Scholastic Corp (SCHL) 2005 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 your questions following the presentation.

If at any point during the presentation you would like to register your question please press star 1 on your touch-tone phone.

It is now my pleasure to turn the floor over to David Nelson, Vice President of Investor Relations and Treasury.

Sir, you may begin.

Thank you.

Good morning.

Before we begin I'd like to point out that the slides for this presentation are available for simultaneous viewing by going to our web site Scholastic.com, clicking on investor relations, and following the links on that page.

Now, before we begin, I'd like to also point out that the presentation contains certain forward-looking statements which are subject to various risk and uncertainties including the conditions of the children's book and educational materials markets, and the acceptance of the Company's products in those markets and other risks and factors identified from -- by -- 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'd like to introduce Dick Robinson, Chairman, CEO and President of Scholastic to begin our presentation.

Thank you.

Thank you.

Thank you, Dave.

Good morning to all, including our investors, the analysts and the wonderful members of Scholastic management who are here in the audience as well as those that are on the stage.

I think we put everybody on the stage that would fit, and then those who couldn't fit, are here in the front row.

So we're -- we're all here to talk a little bit about our 205 year and where we're going for 2006.

We've got people on the telephone so we've -- we've got two audiences here.

Those that are present in front of me, and those that are on the phone so we'll keep both of them in mind as we present and ask questions.

Before we talk about last year, let's start with a little magic from our current fiscal year.

As the world knows, last Saturday we released Harry Potter and the Half-Blood Prince, the sixth book in the seven-book series and sold over 6.9 million copies in the first 24 hours alone, which are statistically-minded chief counsel calculated as an astonishingly 80 copies per second, easily surpassing book five and our retail accounts are reporting that through yesterday, our -- our -- the sales remain very strong.

And of course, all of us are proud and many of you in the audience here from the staff and certainly those on the podium are -- are proud of Scholastic's role in the marketing, publishing, selling, manufacturing and shipping of this great creative work by Jo Rowling which was the largest book release in --in history.

Some very tired people from the staff, but very happy are present here celebrating that great achievement.

In fiscal 2005, we hit our targets for higher earnings per share and operating margins, and -- and those of you who were here last rear will remember that that was the Number 1 focus for the -- for the year, improving our operating margin.

And that was despite lower revenues compared to 2004, when we released Harry Potter 5, and this year we -- this 205 year we also exceeded our targets for free cash flow.

We strengthened our core children's book business, we produced strong gains in education which had a -- a marvelous year, great year.

We stabilized our direct-to-the-home business and improved results in international and successfully launched a new media property, Maya & Miguel.

We also continued to strengthen our management team with key appointments in children's books and e-Scholastic.

Our principal focus, as I said, remains on expanding margins while growing revenues.

Sounds simple but that's the -- that's the main thrust of the Company.

Higher margins in our core children's book business will come, we think, from better information about our customers, leveraging our products more systematically across our channels, driving costs and operating efficiencies, and moving more of our business to the Internet.

To grow the company beyond our core children's book business, which we have been doing steadily, we are doing several things.

Three.

First, partnering with schools to raise student achievement by building on our leading position in education technology; second, helping parents to help their children's learning at home by leveraging our creative strengths and our strong trusted relationship with young families; and third, meeting the global demand for reading and learning, especially in English, that's outside the United States as well as inside.

In Children's Book Publishing and Distribution, we're trying -- we're going back to viewing this business as a whole rather than as a series of -- of collect -- of divisions and activities.

We're -- we're bringing our channels closer together to achieve higher margins as well as long-term growth.

There're several ways we're doing this.

First, our -- we're investing in technology to help us know more about our customers and communicate more easily with them.

In book clubs, for example, online ordering has been a huge success.

Our customers find it simpler, and we get better data on what they buy.

We expect similar success as more parents use Parent Cool, which we tested last year, that is our parent -- the parent version of our club ordering online for teachers.

In book fairs, new customer relationship management tools enable our book fair sales people to segment, target and track the 120,000 fairs we conduct annually.

We've got something called Customer Connect, which is realtime online service for our sales people right own our desks as they call the book fair schools.

But we also have online sales tools for our customers, such as the chairperson's tool kit, again, an Inter -- a web-based direct link with fair organizers, they can dial it up and see how to run a fair.

We're also introducing new systems to get more timely and detailed sales information, which will, in fairs, benefit product acquisition inventory level and better positioning of product for sa -- for sales and distribution.

In trade, we're creating stronger relationships with our ac -- with our accounts.

This showed up a bit in last year's improved sales and lower returns, as well as the great bonds forged in the past several months by our successful Harry Potter 6 launch with our retail customers who are all very pleased with the way we handled that -- that launch.

Customers all -- all across -- across all of Scholastic rely on Scholastic.com, which has become a top-rated content and commerce site for parents, teachers and children.

In fact, last year our -- our Internet sales, including book club orders, were almost 240 million, and interestingly enough this ranks us as the Number 3 Internet book seller in the world as well as being in the top 50 e-commerce sites, an interesting statistic for those of us who have been working on that for a long time.

Second we're -- we're using better customer information from our direct channels to create and mar -- and market better products.

And we've always had the ability to know what kids buy through our book clubs.

But we're continuing to refine that information and -- and pair it with book fair information that we also get and bring this to our trade people who then help create better product, as well as selecting better product and choosing better product in clubs and fairs.

And this -- this results in -- in many good things for the Company.

We're focusing on this, and enhancing and improving it, you'll hear more about that in the question-and-answer period.

This has several effects here.

One, we contri -- we continue to cro -- create cross-channeled best sellers with talented authors like Cornelia Funke;

Dav Pilkey, of Captain Underpants; and Jenny Nimmo, the author of Charlie Bone, a book that started in book fairs, and then went in the trade and is now a New York Times best seller.

We are focusing product development on key areas of -- key areas of opportunity identified by our customers.

This includes babies and toddlers.

