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Edited Transcript of SCHL earnings conference call or presentation 19-Sep-19 8:30pm GMT

Q1 2020 Scholastic Corp Earnings Call

NEW YORK Sep 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Scholastic Corp earnings conference call or presentation Thursday, September 19, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Richard Robinson

Scholastic Corporation - Chairman, President & CEO

* Kenneth J. Cleary

Scholastic Corporation - CFO

* Gil Dickoff

Scholastic Corporation - Senior VP & Treasurer

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Conference Call Participants

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* Andrew Edward Crum

Stifel, Nicolaus & Company, Incorporated, Research Division - VP

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Scholastic reports first quarter 2020 results call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Senior Vice President, Treasurer and Head of Investor Relations, Gil Dickoff. Sir, please go ahead.

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Gil Dickoff, Scholastic Corporation - Senior VP & Treasurer [2]

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Thank you, Latif, and good afternoon, everyone. Welcome to Scholastic's First Quarter 2020 Earnings Call. With me here today are Dick Robinson, our Chairman, President and Chief Executive Officer; and Ken Cleary, the Company's Chief Financial Officer. We've posted an investor presentation on our Investor Relations website at investor.scholastic.com, which we encourage you to download if you have not already done so.

I would 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 reconciliations 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.

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

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Richard Robinson, Scholastic Corporation - Chairman, President & CEO [3]

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Good afternoon, everyone, and thank you for joining the call today. As millions of U.S. students and teachers settle into their classrooms this new school year, the 99th back-to-school season for Scholastic, the vast majority will come in contact with and find support from Scholastic, whether it be through our clubs, fairs, the classroom library we've helped teachers build, instructional materials or classroom magazine, we're a driving force in creating a positive environment for literacy.

As we near our 100th anniversary and celebrate this unparalleled reach and impact, we are working on how to expand this important connection to schools and families for the next 100 years. This vision motivates our technology enhancements to better find and serve consumers, our expansion into new education markets and leveraging our strength as publishing innovators as well as critical distribution channels for kids to find engaging fiction and nonfiction.

We're moving forward with a rigorous process to improve operating income as we detailed in our July call, which started to take effect in our first quarter. To that end, we typically record a loss in the first quarter as U.S. schools are on break over the summer as you know. First quarter revenue was $232.6 million, an increase of 7% compared to $218.4 million in the first quarter of 2019. Adjusted EBITDA in the first quarter was $61 million compared to $64.5 million 1 year ago, both meeting our expectations.

As such, we are affirming our outlook for revenues for the 2020 fiscal year in the range of $1.67 billion to $1.70 billion, and in a few minutes, Ken Cleary will detail our quarterly operating results, EPS and adjusted EBITDA.

First, I'd like to share highlights and updates with you. Our distribution channels of Clubs and Fairs remain important access points for kids to find books at affordable prices, books they want to read because they have relatable characters and storylines and information that resonates. Clubs and Fairs are also a significant support for teachers in building classroom libraries and filling supply needs through incentive programs.

This year, we will deliver approximately 120,000 Book Fairs in 60,000-plus schools supported by more than 3,000 employees in our Book Fair group from field representatives to operations and served by 58 regional distribution centers. More, the experience of the Scholastic Book Fair is as culturally relevant as ever as proven by hundreds of thousands of social media posts touting the unique passion the events evoke.

Even in the face of increased national competition, we have enhanced our leading reputation and market share while keeping a focus on margin improvement. Our ongoing efforts include fair segmentation and targeting, improved POS devices and automation of operational processes to schedule fairs and assigned product. In the coming months, we are looking forward to hosting fairs with new and returning customers and to seeing continued adoption of our eWallet feature, encouraging more fair chairpersons to reach out to family members and the community to digitally preauthorize purchases for children to independently select their own books.

As mentioned in previous calls, the new sales tax collection program instituted in response to the Supreme Court's Wayfair decision represented a significant for -- change for clubs last spring. We will have more data on our -- how our more than 750,000 teacher customers are adjusting to this change in future calls this year. This past quarter was focused on back-to-school enhancements and engagement of our teacher-sponsors. We anticipate improved sales tax collection as well as online experience improvements to encourage parents and teachers to fulfill orders digitally using the process and reducing marketing expense while still being able to benefit from the core flyers that drive club participation. Additional improved margin efforts include deployment of a real-time management dashboard for better analytics, selective price increases, rationalized promotion offerings and improved customer service.

