UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934
SCHOLASTIC CORPORATION (Exact name of Registrant as specified in its charter)
Registrant's telephone number, including area code (212) 343-6100
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes X No _
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer X Accelerated filer _ Non-accelerated filer _
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes _ No X
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SCHOLASTIC CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED(Amounts in millions, except per share data)
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1. Basis of Presentation
The accompanying condensed consolidated financial statements consist of the accounts of Scholastic Corporation (the “Corporation”) and all wholly-owned subsidiaries (collectively “Scholastic” or the “Company”). These financial statements have not been audited but reflect those adjustments consisting of normal recurring items that management considers necessary for a fair presentation of financial position, results of operations and cash flow. These financial statements should be read in conjunction with the consolidated financial statements and related notes in the Annual Report on Form 10-K for the fiscal year ended May 31, 2005.
The Company’s business is closely correlated to the school year. Consequently, the results of operations for the three and six months ended November 30, 2005 and 2004 are not necessarily indicative of the results expected for the full year. Due to the seasonal fluctuations that occur, the November 30, 2004 condensed consolidated balance sheet is included for comparative purposes.
The Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements involves the use of estimates and assumptions by management, which affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The Company bases its estimates on historical experience, current business factors, and various other assumptions believed to be reasonable under the circumstances, all of which are necessary in order to form a basis for determining the carrying values of assets and liabilities. Actual results may differ from those estimates and assumptions. On an on-going basis, the Company evaluates the adequacy of its reserves and the estimates used in calculations, including, but not limited to: collectability of accounts receivable and installment receivables; sales returns; amortization periods; pension obligations; and recoverability of inventories, deferred promotion costs, deferred income taxes and tax reserves, prepublication costs, royalty advances, goodwill and other intangibles.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Stock-Based Compensation
Under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company applies Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock-based benefit plans. In accordance with APB No. 25, no compensation expense was recognized with respect to the Company’s stock-based benefit plans, as the exercise price of each stock option issued was equal to the market price of the underlying stock on the date of grant and the exercise price and number of shares subject to grant were fixed. If the Company had elected to recognize compensation expense based on the fair value of the options granted at the date of grant and in respect to shares issuable under the Company’s equity compensation plans as prescribed by SFAS No. 123, net income and basic and diluted earnings per share would have been reduced to the pro forma amounts indicated in the following table:
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In December 2004, the Financial Accounting Standards Board (the “FASB”) issued SFAS No.123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which requires companies to expense the fair value of all share-based payments as currently permitted, but not required, under SFAS No. 123. SFAS No. 123R will be effective for the Company commencing June 1, 2006. Retroactive application of the fair value recognition provisions of SFAS No. 123 is permitted, but not required. Alternatively, a company may use the modified prospective transition method for application of SFAS No. 123R. Under this method, compensation cost is recognized for all share-based payments granted, modified or settled after the date of adoption based on their grant-date fair value. For awards granted prior to the adoption date, the compensation cost of any unvested portion is recognized over the remaining service period. The Company intends to use the modified prospective transition method to adopt SFAS No. 123R and is currently evaluating the impact that the adoption of SFAS No. 123R will have on its financial position, results of operations and cash flows.
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2. Restatement of Previously Issued Consolidated Financial Statements
As a result of a comprehensive review of its lease accounting in the fourth quarter of fiscal 2005, the Company determined that it was appropriate to restate its previously issued annual and interim consolidated financial statements. The restatement was principally attributable to the treatment of certain leases previously classified as operating leases that should have been classified as capital leases and certain other operating leases that previously did not reflect future payment escalation clauses in determining rent expense. The classification of certain capital leases as operating leases principally had the effect of excluding assets subject to capital leases and the related capital lease obligations from the Company’s Consolidated Balance Sheet and treating rental payments as rent expense, rather than as interest expense and principal payments on capital lease obligations. Also, not considering future payment escalation clauses in determining rent expense for certain operating leases principally had the effect of understating rent expense in the early periods of the lease agreements and overstating rent expense in the later periods of the lease agreements.
