Scholastic Corporation (SCHL) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Scholastic Reports Fiscal 2017 Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later we will host a question-and-answer session and our instructions will follow at that time. [Operator Instructions] As a reminder to our audience, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Gil Dickoff, Senior Vice President and Treasurer. Sir, the floor is yours.

Thank you very much, Brian, 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 as well as other risks and factors identified from time-to-time in the company’s filings with the SEC. Actual results can differ materially from those currently anticipated. Our comments today also 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 would like to introduce Dick Robinson, the Chairman, CEO, and President of Scholastic to begin today’s presentation.

Good morning everybody, and thank you for joining the call today. This quarter we had revenue of $623.1 million, up 4% year-over-year and EPS from continuing operations was $1.99 versus $1.89 last year, excluding one-time items, driven by excellent results in children's trade publishing and international. Children's book publishing and distribution growth was driven by our strong trade publishing lineup led by Harry Potter and the Chamber of Secrets, the illustrated edition and the original screenplay book for Fantastic Beasts and Where to Find Them, which was released late in the quarter. Long-standing and newer fans of the world of Harry Potter have responded with great global support of the new Fantastic Beasts franchise and we look forward to the rollout of the next installments in years to come. On top of Harry Potter's strength, our core trade publishing grew with new titles including Dog Man by Dav Pilkey, Ghosts by Raina Telgemeier, and Five Nights at Freddy's: The Silver Eyes, which is the first of the multi-book series based on the popular Five Nights at Freddy's game franchise. As we told you on previous calls, our strategy for school, clubs, and fairs is to improve profitability by reducing costs on flat revenue. In book fairs, we are on-track to deliver annual revenue roughly in line with last year, while focusing on more profitable execution as we match our resources to each school size, interest and ability to conduct book fairs. As such we reduced the number of fairs held in the second quarter, but reduced revenue -- increased revenue per fair by 7%. In book clubs, our adjustments to our catalog mailings strategy succeeded in lowering costs that also had a more adverse impact on sales than expected. Therefore in the new calendar year, we're adapting our strategy and we'll refocus on our classic club catalogs, which traditionally generates higher revenue per order. I also want to point out that this flow was slightly different from past years and that there was not a key blockbuster franchise aside from Harry Potter contributing to sales in clubs and fairs. As you recall last year, we had several popular titles related to third-party licensed content such as Minecraft and we expect this to pick up in the second half of the fiscal year with license publishing for Disney's Moana, Star Wars, DreamWorks, Trolls, and The Lego Batman Movie. In our education business, we delivered revenue growth in classroom books and literacy initiatives such as Reading Is Fundamental and Reach Out and Read sales as well as Professional Services and Family Engagement programs. We have a significant pipeline of opportunities including a large -- a number of large district sales over balanced literacy solutions. This strengthens our belief that our comprehensive customizable literacy solutions and services will be a core growth driver over the next several years. Recent research confirms that administrators and teachers are increasingly responsive to custom curricular that are built upon non-fiction texts and literature, while providing the essential skills children's needs. This plays directly to our strength and equally important, we provide crucial support of professional tools to implement effective teaching strategies. We believe we are in an excellent position to capitalize on this opportunity with our investments in our sales team, while building the services business, which complements and strengthens our core instructional programs in pre-K to 8 literacy. Revenue in our international operations grew by 6% excluding the impact of foreign exchange and operating profit grew by 45% excluding one-time, driven by the strength of the new Harry Potter publishing in Canada and through our export business as well as excellent results in international local trade publishing clubs and fairs, particularly in Canada, the U.K., and Australia. We also had several local trade publishing frontlist standouts such as Liz Pichon's Tom Gate Series and new titles from Julia Donaldson in the U.K. as well as new Pig, the Pug series titles and on those Weirdo books in Australia. We're building momentum in clubs, fairs, and trade throughout international where we are boosting our already leading market position. In the second half of the year, we expect continued strength in trade with exciting new titles ahead. That said following the release of the Cursed Child Script Book and the Fantastic Beasts and Where to Find Them screenplay book in the first half and these were the number one bestsellers in U.S. of all trade books, adults or children. We expect a somewhat lower pace of growth in the second half. We also continue to expect flat annual revenue in clubs and fairs as we focus on more profitable execution. In education, we're anticipating a strong second half as our business is more heavily weighted toward the fourth quarter. Finally, we expect trade growth in Australia, Canada, Asia, and the U.K. this year, and further expansion of our education products in Asia. We're therefore affirming our outlook for fiscal 2017 as we continue to strengthen our market position by delivering on our core mission of helping children around the world to become strong readers and develop a higher level of thinking skills that will enable them to succeed in school and in life. With that, I will turn the call to Maureen. Maureen O’Connell: Thank you, Dick, and good morning everyone. My remarks this morning, I will refer to our adjusted results from continuing operations excluding one-time items unless otherwise indicated. Total second quarter revenues were $623.1 million, a 4% increase from last year. Operating income was $115.3 million, up 7% from last year, resulting in earnings per diluted share of the $1.99 versus a $1.89 in Q2 of last year. Results for the second quarter included one-time pretax expenses of $3.9 million for severance related to our cost reduction programs. As a reminder, we had one-time pretax expense of $2.4 million last year from our cost reduction programs, warehouse optimization, and a one-time transaction related expense. Moving on to segment results, children's book publishing and distribution revenues in the second quarter were $432.5 million, an increase of 5% and operating income was up by 9%. Trade revenues grew 60%, driven by our Harry Potter frontlist and backlist as well as licensed product for Fantastic Beasts and Where to Find Them and strong sales of new releases, which more than offset the decline in Minecraft sales. Similar to other retailers, we saw decreased traffic at the end of October, which we believe may have been related to the election. While revenues declined in our school distribution channel, we are successfully executing our strategy to drive higher profits as demonstrated by the lower operating expenses. In education, revenue fell by 2% to $71.1 million. We had strong revenues in classroom books, which includes our literacy initiatives and professional service offerings. This business grew by 7% with a 15% year-to-date growth rate. These revenue gains were offset by lower consumer magazines and library publishing. Classroom magazine sales lag prior year as a result of the timing of deliveries and related revenue recognition. Our classroom magazine circulation is over 15 million, an all-time high. Although we expect growth in our classroom magazine business for the year, results for the quarter were not to the level anticipated as we believe fewer teachers were focused on the election as part of their instruction. As Dick mentioned, we continue to expect a strong second half as the education business tends to be more heavily weighted towards the latter part of the fiscal year. Operating income was $8.7 million versus $10.4 million last year due to our planned investment in our educational salesforce and new marketing support. International revenues were $119.5 million, up 3%. Excluding FX impact, revenues grew 6%. Operating income was $16.7 million, up 45% versus last year. We are pleased with our results in international, which are largely driven by Harry Potter publishing in Canada and export as well as strong results in clubs, fairs, and trade throughout our international markets. I want to point out that this quarter also had lower software distribution revenues as a result of our exit of the low margin media business in Australia. Corporate overhead in Q2 was $31.2 million versus $25.3 million last year. The increase is due to our ongoing investment in strategic technology platforms and solutions and facility upgrades, both of which remain on-track as well as higher medical claims experience, which continued into the quarter. Our plan to create premium retail space at our 555 and 557 Broadway building in Soho is also on plan and we are continuing to meet with high quality retailers with regards to our premium retail space. In the second quarter, we continue to expect year-over-year increases in capital spend as a result of our headquarters' construction plan and technology investments as part of our three-year enterprise-wide platform upgrade, including content and customer management systems and our transition to a more cost effective e-commerce platform. We have successfully implemented approximately $20 million in annualized cost saving initiatives to offset the income related to the transition service agreement with HMH, which has now terminated. We have achieved $12.5 million in savings to date. As a reminder, the savings is mostly reflected within business operating income, rather than in corporate overhead. In the second quarter, we have free cash flow of $164.1 million compared to $101.8 million last year. We also paid $5.2 million in dividends and repurchased $6 million of common stock at an average price of $38.36 per share during the quarter. We ended the quarter with a strong cash position in balance sheet and no longer have any restricted cash related to the sale of the Ed tech business as the final $5 million was distributed from escrow at the end of November. Now, turning to our outlook, we continue to expect total revenues for fiscal 2017 of $1.7 billion to $1.8 billion and earnings per diluted share in the range of a $1.60 to $1.70 excluding one-time items. In 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. In summary, we believe performance in fiscal 2017 will be driven by our core growth opportunities in publishing and education in the United States and around the globe with improved execution and more streamlined operations. I will now turn the call over to Gil to moderate a question-and-answer session. Thank you.

