Q2 2024 Scholastic Corp Earnings Call

Participants

Jeffrey Matthews; EVP, Corporate Development and Investor Relations; Scholastic Corporation

Peter Warwick; President & CEO; Scholastic Corporation

Ken Cleary; CFO & Acting President, International; Scholastic Corporation

Brendan McCarthy; Analyst; Sidoti & Company, LLC

Presentation

Operator

Good day. And thank you for standing by, and welcome to the Scholastic Corporation fiscal 2024 second quarter earnings call. (Operator Instructions) Again, 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.

Jeffrey Matthews

Thank you. And hello, and welcome, everyone, to Scholastic's fiscal 2024 second quarter earnings call. During 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 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. Reconciliations of these measures to the most directly comparable GAAP measures found in the Company's earnings release and accompanying financial tables filed this afternoon on a Form eight K.
Turning to it 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. If you have any questions after today's call, please send them directly to our IR e-mail address investor underscore relations at scholastic.com and now I would like to turn the call over to Peter Warwick to begin this afternoon's presentation.

Peter Warwick

Thanks, Jeff. And good afternoon, everyone. We appreciate you joining us and I think executed solidly in our second quarter during the important back-to-school season in the Northern Hemisphere as school reading events and Education Divisions. While progressing that plans continue to demonstrate Scholastic's unique capabilities, give tens of millions of kids access to engaging high-quality board elastics, 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 second pillar of Scholastic's unique integrated publishing and distribution strategy with kids back in school and parents and educators, refocused on the importance of reading and learning. Scholastic's mission is as relevant as ever today, even in the more complex environments in US schools in which we currently find ourselves operating this year last quarter, we also took actions to create long-term value, continuing our investments in growth initiatives and returning over $58 million to shareholders through share buybacks and our dividends Fortitude profits remained steady on modestly lower revenues. 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 the school year. As a result, we've adjusted our fiscal 2024 guidance and have taken steps to target additional revenue opportunities and align spending in the second half of the year. We remain positive about our 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 second quarter results and updated outlook for the rest of the year. And Ken will then discuss our financial results in more detail. I'd like to begin with some comments on the macro environment in which we're operating. First, as I referenced, I referenced a moment ago compared to a year ago, environment in US schools is currently more complex and challenging, reflecting growing polarization in US society and politicized nations 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 eBooks and mandate changing how kids are taught, especially with respect to literacy instruction, 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 will continue to focus on serving all kids families and educators as we've done for the past 100 plus years.
Second, 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. This pattern is in line with trends reported by some retailers this fall, retail sales of children's new auto books also declined 2% during our second quarter versus a year ago. According to book scales, 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.
Third and positively, we continue to benefit from lower costs of paper manufacturing, freight and shipping versus a year ago. This is seen in our inventory purchasing already and therefore cash flows and will be reflected in our P&L as we sell through. (technical difficulty)
Turning to our results, Q2 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%, US sales grew 1% to $242 million in Q2, surpassing the previous year's record and demonstrating their enduring presence in the US education system. Share 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 fans for the full schedule as we increase that count, cancellation rates improved year over year over the past two years, we've transformed Book Fairs with new customer-centric strategies and operational improvements, which have resulted in higher participation in transaction sizes, contributing to higher revenue per fair average revenue per fair or RPF. remains close to record levels, reflecting the progress we've made. However, this full year, we have seen our PF. grow more slowly than last year for our expectations for the current one dampened by the macro factors in schools and consumer spending that I just described. Largely as a result, fair profitability did not meet expectations because our PF. contribute strongly to operating leverage from the expanding margin.
Looking ahead, at the second half of the school year weeks, we largely expect for trends to continue into the spring, as is the historical pattern in response. However, we've made adjustments to our merchandising strategy in France for the spring, which we're optimistic about. We also remain confident in achieving near 90% of pre-pandemic fair counts this year. We remain focused on innovating and improving the book fair host experience with new tools like our updated online fare preview and improved online restart 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 will fast into a combined school reading events division last quarter, clubs gross profit remained approximately level with prior year, while we rightsized the business revenues declined 44% with planned reduction in unprofitable offers and promotional spending resulting in lower orders. Participation 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 top 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 clubs, bringing results elastic trade publishing continued to execute strongly in a retail bookselling market that was down slightly year over year, as I just described. This primarily impacted backlist titles, very encouragingly, Scholastic's new frontlist titles continued to dominate and expand our presence on bestseller list achieving 117 weeks cumulatively on the New York Times middle grade bestseller list and 88 weeks on the Times young adults bestseller list.
