Scholastic Corporation
Q2 2021 Earnings Call Transcript

Published: 17 Dec 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Scholastic Reports Q2 Fiscal Year 2021 Results Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. It is now my pleasure to introduce Senior Vice President, Treasurer, Head of Investor Relations, Gil Dickoff.

[Gil Dickoff:]

Thank you, Andrew, and good afternoon, everyone. Welcome to Scholastic's fiscal 2021 second quarter earnings call. Joining me on the call 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.

[Richard Robinson:]

Good afternoon, and thank you for joining our call. In the second quarter, schools opened late and only one-third of U.S. schools were operating with in-person learning. As they met the continuing challenges of keeping students safe, almost all schools struggled with schedule changes and different modes of learning. This substantially affected our ability to run our iconic in-person book fairs, and we took action to preserve profitability and liquidity while also supporting our customers as they navigate the pandemic. I am proud of the way our company has adapted to the continuing issues with COVID-19, which would have affected our school-based businesses. With resilience and urgency, we found new ways of reaching customers at school and at home and finding new sources of revenue, while we reduced costs throughout the company to protect our operating income and cash. First, as most schools were not yet ready to commit to hold in-person fairs in the second quarter, we did not see fair sales increase at the end of the quarter. Our customers tell us that they are eager to host fairs and they expect to do so as soon as more children attend school in-person and schools operate more normally. We are cautiously optimistic that with a push to return to in-person learning in fall 2021 and into the future in 2021, and as health conditions improve into our society overall, we will be able to improve fairs performance in the spring season of our fiscal fourth quarter. At the same time, schools and parents are relying on us for reading and instructional materials, as they grapple with reversing the COVID slide and our role as their trusted partner in literacy is deepening.

[Kenneth Cleary:]

