Results of Operations – Consolidated
Revenues for fiscal 2004 increased 14.1%, or $275.5 million, to $2,233.8 million, as compared to $1,958.3 million in fiscal 2003, due to revenue growth in each of the Company’s four operating segments. Children’s Book Publishing and Distribution segment revenue grew by $168.7 million, primarily from higher Harry Potter revenues, which increased approximately $125 million, substantially due to the June 21, 2003 release of Harry Potter and the Order of the Phoenix, the fifth book in the Harry Potter series. In fiscal 2003, revenues increased 2.2%, or $41.3 million, as compared to $1,917.0 million in fiscal 2002, primarily as a result of increased revenues in the Children’s Book Publishing and Distribution segment and the International segment of $21.3 million and $17.3 million, respectively. Businesses acquired in fiscal 2002 contributed approximately $58 million of incremental revenues to the Company in fiscal 2003.
Cost of goods sold as a percentage of revenues increased to 48.6%, including the Cost of goods sold – Continuity charges of $6.8 million, in fiscal 2004, from 45.0% in fiscal 2003, primarily due to higher costs related to the release of Harry Potter and the Order of the Phoenix. In fiscal 2003, Cost of goods sold as a percentage of revenues increased to 45.0% from 44.4% in fiscal 2002, principally due to an unfavorable change in revenue mix.
Selling, general and administrative expenses as a percentage of revenues decreased to 39.6%, including the Selling, general and administrative – Continuity charges of $15.2 million, in fiscal 2004, from 42.2% in fiscal 2003. The decrease was primarily due to higher Harry Potter revenues without a corresponding increase in expenses. In fiscal 2003, Selling, general and administrative expenses as a percentage of revenues increased to 42.2% from 40.3% in fiscal 2002, primarily due to higher costs of general and health care insurance and other employee benefit costs.
Bad debt expense increased to $90.3 million, or 4.1% of revenues, including the Bad debt expense – Continuity charges of $2.0 million, in fiscal 2004, as compared to $72.3 million, or 3.7% of revenues, in fiscal 2003. This increase was primarily attributable to higher bad debt expense from the Company’s continuity programs, which are primarily included in the Children’s Book Publishing and Distribution segment. In fiscal 2003, Bad debt expense increased $3.6 million from $68.7 million, or 3.6% of revenues, in fiscal 2002, due to growth in continuity programs.
Depreciation expense for fiscal 2004 increased by $7.6 million to $53.2 million, as compared to $45.6 million in fiscal 2003, primarily due to the completion of information technology projects in the prior fiscal year. In fiscal 2003, depreciation expense increased by $10.0 million from $35.6 million in fiscal 2002. This increase was primarily due to incremental depreciation of $4.8 million related to the completion of capital projects, including information technology and Internet projects, and $2.7 million related to the expansion of facilities.
On May 28, 2003, the Company announced a reduction in its global work force of approximately 400 positions. This decision resulted in a Special severance charge of $10.9 million in fiscal 2003. In connection with that announcement, Special severance charges totalling $3.3 million were recorded in fiscal 2004 for employees notified in that fiscal year.
Litigation and other charges reflect a $1.9 million charge recorded in fiscal 2003 for the settlement of a securities lawsuit initiated in 1997, which represents the portion of the total settlement amount of $7.5 million that was not paid by the insurance carrier. In fiscal 2002, the Company recorded a $1.2 million charge for the settlement of a lawsuit filed in 1995, which represents the amount by which the settlement and related legal expenses exceeded the previously recorded liability.
The resulting operating income decreased by $3.7 million, or 3.1%, to $115.0 million, or 5.1% of
20
revenues, in fiscal 2004, as compared to $118.7 million, or 6.1% of revenues, in fiscal 2003. This decrease includes the effect of the continuity charges of approximately $25 million recorded in fiscal 2004, of which approximately $22 million was reflected in the results of the Children’s Book Publishing and Distribution segment. Including these continuity charges, operating profit in the Children’s Book Publishing and Distribution segment decreased by $19.6 million, primarily due to weaker results in the Company’s continuity business. The decrease in the continuity business was largely offset by improvements in the balance of the Children’s Book Publishing and Distribution segment and in each of the Company’s remaining three operating segments. Operating income for fiscal 2003 decreased by $68.0 million, or 36.4%, from $186.7 million, or 9.7% of revenues, in fiscal 2002. This decrease was primarily due to lower profits of $44.0 million in the Children’s Book Publishing and Distribution segment and the Special severance charge of $10.9 million recorded in fiscal 2003.
In fiscal 2004, the Company recorded $8.0 million in Other income, representing the net gain on the early termination of a sublease by one of its tenants. Other income was $2.9 million in fiscal 2003, representing a gain from the sale of a portion of an interest in a French publishing company. Other expense was $2.0 million in fiscal 2002, representing a charge for the write-off of an equity investment.
Net interest expense for fiscal 2004 increased $1.0 million to $32.5 million, as compared to $31.5 million in fiscal 2003. This increase was primarily due to $7.4 million in interest expense related to the $175.0 million of 5% Notes due 2013 (the “5% Notes”) issued by Scholastic Corporation in April 2003, partially offset by reduced interest expense of $4.0 million due to the repayment of $125.0 million of 7% Notes of Scholastic Corporation (the “7% Notes”) at maturity in December 2003 (see “Liquidity and Capital Resources”) and a $2.7 million reduction in interest expense on revolving credit agreements as a result of lower utilization of these agreements due primarily to the issuance of the 5% Notes.
The Company’s effective tax rates were 35.5%, 35.0% and 35.6% of earnings before taxes for fiscal 2004, 2003 and 2002, respectively.
In fiscal 2002, the Company recorded an after-tax charge of $5.2 million, which was reflected as a Cumulative effect of accounting change, as a result of its adoption of Statement of Position No. 00-2, “Accounting by Producers and Distributors of Films.”
Net income was $58.4 million, or 2.6% of revenues, in fiscal 2004, $58.6 million, or 3.0% of revenues, in fiscal 2003 and $93.5 million, or 4.9% of revenues, in fiscal 2002. The basic and diluted earnings per share of Class A Stock and Common Stock were $1.48 and $1.46, respectively, in fiscal 2004, $1.50 and $1.46, respectively, in fiscal 2003 and $2.55 and $2.38, respectively, in fiscal 2002.
Results of Operations – Segments
CHILDREN’S BOOK PUBLISHING AND DISTRIBUTION
The Company’s Children’s Book Publishing and Distribution segment includes the publication and distribution of children’s books in the United States through school-based book clubs and book fairs, school-based and direct-to-home continuity programs and the trade channel.
| ($ amounts in millions) | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenue | | $1,358.6 | | $1,189.9 | | $1,168.6 | |
| Operating profit | | 114.8 | (1) | 134.4 | | 178.4 | |
|
| Operating margin | | 8.4 | % | 11.3 | % | 15.3 | % |
| (1) | | The fiscal 2004 operating profit includes the portion of the continuity charges related to this segment of approximately $22, reflected primarily in Cost of goods sold; Selling, general and administrative expenses; and Bad debt expense. | |
Children’s Book Publishing and Distribution revenues accounted for 60.8% of the Company’s revenues in fiscal 2004, 60.8% in fiscal 2003 and 61.0% in fiscal 2002. In fiscal 2004, segment revenues increased 14.2%, or $168.7 million, to $1,358.6 million from $1,189.9 million in fiscal 2003.
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The fiscal 2004 segment revenue increase relates primarily to higher Harry Potter trade revenues of approximately $125 million and increases in school-based book club and school-based book fair revenues of $53.5 million and $18.0 million, respectively. These revenue increases were partially offset by a decline in continuity program revenues of $15.5 million as compared to the prior fiscal year. Excluding the direct-to-home continuity business described in the table below, segment revenues in fiscal 2004 increased by $177.2 million to $1,154.8 million, as compared to $977.6 million in fiscal 2003.
In fiscal 2003, segment revenues increased 1.8%, or $21.3 million, from $1,168.6 million in fiscal 2002. Businesses acquired in fiscal 2002 contributed incremental revenues of $43.4 million to this segment in fiscal 2003. In fiscal 2003, revenues from school-based continuity programs and school-based book fairs increased $17.3 million and $14.5 million, respectively, compared to fiscal 2002. These increases were partially offset by lower Harry Potter trade revenues of approximately $30 million in fiscal 2003. Excluding the direct-to-home continuity business described in the table below, segment revenues in fiscal 2003 increased by $18.0 million from $959.6 million in fiscal 2002.
School-based book club revenues accounted for 29.7% of Children’s Book Publishing and Distribution revenues in fiscal 2004, compared to 29.5% in fiscal 2003 and 30.8% in fiscal 2002. In fiscal 2004, school-based book club revenues increased by 15.3%, or $53.5 million, over fiscal 2003, primarily due to an increase in the number of orders aided by the July 2003 acquisition of selected assets of Troll Holdings, Inc., formerly a national school-based club operator and publisher (“Troll”). In fiscal 2003, school-based book club revenues declined by 2.2%, or $8.0 million, over fiscal 2002, primarily due to a decrease in orders.
Revenues from school-based book fairs accounted for 25.4% of segment revenues in fiscal 2004, compared to 27.5% in fiscal 2003 and 26.8% in fiscal 2002. In fiscal 2004, school-based book fair revenues increased by 5.5%, or $18.0 million, to $345.6 million, over fiscal 2003, primarily due to growth in revenue per fair. In fiscal 2003, revenues from school-based book fairs increased 4.6%, or $14.5 million, over fiscal 2002, primarily due to growth in fair count of approximately 7%.
In fiscal 2004, continuity revenues accounted for 21.0% of segment revenues, as compared to 25.3% in fiscal 2003 and 24.0% in fiscal 2002. Revenues from the direct-to-home continuity business were 15.0%, 17.8% and 17.9% of segment revenues in fiscal 2004, 2003 and 2002, respectively. Revenues from school-based continuity programs were 6.0%, 7.5% and 6.1% of segment revenues in fiscal 2004, 2003 and 2002, respectively. In fiscal 2004, revenues from the direct-to-home continuity business decreased 4.0%, or $8.5 million, to $203.8 million, from $212.3 million in fiscal 2003, principally as a result of lower net revenues generated through telemarketing, which was adversely affected by the implementation, effective October 1, 2003, of the National Do Not Call Registry legislation. Revenues from school-based continuity programs in fiscal 2004 decreased 7.9%, or $7.0 million, in revenues, as compared to fiscal 2003. In fiscal 2003, revenues from the direct-to-home continuity business increased 1.6%, or $3.3 million, from $209.0 million in fiscal 2002, primarily due to incremental revenues of $12.2 million from the fiscal 2002 acquisition of Baby’s First Book Club. Higher enrollments from school-based continuity programs resulted in an increase of $17.3 million in revenues in fiscal 2003 as compared to fiscal 2002.
The trade distribution channel accounted for 23.9% of segment revenues in fiscal 2004, as compared to 17.7% in fiscal 2003 and 18.4% in fiscal 2002. Trade revenues increased in fiscal 2004 by $112.7 million, or 53.6%, compared to $208.3 million in fiscal 2003, substantially due to the June 21, 2003 release of Harry Potter and the Order of the Phoenix. In fiscal 2003, Trade revenues decreased 3.0%, or $6.5 million, from $214.8 million in fiscal 2002, principally due to a decline in revenues from Harry Potter backlist titles of approximately $30 million and other backlist titles of approximately $6 million, partially offset by incremental revenues of $31.3 million from the fiscal 2002 acquisition of Klutz. Trade revenues for Harry Potter accounted for
22
approximately $175 million, $50 million and $80 million in fiscal 2004, 2003 and 2002, respectively.
Segment operating profit in fiscal 2004 declined $19.6 million, or 14.6%, to $114.8 million, or 8.4% of revenues, compared to $134.4 million, or 11.3% of revenues, in fiscal 2003. The decline in segment operating profit in fiscal 2004 was primarily due to lower operating results for continuity programs, partially offset by improvements in the Company’s trade business of approximately $21 million, resulting primarily from higher Harry Potter revenues, and in the school-based book club business of approximately $17 million. In fiscal 2004, the Company experienced greater than anticipated challenges in its continuity business, including the effects of the National Do Not Call Registry legislation. These challenges resulted in lower net revenues generated through telemarketing, increased promotion costs and higher bad debt provisions. As a result, the Company reviewed and made changes in its continuity business in fiscal 2004, resulting in continuity charges of approximately $22 million for this segment, primarily representing write-downs of deferred promotion costs of approximately $11 million and inventory from discontinued programs of approximately $6 million. In fiscal 2004, the direct-to-home continuity business operating loss was $10.7 million, which includes approximately $15 million of the continuity charges, as compared to operating income of $30.7 million in fiscal 2003. Excluding the direct-to-home continuity business described in the table below, segment operating profit in fiscal 2004 increased $21.8 million to $125.5 million, or 10.9% of revenues, from $103.7 million, or 10.6% of revenues, in fiscal 2003.
In fiscal 2003, segment operating profit declined $44.0 million, or 24.6%, to $134.4 million, or 11.3% of revenues, compared to $178.4 million, or 15.3% of revenues, in fiscal 2002. This decrease was primarily related to a revenue decline in higher margin Harry Potter and other trade backlist titles. Operating profit for the direct-to-home continuity business decreased in fiscal 2003 to $30.7 million, or 14.5% of revenues, from $39.7 million, or 19.0% of revenues, in fiscal 2002. The $9.0 million decrease in operating profit in fiscal 2003 was primarily related to an increase of approximately $6 million in Selling, general and administrative expenses. Excluding the direct-to-home continuity business described in the table below, segment operating profit in fiscal 2003 decreased $35.0 million to $103.7 million, or 10.6% of revenues, from $138.7 million, or 14.5% of revenues, in fiscal 2002.
The following table highlights the results of the direct-to-home portion of the Company’s continuity programs, which consist primarily of the business formerly operated by Grolier and are included in the Children’s Book Publishing and Distribution segment.
| ($ amounts in millions) | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenue | | $203.8 | | $212.3 | | $209.0 | |
| Operating (loss) profit | | (10.7) | (1) | 30.7 | | 39.7 | |
|
| Operating margin | | * | | 14.5 | % | 19.0 | % |
| * | not meaningful | |
| (1) | The fiscal 2004 operating loss includes the direct-to-home portion of the continuity charges related to this segment of approximately $15, reflected primarily in Cost of goods sold; Selling, general and administrative expenses; and Bad debt expense. | |
EDUCATIONAL PUBLISHING
The Company’s Educational Publishing segment includes the publication and distribution to schools and libraries of curriculum materials, children’s books, classroom magazines and print and on-line reference and non-fiction products for grades pre-K to 12 in the United States.
| ($ amounts in millions) | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenue | | $ 369.1 | | $ 325.9 | | $ 316.9 | |
| Operating profit | | 53.2 | | 41.9 | | 44.1 | |
|
| Operating margin | | 14.4 | % | 12.9 | % | 13.9 | % |
Segment revenues accounted for 16.5% of the Company’s revenues in fiscal 2004, compared to 16.6% in fiscal 2003 and 16.5% in fiscal 2002. In fiscal 2004, Educational Publishing revenues increased to $369.1 million from $325.9 million in fiscal 2003. The $43.2 million revenue increase in fiscal 2004 was due to higher sales of children’s books, primarily sold to public school systems as
23
classroom libraries and other collections, of $28.3 million and increased Read 180® revenues of $19.2 million. These increases were partially offset by a decrease in Scholastic Literacy Place® revenues. In fiscal 2003, the $9.0 million increase in Educational Publishing revenues as compared to fiscal 2002 was primarily due to $10.4 million of incremental revenues related to fiscal 2002 acquisitions.
Segment operating profit for this segment in fiscal 2004 increased by $11.3 million, or 27.0%, to $53.2 million, as compared to the prior fiscal year, primarily due to the increase in revenues, as well as higher gross margins resulting from a favorable sales mix. In fiscal 2003, operating profit decreased $2.2 million from $44.1 million in fiscal 2002, primarily due to the $2.1 million portion of the Special severance charge related to this segment in fiscal 2003.