The Company has revised its accounting for these leasing transactions and restated its previously issued annual and interim Consolidated Financial Statements in its Annual Report on Form 10-K for the fiscal year ended May 31, 2005 to appropriately classify its leases and to appropriately reflect future payment escalation clauses in determining rent expense.
The following is a summary of the impact of the restatement on the Company’s Condensed Consolidated Statements of Operations for the three and six months ended November 30, 2004:
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The following is a summary of the impact of the restatement on the Company’s Condensed Consolidated Balance Sheet at November 30, 2004 and the Consolidated Statement of Cash Flows for the six months ended November 30, 2004:
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3. Segment Information
Scholastic is a global children’s publishing and media company. The Company distributes its products and services through a variety of channels, including school-based book clubs, school-based book fairs, school-based and direct-to-home continuity programs, retail stores, schools, libraries, the internet and television networks. The Company categorizes its businesses into four operating segments: Children’s Book Publishing and Distribution; Educational Publishing; Media, Licensing and Advertising (which collectively represent the Company’s domestic operations); and International. This classification reflects the nature of products and services consistent with the method by which the Company’s chief operating decision-maker assesses operating performance and allocates resources. Revenues and gross margin related to a segment’s products sold or services rendered through another segment’s distribution channel are reallocated to the segment originating the products or services.
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Lines of Credit
Scholastic Corporation’s international subsidiaries had unsecured lines of credit available in local currencies equivalent to $76.4, in the aggregate, at November 30, 2005, as compared to $64.8 at November 30, 2004 and $61.8 at May 31, 2005. There were borrowings outstanding under these lines of credit equivalent to $41.3 at November 30, 2005, as compared to $33.6 at November 30, 2004 and $24.7 at May 31, 2005. These lines of credit are considered short-term in nature. The weighted average interest rates on the outstanding amounts were 5.5% and 5.6% at November 30, 2005 and 2004, respectively, and 5.4% at May 31, 2005.
Credit Agreement
On March 31, 2004, Scholastic Corporation and Scholastic Inc. entered into an unsecured revolving credit agreement with certain banks (the “Credit Agreement”), which replaced a similar loan agreement that was scheduled to expire in August 2004. The Credit Agreement, which expires on March 31, 2009, provides for aggregate borrowings of up to $190.0 (with a right in certain circumstances to increase borrowings to $250.0), including the issuance of up to $10.0 in letters of credit. Interest under this facility is either at the prime rate or at a rate equal to 0.325% to 0.975% over LIBOR (as
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defined). There is a facility fee ranging from 0.10% to 0.30% and a utilization fee ranging from 0.05% to 0.25% if borrowings exceed 50% of the total facility. The amounts charged vary based upon the Company’s credit rating. The interest rate, facility fee and utilization fee (when applicable) as of November 30, 2005 were 0.675% over LIBOR, 0.20% and 0.125%, respectively. The Credit Agreement contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. There were no borrowings outstanding under the Credit Agreement at November 30, 2005 and May 31, 2005. At November 30, 2004, $45.0 was outstanding under the Credit Agreement at a weighted average interest rate of 2.5% .
Revolver
Scholastic Corporation and Scholastic Inc. are joint and several borrowers under an unsecured revolving loan agreement with a bank (the “Revolver”). As amended effective April 30, 2004, the Revolver provides for unsecured revolving credit of up to $40.0 and expires on March 31, 2009. Interest under this facility is either at the prime rate minus 1% or at a rate equal to 0.375% to 1.025% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30% . The amounts charged vary based upon the Company’s credit rating. The interest rate and facility fee as of November 30, 2005 were 0.725% over LIBOR and 0.20%, respectively. The Revolver contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. There were no borrowings outstanding under the Revolver at November 30, 2005 and May 31, 2005. At November 30, 2004, $6.1 was outstanding under the Revolver at a weighted average interest rate of 2.4% .
5.75% Notes due 2007
In January 2002, Scholastic Corporation issued $300.0 of 5.75% Notes (the “5.75% Notes”). The 5.75% Notes are senior unsecured obligations that mature on January 15, 2007. Interest on the 5.75% Notes is payable semi-annually on July 15 and January 15 of each year. The Company may, at any time, redeem all or a portion of the 5.75% Notes at a redemption price (plus accrued interest to the date of redemption) equal to the greater of (i) 100% of the principal amount, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption. Through November 30, 2005, the Company had repurchased $2.0 of the 5.75% Notes on the open market.
