Scholastic Corporation (SCHL) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2014 Results and Fiscal 2015 Outlook Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Gil Dickoff, Senior Vice President and Treasurer. Sir, you may begin.

Thank you so much, Litoya, and good morning, everyone. Before we begin, I would like to point out that the slides for this presentation are available for simultaneous viewing on our Investor Relations website at investor.scholastic.com. I would also like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the condition of the children's book and educational materials markets and acceptance of the company's products in those markets and other risks and factors identified from time to time in the company's filings with the SEC. Actual results could differ materially from those currently anticipated. Our comments today include references to certain non-GAAP financial measures as defined in Regulation G. The reconciliation of these non-GAAP financial measures with the relevant GAAP financial information and other information required by Regulation G is provided in the company's earnings release, which is posted on the Investor Relations website, 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 fourth quarter and fiscal 2014 analyst and investor conference call. For this morning's prepared comments, I'm joined by Maureen O'Connell, CFO and CAO. In 2014, we had a strong fourth quarter and achieved our guidance for the year with annual revenues of $1.82 billion, earnings per diluted share of $1.84, excluding onetime charges and free cash flow of $63.7 million. In Children's Book Publishing and Distribution, annual revenue grew by 3% to $873.5 million, while operating income, excluding onetime items, increased by 90% to $54.2 million. This growth was driven by higher revenue-per-book club order and higher revenue per fair in our school-based distribution channels. In 2014, we grew the top line in clubs by successfully launching a new grade-specific strategy, including expanded club offers, which was a major driver of our revenue growth of 12% for the year, and 55% for the fourth quarter in book club. Teachers are responding to our revised marketing programs with higher value orders and increased ordering frequency. We also benefited from strategies to maximize revenue per fair in our book fairs unit. Our strong club marketing strategy as well as coordinated inventory purchases throughout the organization brought significant benefits this year, particularly for the January-to-May period. Trade sales were up by 22% in the fourth quarter although down slightly for the year. The Hunger Games trilogy sales declined in-line with our expectations and remain a strong contributor to revenue overall. Frontlist growth was driven by middle-grade bestsellers, including Star Wars: Jedi Academy and Wings of Fire, as well as our LEGO movie tie-ins and Minecraft handbooks. The first 2 Minecraft titles soared to the #1 and #2 position on The Wall Street Journal's nonfiction bestseller list within the first 2 months of release. And with 2 new handbooks and a boxed set plan for fiscal 2015, Minecraft will continue to be a revenue driver across all of our distribution channels. Scholastic is an essential resource for parents and teachers who rely on our clubs and fair channels for a wide range of titles, particularly in a time of fewer brick-and-mortar retail outlets and reduced access to libraries. Our channels play a critical role in introducing children to new titles and authors and in creating opportunities for children to discover and choose the books they want to read, a proven tactic parents and teachers use to encourage more time spent reading. Over the course of the year, we made significant progress expanding the reach of our media contents, such as Clifford the Big Red Dog, The Magic School Bus and Goosebumps across multiple media platforms, including NetFlix. Principal photography was also just completed on the Goosebumps movie in association with Sony, and we will issue new Goosebumps titles in anticipation of the film release in August 2015. In 2015, Scholastic is also converting to a streaming model for Storia, our children's ebook delivery system. Our original ereading apps were designed specifically for individual operating systems, such as iOS and Android. The new HTML-based streaming across a cross-platform delivery model will adopt EPUB 3, the new industry standard for ebook production. It'll be a more efficient way for Scholastic to deliver ebooks to our customers, lowering maintenance costs, making it easier and less costly to convert our titles to