Part I
Item 1 | Business
Overview
Scholastic Corporation (together with its subsidiaries, “Scholastic” or the “Company”) is a global children’s publishing and media company. The Company believes that it is the world’s largest publisher and distributor of children’s books. Scholastic creates quality educational and entertaining materials and products for use in school and at home, including children’s books, textbooks, magazines, technology-based products, teacher materials, television programming, film, videos and toys. The Company distributes its products and services through a variety of channels, including school-based book clubs, school-based book fairs, school-based and direct-to-home continuity programs, retail stores, schools, libraries and television networks. The Company’s Website, Scholastic.com, is a leading site for teachers, classrooms and parents, and an award-winning destination for children. With the June 2000 acquisition of Grolier Incorporated (“Grolier”), the Company became the leading operator in the United States of direct-to-home book clubs primarily serving children age five and under, and the leading print and on-line publisher of children’s reference and non-fiction products sold primarily to United States school libraries. Internationally, Scholastic has long-established operations in Canada, the United Kingdom, Australia and New Zealand, and newer operations in Argentina, Hong Kong, India, Ireland and Mexico. The Grolier acquisition expanded the Company’s international operations in Canada, the United Kingdom, Australia and Southeast Asia.
During its 83 years of operation, Scholastic has emphasized quality products and a dedication to learning. Scholastic Corporation was incorporated under the laws of Delaware in 1986 and, through predecessor entities, has been in business since 1920. Grolier, through its predecessor entities, has been in business since 1895.
Operating Segments
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. During the three-year period ended May 31, 2003, Scholastic’s revenues have grown at an average annual compounded rate of 11.8%, including the Grolier acquisition, and 4.7%, excluding the Grolier acquisition. The following table sets forth revenues by operating segment for the three fiscal years ended May 31:
| (Amounts in millions) | |||||||
| 2003 | 2002 | 2001 | |||||
| Children’s
Book Publishing and Distribution |
$ 1,189.9 | $ 1,168.6 | $ 1,221.9 | ||||
| Educational Publishing | 325.9 | 316.9 | 311.2 | ||||
| Media, Licensing and Advertising | 123.5 | 129.8 | 132.5 | ||||
| International | 319.0 | 301.7 | 296.7 | ||||
| Total | $ 1,958.3 | $ 1,917.0 | $ 1,962.3 | ||||
Reported revenues include Grolier’s operations since June 22, 2000, the date of acquisition. Additional financial information covering the Company’s operating segments is included in Note 2 of Notes to Consolidated Financial Statements in Item 8, which is incorporated herein by reference. Certain revenues and expenses related to the Company’s Internet activities have been reallocated to reflect the transition from a developing platform previously included in the Media, Licensing and Advertising segment to operational systems included in the Children’s Book Publishing and Distribution and Educational Publishing segments. Prior year segment results have been restated to reflect this reclassification.
CHILDREN’S BOOK PUBLISHING
AND DISTRIBUTION
(60.8% of fiscal 2003 revenues)
General
The Company’s Children’s
Book Publishing and
Distribution segment includes the publication and distribution of children’s
books in the United States through school-based book clubs and book fairs, school-based
and direct-to-home continuity programs and the trade channel.
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The Company believes it is the largest publisher and distributor of children’s books and is the largest operator of school-based book clubs and school-based book fairs in the United States. The Company is also a leading publisher of children’s books distributed through the trade channel and the leading distributor in the United States of children’s books through direct-to-home continuity programs primarily for children ages five and younger. In fiscal 2003, the Company distributed in excess of 320 million children’s books in the United States.
Scholastic offers a broad range of quality children’s literature. Many of the Company’s books have received awards for excellence in children’s literature, including the Caldecott and Newbery awards.
The Company obtains titles for sale through its distribution channels from three principal sources. The first source for titles is the Company’s publication of books written under exclusive publication agreements with authors, book packagers or other media companies. Scholastic generally owns the rights to sell these titles in all United States channels of distribution. Scholastic’s second source of titles is licenses to publish books exclusively in specified channels of distribution, including reprints of books originally published by other publishers, for which the Company acquires rights to sell in the school market, and licenses to publish books for exclusive sale in direct-to-home continuity programs. The third source of titles is the Company’s purchase of finished books from other publishers to be sold in the school market. At May 31, 2003, the Company’s active backlist (a list of titles published as new titles in prior years) included more than 6,000 titles.
School-Based Book Clubs
Scholastic founded its first school-based book club in
1948. The Company operates eleven school-based book clubs: Firefly®,
serving pre-kindergarten (“pre-K”) and kindergarten (“K”)
students; Seesaw®, serving students grades K to 1; Lucky®,
serving students grades 2 to 3; Arrow®, serving students
grades 4 to 6; TAB®, serving students grades 6 to
8; three Trumpet® clubs, serving students pre-K to
grade 6; and three Troll®/Carnival® clubs,
serving students K to grade 6. In addition to its regular periodic offerings, the
Company creates special theme-based offers targeted to the different grade levels
during the year, such as holiday offers, science offers, curriculum offers and Spanish
language offers.
The Company estimates that over 80% of all elementary school teachers in the United States participate in school-based book clubs, with substantially all of these teachers using Scholastic book clubs at least once during the school year. The Company believes that teachers participate in school-based book clubs because it is their opinion that quality books at affordable prices will be of interest to families and will improve students’ reading skills. The Company also believes that teachers participate because the school-based book clubs offer easy access to a broad range of books.
The Company mails promotional materials containing order forms to teachers in the vast majority of the pre-K to grade 8 classrooms in the United States. Participation in any offer does not create an obligation to participate in any subsequent offer, nor does it preclude participation in other book clubs. Teachers who wish to participate in a school-based book club distribute the order forms to their students, who may choose from generally 75 or more selections at substantial reductions from list prices. The teacher consolidates the students’ orders and forwards them to the Company primarily by phone and mail and increasingly by the Internet, which in fiscal 2003 accounted for more than 20% of orders. The orders are then shipped to the teacher for distribution to the students. Teachers who participate in the book clubs receive bonus points for use by their school, which may be redeemed for the purchase of additional books and other items for their classrooms.
In its school-based book club business, the Company competes on the basis of book selection, price, promotion and customer service. The Company believes that its broad offerings of titles, many of which are distributed in this channel exclusively by Scholastic, combined with low costs and its efficient use of promotional mailings, enable the Company to compete effectively.