In fiscal 2019, we saw a sharp growth in our trade business and momentum continues this year. We are delighted that just last week, we had 7 out of the top 10 New York Times Children's Best -- Series Best Sellers. Dog Man: For Whom the Ball Rolls released at #1 in August remains the top book across all categories and as noted by Publishers Weekly, had the best first week sales in any Dog Man book to date, all good news.

Dav Pilkey's influence within the industry continues to grow as evidenced by Dog Man and Captain Underpants sharing the #1 and #2 spots on best-seller lists, while Dav's Do Good Tour fill stadiums. During these events, he champions messages of kindness, which resonate with kids as well as their parents, who we know are increasingly focused on character building when seeking out books for their children.

The power of graphic novels is a landmark example of Scholastic's unmatched ability to understand what kids want to read, filling an unmet need by pioneering this genre for kids. Our branches and Acorn lines of early readers are a further example of our filling fast-growing niches within the market. Observing that kids who were graduating from early readers to chapter books desire a bridge for that experience, our editors created these formats to meet kids where they are and better encourage lifelong readers.

Newly acquired Make Believe Ideas' interactive and innovative novelty books are yet another market leader we are proud with share with young families. Never Touch a Porcupine has been #1 at mass market Sam's Club, and we will expand the best-selling series to 10 board books this fiscal year with the release of new titles.

As always, we have highly anticipated titles debuting, including this week, Raina Telgemeier's Guts continuing to leverage our strength in graphics and bringing relatable struggles such as anxiety through strong characters to our readers. Just this week, she filled the Barnes & Noble in New York City with young fans eager to talk with her about her book, her characters and her life. She was in the building here at Scholastic today, talking to the staff and as usual, conveyed her unique approach to writing and linking her books to the real life of kid -- real lives of kids.

Harry Potter and the Goblet of Fire, The Illustrated Edition, will release on October 8, followed by the November release of Harry Potter and the Cursed Child, The Journey: Behind the Scenes of the Award-Winning Stage Production and the global release of The Dinky Donkey, the sequel to viral sensation, The Wonky Donkey, will be available November 1. As the live-action Clifford the Big Red Dog movie moves to postproduction, and we eagerly await the December debut of the new animated series, we also anticipate increased buzz and publishing around our beloved character.

In international markets, we continue to see growth in trade publishing although a strong U.S. dollar negatively affects our revenues. In addition, we are building upon global resources of print and digital content and strong brand recognition to support strong revenue and profit goals in our Asia business. We continue to receive positive responses to our digital English language learning programs, targeted to meet the needs of a growing middle class of consumers.

In education, we're -- in the U.S., we are emphasizing a comprehensive approach to literacy, working with school districts and community-based organizations to build programs for 365-day learning. We support literacy instruction in schools through a coordinated effort included -- including personalized learning for students and professional development for teachers with supplementary products such as guided reading or our new Core Curriculum Scholastic Literacy and Digital subscriptions with engaging content designed to create excitement, all the while providing critical foundational skill development in phonics and vocabulary.

Scholastic Literacy sales have begun but are not a driver in this year's first quarter as the product is just coming off press and being delivered to early adopting schools in Alabama, Indiana and Ohio. Our supplemental products remain strong, and innovation continues to come from the group such as this coming quarter's Rising Voices, a new classroom collection designed to resonate with boys of color.

Our Scholastic Digital subscriptions such as Scholastic F.I.R. S.T. and W.O.R. D., key components of Scholastic Literacy as well as standalone offerings, are gaining momentum as district administrators, school principals, curriculum specialists and teachers see how the needs of their students are directly met by these programs. The largest sale of Scholastic Literacy Pro to date closed this summer with Cypress-Fairbanks Texas purchasing 8 years upfront. As of this back-to-school season, educators are welcoming increased ease of access to Scholastic Digital education products available through single sign-on integration with Google Classroom as well as certified standards-based LTI integration with their own learning management systems.

