Scholastic Corporation (SCHL) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2017 Third Quarter Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mr. Gil Dickoff, Senior Vice President and Treasurer. Sir, you may begin.

Thank you very much, Sophie, 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 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.

Thank you, Gil. Good morning and thank you for joining us today. After an exceptional performance in the first-half of the fiscal year, particularly in trade. The third quarter sales in our book club and trade channels dropped by $20 million compared to the prior year. However, because of the cost reductions we put – programs we put in place earlier this year in clubs and fairs, segment operating income for the Children’s Book Group declined by only $1.9 million in the quarter. Reading club revenues were affected by lower than expected sales of media titles and a segmentation strategy, which did not work effectively, resulting in fewer sponsored reading club orders and lower revenue per order. Of course, we are disappointed with this result, but we are confident we can recover momentum in the club business next fall through enhanced product and incentive programs, as well as improved marketing strategies. In trade, sales dropped in the quarter by $8 million compared to the prior year, almost entirely because of the comparisons to the very strong performance of the adult coloring books last year. However, at the end of the third quarter, we are still $99 million head of the prior year in trade revenues, primarily due to the strength of Harry Potter and the Cursed Child Parts One and Two, and the Fantastic Beasts and Where to Find Them film script. Scholastic strategy to build on our leading position for global children’s books and significantly grow our education business in the U.S. and around the world is underpinned by a carefully developed three-year investment plan in transformational technology. We are investing to ensure that our infrastructure remains ahead of the curve, enabling us to leverage our unique market position and customer relationships to grow our market share and reduce costs. We’re transitioning our technology infrastructure to enterprise-wide platforms and migrating to software-as-a-service solutions, which will result in improved business processes and much improved visibility to our school-based customers across all lines of business. After implementation, our enhanced platform will also reduce our operational expenses globally, largely as a result of our technology OpEx investment, which are included in overhead. Our overhead expenses increased compared to the prior year, excluding one-time items by $6 million in the third quarter and $23 million for the nine months year-to-date. In Children’s Book Publishing and Distribution, our plan to improve profitability in fairs by better matching fair resources to each school size and interest remains on track, and we had higher revenue per fair in the quarter, as well as reduce costs. And while revenue declined in clubs, we realized cost savings on product and promotional expenses. Scholastic’s own successful franchises, Dog Man in particular, are performing very well in clubs and fairs. But we have not seen a blockbuster title from third-party content providers this year as we had in past years. In trade, we had a number of standout titles in Q3 with continued strong performance from Dav Pilkey’s Dog Man books. We also launched our publishing program based on the iconic American Girl brand beloved by millions of children around the world. Conversely, sales of adult coloring books, which were very popular at this time last year declined, and we expect coloring books to be a tough comparison in the fourth quarter as well. Looking ahead with the upcoming release of the feature film adaptation of Captain Underpants from DreamWorks Animation in early June, we expect to see increasing interest in our Captain Underpants backlist and new movie tie-in titles, which will also sell in clubs and fairs. We are also excited about our lineup of new trade releases, including Happy Dreamer, a picture book written and illustrated by Peter Reynolds. The Lotterys Plus One by Emma Donoghue, and the first book in our new adult multiplatform series Horizon by Scott Westerfeld, a number one New York Times best selling author. In education, we continue to expect our new business pipeline for the year to be back-end loaded, and we see a strong finish to the year in this fourth and final quarter we’re now in. Recent research confirms that teachers and principals prefer to use a combination of engaging print and digital resources for instruction and we are therefore, seeing more opportunities to replace basal textbooks with our comprehensive core curriculum programs and pre-K to 6 balance literacy. Teachers tell us that our core literacy curriculum allows teachers to help students build reading skills in a more interesting and relevant way than they can with a basal textbook. We also recently partnered with u.gov on a study that, among other things confirmed our long held belief that the best way to enable each student to reach his or her full potential is to instill in a student support system that