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Scholastic Corporation (NASDAQ:SCHL)

Q2 2010 Earnings Call

December 17, 2009 8:30 am ET

Executives

Jeff Matthews – IR

Richard Robinson – President & CEO

Maureen O’Connell – EVP, CAO & CFO

Margery Mayer – President Scholastic Education

Ellie Berger – President Scholastic Publishing

Deborah Forte – President Scholastic Media

Judy Newman – President Scholastic Book Clubs

Hugh Roome – President Scholastic International

Analysts

Drew Crum – Stifel Nicolaus

Peter Appert – Piper Jaffray

Barry Lucas – Gabelli & Co.

Operator

Good day and welcome to the Scholastic second quarter 2010 earnings conference call. I will now turn the call over to Mr. Jeff Matthews, VP of Corporate Strategy, Business Development, and Investor Relations. Please go ahead, sir.

Jeff Matthews

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, www.scholastic.com, clicking on Investor Relations, and following the link from 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 market, the 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 Richard Robinson, the Chairman, CEO, and President of Scholastic to begin our presentation.

Richard Robinson

Thank you Jeff and good morning, thank you everyone for joining us on our fiscal 2010 second quarter conference call. This morning I’m joined by Maureen O’Connell, Chief Administrative Officer and CFO, Margery Mayer, President of Scholastic Education, and Judy Newman, President of Scholastic Book Clubs and ecommerce. Our other members of the executive team are available to answer questions at the end of our comments here.

Scholastic had a very solid second quarter and we have affirmed that we are on plat to meet fiscal 2010 earnings guidance. We delivered substantially higher operating margins, earnings, and free cash flow before one-time primarily non-cash items on slightly increased revenue.

First in Scholastic Education sales of READ 180 and other educational technology nearly doubled in the quarter. This reflected strong execution and several new products including System 44, as well as the benefit of the Federal stimulus program which is augmenting tight school budgets.

Second, we remained focused on our goal of 9% operating margins and saw significant benefits from cost reductions in pricing across the company particularly in the Children’s Book segment. This yielded higher margins and profits in that segment compared to a year ago despite a revenue decline which partially reflected planned reductions in club promotions and the late start of schools.

Third, lower inventories and working capital improvements on top of higher cash earnings drove the $92.5 million increase in free cash flow in the quarter relative to a year ago. As a result we continue to reduce the company’s net debt which at quarter end was more than $250 million below last year’s level.

The quarter’s GAAP results include $42 million of primarily non-cash one-time charges based on actions we took to reduce the cost base and write-down unproductive assets and US library publishing into the UK. I’ll discuss these in a moment.

Excluding these items which are not in our guidance operating income was up more than $55 million in the first half of the year compared to a year ago. This positions us well to attain our goal of $30 to $70 million in incremental operating income for the full year which would result in 9% operating margins if we reach the top end.

Scholastic Education, the technology focused portion of the educational publishing segment had a great quarter, contributing significant revenue and profit growth. Strong execution by the team and incremental Federal stimulus funds helped sustain our first quarter momentum as Margery Mayer will discuss in a few moments.

Year to date sales of educational technology and related services are now up over $60 million or 75% from a year ago. In Scholastic supplemental print education business sales of core paperback collections for classroom libraries held solid in the quarter, while sales to school libraries declined.

As part of our company plan we have consolidated the publishing output for non fiction and library print into Children’s Books so our trade group is publishing non fiction titles for the entire company including books for sale in the library channel.

This move has already resulted in greater efficiencies and reduced costs for the company. Because we no longer intend to publish new titles exclusively for the library market we have written off intangible and other long lived assets associated with print publishing for libraries. This resulted in one-time non-cash charge of $36.3 million or $0.60 per diluted share last quarter in the Education segment.

Excluding this item which is not part of guidance Education segment operating income more than doubled in the quarter reflecting higher margin educational technology sales and tight cost control. Year to date profits are up by $38 million compared to last year. These results are a key part of our fiscal 2010 plan and also confirms Scholastic Education’s market leading position and long-term growth opportunity.

In the Children’s Book segment our focus this year is on improving margins and profitability. We raised prices in select areas, reduced promotion spending in clubs, consolidated regions, and fairs, and as I previously noted assigned publishing to trade. These actions resulted in higher profits and margins for the segment last quarter despite modestly lower revenue.