We also maintained our leading presence on the New York Times graphic books and Manga and children's series bestseller list as best of VLSI.
The published Scholastic titles have found throughout among our top sellers last quarter, interactive edition of Harry Potter and the Prisoner of ask about the Harry Potter visiting all and both regularly ranked on bestseller list Cat Kid Comic club number five influences from day silky, which shipped during quarter two and went on sale on November 28th became the number one best-selling book on book scan across kids and adult categories. Its success has lifted backlist sales of dead Dog Man and Captain Underpants series to the new paperback edition of the ballet of solvents and snakes. Suzanne 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 legacy publishing franchises.
Looking ahead, we're excited about our publishing plan for the spring, which includes new titles, and Dave silk is document analysis, Alex Hausmann, hot stopper series, both of which are hugely popular as well as a new title from New York Times best selling title in young adults. Also Allen graphs, a new graphic novels in our Wings of Fire baby sitters club and ambulance series, the new live-action Goosebumps TV series, coproduced by Scholastic Entertainment with Disney also debuted in Q2 based on the classic Scholastic series, which has sold over 400 million copies. Goosebumps was Disney's most-watched season premiere of the year on both Disney plus and Hulu. Since its launch series has reached the top 10 spot in streaming rankings overall, according to the Hollywood would report tests its success makes it close around non Marvel or Star Wars original series for Disney plus in Nielsen's direct case, keeping up this momentum with today's readers will view as finding comfort in the familiar brands of childhood. Scholastic Entertainment has a broad slate of new Stanger projects in development that bring back legacy Scholastic properties in fresh and innovative way. We're partnering with top-tier platforms produces screen writers and actors, including co-produced, seeing the 39 Clues with Amlin for Netflix, developing Unimast and flying guy has feature films and working with Elizabeth Banks and Mark plant productions to bring the Magic School Bus to the big screen. All of our entertainment projects include fresh publishing programs tied to our new media model as well as classic and tying consumer product programs to the existing and emerging fan bases.
Now moving to education solutions. Q2 sales were up 1% relative to last year's record levels as this division also navigated the changing school environment while developing new channels and models, expand kids access to books and literacy beyond schools, we also continued investing to build new, flexible supplemental lending programs that respond to evolving needs in the marketplace. Sales of book collections rose through our partnerships with states and school districts. This growth continued to offset declines in sales of supplemental instructional materials that we've seen over the past few quarters as districts shift approaches to Nutrien's literacy instruction often in response, state and local laws and regulations. In some cases, districts are pausing new purchases, leaving teachers using existing materials and technologies 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 product.
Looking ahead, we remain positive about the mid and long-term opportunity for Scholastic's literacy focused education business as we move forward with our plans to build new digital 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 in books at home and outside normal school hours. Year round elastic acquired MetLife, Inc. rights to and control of lip count, 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 Mexichem's new companion program to lift 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 four months in the physician education solutions, President felt that the car is moving forward with plans. Reinvent our classroom magazines business has 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, particularly focused on the approximately $50 billion in unspent federal 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 fairs and trade sales in the UK partly offset this. As a reminder, Ken Cleary now leads this division's President of International building on its deep operating knowledge of Scholastic to help our international subsidiaries, better leverage US resources and drive growth. Of course, he's also also continues to serve as our CFO. As we move forward with the search process, which is being productive, we look forward to providing a further update in the coming weeks.
As Ken will discuss in more detail shortly largely as a result of external factors, we are revising our fiscal 2024 guidance on account of lower than expected profit growth in quarter two and reduced expectations for the second half of the year. Elastic continues to build on our unique strengths as the world's largest and most trusted children's publisher and distributor last quarter, 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.

