Scholastic Corporation (SCHL) Q3 2022 Earnings Call Transcript

Scholastic Corporation (NASDAQ: SCHL) Q3 2022 earnings call dated Mar. 17, 2022

Corporate Participants:

Paul Hukkanen — Chief Accounting Officer and Vice President

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 the Scholastic Fiscal 2022 Third Quarter Earnings Call. [Operator Instructions] Please be advised, this call is being recorded. [Operator Instructions]

I would now like to hand the conference over to your host today Paul Hukkanen, Chief Accounting Officer and Investor Relations. You may begin.

Paul Hukkanen — Chief Accounting Officer and Vice President

Hello, and welcome, everyone, to Scholastic’s fiscal 2022 third 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’ve 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 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 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.

While there’s what we hope to be promising news in moving past the pandemic, we’re, of course, deeply saddened and concerned by the events unfolding in Ukraine. As we’ve been for more than a century, we’re focused on how we can support children in deciphering these challenging times. Our expert team of writers and editors at Scholastic Magazines+ immediately created tailored materials to help teachers facilitate classroom conversations appropriately.

We also have a number of trade book titles such as Alan Gratz’s Refugee, which can be starting points for children at home or in school to begin to understand what this experience may be like for displaced families. We’ll continue to listen to teachers, parents and children to learn what they need and execute our mission by being a timely and reliable resource for them. From an operations perspective, while our financial exposure is limited, we have suspended any business dealings with Russia.

Turning to our third quarter fiscal year 2022. A number of continuing themes drove positive momentum around Scholastic. Our intellectual property continues to lead the industry, and in many cases, crosses over audiences, regions and media. Increased demand for independent reading is bolstering our business. Book fairs are back and growing, providing a renewed sense of normalcy in schools.

Loyalty to book clubs remained strong, a unified approach to the education business, increased opportunity and has grown revenue. And finally, customers and stakeholders continue to turn to us, knowing that our committed and mission-driven employees will meet their needs as they reemerge from the pandemic. Ken will provide greater detail as usual, but I’m pleased to share that revenues for the third quarter grew 24% to $344.5 million versus $277.5 million in the prior year period.

Now, I’d like to walk you through highlights from our segments this past quarter, and areas that we’re looking forward to in our all important quarter four. In trade, as written about in Publishers Weekly, Dav Pilkey led a number of lists in 2021. Dog Man, Mothering Heights was the overall top selling book with more than one million copies sold. Dog Man: Grime and Punishment also stayed strong. And the newest title, Cat Kid Comic Club: Perspectives, was high in the hardcover frontlist category.

In the same category, JK Rowling’s The Christmas Pig came in at number five, and Harry Potter continues to rank well throughout the lists. We also have exciting activity in the world of film, TV and streaming. Aaron Blabey’s The Bad Guys, a highly anticipated animated feature with DreamWorks debuts in April. This series, which originated with us in Australia remains an excellent example of the strength of our international book publishing to capture the attention of children throughout the world. And our own Scholastic Entertainment continues to bring our backlist intellectual property to the forefront with a number of production announcements, such as the recently greenlit live-action series of Goosebumps with Disney+, and Season Two of Stillwater on Apple TV.

Overall, this activity not only raises the potential of our backlist, but also strengthens our opportunity for licensing. All of these engaging titles in combination with a curated selection of books from publishers worldwide translate into an unparalleled distribution channel in our fairs and clubs business. As we shared in December, our fairs comeback in quarter two exceeded expectations and we’re pleased to report this positive trend has continued.

We’re maintaining 70% of our pre-pandemic levels of in-person fairs. Revenue per fair remains strong. And it’s been great to see the joy expressed by children and adults alike, who are thrilled to have the fairs experience come back to their schools. As I noted earlier, our book clubs business is seeing a clear demand for independent reading and continued loyalty from teachers.

