Scholastic Corp (SCHL) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

At this time, I would like to welcome everyone to the fiscal 2006 second quarter earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the floor over to your host, Mr. Jeffrey Matthews.

Sir, you may begin the conference.

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 website, scholastic.com, clicking on Investor Relations and following the links on that page.

I'd also like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the condition of the children's book and educational materials market, 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'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin our presentation.

Thank you, Jeff, and welcome to Scholastic's earnings -- earnings call and presentation for the second quarter of fiscal 2006.

And, also, happy holidays to all.

I'm joined today by Chief Financial Officer, Mary Winston, who will speak after me.

And at the end of our presentation, we'll both be available for questions, as will members of our executive team.

After a good first quarter, many of Scholastic's businesses continued to show strength in the second quarter, and we also continued to generate solid free cash flow and reduced our debt levels.

The profits declined compared to last year, however, reflecting lower International results, the impact of hurricanes and challenges in Clubs and Continuities.

As we'll discuss this morning, we have taken steps to address these issues, to reduce costs and to drive profitable revenue growth.

These plans will help us to generate better results compared to last year, particularly in the fourth quarter.

Reflecting both last quarter's challenges and our efforts to offset them in the balance of the year, we are maintaining our outlook for revenues and free cash flow and expect full-year earnings to be at the bottom end of our previously announced range.

Like many other company's, our business was impacted by hurricanes earlier this fall, which closed several thousand schools, displaced more than 300,000 students and their families and, in turn, affected those schools, which took in the displaced children.

This has im -- impacted our Clubs, Fairs, Continuities and education businesses.

Anxiety created by these storms and higher fuel costs also has had an indirect and less-quantifiable impact on spending by parents, teachers and school districts.

For example, in some cases, districts have delayed purs -- purchases because of concerns about upcoming winter heating and transportation bills.

All together, we estimate that the direct and indirect effect of hurricanes and their after-math was between $0.05 and $0.10 per share in the quarter.

School Book Club results were down last quarter, reflecting the impact of hurricanes, as well as operational challenges.

To rebuild profitable revenue in Clubs this fall, we focused our marketing efforts on Scholastic's core Clubs, which account for more than 70% of revenues.

Based on very positive tests last spring, we increased the number of products and promotion pages for the fall in these Clubs, increased incentives for early activation and continued our strategic pricing initiatives.

These efforts successfully yielded higher revenue, revenue per order and revenue per item in the Scholastic core Clubs.

However, revenue from other club brands, such as Troll, Trumpet and special offers was down more than expected, reflecting a shift of spending to the core Clubs.

Therefore, overall club revenue declined slightly and profitability was reduced by higher expenses from the new promotion strategies, as well as freight costs from higher fuel prices.

These costs will largely not recur in the second half.

For the spring, we is simplifying offers, reducing promotion expenses and up-pricing.

These actions will improve profitability in the fourth quarter.

Finally, we are encouraged by a strong -- a third quarter start for Clubs, with December sales ahead of last year.

In Continuities, our plan of focusing on our most productive customers and improving the customer experience has continued to yield higher pay rates and lower bad debt and returns.

Lower revenues and profits reflected a plan decline in historical programs, partly offset by revenues from profits launched this year, including from our new phonics program, which we have tested thoroughly in the first half and now will roll at -- roll out in the second part of the year.

Based on these results and further product launches, we expect to see revenue growth and improved profitability from this business in the fourth quarter.

School Book Fairs were strong last quarter, though Fair count was down slightly from the prior year because of over 700 hurricane-related Fair cancellations and reschedulings.

Revenue per Fair rose 5% from a number of successful initiatives, including improved merchandising from more sales data, better Fair scheduling in peek periods, increased customer participation in marketing programs like teacher's wish lists and family nights, and higher credit card usage.

We are working aggressively to improve the long-term profitability of this business by consolidating warehouses and improving inventory information, and we continue to make progress on this strategic goal.

Trade Publishing was also strong in the quarter, with growth driven by Harry Potter sales, in particular, back-list titles.

This was the result of a focus strategy to work with booksellers and retailers leading up to both last month's movie release of the Goblet of Fire, as well as the holiday season.

