Scholastic Corporation — Form 10-Q Summary
Reporting period: Quarter and six months ended November 30, 2016. This is the second quarter of Scholastic’s fiscal 2017. The company publishes and distributes children’s books and educational materials through its Children’s Book Publishing and Distribution, Education, and International segments. Results are seasonal; school-based activity is concentrated in the second and fourth fiscal quarters.
Financial performance
| Metric | Three months ended Nov. 30, 2016 | Six months ended Nov. 30, 2016 |
|---|---|---|
| Revenue | $623.1 million, up 3.5% from $601.8 million | $905.8 million, up 14.2% from $793.0 million |
| Operating income | $111.4 million, versus $105.1 million | $48.3 million, versus $25.6 million |
| Continuing-operations net income | $67.9 million, versus $65.2 million | $28.4 million, versus $16.3 million |
| Net income | $67.9 million, versus $64.9 million | $28.3 million, versus $15.5 million |
| Diluted EPS | $1.92, versus $1.84 | $0.80, versus $0.44 |
| Cash from operating activities | Not presented separately for the quarter | $74.2 million provided, versus $178.0 million used |
Margins and costs: Consolidated cost of goods sold was 43.5% of revenue in the quarter, compared with 42.7%; for the six months it was 48.7%, compared with 46.9%. Higher royalties on Harry Potter sales were the main pressure, partly offset by fixed-cost leverage and favorable product mix. Quarter operating margin was approximately 17.9%, versus 17.5%; six-month operating margin was approximately 5.3%, versus 3.2%, calculated from reported revenue and operating income.
Segments: In the quarter, Children’s Book Publishing and Distribution revenue was $432.5 million and operating income was $121.1 million; Education revenue was $71.1 million and operating income was $8.7 million; International revenue was $119.5 million and operating income was $16.5 million. For the six months, segment revenues were $570.3 million, $126.3 million, and $209.2 million, respectively; operating income was $84.9 million, $4.3 million, and $20.4 million.
Liquidity and debt: Cash and cash equivalents were $442.9 million at November 30, 2016, versus $399.7 million at May 31, 2016. Total reported debt was $7.3 million, consisting of short-term local-currency borrowings; there were no borrowings under the $425 million revolving credit facility. The company reported approximately $40.7 million of availability under short-term credit facilities after borrowings and letters of credit. It was in compliance with credit-facility covenants.
Six-month investing cash outflow was $23.0 million, including $19.5 million of property, plant and equipment additions and $13.0 million of prepublication and production expenditures. Financing activities used $7.6 million, including $10.4 million in dividends and $6.0 million in share repurchases. The quarterly dividend was $0.15 per share.
Changes versus the prior comparable period
- Quarterly revenue growth was led by U.S. and Canadian trade publishing, especially new Harry Potter-related titles and other bestsellers. Six-month growth also reflected Harry Potter and the Cursed Child.
- Children’s Book Publishing and Distribution operating income increased to $121.1 million for the quarter and $84.9 million for six months. International operating income rose to $16.5 million and $20.4 million, respectively, with management citing Harry Potter publishing and stronger major-market trade, club, and fair sales.
- Education revenue declined in the quarter but increased for the six-month period. Lower custom publishing and consumer-magazine sales weighed on results; classroom books and literacy initiatives provided support.
- Quarterly SG&A increased modestly to $230.8 million; six-month SG&A rose to $397.4 million from $374.7 million. Higher employee, technology, facilities, and severance costs partly offset lower book-club promotion and catalog spending.
- Operating cash flow improved substantially year over year, principally because the prior-year period included approximately $186 million of income tax paid related to the sale of the Ed Tech business. The current period also benefited from working-capital changes, including higher accrued royalties.
Outlook, commentary, and risks
- Management said the full-year plan for level book-fair revenue and higher profits was on track. Book-club revenue was below expectations after reduced catalog mailings; the company planned to expand mailings of better-performing catalogs and anticipated improved club revenue in the second half.
- The company expects a full-year effective tax rate, inclusive of discrete items, of approximately 40.8%. The stated annual rate excluding certain items was approximately 38.9%.
- Management expects strategic technology spending and investment in headquarters modernization and premium retail space to continue into current and future fiscal periods.
- Seasonality creates significant cash-flow variation; the company generally experiences operating losses in the first and third fiscal quarters and typically uses cash from June through October.
- Foreign-exchange movements affected international results; foreign operations also faced higher bad-debt expense in the Philippines, Thailand, and Indonesia. The company uses foreign-currency contracts as economic hedges, not for speculation.
- Wisconsin assessed Scholastic Book Fairs $5.4 million, excluding penalties and interest, for sales taxes for fiscal years 2004–2014. Scholastic disputes the assessment, is litigating, and recorded no liability; the filing says an adverse outcome remains reasonably possible.
- The company was under IRS audit for fiscal 2014. It also noted ongoing sales-tax examinations and associated uncertainties.
- The board approved termination of the frozen U.S. pension plan, subject to regulatory approvals; the process was expected to take approximately 15–21 months. A settlement charge could arise if fiscal-year lump-sum payments exceed $3.2 million; $1.5 million had been paid in the first six months.
- The filing reports no material adverse expectation from ordinary-course litigation and claims. Actual outcomes and forward-looking results remain subject to the risks described in the filing and prior SEC reports.
Most important facts for investors to verify
- Whether the expected second-half book-club revenue recovery and full-year book-fair profit plan materialized.
- How much earnings growth depended on Harry Potter and other hit titles, and the effect of associated royalty costs on margins.
- Whether higher technology, employee, facilities, and capital-project spending continued as expected.
- Developments in the Wisconsin sales-tax litigation and the IRS audit, including any change to recorded reserves or exposures.
- Cash conversion across the full fiscal year, given seasonal working-capital needs and the prior-year tax-payment comparison.
- Progress and financial effects of the U.S. pension-plan termination, including any settlement charge.