SCHL - NASDAQ

Thank you for standing by, and welcome to Scholastic's Third Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. I'd now like to hand the call over to Jeffrey Mathews, EVP, Corporate Development and Investor Relations. Please go ahead.

Hello and welcome, everyone, to Scholastic’s fiscal 2023 third quarter earnings call. Today on the call, I am joined by Peter Warwick, our President and Chief Executive Officer; and Ken Cleary, our Chief Financial Officer. As usual, we posted the 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 reconciliation of those measures to the most directly comparable GAAP measures can be 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, [email protected]. And now, I’d like to turn the call over to Peter Warwick to begin this afternoon’s presentation.

Thank you, Jeff, and good afternoon, everyone. Thanks for joining us. In the fiscal 2023 third quarter, Scholastic recorded modest sales declines and higher losses as we continue to navigate short term market headwinds, whilst also increasing investment for the long term in blended learning programs and digital tools in our education solutions business. As a reminder, Scholastic's third quarter is seasonally smaller and typically loss making. We have modestly lowered our financial guidance for FY '23 as a result of the ongoing softness we're seeing in the retail bookselling market and purchasing delays for educational materials on the part of schools and school districts, something that has impacted our quarter three results and we now expect to continue into quarter four. Our team has taken decisive steps to align short term spending across the company with our new top line outlook. They've dedicated themselves to initiatives to improve margins. The team is also being mindful to protect strategic growth initiatives that are essential to our near and long-term opportunities. We remain confident in the performance and long-term outlook for our business, in our market-leading children's book publishing and providing high quality blended learning solutions for schools and in our international business. Reflecting that optimism, in the third quarter, we returned over $50 million to shareholders, in addition to investing in key growth opportunities. We are more committed than ever to deploying our capital to drive long-term growth and sustained value for our shareholders and all stakeholders. This afternoon, I'd like to review our results and outlook in more detail. Ken will then walk through our financial results and revised expectations for fiscal 2023. I'd like to begin with an update on the current business environment where the headwinds we described on last quarter's call continue to affect our industry and our business. First, the near term retail book selling environment, especially for children's books, continues to be challenging compared to a year ago. Consumer demand and confidence have fallen in the face of ongoing inflation and economic uncertainty. We're seeing this in the US as well as in Canada, the UK and Australia and New

