Scholastic Corporation
Q4 2015 Earnings Call Transcript

Published: 23 Jul 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2015 Results and Fiscal 2016 Outlook 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] And as a reminder, this conference call is being recorded. I would now like to turn this conference over to Gil Dickoff, Senior Vice President, Treasurer, and Head of Investor Relations. Please begin.

[Gil Dickoff:]

Thank you very much Latoya, and good morning everyone. Before we begin, I would like to point out that the slides of this presentation are available on our Investor Relations Web site at investor.scholastic.com. I would also like to note that this presentation contains certain forward-looking statements which are subject to the 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 Web site. Again, that's at investor.scholastic.com. Now, I would like to introduce Dick Robinson, the Chairman, CEO, and President of Scholastic to begin today's presentation.

[Dick Robinson:]

Welcome everybody to our year end presentation. We are excited to be here with you. Our results for the year from our continuing operations, which excludes the results of our recently sold Ed Tech business now treated as a discontinued operation, were in line with expectations driven by our revitalized school-based distribution channels and our strong education segment, which includes classroom books, magazines, and instructional programs in literacy. Revenue from continuing operations for the year was 1.64 billion, an increase of 5% over 2014. Operating income from continuing operations, excluding special one-time items grew by 14%. Earnings per diluted share from continuing operations excluding special one-time items were 129 versus 117 in fiscal 2014, an increase of 10%. With enthusiasm for independent reading and for books in schools at a high point, our businesses are performing very well, and we have a tremendous opportunity to build on the favorable market dynamics and grow both our core print and digital publishing businesses and children's books and education. As you know, we completed the sale of the Ed Tech business to Houghton Mifflin Harcourt at the end of May. We also repositioned our media operations so they are better aligned with our core children's book publishing. Accordingly, we now report our results in three segments

[Maureen O'Connell:]

