Earnings Call Transcript - SCHL Q2 2024

Operator, Operator

Good day and thank you for standing by. Welcome to the Scholastic Corporation Fiscal 2024 Second Quarter Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeffrey Mathews. Thank you, Allen. Hello, and welcome, everyone, to Scholastic's fiscal 2024 second quarter earnings call. Today on the call, I'm joined by Peter Warwick, our President and Chief Executive Officer, and Ken Cleary, our Chief Financial Officer and Acting President, International. As usual, we 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'd 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'll 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 the accompanying financial tables, filed this afternoon on a Form 8-K. This earnings release has also been posted to our Investor Relations website. We encourage you to review the disclaimers in the release and investor presentation and to review the risk factors disclosed in the company's annual and quarterly reports filed with the SEC. Should you have any questions after today's call, please send them directly to our IR email address, investor_relations@scholastic.com. And now I'd like to turn the call over to Peter Warwick to begin this afternoon's presentation.

Peter Warwick, CEO

Thank you, Jeff, and good afternoon, everyone. We appreciate you joining us. Scholastic performed well in the second quarter during the crucial back-to-school season in the Northern Hemisphere. Our School Reading Events and Education divisions have made progress in their plans and continued to showcase Scholastic's unique ability to provide tens of millions of kids with engaging high-quality books. Scholastic's Trade Publishing and Entertainment teams persist in creating and publishing best-selling books and content, fulfilling an essential part of Scholastic's integrated publishing and distribution strategy. With children back in school and a renewed focus on the importance of reading and learning from parents and educators, Scholastic's mission remains vital, even in the challenging U.S. school environment we’re currently navigating. Last quarter, we took measures to generate long-term value, investing in growth initiatives and returning over $58 million to shareholders through share buybacks and dividends. Profits for the second quarter stayed steady, despite modestly lower revenues. However, these results fell short of our profit growth expectations due to external factors, a trend we anticipate will persist for the remainder of the school year. Consequently, we've revised our fiscal 2024 guidance and are targeting additional revenue opportunities in response to spending changes in the second half of the year. We remain optimistic about our long-term growth outlook and impact as we execute our strategy, invest in content and capabilities to drive growth, and return capital to shareholders under an expanded share repurchase authorization announced today. This afternoon, I’ll review our second-quarter results and updated outlook for the rest of the year, after which Ken will discuss our financial results in more detail. I'd like to start with some comments on the macro environment we’re operating in. As noted earlier, the environment in U.S. schools is more complex and challenging compared to a year ago, reflecting increased polarization in society and the politicization of schools, higher absenteeism rates, and chronic teacher shortages. These factors have placed additional demands on schools and teachers, including expanded restrictions on book choices and changes in literacy instruction methods. Nonetheless, it's evident that reading, literacy, and learning are priorities that families, educators, and leaders universally support, regardless of location or political affiliation. Scholastic is well-positioned to address these needs today and in the future. We will continue focusing on serving all kids, families, and educators, as we have done for over a century. We also noted a modest short-term slowdown in consumer spending growth this fall compared to last year and expectations in our school-based channels. However, recent weeks have shown signs of recovery, consistent with trends reported by some retailers this fall. Sales of children's and young adult books saw a 2% decline in our second quarter compared to a year ago, according to BookScan, although the retail market for both adult and kids' books remains significantly above the levels seen in 2019. We interpret this dynamic as largely a return to pre-pandemic growth trends. Furthermore, we