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Scholastic Corporation (NASDAQ:SCHL)

F4Q08 Earnings Call

July 24, 2008 8:30 am ET

Executives

Dick Robinson - Chairman of the Board, President, Chief Executive Officer

Maureen O'Connell - Chief Administrative Officer and CFO

Deborah Forte - Executive Vice President and President, Scholastic Media

Ellie Berger - President, Trade Publishing

Margery Mayer - Executive Vice President and President, Scholastic Education

Judith Newman - Executive Vice President and President, Book Clubs

Jeffrey Mathews - Investor Relations

Analyst

Drew Crum - Stifel Nicolaus

Peter Appert - Goldman Sachs

Catriona Fallon - Citigroup

Amy Minella - Cardinal Capital Management

Operator

Welcome everyone to the Scholastic quarter four fiscal 2008 earnings conference call. (Operator Instructions). Thank you it is now my pleasure to turn the floor over to your host Jeffrey Matthews, Head of Investor Relations.

Jeffrey Mathews

Before we begin, I’d like to point out that the slides for this presentation are available for simultaneous viewing by going to our website, scholastic.com, clicking on Investor Relations, and following the links on that page.

I would also like to note that this presentation contains certain forward-looking statements which are subject to various risks and uncertainties, including the condition of the children’s book and educational materials market and acceptance of the company’s products in those markets, and other risks and factors identified from time to time in the company’s filings with the Securities and Exchange Commission. Actual results could differ materially from those currently anticipated.

Now I’ll introduce Dick Robinson, the Chairman, CEO, and President of Scholastic to begin our presentation.

Dick Robinson

Well thank you Jeff. Good morning and thank you everyone for joining us on our fiscal 2008 year-end conference call. I’m joined today by Maureen O'Connell, Chief Administrative Officer and CFO and the President’s of Scholastic club, trade, media and education businesses who will be speaking later.

As you know fiscal 2008 was an important turning point for Scholastic, of course we had to insure the successful publication of Harry Porter and the Deathly Hollows which launched just the year ago. This week was a stunning performance, selling 14 million copies efficiently and profitably. We also know that this was the final year of the new Harry Porter release so we took strong actions to attain our goal of 9% to 10% operating margins for fiscal 2010.

First we executed our two year $14 million overhead cost production plan. These actions mitigated approximately $15 million in cost increases primarily from postage. Second we excited the unprofitable Direct-to-Home Continuities business, so we can focus on building relationships to the home to our profitable clubs, fares and online businesses.

Third we invested across the company in initiatives to drive revenue growth, as I’ll discuss in a moment, and we continue to work on improving our cash and balance sheet. We generated over $188 million in free cash flow exceeding our plan and bringing our cumulative total over the past five years to more than $500 million. This has allowed us to maintain a strong balance sheet and significant liquidity as we repurchased $220 in stock.

Additionally this morning we announced the initiation of $0.75 quarterly dividend demonstrating our commitment to returning cash to shareholders. This morning we will focus on what we’re doing to reach our 9% to 10% operating margin goals. First further cost reduction is a key element of our plan and is our top priority in a tight economic period. This is particularly critical because in fiscal 2009 we expect paper printing shipping and fuel cost to increase by another $15 million to $20 million.

To offset cost inflation and to reach our goals 9% to 10% margins in 2010 we have set an aggressive plan of further reducing cost by $25 million to $35 million on an annualized basis in fiscal 2009. As Maureen will discuss later, we are tacking our supply chain in manufacturing cost as well as posted, shipping and freight. We also plan to reduce headcount and improved efficiencies through streamlining some parts of our business.

Modest revenue growth is the other critical element of our plan to reach 9% to 10% operating margins. Scholastic’s businesses have strong operating leverage with high variable profit margins and therefore modest revenue growth can drive significantly higher earnings in margin improvement. Let me give an overview of how and why Scholastic will grow.

First we will leverage our scale of unique distribution channels to increase market share and profits. Last year Scholastic sold nearly half of the children’s books in the U.S. on a unit basis through our school book clubs, fairs, trade, education and online channels. We have unmatched reach to teachers, parents and kids in a strong value proposition. This advantage can be seen in last year’s solid growth in book fairs, for example which grew versus flat or negative same-store sales growth among retail book sellers in the same period.

Our core children’s book businesses represent a strong opportunity for increased profitability given their particularly strong operating leverage. Second we will implement strategic price increases. After several years of trailing our competitors price hikes, many of our books now sell at a significant discount to the market, in fairs and clubs in particular but also in trade and class room library

Consequently we have substantial opportunities to selectively raise some prices while preserving our value proposition in competitive pricing position. We believe this will have minimal impact on demand while providing at least $20 million of increased profitability in ’09. Third we’ll leverage our scale and differentiation to grow online as we expand our sales direct to parents and kids.

As Judy Newman, President of Scholastic Book Clubs will describe shortly, Scholastic has an opportunity to substantially increase online sales across the company beginning with clubs. We are already, the third largest internet book seller in the U.S. with the launch of the second generation of Cool or clubs ordering online, we are leveraging our online relationships with teachers and extending it to parents and kids. The Cool will also serves as a platform for selling digital products.

Fourth, as we have done for more that 20 years. From Clifford to Baby Sitter's Club and The Magic School Bus through Goosebumps and Harry Porter we will continually creating great children’s content and use it in print, online, TV, film and digital media to grow revenues. As Ellie Berger, President of Scholastic Trade will discuss, this year we are introducing a number of strong titles including innovator multimedia concepts, The 39 Clues were books, collectibles, games and interactive website together engaged kids in a great story.

Scholastic also has a strong track record taking print franchises to TV, film and interactive platforms to drive incremental revenue and book sales. Debarah Forte, President of Scholastic Media will discuss our strong line up with television, interactive games and movie production as well as the recent excitement about The 39 Clues.

