Scholastic Corp (SCHL) 2007 Q2 法說會逐字稿

Good morning.

My name is Jackie and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Scholastic second quarter 2007 earnings conference call.

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

After the speaker's remarks there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you.

It is now my pleasure to turn the floor over to Jeffrey Mathews, Head 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 Web site scholastic.com, clicking on Investor Relations and following the links on that page.

I'd also like to note that this presentation contains certain forward-looking statements which are subject to various risks and uncertainties including the conditions of the children's book and educational materials market and acceptance of the Company's products in those markets and other risks and factors identified from time to time in the Company's filings with the Securities and Exchange Commission.

Actual results could differ materially from those currently anticipated.

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

Thank you, Jeff, and welcome to Scholastic's earnings call and presentation for the second quarter of fiscal 2007.

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 had a positive second quarter.

In particular, strong results in Clubs and Fairs drove growth and higher margins in the Children's Book business.

Scholastic Education in a seasonally smaller quarter achieved continued growth in educational technology sales.

Soft spending by schools on supplemental curriculum materials impacted the print portions of Scholastic Education.

Both International and Media Licensing and Advertising showed top line growth and margin improvements.

We also continued implementing our overhead cost reduction plan which we announced last spring and are on target to reach our savings goals.

As a result, operating margins expanded in the quarter and net income increased solidly.

In school book clubs last quarter revenue exceeded expectations.

Significantly higher sales and orders in the core clubs nearly offset revenue loss from the discontinuance of the Troll and Trumpet Clubs which represented 15% of revenues last year but were eliminated this school year as part of a strategy to streamline club brands.

Teacher's positive reaction to this change reflects both their preference for a simpler club experience and strong execution of our plan.

Significant promotion and fulfillment cost savings resulted from consolidating clubs.

In addition to a decrease in the number of club kits mailed, orders that previously would have been split among multiple clubs were shipped as a single order resulting in a decrease of half a million shipments directly benefiting mailing costs.

Club profits and margins rose significantly last quarter compared to a year ago.

Overall we are pleased with these results and remain confident about the outlook for the rest of the year.

School book fairs were also up strongly last quarter.

Revenue per fair rose over 5% as we continue to focus on the customer experience including major enhancements to the chairperson's tool kit which enables online management of fairs.

We also continue to increase the number of credit card processing units in the field.

Popular with customers, these units also decreased transaction costs and speed up collections.

Fair count was also up last quarter, helping drive revenue gains.

This reflected bookings of new fairs as well as the rebooking of fairs that were cancelled due to hurricanes a year ago.

Bottom line results in this channel improved, reflecting higher sales as well as headcount reductions over the summer and the centralization of order restocking.

In Scholastic at Home, also known as continuities, revenue in the total customer base grew again strongly in second quarter as we rebuild the business through customer acquisition mainly online.

As anticipated, bad debt rose slightly year-over-year but less so than in the first quarter as we fine-tune our acquisition offers and credit screens especially in the Internet channel.

We continue to invest in promotion as part of a strategy to build long-term productive relationships with our customers.

Increased promotion spending offset the benefit of higher sales and results were approximately level compared to the prior year, however, based on continued growth, we still expect results to improve year-over-year.

At this time, Scholastic at Home is beginning to grow again and the first phase of the turnaround plan is complete.

Accordingly, I'm asking Judy Newman, President of Scholastic Book Clubs, who had been supervising Scholastic at Home, to concentrate on growing the club businesses which have had a great start this year and on expanding sales of other products to classroom teachers with whom we have a very strong relationship.

As announced earlier this month, Seth Radwell, who currently serves as President of E-Scholastic, has now assumed responsibility for Scholastic at Home.

At a time when Scholastic at Home is moving its promotion to the Internet, Seth's background in online marketing plus his extensive experience in consumer book clubs should enable him to move Scholastic at Home to the next stage of revenue and profit growth.

In Scholastic Education in the second quarter, technology sales continued to grow solidly up 7% in the quarter compared to a record prior year.

READ180 was a major component of overall growth and was up 5% for the quarter and 9% year-to-date.

In addition to upgrades and expansions with existing customers, new customers continue to be a key source of new sales as school districts pick READ180 for its proven ability to help improve reading scores through superior efficacy and support services.

FASTT Math, the math intervention program based on research from the author of READ180, also had another strong quarter.

Sales of Scholastic Education print products declined modestly in line with the decline in school spending.

