Attached files

file filename
EX-32.2 - CERTIFICATION PURSUANT TO SECTION 1350, BY CFO - SCHOOL SPECIALTY INCdex322.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 1350, CEO - SCHOOL SPECIALTY INCdex321.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302, BY CFO - SCHOOL SPECIALTY INCdex312.htm
EX-12.1 - STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - SCHOOL SPECIALTY INCdex121.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302, BY CEO - SCHOOL SPECIALTY INCdex311.htm
EXCEL - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCFinancial_Report.xls
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JULY 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM              TO             

Commission File Number: 000-24385

 

 

SCHOOL SPECIALTY, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Wisconsin   39-0971239

(State or Other Jurisdiction

of Incorporation)

 

(IRS Employer

Identification No.)

W6316 Design Drive

Greenville, Wisconsin 54942

(Address of Principal Executive Offices)

(Zip Code)

(920) 734-5712

(Registrant’s Telephone Number, including Area Code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x    No   ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

  

Outstanding at August 31, 2011

Common Stock, $0.001 par value    18,990,535

 

 

 


Table of Contents

SCHOOL SPECIALTY, INC.

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JULY 30, 2011

 

      Page
Number
 
PART I - FINANCIAL INFORMATION   
ITEM 1.    CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS   
  

Condensed Consolidated Balance Sheets at July 30, 2011, April 30, 2011 and July 24, 2010

     2   
  

Condensed Consolidated Statements of Operations for the Three Months Ended July 30, 2011 and July  24, 2010

     3   
  

Condensed Consolidated Statements of Cash Flows for the Three Months Ended July 30, 2011 and July  24, 2010

     4   
   Notes to Condensed Consolidated Financial Statements      5   
ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION      20   
ITEM 3.   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     26   
ITEM 4.   

CONTROLS AND PROCEDURES

     26   
PART II - OTHER INFORMATION   
ITEM 1.   

LEGAL PROCEEDINGS

     27   
ITEM 1A.   

RISK FACTORS

     27   
ITEM 6.   

EXHIBITS

     27   

 

-Index-


Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Unaudited Financial Statements

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In Thousands, Except Share Data)

 

     July 30,
2011
    April 30,
2011
    July 24,
2010
 

ASSETS

      

Current assets:

      

Cash and cash equivalents

   $ 3,927      $ 9,821      $ 8,586   

Accounts receivable, less allowance for doubtful accounts of $2,788, $1,951 and $3,178, respectively

     194,507        67,442        177,888   

Inventories

     121,526        111,266        126,828   

Deferred catalog costs

     11,206        16,639        10,268   

Prepaid expenses and other current assets

     15,584        14,516        16,115   

Deferred taxes

     1,875        —          9,866   
  

 

 

   

 

 

   

 

 

 

Total current assets

     348,625        219,684        349,551   

Property, plant and equipment, net

     62,268        65,571        64,672   

Goodwill

     129,091        129,390        126,786   

Intangible assets, net

     153,218        155,889        163,541   

Development costs and other

     36,063        36,383        33,134   

Deferred taxes long-term

     7,012        10,227        —     

Investment in unconsolidated affiliate

     20,380        20,400        28,299   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 756,657      $ 637,544      $ 765,983   
  

 

 

   

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

      

Current liabilities:

      

Current maturities - long-term debt

   $ 42,765      $ 98,243      $ 133,809   

Accounts payable

     125,554        85,639        126,169   

Accrued compensation

     8,903        7,972        10,764   

Deferred revenue

     4,348        3,600        5,466   

Accrued income taxes

     13,856        11,855        4,264   

Deferred taxes

     —          4,454        —     

Other accrued liabilities

     37,583        25,428        37,458   
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     233,009        237,191        317,930   

Long-term debt - less current maturities

     306,926        198,036        201,587   

Deferred taxes

     —          —          27,867   

Other liabilities

     688        688        1,423   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     540,623        435,915        548,807   
  

 

 

   

 

 

   

 

 

 

Commitments and contingencies

      

Shareholders’ equity:

      

Preferred stock, $0.001 par value per share, 1,000,000 shares authorized; none outstanding

     —          —          —     

Common stock, $0.001 par value per share, 150,000,000 shares authorized; 24,300,545, 24,290,345 and 24,290,345 shares issued, respectively

     24        24        24   

Capital paid-in excess of par value

     442,764        441,335        437,513   

Treasury stock, at cost - 5,420,210, 5,420,210 and 5,420,210 shares, respectively

     (186,637     (186,637     (186,637

Accumulated other comprehensive income

     25,818        26,390        21,113   

(Accumulated deficit)

     (65,935     (79,483     (54,837
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     216,034        201,629        217,176   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 756,657      $ 637,544      $ 765,983   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands, Except Per Share Amounts)

 

     For the Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Revenues

   $ 276,084      $ 252,984   

Cost of revenues

     164,808        144,912   
  

 

 

   

 

 

 

Gross profit

     111,276        108,072   

Selling, general and administrative expenses

     79,776        77,848   

Impairment charge

     —          411,390   
  

 

 

   

 

 

 

Operating income/(loss)

     31,500        (381,166

Other expense:

    

Interest expense

     7,912        8,130   

Expense associated with convertible debt exchange

     1,090        —     
  

 

 

   

 

 

 

Income/(loss) before provision for income taxes

     22,498        (389,296

Provision for (benefit from) income taxes

     8,928        (57,669
  

 

 

   

 

 

 

Income/(loss) before investment in unconsolidated affiliate

     13,570        (331,627
  

 

 

   

 

 

 

Equity in losses of investment in unconsolidated affiliate

     (20     —     
  

 

 

   

 

 

 

Net income/(loss)

   $ 13,550      $ (331,627
  

 

 

   

 

 

 

Weighted average shares outstanding:

    

Basic

     18,873        18,864   

Diluted

     18,925        18,864   

Net Income/(Loss) per Share:

    

Basic

   $ 0.72      $ (17.58

Diluted

   $ 0.72      $ (17.58

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

 

     For the Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Cash flows from operating activities:

    

Net income/(loss)

   $ 13,550      $ (331,627

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and intangible asset amortization expense

     7,218        6,988   

Amortization of development costs

     1,602        1,537   

Amortization of debt fees and other

     1,248        625   

Impairment charge

     —          411,390   

Equity in losses of investment in unconsolidated affiliate

     20        —     

Share-based compensation expense

     517        827   

Deferred taxes

     (3,728     (64,712

Expense associated with convertible debt exchange

     1,090        —     

Non-cash convertible debt interest expense

     2,453        3,436   

Changes in current assets and liabilities (net of assets acquired and liabilities assumed in business combinations):

    

Accounts receivable

     (127,066     (105,190

Inventories

     (10,259     (26,921

Deferred catalog costs

     5,433        3,325   

Prepaid expenses and other current assets

     (1,069     (259

Accounts payable

     39,793        77,721   

Accrued liabilities

     15,573        15,181   
  

 

 

   

 

 

 

Net cash used in operating activities

     (53,625     (7,679
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions to property, plant and equipment

     (1,265     (2,410

Investment in product development costs

     (1,954     (2,181
  

 

 

   

 

 

 

Net cash used in investing activities

     (3,219     (4,591
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from bank borrowings

     176,500        35,400   

Repayment of debt and capital leases

     (123,887     (35,579

Payment of debt fees and other

     (1,663     —     
  

 

 

   

 

 

 

Net cash provided by/(used in) financing activities

     50,950        (179
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (5,894     (12,449

Cash and cash equivalents, beginning of period

     9,821        21,035   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 3,927      $ 8,586   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Interest paid

   $ 5,001      $ 4,168   

Income taxes paid

   $ 10,687      $ 636   

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature unless otherwise noted) considered necessary for a fair presentation have been included. The balance sheet at April 30, 2011 has been derived from School Specialty, Inc.’s (“School Specialty” or the “Company”) audited financial statements for the fiscal year ended April 30, 2011. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2011.

NOTE 2 – INCOME TAXES

The Company files income tax returns with the U.S., various U.S. states, and foreign jurisdictions. The most significant tax return the Company files is with the U.S. The Company’s tax returns are no longer subject to examination by the U.S. for fiscal years before 2007. The Company has various state tax audits and appeals in process at any given time. It is not anticipated that any adjustments resulting from tax examinations or appeals would be material to the Company’s financial position or results of operations.

The balance of the Company’s liability for unrecognized income tax benefits, net of federal tax benefits, at July 30, 2011, April 30, 2011 and July 24, 2010, was $688, $688 and $1,423, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any material changes in the amount of unrecognized tax benefits within the next twelve months. The Company classifies accrued interest and penalties related to unrecognized tax benefits as income tax expense in its consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.

