Scholastic Corp (SCHL) 2007 Q3 法說會逐字稿

Good morning, my name is Tony and I will be your conference operator today.

At this time I would like to welcome everyone to the Scholastic third-quarter 2007 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period.

(OPERATOR INSTRUCTIONS).

Thank you.

It is now my pleasure to turn the floor over to your host Jeffrey Mathews, Vice President of Investor Relations.

Sir, you may begin your conference.

Good morning.

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'd also like to note that this presentation contains certain forward-looking statements which are subject to various risks and uncertainties including the conditions of the children's book and educational materials market 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.

Not I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin our presentation.

Good morning and welcome to our third-quarter call.

Thank you, Jeff, for the introduction.

This was a very good quarter in most areas of the Company.

Our core book business is strong and we've reached almost all the financial goals we have set.

The exception is in our continuities business where results have caused us to lower our full-year estimate.

This is disappointing as the Company is moving ahead strongly in our base business turnaround as well as in cost reduction and cash generation.

We do not like to reduce our estimate, but we are doing so because our continuity business is hitting some bumpy weather as we encounter different purchasing patterns from our Web source customers.

More of this later.

Let me review now the strong points of our quarter.

First, Maureen O'Connell joined the Company two months ago as Chief Administrative Officer, a newly created position, as well as being Chief Financial Officer.

Her extensive experience in the publishing, book distribution and direct marketing industries is already having a positive affect.

As CAO and CFO she's providing excellent leadership for finance, administration and operations and I believe this will help to improve efficiencies and financial results both in individual businesses and for the Company.

She's here with me on the call this morning; you will hear from her in a moment.

Also last quarter school book clubs continued their impressive turnaround.

Strong sales in core clubs and greatly improved efficiencies have caused the profits of this business to improve dramatically.

Scholastic Education also had a strong quarter with higher profits and margins.

Educational technology sales were up over 25% compared to a year ago driven by new sales and conversions of customers to READ180 enterprise.

Scholastic reading inventory and ReadAbout also had strong quarters.

International profits and margins also rose on improved results in the UK, Puerto Rico and export.

We also continue to see positive results in reducing costs as evidenced by lower corporate overhead and SG&A.

On the other hand, results in continuities were disappointing.

Though new products and Web-based acquisition channels continue to drive revenue growth, evidenced that we're providing a valuable service to young children and their parents, higher bad debt and promotion amortization hurt results.

You have heard me say before why we entered the direct to the home business more than six years ago.

By providing direct access to children below school-age -- and their families -- direct access to children below school-age and their families, Scholastic at Home plays an important role in the Company's overall strategy especially as families move to the Internet for their reading and learning resources.

For the first three years of our ownership the continuities business provided us outstanding profits.

In 2004, as a response to do not call legislation, we shifted our business model to focus on lower revenues and more creditworthy customers, and after a difficult period we stabilized this business.

Last year with strong new programs we began to grow the revenues and we began to migrate the business from print and phone source customers to Web source customers.

While the good news is that our Web source customers are responding to our offers, their subsequent customer behavior has shown a different pattern from our traditional customers causing higher bad debt and promotion amortization in the third and will be in the fourth quarter as well.

This is the cause of our down revision in our expectations for the year.

Right now we are taking action on all these issues in continuities and we are making a thorough going assessment of the outlook of this business.

We will update you in our July call when we'll have a secure plan for achieving longer-term growth and profitability in this business or we will outline other options for continuities.

On a brighter note, let's talk about Harry Potter.

Last quarter we announced a July 21st release date for Harry Potter and the Deathly Hallows, the seventh and final book in the phenomenal Harry Potter series.

The initial print run will be 12 million copies, the largest first printing in history topping the record 10.8 million first print run for Harry and the Half Blood Prince in 2005.

Deathly Hallows will have a cover price of $34.99, a slight increase from Half Blood Prince.

The marketing campaign for Deathly Hallows launches on April 17th and will include the bus national tour based on the same bus featured in the series that will visit 40 libraries in 10 major metropolitan areas and an extensive online and retail campaign built around the seven questions which you'll learn about soon.

