Scholastic Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Scholastic Report's Q2 fiscal year 2021 results call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. It is now my pleasure to introduce Senior Vice President, Treasurer, Head of Investor Relations, 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. I would like to point out that certain statements made today will be forward-looking. Such forward-looking statements are subject to various risks and uncertainties, including those arising from the continuing impact of COVID-19 on the company's business operations. These forward-looking statements by their nature are uncertain 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, 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 8K, 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.

Dick 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'm proud of the way our company has adapted to the continuing issues with COVID-19, which 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 2021, fall 2021, and into the future in 21, and as health conditions improve into our society overall, we will be able to improve Ferris' performance in the spring season, 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. Our trade and education businesses are thriving, driven by our best-selling books and our reading packs, workbooks, and digital subscriptions. After a slow start due to delayed school openings, Our clubs business is on track, and we are seeing momentum in our international business, largely from sales gains and trade publishing in the UK, Canada, and Australia. Finally, we're reducing operating costs and streamlining our operational structure, including significantly cutting SG&A expenses. We are seeing ongoing improvements from our $100 million investment a $100 million labor cost savings program implemented in the first quarter with benefits continuing through the second quarter and subsequent periods. Because we expected substantially reduced revenues in the second quarter, we also took additional cost-saving actions in that quarter, especially in the fares business. In summary, we were able to lessen the bottom-line impact of the revenue declines in fares with strong performance in our trade, education, and international businesses and our rigorous cost reductions. As a result of these factors, second quarter revenue was $406.2 million, a decrease of 32% compared to last year. We reduced SG&A costs by 33%. Operating income was $48.8 million compared to $105.1 million last year. We had free cash flow of $30.9 million compared to $87.7 million last year. We continue to expect improvement in the second half, especially in our important fourth quarter, but given the variables from the pandemic, we are not providing financial outlook for fiscal 2021. Turning now to our results for each segment, the children's book publishing and distribution segment revenues fell 173.3 million, or 42%, largely due to the decline in book fairs. During the quarter, thanks to our lineup of critically acclaimed titles, Trade continued to be a standout with 21% revenue growth over last year. Trade performance was driven by titles such as Dave Pilkey's Dogmen, Grime and Punishment, The Ichabod by J.K. Rowling, and All Because You Matter by Tammy Charles, as well as our many beloved series including The Bad Guys, Pig the Pug, Babysitter's Club graphic novels, and of course our Harry Potter backlist. We were proud to have Case and Calendar's King and the Dragonflies received the National Book Award for Young People's Literature, the most significant honor. We have an exciting pipeline of titles for this holiday season and into the spring, with Dave Kilkey's new graphic novel series, Cat Kid Comic Club, released on December 1, climbing Amazon's overall bestseller list right now. DreamWorks recently announced a feature film based on Dogman, which will further expand the already huge, tilky fan base of children ages 5 to 12. As we noted in September, clubs started slowly this school year due to delayed openings and significant disruption in classroom practices, and we're pleased that orders ramped up over the quarter, driven by the strong response to our ship-to-home fulfillment option. We've restructured our club's platform to operate more profitably at a lower revenue base, and this redesign is working well. Our fairs business continues to feel the impact of the virus most acutely. However, we have a number of reasons to be cautiously optimistic about this spring. More schools are committed to remaining safely open for in-person learning, especially in elementary schools. While new tools and programs do provide solutions for remote learning and hybrid instruction, Experts agree that in-person learning is far better for children in grades pre-K to six. Without in-person instruction, children are at risk of falling behind academically, causing increased educational inequities. Therefore, at the end of the fall, more schools move to in-person learning, and we expect that this trend will increase significantly in 2021. The COVID relief bill being finalized today in Congress contains federal funding for schools, which, if passed, will bring significant additional support for schools to acquire more resources for keeping schools open and safe and for helping children to learn. In addition, our customers tell us that they're eager to hold fairs, and as conditions improve, they will host scholastic book fairs because they are an essential part of school life and rewarding for both students and schools. Our fairs provide a sense of normalcy connection and joy that can help with learning and prevent reading loss. Importantly, schools also have an economic incentive to host fairs. Our fair rewards programs provide free critical resources to schools that are facing budget cuts and increased costs, and our programs allow schools to acquire the books and supplies that they need now more than ever. We have shown the ability to adjust to the new environments in schools with our flexible solutions. including in-person, online, virtual, shippable, and drive-through fare formats, as well as our home delivery service for online