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Scholastic Corporation (NASDAQ:SCHL)

F3Q14 Earnings Conference Call

March 20, 2014 08:30 AM ET

Executives

Gil Dickoff - SVP, Treasurer and IR

Dick Robinson - Chairman, CEO and President

Maureen O’Connell - CFO and CAO

Margery Mayer - EVP and President

Analysts

Drew Crum - Stifel Nicolaus

Barry Lucas - Gabelli & Company

Operator

Good morning, ladies and gentlemen, and thank you for standing by and welcome to the Scholastic Third Quarter Fiscal Year 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today’s conference maybe recorded. Now, it’s my pleasure to turn the floor over to Gil Dickoff, Senior Vice President, Treasurer and Investor Relations. Sir, the floor is yours.

Gil Dickoff

Thank you very much, operator and good morning everybody. Before we begin, I'd like to point out that 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 risks and 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.

Dick Robinson

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 in services segment experienced lower sales, this was mainly due to the time and resources that we’re focused on the integration of our educational technology and classroom and supplemental material 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 onetime 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 through 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 and finding great books and clubs and Fairs and through our classroom library channel. Reading for pleasure always important is becoming an even more valuable practice as both helps to develop critical thinking skills and provides an important balance to the more complex informational tax that are now part of a common core driven curriculum. This balance keeps kids motivated, encourages all readers that makes classrooms lively and inspiring.

In book fairs we grew revenue per book fair despite lower foot traffic in certain fairs due to severe winter weather conditions in 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 catalogue promotion strategies and marketing initiatives which led to 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 pleasures 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 have 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 Best Seller 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, The Finisher was recently released to wide acclaim and is already number one on the New York Times Children’s Best Seller list and the Redstone Handbook, the second book in the popular Minecraft series will be released on March 25th and the paperback edition of Mockingjay, The Final Book of The Hunger Game’s trilogy also began to ship late last month as a lead up to the third movie in fall 2014.

The media licensing and advertising of 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 are also pleased to start production next month on the Goosebumps movie for Sony starring Jack Black. Goosebumps is one of the best-selling global children’s book and TV series of all time. Between now and March 2016 film release date, we will start to enlist a new generation of Goosebumps readers but we expect that 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 temporally affected by the combination of our educational technology and classroom supplemental materials sales team. 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 sales people in schools to market the resources in professional development teachers need to raise the bar for their students in math and language and at 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 program such as READ 180 and MATH 180 will be more important than ever for the tens of thousands of educators return to Scholastic for the tools that consistently deliver great results and have proven to raise student achievement. Our focus will continue to be on providing professional training and service support as well as quality instructional materials that teachers need to help their students reach their new more ambitious goals.

Our international segment posted strong trade results across our major markets 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 strong sales of popular front list titles including The Hunger Games trilogy as well as a popular locally published title such Julia Donaldson Super Worm 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 vigor in the classroom will drive growth in our education business internationally while we expect that the growing trend toward independent reading for pleasure is spurring more demand for Scholastic’s strong line-up 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 depth.

Maureen O’Connell

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 and book clubs, and lower educational technology products 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 the tax benefit as a 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-time items. As you know the third quarter is 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 and 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 catalogue 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 a 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 a result of lower READ 180 revenues and higher prepub 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 felled 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 by other 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 a result of higher sales of Parent and 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 to 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 it’s meant 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 bills and 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 fiscal 2014 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 cost related to our cost savings initiatives that I just described.

We expect fiscal 2014 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 ready to open the call for questions.

Question-and-Answer Session

Operator

Sure. Thanks. (Operator Instructions) And it looks like our first question will come from the line of Drew Crum with Stifel. Please go ahead, your line is now open.

Drew Crum - Stifel Nicolaus

Yes thanks. Good morning everyone. So Maureen I just want to start with the housekeeping question, can you quantify the impact from this return reserve adjustments in last year’s trade number?

Maureen O’Connell

It’s more than the total revenue decline, so without the return reserve adjustment, revenue would have been up on the core business, and a flow through almost 90% to the bottom line.

Drew Crum - Stifel Nicolaus

Okay, got it very helpful, okay. And then 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 fields like the fund environment might be getting a little bit better as well? Just wanted to hear your thoughts around that?

Dick Robinson

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

Margery Mayer

Yes Drew I think the 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 the funding to be positive going forward.

Drew Crum - Stifel Nicolaus

And then Maureen going back to the building purchase, you’re kind enough to quantify the impact on cash flow. Can you give a sense as to what the impact will be on the P&L?

Maureen O’Connell

Sure, so rent expense line item which was in SG&A will be a saving 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.

Operator

Thank you sir. And it looks like our next question in queue will come from Barry Lucas with Gabelli and Company. Please go ahead with your question please.

Barry Lucas - Gabelli & Company

Thanks and good morning Dick. I was hoping Margery might be able to extend the discussion a little bit on the macro. I am just harkening back to Houghton Miflin’s call, we’re extremely upbeat about the adoption opportunities this year the ballpark number they’re talking about is going north of $3 billion. I'm 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.

Dick Robinson

We’re not quite as focused on the adoption business as certainly as Houghton is, and we do benefit in certain places which Margery will address but we are -- we continue to have strong support from federal funding both in IDA and title 1 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.

Margery Mayer

Hi Barry it’s Margery, 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. Our business, our solution is so unique in what we do, it doesn’t fit into adoption situations and we don’t want to force it into adoption situations where we get in to shootouts on terms that are -- were not designed -- our businesses isn't designed, our business is really designed on comprehensive technology profound and effective services and raging achievement, and that’s just not what adoptions are about.

We do believe that Common Core is good for our business especially as new assessments roll out because what we think we’re going to see is that even more kids than we 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 2 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 in our clubs business which is exciting but we’re also seeing 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.

Barry Lucas - Gabelli & Company

If I could ask two more, one just again drilling down on the kind of dislocation on educational technology sales and sales force integration. Any specific or anecdotal comments you can make in terms of where the difficulties were incurred in, and I ask this in a sense that you have more arrows in the quiver, more products that are being sold into this area then I think you have ever had. And yet despite facts slow quarter all of that, sales were down -- it just doesn’t quite feel right.

Margery Mayer

So integrating sales forces is hard work and it takes time and sales people 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 are going to be and their territories and who their boss is going to be. And we think we 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 midyear implementations also. I think that we were disappointed, we would have like to see more sales in the quarter but we feel the fundamentals of our business are fantastic and we're excited about going forward.

Dick Robinson

We had such a strong first half Barry and we were excited by that and the momentum was still there but as Margery pointed out the major difference in 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 will see a strong season over the next three to six months at least.

Barry Lucas - Gabelli & Company

Okay. Last item for me goes back to the building and 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 product took a space on the ground floor at about a $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 means?

Maureen O'Connell

Well, I think the good thing about the transaction is we now own the entire facility in SoHo which is on Broadway in 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 will review those options and make the best possible decision for the company.

Operator

Thank you sir and presenters that does conclude our time for questions. I like to turn the program back over to Mr. Robinson for any additional or closing remarks.

Dick Robinson

Well, thank you all for your support. We are 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 are happy for your continued support. Thank you very much.

Operator

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. Attendees you may log-off at this time.

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