MEDIA, LICENSING AND ADVERTISING
The Company’s Media, Licensing and Advertising segment includes the production and/or distribution of software in the United States; the production and/or distribution primarily by and through SEI; of programming and consumer products (including children’s television programming, videos, software, feature films, promotional activities and non-book merchandise), and advertising revenue; including sponsorship programs.
| ($ amounts in millions) | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenue | | $136.4 | | $123.5 | | $129.8 | |
| Operating loss | | (2.5) | | (2.9) | | (0.2) | |
|
| Operating margin | | * | | * | | * | |
|
|
* not meaningful
Media, Licensing and Advertising revenues accounted for 6.1% of the Company’s revenues in fiscal 2004, 6.3% in fiscal 2003 and 6.8% in fiscal 2002. In fiscal 2004, revenues increased by $12.9 million, or 10.4%, to $136.4 million from $123.5 million in fiscal 2003, primarily due to $17.5 million of incremental revenues generated from the Back to Basics direct-to-home toy catalog business that the Company acquired in August 2003. Additionally, programming revenues increased by $5.9 million, primarily due to the February 2004 completion and delivery of the feature film Clifford’s Really Big Movie. These revenues were partially offset by $9.6 million in decreased revenues from software and multimedia products. In fiscal 2003, revenues decreased by 4.9%, or $6.3 million, from $129.8 million in fiscal 2002, primarily due to lower sales of software and multimedia products of $9.7 million and lower non-book merchandise revenues of $3.3 million, partially offset by increased television programming revenues of $3.7 million from Clifford the Big Red Dog and incremental television programming revenues of $3.6 million relating to fiscal 2002 acquisitions.
The operating loss for the Media, Licensing and Advertising segment in fiscal 2004 improved by $0.4 million to $2.5 million, compared to an operating loss of $2.9 million in fiscal 2003, as contributions from Back to Basics were offset by lower margins as a result of changes in business mix. In fiscal 2003, segment operating loss increased by $2.7 million from $0.2 million in fiscal 2002, primarily due to decreased revenues.
INTERNATIONAL
The International segment includes the publication and distribution of products and services outside the United States by the Company’s international operations, and its export and foreign rights businesses.
| ($ amounts in millions) | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenue | | $369.7 | | $319.0 | | $301.7 | |
| Operating profit | | 24.3 | (1) | 19.4 | | 24.6 | |
|
| Operating margin | | 6.6 | % | 6.1 | % | 8.2 | % |
| (1) | | The fiscal 2004 operating profit includes the portion of the continuity charges related to this segment of approximately $3, reflected primarily in Cost of goods sold and Selling, general and administrative expenses. | |
International revenues accounted for 16.6% of the Company’s revenues in fiscal 2004, 16.3% in fiscal
24
2003 and 15.7% in fiscal 2002. Segment revenues increased $50.7 million, or 15.9%, to $369.7 million in fiscal 2004 from $319.0 million in fiscal 2003. This revenue growth was primarily due to the favorable impact of foreign currency exchange rates of $36.5 million and increased revenues from the Company’s export business of $12.3 million. In fiscal 2003, International revenues increased $17.3 million, or 5.7%, from $301.7 million in fiscal 2002, primarily due to the favorable impact of foreign currency exchange rates of $16.8 million.
International operating profit increased $4.9 million to $24.3 million, or 6.6% of revenues, in fiscal 2004 from $19.4 million, or 6.1% of revenues, in fiscal 2003, primarily due an increase in operating profit from the export business. In fiscal 2003, operating profit decreased $5.2 million from $24.6 million, or 8.2% of revenues, in fiscal 2002, primarily due to the $3.8 million portion of the Special severance charge related to this segment in fiscal 2003.
Seasonality
The Company’s school-based book clubs, school-based book fairs and most of its magazines operate on a school-year basis. Therefore, the Company’s business is highly seasonal. As a consequence, the Company’s revenues in the first and third quarters of the fiscal year generally are lower than its revenues in the other two fiscal quarters. Typically, school-based book club and book fair revenues are greatest in the second quarter of the fiscal year, while revenues from the sale of instructional materials are the highest in the first quarter. The Company experiences a substantial loss from operations 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
Cash and cash equivalents were $17.8 million at May 31, 2004, compared to $58.6 million at May 31, 2003 and $10.7 million at May 31, 2002.
Cash flow provided by operations increased $33.1 million to $212.3 million in fiscal 2004, including $10.0 million received in connection with the early termination of a sublease by one of the Company’s tenants, compared to $179.2 million in fiscal 2003. Deferred promotion costs decreased $12.6 million in fiscal 2004 compared to an increase of $7.5 million in fiscal 2003, primarily due to the write-down of deferred promotion costs included in the continuity charges. Amortization of prepublication and production costs increased $18.1 million to $79.1 million in fiscal 2004 compared to $61.0 million in fiscal 2003, primarily due to higher amortization of prepublication costs for product updates in the Company’s Educational Publishing segment. Depreciation and amortization increased $7.4 million in fiscal 2004 as compared to fiscal 2003, primarily due to the completion of information technology projects in fiscal 2003. Accounts payable and other accrued expenses increased $8.3 million in fiscal 2004 compared to an increase of $21.5 million in fiscal 2003, primarily due to the timing of payments.
Cash outflow for investing activities was $147.6 million for fiscal 2004. Additions to property, plant and equipment totaled $43.4 million in fiscal 2004, a decrease of $40.5 million from fiscal 2003. This decrease was principally due to the acquisition of the Maumelle Facility for $14.7 million, spending on the expansion of Internet operations of $11.1 million and expenses related to the development of an inventory planning software system of $10.0 million in fiscal 2003. Acquisition-related payments of $8.8 million in fiscal 2004 relate to the purchase of certain assets of Troll and the purchase of Back to Basics.
In April 2003, Scholastic Corporation issued the 5% Notes. Net proceeds of $171.3 million were used: (a)
25
to retire all outstanding indebtedness of $36.0 million under a credit facility that had been established by the Company in June 2000 to finance a portion of the purchase price for Grolier, which was then canceled; and (b) to reduce $135 million of indebtedness outstanding under the Loan Agreement and the Revolver, as defined in “Financing” below. Scholastic Corporation repaid all $125.0 million of the outstanding 7% Notes at maturity on December 15, 2003 using cash on hand and borrowings available under the Loan Agreement and the Revolver made possible by the issuance of the 5% Notes. Consequently, the Company had decreased cash and lower debt levels at May 31, 2004 as compared to May 31, 2003.
The Company believes its existing cash position, combined with funds generated from operations and available under the Credit Agreement, described in “Financing” below, and the Revolver, will be sufficient to finance its ongoing working capital requirements. The Company anticipates refinancing its debt obligations prior to their respective maturity dates, to the extent not paid through cash flow.
The following table summarizes, as of May 31, 2004, the Company’s contractual cash obligations by future period (see Notes 3 and 4 of Notes to Consolidated Financial Statements in Item 8, “Consolidated Financial Statements and Supplementary Data”):
| | | Payments Due by Period |
|
| | Less than | | | | | | After | | |
Contractual Obligations | | 1 Year | | 1-3 Years | | 4-5 Years | | 5 Years | | Total | |
|
| Long-term debt | | $ — | | $ 300.0 | | $ 14.2 | | $ 175.0 | | $ 489.2 | |
| Lines of credit and short-term debt | | 24.1 | | — | | — | | — | | 24.1 | |
| Operating leases | | 43.1 | | 76.0 | | 23.1 | | 162.7 | | 304.9 | |
| Royalty advances | | 7.9 | | 2.0 | | — | | — | | 9.9 | |
| Other obligations | | 6.9 | | 1.9 | | — | | — | | 8.8 | |
|
| Total | | $ 82.0 | | $ 379.9 | | $ 37.3 | | $ 337.7 | | $ 836.9 | |
|
Financing
On March 31, 2004, Scholastic Corporation and Scholastic Inc. entered into an unsecured revolving credit agreement with certain banks (the “Credit Agreement”), which replaced a similar loan agreement that was scheduled to expire on August 11, 2004 (the “Loan Agreement”). The Credit Agreement, which expires on March 31, 2009, provides for aggregate borrowings of up to $190.0 million (with a right in certain circumstances to increase borrowings to $250.0 million), including the issuance of up to $10.0 million in letters of credit. Interest under this facility is either at the prime rate or 0.325% to 0.975% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30% and a utilization fee ranging from 0.05% to 0.25% if borrowings exceed 50% of the total facility. The amounts charged vary based upon the Company’s credit rating. The interest rate and facility fee as of May 31, 2004 were 0.55% over LIBOR and 0.15%, respectively. The Credit Agreement contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. On May 31, 2004, $12.0 million was outstanding under the Credit Agreement at a weighted average interest rate of 1.7%. There were no borrowings outstanding under the Loan Agreement at May 31, 2003.
Scholastic Corporation and Scholastic Inc. are joint and several borrowers under an unsecured revolving loan agreement with a bank (the “Revolver”). As amended effective April 30, 2004, the Revolver provides for unsecured revolving credit of up to $40.0 million and expires on March 31, 2009. Interest under this facility is either at the prime rate minus 1%, or 0.375% to 1.025% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30%. The amounts charged vary based upon the Company’s credit rating. The
26
interest rate and facility fee as of May 31, 2004 were 0.60% over LIBOR and 0.15%, respectively. The Revolver contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. At May 31, 2004, $2.2 million was outstanding under the Revolver at a weighted average interest rate of 3.0%. There were no borrowings outstanding under the Revolver at May 31, 2003.
Scholastic Corporation repaid the 7% Notes at maturity on December 15, 2003, in part using borrowings available under the Loan Agreement and the Revolver made possible by the issuance of the 5% Notes.
In February 2002, Scholastic Corporation 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,” whereby the Company received a fixed interest rate payment from, and paid an amount based on a variable interest rate to, the counterparty based on a notional amount, in order to exchange the fixed rate payments on a portion of the Corporation’s $300.0 million in outstanding 5.75% Notes due 2007 issued in January 2002 (“the 5.75% Notes”) for variable rate payments. In accordance with SFAS No. 133, the swap was considered perfectly effective and all changes in fair value were recorded to Other assets and Long-term debt. On May 28, 2003, $50.0 million of the original $100.0 million notional amount was settled and the Company received a payment of $5.4 million from the counterparty. On November 3, 2003, the remaining $50.0 million under the agreement was settled, and the Company received a payment of $3.8 million from the counterparty. The cash received was used to fully reduce the Other asset previously established, and the corresponding credit is being amortized over the remaining term of the 5.75% Notes.
Unsecured lines of credit available in local currencies to Scholastic Corporation’s international subsidiaries were equivalent to $62.1 million at May 31, 2004, as compared to $57.8 million at May 31, 2003. These lines are used primarily to fund local working capital needs. At May 31, 2004, borrowings equivalent to $23.0 million were outstanding under these lines of credit, as compared to $28.5 million at May 31, 2003, at weighted average interest rates of 5.5% and 6.9% at May 31, 2004 and 2003, respectively.
The Company’s total debt obligations at May 31, 2004 and 2003 were $516.6 million and $635.9 million, respectively, primarily due to the issuance of the 5% Notes in April 2003 and the repayment at maturity of the 7% Notes in December 2003. For a complete description of all the Company’s debt obligations, see Note 3 of Notes to Consolidated Financial Statements in Item 8, “Consolidated Financial Statements and Supplementary Data.”
Acquisitions
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.
On July 1, 2003, the Company acquired certain assets of Troll for $4.0 million in cash and the assumption of certain ordinary course liabilities. On August 8, 2003, the Company acquired the stock of BTBCAT, Inc., which operates the Back to Basics direct-to-home toy catalog business, for $4.8 million in cash.
During fiscal 2002, the Company completed the acquisitions of the stock or assets of the following companies: Troll Book Fairs LLC, a national school-based book fair operator; Tom Snyder Productions, Inc., a developer and publisher of interactive educational software and producer of television programming; Sandvik Publishing Ltd., d/b/a Baby’s First Book Club, a direct marketer of age-appropriate books and toys for young children; Klutz, a publisher and creator of “books plus” products for children; Teacher’s Friend Publications, Inc., a producer and marketer of materials that
27
teachers use to decorate their classrooms; and Nelson B. Heller & Associates, a publisher of business-to-business newsletters. The aggregate purchase price for these acquisitions, net of cash received, was $66.7 million.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires variable interest entities to be consolidated by the primary beneficiary of the entity if certain criteria are met. FIN 46 was effective immediately for all variable interest entities created after January 31, 2003. For variable interest entities created or acquired before February 1, 2003, the provisions of FIN 46 became effective for the Company during the fourth quarter of fiscal 2004. The Company’s adoption of FIN 46 did not have a material impact on its financial position, results of operations or cash flows.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP 106-2 applies only to a single-employer defined benefit post-retirement health care plan for which an employer has concluded that prescription drug benefits available under the plan are “actuarially equivalent” to the prescription drug benefit now provided under Medicare pursuant to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 and therefore qualify for a federal subsidy introduced by that Act. Although the Company is not required to apply the guidance in FSP 106-2 until its fiscal quarter ending November 30, 2004, it has determined that its plan qualifies for such subsidy and has elected to begin accounting for the effects of the subsidy during its fiscal quarter ended May 31, 2004.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
This Annual Report on Form 10-K contains forward-looking statements. Additional written and oral forward-looking statements may be made by the Company from time to time in SEC filings and otherwise. The Company cautions readers that results or expectations expressed by forward-looking statements, including, without limitation, those relating to the Company’s future business prospects, revenues, operating margins, working capital, liquidity, capital needs, interest costs and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to factors including the following and other risks and factors identified from time to time in the Company’s filings with the SEC:
| • | | The Company’s ability to continue to produce successful educational, trade, entertainment and software products; | |
| | | | |
| • | | The ability of the Company’s school-based book clubs and book fairs to continue to successfully meet market needs; | |
| | | | |
| • | | The Company’s ability to maintain relationships with its creative talent; | |
| | | | |
| • | | Changes in purchasing patterns in and the strength of educational, trade, entertainment and software markets; | |
| | | | |
| • | | Competition from other educational and trade publishers and media, entertainment and Internet companies; | |
| | | | |
| • | | Significant changes in the publishing industry, especially relating to the distribution and sale of books; | |
| | | | |
| • | | The effect on the Company of volatility in the price of paper and periodic increases in postage rates; | |
| | | | |
| • | | The Company’s ability to effectively use the Internet to support its existing businesses and to launch successful new Internet initiatives; | |
| | | | |
| • | | The impact of governmental initiatives, including the expansion of restrictions on communications with actual and potential customers; | |
28
| • | | The general risks attendant to the conduct of business in foreign countries; | |
| | | | |
| • | | The general risks inherent in the market impact of rising interest rates with regard to its variable-rate debt facilities. | |
The foregoing list of factors should not be construed as exhaustive or as any admission regarding the adequacy of disclosures made by the Company prior to the date hereof. The Company disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.
| | |
| Item 7a | | 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 does not represent a significant risk in the context of the Company’s current international operations. In the normal course of business, the Company’s operations outside the United States periodically enter into short-term forward contracts (generally not exceeding $20.0 million) to match selected purchases not denominated in their respective local currencies.
Market risks relating to the Company’s operations result primarily from changes in interest rates, which are managed by balancing the mix of variable-rate versus fixed-rate borrowings. Additionally, financial instruments, including swap agreements, have been used to manage interest rate exposures. Approximately 7% of the Company’s debt at May 31, 2004 bore interest at a variable rate and was sensitive to changes in interest rates, compared to approximately 12% at May 31, 2003. The Company is subject to the risk that market interest rates will increase and thereby increase the interest charged under its variable-rate debt.
Additional information relating to the Company’s outstanding financial instruments is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
The following table sets forth information about the Company’s debt instruments as of May 31, 2004 (see Note 3 of Notes to Consolidated Financial Statements in Item 8, “Consolidated Financial Statements and Supplementary Data”):
| | | ($ amounts in millions) | |
|
| | | | | | | | | | | | | | | | | Fair Value | |
| | | Fiscal Year Maturity | | | | as of | |
| | |
| | | | May 31, | |
| | | 2005 | | 2006 | | 2007 | | 2008 | | 2009 | | Thereafter | | Total | | 2004 | |
|
| Lines of credit | | $ 23.0 | | $ — | | $ — | | $ — | | $ — | | $ — | | $ 23.0 | | $ 23.0 | |
| Average interest rate | | 5.48 | % | | | | | | | | | | | | | | |
| Long-term debt including |
| current portion: | | | | | | | | | | | | | | | | | |
| Fixed-rate debt | | $ 1.1 | | $ — | | $ 300.0 | | | | $ — | | $ 175.0 | | $ 476.1 | | $ 477.7 | |
| Average interest rate | | 7.10 | % | | | 5.75 | % | | | | | 5.00 | % | | | | |
| Variable-rate debt | | $ — | | $ — | | $ — | | $ — | | $ 14.2 | (1) | $ — | | $ 14.2 | | $ 14.2 | |
| Average interest rate | | | | | | | | | | 1.93 | % | | | | | | |
|
| (1) | | Represents amounts drawn on the Credit Agreement and Revolver with credit lines totaling $230.0, which expire in fiscal 2009. | |
29
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30
Item 8 | Consolidated Financial Statements and Supplementary Data
| Index to Consolidated Financial Statements and Financial Statements Schedule | | Page(s) | |
| | | | |
| Consolidated Statements of Income for the years ended May 31, 2004, 2003 and 2002 | | 32 | |
| | | | |
| Consolidated Balance Sheets at May 31, 2004 and 2003 | | 33-34 | |
| | | | |
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive
Income for the years ended May 31, 2004, 2003 and 2002 | | 35-36 | |
| | | | |
| Consolidated Statements of Cash Flows for the years ended May 31, 2004, 2003 and 2002 | | 37 | |
| | | | |
| Notes to Consolidated Financial Statements | | 38-58 | |
| | | | |
| Report of Independent Registered Public Accounting Firm | | 59 | |
| | | | |
| Supplementary Financial Information – Summary of Quarterly Results of Operations (unaudited) | | 60 | |
| | | |
The following consolidated financial statement schedule for the years
ended May 31, 2004, 2003 and 2002 is included in Item 15(d): | | |
| Schedule II – Valuation and Qualifying Accounts and Reserves | | 67 | |
All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Consolidated Financial Statements or the Notes thereto.
