SCHL

Scholastic Corp. 10-Q Summary: Period Ended November 30, 2004

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended November 30, 2004, 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/Advertising, and International. The company's business is highly seasonal, closely correlated with the school year.

Key Financial Metrics

Material Changes vs. Prior Period

• Quarterly Performance: Revenues declined 2.2% to $683.3 million compared to the prior year quarter. However, Net Income increased 9.0% to $72.7 million, and Operating Margin improved to 17.6% from 16.2%.
• Six-Month Performance: Revenues decreased 14.3% to $1,007.0 million, and Net Income dropped significantly to $22.4 million (from $41.9 million). Operating margin contracted to 4.9% from 7.1%.
• Segment Drivers:
  • Children's Book Publishing: Revenues fell due to the absence of a new Harry Potter release (down ~$170 million in trade revenues over six months) and a strategic reduction in the continuity business. However, bad debt expense decreased significantly ($19.6M vs $28.4M in Q3).
  • Educational Publishing: Revenues grew 8.2% in the quarter and 10.2% over six months, driven by the Read 180 reading intervention program.
  • International: Revenues increased slightly, aided by favorable foreign currency exchange rates.
• Costs: Bad debt expense decreased as a percentage of revenue (2.9% in Q3 vs 4.1% prior year). Selling, general, and administrative (SG&A) expenses included $3.6 million in "Continuity Charges" (severance) for the six-month period.

Outlook, Risks, and Unusual Items

• Management Commentary: Results for the quarter were consistent with the goal of achieving higher profits and margins on lower revenues in a year without a new Harry Potter release. The company is focusing on its most productive customers in the continuity business.
• Unusual Items:
  • Continuity Charges: $3.6 million in severance costs were recorded in the six months ended Nov 30, 2004, related to restructuring the continuity business.
  • Special Severance: No special severance charges were recorded in the current period; prior year charges related to a 2003 workforce reduction.
• Liquidity: The company maintains a $190 million Credit Agreement and a $40 million Revolver. Management believes existing cash and borrowing capacity are sufficient for working capital needs.
• Risks: The filing highlights risks related to the condition of the children's book market, acceptance of products, and foreign currency fluctuations. Approximately 15% of debt is variable-rate, exposing the company to interest rate changes.

Investor Verification Checklist

• Harry Potter Impact: Verify the extent of revenue decline in the trade channel specifically attributed to the lack of a new Harry Potter title compared to the prior year's Order of the Phoenix release.
• Continuity Business Strategy: Confirm the long-term profitability outlook for the direct-to-home continuity segment following the strategic revenue reduction and associated severance charges.
• Bad Debt Reserves: Review the adequacy of bad debt reserves given the significant reduction in bad debt expense, ensuring it reflects the current economic environment and customer base changes.
• Debt Maturities: Assess the refinancing risk for the $300 million 5.75% Notes due in 2007 and the $175 million 5% Notes due in 2013.
• Read 180 Growth: Evaluate the sustainability of the revenue growth in the Educational Publishing segment driven by the Read 180 program.