Scholastic Corp (SCHL) 2008 Q1 法說會逐字稿

Good morning.

My name is Jackie, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Scholastic first quarter 2008 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

Thank you.

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 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 companies 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'd like to introduce Dick Robinson, the Chairman and CEO and President of Scholastic, to be in our presentation.

Thank you, Jeff, and welcome everyone to Scholastic's earnings call and presentation for the first quarter of fiscal 2008.

I'm joined by Maureen O'Connell, Scholastic's Chief Administrative Officer and CFO who will speak after me, and at the end of the presentation we'll both be available for questions as will members of our executive team.

What a terrific first quarter this was, with the amazing sale of more than 12 million copies of Harry Potter and the Deathly Hallows adding nearly $225 million in revenues to our first quarter, normally our smallest revenue period in the year.

According to all reviews and the universal praise which greeted this book, Harry Potter and the Deathly Hallows is a classic and a fitting finale to this amazing series.

But phenomenal sales also reflect an exceptional promotion and marketing campaign which contributed to overwhelmingly favorable publicity.

Nearly flawless execution of our distribution strategy yielded the highest sell-through yet for the series, which at quarter end was up over 20 points relative to Harry Potter and the Half-Blood Prince, two years ago, along with the increase in cover price, this high sell-through made this the most profitable Harry Potter launch ever, as seen in our first quarter results.

This was Scholastic's last record breaking Harry Potter launch, but it has big implications for our future outlook.

First, it demonstrates our unique ability to publish quality children's books to make reading and learning fun and exciting and to distribute and sell books, however large the demand, with unmatched execution and efficiencies.

These competitive advantages in distribution and marketing capability both underlie our long term strategy to grow revenues, improve margins and create value for shareholders.

Last quarter, Harry Potter launch also impacts our outlook, because strong profit enables us to make planned investments this year to accelerate our strategy, and in particular, to make progress toward our 9 to 10% operating margin goal for fiscal 2010.

Reaching this goal will require $70 million in additional operating income relative to last year's.

We are pursuing four significant opportunities to fill this profitability gap.

First, we have committed to turning around or exiting the direct to home continuities business.

As we discussed in July, we're implementing major changes to reorient the business toward the web, and have set a goal to reduce losses by $20 million this year and achieve profitability next year.

We are closely monitoring the business and still must validate its strategy, however we have committed to exiting the business if we determine we will not meet this year's goal, and in either scenario, companywide operating margins will improve significantly.

Second we're making investments in leveraging Scholastic 's unique competitive advantages in scale as I just discussed in our core children's book business to grow revenues modestly but strongly increase profits.

We believe this will have a big impact on margins by 2010.

Here is how we are approaching this opportunity.

In clubs last year, we revamped our core business, resulting in a 50% increase in profit by streamlining promotion, increasing order size, and reducing shipping and postage cost.

This year with more than half of our club orders coming in through COOL, our online ordering system, we're investing in a second generation platform which will improve efficiencies and generate incremental sales by not only taking orders, but actively marketing and selling to teachers and parents online, again leading to more promotion and shipping efficiencies.

In fairs this year, we're investing in more point-of-sale devices to enable parents to pay by credit card, as well as expanding the use of the Internet to help schools better promote and merchandise their fairs.

This will help drive continued revenue per fair growth, which benefits margins, because large fairs are significantly more profitable than small ones, and we are also implementing best practices across the extensive network of warehouses, with a focus on raising margins at 20 under performing locations to at least medium levels.

In Trade, we're continuing our strategic focus on children's series, with Goosebumps Horrorland, a new series by R.L.

Stine, based on his original Goosebumps books.

Horrorland has a unique internet connection which become part of the overall story itself.

We are also publishing Allie Finkel, a new series for tweens by Meg Cabot, Author of Princess Diaries, and are excited about several new titles from Cornelia Funke.

Looking across all of Scholastic Children's Book businesses, we are beginning to implement a portfolio approach to optimizing pricing.

