Scholastic Corporation (SCHL) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Scholastic Reports Fiscal 2017 First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to turn the conference over to Gil Dickoff, Senior Vice President and Treasurer. You may begin.

Thank you very much, Nicole and good morning everyone. 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 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 risk factors which we 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 also 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.

Good morning and thank you for joining the call today. We had a very strong first quarter driven by growth in all three segments. In children’s book publishing and distribution, Harry Potter and The Cursed Child script book helped to more than double segment revenue in the quarter. Sales of the initial print run, which were right in line with our expectations, demonstrate the continued strong enthusiasm and excitement for all things Harry Potter. 9 years after the publication of the seventh book, Harry Potter continues to bring imagination and creativity to our readers’ lives. And while The Curse Child trade sales were the clear standout in the quarter, we generated strong results throughout the company in each reporting segment in a quarter that is typically a smaller revenue quarter for Scholastic as most schools in the U.S. are not in the session. On November 18, the screenplay for the feature film, Fantastic Beasts and Where To Find Them will hit the bookstores accompanied by license publishing titles related to the Fantastic Beasts film and original Harry Potter movies. We are also looking forward to continued strong performance from other recent trade releases such as Dog Man by Dav Pilkey; A New Class, the fourth book in the Star Wars: Jedi Academy series; Ghosts by Raina Telgemeier as well as excellent backlist sales of the original Harry Potter titles. Looking ahead, we also have a very engaging title coming from the number one New York Times’ Best Selling creative team, Eric Litwin and Tom Lichtenheld, their new Groovy Joe character will kick off this month in the launch of Groovy Joe Ice Cream and Dinosaurs. These titles are also performing well in our clubs and fair channels, where we are focusing on executing our plan to maintain our fiscal 2016 level of revenue, while improving profitability on lower costs. We are encouraged with our back-to-school results year-to-date. Although it is still very early in the quarter and almost 10% of schools in the U.S. opened later this year than last shortening the time period in which clubs and fairs operate in the busy fall season. In education, our customized curriculum solutions grew by double-digits in the quarter driven mainly by classroom books. We are expanding our curriculum publishing business because many teachers and principals across the country tell us they prefer to use the combination of engaging print and digital resources such as guided reading and level bookrooms for instruction rather than basal reader textbooks. In addition to strong curriculum publishing for pre-K to 8 literacy, we are also building upon decades of serving as a trusted partner in schools by expanding our services business both professional development and family and community engagement, or FACE services. Our professional development team helps teachers improve their ability to use our pre-K to 8 literacy curriculum programs in the classroom and our FACE team shares proven techniques for helping schools to engage parents in supporting the literacy skills of their children. These are also important ways to drive independent reading and so are a natural extension of our role is the key content distribution partner through clubs and fairs. Our expanded education sales team is successfully selling at the district level gaining traction in key markets such as Palm Beach, Houston, San Antonio and Portland, where our materials are used for core pre-K to 8 literacy teaching and instruction. Looking ahead, we anticipate continued growth in classroom books as well as classroom magazines which we expect will have a strong second quarter as Presidential elections drive interest in our grade appropriate magazine titles as well as our election skills books. Our international business is also off to a strong start, with 23% revenue growth driven primarily by Harry Potter in Canada and by export, trade sales in Australia and direct sales in Malaysia. The impact from foreign exchange was minimal this quarter. So, our results show the underlying strength of our international operations. We are the leading children’s publisher in many key international markets, the UK, Australia, Canada, throughout Southeast Asia and India, where we are also the number four publisher overall in that country. We are continuing to build upon our role as a key global partner in fostering literacy and learning as we look at our business from a global perspective. Our success is driven in part by our ability to collaborate on international children’s book, trade and education templates that grow our businesses both in the developed markets such as the Canada, the UK and Australia and in the developing Asian markets of Thailand, Malaysia, Indonesia, Philippines, India and China where we are expanding at double-digit rates. Finally, we are executing our plan to create premium retail space and modernize our headquarters office space with construction already underway here at 555-557 Broadway. Our investments to improve our technology systems and operations are also on target as our 3-year transformation technology plan is already working to provide better information and support to our global customers. Scholastic’s business plan delivers on our core mission of helping children to become strong readers as part of their learning and personal growth. There