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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED APRIL 25, 1998
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 I.R.S. Employer
Incorporation or Organization) Identification No.
1000 NORTH BLUEMOUND DRIVE 54914
APPLETON, WI (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (920) 734-2756
Securities registered pursuant to Section 12(b) of the Act:
NONE.
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.001
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_X_
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. _X_
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of July 17, 1998 was $202,007,352.
As of July 17, 1998, 14,572,784 shares of the Registrant's common stock,
$.001 par value per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
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TABLE OF CONTENTS
DESCRIPTION PAGE
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Part I
Item 1. Business......................................................................................... 1
Item 2. Properties....................................................................................... 7
Item 3. Legal Proceedings................................................................................ 7
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 7
Part II
Item 5. Market for the Company's Common Equity and Related Shareholder Matters........................... 8
Item 6. Selected Financial Data.......................................................................... 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 10
Item 8. Financial Statements and Supplementary Data...................................................... 21
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure.............. 48
Part III
Item 10. Directors and Executive Officers of the Registrant.............................................. 48
Item 11. Executive Compensation.......................................................................... 50
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................. 55
Item 13. Certain Relationships and Related Transactions.................................................. 56
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 57
PART I
THIS ANNUAL REPORT ON FORM 10-K (THE "ANNUAL REPORT") CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. WHEN USED
HEREIN, THE WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," "INTEND," "MAY," "WILL"
AND "EXPECT" AND SIMILAR EXPRESSIONS AS THEY RELATE TO SCHOOL SPECIALTY, INC.
("SCHOOL SPECIALTY" OR THE "COMPANY") OR ITS MANAGEMENT ARE INTENDED TO IDENTIFY
SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS COULD DIFFER MATERIALLY FROM THE RESULTS EXPRESSED IN, OR IMPLIED
BY, THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO
SUCH DIFFERENCES INCLUDE THOSE DISCUSSED IN "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-- FACTORS AFFECTING
THE COMPANY'S BUSINESS." THE COMPANY DOES NOT UNDERTAKE ANY OBLIGATION TO REVISE
THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY FUTURE EVENTS OR CIRCUMSTANCES.
ITEM 1. BUSINESS
COMPANY OVERVIEW
The Company believes that it is the largest U.S. distributor focusing on
non-textbook educational supplies and furniture for grades pre-kindergarten
through 12 ("pre-K-12"). The Company provides a comprehensive offering of high
quality educational supplies and furniture to school districts, school
administrators and teachers through the broad distribution of its catalogs.
School Specialty distributes general school supplies, including classroom and
art supplies, instruction materials, furniture and equipment. The Company also
distributes supplies and furniture for certain educational disciplines,
including early childhood education under the Childcraft name, art supplies
under the Sax Arts & Crafts name and library-related products under the
Gresswell name. In order to broaden its geographic presence and product
offering, the Company has acquired 17 companies since May 1996. For the fiscal
year ended April 25, 1998, the Company's revenues aggregated $310.5 million and
operating income aggregated $16.2 million, which represented compound annual
increases of 35.8% and 122.8%, respectively, over revenues and operating income
for the year ended December 31, 1994.
With over 32,000 stock keeping units ("SKUs"), School Specialty offers
customers one source for virtually all of their non-textbook school supply and
furniture needs. School Specialty markets its products through an innovative
two-pronged approach, targeting both administrators and teachers to cover the
full spectrum of decision makers. The Company's "top down" approach, utilizing
its 290 sales representatives and its School Specialty general supply and
furniture catalog (the "School Specialty Catalog"), focuses on procurement
officials at the state, regional and local levels, while its "bottom up"
approach focuses on curriculum specialists and teachers. Sales to curriculum
specialists and over 2.1 million teachers are made primarily through the 6.3
million general supply catalogs of Re-Print LLC ("Re-Print") and specialty
catalogs that are mailed each year.
The Company believes that annual sales of non-textbook educational supplies
and equipment to the school supply market aggregate approximately $6.1 billion,
with over $3.6 billion sold to institutions and $2.5 billion sold to consumers.
The Company also believes there are over 3,400 distributors of school supplies,
the majority of which are family- or employee-owned companies with revenues
under $20 million that operate in a single region. The Company believes the
demand for timely order fulfillment at competitive prices, combined with the
need to invest in automated inventory and electronic ordering systems, is
accelerating the trend toward consolidation in the industry. School Specialty
also believes that it is well positioned to capitalize on this consolidation as
the largest distributor in its industry with annual revenues which it believes
exceed those of its next two largest competitors combined. Although the Company
is the largest distributor in the industry, its share of the $6.1 billion school
supply market is less than 6%, giving the Company substantial growth
opportunities.
The volume of school supplies is directly influenced by the size of the
student population. Kindergarten through 12th grade ("K-12") student enrollment
reached an all-time peak in 1996 with 51.5 million students and the U.S.
Department of Education projects that student enrollment will continue to grow
to
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54.3 million by the year 2006. As a result of these trends, the U.S. Department
of Education projects that expenditures in public elementary and secondary
schools will continue to rise through the year 2007. These rising expenditures
include a projected increase in total per pupil spending in current dollars from
$5,961 per pupil in 1997 to $7,179 by the year 2001. The Company believes that
as the largest U.S. distributor of non-textbook educational supplies it will be
a major beneficiary of this growth in expenditures.
