Attached files
file | filename |
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EX-32.2 - EX-32.2 - SCHOOL SPECIALTY INC | d550624dex322.htm |
EX-32.1 - EX-32.1 - SCHOOL SPECIALTY INC | d550624dex321.htm |
EX-31.2 - EX-31.2 - SCHOOL SPECIALTY INC | d550624dex312.htm |
EX-31.1 - EX-31.1 - SCHOOL SPECIALTY INC | d550624dex311.htm |
EX-10.3 - EX-10.3 - SCHOOL SPECIALTY INC | d550624dex103.htm |
EX-10.2 - EX-10.2 - SCHOOL SPECIALTY INC | d550624dex102.htm |
EX-10.1 - EX-10.1 - SCHOOL SPECIALTY INC | d550624dex101.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: |
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018
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)
Delaware | 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
(Registrants 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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of large accelerated filer, accelerated filer, smaller reporting company, and emerging growth company in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer | ☐ | Accelerated filer | ☒ | |||
Non-accelerated filer | ☐ (Do not check if a smaller reporting company) | Emerging growth company | ☐ | |||
Smaller reporting company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the Registrants common stock held by non-affiliates as of June 30, 2017 was $77,217,446.
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
Outstanding at August 7, 2018 |
|||
Common Stock, $0.001 par value |
7,000,000 |
Table of Contents
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018
-Index-
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Unaudited Financial Statements
SCHOOL SPECIALTY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In Thousands, except share and per share amounts)
June 30, 2018 | December 30, 2017 | July 1, 2017 | ||||||||||
ASSETS |
||||||||||||
Current assets: |
||||||||||||
Cash and cash equivalents |
$ | 8,640 | $ | 31,861 | $ | 6,900 | ||||||
Accounts receivable, less allowance for doubtful accounts of $1,310, $1,059, and $1,136, respectively |
90,470 | 69,297 | 87,461 | |||||||||
Inventories, net |
131,761 | 77,162 | 124,906 | |||||||||
Deferred catalog costs |
| 3,450 | 6,762 | |||||||||
Prepaid expenses and other current assets |
21,154 | 14,121 | 11,145 | |||||||||
Refundable income taxes |
2,115 | 547 | 1,325 | |||||||||
|
|
|
|
|
|
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Total current assets |
254,140 | 196,438 | 238,499 | |||||||||
Property, plant and equipment, net |
32,063 | 33,579 | 32,180 | |||||||||
Goodwill |
26,842 | 26,842 | 21,588 | |||||||||
Intangible assets, net |
35,184 | 37,163 | 33,247 | |||||||||
Development costs and other |
16,191 | 16,339 | 12,600 | |||||||||
Deferred income taxes long-term |
8,347 | 2,046 | 193 | |||||||||
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|
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Total assets |
$ | 372,767 | $ | 312,407 | $ | 338,307 | ||||||
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LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||
Current liabilities: |
||||||||||||
Current maturitieslong-term debt |
$ | 64,600 | $ | 10,989 | $ | 46,882 | ||||||
Accounts payable |
61,894 | 26,591 | 59,125 | |||||||||
Accrued compensation |
8,209 | 11,995 | 9,173 | |||||||||
Contract liabilities |
5,804 | 3,454 | 2,808 | |||||||||
Accrued royalties |
1,998 | 5,699 | | |||||||||
Other accrued liabilities |
12,265 | 15,442 | 12,547 | |||||||||
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|
|
|
|
|||||||
Total current liabilities |
154,770 | 74,170 | 130,535 | |||||||||
Long-term debtless current maturities |
130,437 | 130,574 | 124,849 | |||||||||
Other liabilities |
792 | 172 | 169 | |||||||||
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Total liabilities |
285,999 | 204,916 | 255,553 | |||||||||
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Commitments and contingenciesNote 16 |
||||||||||||
Stockholders equity: |
||||||||||||
Preferred stock, $0.001 par value per share, 500,000 shares authorized; none outstanding |
| | | |||||||||
Common stock, $0.001 par value per share, 50,000,000 shares authorized; 7,000,000 shares outstanding |
7 | 7 | 7 | |||||||||
Capital in excess of par value |
124,149 | 123,083 | 121,940 | |||||||||
Accumulated other comprehensive loss |
(1,832 | ) | (1,425 | ) | (1,600 | ) | ||||||
Accumulated deficit |
(35,556 | ) | (14,174 | ) | (37,593 | ) | ||||||
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|||||||
Total stockholders equity |
86,768 | 107,491 | 82,754 | |||||||||
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|
|
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Total liabilities and stockholders equity |
$ | 372,767 | $ | 312,407 | $ | 338,307 | ||||||
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|
|
See accompanying notes to condensed consolidated financial statements.
1
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 Six Months Ended | |||||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Revenues |
$ | 169,272 | $ | 160,177 | $ | 268,559 | $ | 257,288 | ||||||||
Cost of revenues |
110,528 | 99,682 | 173,694 | 162,269 | ||||||||||||
|
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|
|
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|
|
|||||||||
Gross profit |
58,744 | 60,495 | 94,865 | 95,019 | ||||||||||||
Selling, general and administrative expenses |
53,808 | 51,721 | 110,946 | 99,189 | ||||||||||||
Facility exit costs and restructuring |
171 | 44 | 482 | 217 | ||||||||||||
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|
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|
|||||||||
Operating income (loss) |
4,765 | 8,730 | (16,563 | ) | (4,387 | ) | ||||||||||
Other expense (income): |
||||||||||||||||
Interest expense |
3,688 | 4,197 | 7,194 | 8,247 | ||||||||||||
Loss on early extinguishment of debt |
| 4,298 | | 4,298 | ||||||||||||
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|
|
|
|||||||||
Income (loss) before provision for (benefit from) income taxes |
1,077 | 235 | (23,757 | ) | (16,932 | ) | ||||||||||
Provision for (benefit from) income taxes |
1,059 | 99 | (5,097 | ) | (292 | ) | ||||||||||
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|
|
|
|
|
|||||||||
Net income (loss) |
$ | 18 | $ | 136 | $ | (18,660 | ) | $ | (16,640 | ) | ||||||
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|
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Weighted average shares outstanding: |
||||||||||||||||
Basic EPS |
7,000 | 7,000 | 7,000 | 7,000 | ||||||||||||
Diluted EPS |
7,129 | 7,077 | 7,000 | 7,000 | ||||||||||||
Net loss per Share: |
||||||||||||||||
Basic |
$ | 0.00 | $ | 0.02 | $ | (2.67 | ) | $ | (2.38 | ) | ||||||
Diluted |
$ | 0.00 | $ | 0.02 | $ | (2.67 | ) | $ | (2.38 | ) |
See accompanying notes to condensed consolidated financial statements.
2
Table of Contents
SCHOOL SPECIALTY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(In Thousands)
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Net income (loss) |
$ | 18 | $ | 136 | $ | (18,660 | ) | $ | (16,640 | ) | ||||||
Other comprehensive income, net of tax: |
||||||||||||||||
Foreign currency translation adjustments |
(171 | ) | 139 | (407 | ) | 184 | ||||||||||
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Total comprehensive income (loss) |
$ | (153 | ) | $ | 275 | $ | (19,067 | ) | $ | (16,456 | ) | |||||
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See accompanying notes to condensed consolidated financial statements.
3
Table of Contents
SCHOOL SPECIALTY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
For the Six Months Ended | ||||||||
June 30, 2018 | July 1, 2017 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (18,660 | ) | $ | (16,640 | ) | ||
Adjustments to reconcile net income to net cash used in operating activities: |
||||||||
Depreciation and intangible asset amortization expense |
9,393 | 6,473 | ||||||
Amortization of development costs |
2,687 | 2,283 | ||||||
(Gain) on disposal of assets |
(20 | ) | | |||||
Amortization of debt fees and other |
541 | 797 | ||||||
Loss on early extinguishment of debt |
| 4,298 | ||||||
Unrealized foreign exchange (gain) loss |
69 | (30 | ) | |||||
Share-based compensation expense |
1,066 | 1,091 | ||||||
Deferred taxes |
(5,355 | ) | (7 | ) | ||||
Non-cash interest expense |
1,170 | 1,921 | ||||||
Changes in current assets and liabilities: |
||||||||
Accounts receivable |
(21,261 | ) | (25,665 | ) | ||||
Inventories |
(56,071 | ) | (51,254 | ) | ||||
Deferred catalog costs |
| (1,526 | ) | |||||
Prepaid expenses and other current assets |
(6,850 | ) | 233 | |||||
Accounts payable |
35,118 | 37,141 | ||||||
Accrued liabilities |
(7,744 | ) | (5,353 | ) | ||||
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Net cash used by operating activities |
(65,917 | ) | (46,238 | ) | ||||
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Cash flows from investing activities: |
||||||||
Additions to property, plant and equipment |
(5,978 | ) | (8,167 | ) | ||||
Investment in product development costs |
(2,650 | ) | (1,050 | ) | ||||
Proceeds from sale of assets |
100 | | ||||||
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Net cash used in investing activities |
(8,528 | ) | (9,217 | ) | ||||
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Cash flows from financing activities: |
||||||||
Proceeds from bank borrowings |
117,228 | 220,485 | ||||||
Repayment of debt and capital leases |
(65,166 | ) | (189,267 | ) | ||||
Earnout payment for acquisition |
(625 | ) | | |||||
Payment of debt fees and other |
| (4,009 | ) | |||||
Net cash provided in financing activities |
51,437 | 27,209 | ||||||
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Effect of exchange rate changes on cash |
(213 | ) | 49 | |||||
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Net decrease in cash and cash equivalents |
(23,221 | ) | (28,197 | ) | ||||
Cash and cash equivalents, beginning of period |
31,861 | 35,097 | ||||||
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Cash and cash equivalents, end of period |
$ | 8,640 | $ | 6,900 | ||||
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Supplemental disclosures of cash flow information: |
||||||||
Interest paid |
$ | 5,483 | $ | 5,529 | ||||
Income taxes paid, net |
$ | 1,245 | $ | 244 |
See accompanying notes to condensed consolidated financial statements.
4
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (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 GAAP for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature unless otherwise noted) considered necessary for a fair presentation have been included. The balance sheet at December 30, 2017 has been derived from School Specialty, Inc.s (School Specialty or the Company) audited financial statements for the period ended December 30, 2017. For further information, refer to the consolidated financial statements and notes thereto included in the Companys Form 10-K for the period ended December 30, 2017.
NOTE 2 INCREASED AUTHORIZED SHARES AND STOCK-SPLIT
At the Special Meeting of Stockholders of School Specialty, Inc. (the Company) held on August 15, 2017, the Companys stockholders voted on a proposal to approve the proposed amendment to the Companys Amended and Restated Certificate of Incorporation, as amended, to increase the number of authorized shares of common stock, par value $0.001 per share, of the Company (Common Stock) from 2,000 to 50,000 shares (the Amendment) for the purpose of, among other things, effecting a seven-for-one stock split of the Common Stock as part of the Amendment. Our condensed consolidated financial statements, related notes, and other financial data contained in this report have been adjusted to give retroactive effect to the increased authorization and stock split for all periods presented.
NOTE 3 RECENT ACCOUNTING PRONOUNCEMENTS
In June 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-07, Compensation Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 simplifies the accounting for non-employee stock based compensation. Specifically, stock based compensation to non-employees is now measured on the grant date by estimating the fair value of the equity compensation to be issued. Entities should remeasure non-employee stock based compensation only for those not settled as of the measurement date through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2018, including interim periods within those annual periods, and early adoption is permitted for interim or annual periods, but no earlier than the entitys adoption date of Topic 606. The adoption is not expected to have a material impact on the consolidated financial statements.
In February 2018, the FASB issued Accounting Standards Update ASU No. 2018-02, Income Statement Reporting Comprehensive Income: Reclassification of Certain Tax Effect from Accumulated Other Comprehensive Income. ASU 2018-02 permits a company to reclassify the income tax effects of the U.S. Tax Cuts and Jobs Act of 2017 (the Tax Act) on items within accumulated other comprehensive income or loss (AOCI-L) to retained earnings. Because most items that are charged to AOCI-L are recorded net of applicable income taxes, the subsequent reclassification of these items from AOCI-L to the statement of operations will be at different income tax rates due to the Tax Act, thereby leaving a stranded tax balance within AOCI-L. ASU 2018-02 will allow a company to transfer these stranded amounts from AOCI-L to retained earnings. ASU 2018-02 will be effective for the Company at the beginning of fiscal 2019, with early adoption permitted. The adoption is not expected to have a material impact on the consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, CompensationStock Compensation: Scope of Modification Accounting. ASU 2017-09 amends the scope of modification accounting for share-based payment arrangements. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early adoption is permitted for interim or annual periods. The adoption did not have a material impact on the consolidated financial statements.
5
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU No. 2016-02 requires lessees to recognize the assets and liabilities arising from leases on the balance sheet. The new guidance requires that all leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements. This guidance will be effective for periods beginning after December 15, 2018. The Company is currently in the process of evaluating the impact of adoption of this ASU on the Companys consolidated financial statements.