is an expanding market in schools for literature and nonfiction material that connect night children’s motivation to read and help to build higher level thinking skills. Scholastic is providing increased support to schools and families to support children’s reading as the key of success in school and life and our continued success in this area is also providing a strong return for shareholders as we grow revenues and profits around the world. I will now turn the call to Maureen for a detailed review of our financial results. Maureen O’Connell: Thank you, Dick, and good morning everyone. In my remarks this morning, I will refer to our quarterly results from continuing operations unless otherwise indicated. Total first quarter revenues were $282.7 million, an increase of 48% from last year due to higher revenue in all three segments. Operating loss was $63.1 million versus $79.5 million last year and loss per diluted share was $1.15 versus $1.46 in Q1 of last year. As you know, we typically record a loss in our first quarter since most U.S. schools are not in session. Now, turning to segment results, in children’s book publishing and distribution, first quarter revenue was $137.8 million, an increase of 104% and our seasonal operating loss improved to $36.2 million versus $56 million last year. Consolidated trade revenue was $116.9 million driven by the exceptional front list performance of Harry Potter and The Cursed Child Part One and Two, the sales for which are expected to be primarily in the first quarter. Revenues from clubs and fairs increased 2% over last year’s first quarter as a result of our lineup of strong titles, although this is not a significant quarter for our school-based distribution channels. In education, revenue was $55.2 million, a 10% increase over last year and operating loss was $4.4 million versus $4.3 million last year. The relatively flat operating loss is mostly due to a decrease in advertising revenues from consumer magazines and the annualized impact of our expanded sales force and service team. We continue to see strong demand for classroom books and literacy initiatives. Sales of classroom books and magazines drove our strong performance in the quarter. We remain in a great position to build market share in this growing business. In international, revenues was $89.7 million, an increase of 23% over the same period last year and operating income improved to $3.9 million versus a loss of $2.7 million last year, primarily due to the strength of the new Harry Potter title, especially in Canada, local trade publishing in major markets and overall growth in Asia. As we look ahead to Q2, please keep in mind that last year’s second quarter sales were adversely impacted by the labor action in Ontario, which will not be a factor this year. First quarter corporate overhead was $26.4 million versus $16.5 million in the prior year period, which included one-time items of $1.4 million. The increase in overhead is related to higher medical claims, our previously announced wage improvement program, facility related expenses including [freeing] [ph] space and construction costs as well as our investment in strategic technology platforms and solutions. With regards to our facility upgrades, construction is underway to create new premium retail space and increase the capacity of our office space at 555 and 557 Broadway building in SoHo. Our technology investments, which remain on track and will continue through to 2018, will bring significant benefit, including allowing us to better target our markets, improve processes, including product inventory and content management, which will lower our cost over time. Our transition to cloud based, hosted e-commerce platform, which is underway, will also help us to improve operating margins over time and make us faster, better and easier to do business with. We have also identified savings to offset income related to the transitional service agreement with HMH, which now has been terminated. These savings are already included in our outlook and will be reflected for the most part in improved operating income within our business units rather than in the corporate overhead. In the first quarter, we had free cash used of $122.4 million compared to the use of $303.2 million last year, which included a large tax payment related to the sale of EdTech. And our cash and cash equivalents exceeded total debt by $275.5 million compared to $244.6 million last year. As you know, the first quarter is typically our highest cash use quarter as we build inventories in advance of the school selling season. This year, cash use was also augmented by a large initial print run for Harry Potter and The Cursed Child and higher year-over-year spending on our strategic technology initiatives. Now turning to the outlook, our first quarter results were within our expectations and we continue to expect total revenue for fiscal 2017 of $1.7 billion to $1.8 billion and earnings per diluted share in the range of $1.60 to $1.70, excluding one-time items. Fiscal 2017 free cash flow is expected to be between $40 million and $50 million. As a reminder, this includes capital expenditures of $70 million to $80 million and pre-pub and production spending of $30 million to $40 million. As anticipated, the increase in capital spending is primarily related to our headquarters’ construction plan as well as higher strategic technology spend is part of our 3-year initiative to upgrade our enterprise wide platforms, including for content and customer management solutions and our transition to a more cost effective e-commerce platform. In summary, we had a solid start to the year and continue to believe fiscal 2017 will be another strong year, driven by our core growth opportunities and more streamlined operations. I will now turn the call over to Gil to moderate a question-and-answer session.