Ken Cleary

Thank you, Peter. And good afternoon, everyone. To note that we recorded no one-time items in fiscal 2023 for the second quarter of fiscal 2024. Please refer to our press release tables and SEC filings for a complete discussion of one-timers.
As Peter discussed earlier, our second 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 turned to our consolidated financial results. Second quarter revenues decreased 4% to $562.6 million. Operating income in the quarter was $101.3 million, up from $100.1 million in the prior year period. Net income was $76.9 million compared to $75.3 million in the prior year period. And adjusted EBITDA increased to $124 million from $122 million a year ago. Earnings per diluted share was $2.45 compared to $2.12 last year. As our share buyback efforts over the previous four quarters have driven down our outstanding share count.
Now turning to our segment results in Children's Book Publishing and Distribution revenues for the second quarter decreased 6% to $392.8 million, primarily driven by lower participation in orders and book clubs as the businesses reposition 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 $110.8 million. Lower spending in clubs on promotions and operations, improved gross margins and consolidate trade partially offset the impact of lower sales book fairs revenues increased 1% to $242.1 million in the quarter, driven by higher fair count and increased redemptions of incentive program credits, partially offset by lower revenue per fair.
As Peter noted, we benefited from modestly higher revenue per fair on the same fair basis. Fair count remains on track to reach nearly 90% of pre-pandemic levels this year, up from 85% in fiscal 2023. Book clubs revenues of $32.4 million were down versus the prior year period revenues of $57.6 million as part of the transition of this challenge to a smaller, more profitable core, we eliminated unprofitable offerings during the back-to-school season.
Consolidated trade revenues were $118.3 million in the second quarter compared to prior period revenues of $119.9 million. The segment revenue decrease was driven by lower revenues in Scholastic Entertainment relative to the prior year when the Company completed the delivery of episodes of the animated series, EBIT-R was based on Scholastic's our diary series. Excluding the year-over-year impact of these media revenues, trade increased 3% driven by multiple frontlist bestsellers in the quarter, despite continued softness in the retail bookselling market.
Education Solutions segment revenues were up 1% to $81 million in the second 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 $1.2 million to $5.8 million compared to the prior period, largely reflecting lower gross margins due to product mix growth and 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 $86.5 million in the second quarter trailed the prior year period. Revenues of $89.6 million. Excluding the $700,000 year-over-year impact of favorable foreign currency exchange, international revenues were down 3.8 million, reflecting lower revenues in Australia and New Zealand and softness in retail bookselling continue to impact trade sales in these countries.
Segment operating income increased $1.3 million to $8 million, primarily driven by improved results in Canada, which benefited from the reorganization of book clubs in the first quarter. Unallocated overhead costs of $23.3 million decreased from $26.8 million in the prior period, benefiting from higher rental income associated with an additional tenant in the retail space of the company's own headquarter building in New York City, we continue to market floors two through four of our headquarter building for outside tenants, we recognize rental revenue of $2.3 million in the second quarter. As a reminder, this was previously recorded as a benefit in SG&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 $9.9 million in fiscal 2024 that turned to cash flow on 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. 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 spent. 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&L in the second half of this fiscal year.
Free cash flow in the second quarter was $88.6 million compared to $62.7 million in the prior year period. Reflecting this tighter inventory management at the end of the second quarter. At the end of the quarter, cash and cash equivalents net of total debt was $143.2 million compared to $218.5 million at the end of fiscal 2023. In addition to investments in content and capabilities to drive growth, we continued to return capital to shareholders in the second quarter for our regular dividend and open-market share repurchases, we repurchased almost 1.4 million shares last quarter for $52.3 million, together with our regular dividend we returned over $58 million in the second quarter and $101 million this fiscal year in the fiscal year 2024 thus far in 24. Thus far, we have repurchased 2.2 million shares, which net of 391,000 shares issued related to stock compensation represents 6% of the company's shares outstanding company shares outstanding are now below 30 million. Today, we announced that our Board of Directors has authorized an additional $66.2 million for repurchases, topping up our current share buyback authorization to $100 million.
Lastly, remains consistent in our capital allocation priorities, and we are committed to pursuing 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 return.
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 million to $175 million. This excludes the impact of one-time charges related to restructuring and cost savings activities of $7 million to $10 million, of which we have incurred $6.3 million 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. We continue to expect solid fourth quarter performance following a seasonally smaller third quarter. We now forecast fiscal 2020 for CapEx and prepublication spending of $100 to $110 million compared to $88.9 million in fiscal 2023 and full year free cash flow of between $35 million and $45 million. As Peter discussed earlier, in response to this revised outlook, we have taken steps to target additional revenue opportunities in line spending in the second half of the year, 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.

