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John Wiley & Sons Ltd. (NYSE:JW.A)

Q2 2013 Earnings Call

December 10, 2012 10:00 am ET

Executives

Stephen Smith – President, Chief Executive Officer

Ellis Cousens – Executive Vice President, Chief Financial Officer

Analysts

Drew Crum – Stifel Nicolaus

Michael Corty – Morningstar

Ian Whittaker – Liberum Capital

Daniel Moore – CJS Securities

Operator

Welcome to the John Wiley & Sons’ quarterly earnings call. Before introducing Steve Smith, President and Chief Executive Officer, I would like to remind you that this call is being recorded and may include forward-looking statements. You should not rely on such statements as actual results may differ materially and are subject to factors that are discussed in detail in the company’s 10-K and 10-Q filings with the SEC. The company does not undertake any obligation to update or revise forward-looking statements to reflect subsequent events or circumstances.

Mr. Smith, please go ahead.

Stephen Smith

Good morning. Thank you for participating in Wiley’s fiscal year 2013 second quarter investor conference call. Ellis Cousens, Executive Vice President and Chief Financial and Operations Officer, and Brian Campbell, Director of Investor Relations are with me on the call. I’ll take a few moments to provide an overview of Wiley’s performance in the second quarter and we will then respond to your questions and comments.

But first a quick update on my health situation. Wiley disclosed in September that I would be having follow-up radiation and chemotherapy treatment following my earlier treatment for urologic cancer a year ago. I’m happy to report that I am now at the end of that treatment and that my doctors are pleased with my progress and response. Of course, we will keep you informed of any future developments.

The prolonged economic downturn continues to depress revenue growth in the markets where Wiley competes, resulting in disappointing performance for the company at the midyear. Structural changes in our markets that we had anticipated and prepared for appear to be accelerating. While these changes in market conditions will open exciting new opportunities for Wiley in the medium term, we are concerned about the pressures on our core businesses in the short term. In response, we will move quickly to restructure the cost base supporting those core businesses to generate significant cost savings. Those cost savings will be deployed to generate improved financial results as well as to support further investments in transformational growth opportunities in the longer term.

Wiley’s revenue declined by 3% in the second quarter, both including and excluding the effects of foreign exchange. Currency-adjusted revenue growth of 0.5% in STMS was offset by declines of 7% in professional development and 6% for global education. Tight library budgets, sluggish retail sales, and an unexpectedly sharp decline in the higher education textbook market affected the top line results.

Adjusted EPS for the quarter decreased by 4% to $0.77 per share, excluding foreign exchange. Adjusted EPS excludes an asset impairment charge of $0.16 per share and a 10% per share gain related to the consumer publishing assets sold in the quarter and those remaining to be sold or discontinued. Adjusted earnings performance is due to top line results and higher interest expense partially offset by operating and administrative expense control measures.

For the six months, revenue of $842 million declined 4% or 2% on a currency-neutral basis. Adjusted EPS for the six months fell by 13% excluding foreign exchange to $1.29 due to top line results and higher interest costs partially offset by cost control measures. Adjusted EPS for the six month excludes the following one-time items: consumer publishing gain on impairment of $0.06, restructuring charge of $0.06, and a U.K. tax benefit of $0.14 per share.

Year-to-date gross profit as a percent of revenue was 69.5%, 0.6% below the prior year figure of 70.1% reflecting lower print book volume across all three businesses and higher composition costs in global education partially offset by high margin revenue in professional development from the Inscape acquisition and the transition to digital products.

Year-to-date shared services and administrative costs of $190 million, excluding foreign exchange, declined by 1% due to lower distribution costs in connection with the transition to digital products and corresponding lower print sales volumes, and lower occupancy costs primarily related to overlapping rental expenses for new facilities in Asia and the U.K. in the prior year.

Free cash flow for the first six months was a use of $143 million, $55 million greater than the prior year. The increase was driven by higher cash use for operating assets and liabilities primarily due to a disputed tax payment in Germany and the timing of journal subscription receipts, as well as lower cash earnings. Net debt – that’s long-term debt less cash and cash equivalents – increased from prior year by $182 million to $609 million. Higher borrowings included $220 million to finance the acquisition of Deltak.edu in October.

Now I’d like to provide some information regarding the performance of Wiley’s global businesses. STMS second quarter revenue of $250 million increased by 0.5%, excluding the effect of foreign exchange. Currency-neutral journals revenues grew by 1.4% over prior year, reflecting modest underlying calendar year 2012 subscription growth, funded access and digital book sales growth partially offset by lower back file sales, lower advertising revenue, and a decline in print book sales. Calendar year 2012 journal subscription growth is up 1.8% year-to-date. It is still early in the calendar year 2013 journal subscription renewal process and we are working closely with our customers on a large number of significant license renewals. Early indications both on 2013 business closed to date are that our growth rates will be similar to those experienced in calendar year 2012.

