Scholastic Corp (SCHL) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to your Scholastic third-quarter earnings release conference call.

At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following today's presentation.

It is now my pleasure to turn the floor over to your host, Ray Marchuk, Senior Vice President of finance and investor relations.

Sir, the floor is yours.

Thank you.

Welcome to Scholastic's third-quarter earnings presentation for shareholders and analysts.

Before we begin, I would like to point out that the slides for this presentation are available simultaneously 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 conditions of the children's book and educational materials markets, and the acceptance of the company's products in those markets, and other risks and factors identified from time to time in our filings with the Securities and Exchange Commission.

Actual results could differ materially from those currently anticipated.

Now I'd like to introduce Dick Robinson, the Chairman, CEO, and President of Scholastic, to begin our presentation.

Thanks, Ray, and welcome, everybody, to our third-quarter earnings call.

Let me say it once that we're disappointed in the quarter and the forecast for the year, determined to get this business back on course to improve the consistent profitability, and also confident because we know we have a strong business and have begun to attack the areas that were weak this year.

What went right and wrong in the quarter?

The direct-to-home continuities and trade both slipped significantly at the end of last quarter and will fall below plan for the year.

As a consequence, we reported lower profits in that period and have reduced our estimate for the year.

These results will offset positive improvements in several core businesses.

School book club revenues grew by 18 percent last quarter.

In educational publishing strong sales of READ 180, teaching resources, and classroom libraries resulted in higher revenues and margins in our international business.

Both export and Canada operations grew solidly.

And School book fairs also grew modestly.

However, results were down and direct-to-home continuities in the first full quarter since the national 'Do Not Call' registry went into effect. 'Do Not Call' has reduced the number of new families available for telemarketing and increased the cost to contact those still available.

Trade revenues also fell significantly last quarter partly due to aggressive inventory management by booksellers, combined with lower backlist sales.

Profit shortfalls in both businesses affected Scholastic's earnings in the third quarter, and the more negative outlook in trade and direct-to-home continuities has caused us to reduce our estimate for the fourth quarter and the fiscal year.

We now expect earnings per share to be below $1.95 but above last year's result.

This excludes special and nonrecurring items in both periods.

We have taken the following management actions to address these disappointing results.

First, Barbara Marcus, President of Children's Book Publishing and Distribution, will focus her extraordinary skills in Children's Book Publishing on trade and book fairs.

We have an excellent opportunity here, and Barbara's full-time focus on these two important businesses will help us achieve stronger growth and more consistent profitability over the long term.

She has already made progress creating a new mass-market team, expanding our licensing programs, focusing the front list, and developing fair booking and inventory strategies to support revenue per fair growth.

Her undivided attention will reinvigorate trade and accelerate margin improvement and growth in the fairs.

Second, Judy Newman, Senior Vice President, who most recently executed the impressive turnaround in school book clubs, will also expand her day-to-day role in continuities, working directly with me.

While 'Do Not Call' has created new challenges, our continuity business is a profitable means of reaching young families and has produced more than 100 million in net cash since it was acquired in June 2000.

With Judy's focus we will take a fresh look at this business and develop new models of customer acquisition and profitable growth.

We've also accepted the resignation of the President of Continuities and of the Senior Vice President for Trade Sales.

Finally, to improve our budgeting and forecasting processes, all business unit finance managers who previously reported to division presidents will now report to Mary Winston, our new Chief Financial Officer.

I'm now joined by Mary, who came to Scholastic three weeks ago.

I'm confident that her presence will greatly help us improve profitability and cash flow in our core businesses.

This morning she will comment on last quarter's results and the outlook for this fiscal year.

Thanks, Dick.

First let me say that I am thrilled to be joining Dick in this great company, and I look forward to doing my part to tackle today's challenges and opportunities.

The third quarter is Scholastic's second smallest revenue period during the year and typically produces a small profit or a loss.

As we announced in yesterday's press release, third-quarter revenues were up 9 percent from a year ago, with gains in school book clubs, book fairs, education, international, and media.

However, net loss for the quarter increased to $6 million principally because of a decline in profits in our trade and direct-to-home businesses.

Per diluted share, our net loss for the quarter was 15 cents, versus a loss of a penny a year ago.

