Scholastic Corp (SCHL) 2006 Q3 法說會逐字稿

Good day.

My name is Jackie and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Scholastic third-quarter 2006 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to Jeffrey Mathews, Vice President of Investor Relations.

Sir, you may begin your 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 Investors 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 conditions 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 would like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to be in our presentation.

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

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

At the end of our presentation, we will both be available for questions, as will members of our executive team.

Scholastic's third quarter was disappointing for sure as higher expenses in the children's book segment and lower educational technology sales resulted in a greater seasonal loss.

While we will explain these shortfalls today, most important we are doing something about them to strengthen our business and reduce cost.

It is also important to note that for the children's book business, demand remains solid for our club fair and trade programs.

Our issues in this segment were largely costs, not revenues, as the changes in our club program prompted teachers to request and use the larger 12 page kits for the Scholastic core clubs and not to order from our Troll and Trumpet club.

Customer demand for our Scholastic core clubs increased promotion cost, as well as fulfillment in customer service costs, a trend which began in the second quarter, but intensified in the third.

Obviously we responded to our customer needs, but at a higher cost.

In fairs, while the third quarter is typically a low revenue one, increased costs staffing to handle our fourth-quarter business reduced our quarter profits.

These cost increases in children's book publishing were the primary driver of nearly $18 million of profit loss in the quarter compared to the prior year.

Finally, in keeping with trends towards greater seasonality of revenues for READ 180 and the tough comparison with last year, we experienced a drop of $8 million in operating profits in education compared to the prior year.

While the third quarter is a small revenue quarter for Scholastic as our programs are largely not in use from mid-December to mid-January, February is the key month for both children's books and education.

So these trends were not manifested until the end of the month.

As a result of the difficult third quarter, we have reevaluated our fourth quarter, typically a very strong one for the Company, and have taken our estimate down for the quarter more in keeping with last year's actual performance.

In short, we are now expecting net income of about 170 to 180 for the year with about half of that change already recorded in the third quarter and a similar amount in reducing the fourth-quarter estimate primarily through anticipating some lower revenues than planned, as well as a conservative estimate on cost savings.

What are we doing about the situation?

First, we are revamping our club program to respond to important learnings about customer behavior.

At the same time, we're strengthening our trade business, improving our use of Scholastic children's book product in all of our channels and strengthening fair marketing, as well as tending to cost.

We're confident that the third-quarter shortfall in expected revenue in education is more of a seasonal shift than a slowdown in sales in this key segment and we are maintaining and strengthening our leading position in reading intervention and educational technology.

Finally, we have a determined plan to improve margins and as part of that plan, we have identified $40 million of savings in division and corporate overhead, which we have concrete plans to reduce and we will be also reducing cost elsewhere in the business.

Let me give you a little bit more detail on each of these items.

As indicated last quarter, operating contribution from children's book publishing and distribution declined by almost $18 million principally.

Because of higher costs in school book clubs and fairs, revenues stayed approximately level.

This has been a stimulus for fundamental changes in clubs.

Based on customer reaction to extensive market tests, next year, we will focus exclusively on Scholastic branded clubs and will discontinue Troll and Trumpet, two smaller less efficient clubs.

We have also reduced clubs' editorial staff by approximately 10%.

This should substantially reduce overhead, promotion and fulfillment expenses in clubs while increasing profitability.

We are also taking steps to reduce fixed costs and continuities.

At the same time, we have begun reversing declines caused by Do Not Call.

Last week, we closed an in-house call center, eliminating 72 staff positions and shifting all remaining out-bound telemarketing to outside vendors.

This should reduce selling and overhead expenses by over $1 million annually.

In School Book Fairs, we're expanding our goals for cost reduction and warehouse rationalization.

We expect to incorporate these into our fiscal 2007 plan and our fair staff is highly motivated to deliver on this plan of reduced costs while continuing to deliver strong revenue prepare growth and we built a stronger but still lean trade team by giving greater roles to our top in-house staff, as well as attracting outstanding new talent in editorial, trade marketing, sales and publicity.

As indicated in education, the other cause of lower results in the third quarter was an $8 million decline in operating contribution from education.