benefit from lower costs of paper, manufacturing, freight, and shipping compared to last year, which is already reflected in our inventory purchasing and cash flows, and will further be evident in our operations. In terms of results, the second quarter is the largest for the Children's Book segment. Segment revenue declined by 6%, influenced by the planned resizing of Book Clubs and lower than expected production revenue from Scholastic Entertainment, which is included in our consolidated trade figures. Excluding Scholastic Entertainment, consolidated trade sales rose by 3%. Fair sales grew by 1% to $242 million in the second quarter, surpassing last year’s record and highlighting our continued presence in the U.S. education system. The number of fairs increased as planned, and revenue per fair rose modestly on a same-fair basis but decreased on average due to the mix, reflecting the addition of mostly smaller fairs in the fall schedule. Cancellation rates improved compared to the previous year. Over the past two years, we have transformed Book Fairs with new customer-centric strategies and operational enhancements, leading to increased participation and transaction sizes, thereby boosting revenue per fair. While our average revenue per fair remained near record levels, we have seen it grow more slowly this year due to the macro factors affecting schools and consumer spending. Consequently, Fair's profitability did not meet expectations, as revenue per fair is crucial for operating leverage and margin expansion. Looking ahead to the second half of the school year, we expect trends to continue into the spring, following historical patterns. In response, we have adjusted our merchandising strategy for fairs in the spring, and we are optimistic about this approach. We also believe we can achieve nearly 90% of pre-pandemic fair counts this year. Our focus on innovating and improving the Book Fair host experience includes new tools such as our updated online fair preview and enhanced online restock processes, while we concentrate on high-quality, kid-centered merchandising. This year is transitional for our School Book Clubs as we integrate them with Fairs into a combined School Reading Events division. Last quarter, Clubs’ gross profit remained roughly the same as the previous year as we adapted the business. However, revenues declined by 44% due to a planned reduction in unprofitable offers and promotional spending, leading to fewer orders. Participation and spending by teachers and families were also lower than anticipated, resulting in reduced revenue per order, echoing broader macro trends. We are improving response rates as we refine our redesigned club flyers, which should positively impact order volumes in the second half of the year. However, we expect the effects of decreased teacher participation and spending in the fall to affect Clubs' spring results as well. In terms of Scholastic's trade publishing, we performed well in a retail market that saw a slight decline year over year, mainly affecting backlist titles. On a positive note, Scholastic's new frontlist titles are performing exceptionally well, with significant success on bestseller lists, achieving 117 weeks cumulatively on the New York Times Middle-Grade bestseller list and 88 weeks on the Young Adult bestseller list. We maintained a leading presence on the New York Times Graphic Books, Manga, and Children's series bestseller lists, and if year-end lists are published, our titles have appeared prominently. Among our top performers was the interactive edition of Harry Potter and the Prisoner of Azkaban and The Harry Potter Wizarding Almanac, which frequently ranked on bestseller lists. Additionally, Cat Kid Comic Club Number 5; Influencers by Dav Pilkey, launched during the second quarter, became the number one bestselling book across kids and adult categories on BookScan. This success positively impacted backlist sales for Dav's Dog Man and Captain Underpants series. The new paperback edition of The Ballad of Songbirds and Snakes, a prequel to The Hunger Games series, also performed strongly due to the recent movie release. Once again, Scholastic benefited from the synergy of page-to-screen, enhancing our major publishing franchises. Looking ahead, we are excited about our publishing plans for spring, featuring new titles in Dav Pilkey's Dog Man and Alice Oseman's Heartstopper series, along with new works from bestselling adult author Alan Gratz and new graphic novels in our Wings of Fire, Baby-Sitters Club, and Amulet series. The new live-action