Scholastic Corporation (SCHL) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2018 First Quarter Results Conference 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, this conference call may be recorded. I will now turn the conference over to Tammy Lemanowicz, Director of Treasury Operations. You may begin.

Thank you and good morning, everyone. Welcome to Scholastic's First Quarter 2018 Earnings Call. Joining me here today are Dick Robinson, our Chairman, President and Chief Executive Officer; and Maureen O'Connell, our Executive Vice President, Chief Administrative Officer and CFO. We have posted an investor presentation on our IR website at investor.scholastic.com, which we encourage you to download if you have not done so already. I would like to point out that certain statements made today will be forward-looking. These forward-looking statements by their nature are uncertain and may differ materially from actual results. In addition, we will be discussing some non-GAAP financial measures, as defined in Regulation G and the reconciliations of those measures to the most directly comparable GAAP measures can be found in the Company's earnings release filed this morning on the Form 8-K, which have also been posted to our Investor Relations website. We encourage you to review the disclaimers in our press release and investor presentations and to review the risk factors contained on our annual and quarterly reports filed with the SEC. Now, I would like to turn the call over to Dick Robinson.

Good morning and thank you for joining us today. As you know, schools are not operating in North America in the summer, so the first quarter is traditionally our lowest-revenue period of the year. Following very strong sales from the Harry Potter and the Cursed Child last year, we returned to a normalized summer this year, but nonetheless, we had excellent trade results. With the sensational performance of Dav Pilkey's Dog Man A Tale of Two Kitties, Scholastic has the top-selling book in North America for both children and adults in late August and early September. Dog Man has the makings of a breakthrough series which will grow revenues in the second quarter and throughout the year. In addition, Scholastic held four of the top six positions for children's series including Dog Man, Harry Potter, I Survived, and Pilkey's Captain Underpants, and the children's bestseller list included many other Scholastic titles such as Aaron Blabey's The Bad Guys, Allan Gratz's The Refugee, and Five Nights at Freddy's. Scholastic had the top two selling books in the UK for children: The Ugly Five, Zog and The Flying Doctors by Julia Donaldson and Axel Scheffler, and the topselling book in Australia, WeirDo Really Weird! by Anh Do, as well as the bestseller in India, Geronimo Stilton. We're looking forward to the fourth title of the Dog Man series: Dog Man and Cat Kid, which will hit bookstore shelves in January and like all our Dog Man titles should also sell strongly in both trade and club and peer channels. Once again, Scholastic has shown that it can consistently find and nurture the bestselling content across the world for children's book from series, which become top sellers for generations. From The Baby-Sitters Club in the 1980s, to Goosebumps in the mid-1990s and Harry Potter since 1998, The Hunger Games since 2008 and Dav Pilkey's Captain Underpants over a 20-year period, and now Dav's Dog Man series, Scholastic builds powerful franchises, which spanned generation's popularity around the world. This is really due to the interplay between our publishing creativity and our ability to reach children through our direct channels of clubs and fairs, ensuring that we always know the books kids want to read and buy. This is the strength of Scholastic, which sets us apart from other publishers. We [indiscernible] visibility in content creation to our profitable Classroom Magazine business through which millions of children from Pre-K to high school read our print and digital magazines in classrooms each week and under the direction of their teachers learn to acquire reading skills and understanding of contemporary issues which affect their world. We're building a profitable education segment supported by guided reading, for which the use of our authentic full-length books drives the skills and motivation that allow the children to learn Pre-K to 6 core literacy principles. Content and creativity drives the Scholastic mission to change children's lives through reading and learning. To support that mission, we also need to focus on profitability by linking our technology investments to improve marketing, leading to the growth in sales and to improve business processes which will reduce operating costs. The Scholastic 2020 plan introduced in August is designed to substantially improve revenue growth and operating income over a three-year period leading up to our 100th anniversary in October 2020. Scholastic 2020 is a performance management structure that will leverage our ongoing investments in technology to improve sales and marketing efficiency through better customer data and to provide better information in our manufacturing inventory, management, supply chain and transportation areas of the business, using this information to drive process improvements and reduce cost. We have already taken steps to identify customer information that will lead to a successful implementation of the new CRM system in June 2018 to drive improvements in marketing across our school-based businesses. We're focusing on reducing cost of fulfillment with the introduction of new Oracle transportation management technology this year as well as more streamlined financial information through Oracle ERP beginning in January of 2018. We'll also realize technology cost savings as we consolidate systems into one enterprise wide architecture which allows for a more flexible technology staffing model. By strengthening our internal systems, we will improve business processes, reduce cost of distribution while marketing our club's fair and education programs more effectively in the U.S. and across the globe. Scholastic 2020 will also help us achieve our growth strategies for each business. In children's book publishing and distribution, we have already outlined the importance of the surge in core trade publishing operation, which should grow significantly this year except for the comparison to last year's success of Harry Potter and the Cursed Child. In addition to the titles previously mentioned including Dog Man, we will also be releasing two new illustrated editions of original Harry Potter titles, Prisoner of Azkaban in October, and Fantastic Beasts and Where to Find Them in November, as well as Harry Potter: A Journey Through a History of Magic, the companion book to the new British library exhibition leading up to the 20th anniversary of Harry Potter in the U.S. next year. We're also implementing a well=-honed book fair strategy in this important back-to-school selling season. As we communicated in July, we're focusing on growing revenue per fair in our most profitable fair segments by right-sizing the fairs and by better-matching resources to each school's demographics and needs. Our new CRM platform and new dashboards for the book fair’s sales teams will help these efforts. In addition, we are upgrading point-of-sale systems to simplify transactions as well as implementing a new merchandising strategy that makes it easier for parents and kids to find the best books curated specially for their age group. We believe this approach will lead to a higher level of participation and more revenue for transaction and fairs. In clubs, we're focused on sponsor retention and leaner cost structure, as well as a return to the multi-grade book club offers that have been effective in the past. We're also building our education business through new offerings like Scholastic EDGE, a major component of our guided readings program, new grammar writing and usage programs, and foundational phonics programs all in the pipeline are soon to be released. These new programs will grow market share beyond supplemental materials for Scholastic and include a complete Pre-K through Grade 6 core literacy program of instruction. We know there's a very attractive market for this solution given teachers' growing preference to build their own customized curriculums instead of relying on basic reading textbook. We're also bolstering our sales force, making targeted hires and sales professionals with experience in solution selling as well as adding editorial staff to expand our program offering. In international, Scholastic Asia is an important growth driver, given the dedication to English language learning, the rising middle class, and Scholastic’s strong brand recognition throughout the region. This includes continued growth in trade and direct sales as well as in education. We're also implementing a shared-services operation for Asia business units with a single financial and operational management system to leverage scale and minimize operating costs. In short, Scholastic expects strong underlying growth from trade from our club and fair channels and more focused strategy to expand education to take advantage of the changing market opportunity for core Pre-K to 6 literacy curriculum. We're expanding guided reading into a complete program of reading in the language arts skill, our classroom magazines will continue to provide the nonfiction content that teachers are looking for both in print and digital form. On top of that, the Scholastic 2020 program will help us manage a clear process to achieve marketing improvements in the reduction of distribution cost. With that, Maureen [ph] quarter results in more detail. Maureen?