We also have a new interactive Early Years product line from Klutz called Chicken Socks and ver -- and new reading platforms that we'll talk a little bit more about later.

We also are creating cross-channel products with our high quality film and TV entertainment like Maya & Miguel, which launched last year and is the highest rated program on PBS for school-age kids and has spurred books and other product sales in other channels.

More custor -- customer information also improves marketing and merchandising.

In clubs this fall new offers in product presentations will, we think, drive top line growth as we build on what we learned from last year's pricing strategies but also innovate some new ways -- of presenting our -- our product.

In fairs, improved customer and sales data will make merchandising more responsive, driving higher revenue per fair.

And third we're improving our cost reduction efforts to a new level as we are putting our staff through the new SIx Sigma -- now to us, Six Sigma methodology.

These are several ways that we're moving to improve the -- this revenue growth and the bottom line of our core children's books business, which we're -- as I say, we're focusing on that as --as an entity where we're trying to work together to improve both the revenue and the margins and we are -- I think we're already seeing some good signs of success in that area.

Moving to education, which had such a great year, we're really creating a new business model here.

We --we call it partnering with schools to raise academic achievement, but it's based on more than just our great product READ 180.

It's really a new service and support model, which we call partnership or solution selling.

And why -- why are we doing this?

As the just-released NAPE data showed, there's been little growth in middle school and high school achievement, there's been good growth in -- in early years achievement.

But two out of three adolescent students still read below grade level and only a third of them are reading at what is called proficient.

The others are reading at either basic or below basic, all of which is below grade level.

Meanwhile, educators need to meet the legal requirements of no child left behind, leading them to look for new solutions and, therefore, opening the door for READ 180 and other products and services, of course, from Scholastic, but also for a partner in helping them solve the -- the problem of how to raise the scores of struggling adolescent readers.

The success of READ 180 shows how technology is now front and center in America's classrooms providing teachers and administrators with realtime data to make the right instructional decisions for their students.

This may explain why technology now makes up more than 30 percent of education sales, but kids really have -- love using the computer and the computer is able to spot their weaknesses and build on those -- build on their strengths.

So it's moving toward sort of an individualized mode of instruction and that's part of the reason why technology is so successful.

But technology -- using technology in the schools is -- is a new thing on a widespread basis and it requires a new model.

READ 180 is -- is a great product, yes, the most validated and researched intervention program available.

But in our -- in our new paradigm, we also need to provide technical assistance, that is making sure the computers work; professional development, making sure teachers really know how to use the program; and educational support teams, people who are trouble shooters going out and calling on schools and saying is this program working, or there's a school over here where it's working great but over here or even a classroom within the same school, over here we need a little bit more help so we bring in special support for the places where it's not working.

This is really a new thing in educational publishing, although this is been going on in the software business for -- for some time.

But this is a new way of looking at this business, a new way of conducting it.

And you may -- Margery may be able to en -- enhance that a little bit later.

This year we're offering a new READ 180 addition, which we're calling ent -- READ 180 Enterprise, which is both an upgrade to our installed base and, of course, to new customers, much more powerful and -- and robust.

We also have several new technology launches, really quite a few.

Zip Zoom, a new learning system for K2 English language learners, which supports language ac -- acquisition and beginning reading skills.

Now there's not that much out there for young ELL students, that is kids who -- whose primary language is other than English coming into first, second and third grade, and they -- there's not much there to help them.

So Zip Zoom is -- is a tested program created in Hawaii in a federal lab, which we think has great potential.

And our customers are responding to it.

Fast Math, already a fast-selling program, is a targeted program created by the author of READ 180 to guarantee fluency with math facts, that's coming through our Tom Snyder Productions.

We're also expanding our course offerings for RED, which is our rap -- rapidly growing online professional development business which had a -- a terrific sales gain from a small base this past year but which is part of the new paradigm we're talking about professional development programs being done by teachers online.

So we've transformed our sales model, moved away from a textbook paradigm to one which puts greater focus on service and partnering with our customers to ensure that our programs work.

But print products are working well, too.

It's not just technology.

We're seeing gro -- great growth in sales of books and magazines and certainly profitable growth.

Sales have been particularly good among reading first schools as they enter the third year of federal funding and are looking for high-quality classroom libraries and other print to boost reading scores.

In other words, once the kids can read, what are they going to read?

So we're -- we've been successful in getting large school systems to buy classroom libraries here in New York City, there's one in every single classroom -- classroom library from Scholastic from K to grade 9.

And we expect this trend to continue, therefore, publishing several targeted products such as Math Libraries by Marilyn Burns, also getting a great response, which -- she's a note -- a noted math educator who is particularly popular with teachers.

So our print is still right in there.

So new paradigm in education, still supporting with wonderful reading materials, terrific growth in that area, beautiful improvement in margins, very strong momentum in that business.

Scholastic's second growth opportunity is to extend the brand values of our Company to parents through the direct to the home market.

Parents are increasingly concerned about how they can help their children develop and be more successful as readers and learners.

They no longer see the school as the sole place for education to take place.

They feel that they've got to take more responsibility themselves for their child's education.

And our -- Scholastic's trusted reputation and our good relationships with parent customers help us to help them meet this need.

How are we doing this?

We're building on our existing relationships with families through our continuities business.

Last year, Scholastic at Home primary direct channel to families of young children imple -- implemented a revised strategy of focusing on our most productive customers.

We've talked about this before.

And but we -- we did it.

It worked.

Improved targeting, better service and a shift toward lifetime customer value will all continue in fiscal 2006 as this business has become stabilized and we're now putting it back on a path for growth.

Second, we have some innovative high-quality learning products in several different places.

This fall, our media group will introduce Read With Me DVD, I hope some of you can see it upstairs after this session.

This is a product we're developing in partnership with Fisher-Price.

Fisher-Price is marketing it through their retail channels and it's got a nice early introduction.