School Specialty is a Delaware corporation formed in February 1998 to hold
the Educational Supplies and Products Division of U.S. Office Products. School
Specialty, Inc., a Wisconsin corporation ("Old School") formed in October 1959,
was acquired by U.S. Office Products in May 1996. School Speciality's
wholly-owned subsidiary, The Re-Print Corp., was acquired by U.S. Office
Products in July 1996 and has been in operation since 1921. In connection with
the Strategic Restructuring Plan (defined below), The Re-Print Corp. was
reorganized as Re-Print LLC. The specialty product lines, Childcraft, Sax Arts &
Crafts and Gresswell, were all acquired by U.S. Office Products in 1997, and
have been in operation since 1946, 1945, and 1938, respectively. On June 9,
1998, U.S. Office Products distributed the shares of School Specialty to the
stockholders of U.S. Office Products (the "School Specialty Distribution"). The
School Specialty Distribution was part of a comprehensive restructuring plan
adopted by the U.S. Office Products Board of Directors (the "Strategic
Restructuring Plan") in which U.S. Office Products spun-off (the
"Distributions") all of the shares of School Specialty and three other companies
that operate in the print management, technology solutions and corporate travel
services business (the "Spin Off Companies").
COMPANY GROWTH STRATEGY
School Specialty's objective is to further enhance its position as the
leading distributor of non-textbook educational supplies through the continued
implementation of the following strategies:
PURSUE ACQUISITIONS AGGRESSIVELY. The Company believes that there are
extensive acquisition opportunities among the over 3,400 school distributors in
the U.S. The Company intends to pursue two types of acquisitions: (i) general
school supply and furniture companies in geographic markets in which the Company
has a limited presence, and (ii) specialty companies focusing on disciplines
such as physical education, science, technology and music. School Specialty
believes it can improve the margins of acquired entities through its efficient
integration process to achieve economies of scale. Although the Company is the
largest distributor in the industry, its share of the $6.1 billion school supply
market is less than 6%, giving the Company substantial growth opportunities.
In furtherance of its acquisition strategy, School Specialty routinely
reviews and conducts investigations of potential acquisitions of school supply
businesses. When School Specialty believes a favorable opportunity exists, it
enters into discussion with the owners of such businesses regarding the
possibility of an acquisition by School Specialty.
IMPROVE PROFITABILITY. School Specialty improved its operating margin from
1.5% in 1995 to 5.3% for the fiscal year ended April 25, 1998. School Specialty
believes that there are substantial opportunities to further improve margins by
(i) increasing the efficiency of recent acquisitions, (ii) expanding purchasing
power and (iii) improving warehousing and distribution.
PENETRATE NEW MARKETS AND EXPAND CUSTOMER BASE IN EXISTING MARKETS. School
Specialty believes that it can increase sales by adding sales representatives in
geographic markets in which the Company does not have a significant presence. In
addition, the Company believes that it can further increase sales by cross
merchandising its specialty supplies to its general supplies customers. Lastly,
the Company intends to increase international sales in English-speaking
countries.
PRODUCT LINES
SCHOOL SPECIALTY. The School Specialty Catalog offers a comprehensive
selection of classroom supplies, instructional materials, educational games, art
supplies, school forms (such as reports, planners
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and academic calendars), physical education equipment, audio-visual equipment,
school furniture, and indoor and outdoor equipment and is targeted to
administrative decision makers. School Specialty believes it is the largest
school furniture resale source in the United States. School Specialty has been
granted exclusive franchises for certain furniture lines in specific territories
and School Specialty enjoys significant purchasing power in open furniture
lines.
The Company's specialty brands offer product lines for specific educational
disciplines.
RE-PRINT. Re-Print offers its customers substantially the same products as
the School Specialty Catalog but focuses on reaching teachers and curriculum
specialists directly through its mail-order catalogs.
CHILDCRAFT. Childcraft distributes early childhood education products and
materials. Childcraft also distributes over 1,000 proprietary or exclusive
products manufactured by its Bird-in-Hand Woodworks subsidiary, including wood
classroom furniture and equipment such as library shelving, cubbies, easels,
desks and play vehicles.
SAX ARTS & CRAFTS. Sax Arts & Crafts is a leading distributor of art
supplies and art instruction materials, including paints, brushes, paper,
ceramics, art metals and glass, leather and wood crafts. Sax Arts & Crafts
offers customers a toll free "Art Savvy Hotline" staffed with 15 professional
artists to respond to customer questions.
GRESSWELL. Gresswell distributes library-related products in the U.K.
including furniture, and media display and storage. Gresswell's dedicated sales
and design team helps customers plan, design and install library projects using
Computer Assisted Design equipment.
EDUCATION ACCESS. Education Access is a catalog reseller of technology
solutions for the K-12 education market. This new product line will offer
curriculum software, productivity software, peripherals, networking products,
and other related products. Education Access publishes a 110-page catalog twice
a year and mails interim Technology Flash Updates to the K-12 market in the
United States.
School Specialty employs merchandising managers who continually review and
update the product lines for each operating division. The merchandising managers
convene customer focus groups and advisory panels to ascertain whether current
offerings are well-received and to anticipate future demand. The merchandising
managers also travel to product fairs and conventions seeking out new product
lines. This annual review process results in an organic reshaping and expansion
of the educational materials being offered by School Specialty.
OPERATIONS
SALES AND MARKETING
School Specialty believes it has developed a substantially different sales
and marketing model from that of traditional school supply and school
furnishings distribution companies in the United States. School Specialty's
strategy is to use its position of owning two distribution platforms with which
it can approach the school market. School Specialty's 290 sales representatives
focus on "top down" selling (through districts, school purchasing authorities
and schools), while School Specialty's Re-Print Division uses the "bottom up"
approach through its direct mail catalog selling directly to teachers. To
further strengthen its position in the market, School Specialty also owns
premier specialty education brands (Childcraft, Sax Arts & Crafts, and
Gresswell) that have the potential to enrich the general product offering
through cross-merchandising.
School Specialty has a broad customer base and no single customer accounted
for more than 2% of sales during fiscal 1998. Schools typically purchase school
supplies and furniture based on an established relationship with relatively few
suppliers. School Specialty establishes and maintains its relationship with its
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customers by assigning accounts within a specific geographic territory to a
local area sales representative. Additionally, each account is assigned its
designated inside customer service representative.