Finally, across our businesses, we are seeing the benefits of our technology and efficiency improvements as guided by our Scholastic 2020 plan. Incremental savings are primarily driven through procurement, print optimization, warehousing efficiencies through process changes, rationalizing shipping costs and increasing routing efficiencies.

This fall, our educational sales team is using a dynamic automated dashboard via salesforce.com to manage performance and pipeline. They now have better top line visibility into Scholastic's current relationship within each district and school account across Scholastic channels.

With that background, I will turn the call over to Ken Cleary, Chief Financial Officer.

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Kenneth J. Cleary, Scholastic Corporation - CFO [4]

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Thank you, Dick, and good afternoon. Today, I will refer to our adjusted results for the first quarter, excluding onetime items unless otherwise indicated. We adopted the new revenue recognition standards pursuant to ASC 606 in the first quarter of the last fiscal year, so we will no longer break out the impact of the new standard on our results for comparison purposes.

In the current quarter, we adopted the new ASC 842 lease accounting standard. This adoption required us to record substantially all of our leases on the balance sheet but had no impact on the company's results of operations.

As Dick mentioned, revenues were $232.6 million versus $218.4 million in the first quarter of last year, an increase of 7%. The big story in the quarter was our strong trade frontlist worldwide with our U.S. trade operations up 21% year-over-year. Most impressive was our strength in series publishing. Dog Man, Captain Underpants, Harry Potter, The Bad Guys and Wings of Fire where each new release had a positive pull on the earlier titles in our backlist.

Our operating loss was $83.1 million versus $83.3 million last year with contribution from higher sales along with better cost management in Children's Book Publishing and Distribution and Education in the quarter. Adjusted EBITDA showed a loss of $61 million compared to a loss of $64.5 million in the first quarter of 2019, an improvement of 5%. We believe that adjusted EBITDA is the most meaningful measure of operating profitability and useful for measuring returns on capital investment over time since it's not distorted by unusual gains, losses or other items such as share repurchases.

The better operating results in Children's Books and Education were partially offset by higher depreciation expense and higher technology spend and corporate overhead, both as expected as well as slightly higher operating expenses in some of our international businesses. I should remind you that Scholastic typically records a loss in its first quarter while most U.S. schools are closed for summer break, and our school channels did not have significant revenues.

We had $4.3 million of onetime items in the current period, all in overhead. $2.8 million in pretax severance associated with Scholastic 2020 repositioning programs, and $1.5 million for an amicable, no-fault settlement on a legacy claim for an alleged patent infringement. There was $500,000 of onetime items in the prior period.

Now turning to our operating segments. Children's Book Publishing and Distribution first quarter revenues rose 15% to $109.6 million from $95.7 million last year. The main driver, as we've already discussed, was a strong trade frontlist led by 2 new summer releases in our best-selling Dog Man and Wings of Fire series. This was augmented by the incremental revenue from our Make Believe Ideas business in the U.K., where we now consolidate revenues after having completed our purchase of a majority interest in the company this past spring. Prior to this, our minority position in MBI was held as an equity investment, and sales were not consolidated in our operating results.

We also saw a positive contribution on the segment's top line from the timing of new Scholastic Entertainment programming sales as well as higher net redemptions of Scholastic Dollars in our school book fairs channel. While we're optimistic that we're effectively dealing with the new sales tax requirements and Book Clubs and the impact from greater competition in the fair space, it's too early in the school year to make any meaningful comments on either front.

Segment operating loss improved by $4.3 million on the higher sales in trade and lower operating cost in clubs and fairs. Education segment revenues increased 1% to $48.4 million with initial sales of recent released Scholastic Literacy, our new core literacy instruction program along with higher sales of our professional learning products and teaching resources. These revenue gains were partially offset by declines in Summer Reading and classroom collections in the quarter.

Higher classroom magazine and digital subscription billings in the quarter will be recognized in future periods upon delivery, magazines over the course of the fiscal year and certain digital subscriptions extending out multiple years. The segment operating loss improved by $1.5 million or 10% on better cost management.

