Scholastic Corporation (SCHL) Q2 2022 Earnings Call Transcript

Scholastic Corporation (NASDAQ: SCHL) Q2 2022 earnings call dated Dec. 16, 2021

Corporate Participants:

Gil Dickoff — Senior Vice President and Treasurer and Head of Investor Relations

Peter Warwick — President and Chief Executive Officer

Kenneth J. Cleary — Chief Financial Officer

Presentation:

Operator

Good day, and thank you for standing by, and welcome to Scholastic Reports Q2 Fiscal Year 2022 Results Conference Call. At this time all participants are in a listen-only mode. Please be advised that this call is being recorded.

[Operator Instructions] I would now like to hand the conference over to your host today, Gil Dickoff, Senior Vice President and Treasurer and Head of Investor Relations. You may begin.

Gil Dickoff — Senior Vice President and Treasurer and Head of Investor Relations

Hello, and welcome, everyone, to Scholastic’s fiscal 2022 second quarter earnings call. Joining me on the call today are Peter Warwick, our President and Chief Executive Officer; and Ken Cleary, our Chief Financial Officer.

As usual, we have posted the accompanying 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. Such forward-looking statements are subject to various risks and uncertainties, including those arising from the continuing impact of COVID and its variants on the company’s business operations. These forward-looking statements by their nature are uncertain 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 reconciliations of those measures to the most directly comparable GAAP measures may 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. If you have any questions after today’s call, please send them directly to our IR e-mail address, investor_relations@scholastic.com.

And now I would like to turn the call over to Peter Warwick, to begin this afternoon’s presentation.

Peter Warwick — President and Chief Executive Officer

Good afternoon, everyone, and thank you for joining the call today. I hope you’re each enjoying this holiday season, which in many ways feels closer to normal, even as we remain watchful of COVID developments.

The ongoing balance of moving forward in our new normal while continuing to remain cautious, made our second quarter especially meaningful this year. We’ve stayed in close touch with families and educators, as they navigated a new school year, thankfully for the most part, finally back in the classroom. We’ve shared these insights throughout the company, while increasing our reach. In fact, this fiscal year-to-date, we’ve increased our parent reach through e-mail by almost sixfold. And as we’ve seen throughout our 101-year history, it’s this deep relationship, that yet again contributed to positive results because of our ability to meet real time needs and to evolve.

All of these efforts led to a 29% increase in revenues and an approximately $30 million improvement in operating income. While Ken will provide you with specific details of our second quarter results, I’d like to address what I expect is the upper most question in most people’s minds, given our experience with COVID during the past 18 months or so. And that’s the question, are our book fairs back? Well, I’m pleased to say that, yes, our book fairs business is coming back.

As with all COVID impacted businesses, our optimism comes with caution due to the unpredictable nature of the virus. But overall, we believe we have made significant steps in moving beyond the pandemic and with the confidence, that while repeated wide scale school closures are unlikely, we have systems in place to manage through it all.

We’ve not yet reached pre-pandemic levels of book fair bookings, which was not in our outlook. However, we have exceeded our expectations with higher than anticipated revenue per fair. Significant increase in revenue per fair as well as the demand for Scholastic Book Clubs, tells us that our customers agree to getting books in the hands of kids is a priority, as we all re-emerge from the pandemic. Related to Book Clubs, this is where we’ve been most deeply affected by the industry-wide labor shortage. Additionally affected by discrete system issue, a large backlog of orders, which we continue to address has been diligently worked on by our staff at our Jefferson City warehouse. Our staff are also staying in close contact with customers to offer digital opportunities to enhance literary experiences in the classroom, as they await their orders.

I had the pleasure of visiting our flagship warehouse myself this past quarter, and I must share that the staffs dedication to the Scholastic mission and fulfillment of these orders is second to none. I was so impressed and grateful for the warm welcome they provided and thank you one and all for your continued work this holiday season.

In trade, we closed our quarter with the release of the new graphic novel Cat Kid Comic Club: Perspectives. This is the second title in Dav Pilkey’s new worldwide best-selling series and made available just in time to be a holiday gift.

And speaking of the holidays, The Christmas Pig remains on top of our bestseller list. We’re pleased to see many year-end favorite and gift giving list include our titles such as Wishes, which alone has been included on 4. And we have much to be proud of, as there is no equal among graphic novels publishers. According to BookScan, Graphix accounted for 40% of all graphic novels sold in 2020. And we also remain a runaway leader in the overall category of children’s book series.