School Specialty's customer service representatives call on existing
customers frequently to ascertain and fulfill their school supply needs. The
representatives maintain contact with customers throughout the order cycle and
assist in processing orders.
School Specialty's primary compensation program for sales representatives is
based on commissions as a percentage of gross profit on sales. For new and
transitioning sales representatives, School Specialty offers salary and expense
reimbursement until the representative is moved to a full commission
compensation structure.
School Specialty utilizes direct mail catalogs to reach its broader customer
base. School Specialty distributes five major catalogs, one for each of its
School Specialty general supply, Re-Print, Childcraft, Gresswell, and Sax Arts &
Crafts lines. The catalog distribution calendar is generally the same across all
product lines. A major catalog containing all product offerings is distributed
toward the end of the calendar year so that it is available for school buyers at
the beginning of the year. During the year, various catalog supplements are
distributed to coincide with the peak school buying season in June through
September and following the return of students to school in the fall.
The approximate number of catalogs distributed for School Specialty,
Re-Print, Childcraft, Gresswell and Sax Arts & Crafts for each of the past three
calendar years and projected catalog distribution for 1998 is set out below. The
figures set forth below include all books of over 32 pages sent out (or, with
respect to 1998, expected to be sent out) during the calendar year but do not
include catalogs that were distributed by discontinued operations.
1995 1996 1997 1998
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(PROJECTED)
School Specialty Catalog........................... 115,000 296,750 450,750 600,000
Re-Print........................................... 998,000 1,175,000 2,275,000 3,400,000
Childcraft......................................... 1,583,000 1,308,000 1,360,000 1,728,000
Gresswell.......................................... 100,000 180,000(1) 130,000 150,000
Sax Arts & Crafts.................................. 750,000 823,000 1,043,500 1,064,000
---------- ---------- ---------- ----------
Total.......................................... 3,546,000 3,782,750 5,259,250 6,942,000
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(1) Includes an extra catalog published against a competitive launch.
Pricing for School Specialty's general and specialty product offerings
varies by product and channel of distribution. The Company generally offers a
negotiated discount from catalog prices for supplies and responds to quote and
bid requests for furniture and equipment. In addition, local sales
representatives work with the Company's corporate sales force and school supply
buyers to achieve an acceptable pricing structure based upon the mix of products
being procured.
School Specialty distributes products through its distribution centers as
well as placing customer orders directly with School Specialty's suppliers.
Furniture is generally shipped directly from the manufacturer to the user,
bypassing School Specialty's distribution centers.
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PURCHASING AND INVENTORY MANAGEMENT
School Specialty manages its inventory by continually reviewing daily
inventory levels compared to a running 90-day inventory for the previous year,
adjusted for incoming orders. School Specialty constantly refines the focus of
inventory products through its automated inventory management system to pursue
the optimum level of scope and depth of product offered. Every item in each of
the various distribution regions is forecasted on a daily basis to account for
the anticipated demand curve, current order activity, and available stock as
well as the expected lead time from the supplier. The forecast allows inventory
purchases to respond quickly to the high seasonal demand while keeping
off-season inventory to a minimum. The information systems for all of School
Specialty's distribution centers are interconnected to allow transfer of
inventory between facilities to fill regional demand. In addition, all orders
can be redirected to the distribution center which is the primary stocking
location for a product. School Specialty's inventory management results in
inventory turnover that management believes is higher than industry turnover
rates and reduces the level of discontinued, excess and obsolete inventory
compared to businesses acquired by School Specialty.
School Specialty believes its large size enhances its purchasing power with
suppliers and results in lower product costs than most of the Company's
competitors. Further, School Specialty believes it can leverage this purchasing
power to acquired companies in the future to improve the operating margins for
both general supply and specialty businesses. The Company also believes its
purchasing power for general supplies should result in improved margins for its
specialty businesses.
Market surveys by Krebs and Company have shown that the primary determinants
of customer satisfaction in the educational supply industry are the completeness
and accuracy of shipments received and the timeliness of delivery. School
Specialty continues to invest in sophisticated computer systems to automate the
order taking, inventory allocation and management, and order shipment processes.
As a result, School Specialty has been able to provide superior order
fulfillment to its customers. In addition, School Specialty has developed OMS,
which allows schools to customize their orders and enter them electronically
with School Specialty and provides historical usage reports to schools useful
for their budgeting process. During the academic year, School Specialty seeks to
fill orders within twenty-four hours of receipt of the order at a 95.0% fill
rate and a 99.5% order accuracy rate. During the summer months, School Specialty
shifts to a production environment and schedules shipments to coincide with the
start of the school year. During the summer months, School Specialty's
objectives are to meet a 100% fill rate at a 99.5% order accuracy rate. In the
aggregate, School Specialty's order fill rate for June, July and August 1997
exceeded 97.0%. The Company defines "fill rate" as the percentage of line items
in a customer's order that are initially shipped to the customer in response to
the order by the requested ship date.
During the peak shipping season between June 1 and September 30, each of
School Specialty's distribution centers contracts with local common carriers to
deliver its product to schools and school warehouses. Re-Print and Sax Arts &
Craft rely on carriers such as Roadway Package Service, United Parcel Service
and the U.S. Postal Service for distribution to customers.
INFORMATION SYSTEMS
The Company believes that through the utilization of technology in areas
such as (i) purchasing and inventory management, (ii) customer order fulfillment
and (iii) database management, School Specialty is able to turn inventory more
quickly than competitors, offer customers more convenient and cost effective
product ordering methods and conduct more precisely targeted sales and marketing
campaigns. School Specialty uses two principal information systems, one for its
general distribution and another for its specialty market distribution. In
general school supply distribution, School Specialty utilizes a specialized
distribution software package used primarily by office products and paper
distributors. The software offers a fully integrated process from sales order
entry through customer invoicing, and inventory requirements
5
planning through accounts payable. School Specialty's system provides
information through daily automatic posting to the general ledger and integrated
inventory control. School Specialty has made numerous enhancements to this
process that allow greater flexibility in addressing seasonal requirements of
the industry and meeting specific customer needs.
