Scholastic Corporation (SCHL) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the Scholastic Reports Fiscal 2016 First Quarter Results Call. [Operator Instructions]. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Mr. Gil Dickoff, Senior Vice President, Treasurer and Head of Investor Relations. Please, go ahead.

Thank you very much and good morning, Candace and everyone on the phone. Before we begin, I'd 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 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 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. A 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 at investor.scholastic.com. Now, I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic to begin today's presentation.

Good morning, everybody. Thank you for joining us today. In the first quarter, performance in each of our businesses was in line with our expectations. We were pleased, in particular, with the strong performance in the children's book publishing trade business. Revenue for the quarter was $191.2 million slightly ahead of last year and loss from continuing operations improved to $1.46 per share compared to a loss of $1.67 per share last year. As most of you know, the first quarter when most U.S. schools are not in session is usually a small quarter in which we typically report a loss. Moreover, the first fiscal quarter always was a key selling period for our former Educational Technology and Services business. Following the sale of the EdTech business in FY ‘15, we expected our seasonal pattern for revenue and cash flow to be even more correlated to the school year, with sales concentrated in the second and fourth fiscal quarters. The EdTech transaction also affected our cash position at the end of the quarter; as we made approximately $200 million in tax and other payments related to the sale of EdTech in the quarter as expected. Looking ahead, I want to focus today on the compelling opportunities for Scholastic which are driven by a growing need for high-quality books and learning materials which motivate and engage children in school and at home. As we begin the new school year, the climate for children's books and instructional materials is excellent. According to a study released this June by the Association of American Publishers, the children's books segment exhibited the strongest growth among any segment in the trade category in 2014. The study also showed that the size of the children and young adult market surpassed the adult market for the first time, with children's and YA selling at 843 million units to 746 million units for adults; although, adult books usually fetch a higher price per unit. This data supports the trends that we’re seeing ourselves in our engagements with schools and families; our belief that the strong market dynamics and focus on independent reading will continue to support company-wide growth. This quarter our ability to capitalize on these trends was demonstrated by excellent performances in children's books, specifically in trade sales in the U.S. Together, clubs, fairs and trade provide both the product and distribution capabilities to reach millions of children and parents and get them excited about buying and reading books. First quarter trade revenue growth of 22% year-over-year was due in large part to sales of Star Wars: Jedi Academy, Captain Underpants and the Baby-Sitters Club graphic novels to name a few, as well as continued strong performance of our Harry Potter and Minecraft series. Looking ahead, we have even more exciting titles in the pipeline for the fall, including, Brian Selznick's highly anticipated, The Marvels; the second book in the Vega Jane series, The Keeper by David Baldacci which debuted at number 10 on the U.S.A Today bestseller list this week and Game On 2016, a strong nonfiction title. Further, the highly anticipated Harry Potter and the Sorcerer's Stone illustrated edition hits stores on October 6. We’re very excited about this full-color edition, lavishly illustrated by award-winning artist Jim Kay which lists for $39.99. We also are optimistic for our tie-in books with the upcoming Goosebumps movie. In our International business, first quarter sales were generally in line with last year on a constant currency basis driven by strong trade sales globally, continued growth in Asia and improved performance in Australia. With the recent acquisition of a book fair competitor in the UK and Ireland, we have added a network of experienced independent distributors who conduct about 7000 fairs each year. We’re also growing our education business internationally in our Singapore publishing hub, where our PR1ME math product was developed. We'll continue to provide other educational product to be sold globally. In education, especially in K-8 literacy and reading, the market is shifting to include combinations of our guided reading instructional programs and nonfiction content supported by digital supplements which we provide through our classroom magazines. In today's environment of rigorous academic standards, schools are increasingly customizing their classroom curriculum beyond textbooks, so they can keep kids motivated and as they help them develop the higher-level thinking skills they need to succeed in school and beyond. Educators are also recognizing the importance of independent reading as a critical component of a comprehensive literacy solution. This has opened up the market for educational programs that are flexible and easy to implement. Educators are turning to Scholastic as a partner they know and trust to provide the motivating and engaging content that will help raise student achievement. We have now enhanced our approach by offering customizable comprehensive literacy solutions that link independent reading through clubs, fairs and classroom book collections, with our classroom instructional materials such as guided reading, including print and digital classroom magazines and digital subscription programs as well as professional learning and family and community engagement initiatives. Our field sales and marketing teams can shape a collection of digital and print content that best suits the needs of a particular school and couple that with building level or district-wide school improvement consulting for family engagement and learning supports as well as professional learning and program implementation services. For example, we had a recent sale in Houston where we packaged level book rooms with customized classroom libraries, professional learning for educators altogether. To support the significant growth opportunity that we see for this business which in fact our education segment is now larger than the former EdTech business we sold, we have added top education experts to our leadership team. We’re developing new content and services, particularly in the areas of professional learning and family engagement. Our simpler more focused structure has created a nimble operating environment within the Company that enables our children's book education International teams to collaborate on product development, sales and marketing in a cost-efficient way that is key to profitable growth. Our three closely aligned business segments support the excitement of independent reading through clubs, fairs and trade, the power of literacy skills through education and the global access to books and reading through International meeting the needs of children worldwide. We’re certainly aware of the significant cash proceeds from our sale of the EdTech business just four months ago and our ability to generate meaningful levels of free cash flow on an ongoing basis as we have demonstrated year after year. We continue to weigh alternatives for the appropriate use of this capital, including opportunities to invest in organic growth and strategic acquisitions as well as to return capital to shareholders. Our goal here is to continue to balance the strategic capital needs of the Company and its operations with share buybacks and quarterly dividends. For more information on our current results and outlook, I will now pass the call to Maureen.