school, while improving flexibility and choice for readers while retaining the content and look of the original app. We recently announced our streaming Storia school edition, which we are launching in September for the start of this school year. Our streaming Storia edition for families will follow at a later date and will be available through our clubs and fairs. This change in delivery model resulted in an $18 million pretax charge in the fourth quarter, much of which is an acceleration of the normal depreciation pattern for our initial investments in Storia software across multiple operating platforms. In 2014, Educational Technology and Services segment was up 9%, while segment operating income increased 34%. We had excellent rollouts of MATH 180, iRead, READ 180 for iPad, System 44 Next Generation and Common Core Code X early this year. Our award-winning MATH 180 program had the best first year performance of any Scholastic educational product launch to date. We were able to achieve this first year of -- strong first year performance in part because we modeled our launch of a comprehensive MATH plan on our successful strategy for literacy. Thus for MATH, we were able to offer consultative selling, aligned professional development and a blended instructional model built on the best research, in other words, a full solution for MATH intervention. And our position will be further enhanced with the launch of course 2 for MATH 180 in the fourth quarter of 2015. Course 2 builds on concepts mastered in course 1 and also prepares students for algebra. Sales of READ 180 increased in the fourth quarter following the completion of our sales force realignment. We saw a strong growth for System 44 Next Generation with sales up by more than 40%, and we will launch the iPad addition of System 44 in 2015. iRead, our new K-2 foundational reading program, had a strong first year as well. This program was built on the intelligence of System 44, but redesigned for younger readers. With System 44 Next Gen and iRead, we can now serve every student at risk of reading difficulty from kindergarten through high school, and we can support the growth of their teachers through our professional development services. Summer reading programs, classroom libraries and classroom magazines also continue to be strong contributors to our growth. This year, circulation of classroom magazines increased to over 13 million, and we had record-breaking growth in our Scholastic News Weekly/Reader digital views. Our International segment is benefiting from growing demand for English language learning, strong trade sales and a promising launch of 2 new education programs, Scholastic Literacy Pro and Scholastic PR1ME Mathematics. Most international markets experience sales growth in local currency terms for the year, including double-digit growth in Asia. However, the strengthening of the U.S. dollar continued to unfavorably impact revenues in U.S. dollar terms. Before I turn to outlook, I want to share our perspective on the new standards. While the term Common Core has come under fire in some parts of the country, the shift to new more rigorous standards, designed to prepare all students for college and career, is nearly universal. Market research shows that educators are embracing the higher standards but are concerned about what it's going to take to move all students to those standards. With roughly 2/3 of all students performing below proficiency on national tests, our focus on results through comprehensive instructional systems and our support for teachers through professional development has never been more resonant. We believe we are recognized as the leader in innovative intervention that staircases all students' academic success, and we expect demand for our solutions to grow as the new assessments mature. Additionally, the use of our magazines and books is growing across all of our channels. Our teachers understand that's going to take more reading experience by students to meet the new standards. Teachers are looking to us for high-quality nonfiction and for those great stories that spark independent reading, which in turn help build vocabulary, content knowledge and higher level reading skills. For 2015, we expect revenue growth and enhanced profitability across majority of our businesses, with increased momentum for our Educational Technology products, continuing improvements in club and fair performance and exciting new trade releases. We also expect to increase investments in information technology and sales resources during the year. In 2014, we completed the review of our technology needs in order to ensure that our