Thank you, Dick, and good morning. This morning, I will refer to our adjusted results from continuing operations for the quarter excluding one-time items unless otherwise indicated. Revenues were $189.2 million versus $282.7 million in the first quarter last year, which benefited from the publication of Harry Potter and the Cursed Child Part 1 and 2, the bestselling book of 2016 across all genres. Operating loss was $93.5 million versus $62.5 million last year and the loss per share was $1.67 versus $1.15 last year. As you know, we typically report a loss in the first quarter. We had $8.3 million in non-recurring items in Q1 including $6.7 million in non-cash charges related to our headquarters renovation, as well as $1.6 million in restructuring severance charges. Turning to segment results. Children's book publishing and distribution segment revenues were $66.8 million. Trade results were unplanned. We had an anticipated a return to more normal levels following the extraordinary Harry Potter sales last year and we were very pleased with the performance of our non-Harry Potter core published this quarter. At the end of the quarter, we had four of the top six books in book stand's juvenile top 100 including Dog Man, A Tale of Two Kitties at number 1; I Survived the American Revolution, 1776; The Bad Guys and the Attack of the Zittens; and the new paperback edition of Harry Potter and the Cursed Child's Part 1 and 2. As children continue to embrace the new works of Dav Pilkey, we also saw a strong performance of both [indiscernible] and backlist titles in his Captain Underpants and Dog Man series in the quarter. And we expect continued strength in the back-to-school selling season and throughout the year. As Dick described, we are implementing our strategy to return to multi-grade book club offers and to grow revenue for fair in our most profitable segments by using deep analytics to better-match revenue opportunities to each school's demographics. Education segment revenues were $45 million compared to $55.2 million last year. The year-on-year sales decrease in education was related to the timing of orders. Our expectation for the year in education remain intact, which much of the sales weighed towards the fourth quarter than in-year. We are executing our strategy to grow revenues by extending our Pre-K to 6 balanced literacy programs for school district and capturing market share for our core literacy curriculum which includes guided and level-reading programs, classroom book collections and professional services. As Dick mentioned, we are strengthening our sales and marketing teams to bring in more professionals with experience in selling core literacy instructions - a number of whom have already been hired. In addition, we continue to expect year-over-year growth in core curriculum enhance by a number of new products including Scholastic EDGE, an expansion of our guided reading the lines that provide accessible compelling age-appropriate level fiction and non-fiction titles of various genres and text types. We also expect strong performance from version four [ph], our summer lit camps which grew very quickly in 2017 and a new writing grammar and usage programs scheduled for release later this year. International segment revenues were $77.4 million versus $89.7 million last year with the decrease largely driven by last year's Harry Potter sales in Canada and export. We are confident in our expectation for the year driven by strong trade including two popular September releases in the UK - The Ugly Five by Julia Donaldson which is currently the bestselling hardcover picture book in the UK, and Beyond the Sky: You and the Universe, the first children's book by Dara O'Briain, UK and Ireland's popular beloved comedian. We also have four of the top 10 titles to the first half of 2017 in Australia according to BookScan including WeirDo Really Weird by Anh Do, which took the number one spot. We remain focused on growing our international business by building the presence of key products and leveraging our position as a global partner with schools as we continue to support research-based and instructional literacy and mathematics program. We are seeing traction for our efforts to improve our direct sales performance in Malaysia and we are continuing to implement measures to bring similar results to the Philippines and Thailand. Corporate overhead expenses were $19.3 million versus $26.1 million last year on lower employee-related expenses. Net cash used in operating activities was $92.4 million versus $105.5 million last year, and free cash used was $131 million versus $122.4 million last year, both in-line with expectations. We repurchased $4.7 million of common stock during the quarter and a quarter-end cash and cash equivalent exceeded debt by $299.9 million. In the first quarter, we had $32.7 million in capital including $20.7 million in capital related to our headquarters' renovation which remain on track to be completed by the end of the calendar year. We are also experiencing benefits from the more collaborative work environment and continue to expect our state-of-the-art headquarters to be an attractive feature for recruiting. There was also $10 million in capital used in our strategic technology transformation program. Now turning to the outlook. We are reaffirming fiscal 2018 outlook of $1.65 billion to $1.7 billion in revenues and earnings per diluted share in the range of $1.20 to $1.30 excluding one-time item and a non-cash charge resulting from the previously announced termination of our domestic defined benefit plan that we expect to take later in the fiscal 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 pre-publication and production spending of $30 million to $40 million, compared to $26.9 million in fiscal 2017. After fiscal 2018, we continue to expect operating income growth, leading up to Scholastic's 100th anniversary in October 2020. As Dick mentioned at our annual shareholders' meeting yesterday, our stretch target is for $2 billion sales in fiscal 2021, our anniversary year; leveraging our creative content, our unique market position, strategic technology investments and planning process structure embedded in our Scholastic 2020 plan. We are excited for and energized by the opportunities ahead and believe we are very well-positioned to capture market share as we also improve profitability through the organization. Before I turn the call over for your questions, I want to speak about hurricanes Harvey and Irma, which had a devastating impact on many of our communities. Our offices withstood the storm well and our six Texas distribution centers are fully operational and delivering fairs to schools that are able to receive them; and our branches in Florida are now up and running as well. We are assessing the potential impacts of school closings on our business and currently estimate approximately $5 million of book fair sales have been impacted or roughly 1% of the annual book fair business, and approximately $1 million in book club sales. We are working to reschedule fairs where possible and supporting affected area schools to ensure that they have the resources they need to get back to instruction as quickly as possible as we also help them evaluate and fulfill their longer term needs. With that, Operator, we are ready to open the line for questions.