For September and October, overall education industry sales of supplemental materials declined 16%.

While we expect the funding environment will continue to be soft this school year, we are launching a number of new products this spring which we believe will drive long-term growth.

The new classroom library called "Go the Distance" developed with Mohammed Ali and based on his core values, has already received very favorable reviews and publicity.

We are also increasing marketing programs to show how classroom libraries can be a key part of schools reading efforts.

Other highlights from the second quarter include strong core trade sales especially of Maurice Sendak's "Mommy" and backlist titles including "I Spy Christmas" and the "Read and Learn Bible".

International revenues and margins also improved last quarter largely from strong results in Canada and also Australia and Southeast Asia.

We continue to build Scholastic clubs and book fairs in the Philippines, Malaysia, Thailand and India.

In Media Licensing and Advertising, advertising sales drove improved performance.

Additionally, we remain on plan to meet our cost reduction goals and given our strong liquidity our position to pay down a significant amount of debt.

In summary, strong second quarter results position us solidly to meet our goals for the year.

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

Thanks, Dick, and good morning, everyone.

As Dick said, last quarter's results were positive driven by growth and improved margins in the Children's Book, International and Media, Licensing and Advertising segments.

Total company revenue was up 6% and operating income rose 10 %.

Earnings per diluted share increased $0.17 to $1.75.

Cost of goods sold as a percent of revenues rose slightly to 43.9% from 43.3% in the prior year quarter primarily due to product mix and the companywide benefit of printing discounts a year ago when we had a major Harry Potter release.

Selling, general and administrative expenses declined as a percent of revenue to 34.1% from 35.5% reflecting lower promotion spending in clubs and overhead cost reductions.

As we discussed previously, our overhead reduction program is focused on lowering costs by reducing staff, eliminating the use of temp labor, coordinating and reducing marketing spend, outsourcing certain functions and managing discretionary spending on travel, supplies and other things.

We remain on track with all of these plans and are seeing expense reductions in the related cost categories which are positively impacting segment results as well as corporate overhead.

The impact of these efforts on total SG&A last quarter was partially offset by increased promotion cost in continuities and the timing of certain accruals.

Stock-based compensation expense, which increased in the current fiscal year due to the adoption of FAS 123R, was $0.01 per diluted share.

Severance in the second quarter was $0.05 per diluted share compared to $0.06 in the prior year period.

Bad debt rose primarily as a result of slightly higher bad debt rates in continuities as Dick has discussed.

Net interest expense fell reflecting the Company's lower debt compared to a year ago.

Scholastic's effective tax rate in the second quarter was 36.4% which was lower than a year ago.

Looking at the segment operating results, revenue in Children's Book Publishing and Distribution rose solidly as a result of strong sales in fairs and continuities.

Fair revenue grew from a 5% increase in revenue per fair and a 4% higher fair count, which reflected strong fair bookings and the shift of some fairs from December to November.

Continuities revenues also was up as a result of growth in online channels and in new products.

As expected, based on our growth during the period, bad debt rose as a result of new customer acquisitions to 24% of revenue.

As Dick described, core club sales exceeded expectations and total club revenue was down only 1%.

Trade sales also declined slightly from an expected decline in Harry Potter sales relative to a year ago when the fourth movie in the series was released.

This was partly offset by strong sales of other backlist titles.

Operating income and margins for the segment increased solidly reflecting lower cost in clubs and higher sales in fairs.

In Educational Publishing, revenues were down slightly reflecting a 7% rise in education technology sales, offset by a decline in revenue from print products including paperbacks, library publishing, and classroom magazines, amid a soft market for supplementary curriculum materials.

Segment operating profits declined as a result of lower print revenues as well as the timing of certain expenses and volume discounts in the quarter a year ago.

In International revenues were up 14% in U.S. dollars and 9% in local currencies, and segment operating profit improved principally due to strong sales and profits in Canada, Australia and Southeast Asia.

Results in the U.K. were approximately level with the prior year with key factors in the core trade business indicating that the turnaround there is on plan.

Revenues in Media, Licensing and Advertising rose 9% in the second quarter compared to the prior year period reflecting higher advertising and software sales, partially offset by lower production revenue from a planned reduction in program deliveries in the quarter.

Operating income rose 19%.

Finally, corporate overhead was $19.3 million compared to $15.4 million in the prior year period.

As I mentioned previously, overhead expenses are lower in those areas that we've been focusing on but those savings are offset by the timing of certain accruals as well as allocations of overhead back to the business units.

