Scholastic Corp (SCHL) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Scholastic Q3 2010 earnings conference call.

At this time all participants are in a listen only mode.

Later we will conduct a question and answer session and instructions will be given at that time.

(Operator Instructions) As a reminder today's conference call is being recorded.

I'd now like to turn the conference over to your host, Mr Jeff Matthews, Vice President of Corporate Strategy, Business Development, and Investor Relations.

Please go ahead.

Thanks and good morning everyone.

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 and 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 markets, acceptance of the Company's products in those markets, and other risks and factors identified from time to time in the Company's filings with the Securities and Exchange Commission.

Actual results could differ materially from those currently anticipated.

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

Thank you, Jeff, and good morning and thank you everyone for joining us on our fiscal 2010 third quarter conference call.

This morning I'm joined by Maureen O'Connell, CFO and CAO, members of the executive team are also available to answer questions at the end of our comments.

Last quarter Scholastic again delivered improved results as we maintained our momentum towards significant profit growth and our goal of 9% operating margins if we reach the top of our guidance.

First as a result of higher year-to-date earnings and substantially reduced inventories, we generated $137 million in free cash flow for the first nine months of this year, we continued to pay down debt while returning cash to shareholders through a dividend and a $20 million share repurchase program authorized last December.

As a result of the end of the quarter we had a net debt level of only $26 million.

Maureen will provide further detail about this in a moment.

Second, strong growth in Scholastic Education combined with aggressive cost control across the Company helped us achieve solid overall operating results last quarter despite challenging prior year comparisons for children's books.

Third, based on these results and a solid outlook for the fourth quarter, we have narrowed our earnings guidance toward the top end of the range and increased our forecast for free cash flow.

Scholastic Education, the technology and solutions business within the educational publishing segment continued to achieve significant growth reaching more than $180 million in year-to-date sales of technology related products and services.

This is a 65% increase over the same period last year.

Our flagship reading intervention program, READ 180 continues to be a key source of growth.

System 44, the prequel to READ 180, which was launched in the third quarter of last fiscal year, also continues to do well while our math products, including Do the Math, are also selling briskly.

As a result of federal stimulus funding, along with excellent execution and new products, we are dramatically expanding and deepening our customer base creating a stronger platform upon which Scholastic Education will continue to build.

Sales in Scholastics Classroom and Library group held level last quarter overall and sales of core paperback collections for classroom libraries, and especially our guided reading program, rose solidly.

In the children's book segment, lower year-over-year revenue primarily reflected three key factors.

First, a year ago we recorded strong sales in the Harry Potter series driven by the tales of Beetle the Bard, a charity book by JK Rowling, which was launched in December 2008 and sold strongly in that quarter.

Second, last quarter, clubs continued to be affected by lower numbers of sponsors as experienced in the Fall when teacher reassignments in many schools reduced teacher use of clubs.

In contrast, March results have been in line with the prior year.

Third, severe winter weather reduced participation in clubs and fairs especially in February.

However, we have successfully rescheduled substantially all of our affected fairs to the fourth quarter.

Lower segment revenue cut into profitability in the quarter, partially offset by cost reductions and pricing.

Last quarter we also made progress toward key elements of our long term strategy in children's book publishing and distribution.

In Trade, our innovative multi platform adventure series, The 39 Clues, continued to show at the top of best seller lists.

Traditional series publishing was also strong.

The first two books in the Catching Fire trilogy by Suzanne Collins as well as Shiver, the first in the series by Maggie Stiefvater, have regularly topped best seller lists.

In School Book Clubs, we've expanded testing of New Cool and are seeing more parents placing online Club orders through their child's teacher, a key strategy for the Company.

We expect to have new COOL fully rolled out for the start of school next Fall.

In School Book Fairs, revenue per fair increased 2% in the quarter and customers have reacted very positively to our new incentive program as well as the initial rollout of point-of-sale equipment in two of our seven regions.

Overall, we were able to sustain strong momentum in the third quarter despite a challenging comparison and market.

With two months left in the fiscal year, we are narrowing earnings guidance toward the top end and increasing the free cash flow outlook above our original plan.

Most important, if we hit the top end of our guidance, we will achieve our longstanding goal of a 9% operating margin while we expand our e-commerce capabilities, prepare for the digital future, and build a significant educational technology business.

Now, Maureen O'Connell will review our third quarter results in detail and the outlook for the remainder of the year.

Thanks, Dick, and good morning, everyone.

