Scholastic Q2 2024 Earnings Call Transcript

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December 14, 2023

There are 5 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Scholastic Corporation Fiscal 20 24 Second Quarter Earnings Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeffrey Matthews.

Speaker 1

Thank you, and hello, and welcome, everyone, to Scholastic's fiscal 2024 Second Quarter Earnings Call. Today on the call, I'm joined by Peter Warrick, 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 have not already done so. We'd like to point out that certain statements made today will be forward looking.

Speaker 1

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 reconciliations of these measures to the most directly comparable GAAP measures may be found in the company's earnings release and the company's financial tables filed this afternoon on a Form 8 ks. 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.

Speaker 1

Should you have any questions after today's call, please send them directly to our IR email address, investorrelationsscholastic.com. And now, I would like to turn the call over to Peter Wark to begin this afternoon's presentation.

Speaker 2

Thanks, Jeff, and good afternoon, everyone. We appreciate you joining us. Elastic executed solidly in our second quarter during the important back to school season in the Northern Hemisphere. Our School Reading, Events and Education divisions, while progressing their plans, continued to demonstrate Scholastic's unique capabilities to give tens of millions of kids access to engaging high quality books. Scholastic's trade publishing and entertainment teams continue to create and publish best selling books and highly rated content and IP for the company's own channels as well as retailers and third party ones, fulfilling the 2nd pillar of Scholastic's unique integrated publishing and distribution strategy.

Speaker 2

With kids back at school and parents and educators refocused Based on the importance of reading and learning, Scholastic's mission is as relevant as ever today, even in the more complex environment in U. S. Schools in which we currently find ourselves operating this year. Last quarter, we also took actions to create long term value, continuing our investment in growth initiatives and returning over $58,000,000 to shareholders through share buybacks and our dividend. Quarter two profits remained steady on modestly lower revenues.

Speaker 2

These results, however, came in below our expectations for profit growth as a result of external factors, a trend we now forecast to continue for the remainder of this school year. As a result, We've adjusted our fiscal 2024 guidance and have taken steps to target additional revenue opportunities, and underlying spending in the second half of the year. We remain positive about long term outlook for growth and impact as we continue executing on our strategy, investing in content and capabilities to drive growth and returning capital to shareholders, including under an expanded share repurchase authorization announced today. This afternoon, I'd like to review our 2nd quarter results and updated outlook for the rest of the year. Ken will then discuss our financial results in more detail.

Speaker 2

I'd like to begin with some comments on the macro environment in which we're operating. 1st, as I referenced a moment ago, compared to a year ago, The environment in U. S. Schools is currently more complex and challenging, reflecting growing polarization in our society and politicization of schools and school boards, higher rates of absenteeism and chronic teacher shortages. Together, these factors have put greater demands on schools and teachers, including through expanded restrictions on educators, parents and kids' ability to choose books and mandates changing how kids are taught, especially with respect to literacy instruction.

Speaker 2

Taking the longer view, however, it's clear that reading, literacy and learning are acute priorities that families, educators and leaders all agree on, independent of geography or party affiliation. Scholastic remains uniquely positioned to respond to these needs today and in the future. We'll continue to focus on serving all kids, families and educators as we've done for the past 100 plus years. 2nd, we saw signs of a modest Short term slowdown in consumer spending growth for a period this fall relative to prior year and expectations for our school based channels. During recent weeks, we've seen signs of a rebound.

Speaker 2

This pattern is in line with trends reported by some retailers this fall. Retail sales of children's and young adult books also declined 2% during our Q2 versus a year ago according to BookScan. The retail adult and kids book market is still up significantly compared to the same period in 2019. So we see this dynamic largely as a reversion to pre pandemic growth trends. 3rd, and positively, we continue to benefit from lower costs of paper, manufacturing, freight and shipping versus a year ago.

