SCHL

Scholastic Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended November 30, 2001, and the six months ended on that 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 to the school year.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 4.7% for the quarter and 8.5% for the six-month period compared to the prior year. This was primarily driven by a significant drop in Harry Potter trade sales (approx. $25M lower in the quarter, $115M lower in the six months) compared to the strong prior-year release of Harry Potter and the Goblet of Fire.
• Operating Income: Operating income increased 10.6% for the quarter to $112.2 million but decreased 25.5% for the six-month period to $70.5 million. The six-month decline was exacerbated by a $5.2 million after-tax charge related to the adoption of SOP 00-2 (film accounting).
• Cost Management: Cost of goods sold as a percentage of revenue improved to 40.8% (quarter) and 43.7% (six months) due to the strategic decision to exit the basal textbook market (Scholastic Literacy Place), resulting in a $72.9 million write-off of prepublication costs in the prior quarter which reduced current amortization.
• Bad Debt: Bad debt expense increased to $21.1 million (3.3% of revenue) for the quarter and $40.6 million (4.3% of revenue) for the six months, largely due to the inclusion of three additional weeks of the direct-to-home continuity business which has lower collection rates.

Guidance, Outlook, and Risks

• Accounting Changes: The company adopted SFAS No. 142 (Goodwill and Other Intangible Assets), eliminating goodwill amortization. A transitional impairment review found no write-downs required. The adoption of SOP 00-2 resulted in a one-time $5.2 million charge.
• Debt and Liquidity: Total debt stands at $673.6 million. The company holds $350.0 million under the "Grolier Facility" expiring June 2002 and $56.0 million under the Loan Agreement/Revolver. Management believes existing cash and credit facilities are sufficient for working capital needs through fiscal 2002.
• Debt Redemption: The company announced the redemption of all outstanding 5% Convertible Subordinated Debentures ($110.0 million) on January 11, 2002. Most were converted to common stock.
• Legal Contingencies: Significant litigation remains regarding the Goosebumps series with Parachute Press, Inc., involving claims of breach of contract and fraud. The company does not believe this will have a material adverse effect. A securities class action lawsuit was remanded for further proceedings after the Supreme Court denied certiorari.
• Market Risk: Approximately two-thirds of the company's debt is variable-rate. A 15% change in interest rates would impact pre-tax results by approximately $2.2 million annually.

Investor Verification Checklist

• Harry Potter Dependency: Verify the extent of revenue concentration in Harry Potter titles and the sustainability of margins without the blockbuster sales seen in the prior year.
• Direct-to-Home Performance: Review the profitability and collection rates of the acquired Grolier direct-to-home continuity business, which contributed to higher bad debt expenses.
• Debt Maturity Wall: Confirm the refinancing status of the $350 million Grolier Facility maturing in June 2002 and the impact of the upcoming debenture redemption on liquidity.
• Legal Exposure: Monitor the status of the Goosebumps litigation with Parachute Press and the securities class action for potential financial impact.
• Segment Margins: Analyze the divergence between the strong quarterly operating margin (17.6%) and the weaker six-month margin (7.5%) to understand the impact of the one-time accounting charge and seasonality.