Strong sales of the first book in the series, Harry Potter and the Sorcerer's Stone. attest to our ability to attract new readers to this amazing franchise and attest to its continuing power.

We have recently announced new appointments to our Trade team, as well.

Under Lisa Holton's leadership, Scholastic's Trade Publishing continues to attract the highest quality, most creative children's authors, while harnessing Scholastic distribution channels to build franchises.

Earlier this week, we announced that Michael de Capua will be moving his imprint to Scholastic, where he will continue working with his authors, including Maurice Sendak, Jules Feiffer and Natalie Babbitt.

Lower International profits in the quarter stemmed, in part, from continued investments in the UK, where we are rebuilding the business with the leadership of our newly appointed Managing Director, Kate Wilson.

She had strengthened her Trade team dramatically and attracting several new strong editors and marketing people to Scholastic, while investing in Clubs and Fairs with the goal of making these businesses as strong in the UK as they are in the U.S., Canada and Australia.

While we are taking reduced profits in the UK now, we are confident that this business will grow in revenues and profits next year and beyond, as well as improving slightly in the -- in the fourth quarter.

Other highlights from the second quarter including education -- include educational publishing, where educational technology sales rose more than 25% from a year ago, reaching approximately 30 million in the quarter.

Technology also drove growth in our consumer software business in the Media Licensing and Advertising segment.

Scholastic produced titles such as I Spy and Math Missions for LeapFrog's Leapster, and Where the Wild Things Are for Fisher Price's Read With Me DVD have been top-sellers this holiday season, generating almost four million in new sales in the quarter.

Also, sales through COOL and our other internet channels continue to grow rapidly and were up over 15% last quarter.

And lastly, key financial metrics improved last quarter.

Net-debt levels fell 50% from record free cash flow of over 200 million.

Despite last quarter's challenges, we are optimistic about achieving higher results in the second half of fiscal 2006, and are focused on opportunities in each of our businesses.

We are taking aggressive steps to streamline and simplify Clubs, reducing costs and improving the teachers ordering experience on the internet.

We're beginning to see revenue impact from new continuity programs, which should accelerate in the latter part of the year.

Revenue per Fair has been strong and we'll continue executing improved merchandising strategies, which are building revenue.

Our U.S.

Trade team is better positioned to publish great children's books and build long-term franchises, as we have done many times over the years and are currently doing with Harry Potter, Cornelia Funke's Inkspell, Dragon Writer, and -- Captain Underpants and several other wonderful franchises.

We are making concrete progress in the UK and expect it to contribute improved results later this year and beyond.

And we expect Scholastic Education to continue delivering high margin growth, driven by educational technology.

Most important, our management team is committed to improving revenues and profits in the second half of the year, and to attain higher margins going forward.

Mary Winston will now discuss last quarter's results in more detail and our outlook for the rest of the year.

Thanks, Dick, and good morning, everyone.

As Dick has said, revenues rose slightly last quarter, driven by growth in the Educational Publishing and Media Licensing and Advertising segments, as well as foreign exchange benefits.

Cost of goods sold, as a percent of revenue, decreased to 42.8% from 44.1% in the prior year, primarily due to cost savings programs and better inventory management.

Selling, general and administrative expenses rose, as a percent of revenue, to 36.1% from 33%, reflecting higher employee and related costs, including additional investment in sales and support and education, and higher promotion expense and Continuities and Clubs, offset by lower corporate overhead.

Bad debt expense decreased 23% in absolute dollars, and as a percent of revenue to 2.2% from 2.9%, driven by improvements in Continuities.

With an increase in the effective tax rate to 37%, from 35.5%, because of higher effective tax rates on foreign earnings and a higher state tax provision, net income in the quarter was 66.9 million, 8% below the prior year.

We estimate that hurricane-related revenue losses and higher costs had a direct and an indirect impact of $0.05 to $0.10 per diluted share.

Now, looking at the segment operating results.

Revenue in Children's Book Publishing and Distribution was down slightly, as a result of soft club sales and expected declines in Continuities, offset by growth in Fairs and Trade.

Club sales were down modestly, as growth in revenue from core Clubs was more than offset by weakness in nonscholastic-branded Clubs.

Fair sales grew strongly last quarter, from higher revenue per Fair.

As Dick described, Fair count was down slightly because of hurricane-related school disruption.

