Scholastic Corporation (SCHL) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Scholastic Reports Fiscal 2019 Second Quarter Results Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] And as a reminder, today’s conference call is being recorded. I’d now like to turn the conference over to Gil Dickoff, Senior Vice President, Treasurer and Head of Investor Relations. Please go ahead.

Thank you so much Candice. And good morning everyone. Welcome to Scholastic's second 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. 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 and thank you for joining our call during this busy holiday season.. Scholastic’s core businesses remained strong during our second quarter, putting us in position to achieve our operating objectives for the fiscal year. This is in thanks - thanks in no small part to our ability to serve the needs of roughly 90% of U.S. schools during the back to school period, which spans our first two quarters, and our continued strength in trade publishing even as the company continues to experience rising product and fulfillment costs similar to other businesses. Revenues up 4% year-to-date before the impact of the new revenue recognition guidelines and net income of $71.6 million versus $57.1 million last year that was partly the result of a lower effective tax rate. Later in the call, Ken will detail our quarterly financial results EPS and EBITDA, as well as the impact of the newly adopted revenue recognition procedures. But first I'd like to share highlights from our second quarter. This fall, reading and children's books, many from Scholastic took center stage in cultural moments that played out across the media landscape underscoring the importance of our role both as a book publisher and trusted partner to educators. I’ll walk you through these cultural conversations and how they dovetail with our business. First, reading is a driver of pop culture and social media buzz. The power of children's books to create pop culture excitement this quarter reflects the strength of our trade publishing whose revenues were up 16% in the current quarter versus last year and our ability to ensure these titles reach classrooms and children directly through our clubs and fairs. More than 10,000 kids turned out this fall to see Dav Pilkey on his nine-city study and book tour, supporting Dog Man: Lord of the Fleas. As one Austin bookseller commented in Publishers Weekly not since the days of Harry Potter midnight parties had she seen crowds of this size. The sixth title of the series, Dog Man: Brawl of the Wild will be released next week with a historic 5 million copy first run printing. Meanwhile a 10 year old picture book called The Wonky Donkey originally published by Scholastic in New Zealand became an Internet sensation this fall when a video of Scottish grandma Janice Clark reading the book out loud to her grandchild went viral, catapulting The Wonky Donkey back into the spotlight with two million views. Scholastic immediately launched an impressive 1.2 million copies sales here in just two months. Right now three of the top 10 box office leaders are adaptations of children's books, including our own Fantastic Beasts: The Crimes of Grindelwald. In clubs, increased sponsorship year-over-year drove slightly higher revenues in the current quarter and technology improvements contributed to a shift into more online ordering from both teachers and parents. This is not only provided a better customer experience, but should also benefit our business and operating and sales tax collection efficiency. This is timely as we plan for additional costs and close this year and state sales tax requirements related to the recent Supreme Court ruling. We are working to address these expected challenges and Ken will have more on this later. Online improvements have also benefited the Scholastic store online and the Teachers store online, which are experiencing double-digit growth in visits. Book Fair revenue is on par with last year and number of fares is slightly up despite increased competition and the impact of revenue recognition under the recently adopted guidelines. Fairs has also completed its transition to salesforce.com, including training the field. We've begun to see key benefits such as sales productivity through mobile integration, improved predictive analysis, as well as real time reports on dashboards which allow greater efficiencies and capacity planning. We also plan to continue the rollout of our new point-of-sale systems in all of our sales regions this spring. Second, reading helps kids better understand their world. Scholastic continued its commitment this quarter to provide content to help children navigate the more challenging aspects of the world around them. We've always been viewed by teachers as a source of social emotional learning