NOTE 3 – SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

Changes in condensed consolidated shareholders’ equity during the three months ended July 30, 2011 and July 24, 2010 were as follows:

 

Shareholders’ equity balance at April 30, 2011

   $ 201,629   

Net income

     13,550   

Share-based compensation expense

     517   

Convertible debt exchange

     938   

Income tax deficiency from stock options

     (28

Foreign currency translation adjustment

     (572
  

 

 

 

Shareholders’ equity balance at July 30, 2011

   $ 216,034   
  

 

 

 

Shareholders’ equity balance at April 24, 2010

   $ 551,188   

Net (loss)

     (331,627

Share-based compensation expense

     827   

Income tax deficiency from stock options

     (273

Foreign currency translation adjustment

     (2,939
  

 

 

 

Shareholders’ equity balance at July 24, 2010

   $ 217,176   
  

 

 

 

 

5


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

Comprehensive income/(loss) for the periods presented in the condensed consolidated statements of operations was as follows:

 

     For the Three Months Ended  
     July 30, 2011     July 24, 2010  

Net income/(loss)

   $ 13,550      $ (331,627

Foreign currency translation adjustment

     (572     (2,939
  

 

 

   

 

 

 

Total comprehensive income/(loss

   $ 12,978      $ (334,566
  

 

 

   

 

 

 

NOTE 4 – EARNINGS PER SHARE

Earnings Per Share

The following information presents the Company’s computations of basic earnings per share (“basic EPS”) and diluted earnings per share (“diluted EPS”) for the periods presented in the condensed consolidated statements of operations:

 

    Income/(Loss)
(Numerator)
    Shares
(Denominator)
    Per Share
Amount
 

Three months ended July 30, 2011:

     

Basic EPS

  $ 13,550        18,873      $ 0.72   
     

 

 

 

Effect of dilutive stock options

      —       

Effect of dilutive non-vested stock and restricted share units

      52     
 

 

 

   

 

 

   

Diluted EPS

  $ 13,550        18,925      $ 0.72   
 

 

 

   

 

 

   

 

 

 

Three months ended July 24, 2010:

     

Basic and diluted EPS

  $ (331,627     18,864      $ (17.58
 

 

 

   

 

 

   

 

 

 

The Company had additional stock options outstanding of 1,690 and 1,524 during the three months ended July 30, 2011 and July 24, 2010, respectively, that were not included in the computation of diluted EPS because they were anti-dilutive.

The remaining $42,500, 3.75% 2006 Debentures, had no current impact on the Company’s denominator for computing diluted EPS because conditions under which the debentures may be converted have not been satisfied. See Note 9.

The $157,500, 3.75% convertible subordinated debentures, had no current impact on the Company’s denominator for computing diluted EPS because conditions under which the debentures may be converted have not been satisfied. See Note 9.

NOTE 5 – SHARE-BASED COMPENSATION EXPENSE

Employee Stock Plans

The Company has three share-based employee compensation plans under which awards were outstanding as of July 30, 2011: the School Specialty, Inc. 1998 Stock Incentive Plan (the “1998 Plan”), the School Specialty, Inc. 2002 Stock Incentive Plan (the “2002 Plan”), and the School Specialty, Inc. 2008 Equity Incentive Plan (the “2008 Plan”). All plans have been approved by the Company’s shareholders. The purpose of the 1998 Plan, the 2002 Plan and the 2008 Plan is to provide directors, officers, key employees and consultants with additional incentives by increasing their ownership interests in the Company. No new

 

6


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

grants may be made under the 1998 Plan, which expired on June 8, 2008. Under the 2002 Plan, the maximum number of equity awards available for grant is 1,500 shares. Under the 2008 Plan, the maximum number of equity awards available for grant is 2,000 shares.

A summary of option activity during the three months ended July 30, 2011 follows:

 

     Options Outstanding      Options Exercisable  
     Options     Weighted-
Average
Exercise
Price
     Options      Weighted-
Average
Exercise
Price
 

Balance at April 30, 2011

     1,506      $ 29.29         988       $ 33.61   

Granted

     451        13.78         

Exercised

     —          —           

Canceled

     (32     24.44         
  

 

 

         

Balance at July 30, 2011

     1,925      $ 25.73         1,116       $ 32.25   
  

 

 

         

The following tables detail supplemental information regarding stock options outstanding at July 30, 2011:

 

     Weighted Average
Remaining
Contractual Term
     Aggregate
Instrinsic
Value
 

Options outstanding

     6.91       $ —     

Options vested and expected to vest

     6.81         —     

Options exercisable

     5.25         —     

 

     Options Outstanding      Options Exercisable  

Range of Exercise Prices

   Shares
Underlying
Options
     Weighted-
Average
Life
(Years)
     Weighted-
Average
Exercise
Price
     Shares
Underlying
Options
     Weighted-
Average
Exercise
Price
 

$13.41 - $19.04

     717         9.51       $ 15.64         66       $ 18.84   

$19.05 - $29.48

     397         5.99         22.33         263         23.08   

$29.49 - $36.01

     305         5.06         33.35         286         33.50   

$36.02 - $39.71

     506         5.07         38.10         501         38.12   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,925         6.91       $ 25.73         1,116       $ 32.25   
  

 

 

          

 

 

    

Options are generally exercisable beginning one year from the date of grant in cumulative yearly amounts of twenty-five percent of the shares granted and generally expire ten years from the date of grant. Options granted to directors and non-employee officers of the Company vest over a three year period, twenty percent after the first year, fifty percent (cumulative) after the second year and one hundred percent (cumulative) after the third year. The Company’s option plans allow for the net settlement of the exercise price and related employee tax withholding liabilities for non-qualified stock option exercises. For the three months ended July 30, 2011, no shares were issued upon the exercise of stock options.

During first quarter of fiscal 2011, the Company granted 77 non-vested stock unit (“NSU”) awards to members of the Company’s management under the 2002 Plan. There were no NSU awards granted to the Company’s management in the first quarter of fiscal 2012. The NSUs are performance-based and vest at the end of a three-year cycle and will result in an issuance of shares of the Company’s common stock if

 

7


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

targeted metrics are achieved at a threshold level or above. The NSUs will be settled in shares of Company common stock with actual shares awarded ranging from 80% of the target number of shares if performance is at the threshold level up to 200% of the target number of shares if performance is at or above the maximum level. The approximate fair value of awards granted during the three months ended July 24, 2010 was $1,468, assuming the metrics are achieved at the target level. The Company is recognizing share-based compensation expense related to performance-based NSU awards on a straight-line basis over the vesting period adjusted for changes in the expected level of performance. During the three months ended July 30, 2011 and July 24, 2010, the Company recognized $86 ($52 net of tax) and $209 ($128 net of tax) of expense related to performance-based NSU awards, respectively.

During the first quarters of fiscal 2012 and 2011, the Company granted 14 and 10 time-based NSU awards to non-employee directors of the Company with an approximate fair value of $194 and $194, respectively. The awards vest one year from the date of grant and the Company is recognizing share-based compensation expense related to time-based NSU awards on a straight-line basis over the vesting period. During the three months ended July 30, 2011 and July 24, 2010, the Company recognized $52 ($32 net of tax) and $37 ($23 net of tax) of expense related to time-based NSU awards, respectively.

During the first quarter of fiscal 2011, the Company awarded 118 time-based restricted stock units (“RSU”) to employees of the Company under the 2002 Plan. There were no RSU awards granted to the Company’s senior management or other employees in the first quarter of fiscal 2012. The RSUs awarded to senior management vest over a five-year period, thirty percent after the third year, sixty percent (cumulative) after the fourth year and one-hundred percent (cumulative) after the fifth year. The RSUs awarded to other employees vest over a four year period, thirty percent after the second year, sixty percent (cumulative) after the third year and one-hundred percent (cumulative) after the fourth year. The approximate fair value of the awards granted during the three months ended July 24, 2010 was $2,250. During the three months ended July 30, 2011 and July 24, 2010, the Company recognized $116 ($71 net of tax) and $27 ($11 net of tax) of expense related to time-based RSU awards, respectively.

During the three months ended July 30, 2011 and July 24, 2010, the Company recognized $517 ($263 related to stock options, $138 related to NSU awards and $116 related to RSU awards) and $827 ($554 related to stock options, $246 related to NSU awards and $27 related to RSU awards), respectively, in share-based compensation expense, which is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations. The income tax benefit recognized related to share-based compensation expense was $201 and $321 for the three months ended July 30, 2011 and July 24, 2010, respectively.