In the school market book fairs successfully held sales level last quarter as an increase in fair count offset a modest decline in revenue per fair. The move to a hub and spoke distribution and warehousing model has led to improved service at lower costs and the new incentive program Scholastic Dollars has been embraced by customers.

The school volunteers who run our book fairs are also enthusiastic about the new point of sale technology we are testing in two regions. In Book Clubs, Scholastic’s other school channel, revenue declined 14% in the second quarter relative to a year ago. One factor was the teachers who often order books for themselves when they place book club orders for their students, are spending less of their own money this year.

Targeted price increases is reflected by a 10% increase in revenue per item partially offset the gross margin impact of lower sales as did the lower promotion spending. Judy Newman will speak in a moment about the club’s business and our plans for the spring. She’ll also give an update on our over arching goal to move this business online.

In the trade channel, net revenue was down 5% in the quarter relative to strong Harry Potter sales a year ago. Scholastic’s publishing continues to top best seller lists with series like The 39 Clues, The Hunger Games, as well as Shiver the first title in a new trilogy by Maggie Stiefvater.

We also published eagerly awaited new titles like How Do Dinosaurs Say I Love You, the fourth title in the Allie Finkle series, and Skeleton Creek #2. In the international segment profits were up excluding one-time items as sales held level excluding modestly favorable foreign exchange effect.

Higher profits and margins primarily reflect the negative impact of foreign exchange a year ago as well as improved results in Canada and Asia. In the UK we’re making progress restructuring operations and reducing our footprint in order to return to long-term profitability in this business. Related to this last quarter there was a mostly non-cash expense of $5.7 million or $0.15 per share related to intangible write-downs as well as costs associated with the consolidation of the UK distribution facility.

As a result of these actions we expect that narrow UK losses in fiscal 2010 to reach operating break-even in fiscal 2011 and be profitable thereafter. In summary Scholastic’s second quarter results were strong and we’re on track to meet our fiscal 2010 plan. Now I’ll ask Margery Mayer to give an update on Scholastic Education. She will be followed by Judy Newman who will address our strategy in Club.

Margery Mayer

Thanks Richard, and good morning to everyone. As Richard noted we achieved tremendous gains in the second quarter continuing our momentum from the summer. For the first half of fiscal 2010 we’ve now achieved more than $60 million or 75% growth in sales of educational technology and service compared to the same period last year.

By filling gaps and tight local school budgets, Federal stimulus funding has accelerated growth in four key areas. First our flagship product READ 180 was up nearly 100% last quarter compared to the same quarter a year ago from increases with both existing and new customers. We believe READ 180 remains the market leading and most effective reading intervention program available.

Notably the What Works Clearinghouse, the influential federal agency that helps educators and policy makers choose educational materials and programs recently confirmed that READ 180 is effective in improving comprehension and general literacy achievement based on studies of thousands of students using the program.

Second, System 44, our prequel to READ 180, is a break out hit with more than $30 million in sales since we began shipping the program 12 months ago. Third, sales of consulting services have also grown dramatically contributing profitable revenue gains as well as multiple opportunities to strengthen relationships and customer results.

And fourth, our math business though smaller than our reading business doubled in the quarter and is showing promising signs of progress. In the second half of fiscal 2010 we expect to continue to have robust sales growth and improved margins compared to a year ago. Both are expected to moderate somewhat as System 44 passes its first anniversary and now faces prior year comparisons.

In addition California adoption sales of READ 180 and System 44 were largely a fiscal first half event and aren’t expected to be significant in the remainder of the year. And the second half will also have a larger percentage of service business based on contracts already signed and higher prepublication amortization associated with new products.

This year Scholastic Education has taken big strides successfully expanding our promise beyond READ 180, at the same time we grow the READ 180 footprint. We have also matured as a service organization providing consulting and professional development at the district building and classroom level.

Looking forward we are focused on raising achievement not simply on selling a product that traditional educational publishers tend to be. We have worked to establish a service model that is iterative and continuous thus positioning us as a true partner to schools, working to improve performance.

At this moment in time when schools are looking for innovative practices with lasting effect, we have differentiated ourselves as a new kind of education company while building on Scholastic’s 90 year old values and brands.

Now Judy will speak, thank you.

