Scholastic Corporation (SCHL) Q4 2022 Earnings Report, Transcript and Summary

Good day and thank you for standing by and welcome to the Scholastic Reports Q4 and Fiscal Year 2022 Results Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Paul Hukkanen. You may begin.

Hello and welcome everyone to Scholastic’s fourth quarter and fiscal 2022 earnings call. Joining me on the call today are Peter Warwick, our President and Chief Executive Officer and Ken Cleary, our Chief Financial Officer. As usual, we have 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 would like to point out that certain statements made today will be forward-looking. These forward-looking statements, by their nature, are subject to various risks and uncertainties and actual results may differ materially from those currently anticipated. In addition, we will be discussing some non-GAAP financial measures as defined in Regulation G. The reconciliations of those measures to the most directly comparable GAAP measures maybe found in the company’s earnings release and 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 e-mail address, investor_relations@scholastic.com. And now, I’d like to turn the call over to Peter Warwick to begin this afternoon’s presentation.

Good afternoon, everyone and thank you for joining today’s call. Our fiscal year 2022 came to a close with a strong fourth quarter, which builds upon three solid quarters to secure impressive results for the full year and establish positive momentum for moving forward. These results are a direct reflection of the adaptability, resolve and unparalleled dedication of Scholastic employees. To that point, we delivered more than 500 million units of books and educational materials in the United States this past fiscal year. It takes strong teamwork at every level to accomplish that. As usual, Ken will provide greater detail later in the call. But at a high level, our results exceeded expectations for this rebuilding year, particularly for Book Fairs, which was initially the area most affected by COVID. Overall, full year revenues grew 26%, operating income increased by $120 million, and free cash flow increased by $162 million. Based on our strong performance and our optimism for the future, we were pleased to announce yesterday a 33% increase in our regular quarterly dividend, the first change in nearly a decade. Further, we are resuming guidance for our new fiscal year, which we suspended in 2020 due to the uncertainties of the pandemic. We expect fiscal year 2023 revenue growth in the range of 8% to 10% and adjusted EBITDA is expected to be $195 million to $205 million, up from $189 million in 2022. If we learned anything over the past 2 years, it’s that change is a certainty and the pace of that change is more rapid than previous generations have ever experienced. Our confidence moving forward is rooted in that knowledge and fueled by our proactive work to both prepare for and to embrace the future. Our highly skilled management team is working effectively to better tap the full expertise and passion of our employees who benefit from our more streamlined operations. And we have continued to better our strategies to serve our staff by adding a new key role of Chief People Officer, which was announced and filled by Cristina Juvier this past April. We are also using changes to our deeply engaged Board as an opportunity to broaden the business backgrounds of our members. As you all know, Mary Beech stepped down earlier this year to contribute her expertise to the company in a new role as our Chief Marketing and Transformation Officer. And we have since welcomed to the Board, Linda Li, Senior Vice President and General Manager of Wirecutter, the New York Times Company. Linda is bringing her nimble sensibility to our digital growth strategy based on her extensive experience in both technology and media companies. Together, we are all embracing new approaches to enterprise strategy in order to best unlock the full potential of all our businesses. And finally, I’d like to thank Maggie Williams for her 12 years of dedicated service on our Board. I personally much enjoyed serving alongside her, and Scholastic has benefited a great deal from her insights developed by her distinguished career experience. Maggie recently announced that she will not stand for reelection this coming September and we’ll share news of her replacement in the coming weeks. I’d now like to walk you through the positive trends displayed by our results and that we see ahead of us. Children’s Book Publishing and Distribution had a very strong fourth quarter as did Education Solutions, with increases in revenue year-over-year of 42% and 26% respectively. In trade, there is an exemplary story of how the best content rises to the top of all platforms, all beginning with books. A runaway success was our young adult graphic novel series, Heartstopper by Alice Oseman, which this past year reached the New York Times Best Seller list and was further bolstered by the Netflix series adaptation that was quickly renewed for two more seasons. We also saw another blockbuster in the feature animated film from DreamWorks, The Bad Guys, which heightened interest