Scholastic Corporation (SCHL) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Scholastic reports fiscal 2019 first quarter results. At this time, all participants are in listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Gil Dickoff, Senior Vice President, Treasurer and Head of Investor Relations. Sir, you may begin.

Thank you. Good morning Shannon. And thank you everybody on the call this morning. Welcome to Scholastic's first quarter 2019 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 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. Also 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 has also been posted on our Investor Relations website. We encourage you to review the disclaimers in our press release and investor presentation and to review the risk factors contained in our annual and quarterly reports filed with the SEC. And now, I would like to turn the call over to Dick Robinson.

Good morning everybody and thank you for joining our first quarter call. Scholastic begins the new fiscal year with positive indicators for year-over-year improvement in our core businesses, placing us firmly on track for achieving our fiscal 2019 operating results and goals. Our results this quarter reflect the strength of our trade publishing globally with sales up in a relatively flat market for children's and young adult books in the U.S. According to Publishers Weekly recently released annual rating based on 2017 sales, Scholastic is now the largest U.S.-owned book publisher, as well as the ninth largest publisher in the world. We also saw improved education revenues in the first quarter, despite a generally downmarket in that sector. And although we typically record a loss in the first quarter as U.S. schools are not in session over the summer, we delivered a smaller operating loss with margin improvement. In the quarter, we continued our companywide strategic technology advancements as well as the rollout of new print and digital core instruction products before the scheduled January 2019 launch of Scholastic literacy, our pre-K-12 balanced literacy core reading program and a major part of our education growth strategy. In a few moments, Ken Cleary will detail or quarterly financial results, EPS and EBITDA as well as the impact of the newly adopted revenue recognition guidelines in the quarter. But first I would like to walk you through some first quarter highlights. In children's book publishing and distribution, despite the Association of American Publishers reporting relatively flat revenue industrywide for the children's and young adult categories for 2018, Scholastic trade publishing was up year-over-year. Why? Scholastic books are loved by children and embraced by teachers and parents and in many cases, become part of our cultural fabric. We see evidence of this in the tremendous fan response to our ongoing celebration of the 20th anniversary of the U.S. release of Harry Potter and the Sorcerer's Stone, as well as the inclusion of both Harry Potter and The Hunger Games titles in the list of 100 most beloved books in America as selected by The Great American Read series currently airing on PBS. This also speaks to our significant strength as a publisher of series that dominate bestseller lists, creating loyal committed readers and continually reinvigorating backlist sales. In fact, we ended the first quarter with five of the top New York Times best-selling children's book series in the U.S. This story plays out globally as well, highlighting the strength of our local publishing strategy. The Bad Guys series by Aaron Blabey, now an international success, was originally developed in Australia. And I should also mention that The Wonky Donkey, a picture book originally published in New Zealand many years ago, recently rode a wave of viral social media buzz to become the number one book on Amazon across all genres. Our distribution center in Missouri is working overtime to fill orders for these popular titles and series and excitement there is great from our fulfillment staff. Speaking of best-selling series, after a historic initial print of three million copies, the latest book in Dav Pilkey's blockbuster Dog Man series flew to the top of the charts immediately after its release in late August. Dog Man: Lord of the Fleas is currently number one on the New York Times bestseller list, the BookScan's Top 100 list and is number one book on Amazon bestsellers in the children's comics and graphic novels category. Dog Man: Lord of the Fleas also launched as the best-selling book overall in Canada. The Dog Man series is just one example of the many engaging titles from graphics. Our graphic novel imprint, that is an important part of our mission to encourage young readers at all levels with a