goes well beyond the classroom, including strong partnerships between schools, families, and communities with our core literacy curriculum combining print and digital solutions and our growing professional development services and family and community engagement programs, we can continue to build our market position in education. In International, we continue to see overall growth in key emerging markets in Asia, such as India, China, Philippines, and Malaysia, where revenue grew by 3% in local currency terms, as we continue to expand distribution by building on our global product and distribution assets. As these countries build a growing middle class, we see expanding demand for our English language print and digital products that help children learn at school and at home. In Asia, products are delivered through our unique club and fair channels, as well as a large regional network of direct-to-consumer sales teams. Similar growth was also realized in our export business, especially in Latin America, which was up this quarter by 21% versus prior year. We saw local currency gains in trade publishing in the UK and Australia, New Zealand with strong sales of Aaron Blabey’s The Bad Guys and RL Stine’s Goosebumps. Looking forward, we’re continuing to focus on enhancing profitability by leveraging global product to grow our trade and education business, while making investments in technology that will help to lower product cost as well as fulfillment in operating expenses. Moving on to real estate, we’re making good progress on our Soho headquarters building renovations, which as you know, will create new premium retail space and increase the capacity of the office floors, reducing our reliance on costly external lease space. We are continuing negotiations with high-quality retail tenants and we expect to announce a 15-year lease for our 557 Broadway facing retail space within the next few months. Throughout the world, schools are increasingly focused on independent reading of children’s books is central to literacy and educational development. We continue to see growth in children’s book sales, while we significantly expand our pre-K to 6 core curriculum literacy programs, as well as our – in our supplementary offerings in education. We remain confident in our strategy to grow our print and digital publishing businesses to serve our primary customers, teachers, parents, children and schools. We are reaffirming our outlook for fiscal 2017, as we continue to strengthen our market position by delivering on our mission of helping children to become strong readers and develop high-level thinking skills, both through independent reading and curriculum-based literacy programs. At the same time, our technology investments enable us to market more effectively and reduce operating costs. With that, I will turn the call over to Maureen. Maureen O’Connell: Thank you, Dick, and good morning, everyone. In my remarks this morning, I will refer to our adjusted results from continuing operations, excluding one-time items unless otherwise indicated. Third quarter revenues, excluding $1.3 million impact of FX were $337.5 million, a decrease of 8% from last year. Operating loss was $18.7 million compared to $8.1 million last year, resulting in a loss from continuing operations of $0.36 per diluted share versus $0.06 last year. As you recall, our third quarter is a seasonally lower revenue quarter for Scholastic in which we typically record a loss. Results for the third quarter included one-time items that totaled $4.9 million, which included $4.4 million and severance charges taken in connection with our cost reduction programs, as we move from a fixed cost environment to a variable cost model and technology services, and $0.5 million related to the exit of lower margin software distribution business in Australia. Last year, third quarter one-time items totaled $8.3 million and included the non-cash write-down of legacy prepublication assets for $6.9 million and $1.4 million related to severance. Moving on to our segment results. Children’s Book Publishing and Distribution revenues was a $199 million compared to $219.8 million last year, and operating income was $6.3 million versus $8.2 million last year. The decline was largely related to lower book club orders and the softening adult coloring book sales trend. We were able to partially offset these factors with our cost reduction initiatives in clubs and fairs, such as lower catalog and promotion cost in book clubs and improve productivity in book fairs fulfillment operations. Education segment revenue was $6.1 million compared to $63.9 million last year, and operating income was $3.5 million compared to operating income of $4.5 million last year. We are gaining traction with our professional development and service revenues, which increases quarter. While the decline of classroom books was a result of a shift in our pipeline to our fourth quarter, our company-wide focus on improving profitability resulted in lower operating expenses, especially in the digital subscription businesses. In International segment, revenue was $77.1 million compared to $82.3 million last year. Lower sales on our major markets were partially offset by growth in Asia and export. The FX impact