Goosebumps TV series co-produced by Scholastic Entertainment and Disney also launched in the second quarter and has proven immensely popular, being Disney's most-watched season premiere year-to-date on both Disney Plus and Hulu. The series quickly reached the top 10 in streaming rankings. As reported, this success is notable for a non-Marvel or Star Wars series on Disney Plus in terms of Nielsen's rankings. To maintain momentum with today's audiences, Scholastic Entertainment has a range of new projects in development that bring back classic Scholastic properties in innovative ways. We are collaborating with premier platforms, producers, screenwriters, and actors—including co-producing The 39 Clues with Amblin for Netflix, developing Animorphs and Fly Guy as feature films, and working with Elizabeth Banks and Marc Platt Productions to adapt The Magic School Bus for the big screen. Each of these Entertainment projects is linked to fresh publishing programs and classic product offerings for current and prospective fan bases. Shifting to Education Solutions, sales in the second quarter increased by 1% compared to record levels from the previous year. This division is adapting to the evolving school environment while establishing new channels and models to enhance kids' access to books and literacy outside of school. We are also investing in new flexible supplemental learning programs that address market needs. Sales of book collections rose through our partnerships with states and school districts, helping to offset declines in supplemental instructional material sales we have seen over the last few quarters. Districts are adjusting their approaches to literacy instruction in response to state and local laws, leading to some pausing on new purchases as teachers work to retrain and implement new curricula. Meanwhile, we are working to realign key product lines with the trends in reading while developing new content and products. Looking ahead, we are optimistic about the mid- and long-term opportunities for Scholastic's Literacy Focus Education business as we advance our plans for new digital and print solutions, building upon our current profitable print-based education offerings. Recently, we expanded our summer learning offerings, which represent a significant opportunity for Scholastic to grow and make an impact. Schools have an urgent need for instructional programs and books that support students, educators, and families year-round. We acquired rights from LitLife, Inc. for LitCamp, a foundational reading skills program for summer and extended learning, which we have been successfully selling since 2015. We also acquired rights to MathCamp, a new companion program to LitCamp, which we anticipate releasing this summer. We believe this acquisition strengthens Scholastic's position as a leading provider of impactful summer learning solutions. After nearly four months in her role, Education Solutions President Beth Polcari is moving ahead with plans to revamp our classroom magazines business into a comprehensive, blended content and data-driven instructional program. She and the Education Solutions Team are also exploring opportunities to enhance other core businesses within the division while focusing on revenue opportunities, particularly the estimated $50 billion in unspent federal ESSER funding that must be committed by September 2024. Regarding our International segment, revenues in local currency fell by 4% as sales in Australia and New Zealand were affected by ongoing softness in the retail market, though higher Book Fair and trade sales in the U.K. provided some offset. Ken Cleary is now leading this division, leveraging his extensive operational knowledge of Scholastic to help International subsidiaries utilize U.S. resources more effectively and drive growth. He is also continuing as our CFO as we progress with the search process, which is going well. We anticipate sharing more updates in the coming weeks. As Ken will elaborate on shortly, we are revising our fiscal 2024 guidance due to unexpected profit growth in quarter two and lowered expectations for the second half of the year, largely stemming from external factors. Scholastic is building upon our unique strengths as the world's largest and most trusted children's publisher and distributor. The solid execution in the last quarter reinforces our confidence in our long-term growth outlook and our commitment to continue investing in growth and enhancing shareholder returns. Now, I’ll hand it over to Ken for a deeper dive into the quarter's results.