Peter Warwick

Thank you, Ken. As you and I have discussed this afternoon, Scholastic performed solidly in the second 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.
I wanted 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.

Jeffrey Matthews

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

Question and Answer Session

Operator

(Operator Instructions) Brendan McCarthy, Sidoti.

Brendan McCarthy

Hey, good afternoon, Ken and Peter.
Thanks for taking my questions today, paper and Treasure Bay.
So I think we could 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 to get eventually?

Peter Warwick

Well, I don't I don't think we've got an exact an exact number in mind. And actually what we 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 room, stable basis in order to go forward and to increase the TAM profitability. So essentially, what we've been doing is just 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, undermine the strategy that we're that we are pursuing for a longer-term plan in a profitable and stable book clubs business.

Brendan McCarthy

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

Peter Warwick

But the thing that was happening within schools and literacy is sort of a movement away from what was termed as a guided reading approach to them literacy towards a more phonics based approach, which is called the science of reading. And that's a trend that has accelerated over the last two or three years. And what we're doing is clearly adapting our own supplemental materials so that they are much more in tune. And with the sciences reading, what's important to say is the independent reading is still incredibly important in the literacy journey and that Scholastic is better positioned there than any other literacy Provida.

Brendan McCarthy

Got it.
That's helpful. And 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 second quarter second fiscal quarter for what that is due to what's got to happen is that the funding has to be obligated, in other words, doesn't necessarily have to be immediately spent, but it has to be committed by no later than September 2024.

Peter Warwick

And so we would expect that with a lot of hard assets on our part, but there are still good opportunities for us, both and in the second part of this financial year, but also in the following financial year as well.
And also, we're encouraging all that we can to make sure that those as a federal lesser funds can be used in areas where we have really tremendous products. So particularly in areas like summer reading, for example. And 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 how the how they do things, which is why the summer, book collections, et cetera, have become so important to us. And we can see that the remaining a 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.

Brendan McCarthy

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 frontlist titles. I'm just curious as to maybe your outlook on the backlist titles and when that market, my return to growth I don't have a complete roadmap on that.

Peter Warwick

But and I think what we one of the things that we have been seeing and is some pickup in trade sales and Main Street sales as it were during the last few weeks. And we are particularly benefiting from that. And because of the titles that we've got that have done so well, the cap kid and other titles. I think what's important about backlist is that the the most successful publishers or how really strong backlist and is particularly important for us because we can monetize those backlist, not just through sales of books on bookshelf and but we have through our major activities and we're able to, as I mentioned in the in the report that we can see other purposes for that intellectual property. And you know, that is going to be an increasingly important part of what we do. And furthermore, and as there's been sort of changes in the sort of screen-based and market at the moment, whereby fewer but much more higher value and properties are being have been transformed into and into major into streaming and particularly into into feature films than the high quality of our backlist titles. And our characters are are really important. And as we've discovered in recent discussions with houses in L.A. and elsewhere is the tremendous value that screen base companies see in our backlist. And so having that Baxter's, I think what we're going to find is that 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, when in the talk, it's a virtuous circle going from print to screen to merchandising to come back to the back to the book.
Yes.

Brendan McCarthy

Thank you. That's all for me.

Peter Warwick

Thank you.

Operator

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

Peter Warwick

So I 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, and we look forward to engaging with our investors in coming days and to providing a further update on our progress in March on our Q3 call.
Thank you.

Operator

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