Harry Potter and--What Else?

Scholastic could use a few more magic tricks

For Richard Robinson, the release of the long-anticipated Harry Potter installment was like a High Holiday of publishing. "There isn't a bookseller in the U.S. who wasn't on [his] knees, praying for June 21 to come," says Robinson. As chairman and CEO of Scholastic Corp., Potter's U.S. publisher, he was right down there with them. The company is betting big on the boy wizard, planning as much as $4 million in marketing support and a record print run of 8.5 million books.

That could contribute $120 million in additional revenue for the year and about 17% of Scholastic's earnings, estimates Neil Godsey, an analyst at ThinkEquity Partners in San Francisco. Given the runaway success of the previous four Potter titles, Robinson boasts that Harry Potter and the Order of the Phoenix will make history again: "No book ever had anything like this kind of impact on American society."

So why can't Potter work its magic on Scholastic's bottom line? Although it remains the premier publisher of children's books, with staggering reach into schools and homes, the New York company has struggled through a tough year. To be sure, tighter state and local budgets for schools and libraries are squeezing all publishers, while everything from war jitters to bad weather has kept people out of bookstores. Children's hardcover book sales were down 23% in the first four months of 2003 over a year earlier, according to the Association of American Publishers, while children's paperback sales were off 4.6%. Years of Pottermania may have also made people forget that Scholastic is in a mature industry not given to gravity-defying growth.

Still, Scholastic could do more to exploit its special advantages, say analysts. Those include unparalleled access to young readers through school book clubs and more than 100,000 school book fairs every year. Not only has Scholastic cluttered up its club catalogs with some junky offerings, critics say, but it hasn't paid enough attention to wooing teachers or nurturing more new hits.

It shows in Scholastic's financial report card: The company posted flat sales of $434 million in the third quarter and a loss of $500,000 vs. an $11.9 million profit a year ago. It is expected to report lackluster results for the fiscal year ended May 31. Robinson faced everything from higher employee benefit costs to disappointing sales of the Potter backlist. Earlier this year, in fact, Scholastic allowed booksellers to defer payment for the backlist in the hope that the latest installment will boost demand for the excess inventory -- a move that inflated the true sales for the period, argues Marc Siegel of the Center For Financial Research & Analysis. (The company has publicly disclosed the practice and says it is an appropriate way to minimize returns.) The stock has been climbing with the overall market, but at $32 is still more than one-third below its 52-week high of almost $49 in October. Last month, mere weeks before the Potter release, the company fired 400 people, or 4% of its workforce, to cut costs.

Even the prospect of another blockbuster can go only so far. Potter is expected to make up just 5% to 7% of Scholastic's sales this year. And although it will no doubt sell well, this latest Potter opus pushes the boundaries of children's fiction: It arrives at a book-bag-straining 896 pages and with a price tag of $29.99, of which roughly half goes to the publisher. Beyond that, who knows how many years will pass before author J.K. Rowling pens the sixth of the projected seven-book series? It took three years to follow up on Harry Potter and the Goblet of Fire. No wonder Wall Street wants to know what's happening elsewhere in the company. As Lauren Rich Fine of Merrill Lynch & Co. puts it: "When they don't have a new Harry Potter title, where do they get the growth?"

Even with a tough environment, Robinson is determined to find the answer. To boost the book-club business, which makes up 20% of sales, Robinson plans to cut offerings by 5% to 10% from an average of 90 titles per catalog and give more incentives to the grade-school teachers who push sales in the classroom. Growing political interest in boosting literacy is helping Scholastic's educational business, which includes the lucrative READ 180, a program aimed at struggling readers.

Robinson is also working on everything from new television shows to book titles for hot brands such as Clifford the Big Red Dog and Captain Underpants. He also has high hopes for such new properties as The Misadventures of Maya and Miguel, an animated TV series aimed mainly at the Hispanic market. Analyst Godsey says Scholastic's future is "going to be mostly blocking and tackling on what they do best."

For a company that already reaches into 80% of all U.S. classrooms up to grade six, that might not be so bad. But the biggest boost would come from a sustained economic upturn. Tough times tend to batter book publishers, and competitors from Houghton Mifflin Co. to Simon & Schuster Inc. have also faced a difficult climate. In children's books, as John Frelinghuysen, a vice-president at consultants Booz Allen Hamilton Inc., says: "Parents have a low-cost substitute in the library."

Harry Potter will certainly relieve Scholastic's pain for a while. The publisher bought U.S. rights to the first book in 1997 for only $105,000. Since then, the series has sold 80 million copies, generating sales of more than $500 million. But the force behind Pottermania has her own timetable. Rowling "felt she really rushed when she wrote Goblet of Fire and really wanted to take her time with this one," says Barbara A. Marcus, Scholastic's president of children's book publishing. For a star author, that's par for the course. But for a publisher struggling to thrive in a tepid market, the speedy arrival of Potter installment No. 6 can't come too soon.

By Diane Brady in New York

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