Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

School Specialty, Inc. (NASDAQ:SCHS)

F3Q08 Earnings Call

February 21, 2008, 11:00 am ET

Executives

Mark Fleming – Director of Investor Relations and Corporate Communications

David Vander Zanden – CEO

Thomas Slagle – President and COO

Kevin Baehler – VP, Interim CFO

Analysts

Mark Marostica – Piper Jaffray

Bob Evans – Craig-Hallum Capital

Lee Matheson – KG Harrison and Partners

Lana Gordon Lasek – Robert W. Baird

Charles Laporta - Artos Partners

Operator

Greetings and welcome to School Specialties Fiscal Third Quarter Conference Call. (Operator Instructions) It is now my pleasure to introduce Mark Fleming, Director of Investor Relations and Corporate Communications for School Specialty. Thank you, Mr. Fleming; you may begin.

Mark Fleming

Thank you, Ryan. Good morning, everyone, and welcome to School Specialties Fiscal 2008 Third Quarter Conference Call. Our presenters today are Chief Executive Officer Dave Vander Zanden, our President and Chief Operating Office Tom Slagle and our Vice President and Interim CFO Kevin Baehler.

Before I turn the call over to Mr. Vander Zanden, I would like to take a moment to read the “safe harbor” statement. Any statement made during this call concerning future results of operations, expectations, plans or prospects are forward-looking statements. Forward-looking statements also include those preceded by or followed by words like “anticipates,” “believe,” “could,” “estimate,” “expect,” “intends,” “targets” or similar expressions. These forward-looking statements are based on School Specialties current estimates and assumptions and as such involve uncertainty and risks. These statements are not guaranteed to future performance and actual results may differ materially from those contemplated by the forward-looking statements due to a number of factors, including those described in Item 1(a) of the Company’s Annual Report on Form 10-K for the 2007 fiscal year. Those factors are incorporated by reference except to the extent required under federal securities laws, School Specialty does not intend to update or review the forward-looking statements.

With that, I’m pleased to introduce Dave Vander Zanden.

David Vander Zanden

All right. Thank you, Mark. Good morning, everyone, and welcome to our third quarter conference call. I’m going to give you just a couple of comments this morning on the quarter, and Tom and Kevin will provide much more detail and insight as to what’s happening.

I just wanted to comment a little bit that overall from our perspective, it’s a pretty small quarter, but it was a pretty good quarter for us. We did see some growth in both segments, the consumable business in Essentials and the furniture business both shared some good improvement. The furniture pipeline that we’re looking at for the large project business looks very good right now and that will feed our summer delivery. Just to help you understand the funding there, typically that’s financed with municipal bonds, and those bonds are issued well in advance of the start of the construction of the project and so we’re starting to those orders against those projects come in and feeling pretty good about what we’re seeing at this point.

The Specialty side of our business also continues to perform well, and of course it’s led by the adoptions in Q3. Q4 should be pretty light from adoption revenue standpoint and pretty minor as it was last year at this time. The mass merchant volume we commented on in the press release, continued through Q3 at about the level we expected. As we said last quarter, we expect that to turn and show some improvement in Q4. Then my final comment on the numbers is cash flow performance for the year is looking very good for us. I think its solid and it puts in a pretty good position. So Tom and Kevin in a couple minutes will comment a little bit more on the quarter and what’s going around the numbers there.

From The EBS standpoint of Phase 2 conversion to Oracle went pretty well for us. We had a very successful conversion, minor bumps afterwards to deal with but we’re in very good shape. As you recall, that puts about 80% of our business now on Oracle. The last step in this process is for us to balance the system capacity we’re going to need for summer peak performance. We’re doing some testing around that and we’ll continue to watch the load balance over the next few months and can pretty much have Oracle behind us as we move forward. The last phase of Oracle will occur this fall, and we’ll complete that process and have a lot of folks focused back on the customer and not so much on inside the Company and what’s going on. So with that capability, we’re really focused now building the model out for category management, and we’re starting with the art and early childhood categories and we’ve begun to do some work there with those business units to start to effect that change. So that’s now in the process and off and running.

We had a very tiny acquisition during the quarter, product take on with a company by the name of Sitton Spelling. That acquisition has only a couple million dollars of revenue, 50 SKUs and one employee. What we were after there was the professional development services offered that compliments are reading intervention strategy so to round out our capabilities there. That one is extremely small. We acquired it in the quarter, and it’s completely integrated at this point.

From a funding and outlook standpoint, science adoptions coming in fiscal ’09 hereto for California, Georgia and Kentucky. We’ve made some very early estimates without much, without any customer commitments at this point, so we’re trying to pretty careful as we were last year. We do expect to be a lighter than we thought in Georgia, but we think that California will perform pretty well for us.

From business conditions, marketplace and economic, we really don’t see any impact on our business in the current year, and we really don’t see expect to see any as we go through fourth quarter. We did take a look at our ’09 guidance and took into account what was going on in the marketplace when we trimmed the growth rate on the core business just a little bit. But again, we’ve got good visibility on parts of the business. Furniture is expected to perform well with the large projects already being funded.

The federal government really has increased funding for education this year and we’ve seen Bush’s proposal and we are seeing a request for additional increases in Title 1 in reading first for next year, so we don’t expect issues at the federal level. States are starting to experience revenue collection issues, but this is the first part of the pressure and they have reserves to tap that can help offset some of that. The only information that we can get out of the market right now on what’s happening at the state level are proposals from governors on budgets. In some of the large states, New York, Florida, Texas, Pennsylvania, we see governors proposing increased in education between 4% and 7% in the K-12 category. Some of those same states are also considering tax rebates within the state to compliment what the feds did.

