SCHL

Scholastic Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended August 31, 2004. 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 first quarter is historically the company's smallest revenue period due to the school year cycle, typically resulting in a seasonal operating loss.

Key Financial Metrics

Liquidity: Cash used in operating activities was $78.8 million. Financing activities provided $106.0 million, primarily through borrowings under credit agreements and lines of credit to fund seasonal working capital needs.

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 31.9% ($151.7 million) year-over-year. This was primarily driven by a $166.1 million drop in the Children's Book Publishing and Distribution segment due to the absence of the Harry Potter and the Order of the Phoenix release, which generated approximately $170 million in the prior year.
• Segment Performance:
  • Children's Book Publishing: Revenue fell to $121.8 million; operating loss widened to $65.0 million (including $3.6 million in continuity severance charges).
  • Educational Publishing: Revenue grew 11.7% to $118.2 million, and operating profit increased 43.2% to $22.2 million, driven by sales of the Read 180 technology product.
  • International: Revenue increased 10.0% to $71.8 million, aided by favorable foreign currency exchange rates.
• Expense Management: Cost of goods sold as a percentage of revenue improved to 54.5% from 59.2%. Bad debt expense decreased to $16.2 million from $20.7 million due to better credit performance in the continuity business.
• Debt Levels: Total debt decreased to $618.9 million from $701.1 million in the prior year, following the repayment of 7% Notes in December 2003.

Outlook, Risks, and Unusual Items

• Continuity Charges: The company recorded $3.6 million in severance and employee-related expenses related to its continuity business restructuring. Substantially all payments are expected by May 31, 2005.
• Seasonality: Management notes that the first quarter is typically a loss-making period. The company anticipates negative cash flow from June through October due to seasonal inventory purchases.
• Liquidity Strategy: The company relies on existing cash, operating funds, and available credit facilities (Credit Agreement and Revolver totaling up to $230 million) to meet working capital requirements. It anticipates refinancing debt obligations prior to maturity.
• Market Risks: The company is exposed to foreign currency fluctuations and interest rate changes. Approximately 23% of debt bore variable interest rates as of August 31, 2004.

Investor Verification Checklist

• Harry Potter Impact: Verify the extent to which the revenue decline is attributable solely to the timing of the Harry Potter release versus underlying demand trends in the trade book market.
• Continuity Business Restructuring: Monitor the execution of the continuity business plan and the impact of the $3.6 million severance charges on future profitability.
• Read 180 Growth: Assess the sustainability of the revenue growth in the Educational Publishing segment driven by the Read 180 program.
• Debt Covenants: Review the financial covenants in the Credit Agreement and Revolver to ensure compliance given the current operating loss.
• Inventory Levels: Note the increase in inventories to $533.7 million (from $402.6 million at May 31, 2004) and monitor for potential write-downs if sales do not meet seasonal expectations.