Scholastic Corporation
Q4 2019 Earnings Call Transcript

Published: 26 Jul 2019

[Operator:]

Good day, ladies and gentlemen and thank you for your patience. You have joined the Scholastic Reports Q4 Fiscal 2019 Results and Fiscal 2020 Outlook. [Operator Instructions] I would now like to turn the call over to your host, Senior Vice President, Treasurer, and Head of Investor Relations, Gil Dickoff. Sir, you may begin.

[Gil Dickoff:]

Thank you very much and good afternoon everyone. Welcome to Scholastic’s fourth 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 the Form 8-K, which has also been posted to our Investor Relations website. We encourage you to review the disclaimers in the 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.

[Dick Robinson:]

Good afternoon, everyone and thank you for joining our call. In fiscal 2019 after three quarters performance similar to fiscal 2018, operating income dropped nearly 40% in the fourth quarter primarily due to the impact of state sales tax collection efforts in our book clubs business and in book fairs largely because of increased spending for incentives. We also continue to have increased costs for paper printing and labor. While 2019 saw a 2% revenue increase on strong trade performance and other important gains for the business, our focus for 2020 is on increasing operating income through targeted pricing initiatives and cost management. Our comments today will detail our plan to improve operating income. But first, I will provide some detail on the fourth quarter.In clubs responding to the Supreme Court’s Wayfair ruling, we implemented a program to collect and remit state sales tax for Book Club customers in every state. This was a significant change in the way teachers had to manage their classroom orders and led to revenue loss as well as higher expenses. We anticipate some continued impact in fiscal year 2020. However, we believe this will abate as the new process becomes familiar to our customers as has happened outside of the United States when we have had similar tax collection transitions. In book fairs to counter competition from a new national book fair provider, we increased incentives, including Scholastic dollars to our customers leading to higher expenses in the fourth quarter. In terms of GAAP reporting, we also had a change in accounting ASC 606, which Ken will explain more fully. Scholastic has proven time and again that we know what captures the hearts and minds of young readers around the world. Fiscal 2019 was no exception with our front and backlist titles and iconic brands leading to a great year for trade publishing globally. Likewise, our school channels offer access at low prices to the best books for young people to support independent reading which has a significant impact on the skills and motivation of all children.In education, we are introducing new supplemental programs in print and digital as well as bringing Scholastic literacy to the $1 billion core reading market and we are expanding in Asia through English language learning products and services, which are growing rapidly to meet market needs throughout the region. To improve margins, we are selectively increasing prices, reducing costs and leveraging new technologies for operating efficiencies. As a result of our efforts to improve margins in 2020 while increasing revenues, we expect fiscal year 2020 revenues in the range of $1.67 billion to $1.70 billion, up from $1.65 billion in fiscal year 2019 and adjusted EBITDA is expected to be $140 million to $160 million, up from $121.3 million in 2019.Here are some of the key initiatives for 2020 and beyond. First, a focus on clear strategies to strengthen our largest business, our market leading school distribution channels in the U.S. While we expect slightly lower revenues in fiscal year 2020 for clubs and fairs, we are making changes to prepare them for the future through improved technology and simplicity of use. These channels remain key to our sale children’s books direct to students and families beloved by the teachers and schools they support. Research studies and education show the importance of independent reading to the social, emotional and academic growth of kids, and Scholastic Book Clubs and Book Fairs are by far are the most important channels for promoting independent reading in school enabling children to choose and buy books they want to read from a wide range of quality books at favorable prices. In fairs, we have grown our position significantly over a 20-year period becoming the market leader by far. We deliver more than 110,000 fairs in more than 60,000 schools each year from our 58 regional distribution centers. In 2019, we have maintained revenues even as we faced increased competition. We are confident in our ability to preserve and extend this position over the long-term viewing competition as a healthy stimulus to offer the best customer experience. While managing our costs even more effectively through better targeting incentives, we also will focus on these value propositions.First, improve the experience for fair chairpersons, students and parents the full rollout of new POS devices enables better connectivity and broader parent use of an eWallet to deposit money in their children’s book fair account. Second, increase fair participation through marketing and promotional activities. Third, provide personalized support services for volunteers hosting fairs. Fourth, expand our roster of high value fairs through targeted incentives and fifth, offering streamline fairs, which can be setup quickly. In clubs, we will be focusing on transitioning a greater portion of parents to purchasing online which supports our customer-first goals by simplifying sales tax collection while we continue to improve our e-commerce experience to meet today’s expectations. Our more than 750,000 teacher customers tell us that more than ever in these times of tight school budgets, our Book Club Rewards program enables them to get free and inexpensive books to build their classroom libraries and stimulate independent reading among their students. This is of critical importance to our nation’s students as the recent kids and family reading report showed us only one-third of school age children have classroom libraries with books that they want to read. In both of these channels, which carry the Scholastic brand in every school everyday, we have built deep relationships with publishers across the globe who make or license products to us and continue to be viewed as the must have school partner who can engage children and families, celebrate reading and bring the most popular and diverse titles from all publishers to kids at affordable prices.Next, unquestionable strength in children’s book publishing across age ranges. This coming year we have highly anticipated titles for every age group. In middle grade, The Dog Man Series continues to dominate best seller list and draw unprecedented numbers of new readers, Dav Pilkey’s seventh book in the series Dog Man

