Scholastic Corporation (NASDAQ:SCHL) Q2 2023 Earnings Call Transcript

Scholastic Corporation (NASDAQ:SCHL) Q2 2023 Earnings Call Transcript December 15, 2022

Operator: Good day and thank you for standing by. And welcome to Scholastic Reports Q2 Fiscal Year 2023 Results Conference Call. At this time, all participants are in a listen-only mode. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jeffrey Mathews. Please go ahead.

Jeffrey Mathews: Welcome, everyone, to Scholastic’s fiscal 2023 second quarter earnings call. Today on the call, I am joined by Peter Warwick, our President and Chief Executive Officer; and Ken Cleary, our Chief Financial Officer. As usual, we posted the company investor presentation on our IR website at investor.scholastic.com, which you may download now if you have not already done so. We would like to point out that certain statements made today will be forward-looking. These forward-looking statements, by their nature, are subject to various risks and uncertainties and actual results may differ materially from those currently anticipated. In addition, we will be discussing some non-GAAP financial measures as defined in Regulation G.

The reconciliation of those measures to the most directly comparable GAAP measures can be found in the company’s earnings release and accompanying financial tables filed this afternoon on a Form 8-K. This earnings release has also been posted to our Investor Relations website. We encourage you to review the disclaimers in the release and investor presentation and to review the risk factors disclosed in the company’s annual and quarterly reports filed with the SEC. Should you have any questions after today’s call, please send them directly to our IR e-mail, investor_relations@scholastic.com. And now, I’d like to turn the call over to Peter Warwick to begin this afternoon’s presentation.

Peter Warwick: Thank you, Jeff, and good afternoon, everyone, and thanks for joining us. Scholastic delivered strong revenue growth and higher earnings in our second quarter of fiscal 2023, as we successfully navigated continued market and cost headwinds during the important back-to-school season. The company’s sustained momentum reflected three things; first, the strength of Scholastic’s brand, unique channels, children’s content and educational products; second, the improved operating efficiencies we have achieved over the past three years; and third, our continued investments in long-term growth opportunities. Last quarter, we continued taking steps to deploy capital for long-term growth and shareholder value. We completed our acquisition of Learning Ovations and made progress integrating its product, technology and team.

We also accelerated capital returns to shareholders, executing a modified Dutch Auction tender offer and expanding our open market share repurchase authorization as announced this afternoon. We expect this momentum to continue in the second half of fiscal 2023, especially in our seasonally important fourth quarter and have affirmed our guidance for the year, as I will discuss further in a moment. These are very encouraging results, but I am especially proud of Scholastic’s nearly 7,000 employees who continue to perform at such a high level without losing focus on Scholastic’s important mission and enormous long-term opportunity, supporting the growth of children through literacy and the power of stories. This afternoon, I’d like to review our momentum and outlook across our business.

Ken will then walk through our financial results and expectations for fiscal 2023. But first, a few words on the current business environment. As it’s been widely reported, consumer confidence in the U.S. has continued to decline this fall, even more so in the U.K. and Canada, two of our largest international markets. This has impacted the retail bookselling environment, which has been softer this calendar year compared to a strong year in 2021. In U.S. schools and school districts, federal and state funding remains at historically high levels. But as we discussed last quarter, short staffing and the need to digest last year’s product purchases have lengthened selling cycles across the industry and has shifted some expected sales into our fiscal fourth quarter.

On the cost side, paper, manufacturing and shipping costs remain at high levels. In this slide, I believe Scholastic’s quarter two gains are even more impressive, indicative of our company’s strengths and competitive advantages and I am also optimistic about the near- and long-term market outlook. In the short-term, there are encouraging signs of a rebound in consumer confidence as, for example, gas prices have fallen. Also, the impact of higher input costs is now fully reflected in cost of product and our P&L after first flowing through inventories, reducing that year-over-year headwind. There are signs of cost improving in some areas, including reduced lead times for inventory purchases and lower transportation costs. In the long-term, we see families and kids need and demand for literacy and stories to promote happiness, knowledge and confidence only growing in the future, as the world becomes even more complex and competitive.

