Scholastic Corp (SCHL) 2014 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by.

And welcome to the Scholastic third quarter FY14 earnings conference call.

(Operator Instructions)

As a reminder, today's conference may be recorded.

It's now my pleasure to turn the floor over to Gil Dickoff, Senior Vice President, Treasurer and Investor Relations.

Sir, the floor is yours.

Thank you very much, operator, and good morning everybody.

Before we begin, I'd like to point out what the slides for this presentation are available for simultaneous viewing on our Investor Relations website at investor.

Scholastic.com.

I would also like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the condition of the children's book and educational materials markets, and acceptance of the Company's products in those markets, and other risk factors identified from time to time in the Company's filings with the SEC.

Actual results could differ materially from those currently anticipated.

Our comments today include references to certain non-GAAP financial measures as defined in Regulation G. The reconciliation of these non-GAAP financial measures with the relevant GAAP financial information, and other information required by Regulation G, is provided in the Company's Earnings Release, which is posted on the Investor Relations website at investor.

Scholastic.com.

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

Thank you, Gil.

Good morning, and thank you for joining our third quarter 2014 analyst and investor conference call.

For this morning's prepared comments, I'm joined by Maureen O'Connell, CFO and CAO of Scholastic.

As you can see from our press release, the third quarter was a solid quarter for our children's book segment, driven by higher revenues in our School Book Clubs and fairs, and sales of our popular new trade releases through these channels.

We also had strong sales in our trade business, which may not be readily apparent, due to a favorable return adjustment taken in the prior year.

In our education business, our classroom and supplemental materials publishing segment showed growth over last year, but the educational technology and services segment experienced lower sales.

This was mainly due to the time and resources that were focused on the integration of our educational technology and classroom and supplemental materials sales forces in the quarter, which was largely completed during this quarter.

While sales and profits were down in the quarter after a very strong first half for education, year-to-date new product sales are strong, and our team is ready for the important summer and back-to-school season.

In our international segment, trade revenues in particular increased in Canada, Australia and the UK.

However, this positive performance was offset by the impact of foreign exchange rates.

I would like to point out that our results this quarter do include one-time non-cash items that favorably affected our results, but did not benefit our operating performance, which showed higher losses in the quarter.

These items are detailed in our press release, which Maureen will review later in the call.

With that overview, I'll now review our segment performance in more detail.

Children's book results were driven by standout new releases sold through our school book club channels, as well as to the trade.

In our discussions with parents and teachers, we are finding that more and more, parents and teachers are encouraging children to read independently for pleasure.

And they are turning to Scholastic for help in finding great books in clubs and fairs, and through our classroom library channel.

Reading for pleasure, always important, is becoming an even more valuable practice, as it both helps to develop critical thinking skills and provides an important balance to the more complex informational texts that are now part of a Common Core-driven curriculum.

This balance keeps kids motivated, encourages all readers and makes classrooms lively and inspiring.

In book fairs, we grew revenue per book fair despite lower foot traffic at certain fairs due to severe winter weather conditions, particularly in the Southeast.

Some rescheduled fairs were held late in the quarter, and we expect revenue benefits to carry over into the fourth quarter.

Our improved book club performance was driven by strong titles such as Minecraft and LEGO, but even more so by new catalog promotion strategies and marketing initiatives, which led to the higher revenue per order.

This sparked a 9% growth in club revenues for the quarter.

As noted, there is also definitely an upbeat mood in schools about reading for motivation and pleasure, as well as for information and understanding.

So Scholastic's approach to reading is being supported by teachers who seek out books through our club and fair channels.

In trade, we had robust sales of the I Survived Series by Lauren Tarshis, the Minecraft Essential Handbook, LEGO, The LEGO Movie, which has been on the New York Times children's bestseller list for seven weeks now, and the second book in the multi-platform Spirit Animals series.

The Hunger Games Trilogy sales continued to perform in line with our expectations.

And as we look ahead, we are very excited also about our new releases.

For example, our new David Baldacci book, The Finisher, was recently released to wide acclaim, and is already number one on the New York Times children's bestseller list.

And the Red Stone Handbook, the second book in the popular Minecraft series, will be released on March 25.

And the paperback edition of Mockingjay, the final book of The Hunger Games Trilogy, also began to ship late last month as a lead-up to the third movie in fall 2014.

In media licensing and advertising, our much-loved franchises are becoming even easier for children to get to know and love, as streaming service subscriptions and electronic sell-through sales grow.

For example, kids can easily watch the Evergreen shows in our TV programming library wherever and whenever they have access to the Internet.

We're also pleased to start production next month on the Goosebumps Movie for Sony, starring Jack Black.