in Aaron Blabey’s new book in the series and keeps the backlist titles at the forefront. And of course, we must applaud the success of Dav Pilkey’s latest series of Cat Kid Comic Club, where book after book reaches the top of bestseller lists and who has a feature film based on the Dog Man series in development with DreamWorks. This virtuous circle of content revolving from the page to screen to licensed merchandise is being utilized and grown by our Scholastic Entertainment division. Apple TV+, tremendous partner since the division’s relaunch, recently announced that the animated series, Eva the Owlet, based on our highly successful Owl Diaries will launch in the spring of 2023. This will be hard on the heels of the announced Season 2 of Stillwater on Apple TV+ and from Disney+, the live-action Goosebump series. Better still, we anticipate that this momentum is just the first chapter in our intellectual property growth story. For context, consider that in 2015, Scholastic Entertainment had five projects in development. Today, that number exceeds 35 and is further fueled by expanding licensing opportunities as partners have witnessed the merchandise success of projects such as the Clifford the Big Red Dog feature film and animated series. Perhaps you have caught the new GEICO commercial featuring Clifford as the neighbor’s friendly dog. Fairs closed out this past fourth quarter with clear and sustainable strength. Throughout the school year, we maintained a healthy percentage of pre-pandemic fair count levels while managing the ongoing supply chain and labor challenges affecting the industry. Ultimately, we closed the fiscal year with 72% of pre-pandemic in-person fair count levels. And perhaps more impressively, the division drove record levels of revenue per fair. The drivers of this success include increased participation rates by children and in the number of books per transaction as well as permanent operational cost savings. We also have exciting momentum in our equity initiatives to ensure that every child, no matter their circumstances, leaves the fare with a book of their own from 700 sponsored fairs in recent months to new digital funding pathways to allow the community to more easily support its own students to grow home libraries. Clubs were able to rebound from the challenges presented in the first half of fiscal year 2022, and we’ve done significant work to alleviate the previously disclosed systems issues and labor shortage. Our team is poised to begin this next school year with a renewed focus on engaging with teachers and doing all that we can to assist them in overcoming the challenges they face in these times. With our Education businesses now fully integrated under one leader, during the past fiscal year, the newly formed management team fostered connectivity between the best, most relevant and important content for children with services and tools to improve student reading, writing and comprehension, including as part of state and district shifts to the signs of reading. The source of pride throughout the company comes from our founding offering of magazines for the classroom, recently rebranded Magazines+, which are designed to develop reading and writing skills in the context of helping children build knowledge and understand our complex world. A prime example of combining digital teaching and learning and print, Magazines+ has returned close to pre-pandemic levels of engagement as reflected in subscription count and revenue across titles. Our supplemental curricular and collections team has a keen and advancing ability to nimbly meet the needs of our customers for modular print and digital libraries, summer programs, skills practice and independent reading. Our future investments could include targeted acquisitions for key capabilities, greater development in digital content and functionality, data analytics and staff to enable these innovations. Accordingly, this division will report increases in capital spending, prepublication costs and selling, general and administrative expenses in the coming year. While Education Solutions have certainly benefited from some strategic investments by schools using ESEA funds, it is important to note that our family engagement offerings are a key driver in our results and are more typically funded by traditional lines of Title 1 funding and locally, giving us a strong and sustainable base of home literacy initiatives beyond the current ground swell of federal support of schools. In International, our markets continue to vary based on the degree of local impact of the ongoing pandemic. Beyond our Trade Publishing, which remains strong, within the global recovery from COVID, we see the success of Book Fairs in Canada and the UK. A review of our business in Asia has led us to refocus our strategy and exit from our direct sales business through a sale to new owners. Overall, I believe you’ll agree that across our core businesses, there is a connective thread of a clear demand for high-quality content and an overall deeper appreciation of the importance of children’s book ownership through home libraries. Ken, I now turn the call over to you for our detailed results and outlook.