So we’re not overly stressed with funding issues. We’ll continue to watch and see what’s going on. California has a large deficit to address; it’s probably the most serious situation. But again, it’s early in the process and we can’t get a read yet on what is likely to occur there. In the last recession that was very deep back in the fiscal 2003 and 2004 range for us, we saw teacher layoffs in a number of very serious situations for states. Our revenue declined and that period was only down 2%, so we tend to be somewhat recession resistant. We’ll update our viewpoint and our guidance as we get to the next conference call in June when we’ll have a little more time under our belt to see what’s happening with economic conditions and a little bit better look inside the budgets from the state.

A couple quick comments on the sale of the Media business, that process is going a little slower than we expected, but we do expect to conclude it in Q4.

The CFO search, we do expect to conclude in the March timeframe.

Then I just want to finish up with a couple of comments on our content strategy which continues to push us toward education with content rich products. The category management and the content acquisition of development that we’re talking about will continue to transform the company from a distributive of commodities to a content-rich education company. The product focus and the mix will continue to change really leading to changes in the traditional reporting of our two segments,

Essentials and Specialty, some time over the next year to two. From a curriculum standpoint, we expect to make some very small acquisitions over the next couple of years to gain some platform areas in that and art that will help us invest into programs that will become (inaudible)-like programs that we have in our science area. Then of course our specialty product development that we today where we invest about $10 million a year will continue and combining that with category management will really lead us to solutions for customers that are more unique and move us away from the dependence on the commodity products.

So with that, I’ll stop and turn the call over to Tom and Kevin, and we’ll get some more details there. Tom.

Thomas Slagle

Thanks, Dave. Good morning, everyone. Let me start by just kind of reiterating, as Dave mentioned, we’re very pleased to report that both our Specialty and Essential segments showed organic growth in the third quarter. While our Essentials growth is modest, we’re certainly beginning to some of the positive progress with the strategies that we’ve been working on and that’s encouraging for us. While one quarter does not build the trend, and we recognize that, it does build a bit of momentum that we’re starting to believe that the strategies we’re putting in play will help us drive consistent growth in the four up quarters. I want to emphasize that we have our feet squarely on the accelerator in terms of customer, competitor marketplace intelligence efforts and are resulting alignment actions. Our efforts to drive growth, innovation and efficiencies within the Essentials group is strong as well as across the entire company and that will be our continued mantra going forward.

Dave covered several other high points for the Specialty business. I do want to reiterate what he said about the encouraging and unique market position that we’ve carved out in our science offering, and the successful efforts of building our presence in reading intervention with a research-based focus and new product introductions. While the general supplemental reading market has recently struggled, we’ve turned in some very encouraging growth year-to-date in this segment for us. We’ve seen good organic growth from existing products, and we’ve also launched two new research-based products that expand our presence in the reading intervention market. The first is called Worldly Wise, and it’s the only K-12 to vocabulary program on the market. The supplementary learning series builds on students’ vocabulary and at the same strengthens reading, writing and critical thinking skills. The second new product that we’ve launched is called Spire [sic], it offers pre K through middle school teachers with the best practice approach to helping struggling readers with everything from phonics, vocabulary to handwriting and reading comprehension. Programs very much at the near of our reading focus and emphasizes early diagnosis and intervention with the mission to prevent reading failure at the earliest possible age. Educators recognize the importance of reading to success on subject areas. These types of products should provide us with some attractive growth opportunities in the future.

Our science business, which obviously has had a very strong year, was recently awarded an award that is tied to its efforts combining reading instructions with its core science curriculum; it’s a very unique approach. We talked with many of you in the past about our science readers. These are series of 23 pieces that cover different science topics called the Seeds of Science Roots of Reading. Learning Magazine gave the program a teacher’s choice award for its unique approach to teaching science and reading together. This product is an excellent example of the value that we can provide educators and our capabilities in curriculum development, particularly if they are stressed for time in the classroom. We’re also very excited about a new student agenda product that’s in the marketing stage right now for delivery to schools this coming fall. The agenda is a partnership with former UCLA Basketball Coach John Wooden. Our developers have taken Coach Wooden’s character development messages from his well known Pyramid of Success and his children’s books and they’ve created content for special agendas that help students be successful academically, physically, socially and emotionally. The agenda has been piloted in a number of schools this winter and has received excellent reviews. New products combined with a solid service and delivery season last year provide us with positive growth opportunities in this part of our business.

So all in all, good progress in our Specialty segment, as Dave mentioned, and some momentum building for the back-to-school season, which we’re excited about.

Now let me move on to our Essential segment and make some comments there. Strengthening our growth prospects and essentials remains a top priority for us. We’ve aligned our businesses to better serve our customers improving our customer outreach efforts and generally focusing on the blocking and tackling of execution in all areas. Without going into a lot of specific details for some competitive reasons, I do want to give you some color around the activities that we’re pushing, all of which are building some optimization for us and helping us feel positive about our prospects for continuing and accelerating growth in the third quarter and beyond. In the furniture and equipment segment, let me start there, we’ve rebounded after a couple quarters of delayed school projects.

