Attached files

file filename
EX-31.2 - SECTION 302 CFO CERTIFICATION - SCHOOL SPECIALTY INCd304885dex312.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - SCHOOL SPECIALTY INCd304885dex321.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - SCHOOL SPECIALTY INCd304885dex311.htm
EX-12.1 - STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - SCHOOL SPECIALTY INCd304885dex121.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - SCHOOL SPECIALTY INCd304885dex322.htm
EXCEL - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCFinancial_Report.xls
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR2.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR7.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR5.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR9.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR4.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR8.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR3.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR6.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR1.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR16.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR18.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR17.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR10.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR13.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR11.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR12.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR15.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR14.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR20.htm
XML - IDEA: XBRL DOCUMENT - SCHOOL SPECIALTY INCR19.htm
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 JANUARY 28, 2012

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, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer’ and “smaller reporting company” 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.

 

     Outstanding at  
                                 Class    March 7, 2012  

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 JANUARY 28, 2012

 

         Page
Number
 

PART I—FINANCIAL INFORMATION

  
ITEM 1.  

CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

  
 

Condensed Consolidated Balance Sheets at January 28, 2012, April  30, 2011 and January 22, 2011

     2   
 

Condensed Consolidated Statements of Operations for the Three Months Ended January 28, 2012 and January 22, 2011 and for the Nine Months Ended January 28, 2012 and January 22, 2011

     3   
 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended January 28, 2012 and January 22, 2011 and for the Nine Months Ended January 28, 2012 and January 22, 2011

     4   
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended January 28, 2012 and January 22, 2011

     5   
 

Notes to Condensed Consolidated Financial Statements

     6   
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION      24   
ITEM 3.  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     33   
ITEM 4.  

CONTROLS AND PROCEDURES

     33   
PART II—OTHER INFORMATION   
ITEM 1.  

LEGAL PROCEEDINGS

     34   
ITEM 1A.  

RISK FACTORS

     34   
ITEM 6.  

EXHIBITS

     34   

 

1


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)

 

     January 28,
2012
    April 30,
2011
    January 22,
2011
 

ASSETS

      

Current assets:

      

Cash and cash equivalents

   $ 975      $ 9,821      $ 1,667   

Accounts receivable, less allowance for doubtful accounts of $1,877, $1,951 and $1,875, respectively

     64,290        67,442        70,767   

Inventories

     79,715        111,266        80,747   

Deferred catalog costs

     15,412        16,639        16,597   

Prepaid expenses and other current assets

     12,873        14,516        13,329   

Deferred taxes

     5,737        —          9,867   
  

 

 

   

 

 

   

 

 

 

Total current assets

     179,002        219,684        192,974   

Property, plant and equipment, net

     57,754        65,571        64,383   

Goodwill

     41,065        129,390        127,694   

Intangible assets, net

     126,860        155,889        158,205   

Development costs and other

     33,847        36,383        34,352   

Deferred taxes long-term

     26,459        10,227        —     

Investment in unconsolidated affiliate

     18,907        20,400        27,215   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 483,894      $ 637,544      $ 604,823   
  

 

 

   

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

      

Current liabilities:

      

Current maturities—long-term debt

   $ 957      $ 98,243      $ 193,375   

Accounts payable

     65,302        85,639        64,045   

Accrued compensation

     4,234        7,972        6,949   

Deferred revenue

     3,576        3,600        4,112   

Accrued income taxes

     8,476        11,855        19,204   

Deferred taxes

     —          4,454        —     

Other accrued liabilities

     17,019        25,428        26,266   
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     99,564        237,191        313,951   

Long-term debt—less current maturities

     265,112        198,036        60,395   

Deferred taxes

     —          —          10,751   

Other liabilities

     688        688        1,423   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     365,364        435,915        386,520   
  

 

 

   

 

 

   

 

 

 

Commitments and contingencies—Note 13

      

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

     443,897        441,335        438,818   

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

     22,914        26,390        22,984   

(Accumulated deficit)

     (161,668     (79,483     (56,886
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     118,530        201,629        218,303   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 483,894      $ 637,544      $ 604,823   
  

 

 

   

 

 

   

 

 

 

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     For the Nine Months Ended  
     January 28,
2012
    January 22,
2011
    January 28,
2012
    January 22,
2011
 

Revenue

   $ 85,258      $ 89,859      $ 612,717      $ 634,723   

Cost of revenue

     54,630        56,910        375,753        376,179   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     30,628        32,949        236,964        258,544   

Selling, general and administrative expenses

     54,048        59,169        207,229        216,335   

Other general expenses, net

     (4,376     —          (4,376     —     

Impairment charges

     107,501        —          107,501        411,390   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (126,545     (26,220     (73,390     (369,181

Other expense:

        

Interest expense

     6,293        6,365        21,072        21,241   

Expense associated with convertible debt exchange

       —          1,090        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before benefit from income taxes

     (132,838     (32,585     (95,552     (390,422

Benefit from income taxes

     (29,832     (13,385     (14,860     (57,832
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before investment in unconsolidated affiliate

   $ (103,006   $ (19,200   $ (80,692   $ (332,590
  

 

 

   

 

 

   

 

 

   

 

 

 

Losses of unconsolidated affiliate

     (1,608     (950     (1,493     (1,085
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (104,614   $ (20,150   $ (82,185   $ (333,675
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        

Basic and Diluted

     18,880        18,870        18,878        18,868   

Net Loss per Share:

        

Basic and Diluted

   $ (5.54   $ (1.07   $ (4.35   $ (17.68

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In Thousands)

 

     For the Three Months Ended     For the Nine Months Ended  
     January 28,
2012
    January 22,
2011
    January 28,
2012
    January 22,
2011
 

Net loss

   $ (104,614   $ (20,150   $ (82,185   $ (333,675
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax:

        

Foreign currency translation adjustments

     (689     1,145        (3,476     (1,068
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive loss

   $ (105,303   $ (19,005   $ (85,661   $ (334,743
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

 

     For the Nine Months Ended  
     January 28,
2012
    January 22,
2011
 

Cash flows from operating activities:

    

Net loss

   $ (82,185   $ (333,676

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

    

Depreciation and intangible asset amortization expense

     22,351        20,742   

Amortization of development costs

     4,950        3,838   

Amortization of debt fees and other

     2,157        1,602   

Impairment charges

     107,501        411,390   

Losses of unconsolidated affiliate

     1,493        1,085   

Share-based compensation expense

     1,867        2,304   

Expense associated with convertible debt exchange

     1,090        —     

Deferred taxes

     (27,607     (82,094

(Gain) on sale of assets

     (4,376     —     

Non-cash convertible debt deferred financing costs

     7,290        7,691   

Changes in current assets and liabilities

    

Accounts receivable

     2,101        2,332   

Inventories

     30,815        19,162   

Deferred catalog costs

     1,227        (3,004

Prepaid expenses and other current assets

     1,638        2,528   

Accounts payable

     (20,693     15,883   

Accrued liabilities

     (15,588     13,784   
  

 

 

   

 

 

 

Net cash provided by operating activities

     34,031        83,567   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions to property, plant and equipment

     (6,616     (10,220

Investment in product development costs

     (5,560     (6,655

Proceeds from sale of assets

     6,650        —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (5,526     (16,875
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from bank borrowings

     500,300        632,600   

Repayment of debt and capital leases

     (493,488     (585,660

Redemption of convertible debt

     (42,500     (133,000

Payment of debt fees and other

     (1,663     —     
  

 

 

   

 

 

 

Net cash used in financing activities

     (37,351     (86,060
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (8,846     (19,368

Cash and cash equivalents, beginning of period

     9,821        21,035   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 975      $ 1,667   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Interest paid

   $ 12,912      $ 14,160   

Income taxes paid

   $ 14,077      $ 3,497   

See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

NOTE 1—BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”) 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 condensed consolidated 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—RECENT ACCOUNTING PRONOUNCEMENTS

In May, 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2011-04, Fair Value Measurements, FASB Accounting Standards Codification (“ASC”) Topic 820. The purpose of ASU No. 2011-04 was to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with US GAAP and International Financial Reports Standards (“IFRS”). ASU No. 2011-04 was effective for interim and annual reporting periods beginning after December 15, 2011. The adoption ASU No. 2011-04 by the Company did not have a material impact on the Company’s financial position, results of operations, comprehensive income (loss) or cash flows.