31
Consolidated Statements of Income
| (Amounts in millions, except per share data) | |
| Years ended May 31, | |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Revenues | | $ 2,233.8 | | $ 1,958.3 | | $ 1,917.0 | |
| Operating costs and expenses: |
| Cost of goods sold (exclusive of depreciation) | | 1,080.0 | | 882.1 | | 852.1 | |
| Cost of goods sold – Continuity charges | | 6.8 | | — | | — | |
| Selling, general and administrative expenses | | 869.7 | | 826.3 | | 771.7 | |
| Selling, general and administrative expenses – Continuity charges | | 15.2 | | — | | — | |
| Bad debt expense | | 88.3 | | 72.3 | | 68.7 | |
| Bad debt expense – Continuity charges | | 2.0 | | — | | — | |
| Other operating costs: |
| Depreciation | | 53.2 | | 45.6 | | 35.6 | |
| Special severance charges | | 3.3 | | 10.9 | | — | |
| Goodwill and other intangibles amortization | | 0.3 | | 0.5 | | 1.0 | |
| Litigation and other charges | | — | | 1.9 | | 1.2 | |
|
| Total operating costs and expenses | | 2,118.8 | | 1,839.6 | | 1,730.3 | |
|
| Operating income | | 115.0 | | 118.7 | | 186.7 | |
| Other income (expense) | | 8.0 | | 2.9 | | (2.0 | ) |
| Interest expense, net | | 32.5 | | 31.5 | | 31.4 | |
|
| Earnings before income taxes and Cumulative effect of accounting change | | 90.5 | | 90.1 | | 153.3 | |
| Provision for income taxes | | 32.1 | | 31.5 | | 54.6 | |
|
| Earnings before Cumulative effect of accounting change | | 58.4 | | 58.6 | | 98.7 | |
| Cumulative effect of accounting change (net of income taxes of $2.9) | | — | | — | | (5.2 | ) |
|
| Net income | | $ 58.4 | | $ 58.6 | | $ 93.5 | |
|
| Earnings per Share of Class A and Common Stock: |
| Earnings before Cumulative effect of accounting change: |
| Basic | | $ 1.48 | | $ 1.50 | | $ 2.69 | |
| Diluted | | $ 1.46 | | $ 1.46 | | $ 2.51 | |
| Cumulative effect of accounting change (net of income taxes): |
| Basic | | $ — | | $ — | | $ (0.14 | ) |
| Diluted | | $ — | | $ — | | $ (0.13 | ) |
| Net income: |
| Basic | | $ 1.48 | | $ 1.50 | | $ 2.55 | |
| Diluted | | $ 1.46 | | $ 1.46 | | $ 2.38 | |
|
32
Consolidated Balance Sheets
|
ASSETS | | 2004 | | 2003 | |
|
| Current Assets: |
| Cash and cash equivalents | | $ 17.8 | | $ 58.6 | |
| Accounts receivable (less allowance for doubtful accounts of $63.2 at May 31, 2004 | | | | | |
| and $55.6 at May 31, 2003) | | 265.7 | | 252.3 | |
| Inventories | | 402.6 | | 382.6 | |
| Deferred promotion costs | | 40.6 | | 52.8 | |
| Deferred income taxes | | 73.4 | | 74.6 | |
| Prepaid and other current assets | | 42.6 | | 47.3 | |
|
| Total current assets | | 842.7 | | 868.2 | |
|
| Property, Plant and Equipment: |
| Land | | 10.7 | | 10.0 | |
| Buildings | | 80.9 | | 77.2 | |
| Furniture, fixtures and equipment | | 326.0 | | 285.5 | |
| Leasehold improvements | | 159.8 | | 158.0 | |
| | | | | |
|
| | | 577.4 | | 530.7 | |
| Less accumulated depreciation and amortization | | (242.8 | ) | (189.0 | ) |
|
| Net property, plant and equipment | | 334.6 | | 341.7 | |
|
| Other Assets and Deferred Charges: |
| Prepublication costs | | 116.7 | | 122.0 | |
| Installment receivables (less allowance for doubtful accounts of $5.1 at May 31, 2004 | | | | | |
| and $4.9 at May 31, 2003) | | 13.1 | | 13.9 | |
| Royalty advances | | 47.8 | | 49.8 | |
| Production costs | | 5.5 | | 11.0 | |
| Goodwill | | 250.3 | | 246.0 | |
| Other intangibles | | 78.9 | | 74.2 | |
| Noncurrent deferred income taxes | | 5.1 | | 7.7 | |
| Other | | 61.1 | | 66.5 | |
|
| Total other assets and deferred charges | | 578.5 | | 591.1 | |
|
| Total assets | | $ 1,755.8 | | $ 1,801.0 | |
|
See accompanying notes
33
| (Amounts in millions, except share data) | |
| Balances at May 31, | |
|
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | 2004 | | 2003 | |
|
| Current Liabilities: |
| Lines of credit and short-term debt | | $ 24.1 | | $ 153.7 | |
| Accounts payable | | 150.1 | | 139.4 | |
| Accrued royalties | | 30.7 | | 32.3 | |
| Deferred revenue | | 22.7 | | 18.8 | |
| Other accrued expenses | | 129.8 | | 133.5 | |
|
| Total current liabilities | | 357.4 | | 477.7 | |
|
| Noncurrent Liabilities: |
| Long-term debt | | 492.5 | | 482.2 | |
| Other noncurrent liabilities | | 49.9 | | 68.5 | |
|
| Total noncurrent liabilities | | 542.4 | | 550.7 | |
|
| | | | | |
| Commitments and Contingencies | | — | | — | |
| |
| Stockholders’ Equity: |
| Preferred Stock, $1.00 par value; Authorized – 2,000,000 shares; Issued-None | | — | | — | |
Class A Stock, $.01 par value; Authorized – 2,500,000 shares; Issued and
outstanding – 1,656,200 shares | | 0.0 | | 0.0 | |
Common Stock, $.01 par value; Authorized – 70,000,000 shares; Issued and
outstanding – 37,930,986 shares (37,608,333 shares at May 31, 2003) | | 0.4 | | 0.4 | |
| Additional paid-in capital | | 388.1 | | 379.9 | |
| Deferred compensation | | (0.6 | ) | (1.1 | ) |
| Accumulated other comprehensive loss: | | | | | |
| Foreign currency translation adjustment | | (4.5 | ) | (9.8 | ) |
| Minimum pension liability adjustment | | (17.0 | ) | (28.0 | ) |
| Retained earnings | | 489.6 | | 431.2 | |
|
| Total stockholders’ equity | | 856.0 | | 772.6 | |
|
| Total liabilities and stockholders’ equity | | $ 1,755.8 | | $ 1,801.0 | |
|
34
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
| | | | | | | | | | | |
|
| |
| | | Class A Stock | | Common Stock | | Additional | |
| | |
| |
| | Paid-in | |
| | | Shares | | Amount | | Shares | | Amount | | Capital | |
|
| Balance at May 31, 2001 | | 1,656,200 | | $ 0.0 | | 33,632,047 | | $ 0.3 | | $ 233.7 | |
| Comprehensive income: | | | | | | | | | | |
| Net income | | | | | | | | | | | |
| Other comprehensive loss, net: | | | | | | | | | | |
| Foreign currency translation adjustment | | | | | | | | | | | |
| Minimum pension liability adjustment | | | | | | | | | | | |
| Total other comprehensive loss | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | |
| Deferred compensation, net of amortization | | | | | | | | | | 0.4 | |
| Proceeds from issuance of common stock | | | | | | | | | | |
| pursuant to employee stock plans | | | | | | 927,374 | | 0.1 | | 19.9 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | 8.8 | |
| Conversion of Convertible Subordinated | | | | | | | | | | |
| Debentures and related costs | | | | | | 2,857,801 | | 0.0 | | 110.9 | |
|
| Balance at May 31, 2002 | | 1,656,200 | | 0.0 | | 37,417,222 | | 0.4 | | 373.7 | |
| Comprehensive income: | | | | | | | | | | |
| Net income | | | | | | | | | | | |
| Other comprehensive income (loss), net: | | | | | | | | | | |
| Foreign currency translation adjustment | | | | | | | | | | | |
| Minimum pension liability adjustment | | | | | | | | | | | |
| Total other comprehensive loss | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | |
| Deferred compensation, net of amortization | | | | | | | | | | 1.2 | |
| Proceeds from issuance of common stock pursuant to employee stock plans | | | | | | 191,111 | | 0.0 | | 4.7 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | 0.3 | |
|
| Balance at May 31, 2003 | | 1,656,200 | | 0.0 | | 37,608,333 | | 0.4 | | 379.9 | |
| Comprehensive income: |
| Net income | | | | | | | | | | | |
| Other comprehensive income, net: |
| Foreign currency translation adjustment | | | | | | | | | | | |
| Minimum pension liability adjustment | | | | | | | | | | | |
| Total other comprehensive income | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | |
| Deferred compensation, net of amortization | | | | | | 4,102 | | 0.0 | | 0.0 | |
| Proceeds from issuance of common stock pursuant to employee stock plans | | | | | | 318,551 | | 0.0 | | 7.6 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | 0.6 | |
|
| Balance at May 31, 2004 | | 1,656,200 | | $ 0.0 | | 37,930,986 | | $ 0.4 | | $ 388.1 | |
See accompanying notes
35
| | | | | | | | (Amounts in millions, except share data) |
| | | | | | | | Years ended May 31, 2004, 2003 and 2002 |
|
| |
| | | | Foreign | | Minimum | | | | Treasury Stock | | Total | |
| | Deferred | | Currency | | Pension | | Retained | |
| | Stockholders’ | |
| | Compensation | | Translation | | Liability | | Earnings | | Shares | | Amount | | Equity | |
|
| Balance at May 31, 2001 | $ (0.2) | | $ (12.8) | | $ (3.6) | | $ 279.1 | | (55,319) | | $ (2.8) | | $ 493.7 | |
| Comprehensive income: | | | | | | | | | | | | | |
| Net income | | | | | | | 93.5 | | | | | | 93.5 | |
| Other comprehensive loss, net: | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | (0.7) | | | | | | | | | | (0.7) | |
| Minimum pension liability adjustment | | | | | (10.3) | | | | | | | | (10.3) | |
|
| Total other comprehensive loss | | | | | | | | | | | | | (11.0) | |
|
| Total comprehensive income | | | | | | | | | | | | | 82.5 | |
| Deferred compensation, net of amortization | (0.2) | | | | | | | | | | | | 0.2 | |
| Proceeds from issuance of common stock | | | | | | | | | | | | | |
| pursuant to employee stock plans | | | | | | | | | 55,319 | | 2.8 | | 22.8 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | | | | 8.8 | |
| Conversion of Convertible Subordinated | | |
| Debentures and related costs | | | | | | | | | | | | | 110.9 | |
|
| Balance at May 31, 2002 | (0.4) | | (13.5) | | (13.9) | | 372.6 | | — | | — | | 718.9 | |
| Comprehensive income: | | | | | | | | | | | | | |
| Net income | | | | | | | 58.6 | | | | | | 58.6 | |
| Other comprehensive income (loss), net: | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | 3.7 | | | | | | | | | | 3.7 | |
| Minimum pension liability adjustment | | | | | (14.1) | | | | | | | | (14.1) | |
|
| Total other comprehensive loss | | | | | | | | | | | | | (10.4) | |
|
| Total comprehensive income | | | | | | | | | | | | | 48.2 | |
| Deferred compensation, net of amortization | (0.7) | | | | | | | | | | | | 0.5 | |
Proceeds from issuance of common stock pursuant to
employee stock plans | | | | | | | | | | | | | 4.7 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | | | | 0.3 | |
|
| Balance at May 31, 2003 | (1.1) | | (9.8) | | (28.0) | | 431.2 | | — | | — | | 772.6 | |
| Comprehensive income: |
| Net income | | | | | | | 58.4 | | | | | | 58.4 | |
| Other comprehensive income, net: |
| Foreign currency translation adjustment | | | 5.3 | | | | | | | | | | 5.3 | |
| Minimum pension liability adjustment | | | | | 11.0 | | | | | | | | 11.0 | |
|
| Total other comprehensive income | | | | | | | | | | | | | 16.3 | |
|
| Total comprehensive income | | | | | | | | | | | | | 74.7 | |
| Deferred compensation, net of amortization | 0.5 | | | | | | | | | | | | 0.5 | |
Proceeds from issuance of common stock pursuant to
employee stock plans | | | | | | | | | | | | | 7.6 | |
| Tax benefit realized from stock option transactions | | | | | | | | | | | | | 0.6 | |
|
| Balance at May 31, 2004 | $ (0.6) | | $ (4.5) | | $ (17.0) | | $ 489.6 | | — | | $ — | | $ 856.0 | |
|
| |
36
Consolidated Statements of Cash Flows
| | | | | | (Amounts in millions) |
| | | | | | Years ended May 31, |
|
| | | 2004 | | 2003 | | 2002 |
|
| Cash flows provided by operating activities: |
| Net income | | $ 58.4 | | $ 58.6 | | $ 93.5 |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | |
| Amortization of prepublication and production costs | | 79.1 | | 61.0 | | 50.2 |
| Depreciation and amortization | | 53.5 | | 46.1 | | 36.6 |
| Royalty advances expensed | | 28.5 | | 31.6 | | 26.6 |
| Deferred income taxes | | 3.0 | | 12.3 | | 18.0 |
| Non-cash portion of Cumulative effect of accounting change | | — | | — | | 8.1 |
| Changes in assets and liabilities: |
| Accounts receivable, net | | (9.0) | | (17.9) | | (14.1) |
| Inventories | | (14.7) | | (16.7) | | (7.3) |
| Prepaid and other current assets | | 7.0 | | 12.3 | | 5.5 |
| Deferred promotion costs | | 12.6 | | (7.5) | | (0.5) |
| Accounts payable and other accrued expenses | | 8.3 | | 21.5 | | (42.5) |
| Accrued royalties and deferred revenue | | 1.0 | | (4.1) | | (6.0) |
| Tax benefit realized from stock option transactions | | 0.6 | | 0.3 | | 8.8 |
| Other, net | | (16.0) | | (18.3) | | (12.3) |
|
| Total adjustments | | 153.9 | | 120.6 | | 71.1 |
|
| Net cash provided by operating activities | | 212.3 | | 179.2 | | 164.6 |
| Cash flows used in investing activities: |
| Prepublication expenditures | | (53.2) | | (55.7) | | (53.5) |
| Additions to property, plant and equipment | | (43.4) | | (83.9) | | (78.4) |
| Royalty advances | | (26.1) | | (30.3) | | (31.7) |
| Equity investment and related loan | | — | | (23.3) | | — |
| Production expenditures | | (15.6) | | (15.5) | | (13.0) |
| Acquisition-related payments | | (8.8) | | (10.2) | | (66.7) |
| Proceeds from sale of investment | | — | | 5.2 | | — |
| Other | | (0.5) | | (0.3) | | 4.8 |
|
| Net cash used in investing activities | | (147.6) | | (214.0) | | (238.5) |
|
| Cash flows (used in) provided by financing activities: |
| Borrowings under Loan Agreement, Revolver and Credit Facility | | 599.4 | | 521.1 | | 835.2 |
| Repayments of Loan Agreement, Revolver and Credit Facility | | (585.2) | | (571.1) | | (785.2) |
| Borrowings under Grolier Facility | | — | | 138.0 | | — |
| Repayments of Grolier Facility | | — | | (188.0) | | (300.0) |
| Repayment of 7% Notes | | (125.0) | | — | | — |
| Proceeds received from issuance of 5.75% Notes, net of related costs | | — | | — | | 296.7 |
| Proceeds received from issuance of 5% Notes, net of related costs | | — | | 171.3 | | — |
| Borrowings under lines of credit | | 294.1 | | 184.7 | | 151.8 |
| Repayments of lines of credit | | (300.7) | | (183.7) | | (150.7) |
| Proceeds pursuant to employee stock plans | | 7.6 | | 5.1 | | 22.8 |
| Other | | 3.9 | | 5.4 | | 0.2 |
|
| Net cash (used in) provided by financing activities | | (105.9) | | 82.8 | | 70.8 |
| Effect of exchange rate changes on cash | | 0.4 | | (0.1) | | 0.0 |
|
| Net (decrease) increase in cash and cash equivalents | | (40.8) | | 47.9 | | (3.1) |
| Cash and cash equivalents at beginning of year | | 58.6 | | 10.7 | | 13.8 |
|
| Cash and cash equivalents at end of year | | $ 17.8 | | $ 58.6 | | $ 10.7 |
|
| Supplemental information: | | | | | | |
| Income taxes paid | | $ 24.5 | | $ 14.6 | | $ 27.5 |
| Interest paid | | $ 39.0 | | $ 32.5 | | $ 28.0 |
|
| |
See accompanying notes
37
Notes to Consolidated Financial Statements
(Amounts in millions, except share and per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The consolidated financial statements include the accounts of Scholastic Corporation (the “Corporation”) and all wholly-owned subsidiaries (collectively “Scholastic” or the “Company”). All significant intercompany transactions are eliminated.
