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Consolidated Statements of Cash Flows (Amountsin millions)Years ended May 31, 2003 2002 2001 Cashflows provided by operating activities: Netincome $ 58.6 $ 93.5 $ 36.3 Adjustmentsto reconcile net income to net cash provided by operating activities: Amortizationof prepublication and production costs 61.0 50.2 68.8 Depreciationand amortization 46.1 36.6 42.4 Royaltyadvances expensed 31.6 26.6 28.7 Deferredincome taxes 12.3 18.0 (15.1) Non-cashportion of Cost of goods sold - Special Literacy Place and other charges — — 71.4 Non-cashportion of Cumulative effect of accounting change — 8.1 — Changesin assets and liabilities: Accountsreceivable, net (17.9) (14.1) 22.5 Inventories (16.7) (7.3) (25.7) Deferredpromotion costs (7.5) (0.5) (1.6) Prepaidand other current assets 12.3 5.5 (22.0) Accountspayable and other accrued expenses 21.5 (42.5) (17.7) Accruedroyalties and deferred revenue (4.1) (6.0) 4.4 Taxbenefit realized from stock option transactions 0.3 8.8 6.9 Other,net (18.3) (12.3) 6.3 Totaladjustments 120.6 71.1 169.3 Netcash provided by operating activities 179.2 164.6 205.6 Cashflows used in investing activities: Additionsto property, plant and equipment (83.9) (78.4) (90.5) Prepublicationcosts (55.7) (53.5) (54.5) Royaltyadvances (30.3) (31.7) (25.5) Equityinvestment and related loan (23.3) — — Productioncosts (15.5) (13.0) (13.7) Acquisition-relatedpayments (10.2) (66.7) (396.4) Proceedsfrom sale of investment 5.2 — — Other (0.3) 4.8 3.3 Netcash used in investing activities (214.0) (238.5) (577.3) Cashflows provided by financing activities: Borrowingsunder Loan Agreement and Revolver 521.1 835.2 552.3 Repaymentsof Loan Agreement and Revolver (571.1) (785.2) (558.1) Borrowingsunder Grolier Facility 138.0 — 350.0 Repaymentsof Grolier Facility (188.0) (300.0) — Proceedsreceived from issuance of 5.75% Notes, net of related costs — 296.7 — Proceedsreceived from issuance of 5% Notes, net of related costs 171.3 — — Borrowingsunder lines of credit 184.7 151.8 100.1 Repaymentsof lines of credit (183.7) (150.7) (90.7) Proceedspursuant to employee stock plans 5.1 22.8 24.2 Other 5.4 0.2 (1.3) Netcash provided by financing activities 82.8 70.8 376.5 Effectof exchange rate changes on cash (0.1) 0.0 0.0 Netincrease (decrease) in cash and cash equivalents 47.9 (3.1) 4.8 Cashand cash equivalents at beginning of year 10.7 13.8 9.0 Cashand cash equivalents at end of year $ 58.6 $ 10.7 $ 13.8 Supplementalinformation: Incometaxes paid $ 14.6 $ 27.5 $ 58.6 Interestpaid $ 32.5 $ 28.0 $ 43.5 Seeaccompanying notes 33Notes to Consolidated Financial Statements(Amounts in millions,except share and per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESPrinciples of consolidationThe consolidated financial statements include the accounts of Scholastic Corporation and all wholly-owned subsidiaries (the “Company”).All significant intercompany transactions are eliminated. Use of estimatesThe Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements involves the use of estimates and assumptions by management, which affect the amounts reported in theconsolidated financial statements and accompanying notes. The Company bases its estimates on historical experience, current business factors, and various otherassumptions believed to be reasonable under the circumstances, all of which are necessary in order to form a basis for determining the carrying values of assetsand liabilities. Actual results may differ from those estimates and assumptions. On an on-going basis, the Company evaluates the adequacy of its reserves and theestimates used in calculations, including, but not limited to: collectability of accounts receivable; sales returns; amortization periods; pension obligations; andrecoverability of inventories, deferred promotion costs, prepublication costs, royaltyadvances, goodwill and other intangibles. Revenue recognitionThe Company’s revenue recognition policies for itsprincipal businesses are as follows: School-Based Book Clubs — Revenue from school-basedbook clubs is recognized upon shipment of the products.School-Based Book Fairs — Revenue from school-basedbook fairs is recognized ratably as each book fair occurs.Continuities — The Company operates continuityprograms whereby customers generally place a single order and receive multiple shipmentsof books over a period of time. Revenue from continuitiesis 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 recordedas 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 returnrates and sales patterns.Trade — Revenue from the sale of children’sbooks for distribution in the retail channel primarily is recognized at the timeof shipment, which generally is when title transfers to the customer. A reservefor estimated returns is established at the time of sale and recorded as a reductionto revenue. Actual returns are charged to the reserve as received. The calculationof the reserve for estimated returns is based on historical return rates and salespatterns.Film Production and Licensing — Revenue fromthe sale of film rights, principally for the home video and domestic and foreignsyndicated television markets, is recognized when the film has been delivered andis available for showing or exploitation. Licensing revenue is recorded in accordancewith royalty agreements at the time the licensed materials are available to thelicensee and collections are reasonably assured.Magazines — Revenue is deferred and recognizedratably 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 bythe customer. Shipments to depositories are on consignment. Revenue is recognizedbased on actual shipments from the depositories to the schools. For certain software-basedproducts, the Company offers new customers installation and training. In such cases,revenue is recognized when installation and training are complete.Magazine Advertising — Revenue is recognizedwhen the magazine is on sale and available to the subscribers.Scholastic In-School Marketing — Revenue isrecognized when the Company has satisfied its obligations under the program andthe customer has acknowledged acceptance of the product or service.34Cash equivalentsCash equivalents consistof short-term investments with original maturities of less than three months. Accounts receivableAccounts receivable are recorded net of allowances fordoubtful accounts and reserves for returns. In the normal course of business, theCompany extends credit to customers that satisfy predefined credit criteria. TheCompany is required to estimate the collectability of its receivables. Reservesfor returns are based on historical return rates and sales patterns. Allowancesfor doubtful accounts are established through the evaluation of accounts receivableagings and prior collection experience to estimate the ultimate realization of thesereceivables.InventoriesInventories, consisting principally of books, are statedat the lower of cost, using the first-in, first-out method, or market. The Companyrecords a reserve for excess and obsolete inventory based primarily upon a calculationof forecasted demand utilizing the historical sales patterns of its products.Deferred promotion costsDeferred promotion costs represent direct mail and telemarketing promotion costs incurred to acquire customers in the Company’s continuity andmagazine businesses. Promotional costs are deferred when incurred and amortized in the proportion that current revenues bear to estimated total revenues. The Companyregularly 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 promotion costs that are deferred as discussedabove. Property, plant and equipmentProperty, plant and equipment are carried at cost. Depreciationand amortization are recorded on a straight-line basis. Buildings have an estimateduseful life, for purposes of depreciation, of forty years. Furniture, fixtures andequipment are depreciated over periods not exceeding ten years. Leasehold improvementsare amortized over the life of the lease or the life of the assets, whichever isshorter. Interest is capitalized