Trade sales were also strong, primarily from strong Harry Potter back-list sales.

Other top titles, though, like Cornelia Funke's Inkspell and Dragon Writer, How Do Dragons Eat Their Food, and the Read And Learn Bible, also performed well.

In Continuities, revenue from our historical product lines declined and began to offset -- and began to be offset by new product revenues, as planned.

Operating income for the segment declined modestly, reflecting the negative impact of hurricanes, the decline in Continuities revenues and higher promotion expenses in Clubs and Continuities.

In Education Publishing revenues were up 5% and profits were up slightly, reflecting strong educational technology sales, offset partially by lower classroom magazine revenues compared to last year's strong sales of election-related materials.

Also, we continue to make investments in sales, service and technical support, as we shift to a no model as a solution provider, a key aspect of our long-term growth strategy in this business.

In International, revenues were up 3%, or 1% in local currency, with gains in Asia, export, and Australia, largely offset by declines in the UK.

Segment profits declined, in part, from lower revenues in the UK, as Dick has described.

Revenues in Media Licensing and Advertising were up 9% in the second quarter compared to the prior-year period, primarily from strong growth in Back To Basics toys and in consumer magazines.

Profits fell, primarily reflecting a reduced level of revenues from sales of higher margin products.

Finally, corporate overhead declined by 15% from the second quarter, reflecting lower salary-related expenses and expenses related to Sarbanes-Oxley compliance.

Net cash flow from operations increased significantly during the quarter, compared to a year ago, reflecting the collection of receivables related, primarily, to the Harry Potter 6 launch, as well as improved working capital and expense management.

Additionally, while capital spending and royalty advances are up slightly versus the prior year, both are less than the related depreciation or earn-downs and are, therefore, cash flow positive.

At the end of the second quarter, Scholastic's balance sheet was stronger, with lower debt than a year ago.

Key elements of working capital also improved.

Accounts receivable primarily declined, due to lower Continuities revenue.

Accrued royalties were also higher, primarily due to Harry Potter launch in the first quarter.

The majority of these royalties will be paid in the fourth -- fourth fiscal quarter.

Long term debt declined 55 million compared to a year ago, as the strong cash position reduced borrowing against our credit agreements and revolver.

Net debt declined by 270 million in the quarter, driven by the quarter's remarkably strong free cash flow.

Net debt to cap ratio declined to 21% from 38%.

As we look ahead, we have responded to last quarter's challenges with a plan to improve performance in the second half of the year, especially in the fourth quarter, which is always an important one for us.

For example, in Clubs, we are rationalizing our promotion strategy, leveraging last quarter's success in our core clubs, while reducing our spend in the other Clubs and offerings.

In Continuities, we expect recent new product launches to generate continued revenue growth, further offsetting declines in historical business later in this year.

We are also launching additional new programs before the end of the year.

In Fairs, we are aggressively rebooking cancelled Fairs and continuing to drive revenue per Fair.

Across the Company, we have identified opportunities to reduce costs in our overhead functions, and we're also streamlining our back-end fulfillment and operations, aligning them with our current outlook for volume and sales in Clubs.

We have also delayed hiring across the Company of many positions.

These steps and others will help mitigate the impact of this quarter's challenges in the upcoming quarter, and deliver offsetting improvements in the fourth quarter.

Consequently, we expect our second half results to improve over last year's, based on an -- improved results in the fourth quarter.

This year's quarterly results have been somewhat different than in the past, with a stronger-than-usual performance in the first quarter, lower results in the second quarter, and looking forward, we expect a greater seasonal loss in the third quarter, followed by a strong fourth quarter that benefits from our action plans.

We also remain very focused on the balance sheet and free cash flow.

Though we anticipate some significant payments later in the year, we're exploring strategies to manage our cash and long-term debt.

Based on this, we're maintaining our outlook for free cash flow of 85 to 95 million and revenue of 2.3 to 2.4 billion.

Although we have to meet certain challenges, we expect to be at the bottom end of our previously announced range of $2.30 to $2.50 per diluted share.

And with that, I will turn the call back over to Dick.

Thank you, Mary.

I will now moderate a question-and-answer period.

