Scholastic Corporation (SCHL) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic's Q1 FY 2014 Earnings Call. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to turn the conference over to your host, Mr. Gil Dickoff, SVP of Treasury and Investor Relations. Please go ahead.

Thank you very much, Ally, and good morning, everyone. Before we begin, I would like to point out that the slides of this presentation are available for simultaneous viewing on our Investor Relations website and that can be found at investor.scholastic.com. I would also like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the condition of the children's book and educational materials markets and acceptance of the company's products in those markets, and other risks and factors identified from time to time in the company's filings with the Securities and Exchange Commission. 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, again, at investor.scholastic.com. Now I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin our presentation.

Thank you, Gil. Good morning, and thank you for joining our First Quarter 2014 Analyst and Investor Conference Call. For this morning's prepared comments, I'm joined by Maureen O'Connell, CFO and CAO. With revenue in the first quarter of $276 million, we're off to a great start, especially because of the strong launch of 5 major new education technology products, all working well, all on plan, all on budget with very exciting levels of customer acceptance. This is a testament to the strength of our strategy of providing comprehensive solutions to schools, as well as our team's superb execution. These products are extremely well positioned to meet the growing demand for instructional materials in the Common Core era, and we expect the market for these new programs to remain strong for the foreseeable future. Education Technology and Services segment revenue and operating profit grew by 19% and 46%, respectively. Our technology programs and guided reading programs are high-margin products for Scholastic, so the robust sales in the quarter helped to improve net loss on a consolidated basis to $0.94 in the first quarter compared to $1.02 a year ago. Excluding onetime items in discontinued ops, our seasonal net loss improved to $0.90 versus $1.01 a year ago. This is a pivotal time for K-12 education, as the new Common Core State Standards and increasing use of tablets in the classroom drive change in schools throughout the country. Schools are increasingly turning to us for comprehensive solutions, including both materials and services, to help students reach the higher levels of thinking required by Common Core. In our club and fair businesses, we have new opportunities to encourage more independent reading, which is critical of children or to achieve the higher standards, which will be tested starting in 2015. Schools are seeking broad-scale instructional solutions, linking instructional materials, assessments, professional development, tech support, coaching and consulting, which, in the past, were typically purchased separately from different companies. Scholastic is able to provide all of these components of the comprehensive solution through a single touch point for our customers. As a result, we are helping districts meet a wider range of needs than ever before. Our education groups are collaborating on marketing development and field sales to capitalize on the increasing number of opportunities available to us. Our success to date demonstrates our ability to deepen our partnerships with schools with existing customers and also to expand our customer base. For example, iRead, our new technology program which teaches children in grades K-2 how to read, expands the reach of our technology programs into the early grades. Code X, our new Common Core middle school English language arts program, was first developed for New York City and has now been adopted in many other districts. And our System 44 Next Gen launched is supporting READ 180 sales, as many schools are buying these programs together. We also began to offer READ 180 for iPad this summer, providing a READ 180 tablet experience that captures the individualization of the desktop version. And we were very excited about how students are engaging with this program. Our teams are also working on making other programs tablet ready. We leveraged our READ 180 experience and the content and consulting expertise of our Math Solutions subsidiary to build MATH 180, the first intervention program designed to build the math foundations students need to meet the rigors of the Common Core. Working with a leading set of math educators, several of whom were involved with developing the Common Core Standards, we designed MATH 180 to support the 2/3 of middle school students who need math intervention. Many of these students have become hard to reach, believing that they are "bad at math, hate math or both". And their teachers often lack new structural programs and professional development to help these students learn math basics, much less prepare them for Common Core. MATH 180 helps to rebuild middle students' growth mindsets right from the beginning, making math relevant and important to their lives through real-life problems and simulations set up with engaging video. Students work in MATH 180's revolutionary software on essential principles of the Common Core, supported by video, modeling and experience with next-gen assessment type problems. They also have the opportunity to practice problem solving and fluency in an exciting set of games, which are served up according to each student's individual progress. All data is captured and organized for their teachers, so they can provide individualized instruction in smaller learning settings. It's early, but we're off to a strong start. And teachers and students are very excited about how well they are learning Common Core math principles through MATH 180. We expect our new products to bring revenue and earnings benefits over the course of this year and beyond, as Common Core implementations progress and we continue to broaden and deepen our customer engagement. Remember, our school customers turn to us for more than technology products and curriculum materials. We also perform program installation, implementation, maintenance and upgrades, and we provide professional development and school improvement services to support our customers' drive to improve student achievement. Scholastic's Common Core-driven opportunities extend beyond our education business. In clubs, our new grade-level specific flyers are designed to help parents find the right books for their child's grade level. This is crucial because children need to read more and on a higher -- at a higher level to meet the new standards. With features and products to support objectives linked to the Common Core, Storia, which just won a parents' choice award, continues to be an important vehicle for making ebooks more exciting and accessible for children in classrooms and at home. Usage continues to grow as the children's ebook market expands. First quarter results in trade were also on track. Sales of The Hunger Games did decrease in domestic and international markets compared to last year's level but were within our expectations for this quarter. We are looking forward to the Catching Fire film in November, which many have named the most-anticipated film of the year, and we expect that new fans will be drawn to the books around the film release. The trade paperback editions of the Harry Potter