on major constructionprojects based on the outstanding construction-in-progress balance for the periodand the average borrowing rate during the period.Prepublication costsThe 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 ona straight-line basis over a three to seven year period. The Company regularlyreviewsthe recoverability of the capitalized costs. Royalty advancesThe Company records a reserve for the recoverability ofits outstanding advances to authors based primarily upon historical earndown experience.Royalty advances are expensed as related revenues are earned or when future recoveryappears doubtful.Goodwill and other intangiblesEffective June 1, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and OtherIntangible Assets,” under which goodwill and other intangible assets with indefinitelives are no longer amortized. The Company reviews its goodwill and non-amortizableintangibles on an annual basis for impairment, or more frequently if impairmentindicators arise, in accordance with the provision of SFAS No. 142. Priorto adoption of SFAS No. 142, the Company amortized goodwill and other intangibleassetsover their estimated useful lives. Income taxesThe Company uses the asset and liability method of accountingfor income taxes. Under this method, deferred tax assets and liabilities are determinedbased on differences between financial reporting and tax bases of assets and liabilitiesand are measured using enacted tax rates and laws that will be in effect when thedifferences are expected to enter into the determination of taxable income.Noncurrent LiabilitiesAll of the rate assumptions discussed below impact theCompany’s calculations of its pension and post-retirement obligations. Therates applied by the Company are based on the portfolios’ past average ratesof return and discussions with actuaries. Any change in market performance, interestrate 35performance, assumed health care costs trend rate, or compensation rates could result in significant changes in the pension and post-retirement obligations.Pension obligations—ScholasticCorporation and certain of its subsidiaries have defined benefit pension plans coveringthe majority of its employees who meet certain eligibility requirements. The Companyfollows SFAS No. 87, “Employers’ Accounting for Pensions,” in calculatingthe existing benefit obligations and net cost under the plans. These calculationsare based on three primary actuarial assumptions: the discount rate, the long-termexpected rate of return on plan assets, and the anticipated rate of compensationincreases. The discount rate is used in the measurement of the projected, accumulatedand vested benefit obligations and the service and interest cost components of netperiodic pension costs. The long-term expected return on plan assets is used tocalculate the expected earnings from the investment or reinvestment of plan assets.The anticipated rate of compensation increase is used to estimate the increase incompensation for participants of the plan from their current age to their assumedretirement age. The estimated compensation amounts are used to determine the benefitobligations and the service cost. Pension benefits in the U.S. cash balance planare based on formulas in which the employees’ balances are credited monthlywith interest based on 1-year U.S. Treasury Bills plus 1%. Contribution creditsare based on employees’ years of service and compensation levels during theiremployment period.Other post-retirement benefits—Scholastic Corporationprovides post-retirement benefits including healthcare and life insurance benefitsto retired U.S. employees. A majority of the Company’s U.S. employees may becomeeligible for these benefits if they reach normal retirement age while working forthe Company. The post-retirement medical plan benefits are funded on a pay-as-you-gobasis. The Company follows SFAS No. 106, “Employers’ Accounting for Post-RetirementBenefits 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 benefitobligations and the service and interest cost components of net periodic post-retirementbenefit cost. The assumed health care cost trend rate is used in the measurementof the long term expected increase in medical claims.Foreigncurrency translationThe Company’s non-U.S. dollar denominated assets andliabilities are translated into United States dollars at prevailing rates at thebalance sheet date and the revenues, costs and expenses are translated at the averagerates prevailing during each reporting period. Net gains or losses resulting fromthe translation of the foreign financial statements and the effect of exchange ratechanges on long-term intercompany balances are accumulated and charged directlyto the foreign currency translation adjustment component of stockholders’ equity. ReclassificationsCertain prior year amounts have been reclassified to conformto the current year presentation.Earnings per shareBasic earnings per share is based on the weighted averageshares of Class A Stock and Common Stock outstanding. Diluted earnings per shareis based on the weighted average shares of Class A Stock and Common Stock outstandingadjusted for the impact of potentially dilutive securities outstanding. The dilutiveimpact of options outstanding is calculated using the treasury stock method, whichtreats the Common Stock issuable upon the exercise of the options outstanding asif they were exercised at the beginning of the period, adjusted for Common Stockassumed to be repurchased with the proceeds and tax benefit realized upon exercise.The dilutive impact of convertible debt outstanding is calculated on an if-convertedbasis, adjusting for interest foregone and Common Stock issuable upon conversionof the debt as if it was converted at the beginning of the period. Any potentiallydilutive security is excluded from the computation of diluted earnings per sharefor any period in which it has an anti-dilutive effect.Stock-based compensationUnder the provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation,” the Company applies Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” (“APB25”), and related interpretations in accounting for its stock option plans.In accordance with APB 25, no compensation expense was recognized with respect tothe Company’s stock option plans, as the exercise price of the Company’sstock options was equal to the market price of the underlying stock on the dateof grant and the exercise price and number of shares subject to grant were fixed. 36If 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 diluted earnings per share for the three fiscal years ended May 31 would have been reduced to the pro forma amounts indicated in the table below: 2003 2002 2001 Netincome — as reported $ 58.6 $ 93.5 $ 36.3 Add: Stock-basedemployee compensationincluded in reported netincome, net of tax* 0.3 0.2 0.0 Deduct: Total stock-based employeecompensation expense determinedunder fair value based method,net of tax 14.3 9.6 12.3 Netincome — pro forma $ 44.6 $ 84.1 $ 24.0 Basicearnings per share— as reported $ 1.50 $ 2.55 $ 1.05 Basic earningsper share —pro forma $ 1.14 $ 2.29 $ 0.69 Diluted earnings per share— as reported $ 1.46 $ 2.38 $ 1.01 Diluted earningsper share —pro forma $ 1.14 $ 2.22 $ 0.69 * Related to the Management Stock PurchasePlan The fair value of each option grant is estimated on the date ofgrant using the Black-Scholes option-pricing model with the weighted average assumptionsfor the three fiscal years ended May 31 as follows: 2003 2002 2001 Expecteddivided yield 0.0%0.0%0.0%Expected stockprice volatility 61.5%66.1%44.5%Risk-free interest rate 3.45%4.59%6.03%Expected lifeof options 5 years 5 years 5 years The weighted average fair value of options granted during fiscal2003, 2002 and 2001 was $18.00, $25.24 and $15.59 per share, respectively. For purposesof pro forma disclosure, the estimated fair value of the options is amortized overthe options’ vesting periods.New accounting pronouncementsIn June 2001, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” Thisstatement addresses financial