5% Notes due 2013
In April 2003, Scholastic Corporation issued $175.0 of 5% Notes (the “5% Notes”). The 5% Notes are senior unsecured obligations that mature on April 15, 2013. Interest on the 5% Notes is payable semi-annually on April 15 and October 15 of each year. The Company may at any time redeem all or a portion of the 5% Notes at a redemption price (plus accrued interest to the date of the redemption) equal to the greater of (i) 100% of the principal amount, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption.
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5. Comprehensive Income
The following table sets forth comprehensive income for the periods indicated:
Basic earnings per share is computed by dividing net income by the weighted average Shares of Class A Stock and Common Stock outstanding during the period. Diluted earnings per share is calculated to give effect to potentially dilutive options to purchase Common Stock issued pursuant to the Company’s stock-based benefit plans that were outstanding during the period. The following table summarizes the reconciliation of the numerators and denominators for the basic and diluted earnings per share computation for the periods indicated:
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7. Goodwill and Other Intangibles
Goodwill and other intangible assets with indefinite lives are reviewed for impairment annually, or more frequently if impairment indicators arise.
The following table summarizes the activity in Goodwill for the periods indicated:
In the twelve months ended May 31, 2005, Additions due to acquisitions includes the purchase price for the acquisition of Chicken House Publishing Ltd. and the accrual of a final payment related to the fiscal 2002 acquisition of Klutz.
The following table summarizes Other intangibles subject to amortization at the dates indicated:
Amortization expense for Other intangibles totaled $0.1 and $0.2 for the three and six months ended November 30, 2005, respectively, $0.1 for each of the three and six months ended November 30, 2004, and $0.3 for the twelve months ended May 31, 2005. Amortization expense for these assets is currently estimated to total $0.3 for the fiscal year ending May 31, 2006, and $0.2 for each of the fiscal years ending May 31, 2007 through 2010. The weighted average amortization periods for these assets by major asset class are two years and twelve years for customer lists and other intangibles, respectively.
The following table summarizes Other intangibles not subject to amortization at the dates indicated:
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8. Pension and Other Post-Retirement Benefits
The following table sets forth components of the net periodic benefit costs under the Company’s cash balance retirement plan for its United States employees meeting certain eligibility requirements, the defined benefit pension plan of Scholastic Ltd., an indirect subsidiary of Scholastic Corporation located in the United Kingdom (the “U.K. Pension Plan”), the defined benefit pension plan of Grolier Ltd., an indirect subsidiary of Scholastic Corporation located in Canada (collectively, the “Pension Plans”), and the post-retirement benefits provided by the Company to its retired United States-based employees, consisting of certain healthcare and life insurance benefits (the “Post-Retirement Benefits”), for the periods indicated:
The Company currently estimates that Scholastic Ltd. will contribute the equivalent of $1.1 to the U.K. Pension Plan in the fiscal year ending May 31, 2006. For the six months ended November 30, 2005, Scholastic Ltd. contributed the equivalent of $0.6 to the U.K. Pension Plan.
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Overview and Outlook
Revenue for the quarter ended November 30, 2005 increased 2.0% to approximately $697 million, as compared to the prior fiscal year quarter, reflecting revenue increases in the International, Educational Publishing and Media, Licensing and Advertising segments. Operating income for the quarter decreased 5.4% as compared to the prior fiscal year quarter, and operating margin decreased to 16.5% in the current fiscal year quarter as compared to 17.8% a year ago. These decreases were principally due to lower operating results in the International segment.
Key factors in the quarter ended November 30, 2005 included growth in revenues in the Company’s school-based book fair and trade businesses and the Educational Publishing segment, led by sales of educational technology products. These increases were offset by a decrease in revenues in the Company’s continuity and school-based book club businesses. The Company’s domestic operations were also adversely affected during the quarter by hurricane-related school disruptions and resulting higher fuel costs.
