Scholastic Corporation (SCHL) Q3 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Scholastic Reports Fiscal 2015 Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Gil Dickoff, Senior Vice President and Head of Investor Relations. You may begin.

Thank you very much Nicole and good morning everybody. Before we begin, I would like to point out that the slides of this presentation are available 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 the various risks and uncertainties, including the condition of the children's book and educational materials markets, and acceptance of the company's products in those markets, and other risk factors that 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 earning release, which is now posted on the Investor Relations website, again, at investor.scholastic.com. Now I would like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic to begin today's presentation.

Thank you, Gil. Good morning and thank you all for joining our third quarter earnings conference call. For this morning's prepared remarks I am joined by Maureen O'Connell, CFO and CAO. In our traditionally small third quarter, Scholastic's strong results in children's books and classroom publishing, continue to be helped by the enthusiasm in the market for children's independent reading. However, these gains were partly offset this quarter, by the adverse effect of foreign currency translations and a decline in Ed Tech, that is largely attributable to a tough comparison from last year, when we had a large MATH 180 sale that did not repeat this year, as well as lower consulting revenues. During the quarter, we took actions to restructure our media organization, to better align its operations with our core businesses, including moving our audio/video book operations to our book publishing group. Also while there is strong interest in Scholastic's programming, in today's evolving media landscape, it is no longer necessary for us to maintain the infrastructure required for production, and we will be closing down our Soup2Nuts production unit in this quarter. We have also agreed to enter into a three year agreement [indiscernible] Universal, NBC Universal, a first look at our trade publishing properties for live action movies. This gives us an opportunity to work with this top studio that has a direct stake in ensuring that our properties can become outstanding motion pictures. As brick and mortar retailers contract, more children are buying books through our club and fair channels. In fact, the kids and family reading report, released in January, found that our book clubs and book fairs rank second only to libraries, as the key sources for children's book. The 17% revenue growth this quarter in our clubs in particular, reflects higher engagement levels in schools, increasedness [ph] in the number of teacher sponsors, and more student participation. This remarkable turnaround in clubs took place in calendar 2014, starting with our January offers last year, and sales have grown in that period by more than 30%. We now expect sales for the rest of this school year to be equal to the very strong performance in Q4 last year. We reported 2% growth in book fairs. Steadfast support in schools is leading to higher attendance at our book fairs and higher revenue per fair. However, we had a slight year-over-year decrease in the number of fairs in the third quarter, because some schools had to postpone fairs, due to the harsh winter weather in parts of the U.S. Most of these fairs have been rescheduled, and we expect a strong fourth quarter in book fairs. As a result of our direct connections to kids through our clubs and fairs in particular, we know what books children love to read. In trade this quarter, we continue to see strong results from the Minecraft handbook series, with great early sales of the new handbook, Minecraft Block-o-pedia. As we look ahead to next year, we are ramping up for the October 2015 release of the Goosebumps movie, starring Jack Black, and we have an exciting lineup with a tie-in publishing that we will roll out this fall. Further bolstering our trade business, we purchased a minority equity interest in the U.K. book publisher Make Believe Ideas. MBI is a highly regarded publisher of innovative early childhood books sold in mass market channels, including Walmart and Target. Their vivid interactive books inspire creativity in early learning, principles that are well aligned with Scholastic's own. The first Scholastic branded MBI books will be introduced next week at the Bologna Book Fair and are slated for global release in fall 2015. We achieved 7% growth in the partner in classroom and supplementary publishing overall, which continues to be a growing business for the company. We are strengthening our position in U.S. schools on the basis of our ability to help teachers supplement reading and social studies programs, with personalized learning options and customized curriculum. Sales of guided reading materials and classroom books continue to grow strongly. Scholastic's guided reading help teachers ensure reading achievement and differentiated instruction, as they develop their curriculum. Our classroom magazines also answer the need for high quality engaging non-fiction content in classrooms. Circulation in classroom magazines exceeded 14 million copies per issue this quarter, as teachers continue to turn to our print editions and digital companions, to enhance the classroom experience. In Ed Tech, we are continuing to implement initiatives to expand the user base for all of our core intervention programs, especially our higher margin offerings. This quarter, we are encouraged by the growth in new business for READ 180, and as you may recall, READ 180 customers are highly likely to purchase additional programs from us in the future. MATH 180 Course II concentrating on algebra readiness has been field tested now, and will be released later this year. We know that schools are very excited about this new program, and the fourth quarter is a rather significant revenue quarter for Ed Tech and we are well positioned for the summer and back-to-school seasons. In International, we grew overall revenue before the impact of foreign exchange. Our fast growing business in Asia will now reach more than $100 million in sales this year. Solid local currency sales in that region and India, were supported by the growing global commitment to helping children learn to read in English and local languages, as well as math instruction in English. We are continuing to build our education publishing capacity in Asia, both for local and global markets, and are growing our consumer book revenues in Asia, through both direct sales and trade channels. In conclusion, we look forward to a strong fourth quarter in children's books, supplemental education and international, and we remain confident that the initiatives underway to strengthen sales operations and our educational technology business will support our sales efforts as we close out the year. With that, I will turn the call over to Maureen to provide more detail on our financial results.

