Scholastic Corporation (SCHL) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Q4 and Fiscal 2017 Results and Fiscal 2018 Outlook Conference Call. At this time, all participants are in a listen-only mode. Following managements prepared remarks we will host a question-and-answer session and our instructions will follow at that time. [Operator Instructions] As a reminder, to our audience today this conference is being recorded for replay purposes. Now it’s my pleasure to hand the conference over to Mr. Gil Dickoff, Senior Vice President and Treasurer. Sir, you may go ahead.

Thank you very much, Brian, and good morning, everyone. Before we begin, I would like to point out that the slides of 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 the various risks and uncertainties, including the condition of the children’s book and educational materials markets and the 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 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 us today. We had a solid year in 2017 helped by strong trade and publishing especially as we had two new Harry Potter titles for the first time since the conclusion of the original book series in 2007 as well as the first two titles and the successful new graphic novel franchise, Dog Man by Dav Pilkey. We also continued to build momentum in Scholastic Education with market share growth in Pre-K to 6 core literacy as well as summer reading. Maureen will review our 2017 year in a few minutes. I will talk briefly now about our outlook for the future as we reach towards Scholastic's 100th anniversary in October 2020. To drive our future growth and profitability, we are launching a 3-year plan called Scholastic 2020, the goal of which is to build substantially increased operating income for the company over the three year period. This plan particularly addresses the operations and fulfilment side of our clubs and fair distribution business which are labor and freight intensive. The Scholastic 2020 process also directly links our transformational type technology work to the operating work of the publishing units ensuring that the new systems will provide the business leaders expanded and focused information about product, content, customer data and manufacturing and fulfilment cost. This direct linkage will result in reduced operating cost by simplifying business processes and will result in improved revenue through better targeted marketing and sales initiatives. Overtime, we will also reduce technology costs through centering on a single enterprise architecture for the company and we will drive significant operating efficiencies through lower cost of inventory and distribution, including improved procurement and the optimization of our U.S. clubs and fairs distribution network. Our new product information systems for example will help us to reduce duplicate data and eliminate double handling of product. This in turn will enable us to match inventory with sales data, reduce time for delivery of inventory and improve visibility to product movement leading to operations and fulfilment savings throughout the organization. At the same time, our technology improvements will include greater use of social media and digital communication as tools to market and sell the current and potential customers. As you know Scholastic’s greatest strength stems from our powerful brand based on our deep relationship with U.S. schools and teachers and our tremendous reach into the daily life of classrooms and families through our school presence. The slide on our WebEx shows Scholastic’s significant penetration by product line in U.S. schools. We are doing business with 90% of U.S. schools and our clubs, magazine’s, fairs and curriculum materials are each present in more than 60% of U.S. K–12 schools, through a new CRM systems which includes salesforce.com our publishing divisions will have broader and more accessible customer information about each of our school businesses for clubs, bookfairs, classroom magazine and Pre-K to 6 literacy programs which will enable more cost efficient and more targeted communications through our customers leading to cross selling opportunities as well as maximizing the revenue potential of each of our product lines. We will greatly expand our opportunities to build sales in each school through improved CRM and greater use of analytics to target our products and marketing. As we move to the next steps of our multiyear transformation plan, we are also introducing new financial and operational ERP systems utilizing Oracle in North America and NetSuite internationally, to provide state of the art financial and operations information. The secret sauce [ph] of the Scholastic 2020 plan is a detailed management process that will connect their systems work to specific improvements in divisional operations ensuring that the divisions are effectively utilizing this new information and are able to reach our goals for lowering cost and increasing revenue opportunities through targeted sales and marketing. While we have made significant improvements over the past several years in our Scholastic strategic type technology transformation, we are now at the point where we can embed these improvements in our divisional plants for higher revenue and lower costs. As a result of our Scholastic 2020 plan, we expect significant double digit operating income improvements in 2019 through 2021. However, we will record a lower level of operating income in fiscal 2018 than we have achieved in the past two years given the increased expenses of our investments and technology and tough comparisons with 2017 when we had a 45% increase in trade sales based largely on the two new Harry Potter titles. As we moved into 2018 and look forward to our 100th anniversary in 2020, here is a look at our key businesses. Based on our three year plan for the education business we will deliver complete Pre-K to 6 core literacy program to districts expanding our sales opportunities in core instruction, growing revenues