For the six months ended November 30, 2005, revenues and operating income increased over the prior fiscal year period by $188.1 million and $37.6 million, respectively. Operating margin increased to 7.5% in the current fiscal year period as compared to 5.2% in the prior fiscal year period. These improvements were primarily due to better operating results in the Children’s Book Publishing and Distribution and Educational Publishing segments. The Company remains on track to achieve its goals for fiscal 2006 of expanding margins while growing revenues.
Results of Operations - Consolidated
Revenues for the quarter ended November 30, 2005 increased $13.4 million, or 2.0%, to $696.7 million, compared to $683.3 million in the prior fiscal year quarter. The increase was principally due to higher revenues in the International, Educational Publishing and Media, Licensing and Advertising segments of $5.2 million, $4.7 million and $4.3 million, respectively. For the six months ended November 30, 2005, revenues increased $188.1 million, or 18.7%, to $1,195.1 million, compared to $1,007.0 million in the prior fiscal year period due to increases in each of the Company’s four operating segments, led by $152.7 million in higher revenues from the Children’s Book Publishing and Distribution segment as a result of the July 2005 release of Harry Potter and the Half-Blood Prince, the sixth book in the series.
Cost of goods sold as a percentage of revenues decreased to 42.8% for the quarter ended November 30, 2005, as compared to 44.1% in the prior fiscal year quarter. For the six months ended November 30, 2005, cost of goods sold as a percentage of revenues increased to 49.5%, as compared to 47.4% in the prior fiscal year period, primarily due to costs related to the release of Harry Potter and the Half-Blood Prince.
Selling, general and administrative expenses as a percentage of revenues for the quarter ended November 30, 2005 increased to 36.1% from 33.0% in the prior fiscal year quarter, primarily due to an increase in employee and related expenses. For the six months ended November 30, 2005, Selling, general and administrative expenses as a percentage of revenues decreased to 38.0% from 40.8% in the prior fiscal year period, primarily due to the revenue benefit fromHarry Potter and the Half-Blood Prince without a corresponding increase in expense. For the six months ended November 30, 2004, Selling, general and administrative expenses included a charge of $3.6 million, primarily related to severance costs, recorded in connection with the fiscal 2004 review by the Company of its continuity business (the “Continuity Charges”).
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Bad debt expense decreased to $15.1 million, or 2.2% of revenues, for the quarter ended November 30, 2005, compared to $19.6 million, or 2.9% of revenues, in the prior fiscal year quarter. For the six months ended November 30, 2005, bad debt expense decreased to $27.7 million, or 2.3% of revenues, compared to $35.8 million, or 3.6% of revenues, in the prior fiscal year period. The lower levels of bad debt expense in the three- and six-month periods related primarily to lower bad debt in the Company’s continuity business as a result of the Company’s previously announced plan for this business to focus on its more productive customers.
Depreciation and amortization expense for the quarter ended November 30, 2005 increased to $16.8 million, or 2.4% of revenues, compared to $15.1 million, or 2.2% of revenues, in the prior fiscal year quarter. For the six months ended November 30, 2005, Depreciation and amortization expense increased to $32.4 million, or 2.7% of revenues, compared to $30.8 million, or 3.1% of revenues, in the prior fiscal year period. These increases were principally due to higher depreciation of information technology equipment.
The resulting operating income for the quarter ended November 30, 2005 decreased by $6.6 million to $115.3 million, or 16.5% of revenues, compared to $121.9 million, or 17.8% of revenues, in the prior fiscal year quarter. For the six months ended November 30, 2005, the resulting operating income increased to $90.1 million, or 7.5% of revenues, compared to $52.5 million, or 5.2% of revenues, in the prior fiscal year period.
The effective income tax rate for each of the three and six months ended November 30, 2005 increased to 37.0%, compared to 35.5% in each of the prior fiscal year periods, primarily due to a higher effective tax rate on foreign earnings and a higher state tax provision.
Net income was $66.9 million, or $1.59 per diluted share, for the quarter ended November 30, 2005, compared to net income of $72.5 million, or $1.80 per diluted share, in the prior fiscal year quarter. For the six months ended November 30, 2005, net income was $45.7 million, or $1.10 per diluted share, compared to net income of $22.0 million, or $0.55 per diluted share, in the prior fiscal year period.
