 10 years. So we continue to use these. In fact, we granted some options just yesterday. And we granted some throughout the company back in March at levels below officers and management. So we believe in those and we believe that those options will be a primary motivator, not only for the employees, but is going to drive shareholder value. Absolutely I believe it and I believe it's going to happen.

Bonuses, we didn't pay any bonuses this year. Even divisions that made their targets getting no bonus because the company didn't perform well enough for us to give management bonuses to anybody. This hurts. This hurts. But in a way it's a good thing, too, because while it's temporary, it has a temporary impact on people and disappointed, it is a reminder that this company and all companies have to perform in order to pay the employees and serve the customers. We've got to make more money. We've got to improve our operating margins and produce more cash and all those things that we've been talking about today. So next year our bonus plan will pay off only significantly when we reach our target. So if we reach our target, we will pay management bonuses. But only after the shareholders have received value for our meeting the targets. A long answer but I felt it was an important question. Sort of core to the company and how it functions. So -- let's see, who has the microphones here? Yes.

Dick , I have two questions. Start out with, with the U.S. economy it's going to be difficult this year with book fairs and all and school budgets won't show any return for another 18 months if the economy improves. Now, the areas I want to expand on, I have two questions now. First off with the international market, you brought that up. That's only English speaking countries and the other markets and we have some Spanish speaking countries and further onto that into Europe.

Well, internationally we're -- we have subsidiaries in England, Australia, Canada and the UK, which have been around for a long time, and they're in various stages of improvement in profitability, but more through internal management rather than through the economy. The economies in Canada and UK are very good. Australia is also good. And there we're improving our operating margins and have a longer term turn around plan. In respect to Asia and Latin America, that's where we're focusing, our revenues there are about $50 million in Asia. That's a very significant growth area for us.

Is that in the U.S. -

In English and some local languages as well, yeah. In respect to education budgets, I think we've sort of answered that in our presentation. I mean we have wonderful products that are meeting reading and learning needs right now and they seem to be selling despite the difficulties in the marketplace in education funding. One exception would be library publishing, which is where we're getting hit a little bit harder. I think we should probably move to the phone now. So thank you for the questions from the audience, and we'll turn to the phone.

Thank you. The floor is now open for questions. If you have a question or a comment, please press the number 1 followed by 4 on your touch tone phone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask while you post your questions, that you pick up your handset to provide optimum sound quality. Once again, to ask a question, please press the number 1 followed by 4 on your touch-tone telephone at this time. Our first question is coming from Peter Appert from Goldman Sachs. Please go ahead with your question.

Hi, good morning. Actually, three questions for Barbara. And I'll just throw them all out. Number one, you've had great success growing the number of fairs and multiple fairs per school. And I'm wondering if one of the issues in the fair business is just that you've reached saturation and as you get these multiple fairs you see diminution in revenue per fair and there's really not much to do about that? That's number one. Number two, on the Harry Potter back list sales, do you have pretty good comfort at this point, Barbara, that you're covered in terms of inventory levels and that we're not going to have some risk later in the year of push back from retailers in terms of excess inventory. And then three, finally, you mentioned a do not call list. How significant issue is this for the continuity business? What portion of the new customers come from telephone solicitation? Thanks

Want to go -- it's addressed to you.

On the saturation of fairs, we have been over the year trying, slowing our fair bookings and starting to focus on revenue per fair. And I think that especially compounded with the experience we had in the fourth quarter that we really realized that that is where our focus is going to be. We have trained people who know how to book fairs and I think now we are turning to realize that it is increasingly important for the emphasis in our fair business to be on increasing revenue per fair. Our general managers and our regions know that that is their number one priority, to increase revenue per fair. So there is some truth to what you just said, but I believe we are cautious. We still have our end market schools where we are not -- where we book schools that have a certain population in them and we will continue to work on the second fair strategy as we do feel that is a viable one and focus on revenue per fair.

But on a near term basis we should assume that the number of fairs will grow at a slower pace than in recent years?