The STMS book business for the quarter was down by 3% against prior year on a currency-neutral basis, reflecting tight library budgets. Solid growth in digital book revenue, which is up 14%, was more than offset by a 10% decline in print book revenue with the declines coming from all regions, but particularly from Europe. Direct contribution to profit for the quarter of $109 million was 2.5% ahead of prior year on a currency-neutral basis.

For the six months, STMS revenue declined 1.6% on a currency-neutral basis to $486 million, reflecting lower journals reprint and advertising sales, lower back files and print book sales partially offset by the growth in digital books and digital rights. At the midyear point, digital books are showing solid growth, up 24%, while print book revenue declined 9%. Year-to-date direct contribution to profit declined by 4.5%, excluding foreign exchange.

In the quarter, STMS signed new contracts with societies to publish five new journals with combined annual revenue of $2.4 million and renewed or extended contracts to publish 14 journals with combined annual revenue of $7.4 million. We lost no journals in the quarter.

For the 12 months ending October 2012, full text accesses on Wiley Online Library increased by 12% across all product types compared with the same period a year ago. In the second quarter, the company launched its functional chemistry program on Wiley Online Library. This program represents a significant enhancement to our digital publishing capabilities and is expected to lead to increased usage of our chemistry content, longer session times, greater up-sell opportunities for related content, and increased user engagement and satisfaction.

Eight Wiley STMS authors were named amongst the list of 2012 Nobel laureates. Wiley authors were joint winners of the 2012 Nobel Prizes in chemistry, physics, economic sciences and physiology of medicine.

Second quarter professional development revenue of $101 million declined 7.3%, excluding the effect of foreign currency. The decline is largely attributable to softness in consumer categories, which were $8 million below prior year, particularly the divested categories cooking and travel, partially offset by higher e-book sales and other digital revenue, including $5.5 million from the Inscape acquisition. Approximately $2 million of revenue was delayed until November due to Hurricane Sandy distribution interruption.

For the six months, professional development revenue of $204 million declined 1.9%, excluding the effect of foreign exchange. Excluding the divested consumer categories, sales of the retained businesses are approximately 1.2% ahead of prior year for the six months.

In August, Wiley sold its travel publishing program, including the Frommer’s brand, to Google for $22 million. In November, Wiley announced the sale of its culinary, Cliff Notes and Webster’s New World Dictionary consumer publishing programs to Boston-based global learning company, Houghton Mifflin Harcourt for $11 million. In November, Wiley acquired Efficient Learning Systems – ELS Inc., an e-learning system provider in areas like professional finance and accounting, for $24 million. The acquisition helps Wiley become a leader in growing global online CPA exam preparation market and will accelerate our e-learning strategies with capabilities that could be scaled to other accounting and financial certifications. Annual revenue is expected to be approximately $7 million. As a result of these divestments and acquisitions, Wiley Professional Trade changed its name to Wiley Professional Development, signifying our strategic focus on professional career development.

Revenues in the business finance categories continue to grow, powered by our partnership with the Chartered Financial Analyst Institute and the growth of Inscape. Digital book revenue grew 17% to $11 million in the quarter. We expect to see a further increase in e-book sales following the release of a number of new digital reader devices in the coming holiday period. We have signed new distribution agreements with a large number of e-book vendors in Europe, Asia and Latin America in recent months.

Gross profit margin for the second quarter was 64.2%, up about 1%, while for the six months gross margin profit margin improved slightly by 0.3 percentage points to 63.7% due to the growth of digital sales and high margin revenues from Inscape. Digital sales now account for over 20% of total PD sales.

Adjusted direct contribution to profit for the quarter declined 13% to $26 million, excluding foreign exchange, asset impairment charges of $16 million, and a $10 million gain on the sale of travel publishing operations. For the six month period, adjusted direct contribution to profit declined 6% to $48 million. The drop in adjusted direct contribution reflects lower top line results, higher gross margins from digital products, and cost controls.

Second quarter global education revenue was down 6.3% to $81 million, excluding foreign exchange. The decline reflects a 14% drop in sales of traditional print textbooks due to lower enrollment in the for-profit segment, changes in student buying patterns, the impact of rental and the build-up of rental inventories in the prior year, and lower print inventory held at bookstores. According to published industry data, the U.S. higher education market declined by 4.5% from January to October, during which period Wiley’s U.S. sales decreased by 3.4%. Non-traditional and digital revenue in the quarter, which includes Wiley Plus, e-books, digital content sold directly to institutions, binder additions and custom publishing was up 10% to $30 million.