Judy Newman

Margery thank you, and good morning everybody. As Richard mentioned a moment ago Book Club revenue declined last quarter by approximately 14% partly reflecting the reduced mailing plan and the late start of the school year.

However we did not anticipate that teacher layoffs and reassignments in many school districts would disrupt Book Club ordering, especially in September which is typically the most important month of the year for this business.

Yet this year represented two thirds of last quarter’s declines. We’ve taken immediate steps to redeploy mailings and refine promotions and are encouraged that both teacher participation and order volumes began to recover in October and November.

For the second half of the year we expect to close the gap further achieving revenue more in line with the prior year. In contrast with Clubs, book fairs were less impacted by the late school start and disruption in September, because relatively few fairs are normally held at the beginning of the school year.

As we actively manage the current environment we are making progress with our strategic goal of moving the clubs online with a robust e-commerce experience for parents and kids, as well as for teachers. This fall we offered new clubs ordering online or COOL, in a Beta version to a limited number of teachers.

This new online marketing platform extends Club’s unique [curated] offers with additional information and recommendation. It also enables parents and kids to find and buy books from popular series, and other offers, for example from the previous month or a different club.

And it also allows them to use credit cards. In parallel we are actively encouraging parents to order online using the current COOL platform and are seeing very strong results. Online ordering by parents makes the club process easier for teachers, compared to the traditional paper based approach.

And even without the added marketing and personalization of new COOL we’re seeing significantly increased parent engagement and spending through COOL. Though relative to a small base we have increased parent online ordering by 200% so far this year.

To support our progress in this area we’ve recently made some strategic hires who have deep online experience. We’ve added to our team the former EVP of e-commerce at Barnes and Noble, and is VP of e-commerce at Bertelsmann. We believe that the full rollout of the new COOL will be a transformative growth opportunity for Clubs and for Scholastic’s nearly $400 million online business as we build a much closer selling relationship with millions of parents while continuing to promote ordering through the child’s teacher.

In addition to providing more opportunities to sell printed books, new COOL is also a key element of our unique children’s e-book strategy. This market is still embryonic compared to the very recent activity and tremendous buzz in the adult e-book space, but we’re already aggressively building capabilities, leveraging new COOL and the company’s deep knowledge of how kids, parents, and teachers read and use books together.

We expect to begin market tests in the coming calendar and we really look forward to providing more information in the future. With that I’ll turn the call back over to Richard.

Richard Robinson

Thanks Judy and Margery, now I’ll ask Maureen O’Connell to review our second quarter results in more detail as well as provide the outlook for the remainder of the year.

Maureen O’Connell

Thanks Richard, and good morning everyone. As Richard has described last July we laid out a plan to significantly increase profits, reaching 9% operating margins if we attained the top end of our guidance.

This plan includes three elements, first, driving significant growth in educational technology. Second, improving margins and profits in children’s books, and third reducing cost across the company. We also committed to maximizing free cash flow by strictly managing working capital and investment.

I’m pleased to say that we made substantial progress in all of these areas last quarter. On an operating basis, excluding one-time primarily non-cash items that Richard has discussed, and that are detailed on this slide, EPS rose nearly 35% in the second quarter, which is typically Scholastic’s seasonally most profitable.

Operating income rose by nearly $29 million, as operating margins improved 420 basis points to 22.4% and free cash flow increased by more than $92 million to $141.2 million. Now I’d like to review the income statement adjusted to exclude the one-time items I just described.

Revenues rose 1% primarily reflecting higher Educational Publishing sales, offset by a modest decline in Children’s Books. International sales were up due to favorable foreign exchange impact. Excluding foreign exchange international revenues and the company’s overall sales were level with the prior year.

Cost of goods sold decline in absolute dollars and as a percent of sales reflecting higher margin educational technology sales, as well as the benefit of higher pricing in the Children’s Book segment. Lower paper manufacturing costs also contributed to higher gross margins. SG&A also declined primarily due to cost reduction efforts including reductions in Club’s promotion spending, and lower salary expenses.

These factors were partially offset by higher commissions in education, higher medical expense and increased bonus accruals relative to the prior year. Bad debt expense decreased by $2.8 million or 39% relative to the prior year period when reserves were established for certain US and UK trade accounts.

