SCHOLASTIC CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Overview and Outlook Revenues for the first quarter ended August 31, 2022 were $262.9 million, compared to $259.8 million in the prior fiscal year quarter, an increase of $3.1 million. The Company reported net loss per diluted share of Class A and Common Stock of $1.33 in the first quarter of fiscal 2023, compared to a net loss of $0.70 in the prior fiscal year quarter. The Children's Book Publishing and Distribution segment drove a majority of the revenue increase in the first quarter with increased book fairs redemptions of incentive program credits. Although the trade channel experienced lower frontlist sales, backlist titles from the Company's popular series continued to drive sales and the trade channel benefited from revenue associated with the production of the animated series "Eva the Owlet," TM based on the Owl Diaries TM books, which will be released on AppleTV +® later this fiscal year. Within the Education Solutions segment, the New Worlds Reading Initiative shipped over 800,000 books to students in the program during June and July as the first year of the program concluded. As expected, segment revenues decreased due to the timing of sales of instructional products and programs in the first quarter. In the International segment, Australia and Canada drove increased revenues from their respective book fairs and trade channels, while the Asia markets had lower sales, primarily due to the disposition of the direct sales business. Operating loss was $58.1 million for the quarter ended August 31, 2022, which was consistent with the Company's expectations and seasonality of the business. The increase over the prior year period was due to increased product costs, which were impacted by higher freight and printing costs due to the continued inflationary pressures, coupled with the timing of revenues in the Education Solutions segment. The Company is expecting increased sales from the Children’s Book Publishing and Distribution segment, with book fairs anticipated to reach its goal of 85% of pre-pandemic fair count levels and the trade channel expected to benefit from multiple new releases from bestselling authors, including the fourth Cat Kid Comic Club ® in Dav Pilkey’s latest series. The Education Solutions segment will focus on the integration of the Learning Ovations TM acquisition and continue to assess capital allocations to enhance literacy offerings. Due to the seasonality of the education selling cycle, any benefits from state and federal funding for literacy initiatives would occur toward the end of the fiscal year, primarily in the fourth fiscal quarter. Internationally, the Company expects to benefit from the recovery in Canada, Australia and New Zealand, while the UK continues to be negatively impacted by inflationary pressures. Operating income is expected to improve from higher revenues in Australia and the disposition of the low margin direct sales business in Asia which generated losses in the prior fiscal year. Margin improvement is expected to be partially offset by the lack of government subsidies in certain markets, the slow recovery in Asia and the impact of foreign currency translation due to the strong U.S. dollar. The Company continues to monitor and control discretionary spending which is expected to favorably impact unallocated overhead costs except to the extent offset by headwinds from inflationary pressures, primarily higher freight costs that are still expected to impact the cost of product. Results of Operations Consolidated Revenues for the quarter ended August 31, 2022 increased by $3.1 million to $262.9 million, compared to $259.8 million in the prior fiscal year quarter. The Children's Book Publishing and Distribution segment revenues increased by $8.9 million, primarily driven by higher book fairs channel revenues resulting from increased redemptions of book fair incentive program credits, partially offset by lower trade channel revenues. In the Education Solutions segment, revenues decreased by $6.9 million, primarily driven by lower sales of instructional products and programs due to the timing of shipments as compared to the prior fiscal year quarter, as well as lower professional learning services and sales of teaching resources products, partially offset by revenues from the New Worlds Reading Initiative . In local currency, the International segment revenues increased by $5.8 million, primarily driven by increased sales in the book fairs and trade channels within the Australia and Canada markets, partially offset by decreased revenues as a result of the disposition of the direct sales business in Asia. International segment revenues were impacted by unfavorable foreign exchange of $4.7 million in the quarter ended August 31, 2022. 