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School Specialty Inc. (NASDAQ:SCHS)

Q1 2010 Earnings Call

August 20, 2009; 11:00 am ET


Dave Vander Zanden - Chief Executive Officer

Tom Slagle - President & Chief Operating Officer

Dave Vander Ploeg - Executive Vice President & Chief Financial Officer

Mark Fleming - Director of Investor Relations


Bob Evans - Craig-Hallum Capital

Gordon Lasic - Robert W. Baird

Ildiko Hildreth - Waterstone Capital

Trace Urdan - Signal Hill


Greetings and welcome to the School Specialty fiscal 2010 first quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

It is now my pleasure to introduce School Specialty’s Investor Relations Director, Mark Fleming. Mr. Fleming you may begin.

Mark Fleming

Thank you, Jackie and good morning everyone. Welcome to School Specialty’s earnings conference call. Our presenters this morning are CEO Dave Vander Zanden; our President and Chief Operating Officer Tom Slagle; and Executive Vice President and CFO Dave Vander Ploeg.

Before I turn the call over to Mr. Vander Zanden, I’d like to read our Safe Harbor statements. Any statement made during this call concerning future events of operations, expectations, plans or prospects are forward-looking statements.

Forward-looking statements also include those preceded by or followed by words like anticipates, believe, could, estimate or expect. These forward-looking statements are based on School Specialty’s current estimates and assumptions and as such involve uncertainty and risks.

These statements are not guarantees of future performance and actual results may differ materially from those contemplated by the forward-looking statements due to a number of factors, including those described in Item 1A of the company’s Annual Report on Form 10-K for the 2007 fiscal year.

Those factors are incorporated by reference, except to the extent required under Federal Securities Laws, School Specialty does not intend to update or revise the forward-looking statements.

With that, I’d like to turn the call over to Dave Vander Zanden. Dave.

Dave Vander Zanden

Good morning everyone. Welcome to our conference call. I want to start of today with just a couple of comments on what we’re seeing in the season. I’ll give you a few more comments on funding and stimulus funding and we expect there.

Then I’d like to spend a little time on the two transactions that we announced, the acquisition of AutoSkill and disposition of our retail trade business, and then close up with a few comments on the outlook and guidance that we provide in this quarter.

Overall as we look at the season, it’s unfolding pretty much as we expected. Budgets are late, budgets are cut, there’s less spending and delayed spending throughout the educational system.

Discretionary items like furniture and equipment are in our catalog are showing the largest declines. As an example in the educational resources area, this time of year we look at our book and build business to get a view of where we are in the season and how thing are stacking up, and two thirds of the decline that we see there is in the F&E area and one third in consumables.

F&E represents about a third of our educational resources revenue and about a quarter of the company revenue. So the high value discretionary furniture and equipment items are the ones that are getting hit the hardest as we go through the season. Consumables overall are showing more strength.

As we watch the consumable bookings from the beginning of the fiscal year we see each consecutive month showing better performance, June better than May, July better than June and August better than July.

We have two shipping days left in August as we stands here today and from just an order standpoint, we are showing low single digit growth in consumable orders for the month of August. So we see thing improving as we go forward and customers are clearly pressured.

We see them trading down to the next level of product and that’s affecting the margins on the publishing side of our business more than the educational resources side. We’re not reducing prices, we don’t think that makes a difference, but customers are clearly looking for lower spending and more value at this point.

As we look at the seconds half of what we call our busy season, our second quarter and we kind of expect the same run rate that we saw in the first quarter and expect the adoption revenue to decline about $9 million in that quarter as compared to $10 million in the first quarter, and both Tom and Dave are going to add a little color to these comments in a couple of minutes.

Shifting over to the funding, the unknown that seems to be in the marketplace and gets a lot of talk these spaces is the Federal stimulus dollars coming into schools. Our view is that those dollars are going to be used really and have been used to fill budget holes.

We are not looking for any real large up-tick in spending when those dollars are received and we don’t believe they’re going to any new purchasing. We think districts are really substituting those dollars for purchases that were likely to be made anyway, and just moving number around their budget to satisfy Federal requirements.

Superintendents today are really cautious. We think as the economy improves they relax a little bit. Their fear today is that later in the fiscal year after the first the calendar year things worsen states may not provide the funds that they’re promising right now and that’s what they saw last year. So they’re being very cautious and they’re being very careful, which you would expect in this kind of environment.