Fifth we will build on our leading educational technology where we are number one player offering tech products that are proven to raise achievements. The U.S. educational systems faces a staggering achievement gap and must continue to ship spending towards more effective tools, such as our solid technology products and away from successful traditional methods. Margery Mayer president of Scholastic education will describe how our growing educational technology business is benefiting from this important educational trend.

Sixth we will target middle class families around the world who want their children to learn English. As you know, we have a strong base in Southeast Asia including the Philippians, Malaysia, Thailand, Indonesia, Singapore and India. Our total revenue in this region exceeded $75 million last year and is growing at approximately 15% to 20%.

China is potentially an enormous English speaking market, especially among the countries children who are the first generation being thought English widely. For this reason we are building a strong scalable position in China. Several years ago, we launched innovated English language teaching for young children in our school in Shanghai and now have 1500 students in five Scholastic schools. Last year, we also launched Scholastic book clubs in China with revenues approaching $1 million in the very first year.

Augmenting our own schools, we have recently entered into a licensing agreement with red, yellow, blue kindergartens. A private chain of early childhood centers in China to create Scholastic’s brand its English language centers inside their school. This will substantially increase our English language teaching revenues in China. We have also recently reached an agreement with China Daily, the premier English language newspaper in China to partner in selling English language classroom magazines for Elementary, High School and College classes. This is just one example of our growth plans in Asia.

These incremental investments we have made in six key areas will help build revenue growth in fiscal ’09 and beyond, even in a challenging economic climate. We also know historically that spending on children’s education and books continues to grow even during economic slow down and our competitive price and strong value propositions are key advantages relative to other channels of distribution, in particularly when parents and teachers become more value conscious or when school districts must pick the highest impact purchases in a constrained budget.

For this reason we are confident we can achieve modest company wide revenue growth in fiscal 2009 and in the long-term. Now I would like to ask Judy, Ellie, Deborah and Margery to speak briefly about our specific plans in each of these areas.

Judith Newman

Thank you Dick, good morning everyone. I’m Judy Newman, President of Scholastic Book Clubs. School Book Clubs has built a highly profitable direct selling model, unmatched by any other book seller. Other 1 million elementary and middle school teachers and tens of millions of families participate, buying carefully selected value price children’s book each month.

For their support of Scholastic Book Clubs, teachers received valuable incentives which they redeemed for books and materials for their class room. By supporting teaching in this way and offering quality, value priced books for 60 years Scholastic Book Clubs has earned tremendous royalty among teachers and parents like few other companies.

Over the past several years we have worked hard to continue to meet our customer’s needs and increased profitability. In particularly, we have migrated the majority of teacher ordering to the Internet, to clubs ordering online, which we referred to S-Cool and tightened our print catalog promotion strategy in spending. This has improved profitability and strengthened the business. We also know through our ongoing research that School Book Clubs and children's books remains as relevant today for parents, teacher’s and kids as ever.

Based on this solid foundation we are poised for big steps ahead in fiscal 2009. As Dick mentioned, in the upcoming school year we are rolling out new Cool, a completely revamped approach to our online business, and our relationship with teachers, parents and children. As you know, we have been taking orders with our first-generation Cool for seven years, but new Cool is much more than an ordering device. It’s a full grown online marketing system with up to the minute e-commerce functionality and significant additional information about our products.

As illustrated on the current slide new Cool also makes it much easier for parents and their children to directly order competitively priced, quality books online and pay for them with the credit card, all the while continuing to benefit the teacher. Teachers have always been the crux of the clubs business and New Cool gives teachers convenient new tools to match children to just the right books for their reading levels and interest. New Cool has functionality also to help parent’s make the best selections and teachers can make customize recommendations to parents based on the child’s individual needs and tie to what she’s teaching in class.

As you can see on the next slide new Cool also has compelling new features such as teacher classrooms wish list, whereby a teacher can list books she’d like parents to purchase for the classrooms. A great resource for teachers, and a great direct ways for parents to be involved in their child’s classroom

New Cool maintains all the benefits of engaging teachers to still coordinate and manage their student’s orders. As always we will continue shipping orders together and efficiently to the classroom where the teacher is responsible for distributing the books to their students. These are the key points that differentiate our value proposition and economics from all other Internet retailers, this is really exciting.

Scholastic’s distribution businesses have traditionally required large fixed expenses to drive revenue, for example printed catalogues and postage in Clubs, and warehouses and logistics in Fairs. New Cool enable us to market and sell to our unique customer base online opening new growth opportunities and eventually transforming our economics overtime.

With New Cool we can better enlist a teacher to promote reading a book, give our customers access to all of our authorizing Clubs across great level and target promotions to individual teachers and family. In addition to the push promotions in Clubs where we decide what to offer each month, new Cool will become an online destination for all of Scholastic’s products.

One of the exciting demands instead of New Cool is that for the first time in fiscal 2009 customers will be able buy books from core franchises such as Harry Potter, Clifford and Goosebumps at very competitive prices whenever they want to, not just when they are available in the monthly club mailing or at school book fair. Overall, new Cool builds on a strong business and online foundation will change the game for Scholastic’s online relationships with our loyal installed customer base with teachers, parents and kids.

Now Ellie Berger, President of Scholastic Trade will discuss how we’re building children’s publishing franchises.

Ellie Berger

Thanks Judi. Good morning everyone. Scholastic Trade publishing has earned a reputation as a leader in children’s books, publishing books that are both commercially successful and critically acclaimed. Last year for example, we raised the bar on top of books with Matthew Reinhart’s phenomenally successful Star Wars: A Pop-Up Guide to the Galaxy. It includes intricate paper engineering; battery operated lifesavers, and spent 22-weeks on The New York Times bestseller list.

We’ve also published The Invention of Hugo Cabret written and illustrated by Brian Selznick. This 544 page book redefined children’s picture books, winning the very prestigious 2008 Caldecott Medal. It is still in The New York Times bestseller list more than one year after publication.

