Scholastic Corporation (SCHL) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Scholastic reports Second Quarter 2020 results conference call. [Operator Instructions]. I would now like to hand the conference to your speaker today, Gil Dickoff, Senior Vice President and Treasurer, Head of Investor Relations. Please go ahead, sir.

Thank you, Joel, and good afternoon, everyone. Welcome to Scholastic's Second Quarter 2020 Earnings Call. With me here today are Dick Robinson, our Chairman, President and Chief Executive Officer; and Ken Cleary, the company's Chief Financial Officer. We have posted an investor presentation on our IR website at investor.scholastic.com, which we encourage you to download if you have not already done so. I'd also like to point out that certain statements made today will be forward-looking. These forward-looking statements, by their nature, are uncertain and may differ materially from actual results. In addition, we will be discussing some non-GAAP financial measures as defined in Regulation G, and the reconciliations of those measures to the most directly comparable GAAP measures can be found in the company's earnings release filed this afternoon on a Form 8-K, which has also been posted to our Investor Relations website. We encourage you to review the disclaimers in our press release and investor presentation and to review the risk factors contained in our annual and quarterly reports filed with the SEC. And now I would like to turn the call over to Dick Robinson.

Good afternoon, everyone, and thank you for joining our call during this busy holiday season. Following our second quarter results, we're in a good position to realize our fiscal goals as our high-quality children's content is selling well, and our investments in technologies and efficiencies are showing benefits. Book Fairs performed strongly in the quarter with revenue per fair and profitability both increasing, a rebound from a difficult finish last school year. Children's Books remains strong for the publishing industry overall, with some growth in the category offsetting a decline in adult books. Based on 2018 revenues, Scholastic remained in the top 10 of global book publishers as recently reported by Publishers Weekly. And uniquely, we're the only publisher in this influential group that is solely focused on Children's Books and education sales in the K-12 market. The demand for children's content goes beyond publishing and is actively sought in TV and film as well. The new Clifford the Big Red Dog animated series had its larger-than-life debut on Amazon Prime Video and PBS KIDS earlier this month and buzz continues to grow. Internationally, this appetite for engaging content also extends to English language learning materials. We are expanding our essential connection to schools and families globally while utilizing technology advancements to improve operating income. With that, second quarter revenue was $597.2 million, a decrease of 1% compared to $604.7 million in the second quarter of 2019. Operating income in the second quarter was $105.1 million, a 7% increase compared to $98.2 million 1 year ago. We are affirming our outlook for revenues for the 2020 fiscal year in the range of $1.67 billion to $1.70 billion. And in a few minutes, Ken Cleary will detail our quarterly operating results, EPS and adjusted EBITDA. But first, I'd like to share some highlights and updates with you. Our trade business is having exceptional year-over-year growth at 8% in revenues, even when compared to prior year results, which included the release of JK Rowling's Fantastic Beasts: The Crimes of Grindelwald. We have seen headlines this fall around the power of graphic novels with our own authors Dav Pilkey and Raina Telgemeier at the forefront. When featuring her newest release, Guts, the New York Times said as follows: "Raina's intimate, accessible style and stories about young characterizing everyday struggles with schools, family drama, friendships and bullies seem to speak directly to kids." We are seeing through events and reader response that this graphic novel has struck an unmistakable cord within a generation of tween girls that is rarely seen. And as this year comes to a close, Raina's Guts has appeared on 11 best of 2019 lists to date. Other bestsellers include Tui Sutherland's Wings of Fire; the Baby-Sitters Club graphic novels; The Dinky Donkey; Alan Gratz' Allies; Maggie Stiefvater's Call Down the Hawk, which launches a new trilogy; and Harry Potter and the Goblet of Fire: The Illustrated Edition. Dog Man: Fetch-22, realized -- released earlier