Free cash flow in the last quarter was approximately $108 million compared to $286 million a year ago, primarily from the timing of Harry Potter related receipts and payments in the second quarter last year which benefited net cash provided by operations.

Cap Ex declined slightly from lower IT spending and the delay in the timing of some projects to later in the year.

Production costs were lower compared to the prior year when we were producing Maya & Miguel episodes.

Prepublication costs also declined from lower spending in the library publishing business as a result of our decision not to update certain print reference sets as announced at year-end.

Looking at the balance sheet, cash and cash equivalents declined year-over-year reflecting changes in working capital, in particular a decrease in accrued royalties relative to last year's higher Harry Potter sales.

In addition, accounts receivable rose as a result of higher sales primarily in continuities.

Inventories rose as we increased stock levels to support new products.

Accounts payable fell partly reflecting timing of Harry Potter sales a year ago as well as lower spending last quarter.

Total debt was down reflecting the repurchase over the last year of approximately $40 million out of the total $300 million of debt maturing on January 15, 2007.

We will fund the maturity of the remaining $260 million in bonds from current year cash flow and existing revolving credit agreements.

For the interim period we believe this will leave us with ample liquidity including $100 million in available credit and positive free cash flow in the second half of the year.

We continue to explore additional long-term financing options including issuing debt and expanding our revolving credit facility.

Looking at our outlook for the year, we expect Children's Books to continue on plan with solid results, in particular, clubs should continue to benefit from lower cost on slightly lower revenues, and fairs, revenue per fair should remain strong and we remain on plan for a slight year-over-year increase in fair count.

Continuities should continue growing with improved results later in the year.

In Education, technology sales should continue to be solid offset by softness in print.

As I discussed, we're also making significant progress toward reducing overhead costs.

This, as well as a number of other factors that I've discussed, will benefit the latter half of the year especially the fourth quarter.

Overall, we're on plan for our fiscal 2007 goals which as we described in July include revenue of 2.1 to $2.2 billion, earnings per diluted share of $1.55 to $1.85 and free cash flow of 75 to $85 million.

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

Thank you, Mary.

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

With me here in addition to Mary are Beth Ford, Senior Vice President of Global Operations and IT, Lisa Holton, President of Book Fairs and Trade, Margery Mayer, President of Scholastic Education, Judy Newman, President of Book Clubs, Seth Radwell, President of E-Scholastic and Scholastic at Home, and Hugh Roome, President of Scholastic International.

The floor is open for questions, Operator.

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

Hi, good morning.

A couple questions.

I guess, first, is there any way to quantify how much you've achieved at the cost savings to date of the $40 million that you've laid out?

Mary, do you want to tackle that one?

Well, Stacy, I can't confirm that we're on plan for the numbers that we announced, so of the $40 million we said that we would achieve two-thirds of that this year and that there would be some offset for severance expense and you can see severance is pretty much in line with the guidance that we gave, and in terms of the underlying cost savings, we're on track to achieve the two-thirds of the $40 million that we indicated.

Okay.

I guess if you could talk a little bit more about the decline in profitability at Educational Publishing, it caught me a little bit by surprise.

And is this something that we should anticipate to see for the rest of the year?

Well, clearly, it has to do with the softness in supplemental area, in particular, paperback classroom libraries, but we will, and we expect the softness to continue, however, the sales of technology is moving ahead strongly and as some of these issues are partly timing.

Margery, do you want to deal with that further question?

Yes, hi, Stacy, this is Margery.

I think Dick gave you the answer.

It's really the decline in the paperbacks and then as Mary said in her comments, we had a one-time favorable credit on printing last year that fell into the second quarter.

I mean, what we're really seeing in terms of the supplemental business is we had a couple large sales in the second quarter of last year and that's really what caused the large variance in our numbers.

I mean overall, we're seeing a little bit of softness in our other channels but basically our supplemental sales are doing better than the market overall.

Were you surprised by the 5% growth at educational technology?

You know, you've been growing a bit faster than that.

Well, we had a really good quarter last year and because we had a lot of shipments that moved from August into September, so we thought that the growth in technology for the quarter was good and we had a good increase in new accounts.

This is not the biggest quarter, you know, we've talked about the seasonality of technology and how more and more has moved into the summer, so we're on plan for our year in technology.

Great.

Thank you.

Thank you.

Your next question is from Drew Crum of Stifel Nicolaus.