School-Based Book Fairs
Scholastic entered the school-based book fair business
in 1981. The Company has grown this business by expanding into new markets, including
through selected acquisitions, and by increasing its business in existing markets
by reaching new school customers, holding more fairs per year at its existing school
customers and growing revenue on a per fair basis. The Company is the leading operator
of school-based book fairs in the United States.
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Book fairs are generally week-long events conducted on school premises, operated by school librarians and/or parent-teacher organizations. Book fair events provide children with access to hundreds of different titles and allow them to purchase books and other select products of their choice at the school. Although the Company provides the school with the books and book display cases, the school itself conducts the book fair. The Company believes that the primary motivation for schools sponsoring fairs is to make quality books available to their students at reasonable prices in order to stimulate interest in reading. In addition, the school retains a portion of the book fair revenues, which can then be used to purchase books, supplies and equipment for the school.
The Company operates school-based book fairs in all 50 states under the name Scholastic Book Fairs®. Books and display cases are delivered to schools from the Company’s warehouses by a fleet of leased vehicles. Sales and customer service functions are performed from regional sales offices, supported by field representatives. The Company believes that its competitive advantages in the book fair business include the strength of the relationship between its sales representatives and schools, broad geographic coverage, quality customer service and breadth of product selection. Over 90% of the schools that sponsored a Scholastic book fair in fiscal 2002 sponsored a Scholastic book fair again in fiscal 2003.
Continuity Programs
The Company
operates continuity programs whereby children and their families generally
place a single order and receive more than one shipment
of books. Continuity programs are promoted through (i) direct-to-home offers
primarily through direct mail, telemarketing and print and on-line advertisements,
and (ii)
offers in school-based book clubs. The Company’s direct-to-home continuity
business, acquired as part of the Grolier acquisition, is the leading direct-to-home
seller of children’s books primarily serving children age five and under. In
fiscal 2003, the Company’s direct-to-home continuity business included Scholastic
publishing properties, such as Clifford & Company™, Hello
Kitty™,
Magic University™ and Goosebumps™, as well as programs previously
operated by Grolier, such as Disney Book Club™, Barbie™,
Dr. Seuss™ Beginning Readers Program and The New Book of Knowledge
EncyclopediaTM. In April 2002, the Company acquired
Baby’s First Book Club®, a direct
marketer through continuity programs of age-appropriate books and toys for young
children. Continuity programs offered primarily through Scholastic’s school-based
book clubs include Spy UniversityTM, Clifford
The Big Red Dog™, Nick Jr., Thomas the Tank Engine
and Scooby Doo.
Trade
Scholastic is one of the
leading sellers of children’s
books through bookstores and mass merchandisers in the United States. The Company
maintains over 6,000 titles for trade distribution. Scholastic’s original
publications
include Harry Potter®, I Spy™, Clifford
The Big Red Dog®, Goosebumps®,
Dear America®, The Baby-sitters Club®,
The Magic School Bus®, Captain Underpants®
and Miss Spider® and licensed properties such as Barney®,
Star Wars® and Scooby Doo®.
In April 2002, the Company purchased Klutz, a publisher and creator of “books
plus” products for children. The Company’s trade sales organization focuses
on marketing and selling Scholastic’s publishing properties to book store
accounts,
mass merchandisers and specialty sales outlets.
The Company’s fiscal 2003 sales in the trade market were led by the Harry Potter books. Other Scholastic bestsellers during fiscal 2003 included books from the Clifford The Big Red Dog, I Spy, Dear America and Captain Underpants series.
EDUCATIONAL PUBLISHING
(16.6% of fiscal 2003 revenues)
General
The Company’s Educational Publishing segment
includes the publication and distribution to schools and libraries of curriculum
materials, classroom magazines and print and on-line reference and non-fiction products
for grades pre-K to 12 in the United States.
Scholastic has been providing quality innovative educational materials to schools and libraries since it began publishing classroom magazines in the 1920’s. The Company added supplementary books and texts to its product line in the 1960’s, professional books for teachers in the 1980’s and early childhood products and core curriculum materials in the 1990’s. In 1996, the Company strengthened its Spanish language offerings through the acquisition of Lectorum Publications, Inc.,
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the largest Spanish language book distributor to schools and libraries in the United States. Through the acquisition of Grolier in June 2000, the Company became the leading print and on-line publisher of children’s reference and non-fiction products sold primarily to school libraries in the United States. The Company markets and sells its Educational Publishing products through a combination of field representatives, direct mail and telemarketing.
Curriculum Publishing
and Teaching Resources
The Company’s curriculum
publishing and teaching resources operations develop and distribute instructional
materials directly to schools in
the United States, primarily purchased through school and district budgets. These
operations include reading improvement programs, individual paperbacks and collections
and professional books designed for, and generally purchased by, teachers.
The Company focuses its supplemental and core publishing efforts on reading improvement materials. Scholastic’s reading improvement programs are led by Read 180®, a reading intervention program for students in grades 4 to 12 reading at least two years below grade level, and other technology-based products such as Wiggleworks®, which assists in teaching reading to students, and Scholastic Reading Counts!™, which encourages reading through a school-managed incentive program. Other reading improvement products include Scholastic Read XL®, a program for students in grades 6 to 8, which provides high-interest and increasingly demanding text to assist students reading one to three years below grade level; Building Language for Literacy™, a program of books and audio tapes to guide children through the critical pre-K to K stages of literacy development; and Scholastic Phonics Reading Program™, which is a beginning phonics instruction program for grades K to 1. In December 2001, the Company acquired the assets of Tom Snyder Productions, Inc., a leading developer and publisher of interactive educational software.
The teaching resources group publishes professional books designed for and generally purchased by teachers and distributes individual paperbacks and collections to schools and school districts. In addition, the Company provides paperbacks and collections to literacy organizations. In fiscal 2002, the Company launched an on-line Teacher Store, which provides professional books and other educational materials to schools and teachers. Scholastic.com is a leading website for teachers and classrooms, offering multimedia teaching units, lesson plans, teaching tools and on-line activities. In April 2002, the Company acquired Teacher’s Friend Publications, Inc., a leading producer and marketer of materials that teachers use to decorate their classrooms.