this month, is the number one top-selling U.S. book across all categories. And looking forward, we eagerly await The Ballad of Songbirds and Snakes, the new Hunger Games novel by Suzanne Collins coming in May. To ensure that every child has an opportunity to access these engaging characters and stories, our distribution channels have never been more important. As we've previously mentioned on calls, we have been implementing cost-saving strategies in both our Fairs and Clubs businesses with benefits seen in this past quarter. As I briefly noted earlier, in addition to trade success, Book Fairs had a very strong fall performance. Our clear focus on fair quality, including breadth and depth of product and utilization of technology enhancements, such as eWallet and access to increased data, has strengthened our ability to bring the right fair to customers at the right time, generating greater revenue and profitability per fair. In fact, the last 4 months have been among the best in the last 15 years of Scholastic Book Fairs. It's, therefore, the perfect time to thank Alan Boyko for his distinct career at Scholastic and welcome his successor to carry forward this legacy. After more than 30-dedicated years with Scholastic, 14 of which he served at the helm of Fairs. Alan announced his pending retirement earlier this year. You may have seen our announcement yesterday, welcoming Sasha Quinton to join us as EVP and President of Scholastic Book Fairs on January 1. Sasha is well respected and highly regarded in our industry with an impressive track record. She began her 17-year career starting at Books Are Fun and has held leadership roles at Readerlink and most recently served as VP and General Merchandising Manager Bookstore for Barnes & Noble. She and Allen will be working hand-in-hand for a seamless transition in Book Fairs. Thank you, Alan, and welcome Sasha. In Clubs, while revenues have decreased in the quarter, in large part due to fewer teacher sponsorships and required sales tax collection, cost reduction significantly reduced the impact on profitability. In education, we recorded strong second quarter sales in classroom collections and professional services, while teaching resources have seen double-digit growth in dealer trade channels. We are seeing continued strength in our customized classroom library business, and we are very encouraged by the intense demand for our newly launched Rising Voices K-5 book collections directed to African-American and Latino boys. The accelerated growth in professional learning services strengthens our position as a leading provider of a comprehensive approach to literacy instruction, including personalized learning through digital subscriptions, supplemental and core reading products and as well as family and community engagement. As part of this, we are experiencing a very positive response to our core reading program for grades K-6 Scholastic Literacy from pilots and early adopters and are optimistic about its future growth. Turning to international. During the first 6 months of the fiscal year, we saw continued growth in Asia's trade and education channels. We continue our focus on reaching a growing middle class of families interested in English language learning. And our strong brand, proven effective products and engaging book and audio content in both print and digital formats are sold throughout Asia in school channels, direct to the home and trade retail as well as through partnerships with large online providers. Our core digital learning products, Scholastic Literacy Pro and Scholastic Literacy Pro library registered a 40% increase in active users across key markets in Asia this year. Also, our trade business grew around the world, reflecting our ability to find the best authors and content in Children's Books. Dav Pilkey just concluded his global Do Good Tour, which included stops in Asia, showing that his messages of kindness and the importance of reading know no boundaries. And Aaron Blabey continues to grow in his following with fans eagerly awaiting the 2020 animated -- 2021 animated film adaptation of The Bad Guys. In closing, we're encouraged by all of the evidence of traction related to our technology and efficiency improvements as guided by our Scholastic 2020 plan and our focused approach to operating income improvements. As I mentioned, better cost management in Fairs and Clubs is progressing. Our selective price increases appear to be accepted in the market and net technology-related costs are down year-over-year. With that background, I will turn the call over to Ken Cleary, CFO.

