Scholastic Corporation (SCHL) Q1 2023 Earnings Call Transcript

Scholastic Corporation (NASDAQ: SCHL) Q1 2023 earnings call dated Sep. 22, 2022

Corporate Participants:

Jeff Mathews — Executive Vice President, Corporate Development and Investor Relations

Peter Warwick — President and Chief Executive Officer

Kenneth J. Cleary — Chief Financial Officer

Presentation:

Operator

Thank you for standing by. Welcome to Scholastic Reports First Quarter Fiscal Year 2023 Results. [Operator Instructions] As a reminder, today’s program may be recorded. And now I’d like to introduce your host for today’s program, Jeff Mathews, Executive Vice President, Corporate Development and Investor Relations. Please go ahead, sir.

Jeff Mathews — Executive Vice President, Corporate Development and Investor Relations

Hello, and welcome, everyone, to Scholastic’s Fiscal 2023 First Quarter Earnings Call. I’m excited to be back at Scholastic, a company defined by its incredible people and mission. Over the coming months, I look forward to reconnecting with and getting to know again Scholastic’s investment community as we work to reach a new level of understanding of our shareholders’ perspective and communicate our strategy, opportunity and progress.

Today on the call, I’m joined by Peter Warwick, our President and Chief Executive Officer; and Ken Cleary, our Chief Financial Officer. As usual, we have posted the company investor presentation on our IR website at investor.scholastic.com, which you may download now if you have not done so already.

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 these 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. Should you have any questions after today’s call, please send them directly to me at our IR e-mail address, investor_relations@scholastic.com.

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

Peter Warwick — President and Chief Executive Officer

Good afternoon, everyone, and thank you, Jeff. I’ll start by welcoming you back to Scholastic in the new role of Executive Vice President, Corporate Development and Investor Relations. I’m confident that Jeff is the right person to assume this important new position, which marks a key milestone in our plan to strategically expand the expertise available in our already highly skilled management team.

Jeff’s previous tenure and some deep knowledge of Scholastic combined with his recent experience advising an expansive list of high-level corporate clients will be invaluable to the company and our shareholders. He’s already been instrumental to advancing our strategic growth investments, leading the recently announced Learning Ovations acquisition.

In advance of Ken’s detailed walk-through of our first quarter of fiscal year 2023, I’m pleased to share that results are in line with our plan for top and bottom line growth in 2023 with lower year-over-year operating income and earnings as expected, primarily reflecting increased investments in growth initiatives in our Education business and a return to more typical seasonal revenue patterns post pandemic, as I’ll discuss in a moment.

Based on Q1 performance and the momentum we see today, we are affirming guidance to deliver an 8% to 10% increase in revenue in fiscal year ’23 and adjusted EBITDA of $195 million to $205 million, up from $189 million in fiscal 2022. Back-to-school Is significant to both our first and second fiscal quarters. The circumstances this year contrast with those of last year. A year ago, concern about supply chain issues resulted in that year’s back-to-school purchasing season beginning earlier than usual because teachers, librarians and parents were aware of book supply issues. Purchasing this year has reverted to a more normal pattern, which means we anticipate proportionately higher revenues from back-to-school in Q2 than last year. We plan for and are prepared for this shift and are excited to be there for our young readers, their teachers and their families.

From our Trade Publishing group, we’ve seen sustained success publishing best sellers. To date, in calendar year 2022, Scholastic titles have garnered nearly 100 starred reviews from influential outlets, such as Publishers Weekly and School Library Journal. Scholastic titles also have had a strong presence on the New York Times Best Seller list this year, with graphic novels capturing a record 11 out of 15 spots in the category.

This fall, we have a number of exciting releases, including the stunning picture book from civil rights icon Ruby Bridges, the Three Billy Goats Gruff from the renowned award-winning duo and picture book pioneers, Mac Barnett and Jon Klassen. In addition, for the latest Bad Guys #16 by Aaron Blabey and the illustrated edition of Harry Potter and the Order of the Phoenix. Looking to the next calendar year, we’ll also have Dav Pilkey’s recently announced next Dog Man book, Colin Kaepernick’s YA graphic novel memoir, a new Wings of Fire graphic novel by Tui Sutherland and Brian Selznick’s Big Tree. We continue to bring more and varied opportunities to our content through Scholastic Entertainment. We recently announced a deal to co-develop and co-produce the middle-grade memoir, Signs of Survival: A Memoir of the Holocaust by Renee Hartman and Joshua M. Greene. The project is in partnership with Amblin Television and Oscar winning actress Marlee Matlin’s Solo One Productions.

