Scholastic Corporation
Q4 2014 Earnings Call Transcript

Published: 24 Jul 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2014 Results and Fiscal 2015 Outlook Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Gil Dickoff, Senior Vice President and Treasurer. Sir, you may begin.

[Gil Dickoff:]

Thank you so much, Litoya, and good morning, everyone. Before we begin, I would like to point out that the slides for this presentation are available for simultaneous viewing on our Investor Relations website at investor.scholastic.com. I would also like to note that this presentation contains certain forward-looking statements, which are subject to various risks and uncertainties, including the condition of the children's book and educational materials markets and acceptance of the company's products in those markets and other risks and factors identified from time to time in the company's filings with the SEC. Actual results could differ materially from those currently anticipated. Our comments today include references to certain non-GAAP financial measures as defined in Regulation G. The reconciliation of these non-GAAP financial measures with the relevant GAAP financial information and other information required by Regulation G is provided in the company's earnings release, which is posted on the Investor Relations website, again, at investor.scholastic.com. Now I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin our presentation.

[Richard Robinson:]

Thank you, Gil. Good morning, and thank you for joining our fourth quarter and fiscal 2014 analyst and investor conference call. For this morning's prepared comments, I'm joined by Maureen O'Connell, CFO and CAO. In 2014, we had a strong fourth quarter and achieved our guidance for the year with annual revenues of $1.82 billion, earnings per diluted share of $1.84, excluding onetime charges and free cash flow of $63.7 million. In Children's Book Publishing and Distribution, annual revenue grew by 3% to $873.5 million, while operating income, excluding onetime items, increased by 90% to $54.2 million. This growth was driven by higher revenue-per-book club order and higher revenue per fair in our school-based distribution channels. In 2014, we grew the top line in clubs by successfully launching a new grade-specific strategy, including expanded club offers, which was a major driver of our revenue growth of 12% for the year, and 55% for the fourth quarter in book club. Teachers are responding to our revised marketing programs with higher value orders and increased ordering frequency. We also benefited from strategies to maximize revenue per fair in our book fairs unit. Our strong club marketing strategy as well as coordinated inventory purchases throughout the organization brought significant benefits this year, particularly for the January-to-May period. Trade sales were up by 22% in the fourth quarter although down slightly for the year. The Hunger Games trilogy sales declined in-line with our expectations and remain a strong contributor to revenue overall. Frontlist growth was driven by middle-grade bestsellers, including Star Wars

[Maureen E. O’Connell:]

Thank you, Dick, and good morning, everyone. On today's call, I will focus on our adjusted full year earnings. For fiscal 2014, total revenues were $1.82 billion, a 2% increase versus 2013 and in-line with our guidance. Cost of goods sold in 2014 as a percent of sales was 46.3%, in-line with last year and SG&A decreased. Excluding onetime items, operating income was $107 million, an increase of 31% compared to last year, resulting in earnings per diluted share of $1.84 in 2014 versus $1.22 in 2013, which also excludes onetime items. The onetime items above the operating line in the year totaled $43.9 million and included

[Gil Dickoff:]

Operator, we're ready to queue up any questions that are coming through the phone line.

[Operator:]

[Operator Instructions] And we have a question from Drew Crum of Stifel.

[Andrew E. Crum:]

I had a couple questions on cash flow. If I look at the performance for fiscal 2014, it looks like you came in at the low end of your guidance range, and CapEx was significantly below what you had forecasted. Were there any anomalies or onetime items in cash flow from operating activities that may have influenced that? And then, on a related note, can you talk about the board's decision not to increase the dividend for fiscal '15, if I understand that correctly?

[Richard Robinson:]

So Maureen will talk on the cash flow, and I'll be glad to address the dividend question, Drew.

[Maureen E. O’Connell:]

So there was 1 thing that affected cash flow during the year, and we saw a slowdown in collection in our Educational Technology sales. And also, May was a very strong month for education, so they shifted to later in the year. We have seen that collection come in, in June. We made a concentrated effort within our distribution center and our call center in our NSO locations to really drive those collections, but that was a slowdown and that did impact negatively cash flow this year.