Thank you, Maureen. Brian, we're ready now to open the lines for questions.

Thank you, sir. [Operator Instructions] Our first question will come from the line of Drew Crum with Stifel. Please go ahead.

Okay. Thanks. Good morning everyone. Wanted to start with the clubs business, your commentary in terms of the second quarter performance and your expectations for improved performance in the second half, does that enable you to make up the shortfall you saw in fiscal 2Q and end of the year kind of flattish or levels you've characterized?

I think we may -- we'd be very happy to get back to the flat. We think we can make it most of the back Drew. It will turn this over to Judy to respond to the question.

Hey, Drew, how are you?

Hi Judy.

As Dick and Maureen said, we focused on profit and get reductions -- catalog reductions in the first half of the year, but we went a little bit too far. So, while the profit held up really well, the revenue declined too much. So, beginning in January, we are going to be restoring those classic kits, SeeSaw, lucky, arrow, more aggressively to market sponsors and we know those have typically higher revenue because they are broader grade spans and they appeal to customers. So, we're pretty optimistic that beginning in January, we're going to keep the flat revenue for the second half of the year and we know that our customers are to be responding quite well to that.

And you are comfortable you can achieve your profit target for fiscal 2017?

Yes, we are.

Okay, got it. Okay. And then on the trade business, I wonder if you'd be willing to comment on the performance of the Harry Potter franchise in fiscal 2Q versus fiscal 1Q. And just remind us what you have planned in terms of new content for the second half of fiscal 2017 as it relates to this franchise?