We're also aggressively launching products through Scholastic at Home, like Scholastic Phonics, Scholastic Classics, a library of great children's literature, Vegitales, which many of you know about, very good response, and a -- and a new -- new book of knowledge, all of which have proved successful in -- in tests as well as continuing our popular programs like Dr. Suess, Disney, Nickelodeon, and a newly refreshed Baby's First Steps to Learning.

We've also seen strong growth in our Back to Basics toy catalog business, in which we are successfully marketing high quality educational toys direct to the home both in print and online.

And third, based on our -- our 10-year commitment to building our Internet business, we're also in -- in a very good position to use the Internet to reach families directly as -- as described earlier.

Building on these strengths is a key focus of Seth Radwell and our new president of e-Scholastic and his team.

And I'll introduce you to him in a few moments.

Finally we'll meet the growing global demand for reading and learning outside the United States especially in English by leveraging our core strengths in children's book and reading and our extensive global presence.

We are profitably growing subsidiaries in Canada, the U.K., Australia and New Zealand, those are our -- our -- our long-term businesses that we've been in for many years.

Last year we made dramatic progress in Australia, reducing costs and growing revenues.

In Canada we're building fairs and education on a very clubs -- very solid clubs and trade foundation.

And in the U.K., we've made significant changes throughout the organization to increase marketing effectiveness and rebuild our -- our trade business.

We're building the export business, too, with the launch of international COOL, which enables international schools around the world to use the Internet to order book clubs.

Through a major State Department contract, very exciting to all of us here, we developed the first Arabic language children's book libraries, which we will sell later this year in -- in several Arab countries.

Exports of English language teaching material in Asia are growing rapidly driven by products like Zip Zoom, which we talked about before, as well as our broad array of inexpensive paper backs.

We're adapting our school based distribution models in -- in Asia and Latin America where clubs and fairs are exciting new concepts and a single book fair can draw over 30,000 people as happened in a fair in Philippines last year.

And we're -- we're targeting and adapting literacy education products to meet the rising demand for English language learning in Asia both through exports and through developing a new presence locally.

So last year we met or exceeded our key goals for margins, profits and free cash flow, while strengthening the core children's books business, continuing strong momentum in education, making progress in continuities and international.

These results show our progress as we leverage our strengths for profitable growth.

Last week's phenomenal launch of Harry Potter and the Half-Blood Prince was a great start for fiscal 2006, and -- and we are confident that we -- with the new management team, too, as well as the people who have been with us for several years, I'm confident we can build our business in the three ways I've discussed with you, by better use of customer information, better products through closer collaboration across channels, lowering costs of manufacturing distribution, all leading to improved margins in our core children's books business.

Second, driving growth in education, home learning= and international.

All of these leading to improved margins and renewed revenue growth.

That is our story more broadly for 2005 and our strategy going forward.

Mary Winston, CFO, will now discuss our results for the fourth quarter and after that, I will introduce the people here on the stage and we'll have some questions and answers directed to-- to any of us.

Mary, your turn.

Okay.

Okay.

Thank you, Dick.

Good morning, everyone.

As Dick has described, we're very pleased with our results for fiscal 2005.

We exceeded our guidance for earnings of free cash flow, we've improved margins in the financial strength of the company overall and we've laid the foundation for our margins to continue to improve in the coming years.

As we stated last year, Scholastic has several top financial priorities.

First, increasing profitability of our individual businesses, but also looking collectively across our businesses and leveraging and increasing the profita -- profitability of the Company overall.

Second, improving free cash flow and shareholder value.

Thirdly, we're focussed on improving capital utilization and our long-term financial returns.

And finally, on ongoing -- our -- an ongoing priority is to improve our key financial processes and maintain strong internal controls.

I believe we've made considerable progress in all of these areas last year and I'll describe in a minute our margins, profits and free cash flow and how we improved that for the year.

For fiscal 2005, overall revenue was approximately 2.1 billion and declined 7 percent from the prior year.

As you will see when we review the results by segment, declines in children's book publishing and distribution as the result of the expected lower Harry Potter sales and the new strategy in our continuities business were partially offset by strong growth in education and international.

Cost of goods sold declined from 49 percent of revenue to 47 percent, reflecting growth in higher margin education technology sales and higher costs associated with Harry Potter in the prior year.

SG&A declined 21 per -- 21 million or 2 percent.

Excluding the year-over-year difference in the continuities related charge, SG&A declined 10 million, reflecting lower selling and marketing costs offset by expenses associated with Sarbanes-Oxley compliance.

Bad debt expense declined dramatically as our strategy for the continuities business focussed on our more productive customers.

Aggregate bad debt and returns were down while customer pay rates were up.

On a GAAP basis, fiscal 2005 diluted EPS was $1.58 per share, up 10 percent from the prior year.

As we have previously stated, this includes a $0.06 severance charge incurred in the first quarter of the year associated with the restructuring of our continuities business.

Without this charge, full-year earnings per diluted share were $1.64.

Now, we'll look at the segments.

In children's books publishing and distribution, revenue declined 5 percent last quarter, principally due to lower sales and continuities, consistent with our strategy for that business.

However, profits and margins rose in the quarter, even after adjusting for last year's continuity related charge.

These positive results were driven primarily by continued improvements in trade, and continuities and the year-over-year growth in fairs.

For the year, segment revenues were down 15 percent, reflecting these same factors as well as the anticipated decline in Harry Potter sales.

As a result, absolute segment profits for the year declined.

In clubs, after our strong 15 percent growth in fiscal 2004, revenues were down approximately 2 percent for the year.

Primarily driven by a -- a slight decline in revenue per order.

Building on the -- what we learned about last year's price changes, we anticipate that improvements in product selection and presentation and cost control initiatives will allow the business to return to top line growth and higher margins in fiscal 2006.

Fairs were an area of growth last year, and improved merchandising and product availability improved revenue per fair by 4 percent and stronger marketing resulted in a modest increase in fair count.

We have previously outlined the strategy for our continuities business, and Dick talked about it, and I'll just reemphasize it here, and that is to focus on more targeted promotion spending, better customer service, new product development and a shift toward higher value customers.

