10-Q 1 a2076790z10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended February 28, 2002 Commission File No. 0-19860 SCHOLASTIC CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 13-3385513 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 557 BROADWAY, NEW YORK, NEW YORK 10012 (Address of principal executive offices) (Zip Code) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Title Number of shares outstanding of each class as of March 29, 2002 ------------- -------------------- Common Stock, $.01 par value 37,251,690 Class A Stock, $.01 par value 1,656,200
SCHOLASTIC CORPORATION FORM 10-Q FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 2002 INDEX ------------------------------------------------------------------------------------------------------------------- PART I - FINANCIAL INFORMATION PAGE Item 1. Financial Statements Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February 28, 2002 and 2001 1 Condensed Consolidated Balance Sheets at February 28, 2002 and 2001, and May 31, 2001 2 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February 28, 2002 and 2001 3 Notes to Condensed Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk 29 PART II - OTHER INFORMATION Item 1. Legal Proceedings 30 Item 6. Exhibits and Reports on Form 8-K 31 SIGNATURES 32 -------------------------------------------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SCHOLASTIC CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA)
============================================================================================================ THREE MONTHS ENDED NINE MONTHS ENDED FEBRUARY 28, FEBRUARY 28, ============================================================================================================ 2002 2001 2002 2001 ============================================================================================================ REVENUES $ 432.7 $ 433.0 $ 1,376.0 $ 1,463.4 Operating costs and expenses: Cost of goods sold 190.5 199.7 602.8 669.5 Selling, general and administrative expenses 194.9 187.3 598.4 600.6 Bad debt expense 11.0 19.9 51.6 52.3 Depreciation 9.5 6.3 25.4 19.6 Goodwill and other intangibles amortization 0.2 3.5 0.6 10.5 ------------------------------------------------------------------------------------------------------------ TOTAL OPERATING COSTS AND EXPENSES 406.1 416.7 1,278.8 1,352.5 Operating income 26.6 16.3 97.2 110.9 Interest expense, net 7.9 10.5 24.3 33.7 ------------------------------------------------------------------------------------------------------------ Income before income taxes and cumulative effect of accounting change 18.7 5.8 72.9 77.2 Provision for income taxes 6.8 2.1 26.2 27.8 ------------------------------------------------------------------------------------------------------------ Income before cumulative effect of accounting change 11.9 3.7 46.7 49.4 Cumulative effect of accounting change (net of income taxes) -- -- (5.2) -- ------------------------------------------------------------------------------------------------------------ NET INCOME $ 11.9 $ 3.7 $ 41.5 $ 49.4 ============================================================================================================ Net income per Class A and Common Share: Basic $ 0.32 $ 0.11 $ 1.15 $ 1.43 Diluted $ 0.31 $ 0.10 $ 1.09 $ 1.34 ============================================================================================================ ============================================================================================================
SEE ACCOMPANYING NOTES 1
SCHOLASTIC CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================================================== FEBRUARY 28, 2002 MAY 31, 2001 FEBRUARY 28, 2001 ================================================================================================================== (UNAUDITED) (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 12.6 $ 13.8 $ 11.9 Accounts receivable, net 233.9 220.7 242.8 Inventories 408.2 340.3 406.3 Deferred promotion costs 42.8 44.0 46.7 Deferred income taxes 87.6 89.3 58.4 Prepaid and other current assets 68.7 61.4 63.6 ------------------------------------------------------------------------------------------------------------------ TOTAL CURRENT ASSETS 853.8 769.5 829.7 Property, plant and equipment, net 278.3 257.3 223.6 Prepublication costs 109.5 103.3 138.6 Production costs 11.6 13.8 13.2 Goodwill 235.3 221.9 213.9 Other intangibles 61.3 61.9 62.9 Other assets and deferred charges 82.5 74.1 86.8 ------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $ 1,632.3 $ 1,501.8 $ 1,568.7 ================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Lines of credit and current portion of long-term debt $ 77.9 $ 23.3 $ 22.4 Accounts payable 136.1 157.3 136.3 Accrued royalties 69.5 45.7 97.3 Deferred revenue 34.4 12.1 29.6 Other accrued expenses 127.1 136.5 132.0 ------------------------------------------------------------------------------------------------------------------ TOTAL CURRENT LIABILITIES 445.0 374.9 417.6 NONCURRENT LIABILITIES: Long-term debt 471.2 585.3 596.7 Other noncurrent liabilities 48.1 47.9 48.1 ------------------------------------------------------------------------------------------------------------------ TOTAL NONCURRENT LIABILITIES 519.3 633.2 644.8 COMMITMENTS AND CONTINGENCIES -- -- -- STOCKHOLDERS' EQUITY: Preferred Stock, $1.00 par value -- -- -- Class A Stock, $.01 par value 0.0 0.0 0.0 Common Stock, $.01 par value 0.4 0.3 0.3 Additional paid-in capital 365.3 233.7 236.7 Deferred compensation (0.5) (0.2) (0.2) Accumulated other comprehensive loss (17.8) (16.4) (13.6) Retained earnings 320.6 279.1 292.2 Less shares of Common Stock held in treasury -- (2.8) (9.1) ------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY 668.0 493.7 506.3 ------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,632.3 $ 1,501.8 $ 1,568.7 ================================================================================================================== ================================================================================================================== SEE ACCOMPANYING NOTES
2 SCHOLASTIC CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED (AMOUNTS IN MILLIONS)
==================================================================================================================== NINE MONTHS ENDED FEBRUARY 28, ==================================================================================================================== 2002 2001 ==================================================================================================================== NET CASH PROVIDED BY OPERATING ACTIVITIES $ 65.5 $ 135.4 CASH FLOWS USED IN INVESTING ACTIVITIES: Additions to property, plant and equipment (46.5) (49.6) Prepublication costs (39.4) (36.6) Royalty advances (23.7) (19.3) Acquisition-related payments (13.1) (396.4) Production costs (10.5) (10.2) Other 0.2 (4.4) -------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (133.0) (516.5) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES: Borrowings under Loan Agreement and Revolver 666.8 454.4 Repayments of Loan Agreement and Revolver (620.6) (448.8) Borrowings under Grolier Facility -- 350.0 Repayment of Grolier Facility (300.0) -- Proceeds received from issuance of 5.75% Notes, net of related costs 296.7 -- Borrowings under lines of credit 110.2 78.0 Repayments of lines of credit (103.5) (70.1) Proceeds pursuant to employee stock plans 17.1 21.8 Other (0.4) (1.3) -------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 66.3 384.0 -------------------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (1.2) 2.9 Cash and cash equivalents at beginning of period 13.8 9.0 -------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 12.6 $ 11.9 ==================================================================================================================== ====================================================================================================================
SEE ACCOMPANYING NOTES 3 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements consist of the accounts of Scholastic Corporation and its wholly-owned subsidiaries (the "Company"), which include the consolidated accounts of Grolier Incorporated ("Grolier") and its subsidiaries as of the date of acquisition on June 22, 2000 (See Note 2). These financial statements have not been audited, but reflect those adjustments consisting of normal recurring items which 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 Report on Form 10-K for the fiscal year ended May 31, 2001, as well as the Current Reports on Form 8-K dated July 7, 2000, as amended on September 5, 2000, February 8, 2001 and January 22, 2002, filed in connection with the acquisition of Grolier. The Company's business is closely correlated to the school year. Consequently, the results of operations for the nine months ended February 28, 2002 and 2001 are not necessarily indicative of the results expected for the full year. Due to the seasonal fluctuations that occur, the February 28, 2001 condensed consolidated balance sheet is included for comparative purposes. The preparation of the financial statements, in accordance with accounting principles generally accepted in the United States, requires management to make estimates and assumptions that 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, which are necessary in order to form a basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from those estimates and assumptions. On an on-going basis, the Company evaluates its estimates which include, but are not limited to: collectability of accounts receivable; book returns; amortization periods; and recovery of inventories, deferred promotion costs, prepublication costs, royalty advances, production costs and long-lived assets. Certain prior year amounts have been reclassified in the accompanying condensed consolidated financial statements to conform to the current year presentation. NEW ACCOUNTING PRONOUNCEMENT In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 establishes a single accounting model, based upon the framework established in SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," for long-lived assets to be disposed of by sale and to address significant implementation issues. The Company is required to adopt this statement by the first quarter of fiscal 2003. The Company does not expect that the adoption of SFAS No. 144 will have a material impact on its financial position, results of operations or cash flows. 