Moving on to AutoSkill, we think that’s an excellent acquisition for our company. This is a very good technology based company with a strong management team and proven technology products and the comprehensive reading math and response to intervention or RTI areas and it’s supported by numerous efficacy studies.

It’s a real fast growing space today in reading intervention. States are starting to adoption intervention programs like they do textbook adoption with California, Florida being the last two and the first two, really.

The feds require response to intervention programs by 2010 and AutoSkill has products for all of those. This is a really, really good fit with our business unit EPS, which is a skill based reading intervention company.

AutoSkill would be considered more of a comprehensive based reading intervention company and we have a lot of content in EPS that can enhance and complement the AutoSkill products. The combination of these two will provide customers with both a comprehensive and a skill based solutions for reading intervention.

We also pick up technology that will help us with some solutions in our science offering as well and could lead to science intervention products down the road. This was very good company that has very limited distribution. They have only three direct salespeople and the balance of their sales occur through two step distribution and distributors with coverage in only 26 states.

There is no presence in the Northeast or in the west and in spite of that the revenue is expected to grow 10% this year. We have 25 direct salespeople at EPS, so we’ll be adding that coverage to AutoSkill and taking up the products with those people as well and we expect to grow the sales force for our reading and math intervention programs as we move forward up to 50 over the next 18 to 24 months.

This is just an excellent opportunity for School Specialty. Regarding the School Specialty retail trade business, we did sign a definitive agreement to sell that business to Carson-Dellosa and become a minority shareholder. We announced a couple of years ago that, this business was no longer core to our future and this sail is a really good first step toward liquidation and we believe it will result in a higher value down the road for our investment.

Carson-Dellosa is a supplier to educational resources and a competitor of School Specialty Publishing operating primarily in the dealer to school market and teacher source space. Putting these two businesses together makes a very strong company and the integration savings are significant, which will add to the bottom line.

Carson-Dellosa has a very strong management team. They will operate the combined entity. School Specialty will remain one of the largest customers and have no day-to-day management responsibility. We expect the transaction will close sometime in October.

From an outlook standpoint, we think we have better visibility today, so we provided guidance on both revenue and earnings as well as cash flow. On our last call we indicated that we had lowered the company’s breakeven point for growing EPS to about $960 million for an EPS over the prior year.

With the additional cost reductions, we were able to gain, as we went through the first quarter we believe we’ve lowered that breakeven number if you will to $925 million or so. We continue to look for opportunities to liquidate current assets on a permanent basis and find more cost reduction and we see easier comps as we enter the third quarter.

We are very confident in our cash flow guidance and continue to apply free cash flow to pay down debt while watching for small acquisitions that are strategic like AutoSkill that can help us achieve long term goals are on growing our curriculum business with accelerated learning opportunities.

At this point, I’d like to turn the call over to Tom for more color on what’s happening with the season to-date and then we’ll be back for questions. Tom.

Tom Slagle

Good morning, everyone. I’m going to give a little more color as Dave mentioned to Q1 and then perspective on how we see the season unfolding. As stated earlier, the Q1 revenue declined 10% net of adoption from prior year. So that run rate decline is remaining somewhat constant and we don’t see that changing as we enter into Q2, particularly driven by certain categories.

We identified a couple of trends early on that unfortunately did not rebound for us. The first was that, typical year end of budget cycle that the schools typically spend to deplete their budgets just were not spend this year. We believe and we’ve been confirmed by customers that they have actually pulled those dollars back and were asked to basically reconsider those purchases.

Order velocity for consumables and supplementary materials was slower than we expected in Q1, but it did begin to improve sequentially as Dave mentioned late in the quarter and we are seeing this carry into August.

Areas such as durable equipment, furniture, AV, other equipment has clearly been labeled by our customers as discretionary spend and they are cutting back on those spend and we are not sure if those are going to be something that will comeback unless budgets are confirmed later in the season.

Dave did touch on the fact that the backlog of orders at this point is slightly less than prior year, primarily driven by furniture equipment, but again as schools are starting session, we are tracking these areas of the country that are coming back into the classroom and they are beginning to place orders at a higher rate.

We believe that’s what driving some of our order up tick in August. We’re going to watch this as other areas of the country begin to comeback into session. We fully expect that the order volumes will continue to remain stronger than we have seen over the next several weeks.