While this has resulted in lower revenues as anticipated, we have also lowered bad debt and returns as a percent of revenue and have improved our customer pay rates.

As a result, continuities profitability improved last year and in the fourth quarter, even excluding the charges included in the prior year and the first quarter numbers.

We now believe that this business is on track to grow profitably in the future as Dick has described.

Finally, lower Harry Potter revenue was the primary cause of lower revenues in the segment and in trade for the year.

However, this decline has partially off -- -- was partially offset by our successful growing of non-Harry Potter back list sales and lowering of returns.

We believe this result reflects the strength of our core publishing program and the tighter relationships we've formed with book sellers over the past year.

Education publishing had another strong year.

Profits rose in education publishing by 41 percent last year or 23 million, building on strong growth in the prior year.

Revenues for the year were up 10 percent and in the quarter by 5 percent.

Operating margins also rose dramatically for the year, and in particular in the fourth quarter, largely reflecting strong growth in higher margin education technology products.

As Dick described, a key driver of this impressive result in education technology is sales -- is education technology sales totaling 124 million last year, up 40 percent from the prior year.

This validates our strategy of partnering with education to raise achievement by providing reading solutions.

READ 180 is one of the leading components of the education technology sales last year.

And continues to be the leading technology-based reading intervention program in the U.S.

Sales were also up for other technology products and services including Scholastic RED and Grolier online.

Overall, education publishing had a very strong year, complementing our education technology revenue from classroom libraries, classroom magazines, and library publishing also rose strongly last year, showing demand for high quality reading products especially when offered as part of a reading solution.

In international.

Revenues in the international segment rose 8 percent in the fourth quarter, and 5 percent for the year.

And local currency revenues were up 2 percent in the quarter and they were up slightly for the year.

For the year, strong revenue growth in the core children's books businesses in Australia and Canada was partially offset by declines in the U.K. as we invest in restructuring that business.

Profits in the international segment rose 25 percent last year and were up significantly in the fourth quarter, driven by higher profitability in Australia as well as our export business.

Media licensing and advertising is a business that has a lot of synergies with our book publishing businesses.

As we've said in the past, the strategy for this business is to drive brand awareness that leads to greater book sales elsewhere in Scholastic.

Likewise, it works both ways.

The school-based channels within school book -- children's books publishing and distribution support the software business, which is reflected in the Media Licensing and Advertising segment by selling those products.

In fiscal 2005, we improved our ability to quantify and appropriately allocate costs and profits to the software sales, which are reflected in this business.

Resulting in a reallocation of greater profits from children's book publishing and distribution to this segment.

For comparability we also adjusted the prior year's profit allocation to be on the same basis.

Revenues in media licensing and advertising rose 20 percent in the fourth quarter due to higher production and licensing revenues from Maya & Miguel and strong sales in consumer magazines.

For the year, revenues in the segment were down slightly, and for the year -- as the year's production and licensing revenue for Maya & Miguel, mostly offset revenue associated with the prior-year release of Clifford's Really Big Movie.

Corporate overhead's increased 4 million for the year to 78 million.

Controlling costs has been and will continue to be a priority for Scholastic.

During fiscal '05, overall cost reductions, however, were offset by increases in costs associated with the preparation for Sarbanes-Oxley comp -- compliance.

As described in yesterday's press release, we performed a comprehensive review of the Company's lease accounting practices.

Following last February's release of a letter from the office of the chief accountant of the SEC regarding lease accounting.

In our review, we determined that some of the leases which were previously accounted for as operating should have been accounted for as capital in accordance with FAS-13.

We also determined that some operating leases did not consider future payment escalation clauses in determining lease expense.

While we do not consider these lease accounting corrections to be material in any one year, the cumulative impact if recorded in the current year would be material.

And so we -- therefore, we decided to restate the prior years to provide additional financial clarity.

Our restated financials will be reflected in this year's Form 10-K which will be filed before August 15th.

As you can see from this slide, the principal impact of these adjustments is on the balance sheet which increases -- with increases in net property plant and equipment, deferred taxes and capital lease payables reflecting capitalization of leases primarily in our New York City offices.

The decrease in retained earnings as well as the minimal P&L impact is the result of both the capitalization of certain leases and the straight line treatment of rent escalation clauses and the operating leases.

It's important to note that these adjustments have no impact on historical or future cash balances or on the timing or amount of our lease payments.

Scholastic continued to generate strong free cash flow in fiscal 2005, significantly exceeding our guidance of 40 to $50 million.

Key to this success was continued strong cash from operations generated by higher earnings and tight working capital management.

Free cash flow also benefited the cap -- by capital spending at the lower end of our guidance range with the timing of some of these capital projects shifting to fiscal 2006.

Though not part of our definition of free cash flow, proceeds pursuant to employee stock plans increased by 24 million last year, also contributing to cash at the end of the year.

Please note that ca -- cash flow in both years is increased by higher capital lease amortization resulting from lease adjustments in both periods as just discussed.

Looking at the balance sheet, cash and cash equivalents increased by 93 million to 111 million at the end of the fiscal year as a result of strong positive cash flow.

This excess cash is being used to fund our seasonal working capital needs during the first quarter of this year.

Overall, the Company's financial position is significantly stronger, with net debt declining by 108 million at the end of the year and net debt to capitalization down to 29 percent from 37 percent a year ago.

We continue to focus on improving our management of inventory levels, and excluding paper inventory of approximately 6 million related to the launch of Harry Potter and the Half-Blood Prince at year-end, and foreign change effects, inventory would have declined by about 2 percent last year.

As we begin fiscal 2006, we're excited about last year's progress and the strategic plans that Dick has described to achieve higher margins and top line growth.

Now, let's look at this strategy in the context of segments for 2006.

In Children's Books Publishing and Distribution, of course, the record breaking sales of Harry Potter 6 will generate a significant increase in trade sales predominantly in the first quarter while we expect a solid front and back list, a focus on lower returns and tighter relationships with book sellers will drive further improvement throughout the rest of trade.