Overall adjusted earnings per share from continuing operations was $2.29 compared to $1.72 a year ago. Discontinued operations generated a smaller loss last quarter compared to a year ago when we incurred primarily non-cash non-operating charges associated with exiting unprofitable non-core businesses.

Higher free cash flow last quarter reflected both strong cash earnings and working capital improvement. We continue to successfully hold inventories down relative to a year ago due to timing and more efficient purchasing. We continue to manage our receivables very carefully.

As was the case in the first quarter, last quarter’s increase was associated with the increase in educational sales. However we successfully offset most of the impact on working capital through tight controls on payables. As a result of consistently higher free cash flow over the last four quarters, total debt and net debt continued to decline.

As of November 30, 2009 net debt was $101.3 million down from $359.2 million a year ago. This reflected significantly higher cash on hand as well as debt repayments over the past 12 months. We remain undrawn on our committed $325 million revolving credit agreement. We continue to look for efficient means to return cash to our shareholders and yesterday announced that the Board of Directors has authorized an additional $20 million share repurchase program. We also declared our third quarter dividend.

For the first half of fiscal 2009 year to date EPS is up by $1.04 per diluted share and operating income has risen by nearly $56 million compared to a year ago excluding the impact of any one-time items associated with cost reductions or non-cash non-operating items as we have just discussed.

On that basis we feel confident affirming our guidance of $1.80 to $2.30 per diluted share for continuing operations. As we said this is equivalent to $140 to $180 million in adjusted operating income, which at the high end equates to a 9% operating margin.

Excluding one-time items we generated $1.28 per diluted share and $110 million in operating income for the full year in fiscal 2009. We anticipate our strong first half profit improvement will continue though our run rate will moderate somewhat.

As Margery described we expect less top and bottom line growth from Scholastic Education’s second half, following a record breaking first half. Headcount reductions a year ago also benefited the second half of last year and will not provide a year over year benefit in the remainder of the year.

We also anticipate higher bonus accruals, higher medical expense, and amortization associated with new education products and new COOL. We continue to expect one-time expenses in fiscal 2010 related to the UK restructuring of $7 to $10 million or $0.19 to $0.20 per diluted share after tax, because UK losses are not tax deductible. This amount includes last quarter’s charge.

Scholastic continues to target free cash flows for the company of $90 to $120 million. We anticipate continued free cash flow improvement in the second half of the year, however we do not expect working capital improvements to be at the level realized in the first half when there was a significant inventory benefit due to the consolidation of the [fair] regions as well as timing of purchases.

Furthermore a tax benefit carried over from fiscal 2009 was realized in the first half of the year and will not benefit the second half.

Richard Robinson

Thanks Maureen, as you all know our top priority for the year is to attain our long-term target of 9% operating margins and half way through fiscal 2010 we are pleased that the progress we’ve made toward our fiscal goals, especially our target of 9% operating margins which we’ll meet if we attain the top end of the guidance.

As Maureen just described so far this year we’re achieving all three elements of our plan. First, we’ve attained exceptionally strong educational technology sales which reflects strong fundamentals in the way we’re doing this business accelerated by incremental Federal stimulus funds in an otherwise difficult funding environment.

Second, we’ve increased profits in Children’s Books through targeted price increases and cost reduction even as revenues declined modestly. At the same time we’re moving forward with a robust strategy for long-term growth in the segment leveraging our unique school channels for online sales, print, and electronic books.

Third, we continue to hold down our cost base sustaining the progress we made with last year’s headcount reductions and operating improvements. All of these factors are combining to drive higher cash flow and margins and profits which we believe are sustainable and we look forward to reporting on further progress.

We’ll now open the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Drew Crum – Stifel Nicolaus

Drew Crum – Stifel Nicolaus

I just wanted to get into your guidance a little more in detail, if I look at what you’ve done year to date the implication is that the second half is going to be down significantly or kind of flattish year on year and it seems like you have good momentum in the publishing business, you’re going to get some momentum from FX in the international business, I appreciate the color you gave Maureen but is there anything else you can give us. Is this a matter of conservatism on your part or is there something else that you’re seeing in the business that would lead to keeping the guidance as it is today.

Maureen O’Connell

One of the success factors in the first half of the year has been the tremendous growth in our educational technology business which as Margery said benefited from the California adoption in the first quarter and high sales of System 44. And as we anniversary System 44 we won’t get that same growth rate in the second half and California was first half loaded.

