Scholastic Corporation (NASDAQ: SCHL) Q3 2023 earnings call dated Mar. 23, 2023
Corporate Participants:
Jeffrey 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, and welcome to Scholastic’s Third Quarter Fiscal Year 2023 Earnings Call. [Operator Instructions]
I would now like to hand the call over to Jeffrey Mathews, EVP, Corporate Development and Investor Relations. Please go ahead.
Jeffrey Mathews — Executive Vice President, Corporate Development and Investor Relations
Hello, and welcome everyone to Scholastic’s fiscal 2023 third 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’ve posted the 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. 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 payables 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 address investor_relations@Scholastic.com.
And now I’d like to turn the call over to Peter Warwick to begin the afternoon’s presentation.
Peter Warwick — President and Chief Executive Officer
Thank you, Jeff, and good afternoon, everyone. Thanks for joining us. In the fiscal 2023 third quarter, Scholastic recorded modest sales declines and higher losses as we continued to navigate short-term market headwinds, whilst also increasing investment for the long-term in blended learning programs and digital tools in our Education Solutions business. As a reminder, Scholastic’s third quarter is seasonally smaller and typically loss making.
We have modestly lowered our financial guidance for FY ’23 as a result of the ongoing softness we’re seeing in the retail bookselling market and purchasing delays for educational materials on the part of schools and school districts, something that has impacted our quarter three results, and we now expect to continue into quarter. Our team has taken decisive steps to align short term spending across the company with our new top line outlook. They’ve dedicated themselves to initiatives to improve margins. The team is also being mindful to protect strategic growth initiatives that are essential to our near- and long-term opportunities.
We remain confident in the performance and long-term outlook for our business in our market-leading children’s book publishing, in providing high-quality blended learning solutions for schools, and in our international business. Reflecting that optimism, in the third quarter, we returned over $50 million to shareholders in addition to investing in key growth opportunities. We’re more committed than ever to deploying our capital to drive long-term growth and sustain value for our shareholders and all stakeholders.
This afternoon I’d like to review our results and outlook in more detail. Ken will then walk through our financial results and revised expectations for fiscal 2023. I’d like to begin with an update on the current business environment where the headwinds we described on last quarter’s call continue to affect our industry and our business. First, the near-term retail bookselling environment, especially for children’s books, continues to be challenging compared to a year ago. Consumer demand and confidence have fallen in the face of ongoing inflation and economic uncertainty. We’re seeing this in the U.S. as well as in Canada, the U.K., and Australia and New Zealand, Scholastic’s major international markets, which are also being impacted by the strong U.S. dollar.
While children’s retail book sales have historically been less cyclical than other areas of discretionary consumer spending, some of the year-over-year decline in the third quarter may reflect a one-time return to pre-pandemic purchasing patterns by our retail partners and then customers. After stocking up due to supply chain uncertainty and challenges during the pandemic, retailers and wholesalers are resuming more normal inventory management policies. Similarly, retail book sales benefited over the past couple of years as families bought more children’s books during the lockdown, which we are now lapping.
Second, as we discussed during our last two calls, school and district administrators still face a pressing need to manage staffing challenges, which has lengthened selling cycles for instructional materials across the industry. This is delaying sales, even as federal and state funding for U.S. schools remains at historically high levels.
Third, as seen throughout the economy, costs remain high for paper, manufacturing, and freight and shipping in particular. These costs are now fully reflected in the inventory we’re currently selling, impacting margins across our business. We are, however, beginning to see improvements in these areas, especially in freight and shipping costs, which should create tailwinds in coming quarters as they flow through into our margins, in addition to the benefit of price increases that are reflected in inventory that’s currently being sold. Importantly, I’d like to emphasize that we believe all of these trends are short-term and not the new normal.
Let me now walk through our quarter three results in light of these factors. In the children’s book segment, revenues rose 1.5%, outperforming declines in the overall children’s book market. Book Fairs revenues grew an impressive 36% in the quarter, benefiting from increased fair count, which we expect to reach approximately 85% of the pre-pandemic levels. Robust increases in revenue per fair also contributed to higher sales, further underlying the differentiated value proposition of Scholastic’s school book channels compared to retail channels.