This will culminate with midnight release parties around the country on July 21st, which have become a signature of the Harry Potter phenomenon.

Now it's my pleasure to introduce Maureen who will further discuss our quarter performance.

Thanks, Dick, and good morning, everyone; it's great to join you this morning.

Over the last two months I've had the opportunity to see the strength of our businesses firsthand.

I've visited our Jefferson City warehouse and fulfillment operations and saw the positive momentum we are achieving in book clubs.

In fact, we shipped 750,000 fewer boxes this year than last despite an increase in the number of orders.

I have also seen the configuration and packaging of READ180 which consist of books and technology as we prepare for our peak selling season.

In Jefferson City I had the opportunity to listen to inbound calls from teachers and parents.

In Lake Mary, Florida I visited our book fair operation, meeting with the team to discuss merchandising and category management for the upcoming spring season.

And of course I've spent time visiting our accounting and IT teams in New Jersey and our continuity team in Connecticut.

Overall I'm enthusiastic about the strength of our businesses and the opportunities that lay ahead.

My first area of focus is on partnering with the Company's business units to improve efficiencies and drive profitable growth.

And for those businesses that are not profitable enough, we need to rethink our operating models or develop plans to concentrate on those activities we do best.

I am also very focused on cost management and reductions at the corporate level as well as within the business units.

Our plan to reduce specific areas of overhead spending by $40 million is critical to achieving our margin goals.

It also offsets increases in postage, fuel, employee related expense and other cost areas.

We are on plan but more remains to be done.

We have a strong balance sheet and I'm focused on maximizing free cash flow, in particular by reducing inventory levels with a coordinated effort across the Company.

Progress was ongoing in all of these areas when I arrived.

I look forward to having more to say about specific accomplishments and targets in each of these areas on our year-end call.

Now turning to the third-quarter results.

As Dick said, most of our businesses across the Company, including clubs, fairs, educational technology and international, had very positive results.

Operating income rose $10 million on a $9 million increase in revenue showing significant leverage in SG&A and cost of goods sold.

Cost of goods sold improved partly as a result of higher technology sales and improvement in our clubs and fair businesses.

Lower SG&A largely reflected our progress reducing overhead spending and better promotion and fulfillment efficiencies in clubs.

These improvements were offset by other factors including higher promotion amortization in continuities, higher severance and higher stock based compensation expense.

Bad debt expense rose last quarter due to an increase in continuities.

In continuities bad debt as a percent of revenues rose to 25.2% as compared to 20.8% a year ago.

The results also included a pre-tax gain on the sale of an investment of $3 million.

Net loss for the quarter improved to $0.18 per share or $0.22 excluding the onetime gain from $0.37 a year ago.

Free cash flow in the quarter improved relative to the prior year, reflecting a lower net loss and strong working capital management during the quarter.

However, free cash flow was negatively impacted by lower pay rates and higher promotion spending in continuities.

These factors are also expected to impact the fourth quarter.

Net debt, which is debt minus cash, at the end of the quarter was somewhat higher due to the timing of Harry Potter related receipts and payments in fiscal 2006.

During the quarter the Company paid down approximately $260 million of 5.75% notes with cash on hand in existing credit facilities.

I am focused on helping the business units improve their profitability.

An immediate priority is our continuity business.

Scholastic at Home continues to be in transition, shifting from a business that markets primarily through mail and phone to one based on acquiring and building relationships with customers through the Web.

Seth Radwell, who recently became the President of Scholastic at Home, has a strong background in continuity marketing, especially on the Internet.

This experience along with his understanding of the Company's other Internet businesses will be vital to reposition this business for profitability in an Internet based environment.

We have begun a detailed analysis of the business.

Our initial conclusions are -- first, our strong top-line growth is very positive resulting from successful new products and the switch to the Internet.

New products like Scholastic Phonics have been particularly successful online.

Pay rates among new customers remain consistent and in line with our expectations.