Thank you, Peter, and good afternoon. Today, I will refer to our adjusted results for the fourth quarter and full fiscal year, excluding one-time items unless otherwise indicated. Please refer to our press release tables and SEC filings for a complete discussion of one-time items. My focus this afternoon will be primarily on the full year results given the backload seasonality of our business. We have performed well in this transitionary year coming out of the pandemic under Peter’s leadership. The operating leverage we created through our cost-savings programs during the pandemic are evidenced in our EBITDA results for the year. We have set the stage for future growth while ensuring current operations provide substantial returns for our investors. Overall, we are pleased with our performance. Revenue for the fourth quarter was $514.4 million compared to $401.4 million in the prior year period. For the full fiscal year, revenue was $1.64 billion compared to $1.3 billion in the prior fiscal year. Operating income in the quarter was $66.1 million versus $41.6 million in the fourth quarter last year. For the full year, operating income was $97.5 million versus $39 million last year. Full year operating income increased $58.5 million on incremental revenues of $342.6 million, demonstrating the high operating leverage the company created through the prior year’s cost-savings initiatives. Likewise, full year adjusted EBITDA increased from $139.6 million in fiscal 2021 to $188.9 million in fiscal 2022, an increase of $49.3 million. And diluted EPS for the full year more than doubled to $2.38 from $1.02. Net cash provided by operating activities was $47.5 million in the quarter compared to $34.5 million in the prior year’s fourth quarter. Free cash flow for the quarter was $34.9 million compared to $19 million last year. For the full year, net cash provided by operating activities was $226 million compared to $71 million in the prior year. Free cash flow was $182.8 million in the current year compared to $20.5 million last year, an improvement of $162.3 million, reflecting the company’s continued recovery from the pandemic, the permanent cost savings previously mentioned and the first quarter tax refund of $63.1 million. At the end of the fiscal year, cash and cash equivalents exceeded total debt by $310.1 million compared to $176.3 million at the end of the prior year. Capital expenditures and capitalized prepublication costs in the fourth quarter were $18.2 million compared to $15.5 million last year. And full year capital expenditures and prepublication costs totaled $59.2 million this year compared to $67.9 million in the prior fiscal year. We expect CapEx and prepublication costs to increase this year as we invest in upgrades to our Jefferson City, Missouri distribution equipment and we continue to broaden our Education Solutions offerings. Inventory levels have increased to $281.4 million and will continue to increase throughout the summer months as we procure inventory well in advance of the upcoming fall season when we expect higher revenues and volumes than last year, notably in our Book Fairs business. While like everyone else, we were impacted by supply chain issues. We have mitigated the impact by diversifying our vendor footprint, including using more North American printers, increasing lead times for purchase orders and implementing systems and processes to better coordinate our demand with our supply chain. As of now, we believe our inventory position is ready for the fall season. For the full fiscal year, we reacquired 870,000 shares for $33.4 million. In light of our strong balance sheet, we expect to continue open-market repurchases of our shares for the foreseeable future. Additionally, we have raised our regular quarterly dividend to $0.20 per share as we expect our future earnings to remain above historical levels due to our low-cost base, current revenue projections and future growth opportunities. Now turning to our quarterly segment results. In Children’s Book Publishing and Distribution, Book Fairs continued its strong recovery from the pandemic. Book Fair quarterly revenue of $161.5 million exceeded the prior period revenue of $76.4 million. For the full year, revenue from Book Fairs operations increased to $429.7 million from $164.3 million in fiscal 2021. In-person fairs executed for the full year have now reached approximately 72% of pre-pandemic levels, and we expect to achieve approximately 85% of pre-pandemic fair count in fiscal 2023. Equally important, our revenue per fair has increased 13% on a same-fair basis when compared to pre-pandemic levels. Higher revenue per fair greatly improves our profit margins as there is minimal incremental distribution costs. Revenue per fair may slightly decrease next year as we add more fairs at lower revenue levels. But overall, profits will increase as a result of the higher number of in-person fairs. Fourth quarter Book Clubs revenue of $27.2 million trailed the prior year’s comparable period reported revenue of $37.5 million due entirely to new system implementation growing pains exacerbated by supply chain difficulties. The full year revenues of $126.4 million fell short of last year’s revenues of $145.4 million due to the system issues, labor shortages in the fall and impacts from the worldwide supply