Both books were among our strongest front list revenue drivers for fiscal 2008 and continue to have very strong back-list sales, as we published and introduced exciting new franchises and properties in fiscal 2009.

In September, we will publish The Hunger Games by Suzanne Collins, the first in the futuristic trilogy for teens. We’ve done an exhaustive pre-publication launch campaign and in the industry this is now where the most highly anticipated books of the fall. In October, we’ll publish Inkdeath, the anxiously awaited conclusion to Cornillia Funke’s Inkheart trilogy. The two earlier titles in this series spent 60 weeks on The New York Times bestseller and we announced a large initial printing of 350,000 copies for the newest book.

The well received Goosebumps Horrorland series just launched in the spring of 2008, is a great example of how we leverage and reinvent Corus Classic franchises. Working with our RL Stein, the author of the original series on a new 12 book arc created an interactive website that accompanies all new Goosebumps book and delivers online games and rich serialized content. We’ve just published those first three books in this newly imagined series and web traffic and sales are gaining momentum with each new book and of course, we continue to focus on bringing new generations of readers to Harry Potter.

On September 23, we’ll publish a special tenth anniversary edition of Harry Potter and the Sorcerer's Stone, with all new illustrations by Mary GrandPre plus a page of exclusive new materials from J.K. Rowling.

Showing the most innovative product is the worldwide simultaneous English language launch of the 39 Clues on September 9. The idea for this multiplatform property was conceived and developed in-house of Scholastic and we have all worldwide right to the property. We’re partnered with best selling author Rick Riordan who wrote the first book in this series and knocked out the whole 10 book top line which we’ll publish over the next two years.

Each book in this series is being written by a well-known children’s book author. In addition to 10 wonderful books, readers will be able to join the book characters hunt online, gathering Clues, collecting games cards, playing interactive games and winning prices. We’ve announced the 500,000 copies first print for the first book in this series, and for that first card pack which will be sold separately.

Building the multiplatform world for this exciding new Scholastic property has been extremely collaborative with trades, publishing, working closely with our online group and Scholastic Media on franchise development. Deborah will now shares even more exiting about the future of the 39 Clues.

Deborah Forte

Thanks Ellie. Good morning I am Deborah Forte, President of Scholastic Media. This year we will build upon our strong track record of creating successful global media franchises which drive books sales and generate incremental production, licensing and merchandising fees by focusing on the 39 Clues and Goosebump’s as our major opportunities.

We’re excited about our collaboration with Scholastic Trade Publishing on the web component of the 39 Clues. Our team is energized and focused on developing the creative assets to build the property as a global media franchise for merchandise, interactive and movies.

As announced earlier this month, we’re in development on the 39 Clues movie with DreamWorks and Steven Spielberg and have just high to writer to begin scripting the project. Interacted games for the Nintendo DS platform to be followed by the Wii platform are planned for fiscal ’09 and ‘10 respectively. Merchandise will rollout in the fall of ’09.

Goosebump’s remains an important priority for us. In September we will unveil our newly designed Goosebump’s website which will provide a home-base for the brand allowing fans an opportunity to interact with all aspects of the franchise. Our Goosebump’s TV series continues to attract audiences.

With Cartoon Network this fall we’re planning a Goosebump’s TV marathon featuring new episodes from our library and promoting our books and newly produced Goosebump’s games for the PlayStation II as well as the Nintendo DS and Wii platforms. These games will be released in October just in time for Halloween. In addition to all of this activity we just completed a deal to produce Goosebump’s movie for Sony Picture.

Scholastic Media recognizes that children spend a significant amount of time with Screen Media, by aggressively extending our franchises so that they are available online, on television, in games and in movie theaters. We can maximize the value of our intellectual property and ensure that our brands have a strong presence in all segments of the children’s and family market. Now Margery Mayer will discuss Scholastic’s growth opportunity in educational technology.

Margery Mayer

Thanks Deborah, good morning everyone, as Deborah said I am Margery Mayer, President of Scholastic education. Scholastic’s direct-to-home and educational technology business has been an important source of higher margin growth for the company over the past five year. Our research based products especially READ 180 the countries top reading intervention program and ability to partner with school districts have made us the market leader in technology based instruction. This segment of the education market continues to take a larger shares spending regardless of the economic cycle as dollar are diverted from traditional print materials.

The momentum behind the use of technology in schools will continue, fueled by the clerical need to raise achievements. Despite some modest improvement under no child left behind, roughly two out three students stilled do not read at a proficient level. These numbers are magnified in our countries biggest cities, many of which are struggling to graduate even half of their students.

The fact is the traditional print programs cannot move the needle at scale and educators largely recognize this. They realize that technology based on research and well implemented is essential for providing students with the individualized learning that meet their needs and engages them. Our focus at Scholastic has been technology that promotes teaching and learning and in Mandarina we are number one with more than $160 million in sales.

As the heart of our technology business is READ 180 which has evolved from being a product to a platform for technology based instruction. We are using our strong position with READ 180 to expand our business, through more READ 180 sales to our existing base. Through new products that run on our Proprietary Enterprise Management System and through an enhanced list of service we are offering schools and districts. A great example of this can be found in the recoveries schools in New Orland’s where the district is using READ 180 as their core addles at literacy program.

They’ve enhanced the program by using our assessment SRI and our reading motivation programs, Scholastic Reading Counts. They’ve contracted with us to provide ongoing professional development including in-room coaching, they’ve leveraged their investment in our management system by purchasing our enterprise addition of our math fluency program FASTT Math, and they have a expanded their class room libraries as part of their compressive literacy plan with Scholastic paper bags. The politeness is that the recovery schools have made impressive games and reading through their hard determined work and used of our programs and consulting.