This is mostly due to lower educational technology sales reflecting the fact that our educational technology sales increasingly occur during the summer when school districts make the majority of their budgeted purchases.

The large READ 180 sale in the prior year also contributed to the decline.

In addition to lower technology revenues, increased investment in sales and support staff to service the larger READ 180 customer base impacted results, especially in the small quarter.

Finally, we had higher bad debt reserves associated with a large educational service provider.

Year-to-date, however, sales of educational technology are up 18% and READ 180 remains the leading technology-based intervention program in the U.S.

As we enter the fourth quarter in the summer, we are focused on a strong pipeline of sales prospects and continue pursuing a winning three-part strategy partnered with educators and with raising student achievement, to offer research-based products with proven efficacy and to service our customers with a strong field sales and support team.

While we have made efforts to cut costs in the past, after last quarter, we are more determined than ever to reduce overhead at Scholastic.

In December, we began a complete analysis of corporate and divisional overhead and have already identified $40 million in savings fully realizable by fiscal 2008 with a significant benefit next fiscal year.

We are now accelerating the implementation of this plan, which is focused on four areas.

One, standardizing systems and processes and removing redundancy between corporate and divisional functions.

Two, coordinating our strategic investments better across the Company.

For example, we're centralizing our Internet investments, which previously were dispersed throughout the businesses.

Leveraging our vendor relationships in travel and telecom for example and outsourcing the existing functions where advantageous.

Fourth, reducing the number of facilities we occupy bringing them in line with the Company's streamlined needs.

We'll incorporate these changes in our fiscal 2007 plan.

Based on our third-quarter results and their impact on the fourth quarter, we have reduced our outlook as indicated for the fiscal year.

Now expect full-year earnings between $1.70 and $1.80 per diluted share.

In this context, we are determined to drive improvements across Scholastic as I have suggested and summarize, we are streamlining School Book Clubs and strengthening and reducing costs in the children's book segment.

We're driving higher margin growth in Scholastic education and educational technology.

We have launched a $40 million overhead cost reduction program.

While some of these steps will help to control cost in the fourth quarter, we expect them to have significant impact next year resulting in lower costs and stronger businesses and advancing us toward our 9% to 10% margin goals.

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

Thanks, Dick, and good morning.

I will begin with our income statement.

Revenues rose slightly last quarter driven by growth in the media, licensing and advertising and international segments partly offset by lower educational publishing sales and a slight decline in children's book publishing and distribution.

Cost of goods increased primarily due to product mix reflecting the impact of higher sales of lower margin products.

Selling, general and administrative expenses rose mostly from higher promotion and selling expenses.

Bad debt expense increased slightly to 3.2% of revenue from 3.1% primarily because of higher bad debt reserves in educational publishing.

Higher expenses on modest revenue growth in our second smallest quarter caused our net loss to increase to $15.5 million from $0.8 million a year ago.

Looking at last quarter's results in children's book publishing and distribution by channel, first, School Book Club results continued the trend set in the second quarter.

Revenues were down 4% due to revenue declines in non-core clubs.

Promotion spending was higher as we executed a plan to strengthen our core clubs.

Given the lead times for promotions, steps we took after the second quarter to reduce promotion spending are now taking effect and we expect promotion spending to be more in line with the prior year in the fourth quarter.

School Book Fair revenues were down slightly primarily due to year-over-year differences in fair timing.

We expect an offset in the fourth quarter and full-year fair count to be about level with the last year in spite of the impact of hurricanes last fall.

Revenue per fair was up in the third quarter as we continued last fall's initiatives to improve merchandising, fair scheduling and credit card usage.

This should improve in the fourth quarter.

Staffing expenses were higher to support an increased level of fair bookings in the fourth quarter.

Trade sales were also solid last quarter driven primarily by backlist sales and over seven New York Times bestsellers.

Scholastic titles also received Caldecott and Newbery honors last quarter.

In continuities, revenue rose last quarter for the first time in more than two years as growth in new sales channels, especially the Web and from new products such as Scholastic Phonics, more than offset declines in historical programs.