The Company recognizes share-based compensation expense ratably over the vesting period of each award along with cumulative adjustments for changes in the expected level of performance for performance-based awards. During the three months ended July 30, 2011 and July 24, 2010, total unrecognized share-based compensation expense related to stock options was $4,206 and $4,594, net of estimated forfeitures, total unrecognized share-based compensation expense related to NSUs was $432 and $2,130 and total unrecognized share-based compensation expense related to RSUs was $1,353 and $1,815, respectively. The Company expects to recognize this expense over a weighted average period of approximately 3.1 years.

 

8


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

The weighted average fair value of options granted during the three months ended July 30, 2011 and July 24, 2010 was $5.04 and $6.78, respectively. The fair value of options is estimated on the date of grant using the Black-Scholes single option pricing model with the following weighted average assumptions:

 

     For the Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Average-risk free interest rate

     2.11     2.00

Expected volatility

     35.96     34.97

Expected term

     5.5 years        5.5 years   
     For the Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Total intrinsic value of stock options exercised

   $ —        $ 61   

Cash received from stock option exercises

   $ —        $ 0   

Income tax deficiency from stock options

   $ (28   $ (273

NOTE 6 – GOODWILL AND OTHER INTANGIBLE ASSETS

The following tables present details of the Company’s intangible assets, excluding goodwill:

 

July 30, 2011

   Gross Value      Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

       

Customer relationships (10 to 17 years)

   $ 36,972       $ (21,218   $ 15,754   

Publishing rights (15 to 25 years)

     113,260         (30,200     83,060   

Non-compete agreements (3.5 to 10 years)

     5,481         (4,956     525   

Tradenames and trademarks (10 to 30 years)

     3,504         (1,089     2,415   

Order backlog and other (less than 1 to 13 years)

     2,284         (1,515     769   

Perpetual license agreements (10 years)

     14,506         (3,931     10,575   
  

 

 

    

 

 

   

 

 

 

Total amortizable intangible assets

     176,007         (62,909     113,098   
  

 

 

    

 

 

   

 

 

 

Non-amortizable intangible assets:

       

Tradenames and trademarks

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total non-amortizable intangible assets

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 216,127       $ (62,909   $ 153,218   
  

 

 

    

 

 

   

 

 

 

 

9


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

April 30, 2011

   Gross Value      Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

       

Customer relationships (10 to 17 years)

   $ 36,998       $ (20,631   $ 16,367   

Publishing rights (15 to 25 years)

     113,260         (28,797     84,463   

Non-compete agreements (3.5 to 10 years)

     7,110         (6,471     639   

Tradenames and trademarks (10 to 30 years)

     3,504         (1,041     2,463   

Order backlog and other (less than 1 to 13 years)

     2,634         (1,807     827   

Perpetual license agreements (10 years)

     14,506         (3,496     11,010   
  

 

 

    

 

 

   

 

 

 

Total amortizable intangible assets

     178,012         (62,243     115,769   
  

 

 

    

 

 

   

 

 

 

Non-amortizable intangible assets:

       

Tradenames and trademarks

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total non-amortizable intangible assets

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 218,132       $ (62,243   $ 155,889   
  

 

 

    

 

 

   

 

 

 

July 24, 2010

   Gross Value      Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

       

Customer relationships (10 to 17 years)

   $ 36,488       $ (18,691   $ 17,797   

Publishing rights (15 to 25 years)

     113,260         (24,608     88,652   

Non-compete agreements (3.5 to 10 years)

     7,110         (6,091     1,019   

Tradenames and trademarks (10 to 30 years)

     3,504         (898     2,606   

Order backlog and other (less than 1 to 13 years)

     2,634         (1,633     1,001   

Perpetual license agreements (10 years)

     14,506         (2,160     12,346   
  

 

 

    

 

 

   

 

 

 

Total amortizable intangible assets

     177,502         (54,081     123,421   
  

 

 

    

 

 

   

 

 

 

Non-amortizable intangible assets:

       

Tradenames and trademarks

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total non-amortizable intangible assets

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 217,622       $ (54,081   $ 163,541   
  

 

 

    

 

 

   

 

 

 

Intangible asset amortization expense included in selling, general and administrative expense for the three months ended July 30, 2011 and July 24, 2010 was $2,659 and $2,768, respectively.

Intangible asset amortization expense for each of the five succeeding fiscal years and the remainder of fiscal 2012 is estimated to be:

 

Fiscal 2012 (nine months remaining)

   $ 7,891   

Fiscal 2013

     9,959   

Fiscal 2014

     9,665   

Fiscal 2015

     9,448   

Fiscal 2016

     9,257   

Fiscal 2017

     8,503   

 

10


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

The following information presents changes to goodwill during the period beginning July 24, 2010 through July 30, 2011:

 

     Reporting Units            Reporting Units               
     Education
Resources
    Califone      Educational
Resources
Segment
    Science     Planning
and Student
Development
    Reading      Health      Accelerated
Learning
Segment
    Total  

Balance at July 24, 2010

                     

Goodwill

   $ 249,695      $ 14,852         264,547      $ 75,652      $ 180,303      $ 17,474       $ —           273,429        537,976   

Accumulated impairment losses

   $ (249,695   $ —           (249,695   $ (55,372   $ (106,123           (161,495     (411,190
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ —        $ 14,852       $ 14,852      $ 20,280      $ 74,180      $ 17,474       $ —         $ 111,934      $ 126,786   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Fiscal 2011 Activity:

                     

Currency translation adjustment

     —          —           —          —          2,604        —           —           2,604        2,604   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Balance at April 30, 2011

                     

Goodwill

   $ 249,695      $ 14,852         264,547      $ 75,652      $ 182,907      $ 17,474       $ —           276,033        540,580   

Accumulated impairment losses

   $ (249,695   $ —           (249,695   $ (55,372   $ (106,123   $ —         $ —           (161,495     (411,190
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ —        $ 14,852       $ 14,852      $ 20,280      $ 76,784      $ 17,474       $ —         $ 114,538      $ 129,390   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Fiscal 2012 Activity:

                     

Currency translation adjustment

     —          —           —          —          (299     —           —           (299     (299
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Balance at July 30, 2011

                     

Goodwill

   $ 249,695      $ 14,852         264,547      $ 75,652      $ 182,608      $ 17,474       $ —           275,734        540,281   

Accumulated impairment losses

   $ (249,695   $ —           (249,695   $ (55,372   $ (106,123   $ —         $ —           (161,495     (411,190
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ —        $ 14,852       $ 14,852      $ 20,280      $ 76,485      $ 17,474       $ —         $ 114,239      $ 129,091   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

In accordance with the accounting guidance on goodwill and other intangible assets, the Company performs its impairment test of goodwill at the reporting unit level and indefinite-lived intangible assets at the unit of account level during the first quarter of each fiscal year, or more frequently if events or circumstances change that would more likely than not reduce the fair value of its reporting units below their carrying values.

According to ASC Topic 350-20-20, a reporting unit is the level at which goodwill impairment is tested and can be an operating segment or one level below an operating segment, also known as a component. ASC Topic 350-20-35-34 states that a component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available for segment management to regularly review the operating results of that component. As of April 30, 2011, the Company had six reporting units, four of which had goodwill balances. The Educational Resources segment consists of the Education Resources and Califone reporting units. The Accelerated Learning segment consists of the Science, Planning and Student Development, Reading, and Health reporting units. The goodwill for each reporting unit is shown in the table above.

The accounting guidance requires a two-step method for determining goodwill impairment. In the first step, the Company determined the fair value of the reporting unit, generally by utilizing a combination of the income approach (weighted 90%) and the market approach (weighted 10%) derived from comparable public companies. The Company believes that each approach has its merits. However, in the instances where the Company has utilized both approaches, the Company has weighted the income approach more heavily than the market approach because the Company believes that management’s assumptions generally provide greater insight into the reporting unit’s fair value. This fair value determination was categorized as level 3 in the fair value hierarchy pursuant to FASB ASC Topic 820, “Fair Value Measurements and Disclosures”. The estimated fair value of the reporting units is dependent on several significant assumptions, including earnings projections and discount rates.

 

11


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

During the first quarter of fiscal 2012, the Company performed its annual goodwill and indefinite-lived intangible asset impairment test. The Company reviewed both its current market capitalization and future cash flow projections and concluded no evidence of impairment existed in both goodwill and indefinite-lived intangible assets.