Speaker 2

This is seen in our inventory purchasing already and therefore cash flows and will be reflected in operating margins as we sell through Turning to our results. Quarter 2 is the seasonally largest quarter for the children's Book segment. Segment revenue declined 6%, reflecting the planned resizing of book clubs as well as lower expected production revenue from Scholastic Entertainment, which is reported in consolidated trade. Excluding Scholastic Entertainment, consolidated trade sales rose 3%. Fare sales grew 1% to $242,000,000 in quarter 2, surpassing the previous year's record and demonstrating their enduring presence in the U.

Speaker 2

S. Education System. Fare count rose as planned. Revenue per fare rose modestly on a same fare basis, but declined on average due to mix, reflecting the addition of mostly smaller fares to the full schedule as we increased fare count. Cancellation rates improved year over year.

Speaker 2

Over the past 2 years, we've transformed book fairs with new customer centric strategies and operational improvements, which have resulted in higher participation and transaction sizes contributing to higher revenue per fare. Average revenue per fare or RPF remains close to record levels, reflecting the progress we've made. However, this full year, we have seen RPF grow more slowly than last year or our expectations for the current one, dampened by the macro factors in schools and consumer spending that I just described. Largely as a result, FAERS profitability did not meet expectations because RPF contributes strongly to operating leverage and expanding margins. Looking ahead at the second half of the school year, we largely expect fall trends to continue into the spring as is the historical pattern.

Speaker 2

In response, however, we've made adjustments to our merchandising strategy in fares for the spring, which we're optimistic about. We also remain confident in achieving near 90% of pre pandemic fare counts this year. We remain focused on innovating and improving the book fair host experience with new tools like our updated online fair preview and improved online restock process, while maintaining our focus on kids with high quality kid centric merchandising. In our school book clubs, this year is a transitional year as we integrate clubs and fairs into our combined School Reading Events division. Last quarter, clubs gross profits remained approximately level with prior year, while we right sized the business.

Speaker 2

Revenues declined 44% with planned reduction in unprofitable offers and promotional spending, resulting in lower orders. Participation and spending by teachers and families, however, were also lower than expected, delivering lower revenue per order, echoing the macro trends we're seeing elsewhere. We see improvements in response rates as we continue to iterate our redesigned flyers, which should benefit order numbers in the second half of the year. That said, we also expect to see the impact of lower teacher participation and spending in the fall to carry over into club spring results. Scholastic's Trade Publishing continued to execute strongly in the retail book selling market that was down slightly year over year as I just This primarily impacted Battlest titles.

Speaker 2

Very encouragingly, Scholastic's new frontlist titles continue to dominate and spanned our presence on bestseller lists, achieving 117 weeks cumulatively on The New York Times Middle Grade Best Seller List and 88 weeks on The Times Young Adults Best Seller List. We also maintained our leading presence on The New York Times Graphic Books and Manga and Children's Series Best Seller lists. As best of year lists are published, Scholastic titles are found throughout. Among our top sellers last quarter, the interactive edition of Harry Potter and the Prisoner of Azkaban and the Harry Potter Wizarding Almanac, both regularly ranked on bestseller lists. Cat Kid Comic Club 5 Influencers from Dave Pilkey, which shipped during quarter 2 and went on sale on November 28, became the number one best selling book on BookScan across kids and adult categories.

Speaker 2

Its success has lifted backlist sales of data Its success has lifted backlist sales of Data Darkman and Captain Underpants Series 2. The new paperback edition of The Ballad of Songbirds and Snakes, the Zane Collins prequel to the Hunger Games series also performed strongly, driven by the highly anticipated movie release last month. Once again, Scholastic benefited from the virtuous circle From page to screen and back to page, which has helped build many of our mega publishing franchises. Looking ahead, we're excited about our publishing plan for the spring, which includes new titles in Dave Pilkey's Dog Man and Alice Oseman's Heartstopper series, both of which are hugely popular, as well as a new title from New York Times bestselling adult and young adult author, Allen Gratz, a new graphic novels in our Wings of Fire, Babysitter's Club and Amulet series. The new live action Goosebumps TV series, co produced by Scholastic Entertainment with Disney, also debuted in quarter 2.