Ken Cleary, CFO

Thank you, Peter, and good afternoon, everyone. We did not record any one-time items in fiscal 2023 or in the second quarter of fiscal 2024. For a complete discussion of one-time items, please refer to our press release tables and SEC filings. As Peter mentioned earlier, our profits for the second quarter improved compared to last year, and we remain confident in our long-term growth outlook and strategy for creating shareholder value. However, our results were slightly below expectations, mainly due to external factors. Regarding our consolidated financial results, second quarter revenues fell 4% to $562.6 million. Our operating income for the quarter was $101.3 million, an increase from $100.1 million in the same period last year. Net income rose to $76.9 million from $75.3 million in the previous year, and adjusted EBITDA increased to $124 million from $122 million a year ago. Earnings per diluted share were $2.45, up from $2.12 last year, primarily due to our share buyback efforts over the past four quarters that reduced our outstanding share count. Now, looking at our segment results. In Children's Book Publishing and Distribution, second quarter revenues decreased 6% to $392.8 million, mainly due to lower participation in Book Clubs, as the business has focused on a smaller, more profitable core. We also saw reduced production revenue from Scholastic Entertainment. Operating margins improved, and operating income only dropped by 2% from the prior year period to $110.8 million. The impact of lower sales was partially offset by reduced spending on promotions and operations, along with improved gross margins in consolidated trade. Book Fairs revenues grew 1% to $242.1 million in the quarter, driven by a higher fair count and increased redemptions of incentive program credits, though this was partially offset by lower revenue per fair. Peter pointed out that we experienced modestly higher revenue per fair on a same fair basis. The fair count is on track to reach nearly 90% of pre-pandemic levels this year, up from 85% in fiscal 2023. Revenues from Book Clubs were $32.4 million, down from $57.6 million in the prior year, as we eliminated unprofitable offerings during the back-to-school season in our shift to a more profitable core. Consolidated trade revenues were $118.3 million in the second quarter, compared to $119.9 million in the prior period, primarily due to lower revenues from Scholastic Entertainment in the previous year when we completed the delivery of the animated series episodes based on the Owl Diaries series. Excluding the impact from these media revenues, trade revenues increased by 3%, supported by several front-list bestsellers despite ongoing softness in the retail book-selling market. In the Education Solutions segment, revenues rose 1% to $81 million in the second quarter, boosted by higher revenues from state and district partnerships, although this was partially offset by declines in sales of supplemental instructional materials due to shifting approaches to literacy instruction. Segment profit decreased by $1.2 million to $5.8 million compared to the previous period, largely due to lower gross margins stemming from a product mix shift. The growth in lower-margin customized book collections, driven by districts aiming to meet content mandates, contributed to this change. International segment revenues reached $86.5 million in the second quarter, down from $89.6 million the previous year. Adjusting for a favorable foreign currency exchange impact of $700,000, International revenues decreased by $3.8 million, influenced by lower revenues in Australia and New Zealand, where we continued to see softness in retail book sales impacting trade. Segment operating income, however, increased by $1.3 million to $8 million, mainly due to improved results in Canada, which benefitted from the reorganization of Book Clubs earlier this year. Unallocated overhead costs of $23.3 million were down from $26.8 million in the prior period, resulting from increased rental income due to an additional tenant in our headquarters building in New York City. We continue to market the upper floors of our headquarters for outside tenants and recognized rental revenue of $2.3 million in the second quarter. This was previously recorded as a benefit in SG&A in the prior year. With 26,600 square feet currently leased, we anticipate annualized straight-line rental revenue of around $9.9 million in fiscal 2024. Now, regarding cash flow and the balance sheet. Net cash provided by operating activities was $109.7 million in the current quarter, compared to $81.6 million in the prior period. The reduction in inventory spending this quarter, attributed to lower freight and manufacturing costs compared to last year, supported working capital. As we mentioned last quarter, we have been managing our inventory purchases closely aligned with demand, resulting in sufficient inventory levels and reduced spending. We also expect our cost of product per unit to decline in fiscal 2024 compared to last year, with this benefit reflected in our profits in the latter half of this fiscal year. Free cash flow in the second quarter was $88.6 million, an increase from $62.7 million during the same period last year, as a result of tighter inventory management. At the end of the quarter, our cash and cash equivalents, net of total debt, amounted to $143.2 million, a decline from $218.5 million at the end of fiscal 2023. Alongside our investments in content and capabilities for growth, we continued to return capital to shareholders in the second quarter through our regular dividend and share repurchases. We bought back nearly 1.4 million shares last quarter for $52.3 million. In total, including our regular dividend, we returned over $58 million in the second quarter and $101 million this fiscal year. Therefore, in fiscal 2024 to date, we have repurchased 2.2 million shares, net of 391,000 shares issued for stock compensation, representing 6% of the company’s outstanding shares. Our shares outstanding are now below 30 million. Today, we announced our Board of Directors has authorized an additional $66.2 million for share repurchases, increasing our total buyback authorization to $100 million. Scholastic remains committed to our capital allocation priorities. We aim 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. Looking at our outlook, based on our second quarter results and current forecast for the latter half of the year, we've updated our fiscal 2024 guidance. We now project adjusted EBITDA between $165 million and $175 million, excluding one-time restructuring and cost savings charges of $7 million to $10 million, of which we have incurred $6.3 million thus far this year. Full-year revenue is expected to remain approximately level with or slightly below the prior year. Scholastic typically generates the highest contribution in the seasonally important second and fourth quarters, and we continue to anticipate strong performance in the fourth quarter following a smaller third quarter. We now forecast fiscal 2024 capital expenditures and prepublication spending between $100 million and $110 million, up from $88.9 million in fiscal 2023, and we expect full-year free cash flow to fall between $35 million and $45 million. As Peter mentioned earlier, in light of this revised outlook, we are taking steps to pursue additional revenue opportunities and align our expenditures for the latter half of the year. While we have adjusted our expectations for the year due to external factors, our business remains fundamentally strong and focused on our long-term growth and capital allocation priorities, including returning capital to shareholders. Thank you for your time today, and have a happy holiday season. I'll now turn the call back to Peter for his final remarks.