As Dick has described, we achieved solid results last quarter, continuing our positive trend for fiscal 2010.

On an operating basis, excluding one-time items that are excluded from guidance and detailed on this slide, operating margins and earnings improved despite a modest decline in revenues.

The third quarter is typically Scholastic's second smallest quarter when we generate a loss.

Now, I'd like to review the income statement adjusted to exclude the one-time items I just described.

Revenues declined 6% primarily reflecting the prior years strong Beetle the Bard and Harry Potter sales in Trade and continued softness in clubs partially offset by higher sales of educational technology and services.

Cost of goods sold declined in absolute dollars and as a percent of sales relative to a year ago, when we contributed profits from Beetle the Bard to JK Rollins charity.

Last quarters rise in educational technology sales also contributed to higher gross margins.

SG&A also declined, primarily due to cost reduction efforts including reduced Club promotion spending and salary expense, partly offset by higher sales commissions and Scholastic Education.

Overall, the adjusted loss per share from continuing operations was $0.04 compared to $0.10 a year ago due to the continued Operations generated a smaller loss last quarter compared to a year ago.

This slide provides segment results on an adjusted basis excluding one-time items.

Significantly higher year-to-date free cash flow reflecting both higher cash earnings and working capital improvements.

In the quarter free cash flow held level with the prior year.

More efficient and better coordinated purchasing across channels, as well as a delay in some buying, continued to result in lower inventories which declined by $37.7 million relative to a year ago, excluding a $50 million impact of foreign exchange, inventories have declined by over $50 million or 13% relative to a year ago.

Higher free cash flow over the last four quarters reduced the Company's total debt and net debt.

As of February 28, 2010, net debt was $26.4 million down from $279.1 million a year ago.

This reflected significantly higher cash on hand as well as debt repayment and repurchases over the last 12 months.

We remain undrawn on our committed $325 million revolving credit agreement.

We continue to pursue efficient means of returning cash to shareholders.

As of yesterday, we have repurchased 128,000 shares for approximately $3.7 million under the $20 million share repurchase program authorized by our Board of Directors in December.

In total, year-to-date we have purchased 182,000 shares of stock for $4.8 million.

Yesterday, we also declared our fourth quarter dividend.

For the first nine months of fiscal 2010, year-to-date EPS is $1.58 per diluted share versus $0.48 a year ago excluding the impact of any one time items.

As Dick indicated, we are narrowing our outlook for the remainder of the fiscal year towards the top end of our original range.

In Book Clubs, revenues are expected -- revenue declines are expected to moderate.

In Book Fairs, total fair count is expected to be in line with the prior year and we continue to achieve modest revenue per fair growth and in Scholastic Education we're optimistic as we approach the big Summer selling season.

Last years' fourth quarter was strong and we were already benefiting from System 44, the California Adoption, and anticipated stimulus funding.

Therefore we expect moderated year-over-year growth.

On the profit side, we continue to benefit from cost reduction and salary reductions, but since those actions also benefited the fourth quarter of last year, we do not expect a year-over-year difference.

As we have discussed in prior calls, we do anticipate higher medical expenses, higher bonus accruals and increased amortizations associated with new educational products in the fourth quarter.

As a result, we expect overhead to be higher year-over-year in the fourth quarter.

Based on these factors we are narrowing our outlook to $2 to $2.30 per diluted share for continuing operations excluding one-time items.

As Dick indicated, if we reach the top end of this range, we will have achieved our long term goal of 9% operating margins.

This full year target compares to $1.28 per diluted share that we generated in fiscal 2009, excluding one-time items.

We continue to expect one-time expense in fiscal 2010 related to the UK restructuring of up to $10 million or $0.27 per diluted share after-tax, because the UK losses are not tax deductible.

This amount includes year-to-date restructuring expenses of $8 million or approximately $0.21 per diluted share.

Our outlook for free cash flow to exceed $120 million which was the top of our original guidance, reflects both higher anticipated earnings this year and in particular, our success in managing working capital.

As we have said, we do not expect fourth quarter working capital improvements to be at the level realized year-to-date when there was a significant inventory benefit due to the consolidation of the fair regions as well as the timing of purchases.

Furthermore, a tax benefit carried over from 2009 was realized in the first half and will not benefit the second half.

Thank you, Maureen.

With two months left in fiscal 2010, we remain focused on achieving our goals for the current year while building a strong plan for fiscal 2011.

As we have discussed key elements of our strategy include first, fiscal 2011 will be on important year for Scholastic as we continue to transition the Company to making more digital products which will be sold through our proprietary consumer and education e-commerce channels.