In addition to our progress improving and stabilizing pay-rates, returns and bad debt, this further confirms our strategy of focusing on our most productive customers and improving the customer experience.

This quarter, we will continue to drive revenue by building these new sales channels and expanding sales in new products like Scholastic Phonics, Scholastic Classics and Veggie Tales.

So overall segment revenue was down slightly.

Pretax operating contribution fell by approximately $18 million reflecting the impact of higher expenses in clubs and fairs as we have just described.

In educational publishing, sales of education technology were lower last quarter as Dick explained.

This decline in a small quarter and greater investments in sales and service support to support a larger customer base were the primary factors resulting in an operating loss in the quarter.

Given the shifting seasonality of this business, the fourth quarter will be important and we believe will reflect our large opportunity on reading intervention and education technology.

In international, revenues were up 5% in local currency from growth in Canada and Australia partially offset by lower sales in the U.K. where the trade market continues to be soft.

The plan to restructure and turn around the U.K. business while progressing led to lower results in the quarter.

Consequently, overall segment profits declined slightly.

Revenues in media, licensing and advertising were up 25% in the third quarter compared to the prior year period from all business lines, including software and multimedia sales, back to basics toys and consumer magazines.

Profits rose from improved results across all businesses.

Finally, corporate overhead was up slightly due to the timing of certain payments and accruals.

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

Inventories rose from earlier product purchasing in School Book Fairs.

Accrued royalties were higher primarily due to the Harry Potter launch in the first quarter and the majority of these royalties will be paid in the fourth fiscal quarter.

Short-term debt rose and long-term debt declined reflecting the recharacterization of approximately $300 million of notes due in January 2007.

Net debt declined over $200 million from the year-ago period driven by strong free cash flow in the prior four quarters.

Net debt to cap ratio declined to 22% from 35%.

Net cash provided by operations declined compared to a year ago reflecting higher tax payments, higher net loss in the quarter and earlier purchasing and fairs.

CapEx increased reflecting planned investments in IT infrastructure, pre-pub and preproduction costs fell reflecting the timing of projects.

However, all of these spending categories are less than the related depreciation and amortization and are therefore slightly cash flow positive.

In total, free cash used for the quarter was approximately $13 million compared to a free cash flow of $40 million a year ago.

As we responded to last quarter's challenges with significant steps to reduce costs and strengthen our businesses, last quarter's cost increases, we expect -- after last quarter's cost increase, we expect these steps to help control costs in the fourth quarter and deliver significant cost reductions beginning next year.

However, giving year-to-date results and a reduced outlook for the fourth quarter, we now expect earnings per share of $1.70 to $1.80 per diluted share, including approximately $0.15 of severance expense, revenues of approximately $2.3 billion and free cash flow between $70 and $80 million in the year.

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

Thank you, Mary.

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

I've got most of Scholastic's executive management team here.

Beth Ford, Senior VP of Global Operations and IT;

Deborah Forte head of Scholastic Entertainment;

Lisa Holton, head of Book Fairs and Trade;

Margery Mayer, head of Education;

Judy Newman, head of Book Clubs and At Home;

Seth Radwell, Head of e-Scholastic and Hugh Roome, head of Scholastic International, are all here to help me answer questions and to support your interest in knowing more about the quarter and about the Company.

With that, let's open the floor to questions.

(OPERATOR INSTRUCTIONS).

Stacy Fleck, Merrill Lynch.

I was hoping you could I guess discuss the relative size of the Troll and Trumpet book clubs relative to the size of the book club business overall right now?

I will answer that, Stacy.

Troll and Trumpet represent between 10% and 15% of our total revenues for book clubs.

So we don't anticipate that we will actually lose all of those revenues either because in our tests where we've only used core clubs in certain rather broad-based tests that we have run, we have seen that our core clubs will attract most of the revenue that Troll and Trumpet got separately.

I guess how did the revenues at your traditional book clubs do in the quarter?

Scholastic core clubs increased.

Judy, do you want to elaborate on that?

Yes.

Core club revenue in the quarter were up.

They were up over 5%.

And I guess just lastly, could you be a bit more specific about what fair count increase you're expecting in the fourth quarter?

Lisa, do you want to answer that, please?