Second, we have identified areas where we can adapt this business better to the fast-growing number of Web based customers who represent a key strategic opportunity for Scholastic at Home, as our traditional customer base declines.

However, this new customer segment behaves differently than our traditional customers and requires new billing, gunning and shipment processes.

Also, in order to maximize the lifetime value of Web based customers, we need promotions to upsell them online instead of through print and phone.

These issues have caused bad debt and promotion amortization to be higher among existing customers.

Combined with higher bad debt among new customers that we expected from the strong growth, this has had a large impact on our quarter's results which will continue into the fourth quarter.

We have taken immediate steps to act on these findings, strengthening the team, particularly in finance and credit, and making immediate corrections to our credit granting, payment and forecasting processes.

Furthermore, we have begun to develop a plan for promoting to our customers more effectively through Web based marketing and inbound phone.

We are committed to returning this business to profitability and will share our plan on the next call.

As Dick said, if we do not have a plan we believe in we will explore other options.

Now turning to the fourth quarter, we expect continued strength in our core children's book business; clubs will continue to benefit from lower cost on slightly lower revenues.

For our fair business, revenue per fair will continue to be strong and we remain on plan for a slight increase in fair count.

For Educational Publishing technology sales should continue to grow solidly.

For international we expect continued revenue growth and improved results in the UK, Canada, Australia and exports.

Overhead cost reductions are expected to be on plan.

For Scholastic at Home we will continue our in depth analysis, although we expect continued higher bad debt and promotion expense in the fourth quarter.

Based on our lower-than-expected third-quarter results and these assumptions we have updated our fiscal 2007 goals.

We now expect earnings per diluted share of $1.40 to $1.60 on revenues of 2.1 to $2.2 billion.

Free cash flow is now forecasted to be between 50 and $70 million.

Thank you.

Hello, this is Dick Robinson again.

As I said before, in most areas it was a very positive quarter.

Clubs showed a continued dramatic turnaround.

Educational technology sales rose more than 25%.

International profits and margins were higher.

Overall results improved compared to last year.

We expect these trends to continue in the fourth quarter.

As I said earlier, we will return the continuities business to profitability or explore other options.

We are confident that we will be able to come up with a good plan and to continue this important business, but if we can't of course we will look at other options for the business.

As we plan for 2008 we are looking forward to a great year in all of our businesses and we're very focused on the summer's launch of possibly the biggest book in history.

I'm confident we can execute another record-breaking release of course, but this won't be the end of the story for Harry Potter and readers around the world.

Continued strong Harry Potter sales show that the series is already a classic that has taught tens of millions of kids a love of reading.

We are proud to be the U.S.

publisher and know that Harry Potter will continue to be a best seller for many generations of children to come.

I will now moderate a question-and-answer period.

Several of our executives are here including Beth Ford, Senior VP of Global Operations and IT; Lisa Holton, President of Book Fairs and Trade; Margery Mayer, President of Scholastic Education; Judy Newman, President of the Scholastic Book Clubs; Seth Radwell, President of eScholastic and Scholastic at Home; Hugh Roome, President of Scholastic International are all here with me and with Maureen.

So let's transition to any questions that you may have about this quarter and the year.

(OPERATOR INSTRUCTIONS).

Stacy Fleck, Merrill Lynch.

Good morning.

I was hoping you could go into a bit detail on the promotion amortization.

I'm just trying to understand how -- it was really different than your expectations as I would have thought it would have been somewhat predictable.

Thank you, Stacey.

Obviously when the customer behavior is different you then expect you have to look at the future value of that promotion investment.

And if you can't see the future value of it based on current results then you need to write down that promotion and that caused a significant promotion write-down in the quarter.

Let me ask Maureen and/or Seth to explain that further.

What we do is, as you know; capitalize our promotion spending over the life of the program and the customer and the promotion.

So as we adjust our bad debt rate and our assumptions about performance we have to then look at that capitalization and whether it should be amortized faster.

And we did that in this quarter and determined that we did need to amortize faster because we had a decline in performance on the existing customer base.