series have just been reissued with beautiful new cover art, sparking renewed interest in the series. We just launched the first book in our innovative new multi-platform series, Spirit Animals, which in just 10 days has already reached the best seller list. And we're looking forward also to publishing a new David Baldacci fantasy novel for middle-grade readers this spring. Due to growing Common Core-related interests in the breadth of our nonfiction Publishing, our backlist is also performing well. We are leveraging our content and brands across digital platforms. For example, we recently announced an agreement with Netflix to make a selection of our television series and videos available to Netflix subscribers. Partnerships like this will extend the reach of our library of TV shows and key brands with new groups of readers. We are affirming our fiscal 2014 guidance and continue to expect -- improve -- to expect to improve profitability and maintain strong free cash flow in fiscal 2014. Sales growth this year will be driven by our education business as a result of our new product introductions and increased demand for customized learning solutions. And we continue to expand -- expect our collaborative marketing sales and publishing efforts in both our education and children's book businesses to improve our operating efficiency and our ability to serve our customers. Now I'd like to turn the call over to Maureen to discuss our first quarter financial results in more detail. Maureen E. O’Connell: Thanks, Dick, and good morning, everyone. I will begin with the income statement. Looking at first quarter results, revenues declined by 6% to $276.3 million compared to $293.4 million a year ago, driven by lower U.S. and International sales of The Hunger Games trilogy. This was partially offset by strong sales of Scholastic's new education technology products. Cost of goods sold as a percent of sales decreased by approximately 2% this quarter. A large portion of the company's revenues -- a larger portion of the company's revenues came from our high-margin education technology products, which resulted in improved gross margins. SG&A declined by $6 million, which includes $2 million in onetime severance costs compared to the prior year, primarily due to lower employee-related expenses from cost reduction programs. Salaries and benefits were down $5.7 million in the quarter as a result of the cost savings initiatives. Loss per share from continuing operations was $0.94 compared to $1.01 a year ago. The consolidated loss per share was $0.94 compared to $1.02 last year, which included a loss per share of $0.01 related to discontinued operations. Excluding onetime expenses of $0.04 per share related to cost reduction programs, first quarter 2014 loss per share from continuing operations was $0.90 versus $1.01 a year ago. In the Children's Book Publishing and Distribution segment, revenues were $54.6 million compared to $70.9 million last year. Strong frontlist titles, including the new Harry Potter paperback collection and Star Wars: Jedi Academy, both released in August, partially offset the anticipated lower sales of The Hunger Games trilogy. Because most U.S. sales -- schools are not in session, revenue from book fairs and book clubs is minimal in the first quarter, and year-over-year differences are not meaningful. The seasonal operating loss of the segment was $61.5 million compared to $54.9 million a year ago, as lower book club costs partially offset the impact of the anticipated decline in The Hunger Games sales. In Educational Technology and Service, segment revenue was $94.9 million -- $94.8 million compared to $80 million last year, a 19% increase, reflecting robust sales of new products. We expect the increase to our installed customer base to lead to ongoing revenue from our implementation and support services, including technology services, hosting and professional development. Segment operating income increased 46% to $36.2 million due to higher revenues from high-margin educational technology programs in the current year period. Segment revenue in Classroom and Supplemental Materials Publishing was $37.8 million, approximately equivalent to $37.9 million recorded last year. However, segment operating loss improved to $1.6 million compared to the prior year operating loss of $2.6 million due to increased sales of the company's high-margin guided reading programs and classroom books in the current quarter. In our International segment, revenues decreased to $78.7 million from $90.2 million last year, as higher direct sales in Asia were partially offset by lower sales of The Hunger Games in the U.K. and Canada. India continues to be a great story for Scholastic with strong growth in our traditional businesses and the added success of new education products. As we continue to expand and deliver our region-specific products and English language learning programs, we are well positioned for growth throughout Asia and the emerging markets in 2014. Foreign currency exchange rates adversely impacted revenue by $4.3 million in the quarter. Segment operating loss was $0.7 million compared to income of $2.8 million last year. In Media, Licensing and Advertising, revenue was $10.4 million, down from $14.4 million last year, primarily due to lower sales of The Hunger Games audio books. As a result, segment operating loss was $1.9 million compared to operating income of $0.2 million last year. Corporate overhead was $16.4 million compared to $17.3 million last year, reflecting lower employee-related expenses in the current period as a result of cost saving programs implemented by management, as well as severance costs. Turning to the balance sheet. Free cash use in the quarter was $93.8 million compared to free cash flow of $4 million last year. As you will recall, we had over $90 million in cash collections from the sales of The Hunger Games in the first quarter of fiscal 2013, which make up the year-over-year difference. We maintained a strong balance sheet with only $13.4 million in net debt due to seasonal working capital needs. The company has ample headroom for borrowings under its $425 million committed credit facility due in 2017. The company's net debt to total capital ratio, excluding capitalized leases, was 1.6% at August 31. During the quarter, the company repurchased approximately 21,000 shares in the open market and had $19 million remaining under its current board authorization for share repurchases. On September 18, the Board of Directors raised our quarterly cash dividend to $0.15 per share in the company's Class A and common stock to the second quarter of fiscal 2014, an increase of 20%. This dividend is payable on December 16, 2013, to stockholders of record as of the close of business on October 31, 2013. The annualized dividend will now be $0.60 per share. In conclusion, as Dick said, we are off to a strong start to the year, and we are affirming our 2014 fiscal outlook for total revenue of approximately $1.8 billion and earnings per diluted share from continuing operations in the range of $1.40 to $1.80 before the impact of any onetime items associated with cost reduction programs or noncash, nonoperating items. We continue to expect free cash flow in the range of $60 million to $80 million. This outlook includes capital expenditures between $55 million and $65 million, and prepublication and production spending of approximately $65 million to $75 million. And now I will turn the call over to Gil to moderate the question-and-answer session.