In performing the impairment assessment, the Company estimated the fair value of its reporting units using the following valuation methods and assumptions:

 

  1. Income Approach (discounted cash flow analysis) – the discounted cash flow (“DCF”) valuation method requires an estimation of future cash flows of an entity and then discounting those cash flows to their present value using an appropriate discount rate. The discount rate selected should reflect the risks inherent in the projected cash flows. The key inputs and assumptions of the DCF method are the projected cash flows, the terminal value of the reporting units and the discount rate. The growth rates used for the terminal value calculations and the discount rates of the respective reporting units were as follows:

 

     May 1, 2011  
     Terminal Value
Growth Rates
    Discount
Rate
 

Education Resources

     2.0     12.4

Califone

     2.0     11.2

Science

     6.0     13.8

Planning and Student Development

     3.0     13.8

Reading

     2.0     14.7

Health

     2.0     13.8

 

  2. Market Approach (market multiples) – this method begins with the identification of a group of peer companies in the same or similar industries as the company reporting unit being valued. A valuation average multiple is then computed for the peer group based upon a valuation metric. The Company selected a ratio of enterprise value to projected earnings before interest, taxes, depreciation and amortization (“EBITDA”) and a ratio of enterprise value to projected revenue as appropriate valuation metrics. These two metrics were evenly weighted for the Education Resources, Reading, and Planning and Student Development reporting units. Various operating performance measurements of the reporting unit being valued are then benchmarked against the peer group and a discount rate or premium is applied to reflect favorable or unfavorable comparisons. The resulting multiple is then applied to the reporting unit being valued to arrive at an estimate of its fair value. A control premium is then applied to the equity value. The Company selected 7 companies that were deemed relevant to the Planning and Student Development and Reading reporting units and 5 companies that were deemed relevant to the Education Resources and Califone reporting units under the guideline public company method to provide an indication of value. A control premium was then applied to the enterprise value of the reporting unit. The control premium was established based on a review of transactions over an 18 month period. The resulting multiples and control premiums were as follows:

 

     May 1, 2011  
     EBITDA
Multiples
     Revenue
Multiples
     Control
Premium
 

Education Resources

     8.5x         0.4x         12.4

Califone

     6.5x         N/A         12.4

Reading

     7.1x         2.2x         17.4

Planning and Student Development

     6.4x         1.5x         17.4

 

12


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

The Company did not use the market approach for the Science reporting unit because of the variability in revenue due to the curriculum adoption schedule. The Company did not use the market approach for the Health reporting unit because of the lack of financial history.

Based upon the assessment of goodwill impairment performed in the first quarter of fiscal 2011, the Education Resources, Science and Planning and Student Development reporting units failed step one of the goodwill impairment test, requiring a step two analysis with respect to those reporting units. In step two, the Company allocated the fair value of the reporting units to all of the assets and liabilities of the reporting units, including any unrecognized intangible assets, in a hypothetical calculation to determine the implied fair value of the goodwill. The impairment charge, if any, is measured as the difference between the implied fair value of goodwill and its carrying value.

As a result of this analysis, $411,190 of goodwill was considered impaired during the first quarter of fiscal 2011. Assumptions utilized in the impairment analysis are subject to significant management judgment. Changes in estimates or the application of alternative assumptions could have produced significantly different results. As shown above in the table, the Education Resources reporting unit, which is part of the Educational Resources segment, and the Science and Planning and Student Development reporting units, which are part of the Accelerated Learning segment, were determined to have an impairment of their goodwill balance as of July 24, 2010.

The Company believes the first quarter is the appropriate quarter for conducting its assessment since the Company’s business is highly seasonal, with approximately 75% of its revenue and over 100% of its net income occurring in the first two quarters of the fiscal year. The Company has much better insight into the projected annual performance during the first quarter due to the timing of school budgets and ordering by schools and school districts. The fiscal 2011 impairment charge was due in part to the continued deterioration of school spending amid the continuation of state budget challenges and school spending cuts. During the first quarter of fiscal 2011, the Company experienced a significant decline in actual revenue of 23.4% and operating income of 44.6% prior to the impact of the impairment charge. Additionally, the Company experienced a decline in its market capitalization beginning in fiscal 2009 and which continued into the first quarter of fiscal 2011. As of April 24, 2010, the Company’s market capitalization was $463,538, compared to the Company’s book value of $551,188 on that date. As of the end of the first quarter ended July 24, 2010, the Company’s market capitalization had decreased by an additional $109,461 to $354,077.

The Company also performed an impairment test of its indefinite-lived intangible assets during the first quarter of fiscal 2011, and concluded that a $200 impairment charge related to a non-amortizable trademark in the Educational Resources segment was necessary. The following table presents a summary of the carrying value of indefinite-lived intangible assets:

 

     Educational
Resources
    Accelerated
Learning
     Total  

Tradenames

   $ —        $ 38,890       $ 38,890   

Trademarks

     1,430        —           1,430   

Impairment loss

     (200     —           (200
  

 

 

   

 

 

    

 

 

 

Balance at July 24, 2010:

   $ 1,230      $ 38,890       $ 40,120   
  

 

 

   

 

 

    

 

 

 

 

13


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

NOTE 7 – INVESTMENT IN UNCONSOLIDATED AFFILIATE

The investment in unconsolidated affiliate is accounted for under the equity method, and consisted of the following as of July 30, 2011:

 

     Percent-
Owned
    July 30, 2011      April 30, 2011      July 24, 2010  

Carson- Dellosa Publishing, LLC

     35   $ 20,380       $ 20,400       $ 28,299   

On November 13, 2009, the Company completed the divestiture of the School Specialty Publishing business unit to Carson-Dellosa Publishing, LLC, a newly-formed business entity. Under the divestiture agreement, the Company combined its publishing unit net assets with those of Cookie Jar Education, Inc. and received a 35% interest, accounted for under the equity method, in Carson-Dellosa Publishing. The fair value of the Company’s total contribution was $29,438, including cash of $2,226, which was materially consistent with the book value of the Company net assets contributed. For the first quarter ended July 30, 2011, the Company recorded a pre-tax loss of $20 resulting from its 35% minority equity interest in Carson-Dellosa Publishing, LLC.

The investment amount represents the Company’s maximum exposure to loss as a result of the Company’s ownership interest. Losses are reflected in “Equity in losses of investment in unconsolidated affiliate” on the condensed consolidated statement of operations.

NOTE 8 – PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

 

     July 30,
2011
    April 30,
2011
    July 24,
2010
 

Land

   $ 158      $ 158      $ 158   

Projects in progress

     6,956        10,326        3,980   

Buildings and leasehold improvements

     29,908        29,867        29,828   

Furniture, fixtures and other

     94,869        90,503        109,879   

Machinery and warehouse equipment

     39,476        39,463        39,486   
  

 

 

   

 

 

   

 

 

 

Total property, plant and equipment

     171,367        170,317        183,331   

Less: Accumulated depreciation

     (109,099     (104,746     (118,659
  

 

 

   

 

 

   

 

 

 

Net property, plant and equipment

   $ 62,268      $ 65,571      $ 64,672   
  

 

 

   

 

 

   

 

 

 

Depreciation expense for the three months ended July 30, 2011 and July 24, 2010 was $4,559 and $4,220, respectively.

NOTE 9 – DEBT

Credit Agreement

On April 23, 2010, the Company entered into a Credit Agreement which replaced the Company’s previous Amended and Restated Credit Agreement dated as of February 1, 2006. The second amendment to the Credit Agreement provided the Company the availability to exchange at least $50,000 in aggregate principal amount of the Company’s 2006 Debentures and provided that the delay draw term commitments will be permanently reduced by the amount of the 2006 Debentures so exchanged. The amended Credit Agreement matures on April 23, 2014 and provides borrowing capacity of $242,500. This capacity consists of a revolving loan of $175,000 and a delayed draw term loan of up to $67,500, which can be used to refinance a portion of the Company’s convertible notes. To the extent a lesser amount than $67,500 is used on the delay draw term loan, the Company can elect to increase the revolving portion of the facility by the difference.