There’s also a strong consensus that pandemic-related declines in student’s reading skills, which were already distressingly low in the U.S., demand sustained long-term investments in new outcomes based approaches to teaching literacy, especially in the earlier grades and this is exactly where Scholastic’s brand, experience, teacher relationships and sales channels are strongest and where we are targeting investments to scale our Education Solutions business. So turning to our quarter two results. Last quarter’s gains were led by strong results in the Children’s Books segment. Revenues rose 19%, reflecting robust sales in Scholastic’s unique school-based Book Fairs and Book Club channels and the benefit of our bestselling children’s publishing.

Operating income increased 33%, driven by higher sales strong operating leverage and improved efficiencies. The Scholastic Book Fairs team achieved a record fall with revenues up 37%. Share counts rose to 85% of pre-pandemic levels as we planned compared to 70% a year ago and we experienced even stronger revenue per fair than last year. In Book Fairs, operating leverage on higher sales, as well as investments over the past three years to optimize warehouse branches, enhance processes and improve overall marketing and sales efforts, all these contributed to higher segment profitability. In our Trade channel, revenues held near last year’s high levels. Bestselling, publishing and multiple new releases mostly overcame the impact of a softer retail market.

They also benefited sales in our Other Channels and in our International and Export businesses. Scholastic’s Graphix imprint continues to dominate the young adult graphics novels segment, which it effectively created. In November, Scholastic titles held 18 of the top 20 bestsellers on NPD BookScan Young Adult Graphic Novel List. Dav Pilkey’s newly released Cat Kid Comic Club #4, held a number one position and in fact was the bestselling title children’s and adult categories in its first week of release, also performing well in school channels. Scholastic also continues to benefit from a tremendously strong backlist of children’s and young adult books and series, including recent classics like Harry Potter, of course. Last quarter, orders for the new illustrated edition of Harry Potter and the Order of the Phoenix were strong, and we are excited for the upcoming 25th anniversary of the series next September.

J.K. Rowling’s Christmas Pig also sold very strongly in its second season on its way to becoming an evergreen holiday classic. We continue to successfully develop our IP for the screen too, Stillwater, the animated series on Apple TV+, which celebrates mindfulness and is based on Jon Muth’s titles, just this past weekend received its second Emmy Award. We are eager to see the positive response to Eva the Owlet in quarter three, the live action Goosebumps series later on. Book Clubs revenues rose 11% last quarter relative to the prior year quarter when the business experienced significant labor and systems issues that delayed revenues into the third quarter of fiscal 2022. Book Clubs has experienced higher revenue per event, but lower than forecast teacher participation so far this school year, in part reflecting the enormous and increasing demands on teacher’s time.

We are focused on the activation and reactivation of teacher sponsors and increased student and family participation. At the same time, Book Clubs continue to provide a critical connection between Scholastic and teachers, families and kids, which benefits the entire company. Book Club flyers and the Club’s online presence are key channels that build awareness of new book titles, reinvigorate the backlist, feed potential purchases to our website and reinforce the Scholastic brand. Now moving to Education Solutions. Quarter two sales to schools, districts and states held steady at last year’s record levels, as we continue investing in the division’s long-term growth opportunity. As mentioned earlier, longer selling cycles for educational products are having an impact on timing.

This dynamic means that some of the sales that in prior years, we might have expected in the first and second quarters we now expect to come through in the second half and in the fourth quarter, in particular. As planned, continued strategic investments in long-term go-to-market capabilities for this segment impacted operating income. We are progressing well with the integration of the recently acquired A2i Literacy Assessment, an instruction system and Learning Ovations development, professional learning and research teams are now integral parts of the Education Solutions division. Increased employee-related costs will assist in the continued development of the company’s comprehensive digital literacy platform. Next, looking at our International segment.

In local currency, revenues increased 8%, but declined overall due to the strengthening of the U.S. dollar. Higher local revenues were primarily driven by continued recovery of Book Fairs and the success of the company’s bestselling series titles in trade. However, revenues are also impacted by more challenging market conditions in Canada and the U.K. than in the U.S. Segment operating income decreased $2 million, reflecting higher inflationary costs related to freight, paper, fuel and labor in major markets, and economic conditions in Canada and the U.K. This was partially offset by improved margins in Asia and export, following the company’s exit from the low margin direct-to-consumer business in Asia, which generated losses in the prior period.

