Scholastic Corp (SCHL) 2006 Q4 法說會逐字稿

Good morning, my name is Jackie and I'll be your conference facilitator today.

At this time I would like to welcome everyone to the Scholastic fourth quarter 2006 year-end earnings conference call. [OPERATOR INSTRUCTIONS] Thank you, it is now my pleasure to turn the floor over to Jeffrey Matthews, Director 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 investor relations and following the links on that page.

I would also like to note that this presentation contains certain forward-looking statements which are subject to various risks and uncertainties, including the conditions of the children's book and educational materials markets, acceptance of the Company's products in those markets, and other risk 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 everybody to Scholastic's earnings call and presentation for the fiscal fourth quarter year 2006.

I'm joined today by Chief Financial Officer Mary Winston, who will speak in a moment.

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

Fiscal 2006 was a challenging year, particularly because of higher costs and lower revenues in School Book Clubs resulting from significant changes in our promotion plan.

Based on what we have learned, we have simplified our club offerings and promotions for fiscal 2007, which we strongly believe will return this business to greater profitability.

We also made key investments and expanded field sales, service and technical support staff in education, as well as in a stronger management team and turnaround plan for the UK business.

While these investments reduced results in the current year than the '06 year, they will pay off in '07 and beyond.

Meanwhile, strongly positive results in trade and good performance in School Book Fairs helped boost fiscal 2006 profits above the prior year, but well below our original expectations for a Harry Potter release year.

To improve margins in 2007 we're reducing overhead costs, strengthening our core children's book business, expanding in educational technology, growing internationally, and utilizing our strong internet presence with teachers, parents, and kids to sell more through this rapidly growing commerce and content channel.

This morning we will discuss what happened in 2006, what actions we have taken in each business, and how we plan to reduce costs and improve margins in 2007.

The most significant cause of higher revenue and profit in children's books in fiscal '06 was clearly the successful release of Harry Potter and the Half-Blood Prince last summer.

Next week we will release data from the Yankolovitch survey entitled The Kids and Family Reading Report, which underlines the tremendous impact of Harry Potter on the reading habits of young people ages eight to 17.

For example, in this report, more than half of the kids who read Harry Potter said that before Harry they didn't read books for fun and now they did.

While 65% said they have been doing better in school since they have started reading the series.

Not only has Harry Potter truly changed young people's attitudes toward reading, but the launch of Harry Potter and the Half-Blood Prince last summer was a tremendous success for Scholastic, resulting in the sale of 12 million hardcover copies.

We also made progress in other areas of our trade business too.

At least one of Cornelius Funke titles graced the New York Times best seller list every single week during the entire year, making her one of the most consistently best selling authors in the U.S.

Jenny Nimmo's Charlie Bones series also continued its reign on both New York Times and USA today best seller lists.

In addition, continuing series from Garth Nix, Philip Kerr, Pat Carmen, Blue Balliett and Jim Benton had strong sales and each achieved best seller status at some point during the year.

A few of our highlights from fiscal 2007 include the first new Captain Underpants title in three years, Here We Go.

The Preposterous Plight of the Purple Potty People, with a first printing of 1 million copies.

Mommy?

Maurice Sendak's pop-up book with a first printing of 500,000 copies.

A new holiday gift book by Newbery Honor winner Ann Martin.

Ghost Hunters, a new paperback series by Cornelia Funke.

The sequel to Owen & [Mazy], last year's New York Times number one best selling picture book and a unique book by Brian Selznick, which is already generating great excitement.

We also have the strong new sales and marketing team in Trade, which will now be augmented by joining forces with our [Clubs] sales group.

Under the direction of Alan Boyko, affairs veteran who became president of this unit last year, School Book Fairs raised revenue per fare by approximately 6% last year, largely through collecting more timely and accurate information about what titles were selling and adjusting inventories and product selection accordingly.

We are also working to improve operating efficiencies in Fairs.

This year we have consolidated our customer service functions to lower cost and improve customer satisfaction.

Ongoing efforts include implementing a point-of-sales system to reduce accounts receivable and shrinkage while improving pricing and reporting, continuing to leverage our CRM investments to improve fair scheduling and achieve revenue per fair goals, and aggressively standardizing business processes across all of our fair regions.

Based on these actions we expect continued improvement from fairs next year.

In School Book Clubs, changes to our club promotion program in '06 caused teachers to request and use larger more expensive 12-page kits in the core clubs and order less from our Troll and Trumpet clubs.

More kit requests in the core clubs increased promotion costs as well as fulfillment and customer service costs.

These challenges also resulted in soft revenues and particularly in the fourth quarter as we reduced mailings to mitigate costs.

For fiscal '07, responding to what our customers did and said, we have simplified the club promotion program by eliminating the Troll and Trumpet club mailings.

We will focus exclusively on the scholastic branded clubs and on an increased number of targeted special offers to complement them.

This will reduce promotion, fulfillment and overhead spending and make it easier for customers to get maximum benefits from the five age-graded scholastic clubs.

Although we expect a modest decline in total club revenues, profits should improve next year.

While Continuities have had a slower turnaround than expected, revenue increased for two consecutive quarters this year and in the fourth quarter was up 14% compared to the prior year.