We’ve also been aggressive in rebuilding our sales and marketing coverage in certain regions of the country. We’re increasing the visibility we have throughout the country by using our differentiated projects by design model to bring a turnkey design installation solution for our schools, and we’re also aggressively aligning ourselves more closely with the building project designers and construction managers so that we can get involved in these projects much earlier in the process.

We’ve had great activity toward the end of the quarter. As Dave mentioned, our backlog at this time of the year indicates that we’re making great progress and that should pay off for us in the upcoming quarters.

In the consumable segment, we’re again optimistic about the upcoming busy season. We’ve been working hard at this one and we’ve instituted a number of initiatives. We’ve deployed a targeted pricing strategy that focuses on driving volume in key areas while protecting margin in others. Several new marketing strategies are providing more frequent and directed contacts with customers. Target assortment offers as well as greater focus, training and measurement around our direct selling model while providing them the necessary tools to drive growth in their markets.

Our School Smart offering continues to grow and we’ve created through the value line here that our customers recognize for both good quality and low cost. So far this fiscal year, we’ve introduced more than 1,340 new products in the School Smart line and we continue to have success in that category. We’ve also been very active with new product introduction efforts across the entire Essentials group. Our just released main catalog that came out in January contained more than 2,500 new items. To support these additions, we’re launching new go to market strategies and promotional activities that will significantly increase the frequency of customer contact and result in increased adoption for these new products. But at the same time, we’re also stepping up our supply chain focus to make sure that as we expand our product and service offerings, we have the systems and processes in place to meet customer fulfillment expectation, as well as maximizing efficiencies from source to delivery.

We’re going to remain very aggressive around controlling inventories and SKUs through a disciplined product lifecycle management and leveraging the capabilities within the new Oracle system to reduce working capital requirements for our business overall. A big part of our effort involves merchandising, which is key to the success, we believe, in this consumable segment; and we’re putting a laser focus on assortment planning and, what I mentioned above, product lifecycle management, which we think will bring some great benefits in the operation.

We have a new leadership team in this important area that’s instilling a model and discipline that we do feel is key to our strategy and we’re pleased with their progress to date. We’ll emphasizes an orderly progression of new items from testing, evaluation, all the way through to the end of that product’s life and continually add appropriate and value-added replacements along the way. There is great potential for us as we rollout these new approaches to vendor relations, how we interact with those vendor partners we deal with, product acquisition, merchandising and delivery. We’re going to continually offer customers new products based on their needs and educational trends and we’re going to take greater control of our supply chain and inventories in doing so so that we can leverage our capabilities through the financials. Our capabilities flow directly from our investment, as we’ve talked about before, in our direct marketing analytics - the Oracle system, that Dave spoke about briefly, and the rollout of the category management alignment that we’re making good progress on.

We are still at the beginning stages of pulling all this together right now and we’ve talked about this. We’re laying the foundation for being able to apply best practice approaches to many of the key areas of our business. At the end of the day, our efforts are all about making School Specialty easier to understand for our customers and easier to do business with - expanding our abilities to support the needs of our diverse customer base, driving innovation and efficiencies in everything that we do.

Another key foundation that you’ve heard me talk about on all the calls before is our lean initiative. We’re calling this “The School Specialty Way.” It represents a cultural shift in how we approach problem solving, process improvement and innovation and waste elimination driven by the voice of our customer. During the past quarter, we appointed our Executive Leadership Team for the lean process. We’ve identified key priorities. We started team training and we’ve launched several rapid improvement events to drive associate engagement and improvement in high potential areas. We have already engaged many of our associates into the events and we’ve gotten great responses. We’ve assigned a full-time leader now to build our roadmap for this important strategy initiative, partnering with the outside firm that we’re utilizing.

Our near-term objective is to make some dramatic improvement in a few processes that can have an impact on the upcoming busy season and we think we’ve got that nailed as far as what those are. As our associates begin to see and hear about early successes, we’re going to drive enthusiasm among our associates, and we’re beginning to feel that from those folks who are now believing they have the ability to make change in processes that we’ve been living with for a while. Those of you that are familiar with lean thinking methodology knows that it’s a rigorous continuous process of improvement. I’m excited that we started our journey and we expect that the benefits will accrue for us.

To summarize, our teams are working very hard and they’re advancing in some very important areas. Our strategic planning model is being embraced. It’s laying out very clear paths for us on what we should be doing and also what we should not be doing around markets, offerings, innovation and growth. Tangible progress is already been made in merchandising, direct marketing, supply chain management and new business systems, category management and, as I mentioned, the lean process improvement. So we’ve got some measurable progress that we’re proud of and we now need to begin to accrue those results from the effort.

While we fully expect to see progress in fiscal ’09, next year will be a year of building on those capabilities and a year of transitioning our associates to a new of thinking, a new of operating and a new way of serving our customers day-to-day. As I said during last quarter’s conference call, we expect to report financial benefits from these initiatives in fiscal ’09, but certainly more significant impacts will be accruing into 2010. We’ve made solid progress in laying the foundational work necessary to begin driving more consistent growth. The management team has clarity around our strategies. We have confidence in our plans and our teams are committed to execute, so I’m excited about moving forward.

So with that said, I’ll turn the call back over to Kevin Baehler.

Kevin Baehler

Thanks, Tom, and good morning. As usual, we have the release available to you in its entirety. Just direct your attention to the release for a moment. We have the narrative and the four added schedules, income statements and then balance sheet, statement of cash flows and the segment analysis. As reminder, consistent with the past few quarters, the presentation of the income statement reflects the operations of the School Specialty Media business as a discontinued operation. As such, the income statement lines revenue through income from continuing operations excludes the operating results of that media business unit. Balance sheet and cash flows, though… The balance sheet and cash flow statements have not been restated to exclude Media as it was not material to the balance sheet as a whole. Segment tables for revenue and gross margin, which is the final page of the release here, (inaudible) income statement and exclude the Media business.