beyond our current supplementary focus. We have substantially expanded our curriculum publishing programs and our field organization to grow our market share for guided reading and core literary. Our suite of digital subscription programs will deliver more engaging ways to deepen new reader’s foundational skills. Our highly successful classroom magazines provide schools with strong non-fiction publishing in both in digital and print and are seen as important supplements to core instruction in reading social studies and science. As a result of these expanded services, we see a significant opportunity to take larger market share in the Pre-K to 6 education market in the U.S. In Children’s books for 2018, Scholastic book fairs are growing revenue per fair in our most profitable segments through improved analytics and matching revenue opportunities to school demographics. Scholastic books clubs has simplified its program eliminating the single grade offers to focus on our traditionally successful multi grade club offerings which will enable teachers to gain access to a wider range of titles. We expect trade to return to normal levels in 2018 but we see excellent growth from new authors as well as the remarkable popularity of Dav Pilkey’s Dog Man and Captain Underpants series. We look forward to further publishing around J.K. Rowling’s Fantastic Beasts in 2019 as that major franchise continues to build through a total of five projected films. We expect flat revenue growth in international in the upcoming year since we will not have new Harry Potter titles in Canada at our export, but we expect increased growth in Asia as we strengthen our management there and expand our key education products while trade continues to grow throughout the region, our three year trajectory in Asia calls for high single digit growth. Our forward looking vision for Scholastic is made tangible by the opening of the first two new floors in our headquarters building this past few weeks, where our staff is now operating in a bright office environment with new technology and a completely refreshed feeling to the work space. As we finish the renovation in December and bring most of our New York staff together in one building, we believe the new work space redefines Scholastic and complements the Scholastic 2020 plan to provide increased service to schools while we significantly improve operating income in the three years through 2020. We are also pleased to announce that Sephora our current tenant in 555 Broadway and one of the world’s most successful retailers is completing an agreement to extend its lease through 2033 taking the new 557 space facing Broadway when it becomes available next year. I will now ask Maureen to talk more about 2017 as well as updating you on our 2018 outlook. With that, I’ll 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 for the fiscal year excluding one-time items unless otherwise indicated. Revenues grew 4% to $1.74 billion and excluding the foreign exchange impacts revenues grew 5% over the last year. Operating income was $109.1 million up 17% from last year and operating margins improved in all three segments. Earnings per diluted share was $1.83, an increase of 8% over last year. Non-recurring items in our pre-tax results was $20.2 million for the year including $11.4 in Q4. These charges were largely related to restructuring severance, non-cash write down of legacy website development and prepublication assets and the discontinuation of our software distribution business in Australia. Over the year we successfully implemented approximately $20 million in cost savings initiatives to offset the income related to transitional service agreement with HMH that terminated early in the fiscal year. As a reminder these savings are reflective within our business segments, operating income rather than incorporate overhead. Children’s book publishing and distribution segment revenues increased by 5% to $1 billion driven by strong trade sales including the successful release of Harry Potter and the Cursed Child Parts One and Two, 2016th bestselling book in North America. And the original Fantastic Beast and Where to Find Them, screenplay by J.K. Rowling in the first half of the year as well as Dav Pilkey’s backlist Captain Underpants books and new Dog Man titles. This was partially offset by reduced adult coloring book sales in our trade channel and lower book fairs and book club revenues. Operating income was $143.1 million, an increase of 19%. We expected education results to be backend loaded and we had a strong finish to the year in this segment. Revenues were $312.7 million, 4% growth, and operating income was $51.8 million, a 4% [ph] improvement. Performance was driven by higher sales of our balanced literacy programs and classroom magazines and high demand for our summer reading products in Q4. Other standouts were two books in our professional service offering, the next forward in guided reading and disruptive thinking, why, how we read matters, as well as our next step guided reading assessment product. International revenues were up 1% to $376.8 million, operating income increased $7.8 million or 63%. Growth was driven by new Harry Potter content in Canada and export and strong children's trade publishing in Australia, Canada, the UK and Asia, partially offset by weaker results in Asia overall largely in Thailand and the Philippines. Our capital spending for the year included $30.6 million for strategic technology upgrades and initiatives as part of our multiyear transformational technology investment program. Our technology investment will enable us to better use customer data analytics as we fine-tune our go-to-market strategy, simplify and standardize business practices across divisions, communicate more effectively with customers and leverage corporate investment for the benefit of all our business groups. We also invested capital of $20.6 million of the planned $65 million to $70 million budget to redesign and upgrade our headquarters