accounting and reporting for obligations associatedwith the retirement of tangible long-lived assets and the associated asset retirementcosts. The Company is required to adopt this statement by the first quarter offiscal2004. The Company does not expect that the adoption of SFAS No. 143 will haveamaterial impact on its financial position, results of operations or cash flows. In January 2003, the FASB issued FASB Interpretation No.46, “Consolidation of Variable Interest Entities” (“FIN 46”),which requires variable interest entities to be consolidated by the primary beneficiaryof the entity if certain criteria are met. FIN 46 is effective for all new variableinterest entities created after January 31, 2003. For variable interest entitiescreated or acquired before February 1, 2003, the provisions of FIN 46 become effectivefor the Company on September 1, 2003. The Company does not expect that the adoptionof FIN 46 will have a material impact on its financial position, results of operationsor cash flows.In April 2003, the FASB issued SFAS No. 149, “Amendmentof Statement 133 on Derivative Instruments and Hedging Activities.” This statementamends and clarifies financial accounting and reporting for derivative instruments,including certain derivative instruments embedded in other contracts (collectivelyreferred to as derivatives) and for hedging activities under SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities.” Except as noted below,the Company is required to adopt this statement by the first quarter of fiscal 2004.Certain provisions of this statement relating to SFAS No. 133 implementation issuesthat have been effective for prior fiscal quarters will continue to be applied inaccordance with their respective effective dates. The Company does not expect thatthe adoption of SFAS No. 149 will have a material impact on its financial position,results of operations or cash flows.In May 2003, the FASB issued SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities and Equity.”SFAS No. 150 establishes standards for classification and measurement of certainfinancial instruments with characteristics of both liabilities and equity. SFASNo. 150 is effective for the Company on September 1, 372003. The Company does not expect that the adoption of SFAS No. 150 will have a material impact on the Company’s financial position, results of operations or cash flows. 2. SEGMENT INFORMATIONThe Company categorizes its businesses into four operatingsegments: Children’s Book Publishing and Distribution; Educational Publishing;Media, Licensing and Advertising (which collectively represent the Company’sdomestic operations); and International. This classification reflectsthenature of products and services consistent with the method by which the Company’schief operating decision-maker assesses operating performance and allocates resources. Certain revenues and expenses related to the Company’sInternet activities have been reallocated to reflect the transition from a developingplatform previously included in the Media, Licensing and Advertising segmentto operational systems included in the Children’s Book Publishing and Distributionand Educational Publishing segments. Prior year segment results havebeen restated to reflect this reclassification.• Children’s Book Publishingand Distribution includes the publication and distribution of children’sbooks in the United States through school-based book clubs and book fairs, school-basedand direct-to-home continuity programs and the trade channel. • Educational Publishingincludes the publication and distribution to schools and libraries of curriculummaterials, classroom magazines and print and on-line reference and non-fictionproducts for grades pre-kindergarten to 12 in the United States. • Media, Licensing and Advertisingincludes 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., of programming and consumer products (including children’stelevision programming, videos, software, feature films, promotional activitiesand non-book merchandise), and advertising revenue, including sponsorship programs. • International includesthe publication and distribution of products and services outside the United Statesby the Company’s international operations, and its export and foreign rightsbusinesses. 38The 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 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 10.1 3.9 3.1 25.3 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) 137.1 41.7 (5.4)(74.1)99.3 19.4 118.7 Segment assets 745.6 300.2 66.3 416.6 1,528.7 272.3 1,801.0 Goodwill 126.3 82.3 10.2 0.0 218.8 27.2 246.0 Expenditures for long-lived assets(4) 73.5 38.1 24.9 49.1 185.6 33.3 218.9 Long-livedassets(5) 299.3 191.7 39.9 250.5 781.4 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 8.0 3.4 1.5 18.3 31.2 4.4 35.6 Amortization(2) 16.0 22.8 11.4 0.0 50.2 1.0 51.2 Royalty advancesexpensed 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 685.5 303.8 55.3 362.1 1,406.7 222.9 1,629.6 Goodwill 129.5 82.9 10.0 0.0 222.4 33.8 256.2 Expendituresfor long-lived assets(4) 112.5 51.9 22.4 47.8 234.6 8.7 243.3 Long-lived assets(5) 283.2 187.6 33.6 227.2 731.6 72.8 804.4 2001 Revenues $ 1,221.9 $ 311.2 $ 132.5 $ 0.0 $ 1,665.6 $ 296.7 $ 1,962.3 Bad debt 62.8 1.2 2.5 0.0 66.5 9.0 75.5 Depreciation 6.4 3.4 0.2 13.9 23.9 4.3 28.2 Amortization(2) 16.6 46.6 17.2 0.3 80.7 2.3 83.0 Royalty advances expensed 22.9 0.9 3.4 0.0 27.2 1.5 28.7 Segment profit(loss)(3) 202.9 (67.1)(6)(3.5)(58.4)73.9(6)24.8 98.7(6)Segment assets 640.0 263.5 56.9 322.6 1,283.0 218.8 1,501.8 Goodwill 109.2 71.1 8.4 0.0 188.7 33.2 221.9 Expenditures for long-lived assets(4) 271.4 187.6 18.9 74.6 552.5 28.1 580.6 Long-livedassets(5) 268.3 178.6 34.6 168.2 649.7 68.3 718.0 (1) Overhead includes all domestic corporateamounts not allocated to reportable segments, which includes unallocated expensesand 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. Unallocatedassets are principally comprised of deferred income taxes and property, plant andequipment related to the Company’s headquarters in the metropolitan New Yorkarea, its fulfillment and distribution facilities located in Missouri and Arkansas,and an industrial/office building complex in Connecticut. (2) In fiscal 2003 and 2002, includesamortization of prepublication costs, production costs and other intangibles withdefinite lives. In fiscal 2001, includes amortization of prepublication costs, productioncosts, goodwill and other intangibles. (3) Segment profit/(loss) representsearnings before other income (expense), interest and income taxes. In fiscal 2002,it excludes the cumulative effect of accounting change of $5.2 net of tax, or $0.13per diluted share, related to the Media, Licensing and Advertising segment.The impact on segment profit (loss) of the reclassification of Internet revenuesand expenses was: a decrease in Children’s Book Publishing and Distributionsegment profit of $12.8, $8.6 and $10.4 in fiscal 2003, 2002 and 2001, respectively;a decrease in Educational Publishing segment profit of $4.7 and $7.4 in fiscal2003 and 2002, respectively, and an increase in Educational Publishing segmentloss of $9.0 in fiscal 2001; offset by a decrease in the Media, Licensing andAdvertising segment loss of $17.5, $16.0 and $19.4 in fiscal 2003, 2002 and2001, respectively. (4) Includes expenditures for property,plant and equipment, investments in prepublication and production costs, royaltyadvances and acquisitions of, and investments in, businesses. (5) Includes property, plant and equipment,prepublication costs, goodwill, other intangibles, royalty advances, productioncosts and long-term investments. (6) Educational Publishing segmentloss for fiscal 2001 reflects the Company’s decision not to update ScholasticLiteracy Place, which resulted in a $72.9 specialcharge to cost of goods sold. 39The following table separately sets forth information for the three fiscal years ended May 31 for the U.S. 