To that end we are further expanding our e-commerce through COOL and other consumer and teacher online stores.

We are also growing sales of digital products including educational technology as well as children's e-books which we expect to begin selling online by the end of calendar 2010.

Second, we will sustain the progress we've made in expanding margins and reducing costs over the past two years, maintaining the improved margins we have achieved this year combined with modest revenue growth will help us continue to improve earnings and free cash flow growth going forward.

In July, we will provide more detail about this plan including key goals and milestones for a digital business as well as our financial goals for fiscal 2011.

Now, I will moderate a question and answer period in addition to Maureen, I'm joined this morning by these Division Presidents, Ellie Berger of Scholastic Trade, Deborah Forte of Scholastic Media, Margery Mayer of Scholastic Education, Judy Newman of Scholastic Book Clubs and e-commerce, Hugh Roome with Scholastic international.

With that let's open the call to questions.

(Operator Instructions) Our first question comes from Drew Crum of Stifel Nicolaus.

Please go ahead.

Okay, great.

Good morning everyone.

Just wanted to start with the educational publishing business, if there's any update you can provide in terms of your outlook for federal stimulus and what are you factoring into your guidance in terms of capturing revenue from Race to the Top and the adoption opportunities both California last year, any residual sales there and I know you're not in Texas this year, but any opportunities there as well?

Thanks Drew.

I think Margery can answer those questions for you.

Hi, Drew, how are you?

Good.

So, with Race to the Top, as you know, only two states are awarded the first round of Race to the Top grants which were Delaware and Tennessee, and we're well positioned in both those states, but I don't think we see any immediate benefit from Race to the Top money in those two states.

I think that's going to be a longer time frame work for things.

In terms of stimulus, there's still stimulus out there.

We expect stimulus to benefit schools for at least the rest of this year in the next school year and in terms of adoptions, our businesses is stronger in California than one would expect from having reading the newspapers out there.

We have good traction with READ 180 and System 44, and in Texas in April we're submitting our new early childhood program, which we've been the leader in Texas in early childhood for the last couple of adoptions.

The schedule on that is submission in April, review in the Summer, and then the real revenue from that program in Texas is a full year away in the following Summer.

Okay, and just to follow-up on your comments and maybe Maureen you can chime in.

Just the thinking on federal stimulus.

Is it still kind of evenly balanced between fiscal 2010 and 2011?

Well, Drew as you know we don't give out our guidance for next year until July but as we said, we expect about half the growth this year is coming from stimulus funding and half really through great product and execution of the sales force, and we'll update you on our thinking come the July call.

Drew in terms of the timing on stimulus, I think it's a bit of a patchwork.

We've seen some states where we feel that a lot of the stimulus money has been used, but then there are other states which are still have quite a bit of stimulus to spend.

So I couldn't tell you how it divides exactly between the years but we do think there will be stimulus in the coming school year.

Fair enough.

Just shifting gears to international, if you take out the FX, it looks like the top line was down about 12%.

Can you talk about what you saw in the quarter and in addition to that, the UK charge year-to-date we're looking at I think about $8.5 million or $8.1 million.

Is the guidance still $7 million to $10 million for fiscal 2010?

Okay, first question regarding the decline in international, you're correct.

There was about $11.5 million impact from FX, so excluding that we're down 10 and primarily that was in Canada where we're down eight and we're down eight really similar to the US, there's softness in the Book Club area in Canada and fairs was also down.

And in Canada, unlike the US market, the Education System is going through changes, so there's a new education program being developed, so that has slowed sales in education within Canada.

As far as the UK charges, you're correct.

We've taken $8 million to date.

Our guidance was up to $10 million and we're still guiding to up to $10 million.

Okay, and then Clubs, I know you don't disclose margins or profitability, but can you just talk about directionally what you saw in the quarter relative to the revenue performance?

Well, I think we saw February was weak and that certainly affected the quarter but as we don't normally talk about our current quarter in this call, but we did since it's the end of March, we did indicate that March was improved.

We're holding our profitability despite the revenue declines, so the profit declines are not as significant as the revenue declines but we're expecting things are evening out a little bit in Club business this Spring.

Okay, and one last question.

Given the strong free cash flow, any update in terms of uses of cash?

Well, in December, at our last Board meeting, the Board reauthorized share repurchase programs so we have an open to buy of $20 million right now of which we still have a substantial balance left and as you know, yesterday we declared a dividend.

