Scholastic Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Scholastic Corporation (SCHL)

Scholastic (NASDAQ:SCHL)

Q3 2013 Earnings Call

March 21, 2013 8:30 am ET

Executives

Gil Dickoff

Richard Robinson - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Maureen E. O’Connell - Chief Financial Officer, Chief Administrative Officer and Executive Vice President

Judith A. Newman - Executive Vice President and President of Scholastic Book Clubs & E-Commerce

Analysts

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Scholastic's Third Quarter Fiscal Year 2013 Earnings Call. [Operator Instructions] As a reminder, today's call is being recorded.

I would now like to turn the conference over to Gil Dickoff, Senior Vice President, Treasury and Investor Relations. Sir, you may begin.

Gil Dickoff

Thank you, 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. That's at investor.scholastic.com.

I'd also like to note that this presentation contains certain forward-looking statements, which are subject to the various risks and uncertainties, including the condition of the children's book and educational markets and 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.

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

Richard Robinson

Thank you, Gil. Good morning, and thank you for joining our Fiscal 2013 Third Quarter Analyst and Investor Conference Call. For this morning's prepared comments, I'm joined by Maureen O'Connell, CFO and CAO.

We knew that fiscal 2013 would be challenging and in the third quarter, the trends we experienced earlier this year continued. Our third quarter revenue was $380.5 million compared to $467 million a year ago, and the great majority of this decline was due to lower sales of The Hunger Games trilogy versus last year when we benefited from extraordinarily strong book revenues in advance of the film released in March.

While we expect the trade sales to decline this year when compared to last year's phenomenal performance, third quarter Hunger Games resulted in some delays in customer purchases -- sorry, third quarter Hunger Games sales were much lower than our expectations, particularly in the U.S., Canada and Australia. While our fairs business grew modestly as a result of our growing fair count, in Book Club, sales declined by 21% versus last year due to a decrease in revenue per order.

We still see strong engagement from our teacher customers who continue to value Book Clubs to find the best books for their classroom and to bring reading excitement to their students. Teachers are actually placing more orders, but they are using our online ordering system to find less expensive titles, thereby reducing the total value of their orders. At the same time, we are seeing a positive trend among parents who are ordering online. These parents are placing larger orders than parents using our paper ordering system.

Our clubs business is in transition as it becomes an online business. Our research shows that we can offer teachers more opportunities to grow their order size and build on the positive trends in parent ordering to rebuild this business next year and beyond.

In Educational Technology, revenues were ahead of the prior period but below our internal expectations. Here, spending in school schools was soft due to concern about sequestration and because districts are working through their programmatic and professional learning needs arising from Common Core. This resulted in some delays in customer purchases of our higher-margin education products. We did have strong results from our Common Core focus professional development and consulting.

We reported a loss per share from continuing operations of $0.63 versus a loss of $0.32 in the prior-year period. This was primarily the result of significant lower Hunger Games sales, as well as lower Book Club revenues. We were able to offset these losses partially with cost savings and stronger performance in some other areas of the business.

As a result, we're revising our outlook for fiscal 2013. We now expect total revenue of $1.75 billion to $1.8 billion for fiscal 2013, and earnings per diluted share from continuing operations in the range of $1.10 to $1.30 before the impact of onetime items associated with cost reduction programs and noncash, non-operating items.

In addition, we now expect free cash flow in the range of $45 million to $55 million. We are revising our free cash flow based on -- outlook based on lower net income, delays in receiving payment for purchases of educational products in this fiscal year, the impact of onetime payment of approximately $15 million associated with state sales tax liabilities accrued in fiscal 2012 and a higher level of prepublication expenses due to accelerated investments in new educational products.

We continue to make significant progress in our digital transition strategy, and we believe that our investments will substantially benefit educators, students and our business in the long term. Our digital investments are on plan and this summer, we will achieve a major milestone of our strategy when we launch 5 major new Ed Tech products. Here's a brief summary.