programs were aligned with our strategy for growth. Our investments will result in more effective customer analytics and enhanced delivery platforms, which will assist with new product development, enable more productive marketing spend and generate greater customer satisfaction. We were pleased with our operational performance in 2014 and expect to build on the success in 2015. We have strong businesses that are all on track for continued growth, and we have aligned our strategy for growth around systems and programs that help kids succeed in school and in life. With that, I will turn the call over to Maureen to provide more detail on our financial results and outlook. Maureen E. O’Connell: Thank you, Dick, and good morning, everyone. On today's call, I will focus on our adjusted full year earnings. For fiscal 2014, total revenues were $1.82 billion, a 2% increase versus 2013 and in-line with our guidance. Cost of goods sold in 2014 as a percent of sales was 46.3%, in-line with last year and SG&A decreased. Excluding onetime items, operating income was $107 million, an increase of 31% compared to last year, resulting in earnings per diluted share of $1.84 in 2014 versus $1.22 in 2013, which also excludes onetime items. The onetime items above the operating line in the year totaled $43.9 million and included: a pretax mostly noncash charge of $80 million related to the transition from operating system-specific Storia apps to a streaming model for children's ebook delivery, which was taken in the fourth quarter; a noncash pretax settlement charge of $1.7 million related to our pension plan; a $10.8 million pretax charge in connection with the company's cost reduction and restructuring programs, of which $1.6 million impacted the fourth quarter results; finally, we recorded a $13.4 million pretax noncash impairment charge related to goodwill from book club acquisitions made more than 10 years ago, Troll and Trumpet clubs and which we announced earlier this year. Now turning to segment results. Children's Book Publishing and Distribution revenue in 2014 was $873.5 million, a year-over-year increase of $26.6 million. Operating income, excluding onetime items for the full year, increased by $25.7 million or 90%. Segment results primarily reflect higher revenue-per-book-club order and higher revenue per fair in our school-based distribution channels. Growth in the frontlist, driven by multiplatform best-selling SPIRIT ANIMALS and David Baldacci's The Finisher, as well as the strength of our Minecraft fan books and LEGO movie tie in, which were leveraged across all channels. Educational Technology and Services revenue was $248.7 million, up $21 million or 9% compared to last year. Operating income increased by 34% from $29.5 million to $39.6 million. We had strong sales of our new education technology products, including MATH 180, iRead, System 44 Next Generation. Also, fourth quarter sales of READ 180 grew year-over-year, reversing the third quarter trend when we experienced some disruption from our sales force realignment. Operating profit increased due to strong sales, partially offset by higher prepub amortization on our new products. Classroom and Supplemental Materials Publishing revenue was $229.6 million, up 5%, compared to $218 million a year ago. Operating income improved by 27% to $37.5 million in fiscal 2014. Results were driven by strong sales of classroom magazines, especially the print and digital editions of Scholastic News/Weekly Reader and strong sales of classroom books. International segment revenue was $414.3 million compared to $441.1 million in the prior year. This includes a negative impact from foreign exchange of $24.2 million. Segment operating income in fiscal 2014 was $31.4 million compared to $41.8 million last year. Results were impacted by the decline in The Hunger Games trilogy sales, higher cost of U.S. dollar-denominated product and higher levels of investment and expanded education product development in India and Singapore, in both print and digital. In Media, Licensing and Advertising, revenue was $56.2 million versus $58.7 million last year. Operating loss for the segment was $0.7 million compared to income of $4.7 million a year ago. Segment results are primarily the result of lower consumer magazine and custom publishing revenues and decreased sales of interactive products, partially offset by higher proceeds from the sales of Scholastic Media programming. Corporate overhead expenses were $55 million, compared to $52.6 million in 2013, reflecting higher incentive compensation expense in the current period, which offset cost savings in salary and consulting