I’ll begin with a review of the operating results for the third quarter and then the nine months ended January 2008. I’ll cover the third quarter first. As all or most of you know, the third quarters are seasonally the slowest quarter of the year. As a result, expense and mix shifts do have a more pronounced impact on margins and are not necessarily a good indicator of future performance. Revenues for the third quarter were $135 million, which was up approximately $6 million or 4.7%. As Tom mentioned, both segments contributed organic revenue growth in the quarter. Specialty segment revenue was up 7.5% in the quarter to $81 million from the $75 million in last year’s third quarter. The increase included an incremental $3 million of state adoption revenues from our science curriculum offering in the quarter. However, that increase from the adoption offering was offset by a decline of a comparable amount in our mass merchant business. Adjusting for these two items, though, are organic growth from the remaining Specialty business is the core specialty businesses was approximately 8% for that quarter. Essential segments had revenue growth in the third of 1.5%. Growth was driven by the furniture business within the segment as the consumables portion of the Essential segment was essentially flat to the prior year. As Tom indicated, we’re satisfied with the modest growth that we generated in the essential segment for the quarter as it does reverse the downward trend that we had been expressing through Q2 and provide some positive enforcement of our essential strategies.

Moving on to gross profit: Consolidated gross profit for the quarter was $52 million, up $1 million or nearly 2% from last year. We did experience some decline in the gross margins for the quarter in both segments. Within the Specialty segment, gross margin declined 70 basis points for the quarter. The entire decline was related to a charge of approximately $600,000 for the donation of an overstock inventory related to the termination of one specific vendor distribution agreement that we had. Absent that one-item, Specialty margins would’ve been flat with last year. For the Essential segment, gross margin declined from 30.2% to 28.7% in the quarter. The majority of this decline is related to product mix within the Essential segment. The segment, Essential segment gross margin also was negatively impacted by some adjustments related to changes and estimates for such items like customer incentives. Again, the seasonally low revenue for the quarter, with the seasonally low revenue for the quarter, it does not take much to shift the margins on way or the other, thus the margins in the quarter when looked at in isolation, don’t give a fair indicator of the direction of the business.

Moving on to SG&A: As we expected, our SG&A costs for the quarter were approximately $500 million. The increase can be broken into the following main areas: 1) There was approximately $1 million attributable to the increased volume in the quarter, being the sales volume. So these expenses include the incremental warehouse, transportation and selling costs to support the $6 million of revenue increase in the quarter. 2) We had approximately $1.5 million of performance based incentive compensation in the quarter over and above what we had had last year. That includes about $0.5 million incremental stock-based compensation expense in the quarter. 3) We incurred approximately $1 million of incremental costs to support our Oracle business system conversation. These costs consisted of some redundancy costs within mainly the transaction processing areas of the business to support the learning curve of utilizing the new system as well as the running of multiple systems. It also includes incremental depreciation related to placing the second phase of the business system into service in Q3. Remaining increase of the SG&A is for the adjustment in the various initiatives such as our database marketing group and IT infrastructure to support the multiple systems.

Operating loss for the quarter was $24.9 million versus $20.7 million in the pervious year’s third quarter. Interest expense was $4.5 million versus $5 million in fiscal 2007, which reflect a 44 basis point reduction in our effective interest rate versus Q3 of last year, as a well as a slight decrease in our average outstanding borrowings for the quarter. The loss per share from continuing operations was $0.95 versus a loss per share of $0.79 for the same period last year. Approximately $0.05 of that decline is attributable to the reduced share count from our stock repurchases as you’ll see from the updates of the income statement our share count, basic share count is (inaudible) $1.2 million Q3 this year versus Q3 last year. During the quarter, we did repurchase approximately 435,000 shares for an aggregate purchase price of $15.3 million.

With that, let’s turn to our focus to the nine-month period for a brief update on the year-to-date results. Revenue for the first nine months was up 4.2% to $914 million versus $877 million for fiscal ’07, for that same period of fiscal ’07. Increase relates to growth in the Specialty segment which has been offset to some extent by our Essential segment. Specialty segment revenue growth for the nine-months was $58 million, up nearly 12%. As we’ve discussed previously, one of the main drivers of the Specialty segment growth is the revenue attributable to the state adoption of the science curriculum offerings. Adoption revenues in the first nine months of the year were up over the comparable period last year by approximately $46 million and of course the majority of that increase is in the State of California. The increase has been offset to some extent by our mass merchant retail revenues, which are down approximately $10 million in fiscal 2008 to date.

In looking at the Specialty growth rate for the nine-month period and if we were to adjust for the science business as it relates to the adoptions and mass merchant business, the core Specialty business grew approximately 5% in the nine-month period. That’s very much in line with our expectations.

Turning to the Essential segment, revenue for the first nine months was $384 million as compared to $404 million in last year’s first nine months, down approximately $20 million or just under 5%. As mentioned in the Q2 conference call, the decline is related to a combination of the reduced Louisiana spending on school reconstruction, elimination of unproductive catalog and our decision to not pursue some low margin business.