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 2003 2002 2001 2003 2002 2001 2003 2002 2001 Revenues $ 212.3 $ 209.0 $ 217.9 $ 977.6 $ 959.6 $ 1,004.0 $ 1,189.9 $ 1,168.6 $ 1,221.9 Bad debt 41.9 39.6 43.4 22.2 18.9 19.4 64.1 58.5 62.8 Depreciation 0.3 0.4 0.3 9.8 7.6 6.1 10.1 8.0 6.4 Amortization(1) 1.5 0.7 3.6 15.4 15.3 13.0 16.9 16.0 16.6 Royalty advances expensed 4.5 1.2 0.2 21.3 22.4 22.7 25.8 23.6 22.9 Business profit(2) 30.7 39.7 13.5 106.4 138.7 189.4 137.1 178.4 202.9 Business assets 258.4 241.8 243.1 487.2 443.7 396.9 745.6 685.5 640.0 Goodwill 93.0 93.4 88.4 33.3 36.1 20.8 126.3 129.5 109.2 Expenditures for long-livedassets(3) 6.8 9.5 213.9 66.7 103.0 57.5 73.5 112.5 271.4 Long-livedassets(4) 142.5 142.6 137.9 156.8 140.6 130.4 299.3 283.2 268.3 (1) In fiscal 2003 and 2002, includesamortization of prepublication costs and other intangibles with definite lives.In fiscal 2001, includes amortization of prepublication costs, goodwill and otherintangibles. (2) Business profit represents earningsbefore other income (expense), interest and income taxes. (3) Includes expenditures for property,plant and equipment, investments in prepublication costs, royalty advances and acquisitionsof businesses. (4) Includes property, plant and equipment,prepublication costs, goodwill, other intangibles and royalty advances. 3. DEBTThe following summarizes debt as of May 31: Carrying Fair Carrying Fair Value Value Value Value 2003 2002 Linesof Credit $ 28.5 $ 28.5 $ 23.3 $ 23.3 Grolier Facility — — 50.0 50.0 Loan Agreementand Revolver — — 50.0 50.0 7% Notes due 2003, net of discount 125.0 128.5 124.9 130.4 5.75% Notesdue 2007, net of premium/discount 303.8 322.4 298.9 297.5 5.75% Notes due 2007 - swap valuationadjustment 5.6 5.6 1.8 1.8 5% Notes due2013, net of discount 172.6 182.7 — — Other debt 0.4 0.4 0.4 0.4 Totaldebt 635.9 668.1 549.3 553.4 Less lines ofcredit and short-term debt (153.7)(157.2)(23.5)(23.5)Totallong-term debt $ 482.2 $ 510.9 $ 525.8 $ 529.9 Short-termdebt is carried at cost which approximates fair value. Fair values were estimatedbased on market quotes, where available, or dealer quotes. 40The following table sets forth the maturities of the carrying values of the Company’s debt obligations as of May 31, 2003 for fiscal years ended May 31: 2004 $ 153.7 2005 0.1 2006 0.1 2007 309.4 2008 — Thereafter 172.6 Totaldebt $ 635.9 Lines of CreditScholastic Corporation’s international subsidiaries had unsecured lines of credit available in local currencies equivalent to $57.8and $53.5 at May 31, 2003 and 2002, respectively. There were $28.5 and $23.3 outstanding under these credit lines at May 31, 2003 and 2002, respectively. These lines ofcredit are considered short-term in nature. The weighted average interest rates on the outstanding amounts were 6.89% and 5.43% at May 31, 2003 and 2002,respectively. Grolier FacilityOn June 22, 2000, Scholastic Inc. established a credit facility to finance $350.0 of the $400.0 Grolier purchase price (the “GrolierFacility”). As described in “5% Notes due 2013” below, the GrolierFacility was cancelled effective April 10, 2003. At May 31, 2002, $50.0 was outstandingunder the Grolier Facility at a weighted average interest rate of 2.4%. Loan AgreementScholastic Corporation and Scholastic Inc. are joint and several borrowers under an amended and restated loan agreement with certain banks,effective August 11, 1999 and amended June 22, 2000 (the “Loan Agreement”).The Loan Agreement, which expires on August 11, 2004, provides for aggregate borrowingsof up to $170.0 (with a right in certain circumstances to increase borrowings to$200.0), including the issuance of up to $10.0 in letters of credit. Interest underthis facility is either at the prime rate or 0.325% to 0.90% over LIBOR (as defined).There is a facility fee ranging from 0.10% to 0.30% and a utilization fee rangingfrom 0.05% to 0.15% if borrowings exceed 33% of the total facility. The amountscharged vary based upon the Company’s credit rating. The interest rate,facilityfee and utilization fee (when applicable) as of May 31,2003 were 0.475% over LIBOR, 0.150% and 0.075%, respectively. The Loan Agreementcontains certain financial covenants related to debt and interest coverage ratios(as defined) and limits dividends and other distributions. At May 31, 2003 and 2002,$0 and $50.0, respectively, were outstanding under the Loan Agreement. The weightedaverage interest rate at May 31, 2002 was 2.7%.RevolverScholastic Corporation and Scholastic Inc. are joint and several borrowers under a Revolving Loan Agreement with a bank, effective November10, 1999 and amended June 22, 2000 (the “Revolver”). The Revolver providesfor unsecured revolving credit of up to $40.0 and expires on August 11, 2004. Interestunder this facility is either at the prime rate minus 1%, or 0.325% to 0.90% overLIBOR (as defined). There is a facility fee ranging from 0.10% to 0.30%. The amountscharged vary based upon the Company’s credit rating. The interest rate andfacility fee as of May 31, 2003 were 0.475% over LIBOR and 0.150%, respectively.The Revolver has certain financial covenants related to debt and interest coverageratios (as defined) and limits dividends and other distributions. At May 31,2003and 2002, there were no borrowings outstanding under the Revolver. 7% Notes due 2003On December 23, 1996, Scholastic Corporation issued $125.0of 7% Notes (the “7% Notes”). The 7% Notes are senior unsecured obligationsthat mature on December 15, 2003. The 7% Notes are not redeemable prior to maturity.Interest on the 7% Notes is payable semi-annually on December 15 and June 15ofeach year. 5.75% Notes due 2007On January 23, 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. 41Interest Rate Swap AgreementOn February 5, 2002,Scholastic Corporation entered into an interest rate swap agreement, designatedas a fair value hedge as defined under SFAS No. 133, whereby the Company would receivea fixed interest rate payment based on a notional amount and pay a variable interestrate to the counterparty, which is reset semi-annually based on six-month LIBOR(as defined). This agreement was entered into in the notional amount of $100.0 toexchange the fixed interest rate payments on a portion of the 5.75% Notes for variableinterest rate payments. In accordance with SFAS No. 133, the swap is consideredperfectly effective and all changes in fair value are recorded to Other assets andLong-term debt. On May 28, 2003, $50.0 of the initial notional amount was settled,and the Company received a payment of $5.4 from the counterparty. The cash receivedwas used to partially reduce the Other asset previously established, and the correspondingcredit will be amortized over the remaining term of the 5.75% Notes. The fair valuerecorded as of May 31, 2003 and 2002 was $5.6 and $1.8, respectively.5% Notes due 2013On April 4, 2003, Scholastic Corporation issued $175.0of 5% Notes (the “5% Notes”). The 5% Notes are senior unsecured obligationsthat mature on April 15, 2013. Interest on the 5% Notes is payable on April 15andOctober 15 of each year, beginning October 15, 2003. The Company may at any timeredeem all or a portion of the 5% Notes at a redemption price (plus accrued interestto the date of the redemption) equal to the greater of (i) 100% of the principalamount, or (ii) the sum of the present values of the remaining scheduled paymentsof principal and interest discounted to the date of the redemption. Net proceedsfrom the sale, after deducting discounts, commissions and estimated expenses,wereused to retire all outstanding indebtedness under the Grolier Facility, whichwas then cancelled; and to reduce indebtedness outstanding under the Loan Agreementand the Revolver. 