Previous pricing actions have focused on individual channels , however, we recently completed an in depth analysis of company sales data showing additional opportunities to increase prices and optimize profitability between channels.

We are now testing these new pricing strategies in this fiscal year for implementation next year.

The third major opportunity to reach our margin goals is an educational technology, where this year we are making significant investments to accelerate the growth opportunities in this higher margin business.

We invested in the sales organization, separating it into distinct educational technology and supplemental publishing segments, effective September 1st.

Now that it is focused exclusively on top down solutions selling to school districts, our curriculum sales force is better positioned to sell educational technology and core curriculum products which are proven to increase achievement and require extensive service, technical support and professional development.

The supplemental salesforce, on the other hand, benefits from a larger bag of products, including classroom magazines, classroom books, supplemental curriculum and Library Publishing, which it sells at the school level.

The two organizations continue to work together where a joint solution benefits the customer.

This change should drive sales productivity and has already been very popular with the salesforce.

This year, in this area, we're also increasing investment in new product development by nearly $20 million, prioritizing technology products that complement READ 180.

READ 180 targets the enormous opportunity to help children in Grades 4 to 12 whose reading is two or more grade levels behind, however significant numbers of students lack even basic phonics and decoding skills necessary to begin reading.

To address this need, we are developing System 44, based on the work of Marilyn Adams, the country's preeminent literacy and phonics researcher.

System 44 is a technology-based intervention program for grades 3 to 12 that assesses and builds awareness of the 44 phonemes in the English language.

We're very excited about this product both as a standalone solution and sold in connection with READ 180, and are currently targeting launch in the second half of next fiscal year.

Nevertheless we are already hearing from educators who are eager to have System 44 in their schools.

These planned investments in the sales organization and new products will slightly reduce Education segment operating profits for the remainder of this year; however, we expect profits to benefit next year and for the long term.

Finally our fourth opportunity to improve operating margins is through continued reductions in overhead spending and operating divisions and corporate functions as we achieve the $40 million annualized goal announced six quarters ago.

This too will help fill our margin gap and offset $15 million in anticipated post ge, shipping and paper cost increases in this fiscal year.

However, our goal of reducing overhead is never complete, with all support services now reporting to Maureen, we've begun exploring opportunities to consolidate functions, reduce redundancy and improve efficiency, so while this quarter has benefited enormously from the finale of the amazing Harry Potter series, we are using this opportunity to build our business for '09 and '10 when we are committed to achieving our operating margin targets, and we have the specific plan for doing so.

Along with growth opportunities in international and internet sales, this represents our answer to the question, "What will Scholastic do after Harry Potter?" Maureen will now comment on last quarter's results and this year's

Thanks, Dick, and good morning, everyone.

Scholastic started the fiscal year with a great first quarter, positioning us well to meet our fiscal 2008 plan.

As Dick described, the launch of Harry Potter and the Deathly Hallows was a record breaking success for Scholastic in terms of total sales, sell-through and profitability.

With the seven book series complete, sales of earlier titles including Sorcerer's Stone, the first, were also very strong last quarter, more than doubling from a year ago.

Total Harry Potter sales in the quarter were approximately $240 million compared to $5 million a year ago.

Scholastic's other businesses also made solid progress towards their fiscal 2008 goals last quarter.

Scholastic Education Achieved a 9% increase in educational technology sales in its primary selling season in the summer, despite continued soft spending on supplemental products, solid sales of READ 180, especially related support services and consumables led this growth.

FASTTMath also was up significantly in its third selling season, as it proves itself a powerful tool in the classroom to assess and build students' numerical skills.

Lower segment results reflected in offsetting decline in paperback sales and increased investments in the salesforce organization.

In International, results rose again last quarter, led by higher Harry Potter export sales and continued strengthen Australia.