or SEL support through classroom magazines and curated book collections that kids choose and want to read, helping them build empathy while fostering self-confidence. The need for SEL was underscored by an increased call for resources from educators, fostered in part by funding provisions in the Every Student Succeeds Act, or ESSA. Additionally, from our forthcoming seventh edition of the kids and family reading report we know 73% of children agree that reading helps them understand current issues and 88% of parents believe reading fiction and non-fiction helps their children better understand the world. With circulation reaching 15 million students during the school year, our classroom magazines are already a powerful teaching resource. In the last quarter under new editorial leadership, the scholastic team developed two new initiatives in response to classroom needs. This includes Stories for a More Tolerant World, a curated collection of online magazine content introduced after the tragic synagogue shootings in Pittsburgh. The site received nearly 50,000 page views upon launch and strongly positive feedback from teachers across the country. Also underway is Words into Action, providing non-fiction and teaching plans designed to inspire student led community service. Both of these initiatives demonstrate the effectiveness of our print and digital classroom magazines to support student learning. Third, reading instruction is a topic worthy of mainstream media attention, a debate about best practices and literacy instruction are in prominent placement on the opinion pages of The New York Times and Washington Post earlier this fall, inspiring hundreds of comments and spirited social comment - social media commentary. Pam Allyn, SVP of Innovation for Scholastic Education, was part of the conversation, writing in the Times that the literacy field agrees on one thing, the children's reading - the child's reading life can be joyous, hopeful and exceptionally productive when the teacher provides a strong disciplined comprehensive approach. This need for a comprehensive approach is also the foundation of Scholastic Literacy, launching in 2019 and reflecting our unique ability to combine engaging content from trade books with well-designed teaching plans that directly connect to the standards, along with professional development support. Scholastic Literacy is a comprehensive K6 reading curriculum that will also benefit from the – our growing strength in digital learning, as it integrates our Eddie award-winning Ooka Island and Literacy Pro products as well as our most recently launched W.O.R.D. from the renowned vocabulary expert, Dr. Freddy Hiebert. Further reinforcing our credentials in the SEL space, we recently announced the Yale Child Study Center-Scholastic Collaborative for Child & Family Resilience, which will focus research on the intersection of literacy and health and work toward fostering resilience in communities. Findings from the collaborative will have cross-divisional impact to Scholastic and support our early childhood initiatives globally, including our upcoming early childhood curriculum. We're honored to be a partner with the Yale Child Study Center and believe this important partnership will help advance students academic and emotional outcomes. Our education business is also benefiting from our adoption of salesforce.com, providing a streamlined view of sales results and deeper insight into the sales pipeline, while identifying new opportunities within districts. International had an overall positive quarter before the impact of currency with our major markets up year-over-year, especially in trade publishing in Canada, Australia and New Zealand, the UK and Asia. Rapidly growing sales in China continue to reflect the increased impact of the region's growing middle class and the need for English language learning materials. The revenues were flat in US dollars. We were up 4% in local currencies and international. Finally an update on our building. You may have seen our renovation was covered in fastcompany this week with the headline Scholastic's new HQ is unlike any corporate office you you've ever seen, highlighting the graphic art installations of our iconic brands by pentagram. As our staff enjoys our new space, Sephora has completed its move to its new location within our newly developed retail space at 557 Broadway. This paves the way for the final stage in preparation for a new leasing engagement at our 555 Broadway location. SoHo remains a desirable location with larger retailers looking for concept store spaces on Broadway and high-end boutiques drawn to Mercer Street. Our location has the added benefit of proximity to established luxury brands nearby, keeping consumers in the area and revitalizing the neighborhood. With that, I'd like to pass the call to Ken Cleary.