[Ken Cleary:]

Thank you, Dick and good afternoon. Today, I will refer to our adjusted results for the fourth quarter and full year excluding one-time items unless otherwise indicated. As you know, we adopted the new revenue recognition guidelines under ASC 606 in fiscal 2019. Since the prior year’s results have not been restated, I will highlight the impact of these new standards on the current year’s revenues and operating profits. Note that we will not need to make these accounting comparisons in future periods. The net effect from the application of ASC 606 on overall results in fiscal 2019 was a deferral of $12.8 million in revenues into the next fiscal year and a $7.7 million deferral of operating income, mainly affecting our book fairs business. The impact was more significant on our fourth quarter results which had a $23.9 million in deferred revenues and a $14.8 million reduction in operating income.Fiscal 2019 revenues were $1.65 billion versus $1.63 billion last year. Operating income was $41 million compared to $75 million in fiscal 2018. As we guide on May 30, earnings per diluted share excluding one-time items were $0.92 and adjusted EBITDA was $121.3 million. Both of these are non-GAAP measures, which we defined in the financial tables accompanying this afternoon’s release. Excluding one-time items and the impact of ASC 606 in the current year pro forma earnings per share were $1.08 versus $1.43 last year. The year-over-year shortfall versus our original fiscal 2019 outlook was predominantly a fourth quarter event highlighted by three main factors.One, we transitioned to a new sales tax collection program in our Book Clubs operation in March and responds to Supreme Court’s Wayfair decision and subsequent state registration requirements. This transition significantly impacted Book Club revenues and operating income in the fourth quarter, results have largely been in line with the prior year until that time. Two, we had higher promotional and marketing spending including the use of more Scholastic dollars in our Book Fairs business as we work more closely with our customers to create and deliver the incentives and services they desire in order to reinforce our market leadership in fairs, which help fair revenues in the fourth quarter as sales were 1% higher, excluding the impact of ASC 606. Three, we had a greater impact from the application of ASC 606 on sales and profits in the fourth quarter, as we issued more promotional Scholastic dollar incentives in Book Fairs during that period.Full year results were also affected by higher depreciation and amortization expense as expected of $14.7 million and the strong US dollar, which resulted in a $15.4 million reduction in revenues and a $1.1 million reduction in operating income. One-time items reflected in our pre-tax results above the operating line for the fiscal year, totaled $16 million and included $8.1 million for the settlement of a legacy sales tax assessment, and $6.5 million in severance, as well as a $900,000 impairment recognized in connection with our New York City headquarters renovation and a $500,000 charge related to branch consolidation in our international operations. For comparison, the prior year period saw a $19.4 million in one-time items above the operating line.Now turning to our segment results, in children’s book publishing and distribution, segment revenues for the fiscal year increased $20.1 million or 2% to $990.3 million, as compared to the prior year driven by a 20% sales improvement and trade on the strength of a strong front list, including two new Dav Pilkey Dog Man releases in the year and J.K. Rowling’s Fantastic Beasts

[Gil Dickoff:]

Thanks very much, Ken. We are ready to now open the line for questions.