In June, 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, FASB ASC Topic 220. The purpose of ASU No. 2011-05 was to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. ASU No. 2011-05 is effective for fiscal years and interim reporting periods within those years beginning after December 15, 2011, and early adoption is permitted. The Company early adopted ASU No. 2011-05 during the second quarter ended October 29, 2011. Early adoption of ASU No. 2011-05 resulted in the inclusion of the condensed consolidated statements of comprehensive income (loss) in the condensed consolidated unaudited financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment, FASB ASC Topic 350. The intent of ASU No 2011-08 is to simplify how entities test goodwill for impairment. ASU No. 2011-08 is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, and early adoption is permitted. The Company has not yet adopted ASU No. 2011-08. In the course of preparing the financial statements for the third quarter of fiscal 2012, the Company identified a triggering event in the third quarter of fiscal 2012 that resulted in an interim impairment test of goodwill. See Note 7 for the goodwill and intangible asset impairment charge recorded by the Company in the third quarter of fiscal 2012.

NOTE 3—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 2011. 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 result in a material change 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 January 28, 2012, April 30, 2011 and January 22, 2011, 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.

During the third quarter of fiscal 2012, the Company recorded a $2,860 valuation allowance related to a deferred tax asset for charitable contribution carryforwards that the Company now expects will not be utilized prior to expiration.

 

6


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

NOTE 4—SHAREHOLDERS’ EQUITY

Changes in condensed consolidated shareholders’ equity during the nine months ended January 28, 2012 and January 22, 2011 were as follows:

 

Shareholders’ equity balance at April 30, 2011

   $ 201,629   

Net loss

     (82,185

Share-based compensation

     1,867   

Income tax deficiency from stock options

     (111

Convertible debt exchange

     806   

Foreign currency translation adjustment

     (3,476
  

 

 

 

Shareholders’ equity balance at January 28, 2012

   $ 118,530   
  

 

 

 

Shareholders’ equity balance at April 24, 2010

   $ 551,188   

Net loss

     (333,675

Share-based compensation

     2,304   

Income tax deficiency from stock options

     (446

Foreign currency translation adjustment

     (1,068
  

 

 

 

Shareholders’ equity balance at January 22, 2011

   $ 218,303   
  

 

 

 

NOTE 5—EARNINGS PER SHARE

Earnings Per Share

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

 

     Net Loss
(Numerator)
    Weighted
Average Shares
(Denominator)
     Per Share
Amount
 

Three months ended January 28, 2012:

       

Basic and diluted EPS

   $ (104,614     18,880       $ (5.54
  

 

 

   

 

 

    

 

 

 

Three months ended January 22, 2011:

       

Basic and diluted EPS

   $ (20,150     18,870       $ (1.07
  

 

 

   

 

 

    

 

 

 

 

     Net Loss
(Numerator)
    Weighted
Average Shares
(Denominator)
     Per Share
Amount
 

Nine months ended January 28, 2012:

       

Basic and diluted EPS

   $ (82,185     18,878       $ (4.35
  

 

 

   

 

 

    

 

 

 

Nine months ended January 22, 2011:

       

Basic and diluted EPS

   $ (333,675     18,868       $ (17.68
  

 

 

   

 

 

    

 

 

 

 

7


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

The Company had stock options outstanding of 1,865 and 1,823 during the three and nine months ended January 28, 2012, respectively, that were not included in the computation of diluted EPS because they were anti-dilutive. The Company had stock options outstanding of 1,541 and 1,531 during the three and nine months ended January 22, 2011, that were not included in the computation of diluted EPS because they were anti-dilutive.

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 were not satisfied. See Note 10.

NOTE 6—SHARE-BASED COMPENSATION EXPENSE

Employee Stock Plans

The Company has three share-based employee compensation plans under which awards were outstanding as of January 28, 2012: 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 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 nine months ended January 28, 2012 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

     776        13.76         

Exercised

     —          —           

Cancelled

     (122     21.66         
  

 

 

         

Balance at January 28, 2012

     2,160      $ 25.97         1,102       $ 32.26   
  

 

 

         

The following table details supplemental information regarding stock options outstanding at January 28, 2012:

 

     Weighted Average
Remaining
Contractual Term
     Aggregate
Instrinsic
Value
 

Options outstanding

     6.15 years       $ 332   

Options vested and expected to vest

     6.07 years         —     

Options exercisable

     4.42 years         —     

 

8


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

     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
 

$  2.26 - $19.19

     991         8.96       $ 11.27         68       $ 18.55   

$19.20 - $29.48

     384         5.25         22.37         259         23.06   

$29.49 - $36.01

     279         4.04         33.52         268         33.63   

$36.02 -   39.71

     506         4.29         38.10         507         38.10   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,160         6.15       $ 25.97         1,102       $ 32.26   
  

 

 

          

 

 

    

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. Prior to fiscal 2009, the Company issued new shares of common stock to settle shares due upon option exercise. In fiscal 2009, the Company’s option plans were amended to allow for the net settlement of the exercise price and related employee tax withholding liabilities for non-qualified stock option exercises. For the nine months ended January 28, 2012, no shares were issued upon the exercise of stock options. For the nine months ended January 22, 2011, approximately 3 new shares were issued upon the exercise of stock options, 12 shares were tendered to satisfy the exercise price, and zero shares were surrendered to satisfy employee tax liabilities.

Option information provided in the tables in the Note includes 75 shares subject to an inducement option granted to Michael P. Lavelle, the Company’s President and Chief Executive Officer, in connection with the commencement of his employment with the Company effective January 12, 2012. One-third of the inducement options will become exercisable on the date Mr. Lavelle purchases a number of shares of Company common stock with an aggregate purchase price of at least $400 (the “Purchase Date”), and another one-third of which will become exercisable on each of the first and second anniversaries of the Purchase Date.

During the first nine months 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 nine months 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 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 nine months ended January 22, 2011 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 first nine months 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 third quarter of fiscal 2012, the Company awarded 75 shares of restricted stock to Mr. Lavelle in connection with the commencement of his employment with the Company. The restricted stock will vest as to one-third of the shares on the Purchase Date and will vest as to an additional one-third on each of the first and second anniversaries of the Purchase Date. During the first nine months of fiscal 2011, the Company awarded 118 time-based restricted stock units (“RSUs”) to employees of the Company under the 2002 Plan. 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 nine months ended January 22, 2011 was $2,250.

 

9


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

The following table presents the share-based compensation expense recognized during the three and nine months ended January 28, 2012 and January 22, 2011:

 

     For the Three Months Ended      For the Nine Months Ended  
     January 28, 2012      January 22, 2011      January 28, 2012      January 22, 2011  
     Gross      Net of Tax      Gross      Net of Tax      Gross      Net of Tax      Gross      Net of Tax  

Stock Options

   $ 464       $ 284       $ 635       $ 389       $ 1,166         714       $ 1,703       $ 1,042   

Management NSUs

     87         53         86         53         259         159         259         160   

Director NSUs

     48         29         49         30         149         91         134         83   

Management RSUs

     87         53         91         56         293         179         208         129   
  

 

 

       

 

 

       

 

 

       

 

 

    

Total stock-based compensation expense

   $ 686          $ 861          $ 1,867          $ 2,304      
  

 

 

       

 

 

       

 

 

       

 

 

    

The stock-based compensation expense is reflected in selling, general and administrative (“SG&A”) expenses in the accompanying condensed consolidated statements of operations. The income tax benefit recognized related to share-based compensation expense was $266 and $334 for the three months ended January 28, 2012 and January 22, 2011, respectively, and was $724 and $894 for the nine months ended January 28, 2012 and January 22, 2011, respectively. The Company recognized share-based compensation expense ratably over the vesting period of each award along with cumulative adjustments for changes in the expected level of attainment for performance-based awards.

The total unrecognized share-based compensation expense as of January 28, 2012 and January 22, 2011 was as follows:

 

     January 28,
2012
     January 22,
2011
 

Stock Options, net of estimated forfeitures

   $ 3,704       $ 3,223   

NSUs

   $ 163       $ 776   

RSUs

   $ 1,313       $ 1,514   

The Company expects to recognize this expense over a weighted average period of approximately 2.6 years.