Thank you, Dick, and good afternoon. Today, I will refer to our adjusted results for the second quarter, excluding onetime items, unless otherwise indicated. As Dick mentioned, revenues were $597.2 million versus $604.7 million in the second quarter of last year. The 1% year-over-year decline was in the face of tough comps with last year's release of Fantastic Beasts: The Crimes of Grindelwald, an original screenplay by J.K. Rowling; and the viral global sensation, The Wonky Donkey, which together accounted for nearly $13 million in net sales in the second quarter of fiscal year 2019. Partially offsetting this tough comp is Make Believe Ideas, the U.K.-based children's book publisher that we acquired in the spring, completing our acquisition of a majority interest. In the prior period's results, our minority interest in MBI was carried as an equity investment. Adjusted EBITDA, as defined, was $129.3 million compared to $123.2 million in the second quarter of 2019, an improvement of 5%. We believe that adjusted EBITDA is the most meaningful measure of operating profitability and useful for measuring returns on capital investment over time since it is not distorted by unusual gains, losses and other items such as share repurchases. Operating income was $107 million, a 4% improvement versus $102.9 million last year, with a higher contribution on the margin resulting from cost mitigation strategies, primarily U.S. Clubs and Fairs channels as well as lower technology-related expenses and overhead in the current quarter. The current quarter also benefited from lower net sales tax expense in Book Clubs due to the sales tax collection mechanisms put in place in the fourth quarter of the last fiscal year. We had $1.9 million of onetime items in the current period, both in overhead. $1 million related to a settlement arising from an intellectual property producing agreement and $900,000 in pretax severance associated with Scholastic 2020 repositing programs. This compared to $4.7 million in onetime items in the prior period. Now turn to our operating segments. Children's Book Publishing and Distribution second quarter revenues declined by 1% to $413.6 million from $417.9 million last year. The second quarter's new trade frontlist performed exceptionally well, and we continue to see incredible strength from Dav Pilkey's Dog Man, where the first seven titles sat in the top 33 spots on BookScan at the end of the quarter. Book Fairs was also a key driver in the current quarter with a 2% increase in sales versus the prior year period. As Dick mentioned, our previous investments in transformational technology and data analytics helped us better manage the scheduling affairs in our peak period and drive down costs associated with the delivery of the Fairs, improving our margin. While this resulted in a lower number of Fairs in the quarter, as planned, we saw both higher transactions per fair and higher revenue per fair in the quarter. Despite Clubs drop in sales, lower staffing and promotional costs as well as higher sales tax collections as a result of our new collection programs helped to lessen the revenue drops impact on Club profitability. Lastly, we saw higher media and entertainment revenues tied to our new Clifford MA programming, which launched on Amazon Prime Video and PBS KIDS in early December. Segment operating income improved 3% to $109.6 million primarily on the lower operating costs in Clubs and Fairs. Education segment revenues declined 2% to $69.9 million, mainly due to lower custom publishing in the segment's national partnership program, which develops high-quality content used by corporate and other sponsors to support learning in and out of the classroom. The segment also saw growth in its classroom book collections business and in professional services. There was a small increase in digital subscription revenue in the current quarter, specifically Literacy Pro, which provides access to over 2,000 fiction and nonfiction e-books for independent reading. Segment operating income was $6.2 million versus $8.3 million in the second quarter of fiscal 2019, and it was mostly due to the lower national partnership revenues as well as higher amortization expense for components of Scholastic Literacy that launched last year. International segment's second quarter revenues of $113.7 million were down 1% versus the prior year, but were slightly improved on a constant currency basis after adjusting for the $1.9 million adverse impact of foreign exchange in the quarter. In local currency terms, we saw growth in trade publishing in Australia, New Zealand, the U.K. and in India. The company's English language learning franchises in China also continued to grow with our strong-branded products. Operating income for the quarter was $11.7 million, down $1.3 million from the prior year period, partially reflecting the lower revenues from the Club and Fairs school-based channels in Canada and higher expenses in Asia as well as the impact of foreign exchange. Second quarter unallocated corporate overhead expenses were $20.5 million versus $24.7 million in the second quarter of fiscal 2019. The lower overhead costs, excluding onetime items in the current period, is mainly due to favorable staffing levels in our technology operations as planned. Net cash provided by operating activities was $111.9 million in the current fiscal quarter compared to $128.5 million last year. And free cash flow was $87.7 million in the second quarter of fiscal 2020 versus $93.5 million a year ago. The variance is mainly due to higher working capital usage and the timing of payments made to suppliers, resulting in higher vendor discounts and rebates. At quarter end, we had $277.8 million in cash and cash equivalents compared to $358.1 million a year ago, but up $78.4 million versus our cash balance at the end of the first quarter. In the second quarter, we had $17.2 million of planned capital expenditures and $7 million in prepublication and production spend as well as $7.1 million in open market repurchases and $5.2 million in dividends, both reported below the free cash flow line. Including repurchases made to date, the company has now bought back $20.3 million of its shares in open market transactions this year. We are affirming our fiscal 2020 outlook for revenues in the range of $1.67 billion to $1.7 billion and adjusted EBITDA of $140 million to $160 million, and we have more closely tied senior management incentive compensation to achievement of these adjusted EBITDA targets. Our investments in new technology and data analytics, the key components of our capital spending plans this year remain on track with overall capital expenditures projected in the $75 million to $85 million range. We are continuing to drive positive process change through technology and enhanced data analytics, clearly evidenced this quarter by the margin improvement in our Fairs operations through more efficient fair scheduling, transportation and fulfillment. Fairs now utilize live analytics dashboards, powered by Tableau and Scholastic Data Cloud to analyze weekly capacity into scheduled fares, ensuring better utilization of resources, such as labor, transportation, inventory. Lastly, we went live with our direct procurement management platform in Oracle this quarter. The new system will support more efficient procurement, standard costing, clear view of inventory by channel, laying the groundwork for better procurement decisions and processes in future periods. We expect to report further on these technology-enabled cost savings and process improvements in future quarters. With that, I will hand the call back to Gil.