19 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Components of Cost of goods sold for the three months ended August 31, 2022 and August 31, 2021 are as follows: Three months ended August 31, August 31, 2022 2021 ($ amounts in millions) $ % of Revenue $ % of Revenue Product, service and production costs and inventory reserves $ 82.4 31.4 % $ 76.3 29.4 % Royalty costs 27.4 10.4 % 27.8 10.7 % Prepublication amortization 6.4 2.4 % 6.9 2.7 % Postage, freight, shipping, fulfillment and other 28.3 10.8 % 22.3 8.5 % Total $ 144.5 55.0 % $ 133.3 51.3 % Cost of goods sold for the quarter ended August 31, 2022 was $144.5 million, or 55.0% of revenues, compared to $133.3 million, or 51.3% of revenues, in the prior fiscal year quarter. Cost of goods sold was impacted by higher inbound freight and printing costs resulting in an increase in product costs, as well as higher postage, freight and shipping costs. These cost increases were due to continued inflationary pressures, which are expected to continue to negatively impact costs during the remainder of fiscal 2023. Selling, general and administrative expenses for the quarter ended August 31, 2022 increased to $162.8 million, compared to $143.6 million in the prior fiscal year quarter. The $19.2 million increase was primarily attributable to increased strategic spending and higher labor costs, primarily in the book fairs channel as the Company prepares for the anticipated increase in fair count, in addition to the discontinuation of government subsidies related to the COVID-related governmental retention program in Canada. The increase was also driven by the $6.6 million of insurance recoveries received in the quarter ended August 31, 2021 related to the intellectual property legal settlement accrued in fiscal 2021 that did not reoccur in the current quarter, higher marketing costs associated with the New Worlds Reading Initiative and lower equity investment income. Partially offsetting this increase, the Company incurred lower severance expense from its restructuring programs of $2.4 million. Depreciation and amortization expenses in the three months ended August 31, 2022 were $13.7 million compared to $14.9 million in the prior fiscal year quarter. The $1.2 million decrease was primarily attributable to a shift towards spending on cloud computing arrangements in which the amortization expense is included in Selling, general and administrative expenses rather than Depreciation and amortization. Amortization related to cloud computing arrangements increased $1.0 million when compared to the prior fiscal year quarter which substantially offset the decrease in Depreciation and amortization as there were no significant assets placed into service during the first quarter of fiscal 2023. Management expects this trend to continue as more cloud-based software tools are utilized by the Company. Net interest income in the quarter ended August 31, 2022 was $0.2 million compared to net interest expense of $1.3 million in the prior fiscal year quarter. The Company had lower average debt borrowings as compared to the prior fiscal year quarter as the outstanding borrowings on the U.S credit agreement were paid down during fiscal 2022, resulting in no outstanding borrowings as of August 31, 2022. The Company’s effective tax rate for the quarter ended August 31, 2022 was 21.6%, compared to 26.7% in the prior fiscal year quarter. The decrease in the interim effective tax rate was primarily due to tax shortfalls related to vested option cancellations in the fiscal year quarter ended August 31, 2022. Net loss attributable to Scholastic Corporation for the quarter ended August 31, 2022 increased by $21.3 million to $45.5 million, compared to $24.2 million in the prior fiscal year quarter. Loss per basic and diluted share of Class A and Common Stock was $1.33 and $1.33, respectively, for the fiscal quarter ended August 31, 2022, compared to loss per basic and diluted share of Class A and Common Stock of $0.70 and $0.70, respectively, in the prior fiscal year quarter. Net income attributable to noncontrolling interest for the quarter ended August 31, 2022 was $0.1 million compared to Net loss attributable to noncontrolling interest of $0.2 million in the prior fiscal year quarter. 20 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Children’s Book Publishing and Distribution Three months ended August 31, August 31, $ % ($ amounts in millions) 2022 2021 Change Change Revenues $ 124.7 $ 115.8 $ 8.9 7.7 % Cost of goods sold 77.1 66.1 11.0 16.6 % Other operating expenses (1) 77.7 71.4 6.3 8.8 % Operating income (loss) $ (30.1) $ (21.7) $ (8.4) (38.7) % Operating margin — % — % (1) Other operating expenses include selling, general and administrative expenses, bad debt expenses and depreciation and amortization. Revenues for the quarter ended August 31, 2022 increased by $8.9 million to $124.7 million, compared to $115.8 million in the prior fiscal year quarter. The increase in segment revenues was primarily driven by higher book fairs channel revenues of $12.3 million resulting from increased redemptions of book fair incentive program credits, which are common in the summer months, but were not significant in the prior fiscal year quarter as the book fair business had not yet begun to recover from the pandemic-related shutdowns. Decreased trade channel sales of $2.9 million partially offset book fairs revenues on lower sales of frontlist titles, due in part to the prior fiscal year quarter release of the limited edition foil covers for Dog Man ® , which did not repeat in the current quarter. The trade channel benefited from increased sales of backlist titles, with continued strong sales from the Company's popular series, including Five Nights at Freddy's TM , The Baby-sitters Club ® Graphix TM , Heartstopper TM , Wings of Fire TM , The Bad Guys TM , Cat Kid Comic Club ® and I Survived . The trade channel also benefited from an increase in media revenue as the Company delivered certain episodes associated with the production of the animated series "Eva the Owlet," TM based on the Owl Diaries TM books, which will be released