Thank you, Dick. I will review our full year results, and we will refer to our adjusted full year results from continuing operations only, excluding the Ed Tech business which was sold, unless otherwise indicated. For fiscal 2015, total revenues were 1.64 billion, a 5% increase over 2014. Cost of goods sold as a percent of revenues for the fiscal year ended May 31, 2015 remain constant at 46.3%, compared to the prior fiscal year. SG&A increased versus the prior year primarily driven in equal parts by higher promotion expense in book clubs and higher technology spend on strategic initiatives. Operating income was 79.6 million, up 14% from 69.6 million last year, and resulting in earnings per diluted share of $1.29 in fiscal 2015, versus $1.17 in fiscal 2014. Taking a closer look at our technology spend, the higher technology spend in fiscal 2015 is largely offset in depreciation as we capitalized less of our spend during the design phase. As you will hear in our outlook, we expect to incur higher capital expenditures in fiscal 2016 as these strategic systems go live. Overall, technology spend increased by only 3 million for the year. As previously reported, over the course of the year we had been strategically investing in enterprise-wide content and customer management systems. These technology enhancements will improve our data analytics capability and drive closer, more efficient customer engagements. As part of this process, we are moving to cloud-based staff solutions which will give us flexibility to scale our systems up and down as needed. This should lead to lower technology spend and lower technology risk over time. The special one-time items impacting our continuing operations totaled $0.83 for the year, and included pre-tax charges related to unabsorbed overhead associated with the former Ed Tech business, 15.8 million pre-tax, one-time severance paid in connection with cost reduction and restructuring programs, 8.9 million, the non-cash write down of certain production and programming assets and related goodwill taken in connection with the repositioning of the company's media and entertainment businesses, 8.3 million, and the discontinuance of certain outdated technology platforms, 4.6 million. I should remind you that in the future quarters, now that Ed Tech transaction has closed, we will be reimbursed for certain costs associated with the unallocated overhead related to the former Ed Tech business under the terms of a two-year transitional service agreement with HMH. In the interim period, we will begin cost savings initiatives to reduce any unabsorbed overhead burden after the transition has been completed. We also reported charges in connection with the closure of our retail store in SoHo 2.9 million. A warehouse optimization project in Canada, 1.5 million, as well as non-cash pension settlement charge of 4.3 million. All of which we have discussed in previous quarters. In children's books revenue was 958.7 million, an increase of 7%. And operating income increased by 74% to 96.2 million. We were very pleased with performance in this segment which was also a breakout year for book clubs. We had higher level of teachers' sponsorship of our reading clubs in the classroom, and higher student participation rates which resulted in higher revenue. Book fair business also grew as we continue to shift the higher performing fairs. Trade revenues were basically on par with the prior year. Before I move to education, I want to point out that the children's book segment now includes audio and video books, and the associated rights and licensing which were previously in our media segment. In our renamed education segment, the school year revenues was 275.9 million, an 8% improvement compared to 255.1 million last year. Operating income improved by 26%, to 48.4 million. This was the result of continued strength in our guided reading and summer reading programs, as well as in classroom magazines where circulation is now more than 14 million. As a reminder, Instructor magazine, and the digital edition of Parent & Child as well as the associated advertising are now incorporated in our education segment. Like many companies with global operations, our revenue and operating income results were significantly affected by the strengthening U.S. dollar. Foreign currency exchange had a significant impact on our international segment, an unfavorable foreign currency translation impact of 19.7 million in the year. This was the primary factor behind our sales decrease in this segment. Revenue was 401.2 million compared to 413.4 million in the prior year. Excluding one-time items, segment operating income decreased by 4.7 million or 15% due to the higher cost of U.S. denominated product, and increased spending on new products and technology, including a new accounting system. Corporate overhead expense was 91.3 million in fiscal 2015 excluding special one-time items of 30.4 million. Last year, corporate overhead was 55.1 million excluding 27.2 million of one-time items. The year-over-year difference is mainly attributable to approximately 25 million in strategic corporate level technology spend, of which approximately 22 million was offset by lower business-specific technology spend, about 5 million in higher depreciation and facility charges as a result of the purchase of our headquarters building in 2014, which was largely offset by lower interest expense below the operating line and roughly 5 million in higher salary-related expense. Free cash flow, which includes both continuing and discontinued operations was 73.7 million for the year, compared to 63.7 million in fiscal 2014. At year end, cash and cash equivalent exceeded total net debt by 500.8 million, compared to a net debt position of a 114.9 million a year ago. The higher net cash position is primarily due to the proceeds from the Ed Tech sale but does not include 34.5 million of cash proceeds held in escrow pursuant to the terms of the sale of the Ed Tech business. These funds are recorded as restricted cash in our balance sheet. We expect our excess cash position to decline as a result of a pending tax payment of approximately a 186 million related to the gain on the sale of the Ed Tech business. Our balance sheet has never been stronger. The strong financial position will support our focused investment in long term profitable growth initiatives, enable us to return value to our shareholders through regular dividend and share repurchases. Turning to the dividend, as previously announced, the Board of Directors declared a quarterly cash dividend of $0.15 per share on the company's Class A and common stock for the first quarter fiscal 2016. The dividend is payable on September 15, 2015 to shareholders of record, as of the close of business on August 31, 2015. As Dick mentioned, we just increased our authorization for open market buybacks. I am sure you all have questions about our real estate assets. But as we explained in April, we decided to postpone further discussions on any potential monetization of our real estate holdings as we evaluate the appropriate use of proceeds from the sale of the Ed Tech business. We expect the commercial real estate market in New York City to remain strong, and believe the value of retail space in our headquarters will add significantly to our long term resources. Now, turning to outlook, we expect total revenue in fiscal 2016 of approximately 1.7 billion, and earnings per diluted share in the range of $1.35 to $1.55 before the impact of one-time items. Fiscal 2016 free cash flow is expected to be between 35 million and 45 million, compared to 73.7 million in fiscal 2015. The $35 million reduction in expected free cash flow as a result of the payment of one-time transaction-related fees and expenses estimated at 20 million, the impact of Ed Tech sale, estimated at 10 million, an incremental capital spend related to technology spend of 5 million. Our outlook includes capital expenditures of 40 million to 50 million, compared to 30.7 million in fiscal 2015 when most of our technology spend was expense not capitalized, and prepublication and production spending of approximately 30 million to 40 million, compared to 62.5 million in fiscal 2015, which included 33.5 million in prepublication and production spending from Ed Tech and other discontinued businesses. I would remind you that Ed Tech has significant amount of prepublication expense and very little capital expenditure. I will take a moment to provide a bit more color in the assumptions that are behind this outlook. We expect steady, but moderate growth across our children's book and education segment driven by students' enthusiasm for reading, and based more specifically on the following factors. Sustained growth in the low single digits in clubs and fairs will be supported by the emphasis on independent reading, and the continued shift to higher-performing fairs. In trade, we expect to take advantage of market opportunities, particularly in the early childhood, middle-grade series, and licensing. In addition, we had stand out titles scheduled for release in fiscal 2016. Our leadership position in schools for classroom books and classroom magazines will continue to benefit from the higher educational standards. In education, we expect to see continued strong growth, as the current educational standards for language, arts, and literacy will continue drive profitable growth in children's book, classroom books, classroom magazines, and digital subscriptions. And as school in districts seek to improve student achievement and teacher effectiveness, our customized curriculum solutions, professional development offerings, and family and community engagement consulting practices will be in high demand. In the international segment, the emerging middle class in developing countries should continue to drive demand for English language books and instructional material, and our Singapore Math text books which are developed in Asia for the broader market place. However, we expect the U.S. dollar to remain strong, which could impact sales growth in U.S. dollar terms. Overhead is expected to be flat with the prior year. With that, I'll turn the call back to Dick for closing remarks.