This suggests progress with our strategy of focusing on the most productive customers and engaging them with improved customer service and developing new products and acquisition channels, especially the web to offset declines in the traditional business model.

We also took steps last year to reduce costs in this business, outsourcing all remaining outbound telemarketing, closing the call center and eliminating 75 staff positions.

Based on the success of new products like Veggie Tales and the web and other new channels selling traditional products like Disney and Dr. Seuss, we expect Continuities will grow in fiscal '07 and profits will improve.

Overall demand remains solid in our children's book business.

Last year's issues were largely related to costs.

Based on the actions we've taken to reduce costs and forge a more integrated cross channel approach to our customers and schools and homes, we believe our children's book business is significantly stronger today and will generate longer term growth and higher margins.

Fiscal 2006 was an important year of growth and building in scholastic education, especially in strong sales of educational technology.

Segment profits, however, were down based on three factors.

First, we increased our technical support and educational service consulting to help schools install and implement our educational technology products.

While this expanded capability, added to cost in 2006, schools have shown a willingness to pay for these services over time.

Equally important, this new resource was essential to the successful introduction of our READ 180 Enterprise Edition, the first major upgrade to this product, supporting larger installations and improved student data management.

As a result, READ 180 is now used in 10,000 classrooms nationwide up from 7,000 last year.

We believe we will continue to add new school districts this year as the READ 180 Enterprise Edition solidifies their position as the market leader in reading intervention.

Second, lower results in Scholastic Library Publishing also affected profitability.

With increasing use of the internet in libraries and for research, we're putting more focus on Grolier Online, our award winning internet based reference product, and so have decided not to update several print reference products at this time.

This decision resulted in a write-down of related prepublications assets in the fourth quarter.

We also eliminated positions both in the first quarter of fiscal 2006 and another 36 positions in the first quarter of this year bringing operating costs more in line with the revenues.

These actions will benefit profitability in 2007.

Lastly, the Bankruptcy Platform Learning, a for profit education service provider, directly impacted fiscal '06 results.

While these factors reduced results, we also had significant gain.

We strengthened our classroom libraries business with new products and marketing capability.

We launched Read About and Zip Zoom English, two new tech products, for which we will begin seeing revenue growth in fiscal '07.

We entered the math market and had strong first-year results from Fast Math, a technology product based on research by the developer of READ 180.

By sustaining growth in technology sales, expanding our sales and service capabilities and reducing costs in libraries, Scholastic Education made significant progress in fiscal 2006 as it evolves into a comprehensive solution provider and partner with educators.

Fiscal '07 revenues, margins, and profits should improve as a consequence.

International revenues were up for the year on growth in Asia, Australia and Canada.

Profits were down, however, because of investments earlier in the year to turnaround the UK business.

However, segment revenue and profit improved in the fourth quarter year-over-year as anticipated.

Our strategy in this segment has two elements.

In our largest international operations in Canada, the UK and Australia and New Zealand, we are focusing on reducing costs and improving efficiencies while sustaining growth.

With the new strong Trade team in place and improved clubs and fair businesses, we expect that the UK will show improvements in fiscal '07.

Revenues and margins rose significantly in Australia last year for the second year following a turnaround there, and we expect continued good results.

In Canada we continue to build our Fairs and Education business on the solid clubs and Trade foundation.

We also continue pursuing growth opportunities on our export business and in our newer subsidiaries, in particular the growing middle class and demand for English language learning in Asia, presents a significant opportunity and we are adopting our school-based distribution models as well as our literacy and education products for this market.

Based on these actions, we expect to see modest growth and improved margins in '07.

Last year, the media licensing and advertising segment demonstrated how it expands Scholastic's presence in non-print media and the internet and creates profitable revenue streams.

Sales of interactive products, including Leapster and Fisher-Price titles grew strongly last year driven by success in retail channels and in clubs and fairs.

Sales at Back To Basics Toys, the catalog business we acquired almost three years ago is part of our direct to the home strategy, grew over 20% reaching almost 25 million in sales and margins improved.

Since we acquired it, we have added an online channel to this business, which has significantly contributed to its growth.

Across the Company, the internet continues to grows as a key channel, especially in the children's book business and we continue ranking as the third largest internet book seller.

In fiscal 2006, total online revenues were almost 300 million, as we transition more of our customer base and develop new customers online, the trend which we expect will continue in '07.

To summarize Scholastic's outlook for growth and improved profitability in fiscal 2007 and beyond rests on five elements of our strategy.

We are executing a plan to leverage our scale, our unique customer relationships, and our world class publishing team, brands, and content for growth and higher margin in children's books.

Second, we're focussed on driving higher margin growth in education, with our market leading technology products and our ability to partner with educators to raise kids' achievement.

Third, we are meeting the growing global demand for children's books and English language learning in our international businesses.

Fourth, we are building our strong internet presence to transform our method of communicating with and selling to our customers while improving efficiencies.

And finally, we're reducing costs, improving free cash flow generation, and strengthening our balance sheet.

Mary Winston will now discuss our results for 2006 and our outlook for 2007.

Thanks, Dick.

And good morning, everyone.

As I've stated previously, Scholastic has four top financial priorities.

First increasing the profitability of the individual businesses and of the Company as a whole.

Second, improving free cash flow and shareholder value, third, improving capital utilization and financial returns, and finally an ongoing priority is to improve our key financial processes while maintaining strong controls.