 

14


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

Interest on borrowings under the Credit Agreement accrues at a rate of, at the Company’s option, either a Eurodollar rate plus an applicable margin of up to 4.50%, or the lender’s base rate plus an applicable margin of up to 3.50%. The Company also pays a commitment fee on the revolving loan of up to 0.50% on unborrowed funds. The effective interest rate under the credit facility for the first quarter of fiscal 2012 was 6.22%, which includes amortization of loan origination fees of $368 and commitment fees on unborrowed funds of $175. The revolving loan provides for a letter of credit sub-facility of up to $15,000, under which $2,695 was issued and outstanding as of July 30, 2011. As of July 30, 2011, the outstanding balance on the revolving loan of $144,000 was reflected as non-currently maturing, long-term debt in the accompanying consolidated balance sheets. The Credit Agreement is secured by substantially all of the assets of the Company and contained certain financial covenants, including a consolidated total and senior leverage ratio, which are waived for the first and second quarter of fiscal 2012, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures. A minimum Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) financial covenant is in effect for the first and second quarters of fiscal 2012. The Company was in compliance with financial covenants as of July 30, 2011.

The Company closely evaluates its expected ability to remain in compliance with the consolidated total leverage ratio, interest coverage ratio and minimum EBITDA due to the ratios’ sensitivity to the Company’s financial results. The recent economic trends impacting the Company’s performance, such as the decline in school funding which led to a decrease in the Company’s revenue and margins, have put pressure on the Company’s ability to remain in compliance with these ratios. Based on current forecasts reflected in the Company’s most recent guidance, the Company expects to maintain compliance with these financial covenants during fiscal 2012. If the Company was unable to maintain compliance with these covenants, the Company would work with its lenders to secure a waiver or amend such ratios in the near future. Any amendment or waiver would result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings.

Convertible Notes

FASB ASC Topic 470-20 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the market interest rate at debt issuance without the conversion feature. The Company had three convertible debt instruments outstanding during portions of fiscal 2011 and 2012 that are subject to FASB ASC Topic 470-20. The standard requires that a fair value be assigned to the equity conversion option of (1) the Company’s $133,000, 3.75% convertible subordinated notes due 2023 (the “2003 Notes”), which were issued on July 14, 2003 and no longer outstanding as of the second quarter of fiscal 2011; (2) the Company’s $200,000, 2006 Debentures issued November 22, 2006 (of which $42,500 in aggregate principal amount are currently outstanding); (3) the Company’s $100,000, 2011 Debentures, which were issued on March 1, 2011; and (4) the additional $57,500, 2011 Debentures, which were issued on July 7, 2011 (collectively, the “Convertible Notes”). This change results in a corresponding decrease in the value assigned to the carrying value of the debt portion of the instruments.

The values assigned to the debt portions of the Convertible Notes were determined based on market interest rates for similar debt instruments without the conversion feature as of the respective July 14, 2003, November 22, 2006, March 1, 2011 and July 7, 2011, issuance dates of the Convertible Notes. The difference in market interest rates versus the coupon rates on the Convertible Notes results in non-cash interest that is amortized into interest expense over the expected terms of the Convertible Notes. For purposes of the valuation, the Company used an expected term of seven years for the Convertible Notes issued on July 14, 2003, an expected term of five years for the Convertible Notes issued on November 22, 2006 and an expected term of four years for the Convertible Notes issued March 1, 2011 and July 7, 2011, which corresponds with the date the holders of the respective Convertible Notes originally could put their Convertible Notes back to the Company.

 

15


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

The put date occurred on July 30, 2010 for the 2003 Notes. All of the 2003 Notes were repaid during the second quarter of fiscal 2011 using proceeds from the Credit Agreement. The put date will occur on November 30, 2011 for the 2006 Debentures and the put date will occur on November 30, 2014 for the 2011 Debentures.

During 2003, the Company sold an aggregate principal amount of $133,000 of convertible subordinated notes due in 2023. The Company used the total net proceeds from the offering of $128,999 to repay a portion of the debt outstanding under the Company’s credit facility. All of the notes were repaid during the second quarter of fiscal 2011 using proceeds from the Credit Agreement. The notes carried an annual coupon interest rate of 3.75% until August 1, 2010, at which time the notes provided that they would cease bearing interest and the original principal amount of each note would commence increasing daily by the annual rate of 3.75%. The notes became convertible into shares of the Company’s common stock at an initial conversion price of $40.00 per share during fiscal 2006 and were recorded as a current liability. Holders of the notes were entitled to surrender the notes for conversion at any time from October 1, 2005 until July 31, 2023. Holders that exercised their right to convert the notes would have received up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, in shares of Company common stock or cash, at the Company’s discretion. No notes were converted into shares of common stock.

On November 22, 2006, the Company issued $200,000 in aggregate principal amount of the 2006 Debentures, of which $42,500 remain outstanding as of July 30, 2011. The 2006 Debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted or the Company’s total conversion obligation, and will deliver, at its option, cash or shares of its common stock in respect of the remainder, if any, of its conversion obligation. The initial conversion rate is .0194574 shares per $1 principal amount of debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Company’s option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require the Company to repurchase all or some of the debentures.

 

16


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

On March 1, 2011 and July 7, 2011, the Company entered into separate, privately negotiated exchange agreements under which it retired $100,000 and $57,500, respectively, in aggregate principal of the then outstanding 2006 Debentures in exchange for the issuance of $100,000 and $57,500, respectively, in aggregate principal of the 2011 Debentures. The 2011 Debentures will pay interest semi-annually at a rate of 3.75% per year in respect of each $1,000 original principal amount of 2011 Debentures (the “Original Principal Amount”) on each May 30th and November 30th, and the principal will accrete on the principal amount of the 2011 Debentures (including the Original Principal Amount) at a rate of 3.9755% per year, compounding on a semi-annual basis (such principal amount, including any accretions thereon, the “Accreted Principal Amount”). The 2011 Debentures will be convertible, at the option of the Company, into cash or a combination of cash and shares of Company common stock, par value $.001 per share (“Company Common Stock”), upon satisfaction of certain conditions set forth below. The initial conversion rate is 44.2087 shares for each $1,000 of Original Principal Amount (subject to adjustment in certain events), which represents an initial conversion price of approximately $22.62 per share. However, the Company will not issue any shares of Company common stock pursuant to the 2011 Debentures if, after giving effect to such issuance, the aggregate number of shares issued pursuant to the 2011 Debentures would exceed 19.99% of the number of shares of Company Common Stock outstanding as of March 1, 2011, unless the Company first receives the approval of the Company’s shareholders, which the Company has no obligation to seek. The 2011 Debentures will mature on November 30, 2026, unless earlier redeemed, repurchased or converted. Holders of the 2011 Debentures have the option to require the Company to purchase the 2011 Debentures outstanding on November 30, 2014, November 30, 2018 and November 30, 2022 at a price equal to 100% of the Accreted Principal Amount of the 2011 Debentures delivered for repurchase plus any accrued and unpaid interest on the Original Principal Amount of the 2011 Debentures delivered for repurchase. The Company has the right to redeem the 2011 Debentures beginning May 30, 2014 at a price equal to 100% of the Accreted Principal Amount of the 2011 Debentures to be redeemed plus any accrued but unpaid interest on the Original Principal Amount of the 2011 Debentures redeemed.

The estimated fair value of the Company’s $42,500, $100,000 and $57,500 convertible subordinated notes at July 30, 2011 was approximately $42,075, $100,780 and $57,949, respectively and the carrying value was $41,849, $95,368 and $55,124, respectively. The estimated fair value was determined using Level 2 inputs as described in FASB ASC Topic 820, “Fair Value Measurements and Disclosures”.

NOTE 10 – SEGMENT INFORMATION

The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Company’s Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company has determined that it operates in two operating segments, Educational Resources and Accelerated Learning, which also constitute its reportable segments. The Company operates principally in the United States, with limited operations in Canada. The Educational Resources segment offers products that include basic classroom supplies and office products, supplemental learning materials, physical education equipment, classroom technology, and furniture. The Accelerated Learning segment is a PreK-12 curriculum-based publisher of proprietary and non-proprietary products in the categories of science, reading and literacy, coordinated school health, and planning and student development. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies as included in the Company’s Form 10-K dated April 30, 2011. Intercompany eliminations represent intercompany sales primarily from our Accelerated Learning segment to our Educational Resources segment, and the resulting profit recognized on such intercompany sales.

