Scholastic Corporation (SCHL) Q2 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Scholastic Reports Fiscal 2015 Second 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 follow at that time. [Operator Instructions]. As a reminder, today's conference is being recorded. I would now like to turn the conference over to Gil Dickoff, Senior Vice President, Treasurer, and Head of Investor Relations. Sir, you may begin.

Thank you very much, Candice, and good morning everybody. Before we begin, I would like to point out that the slides for this presentation are available on our Investor Relations website 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 materials markets and acceptance of the company’s products in those markets, and other risk factors that we may identify 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 now posted on the Investor Relations website, 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 for joining our second quarter earnings conference call. For this morning's prepared remarks I am joined by Maureen O’Connell, CFO and CAO. Our second quarter results were on plan. Revenue was $665.6 million, a 7% increase over last year and earnings per share were $2.05 versus $1.80 in the second quarter of last year. Our solid revenue growth with significant gains in clubs, and fairs, and classroom books was driven by strong enthusiasm in the market for children's reading. In schools we are seeing a continued focus on independent reading as a key way to improve children's motivation and reading skills and to drive achievement. This is leading to higher engagement throughout our business and especially in our clubs and fairs, school distribution channels. In our Ed Tech business we know our reading and math intervention programs can turn around the lives of kids who are below proficient level in reading and math and that is the majority of students in our public schools today. Of course at the heart of our engagement is our trusted brand, parents, educators, and kids turn to us for the high quality relative content and technology that fosters a love for reading and learning. Second quarter results in Children’s books were led by school book clubs which achieved revenue growth of 33%. The marketing initiative was implemented in the second half of last year including new grade specific catalogs and a strategic shift into kid friendly books continue to drive our improved performance. Although we will have a tough comparison to last year’s second half, we’re having a good December and expect to sustain momentum throughout the year. Strong support in schools for independent reading is also leading to higher attendance at our book fairs and driving higher fair count and revenue per fair. As with clubs we have provided strong titles to match student’s interest. We expect fair performance to remain strong this spring as we match each school to the fair type that is best suited for their school size and demographic. In trade this quarter we saw a strong sales of the Minecraft Handbook series, of Harry Potter and the New Captain Underpants book and the graphic novel Sisters by Raina Telgemeier. As we look to the year ahead we have a number of exciting new global releases including The Marvels by Brian Selznick, the number one New York Times bestselling author and illustrator of The Inventions of Hugo Cabret. In our education business, research shows schools continue to allocate spending to implantation of new curricular associated with more exacting educational standards. This has bolstered our classroom books business which offers teachers the best selection of fiction and non-fiction in the industry. The nonfiction content required by the new standards has also helped to increase circulation of our award winning classroom magazines especially Scholastic News, Storyworks and Scope to over 13.6 million subscriptions. In Ed Tech and Services we are continuing to implement a number of initiatives with our field sales team to expand the user base for our core intervention program, especially our higher margin programs. For example we are building our sales force and expanding the number of territories by roughly 10%. While second quarter sales of our education technology products declined when compared to last year, our sales initiatives are gaining traction and our pipeline is improving. As we reported, our sales cycle requires time and so it will take more time to realize the full benefits of our stronger, more strategic sales management. Our Math business continues to grow thanks to the success of MATH 180 launch last year. And do the Math, the classroom based program aligned to the shifts in math instruction as well as math solutions, the nation’s leader in professional development for math teachers. Our strong and growing position in math now makes up more than 20% of our education technology business. As with reading our math products have been proven to raise student proficiency. For example in Hillsborough County students using MATH 180 significantly outperformed students in a match group on all assessments. In January we will host our largest Math Summit ever with more than 200 school decision makers attending and in the fourth quarter of this year we will launch MATH 180 Course 2 which is concentrated on Algebra readiness, one of the largest markets in math and a critical focus for schools. Our international business also continues to perform well with solid sales growth in local currencies. We are building significant capacity in educational publishing in Asia for both local and global markets and we are continuing to grow our consumer books both direct sales and trade in Asia where revenues now exceed $100 million annually. We are confident that the initiatives underway in our educational technology business will improve sales performance in the second half of the year and of course we are pleased with the sustained momentum of our Children’s book business. We are firming our fiscal 2015 outlook for total revenue of approximately $1.9 billion and earnings per diluted share from continuing operations in the range of $1.80 