Today, the unique book fairs experience is as exciting and fun as ever for schools, parents, families, and most importantly, kids, as we’ve innovated, modernized, and increased kid appeal. This is borne out by the higher fair participation we’re seeing compared to pre-pandemic levels. Growing revenue per fairs has also been favorably influenced by successful kid-centric product selection and merchandising innovations like eWallet and the expansion of our friends and family functionality, which allows family members and friends to fund the kids fair purchases.
We’re excited about opportunities to continue investing in the fair experience to make it easier and more fun for kids and families to participate, buy books, and support their schools, while also making fairs available to more kids, families and communities, through our comprehensive equity initiatives. As expected, book clubs declined compared to the prior year period when sales benefited from a significant one-time backlog in shipments. Book clubs continue to experience higher revenue per event, but lower than forecasted participation by hard-pressed teachers. As we focus on activating and reactivating teacher sponsors and increasing student and family participation across all school channels, we’re also exploring ways to leverage book club strategic strengths across the company, especially building awareness of new titles, driving online traffic, and reinforcing the Scholastic brand.
Looking across our school channel, sales were up double digits last quarter, even in a difficult overall market. These results demonstrate the power of Scholastic’s publishing and our trusted position in schools to engage and excite kids about reading and books. We’re excited about the innovations and improved efficiencies we’ve achieved since the pandemic and even more excited for innovations that will come from greater collaboration across our business.
Turning to our sales in the trade channel. Sales declined in line with overall softness in the retail market. This dynamic primarily impacted backlist titles and was partially offset by best-selling new titles, especially from our graphic novel in print graphics. These include new graphic novel titles in major series like Heartstoppers, Cat Kid Comic Club, Wings of Fire, and the Baby-Sitters Club. Anticipation and early orders are also very encouraging for number 11 in Dav Pilkey’s best-selling series Dog Man: Twenty Thousand Fleas Under the Sea, which goes on sale on March 28th and should benefit our quarter four results.
Speaking of our major franchises, Scholastic Entertainment is a key component of our strategy to build must-read series and franchises. At the end of last quarter, we had nearly 40 projects in development and three in production. We’re very excited that Eva the Owlet launches on Apple TV Plus next week. It’s produced by Scholastic Entertainment and based on our New York Times bestselling book series, Owl Diaries. Supported by an extensive joint marketing effort with Apple, we’re promoting Eva across our channels, and publishing Eva even held center stage in the Scholastic-sponsored World Read Aloud Day last month.
Now moving to Education Solutions. In quarter three, sales were down and were delayed into quarter four or in some cases into fiscal 2024, partly as a result of ongoing selling challenges into schools and district administrators as described a moment ago. In response to this uncertain environment, we’ve taken actions to manage sales opportunities and partner with administrators to best support their key decision making and operational needs. Sales of supplemental print programs and collections were impacted most in quarter three.
In contrast, revenues from our state-sponsored programs, including in Florida, remained solid against the big prior year comparison. We were pleased to be chosen by the state of Louisiana as their partner for READ, a new state-funded book and literacy program designed to help support pre-K4 through 5th grade students in the state who are not yet reading on grade level. Scholastic will provide eligible students with home delivery of free, age-appropriate, high-quality, and engaging literacy resources beginning shortly.
Last quarter we also increased our investments in go-to-market capabilities and in our literacy platform strategy led by our new Senior Vice President, Andreas Vogt. We announced the launch of Ready4Reading, a new simple-to-implement print and digital K-3 phonics program aligned with the Science of Reading. It’s also our first speech-enabled literacy product, powered by a new partnership with SoapBox technology. SoapBox’s award-winning artificial intelligence-based speech engine has been built to accurately recognize children’s voices and diagnose reading fluency issues, regardless of background, age or ethnicity. This technology benefits both teaching and learning. Young students use their voices to independently practice reading aloud while building confidence as they learn, educators gain actionable real-time feedback to personalize and target instructional time. We’re very excited about Ready4Reading, which will be in the market this summer.
