Scholastic Corp (SCHL) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2018 Second Quarter Results Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Gil Dickoff, Senior Vice President, Treasurer and Head of Investor Relations. Please go ahead.

Thank you, Krystal, and good morning, everyone. Welcome to Scholastic's Second Quarter 2018 Earnings Call. Joining 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 also 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 a Form 8-K, which has also been posted to 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 us today. I look forward to introducing you to Ken Cleary, our new CFO in just a few minutes. Ken has been with Scholastic for 10 years, most recently as Chief Accounting Officer, and he's entirely familiar with all our financial and business operations. He's quickly moved ahead in his new role bringing excellent analytical skills and a hands-on approach to working with the business units to improve profitability.

As you know, the 2018 fiscal year is a swing year between 2017 when we had a significant additional revenues from Harry Potter and the Cursed Child, and the 2019 fiscal year when the effects of our Scholastic 2020 plan will begin to kick in. Second quarter results demonstrated progress in our core businesses and were solidly in line with expectations, including holding profitability for the corporation, even though we were down almost $18 million in trade revenues based on the comparison with the Fantastic Beasts screenplay, released on November 16 -- November 2016, which led to strong revenues in the second quarter last year.

Cost savings throughout the organization, including overhead, resulted in only a slight decline in profits versus last year and kept us on pace with our forecast for 2018. We are, therefore, affirming our guidance for the full year. Our core Children's Book Publishing showed resilience in the quarter, underlining the many reasons why Scholastic is the world's largest publisher and distributor of children's books. While Book Clubs and Book Fairs both lost revenues in September from the hurricanes in Texas and Florida, we were able to end the quarter with increases in profitability for both Clubs and Fairs. We also had improved trade results compared to our plan through the strong performance in such new titles as Dav Pilkey's Dog Man.

As you know, Education is a major growth area for the company, especially in K-6 core reading, as schools move to balance literacy and reading solutions which are strongly identified with Scholastic. In the quarter, we added sales and marketing positions which will bring incremental costs, but will lead to greater sales later in fiscal '18. We were highlighted in the 2017 EdWeek Market Brief survey, in which teachers and district leaders ranked Scholastic as the highest-quality producer among 4 major educational companies, with 85% expressing positive support for Scholastic compared to the mid-60s for the next ranked company. In the quarter, we made some significant changes in our Asia operations, while also pushing forward with our 2020 plan and nearing completion of our office build-out in SoHo, as our staff is relocated back to the building after 18 months of renovations. I will address these topics in turn.

In Children's Book Publishing and Distribution, in addition to the Dog Man series and its predecessor Captain Underpants, best-selling titles in the quarter included tie-ins to best-selling Five Nights at Freddy's video games as well as Harry Potter and the Prisoner of Azkaban: The Illustrated Edition; and Harry Potter: A Journey Through a History of Magic. Alan Gratz' highly acclaimed Refugee also continued to sell strongly. We're eagerly awaiting sales of the fourth title in the Dog Man series, Dog Man and Cat Kid, which is scheduled for release on December 26. We have a strong upcoming list for spring, including titles from Super Bowl champion and literacy crusader Malcolm Mitchell, who debuts with his picture book, The Magician's Hat. Also The Traitor's Game by New York Times and USA TODAY best-selling author Jennifer Nielsen; James Swanson's Chasing King's Killer: The Hunt for Martin Luther King Jr.'s Assassin; and The Word Collector, a new picture book by Peter Reynolds, all scheduled to be released in early 2018. Throughout the 2018 calendar year, we will celebrate the 20th anniversary of the U.S. publication of Harry Potter and the Sorcerer's Stone, with major events in July and September.

Book Club sales began slowly this fall, as teachers took time to adjust to a new sequence of Club offerings. However, Club sponsors came back strongly in November, with sales in the month increasing compared to the prior year. Profitability improved on lower revenues as we realized cost savings through process improvements, including digital-marketing initiatives and more services provided online. Book Fairs showed sales growth and improved profitability in the quarter. Our focus on revenue per fair growth is driven by matching our fairs more closely to the needs of each school in terms of book selection, fair mix and number of titles.