Our revolutionary and highly anticipated Math 180 intervention program is the mathematics equivalent to our very successful Read 180 program. We are also expanding our reading franchise to include younger students with iRead, our new technology-based early literacy program for grades K-2. iRead is perfectly positioned to support the administration's new focus on early education, including kindergartners.

Code X is a middle school language arts program, which has been selected by New York City to be part of the Core-ready program. The city specifically requested an all-new program aligned to the Common Core State Standards. We are proud that this program has been chosen by New York City, and we believe other districts will adopt Code X to support the Common Core in middle schools.

System 44 Next Generation, which we'll launch at the end of this fiscal year, is a completely revised version of our middle school phonics program, which has been so successful in helping older struggling readers to master decoding and so improve reading fluency. Finally, we've adapted our major reading program, Read 180, for the iPad and we'll launch this fall -- in the fall of 2013 to support those schools who are buying iPads for classroom instruction.

There remains solid support for education spending at the federal and local level despite ongoing budget issues in Washington. Importantly, for Scholastic, budgets are tightening around textbook funding, an area that we are not in and are being built out around digital solutions and core driven content where we excel. Our ability to develop trusted content both in print and digital formats is what fosters our connection with students, as well as their parents and teachers.

As just one example, Scholastic Classroom Magazines, one of the most widely read educational resources -- widely used educational resources in America, with more than 11 million copies going into schools every month, continue to be turned to by teachers for the nonfiction content and interactive features that can be used on whiteboards and personal devices. Teachers still prefer to use the print and digital versions of our magazines as companions to one another even as they incorporate more of our digital offerings in the classroom. And we continue to see strong traction here, with magazine circulation growing substantially this year as teachers seek more nonfiction to support Common Core.

We have received excellent feedback from teachers and parents on Storia, our ereading application, which is gaining momentum at school and at home. Our app downloads and registrations are right on track with our expectation. And as you can see on Slide 7, we have been on average at the top of the free ebook app rankings for iPads since our launch in September.

We are meeting evolving content needs by continually adding fiction and nonfiction titles to our ebook library, and major publishers have now committed to offering titles on Storia, including Little, Brown, which we had announced last week. And today, we are glad to announce a new agreement with HarperCollins Children's Books to offer hundreds of their popular titles in ebook format on Storia and through our clubs and fairs starting later this spring.

In clubs, we found that as children make the transition to ereading, teachers and parents alike are increasingly experimenting with the ebooks. And they prefer to order ebooks and print books together. Studies show that parents tend to provide -- prefer the efficiency of ordering online. Our ability to customize and improve their online shopping experience should help to deepen their engagement as more parents move to our online channel and order from our compelling library of both print and ebooks.

We are building on our 92 years of experience, providing advice and tools to educators and parents so they can help children become lifelong readers and get ready for college and careers. While our fiscal 2013 results have been significantly impacted by the decline in Hunger Games sales, we are optimistic for fiscal 2014 when we are significantly expanding our educational technology lineup in what we believe will be a receptive market environment. We expect that our digital initiatives, including Storia for school and home sale of ebooks as well as our new educational technology programs, will generate strong profit growth in the future.

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

Maureen E. O’Connell

Thank you, Dick, and good morning, everyone. Let me begin with the income statement. Looking at the third quarter results, revenues declined by 18.5% relative to last year, primarily reflecting significantly lower sales of The Hunger Games versus the prior-year period and lower Book Club revenue. Cost of goods sold as a percent of sales increased by approximately 3 percentage points this quarter, primarily reflecting a lower revenue base for our fixed costs and changing sales mix.

SG&A declined by $41.9 million compared to the prior year due to lower employee-related expenses. SG&A included onetime expenses of $3 million related to cost savings initiatives in the third quarter of this year and $2.5 million in the previous period due to a voluntary retirement program.

Loss per share from continuing operations was $0.63 compared to a loss per share of $0.32 a year ago. The consolidated loss per share was $0.63 in the quarter compared to a loss of $0.33 last year. The decline in net income was largely the result of lower revenues, especially from lower Hunger Games sales, as well as the company's plan to increase in investments in digital initiatives, partially offset by cost cutting measures implemented during the quarter.