NOTE 4 CHANGE IN ACCOUNTING PRINCIPLE
In the first quarter of 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers. ASU No. 2014-09 provides guidance for revenue recognition. The standards core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. The guidance within this standard must be applied using either of the following transition methods: (1) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (2) a modified retrospective approach with the cumulative effect of initially adopting the standard recognized at the date of adoption (which requires additional footnote disclosures). The Company chose to adopt ASC 606 using the modified retrospective approach applied to contracts not completed as of the date of adoption. We recognized the cumulative effect of initially applying the new revenue standard, net of tax, as an increase of $2,722 to the opening balance of accumulated deficit. The comparative financial information has not been restated and continues to be reported under the accounting standards in effect for that period. We do not expect the adoption of the new revenue standard to have a material impact on our net income on an ongoing basis.
Revenue is recognized upon the satisfaction of performance obligations, which occurs when control of the good or service transfers to the customer. Approximately 98% of the Companys consolidated revenues are related to the sale of products. Under our standard contracts or purchase orders received from customers, the only performance obligation is the shipment of products. Revenue for products is recognized and the customer is invoiced when the control of the product transfers to the customer, which is generally when the product is shipped. The Company determines the time at which transfer and control of products has passed to its customers, and the time at which it is able to invoice the customers, based on review of contracts, sales agreements and purchase orders. Payment terms are generally established to be 30 days from the shipment date. We generally determine standalone selling prices based on the prices charged to customers for all material performance obligations.
The Company provides its customers an implicit right of return for full or partial refund. Prior to the adjustment for ASC 606 the Company reflected the right of return in accounts receivable. Under ASC 606 the Company has reclassified this right of return from accounts receivable into a combination of a refund liability, included within other accrued liabilities for the gross return or credit, and other current assets for the assumed value of the returned product.
Variable consideration is accounted for as a price adjustment (sales adjustment). Examples of variable consideration that affect the Companys reported revenue include implicit rights of return and trade promotions. Implicit rights of return are typically contractually limited, amounts are estimable based upon historic return levels, and the Company records provisions for anticipated returns at the time revenue is recognized. Trade promotions are offered to cooperatives and end users through various programs, generally with terms of one year or less. Such promotions typically involve rebates based on annual purchases. Payment of incentives generally take the form of cash and are paid according to the terms of their agreement, typically within a year. Rebates are accrued as sales occur based on the program rebate rates.
Amounts billed to customers for shipping and handling are included in revenues when control of the goods and services transfers to the customer. Shipping and handling is arranged with third party carriers in connection with delivering good to customers. Amounts billed to customers for sales tax are not included in revenues.
6
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company typically does not have contracts with significant financing components as payments are generally received within 60 days from the time of completion of the performance obligations. Cost incurred to obtain contracts are settled within 12 months of contract inception. Our accounting policy under ASC 606 remains consistent with past accounting policy whereby such costs are expensed as incurred.
In the analysis of the revenue streams, the Company identified two revenue streams for which the timing of revenue recognition would change.
1) | Furniture revenue associated with projects was previously recognized upon the completion of the project, or at customer acceptance. Under ASC 606, the Company has determined that is has two performance obligations within the project revenue stream: a) the delivery of equipment or furniture and b) the installation of the equipment or the furniture. For furniture associated with projects, the Company determined that control of the furniture was transferred to the customer upon delivery of the furniture to the customer site as the customer is in possession of the product at that time. The revenue attributable to the performance obligation associated with the delivery of the equipment is accelerated under the new revenue recognition standard and recognized upon delivery. The revenue attributable to installation is recognized over time during the installation process based on costs incurred relative to total expected installation costs. Under the contract terms the customer is not billed for the equipment or furniture or installation until the installation is complete. The Company allocates revenues to these two performance obligations using a cost plus margin approach, whereby gross margins are consistent for each component. The revenue associated with unsatisfied performance obligations for furniture is related to installation. The installation is typically completed and the associated revenue is recognized within approximately 90 days following the delivery of the equipment or furniture. The impact of this change in the second quarter of fiscal 2018 was the acceleration of the recognition of $5,388 of revenue and $1,144 of gross profit. The cumulative impact of this change year to date during fiscal 2018 was the acceleration of the recognition of $5,928 of revenue and $1,179 of gross profit. |
2) | Professional development or training days are provided to customers that order certain of the Companys curriculum products, the most prominent of which being the FOSS product line. The Company bills for these training days at the same time the customer is billed for the product based on the stand alone selling price. Prior to the adoption of ASC 606, the Company accrued the estimated costs associated with providing training days, when the product was shipped. After the adoption of ASC 606, the Company is deferring revenue associated with providing training days and will recognize the cost associated with providing the training when the costs are incurred. Training typically is completed and revenue is recognized within six to nine months following the shipment of the product. As the value of the training provided in both the three and six month periods ended June 30, 2018 exceeded the value of training days billed in the respective periods, the adoption of ASC 606 resulted in incremental revenue, gross profit and SG&A in each period. The impact of this change in the second quarter of fiscal 2018 was the recognition of $314 of both revenue and gross profit and SG&A of $175. The cumulative impact of this change year to date during fiscal 2018 was the recognition of $497 of both revenue and gross profit and SG&A of $221. |
3) | Certain customer contracts specifically indicate that the customer obtains control of the product upon delivery. While the Companys sales orders, invoices and catalog order forms indicate that control of the products has passed to the customer at time of shipment, a review of contracts has identified certain contracts for which the language associated with control of the product is deemed to supercede invoice terms and conditions. In the second quarter of fiscal 2018, this change resulted in the deferral of $1,016 of revenue and $394 of gross profit. The impact of this change as of 2017 year end and the end of the first quarter 2018 was immaterial, due primarily to the Companys seasonality. |
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company also evaluated its catalog costs under the new revenue recognition standard and determined that its catalog costs should be treated as costs incurred to obtain contracts. Since catalog costs are incurred regardless of whether specific customer contracts or purchase orders are obtained, catalog costs are now expensed as incurred. Under the prior guidance, the Company capitalized catalog costs and amortized over the period within which revenues attributable to the catalogs were generated, which was generally one year or less. The impact of this change resulted in lower catalog expense in SG&A by $1,697 in the second quarter of fiscal 2018. This reduction reflects the difference between catalog costs incurred during the period and the catalog amortization expense prior to adopting ASC 606. The cumulative impact of this change year to date during fiscal 2018 was the acceleration of the recognition of catalog costs in SG&A of $2,527.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The cumulative effect of the changes made to our consolidated condensed balance sheet on December 31, 2017 (the first day of our fiscal 2018) for the adoption of the new revenue standard was as follows:
Reported as of December 30, 2017 |
Adjustments Due to ASC 606 |
As Adjusted December 31, 2017 |
||||||||||
ASSETS |
||||||||||||
Accounts receivable (3) |
$ | 69,297 | $ | 458 | $ | 69,755 | ||||||
Inventories, net |
77,162 | (1,468 | ) | 75,694 | ||||||||
Deferred catalog costs |
3,450 | (3,450 | ) | | ||||||||
Prepaid expenses and other current assets (1) (3) |
14,121 | 2,043 | 16,164 | |||||||||
Deferred taxes long-term |
2,046 | 947 | 2,993 | |||||||||
|
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|
|
|
|
|||||||
Total Assets |
312,407 | (1,470 | ) | 310,937 | ||||||||
LIABILITIES |
||||||||||||
Contract liabilities (2) (4) |
3,454 | 2,723 | 6,177 | |||||||||
Other accrued liabilities (2) (3) |
15,442 | (1,471 | ) | 13,971 | ||||||||
|
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|
|
|
|
|||||||
Total Liabilities |
204,916 | 1,252 | 206,168 | |||||||||
STOCKHOLDERS EQUITY |
||||||||||||
Accumulated deficit |
$ | (14,174 | ) | $ | (2,722 | ) | $ | (16,896 | ) | |||
|
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|
|
|
|
|||||||
Total Stockholders Equity |
107,491 | (2,722 | ) | 104,769 | ||||||||
Total Liabilities and Stockholders Equity |
$ | 312,407 | $ | (1,470 | ) | $ | 310,937 |
(1) | Contract assets of $1,750 are included in Prepaid expenses and other current assets above. |
(2) | Customer rebates of $1,689 have been reclassified from Other accrued liabilities to Contract liabilities. |
(3) | The reserve for customer returns, refunds and allowances, in the amount of $458, was reclassified as follows: a) The amount associated with refund liabilities, of $755, has been reclassified to Other accrued liabilities; and b) The amount associated with the estimated value of returned product, of $297, has been reclassified to Prepaid expenses and other current assets. |
(4) | The amounts classified as Deferred revenues in the Companys December 30, 2017 consolidated balance sheets, have been reclassified to Contract liabilities in accordance with ASC 606. |
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The cumulative effect of the adjustments to our June 30, 2018 condensed consolidated statement of operations and condensed consolidated balance sheet for the adoption of ASC 606 were as follows:
For the Three Months Ended | For the Six Months Ended | |||||||||||||||||||||||
June 30, 2018 | June 30, 2018 | |||||||||||||||||||||||
Prior to Adoption of ASC 606 |
Adjustments Due to ASC 606 |
As Reported | Prior to Adoption of ASC 606 |
Adjustments Due to ASC 606 |
As Reported | |||||||||||||||||||
Revenues |
$ | 164,586 | $ | 4,686 | $ | 169,272 | $ | 263,151 | $ | 5,408 | $ | 268,559 | ||||||||||||
Cost of revenues |
106,906 | 3,622 | 110,528 | 169,567 | 4,127 | 173,694 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Gross profit |
57,680 | 1,064 | 58,744 | 93,584 | 1,281 | 94,865 | ||||||||||||||||||
Selling, general and administrative expenses |
55,330 | (1,522 | ) | 53,808 | 108,198 | 2,748 | 110,946 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Operating income (loss) |
2,179 | 2,586 | 4,765 | (15,096 | ) | (1,467 | ) | (16,563 | ) | |||||||||||||||
Income (loss) before benefit from income taxes |
(1,509 | ) | 2,586 | 1,077 | (22,290 | ) | (1,467 | ) | (23,757 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Benefit from (payment of) income taxes |
412 | 647 | 1,059 | (4,730 | ) | (367 | ) | (5,097 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net income (loss) |
$ | (1,921 | ) | $ | 1,939 | $ | 18 | $ | (17,560 | ) | $ | (1,100 | ) | $ | (18,660 | ) | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2018 | ||||||||||||
Prior to Adoption of ASC 606 |
Adjustments Due to ASC 606 |
As Reported | ||||||||||
ASSETS |
||||||||||||
Accounts receivable (3) |
$ | 90,733 | $ | (263 | ) | $ | 90,470 | |||||
Inventories, net |
137,354 | (5,593 | ) | 131,761 | ||||||||
Deferred catalog costs |
5,977 | (5,977 | ) | | ||||||||
Prepaid expenses and other current assets (1) (3) |
12,907 | 8,247 | 21,154 | |||||||||
Deferred taxes long-term |
7,980 | 367 | 8,347 | |||||||||
|
|
|
|
|
|
|||||||
Total Assets |
375,986 | (3,219 | ) | 372,767 | ||||||||
LIABILITIES |
||||||||||||
Contract liabilities (2) |
$ | 3,687 | $ | 2,117 | $ | 5,804 | ||||||
Other accrued liabilities (2) (3) |
12,838 | (573 | ) | 12,265 | ||||||||
|
|
|
|
|
|
|||||||
Total Liabilities |
284,455 | 1,544 | 285,999 | |||||||||
STOCKHOLDERS EQUITY |
||||||||||||
Accumulated deficit |
$ | (30,793 | ) | $ | (4,763 | ) | $ | (35,556 | ) | |||
|
|
|
|
|
|
|||||||
Total Stockholders Equity |
91,531 | (4,763 | ) | 86,768 | ||||||||
Total Liabilities and Stockholders Equity |
$ | 375,986 | $ | (3,219 | ) | $ | 372,767 |
(1) | Contract assets of $7,678 are included in Prepaid expenses and other current assets. |
(2) | Customer rebates of $1,578 have been reclassed from Other accrued liabilities to Contract liabilities. |
(3) | The reserve for customer returns, refunds and allowances, in the amount of $753, was reclassified as follows: a) The amount associated with refund liabilities, of $1,322, has been reclassified to Other accrued liabilities; and b) The amount associated with the estimated value of returned product, of $569, has been reclassified to Prepaid expenses and other current assets. |
The below table shows the Companys disaggregated revenues for the three months and six months ended June 30, 2018 and July 1, 2017.