We believe that better customer information, which in turn is improving merchandising and offering, will help drive modest top line growth in clubs.

In fairs, we expect more responsive merchandising to continue to drive higher revenue per fair, especially with more targeted fair bookings and better sales visibility, while investments in this business to improve the efficiency will have a longer term impact on profitability.

In continuities, we expect revenues to be flat or up slightly and revenues to increase in this business now that it has stabilized and profits to increase.

For educational -- in educational publishing we expect growth across the business led by solution selling and education technology.

In international, Australia, Asia direct sales, and exports should continue to deliver strong results as we build clubs and fairs in Asia and invest in rebuilding the U.K. business for the long term.

Finally, in Media, Licensing and Advertising, revenue and margins will benefit from a focus on more aggressive licensing and additional production and selling of our top rated TV programs.

Aggregating across the segments, our outlook for the full year is revenue of 2.3 to 2.4 billion.

We expect margins to raise significantly in fiscal 2006 partly because of the large first quarter increase in Harry Potter sales without a corresponding increase in overhead.

But also because we're focussed on achieving sustain -- sustainable improvement in margins through growth in higher margin technology sales, strategic pricing actions, more targeted promotion spending, lower bad debt, and ongoing con -- cost reduction programs.

With higher revenues and margins we're projecting a diluted EPS range for the year of $2.30 to $2.50 per share.

As we've said in the past, many of our businesses are seasonal and this materi - materially effects quarterly revenue and earnings.

Typically, our first quarter during the summer months when the U.S. schools are not in session is small -- or small revenue quarter and generates a loss.

Though this will be partially offset this year by the sales of Harry Potter.

We anticipate capital expenditures of 65 to 75 million to make additional investments in the enabling technologies that Dick has described.

Based on these assumptions we expect to generate free cash flow of 85 to 95 million next year.

Overall, our positive outlook for solid revenue growth, improved margins, strong free cash flow in -- in fiscal 2006 builds on the progress we've made in fiscal 2005 and reflects our long-term strategy to expand margins and drive growth.

And now I'll turn the podium back over to Dick.

Okay.

Well, first we're going to give you a test on lease accounting.

Okay.

Well, you've gotten this -- the sort of dry version of Scholastic, right?

The excitement is -- if you -- any of you, of course the staff all saw this, but any of you who came by the Harry Potter place last Friday night to see some of the reality of how we touch people throughout the United States and the world, and one of our investors here told me that he walked by and he was astounded to see all the activity and the faces and the children and the wands and the painting and -- and it was a truly great thing.

And that -- we really do have to remember that that's what Scholastic is throughout the world, just touching millions, and millions of people and helping children learn how to read more.

Both love -- learn to love to read and also learning how to read.

And that that's our -- that remains our key mission, and that we have -- we're selling lower-priced products, most -- mostly to people all around the world and touching, you know, millions and millions of -- of lives that -- that teachers, parents and -- and children.

Now, we're going to move to having you meet some of the people on -- some of the newer -- newer people here and also addressing some of the issues that we have.

But let me go across the group here.

Sitting next to Mary is Lisa Holton, who has been with the Company for about two months and is the President of Trade and Fairs;

Judy Newman, the President of Clubs and Home;

Seth Radwell, the President of e-Scholastic and new to the Company;

Margery Mayer, who's been a great partner for me for 15 years, and having her greatest year, yes?

Totally.

I thought so.

And Hugh Roome, President of International.

Margery's President of Education.

I guess I assumed everybody knew that.

And International had a terrific year this year and we're --we're very proud of what we're doing there.

Deborah Forte, President of Scholastic Media including Scholastic Entertainment, responsible for Maya & Miguel as well as the software and Beth Ford, head of glo -- head of global operations for the Company and driving many of the cost reduction and efficiency projects and -- and better information products in the -- in the I -- our IT operations.

So, here's what we thought we would do.

Judy will talk a little bit about what we're doing to move the clubs back to rapid -- or improved growth next year, then I'm going to ask Lisa Holton to make a few observations about her two-month experience so far with fairs and trade, and then Seth will give you what he refers to as his 90-second commercial for -- for e-Scholastic, then we'll go -- we'll move to questions-and-answers, and I'm -- I'm sure you will have questions for the other people here on the -- on the stage.

So we're -- this -- we're moving to the entertaining part of our presentation now, starting with Judy who will tell you what we're going to do with clubs for '05, '06, and believe me, it's a very exciting program coming forward this year.

Okay.

So coming off of 15 percent growth in '03, '04, we knew we couldn't really reliably sustain that kind growth with a -- without a real strategic plan.

So our goal this year was to really maintain revenue, focus on costs and profit, but really invest in learning a lot so we could, for the long term, really build a plan that we could build on long-term growth.

So our goal, we had to grow three strategics that -- that we spent a lot of time learning on and we're going to take those learnings, and those are the basics for next year's plan.

And that's really the foundation for our growth.

So the first is we're taking what we learned about pricing and we're taking that and we're combining it with a real wholesale evaluation of what kids are buying by category, by product category.

So we're combining product category analysis with pricing, and we're combining that into what we call a merchandising template.

So we're using our Student News and we've got it organized by product -- product category and with a pricing overlay and our category managers are now creating their catalogs with a whole new set of real data which we know is going to drive student -- student buying.

Secondly, we tested Parent COOL this year, as you've heard us talk about.

We had great results and we're about ready to roll that out for September.

That's a great new strategic initiative, it's an online interaction with parents, it's the first time we've been interacting with parents online.

Of course they still go through the teachers but it's a big strategic drive forward and it will be the foundation for our parent strategy as well.

So it's a big strategic move and we laid the groundwork for that this year as well.

Thirdly, we've done a lot of research on broadening our product mix.

We'll be -- and we've done some work on experimenting and testing a 12-page Student News format which allows us again to offer more types of product to meet students, of course, increasing varied needs and interests.