Speaker 2

Based on the classic Scholastic series, which has sold over 400,000,000 copies, Goosebumps was Disney's most watched Season premiere of the year on both Disney plus and Hulu. Since its launch, the series has reached the top 10 spot in streaming rankings overall. According to The Hollywood Reporter, its success makes it a rare non Marvel or Star Wars original series for Disney plus in Nielsen's rankings. Keeping up this momentum with today's readers and viewers finding comfort in the familiar brands of childhood, Scholastic Entertainment has a broad slate of new Stalgia projects in development that bring back legacy Scholastic Properties in fresh and innovative ways. We're partnering with top tier platforms, producers, screenwriters and actors, including co produced Seeing the 39 clues with Amblin for Netflix, developing Animorphs and Fly Guy as feature films and working with Elizabeth Banks and Mark Platt Productions to bring the Magic School Bus to the big screen.

Speaker 2

All of our entertainment projects programs for the existing and emerging fan bases. Now moving to Education Solutions. Quarter 2 sales were up 1% relative to last year's record levels. This division also navigated the changing school environment while developing new channels and models to expand kids' access to books and literacy beyond schools. We also continued investing to build new flexible supplemental learning programs that respond to evolving needs in the marketplace.

Speaker 2

Sales of book collections rose through our partnerships with states and school districts. This growth continued to offset declines in sales of supplemental instruction materials that we've seen over the past few quarters. The district shift approaches to Literacy instruction, often in response to state and local laws and regulations. In some cases, Districts are pausing new purchases, leaving teachers using existing materials and pedagogies as they work to retrain teachers and implement new curricula. In the meantime, we continue work to realign key product lines to the science of reading, while we invest in new content and products.

Speaker 2

Looking ahead, we remain positive about the mid and long term opportunity Scholastic's literacy focused education business. As we move forward with our plan to build new digital and print solutions, building on our current profitable print based education business as I just discussed. Last week, we announced an expanded investment in our summer learning offering, which has emerged as a significant differentiated opportunity for Scholastic to grow and drive impact. School districts have acute needs to support students, educators and families with instructional programs and books at home and outside normal school hours year round. Scholastic acquired from Litlife Inc.

Speaker 2

Rights to and control of Lidcamp, a foundational reading skills program for summer and extended learning, which we co developed and have been successfully selling since 2015. We also acquired all rights and control of MatKam, a new companion program for lip camp, which we expect to be in the market for this summer. We're excited about This move, which solidifies Scholastic's position as a leading provider of high impact solutions for summer learning. After nearly 4 months in the position, Education Solutions President, Beth Pulkari is moving forward with plans to reinvent our Classroom Magazines business as a comprehensive blended content and data driven instructional program. She and the Education Solutions team are also looking at opportunities to strengthen other core businesses within the division, while targeting revenue opportunities.

Speaker 2

We're particularly focused on the approximately 50,000,000,000 dollars in unspent federal ESSA funding, which must be obligated by September 2024. Turning to our International segment. Revenues declined 4% in local currencies. The sales in Australia and New Zealand were impacted by continued softness in the overall retail market, but higher book fares and trade sales in the UK partly offset this. As a reminder, Ken Cleary now leads this division as President of International, building on its deep operating knowledge of Scholastic to help our international subsidiaries better leverage U.

Speaker 2

S. Resources and drive growth. Of course, He also continues to serve as our CFO as we move forward with the search process, which has been productive. We look forward to providing a further update in the coming weeks. So as Ken will discuss in more detail shortly, largely as a result of external factors, we're revising our fiscal 2024 guidance on account of lower than expected profit growth in quarter 2 and reduced expectations for the second half of the year.