Peter Warwick, CEO

Thank you, Ken. As you and I discussed this afternoon, Scholastic performed solidly in the second quarter despite the macro environment, the slowed profit growth below our expectations, and that's caused us to adjust our guidance. I'm confident that Scholastic's unique scale and ability to create high-quality books and content and get it to millions of kids in the U.S. and globally, there's so much potential for growth and impact today. I want to take a moment to thank Scholastic's world-class employees. They've worked tremendously hard this fall to serve our customers, engage our partners, and protect Scholastic's long-term mission and opportunity, and I'd also want to thank our shareholders for their continued support. So let me now turn the call over to Jeff.

Operator, Operator

Thank you, Peter. We appreciate your time today and continued support. With that, I will turn the call over to the operator.

Operator, Operator

And our first question comes from Brendan McCarthy with Sidoti. You may proceed.

Brendan McCarthy, Analyst

Hi, good afternoon, Ken and Peter. Thanks for taking my questions today.

Ken Cleary, CFO

Hi, Brendan.

Peter Warwick, CEO

Pleasure.

Brendan McCarthy, Analyst

Hi, so I think we could start off by taking a look at Book Clubs business, I guess, how from a revenue perspective or just in general, how small do you expect the business to get eventually?

Peter Warwick, CEO

Well, I don't think we've got an exact number in mind, and we've always anticipated a reduction in the revenues from Book Clubs. However, this reduction will create a more stable foundation for future growth and increased profitability. Essentially, we are implementing a shrink to grow strategy. The revenues have been slightly below what we had anticipated due to the overall environment in schools, but I don’t believe this undermines the long-term strategy we have for a profitable and stable Book Clubs business.

Brendan McCarthy, Analyst

Got it. Understood. And then looking at the Education Solutions segment, you mentioned there has been a shift in spending supplemental instruction spending at the school and district level, can you go into detail about, I mean, what exactly this change looks like, and then also maybe what Scholastic is going to adapt?

Peter Warwick, CEO

There is a notable shift in schools and literacy from a guided reading approach to a more phonics-based method known as the signs of reading. This trend has gained momentum over the past two to three years. In response, we are adapting our supplemental materials to better align with these signs of reading. It's also important to highlight that independent reading remains a crucial aspect of the literacy journey, and Scholastic is better positioned than any other literacy provider to support this.

Brendan McCarthy, Analyst

Got it. That's helpful. Peter, you mentioned that the ESSER funding initiative is expected to end in 2025. Did you notice any benefit from that spending in the second fiscal quarter?

Peter Warwick, CEO

It's important to note that the funding needs to be committed by September 2024, even if it isn't spent right away. Therefore, we anticipate good opportunities in the latter half of this financial year and into the next. We are actively encouraging the use of federal ESSER funds in areas where our products can make a significant impact, such as summer reading. This is crucial for ensuring that schools receive the necessary funding, especially as summer book collections gain importance. We believe that the remaining ESSER funding will allow us to maintain strong purchasing representation during this period.

Brendan McCarthy, Analyst

Got it. And then one last question for me, just with regards to the retail book market, I know you mentioned strong results from the frontlist titles, I'm just curious as to maybe your outlook on the backlist titles and when that market might return to growth?

Peter Warwick, CEO

I don't have a complete roadmap on that, but we have noticed an increase in trade sales and main street sales over the past few weeks. We're benefiting from this due to the success of titles like Cat Kid and others. A strong backlist is crucial for successful publishers, and for us, it allows us to monetize those titles beyond book sales. Through our media activities, we can explore other uses for that intellectual property. This is becoming an increasingly significant aspect of our operations. With current changes in the screen-based market, where fewer but higher-value properties are generating media interest, the quality of our backlist titles and characters is vital. Recent discussions with companies in LA have highlighted the considerable value that screen-based industries see in our backlist. Therefore, we anticipate that more of that value will arise from screen-based opportunities rather than just book sales. Ultimately, as mentioned before, there's a beneficial cycle that flows from print to screen to merchandising and back to books.

Brendan McCarthy, Analyst

Thank you. That's all from me.

Peter Warwick, CEO

Thank you.

Operator, Operator

Thank you. And this concludes our Q&A, I will pass the call back to management for any closing remarks.

Peter Warwick, CEO

Thank you very much, and thank you to all of you who joined us this afternoon, and of course, I wish everyone a very happy holiday season. We look forward to engaging with our investors in coming days and to providing a further update on our progress in March on our quarter three call. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.