The negative impacts from the industry-wide labor shortage in our previously disclosed systems issue did impact quarter three. But I’m pleased to say that thanks to our diligent employees and management of the labor issue, our backlog from the fall is fully rectified, and all critical systems issues have been addressed. While we mitigate any remaining issues, we resumed our standard day-to-day processes, and we’re returning to the service levels our customers expect and deserve.

Our dedication to the literacy journey for each child is what truly sets us apart in the industry. Our Education Solutions division adds to that mission by creating high-quality book collections, reading curricula, and print and digital instructional tools for U.S. schools and districts. Our company was founded on magazines in 1921. And now 101 years later, I think you’d be hard pressed to find a magazine success story leveraging print and digital experiences comparable to Scholastic in relevancy and reach.

This month, we announced an expansion of our titles to meet increased demand for high-quality materials. Magazines+ launched pre-orders for the highly anticipated Storyworks 1, which will first ship in fiscal 2023. And now creates a full line of Storyworks English language arts titles for grades one to six, making it an important whole school offering aligned to standards for any U.S. Elementary School.

Pairing our deep expertise in reading with our ability to involve keeps our magazines strong and profitable as we continue to advance from print into a highly interactive digital experience. Overall, our Education Solution segment is performing ahead of expectations with continuing momentum around our curriculum and digital offerings. Summer Reading remains at the forefront of needs among educators who are working to accelerate learning and to catch up from lost time due to the pandemic. The environment remains unpredictable due to both COVID and because of the varying size and accessibility of district and school funding channels. With our longevity and expertise, as well as our experience with market cycles, positions us well for the demanding quarter four, which is historically a high volume period.

In international, as I mentioned earlier, we continue to see strength in our publishing, with standouts from Australia-based Aaron Blabey and the global response to U.S. based Dav Pilkey. In the U.K., Tom Gates’ latest titles performed well, and his brand extends to Sky TV and merchandise. Outside of publishing, our international fairs and clubs businesses continue to work their way through the impact of COVID.

In Asia, we’re working closely with our franchise partners and our direct-to-home team to manage costs and better understand new regulations in China. Finally, a brief update on our cross divisional collaboration, The New Worlds Reading Initiative with the State of Florida and The University of Florida Lastinger Center for Learning. This past quarter, we surpassed the milestone of 100,000 children having signed up for home delivery of books to promote independent reading. This is a remarkable achievement in such a short time, with 350,000 books shipped since we started in December.

To execute this five-year partnership, which we expect will only grow in its reach, we’ve opened a new distribution facility in Florida. Overall, Scholastic’s positive results this fiscal year to date have benefited from the long-term effects of our previous investments in technology and infrastructure, as well as the enduring expertise and passion of our employees and the ongoing loyalty of our customers. We enter the final quarter of our fiscal year with strong and solid momentum driven by a thoughtful strategic vision rooted in our enduring educational mission. I look forward to sharing more with you in the future on forthcoming titles, initiatives and offerings.

And with that, I’ll now turn the call over to Ken.

Kenneth J. Cleary — Chief Financial Officer

Thank you, Peter, and good afternoon.

Today, I will refer to our adjusted results for the third quarter, excluding one-time items, unless otherwise indicated. Please refer to our press release tables in SEC filings for a complete discussion of one-time items.

While the third quarter is seasonally quieter than either the second or fourth quarters, book fairs finished a strong fall season and has started the spring season on the same trajectory. Book clubs has recovered from operational issues created by labor shortages and software implementation issues and is seeing demand recover early in the spring season. Education Solutions had a typically quiet third quarter and was [Phonetic] building inventory to meet expected demand in the fourth quarter. Our trade channel continues to dominate bestseller lists, as Peter discussed.

International operations continue to be negatively impacted by pandemic-related difficulties in Asia, we’re starting to turn the page on the pandemic in Australia and New Zealand. Overall, we are very pleased with our results and our preparation for future growth.