Classroom Magazines
Scholastic
is a leading publisher of classroom magazines. Teachers in grades K to 12
use these magazines as supplementary educational materials.
Publishing the Company’s classroom magazines under the Scholastic name reinforces
the Company’s educational reputation with students, teachers and school
administrators. The Company believes that publishing quality magazines, maintaining
an extensive
magazine mailing list and having a large customer base of teachers helps generate
customers for its school-based book clubs and other Scholastic products. At the
same time, the Company leverages its school-based book club mailings to help
secure
additional circulation for its classroom magazines.
The Company believes that its magazines play an important role in educating students about world events at an age appropriate level. The Company’s 34 classroom magazines supplement the school’s formal learning program by bringing subjects of current interest into the classroom. The magazines are designed to encourage students to read and also to cover diverse subjects, including English, reading, literature, math, science, current events, social studies and foreign languages. The most well known of the Company’s domestic magazines are Scholastic News® and Junior Scholastic®.
Scholastic’s classroom magazine circulation in the United States in fiscal 2003 was more than 7.5 million, with approximately two-thirds of the circulation in grades K to 6. In fiscal 2003, teachers in over 60% of the elementary schools and in over 70% of the secondary schools in the United States used the Company’s classroom magazines. The various classroom magazines are distributed either on a weekly, bi-weekly or monthly basis during the school year.
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The majority of the magazines purchased are paid for with school funds, with teachers or students paying for the balance. Circulation revenue accounted for substantially all of the classroom magazine revenues in fiscal 2003.
Library Publishing
Scholastic is
a leading publisher of quality children’s
reference and non-fiction products, and encyclopedias sold primarily to schools
and libraries in the United States. Products include Encyclopedia Americana®,
The New Book of Knowledge® and Cumbre™,
a Spanish language encyclopedia; and reference materials published under the Grolier®
name. Grolier Online® provides subscriptions to reference databases
for schools and libraries. The Company’s products also include non-fiction
books published in the United States under the imprints Children’s Press®
and Franklin Watts®.
MEDIA, LICENSING AND ADVERTISING
(6.3% of fiscal 2003 revenues)
General
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 by and through the Company’s subsidiary,
Scholastic Entertainment Inc. (“SEI”), of programming and consumer products
(including children’s television programming, videos, software, feature
films, promotional activities and non-book merchandise), and advertising revenue,
including
sponsorship programs.
Production and Distribution
SEI
extends the Company’s franchises by creating programming
and managing global brands based on Scholastic’s publishing properties. It
also creates original programming concepts and options properties from other publishers.
SEI develops and produces children’s television programming, videos, software,
feature films, branded web sites, brand marketing campaigns including consumer promotions
and non-book consumer products. SEI’s multimedia programming generates revenues
for branded merchandise and tie-in publishing worldwide. In December 2001, the
Company
acquired Soup2NutsTM, an award-winning producer
of animated television and web programming, as part of the acquisition of the assets
of Tom Snyder Productions, Inc.
SEI has built a television library of over 285 half-hour productions including: Clifford The Big Red Dog®, Scholastic’s The Magic School Bus®, I SpyTM, Goosebumps®, Animorphs®, Dear America® and The Baby-sitters Club®. These television series collectively have been licensed for broadcast in more than 80 countries. Since its launch, Clifford The Big Red Dog, an animated television series based on the Company’s best-selling books by Norman Bridwell, has been nominated for 14 Emmy awards and has become a top rated show. A total of 65 episodes have been produced to date, and the show has aired in over 60 countries. During fiscal 2003, SEI commenced production of a feature length Clifford film for Warner Home Entertainment, which is expected to be released in 2004. The Company also commenced production of 25 episodes of a new series, Clifford’s Puppy Days, for PBS Kids, which is scheduled to launch in the Fall of 2003. In fiscal 2003, SEI launched 13 episodes of I Spy on HBO Family, based on the Company’s best-selling book series, which received an Emmy award in May 2003. Thirteen additional I Spy episodes have been produced and are scheduled to begin airing in fiscal 2004.
Brand Marketing and Consumer Products
SEI creates and develops global branding campaigns for
Scholastic properties. For example, the successful Clifford The Big Red Dog program
on PBS Kids is part of a comprehensive brand marketing campaign including TV
tie-in books, consumer products, interactive media, and promotions, supporting
Clifford’s position as a leading pre-school brand. In connection with its branding
campaigns, SEI has received numerous marketing and licensing awards, including a
2003 LIMA award for Clifford as “Best Character License.” In addition,
SEI creates, manufactures and distributes high-quality consumer products primarily
based on Scholastic’s literary properties, such as a line of upscale plush
toys and wooden puzzles based on Clifford The Big Red Dog®,
Scholastic’s The Magic School Bus®, The
Real Mother Goose™ and Stellaluna™. The products are available
through independent toy/gift stores, specialty chains, department stores, mail
order
catalogs and bookstores, as well as through Scholastic’s school-based book
clubs, school-based book fairs and continuity programs.
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Scholastic boutiques at Toys “R” Us feature Scholastic-branded learning toys. The Company also produces and markets videos in the school market through its subsidiary, Weston Woods, a producer of videos based on high quality children’s books. A consumer line of videos, branded as the Scholastic Video Collection, featuring Weston Woods content, was launched in fiscal 2003. Scholastic.com is an award-winning destination for children featuring sites with favorite characters, such as Harry Potter™, Captain Underpants™, Clifford The Big Red Dog™, I Spy™ and Animorphs™.
Consumer Software
Scholastic sells
original and licensed consumer software for grades K to 8 through school-based
software clubs, school-based book clubs and
school-based book fairs. The Company acquires software for distribution in all
of these channels through a combination of licensing, purchases of product
from software
publishers and internal development. Scholastic’s school-based software clubs
are marketed in the same manner as its school-based book clubs. The Company’s
internally developed CD-ROM titles, including the award-winning series of Clifford®
and I Spy™, are also sold through trade channels.