to $2 before the impact of onetime items associated with cost reduction programs or non cash, non operating items. We continue to expect free cash flow in the range of $65 million to $85 million. Now I will turn the call over to Maureen to provide more detail on our financial results. Maureen O’Connell: Thank you Dick and good morning everyone. Our second quarter revenue was $665.6 million compared to $623.2 million last year, an increase of 7% and cost of goods sold was $288.7 million. Excluding onetime items our operating income was $120.3 million which resulted in earnings per share of $2.17. This compares to operating income of $113.6 million and earnings per share of $2.15 last year which also excludes onetime items. The increase in operating income primarily from the Children's books segment was partially offset by a decline in our high margin educational technology product sales and planned investments in transformational technology initiatives. We reported onetime expenses of $0.12 per share this quarter in mostly non-cash charges related to the planned closure of our SoHo store, severance charges associated with cost savings initiatives, and a non-cash settlement charge for our defined benefit pension plan. During the quarter we offered certain former employees the option of receiving onetime lump sum payments from the plan and this charge is the result of those payments. As a reminder we had onetime expenses of $0.35 per share in the second quarter of last year including a goodwill impairment charge of $0.25 per share in the Children's book publishing and distribution segment. Now turning to our segment results, in Children's book publishing and distribution revenue was $402.6 million, a 14% increase over last year. The operating profit for this segment excluding onetime items improved to $108.3 million, an increase of $26 million due to higher sales in all three of our businesses; book clubs, book fairs, and trades. As well as lower cost in book clubs partially offset by higher promotional spending and lower investment in Storia. Although our book clubs grew over 30% in the first half of the year, we expect the second half grow to moderate as we anniversaried the changes in our promotional and merchandising strategies for clubs. In Educational Technology and Services, revenue was $50.9 million, a 16% decrease compared to last year and operating income declined by $8.1 million primarily due to lower sales of Educational Technology products which takes the tougher comparison to our launch period last year. We did see gains in technology support and product dependent services and in math solutions which was up in the quarter. As Dick said earlier we are continuing to implement a number of initiatives with our sales team and expect to see improved performance over the remainder of the fiscal year. Classroom supplemental materials publishing revenue was $64.8 million, an increase of 6% over last year and segment operating income improved 9% to $12.7 million. Our results here demonstrate the continued strength and demand for our guided reading, classroom book collections, and classroom magazines. International segment revenue in the second quarter was $132.8 million, excluding unfavorable foreign exchange of $5.4 million, segment revenue grew 2% in local currency driven by higher media and trade sales in Australia. In the UK where our Chicken House imprint performed well on the strength of its trend list, particularly the top selling the Maze Runner and higher direct sales in the Asia Pacific region and India. Segment operating income was $19.9 million compared to $22.2 million in the prior year, primarily the results of lower sales in Canada and higher investment in both new products and infrastructure. Media licensing and advertising revenue was $14.5 million, up 6% from last year while segment operating loss improved to $0.7 million from a loss of $1.3 million last year benefiting from higher sales of our programming library to streaming platforms. Corporate overhead in the quarter was $18.7 million excluding onetime items compared to $8.1 million last year. Higher corporate overhead in the current quarter was primarily the result of our increased investment in transformational technology as well as higher depreciation due to the purchase of our headquarter building in the last fiscal year. The higher depreciation however, was offset by lower interest expense below the line. As a reminder the strategic investments in our technology infrastructure are focused on programs that will improve our data, analytics, and selling capability. Such as an enterprise system for single, more complete view of the customer, a more robust content management system, and a migration to the cloud for enhanced scalability and flexibility. Free cash flow for the second quarter was $125.7 million compared to $129.4 million in the second quarter last year. During the quarter we repaid $94.7 million of debt, distributed $5.1 million in dividends to our shareholders, and repurchased 3.5 million of our common stock in open market transactions. And we continue to delever at a very rapid pace. At the end of the quarter our net debt was $61.3 million. As announced yesterday the Board of Directors declared our regular quarterly cash dividend of $0.15 per share on the common stock. Moving on to an update on real estate, as you know we are redesigning and reconfiguring the ground floor of our 557, Broadway Headquarters in an effort to maximize the value of the retail component of the building. As a result we will close our SoHo retail store by mid-January 2015. We are excited by the prospect of this premium retail space and will provide a more detailed update on our plans at the end of the fiscal year. In closing for fiscal 2015, we continue to expect revenue growth and enhanced profitability across a majority of our businesses as our strengthening Ed Tech pipeline converts to revenue and earnings results and we continue to see strong sales and profit growth in our Children’s book business. Before taking your questions I’d like to turn the call back over to Dick.