Larger projects with school builds, class remodels, etc. have remained forwarder most part intact, meaning that our original pipeline is solid. We are seeing no pull backs on already approved proposals, but we do anticipate that there will be ongoing pressure going forward relative to new capital project approvals, again with some of the uncertainty as to the state revenue outlooks and how the districts will interpret them.

We have been able to identify some stimulus funded purchases in our science and reading categories. However, we don’t categorize these as what would call incremental spending as in virtually each case, the customers were intending to acquire our product anyway, but they simply shifted the funding source to the stimulus funds to purchase.

Customers indicate that September is going to be a better gauge relative to stimulus spending as they spent a lot of time doing the planning and documenting and we’re hoping that we get better clarity and we begin to see spending happen in a larger scale as we reach the late September, October timeframes.

As we discussed last quarter, we remain very active in the market with a lot of marketing programs such as our back-to-school incentive, focus on large districts as well as our stretcher budget campaigns directed more at the build, and building sight and teacher segments.

We also have several targeted direct sales offering targeting title one and IDA opportunities. While we track these, we have realized very positive trending on the bulk of these marketing campaigns. Unfortunately, our base business has been impacted by the economic pressures, much of this in the furniture and equipment line at the district levels that have negated these gains and caused to us see the decline.

This is also amplified in a handful of our largest populated states, which we can isolate large year-over-year spending portion decline directly driven by some of the state budget challenges that they are facing.

Last call, I shared that we were in our first phase of deploying our strategic account initiatives. Our focus remains in that area around delivering our value propositions within the largest districts. Leveraging our capabilities created through the category management model, as well as the strength of school specialty as a whole.

I shared on our last call, a large success we had from this district strategy in the Midwest. We’ve expanded this focus to several other markets hadn’t success with three additional large districts in both the southwest and southeast part of the country.

This focused on simplicity of contracting and pricing, aggregation of our deep assortment and our unique proprietary offerings continues to drive growth and we’re going to expands this at a rapid pace as we go forward.

As we are engaging at these large districts many of them are voicing large concerns with us that their current budget challenges are forcing them to become more business mined. They are looking for opportunities to drive efficiencies into their system and they’re also seeking help to find solutions to deal with this, “How to take cost out of my system?”

Of particular interest that they are voicing to us is around tackling the non-instructional spend areas, recognition of inefficiencies and waste in many of these processes is an area of opportunity. We’re currently piloting several solutions in three districts and we believe this will open up additional opportunities for us to both deepen our relationship with the customer as well as further expands our business, and as these are validated we’ll continue to expand across the country.

The folks we placed on margin improvement in our educational resource consumable segment of the business is delivering as we had projected. The focus placed on contracts, international vendor costing. Our overall pricing strategy has improved margins in this segment by 150 basis points versus prior year.

However, the various mix shifts that we’re seeing in other areas of the business has created a flat overall margin performance year-over-year. Dave Vander Ploeg will give some more detail on that in his comments.

Our focus on cost reduction has delivered the savings that will meet our original projections. Rightsizing, acceleration of our educational resources consolidation, activity around the lean process improvement, renegotiated freight parcel rates and variable costs from volume reductions drove a $12.9 million favorable variance to last year for the quarter.

We are maintaining a very disciplined approach to managing these costs, and we will do that throughout the remaining part of the year. As stated we are on track here and will deliver at least to the $20 million reduction in cost savings that we had committed to earlier.

Now let me provide a brief update regarding our operational perform for the season. This was our second busy season operating on the new enterprise system oracle. I’m pleased to record that we have realized very solid performance and stability through this heavy demands quarter. Many of the capabilities necessary to enable category management simply could not have been provided without getting the system integration in place and while we went through some pains, we are now beginning to realize the benefits.

The system in combination with of the work and activity our teams have put into the lean process improvement focus has and will continue to improve service and simplify our business. We’ve delivered significant improvements in service levels to our customers this year generating tangible and sustainable benefits in operating performance internally, but most importantly for meeting our customer requirements.

We have continued to improve our free cash flow through efficiencies in our working capital base, inventory and particularly receivables. The focus here continues and drove the benefit that you saw in the 44% improvement in cash flow this quarter, but the positive effects on internal leverage that we generate from carrying the right inventory at the right time, as well as the efficiencies from reducing the time and efforts to resolve past to invoices are significant.

