Scholastic Corp (SCHL) 2009 Q1 法說會逐字稿

Good morning.

I'll be your conference operator today.

At this time I would like to welcome everyone to the Scholastic quarter one 2009 earnings conference call.

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

After the speakers' remarks there will be a question and answer period.

(OPERATOR INSTRUCTIONS) Thank you.

It is now my pleasure to turn the floor over to your host, Jeffrey Matthews, head of Investor Relations.

Sir, you may begin your conference.

Thank you, and good morning everyone.

Before we begin, I would 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 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 will introduce Dick Robinson, the Chairman, CEO and President of Scholastic to begin our presentation.

Thank you Jeff, and good morning and thank you everyone for joining us on our fiscal 2009 first quarter call.

This morning I'm joined by Maureen O'Connell, CAO and CFO; Margery Mayer, President of Scholastic Education, other members of the executive team are available to answer questions at the end of our prepared comments.

In the first quarter, Scholastic's smallest revenue quarter, we made progress toward our fiscal 2009 financial targets.

We took agressive steps to reduce costs and salary expense.

We laid the groundwork for margin and revenue growth in the children's book segment.

And are encouraged by this fall's early results.

We improved sales execution and prepared to launch major new products in our Education business.

And we ended the quarter with a strong balance sheet and ample liquidity.

Based on these factors, we believe Scholastic is well-positioned to deliver steady profitable growth even in today's uncertain climate.

In a moment we'll talk about the outlook for children's books as we head into our big season.

But first, let me comment on Scholastic Education, and our actions to improve margins there.

In Scholastic Education, Educational Technology sales were down last quarter.

This was partly anticipated, but it was also an opportunity to improve sales execution as we continued to pursue the strategy we began a year ago to ensure long-term growth in this key area.

These changes including the separation of the print and technology sales forces, more quickly benefited our print business given its shorter and simpler sales cycle.

On the technology side, the sales cycle is longer and more complex.

However, as Margery will describe in a moment, we have made significant changes in our sales process as we enter the second quarter and a new sales year.

We also have major new product launches.

Overall, we remain confident in the long-term growth and margin prospects for Scholastic's market leading Educational Technology business.

As for margins, in July we described two levers.

Cost reduction and price increases.

After the first quarter, we are on track to reach a goal of 25 million to $35 million in annualized cost savings in this fiscal year.

We have been attacking supply chain and manufacturing costs as well as postage, shipping and freight.

In addition, we are making progress with plans to reduce headcount and streamline certain areas of the business.

We have also implemented price increases in our children's book business which will offset higher commodity costs as these businesses begin ramping up in the new school year.

Both cost reduction and pricing are important parts of our plan to improve profitability, and reach 9 to 10% operating margins next year.

Maureen will provide more details in a moment.

With schools out in the US, the first quarter was a small one for the children's book segment, especially compared to a year ago when we benefited from the record breaking publication of Harry Potter and the Deathly Hallows, the last book in the now classic seven book series.

Still, during the summer period, we laid the groundwork for modest growth and improved margins in children's books and were encouraged by how things are going so far.

In one of the most successful summers in recent years, ex Harry Potter, Scholastic Trade Publishing launched a broad range of exciting new franchises while strengthening existing ones.

The we published The Maze of Bones, the first title in The 39 Clues, our innovative new franchise that combines books, an interactive website, prizes, and collectible cards.

There's been an enormous amount of buzz about this and the book has already reached the top of the New York Times Best Seller List after only two weeks of being on sale.

We are also moving forward on the development of a film of -- of the film with Dreamworks, hiring a high profile screen writer, web traffic and sell-through books and cards have been strongly positive.

We published the second title in the series called One False Note on December 2.

Last month we released the Hunger Games by Suzanne Collins, the first in a trilogy.

It has received great reviews, including one from Steven King and debuted on this weeks' New York Times Best Seller List at number 9.