Thanks, Maureen. Before our operator provides queuing instructions for the Q&A session, I wanted to address a few questions that we have received from investors and analysts over the quarter. The first question is on Harry Potter and the impact that we expect from J.K. Rowling's new film inspired by the Harry Potter Fantastic Beasts and Where to Find Them book. Ellie, is that something you can answer?

A strong interest and love for Harry Potter continues today, 15 years after we originally published the first book in the series. We published Fantastic Beasts and Where to Find Them in February of 2001 and are excited to have a new gifty [ph] Paper-over-board edition of the book available and The Hogwarts Library that we're releasing next month. This collection also includes Quidditch Through the Ages and Tales of Beedle the Bard. The new Warner Bros. movies will continue to generate excitement about the -- around the Harry Potter franchise and bring new readers to the Harry Potter series of books, as has the newly covered 15th anniversary trade paperbacks of the Harry Potter series, which we recently released and are once again on The New York Times Best Seller list. Like Harry Potter fans everywhere, we're also looking forward to the planned film.

Thanks very much, Ellie. The second question is on our new ed tech products, specifically, do we expect our typical sales patterns and revenue models to change with the new product introductions? Margery, can I turn that over to you for an answer?

Thanks, Gil. Well, first of all, I wanted to say how thrilled we are with our new products and the feedback we're receiving from teachers and, of course, the response we're getting from kids. I'll just use MATH 180 as an example. We're hearing the same kind of feedback on MATH 180 that we heard when we launched READ 180 comments like, "I now have to kick my students out of math class, something I never thought would happen." Our team did a great job in the field with our launches, and as Dick said earlier, we were able to pull this off beautifully, on budget and in line with our objectives. These programs were just introduced in July and August, and we had a fabulous month in August, and so far, September is looking great, too. We expect continued demand for our product and services throughout the year. Now on the revenue side, I want to talk a little bit about our typical sales patterns, which carry over to our new products as well. What we usually see is schools start with a partial implementation to get a feel for the product. Almost all the time, this initial implementation is successful and is converted into subsequent product sales. Along with products, teachers -- customers ask us for hosting solutions and technical support, which are recurring revenue for Scholastic. And we have a very high renewal rate on these services. Teachers also come to us for renewable components, such as consumable books and replacement teaching guides, and almost all of our programs are sold with professional development services. So you can see that we typically engage with our customers on more than just a program sale and implementation. These are long-term partnerships, and customers are asking us to help them with broad-scale instructional solutions.

Margery, thanks very much. Operator, we're now ready for you to provide instructions for the Q&A session, and I will turn the call back to Dick Robinson. Thank you.

