School Specialty F4Q08 (Qtr End 04/26/2008) Earnings Call Transcript

| About: School Specialty, (SCHS)

School Specialty (NASDAQ:SCHS)

F4Q08 Earnings Call

June 12, 2008 11:00 am ET


Mark Fleming – Director of Investor Relations and Corporate Communications

David Vander Zanden - Chief Executive Officer

Thomas Slagle – President and Chief Operating Officer

David Vander Ploeg - Executive Vice President and Chief Financial Officer


Mark Marostica - Piper Jaffray

Amy Junker - Robert Baird

Trace Urdan - Signal Hill

Bob Evans - Craig-Hallum

Gregory Macosko - Lord Abbett


Welcome to the School Specialty fourth quarter and fiscal year 2008 year-end earnings conference call. (Operator Instructions) It is now my pleasure to introduce School Specialty’s Investor Relations Director, Mark Fleming.

Mark Fleming

Welcome to School Specialty’s fiscal 2008 fourth quarter and year-end conference call. Our presenters today are CEO, Dave Vander Zanden; our President and COO, Tom Slagle; and our Executive Vice President and CFO, Dave Vander Ploeg.

Before I turn the call over to Mr. Vander Zanden, I would like to take a moment to read the safe harbor statement. Any statement made during this call concerning future results of operations, expectations, plans, or prospects are forward-looking statements.

Forward-looking statements also include those preceded by or followed by words like “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “targets” or similar expressions. These forward-looking statements are based on School Specialty’s current estimates and assumptions and, as such, involve uncertainty and risk.

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 would like to introduce your host on the call, Dave Vander Zanden.

David Vander Zanden

This morning you will hear from me on a couple of comments on what I thought were some of the major investments initiatives that we put in place in fiscal 2008. And I will talk a little about funding. Tom is going to talk through performance in Q4 and how the operations are going and how we are set for the coming busy season. And then Dave Vander Ploeg will take you through the numbers and we will have, of course, time for questions at the end.

But before I start, I just like to welcome Dave to School Specialty, he comes to us from Schneider National, which is about a $4 billion trucking company, where he was the CFO, and we are very happy to have him here. He has been here all of seven weeks getting to know everybody and I think he is going to fit in with our team really well. And I think he is going to be a very good business partner for us, and I think we’re going to see much more involvement in the operations from our financial focus in the future. And I’m very happy to have Dave onboard.

I would also like to thank Kevin Baehler, who is here with us as well today. Kevin served us our Interim Chief Financial Officer for the last nine months and just did an outstanding job for us. He sat in two chairs, both the CFO and the Controller’s position, balanced both very well and kept us focused and on track as we went through the search process. So, I would like to thank Kevin for that extra effort as well.

For the fiscal year, we had quite a few accomplishments. I’ll start out with a couple on cash flow, which was about $75 million or $3.65 per share. We view this as a very good base of cash flow and our cash flow here is very consistent and reliable, and we expect to improve on that as we move into fiscal ’09. Dave will cover in a few minutes that we increased the guidance on cash flow that we set in February to reflect that confidence.

We had excellent performance this year with science adoptions in California. In fiscal ‘09, we also won the largest district in year two in California, which is San Diego. And we have adjusted our guidance about 10% to reflect that and Dave will cover that as well.

We set an inventory reduction goal this year, which we did achieve at the end of the fourth quarter, and we expect to continue to reduce inventories over the next two years and we think there is a plenty of opportunity for us to improve there and to free up some cash.

We have positioned last year our reading position as that in the reading intervention space. And during the year, in December, we added Sitton Spelling in the small acquisition, and we also terminated two partnerships that we are not focused in that reading intervention space, and as we go through the call today, you will hear about inventory donations and they were related to the termination of those two partnerships.

We expect in the next couple of years to invest significant amount into the development of our reading intervention program and we think this will be a major growth area for us over the next three years.

We are also developing our coordinated school health curriculum program called SPARK which had very good success in fiscal year 2008. This is a health nutrition wellness program that we are repositioning around coordinated school health, started out with San Diego as a curriculum program for physical education instructors.

Coordinated school health arrived on the scene and it’s a new position that schools need to address a couple of years ago and we have been investing in this program and we will continue to do that and do expect that we will see some very good performance in this program in the next couple of years as well.

We finished up Phase 2 of the Oracle conversions. We now have 80% of the business on Oracle and Phase 3 will be complete by the end of the year. We will have those major conversions behind us and we will be able to start to leverage that investment. We increased investment in database marketing in fiscal 2008 and we are increasing that again in 2009. So we have the technology and we now have the capability to leverage that information with our database-marketing group.

So that leaves us to what we announced last year which is a reorganization of our business around category management. That plan was completed and we are beginning to implement that now in fiscal 2009 and should have it, the structure complete by the end of the calendar year, and we will begin to see some results in fiscal 2010.

Greg Cessna is leading this effort for us and Greg has done a very good job to-date working with all of our business units and bringing together a very good strategy on how to accomplish this task. Some of you have been in here and met Greg, he is a very good strategic thinker, he has got very good people skills and he has done an excellent job leading this effort for us.