The specialty divisions are moving towards a common mail order system
provided by Smith-Gardner & Associates. The Mail-order and Catalog System
("MACS") meets the unique needs of the direct marketing approach with extensive
list management and tracking of multiple marketing efforts. The system provides
complete and integrated order processing, inventory control, warehouse
management, and financial applications.
Although School Specialty has two principal information systems, these
systems integrate general ledger, purchasing and inventory management functions.
The software and hardware allow for continued incremental growth as well as the
opportunity to integrate new client-server and other technologies into the
information systems. Currently, all acquired School Specialty general
distribution companies (except one acquired in December 1997) are on the same
computer system. The specialty businesses and Re-Print operate on different
systems but intend to implement the common MACS system. School Specialty intends
to continue to use two principal information systems in its business.
YEAR 2000 COMPLIANCE
School Specialty's current information systems as well as those being
considered for acquisition by School Specialty's mail order and specialty
distribution divisions, currently meet information standards for Year 2000
compliance. School Specialty does not expect that it will incur any material
costs and expenses to meet information standards for Year 2000 compliance. See "
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting the Company's Business."
COMPETITION
School Specialty operates in a highly competitive environment. The Company's
principal competitors are other national and regional school supply distribution
companies. School Specialty is also faced with increasing competition from
non-traditional alternate channel competitors, such as office products contract
stationers and superstores. Among traditional school supply distributors, School
Specialty believes that there are only two other companies with sales in excess
of $130 million: Beckley-Cardy and the J.L. Hammett Co. School Specialty
believes that it competes favorably with these companies on the basis of service
and price.
The market is highly competitive on a regional basis, but School Specialty
believes its heaviest competition is coming from alternate channel competitors
such as office product contract stationers and superstores. Their primary
advantages over School Specialty are size, location, greater financial resources
and buying power. Their primary disadvantage is that their product mix covers
only 15% to 20% of the school's needs (measured by volume). In addition, the
Company's competitors do not offer special order fulfillment software, which
School Specialty believes is increasingly important to adequately service school
needs. School Specialty believes it competes favorably with these companies on
the basis of service and product offering.
EMPLOYEES
As of April 25, 1998, School Specialty had 1,220 full-time employees, 272 of
whom were employed primarily in management and administration, 416 in regional
warehouse and distribution operations, and 532 in marketing, sales, order
processing, and customer service. To meet the seasonal demands of its customers,
School Specialty employs many seasonal employees during the late spring and
summer seasons. Historically, School Specialty has been able to meet its
requirements for seasonal employment. As of April 25, 1998, approximately 43 of
School Specialty's employees were members of the Teamsters Labor
6
Union at Sax Arts & Crafts' New Berlin, Wisconsin facility. School Specialty
considers its relations with its employees to be very good.
ITEM 2. PROPERTIES
School Specialty's corporate headquarters are located at 1000 North
Bluemound Drive, Appleton, Wisconsin, a combined office and warehouse facility
of approximately 120,000 square feet. School Specialty's lease on the Appleton
headquarters expires on December 31, 2001. School Specialty leases or owns the
following distribution facilities.
APPROXIMATE
SQUARE OWNED/ LEASE
LOCATIONS FOOTAGE LEASED EXPIRATION
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Agawam, Massachusetts............................................. 163,300 Owned --
Bethlehem, Pennsylvania........................................... 25,600 Leased February 28, 1999
Birmingham, Alabama............................................... 180,365 Leased November 20, 2006
Bowling Green, Kentucky........................................... 42,000 Leased June 30, 2001
Cary, Illinois.................................................... 75,767 Owned --
Enfield, London, England.......................................... 8,000 Owned --
Fresno, California................................................ 18,480 Leased December 31, 2001
Hoddesdon, London, England........................................ 10,000 Leased September 1999
Hoddesdon, London, England........................................ 10,000 Leased September 2015
Lancaster, Pennsylvania........................................... 75,434 Leased December 31, 2002
Lancaster, Pennsylvania........................................... 165,750 Leased February 28, 1999
Mt. Laurel, New Jersey............................................ 48,000 Leased May 31, 2001
New Berlin, Wisconsin............................................. 97,500 Leased March 31, 2002
Oklahoma City, Oklahoma........................................... 37,340 Leased July 16, 2001
Pollocksville, North Carolina..................................... 84,071 Owned --
Portland, Oregon.................................................. 30,456 Leased May 31, 2001
Salina, Kansas.................................................... 123,000 Owned --
The Lancaster, Pennsylvania facility is used for manufacturing and the
Salina, Kansas facility is used for production of school forms. In addition,
School Specialty has ten sales offices throughout the United States.
School Specialty believes that its properties are adequate to support its
operations for the foreseeable future. School Specialty reviews on a regular
basis the consolidation of its facilities.
ITEM 3. LEGAL PROCEEDINGS
The Company is, from time to time, a party to legal proceedings arising in
the normal course of its business. Management believes that none of these legal
proceedings will have a material adverse effect on the financial position,
results of operations or cash flows of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's stockholders for consideration
during the quarter ended April 25, 1998.
7
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
(a) The Company's common stock (the "Common Stock") has traded on the Nasdaq
National Market since June 10, 1998 under the symbol "SCHS." There was no market
for the Company's Common Stock prior to that date.
The number of record holders of the Company's Common Stock as of July 17,
1998 was 3,940. The Company believes that a substantially larger number of
beneficial owners hold such shares of Common Stock in depository or nominee
form.