chain crisis. We have dedicated substantial resources to optimizing our distribution efficiency this summer and expect to be ready to meet our teacher and parent demand for back-to-school. Trade delivered another strong year as quarterly revenues of $88.5 million exceeded the revenues of $81.9 million in the same quarter a year ago. And full year revenues of $390.4 million exceeded fiscal 2021 revenues of $365.3 million. Strong demand for backlist titles solidified the year sales, and the current quarter benefited from the release of the third title in Dav Pilkey’s Cat Kid Comic Club series. The company’s focus on series publishing is strategic in a number of ways. Not only does it provide increased confidence in demand for new releases within existing series, it also drives a higher rate of pull-through selling of backlist titles and expands the potential and longevity in our IP licensing and entertainment opportunities. Total Children’s Book Publishing and Distribution revenues for the current quarter of $277.2 million exceeded the prior period revenues of $195.8 million, and our full year revenue increased 40% to $946.5 million from $675 million in the prior fiscal year. Operating income of $46.8 million for the quarter exceeded the prior year’s fourth quarter operating income of $12.6 million, and the full year operating income of $115.3 million exceeded last year’s operating income of $14.3 million as we recover from the pandemic with higher margins than we entered the pandemic. Education Solutions closed out a strong year with a record quarter. Fourth quarter revenues of $156.8 million exceeded the prior year quarterly revenues of $124.9 million. Quarterly operating income was $45.8 million, exceeding the prior year performance of $40.1 million. For the full year, revenues of $393.6 million exceeded the prior fiscal year’s revenue of $312.3 million and full year operating income of $81.8 million exceeded fiscal 2021 operating income of $57.7 million. Much of the year’s improvement in revenue and profits came from new sources, some of which were identified during the pandemic and some of which were created this year. Educators, administrators, parents and advocates continue to align to get books in the hands of kids, providing evidence of higher demand for children’s book ownership. Higher sales of books and materials through sponsorship programs, such as the Florida New World’s Reading initiative we previously disclosed, community engagement organizations on affiliate with schools and larger orders directly from schools and districts for summer reading and other take-home initiatives have all added to this segment’s increased revenues and profits. Our focus on instructional materials for the classroom also drove higher revenues as curriculum products such as PreK On My Way performed well, highlighting the demand for early childhood materials that are created with bilingual learners in mind. In fiscal 2021, increased demand for summer reading and other products, combined with supply chain issues, resulted in a $10 million backlog of orders that ultimately were delivered in fiscal year 2022. In fiscal year 2022, we better forecasted the high demand and product mix, and we are able to ship the majority of summer orders received prior to year-end, closing out the year with a substantially lower backlog and return to our typical seasonal timing of delivery and revenue recognition. As Peter mentioned, ESEA funding, while not easily identifiable due to its fungible nature, is providing support for Education Solutions traditional business. We expect this funding to continue in fiscal 2023. As we continue to expand beyond schools and school districts to sponsored sales and community engagement sales, we expect to become less reliant on this type of funding in the future, but schools and districts will always be this segment’s largest customer base. Accordingly, expanding our opportunities through targeted investments, increased market penetration and the shift to a full solution versus product strategy to schools and districts will be a company focus. International segment revenues of $80.4 million approximated the prior year’s quarterly revenues of $80.7 million. Operating income of $1.9 million for the fourth quarter was unfavorable to the prior year period operating income of $3.9 million. For the full year, revenues of $302.8 million trailed the prior year’s revenue of $313 million, and operating income of $5 million trailed the prior year operating income of $28.4 million. The prior year results included $11.2 million of government subsidies, while the current year included $1.2 million. The company’s major markets continue to rebound from the pandemic with Canada and UK operations largely mirroring the U.S. recovery for book fairs and other businesses. Australia and New Zealand were impacted early in the year by COVID-related school closures and government lockdowns and restrictions, but have rebounded in the fourth quarter. Asia continued to struggle with COVID-related restrictions and government regulations in China around tutoring and foreign content. In the fourth quarter, the company decided to exit its non-strategic and low-margin direct-to-consumer business in Asia, which is being sold to a longtime company employee, incurring a $15.1 million loss on the expected