In Education, as earlier stated, we are expanding our efforts to increase new publishing and sales capabilities, as customers shift to customizable core literacy curriculum and away from basal readers and textbooks. We are incurring some near-term cost for this expansion, but we're confident that these expenditures will position us very well for next year with a broader product range. We're on plan for the spring launch of Scholastic EDGE, an extension of our -- the company's Guided Reading core literacy curriculum offerings. EDGE provides a larger range of a high-interest and age-appropriate titles at lower reading levels, enabling Striving Readers to build their skills and capability to read a wider range of books. We also expect sales gains in the second half of the year in our Summer Reading programs and Leveled Bookroom 4.0 introduced in April 2017, with over 6,200 texts and professional learning support. In addition to these, we are developing more print and digital products, aimed at providing a full curriculum -- core curriculum to address the complete range of literacy solutions for classrooms, including new grammar, writing and usage programs as well as a new digital phonics program. We recently appointed 3 outstanding professionals to advance the division's strategic growth plan by providing districts with core literacy curriculum from pre-K to grade 6, expanding the services business, including professional development and family engagement, while increasing sales and marketing capacity.

In the International, strong trade-publishing businesses in the major markets, Canada, U.K. and Australia and New Zealand continue to drive results, while we are also focusing on the increasing needs for English language learning products for expanding markets in Asia. In Asia, we have also initiated several strategic changes in our direct-to-consumer book business with new leadership in India, Thailand and Indonesia, with deep direct selling experience in these markets. We've also recently appointed a new Regional Marketing Head to leverage proven programs across all markets. To accelerate sales growth, we are refocusing our sales teams from door-to-door selling to high-traffic malls, allowing us to promote and advertising large-scale events and demonstrations using well-known local characters as a draw. Coupled with this new selling strategy, we are developing new learning products, including some all digital programs that we'll launch in 2018.

Let me now turn to Scholastic 2020, the 3-year plan we launched earlier this year to substantially increase operating income and improve our organizational effectiveness as we approach our 100th year in October 2020. We believe this comprehensive plan will position the company to operate more effectively across business groups, with better information about product, content, customer data that will not only support more effective marketing, including cross-selling opportunities, but will also result in more efficient business processes, especially in the labor- and freight-intensive distribution operations. This will lower costs, along with a management process that aligns our 2020 activities with the company's strategic objectives, with clear targets and accountabilities. As a result of our Scholastic 2020 plan, we expect significant double-digit operating income improvements in 2019 through 2021. We are already starting to see elements of this plan deliver increasing value to our business units. I already discussed how marketing automation and e-commerce improvements in our Book Club division helped improve profitability this quarter. In Book Fairs, we are piloting a new POS system this month, along with a new digital wallet feature, that will allow parents to safely create a digital account to fund their children's book fair purchases. We expect this to improve both participation in Fairs and revenue per Fair. We have also introduced a new CRM platform in Book Fairs and Education, enabling sales and support teams to access customer data, manage pipeline opportunities in sales territories and administer field-service functions on mobile and desktop.

In classroom magazines, we have completed the migration of all 24 digital magazines to a single platform. Our digital education and subscription products are now all operating on a new digital manager platform, allowing teachers to set up classrooms and enabling our sales teams to package digital products in response to district needs. On the operations side, new fleet management and inbound freight modules went live on the new Oracle transportation management platform this quarter.

Finally, on our real estate project, Scholastic employees have been relocated back to our corporate headquarters in SoHo out of leased space. And we've now hired the country's leading, independent, real-estate specialist firm to market the 42,500 square feet of retail space at our 555-557 Broadway location.

With that, I will pass the call to CFO, Ken Cleary.

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 noted.