Good morning, everyone.

Dick, I wonder if you could comment on the cuts to promotional costs in clubs?

If you could quantify what cost savings came through in the quarter and any additional savings we might see through the remainder of the year?

Well, Drew, we, by cutting out the number of clubs, cutting down the number of clubs, obviously, we mailed fewer kits as we announced last spring and I believe we announced that there was a difference in the two years of promotion spending of $14 million.

Some of that was certainly realized, or the majority of it was realized in the first quarter, in the second quarter, quarter just completed, but Judy can give you a little more color on this and what will happen in the rest of the year.

Yes, hi.

The great thing about the execution of this plan is that, as you know, we've now realized just pretty much flat revenue only is down 1% with so many fewer offers.

In fact, just to give you a little color, we had 65 offers to date last year and now we're running 37 offers, so we're realizing pretty much the same revenue with almost half as few offers.

So we're realizing a corresponding decline in promotion expense so we are on track to do that.

We're right on budget and we will be realizing the full $14 million in savings through the year.

Okay.

Another question on continuities.

Four consecutive quarters of top line growth there.

How sustainable is that level of growth and maybe talk about some of the swing factors you see for the remainder of the year in terms of improving profitability for that business.

We're going to have a two-headed answer here.

Okay.

With this question, Judy will deal with the revenue growth in the first and four quarters as you correctly point out and then Seth will give you some of his views on the future profitability of the business.

Yes, it's a great opportunity to be able to hand over kind of a robust revenue growth story to Seth, and we're very encouraged that after do-not-call, as you've been hearing us talk about, we are able to get back to customers largely on the Web and we do what's very encouraging is we have both traditional products, Disney and Seuss, which are selling online as well as our new products and so those are good barometers of sustainable growth we believe.

Some of our new products, Phonics and Veggie Tales, the customers are really liking them so that shows us that this is a sustainable thing.

New customers are coming in and now we'll be nurturing them on the back end and so we're seeing consistent growth over the four quarters and Seth, with his background and expertise in this business, is well positioned to take it to the next level.

Seth?

We're very excited about moving forward and rebuilding the file in the continuities business.

We've had, as you've noted [then], we're building newer relationships as Judy mentioned in new channels following the move from telemarketing to the Internet and other new growth channels.

We're confident that our [credits] reading metrics are improving and that we're excited that the top line growth will result in a great outlook for the year.

Okay.

One final one, guys, and maybe Mary can address this one.

A severance charge of $0.05 in the quarter.

Are you done taking severance charges for the year?

I believe your guidance was 10 to $0.15 for the year.

Or should we see anything more at the back end of '07?

It is certainly possible that there might be additional severance in the back half of the year but as we had indicated previously, it's predominantly front end loaded, so I think on a year-to-date basis, we're about in the middle of the range, so for the full-year, we'll probably be toward the upper end of that range.

Okay.

Thanks, guys.

Thank you.

Your next question is from Peter Appert of Goldman Sachs.

Good morning.

Dick, I think you or Mary mentioned that there was some shift in fair count from December to November.

Could you quantify what impact that might have had on results and should we be anticipating then that the fair business might be a little bit softer than otherwise expected for the third quarter?

I'll ask Lisa to tackle that, but first, the early Thanksgiving probably shifted a little bit of fairs into the week after Thanksgiving which this year fell in November and last year fell in December, so that it's possible that that would have some effect on the third quarter fair business but Lisa will give you more information on that.

Hi, Peter.

You're right.

There was a slight shift from some December fairs into November, so you will see that in the Q3, but I would say the other three factors for fair count was one, we regained some hurricane related fairs that we had lost in Q2 of last year.

The shift was not only the early Thanksgiving but also the results of our peak program in which we're actually planning on moving and shifting our fairs to be more profitable and spread throughout the year.

And then finally, our rebooking actually is up slightly and that's contributing as well so we will continue to see that through the year.

In addition to our fair count being slightly up, our revenue per fair is actually up quite well over last year and we're pleased with that.

Great.

Thank you.

And then Dick, can you talk about what you've done broadly this year from a pricing perspective?

You know, Peter, we have done some in pricing.

On clubs, obviously, we were concentrating on getting the business righted again and we obviously did that extremely well in the second quarter.

We have had some pricing changes in Education, not very many.

I'll turn to Judy and Lisa to ask about price in clubs and fairs.

Hi, Peter.