Absolutely.

OK. Thank you.

Backlist Harry Potter. As we said in the presentation, we have Harry Potter back list in the field. We did that both in response to our Harry Potter incentive program and working with our retail accounts who wanted Harry Potter back list in their stores prior to June 21st. That inventory is there and is selling extremely well. It is 300% of the low level of sales we had on the Harry Potter backlist going into June 21st. On the other hand, we are working quite carefully because we do believe there is solid inventory in the field on working with our retailers on what we both really feel their needs will be for the fall. We clearly are elephants and are being quite careful on the amount of books we are putting into the field on Harry Potter backlist.

The incentive program is over at this point?

It is absolutely over. And the last I think is the Do Not Call. We have been dealing with the state-by-state Do Not Call list. They are extensive they have really not gotten the press that the federal legislation has gotten but over the last year, especially two years we've been dealing with increasing state Do Not Call lists and have been investigating a variety of ways of looking at customer acquisitions. We will clearly continue to do that. It's unclear, Peter, at this point, whether -- because the federal list is basically a duplication of the state list. So what the net - net increased or level will be is really unknown at this point. But we are assuming that it is our job to vary the kind of customer acquisition that we are using. Telemarketing has been a big part of our acquisition. It's less than a third, but it is something that we have used over the years.

Great. Thank you.

Thank you. Our next question is coming from Lauren Fine from Merrill Lynch. Please go ahead with your question.

Thank you. I have a couple of questions. One, I'm wondering if you could discuss the revenue contribution from Goose Bumps over the last year without promotion and what kind of promotion you expect. Secondly, I'm wondering if you could let us know sort of what time will you know of your strategy on the book club program is successful; is that something you know with one of your first two mailings so you might know it as soon as something like September. And third, I guess I need to go back to the fourth quarter and really understand maybe a little bit more about your internal system, that if it was -- I guess I would like to know what kind of revenues you really thought you were going to get in the fourth quarter since the sales actually looked pretty good, all things considered. And why it was such a late response on the cost side are the right internal programs in place to really track things real time?

Let's see, Barbara, you'll take the Goosebumps story. I think, book club strategies we probably really will not be able to talk much about those until the end of the second quarter, but obviously during the October/November period we'll know whether our sales are up or not. But we won't be in a period when we'll be able to discuss that. So at the end of November we would be -- we certainly would be able to talk about where we are with Club. In respect to the response time on costs, and recognizing that our sales were down, Kevin, do you want to tackle that problem?

One, as Dick mentioned early on, the major two factors in the fourth quarter was the reduced revenue growth and trade and in fairs. And as I believe Dick mentioned we had hoped for a rebound from the rather significant hit we had seen in the retail sales and the holiday period. And frankly that was not forthcoming. We had hoped to be able to develop some new opportunities that just didn't. And the back list, it did not work out on the trade.

In the book fairs, this was I think the word has been used unprecedented in terms of a reduction in the revenue and revenue per fair in the fourth quarter. Somewhat related we believe to the economy, but nonetheless still had an adverse impact. We had been taking throughout the second half cost reduction steps over and above the reductions that we have placed, put in place beginning of the year in term of head counts, freezes and the like, but obviously once you get into the fourth quarter, most of the year is behind us.

And we feel we need to sharpen up our forecasting processes. I think partly we were hoping that trade environment, the difficulties of January, February and March, in particular, just couldn't continue and in fact they did. And the trade environment remained were still really liable with Harry Potter 5 in the stores. So I don't think there was -- we should have been more skeptical and conservative and instead we were more hopeful that things would rebound and they didn't. And I think that was one of the issues in our business forecast.

I'm not quite sure what you're looking for here. There's been quite modest -- and I don't have a number to share with you. Clearly we can find that out. But it's been quite modest. And in fact though we have been interested in re-launching it, our retailers have been very supportive, have also been quite interested in this. So it was a meeting of the minds of our re-launching. Kevin, do you have a number?