Education Essentials, we showed some good strong growth again in Q4 and as we move into fiscal 2009 we are seeing very strong furniture orders to-date. Now, I just want to remind you that that is a different funding source than traditional state funding, most of those large projects are funded by bonds that were issued likely more than a year, a year-and-a-half ago. And we are making good progress on the initiatives in Education Essentials and this area is also led by Greg Cessna.

And finally during the year, we disposed of our media business. We completed the transaction in Q4. We have that behind us which will free up management as well to focus on the continuing operations. So, in 2008, we laid a lot of groundwork to provide for better information and tools for our people and to better serve customers, and we increased investments in a lot of areas that will fuel growth for the company in the coming years.

From a funding outlook standpoint, we see the state funding unfolding as we expected in February. Back in at that time California, the governor was proposing a 10% cut to school funding. The latest proposal, now out in May, is that the funding will be up $72 million, and that budget is yet to be passed, and we think there is some optimism around an even a higher number as a legislature may get a chance to increase the funding for education.

Another state we were focused on was Florida, and Florida did pass their budget and education cut was only 2%. So, two large concerns seem to be coming in the right direction and are fitting into more of what our expectations were in February.

We are seeing states increasing fees where they can and they are using reserves to offset deficits. The last information that we have is that the states on average have 7% of their annual revenues in reserves and typically, in these kinds of markets, they will use those reserves to shore up their funding. So, from the state funding standpoint, no real surprises there, it’s coming together as we thought.

We are also keeping an eye on diesel and heating oil, which during this past school year, increased about 35% for the schools over the prior year at today’s prices. So, they absorbed that pretty well as we went through the school year. If you take today’s price and compare to the average for that school year, it would imply another 25% to 30% increase. It’s a little bit concerning and negative, but at the same time not a big area of focus for us and not a very large concern, but one that we are keeping our eye on.

We’re also watching our own pricing in purchasing commodities. Our foreign prices, for the most part, are locked until we hit the end of the calendar year. It’s also true of domestic prices, excluding paper, and we are keeping an eye on higher fuel cost, but we have anticipated higher fuel cost and that is included in our guidance today.

So, overall on the funding outlook, at this early stage things seem to be coming together as we expected them to at this point.

We also announced in the press release a stock buyback. We spent the balance of the authorization that we had during Q4. The Board authorized an additional $50 million and at these current prices, we believe our stock is the best use of our cash.

So, at this point, I’d like to stop and turn the call over to Tom and then we will go to Dave and back for questions.

Thomas Slagle

I am going to try to give you a little more granularity in some of the business updates that Dave mentioned. Dave commented in his opening remarks that we did make good progress over the past year both financially and operationally. We delivered an overall revenue increase in the business of 4.3%. Our Specialty segment delivered 10% increase, and while our Essentials segment reported a 3.3% revenue decline for the full year. This shows some good momentum in the second half by growing 4% in the November through April time period.

Our earnings from continuing operation grew 16.8%, diluted earnings per share rose to solid 27% and our free cash flow as Dave mentioned continue to grow up nearly 18% for the year to $3.65 per share.

Last year, operationally, we laid out a very aggressive agenda early in the year and I’m very pleased at the team’s progress and how we were able to make some advancements in those initiatives. We’ve launched several of those initiatives because we believe they have a great deal of potential for creating competitive advantage and driving sustainable organic growth in the businesses.

I would like to briefly review the activities that we said we focus on at the beginning of the fiscal year. I’m going to give you an update on our progress as well as provide you some, then, specific updates to our view of the upcoming busy season, which we are just getting started with.

Our major focus area last year was on building and organizing our business strategy around two distinct competencies. We’ve talked an awful lot about category management and that model, but there is also a second model that’s really framed within this strategy that is around our publishing model geared at content and curriculum development.

We have the models mapped and we are beginning to implement to begin providing a Phase 2b customer that matches how they think and also their workflow around the educational marketplace. As mentioned, this model is built around the core competencies of content curriculum development and category management.

The coordination of these activities is the responsibility of the two operating groups, Education Resources led by Greg Cessna and then our Educational Publishing group led by Stephen Korte. Both of these gentlemen are experienced leaders in the industry and we feel very good about how they’re advancing these strategies.

There are many details behind the strategy that we won’t have time to go through in this call. But the important takeaway is that now with two operating groups under common leadership we believe we are positioned to coordinate our resources better, eliminate redundancies and begin leveraging our combined capabilities.

The strategy in the organizational model will help us drive expansion and innovation in educational content, help us coordinate merchandising and marketing strategies, and ensure that we are connecting with our customers so that they have a complete view of the broad capabilities of one School Specialty.

We are beginning to see some early benefits from these new strategies. Our new leadership over our merchandising group has already launched several initiatives by applying some basic well-known best practices of category management. I will give you a couple examples so you have a sense of what we are referring to. They are very simplistic but they do make a difference in the business.

As a result of our database analysis and customer input, we have made changes to a number of product pack sizes. In one example, our research showed that the customers wanted to buy the product by a case. By simply adjusting our salable unit of measure, we are selling more of it and also creating a more efficient pick through our warehouses.