[Operator Instructions] Our first question comes from Drew Crum of Stifel. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: So just want to -- I guess, point of clarification with respect to the publishing business. In the press release, you indicated that you expect to see increasing sales of instructional programs and services over the course of the year. Is that for ed publishing or ed tech? And is that a year-on-year increase? Or is that a sequential increase from the fiscal first quarter?

We think it's going to be in all of the education businesses but mainly focusing on ed tech, Drew. So -- and Margery can follow up on that question.

Yes. We're already -- we're seeing September get off to a good start, and we believe that our new programs can be implemented during the course of the year. And we're seeing so much demand for Common Core -- help with Common Core that we expect that we will have implementations of iRead, MATH 180, especially during the school year. So we're expecting the second quarter, the third quarter and the fourth quarter all to be above last year. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Got it. Okay. And on MATH 180, Margery, could you talk about -- maybe contrast that with the reading intervention products that you have in the market? What is the market opportunity for a MATH 180-type product?

Yes. So about the same percentage of kids are struggling in math and struggle in reading. And it might -- the data says that there's a few less kids in math than there are in reading, but it's not material. And with Common Core assessment coming along, next-generation assessments, as Dick mentioned, we expect that schools are going to see that kids who seem like they were doing okay really aren't doing okay on these new rigorous assessments. So right now, we brought MATH 180 out. It's targeted at middle school. We have a few places that are looking at it for upper elementary. But as you know, with READ 180, we have a version of READ 180 for elementary, middle and high. Over the next 18 months, we're going to bring out the second year of MATH 180, which we think will again expand our market for it. We believe there's tremendous opportunity for math program. And what we're seeing with our acquisition of Math Solutions, which is doing extremely well and our other math products that we've been publishing over the past few years, we're seeing that our field is getting very comfortable selling math, even though they've been traditionally certainly reading. We have math sales in virtually every state of the United States now, not just MATH 180 but our math line. And we think math is an important growth area for our company. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: And I want to shift gears to clubs and fairs. Can you offer any updated thoughts on growth or your expectations for those 2 businesses in fiscal 2014? And the follow-on to that is that in the fiscal second quarter last year, both the clubs and fairs businesses were impacted by Hurricane Sandy. Can you quantify the amount of business you expect to recoup in this year's fiscal second quarter absent storm-related issues?

Our fair -- revenue per fair is budgeted to be up in fairs, Drew. We're also moving people who are below certain revenue levels from our case there, is where we deliver the books to the schools and through our trucks and set them up in the schools to our mail fairs, which are basically sent through UPS to the schools, and the schools operate them themselves and open the boxes and so forth. So we believe that that will -- that, that's going to improve our revenue per fair as we switch more people to higher-level fairs. In terms of Sandy, we -- it did affect our clubs and fairs last year, but I would say we -- it was about a maybe a 2 to 3 days of revenues. So I don't think it's going to have a significant differential this year. But we are seeing -- our early fairs are seeing good revenue per fair. On the clubs, I'll ask Judy to answer that question.

So the big news about clubs that we can report on because, obviously, it's still early in the school year is that we've redesigned the flyers to be grade specific, and this has the benefit of really helping teachers connect to the Common Core needs that their kids have and also, for the parents who can clearly identify and say, "My child is in the first grade." And here's the first-grade flyer to help them really get the books that they need right for the child. So we're having very good early qualitative feedback from teachers and parents. And we're very excited, and it also really helps us position books well right for the kids at that grade level, right at their sweet spot when they need those books, particularly now to help with independent reading to support their Common Core. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Okay. Last question, was there any contribution from the Netflix deal in the quarter? Is that something we should expect later in fiscal '14? Maureen E. O’Connell: Yes. We recognize revenue for Netflix in the quarter, and we deferred a very small amount that will go into the second quarter. So most of that revenue was recognized in the quarter and was recognized in our MLA segment. But in the prior year, we also had a revenue recognition related to residuals from PBS, which was about the same amount, so you don't see a year-over-year change in the segments of that.

[Operator Instructions] Our next question comes from Barry Lucas of Gabelli & Company. Barry L. Lucas - Gabelli & Company, Inc.: I have a couple of items, Dick, and I'd like to come back to the issue of the take-up rate of new products. And I'm just looking back across first and second quarter results for a couple of years, the relaunch of READ 180 2 years ago and the stimulus impact over earlier years. And I'm just wondering, given the fact you have so many new products in the market, revenues are still below some of those peak numbers and again, understanding that some of that was stimulus related, but I'm just -- to follow-on to Drew's question, I mean, what is the market potential for the addressable market that you think we're talking about here?