variety of stories and formats that help put them on the path to reading success. Found in 2005 as a first of its kind, graphics continues to publish books that win both popular and critical acclaim, including the trailblazing Bone series by Jeff Smith and Raina Telgemeier's Smile, Drama and Sisters to today's refresh of Ann M. Martin's beloved Baby-Sitters' Club series and last week Hey, Kiddo, a new YA graphic novel by Jarrett Krosoczka was named to the prestigious National Book Awards Longlist. Hey, Kiddo was the second Scholastic title on that Longlist this year along with The Journey of Little Charlie by Christopher Paul Curtis. Our publishing success expanded into licensed content, including impressive sales of our Klutz LEGO books plus titles and the popularity of both Pokemon Super Deluxe Essential Handbook and the fifth book in the Five Nights at Freddy's series. In our school-based distribution channels, which are typically quiet in the first quarter, our clubs business built higher levels of teacher sponsors year-over-year, which will provide momentum as we continue our efforts to increase book club events held and classroom participation during the important back-to-school season. Our fairs business benefited from the increase in revenue per fair and the redemption of Scholastic dollars from previously held fairs. In Scholastic education, revenues were up 12% this quarter, driven by summer literacy programs and guided reading offerings, as well as our classroom collections and leveled book rooms, which reflect the high quality of the trade books we uniquely can provide to schools. We were reminded of the critical need to integrate complete stories and real books into learning at our annual meeting of the Scholastic's National Advisory Council earlier this month, an esteemed group of thought leading K-12 educators and researchers. As one councilmember told us, access to great stories connects with great achievement. Providing high-quality content is integral to Scholastic literacy, our core pre-K to six reading program, which benefits from the trend in many schools to use balanced literacy programs to provide student motivation and skills mastery. Also in our education segment this past quarter, we realigned leadership and product oversight in the Scholastic magazines group to advance the objectives of our 2020 strategic plan. Our 30 classroom magazines with a combined circulation of 15 million readers as well as the teaching resources business and our digital subscription products such as Literacy Pro, W.O.R.D., Ooka Island, the Flix programs, Core Clicks and Scholastic Go now sit within a unified organizational structure. Notably the move to bring our digital products including our online magazine supplements under common leadership allows us to build upon our existing credibility as a trusted resource and technology. As noted in Ed Week's market brief recent, a survey of K-12 technology buyers listed Scholastic as one of the top three technology companies they would engage to help improve student achievement in their district ahead of all of our publishing competitors and behind only Apple and Google. In international, we saw improve results in the U.K. across all channels. In Asia, our direct sales improved in a number of countries. As we have said before about Asia, the rising middle class in the emerging markets is driving the need for English language learning products as English becomes the language of global education. We look to continue to leverage our very strong franchises, our high quality content and affordability in these markets such as China and Korea where our English language learning products are growing rapidly. On the technology transformation front, we are starting to see improvements in sales productivity and effectiveness through improved tools and customer analytics. We have just introduced our new salesforce.com customer relationship management system in both book fairs and Scholastic education. And our new customer master data management system is now integrated with the CRM solution. We have also successfully tested enhanced marketing approaches to reach school level decision-makers through our upgraded teacher store online using new digital tools to help support potential buyers through the research and purchase making process. Additionally, we are developing more targeted digital marketing in the club's channel, which has helped grow sponsorship levels while also helping to reduce our reliance on costly paper-based marketing. These technology advancements allow us to improve our customer information at the district school and teacher level, enabling cross-selling and greater access to customers. With that, I would like to pass the call along to Ken Cleary, CFO.