Our Asian subsidiaries also continued to deliver improved results as they fund their own growth, and Scholastic Media, sales of interactive products were up significantly last quarter and strong sales of Clifford television program, for which expenses have already been amortized benefited the bottom line results.

In Continuities last quarter, modest revenue growth on the web was offset by higher bad debt from historical programs and losses increased slightly.

As Dick said, we are monitoring this business closely to validate the new strategy.

At this point, it's too early to tell if the new plan will yield sufficient results.

Regardless, we have taken additional actions to cut overhead, reducing the staff by 10% and controlling other discretionary spending.

We are also ready to pursue other options, including exiting the business should we not meet our goals this fiscal year.

Turning to the first quarter financial results, revenues rose significantly from higher Harry Potter sales.

In turn, higher Harry Potter-related expenses caused cost of goods sold as a percent of revenue to increase four points.

Selling, general and administrative expenses rose modestly on absolute basis, primarily due to Harry Potter-related spending; however, as a percent of revenues, SG&A declined by nearly 21 percentage points.

This illustrates the considerable operating leverage we obtained from high Harry Potter sales.

As a result, operating income and margins improved substantially.

Bad debt rose last quarter due to the Continuity business, where historical promotions resulted in bad debt as a percent of revenues of 31.8%, compared to 29.4% a year ago.

The loss per share last quarter was $0.07 improving significantly from $1.12 in the prior period.

The tax benefit associated with the loss would have been 37% due to FIN 48 and FAS 109 impact, however the net tax effect was 12.2, increasing our losses.

Free cash flow in the quarter was $129.7 million, free cash flow use $129.7 million compared to $147.9 million in the prior period, reflecting improved operating results and lower inventory, partially offset by higher Harry Potter-related net working capital.

Year-over-year inventories declined by 3%.

Following the accelerated share repurchase, we received 5.1 million shares last quarter, and may receive up to 1.1 million additional shares at the end of next month, with the final amount based on the average price of the common stock over the term of the ASR.

At this point, we do not expect to receive the full 1.1 million.

Net debt was $546.8 million at quarter end, up from $456.1 million a year ago, reflecting additional debt to finance the ASR, partially offset by strong free cash flow in the intervening 12 months.

Still at quarter end, the balance sheet was conservatively levered at a net debt-to-capitalization ratio of 37%.

Now, to review our fiscal 2008 guidance by segment.

In the children's book publishing and distribution, we've already achieved our full year goal for strong Harry Potter Trade sales.

While it's too early to update our outlook for clubs and fairs, we continue to expect fairs will show solid results in revenue per fair and improve results and margins as we focus on our most profitable fairs and drive consistent performance across our network of warehouses.

In clubs, we expect relatively level revenues in profit this year as we reinvest the benefit of further streamlined promotion spending into the next generation of COOL and position Clubs for future growth.

Having completed the summer selling season in the education business, we continue to anticipate year-over-year revenue growth in the segment for the remainder of the year, despite the soft spending environment.

However, segment profits will be down, reflecting significant investments in the sales organization and in new product development as Dick discussed.

In international we continue to expect revenue and profits will grow solidly across all businesses, and media, licensing, and advertising we expect revenue and profits to increase modestly throughout the remainder of the year.

Corporate overhead is expected to be higher for the remainder of this year, reflecting continued Harry Potter related expenses, hiring to fill critical open positions, higher stock-based compensation expense, and increased rents relative to last year.

These increases will be partially offset by overhead cost reductions.

To conclude, the first quarter results were strong and position us well to meet our fiscal 2008 goals, as set out in July.

Largely driven by the tremendous success with the launch of Harry Potter and the Deathly Hallows, these results will also fund significant investments this year in our long term strategy to increase margins, grow earnings, and maximize free cash flow, as Dick and I have discussed this morning.

Now with that, I'll turn the call back over to Dick.

Thank you.

Thanks, Maureen.

I'll now moderate a question and answer period.

