Scholastic Corporation F3Q10 (Qtr End 02/28/10) Earnings Call Transcript

| About: Scholastic Corporation (SCHL)

Scholastic Corporation (NASDAQ:SCHL)

F3Q10 Earnings Call

April 1, 2010 8:30 am ET


Jeff Mathews - Vice President of Corporate Strategy, Business Development, and Investor Relations

Dick Robinson - Chairman, CEO, and President

Maureen O’Connell - CFO and CAO

Ellie Berger - Scholastic Trade

Deborah Forte - Scholastic Media

Margery Mayer - Scholastic Education

Judy Newman - Scholastic Book Clubs and ecommerce

Hugh Roome - Scholastic International


Drew Crum – Stifel Nicolaus

Peter Appert – Piper Jaffray

Barry Lucas – Gabelli & Company


(Operator Instructions) Welcome to the Scholastic Q3 2010 Earnings Conference Call. I’d now like to turn the conference over to your host, Mr. Jeff Mathews, Vice President of Corporate Strategy, Business Development, and Investor Relations.

Jeff Mathews

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,, clicking on Investor Relations, and following the links from 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, 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 will introduce Dick Robinson, the Chairman, CEO, and President of Scholastic to begin our presentation.

Dick Robinson

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, at 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 Scholastic’s classroom and library group held level last quarter overall and sales of core paperback collection for classroom libraries, and especially our guided reading program, rose solidly. In the Children’s Books segment, lower year over year revenue primarily reflected three key factors. First, a year ago we recorded strong sales of the Harry Potter series driven by the The Tales of Beedle the Bard, a charity book by J.K. 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 teach 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 for 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 towards key elements of our long term strategy in Children’s Books 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. 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 long standing goal of a 9% operating margin while we expand our ecommerce 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.

Maureen O’Connell

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 year strong The Tales of Beedle the Bard and Harry Potter sales and trade and continued softness in clubs, partially offset by higher sales at Educational Technology and Services.

Cost of goods sold decline in absolute dollars and as a percent of sales relative to a year ago. When we contributed profits from The Tales of Beedle the Bard to J.K. Rowling’s charity. Last quarter’s rise in Educational Technology sales also contributed to higher gross margin. SG&A also declined, primarily due to cost reduction efforts including reduced club promotion spending and salary expense, partly offset by higher sales commissions in Scholastic Education. Overall, the adjusted loss per share from continuing operations was $0.04 compared to $0.10 a year ago. This 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 $15 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 un-drawn 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 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.

In Scholastic Education, we’re optimistic as we approach the big summer selling season. Last year’s 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 $2.00 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.

Dick Robinson

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 an 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 ecommerce channels.

To that end we are further expanding our ecommerce 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 eBooks 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 our 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, Scholastic Trade, Deborah Forte, Scholastic Media, Margery Mayer, Scholastic Education, Judy Newman, Scholastic Book Clubs and ecommerce, and Hugh Roome, Scholastic International.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from Drew Crum – Stifel Nicolaus

Drew Crum – Stifel Nicolaus

I wanted to start with the Educational Publishing business if there’s any update you can provide in terms of your outlook for Federal Stimulus. What are you guys factoring in to your guidance in terms of capturing revenue from Race to the Top and any key adoption opportunities both California last year any residual sales there? I know you’re not in Texas this year but any opportunities there as well.

Margery Mayer

With Race to the Top, as you know only two states were awarded the first round of Race to the Top grants which were Delaware and Tennessee. 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 framework 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 and the next school year. In terms of adoptions, our business is stronger in California than one would expect from reading the newspapers out there. We have good traction with READ 180 and System 44.

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.

Drew Crum – Stifel Nicolaus

The thinking on Federal Stimulus does it still evenly balance between fiscal ’10 and ’11?

Maureen O’Connell

As you know, we don’t give out our guidance for next year until July. 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. We’ll update you on our thinking come the July call.

Margery Mayer

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 still have quite a bit of Stimulus to spend. 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.

Drew Crum – Stifel Nicolaus

Shifting gears to International, if take out the FX looks like the top line was down about 12%. Can you talk about what you saw in the quarter? 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 to $10 million for fiscal ’10?

Maureen O’Connell

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 million. Primarily that was in Canada where we’re down $8 million and we’re down $8 million similar to the US there’s softness in the Book Club area in Canada, Fairs is also down. In Canada, unlike the US market, the Education system is going through changes and so there’s a new education program being developed and so that has slowed sales in Education within Canada.

As far as the UK charges, you are 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.

Drew Crum – Stifel Nicolaus

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

Dick Robinson

I think we saw February was weak and that certainly affected the quarter. As we don’t normally talk about our current quarter in this call but 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. We’re expecting that things are evening out a little bit in Club business this spring.

Drew Crum – Stifel Nicolaus

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

Maureen O’Connell

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


Your next question comes from Peter Appert – Piper Jaffray

Peter Appert – Piper Jaffray

A follow on, on the growth in the Ed Tech market. Maureen mentioned I think half the growth Stimulus related, half product related. Can you give us any more color in terms of how you see the drivers of sales growth in terms of specifically new products, growth in existing accounts versus penetration of new markets?

What’s next in terms of product that we could look for in fiscal ’10 and beyond in terms of revenue drivers?