And I guess is there any way to quantify the loss of continuities in the quarter and/or I guess for the full year are you expecting the loss in continuities to be greater or less than it was in fiscal '06?

It will be greater than it was in fiscal '06.

But, Maureen, do you want to answer that further?

Yes, the impact on this quarter was about $0.15 per share and so we would have had significantly stronger performance without that.

And is that the bad debt and promotion or just the promotion?

Bad debt and promotion.

And that was relative to our expectations.

That's very helpful.

Thanks.

And I guess just one last question.

On the international side revenue growth really slowed kind of sequentially from Q2 to Q3 and I was just wondering what was the reason for that?

Well, we're experiencing the benefit of the turnaround in our UK business which is contributing strongly to the growth as well as strength in Asia and exports.

The revenue turnaround, I'll ask Hugh to describe what happened.

And essentially Australia schools are not in session and in other parts of the world the book club and book fair business patterns were a little bit different.

But Hugh, do you want to take that further?

You'll note on the nine-month year-to-date we booked $320 million with $18 million of profit, up 8% in revenue and 85% on profit.

This is a somewhat slow quarter but really it's a seasonal factor based on the way we book some of our big export sales and we're expecting a very strong year.

And we tracked extremely well in Asia where our presence is growing and where we're building the scholastic channels.

Canada is quite strong, as you know, and Australia, which had had troubles a few years ago, is producing revenue growth and strong profits.

And then significantly we've got revenue growth and profit improvements in the UK.

So almost across the board international is growing and becoming a bigger part of the Company all the time.

Great, thank you.

Drew Crum, Stifel Nicolaus.

Good morning, everyone.

A couple questions on clubs and fairs -- and I apologize if I missed this.

But did you mention what they revenue growth was for core clubs relative to last year?

We didn't use a number for that.

But, Judy, do you want to talk about that?

Yes, good morning.

As you know, we're really pleased with club performance and the core clubs are running up about 10% right now and we're thrilled of course but this is happening on lower catalogs, a lower number of catalogs.

We've reduced the number of catalogs out there from about 100 at this point in time to about 60.

And so the customers are really responding to this program and getting their orders and of course this is resulting in all kinds of cost savings that we're seeing in improved profitability.

So it's a great customer experience and really realizing a lot of benefits on the P&L as well.

On the fair side, coming off the second quarter you had mentioned that there were some shifts then in the number of fairs moving into the second quarter.

How much of an impact did that have on your third-quarter results?

Lisa, do you want to take that question?

Sure.

Actually it had a fairly minimal impact on revenues.

Our revenue per fair growth continued to be strong last quarter.

Our fair count was actually fairly strong as well.

Okay.

Severance charges, if my numbers are correct here, are about $0.18 year-to-date.

I think your guidance was $0.10 to $0.15.

Are we going to see any additional severance charges in the fourth quarter?

And are these going to flow into fiscal year '08 as well as you institute the cost reduction program?

Maureen will take that question.

Your calculation is correct in terms of the impact year-to-date and we do expect some minimal impact in the fourth quarter because we're going to continue to refine our business and the number of people servicing our business.

However, we're not prepared to give any guidance jet related to next year.

Last question, I know there's a lot of focus on book seven.

Have there been any discussions with J.K.

Rowling on doing a subsequent book to Harry Potter?

Lisa?

I think if you follow the story and if you follow Jo Rowling's comments, it's pretty clear that book seven is the final book in the Harry Potter series.

I guess beyond Harry Potter, a different type of book, a children's book or some other novel?

She herself has stated that she will be writing more books.

She's a writer, it's what she does.

And contractually is she obligated to publish with you folks or can she go elsewhere?

I would say we're very happy to be her U.S.

publisher.

Okay, thanks.

Peter Appert, Goldman Sachs.

Dick, just a follow-up on the club business, 10% growth in the core business offset obviously by a decline in the operations you shut down.

So the overall revenue is sort of flat to down a little I guess in that business.

Does that business grow then as we get into fiscal '08?