4 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ 2. ACQUISITION OF GROLIER On June 22, 2000, Scholastic Inc., a subsidiary of the Company, acquired all of the issued and outstanding capital stock of Grolier, a Delaware corporation, for $400.0 in cash. The acquisition was financed by the Company using bank debt, of which $350.0 was borrowed under a new facility and $50.0 was borrowed under the Company's existing credit facility. (See Note 4) Through the purchase of Grolier, the Company acquired the leading operator in the United States of direct-to-home continuity book clubs serving children primarily age five and under and the leading print and on-line publisher of children's non-fiction and reference products sold primarily to school libraries in the United States. The acquisition also expanded the Company's operations in the United Kingdom, Canada and Southeast Asia. In accordance with SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," the Company has analyzed economic characteristics, similarity of nature of products, similarity of the nature of production, class of customer and method of distribution of products of the acquired Grolier businesses. Accordingly, the Grolier businesses have been included in the following business segments: the domestic direct-to-home continuity and trade operations have been included in the Children's Book Publishing and Distribution segment; the children's reference and non-fiction operations have been included in the Educational Publishing segment; software operations have been included in the Media, Licensing and Advertising segment; and all international operations have been included in the International segment. The Grolier acquisition has been accounted for under the purchase method of accounting and, accordingly, the operating results of Grolier have been included in the Company's condensed consolidated results of operations since the date of acquisition. The assets and liabilities at the acquisition date were adjusted to their fair values, based upon an independent valuation, with the excess purchase price over the fair value assigned to goodwill. The valuation was finalized as of the end of fiscal 2001. With regard to any possible future adjustments to established liabilities, such adjustments will be included in the determination of net income. The following table sets forth the final allocation of the Grolier purchase price, based on the independent valuation, and includes the related transaction and financing costs:
================================================================== VALUE ================================================================== Accounts receivable $ 95.3 Inventory 45.5 Other current assets 58.5 Property, plant and equipment, net 18.9 Goodwill and other intangibles 231.8 Other assets 44.2 Current liabilities (85.6) Non-current liabilities (12.2) ----------------------------------------------------------------- CASH PAID FOR ACQUISITION, NET OF CASH RECEIVED $ 396.4 ================================================================
5 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ The following table sets forth the allocation of Goodwill and Other Intangibles resulting from the acquisition of Grolier:
=================================================================== VALUE =================================================================== Goodwill $ 170.2 ---------------------------------------------------------------- Titles 29.8 Licenses 17.8 Major sets 11.8 Customer lists 2.2 ---------------------------------------------------------------- Total other intangibles 61.6 ---------------------------------------------------------------- TOTAL GOODWILL AND OTHER INTANGIBLES $ 231.8 ================================================================
In connection with the Grolier acquisition, the Company established a plan for integrating Grolier's operations. Accordingly, the Company established liabilities of $17.7 relating primarily to severance, fringe benefits and related salary continuance, as well as certain exit costs associated with the integration and relocation of certain of Grolier's operational and administrative functions. This amount, originally estimated at $12.4, was increased at May 31, 2001 as the Company refined its estimate of the costs of the integration plan. As of February 28, 2002, $10.4 of these liabilities remained unpaid. Payment of these liabilities, which result from actions already taken, will be made over the next three years. A summary of the fiscal 2002 activity in the established reserves is detailed in the following table:
============================================================================================================ SEVERANCE AND RELATED COSTS OTHER EXIT COSTS TOTAL ============================================================================================================ Liability balance at May 31, 2001 $ 11.5 $ 3.2 $ 14.7 Fiscal year 2002 payments to date (3.9) (0.4) (4.3) ------------------------------------------------------------------------------------------------------------ Liability at February 28, 2002 $ 7.6 $ 2.8 $ 10.4 ============================================================================================================
6 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ The following table reflects the unaudited pro forma results of operations of the Company, giving effect to the acquisition of Grolier as if it was consummated as of the first day of the nine-month period ended February 28, 2001, including the effect of increased interest expense on debt related to the acquisition. Additionally, the nine-month period ended February 28, 2001 reflects the adoption of SFAS No. 142 ("Goodwill and Other Intangible Assets"), which resulted in a pro forma reduction of amortization expense. This information does not necessarily reflect the actual results of operations that would have occurred had the purchase been made at the beginning of the period presented, nor is it necessarily indicative of future results of operations of the combined companies.
NINE MONTHS ENDED FEBRUARY 28, =================================================================================================== 2002 2001 =================================================================================================== Revenues $ 1,376.0 $ 1,499.0 Net income before cumulative effect of accounting change $ 46.7 $ 57.5 Net income $ 41.5 $ 57.5 Net income per Class A and Common Share: Basic before cumulative effect of accounting change $ 1.30 $ 1.66 Diluted before cumulative effect of accounting change $ 1.22 $ 1.55 Basic net income $ 1.15 $ 1.66 Diluted net income $ 1.09 $ 1.55
7 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ 3. SEGMENT INFORMATION The Company is a global children's publishing and media company with operations in the United States, the United Kingdom, Canada, Australia, New Zealand, Mexico, Hong Kong, India, Ireland, Argentina and Southeast Asia, and 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, and trade. The Company's operations are categorized in the following four segments: CHILDREN'S BOOK PUBLISHING AND DISTRIBUTION; EDUCATIONAL PUBLISHING; MEDIA, LICENSING AND ADVERTISING; and INTERNATIONAL. Such segment 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. o CHILDREN'S BOOK PUBLISHING AND DISTRIBUTION 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. The direct-to-home continuity and trade businesses formerly operated by Grolier are incorporated in this segment from June 22, 2000, the date on which Grolier was acquired. o EDUCATIONAL PUBLISHING includes the publication and distribution to schools and libraries of supplemental and core materials, classroom magazines and print and on-line reference and non-fiction products for grades K to 12 in the United States. The reference and non-fiction business formerly operated by Grolier is included in this segment from June 22, 2000, the date on which Grolier was acquired. o MEDIA, LICENSING AND ADVERTISING includes the production and/or distribution in the United States of software, Internet services and the production and/or distribution by and through the Company's subsidiary, Scholastic Entertainment Inc. ("SEI"), of programming and consumer products (including children's television programming, videos, software, feature films, promotional activities and non-book merchandise). The software business formerly operated by Grolier is included in this segment from June 22, 2000, the date on which Grolier was acquired. o INTERNATIONAL includes the publication and distribution of products and services outside the United States by the Company's international operations and its domestic export and foreign rights businesses. The international businesses formerly operated by Grolier are included in this segment from June 22, 2000, the date on which Grolier was acquired. 8 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ The following table sets forth the Company's segment information for the periods indicated. Certain prior year amounts have been reclassified to conform with the current year presentation.
CHILDREN'S BOOK MEDIA, PUBLISHING LICENSING AND EDUCATIONAL AND TOTAL DISTRIBUTION PUBLISHING ADVERTISING OVERHEAD(1) DOMESTIC INTERNATIONAL CONSOLIDATED ==================================================================================================================== THREE MONTHS ENDED FEBRUARY 28, 2002 ==================================================================================================================== Revenues $ 268.9 $ 60.9 $ 32.4 $ 0.0 $ 362.2 $ 70.5 $ 432.7 Bad debt (3) 7.9 0.3 0.5 0.0 8.7 2.3 11.0 Depreciation 1.7 0.5 1.4 4.8 8.4 1.1 9.5 Amortization (2) 4.7 4.8 2.7 0.0 12.2 0.0 12.2 Royalty advances expensed 5.0 0.2 0.0 0.0 5.2 0.0 5.2 Segment profit/(loss)(3) 43.1 (1.6) (3.3) (14.6) 23.6 3.0 26.6 Expenditures for long-lived assets (4) 9.8 16.5 7.9 11.5 45.7 0.9 46.6 ==================================================================================================================== THREE MONTHS ENDED FEBRUARY 28, 2001 ==================================================================================================================== Revenues $ 266.4 $ 59.4 $ 35.6 $ 0.0 $ 361.4 $ 71.6 $ 433.0 Bad debt 17.0 0.4 0.7 0.0 18.1 1.8 19.9 Depreciation 1.1 0.5 0.2 3.4 5.2 1.1 6.3 Amortization (2) 4.9 12.4 6.7 0.1 24.1 1.0 25.1 Royalty advances expensed 4.0 0.3 0.3 0.0 4.6 0.0 4.6 Segment profit/(loss)(3) 39.3 (7.8) (3.3) (14.2) 14.0 2.3 16.3 Expenditures for long-lived assets (4) 10.8 10.6 4.8 15.6 41.8 1.0 42.8 ==================================================================================================================== NINE MONTHS ENDED FEBRUARY 28, 2002 ==================================================================================================================== Revenues $ 836.9 $ 225.9 $ 98.3 $ 0.0 $ 1,161.1 $ 214.9 $ 1,376.0 Bad debt (3) 43.2 0.9 1.9 0.0 46.0 5.6 51.6 Depreciation 4.4 1.3 3.3 13.1 22.1 3.3 25.4 Amortization (2) 12.7 17.1 14.9 0.0 44.7 0.6 45.3 Royalty advances expensed 13.4 1.0 0.6 0.0 15.0 0.0 15.0 Segment profit/(loss)(3) 118.0 25.3 (11.8) (42.6) 88.9 8.3 97.2 Segment assets 725.8 262.2 76.7 353.6 1,418.3 214.0 1,632.3 Goodwill 110.9 77.4 9.4 4.6 202.3 33.0 235.3 Long-lived assets (5) 258.1 173.6 44.7 213.8 690.2 60.0 750.2 Expenditures for long-lived assets (4) 48.0 32.0 23.9 24.6 128.5 4.7 133.2 ==================================================================================================================== NINE MONTHS ENDED FEBRUARY 28, 2001 ==================================================================================================================== Revenues $ 918.5 $ 226.2 $ 101.4 $ 0.0 $ 1,246.1 $ 217.3 $ 1,463.4 Bad debt 43.7 0.7 1.7 0.0 46.1 6.2 52.3 Depreciation 3.2 1.3 2.4 9.6 16.5 3.1 19.6 Amortization (2) 13.3 38.1 13.6 0.1 65.1 2.1 67.2 Royalty advances expensed 15.5 1.3 1.4 0.0 18.2 0.3 18.5 Segment profit/(loss)(3) 157.5 (1.4) (13.6) (43.4) 99.1 11.8 110.9 Segment assets 699.2 286.3 72.4 285.0 1,342.9 225.8 1,568.7 Goodwill 101.7 65.9 8.6 4.3 180.1 33.4 213.9 Long-lived assets (5) 236.6 190.3 40.0 177.5 644.4 59.7 704.1 Expenditures for long-lived assets (4) 251.0 169.5 15.7 50.1 486.3 25.8 512.1