So we continue to look at reinvesting cash in our business and ways to enhance shareholder value and right now that's through stock repurchases as well as dividends.

Okay, thanks.

Our next question comes from Peter Appert of Piper Jaffray.

Please go ahead.

Thanks, good morning.

Margery, just a follow on on the growth in the ed tech market.

So Maureen mentioned half the growth stimulus related, half product related.

Can you give us anymore color in terms of how you see the drivers of sales growth in terms of specifically new products, or contributions of new products, growth in existing accounts versus penetration of new markets?

And then a separate question, Margery, what's next in terms of product that we could look for in fiscal 2010 and beyond in terms of revenue drivers?

Thanks.

Well, so let's see.

Well this year, READ 180 had a phenomenal year, Peter.

We were up on every metric of READ 180 both looking at the different components of the product, so we filled more stages, we sold more licenses, we sold more materials, also if you look at it by customer, we added a lot of customers in READ 180 and I think stimulus helped us there.

We had people that wanted to buy READ 180, but didn't have the funds and so when they got the stimulus money they could, I'll just give you an example.

In Vestavia, Alabama, which is very middle class district, high performing district, they've been wanting READ 180, they had a relatively small population of kids who needed it and thanks to stimulus they were able to buy it, and we heard that kind of story over and over again.

But in addition to READ 180 we've had great success with System 44.

Its been terrific, it's our best launch ever.

We're doing better with it in the beginning than we even did with Reed 180, so we're thrilled with that.

Do the Math, which is our math program we did with Marilyn Burns, has been really successful and we've sold it into all 50 states now which we think is an accomplishment.

And I need to mention the fact that our services business is up somewhere around 80% to 85% which is good for us not only in terms of revenue and profitability, but it is deepening our relationship with our customers.

So we're in a lot of school districts where we're providing coaching, ongoing professional development, feedback on data to our customers, so it's really marrying us to the customer in a new way.

In terms of looking forward at new products, I mentioned our early childhood program is coming and we're going to be selling it beginning this Summer.

We have two new math products that we're launching right now.

One is an assessment called the Scholastic Math Inventory, and we have a new product called Fraction Nation which is an intervention program in fractions and we have really good early sales on it.

We released it in February.

We're working on updates to READ 180.

We're doing more products in math.

We have a really rich pipeline coming out over the next couple of years.

Think about penetration, Margery, for the READ 180 product specifically.

Like how penetrated are we?

How penetrated the market is and therefore how big the remaining revenue opportunity is.

Well, I get asked this question every year and every year we're able to grow READ 180.

What we're seeing is if you take a look at how many districts we're in, we're in a much higher number of districts and I don't have the number in front of me right now, Peter.

I think we're saying we're in 20,000 classrooms or something like that, but what we're seeing is a lot of expansion in the districts that we're already in.

There are a lot of students in this country that need reading intervention and I think we've really cemented ourselves as the leading reading intervention company.

We had a great data coming out of the what works clearing house in the Fall and I'm not saying we're the only people out there, but we are the dominant player in reading intervention.

Great.

Thanks, Margery.

And then a question for Judy.

On the Club revenue numbers have been relatively static for a few years now and I'm wondering if that is just an indication that the interest level in this distribution channel has waned, teachers are using other tools to promote supplemental reading that structurally might just indicate maturation or decline in this market.

How do you think about that, Judy?

So, good morning, first of all, what we're doing really is we're managing this business strategically.

We're focusing on cost containment and really on profitability in the base business, but at the same time we're planning for growth online.

So just to recap for a second, this year, as Dick, said several things happened.

There was a lot of teacher reassignment in the Fall.

Teachers were dislocated.

They were in different schools and different grades and at the same time we were reducing our catalogs in circulation by 7 million and cutting back on our promotion program.

Again in that cost focused profitability focus on the base business strategy.

So given the dislocation of teachers we really had trouble kind of finding them in their new classrooms given the lower levels of promotion in the market.

So that was resulting in fewer sponsors, which were sort of suffering with all year.

But at the same time, our online results are very promising and we are really seeing tremendous reception by teachers and parents to COOL and new COOL and Parent COOL.

So we're seeing much higher levels of engagement with teachers and with parents and much more opportunities to connect with teachers and parents with more frequency, with deeper product selection, and really, I think it's showing a much, sort of reaffirmation of this business online.

That translates, Judy, into positive revenue comps as we get into fiscal 2010 then?