In the coming year we have an existing line of our products that build on our READ 180 base. Most significant of these is System 44 which internally we call the READ 180 pre pool. With all these to our READ 180 users that students needs have a certain level of prerequisite reading skills to benefit from the program. Our customer’s have thus been using various programs to built foundation of reading skills with varying success.

Now we can use system 44 which is named for the 44 sounds in the English language. The products fits into READ 180 seamlessly or can used independently, its pricing is also comparable to READ 180. An additional benefit for us is that it allows us to keep a substantial percentage of students in the READ 180 system for an additional year, thus expanding our renewable business.

Perhaps more importantly system 44 expands our addressable market in reading intervention by perhaps 20% to 25% and it should further deepen our track record of success in schools and districts that use our 180 suite. In Math, we’ve recently launched our same enabled version of FASTT Math and in March we published the new Math intervention program with Americas top Math educator Marilyn Burns.

We are supporting these products with high level customer Math form, that have been pleased and encouraged with our fast progress in the Math market. We have plans to do more Maths next year and beyond.

Lastly I want to discuss our investments in sales and service. Early on we’ve realized the technology cannot be solved the same way textbooks are. To use technology effectively school districts require extensive service, technical support, professional development and integration skills. Scholastic is evolved a unique approach to selling both products and support the school districts.

Last year we took a major step forward in the strategy, we separated the technology and curriculum organization from the classroom and library group and added new sales implementation support and consulting staff. As expected this transition created extra work and expense and occupied valuable selling time. Nevertheless last year, we bucked the market maintaining our sales as many competitors saw declines in their supplemental curriculum revenues. We will continue our evolution in fiscal 2009 consolidating sales management, streamlining, spending and updating the compensation plan. These will improve our efficiency and build on last year’s progress.

School districts across the country face many challenges today. Scholastic educations mission is focused on addressing schools most important long term goal raising student achievement. Therefore regardless of short term pressures on spending, we are well positioned for the long term profitable growth. Now I will turn the call over to Maureen.

Maureen O'Connell

Thank you, Margery and good morning everyone. Fiscal 2008 was a solid year. We made the top half of our guidance with earnings from continuing operations of $2.82 per share. We also significantly exceeded our cash flow guidance, which I will discuss in a moment.

Looking first with our segment results; in children’s book publishing and distribution, revenue and profits were up significantly for the year. This primarily reflects tremendous sales of Harry Potter seventh book in the series, mostly in the first quarter.

Fourth quarter segment results declined however, primarily due to incremental expenses incurred as a final accounting of the Harry Potter’s series. Overall this was our most profitable Harry Potter launch ever. Very high sell-through, efficient distribution and execution allowed us to achieve incremental margins in the excess of 30%. Of course we obtain such high margins by leveraging Scholastic substantial infrastructure and a unique manufacturing distribution and logistic capabilities.

Looking at the rest of our trade business, sales held approximately leveled during the year and we had a number of hits in the New York Times bestsellers, like the Star Wars: Pop-Up book and Hugo Cabret.

Turning to School Book sales, revenue and profitability were up last year, driven by modest gains and revenue per fair, which provides the greatest operating leverage and continues to be our growth focus. In Clubs, revenues declined as anticipated as we continued streamlining promotions. Increased spending and the roll-out of new Cool and our marketing test impacted full-year and fourth quarter profits in this business.

Turning to the Education Publishing segment, revenues were approximately flat and profits were down to the year in the quarter as we invested in strong sales and service organization and the new product development. However, even as industry-wide supplemental sales declined significantly over last year, our sales were sold in comparison. Scholastic’s print business decreased only modestly and our sales of educational technology and READ 180 remained level.

In international revenues rose strongly for the year as a result of strong sales in Australia, the U.K. and Asia, as well as foreign exchange benefit. Profits also rose from strong performance in those areas offset partially by lower profits in our export business, which had a large READ 180 sale on the prior year.

In Media, Licensing and Advertising, revenue and profits declined in the year and the fourth quarter. Primarily because of a shift in School Book sales, merchandizing strategy towards books and away from PC software which is recorded in this segment. Looking at the consolidated income statement, cost of goods sold increased in fiscal 2008 as a result of costs related to Harry Potter sales.

SG&A expense increased primarily reflecting Harry Potter related spending, the year-over-year impact of foreign exchange and greater spending on sales and service and education. As we said in the press release this morning, we move forward for negotiation for the sale of our direct-to-home business last quarter and we expect to finalize terms in the first quarter of this year.

Last quarter we also shutdown our school-based continuity business. This business was facing similar negative trends as our direct-to-home business and would have required additional investment to operate independently. As of consequence this business has also been classified as a discontinued op in the current quarter end-year as well as in prior periods.

When we issued guidance in March, we had not yet decided to discontinue the school-based continuities. At that point losses of approximately $0.06 per share for the first nine months of the year are included in the results from continuing operation. These losses have now been re-classed to discontinued operations.

Turning to cash flow in our balance sheet, free cash flow was very strong last year at $187.7 million compared to $76.3 million in the prior year. It also exceeded our guidance of a $100 million, due to the timing of spending in working capital improvements. First prepublication and capital spending were approximately $40 million below our original guidance, as we staged the development and roll out of new educational products.

Second approximately $25 million in payables and royalties moved into 2009 due to timing. The third and remaining benefit was working capital improvements of $20 million largely in discontinued operations. We were able to reduce spending in certain areas of our direct-to-home business in the fourth quarter as we negotiated and gained an understanding of deal terms. This factor was not included in our free cash flow guidance.

Compared to the prior year, the strong improvement in free cash flow was primarily due to higher earnings from continuing operations and favorable movement in working capital, especially from strong cash collections and lower inventory spending. The late payment of royalty and expenses and the working capital benefit in discontinued operations that I described also contributed to the year-over-year increase.