The Company has not declared or paid any cash dividends on the Company's
Common Stock to date and does not anticipate paying any cash dividends on its
shares of Common Stock in the foreseeable future because it intends to retain
its earnings, if any, to finance the expansion of its business and for general
corporate purposes. Any payment of future dividends will be at the discretion of
the Board of Directors and will depend upon, among other things, the Company's
earnings, financial condition, capital requirements, level of indebtedness,
contractual restrictions with respect to the payment of dividends and other
factors that the Company's Board of Directors deems relevant. Further, the
Company's credit facility restricts the Company's ability to pay dividends to
the extent that there is a default under the credit facility.
(b) On June 9, 1998, the Company's registration statement (the "Registration
Statement") on Form S-1 filed pursuant to the Securities Act of 1933, as amended
(file number 333-47509) was declared effective by the Commission. The
Registration Statement related to an offering (the "Offering") of 2,125,000
shares of the Common Stock, par value $.001 of the Company at an aggregate
offering price of $32,937,500. Additionally, School Specialty registered 318,750
shares to cover over-allotments. On June 10, 1998, School Specialty sold
2,125,000 shares of Common Stock. The underwriters for the Offering were
Goldman, Sachs & Co., NationsBanc Montgomery Securities LLC, Salomon Smith
Barney and Piper Jaffray, Inc. In addition, the Company sold 250,00 shares
directly to Daniel P. Spalding, the Chariman of the Board and its Chief
Executive Officer, David J. Vander Zanden, its President and Chief Operating
Officer, and Donald Ray Pate, Jr., its Executive Vice President for Re-Print.
The shares were sold at a price of $14.415 for aggregate consideration of
$3,603,750. The sale of these shares was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
The total proceeds to the Company of the Offering, net of underwriting
discounts and commissions of $2,305,625, were $30,631,875. In addition, the
Company incurred approximately $1,500,000 of expenses in connection with the
Offering, consisting primarily of the costs of registering the Offering under
the Securities Act of 1993, as amended, and with the National Association of
Securities Dealers, Inc., printing fees and professional expenses. The net
proceeds to the Company of the Offering were approximately $29,131,875. None of
such payments were made to directors or officers of the Company or their
associates or to persons owning 10% or more of any class of equity securities of
the Company or to affiliates of the Company. None of the proceeds were received
prior to April 25, 1998. The net proceeds were used to reduce indebtedness
outstanding under the Company's credit facility. The debt under the credit
facility had been incurred to pay debt of U.S. Office Products allocated to the
Company in connection with the Distributions. See "Item 7--Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data provided herein should be read in conjunction
with the historical financial statements, including the notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operation," all of which appear elsewhere in this Annual Report.
8
The historical Selected Financial Data for the fiscal years ended April 25,
1998 and April 26, 1997, the four months ended April 30, 1996, and the years
ended December 31, 1995 and 1994 have been derived from School Specialty's
consolidated financial statements that have been audited. The historical
Selected Financial Data for the fiscal years ended April 25, 1998 and April 26,
1997, the four months ended April 30, 1996, and the year ended December 31, 1995
are included elsewhere in the Annual Report. The historical Selected Financial
Data for the year ended December 31, 1993 have been derived from unaudited
consolidated financial statements which are not included elsewhere in this
Annual Report. These unaudited consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements and,
in the opinion of management, contain all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation of the results of
operations for the periods presented. The historical financial information of
Old School and Re-Print has been combined on a historical cost basis in
accordance with generally accepted accounting principles ("GAAP") to present
this financial data as if the Pooled Companies had always been members of the
same operating group. The financial information of the Purchased Companies is
included from the dates of their respective acquisitions.
FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOUR MONTHS YEAR ENDED
FISCAL YEAR ENDED ENDED DECEMBER
---------------------- ------------- 31,
APRIL 25, APRIL 26, APRIL 30, ----------
1998 1997 1996 1995
---------- ---------- ------------- ----------
STATEMENT OF INCOME DATA:
Revenues....................................................................... $ 310,455 $ 191,746 $ 28,616 $ 150,482
Cost of revenues............................................................... 219,313 136,577 20,201 105,757
---------- ---------- ------------- ----------
Gross profit................................................................. 91,142 55,169 8,415 44,725
Selling, general, and administrative expenses.................................. 71,403 43,462 10,307 39,869
Non-recurring acquisition costs................................................ 1,792 1,122
Restructuring costs............................................................ 2,491 194 2,532
Strategic restructuring costs.................................................. 1,000
---------- ---------- ------------- ----------
Operating income............................................................. 16,248 9,721 (3,014) 2,324
Interest expense............................................................... 5,505 4,197 1,461 5,536
Interest income................................................................ (132) (6)
Other (income) expense......................................................... 156 (196) 67 (18)
---------- ---------- ------------- ----------
Income (loss) before provision for income taxes................................ 10,719 5,720 (4,536) (3,194)
Provision for (benefit from) income taxes (1).................................. 5,480 (2,412) 139 173
---------- ---------- ------------- ----------
Net income (loss).............................................................. $ 5,239 $ 8,132 $ (4,675) $ (3,367)
---------- ---------- ------------- ----------
---------- ---------- ------------- ----------
Net income (loss) per share:
Basic........................................................................ $ 0.40 $ 0.81 $ (0.54) $ (0.51)
Diluted...................................................................... $ 0.39 $ 0.80 $ (0.53) $ (0.50)
Weighted average shares outstanding:
Basic........................................................................ 13,284 10,003 8,611 6,562
Diluted...................................................................... 13,547 10,196 8,789 6,669
1994 1993
---------- ---------
STATEMENT OF INCOME DATA:
Revenues....................................................................... $ 119,510 $ 76,926
Cost of revenues............................................................... 87,750 56,280
---------- ---------
Gross profit................................................................. 31,760 20,646
Selling, general, and administrative expenses.................................. 27,281 18,294
Non-recurring acquisition costs................................................