We will begin shipping Inkdeath, the eagerly awaited final installment in Cornelia Funke's trilogy.

The first two books in this series have sold nearly 3.5 million copies in English worldwide.

Momentum is building with the Goosebumps franchise, with the fourth (inaudible) book a top seller for us last quarter and writers announced for the Goosebumps movie.

We will introduce new Goosebumps games for PlayStation 2, Nintendo DS and Wii platforms in time for Halloween.

As for Harry Potter, we're building the franchise ahead of the holiday season.

This week we launched a special tenth anniversary edition of Harry Potter and the Sorcerer's Stone, the very first book in the series with the hopes of attracting new readers and in December we'll publish The Tales of Beedle the Bard, a book of wizard fairy tales written by JK Rowling and mentioned in the Deathly Hallows.

Sales of the book will benefit Rowling's charity so they will not have a material impact on our bottom line but we expect lift for Harry Potter backlift sales.

Overall we have started strong in Scholastic Trade this year.

In School Book Clubs we're optimistic about modest revenue growth and improved margins based on the launch of New COOL and updated marketing and pricing.

New COOL as we said in prior calls is the revamped online selling and marketing platform which expands our direct reach to parents and kids and improves the club experience for teachers.

We plan to go live with the first group of classrooms in November in a staged rollout.

This should begin driving incremental higher leverage growth starting in the second half of fiscal 2009.

Club customers are reacting positively to enhancements in our print promotion strategy such as rounded pricing and information about books reading levels.

It's still early in the school year of course, but we're seeing strong order volumes offset by a shift toward lower price items.

This enthusiasm among customers looking for value is encouraging and a reflection of Club strength in a tight economy.

In School Book Fairs our plan is to drive higher revenue per fair and prices to grow revenues and profits.

We continue to improve merchandising and we have developed tools to help Fair chair people increase family involvement.

Both key to revenue for Fair drivers.

This summer we instituted new strategic pricing for Fairs while adding a fuel surcharge for Fair deliveries.

The latter provides a significant offset to higher fuel costs in the business, without adversely impacting Fair bookings which are on plan and in line with prior year.

Rebooking rates are strong, especially among the larger more profitable Fairs.

While August and September are small months for Fairs and Clubs, so there are few earlier results to report, we remain optimistic about Fairs prospect for modest revenue growth this year, even in an environment that is proving difficult for traditional booksellers.

Finally, last quarter we closed the sale of the US direct to the home continuities business.

This allows us to focus on building relationships with our parent and child customers through the profitable school book club, Fair and Online businesses.

In summary, we're on track to achieve our cost reduction targets.

Scholastic's children's book businesses are well positioned to drive modest growth in revenue and profits in the remainder of the year.

Now Margery Mayer will provide our outlook for the Educational Technology business which continues to be a key part of the Company's growth plan.

Thanks, Dick.

Scholastic Education has emerged as the fourth largest educational publisher in the US and the leader in Educational Technology.

The tremendous success of Read 180 with almost $600 million in sales to date has driven this growth.

But Scholastic's unique end-to-end approach to selling Technology Solutions to school districts has also differentiated us from the competition and helped us grow.

To reinforce this strategy and seize long-term opportunity, last September we split the print and technology sales forces apart, we beefed up our service and support staff and we accelerated product development.

This impacted short-term results during the first year under the new strategy, including the last quarter when technology sales were down.

Now we anticipated much of this decline.

A large sale a year ago left us with a challenging comparison, we knew we faced a tough selling environment especially in a couple of key states.

In general we are seeing medium to large districts delay purchases as they face the largest deficits they have seen in years.

However, this summer's performance also made it clear we had opportunities to improve execution.

As we discussed in July, technology based solutions require distinct sales planning and tracking practices.

To address a capability gap, this summer we improved our hiring process, consolidated sales management, centralized field marketing and changed how we align account executives with opportunities.