Revenues in the children's book publishing and distribution businesses were up slightly in the third quarter, but operating income declined by 12 million.

School book clubs revenues continued to rise strongly due to the Troll acquisition, as well as successful changes in our promotion strategy.

We expect revenue growth to be approximately 15 percent for the year, exceeding our original plan.

School book fairs revenue were up 4 percent last quarter, as a result of increased revenue per fair.

Based on current fair bookings, we expect the fourth quarter to benefit from higher fair count.

For the year, school book fair revenues should grow by approximately 5 to 8 percent.

Last quarter, in continuities, which includes direct-to-home, we experienced our first full quarter of the 'Do Not Call' legislation's impact on consumer behavior.

Response rates to our telemarketing decreased, resulting in fewer new customers and lower revenues.

This also increased our cost to acquire new customers and increased the pace of amortization of deferred promotion cost over a smaller revenue base.

These factors had the greatest impact in the month of February, when profits declined $6 million in direct-to-home continuities year-over-year.

Bad debt was slightly higher than a year ago, though it improved relative to the second quarter.

Overall, while continuities revenues declined 8 percent, profits declined substantially, impacting the quarter's results and our outlook for this business.

In trade, revenues declined last quarter by approximately $11 million, principally because of lower backlist orders and increased returns, especially in February.

A significant factor was aggressive inventory management by booksellers.

Based on pre-orders and the strength of our new titles, including Shrek 2 and Spiderman 2, the outlook is positive for the frontlist in the fourth quarter, with continued softness expected in the backlist.

In educational publishing, sales of READ 180 and other curricular materials were up over 50 percent; and sales in classroom libraries and teaching resources were up more than 15 percent.

Profits in the segment increased by $6 million, continuing a very strong year.

In spite of a tough funding environment we now expect educational publishing to exceed our plan for the year.

International revenues were up about 18 million or 25 percent last quarter, and operating income increased 500,000.

While foreign exchange added 11 million in revenue, 9 percent real growth in exports and our Canadian operations contributed to both revenue and profits.

Our outlook for the year is to exceed our plan with mid-teen percentage revenue growth and improved profits.

Revenues in media, licensing, and advertising were up substantially, including 9 million in revenue from Back to Basics Toys, which we acquired last summer.

The quarter also included 8 million in revenue, as well as corresponding expenses, from the release of Clifford's Really Big Movie which opened in five markets in February.

Warner Bros. has decided to expand distribution of this movie to 19 additional markets in April, which should further stimulate sales of the video when it is released later this year.

Key components of cash flow improved greatly in the first three quarters of fiscal 2004, relative to last year.

Net cash from operating activities increased by 88 million to 119 million year-to-date.

This reflects greater operating income for the year as well as improved working capital.

In addition, capital expenditures for the year were down 36 million relative to last year, when we invested in a new distribution facility.

Overall, free cash flow, which represents the cash provided by our operating activities, less capital expenditures, prepublication and production costs and royalty advances, was 22 million in the first nine months of the fiscal year, compared to a cash use of 101 million in the comparable period a year ago.

Even with higher tax and royalty payments anticipated in the fourth quarter, we now expect free cash flow for the fiscal year to be approximately $50 million.

To summarize our current outlook for fiscal 2004, revenue should be about 2.2 billion; we now forecast earnings per diluted share to be below $1.95 but above last year's results.

This excludes special and nonrecurring charges in both periods.

Again, this revised outlook is primarily the result of trends in direct-to-home continuities and trade.

For next year, I am focused on strengthening our core businesses with more accurate forecasting, further expense reductions, better capital allocation, and greater cash generation.

We will discuss this plan in our July meeting.

Dick will now moderate our question-and-answer period.

Barbara Marcus, President of Children's Book Publishing and Distribution, and Margery Mayer, President of Scholastic Education, will join us.

Thank you for listening.

Operator. we will now take question.

(OPERATOR INSTRUCTIONS) Lauren Fine of Merrill Lynch.

I guess I have a couple of quick questions.

First of all, I'm wondering if you can quantify what Troll did contribute in the quarter.

I think you gave us Back to Basics but not Troll, in terms of its revenue.

And also I guess what it contributed on the cost side as well, since the cost of goods sold was up pretty high.

