Scholastic Corp (SCHL) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Scholastic second-quarter fiscal 2004 earnings release conference call.

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

It is now my pleasure to turn the floor over to Mr. Ray Marchuk.

Thank you.

Welcome to Scholastic's second-quarter earnings presentation for shareholders and analysts.

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

Before I begin, as you know, this presentation is also going to be available by simulcast on the Internet.

Right now, there is a technical difficulty.

We're hoping to come up during the call.

But you can go to Scholastic.com, click on investor relations to follow the slides on the Internet.

I would also 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 educational materials markets and acceptance of the Company's products in those markets, and other risks and factors identified from time to time in the Company's filings with the Securities and Exchange Commission.

Actual results could differ materially from those currently anticipated.

Now, I would like introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin our presentation.

Thanks, Ray and welcome, everybody to our second-quarter earnings call.

In a moment, we will review the highlights from the second quarter and the Company's outlook.

I am joined by CFO Kevin McEnery, who will provide more detail about the quarter's financial results;

Barbara Marcus, President of Children’s Book Publishing and Distribution will speak about progress in clubs and fairs, as well as how we are attacking the issues in continuities in trade publishing.

She will be followed by Beth Ford, Senior Vice President of Global Operations and Information Technology, who will give an update on cost saving and distribution and purchasing.

And after a wrapup, we will all be available for questions.

And we also have Margery Mayer, President of Education Publishing, who will be here for questions as well.

Last quarter, we successfully met our plan and continue on track for our fiscal '04 goal.

Here are some highlights.

First, we are particularly pleased that decisive actions in our core distribution business, School Book Clubs and Fairs, delivered strong performance.

Club revenues were up 16 percent, fair revenues up 5 percent, and profits and margins were up in both businesses.

Second, free cash flow in the first half improved by 86 million relative to the prior period, putting us well on plan to meet our goal for the year.

We achieved this through improved operating results and reduced capital expenditures.

Third, revenues and margins in International were up significantly, largely from growth in our export business as well as cost savings.

Educational Publishing delivered another quarter of double-digit revenue growth, with Classroom Library selling strongly, READ 180 continuing to lead the growing market for reading intervention.

This success is notable given the currently difficult market for educational publishing.

These positive factors helped offset softness in Trade, where sales were down 30 percent and lower performance in Direct to Home, where bad debt was up.

We continue to focus on cost reduction and process re-engineering throughout the Company.

Overall earnings per share for the first six months were $1.05 as compared to 75 cents last year.

For the year, we expect revenues to be modestly above 2.2 billion.

We are on plan to achieve the fiscal '04 targets announced in July, with earnings per share of $1.95 to $2.35 and free cash flow of 40 to $50 million.

Here is Kevin to talk about the quarter results.

Thank you, Dick.

While we are pleased that we achieved earnings per share of $1.67 for the quarter, which was consistent with our plan, it is lower than the $1.85 recorded in last year's second quarter.

Some of the key reasons why profits were lower in the quarter include, first, there was a $22 million decrease in our high-margin Trade revenue, which included Harry Potter sales of $13 million as compared to $25 million in the prior year.

As you know, the vast majority of our Harry Potter sales occurred in the first quarter of this year.

Our first half Harry Potter sales total approximately 185 million, as compared to 40 million in last year's first six-month period.

Secondly, we experienced lower profits in our Continuity Programs, largely due to $9 million increase in bad debt last quarter, which resulted from initiatives that Barbara will be discussing.

Thirdly, other items that adversely affected the results of the quarter by about $10 million included the planned increases in healthcare costs, depreciation, interest, and the severance expense, as well as lower performance by Scholastic Library Publishing and lower television syndication revenue.

These items were more than offset by the higher profits in book clubs, book fairs, the International segment and by the benefits of the Company's cost savings program.

Altogether, these factors largely accounted for the decrease in pretax profit of $11 million on the revenue growth of 39 million.

After-tax earnings for the quarter were 66.7 million, which is consistent with our fiscal '04 plan.

Now I would like to review the operating results on a segment basis.

In Children’s Book Publishing and Distribution, revenue increased 3 percent to 450 million, as compared to 438 million in the year-ago quarter, while the segment's operating income was 95 million, as compared to 107 million.

Within this segment, School Book Club revenues were up 16 percent during the quarter, reflecting the strong increase in orders, while Fair revenues were up 5 percent, with revenue per fair growing 2 percent and fair count up 3 percent.