on AppleTV +® later this fiscal year. Book clubs channel revenues remained relatively consistent with the prior fiscal year quarter, decreasing $0.5 million, as this channel is seasonally quiet during the summer months. Cost of goods sold for the quarter ended August 31, 2022 was $77.1 million, or 61.8% of revenues, compared to $66.1 million, or 57.1% of revenues, in the prior fiscal year quarter. The increase in Cost of goods sold as a percentage of revenue was primarily driven by increased product and freight costs due to continued inflationary pressures, predominantly in the trade channel. Other operating expenses for the quarter ended August 31, 2022 increased to $77.7 million, compared to $71.4 million in the prior fiscal year quarter. The $6.3 million increase was primarily attributable to higher labor costs, largely in the book fairs channel as the Company prepares for the anticipated increase in fair count during fiscal 2023. Labor costs were also impacted by inflationary pressures. Segment operating loss for the quarter ended August 31, 2022 was $30.1 million, compared to $21.7 million in the prior fiscal year quarter. The $8.4 million increase in the operating loss was primarily driven by increased cost of goods sold and selling, general, and administrative costs, both due to inflationary pressures on freight and labor costs. Education Solutions Three months ended August 31, August 31, $ % ($ amounts in millions) 2022 2021 Change Change Revenues $ 73.2 $ 80.1 $ (6.9) (8.6) % Cost of goods sold 30.4 32.8 (2.4) (7.3) % Other operating expenses (1) 47.1 40.0 7.1 17.8 % Operating income (loss) $ (4.3) $ 7.3 $ (11.6) NM Operating margin — % 9.1 % (1) Other operating expenses include selling, general and administrative expenses, bad debt expenses and depreciation and amortization. NM Not meaningful Revenues for the quarter ended August 31, 2022 decreased by $6.9 million to $73.2 million, compared to $80.1 million in the prior fiscal year quarter. The decrease in segment revenues was largely driven by lower sales of instructional products and programs, primarily early childhood programs and summer learning product 21 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) offerings, as the prior fiscal year quarter benefited from shipments, which primarily consisted of summer learning products, that shifted in from the fourth quarter of fiscal 2021 due to supply chain constraints at that time. During the fourth quarter of fiscal 2022, orders were shipped more timely with fewer sales shifted into the first quarter of fiscal 2023. In addition, the segment had lower revenues in the first quarter from professional learning services and teaching resource products. The overall decrease was partially offset by revenues of $9.2 million from the New Worlds Reading Initiative , which did not commence shipping until the third quarter of the prior fiscal year. Cost of goods sold for the quarter ended August 31, 2022 was $30.4 million, or 41.5% of revenues, compared to $32.8 million, or 40.9% of revenues, in the prior fiscal year quarter. The increase in Cost of goods sold as a percentage of revenues was primarily attributable to increased postage and freight costs driven by inflationary pressures, in addition to moderately higher royalty costs driven by the mix of products sold in the first quarter of fiscal 2023. Other operating expenses for the quarter ended August 31, 2022 were $47.1 million, compared to $40.0 million in the prior fiscal year quarter. The $7.1 million increase in Other operating expenses was primarily related to increased marketing costs associated with the New Worlds Reading Initiative as well as higher employee-related costs. Segment operating loss for the quarter ended August 31, 2022 was $4.3 million, compared to income of $7.3 million in the prior fiscal year quarter. The $11.6 million change was driven by the lower revenues in the first quarter of fiscal 2023, coupled with increased cost of goods sold due to higher freight and royalty costs, marketing costs associated with the New Worlds Reading Initiative and employee-related costs. International Three months ended August 31, August 31, $ % ($ amounts in millions) 2022 2021 Change Change Revenues $ 65.0 $ 63.9 $ 1.1 1.7 % Cost of goods sold 39.5 36.1 3.4 9.4 % Other operating expenses (1) 29.0 29.5 (0.5) (1.7) % Operating income (loss) $ (3.5) $ (1.7) $ (1.8) NM Operating margin — % — % (1) Other operating expenses include selling, general and administrative expenses, bad debt expenses, severance and depreciation and amortization. NM Not meaningful Revenues for the quarter ended August 31, 2022 increased to $65.0 million, compared to $63.9 million in the prior fiscal year quarter. Local currency revenues across the Company's foreign operations increased by $5.8 million, offset by an unfavorable foreign exchange impact of $4.7 million. The increase in segment revenues was primarily driven by higher revenues in Australia, New Zealand and Canada. Australia and New Zealand local currency revenues increased by $6.1 million as a result of increased sales in the book fairs and trade channels as the additional lockdowns imposed by the COVID variant, which had occurred later than in other markets, have continued to be lifted. In Canada, local currency revenues increased $4.0 million driven by higher trade channel sales of best-selling titles including Heartstoppers TM , coupled with increased sales in the book fairs and education