Thank you, Peter, and good afternoon. Today I will refer to our adjuster results for the third quarter, excluding one-time items in the prior year period unless otherwise indicated. Now, we record no one-time items in this third quarter. Please refer to our press release table and SEC filings for complete discussion of one-time items. As Peter discussed, company performance was lower than expected, partly due to the near-term softness in the retail children's book market and ongoing purchasing delays by schools and district administrators. In children's books, our Book Fair's channel outperform the prior year, achieving higher fair count and revenue per fair, partially offsetting the selling challenges in the trade market and continuing trend in book clubs operations. We continue to experience higher costs due to inflationary and supply chain pressures. We're starting to see these higher costs slow. In education solutions, we took steps to adapt to a more challenging market environment. We also invest in our long-term literacy platform, including the upcoming launch of the new K3 phonic system, ready for reading, the integration of A2i and the buildout of staff and capabilities to compete in this education solutions market. Likewise, we're investing in modernized distribution assets and automation to reduce costs and improve customer service. We continue to see opportunities to optimize certain components of our business, while we see substantial growth opportunities in the education solution space and our book fairs operations. As such, we remain bullish on our long-term outlook for the future, but we acknowledge some short-term headwinds to our operations. As a result of the softness in the retail book market and the uncertainty of Q4 education solution sales, we have updated our guidance. We now expect adjusted EBITDA of $175 million to $185 million and revenue growth of approximately 4%. Turning to our consolidated financial results, revenues decreased 6% to $324.9 million. Operating loss in the quarter was $27.7 million versus $16.7 million last year. Net loss was $19.2 million compared to $13.2 million last year and adjusted EBITDA was a loss of $5.4 million compared to a gain of $5.9 million in the third quarter of last year. Loss per diluted share was $0.57 compared to a loss of $0.38 last year. For the nine-month period, revenue was $1.176 billion compared to $1.129 billion last year and operating income was $14.3 million compared to $31.4 million last year. Nine month adjusted EBITDA was $81.3 million compared to $100.4 million last year. Net cash provided by operating activities for the nine-month period was $28.9 million compared to $178.5 million last year. Free cash use for the nine month period was $25.7 million compared to free cash flow of $147.9 million last year, with successfully acquired inventory during the first half of this year in anticipation of increased sales and longer lead times, which has enabled the growth we've seen in children's books. Inventory purchases year-to-date have increased approximately $114 million over last year, while inventory purchases in the third quarter decreased by approximately $25 million. We expect the full year to have positive free cash flow between $25 million and $35 million. We expect future years to return to a more normal free cash flow pattern than we experienced this year through our need to build back inventory levels. As mentioned, the inflationary and supply chain pressures that have caused the current fiscal year's increase in paper printing wage and transportation costs are beginning to abate. Last year into early this year, we experienced higher product costs of approximately 15% compared to late in calendar year 2021 and higher wage costs of as much as 20% for driver and distribution labor. The rate of increase has slowed dramatically and in the case of overseas transportation costs has declined from peak levels. Our top priority was to ensure we could meet demand and continue on a strong recovery from the pandemic, notably, in our book fairs and education solutions operations. To do this, we procured substantial quantities of inventory when lead times for purchases were longer and costs were higher. Accordingly, the inventory we are currently selling and will continue to sell for a critical fourth quarter was procured at relatively high prices, which will be reflected in our margins. With this context of higher inventory costs and purchasing this year, I'd like to dedicate a few minutes to discussing some of the ways we have greatly improved our procurement and inventory management as well as related distribution activities for the long term. Our supply chain is more resilient. We have broadened our vendor base to include vendors from around the world, including Europe, the Americas and Asia. This broader array of vendors allows us substantial leverage in sourcing product. We have also strengthened relationships with key US vendors who due to close proximity with our warehouse facilities and added capacity can reduce lead times for orders dramatically. Scholastic supply chain inventory management is also more agile. We have enabled the use of digital printers who can provide smaller print runs to reduce waste and quickly meet near-term customer demand. We have developed product specification standards that allows to simplify the manufacturing process while ensuring the highest quality product for our customers. We have upgrade tools and resources to better match the timing and quantities of supply to customer demand. Last, our planning processes are more strategic. We have had analytics and tools to optimize our curation and offering and better coordinate these efforts with our marketing programs, allowing us to better understand our customer base and provide the appropriate product to the targeted market segment. All these improved capabilities developed since the beginning of the pandemic and supply chain crisis will enable us to reduce inventory costs, reduce waste, improve margins, and most importantly, ensure we have the best product to meet our customers' demand. Now back to our financial review. At the end of the quarter, cash and cash equivalent exceeded total debt by $193.6 million compared to $295.2 million at the end of the third fiscal quarter a year ago. Per our longstanding policy, all cash balances are held in investment grade banks. Capital expenditures, and capitalized pre-publication cost for the nine month period were $54.6 million compared to $41 million last year. We expect CapEx and pre-pub spend of between $85 million and $90 million this year, primarily driven by investments in our education solutions business and distribution operations. In the current fiscal year, we return capital through our dividend, a tender offer for our shares and open market repurchases. As Peter discussed through today, we have reacquired almost 1.9 million shares returning $81 million to shareholders in the current fiscal year with more than half