Overall, state and district budget pressures have filtered down into reduced spend patterns from our schools, it’s not unanticipated. We are seeing certain categories as mentioned being affected much more than others, but we continue to focus on driving market share opportunities in different segments of the market where funding is available and we believe that we will continue to drive success in those areas.

We are seeing different behaviors as mentioned earlier on individual state economic situations and unfortunately some of these larger states are under the most pressure and we are not getting a real clear signal from some of them yet, California in particular as to how these issues will be resolved.

The outlook suggests that these pressures in terms spending are going to continue, affecting again some categories more than others particularly that durable equipment bucket. Our consumable segment is showing some rebound and as schools continue to come back into session we anticipate that will continue.

We will look for stimulus opportunities. We believe that by the ends of September we will have a much better read to determine what may be deemed as truly incremental spends versus just supplanting other budgeted buys with different funding sources and our plans on margin, growth and cost management are going to remain high for the remaining part of the year.

I’m confident based on what I see and our ability to deliver the commitments that we have for the remainder of the year. I’d also like just briefly comment on actually our newly acquired AutoSkill company today in Ottawa, Canada and I would like to reemphasize the fact that we are truly excited to have this AutoSkill team joining us at School Specialty. The integration of their learning technology capabilities with School Specialty strengths is very exciting for both organizations and we look forward to keeping you updated as to our progress in future calls.

So, at this point I’d like to turn the discussion over to Dave Vander Ploeg.

Dave Vander Zanden

Thank you Tom and good morning everyone. As I do each quarter I will spend a few minutes and add some additional context to the press release and the related financial schedules, which were issued this morning. As a reminder we are now reporting our business with a new segmentation, that being the educational resources segment or ER for short and the publishing segment.

In addition, this is the first quarter we have reported results under the recently implemented APB pronouncement also known as accounting for convertible debt instrument, which essentially adds non-cash interest expense to our income statement and adjust both the debt and equity sections of the balance sheet.

As I go through my comments, please note that all prior periods have also been restated. Let me start my comments around revenue and cost performance before transitioning to the balance sheet and cash, and I’ll also try to add some financial color to the two transactions, which Dave briefly spoke about in his remarks.

First quarter consolidated revenues declined 12.8% year-over-year with both of our segments reporting declines in sales. Education resources was down nearly 11% as both teacher orders and administrator orders were well below last busy season or at a minimum delayed, and as Tom just mentioned we saw some pick up in order velocity as we have moved into August, but as a general rules schools are conducting business cautiously.

On the publishing side reported revenues were down 16%. However, adjusting for the California adoption revenue, which we have discussed several times in past quarters, the comparative decline was 9% and as Dave and Tom both alluded to, but I think it’s worth repeating a trend began to emerge two quarters ago and continues today and that is that items you would classify as more discretionary, things like the furniture that Tom just talked about, electronics, phys ed equipments, are much softer than the traditional consumable categories.

As we look forward, we expect the revenue declines to moderate as we lap the downturn in November, and as such we have established revenue guidance for fiscal 2010 with the range of $915 million to $940 million.

Gross profit declined $21.2 million year-over-year in the first quarter, with nearly the entire decline tied directly to the drop in volume. The gross margin percentage moved only seven basis points year-over-year. However, price increases, vendor and cost management and product mix all played a significant role. Last year at this time, we talked extensively about the sharp increases in commodity costs and our inability to change the catalog pricing quickly.

As Tom mentioned, we are pleased to report this situation has been corrected and we have returned the margins in the core ER business to expected levels. Tightly managed vendor contracts are in place for all key suppliers and price corrections where necessary have been implemented. The result is a 150 basis points improvement to the gross margin in educational resources overall and a 250 basis points improvement in the core supplies and supplemental categories, which were the hardest hit by the margin squeeze last year.

Product mix on the other hand produced sharp downward pressure on the overall margins of the company, and Dave talked a little bit about this in his comments. This is most evident in the publishing segment, which saw 240 basis points drop in gross margin percentage and 75% of this drop was due strictly to product mix.

Lower FOSS science curriculum sales, mostly due to the California adoption and softer order levels in other high content, high margin products eroded much of the margin gains in the Educational Resources segment.

This coupled with the fact, that publishing today is a slightly smaller piece of the overall portfolio than it was last year has it resulted in a consolidated gross margin percentage that was relatively flat in quarter one. Looking forward, we continue to believe that the full year gross margin percentage will meet or exceed the improvements that we had discussed in our conference call back in June.