10
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Distribution revenues by product line: |
||||||||||||||||
Supplies |
$ | 80,241 | $ | 76,756 | $ | 133,673 | $ | 134,955 | ||||||||
Furniture |
52,354 | 42,774 | 76,305 | 65,370 | ||||||||||||
Instruction & Intervention |
14,337 | 10,238 | 26,858 | 16,420 | ||||||||||||
AV Tech |
4,089 | 4,502 | 8,366 | 9,286 | ||||||||||||
Agendas |
4,588 | 6,476 | 4,834 | 6,746 | ||||||||||||
Freight Revenue |
2,581 | 2,454 | 4,387 | 3,993 | ||||||||||||
Customer Allowances / Discounts |
(2,415 | ) | (1,856 | ) | (4,028 | ) | (3,473 | ) | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Distribution Segment |
$ | 155,775 | $ | 141,344 | $ | 250,395 | $ | 233,297 | ||||||||
Curriculum revenues by product line: |
||||||||||||||||
Science |
$ | 13,497 | $ | 18,833 | $ | 18,164 | $ | 23,991 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Curriculum Segment |
$ | 13,497 | $ | 18,833 | $ | 18,164 | $ | 23,991 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total revenues |
$ | 169,272 | $ | 160,177 | $ | 268,559 | $ | 257,288 | ||||||||
|
|
|
|
|
|
|
|
Revenues from the sale of products comprise the significant portion of revenues in all product categories in the above table. The product revenues associated with the above disaggregated revenues are recorded when control of goods or services are transferred to the customer. The Furniture category includes installation revenues that are recorded over time as installation services are incurred. The Instruction & Intervention category includes subscription revenues which are recognized over the subscription period, typically twelve months. All product categories are impacted by school budget funding.
The Company had a contract liability balance of $6,177 as of December 31, 2017, after the cumulative effects related to the adoption of ASC 606. During the six months ended June 30, 2018, the Company recognized into revenues $4,684, which had been included in the contract liability balance as of December 31, 2017.
NOTE 5 BUSINESS COMBINATIONS
On August 18, 2017, the Company completed the acquisition of the assets of Triumph Learning, LLC (Triumph Learning) pursuant to the terms of an Asset Purchase Agreement dated August 18, 2017 (the Purchase Agreement) by and among School Specialty and Triumph Learning, LLC, a Delaware limited liability company. School Specialty acquired all the assets of Triumph Learning for $20,376 plus the assumption of certain liabilities. At closing, $18,114 of the total purchase price was paid using the Companys existing debt facilities (see Note 12 Debt). The Company drew $14,000 from the delayed draw term loan feature of its New Term Loan (as defined in Note 12) and drew $4,114 from its ABL Facility (as defined in Note 12) to fund this portion of the purchase price. In November 2017, the Company paid $912 as a final working capital adjustment, which was funded through the Companys ABL Facility. The remaining purchase price in excess of the cash paid at closing represents the discounted fair value of the contingent portion of the purchase price. The contingent portion of the purchase price is 4.5% of net Triumph Learning revenues from certain Triumph Learning products over the period August 18, 2017 through December 18, 2018, subject to a maximum consideration of $1.5 million. The contingent portion of the purchase price is scheduled to be paid quarterly over the above-mentioned period, and $343 of this contingent obligation was paid in the first quarter ended March 31, 2018 and $282 was paid in the second quarter ended June 30, 2018. The maximum present value of the contingent portion of the purchase price is $1,350. The Company accounted for this acquisition as a business combination in accordance with ASC 805.
11
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Triumph Learning is a publisher of state-specific assessment preparation, and supplemental and intervention curriculum products for the K-12 education market. For over 25 years, Triumph Learnings flagship product, Coach, has been utilized throughout education, providing educational facilities and teachers with hands-on test preparation books for English and Language Arts (ELA), Math, Science and Social Studies, with materials customized to state-specific best practices, along with a comprehensive series of supplemental and intervention resources for Math, ELA and Science. Solutions are delivered through multiple platforms, including both print and digital, as well as through third-party platforms and applications. Triumph Learnings products are complementary to School Specialtys current offering and others that it intends to bring to market, as it expands its product offering in the Instruction & Intervention category. There are also significant potential synergies beyond the product offering as the Company anticipates the acquisition will result in a broader and more effective selling organization and an extended customer reach that will enable the Company to deliver a true blended learning solution to its customers.
School Specialty incurred acquisition and integration costs of $1,404 in the first and second quarters of 2018 and $3,203 in the third and fourth quarters of fiscal 2017 related to the Triumph Learning acquisition. These costs included legal, due diligence and integration-related costs and are recorded as SG&A.
The Company engaged a third party to complete a full valuation of the assets, including any identified intangible assets of Triumph Learning. School Specialtys estimates and assumptions are subject to change during the measurement period (up to one year from the acquisition date), as the Company finalizes the valuations of certain liabilities assumed in connection with the acquisition. The table below summarizes the fair value amounts of the $20,376 of net assets acquired.
Accounts receivable |
$ | 4,409 | ||
Inventory |
2,307 | |||
Prepaids |
476 | |||
Property, plant & equipment |
920 | |||
Product Development |
4,273 | |||
Coach Brand |
3,887 | |||
Customer Relationships |
1,994 | |||
Goodwill |
5,253 | |||
|
|
|||
Total assets |
$ | 23,519 | ||
|
|
|||
Accounts payable |
$ | 2,251 | ||
Other accruals |
892 | |||
Deferred revenue |
| |||
|
|
|||
Total liabilities |
$ | 3,143 | ||
|
|
|||
Cash paid |
$ | 20,376 | ||
|
|
The unaudited pro forma consolidated results in the following table include the Companys reported results for each respective period and the historical results of Triumph Learning for those periods. The unaudited condensed combined statements of operations for the three and six month periods ended July 30, 2018 and the unaudited pro forma condensed combined statements of operations for the three months and six months ended July 1, 2017 give effect to the acquisition of Triumph Learning as if it had occurred at the beginning of the periods presented.
Anticipated synergies from the combined operations have not been incorporated into the pro forma results as synergies are preliminary. Net income does reflect the incremental interest expense which would have been incurred if the acquisition had been completed at the beginning of the periods presented.
12
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
CONDENSED COMBINED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Amounts)
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Revenues |
$ | 169,272 | $ | 165,843 | $ | 268,559 | $ | 270,512 | ||||||||
Net income (loss) |
18 | (858 | ) | (18,660 | ) | (17,642 | ) | |||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic EPS |
7,000 | 7,000 | 7,000 | 7,000 | ||||||||||||
Diluted EPS |
7,129 | 7,077 | 7,000 | 7,000 | ||||||||||||
Net income per Share: |
||||||||||||||||
Basic |
$ | 0.00 | $ | (0.12 | ) | $ | (2.67 | ) | $ | (2.52 | ) | |||||
Diluted |
$ | 0.00 | $ | (0.12 | ) | $ | (2.67 | ) | $ | (2.52 | ) |
NOTE 6 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 Companys tax returns are no longer subject to examination by the U.S. for fiscal years before 2015. 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 Companys financial position or results of operations.
The Company has net operating loss (NOL) carryforwards of approximately $3,400 for federal and approximately $3,400 for state. The federal NOL begins to expire in 2037. In December 2017, the Tax Act was enacted into law, significantly changing income tax law that affects U.S. corporations. Key changes included a corporate tax rate reduction from 35 percent to 21 percent effective January 1, 2018, expensing of certain qualified property, significant changes to the U.S international tax system such as a one-time transition tax on accumulated foreign earnings, and how foreign earnings are subject to U.S. tax. Due to the timing of the Tax Act and additional guidance and interpretations that may be issued in the future, the Company has not completed its analysis of the effects of the Tax Act as it relates to the one-time transition tax on accumulated foreign earnings. The Company has estimated the impact of the one-time transition tax to be between zero and $1,000. For the period ended December 30, 2017, the Company recorded a tax benefit of $704 associated with the re-measurement of deferred taxes for the corporate rate reduction and a provisional tax provision of zero for the one-time transition tax. The provisional estimates will be adjusted during the measurement period of twelve months from the initial date of the Tax Act, defined under SAB 118, based upon the Companys ongoing analysis of its data and tax positions along with new guidance from regulators and interpretations of the law.
The Company has considered the effect of U.S. Internal Revenue Code (Code) Section 382 on our ability to utilize existing net operating losses and foreign tax credit carryforwards. Section 382 imposes limits on the amount of tax attributes that can be utilized where there has been an ownership change as defined under the Code. The Company has determined that an ownership change occurred in fiscal 2013 that was subject to Section 382. Due to the application of Section 382, certain federal and state deferred tax attributes, such as foreign tax credits, were subject to future limitation.
13
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In the fourth quarter of fiscal 2017, the Company decreased its valuation allowance by approximately $1,700. Based on the Companys trend of positive earnings before tax plus projections of the future earnings before tax we believe it is more likely than not that we will realize the tax benefit associated with $1,700 of net deferred tax assets. As of December 30, 2017, the Company continued to maintain a valuation allowance of $7,263 against its foreign tax credits and capital loss carryovers based on projections that reflect minimal to zero foreign source income and capital gains. The Company previously had concluded that the realization of substantially all its deferred tax assets did not meet the more likely than not threshold and recorded a tax valuation allowance due to the lack of taxable income. As of June 30, 2018, the Company had an immaterial amount of unremitted earnings from foreign investments.
The balance of the Companys liability for unrecognized income tax benefits, net of federal tax benefits, at June 30, 2018, December 30, 2017, and July 1, 2017, was $792, $172, and $169, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any material changes in the amount of unrecognized tax benefits within the next twelve months. The Company classifies accrued interest and penalties related to unrecognized tax benefits as income tax expense in its consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.
NOTE 7 STOCKHOLDERS EQUITY
Changes in condensed consolidated stockholders equity during the six months ended June 30, 2018 and July 1, 2017, were as follows:
(in thousands) |
Common Stock |
Capital in Excess of Par Value |
Retained Earnings (Accumulated Deficit) |
Accumulated Other Comprehensive Income (Loss) |
Total Stockholders Equity |
|||||||||||||||
Balance, December 30, 2017 |
$ | 7 | $ | 123,083 | $ | (14,174 | ) | $ | (1,425 | ) | $ | 107,491 | ||||||||
Cumulative effect of change in accounting principle (1) |
| | (2,722 | ) | | (2,722 | ) | |||||||||||||
Net loss |
| | (18,660 | ) | | (18,660 | ) | |||||||||||||
Share-based compensation expense |
| 1,066 | | | 1,066 | |||||||||||||||
Foreign currency translation adjustment |
| | | (407 | ) | (407 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Balance, June 30, 2018 |
$ | 7 | $ | 124,149 | $ | (35,556 | ) | $ | (1,832 | ) | $ | 86,768 | ||||||||
|
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|
|
|
|
|
|
|
|||||||||||
Balance, December 31, 2016 |
$ | 7 | $ | 120,849 | $ | (20,953 | ) | $ | (1,784 | ) | $ | 98,119 | ||||||||
Net loss |
| | (16,640 | ) | | (16,640 | ) | |||||||||||||
Share-based compensation expense |
| 1,091 | | | 1,091 | |||||||||||||||
Foreign currency translation adjustment |
| | | 184 | 184 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Balance, July 1, 2017 |
$ | 7 | $ | 121,940 | $ | (37,593 | ) | $ | (1,600 | ) | $ | 82,754 | ||||||||
|
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|
|
|
|
|
|
|
(1) | See Note 4, Change in Accounting Principle, of the notes to condensed consolidated financial statements for further discussion. |
14
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 8 EARNINGS PER SHARE
Earnings Per Share
The following information presents the Companys computations of basic earnings per share (basic EPS) and diluted earnings per share (diluted EPS) for the periods presented in the condensed consolidated statements of operations:
Income (loss) (Numerator) |
Weighted Average Shares (Denominator) |
Per Share Amount |
||||||||||
Three months ended June 30, 2018: |
||||||||||||
Basic EPS |
$ | 18 | 7,000 | $ | 0.00 | |||||||
|
|
|||||||||||
Effect of dilutive stock options |
| | ||||||||||
Effect of dilutive restricted stock units |
| 129 | ||||||||||
|
|
|
|
|||||||||
Diluted EPS |
$ | 18 | 7,129 | $ | 0.00 | |||||||
|
|
|
|
|
|
|||||||
Three months ended July 1, 2017: |
||||||||||||
Basic EPS |
$ | 136 | 7,000 | $ | 0.02 | |||||||
|
|
|||||||||||
Effect of dilutive stock options |
| | ||||||||||
Effect of dilutive restricted stock units |
| 77 | ||||||||||
|
|
|
|
|||||||||
Basic and diluted EPS |
$ | 136 | 7,077 | $ | 0.02 | |||||||
|
|
|
|
|
|
|||||||
Income (loss) (Numerator) |
Weighted Average Shares (Denominator) |
Per Share Amount |
||||||||||
Six months ended June 30, 2018: |
||||||||||||
Basic EPS |
$ | (18,660 | ) | 7,000 | $ | (2.67 | ) | |||||
|
|
|||||||||||
Effect of dilutive stock options |
| | ||||||||||
Effect of dilutive restricted stock units |
| | ||||||||||
|
|
|
|
|||||||||
Basic and diluted EPS |
$ | (18,660 | ) | 7,000 | $ | (2.67 | ) | |||||
|
|
|
|
|
|
|||||||
Six months ended July 1, 2017: |
||||||||||||
Basic EPS |
$ | (16,640 | ) | 7,000 | $ | (2.38 | ) | |||||
|
|
|||||||||||
Effect of dilutive stock options |
| | ||||||||||
Effect of dilutive restricted stock units |
| | ||||||||||
|
|
|
|
|||||||||
Basic and diluted EPS |
$ | (16,640 | ) | 7,000 | $ | (2.38 | ) | |||||
|
|
|
|
|
|
The Company had weighted average stock options outstanding of 714 for both the three months ended June 30, 2018 and July 1, 2017, which were not included in the computation of diluted EPS because they were anti-dilutive. The Company had weighted average stock options outstanding of 718 and 623 for the six months ended June 30, 2018 and July 1, 2017, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive.