It is small. Maintain a good stable base. It's shown some life recently. But in terms of a trade revenue it's in the low seven figures.

I guess I'm just curious if you have any sense of how big it can be now that you're ready to re-launch and promote.

I think we are being cautious about it, but we have very great enthusiasm. We are launching, just so you know, with 25 titles in the fall, where we're putting them out to sort of have a mass of titles coming back into the marketplace with new covers and we have -- we feel quite good about it and so do our retailers, but we are, many of those titles have been sort of out there but not with the focused promotion that we'll be giving them in the fall.

Thank you.

Thank you. Our next question is coming from John Mackins (ph) from Artmust Capital (ph). Please go ahead with your question.

Am I seeing the indication correct. It's saying eight to 12. That couldn't possibly be right.

We missed your question, Mr. Mackins, could you repeat it.

We'll move on to our next question. Our question is going to be coming from Patrick Kent from Boston Company. Please go ahead with your question.

Hello.

Sir, your line is live. We can hear you.

Thank you. I just had a couple cleanup questions. I mean just on the costs and expenses for the third quarter and for the year, what was the SG&A in cost of goods split? Do you have those numbers?

For the fourth quarter.

Fourth quarter and for the year.

Yes, Hang on one second. Let me see if I can pull it up. I thought that was in one of our slides. For the year -

Fourth quarter is fine.

I have that for the year. SG&A for the year was 826,000 -- 826 million dollars.

OK. That's great.

Thank you.

That's not my only question. If you don't mind. Just so I understand this guidance correctly, I mean I guess I'm looking at sort of 7 to 12 % revenue increase but with $150 to 170 million in Harry Potter sales, I mean that's basically most of the increase; is that the idea? And that that gets you basically to the most of the EPS guidance range based on sort of the incremental margins I've discussed with management in the past on these?

I think as we said in our presentation, that on the low end of the revenue and the profits we would be anticipating that most of the rest of the operations would be the same as 2003 and that Harry Potter would represent the difference. On the higher end would represent the implementation, effective implementation of the plans that we talked about here today

Then I guess my question, I heard that, but I guess the question I have is where -- how much of the cost savings, the $40 million cost savings have you realized yet, where is that, what's the incremental contribution in '04 and then what's the incremental cost drag from the benefits increase? Because you know what your budget is and you know what you're going to be paying for health benefits so what's the cost drag the EPS line for the incremental benefit and is it totally offset by the cost savings? I mean what's the -- so it's a neutral impact or is there some positive impact or are we just not including that, or what's the -

I think the global answer here is that we come off of a difficult year when we missed our forecast and we are providing a wide range of, starting with a relatively conservative number. Well, we can do all the arithmetic and add up something that feels very good to us, nonetheless we're looking at our expense last year and tempered with some conservatives, we're projecting a fairly broad range. Kevin do you want to comment on any of the cost issues?

I think that Dick's comments are probably the most appropriate. I think specifically in terms of the cost as we indicated, a lot of the costs we had incurred, incremental costs in this year, postage and some facilities being significant, will not necessarily recur the same extent necessary next year and with the $40 million cost reduction program more of that will be able to be retained. But I would go back to Dick's observation about the process by which we've arrived at this guidance.

We would very much like to do at least as well as we're forecasting and maybe a little bit better than the middle of the range. But we are cautious because of the experience we've had this past year. So we're providing a broad range and we're working hard to make sure we achieve our targets.

I think in light of the time, which is now about 9:30, we should call this session to a halt. We should call this discussion to hold. We should want to thank all the people on the telephone, as well as those in the audience for their support. I think we all know that this has been a difficult year and that you all have been supportive of us and firm but friendly questions have been asked and we appreciate that. I want to thank also the staffs of Scholastic, who are here present and those on the phone. We will do a great job this coming year and a year from now we will be glad to tell our last caller that we over achieved rather than underachieved our forecast. Thank you.

Thank you, that does conclude today's teleconference. You may disconnect your lines at this time. And have a wonderful day.