Use of estimates
The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements involves the use of estimates and assumptions by management, which affect the amounts reported in the consolidated financial statements and accompanying notes. The Company bases its estimates on historical experience, current business factors, and various other assumptions believed to be reasonable under the circumstances, all of which are necessary in order to form a basis for determining the carrying values of assets and liabilities. Actual results may differ from those estimates and assumptions. On an on-going basis, the Company evaluates the adequacy of its reserves and the estimates used in calculations, including, but not limited to: collectability of accounts receivable and installment receivables; sales returns; amortization periods; pension obligations; and recoverability of inventories, deferred promotion costs, deferred income taxes, prepublication costs, royalty advances, goodwill and other intangibles.
Revenue recognition
The Company’s revenue recognition policies for its principal businesses are as follows:
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 each book fair occurs.
Continuity Programs – The Company operates continuity programs whereby customers generally place a single order and receive multiple shipments of books and other products over a period of time. Revenue from continuity programs is recognized at the time of shipment or, in applicable cases, upon customer acceptance. Reserves for estimated returns are established at the time of sale and recorded as a reduction to revenue. Actual returns are charged to the reserve as received. The calculation of the reserve for estimated returns is based on historical return rates and sales patterns.
Trade – Revenue from the sale of children’s books for distribution in the retail channel 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 and recorded as a reduction to revenue. Actual returns are charged to the reserve as received. The calculation of the reserve for estimated returns is based on historical return rates and sales patterns.
Educational Publishing – For shipments to schools, revenue is recognized on passage of title, which generally occurs upon receipt by the customer. Shipments to depositories are on consignment. Revenue is recognized based on actual shipments from the depositories to the schools. For certain software-based products, the Company offers new customers installation and training. In such cases, revenue is recognized when installation and training are complete.
Toy Catalog – Revenue from the sale of children’s toys to the home through catalogs is recognized at the time of shipment, which is generally when title transfers to the customer. A reserve for estimated returns is established at the time of sale and
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recorded as a reduction to revenue. Actual returns are charged to the reserve as received. The calculation of the reserve for estimated returns is based on historical return rates and sales patterns.
Film Production and Licensing – Revenue from the sale of film rights, principally for the home video and domestic and foreign 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 the licensed materials are available to the licensee and collections are reasonably assured.
Magazines – Revenue is deferred and recognized ratably over the subscription period, as the magazines are delivered.
Magazine Advertising – Revenue is recognized when the magazine is on sale and available to the subscribers.
Scholastic In-School Marketing – Revenue is recognized when the Company has satisfied its obligations under the program and the customer has acknowledged acceptance of the product or service.
Cash equivalents
Cash equivalents consist of short-term investments with original maturities of less than three months.
Accounts receivable
Accounts receivable are recorded net of allowances for doubtful accounts and reserves 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. Reserves for returns are based on historical return rates and sales patterns. Allowances for doubtful accounts are established through the evaluation of accounts receivable agings and prior collection experience to estimate the ultimate collection of these receivables.
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 a calculation of forecasted demand utilizing the historical sales patterns of its products.
Deferred promotion costs
Deferred promotion costs represent direct mail and telemarketing promotion costs incurred to acquire customers in the Company’s continuity and magazine businesses. 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 and adjusts the carrying value accordingly. All other advertising costs are expensed as incurred.
Property, plant and equipment
Property, plant and equipment are carried at cost. Depreciation and amortization are recorded on a straight-line basis. Buildings have an estimated useful life, for purposes of depreciation, of forty years. Furniture, fixtures and equipment are depreciated over periods not exceeding ten years. Leasehold improvements are amortized over the life of the lease or the life of the assets, whichever is shorter. Interest is capitalized on major construction projects based on the outstanding construction-in-progress balance for the period and the average borrowing rate during the period.
Prepublication costs
The Company capitalizes the art, prepress, editorial and other costs incurred in the creation of the master copy of a book or other media (the “prepublication costs”). Prepublication costs are amortized on a straight-line basis over a three to seven year period. The Company regularly reviews the recoverability of the capitalized costs.
Royalty advances
The Company records a reserve for the recoverability of its outstanding advances to authors based primarily upon historical earndown
39
experience. Royalty advances are expensed as related revenues are earned or when future recovery appears doubtful.
Goodwill and other intangibles
Goodwill and other intangible assets with indefinite lives are reviewed for impairment annually, or more frequently if impairment indicators arise. With regard to goodwill, these reviews require the Company to estimate the fair value of its identified reporting units. For each of the reporting units, the estimated fair value is determined utilizing the expected present value of the projected future cash flows of the units, which is compared to the carrying value of the net assets of the reporting units. With regard to other intangibles with indefinite lives, the Company determines the fair value by asset, which is then compared to its carrying value.
Income taxes
The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to enter into the determination of taxable income.
It is the Company’s policy to establish reserves for probable exposures as a result of an examination by tax authorities. The Company establishes the reserves based upon management’s assessment of exposure associated with permanent tax differences, tax credits and interest expense applied to temporary difference adjustments. The tax reserves are analyzed periodically (at least annually) and adjustments are made, as events occur to warrant adjustment to the reserve.
Other noncurrent liabilities
All of the rate assumptions discussed below impact the Company’s calculations of its pension and post-retirement obligations. The rates applied by the Company are based on the portfolios’ past average rates of return and discussions with actuaries. Any change in market performance, interest rate performance, assumed health care costs trend rate, or compensation rates could result in significant changes in the pension and post-retirement obligations.
Pension obligations – Scholastic Corporation and certain of its subsidiaries have defined benefit pension plans covering the majority of their employees who meet certain eligibility requirements. The Company follows Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions,” in calculating the existing benefit obligations and net cost under the plans. These calculations are based on three primary actuarial assumptions: the discount rate, the long-term expected rate of return on plan assets, and the anticipated rate of compensation increases. The discount rate is used in the measurement of the projected, accumulated and vested benefit obligations and the service and interest cost components of net periodic pension costs. The long-term expected return on plan assets is used to calculate the expected earnings from the investment or reinvestment of plan assets. The anticipated rate of compensation increase is used to estimate the increase in compensation for participants of the plan from their current age to their assumed retirement age. The estimated compensation amounts are used to determine the benefit obligations and the service cost. Pension benefits in the cash balance plan for employees located in the United States are based on formulas in which the employees’ balances are credited monthly with interest based on the average rate for one-year United States Treasury Bills plus 1%. Contribution credits are based on employees’ years of service and compensation levels during their employment period.
Other post-retirement benefits – Scholastic Corporation provides post-retirement benefits, consisting of healthcare and life insurance benefits, to retired United States-based employees. A majority of these employees may become eligible for these benefits if they reach normal retirement age while working for the Company. The post-retirement medical plan benefits are funded on a pay-as-you-go basis, with the Company paying a
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portion of the premium and the employee paying the remainder. The Company follows SFAS No. 106, “Employers’ Accounting for Post-Retirement Benefits Other than Pensions,” in calculating the existing benefit obligation, which is based on the discount rate and the assumed health care cost trend rate. The discount rate is used in the measurement of the expected and accumulated benefit obligations and the service and interest cost components of net periodic post-retirement benefit cost. The assumed health care cost trend rate is used in the measurement of the long term expected increase in medical claims.
Foreign currency translation
The Company’s non-United States dollar denominated assets and liabilities are translated into United States dollars at prevailing rates at the balance sheet date and the revenues, costs and expenses are translated at the average rates prevailing during each reporting period. Net gains or losses resulting from the translation of the foreign financial statements and the effect of exchange rate changes on long-term intercompany balances are accumulated and charged directly to the foreign currency translation adjustment component of stockholders’ equity.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
Earnings per share
Basic earnings per share is based on the weighted average shares of Class A Stock and Common Stock outstanding. Diluted earnings per share is based on the weighted average shares of Class A Stock and Common Stock outstanding adjusted for the impact of potentially dilutive securities outstanding. The dilutive impact of options outstanding is calculated using the treasury stock method, which treats the options as if they were exercised at the beginning of the period, adjusted for Common Stock assumed to be repurchased with the proceeds and tax benefit realized upon exercise. Any potentially dilutive security is excluded from the computation of diluted earnings per share for any period in which it has an anti-dilutive effect.
Stock-based compensation
Under the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company applies Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option plans. In accordance with APB No. 25, no compensation expense was recognized with respect to the Company’s stock option plans, as the exercise price of each stock option issued was equal to the market price of the underlying stock on the date of grant and the exercise price and number of shares subject to grant were fixed. If the Company had elected to recognize compensation expense based on the fair value of the options granted at the date of grant and in respect to shares issuable under the Company’s equity compensation plans as prescribed by SFAS No. 123, net income and basic and diluted earnings per share for the three fiscal years ended May 31 would have been reduced to the pro forma amounts indicated in the following table:
|
| 2004 | | 2003 | | 2002 |
|
| Net income–as reported | $ 58.4 | | $ 58.6 | | $ 93.5 |
| Add: Stock-based employee compensation included inreported net income, net of tax | 0.4 | | 0.3 | | 0.2 |
| Deduct: Total stock-based employee compensation expense determined under fair value-based method, net of tax | 13.6 | | 14.3 | | 9.6 |
|
| Net income–proforma | $ 45.2 | | $ 44.6 | | $ 84.1 |
|
| Earnings pershare – as reported |
| Basic | $ 1.48 | | $ 1.50 | | $ 2.55 |
| Diluted | $ 1.46 | | $ 1.46 | | $ 2.38 |
| Earnings per share – pro forma | | | |
| Basic | $ 1.15 | | $ 1.14 | | $ 2.29 |
| Diluted | $ 1.13 | | $ 1.12 | | $ 2.17 |
|
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, with the weighted average
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assumptions for the three fiscal years ended May 31 as follows:
|
| 2004 | | 2003 | | 2002 |
|
| Expected dividend yield | 0.0% | | 0.0% | | 0.0% |
| Expected stock price volatility | 60.5% | | 61.5% | | 66.1% |
| Risk-free interest rate | 2.92% | | 3.45% | | 4.59% |
| Expected life of options | 5 years | | 5 years | | 5 years |
|
The weighted average fair value of options granted during fiscal 2004, 2003 and 2002 was $15.60, $18.00 and $25.24 per share, respectively. For purposes of pro forma disclosure, the estimated fair value of the options is amortized over the options’ vesting periods.
New accounting pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires variable interest entities to be consolidated by the primary beneficiary of the entity if certain criteria are met. FIN 46 was effective immediately for all variable interest entities created after January 31, 2003. For variable interest entities created or acquired before February 1, 2003, the provisions of FIN 46 became effective for the Company during the fourth quarter of fiscal 2004. The Company’s adoption of FIN 46 did not have a material impact on its financial position, results of operations or cash flows.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP 106-2 applies only to a single-employer defined benefit post-retirement health care plan for which an employer has concluded that prescription drug benefits available under the plan are “actuarially equivalent” to the prescription drug benefit now provided under Medicare pursuant to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, (the “2003 Medicare Act”), which was signed into law in December 2003, and therefore qualify for a federal subsidy introduced by that Act. Although the Company is not required to apply the guidance in FSP 106-2 until its fiscal quarter ending November 30, 2004, it has determined that its plan qualifies for such subsidy and has elected to begin accounting for the effects of the subsidy during its fiscal quarter ended May 31, 2004.
2. SEGMENT INFORMATION
The Company categorizes its businesses into four operating segments: Children’s Book Publishing and Distribution; Educational Publishing; Media, Licensing and Advertising (which collectively represent the Company’s domestic operations); and International. This classification reflects the nature of products and services consistent with the method by which the Company’s chief operating decision-maker assesses operating performance and allocates resources.
| • | | 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. | |
| • | | Educational Publishing includes the publication and distribution to schools and libraries of curriculum materials, children’s books, classroom magazines and print and on-line reference and non-fiction products for grades pre-kindergarten to 12 in the United States. | |
| • | | Media, Licensing and Advertising includes the production and/or distribution of software in the United States; the production and/or distribution primarily by and through the Company’s subsidiary, Scholastic Entertainment Inc.; of programming and consumer products (including children’s television programming, videos, software, feature films, promotional activities and non-book merchandise), and advertising revenue; including sponsorship programs. | |
| • | | International includes the publication and distribution of products and services outside the United States by the Company’s international operations, and its export and foreign rights businesses. | |
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The following table sets forth information for the three fiscal years ended May 31 for the Company’s segments. Certain prior year amounts have been reclassified to conform with the present year presentation.