And we're working across the company with the ED group to repurpose the education product for consumers, as well as media products, software, so we'll have a whole wide range of product, different prices on these new broader Student News templates to drive revenue.

Great.

Okay.

Lisa, do you want to talk a little bit about your first impressions of trade and fairs as well as the rest of Scholastic that we are now cooperating so nicely with?

Sure.

Well, I have to say it's been an incredible two months.

And one of the things I learned at some of my former employers is that the best way to figure out how to drive your business in a corporation like this is to immediately figure out what's going on in the other divisions, find the exciting places that you think is a strategic fit and then really line them up.

And one of the greatest things I've found in the two months is that as I've gone around and gotten to know a little bit about what's going on in education, in international, in media and licensing, in e-Scholastic, in clubs, in continuity is -- is there's incredibly exciting things going on in all of them.

I find myself every time I look at the fact that we're on cut -- on the cutting edge of education and knowing what kids are doing in schools better than anyone else.

The things that are going on in international, what Deborah has planned in the future, I want to line up our businesses across every single one and that's what really excites me about the future that I think that there's incredible strategic fit, I think it makes sense and I think what's going on across the board at this company is -- is thrilling.

So I'm really glad to be here.

I would say in terms of trade and fairs, the coming year is a mix of some kind of short-term tactical strategies that we've put in place already and also planting seeds for some longer term exciting developments.

So, in fairs, actually we just had our sales rally which kicks off the big year, which a bunch of us went down to Orlando for.

And I have to say that the momentum and excitement at that rally was infectious.

Right?

And it was born in part because Dick and I spent probably three days. maybe a week. into my tenure here, made a management change and put Alan Boyco (ph) in as the new President of School -- Scholastic Book Fairs.

Alan is actually one of the original, kind of, founders of the book fair model.

He's a great entrepreneur, he's a great businessman, but more importantly, he is the chief evangelist for what a book fair is.

And this is a very mission-driven business.

It's a business where you need to motivate people, where people need to understand what they're doing in the schools, it's not just a retail, it's about fundraising and connecting to kids in schools.

And Alan does that better than anything else -- anyone else.

The other thing he does is he's really a team builder.

So Beth's group, we have incredibly strong people down there in terms of operations in IT and I think now for the first time they're actually one team.

They're working together, they're talking about operations, inventory, sales and marketing and product selection completely across the board.

As Dick mentioned this year the real focus is on a number of big initiatives, but I would say first and foremost is our sales initiatives and with the investment we've made in customer connect it's allowing to us use the software so instead of just simply chasing the huge volume we do in booking fairs, to making it a little more strategic in looking at those fairs and figuring out how we can change a lot of focus in terms of building revenue per fair.

We obviously have a lot of big initiatives going on in the fairs, it's a complex business.

We have an investment we're making in terms of our inventory management system which will eventually allow us to really understand what's going on in terms of sales per segment and really change of change the way we're looking at product that will be a longer term initiative.

But I think we have some really exciting short-term and most of all I think we have a great team in place with a terrific leader who has everybody on fire for this year.

So that's great.

In trade, of course, I arrived in May and the team was in full operational mode for Harry Potter.

And I just want to pause for a minute because having been in the publishing business for 20 years and you walk in on something like this, you know, what just happened is not an accident and it's not luck.

And while it is all stemming from an incredibly brilliant book and it's one of the reminders that at the end of the day our business is actually about talent and it's about writing and it's about voice.

But what was so great about what I watched is that the strategic thought that went into every single element, the operations, the distribution, working with our accounts, and looking at sales, looking at marketing, looking at publicity, and the team pulling it all together, it was extraordinary.

We went from 800 parties on Number 5 to over 5,000 midnight parties on Friday night.

So I was so impressed with every element of the team and every person on the team, I was impressed with the team itself, how well they worked together to orchestrate this moment in history, and I, you know, I don't -- I think we should never forget that, I think we should never take that for granted, that that -- there's a reason that this team just made history.

That's also certainly great momentum as Dick said our retailers are really happy with us right now.

There were -- I'm looking at a very tired sales team right now because there were thousands, and there still are, every day we're probably in the hundreds in terms of phone calls, of what's going on at every single retail location, where's sell through, where's -- there's still a lot of demand and sell through is really, really great.

So, they're feeling really great about us, and I think one of the other things that's happened in trade over the last year that's really, really key is a focus on net selling.

As Dick mentioned, we've really decreased our returns rate which is great, and Scholastic won vendor of the year last year at Levy.

Levy is the wholesaler who many of you know probably supplies some of our big mass accounts.

That's a huge honor, you're competing with many other companies.

And the reason that Scholastic won it is instead of approaching Levy as a sales rep to a buyer, they approached it company to company.

So, a whole team of editorial marketing and sales flew to Chicago many times.

Figured out exactly what their customers wanted, what their planogram looked like, what their marketing plans were when they developed a whole new line of baby and toddler product.

They brought the product to Levy at every single stage, it resulted in a 40 percent increase in planogram and more importantly a 180 percent increase in sales at Levy.

What a fantastic model.

A model that we're now going to replicate with a lot of our accounts.

And so that begins to give us a foundation for the much more important part of trade, with -- not important but kind of the thing this drives us which is the book themselves.

And in that case, what we're doing is working very closely with clubs and fairs.

We've instituted a cross-channel strategic meeting where the senior team every other Thursday, clubs, fairs and trade, they sit down with each other and they make decisions together,.That -- they -- so we're making decisions all at once about what books and series we're getting behind, how we're getting behind them.

And I think that now that we have that foundation when we attract talent, and we're always to be to be increasing our efforts to attract talent because that's is always what we need to be doing, we're going to bring that talent in to a really, really strategic foundation where everyone's together and everyone's figuring out how in this very crowded and noisy market, to be really focussed and getting the right books to the right customers.

So, I'm really excited to be here and I'm really excited about the future.