The Company had weighted average restricted stock units outstanding of 214 and 205 for the three and six months ended June 30, 2018, respectively. The Company had weighted average restricted stock units outstanding of 196 for the three and six month periods ended July 1, 2017.
For the three month period ended June 30, 2018 and July 1, 2017, 85 and 128 of the restricted stock units were not included in the computation of diluted EPS because they were anti-dilutive. For the six month periods ended June 30, 2018 and July 1, 2017, no portion of the restricted stock units were not included in the computation of diluted EPS because they were anti-dilutive due to the net loss.
On August 15, 2017, the Companys stockholders approved an increase in the number of authorized shares of School Specialty common stock from 2,000 shares to 50,000 shares, for the purpose of, among other things, effecting a seven-for-one stock split of School Specialtys shares. The stock split became effective on August 23, 2017, and the number of outstanding shares of School Specialty stock increased from 1,000 to 7,000. All previously stated values have been restated to adjust for this seven-for-one stock split.
15
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 9 SHARE-BASED COMPENSATION EXPENSE
As of June 30, 2018, the Company had one share-based employee compensation plan: the School Specialty, Inc. 2014 Incentive Plan (the 2014 Plan). The 2014 Plan was adopted by the Board of Directors on April 24, 2014 and approved on September 4, 2014 by the Companys stockholders. On June 12, 2018, the Companys stockholders approved an amendment to the 2014 Plan, which increased the number of share available under the 2014 Plan by an additional 700 shares.
Options
The Compensation Committee of the Board of Directors of the Company (Compensation Committee) granted 238 stock option awards during the six month period ended July 1, 2017 to members of management including its CEO. The options awarded to the Companys CEO will vest as to one-fourth of the options on the first four anniversaries of the date of the award. The options that were awarded to the other members of management will vest as to one-half of the options on the second anniversary of the date of the award and as to one-fourth of the options on each of the third and fourth anniversaries of the award date. The Company did not grant stock option awards during the three and six month periods ended June 30, 2018.
The fair-value of the options granted in the three month period ended July 1, 2017 was $10.08 per share. The fair value of the options is estimated on the measurement date using the Black-Scholes single option pricing model. The assumptions included a risk-free rate of 1.92%, expected volatility of 59% and an expected term of 6.3 years.
The fair-value of the options granted in the six month period ended July 1, 2017 was $10.14 per share. The fair value of the options is estimated on the measurement date using the Black-Scholes single option pricing model. The assumptions included a risk-free rate of 2.31%, expected volatility of 59% and an expected term of 6.3 years.
A summary of option transactions for the six months ended June 30, 2018 and July 1, 2017 were as follows:
Options Outstanding | Options Exercisable | |||||||||||||||
Options | Weighted- Average Exercise Price |
Options | Weighted- Average Exercise Price |
|||||||||||||
Balance at December 30, 2017 |
721 | $ | 18.57 | 350 | $ | 18.57 | ||||||||||
Granted |
| |||||||||||||||
Exercised |
| |||||||||||||||
Canceled |
(14 | ) | 18.57 | |||||||||||||
|
|
|||||||||||||||
Balance at June 30, 2018 |
707 | $ | 18.57 | 433 | $ | 18.57 | ||||||||||
|
|
|||||||||||||||
Balance at December 31, 2016 |
497 | $ | 18.57 | 224 | $ | 18.57 | ||||||||||
Granted |
238 | 18.57 | ||||||||||||||
Exercised |
| |||||||||||||||
Canceled |
(21 | ) | 18.57 | |||||||||||||
|
|
|||||||||||||||
Balance at July 1, 2017 |
714 | $ | 18.57 | 315 | $ | 18.57 | ||||||||||
|
|
The weighted average life remaining of the stock options outstanding as of June 30, 2018 was 6.9 years and as of July 1, 2017 was 7.9 years.
16
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Restricted Stock Units
On June 18, 2018, the Compensation Committee granted an aggregate of 109 Restricted Stock Units (RSUs) under the Companys 2014 Plan to members of the Companys senior management. The RSUs have time-based vesting provisions, with one-third of the RSUs vesting on each March 15 of 2019, 2020 and 2021. In addition, the Compensation Committee granted an aggregate of 15 RSUs under the 2014 Plan to each of the non-employee members of the Board of Directors. The RSUs have time-based vesting provisions, with all of the RSUs vesting on June 18, 2019.
On March 23, 2016, the Compensation Committee of the Board of Directors of the Company granted an aggregate of 196 RSUs under the Companys 2014 Plan to members of the Companys senior management. The RSUs are performance-based. A certain percentage of the RSUs will vest on the third anniversary of the date of grant, with such percentage based on the 15 day Volume Weighted Average Price (VWAP) of the Companys common stock prior to the vesting date. The percentage of RSUs that will vest shall be determined as follows:
Vesting % |
15 Day VWAP | |
0% | VWAP less than $15.43 | |
20% | VWAP greater than or equal to $15.43, but less than $16.86 | |
40% | VWAP greater than or equal to $16.86, but less than $18.29 | |
60% | VWAP greater than or equal to $18.29, but less than $19.71 | |
80% | VWAP greater than or equal to $19.71, but less than $21.14 | |
100% | VWAP greater than or equal to $21.14 |
Due to the nature of the vesting conditions of the RSUs, a valuation methodology needed to incorporate potential equity value paths for the Company. As such, the fair value of the RSU grants was determined under a Monte Carlo approach with a simulation of the Companys stock price to a date that is 15 trading days prior to the vesting date. A large number of trials were run under the Monte Carlo approach to ensure an adequate sampling of different potential scenarios was achieved. Based on this approach, the fair value of the RSUs granted on March 23, 2016 was $11.55 per share. Any RSUs that vest will be settled in shares of Company common stock
Stock Appreciation Rights
On May 28, 2014, the Board granted 39 stock appreciation rights (SARs) to each of the non-employee members of the Board under the 2014 Plan. On September 28, 2015, the Board granted 39 SARs to each of the two new non-employee members of the Board. On January 17, 2018, the Board granted 39 SARs to its new non-employee member of the Board. Each SAR has a grant date value of $18.57 and will be settled in cash upon exercise. As such, the SARs are accounted for as liability awards. As the Companys stock trading price was exceeded each SARs exercise price as of June 30, 2018, expense of $99 was recorded for the SARs during the three months ended June 30, 2018. The SARs vested as to one-half of the SARs on the second anniversary of the date of grant and vested as to one-fourth of the SARs on each of the third and fourth anniversaries of the date of grant. 39 of the outstanding SARs were exercised by a member of the Board and $31 of expense was recognized. Total SARs that remain outstanding as of June 30, 2018 are 154.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The following table presents the share-based compensation expense recognized for the three and six month periods ended June 30, 2018 and July 1, 2017:
For the Three Months Ended | ||||||||||||||||
June 30, 2018 | July 1, 2017 | |||||||||||||||
Gross | Net of Tax | Gross | Net of Tax | |||||||||||||
Stock Options |
$ | 267 | $ | 200 | $ | 322 | $ | 196 | ||||||||
SARs |
131 | 98 | | | ||||||||||||
RSUs |
227 | 170 | 189 | 115 | ||||||||||||
|
|
|
|
|||||||||||||
Total stock-based compensation expense |
$ | 625 | $ | 511 | ||||||||||||
|
|
|
|
|||||||||||||
For the Six Months Ended | ||||||||||||||||
June 30, 2018 | July 1, 2017 | |||||||||||||||
Gross | Net of Tax | Gross | Net of Tax | |||||||||||||
Stock Options |
$ | 651 | $ | 488 | $ | 704 | $ | 430 | ||||||||
SARs |
131 | 98 | | | ||||||||||||
RSUs |
415 | 311 | 387 | 236 | ||||||||||||
|
|
|
|
|||||||||||||
Total stock-based compensation expense |
$ | 1,197 | $ | 1,091 | ||||||||||||
|
|
|
|
The stock-based compensation expense is reflected in selling, general and administrative (SG&A) expenses in the accompanying consolidated statements of operations. The Company records actual forfeitures in the period the forfeiture occurs. Stock-based compensation expense associated with stock options and RSUs are non-cash expenses which are recorded to additional paid in capital. Stock-based compensation expense associated with SARs must be cash-settled and are recorded to other accrued liabilities until settled.
The total unrecognized share-based compensation expense as of June 30, 2018 and July 1, 2017 was as follows:
June 30, 2018 | July 1, 2017 | |||||||
Stock Options, net of actual forfeitures |
$ | 1,701 | $ | 3,335 | ||||
SARs |
55 | | ||||||
RSUs |
2,921 | 1,378 |
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 10 GOODWILL AND OTHER INTANGIBLE ASSETS
The following tables present details of the Companys intangible assets, including the estimated useful lives, excluding goodwill:
June 30, 2018 |
Gross Value |
Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10-13 years) |
$ | 13,294 | $ | (4,601 | ) | $ | 8,693 | |||||
Publishing rights (20 years) |
4,000 | (1,017 | ) | 2,983 | ||||||||
Trademarks (20 years) |
26,587 | (5,948 | ) | 20,639 | ||||||||
Developed technology (7 years) |
6,600 | (4,793 | ) | 1,807 | ||||||||
Content (5 years) |
4,400 | (4,400 | ) | | ||||||||
Perpetual license agreements (5 years) |
1,200 | (1,200 | ) | | ||||||||
Favorable leasehold interests (10 years) |
2,160 | (1,098 | ) | 1,062 | ||||||||
|
|
|
|
|
|
|||||||
Total intangible assets |
$ | 58,241 | $ | (23,057 | ) | $ | 35,184 | |||||
|
|
|
|
|
|
|||||||
December 30, 2017 |
Gross Value |
Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10-13 years) |
$ | 13,294 | $ | (4,067 | ) | $ | 9,227 | |||||
Publishing rights (20 years) |
4,000 | (917 | ) | 3,083 | ||||||||
Trademarks (20 years) |
26,587 | (5,283 | ) | 21,304 | ||||||||
Developed technology (7 years) |
6,600 | (4,321 | ) | 2,279 | ||||||||
Content (5 years) |
4,400 | (4,400 | ) | | ||||||||
Perpetual license agreements (5 years) |
1,200 | (990 | ) | 210 | ||||||||
Favorable leasehold interests (10 years) |
2,160 | (1,100 | ) | 1,060 | ||||||||
|
|
|
|
|
|
|||||||
Total intangible assets |
$ | 58,241 | $ | (21,078 | ) | $ | 37,163 | |||||
|
|
|
|
|
|
|||||||
July 1, 2017 |
Gross Value |
Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10-13 years) |
$ | 11,300 | $ | (3,549 | ) | $ | 7,751 | |||||
Publishing rights (20 years) |
4,000 | (817 | ) | 3,183 | ||||||||
Trademarks (20 years) |
22,700 | (4,635 | ) | 18,065 | ||||||||
Developed technology (7 years) |
6,600 | (3,850 | ) | 2,750 | ||||||||
Content (5 years) |
4,400 | (4,400 | ) | | ||||||||
Perpetual license agreements (5 years) |
1,200 | (980 | ) | 220 | ||||||||
Favorable leasehold interests (10 years) |
2,160 | (882 | ) | 1,278 | ||||||||
|
|
|
|
|
|
|||||||
Total intangible assets |
$ | 52,360 | $ | (19,113 | ) | $ | 33,247 | |||||
|
|
|
|
|
|
The gross values were determined by valuations performed either as part of fresh start accounting or the acquisition of Triumph Learning. In addition to the intangible assets above, the Company recorded $26,842 of goodwill. This includes $5,253 of goodwill associated with the purchase price allocation for the Triumph Learning acquisition.
Intangible asset amortization expense was including in selling, general and administrative expense. Intangible asset amortization expense for the three month periods ended June 30, 2018 and July 1, 2017, was $979 and $901, respectively. Intangible asset amortization expense for the six month periods ended June 30, 2018 and July 1, 2017, was $1,978 and $1,802, respectively.