Restructuring costs............................................................
Strategic restructuring costs..................................................
---------- ---------
Operating income............................................................. 4,479 2,352
Interest expense............................................................... 3,007 1,845
Interest income................................................................
Other (income) expense......................................................... (86) 228
---------- ---------
Income (loss) before provision for income taxes................................ 1,558 279
Provision for (benefit from) income taxes (1).................................. 218 199
---------- ---------
Net income (loss).............................................................. $ 1,340 $ 80
---------- ---------
---------- ---------
Net income (loss) per share:
Basic........................................................................ $ 0.26 $ 0.02
Diluted...................................................................... $ 0.26 $ 0.02
Weighted average shares outstanding:
Basic........................................................................ 5,062 4,918
Diluted...................................................................... 5,078 4,918
DECEMBER
31,
APRIL 25, APRIL 26, APRIL 30, ----------
1998 1997 1996 1995
---------- ---------- ------------- ----------
BALANCE SHEET DATA:
Working capital (deficit)...................................................... $ 47,791 $ 14,491 $ (3,663) $ (1,052)
Total assets................................................................... 223,729 87,685 54,573 54,040
Long-term debt, less current portion........................................... 315 566 15,031 15,294
Long-term payable to U.S. Office Products...................................... 62,699 33,266
Stockholders' (deficit) equity................................................. 106,466 16,329 (4,267) (620)
1994 1993
---------- ---------
BALANCE SHEET DATA:
Working capital (deficit)...................................................... $ 3,512 $ 1,140
Total assets................................................................... 44,267 23,190
Long-term debt, less current portion........................................... 11,675 7,175
Long-term payable to U.S. Office Products......................................
Stockholders' (deficit) equity................................................. 1,827 545
- ------------------------
(1) Results for the fiscal year ended April 26, 1997 include benefit from income
taxes of $2.4 million primarily arising from the reversal of a $5.3 million
valuation allowance in the quarter ended April 26,
9
1997. The valuation allowance had been established in 1995 to offset the tax
benefit from net operating loss carryforwards included in the Company's
deferred tax assets, because at the time it was not likely that such tax
benefit would be realized. The valuation allowance was reversed subsequent
to the Company's being acquired by U.S. Office Products, because it was
deemed "more likely than not," based on improved results, that such tax
benefit would be realized.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results
of operation of the company should be read in conjunction with the financial
statements and the notes thereto which appear elsewhere in this annual report.
OVERVIEW
School Specialty is the largest U.S. distributor focusing on non-textbook
educational supplies and furniture for grades pre-K-12. The Company provides a
comprehensive offering of high quality educational supplies and furniture to
school districts, school administrators and teachers through the broad
distribution of its catalogs. Specialty brands, which target specific curriculum
disciplines, include Childcraft, which sells to the early childhood market; Sax
Arts & Crafts, which distributes a broad line of art supplies and materials; and
Gresswell, which distributes library-related products in the United Kingdom.
Revenues have increased from $65.0 million in the fiscal year ended December
31, 1992 to $310.5 million for the fiscal year ended April 25, 1998. This
increase resulted primarily from 16 acquisitions, 14 of which occurred during
fiscal 1997 and 1998, as well as internally generated growth.
School Specialty's gross profit margins have improved by achieving increased
buying power and by acquiring specialty companies which usually have higher
gross margins than the Company's general products divisions. The Company expects
gross profit margins to be further enhanced by acquiring additional specialty
companies and continuing to improve its purchasing power.
School Specialty's operating margin has improved significantly over the last
several years. This improvement reflects the Company's acquisition of specialty
companies which have higher operating margins than the Company's general
products divisions. In addition, operating margins have increased as the Company
has reduced selling, general and administrative expenses of acquired companies
by eliminating redundant administrative functions. Currently, nine of the ten
general school supply companies acquired since May 1996 have been integrated.
The benefit from income taxes in Fiscal 1997 of $2.4 million reflects the
reversal of a $5.3 million deferred tax valuation allowance in the fourth
quarter. The Company believes an effective income tax rate of 46.0% is more
representative of future effective income tax rates.
School Specialty's business and working capital needs are highly seasonal
with peak sales levels occurring from May through October. During this period,
the Company receives, ships and bills the majority of its orders so that schools
and teachers receive their merchandise by the start of each school year. School
Specialty's inventory levels increase in April through July in anticipation of
the peak selling season. The majority of cash receipts are collected from
September through December.
In the past, the Company has recorded restructuring costs associated with
consolidation of warehouse facilities. These costs typically include: costs to
exit the facility, such as rent under remaining lease terms, occupancy,
relocation costs and facility restoration; employee costs, such as severance;
and asset impairment costs. The Company expects to incur such costs in the
future as it continues to integrate acquired companies. Based on the additional
time and resources expected to be involved in the development, review and
approval of any such restructuring plans, the Company cannot presently predict
the timing or overall magnitude of such a charge.
10
In the first quarter of fiscal 1999, the Company will record a compensation
charge of approximately $1.1 million, representing (i) non-cash compensation
related to certain employees of School Specialty who tendered in the U.S. Office
Products equity self-tender offer options that were previously granted by U.S.
Office Products and (ii) the difference between the amount which Messrs.
Spalding, Vander Zanden and Pate paid for the 250,000 shares of Common Stock
purchased directly from the Company in connection with the Company's initial
public offering and the amount which they would have paid for such shares if the
purchase price per share had been the initial public offering price of the
shares offered in the offering. The charge related to the equity self-tender was
incurred solely as a result of the tender of options into the equity self-tender
and was incurred prior to the School Specialty Distribution.
