Scholastic Corporation (SCHL) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Q4 and Fiscal 2018 Results and Fiscal 2019 Outlook. [Operator Instructions] And as a reminder, 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, Treasurer and Head of Investor Relations. Sir, you may begin.

Thanks you very much Brian and good morning everyone. Welcome to Scholastic's fourth quarter 2018 earnings call. With me here today are Dick Robinson, our Chairman, President and Chief Executive Officer; and Ken Cleary, the company's Chief Financial Officer. We have posted an investor presentation on our IR website at investor.scholastic.com, which we encourage you to download if you have not already done so. I'd 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 Form 8-K, which is also available on our Investor Relations website. We encourage you to review the disclaimers in our press release and in the investor presentation, and to review the risk factors contained in our annual and quarterly reports filed with the SEC. And now I'd like to turn the call over to Dick Robinson.

Good morning, everybody. And thank you for joining us today. Last year at this time we shared our plan for driving long-term profitability through our multi-year Scholastic 2020 plan, designed to substantially increase operating income in the next three years. We'll discuss how we're carrying out this plan in just a moment. But turning to fiscal 2018 results we're pleased to have delivered on our guidance for earnings per share as adjusted and free cash used for the year. We began fiscal 2019 with strong strategies for our core Children's Book education in international businesses, a lower tax rate and continued optimism about the dynamic leasing environment for our SoHo retail space. Given the longer range and strategic outlook of Scholastic 2020, we're taking a new approach to guidance by introducing an EBITDA target. We believe that this non-GAAP measurement will be most useful for comparing our operating performance and value creation from period-to-period, Ken Cleary will discuss this at our outlook later in the call. Recognizing the fiscal 2018 was a transition year between the combined impact of Harry Potter and the Cursed Child in 2017, and Scholastic 2020 related investments which take effect in 2019. Here are some highlights of the recently completed fiscal year. Revenues were $1.63 billion. The year-over-year decline was expected as fiscal 2017 sales were bolstered by the performance of best selling Harry Potter and the Cursed Child, as well as J.K. Rowling’s original screenplay for the film Fantastic Beasts and Where to Find Them. Excluding those titles the fiscal 2018 trade sales were actually higher with top-selling titles across all the genres. On a GAAP basis loss per diluted share from continuing operations was $0.14, compared to earnings per share from continuing operations of $1.48 in fiscal 2017. Excluding onetime items earnings per diluted share from continuing operations were $1.43 towards the high-end of our previously revised guidance range versus $1.83 in fiscal 2017. Free cash flow used was $16.1 million roughly at the midpoint of the guidance for the year. We expect to return to modest positive free cash flow generation in fiscal 2019 on lower facilities related investments. Capital expenditures totaled $121.5 million for the year, and new product development spending was $36.1 million. CapEx included a substantial upgrade of our New York headquarters building, and we are now focused on completing our high value retail space for occupancy in fiscal 2019. We expect Cap expenditures will be in the range of $75 million in fiscal 2019. Share repurchases for the year totaled $27 million. Turning now to our Scholastic 2020 update, since beginning our technology transformation we have built out a new enterprise architecture lowering our e-commerce and web maintenance costs and realizing related labor savings. Here are some highlights. We've retired over half of our legacy systems, 95% of our customer facing applications have been migrated to the cloud. Our e-commerce sites are all now powered by a new cloud-based solution benefiting from reduced cost to operate and improve site conversion, higher quality traffic coming from our content sites to the online Scholastic stores. We've implemented salesforce.com for education and fairs as part of the first phase of our CRM applications. In book fairs we're able to identify higher value fair opportunities through CRM and analytics, and use new applications such as eWallet to drive revenue. We also see improved customer information from our new POS system. In education we have now improved data-guided selling for field and inside sales. Across education and book fairs we've introduced web-based business intelligent dashboards that highlight leaves and allow managers and sales people to prioritize their sales opportunities. In operations, we're producing better information leading to reduce fulfillment and transportation costs. We're also seeing operating efficiencies through labor optimization and improvements in procurement, storage, fulfillment and distribution, reduced inventory carrying costs through increased returns and lower cost of product through improved vendor diligence and negotiation. We expect these Scholastic 2020 initiatives to drive $10 million in savings in the year ahead. It is also important to note that this management framework has served to refocus the Company's energies on sustainable profitability through margin expansion as a measure of deficiency ahead of revenue growth. Now let me briefly review our business unit results for the year and provide some perspective on key drivers for each of our segments in fiscal 2019. Scholastic