Revenues were $598.3 million versus $623.1 million in the second quarter last year. Operating income for the current quarter was $110.9 million compared to $116 million in the second quarter of fiscal 2017, a period that saw the successful release of Fantastic Beasts and Where to Find Them: The Original Screenplay. Earnings per diluted share was $1.92 versus $1.99 the prior year period, excluding one-time items in each period. We had $19.1 million in nonrecurring items in Q2, including a $15.4 million noncash partial settlement charge taken below the operating line associated with the termination of our cash balance-defined benefit pension plan here in the U.S. and $3.7 million of one-time severance and stock-comp charges.

Overall, profitability improved in the quarter on lower sales, as the company realized savings in cost of product, fulfillment and catalog and promotion costs, a key focus of ours as we look to achieve a significant increase in operating income by 2020. We have now cycled 12 months of last year's wage adjustment program at our warehouse fulfillment and customer support operations in response to the competitive, seasonal labor markets. Countering the increase in wages, we have revamped training programs that engage our seasonal workforce and produced a 13% year-over-year supply chain improvement in the second quarter. We also implemented and improved an highly predictive staffing models that put trained resources in the right place at the right time in order to meet customer demands.

Now turning to our segment results. Children's Book Publishing and Distribution segment revenues were $411.8 million compared to $432.5 million last year. Segment operating income was $115.1 million versus $121.1 million in the prior year period, primarily a result of the lower Harry Potter sales in trade channel as expected. Education segment revenue was $70.9 million compared to $71.1 million last year, with solid results in our target core literacy and supplemental instruction lines of business, classroom libraries, professional learning and classroom magazines, all offset by declines in the segment's consumer magazine and teaching resources channels. Segment operating income of $3.8 million was down $4.9 million year-over-year, primarily as a result of higher employee expenses for an expanded sales and marketing force with expertise in solution selling of core literacy instruction programs, a key element of the Scholastic 2020 plan.

International segment revenue was $115.6 million versus $119.5 million last year. Segment operating income was $14.7 million compared to $16.9 million in the prior year period, which excluded a one-time charge of $200,000 for restructuring severance. The decline was primarily a result of lower Harry Potter sales in Canada and in the export market, as expected, as well as softness in the company's direct-to-consumer selling business in Asia. Corporate overhead expenses were $22.7 million versus $30.7 million last year. The lower overhead expense was primarily a result of lower employee-related expenses in the current quarter as well as some timing related to moving expenses in the prior year period.

Net cash provided by operating activities was $120.8 million versus $179.7 million last year. And free cash flow, as defined by the company, was $90.7 million compared to $164.1 million last year, when we realized a higher level of customer remittances from the significant sales of Harry Potter publishing in the first half of 2017. We distributed $5.3 million of dividends and repurchased $8.6 million of common stock during the quarter, leaving outstanding authorization of $25.3 million for future buybacks.

At quarter-end, cash and cash equivalents exceeded debt by $376.5 million compared to $435.6 million a year ago. The reduction in cash balances was mainly due to our previously announced capital spending programs. As you know, we had projected to use cash this fiscal year for the first time in many years due to the redevelopment of our headquarters building, along with higher levels of spending on technology upgrades. We expect to return to positive free cash flow next fiscal year as the work on the building is completed. In the second quarter, we had $21.3 million in capital expenditures, including $9.1 million in connection with our headquarters renovations. We remain on schedule to complete the majority of the office upgrades by the end of calendar year 2017. We also used $7.8 million capital for strategic technology transformation program.

Before I discuss our outlook, let me take a minute to provide some perspective on the financial statement impact of our investments in Scholastic 2020 growth-and-productivity initiatives, including upgrades to our office workspace and continuing development deployment of strategic technologies. These investments include both operating expenses that are reflected in the income statement in the period they are incurred and capital expenditures that will be reflected in subsequent periods as incremental depreciation. When initiatives are complete, 2018 for the building and 2020 for the technology, capital spending will decline, and we expect the net positive impact to earnings, as a reduction in Scholastic 2020-related operating expenses, along with the benefits of the plan itself, will be partially offset by higher depreciation as the building improvements and technology deployments are placed into service.