I'm joined by most of the executive team including Lisa Holton, President of Fairs and Trade, Judy Newman, President of Book Clubs, Seth Radwell, President of E-Scholastic and Scholastic At Home and Hugh Roome, President of Scholastic International.

With that, let's open the call to questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Your first question is from Peter Appert with Goldman Sachs.

Hi, good morning, Dick, congrats on the great success with Harry Potter.

Thank you, Peter.

Do you have any early indications in terms of fair bookings in terms of just number of fairs, what it's looking like going into Fall season?

Fair bookings are good.

They're meeting our plan, but of course, only a few fairs have been held at this point, Peter.

Right.

But the bookings are fine.

Okay, so sort of up a percent or two?

Yes, it's in that range.

Okay, and then any very early results on club sales at this point?

Well, Judy was anticipating that you might ask that so she's ready to answer that one.

Thank you.

Good morning, Peter, how are you?

Good, thanks.

That's good.

Yes, we're kicking off the year and orders are coming in and as you've probably been reading in the press, Texas and Florida started school a little bit later, so that notwithstanding those orders are just starting to flood in now, but all things are looking good and we're off to a good back-to-school.

So it's early, as Dick said, but all things are good.

Okay, the average price increase going into the fall, what would it look like in the club business?

Right now, I think we're looking at about a 5% increase across-the-board.

Okay, thank you.

And then Dick, I'm not sure if Marjorie is there, but can you quantify the investment you're making in terms of the salesforce expansion, the new product introductions, and then just separately, this will be the last item, some comments on why the supplemental materials business do you think is so weak not just for you but broadly?

Well, we're making, we're investing somewhat in our sales organizations would be in the low single digits of millions of investment, but it's significant, Peter, in that we kept almost all of our salespeople, account executives but focused them on educational technology and core curriculum, which is around $170 million of our revenue.

The rest of the people, we expanded the Scholastic library salesforce to handle all of our supplemental products, including class books.

The supplemental market is periodic in the U.S.

And has been over the many years that I've followed it.

It tends to drop in cycles where there's heavy textbook adoptions and as you know in the last two years there have been a fair number of basal adoptions in California, Texas, and other states so typically that reduces the supplementary sales and then they come back up later on.

I think also some people have diminished their focus on this market and I think there's less effort going in the market overall than there has been in the last 20 years probably.

So we think that there's a great market share opportunity for us in this highly profitable segment of our business, and that's why we're expanding our effort in the supplementary market just at a time when the market is weak, because we know it will come back and we believe we'll be strongly positioned to get the benefit of that.

Okay, great.

Thanks, Dick.

Thank you.

(OPERATOR INSTRUCTIONS).

Your next question is from Drew Crum with Stifel Nicolaus.

Good morning, everyone.

A couple of Harry Potter questions if I might.

First on the revenue, which you reported at $240 million, was that specific to trade because you also mentioned strong export sales of Harry Potter, so I wonder if you could maybe --

Well the 240 is U.S.

Trade.

Okay.

But it includes both the new book and the backlist titles.

We haven't broken out the International sales but those were, much much much smaller but they were still greater than they were in prior years.

Okay.

Maybe sticking with International, obviously very strong top line growth there, just curious as to, I know seasonally less important period for you guys with that business but why operate it as a loss?

Any major swing factors there?

Hugh, do you want to address those questions?

Hugh Roome of International.

Drew, we had a great quarter, as you can see, up 26% in the top line and 50% plus on the bottom line in terms of reducing the loss, but in terms of our long time pattern the first quarter overseas as in the United States we're building inventory and preparing for the opening schools in almost all of our Markets except those in the Southern Hemisphere, Australia, New Zealand and Argentina.

The pace though, is very very positive for the year, and we believe that we're well on track for another very solid year.

Okay, maybe I can ask the question on Continuities.

You guys obviously got a plan in place.

At what point during the fiscal year do you make the determination that if things aren't working, they aren't working and you decide to pull the plug, when should we get a sense as to what direction you're going to be going with this business?