expense. The company's balance sheet remains strong, ending the year with net debt position of $114.9 million. A year ago, cash and cash equivalents exceeded total debt by $85.4 million. The change in the company's net debt position was directly attributable to the purchase of our headquarters building in SoHo at the end of the third quarter. During the fourth quarter, we repaid $42.8 million of the $175 million that we borrowed to fund the purchase. As we have said previously, we plan to evaluate strategic opportunities to monetize our real estate holdings in SoHo in fiscal 2015 and believe that the market continues to offer us very favorable options to do so. Free cash flow for fiscal year was $63.7 million, compared to $59.6 million in fiscal 2013. We also declared a quarterly cash dividend of $0.15 per share on the company's Class A and common stock for the first quarter of fiscal 2015. The dividend is payable on September 15. Now I'd like to discuss our outlook for fiscal 2015. In fiscal 2015, we expect revenue growth and enhance profitability across the majority of our businesses. This outlook reflects our expectation for increased revenue per fair in our book fair unit and growth in our repositioned book clubs, which will face a tough comparison in the second half of 2015. We are well positioned to capitalize on a recent success of Minecraft, with 2 additional titles and a boxed set schedules for release later this year as well as new titles in many of our best-selling series, including Captain Underpants, Amulet and Star Wars: Jedi Academy. We plan to extend our leadership position in multiplatform publishing with the introduction of Tombquest in early 2015, while continuing to promote our backlist and our digital offerings. Sales of The Hunger Games Trilogy in both domestic trade and international major markets are expected to decrease in 2015 but remain a significant contributor to revenue. We expect continued revenue growth from our Educational Technology products and services. We plan to add to our sales resources, increasing the size of our team by approximately 10% in order to strengthen our ability to broaden the user base of our high-margin programs, such as READ 180 and System 44. We are making these investments to support the long-term growth of this business. And while we will see incremental sales benefits in fiscal 2015, we expect our new sales team to reach full productivity in approximately 18 to 24 months. In our classroom book unit, we expect revenue growth to be driven by the acceptance of our new guided reading nonfiction books and instructional resources. Growth in our International segment is expected to be partially offset by increased investment in new educational programs and the expansion of our sales organization in Asia. We also plan to make strategic investments that focus on moving to enterprise systems in a single, more comprehensive view with the customer. This will allow us a stronger school-to-home connection and will improve our data and analytics capabilities. For example, in the second half of the fiscal year, we plan to launch new teacher ordering functionality for COOL, which will make it easier for teachers to place and track individual student orders and will give Scholastic greatly enhanced information and analytics about each student's order within a classroom. Additionally, we will create more robust content management systems to allow us to easily access to our content company-wise and create standardized services across the businesses. Finally, we will be moving our technology infrastructure to the cloud. Our outlook assumes capital expenditures return to more normal levels of $45 million to $55 million compared to $27 million in fiscal 2014, including investments and facilities and infrastructure in Canada and Asia. Our outlook also includes prepublication and production spending of approximately $65 million to $75 million compared to $66.1 million in fiscal 2014. As a result of these factors, we expect total revenue in fiscal 2015 of approximately $1.9 billion and earnings per diluted share in the range of $1.80 to $2, before the impact of special onetime items. Fiscal 2015 free cash flow is expected to be between $65 million and $85 million. In summary, we expect another strong year in fiscal 2015, building on our successes in fiscal 2014 with growth in each of our businesses that will be partially offset by increased investment in technology and our educational sales resources in U.S. and Asia and lower high margin sales of The Hunger Games trilogy. Now I will turn the call back to Gil to moderate a question-and-answer session.