Thank you, Dick, and good morning everyone. Our third quarter revenue grew by just over 2% to $382.1 million, and excluding onetime items, loss per share from continuing operations was $0.59, an improvement over a loss of $0.68 last year. Before I get to the detail behind our operating performance, I'd like to quickly review the one time mostly non-cash items for the quarter, which were $0.09 per share in total. These are mostly comprised of $2.9 million in severance charges associated with the restructuring of our interactive media business, where we are streamlining operations, so they are better aligned with our growth opportunities in children's publishing. We also had an asset write-down of $1.5 million related to a warehouse consolidation in Canada, and a non-cash settlement charge of $0.6 million, connected to our defined benefit pension plan. As you may recall, we had a onetime net benefit of $0.30 per share in the third quarter last year, which included a favorable settlement of outstanding federal tax audits. Cost of goods sold, excluding onetime items increased about 1% to 52% of sales, mostly due to higher free book promotions and clubs, Minecraft margins, higher cost of product due to foreign exchange in Canada, higher trade fulfillment costs in Australia, and higher product amortization in our Educational Technology business. SG&A excluding one time items, was essentially flat to the prior year. Now turning to our segment results, children's book publishing and distribution segment performance was strong, with revenue growth of 7% to $202.9 million. On the strength of marketing strategies implemented last year, school book club revenues grew by 17%. In school book fairs, we increased revenue per fair for the eighth consecutive quarter and grew revenue overall to $91.2 million. The harsh winter weather did have an unfavorable impact on the fair count in Q3, as Dick mentioned, and we expect to make up that in Q4, when the rescheduled fairs take place. In trade, 2% sales growth was largely due to the popular Minecraft handbook series and core backlist titles, including Harry Potter. Overall, segment operating loss improved to $2.2 million, versus a loss of $10.6 million last year, as a result of higher sales volume, together with lower operating costs and lower technology spend, partially offset by higher promotional spending in clubs. As you know, the third quarter is a smaller period for Educational Technology business and sales, as many schools and districts do not implement new curriculum programs midyear. Segment revenue in Educational Technology and Services fell by 4% to $34.3 million; mostly due to lower Math product and consulting revenues during the quarter. READ 180 new business revenue and expansion stage sales grew in the quarter. Segment operating loss was $12.4 million, as a result of lower sales and higher amortization expenses. We had a strong quarter in classroom and supplemental materials publishing, with segment revenue increasing by 7% to $49.1 million, and operating income increasing by 62% to $3.4 million. These results were driven by classroom magazines, where we were able to both increase pricing, and achieve a higher circulation, and guided reading and classroom book collection, which are becoming an even more vital element of our classrooms throughout the country. International revenue in the quarter was $86.3 million versus $91 million last year. Our international revenues are heavily impacted by the strengthening U.S. dollars, and we had a $5.5 million unfavorable foreign exchange translation effect this quarter. In local currencies, revenue growth in Australia/New Zealand, the Asia Pacific region and export was partially offset by lower Hunger Games sales in the United Kingdom and Canada this quarter. Segment operating income improved to $0.9 million versus $0.1 million last year. We are investing modestly to increase publishing capability in Asia, where we are seeing healthy demand for English language instructional material, and these investments offset the impact of lower promotion and salary related costs, and an insurance recovery from a warehouse fire in India. Overall, media segment revenue this quarter was $9.5 million, compared to $10.7 million in the prior year period, and segment operating loss improved to $2 million from a loss of $2.3 million in the prior period. As I mentioned earlier, we are restructuring our media operations, so that they are better aligned with our core publishing operations and opportunities. As such, we have deferred the timing of recognition revenue of certain programming. This deferral, along with lower revenue from Leapster and lower audiobook sales, caused our revenue to decrease this quarter. As part of the restructuring, we shifted audio and video book operations to be part of our trade publishing group. The audio and video book sales will now be reported as part of children's book publishing and distribution, beginning in the fourth quarter. Corporate overhead in the third quarter was $19.4 million compared to $11.2 million in the prior year period, excluding onetime items. This increase was primarily due to higher planned investment in corporate level information technology in the current quarter, to improve our data, analytics and selling capabilities. The overall impact of these investments was essentially offset by lower technology spent in the business segment. We had a year-over-year increase in depreciation expense related to our purchase of our headquarters' building. During the third quarter, free cash use was $4.6 million compared to a use of $70 million in the prior year period. At quarter end, net debt was $69.5 million compared to $157.7 million a year ago. During the quarter, we repaid $20.1 million of debt, and distributed $4.9 million in dividends to our shareholders from cash on hand. We announced yesterday that the Board of Directors declared a regular quarterly dividend of $0.15 per share on common stock in the quarter. Now turning to our outlook for fiscal 2015, we are affirming our outlook for total revenue of $1.9 billion and earnings per diluted share from continuing operations in the range of $1.80 to $2. Although we now expect to come in towards the lower end of our EPS range. We expect free cash flow in the range of $65 million to $85 million; the fourth quarter is a significant period for us, particularly for our education businesses. We also expect the restructuring of media business and actions taken to reduce overall costs will improve earnings in the fourth quarter and beyond. Finally, turning to real estate; I know many of you are very focused on this topic, so I will provide a short update today. We have entered into discussion with a shortlist of potential real estate investors on various strategies to monetize a portion of our real estate holdings in SoHo. Interest from these investors remain high. As previously indicated, we will provide a more detailed update on our real estate plans at the end of the fiscal year. And now I will turn the call back over to Gil, to moderate the question-and-answer session.