[Dick Robinson:]

Thanks, Maureen. In summary, we're executing on a clear strategy that highlights Scholastic's strong core publishing and ongoing education businesses connected to unparallel distribution channels, with presence in 90% of U.S. schools. We're expanding companywide sales by driving greater collaboration among businesses to build broader relationships with children, parents, teachers and school administrators. We're leveraging the use of shared editorial and creative content in titles in print and digital throughout the company, and further developing our international publishing capacity in Asia for the strategic sourcing of educational materials for all of our markets. And we are also improving our enterprise-wide technology platforms for content and customer relationship management, and developing enhanced data analytics to support or sales and marketing strategies for classroom magazines, book clubs, book fairs, and classroom books at the school building level, and our broader literacy solutions at district level. We're excited about all these opportunities, and for the opportunity to focus the Scholastic brand and the Scholastic tremendous resources on a clear core mission that will build profitable growth for the future. Thank you. And we'll open the line for questions.

[Operator:]

Thank you. [Operator Instructions] We have a question from Drew Crum of Stifel. Your line is now open.

[Drew Crum:]

Good morning everyone. Maureen, I had a question on the free cash flow. If you look at where you were in fiscal '15 and what you're guiding to the fiscal '16, you've got a number of puts and takes there, kind of one-time items. What is the more normalized free cash flow level that we should expect for the business going forward, now that Ed Tech is not part of the mix? And then on a related note, where should we expect cash -- your ending cash balance to be at the end of fiscal '16? Thanks.

[Maureen O'Connell:]

Okay. So Drew, as far as our ongoing cash flow, the transaction-related fees are 20 million, that's a one-time item, and the 10 million of Ed Tech cash flow contribution, well, that will be out of our numbers. So I think you can expect going forward that our cash flow would be very similar to our historical levels, but 10 million less for Ed Tech.

[Drew Crum:]

Okay. And the CapEx that you're guiding to this year is elevated [ph] obviously. What is a more normalized run rate for CapEx going forward?