We are indeed realizing a nice increase in revenue per item in clubs and the good news is that at the same time, we're also seeing an increase in paid books per order, so those are both contributing to an overall increase in revenue per order, so we were able to get higher price.

We've done things like reduce the number of $0.95 items in the offer, down from two to one, and we've consolidated demand around that one item which has actually created excitement, so we got a price increase and a little marketing opportunity out of it.

So this is all part of a strategic pricing objective that is really embedded into our club strategy now in a very strategic quantified way, so it's really working in the club business right now.

On fairs, I would say it's a similar story.

We do have an aggressive pricing strategy and we're looking very close at our mix and that's certainly one of the contributors to our increase in revenue per fair, but at the same time I will say we're also very sensitive to our customers and we're also very conscious of the mix that we put out there and making sure that we're always putting out affordable books to the kids in all areas of the country.

Just thinking about this, Peter, it's more of a volume story this year.

We got the demand back.

I think the pricing here and there played a role improving the profitability but this was basically a demand story rather than a pricing story.

Okay.

Great.

Thanks.

And one last thing, Dick.

The conference call, of course, would not be complete if someone didn't ask you about how you're thinking about the long-term trend in operating margin and I'm thinking specifically that given the very positive momentum here you're seeing in the current quarter, you might be thinking more optimistically about the timing or the magnitude of the margins you can reach in this business over the next several years, so --

You're paying me back for my answer to your question the last time, but you know, this is obviously an extremely important factor for Scholastic, Peter, as you know, and we're focusing on building that margin to the 9 to 10% area.

We made some good headway in this quarter and we are going to continue to focus on this as our number one objective along with producing more cash.

So we're not really putting a timing on this.

I believe we said in the past that this is an '09 goal and we're not moving off of that at this point.

Okay.

Great.

Thanks, Dick.

Thank you.

Thank you.

Your next question is from Steven Barlow of Prudential.

Good morning.

Lisa, could you just tell us what trade revenues looked like year-over-year ex-Harry Potter?

And then also if you would talk about your pre-club spending, it sounded, I guess, from Mary's comment that it's down and just give us an order of magnitude on what's happening there.

And then lastly for Mary, I'm still a little confused about the debt level.

If you look at your release seeing the net debt level at 343.5 versus 265.6 a year ago it sort of looks like an increase and I think you talked about decreasing because interest may have gone down because of decreased debt and I'm a little confused.

Thanks.

Mary, do you want to take the latter question on net debt?

Well, Steve, on the net debt, you'll have to recall that it is a net number that's net of cash on the balance sheet and the second quarter last year, cash was $286 million, so the net debt level, of course, would have been lower because we had a high cash position.

So that's the main thing that's driving that.

In terms of the debt that we have outstanding, it remains the same with the exception, as I said, of our repayment of or repurchase of $40 million of the outstanding notes that are coming due in January.

I guess if you just look at the net debt number, I mean it looks like net debt including that cash is up which you're generating cash so I'm a little confused where the money might be leaking.

Net debt is up this quarter because cash is down and, clearly, if you look at our working capital, that's really where, if you look at the cash flow statement, the working capital is where the shifts are, so it would be in the receivables and payable shifts associated with Harry Potter.

As we discussed, inventory is up a little bit so that's what's impacting it.

Okay.

Okay.

Now, on the pre-pub spending and trade sales, the majority of our pre-pub spending is in Education, and I think rather than Lisa, where the pre-pub spending is moderate, I'll ask Margery to address the pre-pub spending and then Lisa can come back on the trade sales for the quarter which, as we announced, were down slightly.

Hi, Steven, it's Margery.

It's really just a timing issue on the pre-pub spending.

We've got some exciting things in development that are, we think, are going to be, are going to fit really well are our READ180 suite and it's just really a question of timing.

And in terms of the trade sales, I believe you asked about trade sales ex-Harry Potter.

In fact, our core business sales are up 5% over the same period last year and we're pleased because it's a really nice mix of frontlist and backlist.

On the December 10th New York Times Best Seller list we actually had seven slots led by Maurice Sendak's "Mommy" which has gotten incredibly rave reviews and is selling well, but we've also had "The Wandmakers Guidebook" which has been a big hit as well as Robert Subuda's "Christmas" and "Owen & Mzee" and then we've had incredibly strong sales from our backlist both in terms of franchises like "I Spy" and "Can You See What I See" as well as Cornelius Funke and Blue Balliett.