The Company granted 326 options during the three months ended January 28, 2012. The weighted average fair value of the options granted during the three months ended January 28, 2012 was $1.70 per share. There were no options granted during the three months ended January 22, 2011. The weighted average fair value of options granted during the nine months ended January 28, 2012 and January 22, 2011 was $5.04 and $6.74 per share, 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     For the Nine Months Ended  
     January 28,
2012
    January 22,
2011
    January 28,
2012
    January 22,
2011
 

Average-risk free interest rate

     1.01     2.05     2.11     2.00

Expected volatility

     43.65     36.52     35.98     35.00

Expected term

     5.5 years        5.5 years        5.5 years        5.5 years   

 

10


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

     For the Three Months Ended      For the Nine Months Ended  
     January 28,
2012
    January 22,
2011
     January 28,
2012
    January 22,
2011
 

Total intrinsic value of stock options exercised

   $ —        $ —         $ —        $ 61   

Cash received from stock option exercises

   $ —        $ —           —          0   

Income tax benefit/(deficiency) from stock option/NSU activity

   $ (82   $ 13       $ (111   $ (446

NOTE 7—GOODWILL AND OTHER INTANGIBLE ASSETS

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

 

January 28, 2012

   Gross Value      Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

       

Customer relationships (10 to 17 years)

   $ 36,858       $ (22,356   $ 14,502   

Publishing rights (15 to 25 years)

     113,260         (33,006     80,254   

Non-compete agreements (3.5 to 10 years)

     5,481         (5,186     295   

Tradenames and trademarks (10 to 30 years)

     3,504         (1,185     2,319   

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

     1,767         (1,095     672   

License agreement (10 years)

     14,506         (4,798     9,708   
  

 

 

    

 

 

   

 

 

 

Total amortizable intangible assets

     175,376         (67,626     107,750   
  

 

 

    

 

 

   

 

 

 

Non-amortizable intangible assets:

       

Tradenames and trademarks

     19,110         —          19,110   
  

 

 

    

 

 

   

 

 

 

Total non-amortizable intangible assets

     19,110         —          19,110   
  

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 194,486       $ (67,626   $ 126,860   
  

 

 

    

 

 

   

 

 

 

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   

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   
  

 

 

    

 

 

   

 

 

 

 

11


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

 

January 22, 2011

   Gross Value      Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

       

Customer relationships (10 to 17 years)

   $ 36,564       $ (19,943   $ 16,621   

Publishing rights (15 to 25 years)

     113,260         (27,401     85,859   

Non-compete agreements (3.5 to 10 years)

     7,110         (6,355     755   

Tradenames and trademarks (10 to 30 years)

     3,504         (993     2,511   

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

     2,634         (1,750     884   

License agreement (10 years)

     14,506         (3,051     11,455   
  

 

 

    

 

 

   

 

 

 

Total amortizable intangible assets

     177,578         (59,493     118,085   
  

 

 

    

 

 

   

 

 

 

Non-amortizable intangible assets:

       

Tradenames and trademarks

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total non-amortizable intangible assets

     40,120         —          40,120   
  

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 217,698       $ (59,493   $ 158,205   
  

 

 

    

 

 

   

 

 

 

Intangible amortization expense included in SG&A expense for the three months ended January 28, 2012 and January 22, 2011 was $2,642 and $2,671, respectively, and $7,953 and $8,142 for the nine months ended January 28, 2012 and January 22, 2011, respectively.

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

 

Fiscal 2012 (three months remaining)..

   $  2,622   

Fiscal 2013

     9,959   

Fiscal 2014

     9,665   

Fiscal 2015

     9,448   

Fiscal 2016

     9,257   

Fiscal 2017

     8,503   

 

12


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

The following information presents changes to goodwill during the period beginning January 22, 2011 through January 28, 2012:

 

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

Balance at January 22, 2011

                 

Goodwill

  $ 249,695      $ 14,852        264,547      $ 75,652      $ 181,211      $ 17,474      $ —          274,337        538,884   

Accumulated impairment losses

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 22, 2011

  $ —        $ 14,852      $ 14,852      $ 20,280      $ 75,088      $ 17,474      $ —        $ 112,842      $ 127,694   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fiscal 2011 Activity:

                 

Currency translation adjustment

    —          —          —          —          1,696        —          —          1,696        1,696   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at April 30, 2011

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fiscal 2012 Activity:

                 

Currency translation adjustment

    —          —          —          —          (1,834     —          —          (1,834     (1,834
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 28, 2012

                 

Goodwill

  $ 249,695      $ 14,852        264,547      $ 75,652      $ 181,073      $ 17,474      $ —          274,199        538,746   

Accumulated impairment losses

  $ (249,695   $ (10,959     (260,654   $ (75,652   $ (153,603   $ (7,772   $ —          (237,027     (497,681
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 28, 2012

  $ —        $ 3,893      $ 3,893      $ —        $ 27,470      $ 9,702      $ —        $ 37,172      $ 41,065   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In accordance with FASB ASC Topic 350, Intangibles—Goodwill and Other, 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 FASB ASC Topic 350-20-20, a reporting unit is the level at which goodwill impairment is tested. A reporting unit can be an operating segment or one level below an operating segment, also known as a component. FASB 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 most recent date on which the annual impairment test was measured, 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.

In connection with the preparation of the financial statements for the third quarter of fiscal 2012, the Company concluded a triggering event had occurred which would more likely than not reduce the fair value of the reporting units below their carrying value. The triggering event was a combination of the continued decrease in the Company’s market capitalization and declines in the Company’s forecasted future years’ operating results and cash flows. On December 31, 2011, the Company’s closing stock price was $2.50 per share compared with $14.15 as of May 1, 2011. As a result of the Company’s performance of the goodwill and indefinite-lived intangible asset impairment test as detailed below, the Company recorded an impairment charge of $86,491 for goodwill and $21,010 for indefinite-lived intangible assets.

FASB ASC Topic 350 requires a two-step method for determining goodwill impairment. In the first step, the Company determined the fair value of the reporting unit by utilizing a combination of the income approach (weighted 90%) and the market approach (weighted 10%) derived from comparable public companies, except for the Science and Health reporting units for which only the income approach was used due to the limited availability of comparable public company data. The Company believes that each approach has its merits.

 

13


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

However, in the instances where both approaches were utilized, 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 a non-recurring level 3 fair value hierarchy pursuant to FASB ASC Topic 820, “Fair Value Measurements”. The estimated fair value of the reporting units was dependent on several significant assumptions, including earnings projections and discount rates. There were no changes to the valuation techniques during fiscal 2012, relative to fiscal 2011.

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

 

  1. Income Approach (discounted cash flow analysis)—the discounted cash flow (“DCF”) valuation method requires an estimation of future cash flows of a reporting unit 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:

 

     Terminal Value
Growth Rates
    Discount
Rate
 

Education Resources

     2.0     19.6

Califone

     2.0     18.4

Science

     2.4     15.4

Planning and Student Development

     3.0     17.9

Reading

     2.0     19.3

Health

     2.0     17.9

 

  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 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 8 companies that were deemed relevant to the Planning and Student Development and Reading reporting units and 9 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:

 

     EBITDA
Multiples
     Revenue
Multiples
     Control
Premium
 

Education Resources

     4.2x         N/A         13.8

Califone

     3.9x         N/A         13.8

Reading

     5.8x         1.2x         15.1

Planning and Student Development

     4.6x         0.8x         15.1

 

14


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

Based upon the assessment performed in the third quarter of fiscal 2012, the Califone, Science, Planning and Student Development and Reading 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, $86,491 of goodwill was considered impaired during the third quarter of fiscal 2012. 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 Califone reporting unit, which is part of the Educational Resources segment, and the Science, Reading 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 January 28, 2012.

Due to the triggering events described above, the Company also performed an impairment test of its indefinite-lived intangible assets during the third quarter of fiscal 2012. The Company utilized an income approach, whereby the assets are valued by reference to the amount of royalty income generated if the assets were licensed to a third party. In this method, a sample of comparable guideline royalty or license agreements was analyzed. The Company recorded a $21,010 impairment charge related to a non-amortizable trademark in the Educational Resources segment and to non-amortizable tradenames in the Accelerated Learning 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   

Accumulated impairment loss

     (1,020     (20,190     (21,210
  

 

 

   

 

 

   

 

 

 

Balance at January 28, 2012:

   $ 410      $ 18,700      $ 19,110   
  

 

 

   

 

 

   

 

 

 

 

15


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

The following discussion relates to the goodwill and other intangible assets impairment test performed during the first quarter of fiscal 2011.