[Maureen O'Connell:]

Also, I should say that our definition of free cash flow in 2016 does not include the $186 million tax payment related to Ed Tech sales. So that is not included, which would write down our cash balance at year end. As far as the normal CapEx, I think the range that we are guiding to today is more normal. If you look at our historical levels that would be the range we are normally in. The last two years we stopped CapEx, particularly in the technology area as we assessed what our corporate level needs were. And most of what we spent last year in technology was expense, as opposed to capitalized, because we were in the design phase. Now we will start capitalizing as we go live with certain systems.

[Drew Crum:]

Got it, okay. That's helpful. And then just moving over to the international business, do you have an expectation for growth ex-foreign currency in terms of sales? And you guys did some investment spending in fiscal '15, does that continue in '16, and how much of a drag is that on profitability?

[Maureen O'Connell:]

So we do expect to grow ex-currency about 4% next year. And this year we grew ex-currency about $7.5 million on that $400 million base. So in real terms, the market currencies are -- the local markets are growing. We're seeing strong growth in Asia, and continue to see double-digit growth. And then single growth in Australia, and the U.K. Canada had some headwinds this year, so they didn't see the same level of growth.

[Drew Crum:]

Okay. Just one more question. It's unclear to me what your sales expectations are for trade. It looks like you've got a pretty good pipeline of content coming. Could you frame up what you're assuming in terms of the growth for the business?

[Maureen O'Connell:]

Well, we had a great success this year with our Minecraft books and series. And so we have to replace that next year. And so even though we have a very strong outlook in pipeline of new products coming out in 2016, we need to replace the revenues similar to what we did this year with Minecraft replacing some of the Hunger Game revenues.

[Drew Crum:]

Okay. Thank you.

[Dick Robinson:]

Thanks, Drew.

[Maureen O'Connell:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] The next question is from Barry Lucas of Gabelli & Company. Your line is open.

[Barry Lucas:]

Great, thank you and good morning. I've got a host of odds and ends, if you don't mind. Maureen, you touched on some normalized numbers earlier, what would be the normalized overhead burden that we are looking at going forward?

[Maureen O'Connell:]

I think right now, the way that we are driving our technology spend we leave it all in overhead, and we're not allocating it out to our divisions. So in absolute terms, overhead only went up for technology by 3 million. So overhead -- I'm sorry; the whole company's technology spend only went up by 3 million. Within our overhead, it looks like a $27 million increase. It is offset primarily in the children's books, with a decrease in spend. So next year you will see flat overhead year-over-year, but remember that's about $25 million, $27 million that sits in overhead that used to sit in the divisions.

[Barry Lucas:]

Okay. And the restricted cash that's sitting on the balance sheet, when those restrictions get listed, or is it somehow tied to these payments that you'll be reimbursed for by the Houghton?

[Maureen O'Connell:]

So the way that the restricted cash works is most of it is tied to our service agreements and meeting certain standards of service. And the money begins to be released in August. It's about $2.4 million will be released in August, and our expectation is that escrow will be released during the year. Right now we are meeting all service level requirements, and we feel we are in a good place with our service agreement.

[Barry Lucas:]

Okay. One on the business and then capital allocation, you touched base on Goosebumps and the movie that's coming out, anything special, I'm sure you're doing some specials. I hope you can provide a little color as to how you prep for that, and what would be the anticipation in terms of revenues or the benefits thereof from the movie?

[Dick Robinson:]

I think that Ellie Berger will answer that question, Barry. Thank you.

[Ellie Berger:]

Well, it's actually already started a pretty ambitious program in anticipation of the movie as you say will come out in the fall. So we already have a big promotion going on in Barnes and Noble, which is off to a great, great start. We have a lot of enthusiasm across the board. In addition to the backlist, which we have refreshed a lot of books, we have five tie-in [ph] books coming out a few weeks in advance of the movie. And we're also leveraging that across all of our channels, and as well as globally. So we have a lot of enthusiasm, a lot of momentum in the market leading up to the movie.