Very good.

Thank you.

Okay.

Thank you, Steve.

Next question?

Thank you. [OPERATOR INSTRUCTIONS] Your next question is from Brandon Dobell of Credit Suisse.

Hi.

A couple of quick ones.

Maybe if you could touch on what the product mix in fairs looks like these days relative to where it may have been a year ago and do you think that's the right mix for how, or for what the reactions from parents are, what the reactions from the fair leaders are and how much do you think that the change in mix, kind of on a year-over-year basis has helped or hurt margins?

And then I'd also like to get a feel for how, do you think you have enough, I guess, customer history yet with kind of the new channel being online to gauge what those customers are going to look like from a bad debt perspective?

Just trying to gauge how much of the impact in the year-over-year bad debt expense was from the Internet versus legacy customers, that kind of thing.

Thanks.

Okay.

Lisa, do you want to talk about product mix and the fairs and then we'll move to Seth and Judy to look at the bad debt question relative to the Internet?

Sure.

I'll say that in terms of the product mix and the way it looks relative to last year, I would say, actually, the only difference is that we are constantly looking for the new and exciting and wonderful mix of books to make the kids excited when they walk in the door.

I would say overall the mix, I think you're asking in terms of books versus non-book, is relatively the same and it skews hugely towards book.

It's a literacy fair but at the same time we have always historically provided activities and other ancillary materials that support the literacy event.

And in terms of parent's reactions, one of the great things about the fair is that it's voluntary in its choice, and many, many schools choose a wide spectrum in terms of everything from all books to a different mix depending on what their philosophy is.

Our philosophy is that the fairs are all about encouraging kids to have fun with reading.

They are events more than they are retail experiences and we're actually pleased with the product mix.

And in fact I'd say one of the things that's happening is our category management and our monitoring of the sales has really helped us look at what's selling and how we respond in the market and I think that's what's really driving some of our revenue per fair numbers.

Okay.

Thanks.

Okay, Judy?

You're looking towards Seth.

Would you like him to--?

I would just say that Seth can talk about it, but we, all this new sales that have been brought in for the acquisition customers have all been put through our screening models so really the bad debt should be in line.

But Seth, do you want to take that?

Sure.

I think as Judy and Dick have mentioned, we're now in a growth mode, building relationships with new families across many channels especially online.

Consequently, a higher proportion of the overall revenue mix is with new customers and such customer, new customer build as in most direct marketing businesses is, in fact, associated with a higher bad debt relative to customers who have been on the file for a while and have proven pay histories.

We're confident that, as Judy mentioned, that our credit [screening] models, especially online, are continuing to improve and we're excited that this top line growth will lead to better bottom line performance for the full-year.

Okay.

And then one quick follow-up if I could.

I think earlier on in your prepared remarks, Dick, you mentioned building clubs and fairs in some of the smaller overseas markets, Thailand, India, those kind of things.

Uh-huh.

Let's get a sense of how you guys are executing that.

Is it with your own assets on the ground?

Is it with partnerships and whether you think those small countries can be, obviously, not the same size as the U.K. or the U.S., but from a profit margin perspective or from a return perspective, can they generate the kind of returns that you think are good enough for the business?

Good question.

As you know, with the Grolier acquisition in the year 2000, we developed, we acquired a network of door-to-door operations selling encyclopedias primarily in seven Southeast Asia countries.

This is proven, including the three that I mentioned on the call.

This is proven to be a very strong business in and of itself which continues door-to-door, but also it's served as a launching pad for Scholastic core businesses, and overtime this growth is quite rapid in these areas even on a small base and we've actually doubled sales in that area, or a little bit more than doubled sales since the acquisition.

So they're no longer really quite as small as they once were and the three that I mentioned are all profitable.

Hugh could give you a little more color on what's actually happening there.

Well what we're finding is that we have an excellent opportunity with both book clubs and book fairs in the developing world.

We're going slowly and on a self-funding basis using our own people.

But again, using the platform that we have in Southeast Asia has enabled us to take advantage of booming economies there, Thailand, Philippines, and Malaysia most notably, but we're also strengthening in the Caribbean and we're testing book fairs on both a local operating basis and an export basis and in many other countries.

We believe in the long-term that this is a very, very good platform for Scholastic in these countries.

Okay.

Great.

Thanks a lot.

Thank you.

Thank you.

Your next question is from William Bird of Citigroup.