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

Okay, thanks. Good morning, everyone. Maureen, just a follow up on your last comment on the hurricanes, are you saying that it's in your guidance or that’s the potential impact, or you could potentially get that back later in the fiscal year? I just want to understand how you're thinking about that $6 million impact you referenced . Maureen O’Connell: Right now we are trying to reschedule fairs, but in many of the Texas location, on Florida locations, the schools are still not open. At this point, that is our best estimate. We're trying to mitigate that as best as we can, but I would say that's a fair estimate at the moment.

Got it. Okay. And then on the education business, any way you can quantify the impact of this timing issue? Would you expect to pick some of that up in the fiscal second quarter? I think you made a comment that you expect to get some of it in the fiscal fourth quarter if I understood correctly. If that's accurate, are we seeing an ongoing shift to where this business is more back-end weighted more fiscal fourth quarter or is this year just unique and different and we would expect a return to more normalized performance going forward? Maureen O’Connell: Our business is fourth quarter-loaded. It is much greater in the month of May than any other month during the year and we continually make improvements in operations so that we can deliver that big peak in the month of May. So we do expect this year most of the growth will come in the fourth quarter.

Okay. One last question and I'll jump back into the queue. As it relates to the Dav Pilkey title, it released very late in the quarter, just to help us understand the order of magnitude, the contribution that you get in the second quarter relative to the first quarter?

Well, the effect of Dog Man, the new title, the third one in the series, it was a little bit – at the end as you pointed out, it was shipped on August 29th and we recorded the initial trade sales distribution at that time. The popularity of that title was so strong and the ramp up for this series was so great that by far the largest part of this is going to be in the second quarter.

Got it.

And the subsequent quarter. Typically as we get into January, Drew when the fourth one comes out, this series is having a terrific impact on children and we expect it to do very well for us in this fiscal year.

Great. Okay. Very good. Thanks, guys. Maureen O’Connell: Thank you.

Thank you. And I'm showing no further questions at this time. I'd like to hand the call back over to Dick Robinson for any closing remarks.

Thank you, all, for joining us. For those who are not able to be here because of the religious holiday, we will welcome you back at our next presentation in December. Thank you for your support to Scholastic.

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