Last year we not only had strong free cash flow, but we had a strong balance sheet. Unlike many media companies with highly leveraged balance sheets we end fiscal 2008 with the net debt to cap ratio of 20%. After repaying $75 million in bank debt and buying $15 million in public debt on the open market, we had $120 million in cash in the bank at year end. Combined this with $325 million available under our existing credit lines and we had ample liquidity and are well positioned to take advantage of strategic opportunities, especially in online and the educational technology spaces.

Last year we also purchased 6.4 million shares to Scholastic stock for $220 million. At the end of the year, we authorized a program to purchase an additional 20 million of common stock under which we had purchases, an additional 252,000 shares to-date during the first quarter of fiscal 2009.

Now, turning to fiscal 2009, as Dick commented we committed to our goal of 9% to 10% margins in fiscal 2010. Our plan for fiscal 2009 is to achieve modest ongoing revenue and solid margin growth excluding Harry Potter.

Looking at the individual segments, in Children’s Book Publishing and Distribution we expect modest ongoing revenue growth and improved operating leverage. This will come from incremental orders and higher revenue per order online and clubs as Judy discussed especially in the second half of the year continued growth and revenue per fair in our Book Fair business, a strong front list and exciting new series and trade as Ellie described. We expect Harry Potter, now a classic on our backlist to generate sales in between $10 million and $15 million as we leveraged the 10th anniversary edition of the Sorcerer's Stone and the November release of the sixth movie in the series.

With improved operating leverage, overall operating margins in our children’s book segment should increase by at least to 100 basis points next year excluding Harry Potter. As this typical close and fair seasonality follows to school year with the greatest revenue in fiscal second and fourth quarters, these businesses have minimal revenue in the first quarter when we typically reported seasonal loss.

In education for our launches of new technology products increased focus on implementation support and the benefit of last year’s new sale from services hires should drive renewed revenue growth in fiscal 2009. Most growth is expected to occur in the second and fourth quarters given the schedule and new product launches.

Sales for the educational technology led by READ 180 are expected to rise approximately 3% to 5% for the year, though we will be down in the first quarter relative to the past year due to the prior year comparisons. Educations operating profits for the year are expected to increase from higher margin sales growth and the consolidation of sales management.

In international revenue and profits are expected to hold approximately level, reflecting growth in Australia, Canada and Asia offset by a difficult comparison in the U.K. In media licensing and advertising revenue and margins are expected to increase strongly primarily as a result of solid interactive sales in retail channels. Corporate overhead is expected to increase modestly from higher facility in medical cost as well as stock-based compensation partially offset by lower spending on salaries and outside services.

Our outlook for continuing operations for fiscal 2009 is for total revenue of approximately $2 billion to $2.1 billion and earnings per diluted share of $1.75 to $2.10. This outlook represents an approximately 3% to 5% revenue growth excluding Harry Potter and a 10% to 25% earnings growth.

You’ve heard a lot about our growth initiatives, pricing actions and operating leverage, now let me focus on the cost side. As Dick said, we achieved $40 million in overhead cost reductions over the past two years, successfully mitigating $15 million in higher cost last year, primarily from postage.

As you know, commodity prices continue to rise especially as the paper industry consolidates. Also rate increases in our printing contracts are typically pegged to CPI which has accelerated in the past year. Because of these factors as well as rising fuel prices we anticipate $15 million to $20 million in higher cost in fiscal 2009.

We plan to improve margins more than offsetting these higher costs by reducing spending by $25 million to $35 million this year on top of the price increase of at least $20 million that Dick described earlier. This said another way, price increases will offset commodity increases and we have a cost reduction plan on top of that of $25 million to $35 million.

We are taking actions in several areas to achieve this. First, we are aggressively renegotiating and consolidating our supplier relationships for paper, shipping, test service and travel. Second, we are coordination printing formats and paper specification across the businesses to increase the size of our paper buys and print runs in lower costs.

Third, we are linking more shipments and clubs and reconfiguring warehouse operations to be more efficient. We are also improving utilization of our fleet and book fairs. Fourth, we are restructuring operations and lowering headcount to achieve the significant part of these savings. We have already taken firm steps, eliminating positions in book fairs and consolidating sales management in education.

Next we are consolidation certain IT, supply chain manufacturing functions as well as business operations to reduce costs and improve efficiencies. Our outlook currently includes severance of $0.11 per diluted share inline with last year; however there maybe additional severance charges, which we will quantify during the course of the year.

Stock-based compensation expense is expected to be between $0.15 and $0.20 per diluted share after tax next year compared to a $0.11 per diluted share in fiscal 2008. Based on the currently authorized share repurchase program, our outlook is to have approximately 38.6 million shares for the year on a fully diluted basis.

In fiscal 2009, despite the delay of approximately $60 million in spending from fiscal 2008 that I described earlier, we still expect to have strong free cash flow of $90 million to $100 million. Given the rescheduling of projects, capital expenditures will increase year-over-year between $65 million and $75 million, while pre-pub and production spending is expected to increase $80 million to $90 million. As Dick discussed, we’re beginning to pay a $7.05 per share quarterly dividend in September or approximately $10 million to $11 million per year.

Given our balance sheet and free cash flow outlook, we are well positioned to return cash to shareholders and still pursue a strategic initiative. In summary we have a solid plan to deliver ongoing revenue margin and earnings growth in fiscal 2009 as we move towards our fiscal 2010 margin goal. We have a strong cash flow generation and we have a strong balance sheet. With that I’ll turn the call over to Dick.

Dick Robinson

Well, thanks Maureen and thanks to all of the speakers of this morning. As we have discussed Scholastic is pursuing aggressive cost reduction combined with modest revenue growth and strategic pricing. Our plan for fiscal 2009 is to deliver solid revenue and profit growth excluding Harry Potter in a tight environment. This is a critical step toward attaining 9% to 10% operating margins in fiscal 2010, a goal we remain completely committed to. We look forward to reporting on our progress during the year.