remains the largest global publisher and distributor of children's books. While we already have a very strong position in this market, we continue to grow. In fiscal 2018 our – Children's Book Publishing and Distribution businesses showed resilience despite a revenue drop of 9%, compared to the year ago period in line with our expectations given the strong performance from the fiscal 2017’s best selling Harry Potter and the Cursed Child. In trade, we continue to be the leader with exciting titles and growing core series like Dav Pilkey's Dog Man, the blockbuster follow up series, The Captain Underpants. The first four Dog Man books have topped the bestseller charts and we enthusiastically await the fifth installment of Dog Man: Lord of the Fleas. It’s scheduled for release next month. Looking ahead we continue to create the best selling content in children's books, which are used by trade clubs, fairs and international. This past week we continue to hold six of the top 10 New York Times children's series, the highest revenue category. Despite a somewhat flat U.S. children's book market, we continue to grow market share driving revenue across all age groups and genres. In fiscal 2019 the marketing program for the 20th anniversary of the U.S. publication of Harry Potter proclaims the continued relevance of this amazing series. This includes the release of anniversary editions of the original titles with new cover artwork by Brian Selznick, Harry Potter: A History of Magic; the companion addition to the widely anticipated exhibit at the New-York Historical Society this fall, and Fantastic Beasts: The Crimes of Grindelwald, an original screenplay by J. K. Rowling to accompany the film's release in November. Top selling author Dav Pilkey will also be the subject of a yearlong campaign for new Dog Man titles, as well as new color editions and audio versions from his much loved Captain Underpants series. New releases include titles and bestselling series like Amulet, Bad Guys, Wings of Fire, and I Survived, along with Impostors, an exciting new book by New York Times’ bestselling author, Scott Westerfeld. In our book club distribution channel we expect to grow revenues modestly by providing more titles in the early grades, as well as the increasing student incentives to drive higher participation. Improved information, analytics, and new e-commerce capability should lead to lower marketing and operating cost, improving margin. In book fairs we expect to continue to target growth in the higher value fair segments through increased customer segmentation and differentiated merchandising while leveraging our investment in the new POS system for improved data and lower cost. Education revenues for 2018 were down 5% for the year. This is in part due to a shift in customer buying patterns for leveled book room and guided reading products, partially offset by growth from our newly released Scholastic EDGE program and gains in our professional learning and classroom magazine offerings. As we have discussed, expansion into core curriculum reading is a major part of our growth strategy for education. In the upcoming school year, we plan to launch Scholastic Literacy, a complete, balanced literacy program in print and digital to meet the needs of pre-K to six students. Scholastic Literacy is a curriculum product that positions us as an important player in the $2 billion reading materials market. Scholastic already has a significant market share in supplementary, and core instruction is a new opportunity. The significant size of this market is the primary reason for the investment we're making in expanding our sales force and enhancing our training programs as we enter a busy selling period starting in a few weeks. We will capitalize on this new growth opportunity as we expand from supplementary into core in both strategy and execution responding to the growing need for balanced literacy materials. We've also launched several new digital programs both as components within Scholastic Literacy and standalone subscription products. As we've mentioned on earlier calls there is great anticipation for this fall’s introduction of Literacy Pro, a reading motivation and assessment program, as well as W.O.R.D., a complete vocabulary program for grades K to five, all in digital subscription form. We also have a new offering for grades pre-K to two, in Ooka Island, an adaptive game-based and a foundational phonics skills program to help students become confident early readers. This set of digital products was incredibly well received this past month at ISTE, the leading educational technology conference. International had a solid year with a robust list of new trade titles in Australia, Canada, the UK and Asia, partially offsetting a 2% decline in revenue as the result of strong sales of Harry Potter and the Cursed Child in the Canadian and export channels in fiscal 2017. We will leverage U.S. technology investments to improve profitability in our major markets and to enable more rapid growth in Asia. We will also continue to make focused investments in education and trade across all the international markets. Specifically in Canada, we expect trade growth to be driven by new Harry Potter publishing and book club performance improvement as a result of new e-commerce capabilities. In the UK, we expect continued strength in trade publishing and fairs. And finally, in Asia, we expect meaningful top line growth driven by new educational publishing, our franchise schools in China and in direct to the consumer sales in Asia, which should benefit from our revised marketing model and the increasing demand for English language instruction among the growing middle class. With that I'd like to pass the call to Ken Cleary.