9 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ (1) OVERHEAD INCLUDES ALL DOMESTIC CORPORATE-RELATED ITEMS NOT ALLOCATED TO REPORTABLE SEGMENTS WHICH INCLUDES UNALLOCATED EXPENSES AND COSTS RELATED TO THE MANAGEMENT OF CORPORATE ASSETS. UNALLOCATED ASSETS ARE PRINCIPALLY COMPRISED OF DEFERRED INCOME TAXES AND PROPERTY, PLANT AND EQUIPMENT RELATED TO THE COMPANY'S HEADQUARTERS IN THE METROPOLITAN NEW YORK AREA, ITS NATIONAL SERVICE OPERATION LOCATED IN MISSOURI AND AN INDUSTRIAL/OFFICE BUILDING COMPLEX IN CONNECTICUT. (2) IN FISCAL 2002, INCLUDES AMORTIZATION OF OTHER INTANGIBLES WITH DEFINITE LIVES, PREPUBLICATION AND PRODUCTION COSTS. IN FISCAL 2001, INCLUDES AMORTIZATION OF GOODWILL, OTHER INTANGIBLES, PREPUBLICATION AND PRODUCTION COSTS. (3) SEGMENT PROFIT/(LOSS) REPRESENTS EARNINGS BEFORE INTEREST AND INCOME TAXES. IN THE NINE MONTHS ENDED FEBRUARY 28, 2002, IT EXCLUDES THE CUMULATIVE EFFECT OF ACCOUNTING CHANGE OF $5.2 ($0.13 PER DILUTED SHARE) RELATED TO THE MEDIA, LICENSING AND ADVERTISING SEGMENT ). IN THE THREE- AND NINE-MONTH PERIODS ENDED FEBRUARY 28, 2002, CHILDREN'S BOOK PUBLISHING AND DISTRIBUTION INCLUDES THE NET EFFECT OF THE REDUCTION IN BAD DEBT EXPENSE OF $3.9 ($0.10 PER DILUTED SHARE), RESULTING FROM THE REFINEMENT OF THE BAD DEBT RESERVE. IN THE THREE-MONTH PERIOD ENDED FEBRUARY 28, 2001, CHILDREN'S BOOK PUBLISHING AND DISTRIBUTION INCLUDES THE NET EFFECT OF THE CHANGES IN SALES RETURNS ESTIMATES WHICH RESULTED IN AN INCREASE TO NET INCOME OF $3.6 ($0.10 PER DILUTED SHARE). (4) INCLUDES EXPENDITURES FOR PROPERTY, PLANT AND EQUIPMENT, INVESTMENTS IN PREPUBLICATION AND PRODUCTION COSTS, ROYALTY ADVANCES AND ACQUISITIONS OF BUSINESSES. (5) INCLUDES PROPERTY, PLANT AND EQUIPMENT, PREPUBLICATION COSTS, GOODWILL, OTHER INTANGIBLES, ROYALTY ADVANCES AND PRODUCTION COSTS. The following table separately sets forth information for the U.S. direct-to-home continuity business formerly operated by Grolier, which, effective June 22, 2000, is included in the Children's Book Publishing and Distribution segment, and for all other businesses included in the segment:
============================================================= THREE MONTHS ENDED FEBRUARY 28, ============================================================= Direct-to-home All Other Total 2002 2001 2002 2001 2002 2001 ---- ---- ---- ---- ---- ---- Revenues $ 47.1 $ 58.0 $ 221.8 $ 208.4 $ 268.9 $ 266.4 Bad debt (2) 3.3 11.4 4.6 5.6 7.9 17.0 Depreciation 0.1 0.0 1.6 1.1 1.7 1.1 Amortization (1) 0.4 2.6 4.3 2.3 4.7 4.9 Royalty advances expensed 0.0 0.2 5.0 3.8 5.0 4.0 Business profit (2) 10.7 5.3 32.4 34.0 43.1 39.3 Expenditures for long-lived assets (3) 1.1 0.5 8.7 10.3 9.8 10.8 ============================================================= NINE MONTHS ENDED FEBRUARY 28, ============================================================= Direct-to-home All Other Total 2002 2001 2002 2001 2002 2001 ---- ---- ---- ---- ---- ---- Revenues $ 157.6 $ 161.9 $ 679.3 $ 756.6 $ 836.9 $ 918.5 Bad debt (2) 27.6 30.8 15.6 12.9 43.2 43.7 Depreciation 0.2 0.2 4.2 3.0 4.4 3.2 Amortization (1) 1.1 3.6 11.6 9.7 12.7 13.3 Royalty advances expensed 1.2 0.6 12.2 14.9 13.4 15.5 Business profit (2) 21.0 11.5 97.0 146.0 118.0 157.5 Business assets 245.6 247.4 480.2 451.8 725.8 699.2 Goodwill 86.1 80.6 24.8 20.7 110.9 101.7 Long-lived assets (4) 135.9 132.0 122.2 104.6 258.1 236.6 Expenditures for long-lived assets (3) 3.3 210.1 44.7 40.9 48.0 251.0
(1) IN FISCAL 2002, INCLUDES AMORTIZATION OF OTHER INTANGIBLES WITH DEFINITE LIVES AND PREPUBLICATION COSTS. IN FISCAL 2001, INCLUDES AMORTIZATION OF GOODWILL, OTHER INTANGIBLES, AND PREPUBLICATION COSTS. (2) BUSINESS PROFIT REPRESENTS EARNINGS BEFORE INTEREST AND INCOME TAXES. IN THE THREE- AND NINE-MONTH PERIODS ENDED FEBRUARY 28, 2002, DIRECT-TO- HOME INCLUDES THE NET EFFECT OF THE REDUCTION IN BAD DEBT EXPENSE OF $3.9 ($0.10 PRE DILUTED SHARES), RESULTING FROM THE COMPANY'S REFINEMENT OF THE BAD DEBT RESERVE. IN THE THREE-MONTH PERIOD ENDED FEBRUARY 28, 2001, "ALL OTHER" INCLUDES THE NET EFFECT OF THE CHANGES IN SALES RETURNS ESTIMATES WHICH RESULTED IN AN INCREASE TO NET INCOME OF $3.6 ($0.10 PER DILUTED SHARE). (3) INCLUDES EXPENDITURES FOR PROPERTY, PLANT AND EQUIPMENT, INVESTMENTS IN PREPUBLICATION COSTS, ROYALTY ADVANCES AND ACQUISITIONS OF BUSINESSES. (4) INCLUDES PROPERTY, PLANT AND EQUIPMENT, PREPUBLICATION COSTS, GOODWILL, OTHER INTANGIBLES AND ROYALTY ADVANCES. 10
SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) =================================================================================================================== 4. DEBT The following table sets forth the Company's debt balances as of the dates indicated: ================================================================================================================= FEBRUARY 28, 2002 MAY 31, 2001 FEBRUARY 28, 2001 ================================================================================================================= Lines of Credit $ 27.9 $ 23.1 $ 22.4 Grolier Facility 50.0 350.0 350.0 Loan Agreement and Revolver 46.3 -- 11.2 7% Notes due 2003, net of discount 124.9 124.9 124.9 5.75% Notes due 2007, net of discount 299.6 -- -- Convertible Subordinated Debentures -- 110.0 110.0 Other debt 0.4 0.6 0.6 ----------------------------------------------------------------------------------------------------------------- TOTAL DEBT 549.1 608.6 619.1 Less current portion of long-term debt and lines of credit (77.9) (23.3) (22.4) ----------------------------------------------------------------------------------------------------------------- TOTAL LONG-TERM DEBT $ 471.2 $ 585.3 $ 596.7 =================================================================================================================
The following table sets forth the maturities of the Company's debt obligations for the remainder of fiscal 2002 and the next five fiscal years:
================================================================================ MAY 31, ================================================================================ Three-month period ending: 2002 $ 27.9 Fiscal years ending: 2003 50.0 2004 125.3 2005 46.3 2006 -- THEREAFTER 299.6 ------------------------------- Total $ 549.1 ===============================
GROLIER FACILITY. On June 22, 2000, the Company established a new credit facility (the "Grolier Facility") to finance $350.0 of the $400.0 Grolier purchase price. The Grolier Facility expires on June 21, 2002. Scholastic Inc. is the borrower, and the Company is the guarantor. Borrowings bear interest at the prime rate, or 0.39% to 1.10% over LIBOR (as defined). The Grolier Facility also provides for a facility fee ranging from 0.085% to 0.25%, based on the Company's credit rating. Based on the Company's current credit rating, the interest rate and facility fee as of February 28, 2002 were 0.575% over LIBOR and 0.125%, respectively. The Grolier Facility contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. At February 28, 2002, $50.0 was outstanding under the Grolier Facility and no additional borrowings were available. The net proceeds from the issuance of the 5.75% Notes in January 2002 were used to repay a portion of the Grolier Facility (see 5.75% Notes due 2007 below). 11 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ LOAN AGREEMENT. The Company and Scholastic Inc. are joint and several borrowers under an amended and restated loan agreement with certain banks, effective August 11, 1999 and amended June 22, 2000 (the "Loan Agreement"). The Loan Agreement, which expires on August 11, 2004, provides for aggregate borrowings of up to $170.0 (with a right in certain circumstances to increase borrowings to $200.0), including the issuance of up to $10.0 in letters of credit, of which none was outstanding at February 28, 2002. Interest under this facility is either at the prime rate or 0.325% to 0.90% 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 0.15% if borrowings exceed 33% of the total facility. The amounts charged vary based upon the Company's credit rating. Based on the Company's current credit rating, the interest rate, facility fee and utilization fee (when applicable) as of February 28, 2002 were 0.475% over LIBOR, 0.150% and 0.075%, respectively. The Loan Agreement contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. At February 28, 2002, $40.0 was outstanding under the Loan Agreement. REVOLVER. The Company and Scholastic Inc. are joint and several borrowers under a Revolving Loan Agreement with a bank, effective November 10, 1999 and amended June 22, 2000 (the "Revolver"). It provides for unsecured revolving credit loans of up to $40.0 and expires on August 11, 2004. Interest under this facility is at the prime rate minus 1% or 0.325% to 0.90% 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. Based on the Company's current credit rating, the interest rate and facility fee as of February 28, 2002 were 0.475% over LIBOR and 0.150%, respectively. The Revolver has certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. At February 28, 2002, $6.3 was outstanding under the Revolver. 