Additionally, we put new management into our implementation organization.

We're already seeing the benefits of these measures and improving sales productivity.

For example, we hope to announce soon our largest ever single contract for Read 180 after being selected as the single source provider in a reading intervention RFP from one of the country's major urban school districts.

Service revenue was up 30% last quarter, evidence of our customer's commitment to Read 180 specifically and Scholastic in general as a partner in raising achievement.

We are building a growing consulting business, helping build leadership capacity in challenged schools.

For example, we've had good success with that in Louisiana and California.

In addition, we have a strong Read 180 customer base and franchise which we are leveraging with key product enhancements and new programs.

In November we officially released System 44, our prequel to Read 180.

We have a lot of excitement about that among our customers and nearly $3 million in presales.

Also in November we released a new hosted version of Read 180 for customers who haven't had the infrastructure to support Read 180 on their own.

Next spring we're looking forward to early sales of our new California edition of Read 180 which we are hopeful will be approved by the state Board for adoption in November.

We're also excited about our burgeoning math intervention business.

Following on the success of fast math, do the math is on plan to achieve substantial growth this year.

In summary, we are more committed than ever to growing our technology and curriculum business for the long-term.

We believe that as schools demand for innovation continues to rise, along with the urgency of raising children's achievement, we will continue to benefit and grow.

Thank you.

I think now Maureen, you're next, right?

Yes, thanks, Marjorie.

Maureen O'Connell will now discuss our progress for reducing costs last quarter as well as our results and our outlook.

Thank you, Dick and good morning everyone.

In addition to revenue growth, as Dick and Marjorie just discussed, cost savings are a key lever to help us reach 9 to 10% operating margins in fiscal 2010.

We made significant progress with our cost reduction plan in the first quarter and are on track to achieve savings of 25 million to $35 million on an annualized basis.

Our first quarter focus has been on external cost and renegotiating with our vendors.

For example, we have worked with our key suppliers to manage rising paper costs by prebuying, reducing paper specification, and setting pricing caps.

We have negotiated new manufacturing contracts.

For example, reducing pricing on common formats and eliminating inflation pegged pricing on some contracts.

We are increasing our bundling and co-mailing of catalogs, magazines, and club promotions to reduce postage expense.

We have renegotiated and consolidated our local delivery contracts, yielding substantial savings.

We have successfully reduced our rates for temporary labor under new contracts.

We are in the process of renegotiating and standardizing our fleet of book fair trucks as well as sales force cars.

We are implementing new travel and entertainment policies, renegotiating vendor contracts and instituting new reporting tools to increase compliance and reduce expenses.

We are closely examining our existing IT vendor relationships, exploring new relationships and consolidating cross Company purchases to lower costs.

These are only some of the examples of efforts across the Company to reduce spending strategically which has been our first priority, before turning to salaries and headcount.

On the latter front we have made some very difficult decisions.

We have suspended annual salary increases, normally made in October for most staff and management.

We have implemented a voluntary retirement program for employees over 50 years of age with at least 10 years of service.

Qualifying employees must decide by October.

We have frozen hiring.

Finally, we are working on plans to streamline other areas of the business and find synergies among them.

We expect to accomplish much of this work by the end of the calendar year with savings beginning in the second half of the fiscal year.

We currently expect associated severance and one-time expenses to be comparable with this year's realized savings.

We will update you as we know more.

Turning now to the first quarter results, revenue and earnings fell relative to a year ago when we released the last book in the Harry Potter series.

And benefited from approximately $240 million in incremental revenues.

Cost of goods sold declined in absolute dollars and as a percent of sales compared to last year's higher Harry Potter related expenses.

SG&A declined in absolute dollars in the first quarter for the same reason.

However, as a percent of revenue, SG&A increased reflecting the higher operating leverage of Harry Potter sales a year ago.

We typically use cash during the summer with schools out of session and the need to build inventories before the fall.