Thank you. I will review our first quarter results and will refer to our results from continuing operations only unless otherwise indicated. First quarter 2016 revenues were $191.2 million, up slightly from last year. Like most global companies, we were affected this quarter by the continued strength of the U.S. dollar which resulted in an unfavorable foreign currency impact of $11.7 million. Cost of goods sold as a percent of revenue was 60% or $114.5 million, up slightly due to higher cost of product in International markets using U.S.-sourced product. SG&A decreased versus last year by approximately $4.7 million or 3%, due to lower employee-related expenses. We reported a loss per share from continuing operations of $1.46 versus a loss of $1.67 per share in the prior-year period. Including the results of discontinued operations, we reported the consolidated net loss per share of $1.48 this quarter versus $1.05 last year which included earnings of $0.62 per share, primarily from the former EdTech business which is classified as a discontinued operation. This quarter, we had one-time expenses of $0.04 per share which included $1.4 million of pretax severance as part of our cost reduction program and $1 million pretax charge related to a warehouse optimization project in our book fair operations. Last year, we had one-time expenses of $0.08 per share mostly from costs related to unabsorbed burden associated with the former EdTech business. In children's book publishing and distribution, revenue was $68.1 million showing 15% growth. Operating loss improved by 5% to $57.5 million. Trade revenues grew year-over-year by 22%. As schools and parents continue to emphasize independent reading, we have excellent opportunities to market our robust and varied offerings in trade including early childhood, middle grade series, YA and licensed titles. In the quarter, we had 3% combined sales growth in our children's book club and book fairs. This shows the continued strength of these channels and our strategy to make it easy and affordable for children and parents to choose their own books. However, we do expect a tough comparison for the second quarter in clubs given the timing of Labor Day and the holidays this fall, resulting in a later start for our book clubs. In education, revenue was $50 million, an increase of 7%. Operating loss declined slightly to $2.8 million. As Dick mentioned, our enhanced offerings in education is aligned with the need for students to develop higher-level thinking skills which is driving interest in our classroom books and other literacy initiatives. We’re also seeing higher advertising revenues from our digital consumer magazines. In our International segment, revenues decreased 14% to $73.1 million due to FX. Operating loss improved by 10% to $2.7 million. If you strip out foreign currency exchange, International revenue slightly improved in local currency terms and were in line with our expectations. We expect the U.S. dollar to remain strong which will impact sales growth in U.S. dollar terms. Based on past performance, we expect global demand for our English language books and instructional materials will continue to grow despite microeconomic headwinds in emerging markets. Corporate overhead expense was $16.5 million compared to $20.4 million in the prior year, due to lower employee-related expenses. Note that HMH is reimbursing us for costs associated with the unallocated overhead related to the former EdTech business as part of our transitional service agreement with them. Free cash use was $303.2 million for the quarter compared to $76.9 million last year. The prior-year period includes results from EdTech which typically had a strong first quarter earnings and cash flow. We made approximately $200 million in tax and other payments related to the sale of EdTech as expected. Our excess cash position was also impacted by our normal seasonal working capital requirements, as we built inventories in advance of the school year. At quarter end, our cash and short-term investments exceeded our total debt by $244.6 million compared to a net debt position of $183.5 million a year ago. This week, our Board of Directors declared a quarterly cash dividend of $0.15 per share on our Class A and common stock for the second quarter of FY ‘16. The dividend is payable on December 15, 2015 to shareholders of record as of the close of business on October 30, 2015. While the Company has no immediate need for cash, we understand that there's substantial investor interest in our plans to monetize our real estate holdings in New York City. The Soho real estate market is vibrant and interest in our property from real estate investors, retail partners and traditional commercial mortgage lenders remain high. We expect to announce a plan by our second quarter earnings call in December. We’re beginning construction on the new retail site this November. Now turning to outlook, we continue to expect total revenues in FY ‘16 of approximately $1.7 billion and earnings per diluted share in the range of $1.35 to $1.55 before the impact of one-time items. FY ‘16 free cash flow is expected to be between $35 million and $45 million compared to $73.7 million in FY ‘15, driven by EdTech's transaction-related payments made in the current fiscal year and the impact of discontinued operations on this year's cash flow, as well as slightly higher planned technology spend for new enterprise-wide customer relationship and content management platforms. As previously noted, free cash flow guidance excludes the one-time tax payment related to our EdTech sale. Our outlook includes capital expenditures of $40 million to $50 million compared to $30.7 million in FY ‘15 and pre-publication and production spending of approximately $30 million to $40 million compared to $62.5 million in 2015 which included EdTech. I would remind you that our EdTech business had significant amount of pre-publication expenses and very little capital expenditures. I will now turn the call back to Dick for some closing remarks before we move to questions.