Evidence and science-based approaches have become key considerations for district administrators and educators, purchasing new literacy programs and supplemental materials. We believe this is a positive trend for kids and also Scholastic long-term. Our editorial team and authors are deeply committed to outcomes-based approaches to literacy as seen most recently in our acquisition of A2i and announcement of Ready4Reading. Independent reading is also a key component of any science-based approaches to literacy. Scholastic is uniquely positioned to provide kids relevant and diverse books that engage and excite them, and we’re taking steps to update our paperback collections to take advantage of this trend.
Next, looking at our international segment. In local currency, revenues decreased 18%, partly driven by the exit of the unprofitable direct-to-consumer business in Asia in quarter one. In addition, international results were impacted by lower trade sales in Canada, the U.K., and Australia, partly offset by strong performance in book fairs. While conditions in our major international markets are currently challenging, we remain optimistic about Scholastic’s long-term prospects outside the U.S., especially as we further expand our global publishing, product development, and cross-company collaboration.
Next, I’d like to address Scholastic’s continued progress towards its capital allocation strategy and priorities. Following October’s tender offer and the expanded $75 million authorization we announced with our quarter two results, we substantially accelerated open market share purchases in quarter three, in addition to our regular dividend. In total we returned over $53 million in the quarter, bringing our total year-to-date amount up to nearly $100 million. In support of this progress, our board of directors has authorized an additional $50 million for repurchases.
As we look ahead, we will continue to pursue opportunities to leverage our balance sheet and deploy capital by first investing in growth opportunities; second, maintaining a strong and efficient balance sheet; and third, returning excess cash to shareholders to enhance their returns. As Ken will discuss in more detail shortly, we’ve revised our FY ’23 guidance based on results in quarter three and an updated outlook for our seasonally important quarter four, both of which have been impacted by short-term headwinds in the retail bookselling and the U.S. educational materials markets.
Regardless of the ongoing short-term volatility being experienced across our industry and economy, we’re confident that in the near- and long-term, the critical need for children’s books and for solutions to help kids learn to read will remain paramount. And we’re bullish about Scholastic’s unique ability to address these important needs and to grow.
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 third quarter, excluding one-time items in the prior year period, unless otherwise indicated. We recorded no one-time items in this third quarter. Please refer to our press release table and SEC filings for complete discussion of one-time items.
As Peter discussed, company performance was lower than expected, partly due to the near-term softness in the retail children’s book market and ongoing purchasing delays by schools and district administrators. In children’s books, our Book Fairs channel outperformed the prior year, achieving higher fair count and revenue per fair, partially offsetting the selling challenges in the trade market and continuing trend in Book Clubs operations. We continue to experience higher costs due to inflationary and supply chain pressures, but we’re starting to see these higher costs slow.
In Education Solutions, we took steps to adapt to a more challenging marketing environment. We also invested in our long-term literacy platform, including the upcoming launch of the new K-3 phonic system, Ready4Reading, the integration of A2i, and the buildout of staffing capabilities to compete in this Education Solutions market. Likewise, we are investing in modernized distribution assets and automation to reduce costs and improve customer service. We continue to see opportunities to optimize certain components of our business while we see substantial growth opportunities in the Education Solutions space and our Book Fairs operations.
As such, we remain bullish on our long-term outlook for the future, but we acknowledge some short-term headwinds to our operation. As a result of the softness in the retail book market and the uncertainty of Q4 Education Solutions sales, we have updated our guidance. We now expect adjusted EBITDA of $175 million to $185 million, and revenue growth of approximately 4%.
Turning to our consolidated financial results. Revenues decreased 6% to $324.9 million. Operating loss in the quarter was $27.7 million versus $16.7 million last year. Net loss was $19.2 million compared to $13.2 million last year and adjusted EBITDA was a loss of $5.4 million compared to a gain of $5.9 million in the third quarter of last year. Loss per diluted share was $0.57 compared to a loss of $0.38 last year.
For the nine-month period, revenue was $1.176 billion compared to $1.129 billion last year and operating income was $14.3 million compared to $31.4 million last year. Nine month adjusted EBITDA was $81.3 million compared to $100.4 million last year. Net cash provided by operating activities for nine-month period was $28.9 million compared to $178.5 million last year. Free cash used for the nine-month period was $25.7 million compared to free cash flow of $147.9 million last year. We successfully acquired inventory during the first half of this year in anticipation of increased sales and longer lead times, which has enabled the growth we’ve seen in children’s books.