Moving to SG&A expenses, the cost reduction programs that we first introduced last November are bearing fruit and, and as Tom mentioned are tracking ahead of our internal goals. Of the nearly $13 million improvement in the first quarter, about one-third of the savings is tied to variable costs that correlate to the revenue declines and about two-thirds or $8.5 million of the savings tie back to our specific cost reduction programs.

The consolidation of operating activities and the fewer locations and the overall rightsizing of the business has yielded in excess of $4 million of cost reductions year-over-year. The operational improvements, and order fulfillment and transportation have yielded about $2.5 million of savings. The elimination of various discretionary spend categories has yielded about $2 million of savings.

A few of the operating metrics that support these improvements include, warehouse productivity is up 6%, bill rate is up 4% and shipping costs as a percent of revenue is down 14%. While I like to say the work is never done in this area, we are pleased by the progress to-date and we are tracking ahead of our SG&A percentage targets that were cited on our June conference call.

Moving on to interest expense and other, this category in total declined by $735,000 in the first quarter, reflecting overall lower borrowing levels which were driven by strong free cash flow in the back half of fiscal 2009. The other category in fiscal 2009 represented the discount cost on the AR securitization program, which you recall expired at the end of January of this year. Also as noted in the press release, interest expense now includes about $3.2 million per quarter of non-cash charges to comply with the requirements of APB 14.

Looking at income taxes, the effective rate in the first quarter was 39.5% versus 39% last year. For modeling purposes, I would anticipate the 39.5% to be a good benchmark for the full year provision. Income from continuing operations declined $5 million or 14.8% over the same period last year, earnings per share from continuing operations was $1.51 versus $1.75 last year or a decrease of 13.7%. There was no share repurchase activity in the quarter.

Let me now transition to my balance sheet and cash flow comments. This is the time of the year that working capital will peak and we will convert inventory into accounts receivable. Speaking first to AR, the prior year balance was reduced by $50 million due to the securitization program that was still in place last year.

Adjusting for this, actual AR is down $53 million, $38 million is due to volume and $16 million is due to improved collections. Over the past year we have taken over two days out of our average DSO, which is just one example of the leverage we are now getting out of the oracle ERP system.

Inventory on the other hand, was down only $2.9 million which was by design. We consciously decided to order our fastest moving items earlier this busy season to improve our back order performance and deliver a superior customer experience.

There was a corresponding trade payables benefit as we timed the orders to maximize payment terms. As this busy season winds down, we do project that the year-over-year improvements in inventory will mirror those of the AR trends.

Total debt on the balance sheet changed by $64 million, though the actual cash debt was reduced by $125 million, this difference is due to (1) the elimination of the $50 million off balance sheet AR securitization facility, and (2) the accretion of $12 million to our debt balances related to the APB pronouncement. There will be a detailed footnote in our 10-Q explaining all the moving parts on APB 14 and this should be filed in the next two to three business days.

With regard to free cash flow, year-over-year we improved $21.5 million, which was driven by strong working capital management discussed above and a continued focus on managing investments carefully. Our guidance in this area calls for us to deliver between $70 million and $80 million of free cash flow for fiscal ‘10.

At this pace, we would end the fiscal year off the revolver with $10 million to $20 million of cash on the balance sheet. This position is allowing us to continue to monitor current trends in the credit markets and to continue investigating several alternatives to deal with the first convertible note that has a put date of next August. We remain confident in this approach.

Before I close, let me make a few comments on the two transactions that were announced as part of our press release. With regard to AutoSkill, we purchased a fully loaded bleeder with peak receivables. Normalizing the AR balance brings the $11.7 million purchase price down to about $11 million.

In addition, we will realize on a present value basis about $3 million of cash tax benefit from the amortization of the goodwill. So internally, we view this as an $8 million deal. We see the integration as being fairly seamless given the presence in reading intervention we already have with our EPS publishing business.

There will likely be a couple of cents of integration cost, but we do expect the new business to deliver solid double digit top line growth and be accretive to the EPS in fiscal ‘11 probably by $0.05 to $0.07 per share. The FSP transaction on the other hand really allows to us divest avenue non-core business in a two step process.

