We talk a lot about the virtues of free cash flow on Fool.com. But sometimes, words can take on a sort of meaning all their own, and those who use them (such as yours truly) forget what their original meaning was. It's worth taking a moment, every once in a while, to reconsider exactly what we're talking about here. The release of Scholastic Corp.'s (NASDAQ:SCHL) second-quarter earnings report yesterday provides an excellent incentive to do just this. If you'll skip over the headline numbers for just a second...
No? OK, real quick: Revenues declined 2% but profits increased 9%. Happy now?
Moving on then. Down at the very bottom of the earnings report, Scholastic goes into some detail on its free cash flow for the first half of fiscal 2005. The long and the short of which is that this company is bleeding cash all over the floor. In the first half of last fiscal year, Scholastic reported a mere $2.1 million in free cash flowing into its coffers. One year later, the company now confesses that even that free cash flow trickle has dried up, to be replaced by a torrent of net cash outflow -- negative $42.1 million worth. Egads!
That should come as quite a surprise to Fools -- again, such as yours truly -- who went into this earnings report thinking that Scholastic was a pretty profitable company, based on the numbers ascribed to it by Yahoo! (NASDAQ:YHOO) Finance: $168.5 million in trailing 12 months (TTM) free cash flow.
Which brings us to the question: What does free cash flow mean, really? The standard definition is that it's cash from operations (a line entry found on the cash flow statement) minus capital expenditures (found on the same statement, a few lines down). Using that definition, though, Scholastic had not $2.1 million in free cash flow in the first half of fiscal 2004, but $49.3 million. And for the first half of fiscal 2005, it had not negative $42.1 million, but positive $5.7 million. So what gives?
Quite simply, Scholastic knows its business better than we outsiders do. And it remembers the true meaning of free cash flow, aptly described by Fool alum Jeff Fischer as "money earned from operations that a business can actually put into its proverbial savings account after all is said and done." Money a business absolutely has to spend in order to keep the money coming in, then, is not free cash. For that reason, Scholastic deducts not just "capital expenditures", but other necessary expenses, including production costs and royalty payments, from its cash from operations in calculating its own interpretation of its free cash flow. The result is not at all a pretty picture, but it's more accurate, and so kudos are due to the company for not trying to hide the ugly numbers from potential investors.
For more Foolish reviews of Scholastic news, read:
- Hogwarts and All for Scholastic
- Scholastic Must Hit the Books
- Get Ready for Harry Potter VI
- Scholastic Stumbles
Fool contributor Rich Smith has no position in any company mentioned in this article.