Despite a year of challenges and investments in some businesses, I think we made progress in each of these areas last year.

Looking at the first goal, revenue and profits were both up in fiscal 2006.

Overall revenue was up 10%, and net income rose 7% on strength in children's book publishing and distribution, which benefited significantly higher Harry Potter sales associated with the release of the sixth book in the series.

Cost of goods sold rose 13% in fiscal 2006, primarily due to higher costs related to Harry Potter sales, as well as the write-down of reference set assets in the Education Segment of 3.2 million in the fourth quarter.

SG&A increased 9% as a result of higher promotion expenses in children's books and higher selling and service expense in Education.

Bad debt declined in absolute terms and as a percent of sales with improvements in the Continuities business more than offsetting a bad debt of 2.9 million from the bankruptcy of a customer in Education, half of which was recorded in the fourth quarter.

Net interest expense declined based on higher interest income from the Company's strong cash position.

The Company's tax rate increased due to higher effective state and local tax rates and on a GAAP basis, fiscal 2006 earnings were $1.66 per diluted share, up 5% from the prior year, including $0.07 in expense in the fourth quarter from the asset write-down and the bad debt in Education.

Looking at the segment results for the fourth quarter, revenues were flat in children's book publishing and distribution as strong revenue per fair driven growth in School Book Fairs and a second consecutive quarter of growth in Continuities offset lower Club revenue, which declined as we made further reductions in mailings during the year.

Fourth quarter Trade revenue was also down relative to the prior year period, which has strong Harry Potter backlist revenue in anticipation of the launch of Harry Potter 6.

Segment operating profit declined modestly in the quarter, reflecting the impact of soft revenues in Clubs, partially offset by higher profits in Trade and School Book Fairs.

For the full year, children's book publishing and distribution revenues and profits were up, largely reflecting strong full-year trade results from the hugely successful first quarter Harry Potter release and the associated sales of the Harry Potter backlist.

School Book Fairs also had a strong year from higher revenue per fair.

Fair count for the year was down slightly, partly reflecting hurricane-related cancellations last fall.

Fair profit improved slightly.

These positive factors were partly offset by higher cost and soft revenues in Clubs, as Dick described, and by lower full-year revenues in Continuities, where a turnaround in revenues in the second half of the year partially offset first half revenue declines.

Revenue grew modestly in Education Publishing in the fourth quarter and full year, though profit declined.

Also segment results were more seasonal than in the prior year.

These results reflect a strong educational technology sales primarily in the first quarter, which for the year rose 14% to over $140 million, largely due to an 18% growth in READ 180 sales.

This was partially offset by lower Library Publishing sales.

The profit impact of the higher technology sales was offset by increased spending on field sales and technical support staff throughout the year to enable long-term growth in this business.

Costs related to the write down of reference set assets and bad debt in the fourth quarter also impacted profits for the quarter and the year.

In the International Segment, in the fourth quarter, revenues and profits increased due to strong performance in Canada as well as improved results in the UK.

Foreign exchange effects contributed less than $1 million to revenue and profit in the quarter.

For the full year, revenue was up as revenue growth in Asia, Australia, and Canada more than offset revenue decline in the UK.

Foreign exchange benefited revenue by approximately 5 million in the year.

Profit fell primarily because of lower results in the UK where we invested in a turnaround plan.

In media licensing and advertising in the fourth quarter revenue was down slightly, primarily because of lower production revenues compared to the prior year when we delivered more Maya & Miguel episodes.

Operating profits also declined.

For the full-year, revenue was up from growth in all business lines, including software and multi-media sales, consumer magazines and Back To Basic Toys.

Operating profit in the segment declined slightly.

Corporate overhead declined modestly in the fourth quarter and the full-year due to cost controls.

Free cash flow was again strong last year and exceeded net income.

Net cash provided by operations declined in fiscal 2006 because of higher inventories at year-end, partially offset by higher payables and accrued expenses.

CapEx rose relative to last year primarily due to planned spending on IT infrastructure, but was at the bottom-end of our guidance and approximately in line with the related depreciation expense.

Pre [INAUDIBLE] and production spending was lower due to the timing of certain projects as well as careful monitoring of spending decisions throughout the year.

In fiscal 2006, Scholastic's balance sheet grew stronger, key year-over-year differences include a higher cash position at year-end resulting from strong free cash flow.

This excess cash will be used in part to fund our seasonal working capital needs during the first quarter of this year.

Though we continue to focus on improving our inventory management across the business, instituting new processes that should have long-term benefits, inventories rose last year primarily due to softer than expected sales in children's books.

At year-end, short-term debt was up and long-term debt dow, reflecting the recharacterization of approximately 300 million of notes due in January 2007.

Total debt was approximately flat and our committed bank credit lines were un-utilized at year-end.

Net debt declined by approximately 94 million, based on the year-end cash position and the Company's net debt to cap ratio fell to 22% from 29% in the prior year.

Scholastic's cash position is strong, as I just discussed.

And with existing credit agreements, the Company has significant liquidity.

This puts us in a strong position to pay down or refinance debt, especially as we approach next January's maturity of approximately 300 million in bonds.