We believe there are in excess of $4 million of synergies that can be realized very quickly by combining these two entities together. We expect this transaction to close as Dave mentioned by the ends of Q2 and we will account for this investment under the equity method of accounting and as such our financials will reflect the transaction prospectively.

We anticipate a flow through of the integration cost to hit our P&L probably mostly in quarter three and will be in the $0.07 to $0.09 range from an EPS standpoint. Beginning in fiscal ‘11 this transaction should also be accretive to earnings. Both of these transactions are consistent with the longer term strategy of School Specialty and both have been factored into our guidance.

Finally, the full year guidance we are putting for us with regard to earnings per share is $1.40 to 1.60% per share, adjusting for the one time integration cost related to the two transactions mentioned above, this range would equate to $1.50 to $1.70 per share which compares to $1.44 restated in fiscal 2009.

With that, I’ll turn it back over to Dave Vander Zanden.

Dave Vander Zanden

Jackie, I think we are ready for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bob Evans - Craig-Hallum Capital

Bob Evans - Craig-Hallum Capital

First, I want to make sure I heart something properly. As we look at Q2, how much adoption revenue did you have last year? Do you have a ballpark idea?

Dave Vander Zanden

Change in the adoption revenue of Q2 will be about $9 million year-over-year.

Bob Evans - Craig-Hallum Capital

Did you say similar trends, Q2 this year same as Q1 that was just reported kind of down 10’ish percent net of the $9 million?

Dave Vander Ploeg

We are looking at it, as we’ve had a nine month trends of about down 10 X adoptions and we think what we are looking at today is that trend will continue through Q2.

Bob Evans - Craig-Hallum Capital

The AutoSkill trends, the company you are acquiring sounds like you’re excited about it, seems like a good fit. Can you give us some sense of how big a business that can be with your sales force and maybe a little bit on how they get paid, what’s kind of recurring revenue versus more one time sales?

Dave Vander Ploeg

Bob there is only three direct sales guys here, and the rest are two steppers and the distributors today get paid through a discount which runs about 40% off the revenue ticket the schools pay. So, we are going to want to take a good look at some of those economics and see how that works. We think this business can grow pretty large over the next several years.

The reading and renting space is growing significantly, fairly small today but we think it’s going to be an important factor in education in the future and there should be as a pretty healthy spend in this area over the next several years.

Bob Evans - Craig-Hallum Capital

It is a business where you’d be pleased if it was a $50 million business, a $100 million business..?

Dave Vander Ploeg

To help it little bit with where we are, if you took our EPS business and combined it with AutoSkill we are just under $40 million already.

Bob Evans - Craig-Hallum Capital

On the business you are going to divest, can you give a sense of scale how big that business is?

Dave Vander Ploeg

Yes, that’s about a $30 million business, Bob and we’ll account for it prospectively assuming it closes at the end of Q2 about half that revenue will stay in our income statement, half will come out and then it will all be out next year.

Bob Evans - Craig-Hallum Capital

So from a modeling standpoint $30 million and that will hit the second, but you probably won’t have a lot of that hit the second half?

Dave Vander Ploeg

Well, we had talked about in our press release that the two together would impact revenues down about ten and you’d get there by taking $16 million out for publishing and maybe adding $6 million back in for the remainder of the year on AutoSkill.

Bob Evans - Craig-Hallum Capital

Can you also talk in terms of margin potential in terms of what the biggest leverage you have right now in terms of trying to improve margins going forward?

Dave Vander Zanden

This is Dave Vander Ploeg I will give my take and others consignment, I think we have two big levers we will continue to work. On the gross margin side of the equation we were able to make the price corrections and product mix is kind of what it is, but we are seeing tremendous opportunities now as we have consolidated our merchandising groups together and really begin looking at vendor rationalization and the cost side of gross margin. So we believe that we can move the gross margin up through better cost management and better vendor management.

On the SG&A side, I think it will continue to be doing the things that we’re doing. The consolidation efforts are yielding the type of savings that we thought they would and we have more we can do there.

The supply chain management area has shown great progress in terms of just how effective we are at fulfilling the orders and we believe we can continue to harvest more fruit in that area. So we believe that the opportunity exist to keep driving further improvements on both of those.


Your next question comes from Gordon Lasic - Robert W. Baird.

Gordon Lasic - Robert W. Baird

I just wanted to circle back on that guidance question. So, just I want to make sure my understanding was correct. Last quarter you talked about 60 to 70 basis points of gross margin expansion and 30 to 70 basis points of SG&A cost growth, assuming $360 million in revenue. So are you now assuming those same types of expectations, assuming $925 million in revenue? Am I, understanding that correctly?