7% NOTES DUE 2003. On December 23, 1996, the Company issued $125.0 of 7% Notes (the "Notes"). The Notes are unsecured and unsubordinated obligations of the Company and will mature on December 15, 2003. The Notes are not redeemable prior to maturity. Interest on the Notes is payable semi-annually on December 15 and June 15 of each year. 5.75% NOTES DUE 2007. On January 23, 2002, the Company issued $300.0 of 5.75% Notes (the "5.75% Notes"). The 5.75% Notes are unsecured and unsubordinated obligations of the Company and will 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 a) 100% of the principal amount, or b) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption on a semiannual basis. The net proceeds were used to permanently repay a portion of the $350.0 Grolier Facility. INTEREST RATE SWAP AGREEMENT. On February 5, 2002, the Company entered into an interest rate swap agreement, designated as a fair value hedge as defined under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," with a notional amount totaling $100.0 and a variable interest rate which is reset semi-annually based on six-month LIBOR (as defined). This agreement was entered into to exchange the fixed interest rate on a portion of the Company's 5.75% Notes for a variable interest rate. In accordance with SFAS No. 133, the value of the Company's 5.75% Notes was increased by $0.9 to reflect an increase in the fair value as of February 28, 2002 and the corresponding swap asset of $0.9 was recorded in Other assets. Changes in the fair value of the interest rate swap offset changes in the fair value of the fixed rate debt due to changes in market interest rates. As such, there was no ineffective portion to the hedge recognized in earnings during the period. 12 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ CONVERTIBLE SUBORDINATED DEBENTURES. On August 18, 1995, the Company sold $110.0 of its 5.0% Convertible Subordinated Debentures due August 15, 2005 (the "Debentures"). Effective January 11, 2002, pursuant to a Notice of Redemption issued by the Company on November 29, 2001, $109.8 of the Debentures were converted into 2.9 shares of common stock and $0.2 was redeemed for cash. 5. CONTINGENCIES As previously reported, three purported class action complaints were filed in the United States District for the Southern District of New York against the Company and certain officers seeking, among other remedies, damages resulting from defendants' alleged violations of federal securities laws. The complaints were consolidated. The Consolidated Amended Class Action Complaint (the "Complaint") was served and filed on August 13, 1997. The Complaint was styled as a class action, In re Scholastic Corporation Securities Litigation, 97 Civ.II 2447 (JFK), on behalf of all persons who purchased Company common stock from December 10, 1996 through February 20, 1997. The Complaint alleged, among other things, violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, resulting from purportedly materially false and misleading statements to the investing public concerning the financial condition of the Company. Specifically, the Complaint alleged misstatements and omissions by the Company pertaining to adverse sales and returns of its popular Goosebumps(R) book series prior to the Company's interim earnings announcement on February 20, 1997. On January 26, 2000, an order was entered granting the Company's motion to dismiss plaintiffs' Second Amended Consolidated Complaint without leave to further amend the complaint. Previously, on December 14, 1998, an order was entered granting the Company's motion to dismiss plaintiffs' First Amended Consolidated Complaint, with leave to amend the complaint. On June 1, 2001, the Court of Appeals for the Second Circuit reversed the dismissal of the Second Amended Consolidated Complaint and remanded the case for further proceedings. On December 10, 2001, the Supreme Court of the United States denied the Company's Petition for a Writ of Certiorari to review the Second Circuit's decision. The Company continues to believe that the litigation is without merit and will continue to vigorously defend against it. As previously reported, on February 1, 1999, two subsidiaries of the Company commenced an action in the Supreme Court of the State of New York, New York County, against Parachute Press, Inc. ("Parachute"), the licensor of certain publication and nonpublication rights to the Goosebumps series, certain affiliated Parachute companies and R.L. Stine, individually, alleging material breach of contract and fraud in connection with the agreements under which such Goosebumps rights are licensed to the Company. The issues in the case, captioned Scholastic Inc. and Scholastic Entertainment Inc. v. Parachute Press, Inc., Parachute Publishing, LLC, Parachute Consumer Products, LLC, and R.L. Stine (Index No. 99/600512), are also, in part, the subject of two litigations commenced by Parachute following repeated notices from the Company to Parachute of material breaches by Parachute of the agreements under which such rights are licensed, and the exercise by the Company of its contractual remedies under the agreements. The previously reported first Parachute action, Parachute Press, Inc. v. 13 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ Scholastic Inc., Scholastic Productions, Inc. and Scholastic Entertainment Inc., 97 Civ. 8510 (JFK), in which two subsidiaries of the Company are defendants and counterclaim plaintiffs, was commenced in the federal court for the Southern District of New York on November 14, 1997 and was dismissed for lack of subject matter jurisdiction on January 29, 1999. In August 2000, the Court of Appeals for the Second Circuit vacated the dismissal and remanded the case for further proceedings. The second action, captioned Parachute Press, Inc. v. Scholastic Inc., Scholastic Productions, Inc. and Scholastic Entertainment Inc. (Index No. 99/600507), was filed contemporaneously with the filing of the Company's complaint on February 1, 1999 in the Supreme Court of the State of New York, New York County. In its two complaints and its counterclaims, Parachute alleges that the exercise of contractual remedies by the Company was improper and seeks declaratory relief and unspecified damages for, among other claims, alleged breaches of contract and acts of unfair competition. Damages sought by Parachute include the payment of the total of approximately $36.1 of advances over the term of the contract, of which approximately $15.3 had been paid at the time the first Parachute litigation began and payment of royalties set-off by Scholastic against amounts claimed by the Company. On July 21, 2000, the Company and Parachute each filed motions for partial summary judgment in the pending state court cases, which on April 4, 2002 were denied in all material respects. On May 18, 2001, each party filed motions for summary judgment in the federal court case. The Company is seeking declaratory relief and damages for, among other claims, breaches of contract, fraud and acts of unfair competition. Damages sought by the Company include repayment by Parachute of a portion of the $15.3 advance already paid. The Company intends to vigorously defend its position in these proceedings. The Company does not believe that this dispute will have a material adverse effect on its financial condition. In addition to the above actions, various claims and lawsuits arising in the normal course of business are pending against the Company. The results of these proceedings are not expected to have a material adverse effect on the Company's consolidated financial position or results of operations 6. COMPREHENSIVE INCOME The following table sets forth comprehensive income for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED =========================================================================================================================== FEBRUARY 28, 2002 2001 2002 2001 =========================================================================================================================== Net income $ 11.9 $ 3.7 $ 41.5 $ 49.4 Other comprehensive (loss)/income: Foreign currency translation adjustment net of provision for income taxes (2.2) 1.5 (1.4) (2.5) --------------------------------------------------------------------------------------------------------------------------- COMPREHENSIVE INCOME $ 9.7 $ 5.2 $ 40.1 $ 46.9 ===========================================================================================================================
14 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ 7. EARNINGS PER SHARE Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated to give effect to potentially dilutive stock options and Debentures 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 ("EPS") computations for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED ============================================================================================================= FEBRUARY 28, 2002 2001 2002 2001 ============================================================================================================= Net income for basic EPS $ 11.9 $ 3.7 $ 41.5 $ 49.4 Dilutive effect of Debentures 0.4 -- (1) 2.1 2.6 ------------------------------------------------------------------------------------------------------------- Adjusted net income for diluted EPS $ 12.3 $ 3.7 $ 43.6 $ 52.0 ============================================================================================================= Weighted average Class A and Common Shares outstanding for basic EPS 37.3 35.0 36.0 34.5 Dilutive effect of shares issued pursuant to employee stock plans 1.7 1.7 1.5 1.4 Dilutive effect of Debentures 1.3 -- (1) 2.4 2.9 ------------------------------------------------------------------------------------------------------------- Adjusted weighted average Class A and Common Shares for diluted EPS outstanding 40.3 36.7 39.9 38.8 ============================================================================================================= Earnings per Class A and Common Share: Earnings before cumulative effect of accounting change Basic $ 0.32 $ 0.11 $ 1.30 $ 1.43 Diluted $ 0.31 $ 0.10 $ 1.22 $ 1.34 Cumulative effect of accounting change (net of income taxes) Basic -- -- $ (0.15) -- Diluted -- -- $ (0.13) -- Net income Basic $ 0.32 $ 0.11 $ 1.15 $ 1.43 Diluted $ 0.31 $ 0.10 $ 1.09 $ 1.34 =============================================================================================================