fares. Revenue per fare was strong for the limited number of in-person fares that were held this fall, and we had an encouraging response to our new 360 walk-through virtual format for online fares. Our book fair customers tell us that our multiple format options and our customer-focused service orientation will give them the support they need to host engaging, efficient, and easy fairs as conditions permit this spring. While the COVID situation remains fluid, given the increasing confidence about in-person learning in schools, recent positive news about vaccines, including going to teachers, and promising early indicators for Q4 fair bookings, we continue to expect performance to improve in the second half of the year, driven by our anticipation of an increase in fares held in the March to May period. In education, revenue was down slightly by 3% versus last year, but operating income improved by $5.7 million over last year. Because of our newer digital subscription lines, the timing of revenue recognition has shifted as we recognize subscription revenue over the months or years of the billings instead of up front. Our digital subscription business, which includes Scholastic Literacy Pro, BookFlix, First, and Word, recorded a 30% increase in revenues and a 43% increase in digital subscription billings in the quarter. Revenues from workbooks and early readers increased in multiple sales channels, and we have a strong education segment pipeline for the second half of the fiscal year. We're also pursuing opportunities to partner with schools to help prevent the COVID slide. For example, in the LA Unified School District, We are providing and have delivered more than 1 million books to 250,000 students through our grab-and-go reading packs. And Literacy Pro is helping to mitigate the effects of school closures in the district by providing over 2,500 e-books for students to use at home. In Tennessee, we launched a public-private initiative to deliver 580,000 books to students and teachers across the state. and we have a similar program in Connecticut. We continue to expect digital engagement to drive growth in our education business over the long term as we deepen our leading position as schools' trusted professional learning partner in supporting teachers. In the international business, operating income was up despite the revenue decreases from lower book fair sales in Canada and the UK. We have improved results in Australia and New Zealand where the impact of COVID has decreased, and trade publishing was strong in all of our major international markets. In addition, we benefited from wage subsidies in Canada, the UK, and Australia. Across our entire business, we are continuing to lower costs and increase efficiency, taking major steps to reduce our operating costs, right-size our employee base, and match our inventory purchases to consumer demand. We met our $100 million cost savings target, which will continue to benefit us through the fiscal period, and identified areas for additional savings in the second half of the fiscal year, which Ken will discuss in more detail. Cost management continues to be a major focus as we lower our cost base and improve our long-term operating leverage. We are also continuing to invest in our most promising growth areas, which are all tightly linked to our position as the foremost company in supporting reading and children's literacy. We are proud to announce that Rose Ellis Mitchell is rejoining Scholastic to lead our new education solutions group, which will be comprised of the Scholastic Education and Classroom Magazine groups that have operated separately within our education segment. Rose was instrumental in building our former EdTech business, which was sold several five years ago and she will lead our efforts to deliver a clear connected vision and support for literacy instruction and reading achievement whether in print or digital form in person or virtually. Over the coming months Rose will work with Greg Worrell and Beth Bolcari to unify the education solution team under a combined structure and plan, which will become effective on June 1st, 2021. The group will be the largest supplementary publisher serving the education market and will expand our impact on schools throughout the United States, serving classroom teachers, individual schools, and school districts with differentiated marketing and sales capabilities. In addition, We have announced that Beth Bocari, currently president of our Classroom Magazines Division, will succeed Nelson Hitchcock as president international upon Nelson's retirement at the end of this year. She will work closely with division presidents in the UK, Australia, New Zealand, and Asia, as well as the Export Division, to leverage U.S. resources to support our opportunities internationally today. to expand our significant position in the global trade publishing business and to facilitate development of new digital programs for teaching English language learning, a major growth area for us, particularly in Asia. Looking ahead, though we face continued uncertainty in the third quarter, we believe we will be able to improve our operating results in the second half of the fiscal year versus the same period last year. Undoubtedly, the pandemic has put a spotlight on the importance of reading, for learning as well as for kids' social and emotional development. Educators and parents are worried about COVID slide, and we expect to continue to play a key role in helping to reverse the learning loss experienced for months away from the classroom. We see many opportunities to grow our business driven by our core expertise, which is helping kids to learn and love to read. And we know that the breadth and depth of our relationships in schools and with families will allow us to capitalize on the growth opportunities ahead. We expect that U.S. schools will likely stabilize in the early part of 2021, focusing on in-person learning in elementary schools, which will encourage our customers to expand their connection with all of our school literacy services, including book fairs, especially in the fiscal fourth quarter. With that, I will turn the call over to Ken.