As I previously discussed, we are confident in our ability to continue navigating the current business environment and are affirming our fiscal 2023 guidance for adjusted EBITDA of $195 million to $205 million based on our momentum in the first half of the year and expectations for a strong fourth quarter, following a seasonally smaller third quarter. When looking ahead at the second half of fiscal 2023 and our plan to achieve this goal, it’s important to consider Scholastic’s business seasonality, which now more closely resembles what we routinely experienced before pandemic. Traditionally, the second and fourth fiscal quarters have been our largest, most profitable periods, with losses recorded in the smaller first and third quarters, when schools are on summer or winter holidays.

I’d also point out that earnings and adjusted EBITDA typically being highest in the second half of the year. We are seeing a return to the seasonality in fiscal 2023. We and we expect the final quarter of the year, I have to say March, April and May to be driven by the strength in our Book Fairs and strong sales in Education Solutions. Finally, I’d like to address Scholastic’s continued progress towards its capital allocation strategy and priorities. As I said, Scholastic’s significant margin improvements over the past three years and our strong free cash flow outlook create new opportunities to deploy capital for strategic growth. At the same time, they enable us to maintain a strong balance sheet and return excess capital to shareholders.

Last quarter, the company returned over $32.9 million to shareholders through an increased dividend, open market repurchases and the modified Dutch Auction tender offer. Today, we also announced that our Board has significantly expanded the company’s open market repurchase program with an increased authorization of $48.8 million to make $75 million currently available for this purpose. In order to deploy this authorization, we will take maximum advantage of opportunities under our open market repurchase program. As we look ahead, we will continue to pursue opportunities to deploy capital in three key areas, consistent with our allocation priorities. First, we will continue to invest in building or acquiring strategic products and capabilities that leverage our current brand channels and capabilities.

For example, investments to build capacity and efficiencies in our Book Fairs and Jefferson City distribution networks. We will also continue to explore larger more transformative investments to build or acquire new platforms as we are doing with our literacy platform. Second, will continue to leverage the strength of our balance sheet to manage risk and support our operations as we have done by funding early inventory purchases or payment discounts to offset supply chain difficulties and higher costs. We will also continue to review opportunities to optimize our capital structure, while protecting our balance sheet strength. And third, we are committed to continuing to return excess capital to shareholders. In addition to our dividend, which we raised this summer and expanded open market repurchases, we will continue to explore additional return mechanisms as we undertake to build market liquidity in our stock to facilitate future repurchases.

And now, I will ask Ken to provide greater detail on the quarter’s results.

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Ken Cleary: Thank you, Peter, and good afternoon. Today I will refer to our adjusted results for the second quarter, excluding one-time items in the prior year period unless otherwise indicated. Note we recorded no one-time items in the second quarter. Please refer to our press release tables and SEC filings for a complete discussion of one-time items. As Peter discussed, company performance during the critical back-to-school second quarter of our fiscal year was excellent, driven by strong performance in our Children’s Book Publishing and Distribution segment, which benefited from our improved Book Fair operations in a more normalized school environment. On the operations side, our plan to order inventory well in advance of the season, given the long lead times in our supply chain has been successful, as product availability across the company has driven down backlog, improved customer satisfaction and helped to reduce operating costs.

Across the company, we are managing operating and headcount costs to below pre-pandemic levels while still investing in growth in this. We are experiencing substantial cost increases for paper, printing and transportation that are impacting our gross margins, but are seeing the inflationary pressures starting to abate. In short, we continued our strong start to our fiscal year in the important second quarter and are optimistic about the future. We are therefore affirming our adjusted EBITDA guidance of $195 million to $205 million for fiscal 2023. Turning to our consolidated financial results, revenues grew 12% to $587.9 million, operating income in the quarter was up 19% to $100.1 million, net income was $75.3 million, compared to $64.4 million last year and adjusted EBITDA rose 14% to $122.3 million, compared to the second quarter last year.