Operating results in both the Clubs and the Fairs improved, benefiting from this revenue growth and cost savings.

Revenues in Continuities were up 3 percent from higher orders, but operating results declined on the $9 million increase in bad debt on our School and Direct-to-Home Continuity channels.

Trade revenues declined 30 percent, or 22 million, due to the lower Harry Potter sales in the quarter and reduced sales of other backlist titles.

The segment revenue increased while the margins were lower due to the decrease in the high-margin Trade revenue and the effect of the increased bad net debt in the Continuity business.

In Educational Publishing, revenue increased 13 percent to 87 million as compared to 77 million in the year-ago quarter.

Increased sales of Classroom Libraries and Read 180 more than offset the continued soft Scholastic Library revenue.

The segment's operating income was $14 million, down $1 million due to the higher amortization of prepublication costs and higher promotion and other operating costs, incurred primarily to benefit future periods.

On a full-year basis, we expect Education to have revenue growth of approximately 10 percent, surpassing our original target.

Revenue in the International segment increased 16 percent to 115 million as compared to 99 million in the year-ago quarter.

About 5 million of this increase was due to the Department of Defense order, with the balance largely due to positive currency translation.

Compared to last year in local currencies, revenue from Canada was up, while the revenues in Australia and the UK were modestly down.

Operating income in the segment was 21 million, up from 14 million in the year-ago quarter, reflecting the margin on the higher revenue and the benefit of cost savings initiatives in that segment.

For the full year, we now expect low double-digit revenue growth in the International segment, using the current exchange rates.

In Media, revenue was up slightly to 47 million.

Approximately 8 million in revenue from the recently acquired Back to Basics Toys catalog business partially offset the loss of last year's high-margin syndication revenues from the Magic School Bus, as well as lower software sales.

Operating income of $2 million was down $3 million as a result.

Corporate overhead expenses were approximately level with that of the prior year.

Overall, our cost reduction efforts resulted in lower costs in the quarter of about $15 million and brings our year-to-date savings to 22 million, well on track for our full-year target of 40 million.

Now here are some details from our income statement.

Cost of sales increased slightly to 44 percent of revenue from 43 percent last year, and this reflects the shift in the Trade sales mix, the higher cost of sales for Classroom Libraries and the reduced syndication revenue.

These increases were partly offset by the procurement savings.

SG&A increased 11 million, or 5 percent, and was flat as a percentage of revenue at 34 percent.

The dollar increase was largely due to increased promotional costs, primarily in Book Clubs and Continuities, partially offset by the cost savings program.

Bad debt as a percentage of revenue increased to 4.1 percent from 2.8 percent last year, and depreciation and amortization increased 2.6 million, reflecting recent investments made in facilities and IT systems.

The results of the quarter included $1 million in severance for staff reductions pertaining to the RIF announced in May, but implemented during the second quarter of this year.

Consistent with our plan for the year, interest expense increased by $1 million due to the prefunding of the $125 million 7 percent notes, which matured and were paid off earlier this week.

During the quarter, our balance sheet strengthened, cash was up significantly during the quarter, and that was reflected in the balance sheet and as a result of our strong cash flow.

Accounts Receivable were basically flat year-over-year in spite of the increased revenue and the higher value of the non-U.S. currencies, and this reflects an improvement in our agings.

Inventory was up about 8 percent, primarily due to the effect of the foreign exchange, the Troll and Back to Basics acquisitions, and some new product introductions.

Net debt, which we define as debt less cash and cash equivalents, decreased by 72 million as compared to last year's second quarter to 570 million, and this was due to the improved cash generation in the first half.

This improved the Company's net debt to capitalization ratio by 5 percentage points to 41 percent as compared to last year's 46 percent.

We are pleased with our year-to-year performance as measured by free cash flow, which represents cash provided by our operating activities less capital expenditures, prepublication and production costs, and royalty advances.

Cash flow continues to be an area of focus for us.

The decrease in capital expenditures in the first half of this year is in part due to last year's acquisition of a warehouse facility in Maumelle, Arkansas.

Free cash flow for the first half of the year improved by 86 million as compared to the same period last year, reflecting the benefit of the operating results and reduced CAPEX.

This year-over-year improvement will be somewhat offset by higher tax payments in the second half of the year due to the improved operating results, and we remain on plan to meet our target of 40 to $50 million in free cash flow in fiscal '04.