Results of Operations - Segments
In the fourth quarter of fiscal 2005, the Company reviewed the estimated Cost of goods sold related to products originated by the Media, Licensing and Advertising segment that are sold through channels included in the Children’s Book Publishing and Distribution segment. The Company determined that actual costs were lower and gross margins higher on these products than was previously estimated. As a result, the prior fiscal year quarter inter-segment allocations were adjusted (the “Segment Reallocation”), resulting in higher gross margin and profits in the Media, Licensing and Advertising segment with an offsetting decrease in gross margin and profits in the Children’s Book Publishing and Distribution segment.
Children’s Book Publishing and Distribution
The Company’s Children’s Book Publishing and Distribution segment includes the publication and distribution of children’s books in the United States through school-based book clubs and book fairs, school-based and direct-to-home continuity programs and the trade channel.
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Revenues in the Children’s Book Publishing and Distribution segment for the quarter ended November 30, 2005 were nearly flat at $424.2 million, compared to $425.0 million in the prior fiscal year quarter. Within the segment, revenues from school-based book fairs increased $10.4 million due to higher revenue per fair, and trade revenues increased $5.2 million, primarily due to a higher level of Harry Potter back list revenues. Revenues in the Company’s continuity business decreased by $10.9 million, principally as a result of the Company’s previously announced plan to focus on its more productive customers, and school-based book club revenues decreased by $5.5 million, primarily due to a lower number of orders.
Segment operating profit for the quarter ended November 30, 2005 decreased by $2.3 million, or 2.5%, to $88.6 million, compared to $90.9 million in the prior fiscal year quarter, principally due to a decrease in operating profits in the Company’s school-based book club business as a result of lower revenues and increased promotional costs, partially offset by an operating profit increase in the balance of the segment, primarily from school-based book fairs.
Revenues for the six months ended November 30, 2005 increased $152.7 million, or 27.9%, to $699.5 million, compared to $546.8 million in the prior fiscal year period. This increase was principally due toHarry Potter revenues of approximately $195 million, as compared to approximately $15 million of Harry Potter revenues in the prior fiscal year period. In addition, revenues for the Company’s school-based book fair business increased $13.4 million due to an increase in revenue per fair. These revenue increases were partially offset by a decline in revenue from the Company’s continuity business of $28.1 million.
Segment operating profit for the six months ended November 30, 2005 improved by $42.0 million, to $68.9 million, compared to $26.9 million in the prior fiscal year period. This improvement was primarily due to increased operating profits for the Company’s trade business resulting from the higher Harry Potter revenues.
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The following highlights the results of the direct-to-home portion of the Company’s continuity programs, which consists primarily of the business formerly operated by Grolier and is included in the Children’s Book Publishing and Distribution segment.
Revenues from the direct-to-home portion of the Company’s continuity business decreased by $9.4 million, or 23.9%, to $30.0 million for the quarter ended November 30, 2005, as compared to $39.4 million in the prior fiscal year quarter, and decreased by $22.2 million, or 27.5%, to $58.4 million for the six months ended November 30, 2005, as compared to $80.6 million in the prior fiscal year period.
The operating loss for the direct-to-home portion of the continuity business was $4.6 million in the quarter ended November 30, 2005, as compared to a $0.3 million operating loss in the prior fiscal year quarter, and $10.8 million for the six months ended November 30, 2005, compared to a $4.9 million operating loss in the prior fiscal year period, which included $3.6 million of Continuity Charges.
Excluding the direct-to-home portion of the continuity business, segment revenues increased by $8.6 million, or 2.2%, to $394.2 million for the quarter ended November 30, 2005, compared to $385.6 million in the prior fiscal year quarter, and increased by $174.9 million, or 37.5%, to $641.1 million for the six months ended November 30, 2005, compared to $466.2 million in the prior fiscal year period.
Excluding the direct-to-home portion of the continuity business, segment operating profit was $93.2 million in the quarter ended November 30, 2005, compared to $91.2 million in the prior fiscal year quarter, and was $79.7 million in the six months ended November 30, 2005, compared to $31.8 million in the prior fiscal year period.