 

17


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

 

     Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Revenues:

    

Educational Resources

   $ 186,064      $ 175,418   

Accelerated Learning

     89,853        77,399   

Corporate and intercompany eliminations

     167        167   
  

 

 

   

 

 

 

Total

   $ 276,084      $ 252,984   
  

 

 

   

 

 

 

Operating income (loss) and income (loss) before taxes:

    

Educational Resources

   $ 16,164      $ (230,494

Accelerated Learning

     25,693        (140,868

Corporate and intercompany eliminations

     (10,357     (9,804
  

 

 

   

 

 

 

Operating income (loss)

     31,500        (381,166

Interest expense and other

     9,002        8,130   
  

 

 

   

 

 

 

Income (loss) before provision for income taxes

   $ 22,498      $ (389,296
  

 

 

   

 

 

 
     July 30,
2011
    July 24,
2010
 

Identifiable assets (as of quarter end):

    

Educational Resources

   $ 253,756      $ 251,737   

Accelerated Learning

     403,809        400,480   

Corporate assets

     99,092        113,766   
  

 

 

   

 

 

 

Total

   $ 756,657      $ 765,983   
  

 

 

   

 

 

 
     Three Months Ended  
     July 30,
2011
    July 24,
2010
 

Depreciation and amortization of intangible assets and development costs:

    

Educational Resources

   $ 1,607      $ 1,772   

Accelerated Learning

     4,079        4,028   

Corporate

     3,134        2,725   
  

 

 

   

 

 

 

Total

   $ 8,820      $ 8,525   
  

 

 

   

 

 

 

Expenditures for property, plant and equipment, intangible and other assets and development costs:

    

Educational Resources

   $ 192      $ 349   

Accelerated Learning

     2,262        2,726   

Corporate

     765        1,516   
  

 

 

   

 

 

 

Total

   $ 3,219      $ 4,591   
  

 

 

   

 

 

 

NOTE 11 – COMMITMENTS AND CONTINGENCIES

Various claims and proceedings arising in the normal course of business are pending against the Company. The results of these matters are not expected to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

18


Table of Contents

The Company determined, based on an ongoing state tax audit, that the Delta Education, LLC (“Delta”) subsidiary had a liability to the state that survived the Company’s acquisition of Delta in fiscal 2006. The Company has estimated the potential exposure for this liability, including interest and net of federal tax benefit, to be a range of $2,300 to $7,600, depending upon the resolution of certain outstanding issues related to the liability. The Company’s best estimate of this liability is $4,000. The final determination of the amount of the liability due is not expected to be finalized until later in fiscal 2012, or thereafter. The Company is continuing to negotiate with the state, and it may have claims against various third parties to recover some or all of the amount of the liability.

 

19


Table of Contents

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Quarterly Overview

School Specialty, (the “Company”), is an education company that provides innovative and proprietary products, programs, and services to help educators engage and inspire students of all ages and abilities to learn. Through each of our leading brands, we design, develop, and provide preK-12 educators with the latest and very best curriculum, supplemental learning resources and classroom basics. Working in collaboration with educators, we reach beyond the scope of textbooks to help teachers, guidance counselors, and school administrators ensure that every student reaches his or her full potential.

Our business is subject to seasonal fluctuations. Our historical revenues and profitability have been dramatically higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Due to variations in the timing of shipments within this season primarily as a result of changes or delays in the finalization of state education budgets, the Company views a year-over-year comparison of the first six months of the fiscal year to be a more meaningful analysis than year-over-year comparative results for quarterly periods on an individual basis.

The six month comparison is especially important in comparing results of fiscal 2012 to the results of fiscal 2011. This is due to the fact that one of the Company’s largest shipping weeks, the last week of calendar July, fell within the second quarter of fiscal 2011. However, due to the 53 week 2011 fiscal year, the calendar weeks of fiscal 2012 have shifted such that the last week of calendar July is included within fiscal 2012’s first quarter. This “shift in weeks” for our seasonal business resulted in higher revenue in the first quarter, due to timing, at the expense of second quarter revenue. Total revenue for the full back to school season (first six months of the fiscal year) will be comparable. The shift in weeks only impacts revenue and gross profit, but does not have a significant impact on selling, general and administrative (“SG&A”) expenses, other than the variable costs within SG&A.

During the first quarter of fiscal 2012, consolidated revenues increased 9.1% over the first quarter of fiscal 2011. The Educational Resources segment and the Accelerated Learning segment had revenue increases in the quarter of 6.1% and 16.1%, respectively. The aforementioned shift in weeks accounted for approximately $18 million of additional revenue in the first quarter of fiscal 2012 compared to the first quarter of fiscal 2011. Adjusting for the shift in weeks, revenue grew approximately 1.7% over the first quarter of fiscal 2011. Gross margin was 40.3% for the first quarter of fiscal 2012, down 240 basis points from the comparable quarter last year. This decline is related primarily to competitive pricing pressures and cost increases within the Educational Resources segment and customer incentives and product mix within the Accelerated Learning segment.

SG&A decreased as a percentage of revenues to 28.9% in the first quarter of fiscal 2012 as compared to 30.8% in the first quarter of fiscal 2011. The decrease in SG&A as a percentage of revenue is due to staffing reductions within the Company. Total permanent headcount is down approximately 5 percent in the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011. Total SG&A increased by $2.0 million in the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011. The increase in SG&A is due to an increase in variable costs, such as transportation, warehouse and selling, associated with the increase in revenue.

Operating income was $31.5 million for the first quarter of fiscal 2012, an increase of $412.7 million from the prior year quarter which included a $411.4 million goodwill and other intangibles asset impairment charge. Net income was $13.6 million in the first quarter of fiscal 2012, an increase of $345.2 million from the prior year quarter.

 

20


Table of Contents

Results of Continuing Operations

The following table sets forth various items as a percentage of revenues on a historical basis concerning the Company’s results of operations for the three months ended July 30, 2011 and July 24, 2010:

 

     Three Months Ended  
     July 30, 2011     July 24, 2010  

Revenues

     100.0     100.0

Cost of revenues

     59.7        57.3   
  

 

 

   

 

 

 

Gross profit

     40.3        42.7   

Selling, general and administrative expenses

     28.9        30.8   

Impairment Charge

     —          162.6   
  

 

 

   

 

 

 

Operating income/(loss)

     11.4        (150.7

Interest expense, net

     2.9        3.2   

Expense associated with convertible debt exchange

     0.4        —     
  

 

 

   

 

 

 

Income/(loss) before provision for income taxes

     8.1        (153.9

Provision for (benefit from) income taxes

     3.2        (22.8
  

 

 

   

 

 

 

Earnings/(loss) from continuing operations

     4.9     (131.1 )% 
  

 

 

   

 

 

 

Three Months Ended July 30, 2011 Compared to Three Months Ended July 24, 2010

Revenues

Revenues increased 9.1% from $253.0 million for the three months ended July 24, 2010 to $276.1 million for the three months ended July 30, 2011.

Educational Resources segment revenues increased 6.1% from $175.4 million for the three months ended July 24, 2010 to $186.1 million for the three months ended July 30, 2011. Both periods are comprised solely of sales to external parties. Approximately $9 million of the total segment revenue increase was timing between the first and second quarter as one of the Company’s historically strongest shipping weeks, the last week of calendar July, fell in this year’s first quarter versus the second quarter of fiscal 2011. Excluding the shift in weeks, revenue increased approximately $2 million as compared to the first quarter of fiscal 2011. Based on the segments order rate trends during the first quarter, the Company believes the prior fiscal year to be the low point of education funding and demand and that school spending may have stabilized.

Accelerated Learning segment revenues increased 16.1% from $77.4 million for the three months ended July 24, 2010 to $89.9 million for the three months ended July 30, 2011. Both periods are comprised solely of sales to external parties. The aforementioned shift in weeks in fiscal 2012 accounted for approximately $10 million of the total segment revenue increase. Excluding the shift in weeks, revenue increased approximately $3 million as compared to the first quarter of fiscal 2011. The Company’s Science unit accounted for the increase in revenue in the first quarter of fiscal 2012 as compared to fiscal 2011 on stronger open territory sales of the Foss science curriculum.

Gross Profit

Gross profit increased 3.0% from $108.1 million for the three months ended July 24, 2010 to $111.3 million for the three months ended July 30, 2011. The increase in consolidated revenue accounted for the $3.2 million increase in gross profit. Gross margin declined 240 basis points from 42.7% for the three months ended July 24, 2010 to 40.3% for the three months ended July 30, 2011. Competitive pricing pressures, customer incentives and cost increases accounted for the decline in gross margin in the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011. Partially offsetting the gross margin decline was a shift in product mix between the Company’s segments. This shift contributed approximately 40 basis points of additional gross margin. The Accelerated Learning segment generates higher gross margin due to its curriculum-based products than the Educational Resources segment and accounted for 32.5% of the consolidated revenue in the first quarter of fiscal 2012 compared to 30.6% of the consolidated revenue in the first quarter of fiscal 2011.