Thank you, Dick and good morning. On this call I will refer to our adjusted results from continuing operations for the year, excluding onetime items unless or otherwise indicated. Revenues were $1.63 billion, versus $1.74 billion last year. Operating income was $75 million, compared to $109.4 million in fiscal 2017. Revenues were slightly below our guidance range, mainly as a result of a shortfall in education orders in Q4, at least a portion of which are being picked up in a new fiscal year. Non-recurring items reflected in our pretax results for the fiscal year totaled $76.7 million and included $57.3 million in non-cash charge below the operating line in connection with the previously reported termination of our domestic cash balance defined benefit retirement plan, a $11.2 million in non-cash impairment charges associated with the renovation of the New York City headquarters building and one time severance and stock compensation charges of $8.1 million, as well certain other non-recurring items as shown in the accompanying financial tables. The $5 million of these onetime charges were recorded in the fiscal fourth quarter. Non-recurring items reflected in the prior year pretax results totaled $20.2 million, of which $11.4 million were recorded in the fourth quarter of fiscal 2017. There was also a small reversal of the estimated non-cash charge in the third quarter related to the re-measurement of the Company's U.S. deferred tax balance in connection with the passage of the Tax Cuts and Jobs Act of 2017. For the year the total one time charge to the tax reform was $5.7 million or $0.16 per share. In Children's Book Publishing and Distribution, segment revenues for the fiscal year decreased $90.6 million, or 9% to $961.5 million, as compared to the prior year, driven by 27% sales decline in trade as predicted, given the prior year’s outstanding success of Harry Potter and the Cursed Child. Operating income for the year was $105.8 million, a decrease of $37.3 million or 26% as compared to the prior year, which include Harry Potter and the Cursed Child. In the fourth quarter, segment sales were up $700,000 versus the fourth quarter of 2017 on stronger consolidated trade results. Segment operating income in the fourth quarter declined $1.4 million or 3% as compared to the prior year period, mainly the result of higher costs associated with the rollout of a new point-of-sale system in book fairs. In trade, the lower Harry Potter revenues were partially offset by the performance of a strong core publishing list, including titles from Dav Pilkey's Dog Man and Captain Underpants series, as well as higher sales of the company's clubs premium books plus activity products. In clubs and fairs, higher sales in the company's books fairs operations are more than offset by lower sales in the club's channel. In education, for the fiscal year, segment revenue was $297.3 million, compared to $312.7 million a year ago, partially as a result of a change in school buying patterns impacting our order pipeline opportunities for leveled book room and guided reading products. Segment operating income was $34.1 million in fiscal 2018, down from $17.7 million from the prior fiscal year. As a result of sales shift and increased investment to support our push into comprehensive literacy, core curriculum market to compete with basal textbooks and the related expansion of our sales force with expertise in selling complete literacy curriculum programs as discussed in previous quarters. Segment revenue in the fourth quarter was $119.7 million, a decrease of $6.6 million or 5% versus the prior period revenue of $126.3 million. Segment operating income for the quarter was $43 million, a slight decrease versus the $44 million recorded in the fourth quarter of fiscal 2017. In International, segment revenues for the fiscal year fell $7.2 million or 2%, to $369.6 million, compared to $376.8 million in the prior year, as a result of sales of Harry Potter and the Cursed Child in the Canadian and export channels in the prior year period, partially offset by a strong list of new trade titles in Australia, Canada, the United Kingdom and Asia. This includes The Ugly Five by Julia Donaldson and Axel Scheffler and new titles in the Liz Pichon Tom Gates series in the UK, as well as Dav Pilkey's Dog Man in Canada. Segment operating income in fiscal 2018 was down $2.6 million or 12% from the prior year. Sales in the fourth quarter rose $2.5 million or 3% to $93 million, versus the prior year period, driven by robust performance in the UK and in Asia. International finished strong with operating income in the fourth quarter of $5.9 million, up $2.7 million or 84% compared to the fourth quarter of 2017. Corporate overhead for the fiscal year was $83.4 million, which compared favorably with the $106.6 million recorded in the prior year. The lower overhead expense in the current fiscal year was primarily due to lower salary-related and incentive compensation, as well as better cost management of the Company's shared service distribution center in Jefferson City, Missouri. Corporate overhead for the fourth quarter was $22.8 million, a slight decrease versus a $23.4 million recorded in the fourth