I'm confused.

I guess I would've expected in the media and licensing area that the movie contribution would've carried a higher margin.

And I am also wondering if maybe Back to Basics lost money in the quarter, because the numbers on the operating side did not make as much sense there.

And then I guess, on the continuity business, if I recall I think you paid about 400 million for that business, and that was quite a number of years ago.

It feels to me like it has been more of a problem than a help through the years.

You made a positive comment about the cash that it has generated, but I am trying to figure out if you think that is a good return at this point.

I will answer those questions;

I might start in the reverse order.

We paid about 400 million for the acquisition of Grolier in June of 2000.

There were three components to Grolier.

The direct-to-the-home business which is the largest revenue component; the library business and reference business; and the Southeast Asia business, which was direct sales of encyclopedias to people at home in seven Southeast Asian countries.

So then the aggregate revenues for those businesses were about 450 million at the time.

In terms of allocating among the various businesses, we certainly could do that, but we think we made a very good acquisition in all three areas, because all three were strategic to our growth.

The direct-to-the-home business is particularly strategic to our growth because we feel that over time getting more revenues from parents at home is one of our key strategies, especially using the access that Grolier has to those customers.

In the last several years, we have had over 100 million of cash from that business, net cash flow from that business, and the operating profits from that business have been about the same as the cash flow, a little bit higher.

So, that business has actually performed exceedingly well over the period that we have owned it.

This year, it has had a lot of difficulty.

Last year it was extremely profitable.

And we believe that we can return that business to profitability by reconstituting our relationship with the customers, adding new product, and redefining the customer model and the business model somewhat.

So, we are by no means concerned about the viability of that business.

It's been good for us in the last three years.

It had a difficult year this year.

We believe it is susceptible to a turnaround.

We're looking at it very carefully.

We recognize that this was a tough year for that business, and that we need to take strong action to ensure that it will have a strongly profitable future.

Back to Basics was marginally profitable in the quarter.

It has made money as an acquisition, and it has contributed a bit to the higher cost of sales ratio to revenue, because it is not as profitable as some of our other businesses.

But is a fine catalog business that we will add onto over the years.

In respect to Troll, about half of the revenue increases have come from Troll.

So, of the club growth of 18 percent in the quarter, maybe 9 percent or so was coming from Troll, and the other half was coming from the excellent changes we made in our promotion.

On the Clifford movie, the recognition of the revenue triggers the amortization of the negative cost.

So we actually match cost with revenues on that.

So that is another reason why our cost of sales is up for the quarter, because we were recognizing 9 million of revenues and 9 million of amortization, of negative there.

But the money will be made in the video when that is released later, and of course in increased sales for our Clifford book series.

I think that covers your questions.

I think you did a great job.

Thanks.

Peter Appert, Goldman Sachs.

Good morning.

Two questions.

First, Dick, could you outline for us, maybe in more detail, what steps you think are possible to be taken to turn around the continuities business.

It feels like there is a structural change in this business that has occurred that may permanently diminish its potential profitability.

I'm wondering if you agree with that.

And if it is possible at this point to outline steps to get it back on track.

Secondly, just some comments on how big the Harry Potter revenues were this quarter, if that was meaningful.

And in terms of the higher rates of returns you're seeing for your backlist product, does it indicate anything in terms of the sustainability of any of the existing franchises that you have got out in the market?

Peter, let me try the continuity issue; and then Barbara will talk about the other questions in respect to the trade.

There is a change in the marketplace, no question, for the continuity business.

This model has been very effective for 50 years of selling continuity books to -- identifying new families and bringing them very good value programs for use for the young children.

And that has worked extremely well.

The demand and the need for these products is still there.

I think with 'Do Not Call' and the greater use of the Internet and other things, there is a different atmosphere in the marketplace, and we have already begun to make some changes in our customer service policies, increasing the communication with these customers.

But I think you'll appreciate, with your great understanding of our business that contact with these early parents of young children at an early age of the children is a very important strategic factor for our company.

Once we make that relationship, the key to making money in the continuity business is to maintain your relationship with people.

And once you have identified them, which is the expensive part, to sell those things over time.

We have not really focused on that as much as we need to, and in our strategic changes we are going to think about how we can, and act on how we can, sell more to those customers over a longer period of time.

