Scholastic Corporation (NASDAQ:SCHL)
Q4 2016 Earnings Conference Call
July 21, 2016 8:30 a.m. ET
Dick Robinson - CEO
Maureen O'Connell - CFO
Ellie Berger - President, Trade Publishing
Gil Dickoff – SVP, Treasurer
Drew Crum – Stifel
Ian Zaffino - Oppenheimer
Good day, ladies and gentlemen and welcome to the Scholastic Reports for the Fourth Quarter and Fiscal 2016 Results and Fiscal 2017 outlook. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, the conference is being recorded.
I would now like to hand the meeting over to Gil Dickoff, Senior Vice President and Treasurer. Please go ahead, sir.
Thank you so much, Karen and good morning everyone. Before we begin, I would like to point out that the slides in this presentation are available on our investor relations website at investor.scholastic.com. I'd 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 those 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 also posted on the investor relations website at investor.scholastic.com.
Now I'd like to introduce Dick Robinson, the Chairman, CEO and President of Scholastic, to begin today's presentation.
Good morning, and welcome to our fiscal ’16 yearend call. Last year at this time, just after we’d sold our educational technology business to HMH, we shared our plans to focus on our significant growth opportunities in children’s books publishing and distribution and the education segment where our magazines and comprehension literacy solutions business was growing dynamically.
Our fiscal year results demonstrate the success of the strategy with revenue growth of 2% to $1.67 billion or 5% when excluding foreign exchange, double digit operating income growth and earnings from continued operations of $1.26 per share or $1.70 after one-time items, which exceeded our guidance of approximately $1..35 per share.
With our focus on just three segments, children’s books publishing and distribution, education and international, we are a nimbler company with teams who are deeply connected by the mission of providing high quality book and educational materials in support of children’s reading and learning and our opportunities continue to expand. In children’s books publishing, we saw a 14% growth in trade revenues from the renewed strength of Harry Potter as well as solid performance from our core front list and back list titles. We expect another year of double digit growth in 2017, largely driven by the upcoming Harry Potter releases, as well as new multi-platform series such as Horizon, with the story arc and first book written by Scott Westerfield, Dav Pilkey's new series Dog Man, and Raina Telgemeier’s Ghosts.
We’re expanding our list in strong niches such as early childhood, global licenses and continue series publishing, and we’ve entered into a multi-year agreement with American Girl, giving us the rights to publish books based on their characters starting in January 2017. In book clubs and book fairs, we expect to maintain our current levels of revenue while focusing on more profitable execution. We’re intensifying a strategy to more precisely match our promotion and operational resources to each school’s size, interest and ability to conduct book clubs and book fairs. Through more targeted marketing and carefully managing the number and type of fairs held, we can ensure that we’re optimizing our resources while providing the right reading experience to each school.
In the education segment, annual revenue growth of 8% was a standout in an educational materials market that was down 4% in the last 12 months. This growth was driven by our comprehensive literacy solutions programs in grades pre-K to 8. Schools are telling us they’re interested in customized solutions matched to their own student learning needs and prefer to use outstanding literature as core instructional resource as an alternative to basal reader textbook. We’re gaining market share by providing customized curriculum, including guide to reading and leveled book rooms, and associated consulting service in professional learning and family and community engagement. In addition, our classroom magazines continue to deliver strong growth and there are now over 15 million subscribers to our 32 print and digital magazines.
In the international segment, we’re continuing our strategy to grow the local currency consumer book sales in Asia, while building trade and education revenues around the world through shared global product development and marketing strategies. Although the strength of the US dollar reduced fiscal 2016 international revenues and profits in dollar terms, we saw trade growth in most countries, along with across the board strength in clubs, fairs, trade and education in India. We expect increased trade sales in Australia, Canada, Asia and the UK this year, while we’re expanding our education product sales especially in Asia.
We’re also continuing to explore opportunities to provide meaningful returns to shareholders over time, balanced with our long term operating needs and our other strategic investment. In fiscal 2016, we paid 420.5 million in dividends and repurchased 14.4 million of our shares in the open market since resuming our buyback program at the end of the third quarter. We will continue to review opportunities to return capital to shareholders.
Looking ahead to fiscal 2017, we expect our strategy to streamline our businesses and focus on core growth opportunities to deliver another year of strong results, with total revenue of $1.7 billion to $1.8 billion and earnings per share in the range of $1.60 to $1.70, excluding one-time items. As we begin the new fiscal year, we’re implementing a wage improvement program for our employees in our US distribution centers, both to attract, retain, motivate and support our employees and to strengthen our operations and drive higher levels of productivity. This program will increase wages by approximately $10 million to $15 million on an annualized basis. We’re also continuing to develop our technology systems and operations functions to help provide our business units with better information systems and processes to serve our US and international customers even more efficiently and at lower cost.
With the expected long term benefits from these investments in our people and our platforms, the continued synergies from the close alignment of our businesses and intensified strategies for improving clubs and fairs, the continued development of our education segment and our new Harry Potter publishing make us excited about our prospects for continuing growth as we deliver on our mission to support literacy and learning in school and at home.