quarter of fiscal 2017. Net cash provided by operating activities was $141.5 million, compared to $141.4 million last year. And free cash flow with the net use of $16.1 million, roughly the midpoint of our guidance range versus free cash flow of $48.8 million last year. Capital expenditure, the primary driver of free cash use in the year, was $121.5 million, higher than our guidance range of $90 million to $100 million due to work performed on the headquarters buildings, well the actual cash will go out the door in fiscal 2019. We expect to return to modest free cash generation in fiscal 2019, as cash usage will fall from peak levels after the completion of our headquarters renovation. Although cash will still be impacted by the timing of payments for work performed and expense accrued but not paid in 2018. As we will soon discuss, we will no longer be providing guidance for free cash flow, but we will discuss EBITDA targets instead. We issued $21.1 million in dividends and repurchased $27.3 million of our common stock during the year. Our remaining buyback authorization at fiscal year-end was $61.4 million. Under this program, which we’ll continue to be funded with available cash, we may repurchase our shares from time-to-time as conditions allow. At fiscal year-end our net cash position was $384 million, compared to $437.9 million a year ago. The lower net cash balance is primarily due to higher levels of spending as previously discussed related to company’s capital programs. Before discussing our outlook I'd like to comment briefly on the Supreme Court's recent ruling that allows states to require out-of-state retails, including those that are operated remotely online to collect sales tax. We are assessing the impact of the ruling and waiting for states to clarify their rules, including the annual revenue thresholds that require tax collection in the dates by which retailers must be in compliance. In the meantime we are reviewing our own tax collection policies, including any required program modifications to our online ordering platforms to prepare for coming changes. Now turning to outlook, as Dick mentioned earlier, we believe that our longer term revenue target, and annual EBITDA targets are better suited to level set expectations as we work towards fiscal 2021, when the Scholastic 2020 plan comes to fruition. We project top line growth in select businesses, enabled by new publishing in education and trade combined with more targeted revenue growth in other businesses as we utilize our transformative technology investments to launch products in a more efficient manner, expand our existing customer relationships and target new customers more effectively. We have set a fiscal 2021 revenue target of $1.8 billion, up from $1.63 billion in fiscal 2018. We expect moderate revenue growth in fiscal 2019, with an indicative of $1.65 billion to $1.7 billion in revenues with some acceleration in the outer years. We believe that the greatest impact from our three-year Scholastic 2020 plan initiatives will be reflected in future cash flows as measured by earnings before interest, taxes, depreciation and amortization, a non-GAAP measured that will be reconciled to net income in our supplemental financial tables. And I have set an EBITDA target for fiscal 2019 of $116 million to $170 million, up from $140.1 million excluding one-time items in fiscal 2018. As Dick has said, we believe that this metric is more useful as a measurement of performance of value creation since the minimize of the noise created by fluctuation and interest rates, effective tax rates, as well as the depreciation and amortization of non-cash charges. We expect fiscal 2019 earnings per diluted share in the range of $1.60 to $1.70, up from EPS excluding onetime items of $1.43 in 2018, reflecting the projected increase in operating income, as well as a reduction in the Company's effective tax rate as a result of a full year’s benefit of recent corporate tax reforms. Over the next three years we expect to continue to make higher than normal levels of capital investment, technology innovation programs in conjunction with our Scholastic 2020 plan, which is expected to impact both cash and earnings in fiscal 2019, as a portion of these investments will be expensed and impact our operating margins. Higher levels of depreciation from the building improvements and technology platforms now in service will partially offset the additional capital investment. This outlook includes capital expenditures of $70 million to $80 million in fiscal 2019, compared to $121.5 million in fiscal 2018. During this three-year period our overall goal for growing operating income reflects our expectations for targeted revenue growth and lower operating costs. We’re fully committed to delivering an improvement in operating margin using new Scholastic 2020 work streams to leverage technology, to improve market efficiency, lower cost to help offset inflationary pressures across key cost of good expense categories and improve business processes. We expect to report progress against key milestones relative to Scholastic 2020 initiatives in future periods. With that I'll hand the call back to Gil go for the Q&A session.