David Vander Ploeg

We continue to be very comfortable with those ranges that we cited on the call in June. As it relates to the SG&A area, we’re actually tracking ahead of our internal targets there.

Gordon Lasic - Robert W. Baird

Then a couple more questions. This is for Dave Vander Zanden. We’ve been reading several articles where there is projections of 10 more states cutting, planning mid fiscal 2010 budget cuts and seven stays have already received waivers from the DOE allowing them to keep stimulus funds even though they will be below 2005, 2006 levels.

I guess my question for you is, to what extent do you believe that $40 billion in state stabilization funds, this year we’ll plug the holes necessary in education funding and do you think that is enough, your general thoughts there?

Dave Vander Zanden

Gordon, I don’t think it’s going to plug all the holes. States like California that got the waiver and it’s not enough anyway, they need did another $5 billion in cuts to education, but there are other states that didn’t need the money at all like Texas. They have a lot of money in Texas.

I think overall, when the dust settles on this school year and we won’t see the numbers collected unfortunately until a year to a year and a half after it’s over. You’ll see spending on education from all sources probably with a slight increase.

What the educators are spending their money on today on salaries, wages and benefits and I think a lot of the stimulus is going to hold teachers in the classroom. Even though the feds intended it for other purposes, I think the Superintendents are moving numbers around the budgets and the income statements to show compliance with the use of funds for the feds, but I think they’re really plugging holes for salaries and wages to hold teachers in the classroom.

Gordon Lasic - Robert W. Baird

Is your fiscal 2010 revenue guidance assume additional cuts? What assumptions are you making?

Dave Vander Zanden

It’s a good question, Gordon. We’re looking forward with the economy kind of moving where it is. We see a slow but steady improvement there and we’re assuming that continues to be the case. There will be a couple of states that will get surprises in their revenue forecasts, but we think most states were conservative enough in their estimates of tax collections that we don’t anticipate any big cuts [Inaudible] negative economic impact to the whole economy.

Gordon Lasic - Robert W. Baird

I just had one final question. I understand that the shift in stated adoption revenue for this year, but can you remind us what adoptions are on the horizon over the next couple of years and what the opportunities there are?

Dave Vander Zanden

Small states this year, very little of adoption activity that’s going to repeat itself, again as we go into the next fiscal year. Some of the states are looking at delays. We’re very fortunate in California to have received the adoption revenue we did the last couple of years, because California just came out and said they are going to delay all adoptions for two to three years.

That won’t affect us, because they won’t adoption science for several more years anyway, but there are little states that are coming up in the next couple of years like North Carolina, that did a one year delay. A great state for us, the last go around, we expect to go well there again, now its 12 months out. Some of that will move around back and forth as funding changes.

So funding could step up a little on the next 12 to 24 months and you might see North Carolina step it back up. So the bigger period that’s coming forward for us will be in the 2012 to 2013 range, we’ll see some step up and that by Texas are expected to go in 2013. So a couple of years of very little activity this year, next year starting to come up a little and then some significant list after that.


Your next question comes from Ildiko Hildreth - Waterstone Capital.

Ildiko Hildreth - Waterstone Capital

Could you please elaborate on the Taxes, things you’re talking about to deal with the convert that’s comes as portable on this 2010?

David Vander Ploeg

We’ve talked about on last several calls. There’s really three or four viable alternatives, then we’re looking at all of those. One alternative is to amend the current credit facility. The second alternative is to renew the current credit facility a little bit earlier than we might otherwise as a reminder that has a renewal date of February 2011. So it comes due about five months after the first convert.

We’ve also been watching the high yield market, which is become much more active and much more rational in the last two months and then we’ve also explored the swapping out of the convert for a different one or extending the terms on it. So really those are some of the avenues that we have looked at and talked to people about and we’ll just continue to explore those alternatives to tell the time is right to pick one of them and move forward.


Your next question comes from Trace Urdan - Signal Hill.

Trace Urdan - Signal Hill

Just want to do start with a housekeeping question. Can you speak to the seasonality both of the acquired business and the divested business?