For the six month period, global education revenue declined 5.8% to $153 million due to lower print textbook sales. Wiley Plus revenue was up 25% for the six months year-to-date while sales of e-books and digital content direct to institutions were up 29%. Digital revenue now accounts for 15% of total global education revenue, up from 11% a year ago. Global education direct contribution to profit for the quarter was down 12% at $29 million. The decrease reflected top line results and lower gross profit margins partially offset by cost reduction initiatives. For the six months year-to-date, direct contribution to profit was down 15% to $51 million.

We were pleased to announce the acquisition of Deltak for $220 million in the second quarter. Deltak, based in Chicago, has been highly successful for the past 10 years as an independent company in the fast-growing area of creating and managing online degree programs for traditional non-profit colleges and universities. This acquisition positions Wiley as a significant educational services provider. We have expanded beyond content, becoming a larger part of the services and content value chain for how people teach and learn. Through Deltak, we will now provide a complete solution to help traditional colleges and universities transition their programs into valuable online experiences offering market research, instructional design, marketing, and student recruitment and retention services with the goal of boosting the quality and efficacy of online and hybrid programs.

Deltak provides Wiley with access to high growth markets with a high revenue per student ratio and a variety of capabilities and technologies for our expansion into custom online courses and curriculum development. Wiley offers Deltak a stable base for new program investment, the ability to accelerate their growth globally, access to professional consumers, and expanded offerings of content and faculty development. The combination of Wiley and Deltak yields significant opportunities to accelerate growth and to drive improvement in profit margins and return on investment in the years ahead.

In conclusion, our disappointing revenue and EPS performance at midyear reflects the continuing softness we are facing in many of our markets, particularly for higher education. The Wiley leadership is intensely focused on the need to improve the financial performance of our core business, even as we innovate to create new business opportunity and revenue streams that leverage Wiley’s unique combination of talent-rich content and enduring customer relationships. The comprehensive program of business restructuring and cost reduction initiatives which I spoke earlier will focus on areas such as sourcing and procurement of third party services, cost of sales and direct expenses. It will also evaluate the structure of our product acquisition, product development, marketing and sales organizations to ensure that resources are aligned with future market opportunities. While continuing to invest in our future, we believe we can identify significant opportunities to adjust our cost base with the aim of improving profitability, earnings and return on investment for the business as a whole in fiscal year 2013 and beyond.

Based on our first half results and expected market conditions, we are lowering our full-year revenue guidance from mid-single digit growth to flat. As a result of the lower revenue, we are reducing guidance for U.S. GAAP EPS to $2.95 to $3.05. This includes the impact of weaker than expected operating performance, modest dilution from acquisitions made this year, the net negative impact from the divestment of consumer businesses, the first quarter $0.06 restructuring charge, $0.14 benefit from changes in U.K. tax rates, and forecasted $0.02 of negative foreign exchange. At present, we do not have all the information required to quantify the earnings impact of additional restructuring charges that may result from accelerated cost restructuring actions yet to be taken this year.

With that as background, we welcome your comments and questions.

Question and Answer Session

Operator

Thank you. [Operator instructions]

And we’ll take our first question from Drew Crum, Stifel Nicolaus.

Drew Crum – Stifel Nicolaus

Okay, thanks. Good morning everyone. So want to ask some additional questions concerning the restructuring and the cost savings, both for Steve and Ellis. Can you give us some sense as to what the cadence will look like or the timing of those restructurings, and any clarity or discussion you can provide around the magnitude of the cost savings you’re anticipating would be helpful.

Ellis Cousens

Okay, Drew. You want to start, Steve, and I’ll pick up?

Stephen Smith

Well, it’s going to be quickly handed to you, Ellis. But just to say that we’re not—at this point, we’re not able to quantify the financial impact of those restructuring savings, but we do expect to be in that position by March. And I’ll let Ellis talk qualitatively and to the timing of those.

Ellis Cousens

Yeah, thanks Steve. So Drew, as Steve says, as I think you know from prior history with us is that our planning cycle runs from pretty much December to March. In March, the Board approves an operating plan for the coming year. I think we’ve also been pretty clear that given that $4.8 million charge we took in the first part of the year, that we’re already in this year undertaking a number of cost restructuring activities that when we disclosed that and discussed that at the end of last year and in the first quarter, that the benefits of those will come over the next 18 months, meaning 18 months from the beginning of this year. So some of those savings are reflected in some of the performance of the business to come, very little in the first half, a little bit in the second half to come. These activities go above and beyond that. We’re in the midst of planning those activities and building those into our FY14 through ’16 plans, so we would expect that when we get to March, we can give you a lot of clarity about the size of that overall initiative and quantify that, the areas it will affect and the periods of time in which we should realize savings.