In performing the impairment assessment, the Company estimated the fair value of its reporting units using a combination of the Income Approach and Market Approach discussed above. Key assumptions used in these approaches were as follows:

 

     Terminal Value
Growth Rates
    Discount
Rate
 

Education Resources

     2.0     12.0

Califone

     2.0     11.5

Science

     6.0     14.5

Planning and Student Development

     3.0     11.9

Reading

     2.0     13.7

Health

     2.0     13.7

 

     EBITDA
Multiples
     Revenue
Multiples
     Control
Premium
 

Education Resources

     8.5x         0.4x         13.4

Califone

     6.5x         N/A         13.4

Reading

     7.1x         2.2x         17.9

Planning and Student Development

     6.4x         1.5x         17.9

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 reporting unit’s lack of financial history.

Based upon the assessment 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 believed the first quarter of fiscal 2011 was 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 historically had 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. During the second and third quarters of fiscal 2011, the Company reviewed both its current market capitalization and future cash flow projections and concluded no evidence of further impairment existed.

 

16


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

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. During the second and third quarters of fiscal 2011, the Company concluded no evidence of further impairments existed. 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   

Accumulated impairment loss

     (200     —           (200
  

 

 

   

 

 

    

 

 

 

Balance at January 22, 2011:

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

 

 

   

 

 

    

 

 

 

NOTE 8—INVESTMENT IN UNCONSOLIDATED AFFILIATE

Investment in unconsolidated affiliate is accounted for under the equity method, and consisted of the following:

 

     Percent-
Owned
    January 28,
2012
     April 30,
2011
     January 22,
2011
 

Carson—Dellosa Publishing, LLC

     35   $ 18,907       $ 20,400       $ 27,215   

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, LLC. 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. The Company recorded pre-tax losses for its 35% minority equity interest in Carson-Dellosa Publishing, LLC in the following amounts: $1,608 and $950 for the three months ended January 28, 2012 and January 22, 2011, respectively and $1,493 and $1,085 for the nine months ended January 28, 2012 and January 22, 2011, respectively.

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

 

17


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

NOTE 9—PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

 

     January 28,
2012
    April 30,
2011
    January 22,
2011
 

Land

   $ 158      $ 158      $ 158   

Projects in progress

     6,712        10,326        7,976   

Buildings and leasehold improvements

     29,854        29,867        29,851   

Furniture, fixtures and other

     100,067        90,503        99,399   

Machinery and warehouse equipment

     39,467        39,463        39,554   
  

 

 

   

 

 

   

 

 

 

Total property, plant and equipment

     176,258        170,317        176,938   

Less: Accumulated depreciation

     (118,504     (104,746     (112,555
  

 

 

   

 

 

   

 

 

 

Net property, plant and equipment

   $ 57,754      $ 65,571      $ 64,383   
  

 

 

   

 

 

   

 

 

 

Depreciation expense for the three months ended January 28, 2012 and January 22, 2011 was $5,172 and $4,202, respectively, and $14,398 and $12,600 for the nine months ended January 28, 2012 and January 22, 2011, respectively.

NOTE 10—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. 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 provided borrowing capacity of $242,500. This capacity consists of a revolving loan of $200,000 and a delayed draw term loan of up to $42,500, which was used to refinance a portion of the Company’s convertible notes in the third quarter of fiscal 2012. As of January 28, 2012, the outstanding balance on the delayed-draw term loan was $34,788.

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 third quarter of fiscal 2012 was 6.79%, which includes amortization of loan origination fees of $332 and commitment fees on unborrowed funds of $147. 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 January 28, 2012. As of January 28, 2012, the outstanding balance on the revolving loan and the delayed-draw term loan were $98,488 and $34,788, respectively, and were reflected in “Long-term debt – less current maturities” on the condensed consolidated balance sheets. The Credit Agreement is secured by substantially all of the assets of the Company and contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures. The Company was in compliance with these financial covenants as of January 28, 2012. The gain on asset sale that was realized in the third quarter of fiscal 2012 and cost cutting measures were factors that contributed to the Company remaining in compliance.

The Company closely evaluates its expected ability to remain in compliance with the consolidated total and senior leverage and interest coverage ratios. The recent economic trends impacting the Company’s performance, such as the decline in school funding, which had led to a decrease in the Company’s revenues and margins, have put pressure on the Company’s ability to remain in compliance with these ratios. Based on the low end of the range of the Company’s current forecasts reflected in our most recent guidance, the Company may be unable to comply with one or all of these financial covenants in the fourth quarter of fiscal 2012. The Company may need to work with its lenders to secure a waiver or amend such ratios or to refinance these obligations in the near future. Any amendment, waiver or refinancing may result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings. The Company believes it will be able to maintain compliance with the financial covenants by working with its lenders, if an amendment or waiver is necessary. If the Company fails to maintain compliance with the covenants and fails to obtain amendments to or waivers under the Credit Agreement or refinancing, the Company’s lenders could take remedies pursuant to the agreement. If acceleration occurs, the Company may have difficulty in obtaining sufficient additional funds to refinance the accelerated debt.

 

18


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

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 four convertible debt instruments outstanding during portions of fiscal 2012 and 2011 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 convertible subordinated debentures due 2026 (“the 2006 Debentures”), which were issued November 22, 2006 of which $42,500 in aggregate principal amount was repaid in the third quarter of fiscal 2012 and the balance of which was exchanged for the Debentures described in the following clauses (3) and (4); (3) the Company’s $100,000 convertible subordinated debentures (“the 2011 Debentures”), which were issued on March 1, 2011 of which $100,000 in aggregate principal amount are currently outstanding; and (4) the additional $57,500 of the 2011 Debentures, which were issued on July 7, 2011, of which $57,500 in aggregate principal amount are currently outstanding (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 first date the holders of the respective Convertible Notes could put their Convertible Notes back to the Company.

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 occurred on November 30, 2011 for the 2006 Debentures. All of the remaining 2006 Debentures were repaid during the third quarter of fiscal 2012 using proceeds from the delayed-draw term loan component of the Credit Agreement. The put date is 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. 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. The 2006 Debentures were unsecured, subordinated obligations of the Company, paid interest at 3.75% per annum on each May 30th and November 30th, and were convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company would have been required to deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted or the Company’s total conversion obligation, and would have been required to 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 was .0194574 shares per $1 principal amount of debentures, which represented an initial conversion price of approximately $51.39 per share. The debentures were redeemable at the Company’s option on or after November 30, 2011. No debentures were converted into shares of common stock.

 

19


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(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 amount of the then outstanding 2006 Debentures in exchange for the issuance of $100,000 and $57,500, respectively, in aggregate principal amount of the 2011 Debentures. The 2011 Debentures 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 accretes 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 0.442087 shares per $1 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 $100,000 and $57,500 convertible subordinated notes at January 28, 2012 was approximately $70,602 and $40,596, respectively and the carrying value was $98,053 and $56,634, respectively. The estimated fair value was determined using Level 2 inputs as described in FASB ASC Topic 820.

NOTE 11—RESTRUCTURING

In the first nine months of fiscal 2012 and fiscal 2011, the Company recorded restructuring costs associated with severance related to headcount reductions, which is recorded in SG&A on the condensed consolidated statements of operations. The Company completed the fiscal 2012 headcount reductions during the third quarter of fiscal 2012. The fiscal 2011 headcount reductions were substantially complete during the third quarter of fiscal 2011. The following is a reconciliation of accrued restructuring costs for the nine months ended January 28, 2012 and January 22, 2011:

 

20


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

      Educational
Resources
    Accelerated
Learning
    Corporate     Total  

Accrued Restructuring at April 24, 2010

   $ 1,123      $ 38      $ 365      $ 1,526   

Amounts charged to expense

     1,063        —          11        1,074   

Payments

     (874     (34     (198     (1,106
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at July 24, 2010

   $ 1,312      $ 4      $ 178      $ 1,494   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts charged to expense

     138        22        12        172   

Payments

     (442     —          (159     (601
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at October 23, 2010

   $ 1,008      $ 26      $ 31      $ 1,065   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts charged to expense

   $ 190      $ 180      $ 231        601   

Payments

   $ (544   $ (107   $ (118     (769
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at January 22, 2011

   $ 654      $ 99      $ 144      $ 897   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

      Educational
Resources
    Accelerated
Learning
    Corporate     Total  

Accrued Restructuring at April 30, 2011

   $ 309      $ 44      $ 8      $ 361   

Amounts charged to expense

     10        —          —          10   

Payments

     (178     (44     (8     (230
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at July 30, 2011

   $ 141      $ —        $ —        $ 141   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts charged to expense

     525        704        187        1,416   

Payments

     (96     (9     —          (105
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at October 29, 2011

   $ 570      $ 695      $ 187      $ 1,452   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts charged to expense

     173        7        —          180   

Payments

     (395     (274     (138     (807
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Restructuring at January 28, 2012

   $ 348      $ 428      $ 49      $ 825   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 12—SEGMENT INFORMATION

The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Company’s CEO, 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 and Accelerated Learning segment revenues for the three and nine months periods ended January 28, 2012 and January 22, 2011, respectively, were comprised solely of sales to external parties. 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 for the fiscal year ended April 30, 2011.