As you know, our fair count -- third quarter is a relatively small quarter for us and fourth quarter is a huge quarter for us and all of the indications that we have right now for fourth quarter are incredibly positive.

We believe that our fair count will be up somewhere in the neighborhood of over 1% over last year and some of the early indications -- we are now running spring fairs.

February was the first time that we really saw how our spring fairs rolled up and the revenue per fair increase was quite substantial.

So we're very, very positive about our fourth-quarter outlook for both fair count, as well as revenue per fair.

I guess I don't understand why staffing had to be increased more than usual because the fair count increase doesn't seem that dramatic.

Well actually even -- what do mean more than usual?

Well, I guess I have never heard you guys talk about staffing levels at the book fairs kind of impacting costs in the quarter.

So I was just surprised about what -- it seems like a contributor to the loss in the quarter.

Well if you look at it, it is actually a combination of two things.

It is timing.

It is actually some of the revenue from the fairs that were falling into third quarter last year and moving over to fourth quarter and that highlights more of the staffing issues.

So in fact, the staffing issues probably are the same in the third quarter.

It is just that most of the revenue from the third quarter last year in terms of fairs has moved over to fourth quarter.

Some of it anyway.

Yes.

And there was a depreciation advancement in there that we didn't expect due to the discontinuance of the system and there were several other issues connected to staffing and cost of fairs, which we don't expect to recur.

Brandon Dobell, Credit Suisse.

Maybe focusing on the international business for a bit.

Remember a couple, three years ago, there was some relatively significant changes in how you went to that market with a partnership and kind of a revamping of the business.

Wondered why -- or maybe some more color on what is going on there.

Have those brands, a couple, three years ago, panned out or has the market changed around you?

And then just your broader thoughts on maybe kind of ranking within international the countries that are performing at levels that you think are appropriate from a margin or return perspective than countries where they aren't maybe what you guys can do to get those ones headed in the right direction.

Thanks, Brandon.

That's helpful question.

I will ask Hugh to answer the second part of it;

I will take the first part.

I think you meant the investment in the U.K.

Although you didn't say so, I think you meant the investment in the U.K. and we did make investment in the U.K. in a company called Book People and that company is thriving.

We are an equity participant in that company and we partner on certain things.

We have a joint venture there for two clubs; one, Red House to the home and one is called [Schooling], which is sort of a consumer's club that runs through the school.

The Book People core business is doing well and the two joint ventures, the two clubs that are in the joint venture, both doing well, but these don't really show up in our income because our equity participation in that operation is not very high.

Now, we are getting some benefits of working with them on product purchase and sale of our own product to them and we are also engaged in the U.S. in Book People type of program, which is display marketing, which we are expanding in the U.S. and while that business is losing money and contributing to our loss at the moment, it is growing rapidly and looks very, very promising in the U.S.

Now, Hugh, you may want to touch on some of the other things going on in international and also answer Brandon and the question of where do you rank the various profitability opportunities internationally.

Brandon, Hugh Roome.

Just setting off of the U.K. question, I think right now we are building in London a truly world-class children's publishing team.

It is going to make a difference in all parts of the world because we will derive we believe great properties down the road that we can sell on a global basis.

But the international story is quite a broad one.

We're selling in more than 160 countries where we have an export team and have subs in 15 countries.

Among those subs, the biggest story is that Australia, which had somewhat disappointing results in previous years, has come along strong last year and even stronger this year and promises to redouble its strength in the year ahead.

They have reshaped their book club business and it is growing very, very dynamically along with its trade and fair business.

In Canada, we have a large company and it is doing terrifically, a very high margin business and a great club fair and trade enterprise.

Perhaps most significant though is what we're doing in Asia.

In Asia, we are getting a little better than 20% growth.

We have a strong presence in Southeast Asia and particularly in Thailand, the Philippines and Malaysia, which are all growing strongly this year.

In smaller companies where we have had presence for many years, such as Singapore, where we have got extremely dynamic growth and in large countries like Indonesia and India, we have got a growing point of presence and a unique position in the as a children's book publisher and distributor.

I think significantly in China we have built a good platform franchise.

