Scholastic (SCHL) Q3 2018 Earnings Conference Call Transcript

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Scholastic (NASDAQ: SCHL) Q3 2018 Earnings Conference CallMarch 21, 2018 4:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Scholastic Reports Fiscal 2018 Third Quarter Results Conference Call. [Operator instructions] And as a reminder, this conference may be recorded. I would now like to turn the conference over to Mr. Gil Dickoff, senior vice president, treasurer, and head of investor relations.

Sir, you may begin.

Gil Dickoff -- Senior Vice President and Treasurer

Thanks so much, Sabrina, and good afternoon everyone, and thank you for accommodating the new time for our call this quarter. Welcome to Scholastic's Third-Quarter 2018 Earnings Call. Joining me here today are Dick Robinson, chairman, president, and chief executive officer; and Ken Cleary, the company's chief financial officer. We've posted an investor presentation on our website, on our IR website, at investor.scholastic.com, which we encourage you to download if you have not already done so.

I'd like to point out that certain statements made today will be forward-looking. These forward-looking statements by their nature are uncertain and may differ materially from actual results. In addition, we'll be discussing some non-GAAP financial measures as defined in Regulation G, and the reconciliation of those measures to the most directly comparable GAAP measures can be found in the company's earnings release filed this afternoon on a Form 8-K, which has also been posted to our Investor Relations website. We encourage you to review the disclaimers in our press release and investor presentation and to review the risk factors contained in our annual and quarterly reports filed with the SEC.

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And now I'd like to turn the call over to Dick Robinson.

Richard Robinson -- President and Chief Executive Officer

Good afternoon, and thank you for participating on today's call from snowy New York. The third quarter was very active at Scholastic. We continued to grow key publishing franchises while investing in technology-driven improvements, real estate upgrades, new product introductions, and the expansion of our education sales force.Our operating results were firmly in line with our expectations, with revenue up 3% from the prior-year period and the operating loss from continuing operations showing a 4% improvement in what is traditionally a loss quarter for Scholastic. We've always raised -- we've also raised our fiscal 2018 outlook for earnings per share to reflect the partial-year impact of the recent passage of the tax cut bill.

From a financial-reporting perspective, we had two significant nonoperating noncash charges this quarter that affected EPS. Ken will provide more details on these charges in a moment. Excluding these and other one-time charges, our loss per share from continuing operations in the quarter improved by $0.06, or 17%, versus the third quarter of last year. We're also active in repurchasing common stock, with $27 million worth of shares acquired in our FY 2018 to date.

And as you saw the release we issued earlier today, our board has increased our stock-repurchase authorization by $50 million. Looking forward, our core businesses are performing well, and we see growing momentum in the Scholastic 2020 initiatives, which are designed to deliver margin expansion through technology-driven process improvements, leading to increased productivity and more targeted, data-driven marketing. Our tax rate will be lower as a result of tax reform. The termination of our domestic pension plan will eliminate future funding requirements, and we anticipate additional cash flow beginning in FY 2019 as the transformation of our headquarters building is nearing completion.

And we are currently working to rent our expanded retail space, which we will discuss a little bit later. Children's book publishing and distribution continued to show resilience, with revenue for the quarter essentially flat compared to the year-ago period, when we had strong revenues from new Harry Potter titles, especially Harry Potter and the Cursed Child, and the original J.K. Rowling screenplay for the film Fantastic Beasts and Where to Find Them. In trade, we continued to be the leader in core series such as Harry Potter, I Survived, and the first four best-selling titles of Dav Pilkey's Dog Man following the earlier success of Pilkey's Captain Underpants.

We're enthusiastically waiting the fifth book, Dog Man: Lord of the Fleas, which is scheduled for release in August 2018. Building upon the important foundation of core trade series, upcoming new releases include new workbooks for both beginning and emerging readers in the Bob Books series, the sixth book in the best-selling Bad Guys series, and Whatever After No. 11. As we celebrate the 20th anniversary of Harry Potter, we look forward to the stage play of Harry Potter and the Cursed Child parts 1 and 2, which opens on Broadway in April and will reignite interest in this title, which was originally published in 2016 and is now available in paperback.

