Scholastic Debt Rating Placed on CreditWatch Negative

S&P cites weaker-than-anticipated operating performance and discretionary cash flow for the Harry Potter publisher

On July 18, 2003, Standard & Poor's Ratings Service placed its 'BBB' corporate credit rating for Scholastic Corp. (SCHL ) on CreditWatch with negative implications.

New York, N.Y.-based Scholastic is a leading publisher and distributor of children's books. Total debt as of May 31, 2003, was $636 million and cash balances were $59 million.

The CreditWatch listing is based on weaker-than-anticipated operating performance and discretionary cash flow in the fiscal fourth quarter ended May 31, 2003. Operating income, before severance charges, fell 29% in the three months ended May 31, 2003, due to an unfavorable shift in the revenue mix and increased costs. Two of the company's core businesses, school book clubs and fairs, were flat in the fourth quarter, while trade publishing revenues declined 6%. Trade revenues declined 3% in the fiscal 2003 due to lower sales of older titles in the high-margin Harry Potter book series, which account for a significant percentage of trade book sales.

Cost reductions in fiscal 2003 were more than offset by increases in healthcare, insurance, postage, information technology, and facilities expenses. Discretionary cash flow, while slightly improving, has remained negative due to lower profitability and higher capital expenditures. The company had been previously expecting debt levels to rise 2% in fiscal 2003, while, debt net of cash balances, increased 7%.

Profitability in fiscal 2004 will benefit from Scholastic's June release of the highly popular fifth Harry Potter book. However, trade publishing profitability is highly volatile, and Standard & Poor's expects trade results will decline in the following year. Also, Standard & Poor's has concerns regarding the growth prospects of the core book club and fair businesses.

Scholastic is implementing additional cost-reduction measures, reducing capital spending, as well as a revised strategic plan designed to restore the profitability of its core businesses and generate positive discretionary cash flow. Standard & Poor's will reevaluate the company's future business strategies and operating outlook in completing the CreditWatch review.