I was wondering if you could help us gauge how free cash flow performed excluding Harry Potter.

And just a follow-on on the bad debt question, was wondering if you feel that bad debt as a percent of revenues is now at a normalized level for continuities or would you expect it to rise or fall from here?

Thank you.

Mary, do you want to deal with the debt question?

Yes.

I don't have free cash flow excluding Harry Potter right at my fingertips but I can say that I would say we did have some increased working capital that was not Harry Potter related, certainly the biggest swings were, but we did have some increase in inventory associated with new products in a couple of our businesses so that, of course, would have used up working capital so I think that we probably had some cash going to that.

On the other hand, we had, as you saw, lower spending in Cap Ex and pre-pub and what not, so don't have the exact number but there were some ups and downs that were not related to Harry Potter.

Bad debt?

Yes, bad debt was approximately 24% versus 22.5% a year ago which, as we said, was expected.

There are many factors changing in this market, as you know, with the introduction of more products on the Internet and with new screening models so we're confident that we're building long-term relationships with the appropriate bad debt levels.

We will continue to keep an eye on that and watch it going forward.

Yes.

It could go up and down a bit, Brandon.

I don't think we have seen, you know, we can't say unequivocally that we've hit the bottom or that it's going to stay right at 24%.

As we increase new business, we'll probably get some swings in bad debt.

Thank you.

Thank you.

Your next question is from Richard [Tulow] of Sidoti & Company.

Yes, hi.

Just to harp on this bad debt issue, it seems to me that if the business is migrating to the Internet and the Internet is largely credit card driven, I'm having a hard time understanding and maybe others are, is why the debt number, bad debt number is increasing.

First question.

Second question is accounts receivable seemed to be up roughly $30 million.

Is that the result of some of the fair business being pulled into this quarter?

Mary, you want to take the accounts receivable question?

Yes.

The increase in the accounts receivable is predominantly associated with the increased sales in the continuities business.

So the continuities business is driving the bad debt and the increase in the accounts receivable?

Yes.

Thank you.

Yes, on the bad debt question on the Internet, I think as we've said last time, we do have a much higher proportion of credit cards online for new customers.

We do, however, also do a lot of bill me business online and we do credit screening accordingly, so those models are getting refined.

But I think as you'll note with most direct marketing businesses, it's very common when you're prospecting for new business, especially with new channels, to have this level of bad debt.

Okay.

Thank you.

Thank you.

Your next question is from Philip Olesen of UBS.

Yes, thanks for taking the question.

Just wanted to maybe get a little bit more insight into your kind of updated thinking with respect to refinancing the upcoming '07 maturity and specifically, by using cash on hand and the existing credit facility, are you comfortable that you will have sufficient liquidity to kind of handle your seasonal borrowing requirements?

And I guess as a second question, you've talked about kind of continuing to focus on debt reduction.

What is your comfort range or how much is too much?

Where would you like to see either gross debt or net debt or leverage get to, just to kind of give us a better sense of when you can start using free cash flow for other sources?

Thanks.

Mary, you want to handle both questions?

Yes.

First of all, in terms of the strategy that we're pursuing in the short-term we are very comfortable.

I mean, as you know from looking at our balance sheet, we have over $130 million in excess cash and the majority of that is free, you know, for us to use to repay debt.

We also have $230 million unused capacity on our credit agreements.

So in terms of repaying the debts or funding the maturity of the debt in January, we're perfectly comfortable with that strategy and that still leaves us with $100 million, a little bit more untapped utilization on our credit facility.

Now, you are right to point out that we do have a seasonal business but the back half of the year, and particularly the fourth quarter, are generally strong cash flow quarters for us, so we're not concerned through that period.

As we move into the summer months, which would be the first quarter of fiscal '08 for us, we certainly will be in a cash use period and would need to have a more permanent strategy in place.

In terms of our comfort around the debt range, we haven't changed what we said before there.

I think our key objectives are managing our weighted average cost of capital and looking at a investment grade level of debt, and so those continue to be our priorities.

In the past I think we said kind of a target of 30% debt to cap and that continues to be what we viewed as a reasonable investment grade level of debt.

That's great.

Thank you.

Thank you.

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

Well, thank you all for your support and for your very good questions.

I hope we explained, particularly the bad debt issue to your satisfaction.

I wish you all happy holidays.

We feel good about the quarter and glad for the support that you've shown us.

Thank you very much.

This concludes today's Scholastic conference call.

You may now disconnect.