International segment's first quarter revenue of $74.6 million was on par with the prior year. However, revenues were up 3% year-over-year on a constant currency basis. We realized higher trade sales in all of our major markets with best-selling books by leading authors, Dav Pilkey, Aaron Blabey, Liz Pichon, Anh Do and Julia Donaldson and Axel Scheffler as well as higher education sales in Asia, though our direct-to-home sales in some Asian markets and our export business fell slightly.

First quarter corporate overhead expense was $24.3 million versus $20.4 million in the first quarter of 2019. The higher overhead, excluding onetime items in the current period, is mainly due to the timing of spend related to our ongoing rollout of new technology and data analytics platforms as well as higher depreciation expense for recent new system implementations placed into service. We expect cash to begin to build again in the later part of the second quarter as is typical for this time of year.

Net cash used in operating activities was $97.6 million in the current fiscal quarter compared to a use of $89 million last year. And free cash use was $118.5 million in the first quarter of fiscal 2020 versus a free cash use of $125.9 million a year ago, an improvement of 6% and in line with our internal expectations.

At quarter end, we had $199.4 million in cash and cash equivalents compared to $269.8 million a year ago. In the first quarter, we had $13.5 million of plant capital expenditures and $7.4 million in prepublication and production spend as well as $12.6 million in open market repurchases and $5.3 million in dividends, both reported below the free cash flow line. I will note that our combined new capital and prepublication spend is $60 million or 43% below this time last year.

We are affirming our fiscal 2020 outlook for revenues in the range of $1.67 billion to $1.7 billion and adjusted EBITDA of $140 million to $160 million. And we have more closely tied senior management incentive compensation to the achievement of these adjusted EBITDA targets. Our investments in new technology and data analytics, the key component of our capital spending plans this year, remain on track with overall capital expenditures projected in the $75 million to $85 million range.

To achieve these year-over-year target gains, we are focused on controlling cost and improving efficiencies throughout our operations. Significant process changes are underway, supported by analytics, new systems and tools that are altering the way we buy inventory, influencing business unit decisions to improve clarity around operational cost and helping us better assess the cost-benefit trade-off across modes of distribution.

In particular, in fairs, we are reducing inventory purchasing through more efficient buying and printing strategies, freeing up working and human capital, encouraging the use of existing excess inventory with better margins and avoiding future inventory waste as well as using our fairs' customer incentive programs in a more targeted way.

Our new Oracle direct procurement system is slated to go live in Q2, enabling a series of process changes that will help with upstream product demand and supply planning for improved return on inventory purchasing spend. We're also deploying a new workforce management solution in our Jefferson City, Missouri national distribution operations to drive warehouse labor savings through a more dynamic and mobile-enabled scheduling and managerial oversight.

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

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Gil Dickoff, Scholastic Corporation - Senior VP & Treasurer [5]

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Thanks very much, Ken. Latif, we are now ready to open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Drew Crum of Stifel.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [2]

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So I have a couple. Maybe starting with Dog Man. You talked about the week 1 sell-through. Can you address the initial front -- print run, how that compared to the last book? I believe it was 5 million copies.

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Richard Robinson, Scholastic Corporation - Chairman, President & CEO [3]

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It's a similar print run, Drew. We're not announcing the numbers but we're -- and we're keeping a focus on management of inventory but our confidence in Dog Man grows. And as you may have noticed, the new book sold better than the last year's release. So it's definitely on the upswing. And just judging from kids' comments and the incredible amount of publicity coming in here and enthusiasm from kids and kids stopping people in the street and asking, "When is the next Dog Man coming?" It's really still accelerating its impact.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [4]

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Okay. Got it. And then I know in a couple of occasions, you suggested it was a little bit early in the fiscal year to gauge the efforts you're making around addressing competition in fairs and sales tax collections with clubs. But what does your guidance imply or embed in terms of improving margins for those 2 businesses? I know it's a target, it's a goal obviously, but what is your guidance?

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Richard Robinson, Scholastic Corporation - Chairman, President & CEO [5]

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Well, certainly, we see good progress in cost management in the first quarter even though that's a -- it's not an operational quarter. It is a quarter where we're doing an awful lot of stuff preparing for the year, and we are holding our cost very well in fairs and everywhere else in the company in that quarter. We have very targeted programs in respect to bringing down the cost of our operations in fairs. We have an ongoing group that works every single day to focus on a number of different projects in that area.