Thank you, Maureen. I want to conclude by referring to the recent changes in our Board of Directors which resulted in a reduction in the size of the Board as well as the average age and tenure of our independent Directors. First, we had four Directors who did not stand for reelection at this week's annual shareholders meeting. I want to thank them for their long commitment in service to Scholastic. Dick Spaulding began his career at Scholastic more than 50 years ago. His work touched nearly all areas of the business including a particular strength in marketing. He had served as a Director of Scholastic for 41 years. Dr. Mae Jemison is a Medical Doctor, Professor of Environmental Studies, Astronaut, Author and President of her own technology consulting firm. She had served the Company for 22 years as a Director. Gus Oliver, an independent advisor and managing Director of a private equity investment firm, was our lead independent Director and headed the Board's Audit Committee with great foresight. Gus is the grandson of an original stockholder and Director and former Chairman of the Board of Scholastic many, many years ago. Peter Mayer is a legend in the book publishing business, former Chairman and CEO of Penguin Group for 20 years and the President of his own Overlook Press in the U.S. and Duckworth Publishers in the UK and an outstanding trade publisher from whom we learned a great deal. I have felt privileged to have worked with these fine people and am thankful for their sound strategic counsel over these past years. I also want to welcome the two new outstanding Directors to our Board, Andres Alonso and Katrina Lane. Dr. Alonso has substantial experience in all areas of public education. He is an innovative leader in education reform and was appointed a professor at Harvard Graduate School of Education in 2013 following a distinguished career as Administrator in New York City Department of Education and as Superintendent of the Baltimore City Public Schools. He began his career in education as an English and Special Needs teacher in Newark, New Jersey. A trustee of Teachers College of Columbia, Dr. Alonso is also Chair of the Carnegie Foundation For Teaching and Learning and co-Chair of the Public Education Leadership Project in collaboration of the Harvard Graduate School of Education and Harvard Business School. Miss Lane brings significant experience in data-driven marketing technologies -- strategies that are relevant to our strategic objectives, as well as a deep management business and operational experience developed during her years of experience as a Senior Executive at a consumer based business. She was appointed Executive Vice President Consumer Marketing and Operations of American Express Company this year and previously held senior leadership roles at Caesars Entertainment and May Department Stores. She began her career as a consultant at McKinsey and Company. Finally, I would note that at Tuesday's Board of Directors meeting, Jimmy Barge was appointed Lead Independent Director. We look forward to working with our new Directors and to their valuable insights and contributions. With that, I will turn the call back to Gil to facilitate the Q&A session.

Thank you very much, Dick. Candace, we’re now ready to open the lines for questions.

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

Just to start with a housekeeping item. Maureen, can you tell us what the one-time transaction-related expenses pertaining to the EdTech business was? It sounds like it was around $14 million if I adjust for the tax payment. Are you expecting more expenses related to this through the balance of the year?

The taxes, you're correct, were $186 million and about $15 million in expenses related to the transaction. That's the majority of the expenses were paid in the first quarter.

And then moving over to the trade business, obviously a very strong start to the year, any change in your outlook for the business for FY ‘16? I think at the beginning of the call, Dick, you described the climate as being excellent. It sounds like you've got a number of titles that you're excited about that are launching in the near term. I just wanted to get your thoughts -- updated thoughts on the outlook for the trade business?

Well, I'm going to ask Ellie to answer that. But first, Drew, she'll probably say this too. We have very strong fall list. We hope that momentum will continue to the spring but we certainly are happy about the fall reception of our titles.

Yes. Just to add to what Dick said, we do have a really exciting lineup for the year. We did know going into the year that it was very heavily front-loaded into the fall, but we’re expecting to see that continue into the spring as well.

Okay. And then just one more question for me. Any update on Canada? Obviously, it's a key market for you guys and dealing with some economic challenges. Just wondering how you're thinking about that business for FY ‘16?