building, and we expect to spend the remainder of this capital in fiscal 2018. These upgrades are creating a workplace that integrates scalable technology to increase capacity and improve productivity, while freeing up higher value Broadway-facing retail space. In addition, the location of our SoHo Building remains a catalyst for attracting the best editorial and creative content teams and technologists. Net cash from operating activities was a $141.4 million compared to net cash use of $78.9 million last year, and we had free cash flow of $48.8 million, compared to free cash use of a $139.7 million last year, which included the tax payment on the sale of the education technology business. At the end of the year cash and cash equivalents exceeded total debt by $437.9 million compared to $393.4 million last year, mostly due to our free cash flow. Now turning to outlook, Scholastic 2020 will align our investments in strategic technology, facilities, people and content and will create a performance management structure to drive margin growth at all levels within Scholastic. As Dick said, we expect to drive higher revenues and reduce cost as a result of this plan. Although we are projecting lower operating income in fiscal 2018 due to the absence of new Harry Potter titles which help drive 45% increase in trade revenues in the past year, and we expect increased technology and facility spend, we do expect double-digit growth in operating income in 2018 excluding the impact of new Harry Potter titles. We will continue our planned investment in strategic technology and our headquarters building and we expect to complete all construction work in the coming year. Fiscal 2018 free cash flow is expected to be a use of $10 million to $20 million compared to a source of $48.8 million in fiscal 2017. This outlook includes capital expenditures of $90 million to $100 million compared to $65.7 million in fiscal 2017 and prepublication and production spending of $30 million to $40 million compared to $26.9 million in fiscal 2017. Construction spend will exceed 2017 levels due in part to the timing of payment and this has been included in our outlook. We have also begun to upgrade and substantially expand our Oracle ERP systems for financial management, manufacturing, transportation and logistics. We therefore expect capital spending and technology projects to be higher in 2018 than it was in 2017, which is also factored into our 2018 guidance. We expect revenue, total revenue in fiscal 2018 of $1.6 billion to $1.7 billion in the absence of new Harry Potter titles in North American trade and export, and a commensurate decline in operating profits under lower project sales, as well as higher cost associated with strategic technology initiatives and facility upgrades without any anticipated rise in retail rents. Operating income excluding the impact of new Harry Potter publishing in the prior year is expected to grow double-digit. Scholastic expects earnings per diluted share in the range of $1.20 to $1.30 excluding one-time items and a non-cash pension curtailment charge we expect to take as a result of the termination of our domestic defined benefit plan. After fiscal 2018 we expect double-digit operating income growth in each fiscal year 2019, 2020, 2021 as we celebrate a 100-year anniversary in October 2020. In children's book publishing and distribution we expect trade revenues to return to more normal levels after the strong performance of new Harry Potter titles in 2017. This year we will release Cursed Child in paperback, as well as two new illustrated editions of titles from the original Harry Potter series. We are also planning to take advantage of exciting market opportunities in connection with Harry Potter's 20th Anniversary in the U.S. in the fall of 2018, and our fiscal 2018 publishing plan will also include upcoming title such as Dav Pilkey's Dog Man, a Tale of Two Kitties, Swing It, Sunny!, the follow-up to New York Times bestseller Sunny Side Up, All the Crooked Saints, the Word Collector, a new picture book by Peter Reynolds and tie-in books to Netflix’s new animated series of Magic School Bus show. We expect low to mid single-digit revenue growth in our school-based distribution channels. Book Clubs will return to growth as a result of a simplified promotion strategy and a return to traditional monthly fliers, where teachers have told us they favor over graded catalogs. We expected book sales to increase revenue per fair as we apply more robust business analytics to write-sized its fair segments and more specifically target growth opportunities by demographics. In education we plan to grow revenues by expanding our pre-K to six balanced literacy program for school district and capturing market share for our core literacy curriculum, guided and level reading programs, classroom books and professional services. We anticipate revenue growth in mid single-digit in fiscal 2018 as we expanded distribution of our comprehensive literacy curriculum for core instruction and build out our service business for educators focused on product aligned, professional development and family and community engagement services. In international, revenue is expected to be level with the past year with growth in most countries offset by a return to more typical revenue line level in Canada and export after this year's gains driven by the new Harry Potter titles. We will focus on growing in both mature and emerging markets by expanding our market presence of our key products and leveraging our position as a global partner with schools as we support research-based instructional literacy and mathematics programs. We also expect our enhanced sales force in Asia to lead to growth in direct sales in that region. We are excited by the opportunities ahead of us and as we invest to capitalize our best growth opportunities we remain intensely focused on improving our profitability as we approach our 100 anniversary in 2020. Now I’ll turn the call over to Gil for question and answers.