|
| | | Children’s | | | | | | | | | | | | | |
| | | Book | | | | Media, | | | | | | | | | |
| | | Publishing | | | | Licensing | | | | | | | | | |
| | | and | | Educational | | and | | | | Total | | | | | |
| | | Distribution | | Publishing | | Advertising | | Overhead(1) | | Domestic | | International | | Consolidated | |
|
| 2004 | | | | | | | | | | | | | | | |
|
| Revenues | | $ 1,358.6 | | $ 369.1 | | $ 136.4 | | $ 0.0 | | $ 1,864.1 | | $ 369.7 | | $ 2,233.8 | |
| Bad debt | | 78.6 | | 1.0 | | 1.2 | | 0.0 | | 80.8 | | 9.5 | | 90.3 | |
| Depreciation | | 13.2 | | 3.2 | | 1.8 | | 28.5 | | 46.7 | | 6.5 | | 53.2 | |
| Amortization (2) | | 16.0 | | 36.3 | | 24.6 | | 0.0 | | 76.9 | | 2.5 | | 79.4 | |
| Royalty advances expensed | | 20.7 | | 0.9 | | 4.7 | | 0.0 | | 26.3 | | 2.2 | | 28.5 | |
| Segment profit (loss) (3) | | 114.8 | | 53.2 | | (2.5) | | (74.8) | | 90.7 | | 24.3 | | 115.0 | |
| Segment assets | | 737.7 | | 311.8 | | 60.3 | | 347.2 | | 1,457.0 | | 298.8 | | 1,755.8 | |
| Goodwill | | 127.9 | | 82.5 | | 10.7 | | 0.0 | | 221.1 | | 29.2 | | 250.3 | |
| Expenditures for long-lived assets (4) | | 53.3 | | 35.5 | | 27.6 | | 21.5 | | 137.9 | | 9.2 | | 147.1 | |
| Long-lived assets (5) | | 304.7 | | 187.5 | | 34.4 | | 240.7 | | 767.3 | | 103.4 | | 870.7 | |
|
| 2003 |
|
| Revenues | | $ 1,189.9 | | $ 325.9 | | $ 123.5 | | $ 0.0 | | $ 1,639.3 | | $ 319.0 | | $ 1,958.3 | |
| Bad debt | | 64.1 | | 0.8 | | 1.0 | | 0.0 | | 65.9 | | 6.4 | | 72.3 | |
| Depreciation | | 10.9 | | 3.9 | | 3.1 | | 24.5 | | 42.4 | | 3.2 | | 45.6 | |
| Amortization (2) | | 16.9 | | 27.8 | | 16.3 | | 0.0 | | 61.0 | | 0.5 | | 61.5 | |
| Royalty advances expensed | | 25.8 | | 2.5 | | 0.9 | | 0.0 | | 29.2 | | 2.4 | | 31.6 | |
| Segment profit (loss) (3) | | 134.4 | | 41.9 | | (2.9) | | (74.1) | | 99.3 | | 19.4 | | 118.7 | |
| Segment assets | | 749.1 | | 300.2 | | 66.3 | | 408.2 | | 1,523.8 | | 277.2 | | 1,801.0 | |
| Goodwill | | 126.3 | | 82.3 | | 10.2 | | 0.0 | | 218.8 | | 27.2 | | 246.0 | |
| Expenditures for long-lived assets (4) | | 73.8 | | 38.1 | | 24.9 | | 48.8 | | 185.6 | | 33.3 | | 218.9 | |
| Long-lived assets (5) | | 302.8 | | 191.7 | | 39.9 | | 247.0 | | 781.4 | | 99.9 | | 881.3 | |
|
| 2002 |
|
| Revenues | | $ 1,168.6 | | $ 316.9 | | $ 129.8 | | $ 0.0 | | $ 1,615.3 | | $ 301.7 | | $ 1,917.0 | |
| Bad debt | | 58.5 | | 0.9 | | 2.1 | | 0.0 | | 61.5 | | 7.2 | | 68.7 | |
| Depreciation | | 8.6 | | 3.4 | | 1.5 | | 17.7 | | 31.2 | | 4.4 | | 35.6 | |
| Amortization (2) | | 16.0 | | 22.8 | | 11.4 | | 0.0 | | 50.2 | | 1.0 | | 51.2 | |
| Royalty advances expensed | | 23.6 | | 1.6 | | 0.8 | | 0.0 | | 26.0 | | 0.6 | | 26.6 | |
| Segment profit (loss) (3) | | 178.4 | | 44.1 | | (0.2) | | (60.2) | | 162.1 | | 24.6 | | 186.7 | |
| Segment assets | | 689.5 | | 303.8 | | 55.3 | | 358.1 | | 1,406.7 | | 222.9 | | 1,629.6 | |
| Goodwill | | 129.5 | | 82.9 | | 10.0 | | 0.0 | | 222.4 | | 33.8 | | 256.2 | |
| Expenditures for long-lived assets (4) | | 112.5 | | 51.9 | | 22.4 | | 47.8 | | 234.6 | | 8.7 | | 243.3 | |
| Long-lived assets (5) | | 287.2 | | 187.6 | | 33.6 | | 223.2 | | 731.6 | | 72.8 | | 804.4 | |
|
| (1) | | Overhead includes all domestic corporate amounts not allocated to reportable segments, which includes unallocated expenses and costs related to the management of corporate assets. For fiscal 2003, includes $1.9 for the settlement of a securities lawsuit initiated in 1997. For fiscal 2002, includes $1.2 regarding the settlement of a litigation and related costs. 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, fulfillment and distribution facilities located in Missouri and Arkansas, and an industrial/office building complex in Connecticut. | |
| (2) | | Includes amortization of prepublication costs, production costs and other intangibles with definite lives. | |
| (3) | | Segment profit/(loss) represents earnings before other income (expense), interest expense, net and income taxes. In fiscal 2004, Children’s Book Publishing and Distribution and International include charges of $22.7 and $2.7, respectively, related to the Company’s review of the continuity business. In fiscal 2002, Segment profit (loss) excludes the cumulative effect of accounting change of $5.2 net of tax, or $0.13 per diluted share, related to the Media, Licensing and Advertising segment. | |
| (4) | | Includes expenditures for property, plant and equipment, investments in prepublication and production costs, royalty advances and acquisitions of, and investments in, businesses. | |
| (5) | | Includes property, plant and equipment, prepublication costs, goodwill, other intangibles, royalty advances, production costs and long-term investments. | |
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The following table separately sets forth information for the three fiscal years ended May 31 for the United States direct-to-home continuity programs, which consist primarily of the business formerly operated by Grolier Incorporated (“Grolier”) and are included in the Children’s Book Publishing and Distribution segment, and for all other businesses included in the segment:
|
| | | Direct-to-home | | All Other | | | | Total | | | |
|
| | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | |
|
| Revenues | | $ 203.8 | | $ 212.3 | | $ 209.0 | | $ 1,154.8 | | $ 977.6 | | $ 959.6 | | $ 1,358.6 | | $ 1,189.9 | | $ 1,168.6 | |
| Bad debt | | 49.9 | | 41.9 | | 39.6 | | 28.7 | | 22.2 | | 18.9 | | 78.6 | | 64.1 | | 58.5 | |
| Depreciation | | 0.5 | | 0.3 | | 0.4 | | 12.7 | | 10.6 | | 8.2 | | 13.2 | | 10.9 | | 8.6 | |
| Amortization (1) | | 1.3 | | 1.5 | | 0.7 | | 14.7 | | 15.4 | | 15.3 | | 16.0 | | 16.9 | | 16.0 | |
Royalty advances
expensed | | 0.8 | | 4.5 | | 1.2 | | 19.9 | | 21.3 | | 22.4 | | 20.7 | | 25.8 | | 23.6 | |
| Business profit (loss) (2) | | (10.7) | | 30.7 | | 39.7 | | 125.5 | | 103.7 | | 138.7 | | 114.8 | | 134.4 | | 178.4 | |
| Business assets | | 234.8 | | 252.1 | | 240.8 | | 502.9 | | 497.0 | | 448.7 | | 737.7 | | 749.1 | | 689.5 | |
| Goodwill | | 92.4 | | 93.0 | | 93.4 | | 35.5 | | 33.3 | | 36.1 | | 127.9 | | 126.3 | | 129.5 | |
Expenditures for
long-lived assets (3) | | 4.6 | | 6.8 | | 9.5 | | 48.7 | | 67.0 | | 103.0 | | 53.3 | | 73.8 | | 112.5 | |
| Long-lived assets (4) | | 143.9 | | 142.5 | | 142.6 | | 160.8 | | 160.3 | | 144.6 | | 304.7 | | 302.8 | | 287.2 | |
|
| (1) | | Includes amortization of prepublication costs and other intangibles with definite lives. | |
| (2) | | Business profit (loss) represents earnings (loss) before other income (expense), interest expense, net and income taxes. In fiscal 2004, Direct-to-home and All Other include charges of $14.9 and $7.8, respectively, related to the Company’s review of the continuity business. | |
| (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. | |
3. DEBT
The following summarizes debt as of May 31:
|
| | | Carrying | | Fair | | Carrying | | Fair |
| | | Value | | Value | | Value | | Value |
|
| | | 2004 | | 2003 |
|
| Lines of Credit | | $ 23.0 | | $ 23.0 | | $ 28.5 | | $ 28.5 |
| Credit Agreement and Revolver | | 14.2 | | 14.2 | | — | | — |
| 7% Notes due 2003, net of discount | | — | | — | | 125.0 | | 128.5 |
| 5.75% Notes due 2007, net of premium/discount | | 305.5 | | 313.5 | | 303.8 | | 322.4 |
| 5.75% Notes due 2007 – swap valuation adjustment | | — | | — | | 5.6 | | 5.6 |
| 5% Notes due 2013, net of discount | | 172.8 | | 163.1 | | 172.6 | | 182.7 |
| Other debt | | 1.1 | | 1.1 | | 0.4 | | 0.4 |
|
| Total debt | | 516.6 | | 514.9 | | 635.9 | | 668.1 |
| Less lines of credit and short-term debt | | (24.1) | | (24.1) | | (153.7) | | (157.2) |
|
| Total long-term debt | | $ 492.5 | | $ 490.8 | | $ 482.2 | | $ 510.9 |
|
| Short-term debt is carried at cost that approximates fair value. Fair values were estimated based on market quotes, where available, or dealer quotes. | |
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The following table sets forth the maturities of the carrying values of the Company’s debt obligations as of May 31, 2004 for fiscal years ended May 31:
|
| | Value |
|
| 2005 | | $ 24.1 |
| 2006 | | — |
| 2007 | | 305.5 |
| 2008 | | — |
| 2009 | | 14.2 |
| Thereafter | | 172.8 |
|
| Total debt | | $ 516.6 |
|
Lines of Credit
Scholastic Corporation’s international subsidiaries had unsecured lines of credit available in local currencies equivalent to $62.1 and $57.8 at May 31, 2004 and 2003, respectively. There were borrowings equivalent to $23.0 and $28.5 outstanding under these credit lines at May 31, 2004 and 2003, respectively. These lines of credit are considered short-term in nature. The weighted average interest rates on the outstanding amounts were 5.48% and 6.89% at May 31, 2004 and 2003, respectively.
Credit Agreement
On March 31, 2004, Scholastic Corporation and Scholastic Inc. entered into an unsecured revolving credit agreement with certain banks (the “Credit Agreement”), which replaced a similar loan agreement that was scheduled to expire on August 11, 2004 (the “Loan Agreement”). The Credit Agreement, which expires on March 31, 2009, provides for aggregate borrowings of up to $190.0 (with a right in certain circumstances to increase borrowings to $250.0), including the issuance of up to $10.0 in letters of credit. Interest under this facility is either at the prime rate or 0.325% to 0.975% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30% and a utilization fee ranging from 0.05% to 0.25% if borrowings exceed 50% of the total facility. The amounts charged vary based upon the Company’s credit rating. The interest rate and facility fee as of May 31, 2004 were 0.55% over LIBOR and 0.15%, respectively. The Credit Agreement contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. On May 31, 2004, $12.0 was outstanding under the Credit Agreement at a weighted average interest rate of 1.7%.
Revolver
Scholastic Corporation and Scholastic Inc. are joint and several borrowers under an unsecured revolving loan agreement with a bank (the “Revolver”). As amended effective April 30, 2004, the Revolver provides for unsecured revolving credit of up to $40.0 and expires on March 31, 2009. Interest under this facility is either at the prime rate minus 1%, or 0.375% to 1.025% over LIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30%. The amounts charged vary based upon the Company’s credit rating. The interest rate and facility fee as of May 31, 2004 were 0.60% over LIBOR and 0.15%, respectively. The Revolver contains certain financial covenants related to debt and interest coverage ratios (as defined) and limits dividends and other distributions. At May 31, 2004, $2.2 was outstanding under the Revolver at a weighted average interest rate of 3.0%. There were no borrowings outstanding under the Revolver at May 31, 2003.
7% Notes due 2003
Scholastic Corporation repaid all $125.0 of its 7% Notes at maturity on December 15, 2003, using cash on hand and borrowings available under the Loan Agreement and the Revolver made possible by the issuance of the 5% Notes, as defined below.
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5.75% Notes due 2007
In January 2002, Scholastic Corporation issued $300.0 of 5.75% Notes (the “5.75% Notes”). The 5.75% Notes are senior unsecured obligations that mature on January 15, 2007. Interest on the 5.75% Notes is payable semi-annually on July 15 and January 15 of each year. The Company may, at any time, redeem all or a portion of the 5.75% Notes at a redemption price (plus accrued interest to the date of redemption) equal to the greater of (i) 100% of the principal amount, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption.
Interest Rate Swap Agreement
In February 2002, Scholastic Corporation 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,” whereby the Company received a fixed interest rate payment from, and paid an amount based on a variable rate to, the counterparty based on a notional amount, in order to exchange the fixed rate payments on a portion of the 5.75% Notes for variable rate payments. In accordance with SFAS No. 133, the swap was considered perfectly effective and all changes in fair value were recorded to Other assets and Long-term debt. On May 28, 2003, $50.0 of the original $100.0 notional amount was settled and the Company received a payment of $5.4 from the counterparty. On November 3, 2003, the remaining $50.0 under the agreement was settled, and the Company received a payment of $3.8 from the counterparty. The cash received was used to fully reduce the Other asset previously established, and the corresponding credit is being amortized over the remaining term of the 5.75% Notes. The fair value of this interest rate swap agreement was $5.6 at May 31, 2003.
5% Notes due 2013
On April 4, 2003, Scholastic Corporation issued $175.0 of 5% Notes (the “5% Notes”). The 5% Notes are senior unsecured obligations that mature on April 15, 2013. Interest on the 5% Notes is payable semi-annually on April 15 and October 15 of each year. The Company may at any time redeem all or a portion of the 5% Notes at a redemption price (plus accrued interest to the date of the redemption) equal to the greater of (i) 100% of the principal amount, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption.
4. COMMITMENTS AND CONTINGENCIES
Commitments
The Company leases warehouse space, office space and equipment under various operating leases. Certain of these leases provide for rent increases based on price-level factors. In most cases, management expects that in the normal course of business leases will be renewed or replaced by other leases. The Company has no significant capitalized leases. Total rent expense relating to the Company’s operating leases was $47.8, $48.3 and $44.2 for the fiscal years ended May 31, 2004, 2003 and 2002, respectively. The rent payments are subject to escalation provisions and are net of sublease income. The aggregate minimum future annual rental commitments at May 31, 2004 under all non-cancelable operating leases, totaling $304.9, are as follows: 2005 – $43.1; 2006 – $34.1; 2007 – $24.1; 2008 – $17.8; 2009 – $13.2; later years – $172.6.
The Company had certain contractual commitments, principally relating to royalty advances, at May 31, 2004 totaling $18.7. The aggregate annual commitments are as follows: 2005 – $14.8; 2006 – $3.5; 2007 – $0.4.
Contingencies
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.
46
5. ACQUISITIONS
Fiscal 2004 Acquisitions
On July 1, 2003, the Company acquired certain assets of Troll Holdings, Inc. (“Troll”), formerly a national school-based book club operator and publisher, for $4.0 in cash and the assumption of certain ordinary course liabilities. On August 8, 2003, the Company acquired the stock of BTBCAT, Inc., which operates Back to Basics Toys (“Back to Basics”), a direct-to-home catalog business specializing in children’s toys, for $4.8 in cash. The assets and liabilities of each business acquired were adjusted to their fair values as of the date of acquisition, with the purchase price in excess of the fair market value assigned to goodwill.
The following summarizes the allocation of the aggregate purchase price of the fiscal 2004 acquisitions:
|
| | | | | | | Value |
|
| Inventory | | | | | | $ 1.7 |
| Other current assets | | | | | | 1.0 |
| Goodwill | | | | | | 3.0 |
| Other intangibles | | | | | | 4.9 |
| Noncurrent deferred taxes | | | | | | 0.2 |
| Current liabilities | | | | | | (2.0) |
|
| Cash paid for acquisitions, net of cash received | | | | | | $ 8.8 |
|
The operating results of each fiscal 2004 acquisition have been included in the Company’s consolidated results of operations since the respective dates of acquisition. The effect on operating results of including the acquired business operations on a pro forma basis would not be material.
Fiscal 2003 Acquisition
In fiscal 2003, the Company acquired all worldwide rights to the Goosebumps™ property from Parachute Press, Inc. and its affiliates (“Parachute”) and the parties settled all outstanding disputes between them. Under the agreement, the Company paid $9.7 to acquire all Parachute’s rights in the Goosebumps trademark, to publish existing and future Goosebumps books and to develop and exploit the property on a worldwide basis in all media, without future royalty obligations to Parachute.
Fiscal 2002 Acquisitions
During fiscal 2002, the Company completed the acquisitions of the stock or assets of the following companies: Troll Book Fairs LLC, a national school-based book fair operator; Tom Snyder Productions, Inc., a developer and publisher of interactive educational software and producer of television programming; Sandvik Publishing Ltd., d/b/a Baby’s First Book Club®, a direct marketer of age-appropriate books and toys for young children; Klutz, a publisher and creator of “books plus” products for children; Teacher’s Friend Publications, Inc., a producer and marketer of materials that teachers use to decorate their classrooms; and Nelson B. Heller & Associates, a publisher of business-to-business newsletters. The aggregate purchase price for these acquisitions, net of cash received, was $66.7. In addition to the initial purchase price paid for Klutz of $42.8, the purchase agreement provided for additional payments of up to $31.3 in 2004 and 2005, contingent upon the achievement of certain revenue thresholds. The Company does not expect to make any payment for 2004.
The assets and liabilities of each business acquired were adjusted to their fair values as of the date of acquisition, with the purchase price in excess of the fair market value assigned to goodwill.