Educational Resources segment gross profit decreased $1.7 million from $62.1 million for the three months ended July 24, 2010 to $60.4 million for the three months ended July 30, 2011. Gross margin decreased by 290 basis points from 35.4% in the first quarter of fiscal 2011 to 32.5% in the first quarter of fiscal 2012. Approximately 100

 

21


Table of Contents

basis points of the decline was related to price discounting in response to competitive pressures. Higher freight costs attributable to fuel prices and substitutions of higher cost domestic products to meet an increase in demand of products typically sourced overseas reduced gross margin by 85 basis points. The remaining difference in gross margin is related to inflationary cost pressures and mix. The Company expects the gross margin rate of decline to lessen in the second quarter.

Accelerated Learning segment gross profit increased $4.9 million from $45.3 million for the three months ended July 24, 2010 to $50.2 million for the three months ended July 30, 2011. Gross margin decreased by 270 basis points from 58.5% in the first quarter of fiscal 2011 to 55.8% in the first quarter of fiscal 2012 due to increased customer incentives within the agendas business and the mix of products within the agenda and reading business.

Selling, General and Administrative Expenses

SG&A includes selling expenses, the most significant of which are sales wages and commissions; operations expenses, which includes customer service, warehouse and out-bound freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal and human resources; and depreciation and intangible asset amortization expense.

SG&A increased $2.0 million from $77.8 million in the first quarter of fiscal 2011 to $79.8 million in the first quarter of fiscal 2012. As a percent of revenue, SG&A decreased from 30.8% for the three months ended July 24, 2010 to 28.9% for the three months ended July 30, 2011. SG&A attributable to the Educational Resources and Accelerated Learning segments increased a combined $1.4 million and Corporate SG&A increased $0.6 million in the first quarter as compared to last year’s first quarter. The increase in Corporate SG&A was related primarily to incremental depreciation related to the Company’s investment in information technology over the past years.

Educational Resources segment SG&A increased $1.6 million, or 3.8%, from $42.7 million for the three months ended July 24, 2010 to $44.3 million for the three months ended July 30, 2011. Approximately $1 million of the increase was due to variable costs such as transportation, warehousing, and selling expenses associated with increased revenues. In addition, the segment had an increase of $2.1 million in its marketing costs primarily associated with an increase in catalog circulation. These increases were partially offset by severance and other related charges incurred in the first quarter of fiscal 2011. Educational Resources segment SG&A decreased as a percent of revenues from 24.3% for the three months ended July 24, 2010 to 23.8% for the three months ended July 30, 2011. The reduction in SG&A as a percent of revenue is reflective of the impact of the leverage in fixed SG&A costs from revenue increases.

Accelerated Learning segment SG&A decreased $0.2 million, or 0.8%, from $24.7 million for the three months ended July 24, 2010 to $24.5 million for the three months ended July 30, 2011. Accelerated Learning segment SG&A decreased as a percent of revenues from 31.9% for the three months ended July 24, 2010 to 27.2% for the three months ended July 30, 2011. The reduction in SG&A as a percent of revenue reflects the impact of the leverage in fixed SG&A costs from revenue increases.

Impairment

In the first quarter of fiscal 2011, the Company recorded $411.4 million of impairment charges pursuant to its goodwill and indefinite-lived intangible asset impairment assessment. The goodwill impairment charge was $411.2 million, which consisted of $249.7 million, $55.4 million and $106.1 million for the Education Resources, Science and Planning and Student Development reporting units, respectively. An impairment of $0.2 million was related to an indefinite-lived tradename intangible. There were no impairment charges based on the Company’s goodwill assessment in the first quarter of fiscal 2012.

Interest Expense

Net interest expense decreased $0.2 million from $8.1 million for the three months ended July 24, 2010 to $7.9 million for the three months ended July 30, 2011. Approximately $0.9 million of the decrease in interest expense was related to the non-cash interest expense associated with the Company’s convertible notes. This was partially offset by an increase in the amortization of debt fees which was attributable to debt restructuring.

 

22


Table of Contents

Provision for (Benefit from) Income Taxes

The provision for income taxes was $9.2 million in the first quarter of fiscal 2012 compared to a benefit for income taxes of $57.7 million for the first quarter of fiscal 2011. The effective tax rate in the first quarter of fiscal 2012 was 39.8% compared to 14.8% for the first quarter of fiscal 2011. The prior year income tax benefit includes $66.5 million of income tax benefit related to the $411.4 million goodwill and non-amortizable intangible asset impairment. Due to the significant impact the impairment charge had on the prior year’s quarter effective rate, the Company believes the tax benefit and the effective tax rate excluding the $411.4 million impairment charge are more meaningful comparisons to fiscal 2012. Excluding the impairment impact, the tax provision in the first quarter of fiscal 2011 was $8.8 million as compared with $9.2 million in the first quarter of fiscal 2012. The increase is related to an increase in earnings before tax. Excluding impairment, the effective tax rate was 39.8% in the first quarter of fiscal 2011 and the first quarter of fiscal 2012.

Liquidity and Capital Resources

At July 30, 2011, we had working capital of $115.6 million. Our capitalization at July 30, 2011 was $565.7 million and consisted of total debt of $349.7 million and shareholders’ equity of $216.0 million.

On April 23, 2010, the Company entered into a Credit Agreement which replaced the Company’s previous Amended and Restated Credit Agreement dated as of February 1, 2006. During both the fourth quarter of fiscal 2011 and the first quarter of fiscal 2012, the Company amended the Credit Agreement. The amended Credit Agreement matures on April 23, 2014 and provides borrowing capacity of $242.5 million. This capacity consists of a revolving loan of $175 million and a delayed draw term loan of up to $67.5 million, which can be used to refinance a portion of the Company’s convertible notes. To the extent a lesser amount than $67.5 million is used on the delay draw term loan, the Company can elect to increase the revolving portion of the facility by the difference. Interest accrues at a rate of, at the Company’s option, either a Eurodollar rate plus an applicable margin of up to 4.50%, or the lender’s base rate plus an applicable margin of up to 3.50%. The Company also pays a commitment fee on the revolving loan of up to 0.50% on unborrowed funds. The effective interest rate under the credit facility for the first quarter of fiscal 2012 was 6.22%, which includes amortization of loan origination fees of $0.4 million and commitment fees on unborrowed funds of $0.2 million. The revolving loan provides for a letter of credit sub-facility of up to $15 million, under which $2.7 million was issued and outstanding as of July 30, 2011. As of July 30, 2011, the outstanding balance on the revolving loan of $144 million was reflected as non-currently maturing, long-term debt in the accompanying condensed consolidated balance sheets. The Credit Agreement is secured by substantially all of the assets of the Company and contained certain financial covenants, including a consolidated total and senior leverage ratio, which are waived for the first and second quarter of fiscal 2012, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures. For the first and second quarter of fiscal 2012, a minimum Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) is required. The Company was in compliance with the minimum EBITDA requirement as of July 30, 2011.

The Company closely evaluates its expected ability to remain in compliance with the consolidated total leverage ratio, interest coverage ratio and minimum EBITDA due to the ratios’ sensitivity to the Company’s financial results. The recent economic trends impacting the Company’s performance, such as the decline in school funding which led to a decrease in the Company’s revenue and margins, have put pressure on the Company’s ability to remain in compliance with these ratios. Based on current forecasts reflected in the Company’s most recent guidance, the Company expects to maintain compliance with these financial covenants during fiscal 2012. If the Company was unable to maintain compliance with these covenants, the Company would work with its lenders to secure a waiver or amend such ratios in the near future. Any amendment or waiver would result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings.

Holders of the Company’s $133.0 million, 3.75% convertible subordinated notes due 2023 presented $132.9 million in aggregate principle amount of the notes to the Company for redemption during the second quarter of fiscal 2011. The remaining outstanding amount of this issuance, $0.1 million, was called by the Company during the second quarter of fiscal 2011. The Company satisfied the $133.0 million repayment in cash by borrowing on its credit facility.

In November 2006, we sold $200.0 million of convertible subordinated debentures due 2026, (“the 2006 Debentures”), of which $42.5 million remained outstanding as of July 30, 2011. The 2006 Debentures are

 

23


Table of Contents

unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, we will deliver cash equal to the lesser of the aggregate principal amount of 2006 Debentures to be converted and our total conversion obligation, and will deliver, at our option, cash or shares of our common stock in respect of the remainder, if any, of our conversion obligation. The initial conversion rate is 19.4574 shares per $1,000 principal amount of 2006 Debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at our option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require us to repurchase all or some of the 2006 Debentures.