To make a final decision, we're evaluating multiple options, including issuing debt in the public or private market where spreads remain attractive from historical perspectives, expanding our revolving credit facility in the bank market, which is favorable at the moment, or refunding the '07 notes with the Company's existing liquidity, which based on cash on hand and continued strong free cash flow and existing credit agreements, should be ample.

As we make this decision, the Company's cost of capital and long-term liquidity needs are important factors.

Based on current factors, we expect to implement a final plan, which could be some combination of these options, early in the second quarter.

An important point to note is that we believe the Company's current credit rating has no material impact on these options.

In fiscal 2007, we expect to see the benefit of actions taken to address last year's challenges, reduce costs, and drive profitable growth across the Company.

In children's book publishing and distribution, we expect modest growth and improved results in non-Harry Potter trade from a strong front list.

In School Book Fairs, we expect continued increases in revenue per fair, slightly higher fair counts and further operational efficiencies.

Building on last year's second half improvements, Continuities revenues and profitability should rise based on new product introductions, the success of new channels and continued cost control.

School Book Club results should also improve from lower promotion, fulfillment and overhead expenses on a modest decline in revenues as growth in the core clubs partially offsets the elimination of Troll and Trumpet clubs.

Overall segment revenues and profits are expected to decline primarily based on lower Harry Potter sales compared with the last year, when we released a new title in the series.

In Educational Publishing we expect continued growth in educational technology supported by last year's investment in sales and service, as well as modest growth across the rest of the segment.

Profits and operating margins should also benefit.

In International we expect modest growth overall driven in particular by Australia, Asia, and exports based on a turnaround in the UK, results there and in the segment should improve.

In media licensing and advertising, we expect a modest decline in revenues, however based on improved cost management segment profitability should improve.

Finally corporate overhead should decline, reflecting a portion of the Company-wide overhead reductions, partially offset by higher depreciation and amortization and additional costs incurred to streamline these functions.

Our plan to reduce overhead spending by 40 million annually is a key element of our plan to improve Company-wide profitability and to make progress toward our goal of 9 to 10% operating margins before stock option expense.

It also is critical to offset continued cost increases, for example, in postage, paper, and fuel next year and in the future.

As we discussed in the third quarter call, we arrived at this cost reduction plan through a bottoms up analysis of opportunities to rationalize our central processes, eliminate redundancy, manage vendors differently, and outsource non-strategic administrative functions.

Since then, we've made major headway to reduce costs in a number of of our overhead functions.

Specific actions that we have already taken include reducing staff, eliminating the use of consultants and temporary labor, renegotiating key vendor relationships, coordinating and reducing marketing spend, and outsourcing certain functions.

Based on these actions, we have already secured a large portion of our fiscal 2007 savings goal and are confident that we will achieve two-thirds of the 40 million in annual savings before severance in fiscal 2007 and the full amount by fiscal 2008.

The impact of these reductions will be seen in the operating segments and corporate overhead.

Aggregating the segment outlooks, we project full year revenue of 2.1 to 2.2 billion based on lower Harry Potter and book club revenues and modest growth elsewhere.

We expect margins to rise in fiscal 2007, based on actions to reduce cost and drive profitable growth.

Severance and other transaction expenses related to these cost savings is expected to be $0.10 to $0.15 per diluted share, partially offsetting these cost of reductions in 2007.

Also, Scholastic adopted FAS123R beginning in fiscal 2007 and as a result anticipate stock option expense of $0.05 to $0.08 per diluted share in fiscal '07.

On modestly lower revenue, we're projecting full year earnings per diluted share of $1.55 to $1.85 on a GAAP basis, including the factors I just mentioned.

Based on these assumptions, we expect to generate free cash flow of 75 to 85 million next year with anticipated capital expenditures of 55 to 65 million.

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

Typically, our first quarter, which falls during the summer months when U.S. schools are not in session, is a small revenue quarter for our children's book businesses and the largest for Education Publishing.

Overall, we generate a loss in that quarter.

The second and fourth quarters are typically our largest revenue quarters in which we generate profits.

Third quarter, coinciding with school, winter holidays typically generates a small loss.

Overall, our positive outlook for core revenue growth, cost reductions, improved margins, and strong free cash flow for fiscal 2007 builds on the lessons we've learned and the actions we've taken in fiscal 2006.

And reflects our long-term strategy to expand margins and drive modest growth.

With that, I'll turn the podium over to Dick who will conclude.

Thank you, Marie.

I will now moderate a question and answer period.

I'm joined by most of the executive team including Beth Ford, Senior VP of Global Operations and IT, Lisa Holton, President of the Book Fairs and Trade, Margery Mayer, President of Education, Judy Newman, President of Clubs and Scholastic at Home, Seth Radwell, President of E-Scholastic, and Hugh Roome, President of Scholastic International.

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

Thank you. [OPERATOR INSTRUCTIONS] Your first question is from Stacy Fleck of Merrill Lynch.

Hi, good morning, just a couple of questions.

Is there any way for you guys to quantify the savings and promotional expense that you expect from eliminating the non-core book clubs?

And then I have a couple of follow-ups.

Yes, Stacy, we should eliminate about $14 million in promotion expense from eliminating Troll and Trumpet.

Okay.

And could you remind us what your long-term goal of free cash flow as a percent of net income is?

Mary?