Now turning to outlook. We are reaffirming fiscal 2018 outlook of $1.65 billion to $1.7 billion in revenue, and earnings per diluted share in the range of $1.20 to $1.30, excluding one-time items and noncash charges resulting from the previously announced termination of our domestic-defined benefit plan. Fiscal 2018 free cash flow is expected to be use of $10 million to $20 million, and includes capital expenditures of $90 million to $100 million, and prepublication and production spending of $30 million to $40 million.

With that, I will hand the call back to Gil for follow-up questions.

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

(Operator Instructions) And our first question comes from Drew Crum from Stifel.

So Harry Potter has been a headwind during the first half of fiscal '18. Do you expect that to reverse in the second half and the franchise to grow? And anything you can share in terms of the events that you referenced in July and September of calendar '18?

I will ask Ellie to answer that question, Drew. The question being the trajectory of Harry Potter, yes.

Again, we have a lot of excitement coming out in the market with play opening in -- on Broadway in April. And the exhibition opening at the New-York Historical Society in the fall. And against that, we have additional tie-in publishing coming out this summer, and a tremendous 20th anniversary marketing campaign that we're kicking off starting in the next few months and continuing throughout the year. So we have a lot of key marketing and promotional moments coming up, so we expect sales to remain strong.

Yes. I think the headwinds are probably somewhat over at this point, Drew, but the second quarter, there was still considerable Harry Potter revenues in 2017 from Fantastic Beasts. Not to mention the first quarter where we had very significant revenues for Harry Potter and the Cursed Child.

Got it, okay. And then, Dick, can you expound upon what you're doing as far as digital marketing is concerned with the Clubs business? Is this something that's new and something you expect to use going forward?

Yes. I'll ask Judy to fill you in on that one, Drew.

Drew, this year, in Clubs, (inaudible) is up and running on Demandware and we have a lot of data about our customers, so we were able to really eliminate a lot of print marketing expenses, posters and mailings and direct marketing that we've done in print before and now we're able to do that online. So we can talk directly to our customers, we can identify that we know who they are. We can upsell to them, we can encourage them to place their next order. So now that our site is robust and working, we have really good access to our data. We can take all of that targeted marketing for our 700,000 teachers across the country, and do a lot of one-to-one digital marketing online, which is both reducing cost much more personal, state-of-the-art e-commerce and really improves profitability of the business.

Okay, great. And then just maybe one last question for Ken. You mentioned the purchase of an annuity contract from a third-party insurance company for the remaining pension liability. What is the cash flow impact you're anticipating from that, if there is any? And then you also referenced the noncash settlement charge, I think, you're going to take in the third quarter. Can you quantify what that will be?

Sure, sure, Drew. So the plan is fully funded at this point in time as per our actuary evaluations. So actually, it's funded to about 105% right now, if you look to both year-end and where we are today. So we don't expect any cash flow to -- any cash flow impact to the company. It will all be out of planned assets.

Got it, okay. Okay, and the charge -- the noncash charge you're anticipating in the...

So we still have a noncash charge that comes out of comprehensive income. It's no impact to equity. It is probably -- we've probably recognized 1/3 of it, and probably have 2/3 to go. So probably, roughly $30 million to go, pretax.

(Operator Instructions) And our next question comes from Barry Lucas from Gabelli & Company.

Any way to size the hurricane impact on Clubs and Fairs either in revenues and operating income?

I'll ask Ken to deal with that one, Barry.

Sure, sure. So it did have an impact on us. It's tough to say exactly. We did have some Fair cancellations. But really, it was traffic flow that slowed down in some of the Fairs. Probably, single digits, millions, maybe $4 million, maybe $4-plus million, maybe $4 million to $5 million on the top line.

Okay. And Judy, I think, was good enough to speak about where the benefits come from when you look at the -- I would say, the profit improvement or the efficiency that you gained. But as I look at in round numbers, $800 million or so, of cost to goods, and somewhat comparable amount of SG&A. Where do you think the big benefits come from in these sufficiency actions that you're taking? Then I've got one more follow-up on that subject.

You mean in respect to the 2020 plan?

Yes. Exactly.