We brought in as the head of our Asia Company, Frank Wong, who was the very successful head of Pepsi Food in China.

He knows the market well and is giving Scholastic the possibilities for a significant long-term opportunity in China.

Also on the export side, we have begun to build our global club business.

We now have streamlined through Internet ordering and much expedited delivering our ability to take children's book clubs out on a global basis.

At the end of the day, our large long-standing subsidiaries are strengthening and in a good position, but most significantly our Asia presence is extremely dynamic.

We're focused there as we bring children's book clubs and fairs, trade and education into those markets.

Thank you, Hugh.

While we're doing better in Latin America, those continue to lag a bit.

So in answer, Brandon, I wanted to indicate that there are some places that need to do better.

Then one final.

As I think about educational publishing in the near term in the next quarter or two, looking back on a year-over-year basis, any tough comps that we should be aware of?

Your confidence in the seasonality aspect of what happened during Q3 kind of mitigating going forward or should we really take a different approach to modeling parts of that ed. publishing segment to get a better handle on what their year-over-year revenue amount was like?

Brandon, I will ask Margery to answer, but, first of all, as we said several times in our presentation, we have undiminished confidence in our education business.

We do believe that, as you well know from your experience in the field, the summer is usually a big time in education and more than half of the sales for the large K-12 companies are often recorded in June, July and August.

And we are kind of moving toward that we READ 180, but Margery will give you more color on that particular situation.

I think Dick just said it.

Last year, we had a really nice fourth quarter with READ 180 and we are forecasting to beat that quarter in this coming year.

I think we are just going to see more and more business in the fourth quarter and the first quarter and second and third is going to be lighter going forward.

We were really proud of the fact that a couple of weeks ago the U.S.

Department of Education announced eight grants for improving adolescent literacy.

They were called Striving Reader Grants that went to different districts across the country and READ 180 was in four of the eight, which we were thrilled about.

We feel READ 180 continues to build momentum.

That it's the acknowledged leader, not only in raising literacy, but it is really at the heart of middle school and high school reform.

So we couldn't be more proud of how it is doing.

And one add-on there.

Last time that you and I talked, we had talked a little bit about extending the READ 180 pedagogy methodology into different subjects or different grades.

Any update there on extending that product?

Yes.

Well, we just introduced a few months ago a much smaller product called Fast Math, which uses some of the brain theory behind READ 180 to reinforce and build fluency in math facts 0 to 12.

In addition to that, we have just launched in the last two weeks two more technology products.

One of them is called ReadAbout for upper elementary and it runs on the same management system as READ 180 and we have also introduced something called Zip Zoom, which is a program for kindergarten through second grade for English language learners that reinforces English language skills and foundational reading skills.

William Bird, Citigroup.

I was wondering if you could discuss how much of the 40 in reduced overhead you expect to realize in '07.

How many fair warehouse closures does this capture and if you could also just address timing of discontinued Troll and Trumpet clubs?

Thanks.

The $40 million is divisional and corporate overhead only, so it doesn't include any fair rationalization.

We are targeting about two-thirds of the 40 to be realized next year and the balance to be -- or the full 40 to be realized in fiscal '08.

But that is by no means the only area of cost reduction that we're focusing on.

We do continue to focus on fair rationalization and I'll ask Lisa and Beth to comment or Lisa supplemented by Beth to comment on that.

On Troll and Trumpet, we will stop offering Troll and Trumpet in September.

We will focus on the core clubs starting in September and we expect to see significant promotion and fulfillment cost reductions starting next fiscal year.

I may have missed one of the questions.

No, that covers it.

Thank you.

Lisa, do you want to talk further about the fair issues?

Sure.

I would love to.

This summer, we consolidated four additional warehouses and we have two more currently underway in the next several months.

So this will bring our total down from a high of 82 to a current of 65.

In the fiscal 2007 plan, we are definitely looking at an acceleration of the network consolidation, but that is part of a larger look.

One of the things that has happened in fairs, which is so exciting, is that our use of technology has really started to help us really build revenue per fair.

It is a combination of what we have been doing in terms of the peak optimization, which has allowed us to move some of, as you know, some of our scheduling out of the peak and produce better fairs and better revenues per fair.