Now here is Barbara Marcus, who will speak about Children’s Book Publishing and Distribution.

Thanks, Kevin.

Today, I would like to give an update on the four parts of this business.

School Book Clubs showed real strength last quarter, with more teacher sponsors and more spending per teacher.

This was a direct result of the actions we took going into the year.

First, we overhauled our offers, kits, and promotional strategy in response to feedback from our customers.

These new programs quickly benefited results, attracting more teacher sponsors, including new teachers, and increasing order frequency.

Second, the integration of the Troll customer base exceeded our expectations, and these customers are now active participants in Scholastic Clubs across the board.

Overall, we estimate that this factor accounted for about half of last quarter's revenue growth in Clubs.

Third, online ordering continues to grow, now accounting for almost 30 percent of orders, and is especially used by our highest value customers.

Online ordering strengthens customers' relations with book clubs, encouraging more frequent ordering and greater overall spending.

We believe that this will allow us to offer additional products and services, which we expect to be sources of long-term growth.

Our work in Clubs has clearly delivered positive results, and for the rest of the year we expect to exceed our original fiscal '04 plan, achieving low double-digit revenue growth.

As with our Clubs, changes we made in School Book Fairs delivered solid results in the second quarter.

A major priority for us has been increasing revenue per fair, so we are encouraged that we have succeeded in returning to positive 2 percent growth after a difficult spring.

Better title availability and new promotional programs supporting fair chairpersons all contributed to this turnaround.

Fair bookings are on plan.

In addition, we are also developing growth strategies for middle school Book Fairs.

These fairs have shown positive initial results.

We also are making major progress improving the efficiency of our operations, streamlining our warehouses, and implementing more efficient routing.

These programs are critical to our long-term strategy for growing profits in this business.

Overall, Fairs are on plan and we expect them to meet our mid to upper-single-digit revenue growth target for the year.

Scholastic's Direct-to-Home business serves more than 3 million new families each year and is an essential part of our strategy to directly reach parents, teachers and children, and to leverage our trusted brands.

As Kevin said earlier, revenues were up slightly in this channel last quarter, but profits were down.

This primarily reflects initiatives we tested this spring and summer to reach new and existing customers in anticipation of implementation of the federal do-not-call list.

Certain of these tests resulted in higher than anticipated bad debt in the second quarter and have been discontinued.

We are confident we can adapt to this new legislation and are continuing to evaluate new customer acquisition initiatives.

Among other programs, we are partnering with major consumer brands like Nickelodeon and a major fast food chain to cross-sell and promote our offers.

Changes in this business inherently have longer lead times.

For the rest of year, we expect revenues to be flat, with bad debt improving relative to last quarter.

Overall, we believe that the Direct-to-Home channel is a fundamentally sound way to deliver high-value, low-priced books to families with young children, and we are committed to it.

In Trade, of course, we're extremely pleased to be the publishers of the best-selling Harry Potter, having now shipped more than 12 million copies of "Harry Potter and the Order of the Phoenix" and have broken all records.

Otherwise, 2003 has been a difficult year for books and bookselling, especially children's books, and this has impacted our Trade Publishing revenues.

Here are three things we're doing to strengthen our Trade business in the future.

First is a renewed focus on developing properties that work across our Trade Club and Fair channels.

This creates more outlets for our titles and allows us to drive demand in the Trade channel through our proprietary clubs and fairs.

For example, in the third quarter, we are launching in all channels our first new monthly paperback series in several years.

Geronimo Stilton already is an international children's bestseller, available in 36 languages, about a mouse newspaper editor.

Second, the mass market is of growing importance to us.

Going forward, we have a new and very strong licensed property program, including Shrek 2, Spider-Man 2, Rubbadubbers and Care Bears.

We have also added new teams in charge of mass sales, licensed property brand, marketing and editorial.

Third, we have undertaken a number of initiatives to repackage, repromote, and refresh more titles in our large backlist portfolio, as we recently did with Goosebumps, which is selling very well in bookstores.

Overall, we believe we have a long-term strategy to strengthen our high margin position in Trade publishing.

For the balance of the year, we estimate that the third quarter will be down somewhat due to continued softness in the backlist; but with a strong front list, the fourth quarter should be up.

Here is Beth Ford, who will give an update on our cost savings programs and operations.