(1) THE EFFECT OF THE DEBENTURES ON THE WEIGHTED AVERAGE SHARES OUTSTANDING FOR DILUTED EPS WAS ANTI-DILUTIVE AND NOT INCLUDED IN THE CALCULATION. 15 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) ================================================================================ 8. GOODWILL AND OTHER INTANGIBLES Effective as of June 1, 2001, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and other intangible assets with indefinite lives are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise. During the quarter ended November 30, 2001, the Company completed the required transitional impairment review of goodwill. This review required the Company to estimate the fair value of its identified reporting units as of June 1, 2001. For each of the reporting units, the estimated fair value was determined utilizing the expected present value of the future cash flows of the units. In all instances, the estimated fair value of the reporting units exceeded their book values and therefore no write-down of goodwill was required as of June 1, 2001. The following table reflects unaudited pro forma results of operations of the Company, giving effect to SFAS No. 142 as if it were adopted on June 1, 2000:
NINE MONTHS ENDED FEBRUARY 28, ============================================================================================================ 2002 2001 ============================================================================================================ Net income, as reported $ 41.5 $ 49.4 Add back: amortization expense, net of tax - 6.1 -------------------------------------------------------------------- -------------------- -------------------- Pro forma net income $ 41.5 $ 55.5 Basic net income per Class A and Common Share: As reported $ 1.15 $ 1.43 Pro forma $ 1.15 $ 1.60 Diluted net income per Class A and Common Share: As reported $ 1.09 $ 1.34 Pro forma $ 1.09 $ 1.50 ============================================================================================================
The following table summarizes the activity in Goodwill for the periods indicated: ===================================================================================================================== NINE MONTHS ENDED TWELVE MONTHS ENDED NINE MONTHS ENDED FEBRUARY 28, 2002 MAY 31, 2001 FEBRUARY 28, 2001 ===================================================================================================================== Beginning balance $ 221.9 $ 63.5 $ 63.5 Additions due to acquisitions 13.1 169.9 158.6 Amortization - (10.3) (7.3) Other, principally translation adjustments 0.3 (1.2) (0.9) --------------------------------------------------------------------------------------------------------------------- TOTAL $ 235.3 $ 221.9 $ 213.9 =====================================================================================================================
The following table summarizes Other intangibles subject to amortization at the dates indicated: ===================================================================================================================== FEBRUARY 28, 2002 MAY 31, 2001 FEBRUARY 28, 2001 ===================================================================================================================== Customer lists $ 2.2 $ 2.2 $ 2.2 Accumulated amortization (1.8) (1.3) (0.9) --------------------------------------------------------------------------------------------------------------------- Net customer lists $ 0.4 $ 0.9 $ 1.3 Other intangibles 3.9 3.9 3.9 Accumulated amortization (2.1) (2.0) (1.9) --------------------------------------------------------------------------------------------------------------------- Net other intangibles $ 1.8 $ 1.9 $ 2.0 --------------------------------------------------------------------------------------------------------------------- TOTAL $ 2.2 $ 2.8 $ 3.3 =====================================================================================================================
16 SCHOLASTIC CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA) =================================================================================================================== The following table summarizes Other intangibles not subject to amortization at the dates indicated: ============================================================================================================== FEBRUARY 28, 2002 MAY 31, 2001 FEBRUARY 28, 2001 ============================================================================================================== Net carrying value by major class: Titles $ 28.7 $ 28.7 $ 29.0 Licenses 17.2 17.2 17.3 Major sets 11.4 11.4 11.5 Trademarks and Other 1.8 1.8 1.8 -------------------------------------------------------------------------------------------------------------- TOTAL $ 59.1 $ 59.1 $ 59.6 ==============================================================================================================
Amortization expense for Other intangibles totaled $0.2 and $0.6 for the three and nine months ended February 28, 2002, respectively, and $1.1 and $3.2 for the three and nine months ended February 28, 2001, respectively. Amortization expense for the twelve months ended May 31, 2001 totaled $3.9. 9. CUMULATIVE EFFECT OF ACCOUNTING CHANGE On June 1, 2001, the Company adopted Statement of Position No. 00-2 ("SOP 00-2"), "Accounting by Producers and Distributors of Films," which replaced SFAS No. 53, "Financial Reporting by Producers and Distributors of Motion Picture Films." SOP 00-2 provides that film costs should be accounted for under an inventory model and discusses various topics such as revenue recognition and accounting for exploitation costs and impairment assessment. In addition, SOP 00-2 establishes criteria for which revenues should be included in the Company's ultimate revenue projections. The Company recognizes revenue from its film licensing arrangements when the film is complete and delivered, the license period has begun, the fee is fixed or determinable and collection is reasonably assured. Costs of producing film and acquiring film distribution rights are capitalized and amortized using the individual-film-forecast method. This method amortizes such residual costs in the same ratio that current period revenue bears to estimated remaining unrecognized revenue as of the beginning of the fiscal year. All exploitation costs are expensed as incurred. As a result of the adoption of SOP 00-2, the Company recorded a charge of $5.2, net of tax, in the first quarter of fiscal 2002, to reduce the carrying value of its film production costs. This charge is reflected in the Company's condensed consolidated statements of operations as a cumulative effect of accounting change and is attributed entirely to the Media, Licensing and Advertising segment. Management estimates that 100% of the costs of its unamortized films will be amortized over the next three years. 10. SUBSEQUENT EVENT On April 8, 2002, the Company acquired the shares of Klutz, a publisher and creator of "books plus" products for children, from Corus Entertainment, Inc. The Company's initial payment was $42.8 in cash. The agreement provides for additional payments of up to $31.3 to be made to the seller in 2004 and 2005, contingent upon the achievement of certain revenue thresholds for Klutz. 17 SCHOLASTIC CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A") ================================================================================ CRITICAL ACCOUNTING POLICIES AND ESTIMATES GENERAL: 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 requires management to make estimates and assumptions that 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, which are necessary in order to form a basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from those estimates and assumptions. On an on-going basis, the Company evaluates its estimates which include, but are not limited to: collectability of accounts receivable; book returns; amortization periods; and recovery of inventories, deferred promotion costs, prepublication costs, royalty advances, production costs and long-lived assets. The Company has identified the following policies as critical to its business operations and the understanding of its results of operations: REVENUE RECOGNITION: The Company's revenue recognition policies for its principal businesses are as follows: TRADE - Revenue from the sale of children's books to bookstores and mass merchandisers primarily is recognized at the time of shipment, which generally is when title transfers to the customer. A reserve for estimated returns is established at the time of sale, based on historical experience, and recorded as a reduction to revenue. Actual returns are charged to the reserve as received. Actual returns could differ materially from the Company's estimate, and may result in a revision to net revenue. CONTINUITIES - The Company operates continuity programs in which customers generally place a single order and receive more than one shipment of books over a period of time. Revenue from continuities is recognized at the time of shipment or upon customer acceptance. Reserves for estimated returns are established at the time of sale, based on historical experience, and recorded as a reduction to revenue. Actual returns are charged to the reserve as received. Actual returns could differ materially from the Company's estimate, and may result in a revision to net revenue. SCHOOL-BASED BOOK CLUBS - Revenue from school-based book clubs is recognized upon shipment of the products. SCHOOL-BASED BOOK FAIRS - Revenue from school-based book fairs is recognized ratably as the book fair occurs. 18 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ FILM PRODUCTION AND LICENSING - Revenue from the sale of film rights, principally for the home video and domestic and foreign syndicated television markets, is recognized when the film has been delivered and is available for showing or exploitation. Licensing revenue is recorded in accordance with royalty agreements, at the time characters are available to the licensee and collections are reasonably assured. These policies are compliant with Statement of Position 00-2, "Accounting by Producers and Distributors of Films" ("SOP 00-2"), issued in June 2000, which the Company adopted in June 2001. (See Note 9 in the Notes to Condensed Consolidated Financial Statements.) ACCOUNTS RECEIVABLE, NET: Accounts receivable are shown net of allowance for doubtful accounts and reserve for returns. In the normal course of business, the Company extends credit to customers that satisfy predefined credit criteria. The Company is required to estimate the collectability of its receivables. Judgment is required in determining the ultimate realization of these receivables, including the current credit-worthiness of each customer. Significant revisions to bad debt expense and the related allowance for doubtful accounts have been recorded and may occur in the future. INVENTORIES: Inventories, consisting principally of books, are stated at the lower of cost, using the first-in, first-out method, or market. The Company records a reserve for excess and obsolete inventory based primarily upon historical and forecasted demand for its products. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. DEFERRED PROMOTION COSTS: Deferred promotion costs represent direct mail and telemarketing promotion costs incurred to acquire customers in the Company's continuity businesses and classroom magazine subscriptions. Promotional costs are deferred when incurred, and amortized in the proportion that current revenues bear to estimated total revenues. The Company regularly evaluates the operating performance of the promotions over their life cycle based on historical and forecasted demand. Based on this evaluation, adjustments may be required to promotional expense. PREPUBLICATION COSTS: The Company capitalizes prepublication costs, consisting primarily of art, prepress and editorial expenses incurred in the creation of the master copy of a book or other media. Prepublication costs are amortized over the product life cycle on a straight-line basis over a three- to seven-year period, commencing with publication. The Company regularly evaluates the profitability of the products over their life cycle based on historical and forecasted demand. Based on this evaluation, adjustments may be required to amortization expense. 19 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ GOODWILL AND OTHER INTANGIBLES: In accordance with Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"), goodwill and other intangible assets with indefinite lives are no longer amortized. The Company reviews its goodwill and non-amortizable intangibles on an annual basis for impairment, or more frequently if impairment indicators arise. The impairment review process entails determining the future cash flows for the Company's identified reporting units and comparing those cash flows to the reporting units' carrying values. The determination of cash flows requires management to make significant estimates and assumptions about its reporting units' future operating performance. Actual operating results could differ materially from those estimates and assumptions. The Company's judgment regarding the existence of impairment indicators is based on legal factors, market conditions and operational performance of the acquired businesses. Future events could cause the Company to conclude that impairment indicators exist and result in an impairment charge to goodwill and/or non-amortizable intangibles. (See Note 8 in the Notes to Condensed Consolidated Financial Statements.) RESULTS OF OPERATIONS - CONSOLIDATED Revenues for the quarter ended February 28, 2002 of $432.7 million were nearly level with revenues of $433.0 million in the third quarter of the prior fiscal year. School-based book club and school-based book fair revenues for the quarter increased by $15.8 million and $11.4 million, respectively, over the prior year quarter. The school-based book club revenue increase primarily reflected the impact of higher order volume. The school-based book fair revenue increase was due to increased revenue per fair as well as a higher number of fairs. The elimination of less profitable programs in the direct-to-home continuity business resulted in a decrease in revenues of $10.9 million to $47.1 million for the quarter ended February 28, 2002, as compared to revenues of $58.0 million in the prior year quarter. Also, lower enrollments from the school-based continuity programs contributed to a decrease of $7.0 million in revenues for the current year quarter as compared to the prior year quarter. The year ago quarter benefited from strong sales of HARRY POTTER(R) titles, which provided approximately $25 million in revenues (including approximately $12 million from the launch of the HARRY POTTER companion books, the net proceeds of which were donated to a charity at the request of author J.K. Rowling), as compared to approximately $17 million in the current year quarter. For the nine months ended February 28, 2002, revenues decreased 6.0% to $1,376.0 million from $1,463.4 million in the prior year period. In the year ago period, the Company benefited from strong sales of HARRY POTTER books, fueled by the successful domestic trade release of HARRY POTTER AND THE GOBLET OF FIRE, totaling approximately $190 million as compared to approximately $70 million in the current fiscal period. Also contributing to the revenue decrease was the Company's decision not to update SCHOLASTIC LITERACY PLACE(R), which resulted in a decrease of $12.8 million to $38.3 million in the current fiscal period, from $51.1 million in the prior year. These anticipated declines were partially offset by strong growth in school-based book fairs and school-based book clubs of $24.2 million and $23.1 million, respectively. 20 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ Cost of goods sold as a percentage of revenues improved to 44.0% in the quarter ended February 28, 2002 from 46.1% in the prior year quarter. This improvement was primarily attributable to the Company's ongoing cost savings program, which produced approximately $6 million of savings, or 1.4% of revenues in the current year quarter. Also contributing to the improvement was the Company's April 2001 decision not to update SCHOLASTIC LITERACY PLACE, thereby reducing amortization expense of prepublication costs included in cost of product in the current quarter by $4.4 million, or 1.0% of revenues. For the nine months ended February 28, 2002, cost of goods as a percentage of revenues improved to 43.8% from 45.7% in the prior year period, primarily as a result of the Company's cost savings program. As a percentage of revenues, selling, general and administrative expenses increased to 45.0% for the quarter ended February 28, 2002 compared to 43.2% in the year ago quarter. This increase was primarily the result of the prior year's strong sales of HARRY POTTER titles without the incurrence of proportionate marketing and promotional expenses. For the nine-month period ended February 28, 2002, selling, general and administrative expenses as a percentage of revenues increased to 43.5% from 41.0% in the prior fiscal year period. This increase reflected the impact of the decrease in HARRY POTTER revenues of approximately $120 million from the prior fiscal year, partially offset by the benefit of the Company's ongoing cost savings program of approximately $16 million. Bad debt expense decreased to $11.0 million, or 2.5% of revenues, for the quarter ended February 28, 2002, as compared to $19.9 million, or 4.6% of revenues, in the prior year quarter. In the current fiscal quarter, the Company refined its estimation of the bad debt reserve for the direct-to-home continuity business to reflect better than previously anticipated credit performance. These refinements resulted in a decrease in bad debt expense of $6.1 million. The after-tax effect of the bad debt reduction on net income was $3.9 million, or $0.10 per diluted share. For the nine months ended February 28, 2002, bad debt expense increased to 3.8% of revenue, as compared 3.6% of revenue, in the prior year period. This increase was due primarily to the inclusion in the current period of three additional weeks of the direct-to-home continuity business, which has lower collection rates than the Company's other businesses. Depreciation for the quarter ended February 28, 2002 increased to $9.5 million from $6.3 million in the prior year quarter. For the nine months ended February 28, 2002, depreciation increased to $25.4 million from $19.6 million in the prior year period. These increases are a result of depreciation on projects recently placed in service, including information technology initiatives. Goodwill and other intangibles amortization reflected reductions of $3.3 million and $9.9 million in the quarter and the nine-month periods ended February 28, 2002, respectively, related to the Company's adoption of SFAS 142. Under this pronouncement, the Company is required to take an impairment-only approach to amortizing goodwill and other intangible assets with indefinite lives, which accordingly reduced amortization expense. (See Note 8 in the Notes to Condensed Consolidated Financial Statements.) 21 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ The resulting operating income for the quarter ended February 28, 2002 grew over the prior year quarter by $10.3 million to $26.6 million, or 6.1% of revenue, as compared to $16.3 million, or 3.8% of revenue, in the prior year quarter. For the nine months ended February 28, 2002, operating income decreased to $97.2 million, or 7.1% of revenue, compared to $110.9 million, or 7.6% of revenue, in the prior fiscal year. Net interest expense decreased to $7.9 million and $24.3 million from $10.5 million and $33.7 million in the three- and nine-month periods ended February 28, 2002, respectively, primarily due to lower interest rates. In the first quarter of fiscal 2002, the Company adopted SOP 00-2. As a result, the Company recorded an after-tax charge of $5.2 million, which was reflected as a cumulative effect of accounting change. (See Note 9 in the Notes to Condensed Consolidated Financial Statements.) Net income for the third fiscal quarter increased to $11.9 million, or $0.31 per diluted share, compared to $3.7 million, or $0.10 per diluted share, in the prior year quarter. For the nine months ended February 28, 2002, net income decreased to $41.5 million, or $1.09 per diluted share, from $49.4 million, or $1.34 per diluted share, in the prior year. Included in the current year's net income was the effect of the SOP 00-2 charge of $5.2 million, or $0.13 per diluted share. RESULTS OF OPERATIONS - SEGMENTS 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. The direct-to-home continuity and trade businesses formerly operated by Grolier are incorporated in this segment from June 22, 2000, the date on which Grolier was acquired.
(IN MILLIONS) THREE MONTHS ENDED NINE MONTHS ENDED ==================================================================================================================== FEBRUARY 28, 2002 2001 2002 2001 ==================================================================================================================== Revenue $ 268.9 $ 266.4 $ 836.9 $ 918.5 Operating profit 43.1 39.3 118.0 157.5 -------------------------------------------------------------------------------------------------------------------- OPERATING MARGIN 16.0% 14.8% 14.1% 17.1%
The following table highlights the results of the direct-to-home continuity business included in the Children's Book Publishing and Distribution segment, formerly operated by Grolier, from June 22, 2000, the date on which Grolier was acquired.