Goosebumps is one of the bestselling global children's book and TV series of all time.

Between now and the March 2016 film release date, we will start to enlist a new generation of Goosebumps readers, but we expect any film-related impact on book sales to be realized closer to the March 2016 film release.

In our education business, the third quarter is typically a small revenue quarter, during which our performance this year was temporarily affected by the combination of our educational technology and classroom and supplemental materials sales teams.

Product sales slowed, especially READ 180, during the integration, as our field sales team adjusted to new reporting relationships.

We are confident that our team is now ready to capitalize on the opportunities available to us during the summer and back-to-school season with our new products.

Scholastic's unified sales and marketing group will increase the number of salespeople in schools to market the resources and professional development teachers need to raise the bar for their students in math and language, and at the same time, effectively support their students who are struggling.

Our new products continue to receive great feedback in the field, and MATH 180 is on track for the best first-year performance of any Scholastic educational product launch.

In respect to the Common Core standards, we believe that educators have embraced the principles underlying the Common Core, and expect that it will continue to be a catalyst for our education business.

Our programs, such as READ 180 and MATH 180, will be more important than ever for the tens of thousands of educators who turn to Scholastic for the tools that consistently deliver great results and have proven to raise student achievement.

Our focus will be to continue to be on providing the professional training and service support, as well as quality instructional materials, that teachers need to help their students reach the new, more ambitious goals.

Our international segment posted strong trade results across our major markets and in Asia, where our direct to consumer business is benefiting from growing demand for English language learning.

In the UK, Canada and Australia, trade performance was driven by stronger sales of popular front list titles, including the Hunger Games Trilogy, as well as popular locally published titles such as Julia Donaldson's Superworm in the UK and Weirdo by Anh Do in Australia.

However, the higher revenues in local currency terms were more than offset by foreign exchange.

Scholastic remains on track to achieve our 2014 financial outlook.

Our results this year will be driven by our new products and increased demand for our customized learning solutions in education, and by our popular and engaging titles in children's books available through our channels.

We know that the call for more rigor in the classroom will drive growth in our education business and internationally, while we expect that the growing trend toward independent reading for pleasure is spurring more demand for Scholastic's strong lineup of books, and our motivational approach to reading and learning.

With that, I will turn the call over to Maureen to review the third-quarter financials in detail.

Thank you, Dick, and good morning everyone.

Let me begin with the income statement.

For the third quarter, revenues were up slightly, excluding unfavorable foreign exchange of $6.7 million.

Cost of goods sold increased about 1%, mostly due to increased cost of back orders in book clubs and lower educational technology product sales.

SG&A increased $0.3 million to prior year.

SG&A, excluding one-time severance charges in both periods, increased slightly.

Excluding one-time items, our loss per share was $0.68, compared to a loss per share of $0.56 a year ago, mainly due to declines in our education, technology and service business associated with the integration of the separate educational sales forces during the quarter.

The one-time items in the quarter included a tax benefit, as the result of a favorable settlement of federal tax audits of $13.8 million, or $0.43 per share, which was partially offset by a one-time non-cash charge of $4.7 million related to the write-down of a minority equity investment in the UK.

And $1.7 million of severance associated with the voluntary retirement program.

Consolidated loss per share was $0.38 in the quarter, compared to a loss of $0.63 a year ago.

Again, largely driven by these one-items.

As you know, the third quarter is a seasonally lower revenue quarter, and typically generates a loss.

Segment revenues in children's book publishing and distribution was $190 million, compared to $187.5 million last year.

Higher revenue per fair in School Book Fairs, along with an increase in the number of fairs held, drove a 3% increase in revenue.

In School Book Clubs, revenues increased 9% as a result of our successful catalog, mailing and incentive marketing strategies, as well as a strong title selection.

These results were offset by lower revenue for trade compared to last year, when we benefited from our return reserve adjustment for The Hunger Games.

As you may recall, these return reserve adjustments largely flow through to the bottom line.

Overall, children's books' operating loss was $10.6 million, compared to $9.9 million in the prior-year period.

In education, technology and services, segment revenue declined to $35.8 million from $41.8 million last year, due to the sales force integration, as Dick previously discussed.

Segment operating loss was $10.7 million, compared to a loss of $3.5 million last year, primarily as the result of lower READ 180 revenues, and higher pre-pub amortization on the products introduced earlier in the fiscal year.

In classroom and supplemental materials publishing, segment revenue was $44.5 million, compared to $43.2 million in the prior-year period, driven primarily by higher classroom magazine circulation.

Segment operating income was $1.3 million, versus a loss of $0.2 million in the prior-year period.

In our international segment, revenues fell to $91 million, from $94.4 million in the prior-year period, as a result of adverse foreign exchange.