I can tell you that we’re focused intensely on driving benefits to the bottom line and for reinvestment in some cases over the course of the balance of ’13 and in ’14. Whatever is included in ’13 is included in the guidance we’ve provided, so it’s not incremental to that; but clearly a lot of the activities will be undertaken over the course of fiscal ’14. They’re in areas that we’ve talked a little bit about in the past, but with greater focus. I know we’ve talked about strategic sourcing and procurement. You can see some of the benefits of that already in our technology area. As you might recall, we have retained a new chief technology officer, a CTO who started earlier this year. Two principle focuses or three principal focuses of Patrick around technology, one had to do with effectiveness and efficiency of delivery; the second was to ensure that we had the right kinds of skill sets onboard to transform this business in a more efficient and effective way; and the third was to generate savings or a deflection of the curve from that sort of high teens growth to a growth trajectory that was more moderate than that. I think you’ll see some of that benefit over the course of this year, and by the time we exit this year you’ll see the benefits there, some of that, again, coming from strategic sourcing. We’ve consolidated all of our third party services into two providers from a significant number of providers previously, so we are realizing savings already, some of which, again, is reflected in the first half of the year and more to come in the second half of the year, and then more to come again in the years to come beginning in ’14.

We’re also looking at initiatives that Steve identified in the areas of cost of sales and direct expenses in just those areas that Steve had highlighted. Again, we’ll put together a consolidated structure plan and communicate that in March in detail.

Drew Crum – Stifel Nicolaus

And then just another follow-up question, and thanks Ellis on that. Does it change or accelerate how you think about the margin profile for the company? I think at your investor meeting, you talked about starting to see some benefit from the investments you were making around technology in the next 18 to 24 months. With this accelerated focus on restructuring, does that in any way accelerate the margin expansion or does it alter the outlook for the margin profile for the business?

Ellis Cousens

It should certainly accelerate, but that acceleration would come in ’14, not in ’13. I think if you sort of tee up the time sequence of when I made that statement, that statement would take us to the end of ’14, and certainly the performance of the business has disrupted that somewhat. So we’ve clearly identified the need to take additional actions to in fact reflect market realities, as we noted in the earnings release and also in Steve’s comments, is that how the market responds to some of the print products that we’ve provided in the past is quite different. Some of that relates to economics and the economic downturn; some of that relates to just structural changes and how people are consuming many of the things that we provide in print, as well as the industry does. We see that most prominently, I think, in global education.

As a result of that, we are as part of changing the expense trajectory and improving margins from where they are certainly and where they could have been, we’re going to take a look at how it is we support those kinds of activities that certainly in the present and the future are performing and behaving quite differently. So we need to structure our costs to reflect those realities, and in fact get ahead of that in terms of anticipating continued market changes with respect to those, how those products behave and perform in the marketplace.

So sorry for the long answer, but the short of it is that we will be back on track to the margin improvements that we had anticipated by the end of ’14, but it’s going to take us to ’14 to do that because of this rather somewhat surprising and rapid change, particularly in global education, and some of the things that we had anticipated certainly with respect to restructuring our professional development businesses away from consume and more towards professional. There will also be some benefits coming certainly from the acquisitions that we’ve made. Inscape is a high margin, high growth business; Deltak is a high growth business with margins above the average margins of Wiley overall, so those will certainly add benefits, as will ELS in a smaller way. So certainly there are benefits to come, again mostly in ’14 and beyond with respect to those acquisitions, both from how they perform themselves but also in terms of accelerating some of the digital strategies and transformational strategies we have been pursuing.

Drew Crum – Stifel Nicolaus

Okay, thanks Ellis. And Steve, just going back to global education, can you talk about from your perspective what the keys are to turning the business and maybe for the fortunes for the U.S. industry? I think the headwinds have been known for some time and been pretty well articulated. In your mind, what are the keys to turning the business?

Stephen Smith

Yeah, I think what we are seeing over the course of the last year or two is an acceleration of a process of transition to digital business that has been ongoing for some time, but it’s absolutely clear that the pace of that change has accelerated and at the same time we’ve seen the introduction of new business models in the world of print, particularly around rental, that have accelerated the decline of that side of the business. So we feel well positioned to take advantage of the future growth of digital business opportunities in global education. I mentioned the growth of Wiley Plus. That 25% growth year-to-date is also backed up by a significant increase in the validation rate, so you’re now seeing validation rates of around 78% of students who buy Wiley Plus. That improvement has been fuelled in large part by growth in e-commerce sales as well as by the integration of Wiley Plus with Blackboard, where we see particularly high validation rates as students find it very easy to integrate Wiley Plus into the whole learning experience.