School Speciality is a Delaware corporation formed in February 1998 to hold
the Educational Supplies and Products Division of U.S. Office Products, which
acquired School Specialty, Inc., a Wisconsin corporation ("Old School"), in May
1996 and Re-Print in July 1996. The Company's consolidated financial statements
give retroactive effect to these two business combinations under the
pooling-of-interests method (Old School and Re-Print are referred to as the
"Pooled Companies") and include the results of companies acquired in business
combinations accounted for under the purchase method from their respective dates
of acquisition. Prior to their respective dates of acquisition by U.S. Office
Products, the Pooled Companies reported results on years ending on December 31.
Upon acquisition by U.S. Office Products and effective for the fiscal year ended
April 26, 1997 ("fiscal 1997"), the Pooled Companies changed their year-ends
from December 31 to conform to U.S. Office Products' fiscal year, which ends on
the last Saturday in April.
The following discussion should be read in conjunction with the Company's
consolidated financial statements and related notes thereto.
RESULTS OF OPERATIONS
The following table sets forth various items as a percentage of revenues on
a historical basis for fiscal 1997 and 1998 and the year ended December 31,
1995.
FISCAL YEAR FISCAL YEAR FOR THE YEAR
ENDED ENDED ENDED
APRIL APRIL DECEMBER
25, 1998 26, 1997 31, 1995
----------- ----------- ---------------
Revenues.......................................................... 100.0% 100.0% 100.0%
Cost of revenues.................................................. 70.6 71.2 70.3
----- ----- -----
Gross profit...................................................... 29.4 28.8 29.7
Selling, general and administrative expenses...................... 23.0 22.7 26.5
Non-recurring acquisition costs................................... 0.9
Restructuring costs............................................... 1.1 0.1 1.7
----- ----- -----
Operating income.................................................. 5.3 5.1 1.5
Interest expense, net............................................. 1.8 2.2 3.7
Other (income) expense............................................ 0.1 (0.1)
----- ----- -----
Income (loss) before provision for income taxes................... 3.4 3.0 (2.2)
Provision for (benefit from) income taxes......................... 1.8 (1.3) 0.1
----- ----- -----
Net income (loss)................................................. 1.6% 4.3% (2.3)%
----- ----- -----
----- ----- -----
11
CONSOLIDATED HISTORICAL RESULTS OF OPERATIONS
YEAR ENDED APRIL 25, 1998 COMPARED TO YEAR ENDED APRIL 26, 1997
Consolidated revenues increased 61.9%, from $191.7 million in fiscal 1997,
to $310.5 million in fiscal 1998. This increase was primarily due to the
inclusion of revenues from the eight companies acquired in business combinations
accounted for under the purchase method during fiscal 1998 (the "Fiscal 1998
Purchased Companies") from their respective dates of acquisition and revenues
from the six companies acquired during fiscal 1997 in business combinations
accounted for under the purchase method (the "Fiscal 1997 Purchased Companies"
and together with the Fiscal 1998 Purchased Companies, the "Purchased
Companies") for the entire period. Revenues also increased due to sales to new
accounts, increased sales to existing customers and higher pricing on certain
products in response to increased product costs. Product cost is the most
significant element in cost of revenues. Inbound freight, occupancy and delivery
charges are also included in cost of revenues.
Gross profit increased 65.2%, from $55.2 million, or 28.8% of revenues, for
fiscal 1997 to $91.1 million, or 29.4% of revenues, for fiscal 1998. The
increase in gross profit as a percentage of revenues was due primarily to an
increase in revenues from higher margin products, primarily as a result of the
purchase acquisitions of three companies selling higher margin specialty product
lines during fiscal 1998, and as a result of improved purchasing power and
rebate programs negotiated with vendors. These factors were partly offset by an
increase in the cost of revenues as a result of the increased freight costs
caused by the UPS strike in the summer of 1997 and an increase in the portion of
revenues represented by lower margin bid revenues.
Selling, general and administrative expenses include selling expenses (the
most significant component of which is sales wages and commissions), catalog
costs, general administrative overhead (which includes information systems and
customer service), and accounting, legal, human resources and purchasing
expenses. Selling, general and administrative expenses increased 64.3%, from
$43.5 million, or 22.7% of revenues, for fiscal 1997 to $71.4 million, or 23.0%
of revenues, for fiscal 1998. The increase in selling, general and
administrative expenses as a percentage of revenues was due primarily to the
purchase acquisition of three specialty companies during fiscal 1998, which
typically have higher operating expenses as a percentage of revenue, partially
offset by the efficiencies generated from the elimination of certain redundant
administrative functions, including purchasing, accounting, finance and
information systems, of the Fiscal 1997 Purchased Companies and the
consolidation of two warehouses into one regional facility in the Northeastern
U.S during the third quarter of fiscal 1997. School Specialty has established a
24-month integration process in which a transition team is assigned to (i) sell
or discontinue incompatible business units, (ii) reduce the number of SKUs,
(iii) eliminate redundant administrative functions, (iv) integrate the acquired
entity's MIS system, and (v) improve buying power. However, the length of time
it takes the Company to fully implement its strategy for assimilating an
acquired company can vary depending on the nature of the company acquired and
the season in which it is acquired.
The Company has historically utilized grants of employee stock options as a
method of incentivizing employees by increasing their ownership interests in the
Company, which also has the effect of more closely aligning their interests with
the interests of stockholders of the Company. As a result, if the Company had
recorded compensation expense based upon the fair market value of the stock
options on the dates of grant under the methodology prescribed by SFAS 123, the
Company's net income for the fiscal year ended April 25, 1998 would have been
reduced by approximately $0.8 million or 15.3%.
The Company recorded in the fourth quarter of fiscal 1998 approximately $2.5
million of one-time non-recurring costs, primarily consisting of a write-down of
deferred catalog costs, employee severance and asset impairment costs, and $1.0
million of the transaction costs allocated to the Company under the Distribution
Agreement. The Company incurred non-recurring acquisition costs of $1.8 million
in fiscal 1997, in conjunction with the acquisition of the Pooled Companies.