Educational Publishing
The Company’s Educational Publishing segment includes the publication and distribution to schools and libraries of educational technology products, curriculum materials, children’s books, classroom magazines and print and on-line reference and non-fiction products for grades pre-K to 12 in the United States.
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Revenues in the Educational Publishing segment for the quarter ended November 30, 2005 increased $4.7 million, or 5.0%, to $99.2 million, compared to $94.5 million in the prior fiscal year quarter. Segment revenues for the six months ended November 30, 2005 increased $14.8 million, or 7.0%, to $227.5 million, compared to $212.7 million in the prior fiscal year period. The increases related primarily to higher revenues from sales of educational technology products, led by the Company’s READ 180® reading intervention program, partially offset by an expected decline in classroom magazine revenues due to prior year sales of election-related materials.
Segment operating profit for the quarter ended November 30, 2005 increased slightly to $21.6 million, compared to $21.5 million in the prior fiscal year quarter, as higher profits from sales of educational technology products were largely offset by lower results in the balance of the segment, taken together. Segment operating profit for the six months ended November 30, 2005 increased by $5.3 million, or 12.1%, to $49.1 million, compared to $43.8 million in the prior fiscal year period, primarily due to revenue growth from sales of educational technology products.
Media, Licensing and Advertising
The Company’s Media, Licensing and Advertising segment includes the production and/or distribution of software in the United States; the production and/or distribution, primarily by and through Scholastic Entertainment Inc., of programming and consumer products (including children’s television programming, videos, software, feature films, promotional activities and non-book merchandise); and advertising revenue, including sponsorship programs.
(1) Reflects the Segment Reallocation.
Revenues in the Media, Licensing and Advertising segment for the quarter ended November 30, 2005 increased $4.3 million, or 9.0%, to $51.9 million, compared to $47.6 million in the prior fiscal year quarter, due to an increase in each of the businesses in the segment, led by an increase in revenues from Back to Basic Toys®, the Company’s direct-to-home toy catalog. Segment revenues for the six months ended November 30, 2005 increased $10.5 million, or 17.6%, to $70.0 million, compared to $59.5 million in the prior fiscal year period, primarily due to an increase in television programming revenues.
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Segment operating profit for the quarter ended November 30, 2005 decreased $0.8 million, or 9.4%, to $7.7 million, compared to $8.5 million in the prior fiscal year quarter. Segment operating profit for the six months ended November 30, 2005 decreased slightly to $2.0 million, compared to $2.3 million in the prior fiscal year period.
International
The International segment includes the publication and distribution of products and services outside the United States by the Company’s international operations, and its export and foreign rights businesses.
Revenues in the International segment for the quarter ended November 30, 2005 increased $5.2 million, or 4.5%, to $121.4 million, compared to $116.2 million in the prior fiscal year quarter. This increase was primarily due to the favorable impact of foreign currency exchange rates. Segment revenues for the six months ended November 30, 2005 increased $10.1 million, or 5.4%, to $198.1 million, as compared to $188.0 million in the prior fiscal year period. This increase was primarily due to revenue growth in the Company’s export business of $6.9 million and the favorable impact of foreign currency exchange rates of $6.7 million, partially offset by lower local currency revenues in the United Kingdom.
Segment operating profit for the quarter ended November 30, 2005 decreased $6.4 million, or 33.3%, to $12.8 million, as compared to $19.2 million in the prior fiscal year quarter, most significantly due to lower local currency operating profits in the United Kingdom. Segment operating profit for the six months ended November 30, 2005 decreased $8.9 million, or 54.9%, to $7.3 million, compared to $16.2 million in the prior fiscal year period, primarily due to lower local currency operating profits in the United Kingdom.
Seasonality
The Company’s school-based book clubs, school-based book fairs and most of its magazines operate on a school-year basis. Therefore, the Company’s business is highly seasonal. As a consequence, the Company’s revenues in the first and third quarters of the fiscal year generally are lower than its revenues in the other two fiscal quarters. Typically, school-based book club and book fair revenues are greatest in the second quarter of the fiscal year, while revenues from the sale of instructional materials are highest in the first quarter. The Company experiences a substantial loss from operations in the first quarter of each fiscal year.