The following summarizes the allocation of the aggregate purchase price of the fiscal 2002 acquisitions:
|
| | | | | | | Value |
|
| Accounts receivable | | | | | | $ 9.6 |
| Inventory | | | | | | 10.7 |
| Other current assets | | | | | | 6.1 |
| Property, plant and equipment | | | | | | 1.2 |
| Goodwill | | | | | | 31.5 |
| Other intangibles | | | | | | 0.4 |
| Noncurrent deferred taxes | | | | | | 18.6 |
| Other assets | | | | | | 0.4 |
| Current liabilities | | | | | | (11.8) |
|
| Cash paid for acquisitions, net of cash received | | | | | | $ 66.7 |
|
| |
47
The allocation of the aggregate purchase price was finalized during fiscal 2003. The operating results of each fiscal 2002 acquisition have been included in the Company’s consolidated results of operations since the respective dates of acquisition. The effect on operating results of including the acquired business operations on a pro forma basis would not be material.
In connection with the fiscal 2002 acquisitions, the Company established liabilities of $3.2 at May 31, 2002, relating primarily to severance and other exit costs. As of May 31, 2004, $0.2 of these liabilities remained unpaid.
6. INVESTMENT
In fiscal 2003, the Company entered into a joint venture with The Book People, Ltd., a direct marketer of books in the United Kingdom, to distribute books to the home under the Red House name and through schools under the School Link name. Accordingly, £5.9 (equivalent to $9.1 as of the date of the transaction) relating to Red House was recorded as an investment in the joint venture (see Note 7). The Company also acquired a 15% equity interest in The Book People Group, Ltd. for £12.0 (equivalent to $17.9 as of the date of the transaction) with a possible additional payment of £3.0 based on operating results and contingent on repayment of all borrowings under a £3.0 revolving credit facility established at the date of the transaction by the Company in favor of The Book People Group, Ltd. The revolving credit facility is available to fund the expansion of The Book People Group, Ltd. and for working capital purposes. As of May 31, 2004, £3.0 (equivalent to $5.5 at that date) was outstanding under the revolving credit facility. The equity investment in The Book People Group, Ltd. is included in Other within the Other Assets and Deferred Charges section of the Consolidated Balance Sheets.
7. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets with indefinite lives are reviewed for impairment annually, or more frequently if impairment indicators arise.
The following table summarizes the activity in Goodwill for the years ended of May 31:
|
| | | | | 2004 | | 2003 |
|
| Beginning balance | | | | $ 246.0 | | $ 256.2 |
| Additions due to acquisitions | | | | 3.0 | | 0.4 |
| Investment in joint venture | | | | — | | (9.1) |
| Other adjustments | | | | 1.3 | | (1.5) |
|
| Ending balance | | | | $ 250.3 | | $ 246.0 |
|
| |
The following table summarizes Other intangibles subject to amortization as of May 31:
|
| | | | | 2004 | | 2003 |
|
| Customer lists | | | | $ 2.9 | | $ 2.9 |
| Accumulated amortization | | | | (2.7) | | (2.5) |
|
| Net customer lists | | | | 0.2 | | 0.4 |
|
| Other intangibles | | | | 4.0 | | 3.9 |
| Accumulated amortization | | | | (2.4) | | (2.3) |
|
| Net other intangibles | | | | 1.6 | | 1.6 |
|
| Total | | | | $ 1.8 | | $ 2.0 |
|
Amortization expense for Other intangibles totaled $0.3, $0.5 and $1.0 for the fiscal years ended May 31, 2004, 2003 and 2002, respectively. Amortization expense for these assets is currently estimated to total $0.3 for each of the fiscal years ending May 31, 2005 and 2006, and $0.2 for each of the fiscal years ending May 31, 2007 through 2009. The weighted average amortization periods for these assets by major asset class are two years and 13 years for customer lists and other intangibles, respectively.
48
The following table summarizes Other intangibles not subject to amortization as of May 31:
|
| | | | | 2004 | | 2003 |
|
| Net carrying value by major class: | | | | |
| Titles | | | | $ 31.0 | | $ 31.0 |
| Licenses | | | | 17.2 | | 17.2 |
| Major sets | | | | 11.4 | | 11.4 |
| Trademarks and other | | | | 17.5 | | 12.6 |
|
| Total | | | | $ 77.1 | | $ 72.2 |
|
Trademarks and other increased by $4.9, relating to the fiscal 2004 Troll and Back to Basics acquisitions.
8. INCOME TAXES
The provisions for income taxes for the fiscal years ended May 31 are based on earnings before taxes and Cumulative effect of accounting change as follows:
|
| | | 2004 | | 2003 | | 2002 | |
|
| United States | | $ 89.9 | | $ 81.8 | | $ 144.7 | |
| Non-United States | | 0.6 | | 8.3 | | 8.6 | |
|
| | | $ 90.5 | | $ 90.1 | | $ 153.3 | |
|
| |
The provisions for income taxes attributable to earnings before Cumulative effect of accounting change for the fiscal years ended May 31 consist of the following components:
|
| | | 2004 | | 2003 | | 2002 |
|
| Federal |
| Current | | $ 18.9 | | $ 11.5 | | $ 29.4 |
| ��Deferred | | 6.2 | | 13.4 | | 15.4 |
|
| | | $ 25.1 | | $ 24.9 | | $ 44.8 |
|
| State and local |
| Current | | $ 4.7 | | $ 3.4 | | $ 3.7 |
| Deferred | | 0.8 | | 0.9 | | 2.0 |
|
| | | $ 5.5 | | $ 4.3 | | $ 5.7 |
|
| International |
| Current | | $ 5.6 | | $ 4.3 | | $ 3.5 |
| Deferred | | (4.1) | | (2.0) | | 0.6 |
|
| | | $ 1.5 | | $ 2.3 | | $ 4.1 |
|
| Total |
| Current | | $ 29.2 | | $ 19.2 | | $ 36.6 |
| Deferred | | 2.9 | | 12.3 | | 18.0 |
|
| | | $ 32.1 | | $ 31.5 | | $ 54.6 |
|
| |
The provisions for income taxes attributable to earnings before Cumulative effect of accounting change for the fiscal years ended May 31 differ from the amount of tax determined by applying the federal statutory rate as follows:
|
| | | 2004 | | 2003 | | 2002 |
|
| Computed federal statutory provision | | $ 31.7 | | $ 31.5 | | $ 53.7 |
| State income tax provision, net of federal income tax benefit | | 3.6 | | 2.8 | | 3.6 |
| Difference in effective tax rateson earnings of foreign subsidiaries | | (3.0) | | (1.4) | | (0.7) |
| Charitable contributions | | — | | (1.4) | | (1.8) |
| Other – net | | (0.2) | | 0.0 | | (0.2) |
|
| Total provision for income taxes | | $ 32.1 | | $ 31.5 | | $ 54.6 |
|
| Effective tax rates | | 35.5% | | 35.0% | | 35.6% |
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for income tax purposes as determined under enacted tax laws and rates. The tax effects of items that give rise to deferred tax assets and liabilities as of May 31 for the indicated fiscal years are as follows:
|
| | | | | 2004 | | 2003 |
|
| Net deferred tax assets: |
| Tax uniform capitalization | | | | $ 24.2 | | $ 24.3 |
| Inventory reserves | | | | 18.5 | | 16.7 |
| Allowance for doubtful accounts | | | | 21.5 | | 19.6 |
| Other accounting reserves | | | | 13.5 | | 18.4 |
| Post-retirement, post-employment and pension obligations | | | | 13.6 | | 21.3 |
| Tax carryforwards | | | | 5.7 | | 5.1 |
| Prepaid expenses | | | | (11.0) | | (15.2) |
| Depreciation and amortization | | | | (23.9) | | (10.7) |
| Other – net | | | | (1.5) | | (1.5) |
|
| Total net deferred tax assets | | | | $ 60.6 | | $ 78.0 |
|
Net deferred tax assets of $60.6 at May 31, 2004 and $78.0 at May 31, 2003 include $4.0 and $1.2 in Other accrued expenses at May 31, 2004 and 2003, respectively, and $13.9 and $3.1 in Other noncurrent liabilities at May 31, 2004 and 2003, respectively.
49
The undistributed earnings of foreign subsidiaries at May 31, 2004 were $22.7. Any remittance of foreign earnings would not result in any significant additional tax.
At May 31, 2004, the Company had a charitable deduction carryforward of $7.2, which expires in the fiscal year ending 2008, and foreign operating loss carryforwards of $10.7, which do not have expiration dates.
The Company had tax reserves totaling $8.3 and $8.0 at May 31, 2004 and 2003, respectively.
9. CAPITAL STOCK AND STOCK OPTIONS
Scholastic Corporation has authorized capital stock of 2,500,000 shares of Class A Stock, par value $0.01 per share (the “Class A Stock”); 70,000,000 shares of Common Stock, par value $0.01 per share (the “Common Stock”); and 2,000,000 shares of Preferred Stock, par value $1.00 per share (the “Preferred Stock”).
Class A and Common Stock
At May 31, 2004, 1,656,200 shares of Class A Stock and 37,930,986 shares of Common Stock were outstanding. At May 31, 2004, Scholastic Corporation had reserved for issuance 11,794,154 shares of Common Stock. Of these shares, 9,387,702 shares were reserved for issuance under the Company’s stock-based plans (including shares available for grant and stock options currently outstanding), 1,656,200 shares were reserved for issuance upon conversion of the Class A Stock and 750,252 shares were reserved for future issuances under the Company’s employee stock purchase plans.
The only voting rights vested in the holders of Common Stock, except as required by law, are the election of such number of directors as shall equal at least one-fifth of the members of the Board of Directors. The holders of Class A Stock are entitled to elect all other directors and to vote on all other matters. Holders of Class A Stock and Common Stock are entitled to one vote per share on matters on which they are entitled to vote. The holders of Class A Stock have the right, at their option, to convert shares of Class A Stock into shares of Common Stock on a share-for-share basis.
With the exception of voting rights and conversion rights, and as to the rights of holders of Preferred Stock if issued, the Class A Stock and the Common Stock are equal in rank and are entitled to dividends and distributions, when and if declared by the Board of Directors. Scholastic Corporation has not paid any cash dividends since its public offering in 1992 and has no current plans to pay any dividends on its Class A Stock or Common Stock.
Preferred Stock
The Preferred Stock may be issued in one or more series, with the rights of each series, including voting rights, to be determined by the Board of Directors before each issuance. To date, no shares of Preferred Stock have been issued.
50
Stock Options
At May 31, 2004, the Company maintained three stockholder-approved employee stock-based benefit plans: the Scholastic Corporation 1992 Stock Option Plan (the “1992 Plan”), under which no further awards can be made; the Scholastic Corporation 1995 Stock Option Plan (the “1995 Plan”); and the Scholastic Corporation 2001 Stock Incentive Plan (the “2001 Plan”). The 1995 Plan provides for the issuance of two types of options to purchase Company stock: incentive stock options, which qualify for special treatment under the Internal Revenue Code, and options that are not so qualified, called non-qualified stock options. The 2001 Plan provides for the issuance of non-qualified stock options, incentive stock options, restricted stock and other stock-based awards. At May 31, 2004, non-qualified stock options to purchase 594,956; 4,219,256; and 2,894,875 shares of Common Stock were outstanding under the 1992 Plan, 1995 Plan and 2001 Plan, respectively; and 19,990 and 1,095,125 shares of Common Stock were available for additional awards under the 1995 Plan and 2001 Plan, respectively.
The Company also maintains two stockholder-approved stock option plans for outside directors: the 1992 Outside Directors’ Stock Option Plan (the “1992 Directors’ Plan”), under which no further awards can be made, and the 1997 Outside Directors’ Stock Option Plan (the “1997 Directors’ Plan”). The 1997 Directors’ Plan, as amended, provides for the automatic grant to non-employee directors on the date of each annual stockholders’ meeting of non-qualified stock options to purchase 6,000 shares of Common Stock. At May 31, 2004, options to purchase 311,500 and 12,000 shares of Common Stock were outstanding under the 1997 Directors’ Plan and the 1992 Directors’ Plan, respectively, and 240,000 shares of Common Stock were available for additional awards under the 1997 Directors’ Plan. In September 2003, options were awarded under the 1997 Directors’ Plan at an exercise price of $30.88. On September 23, 2003, the Class A Stockholders approved an increase in the number of shares of Common Stock available for issuance under the 1997 Directors’ Plan of 270,000 shares.
Generally, options granted under the various plans may not be exercised for a minimum of one year after the date of grant and expire ten years after the date of grant.
The following table sets forth the stock option activity for the three fiscal years ended May 31:
|
| | | 2004 | | 2003 | | 2002 |
|
| | | | | Weighted | | | | Weighted | | | | Weighted |
| | | | | Average | | | | Average | | | | Average |
| | | | | Exercise | | | | Exercise | | | | Exercise |
| | | Options | | Price | | Options | | Price | | Options | | Price |
|
| Outstanding – beginning of year | | 6,852,258 | | $ 28.65 | | 5,539,712 | | $ 27.58 | | 6,035,804 | | $ 25.28 |
| Granted | | 1,599,000 | | 27.90 | | 1,392,240 | | 32.69 | | 692,000 | | 42.62 |
| Exercised | | (197,296) | | 23.23 | | (59,694) | | 21.49 | | (911,292) | | 22.07 |
| Cancelled | | (221,375) | | 32.89 | | (20,000) | | 34.31 | | (276,800) | | 32.79 |
|
| Outstanding – end of year | | 8,032,587 | | $ 28.52 | | 6,852,258 | | $ 28.65 | | 5,539,712 | | $ 27.58 |
|
| Exercisable – end of year | | 5,279,912 | | $ 27.43 | | 4,669,518 | | $ 26.05 | | 4,083,962 | | $ 24.52 |
|
51
The following table sets forth information as of May 31, 2004 regarding weighted average exercise prices and weighted average remaining contractual lives for the outstanding stock options, sorted by range of exercise price:
|
| | | Options Outstanding | | Options Exercisable |
|
| | | | | | | Weighted | | | | |
| | | | | | | Average | | | | Weighted |
| | | | | Weighted | | Remaining | | | | Average |
Options | | | | | Average | | Contractual | | Number | | Exercise |
Price Range | | | Number | | Exercise Price | | Life | | Exercisable | | Price |
|
| $ 15.73 — $ 20.97 | | 1,663,666 | | $ 18.36 | | 3.5years | | 1,663,666 | | $ 18.36 |
| $ 20.98 — $ 26.21 | | 1,292,281 | | 25.28 | | 6.2 years | | 992,856 | | 25.42 |
| $ 26.22 — $ 31.45 | | 2,211,400 | | 28.32 | | 7.0 years | | 727,900 | | 29.45 |
| $ 31.46 — $ 36.69 | | 2,117,990 | | 33.60 | | 7.0 years | | 1,391,990 | | 32.93 |
| $ 36.70 — $ 41.94 | | 131,750 | | 38.30 | | 6.1 years | | 80,500 | | 38.18 |
| $ 41.95 — $ 47.18 | | 533,500 | | 43.03 | | 7.5 years | | 354,000 | | 43.12 |
| $ 47.19 — $ 52.42 | | 82,000 | | 49.99 | | 7.6 years | | 69,000 | | 49.88 |
|
Employee Stock Purchase Plan
The Company maintains an Employee Stock Purchase Plan (“ESPP”), which is offered to eligible United States employees. The ESPP permits participating employees to purchase Common Stock, through after-tax payroll deductions, on a quarterly basis at a 15% discount from the lower of the closing price of the Common Stock on NASDAQ on the first or last business day of each fiscal quarter. During fiscal 2004, 2003 and 2002, the Company issued 121,256; 131,417; and 71,073 shares under the ESPP at a weighted average price of $25.01, $25.54 and $35.87 per share, respectively. At May 31, 2004, there were 454,683 shares authorized to be issued under the ESPP.
Management Stock Purchase Plan
The Company maintains a Management Stock Purchase Plan (“MSPP”), which allows certain members of senior management to defer up to 100% of their annual cash bonus payment in the form of restricted stock units (“RSUs”). The RSUs are purchased by the employee at a discount from the lowest closing price of the Common Stock on NASDAQ during the fiscal quarter in which such bonuses are payable and are converted into shares of Common Stock on a one-for-one basis at the end of the applicable deferral period. Effective June 1, 2002, the MSPP was amended to increase the discount on the purchase of RSUs to 25% from 15%. During fiscal 2004, 2003 and 2002, the Company allocated 0 RSUs, 62,071 RSUs, and 45,301 RSUs to participants under the MSPP at a weighted average price of $0, $25.22 and $30.60 per RSU, resulting in an expense of $0.4, $0.5 and $0.2, respectively. Effective December 18, 2002, the MSPP was amended to allow certain additional management personnel to purchase RSU’s at a discount rate of 10%.