Beth Forward, Senior VP of Global Operations and IT, Deborah Forte, President of Scholastic Entertainment, Lisa Holton, President of Book Fairs and Trade, Margery Mayer, President of Scholastic Education, Judy Newman, President of Book Clubs and Scholastic at Home, Seth Radwell, President of e-Scholastic,and Hugh Roome President of Scholastic International Businesses will join us.

So the floor is open for questions, operator.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Lauren Fine with Merrill Lynch.

Hi there.

I guess I've got a few questions, a couple of just really rote ones.

If you could tell me of what the timing is of when you're going expense stock options and what you think the expense will be right now?

On the Trade side, if were you were to exclude Harry Potter, can you give us a sense of what the underlying growth might have been?

And then, I guess finally, could you give us, really, more color on the UK?

I guess I'm not quite sure I understand what the real issues are in that market, if it's by certain product lines, if it's a size of your presence there?

Just any additional color, maybe even just starting from the ground floor of describing what you actually have there today.

Okay, let's see.

Mary, you want to start and then we will ask Lisa to deal with the Trade question, and Hugh and I will talk a little bit about the UK position.

Hi, Lauren.

This is Mary.

I'll address your question on expensing of stock -- stock options.

Given the timing of our fiscal year end, we don't have to implement FAS 123R until our fiscal '07 year, so we'll implement that beginning in June of '06, which is the beginning of our '07 fiscal year.

And in terms of the -- an approximate amount, at this point, we're still going through the process of evaluating exactly how we're going to account for it and coming up with an amount.

But, as you know, we do disclose a pro forma number in the footnotes to our financial statements, and so I think that's probably the best approximation to use at this point.

But are you considering anything, you know, like other company's have used, like acceleration of any vested options or anything of that nature?

We are considering some things, but we have not made any decisions that would lead me to say you should use any other estimate at this point.

Okay.

Lisa, do you want to talk about Harry Potter and the other parts of Trade?

We can't really hear her.

How about now?

Yes.

Much better.

Okay, great.

Hi.

I believe your question was about sales. excluding Harry Potter for the quarter.

Well, if you could quantify Harry Potter, that would be really helpful.

And secondly, just really trying to understand how you did, excluding Harry Potter.

Okay.

Well, net sales of all Harry Potter titles were 195 million year-to-date, compared with 15 million in fiscal 2005.

And back-list sales of Harry Potter last quarter were up over five million compared to a year ago.

I just have to interject we were incredibly happy with the second quarter sales.

We worked very hard with our retailers for plans that actually extend through the full year to place the ba -- back-list in key positions, not only leading up to the movie, but also for the holiday and through the spring.

And the back-list sales that we saw on each and every title were terrific.

And -- no, that's fine.

And then, if you can go on to the UK and, then,one last question I'll throw in.

On the Continuities business, as you look forward, I don't know if it's another year or what it is, but of the businesses you plan to be in today, how big of a business do you really think that'll be on a runrate business, on a runrate basis side?

But the UK first, please.

Okay.

Well, let me start on the UK .

This is Dick talking, Lauren, and then I'll ask Hugh to amplify.

UK business, we've been there -- we've been in the UK for 43 years.

We have -- our Club business there is smaller than it is in the other English-speaking areas, compared to the population.

Our Book Fair business is quite strong and is capable of further growth, but it is larger relative to the marketplace than is Clubs.

The business has been driven a lot by the Trade success, which is very up and down, as you know.

And last year -- last fiscal year, under Hugh's direction and before our new managed managing director came in, we had a -- quite a profitable year, mainly through cost reduction there, which was long overdue. but was done extremely well.

We had a good run in the early '90s in the UK, but in the -- starting in the mid-'90s, that business began to flounder, and it was, I think in large part, a leadership issue that we have -- we finally have, I think, successfully addressed.

We have strong Trade business there.

It's having a rough year this year, but we are seeing very good signs of it picking up later in the spring and for the following year.

About a year ago, we brought in Kate Wilson, a very accomplished Trade publisher, and very energetic person.

And her mandate, really, has been to rebuild this business, and to achieve the volumes that -- and profits that are in the core businesses, which are like those that we have elsewhere.

We're not -- it's not going to be an easy task, but I think she's got the energy and the drive and the direction to do it.