Well, we had established a long-term goal of approximately 70% of net income.

Now in the past years we have overachieved that goal.

But we haven't officially changed that guide post.

I think we always want to allow ourselves the capability to continually invest in the growth of the business going forward.

Okay.

And I guess, as you think about the Continuity business, it obviously had a really good quarter.

And I guess I was wondering kind of what new products you're introducing in fiscal 2007 and kind of what you would view as a long-term growth rate for that business on the top-line.

We were pleased with the growth, obviously, Stacy, and it was sort of long in coming, but we were happy that it confirmed our strategy.

I'll ask Judy to talk about the new products and the long-term growth.

Hi, Stacy, good morning, I think what's exciting about the turnaround that we're finally seeing in Continuities is both the introduction of the new products, like Veggie Tales, which we want you to see and we're really looking to roll out next year and see significant numbers, as well as some of the classic programs like Disney and Dr. Seuss, which we successfully transformed from the traditional media, telemarketing and print, and are now selling very well on the web.

So it's sort of this dual product strategy of the introduction of the new products like Veggie Tales and Phonics, which you have been hearing about really rolling out, as well as these classic products moving on to a new media, which really shows the new excitement for this business.

And any estimate for kind of a long-term revenue growth rate?

Growth rate percentage, Mary?

Not at this point.

I mean, obviously, I think we have been focussed on restructuring this business and turning it around for the past two years.

And we're staying the course with the strategy and we're happy with the progress we're making so far.

So we do expect results to improve next year, but we don't want to give a specific growth number at this point.

Okay, thank you.

Clearly we're pleased with the turnaround there, Stacy.

Your next question is from Peter Appert of Goldman Sachs.

Dick, look at your operating results in the last couple of years, I guess, one of the themes seems to be, just the maturation of the children's publishing business, which is a natural process, and we're seeing it in terms of slower revenue growth, pretty much across the board.

So, I guess the question is in the context of that maturation, is the 9 to 10% margin target, does that require rethinking in terms of whether you're really able to get there given growth rates that are probably lower than you might have been thinking about a few years ago?

Well, Peter, we believe strongly still in the children's book business and some of our execution has not been as good as it should be in the last couple of years.

I think that's contributed to a slow down in our revenue growth.

You heard in my comments here about the kind of turnaround in the trade and the exciting new things we're doing there.

In that business product is everything.

And, while the growth rate of trade books overall is slow or flat, nonetheless, we believe we can do better in that context.

Clubs just had a bad year this year.

But we are following your thought reducing our expenses there and reducing our revenue expectations, as well.

Longer term, we believe that apparent cool, which we've discussed, and the shift over to the internet is going to enable us to get more growth out of the club business.

The whole key to our margin targets of 9 to 10%, which we retain, is our cost base.

We still believe our cost base is too high.

We are working diligently to lower that cost base and the effect of lowering our cost on our margins will be significant.

And so even with slower growth in the children's book business, which we don't believe will be forever, even with the changing media picture in the world.

We believe that through cost reduction we can attain the 9 to 10% operating margins in the three year time frame, which remains our goal.

What do you think, Dick, in terms of the clubs and fairs specifically?

Are these maybe 2, 3% kind of top-line businesses, is that how we should think about them?

I'd say mid-single digits.

I think the overall book market is kind of flat.

I think our channels are a little bit more resilient in the overall book market.

The use of the internet is really causing us to be able to sell in new ways and we think we're finding new customers, as you heard in the Continuity business.

And we're using the internet more and more in clubs and fairs, as well.

Our book fair coordinators are using the internet to help improve the efficiency of their operation.

So, I would say mid-single digits is possible in the children's book business.

Education, of course, remains, especially in technology, a double digit or significant grower.

And on that, one last question.

I think, if I've interpreted this correctly, the Education technology growth rate did slow as the year progressed.

Is that a function of getting to, I'm sure not maximum penetration but maybe higher levels of penetration of the READ 180 product results and the slower growth rate may be somewhat more competitive environment so should we -- or maybe Margery could just talk about that.

Well, I think the answer -- Margery will talk about the installation of the Enterprise Edition and how that affected the year.

There's still a tremendous amount of growth potential in READ 180, Peter.

There's maybe 10% of the kids who need it are getting it now or maybe it's 12% or 15% at the most.

So there's still a lot of opportunity there.

But Margery should talk a little bit about what we did this year and how it contributed to more modest growth, but longer term potential.

Hi, Peter, it's Margery.

I think it's really important to understand this year that we brought out a new addition of READ 180 called the Enterprise Edition, which is an upgrade to our current edition.

And the Enterprise Edition was really made up of two components.

It has a new instructional piece to it, which will benefit the Company because it has a consumable student book that we have seen good response to and are getting repurchasing on now.

And the other piece of it was upgraded technology, which we believe will help reduce costs both for schools and for Scholastic in supporting technology.

We far exceeded our expectations on rolling out our Enterprise Edition.

We somewhat underestimated the amount of work that was going to be involved in going back into our customers and actually reselling to them in the process of upgrading them to Enterprise.

So a lot of this year was about converting our customers or a lot of our customers.

We feel that that was the most important thing we could do this year because we think that it's really a platform for growing our business going forward.

And overall, we're really pleased with how the year went.