10. EMPLOYEE BENEFIT PLANS
Pension Plans
The Company has a cash balance retirement plan (the “Pension Plan”), which covers the majority of United States employees who meet certain eligibility requirements. The Company funds all of the contributions for the Pension Plan. Benefits generally are based on the Company’s contributions and interest credits allocated to participants accounts based on years of benefit service and annual pensionable earnings. It is the Company’s policy to fund the minimum amount required by the Employee Retirement Income Security Act (“ERISA”) of 1974, as amended.
Scholastic Ltd., an indirect subsidiary of Scholastic Inc. located in the United Kingdom, has a defined
52
benefit pension plan (the “U.K. Pension Plan”) that covers its employees who meet various eligibility requirements. Benefits are based on years of service and on a percentage of compensation near retirement. The U.K. Pension Plan is funded by contributions from Scholastic Ltd. and its employees.
Grolier Ltd., an indirect subsidiary of Scholastic Inc. located in Canada, provides a defined benefit pension plan (the “Grolier Canada Pension Plan”) that covers its employees who meet certain eligibility requirements. All full time employees are eligible to participate in the plan after two years of employment. Grolier Ltd.’s contributions to the fund have been suspended due to an actuarial surplus. Employees are not required to contribute to the fund.
The Company’s pension plans have different measurement dates as follows: for the Pension Plan – May 31, 2004; for the U.K. Pension Plan and the Grolier Canada Pension Plan – March 31, 2004.
Post-Retirement Benefits
The Company provides Post-Retirement Benefits to retired United States-based employees (the “Post-Retirement Benefits”) consisting of certain healthcare and life insurance benefits. A majority of these employees may become eligible for these benefits if they reach normal retirement age while working for the Company. In fiscal 2004, the Company amended the Post-Retirement Benefits by changing the prescription drug co-pay schedule for Medicare-eligible participants to be the same as for non-Medicare eligible participants. The impact of this amendment was to reduce the benefit obligation by $2.8. In fiscal 2003, the Company amended the Post-Retirement Benefits by increasing the participants’ contribution rate. The impact of this amendment was to reduce the benefit obligation by $8.6. The balance of these two amendments was recorded as unrecognized prior service cost and will be amortized over 141/2 years. At May 31, 2004, the unrecognized prior service cost remaining was $10.1.
The following table sets forth the weighted average actuarial assumptions utilized to determine the benefit obligations for the Pension Plan, the U.K. Pension Plan and the Grolier Canada Pension Plan (collectively the “Pension Plans”) at May 31:
|
| | | | Post-Retirement |
| | Pension Benefits | | Benefits |
|
| | | 2004 | | 2003 | | 2004 | | 2003 |
|
Weighted average assumptions used to
determine benefit obligations: |
| Discount rate | | 6.5% | | 6.0% | | 6.7% | | 6.0% |
| Rate of compensation increase | | 4.0% | | 4.0% | | — | | — |
Weighted average assumptions used to
determine net periodic benefit cost: | | | | | |
| Discount rate | | 6.0% | | 7.3% | | 6.0% | | 7.3% |
| Expected long-term return on plan assets | | 8.9% | | 8.9% | | — | | — |
| Rate of compensation increase | | 4.0% | | 4.0% | | — | | — |
|
To develop the expected long-term rate of return on assets assumption for its pension plans, the Company, with the assistance of its actuaries, considers historical returns and future expectations. Over the 15-20 year periods ending May 31, 2003, the returns on the portfolio, assuming it was invested at the current target asset allocation in the prior periods, would have been a compounded annual average of 10%-12%. Considering this information and the potential for lower future returns due to a generally lower interest rate environment, the Company selected an assumed weighted average long-term rate of return of 8.9% for all plans.
53
The following table sets forth changes in benefit obligation and plan assets, the reconciliation of funded status and the (decrease) increase in the minimum pension liability included in accumulated other comprehensive loss for the Pension Plans and the Post-Retirement Benefits for the two fiscal years ended May 31:
|
| | | | | | | Post-Retirement |
| | | Pension Benefits | | Benefits |
|
| | | 2004 | | 2003 | | 2004 | | 2003 |
|
| Change in benefit obligation |
| Benefit obligation at beginning of year | | $ 131.2 | | $ 111.6 | | $ 28.8 | | $ 23.4 |
| Service cost | | 7.0 | | 5.9 | | 0.5 | | 0.5 |
| Interest cost | | 7.7 | | 7.7 | | 2.0 | | 1.8 |
| Plan participants’ contributions | | 0.5 | | 0.6 | | — | | — |
| Amendments | | — | | 0.2 | | (2.8) | | (8.6) |
| Actuarial (gains) losses | | (7.2) | | 11.8 | | 5.5 | | 13.9 |
| Foreign currrency exchange rate changes | | 3.2 | | 2.3 | | — | | — |
| Benefits paid | | (11.2) | | (8.9) | | (2.6) | | (2.2) |
|
| Benefit obligation at end of year | | $131.2 | | $131.2 | | $ 31.4 | | $ 28.8 |
|
| Change in plan assets |
| Fair value of plan assets at beginning of year | | $ 88.9 | | $ 87.3 | | $ — | | $ — |
| Actual gain (loss) on plan assets | | 15.8 | | (2.3) | | — | | — |
| Company contributions | | 19.4 | | 11.0 | | — | | — |
| Plan participants’ contributions | | 0.5 | | 0.4 | | — | | — |
| Administrative expenses | | (0.9) | | (0.8) | | — | | — |
| Foreign currrency exchange rate changes | | 2.2 | | 2.2 | | — | | — |
| Benefits paid | | (11.2) | | (8.9) | | — | | — |
|
| Fair value of plan assets at end of year | | $114.7 | | $ 88.9 | | $ — | | $ — |
|
| Funded status |
| Underfunded status of the plans | | $ (16.5) | | $ (42.3) | | $ (31.4) | | $ (28.8) |
| Unrecognized net actuarial loss | | 37.7 | | 54.0 | | 22.4 | | 18.9 |
| Unrecognized prior service cost | | (1.8) | | (2.1) | | (10.1) | | (8.1) |
| Unrecognized net asset obligation | | 0.2 | | 0.4 | | — | | — |
|
| Accrued benefit asset (liability) | | $ 19.6 | | $ 10.0 | | $(19.1) | | $(18.0) |
|
| Amounts recognized in the Consolidated Balance Sheets |
| Prepaid benefit cost | | $ 19.6 | | $ 8.8 | | $ — | | $ — |
| Accrued benefit liability | | (26.1) | | (43.3) | | (19.1) | | (18.0) |
| Intangible asset | | 0.1 | | 0.1 | | — | | — |
| Accumulated other comprehensive loss | | 26.0 | | 43.2 | | — | | — |
|
| Net amount recognized | | $ 19.6 | | $ 8.8 | | $(19.1) | | $(18.0) |
|
(Decrease) increase in minimum liability included
in other comprehensive income | | $ (17.2) | | $ 21.4 | | $ — | | $ — |
|
| |
The accumulated benefit obligation for all Pension Plans was $123.3 and $125.5 at May 31, 2004 and 2003, respectively. Information with respect to the Pension Plans with accumulated benefit obligations in excess of plan assets is as follows for the fiscal years ended May 31:
|
| | | | | 2004 | | 2003 | |
|
| Projected benefit obligations | | | | $ 124.0 | | $ 124.9 | |
| Accumulated benefit obligations | | | | 117.0 | | 118.9 | |
| Fair value of plan assets | | | | 106.6 | | 81.7 | |
|
54
The following table sets forth the components of the net periodic benefit costs under the Pension Plans and the Post-Retirement Benefits for the three fiscal years ended May 31:
| | | | | | | | | | | | | |
|
| | | Pension Benefits | | Post-Retirement Benefits |
|
| | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 |
|
| Components of Net Periodic Benefit Cost: |
| Service cost | | $ 7.0 | | $ 5.9 | | $ 4.7 | | $ 0.4 | | $ 0.5 | | $ 0.4 |
| Interest cost | | 7.7 | | 7.7 | | 7.4 | | 2.0 | | 1.8 | | 1.3 |
| Expected return on assets | | (8.0) | | (8.6) | | (8.8) | | — | | — | | — |
| Net amortization and deferrals | | 0.3 | | 0.1 | | (0.2) | | (0.8) | | (0.6) | | — |
| Curtailment loss | | — | | — | | 0.2 | | — | | — | | — |
| Decrease in valuation allowance | | (1.2) | | — | | — | | — | | — | | — |
| Recognized net actuarial loss | | 2.5 | | 1.2 | | 0.5 | | 2.0 | | 1.0 | | — |
|
| Net periodic benefit cost | | $ 8.3 | | $ 6.3 | | $ 3.8 | | $ 3.6 | | $ 2.7 | | $ 1.7 |
|
| |
Plan Assets
The Company’s investment policy is to actively manage, within acceptable risk parameters, certain asset classes where the potential exists to outperform the broader market.
The total weighted average asset allocations for the Pension Plans at May 31 by asset category are as follows:
|
| | | | | 2004 | | 2003 |
|
| Small cap equities | | | | 17.0% | | 17.4% |
| International equities | | | | 9.2 | | 10.0 |
| Index fund equities | | | | 44.5 | | 42.7 |
| Bonds and fixed interest products | | | | 27.0 | | 28.4 |
| Real estate | | | | 0.1 | | — |
| Other | | | | 2.2 | | 1.5 |
|
| Total | | | | 100.0% | | 100.0% |
|
The Company’s investments include weighted average target asset allocations as follows:
|
| | | | | | | Grolier |
| | | | | U.K. | | Canada |
| | | Pension | | Pension | | Pension |
| | | Plan | | Plan | | Plan |
|
| Equity | | 70.0% | | 68.0% | | 35.0% |
| Debt and cash equivalents | | 30.0 | | 25.0 | | 65.0 |
| Real estate | | — | | 7.0 | | — |
|
| Total | | 100.0% | | 100.0% | | 100.0% |
|
Contributions
Scholastic Ltd. expects to contribute $0.8 to the U.K. Pension Plan and Scholastic expects to contribute $2.5 to its Post-Retirement Benefits in 2005.
55
Estimated Future Benefit Payments
The following table sets forth the expected future benefit payments under the Pension Plans and the Post-Retirement Benefits by fiscal year:
| | | | | | | |
|
| | | | | Post-Retirement |
| | | | |
|
| | | | | | | Medicare |
| | | Pension | | Benefit | | Subsidy |
| | | Benefits | | Payments | | Receipts |
|
| 2005 | | $ 7.8 | | $ 2.5 | | $ — |
| 2006 | | 7.6 | | 2.6 | | 0.1 |
| 2007 | | 8.6 | | 2.7 | | 0.3 |
| 2008 | | 8.5 | | 2.8 | | 0.3 |
| 2009 | | 8.9 | | 2.9 | | 0.3 |
| 2010-2014 | | 42.1 | | 14.8 | | 1.7 |
|
The 2003 Medicare Act introduced a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy of 28% to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the benefit under Medicare Part D. In May 2004, the FASB issued FSP 106-2 to provide disclosure requirements and guidance in accounting for the impact of the federal subsidy provided by the 2003 Medicare Act. Based on this guidance, the Company has determined that the Post-Retirement Benefits provided to the portion of its post-65 retiree population that have retained a 100% Company-sponsored prescription drug coverage, are the actuarial equivalent of the benefits under Medicare. As a result, in fiscal 2004, the Company recognized a reduction of its accumulated post-retirement benefit obligation of $3.9 due to the federal subsidy under the 2003 Medicare Act. Pending any changes to the 2003 Medicare Act of the law, the effect of the subsidy on the measurement of net periodic Post-Retirement Benefits for the current period was a reduction of $0.3.
Assumed health care cost trend rates at May 31:
|
| | | | | 2004 | | 2003 |
|
| Health care cost trend rate assumed for the next fiscal year | | | | 11.0% | | 10.0% |
| Rate to which the cost trend is assumed to decline (the ultimate trend rate) | | | | 5.0% | | 5.0% |
| Year that the rate reaches the ultimate trend rate | | | | 2013 | | 2013 |
|
Assumed health care cost trend rates have a significant effect on the amounts reported for the Company’s health care plans. A one percentage point change in assumed health care cost trend rates would have the following effects:
|
| | | | | Increase | | (Decrease) | |
|
| Total service and interest cost | | | | $ 0.2 | | $ (0.1) | |
| Post-retirement benefit obligation | | | | 2.3 | | (1.5) | |
|
The Company also provides defined contribution plans for certain eligible employees. In the United States, the Company sponsors a 401(k) retirement plan and has contributed $5.9, $5.8 and $4.7 for fiscal 2004, 2003 and 2002, respectively. For its internationally-based employees, the expenses under these plans totaled $2.3, $1.9 and $1.4 for fiscal 2004, 2003 and 2002, respectively.
56
11. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three years ended May 31:
| (Amounts in millions, except per share data) |
|
| | | 2004 | | 2003 | | 2002 | |
|
| Net income for basic earningsper share | | $ 58.4 | | $ 58.6 | | $ 93.5 | |
| Dilutive effect of Debentures | | — | | — | | 2.1 | |
|
| Adjusted net income for dilutedearnings per share | | $ 58.4 | | $ 58.6 | | $ 95.6 | |
|
| Weighted average Shares of Class A Stock and Common Stock outstanding for basic earnings per share | | 39.4 | | 39.1 | | 36.7 | |
| Dilutive effect of Common Stock issued pursuant to stock-based benefit plans | | 0.7 | | 1.0 | | 1.6 | |
| Dilutive effect of Debentures | | — | | — | | 1.8 | |
|
| Adjusted weighted average Shares of Class A Stock and Common Stock outstanding for diluted earnings per share | | 40.1 | | 40.1 | | 40.1 | |
|
| Earnings per share of Class A Stock and Common Stock: |
| Earnings before Cumulative effect of accounting change: |
| Basic | | $ 1.48 | | $ 1.50 | | $ 2.69 | |
| Diluted | | $ 1.46 | | $ 1.46 | | $ 2.51 | |
| Cumulative effect of accounting change (net of income taxes): |
| Basic | | $ — | | $ — | | $ (0.14) | |
| Diluted | | $ — | | $ — | | $ (0.13) | |
| Net income: |
| Basic | | $ 1.48 | | $ 1.50 | | $ 2.55 | |
| Diluted | | $ 1.46 | | $ 1.46 | | $ 2.38 | |
|
On January 11, 2002, pursuant to the exercise of Scholastic Corporation’s optional redemption rights, $109.8 of Scholastic Corporation’s 5% Convertible Subordinated Debentures were converted at the option of the holders into 2.9 million shares of Common Stock and $0.2 were redeemed for cash.
12. 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.” 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. As a result of the adoption of SOP 00-2, the Company recorded a net of tax charge of $5.2 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 consolidated statements of operations as a Cumulative effect of accounting change and is attributed entirely to the Media, Licensing and Advertising segment.
13. SPECIAL SEVERANCE CHARGES
On May 28, 2003, the Company announced a reduction in its global work force. The majority of the affected employees were notified in the fiscal year ended May 31, 2003, and accordingly the Company established liabilities for severance and other related costs of $10.9 for that fiscal year. In the fiscal year ended May 31, 2004, the Company established liabilities of $3.3 for severance and other related costs with respect to the affected employees notified in that fiscal year. These charges are reflected in the Company’s income statement as the Special severance charges for the years ended May 31, 2003 and May 31, 2004.
A summary of the activity in the established liabilities is detailed in the following table:
|
| | | | | | | Amount |
|
| Fiscal 2003 liabilities | | | | | | $ 10.9 |
| Fiscal 2003 payments | | | | | | (1.2) |
|
| Balance at May 31, 2003 | | | | | | 9.7 |
|
| Fiscal 2004 additional liabilities | | | | | | 3.3 |
| Fiscal 2004 payments | | | | | | (10.9) |
|
| Balance at May 31, 2004 | | | | | | $ 2.1 |
|
| |
57
The remaining liability of $2.1 is expected to be paid over the next two fiscal years under salary continuance arrangements with certain affected employees.
14. LITIGATION AND OTHER CHARGES
In fiscal 2003, the Company recorded a pre-tax charge of $1.9 for the settlement of a class action securities lawsuit initiated in 1997, which represented the portion of the total settlement amount of $7.5 that was not paid by the insurance carrier.
In fiscal 2003, the Company recorded a pre-tax charge of $1.2, related to the settlement of a lawsuit filed in 1995, which represents the amount by which the settlement and related legal expenses exceeded a previously recorded liability.
15. OTHER INCOME (EXPENSE)
In the fourth quarter of fiscal 2004, the Company received a payment of $10.0 in connection with the early termination of a sublease by one of its tenants. This transaction resulted in a pre-tax net gain of $8.0. The impact of this gain on earnings per diluted share was $0.13.