Thank you, Maureen. Nicole, we are ready to open up the lines for questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Barry Lucas of Gabelli and Company. Your line is now open.

Thank you and good morning. I have several this morning, Dick, and maybe if we could start with kind of some thoughts about what that classroom business looks like, and I am talking primarily supplemental materials, clubs and fairs, on a more normalized basis, now that you're comping the spike in sales from a year ago. And specifically on the supplemental side, the business you've been in for a long time, what are you really doing differently to get the kinds of results that were seen most recently?

I think the result -- it's from several things Barry. As you know, we have been in this business for a long time, as you said. Right now the enthusiasm for independent reading and for books in schools, is at an all time high, somewhat comparable to the whole language period of the 1980s. Teachers are going back to books after some flirtation with digital, and trying to make that work. These are largely printbook sales, although there is an appetite for digital subscription programs. Our classroom magazines have been amazing in their growth over the past three or four years, because the non-fiction is so beautifully attuned to the common core, and at the same time, our digital companions make it possible for the teacher to, on one hand, take advantage of the simplicity of the print magazine program, which is beautifully orchestrated for their teaching, and also can tell their kids to go look at the digital supplements, and/or teach them themselves the digital supplements on their whiteboard. So that's boosted up to classroom magazine, but underlying all of this, I think there is a dissatisfaction to some extent with core printer basal textbooks. People are looking for different kinds of solutions, and they are customizing their own curriculums to a great degree, so we work with them on that, as well as providing a professional development and support services. So I think it's just a perfect storm of wonderful reception for our supplementary business, and its growing by leaps and bounds, and we are investing more heavily in it. In respect to the clubs going forward, I think we have achieved the remarkable increase in sales since January of 2014 through December of 2014, a one year turnaround program that produced 30% some increase in sales in clubs. Obviously, we are leveling off a little bit right now compared to the tremendous gains that we had last spring. But we see the clubs as part of this overall independent reading thrust, as gaining traction with more teacher sponsors and more child use as independent reading becomes more popular. So we continue to see growth in that business, but the one time growth that we had in the last year which has been so dramatic, we don't see that continuing at that level of sales. Does that answer the combined questions Barry? If not, I can also ask other members of the staff here to talk about those issues?

That would pretty much do it Dick, as -- I won't say for modeling purpose, but is it fair to think about, on a going forward basis, the clubs and fairs, more or less likely to mirror population growth in K6 or into middle school?

I think we are seeing the book business in general, if you look at the trades education and so forth, especially on the trade side, book business is pretty flat. We see more people buying books in clubs and fairs than we have in the past. So I think we see this low single digit growth in that business. That's what we see coming in the future. We think we have continued opportunities as people use our channels for getting children's books as opposed to going to book stores, which are unfortunately dwindling a bit overall in our country.

Great. Thanks Dick.

Yeah.

[Operator Instructions]. And I am showing no further questions at this time. I'd like to hand the call back over to Richard Robinson, for any closing remarks.

Thank you all for your attention in this third quarter earnings call. We will look forward to talking to you again July for our full year results, and we appreciate your continued support of Scholastic.