Bearing in mind that those children will become customers of ours through Clubs and Fairs as well later in their life, their age, and their education.

So, about a third of the direct-to-the-home customers come from telemarketing sources, and those tend to be our profitable customers. 'Do Not Call' has clearly had a bigger impact on this business than we originally anticipated.

We knew we would have fewer customers to call, but the number of customers we obtained is even less than we originally expected, and the attrition rate has been higher.

So all this has impacted our financial statements in several areas.

First, the lower response rates than anticipated, combined with the increased customer attrition rates, have resulted in lower net revenue.

On the expense side, it takes more calls and more expense to get to each customer.

And in addition, fewer customers and more attrition result in deferred promotion costs being amortized at a faster pace.

So the combination of lower revenue and higher cost is having a disproportionate effect on the third-quarter's statement, with a much greater decline in operating profits in comparison to the revenue decline.

In the fourth quarter, the business will be modest.

This quarter it was modestly unprofitable, and in the fourth quarter we have taken the third-quarter trends into account with regard to response rate, customer attrition, and increased cost in our fourth-quarter forecast.

So, seasonally this fourth quarter is a better quarter for this business, so expecting it to be profitable is even with our expectations.

So that is a rather lengthy discussion on that business, but we did want to talk about why we feel that that business was affected this year.

Longer term, this business has been historically profitable, it remains profitable, and we think we can return it to solid profitability.

It is a business that fills a good consumer need, and we need to adjust our model based on what is going on out in the marketplace.

So, Barbara, do you want to talk about the Harry Potter and the issues for trade in the quarter?

Sure.

Regarding Harry, we had expected sales that for Harry 5 would be concentrated in the first quarters.

We did not really anticipate many shipments of Harry this quarter.

As I think you know, year to date, we have shipped 177 million net Harry 5, with a year-to-date return rate of 6 percent.

So, with minimal shipments this quarter, and postholiday returns, we did not see net sales of Harry really in this quarter on the backlist.

But it continues to be on bestseller lists, we continue to sell it, it still is one of the strong properties in our trade area.

Regarding your question on backlist, we are focused on our backlist sales.

We're repackaging, and repromoting, and reselling more titles going forward from our backlist working directly with accounts.

We did that with Goosebumps this year, and we are focused on some of our other backlist properties such as I Spy.

We also feel that the backlist rates will improve with, as we go forward, and there are better comparisons; and our retailers are feeling better about their own sales.

We think that will have a positive impact on our backlist.

Barbara, are their particular products that you're finding resistance to, or is it across the board?

I think it is really sort of one of those changes in the way retailers are focused on backlist.

I think it is really sort of across the board.

Got it.

Thank you.

(OPERATOR INSTRUCTIONS) Tobey Sommer, SunTrust Robinson.

Good morning.

I was wondering if you could discuss your expectations for the upcoming movie tie-ins?

In trade?

Barbara.

The movie is coming.

We are going to be shipping a bit of a paperback of Prisoner of Azkaban and a little merchandise.

But we are not anticipating Scholastic shipping product.

We have worked with our retailers.

They have what we feel and is the proper amount of inventory in the field.

Of course we will sort of top it off in some accounts, but really very very minimal.

We feel we are well represented, Harry is well represented in the marketplace against the movie.

Turning to cash flow, do you have any preliminary expectations for next fiscal year in terms of cash flow generation?

At this point, it's a little premature for us to know exactly what cash flow is going to be, because we're just starting our budget process.

We are taking a hard look at the performance of all of our businesses as well as our balance sheet performance.

So, what I can say at this point is that for me it is clearly a priority in terms of generating higher cash flow from all of our businesses.

But at this point we don't have a number that we can forecast.

We will have that when we finalize our budget, and we will be able to share that in July.

Sorry to bounce around.

I have another question regarding inventory levels in trade.

Is this something that you think is going to cycle through now for a couple more quarters?

As book retailers are a little bit more stringent in their inventory policies?

Barbara, will you take that one, please?

Sure, Dick.

I believe that they have made this decision and we have all sort of adjusted to it.

I think we are working in concert now.

So I do feel that once we move through, and I believe this next quarter, I think we will be able to work with our retailers on working our backlist, specifically.