Notably, this quarter also brought the world, our long-awaited release of the live-action Clifford the Big Red Dog movie from Paramount. Audiences have fallen in love with our beloved character, all over again, and are rediscovering our books. The success of our strategy in re-envisioning how we diversify our IP initially through the 2014 relaunch of Scholastic Entertainment is exhibited by a 30% increase in Clifford U.S. Trade sales since the animated reboot released and our Clifford movie’s high end graphic novel carried in both clubs and fairs is exceeding expectations in sales through our school channels. And momentum is growing, as seen from numerous announcements such as the forthcoming Clifford sequel from Paramount and with partners such as Apple TV+ and Legendary Television.

Scholastic Education Solutions continues in its transformative approach to supporting our school customers. Our new channels of revenue are gaining traction in the market, including our curriculum offering, PreK On My Way and in digital with Scholastic Literacy Pro and Scholastic F.I.R.S.T, formerly known as Ooka Island. These offerings from Education Solutions are critical, supporting literacy skills for countless classrooms, also the positive response seen through district-wide sales of our culturally responsive book collection, Rising Voices Library, displays the needing classrooms for more diverse content and instruction, a need that we’re eager to continue to meet.

In international, we continue to see the impact of the ebb and flow of the pandemic throughout the globe. In Australia, our business is coming back from the most recent surge, and we have the inventory on hand there to meet demand. In Asia, disruptions contributed to a decrease in demand, and we continue to navigate new regulations in China.

We’re optimistic that our results will continue to show the demand for our content and display the long-term benefits made possible by previous investments in technology and infrastructure through our 2020 plan, which enabled us to launch new tools for sales team optimization, inventory management, and new order entry to name a few.

Much of our ability to manage vital change to serve schools and families during the pandemic, while managing both expected and unexpected costs is the direct result from this initiative, setting a path forward for us to continue to shape and prepare Scholastic to ultimately reach our second century.

In the second half of this fiscal year, we look forward to being an exemplary partner to schools and parents for their independent reading needs, through high quality content and education materials, while providing a sense of normalcy by meeting the demand for our clubs and fairs.

We will continue to provide high quality fairs while increasing the number of fairs held as our capacity, in fact, quality continue to improve. And we are poised to recover from our operational difficulties in clubs this upcoming spring season.

In trade, we will release the highly anticipated Cat Kid Comic Club 3: On Purpose by Dav Pilkey and Wings of Fire 15: The Flames of Hope by Tui Sutherland and our pre-K brand, Make Believe Ideas will continue to widen our appeal by expanding its retail presence into sections traditionally reserved for the toy market.

The formal combination of our previously separate education and magazine divisions has allowed for streamlining of marketing, focus growth on new revenue opportunities and has laid a foundation for future offerings. And while challenges remain in our international business, we have the talent and content to work through these.

In closing, our mission to serve all children through literacy and learning continues to be our north star. We’ve used this time to build momentum and renewed energy towards more efficient and effective ways of doing things, centering all our various offerings around our customers. The proof point in our enhanced cross-divisional collaboration is our recently announced 5-year partnership with the University of Florida, Lastinger Center for Learning; and the State of Florida to execute the New Worlds Reading Initiative. Through monthly home book deliveries, the program has the potential to reach up to 500,000 children statewide, who are currently reading behind grade level.

While the revenues and profits will be modest in the start-up year, we expect the program to grow with roughly 70,000 kids already enrolled. Bringing the expertise of our divisions together to create the winning proposal in Florida, truly displays the power of using all of our resources together in a new way to achieve our mission.

With a shared vision, our strong management team will ensure our future success by enhancing collaboration and changing the way how our divisions interact, a movement which we anticipate to be accelerated as we welcome Mary Beech as Chief Marketing and Transformation Officer, are eager to begin our work together this January. And we thank Mary for insights during her time on the Board. More information about a successor Board member will be shared with you when we can.

And with that, I’d like to turn the call over to Ken Cleary.

Kenneth J. Cleary — Chief Financial Officer

Thank you, Peter, and good afternoon. Today, I will refer to our adjusted results for the second quarter, excluding one-time items, unless otherwise indicated. Please refer to our press release tables and SEC filings for a complete discussion of one-time costs and legal settlements.