Thanks, Barbara.

We remain on track to meet our goal of $25 million in savings in our purchasing and supply chain this year.

This is in addition to the $15 million of savings in the reduction in force announced in May, for total of $40 million.

Our progress comes in several related areas.

First, we continue to gain savings in the U.S., UK, and Canada, as we reap the benefits of our multiyear purchasing initiative.

Second, our distribution and warehousing have become more efficient, due in part to further infrastructure consolidation.

Third, our integrated forecasting and planning platform is now online in the U.S. and Canada, and already improving purchase-to-sales inventory ratios in our base businesses.

Fourth, we have improved our IT planning processes, rationalizing projects and focusing our IT investment, and are on track for a 35 percent reduction in capital spending in this area.

Our distribution capabilities have been put to the test in a variety of ways this fiscal year.

In addition to successfully executing the largest publishing laydown in history for the "Harry Potter and the Order of the Phoenix" launch, and doing it under the highest secrecy, we have also fulfilled and delivered large, complex orders for New York City, Los Angeles, and the Department of Defense.

Even with this complexity and the significant volume increases, we continue to improve our key service metrics; for example, reducing club order turn times by more than 15 percent.

These initiatives are all part of a larger strategy of meeting our customers' needs with premier cost-effective distribution and building long-term competitive advantage.

Looking ahead, we're currently developing next year's cost savings and efficiency improvement plan.

Among other areas, we are accessing global sourcing opportunities to further reduce purchasing costs and will continue streamlining activities in School Book Fairs.

We will provide more details as our plans progress.

With that, I will turn things back over to Dick Robinson.

Thank you, Beth.

We're pleased overall with second-quarter results and are solidly on plan for fiscal '04, with improved performance in Clubs, Fairs, International and Education.

Free cash flow is strongly improved, up over $86 million relative to a year ago.

For the second half of the year, we expect to build on these strong performances while we improve Trade and Direct-to-Home businesses.

Next year, we will focus on revenue growth in our core businesses while improving margins through continued cost reductions, including process re-engineering and global sourcing, as well as continued focus on strengthening our free cash flow and tightening our capital allocation process.

We will discuss our '05 outlook in the March call.

Thank you for listening and we're now available for questions.

Thank you. (CALLER INSTRUCTIONS) Peter Appert of Goldman Sachs.

I think this question is for Barbara.

With regard to the Club business, obviously the revenue trends were quite impressive here in the current quarter.

You cite a low double-digit growth rate for the full year, which would, I guess, in the context of the contributions from Troll and then easier comps in the second half, perhaps imply some underlying slowdown in the pace of business, so I was just hoping you could address that issue.

And then secondly, is the profitability within the Club and Fair businesses back to the pre-fiscal '04 levels as a result of the initiatives implemented this year?

I will take the first part and I may give the other to Kevin, just so it is said exactly right.

We do not -- we are being mindful, but we do not truly anticipate a slowdown of our customers responding to our new initiatives.

We have some good, solid pull-throughs and our customers are responding year-to-date, and we think they will continue.

We are mindful that we don't want to overpromise.

And will Troll be as significant?

Is there any issue in Troll's quarterly impact?

In other words, should I anticipate that Troll would be a fairly meaningful percentage of the percentage increases in the third and fourth quarters as well?

Maybe in other words, could you just give us what the annualized revenue contribution from Troll is?

I don't think we have looked at it exactly that way.

Our customers -- the Troll customers are engaged.

They are participating both in the Scholastic Clubs and in Troll Carnival.

Kevin, I don't if you want to add anything here?

No, I think that is probably -- other than, Peter, your question about the profitability.

I think the combination of the revenue growth that we have seen in both the clubs and the fairs and the cost reduction efforts last year, as well as what we see this year, have increased the overall contribution from those two groups.

To prior levels?

To prior levels, yes.

Peter, I just want to say, I think we're feeling very, very positive about both the Troll engagement and the engagement of our existing renewal customers, as well as some new -- attraction of new teachers, so I think we're feeling -- I don't want to go off this question with you not feeling that we don't feel incredibly positive of what we have accomplished this year and will continue to accomplish in the second half on Clubs.

Okay, thank you.

Brandon Dobell of Credit Suisse First Boston.

Maybe the first one for Margery.

Maybe if you could give us a little more color on what the differences are in terms of how to sell into Classroom versus Library.