Revenue for the third quarter grew 24% to $344.5 million versus $277.5 million in the prior year period. Operating loss in the quarter was $16.7 million versus $11.9 million last year. Net loss was $13.2 million compared to $4.8 million last year, and adjusted EBITDA was $5.9 million compared to $14.2 million in the third quarter last year. Loss per diluted share was $0.38 compared to $0.14 last year.

Net cash provided by operating activities was $36.9 million, compared to $16.4 million in the third quarter of last year. Free cash flow for the quarter was $23.4 million compared to $5.5 million last year, demonstrating continued discipline and increased revenues on a lower cost base.

For the nine-month period, net cash provided by operating activities was $178.5 million compared to $36.5 million in the prior year. And free cash flow was $147.9 million in the current year compared to a free cash flow of $1.5 million last year, an improvement of $146.4 million, reflecting the company’s continued recovery from the pandemic, the cost savings initiatives implemented last year and a first quarter tax refund.

At the end of the quarter, cash and cash equivalents exceeded total debt by $295.2 million compared to $162.5 million at the end of the third fiscal quarter a year ago. Capital expenditures and capitalized prepublication costs in the third quarter were $13.5 million compared to $16 million last year.

Domestic inventory purchases for the fiscal year of $262 million increased $65.7 million over last year’s purchases, as the company was able to leverage older inventory for the first nine months of this fiscal year. Due to supply chain difficulties, the company is currently ordering inventory well in advance of anticipated demand, vying for longer manufacturing and transportation lead times.

Newer tools and processes are providing better insight to demand planning and fulfillment, enabling more efficient and cost effective procurement despite the longer lead times. In the current quarter, we continued our share buyback program, which was suspended at the outset of the pandemic. Through today, we have reacquired 498,000 shares for $19.8 million. This includes a privately negotiated transaction with a related party of 300,000 shares for $12.2 million at discounts to market prices. Our cash and liquidity remains strong, and we expect to continue open market repurchases of our shares for the foreseeable future.

Now turning to our quarterly segment results. In Children’s Book Publishing and Distribution, book fairs continues its strong recovery from the pandemic. Book fair revenue of $76 million exceeded the prior period revenue of $27 million. Our in-person fairs executed for the fall season have now reached approximately 70% of fall of calendar year 2019 pre-pandemic levels, and we expect the recovery to continue at this rate for the upcoming spring season.

Equally important, our revenue per fair has increased 13% on a same fair basis when compared to pre-pandemic levels in the fall of calendar year 2019. While we expect the spring season fair count to increase modestly from the fall, we anticipate that revenue per fair will be down from fall levels in line with typical spring season performance. High fair quality remains our primary objective, and we will limit fair count where necessary to ensure that we have continued to deliver the best possible fair experience to our customers.

Trade continued its strong run as revenues of $84.5 million exceeded the revenues of $80.8 million in the same period a year ago, an increase of 4.6%, largely driven by strong demand for backlist titles as our series publishing continues to resonate with young readers. In the prior year’s third quarter, we released Dav Pilkey’s first Cat Kid Comic Club title, followed by the second title this past November. We expect to release the third title in this series in April.

Third quarter book clubs revenues of $40.5 million exceeded the prior year’s comparable period reported revenue of $35.1 million, as we work down the bulk of our previously discussed backlog in December. Labor shortages at our primary distribution facility in Jefferson City, Missouri, have now been resolved, as we have increased wage rates to attract warehouse associates.

While book clubs revenues are down on a year-to-date basis, we expect demand to recover in the spring as teacher and parent engagement remain strong. Total Children’s Book Publishing and Distribution revenues for the current quarter of $201 million exceeded the prior year’s period revenues of $142.9 million. And operating income of $5 million improved over the prior year’s period operating loss of $4.7 million as a result of the increased revenue and cost containment efforts.