4. COMMITMENTS AND CONTINGENCIESCommitmentsThe Company leases warehouse space, office space and equipmentunder various operating leases. Certain of these leases provide for rent increasesbased on price-level factors. In most cases, managementexpects that in the normal course of business leases will be renewed or replacedby other leases. The Company has no significant capitalized leases. Total rentexpenserelating to the Company’s operating leases was $48.3, $44.2 and $41.5 forthe fiscal years ended May 31, 2003, 2002 and 2001, respectively. The rent paymentsare subject to escalation provisions and are net of sublease income. The aggregateminimum future annual rental commitments at May 31, 2003 under all non-cancelableoperating leases, totaling $292.6, are as follows: 2004 - $41.9; 2005 - $33.0;2006- - $24.6; 2007 - $16.5; 2008 - $11.8; later years - $164.8. The Company had certain contractual commitments, principallyrelating to royalty advances, at May 31, 2003 totaling $15.7. The aggregate annualcommitments are as follows: 2004 - $13.3; 2005 - $2.0; 2006 - $0.4.ContingenciesVarious claims and lawsuits arising in the normal course of business are pending against the Company. The results of these proceedings arenot expected to have a material adverse effect on the Company’s consolidatedfinancial position or results of operations. 5. ACQUISITIONSFiscal 2002 AcquisitionsDuring fiscal 2002, the Company completed the acquisitions of the stock or assets of the following companies: Troll Book Fairs LLC, a nationalschool-based book fair operator; Tom Snyder Productions, Inc., a developer and publisher of interactive educational software and producer of television programming; SandvikPublishing Ltd., d/b/a Baby’s First Book Club, a directmarketer of age-appropriate books and toys for young children; Klutz, a publisherand creatorof “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,and the related goodwill and other intangibles was $31.9. In addition to theinitial purchase price paid for Klutz of $42.8, additional payments of up to$31.3 may bemade to the seller in 2004 and 2005, contingent upon the achievement of certainrevenue thresholds. 42The 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 summarizesthe allocation of the aggregate purchase price of the fiscal 2002 acquisitions: Value Accountsreceivable $ 9.6 Inventory 10.7 Other current assets 6.1 Property, plantand equipment 1.2 Goodwill and other intangibles 31.9 Noncurrentdeferred taxes 18.6 Other assets 0.4 Current liabilities (11.8)Cashpaid for acquisitions, net of cash received $ 66.7 The allocation of the aggregate purchase price was finalized duringfiscal 2003. The operating results of each fiscal 2002 acquisition have been includedin the Company’s consolidated results of operations since the respective datesof acquisition. The effect on operating results of including the acquired businessoperations on a pro forma basis would not be material.In connection with the fiscal 2002 acquisitions, the Companyestablished liabilities of $3.2 at May 31, 2002, relating primarily to severanceand other exit costs. As of May 31, 2003, $1.6 of these liabilities remain unpaid.Fiscal 2001 Acquisition — GrolierOn June 22, 2000, Scholastic Inc., a subsidiary of Scholastic Corporation, acquired all of the issued and outstanding capital stock of Grolier.In connection with the Grolier acquisition, the Company established a plan for integratingGrolier’s operations. Accordingly, the Company established liabilities of approximately$17.7 relating primarily to severance, fringe benefits and related salary continuance,as well as certain exit costs associated with the integration of certain of Grolier’soperational and administrative functions. At May 31, 2003 and 2002, the establishedliabilities for integration costs related to severance and other exit costs werein excess of the expected costs by $0.5 and $2.1, respectively, resulting ina decreasein the recorded liabilities and a reduction of Selling, general and administrativeexpenses, which are reflected in the table below. As of May 31, 2003, $1.5 of theseliabilities remain unpaid and are expected to be paid over the next two fiscal years.A summary of the activity in the established liabilitiesis detailed in the following table: Severance and Other Related Exit Costs Costs Total Liabilities established at acquisition $ 13.3 $ 4.4 $ 17.7 Fiscal 2001 payments (1.8 ) (1.2 ) (3.0 ) Balance at May 31, 2001 11.5 3.2 14.7 Fiscal 2002 payments (7.3 ) (0.7 ) (8.0 ) Fiscal 2002 adjustment (1.2 ) (0.9 ) (2.1 ) Balance at May 31, 2002 3.0 1.6 4.6 Fiscal 2003 payments (2.2 ) (0.4 ) (2.6 ) Fiscal 2003 adjustment (0.2 ) (0.3 ) (0.5 ) Balance at May 31, 2003 $ 0.6 $ 0.9 $ 1.5 6. ACQUISITION OF GOOSEBUMPS RIGHTSIn fiscal 2003, the Company acquired all worldwide rightsto the Goosebumps™ property from Parachute Press, Inc. and its affiliates(“Parachute”) and the parties settled all outstanding disputes betweenthem. Under the agreement, the Company paid $9.7 to acquire all Parachute’srights in the Goosebumps trademark, to publish existing and future Goosebumpsbooksand to develop and exploit the property on a worldwide basis in all media, withoutfuture royalty obligations to Parachute Press, Inc. 7. INVESTMENTOn June 24, 2002, the Company entered into a joint venture with The Book People, Ltd., a direct marketer of books in the United Kingdom, todistribute books to the home under the Red House name and through schools under the Scholastic School Link name. Accordingly, $9.6 relating to Red House has beenrecorded as an investment in the joint venture (See Note 8). The Company also acquireda 15% equity interest in The Book People Group, Ltd. for 12.0 (equivalentto $17.9 as of the date of the transaction) with a possible 43additional 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, 2003, 3.0 (equivalent to $4.9) was outstanding under the revolving credit facility. The equity investment in The Book People Group, Ltd. and credit facility are included in Other in the Other Assets and Deferred Charges section of the ConsolidatedBalance Sheets.8. GOODWILL AND OTHERINTANGIBLESThe Company adopted SFAS No. 142, effective as of June1, 2001. Under SFAS No. 142, goodwill and other intangible assets with indefinitelives are no longer amortized but are reviewed annually, or more frequently if impairmentindicators arise. In fiscal 2003 and 2002, the Company completed the required annualimpairment reviews of goodwill. These reviews required the Company to estimate thefair value of its identified reporting units. For each of the reporting units, theestimated fair value was determined utilizing the expected present value of theprojected future cash flows of the units. In all instances, the estimated fair valueof the reporting units exceeded their book values and therefore no write-down ofgoodwill was required.The following table reflects unaudited pro forma resultsof operations of the Company, giving effect to SFAS No. 142 as if it were adoptedon the first day of the fiscal year ended May 31, 2001: 2001 Netincome, as reported $ 36.3 Add back: amortizationexpense, net of tax 8.3 Proforma net income $ 44.6 Basic net incomeper Share of Class A Stock and CommonStock: Asreported $ 1.05 Proforma $ 1.29 Diluted netincome per Share of Class A Stock and CommonStock: Asreported $ 1.01 Proforma $ 1.24 The following table summarizes the activity in Goodwill as of May31: 2003 2002 2001 Beginningbalance $ 256.2 $ 221.9 $ 63.5 Additions dueto acquisitions 0.4 35.4 169.9 Investment in joint venture (9.6)— — Amortization — — (10.3)Other adjustments (1.0)(1.1)(1.2)Total $ 246.0 $ 256.2 $ 221.9 The following table summarizes Other intangibles subject to amortizationas of May 31: 2003 2002 Customerlists $ 2.9 $ 2.8 Accumulatedamortization (2.5)(2.2) Netcustomer lists 0.4 0.6 Otherintangibles 3.9 3.9 Accumulated amortization (2.3)(2.1) Netother intangibles 1.6 1.8 Total $ 2.0 $ 2.4 Amortization expense for Other intangibles totaled $0.5, $1.0and $3.9 for the fiscal years ended May 31, 2003, 2002 and 2001, respectively. Amortizationexpense for these assets is currently estimated to total $0.3 for each of the fiscalyears ending May 31, 2004 through 2006, and $0.2 for each of the fiscal years endingMay 31, 2007 and 2008. The weighted average amortization periods for these assetsby major asset class are three years and 14 years for customer lists and other intangibles,respectively.The following table summarizes Other intangibles not