Well, we will update you every quarter on this, but obviously some of the, because this is such a long term, long tail type business, it's important to let these new web sourced promotions play out a little bit so that we can see their effect, but we're extremely conscious of the importance of resolving this business favorably for either continuing in it at a much lower loss and eventual profitability or exiting it as we have said.

Seth, do you want to add any thoughts to that?

Sure.

Hi.

Hi.

Good morning.

As you know, we're on track with our plan to reorient the business towards the web an we're stabilizing the segment to the business that traditionally have been losing money.

We do have slightly better revenue, and as Dick and Maureen had mentioned, profits were slightly down due to prior quarter performance on some of the traditional segments.

We are monitoring it closely, and we have, as Maureen mentioned, reduced some expenses this quarter by cutting some positions.

We will be continuing to monitor it closely throughout the rest of the year, and reporting back to you as we planned.

We have been monitoring all of our new segments online, especially since that is the direction that we're taking the business, both in terms of new customers we're bringing online as well as how well those customers are performing across the back end promotions that we're trying to up sell and cross sell them to, so we'll continue to report back to you in the upcoming quarters.

Okay, great.

One last one, Maureen.

The adoption of FIN 48 and FAS 109 created a $0.02 dilutive factor in the quarter.

What should we model or what should we think about going forward?

Well, the 109 part of that was about $0.01 which is a one-time item.

Okay.

And the FIN 48 impact was $0.01 and that's probably consistent each quarter.

So it's about $0.04 for the year.

Great.

Thanks, guys.

You're welcome.

Thank you.

(OPERATOR INSTRUCTIONS).

We'll pause for just a moment to compile the Q & A roster.

Your next question is from Catriona Fallon with Citi.

Yes, hi.

Good morning.

I wonder if you could clarify on the Harry Potter, if there's kind of, do you expect kind of an uptick in the back list now that you've had such a great release of the Deathly Hallows, do you expect the backlist to do better throughout the year, and then also if you could clarify your comments regarding the children's book guidance and you kind of commented that you've already achieved your full year outlook, but what do you expect for the rest of the year from that segment?

Thank you.

We achieved our results for Harry Potter, which is a very significant part this year of the children's book segment, but most of the rest of the children's book segment, the clubs and fairs are released second through fourth quarter businesses so it would be too early for us to say that we've achieved those goals because those businesses are just getting started, but on the question about the Harry Potter backlist, Lisa, do you want to tackle that one?

Sure.

Well, as you can see from our first quarter results, i will say that our backlist numbers actually exceeded our expectations as well, and what we saw is that many many people decided to go out and try to read the whole series before they experienced 7, so we do believe that the bulk of the sales for this particular year have already happened, although I will say A) we have a beautiful box set of all seven coming out at Christmas and we do expect some holiday sales, and certainly, our plan both throughout the year and throughout the coming years is to focus on new readers and help the eight and nine and 10 year olds who are just coming to Harry Potter for the first time but I will say for this year, our performance has exceeded our expectations and backlist and we're very very happy with it at the end of the first quarter.

Does that answer your questions?

Yes, it does, thank you.

Thank you very much.

Thank you.

I would like to turn the floor over to Dick Robinson for any additional or closing remarks.

Well obviously we're thrilled with the performance of Harry Potter.

We managed to achieve greater profitability from this launch than we have in the past, but as we said, the importance of this fiscal '08 is to take the wonderful performance of Harry Potter and use that momentum to build on our margin target plan, for we have committed to our shareholders to achieve 9-10% operating margin target in the '09, '10 period, and remarks today were really focused on telling you how we were going to do that.

Meantime, we were delighted and thankful to Jo Rowling, our wonderful author, for the wonderful performance of Harry Potter, which will be a classic for generations to come and thank you all for your attention today.

Thank you.

This does conclude today's Scholastic conference call.

You may now disconnect.