We then also introduced customized kits based on feedback for back-to-school needs containing products that are normally purchased independently by teachers in schools. Because of a customer’s need for what we call turnkey ordering, we’re providing the customer added value by combining and packaging the products into unique configurations, and then we combined that with the unique supplier model that does not disrupt our distribution operations. The result is a unique offer that solves some of our customers basic needs.

The other example is an area that affects operating efficiency, and that’s the linkage between our category leaders and our purchasing and global sourcing teams. Through their focus on vendor lead-times, in fiscal ‘08, we were able to drive a reduction of this combined lead-time cycle by 26%, which again allows us to better serve our customer, as well as manage our working capital more efficiently.

Through category management, we are rolling out these and other merchandising disciplines across all product lines and the benefits will result in a more productive and efficient business model.

We continue to invest, as Dave mentioned, into our database marketing capabilities in order to expand that service to the remaining lines of business. In those categories, where we have tested this model intensely over the past year, we continue to see revenue growth at an accelerated pace. We attribute most of those increases to the database marketing influence around areas of catalog versioning, circulation, new customer acquisition and retention strategies that again are driving good opportunities for the businesses.

We also talked about strengthening our resource model in furniture and equipment to go after some under-penetrated markets. We have expanded coverage with our furniture and equipment and we will continue to look to do so around product experts and service regional coordinators to push the selling process and the available resources for major customer consultations.

While we saw some slow starts last year, this category saw momentum pick-up as the year unfolded, and as we enter ‘09, we’re are encouraged by both the backlog that we see, as well as the pipeline of opportunities that lie ahead.

A very important initiative that’s underway from a corporate standpoint, and I’ve talked to you about this before is our Lean process improvement initiative, or what we’re calling now the “School Specialty Way”. We’ve had the initial way of associate training and the rapid improvement events started in the fourth quarter. To this point, we have now 50 people who have participated in these rapid improvement events and we expect a steady stream of new events throughout the coming year.

The initial focus has been on improving order fill rate and order completeness for our customers, and while the financial benefits take time to accrue as process change is implemented, better service for our customers is our primary driver. However, think about this. Every time we avoid having to shift and deal with the backorder or handle a customer call, we also drive a financial benefit to the organization and create a positive customer experience.

We know the Lean process works. Our Premier Agenda business has been engaged with Lean over the last two years with some very encouraging results. One of its more impressive accomplishments is on the asset side of the business. Before Lean, Premier leased more than 120,000 square feet to support its print operations. As a result of Lean, they have been able to reduce their lease requirements by almost 30% and at the same time they have increased their manufacturing capacity.

Again we’re nearly corporate-wide Lean roll-out, but our associates are engaged in embracing the opportunity to be involved in improving many of the processes that affect customer performance and we think we’ll begin to see benefits of that in fiscal ‘09.

We said we would develop a management model and a discipline focused on setting clear goals and accountability throughout the organization last year. Our management agenda provides that clarity now with clear, strategic, and operating priorities. We have laid out the action plans, we’ve laid out the investments required that we think are necessary to be successful and our focus for fiscal ‘09 will be on executing against those priorities.

We also emphasized forecasting as a process within the organization last year. We are committed to staying focused on understanding our business trends and delivering the expected results that we are committing to as an organization.

We introduced our strategic planning model last year and our second planning cycle is now underway. I anticipate that the quality of our team’s strategic thinking will continue to improve as it’s a crucial part of the management model and we will continue to frame our future management agendas.

And last, we are tying now base compensation and incentive plans to how well our objectives are mapped. We have a performance management system in place that was implemented last year, it’s called APEX, it takes our people process down now to all levels in the organization. It connects the corporate strategies to the business strategies and then to individual goals. The end result is an individual performance review standard for the company that is directly tied to both development and compensation systems.

Another very important metric we have is focused on working capital. This year we were able to reduce inventories by $28 million from prior year through a number of blocking and tackling efforts involving purchasing, stocking discipline, vendor relationships and international sourcing, and as Dave said we believe there is further opportunity to continue to attack our working capital numbers.

At the start of the year, we also promised the launch of Phase 2 of our EBS Oracle System. In late November we delivered on that promise and today nearly 80% of our revenue is operating on the new system and by the end of this fiscal year, we anticipate Phase 3 to be completed. The conversion went well and while we are continuing to adopt standard work process as part of our new platform, all critical elements are functioning and the system is ready for the busy season.

We are also well positioned for the busy season in terms of staffing requirements. We got an early start this year with our seasonal staffing and believe that we are in very good shape in all of our locations. Our catalog drops, promotions, sales assist programs as well as market initiatives all met the deadlines we felt necessary for hitting the market.

So, now what I would like to do is transition away from some of the corporate updates to more of the segment specific updates. Let me turn first to our Essentials group. As I mentioned, growth returned for Essentials in the second half of this past year with Q4 showing growth in both the consumables and the furniture and equipment categories. We expect to improve on our growth in fiscal ‘09.

Our investment in database marketing and merchandising are driving decisions around products, prices assortment, and are making the difference in customer response as well as our internal operating efficiencies. We are going to continue to drive this. This year we launched over 2,500 new products, which is up significantly from prior year.