Education Solutions had a solid quarter with revenues of $77.2 million, exceeding the prior year revenues of $66.3 million. Quarterly operating income was $13.1 million, exceeding the prior year performance of $9.7 million. As Peter mentioned, we have commenced execution of our distribution contract with the State of Florida, which is now fully operational and operating within the state, which accounted for $5.7 million of revenue in this fiscal year’s third quarter. Magazine+ revenue and subscription rates have come back strong post-pandemic, with quarterly revenue from magazines exceeding the prior year’s third quarter by $3.4 million.

Digital revenues were on par with the prior year’s comparable quarter, while teaching resources, which was in high demand during the pandemic, continued to trail the prior year and has returned to historical levels. In the prior year, Education Solutions experienced a strong fourth quarter as demand for Summer Reading during the pandemic and the need to replenish classroom libraries drove demand.

In this year’s fourth quarter, we expect continued demand for Summer Reading, albeit not quite at last year’s levels, an increased demand for diverse titles such as those within the Rising Voices collections. Delivery of these products is likely to straddle [Phonetic] in the fourth quarter of the current fiscal year and the first quarter next fiscal year.

International segment revenues of $66.3 million trailed the prior year’s period revenues of $68.3 million. Operating loss of $4.6 million was unfavorable to the prior year period loss of $800,000. Prior year third quarter operating results include $2.1 million of COVID-related government subsidies.

Canada continues its pandemic recovery, with revenues up $3.2 million in the quarter led by increases across all channels. The U.K. operations revenues increased $200,000 in this year’s fiscal quarter, driven by the resurgence of book fairs. Australia and New Zealand saw widespread lockdowns in the current year, but began to recover in November and December as restrictions lifted, resulting in relatively flat sales for the third quarter.

Sales across Asia were down $4.2 million in the third quarter from the same period last year. Asia continues to struggle with COVID restrictions and government regulations in China around tutoring and foreign content. Unallocated overhead costs of $30.2 million in this year’s fiscal quarter exceeded prior year’s third quarter unallocated costs by $14.1 million. Higher wages and related costs of the company’s Jefferson City, Missouri, distribution facility resulted in $7.6 million of the increase in the period. Higher accrued bonuses, benefit costs and consulting costs also contributed to the increase.

As measured in previous calls, we are on track to achieve the $50 million of permanent savings as a result of last year’s cost containment initiative. Much like everyone else, we face inflationary cost pressures for product, transportation, labor and fuel. Product costs for printing paper and inbound freight have increased our per unit cost by approximately 15% for purchases made this year. And we’re seeing these costs run through our cost of goods sold line as we utilize this inventory.

As previously mentioned, variable labor costs for warehouse associates and drivers have increased over 20%. Likewise, postage and outbound shipping costs have increased. In addition to the higher costs, availability of resources has increased product receipt lead times, which has led us to procure further in advance of demand.

Lastly, recent increases in fuel costs as a result of the Russian invasion of Ukraine will negatively impact our costs, most notably in book fairs, where we manage our own distribution fleet of vehicles. We are addressing these variable cost increases near and longer term through proactive resource allocation, diversifying our vendor base, automation, product rationalization in the case of fuel consumption, route optimization. While our cost savings programs from last year, combined with this year’s efficiency gains will provide some mitigation to higher variable costs, we’ll also be reviewing pricing as appropriate.

As we look forward to next fiscal year, we are encouraged by our strong customer engagement and demand for our products, content and solutions. We expect book fairs to continue their strong pandemic recovery, and we are expanding capacity and procuring incremental inventory to meet this demand. Trade will continue to publish titles in current series and will introduce new characters and content, both in traditional print format and other media.

We’re also excited about the future for Education Solutions business as we expand our digital offerings and content and extend our customer base. Finally, as previously announced, the company approved its regular quarterly dividend of $0.15 per share. Thank you for your time today.

I will now hand the call back to Paul.

Peter Warwick — President and Chief Executive Officer

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.

Operator

[Operator Closing Remarks]