channels. The increase in segment revenues was partially offset by lower local currency revenues in Asia of $3.8 million primarily attributable to the disposition of the direct sales business, coupled with lower sales within the Asia export channel. In addition, local currency revenues in the UK decreased by $0.1 million primarily due to lower sales in the trade and education channels, partially offset by increased sales in the book fairs channel, driven by higher fair count. Export channel revenues also decreased by $0.4 million as compared to the prior fiscal year quarter. Cost of goods sold for the quarter ended August 31, 2022 was $39.5 million, or 60.8% of revenues, compared to $36.1 million, or 56.5% of revenues, in the prior fiscal year quarter. The increase in Cost of goods sold as a percentage of revenue was driven by an overall increase in freight costs across all channels due to inflationary pressures as well as increased paper and printing costs in the UK and increased variable fulfillment costs in Australia due to increased labor costs. 22 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Other operating expenses for the quarter ended August 31, 2022 were $29.0 million, compared to $29.5 million in the prior fiscal year quarter. Other operating expenses decreased $0.5 million impacted by a favorable foreign exchange impact of $1.8 million, resulting in a local currency increase of $1.3 million. This increase was primarily driven by lower equity investment income and increased employee-related expenses as a result of the discontinuation of government subsidies related to COVID-related governmental retention programs, partially offset by lower severance expense related to restructuring programs. Segment operating loss for the quarter ended August 31, 2022 was $3.5 million, compared to a loss of $1.7 million in the prior fiscal year quarter. The increased loss was primarily driven by increased product costs related to freight, paper and printing. Overhead Unallocated overhead expense for the quarter ended August 31, 2022 increased by $4.3 million to $20.2 million, from $15.9 million in the prior fiscal year quarter. The increase was primarily attributable to $6.6 million of insurance recoveries received and recognized in the quarter ended August 31, 2021 related to the intellectual property legal settlement accrued in fiscal 2021, partially offset by lower severance expense from the Company's restructuring programs of $2.0 million. Seasonality The Company’s Children’s Book Publishing and Distribution school-based book club and book fair channels and most of its Education Solutions businesses operate on a school-year basis; therefore, the Company’s business is highly seasonal. As a result, the Company’s revenues in the first and third quarters of the fiscal year generally are lower than its revenues in the other two fiscal quarters. Typically, school-based channels and magazine revenues are minimal in the first quarter of the fiscal year as schools are not in session. Education channel revenues are generally higher in the fourth quarter. Trade sales can vary throughout the year due to varying release dates of published titles. Liquidity and Capital Resources Cash used by operating activities was $60.3 million for the three months ended August 31, 2022, compared to cash provided by operating activities of $63.6 million for the prior fiscal year period, representing an increase in cash used by operating activities of $123.9 million. The increase in cash used was primarily driven by increased inventory purchases of $77.3 million to offset long lead times and meet expected demand, primarily related to the book fairs and trade channels. The increase in cash used was also impacted by the $63.1 million federal income tax refund and $6.6 million of insurance recoveries received in the prior period which was partially offset by $39.6 million in higher customer remittances in the current period. Cash used in investing activities was $16.2 million for the three months ended August 31, 2022, compared to $14.5 million in the prior fiscal year period, representing an increase in cash used in investing activities of $1.7 million. The increase in cash used was driven by higher capital expenditures of $1.2 million, primarily for new equipment to meet the expected demand in the book fairs channel, coupled with increased prepublication spending of $0.5 million related to digital products. Cash provided by financing activities was $1.6 million for the three months ended August 31, 2022, compared to cash used in financing activities of $105.6 million for the prior fiscal year period, representing a decrease in cash used in financing activities of $107.2 million. The decrease in cash used was primarily related to repayments of borrowings under the U.S. credit agreement of $100.0 million during the prior period, coupled with an increase in net proceeds from stock option exercises of $11.6 million in the first quarter of fiscal 2023. Partially offsetting this decrease, the Company reacquired $4.7 million of common stock with no such repurchases in the prior fiscal year period during which the repurchase program was suspended. Cash Position The Company’s cash and cash equivalents totaled $239.7 million at August 31, 2022, $316.6 million at May 31, 2022 and $308.6 million at August 31, 2021. Cash and cash equivalents held by the Company’s U.S. operations totaled $202.2 million at August 31, 2022, $275.5 million at May 31, 2022 and $271.9 million at August 31, 2021. 