We also set forth the new product launch process that’s accompanying these releases and we are seeing a good response early on and while the number of new products introduced is important, we believe the more important metric is the effectiveness of the product introduction and customer response which is showing some positive traction.

Our early outlook around margins with Essentials is what I would call neutral. Mix can certainly drive some fluctuations as can the volatility of commodities, but we believe at this point that we have accounted for this in the planning process and we will stay focused as Dave mentioned on the external pressures with plans in place to avoid any downside pressure that may come over the upcoming quarters.

So overall, we are optimistic about improving growth for Essentials as we continue to align around category management practices in that model. As we improve service levels for our customers and further develop our market analysis merchandising discipline, this completely leverage the capabilities that School Specialty can bring to our customers.

Let me now move to our Specialty segments. I think you all know we are going to have a tough comparison to a very strong fiscal ‘08 primarily due to the adoptions realized in our science business. That said, however, we continue to expect good progress this year.

New product innovation is strong especially across the categories of early childhood with supplemental learning tools and physical health and education, where we are focused on curriculum-related products. We will provide updates in this area on an ongoing basis as we move through the year, but we have a great optimism here.

Our reading intervention categories continues to earn our focus. We invested in expanding our presence in this fast growing area and the result was a strong revenue gain this past year. We have developed and launched new products in reading comprehension, vocabulary, and phonics. Through our acquisition of Sitton Spelling we have gained new language arts offerings and a nation-wide capability now providing professional development seminars. So, we remain optimistic in ‘09 around this category as well.

I’ll speak to science a little bit. We are coming off a very good year driving those contributions with strong execution in the face of heavy demand coming both from adoption and non-adoption territories. Our team delivered to those customers on time and complete throughout the year and we were very pleased with their performance.

In today’s earnings release, we said our fiscal ‘09 outlook for science is for a reduction in adoption revenue of $32 million over the past year. That’s a slight improvement over the initial $35 million reduction we estimated in our third quarter release. I do want to remind you that guidance only refers to adoption revenue not revenue from the 28 states that do not hold statewide curriculum adoptions.

We’ve also been very successful over the years selling our science program in what we call open territories. In fact the 100 largest school districts in the United States, 48 have at some point purchased either our FOSS or CPO science curriculums. And even more impressively seven of the top ten districts have purchased one or more of our science curriculums. So while adoption revenue can be lumpy, our overall success with science penetration continues to grow every year with or without major adoptions.

So, in summary, we’ve accomplished many things over the past year, but I will also be the first to say we still have a lot to do. With the benefits from Oracle settling in I remain positive in our ability to be prepared for this upcoming busy season. Operationally we are prepared to deliver on our financial commitments. I believe we have a good amount of plans and initiatives and accountabilities lined up behind that. And I will look forward to updating you on our progress and milestones as we move through fiscal ‘09.

So, at this point I will turn the call over to David Vander Ploeg.

David Vander Ploeg

It’s great to be on my first conference call as School Specialty’s CFO. I will spend a few minutes and add some additional context to the press release, which was issued this morning and the accompanying financial schedules.

As Dave mentioned earlier, we did complete the sale of our Media business in the fourth quarter and consistent with the previous quarters in fiscal ‘08 we have accounted for this as a discontinued operation. Therefore all revenues and costs have been removed from the comparisons I will be discussing for fiscal ‘08 and fiscal ‘07.

Let me begin my comments on the fourth quarter performance and then transition into the full year. Fourth quarter consolidated revenues grew 4.6% year-over-year and both segments again contributed positively towards our organic growth. As Tom mentioned earlier, we are encouraged by the second consecutive quarter of revenue growth in Essentials, which expanded 6% or $4 million year-over-year. Furniture and equipment continues to be a strong part of this growth.

Revenues in Specialty segment were up 2% for the year, which included an incremental $1 million of state adoption revenue from our science curriculum offering. This increase in adoption revenue however was offset by a decline of approximately $2 million in our publishing mass-merchant business. Adjusting for these two items, organic growth in Specialty was approximately 3%.

As detailed in the press release, gross margins in the fourth quarter declined 390 basis points and there really are four primary reasons for this decline. First, a $2.1 million inventory charge was booked during the quarter related to the charitable donation of inventory of a terminated product line within Specialty, which Dave alluded to in his opening comments.

This charge accounted for about one-third of the total variance mentioned earlier. On the flipside, this donation generated $1.6 million of tax benefits of which $800,000 was incremental and lowered our effective tax rate. Second, the Specialty unit as a whole had some product mix variances that accounted for another 120 basis points of gross margin decrease.

Third, within the Essentials segment, we saw a decrease in gross margin related to the product mix between furniture and consumables. Because furniture is often direct shift from the vendors, it carries a lower gross margin. This shift on a weighted average basis accounted for 65 basis points of the overall decrease.

And finally a greater percentage of our sales in the quarter came from the Essentials side of the business, which does produce a smaller gross margin than Specialty. This segment mix differential along with other minor variances and vendor rebates and freight accounted for the majority of the remaining gross margin decline.