This joins an ever-expanding pipeline of media projects, the majority with creators like Amar’e Stoudemire [Phonetic] and Sterling K. Brown, and distributors such as Paramount, Amazon Prime, AppleTV+ and Disney+.

Turning to our school distribution channels. We’re excited to see that four season book fairs and children bringing home the first monthly club order form in their backpacks once again have captured and amplified the energy we all feel from the time on a tradition of back-to-school. In-person book fair confirmation rates are strong, well outpacing prior year, putting us on track to meet our projected target of 85% of pre-pandemic bookings in fiscal ’22, an increase from 72% last fiscal.

Early fairs data also reveals strong attendance rates and revenue per fair. Additionally, during Q1, Scholastic Dollars redemptions were strong, and we’re readily meeting demand. In Clubs, having resolved prior year systems issues, we’re well prepared for this coming year with an excellent inventory position and strategic marketing that increases our interactions with customers. Even as it’s too early in the business season to delve deeply into results, we’re already seeing a positive response from our participating teachers.

Now a look at our consolidated Education Solutions division. We continue to make great progress addressing classroom and school districts’ most pressing needs around literacy and reading, while strategically increasing investments to scale go-to-market capabilities and expand our differentiated offering of digital solutions. While results were somewhat lower, reflecting the fact that last year’s revenue benefited from a significant number of orders that have been delayed from Q4 2021, Education Solutions nonetheless continued its underlying long-term growth trajectory in Q1.

Beginning the quarter, our teams were laser-focused on supporting Summer Reading through solutions such as take-home book packs. And thanks to their close partnerships with customers, we’ve seamlessly shifted to supporting in-school needs this year. The demand for independent reading is still evident and tangible and our innovative partnership with the State of Florida and the University of Florida Lastinger Center for Learning is gearing up for its second year with a strong base of participants already in the program.

As the recent May results revealed, the learning gap in the U.S. has widened significantly as a result of the profound disruption in our schools caused by the pandemic. Sadly, we saw the largest drop in reading skills in 30 years and the first ever drop in math scores since the nation’s report cards’ inception. This is a priority issue to be addressed at both federal and state levels with historic levels of funding going to schools today.

Today is a pivotal moment and opportunity for Scholastic too, as we work to significantly expand the number of schools, teachers and students that we support. We’re confident in our ability to be a best choice as a partner, just as we’ve time and time again earned unparalleled trust from educators, thanks to our passion for mission paired with high-quality content. And it’s from this position of experience and strength that we’re working with schools and districts to design and implement solutions that deliver outcomes they need in accordance with the funding streams that they have available. At the same time, we’re investing both organically and inorganically to drive long-term growth through strategic enhancements to our literacy platform, such as our recently announced acquisition of Learning Ovations.

And Learning Ovations is the creator of A2i, short for assessment to instruction, which is a Science of Reading-based literacy assessment and instructional system. A2i is backed by over 12 years of rigorous research and more than 2,000 hours of classroom observation turning it the highest efficacy rate possible under the Every Student Succeeds Act. The system provides educators with easy to administer data-driven guidance for instructional planning for both small group and individualized learning, all customized to match the reading needs of individual students.

Given A2i’s gold standard effectiveness and validation and its ability to integrate hundreds of thousands of resources that address essential reading skills, soon to include Scholastic’s unique instructional and curricular resources. The addition of A2i and the Learning Ovations team significantly advances the development of our literacy platform.

And finally, strategy has also moved forward in our International division. We continue to focus on growth areas, rationalizing our lines of business that no longer align with that strategy, including in Asia, where we completed the disposition of the direct sales business. Despite the lingering impact of COVID, which has continued to fluctuate globally, we see positive indicators, particularly in Australia and New Zealand that our global fairs, clubs and trade businesses are rebounding with strength.

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

Kenneth J. Cleary — Chief Financial Officer

Thank you, Peter, and good afternoon. Today, I will refer to our adjusted results for the first quarter, excluding onetime items, unless otherwise indicated. Please refer to our press release tables and SEC filings for a complete discussion of onetime items.

The first quarter of the fiscal year is seasonally our quietest quarter as schools are not in session in most of North America, as Peter just described. Our preparations for the upcoming fall and spring seasons are proceeding as planned, and our readiness for the rest of the year is stronger than it’s ever been at this point in time. We have addressed the supply chain and operational issues we faced last fiscal year and have dedicated substantial resources to ensure we are prepared for the strong demand we are expecting from our customers. We have awarded inventory well in advance of the season, given the long lead times in our supply chain. We have hired sufficient distribution staff to meet the strong expected demand. Initial indicators from our first few Book Fair and Book Club offerings are positive and in line with our expectations.