I will now moderate a question-and-answer period. In addition to those who spoke on the call we’re joined by Hugh Roome, who can speak to our rapidly growing businesses in Southeast Asia. With that operator let us open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Drew Crum with Stifel Nicolaus.

Drew Crum - Stifel Nicolaus

Good morning everyone. I just wanted to get clarification on your revenue guidance for fiscal year ’09 to your educational publishing unit. I think you mentioned in the press release 3% to 5% growth for technology, does that apply for the entire segment?

Dick Robinson

Thank you, Drew. The 3% to 5% does apply to educational technology. Our print sales are slightly up, but not 3% to 5%.

Drew Crum - Stifel Nicolaus

Okay and Dick maybe just discuss your confidence and your ability to grow that business the next fiscal year just given what appears to be an increasingly more challenging environment and your …

Dick Robinson

Your education, you mean...

Drew Crum - Stifel Nicolaus

Yes educational publishing. You’re exiting the year with both supplemental technology down. Now understanding that you do have some new products in the pipeline that are coming, but I just want to get some additional color around that?

Dick Robinson

Well, lets go back to the year ago when we restructured our sales force and redirected our sales operations and split our two sales forces into the educational technology and curriculum on the one hand and supplementary library and classroom and the other. Any change in the sales force organization is going to have some impact on the smoothness of the selling operation in that year and I think we did have a kind of a slow beginning to our the sales force implantation.

At this point however, the sales forces are fully engaged in their new missions. Margery has done a traffic job of redirecting and reorganizing some of the sales force right in the last few weeks and they’re just about to have their sales meetings this coming weekend and both of the supplementary class room and library group and Margery’s education technology sales force are very optimistic about the upcoming years.

We have good pipelines in both the businesses; we’ve got the coming of system 44, which is highly awaited by our customers, we see a little momentum growing in our non READ 180 business. Some of our programs like Read About which we had for some years are showing real signs of growth as it has our map publishing as Margery mentioned and our feeling about the market is this. In tight time -- I’ll ask Margery to supplement this, because I know it’s a great interest to you Drew and to others.

Our feeling is that in tight times people are going to go to those things that have proven results and our educational technology business proven results changes the way those schools operate, changes the way kids improved in team higher reading scores, and our customers know that and their willing to invest money. Some of them are having revenue issues or issues of funding, but we haven’t noticed that they’re stopping their commitment to student achievement and to using the kind of programs that we’re offering.

On the supplementary side we held pretty flat this year in a market that decline significantly in other ways. So we feel that if our new sales force is good, we have new products, there’s good pipeline as I mentioned and so we are pretty optimistic about both business in the current educational funding climate. Margery you want to add to that?

Margery Mayer

No I think you gave a great summary there. I guess just one thing I would add is some of the pressures that are on school funding don’t apply as much to us as they do to some other people that are selling to schools. A lot of our funding comes from federal funds like Special Aid Money and Title One.

We are not going to be effected very much by the decline in reading first dollars, we do sell some paper backed books into there but those dollars have largely gone to more traditional kinds of program. So, our goal is to take our sales force, which we think we’ve made some really important strategic changes in how we’re restructured with liner or more agile and go where the money is and as Dick said there is an incredible focus on raising achievement and we just don’t believe that that’s going to dilute, it’s going to continue.

Obviously there is a lot of schools that are under pressure on funding, but there is also still 15 million kids going to the school everyday and unfortunately two out of three of them still can’t read well and not to make the kind of choices about their future that we want them to be able to make.

Dick Robinson

In addition to that Drew the READ 180 is still growing and we are expanding that and we’re rededicating our sales force to expanding READ 180 both where we have strong installations and also in new business and we’re seeing momentum develop in that area.

Drew Crum - Stifel Nicolaus

Thanks for that color. Maybe I can shift gears and just ask about the school-based continuities business. Is your plans operationally for that business, you said you’re shutting it down; is it going to be a sold or you’re just going to wind it down?

Maureen O'Connell

It has been shutdown we shut it down during this fourth quarter. So, it has been shutdown, it’s completed.

Drew Crum - Stifel Nicolaus

And then lastly just can you talk about the timing of the $25 million to $35 million cost reduction program. Is it front-end loaded in fiscal year ’09 or is it going to be over the course of the period?

Maureen O'Connell

It will be over the course of the year, but we’ve already started taking actions that we have already began renegotiating contracts and as we said we made adjustments in the sales force within education and we’ve already executed against the plan to reduce headcounts in there; so, we’ve already began, but it will occur during the year.

Operator

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

Peter Appert - Goldman Sachs

Thanks. Dick a couple of questions, first on the pricing strategy, what’s implied by the $20 million number in terms of percentage increase overall in terms of price points?

Dick Robinson

Well, we’re referring primarily to our $1 billion children’s book business in the U.S. our average price increase in there is between 3% and 5%. Even if we believe there’ll be some sales follow-up on the higher priced titles we still believe that we can return $20 million profit from those price increases.

Peter Appert - Goldman Sachs

And have you done any pricing in fiscal ’08?

Dick Robinson

Yes, we’ve modestly increased prices in clubs. We did not increase prices in fairs very much.

Peter Appert - Goldman Sachs

And just switching to the Cool offering, because if it feels like that, a pretty significant component of strategy to drive the revenue acceleration and the profit margin improvement, obviously over the next couple of years. So, just so I better understand it, do these circulars get eliminated in this process or do they still exist?

Dick Robinson

They still excite Peter, I’ll let Judy answer that one, but overtime there maybe some reduction of circulars, but that’s going to take while for people to be ordering online directly, but just the chance to see the books come up in color and with your further information that we can give, gives a whole new flavor of experience to online ordering with New Cools. So, Judy do you want to amplify that?