Moving on to gross profit for the nine-month period, consolidated gross profit was $393 million, up $19 million or 5.1% from last year. Our gross margin was up 30 basis points from 42.6% to 42.9% in fiscal 2008. Segment mix was the biggest contributor to the gross margin improvement. Our Specialty segment now accounts for approximately 58% of the consolidated revenues. This is after netting into Specialty the intercompany eliminations which consists of Specialty sales which are made through Essentials. Last year at the end of the first nine months, Specialty sales net of these intercompany eliminations accounted for 54% of our total revenue. Since the Specialty companies have more proprietary products, their gross margins are greater than the Essentials’ gross margins. As that product mix continues to shift towards the higher specialty, towards a higher specialty mix, we have and will continue to see an expanding gross margin.

Looking within the segments, gross margin within Specialty segment was down slightly for the nine-month period at 50.1% versus 50.3% last year. Gross margins for the Essential segment was also down slightly for the first nine months, 31.6% this year versus 32.0%. The decline in essentials is really attributable to the heavier mix of direct shipments versus warehouse shipments for the year. Typically our direct shipments have a lower gross margin than the warehouse shipments because the items which do ship directly from our vendors carry little SG&A costs. So at an operating margin, there’s little difference between direct and warehouse shipments, but it does affect our gross margin.

Overall Essentials’ gross margins are in line with our expectation as balance the elimination of a lower margin bid business with a more competitive marketplace with the Essentials commodity products and, again, the 40 basis points within the segment is really attributable to the mix taking or migrating the mix impact the Essential gross margins, as I’ve said, are right in line with our expectations. SG&A expense for the first nine months was down 40 basis points as a percentage of sales. First nine months of fiscal 2008 SG&A expense was $276 million or 30.2% of revenue as compared with $268 million or 30.6% revenue in the first six months of fiscal 2007. Increase in SG&A expense dollars is due to the increase volume, which of course carries some additional variable cost with it.

The additional performance based compensation costs and incremental costs to support the Oracle business system conversation and other initiatives. Offsetting the portion of the increase and helping drive it, helping drive down SG&A, the percent of sales has been some productivity gains in our distribution centers primarily in the management of freight expense. Gross margin improvement continued leverage in SG&A costs that resulted in a 70 basis point improvement in our year-to-date operating margins as compared to last year. Year-to-date fiscal 2008 operating margins are 12.7% as compared to 12.0% last year.

In looking at interest expense, for the first nine months we were at $14.8 million this year versus $16.8 million last year. That reflects a 60 basis point reduction in our overall effective interest rate as compared to last year and that reduction in the rate is related to a couple of factors, the lowering of the interest rates throughout the year as well as the $200 million convertible debt which was issued in last year’s third quarter, and this year we’re getting the full year benefit on that debt as it relates to our interest rate. As you recall, the convertible debt carries a coupon rate of about or of 3.75% while the effective rate on our credit facility is approximately 6.5% for the year.

A decreased interest expense due to the lower effective borrowing rate is offset to some extent by slight increases in our debt levels. Average debt levels for the first nine months of fiscal 2008 is approximately $15 million higher than the first nine months of fiscal ’07. This increase debt level is a result of the share repurchases of approximately $60 million during the fiscal year offset by our pre cash flow generated over the course of the past year. Other expense, which is broken out separately from interest expanse on the base of the income statement consists primarily of the discount on our accounts receivable securitization and is relatively consistent between years.

In looking at our tax rate: The effective income tax rate for the first nine months was 39.1%, in line with our expectations and in line with last year’s rate which was 39.3% for that same period. The year-to-date tax rate does reflect approximately 30 basis points of benefit related to some inventory donations for which we received a stepped up tax deduction. Income from continuing operations improved $8 million or 15.8% over last year. EPS from continuing operations was $2.78 versus $2.22 last year, up 25.2%. That $0.56 improvement in EPS year-over-year is related to a combination of the increased earnings as well as the decreased share count. Increased earnings from continuing operations has proved an increment $0.35 of diluted EPS of which approximately $0.29 is related to the incremental operating profit and approximately $0.06 as related to the decrease in our interest expense and other. The remaining $0.21 improvement in diluted EPS is due to the decreased share count related to our share repurchases over the past 12 months, which are offset to some extent by stock option exercises.

As you know, just to reiterate a bit of the stock buybacks, we bought back approximately 2.1 million in fiscal 2007. In June of this year, our Board of Directors authorized the buyback of $45 million, another $45 million which had been fully utilized, and which has been fully utilized at this point, and then most recently in December, our Board of Directors authorized an additional 50 million share repurchase program. At this point, at the end of Q3 approximately 35 million of this most recent authorization is still available. Fiscal 2008 in total, we’ve repurchased just in this fiscal year approximately 1.7 million shares in the open market for approximately $60 million.

Last item I want to point out in the income statement is the operations of the Media business which is on the discontinued line. You can see the diluted loss per share in the first nine months of fiscal 2008 was $0.09 per share or $0.7 million as compared to $0.05 per share or $1.3 million loss last year. Bottom line EPS inclusive of discontinued operations $2.69 this year versus $2.07 last year.

Take a couple minutes to cover the balance sheet and the cash flow. What you’ll see at the bottom of the cash flow is we presented a reconciliation of free cash flow which shows the generation of $70 million in free cash for the first nine months of the year versus $77 million at this point last year. We did begin to see some improvement in the cash flow generated in the third quarter of fiscal ’08 as compared to the third quarter of fiscal ’07, as the gap between the two years did narrow a bit in the quarter. A look at the balance sheet shows our inventory levels are approximately $9 million higher than end of Q3 last year.