Well, thanks for the question, Barry, and I'll ask Margery to also answer this. But remember that our customer -- that most of these products were actually only available in the first quarter this year. So the customers didn't really get a chance to preview them and see them and test them and so forth. They were buying because they wanted the product now, and they trusted us to deliver something that they would want to use starting in September. So these are really preliminary sales. They're outstandingly good, so we're not apologizing for that and compare them -- we did get a big impact from stimulus several years ago, but this is what I would refer to as our own stimulus here where we've -- through our new products, we've gotten off to a great start in this quarter. But these are long-term products. We've been selling READ 180 now for 15 years, and it's still going strong. And MATH 180, I think, is going to have a remarkable career in -- over a similar period of time and in some cases, even more difficult to teach these math concepts that are so beautifully carried out by MATH 180. So I think we're going to see a very strong response to that into our iRead program in grades K to 2. But this is just the very, very beginning of it, and we're delighted that the response has been so strong so far. So Margery, would you add some thoughts to that?

Yes. So Barry, I know you know that stimulus was kind of like this amazing moment. We had so much pent-up demand for READ 180. And in the year before stimulus, it was a little bit tight because people were worried about funding. And then stimulus came along. And then we had school districts who said they've been waiting to buy READ 180, and now that they had it, they could buy it. But we're really, really excited about that kind of results that we're seeing out there because when Common Core first started, there were some confusion in the market about what should be done with intervention students. Should they be put into on-level classrooms with higher reading demands? And people were trying to figure out how to schedule kids. We've seen that really evaporate now. And System 44 and READ 180 have had both strong -- both of them have had strong results at the end of the prior year and over the summer. As Dick said, we're just at the beginning of MATH 180 and iRead. We're delighted with how Code X did. It did extremely well, which is our middle school Common Core program. So we're feeling like very optimistic. I was with our field organization the past 2 weeks. They're seeing a lot of demand for our products. And by the way, I should also mention that our services business is doing extremely well, too. There's a lot -- we're all over the country, helping schools with school improvement, with getting teachers ready for Common Core. We're doing a lot of math and literacy training around Common Core. So as you know, K-12 business is a little bit bumpy, and we're feeling like we're riding a high bump right now.

I think, Barry, as you, I think, believe, we're in for a period now of investment in education. The states are stronger in terms of their financing. California devoted $1.2 billion to be -- which is just coming into the market this month to support Common Core programs. So -- and I think this -- the focus on Common Core and the digital and the use of tablets in the classroom is going to usher in a period of prolonged growth in education. And we're just at the beginning of that and the launch of these programs in the first quarter is just the initial impact of what will be a very long trend, in my view. Barry L. Lucas - Gabelli & Company, Inc.: Dick, that's great. Could you or Margery identify any of the districts, particularly for Code X, which was developed for the New York City school system? Are you -- is that meeting -- or is it being accepted readily by other areas, whether they're other urban areas or large districts or small districts? Maybe a little color there would be terrific.

Yes. Well, Barry, we don't have any large district to announce to you right now, but we have sold it in other districts outside of New York. It was -- we published that program fast. We got the agreement with New York that we were going -- were chosen publisher for this in December, and we had the program in New York City warehouses in July. We didn't have a lot of time to show it to a lot of other districts, and where we have shown it to other districts, we've had great interest. And there are some large districts considering it right now, and I just can't talk about. Barry L. Lucas - Gabelli & Company, Inc.: Great. If we just switch gears, Maureen, capital allocation, nice increase in the dividends would suggest to me that the board has a fair degree of confidence and optimism in what's happening. Anything else we can look forward to as the share repurchase program winds down? I think you said we're down to $19 million authorization? Maureen E. O’Connell: Well, I think you're absolutely right, Barry. The board has ultimate confidence in our ability to return capital to investors as well as invest in our business. We launched this dividend less than 2 years ago, and this is our second increase in that time period. So we continue to look for ways to increase the dividend and return it to investors. And as you know, we still have $19 million under authorization for our share repurchase program and bought back 21,000 shares in the quarter. This is our peak borrowing quarter, so this is a quarter when we use cash to build inventories and prepare for school openings. So our cash is at a low point now. Around mid-October, we'll start going cash positive, and then the balance sheet would be even in a stronger position. And we would continue ongoing discussions with our board about how to allocate capital and what's the best use of our cash.

[Operator Instructions]

Well, thank you, everybody. We appreciate your support. We had a great first quarter, and we're looking forward to an excellent year. Thank you for listening, and we'll talk to you in December.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.