Thank you, Ken. Joel, if you would, we are now ready to open up the lines for questions.

[Operator Instructions]. Our first question comes from Drew Crum with Stifel.

So it seems like you were able to make some progress with Clubs and Fairs against some of the issues that impacted the business back in the spring. As we look at the second half of fiscal '20, you're up against easier sales comparisons. With that in mind, should we assume an acceleration for these businesses? And I guess a similar question as it relates to segment profitability. Given some of the initiatives you highlighted, could we see a similar year-on-year improvement in the second half for Children's Books?

Good question. I think we are struggling a little bit with our revenues in Clubs. And while we've overcome those by some very good cost management, cost control, including mailing fewer kits, we do expect that revenue to continue to be a little bit below where it was last year. You're right that we did -- it will be going up against a reduced fourth quarter, so we should be able to pick up something there. Fares seem to be quite strong, and we expect that we will have continued improvement in Fairs.

And Dick, which business, have you seen the acceptance of the price increases? Is that Fairs or Clubs or both?

Yes, I don't think we're seeing any significant price resistance in either of those businesses. We have modestly increased prices to overcome the impact of rising paper costs and tariffs, but we certainly haven't had resistance from our customers. Bearing in mind that we have an extremely strong lineup of trade books and which are also offered on our Fairs and our Clubs. So we're -- with our very strong product offerings, people are really not calling attention to the pricing, they're just grabbing up these books as fast as they can.

Okay. I apologize if I misspoke. I thought I said I -- pricing acceptance not resistance. So it sounds like customers have been accepting of the pricing increases?

Yes, I would say so, yes.

Got it. Okay, okay. And then a couple of questions on the trade business. I guess, first, a housekeeping item. The revenue from Clifford, the animated programming on Amazon Prime and PBS KIDS, was that picked up in the fiscal second quarter? Or will that flow in fiscal 3Q?

Yes, it was picked up in the fiscal second quarter. So we delivered the product and it was available. PBS and Amazon opted to launch it in December.

Got it. Okay. And I think the initial -- or the planned initial print run for The Ballad of Songbirds and Snakes is 2.5 million copies. How does that compare to some of the other Hunger Game books?

Well, certainly, it's in keeping with the -- of initial printings. In fact, it's higher than the initial printings of some of the earlier books. So we're expecting very good market response, and we're getting tremendous support from all the channels that, that book has been top seller on Amazon since the day it was announced.

Okay. And then shifting to the Dog Man series is kind of looking through some numbers. Our sense is, at least the initial print run for the book launch in August was smaller versus the most recent title. Can you talk about the relative performance for the book was launched in December relative to some of the others you've launched in the past couple of quarters here?

Well, the book that we just launched in December was -- had a tremendous positive response, outselling the books that came out in August. So we see the Dog Man the taste -- the drive for Dog Man among our young customers is greater than ever.

Got it. Okay. And then just lastly, on cash flow. Can you talk a little more about some of the unfavorable changes to working capital that you saw in the quarter? And then just any updates on priorities around uses of cash? I think it was maybe almost two years ago, you guys were planning to do and accelerate share buyback. That was eventually scrapped, but is that something that you would reconsider?

So Drew, this is Ken. Yes. So in terms of working capital and really the payables, you have utilized cash to negotiate with vendors on terms regarding early pay discounts, so that has caused us to utilize some cash. And there's some just pure timing in when the payments were made this quarter. So we're looking at some of that. In terms of plans going forward, as we've mentioned in the past, we are always in conversation with our Board regarding that. And we don't have announced -- anything to announce at this point in time. But again, it's constantly being discussed. You did see us buy back a larger number of shares this quarter and really this year-to-date, opportunistically in the open market, and that's a good part of what you're seeing in terms of the total cash decline in the year.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Richard Robinson for closing remarks.

Well, thank you all for your support of Scholastic, and we're happy about this quarter. We're looking forward to fulfilling our financial goals for this upcoming year as well as delighting our customers with the amazing books that we're putting in their hands. Happy holidays to all.

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