Thank you so much, Lisa.

Now, Seth, do you want to talk about your first impressions and -- and what you're doing with the Internet?

Sure.

Scholastic has a rich history of building award-winning online content in e-Commerce for teachers, kids and parents.

In the last years we've increasingly built up our e-Commerce capabilities enabling our core businesses, like clubs and fairs, to operate online more efficiently and to reach customers more efficiently.

As Dick mentioned, that allowed us in the last fiscal period to do 240 million online making us the third largest book retailer according to Internet Retailer.

So while we've achieved much, we're delivering a suboptimal performance today in terms of the experience we deliver for three reasons.

Our search navigation tools are inadequate, making our site difficult to use and the content difficult to find.

We're not adequately tailoring our offerings for individual constituents, be they parents, teachers, administrators or kids.

And we're not enrolling prospects off the site to reach them on an ongoing basis, even when they don't think of visiting us on their own.

So what are we going to do about it?

Our vision going forward is to build a superior web experience for each of our main constituent groups.

We'll do this by recasting our online assets into a new powerful and robust destination site that combines content, commerce and community into a tailored but more seamless web experience.

We'll allow individual consumers a much greater degree of personalization to create a view into My Scholastic, which is most meaningful to them.

We'll also create entry points into this experience throughout the web by building an acquisition machine that leverages these online assets with deep reach into affiliates, search engines and other commercial and institutional sites.

I think Scholastic has built a strong foundation of assets and competencies and with all those across all the businesses, which my colleagues represent here, we can really build this great web experience and thereby help kids read, grow and learn.

Okay.

Now we're going to move to questions.

I hope that you'll have some for other people here on the panel, and we'll take questions both from the audience and we've -- we're -- we have limited amount of time, unfortunately, but we'll take questions both from the audience and from on the phone.

I'd say we have time for about five questions or so.

Yes.

There's the phone -- the microphone for you.

Mary, I was wondering if you could talk a little bit about free cash flow.

What were some of the factors that drove the big surge year-over-year in free cash flow in the fourth quarter, and longer term, what do you think the right percentage of net income that free cash flow ought to be?

Mary, you've -- you've partially addressed that.

Do you want to amplify?

Yes, I'll just do so briefly, though, I mean I think we did have really strong operating performance in fourth quarter that drove cash and we also had more effective working capital management.

And throughout the year that's been a focus for us.

Looking at every element of our working capital maybe in a more detail than we have in the past to drive cash flow.

Also our capital spending came in just below the low end of our range and it came in lower than we were expecting due so -- due to some timing issues so that generated some cash.

Also in the calculated free cash flow number, there is a $10 million impact from the leasing adjustments that's really a non-cash item so -- so that impacted it as well.

In terms of long term target, I think we've said in the past that our expectation is to deliver se -- at least 70 percent of net income in the terms of flow.

And we think that's appropriate because that allows some room for continued investment in the business to grow in the future, fix the infrastructure that we need to fix but it also delivers a -- an appropriate return.

Thank you.

Next question.

Yes?

It's a question for Judy.

If you're focusing on direct-to-home sales to the parents, will that cannibalize what you're doing in terms of -- of -- of the teachers' acquisitions of -- of books in the classroom?

No, it's actually perfectly compatible, we think, you mean through Parent COOL?

No.

Because we're careful to watch that actually as we go forward.

But we feel that we'll be respectful of the initial interaction through the club, but then we'll, if parents want, we can have continued learning products to parents and if they want to continue the relationship.

What we're finding in our initial test, though, is that parents who use Parent COOL, they buy more through the book clubs.

Okay, so we're seeing higher revenue, pretty good, you know, revenue from parents who are buying through the Parent COOL mechanism because it's easy, they're adding -- we feel they're adding onto their orders, that's what some of our research is telling us.

They're more engaged in the process, so we figure that they're likely to buy more, we can see what they're wanting so we can add more to their item.

We don't see any --we see we can add different kinds of products to them, but we'll watch it, of course.

And if there are other children in the family we can reach out to them.

So there's potential all around, we believe.

Okay.

I think I'll turn to the people on the phone.

Operator, could we have questions from the phone?

Your next question is from Lauren Fine of Merrill Lynch.

Thank you very much.

I'm wondering if you could help us just in terms of more specific margin targets and maybe you could start by providing within Children's Books Publishing and Distribution, a sense of eith -- either rank ordering them or giving specific margins on each of the businesses and which ones you expect to see the most improvement in in 2006?

And then also I guess margins on Harry Potter 6, would they be about the same as the last book, higher or lower?

Mary, you want to tackle that one?

Thank you, Lauren.

Hi, Lauren, this is Mary.

Hi.

In terms of margins, I think we've always said that our long-term overall margin for the total company is to get back to the level we were at a few years ago of 9 to 10 percent.

And so that remains our goal over the medium term.

In terms of margins on the subsegments within Children's Books Publishing and Distribution, we don't give margin numbers on the subsegments and the reason for that is that we, at this point, all those businesses are connected strategically, they do operate to some degree in tandem, we're working to improve that, but we also have an overhead structure that supports those businesses.

And because we report them as one segment, the allocation methodology is not precise enough that we would feel comfortable in giving specific margins on specific subsegments.

So we try to focus on segment at all -- overall.

But in general, if I look at the components of that business, who's going to have the highest margin growth, I think we would expect trade to do well in a Harry Potter year.

We expect to see higher margins in the continuity business as a result of the restructuring there.

We expect margins to be probably about level or slightly improvement in fairs, while we -- while some of the initiatives that we put in place have a longer time horizon to really see the true benefits.

And with all the work that's going on in clubs, we except -- expect to see some slight improvement in margins there.

Then also just on Harry Potter 6.

You expect margin on that business to be the same or better than Harry Potter 5?

Well, that's another, we don't disclose margins on specific products and properties, but I would say that there's certainly no reason to expect it to be lower than Harry Potter 5, that's for sure.

Great, thank you.

Okay.