With that, I will ask Maureen O'Connell, CFO and CAO, to review our year-end results and fiscal 2017 outlook in more detail.
Thank you, Dick and good morning everyone. I will refer to fiscal year results from continuing operations, excluding one-time items in my remarks, unless otherwise indicated.
Total fiscal year revenues were $1.67 billion, an increase of 2% from 2015 dues to higher children's book publishing and distribution and education sales, but partially offset by the impact of foreign currency in our international segment. The adverse FX impact on revenues was $43.2 million for the year.
Operating income was $93.4 million, a 17% increase over last year. And earnings per diluted increased over last year by 32% to $1.70.
Turning now to segment results, in children's book publishing and distribution, annual revenue was $1 billion, an increase of 5%, and operating income increased by 20% to $115.8 million. Performance was driven in part by double digit increase in trade sales. In our book club channels, we improved margins and revenue per sponsor, with a particularly good spring performance. In education, annual revenue was $298.1 million, an increase of 8% over fiscal 2015 and operating income increased by 16% to $56 million. We’re seeing continued strength in classroom books and classroom magazines and we increased investment in our sales force to capitalize on favorable trends and our strong positioning to continue to grow market share.
In international, revenue was $372.2 million compared to $401.2 million in 2015, and operating income fell $40 million, primarily due to high US dollar product costs, the labor action in Ontario schools earlier in the year, higher bad debt in Asia and an insurance recovery for a warehouse fire in India in the prior year, as well as the impact of foreign exchange.
Fiscal year corporate overhead was $90.7 million, approximately even with $91.3 million in the prior year. Incremental facility costs and our multi-year strategic technology investments were offset by our cost savings initiatives.
We recently completed a comprehensive companywide review of overhead and operating cost and the cost actions we are taking will offset the loss of fees associated with the TSA with HMH. The expected savings for fiscal 2017 are included in our outlook. We are scheduled to terminate our transitional service agreement with HMH on August 1, 2016. Our strategic technology investments remain on track and will continue through 2018. These investments in e-commerce, CRM, content management and consolidating platforms are expected to bring widespread benefits, including better customer information and improving product inventory and content management. We expect to be able to better target our markets, improve processes and lower costs.
Turning now to our real estate strategy, our plans to upgrade the office component of our SoHo location are on track. We have begun construction to create premium retail space in the first two floors of 555 and 557 Broadway Building in SoHo, and upgrade the office space in the rest of the building. This will enable us to maximize rental income and minimize our use of outside office space by having almost all our New York employees in one building. As we vacate floors to remodel, we expect to have a non-cash impairment charge of $20 million over a three year period for legacy leasehold and other building improvements, approximately $7.5 million in fiscal 2016 and another $12 million in fiscal 2018. These non-cash charges are not included in guidance.
We’re currently in discussion with several premium retailers in order to take full advantage of our opportunities for our retail space. Our expectation for cumulative incremental retail rents over a 10 year period remain unchanged, but we now expect these increases to be more heavily weighted towards the latter part of the period.
In fiscal 2016, we have free cash use of $139.7 million, compared to free cash flow of $73.7 million in fiscal 2015. Our 2016 results include approximately $200 million in tax and other payments related to Ed tech sale in 2015. Excluding the tax payment, free cash flow in fiscal 2016 was $46.3 million, exceeding our outlook because certain planned investments to support our front list were deferred until fiscal 2017.
At year-end, cash and cash equivalent exceeded total debt by $393.4 million, compared to $500.8 million a year ago. Again the lower net cash position is primarily due to the taxes paid on the sale of Ed tech business. Note that our reported net cash position does not include $9.9 million of cash proceeds remaining in escrow pursuant to the terms of the Ed tech sale.
Now turning to outlook, we expect total revenues in fiscal 2017 of $1.7 billion to $1.8 billion. In children’s book publishing and distribution, we anticipate substantial growth in trade as a result of this summer’s release of Harry Potter and the Cursed Child Parts One and Two, and from our new licensed publishing program for the Fantastic Beasts and Where to Find Them movie and its sequel, including movie handbooks, coloring and creative books, cinematic guides, paper crafts, poster and sticker books, as well as other highly anticipated new release.
We expect to maintain our current level of revenue in our school-based clubs and fairs, while focusing on more profitable execution. In the education segment, we expect revenue growth to be led by classroom books and classroom magazines which will benefit from new product introductions such as story works junior and the sale of our 2016 presidential election skills workbooks.
In the international segment, we’re planning for growth in trade publishing and education and we expect significant local currency gains across Asia. In Australia, we see a strong market in trade and the UK’s book fair division is expected to benefit from last year’s acquisition of a complimentary fair business. We also expect that Canada, which was adversely impacted by an Ontario labor action in schools in early fiscal 2016, to benefit from a stronger start to the school year in its book clubs and book fair businesses, as well as sales of the new Harry Potter publishing in the fiscal year.
We are implementing new global shared services and procurement programs that we expect to generate profit and process enhancements across the international group in future years. There are a number of initiatives underway to reduce exposure and create greater operating efficiencies in Asia. A recent opportunity to introduce direct debit as a payment option to our direct sales customers in Malaysia, has resulted in improvement to customer qualification and lower bad debt, as well as lowering our cost of operation and shortening our cash collection cycle over the life of each transaction.