And then these incremental costs for support that Dick talked about earlier, I assume that represents a permanent increase in operating expense.

Does that imply maybe the business is a little bit less profitable going forward?

Well, first of all, the business is incredibly profitable.

And we don't believe that it does imply that.

We believe that this was -- and these were important investments we had to make.

We feel we've made those investments and we're not adding to those investments this year.

And we expect our technology to grow and really be able to absorb that investment going forward.

Okay, thanks.

And people also pay for those too, Peter.

I think to respond to the meaning of your question, I think three things are going on.

One, the children's book business we're transforming in two ways.

We're creating new product, we're improving the efficiency of the channel.

We also are moving to the internet and that's going to change the whole dynamics of that business and of the Company overall.

Second, cost reduction is very important for us in a slower growth mode.

Third, a somewhat relevant point, I think, to your question is the turnaround in Scholastic at Home.

Where we had 40, $50 million in operating income in the 2002, 2003 period, which we believe we can restore a great majority of in the future by our new model.

Thank you, Peter.

Great, thanks.

Thank you.

Your next question is from Brandon Dobell of Credit Suisse.

Thanks, a couple of quick ones.

First on CapEx, Mary, if you maybe give us a little bit of granularity on that 55 to $65 million number for next year.

Kind of how you think about growth investments versus maintenance or some kind of a maybe a segment detail where is this capital going?

And then maybe some color on how you think the processes that you have in place now are you close to being happy with them?

Are you very happy with them?

Just trying to get an idea of how much more work you think you guys need to do on getting the allocation process squared away.

Okay, first let me start with your first question on CapEx.

We don't give CapEx numbers by segment.

But I can say this year, as we built our CapEx budget, we looked at it from a couple different perspectives.

We look at our businesses as a portfolio of businesses.

We looked at what we felt was the right percentage of capital to be investing and just maintaining the base business and that's a baseline spending level that we always have on an ongoing basis.

And then we looked at providing for some strategic investment in key business areas where we want to drive growth.

And we focussed those investments in the educational technology segment, around the internet development, a little bit more investment in some of our IT platforms.

So we looked at those things from both the strategic and a maintenance perspective and made those decisions.

In terms of our processes to support that, you're right, we have been continually refining that process over the past couple of years.

I think things can always be better.

I think we certainly have a more rigorous process than we've had in the past, including more financial rigger around evaluating the potential long-term return from various investments, checking in throughout the year to make sure that things are still on track., And so we have to continue with that.

And there can always be some improvement made, but I think we've made great progress on those processes.

I think you guys have talked about this last year, but from a size or scale basis, the combination of Troll and Trumpet, about how much did that contribute kind of, last year you guys started to roll this off, so maybe -- just trying to get a feel for how big of an impact that's going to be in '07 versus '06, Or I guess, alternatively, as we think about the rest of that business, you guys say kind of modest growth, is that low single digit, mid-single digit, high single digit?

Just trying to get a feel for what drives the assumption there in '07?

The core clubs actually increased slightly in '06 in revenue.

It was Troll and Trumpet that dropped dramatically and/or significantly.

And those represented about 10 to 12% of total revenues.

In terms of going forward, we expect the core clubs to pick up most of the sales that Troll and Trumpet had.

We had tests in the past two years that suggest that people will operate the core clubs and buy almost as much as they would if by ordering from the three clubs.

So we're confident that we're going to be able to maintain our revenues pretty substantially.

Judy, do you want to augment that?

Sure, I think the exciting thing about this plan, as Dick said, it's really based on some good dialogue we've been having with our customers about this.

And I think it's important to understand too, that we do have our solid customer base who has been doing wonderful business with us, of course, since 1948.

And really what happens is when teachers use these catalogs, they're using multiple clubs to the same teacher.

So teachers order from the Scholastic core clubs and then they place second and third orders from Troll and Trumpet.

Because their lives are much different now, what they're asking us for is a simpler way to use our book club business.

And so they're saying to us give us the same excitement of the Troll and Trumpet brand, but put it all together with Scholastic core.

So we're able to do that.

Put it all in one catalog.

Get that same excitement of the book club experience combined into one, and realize tremendous efficiencies both in the promotion expense, by combining it into one catalog, as well as for settlement expense.

And teachers will get one carton, they'll get one catalog, and you can imagine the tremendous efficiencies we'll be realizing as well as the same excitement in delivering the books and promotion that they're used to getting from all of the clubs, it's just now consolidated.

Does that make it a little bit clearer?

Yes.

Definitely.

Appreciate that.

Then finally for Mary, the stock comp guidance was a lot lower than we had estimated based on what the historical footnotes led us to put in our model.

Is there any change in how you guys think about compensation or is it restricted stock?

I guess maybe the broader question for you and Dick is how you guys think about going forward in incentive compensation?

Is it stock options, is it restricted stock, is it a combination of the two?

How should we think about that?

At this point our stock compensation program is a combination of the two.

We implemented a restricted stock program a year or so ago, and right now we're not making any changes.

We're monitoring it, though.

Our comp committee is involved in those discussions.

And in the coming year to two years, we may make some changes, but at this point we don't have anything planned on the immediate horizon.

Great, thanks a lot.

Thank you, your next question is from William Bird of Citigroup.