Thank you, Dick, and good afternoon. Today, I will refer to our adjusted results for the second quarter, excluding one-time items, unless otherwise indicated. Second quarter revenue was $406.2 million, a decrease of 32% compared to $597.2 million last year, due to lower sales in our school distribution channels, particularly fairs from COVID-related disruptions. As Dick indicated, our Trade, Education and International businesses, excluding fairs all performed according to plan driven by our trade lineup and our literacy solutions and education. Operating income in the second quarter was $54.3 million versus $107 million last year. Net income was $39.4 million compared to $72.4 million last year and adjusted EBITDA was $77.7 million compared to $129.3 million in the second quarter last year. Earnings per diluted share was $1.15 compared to $2.06 last year. Net cash provided by operating activities was $46.1 million compared to $111.9 million in the second quarter of last year. Free cash flow for the quarter was $30.9 million compared to $87.7 million last year. For the six-month period, net cash provided by operating activities was $20.1 million compared to $14.3 million in the prior year and free cash use was $4 million this year compared to $30.8 million in the prior year, an improvement of $26.8 million reflecting our capital preservation program during the pandemic. At the end of the quarter, cash and cash equivalents exceeded total debt by $161.8 million compared to $135.6 million at the end of the first quarter of this fiscal year and $261.7 million at the end of the second fiscal quarter a year-ago. Capital expenditures and capitalized pre-publication costs in the second quarter totaled $15.2 million compared to $24.2 million last year. This limited spending was focused on our technology platforms and digital products and services as well as on relocating and consolidating some of our distribution, warehousing and back-office operations, which will help to reduce fixed operational costs in the future. Inventory purchases declined over $50 million for the six-month period compared to last year, as we continue to leverage newer processes and tools to manage inventory levels, as demand changes. Our balance sheet remains solid, and our working capital management and access to liquidity remains strong. At quarter end, we had $356.6 million in cash on our balance sheet. We also entered into an amendment to our committed credit facility, including adjustments to, and suspension of, certain covenant thresholds. The revised terms, which were covered in our press release, include covenant relief made available by our lenders, which we believe provides us with both financial assurance and the necessary liquidity and flexibility to enable us to manage the business through the pandemic. We will continue to assess funding needs in the context of evolving information on in-school instruction patterns and, of course, banking market conditions. Turning now to our segment results. In Children's Book Publishing and Distribution, second quarter revenues decreased to $240.3 million, down $173.3 million compared to the year-ago quarter, primarily from the decline in fairs. As Dick noted, trade revenues increased by 21% year-over-year driven by demand for our frontlist and backlist titles. Segment operating income was $37.7 million, 66% below last year as a result of the book fair revenue decline. Our cost savings and restructuring activities are focused on mitigating the impact of COVID disruptions to our book fairs business. In Education, segment revenue was $67.5 million down by just 3%. As previously announced, we are winding down our Custom Publishing business and a year-over-year decline is due to lower sales in this area. Our Grab and Go summer reading packs, workbooks and early readers continue to be in high demand in the quarter as were our community-based services and resources designed to support students and families who are learning at home. Digital revenues increased by 30% and bookings were up by 43%. Segment operating income was $11.9 million, up by 92% due to improved product mix and operating cost reductions. In our International segment, second quarter revenues were $98.4 million, down 13% from last year due to COVID-related disruptions to the fairs business in Canada and UK and lower direct sales in Asia. Our sales in Australia, New Zealand have rebounded and trade publishing sales were up over last year in all of our major international markets. Foreign exchange benefited reported revenues by $2.5 million due to the weakening U.S. dollar. Operating income was $20.8 million, which was a $9.1 million improvement as a result of our cost mitigation efforts. We have overachieved our expected full-year cost savings target of $100 million this year. Additionally, we have identified areas where we can achieve additional savings in the second half of the year, including optimizing our distribution network and reducing our footprint for warehouse and office space. We continue to limit discretionary spending and to calibrate inventory purchases to match expected sales volumes. In the second quarter, our cost reductions drove more than $70 million reduction in SG&A expense year-over-year, a decline of 35% compared to last year. While these savings includes certain variable costs, much of these cost savings are sustainable beyond fiscal 2021. Our actions will improve efficiencies, increase operational leverage and reduce our cost base after the pandemic. While we are not providing outlook for the fiscal year, we will provide additional color on the factors impacting our business. As Dick said, we know that our customers are eager to hold fairs, but many are not able to do so as a result of COVID where that is because of continued full or partial school closures, limited resources or capacity restraints. We believe that returning to in-person instruction will be a priority for school districts across the country in 2021, and we will have a positive impact on our Fairs business as more schools will be in a position to hold in-person book fairs. Return to in-person instruction will also benefit our Education business as schools will need to replenish their classroom book collections and will need other instructional resources. We are remaining in close touch with our book fairs host customers focused on booking fairs for the March to May period, when we believe conditions will be more conducive to supporting in-person fairs. We have added incremental resources to our sales and outreach functions, and our distribution operations are prepared to provide fairs as the demand returns. Accordingly, we are cautiously optimistic that we will see improved results in the fourth quarter, particularly in book fairs, based on schools returning to in-classroom instruction. In the meantime, we are continuing to support schools with virtual fairs, digital engagement tools, flexible distribution methods, such as our popular ship-to-home option. Our digital subscription program should continue to see higher sales among districts that continue remote or hybrid learning models. Our outlook for trade remains positive and we expect continued momentum. We have an incredibly strong new release pipeline for the second half, including the launch of Dav Pilkey’s Cat Kid Comic Club series and new releases in The Baby-Sitters Club graphic novel, Dog Man and Wings of Fire series. We are also looking forward to new tiles like Ground Zero by Alan Gratz. We believe that production partnerships and licensing deals in our growing media and entertainment business will continue to bolster book sales. In summary, we remain intently focused on reducing our cost base, preserving profitability and maintaining liquidity as we adjust our operations to navigate through the pandemic. With that, I will hand the call back to Gil for the Q&A session.

[Gil Dickoff:]

Thanks very much, Ken. Andrew, we are now ready to open the lines for questions.

[Operator:]

Certainly. And I am sure we have a question from the line of Drew Crum with Stifel. One moment please. Your line is now open.