Speaker 2

Scholastic continues to build on our unique strengths as the world's largest and most trusted children's publisher and distributor. Last quarter's solid execution reinforces our conviction in our long term growth outlook as well as our commitment to continue deploying capital to invest in growth and enhance shareholder returns. And now I'll ask Ken to provide greater detail on the quarter's results.

Speaker 3

Thank you, Peter, and good afternoon, everyone. Note that we recorded no one time items in fiscal 2023 or in the Q2 of fiscal 2024. Please refer to our press release tables and SEC filings for a complete discussion of one time items. As Peter discussed earlier, our 2nd quarter profits improved year over year and we remain confident in our long term growth outlook and shareholder value creation strategy. Results came in below expectations however, largely due to external factors.

Speaker 3

Turning to our consolidated financial results. 2nd quarter revenues decreased 4% to $562,600,000 Operating income in the quarter was $101,300,000 up from $100,100,000 in the prior year period. Net income was $76,900,000 compared to $75,300,000 in the prior year period and adjusted EBITDA increased to $124,000,000 from $122,000,000 a year ago. Earnings per diluted share was $2.45 compared to $2.12 last year as our share buyback efforts over the previous 4 quarters have driven down our outstanding share count. Now turning to our segment results.

Speaker 3

In children's book publishing and distribution, revenues for the 2nd quarter decreased 6% to $392,800,000 primarily driven by lower participation in orders and book clubs as the business is repositioned to a smaller more profitable core as well as lower timing related production revenue from Scholastic Entertainment. Operating margins improved and operating income decreased by only 2% from the prior year period to $110,800,000 Lower spending in clubs on promotions and operations improved gross margins and consolidated trade partially offset the impact of lower sales. Book fairs revenues increased 1 percent to $242,100,000 in the quarter, driven by higher fare count and increased redemptions program credits partially offset by lower revenue per fare. As Peter noted, we benefited from modestly higher revenue per fare on a same fare basis. Fare Count remains on track to reach nearly 90% of pre pandemic levels this year, up from 85% in fiscal 2023.

Speaker 3

Book Club's revenues of $32,400,000 were down versus the prior year period revenues of $57,600,000 As part of the transition of this channel to a smaller, more profitable core, we eliminated unprofitable offerings during the back to school season. Consolidated trade revenues were $118,300,000 in the 2nd quarter compared to prior period revenues of $119,900,000 The segment revenue decrease was driven by lower revenues in Scholastic Entertainment relative to the prior year when the company completed delivery of episodes of the animated series EBITDAOwl, based on Scholastic's Owl Diary series. Excluding the year over year impact of these media revenues, Trade increased 3% driven by multiple frontless best sellers in the quarter despite continued softness in the retail book selling market. Education Solutions segment revenues were up 1% to $81,000,000 in the 2nd quarter, driven by higher revenues in state and district partnerships, partially offset by sales declines in supplemental instructional materials related to the shift in prevailing approaches to literacy instruction. Segment profit decreased $1,200,000 to $5,800,000 compared to the prior period, largely reflecting lower gross margins due to product mix.

Speaker 3

Growth in low margin customized book collections driven by districts seeking to comply with state and local content mandates contributed to this shift. International segment revenues of $86,500,000 in the 2nd quarter trailed the prior year period revenues of $89,600,000 Excluding the $700,000 year over year impact A favorable foreign currency exchange, international revenues were down $3,800,000 reflecting lower revenues in Australia and New Zealand and softness in retail book selling continued to impact trade sales in these countries. Segment operating income increased $1,300,000 to $8,000,000 primarily driven by improved results in Canada, which benefited from the reorganization of book clubs in the Q1. Unallocated overhead costs of $23,300,000 decreased from $26,800,000 in the prior period benefiting from higher rental income associated with an additional tenant in the retail space of the company's owned headquarter building in New York City. We continue to market floors 2 through 4 of our headquarter building for outside tenants.