We started the school year with strong demand across all of our channels, but most notably in our book fairs channel, where the pandemic essentially shut us down at the start of the prior school year. Our trade channel continue to dominate bestseller list and our Education Solutions business has strong results as well.

We are experiencing higher costs for labor and product in our book clubs channel, the scarcity of labor led to delays in the shipment of product to our customers. The pandemic continued to impact some of our foreign operations, normally in Asia, Australia and New Zealand. Overall, we are very pleased with our results, which exceed our expectations.

Revenues for the second quarter grew to $524.2 million versus $406.2 million in the prior year period. Operating income in the second quarter was $84.3 million versus $54.3 million last year. Net income was $69 million compared to $39.4 million last year and adjusted EBITDA was $113.7 million compared to $77.7 million in the second quarter of last year. Earnings per diluted share was a $1.93 compared to $1.15 last year.

Net cash provided by operating activities was $78 million compared to $46.1 million in the second quarter last year. Free cash flow for the quarter was $75.4 million compared to $30.9 million last year. For the six-month period, net cash provided by operating activities was $141.6 million compared to $20.1 million in the prior year and free cash flow was $124.5 million in the current year compared to a free cash use of $4 million last year, an improvement of $128.5 million, reflecting the company’s recovery from the pandemic, the cost savings initiatives implemented last year and the first quarter tax refund.

At the end of the quarter, cash and cash equivalents exceeded total debt by $286.4 million compared to $161.8 million at the end of the second fiscal quarter a year ago. Capital expenditures and capitalized pre-publication costs in the second quarter were $30 million compared to $15.2 million last year. This limited spending was focused on our technology platforms and digital products and services.

Domestic inventory purchases for the fiscal year of $172.4 million increased $20.7 million over last year’s purchases, but still remain substantially below historical levels as the company was able leverage inventory on hand and continues to improve processes and tools to manage inventory levels as demand changes.

Given the strong cash flow in October, we paid down the remaining $75 million of borrowings under our revolving credit facility, which we renegotiated and extended during the current quarter, increasing our borrowing capacity to $300 million under the facility. Also in the second quarter we restarted our share buyback program, which we suspended at the outset of the pandemic. Through today, we have reacquired over 134,000 shares for $5 million.

Now turning to our quarterly segment results. In Children’s Book Publishing and Distribution, our biggest objective for the fiscal year is the recovery of book fairs business heading out of the pandemic. Fortunately, almost all U.S. schools this year are opening for in-person learning and book fairs revenue of $176.2 million exceeded the prior period revenue of $47.7 million. Our in-person fairs execute for the fall season are now approximately 70% of fall of calendar year 2019 pre-pandemic levels, as demand for our school fair is strong and ahead of our expectations.

We have also used the time during the pandemic to improve our data analytics capabilities, more closely meeting our book fairs customers needs and driving higher traffic at in-person book fairs. Accordingly, as Peter alluded, revenue per fair has increased 12.3% on a same fair basis when compared to pre-pandemic levels in the fall of calendar year 2019.

We expect the spring season to increase sequentially from the fall, albeit a slower pace than the sequential increase seen in the current period as we continue to closely match our capacity with our demand.

Trade continued the strong run as revenues of $124.4 million modestly trailed the prior period revenue of $129.3 million, which included the release of JK Rowling’s The Ickabog. Strong performance from frontlist releases were bolstered by continued strong demand for the backlist titles and our on-screen adaptations for its Scholastic brand awareness and drove front and backlist product sales.

Book clubs revenue of $51.9 million trailed the prior period reported revenue of $67 million. The decline in revenue was not the result of a lack of demand as orders for the period were ahead of our expectations. Labor shortages at our primary distribution facility in Jefferson City, Missouri, combined with system implementation growing pains, led to a backlog of orders.

As of November 30, 2021 our back orders for book clubs stood at $21.3 million or $18.4 million higher than the same time last year. Our distribution facility has increased wages and incentives and now has sufficient warehouse associates and expects to work down this backlog early in the new calendar year.

Total Children’s Book Publishing and Distribution revenues for the current quarter of $352.5 million greatly exceeded the prior period revenues of $244 million, and operating income of $85.2 million exceeded the prior period operating income of $35.4 million as a result of the increased revenues.