At the same time, we're very focused on being strong competitors and providing the very best possible fair experience, including inventory availability and well-managed fairs. And we are -- we believe that we're in a position to do that while managing our cost down in fairs.

On sales tax, it's too soon to say, but our guidance certainly implies that we don't see any major problems, but it's too early to say because it's so early in the quarter, and we're just beginning to get sales from teachers who are collecting now from kids as kids come back to school.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [6]

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Okay. And then the overhead costs were up year-on-year. You gave an explanation as to why that makes sense. Just curious as to whether or not this is indicative of the type of increase we should expect to see through the balance of the fiscal year.

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Kenneth J. Cleary, Scholastic Corporation - CFO [7]

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So yes, you're -- remember, a big piece of this is depreciation expense. So you will see the depreciation expense continue to come through. And our spending in terms of technology spend, noncapitalized technology spend this year will certainly continue at a similar rate, will go down in years beyond that though.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [8]

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Okay. And then I think going into the fiscal year, you guys are pretty bullish on Asia. I know it's just one quarter, but can you address the lower direct-to-home sales in the quarter along with the export business? Would you expect that to snap back in the out quarters?

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Richard Robinson, Scholastic Corporation - Chairman, President & CEO [9]

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I think the Asia's direct-to-the-home sales, are -- they're -- we carry these out in primarily developing countries including Malaysia and Thailand, Philippines, Indonesia are the principal markets for that business. And there's always something going on in those markets. This year, in the first quarter, it was in Malaysia where there was some changes in the pattern of going into the malls. I will not bore you with the long description but it's a timing matter, and we believe that business will come back later.

So an export -- with the strong U.S. dollar, export is facing headwinds because their pricing is in U.S. dollars so that does affect the business. But we seem to have some momentum in that business, and it seems that they were on track for our budget overall for the year despite that performance in the quarter.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [10]

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Okay. Just one more from me. Can you quantify the impact from new program and sale in the quarter? And how should we think about the cadence of these contributions for the balance of the year? And I guess a separate item, you're consolidating the Make Believe business now, is that meaningful to sales in the fiscal first quarter?

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Kenneth J. Cleary, Scholastic Corporation - CFO [11]

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So let me take the latter one first. In terms of MBI, yes, there's sales in there and it's a part of the pickup that we have in trade but it's single digits in terms of revenue for the quarter. Remember, MBI product is sold throughout all of our international operations as well as our U.S. channels, our U.S. school channels, so it's -- you're not going to see it all in one spot. It really is an integrated type of operation.

In terms of SEI, our programming revenue, remember we had the big pickup last year, but that wasn't really backlist sales. So when you're talking about contribution going forward, the biggest contribution, yes, there's some top line revenue in there, single digits, but we're -- you're not looking at a major contribution because we have programming costs or we have costs associated with that as well, whereas when we saw the backlist, everything was already off the books. So you're not looking at a major contribution there but you're looking at an opportunity to sell product through as well, pull-through product. So it's good to get the brand out there obviously, and that's what we're doing.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [12]

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Okay. And just to clarify, Ken, to go back to the MBI business, you're capturing or recording revenue in both trading and international?

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Kenneth J. Cleary, Scholastic Corporation - CFO [13]

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Yes. You'll see, they have -- yes, so trade, international. And what I'm saying is they sell product into our other subsidiaries and our other subsidiaries onwards sell the products. So MBI, as a standalone entity, has sales of their own but we're deploying the other channels as well to -- we're leveraging the other channels as well to sell that product.

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Operator [14]

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At this time, I'd like to turn the call over to Richard Robinson, Chairman, President and Chief Executive Officer for closing remarks.

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Richard Robinson, Scholastic Corporation - Chairman, President & CEO [15]

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Yes, sir. Thank you all for listening to our first quarter report. We're happy to be moving forward in the new school year, and we will look forward to talking to you in December, where we will be giving more information on our club and fair activity, of course. Thank you very much for your support, and thank you for listening today.

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Operator [16]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.