And we are investing this year in investments in Clubs and Fairs, as well as we're seeing some downturn in Trade, based on product cycles, that are bringing the profits down in that business.

But it's this, with a goal of rebuilding the business and making it more profitable.

It's about an $80 million business.

We believe it can be bigger than that.

Hugh, would you like to add to that? [CONNECTIVITY PROBLEMS] You're not coming through.

No, get another phone.

Sorry, he's coming to the phone now.

Thank you.

-- decided to focus on a long-term strategy that'll give us significant growth and future profitability in the business.

We've brought in what we think to be an extraordinarily gifted editorial team for children's books, and an extraordinarily gifted marketing team.

And with that, we are rebuilding the fundamental franchises that are Scholastic's great strength elsewhere in the English-speaking world.

Thank you.

Lauren, on to the Continuities business.

We are -- we're in a period of bringing the revenues down, as you know, and focusing on more profitable customers, and I think it's a very natural question to ask, you know, what is the bottom -- how can did go back up and how far?

This was a business in the 300 million range, that contributed a very substantial amount of operating profit in the early part of 2000, 2001, '02, and '03.

In 2004, prompted in part by Do Not Call, but also by the business model, we experienced a decline in profits in that business, and we have revamped our strategy, bringing the revenues down and rebuilding as -- in part, as a home-learning business, with further Continuities being tested in that period.

We are now ready to bring those Continuities -- new Continuities into play.

This business will probably not go back to the $300-plus million range, but we think it probably should be in the low 200's but that -- it's a bit premature to try to answer that question until we see what kind of success we have with these new programs.

So Judy Newman, who has been running that business recently, will give you further color on this point.

Hello, Lauren.

You can hear me?

Perfectly.

Okay, good.

You know, you've heard me talk about this over the past few quarters and we're very pleased with how our strategy is rolling out.

All our key metrics in this business are really delivering stronger pay rate, lower bad debt, lower return rates, and we really look at this business on three dimensions.

Better quality customers, we are really segmenting our customer base now, to be able to deliver them bes -- the best quality product for what they need.

We are opening up new channels, of course.

As telemarketing becomes less important in our mix, we're looking at all new ways of driving inbound customers to us, as well as leveraging our school distribution, using print.

And then we are, as Dick said, developing a whole new line of new learning products, which, of course, is the perfect amplification of the Scholastic strategy to get learning products to parents directly at home.

And we've done a lot of excellent testing this year, which we are beginning to roll out with.

We have great testing results behind us, particularly with Scholastic Phonics, which you'll start to see some real sales numbers on in the third and fourth quarters.

We have other programs, Word Advantage, which we have some strong test results, also.

And, again, this is bringing learning products to parents at home.

Lauren, in my summary of revenues, I neglected to put the two businesses together.

I was referring, primarily, to the Direct To Home revenues, which just a little above 200 million right now.

But we also have about $60 million or $65 million in revenues in the School Continuities, which are a related business, so the two together would be in the, you know, around 275 million.

Great.

Well, thank you.

Okay.

Thank you.

Thank you.

Our next question is coming from Branden Dobell with Credit Suisse First Boston.

Hi, it is actually Collin, filling in for Branden.

Just wondering when you -- you know, when you look at the earnings shortfall in the quarter, what gives you comfort that you could achieve your free cash flow targets for the year?

Is it just, you know, you make up the profits in the back half of the year, or is it improving working capital, or some combination of both?

Thanks.

This is Mary.

I would say it is a combination of both.

I think that, you know, as we know, we do expect revenue to still be on track.

We are going to manage expenses very aggressively, as we've already talked about, so we do expect to be at the bottom end of the range.

So, we think we can achieve the cash flow target.

As you know, we've already been pursuing a number of working capital specific initiatives around inventory and other components of working capital, and we're going to continue to diligently pursue those, as well, through the end of the year.

Great.

Thank you.

Okay.

Thank you.

Our next question is coming from William Bird with Citigroup.

Yes, I was just wondering if you could talk about, you know, how much higher promotion and fuel-impacted expenses?

And in International, is the higher expense base what we should expect going forward?

Thanks.

Okay.

In terms of promotion spending, it is not up dramatically, so I'll say it's less than five million.

We talked about higher promotion across Continuities and Clubs.