The impact of foreign exchange masked better trade sales in our major markets and strong direct sales business in Asia.

Segment operating income was $0.1 million, compared to $2 million in the prior-year period, mainly due to sales mix and increased investment in our Singapore publishing business.

In media licensing and advertising, segment revenue improved to $12.2 million, compared to $11.7 million last year, as the result of higher sales of Parent & Child magazine.

This quarter's results also benefited from media revenues recognized from the production order for a new season of the Emmy Award-winning series WordGirl for PBS.

And programming library sales to Netflix and other streaming services.

Segment operating loss improved to $1.5 million from a loss of $2.2 million in the prior-year period.

Corporate expense was $11.2 million in the quarter, excluding one-time expenses of $1.7 million, compared to $10.6 million in the prior-year period, which excludes one-time expenses of $3 million.

In both periods, these one-time expenses were related to severance associated with our cost-cutting initiatives.

On the last day of the quarter, we closed the purchase of our headquarter property at 55 Broadway in New York City, for a net price of approximately $255 million.

To fund this purchase, we borrowed $175 million under our committed revolving credit facility.

We expect that this purchase will be accretive to cash flow, and intend to repay borrowings over time from operating funds and future proceeds from additional potential strategic uses of our wholly owned combined properties in SoHo, which include coveted retail space as well as our offices.

Rent expense and the related interest expense on capitalized lease will now be offset by higher depreciation.

The benefit to cash flow on an annualized basis will be approximately $6 million.

At quarter end, net debt was $157.7 million, as a result of the building purchase.

Even after funding the building purchase with cash on hand and incremental borrowings, there is ample room under our $425 million committed credit facility.

Our total balance sheet debt only increased by approximately $117 million, since the new borrowings were partially offset by a reduction of $58.3 million and capitalized lease obligations related to the cancellation of the master lease on the 555 Broadway building.

As we announced yesterday, the Board declared a regular quarterly dividend of $0.15 per share, which will be payable on June 16, 2014, to stockholders of record on April 30, 2014.

We did not purchase any shares in the open market during the quarter.

During the quarter, free cash use was $17 million, compared to free cash use of $51.5 million in the prior-year period, primarily due to lower capital expenditures and improved working capital.

We are firming our FY14 guidance.

We remain on track to deliver total revenues of approximately $1.8 billion, and earnings per diluted share from Continuing Operations in the range of $1.40 to $1.80, before the impact of non-cash one-time items such as the tax settlement, asset impairment charge, and severance costs related to our cost savings initiatives that I just described.

We expect FY14 free cash flow to be approximately $60 million to $80 million.

This outlook includes capital expenditures between $55 million and $65 million, and prepublication and production spending of approximately $65 million to $75 million.

And now, operator, we're open -- we're ready to open the call for questions.

(Operator Instructions)

It looks like our first question will come from the line of Drew Crum with Stifel.

Please go ahead.

Your line is now open.

Thanks.

Good morning, everyone.

So Maureen, I just wanted to start with a housekeeping question.

Can you quantify the impact from this return reserve adjustment in last year's trade number?

It's more than the total revenue decline.

So without the return reserve adjustment, revenue would have been up on the core business, and it flowed through almost 90% to the bottom line.

Okay.

Got it.

Very helpful.

Okay.

On educational publishing, aside from the sales force integration, and the new tech products you have in the market that have been a catalyst for sales, can you talk about just the overall macro conditions?

Are you seeing things get better with the impending implementation of Common Core?

Feels like the funding environment might be getting a little bit better as well.

Just wanted to get your thoughts around that.

Drew, we'll ask Margery to address that question for you.

Yes, Drew, I think funding is getting better.

Recently, 12 governors have supported increased funding for education.

I know you know about the $1.2 billion in California, and Jerry Brown is considering more money in California for implementing Common Core.

So overall, we expect funding to be positive going forward.

Got it.

Okay.

And then Maureen, going back to the building purchase, you're kind enough to quantify the impact on cash flow.

Can you give us a sense as to what the impact will be on the P&L?

Sure.

So our rent expense line item, which was in SG&A, will be a savings of $1 million.

But depreciation will go up about $4 million, and that will also have interest going down.

So the net impact is, you have a savings in rent and interest, but that's offset by higher depreciation and interest.

Okay.

I'll jump back into queue.

Thanks, guys.

Thank you.

Thank you, sir.

And it looks like our next question in queue will come from Barry Lucas with Gabelli & Company.

Please go ahead to your questions, please.

Thanks, and good morning, Dick.

Good morning, Barry.

I was hoping Margery might be able to extend the discussion a little bit on the macro.

I'm just hearkening back to Houghton Mifflin's call, where they were extremely upbeat about the adoption opportunities this year.