Yes, on the topic of cost-cutting, above and beyond what you're doing at corporate, I was just curious if you have plans to do more in fiscal '07 at the divisional level in terms of cost re-engineering.

And also was wondering if you could describe any steps you're taking to improve operational responsiveness.

Really any efforts you're undertaking to avoid lag to cost cutting, thank you.

Okay.

I'll take the first question, certainly on what we're doing in terms of cost-cutting.

As you know we've had an initiative ongoing to look at overhead and that's at the corporate level as well as at the business unit level.

So at the business units we've also taken a look at all of the overhead that supports the business.

We've looked for opportunities to better leverage activities like marketing and web development and other things across our channels and moving things into the central functions or simply better coordination in order to get greater efficiencies in the business units.

So, we are definitely looking at our operating overhead in the business units.

Then in addition to that, we're looking at just the core operations cost.

So we talked about in clubs not only looking at the promotion spending, but the fulfillment processes and the operations cost and the customer service cost and how we can streamline those.

In Fairs, as you know, for a number of years, we've continued to look at our operating costs and we are continuing to do that, so we're streamlining a number of activities there.

So again, across all of our businesses, as well as corporate, we're looking at cost reductions.

Bill, it sounded like you were asking whether we're doing this fast enough, if I could interpret your question, and the answer is probably not fast enough.

But we're working on it all the time and it's the major focus for our Company this year in '07.

And I guess, specifically, just on fairs was just curious, in looking at your warehousing network how far along are you in broaching the topic of better optimization of assets in place?

We're moving ahead on that.

One of the issues is we need better data on our inventory before we make some very significant changes.

But Lisa and Beth Ford can make further comments on this point.

Yes, this is Beth.

We continue to look at the network.

And I think one of the things we mentioned in the overview is that we're looking at process standardization, which is obviously critical in a multi-site network.

We also continue to consolidate activities where it makes sense.

At the same time the logistics market is driving us into different reviews of our network.

So we want to make the right decision for the long-term and as logistics costs increase, this is a local delivery business, so we look at the logistics costs at the same time we are looking at the infrastructure costs to make the right decision.

So we continue to make investments.

We've continued to re-engineer processes.

We make consolidation decisions where they make sense.

But at the same time, we have to realize what's happening in the logistics market.

Thank you.

Lisa may amplify that.

I'll just add two things.

Two of the specific things that we did this year is we actually consolidated our customer care facility.

We took it out of the regions and moved it to Neosho, which was not only part of cost-cutting, but part of our overall initiative to really improve customer satisfaction.

It was one of our biggest customer dissatisfiers and we're really excited about the potential to provide our customers more service and doing it more efficiently.

And then the second thing, to Beth's point, warehouse consolidation is part of a overall looking at what we call network optimization.

It's really using technology to improve efficiency and we've been using a lot of VeriFone that are the beginning of our POS system.

We have 6500, we're about to get another 2,000, and what we're seeing is a pretty significant improvement in collections and shrinkage in merchandising and in accounts receivable.

Okay, Bill.

Great, thank you.

Your next question is from Steven Barlow of Prudential.

Thanks, a comment first.

Mary, you're being too modest, your CapEx system before you got there was a total mess.

In terms of other areas, is there a way for Margery to size the revenue of the print products that are not being continued in 2007?

And to go back to Brandon's point on the options, you had talked about in your filings the expense looked a lot higher in fiscal 2006.

Obviously you didn't have to book it.

What was the change between your nine month footnote and what you're expecting in 2007?

Did you accelerate some options or what happened there?

I'll certainly take the second question.

We did accelerate the vesting of our outstanding options and we did that in May.

So, of course, then what you're seeing us project for fiscal '07 represents the expense associated with options grants for that year.

Correct.

Okay.

And in terms of the revenue fact, we think it's going to be relatively small because we're continuing to sell the products.

And we think there will be continued demand this year going further out.

I don't think it's going to be a material change in our business.

I won't agree with you, Steve, on the characterization of the total mess.

But I will say that our process is much better now since Mary has entered the Company and has brought some rationalization to our CapEx process.

Fair enough.

And then lastly, just give some guidance on the tax rate, because that's been changing over the last year or so, for '07.

Yes, our tax rate did go up a little bit this past year.

We're not expecting any significant increase as we go into '07.

Very good, thanks.

Thank you, your next question is from Drew Crum of Stifel Nicolaus.

Good morning.

The theme this morning seems to be on cost-cutting.

I wonder if you could talk about what type of flexibility you have in terms of pricing across your businesses.

We have some flexibility and we're going to need to use it, Drew.

Our book clubs are known as a relatively value operation.

And we're delivering tremendous value through the book clubs.

On the other hand, the costs of operating our business are growing in the core paper, postage, and fulfillment areas.

So we need to both tend to reducing those costs as best we can in a rising cost market, but also to keeping up with pricing.

And we're doing a lot of pricing analysis throughout our Company.

Much of this I don't think will show up in this '07 year.

I think we need to look at our prices much more intensely for the '08 fiscal year.

Not that we haven't been paying attention to it.

We have modest price increases built into this year, but the ongoing increases in some of our core costs will require much more attention to pricing.

Okay.

And maybe you can spend a moment on educational publishing, maybe characterize operating conditions.

Are we going to see a continued shift towards the first quarter?