And of course, the acquisition of Deltak, I think, signals very clearly something that we’ve been saying for some time. We aspired and have talked about our aspirations to become much more of an educational services provider, recognizing that while our content remains a very high value, in order for us to continue to improve returns on that value and to yield the kind of return on investment we’re looking for, the addition of high value-added services to institutions, to teachers and to students is seen as a critical part of our growth plan. So we are very pleased to have this opportunity with Deltak. We believe that over the course of the next few years, we will see more and more growth opportunities from the services side of that business.

There are some things about the decline of print sales that certainly reflect some uneven patterns within market channels over the last two years, so we’re expecting to see that normalize a little bit. I’m really referring here to the gearing up of an industry to support the rental business model, and at the same time our brick-and-mortar stores in particular are adjusting their inventory holdings, so we have a lot less inventory out in the marketplace today than we would have had, even a short while ago. So it’s a story we’ve been talking about for a long time. What I see is we are approaching a point where the digital business models really begin to become the predominant source of growth for the business going forward, and as I say, I feel—or we as a leadership team feel good about how Wiley is positioned to compete in that market.

Drew Crum – Stifel Nicolaus

Okay, great. I’ll just ask one last question and jump back into the queue. Can you quantify the impact from the hurricane in terms of EPS impact in the quarter?

Stephen Smith

Ellis?

Ellis Cousens

Yeah Drew, it was about 4 million in revenue, so EPS on the margin was maybe a penny or so.

Drew Crum – Stifel Nicolaus

Okay, got it. Okay, thanks guys.

Ellis Cousens

By the way, we’ve picked that back up in the third quarter, so those deliveries were made right after the storm.

Drew Crum – Stifel Nicolaus

Got it, okay. Thanks, guys.

Operator

And we’ll take our next question from Michael Corty with Morningstar.

Michael Corty – Morningstar

Good morning. Thanks for taking the question. I actually have a few. In regards to the comment about the new market reality and in terms of a long-term projection, is that just your existing businesses might be more in the low single-digit growth range versus maybe what you’d hoped for in the past in terms of mid-single digits? And then a second one – in terms of Deltak, you’ve talked about having the content but needing to provide the service to improve returns. Can you talk about the competitive landscape, kind of where Wiley fits in with Deltak, because I would assume that there’s other competitors looking to improve their returns as well.

Stephen Smith

Sure. So in terms of the new market reality, if you like, I think we’ve been on a continuum for some time of seeing growth rates of our core businesses have begun to moderate as customers find alternative ways to acquire content sometimes at lower price points, and as we see some consolidation in distribution channels. I think the key thing here is really the pace of transition from print to digital. We’ve been talking about that and anticipating that for at least 10 years on these calls, but I think we see that partly driven by economics and partly driven by customer preference a real rapid acceleration of that. And so our key challenge here is really to manage the decline, and there will be an absolute decline in print revenues going forward, not just low single-digit growth but perhaps absolute declines. But those revenues should transition directly to digital revenue that would still yield growth overall for the core businesses. I think characterizing the core business as being—looking forward, and we don’t give guidance obviously beyond a single year, but something that has been similar to the pattern of the last few years is a reasonable projection at this point.

To answer your question about Deltak and the competitive landscape, probably the transaction that some of you may have seen that most paralleled our acquisition of Deltak was the Pearson acquisition of Embanet in the last quarter. Embanet and Deltak are in very similar businesses. It indicates that what we see as being a critical and exciting future opportunity for Wiley probably parallels what somebody is seeing at Pearson. That business has been growing very nicely over the last 10 years – I’m talking here about the general course creation and course development market. It is a relationship business that is founded on the ability to partner with institutions of learning in order to offer them complete turnkey solutions to launch new course offerings and to offer course offerings that are closely tied to employment opportunities for students, so there’s a real focus on value for the university, value for the student.

I think it’s a terrifically exciting business model. I’m sure there will be others who will seek to compete in that marketplace, but again, I feel that we’re early movers there. Deltak has a really enviable track record of growth and has some fantastic relationships based on very long-term commitments with those customers, and it’s something that we are really excited about being able to build upon, not just in traditional not-for-profit university sectors but also leveraging the capabilities globally where Wiley has a strong presence around the world, and also with our customer base in professional as well as those learning societies that we serve in STMS. So there are some really attractive synergistic opportunities there.

Michael Corty – Morningstar

Okay. And then one more – just on the STMS business itself, I know you’re still squeaking out a little bit of growth on the subscription business. Do you get a sense of it’s a tough market out there? I know I’ve asked in the past and it’s hard to get real solid market share data, but do you think you’re gaining share in those markets and your sales are growing faster than some of your competitors? What’s the competitive landscape there in terms of Wiley maybe gaining some market share in a tough environment?