The ballpark number they're talking about is going north of $3 billion.

And just wondering if you can add a little bit more color to that, number one?

And number two, is there -- or are there any small adoptions or places where some of the newer products would fit, particularly in lieu of Common Core?

We're not quite as focused on the adoption business as -- certainly, as Houghton is.

We do benefit in certain places, which Margery will address, but we are -- we continue to have strong support from federal funding, both in IDEA and Title I, as you know, Barry.

And so we're looking forward to continuing to focus on that source of funding, as well.

And the states are doing better.

But Margery will be able to expand on that thought.

Hi, Barry.

It's Margery.

Yes.

So as Dick said, we don't really submit in very many adoptions; we're extremely selective about it.

Right now, READ 180 is listed in Florida, and we expect to be able to make some good announcements about what's going on in Florida with READ 180 in the coming months, but it's not the right time right now.

We -- our business -- our solution is so unique in what we do that it doesn't fit into adoption situations.

And we don't want to force it into adoption situations, where we get into shoot-outs on terms that were not designed -- our business isn't designed on.

Our business is really designed on comprehensive technology, profound and effective services, and raising achievement.

And that's just not what adoptions are about.

We do believe that Common Core is good for our business, especially as the new assessments roll out, because what we think we're going to see is that even more kids than was thought before are going to need intervention.

And we are the best choice for that; we have the most effective programs.

Dick mentioned MATH 180 in his comments.

We're getting a fantastic response to MATH 180, and we're going to be bringing out what we're calling Course Two of MATH 180 in the next fiscal year.

We already have people that are asking for it.

So we're extremely optimistic.

And also, I just want to mention one more thing.

As you can see in our numbers for the quarter, our book business is terrific in schools right now.

People realize that kids need to read books, as well as to dig into text under Common Core.

We see it in our clubs business, which is exciting, but we're also seeing it in our classroom business.

We are seeing it in people who have a big interest in summer reading for kids.

This is an exciting and energizing time for our business.

Great.

If I could ask two more.

One just, again, drilling down on the dislocation in educational technology sales and sales force integration, any specific or anecdotal comments you can make in terms of where the difficulties were incurred?

And I ask this in the sense that, you have more arrows in the quiver, more products that are being sold into this area than I think you've ever had.

And yet, despite the fact of the slow quarter, all of that, sales were down.

It just doesn't quite feel right.

So (multiple speakers).

Yes.

So integrating sales forces is hard work, and it takes time, and salespeople are suspicious people.

We started on the integration in November in a formal way.

And I think it took time for people to feel confident about what their jobs were going to be, and their territories, and who their boss was going to be.

And we think we've settled that out now, that that's feeling good.

We pick this time of year because it is our slowest time of the year.

This is our smallest quarter.

And in terms of our other products, a lot of those products are really back-to-school products.

MATH 180, Code X, iRead, those are not products that we anticipated having large mid-year implementations of.

So I think that -- we were disappointed.

We would have liked to see more sales in the quarter.

But we feel the fundamentals of our business are fantastic, and we're excited about going forward.

We had such a strong first half, too, Barry.

And we were excited by that, and the momentum was still there.

But as Margery pointed out, the major difference was the sales force focus on integration as opposed to selling.

And that didn't last very long, and we're back on track, and we think the momentum will continue.

The underlying demand for the products is very strong, and our selling ability is now multiplied because we have more people out in the field.

So I think we should -- we will see a strong season over the next three to six months, at least.

Okay.

Last item for me goes back to the building.

And the question would be, any way to size the opportunity?

I think I was just looking through some of the real estate trades that right nearby, Prada took a space on the ground floor at about $1,000 a foot.

So any way to put your arms around that?

And how much is surplus?

How much you can actually lease out, and what that would mean?

I think the good thing about the transaction is, we now own the entire facility in SoHo, which is on Broadway and Spring Street, which is one of the most attractive retail locations in the entire area.

And so with owning the full facility, we have a lot of flexibility.

And right now, we see a tremendous interest from many parties trying to contact us and look at options.

And we'll review those options and make the best possible decision for the Company.

Great.

Thanks, Maureen.

Thank you, Barry.

Thank you, sir.

Presenters, that does conclude our time for questions.

I'd like to turn the program back over to Mr. Robinson for any additional or closing remarks.

Thank you all for your support.

We're very happy about the strong performance of our children's book business.

We believe that the temporary drop in our education technology business will be reversed in the next quarter and beyond.

And we're happy for your continued support.

Thank you very much.

Thank you, presenters, and thank you, ladies and gentlemen.

Again, this does conclude today's call.

Thank you for your participation and have a wonderful day.

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