Inventory management has been, continues to be a key initiative in the second half of the year and into next season. Our expectation is that by the end of the fiscal year, inventory levels will be below the fiscal 2007 year end balances. We did some progress on the inventory goal during the quarter as we came into Q3 with $19 million more inventory than at the beginning of 2/3, excuse me, than beginning Q3 fiscal 2007.

As I indicated earlier, we’ve reduced that debt to $9 million. As for receivables, you’ll note that the receivables are up year-over-year by approximately $23 million. That increase is related to a combination of the incremental revenue and an increase in our DSO is approximately four days. The DSO increase is primarily related to the collection cycles on the science curriculum product which tend to be first of all larger dollar values and they’re really a longer collection process. As an example, Los Angeles Unified School District is processing all the payments for the science products that have been sold into the district on an individual school-by-school basis. It’s very time consuming and it does extent out the collection process for us.

With now having said that, we’ve reduced the steady flow of incoming cash or receipts related to, for example, LA Unified in this case. Regular amounts that we’re getting in each week, it just does extend our cash conversion cycle out a bit. We do continue to see strong cash collections in the first three weeks of February, three plus weeks of February. The receipts for this month to date so far have been approximately $7 to $8 million higher than the comparable period from last year. So we are seeing the collections cycle through, it’s just a little bit later than what we were used to. So again, we have made some progress on reducing the year-over-year increase in receivables; and as we close the month of February and get into the early part of March, we’re expecting to receive payment on the rest of these large outstanding balances related to the science curriculum sales. Rest of the balance sheet is in line with our expectations.

In taking a look to the outlook section for a second here, our outlook for the remainder of the year, we’re confirming our guidance for the full year fiscal 2008 revenue that we have revised a bit in November. Revenue will be in the range of $1.0 billion to $1.1 billion. This includes the incremental $46 million of stated adoption revenue from our science curriculum for the year. We’re also confirming our EPS guidance from continuing operations to be in the range of $2.15 to $2.25 for the year and our free cash flow guidance continues to be in the range of $70 to $80 million, which on a free cash flow per share basis $3.33 to $3.81 per share. Fiscal 2009 guidance is we expect revenue growth on the core business to be in the range of 3% to 5%. This excludes the impact of state adoption revenues which is expected to decline by approximately $35 million in fiscal 2009. Taking into account the impact of the change in the state adoption revenues, we expect total revenues to be up 2% to down slightly. Diluted earnings per share is expected to increase 3% to 10% in fiscal 2009. We also expect to generate incremental free cash flow in fiscal 2009 with a range of $75 million to $85 million.

With that, I’ll turn the call back over to Dave.

David Vander Zanden

Very good. Thanks, Kevin. Ryan, I think we’re ready for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time, we’ll be conducting the question-and-answer session. (Operator Instructions) Our first question comes from Mark Marostica with Piper Jaffray.

Mark Marostica – Piper Jaffray

Good morning, guys. My first question, I’m not sure if you’re able to disclose this. But can give you a sense of the margin profile of the adoption revenue for the first nine months?

Kevin Baehler

We don’t disclose that, Mark. We keep saying, as far as disclosure of margins, we keep that at the segment level; and for competitive reasons, we don’t like to break it down any further than that.

Mark Marostica – Piper Jaffray

Fair enough. Looking ahead relative to your guidance, are you assuming any further cost savings on the G&A side; and if so, where will those cost savings be derived from?

Kevin Baehler

One area that we’ll continue to look at as we continually do is on the supply chain side. We’ve seen improvements this year in our management (inaudible). We’re still in kind of the budgeting process right now for fiscal 2009, so we don’t have firm goals set. But as we look at the supply chain in totality, we’ll certainly look to make some improvements there.

Mark Marostica – Piper Jaffray

Do you think that’ll be material this year?

Kevin Baehler

I think there’s opportunity there. We really need to work through the budgeting process, Mark. I think there’s some opportunity.

Mark Marostica – Piper Jaffray

Then just relative to Tom’s comments concerning the lean initiative, what are you savings that you’re expecting to glean from that initiative this year and perhaps next year? When I say this year, I should be really referring to fiscal ’09 and then fiscal 2010 and beyond. How should we frame that?

Thomas Slagle

Yeah, I think, Mark, it’s probably a little early for us to pinpoint a number to it. Obviously what we’re doing is looking at estimated values on a per project basis where we’re going after some very customer-driven performance issues that we think we can solve which we do think will drive value, but as of today, I can’t really put a value on it for you. But again, we’re bullish on what we think that can help us drive for the upcoming fiscal year.

Mark Marostica – Piper Jaffray

Then I want to just step back and address the revenue guidance, organic revenue guidance of 3% to 5%. Just looking back that organic revenue growth guidance seems to be at the high end of the historical organic revenue growth range over the last several years and given the economic backdrop that we find ourselves in, I’m curious, what gives you the level of conviction that you’ll be at the upper end of the historical range?

David Vander Zanden

Mark, this is Dave. (Inaudible) some of the economic conditions that are in the marketplace right now, we’d be looking at in our opinion what we described normal relative 4% to 6% and so we pulled that back a little bit to reflect kind of that softness we’re seeing out there. As we commented this morning, we’ve got some good insight into the furniture side of the Essentials business; and, as Tom said, there’s a lot of new ideas and initiatives and products on the market that are going to help us on the Essential side with better performance in the next cycle. The Specialty side had a pretty good year this year, and we expect that to continue as we move forward and, again, on that side, lots of proprietary products hitting the market as well so….