(IN MILLIONS) THREE MONTHS ENDED NINE MONTHS ENDED ============================================================================================================= FEBRUARY 28, 2002 2001 2002 2001 ============================================================================================================= Revenue $ 47.1 $ 58.0 $ 157.6 $ 161.9 Operating profit 10.7 5.3 21.0 11.5 ------------------------------------------------------------------------------------------------------------- OPERATING MARGIN 22.7% 9.1% 13.3% 7.1%
22 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ Revenues in the CHILDREN'S BOOK PUBLISHING AND DISTRIBUTION segment for the quarter ended February 28, 2002 increased slightly to $268.9 million compared to $266.4 million in the prior fiscal year quarter. This increase in revenues related principally to higher school-based book clubs and school-based book fairs revenues of $15.8 million and $11.4 million, respectively, over the prior fiscal year quarter. Sales growth for school-based book clubs primarily reflected the impact of higher order volume. Sales growth for school-based book fairs reflected continued growth in revenue per fair and fair count, which benefited from the July 2001 acquisition of assets of Troll Book Fairs. Revenue increases were partially offset by lower trade sales of $7.1 million due to the effect of the strong prior year sales of HARRY POTTER titles and a decrease of $7.0 million in the school-based continuity programs reflecting lower customer enrollments. Additionally, in the quarter ended February 28, 2002, revenues for the Company's direct-to-home continuity business decreased 18.8%, or $10.9 million, to $47.1 million when compared to the prior year, reflecting the planned elimination of less profitable programs. Excluding the direct-to-home continuity business, segment revenues for the quarter increased by $13.4 million to $221.8 million compared to the prior year quarter. Operating profit for the quarter increased $3.8 million to $43.1 million compared to $39.3 million in the prior year. Increases in the operating profits of the direct-to-home continuity business, school-based book fairs and school-based book clubs of $5.4 million, $5.3 million and $3.4 million, respectively, were offset by operating profit decreases in trade and school-based continuity programs results of $6.6 million and $3.7 million, respectively. Operating profit for the Company's direct-to-home continuity business increased in the current year quarter to $10.7 million from $5.3 million in the prior year quarter, reflecting planned lower revenues which were more than offset by higher operating margins and the $6.1 million impact of the Company's refinement of the bad debt reserve to reflect better than previously anticipated credit performance. The after-tax effect of the bad debt reduction on net income was $3.9 million, or $0.10 per diluted share. Segment operating margins for the quarter increased to 16.0% from 14.8% in the prior year period, primarily reflecting reduced promotional costs related to the elimination of less profitable programs in the direct-to-home continuity business. Excluding the direct-to-home continuity business, segment operating profit for the quarter decreased to $32.4 million (14.6% of revenue) from $34.0 million (16.3% of revenue) in the prior year period. Revenues for the nine-month period ended February 28, 2002 decreased $81.6 million to $836.9 million compared to $918.5 million in the year ago period. This decrease was primarily due to a decline in trade sales of $118.3 million reflecting strong prior year sales of HARRY POTTER titles, including the release in the summer of 2000 of HARRY POTTER AND THE GOBLET OF FIRE, of approximately $190 million compared to approximately $70 million of sales in the current period. This decrease was partially offset by revenue increases of $24.2 million and $23.1 million in school-based book fairs and school-based book clubs, respectively, as compared to the prior year period. Revenues from the direct-to-home continuity business decreased $4.3 million to $157.6 million from $161.9 million in the prior period. This decrease reflected the elimination of less profitable programs partially offset by the impact of three weeks of additional direct-to-home revenues in the current year of $17.8 million from Grolier's direct-to-home continuity business. Excluding the direct-to-home continuity business, segment revenues decreased by $77.3 million to $679.3 million from $756.6 million in the prior year period. 23 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ Segment operating profit for the nine-month period ended February 28, 2002 decreased $39.5 million to $118.0 million, as compared to $157.5 million for the prior year period. This decrease reflected the impact of the reduced HARRY POTTER sales discussed above. Segment operating margins for the nine-month period decreased to 14.1% from 17.1% in the prior year period, also primarily due to the decrease in HARRY POTTER sales. Operating profit for the direct-to-home continuity business for the nine-month period increased to $21.0 million (13.3% of revenue), from $11.5 million (7.1% of revenue) in the prior year period, primarily as a result of the decrease in the bad debt reserve. Excluding the direct-to-home continuity business, segment operating profit for the nine-month period decreased to $97.0 million (14.3% of revenue) from $146.0 million (19.3% of revenue) in the prior year period. EDUCATIONAL PUBLISHING The Company's EDUCATIONAL PUBLISHING segment includes the publication and distribution to schools and libraries of supplemental and core materials, classroom magazines and print and on-line reference and non-fiction products for grades K to 12 in the United States. The reference and non-fiction business formerly operated by Grolier is included in this segment from June 22, 2000, the date on which Grolier was acquired.
(IN MILLIONS) THREE MONTHS ENDED NINE MONTHS ENDED ==================================================================================================================== FEBRUARY 28, 2002 2001 2002 2001 ==================================================================================================================== Revenue $ 60.9 $ 59.4 $ 225.9 $ 226.2 Operating (loss) profit (1.6) (7.8) 25.3 (1.4) ------------------------------ --------------------- --------------------- -------------------- -------------------- OPERATING MARGIN * * 11.2% *
* - NOT MEANINGFUL Revenues in the EDUCATIONAL PUBLISHING segment for the quarter ended February 28, 2002 increased modestly to $60.9 million, compared to $59.4 million in the comparable quarter of the prior year. The slight increase in revenue for the quarter is due to increases in revenues of paperback reading collections of $2.4 million, the inclusion of $1.6 million of revenues related to the December 2001 acquisition of Tom Snyder Productions Inc. and increases in other core products of $1.1 million. These increases were partially offset by lower sales of Grolier reference and non-fiction products of $2.3 million combined with lower sales of SCHOLASTIC LITERACY PLACE of $1.1 million related to the Company's strategic decision not to update the program. For the nine-month period ended February 28, 2002, revenues decreased slightly to $225.9 million, compared to $226.2 million in the comparable prior year period, reflecting the anticipated decrease of SCHOLASTIC LITERACY PLACE sales of $12.8 million. This decrease was offset by increased sales of paperback reading collections of $9.1 million and the impact of three additional weeks of Grolier reference and non-fiction products in the current year of $4.1 million. Operating loss for this segment for the third quarter improved by $6.2 million over the comparable quarter of the prior year, primarily due to reduced prepublication amortization of $4.0 million, principally related to the Company's April 2001 decision not to update SCHOLASTIC LITERACY PLACE, and reduced goodwill and other intangibles amortization of $1.7 million, resulting from the adoption of SFAS 142 in the current year. For the nine-month period ended February 28, 2002, operating profit improved by $26.7 million over the comparable prior year period, primarily due to reductions in prepublication costs of $17.0 million, in marketing, promotion and editorial costs of $5.5 million and in goodwill and other intangibles amortization of $4.5 million. 24 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ MEDIA, LICENSING AND ADVERTISING The Company's MEDIA, LICENSING AND ADVERTISING segment includes the production and/or distribution in the United States of software, Internet services and the production and/or distribution by and through the Company's subsidiary, Scholastic Entertainment Inc. ("SEI"), of programming and consumer products (including children's television programming, videos, software, feature films, promotional activities and non-book merchandise). The software business formerly operated by Grolier is included in this segment from June 22, 2000, the date on which Grolier was acquired.
(IN MILLIONS) THREE MONTHS ENDED NINE MONTHS ENDED ==================================================================================================================== FEBRUARY 28, 2002 2001 2002 2001 ==================================================================================================================== Revenue $ 32.4 $ 35.6 $ 98.3 $ 101.4 Operating loss (3.3) (3.3) (11.8) (13.6) -------------------------------------------------------------------------------------------------------------------- OPERATING MARGIN * * * *
* - NOT MEANINGFUL MEDIA, LICENSING AND ADVERTISING revenues decreased $3.2 million to $32.4 million for the quarter ended February 28, 2002 compared to $35.6 million in the prior year quarter. The revenue decrease is primarily attributable to reduced SEI film production revenue of $4.3 million, principally due to fewer new shows delivered for the TV series, CLIFFORD THE BIG RED DOG(TM), partially offset by increased licensing royalty revenue from the CLIFFORD property of $3.4 million. For the nine-month period, segment revenues for the current fiscal year amounted to $98.3 million versus $101.4 million in the prior year. The decrease is principally due to the decline in film revenue of $12.1 million due to fewer new CLIFFORD series episodes delivered this year and the benefit of last year's $3.9 million license renewal from FOX TV of THE MAGIC SCHOOL BUS(R) series, partially offset by increased licensing and merchandising revenue of $8.7 million from the CLIFFORD property. For the quarter ended February 28, 2002 and the comparable prior year quarter, segment operating loss was flat at $3.3 million. For the nine-month period, operating loss improved $1.8 million to $11.8 million, primarily reflecting a reduction of $3.6 million in Internet development expenses, partially offset by a decrease in other segment operating results. 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 domestic export and foreign rights businesses. The international businesses formerly operated by Grolier are included in this segment from June 22, 2000, the date on which Grolier was acquired.