 

21


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

     Three Months Ended     Nine Months Ended  
     January 28,
2012
    January 22,
2011
    January 28,
2012
    January 22,
2011
 

Revenue:

        

Educational Resources

   $ 70,428      $ 69,785      $ 429,713      $ 432,897   

Accelerated Learning

     14,313        19,907        182,153        201,325   

Corporate and intercompany eliminations

     517        167        851        501   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 85,258      $ 89,859      $ 612,717      $ 634,723   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss before benefit from income taxes:

        

Educational Resources

   $ (14,246   $ (7,343   $ 15,510      $ (221,369

Accelerated Learning

     (102,345     (10,278     (59,655     (120,318

Corporate and intercompany eliminations

     (9,954     (8,599     (29,245     (27,494
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (126,545     (26,220     (73,390     (369,181

Interest expense

     6,293        6,365        22,162        21,241   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before benefit from income taxes

   $ (132,838   $ (32,585   $ (95,552   $ (390,422
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     January 28,
2012
     April 30,
2011
 

Identifiable assets (as of quarter end):

     

Educational Resources

   $ 137,873       $ 179,689   

Accelerated Learning

     232,821         355,561   

Corporate and intercompany eliminations

     113,200         102,294   
  

 

 

    

 

 

 

Total

     483,894         637,544   
  

 

 

    

 

 

 

 

     Three Months Ended      Nine Months Ended  
     January 28,
2012
     January 22,
2011
     January 28,
2012
     January 22,
2011
 

Depreciation and amortization of intangible assets and development costs:

           

Educational Resources

   $ 1,504       $ 1,601       $ 4,716       $ 5,071   

Accelerated Learning

     4,053         3,413         12,974         11,326   

Corporate

     3,250         2,765         9,611         8,183   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     8,807         7,779         27,301         24,580   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

           

Educational Resources

   $ 34       $ 248       $ 309       $ 880   

Accelerated Learning

     2,475         2,845         7,016         8,247   

Corporate

     2,184         3,478         4,851         7,615   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4,693         6,571         12,176         16,742   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

NOTE 13—OTHER GENERAL EXPENSES

“Other general expenses” on the condensed consolidated statements of operations represents gains or losses on the sale of long-lived assets of the Company and is included in income from continuing operations before income taxes in accordance with to FASB ASC Topic 360-10-45-5, SEC Staff Accounting Bulletin Topic 13, “Revenue Recognition” and Regulation S-X, Rule 5-03(b)(6).

In the third quarter of fiscal 2012, the Company completed the sale of Seeds of Science/Roots of Reading assets as the Company concluded this was an ancillary, non-core program. The sale price was $6,650, including assets of $2,274 and resulting in a gain of sale of assets of $4,376.

NOTE 14—COMMITMENTS AND CONTINGENCIES

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

In the second quarter of fiscal 2012, the Company settled the state tax audit for the Delta Education, LLC (“Delta”) liability that survived the Company’s acquisition of Delta in fiscal 2006. As a result of the settlement, the Company finalized the amount owed by the subsidiary to the state. The settlement resulted in an assessment related to the pre-acquisition years of Delta of $2,600, net of Federal benefit. The matter is closed, and the Company adjusted the previously recorded liability based upon the settlement.

 

23


Table of Contents

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”)

School Specialty 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 revenues and profitability have historically 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 school start dates, the Company views a year-over-year comparison of the first nine 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 Company’s third quarter is historically its lowest revenue and volume quarter. Thus, small changes, whether positive or negative, can have a more dramatic impact on margins.

During the first nine months of fiscal 2012, revenue decreased 3.5% as compared to the first nine months of fiscal 2011. The Educational Resources and Accelerated Learning segments experienced revenue declines in the first nine months of fiscal 2012 of 0.7% and 9.5%, respectively. Educational Resources segment revenue appears to have stabilized as compared with declines in previous years. The Company believes this indicates prior year execution issues in pricing and bid strategy have been corrected and that school funding for Educational Resources products reached its low point in the prior fiscal year. The Company believes that the revenue decline in the Accelerated Learning segment is largely a result of softening agenda revenue, as well as a postponement of school district’s curriculum purchases until next generation core education standards in science and math are finalized and local funding is stabilized at stronger levels. The Company expects these standards to be finalized in calendar 2012.

Gross margin decreased 200 basis points to 38.7% for the first nine months of fiscal 2012 compared to 40.7% for the first nine months of fiscal 2011. The decreased gross margin was related to decreased revenue in the Accelerated Learning segment which has a higher gross margin, as well as higher product costs and higher freight costs attributable to fuel costs.

Total SG&A declined by $9.1 million in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011. SG&A decreased 30 basis points as a percent of revenue in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011. The decrease in SG&A as a percent of revenue is due to compensation –related decisions during the year including employee furloughs and a reduction in force. The Company’s current full-time staffing is down approximately 200 individuals, or 10%, as compared to last year’s third quarter.

In the third quarter of fiscal 2012, the Company sold the Seeds of Science/Roots of Reading product line for $6.7 million. The Company sold assets of $2.3 million and recorded a gain on the sale of assets of $4.4 million.

In the first nine months of fiscal 2012, the Company recorded $107.5 million of pre-tax non-cash impairment charges to reduce the carrying value of goodwill and indefinite-lived intangible assets of the Educational Resources and Califone reporting units, which are part of the Educational Resources segment, and the Science, Planning and Student Development and Reading reporting units, which are part of the Accelerated Learning segment. The triggering event was a combination of the continued decrease in the Company’s market capitalization and declines in the Company’s forecasted future years’ operating results and cash flows. The subsequent testing indicated that goodwill and indefinite-lived intangible assets were impaired.

In the first nine months of fiscal 2011, the Company recorded $411.4 million of pre-tax non-cash impairment charges primarily to reduce the carrying value of goodwill of 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. The Company experienced a significant decline in revenue and operating income in the first quarter, as education spending continued to suffer from the ongoing economic downturn. This, coupled with the decline in the Company’s market capitalization during the first quarter of fiscal 2011, led to the determination during that period that goodwill and an indefinite-lived tradename were impaired.

 

24


Table of Contents

Operating loss was $73.4 million in the first nine months of fiscal 2012, a decrease of $295.8 million from the prior year’s comparable period. Net loss was $82.2 million in the first nine months of fiscal 2012, a decrease of $251.5 million from a net loss of $333.7 million in the first nine months of fiscal 2011.

Results of Continuing Operations

The following table sets forth various items as a percentage of revenues for the three and nine months ended January 28, 2012 and January 22, 2011:

 

     Three Months Ended     Nine Months Ended  
     January 28,
2012
    January 22,
2011
    January 28,
2012
    January 22,
2011
 

Revenues

     100.0     100.0     100.0     100.0

Cost of revenues

     64.1        63.3        61.3        59.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     35.9        36.7        38.7        40.7   

Selling, general and administrative expenses

     63.4        65.8        33.8        34.1   

Other general expenses

     (5.1)        —          (0.7)        —     

Impairment Charges

     126.1        —          17.5        64.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (148.5)        (29.1)        (11.9)        (58.2)   

Interest expense, net

     7.4        7.1        3.6        3.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before benefit from income taxes

     (155.9)        (36.2)        (15.5)        (61.5)   

Benefit from income taxes

     (35.0)        (14.8)        (2.4)        (9.1)   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before investment in unconsolidated affiliate

     (120.9)     (21.4)     (13.1)     (52.4)
  

 

 

   

 

 

   

 

 

   

 

 

 

Three months Ended January 28, 2012 Compared to Three months Ended January 22, 2011

Revenue

Revenue decreased 5.1% from $89.9 million for the three months ended January 22, 2011 to $85.3 million for the three months ended January 28, 2012.

Educational Resources segment revenue increased 0.9% from $69.8 million for the three months ended January 22, 2011 to $70.4 million for the three months ended January 28, 2012. The increase in Educational Resources segment revenue was comprised of an increase of approximately $1 million in the supplies category offset by a modest decline in the furniture category. The Company believes this indicates prior year execution issues in pricing and bid strategy have been corrected and that school funding for Educational Resources products reached its low point in the prior fiscal year.

