SCHL

Scholastic Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended February 29, 2008, and the nine months ended on that date. Scholastic Corporation operates in four segments: Children's Book Publishing and Distribution, Educational Publishing, Media, Licensing and Advertising, and International. The reporting period is heavily influenced by the release of Harry Potter and the Deathly Hallows in July 2007 and the decision to divest its direct-to-home (DTH) continuity business.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Nine-month revenues increased 19.7% to $1,701.4 million, driven primarily by the Harry Potter release in the Children's Book segment (+$213.3 million) and International segment (+$56.7 million). Quarterly revenues rose 2.8% to $458.4 million.
• Profitability: Operating income from continuing operations for the nine months surged to $152.6 million from $66.9 million in the prior year. However, the quarter ended with a minimal operating profit of $0.6 million compared to a $2.0 million loss in the prior year quarter.
• Discontinued Operations Impact: The company recorded a significant non-cash impairment charge of $107.3 million (net of tax benefit: $72.7 million) related to the DTH business divestiture. This resulted in a net loss of $82.1 million for the quarter, masking strong performance in continuing operations.
• Cost Structure: Cost of goods sold as a percentage of revenue decreased slightly for the quarter (49.2% vs 50.0%) but increased for the nine months (48.7% vs 47.8%) due to Harry Potter costs. SG&A expenses as a percentage of revenue improved significantly for the nine months (38.6% vs 42.8%) due to revenue leverage.

Guidance, Outlook, and Risks

• Divestiture: The company intends to sell the DTH business (domestic, UK, Canada) and the Maumelle, Arkansas facility. The sale is targeted for completion by May 31, 2008, or Q1 fiscal 2009.
• Seasonality: The business is highly seasonal, with Q1 and Q3 typically generating lower revenues and often operating losses. Q2 is the strongest quarter for book clubs and fairs.
• Liquidity: The company maintains $201.2 million in cash and $325.0 million in available revolver capacity. Management believes current resources are sufficient for short- and long-term needs.
• Debt Profile: Total debt increased to $373.6 million, primarily due to a $200.0 million Term Loan used to fund an Accelerated Share Repurchase (ASR) in June 2007. Approximately 54% of debt is variable-rate.
• Tax Rate: The effective tax rate for continuing operations was 38.1% for the nine months, higher than the prior year's 35.9%, largely due to the adoption of FIN 48 regarding uncertain tax positions.

Investor Verification Checklist

• DTH Sale Completion: Verify the timeline and final sale price of the DTH business to assess the realization of the $72.7 million net impairment charge.
• Post-Harry Potter Demand: Monitor the Children's Book segment's performance in subsequent quarters to determine if the Deathly Hallows revenue spike was a one-time event or indicative of sustained growth.
• Debt Servicing: Review the impact of the $200 million Term Loan on future cash flows, noting the quarterly principal payments of $10.7 million.
• Share Repurchases: Confirm the status of the remaining $14.6 million authorization under the open market repurchase program announced in December 2007.
• Working Capital: Track the payment of accrued royalties related to Harry Potter, which management expects to settle in the quarter ending May 31, 2008.