(IN MILLIONS) THREE MONTHS ENDED NINE MONTHS ENDED ==================================================================================================================== FEBRUARY 28, 2002 2001 2002 2001 ==================================================================================================================== Revenue $ 70.5 $ 71.6 $ 214.9 $ 217.3 Operating profit 3.0 2.3 8.3 11.8 -------------------------------------------------------------------------------------------------------------------- OPERATING MARGIN 4.3% 3.2% 3.9% 5.4%
25 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ INTERNATIONAL revenues decreased by $1.1 million to $70.5 million for the quarter ended February 28, 2002 from $71.6 million in the year ago quarter. This decrease is due primarily to the adverse impact of foreign currency exchange rates of $2.3 million, as well as lower revenues in the United Kingdom of $2.1 million. These decreases were partially offset by increases of $2.4 million in Canadian revenues and $1.0 million in Australian revenues. International revenues for the nine months ended February 28, 2002 decreased $2.4 million to $214.9 million, as compared to $217.3 million in the prior year period. This decrease is primarily due to the adverse impact of foreign currency exchange rates of $8.1 million, in addition to lower revenues in the United Kingdom and Export operations of $2.9 million and $1.9 million, respectively. These declines were partially offset by three additional weeks of Grolier business revenues of $6.2 million in the current year, along with increases in revenues in Australia and Canada of $2.8 million and $1.7 million, respectively. For the quarter ended February 28, 2002, operating profit increased $0.7 million from the prior year quarter, to $3.0 million. The increase is attributed to higher operating profits in the United Kingdom, Canada and Australia of $0.8 million, $0.8 million and $0.5 million, respectively, partially offset by a decrease in operating profit in Export operations of $0.9 million. For the nine months ended February 28, 2002, operating profit decreased by $3.5 million to $8.3 million as compared to the prior year. This decrease is primarily the result of lower operating profits in Export operations and Canada of $1.6 million and $1.4 million, respectively. 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 are generally lower than its revenues in the other two fiscal quarters. The Company experiences a substantial loss from operations in the first quarter. Typically, school-based book club and book fair revenues are proportionately larger in the second quarter of the fiscal year, while revenues from the sale of instructional materials are highest in the first quarter. In the June through October time period, the Company experiences negative cash flow due to the seasonality of its business. As a result of the Company's business cycle, seasonal borrowings have historically increased during June, July and August, have generally peaked in September or October, and have been at their lowest point in May. LIQUIDITY AND CAPITAL RESOURCES The Company's cash and cash equivalents decreased by $1.2 million during the nine-month period ended February 28, 2002, compared to an increase of $2.9 million during the comparable period in the prior year. Cash flow provided from operations was $65.5 million for the nine-month period ended February 28, 2002, resulting from net income adjusted for non-cash activity of $180.3 million, partially offset by working capital increases of $114.8 million. 26 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ Cash outflows for investing activities were $133.0 million for the current nine-month period as compared to $516.5 million in the prior year period, which reflected the acquisition of Grolier. The spending for the nine months ended February 28, 2002 principally consisted of capital expenditures, prepublication costs, royalty advances, business acquisitions and production costs. Capital expenditures, including capitalized interest, totaled $46.5 million for the nine months ended February 28, 2002, decreasing $3.1 million from the year ago period. Prepublication expenditures increased $2.8 million to $39.4 million in the nine-month period. Payments for royalty advances increased to $23.7 million in the nine-month period from $19.3 million in the prior year nine-month period. The Company believes its existing cash position, combined with funds generated from operations and available under the Loan Agreement and the Revolver, will be sufficient to finance its ongoing working capital requirements for the next fiscal year. FINANCING On January 11, 2002, pursuant to a Notice of Redemption issued by the Company on November 29, 2001, $109.8 million of the Company's 5.0% Convertible Subordinated Debentures were converted into 2.9 million shares of common stock, and $0.2 million was redeemed for cash. On January 23, 2002, the Company issued $300.0 million of 5.75% Notes (the "5.75% Notes"). The 5.75% Notes are unsecured and unsubordinated obligations of the Company and will mature on January 15, 2007. 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 a) 100% of the principal amount, or b) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption on a semiannual basis. The net proceeds were used to permanently repay a portion of the $350.0 million facility (the "Grolier Facility") established in connection with the June 22, 2000 acquisition of Grolier Incorporated. At February 28, 2002, the Company has outstanding $50.0 million on the Grolier Facility which expires on June 21, 2002. The weighted average interest rate under the Grolier Facility at February 28, 2002 was 2.5%. On February 5, 2002, the Company entered into an interest rate swap agreement, designated as a fair value hedge as defined under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," with a notional amount totaling $100.0 million and a variable interest rate which is reset semi-annually based on six-month LIBOR (as defined). This agreement was entered into to exchange the fixed interest rate on a portion of the Company's 5.75% Notes for a variable interest rate. Changes in the fair value of the interest rate swap offset changes in the fair value of the fixed rate debt due to changes in market interest rates. As such, there was no ineffective portion to the hedge recognized in earnings during the period. The Company maintains two unsecured credit facilities, the Loan Agreement and the Revolver, which provide for aggregate borrowings of up to $210.0 million (with a right, in certain circumstances, to increase to $240.0 million), including the issuance of up to $10.0 million in letters of credit. Both the Loan Agreement and the Revolver expire on August 11, 2004. The Company uses these facilities primarily to fund seasonal cash flow needs and other working capital requirements. At February 28, 2002, the Company had $46.3 million in borrowings outstanding under these facilities at a weighted average interest rate of 2.5%. 27 SCHOLASTIC CORPORATION ITEM 2. MD&A ================================================================================ In addition, unsecured lines of credit available to the Company's international subsidiaries totaled $52.0 million at February 28, 2002. These lines are used primarily to fund local working capital needs. At February 28, 2002, $27.9 million in borrowings were outstanding under these lines of credit at a weighted average interest rate of 5.6%. ACQUISITIONS On June 22, 2000, the Company acquired the capital stock of Grolier for $400.0 million in cash, and in July 2001, the Company acquired certain assets of Troll Book Fairs Inc. On December 21, 2001, the Company acquired, for $9.0 million in cash, assets of Tom Snyder Productions Inc., a leading developer and publisher of interactive educational software. On April 4, 2002, the Company acquired Baby's First Book Club(TM), a direct marketer of high quality, age-appropriate books and toys for young children, from Norwegian publisher Sandvik AS for $7.5 million. On April 8, 2002, the Company acquired the shares of Klutz, a publisher and creator of "books plus" products for children, from Corus Entertainment, Inc. The Company's initial payment was $42.8 million in cash. The agreement provides for additional payments of up to $31.3 million to be made to the seller in 2004 and 2005, contingent upon the achievement of certain revenue thresholds for Klutz. In the ordinary course of business, the Company explores domestic and international expansion opportunities, including potential niche and strategic acquisitions. As part of this process, the Company engages with interested parties in discussions concerning possible transactions. The Company will continue to evaluate such opportunities and prospects. FORWARD LOOKING STATEMENTS This Report on Form 10-Q contains forward-looking statements, which are subject to various risks and uncertainties, including the conditions of the children's book and instructional materials markets and acceptance of the Company's products within those markets and other risks and factors identified in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 2001. 28 SCHOLASTIC CORPORATION ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ================================================================================ 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 do not represent a significant risk in the context of the Company's current international operations. Market risks relating to the Company's operations result primarily from changes in interest rate fluctuations, which are managed by balancing the mix of variable- versus fixed-rate borrowings. Additionally, financial instruments, including swap and forward contracts, are used to hedge exposure to interest rate and foreign currency risks. Approximately forty percent of the Company's debt bears interest at a variable rate and is sensitive to changes in interest rates. The Company is subject to the risk that market interest rates will increase and thereby increase the interest rates currently being charged under the variable rate debt. As of February 28, 2002, the balance outstanding under its variable rate facilities, including interest rate swap agreements, was $224.2 million, at a weighted average interest rate of 3.1%. A 15% increase or decrease in the average cost of the Company's variable rate debt under the various facilities at February 28, 2002 would impact the Company's pre-tax results of operations and cash flows by approximately $1 million annually. 29 PART II - OTHER INFORMATION SCHOLASTIC CORPORATION ITEM 1. LEGAL PROCEEDINGS ================================================================================ See Note 5 (Contingencies) of the Notes to Condensed Consolidated Financial Statements - Unaudited appearing in Item 1 of this Report for updated information concerning the two actions captioned SCHOLASTIC INC. AND SCHOLASTIC ENTERTAINMENT INC. V. PARACHUTE PRESS, INC., PARACHUTE PUBLISHING, LLC, PARACHUTE CONSUMER PRODUCTS, LLC, AND R. L. STINE (Index No. 99/600512) and PARACHUTE PRESS, INC. V. SCHOLASTIC INC., SCHOLASTIC PRODUCTIONS, INC. AND SCHOLASTIC ENTERTAINMENT INC. (Index No. 99/600507), which description is incorporated herein by reference. 30 SCHOLASTIC CORPORATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ================================================================================ (a) Exhibits: EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ----------------------- 4.10 Indenture dated January 23, 2002 for 5.75% Notes due January 15, 2007 issued by the Company (incorporated by reference to the Company's Registration Statement on Form S-3 (Registration No. 333-55238) as filed with the Commission on February 8, 2001). (b) Reports on Form 8-K A current report on Form 8-K was filed on January 22, 2002 noticing the Company's announcement that it entered into a Terms Agreement relating to a public offering of $300 million aggregate principal amount of its 5.75% Notes due January 15, 2007 (the "Notes") under its Registration Statement on Form S-3 (no. 333-55238), filed with the Securities and Exchange Commission on February 8, 2001, a prospectus dated February 28, 2001 and the related prospectus supplement dated January 17, 2002. The Notes bear interest at 5.75% and will mature on January 15, 2007. -------------------------------------------------------------------------------- 31 SCHOLASTIC CORPORATION SIGNATURES ================================================================================ 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. SCHOLASTIC CORPORATION (Registrant) Date: April 15, 2002 /s/ Richard Robinson ----------------------------------- Richard Robinson CHAIRMAN OF THE BOARD, PRESIDENT, CHIEF EXECUTIVE OFFICER AND DIRECTOR Date: April 15, 2002 /s/ Kevin J. McEnery ----------------------------------- Kevin J. McEnery EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 32
SCHOLASTIC CORPORATION CURRENT REPORT ON FORM 10-Q, DATED FEBRUARY 28, 2002 EXHIBITS INDEX =================================================================================================================== PAGE NUMBER IN EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION OF DOCUMENT NUMBERED COPY ------ ----------------------- ------------- Exhibit 4.10 Indenture dated January 23, 2002 for 5.75% Notes due January 15, E-1 2007 issued by the Company (incorporated by reference to the Company's Registration Statement on Form S-3 (Registration No. 333-55238) as filed with the Commission on February 8, 2001).
33