SCHL

Scholastic Corp. 10-Q Summary: Period Ended Feb 28, 2005

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended February 28, 2005, and the nine-month period ended on the same 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 with the school year.

Key Financial Metrics

Material Changes vs. Prior Period

• Quarterly Performance: Revenues increased 1.9% to $480.8 million compared to the prior year quarter. The company reported a net loss of $0.7 million, a significant improvement from the $6.0 million net loss in the same period of the prior year. Operating income turned positive at $5.8 million versus a $2.3 million loss previously.
• Nine-Month Performance: Revenues decreased 9.6% to $1,487.8 million. This decline was primarily driven by a $191.0 million drop in the Children's Book Publishing segment due to the absence of the Harry Potter and the Order of the Phoenix release which occurred in the prior year. Net income for the nine months was $21.7 million, down from $35.9 million in the prior year.
• Expense Management: Bad debt expense decreased to 3.1% of revenues for the quarter (from 3.6% previously) and 3.4% for the nine months (from 4.0%). Selling, general, and administrative (SG&A) expenses as a percentage of revenue improved for the quarter but increased for the nine-month period due to lower revenues without a proportional expense decrease.
• Segment Highlights:
  • Educational Publishing: Revenues grew 14.3% quarterly and 11.2% over nine months, driven by educational technology sales.
  • International: Revenues increased 5.0% quarterly, aided by favorable foreign currency exchange rates.
  • Media, Licensing & Advertising: Revenues declined 14.5% quarterly due to lower programming revenues following the prior year's release of Clifford's Really Big Movie.

Guidance, Outlook, and Risks

• Outlook: Management stated that results were consistent with the goal of achieving higher profits and margins in fiscal 2005. Operating margins and profits improved in all segments.
• Unusual Items: The nine-month period included $3.6 million in "Continuity Charges" related to severance costs in the continuity business. Additionally, the prior year included $3.2 million in special severance charges from a 2003 workforce reduction.
• Liquidity: The company maintains cash of $22.1 million and access to credit facilities totaling up to $250.0 million (Credit Agreement) and $40.0 million (Revolver). Management believes existing cash and credit lines are sufficient for working capital needs.
• Risks: The filing highlights risks related to the condition of children's book markets, product acceptance, and foreign currency fluctuations. Approximately 6% of debt is variable-rate, exposing the company to interest rate changes.

Investor Verification Checklist

• Harry Potter Impact: Verify the extent to which the 9.6% nine-month revenue decline is attributable to the timing of the Harry Potter release versus underlying demand trends.
• Continuity Business Restructuring: Monitor the execution of the strategy to focus on productive continuity customers and the impact of the $3.6 million severance charges on future profitability.
• Bad Debt Trends: Confirm that the reduction in bad debt expense (from 4.0% to 3.4% of revenue) is sustainable and not a temporary anomaly.
• Debt Maturities: Review the debt schedule, noting $304.0 million in 5.75% Notes due in 2007 and $173.0 million in 5% Notes due in 2013, to assess refinancing risks.
• Stock-Based Compensation: Note that the company currently uses APB 25 (no expense recognized). Pro forma net income under SFAS 123 would be significantly lower ($12.8 million vs. $21.7 million for the nine months).