[Andrew Crum:]

Okay. Thanks. Hey guys, good afternoon. Happy holidays.

[Richard Robinson:]

Thanks Drew.

[Andrew Crum:]

Maybe starting with fairs, can you talk about how fiscal 2Q progressed? And then your expectations for fiscal 3Q relative to fiscal 2Q, should it be less bad than what you've experienced in fiscal 2Q? And then just the last part of this question, your optimism for fiscal 4Q, can you talk about the fair bookings and how that compares to where you were going into the fiscal second quarter?

[Richard Robinson:]

Three questions.

[Andrew Crum:]

Yes.

[Richard Robinson:]

Let me take a couple of them and I’ll ask Ken to work with me on this. In respect to the progress of the fairs, particularly the in-person fairs during the second quarter, Drew. What happened was we – they started off very slowly. The bookings increased as people got back into schools and we’re able to reach some of the customers. In late October and early November, they’ve showed signs of life although at a much reduced basis compared to normal, of course. But then the increasing COVID towards the end of the month caused cancellations because people were very concerned about the COVID spread at that time, so they canceled some of these in-person fairs. So the trajectory that we anticipated didn't quite happen exactly as we thought. In respect to the relationship between the fourth quarter or the bookings for the spring now compared to the bookings a year-ago, there really isn't a valid comparison there because people are still thinking about they're just considering how they're going to operate book fairs. In January and February, we expect them to go back to normal in-school, and that the biggest increase in bookings is going to take place in that period for the fourth quarter. We are getting bookings now for the fourth quarter, and obviously, for in-person fairs as well as for our virtual fairs, the trajectory is going to be quite different this year from the way it was last year when the fairs were booming in the second quarter. And nobody was anticipating that any fairs would need to be canceled in the fourth quarter at that point. Ken?

[Kenneth Cleary:]

Yes. Hi, Drew. This is Ken. So as Dick pointed out, the booking for Q2, we needed to really book Q2 during this year. And we didn't get a lot booked and we didn't get a lot of fairs by the end of Q2. Q3 is typically a quiet period for us anyway. So as this pandemic goes on, Q3 is generally quiet. But we are booking into the March to May period now. And we've put a lot of resources around outreach, around understanding what our customers are doing and we continued to pursue those opportunities. And our customers want to have fairs. Dick and I sat through a meeting with our marketing team yesterday, where we're clearly – as we talk to our customers, they're very interested in having fairs. It's a matter of being able to get back to them. And so we're increasing our outreach where our calls have volume. I won't give you the call volume, but it's extremely substantial in terms of our customer base. And then another thing that we're looking at is the back half, we have a lot of schools that would ordinarily host a fair in the fall and possibly not in the spring time. So we are looking at the back half of this year, Q4 this year. I was actually having a larger customer base to approach, granted the yield is going to be a little bit different on that. But we do have a larger customer base to approach because we have a lot of schools that didn't host fairs in the fall. So we're busy, Drew. That's what we're doing here.

[Andrew Crum:]

Okay. Got it. Fair enough. Just shifting gears to the Clubs business. It sounds like September was difficult, but then performance improved where October and November were better, were they up year-on-year? And then based on what you saw in the latter part of the quarter, what do you think that portends to for the second half?

[Richard Robinson:]

Well Drew, to start with, we reduced the revenue expectations on clubs in order to right-size the business from a product point of view, so we’ve reduced some cost on mailing out kits and having multiple offers. And so we have changed our business dynamics for the clubs and focusing on profitability out of somewhat lower revenue base. But in September, schools were like madhouse in September. Teachers didn't know who they were teaching, and the kids weren't there one day and then they're back the next day, they're on the virtual one day and so forth. So nothing was going easily for schools in September, and Book Clubs, while there were orders, it * weren't up to our normal September orders. October, November came in line with the prior year. So that was really encouraging, particularly because we’ve reduced our revenue expectations. December is a little slow because in order to get your books shipped by the holidays and U.S. – UPS which we work with very, very closely is struggling with all the packages that they're delivering. So they have put in more time for the books to arrive and particularly at homes where we're seeing more revenue. So December has been a little soft, but we do think that the rest of the year is going to come in line with October and November, and then we're going to experience a pretty solid club performance in the second half.