Inventory purchases year to date have increased approximately $114 million over last year, while inventory purchases in the third quarter decreased by approximately $25 million. We expect the full year to have positive free cash flow between $25 million and $35 million. We expect future years to return to a more normal free cash flow pattern than we experienced this year through our need to build back inventory levels.
As mentioned, the inflationary and supply chain pressures that have caused the current fiscal year’s increase in paper printing, wage, and transportation costs are beginning to abate. Last year, into early this year, we experienced higher product cost of approximately 15% compared to late in calendar year 2021 and higher wage costs of as much as 20% for driver and distribution labor. The rate of increase has slowed dramatically, and in the case of overseas transportation costs, has declined from peak levels. Our top priority was to ensure we could meet demand and continue on a strong recovery from the pandemic, notably in our Book Fairs and Education Solutions operations. To do this, we procured substantial quantities of inventory when lead times for purchases were longer and costs were higher. Accordingly, the inventory we are currently selling and will continue to sell for our critical fourth quarter was procured at relatively high prices, which will be reflected in our margins.
With this context of higher inventory costs and purchasing this year, I’d like to dedicate a few minutes to discussing some of the ways we have greatly improved our procurement and inventory management, as well as related distribution activities for the long term. Our supply chain is more resilient. We have broadened our vendor base to include vendors from around the world, including Europe, the Americas, and Asia. This broader array of vendors allows us substantial leverage in sourcing product. We have also strengthened relationships with key U.S. vendors who due to close proximity with our warehouse facilities and added capacity can reduce lead times for orders dramatically.
Scholastic supply chain inventory management is also more agile. We have enabled the use of digital printers who can provide smaller print runs to reduce waste and quickly meet near-term customer demand. We have developed product specification standards that allow us to simplify the manufacturing process while ensuring the highest quality product for our customers. We have upgraded tools and resources to better match the timing and quantities of supply to customer demand. Last, our planning processes are more strategic. We have added analytics and tools to optimize our curation and offering and better coordinate these efforts with our marketing programs, allowing us to better understand our customer base and provide the appropriate product to the targeted market segment. All of these improved capabilities developed since the beginning of the pandemic and supply chain crisis will enable us to reduce inventory costs, reduce waste, improve margins, and most importantly, ensure we have the best product to meet our customers’ demand.
Now back to our financial review. At the end of the quarter, cash and cash equivalents exceeded total debt by $193.6 million compared to $295.2 million at the end of the third fiscal quarter a year ago. For our longstanding policy, all cash balances are held in investment grade banks. Capital expenditures and capitalized prepublication costs for the nine-month period were $54.6 million compared to $41 million last year. We expect capex and prepub spend of between $85 million and $90 million this year, primarily driven by investments in our Education Solutions business and distribution operations.
In the current fiscal year, we returned capital through our dividends, a tender offer for our shares, and open market repurchases. As Peter discussed, through today, we have reacquired almost 1.9 million shares, returning $81 million to shareholders in the current fiscal year, with more than half acquired in the third quarter alone. To this end our board of directors has approved a $50 million increase in our current share buyback authorization. Additionally, our board of directors has approved a $0.20 per share regular quarterly dividend to be paid in June. 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 third quarter of $204 million exceeded the prior year’s revenues of $201 million. Operating income decreased to $1.9 million compared to $5 million in the prior year period. Our Book Fairs operations led the improved results despite the softening retail demand for children’s books. Book Fairs revenues increased to $103.5 million from $76 million in the prior fiscal quarter. Fair count is on track to rise to about 85% of pre-pandemic levels from 72% last year. Coming out of the pandemic, our operations are greatly improved and participation at our in-person book fairs remains strong while we continue to innovate and improve upon our offering to customers and distribution capabilities. We do not see a return to 100% of in-person fairs held before the pandemic, as many of these fairs were not profitable, but we will see an increase in fair count next year.