Thanks Ken. Brian we are now ready to open the lines for questions.

Thank you, sir. [Operator Instructions] And our first question will come from the line of Drew Crum with Stifel. Your line is now open.

Okay thanks. Good morning everyone. I want to start with the performance in fiscal fourth quarter for the Education segment. Could you address the change in buying patterns that you saw because if I recall, that was the explanation given for the performance in the fiscal first quarter of 2018? Your sales were down 19% that period, down 5% this quarter. I guess I want to understand what the shift is? Should we expect fiscal 1Q to be the primary selling period for your business or is it still the fiscal fourth quarter? Thanks.

Sure, Drew. Good morning. So, this is Ken Cleary.

Hi Ken.

So yes in the current year – we do have sales shifting out from Q4 into Q1 of FY’19. We didn't experience that in the last year. It's going to be a continuing pattern as we go forward, as our customers are really looking to procure products. The schools are looking to procure product more in the summer timeframe, when schools aren't in session. It's going to continue, that pattern will continue even more or so as we move into core curriculum more heavily. So it is impacting us this year, it will probably impact us next year as well. And that will be an ongoing pattern. It does help us in certain ways and that it benefits our selling cycle and also benefits our distribution cycle. So there are some benefits to us, but it does shift out the revenues from one period to the next.

Okay, got it. And then just a point of clarification on the Scholastic 2020 guidance, you're suggesting that EBITDA will grow three times the rate of revenue. What period does that over, is that fiscal 2018 through fiscal 2020, is that fiscal 2020? And what is the rate of growth that you're projecting for revenue? It looks like it’s mid-single digits. I just want to clarify that.

That's correct. So it's through 2021.

Okay.

Okay.

Okay. And then what is – I'm looking at the midpoint of the guidance, the revenue target for fiscal 2021 would imply an acceleration relative to what you saw in fiscal 2018, which obviously had the Harry Potter comp, but even fiscal 2019 looks like kind of 3%-ish type growth at the midpoint. So what do you anticipate driving that acceleration?

I think mainly it's going to be improvements in 2020 marketing efficiencies Drew. We're looking 2020 as a primarily lowering our cost base and improving our operating income through business process improvements, and backend fulfillment costs, and operations decreases. However, with the CRM platforms we will get better information about our customers and then particularly clubs fairs and education, we should be able to increase revenues as we get a growing command of the marketing strength of our CRM capabilities. It's still not a dramatic revenue increase as we're focusing more on improving our operating income, than on the revenue gains.

Okay. And then just last question from me, I know you're moving away from giving the free cash flow guidance, does that suggests there's an exchange in the free cash flow profile for the business? And kind of related to that, I look at the CapEx guidance that would imply about a $47 million swing at the midpoint year-to-year. You're projecting EBITDA to grow by $25 million at midpoint. I guess the offset is the timing of accrued expenses. Are you willing to give any range or numbers on that item?

So just I will give a color on why the move to EBITDA. And you can see it in this year’s results as volatility based upon our cash spend, particularly when we’re in the investment period like we are now. So we feel that really we're making investments today to drive cash flows tomorrow. And EBITDA will reflect that as we move forward.

Thanks guys.

Thank you.

Thank you. [Operator Instructions] One moment for any additional or follow-up questions.

Thank you all for attending our year-end and projected 2019 conference call. We're looking forward to a strong fiscal year. We thank you for your support. And we'll be talking to you again in September.

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