You mentioned on the open remarks that the Classroom sales remain pretty strong, but Library continues to see difficulty.

Is there that big of a difference in how budgets are done or is it the products?

Just looking for some more color there.

And then second question, probably for Barbara.

If you were to give us a sense of how sustainable you think the revenue growth would be in Clubs and Fairs, let's say if you scaled back on promotion now or if you scaled back on going after new initiatives, things like that, just trying to get a sense for if this is more a near-term thing that you have seen some benefit from the original initiatives or if you think there's a structural change that we can count on through the balance of this year and into '05 as well?

Brandon, this Margery, so I'll start your question.

There is some difference between selling into libraries right now and to classroom libraries.

A lot of it has to do with where the funding is.

A lot of school districts and schools are using federal money to put children's books into classrooms, so that kids can have more reading practice.

And the funding for the school library has not benefited as much from the new federal and state initiatives around raising reading achievement.

But I do want to say that we have made, really, we think some very strategic changes in our Library publishing.

Our Library sales operation, we have a new management team there, we have a new president in Library, and we are seeing strengthening in our business there.

So despite the fact that the environment is not great, we feel that we have put that business back on track to meet our goals for it moving forward and we are optimistic about that business, as well as the Classroom Library business.

Okay, thanks.

This is Barbara.

On your clubs and fair question, I think we feel that we have established a promotional strategy that is resonating with our club and fair customers, and we expect this kind of response to continue.

What we did is we really focused on our teacher customers in Clubs, and have been successful in creating something that they really know that we care about them, that we are delivering a strong program to them.

And the way we have done that is we have refined our direct-mail strategy and really have focused on engaging our teacher customers.

I think we feel we have done -- are on the path to do a similar thing in Clubs.

So we are feeling this is not a onetime moment.

Is the promotion spending or the changing how you're going after your customers, is that a material additive expense or is this really just taking your existing dollars and shifting them around?

The latter, absolutely.

We were very careful about that.

I think it is important to note that, to your point, that some of the growth that we have seen this year obviously has been through the acquisition of Troll, and that necessarily -- will not necessarily compound next year.

Thanks a lot, Kevin.

Lauren Fine of Merrill Lynch.

You have given us some bits and pieces in terms of getting at underlying growth rates.

I'm wondering if you could tell us for the company as a whole what the organic revenue growth would have been excluding foreign exchange and acquisitions.

And then maybe more importantly, if you could do the same thing on the cost side, because I'm still a bit confused.

I heard some of the items that you enumerated in terms of the impact of foreign exchange, severance, and some of the other items there, but I'm just curious how much acquisitions affected costs.

And then I'll have a follow-up question.

Lauren, this is Dick Robinson.

Kevin will provide a little bit of detail.

I think we are concerned about the cost increase relative to the revenue increase.

However, much of this is due to the shortfall in trade and the bad debt expense, which hit the bottom line pretty hard, as well as the other items that you mentioned.

So I think we are pleased with the overall organic growth, and Kevin will give you some detail on that point.

Right.

Excluding foreign exchange and the $8 million increase from Back to Basics, we probably grew about 3 percent.

We had 6 percent growth in the quarter, Lauren.

(multiple speakers) Troll as well, though?

Obviously, Troll benefited the Clubs and they benefited Clubs probably by $7 million, so that may be 1 or 2 more percentage points in terms of the total growth rate.

Could you --

I was just wondering on the cost side if you can do the same thing, if you can eliminate the incremental costs you incurred from Back to Basics and Troll and foreign exchange so that we can understand just that impact on the cost increase.

Well, most of the foreign exchange revenue -- I mean, there was a corresponding increase in the foreign exchange cost -- I mean, there was a slight margin pick-up as a result between the spread between the revenue and the expenses, but as our foreign exchange revenue increases, so do the costs that are denominated in foreign currencies.

So that would probably represent 80, 90 percent of the foreign exchange revenue pickup.

So I'd say that's, say, about $9 million.

Back to Basics, although it generated about $8 million worth of revenue, it is just a new acquisition.

It was accretive.

I would say it probably had about a 10 percent operating margin, so of that $8 million, that was about $800,000, so that would leave about $7.2 million worth of expenses.

And then on Troll, I know it is more difficult, but as a program when you acquired it, was it as profitable or less profitable than the way you were running your Club business?

I think the way it has been integrated into the Club business has been very advantageous.