[Barry Lucas:]

So that's part of what you are banking on to replace Minecraft I take it?

[Ellie Berger:]

Yes. That's some of the excitement we have coming into the fall, yes.

[Barry Lucas:]

Okay. Maybe more for Dick now; on the capital allocation, you're talking $315 million net cash after taxes, the restricted cash comes back closing at $350. And then you've got the building. And I don't know, Dick, $50 million repurchase of authorization feels a little skinny.

[Dick Robinson:]

Well, I think the board wanted to respond to the fact that we do have increased cash and we do want to return cash to shareholders. However, we're going to do in this in a measured fashion. And so we chose to do opportunistic stock buybacks as opposed to plan. But we'll keep looking at this, Barry, and knowing that our shareholders are certainly interested in the whole question.

[Barry Lucas:]

Okay. I mean the cash is certainly a drag at -- with practically zero interest rates, it doesn't help performance. Not that we're asking to rush out the money, shouldn't burn a hole in your pocket. Obviously it's not, but it is a drag. And on the building, anything further in terms of color; you've certainly mentioned often enough that the SoHo district is on fire. What are some of the issues that are impeding or swelling the process? I don't want to say impeding…

[Dick Robinson:]

Well, having just completed the Ed Tech transaction, Barry, with those cash which you say is drag, we're not necessarily in a hurry to bring anymore drag into our picture. But as we discussed in our last conference call, we've not entered into any agreement on real estate here in SoHo, but the commercial real estate market as you suggest remained strong for both retail and office space, and interest remains high in our real estate for sure. The purchase of our headquarters location last year was very timely and well executed we think, and we believe our real estate is going to help the company and our shareholders substantially over the long-term, but we're measuring carefully what we want to do with it, and we'll obviously continue to keep you informed when and if we have a plan.

[Barry Lucas:]

Great. Thanks very much, Dick.

[Dick Robinson:]

Thank you, Barry. Good to talk with you.

[Operator:]

Thank you. And I do show we have a question from Drew Crum of Stifel. Your line is open.

[Drew Crum:]

Okay, thanks. Just to follow-up to Barry's question on capital allocation; Dick, can you talk about the board's position on buybacks versus dividends, and philosophically how you approach that? I can appreciate that the $50 million addition to the share buyback, but I know in the past you guys have been reluctant to buyback more stock and -- concerns around reducing your liquidity further given the large buybacks you've done in the past. So can you just address philosophically how the board looks at dividends versus buybacks going forward?

[Dick Robinson:]

Sure. Well, I should remind you that since 2006 we have returned like $560 million to shareholders through a combination of buybacks and dividends. So we haven't been bashful about this over time. The board really didn't stop to consider our dividend policy at this point, Barry, as for this board meeting. I think we're looking to talk about this in our September meeting to figure out for our next year of operation what our dividend policy should be short and longer term. So the lack of an increase in the dividend is not a statement on our long-term attitude toward dividends. At the same time, we are -- sorry, Drew, this is in response to your question, not to Barry. In response to the buybacks, I think again, we will come back to you with a program on the stock buybacks that will be clearer over time.

[Drew Crum:]

Okay. Thanks, guys.

[Dick Robinson:]

Thank you.

[Operator:]

Thank you. At this time, I would like to turn the call back over to Richard for any closing remarks.

[Dick Robinson:]

Thanks very much. We've had a complicated fiscal year to explain. I hope we did that to your satisfaction. We are focused on our core business operations going forward. We are excited about the changes in our marketplace that are giving us great optimism about our near-term and long-term future. We are focused on our core children's book operation, or expanding education operations, and we are building in our international for the long-term. We thank you for your support and interest, and we look forward to talking to you again in September.

[Operator:]

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

[Dick Robinson:]

Latoya, thank you…