19
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Intangible asset amortization expense for each of the five succeeding fiscal years is expected to be as follows:
Fiscal 2018 (6 months remaining) |
$ | 1,878 | ||
Fiscal 2019 |
3,757 | |||
Fiscal 2020 |
3,207 | |||
Fiscal 2021 |
2,814 | |||
Fiscal 2022 |
2,814 | |||
Fiscal 2023 |
2,688 |
The table below shows the allocation of the recorded goodwill as of June 30, 2018 for both the reporting units and reporting segments.
Distribution Segment |
Curriculum Segment |
Total | ||||||||||
Goodwill |
$ | 22,262 | $ | 4,580 | $ | 26,842 | ||||||
|
|
|
|
|
|
|||||||
Balance at June 30, 2018 |
$ | 22,262 | $ | 4,580 | $ | 26,842 | ||||||
|
|
|
|
|
|
NOTE 11 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
June 30, 2018 | December 30, 2017 | July 1, 2017 | ||||||||||
Projects in progress |
$ | 2,983 | $ | 5,186 | $ | 11,284 | ||||||
Buildings and leasehold improvements |
2,971 | 3,048 | 3,298 | |||||||||
Furniture, fixtures and other |
64,828 | 60,046 | 49,383 | |||||||||
Machinery and warehouse equipment |
14,595 | 13,813 | 13,155 | |||||||||
|
|
|
|
|
|
|||||||
Total property, plant and equipment |
85,377 | 82,093 | 77,120 | |||||||||
Less: Accumulated depreciation |
(53,314 | ) | (48,514 | ) | (44,940 | ) | ||||||
|
|
|
|
|
|
|||||||
Net property, plant and equipment |
$ | 32,063 | $ | 33,579 | $ | 32,180 | ||||||
|
|
|
|
|
|
Depreciation expense for the three and six month periods ended June 30, 2018 and July 1, 2017 was $2,955 and $2,425 and $7,414 and $4,671, respectively.
NOTE 12 DEBT
Long-term debt consisted of the following:
` | June 30, 2018 | December 30, 2017 | July 1, 2017 | |||||||||
ABL Facility, maturing in 2022 |
$ | 61,500 | $ | | $ | 44,132 | ||||||
New Term Loan, maturing in 2022 |
112,499 | 121,938 | 109,313 | |||||||||
Unamortized New Term Loan Debt Issuance Costs |
(2,872 | ) | (3,205 | ) | (3,533 | ) | ||||||
Deferred Cash Payment Obligations, maturing in 2019 |
23,910 | 22,830 | 21,819 | |||||||||
|
|
|
|
|
|
|||||||
Total debt |
195,037 | 141,563 | 171,731 | |||||||||
Less: Current maturities |
(64,600 | ) | (10,989 | ) | (46,882 | ) | ||||||
|
|
|
|
|
|
|||||||
Total long-term debt |
$ | 130,437 | $ | 130,574 | $ | 124,849 | ||||||
|
|
|
|
|
|
ABL Facility
On June 11, 2013, the Company entered into a Loan Agreement (the ABL Facility) by and among the Company, Bank of America, N.A., as Agent, SunTrust Bank, as Syndication Agent, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SunTrust Robinson Humphrey, Inc., as Joint Lead Arrangers and Bookrunners, and the Lenders that are party to the Asset-Based Credit Agreement (the Asset-Based Lenders).
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Under the ABL Facility, the Asset-Based Lenders agreed to provide a revolving senior secured asset-based credit facility in an aggregate principal amount of $175,000. On August 7, 2015, the aggregate commitments were permanently reduced, at the election of the Company, by $50,000, from $175,000 to $125,000.
Outstanding amounts under the ABL Facility bear interest at a rate per annum equal to, at the Companys election: (1) a base rate (equal to the greatest of (a) the prime lending rate, (b) the federal funds rate plus 0.50%, and (c) the 30-day LIBOR rate plus 1.00% per annum) (the Base Rate) plus an applicable margin (equal to a specified margin based on the interest rate elected by the Company, the fixed charge coverage ratio under the ABL Facility and the applicable point in the life of the ABL Facility (the Applicable Margin)), or (2) a LIBOR rate plus the Applicable Margin (the LIBOR Rate). Interest on loans under the ABL Facility bearing interest based upon the Base Rate will be due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate will be due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.
In November 2014, the Company amended the ABL Facility. The main purpose for the amendment was to provide the Company additional flexibility in its execution of certain restructuring actions by increasing the cap on the amount that may be added back under the definition of earnings before interest, taxes, depreciation, and amortization (EBITDA) for non-recurring, unusual or extraordinary charges, business optimization expenses or other restructuring charges or reserves and cash expenses relating to earn outs or similar obligations.
In September 2015, the Company amended the ABL Facility. The main purposes for the amendment were to reduce the Applicable Margin for base rate and LIBOR loans, reduce the unused line fee rate and extend the scheduled maturity date. As amended, the maturity date was extended to September 16, 2020, which would have automatically become March 12, 2019 unless the Companys term loan facility had been repaid, refinanced, redeemed, exchanged or amended prior to such date, in the case of any refinancing or amendment, to a date that was at least 90 days after the scheduled maturity date. In addition, the amendment provided for the withdrawal of Sun Trust Bank as a lender and the assumption of its commitments by the remaining lenders.
On April 7, 2017, the Company executed the Third Amendment to its ABL Facility (the ABL Amendment). The ABL Amendment provided a new lower pricing tier of LIBOR plus 125 basis points, a seasonal increase in the borrowing base of 5.0% of eligible accounts receivable for the months of March through August, and the inclusion of certain inventory in the borrowing base, which previously had been excluded. Additionally, certain conforming changes were made in connection with the entry into the New Term Loan Agreement (as defined below). The ABL Amendment extends the maturity of the ABL Facility, as amended, to April 7, 2022 (ABL Termination Date), provided that the ABL Termination Date will automatically become February 7, 2022 unless the New Term Loan (as defined below) has been repaid, prepaid, refinanced, redeemed, exchanged, amended or otherwise defeased or discharged prior to such date.
Pursuant to an Amended and Restated Guarantee and Collateral Agreement dated as of April 7, 2017 (the ABL Security Agreement), the Loan Agreement is secured by a first priority security interest in substantially all assets of the Company and the subsidiary borrowers. Under the New Intercreditor Agreement (as defined below), the ABL Lenders have a first priority security interest in substantially all working capital assets of the Company and the subsidiary borrowers, and a second priority security interest in all other assets, subordinate only to the first priority security interest of the New Term Loan Lenders (as defined below) in such other assets.
The effective interest rate under the ABL Facility for the three months ended June 30, 2018 was 5.33%, which includes interest on borrowings of $455, amortization of loan origination fees of $104 and commitment fees on unborrowed funds of $73. The effective interest rate under the ABL Facility for the three months ended July 1, 2017 was 4.75%, which includes interest on borrowings of $250, amortization of loan origination fees of $104 and commitment fees on unborrowed funds of $83.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The effective interest rate under the ABL Facility for the six months ended June 30, 2018 was 6.54%, which includes interest on borrowings of $538, amortization of loan origination fees of $208 and commitment fees on unborrowed funds of $181. As of June 30, 2018, the outstanding balance on the ABL Facility was $61,500. The effective interest rate under the ABL Facility for the six months ended July 1, 2017 was 8.03%, which includes interest on borrowings of $263, amortization of loan origination fees of $299 and commitment fees on unborrowed funds of $199. As of July 1, 2017, the outstanding balance on the ABL Facility was $44,132. The Company has estimated that the fair value of its ABL Facility (valued under level 3) as of June 30, 2018 approximated the carrying value of $61,500.
The Company may prepay advances under the ABL Facility in whole or in part at any time without penalty or premium. The Company will be required to make specified prepayments upon the occurrence of certain events, including: (1) the amount outstanding on the ABL Facility exceeding the Borrowing Base (as determined in accordance with the terms of the ABL Facility), and (2) the Companys receipt of net cash proceeds of any sale or disposition of assets that are first priority collateral for the ABL Facility.
The Asset-Based Credit Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to a springing financial covenant relating to the Companys fixed charge coverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments.
Term Loan
On June 11, 2013, the Company entered into a Credit Agreement (the Term Loan Credit Agreement) among the Company, Credit Suisse AG, as Administrative Agent and Collateral Agent, and the Lenders defined in the Term Loan Credit Agreement (the Term Loan Lenders). In November 2014, the Company amended the Term Loan Credit Agreement. The main purpose for the amendment was to provide the Company additional flexibility in its execution of certain restructuring actions by increasing the cap on the amount that may be added back under the definition of consolidated EBITDA for non-recurring, unusual or extraordinary charges, business optimization expenses or other restructuring charges or reserves and cash expenses relating to earn outs or similar obligations.
Under the Term Loan Credit Agreement, the Term Loan Lenders agreed to make a term loan (the Term Loan) to the Company in aggregate principal amount of $145,000, including an original issue discount of $2,900. The outstanding principal amount of the Term Loan bore interest at a rate per annum equal to the applicable LIBOR rate (with a 1% floor) plus 8.50%, or the base rate plus a margin of 7.50%. Interest on loans under the Term Loan Credit Agreement bearing interest based upon the base rate were due quarterly in arrears, and interest on loans bearing interest based upon the LIBOR Rate were due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.
The remaining principal amount of the Term Loan, plus accrued interest, was repaid in full on April 7, 2017, and the Term Loan Credit Agreement was terminated on April 7, 2017.
The Term Loan Credit Agreement contained customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants, relating to the Companys (1) minimum interest coverage ratio and (2) maximum net total leverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments. The Company was in compliance with the financial covenants of the loan during the period of time in which the loan was outstanding during fiscal 2017.
The Term Loan required the Company to enter into an interest rate hedge, within 90 days of its effective date, in an amount equal to at least 50% of the aggregate principal amount outstanding under the Term Loan. The purpose of the interest rate hedge was to effectively subject a portion of the Term Loan to a fixed or maximum interest rate. As such, the Company entered into an interest rate swap agreement on August 27, 2013 that effectively fixed the interest payments on a portion of the Companys variable-rate debt. The swap, which terminated on September 11, 2016, effectively fixed the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. The Company did not enter into a subsequent interest rate swap after the termination of the above-mentioned interest rate swap.
22
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Under this swap agreement, the Company paid the counterparty interest on the notional amount at a fixed rate per annum of 1.485% and the counterparty paid the Company interest on the notional amount at a variable rate per annum equal to the greater of 1-month LIBOR or 1.0%. The notional amounts did not represent amounts exchanged by the parties, and thus were not a measure of exposure of the Company.
New Term Loan
On April 7, 2017, the Company entered into a Loan Agreement (the New Term Loan Agreement) among the Company, as borrower, certain of its subsidiaries, as guarantors, the financial parties party thereto, as lenders (the New Term Loan Lenders) and TCW Asset Management Company LLC, as the agent.
Under the New Term Loan Agreement, the Term Loan Lenders agreed to make a term loan (the New Term Loan) to the Company in aggregate principal amount of $140,000. The initial draw on the New Term Loan at closing was $110,000. These proceeds, along with proceeds received from a draw on the ABL Facility (as defined below), were used to repay the Term Loan which had a remaining principal balance including accrued interest of $118,167. The New Term Loan Agreement provides for a delayed draw feature that allows the Company to draw up to an additional $30,000 through April 7, 2019. The ability to access the delayed draw commitment is subject to compliance with certain terms and conditions. The proceeds from the delayed draw can be used to fund distributions, permitted acquisitions, and repayments of existing indebtedness. In the third quarter of fiscal 2017, the Company drew $14,000 under the delayed draw term loan feature in conjunction with the Triumph Learning acquisition. At the Companys option, the New Term Loan interest rate will be either the prime rate or the LIBOR rate (with a LIBOR floor of 1.0%), plus an applicable margin based on the Companys net senior leverage ratio. The Company may specify the interest rate period of one, three or six months for interest on loans under the New Term Loan Agreement bearing interest based on the LIBOR rate.
The New Term Loan matures on April 7, 2022. The New Term Loan requires scheduled quarterly principal payments of 0.625% of the original principal amount which commenced June 30, 2017 and continue through the quarter ended March 31, 2019. Subsequent to March 31, 2019, the scheduled quarterly principal payments are 1.250% of the original principal amount. Required scheduled quarterly principal payments on borrowings under the delayed-draw feature begin in the quarter following a draw on this feature. In addition to scheduled quarterly principal repayments, the New Term Loan Agreement requires prepayments at specified levels upon the Companys receipt of net proceeds from certain events, including but not limited to certain asset dispositions, extraordinary receipts, and the issuance or sale of any indebtedness or equity interests (other than permitted issuances or sales). The New Term Loan Agreement also requires prepayments at specified levels from the Companys excess cash flow. In the first quarter of fiscal 2018, the Company made a $7,801 repayment of principal based on fiscal 2017 excess cash flow. The Company is also permitted to voluntarily prepay the New Term Loan in whole or in part. Voluntary prepayments made before April 7, 2018 will be subject to an early prepayment fee of 2.0%, while any voluntary prepayment made on or after April 7, 2018, but before April 7, 2019, will be subject to a 1.0% early prepayment fee. Voluntary prepayments made on or after April 7, 2019 will not be subject to an early payment fee. All prepayments of the loans will be applied first to that portion of the loans comprised of prime rate loans and then to that portion of loans comprised of LIBOR rate loans. The New Term Loan Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants commencing with the fiscal quarter ending September 30, 2017 relating to the Companys fixed charge coverage ratio and net senior leverage ratio, and an annual limitation on capital expenditures and product development investments, collectively. The Company was in compliance with all such financial covenants during the second quarter of fiscal 2018.