Operator, we're ready to queue up any questions that are coming through the phone line.

[Operator Instructions] And we have a question from Drew Crum of Stifel. Andrew E. Crum - Stifel, Nicolaus & Company, Incorporated, Research Division: I had a couple questions on cash flow. If I look at the performance for fiscal 2014, it looks like you came in at the low end of your guidance range, and CapEx was significantly below what you had forecasted. Were there any anomalies or onetime items in cash flow from operating activities that may have influenced that? And then, on a related note, can you talk about the board's decision not to increase the dividend for fiscal '15, if I understand that correctly?

So Maureen will talk on the cash flow, and I'll be glad to address the dividend question, Drew. Maureen E. O’Connell: So there was 1 thing that affected cash flow during the year, and we saw a slowdown in collection in our Educational Technology sales. And also, May was a very strong month for education, so they shifted to later in the year. We have seen that collection come in, in June. We made a concentrated effort within our distribution center and our call center in our NSO locations to really drive those collections, but that was a slowdown and that did impact negatively cash flow this year.

On the dividend, we continued our dividend for the quarter with no particular philosophy about increasing them. We were happy we had a good year, and the board will continue to look at different ways of returning cash to shareholders, including dividend increases. Andrew E. Crum - Stifel, Nicolaus & Company, Incorporated, Research Division: Got it, okay. And then, Maureen, just as far as the EPS guidance range is concerned, I mean it feels like $1.84 is the comp that we should be working with. I mean the low end of the range would suggest that you're assuming you're down year-on-year, and yet you're forecasting revenue growth. Is it just the function of all the investments you plan to make in fiscal '15? Maureen E. O’Connell: Yes. I mean if you look at our guidance, it's very similar to our actual results in 2014, which was a highly successful year. And we are expecting continued growth in every one of our businesses next year. But that will be offset somewhat with investment in Asia, we're opening new hubs within India, we're expanding our publishing operations within India and Singapore. We're adding educational resources to our Educational Technology sales force. We're also adding resources to a supplemental sales force, and we have less Hunger Games sales, which are very high margin sales. So in our technology, we're expanding our investments there. So those offset the growth, the robust growth, that we're actually planning across all our businesses. Andrew E. Crum - Stifel, Nicolaus & Company, Incorporated, Research Division: Got it. And then, last question, just as it relates to Ed Technology. I guess for clarification purposes, you mentioned System 44 was up 40%. I take it that's a 2014 number, not 4Q?

Margery will answer that one. Thank you.

Drew, it's Margery. Yes, that was for the fiscal year 2014. We did, I think a really great job revising System 44 and we -- System 44 is used in 2 ways. It's used as a standalone and it's also used in combination with READ 180, and we revised the program so it works better in both situations. And we've had a great reception from customers. Andrew E. Crum - Stifel, Nicolaus & Company, Incorporated, Research Division: Margery, just to just follow up, can you talk about some of the key drivers for Ed Tech growth in 2015? It sounds like you did have some tough comparisons with MATH 180 and System 44.

Yes, well, we think both of those products are going to grow. With MATH 180, we've had a great reception to MATH 180. We've sold into 47 states in the first year, which we're really excited about it. It's really in 9 months we sold into 47 states. And we have course 2 coming out in the fourth quarter, so we're really optimistic about MATH 180. And we're optimistic about System 44 as well. We did have a good year with System 44 because we have pent-up demand as we came into the year, but the reception to 44 has been fantastic. And with pressure for more rigorous standards, our customers are looking at how to help support all students.

And the next question is from Barry Lucas of Gabelli & Company.

I have a couple of questions, Dick. If we could start maybe sizing the total investment in Storia versus the write-off and what needs to be done going forward, I mean you're talking about a fair amount of additional technology investments. And given the write-off, I'm a little bit concerned about the dollars being spent there.

Well, the streaming Storia model is complete, and most of those expenses were made in the past fiscal year. So I don't think there's a lot more investment we're going to be making in that area. We have a great platform coming up with a streaming model. It's easily adapted to the consumer over time through our book clubs and book fairs. So I wouldn't look for very much increased Storia-related investment in 2015. Most of the Storia investments have been written down in the current year. Does that answer your question, Barry? I mean we've got -- we built a new good platform. We spend the money on that. We expect to reap the benefits in the coming years, and there will not be a lot of increased Storia spending in that time. New books, we will continue converts to the streaming model, but that's the main expense.

Okay. And maybe to flesh out the investment in the sales force a bit more, how would that be directed? It's more geographic coverage is it more product line function?

Yes, well, Margery can answer that. I think we have a strong Educational Technology business. We haven't increased the sales force in the past several years. We believe there's more opportunity there, Barry. That's a simple answer to the question, but Margery can give you more detail. Maureen E. O’Connell: Yes. I mean it's really what Dick said. When we look at the funding sources for our products and we look at, especially at Title 1, we know that we have massive amounts of unpenetrated districts. So we are measuring where we think the penetration levels could be raised, and that's really our key strategy. There will be some specialists added in some different areas. One of the things that we do is we have a small team of people we call solution architects that help us work with customers to put together solutions that are specifically aimed at their needs. But most of the investment is going to go into improving our coverage in high need areas.