Earnings per diluted share was $2.12, compared to earnings per diluted share of $1.80 last year. For the six-month period, revenue was $850.8 million, compared to $784 million last year, and operating income was $42 million, compared to $48.1 million last year. Six months adjusted EBITDA is $86.7 million, compared to $94.5 million last year. Net cash provided by operating activities for the six-month period was $21.3 million, compared to $141.6 million last year. Free cash used for the six-month period was $13.8 million, compared to free cash flow of $124.5 million last year. As a result of our successful strategy to acquire inventory earlier this year in anticipation of increased sales and longer lead times, as well as due to higher cost of product, inventory purchases year-to-date have increased $140.2 million relative to last year’s suppressed levels, contributing to the increase in cash utilized for this fiscal year.

We estimate that approximately a third of this year-over-year increase reflects the timing of inventory purchases within the fiscal year. We are starting to see lead times for inventory purchases start to decrease and are modifying our buying patents to better match these shorter lead times. Additionally, last year’s cash flow benefited from a $63.1 million federal tax refund. At the end of the quarter, cash and cash equivalents exceeded total debt by $256.3 million, compared to $286.4 million at the end of the second fiscal quarter a year ago. Our strong balance sheet has allowed us to proactively manage working capital through the supply chain crisis by strengthening vendor relationships and negotiating volume rebates at early pay discounts, while also allowing us to invest in content with key bestselling authors.

Capital expenditures and capitalized prepublication costs for the six-month period were $35.1 million, compared to $27.5 million last year. We expect CapEx and prepub spend to exceed last year, as we invest in our Education Solutions business and distribution operations. In the current fiscal year, we returned capital for our tender offer for our shares and open market repurchases. Through today, we have reacquired 724,000 shares, returning $31.1 million to our shareholders in the current fiscal year. While our tender offer was undersubscribed, we will continue to pursue open market share repurchases. To this end, our Board of Directors has approved an increase in our current share buyback authorization from $26.2 million to $75 million. Additionally, our Board of Directors has approved a $0.20 per share regular quarterly dividend to be paid in March.

The company is committed to continuously monitoring and improving our capital allocation, focusing on long-term growth operational efficiency and returning excess capital to shareholders. Now turning to our segment results. In Children’s Book Publishing and Distribution, revenues for the second quarter of $418.3 million exceeded the prior year’s revenues of $352.5 million. Operating income increased to $113.2 million, compared to $85.2 million in the prior year period. Our Book Fairs operations led these impressive results. Book Fairs’ revenues increased to $240.8 million from $176.2 million in the prior fiscal quarter. Fair count is on track to rise about 85% of pre-pandemic levels from 70% last year. Coming out of the pandemic, our operations are greatly improved and demand at event based activities such as our in-person Book Fairs is strong.

Our Book Fairs team has worked to simplify and amplify our fair offerings through improved product assortment, marketing and fair experiences and by facilitating better family and student engagement, including through strategies to expand equity of access. Accordingly, revenue per fair, a key efficiency metric grew substantially over last year. Higher revenue per fair results in improved margins and profitability as it does not entail significant increases in operating costs. Book Clubs revenues of $57.6 million were higher than the reported revenues of $51.9 million in the prior period. As previously mentioned, the prior period was hampered by system implementation issues, which showed higher distribution costs and a backlog of customer orders last year of approximately $20 million as of November 30, 2021.

These orders were delivered in the third quarter of last fiscal year. These systems and operational problems have been fixed, and as a result, our distribution costs have improved dramatically and we did not have order backlog at the end of this Q2. Trade division posted strong results against a good prior year quarter, with revenues of $119.9 million, compared to $124.4 million last year. In the prior fiscal quarter, we released J.K. Rowling’s The Christmas Pig, which drove the higher revenues in the prior period. As previously mentioned, product availability was strong this year, but product costs were substantially higher than the prior year rising about 15%. Our Trade Publishing group is the key content provider for the entire company and our industry leading editorial staff continues to develop and maintain relationships with key authors, illustrators and agents in the children’s publishing world.

