Scholastic Corporation
Q2 2018 Earnings Call Transcript

Published: 14 Dec 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2018 Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [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.

[Gil Dickoff:]

Thank you, Crystal, 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 is 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 on our annual and quarterly reports filed with the SEC. And now, I would like to turn the call over to Dick Robinson.

[Richard 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 ten years, most recently as Chief Accounting Officer and he is entirely familiar with all our financial and business operations. He has quickly moved ahead in his new role bringing excellent analytical skills and 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 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 in 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 balanced 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 2018. We were highlighted in the 2017 EdWeek Market Brief survey in which teachers and the district leaders ranked Scholastic as the highest quality producer among four 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 has 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

[Kenneth 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

[Gil Dickoff:]

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

[Operator:]

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

[Drew Crum:]

Thanks. Hi, guys. Good morning.

[Richard Robinson:]

Good morning.

[Drew Crum:]

So, Harry Potter has been a headwind during the first half of fiscal 2018. Do you expect that to reverse in the second half and the franchise to grow? Anything you can share in terms of the events that you referenced in July and September of calendar 2018?

[Richard Robinson:]

I’ll ask Ellie to answer that question, Drew.

[Ellie Berger:]

Hi, Drew.

[Richard Robinson:]

The question being…

[Drew Crum:]

Hi.

[Richard Robinson:]

The trajectory of Harry Potter, yes.

[Ellie Berger:]

Again, we have a lot of excitement coming out in the market with play opening 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 are 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.

[Richard Robinson:]

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

[Drew Crum:]

Got it. Okay. And then, Dick, can you expound upon what you are 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?

[Richard Robinson:]

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

[Judy Newman:]

Hi, Drew.

[Drew Crum:]

Hi, Judy.

[Judy Newman:]

This year – how are you? This year, in Clubs, goes up and running on demand well 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. So we’ve done in print before and now we are able to do that online. So we can talk directly to our customers. They can identify that we know who they are. We can upsell to them. We can encourage them to place the next order. So now that our site is robust and working, we have really good access to our data. We can take all 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 personnel, state-of-the-art e-commerce and really improves profitability of the business.

[Drew Crum:]

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 are anticipating from that if there is any? And then, you also referenced the non-cash settlement charge, I think you are going to take in the third quarter. Can you quantify what that will be? Thanks.

[Kenneth Cleary:]

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

[Drew Crum:]

Got it. Okay, okay, and the charge, the non-cash charge you are anticipating…

[Kenneth Cleary:]

Yes, so, we still have a non-cash charge that comes out of the comprehensive income. It has no impact to equity. It is probably - if we probably recognize the third of it, and probably have two-thirds to go. So, probably, roughly, $30 million to go.

[Drew Crum:]

Okay.

[Kenneth Cleary:]

Pretax.

[Drew Crum:]

Okay guys. Thank you.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Barry Lucas from Gabelli & Company. Your line is open.

[Barry Lucas:]

Thank you, and good morning. Anyway to size the hurricane impact on Clubs and Fairs either in revenues and operating income?

[Richard Robinson:]

I’ll ask Ken to deal with that one, Barry. Good morning.

[Kenneth Cleary:]

Sure.

[Barry Lucas:]

Good morning.

[Kenneth Cleary:]

Sure, so it did have an impact on us. It’s tough to say exactly. We did had some Fair cancelations, but really it was traffic flow that slowed down in some of the Fairs, probably single-digits millions, maybe 4, maybe 4 plus, maybe $4 million to $5 million.

[Barry Lucas:]

Okay.

[Kenneth Cleary:]

On the top-line.

[Barry Lucas:]

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 it’s somewhat comparable amount of SG&A, where do you think the big benefits come from in these efficiency actions that you are taking? And I’ve got one more follow-up on this subject.

[Richard Robinson:]

I mean, in respect to the 2020 plan…

[Barry Lucas:]

Yes, exactly.

[Richard Robinson:]

Where the cost reduction is going to come from – they are profit improvements, let’s put it that way. This is all profit improvements including cost reductions. I think we can – I’ll ask Ellie to supplement these comments. But 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 be able to pinpoint our marketing more effectively to revenue per fair and various Book Fair schools for example, or of 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 are 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’ll ask Satbir, our Chief Technology Officer to expand a little bit on those comments, Barry. This is our three year Scholastic 2020 plan leading to double-digit operating improvements over the next three years. So, over to Satbir Bedi, Chief Technology Officer.

[Satbir Bedi:]

Hi, Barry. Excuse me, this is Satbir. We are obviously in the early stages of what Dick outlined as the three 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 we also mentioned this has impact on the top-line since we – one of the focuses is to provide better data to the marketers and the sales people in the company to reach our customers and better market and sales blend.

[Barry Lucas:]

Great, thank you. Thank you for that. 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 would have slightly north of 10% EBITDA margins?

[Richard Robinson:]

On an EBITDA basis, perhaps, that will 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, as we have a goal and we are progressing towards 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.

[Barry Lucas:]

Great, thanks for that, Dick.

[Richard Robinson:]

But your goal is, it would be fine and we have it on a – basically on an EBIT basis rather than a EBITDA basis. But, we will accept your goal as optimistic and thing that we would like to achieve for the company and for the shareholders.

[Barry Lucas:]

Great. And if we can just shift gears, maybe a little bit to education, again acknowledging that this is going to be 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 enquiries from school districts or – say, orders on the books or teach enquiries. What’s providing the support there that has convinced you to put more money into sales and marketing and product development?

[Richard Robinson:]

Well, Barry, as you know, as well as, or better than anybody else, there is $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 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 school districts are confirmed by their conversations, 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 interesting the books and materials for K-6 literacy. So this is a 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 are going to get more than the $300 million that we now have. So, we are very, very confident that this is a growth area for the company. We are investing, I think wisely and carefully in it. We are expanding our product as well as our sales and marketing capabilities and I think you will see this business growing significantly over the next three years and it’s certainly a key element in our 2020 growth plan.

[Barry Lucas:]

Thanks for that color, Dick.

[Richard Robinson:]

Thank you.

[Operator:]

Thank you. [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.

[Richard Robinson:]

Well, thank you all for listening to our second quarter call. Happy holidays to all. We are looking forward to a strong fiscal 2018, but also 2019 to 2021 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.

[Operator:]

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