It is difficult to try to -- it would be -- it would not be responsible for me to try to differentiate what the costs are because it has been thoroughly integrated into our business now, but it certainly has been a very successful integration process.

The only other question I have is, when you looked at the progression in the quarter on some of the Book Clubs and the Fairs, did you see any change sequentially.

Because I know last year that had been a problem, where you started out the year reasonably well and then the momentum sort of dissipated.

Did you see any of that trend or was it pretty steady throughout the quarter in both the Club and Fair business?

I'm going to take that, Lauren.

I think we feel that we had specific issues last year in the Clubs and Fairs, and we did -- and have reviewed those internally.

I believe we shared many of those, and I believe we feel we have fixed them, and that we have turned -- focused on what those issues are, addressed them, and how our customers are responding and what we have done internally in the fairs with title availability, with focusing on our fair chairpeople really being able to be engaged in all our programs, the clubs of the promotional program.

I think we really feel that we have listened to our customers, responded, and we should see this kind of response from our customers to continue.

So the momentum obviously has (ph) been throughout the quarter?

Yes.

Thank you very much.

Steven Barlow of Prudential.

Two questions.

On Education, Margery, what quarter do we expect to see increasing operating profit?

Because you had good revenue, but the profit obviously was down this quarter.

Secondly for Kevin, can you give us an indication on the return on invested capital on Continuities in the first half of this year and what it was last year?

I'm going to turn the profit question on education over to Kevin.

We actually saw a profit in the first quarter, which typically is the largest revenue quarter for the Education group, and that was particularly driven by success in the Classroom Libraries and the READ 180.

It was fairly a wash in the second quarter, but we saw good profit in the first quarter.

Now, I didn't quite understand your question --

I said will you have an increased profit, then, in the third and fourth quarter from what you're seeing at this point?

I thought the profit should have gone up this quarter.

I would rather not speak specifically on a segment-by-segment basis in forecasting, Steve.

I think we have given some indication as to what our overall revenue growth is on that, but I would prefer not to break that down into a segment basis going forward.

Now, I did not quite follow your return on investment question on the Continuities.

It's just that we seem to have quarter after quarter of things being a problem there.

And you said you wanted to stay with the business, but I am just curious, I guess.

What has been the success overall since you bought it and just trying to look at it from an ROIC basis.

Where were you last year?

Where are you so far in the first half of 2004?

Steve, let me start with that and then I'll ask Kevin to address the return on investment question.

This business is a staple of the way Americans acquire books, and it has been going on for 50 years.

It serves nearly half of the new families in the United States each year.

We provide on a continuity basis outstanding classics such as Dr. Seuss and popular titles such as Disney, and these are provided on a very low-cost basis.

And this business has weathered different periods, and we are at the moment, of course, in one with do-not-call as an issue, but we're confident and know that we will find good ways of finding new customers.

So as a business it's a solid, steady business that's performed well for a long time.

When we first acquired it, we felt it had too much revenue -- most of the incremental revenue being unprofitable -- so we reduced the size of the business and that worked very well.

And we achieved very satisfactory operating margins and cash flow in that business.

At the moment, as we adjust to the do-not-call environment, we are looking for just fine-tuning exactly the right way to reach our customers.

And that has caused a bit of hiccup in the last -- it's only, I think, the last two quarters that we have been feeling this impact, and do not call, of course, came in in October, but it was anticipated throughout '03.

So we're confident about the business.

It is a good business.

It is a basic way of getting books to young families in the United States.

It has a lot of growth potential for the Company and it has reasonably good financial metrics.

So Kevin, would you try the ROI question please?

Steve, as Dick said, looking at this on a six-month basis probably wouldn't be a good representation.

We have looked at this since the acquisition of the Grolier entity over the past three years, and that has achieved our expectations, and that include ROI in the -- I believe -- now, I'm doing this from memory -- from the 10 percent plus or minus range, 10, 12 percent.

So I think that it has met our expectations, albeit this past six months has been a little bit disappointing from the bad debt standpoint.

Thanks.

(CALLER INSTRUCTIONS) Mark Hughes (ph) of SunTrust Robinson Humphrey.

It's Toby Somner for Mark.

I had a question regarding Clubs in the online ordering.

If you could let us know what your expectations may be for that over time.

Where do you think that can go?

And if you could talk a little bit, give us a little bit more color about the high-value customers that tend to have a propensity to order online, and what that may be able to do for the frequency that they order on an annual basis?