Advertising
Certain of the Company’s
magazine properties generate advertising revenues as their primary source
of revenue, including Instructor™,
Scholastic Administrator™, Instructor New Teacher®,
Scholastic Early Childhood Today™ and Coach and Athletic Director™, which are directed to teachers and education professionals and are distributed
during the academic year. Total circulation for these magazines was approximately
560,000 in fiscal 2003. Subscriptions for these magazines are solicited primarily
by direct mail. Scholastic Parent and Child® magazine,
which is directed at parents and distributed through schools and childcare programs,
had circulation of approximately 1.2 million in fiscal 2003. These magazines
carry
paid advertising, advertising for Scholastic’s other products and paid advertising
for clients that sponsor customized programs.
Also included in this group are: Scholastic In-School Marketing, which develops sponsored educational materials and supplementary classroom programs in partnership with corporations, government agencies and nonprofit organizations; and Quality Education Data, which develops and markets databases and provides research and analysis focused on teachers, schools and education.
INTERNATIONAL
(16.3% of fiscal 2003 revenues)
General
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.
Scholastic has long-established operations in Canada, the United Kingdom, Australia and New Zealand and newer operations in Argentina, Hong Kong, India, Ireland and Mexico. With the acquisition of Grolier, the Company expanded into the direct-to-home continuity business primarily serving children age five and under in Canada, the United Kingdom and Australia, and added the publication and distribution of reference products and services outside the United States, principally in Southeast Asia.
Scholastic’s operations in Canada, the United Kingdom, Australia and New Zealand generally mirror its United States business model. Each of these international operations has original trade and educational publishing programs, distributes children’s books, software and other materials through school-based book clubs, school-based book fairs and trade channels, distributes magazines and offers on-line services. Each of these operations has established export and foreign rights licensing programs and is a licensee of book tie-ins for major media properties. Original books published by each of these operations have received awards of excellence in children’s literature.
Canada
Scholastic Canada,
founded in 1957, is a leading publisher and distributor of English and French
language children’s books, is the largest
school-based book club and school-based book fair operator in Canada and is one
of the leading suppliers of original or licensed children’s books to the
Canadian trade market. Since 1965, Scholastic Canada has produced quality Canadian-authored
books and educational materials. Grolier Canada is a leading operator of direct-to-home
continuity programs in Canada.
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United Kingdom
Scholastic UK, founded
in 1964, is the largest school-based book club and school-based book fair
operator
and is a leading children’s publisher in the United Kingdom, where its trade
books appear frequently on children’s bestseller lists. Scholastic UK also
publishes magazines for teachers and supplemental educational materials, including
professional books. Grolier UK is a leading operator of direct-to-home continuity
programs in the United Kingdom.
On June 24, 2002, the Company entered into a joint venture with The Book People Ltd. (together with its affiliates, “The Book People”), 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 Scholastic School LinkTM name. The Company also acquired a 15% equity interest in The Book People Group, Ltd.
Australia
Scholastic Australia,
founded in 1968, is the leading publisher
and distributor of children’s educational materials in Australia and has the
largest school-based book club and book fair operation in the country, reaching
approximately 90% of the country’s primary schools.
New Zealand
Scholastic New Zealand,
founded in 1964, is the largest
children’s book publisher and the leading book distributor to schools in New
Zealand. Through its school-based book clubs and book fairs, Scholastic New Zealand
reaches approximately 90% of the country’s primary schools.
Asia
The Company’s Asia operations
sell English language reference materials and local language product through
a network of approximately
2,500 independent door-to-door sales representatives in India, Indonesia, Malaysia,
the Philippines, Singapore, Taiwan and Thailand. In India, the Company also
operates
school-based book clubs and book fairs and publishes original titles in the English
and Hindi languages.
Latin America
The Company has operations in Mexico, Argentina and Puerto
Rico. These businesses principally distribute, through school-based book clubs and
book fairs, books and educational material published by
Scholastic, as well as merchandise from other publishers. In Puerto Rico, Scholastic
distributes Spanish language reference materials though a network of independent
door-to-door sales representatives.
Foreign Rights and Export
The Company
licenses the foreign-language rights to selected Scholastic titles to other
publishing companies around the world in over 37 languages.
The Company’s export business sells Scholastic books and products in regions
of the world not otherwise serviced by Scholastic subsidiaries.
MANUFACTURING AND DISTRIBUTION
The
Company’s books, magazines, software and other
materials and products are manufactured by third parties under contracts entered
into through arm’s-length negotiations or competitive bidding. As appropriate,
the Company enters into multi-year agreements that guarantee specified volume
in
exchange for favorable pricing terms. Paper is purchased from third party sources.
The Company does not anticipate any difficulty in continuing to satisfy its manufacturing
and paper requirements.
In the United States, the Company processes and fulfills school-based book club, trade, curriculum publishing, reference and non-fiction products and export orders mainly from its primary warehouse and distribution facility in Jefferson City, Missouri. Magazine orders are processed at the Jefferson City facility and are shipped directly from printers. In June 2002, the Company acquired a distribution facility in Maumelle, Arkansas, which serves as the Company’s primary packaging and fulfillment center (the “Maumelle Facility”) for its continuity programs. In connection with its trade business, the Company generally outsources certain services, including invoicing, billing, returns processing and collection services, and may also ship product directly from printers to customers. School-based book fair orders are fulfilled through a network of warehouses across the country. The Company’s international school-based book club, school-based book fair, trade, continuity businesses and educational operations use similar distribution systems.
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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. The Company
experiences
a substantial loss from operations in the first quarter. 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.
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.
COMPETITION
The markets
for children’s educational and entertainment
materials are highly competitive. Competition is based on the quality and range
of materials made available, price, promotion, customer service and
distribution channels. Competitors include numerous other book, textbook, library,
reference material and supplementary text publishers, distributors and other
resellers
(including over the Internet) of children’s books and other educational
materials, national publishers of classroom and professional magazines with substantial
circulation,
numerous producers of television, video and film programming (many of which are
substantially larger than the Company), television networks and cable networks,
publishers of computer software and distributors of products and services on
the
Internet. In the United States, competitors also include regional and local school-based
book fair operators, including bookstores. Competition may increase to the extent
that other entities enter the market and to the extent that current competitors
or new competitors develop and introduce new materials that compete directly
with
the products distributed by the Company or develop or expand competitive sales
channels.