Thank you, Dick. And good morning. This morning I’ll refer to our adjusted results from continuing operations for the quarter, excluding onetime items unless otherwise indicated. As discussed last quarter, we have adopted a new revenue recognition guidelines under ASC 606 this fiscal year. Prior periods results have not been restated. As a review the quarter sales and operating income, I will highlight the impact of these new standards on the period's results. Revenues were $604.7 million versus $598.3 million in the second quarter last year, an increase of 1%. The current quarter’s reported revenue was $10.8 million lower due to the impact of ASC 606. Absent this impact, quarterly revenue was up 3% versus the prior year period. If you recall, our Q1 revenues were $12.5 million favorable due to ASC 606. These differences are seasonal within our fiscal year and we do not expect a full year impact from this accounting change. Operating profit was $102.9 million versus $110.9 million last year. The net detriment of the accounting change on this quarter's results was $5.6 million. We had $4.7 million in onetime items in the quarter, which included a $4.3 million charge related to a proposed settlement of an outstanding sales tax assessment from prior fiscal years and $400,000 for severance associated with our transformation. Last year's onetime charges included $3.7 million for restructuring severance and stock compensation and a $15.4 million non-cash partial pension settlement charge below the operating line. Adjusted EBITDA for the second quarter was $123.2 million, as compared to $126.7 million last year. For the first half of the year, our EBITDA is up 21%. We expect adjusted EBITDA to improve at a greater rate than operating income as we continue to leverage our investment in technology and facilities. In the current fiscal year, we're beginning to see the benefits of technology investments such as CRM, point-of-sale devices, components of our ERP platform and our upgraded facilities. We're also recognizing the depreciation expense of these investments. We expect these benefits to expand over time as we continue to better utilize these tools and launch new tools and as we begin to collect rents on our new retail space. 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 its not distorted by unusual gains, losses or other items. Now turning to our segment results. Children's book publishing and distribution segment revenues were $417.9 million versus $413.7 million in the prior year period. The quarter saw continued growth in trade publishing with front and backlist bestsellers and the school based marketing channels, clubs and fairs were roughly on par with the prior year period. The new revenue recognition guidelines adversely impacted book fair revenues by $8.5 million in the current quarter. Segment operating profit was $106.3 million versus $115 [ph] million last year, reflecting the lower fair revenue under ASC 606 and higher costs in clubs as we upgrade our customer facing systems to collect sales tax, as well as additional sales tax accruals in the second quarter. Education revenues were $71.5 million versus $69 million last year, mainly driven by higher sales of custom publishing, professional services and classroom libraries. Operating profit was $8.3 million, including a $2.6 million timing benefit from ASC 606, an increase of $4.4 million compared to last year. International second quarter revenues were $115.3 million on par with the prior year period. Absent the adverse impact of foreign exchange of $4.6 million and a drop in recognized revenue of $2.3 million due to the new accounting guidelines, international revenue improved by 6% on strong trade publishing operations in Canada, Australia, New Zealand, the UK and the trade and education businesses in Asia, particularly China. Operating income fell by $1.7 million versus last year, as a result of the lower ASC 606 impacted sales and currency. Second quarter corporate overhead expense was $24.7 million versus $22.7 million in the second quarter of 2018. The slightly higher overhead, excluding onetime items in the current period is primarily due to higher depreciation expense for building and technology upgrades now in service, as well as higher non-capitalized technology costs related to transformation projects. Net cash provided by operating activities was $128.5 million in the current fiscal quarter compared to $120.8 million in the second quarter of fiscal 2018 and free cash flow was $93.5 million in the current quarter, which was in line with our expectations compared to free cash flow of $90.7 million a year ago. At quarter end, we had $358.1 million cash and cash equivalents compared to $269.8 million at the end of the last quarter and $387.8 million a year ago. The lower cash balance versus a year ago reflect the planned spending on our facilities upgrades in technology transformation issues over the past 12 months. The company spent $23.2 million on capital projects in the second quarter, including additional work performed at our headquarters location in New York City in preparation for new retail and continued progress on our multi-year technology transformation issues that also included additional state-of-the-art POS systems for our Book Fairs business, which will be rolled out to all three remaining regions in the second half of the fiscal year. During the quarter, our technology investments were primarily focused on our ERP upgrade and consolidation. We concluded the successful initial implementation of applications to handle our North American financial management accounting, which represents a cornerstone for the remaining components. This will now allow us to retire many legacy applications that were supporting our enterprise financial functions. We have started the process to transform our enterprise quote-to-cash business processes, and have also begun defining our technology requirements and roadmap for warehouse management and further automation of business processes. Our technology transformation spend includes both CapEx and OpEx and the phasing of this spend will impact how these costs are recognized throughout the fiscal year as we continue our transition to new platforms and applications many of which are now in the cloud. The company also spent $11.8 million for prepublication and production. As Dick discussed earlier, as a result of the June 2018 Supreme Court ruling, we will be required to collect and remit sales tax in virtually all states by the end of our fiscal year, although implementation guidelines vary by state. We have already incurred costs to modify our customer facing order platforms, altered paper order forms, design communication plans and complete registration forms in applicable states. We will commence collection from our customers in the third quarter of our fiscal year. In addition to increased development and administrative cost associated with our tax collection efforts, there may also be a portion of the assessed sales tax that we will not be able to collect from our customers during the implementation period. We will also be analyzing the impact on engagement and our customer’s acceptance of the higher all in cost of product in the marketplace. This transition period will enable us to fully comply with sales tax requirements this year, while minimizing any negative impact to our customers. Given our results to date, 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 onetime items in the range of a $1.60 to $1.70. Although as previously mentioned, we continue to experience rising product and fulfillment costs like other businesses as well as costs associated with the collection of remittance of sales tax. We're 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. With that, I will hand the call back to Gil for the Q&A session.