Speaker 3

We recognized rental revenue of $2,300,000 in the 2nd quarter. As a reminder, this was previously recorded as a benefit in SG and A in the prior year period. On the 26,600 Square Feet Leased as of today, we expect annualized Straight line rental revenue to total approximately $9,900,000 in fiscal 2024. Now turning to cash flow and the balance sheet. Net cash provided by operating activities was $109,700,000 in the current quarter compared to $81,600,000 in the prior period.

Speaker 3

Lower inventory spend in the quarter driven by a lower freight and manufacturing costs compared to a year ago benefited working capital. As we noted last quarter, we continue to manage inventory purchases substantially closer to our demand, resulting in sufficient inventory on hand and lower spend. We also continue to expect our cost of product per unit to decline in fiscal 2024 from the prior year with this benefit appearing in the P and L in the second half of this fiscal year. Free cash flow in the second quarter was $88,600,000 compared to $62,700,000 in the prior year period reflecting this tighter inventory management. At the end of the quarter, cash and cash equivalents, net of total debt was 143 $200,000 compared to $218,500,000 at the end of fiscal 2023.

Speaker 3

In addition to investments in content The ability to drive growth, we continue to return capital to shareholders in the Q2 for our regular dividend and open market share repurchases. We repurchased almost 1,400,000 shares last quarter for $52,300,000 Together with our regular dividend, we returned over $58,000,000 in the 2nd quarter and $101,000,000 this fiscal year. In the fiscal year 2024 thus far, we have repurchased 2,200,000 shares, which net of 391,000 shares issued related to stock compensation represents 6% of the company shares outstanding. Company shares outstanding are now below 30,000,000. Today, we announced that our Board of Directors has authorized an additional $66,200,000 for repurchases, topping up our current share buyback authorization to $100,000,000 Elastic remains consistent in our capital allocation priorities and we are committed to pursuing opportunities to leverage our balance sheet and deploy capital by: 1st, investing in growth opportunities 2nd, maintaining a strong and efficient balance sheet and 3rd, returning excess cash to shareholders to enhance their returns.

Speaker 3

Turning to our outlook. Based on our second quarter results and our current forecast for the second half of the year, we have updated our fiscal 2024 guidance. We now expect adjusted EBITDA of $165,000,000 to $175,000,000 This excludes the impact of one time charges related to restructuring and cost savings activities of $7,000,000 to $10,000,000 of which we have incurred $6,300,000 so far this year. Full year revenue is expected to be approximately level with or slightly below the prior year. As a reminder, Scholastic typically generates the greatest contribution in the seasonally important second and fourth quarters.

Speaker 3

We continue to expect solid 4th quarter performance following a seasonally smaller 3rd quarter. We now forecast fiscal 2024 CapEx and pre publication spending of $100,000,000 to $110,000,000 compared to $88,900,000 in fiscal 2023 and full year free cash flow of between $35,000,000 $45,000,000 As Peter discussed earlier, in response to this revised outlook, we have taken steps to target additional revenue opportunities and aligned spending in the second half of the year. Though we have reduced our outlook for the year largely based on external factors that Peter described, Our business remains fundamentally strong and remain focused on our long term growth and our capital allocation priorities, including returning capital to shareholders. Thank you for your time today and have a happy holiday season. I'll now hand the call back to Peter for his final remarks.

Speaker 2

Thank you, Ken. As you and I have discussed this afternoon, Elastic performed solidly in the 2nd quarter despite a macro environment that slowed profit growth below our expectations and has caused us to adjust our guidance. I'm confident 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 has so much potential for growth and impact today.

Speaker 2

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. Thank you,

Speaker 1

Peter. We appreciate your time today and continuing support. With that, I'll turn the call over to the operator.

Operator

Thank you. And our first question comes from the line of Brendan Karthi with Sidoti, you may proceed.