Turning to the segment results. In Children's Books, third quarter revenues were $189.4 million compared to $268.8 million in the prior-year period, primarily due to greater-than-expected decline in The Hunger Games trilogy trade sales. Notwithstanding The Hunger Games decline, we continue to maintain a strong front lift and back lift. In School Book Fairs, revenues increased slightly, reflecting continued increase in overall fair count relative to the prior-year period.

In School Book Clubs, revenues declined by approximately 21% compared to the prior-year period, primarily due to lower revenue per order. Overall, Children's Books operating loss was $10.1 million compared to income of $12.2 million in the prior-year period, as a result of lower Hunger Games revenue and continued investment in e-commerce and ebook initiatives.

In Educational Technology, third quarter revenues were $41.8 million compared to $40 million in the prior-year period, primarily due to increased sales of professional development services and consulting in advance of the Common Core implementation. Operating loss was $3.5 million compared to a loss of $5.9 million in the same quarter last year.

Classroom and Supplemental Materials Publishing revenues were $43.2 million compared to $38.2 million in the prior year, driven by schools needs for the Common Core-aligned nonfiction content that our Classroom Magazines provide. Segment operating loss was $0.2 million versus $3.4 million in the prior-year period.

International revenues were $94.4 million compared to $105.6 million in the prior-year period, reflecting lower Hunger Games sales in Canada and Australia that were partially offset by strong performance in Asia. Segment operating income was $2 million compared to $4.3 million in the prior-year period due to lower sales of The Hunger Games trilogy.

Media, Licensing and Advertising revenues were $11.7 million compared to $14.4 million in the prior-year period as a result of lower production revenues, principally Word Girl. Segment operating losses increased to $2.3 million compared to a loss of $1.2 million in the prior period largely as a result of lower revenues.

Corporate overhead in the third quarter was $13.6 million compared to $17.9 million in the prior-year period, primarily related to lower employee-related expenses. To date, during fiscal 2013, we spent approximately $5.8 million on opportunistic share repurchases and have approximately $25.6 million remaining under our previously authorized limits for open market share repurchases.

We maintained a strong balance sheet with no net debt and access to untapped $325 million credit agreement with favorable terms and conditions. At quarter end, cash and cash equivalents exceeded our total debt by $41.9 million compared to net debt as defined of $53.5 million a year ago. With our solid balance sheet and efficient access to capital, we plan to fund approximately $150 million notes, which mature in April 2013, with borrowings from our revolving credit facilities. We expect this to save more than $5 million in interest expense moving forward. In addition to our quarterly dividend, we repurchased $5.8 million in shares thus far in fiscal 2013 and have approximately $25.6 million remaining under previously authorized limits for open market repurchases.

During the third quarter, free cash use was $52 million compared to free cash use of $1.5 million in the prior-year period. As Dick said earlier, free cash flow was impacted by lower net income, the delays in purchases of education products in this fiscal year, the impact of onetime payments of approximately $15 million associated with sales tax liabilities accrued in fiscal 2012 and a higher level of prepub expenses due to accelerated investments in new educational products.

Based on these factors and the factors that Dick reviewed earlier, we have revised our outlook for fiscal year ending May 31, 2013. We now expect total revenues of $1.75 billion to $1.8 billion for fiscal 2013 compared with our previous outlook of $1.8 billion to $1.9 billion. We expect earnings per diluted share from continuing operations in the range of $1.10 to $1.30 before the impact of onetime items associated with cost reduction programs, noncash, non-operating items compared to our previous outlook of $1.40 to $1.60. We now expect free cash flow in the range of $45 million to $55 million compared to our previous outlook for free cash flow in the range of $100 million to $120 million.

With that, I'll open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Drew Crum of Stifel.

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

So I want to -- I have a couple of questions on the clubs business. You mentioned the revenue per order being lower, which seems to be a consistent theme the last couple of quarters. Can you talk about what you're doing to address that? And then as it relates to Storia, are there any metrics you can share with us to give us a sense as to how that business is tracking and how you're performing against your target to hit 20% to 25% of your revenue from ebooks?