Taking these factors into account, earnings per diluted share is expected to be in the range of $1.60 to $1.70, excluding one-time items. We expect increased operating profits from trade to be offset by three factors. First is the $10 million to $15 million annualized impact of an employee wage improvement program in our US distribution centers as Dick already discussed. Second, we are projecting increases in medical costs. Finally, we expect an increase in income tax as we return to our typical tax rate of 42% following the tax settlement last year which had a $0.15 positive impact on EPS in fiscal 2016.
Fiscal 2017 free cash flow is expected to be between $40 million and $50 million. This includes capital expenditures of $70 million to $80 million and pre-publication and production spending of $30 million to $40 million. As anticipated, the increase in capital spending is primarily related to our headquarters construction plan, as well as higher strategic technology spend as part of our three year initiative to upgrade our enterprise-wide platforms for content and customer management and to migrate to SaaS and cloud-based technology solutions.
In summary, as Dick said, we expect another strong year driven by new publishing and the Harry Potter franchise, our book clubs and book fairs channels where we are focused on improving profitability and our customized education solutions, including classroom book collections and classroom magazine.
I’ll now turn the call over to Gil to moderate the question-and-answer session.
Karen, we are now ready to open the lines for questions. Thanks so much.
[Operator Instructions] Our first question comes from the line of Drew Crum from Stifel.
Okay, thanks. Good morning everyone. Maureen, I was interested in how you’re thinking about normalized CapEx and pre-pub spend. It sure looks like level of spend is going to be elevated. Should we expect that to continue beyond fiscal ’17? And again, what are the normalized levels of spend we would expect for those line items? Thanks.
As you see, our capital expenditure is expected to be between 70 and 80 this year. We believe that will be for a two year period as we remodel and construct our office building and retail space. So you should expect that level for fiscal 2017 and ’18 and then go back to normalized levels after that.
And the pre-pub spend, is this year’s planned spend in line with the notional model?
Yes. Pre-pub is in line with our ongoing rate of spend.
Okay. And on Harry Potter, would you be willing to provide any numbers around print runs for the Curse Child or Fantastic Beasts? Remind us again where you have rights for those pieces of content and on what platforms. And I guess the final question on Harry Potter, in your press release you indicated you expect to get strong revenue contributions from Harry Potter, but there was no mention of profitability. Have the margin characteristic, the profitability characteristics of this franchise changed or are they similar to what we saw several years ago? Thanks.
Let me start off with that, Drew. This is Dick. First, the margin has not changed. So in terms of print runs and so forth, I’m going to ask Ellie Berger, President of Trade to answer to those questions.
Hi. Our initial laydown for Curse Child North America is going to be roughly $4.5 million. We’re working very closely with our accounts and a very short production schedule, so we’re very excited to be delivering those books to them right now.
Our rights are North American at this point, Drew. Before they were just US. Now we have US and Canada for the new publishing.
Any thoughts around the lift that you get by adding Canada?
It’s generally about 10% of the US market.
Got it. Okay, that’s helpful. All right, I’ll jump back into the queue. Thanks guys.
Our next question comes from the line of Ian Zaffino from Oppenheimer.
Just wanted to hone in on the comments about the cumulative rent revenues that you expect to get from the real estate. You’re saying it's back end loaded. Are you seeing something now like maybe a softening that means you’re going to recoup it later? Or kind of just walk us through the cadence of that rental revenue.
We still expect the same cumulative rental increase that we talked about on previous calls. However, as we’re talking to these premium retailers, it depend on what type of configuration they want and how expensive their capital changes are going to be. And so that’s why we said we feel it will be more back end loaded. We had initially thought we would start to see that incremental rent in ’17 or ’18 and now we think it will be a little bit later than that as we -- but we won’t know for sure until we sign those leases and we narrow down to the premium retailer that we will rent to.
Okay. So if you can just break this down a little bit more for us. So this means that you’re going to have a retailer coming in that’s going to have a smaller space initially and then would take a larger space. I’m just trying to get a sense of what you’re assuming versus what you’re seeing now.
There are multiple versions of configuration. It depends on whether you have one very large retailer that wants a lot of space or some smaller retailers and we’re talking to both types. And so once we’ve signed the lease, we can be more specific to the exact amount of rent increase and when they’ll occur, but we’re very confident that the numbers that we said, incremental $10 million a year over 10 years is still going to be realized on a cumulative basis.
Okay. And then when we will start to hit maybe the run rate of $10 million? You’re seeing …
I’d say that’s going to depend on who we sign the lease with and what construction they want and what they’re going to do to the space. It could be smaller retailers who have multiple spaces or it could be one large retailer. We’re talking to both types of tenants.
Okay. All right, thank you very much.
Thank you. That concludes our question-and-answer session for today. I would like to turn the conference back over to Richard Robinson for any additional comments.
We’re very excited about 2017. It’s off to a good start. We’re delighted for your support and we’ll hope to have good news for you in September. All the best. Thank you.
Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day.
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