Pursuant to a Guarantee and Collateral Agreement dated as of April 7, 2017 (the New Term Loan Security Agreement), the New Term Loan is secured by a first priority security interest in substantially all assets of the Company and the subsidiary guarantors. Under an intercreditor agreement (the New Intercreditor Agreement) between the New Term Loan Lenders and the ABL Lenders, the New Term Loan Lenders have a second priority security interest in substantially all working capital assets of the Company and the subsidiary guarantors, subordinate only to the first priority security interest of the ABL Lenders in such assets, and a first priority security interest in all other assets.
23
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The effective interest rate under the New Term Loan for the three months ended June 30, 2018 was 8.70%, which includes interest on borrowings of $2,310 and amortization of loan origination fees of $180. The effective interest rate under the New Term Loan for the three months ended July 1, 2017 was 8.27%, which includes interest on borrowings of $2,139 and amortization of loan origination fees of $170.
As of July 1, 2017, the outstanding balance on the New Term Loan Credit Agreement was $109,313. Of this amount, $2,750 was reflected as currently maturing, long-term debt in the accompanying condensed consolidated balance sheets.
The effective interest rate under the New Term Loan for the six months ended June 30, 2018 was 8.63%, which includes interest on borrowings of $4,740 and amortization of loan origination fees of $358. As of June 30, 2018, the outstanding balance on the New Term Loan Credit Agreement was $112,499. Of this amount, $3,100 was reflected as currently maturing, long-term debt in the accompanying condensed consolidated balance sheets.
The Company has estimated that the fair value of its New Term Loan (valued under Level 3) as of June 30, 2018 approximated the carrying value of $112,499.
Deferred Cash Payment Obligations
In connection with the previously disclosed 2013 Reorganization Plan, general unsecured creditors are entitled to receive a deferred cash payment obligation of 20% of the allowed claim in full settlement of the allowed unsecured claims. Such payment accrues quarterly paid-in-kind interest of 5% per annum beginning on June 11, 2013 (the Effective Date). Trade unsecured creditors had the ability to make a trade election to provide agreed upon customary trade terms. If the election was made, those unsecured trade creditors received a deferred cash payment obligation of 45% of the allowed claim in full settlement of those claims. As of the Effective Date, the deferred payment obligations under the trade elections began to accrue quarterly paid-in-kind interest of 10% per annum. All deferred cash payment obligations, along with interest paid-in-kind, are payable in December 2019.
The Companys reconciliation of general unsecured claims was completed in fiscal 2015. As of June 30, 2018, the Companys deferred payment obligations were $23,910, of which $3,094 represents a 20% recovery for the general unsecured creditors and $12,095 represents a 45% recovery for those creditors who elected to provide the Company standard trade terms with the remaining $8,721 related to accrued paid-in-kind interest.
The Company has estimated that the fair value of its Deferred Cash Payment Obligations (valued under Level 3) approximates $23,827 as of June 30, 2018. The Company estimated the fair value for its Deferred Cash Payment Obligations based upon the net present value of future cash flows using the discount rate that is consistent with our New Term Loan.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 13 CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Changes in accumulated other comprehensive loss during the six months ended June 30, 2018 and July 1, 2017 were as follows:
Foreign Currency Translation |
||||
Accumulated Other Comprehensive Income (Loss) at December 30, 2017 |
$ | (1,425 | ) | |
Other comprehensive income (loss) before reclassifications |
(236 | ) | ||
Amounts reclassified from other comprehensive income |
| |||
|
|
|||
Accumulated Other Comprehensive Income (Loss) at March 31, 2018 |
$ | (1,661 | ) | |
|
|
|||
Other comprehensive income (loss) before reclassifications |
(171 | ) | ||
Amounts reclassified from other comprehensive income |
| |||
|
|
|||
Accumulated Other Comprehensive Income (Loss) at June 30, 2018 |
$ | (1,832 | ) | |
|
|
|||
Foreign Currency Translation |
||||
Accumulated Other Comprehensive Income (Loss) at December 31, 2016 |
$ | (1,784 | ) | |
Other comprehensive income before reclassifications |
45 | |||
Amounts reclassified from other comprehensive income |
| |||
|
|
|||
Accumulated Other Comprehensive Income (Loss) at April 1, 2017 |
$ | (1,739 | ) | |
|
|
|||
Other comprehensive income before reclassifications |
139 | |||
Amounts reclassified from other comprehensive income |
| |||
|
|
|||
Accumulated Other Comprehensive Income (Loss) at July 1, 2017 |
$ | (1,600 | ) | |
|
|
NOTE 14 RESTRUCTURING
In the three and six months ended June 30, 2018 and July 1, 2017, the Company recorded restructuring costs associated with severance related to staffing reductions. The following is a reconciliation of accrued restructuring costs for these periods and are included in facility exit costs and restructuring in the Condensed Consolidated Statements of Operations.
25
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Distribution | Curriculum | Corporate | Total | |||||||||||||
Accrued Restructuring Costs at December 30, 2017 |
$ | | $ | | $ | 50 | $ | 50 | ||||||||
Amounts charged to expense |
| | 311 | 311 | ||||||||||||
Payments |
| | (189 | ) | (189 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Accrued Restructuring Costs at March 31, 2018 |
$ | | $ | | $ | 172 | $ | 172 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Amounts charged to expense |
| | 171 | 171 | ||||||||||||
Payments |
| | (258 | ) | (258 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Accrued Restructuring Costs at June 30, 2018 |
$ | | $ | | $ | 85 | $ | 85 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Distribution | Curriculum | Corporate | Total | |||||||||||||
Accrued Restructuring Costs at December 31, 2016 |
$ | | $ | | $ | 561 | $ | 561 | ||||||||
Amounts charged to expense |
| | 173 | 173 | ||||||||||||
Payments |
| | (574 | ) | (574 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Accrued Restructuring Costs at April 1, 2017 |
$ | | $ | | $ | 160 | $ | 160 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Amounts charged to expense |
| | 44 | 44 | ||||||||||||
Payments |
| | (161 | ) | (161 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Accrued Restructuring Costs at July 1, 2017 |
$ | | $ | | $ | 43 | $ | 43 | ||||||||
|
|
|
|
|
|
|
|
NOTE 15 SEGMENT INFORMATION
The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Companys Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company has determined that it operates in two operating segments, Distribution and Curriculum, which also constitute its reportable segments. The Company operates principally in the United States, with limited operations in Canada.
Beginning in the second quarter of fiscal 2017, the Company revised its internal management reporting structure whereby: a) a new Instruction & Intervention product line included in the Distribution segment was formed consisting of its Reading product lines, formerly managed as a separate product line, and the supplemental education products, which were previously included within the former Instructional Solutions product line: b) the early learning and special needs products from the former Instructional Solutions product line are reported within the Supplies product line: and, c) the science supplies, previously included in the Science product line, within the Curriculum operating segment, were combined within the Supplies product line within the Distribution operating segment. The Company has revised its go-to-market strategy and management structure resulting in the alignment of the reading and science supply products to be consistent with other distributed items within the Distribution operating segment. This change also is consistent with the Companys internal realignment of the new team sell model established in 2017 whereby every customer, district and territory will have a Distribution team supporting their business. The Distribution sales team focuses on selling all Distribution segment products, including the reading and science supplies items. The Distribution segment offers products primarily to the pre-kindergarten through twelfth grade (preK-12) education market that include basic classroom supplies and office products, instructional materials, indoor and outdoor furniture and equipment, physical education equipment, classroom technology, and planning and organizational products.
The Curriculum segment is a publisher of proprietary core curriculum, primarily FOSS and Delta Science Module products, in the science category within the preK-12 education market. The Curriculum segment has a sales team which is unique from the Distribution sales team and focuses exclusively on the products within this segment. In addition, these products have specific product development requirements, and customer purchasing decisions are made in a different manner than the products represented in our Distribution segment. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies as included in the Companys Report on Form 10-K for the fiscal year ended December 30, 2017.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company changed how cost variances are allocated between the two segments beginning in the second quarter of fiscal 2018. The changes were not material. The information prior to the second quarter of fiscal 2018 has been restated to reflect the change in allocation methodologies.
The Company measures profitability of its operating segments at a gross profit level. Since the majority of SG&A costs are managed centrally and allocation methodologies of these costs to the operating segments is arbitrary, the Companys chief operating decision maker does not review segment profitability using operating profit, only gross profit. Accordingly, the segment information reports gross profit at the segment level.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Three Months Ended | Three Months Ended | Six Months Ended | Six Months Ended | |||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Revenues: |
||||||||||||||||
Distribution |
$ | 155,775 | $ | 141,344 | $ | 250,395 | $ | 233,297 | ||||||||
Curriculum |
13,497 | 18,833 | 18,164 | 23,991 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 169,272 | $ | 160,177 | $ | 268,559 | $ | 257,288 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Gross Profit: |
||||||||||||||||
Distribution |
$ | 50,803 | $ | 50,440 | $ | 84,745 | $ | 82,406 | ||||||||
Curriculum |
7,941 | 10,055 | 10,120 | 12,613 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 58,744 | $ | 60,495 | $ | 94,865 | $ | 95,019 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Operating income (loss) and loss before taxes: |
||||||||||||||||
Operating income (loss) |
4,765 | 8,730 | (16,563 | ) | (4,387 | ) | ||||||||||
Interest expense and reorganization items, net |
3,688 | 8,495 | 7,194 | 12,545 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Income (loss) before provision for or benefit from income taxes |
$ | 1,077 | $ | 235 | $ | (23,757 | ) | $ | (16,932 | ) | ||||||
|
|
|
|
|
|
|
|
June 30, 2018 | December 30, 2017 | July 1, 2017 | ||||||||||
Identifiable assets: |
||||||||||||
Distribution |
$ | 301,838 | $ | 230,449 | $ | 276,588 | ||||||
Curriculum |
54,629 | 48,894 | 56,630 | |||||||||
Corporate assets |
16,300 | 33,064 | 5,089 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 372,767 | $ | 312,407 | $ | 338,307 | ||||||
|
|
|
|
|
|
Three Months Ended | Three Months Ended | Six Months Ended | Six Months Ended | |||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Depreciation and amortization of intangible assets and development costs: |
||||||||||||||||
Distribution |
$ | 4,771 | $ | 3,353 | $ | 10,774 | $ | 6,832 | ||||||||
Curriculum |
547 | 964 | 1,336 | 1,924 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 5,318 | $ | 4,317 | $ | 12,080 | $ | 8,756 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Expenditures for property, plant and equipment, intangible and other assets and development costs: |
||||||||||||||||
Distribution |
$ | 3,051 | $ | 4,768 | $ | 6,747 | $ | 8,053 | ||||||||
Curriculum |
922 | 662 | 1,881 | 1,164 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 3,973 | $ | 5,430 | $ | 8,628 | $ | 9,217 | ||||||||
|
|
|
|
|
|
|
|
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The following table shows the Companys revenues by each major product line within its two segments:
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
June 30, 2018 | July 1, 2017 | June 30, 2018 | July 1, 2017 | |||||||||||||
Distribution revenues by product line: |
||||||||||||||||
Supplies |
$ | 80,241 | $ | 76,756 | $ | 133,673 | $ | 134,955 | ||||||||
Furniture |
52,354 | 42,774 | 76,305 | 65,370 | ||||||||||||
Instruction & Intervention |
14,337 | 10,238 | 26,858 | 16,420 | ||||||||||||
AV Tech |
4,089 | 4,502 | 8,366 | 9,286 | ||||||||||||
Agendas |
4,588 | 6,476 | 4,834 | 6,746 | ||||||||||||
Freight Revenue |
2,581 | 2,454 | 4,387 | 3,993 | ||||||||||||
Customer Allowances / Discounts |
(2,415 | ) | (1,856 | ) | (4,028 | ) | (3,473 | ) | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Distribution Segment |
$ | 155,775 | $ | 141,344 | $ | 250,395 | $ | 233,297 | ||||||||
Curriculum revenues by product line: |
||||||||||||||||
Science |
$ | 13,497 | $ | 18,833 | $ | 18,164 | $ | 23,991 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Curriculum Segment |
$ | 13,497 | $ | 18,833 | $ | 18,164 | $ | 23,991 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total revenues |
$ | 169,272 | $ | 160,177 | $ | 268,559 | $ | 257,288 | ||||||||
|
|
|
|
|
|
|
|
The above table is an enhanced disclosure to provide additional details related to our revenues by segment. Prior period amounts in this note have been reclassified in order to present segment and product line amounts consistent with the Companys current reporting structure.