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. Beginning this quarter, we have adopted the new revenue recognition guidelines under ASC 606. Prior period's results have not been restated. The new revenue recognition standard now requires us to defer certain revenues associated mainly with our book fairs incentive program. It has also required us to recognize as a current period expense, certain previously capitalized direct response advertising costs related to our classroom magazines business. As we review the quarter sales and operating income, I will highlight the impact of these new standards on the period costs. Revenues were $218.4 million versus $189.2 million in the first quarter last year, an increase of 15%. The current quarter's revenue includes an incremental $12.5 million in sales that were recognized under the ASC 606 accounting adoption as the seasonal pattern of revenue recognition will change. Later quarterly periods will have net cumulative revenue decreases that should approximate the first quarter increase. Operating loss was $83.3 million versus $93.5 million last year. The net benefit of the accounting change on the quarter's results was an incremental $5.2 million that should also reverse in the later quarterly periods. We had $500,000 in one-time items for severance associated with our cost cutting initiatives in Q1. Last year's one-time items included $6.7 million in non-cash impairment charges related to our headquarters renovation, as well as $1.6 million in restructuring severance charges. Adjusted EBITDA showed a loss of $64.5 million as compared to a loss of $78.1 million last year, reflecting improvement in the company's operating results as noted, including the incremental $5.2 million associated with ASC 606, along with higher levels of depreciation on facilities and technology upgrades now in service. We expect adjusted EBITDA to improve at a greater rate than operating income as we continue to leverage our investments in technology and facilities. Accordingly, as previously stated, we believe that adjusted EBITDA is a meaningful measure of operating profitability and useful for measuring returns on capital investments over time as it is not distorted by unusual gains, losses, or other items. Turning to our segment results. Children's book publishing and distribution segment revenues were $93.3 million, an increase of 40%, driven mainly by core growth in trade, which was up 26% versus the prior year period. We also experienced favorable gains in book club sponsorship levels and higher year-over-year fair count revenue per fair. Although it is too early in new back-to-school period to drive any meaningful trends in our school-based distribution channels as well the seasonal impact of revenue recognition under the newly adopted ASC 606 guidelines since they there are more redemptions of Scholastic dollars incentives in the first quarter relative to fairs held. Operating loss improved by $13 million, compared to last year primarily reflecting leverage on the higher revenues and lower catalog cost in clubs. The adoption of the new ASC 606 standard resulted in the recognition of $12 million in revenue and $8.3 million in operating income in the quarter. This is not indicative of any new run rate as the incremental revenue associated with the accounting adoption and corresponding profits will reverse over the course of the year. Education revenues increased $5.3 million or 12% to $50.3 million, mainly driven by higher sales of classroom collections, summer literacy programs and teaching resources, as well as guided reading and leveled bookrooms, which benefited from a shift in customer buying patterns from the fourth quarter of fiscal 2018. Operating loss increased by $2.5 million, compared to last year, primarily reflecting the adoption of the new ASC 606 accounting guidelines, which drove a seasonal acceleration to direct product expense in classroom magazines of $3.2 million in the quarter as these costs are no longer deferred until later in the school year. Again, this should be viewed as a seasonal change that will reverse later in the fiscal year. Additionally, we experienced increased promotional spending and higher sales staff expense for core literacy instruction in advance of the new product launches later this calendar year. International's first quarter revenues were $74.8 million, down $2.6 million or 3%, with improved results in the U.K.'s education business, which also benefited from the small acquisition which closed last spring as well as in the U.K.'s trade, book fairs and export business units, increased trade publishing and book fairs in Canada and higher direct sales in Indonesia, India and Malaysia. These gains were more than offset by lower results in Australia's school channels and the adverse impact of $1.7 million in foreign exchange. Operating loss improved by $800,000, compared to last year primarily reflecting improved product mix. The adoption of the new ASC 606 standard resulted in a tiny recognition of $500,000 in revenue and a corresponding $100,000 of operating income in the quarter. First quarter corporate overhead expense was $20.4 million versus $19.3 million in the first quarter of 2018. The slightly higher overhead, excluding one-time items, in the current period is primarily due to higher depreciation expense for building and technology upgrades that are now in service. Net cash used in operating activities was $89 million in the current fiscal quarter compared to net cash used in operating activities of $92.4 million in the first quarter of fiscal 2018 and free cash used was $125.9 million in the current quarter, which was in line with our expectations compared to free cash use of $131 million a year ago. At quarter end, we had $269.8 million of cash and cash equivalents, compared to $311.9 million a year ago, reflecting the timing of $28.1 million of capital investment in technology, facilities and other upgrades, as well as higher levels of inventory in advance of the school selling season, including 20th anniversary editions of the original seven Harry Potter titles and a three million copy of first printing of Dav Pilkey's Dog Man: Lord of the Fleas, as planned. We are working on program modifications to our online ordering platforms to comply with the recent Supreme Court ruling that allows states to require out-of-state retailers to collect sales tax. Although we are still waiting for some states to clarify their rules, including the effective dates for collection, we are moving forward to ensure we continue to provide the best customer experience to online shoppers. Although the first quarter is a relatively quiet quarter, given our year-to-date results, we are reaffirming our fiscal 2019 outlook for revenues in the range of $1.65 billion to $1.7 billion and earnings per diluted share, excluding one-time items, in the range of $1.60 to $1.70. We are also affirming our target for adjusted EBITDA of $160 million to $170 million. Our capital investments in technology and facility upgrades remain on track with capital expenditures projected in the $70 million to $80 million range. Before I turn the call over to questions, I want to speak briefly about Hurricane Florence. Although the storm surge and heavy rainfall did overwhelm many areas in which we operate, our book fairs, warehouses and distribution centers in the Charlotte, Raleigh, Greensboro and Columbia remain fully operational and open for business. There were some schools that had to cancel scheduled fairs during the storm and its aftermath, we do not believe there will be a material effect on our fiscal year results. And with that, I will hand the call back to Gil for the Q&A session.