Education Solutions has strong quarter with revenues of $79.5 million exceeding the prior period revenues of $67.5 million. Operating income performance was stronger still, but quarterly operating income of $15.6 million exceeding the prior year performance of $10.3 million. Magazine revenue and subscription rates have come back strong post-pandemic but quarterly revenue from magazines exceeding the prior year by $2.7 million. As incremental magazine subscriptions, which have a digital component, have low marginal costs, these revenues greatly add to the bottom line. Digital revenues approximately budget in prior year or teaching resources which benefit from the pandemic receded to pre-pandemic levels.

Digital product gross bookings for the full year are ahead of last year’s pace. As Peter mentioned, the Company continues its focus on diverse voices in our publishing, with strong sales of rising voices highlighting the quarter. International segment revenues of $92.2 million, for the prior period revenues of $94.7 million.

Operating income of $9 million, likewise trailed the prior period of $19.5 million. Prior year operating income include $2.8 million of COVID-related government subsidies. Canada is rebounding well from the pandemic as schools across Canada are largely open. The U.K. operation school channels are slowly returning to normal than Canada or the U.S. Australia and New Zealand saw widespread lockdowns in the current year that they did not experience earlier in the pandemic, and as a result had substantially lower revenues compared to the prior year second quarter. In November, restrictions began to lift in Australia and are now beginning to ease in New Zealand as vaccination rates increased dramatically.

Sales across Asia were down from the prior period. Asia struggles were twofold. First, COVID restrictions hindered the direct sales business throughout Malaysia and Thailand; and second, Chinese government restrictions around tutoring and foreign content drove down revenues from China as the company, its distributors and customers continue to work through these new restrictions.

Unallocated overhead costs of $25.5 million exceeded the prior year unallocated cost by $14.6 million. Increased wages and related costs at the company’s Jefferson City, Missouri distribution facility result in $5.6 million of the increase over the prior period. Higher accrued bonuses and litigation settlement of $1.3 million also contributed to the increase.

In the quarter, we continued our optimization of workspace by selling our office and warehouse in Lake Mary, Florida, recognizing proceeds of $10.4 million and a gain on the sale of $6.2 million and also entered into an agreement to sell a company owned distribution facility in the U.K., with net proceeds to be realized in March of 2022.

Last year we were able to dramatically reduce costs in the face of the pandemic. During the years preceding the pandemic, we execute on our 2020 plan. Mostly technology driven program, designed to reduce costs and allow for more efficient processes and better product and customer data analytics. The 2020 plan result in the implementation of new tools and processes that enable us to save over $100 million during the year of the pandemic and an estimated $50 million annual reduction in our cost base. Additionally, the move to cloud-based systems enable to us remain connected and work seamlessly while working remotely throughout the pandemic. This foundational work will continue to benefit us as we move forward.

We now have new variable cost challenges in the form of inflationary pressures for product transportation and labor. Product cost for printing paper and inbound freight have increased our per unit costs by approximately 15% for purchases made this year. Much of our inventory for the first half of the year was procured in prior periods at lower costs, particularly for the book fairs division. Therefore, our cost of product recognized to date, do not fully reflect these higher costs. Additionally, variable labor costs across the whole company, but most notably in our primary distribution center in Jefferson City, Missouri have increased as much as 20% or more. Likewise, postage and outbound shipping costs have increased dramatically.

We are addressing these variable cost increases near and longer term through proactive resource allocation, diversifying our vendor base, automation, pricing and product rationalization. New COVID variants not withstanding, we are optimistic about future results. We are encouraged by the success in the first half of the year. Like our industry peers, we have cost and supply chain issues to overcome for the remainder of the fiscal year. However, we have more good news than challenges — much of our previous work will enable us to better navigate these obstacles.

Finally, as previously announced, the company approved its regular quarterly dividend of $0.15 per share.

Thanks for your time today. Have a happy holiday. And I will now hand the call back to Gil.

Gil Dickoff — Senior Vice President and Treasurer and Head of Investor Relations

Thank you, Ken. As a reminder, we invite questions to be directed to our IR mailbox, investor_relations@scholastic.com. We appreciate your time and continuing support and wish you a very enjoyable and safe holiday season ahead.

Operator

[Operator Closing Remarks]