SCHL

Scholastic Corp. 10-Q Summary: Quarter Ended August 31, 2001

Business Context and Reporting Period

This Form 10-Q covers the three-month period ended August 31, 2001 (Fiscal Q1 2002). Scholastic Corporation is a global children's publishing and media company. The business is highly seasonal, with the first quarter (June-August) typically recording the lowest revenues and an operating loss due to the school year cycle. The period includes the impact of the June 2000 acquisition of Grolier Incorporated and the adoption of new accounting standards (SFAS No. 142 and SOP 00-2).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 15.5% year-over-year. The primary driver was a significant drop in Harry Potter sales, which generated approximately $100 million in the prior year quarter compared to only $14 million in the current quarter. This decline was partially offset by an additional three weeks of revenue from the Grolier acquisition.
• Operating Loss Expansion: The operating loss widened to $41.7 million from $6.8 million. This was driven by the $43 million reduction in gross margin from lower Harry Potter sales, partially mitigated by $21 million in additional gross margin from Grolier.
• Accounting Changes: The company recorded a one-time, after-tax charge of $5.2 million due to the adoption of SOP 00-2 regarding film accounting. Additionally, the adoption of SFAS No. 142 eliminated goodwill amortization, reducing expenses by $2.3 million compared to the prior year.
• Segment Performance: The Children's Book Publishing segment swung from a $7.5 million profit to a $27.9 million loss. Conversely, the Media, Licensing, and Advertising segment saw revenue increase 83.3% to $18.7 million.

Guidance, Outlook, and Risks

Liquidity and Capital Resources: Management expects existing cash, operating funds, and available credit facilities to be sufficient to finance working capital needs for the remainder of fiscal 2002. The company anticipates seasonal negative cash flow through October, with borrowings typically peaking in September or October.

Debt Structure: Total debt stands at $720.5 million. Significant obligations include $350 million under the Grolier Facility (maturing June 2002) and $103.9 million under the Loan Agreement and Revolver. Approximately two-thirds of the debt bears variable interest rates, exposing the company to interest rate fluctuations.

Legal Contingencies:

• Securities Litigation: A consolidated class action lawsuit regarding alleged misstatements about Goosebumps sales (1996-1997) was remanded for further proceedings by the Second Circuit Court of Appeals in June 2001. Scholastic filed a petition for a Writ of Certiorari with the U.S. Supreme Court in August 2001.
• Parachute Press Dispute: Ongoing litigation with Parachute Press regarding Goosebumps licensing rights involves claims for approximately $36.1 million in advances and royalties. Management does not believe this will have a material adverse effect.

Investor Verification Checklist

• Seasonality Impact: Verify the magnitude of the seasonal loss in Q1 against the expected recovery in Q2 (September-October) when school-based book clubs and fairs resume.
• Debt Maturity Wall: Confirm the refinancing status of the $350 million Grolier Facility, which matures in June 2002, and the company's ability to meet interest coverage covenants.
• Legal Exposure: Monitor the outcome of the Supreme Court petition regarding the securities class action and the settlement or judgment status of the Parachute Press dispute.
• Product Mix Dependency: Assess the company's ability to generate revenue without the massive Harry Potter tailwinds present in the prior year, specifically looking at the performance of the Grolier integration.
• Working Capital: Review the increase in accounts receivable and inventory levels to ensure they align with anticipated sales growth for the upcoming school year.