Judith Newman

Yes, of course as Dick said the long-term opportunity is for us to trim the number of catalogs that we mail, but initially we do need to send those catalogs out to kind of instigate the order and so we’ve been doing a lot of testing with that particularly in the fourth quarter. The goal would be for Cool to trigger incremental sales, second orders and third orders and of course open up ordering to parents. So that one catalog and that one promotion investment will then really amplifying and deepen and will give us a lot of operating leverage by driving incremental sales.

Peter Appert – Goldman Sachs

And can a teacher opt out of the online ordering. Do you have to order online?

Judith Newman

No, any classroom can have a combination. It’s a very good question; teachers ask us through our research. Teachers can submit an order that has a Parent Cool order, an online order, a paper order and the phone order all combined and our fulfillment business can support that.

Peter Appert – Goldman Sachs

And is your expectation Judy that offering Cool could theoretically cannibalized perhaps sales for the fair and the trade channel and if that were the case would that have negative implications in terms of revenue realization, it’s just given there for price points through the various channels?

Judith Newman

We have really no evidence that that’s ever happened. Actually, our books typically rise together. We’ve seen on our big franchises in particular that when a book is selling on one channel it’s really selling well through all channels and I think all of us Ellie and the people down in book fairs and myself, we all say that the day that every child is reading a books, is the day that we’re saturated. so we really don’t see a lot cannibalization, we see a lot of mutual marketing support and we strategically kind of plan that out and we do discount of course but we do it as a great margin.

Peter Appert – Goldman Sachs

And then on that point Judy, the as proved to the price increase strategy that Dick was mentioning, any thought of lowering the percentage discounts you’re offering in clubs versus other channels.

Judith Newman

Yes we are working on strategic pricing is what we were calling it. So, I would say we’re picking our shots and making our discounts really matter doing it strategically not across the board on every item, but finding really compelling opportunity to do discounting, yes you will see some differentiation.

Dick Robinson

And then Peter just by the way one of the key profit improvement plans we have is a much more strategic relationship among the pricing in the various channels. We do this somewhat now but we’re making a big effort to improve that and make it more a planned pricing program.

Peter Appert – Goldman Sachs

Right and last thing on the call for Judy; any early data to give some crudeness to the theory that order patterns really do improve or order rates do improve as people move to online ordering.

Peter Appert – Goldman Sachs

Yes, we have significant testing. I am going back now really almost 18 months. It shows that when teachers and particularly parents order in Cool, we get much higher revenue per order on the parent. Now there’s not a lot of scale on it yet, but in our test market we do see that.

Peter Appert – Goldman Sachs

Okay, great thank you and then one other unrelated item, Dick. The international profitability in the fourth quarter, took a hit year-to-year and I know you mentioned this in the past on the calls but it seems noteworthy in the context of the benefit you’re gaining from currency etc; is there anything unusual in the fourth quarter in terms of international profitability?

Peter Appert – Goldman Sachs

Well that the export business was primarily where this took place but Hugh Roome is year who operates that business and he can certainly expand on that.

Hugh Roome

Well Peter, its Hugh Roome. We had a strong quarter overall. We had some weakness where we had in prior year some large sale in the fourth quarter related to educational product to entities in Latin American market; without that this year, the comparison is a bit strong, but we hope that these sales will be completed over the summer.

Operator

Thank you. Our next question is coming from Catriona Fallon form Citi.

Catriona Fallon - Citigroup

Can you speak a little bit about the Book Fairs business, its looks like that was an area that actually saw growth year-over-year and I’m wondering was there any change in the seasonality or timing affairs or there are some affairs that were brought forward or back?

Dick Robinson

The April and May were extremely strong for fairs. The revenue per fair increased significantly Catriona in the fourth quarter and then those two months in particular. So, we see an acceleration in the fair revenue per fair.

We did shift some fairs from case fairs, which are the ones we shipped to the schools in trucks to direct mail fairs, so they are some of the lower revenue fairs we shifted and that seem to have had an impact on our efficiency in delivering our case fairs and help revenue per fair and we also had some merchandising improvements in the fourth quarter. So, we think that that boards well for our next year revenue per fair and we just completed our sales meeting for that group and the General Managers all feel very confident that they can boost revenue per fair next year, which is of course their plan.

Catriona Fallon - Citigroup

Okay and how much was the Golden Compass contribution in the quarter?

Dick Robinson

Well, in the quarter it would reduce substantially. The Golden Compass was earlier in the year. Maureen do you want to talk about that? It was primarily sales of [Philipoman’s] original novels and the film High-End Books that took place in the second quarter of the year just before Christmas, just before the release of the film in early December and then there were some related licensing and merchandising that came in at that time, so most of that was second quarter.

The U.K. did improve its profits ex of Gold Compass this year, but The Golden Compass did help them quite a lot in that quarter. Some of that will not be repeated of course in this year and that’s why we referenced the U.K. as not keeping pace with the other international subsidiaries and profit improvement for ’09.

Catriona Fallon - Citigroup

So, specifically then on the residuals from the movie, where there any residuals from the DVD sales that came through?

Dick Robinson

Deborah, do you want to answer that one?

Deborah Forte

We’ll really be seeing that next year, because the rollout is continuing globally of the DVD, so by the time that makes its way back to us we anticipate it will be at the very end of this year or we’ll see it next year.

Catriona Fallon - Citigroup

Okay, and on the education business, I believe it was about a year ago when you talked about the separating of the sales forces and investing in the sales force on the education side for READ 180 and eventually System 44; where we are we at in the size of that sales force now and I guess it seems like the plans there has been reevaluated, maybe the sales force there is being consolidated or shrunk rather than expanded.

Dick Robinson

Well Margery can answer that. I think but we didn’t make any substantial change in the sales force when we move the education sales force primarily to technology and curriculum and we invested some money in the expanded class room and library sales force; that has worked very well in the class room and library we’ve got an increased sales as result of that.

During the year we recognized that we needed to make some improvements in the education technology sales force and Margery will describe what those are and when they happened.

