Scholastic Will Succeed Despite Harry Potter Loss

Scholastic Corporation (Nasdaq:SCHL), publisher of the famed Harry Potter series, could have used one of Potter's spells this quarter to boost its earnings as the company reported a loss even greater than analysts expected. Despite the loss, which was generally expected due to the seasonality of the company's operations, the company is on track to meet its guidance for fiscal 2009 due to strong cost cutting. (Speaking of guidance, be sure to check out Can Earnings Guidance Accurately Predict The Future?)

Here's The Deal

Scholastic reported a loss of $1.18 per share, on a continuing operations basis, with revenues of $285 million, while analysts were looking for a loss of $1 on sales of $295 million. Scholastic has a fairly intense seasonality pattern to its revenues, with Q1 being one of the lightest since school is typically not in session. The company typically operates at a loss in this quarter.

The company reiterated its fiscal 2009 earnings guidance at $1.75 to $2.10 per share and revenues at $2 billion to $2.1 billion.

The Street didn't expect Scholastic to report a better quarter than the same one last year, since Q1 2007 saw the release of Harry Potter and the Deathly Hallows, the seventh and final book of the Harry Potter series. The book boosted sales by $240 million in Q1 2007. It is interesting to note that in the quarter that saw the release of the final Potter book, Scholastic was barely able to eke out a profit from continuing operations of $3.3 million, or 8 cents per share.

Margins Matter

Scholastic has stated a goal of reaching 9-10% operating margins by 2010 and has worked on a two-track strategy to achieve this. The first is annualized cost cutting of $25 million to $35 million, and the company says it has made good progress toward achieving this goal. The company froze hiring in the quarter, enacted a voluntary retirement program for older workers and suspended salary increases for its staff. (Speaking of operating margins, be sure to check out Analyzing Operating Margins.)

The second prong of the strategy to reach the desired margins is to institute price increases in many of the company's product lines. The average price increase has reportedly been 5%. Management said that it was too early to tell if the pricing was sticking, but in answering a question during the conference call, stated, "Customers are searching for good value, so they are kind of seeking out the lower-priced and often good-margin, lower-priced items."

Operating margins the last three years have ranged from 5.6-9.4%:

-	2008	2007	2006
Sales	$2,205,600	$2,179,100	$2,283,800
Operating Income	$206,700	$122,700	$139,300
-	-	-	-
Operating Margin	9.4%	5.6%	6.1%

Scholastic faces an extra $15 million to $20 million in higher costs for paper and postage in the current fiscal year.

Other companies have been hit with higher costs for raw materials, and Scholastic may be one of the lucky ones that can raise prices to compensate. Steelmakers like U.S. Steel (NYSE:X) and Nucor (NYSE:NUE) have successfully raised prices to offset the cost of iron ore, while food processors like Pilgrim's Pride (NYSE:PPC) and Smithfield Foods (NYSE:SFD) have been caught between the soaring cost of feed and weak prices for their products.

Bottom Line

Although Scholastic lacks the strong boost from the Harry Potter series to help sales, the company's almost fanatical cost cutting and innovative product strategy should put it on track to meet its goals of 9-10% operating margins for 2010.