Stephen Smith

As we look at it, there is a real benefit to scale in that marketplace. There’s also a real benefit to having the highest quality, so there is clearly a bit of a move to quality going on as budgets continue to tighten. That benefits those companies with a broad portfolio as well as those with the highest quality content, and Wiley stands to benefit from that. So we believe that we are continuing to take market share both in terms of subscription growth for our existing content but then also through our growth and addition of new content through new society agreements, and I’ll remind you that in January we’ll take on another major society agreement with the American Geophysical Union that will add a lot of growth in calendar year 2013.

So we see ourselves taking growth there—sorry, taking market share, but growth of the market overall is not totally heterogeneous around the world. So we continue to see pretty attractive mid-single digit growth rates coming out of Asia. Again, it’s not uniform but our experience over the last couple of years has been that Asia is outgrowing the rest of the world. We’ve been pleasantly surprised by our performance in North America where subscriptions have held up very nicely and we’ve continued to see good growth, but not surprisingly we’ve run into some significant challenges in some parts of Europe and more lately the Middle East as the impact of the deep recession bites, particularly in southern European countries, as well as some impact from political and economic situations in the Middle East where we’ve seen some medium-sized markets disappear, at least in the short term, as we’ve been unable to serve customers in that region. We don’t see that as being structural, but it will require some stabilization of markets and the situation in Europe and the Middle East.

Michael Corty – Morningstar

Okay, thank you for your answers.

Operator

And up next is Ian Whittaker of Liberum Capital.

Ian Whittaker – Liberum Capital

Hi there. Two questions, please, both on higher education. First of all, can you just comment on your thoughts of what California is doing. They have passed their bill on open source textbooks, and that’s due to come into effect from January 1; and given that the price points they’re talking about – digital content free and print content for $20 for some of their most popular courses – I just wondered whether you think could potentially be a big threat in terms of pricing deflation.

I guess the second question is more of a longer term one. You’ve been very open about the problems facing the industry and sort of your hopes that the transition of print to digital will see growth come back to the overall business in higher education at some point. But can you give sort of a view in your thinking as to how long that will take, and I guess part of the concern there would be that the message that you are giving is similar to what, for example, the newspaper industry has been giving for a number of years now, talking about digital sales eventually offsetting the declines in print; and in virtually all cases, that has just not happened and in fact in some, you’re now starting to see newspaper digital revenues go backwards. So I’m just wondering sort of how long you think this will take and why you think you’re probably a little bit of a different example to, let’s say, newspapers or other industries that have said that digital will offset analog declines but haven’t really seen that come through.

Stephen Smith

Right. Yes, thanks. Taking your first question on open source textbooks, we continue to monitor all of the developments in the area of open source textbooks and the growth and increasing interest around so-called MOOCs – Massive Online Open Courses – that are being offered by several institutions for free. In California particularly, the California digital library and the move towards the creation of a library of content of open source textbooks, it’s not surprising to us that California has driven towards that more aggressively than some other states or other parts of the world, given the economic changes facing California.

In the immediate term, we haven’t seen any impact that we can discern in terms of lost sales as a result of competition from open source textbooks; in fact, one for-profit provider in that space who had a similar model of digital books free and charging for print has recently moved that model to charge for digital as well, finding that frankly free is a fallacy. If there is going to be quality in the creation of these open source textbooks, if they’re going to be well authored and well reviewed, and if they’re going to meet the needs of students in terms of better student performance and ultimately employability, then that requires significant investment both in the creation of the content but also in its digitization distribution. We don’t see free as being sustainable – someone has to pay for it, whether that’s the taxpayer or whether it’s paid for by the consumers of that content.

So I would never be dismissive of changes like this. We don’t, frankly, see this as a great use of taxpayers’ money to develop or to reinvent something that a marketplace has already—has been working well for generations and it serves the needs of teachers and students. We believe that we can continue to differentiate ourselves by the quality of authorship, by the quality of the content that we provide, but also increasingly as I mentioned earlier from the quality of the value-added services that we wrap around that content in areas like assessment, student support, as well as teacher support.

So it’s interesting what’s happening in California. We don’t perceive that to be an immediate major threat, but something that we’ll continue to monitor and make sure that we position ourselves to be able to sustain our position on that value chain.

With regard to how long this transition to digital will take and whether there’s a parallel to the newspaper industry, no one can say for sure where the tipping point is or where it will suddenly flip to a world where it’s primarily digital. But I would certainly say with a pretty high degree of confidence that the pace of that trajectory is accelerating on a monthly basis and that we seem to be moving much more quickly towards acceptance of digital content, acceptance that online learning or blended learning can be at least as effective as face-to-face, moderated teaching. So that represents to us more of an opportunity than it does a threat, but it would be absolutely in our interest to see that migration from print to digital happen even more quickly, which again is why we’re making the investments we’re making in product like Wiley Plus and in the acquisition of Deltak.