Revenues associated with the Triumph Learning acquisition are included within the Instruction & Intervention product line. The above table is consistent with disaggregated revenues in Note 4.
NOTE 16 COMMITMENTS AND CONTINGENCIES
Various claims and proceedings arising in the normal course of business are pending against the Company. The results of these matters are not expected to have a material effect on the Companys consolidated financial position, results of operations or cash flows.
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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operation
Quarterly Overview
School Specialty is a leading provider of innovative solutions that support integrated learning environments. School Specialty designs, develops and delivers a broad assortment of innovative and proprietary products, programs and services to the education marketplace, including essential classroom supplies, furniture, educational technology, supplemental learning resources (instructional solutions), science curriculum solutions, and evidence-based safety and security training. The Company applies its unmatched team of subject-matter experts and customized planning, development and project management tools to deliver this comprehensive offering as the 21st Century Safe School, a concept built around best-practice school environments that support the social, emotional, mental, and physical safety of students improving both learning outcomes and school district performance. The Company provides educators with innovative and proprietary products and services, from basic school supplies to 21st century learning environments to Science, English and Language Arts (ELA), and Math core and supplemental instructional materials. Through its nationwide distribution network, School Specialty also provides its customers with access to a broad spectrum of trusted, third-party brands across its business segments. This assortment strategy enables the Company to offer a broad range of products primarily serving the preK-12 education market at the state, district and school levels. The Company is expanding its presence outside the education market into channels such as partnerships with e-tailers, and healthcare facilities.
Our goal is to grow profitably as a leading provider of innovative 21st century classroom solutions including, supplies, furniture products, services and curriculum for the education market and select other markets. We have experienced three consecutive years of overall revenue growth. We expect to continue to achieve this goal over the long-term through an organic growth strategy based on leveraging our strong brand names and distribution capabilities and transforming the Companys sales and marketing to a team-based selling approach focused on new customer acquisition, customer retention and penetration, and expanding into new markets or product areas. New revenue streams may include opportunities in areas that could expand our addressable market, such as distribution to non-education customers, expansion into new product lines, continued growth in our e-tail partnerships, and potentially, abroad in select international markets. In addition, the Company is committed to continuing to invest in product development in order to expand and improve its product offerings.
While remaining focused on lowering costs through consolidation and process improvement, the Company is equally focused on revenue growth and gross margin management. The Company believes the following initiatives will contribute to continued revenue growth, while effectively managing gross margin and operating costs:
| Successful execution of a new team sell model; |
| Establish momentum in delivering the 21st Century Safe School value proposition; |
| Improve the effectiveness of pricing strategies and margin management; |
| Development of effective strategies to manage margin in competitive bidding scenarios; |
| Increase product line specific sales and support expertise; and |
| Execute on key platform investments to both drive efficiency and improve customer experiences. |
Our business and working capital needs are highly seasonal, as schools and teachers look to receive a material portion of the products they purchase in the weeks leading up to the start of the school year. As such, our peak sales levels occur from June through September. We expect to ship approximately 50% of our revenue and earn more than 100% of our annual net income from June through September of our fiscal year and operate at a net loss from October through May. In anticipation of the peak shipping season, our inventory levels increase during the months of April through June. Our working capital historically peaks in August or September mainly due to the higher levels of accounts receivable related to our peak revenue months. Historically, accounts receivable collections are most significant in the months of September through December as over 100% of our annual operating cash flow is generated in those months.
On August 18, 2017, the Company acquired of the assets of Triumph Learning. Triumph Learning is a publisher of state-specific test preparation, and supplemental and intervention curriculum products for the K-12 education market. For over 25 years, Triumph Learnings flagship product, Coach, has been utilized throughout education, providing educational facilities and teachers with hands-on test preparation books for ELA, Math, Science and Social Studies, with materials customized to state-specific best practices, along with a comprehensive series of supplemental and intervention resources for Math, ELA and Science. Solutions are delivered through multiple platforms, including both print and digital, as well as through third-party platforms and applications.
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Triumph Learnings products are complementary to School Specialtys current offering and others that it intends to bring to market, as it expands its product offering in the Instruction & Intervention category. There are also significant potential synergies beyond the product offering as the Company anticipates the acquisition will result in a broader and more effective selling organization and an extended customer reach that will enable the Company to deliver a true blended learning solution to its customers.
Results of Operations
Costs of Revenues and Selling, General and Administrative Expenses
The following table illustrates the primary costs classified in Cost of Revenues and Selling, General and Administrative Expenses:
Cost of Revenues |
Selling, General and Administrative Expenses | |
Direct costs of merchandise sold, net of vendor rebates other than vender payments for or the reimbursement of specific, incremental and identifiable costs, and net of early payment discounts. |
Compensation and benefit costs for all selling (including commissions), marketing, customer care and fulfillment center operations (which include the pick, pack and shipping functions), and other general administrative functions such as finance, human resources and information technology. | |
Amortization of product development costs. |
Occupancy and operating costs for our fulfillment centers and office operations. | |
Freight expenses associated with moving merchandise from our vendors to fulfillment centers or from our vendors directly to our customers. |
Freight expenses associated with moving our merchandise from our fulfillment centers to our customers. | |
Catalog expenses, offset by vendor payments for or reimbursement of specific, incremental and identifiable costs. | ||
Depreciation and intangible asset amortization expense, other than amortization of product development costs. | ||
The classification of these expenses varies across the distribution industry. As a result, the Companys gross margin may not be comparable to other retailers or distributors. |
Three Months Ended June 30, 2018 Compared to Three Months Ended July 1, 2017
Revenues
Revenue of $169.3 million for the three months ended June 30, 2018 increased by $9.1 million, or 5.7%, as compared to the three months ended July 1, 2017. The adoption of ASC 606 contributed $4.7 million of the incremental revenue, primarily within the Companys Distribution segment.
Distribution segment revenues of $155.8 million for the three months ended June 30, 2018 increased by 10.2%, or $14.4 million, from the three months ended July 1, 2017. Revenues from the Triumph Learning products, acquired in the third quarter of fiscal 2017 and reported in our Instruction & Intervention product category, contributed $4.1 million of incremental revenues in the second quarter of fiscal 2018. After adjusting for the impact of revenues from our Triumph Learning products, Distribution segment revenues are up in the second quarter by $10.3 million compared to the prior year period. Revenues from the Supplies product category, our largest category, increased approximately $3.5 million in the quarter as incoming orders in the quarter were up over 11% compared to incoming orders in the second quarter orders in 2017. Second quarter revenues in our second largest category, Furniture, were up 22.4%, or $9.6 million, compared to last years second quarter. While the adoption of ASC 606 contributed $5.4 million of this increase, incoming orders remained strong throughout the quarter, up 16.5% versus last years second quarter. Adjusting the Instruction & Intervention category to exclude the incremental revenue associated with the Triumph Learning products, the category was flat to prior year. Agendas revenues were $4.6 million in the second quarter of fiscal 2018, or down $1.9 million from last years second quarter. AV Tech revenues of $4.1 million were down $0.4 million as compared to last years second quarter. The revenue performance of Agendas and AV Tech were modestly below our expectations.
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Curriculum segment revenues of $13.5 million for the three months ended June 30, 2018 decreased by 28.3%, or $5.3 million, from the three months ended July 1, 2017. The decline was primarily related to three large school district orders, totaling $4.4 million, which shipped in last years second quarter. With limited state science adoption related opportunities in 2018, we expected declines in segment revenues in fiscal 2018. However, based on the current pipeline of state adoption and significant opportunities in open territory states, we anticipate segment growth resuming in 2019 as adoption related opportunities are expected to increase.
Gross Profit
Gross profit for the three months ended June 30, 2018 was $58.7 million, as compared to $60.5 million for the three months ended July 1, 2017. Gross margin for the three months ended June 30, 2018 was 34.7%, as compared to 37.8% for the three months ended July 1, 2017.
Distribution segment gross margin was 32.6% for the three months ended June 30, 2018, as compared to 35.7% for the three months ended July 1, 2017. Rate variances at a product level negatively impacted gross margins by 250 basis points in the current year second quarter. These negative rate variances are related to certain state, regional and district-level pricing agreements, which became effective at various points in 2017. In addition, the strategic move to more competitive pricing on commodity items also is a contributing factor the decline. However, these pricing actions have driven growth and customer penetration in fiscal 2018. Higher product development amortization in the current year second quarter resulted in 20 basis points of lower gross margin.
Curriculum segment gross margin was 58.8% for the three months ended June 30, 2018, as compared to 53.4% for the three months ended July 1, 2017. Incremental training revenue in the current years second quarter contributed approximately 150 basis points to the gross margin improvement, while favorable lower product costs in the current year contributed approximately 360 basis points to the gross margin improvement. Lower product development amortization in the current year second quarter contributed 30 basis points of the gross margin increase.
Selling, General and Administrative Expenses
SG&A includes: selling expenses, the most significant of which are wages and commissions; operations expenses, which includes customer service, warehouse and out-bound freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal and human resources; and, depreciation and intangible asset amortization expense.
SG&A increased $2.1 million in the second quarter of fiscal 2018, from $51.7 million for the three months ended July 1, 2017 to $53.8 million for the three months ended June 30, 2018. The increase in SG&A is primarily related to the Triumph Learning acquisition completed in August 2017, higher transportation costs, and incremental depreciation and amortization. The impact of ASC 606 on second quarter SG&A costs was $1.5 million.
The Companys acquisition of Triumph Learning during last years third quarter resulted in approximately $2.9 million of incremental SG&A costs in the second quarter of 2018 versus last years second quarter. Approximately $0.3 million of the costs associated with Triumph Learning were related directly to the integration through the finalization of first quarter 2018 estimates. Transportation costs increased by $1.9 million in the second quarter of fiscal 2018 due to a combination of incremental volume in the quarter and industry-wide increases in freight rates. Depreciation and amortization expense increased by $0.8 million in the current year second quarter related primarily to incremental depreciation associated with the Companys implementation of its new e-commerce platform.
These increases were partially offset by a combination of $2.0 million of lower catalog expense associated with the adoption of ASC 606, reductions in marketing and selling costs, and lower incentive compensation expense in the quarter.
As a percent of revenue, SG&A decreased from 32.3% for the three months ended July 1, 2017 to 31.8% for the three months ended June 30, 2018.
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Facility exit costs and restructuring
For the three-month period ended June 30, 2018, the Company recorded $0.2 million of facility exit costs and restructuring charges. For the three-month period ended July 1, 2017, the Company recorded $0.1 million of facility exit costs and restructuring charges. The amounts in both periods were entirely related to severance.
Interest Expense
Interest expense decreased from $4.2 million for the three months ended July 1, 2017 to $3.7 million for the three months ended June 30, 2018. The decrease is related to a reduction in non-cash interest of $0.9 million. This decline in non-cash interest was due to lower interest attributable to the Companys vendor note obligations. The decrease in non-cash interest expense in the second quarter of fiscal 2018 was partially offset by $0.4 million of incremental cash interest associated with an increase in average borrowings in the current quarter. The increase in average borrowings is related to the acquisition of Triumph Learning in the third quarter of fiscal 2017.
Loss on Early Extinguishment of Debt
During the three months ended July 1, 2017, the Company recorded a non-cash charge of $4.3 million related to the write-off of $3.1 million of remaining unamortized debt issuance costs and $1.2 million of remaining original issue discount both of which were associated with the term loan that was repaid on April 7, 2017. No such charge was recorded in fiscal 2018.
Provision for (Benefit from) Income Taxes
The provision for income taxes was $1.1 million for the three months ended June 30, 2018, as compared to tax of $0.1 million for the three months ended July 1, 2017.
The effective income tax rate for the three months ended June 30, 2018 and the three months ended July 1, 2017 was 98.3% and 42.1%, respectively. Due to the minimal amount of income before provision for income taxes in both periods, the effective income tax rate is not representative of the full year expected rate as discrete, such realized built-in loss and foreign tax adjustments, tax items in the quarter can have a large impact on the quarterly rate.
Six Months Ended June 30, 2018 Compared to Six Months Ended July 1, 2017
Revenues
Revenue of $268.6 million for the six months ended June 30, 2018 increased by $11.3 million, or 4.4%, as compared to the six months ended July 1, 2017. The adoption of ASC 606 contributed $5.4 million of the incremental revenue, primarily within the Companys Distribution segment.