Margery Mayer

Yes, I mean we really view this coming year as Phase II of our evolution and what we wanted to do last year is we wanted to make sure that we maintained as much stability as we could and changing sales forces is a tricky business and a risky business might be a better way to describe it. So what we’ve done this year is we are streamlining our sales organization.

Now what we’ve done is we’ve persevered all of our territories or most of our territories and we’ve maybe combined one or two here or there but we condensed our regions from six to three and we’ve eliminated some of our positions that we felt were not as revenue producing as other positions. At the same time we’re investing our implementation team and our consulting business. So it’s really both savings plan and somewhat a reallocation of resources.

We’re going to have some more investment in strategic and high level selling. We’re really aligning our sales force to that kind of business were in which is not just selling products, but talking to districts about their needs, matching their needs with solution products and services, providing services and then being in the district on a regular basis, checking in with them on how its going, helping them understand how to tweak what they’re doing, it’s really put us in a whole different place.

Catriona Fallon – Citigroup

Okay and then just kind of one further question; on the guidance, if I’m backing Harry Potter this year and I know that you’ll get some residual Harry Potter next year, but it looks like guidance is looking for about 3.5% to maybe even 8% revenue growth next year and I’m trying to fit that with the fact that we’re seeing some price increases that could have some impact.

I know when we saw there were some price increases in the clubs, but in fact some of the clubs were kind of down this year, so I’m just wondering, we’ve seen that price increases don’t necessarily result in revenue increases and I’m wondering how do we get to that kind of growth next year.

Dick Robinson

We’ll come back to the growth in a second. I think our Club pricing in the current year was -- we did increase some prices in fiscal ’08, we are continuing to have a selective price increase in Clubs in ’09, but as Judy described this is a very strategic pricing plan. The main difference in our Clubs for next year is going to be a very, very strong online component and a revitalized promotion campaign and some different ideas about how we present our product. So, with the combination of online and catalogue selling, we believe that will give some strength to revenue.

We also having dropped the continuity business and exited that opens ups some space on the back of our four page leaf or the 48 page leaflets that we have in Clubs, which will give us some additional selling space and we expect some revenue increases from that as well. Maureen do you want to talk a little bit about our revenue goals in respect of the estimates that Catriona has talked about?

Maureen O'Connell

Sure, as we mentioned our revenue assumption is at 3% to 5% growth. I think if you do the math on the guidance we gave you regarding the Harry Potter you come in 3% to 8% as you said; however we with our cost saving plans and the initiatives in place we can still achieve the higher end of the guidance with the 3% to 5% growth, which is why guided there and that would represent a 10% to 25% earnings growth.

So, what’s a small moderate growth in revenue is a substantial growth in earnings because of the leverage in our businesses and our businesses have substantial fixed cost in terms of marketing promotion and operations and so a small increase in revenue yields are large increase in profitability.

As far as the pricing increases, as Dick said we expect about $20 million impact of the pricing against a $1 billion book business and so that does assume certain areas we will increase prices, but not in every area. It will be selective a Judy had said earlier.

Operator

Thank you. The next question is coming from Amy Minella with Cardinal Capital Management.

Amy Minella - Cardinal Capital Management

Good morning. Can you give us the dollar amount of the severance that was in the quarter and also the dollar amount of the equity compensation?

Dick Robinson

In the fourth quarter.?

Amy Minella - Cardinal Capital Management

Yes.

Dick Robinson

Well just hold on one second for that one.

Amy Minella - Cardinal Capital Management

Yes. I had the $0.11 I have to go find the dollar amount.

Maureen O'Connell

Yeah, we have both those numbers.

Amy Minella - Cardinal Capital Management

While you’re looking for that could you also give us a further breakdown of what the 2009 capital expenditures and the pre-publication and publication expenses would be?

Margery Mayer

More detailed than the number itself?

Amy Minella - Cardinal Capital Management

Yes.

Margery Mayer

It’s primarily related to our education business on the pre-pub spending as well as our media licensing and advertising business, those are the areas that we are investing pre-pub spending and the capital would include our Cool initiatives as well as some aspects of our online initiatives in our 39 Cools initiatives.

Amy Minella - Cardinal Capital Management

And then with the fact that you have two movie deals going on?

Margery Mayer

No. we do not fund the movie deals, we receive fees related to it, but because we own the property but we do not in anyway fund the movie deals.

Maureen O'Connell

Okay, so severance for the full year is about $6 million this year versus $12 million last year and the impact in dollars versus pre-tax dollars of the FAS 123 or the stock comp is $7 million this year and $3.6 last year.

Amy Minella - Cardinal Capital Management

Okay and on the CapEx and pre-pub again would you expect those levels of expenditures to continue into 2010 and 2011?

Margery Mayer

No, it’s really because of the delay in this year. We delayed about $40 million of anticipated pre-pub spending and CapEx in this year and so when it moved into the year we’re guiding to right now. Generally we would expect our spending to be inline with amortization and depreciation.

Operator

Thank you. At this time, there appears to be no further questions. I would like to turn the call back over to Dick Robinson, Chairman and CEO for any closing remarks.

Dick Robinson

Well, thank you all for your attention, as we tell our story about the ’09 and recap ’08. Obviously we are still working on our deal to sell and exit the home continuity business. We expect that to be completed in the first quarter. The upcoming year which we expect to be in a tight economy is comprised of cost reductions, price increases and modest growth in our core businesses.

We are very confident of our plan for ’09 despite the difficult economy and we are very committed to our profit margin improvement and reaching our goal of 9% to 10% in our ‘09 to ‘10 fiscal year. Thank you all for your attention and thank you for your continued support. I hope the shareholders will appreciate the dividend that is coming their way in September. All the best, thank you very much.

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Source: Scholastic Corporation F4Q08 (Qtr End 05/31/08) Earnings Call Transcript
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