SCHL

Scholastic Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended November 30, 2003, and the six-month period ended on the same date. Scholastic Corporation is a global children's publishing and media company operating through four segments: Children's Book Publishing and Distribution, Educational Publishing, Media, Licensing and Advertising, and International. The company's business is highly seasonal, closely correlated with the school year.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 5.9% ($38.7 million) for the quarter and 21.4% ($207.2 million) for the six months compared to the prior year. The six-month surge was driven primarily by a $145 million increase in Harry Potter revenues following the release of the fifth book in June 2003.
• Profitability: While six-month net income rose 37.8% to $41.9 million, quarterly net income declined 11.1% to $66.7 million. Operating income for the quarter decreased 8.1% to $113.4 million.
• Expense Pressures: Bad debt expense increased significantly to $28.4 million (4.1% of revenue) for the quarter, up from $18.4 million in the prior year, largely due to continuity programs. Cost of goods sold as a percentage of revenue increased to 50.0% for the six months due to higher costs associated with the Harry Potter release.
• Debt Structure: The company issued $175.0 million in 5% Notes due 2013 in April 2003. This refinancing allowed the company to reduce reliance on revolving credit facilities; borrowings under the Loan Agreement and Revolver were zero as of November 30, 2003.

Guidance, Outlook, and Risks

• Seasonality: Management notes that results for the first and third quarters are typically lower than the second and fourth. The company anticipates negative cash flow during the June through October period due to seasonal working capital needs.
• Liquidity: The company believes its cash position, operating cash flow, and available credit facilities are sufficient to finance working capital requirements for the remainder of the fiscal year.
• Acquisitions: The company completed acquisitions of Troll Holdings assets and BTBCAT, Inc. (Back to Basics Toys) in the first half of the fiscal year, contributing to revenue growth in the Children's Book and Media segments.
• Risks: Key risks include the condition of the children's book market, acceptance of new products, foreign currency fluctuations (though hedging is used), and interest rate changes on variable-rate debt (approximately 6% of total debt).
• Unusual Items: The prior year six-month period included a $1.9 million litigation charge for a securities lawsuit settlement. The current period includes $3.2 million in special severance charges related to a global workforce reduction announced in May 2003.

Investor Verification Checklist

• Bad Debt Trends: Verify the sustainability of the increased bad debt expense (4.1% of revenue) in continuity programs and its impact on future margins.
• Harry Potter Dependency: Assess the extent to which the 21.4% six-month revenue growth is attributable to the one-time release of the fifth Harry Potter book versus organic growth.
• Debt Maturity: Confirm the repayment of the $125.0 million 7% Notes due December 15, 2003, and the company's ability to service the new $175.0 million 5% Notes.
• Continuity Segment Performance: Review the direct-to-home continuity business (formerly Grolier), which saw operating profit drop from $6.3 million to $0.4 million in the quarter, to understand the impact of bad debt provisions.
• Working Capital: Monitor cash flow during the upcoming seasonal peak (June-October) to ensure liquidity remains adequate without excessive borrowing.