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

Absolutely. [Operator Instructions] Our first question will come from Drew Crum with Stifel. Please proceed.

Okay. Thanks. Good morning everyone. Can you remind us what your expectations are for CapEx beyond fiscal 2018? Obviously, $66 million in fiscal 2017 expected to step up in fiscal 2018. But if you look back prior to fiscal 2017, it was kind of in that $25 million to $35 million run rate. And I guess I’m asking if we should expect to see that by fiscal 2019 or will be a gradual step down? Maureen O’Connell: So, Drew, at this point we’re not giving guidance for capital and pre-pub into the future. But I can say that we will complete the building construction in 2018, and the building construction is about a use of cash of $50 million in capital, so that you can expect that that will come down for that. The technology spend now will become more and more capital as we put technology and services, but I can't give you specific guidance for that today.

Okay. And then on the Children's Book business any more comment or detail you can provide around your expectations for the trade business? I think you characterize it as returning to more normalized levels. Now if you exclude Harry Potter, is this the business that should grow at low to mid single-digit in fiscal 2018 or any detail or parameters you can give us to work with there?

Yes. I think that’s right, Drew, obviously, the Harry Potter was a significant increase in revenues in 2017. We still continue to sell Harry Potter very well, but in backlist primarily. But we should have I would say, mid single-digit trade revenue improvement in 2018.

Okay. Got it. And then also with fairs, just any comments you guys can provide on the fiscal fourth quarter performance in fiscal 2017. It was a year in which sales decline, which wasn’t a significant decline, but this is a business that’s grown, looking at my model in the last 10 plus years, every year. So just wondering if you could offer little more detail on what happened in fiscal 2017 and confidence you can get back to growth in fiscal 2018?

Yes. Well, we have strong growth projected for fiscal 2018. Our growth did decline in 2017 as you say. This primarily stems from our – I think well thought out plan to focus on revenue per fairs as opposed to fair count. Our business has grown significantly by fair count, but that means that we’re probably delivering unprofitable fairs at the low end, that’s the low end of revenue. So, we took the bold step in 2017, reducing fairs by 10,000 or 8.8% and we’re focused on revenue per fair to offset the decline in number of fairs. We did a good job of this transition, but we probably missed the few steps that we have now analyzed and understand. And so as we look at 2018 we see a much stronger focus on improving the revenue per fair particularly in our custom fairs which is the $8,000 to $12,000 segment and is a significant part of our total revenue. And we have a whole new plan in that area which is very exciting with a stronger increased merchandising and a whole new fair build up from the bottom rather than just adding components to our core fairs, there’s a little more detail perhaps is needed, but that's the general strategy there. And we see very good signs of getting that through our sales organization. Everybody understands it. And we are very confident that we can rebuild growth without adding numbers of fairs.

Got it. Okay. And then just last question from me, Dick, any updated thoughts on returning cash to shareholders? You know nearly $440 million of net cash sitting on the balance sheet. Any updated thoughts there you can share?

Sure. I think Maureen is going to tackle that one, Drew.

Okay.

Thank you. Maureen O’Connell: Well, I think Drew, as you know, we continue to have discussions in each and every quarter with our board about opportunities to return share, cash to shareholders. And we have been under an open-to-buy program. We bought $7 million for stock back this year in ranges between $38 and $42 a share. We still have $38 million remaining under that capacity and we will continue to buy in the open market. And then we had conversations every quarter with our board about whether there are more aggressive programs and we’ll continue to have those conversations.

Okay. Very good. Thank you.

Thank you, Drew. Maureen O’Connell: Thank you.

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

Thank you and good morning. I’ve got several if I may. If we could start with the growth target post the year that we’re in now double digits, any way either to refine that a little bit further or maybe even think about what a margin target might look like as we get it to see the benefits of Scholastic 2020?