Free cash flow use last quarter was somewhat higher than a year ago.

A year ago, Harry Potter had minimal impact on free cash flow due to the timing of collections and payments.

Consequently, the year-over-year difference was primarily due to inventory buying and School Book Fairs where we bought earlier to avoid a potential strike in West Coast ports as well as the timing of payables.

Net debt declined by over $150 million at quarter end, compared to a year ago, reflecting strong free cash flow in the intervening 12 months.

At our point of seasonally high cash usage we had over $325 million of cash on hand and cash available under existing committed credit lines.

Ample liquidity positions us well to take advantage of opportunities, even in uncertain markets.

As Dick noted last quarter, we completed the sale of the US Direct-to-Home business.

As expected, initial cash proceeds from the sale were modest, offsetting severance and other liabilities.

Finally, last quarter we bought back approximately 425,000 shares of our stock for $11.7 million, leaving $8.3 million in current repurchase authorization.

Also, earlier this month we paid our first dividend since going public in 1992, returning additional cash to our shareholders.

Now to review the outlook for the rest of the year.

In children's book publishing and distribution, we continue to expect modest revenue growth and improved operating leverage excluding last year's Harry Potter benefit.

Based on early results we believe Clubs will grow modestly from steady print promotion results, new pricing, and the staged roll-out of New COOL.

Likewise, based on very early results, we expect revenue per share and pricing to drive modest growth in Fairs.

We are also encouraged by trade's strong full front list and the tremendous reception it is receiving.

In Education, as Dick and Margery described, we continue to believe that higher sales productivity, combined with new product launches and growth in services, will help us achieve our goals.

A number of factors such as the continued improvement in sales execution, the speed of System 44 adoption by current Read 180 base, the inclusion of Read 180 in the California reading adoption, are important to this outlook.

In international, with the first quarter's difficult Harry Potter comparisons behind us, revenue and profits should be up modestly for the rest of the year, reflecting growth in Australia, Canada and Asia, partially offset by tough comparisons for the UK where we sold Golden Compass a year ago.

In Media Licensing and Advertising, revenue and margins are expected to continue to improve, driven by sales of interactive products in our retail channels.

Corporate overhead is still expected to increase modestly from higher stock-based compensation and severance as well as higher facility and medical costs.

This will be partially offset by lower salaries and spending and consulting.

Overall, we continue to expect solid profit and margin growth excluding Harry Potter in fiscal 2009 with revenue of $2 billion to $2.1 billion, earnings per diluted share of $1.75 to $2.10, and free cash flow of 90 million to $100 million.

Thanks, Maureen.

Even with today's tougher economic environment, and last year's extraordinary comparisons, we do feel positive about the first quarter results an our outlook.

Scholastic remains unparalleled in its ability to reach teachers, parents and kids with the best, most trusted products and services for their learning, growth and entertainment.

We're unique in our ability to communicate directly with our teacher, parent, student and school customers to help them make the choices that are right for them and we continue to deliver extraordinary, trustworthy service every day.

In a difficult economic period, our products and services remain an important part of the lives of our school and family customers.

This ensures our continued value as a Company that people need in both good and difficult economic times.

We remain focused and committed to improving profitability and growth.

To achieve this in the short-term we're concentrating on execution in all of our businesses to reduce costs and grow sales and for the long-term we will grow the Company in children's books, Educational Technology, international especially in Asia and broader use of eCommerce to sell more books and digital products to our school and family customers.

The school year is now beginning, an exciting time for some of our largest businesses.

We look forward to reporting on the results and progress in December.

Now I will moderate a question and answer period.

In addition to Maureen and Margery I am joined this morning by Ellie Berger, President of Scholastic Trade Publishing; Deborah Forte, President of Scholastic Media; Judy Newman, President of Scholastic Book Clubs; and Hugh Roome, President International.

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

Thank you.

(OPERATOR INSTRUCTIONS) Our first question is coming from Drew Crum with Stifel Nicolaus.