Our customer connect program has also allowed us to get much more visibility into our customers and our schedules and how they meet and that is also helping us produce revenue per fair.

So what we're doing is we're looking at the network optimization, not in and of itself, but as a part of a whole suite of strategies that really revolve around how our sales organization operates, how it has been enhanced by the technology that we have used and how further technology enhancement can actually help us further streamline the distribution system.

Those are all right now being worked on and built into our 2007 plan.

Peter Appert, Goldman Sachs.

It seems to me that you guys have been aggressively focused on the cost side of the equation for a couple of years, have done yeoman-like work in that regard.

So the missing link is more on the revenue side of the equation.

So I was hoping maybe you could just speak broadly about things you can do to try to drive revenue growth, whether we should think that or whether we should conclude that there has been a permanent diminution in the opportunity from a revenue standpoint in the core children's publishing business and what might be the reasons for that?

Well, Peter, we think that our core children's book business can continue to grow.

There are all kinds of things out in the press and so forth about is the book dead and kids only doing media.

My own nine-year-old spends a lot of time on video games, as well as reading, so I am very aware of this situation.

Interestingly enough, the demand for our product seems to be fine.

We are, under Lisa's direction, we are turning around our trade operation with lots of interesting new people, as well as strengthening and putting some support around some of the very fine people that we have already.

And we're going to be looking at some very exciting new product in that area.

When you have new product, you get new customers and new people want it, and so we are going to do fine in that area.

We don't think that this is going to go back into the early '90s and '80s where we were getting 15% growth every year in children's books.

We are looking at, as you and I have discussed before, kind of a mid single-digit growth would be considered to be good in this kind of a market.

Our revenue opportunities really are going to come from educational technology, but we continue to think the fares will outpace the children's book industry in general in revenue growth.

And then the use of the Internet which we have discussed for many years but is now going gangbusters here, as half of our book club customers are now ordering through the Internet, and we are beginning to make some progress on Parent Cool, which is still in a very test infancy stage, but we are also increasing our efficacy of our systems in the Internet.

We are doing more up-selling and we believe that the Internet will offer us all kinds of opportunities to increase sales directly to parents, as well as up-selling teachers.

So it is an exciting prospect and we have got good plans in that area.

But what we done, Peter, is that we have put together a multiyear plan, which is really based on very modest revenue growth and cost reductions because, as you have pointed out gently sometimes and more firmly others, we have not been able to run a very consistent business.

Our goal at the moment is to not rely necessarily on revenue increases, but on rightsizing our cost structure and reducing our overhead cost, both divisional and corporate, and looking at the less well performing activities and eliminating those and focusing on our real opportunities.

Now this is not rocket science obviously, but it is something that we believe we can and must do in order to stabilize the business with a lower cost structure.

So any revenue growth that we get and we think we will get plenty, particularly through the Internet.

We have got new heightened Web ordering for our home business in this quarter, which is very exciting for example.

But we want to have a consistent business that operates with a lower cost base and modest revenue growth and then any extra revenue growth we can get from Margery's efforts in educational technology, Seth's efforts, along with everybody else, the Internet will come on top of that and add to profits rather than add to cost.

So we should be thinking something sort of low single digit in terms of revenue expectations?

Yes.

Low to mid.

Low to mid.

And cost-focused management.

There are areas where it is going to be higher.

Obviously Asia and international where we're growing 15% will continue to grow, but it is on a small base.

So corporately, we would look at kind of low to mid single digit growth as sort of a foundation.

Then we will reduce our cost to that level of growth and then any gains that we make, especially in technology and the Internet and international, will be made on top of that.

So the target of 9% to 10% operating margin you're suggesting can be achieved even if revenues stay at the -- I mean if revenue growth in the low to mid single digits --.

Absolutely.

That is our plan.

That is our plan.

Then just one unrelated item for Margery.

There has been some noise in the educational technology marketplace about more competitive products.

Do you see that as an issue in terms of perhaps some explanation for a little bit of a change in the growth dynamic for READ 180?

There is definitely some additional competition out there, which makes complete sense because we were pretty much all by ourselves for a really long time.