On March 1, 2011 and July 7, 2011, we exchanged $100.0 million and $57.5 million, respectively, in aggregate principal amount of the outstanding 2006 Debentures, for $100.0 million and $57.5 million, respectively, in aggregate principal amount of convertible debentures also due November 30, 2026, (“the 2011 Debentures”). The 2011 Debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. Principal will accrete on the 2011 Debentures at a rate of 3.9755% per year, compounding on a semi-annual basis. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of 2011 Debentures to be converted and the Company’s total conversion obligation, and will deliver, at its option, cash or shares of the Company’s common stock in respect of the remainder, if any, of the Company’s conversion obligation. The initial conversion rate is 44.2087 shares per $1,000 principal amount of 2011 Debentures, which represents an initial conversion price of approximately $22.62 per share. The 2011 Debentures are redeemable at the Company’s option on or after May 30, 2014. On November 30, 2014, 2018 and 2022 and upon the occurrence of certain circumstances, holders will have the right to require us to repurchase all or some of the 2011 Debentures.

Net cash used in operating activities increased by $46.1 million to $53.8 million in the first quarter of fiscal 2012 as compared to $7.7 million used in the first quarter of fiscal 2011. The net use of cash in operating activities during the first quarter is indicative of the highly seasonal nature of our business, with the majority of purchases and other operating cash outflows occurring in the first and second quarters of the fiscal year and the majority of cash receipts occurring in the second and third quarters of the fiscal year. The increase is a result of planned early inventory purchases made during the fourth quarter of fiscal 2011 and the subsequent payments of the related accounts payable.

Net cash used in investing activities decreased by $1.4 million to $3.2 million in the first quarter of fiscal 2012 as compared to $4.6 million for the first quarter of fiscal 2011. Additions to property, plant and equipment decreased $1.1 million from the first quarter of fiscal 2011 to $1.3 million in the first quarter of fiscal 2012. Product development spending remained flat at approximately $2 million in the first quarter of fiscal 2011 and the first quarter of fiscal 2012, primarily as a result of a reduction in capital spending by the Company. The Company is committed to the ongoing investment in the development of curriculum-based products.

Cash flows provided by financing activities increased by $51.3 million from net cash flows used in financing activities of $0.2 million in the first quarter of fiscal 2011 to net cash flows provided by financing activities of $51.1 million in the first quarter of fiscal 2012. The increase was used to fund cash used in operations. In the first quarter of fiscal 2012, the Company’s total borrowings increased by $14.3 million as compared to the first quarter of fiscal 2011.

We anticipate that our cash flow from operations, borrowings available from our existing credit facility and other sources of capital will be sufficient to meet our liquidity requirements for operations, including anticipated capital expenditures and our contractual obligations for the foreseeable future.

Fluctuations in Quarterly Results of Operations

Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by the timing of acquisitions, the timing and magnitude of costs related to such acquisitions, variations in our costs for the products sold, the mix of products sold and general economic conditions. Moreover, the operating margins of companies we acquire may

 

24


Table of Contents

differ substantially from our own, which could contribute to further fluctuation in quarterly operating results. Therefore, results for any fiscal quarter are not indicative of the results that we may achieve for any subsequent fiscal quarter or for a full fiscal year.

Inflation

Inflation, particularly in energy costs, has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.

Critical Accounting Policies

Goodwill and Intangible Assets, and Long-Lived Assets.

As discussed in Item 1, Note 6 of these condensed consolidated financial statements, in the first quarter of fiscal 2011 the Company recorded impairment charges of $411.2 million and $0.2 million related to goodwill and an indefinite-lived tradename intangible, respectively. The impairments were determined as part of the fair value assessment of these assets.

In the first quarter of fiscal 2012, the Company performed its annual impairment test. We tested goodwill for impairment by determining the fair value of the Company’s reporting units using a combined income (discounted cash flow) and market approach (guideline public company comparables) valuation model. The details regarding the determination of the fair value of the reporting units, including the key assumptions used in the impairment analysis, are discussed in Item 1, Note 6 of this report. The impact of modifying any of these assumptions can have a significant impact on the estimate of fair value and, thus, the estimated recoverability, or impairment, if any, of the asset. Changes in estimates or the application of alternative assumptions could have produced significantly different results.

The fair value assessment in the first quarter of fiscal 2012 of the reporting units with goodwill (Califone, Reading, Science and Planning and Student Development) indicated that the goodwill balances of these reporting units were not impaired as the fair value exceeded the carrying value of the units. Since the modification of assumptions used in the valuation model can have a significant impact on the fair value, the Company performed a sensitivity analysis assuming a 100 basis point increase in the discount rate and a 100 basis point decrease in the terminal growth rate. The Company believes these assumptions have the most sensitivity in the valuation model. The results of this sensitivity analysis are as follows:

 

Decrease in fair value

   100 basis point
increase in
discount rate
     100 basis point
decrease in
terminal growth
rate
 

Califone

   $ 3.5 million       $ 1.7 million   

Science

   $ 19.0 million       $ 9.6 million   

Planning and Student Development

   $ 13.8 million       $ 6.9 million   

Reading

   $ 6.6 million       $ 2.7 million   

Because the valuation of the Califone, Reading and Planning and Student Development reporting units concluded the fair value exceeded carrying value by $13.3 million, $42.2 million and $49.1 million, respectively, the decreases in fair value for the sensitivity analysis would not have impaired the goodwill assessment of these three reporting units. A 100 basis point increase in the discount rate for the Science reporting unit would result in the carrying value of the unit exceeding the fair value by $5.4 million. Because step two of the impairment was not required for this reporting unit, any potential goodwill impairment resulting from a 100 basis point increase in the discount rate may be greater or less than the excess of carrying value over fair value indicated by this sensitivity analysis.

Forward-Looking Statements

Statements in this Quarterly Report which are not historical are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include: (1) statements made

 

25


Table of Contents

under Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operation, including, without limitation, statements with respect to internal growth plans, projected revenues, margin improvement, future acquisitions, capital expenditures, adequacy of capital resources and ability to comply with financial covenants; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, belief or current expectation of School Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include forward-looking terminology such as “may,” “should,” “believes,” “expects,” “anticipates,” “estimates,” “continues” or similar expressions.

All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof. We do not undertake to update any forward-looking statements that may be made by us or on our behalf, in this Quarterly Report or otherwise. Our actual results may differ materially from those contained in the forward-looking statements identified above. Factors which may cause such a difference to occur include, but are not limited to, the risk factors set forth in Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended April 30, 2011.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in qualitative and quantitative disclosures about market risk from what was reported in our Annual Report on Form 10-K for the fiscal year ended April 30, 2011.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on an evaluation as of the end of the period covered by this quarterly report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective for the purposes set forth in the definition of the Exchange Act rules.

Changes in Internal Control

No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

26


Table of Contents

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

There have been no material changes in litigation matters subject to the Company in the first quarter of fiscal 2012.

ITEM 1A. Risk Factors

The business and financial results of the Company are subject to numerous risks and uncertainties. The risks and uncertainties have not changed materially from those reported in the fiscal 2011 Annual Report on Form 10-K.

ITEM 6. Exhibits

See the Exhibit Index, which is incorporated herein by reference.

 

27


Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    SCHOOL SPECIALTY, INC.
    (Registrant)
  September 7, 2011  

/s/ David J. Vander Zanden

  Date   David J. Vander Zanden
    Chief Executive Officer
    (Principal Executive Officer)
  September 7, 2011  

/s/ David N. Vander Ploeg

  Date   David N. Vander Ploeg
    Executive Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

28


Table of Contents

EXHIBIT INDEX

 

Exhibit
No.

  

Description

  4.1    Second Amendment dated as of July 1, 2011 to the Credit Agreement dated as of April 23, 2010, by and among School Specialty, Inc., certain subsidiaries of the Company, the lenders identified therein and Bank of America, N.A, as Administrative Agent, incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K dated as of July 7, 2011.
10.1    Employment Agreement dated as of June 27, 2011 between School Specialty, Inc. and David J. Vander Zanden, incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated as of June 27, 2011.
10.2    Form of Exchange Agreement date as of July 7, 2011, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated as of July 7, 2011.
12.1    Statement Regarding Computation of Ratio of Earnings to Fixed Charges.
31.1    Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
31.2    Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
32.1    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
32.2    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
101    The following materials from School Specialty, Inc’s. Quarterly Report on Form 10-Q for the quarter ended July 30, 2011 are furnished herewith, formatted in XBRL (Extensive Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statement of Operations, (iii) the Condensed Consolidated Statement of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

29