Moving on to selling, general and administrative expenses, the quarter saw an absolute dollar increase of $1.8 million, but on a percentage of revenue basis, we did see an improvement of 120 basis points. The primary drivers of the absolute dollar increase fall under three categories. First, our variable expenses things such as warehousing, transportation and selling costs were up approximately $1 million due to the volume increases.

Second, $1.1 million of additional performance based incentive compensation was recorded versus the same quarter last year. And third, we did incur $1.2 million of incremental costs related to the investments in our database marketing efforts, which both Tom and Dave alluded to earlier. These increases were offset by productivity gains in the warehousing and supply chain areas as well as back office savings from centralization.

In summary, it was a pretty straightforward quarter with few special items to call out. We did repurchase 1.1 million shares in the quarter for an aggregate purchase price of nearly $35 million, bringing our total repurchase for fiscal ‘08 to 2.8 million shares at an aggregate purchase price of approximately $95 million.

Moving on to recap of the full year, consolidated revenues grew 4.3% to $1.088 billion. At a segment level, the Specialty business saw a revenue growth of 10.1%, while the Essentials business declined 3.3%. Specialty was aided by the strong science adoptions, which we have discussed throughout the year. Incrementally, adoption revenue was up about $48 million year-over-year. This increase was somewhat offset by our mass-merchant retail business, which was down approximately $11 million in fiscal 2008.

Furthermore, Essentials saw a reduction in the school rebuilding activity especially in the hurricane-ravaged South. These events along with the elimination of unproductive catalog and a decision not to pursue low-margin bid business earlier in the year were the primary contributors to the revenue decline in Essentials.

Gross margins declined 30 basis points in fiscal ‘08 from 42.7% to 42.4%. The Specialty segment became a larger percentage of the overall company as you can see by the revenue growth and given it carries a higher gross margin, this shift helped the overall margin performance by about 150 basis points.

However, this gain was more than offset by product mix within each segment, a heavier mix of direct shipments out of Essentials and the inventory donations that have been discussed today and in previous quarters. As I mentioned earlier, favorable tax treatment is recognized on these inventory donations, which largely contributed to the effective tax rate going from 40.3% in fiscal ‘07 to 38% in fiscal ‘08.

From an operating expense standpoint, steady gains were made in the area of SG&A during fiscal ’08. While the $10 million of absolute cost increase is mostly tied to increased volume this area on the income statement, measured as a percentage of revenue, improved 40 basis points during the year or the equivalent of $4.9 million in net cost savings. Productivity gains in our core distribution centers and the management of our freight spend were the primary drivers of this improvement.

Moving on to interest expense and others, these categories declined by $2.6 million in fiscal ‘08 reflecting an overall 60 basis point reduction in our effective interest rate as compared to last year. This decrease relates to lowering of interest rates throughout the year and the $200 million convertible debt, which was issued back in the third quarter of fiscal ‘07 and carries a lower coupon rate at 3.75% than what our credit facility rates were at that time.

The positive rate variance was somewhat offset by an increase in average debt level of about $15 million year-over-year. This increased debt level is a result of the share repurchase I mentioned a few minutes ago offset by our free cash flow. I should note that the other expense, which is broken out separately on the income statement, consists primarily of the discount on our accounts receivable securitization.

Looking for a minute at income taxes, the effective rate for fiscal ‘08 was 38% as compared to 40.3% in fiscal ‘07 as I mentioned a minute earlier. Most of this favorable variance is driven by the previously mentioned inventory that was donated. In total, $3 million of inventory was donated in fiscal ‘08 and excluding this item, the effective tax rate would have been 39.7% or slightly favorable to fiscal ‘07.

Income from continuing operations improved $7 million or 16.8% over fiscal ‘07. Earnings per share from continuing operations was $2.21 versus $1.74 last year or an increase of 27%. This $0.47 improvement in earnings per share is related to both earnings improvement and decreased share count.

Increased earnings from continuing operations provided an incremental $0.29 of diluted EPS while the remaining $0.18 improvement related to decreased share count. I should point out that this decrease came from share repurchase activity over the past 12 months partially offset by stock option exercises.

Before I close on the income statement, I want to take a moment and cover the sale of our discontinued business, School Specialty Media, which was finalized in the fourth quarter. The business was sold for approximately $8.6 million of which $1.4 was received prior to year-end. Another $1.7 million will be received in the next two months and the remainder will be booked as a note receivable payable over the next three years.

During fiscal 2008, we booked a net loss of $3.2 million or $0.15 a share. In addition, we had a $1.5 million net loss on disposal or about $0.07 per share. About one-third of this loss relates to the disposal of the assets and the rest is due to severance cost, lease termination cost and retention bonuses.

I will quickly transition to covering cash flow on the balance sheet before I wrap up. During fiscal ‘08, we generated $76 million of free cash flow, an increase of $12 million over fiscal ‘07 levels. The many non-cash expense items on our income statement and the low levels of maintenance CapEx make us a strong and predictable cash flow company as evidenced by this 18% improvement year-over-year.

With regard to the balance sheet, working capital management was a focus for the past two quarters and will continue to be a priority going into fiscal ‘09. As both Dave and Tom mentioned, we have made positive strides in the areas of inventory management with the year-end inventory balance down $28 million from fiscal ‘07.

