SCHL

Scholastic Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended February 29, 2004, and the nine-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

Margins (9 Months): Operating margin was 4.9% (up from 4.7% prior year). Cost of goods sold as a percentage of revenue increased to 49.6% from 45.7% in the prior year.

Material Changes vs. Prior Period

• Revenue Growth: Nine-month revenues increased 17.5% ($245.5 million) driven primarily by the Children's Book Publishing segment, which saw a $161.9 million increase largely due to the release of Harry Potter and the Order of the Phoenix.
• Quarterly Loss: The company reported a net loss of $6.0 million for the quarter, compared to a loss of $0.5 million in the prior year quarter. This was driven by a decline in operating profit in the Children's Book Publishing segment ($11.6 million decrease) and increased costs related to the film Clifford's Really Big Movie.
• Segment Performance:
  • Children's Book Publishing: Nine-month operating profit rose slightly to $90.0 million, but quarterly profit fell to $11.4 million. Direct-to-home continuity programs struggled with lower revenues and higher bad debt due to the National Do Not Call Registry.
  • Educational Publishing: Operating profit improved significantly to $32.3 million (9 months) due to favorable product mix and higher sales of classroom libraries.
  • International: Operating profit increased 56.7% to $18.8 million (9 months), aided by favorable foreign currency exchange rates.
• Debt Reduction: Total debt decreased to $574.6 million from $680.0 million in the prior year. The company repaid $125.0 million of 7% Notes at maturity in December 2003.

Guidance, Outlook, and Risks

• Seasonality: Management notes that results for the quarter are not indicative of the full year due to seasonality. The company typically experiences negative cash flow from June through October.
• Financing Update: On March 31, 2004 (subsequent to the period end), the company entered into a new $190 million revolving credit agreement, replacing the expiring Loan Agreement.
• Risks:
  • Bad Debt: Bad debt expense increased to 4.0% of revenues for the nine-month period, primarily due to continuity programs.
  • Market Conditions: Results are subject to the condition of the children's book market and acceptance of products.
  • Interest Rates: Approximately 17% of debt is variable-rate, exposing the company to interest rate fluctuations.
• Unusual Items: The prior year included a $1.9 million litigation charge for a securities lawsuit settlement. The current period included $3.2 million in special severance charges related to a workforce reduction announced in May 2003.

Investor Verification Checklist

• Harry Potter Dependency: Verify the sustainability of revenue growth following the massive spike from the fifth Harry Potter book release.
• Continuity Program Health: Assess the long-term impact of the National Do Not Call Registry on the direct-to-home segment's bad debt and revenue.
• Debt Covenants: Review the financial covenants in the new March 2004 Credit Agreement and the company's ability to maintain interest coverage ratios.
• Inventory Levels: Monitor inventory levels ($484.0 million), which increased significantly from the prior year, to ensure no future write-downs.
• Segment Margins: Analyze the widening gap between the high-margin Educational Publishing segment and the struggling Media/Licensing segment.