We do here about them sometimes when we are with customers, but we have not been able to identify any place where we have really had a competitor affect our business in a very specific way.

So, Peter, I don't really attribute competition to this.

I really don't.

Frederick Searby, JPMorgan.

A couple of questions.

One is associated with the $40 million.

What should we expect in terms of charges in fiscal 2007 and 2008?

I think you highlighted $0.15 in severance charges and I am just wondering what we should bake in over the next two years?

And then secondly, in terms of this -- I guess this has kind of been asked, but it sounds like there is some revenue abandonment with Troll.

I wondered if there is any other associated revenue abandonment with this cost-cutting outside of those two that you are going to walk away from.

And then finally, in terms of investment going forward, should we think of you're basically going to either remove capital outside of the other business and focus on international and the educational side is where you see the opportunity to deploy capital?

Thank you.

Several good questions.

I think some of them should be probably answered in the context of our '07 plan.

We have estimates on what it is going to cost us.

We don't have that plan worked out to the detail where we could give you a number as to the cost of attaining some of the overhead reductions, but we expect there will be some cost.

We would prefer to leave that to our '07 plan.

I don't mean to suggest in my comments that I made to Peter that we are abandoning investment in our core children's book business.

We believe that we have significant opportunities there.

We are just not counting on them -- we're not counting on exceptional growth in that business.

If we get it, then I believe we will get significant growth in trade for example and fairs, good growth.

We will take that on top of a lower cost base.

I think a very promising thing that people have been asking for for some time and which I think we are about to deliver is a more coordinated approach to capital spending and product across the Company.

In other words, we are all looking at this together and we are deciding that we're going to do some of these programs together.

That is one division or education and trade or whatever.

Working together and working with home and so on and clubs so that we probably will be able to invest more, but more effectively, in some of our core children's book operations.

So that would be one answer, Fred.

Then the other would be, yes, we do plan to continue to invest in educational technology.

In international, it is really not a cash requirer.

We are really doing a great job of building substantial growth there and also improving our profits at the same time.

So that business tends to fund itself despite its rapid growth.

With respect to revenue abandonment, yes, there probably will be somewhere as we rationalize some of our programs, we are expecting the lower revenue obviously in clubs next year based on discontinuing Troll and Trumpet.

But we do think our core clubs and we have tests to prove it to ourselves will pick up a significant portion of that revenue.

But our focus will be on profitability rather than revenue enhancement and some revenue may go by the boards, but I wouldn't say that we can put a specific number on that revenue right now.

Do you want to answer, Mary, --?

Yes, I just want to make one clarification because I think there might be a little confusion.

I just wanted to clarify that the $0.15 in severance associated with this year is not associated with the $40 million overhead reduction program that we have announced.

That program we are -- we get firm actions now.

We will be putting more implementation plans in place in the fourth quarter and expecting the full benefit of that, or not the full benefit of the program, but to start implementing in fiscal '07.

So will it be one kind of big charge where you will take a charge for this cost-cutting restructuring charge or will it be something whereas you kind of reduce head count, you dribble out severance charges?

How do I think of that?

At this point, we haven't determined exactly what is going to happen from a charge perspective, but I do think it will be a paced approach because implementation of the various initiatives will be paced to some degree.

Some of them are tied to significant redesign of processes and re-engineering, which will take some time and then reformatting the work that is being done in order to eliminate redundancies.

So you shouldn't think of it in terms of a big upfront charge.

Philip Olsen, UBS.

Actually just a couple of quick questions.

First, can you maybe give us an update on current priorities for free cash flow?

I think Mary can handle that question.

Thank you.

At the moment, as you know, we have been focused on our balance sheet, focused on continuing to strengthen our balance sheet, strengthen our credit metrics, so our top priority has been and continues to be paying down debt.

As you can see in our balance sheet, we do have notes maturing in January of '07, so we have our eye on that.

So while we do have a large cash balance sheet, we are developing our strategies for repaying the debt.

Can you maybe just elaborate a little bit in terms of what those strategies may be and when we think you might be in the market to refinance that debt?

Well we are still formulating our plan right now.