The majority of this improvement has come through improved replenishment practices. In addition about $6 million of the reduction is tied to the Media disposition. While we are pleased with this progress, we will continue to focus on inventory in fiscal ‘09.

Customer receivables on the other hand are up $12 million year-over-year. Adjusting for volume gains and the Media sale, receivables have increased about $9 million or five days of DSO or days sales outstanding. This increase is tied to the transition of a centralized collection group made possible by the Oracle ERP project.

We found that there has been a learning curve not only for our associates, but also for the payables departments at our customers. We are confident that as we move through the upcoming busy season, we will become more efficient and adapt to a new system and process flow and ultimately improve this component of working capital.

Let me close with a few comments on guidance for fiscal 2009. First, we expect strong free cash flow in fiscal ‘09 with a range of $80 to $90 million excluding the cash flow to be generated from the tax savings on the Media disposition. We expect revenue growth on the core business to be in the range of 3% to 5%. This excludes the impact of state adoption revenues, which is expected to decline by approximately $32 million in fiscal ‘09.

Taking this into account, the impact of the changes in state adoption revenues, we expect consolidated revenues to be in the range of $1.077 billion to $1.11 billion. Diluted earnings per share is expected to be in the range $2.27 to $2.43 in fiscal ‘09 or an increase of 3% to 10% over fiscal 2008.

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

David Vander Zanden

We are ready for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

Regarding the guidance on the top line organic growth, which you maintained for the upcoming year, and just question that guidance in the face of what looks to be a tougher economy then when you gave that originally, certainly job growth and retail sales.

And then, while it’s difficult to perhaps interpret this as a trend with April pending home sales up, certainly that may bring into the question, redilation of homes and property tax revenue per states maybe being under some pressure. So maybe pulling all those together, can you give me a sense of why you are still as confident as you were in the top line guidance?

David Vander Zanden

Back in the February timeframe, we listened closely to what the governors’ proposals were in the market and for the most part we saw more favorable proposals than unfavorable, realizing that these governors still had to negotiate with the legislature and they had several months to go and watch the economy.

But we did at that time factor down what we would have normally put out for guidance on top line growth. Watching a lot of the stats in the market, we saw three months and we had two months of that data in our hands in February of job growth for a decline. We saw some improvement in the April timeframe, and actually May job decline came in about half of what we saw at January, February, and March.

Retail sales for the most part of the month have yet to decline, and the most recent data on May is up 1%. So, we look at the data and it’s a bit mixed positive, mixed negative, nothing is causing us to change our position from the macroeconomic data that we are looking at, and I commented on the diesel and the heating oil and the effect that gas prices may have on schools.

And then we updated that information and looked at what the states had done since February. California had us a little more concerned in February. It has moved substantially in a positive direction, Florida has come in about where we thought.

So, as we pull all that data together, we really don’t believe that our outlook has changed greatly from where we were in February and that we have lowered revenue guidance, if you will, at the time we set it in February from what we might have normally put out there. So, our view is that what we are seeing so far is consistent with our expectations.

Mark Marostica - Piper Jaffray

I know Tom had talked about it at some length, but looking at the time period we are at right now in the busy season while very early, I am curious whether or not you’re seeing normal pace of order flow, as perhaps you would have expected to see at this point in time. And maybe if you can compare it to last year at this time too, if it’s above or below or about the same?

Thomas Slagle

We’re watching the order flow carefully, while we are hearing from some areas of the country that some districts or schools are holding back a little bit, to evaluate budgets, for the most part, we are seeing an order flow that is not drastically different than what we saw in prior year. I think it’s still a little early to make that determination, but we’ll clearly get a better handle on that over the next 30 to 45 days, but at this point, I don’t think it’s anything drastic.

Mark Marostica - Piper Jaffray

For the guidance, with Essentials and Specialty mix moving around a little bit, certainly this quarter, with Essentials more than Specialty, I guess it’s a year-over-year change. I am looking ‘09 and I ask the question should we expect Essentials mix of revenue be above what it was in ‘08 or below, based on your guidance?

Thomas Slagle

Mark, are you asking about the mix that you saw?

Mark Marostica - Piper Jaffray

Yes. I’m just looking at the mix change it seems this quarter relative to what we’ve been seeing in terms of trend essentials, up ticked a little bit more on the mix. I’m wondering as you look out to the full-year fiscal ‘09, would you expect Essentials to represent less of a mix of revenue versus fiscal ‘08 or more?

Thomas Slagle

From an F&E standpoint and a mix of F&E and consumables, I would expect that what you saw in Q4 from a mix standpoint is likely to continue to go forward just because we are seeing such strength in the F&E orders right now.

Mark Marostica - Piper Jaffray

For fiscal ‘09 what should we model in terms of the tax rate?

David Vander Ploeg

39.7% pretty consistent with past years.


Your next question comes from Amy Junker - Robert Baird.

Amy Junker - Robert Baird

On the adoption revenues if I understood correctly you had, was it a million and a quarter that you actually recognized? And so, I am just trying to understand what was the actual adoption for the year. So when we think about that $32 million less going forward, what that actual number is?