subjectto amortization as of May 31: 2003 2002 Netcarrying value by major class: Titles $ 31.0 $ 31.0 Licenses 17.2 17.2 Majorsets 11.4 11.4 Trademarksand Other 12.6 1.8 Total $ 72.2 $ 61.4 449. INCOME TAXESThe provisions for incometaxes for the fiscal years ended May 31 are based on earnings before taxes and Cumulativeeffect of accounting change as follows: 2003 2002 2001 UnitedStates $ 81.8 $ 144.7 $ 50.0 Non-UnitedStates 8.3 8.6 7.1 $ 90.1 $ 153.3 $ 57.1 The provisions for income taxes attributable to earnings beforeCumulative effect of accounting change for the fiscal years ended May 31 consistof the following components: 2003 2002 2001 Federal Current $ 11.5 $ 29.4 $ 26.9 Deferred 13.4 15.4 (13.5) $ 24.9 $ 44.8 $ 13.4 Stateand local Current $ 3.4 $ 3.7 $ 4.0 Deferred 0.9 2.0 (2.8) $ 4.3 $ 5.7 $ 1.2 International Current $ 4.3 $ 3.5 $ 5.0 Deferred (2.0)0.6 1.2 $ 2.3 $ 4.1 $ 6.2 Total Current $ 19.2 $ 36.6 $ 35.9 Deferred 12.3 18.0 (15.1) $ 31.5 $ 54.6 $ 20.8 The provisions for income taxes attributable to earnings beforeCumulative effect of accounting change for the fiscal year ended May 31 differ fromthe amount of tax determined by applying the federal statutory rate as follows: 2003 2002 2001 Computedfederal statutoryprovision $ 31.5 $ 53.7 $ 20.0 State incometax provision, netof federal income tax benefit 2.8 3.6 0.8 Difference in effective tax rates on earnings of foreignsubsidiaries (1.4)(0.7)1.8 Charitablecontributions (1.4)(1.8)(1.6)Other — net 0.0 (0.2)(0.2)Totalprovision for income taxes $ 31.5 $ 54.6 $ 20.8 Effectivetax rates 35.0%35.6%36.5% The undistributed earnings of foreign subsidiaries at May 31,2003 are $18.1. Any remittance of foreign earnings would not result in any significantadditional tax.At May 31, 2003, the Company has a charitable deductioncarryforward of $9.6, which expires in the fiscal years ending May 31, 2007 and2008 and a foreign tax credit carryforward of $0.8 which expires in the fiscal yearending May 31, 2007.Deferred income taxes reflect the net tax effects of temporarydifferences between the carrying amounts of assets and liabilities for financialreporting and the amounts used for income tax purposes as determined under enactedtax laws and rates. The tax effects of items that give rise to deferred tax assetsand liabilities as of May 31 for the indicated fiscal years are as follows: 2003 2002 Netdeferred tax assets: Taxuniform capitalization $ 24.3 $ 26.5 Inventoryreserves 16.7 18.4 Allowancefor doubtful accounts 19.6 19.9 Otheraccounting reserves 18.4 21.8 Post-retirement,post-employment andpension obligations 21.3 16.3 Taxcarryforwards 5.1 1.5 Prepaidexpenses (15.2)(12.2) Depreciationand amortization (10.7)(0.3) Other— net (1.5)(4.2)Totalnet deferred tax assets $ 78.0 $ 87.7 45Net deferred tax assets of $78.0 at May 31, 2003 and $87.7 at May 31, 2002 include $1.2 in Other accrued expenses at May 31, 2003 and $3.1 and $4.6 in Other noncurrentliabilities at May 31, 2003 and 2002, respectively.10. CAPITAL STOCKAND STOCK OPTIONSScholastic Corporation has authorizedcapital stock of 2,500,000 shares of Class A Stock, par value $0.01 per share(the “Class AStock”); 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 $1.00per share (the “Preferred Stock”). Class A and Common StockAt May 31, 2003, 1,656,200 shares of Class A Stock and 37,608,333 shares of Common Stock were outstanding. At May 31, 2003, ScholasticCorporation had reserved for issuance 11,346,808 shares of Common Stock. Of these shares, 9,314,998 shares were reserved for issuance under the Company’s stockoption plans (including shares available for grant and options currently outstanding),1,656,200 shares were reserved for issuance upon conversion of the Class A Stockand 375,610 shares were reserved for future issuances under the Company’sstockpurchase plans. The only voting rights vested in the holders of CommonStock, except as required by law, are the election of such number of directors asshall equal at least one-fifth of the members of the Board of Directors. The holdersof Class A Stock are entitled to elect all other directors and to vote on all othermatters. Holders of Class A Stock and Common Stock are entitled to one vote pershare on matters on which they are entitled to vote. The holders of Class A Stockhave the right, at their option, to convert shares of Class A Stock into sharesof 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 Stockand 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 paidany cash dividends since its public offering in 1992 and has no current plans topay any dividends on its Class A Stock or Common Stock.Preferred StockThe Preferred Stock may be issued in one or more series,with the rights of each series, including voting rights, to be determined bythe Board of Directors before each issuance. To date, no sharesof Preferred Stock have been issued.Stock OptionsThe Company presently has three stockholder-approved employee stock plans: the Scholastic Corporation 1992 Stock Option Plan (the “1992 Plan”),under which no further options are issuable, the Scholastic Corporation 1995 StockOption Plan (the “1995 Plan”) and the Scholastic Corporation 2001 StockIncentive Plan (the “2001 Plan”). The 1995 Plan provides for the issuanceof non-qualified stock options and incentive stock options. The 2001 Plan providesfor the issuance of non-qualified stock options, incentive stock options, restrictedstock and other stock-based awards. At May 31, 2003, non-qualified stock optionsto purchase 678,900; 4,316,358; and 1,587,500 shares of Common Stock were outstandingunder the 1992 Plan, 1995 Plan and 2001 Plan, respectively; and 0; 27,490; and2,411,250shares of Common Stock were available for additional awards under the 1992 Plan,1995 Plan and 2001 Plan, respectively. The Company also maintains two stockholder-approved stockoption plans for outside directors: the 1992 Outside Directors’ Stock OptionPlan (the “1992 Directors’ Plan”), under which no further optionsare issuable, and the 1997 Outside Directors’ Stock Option Plan (the “1997Directors’ Plan”), which provide for the grant of non-qualified stockoptions. The 1997 Directors’ Plan, as amended, provides for the automatic grantof 6,000 options to non-employee directors on the date of each annual Stockholders’meeting. At May 31, 2003, options to purchase 257,500 and 12,000 shares of CommonStock were outstanding and 24,000 and 0 shares of Common Stock were available foradditional awards under the 1997 Directors’ Plan and the 1992 Directors’Plan, respectively. In September 2002 and January 2002, options were awarded underthe 1997 Directors’ Plan at exercise prices of $43.54 and $49.70, respectively.On July 14, 2003, the Board of Directors approved Amendment No. 2 to the 1997 Directors’Plan, subject to approval by the Class A Stockholders, to increase the shares ofCommon Stock authorized for issuance under the plan by 270,000.Generally, options granted under the various plans maynot be exercised for a minimum of one year after the date of grant and expire tenyears after the date of grant.46The following tablesets forth the stock option activity for the three fiscal years ended May 31: 2003 2002 2001 Weighted Weighted Weighted Average Average Average Options Exercise Price Options Exercise Price Options Exercise Price Outstanding— beginning of year 5,539,712 $ 27.58 6,035,804 $ 25.28 5,568,966 $ 22.05 Granted 1,392,240 32.69 692,000 42.62 1,724,000 32.81 Exercised (59,694)21.49 (911,292)22.07 (1,170,012)20.68 Cancelled (20,000)34.31 (276,800)32.79 (87,150)30.16 Outstanding— end of year 6,852,258 $ 28.65 5,539,712 $ 27.58 6,035,804 $ 25.28 Exercisable— end of year 4,669,518 $ 26.05 4,083,962 $ 24.52 3,588,804 $ 22.47 The following table sets forth information as of May 31, 2003regarding weighted average exercise prices and weighted average remaining contractuallives for the remaining outstanding stock options, sorted by range of exercise price: Options Outstanding Options Exercisable Weighted Average Weighted Weighted Remaining Average Average Contractual Number