As you recall last year at this time we had our voluntary retirement and we also announced we’d give no bonuses to the staff so we had no bonus accruals in the second half. And now that we are in our ranges we have to reestablish those bonus accruals and so that has an impact.

Our promotion savings in Book Clubs was front end loaded so most of the savings that we expected to realize promotion we did realize in the first half whereas this spring season is not as significant in Book Clubs and so we expect flattish promotion to last year in that category. So those are some of the contributing factors.

Also education sales in the first half was primarily product driven, which is typical of the selling cycle and that follows with service and as you know service is a lower margin for us and so that will require us to add people to service that business and so there’ll be a greater proportion of service sales in the second half.

Drew Crum – Stifel Nicolaus

Sticking with Educational Publishing, is there any update to your guidance as far as what Federal stimulus contributes this year and fiscal 2011, and are you able to quantify the impact you’ve seen to date and just thinking about that, is there a way to quantify what is one-time in nature and what you see as recurring going forward.

Richard Robinson

I’ll ask Margery to answer this but basically we’ve benefited certainly from Federal stimulus funds, how much of those funds still remain to be spent is a question that everybody is trying to answer. But I think the key thing here and I know Margery will underline this, is our business model has now been proven out as the unique and sustainable business model in this education enterprise that we have.

And we’re rolling, we’ve got a bigger footprint in terms of sales and market share and we believe that this is the key reason is really our execution on top of which we’re getting some benefit from stimulus funds.

Margery Mayer

You can imagine, we’re really excited about how well we’re doing and its really across the board. In terms of stimulus we do try to track stimulus and, but its difficult because stimulus in two ways. One is stimulus dollars that are designated stimulus dollars, but there’s also stimulus going into districts that want to buy READ 180 and they feel they can release funds because they now have the relief of some stimulus dollars.

We believe that our business model and stimulus together are what are really driving the business and if I had to put a number on it, I’d say maybe half of the growth was stimulus and half of it was organic from our business model. But I just really want to underscore what Richard just said, we know that when we are able to get READ 180 into a district and we’re able to support it with good service and the district gets results, that leads to more sales.

That leads to more READ 180, it leads to more System 44. We have very good percentages on our districts that are repurchasing materials for READ 180 and extending READ 180, so we feel that we have a big opportunity to continue our momentum because of our larger footprint that we’ve created and we also believe that there is going to be continuing benefit from stimulus going forward.

The nature of those funds may change somewhat from being allocated to stabilization funds to more, to competitive grants, but because we’re right at the heart of what schools are trying to do which is to raise achievement in our most struggling schools, we believe that stimulus is just going to continue to be a good thing for our business.

Drew Crum – Stifel Nicolaus

Do you plan to participate in the Texas reading adoption next year, you had some success in California this year, is that in the works for you.

Margery Mayer

We have pre K program that we’re submitting in April of this year, its called Big Day For Pre K, its adorable, if you have a young child you’ll want to make sure that your kid is in it. We have had a great success with pre K in Texas for the last two adoptions and we expect to have good success with the next adoption.

But we are not going to be in the Basal Reading adoption, Texas is one of our top states right now. We’re doing extremely well in Texas with both reading and math and we think that we can do extremely well with our pre K program and selling outside the adoption READ 180 and System 44.

Drew Crum – Stifel Nicolaus

How do you see the economics playing out for your business as digital becomes the more prominent piece of the business. As you mentioned there’s been a lot of rhetoric, a lot of press related to digital content recently, I just want to get your perspective on that.

Richard Robinson

Well I think its important to realize first and I know you know this that we’ve been in the digital business for a long time especially in the education segment where we sell subscription based programs READ 180 itself is a digitally delivered program. So this is not a new enterprise for us.

Your comments probably refer more to the consumer market, we are obviously we are a distributor of children’s books, we’re the top children’s book distributor publisher in the world. We sell half of the units that are sold of children’s books in the United States. So obviously we have to be in the digital revolution.

We have to extend our distribution channels to include distribution of digital material and we’re hot on that right now and as Judy said, we’re adding a digital delivery component to COOL and we’re obviously following all of the e-book and e-reader announcements very closely and we are right on top of that market as well.