[Richard Robinson:]

On the dividend, we continued our dividend for the quarter with no particular philosophy about increasing them. We were happy we had a good year, and the board will continue to look at different ways of returning cash to shareholders, including dividend increases.

[Andrew E. Crum:]

Got it, okay. And then, Maureen, just as far as the EPS guidance range is concerned, I mean it feels like $1.84 is the comp that we should be working with. I mean the low end of the range would suggest that you're assuming you're down year-on-year, and yet you're forecasting revenue growth. Is it just the function of all the investments you plan to make in fiscal '15?

[Maureen E. O’Connell:]

Yes. I mean if you look at our guidance, it's very similar to our actual results in 2014, which was a highly successful year. And we are expecting continued growth in every one of our businesses next year. But that will be offset somewhat with investment in Asia, we're opening new hubs within India, we're expanding our publishing operations within India and Singapore. We're adding educational resources to our Educational Technology sales force. We're also adding resources to a supplemental sales force, and we have less Hunger Games sales, which are very high margin sales. So in our technology, we're expanding our investments there. So those offset the growth, the robust growth, that we're actually planning across all our businesses.

[Andrew E. Crum:]

Got it. And then, last question, just as it relates to Ed Technology. I guess for clarification purposes, you mentioned System 44 was up 40%. I take it that's a 2014 number, not 4Q?

[Richard Robinson:]

Margery will answer that one. Thank you.

[Margery W. Mayer:]

Drew, it's Margery. Yes, that was for the fiscal year 2014. We did, I think a really great job revising System 44 and we -- System 44 is used in 2 ways. It's used as a standalone and it's also used in combination with READ 180, and we revised the program so it works better in both situations. And we've had a great reception from customers.

[Andrew E. Crum:]

Margery, just to just follow up, can you talk about some of the key drivers for Ed Tech growth in 2015? It sounds like you did have some tough comparisons with MATH 180 and System 44.

[Margery W. Mayer:]

Yes, well, we think both of those products are going to grow. With MATH 180, we've had a great reception to MATH 180. We've sold into 47 states in the first year, which we're really excited about it. It's really in 9 months we sold into 47 states. And we have course 2 coming out in the fourth quarter, so we're really optimistic about MATH 180. And we're optimistic about System 44 as well. We did have a good year with System 44 because we have pent-up demand as we came into the year, but the reception to 44 has been fantastic. And with pressure for more rigorous standards, our customers are looking at how to help support all students.

[Operator:]

And the next question is from Barry Lucas of Gabelli & Company.

[Barry L. Lucas:]

I have a couple of questions, Dick. If we could start maybe sizing the total investment in Storia versus the write-off and what needs to be done going forward, I mean you're talking about a fair amount of additional technology investments. And given the write-off, I'm a little bit concerned about the dollars being spent there.

[Richard Robinson:]

Well, the streaming Storia model is complete, and most of those expenses were made in the past fiscal year. So I don't think there's a lot more investment we're going to be making in that area. We have a great platform coming up with a streaming model. It's easily adapted to the consumer over time through our book clubs and book fairs. So I wouldn't look for very much increased Storia-related investment in 2015. Most of the Storia investments have been written down in the current year. Does that answer your question, Barry? I mean we've got -- we built a new good platform. We spend the money on that. We expect to reap the benefits in the coming years, and there will not be a lot of increased Storia spending in that time. New books, we will continue converts to the streaming model, but that's the main expense.

[Barry L. Lucas:]

Okay. And maybe to flesh out the investment in the sales force a bit more, how would that be directed? It's more geographic coverage is it more product line function?

[Richard Robinson:]

Yes, well, Margery can answer that. I think we have a strong Educational Technology business. We haven't increased the sales force in the past several years. We believe there's more opportunity there, Barry. That's a simple answer to the question, but Margery can give you more detail.

[Maureen E. O’Connell:]

Yes. I mean it's really what Dick said. When we look at the funding sources for our products and we look at, especially at Title 1, we know that we have massive amounts of unpenetrated districts. So we are measuring where we think the penetration levels could be raised, and that's really our key strategy. There will be some specialists added in some different areas. One of the things that we do is we have a small team of people we call solution architects that help us work with customers to put together solutions that are specifically aimed at their needs. But most of the investment is going to go into improving our coverage in high need areas.