Exercise OptionsPrice Range Number Exercise Price Life Exercisable Price $15.73— $20.97 1,726,868 $ 18.34 4.5 years 1,726,868 $ 18.34 $20.98— $26.21 1,433,000 25.19 7.0 years 919,000 25.37 $26.22 —$31.45 740,400 29.44 3.5 years 730,400 29.42 $31.46— $36.69 2,166,740 33.69 7.8 years 972,500 32.06 $36.70 —$41.94 142,250 38.36 8.5 years 58,250 38.08 $41.95— $47.18 551,000 43.02 8.5 years 198,000 43.13 $47.19 —$52.42 92,000 50.25 7.7 years 64,500 49.92 47Employee Stock Purchase PlanThe Company maintainsan Employee Stock Purchase Plan (“ESPP”), which is offered to eligibleU.S. employees. The ESPP permits participating employees to purchase Common Stock,through after-tax payroll deductions, on a quarterly basis at a 15% discountfromthe lower of the closing price of the Common Stock on NASDAQ on the first orlast business day of each fiscal quarter. During fiscal 2003, 2002 and 2001,the Companyissued 131,417, 71,073 and 55,630 shares under the ESPP at a weighted averageprice of $25.54, $35.87 and $28.41 per share, respectively. At May 31, 2003,34,807 shareswere authorized to be issued under the ESPP. On July 14, 2003, the Board of Directorsapproved an amendment to the ESPP, subject to approval by the Class A Stockholders,in order to increase the number of shares of Common Stock authorized for issuanceunder the ESPP by 500,000. Management Stock Purchase PlanThe Company maintains a Management Stock Purchase Plan(“MSPP”), which allows certain members of senior management to defer upto 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 thelowest closing price of the Common Stock on NASDAQ during the fiscal quarter inwhich such bonuses are payable and are converted into shares of Common Stock ona one-for-one basis at the end of the applicable deferral period. Effective June1, 2002, the MSPP was amended to increase the discount on the purchase of RSUs to25% from 15%. During fiscal 2003, 2002 and 2001, the Company allocated 62,071 RSUs,45,301 RSUs, and 27,330 RSUs to participants under the MSPP at a weighted averageprice of $25.22, $30.60 and $22.61 per RSU, resulting in an expense of $0.5, $0.2and $0.1, respectively. Effective December 18, 2002, the MSPP was amended to allowcertain additional management personnel to purchase RSU’s at a discountrateof 10%. 11. EMPLOYEE BENEFITPLANSThe Company has a cash balance retirement plan(the “PensionPlan”), which covers the majority of the U.S. employees who meet certain eligibilityrequirements. The Company funds all of the contributions for the Pension Plan. Benefitsgenerally are based on the Company’s contributions and interest credits allocatedto participants accounts based on years of benefit service and annual pensionableearnings. It is the Company’s policy to fund the minimum amount required bythe Employee Retirement Income Security Act (“ERISA”) of 1974, as amended. Scholastic Ltd., one of the Company’s wholly-ownedsubsidiaries, has a defined benefit pension plan (the “U.K. Pension Plan”)that covers United Kingdom employees who meet various eligibility requirements.Benefits are based on years of service and on a percentage of compensation nearretirement. The U.K. Pension Plan is funded by contributions from the U.K. subsidiaryand its employees.Grolier Ltd., the Company’s wholly-owned subsidiaryin Canada, provides a defined benefit pension plan (the “Grolier Canada PensionPlan”) that covers employees who meet certain eligibility requirements. Allfull time employees are eligible to participate in the plan after two years of employment.The Company’s contributions to the fund have been suspended due to an actuarialsurplus. Employees are not required to contribute to the fund.The Company provides certain Post-Retirement Benefits (the“U.S. Post-Retirement Benefits”) consisting of certain healthcare andlife insurance benefits provided to retired U.S. employees. A majority of the Company’sU.S. employees may become eligible for these benefits if they reach normal retirementage while working for the Company. In fiscal 2003, the Company amended the U.S.Post-Retirement Benefits by increasing the participants’ contribution rate.The impact of this amendment was to reduce the benefit obligation by $8.6. The balancewas recorded as unrecognized prior service cost and will be amortized over 14years. At May 31, 2003, the unrecognized prior service cost remaining is $8.1.48 The following table sets forth the change in benefit obligation and plan assets and reconciliation of funded status under the Pension Plan, the U.K. Pension Plan, the Grolier Canada Pension Plan and the U.S. Post-Retirement Benefits for the two fiscal years ended May 31: Pension Benefits Post-Retirement Benefits 2003 2002 2003 2002 Changein benefit obligation Benefitobligation at beginning of year $ 111.6 $ 103.4 $ 23.4 $ 18.3 Servicecost 5.9 4.7 0.5 0.4 Interestcost 7.7 7.4 1.8 1.3 Planparticipants’ contributions 0.6 0.6 — — Amendments 0.2 — (8.6)— Actuariallosses 11.8 4.2 13.9 5.1 Curtailmentloss — 0.2 — — Foreigncurrency exchange rate changes 2.3 (0.3)— — Benefitspaid (8.9)(8.6)(2.2)(1.7)Benefitobligation at end of year $ 131.2 $ 111.6 $ 28.8 $ 23.4 Changein plan assets Fairvalue of plan assets at beginning of year $ 87.3 $ 93.0 $ — $ — Actual(loss) on plan assets (2.3)(1.3)— — Companycontributions 11.0 4.5 — — Planparticipants’ contributions 0.4 0.4 — — Administrativeexpenses (0.8)(0.3)— — Foreigncurrency exchange rate changes 2.2 (0.4) — — Benefitspaid (8.9)(8.6)— — Fairvalue of plan assets at end of year $ 88.9 $ 87.3 $ — $ — Fundedstatus Underfundedstatus of the plans $ (42.3)$ (24.3)$ (28.8)$ (23.4) Unrecognizednet actuarial loss 54.0 30.6 18.9 6.0 Unrecognizedprior service cost (2.1)(2.6)(8.1)(0.2) Unrecognizednet asset obligation 0.4 0.5 — — Accruedbenefit asset/(liability) $ 10.0 $ 4.2 $ (18.0)$ (17.6)Amountsrecognized in the Consolidated Balance Sheets Prepaidbenefit cost $ 8.8 $ 3.3 $ — $ — Accruedbenefit liability (43.3)(21.9)(18.0)(17.6) Intangibleasset 0.1 — — — Accumulatedother comprehensive loss 43.2 21.8 — — Netamount recognized $ 8.8 $ 3.2 $ (18.0)$ (17.6)Weightedaverage assumptions Discountrate 6.0% 7.1% 6.0% 7.3% Compensationincrease factor 4.0% 4.1% — — The Company’s pension plans have different measurement datesas follows: for the Pension Plan—May 31, 2003; for the U.K. Pension Plan—March31, 2003; and for the Grolier Canada Pension Plan—December 31, 2002. Plan assetsconsist primarily of stocks, bonds, money market funds and U.S. government obligations.49 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: 2003 2002 Projectedbenefit obligations $ 124.9 $ 106.0 Accumulatedbenefit obligations 118.9 103.0 Fair value of plan assets 81.7 80.1 Projected weightedaverage return of plan assets 8.9%9.4% The following table sets forth the components of the net periodicbenefit costs under the Pension Plan, U.K. Pension Plan and Grolier Canada PensionPlan and the U.S. Post-Retirement Benefits for the three fiscal years ended May31: Pension Benefits Post-Retirement Benefits 2003 2002 2001 2003 2002 2001 Components of Net Periodic Benefit Cost: Service cost $ 5.9 $ 4.7 $ 5.1 $ 0.5 $ 0.4 $ 0.3 Interest cost 7.7 7.4 7.3 1.8 1.3 1.4 Expected return on assets (8.6 ) (8.8 ) (9.7 ) — — — Net amortization and deferrals 0.1 (0.2 ) 0.1 (0.6 ) — — Curtailment loss — 0.2 — — — — Recognized net actuarial loss/(gain) 1.2 0.5 (0.2 ) 1.0 — — Net periodic benefit cost $ 6.3 $ 3.8 $ 2.6 $ 2.7 $ 1.7 $ 1.7 The accumulated Post-Retirement benefit obligation was determinedusing a discount rate of 6.0%. Service cost and interest components were determinedusing a discount rate of 7.3%. The assumed health care cost trend rate was 10.0%,with an annual decline of 0.5% until the rate reaches its ultimate rate of 5% infiscal 2013. A decrease of 1.0% in the health care cost trend rate would resultin decreases of approximately $2.7 in the accumulated benefit obligation and $0.3in the annual net periodic post-retirement benefit cost. An increase of 1.0% inthe health care cost trend rate would result in increases of approximately $3.2in the accumulated benefit obligation and $0.3 in the annual net periodic post-retirementbenefit cost.The Company also provides defined contribution plans forcertain eligible employees. In the U.S., the Company sponsors a 401(k) plan andhas contributed $5.8, $4.7 and $4.0 for fiscal 2003, 2002 and 2001, respectively.For its internationally based employees, the expenses under these plans totaled$1.9, $1.4 and $1.2 for fiscal 2003, 2002, and 2001, respectively. 