In fiscal 2003, the Company sold a portion of its interest in a French publishing company for $5.2, resulting in a pre-tax gain of $2.9. The impact of this gain on earnings per diluted share was $0.05.
In fiscal 2002, the Company wrote off an equity investment of $2.0. The impact of this charge on earnings per diluted share was $0.03.
16. CONTINUITY CHARGES
In fiscal 2004, the Company recorded charges of $25.4 related to its continuity business. These continuity charges represent write-downs of deferred promotion costs of $12.7 and inventory from discontinued programs of $6.8, and an increase in bad debts of $2.0, as well as modest increases in returns provisions and related severance costs. These charges are primarily reflected as Cost of Goods Sold; Selling, general and administrative expenses; and Bad debt expense. The impact of this charge on earnings per diluted share was $0.41.
17. OTHER FINANCIAL DATA
Deferred promotion costs were $40.6 and $52.8 at May 31, 2004 and 2003, respectively. Promotion costs expensed were $119.2, $109.1 and $94.5 for the fiscal years ended May 31, 2004, 2003 and 2002, respectively. Promotional expense consists of $111.1, $99.9 and $88.0 for continuity program promotions and $8.1, $9.2 and $6.5 for magazine advertising for fiscal 2004, 2003 and 2002, respectively.
Other advertising expenses were $160.1, $161.4 and $164.2 for the fiscal years ended May 31, 2004, 2003 and 2002, respectively.
Accumulated amortization of prepublication costs was $77.8 and $76.3 at May 31, 2004 and 2003, respectively. The Company amortized $57.8, $47.5 and $42.6 for the fiscal years ended May 31, 2004, 2003 and 2002, respectively.
Other accrued expenses include a reserve for unredeemed credits issued in conjunction with the Company’s school-based book club and book fair operations of $12.5 and $12.4 at May 31, 2004 and 2003, respectively.
58
Report of Independent Registered Public Accounting Firm
THE BOARD OF DIRECTORS AND STOCKHOLDERS
SCHOLASTIC CORPORATION
We have audited the accompanying consolidated balance sheets of Scholastic Corporation (the “Company”) as of May 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income and cash flows for each of the three years in the period ended May 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted the audits in accordance with the standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at May 31, 2004 and 2003 and the consolidated results of its operations and its cash flows for each of the three years in the period ended May 31, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 12 to the consolidated financial statements, effective June 1, 2001 the Company changed its accounting for production costs and recorded a cumulative effect of accounting change of $5.2 million.
New York, New York
July 20, 2004
59
Supplementary Financial Information
Summary of Quarterly Results of Operations
(Unaudited, amounts in millions except per share data)
Years ended May 31, |
|
| | | First | | Second | | Third | | Fourth | | |
| | | Quarter | | Quarter | | Quarter | | Quarter | (1) | Year |
|
| 2004 |
|
| Revenues | | $ 475.4 | | $ 699.0 | | $ 472.0 | | $ 587.4 | | $ 2,233.8 |
| Cost of goods sold | | 281.4 | | 305.5 | | 229.7 | | 263.4 | | 1,080.0 |
| Cost of goods sold – Continuity charges | | — | | — | | — | | 6.8 | | 6.8 |
| Net income (loss) | | (24.8) | | 66.7 | | (6.0) | | 22.5 | | 58.4 |
| Earnings (loss) per share: |
| Basic | | $ (0.63) | | $ 1.70 | | $ (0.15) | | $ 0.57 | | $ 1.48 |
| Diluted | | $ (0.63) | | $ 1.67 | | $ (0.15) | | $ 0.56 | | $ 1.46 |
|
| 2003 |
|
| Revenues | | $ 306.9 | | $ 660.3 | | $ 433.7 | | $ 557.4 | | $ 1,958.3 |
| Cost of goods sold | | 160.2 | | 281.8 | | 198.3 | | 241.8 | | 882.1 |
| Net income (loss) | | (44.6) | | 75.0 | | (0.5) | | 28.7 | | 58.6 |
| Earnings (loss) per share: |
| Basic | | $ (1.14) | | $ 1.92 | | $ (0.01) | | $ 0.73 | | $ 1.50 |
| Diluted | | $ (1.14) | | $ 1.85 | | $ (0.01) | | $ 0.72 | | $ 1.46 |
|
| (1) | | The fourth quarter of fiscal 2004 includes pre-tax charges of $25.4, or $0.41 per diluted share, in connection with the Company’s review of its continuity business, and a pre-tax net gain of $8.0, or $0.13 per diluted share, in connection with the early termination of a sublease by one of its tenants. The fourth quarter of fiscal 2003 includes a pre-tax Special severance charge of $10.9, or $0.18 per diluted share, relating to a reduction in work force. | |
Item 9 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9a | Controls and Procedures
The Chief Executive Officer and Chief Financial Officer of the Corporation, after conducting an evaluation, together with other members of the Company’s management, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of the end of the period covered by this report, have concluded that the Corporation’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Corporation in its reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. There was no change in the Corporation’s internal control over financial reporting that occurred during the quarter ended May 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
60
Part III
Item 10 | Directors and Executive Officers of the Registrant
Information required by this item is incorporated herein by reference from the Corporation’s definitive proxy statement to be filed with the SEC pursuant to Regulation 14A under the Exchange Act. Certain information regarding the Corporation’s Executive Officers is set forth in Part I – Item 1 – Business.
Item 11 | Executive Compensation
Incorporated herein by reference from the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act.
Item 12 | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Incorporated herein by reference from the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act.
Item 13 | Certain Relationships and Related Transactions
Incorporated herein by reference from the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act.
Item 14 | Principal Accountant Fees and Services
Incorporated herein by reference from the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act.
Part IV
Item 15 | Exhibits, Financial Statement Schedules and Reports on Form 8-K
| (a)(1) | | Financial Statements: | |
| | | The following consolidated financial statements are included in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data”: | |
| | | Consolidated Statements of Income for the years ended May 31, 2004, 2003 and 2002 | |
| | | Consolidated Balance Sheets at May 31, 2004 and 2003 | |
| | | Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended May 31, 2004, 2003 and 2002 | |
| | | Consolidated Statements of Cash Flows for the years ended May 31, 2004, 2003 and 2002 | |
| | | Notes to Consolidated Financial Statements | |
| (a)(2) | | Financial Statement Schedule: | |
| | | The following consolidated financial statement schedule is included in Item 15(d): Schedule II – Valuation and Qualifying Accounts and Reserves | |
| | | All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Consolidated Financial Statements or the Notes thereto. | |
| (a)(3) | | Exhibits: | |
| 3.1 | | Amended and Restated Certificate of Incorporation of the Corporation, as amended to date. | |
61
| 3.2 | | Bylaws of the Corporation, amended and restated as of March 16, 2000 (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on April 14, 2000). | |
| 4.1 | | Credit Agreement, dated as of March 31, 2004, among the Corporation and Scholastic Inc., as borrowers, the Initial Lenders named therein, Citibank, N.A., as administrative agent, Citigroup Global Markets Inc. and J.P. Morgan Securities Inc., as joint lead arrangers, and JPMorgan Chase Bank, N.A. and Fleet Bank, N.A., as syndication agents (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on April 2, 2004). | |
| 4.2* | | Amended and Restated Revolving Loan Agreement, dated November 10, 1999, among the Corporation, Scholastic Inc. and Sun Bank, National Association, together with Amendment No. 1, dated June 22, 2000, and Amendment No. 2, dated as of April 30, 2004. | |
| 4.3 | | Indenture dated January 23, 2002 for 5.75% Notes due January 15, 2007 issued by the Corporation (incorporated by reference to the Corporation’s Registration Statement on Form S-3 (Registration No. 333-55238) as filed with the SEC on February 8, 2001). | |
| 4.4* | | Indenture dated April 4, 2003 for 5% Notes due 2013 issued by the Corporation. | |
| 10.1** | | Scholastic Corporation 1992 Stock Option Plan (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 27, 1992, SEC File No. 000-19860), together with Amendment No. 1 to the Scholastic Corporation 1992 Stock Option Plan, effective as of July 18, 2001 (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 24, 2001). | |
| 10.2** | | Scholastic Corporation 1995 Stock Option Plan, effective as of September 21, 1995 (incorporated by reference to the Corporation’s Registration Statement on Form S-8 (Registration No. 33-98186) as filed with the SEC on October 16, 1995), together with Amendment No. 1 to the Scholastic Corporation 1995 Stock Option Plan, effective September 16, 1998 (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on October 15, 1998, SEC File No. 000-19860), and Amendment No. 2 to the Scholastic Corporation 1995 Stock Option Plan, effective as of July 18, 2001 (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 24, 2001). | |
| 10.3** | | Scholastic Corporation 1992 Outside Directors’ Stock Option Plan (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 27, 1992, SEC File No. 000-19860). | |
| 10.4** | | Scholastic Corporation Management Stock Purchase Plan, amended and restated effective as of December 18, 2002 (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on January 14, 2003). | |
| 10.5** | | Scholastic Corporation 1997 Outside Directors’ Stock Option Plan, amended and restated as of May 25, 1999 (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 23, 1999), together with Amendment No. 1 dated September 20, 2001 to the Scholastic Corporation 1997 Outside Directors’ Stock Option Plan (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on January 14, 2002) and Amendment No. 2 to the Scholastic Corporation 1997 Outside Directors’ Stock Option Plan (incorporated by reference to Appendix B to the Corporation’s definitive Proxy Statement as filed with the SEC on August 19, 2003). | |
62
| 10.6** | | Scholastic Corporation 1995 Director’s Deferred Compensation Plan, amended and restated as of May 25, 1999 (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 23, 1999). | |
| 10.7** | | Scholastic Corporation Executive Performance Incentive Plan, effective as of June 1, 1999 (incorporated by reference to the Corporation’s Quarterly Report on Form 10-Q as filed with the SEC on October 15, 1999). | |
| 10.8** | | Scholastic Corporation 2001 Stock Incentive Plan (incorporated by reference to Appendix A of the Corporation’s definitive Proxy Statement as filed with the SEC on August 24, 2001). | |
| 10.9 | | Amended and Restated Lease, effective as of August 1, 1999, between ISE 555 Broadway, LLC, landlord, and Scholastic Inc., tenant, for the building known as 555 Broadway, NY, NY (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 23, 1999). | |
| 10.10 | | Amended and Restated Sublease, effective as of October 9, 1996, between Kalodop Corp., as sublandlord, and Scholastic Inc., as subtenant, for the premises known as 557 Broadway, NY, NY (incorporated by reference to the Corporation’s Annual Report on Form 10-K as filed with the SEC on August 23, 1999). | |
| 21 | | Subsidiaries of the Corporation. | |
| 23 | | Consent of Ernst & Young LLP. | |
| 31.1 | | Certification of the Chief Executive Officer of the Corporation filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | | Certification of the Chief Financial Officer of the Corporation filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32 | | Certifications of the Chief Executive Officer and the Chief Financial Officer of the Corporation furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| (b) | | Reports on Form 8-K. | |
| | | A Current Report on Form 8-K was filed with the SEC on April 3, 2004 reporting under Items 7 (Financial Statements, Pro Forma Financial Information and Exhibits) and 12 (Results of Operations and Financial Condition) a press release regarding results of operations for the Corporation’s fiscal quarter ended February 29, 2004. | |
| | | A Current Report on Form 8-K was filed with the SEC on July 15, 2004 reporting under Item 12 (Results of Operations and Financial Condition) a press release regarding charges recorded in the fourth quarter of the Corporation’s fiscal year ended May 31, 2004 related to its continuity business and estimates of results of operations for that year. | |
| | | A Current Report on Form 8-K was filed with the SEC on July 21, 2004 reporting under Items 7 (Financial Statements, Pro Forma Financial Information and Exhibits) and 12 (Results of Operations and Financial Condition) a press release regarding results of operations for the Corporation’s fiscal year ended May 31, 2004. | |
| | | | |
| * | | Such long-term debt does not individually amount to more than 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. Accordingly, pursuant to Item 601(b)(4)(iii) of Regulation S-K, such instrument is not filed herewith. The Corporation hereby agrees to furnish a copy of any such instrument to the SEC upon request. | |
| ** | | The referenced exhibit is a management contract or compensation plan or arrangement described in Item 601(b) (10) (iii) of Regulation S-K. | |
63Signatures
Pursuant to the requirements of Section 13 or 15(d) 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.
| | |
| | |
| Dated: August 2, 2004 | SCHOLASTIC CORPORATION |
| | By: /s/ Richard Robinson |
| |
|
| | Richard Robinson, Chairman of the Board,
President and Chief Executive Officer |
Power of Attorney
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard Robinson his or her true and lawful attorney-in-fact and agent, with power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing necessary and requisite to be done, as fully and to all the intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
|
| Signature | | Title | | Date |
|
| /s/ Richard Robinson | | Chairman of the Board, President, | | August 2, 2004 |
| ________________________________ | | Chief Executive Officer and | | |
| Richard Robinson | | Director (Principal Executive Officer) | | |
| | | | | |
| /s/ Mary A. Winston | | Executive Vice President and Chief | | August 2, 2004 |
| ________________________________ | | Financial Officer (Principal Financial Officer) | | |
| Mary A. Winston | | | | |
| | | |
| /s/ Karen A. Maloney | | Vice President and Controller | | August 2, 2004 |
| ________________________________ | | (Principal Accounting Officer) | | |
| Karen A. Maloney | | | | |
| | | | | |
| /s/ Rebeca M. Barrera | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Rebeca M. Barrera | | | | |
| | | | | |
| /s/ Ramon C. Cortines | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Ramon C. Cortines | | | |
| | | | | |
| /s/ John L. Davies | | Director | | August 2, 2004 |
| ________________________________ | | | |
| John L. Davies | | | | |
| | | | | |
| /s/ Charles T. Harris III | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Charles T. Harris III | | | | |
| | | | | |
| /s/ Andrew S. Hedden | | Director | | August 2, 2004 |
| ________________________________ | | | |
| Andrew S. Hedden | | | | |
64
| Signature | | Title | | Date |
|
| /s/ Mae C. Jemison | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Mae C. Jemison | | | | |
| | | | | |
| /s/ Peter M. Mayer | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Peter M. Mayer | | | | |
| | | | | |
| /s/ John G. McDonald | | Director | | August 2, 2004 |
| ________________________________ | | | |
| John G. McDonald | | | | |
| | | | | |
| /s/ Augustus K. Oliver | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Augustus K. Oliver | | | | |
| | | | | |
| /s/ Richard M. Spaulding | | Director | | August 2, 2004 |
| ________________________________ | | | | |
| Richard M. Spaulding | | | | |
65
Scholastic Corporation
Financial Statement Schedule
ANNUAL REPORT ON FORM 10-K
YEAR ENDED MAY 31, 2004
ITEM 15(d)
66
Schedule II
Valuation and Qualifying Accounts and Reserves
(Amounts in millions)
Years Ended May 31, |
|
| | | Balance at | | | | | | |
| | | Beginning | | | | Write-Offs | | Balance at |
| | | Of Year | | Expensed | | and Other | | End of Year |
|
| 2004 |
|
| Allowance for doubtful accounts | | $ 60.5 | | $ 90.3 | | $ 82.5 | | $ 68.3 |
| Reserve for returns | | 58.2 | | 193.5 | | 199.1 | (1) | 52.6 |
| Reserve for obsolescence | | 54.4 | | 29.9 | | 25.1 | | 59.2 |
| Reserve for royalty advances | | 45.8 | | 4.3 | | 0.3 | | 49.8 |
|
| 2003 |
|
| Allowance for doubtful accounts | | $ 62.6 | | $ 72.3 | | $ 74.4 | | $ 60.5 |
| Reserve for returns | | 61.3 | | 164.1 | | 167.2 | (1) | 58.2 |
| Reserve for obsolescence | | 55.1 | | 26.7 | | 27.4 | | 54.4 |
| Reserve for royalty advances | | 44.6 | | 5.0 | | 3.8 | | 45.8 |
|
| 2002 |
|
| Allowance for doubtful accounts | | $ 70.1 | | $ 68.7 | | $ 76.2 | | $ 62.6 |
| Reserve for returns | | 63.0 | | 156.8 | | 158.5 | (1) | 61.3 |
| Reserve for obsolescence | | 64.7 | | 22.1 | | 31.7 | | 55.1 |
| Reserve for royalty advances | | 43.0 | | 3.7 | | 2.1 | | 44.6 |
|
| (1) Represents actual returns charged to the reserve. | |
67