COPYRIGHT AND TRADEMARKS
SCHOLASTIC
is a registered trademark in the United States and in a number of countries where
the Company conducts business. Scholastic Inc.,
the Company’s principal U.S. operating subsidiary, has registered and/or has
pending applications to register its U.S. trademarks for the names of each of its
domestic book clubs, the titles of its magazines and the names of all its core curriculum
programs. The Company’s international subsidiaries have also registered
trademarks in the name of Scholastic Inc. for the names of their respective book
clubs and
magazines. Although individual book titles are not subject to trademark protection,
Scholastic Inc. has registered and/or has pending applications to register trademarks
in the United States and in a number of countries for the names of certain series
of books and consumer products, such as The Magic School Bus and Clifford
The Big Red Dog. GROLIER is a registered trademark in the United States and
a number of countries where it conducts business. All of the Company’s publications,
including books, magazines and software, are subject to copyright protection.
Where
applicable, the Company consistently files copyright registrations for its magazines,
books and software in the name of Scholastic Inc. or one of its subsidiaries.
Copyrights
and trademarks are vigorously defended by the Company and, as necessary, outside
counsel may be retained to assist in such protection.
EMPLOYEES
At May 31, 2003, the
Company employed approximately 7,300 people in full-time jobs and 900 people
in part-time jobs in the United States and
approximately 2,600 people internationally. The number of part-time employees
fluctuates
during the year because significant portions of the Company’s business are
closely correlated with the school year. On May 28, 2003, the Company announced
a reduction in its global work force of approximately 400 positions, the majority
of which were scheduled to take effect in the first quarter of fiscal 2004. The
Company believes that relations with its employees are good.
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Executive Officers
| Name | Age | Employed by Registrant Since |
Position(s) for Past Five Years | ||||
| Richard Robinson | 66 | 1962 | Chairman of the Board (since 1982), President (since 1974) and Chief Executive Officer (since 1975). | ||||
| Kevin J. McEnery | 55 | 1993 | Executive Vice President and Chief Financial Officer (since 1995). | ||||
| Deborah A. Forte | 49 | 1983 | Executive Vice President (since 1996), President, Scholastic Entertainment Inc. (since 2001) and Division Head, Scholastic Entertainment Inc. (1995–2001). | ||||
| Donna M. Iucolano | 39 | 2000 | Executive Vice President (since 2000), President, e-Scholastic (since 2003), President, Scholastic Internet Group (2001–2003), Executive Vice President, Scholastic Internet Group (2000–2001); and prior to joining the Company, positions including Senior Vice President (2000) and Vice President (1998–2000) at 1-800-FLOWERS.COM (1994–2000), where she served as the chief e-business strategist. | ||||
| Barbara A. Marcus | 52 | 1983 | Executive Vice President (since 1991), President, Children’s Book Publishing and Distribution (since 1999) and Executive Vice President, Children’s Book Publishing and Distribution (1991–1999). | ||||
| Margery W. Mayer | 51 | 1990 | Executive Vice President (since 1990), President, Scholastic Education (since 2002) and Executive Vice President, Learning Ventures (1998-2002). | ||||
| Hugh Roome | 51 | 1991 | Executive Vice President (since 1996),
President, International Group (since 2001), Executive Vice President, International
(2000–2001) and Executive Vice President, Magazine Group (1996–2000). |
||||
| Richard M. Spaulding | 66 | 1960 | Director (since 1974) and Executive Vice President, Marketing (since 1974). | ||||
| Judith A. Corman | 65 | 1999 | Senior Vice President, Corporate Communications and Media Relations (since 1999); and prior to joining the Company, Senior Vice President at Robinson, Lerer & Montgomery (1994–1999), a strategic communications company, where she handled public relations for various accounts. | ||||
| Charles B. Deull | 43 | 1995 | Senior Vice President (since 1995), General Counsel (since 1999), Senior Vice President, Legal and Business Affairs (1995-1999) and Corporate Secretary (since 1996). | ||||
| Ernest M. Fleishman | 66 | 1989 | Senior Vice President, Education and Corporate Relations (since 1989). | ||||
| Beth Ford | 39 | 2000 | Senior Vice President, Global Operations and Information Technology (since 2002) and Senior Vice President, Global Operations (2000–2002); and prior to joining the Company, Director, Supply Chain at Pepsi Bottling Group/Pepsico (1997-2000). | ||||
| Larry V. Holland | 44 | 1994 | Senior Vice President, Corporate Human Resources and Employee Services (since 1997). | ||||
| Karen A. Maloney | 46 | 1997 | Vice President and Corporate Controller (since 1998). | ||||
9
Item 2 | Properties
The Company maintains
its principal offices in the metropolitan New York area, where it owns or leases
approximately 600,000 square feet of space. The Company also owns or leases approximately
1.8 million square feet of office and warehouse space for its primary warehouse
and distribution facility located in the Jefferson City, Missouri area and approximately
400,000 square feet of office and warehouse space related to its Grolier operations
in Danbury, Connecticut and other United States locations. In addition, the Company
owns or leases approximately 2.2 million square feet of office and warehouse space
in over 80 facilities in the United States for Scholastic Book Fairs.
In June 2002, the Company acquired the Maumelle Facility, consisting of a 500,000 square foot main floor and a 246,000 square foot mezzanine. This facility serves as the Company’s primary packaging and fulfillment center for its continuity programs.
Additionally, the Company owns or leases approximately 1.2 million square feet of office and warehouse space in over 100 facilities in Canada, the United Kingdom, Australia, New Zealand, Southeast Asia and elsewhere around the world for its international businesses.
The Company considers its properties adequate for its current needs. With respect to the Company’s leased properties, no difficulties are anticipated in negotiating renewals as leases expire or in finding other satisfactory space, if current premises become unavailable. For further information concerning the Company’s obligations under its leases, see Note 4 of Notes to Consolidated Financial Statements.
Item 3 | Legal Proceedings
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.
Item 4 | Submission of Matters to a Vote of Security
Holders
During the fourth quarter of the fiscal year covered by
this report, no matter was submitted to the vote of security holders, through the
solicitation of proxies or otherwise.