David Vander Ploeg

We don’t disclose the actual adoption revenue. We are disclosing really just the change between the years.

Amy Junker - Robert Baird

But it was still it was $1 million more in the fourth quarter than what it was last year?

David Vander Ploeg


Amy Junker - Robert Baird

Dave Vander Zanden, can you talk about the acquisition pipeline, how that’s been looking recently? Are deals seeming to be more reasonable at this point? I know you typically shy away from acquisitions during your busy time, any reason to think you might change your mind if something really attractive comes along?

David Vander Zanden

Yes, from a pricing standpoint, things look a little bit better. We are seeing deals price a little bit lower, which is good news. On your comment about not doing deals in the busy season, we do them. We typically integrate after, typically buyers want to get the season under their belt if they are doing well, so you tend to see more of them occur after but it’s ongoing with us. And if something came along that really fit our strategy and we felt was important for us to own and participate in, we certainly would.

Amy Junker - Robert Baird

I think Tom was talking about the number of products introduced in Essentials being 2,500 in fiscal ‘08. Can you just give us a comp for that versus fiscal ‘07?

David Vander Zanden

That was about frankly 25% higher than where we were in prior year.

Amy Junker - Robert Baird

Dave, how should we be thinking about net interest expense going forward, should anything change or in the other income line that you could guide us to or just look at the debt levels versus the rate?

David Vander Ploeg

Well, we are watching the rates closely like everyone else and we’re not modeling out a significant change. I think in terms of the overall net debt levels, a lot of it will depend on how we choose to deploy the free cash flow that we will be generating in fiscal ‘09 and whether some of that free cash flow will end up going towards the debt reduction or not. But that will largely be dictated by the acquisitions that Dave just mentioned or that piece of the puzzle as well as the share repurchase decisions that we will be monitoring.

Amy Junker - Robert Baird

And then also just CapEx expectations for the year?

David Vander Ploeg

They will be relatively consistent with prior years at about $18 million.


Your next question comes from Trace Urdan - Signal Hill.

Trace Urdan - Signal Hill

Could you talk about the dynamics between share repurchase and debt reduction? Is there a point towards the lower part of your free cash flow guidance where you might be more interested in reducing debt versus buying back shares or is that not the right way to think about it?

David Vander Zanden

Everyday we make a decision about what’s the best thing to do with the excess cash. With the stock price where it is, we’ve certainly been focused historically in the last two years on acquiring our own stock. It really depends on the outlook, our initiatives that are happening in the company whether or not we are considering an acquisition.

There are three sources in any point in time. We look at those three, acquire something, pay down debt or acquire stock. It’s difficult to point in a particular direction that may occur in the future. Every day we consider where we are and what’s going on.

Trace Urdan - Signal Hill

Can I get you maybe to speak a little bit to the dynamics between the low end of your revenue guidance range and the high end, what are the principal x factors that you are looking at as you consider what next year is going to come in? Is it more to do with just the state of the economy and budgets or is it maybe more related to individual product initiatives?

David Vander Zanden

Trace, it is all of that I think, as we set the range, we have, historically, had in the guidance range, two to three percentage points. So, four to six, three to five this year, I think that’s pretty normal. It does account for both our viewpoint on funding and the drivers of revenue inside the business. So, it’s difficult to dissect that because we don’t really talk in great detail about some of the business categories and performance that moves around from one year to the next, but it really is a combination of those two.

Trace Urdan - Signal Hill

I didn’t hear you discuss the retail business specifically I know that’s one that you have been looking hard at. Could you talk about how you are thinking about the retail business at this point?

David Vander Zanden

I think, at this point the mass-merchant publishing business is settled in. So, the large decline in revenue that Dave mentioned in his comments pretty well behind us, we think we are at more of a base-level business and we’ll start to see some growth again. So, the big shifts we saw in a lot of the mass-merchants last year, we think, are done.

Trace Urdan - Signal Hill

It’s fair to think that you remain committed to that part of your business.

David Vander Zanden

Yes, we have talked about whether or not we want to move out of that segment. We think if we were to consider putting it on the market for sale that the timing wouldn’t be the best given the market conditions today. We also have some structural issues we would like to do at that business before we make our final decision. So, I think it’s a candidate down the road for us, but the timing we just don’t think is appropriate right now.

Trace Urdan - Signal Hill

It looks like we are fairly far along in the adoption process in Georgia and Kentucky, and I know you didn’t change your guidance. I’m just wondering if the textbook season is coming in in-line with your expectations or ahead or behind.

David Vander Zanden

Yes, Trace actually we did change the guidance a little bit, we improved it by about $3 million.

Trace Urdan - Signal Hill

I’d noticed that, actually I was going to go back and see if there was a typo or not.

David Vander Zanden

No, it wasn’t that big but we did improve it. Kentucky, we commented on the last call that we won the largest district there a couple of years ago so we didn’t expect any significant change in viewpoint as we rolled forward. I think that winning San Diego in California was a real nice win for us, the largest district out there. And I think, we are holding our own in Georgia, I can’t say that we are disappointed, but we are also not knocking the socks off. So, I think we are comfortable with the guidance that’s out there and we feel pretty good about this cycle.