And, also, ma -- let me make sure that we're clear that we're talking about promotion expense on the P&L.

And the way that we account for promotion in our Continuities business is that is capitalized at the time of spending, and then amortized over the revenue period.

So what you're also seeing in the Continuities business is a higher degree of promotion expense amortization hitting the P&L than we are actually spending in that business.

So I think we've been clear that, in that business, we have rationalized promotion spend and are targeting it toward the most productive customers.

So we're not spending at a dramatically higher level, even though that's not necessarily matching what you see on the P&L.

In terms of fuel costs associated with the hurricanes, we expect that to be about a $1 to $2 million for the full year.

On International, William, we are investing in the UK right now, as Dick had mentioned, both in getting a terrific organization together and in promotional spending to build the trajectory of our Club and Fair business.

Overall, Internationally we've got really excellent growth coming, for example, out of Asia, where we're growing a business that;s almost $60 million, growing at a rate of better than 20% and quite profitable.

And, as you know, we've returned our Australian and New Zealand businesses to strong profitability and -- and growing margins.

This is true, overall, and especially as we build our business to -- to the Middle East, Africa and Latin America, through export sales, which is our highest margin business of all.

So just to be clear on the promotion expense, is the five million or less that you mentioned, is that what hit the P&L?

Yes.

Yes.

Okay.

And just to follow on, of this roughly 700 Fairs cancelled, low many would you expect to be re-booked and, really, what's your ability to make up the $0.05 to $0.10 from hurricane losses?

Hi, this is Lisa.

Can you hear me?

Yes.

Okay.

Great.

Of the 700 Fairs that were at issue in the hurricanes to date, we actually expect 500 to be cancelled and not come back.

We have 200 re-scheduled already in the spring.

However, some of those are in schools with damage, and so we're watching them very closely.

I will say, as Dick and Mary both mentioned, two things, one, our revenue per Fair numbers are very, very strong this year, and we expect to continue.

But we've also instituted quite a bit of aggressive cost savings.

We're also aggressively have booking plans in place that involve going after other cancelled Fairs and, in fact, we have backup help from our Ed group at Saint Charles, who are helping us with calls, and so we're aggressively both going after other Fairs that are non-hurricane related.

We're continuing to press our revenue per Fair initiative.

The -- as Dick mentioned, the category management in our product strategy has really been working, we've been using more sales data and monitors to track our sales and we're really seeing great results from that.

Our efforts on peak have actually shown significant improvements this year.

We've moved a lot of Fairs and it is really -- we've shown terrific results, both in October and November.

And I believe, as you know, we have a new management team in place, and they're really doing a great job of looking at expenses, managing and offsetting quite significant fuel increases.

Great.

Thank you.

Are there further questions?

Thank you.

Our next question is coming from Peter Appert with Goldman Sachs.

Dick, I'm wondering if the relative weakness you're seeing in the Club business, which you've actually seen, I guess, for a couple of years now, might, instead of just being a function of, you know, hurricane and cyclical factors, might just indicate that you've reached maturity in that business, and there's less revenue upside than perhaps there has been in the past.

How do you address that issue?

I think that is a very valid point, and one that we're thinking deeply about.

The Club mechanism remains strong.

It's based on the relationship between the teacher, the child, and the parent, and the parent giving the child money to acquire books.

We've updated this relationship by using the internet much more, and almost half of the people now ordering -- the teachers now ordering, are ordering through the internet.

I think that we're just. sort of. at the beginning, Peter, of figuring out how to make this internet work better for us.

And I think that the key to the improvement in Club ordering is going to be making the internet experience simpler and better, and have a bit more merchandising connected with it, as well as giving the teacher opportunities to buy more things herself.

Longer term, as you know, we have -- we've got the parent -- we've got something called Parent Cool, whereby parents are ordering through the teachers mailbox, but using credit cards.

And we're testing this, and we have -- you know, we have orders in the, you know, 40 -- 30 to 40,000 range that reflect the involvement of parents, and these are showing higher revenue per order.

But it's a miniscule number, compared to where we think it can be.

So I think what we're seeing is that, as people in the consumer market learn to use the internet more and as we get better at -- we've done a wonderful job on this, by the way, over the last five years in the internet area, but we just -- we're just beginning to accelerate that, that we're going to make it simpler for the teacher to order, and I think we're going to see resumed growth.