Mark Marostica – Piper Jaffray

Then lastly, your thoughts on product pricing with your catalog drops so far this year, what can you tell us about the trends along that front?

David Vander Zanden

We’re seeing some pricing elasticity in the market. We were I wouldn’t say aggressive; we weren’t conservative, I’d say we went to the market with a model which we felt it would bear and to date we’re feeling that the success is rolling into the P&L. So in aggregate, I think our pricing increases are probably in the range of 1% to 1.5% and as far as how can we look at that in the first couple months of the calendar that are under our belts, it seems to be solid.

Mark Marostica – Piper Jaffray

Fair enough. Thanks, I’ll turn it over.

Operator

Our next question comes from Bob Evans, a private investor.

Bob Evans – Craig-Hallum Capital

Bob Evans from Craig-Hallum Capital. Good morning. I didn’t know I was private investor, wouldn’t mind being one but… A couple questions: First, back to the ’09 guidance, can you comment a little bit more as it relates to the science business and the change of revenue from adoption, recognize that you had a strong year this year, but I would have expected to see some strength next year as well so the change is maybe more than I thought.

David Vander Zanden

Over the course of, call it a three- or four-year period, think in terms of adoption revenue contributing about 200 basis points of organic growth. So I know this is going to be lumpy as we go from year to year with different states, so think in terms of about 200 basis points on average. As we are sitting in this particular time of year, Bob, we have zero commitments from customers, lots and lots of conversations going on, and we’re trying to come up with reasonable numbers based on where we are at this point in time. If you recall what happened last year with California, we’ll be starting off in a similar position; and as started to get commitments and understood customer perspectives with more detail could firm up numbers and we kind of progressed through the year. I think we’re in the same position this year.

Bob Evans – Craig-Hallum Capital

There’s still a large market opportunity out there as it relates to California and a couple of other states and so you’re saying, “So far you’ve got, you don’t have commitments but you expect to; and if you do, that number would go higher?”

David Vander Zanden

That’s right. Yeah, I think what’ll happen in the next 60 days is we’ll start to see things firm up internally and so our next call on June will give you a much better insight.

Bob Evans – Craig-Hallum Capital

How much of that market do you think you penetrated? I guess what I’m trying to say is what’s the market opportunity if you’re successful?

David Vander Zanden

Boy, pull the market size right off the top of my head, with all the states, I don’t remember for you. We had talked about California having a number of districts that, California is unique, has an opportunity to spend the funds in the second year rather than the first. Keep in mind, we got LA in year one so one that size doesn’t exist in year two. But we are looking at a few of the larger ones that haven’t purchased in one year in year two, and we think we have some good opportunity there as well.

Bob Evans – Craig-Hallum Capital

How should we think about gross margin guidance, or how should we think about gross margin trends for fiscal ’09 given what you said or what’s implied?

Kevin Baehler

Well I think it’s a little, some of the new catalogs have just dropped and we have about three weeks of data that we accumulated on the performance of the new catalogs. I think it’s a little bit premature to comment on the gross margins for fiscal ’09.

Bob Evans – Craig-Hallum Capital

Okay, but in the guidance that you gave, I guess, you had to have some type of assumption and I’m just wondering… Because you’re seeing the earnings growth is greater than the revenue growth and I’m wondering if we’re going to see that more from an SG&A leverage standpoint or gross margin improvement.

Kevin Baehler

I think you’ll see on both sides, Bob.

Bob Evans – Craig-Hallum Capital

Oracle spend, could you give us a sense of what that should be like in ’09 versus ’08 or even what’s the net/net type of environment from a capex or expense standpoint?

Kevin Baehler

Yeah, going into next year, as Dave indicated, we now have 80% of the Company on Oracle. We’re continuing to… We have the final phase going live next December. We’re starting this year yet as we get into Q4 to begin the spend on the Phase 3 of the conversion here and that will certainly carry over into fiscal ’09 next year. From a high level what I’m expecting on a year-over-year basis is that we’ll see a reduction in the way of the Oracle spend, if you will, capex in the neighborhood of about $4 million year-over-year.

Bob Evans – Craig-Hallum Capital

How about P&L impact, what kind of reduction?

Kevin Baehler

Most of the expense is… The great, great majority of the expense is capitalized over the year, so we’ll actually see more SG&A as you will have, next year will have a full year of depreciation onto Phase 2 piece of the assets that went live and then we’ll go live with the Phase 3 portion of the asset. You’ll have that depreciation kick in so… Actually, we’ll see a little bit more on the depreciation side as it relates to CBS.

Bob Evans – Craig-Hallum Capital

Do you have a ballpark idea of how much it bump up?

Kevin Baehler

Overall what I’m expecting is depreciation and it’s kind of all in number, Bob. So looking at the Company and taking into account the EBS portion, I’m expecting depreciation to go up in the neighborhood of about $1 million next year.

Bob Evans – Craig-Hallum Capital

Great. Can you comment a little bit more in terms of acquisition pipeline, what are you seeing right now in terms of is there… Are there many opportunities (inaudible)…

David Vander Zanden

Yeah, Bob, there’s quite a bit going on out there as usual, nothing really different. There’s a lot of opportunity around on reading products given the challenge that the marketplace has had in the supplemental areas in the last couple years, nothing different for us and nothing really unusual, pretty steady if you will.