Accelerated Learning segment revenue decreased by 28.1% from $19.9 million for the three months ended January 22, 2011 to $14.3 million for the three months ended January 28, 2012. The decline in revenue is a result of the continued softness in curriculum orders, particularly in Science and Reading. Science revenues declined by approximately $4 million in the quarter, as order count and average order size fell. Reading revenue declined by $2.5 million with margin shortfalls in digital solutions. The wait for next generation core education standards in science and math continues to result in the delay of curriculum orders. The Company believes schools will continue to be hesitant to make these curriculum purchases until core standards are finalized and state and local budget pressures subside, to a greater extent.

 

25


Table of Contents

Gross Profit

Gross profit decreased 7.0%, from $32.9 million for the three months ended January 22, 2011 to $30.6 million for the three months ended January 28, 2012. The decrease in consolidated revenue resulted in $1.7 million of the decline in gross profit had consolidated gross margin remained constant. Gross margin decreased 80 basis points from 36.7% for the three months ended January 22, 2011 to 35.9% for the three months ended January 28, 2012. The decrease in consolidated gross margin resulted in a decrease in gross profit of approximately $0.6 million. A shift in product mix between the Company’s segments accounted for approximately 75 basis points of the decrease in gross margin. The Accelerated Learning segment, which generates a higher gross margin, due to its curriculum-based products, than the Educational Resources segment, accounted for 17% of the consolidated revenue in the third quarter of fiscal 2012 compared to 22% of the consolidated revenue in the third quarter of fiscal 2011.

Educational Resources segment gross profit increased $1.5 million from $22.2 million for the three months ended January 22, 2011 to $23.7 million for the three months ended January 28, 2012. Gross margin in the segment increased 190 basis points from 31.8% for the three months ended January 22, 2011 to 33.7% for the three months ended January 28, 2012. Approximately 220 basis points of the increase in gross margin is related to favorable pricing and product mix within the quarter. After the fiscal 2011 back to school season, the Company modified its pricing strategy to help customers by focusing on better communication of the new price strategy as well as accommodating various customer pricing and discount programs to stabilize price erosion. The more favorable pricing is due to the improved data and analytics within the pricing organization. The Company’s 2012 Big Book Catalog, with increased pricing, was successfully delivered to the market place during the fiscal third quarter of 2012 and reflects the new pricing strategies. Offsetting the increase in gross margin is approximately 50 basis points of a decrease in gross margin due to higher product costs.

Accelerated Learning segment gross profit decreased $3.9 million from $10.3 million for the three months ended January 22, 2011 to $6.4 million for the three months ended January 28, 2012. The decrease in segment revenue resulted in approximately $2.9 million decline in gross profit had segment gross margin remained constant. The remaining decline in gross profit was related to a decline of 700 basis points in segment gross margin from 51.6% for the three months ended January 22, 2011 to 44.6% for the three months ended January 28, 2012. Approximately 280 basis points of the decline was related to increased product development amortization spread over a smaller revenue base. The remaining decline in gross margin was related to unfavorable product mix away from the higher margin curriculum products. Changes in product mix can and did have a more pronounced effect on gross margins in the third quarter since the quarter is historically the Company’s lowest revenue and volume quarter.

Selling, General and Administrative Expenses

SG&A includes selling expenses, the most significant of which are wages and sales 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.

As a percent of revenue, SG&A decreased from 65.8% for the three months ended January 22, 2011 to 63.4% for the three months ended January 28, 2012. SG&A decreased $5.1 million from $59.2 million in the third quarter of fiscal 2011 to $54.1 million in the third quarter of fiscal 2012. Approximately $4.4 million of the SG&A savings in the third quarter of fiscal 2012 is related to company-wide furloughs during the quarter and reduced headcount year-over-year. SG&A attributable to the Educational Resources and Accelerated Learning segments decreased a combined $6.5 million and Corporate SG&A increased $1.4 million in the third quarter as compared to last year’s third quarter. The increase in Corporate SG&A is a result of an increase in depreciation expense and corporate marketing costs within the quarter.

Educational Resources segment SG&A decreased $3.3 million, or 11.3%, from $29.5 million for the three months ended January 22, 2011 to $26.2 million for the three months ended January 28, 2012. SG&A decreased by approximately $1.3 million due to decreases in its variable costs such as transportation, warehousing, and selling expenses. The segment’s portion of the consolidated quarterly savings related to the above-mentioned furloughs was approximately $0.9 million. Educational Resources segment SG&A increased as a percent of revenues from 42.3% for the three months ended January 22, 2011 to 37.2% for the three months ended January 28, 2012.

Accelerated Learning segment SG&A decreased $3.1 million, or 15.4%, from $20.5 million for the three months ended January 22, 2011 to $17.4 million for the three months ended January 28, 2012. SG&A decreased by approximately $2.6 million in its variable costs such as transportation, warehousing and selling expenses associated with decreased revenues. The segment’s portion of the consolidated quarterly savings related to the above-

 

26


Table of Contents

mentioned furloughs was approximately $0.7 million. Accelerated Learning segment SG&A increased as a percent of revenues from 103.2% for the three months ended January 22, 2011 to 121.5% for the three months ended January 28, 2012.

Other General Expense

In the third quarter of fiscal 2012, the Company sold the Seeds of Science/Roots of Reading product line for $6.7 million. The Company sold assets of $2.3 million associated with the product line and recorded a gain on the sale of assets of $4.4 million.

Impairment

The Company recorded $107.5 million of impairment charges in the third quarter of fiscal 2012 due to a triggering event in the quarter. The goodwill impairment charge was $86.5 million, which consisted of $47.4 million, $20.3 million, $7.8 million and $11.0 million for the Planning and Student Development, Science, Reading and Califone reporting units, respectively. An impairment of $21.0 million was related to indefinite-lived intangible assets of both the Educational Resources and Accelerated Learning segments.

Interest Expense

Net interest expense decreased $0.1 million from $6.4 million for the three months ended January 22, 2011 to $6.3 million for the three months ended January 28, 2012. Non-cash interest expense associated with the Company’s convertible notes increased by $0.1 million. This expense was partially offset by decrease in the amortization of debt fees and other commitment fees.

Benefit from Income Taxes

Benefit from income taxes increased $16.4 million from a benefit of $13.3 million in the third quarter of fiscal 2011 to a benefit of $29.8 million in the third quarter of fiscal 2012. The current year benefit from income taxes includes $22.0 million of income tax benefit related to the $107.5 million goodwill and indefinite-lived intangible asset impairment. Approximately $52.6 million of the goodwill and non-amortizable intangible asset impairment was related to non-deductible goodwill and non-amortizable intangible assets associated with past stock acquisition for which a tax benefit was not recorded. The remaining impairment $54.9 million generated the $22.0 of tax benefit. Excluding the impairment charge, the benefit from income taxes in the third quarter of fiscal 2012 was $7.8 million as compared to $13.3 million in the third quarter of fiscal 2011. The remaining decrease in the benefit from income taxes was due primarily to tax related to the gain on sale of assets as well as a $2.9 million valuation allowance for expiring tax carry forwards. The effective tax rate in the third quarter of fiscal 2012 was 22.5%, which was impacted by the non-deductible portion of the goodwill charge. Excluding impairment, the effective tax rate was 30.8% in the third quarter of fiscal 2012 as compared to 41.1% in the third quarter of fiscal 2011. This change is related to the above-mentioned valuation allowance.

 

27


Table of Contents

Nine Months Ended January 28, 2012 Compared to Nine Months Ended January 22, 2011

Revenue decreased 3.5% from $634.7 million for the nine months ended January 22, 2011 to $612.7 million for the nine months ended January 28, 2012.