Great.

Thanks.

Good morning everyone.

Couple items on your guidance for fiscal year '09.

Number one, any change in view in the contributions you're expecting from Harry Potter, given Time Warner's decision to move the movie from the fourth quarter of this year into 2009?

Secondly, any impact you're anticipating from the hurricane down in the Gulf region?

And wanted some additional clarification on the severance costs.

I think the -- originally it was $0.11 and Maureen you made some comment on that.

I just wanted some additional color there.

Drew, I think on the move of the movie, we didn't budget a lot of impact from the movie and I don't think it will make a great difference to us.

But obviously we'll be looking forward to the summer when the movie comes out.

So that -- on that one, we're -- I don't think it will have a big impact.

Okay.

On the -- Ellie, do you want to amplify that?

The only thing I would add is that because we have since the movie's move, we do have Beedle the Bard that we will be be publishing (inaudible) that title in December.

That's important fact.

On the hurricanes, it's really too early to tell.

We have had some cancellations around Houston and so that's had some small impact.

You want to comment further on that, Maureen?

Yes.

We had some cancellation in our Fair business, but as Dick said that was a minimal impact.

Okay.

And as the your question as far as severance, we guided for $0.11 in severance this quarter.

As you say, it was $0.05 per share.

Our guidance hasn't been updated yet for the actions we just announced in terms of the voluntary retirement and the streamlining of the organization.

But we expect that that severance will equal the benefit in the year.

Okay.

And that we'll realize the full benefit of the 25 million to $35 million in savings next fiscal year.

Okay.

And maybe I can follow-on to that point.

Is there any way to quantify the cost savings that you recognized during the first quarter?

Understanding you're still targeting 25 million to $35 million for the fiscal period?

Well, the actions we put in place represent about half of the savings so far.

So as far as freezing headcount and eliminating the annual increases.

We don't yet know how many people will opt into the voluntary retirement program so we don't have numbers for that.

And we're working on activities to streamline our organization and so those plans will be finalized by the end of this calendar year.

So we don't have those yet.

But the first quarter really had minimal realized savings.

We did have strong cost management performance in the overhead Clubs and Fairs but that was offset by higher severance, higher FASB 123 expenses and higher rent costs.

Maureen, your view on pay per postage printing I think originally was 15 million to $20 million for the year.

Does that still hold true?

Yes.

But we had been mitigating those costs by actions that we described, such as co-mingling our mailings, reducing our paper weight in some areas, changing the paper to lower cost options.

And we also prebought this year and entered into some longer term contracts to get paper discounts.

So that's the aggregate amount that we have increased our costs by but we have mitigation strategies in place and as Dick described we've also increased our prices in our book business.

Any early indications in terms of the receptivity to the pricing increases from your customers.

It's quite early to tell as we said in respect to our Clubs, we see some shift to value buying.

Judy, do you want to amplify that?

Yes.

Obviously it's too early to say anything about Clubs because anything I could say would be pretty anecdotal.

But I can say a couple of things.

First of all, we're seeing very strong orders, customers are enthusiastically placing orders across all of our 13 September book club catalogs.

As Dick said.

This is offset somewhat by a shift toward lower priced items.

Customers are searching for good value so they are kind of seeking out the lower price and often good margin lower priced items.

Secondly, customers are very happy, the teacher customers are very happy about our rounded pricing strategy where we went from $3.95 to $4.

Avoids a teacher having to make the change and my in box is actually burst with thank you notes from teachers who are complimenting us on that.

Thirdly, I just got this in, that we are moving forward on our COOL rollout as Dick said for November.

Okay.

Very good.

Maybe one last question.

And I'll jump back into the queue.

Just expectations on CapEx and prepub for the year, they were relatively flat with the year-ago period.

At this point, our expectations remained as we guided last quarter.

Okay.

So no change, although spending will be more geared towards the second half of the year than the first half of the year.