Richard Robinson

Thanks, Drew. On Storia, we're on -- our plan for the year -- we're not -- we haven't said exactly what the revenues are in that plan. We don't -- we will not do that at this point. But we're meeting all of the metrics in terms of downloads, registrations from downloads, expected revenue from ordering by parents and teachers of Storia. At the moment, Storia is -- we're introducing in classrooms, we're focusing on building its connection to schools and teachers. We're seeing teachers using it for supplementary use for free ebooks into their classroom. But we're seeing a trend toward their wanting to order classroom books through Storia for classroom use. On the home side, parents are engaged with Storia. They're getting it through the clubs and fairs. Primarily, much of the response is coming from iPad, but we're also getting a good response through its recent availability on Kindle Fire. We've built up a tremendous number of new titles, including a lot of enriched titles. So we're feeling very good about the progress of Storia so far by all of the metrics that we established for the first year, and we expect it to grow considerably in the following year. In respect to Book Clubs, I'll ask Judy to talk about what we're doing to reverse some of the trends in revenue per order, but one of the things that we pointed out in the call here was that the parents who are ordering online are really ordering quite a lot more than the parents who are using our paper systems, and we think that's a very promising trend for the future. So Judy, would you talk a little bit about the -- what we're doing relative to the revenue per order issue on clubs?

Judith A. Newman

Sure. Drew, as we're really successfully transitioning Book Clubs online, we're seeing 2 kind of patterns, which Dick referenced. One is that teachers are using the system much more efficiently to find inexpensive books and to redeem their points and so on. So we have a really clear opportunity there to manage that much better, what we show teachers, how we present higher-priced items and kind of really controlling the promotion. So as they're moving online, and about 83% of them are ordering online these days, we're able to monitor that and gate that to control what they're redeeming for free and the lower-priced items that they're getting. At the same time, the great news is that as parents are moving online, we're seeing much higher revenue per parent order, significantly higher than print. And as we've been talking about for the past several quarters, we will be able to get real clear information on the individual parents, what their kids need, what books they are buying. And we're able to much better customize our marketing to them on an ongoing basis. So we're seeing early results of that, revenues much higher by the parents. And as more and more of them come on, we will be able to increase that revenue there with better product offerings and more customized ways to drive higher revenue per parent. So it's sort of good news, and it's all rolling up under this transition of the print business to digital.

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And just shifting gears to the trade business. Dick, can you talk about -- you mentioned The Hunger Games sales being weaker than you anticipated. I think we all thought that, that piece of your business would be down year-on-year, but it sounds like sales came in a little lower than you had anticipated. What do you attribute that to? And as you look to fiscal '14, can you talk to any promotions or events or new content you'll have around the theatrical release of Catching Fire?

Richard Robinson

Well, we're building a -- we're bringing out a new paperback for Catching Fire and we're bringing out a wonderful new paperback box set. So we're doing lots of things relative to the November '13 release of Catching Fire movie, and we're beginning to ramp up our promotion marketing over the summer for that movie. The principal falloff in sales right now, Drew, has been on the ebooks side, which the print side continues to do all right. There's a sufficient inventory in the stores but not a great deal of it, and people are still buying the print versions. But the ebook version, which is more of a, as we know from the industry, more of a hit-driven thing where people get excited and order right around the time of the movie. That's fallen off more than the print side has fallen.

Operator

[Operator Instructions] I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Robinson for closing remarks.

Richard Robinson

Well, thank you, all, for your support. We'll continue to work hard to reverse some of the trends that we've seen in the third quarter. We're expecting a phenomenally strong 2014 in respect to our educational programs. I should say that our print products in general, as well as the combination of print and digital products, are really working very, very well, including our Trade Publishing, which is achieving good success in its front list and back list exclusive of The Hunger Games.

Thanks for your support. We'll talk to you again in July. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.

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