I think we're in a temporarily stagnant period, but I don't think it is a long-term thing.

Is this ever going to be a back to the double-digits on the apparent Cool Works, and some really unique way, would that be likely?

But we're going to meld that business together with our direct to the home operations to try to get more long-term revenue from parents.

So, Judy or Seth Radwell may want to amplify on that point.

Sure, Peter, can you hear me.

Yes.

Hi, it is Seth Radwell.

Overall, we've had, actually, great acceptance of our Club ordering online COOL system.

We're growing over 20% higher revenue from last year, a 50% higher in orders.

The platform is scaled very nicely and, as you probably know, is that Retailers named us one of the top 50 retailers, largely because how aggressively we've been able to migrate our Club ordering online.

As more teachers adopt COOL, we'll continue to evolve and improve the platform and web experience, making it simpler, more straightforward, with more merchandising opportunity.

And as Dick mentioned, we believe that Parent Cool, which will really extend the whole orders experience to parents, while still involving the crucial relationship with teachers, will allow us to now push and grow into the parent space directly.

My understanding was that the migration to internet-based ordering was going to generate some fairly significant cost savings, yet it doesn't seem like it is showing up from a margin perspective.

So, was I wrong in that assumption or are there other specific cost pressures that are offsetting that?

Peter, hi.

It's Seth, again.

We actually know that COOL is a much more efficient channel, in that teachers, themselves, are inputting the order.

Obviously, as many new teachers migrate, there are some one-time costs of setting them up on COOL, getting them used to the system, where they call customer service more than usual.

We have had some of that experience this past quarter.

We believe we've identified the issues and rectified them.

And then, maybe for Mary, the weak operating results you're seeing currently, maybe you've seen for the last couple of years, do they cause you to rethink your expectations in terms of the ability to get to nine or 10% operating margins over the next few years?

Peter, first of all, I don't know that I would characterize the operating results as weak, but there's no question, we have had some unexpected challenges, I think we are still planning, though, to deliver at the bottom end of the range that we set out there.

And, so, given that fact, I have no reason to re-think what we're -- you know, what we're pursuing from a long-term perspective.

I think we still have a lot of opportunities to enhance our margins and our profitability, and we're pursuing a lot of things across the Company and, so, I think the goal is still attainable

Okay.

Thank you.

Thank you.

Our next question is coming from Steven Barlow with Prudential.

Good morning.

Can you hear me?

Good morning, Steve.

Could you give a us breakdown, Lisa, please, on the 7% increase in revenues at the Fairs, on what is price and what is volume?

And for Margery, I guess I was surprised at the margins.

It's the Newsletter area was weaker revenue, I would -- I guess I thought that was lower margin, so if the revenues picked up in the technology side, why wasn't profitability higher than it showed up in the quarter?

Lisa, do you -- are you in a good working phone at this point and ---

Can you hear me?

Yes.

You want to talk about the 7% Fair -- the break down of revenue per Fair and number of Fairs, et cetera?

Sure.

I can answer the question about revenue per Fair.

In terms of breaking it down by price and volume, it's actually just not that simple.

I would say that it's coming from a combination of factors.

Some of them are operational.

Some of them have to do with. as I mentioned. the fact that when we -- when we reduce our peak, we're actually packing stronger Fairs, we're packing stronger inventory and we're freeing up personnel to go to those Fairs, which actually is generating more sales.

The efforts we're making in category management does absolutely have to do with some price -- you know, we're seeing higher -- we're moving higher price volume and we're getting higher -- average higher price per Fair.

And then, thirdly, the thing I didn't mention before, some of our marketing programs are really kicking in and we're actually getting much higher participation across our Fairs.

For example, our family events are now close to 90%.

Our teacher wish list, where parents walk in and buy books for the teachers is up over 67%.

We instituted a new program called One For Books, where you can actually go in and donate a dollar for a kid who needs a book and that program, which has just been instituted this yea,r is expected to add, I believe, $2 million in revenue.

So actually, it is a combination of marketing, product and then operational efficiencies that's driving the revenue per Fair.

Good.

Margery, have you a question on the Magazine business, which, Steve, might be more profitable than you think.

Maybe.