In July, we will reissue the original seven Harry Potter books and paperback with brand-new covers designed and illustrated by Caldecott Medal-winning Brian Selznick, as well as publishing the official companion book for the exhibit, Harry Potter: A History of Magic, coming to the New York Historical Order Society in October. And in November, we will publish the J.K. Rowling original screenplay for the movie Fantastic Beasts: The Crimes of Grindelwald, which was announced yesterday. Education revenues were up 3% in the quarter, and our expansion program in new publishing and large sales force continued, designed to address a significant market opportunity as the interest in balanced literacy and more flexible customized instructional programs continues to grow in U.S.

schools. The core reading market in the U.S. is the largest revenue category in K-12 educational publishing, with total market size reaching over $1 billion. This summer, we will launch Scholastic Literacy, a complete balanced literacy program for grades Pre-K to 6, with print and digital components to support blended learning.

This new modular program will teach all the foundational skills students need for success in reading, including phonemic awareness, phonics, vocabulary, fluency, and comprehension. Integrated into Scholastic Literacy are new programs that will bolster its comprehensive impact as a core curriculum offering while providing students with engaging and measurable digital resources for independent reading. These include first, Scholastic EDGE, which we have mentioned on previous calls has now launched. This is a new in-classroom, intervention-guided reading program that is an integral part of our core curriculum balanced literacy framework and provides additional support for striving readers.

Second, Literacy Pro is a digital motivation and assessment program which draws from a wide variety of print and digital titles to provide students with personalized recommendations, making it easier for them to find books they'll enjoy. It also produces dashboards and reports that help teachers track their students' progress and use that information to enrich instruction. W.O.R.D. or Words Opening Reading Doors, is an engaging research-based vocabulary program for grades K-5 which deepens comprehension by teaching the 2,500 word families that make up 90% of all text.

With W.O.R.D., students will master the most essential high-leveraged words necessary for reading success. International had a strong quarter, with solid performance in trade publishing across all of our major markets, Canada, U.K., and Australia and New Zealand, as well as Asia. Revenue also benefited from favorable foreign exchange with the decline in the dollar. Canada and the U.K.

both increased profitability in this quarter. During the quarter, we also opened our new shared-services operation in Kuala Lumpur supporting our businesses in Asia as we begin to centralize the finance, procurement, and support services in the region in an effort to improve efficiencies and reduce costs starting in fiscal 2019. During this fiscal year, we have strengthened our management in Asia with significant new appointments in finance and marketing. Education and trade and international remain major growth opportunities for the company, along with our established business of direct-to-consumer educational books.

Turning now to Scholastic 2020, our three-year plan to substantially increase operating income and improve organizational effectiveness as we approach our 100th year in October 2020. In our first six months of implementation, we have focused mainly on four areas of Scholastic's business: book fairs, education, operations, and technology. We have established financial objectives, performance indicators, and dashboards that will lead to greater collaboration and better visibility. Cross-company teams are developing priorities and testing new strategies.

In book fairs, for example, we're introducing this summer new CRM analytics which will provide updated, easy-access customer information to our 350 salespeople as well as new point-of-sale devices for real-time information on title sales, enabling faster restocking. In education, we're providing richer and more timely pipeline information to the education sales force as well as upgrading our Teachers Store online and establishing a master product-tracking system for improved visibility to product scheduling and availability. In operations, especially in our distribution businesses, which are labor- and freight-intensive, we've improved manufacturing and procurement processes, rationalized paper and printing spend, and reduced freight costs through the utilization of a new transportation-management system. This is the first step in the three-year plan to improve service to our customers through better information, process automation, and more efficient business processes.

And we are aligning our strategic technology resources to better support Scholastic 2020 initiatives in CRM, data engineering, analytics, and digital services. Finally, a brief update on our real estate project. This month, the company entered into a definitive lease agreement with Sephora for a portion of the newly developed retail space at our headquarters building in 557 Broadway, which extends their current lease through 2033. RKF, the country's leading independent real estate firm specializing in retail leasing, has been given an exclusive engagement to lease the remaining 42,500 square feet of multifloor retail space at our headquarters building.