I think our three-year plan, Barry, we definitely have a margin target. We’re not going to announce it, but we have that in mind. The reason we’re not going to announce it is that the 2020 plan is kind of an iterative plan where we’re evolving it over three-year period, but the overall goal is to improve our margin by 2020 significantly. And we expect as we said operating income improvement in double digits in fiscal 2019 through 2021.

All right. If -- maybe switch gears to the real estate a bit. Just wondering, is Sephora [ph], the tenant that you alluded to earlier, I mean if there was kind of an unnamed tenant that you were talking about. So was that's LVMH and Sephora?

Yes.

Okay. And is the plan that they will take more square footage or just remain in roughly the comparable amount of footage that they are in now?

They are in a comparable amount of footage, but it’s a premium space that’s been all redeveloped for them in the front of 557 building on Broadway-facing. The back of that space will be our new Scholastic corporate entrance to our building.

So, is there room for another tenant on the ground floor?

Yes, absolutely. We’re cleaning out the Sephora space, which enables us to have 20,000 of contiguous ground-floor space available for either a significant tenant or for a series of smaller tenants and we have lots of interest. As you know the retail market right now is under attack by the press and everybody is talking about the decline of bricks and mortar. We don’t see you on Broadway at all. We are – [Indiscernible] which is from your retailer just down the block is having sales records in this billing which is just about 200 yards away from ours. And we believe that the retail rent will return on Broadway and it will make a comeback in the next few months once some of the negative publicity on bricks and mortar is behind us. And we’re having dialogue with lots of valuable tenants about the combined 20,000 foot space at 555 Broadway.

Okay. I want to come back to Drew's comment on cap spending. It just feels like if I’ve got the numbers right. Roughly $40 million to spend on building this year, 30, 40-ish on technology which would suggest that kind of maintenance level is back at that 20 million, 25 million. Are those numbers about right, Maureen? Maureen O’Connell: So, the building in total is between 65 million and 70 million of which we spent 20 in fiscal 2017. So the remainder will be spent in fiscal 2018 and will be completed at that point. So there will be no future spending on the building. As far as the technology part of the spent, as we said this year we spent 30 million. We expect something comparable or a little bit higher next year, and that will continue until we complete the full Oracle implementation and we complete the complete CRM implementation and that's part of our Scholastic 2020 plan, because these will lead to benefits in the organization, make our -- streamline our distribution and as Dick said, leverage our school network. And so at this point I’m not in a position to give you capital year by year, obviously we’ll do that as we get to give guidance in those years but I think the capital that we are spending now is part of the 2020 plan because it will really allow us to get those benefits once it’s complete.

Okay. Thanks. One more, a little bit [ph] if I can. You discontinued the software distribution business in Australia which I think contributed to the lower international revenues in the quarter but your operating income was cut in half and I would have thought that eliminating a low margin business it might have atleast improved the profitability instead, you know your margins went from 4.3% in the quarter to 2.4 and just wondering if you could provide a little more color or insight into what transpired? Maureen O’Connell: So we did exit the software distribution business in Australia and that was about half of the revenue declines say $4 million of the revenue decline when you factor out FS. And that was a very low margin business. It did not impact profitability whatsoever, that’s why we exited the business. We did see an impact in profitability for the year within Asia. And so in Asia, it was another decline and we are obviously we are having challenges in the Philippines where they are in a volatile state and also in Thailand and has also led to higher bad debt in that region, so we’ve enhanced our collection efforts and put in more collectors to make sure that that is not a situation going into 2018, we are starting to see that improvement already. But the bad debt impact affected the profitability and then also we increased our reserves for obsolescence in Canada and the U.K. and that had an impact on profitability, part of that was as we launched new titles in the Harry Potter series like the paperback we won’t be selling the older titles and coloring books had an impact on obsolescence as well.

Okay, thanks for that. Thanks for the detail Maureen. Maureen O’Connell: You’re welcome.

Thank you. Ladies and gentlemen, this concludes our question and answer session for today. So now, it’s my pleasure to hand the conference back over to Mr. Richard Robinson Chairman, President and Chief Executive Officer for some closing comments and remarks.

Well thank you all for listening to our year end call today. But more important, the announcement of our 2020 plan, which we believe will add significant operating income over the next several years and we look forward to updating you on that plan and our progress over the next month. Thank you.

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.