Hi, Steve.

How are you?

Fine.

How are you?

Well, there were really two things that happened that affected margins.

One, as Mary and Dick noted, last year was an election year, and every four years -- I mean we wish there were more elections, but this is the way it happens to be.

Every four years we have a great opportunity in selling election skills books to schools, which happen to be very how margin and very seasonal.

The other thing that happened, and I think we're going to see this going forward, is our technology business growth.

We had a lot of work to do in the fall to get schools to -- up and running and implementing new technology, so we had some seasonality and expense in implementation and service expense and taking care of our robust technology business.

Fair enough.

And for Mary, is there a way to give us a range of margin goals in the fourth quarter, with all the initiatives that you are working on?

No, at this point, I don't think that we're going to be able to do that.

I think the most -- in terms of margin, the most I'm going to be able to say is that we are pursuing the bottom end of the range and we've talked about the various initiatives that we have going on, and I think we're going achieve our goals.

Thank you.

And I think Steve and Peter both, we have our teams revised here and I have to tell you that the commitment to improving our margins going forward from this group is really very strong.

Hello?

Thank you very much.

Thank you.

Our next question is coming from Fred Searby with JP Morgan.

Hey, there.

Thank you.

A couple of questions.

One, Mary, you had mentioned that, you know, obviously, free cash flow looks huge, and it's on the working capital side, but you talked about the significant payments, anticipated in the second half.

You can be more specific or give some color there?

And then secondly, kind of a technical question, but I'm just curious as to why, if this is -- with hurricane-related businesses not being pulled forward, why you wouldn't get some business interruption insurance?

And then, finally, if you could just, on the margin front not to beat a dead horse to death, but can you just talk about provisions for doubtful accounts have been coming down, and you're seeing bad debt expense coming down and what the trend is there, and going forward?

Obviously, that is important to the marketing story.

Thank you.

Okay.

In terms of free cash flow, when I referenced the higher payments, it's really related to the royalty payments that we'll be making in the fourth quarter, largely associated with Harry Potter.

And then, in addition to that, we have some tax payments and things like that.

So, that's what that was referring to.

Your second question was on business interruption insurance and, you know, we have a full risk assessment program here at the Company, where we review all of our risks, we review our insurance programs, we determine what we think is adequate coverage, and I think that we feel that we do have it.

I think that, as you know, the circumstance this year with the number of hurricanes that we've had and the disruptions that that created, was certainly an unusual circumstance.

So, maybe in light of that, we go back and review our insurance programs, but at this point we fell that we're covered.

And then your question was on bad debt.

I think -- as you know, we've had dramatic improvement in bad debt over the past year as a result of the restructuring of our Continuities business, and we continue to expect to see that improve, but clearly it is not going to continue to improve at the rate that it has improved thus far.

Okay.

Thank you.

Thank you.

Our last question is coming from Philip Olesen with UBS.

Yes, thanks.

In your prepared remarks, you indicated that you're exploring some strategies to manage cash and debt.

Maybe if you could just give a -- some additional insight in terms of what type of strategies you're looking at?

And, I guess, as a somewhat related question, as part of that review, would you look to re-evaluate the policies, in terms of returning cash to shareholders?

Thanks.

I'll answer your second question first.

I think we're looking at everything.

So, certainly, our shareholder-related policies are under review.

We also have long-term debt, some of which is maturing in January of '07, so we will need to be making a decision on what to do there, anyway, so we're evaluating that.

So we're just looking at our entire capital structure and looking at what's the best way to utilize the cash.

At this juncture, what do you think is the optimum leverage for -- on a runrate basis for the business?

Well, we've said, and I continue to believe, that we would certainly like to have a sustainable debt-to-cap down in the low 30's or around 30%.

So that's what we feel is reasonable for a Company at our credit level.

Okay.

Thank you.

Well, thank you all.

We -- I believe, as a result of this call, we will certainly keep you updated on the Club progress, which we believe will be good in the second part of the year.

And longer term, we will provide you with more updates on the Continuity business, and on the UK business, so -- and International, in general.

So thank you all for attending our second quarter call.

Happy holidays to all and thanks for your continued support.

Thank you.

This concludes today's Scholastic conference call.

You may now disconnect and have a wonderful day.