So we expect to be a digital distributor in the near future in the consumer e-commerce market. The effect on margins I think its really, it’s a partially misleading question because I think the real thing that everybody is looking forward to is an expanded market for digital delivery. We have some outstanding audio visual materials available which we are seeking to build into a digital distribution platform.

Those are going to be available in iPhones and Blackberries in every conceivable way so we think that there’s just a great market expansion available as more and more people get exposed to digital delivery of content and we’re looking forward to that.

Drew Crum – Stifel Nicolaus

Do you see pricing as being problematic going forward.

Richard Robinson

Well pricing is an issue, but its really a question of if you look at iPhones, and the apps on iPhones for example, you can see a totally different pricing model from the one that’s in the book business right now and I think pricing will evolve and I’m not particularly focused on that at the moment.

I’m focused on how do you expand the market through digital distribution. We’ll find a way to make money at it.

Operator

Your next question comes from the line of Peter Appert – Piper Jaffray

Peter Appert – Piper Jaffray

I’m wondering how you think strategically about balancing the promotional spend against the desire to get back to positive revenue comps within the Club channel specifically, the question is driven by the fact that it seems to me that every time you get the benefit of margin from lower promotional spend you see an immediate impact on the sales levels. I understand there’s more going on this year but how do you think about that.

Judy Newman

It is, we did reduce promotion spending and what we’re experiencing now, this revenue decline, is really largely attributable to those as you said unique situations that happened this September, the late Labor Day coupled with tremendous disruption in the teacher population.

And really what we’re focused on as, we’re actively and responsibly managing the base business of course, is really to convert online where the issues of catalogues change a lot. So that’s really our focus. We’re excited about what we’re seeing on COOL and particularly on parent COOL, and we just want to make sure we’re responsibly managing the base business as we’re embarking on this very robust and exciting transition online which we do see as growth opportunity for the clubs.

Peter Appert – Piper Jaffray

So under the COOL scenario obviously you don’t have to print the physical catalogues, is that—

Judy Newman

Yes, sorry, there’ll always be catalogues to get people online but we believe we’ll have much more flexibility in how we can deploy them, we can use them much more strategically and what we’re seeing is we can get incremental sales off of that same promotion.

Peter Appert – Piper Jaffray

And can you remind me what the timeframe is in terms of more broad based rollout of COOL.

Judy Newman

Yes, we’re on schedule. I think what we reported last time this year, we are continuing our full rollout of new COOL and so we’re targeting to be completely on to it by the end of this calendar year, this school year and by back to school, all teachers should be onto the new COOL platform. We solved a lot of our performance problems and we’ve very excited about what we’re seeing now, what customers are reporting back who are using it.

Peter Appert – Piper Jaffray

And is the average order size bigger in the electronic ordering.

Judy Newman

Yes, its bigger, its bigger from the teachers, and its bigger from the parents that we’re starting to see on ordering which is great, significantly higher which is why we’re so optimistic about this future.

Peter Appert – Piper Jaffray

Can you quantify how big the consulting business is currently and whether that continues to grow as a percentage of the revenue.

Margery Mayer

I guess we can say that its about 20% of our READ 180 business, something like that.

Peter Appert – Piper Jaffray

And I think you said I just want to confirm this, that the profitability of that is somewhat lower than traditional product sales, is that right.

Margery Mayer

Yes it is a little lower but it is still profitable and we raised prices on it a little bit this year so it got a little bit more profitable this year and we think it’s a great business. It puts us in a virtuous cycle with our customers, it helps, it almost always leads to larger initial order size, it leads to ongoing sales, and it is profitable in its own right.

Peter Appert – Piper Jaffray

Is that recurring revenue, do you get a consulting fee every year or is that just at the—

Margery Mayer

Yes, well it depends on what our contract is. There are a lot of districts where we’ve signed three year consulting agreements, or a lot of districts where we go in and renew every year. We’ve had very good renewal on our services in our key districts.

Peter Appert – Piper Jaffray

So its not just about implementation.

Margery Mayer

No, its not and we’re doing all kinds of things, we’re doing in classroom coaching with teachers. We’re doing [caudry] meetings, we’re doing training the trainers, a lot of the emphasis in [ARA] is around human capital development and school districts are expending funds to help their teachers be more effective teachers of reading and that’s really what’s going on here.

So I think this is going to be an important area for growth for us going forward as well.