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

Thank you. [Operator Instructions] Our first question comes from the line of Drew Crum of Stifel. Your line is now open. Again Drew Crum, your line is now open.

Can you hear me now?

Yes.

Yes.

Okay. Thanks. Good morning everyone. Sorry about that. So Dick in the past, you guys have been kind enough to share with us the Harry Potter sales figure, assuming that was material to results in the quarter, would you be willing to provide that number and maybe asked differently, just trying to understand the performance of trade ex-Harry Potter in the quarter?

Well, trade improved ex-Harry Potter in the quarter. I think Drew, you actually got this pretty correct in your own analysis of our business. We announced that we have printed about 4.5 million copies, most of those were delivered in the quarter.

Okay, got it. Okay. Just shifting gears to clubs and fairs, you provided some commentary on your expectations, albeit early, anything also you can expound upon, any leading indicators as you look at the back-to-school period for those two businesses?

Well, it’s a little shorter selling season this year because schools opened later in the U.S. by about a week, about [50%] [ph] of schools. So we have to get between now and November 30, at the end of the quarter, we will have to push hard to get the number of selling days in there. But – and we are starting off well and there is – we also have shifted to our new Demandware system, e-commerce system and that’s working well. So we are optimistic and feel that things are on plan. Bear in mind though as you pointed out and how we pointed out and we reminded you in the script, our plan for this year is to hold our revenues flat with 2016 and improve our profitability through cost reductions in terms of number of fairs delivered and in terms of number of kits mailed. And so we are consciously holding our revenues flat while reducing our cost base to improve profitability.

Got it, okay. And then two questions for Maureen, I guess first, the 10% sales growth for education was quite strong, yet we didn’t see it flow through to the bottom line. Any explanation behind that. And then secondly Maureen, any thoughts on the quarterly run rate for overhead expense we should expect to the balance of fiscal ’17, is the fiscal 1Q kind of representative of what we should expect going forward? Thanks. Maureen O’Connell: Okay. So first on the education question, last year we added significant number of new sales people and service people to really grow and ramp up that business and make an investment in our education business. But that was done throughout the year, so there wasn’t much of an impact of the ads in the first quarter of last year. So really what you are seeing is fully staffed, beginning this year where we weren’t fully staffed the beginning of last year. Also consumer magazines, the advertising revenues were down and that’s a higher margin type of revenue. We expect to make that up during the year. But in the first quarter, it was slightly soft.

Okay, got it. Maureen O’Connell: And then on the overhead run rate, right now we are up about $11 million in overhead. About half of that is in technology spend and that’s front loaded. So we don’t expect to be at that rate throughout the year. In the second half of the year it will move from expense to more of a capital because they will be put in production. But we will see the impact of the $20 million loss of the service agreement with HMH. So you should expect $20 million added to our overhead over the year because those benefits and those savings will be reflected in the business units. Also we did forecast for higher medical or higher wage rates and that will also be shown in overhead as well as the business units.

Got it, okay. Thanks guys.

Thank you. Our next question comes from the line of Barry Lucas of Gabelli & Company. Your line is now open.

Thanks so much. A couple of nuts and bolts and then maybe a little bit bigger picture, just coming back to your comments on overhead Maureen, I am trying to get a handle on the debt services agreement, which is now terminated, it’s $20 million to corporate, did we see that in the first quarter or that’s $20 million incremental for the next nine months? Maureen O’Connell: You did see it in the first quarter. It’s about $5 million increase to overhead each quarter, but the savings were reflected in the business units. So we completely offset that $5 million in the first quarter through better cost of product, better manufacturing, lower fulfillment cost and lower allocated overhead to the business units.

Okay. And I noticed on the balance sheet you still have what, $5 million or so in restricted cash and when might that come back? Maureen O’Connell: So that is related to warranties and reps and so we have received all the cash related to the TSA. So the only outstanding cash is related to warranties, which assuming there is no claims, in November we will get that cash.

Okay, thanks. And now sort of big picture and maybe strategic or tactical, I am not sure of which, Dick, but with McGraw-Hill coming public again and listening to Linda at Communacopia yesterday, how you see any potential changes with regard to – even though the three big players are the same, but the line-up has changed a little bit in terms of competitive nature from the existing basal players or I think you alluded to this, more of an opportunity for you to get into schools and school districts with tailored reading programs?

That opportunity is clearly there, Barry. You have always been a great supporter of this side of our business and I think you understand it well. I mean stepping back, the instructional materials market is still strong. There are some changes in that market as we see there is a switch to people being really interested in the kind of things that we do that is reading full length books of literature, non-fiction that is not in textbook form. And we are seeing schools are not only telling us that they want that, surveys are showing that that’s the case as well. As people – there is a bit of frustration with educational improvement and people are looking at what they are doing and saying, is there something we can do better here. And so there are several trends. One is the use of aggregations or customized curriculum, in the – especially in the pre-K to eight literacy area, where people are as I said looking at full books and full literature programs of the kind that we provide. There is some increase use of digital. There is also an opportunity to look beyond the classroom itself and do two things. One, improve this human capital skills the teachers were providing the instruction and who are key to any progress that kids are going to make. And so that opens up an opportunity for our services business and professional learning. And we are pushing hard on that. And then looking even beyond the classroom and beyond the school, how can we engage the community in helping kids more broadly that is bringing together some of the elements in the community that support kids through the school, but from sources outside the school. And that’s a growing interest in all the states and cities is to how that can be done. And we are providing a consulting service in that area that is quite promising in terms of how we help schools do a better job of engaging families and communities. So it’s a different playing field from what it has been. How fast those things will move is always an issue in education. But I think, we are just seeing a different way of people thinking about how do we instruct kids, what materials do we use, how do we organize at all and looking for new solutions beyond the basal textbook.

Great. Thanks for that color, Dick.

Thank you. [Operator Instructions] At this time, I am showing no further questions.

Thank you all for listening to our first quarter. We had a good one. We expect to have a good year. Thanks for your continued support for Scholastic.