sale of this business. We will continue to assess the region and our strategy throughout this fiscal year. Unallocated overhead costs of $28.4 million in this year’s fourth quarter were higher than prior year’s fourth quarter unallocated costs of $15 million. For the full year, unallocated overhead costs of $104.6 million are higher than the prior year’s full year unallocated overhead costs of $61.4 million. Company absorbed higher unallocated wages and incentive compensation in the current year compared to the prior year. As we look forward to next fiscal year, we are encouraged by our strong customer engagement and demand for our products, content and solutions. We expect book fairs to continue their strong pandemic recovery, anticipate achieving 85% of pre-pandemic in-person fair count levels. We are expanding capacity and procuring incremental inventory to meet this demand. Trade will continue to publish titles and current series and will introduce new content, both in traditional print format and other media. We are also excited about the future for our Education Solutions business, as I detailed earlier, and are committed to our activity in International. We continue to expect inflationary cost pressures for our product, transportation, labor and fuel to impact the company for fiscal year 2023. Product costs for printing, paper and inbound freight have increased our per unit cost by approximately 16% for purchases made this year and are expected to remain at these levels for the foreseeable future. Likewise, our variable labor costs for warehouse associates and drivers have increased over 20%. The bigger increases to our costs were seen last year and were recognized in the second half of fiscal 2022. For fiscal 2023, as we ramp up our distribution efforts, we will see greater impacts from rising fuel costs. We are addressing these variable cost increases near and longer term through proactive resource allocation, diversifying our vendor base, automation, pricing where necessary, product rationalization, in the case of fuel consumption, route optimization. While internal investment has been low for the past few years, in part due to the pandemic and the need to preserve capital, we are now entering into a growth period requiring further investment. This investment will come in the form of increased prepublication costs for Education Solutions, increased capital spending for distribution operations, investments to attract and retain authors and content, and higher SG&A costs as we continue to transform the organization for the future and focus on growth initiatives. Under Peter’s leadership, we have implemented stringent controls to ensure that, one, our investment decisions are backed by cross-divisional support. Two, our expected ROI and milestones for these investments are monitored centrally and have appropriate accountability at both the divisional and corporate level. And three, organizational readiness for the investment is in place prior to the commencement of spending. Accordingly, we will focus on those areas that provide the best overall return on investment for the company. While our spending will be higher than fiscal 2021 or fiscal 2022, we do not expect to increase our spending to the level seen in the years prior to fiscal 2020. As Peter mentioned, we are reinstating guidance this year. For the upcoming year, we expect revenue to be approximately $1.8 billion and we expect adjusted EBITDA to range between $195 million and $205 million, all of course subject to economic and market conditions and the path of the pandemic. Finally, as previously announced, the company increased its regular quarterly dividend to $0.20 per share, in line with our current earnings and expected future earnings. Thank you for your time today. I will now hand the call back to Peter for his final remarks.

Thank you, Ken, for that walk-through of our results and future outlook. Overall, we are extremely pleased with the positive momentum of our strategic and operational initiatives, which have positioned us very favorably for fiscal year 2023 and beyond. Importantly, we expect the positive trends from our recent performance to continue, trends, which in many cases lead the industry. In the near-term, we anticipate our book fairs recovery to advance from this year’s 72% of pre-pandemic levels to 85% and for continuing high levels of government funding into K-12 education post-pandemic that will bolster our sales. We will also capitalize on sustainable trends long-term, such as recognizing and growing the demand for independent reading and children’s book ownership, coupled with the need for support to grow students’ literacy skills, an unparalleled level of trust in our brand earned through a century of partnership with families and schools, growing opportunities for our IP that lift our backlist, and finally, ensuring our core businesses remain formidable, gives us the flexibility to implement targeted growth investments to increase innovation and opportunity. With that, I thank you again for joining us today. Paul will now conclude this call for us.

Thank you, Peter. And as a reminder, we invite questions to be directed to our IR mailbox, investor_relations@scholastic.com. We appreciate your time and continuing support.

Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.