Thank you.

Let me start with that one.

We are seeing a steady increase in the use of online ordering by our Club customers.

And this is part of an overall broader strategy of the Company to reach our customers through the Internet and grow revenues through this important distribution channel.

So it is part of an integrated strategy.

We are very pleased with the way, as Barbara said, particularly our higher value customers are interacting with the Internet.

There are both cost-saving and revenue enhancement opportunities here, and it is an important way of transitioning our distribution over the long-term.

So Barbara, would you touch on the basics of this business?

Sure.

I think that Dick explained the strategy, and we will continue to be both speaking to our online customers, knowing that they are still part of our mail stream, but that they also are interested in communicating with us online.

We have had some success on selling them additional properties, showing them, highlighting different kinds of things on our high-value customers -- these are our great customers.

They are really become comfortable ordering online, and what we are finding is we're trying to move all our thinking to not breaking down orders and revenue per order, and really looking at revenue per customer.

And what we are seeing overall, not just online, that our revenue per customer is up 6 percent, and we believe that our -- number one, of course, our high-value customers are driving that, and we are seeing more orders -- it's up 6 percent -- more orders from our customers this year.

As a follow-up, could you distinguish between the value that these customers have in terms of revenue relative to your non-online customers, and then perhaps give us a sense for the cost savings, online ordering versus your other distribution channels?

This is a simpler process.

It is faster, faster delivery.

It has increased the frequency -- in respect to your question about revenue enhancement, it is really basically in the frequency of ordering that this has had an effect.

And so it has been a strong performer in that regard, and we're looking forward to moving more of our customers into this operation.

There are those who love phone ordering with that personal contact, but we think we have achieved a certain level of individualization and personal contact through the Internet as well.

In respect to costs, it is less expensive on a per-order incremental basis, and so as more people move over to that and as we amortize the cost of the development of our Internet systems, this should have a beneficial effect on our cost structure.

Thank you.

William Bird of Smith Barney.

Just two quick questions.

One, have you seen a rise in returns in connection with trade weakness?

Second, I was wondering if you could drill down a little more on Continuities and the problems.

Specifically, I was wondering which customer acquisition channel is giving you some difficulties with bad debt, and specifically, how fixable are those problems in the short-term?

Thanks.

First of all, we think that there is a bit of a sea change in the trade business, with booksellers returning more quickly, trying to be more efficient with their own inventory, and I think throughout the industry we see a tendency for faster returns and somewhat less focus on the backlist.

So there seems to be a sea change in the industry relative to inventory management, particularly at this time of year, as almost all publishers report quicker and larger returns.

So I think that is definitely happening in the business.

Kevin, do you want to deal with the other questions?

I'm going to take the at-home question, but then we can talk about -- on the Trade, we think we are adequately reserved, so I don't think that is an issue.

Just to elaborate on Dick's answer on the Trade is that we do believe they're holding fewer weeks of inventory on hand and are ordering less upfront.

So is sort of a one-time change in their buying behavior, and we believe going forward, even at the end of this year, it will sort of have become balanced.

But it was a difference, is they experienced softer sales last summer and last spring, and even up and down this fall -- you'll see one month up, one month down.

And so, I think they are adjusting their business to the economics they are experiencing, and then we are.

On the at-home business, I think I am answering your question.

In the spring and summer, we did try some initiatives directed towards both our existing and hopefully new customers.

Some of these initiatives included additional shipments to our existing customers and some of this included new methods of customer acquisition, such as using the Internet in a variety of ways.

And we have looked at those various initiatives and tests and we have discontinued those initiatives that have not worked.

But in the interim, we did experience a higher bad debt level.

Thank you.

A follow-up from Lauren Fine of Merrill Lynch.

I'm just wondering on the Harry Potter sales for the quarter, if you could break out how much was Harry Potter 5 versus backlist?

And then secondly, you mentioned that the repackaging or relaunch of Goosebumps went well.

I'm wondering if you could give us any details around that, and how well the new Captain Underpants books have done, because you had very big print runs on those.

Yes.

What Kevin doesn't say, I will supplement.

In the quarter in aggregate, we had about $13 million worth of Harry Potter sales, and approximately two-thirds of that -- 70 percent, perhaps -- was Harry Potter 5.

The bulk of it was Harry Potter 5.