Speaker 4

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

Speaker 3

Hey, Brent. Pleasure.

Speaker 4

So I think we can start off taking a look at the book clubs business. I guess how from a revenue perspective or just in general, how small do you expect the business to get eventually?

Speaker 2

Well, I don't think we've got an exact number in mind. And actually, what we've always planned for is that there would be a reduction in the revenues in book clubs, but that would form a much more Stable basis in order to go forward and to increase the Profitability. So essentially, what we've been doing is a sort of shrink to grow strategy. And The revenues have been a little bit below perhaps what we might have expected because of the general environment within schools. But I don't think it's in any way undermined the strategy that we're pursuing for a longer term profitable and stable Bookshop's business.

Speaker 4

Got it. Understood. And then looking at the Education Solutions segment, you mentioned there's been a shift in spending, supplemental instruction spending at School and District level. Can you go into detail about what exactly this change or it looks like and then also maybe what Scholastic is doing to adapt?

Speaker 2

Well, there's been what's happening within Schools and Literacy is sort of a movement away from what was termed as a guided reading approach To literacy towards a more phonics based approach, which is called the science of reading. That's a trend that has accelerated over the last 2 or 3 years. And what we're doing is clearly Adapting our own supplemental materials so that they are much more in tune with the science of reading. What's important to say is that independent reading is still incredibly important in the literacy journey and that Stelastic is better positioned there than any other literacy provider.

Speaker 4

Got it. That's helpful. Then Peter, I know you mentioned the ESSR funding initiative due to Sunset, I believe in 2025. I guess did you see any benefit from that spending in the 2nd quarter, 2nd fiscal quarter?

Speaker 2

Well, it's due to what's got to happen is that the funding has to be obligated. In other words, It doesn't necessarily have to be immediately spent, but it has to be committed by no later than September 2024. So we would expect that with a lot of hard effort on our part that there are still good opportunities for us both In the 2nd part of this financial year, but also in the following financial year as well. Also, we're encouraging all that we can to make sure that those federal ESSA funds can be used in areas Where we have really tremendous products. So particularly in areas like summer reading, for example, So that we can really make sure that schools have got the funding that they need for what is an increasing priority in How they do things, which is why the summer book collections, etcetera, have become so important to us.

Speaker 2

And we can see that the Remaining ESSER funding is one of the sources whereby we will be able to do and continue to get very, Very strong representation in the purchasing at that time.

Speaker 4

Got it. 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 front list titles. I'm just curious as to maybe your outlook on the backlist titles and when that market might return to growth?

Speaker 2

I don't have a complete roadmap on that. But I think what we one of the things that we have been Seeing is some pickup in trade sales, Main Street sales as it were during the last few weeks. And we're particularly benefiting from that Because of the titles that we've got that have done so well, the CAT kid and other titles. I think what's important about backlist is that the most successful publishers all have really strong backlist. And it's particularly important for us because we can monetize those backlist not just through sales of books on bookshelves, But we through our media activities, we're able to, as I mentioned in the report, that we can see Other purposes for that intellectual property, and that is going to be an increasingly Important part of what we do.

Speaker 2

And furthermore, as there's been sort of changes in the sort of screen based market at the moment whereby fewer but much more higher value properties Being transformed into media, into streaming and particularly into feature films. Then the high quality of our backlist and our titles and our characters are really important. And as we've discovered in recent discussions with houses in LA and elsewhere is the tremendous value That screen based companies see in our backlist. And so having that backlist, I think what we're going to find Is an increasing part of the value of that is going to be coming through screen based opportunities rather than just paper based opportunities. But it is, As I mentioned in the talk, it's a virtual circle going from print to screen To merchandising, to back to the books.

Speaker 4

Got it. Thank you. That's all for me.

Speaker 2

Thank you.

Operator

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

Speaker 2

Thank you very much, Josh, 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 3 call. Thank you.

Operator

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

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