Distribution segment revenues of $250.4 million for the six months ended June 30, 2018 increased by 7.3%, or $17.1 million, from the six months ended July 1, 2017. Revenues from the Triumph Learning products, acquired in the third quarter of fiscal 2017 and which are reported in our Instruction & Intervention product category, contributed $11.1 million of incremental revenues in the first six months fiscal 2018. After adjusting for the impact of revenues from our Triumph Learning products, Distribution segment revenues are up in the first six months of 2018 by $6.0 million. Revenues in the first half of 2018 were impacted by peak season orders building later in the season. The Company entered the third quarter of fiscal 2018 with $11.8 million of incremental open orders, or up 15.4%, as compared to open orders entering last years third quarter. Although revenues from the Supplies product category declined approximately $1.3 million during the six months ended June 30, 2018, the open orders entering the third quarter in the Supplies category are up year-over-year by $2.7 million. In addition, incoming orders have continued to gain momentum in the third quarter. Third quarter to date incoming orders are up year-over-year by 7.8%, resulting in a 4.9% increase in year-to-date orders for the Supplies category. Year-to-date revenues in Furniture were up 16.7%, or $10.9 million, compared to 2017. The adoption of ASC 606 drove $5.9 million of this increase year-over-year, although the full-year impact of the adoption of ASC 606 is expected to be minimal. The incoming order rate for Furniture products remains strong as year-to-date orders were up 12.8% through the end of the second quarter. Third quarter to date Furniture orders are up year-over-year by 21.4% Adjusting the Instruction & Intervention category to exclude the incremental revenue associated with the Triumph Learning products, the category was down 4.0%, or $0.7 million. However, order trends have continued to improve as the year progresses, especially in core proprietary products such as Wordly Wise and Spire, which are up nearly 4% year-to-date. The Companys Agendas and AV Tech categories are down $1.9 million and $0.9 million, respectively, through the first six months of fiscal 2018. Both the AV Tech and Agenda categories are performing modestly below expectations.
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Curriculum segment revenues of $18.2 million for the six months ended June 30, 2018 decreased by 24.3%, or $5.8 million, from the six months ended July 1, 2017. The limited amount of adoption activity in 2018 and fewer large opportunities in open territory states are contributing to the decline. However, the competitive positioning remains strong and the pipeline for opportunities for 2019 is building.
Gross Profit
Gross profit for the six months ended June 30, 2018 was $94.9 million, as compared to $95.0 million for the six months ended July 1, 2017. Gross margin for the six months ended June 30, 2018 was 35.3%, as compared to 36.9% for the six months ended July 1, 2017. Increased revenues contributed $4.6 million of additional gross profit offset by a combination of a shift in product mix, lower product level gross margins and higher product development amortization.
Distribution segment gross margin was 33.8% for the six months ended June 30, 2018, as compared to 35.3% for the six months ended July 1, 2017. Year-over-year product rate variances had a negative impact on gross margin of 170 basis points, which was partially offset by a shift in product mix, primarily related to the Triumph Learning products. A shift in product mix contributed approximately 50 basis points of gross margin improvement in the first six months of fiscal 2018. Higher product development amortization in the current year second quarter resulted in 30 basis points of lower gross margin. More aggressive pricing in certain large state, regional and district-level pricing agreements, which became effective at various points in 2017 resulted in approximately $3.0 million of the decline. In addition, the strategic move to more competitive pricing on commodity items also is a contributing factor the decline. However, these pricing actions have driven growth and customer penetration in fiscal 2018. The Company expects the year-over-year variance in gross margin associated with certain pricing agreements will stabilize or improve slightly in the second half of fiscal 2018.
Curriculum segment gross margin was 55.7% for the six months ended June 30, 2018, as compared to 52.6% for the six months ended July 1, 2017. Lower product development amortization in the current year second quarter contributed 90 basis points of the gross margin increase. The adoption of ASC 606 contributed approximately 120 basis points of the gross margin increase in the first six month of fiscal 2018 due to the increase in training revenues in the first half of 2018 as compared to the first half of 2017. The remaining difference in gross margin is related to a combination of year-over-year changes in product costs.
Selling, General and Administrative Expenses
SG&A increased $11.8 million in the first six months of fiscal 2018, from $99.2 million for the six months ended July 1, 2017 to $110.9 million for the six months ended June 30, 2018. The increase in SG&A is primarily related to the adoption of ASC 606, the Triumph Learning acquisition completed in August 2017, and incremental depreciation and amortization.
The adoption of ASC 606 resulted in a $2.5 million increase in catalog expenses in the first six months of fiscal 2018 as compared to the first six months of fiscal 2017. Under ASC 606, catalog costs are treated as a cost to acquire contracts and are not related to a specific contract, therefore are expensed when incurred. Prior to ASC 606, the Company capitalized catalog costs and amortized the costs over the revenue stream attributable to the catalogs. The Company expects to recognize lower catalog expenses over the remaining two quarters of fiscal 2018 as compared to the last two quarters of fiscal 2017, and full year catalog expenses for 2018 are anticipated to be lower as compared to 2017. The Companys acquisition of Triumph Learning during last years third quarter resulted in approximately $7.2 million of incremental SG&A costs in the first six months of 2018 versus last years first six months. Approximately $1.7 million of the costs associated with Triumph Learning were related directly to the integration. As of the end of the first quarter of fiscal 2018, Triumph Learning is fully integrated into the operations of the Company. Depreciation and amortization expense increased by $2.9 million in the current year first half related primarily to incremental depreciation associated with the Companys new phone system and new e-commerce platform implementations. Remaining SG&A costs were down $0.9 million in the six months ended June 30, 2018, as increases in transportation expenses associated with a combination of volume and increased industry-wide freight rates were offset by reductions in marketing and selling costs and incentive-based compensation expense.
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As a percent of revenue, SG&A increased from 38.6% for the six months ended July 1, 2017 to 41.3% for the six months ended June 30, 2018. The impact of the adoption of ASC 606 contributed 100 bps of this increase. Despite the year-to-date increase through June 30, 2018, the Company expects full-year 2018 SG&A as a percent of revenue to be down as compared to full-year 2017 SG&A as a percent of revenue due to the combination of cost leverage realized on anticipated revenue growth during the remainder of 2018, and further anticipated SG&A reductions tied to cost reduction and process improvement initiatives.
Facility exit costs and restructuring
For the six month period ended June 30, 2018, the Company recorded $0.5 million of facility exit costs and restructuring charges. For the six month period ended July 1, 2017, the Company recorded $0.2 million of facility exit costs and restructuring charges. The amounts in both periods were related entirely to severance.
Interest Expense
Interest expense decreased from $8.2 million for the six months ended July 1, 2017 to $7.2 million for the six months ended June 30, 2018. Non-cash interest and amortization of debt fees were down approximately $1.0 million year-over-year primarily due to lower interest attributable to the Companys vendor note obligations recorded in 2018 as compared to 2017. Cash interest expense was essentially flat in the first six months of 2018 as compared to the first six months of 2017. Incremental interest expense related to increased in borrowings of approximately $10.4 million in the first half of fiscal 2018, was offset by a lower interest rate.
Loss on Early Extinguishment of Debt
During the six months ended July 1, 2017, the Company recorded a non-cash charge of $4.3 million related to the write-off of $3.1 million of remaining unamortized debt issuance costs and $1.2 million of remaining original issue discount both of which were associated with the term loan that was repaid on April 7, 2017. No such charge was recorded in fiscal 2018.
Provision for (Benefit from) Income Taxes
The benefit from income taxes was $5.1 million for the six months ended June 30, 2018, as compared to $0.3 million for the six months ended July 1, 2017.
The effective income tax rate for the six months ended June 30, 2018 and the six months ended July 1, 2017 was 21.5% and 1.7%, respectively. The change in the effective income tax rate year-over-year is due to a combination of lower tax rates associated with the 2017 tax reform as well as the partial reversal of valuation allowances in the fourth quarter of fiscal 2017. The tax benefit recorded in the six months ended June 30, 2018 is expected to be entirely offset by tax provisions recognized against the net income expected to be generated over the remainder of fiscal 2018.
Liquidity and Capital Resources
At June 30, 2018, the Company had net working capital of $99.4 million, a decrease of $8.6 million as compared to July 1, 2017. Net working capital in the current year includes both $8.6 million of cash and $64.6 million of current maturities of long term debt. The Company estimates that the carrying values of its accounts receivable and accounts payable, as shown in the condensed consolidated balance sheets, approximate fair value. The Companys capitalization at June 30, 2018 was $281.8 million and consisted of total debt of $195.0 million and stockholders equity of $86.8 million. The change in accounting principle (See Note 4) resulted in $4.8 million of decreased working capital, primarily related to the immediate expensing of catalog costs.
Net cash used by operating activities was $65.9 million and $46.2 million for the six months ended June 30, 2018 and July 1, 2017, respectively. The increase in cash used by operating activities related primarily to an increased operating loss of $12.2 million in the first six months of 2018 versus the first six months of fiscal 2017. The remainder of the increase in cash used by operating activities was related to incremental working capital changes in the current year. Excluding the working capital impact of ASC 606, inventory and accounts receivable balances increased in the current year due to incremental volume.
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Net cash used in investing activities was $8.5 million in the first six months of fiscal 2018 as compared to $9.2 million in the first six months of fiscal 2017. The Company expects net cash used in investing activities to increase by approximately $2.4 million for the full year fiscal 2018 as compared to full year fiscal 2017 due to investments in the Companys ecommerce platform, product information management systems and curriculum product development. The completion of these projects is expected to result in improvements to the Companys platforms and processes, lower both ongoing operating costs and future investments in systems, and enable revenue growth.
Net cash provided from financing activities was $51.4 million in fiscal 2018 versus $27.2 million in fiscal 2017. In both periods the net cash provided from financing activities represents net draws from the ABL Facility, which combined with beginning of period cash balances, were used to fund operating and investing cash outflows, as well as Term Loan repayments in fiscal 2017. Outstanding borrowings on the ABL Facility were $61.5 million as of June 30, 2018, while the excess availability on that date for the ABL Facility was $59.6 million. The company repaid principal on its Term Loan in the amount of $9.4 million during the first six months of fiscal 2018, which consisted of an excess cash flow payment of $7.8 million and regularly scheduled principal payments of $1.6 million.
The Companys ABL Facility and New Term Loan contain customary events of default and financial, affirmative negative covenants. Based on current projections, the Company believes it will maintain compliance with these covenants throughout the next twelve months.
We believe that our cash flow from operations, borrowings available from our ABL Facility and the remaining portion of the delayed draw term loan available under the New Term Loan will be sufficient to meet our liquidity requirements for operations, including anticipated capital expenditures and our contractual obligations for the next twelve months.
Fluctuations in Quarterly Results of Operations
Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the periods from June through September, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by variations in our costs for the products sold, the mix of products sold and general economic conditions. Therefore, results for any quarter are not indicative of the results that we may achieve for any subsequent fiscal quarter or for a full fiscal year.
Inflation
Inflation, particularly in energy costs, wage rate, and transportation costs has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.
Forward-Looking Statements
Statements in this Quarterly Report on Form 10-Q that 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, Managements Discussion and Analysis of Financial Condition and Results of Operations, including, without limitation, statements with respect to our internal growth plans, projected revenues and revenue growth, margin improvement, capital expenditures, adequacy of capital resources and ability to comply with financial covenants; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, belief or current expectation of School Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include forward-looking terminology such as may, should, believes, expects, anticipates, estimates, continues, projects 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 on Form 10-Q 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 December 30, 2017.
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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 on Form 10-K for the fiscal year ended December 30, 2017.
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 Companys principal executive officer and principal financial officer have concluded that the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) were not effective for the purposes set forth in the definition of the Exchange Act rules due to a material weakness in internal control over financial reporting related to insufficient general information technology controls which impact the reliability of automated inventory and revenue controls. While the Company has operational procedures in the areas of inventory and revenue control, they are not designed, executed and/or documented in a manner that is sufficient to be considered effective manual controls in accordance with the criteria established by Internal ControlIntegrated Framework 2013. Based on the Companys inability rely on these automated and manual controls, the Company has concluded it has material weaknesses in controls related to: a) inventory quantities at the locations subject to routine cycle counts; and b) the accuracy of pricing and quantities shipped to customers. We did not identify any adjustments to our financial statements as a result of either the identification of these material weaknesses, our additional review of these areas, or our initial implementation of measures to remediate these material weaknesses.
Changes in Internal Control Over Financial Reporting
The Company has implemented a number of process-related manual controls in order to address, or compensate for, certain general information technology control deficiencies identified in 2017. In addition, the Company has remediation actions related to its general information technology control deficiencies, most notably remediation of access-related controls. The Company believes the changes or remediations to its process level internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter ended June 30, 2018 are reasonably likely to strengthen, our internal control over financial reporting.
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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) | ||||||
August 7, 2018 | /s/ Joseph M. Yorio | |||||
Date | Joseph M. Yorio | |||||
President and Chief Executive Officer | ||||||
(Principal Executive Officer) | ||||||
August 7, 2018 | /s/ Kevin L. Baehler | |||||
Date | Kevin L. Baehler | |||||
Executive Vice President and Chief Financial Officer | ||||||
(Principal Financial Officer) |
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