10
Part II
Item 5 | Market
for the Registrant’s Common Equity and Related Stockholder Matters
Scholastic
Corporation’s common stock, par value $0.01
per share (the “Common Stock”), is traded on the NASDAQ National Market
System under the symbol SCHL. Scholastic Corporation’s Class A Stock, par value
$0.01 per share (the “Class A Stock”), is convertible into Common Stock
on a share-for-share basis. There is no established public trading market for
the
Class A Stock. The table below sets forth, for the periods indicated, the quarterly
high and low selling prices on the NASDAQ National Market System for the Common
Stock.
| For fiscal years ended May 31, | |||||||||
| 2003 | 2002 | ||||||||
| High | Low | High | Low | ||||||
| First Quarter | $ 46.45 | $ 33.62 | $ 43.17 | $ 36.00 | |||||
| Second Quarter | 48.89 | 40.83 | 47.65 | 37.27 | |||||
| Third Quarter | 45.02 | 23.01 | 51.91 | 42.19 | |||||
| Fourth Quarter | 32.68 | 23.00 | 56.40 | 45.35 | |||||
Scholastic Corporation has not paid any cash dividends since its initial public offering in February 1992 and has no current plans to pay any dividends on the Class A Stock or the Common Stock. In addition, certain of the Company’s credit facilities restrict the payment of dividends. See Note 3 of Notes to Consolidated Financial Statements for further information.
The number of holders of record of Class A Stock and Common Stock as of August 1, 2003 were 3 and approximately 15,800, respectively.
11
Item 6 | Selected Financial Data
|
(Amounts in millions, except
per share data) For fiscal years ended May 31, |
|||||||||||
| 2003 | 2002 | 2001 | 2000 | 1999 | |||||||
| Statement of Income Data: | |||||||||||
| Total revenues | $ 1,958.3 | $ 1,917.0 | $ 1,962.3 | $ 1,402.5 | $ 1,165.5 | ||||||
| Cost of goods sold | 882.1 | 852.1 | 899.7 | 692.8 | 586.1 | ||||||
| Cost of goods
sold — Special Literacy Place and other charges(1) |
— | — | 72.9 | — | — | ||||||
| Selling, general and administrative expenses | 826.3 | 771.7 | 773.1 | 557.6 | 462.1 | ||||||
| Bad debt expense | 72.3 | 68.7 | 75.5 | 20.5 | 17.0 | ||||||
| Other operating costs: | |||||||||||
| Depreciation and amortization | 46.1 | 36.6 | 42.4 | 24.1 | 22.4 | ||||||
| Special severance charge(2) | 10.9 | — | — | — | — | ||||||
| Litigation and other charges(3) | 1.9 | 1.2 | — | 8.5 | — | ||||||
| Operating income | 118.7 | 186.7 | 98.7 | 99.0 | 77.9 | ||||||
| Other income (expense)(4) | 2.9 | (2.0) | — | — | — | ||||||
| Interest expense | 31.5 | 31.4 | 41.6 | 18.6 | 19.0 | ||||||
| Earnings before
Cumulative effect of accounting change |
58.6 | 98.7 | 36.3 | 51.4 | 36.8 | ||||||
| Cumulative effect of accounting
change (net of income taxes)(5) |
— | (5.2) | — | — | — | ||||||
| Net income | 58.6 | 93.5 | 36.3 | 51.4 | 36.8 | ||||||
| Earnings per share before Cumulative
effect of accounting change: |
|||||||||||
| Basic | $ 1.50 | $ 2.69 | $ 1.05 | $ 1.54 | $ 1.13 | ||||||
| Diluted | $ 1.46 | $ 2.51 | $ 1.01 | $ 1.48 | $ 1.10 | ||||||
| Earnings per share: | |||||||||||
| Basic | $ 1.50 | $ 2.55 | $ 1.05 | $ 1.54 | $ 1.13 | ||||||
| Diluted | $ 1.46 | $ 2.38 | $ 1.01 | $ 1.48 | $ 1.10 | ||||||
| Weighted average shares outstanding-basic | 39.1 | 36.7 | 34.7 | 33.4 | 32.8 | ||||||
| Weighted average shares outstanding-diluted | 40.1 | 40.1 | 36.1 | 37.1 | 33.4 | ||||||
| Balance Sheet Data: | |||||||||||
| Working capital | $ 404.4 | $ 466.8 | $ 394.6 | $ 253.9 | $ 222.4 | ||||||
| Total assets | 1,801.0 | 1,629.6 | 1,501.8 | 983.2 | 842.3 | ||||||
| Long-term debt | 482.2 | 525.8 | 585.3 | 241.1 | 248.0 | ||||||
| Total stockholders’ equity | 772.6 | 718.9 | 493.7 | 430.0 | 361.4 | ||||||
| Certain prior year amounts have been reclassified to conform with the present year presentation, and share amounts have been adjusted to reflect a 100% stock dividend in the form of a 2-for-1 stock split on the Class A Stock and Common Stock paid on January 16, 2001. | |||||||||||
| (1) | In fiscal 2001, the Company decided not to update Scholastic Literacy Place®, which resulted in a pre-tax special charge of $72.9, or $1.20 per diluted share, recorded in Cost of goods sold. | ||
| (2) | In fiscal 2003, the Company recorded a pre-tax Special severance charge of $10.9, or $0.18 per diluted share, relating to a reduction in its work force. | ||
| (3) | The fiscal 2003 pre-tax charge of $1.9, or $0.03 per diluted share, relates to the settlement of a securities lawsuit, which was agreed to in principle on September 23, 2002. The fiscal 2002 pre-tax charge of $1.2, or $0.02 per diluted share, and $6.7 of the fiscal 2000 charges, relate to a lawsuit with Robert Harris and Harris Entertainment, Inc., which was settled on July 30, 2002. | ||
| (4) | In fiscal 2003, the Company sold a portion of an equity investment, resulting in a pre-tax gain of $2.9, or $0.05 per diluted share. In fiscal 2002, the Company wrote off an equity investment, resulting in a pre-tax loss of $2.0, or $0.03 per diluted share. | ||
| (5) | In fiscal 2002, the Company adopted Statement of Position No. 00-2, “Accounting by Producers and Distributors of Films,” which resulted in an after-tax charge of $5.2, or $0.13 per diluted share, recorded as a Cumulative effect of accounting change. | ||
12
Item 7 | Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Scholastic is a global children’s publishing and media company. The Company distributes its products and services through a variety of channels, including school-based book clubs, school-based book fairs, school-based and direct-to-home continuity programs, retail stores, schools, libraries and television networks. The Company categorizes its businesses into four operating segments: Children’s Book Publishing and Distribution; Educational Publishing; Media, Licensing and Advertising (which collectively represent the Company’s domestic operations); and International. This classification reflects the nature of products and services consistent with the method by which the Company’s chief operating decision-maker assesses operating performance and allocates resources.