We had some 1 through 4, but mostly Harry Potter 5.

And I think your next question was on Goosebumps.

Goosebumps has done very well.

We have over one million copies in the marketplace.

It has done especially well in our more traditional accounts and we are going to continue to release the backlist going forward.

And Captain Underpants, it is still -- I don't know if you looked at the New York Times list on Saturday.

It is still (indiscernible) -- it still ranks high on the best-seller lists.

It is still -- and did quite well, about our expectations.

I think we have well over 0.5 million copies of each book in the marketplace.

You mean still in the marketplace on (multiple speakers)?

No, I mean sell through. (multiple speakers) No, we released it.

It is selling very well.

There is no issues with Captain Underpants at all.

Sorry, Lauren.

All right, thank you.

A follow-up from Peter Appert of Goldman Sachs.

Kevin, can you remind us please what the capital spending is going to look like in fiscal '04?

And then, any preliminary thoughts on how that might go directionally in '05?

And then related to that, whether we should anticipate another step-up in the free cash flow number in '05 from the '04 level?

We had said that CAPEX would be somewhere in the 55 to $60 million range for '04, and that is where our current view is.

We have also said that we expect that the range going forward to be about 2.5, 3 percent of revenue.

We really haven't given any specific guidance per se as it pertains to '05, but I think that is probably a pretty good metric to use for the time being.

Okay, and in the context of the absence of Harry Potter revenues next year, can you have another increase in free cash flow in fiscal '05?

I think what we're doing now, as Dick indicated, is that we're working hard to develop our plan and other areas of margin improvement for fiscal '05.

But to specifically comment upon that would probably be premature.

Last question, the estimate range is still quite wide, given that you're through the biggest earnings quarter.

Why do you choose not to narrow it?

And maybe more specifically, what would it take to get to the high end of the range?

We are on plan, Peter, for '04.

Of course, given our experience last spring, we really did not want to change the range, but we feel that we are on plan.

To get to the higher end of the range, I think we would have to find that everything was exceeding our current expectations and that there were no significant surprises, but we are pretty much right on our plan for '04.

If the Continuity business, of course, improves, that would help us.

Okay, thanks.

A follow-up from Mark Hughes of SunTrust Robinson Humphrey.

It's Toby Somner.

A question for you on the education business.

Could you comment about what the prospects are in the Classroom sales, if you see further opportunity for the kind of sales that you had in New York, perhaps in other cities, and what the outlook is there?

Toby, it's Margery.

We feel that the purchase in New York was extraordinary and we don't expect other big cities to do that kind of purchasing of Classroom Libraries on that scale.

Having said that, our Classroom Library business is very robust and we are having large sales in other cities, just not the size of New York, which was gargantuan.

We believe that our Classroom Library business and our Paperback Book business is going to be very strong going forward, and we are seeing a lot of interest in buying books for kids to practice reading skills, really across the country.

As a follow-up, you may have mentioned this, but READ 180 has been a source of strength in recent periods.

Could you mention what the revenue was in the quarter and what your outlook is for that going forward?

Kevin, do we say that?

We typically don't say that.

The revenue was up, Toby.

It was up about 40 percent, and that was fairly consistent with the growth that we saw in the first half -- or the first quarter.

I'll just leave it at that.

Thank you.

I'm showing no further questions at this time.

I would like to turn the floor back to the speakers for any further or closing comments.

Thank you.

This is Dick Robinson again.

I do want to reemphasize the commitment we have to free cash flow.

I had indicated in my summary remarks - and this is directed to Peter Appert's question in particular, that we retain an intense focus on free cash flow.

There is an evolutionary process going on in the Company that, because of our investment in programs such as IFPI and other information systems programs, that is giving us better information about how to run the Company.

We do have opportunities in reducing inventory, being more efficient in process re-engineering.

All of this would help to lower our cost base and increase free cash flow.

There's something we are retaining as a focus.

We don't expect any dramatic increases in our free cash flow needs.

As we have said before, we had a period where we had to invest in facilities to keep pace with our growth.

That period appears to be largely over, and we are intensifying our focus, not only on free cash flow as a goal, but also on approved capital allocations.

So Peter, while we avoided making any comments about '05 in this call, we did want you to know, and all of the colleagues that are still listening, of our focus on free cash flow as an important financial indicator of our success and return to stockholder value.

Thank you all for listening and we will look forward to talking to you in March.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.