I thought the fourth quarter being end of school year period would bring greater revenue growth.

And in addition to that, there's at least a perception that there's more competition for READ 180 right now.

There's some new market entrants with new products out there.

Are you having to discount your pricing on READ 180?

Hi, Drew, it's Margery.

No, we have not been discounting our pricing on READ 180.

There are more market entrants.

And so we are coming up and we do come into more situations where school districts are evaluating READ 180 and went with another choice.

However, having said that, we're far and away the leader in the market.

We're in over 10,000 classrooms.

We have a commanding lead in terms of our research on the effectiveness of the program.

Last year the Federal Government awarded Scholastic four out of eight Striving Reader grants.

We are the big kahuna in the market.

People are going to try to compete with us.

And they do try to compete with us on price.

But they can't possibly compete with us on the effectiveness of our program and the kind of service that we can provide to our customers.

Yes, READ 180 is becoming a more seasonal product where with summer is a big installation time.

It does require some scheduling changes for schools when they put READ 180 in because they usually schedule kids into it for two periods, which means it's more effective putting it in in the summer.

We think we'll have good sales during the school year, as well.

But you will expect to see more seasonality in the summer.

I think READ 180 is the transformational product that changes the way instruction takes place.

Most of the competitors that we have seen so far don't reach that transformational level and don't have the effect on kids' reading improvement that READ 180 has been shown to have.

Are you experiencing any apprehension from LEAs making decisions to purchase product with the rising costs of energy and health care, et cetera?

Yes, there's more concern in the schools about energy costs.

There's no question about it.

Is that affecting the business?

However, it's offset, I think, through by what do the schools have to do?

What do they have to do?

In a no child left behind period, they have to raise student performance.

That's the major goal and objective of schools.

They've got to do that.

So they're willing to invest in things that will help them do that, because that's their number one task.

And so other things may have to go, but the things that will turnaround kids reading achievement they will keep.

Okay, and one last one.

I think you mentioned off the second quarter of last year a $0.05 to $0.10 hit from hurricanes and specifically lost several fairs.

The fair count was down this year, are you expecting growth in fair count in '07?

And is it possible to quantify the final impact from hurricanes in '06?

Lisa, do you want to take that one?

Sure, hi, this is Lisa.

Actually the fair count was down this year.

It was partly due to the hurricanes, but it was also a little bit on purpose.

We took some of our fairs, which were more unprofitable, and we actually switched them to our box fair division.

It was really a combination of two.

And in terms of fair count for next year, of course obviously we can't totally predict the future, but the signs are looking good at the moment.

This is more of a revenue per fair game right now.

But we are seeing increasing in fair count even as we try to move some of the less profitable fairs to box fair.

Okay, thank you.

Thank you, your next question is from Philip Olesen of UBS.

Thank you.

Actually I have a couple of questions for Mary.

First in terms of the refinancing options you kind of outlined, I guess, what are the ultimate goals as part of that refinancing?

Is it just to kind of address the '07 maturity or is it to kind of build in a bit of a liquidity cushion?

Well, I think we would have all of the obvious goals.

I mean, obviously we have to refinance the debt that's out there.

We want to maintain a strong balance sheet.

We want to maintain some degree of financial flexibility.

At the same time, we want to optimize our cost of capital.

So we're looking at all of those components in making the decision around what's the right combination of those options.

And in terms of the discussions you've had to date, you indicated that two options could be either, I guess, increasing the existing bank facility or putting in place a new bank line.

Following the rating downgrades, do you believe you'll be able to maintain an unsecured facility?

At this point, we're still having conversations, obviously, with all of our various banks and we don't believe that the recent credit actions are going to have any major impact on our ability to do the things that we need to do to refinance and tweak our existing facilities.

So should I infer then that you would not expect a secured bank facility?

At this point we're still reviewing the options, so we'll see.

Okay.

And I guess, in terms of free cash flow, how do you look from a kind of priority for that free cash flow in fiscal '07?

Well, I think, of course, we are continuing to look at the level of leverage that we have.

And we want to keep some flexibility in order to be able to opportunistically take advantage of things that might come along that could provide growth in our business for the future.

So we're maintaining our financial flexibility, focusing on lowering our debt levels, and those are our priorities.

All right, great.

And one, I guess, final question for Dick.

It was like almost 20 years ago now when you decided to take Scholastic private.

How would you, I guess, compare the situation back in '87 when you decided to pursue that path with kind of what might be the current options facing you in today's environment?

Well, we were a much smaller Company then.

And we had a unique opportunity.

I think at this point we're maintaining our focus on being a public Company.

We're trying to be responsive to our shareholders.

I believe our shareholders are going to be pleased with the level of commitment to cost reduction and improving margins.

And I believe that that's the appropriate thing for us to be doing right now as a larger Company.

Thank you.

Thank you.

I would like to turn the floor back over to Dick Robinson for additional or closing remarks.

Well, thank you all for listening to a rather extended discussion of our '06 results.

I hope we gave you some clarity into what we're trying to accomplish for '07.

We certainly appreciate the thoughtfulness of the questions and the commitment to the Company.

We hope to be worthy of that by cutting our costs and improving our margins in '07.

Thank you very much.

Thank you, this concludes today's Scholastic conference call.

You may now disconnect.