I mean clearly with debt that is maturing in January, we will be finalizing our plan in the next two to three months and making a decision.

So we will probably have more to say about that when we talk to you in July.

I guess on a separate or maybe somewhat related issue, have you had recent conversations with the agencies and are they still comfortable with where you are given the reduced second half outlook?

We have had recent conversations with both rating agencies and they continue to understand our business very well.

The people that we interact with there have followed us for quite some time, so they understand the results that we are putting forward right now, as well as where we are going with the business.

So we hope that they will continue to be supportive.

This is more maybe a question for Dick, but just what are the conversations between yourself and the Board in terms of future succession plans?

We have them and obviously I am determined to see the Company attain the margin targets that we have just reviewed with you, but I will take that in good humor in this difficult quarter, but right now there is no plans for me to leave the scene and I am determined to follow through on some of these commitments that we're making today and also to see whether we can achieve our goals with the Internet, with international and educational technology and many of the expansion ideas that we have discussed with you.

But I have a healthy dialogue with the Board about that subject and when and if there is something to report, I will let you know.

Do think at some point in time it may make sense to provide a little bit more insight into what those strategic options may be when the time comes?

I don't think so, not right now.

Robert Schiffman, Credit Suisse.

I'm sorry to end it with a couple of bondholder questions, but just elaborate on where Phil was going.

If you actually look through what S&P has been saying recently is that underperformance of your earnings and cash flow guidance is likely to lead to a ratings downgrade.

Do you care right now whether or not you maintain investment-grade ratings?

If so, how important is it to you and are you willing to commit that your not going to buy back any stock in the near term in order to maintain those ratings?

Mary, do you want to discuss that, please?

First of all, I can assure you obviously our credit rating is very important to us and remaining investment-grade is very important to us.

And we continue to look at bringing down our level of leverage and debt as a key component of that.

We also, as I indicated, have a very active dialogue with both rating agencies and review with them our credit metrics that are the typical barometers of creditworthiness at a certain credit rating.

And we think we meet those.

We are comfortable within our debt covenants and everything.

So we feel that we are strong in terms of our creditworthiness.

There is no question, you have characterized S&P's view correctly and so they will go through their process and make their own assessment, but it is absolutely clear that our credit rating, investment-grade credit rating is important to us.

That's fair.

The other issue raised though is your net debt position.

So it seems like you're going to be in a position at the end of the year that if you want to finance a January payment with cash on hand, you can do so, but obviously if you were to refinance for some reason.

You would have an access cash position without much use for that cash.

Could you just give us any sort of sense of what types of use cash that you might have over the next 18 to 24 months?

Well, there is nothing specific I can share with you other than to repay the debt.

As you know, we do have a cyclical business, so as we go into the summer months, we will be in a cash use position and then generating cash in the fall.

So the normal cyclicality of our business will affect our liquidity positions and then again our priority is to repay debt.

We do continue to look at strategic opportunities to invest in the business, but as we have said in the past, we are opportunistic in terms of that.

So we look at things as they come along, but there is nothing that we foresee on the immediate horizon.

Thank you.

I would like to hand the floor over to Dick Robinson for any closing comments.

Thank you all for your patience.

Obviously we were very disappointed in this quarter.

What is somewhat mitigating is the fact that is a cost issue rather than a revenue issue and we know that we need to get those costs under control.

And we will do so and we have done so.

We are determined to reduce cost in the Company.

We are strong believers in our core business.

We do believe that we have some very exciting things going on in our children's book business here in the United States, as well as around the world.

We believe in the educational technology and the education segment, which has been performing really well in the last three or four years and we believe will continue to perform well.

We are confident we have international opportunities, which will not require a great deal of investment, but which will build our capability, particularly in Asia.

So we are confident about the Company.

We thank you for your support.

We are sorry to have disappointed you as we have disappointed ourselves, but we are confident in the future of our Company and our business and my great team that is with me today, several of them new, several of them tried and true, and we are all working together to build a great future for the Company.

Thank you very much.

We look forward to seeing you in the summer.

Thank you.

This does conclude today's teleconference.

You may now disconnect your line and have a wonderful day.