This week we received a sad news that Norman Bridwell, the creator of Clifford, the Big Red Dog passed away at the age of 86. He was one of the most popular authors for children ever and was a gracious, caring friend to all of us at Scholastic. Clifford arrived at Scholastic in 1963 having been rejected by every traditional Children’s publisher. Scholastic’s Editor of Lucky Book Clubs at that time, saw Norman Bridwell’s cartoon like picture book and knew immediately that Clifford would be adored by children. Norman Bridwell always said he was fortunate to have come to the right editor, at the right company, at the right time. Because we sold books directly to children, Clifford became popular in book clubs and book fairs where children choose and buy the books they want to read. And so Scholastic was the right home for this lovable character who became the friend of generations of young children. Norman Bridwell himself personified the values of Clifford, he was polite, generous, courageous, kind, and always thought of others. He also was unwavering in his caring for Clifford and for children. In turn he and Clifford were beloved by all. Norman Bridwell will live on through Clifford who is known and loved by children everywhere and so became an icon of childhood and of Scholastic. Apparently people all over the world feel the same way about Norman and Clifford. More than 1 million people shared messages yesterday on social media and 300,000 people left a note of appreciation on Clifford’s Homepage. We are now ready to take your questions.

[Operator Instructions]. And our first question comes from the line of Drew Crum of Stifel, your line is now open.

Okay, thanks. Good morning everyone. So I wanted to ask couple questions on the Ed publishing business, and I guess specifically on technology. I would love to get an update just on state of the state for the industry in terms of macro conditions, funding environment, etc and as it relates to the pipeline you have on MATH 180 Course 2, how does that look and as you think about Ed tax for the fiscal year, you are citing improving trends or expectations for improving trends in the second half, do you think you can grow Ed Tech in fiscal 2015? Thanks.

Drew, I think Margery would enjoy taking this question from you.

Hi Drew.

Good morning.

How are you?

Good.

So on the state of the state I mean, it’s what we believe is happening is that the companies that are selling curriculum for a common core and curriculum shift, they’re having good acceptance of the materials and we’re seeing it in our classroom books business where we have high demand for materials to support common core. I mean it is a little bit harder for us to get visibility on what’s going on in the technology part of the business. We had just completed a study that we did with some outside consultants and it confirmed what our suspicion was which is that districts and schools are putting priority on giving curriculum materials in place and that intervention is going to be the next phase. And we believe that intervention is going to be extremely in demand because as the new test come on board, it’s going to be obvious that many, many of our children more than we even thought in the past cannot do the kind of rigorous work that is asked for in the common core. The second part of your question which is the pipeline on Course 2, we do not have a formal pipeline on Course 2 yet because its coming out in May and usually our pipelines aren’t that extended. But we know that lot of our customers are using Course 1, do want Course 2. We believe we have a lot of demand for it and so we are extremely optimistic about it. And our field can’t wait for it. In terms of whether or not Ed Tech could be up for the year, I don’t think it will be up for the year. We believe the second half will be up over last year and that we are seeing improving trends. We’ve got great management in place, we’ve hired a new regional Vice President and strengthened our Regional Director team. We’ve made a lot of great new hires in the field and we are, as Dick mentioned we are increasing our number of territories by 10%. So we’re really optimistic about what’s going to be going on, on our business in the future.

Great, that’s very helpful, thank you Margery. And then I think shifting gears to the fairs business, it was up almost 8% which is much higher than what we’ve seen in the last several quarters. Anything you can call out there that drove that performance from a top line perspective and that’s sustainable going forward?

Yes, we just executed extremely well this fall. We had great books in stock and we made sure that we had enough stock to fill all the fair demands. We had better segmentation of our customers in matching the fair size and type to the school. There is enthusiasm for reading in the schools Drew, as I mentioned in my comments that probably we haven’t seen for a very long time. In other words the focus on independent reading, the excitement about the books motivating kids to not only read more and be excited about reading but also to develop the higher level thinking skills that only sustained reading can bring. There is more awareness of that and people are talking about it in schools and supporting it. I mean that’s obviously a macro background issue but the real issue has been increased attendance, increased availability of great titles, and we think it is sustainable for the balance of the year.

Did the pricing have any impact on the fairs business?

Prices were modestly up but not significantly up. That’s more volume number of titles and the number of books bought on the unit basis.

Okay, great. Just one last question for me and maybe for Maureen, you mentioned that the corporate overhead was higher due to the higher investment spending and the higher depreciation expense from the purchase of the building, it looks like it’s about 10 million higher year-on-year, is that a quarterly run rate we should expect going forward or should it moderate from here? Maureen O’Connell: Well the depreciation would be quarterly consistent. As far as the transformational initiatives, that’s really more like a first half number because we started early in the year, but we didn’t really start recognizing the expense and having it in place where we had the milestone hit and paying them until this quarter.