Content produced by the trade group also fuels our growing media footprint, with key productions such as Eva the Owlet, which was announced earlier this year. Education Solutions revenues of $80 million were on par with the prior year revenues of $79.5 million. Quarterly operating income was $7 million, compared to prior year operating income of $15.6 million. We are currently investing in this division and we have identified substantial growth opportunities. As Peter mentioned, these are exciting times in Education Solutions as we continue to build out our solutions model and product offering. The Learning Ovations acquisition and their proprietary assessment tool A2i are a key focus of this effort. As a result of this increased investment, we are building out staff, increasing development work, increasing sales capabilities, and spending OpEx and CapEx on the integration of A2i.

Accordingly, we expect higher costs in this segment for the current year. The integration of A2i is now expected to impact earnings by approximately $3 million in the current year, which was not contemplated in our original plan. Overall, federal and state funding is expected to positively impact this segment through calendar year 2024. The ultimate annual results for Education Solutions are largely dependent upon the fiscal fourth quarter, when schools and districts seasonally spend funding on curriculum and other products for the upcoming year and when summer reading programs kick in. While we have outperformed our expectations in each of the last two fiscal fourth quarters, the volume and timing of sales in this period can have material impacts on the company’s fiscal year results.

International segment revenues of $89.6 million trailed the prior period revenues of $92.2 million, with foreign exchange rates driving $10.1 million of the decline due to the strong U.S. dollar. Operating income of $6.7 million was unfavorable to the prior period operating income of $9 million. Australia and New Zealand saw widespread lockdowns in the prior year second quarter but recovered and are now exceeding our expectations for the current fiscal period. While Canada and U.K. operations continued to recover from the pandemic, each of these nations is now being impacted by worsening economic conditions that are driving costs higher and lowering the disposable income of their customers. Much like the U.S., Book Fairs operations and the demand for event-based activities in Canada, Australia, New Zealand and the U.K. are bright fine.

Our business in China continued to struggle under COVID restrictions and government regulations around tutoring and foreign content, but recent actions regarding COVID restrictions are encouraging. Unallocated overhead costs of $26.8 million in this year’s second fiscal quarter, but relatively flat to prior year’s second quarter, as we continue to tightly control discretionary spending and are experiencing improved efficiencies at our centralized distribution facility. I am happy to report that we have recently signed a long-term lease agreement for the remaining Broadway facing retail space in our headquarters property at market rates signaling some return to normalcy in the New York City real estate market. We expect the occupancy to commence later this fiscal year.

As a result of our performance year-to-date and our current forecast, we are affirming our adjusted EBITDA estimate of $195 million to $205 million. Cost of product is trending modestly higher than our initial expectations as a result of higher freight costs. We are starting to see these costs decline. We continue to show strong discipline on discretionary spending. In our school-based channels, Book Fairs’ results, notably revenue per fair have exceeded our expectations, were partially offset by declines in teachers participating in our Book Clubs programs. We are encouraged by our strong customer engagement and demand for our products, content and solutions, and we are focused on delivering current results, while building on growth opportunities for the future.

External economic risks remain, but our businesses have proven to be resilient through economic downturns in the past and we expect any impact to be modest. Thank you for your time today. I will now hand the call back to Peter.

Peter Warwick: Thank you, Ken. As both of us have discussed this afternoon, Scholastic performed strongly in the second quarter, as we leaned into our unique strengths and competitive advantages to serve kids, families and schools, while successfully navigating a more complex business environment. Based on our current momentum and a positive outlook, including for a strong fourth quarter in the near-term and growing long-term demand for our literacy in stories, we are optimistic about our future growth and achieving our full 2023 goals. In closing, I want to again thank every educator, family and partner that’s helping raise up the students in their community, as well as our employees who are working tirelessly to support you. I also want to thank our shareholders for their continued support and I wish everyone a happy holiday season. Thank you all again for joining our call today. Jeff will conclude this afternoon’s presentation for us.

Q&A Session

Jeffrey Mathews: Thank you, Peter. As a reminder, we invite questions to be directed to our IR e-mail, investor_relations@scholastic.com. We appreciate your time and continued support.

Q – :

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.