In addition, we completed the acquisition of Learning Ovations on September 1, greatly accelerating the development of our Education Solutions literacy platform. In short, we are off to a strong start to our fiscal year, and we are, therefore, affirming our guidance of $1.8 billion of annual revenue and $195 million to $205 million of adjusted EBITDA for fiscal 2023 as we balance growth initiatives or current returns for our shareholders.

Revenue for the first quarter grew 1% to $262.9 million versus $259.8 million in the prior year period. Operating loss in the quarter was $58.1 million versus $36.2 million last year. Net loss was $45.5 million compared to $27.3 million last year, and adjusted EBITDA was a loss of $35.6 million compared to a loss of $13 million in the first quarter last year. Loss per diluted share was $1.33 compared to a loss of $0.79 last year.

Net cash used in operating activities was $60.3 million compared to net cash provided by operating activities of $63.6 million in the first quarter of last year. Free cash used for the quarter was $76.5 million compared to free cash flow of $49.1 million last year, returned to a seasonal Q1 cash use.

Last year, we were able to utilize leftover inventory from fiscal 2021 when inventory utilization was negatively impacted by the pandemic. This year, given the long lead times required for procurement of product, we used our strong balance sheet to acquire inventory earlier and our first quarter domestic inventory purchases increased to $152.2 million from $76.5 million in fiscal 2022. Our procurement push has provided us sufficient inventory to meet our expected demand and has helped to mitigate ongoing or threatened supply chain issues. Additionally, last year’s first quarter cash flow benefited from a $63.1 million federal tax refund and a $6.6 million insurance recovery.

At the end of the quarter, cash and cash equivalents exceeded total debt by $233.4 million compared to $219.1 million at the end of the first fiscal quarter a year ago, demonstrating substantial liquidity.

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 and early pay discounts, while also allowing us to invest in content with key best-selling authors. Capital expenditures and capitalized prepublication costs in the first quarter were $16.2 million compared to $14.5 million last year. We expect capex and prepub spend to exceed last year as we invest in our Education Solutions business and distribution operations, we will still be well short of our spending levels from the years preceding the pandemic.

In the quarter, we continued to return capital through our share buyback program. Through today, we have reacquired 122,000 shares for $5.7 million in the current fiscal year. We expect to continue our share buyback program for the foreseeable future.

As previously announced, we have increased our regular quarterly dividend to $0.20 per share, which we paid on September 15 of this year. Given our strong cash flow and expected earnings, the Board of Directors has approved a $0.20 per share regular quarterly dividend to be paid in December. We anticipate that the quarterly dividend will remain at this level, respectively.

Now turning to our segment results. In Children’s Book Publishing and Distribution, our Trade division posted strong results, while our school channels prepared for the fall back-to-school season. Trade revenue of $90.1 million modestly trailed the prior period revenue of $93 million and was consistent with our expectations. As Peter mentioned, we have a number of strong new releases supporting our Trade division in the current fiscal year.

Additionally, our backlist continues to provide a steady source of reliable revenue each quarter driven by our investments in series titles and innovative formats such as graphics. Further supporting this strategy, our Entertainment and Media business, which continues to market and monetize our intellectual property has begun to recognize revenue for the delivery of Eva the Owlet animated series to AppleTV+.Book Fair revenue of $28.3 million exceeded the prior period revenue of $16 million as Scholastic Dollar redemptions were strong.

Scholastic Dollars are reward program earned by schools that conduct book fairs, which as they are redeemed for Scholastic product, we recognize revenue associated with the redemptions. Strong Scholastic Dollars redemptions are indicative of higher customer engagement.

As mentioned in July and confirmed here, we expect our in-person fair count to be approximately 85% of our pre-pandemic in-person fair count level for fiscal 2023. Our Book Fairs division is operationally prepared for the upcoming fall season and early indications are consistent with our high expectations.

In Book Clubs, we have rectified system and distribution shortfalls we experienced last fall, and we expect operations will run at our usual efficiency levels. We are utilizing our proprietary data sources and long-standing relationships with schools and teachers to both reengage with our existing teacher sponsors and to attract new sponsors. First quarter Book Clubs revenue of $6.3 million was flat to the prior year’s comparable period reported revenue of $6.8 million but is not significant as schools were not in session.

Total Children’s Book Publishing and Distribution revenues for the current quarter of $124.7 million exceeded the prior year’s revenues of $115.8 million. Higher cost to support increased fair count expectations and rising freight charges resulted in an operating loss of $30.1 million as compared to $21.7 million in the prior year period.