Okay, thanks guys.

Thank you Drew.

Thank you and our next question comes from the line of Barry Lucas of Gabelli & Company, your line is now open.

Thank you and good morning. Look at a couple of things and maybe we can start with the real estate. I know you said you probably have more information toward the fiscal year-end but closing the store and taking the charges up front suggest that the plan is evolving or just hoping maybe you could provide a little bit more color on what your thoughts are in that direction?

We are obviously going to have 557, Front Broadway retail and so that’s an important decision that we have made maximizing the impact of our retail space and moving the entrance of the company back to Mercer Street. We have commented on that before. That’s about as far as we are at this point Barry and I think we are -- obviously we are continuing to work on this and we will provide updates as we realize our plans.

Okay, thanks Dick. On the trade side, any benefit at all from the latest iteration in the Hunger Games movie in that number?

Well Hunger Games met our targets and so we were pleased with the Hunger Games sales. We achieved higher sales in Minecraft as we said and we achieved Harry Potter and Captain Underpants sales. So Hunger Games came in right at where we expected.

Okay and if we move to the Ed Tech side, I know Drew had several questions there but without being too critical here you’ve got a broader approach not only of product than we’ve seen in quite some time, a very successful products that do what they are supposed to do and that’s a fairly sizeable decrease in revenues and you revamping the sales force, so what’s happening sort of below the surface to the extent you can describe that, it just feels like that business should be doing better?

I’ll ask Margery to address that in a second Barry but I think you remember last year we combined the leadership team of our two sales forces for educational products or supplementary book driven products on the one hand and our Ed Tech products on the other. And that was in the first quarter or second quarter of last year. That didn’t work very well and we unwound that during spring, but that had a lasting effect on the Ed Tech sales and Margery has described some of the things that we are doing to offset that but I’ll turn that back over to her and let her amplify on those comments.

Hey Barry, so this is Margery. I feel it should be doing better, I agree and it will do better. But I think there is two factors going on which we have mentioned and one is I do think there is market conditions where there is less focus on accountability right now. I think you know that in California even though they are giving the new smarter balance test they are not counting scores. In New York state we are giving next generation test, they are not applying the scores to teacher evaluation. And there is just sort of an overall trend of kind of period where we are giving assessments to kids but they don’t count as much as they did a few years ago. So in this period right now we believe that the market is supporting supplying classrooms with materials for the shift and we’ve seen that in our book business and we’ve even seen that in -- we have a supplemental math program call Do The Math which is up and that’s doing well. And Intervention we think is on a little bit of a delay while we are in this moment of lower accountability and then the second factor that’s really going on is honestly we lost some momentum in the field with the reorganization that Dick mentioned last year. We brought back our national sales manager for Ed Tech. He had been well in the reorg [ph], we had him doing some important work but he didn’t have as much direct responsibility for driving sales. And now he does and we are essentially going back and doing the kind of basic kind of work that it takes to sell educational technology. It has a pretty long sales cycle. We have a very defined way we go about things. We use analytics to set up the sale and we are very strategic about when we’ve made a sale going back in and working with our customer on what kind of results they got and talking to them about opportunities for expansion. We’re happy that our service business is good because what we are seeing is that, our coaching days which were supporting our Ed Tech products, they were actually up in the quarter. So we believe that this is around getting people back around in our field, around focusing on selling product and also helping our customer see how important it is not to wait a minute to help their kids read better and compute better as more rigor is demanded.

With the current quarter certainly or generally a smaller quarter than a second quarter would -- what would be the indications, what firm sort of guide post can you point to that say the new changes are working, and we feel more comfortable about this going forward?

You are right that the third quarter is a small quarter and it is a small quarter in Ed Tech as you imply. And we think that we really are not going see in the results of the third quarter a significant boost in Ed Tech sales although the pipeline is stronger. So I think the increases will come in the fourth quarter, Barry but let me ask Margery to...

No, I completely agree. Our best way of calculating what is going on in terms of building momentum for the business is our pipeline which is up now. November showed some really positive signs and we feel we are on plan for December. Maybe I wasn’t supposed to say that, everybody is giving me a look but I am doing it. So, we feel like we have really good indicators that things are getting better. It takes six to nine months to make a sale and we are doing the work that we need to do to make that happen.

Great, thanks very much for that.

Thanks Barry.

Thank you. [Operator Instructions].

Well, thanks to you all for listening to our second quarter call. We wish you a good holiday season and we will look forward to talking to you again in our March call. Thanks very much.