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

Thank you. [Operator Instructions] And our first question comes from Drew Crum with Stifel. Your line is now open.

Okay, thanks. Hey guys, good morning. So – I wanted to ask a couple of questions on the Dog Man book, the 5 million unit print runs for Mr. Pilkey's new book, how does that compare to your original expectations and relative to the fiscal 2019 guidance that was affirmed with 1Q earnings back in September? And then you know, related to that, I am just curious as to what the cadence of book releases for this series will look like going forward? Obviously, you have two in fiscal '19. I think there is another one planned for August of next year. Is two a good number going forward? Or is this year somewhat of an anomaly? Thanks.

Well, I think the trajectory of the printing - first printings has been phenomenally increasing as more kids get excited about Dog Man and wait for it. So I believe our initial printing on the last one was 3 million, now it's up to 5 million with the one that will be distributed on December 24th. You're right there are two - there will be two once the December 24th release takes place this year and there's another one planned for August of 2019. We think the 2 year is probably right. Of course, it depends on the author and his cadence of delivering and creating new manuscripts. But this series now in his sixth book is amazing and we believe will continue probably slightly ahead of the trajectory that we projected earlier Drew.

Okay, okay. That's helpful. And then shifting gears on Scholastic Literacy, can you talk about the pipeline or the interest level, the demand for that product. What does the sales cycle look like for this initiative relative to some of your other products in education? And should we anticipate any meaningful impact from Scholastic Literacy in the second half of fiscal ‘19?

Yeah, Scholastic Literacy is a core curriculum program designed to go after the textbook dollars. And normally our education sales are focused on supplementary materials, but the core textbook market is bigger and we are already have a huge presence in the supplementary market. Scholastic Literacy will be coming into the market more as samples and ability to show customers in the spring, Drew. There will be a small amount of revenue in the summer of - the first quarter of 2020. There probably will be a very small amount coming in before May 31, 2019, yeah.

Okay. And Dick, the sale cycle on this product like a READ 180 for example or is it much…

Yeah, it's a textbook cycle which is really June, July and August with a little bit in September and it's quite different - it's a first quarter business for Scholastic which of course is good for us because that's our loss quarter and we're looking forward to as that product grows to help you know, attenuating the loss in the first quarter. So it will probably be 40% to 50% of its revenues in the first quarter when it gets started and underway.

Okay, got it. And then we've been monitoring the developments in LA Unified School District with interest, just curious as to what potential impact that would have you know, potential strike, I guess that would impact - that would have across your businesses if any?

Well, one of the people in the room here was just talking to an LA superintendent on Friday. I don't know, Beth, that if this topic – that topic came up, but if you have anything to offer go ahead and do so.

Hi, Drew. The topic came up briefly and, of course, LAUSD is concerned about the strike, but I do not feel like it will have any impact on our business. I think they feel like they will resolve this in a matter of a short period of time that I don’t - we discussed ourselves and we don't think will have any impact.

Okay. Okay, fair enough. And then just one last question for me either for Dick or Ken, you know, you referenced the rise in product and fulfilment cost. Where in the P&L or segments results are we seeing that? And aside from the sales tax issue what is the company doing in response to this?

So Drew, you're seeing it really across all channels, particularly in the U.S. and you're seeing it in labor costs, you're seeing in product costs. With regard to those costs, as well as sales tax, with sales tax we have a complete program in place to both introduce it to our customer base with minimal impact to them. We are very cognizant of the impact on teachers and we're treading lightly in that area. With regard to the other areas what we're looking at initially is pricing and we're trying to understand if we can - if we can overcome some price elasticity in certain areas and that will be - those strategic discussions are going on now.

And I think Ken that this was flowing through the cost of goods sold line on the P&L

Yeah, absolutely.

Okay. Okay, guys. I appreciate it. Thank you.

Thank you, Drew.

Thank you. And that concludes our question-and-answer session. I'd like to turn the conference back over to Richard Robinson for closing remarks.

Well, thank you all for your attention here in the holiday season. We're looking forward to a good second half and we appreciate your focus on Scholastic and your help for our businesses. Thank you all. Have a happy holiday.

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