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Liquidity and Capital Resources
The Company’s cash and cash equivalents were $249.3 million at November 30, 2005, compared to $27.1 million at November 30, 2004 and $110.6 million at May 31, 2005.
Cash provided by operating activities was $185.9 million for the six months ended November 30, 2005, compared to $31.7 million in the prior fiscal year period. The increase from the prior fiscal year period was primarily due to higher Net income and favorable changes in working capital in the current fiscal year period. Accounts receivable, net increased by $66.9 million in the six months ended November 30, 2005, compared to an increase of $86.4 million in the prior fiscal year period, primarily due to lower revenues in the Company’s continuity programs. Accounts payable and other accrued expenses increased by $73.3 million during the six months ended November 30, 2005, compared to an increase of $7.2 million in the prior fiscal year period, due primarily to accrued expenses associated with Harry Potter. Accrued royalties increased by $73.9 million in the six months ended November 30, 2005, compared to an increase of $9.6 million in the prior fiscal year period, primarily due to royalties associated with higher Harry Potter revenues that will be paid later in fiscal 2006.
Cash used in investing activities was $81.3 million for the six months ended November 30, 2005, compared to $69.2 million in the prior fiscal year period. Additions to property, plant and equipment totaled $30.7 million for the six months ended November 30, 2005, an increase of $9.3 million over the prior fiscal year period, principally due to increased information technology spending. Acquisition-related payments totaled $3.3 million in the six months ended November 30, 2005 due to a contingent payment related to the acquisition of Klutz in fiscal 2002.
Cash provided by financing activities was $34.0 million in the six months ended November 30, 2005, compared to $46.4 million in the prior fiscal year period, due to the higher cash position at the beginning of the current fiscal year as compared to the beginning of the prior fiscal year, as well as the increase in current year cash provided by operating activities. Proceeds pursuant to employee stock-based plans totaled $24.8 million in the current fiscal year period, an increase of $20.5 million compared to $4.3 million in the prior fiscal year period.
Due to the seasonality of its business as discussed under “Seasonality” above, the Company experiences negative cash flow in the June through October time period. As a result of the Company’s business cycle, seasonal borrowings have historically increased during June, July and November, have generally peaked in September or October, and have been at their lowest point in May.
The Company believes its existing cash position, combined with funds generated from operations and available under the Credit Agreement and the Revolver, described in “Financing” below, will be sufficient to finance its ongoing working capital requirements. The Company anticipates refinancing its debt obligations prior to their respective maturity dates, including its outstanding 5.75% Notes due in January 2007, to the extent not paid through cash flow.
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Financing
On March 31, 2004, Scholastic Corporation and Scholastic Inc. entered into an unsecured revolving credit agreement with certain banks (the “Credit Agreement”), which replaced a similar loan agreement that was scheduled to expire in August 2004. The Credit Agreement, which expires on March 31, 2009, provides for aggregate borrowings of up to $190.0 million (with a right in certain circumstances to increase borrowings to $250.0 million), including the issuance of up to $10.0 million in letters of credit. Interest under this facility is either at the prime rate or at a rate equal to 0.325% to 0.975% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30% and a utilization fee ranging from 0.05% to 0.25% if borrowings exceed 50% of the total facility. The amounts charged vary based upon the Company’s credit rating. The interest rate, facility fee and utilization fee (when applicable) as of November 30, 2005 were 0.675% over LIBOR, 0.20% and 0.125%, respectively. The Credit Agreement contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. There were no borrowings outstanding under the Credit Agreement at November 30, 2005 and May 31, 2005. At November 30, 2004, $45.0 million was outstanding under the Credit Agreement at a weighted average interest rate of 2.5% .
Scholastic Corporation and Scholastic Inc. are joint and several borrowers under an unsecured revolving loan agreement with a bank (the “Revolver”). As amended effective April 30, 2004, the Revolver provides for unsecured revolving credit of up to $40.0 million and expires on March 31, 2009. Interest under this facility is either at the prime rate minus 1% or at a rate equal to 0.375% to 1.025% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30% . The amounts charged vary based upon the Company’s credit rating. The interest rate and facility fee as of November 30, 2005 were 0.725% over LIBOR and 0.20%, respectively. The Revolver contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. There were no borrowings outstanding under the Revolver at November 30, 2005 and May 31, 2005. At November 30, 2004, $6.1 million was outstanding under the Revolver at a weighted average interest rate of 2.4% .