acquired in the third quarter alone. To the end, our board of directors has approved a $50 million increase in our current share buyback authorization. Additionally, our board of directors has approved a $0.20 per share regular quarterly dividend to be paid in June. The company is committed to continuously monitoring and improving our capital allocation, focusing on long-term growth, operational efficiency and returning excess capital to shareholders. Now turning to our segment results; in children's book publishing and distribution, revenues for the third quarter of $204 million exceeded the prior year's revenues of $201 million. Operating income decreased to $1.9 million compared to $5 million in the prior year period. Our Book Fairs' operations led the improved results, despite the softening in retail demand for children's books. Book Fairs’ revenues increased to $103.5 million from $76 million in the prior fiscal quarter. Fair count is on track to rises to about 85% of pre-pandemic levels from 72% last year. Coming out of the pandemic, our operations are greatly improved and participation at our in-person Book Fairs remained strong, while we continue to innovate and improve upon our offering to customers and distribution capabilities. We do not see return to 100% of in-person fares held before the pandemic as many of these fares were not profitable, but we will see an increase in fair count next year. Book Club's revenues of $27.7 million trailed the prior year report revenues of $40.5 million. The prior year period benefited from the shipment of backlog customer orders, which shifted approximately $18 million of revenue in from the second quarter. Our Book Club's revenues continue to trend lower, but these operations are a vital component of the company's outreach to teachers and students. Trade division sales trailed against the prior year quarter, with revenues of $72.8 million compared to $84.5 million last year. Our trade channel continues to be impacted by the industry-wide decline in retail market sales, which are down to about 5%. Product costs continue to trend higher as I previously discussed. We continue to have multiple titles on best bestseller list and are excited for the new Dogman titled by Dav Pilkey Twenty Thousand Fleas Under the Sea, which will be released at the end of March. In addition, we're looking forward to the release of Eva, the Outlet series on Apple TV Plus on March 31. Education Solutions revenues of $70 million trailed the prior year revenues of $77.2 million. Quarterly operating income was $700,000 compared to $13.1 million in the prior year. School and district administrators continued to delay purchasing as they focus on staffing and other matters, which impacted our revenues, specifically from instructional products and programs. Revenues from our Magazines+ business and digital subscription products remain consistent with the prior year. We continue to invest in our literacy platform strategy and key partnerships that will further enhance our solutions model and product offering. As a result, we have brought on key staff with expertise to develop and transform our literacy platform, which includes the integration of A2i. The annual results for Education Solutions are largely dependent upon the fourth fiscal quarter and schools and district continue to delay ordering educational materials. This could have a material impact on the company's fiscal year results. International segment revenues of $50.9 million trailed the prior period revenues of $66.3 million with foreign exchange rates driving $3.5 million of the decline due to the strong US dollar. Operating loss of $9 million was unfavorable to the prior period operating loss of $4.6 million. The international trade channels were also impacted by the softness in children's book retail market, driving the majority of the decrease in our major markets. Similar dynamics that are driving higher demand for book fairs in the US are also driving higher demand for Book Fairs internationally, while much like in the US, Book Club's revenues are declining. International margins continue to see improvement since we exit the unprofitable direct sales business in Asia. Unallocated overhead costs of $21.3 million, decreased versus prior period costs of $30.2 million. This decrease is attributable to favorable photo litigation settlements, our continuing efforts to tightly control discretionary spending and improved efficiencies at our centralized distribution facility. I'm also happy to report that our new tenant for the remaining Broadway facing retail space in our headquarters property in Soho has taken occupancy as of March under a long term market rate lease. We continue to market additional retail space on the Mercer side of our headquarters as well as office space on our lower floors. As a result of our performance year-to-date and our current forecast, we have updated our guidance for adjusted EBITDA, now estimated to be between $175 million and $185 million. We now expect full year revenue to grow approximately 4%. Sales volumes in the critical fourth quarter, particularly in the Education Solutions segment can vary dramatically. In response to this update outlook, we are tightly managing costs as we closed out the year and have taken the following actions. We have revised sales and marketing plans to accelerate sales and trim unproductive spending. We have put controls on discretionary spending, including T&E and are reducing spending on temporary labor. We have also reviewed key corporate vendors and where appropriate, we are negotiating or switching to lower our costs. As Peter has said, our business remains fundamentally sound and we will continue to invest in our growth initiatives and remain committed to return capital to our shareholders. Thank you for your time today. I will now hand the call back to Peter.

Thank you, Ken. Well, we're disappointed to see quarter three results come in lower than expected and to reduce our outlook for quarter four, Scholastic is strong and resilient. We've navigated much more significant challenges than today's short-term headwinds, emerging stronger, and holding our focus on our mission for long-term opportunity. I'm proud of the quick actions the team has taken to adjust spending and preserve margins in line with our adjusted top line outlook. Just as critically, we continue to focus on driving growth and creating shareholder value for the long term. We're sustaining our investments in key growth drivers like our literacy platform, while upholding our commitment to return substantial cash to our shareholders. We're optimistic about our future and look forward to sharing our plan for FY '24 and the longer term on our next call in July. So thank you all again for joining our call today. Jeff will conclude this afternoon's presentation for us.

Thank you, Peter. As a reminder, we invite questions to be directed to our IR mailbox [email protected]. We appreciate your time and continuing support.