Certain revenues and expenses related to the Company’s Internet activities have been reallocated to reflect the transition from a developing platform previously included in the Media, Licensing and Advertising segment to operational systems included in the Children’s Book Publishing and Distribution and Educational Publishing segments.
Certain prior year amounts have been reclassified to conform to the current year presentation. The following discussion and analysis of the Company’s financial position should be read in conjunction with the Company’s Consolidated Financial Statements and the related Notes included in Item 8, Consolidated Financial Statements and Supplementary Data.
Critical Accounting Policies and Estimates
General:
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 its calculations, including, but not
limited
to: collectability of accounts receivable; sales returns; amortization periods;
pension obligations; and recoverability of inventories, deferred promotion costs,
prepublication costs, royalty advances, goodwill and other intangibles.
The following policies and account descriptions include all those identified by the Company as critical to its business operations and the understanding of its results of operations:
Revenue recognition:
The
Company’s revenue recognition policies for its
principal businesses are as follows:
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.
Continuities — The Company operates continuity programs whereby customers generally place a single order and receive multiple shipments of books over a period of time. Revenue from continuities 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. Actual returns could differ from the Company’s estimate.
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
13
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. Actual returns could differ from the Company’s estimate.
Film Production and Licensing — Revenue from the sale of film rights, principally for the home video and domestic and foreign syndicated television markets, is recognized when the film has been delivered and is available for showing or exploitation. Licensing revenue is recorded in accordance with royalty agreements at the time 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.
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.
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.
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 realization 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, except for certain direct
marketing and telemarketing costs that are deferred as discussed above.
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 experience.
Royalty advances are expensed as related revenues are earned or when future recovery
appears doubtful.
Goodwill and other intangibles:
Effective
June 1, 2001, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 142, “Goodwill and Other
Intangible Assets,” under which goodwill and other intangible assets with indefinite
lives are no longer amortized. The Company reviews its goodwill and non-amortizable
intangibles on an annual basis for impairment, or more frequently if impairment
indicators arise, in accordance with the provisions of SFAS No. 142. Prior
to adoption of SFAS No. 142, the Company amortized goodwill and other intangible
assets over their estimated useful lives.
14
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 its employees who meet certain eligibility requirements. The Company follows 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 U.S. cash balance plan are based on formulas in which the employees’ balances are credited monthly with interest based on 1-year U.S. 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 including healthcare and life insurance benefits to retired U.S. employees. A majority of the Company’s U.S. 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. 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.
15
Results of Operations
|
($ amounts in millions, except per share data) For fiscal years ended May 31, |
|||||||||||||
| 2003 | 2002 | 2001 | |||||||||||
| $ | %(1) | $ | %(1) | $ | %(1) | ||||||||
| Revenues: | |||||||||||||
| Children’s Book Publishing and Distribution | 1,189.9 | 60.8 | 1,168.6 | 61.0 | 1,221.9 | 62.3 | |||||||
| Educational Publishing | 325.9 | 16.6 | 316.9 | 16.5 | 311.2 | 15.9 | |||||||
| Media, Licensing and Advertising | 123.5 | 6.3 | 129.8 | 6.8 | 132.5 | 6.7 | |||||||
| International | 319.0 | 16.3 | 301.7 | 15.7 | 296.7 | 15.1 | |||||||
| Total revenues | 1,958.3 | 100.0 | 1,917.0 | 100.0 | 1,962.3 | 100.0 | |||||||
| Cost of goods sold (exclusive of depreciation) | 882.1 | 45.0 | 852.1 | 44.4 | 899.7 | 45.8 | |||||||
| Cost of goods sold — Special Literacy Place and other charges(2) | — | — | — | — | 72.9 | 3.7 | |||||||
| Selling, general and administrative expenses | 826.3 | 42.2 | 771.7 | 40.3 | 773.1 | 39.4 | |||||||
| Bad debt expense | 72.3 | 3.7 | 68.7 | 3.6 | 75.5 | 3.8 | |||||||
| Depreciation and amortization | 46.1 | 2.3 | 36.6 | 1.9 | 42.4 | 2.2 | |||||||
| Special severance charge(3) | 10.9 | 0.6 | — | — | — | — | |||||||
| Litigation and other charges(4) | 1.9 | 0.1 | 1.2 | 0.1 | — | — | |||||||
| Operating income | 118.7 | 6.1 | 186.7 | 9.7 | 98.7 | 5.0 | |||||||
| Other income (expense)(5) | 2.9 | 0.1 | (2.0) | 0.1 | — | — | |||||||
| Interest expense | 31.5 | 1.6 | 31.4 | 1.6 | 41.6 | 2.1 | |||||||
| Earnings before income taxes and Cumulative effect of accounting change |
90.1 | 4.6 | 153.3 | 8.0 | 57.1 | 2.9 | |||||||
| Cumulative effect of accounting change (net of income taxes)(6) | — | — | (5.2) | 0.3 | — | — | |||||||
| Net income | 58.6 | 3.0 | 93.5 | 4.9 | 36.3 | 1.8 | |||||||
| Earnings per share before Cumulative effect of accounting change: | |||||||||||||
| Basic | 1.50 | 2.69 | 1.05 | ||||||||||
| Diluted | 1.46 | 2.51 | 1.01 | ||||||||||
| Earnings per share: | |||||||||||||
| Basic | 1.50 | 2.55 | 1.05 | ||||||||||
| Diluted | 1.46 | 2.38 | 1.01 | ||||||||||
| Certain prior year amounts have been reclassified to conform with the present year presentation, and share amounts have been adjusted to reflect a 100% stock dividend in the form of a 2-for-1 stock split on the Class A Stock and Common Stock paid on January 16, 2001. | |||||||||||||
| (1) | Represents percentage of total revenues. | ||
| (2) | In fiscal 2001, the Company decided not to update Scholastic Literacy Place, which resulted in a pre-tax special charge of $72.9, or $1.20 per diluted share, recorded in Cost of goods sold. | ||
| (3) | In fiscal 2003, the Company recorded a pre-tax Special severance charge of $10.9, or $0.18 per diluted share, relating to a reduction in its work force. | ||
| (4) | The fiscal 2003 pre-tax charge of $1.9, or $0.03 per diluted share, relates to the settlement of a securities lawsuit, which was agreed to in principle on September 23, 2002. The fiscal 2002 pre-tax charge of $1.2, or $0.02 per diluted share, relates to a lawsuit with Robert Harris and Harris Entertainment, Inc., which was settled on July 30, 2002. | ||
| (5) | In fiscal 2003, the Company sold a portion of an equity investment, resulting in a pre-tax gain of $2.9, or $0.05 per diluted share. In fiscal 2002, the Company wrote off an equity investment, resulting in a pre-tax loss of $2.0, or $0.03 per diluted share. | ||
| (6) | In fiscal 2002, the Company adopted Statement of Position No. 00-2, “Accounting by Producers and Distributors of Films,” which resulted in an after-tax charge of $5.2, or $0.13 per diluted share, recorded as a Cumulative effect of accounting change. | ||
16
Results of Operations — Consolidated
Revenues for fiscal 2003 increased 2.2%, or $41.3 million, to $1,958.3 million as compared with revenues in fiscal 2002 of $1,917.0 million. Increased revenues in the Children’s Book Publishing and Distribution segment of $21.3 million, the International segment of $17.3 million and the Educational Publishing segment of $9.0 million were partially offset by decreased revenues in the Media, Licensing and Advertising segment of $6.3 million. Businesses acquired in fiscal 2002 contributed approximately $58 million of incremental revenues to the Company in fiscal 2003.