was $1.3 million unfavorable in the quarter. In addition, our planned exit from the Australian software distribution business impacted our revenues for the quarter by $4.9 million. Operating loss was $3.4 million compared to operating loss of $1.5 million in the prior year, due to the lower sales in general as well as higher royalty and bad debt expense in Asia. Corporate overhead in the third quarter was $25.1 million compared to $19.3 million last year as a result of our investments in facilities and technology as planned, as well as the loss of a transitional service income from HMH. We are replacing disparate business unit systems with enterprise wide systems that will improve our content and customer management capability and will enable a more cost-effective e-commerce platform. I’d like to take a few minutes now to update you on some of our technology investments. We are consolidating our product master data across our business units with one definition of an ISBN that will make it easier to report products sales and rapidly modify strategies and tactics in each channel as appropriate. We are consolidating multiple web content management systems, including for classroom magazines and e-Scholastic websites to one single Adobe experience manager system. We are creating one repository for all our customer data with a simplified system that will better track our customer relationships in all channels. We moved our U.S. book clubs to a SaaS-based Demandware system, which can handle a significantly higher volume of orders and will lower annual technology operating cost. We are extending this platform to our Canada book clubs and our teacher and consumer e-commerce stores over the next year. We launched the Scholastic Digital Manager for all our digital subscription programs in the education business, which will lower costs related to building new digital products and expedite our time to market. We are introducing new business intelligence tools. As a result, we will be able to identify the best and most likely incremental sales opportunities more effectively. We are also beginning the design phase of an oracle ERP platform to manage our financial and supply chain systems, which we expect to complete in fiscal 2019, and we will implement a company wide CRM system. Through this investment program, we are simplifying and standardizing our business processes across divisions using data to improve our customer relationships and leveraging investments in content, which will lead to increased revenue opportunities in all channels. We will also reduce our operating cost, as we move from a fixed cost infrastructure and staffing model to a variable cost model, which gives us the flexibility to scale our infrastructure and staffing levels with volume and activity levels. The combination of increased revenue growth opportunities and lower costs will drive a significant ROI over time. We are confident in our ability to execute this well-planned out strategy. We have successfully implemented approximately $20 million in annual cost saving initiatives to offset the income related to the transitional service agreement with HMH that expired in July. As a reminder, these savings are reflected within segment operating income rather than in corporate overhead. Partially offsetting these savings in the current year is the impact of our wage improvement program at our warehouse distribution and customer service centers of approximately $10 million to $15 million on an annualized basis. The wage rate realignment in this fiscal year has already shown benefits with lower employee turnover at our shared service centers and the retention of seasoned book fair drivers that help us avoid using expensive temporary drivers in the peak season. During the third quarter, we generated free cash flow as defined of $16.6 million compared to $9.6 million last year, and cash and cash equivalents exceeded net debt – exceeded debt by $456 million at the end of the quarter compared to $343 million last year. As we announced earlier this week, the Board of Directors declared a cash dividend of $0.15 per share for the fourth quarter, and we also recently entered into a new five-year $375 million committed credit agreement. The new agreement has substantially similar terms and conditions as the previous one, which was set to expire in December 2017, that allows for an increase in the company’s capacity for dividends and other distributions in respect to its capital stock. We continue to believe performance in fiscal 2017 will be driven by our core growth opportunities in publishing and education in the United States and internationally with improved execution and more streamlined operations. And as Dick said earlier, we are confirming our full-year outlook of $1.60 to $1.70 earnings per diluted share, excluding one-time items on total revenues of $1.7 billion to $1.8 billion. We expect free cash flow to be in the range of $40 million to $50 million. Even with the higher level of strategic investments in technology and real estate, we remain on track to deliver positive free cash flow for the 13th consecutive year, excluding taxes paid last year on the sale of EdTech. I’ll now turn the call over to Gil for the question-and-answer session.