Bob Evans – Craig-Hallum Capital

Can you also comment on your free cash flow, I guess trends or the way you view things going forward? Are you going to be generating significant free cash flow with a balance between perhaps buying back more stock versus paying down debt?

Kevin Baehler

As I indicated, Bob, we have $35 million of remaining authorization. As we moved through the quarter and into fiscal ’09, it’s something that we’ll evaluate as a potential use of our cash. But I’m not going to comment right now on what the plan is I guess on the buyback side. But there is $35 million of remaining authorization out there.

Bob Evans – Craig-Hallum Capital

Thank you.

Operator

Our next question comes from Lee Matheson with KG Harrison and Partners.

Lee Matheson – KG Harrison and Partners

Our questions have been answered. Thank you.

Operator

Our next question comes from Lana Gordon Lasek with Robert W. Baird.

Lana Gordon Lasek – Robert W. Baird

Hello. Thanks for taking my question. I just have a quick follow-up on the science adoptions. Last quarter you talked about (inaudible) going on in Georgia, Kentucky and South Carolina. Are there any other states on the horizon there that you can talk about?

Thomas Slagle

Really it’s Georgia, Kentucky and the second year for California. South Carolina, I’ve heard this year, so it’s really those three are the main states that will generate any significant volume.

Lana Gordon Lasek – Robert W. Baird

Anything going forward, do you have anything kind of in the pipeline there?

Thomas Slagle

I’ll tell you, we can send you the states pretty well publish when signs of actions come up years in advance, so we can connect with the schedule on how that works.

Lana Gordon Lasek – Robert W. Baird

Thank you. Then one more just regarding California, I think you had mentioned that you expect for next year a little up, given the fact that with the budget deficit there, kind of what gives you the confidence that California can grow this year?

Thomas Slagle

The adoption spend is appropriated, so it’s outside the process, so there shouldn’t… The California challenges shouldn’t affect the adoptions.

Lana Gordon Lasek – Robert W. Baird

Well, thank you very much for clarifying that.

Operator

Our next question comes from Charles Laporta with Artos Partners

Charles Laporta with Artos Partners

Hi. I just wanted to ask you, what time do these municipalities usually pull the trigger on new adoptions for the size curriculum?

Thomas Slagle

We start to actually get commitments during our fourth quarter and into the early part of the first quarter.

Charles Laporta with Artos Partners

What’s the latest that they can sort of…

Thomas Slagle

We’ll get some of the smaller ones that we can react to quickly, sometimes get late through July and August. The larger ones, no, they have to get us something pretty quick.

Charles Laporta - Artos Partners

In your revenue guidance for ’09, do you have, I mean you said that South Carolina is already approved for fiscal ’09 adoption and California has already appropriated science curriculum revenues. Are those sort of already assumed in the revenue guidance?

Thomas Slagle

Yeah, the three states for next year are Georgia, Kentucky, California and those states have approved our programs, so that’s in place. Now it’s just whether or not the individual district makes a decision to buy them, and that’s incorporated in the guidance.

Charles Laporta - Artos Partners

.

So basically the state makes this program available and it’s up to the individual school district to sort of…

Thomas Slagle

What happens in about 20 southern states is the states will authorize a number of curriculum programs that they may adopt, so they’re called state options, and that means that the districts can use state money to buy them.

Charles Laporta - Artos Partners

All right, and so your assumption that the curriculum adoptions are expected to decline next year is basically a conservative type thing where by you think there’ll be a little bit less uptake or something like that or?

Thomas Slagle

No, it’s just really kind of market size. California is the largest state in the country and the majority of the largest portion of the adoption occurred in their first year, which is our fiscal ’08, so there’s just less available for year two. Then we’ve got Kentucky and Georgia kicking. Georgia’s not a particularly small state, but it’s not anywhere the size of California, so the opportunities are just smaller in Kentucky and Georgia.

Charles Laporta - Artos Partners

Isn’t it… Even if you had the same number of adoptions to California this year, I mean that it’s consistent revenue stream or no?

Thomas Slagle

No.

Charles Laporta - Artos Partners

You had some sales force issues, I believe, when you talked about last quarter in terms of turnover and such. Could you give us some more color on that?

Kevin Baehler

Sure. Yeah, it really wasn’t a… It’s a situation where we were looking at performance management scenarios and I would say that right now we’re in a much better position. We completed our national sales meeting here a couple months ago and frankly I would say the organization right now is well in place, some significant training provided new tools for the organization. They’re motivated and excited about the upcoming fiscal year.

Charles Laporta - Artos Partners

Just again, in terms of share repurchases, I think the majority of repurchases where executed at prices at least 10% higher than current stock price. Would that assume… Am I safe in assuming that once the quiet periods over, you guys will be active buyers of your stock?

Kevin Baehler

I’m not going to comment on that, Charles.

Charles Laporta - Artos Partners

All right. Thanks very much.

Operator

Seeing that there are no further questions, I’d like to turn the call back to management for concluding remarks.

David Vander Zanden

Very good, Ryan. Thank you very much. Well thank you all very much for taking the time to listen this morning. We are ready and focused on fiscal ’09 and have a lot of good products, good people ready to deliver results. We look forward to talking with you in June and give you an update on how that’s going. Thank you very much.

Operator

Ladies and gentlemen, this concludes today’s teleconference. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: School Specialty, Inc. F3Q08 (Qtr End 01/26/08) Earnings Call Transcript
This Transcript
All Transcripts