And what do you think is a reasonable expectation in terms of top-line growth rate for that business over the next several years?

The club story for this year is really phenomenal.

We've shifted the business model and it's working beautifully.

Customers are happy, they're buying books, they're happy with our bonus plan.

We're operating the business more efficiently; the profits are more than returning to the business, they're really exciting.

We think that the future of this business -- and I'll ask Judy to amplify on this in a minute -- really is going to be determined in part by our new cool system which we're now developing which will be a next generation Internet ordering and marketing tool.

And as you know, while we haven't done a great deal more than just test this, we also have our credit card outreach to parents through parent cool through the book club process which offers other exciting alternatives for growth.

Judy, do you want to talk a little bit more about this?

I don't have a number to put on it exactly, Peter, but we're feeling really very positive about this business right now and it looks like it could return to some significant growth in my view over time.

Good morning, Peter.

I think now that we've got the business kind of well engineered and efficiently running and positioned nicely in terms of what the teachers expect we are of course positioning it for kind of modest revenue growth in the long-term with good higher margins.

But as Dick said, we are looking now at reinventing cool, our online ordering system for teachers, and that does open up an opportunity for us to work with parents online and develop a new robust relationship with parents ordering through book clubs online.

So we do see some opportunities for growth there to extend some of our offers and deepen the relationship with clubs.

So we do see some opportunity for growth there and just to continue to enrich the program, as well as use our database, marketing and segmentation to try to get deeper into some of the segments, a more customized offer.

Again, without going too specific and too customized which would cause some inefficiency, so it's always a balancing act to try to reach our market.

But now that we've got this machine running well we feel it's well positioned for that kind of nice modest longer-term growth.

So modest, Judy, would be maybe low single-digit kind of percentage growth rate?

I think low, modest, long-term, solid, predictable growth with good high margins is what we're going to say.

Okay.

And then unrelated to that -- on Harry Potter, given the higher price point should we assume that the profitability of this release could be perhaps -- just on a per unit basis I'm thinking -- meaningfully higher than the last one?

Peter, there are paper increases, printing, distribution, fuel cost.

So we're obviously going to do a very tight distribution job and manufacturing job as we've done before.

And we're also however looking at some increased security costs for the seventh book.

So we believe that the increased price will certainly cover the cost increases; how much more there will be left after that I think is questionable.

Lisa, do you have any further comment on that?

I would say our profit is in line certainly with our expectations and also point out that we've just announced that we will be printing on paper that contains a minimum of 30% post consumer waste and 65% of the paper used in the first printing will be that certified forest stewardship council, so we've made a commitment to that as well.

Is the royalty rate the same this time as less time?

We don't really give that information, Peter, but there's no major change.

Great, thank you.

(OPERATOR INSTRUCTIONS).

Steven Barlow, Prudential Equity Group.

A quick one, could you give us Harry Potter sales in the third quarter?

Yes, just a minute, Peter, Lisa Will answer that.

Steve, I mean -- sorry.

That's okay.

While Lisa is looking for that --

Actually I can answer you, I'm sorry.

I would just like to say that year-to-date we've actually had sales on Harry Potter of $15 million, $5 million of that was in the third quarter, but we're very happy with $15 million year-to-date.

I think that's a great -- it's a great signal for Harry Potter going forward.

That's great.

And for Marjorie, educational tech sales up 27%, the profitability of the division didn't really change all that much the loss.

A little bit minor -- why are we not seeing any margin out of those tech sales?

First of all, Steve, there's some decline in the classroom library and library business because in that supplemental segment sales are harder to come by and the whole supplemental industry has been tough this year.

So that's the principal reason of some offsetting profit losses in the supplementary segment.

Steve, I think that's really the answer there.

We were really, really happy that we had such good technology sales in the quarter.

We have made some investments in implementation support for our customers and we think that that is -- that we're having a great response to that and that's helping us build more sales in our customer base and more expansions.

So that's really on strategy and on plan.

Okay.