Thank you Ken. Shannon, we are ready to open the lines up for questions now.

[Operator Instructions]. Our first question comes from Drew Crum with Stifel. Your line is open.

Okay. Thanks. Hi guys. Good morning. A couple of questions on Dog Man. Just can we talk about how the performance from the most recent title compares to previous releases? And any impact you are seeing on the backlist for that series? And I guess as it relates to trade in the children's book category described as flattish, any concerns that once the sales for Dog Man slow, your business sees a severe deceleration? I guess just the question is, I am just trying to get a sense of how you are feeling about your pipeline for trade through the balance of fiscal 2019? Thank you.

Yes. Drew, I will ask Ellie to answer some questions specific to Dog Man. But the overall trend in children's books in our list is amazing. I mean we have just tons and tons of great titles and bestsellers in every category. The series are really driving a tremendous amount. Dog Man is part of it and Dog Man is unique this year and it's doing awfully well, but just overall it's still under 10% of our current revenues in trade even in this quarter, which was a big one for Dog Man. And in December, we will have yet another Dog Man, but this is not all about Dog Man. It's about the breadth and range of our trade titles, the momentum we have in the business, the tremendous support we are getting from various distribution people for our trades. I will ask Ellie to enhance that comment and especially in relationship to Dog Man.

Hi. Well, I will say that the Dog Man sales are up significantly from the last book and I think what we are seeing is tremendous momentum building as a series. Since we are able to maintain with Dav Pilkey publishing two books a year, we are seeing it just grow and grow. So the sales are up significantly and we have very high expectations with the book that is coming out in December, as Dick mentioned. In terms of what's the future coming up in children's, we have a really strong list still to be published this fall and going into the spring, with titles that were mentioned, new graphic memoir by Jarrett called Hey, Kiddo. We have more Harry Potter publishing coming up against the exhibition that's opening up in October. A box set of some of the illustrated editions and new publishing. So we have a lot coming up and the movie Fantastic Beast will be opening. We have the original screenplay by J. K. Rowling coming up in November. So we have a lot coming up and a big pipeline that we are excited to be publishing.

Okay. Great. Thank you. And then maybe shifting gears to the clubs business. I know it's only the fiscal first quarter, but you noted an uptick in club sponsorship. Just any commentary on leading indicators going into fiscal 2Q? And has your view on the business in any way changed for fiscal 2019 relative to the guidance or the update provided back in the summer?

Yes. I will ask Judy to talk a little bit about that. We think we are having a very good September and that's great, because that sets the stage for the rest of the year. But you know, those good signs don't mean that we are necessarily going to return to massive revenue increases, although that's very good right now.

Yes. Hi Drew.

Hi Judy.

You know we don't speak about percentages or anything. But it was off to a great start with teacher sponsors coming back online and a lot of enthusiasm in ordering. And I think what also is interesting is that we are having a lot more parents come. And order online and as our technology platform has become really quite sophisticated and up to speed and on terms of other e-commerce platforms, our parents can order online and that number is growing each year. And so that's a big foundational change in the business model that we were able to leverage throughout the year. So we are excited about that. We can do one-to-one marketing to parents and the parent enthusiasm ordering online then reflects up to the teachers in the classroom orders as well. So it's all a very nice new kind of energy in online ordering in our business model.

Okay. Thanks. I guess one last question from me. Just remind us what the timing is for Scholastic literacy? And I guess related to education, Ken, is there anyway to quantify the impact that you saw from the shift in customer buying patterns in the quarter from the fiscal fourth quarter to this quarter? Thanks.

So yes, clearly we saw a lot of the revenues did shift over into this year. Without giving complete numbers, because there are opportunities that come in our pipeline, I would say that most of the increase, you can attribute most of the increase to a shift over from last year.

Okay.

I think the introduction of Scholastic literacy in January will be a very significant event for Scholastic education and for the company. We are back in the core reading game, as you know, Drew, with that new program, which will be very strong in balanced literacy, but will also provide the skills necessary for kids to achieve higher marks on tests. So it's a very comprehensive core literacy, all the skills and with a lot of digital support that I think is really going to make a good impact on reading education.

And Dick, just one more question from me. Texas has got a very large reading adoption in calendar 2019. Are you guys in any way participating in that next year?

We are not. Scholastic literacy just was not -- we are focused on adoptions, but balanced literacy is everywhere and not just in the adoption states. But we will not participate from what you rightly say is a significant Texas adoption. We were working hard in Texas to get people interested in our program, but we won't dip into those particular revenue streams.

Okay. Very good. Thank you guys.

Thank you.

Thank you. [Operator Instructions]. And I am currently showing no further questions at this time. I would like to turn the call back over to Richard Robinson for closing remarks.

Thank you all for participating in our first quarter call. We will look forward to seeing you in December. We are looking forward to a good quarter and a good year. Thank you very much.

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.