[Operator:]

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

[Drew Crum:]

Okay. Thanks. Hi, guys. Good afternoon. Talk a little bit more about your experience with the programs you’ve put into place to address the competition in fairs? And then I guess on a related note, the three issues that impacted fiscal 4Q, you kind of addressed this in your preamble, but could you maybe discuss in more detail when you expect these to stabilize? I guess, I’m speaking specifically to the sales tax collection issues for clubs, the competition in fairs and then the higher input costs?

[Dick Robinson:]

I’ll answer couple of these myself, Drew, and then ask Ken to supplement my comments. In terms of Book Fairs, you asked about the incentive plans and other operating costs. We did, as Ken alluded, we did give out some extra Scholastic Dollars to ensure that we got renewals affairs that we thought might be vulnerable. But we probably extended that program a little further that we needed to, and we’ve gave away a little bit more Scholastic Dollars than we expected. We also had cost increases in certain core areas of shipping labor particularly, driver labor costs and areas like that. But the principle effect was through the Scholastic incentives Scholastic Dollars. On the Club’s, we began the collecting sales tax in the third quarter March through May. We expect that we will have some additional sales tax impact from September 2019 through January 2020. After that we should recalibrate to what people did in the spring. We have improved the offerings that we have made through our collection plus processes and so we’re not expecting a dramatic impact the way we got in the fourth quarter. We’ve corrected some of the issues that caused that revenue decline. So, we do feel we are going to get some impact from sales tax during the year. It will be offset by the fact that as you know, we did pay we self-assess some sales tax historically in the business and as we collect full sales tax from all our customers that will it will that will drop off. I will turn to Ken for the other answers.

[Ken Cleary:]

Sure, Drew. Just to build on Dick’s comments on Scholastic Dollars, there were higher incentives in Q4 and we also did some work to improve fair quality and really provide the fairs that are customers want. So, there was some labor and warehouse costs associated with that as well. As far as sales tax goes, it really isn’t a cost issue going forward, the way it was, it’s now what’s going to be the impact on the business in terms of the topline. So, the work has been done to implement what we’re doing in terms of the collection of sales taxes and we also had to lap some costs in terms of before we implemented sales tax last year. We had to register in certain states and obviously we couldn’t collect in some states and although that’s with our program, we launched in March and we started collecting in March. So, let’s say, state went online with the registration earlier, as early as October in some instances. We were responsible for that sales tax. So, we bought that burden and we talked a little bit about that earlier in the year. What was it? What was the could someone remind me the second question again.

[Drew Crum:]

Yes. You made reference to higher paper, printing and labor cost. So that’s something that you see is ongoing or does that would be, can you offset it with pricing and other initiatives?

[Ken Cleary:]

Sure. So, we are actively working on pricing and other initiatives. In Dick’s comments you heard about margin improvement. So, we’re not predicting substantial revenue pick-ups in particularly in clubs and fairs next year, but we are expecting, margin improvement, and some of that comes through pricing. Now we do have some elasticity in those markets. So, it’s somewhat targeted. It’s not across the board, but we are doing other things to without getting too many details we do have some cross-channel initiatives where procurement should be better targeted than stronger and we should be able to leverage our inventory across the organization better. So, there are things in play. Some of our systems implementations are designed to address some of this as well, and support this. So, it’s really around some of the procurement efforts and making sure that we are doing our demand planning appropriately and on the other side selective pricing.

[Drew Crum:]

Okay.

[Dick Robinson:]

I do think we did we lagged a little in meeting the cost increases. We knew they were coming, but because of the lead times that we have in our businesses. We weren’t able to quite catch up with last year. And we are doing a much better job going forward on that topic. So, we should see some as Ken pointed out margin improvement next year offsetting that cost increases.