Thank you, Lauren.

Next question on the phone?

Your next question is from Peter Appert of Goldman Sachs.

A big part of the margin improvement this year has obviously been a function of the bad debt reduction.

I'm wondering if you can just talk about how much room there is left to bring that bad debt level down.

Maybe some of the other financial metrics that would help us get better confidence in your ability to grow that business again.

Things like response rate or average sales rate, some -- something that would give some insight in terms of how that business can grow again.

Mary do you want to deal with the first part of that, in terms of bad debt, and Judy say a word or two about what you're doing to grow the business?

Okay.

Yes, okay.

As it relates to bad debt in the continuities business, one of the things that we have done this year is really focus on that.

So there's no change in accounting methodology that's driving that, it truly is as a result of strategies in that business and a better management of the credit risk of the customers and better targeting of credit-worthy customers to begin with.

So we are seeing true improvement.

From an accounting perspective we're still using the same methodology which means that we look at the historical performance of our base of receivables, and that's on a program-by-program basis and it could be anywhere from over a 12-month period to a 30-month period.

So on a -- on average it's a couple of years.

So the improvement that you've been seeing is actually not as impressive as what we're seeing in the underlying statistics.

So we're seeing pay rates up substantially and we're just seeing overall credit performance in the files much better.

I think the way we're treating it from it a accounting perspective is somewhat conservative, although appropriate, when you've made this degree of strategic change in any business.

And so I think from a financial perspective we'll start to see continued improvement as we go into next year as well as we continue to get, say, the old credit history customers out of the file and more population of the new credit.

And I'll let Judy talk about some of the metrics in the business.

Right.

As we've been saying all along, this year has been about stabilizing the business and reducing promotion expense to just focus on better quality customers, customers who want to be engaged with us, focusing on good customer service, our 800 number, and customers can get to us on -- on the web, so we have really good customer experience.

So now we have a good base of customers who are happy to be engaged with us and we're seeing those bad debt rates and return rates go down which are these metric that is you're experiencing.

And so now we are building.

This year we've been testing new products.

Scholastic Phonics out in -- on telemarketing and in direct mail, and we're -- and Scholastic Classics and we have a Vegitales program, a new book of knowledge, and we're starting to put a lot of these Scholastic branded products out to these good quality customers and building a really great experience for Scholastic at Home.

So we're seeing really good responsible, solid growth in our future here.

Thank you.

Peter, do you have any -- any further questions or that it for the moment?

Well, I was hoping on an unrelated topic, maybe we could get Margery to talk about the -- the competitive dynamics with READ 180.

You've had a unique situation in terms of relatively non-competitive market which has helped drive the profitability.

I'm wondering if she's seeing anything that might cast a shadow in that regard?

Thank you for asking that question.

If you hadn't, I was going to ask her to do it anyway.

But Margery, why don't you answer Peter's question and if you can expand a little bit on the theme.

Well, Peter, as you said, we've been --we've been, I love what Lisa said about Harry Potter and it's not just luck because I think sometimes people think wow, they have READ 180, how lucky are they?

But we believe that children can learn to read and -- and we were -- also believe that technology could be a critical component in that.

SO, yes we were fortunate to identify READ 180, but I also think that it reflects the skill of the team in education in bringing together the content, the technology, sales skills, and then the customer support pieces that really make READ 180 work in a powerful way.

Obviously, READ 180s attracted a lot of attention in the market from competitors.

I think in some ways they're shocked that we could sell so much technology in such a really central way to improving schools.

So we hear a lot of companies have READ 180 killers that they're working on, which I say, just try.

There will be more and more choices for schools in terms of intervention for adolescents, there's a lot of attention from the government and obviously there's a huge need.

But as READ 180 grows and as we prove over and over again in districts that it really does work with kids, as we build out our organization to provide the kind of partnership with school districts to really help them look at their data, get their teachers up to snuff, make the program work, we're building in, we hope, a kind of resilience in our product.

Our sales are wonderful and -- and when we look at them, we -- we -- we're encouraged by their composition.

More than 50 percent of our sales are to customers who have been using READ 180 who come back to us to buy more stages, to add licenses, so replenish their classrooms and we also have good new customer acquisitions.

So it's -- it's a great -- it's a great thing for us to be out there selling READ 180.

We're so gratified by what we see happening in schools by talking to teachers and kids and -- and seeing that we really and truly are turning lives around.

We are -- our mantra in education is be afraid, be very afraid because obviously we want to keep our momentum going.

But we feel good about where we are right now.

We think the new enterprise addition of READ 180 is going to take us another step ahead of -- of where competitors may be and we think we're going to deliver a fantastic experience for our customers.

So that was a long-winded answer, Peter, but as you can tell, we're very excited about what we're doing out there.

That -- that's -- that's great, thanks.

One -- one other thing, Margery.

The fourth quarter revenue growth rate slowed a little bit in Educational Publishing.

Is that a function, you think, just -- just higher penetration levels within the market for products like READ 180 or are there other things going on?

We -- we feel like we had a great year last year, we were up 10 percent.

One of the things we're seeing with READ 180 is that we're getting a little bit more seasonality in terms of purchasing patterns so we're going to see summer become increasingly important in our READ 180 sales as schools buy more READ 180 to get ready for back-to-school.

Our technology sales were good in -- in the fourth quarter and we feel like we're on track for continued growth.

Great, thank you.

Okay, thank you.

Well, in light of the time, I'm going to thank our fantastic team here on the stage and then all of you here from Scholastic in the audience.

I'm inspired to look at you and see how much you've accomplished but how much more we can accomplish together.

Thank you to the investors who have come today and all who have listened.

We will, for those investors who are here present, we have products on display in the resource room where some of you were this morning, upstairs on the second floor, and we invite you to look a little more in-depth, to read With Me DVD, to READ 180, to COOL, Fast Math and all the many wonderful new products that we've got on display there.

So, thanks -- thanks to you all and we will -- and thanks for attending our investor conference '05.