Since January, following the improved results in holiday retailing, the interest in Scholastic's exceptional space in SoHo has picked up dramatically, with major multiple retailers expressing strong interest in both the Broadway-facing and Mercer Street sides of the building. With that, I'd like to pass the call to Ken Cleary.

Kenneth J. Cleary -- Chief Financial Officer

Thank you, Dick, and good afternoon. On this call, I will refer to our adjusted results from continuing operations for the quarter, excluding one-time items, unless otherwise indicated. Revenues were $344.7 million, versus $336.2 million in the third quarter last year. Operating loss for the third quarter was $19 million, an improvement compared to an operating loss of $19.8 million in the third quarter of fiscal 2017.

Going through some housekeeping items first. There were $4.7 million of one-time items included in the third-quarter operating loss, primarily related to our headquarters renovation, versus $4.9 million in the third quarter of fiscal 2017, primarily related to severance associated with cost-reduction programs. We also had two significant one-time items that were reported below the operating-income line. The first was a $39.6 million noncash pre-tax charge related to the termination of our domestic defined benefit retirement plan.

The second was an $8.3 million noncash charge related to the estimated remeasurement of our U.S. deferred-tax assets following the passage of last December's tax reform legislation. The charges were reflected in our GAAP earnings per share. Turning to our segments.

Children's book publishing and distribution segment revenues were $199.4 million, versus $199 million last year. We reported segment operating loss of $900,000, versus an operating profit of $6.3 million in the prior-year period. The decline reflects a favorable inventory adjustment we took in the third quarter of fiscal 2017, along with higher costs of product in trade. Education segment revenue was $61.7 million, compared to $60.1 million last year.

We reported segment operating loss of $200,000, compared to operating income of $3.5 million last year. The decline in operating income is largely attributable to higher salaries and benefits related to the sales force expansion that Dick previously discussed. International segment revenue was $83.6 million, versus $77.1 million last year. Segment operating income was $700,000, compared to an operating loss of $3.4 million last year.

The increase reflects the higher sales across all major markets as well as the benefit of a weaker U.S. dollar. Corporate overhead expenses were $18.6 million, versus $26.4 last year, with savings realized across a number of overhead departments, especially in salary-related costs. Net cash provided by operating activities was $36.5 million, compared to $39.2 million last year, and free cash flow as defined by the company was a net use of $9.6 million, versus free cash flow of $16.6 million last year, when the company realized an increase in customer remittances from significant sales of the Fantastic Beasts and Where to Find Them screenplay.

We distributed $5.2 million in dividends and repurchased $11.9 million of our common stock during the quarter. Fiscal year to date, we have now reacquired $27.2 million in opportunistic open-market transactions, which reduced our outstanding authorization to $11.4 million. However, as we announced earlier today, our board has authorized a $50 million increase in net authorization, bringing our new buyback program limit to $61.4 million. Under this program, which will continue to be funded with available cash, the company may purchase shares from time to time as conditions allow.

At quarter-end, our net cash position was approximately $355 million, compared to $456 million a year ago. The lower net cash balance is primarily due to higher levels of planned spending related to the company's capital program to upgrade facilities and strategic technology platforms. As you know, our full-year outlook for fiscal 2018 calls for a net use of free cash of $10 million to $20 million, which includes a planned $90 million to $100 million in capital spending, primarily related to the headquarters building and strategic technology upgrades. Fiscal year to date, we have used $50.3 million for construction and $25.7 million for new strategic technologies.

We are maintaining our full-year outlook for net use of free cash. The level of cap spending could exceed our original outlook range purely as a function of timing. We expect to return to free cash generation in the next fiscal year, as cash usage will fall from peak levels as we complete our headquarters redesign. Now turning to outlook, we are reaffirming our fiscal 2018 outlook for revenue of $1.65 billion to $1.7 billion.

However, as Dick discussed, we are raising our outlook for earnings per diluted share from continuing operations by $0.15, to a new range of $1.35 to $1.45, to reflect the partial-year impact of the 2017 U.S. tax-reform legislation. We expect to see a full-year impact of the lower corporate tax rate in the next fiscal year. Of course, we will provide more detail on the next quarter's call when we review our fiscal 2019 outlook.