We're definitely focusing on revenue growth for the future from the online portions of the business, absolutely.

Okay.

And then Dick, last question for me.

I know you haven't given specific guidance for fiscal 2010, but what's your thought in terms of sort of the next target from a margin perspective?

Is it to sustain the margins at the 9% level or do you think there might be some further upside?

Well at the moment, Peter, we're happy to have moved them up toward our target range, 9% to 10%, so we're really pleased that we did that and we worked very hard as a Company to move them this past year, the current fiscal 2010 that we're in now.

For fiscal 2011, as I indicated in my preliminary remarks, we're focused on maintaining the margins while moving more sharply into digital distribution and digital product creation.

So our theme for next year is really continuing to transform the business into more digital opportunities while maintaining our margins and selling it smartly in our children's book business while expanding the tremendous operations that we have going in technology through Scholastic Education, as Margery has already described.

As we move that -- as that becomes the larger component of our revenues it's a higher margin business as you know, so that will also continue to help our margins.

Right, got it.

Thanks.

Thank you.

(Operator Instructions) Our next question comes from Barry Lucas of Gabelli & Company.

Please go ahead.

Great.

Good morning and thank you.

A couple of areas.

Just mechanically on the service part of the business, which is showing good growth and it's nice to see razor blades in effect being sold with the razors, could you just roughly size what percentage of the electronic or if you think of Education business in total, what does that represent?

Margery, we've discussed this before in round terms.

The question is what's the percentage of the total business reflected by services.

Yes, I think it's around 20% and one of our goals, as you mentioned, Barry, is to make sure that we have diversity around our READ 180 revenue.

So when we look at our READ 180 revenue, we consider services part of that diversity plan and also the replacement materials that come with READ 180, just ones saying that we published this year that's doing really nicely for us.

We published a supplement for English language learners and we call it the L-book and that's doing really well.

So as READ 180's base grows, we're also growing these residual revenues that go with READ 180.

Okay, that's great and maybe a couple comments on the E-reader?

It's early but I guess the big day is tomorrow or Saturday for Apple, so would you be willing to talk a little bit about what the prospects are of price points or anything that you think would be of help?

Well we're obviously watching this very carefully as is the rest of the world and we expect that we'll have some of our own e-book content on the iPad at some future time.

We're not in the initial launch, but obviously, the story is broader than the iPad because there are literally hundreds of devices coming into the e-reading market reflecting a fascination by everybody with what's going to happen with reading and how much of it is going to move to digital and we're also looking at that market very carefully.

And in our character as a distribution Company, Barry, we obviously have to maintain the relationships we have with our current customers even as they transition into the digital world.

So that's why we indicated in this call that we're going to have digital sales to our current customer base through our e-commerce proprietary channels in calendar 2010 and we're obviously expanding that as the market moves and focusing exclusively on our own children segment which has different characteristics from the adult segment and has received much less attention in the overall market than the adults so far.

Last area, great job on the balance sheet, the Company is as liquid as I can remember.

So where do you go from here and I know seeing some share repurchase dividends are nice, but when you think about the emphasis that you're putting on digital production and distribution products that you just described, watching this from the portfolio, what's out there in the world that you might like, what don't you have that you really need?

Well that's a good question.

I think most of our capability is internal and that is we have obviously -- we've been in the digital distribution business through our educational operations for a long time and our growth in education which you've been very close to, Barry, has been predominantly in educational technology.

So we're well acquainted with how to produce educational technology and technology in general and how to distribute it.

We also have a very sizeable internet operation with our scholastic.com has a billion page views a year, so it's a very primary distribution channel for now mainly free content but which we're migrating over to paid.

So most of the issues are human capital in digital distribution, it does take money to build e-commerce systems but most of it is really focusing on how you change over your processes internally, how you convert your customers into receiving material digitally, it doesn't require a huge additional investment beyond the infrastructure that we've already got.

Were there to be a really good acquisition in the educational technology area, we would certainly look at that.

In terms of our consumer, we think we are well positioned to make the investments and have the internal creativity and technological capability to get those things going without external help other than from IBM and the vendors and so forth and so on.

Great.

Thanks very much.

Thank you for sharing.

Thank you.

I'm showing no further questions.

I would like to turn the call back over to Mr Richard Robinson.

Well thank you all for joining our third quarter call.

As we said we will be updating you in July on our plans for fiscal 2011 and we're looking forward to talking to you then.

Ladies and gentlemen, that does conclude today's conference.

You may all disconnect and have a wonderful day.