Trace Urdan - Signal Hill

Are we pretty far along in the process then in terms of what could still come in?

David Vander Zanden

I think, we are still booking and there are still districts we are not complete with. So, we are obviously much further along than February, we are starting to zero in on the numbers, but there is still time to go here.


Your next question comes from Bob Evans - Craig-Hallum.

Bob Evans - Craig-Hallum

Can you comment further on the science revenue in terms of timing last year? How should we think about the weighting Q1 versus Q2 last year and thinking about proper weighting again this year? Just trying to make sure we understand the growth comparisons relative to the declines properly?

David Vander Zanden

Bob, if you look back at the information we disclosed on the Qs last year, we showed you the increase in the adoption revenue of each quarter. The timing of shipments on that adoption revenue is a little slippery right now for us to forecast, because we don’t have all the orders in the door yet and request dates. For the time being, you might use a similar mix between the Qs, it would be just as good as anything that we could guide you to today.

Bob Evans - Craig-Hallum

From a seasonality standpoint again Q1 versus Q2, anything else we should take into consideration when thinking about this year?

Thomas Slagle

We are seeing a nice flow of furniture and equipment orders coming in the door that seems to be in pace little stronger than last year, a little sooner, but again relatively, I would say, level to what we saw last year on the remaining sides of the business.

Bob Evans - Craig-Hallum

Barring any major pay down on debt, should we use the last quarter as the proper run rate?

David Vander Zanden


Bob Evans - Craig-Hallum

On the CapEx spending, you referred to earlier. Could you give us a little bit more color in terms of where that spending is going to go and what you view as your maintenance CapEx?

David Vander Ploeg

As I mentioned, we have $18 million of that, we’re planning towards here, which would be consistent with prior years, and some of the components of that we’ve got to continue the Phase 3 implementation of EBS, and really beyond that $10 to $12 million is what our run rate maintenance CapEx has been out for the last several years.

Bob Evans - Craig-Hallum

So, incrementally it’s the one project other than that $10 to $12.

David Vander Zanden

That is likely that $10 to $12 is what you will see after ‘09 as more of a consistent run rate.


Your next question comes from Gregory Macosko - Lord Abbett.

Gregory Macosko - Lord Abbett

Could you talk a little bit about you mentioned briefly about chips and putting together systems and the like for delivering to the schools, etc? How is that, if you could give us some color on that program please?

David Vander Zanden

Yes, there is fundamentally a process where we are partnering with suppliers to aggregate, if you will, common demanded items that are focused on back to school marketed towards the districts in the schools that are looking to provide those needs at the classroom level and beyond.

We think we have a unique opportunity because of the coverage model and the interaction we have with those schools to stay with the aggregate and take a process that has been somewhat complicated for the schools and turn it into more of a turnkey model. So, we are early in the process. This is our first selling cycle with it, but we have been pleased with the results to-date and do think that there is an opportunity for us to continue to move that process forward.

Gregory Macosko - Lord Abbett

Is this affecting the Essential side of your business more than the Specialty side or vice versa or?

David Vander Zanden

Yes, this would be very much focused in the Essential side of the business.

Gregory Macosko - Lord Abbett

With regard to the retail you discussed it a little bit. Is it fair to say that that business is in fact profitable?

David Vander Zanden

Yes it is. It is profitable.

Gregory Macosko - Lord Abbett

And given the restructuring you have done, you would expect that to be improving in fiscal ‘09?

David Vander Zanden

Yes, I think, to Dave’s comment earlier we believe we’ve hit the swell if you will and that the business has leveled. We do think there are some opportunities to see that business bounce back into a bit more of a growth curve here as we move through fiscal ‘09.

Gregory Macosko - Lord Abbett

With regard to the CapEx, did you say $19 million?

David Vander Ploeg

It’s $18 million for fiscal ‘09.

Gregory Macosko - Lord Abbett

So flat basically for the year -over-year.

David Vander Ploeg

Essentially, yes.

Gregory Macosko - Lord Abbett

Help me understand Oracle and does that come into the CapEx and how much do that fall off and what’s the cash flow benefit from in fiscal 2010?

Thomas Slagle

That Oracle spend is about $5 million of the $18 in ‘09 and you are likely to see a decline of that $5 million in rough terms in ‘010, $4 to $5 million or so.

Gregory Macosko - Lord Abbett

And so in terms of the total cost of the final implementation of last 20%, we should figure like $5 million, then.

Thomas Slagle

That is correct. Yes.

Gregory Macosko - Lord Abbett

And then that will be amortized going forward from there?

Thomas Slagle

It’s right.


Your last question is a follow-up from Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

I know you’re not giving specific guidance, but I am curious whether or not this July compared to last year’s July quarter had any incremental or fewer number of weeks in it for the busy season. Just trying to get a sense of July versus October and how the weeks lay out?

David Vander Zanden

Yes, Mark we’re on a 52, 53-week year, so every quarter has exactly the same number of weeks.


There are no further questions at this time.

David Vander Zanden

Well thank you all very much for listening to the call today. We’ll be back with you in about 60 days to give you an update of the first quarter and a good look at how that season is unfolding. So, thank you all very much for your support.

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