I don’t believe that the analogy to the newspaper is a particularly valid one. Newspapers are offering really a platform for advertising. That clearly comes up against a whole range of alternatives, whereas what we’re really focused on is providing the best student experience, the best student outcomes, and helping drive further efficiency in terms of the delivery of education. Our customers are still paying us for content and they are increasingly paying us for additional services alongside that content, so it doesn’t feel to me like we’re in anything like the same situation that newspapers would be with their heavy dependence on advertising.

Ian Whittaker – Liberum Capital

Can I just come back to your answer on the first question? I mean, accept those points are valid, but if you look at California and, indeed, Washington which had a similar program, both of them, their funding is coming from the State itself and both of them have co-opted in the state education institutions and professors into devising their open source textbook programs. So as I understand, I know with Flat World Knowledge they sort of scrapped their free book service, but surely it’s a little bit different if you’ve got the states themselves who fund the educational institutions who are pushing the open source textbooks at such a cheap price rather than, let’s say, a for-profit provider.

Stephen Smith

Well, I think the questions that remain to be answered, and we’ll be looking very closely to see if they answer those questions, really relate to breadth of offering, so how much of the curriculum they’re able to cover and with what degree of quality. Until we see that and we see student performance, I think it’s just bears watching. But I’d also reiterate if they are going to cover the full breadth of the curriculum with high-quality content, with high-quality teaching and learning platforms, with all of the assessment and other capabilities wrapped into that, then it’s going to have a very high cost.

Ian Whittaker – Liberum Capital

Thank you very much.

Operator

And as a reminder, it’s star, one to ask your questions today. We’ll turn next to Daniel Moore of CJS Securities.

Daniel Moore – CJS Securities

Thank you. Can you talk—remind us when you expect the closure of the remaining consumer businesses to be completed, the divestment? And beyond that, are there any other segments of the remaining portfolio you might consider non-core or potential divestment candidates?

Stephen Smith

Sure. Let me start on that, Dan, and then Ellis can jump in. So there are a few categories remaining after the divestment of travel, culinary, Cliff Notes and Webster’s New World – in particular, our general interest publishing program. We are still in conversations with potential acquirers of those businesses, and those conversations are ongoing so I can’t speak to them in detail, only to say that we are well prepared now to begin to wind up those programs if and when we determine that we’re not going to complete a transaction at terms that are attractive to Wiley. Our colleagues who have ably managed and led those businesses are all well briefed and understand what we need to do in order to wind them up.

So Ellis, I don’t know if you wanted to add anything on that?

Ellis Cousens

Yeah, I think that pretty much covers it, Steve, so those programs to the extent that there is a potential to sell any of those remaining businesses, which are Howl House which is pets, and nautical are the two largest pieces. To the extent that there’s a possible sale there, it would be modest, quite frankly, and we’re behaving from a publishing perspective as if we’re winding those businesses down, so we’re not engaging in new publishing, so to speak. The plan is to run that business through the next few months to its logical conclusion.

Stephen Smith

Then on the second half of your question, Dan, as to whether there are any additional programs or areas within Wiley, we continue to evaluate and analyze our entire publishing portfolio with a view the future opportunities to make sure that we are resourcing things appropriately. There is nothing that we see today that does not fit with our vision of where Wiley is headed. As we look at some of the restructuring opportunities and cost saving opportunities, we will be looking at programs that are in areas where there is high growth potential and putting more resources behind those, and at the same time consolidating or reducing the resources that support businesses that are seen to be highly immaterial or in potentially low growth mode for the future. But nothing else that we would identify as being ripe for divestment.

Ellis Cousens

I would just add to that, Dan, that as part of as Steve describes the cost restructuring opportunity, we’re also looking at—I guess I would call it portfolio fine-tuning and pruning where there may be pieces of business that are performing less than we would like them to. We could look to determine if there is an investment opportunity to restore growth and acceptable levels of profitability, but if not, because of the views of the business and where the markets are headed, those would be candidates for us to wind down as well. It’s sort of typical portfolio pruning and tuning. I mean, we do that pretty much on an ongoing basis, but for it not to be lost in the answer or the discussion around those things.

Daniel Moore – CJS Securities

Thanks. And in terms of technology spending, can you give us your expectations for technology spending growth for the remainder, perhaps, of fiscal ’13? Obviously it was flat in the quarter. Are there programs or opportunities that are perhaps being delayed or pushed out, given the need to look at the cost side of the equation a little bit more closely?