Peter Appert – Piper Jaffray

In the traditional print supplemental market it feels like that business [has been declining] for the whole industry for quite a number of years now, is that just going to be a continuing trend do you think.

Richard Robinson

Obviously our educational technology business which Margery is directing is just growing by leaps and bounds. The supplemental market tends to go as you know, tends to go up and down over time. Right now we see a lot of interest in books in large cities, the superintendents what their kids to have classroom libraries, they want to have them exposed to books.

There are very, very sensitive to the fact that the poor kids don’t have as much access to books as the middle class and upper class kids and so there’s a very strong commitment on their part to provide classroom libraries and full book arrays for motivation and for expansion of reading in terms of just kids’ fluency and comprehension and excitement and motivation around reading.

So there is a focus there and some of the sales are moving to more top down just as they are in the education technology area as the superintendents and the chief curriculum officers control more of the funds and tend to allocate the Federal money that’s coming into the system.

So I think you’ll see a renewal of the supplementary business and as we said on our call, classroom library business and supplementary publishing business is pretty strong right now. The library segment has declined for us but we still think it’s a very vital channel for distribution of all of our products into schools.

Peter Appert – Piper Jaffray

As I’m thinking about the great progress you’ve made towards the 9% margin how do you think about the sustainability of the margin, is there potentially some further upside over the next couple of years.

Richard Robinson

I think, as you know we’ve had this goal for a long time and so this 2010 was the year. We’re going to do it this year and so that’s one of the reasons we raised prices and cut promotion and Clubs, which had the effect that you were concerned about. But the overall goal of this company for this year is to reach that margin.

We’re well on the way to doing that as you can see from our first half results. Once we’ve gotten there then we’ll see if we can get it up a little bit but our real goal was to hit a level of operating profit that we considered to be important for our shareholders and necessary for the health of the business.

And I think you can see that a lot of that’s happening with the cash flow, with the cost reductions and so forth and so on. Also as educational technology continues to grow that’s obviously a higher margin business and will have an overall helpful effect on the company’s margin going forward.

Operator

Your final question comes from the line of Barry Lucas – Gabelli & Co.

Barry Lucas – Gabelli & Co.

Not to quibble too much about the back half of the year but when you look at the educational service business that you described at modestly lowest margin but representing about 20% or so of the technology sales, and putting that up against the really rapid growth of the first half, shouldn’t we still be seeing significantly more margin dollars coming from the service side of the business in the back half of the year to, let’s say more than support the upper end of the guidance range.

Maureen O’Connell

In the first half of the year its been predominantly product sales in educational technology and that has significantly higher gross margin as compared to our service side. And on the second half it will be more service, actually in the first half of the year we have a very small amount of component service, its not at the 20% levels in the first half.

That’s what it will be annualized and its much more skewed to the second half of the year and that requires people to service and be in the schools and in the classrooms and help implementation and so that requires us to add staffing to service that business. And some of that staffing we’re going to have to add ahead because we sell it in a subscription and so we’ll bring in the people, have them trained, and then ready to service the business.

So there is some investment in people ahead of the revenue.

Barry Lucas – Gabelli & Co.

Just to come back to the e-reader if you will, Barnes and Noble has a new reader out if they can ever get it into the stores, what do you see as the determining factor in let’s say in moving families and/or we’ll say young adults or kids into the e-reader. Is it a lower priced product, is it Apple coming out with an iBook or does it have to be kind of a Fisher Price iBook.

Richard Robinson

I think there’s lots of speculation in this whole field, there is not right at this moment an e-reader for kids although Nintendo DS has announced something and it requires rather different approach and kids are not buying digital product relative to reading right at the moment.

They’re buying plenty of other digital product so I think its going to take a combination of improved software, greater availability on a number of different platforms. Something that is unique to kids experience and other things like that. So we are of course right on top of this and are working in this field and have our own thoughts on it, but at this moment we’re keeping them to ourselves.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Richard Robinson

I’m going to thank you all, wish you Happy Holiday season. Thanks for your great support and we’ve very, very proud of what we’ve achieved in the second quarter and we look forward to doing almost as well in the back half of the year.

So thank you all and we’ll look forward to talking to you in 2010.

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Source: Scholastic Corporation F2Q10 (Qtr End 11/30/09) Earnings Call Transcript
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