23 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Due to the seasonal nature of its business as discussed under “Seasonality”, the Company usually experiences negative cash flows in the June through September time period. The Company’s operating philosophy is to use cash provided by operating activities to create value by paying down debt, reinvesting in existing businesses and, from time to time, making acquisitions that will complement its portfolio of businesses or acquiring other strategic assets, as well as engaging in shareholder enhancement initiatives, such as share repurchases or dividend declarations. The Company has lifted the temporary suspension of its open-market buy-back program under which $28.8 million remained available for future purchases of common shares as of August 31, 2022. During the three months ended August 31, 2022, the Company repurchased $4.7 million of its common stock. The Company has maintained, and expects to maintain for the foreseeable future, sufficient liquidity to fund ongoing operations, including working capital requirements, pension contributions, postretirement benefits, debt service, planned capital expenditures and other investments, as well as dividends and share repurchases. As of August 31, 2022, the Company’s primary sources of liquidity consisted of cash and cash equivalents of $239.7 million, cash from operations and the Company's U.S. credit agreement. The Company expects the U.S. credit agreement to provide it with an appropriate level of flexibility to strategically manage its business operations. The Company's U.S. credit agreement, less commitments of $0.4 million, has $299.6 million of availability. Additionally, the Company has short-term credit facilities of $36.4 million, less current borrowings of $6.3 million and commitments of $3.7 million, resulting in $26.4 million of current availability under these facilities at August 31, 2022. Accordingly, the Company believes these sources of liquidity are sufficient to finance its currently anticipated ongoing operating needs, as well as its financing and investing activities. Financing The Company is party to the U.S. credit agreement and certain credit lines with various banks as described in Note 5 of Notes to Condensed Consolidated Financial Statements - unaudited in Item 1, “Financial Statements." The Company had no outstanding borrowings under the U.S. credit agreement as of August 31, 2022. The Company is party to loan agreements, notes or other documents or instruments which reference the London Interbank Offered Rate, or LIBOR, as the benchmark interest rate index used to set the borrowing rate on certain short-term and variable-rate loans or advances. The ICE Benchmark Administration (IBA) ceased the publication of 1-week and 2-month USD LIBORs effective December 31, 2021 and will cease overnight, 1-month, 3-month, 6-month and 12-month LIBORs effective June 30, 2023. The Company is working with its financial institutions to replace USD LIBOR with alternative reference rates in financial contracts as they mature, or as the Company requires. The markets have provided several replacements for USD LIBOR, including the Bloomberg Short-Term Bank Yield Index (BSBY) and the ARRC’s Secured Overnight Financing Rate (SOFR), either of which will be made available to the Company by its agent banks as a substitute for USD LIBOR. The Company does not believe that the change in reference rates will have any material effect on its ability to access the credit markets under its existing financing agreements, or its ability to modify or amend financial contracts, if required. 24 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) New Accounting Pronouncements Reference is made to Note 1 of Notes to Financial Statements - unaudited in Item 1, “Financial Statements,” for information concerning recent accounting pronouncements since the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2022. 25 SCHOLASTIC CORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) Forward Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. Additional written and oral forward-looking statements may be made by the Company from time to time in Securities and Exchange Commission ("SEC") filings and otherwise. The Company cautions readers that results or expectations expressed by forward-looking statements, including, without limitation, those relating to the Company’s future business prospects and strategic plans, ecommerce and digital initiatives, new product introductions, strategies, new education standards, goals, revenues, improved efficiencies, general operating costs, including transportation and labor costs and the extent such costs are impacted by inflationary pressures, manufacturing costs, medical costs, potential cost savings, merit pay, operating margins, working capital, liquidity, capital needs, the cost and timing of capital projects, interest costs, cash flows and income, are subject to risks and uncertainties, which may have an impact on the Company's operations and could cause actual results to differ materially from those indicated in the forward-looking statements, due to factors including those noted in the Annual Report and this Quarterly Report and other risks and factors identified from time to time in the Company’s filings with the SEC. The Company disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise. 26 SCHOLASTIC CORPORATION