Educational Resources segment revenue decreased 0.7% from $432.9 million for the nine months ended January 22, 2011 to $429.7 million for the nine months ended January 28, 2012. The decline in Educational Resources segment revenue was comprised of a decline of approximately $2 million in the supplies category and a decline of approximately $1 million in the furniture category. Based on the modest declines and improvements in recent ordering trends, the Company continues to believe that the prior fiscal year was the low point of education funding and demand for Educational Resources products and school spending may have stabilized. In addition, the Company believes that prior year execution issues in bid and pricing strategies have been resolved. Revenue for the supplies category declined in the first nine months of fiscal 2011 due to execution issues in both the consolidation of the Company’s bid departments, which respond to customer bid requests, and the streamlining of the Company’s pricing and discount structure. The consolidation of the Company’s bid departments resulted in an organization that was not properly staffed to effectively respond to bid opportunities. Thus, the Company’s number of successful bid awards was negatively impacted, which the Company believes contributed to decreased revenue. The Company has addressed the staffing issues in the consolidated bid department and believes it is more effectively responding to customer bid requests in fiscal 2012. For the fiscal 2011 back to school season, the Educational Resources segment of the Company consolidated pricing strategies of various brands. Historically, the Educational Resources segment used a variety of price and discount strategies for its different brands and catalogs. In moving to a consolidated pricing structure that was common to all brands, catalog prices and discounts were revised with the intention of creating a more consistent and easier to understand pricing structure for the customer. This consolidated pricing structure instead created customer confusion in fiscal 2011 due to the Company’s ineffective communication of these new price points and discounting to the customer. The Company believes that this customer confusion contributed to a revenue decline in the first nine months of fiscal 2011 and led to the Company offering steeper price discounts in order to prevent any further revenue erosion. The Company believes that better communication to customers of its pricing strategy has stabilized price erosion and its impact on revenue and gross margin.

Accelerated Learning segment revenues decreased by 9.5% from $201.3 million for the nine months ended January 22, 2011 to $182.2 million for the nine months ended January 28, 2012. Approximately $11 million of the decline is related to the Company’s student planner and agenda products. Reductions in school funding of planners and agendas resulted in a combination of schools electing to forego agenda purchases entirely in the current school year, schools transitioning to lower selling priced agendas or lost business to lower-end competitors. The remaining decline was attributable to the Company’s curriculum products for which demand has softened as schools are delaying purchases. The Company believes these delayed purchases are related to softening agenda revenue as well as the anticipated finalization of core education standards in science and math in calendar 2012. Partially offsetting the decline in the curriculum products was approximately $5.6 million of science adoption revenue in Indiana.

Gross Profit

Gross profit decreased 8.3% from $258.5 million for the nine months ended January 22, 2011 to $237.0 million for the nine months ended January 28, 2012. The decrease in consolidated revenue resulted in $9.0 million decline in gross profit had consolidated gross margin remained constant. The decrease in consolidated gross margin of 200 basis points decreased gross profit by $12.6 million. Gross margin decreased 200 basis points from 40.7% for the nine months ended January 22, 2011 to 38.7% for the nine months ended January 28, 2012. The decreased gross margin was related to higher price discounts within the Educational Resources segment due to competitive pricing within the market and decreased revenues and product mix in the Accelerated Learning segment around new curriculum-based materials. In addition, a shift in product mix between the Company’s segments accounted for approximately 50 basis points of gross margin decrease for the nine months ended January 28, 2012. The Accelerated Learning segment, which generates higher gross margin, due to its curriculum-based products, than the Educational Resources segment, accounted for 31.7% of the consolidated revenue for the nine months ended January 22, 2011 compared to 29.7% for the nine months ended January 28, 2012.

Educational Resources segment gross profit decreased $4.6 million from $143.0 million for the nine months ended January 22, 2011 to $138.4 for the nine months ended January 28, 2012. The decrease in segment revenue resulted in a $1.1 million decline in gross profit had segment gross margin remained constant. The decrease in gross margin

 

28


Table of Contents

of 80 basis points from 33.0% for the nine months ended January 22, 2011 to 32.2% for the nine months ended January 28, 2012 decreased gross profit by $4.5 million. Approximately 120 basis points of the decline in gross margin is related to cost increases such as higher freight costs attributable to fuel prices and substitution of higher cost domestic products to meet an increase in demand of products typically sourced overseas. The decline was partially offset by an increase of approximately 20 basis points in gross margin related to product mix shift towards more profitable products.

Accelerated Learning segment gross profit decreased $15.8 million from $113.5 million for the nine months ended January 22, 2011 to $97.7 for the nine months ended January 28, 2012. The decrease in segment revenue resulted in a $10.8 million decline in gross profit had segment gross profit remained constant. The decrease in gross margin of 280 basis points from 56.4% for the nine months ended January 22, 2011 to 53.6% for the nine months ended January 28, 2012 resulted in a decrease in gross margin of $5.4 million. Approximately 100 basis points of the decline was related to increased product development amortization spread over a smaller revenue base. The remaining decrease in gross margin was related to a loss of higher margin revenue associated with the Company’s curriculum products as well as increased plastic costs for agenda products.

Selling, General and Administrative Expenses

As a percent of revenue, SG&A decreased from 34.1% for the nine months ended January 22, 2011 to 33.8% for the nine months ended January 28, 2012. SG&A decreased $9.1 million from $216.3 million for the nine months ended January 22, 2011 to $207.2 million for the nine months ended January 28, 2012. Approximately $2.7 million of the SG&A savings for the nine months ended January 28, 2012 is related to company-wide furloughs during the year and reduced headcount year-over-year. SG&A attributable to the Educational Resources and Accelerated Learning segments decreased a combined $9.7 million and Corporate SG&A increased $0.6 million for the nine months ended January 28, 2012 as compared to last year’s nine months ended January 22, 2011. The increase in Corporate SG&A is a result of an increase in depreciation expense.

Educational Resources segment SG&A decreased $3.4 million, or 2.9%, from $114.5 million for the nine months ended January 22, 2011 to $111.1 million for the nine months ended January 28, 2012. The segment experienced a decrease of approximately $1.7 million in its variable SG&A costs such as transportation, warehousing, and selling expenses associated with decreased revenues. The segment’s portion of the consolidated quarterly savings related to the above-mentioned company-wide furloughs was approximately $1.3 million. Educational Resources segment SG&A decreased as a percent of revenues from 26.5% for the nine months ended January 22, 2011 to 25.9% for the nine months ended January 28, 2012.

Accelerated Learning segment SG&A decreased $6.3 million, or 8.8%, from $72.3 million for the nine months ended January 22, 2011 to $66.0 million for the nine months ended January 28, 2012. Reduced volume led to approximately $4.7 million of a decrease in the segment’s variable costs such as transportation, warehousing, and selling expenses. The segment’s portion of the consolidated quarterly savings related to the above-mentioned company-wide furloughs was approximately $1.0 million. Accelerated Learning segment SG&A increased as a percent of revenues from 35.9% for the nine months ended January 22, 2011 to 36.2% for the nine months ended January 28, 2012.

Other General Expense

In the third quarter of fiscal 2012, the Company sold the Seeds of Science/Roots of Reading product line for $6.7 million. The Company sold assets of $2.3 million associated with the product line and recorded a gain on the sale of assets of $4.4 million.

 

29


Table of Contents

Impairment

The Company recorded $107.5 million of impairment charges in the first nine months of fiscal 2012 based on an assessment conducted during the third quarter of fiscal 2012. The goodwill impairment charge was $86.5 million, which consisted of $47.4 million, $20.3 million, $7.8 million and $11.0 million for the Planning and Student Development, Science, Reading and Califone reporting units, respectively. An impairment of $21.0 million was related to indefinite-lived intangible assets of both the Educational Resources and Accelerated Learning segments.

The Company recorded $411.4 million of impairment charges in the first nine months of fiscal 2011 pursuant to its goodwill and intangible asset assessment. The goodwill impairment charge was $411.2 million, which consisted of $247.9 million, $55.4 million, and $106.1 million for the Educational Resources, Science, and Planning and Student Development reporting units, respectively. An impairment of $0.2 million was related to an indefinite-lived tradename intangible.

Interest Expense

Net interest expense increased $1.0 million from $21.2 million for the nine months ended January 22, 2011 to $22.2 million for the nine months ended January 28, 2012. Non-cash interest expense associated with the Company’s convertible notes decreased by approximately $0.4 million. This expense was partially offset by an increase of 40 basis points in the Company’s borrowings against its credit facility, as well as the expense associated with the convertible debt exchange of $1.1 million.