Well, Canada has got a strong club, trade fairs and education just as the U.S. The trade business is particularly strong in Canada. There are several issues with Canada right at the moment. One, Canada buys its product largely from the U.S. Probably 60% to 80% of the product they sell is sourced from the U.S. and they're paying in U.S. dollars, that's going to affect their bottom line and their cost of sales. Secondly, there is once again a work to rule in the Toronto and the Ontario teachers. So, the teachers are not permitted to collect money for book clubs or to operate any extracurricular activities during the period where they're on strike. Well, they're not on strike, but during the period where they're negotiating their contract with the Ontario Boards. So this is going to certainly affect the opening of school revenues particularly for clubs and somewhat for fairs in the fall of 2015.

[Operator Instructions]. And our next question comes from Barry Lucas of Gabelli & Company. Your line is now open.

I have several areas that I would like you to touch on. One, you did mention new products and getting those products to market faster. So this first part is revenues. What are you doing differently to get those new products to market? How do you get them into the classroom? What are the implications there especially for the education business?

I think, you're particularly referring to education probably, Barry. We have a steady -- we're a strong player in pre-K to 8 literacy in the education segment. We also have a combination of our classroom magazines with digital supplements which have been growing dramatically in the past five years and now have exceeded 15 million circulation copies per issue with a wonderful free digital supplements for each magazine that teachers use. So those are, I would say, probably among the highest used digital materials in the schools in the United States because the teachers find them easy-to-use so they turn them over to the kids. The kids are operating themselves. They're taking quizzes. They're getting further information from digital and so forth. So that is a fast product that is growing rapidly, that's moving to the schools. We're also developing with great alacrity a larger suite of products in the guided reading and instructional reading area in pre-K to 8. Finally, we've expanded our services business which I know you will understand, as an important component of our former EdTech business. We're offering substantially expanded consulting particularly in pre-K to 8 literacy and also in these new fields of family and community engagement and learning supports which are effectively helping schools engage community support for kids in reading through mentoring programs, community events and so forth. So in all of those areas, we’re accelerating our development now that the education business is out of the shadow of our EdTech business and is a real focus for growth for the Company. I hope that answers your question.

If we could switch gears now, move over to the cost side of the equation. You did identify the issues in Canada with U.S. sourced content. I think that's an issue elsewhere beyond Canada. But is there a way to reduce that issue and develop more locally sourced product?

Well, absolutely. We have a major effort within the Company to do global sourcing of our print product. Obviously, the positive side of the strong U.S. dollar is the lower costs elsewhere. So we're shifting our printing to lower cost areas, particularly looking at India and other areas in Asia. We have a real focus on this, centralizing our global purchasing and ensuring that we're going to the lowest cost areas where there's still quality printing and transportation available. I'll ask Maureen to address the other cost reduction areas.

We've been, as you know, in a process of reducing costs across the Company. I think that we have made inroads in terms of consolidating all our back-office functions. We're looking at more consolidations particularly globally where we can decentralize, as Dick said, our buying within Asia, also centralized some of our financial activities and our technology activities. So we've taken over a lot of the International activities that were done locally. We’re doing it more globally. So that's reduced cost.

Last item, Dick, if we could come back to returning cash to shareholders. are there particular milestones that you feel need to be hit? I'm not necessarily just talking about a contract with a real estate developer or what have you? But do you feel it's important to get into the fall selling season and see what happens? Are there macro issues that you're concerned about? Or is it just waiting for that big contract to hit the table? Or agreement if you will?

I think we have a long history of returning cash to shareholders. We're not in a particular hurry to make that decision. You're absolutely right that we're looking at -- we have optimistic views of how our business is going to go this fall. We're certainly -- where there is a late opening of schools, that affects our clubs, we certainly want to be sure that we’re right and that their fairs go forward and perform as we expect them to. There is every sign that they will. Secondly, we're being very deliberate about the building as we have indicated. We will take that in terms of the timetable for cash returned to shareholders, we'll certainly take that into consideration as well. Maureen, why don't you expand on that?

I mean, we have been really focused. As you know, we had a significant tax outflow on the EdTech transaction, paying $186 million of tax on that transaction. So we've been spending time really trying to make sure that we can be as tax efficient on the sale of the building as possible that has added some complication. Also we've been very focused on developing an architectural plan that would maximize the retail proceeds. That's what we've been working on. As we just said, we expect to announce that plan by our December phone call. We will begin construction on our retail site starting in November.

There are different options for looking at the building, Barry. So we’re considering all of those including mortgages or whatever, so that we haven't made that decision yet.

Thank you. I'm showing no further questions at this time. I would like to turn the call back over to Mr. Robinson for final remarks.

We felt we had a good strong quarter in trade. We're looking forward to a good school year. The fundamentals in our business are strong. We thank you for your support. We'll look forward to talking to you again in December.