Okay.

Very good.

Thanks, guys.

Thank you.

Thank you.

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

Hi, good morning.

Question for Marjorie.

Can you just give us an assessment of how you see the competitive dynamic for the reading remediation market and how much is that a factor do you think in the revenue progression?

And then a second one, Margery, just a little bit more about System 44 in terms of how you see the scale of the market opportunity for that product?

Thanks.

Hi, Peter.

How are you?

In terms of competition, I mean, there's definitely more competition than there was five years ago.

So there is.

But we don't see anybody coming up all the time as in a head to head competition on a universal basis.

So it's kind of geographical and spotty.

There's several companies that are likely to be approved for adoption in California.

Call us crazy, but we still believe that we're, not the gold standard but the platinum standard in intervention.

We had more studies this year that our program works.

We had expansion of our product.

So yes, it's more competitive than it was but we still feel that we're the clear leader in our space.

In terms of System 44, there's two -- there are two very nice things about the market for System 44.

First of all, it fits right in, it tucks right under Read 180.

So our base, and we have over 10,000 classrooms using Read 180, System 44 can be sold right into that base.

The other thing about System 44 is there is an existing market for foundational reading programs and there's a number of companies in it.

None of them really use technology and any -- in a medium way and we're using it in a very sophisticated, exciting way.

So I think that it's a break-through program for foundational reading.

We can sell it a little bit younger than we've been selling Read 180.

We can take it down to grade three.

And we already have $3 million in presales without anybody having even actually seen the product.

In terms of the revenue opportunity, then the -- probably not as big as Read 180 in terms of the narrower focus.

No, I think it's going to be smaller than Read 180, but it's material.

Okay.

And the existing sales organization sells it; correct?

Yes.

And no -- and from a technology standpoint, it's the same as Read 180, there's no incremental investment by the school district?

Well, our products have two parts to them.

One part is the management system where students are enrolled and data is generated.

That is the same management system as Read 180.

The other part of our product is student/client.

And it has a new student/client with a new interface and some new features that Read 180 doesn't have.

It's very updated and exciting.

So for schools that already have Read 180 and are using Sam to run Read 180, which they need to, that's our management system, all they have to do is pretty much drop the student/client on top.

The point was no capital investment required by the school?

No, no capital investment just product purchase investment which we look forward to.

You're selling System 44 now; correct?

We are preselling it to customers, we've done some mailings and some limited presentations.

We already have several of our customers Read 180 customers have been lining up to order it.

So yes, we are talking about it but we haven't started physically shipping it until November.

And then last thing, Margery, in the context of the contribution from System 44, do you think the Educational Technology can end the year with up revenues even in the context of the school's financial pressures?

Yes, I mean, we have a path to meeting our goal for the year.

It's based on 44.

It's based on big order we know is coming in and other orders that we're looking forward to.

It's based on our service revenue being up.

It's also based on some early sales in California.

Yes, we definitely have a path that can get us there.

Okay.

Thanks.

Dick or you Judy, can you give us more data on the pricing strategy in terms of what kind of percentage increases in pricing on average are you implementing?

And I was interested in your comments about the -- Judy, your comments on the shift to lower price points and does that effectively neutralize the impact of price increases?

Well, I think we increased prices throughout our children's book business, Peter, based on -- in part on our drive for improving margins but also on the increase in paper costs and shipping costs.

So that we've gone -- we've done that throughout.

Judy can comment in particular on how that plays out in the Clubs but it's really early in Clubs to really know exactly what is the mechanics of how this is all working but she can give you some impressions.

Yes, Peter it is early and as you know we offer a portfolio of products all the way from lower prices all the way up.

And so we're watching what the teachers and parents and kids are taking.

So we made sure to sort of protect the margin at each price point and make sure we do offer the customers a wide range of products and we anticipated coming into this season, this back-to-school season, that there would be a lot of pressure on customers.