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 remained solid, and our working capital management and access to liquidity remained 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 fares. As Dick noted, trade revenues increased by 21% year-over-year, driven by demand for our front-list and back-list titles. Segment operating income was $37.7 million, 66% below last year as a result of the book fare 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 the 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 affairs business in Canada and the UK and lower direct sales in Asia. Our sales in Australia and 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 a more than $70 million reduction in SG&A expense year over year, a decline of 35% compared to last year. While these savings include 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, whether 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 will have a positive impact on our fairs business as more schools will be in a position to hold in-person book fairs. A 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're continuing to support schools with virtual fairs, digital engagement tools, flexible distribution methods such as our popular ship-to-home option. Our digital subscription programs 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 Dave Pilkey's Cat Cake Comic Club series and new releases in the Babysitter's Club graphic novel, Dog Man, and Wings of Fire series. We are also looking forward to new titles 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.

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

Certainly. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. And I'm sure we have a question from the line of Drew Crum with Stifel. One moment, please. Your line is now open.

Okay, thanks. Hey, guys, good afternoon. Happy holidays. Maybe starting with fares, 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 experienced in fiscal 2Q? And then just the last part of this question, your optimism for fiscal 4-2, can you talk about the fair bookings and how that compares to where you were going into the fiscal second quarter?

Three questions. 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, fairs, particularly the in-person fairs during the second quarter, Drew. What happened was they started off very slowly. The bookings increased as people got back into schools and were able to reach some of the customers. In late October, early November, they showed some signs of life, although at a much reduced basis compared to normal, of course. But then the increasing COVID toward the end of the month caused cancellations because people were very concerned about 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, you know, 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. but the trajectory is going to be quite different this year from the way it was last year when the fares were booming in the second quarter and nobody was anticipating that any fares would need to be canceled in the fourth quarter at that point. Ken?

Yeah, hi, Drew. This is Ken. So, yeah, as Dick pointed out, uh the the booking for for q2 we need to really book q2 uh during this year and and we didn't we didn't get a lot booked and we didn't get a a lot of fares by the end of q2 uh q3 is typically a quiet period for us anyway so as this pandemic goes on q3 is is generally quiet but we are booking into the the march to may period now and and we we've put a lot of resources around outreach around understanding what our customers are doing, and we continue to pursue those opportunities. And our customers want to have fairs. Dick and I sat through a meeting with our marketing team yesterday where 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 We're increasing our outreach. Our calls have a volume. I won't give you the call volume, but it's extremely substantial in terms of our customer base. And 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 springtime. So we're looking at the back half of this year, Q4 of this year, as 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.

Okay, got it. Fair enough. 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?

Well, Drew, to start with, we reduced the revenue expectations on clubs in order to right-size the business from a profit point of view. So we reduced some costs of mailing out kits and having multiple offers. And so we have changed our business dynamics for the clubs. and focusing on profitability at a somewhat lower revenue base. But in September, schools were like a madhouse in September. Teachers didn't know who they were teaching. 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, they weren't up to our normal September orders. October and November came in line with the prior year. That was really encouraging, particularly because we reduced our revenue expectations. December is a little slow because in order to get your books shipped by holidays, 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 September 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.

Okay. Helpful. Andre, 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 21 or is the comment specific to the entire fiscal year? As I look at the second half, you are laughing about a 30% comp.

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

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?

I'll turn this to Ken, but I just want to make one comment first for you. I mean, we really did this. I know people talk about their cost-saving programs and there's a certain amount of skepticism attached to them. But in the first quarter, we reduced our costs in labor inside, you know, 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 will ratably should go through the year. So that's a real saving that we're holding on to. Ken runs a cost-saving process where he's looking at these things every day to make sure we're maintaining those costs. So I'll ask him to answer the rest of this call, Drew. But this is something that we've done and we take great pride in. We need it to do. With our revenues declining, we need it to match our cost base to our revenue.

Ken? Yeah, it's so true. 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. Without getting into too many details, it could be about half of it, plus or minus half of it. So I think It's around the rigor that we've taken on this. As Dick mentioned, we're looking at this every day. We've put controls in place to make sure that we keep the costs out of every corner of the business right now. 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'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 um but really a lot of network optimization uh a lot of warehousing and distribution costs and and office spaces is probably our near-term opportunity and maintaining the other billion that we already took out on the labor side we will do that that'll continue

So, you know, that's a lower, permanent lower cost base for the company.

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

Thank you so much, Drew. Thanks, Drew.

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

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 faced 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 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.

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