Unsecured lines of credit available in local currencies to Scholastic Corporation’s international subsidiaries were, in the aggregate, equivalent to $76.4 million at November 30, 2005, as compared to $64.8 million at November 30, 2004 and $61.8 million at May 31, 2005. These lines are used primarily to fund local working capital needs. There were borrowings outstanding under these lines of credit equivalent to $41.3 million at November 30, 2005, as compared to $33.6 million at November 30, 2004 and $24.7 million at May 31, 2005. These lines of credit are considered short-term in nature. The weighted average interest rates on the outstanding amounts were 5.5% and 5.6% at November 30, 2005 and 2004, respectively, and 5.4% at May 31, 2005.
The Company’s total debt obligations at November 30, 2005 and 2004 were $514.9 million and $562.7 million, respectively. The Company’s total debt obligations at May 31, 2005 were $501.4 million. Through November 30, 2005, the Company had repurchased $2.0 million of its 5.75% Notes due 2007 on the open market. For a more complete description of the Company’s debt obligations, see Note 4 of Notes to Condensed Consolidated Financial Statements - Unaudited in Item 1, “Financial Statements.”
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements. These forward-looking statements are subject to various risks and uncertainties, including the conditions of the children’s book and educational materials markets and acceptance of the Company’s products within those markets, and other risks and factors identified in this Report, in the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2005, and from time to time in the Company’s other filings with the Securities and Exchange Commission (the “SEC”). Actual results could differ materially from those currently anticipated.
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The Company has operations in various foreign countries. In the normal course of business, these operations are exposed to fluctuations in currency values. Management believes that the impact of currency fluctuations does not represent a significant risk in the context of the Company’s current international operations. In the normal course of business, the Company’s operations outside the United States periodically enter into short-term forward contracts (generally not exceeding $20.0 million) to match selected purchases not denominated in their respective local currencies.
Market risks relating to the Company’s operations result primarily from changes in interest rates, which are managed through the mix of variable-rate versus fixed-rate borrowings. Additionally, financial instruments, including swap agreements, have been used to manage interest rate exposures. Approximately 8% of the Company’s debt at November 30, 2005 bore interest at a variable rate and was sensitive to changes in interest rates, compared to approximately 5% at May 31, 2005 and approximately 15% at November 30, 2004. The Company is subject to the risk that market interest rates will increase and thereby increase the interest charged under its variable-rate debt.
Additional information relating to the Company’s outstanding financial instruments is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Financing.”
The following table sets forth information about the Company’s debt instruments as of November 30, 2005 (see Note 4 of Notes to Condensed Consolidated Financial Statements - Unaudited in Item 1, “Financial Statements”):
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The Chief Executive Officer and the Chief Financial Officer of the Corporation, after conducting an evaluation, together with other members of the Company's management, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of November 30, 2005, have concluded that the Corporation’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Corporation in its reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and accumulated and communicated to members of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. There was no change in the Corporation’s internal control over financial reporting that occurred during the quarter ended November 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
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PART II – OTHER INFORMATION
The Annual Meeting of Stockholders of the Corporation was held on September 21, 2005 (the “Annual Meeting”). The following sets forth the results of the proposals presented at the Annual Meeting voted upon by the stockholders of the Corporation entitled to vote thereon:
Holders of the 1,656,200 outstanding shares of the Corporation’s Class A Stock voted in favor of electing Richard Robinson, Rebeca M. Barrera, Ramon C. Cortines, Charles T. Harris III, Andrew S. Hedden, Mae C. Jemison, Augustus K. Oliver and Richard M. Spaulding as directors to serve until the next annual meeting of the Corporation’s stockholders and until their respective successors are duly elected and qualified.
Holders of the Corporation’s Common Stock elected the following three nominees as directors to serve until the next annual meeting of the Corporation’s stockholders and until their respective successors are duly elected and qualified. Votes cast by holders of the Common Stock were:
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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