Well, the Cursed Child, in the first quarter, did extremely well. And exceeded our expectations and did -- was the number one best-selling book in the United States for weeks and as Amazon pointed out, it was the top-selling book in 2016 on Amazon. So, that gives you a sense of the strength of the Cursed Child. Fantastic Beasts, the movie did very well. Fantastic Beasts screenplay came out to coincide with the movie on November 18th, right at the end of the quarter, so, the initial sales is in those 12 days, were moderate. I mean they were up to expectations, but they just didn’t have enough time to sell and sell through. So, we will get some continuing Fantastic Beasts sales in the third quarter. We have no additional Fantastic Beasts publishing to introduce all of that is already out in the market.

Okay, got it. And then one last question and I'll jump back into the queue. Maureen, is there a number you can give us in terms of your expectations for overhead -- corporate overhead expense for fiscal 2017? Maureen O’Connell: Yes, Drew. The $20 million that we're reducing related HMH on was a profit against overhead last year. So, for that reason, overhead will go up $20 million. You'll see the benefits of the cost reduction still in the business segments. And then as I mentioned, we have increased our spend in technology and facilities roughly around $10 million. So, you should see overhead increase in total about $30 million, but know that other than the investments in facilities and technology, it's not a real increase. Year-to-date, we're at approximately $17 million, so it's been more frontloaded to the first half of the year.

Okay, very helpful. Thank you.

Thank you.

Thank you. Our next question will come from the line of Barry Lucas of Gabelli & Company. Please go ahead.

Great. Thank you. Good morning, Dick.

Good morning.

Maybe you can talk a little bit higher level and maybe you could talk a little bit about two things; school budgets, how you are viewing them at this point in time; and the appointment or the nominee for the Secretary of Education, Betsy DeVos.

Well, as you well know Barry, and I'm sure you know at least as much as I do about the ESSA legislation passed last year. The huge bulk of the $60 billion of federal contribution to education in the United States is already committed through the ESSA Act. And that money will be passing to the States with certain restrictions on it. But the federal government as already done its thing, the Congress has passed the Bill and it's in effect right now. So, whatever happens at the Federal Department of Education will not really strongly -- or cannot influence the progress of ESSA. And bearing in mind the federal contributions to education now will be 9% of the total spending for education in the United States because over $600 billion for K-12 as you know. So, -- and I think the budgets are -- in schools are of course, the states are going to have to come up with money to support education, and that's -- but I don't see any very substantial change. Education is a top priority of the voters and the people in the United States. We do see some move away from basal textbooks and toward the kind of materials that we publish. So, we're -- I mean our school customers are telling us that they are open to kind of a customized curriculum that we're publishing. So, we're getting a good response, but bear in mind that this is still a relatively small $300 million business for Scholastic and we're pouring significant resources in to response to the opportunities that the changes in curriculum are 40 plus the cries for more service and more support in professional learning and in family and community encouragement which is a requirement of ESSA. But we're running as fast as we can to advantage of the really great opportunities that we see in pre-K to 8 literacy for Scholastic.

Great. That's helpful, Dick, and actually a good segue into the next question. So, to the extent that there was some shortfall in the education segment in 2Q and you are optimistic about the pipeline that you're looking at in terms of opportunity, so is this shortfall strictly a timing issue? You have got enough stuff in the crystal ball there that can tell you that the back half of the year is going to be that much stronger?

Yes, we're very confident in the back of year. We have great pipeline. The second quarter is relatively small for that business. It’s a fourth quarter business for us primarily and our profits come in at the end of the year in that business and a lot of our sales. So, we're -- it's kind of irrelevant where we're right now. We're little bit behind, but we could be a little bit ahead. It's just the timing issue there. And we know that this is a strong area for us. Schools are responding to what we do and we have a very good pipeline for the second half.

Great. Last one for me and I'll let probably Drew take back the mantle. But we're over -- where are we at, just about $13 a share in cash, you bought back $6 million worth of stock in the quarter, the dividend that you declared yesterday evening was held at $0.15. It's piling up, what do you expect to do with the cash, Dick?

Well, we’re obviously looking for opportunities to utilize it. I'll turn that over to Maureen, Barry, and she will answer that question for you.

Thank you. Maureen O’Connell: We continue to look for opportunities to buy back shares. As you so we bought back $6 million in the quarter and we have ample of room to continue buying. And -- we do have ongoing discussions with the Board about how to utilize our cash and including returning cash to shareholders. So, that is certainly top of mind with our Board members and with our management team.

Thanks, Maureen. Maureen O’Connell: You're welcome.

Thank you. Ladies and gentle, this concludes our question-and-answer session for today. So now, it is my pleasure to hand the conference back over to Richard Robinson, Chief Executive Officer for closing comments and remarks. Sir?

Thank you all for your continued support. Have a good Holiday season. We look forward to our March call and we have confidence in the balance of our fiscal year. Thank you very much.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody have a wonderful day.