Book Clubs revenues of $27.7 million trailed the prior year reported revenues of $40.5 million. The prior year period benefited from the shipment of backlog, customer orders, which shifted approximately $18 million of revenue in from the second quarter. Our Book Clubs revenues continue to trend lower, but these operations are a vital component of the company’s outreach to teachers and students. Trade division sales trailed against the prior year quarter with revenues of $72.8 million compared to $84.5 million last year. Our trade channel continues to be impacted by the industry-wide decline in retail market sales, which are down about 5%.
Product costs continue to trend higher, as I previously discussed. We continue to have multiple titles on bestseller lists and our excited for the new Dog Man titled by Dave Pilkey, Twenty Thousand Fleas Under the Sea, which will be released at the end of March. In addition, we’re looking forward to the release of Eva the Owlet series on Apple TV Plus on March 31st.
Education Solutions revenues of $70 million trailed the prior year revenues of $77.2 million. Quarterly operating income was $700,000 compared to $13.1 million in the prior year. School and district administrators continued to delay purchasing as they focus on staffing and other matters, which impacted our revenues, specifically from instructional products and programs. Revenues from our Magazines Plus business and digital subscription products remain consistent with the prior year. We continue to invest in our literacy platform strategy and key partnerships that will further enhance our solutions models and product offering. As a result, we have brought on key staff with expertise to develop and transform our literacy platform, which includes the integration of A2i.
The annual results for Education Solutions are largely dependent upon the fourth fiscal quarter. And as schools and districts continue to delay ordering educational materials, this could have a material impact on the company’s fiscal year results. International segment revenues of $50.9 million trailed the prior period revenues of $66.3 million with the foreign exchange rates driving $3.5 million of the decline due to the strong U.S. dollar. Operating loss of $9 million was unfavorable to the prior period operating loss of $4.6 million. The international trade channels were also impacted by the softness in the children’s book retail market, driving the majority of the decrease in our major markets.
Similar dynamics that are driving higher demand for book fairs in the U.S. are also driving higher demand for Book Fairs internationally, while much like in the U.S. Book Clubs revenues are declining. International margins continue to see improvement since we exited the unprofitable direct sales business in Asia. Unallocated overhead costs of $21.3 million decreased versus prior period costs of $30.2 million. This decrease is attributable to favorable photo [Phonetic] litigation settlements, are continuing efforts to tightly control discretionary spending and improved efficiencies at our centralized distribution facility.
I’m also happy to report that our new tenant for the remaining Broadway-facing retail space in our headquarters property in Soho. Has taken occupancy as of March under a long-term market rate lease. We continue to market additional retail space on the Mercer side of our headquarters as well as office space on our lower floors. As a result of our performance year to date and in our current forecast, we have updated our guidance for Adjusted EBITDA now estimated to be between $175 million and $185 million. We now expect full year revenue to grow approximately 4%.
Sales volumes in the critical fourth quarter, particularly in the Education Solutions segment, can vary dramatically. In response to this updated outlook, we are tightly managing costs as we close out the year and have taken the following actions. We revised sales and marketing plans to accelerate sales and trim unproductive spending. We have put controls on discretionary spending, including T&E, and are reducing spending on temporary labor. We have also reviewed key corporate vendors, and where appropriate, we are negotiating or switching to lower our costs. As Peter has said, our business remains fundamentally sound, and we will continue to invest in our growth initiatives and remain committed to returning capital to our shareholders.
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. While we’re disappointed to see quarter three results come in lower than expected and to reduce our outlook for quarter four, Scholastic is strong and resilient. We’ve navigated much more significant challenges than today’s short-term headwinds, emerging stronger and holding our focus on our mission or long-term opportunity. I’m proud of the quick actions the team has taken to adjust spending and preserve margins in line with our adjusted top line outlook.
Just as critically, we continue to focus on driving growth and creating shareholder value for the long term. We’re sustaining our investments in key growth drivers, like our literacy platform, while upholding our commitment to return substantial cash to our shareholders. We’re optimistic about our future and look forward to sharing our plan for FY ’24 and the longer term on our next call in July.
So thank you all again for joining our call today. Jeff will conclude this afternoon’s presentation for us.
Jeffrey 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]