Thank you very much, Maureen. And operator, we are now ready to open the lines for questions.

[Operator Instructions] And we do have a question from the line of Barry Lucas with Gabelli & Company. Your line is now open.

Thank you and good morning. Dick, could you maybe talk a little bit about what the change at the top of the Department of Education may or may not mean in terms of directions given to local school districts and how they respond?

Well, thank you, Barry, good morning. We discussed this a little bit on the last call, where you asked a very good question in the same vein. Clearly, the initial Trump budget includes a significant reduction in education spending. Over time as these – as this budget gets discussed and finally formulated, we really don’t believe the funding environment will change significantly in education, as most people in our society rank education along with jobs and healthcare as their major concerns. We – our three-year plan in education, which we’re building now, Barry, as you know, is one based on improving our market share, as we still have a relatively small portion of a very significant spending that currently is available for pre-K to 6 core literacy in the schools. So from our point of view, we are forging ahead with our education development thinking about market share of the existing funding, which may go down a little bit. But we still feel we have significant opportunities in growing our Education business. I know you’re also interested in the switch in terms of charter schools.

Yes.

We are expanding our charter school focus on sales, and we’re expecting some increase – the trend is already there in charter schools. There’s not a huge amount of new money devoted to charter schools in the new budget. But clearly, there will be some acceleration in the development of charter schools and we will be there with our special sales effort to focus on those growing number of charter schools.

Great. Thanks, Dick. The two kind of timeline questions, one in terms of the – not just the rental space, but in terms of the construction of the new building and when you really anticipate moving people back in? And then secondarily, in terms of time, as you implement the new – I would say the new technology maybe you can just tell us what inning you are in? When do we really see the larger benefits of the investments that are being made? Thank you.

Let me start with the latter question and I may turn to Maureen as well to supplement whatever I have to say. We’re in the process of a three to four-year of technology transformation. We believe that we’ll begin to see significant improvements there in fiscal 2019, and then they will accelerate in fiscal 2020. But we do believe that our – in our core longer-term strategy is to significantly lower our cost base by the use of this transformational technology and also to improve our marketing focus and capability to increase sales in a very strategic way as a result of the technology investments we’re now making, which are quite sweeping and really affect all aspects of the company. I’ll ask Maureen to come back to that, but let me answer your retail question of the building question first. We are really on target with our building renovation and we will be moving some people in July. And we will be completed by the end of 2017, and we’ll have moved everybody back into the building at that time. As you know, we have half of our staff is relocated elsewhere during this year, which has increased our operating expenses during the year. But we’re really excited about this real estate project. It’s going really well. It’s going to be a fantastically more efficient office and with all a lot of new technology enabling our workforce to do a better job. And on the retail side, which I know has been a concern of yours. We continue to believe that the premium retail on Broadway and Soho remains one of the most desirable places in the world to sell clothing, apparel, accessories to youthful market that they crowd these streets every day and especially on weekends and fill the stores everywhere on the street. So we’re in discussion with a lot of different people about the space. So we expect to announce a major lease soon and we see these opportunities in retail as a long-term investment for Scholastic shareholder. So over to Maureen on the technology question that you asked. Maureen O’Connell: Well, I agree with Dick. I think we will see the major part of the improvement from our technology investments in 2019 into 2020. But I’d like to say that we are already yielding some of those improvements now. We rolled out Demandware for our book clubs at the beginning of the year and reflected in clubs is the savings related to leaving the IBM WebSphere application and moving to Demandware, which is a SaaS solution pay as you go. So we already have reflected in the club business lower operating expenses, because of that, and we can move quicker to change our site because of that. And so that has also allowed us to get faster to market with promotions. As far as other investments that we rolled out this year, we talked about Adobe Digital Manager and classroom magazines and our e-Scholastic site, that has allowed us to bring down the cost of those applications as well as we mentioned in our Education business we moved to Scholastic Digital Manager and you saw in our results that our digital expenses have gone down and our digital businesses the cost of producing digital product. So you are starting to see those investments and you’ll continue to see those investments paying off each year as we roll them out.

Great. Thanks, Maureen.

Thank you. [Operator Instructions] I’m showing no further questions at this time. This does conclude today’s question-and-answer session. I would now like to turn the call back to Mr. Richard Robinson, Chief Executive Officer, President, and Chairman for any closing remarks.

Thank you all for listening to our third quarter story. We’ll look forward to talking to you again in July at our year-end conference. We’ll talk – we’ll see you then. Thank you all for listening today.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

Thank you, Chelsea, very much.

You’re welcome.

Very smooth call. Have a good day now. Bye-bye.