Where the cost reduction is going to come from? The profit improvements, let's put it that way. This is all profit improvement, including cost reductions. I think we can -- I'll ask some of my colleagues to supplement these comments. But the first piece would be the CRM, which will enable us to market more effectively to our Book Fair and Book Club customers as well as our education customers. And this will -- we'll be able to pinpoint our marketing more effectively to revenue per fair in various Book Fair schools, for example, or teacher customers for the Book Clubs and magazines. And that should improve both the top line and the cost of marketing. On the process improvement side and the cost reductions, we're really looking at business process improvements that will reduce our cost base and, particularly, in the heavy fulfillment operations that we have in our Clubs and Fairs programs. So I will ask Satbir, our Chief Technology Officer, to expand a little bit on those comments, Barry. This is our 3-year Scholastic 2020 plan, leading to double-digit operating improvements over the next 3 years. So over to Satbir Bedi, Chief Technology Officer.

Barry, this is Satbir. The -- we are, obviously, in the early stages of what Dick outlined as a 3-year plan for us. But the cost impact, which is specifically addressed, are going to be across the board, certainly in the fulfillment area, and every area which is process-heavy in the company. And as he also mentioned, this has impact on the top line since we -- one of the focus is to provide better data to the marketers and the sales people in the company to reach our customers, and better market and sell to them.

Great. So if I try to roll this up, Dick, and look at the whatever -- however you want to describe the stretch goal of, call it, $2 billion in revenues, can we see a period toward the end of this that you'd have slightly north of 10% EBITDA margins?

On an EBITDA basis, perhaps, that would be a good goal. But the issue with this and the benefit of this program, Barry, is that we keep planning -- we keep articulating and implementing this plan on a kind of a daily, weekly, quarterly basis. So that we -- as we -- we have a goal and we're progressing toward the goal, but we are doing this in increments. So we'll feel more comfortable about offering achievements on the goal as time goes by and we have more concrete things to report about the savings, improvements and the goal toward a higher operating margin. But your goal is -- would be fine. And we have it on a -- basically on an EBIT basis, rather than on an EBITDA basis. But we'll accept your goal as a optimistic and a -- thing that we would like to achieve for the company and for the shareholders.

Great. And if we could just switch gears, maybe, a little bit to Education. Again, acknowledging that this is going to be a really fourth quarter loaded. But as you look into something a little bit more firm than a crystal ball, what's giving you the confidence as you described this as a growth area that whether it's inquiries from a school districts or, I mean, say, orders on the books or teacher inquiries? What's providing the support there that has convinced you to put more money into sales and marketing and product development?

Well, Barry, as you know as well or better than anybody else, there's a $3 billion to $4 billion instructional education budget in the United States for K-12 schools. And that's more if you include technology. The -- so it's a big market and there are multiple competitors, of which we are a significant one. This market is moving away from core -- from basal textbooks to balanced literacy solutions. And every day, our hundreds and hundreds of people that are out in the field are talking to the school districts are -- confirmed by their conversation that this is the direction that school districts want to go. They've got no results from using the textbook day after day, year after year. And they are trying to be more innovative and to improve teacher professional development and learning as well as improving and making more interestingly the books and materials for K-6 literacy. So this is the market that -- it's moving in our direction, and we -- this encourages us to have a rather high target for our growth in this business. Looking at the $3 billion, we are not going to get all of that. We're going to get more than the $300 million that we now have. So we're very, very confident that this is a growth area for the company. We're investing, I think, wisely and carefully unit. We're expanding our product as well as our sales and marketing capabilities. And I think you will see this business growing significantly over the next 3 years, and it's certainly a key element in our 2020 growth plan.

(Operator Instructions) And I am showing no additional questions from our phone lines. I would now like to turn the conference back over to Richard Robinson for any closing remarks.

Well, thank you all for listening to our second quarter call. Happy holidays to all. We're looking forward to a strong fiscal '18, but also '19 to '21, as we get the effects of our 2020 plan in going strong. Thank you all for your support, and we'll look to talk to you in the new year.

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