5012. EARNINGS PER SHAREThe following tablesets forth the computation of basic and diluted earnings per share for the threeyears ended May 31: (amountsin millions, except per share data) 2003 2002 2001 Netincome for basic earnings pershare $ 58.6 $ 93.5 $ 36.3 Dilutive effectof Debentures — 2.1 — Adjustednet income for diluted earningsper share $ 58.6 $ 95.6 $ 36.3 Weightedaverage Shares of ClassA Stock and Common Stock outstandingfor basic earnings pershare 39.1 36.7 34.7 Dilutive effect of Common Stock issued pursuantto employee stockplans 1.0 1.6 1.4 Dilutive effectof Debentures — 1.8 — Adjustedweighted average Shares ofClass A Stock and Common Stockoutstanding for diluted earningsper share 40.1 40.1 36.1 Earningsper Share of Class A Stock andCommon Stock: Earningsbefore Cumulative effect ofaccounting change: Basic $ 1.50 $ 2.69 $ 1.05 Diluted $ 1.46 $ 2.51 $ 1.01 Cumulativeeffect of accounting change(net of income taxes): Basic $ — $ (0.14)$ — Diluted $ — $ (0.13)$ — Net income: Basic $ 1.50 $ 2.55 $ 1.05 Diluted $ 1.46 $ 2.38 $ 1.01 For fiscal 2001, the effect of the potentialconversion of $110.0 of Scholastic Corporation’s 5% Convertible SubordinatedDebentures (the “Debentures”) into 2.9 million shares on Adjusted weightedaverage Shares of Class A Stock and Common Stock outstanding for diluted earningsper share was anti-dilutive and was not included in the calculation. On January11, 2002, pursuant to the exercise of Scholastic Corporation’s optional redemptionrights, $109.8 of the Debentures were converted at the option of the holders into2.9 million shares of Common Stock and $0.2 were redeemed for cash.13. CUMULATIVE EFFECT OF ACCOUNTING CHANGEOn June 1, 2001, the Company adopted Statement of PositionNo. 00-2 (“SOP 00-2”), “Accounting by Producers and Distributorsof Films,” which replaced SFAS No. 53, “Financial Reporting by Producersand Distributors of Motion Picture Films.” SOP 00-2 provides that film costsshould be accounted for under an inventory model and discusses various topics suchas revenue recognition and accounting for exploitation costs and impairment assessment.In addition, SOP 00-2 establishes criteria for which revenues should be includedin the Company’s ultimate revenue projections.TheCompany recognizes revenue from its film licensing arrangements when the filmis complete and delivered, the license period has begun,the fee is fixed or determinable and collection is reasonably assured. The costsof producing film and acquiring film distribution rights are capitalized andamortizedusing the individual-film-forecast method. This method amortizes such residualcosts in the same ratio that current period revenue bears to estimated remainingunrecognizedrevenue as of the beginning of the fiscal year. All exploitation costs are expensedas incurred. As a result of the adoption of SOP 00-2, the Company recorded anetof tax charge of $5.2 in the first quarter of fiscal 2002 to reduce the carryingvalue of its film production costs. This charge is reflected in the Company’sconsolidated statements of operations as a Cumulative effect of accounting changeand is attributed entirely to the Media, Licensing and Advertising segment.Management estimates that these costs will be amortized over the next three years.5114. COST OF GOODS SOLD — SPECIAL LITERACY PLACE AND OTHER CHARGESOn April 16, 2001, theCompany decided not to update Scholastic Literacy Place, its grade K to 6basal reading textbook program, for any future state adoptions. This decision resultedin a pre-tax charge in fiscal 2001 of $72.9. The impact of this charge on fiscal2001 earnings per diluted share was $1.20. The charge consisted of the followingrelated to Literacy Place and other exited programs: previously capitalized prepublicationcosts of $51.6, inventory write-offs of $19.8 and severance and other related costsof $1.5, of which $0.3 and $0.5 remained on the Consolidated Balance Sheets at May31, 2003 and 2002, respectively. 15. SPECIAL SEVERANCE CHARGEOn May 28, 2003, the Company announced a reduction in its global work force of approximately 400 positions, or 4%, the majority of which werescheduled to take effect in the first quarter of fiscal 2004. Severance and related costs related to the reduction in work force totaled $10.9, which is reflected inthe Company’s income statement as the Special severance charge. The following table sets forth total severance and relatedcosts, by segment: Amount Children’sBook Publishing and Distribution $ 2.4 EducationalPublishing 2.1 International 3.8 Media, Licensingand Advertising 1.0 Overhead 1.6 Totalseverance costs $ 10.9 A summary of the activity in the established liabilities is detailedin the following table: Amount Liabilitiesestablished $ 10.9 Fiscal 2003payments (1.2) Balanceat May 31, 2003 $ 9.7 The remaining liability of $9.7 represents payments in the form ofsalary continuance pursuant to severance agreements, which are expected to be paidover the next two fiscal years.16. LITIGATION AND OTHER CHARGESOn September 23, 2002, the Company announced that it hadagreed in principle to settle a class action lawsuit initiated in 1997, captioned In re Scholastic Corporation Securities Litigation, 97 Civ. 2447 (JFK). Thesettlement agreement resulted in a pre-tax charge in fiscal 2003 of $1.9, whichrepresents the portion of the total settlement amount of $7.5 that is not beingpaid by the insurance carrier.On July 30, 2002, the Company agreed in principle to settlea lawsuit filed in 1995 with Robert Harris and Harris Entertainment, Inc., forwhich the Company had established a $6.7 liability in the second quarter of fiscal2000. The case involved stock appreciation rights allegedly granted to Mr. Harrisby the Company in 1990 in connection with a joint venture formed primarily to producemotion pictures. The settlement agreement resulted in a fiscal 2002 pre-tax chargeof $1.2, which represents the amount by which the settlement and related legal expensesexceeded the previously recorded liability.17. OTHER INCOME (EXPENSE)On December 30, 2002, the Company sold a portion of itsinterest in a French publishing company for $5.2, resulting in a pre-tax gain of$2.9. The impact of this gain on fiscal 2003 earnings per diluted share was $0.05in fiscal 2003.In fiscal 2002, the Company wrote off an equity investmentof $2.0. The impact of this charge on earnings per diluted share was $0.03 in fiscal2002.5218. OTHER FINANCIAL DATADeferred promotion costswere $52.8 and $44.6 at May 31, 2003 and 2002, respectively. Promotion costs expensedwere $109.1, $94.5 and $94.7 for the fiscal years ended May 31, 2003, 2002 and 2001,respectively. Promotional expense consists of $99.9, $88.0 and $86.6 for direct-to-homecontinuity program promotions and $9.2, $6.5 and $8.1 for magazine advertising forfiscal 2003, 2002 and 2001, respectively.Other advertising expenses were $161.4, $164.2 and $179.9for the fiscal years ended May 31, 2003, 2002 and 2001, respectively.Thefinancial statement impact of write-downs of deferred promotion costs to net realizablevalue during the periods presented was not material.Accumulated amortization of prepublication costs was $76.3and $62.4 at May 31, 2003 and 2002, respectively. The Company amortized $47.5, $42.6and $54.8 for the fiscal years ended May 31, 2003, 2002 and 2001, respectively.Other accrued expenses include a reserve for unredeemedcredits issued in conjunction with the Company’s school-based book club andbook fair operations of $12.4 and $12.3 at May 31, 2003 and 2002, respectively.53Report of Independent Auditors 2ff7e9595c
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