[Drew Crum:]

Okay. Shifting gears to the trade business. Can you talk about your expectations for this new Hunger Games book maybe relative to what you experienced with the first three books and is there a way to size this Make-Believe Ideas franchise or book program that you’ve acquired?

[Dick Robinson:]

Yes. I think Make Believe Idea runs into the between $35 million and $40 million. Last year, we owned a portion of that. So, we got an equity pickup of some of the operating income, but no revenues. This year, we will get the revenues and we will also get the full benefit of the operating income.

[Drew Crum:]

Dick, I think growing is it a growing franchise?

[Dick Robinson:]

Yes. No, no. So wonderfully, it’s grown we acquired a minority interest four years ago and it’s grown doubled at least in that time.

[Drew Crum:]

Okay. Alright.

[Dick Robinson:]

Early childhood business absolutely remarkable. It goes through mass market channels, primarily from reader link to Wal-Mart, Costco, Target and so forth and so on, so great business.

[Drew Crum:]

Okay. And then on Hunger Games?

[Dick Robinson:]

Hunger Games, it’s hard to tell. We’re coming, it’s the last week of the fiscal year virtually that this thing comes out. So, we will put out a certain number of copies based on past performance. But it’s been some years since the last one came out. And we are if we were confident that the program is as strong as ever, but we are not sure what’s going to happen until we put some copies out in the market and see what happens. So, we’ll be taking some reserves against that whatever expected revenue we might get, but it’s certainly been a great series over time.

[Drew Crum:]

Okay. And then on the education business, there has been some investments made ahead of the Scholastic Literacy launch. Should we, now that’s behind you or I would think the majority of that spend is behind you? Should we expect to see OI improve and I’m sorry if I missed this, if you could cut out during your prepared remarks, but was there any sales impact from Scholastic Literacy during the quarter? And on the press release, if you could made reference to participating in some state adoptions and open territory state. Is that calendar ‘19 or is that calendar ‘20?

[Dick Robinson:]

Most of the revenue is going to be fiscal 21. We’re getting some this summer, a little bit, Drew, but we introduced the program, somewhat late in the year we are sending out samples in February and March. And so, we got some revenues for the summer quarter being the core textbook product in the summer quarters when you would expect the highest level of revenues, but because of the late production, it’s going to be fairly minimal for this summer. But we are big is a several adoption opportunities, which I’m sure you’re aware of in ‘21 and we expect to be participant in that. But I think the main thing is going to be, it just adds another way for us to go into talk to the Literacy Coordinator or the Chief Academic Officer and we’re offering a comprehensive literacy solution, including core supplemental digital, so forth and so on it just complements our offering and gives us expanded revenue opportunities but that’s going to take a while to show up in the operating statement.

[Drew Crum:]

Okay. And just one more question, can you comment on what your expectations are around incremental rental income for fiscal ‘20?

[Dick Robinson:]

We’ll have some so we have several people who are actively engaged in competing for some states that we have, not all of it, but some of it. And unfortunately, I predicted that we would be able to announce these signed leases in this quarterly call, but the market being what it is, it slipped a little bit and so we’ll probably have something to announce fairly soon. And then, but the market is still there, as you know, the retail market is not great overall, but for this position in Soho that we have in the amount of space we have, we’re pretty, pretty strong competitor for all the major brands that want to be in Soho.

[Drew Crum:]

Okay. Great. Okay, Thanks guys.

[Dick Robinson:]

Thank you.

[Ken Cleary:]

Thanks, Drew.

[Operator:]

Thank you. At this time, I’d like to turn the call back over to Chairman, President, Chief Executive Officer, Richard Robinson for any closing remarks. Sir?

[Dick Robinson:]

Well, thank you very much all for your attention. This is a relatively long call for us, as we had an important quarter and we had an important year. We are very disappointed at our fourth quarter performance, as you know. We are taking intense steps throughout the company to improve that. We’ve got commitment from everybody that we’re going to have a better year in 2020 and get back toward our better operating income as the year goes on. We thank you for your support and we will do our best to make good on our promises. Thank you very much and we’ll see you in September.

[Operator:]

Thank you, sir. Ladies and gentlemen that concludes today’s conference. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.