[Andrew Crum:]

Okay. Helpful. On trade, just a point of clarification, you mentioned the pipeline you have in front of you for the second half. Are you suggesting trade can grow in the second half of fiscal 2021 or is the comment specific to the entire fiscal year? Because as I look at the second half, you're lapping about a 30% comp?

[Richard Robinson:]

Yes. The Cat Kid has started off very strong. We have a number of good releases. We're on a roll in the business. We're taking more market share and we – so we believe, we can maintain the place – the pace that we have done in the first, but you're right that we have – I think it was a tough comp there. I think there was another Pilkey book that was in there last year. So we are going against a strong quarter or a strong half.

[Andrew Crum:]

Yes. Okay. Just one last question for me then. On the cost side, you mentioned achieving the $100 million in savings, how much of that is sustainable going forward? And you alluded to some additional opportunities, any way to quantify what the savings – the accompanying savings are from those additional opportunities? Thanks.

[Richard Robinson:]

Yes. We've really – I'll turn this to Ken, but I just want to make one comment first, Drew. I mean, we really did this. I know people talk about their cost saving programs and so there's a certain amount of skepticism attached to them. But in the first quarter, we reduced our costs and labor, inside employee labor and non-employee labor, outside labor by $100 million. And we're seeing the benefit of that come through in the second quarter and we’ll ratably should go through the year. So that's a real saving that we're holding on to. Ken runs a cost saving process, which – where he's looking at these things every day to make sure we're maintaining those costs. So I'll ask Kim * to answer the rest of this, Drew. But this is something that we've done and we take great pride in, and we needed to do with our revenues declining, we needed to match our cost base to our revenue. Ken?

[Kenneth Cleary:]

Yes. So Drew, yes, as Dick pointed out, we're on pace to actually exceed the $100 million for the year and we will do that. How much is sustainable in the long-term is a great question. And without getting into too many details, it could be about half of it, some plus or minus half of it. So I think that's – it's around the rigor though that we've taken on this. So as Dick mentioned that we're looking at this every day and we've put controls in place to make sure that we keep the costs out of every corner of the business right now. So it's a new rigor that we have in the company, and we're monitoring this constantly. In terms of the back half, we're looking at some things that are clearly sustainable. So we're looking at optimizing our distribution network, and we've done a lot of analytics around our logistics support that that's going to help us do that. So we're looking at reducing our footprint. I mean I think everyone in the world now understands what they need in terms of office space and it's not as much. So we're going to be looking into that as well. But really a lot of network optimization, a lot of warehousing and distribution costs and office spaces is probably our near-term opportunity.

[Andrew Crum:]

Got it. Okay. Ken, thanks.

[Kenneth Cleary:]

And maintaining the $100 million that we already took out on the labor side. We will do that. That'll continue. So that's a permanent lower cost base for the company.

[Andrew Crum:]

Okay, guys. Appreciate it. Thanks. Happy holidays.

[Richard Robinson:]

Thank you so much, Drew.

[Kenneth Cleary:]

Thanks, Drew.

[Operator:]

Thank you. I will now turn the call back over to Chairman, President and CEO, Dick Robinson, for any closing remarks.

[Richard Robinson:]

Well, thank you all for your support. We are proud of the way we adapted to the changed circumstances and found new ways of selling and face the cost reduction program that we knew we had to get done. That's continuing in the second quarter, we'll continue through the balance of the year. We are cautiously optimistic on the return of book fairs in the fourth quarter. And we thank you for your continued support and confidence in Scholastic, and we will continue to help parents and teachers with the very difficult issues of overcoming learning loss, which is becoming a deep-rooted problem in the company – in the country and we need to ensure that all kids can read on grade level, and we continue to work on that. Thank you for your support. We will talk to you again in March.

[Operator:]

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