Ellis Cousens

Dan, I partially answered that question in response to an earlier question, all to say that is in the first half the rate of spend was affected by a few things not having to do with any particular view having to do with cost considerations but having to do with sort of the cadence of spend against particular initiatives, but also that we had undertaken some efforts to reduce costs on a structural basis which we would have done in any set of circumstances in the first half into the second half and, again, into fiscal ’14. Having said all of that is that the timing of expenditure is such that – and this is not atypical – is that the second half will be a bigger half, so to speak, with respect to spend, some of that having to do with some change-out in activity and skill sets that positively affected the first half that will, quote, negatively from an expense perspective affect the second half.

However, the rate of spend in the second half is not a rate that one should take as an annualized spending rate. I can tell you that it will be below that sort of mid to high-teens rate when you add it all together, and even the second half will be something clearly higher just by virtue of how I’m talking about it than the first half, so something in the mid-teens or so. But I wouldn’t characterize that as the run rate going forward, so the effort here, which we’ve successfully and are successfully working on, is to reduce the rate of spend in technology, or inflect or deflect the growth rate downward somewhat so as to not see in the future on a sustained basis mid to high teens growth, but it could periodically sort of bounce around up or down, as we’re seeing this year. But in effect, by the time we exit fiscal ’13, we’ll be on a run rate basis at a level lower than we were when we exited the prior year, or lower than where we would have been, I should say, than had we not taken some of the actions that we did take in fiscal ’13. And again, most of those are structural actions. There isn’t a lot of one-time stuff associated with that.

So clearly what we’ve done here, just to make sure that it is clear, is to look carefully and focused at our technology spend, beginning with the retention of a chief technology officer who is taking a careful look at both the nature of delivery, quality of delivery, the effectiveness and efficiency of spend – all of those things taken together, and has seen some pretty significant opportunities to, shall we say, get more for what would have been less, so to speak. So we feel better about the effectiveness of our technology organization and we see a greater efficiency around spend in the technology organization.

Daniel Moore – CJS Securities

Helpful. And lastly, just switching gears, perhaps give us a little bit more detail around Deltak with regards to anything you can tell us about operating margins, the operating model itself, how much of the revenue is recurring and what the incremental margin profile looks like in that business. That would be very helpful.

Ellis Cousens

Steve, I can sort of start on that and if you have anything to add, either quantitatively or qualitatively, certainly please do so.

So as we noted in the earnings release, there’s about $36 million or so of revenue that will come from Deltak this year. That’s a half-year’s worth of revenue. We have noted that the growth rate around Deltak is extremely high, meaning top line growth rate. If you just look at that historically, and that is public information, the growth has been significant double-digit growth over the last couple of years or so. We expect that to continue. I’ll characterize it as the operating margin associated with Deltak is on average higher than the average margin of all of Wiley; however, it is not a high margin play, so to speak, with respect to acquisition. What it is, is a high growth play in a market that we felt we could serve very effectively with the inclusion of their capabilities at a margin which is attractive, so I guess I would characterize that way. Whereas something like Inscape, which is smaller in scale, certainly is both high growth and high margin but coming off of a smaller base. I know you didn’t ask about Inscape, but just to characterize it.

Daniel Moore – CJS Securities

Okay, thank you very much. Obviously Steve, very happy to hear the positive news and we look forward to seeing you both at our coming January conference.

Stephen Smith

Appreciate it. Thanks, Dan.

Operator

And we go back next to Michael Corty of Morningstar.

Michael Corty – Morningstar

Yeah, I just had one more. I know you’ve invested a lot in the business recently, and so the balance sheet has changed just a bit. I just wanted to get your thoughts in terms of capital allocation over the next few years. Maybe more specifically, if the market disagrees with your optimism at a certain point, would you be thinking about going back into the market and buying back some of your shares?

Ellis Cousens

Thanks for the question, Michael. We have 2.1 million shares of open authorization from the Board of Directors. As you saw, we were not active in the second quarter in share repurchase. We were focused on and were anticipating the acquisition of Deltak and the expenditure of $220 million on that, coming on the heels of the acquisition of Inscape a couple of quarters before that, and also the acquisition of ELS at a more modest level but certainly a price nonetheless.

I will say that on a going forward basis, given the open authorization and given the cash performance of the business, which is attractive even if the earnings growth is not, quite frankly, that among our capital allocation opportunities share repurchase would factor into that.

Michael Corty – Morningstar

Okay, great. Thank you.

Operator

And we have no further questions at this time. I’d like to turn the conference back over to Mr. Smith for additional or closing remarks.

Stephen Smith

Well, I’d just like to thank you all for your participation in this second quarter earnings call. We look forward to talking to you again at the end of our third quarter. Thank you very much.

Operator

And this concludes today’s presentation. Thank you for joining and have a nice day.

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