Dave Vander Zanden

Both of those businesses have a little less seasonality than our total trend would be. AutoSkill tends to book as the school season starts. So when we talk about, how much revenue comes out of this fiscal year in that for the acquisition and disposition of about $10 million. AutoSkill is about at the halfway mark and the bigger season for the retail trade business is in the March, April timeframe as they ship into the dealer marketplace. There’s a little up tick there and then some back-to-school in the June, July timeframe as they’re shipping into the mass merchants, so a little bit flatter curve though there, Trace.

Trace Urdan - Signal Hill

I wonder if you could speak to, it’s probably hard to discern in this environment, but maybe if you could talk about sort of market share along the two new business segments and what you’re seeing there. I know you mentioned that large markets were maybe suffering disproportionately, but I’m wondering sort of what you are seeing from the competition and how you’re situated as far as that goes?

Dave Vander Zanden

It’s a little bit early, Trace. We get numbers from the public companies as they come out and we haven’t seen much yet. We think we’re doing pretty well in most areas, but we need to see kind of their second quarter reports for us to really get a good gauge. So it’s a bit early to really conclude anything.

Trace Urdan - Signal Hill

Sort of word from the field does it feel as though people are responding in a new way because of budget pressures with respect to dealing with competition?

Dave Vander Zanden

Yes, I think as Tom mentioned in his comments, this aggregation strategy that we’re pushing out in some of the larger districts is pulling very well. We’re able to get to people at much higher levels in the large institutions that we’re able to before just because of the need for them to watch their costs a little bit closer and we’re able to offer things that with more capability with the oracle systems and so forth that we couldn’t offer in the past. So we’re definitely seeing some change there.

Trace Urdan - Signal Hill

So I understand you guys are basically sort of helping them analyze their spending and their costs?

Dave Vander Zanden

Tom, do you want to put some color on it?

Tom Slagle

I think as we look at the whole non-instructional spend bucket there’s a handful of categories that does align with our core business that we are really engaging the schools with around how do we take the principles of an efficient value stream of procurement and applying it into what they do internally.

As you know, most of these schools are very unsophisticated relative to not having simple things like item masters, they don’t have a lot of contractor discipline, vendor rationalization strategy so as we work with them in concert with what we are doing and have some folk in the field but are really focused on that we are able to identify very significant and specific cost that we are taking out of their system and then monetizing that through value in kind and or other relationships with the customer to buy more products from us. So it’s working out very well at a time where I think the market is extremely interested in looking at these types of areas.

Trace Urdan - Signal Hill

Then with respect to the stimulus, do you, are there certain Grant funding that you all are working on targeting specifically in terms of maybe helping districts right grants and I’m wondering specifically if there’s any portion of your business, maybe the skill view that might be able to step into the race to the top funds?

Dave Vander Zanden

Yes, I will give a perspective from my view, Trace. Clearly in areas like special needs, physical education, IDA, we are very engaged with working with them on Grant funding and tied that in. We have other programs that are much more specific towards skill based development with reading and science actually is one of those areas that are getting a lot more questions particularly in some states that are stressing that particular core. So, there are specific programs but I would say title one IDA are clearly the areas that we are chasing.

Trace Urdan - Signal Hill

Is the interest in science related to the NCLB requirements in your opinion?

Dave Vander Zanden

I think it’s again some states are actually going through an emphasis in science and that tends to be where the focus is placed around our offering.


Your final question comes from Bob Evans - Craig-Hallum Capital

Bob Evans - Craig-Hallum Capital

I want to get your perspective, Dave, on buyback. I know you’ve just spent of that for a while; your free cash flow is building. I know you have got the convert coming up, but just give your and the boards perspective as relates to revisiting a buyback sometime in the future.

Dave Vander Zanden

Bob, that’s a hard one to answer in this kind of environment. We’re still interested and still an option for us but as this environment stays a little more on the tight side we are more in client to do debt reduction as we go forward at least in the short term here and make sure we have powder dry in smart acquisitions that important to us on the way as well. So it’s promptly today in the third seat as we continue to generate positive cash flow, take a look at where these converts are, refinance our credit offerings, the buyback moves up in the chain of interest a little bit more.


Thank you. There are no further questions. I’d like to hand the floor back over to management for any closing comments.

Dave Vander Zanden

Great, thank you, Jackie. Well, thank you all very much. We’ll be back together with you in mid-November presenting the complete season and what happened there and again additional outlook. So, thanks again for listening on the call and we’ll talk to you then.


This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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