So we wanted to make sure that the Book Clubs kind of protected its value proposition and really was there for customers who were looking for good value for books and so we brought forward some of our merchandising on our regular paperback books as opposed to maybe some of the worse margin non-book items, if you will.

So we really expect the higher prices, the price increase overall to yield better margins, to keep the excitement and the engagement which is our main thing.

We didn't want people to look at the club fliers and say oops, too expensive.

This is discretionary, we're not going to buy.

We're very happy to see that engagement, enthusiasm is really working for us right now.

Just because we have this wide range of products, we're just really digging in to see what it is that they're buying.

What, Judy, is sort of the average price increase?

The average price increase was about 5%.

Okay.

And is that, Dick, across Fairs, trade and Clubs?

Yes, it could be higher in some -- in Clubs and trade than -- sorry, in Fairs and trade than in Clubs.

You mentioned the surcharge for shipping in Fairs.

How big is that?

And I assume that just comes out of the profit of the organization running the fair; correct?

You know a lot about this business, Peter.

It's $30 per fair.

We run over 100,000 Fairs.

Case Fairs.

So -- and it comes right out of the first $30 of the substantial commissions that the fair operators get in schools.

You haven't changed the commission structure, have you?

No, it's about the same as it always has been.

It's very satisfactory to the schools.

And of course, a driver of why they run Fairs, along with the impact on families and reaching out to the school population.

Right.

And then last thing, Maureen, you're almost out of share repurchase authorization.

Do you revisit that or do you step back on share repurchases in terms of other uses for cash near-term?

Well, Peter, we not only had share repurchase another $8 million to go, but we are also initiating the first dividend since going public so we are returning money to shareholders and we will continue to look at our cash as we generate it.

We're happy to be generating strong cash flow, and look at the opportunities to reinvest that cash first in our business through prepub in our Education segment and interactive as we develop new products there and also in our trade area and then we would look at whether there's still excess cash left after we fulfilled our prepub needs and our capital needs and then decide what to do with it and we have ongoing discussions with our Board about how to reinvest our cash.

I'm assuming from what you said to Drew earlier that the prepub capital spending numbers are pretty well set and should not be taking a significant step up in the next couple of years; correct?

They're not changing from our guidance which was 65 to 75 in capital and 80 million to 90 million in prepub.

Which is up from last year because as we had some delays last year.

But that spending is predominantly in the Education segment as Margery described the System 44 and other products that would be there as well as in our interactive segment as we launch new products there.

And -- okay.

Fair enough.

Thank you.

Thanks, Peter.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question is coming from Catriona Fallon with Citi.

Yes, hi, thank you for taking the call.

I was wondering if I could get a little bit more detail on how you're renegotiating some of the printing and paper contracts and how much of you expect to save from each of those efforts.

Maureen, you want to tackle that one?

Sure.

Renegotiating of contracts and all the activities that I described that were non-salary related are about a third of our savings.

So all of those activities, cumulatively, represent about a third of the savings in the 25 million to $35 million goal.

And what we're doing is we're shifting work, in common formats to vendors who will offer us better price concessions and they'll get more volumes to do that.

So we look at our vendor universe and we talk from one vendor to the other and whoever will give us the best price at the right delivery times, we'll move business to them.

In the paper area, we did prebuy some paper.

We did consolidate our contracts so that we could go to one vendor and get better buying because we're buying at larger volumes.

Right.

So -- and let me just understand.

There's also the 15 million to $20 million increase in cost this year that you anticipate for paper and postage so you're finding other ways to save.

So the real annual cost savings that you're looking for is more like the 25 to 35 plus the 15 to 20 increase in paper in postage so you're really looking for cost savings of 40 million to $55 million?

No.

Actually, the 15 to 20 in commodity pricing, we expect pricing will offset that, pricing across our book business and then we have a plan to increase our cost savings 25 million to $35 million.