Great, Margery. Two more quick ones if I could. One would be on some of the comments that you made, Dick, regarding Common Core and the pushback despite the need -- the clear need for more rigorous standards. So how does that then get reflected going forward? I mean, we've seen some states pull back, there's been some resistance, but how do you overcome the, let's say the negative buzz in certain communities about Common Core and reinforce the need for the types of products and services that you offer?

Well, I think the Common Core training has proceeded very substantially throughout the country. And the teachers in our polls, and we do a lot of them, which we publicly announce with the results are some of them together with the Gates foundation, that our general understanding from teachers when we talk to them, do research, do polling, they believe in the Common Core Standards or the standards. They have already began to implement them. They understand them. They acknowledge the need for helping kids to perform at higher level. It's the political world on the top that is not really affecting that very much. But there will be some issues around the timing of the tests for Common Core and so forth. But basically, the teachers are already doing the Common Core Standards, and it's reflected in how they're organizing their classroom, the questions they're asking the kids, the materials they're using, and so forth and so on. So we think it's there. It's in the system, we can call it anything you want, college and career ready, new standards, but it's already happened and people see the need for it. And they understand that the communication hasn't been very good on some of it, but we believe it's in the system. The teachers are concerned about having the resources available to take their most challenged kids, which is really in the majority, and help them get to the higher standards. That's the thing they are most concerned about, and will they get support from the schools and the states and the districts in terms of financial training and materials and so forth. Margery, you should -- you probably discuss how this might affect the area that you're responsible...

Well, everything Dick said, I would underscore. I think some of the noise around Common Core is they don't write stories about how much it's permeated the instruction. And so the news stories that get out are about the few states that have been -- where Common Core has become highly politicized. But I don't hear much debate about the interest teachers have around raising rigor, engaging kids in conversation, trying to focus more on critical thinking. And we believe and we've seen evidence of this, that educators know they're going to need to help to get there with their kids. And that's where we come in.

Yes, in the children's book area too, Barry, people -- the teachers are returning back to independent reading, getting kids to read more, more fluently, more often, more widely, because they understand that, that's what helps kids develop higher-level thinking skills. And those are the thinking skills that are called for under the Common Core. So our book business is really resonating because of the interest in higher-level thinking skills and the relationship between fluent-broad reading and higher-level thinking skills and learning.

Great. And just, Dick, if you could flesh out or maybe provide a little more color on the thought process on putting, sounds like more either boots on the ground internationally or building physical facilities versus maybe partnering with others? And how are you thinking about the international side of the operation?

Well, certainly, improving our Canadian distribution is going to save money, but basically, we're consolidating several warehouses into 1, it's going to be much more cost effective as well as better for our customers, so that's a no-brainer in terms of that relatively small investment. In Asia, we have a strong publishing program in Singapore. We're developing materials relatively low cost, highly clear in terms of the skills they teach, popular in Asia, but also importing into the United States, the U.K., other places. So we're very proud of that publishing operation. It's a relatively small investment for the company, overall, but it does require more sales resources to operate it. So some of the spending there will be increasing the sales staff in Asia, primarily to sell the materials that are so successful that we've created. Our Consumer Business there, where we're selling direct to families, has been highly profitable, and we're continuing to invest some sales resources in that area. So these are not big resources. There's no partnership opportunities that make sense because this is our intellectual property. We understand it, we know how to sell it, costs are not that great, but they will affect next year's operating performance in the International segments. But the International is a tremendous opportunity for us, the growth of English language, the rise of the middle class, the focus on education, especially in Asia. All of those are prescriptions for a tremendous opportunity for us in those areas, and we have the right kind of materials that people want and need.

And at this time, I would like to turn the call back over to Richard for closing remarks.

Well, we had a very good year. We're looking forward to good progress next year. We are going to be investing more money in our systems and in our content intellectual property. We're seeing a return of independent reading. We are very confident and excited about the future for the company, and we appreciate the support of our investors, stockholders and partners. Thank you so much.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect at this time.