[Barry L. Lucas:]

Great, Margery. Two more quick ones if I could. One would be on some of the comments that you made, Dick, regarding Common Core and the pushback despite the need -- the clear need for more rigorous standards. So how does that then get reflected going forward? I mean, we've seen some states pull back, there's been some resistance, but how do you overcome the, let's say the negative buzz in certain communities about Common Core and reinforce the need for the types of products and services that you offer?

[Richard Robinson:]

Well, I think the Common Core training has proceeded very substantially throughout the country. And the teachers in our polls, and we do a lot of them, which we publicly announce with the results are some of them together with the Gates foundation, that our general understanding from teachers when we talk to them, do research, do polling, they believe in the Common Core Standards or the standards. They have already began to implement them. They understand them. They acknowledge the need for helping kids to perform at higher level. It's the political world on the top that is not really affecting that very much. But there will be some issues around the timing of the tests for Common Core and so forth. But basically, the teachers are already doing the Common Core Standards, and it's reflected in how they're organizing their classroom, the questions they're asking the kids, the materials they're using, and so forth and so on. So we think it's there. It's in the system, we can call it anything you want, college and career ready, new standards, but it's already happened and people see the need for it. And they understand that the communication hasn't been very good on some of it, but we believe it's in the system. The teachers are concerned about having the resources available to take their most challenged kids, which is really in the majority, and help them get to the higher standards. That's the thing they are most concerned about, and will they get support from the schools and the states and the districts in terms of financial training and materials and so forth. Margery, you should -- you probably discuss how this might affect the area that you're responsible...

[Margery W. Mayer:]

Well, everything Dick said, I would underscore. I think some of the noise around Common Core is they don't write stories about how much it's permeated the instruction. And so the news stories that get out are about the few states that have been -- where Common Core has become highly politicized. But I don't hear much debate about the interest teachers have around raising rigor, engaging kids in conversation, trying to focus more on critical thinking. And we believe and we've seen evidence of this, that educators know they're going to need to help to get there with their kids. And that's where we come in.

[Richard Robinson:]

Yes, in the children's book area too, Barry, people -- the teachers are returning back to independent reading, getting kids to read more, more fluently, more often, more widely, because they understand that, that's what helps kids develop higher-level thinking skills. And those are the thinking skills that are called for under the Common Core. So our book business is really resonating because of the interest in higher-level thinking skills and the relationship between fluent-broad reading and higher-level thinking skills and learning.

[Barry L. Lucas:]

Great. And just, Dick, if you could flesh out or maybe provide a little more color on the thought process on putting, sounds like more either boots on the ground internationally or building physical facilities versus maybe partnering with others? And how are you thinking about the international side of the operation?

[Richard Robinson:]

Well, certainly, improving our Canadian distribution is going to save money, but basically, we're consolidating several warehouses into 1, it's going to be much more cost effective as well as better for our customers, so that's a no-brainer in terms of that relatively small investment. In Asia, we have a strong publishing program in Singapore. We're developing materials relatively low cost, highly clear in terms of the skills they teach, popular in Asia, but also importing into the United States, the U.K., other places. So we're very proud of that publishing operation. It's a relatively small investment for the company, overall, but it does require more sales resources to operate it. So some of the spending there will be increasing the sales staff in Asia, primarily to sell the materials that are so successful that we've created. Our Consumer Business there, where we're selling direct to families, has been highly profitable, and we're continuing to invest some sales resources in that area. So these are not big resources. There's no partnership opportunities that make sense because this is our intellectual property. We understand it, we know how to sell it, costs are not that great, but they will affect next year's operating performance in the International segments. But the International is a tremendous opportunity for us, the growth of English language, the rise of the middle class, the focus on education, especially in Asia. All of those are prescriptions for a tremendous opportunity for us in those areas, and we have the right kind of materials that people want and need.

[Operator:]

And at this time, I would like to turn the call back over to Richard for closing remarks.

[Richard Robinson:]

Well, we had a very good year. We're looking forward to good progress next year. We are going to be investing more money in our systems and in our content intellectual property. We're seeing a return of independent reading. We are very confident and excited about the future for the company, and we appreciate the support of our investors, stockholders and partners. Thank you so much.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect at this time.