SCHL

Scholastic Corp. 10-Q Summary: Period Ended November 30, 2007

Business Context and Reporting Period

This Form 10-Q covers the quarterly and six-month periods ended November 30, 2007, for Scholastic Corporation, a leading publisher and distributor of children's books and educational materials. The company's operations are highly seasonal, closely correlated with the school year. The reporting period includes the significant impact of the July 2007 release of Harry Potter and the Deathly Hallows.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Six-month revenue increased 24.5% to $1,333.1 million, driven primarily by the Harry Potter release which generated approximately $250 million in trade revenues compared to $10 million in the prior year. Quarterly revenue grew 1.5% to $746.2 million.
• Profitability: Six-month operating income surged 124.5% to $135.4 million (from $60.3 million), with operating margin expanding to 10.2% from 5.6%. Quarterly operating income rose 3.0% to $130.2 million.
• Segment Performance:
  • Children's Book Publishing: Six-month revenue up $218.5 million; operating income up $70.1 million. However, the direct-to-home (DTH) continuity business reported an operating loss of $17.2 million for the six months.
  • International: Revenue increased 17.7% quarterly, aided by favorable foreign currency exchange rates.
  • Educational Publishing: Operating income declined 13.5% year-over-year due to planned investments in sales and service organizations.
• Debt Structure: Total debt increased to $414.1 million from $239.6 million at the prior fiscal year-end, primarily due to a new $200.0 million Term Loan utilized to fund an Accelerated Share Repurchase (ASR).

Outlook, Risks, and Unusual Items

• Strategic Divestiture: On December 20, 2007, management announced the intent to sell the direct-to-home (DTH) continuity business (domestic and international) due to its failure to meet financial goals. The company anticipates significant non-cash write-downs and expects to report this as discontinued operations in the next quarter.
• Share Repurchases: The company completed a $200.0 million ASR in June 2007, acquiring 5.8 million shares. A new program to repurchase up to $20.0 million was authorized in December 2007.
• Tax Rate Impact: The effective tax rate for the six months ended November 30, 2007, was 38.1%, an increase from 36.8% in the prior year. This was primarily due to the adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) and a change in a foreign subsidiary's statutory tax rate.
• Legal Proceedings: A class action lawsuit was filed in November 2007 alleging violations of the Fair and Accurate Credit Transactions Act regarding credit card transactions. The company intends to vigorously defend the suit.
• Seasonality: The company notes that results for the first and third quarters are typically lower than the second and fourth due to the school-year cycle.

Investor Verification Checklist

• DTH Business Valuation: Verify the magnitude of anticipated non-cash write-downs associated with the sale of the direct-to-home continuity business.
• Debt Covenants: Confirm continued compliance with interest coverage and leverage ratio tests under the new $525.0 million Loan Agreement.
• Harry Potter Sustainability: Assess the extent to which future revenue growth relies on the one-time impact of the Harry Potter release versus organic growth in other segments.
• Tax Liability: Review the $40.2 million liability for unrecognized tax benefits recognized upon the adoption of FIN 48.
• Share Count: Monitor the impact of the $200 million ASR and the new $20 million repurchase authorization on diluted earnings per share.