With that, I will hand the call back to Gil for the Q&A session.

Questions and Answers:

Gil Dickoff -- Senior Vice President and Treasurer

Thank you very much, Ken. Sabrina, we are now ready to open the lines for questions.

Operator

[Operator instructions] And our first question will come from the line of Barry Lucas with Gabelli & Company.

Barry Lucas -- Gabelli & Company -- Analyst

Thank you, and good evening. I think you were good enough to talk a little bit about the opportunity in reading. I just wondered if you could tie that back to the expansion in the sales force. How far along are you in there? How far up the learning curve is the new sales force? And then specifically, what do you think the opportunity or the market that Scholastic addresses within that reading -- overall reading spend?

Richard Robinson -- President and Chief Executive Officer

Thank you very much, Barry. As you know, we've been in the reading business before. We published Basal reader back in the 1990s. We then introduced Literacy -- what was called Literacy Place.

We dropped out of that business, but we developed a lot of expertise in selling it, which we transferred over to our READ 180 business. In the meantime, we also had a supplementary of the book -- paperback book business, which -- in the institutional sales to schools, which was prospering but was sort of No. 2 to our tech business. So we have a strong background for many, many years in the reading market in instructional materials.

We are -- to address the question of how far along we are, we're introducing a core reading program called Scholastic Literacy in a few months. That is -- we're introducing it in the summer and for sale next year, which will compete in the core reading market, which, as I indicated, is an opportunity there -- the market size is over $1 billion. Our current education revenues are about $320 million-ish, and we expect that business to grow by double digits, significantly over the next three years as we get new revenues from the increased size of our sales force, return to our core competency of selling core instructional materials in reading and our fantastic position in the reading market. Now just to amplify it, on one more point you and I have talked about before in these calls, the core reading market, which was formerly Basal textbook-driven and continues to be heavily Basal textbook, is now moving much more to balanced literacy and combinations of paperback books.

And so those libraries and programs that we have are now being asked for by schools to become core reading materials. So we've buttressed the skills part of these programs, so you now will be able to get all the essential skills that are needed to teach kids how to read in Pre-K to 6 through Scholastic Literacy. We also have lots of supplementary material and libraries that complement the core Scholastic Literacy. Probably too long an answer, Barry, but I hope that covers most of what you wanted to hear.

Barry Lucas -- Gabelli & Company -- Analyst

OK. And just one other thing on the reading part -- when you talk about a kind of a comprehensive program for K-6, does that suggest that this is a product that could be applicable for adoption states and --

Richard Robinson -- President and Chief Executive Officer

Yes. Absolutely, yes. We're seeing adoption states -- thanks for asking that because that's an important part of our strategy. We're seeing adoption states ask for these kinds of programs.

Their restrictions are being loosened up considerably. They're taking many more flexible kinds of materials in these state adoptions, and we have successfully competed in a few of them. But we're expanding our strength in that area right now, and we'll be in those adoptions over the next several years.

Barry Lucas -- Gabelli & Company -- Analyst

Great. And Dick, if we could just switch gears to the real estate side. With a definitive lease in place with Sephora and active marketing on the balance of the -- on the retail space, when would we expect to see revenues and rent contributions, lease contributions in the, hit the P&L?

Richard Robinson -- President and Chief Executive Officer

I think -- well, I think it's going to be '20. We'll sign leases in fiscal '19, but these leases include free introductory lease abatements. So the rent will -- even if we sign them and get people moved in in '19 or early in '20, the revenues really won't begin to start until fiscal '20. But they'll add significantly to our bottom line when they occur.

Operator

[Operator instructions] And I'm showing no further questions at this time.

Richard Robinson -- President and Chief Executive Officer

Thank you very much, Thanks, everybody, for listening in. We look forward to our July call with you when we report year-end and our guidance for 2019. Many thanks.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes your program. You may all disconnect. Everyone, have a great day.

Duration: 24 minutes

Call Participants:

Gil Dickoff -- Senior Vice President and Treasurer

Richard Robinson -- President and Chief Executive Officer

Kenneth J. Cleary -- Chief Financial Officer

Barry Lucas -- Gabelli & Company -- Analyst

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