So right now, our plan is that the commodity pricing will be offset by pricing increases across our business.

We are a low cost offering and so we have a big value gap between other competitors and ourselves.

And so we just shrunk that value gap a bit so where we 30% lower than the nearest competitor, now maybe we're 25% lower, still a great value and so that's why we feel like we could increase prices as commodities went up.

Okay.

And then you mentioned the large deal at the urban school district.

When do you expect that revenue to be recognized?

And how do you -- how should we be thinking about modeling that over the course of the year?

Is it more of a one-time or more of a subscription fee that we'll see?

It's a three-year contract.

We expect it to come in in the second quarter, but there could be a delay because we're dealing with a big city and sometimes those happen and I think that's pretty much what we can say about it right now.

Maureen, do you want to say anything else?

Well, to the point that it's service revenues, we recognize that revenue as a subscription and so some of the service revenue growth doesn't show up in the quarter that we sell because we recognize it over the life of the contract.

Okay.

And then typically, for the Education contracts, if I just look back at the last several years, Q1 tends to be essentially the largest quarter for Education and publishing.

And this quarter it looks like it was kind of -- I think a little weaker than last year and the year before.

I'm just -- is there some change in the seasonality that we should be expecting for Education and publishing?

And then also, when do the school districts make their purchases of something like a System 44 or a Read 180?

Is it typically over the summer months or would we also see that into November and the February quarters?

We did say that we would have a lower than normal first quarter this year because of comparisons with last year, but also how the -- how our sales force was operating and how the product flow, the new product flow was coming.

So we budgeted at a lower level for the first quarter this year than we -- than in the previous two years.

On the other hand, we still fell a little bit below what we had hoped.

The System 44 revenue, which Margery just talked about, will flow through the school year.

Read 180 tends to be heavier in the last quarter of the year and the first quarter of the year.

But Margery, do you want to further talk about that?

I think what Dick said is just right.

We think System 44 could be less seasonal than Read 180.

It's really something that could be started at any time in the year.

So we're expecting to have good sales of System 44 over the next three quarters.

I think the main point is that we have a plan, we are very focused on the next three quarters and how we can increase the revenue in those quarters.

So for this year, we think we can outperform where we have been in previous years in those quarters.

Okay.

And then I guess just two quick questions, then.

Any change in the timing of Fairs this year?

I know that in the past you've benefited when Fairs have been pulled forward or pushed back in different quarters.

Well, the pattern is pretty much the same this year.

I think they may be starting a little bit later, although many schools because of the early Labor Day, schools may have on the average opened a little bit earlier.

Okay.

And then my last question was just on the Direct-to-Home continuities program.

I saw on the press release it said free cash flow used from discontinued operations was basically $3.5 million.

Is that basically all from the sale of the business in this quarter?

That's the operating cash flow prior to selling it.

So that's the use of cash flow that was their operating results for the first quarter while we owned it.

Even for the first quarter of this year?

Yes.

Okay.

Any more details on the sale of that business?

Well, as you know, we sold the Direct-to-Home US business, at this point we received a minimal amount of cash which covered liabilities we have.

We will continue to collect cash which is based on their cash collections but guaranteed rates and we expect to be paying liabilities at the same time so it will have a minimal impact on cash.

Okay.

Okay.

That's my questions.

Thank you.

Thank you very much.

Thank you.

At this time, there appear to be no further questions.

I would like to turn the call back over to Dick Robinson for any closing remarks.

Well, thank you all for listening to our first quarter call.

Obviously, we're heading into our heavy period for school Clubs and Fairs.

We are very encouraged by the terrific summer we had in trade.

We're working very hard to improve our sales execution in educational publishing and to control costs and reduce expenses throughout the Company.

Thank you very much for your support of Scholastic.

Thank you.

That does conclude today's Scholastic quarter one 2009 earnings conference call.

You may now disconnect your lines at this time and have a wonderful day.