Benefit from Income Taxes

Benefit from income taxes decreased $42.9 million from a benefit of $57.8 million for the first nine months ended January 22, 2011 to a benefit of $14.9 million for the first nine months ended January 28, 2012. The current year and prior year benefit from income taxes includes $22.0 million and $66.5 million, respectively, of income tax benefit related to the $107.5 million goodwill and non-amortizable asset impairment for the nine months ended January 28, 2012 and $411.4 million goodwill impairment for the nine months ended January 22, 2011. For the nine months ended January 28, 2012 and January 22, 2011, approximately $52.6 million and $237.8 million, respectively, of the goodwill and non-amortizable intangible asset impairment was related to non-deductible goodwill and non-amortizable intangible assets associated with a past stock acquisition for which a tax benefit was not recorded. The remaining $54.9 million impairment generated the $22.0 million of tax benefit for the nine months ended January 28, 2012 and the remaining $173.4 million impairment generated the $66.5 million of tax benefit for the nine months ended January 22, 2011. Excluding the impairment charge, the tax provision for the first nine months of fiscal 2012 was $7.1 million as compared to $8.6 million in the first nine months of fiscal 2011. The decrease is related to the decrease in earnings before tax offset by $2.9 million valuation allowance for expiring tax carry forwards. Excluding impairment, the effective tax rate was 60.0% in the first nine months of fiscal 2012 as compared to 41.1% in the first nine months of fiscal 2011. This increase is related to the above-mentioned valuation allowance.

Excluding impairment, the effective income tax rate of 60.0% exceeds the federal statutory rate of 35% primarily due to the valuation allowance for expiring tax carry forwards which the Company does not expect to utilize based on its current projections.

Liquidity and Capital Resources

At January 28, 2012, the Company had working capital of $79.4 million. The Company’s capitalization at January 28, 2012 was $384.6 million and consisted of total debt of $266.1 million and shareholders’ equity of $118.5 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 entered into amendments to the Credit Agreement. The amended Credit Agreement matures on April 23, 2014 and provided borrowing capacity of $242.5 million. This capacity consists of a revolving loan of $200 million and a delayed draw term loan of up to $42.5 million, which was used to refinance a portion of the Company’s convertible notes. 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

 

30


Table of Contents

unborrowed funds. For the nine months ended January 28, 2012, the effective interest rate under the credit facility was 6.28% which includes amortization of loan origination fees of $1.0 million and commitment fees on unborrowed funds of $0.4 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 January 28, 2012. As of January 28, 2012, the outstanding balance on the revolving loan and the delayed-draw term loan were $98.5 million and $34.8 million, respectively, and were 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 contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures. The Company was in compliance with financial covenants as of January 28, 2012.

The Company closely evaluates its expected ability to remain in compliance with the consolidated total and senior leverage and interest coverage ratios. The recent economic trends impacting the Company’s performance, such as the decline in school funding, which had led to a decrease in the Company’s revenues and margins, have put pressure on the Company’s ability to remain in compliance with these ratios. Based on the low end of the range of the Company’s current forecasts reflected in our most recent guidance, the Company may be unable to comply with one or all of these financial covenants in the fourth quarter of fiscal 2012. The Company may need to work with its lenders to secure a waiver or amend such ratios or to refinance these obligations in the near future. Any amendment, waiver or refinancing may result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings. The Company believes it will be able to maintain compliance with the financial covenants by working with its lenders, if an amendment or waiver is necessary. If the Company fails to maintain compliance with the covenants and fails to obtain amendments to or waivers under the Credit Agreement or refinancing, the Company’s lenders could take remedies pursuant to the agreement. If acceleration occurs, the Company may have difficulty in obtaining sufficient additional funds to refinance the accelerated debt.

Holders of the Company’s $133.0 million, 3.75% convertible subordinated notes due 2023 presented $132.9 million in aggregate principal 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, the Company sold $200.0 million of the 2006 Debentures, of which $42.5 million remained outstanding and were repaid during the third quarter of fiscal 2012. The 2006 Debentures were unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and were convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company would have been required to deliver cash equal to the lesser of the aggregate principal amount of 2006 Debentures to be converted and the Company’s total conversion obligation, and would have been required to deliver, at the Company’s option, cash or shares of our common stock in respect of the remainder, if any, of our conversion obligation. The initial conversion rate was 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 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 2006 Debentures.

On November 30, 2011, the holders of the Company’s 2006 Debentures presented to the Company for redemption $42.4 million of the $42.5 million 2006 Debentures outstanding. The Company satisfied the $42.4 repayment in cash by borrowing on its credit facility, as permitted under the terms of the credit facility. The remaining outstanding amount of this issuance, $0.6 million, was called by the Company during the third quarter of fiscal 2012.

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, the 2011 Debentures, also due November 30, 2026. 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

 

31


Table of Contents

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 provided by operating activities decreased $49.6 million to $34.0 million in the first nine months of fiscal 2012 as compared to $83.6 million provided in the first nine months of fiscal 2011. The decline in net income, adjusted for non-cash items contributed approximately $5.1 million to the decline in operating cash flow. Approximately $14 million of the decrease in operating cash flow was related to the timing of income tax payments. The remaining decline was a result of planned early inventory purchases made during the Company’s fourth quarter of fiscal 2011 and paid for during fiscal 2012.

Net cash used in investing activities for the first nine months of fiscal 2012 was $5.5 million as compared to $16.9 million for the first nine months of fiscal 2011. The decrease in cash used in investing activities was primarily attributable to $6.7 million received during the first nine months of fiscal 2012 related to the sale of assets. Additions to property, plant and equipment decreased $3.6 million from the first nine months of fiscal 2011 to $6.6 million in the first nine months of fiscal 2012. Product development spending decreased $1.1 million from the first nine months of fiscal 2012 to $5.6 million in the first nine months 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.

Net cash used in financing activities decreased $48.7 million from $86.1 million in the first nine months of fiscal 2011 to $37.4 million in the first nine months of fiscal 2012. The decrease in net cash used by financing activities was primarily related to the Company’s repayment of its borrowings on the credit facility in the first nine months of fiscal 2012 as compared to fiscal 2011.

Fluctuations in Quarterly Results of Operations

The Company’s business is subject to seasonal fluctuations. The Company’s historical revenue and profitability have been dramatically higher in the first two quarters of its 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 the Company’s costs for the products sold, the mix of products sold and general economic conditions. Moreover, the operating margins of businesses the Company acquires may differ substantially from its own, which could contribute to further fluctuation in quarterly operating results. Therefore, results for any fiscal quarter are not indicative of the results that the Company may achieve for any subsequent fiscal quarter or for a full fiscal year.

Inflation

Inflation, particularly in fuel and other oil-related costs, has had and is expected to continue 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 7 of the condensed consolidated financial statements, in the third quarter of fiscal 2012 and the first quarter of fiscal 2011 the Company recorded impairment charges of $86.5 million and $411.2 million, respectively to goodwill and $21.0 million and $0.2 million, respectively to indefinite-lived intangible assets. 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 7 of the condensed consolidated financial statements. 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.

 

32


Table of Contents

The fair value assessments in the third 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 was impaired as the fair value exceeded the carrying value of the units. As a result, the Company recorded impairment charges of $11.0 million, $7.8 million, $20.3 million and $47.4 million to the reporting units of Califone, Reading, Science and Planning and Student Development, respectively.

The fair value assessment in the third quarter of fiscal 2012 on the indefinite-lived intangible assets indicated the fair value exceeded the carrying value. As a result the Company recorded an impairment of $21.0 million to non-amortizable trademark and tradename.

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 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, capital expenditures and adequacy of capital resources; 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” 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 effect, our internal control over financial reporting.

 

33


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 nine months of fiscal 2011.

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 our Annual Report on Form 10-K for the fiscal year ended April 30, 2011.

ITEM 6. Exhibits

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

 

34


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)

March 7, 2012       /s/ Michael P. Lavelle
Date       Michael P. Lavelle
     

Chief Executive Officer

(Principal Executive Officer)

March 7, 2012      

/s/ David N. Vander Ploeg

Date      

David N. Vander Ploeg

     

Executive Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

 

35


Table of Contents

EXHIBIT INDEX

 

Exhibit No.

 

Description

10.1   Employment Agreement between School Specialty, Inc. and Michael P. Lavelle dated as of January 12, 2012, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated as of January 12, 2012.
10.2   Stock Option Agreement (Inducement Option) between School Specialty, Inc. and Michael P. Lavelle dated as of January 12, 2012, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated as of January 12, 2012.
10.3   Stock Option Agreement (Plan Option) between School Specialty, Inc. and Michael P. Lavelle dated as of January 12, 2012, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated as of January 12, 2012.
10.4   Restricted Stock Agreement between School Specialty, Inc. and Michael P. Lavelle dated as of January 12, 2012, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated as of January 12, 2012.
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 January 28, 2012 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 Comprehensive Income, (iv) the Condensed Consolidated Statement of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

36