Margery Mayer

This year READ 180 had a phenomenal year. We were up on every metric of READ 180 both looking at the different components of the products so we’ve 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 give you an example. In Vestavia, Alabama, which is a very middle class district, high performing district, they’d 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. We heard that kind of story over and over again.

In addition to READ 180 we’ve had a great success with System 44. It’s been terrific; it’s our best launch ever. We’re doing better with it in the beginning than we even did with READ 180 so we’re thrilled with that. Do the Math, which is our math program that we did with Marilyn Burns, has been really successful, we’ve sold it into all 50 states now which we think is an accomplishment.

I need to mention the fact that our services business is up somewhere around 80% or 85% which is good for us not only in terms of revenue and profitability but it is deepening our relationship with our customers. We’re in a lot of school districts; 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; we’re going to be selling beginning this summer. We have two new math products that we’re launching right now. One is an assessment call the Scholastic Math Inventory. We have a new product called Fraction Nation which is an intervention program in fractions, we have really good early sales on it, and 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.

Peter Appert – Piper Jaffray

Think about penetration for the READ 180 products specifically?

Margery Mayer

How penetrated are we?

Peter Appert – Piper Jaffray

How penetrated the market is and therefore how big the remaining revenue opportunities?

Margery Mayer

I get asked this question every year. 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. I don’t have the number in front of me right now. I think we’re saying we’re in 20,000 classrooms, something like that.

What we’re seeing is we’re seeing 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. I think we’ve really cemented ourselves as the leading reading intervention company. We had great data coming out of the What Works Clearinghouse in the fall and not saying we’re the only people out there but we are the dominant player in reading intervention.

Peter Appert – Piper Jaffray

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

Judy Newman

What we’re doing really is we’re managing this business strategically. We’re focusing on cost containment and really unprofitability in the base business. At the same time we’re planning for growth online. 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, different grades, and at the same time we were reducing our catalogs and circulation by seven million and cutting back on our promotion program. Again, that cost focus profitability focus on the base business strategy.

Given the dislocation of teachers we really had trouble finding them in their new classrooms, given the lower levels of promotion in the market. That was resulting in fewer sponsors which were suffering with all year. At the same time, our online results are very promising and we’re really seeing tremendous receptivity 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. Really I think it’s showing a much reaffirmation of this business online.

Peter Appert – Piper Jaffray

That translates into positive revenue comps as we get into fiscal ’10 then?

Judy Newman

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

Peter Appert – Piper Jaffray

I know you haven’t given specific guidance for fiscal ’10 but what’s your thought in terms of the next target from a margin perspective? Is it to sustain the margins of 9% level or do you think there might be some further upside?

Dick Robinson

At the moment, we’re happy to have moved them up toward our target range 9% to 10%. 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 ’10 that we’re in now.

For fiscal ’11 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. 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’s already described.

As that becomes a larger component of our revenues, that’s a higher margin business as you know, so that will also continue to help our margins.


Your next question comes from Barry Lucas – Gabelli & Company

Barry Lucas – Gabelli & Company

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?

Dick Robinson

We’ve discussed this before in round terms. The question is what’s the percentage of the total business reflected by services.

Margery Mayer

It’s around 20% and one of our goals as you mentioned is to make sure that we have diversity around our READ 180 revenue. 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 one thing 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. As READ 180 space grows we’re also growing these residual revenues that go with 180.

Barry Lucas – Gabelli & Company

On the e-reader, it’s early but big day is tomorrow or Saturday for Apple. Would you be willing to talk a little bit about what the prospects are or price points or anything that you think would be of help.

Dick Robinson

We’re obviously watching this very carefully as is the rest of the world. We expect that we will have some of our own e-book content on the iPad at some future time. We’re not in the initial launch. Obviously the story is broader than the iPad because there are literally hundreds of devices coming into the e-reading market, reflecting the fascination by everybody with what’s going to happen with reading and how much of it is going to move to digital.

We’re also looking at that market very carefully and in our character as a distribution company, we obviously have to maintain the relationships we have with our current customers even as they transition into the digital world. That’s why we indicated in this call that we’re going to add digital sales to our current customer base through our ecommerce proprietary channels in calendar 2010. We’re obviously expanding that as the market moves in focusing exclusively on our own children’s segment which has different characteristics from the adult segment and less attention in the overall market than the adults so far.

Barry Lucas – Gabelli & Company

Great job on the balance sheet, the company is as liquid as I can remember. Where do you go from here, I know seeing some share repurchase, dividends are nice but we think about the emphasis that you’re putting on digital production distribution products that you just described. What’s missing from the portfolio, what’s out there in the world that you might like, what don’t you have that you really need?

Dick Robinson

I think most of our capability is internal, obviously we’ve been in the digital distribution through our Educational operations for a long time and our growth in Education, which you’ve been very close to, has been predominantly in the Educational Technology. 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 had 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.

Most of the issues are human capital in digital distribution. It does take money to build ecommerce systems. 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.


I’m showing no further questions and would like to turn the call back over to Mr. Richard Robinson.

Dick Robinson

Thank you all for joining our third quarter call. As we said, we will be updating your in July on our plans for fiscal 2011 and we’re looking forward to talking to you then.


That does conclude today’s conference. You may all disconnect and have a wonderful day.

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