But I do think that they have made the decision.

We have sort of felt the impact.

And going forward, I think we can figure out how to manage our business effectively working with them, so we will both have better net sales.

So I'm feeling positive about that as we move towards next year.

Okay.

Thank you very much.

Lauren Fine, Merrill Lynch.

I guess back on trade, Barbara, I'm wondering if you're feeling any change in the competitive landscape?

It's just my sense that other children's publishers have gotten more aggressive, maybe following in the tracks of Harry Potter, about promoting their books.

And so if you think that has any influence?

I guess maybe even a bigger picture, maybe the parent is just tapped out.

They are being hit in too many places.

So maybe the fact that clubs are up big is why continuities isn't and trade isn't.

So I don't know if you have a more kind of global perspective of that?.

Then, Mary, a question for you on CAPEX.

You're certainly trending lower this year.

I am wondering if you have any new CAPEX guidance for the year, or if you have already given it and I missed it.

Let me say in respect to overall interest in children's books, there is tremendous focus on reading in school.

There is a global demand for children's books.

I think Barbara will talk you a little bit about the trade scene.

But I think looking at it as a global business, we feel that children's books has a very strong future and a very strong presence.

I think there are issues about, in a big Harry Potter year, yes, there is a lot of money has gone, flowed into that.

School budgets are not robust.

That may be helping the book clubs some.

But I think as a business, we haven't seen the end of the growth of children's books in the U.S., and certainly as a global business it remains very strong.

Thanks, Dick.

I have to say yes, we have been observed for many years, and our fellow publishers are becoming more competitive.

That is one of the reasons, I think, that I feel it is an opportunity for Scholastic and for myself to get back in there and really more focused on the business.

I think it is a business that focuses on bestsellers.

I think we defined that with our Captain Underpantses and our Harry Potters.

So I think what, again, we have to do is sort of really have that balance, which we are trying to do; publishing wonderful books that will last forever; publishing more focused into the licensed product area.

And continuing with our Clubs and Fairs being our secret weapon to be able to find those properties that will really appeal to kids and become best sellers for kids first, and then for maybe parents and everyone else.

But to really sort of speak to the kids directly, we have to get back into that focus on our publishing.

And we're doing it.

Winston: On the CAPEX, please.

This is Mary to address the CAPEX question.

Yes, as you point out, CAPEX is down significantly from last year.

And that is largely because we invested in a new distribution facility last year.

At this point, we don't have any major significant plans to do anything of that magnitude in the near term.

So while I don't have a specific forecast for the CAPEX number for the coming year, at this point we don't have any major plans for significant investment.

So, we don't expect that to be a significant factor.

Great.

Thanks.

Steven Barlow, Prudential.

This is Scott Ritti (ph) for Steven Barlow; good morning.

Just two questions, one on the fairs.

You noted that I know that you have been focusing on sort of increasing the revenue per fair.

I noted is up 4 percent.

I was wondering if you could sort break out just the increase in revenue per fair that you had seen; and also whether or not there had been an increase in the quarter of the number of fairs that were held.

The second question just having to do with the Back to Basics toys catalog.

I was wondering if you could sort of give us an idea of how much revenue that contributed in the quarter.

Barbara, do you want to talk about the first question, please?

Sure.

This is a small quarter for fairs obviously.

Obviously our biggest quarters are our second and fourth quarter.

We really did sort of focus on putting our fairs, the growth in fairs into the fourth quarter.

Fairs were really just up a tad; and the focus was on revenue per fair.

On Back to Basics in the quarter?

On Back to Basics in the quarter, it was about 9 million in revenue.

Okay.

That's great.

Thank you.

At this time there appear to be no further questions in the queue.

I would like to turn the floor back over to the presenters for any closing remarks.

Thank you all for listening.

We obviously are disappointed by the quarter.

We think we have made effective plans for dealing with the issues.

We have made management changes.

We're seeking to correct the issues in the home and the trade business.

We think we have a strong business overall.

We're optimistic.

We realize we have to improve our forecasting and get a handle on both consistent and improved profitability as well as improved cash flow.

We will do that, and we will welcome your support while we're doing it.

Thank you very much.

Thank you.

That does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.