Education Solutions revenues of $73.2 million trailed the prior year revenues of $80.1 million. Quarterly operating loss was $4.3 million compared to prior year operating income of $7.3 million. In the first quarter of the prior fiscal year, we shipped substantial product, much with Summer Reading programs in June and July for orders we received in May of fiscal 2021. This past fourth quarter, our procurement and distribution teams were able to procure, pick, pack and ship orders more timely, resulting in most of the orders going out in the fourth quarter last year. Accordingly, the first quarter this year was substantially quieter than the first quarter of last year.

This year-over-year decline was partially offset by revenues from our distribution contract with the State of Florida, which commenced shipments in the third quarter of fiscal 2022. While we are trending modestly lower than expected in this division, the ultimate annual results are dependent upon the second half of the fiscal year at a time when school funding is more readily available because of ESSER and other sources of funding.

Importantly, in the Education Solutions segment, we executed the acquisition of Learning Ovations and its proprietary assessment technology, A2i. This is a key accelerator in our development of a comprehensive education solution to enable teachers to better meet students’ literacy needs. The entire organization has embraced this acquisition and the talented employees we have added as a result and integration is well underway. As this acquisition is a component of our growth strategy, it is not expected to be immediately accretive and is likely to be modestly dilutive for the current fiscal year. We expect incremental expense this year to be approximately $1 million to $2 million.

International segment revenues of $65 million exceeded the prior period revenues of $63.9 million. Operating loss of $3.5 million was unfavorable to the prior period loss of $1.3 million. Prior year fiscal quarter operating results included $1.2 million of COVID-related government subsidies.

Canada and U.K. operations continued to recover from the pandemic and like the U.S. are preparing for the upcoming school year. Australia and New Zealand saw widespread lockdowns in the prior year’s first quarter but have recovered and are now exceeding our expectations for the current fiscal period.

China continued to struggle with COVID restrictions and government regulations around touring and foreign content. But overall, Asia operations are recovering from the pandemic. Unallocated overhead costs of $20.2 million in this year’s current fiscal quarter were flat to prior year’s fiscal quarter unallocated costs of $20.5 million as we continue to tightly control discretionary spending.

As a result of our strong preparation work this summer and increasing visibility around demand, we are affirming our revenue guidance of $1.8 billion, and our adjusted EBITDA estimate of $195 million to $205 million. We have achieved our first quarter financial and operational objectives.

Early on, we are seeing some patterns emerge. Notably, cost of product is trending modestly higher than our initial expectations as a result of higher freight costs, but these cost increases are offset by lower-than-planned general and administrative expenses as we continue to control discretionary spending. More importantly, we have gained confidence in our expectations within the Book Fairs and Book Clubs channels as the fall back-to-school season commences.

Our preparation work has been successful, and we are well positioned for the upcoming season. We are encouraged by our strong customer engagement and demand for our products, content and solution. External economic risks, including a decrease in disposable income due to inflation and potential changes in government funding remain, but our businesses have proven to be resilient through economic downturns in the past, and we expect that to be the same going forward.

Thank you for your time today. I will now hand the call back to Peter.

Peter Warwick — President and Chief Executive Officer

Thank you, Ken. This past quarter has built a solid foundation for the rest of the fiscal year and the positive trends that we saw in the previous fiscal year have continued to benefit our performance.

In concluding, I’d like to call out four critical factors. First, funding to close the widening reading achievement gap accelerated by the pandemic should continue. It’s something that the federal government, all state governments and all shades of opinion want to address. We’re uniquely positioned to help with this vital and noble cause because of our IP and because of our unrivaled distribution capabilities and relationships with literacy specialists, teachers and educational administrators.

Second, we’re taking advantage of our strong cash position and improved business results to invest in targeted growth for the future, especially in digital and media solutions, our developing literacy platform and groundbreaking and engaging IP.

Third, a strong financial position has also enabled us to manage our supply chain so that we have the books and the resources we need right now to meet demand.

And finally, our business that was most affected by the disruption to schools during the pandemic, Book Fairs, is already ahead of its performance at this time last year and is very well set to meet its targets this fiscal year and improve further on what was an excellent performance last financial year.

In closing, I want to thank every educator, family and partner that’s helping raise up the students in their community. We see you working tirelessly, and we promised to do the same, mapping out your needs with our solutions and bringing books to children’s homes through fairs, clubs, retail and partnerships.

Thank you all again for joining us on our call today. Jeff will conclude this afternoon’s presentation for us.

Jeff Mathews — Executive Vice President, Corporate Development and Investor Relations

Thank you, Peter. As a reminder, we invite questions to be directed to our IR mailbox, investor_relations@scholastic.com. We appreciate your time and continuing support.

Operator

[Operator Closing Remarks]