Fiscal 2002 revenues declined 2.3%, or $45.3 million, from $1,962.3 million in fiscal 2001, primarily as a result of a $53.3 million decrease in revenues in the Children’s Book Publishing and Distribution segment.
Cost of goods sold as a percentage of revenues increased by 0.6% to 45.0% in fiscal 2003 from 44.4% in fiscal 2002, principally due to an unfavorable change in revenue mix. In fiscal 2002, Cost of goods sold as a percentage of revenues improved as compared to 45.8% in fiscal 2001, primarily attributable to the Company’s cost savings program, which produced approximately $25 million in savings, or 1.3% of revenues, in fiscal 2002.
Fiscal 2001 expenses included the $72.9 million, or 3.7% of revenues, Cost of goods sold-Special Literacy Place and other charges (the “Special Charge”) primarily related to the Company’s decision not to update Scholastic Literacy Place®, its basal reading textbook program.
As a percentage of revenues, Selling, general and administrative expenses increased by 1.9% to 42.2% in fiscal 2003 from 40.3% in fiscal 2002. The increase was primarily due to an increase in the cost of general and health care insurance and other employee benefit costs of approximately 0.9%, an increase in systems and facilities costs of approximately 0.6% and an increase in general expenses related to fiscal 2002 acquisitions of 0.6%. These increases were partially offset by the elimination of management incentive bonuses for fiscal 2003, which represented approximately 0.6% of revenues in fiscal 2002. Selling, general and administrative expenses as a percentage of revenues increased in fiscal 2002 from 39.4% in fiscal 2001. Fiscal 2001 Selling, general and administrative expenses as a percentage of revenues benefited from higher Harry Potter revenues, which did not require a proportionate increase in marketing and promotional expenses. In fiscal 2002, the Company recorded a $4.1 million benefit related to the adjustment of certain acquisition-related reserves reflecting lower than anticipated Grolier integration costs.
Bad debt expense increased to $72.3 million, or 3.7% of revenues, in fiscal 2003 as compared to $68.7 million, or 3.6% of revenues, in fiscal 2002. As a percentage of revenues, bad debt expense increased modestly as the continuity business, which has proportionately higher bad debt expense, experienced greater revenue growth than the overall Company growth rate. Fiscal 2002 bad debt expense decreased $6.8 million from $75.5 million, or 3.8% of revenues, in fiscal 2001. This decrease was primarily attributable to better credit performance for the direct-to-home continuity business.
Depreciation expense for fiscal 2003 increased by $10.0 million to $45.6 million, as compared to $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. In fiscal 2002, depreciation expense increased by $7.4 million from $28.2 million in fiscal 2001. Incremental depreciation of $2.6 million in fiscal 2002 related to information technology projects, including the Internet sites placed into service in fiscal 2002, and $2.2 million was due to the expansion of the Company’s facilities in metropolitan New York.
On May 28, 2003, the Company announced a reduction in its global work force of approximately 400 positions, or 4%. This decision resulted in a pre-tax charge of $10.9 million, or 0.6% of revenues, and is recorded as a Special severance charge. The Company expects to realize more than $15 million in salary related savings in fiscal 2004 related to the reduction in work force.
Goodwill and other intangibles amortization was $0.5 million and $1.0 million in fiscal 2003 and 2002, respectively. In fiscal 2002, goodwill and other intangibles amortization decreased $13.2 million from $14.2 million in fiscal 2001 due to the Company’s adoption of SFAS No. 142. Under this pronouncement,
17
the Company is required to take an impairment-only approach to amortizing goodwill and other intangibles assets with indefinite lives, which accordingly reduced amortization expense.
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 with Robert Harris and Harris Entertainment, Inc., for which the Company had established a $6.7 million liability in fiscal 2000. The $1.2 million charge represents the amount by which the settlement and related legal expenses exceeded the previously recorded liability.
Operating income for fiscal 2003 decreased by $68.0 million, or 36.4%, to $118.7 million, or 6.1% of revenues, as compared to $186.7 million, or 9.7% of revenues, in fiscal 2002. This decrease is primarily due to lower profits of $41.3 million in the Children’s Book Publishing and Distribution segment, which includes $2.4 million of the Special severance charge, as well as the $8.5 million balance of the Special severance charge of $10.9 million. Operating income for fiscal 2002 increased by $88.0 million, or 89.2%, from $98.7 million, or 5.0% of revenues, in fiscal 2001. Fiscal 2001 included the impact of the $72.9 million Special charge.
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.
Interest expense was $31.5 million and $31.4 million in fiscal 2003 and 2002, respectively. In fiscal 2002, net interest expense decreased by $10.2 million from $41.6 million in fiscal 2001, primarily due to lower interest rates.
The Company’s effective tax rates were 35.0%, 35