Then just lastly, on inventory, it was down sequentially from the last quarter by about $5 million or so.

Maureen, is there more to do in inventory?

This has been an area that's sort of been bothering me for the last couple of quarters.

Is there more to do there?

We're very focused on our inventory levels and bringing those down.

And you do see some progress that we made sequentially in the quarter and that was really in our trade and book club businesses as we really focused on reusing where we could and moving the inventory through the system.

And we will continue to focus across all our businesses and have a coordinated effort towards how do we reuse project in multiple channels and drive inventory levels down.

It bothered us too, Steve, and we were happy to see progress in this quarter, as you were.

Very good.

Thank you.

Brandon Dobell, Credit Suisse.

Maureen, any future impact from the changes you guys made to the amortization on the promotion expenses?

Did it pull anything forward or is this going to be kind of a quarterly determination based on current behaviors?

Well, let me first say we didn't change our method for accounting in any way and we didn't change how we look at amortization from any other quarter in the past.

But what we do do since we capitalize and we're looking at a long-time value of the customer, we have to look every quarter and honestly every month and say is the value there in the future and does that justify us continuing to capitalize?

And if it's not there we amortize that to expense and that's exactly what we did this quarter.

So more of a real-time time thing.

If the behavior improves you could see a lengthening of the amortization schedule and the reverse being true next (multiple speakers).

Right, but our expectation at this point is that we will continue to see a higher amortization expense next quarter in the fourth quarter.

Same kind of question for bad debt, any changes to the way you guys have calculated or think about bad debt or is it just because of --?

Again, our accounting and our methodologies for looking at bad debt are exactly the same and consistent with how we've done it historically.

We are obviously spending a lot of time trying to analyze it from multiple directions, but we haven't changed our accounting processes or systems in any way.

But since we have seen a deterioration in performance we expect that will also have an impact next water.

Plus we have much stronger response in front-end on the Web which with higher sales comes higher bad debt.

Over in the education segment's library segment, with the coming couple three years of a pretty good option market, there may be some more state spending out there, does that change how you guys think about the opportunities for classroom or library spending or is it more specific to what's going on with the libraries versus the overall spending environment?

I think the libraries continue to have a reduced amount of money to spend.

Offsetting that slightly is they've become the hub of technology in many schools.

So it cuts a little bit both ways there.

The increased adoption cycles will probably benefit us in the educational technology segment as well as some new programs that Marjorie is going to be bringing out in that area.

In the supplementary business, it's very cyclical depending on the product that you have and the marketing that you're doing at any one time.

And even though the overall market probably will continue to be soft, I believe we can make more headway in that market with new product and some increased aggressive marketing.

And then finally in the fairs business, any changes in terms of the mix of things that you're seeing customers buy, software versus books, other products?

I'm just trying to get a feel for what the margin -- A, what the revenue impact might be, but also what the margin impact might be if there are any changes?

Lisa, do you want to tackle that question?

I would say there's not a significant change in the product mix in terms of revenue.

It's actually been fairly constant.

I would say that we actually in the past year, in the past probably 18 to 24 months are doing an even better job of looking at timely sales data.

So in terms of our category mix and our merchandising and understanding what's selling and being able to react in terms of our buying strategy, I think that's certainly one of the contributing factors to the revenue per fair strength.

You would expect that nonprint media would be increasing and occasionally we see that pattern, but at this moment it does not appear to be a strong increase in nonprint sales through the fairs or the clubs.

Great, thanks a lot.

Thank you.

At this time I would like to turn the floor back over to Dick Robinson for any further or closing remarks.

Thank you very much, all.

We appreciate your support.

We are of course disappointed with the downward revision and our expectation for the year, especially at a time when most of our businesses are doing extremely well and we're feeling very optimistic about the future.

So we thank you for listening to our explanation.

We thank you for your continued support.

We will not of course reappear to talk to you again until the July meeting which is our year-end results.

And we look forward to telling you about the continuities as well as the rest of our business at that time.

Thank you very much.

Thank you.

This does conclude today's Scholastic teleconference.

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