These non-recurring acquisition costs included accounting, legal,
investment-banking fees, real estate and environmental assessments and
12
appraisals and various regulatory fees. Generally accepted accounting principles
("GAAP") require the Company to expense all acquisition costs (both those paid
by the Company and those paid by the sellers of the acquired companies) related
to business combinations accounted for under the pooling-of-interests method of
accounting. In accordance with GAAP, the Company will be unable to utilize the
pooling-of-interests method to account for acquisitions for a period of two
years following the completion of U.S. Office Products' Strategic Restructuring
Plan. During this period, the Company will not reflect any non-recurring
acquisition costs in its results of operations, as all costs incurred of this
nature would be related to acquisitions accounted for under the purchase method
and would, therefore, be capitalized as a portion of the purchase consideration.
See "Factors Affecting the Company's Business--Risks Related to Inability to Use
Pooling-of-Interests Method to Account for Future Acquisitions".
Since U.S. Office Products' acquisition of the Pooled Companies, interest
has been allocated to the Company based upon the Company's average outstanding
payable balance with U.S. Office Products at U.S. Office Products' weighted
average interest rate during such period. Interest expense, net of interest
income, increased 28.0%, from $4.2 million for fiscal 1997 to $5.4 million for
fiscal 1998. The increase was due primarily to higher amounts payable to U.S.
Office Products incurred as a result of the acquisition of the eight companies
acquired in fiscal 1998.
Provision for income taxes increased from a tax benefit of $2.4 million for
fiscal 1997 to $5.5 million for fiscal 1998. The high effective income tax rate
of 51.1% for fiscal 1998, compared to the federal statutory rate of 35.0%, was
primarily due to state income taxes, non-deductible goodwill amortization and
USOP share distribution costs. In 1995, the Company recorded a valuation
allowance of $5.3 million on a deferred tax asset resulting from the net
operating loss carryforwards created during 1995. The valuation allowance had
been established by one of the Pooled Companies prior to its acquisition by U.S.
Office Products to offset the tax benefit from such loss carryforwards, because
at the time it was not likely that such tax benefit would be realized. The
benefit from income taxes in Fiscal 1997 of $2.4 million arose primarily from
the reversal of the $5.3 million deferred tax asset valuation allowance in the
fourth quarter. The valuation allowance was reversed subsequent to the Company's
being acquired by U.S. Office Products, because it was deemed "more likely than
not", based on improved results, that the tax benefit from such operating loss
carryforwards would be realized.
YEAR ENDED APRIL 26, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Consolidated revenues increased 27.4%, from $150.5 million in 1995, to
$191.7 million in fiscal 1997. This increase was primarily due to the inclusion,
for fiscal 1997, of revenues from the Fiscal 1997 Purchased Companies from their
respective dates of acquisition, sales to new accounts, increased sales to
existing customers and higher pricing on certain products in response to
increased product costs.
Gross profit increased 23.4%, from $44.7 million, or 29.7% of revenues, in
1995 to $55.2 million, or 28.8% of revenues, in fiscal 1997. The decrease in
gross profit as a percentage of revenues was due primarily to a shift in revenue
mix, resulting from the acquisition of the Fiscal 1997 Purchased Companies,
which traditionally had lower gross profits as a percentage of revenues. This
decrease was partially offset by improved purchasing and rebate programs
negotiated with vendors and the Company's ability to take advantage of term
discounts due to improved cash flows.
Selling, general and administrative expenses increased 9.0%, from $39.9
million, or 26.5% of revenues, in 1995 to $43.5 million, or 22.7% of revenues,
in fiscal 1997. The decrease in selling, general and administrative expenses as
a percentage of revenues was due primarily to the consolidation of two
warehouses into one regional facility in the Northeastern U.S. during third
quarter of fiscal 1997, the elimination of certain redundant administrative
functions of a company acquired during 1995 in a business combination accounted
for under the purchase method (the "1995 Purchased Company") and reduced
executive compensation expense at one of the Pooled Companies after being
acquired by U.S. Office Products in July 1996.
13
The Company has historically utilized grants of employee stock options as a
method of incentivizing employees by increasing their ownership interests in the
Company, which also has the effect of more closely aligning their interests with
the interests of stockholders of the Company. As a result, if the Company had
recorded compensation expense based upon the fair market value of the stock
options on the dates of grant under the methodology prescribed by SFAS 123, the
Company's net income for the fiscal year ended April 26, 1997 would have been
reduced by approximately $0.7 million or 9.2%.
The Company incurred non-recurring acquisition costs of $1.8 million in
fiscal 1997, in conjunction with business combinations accounted for under the
pooling-of-interests method. These non-recurring acquisition costs included
accounting, legal, investment-banking fees, real estate and environmental
assessments and appraisals and various regulatory fees.
The Company incurred restructuring costs of $2.5 million and $194,000 during
1995 and fiscal 1997, respectively. These costs represent the external costs and
liabilities to close redundant Company facilities, severance costs related to
the Company's employees and other costs associated with the Company's
restructuring plans. The Company expects to incur similar costs in the future as
the Company continues to review its operations, with the intention of continuing
to eliminate redundant facilities.
Interest expense, net of interest income, decreased 24.2%, from $5.5 million
in 1995 to $4.2 million in fiscal 1997. The decrease was due primarily to the
repayment of substantially all of the Company's debt in conjunction with the
acquisition of the Pooled Companies by U.S. Office Products and lower interest
rates being charged on the Company's short-term and long-term debt with U.S.
Office Products.
Provision for income taxes decreased from a tax expense of $173,000 in 1995
to a tax benefit of $2.4 million in fiscal 1997. The Company incurred a tax
expense in 1995, notwithstanding the fact that it reported a pre-tax loss,
because one of the Pooled Companies' earnings were not offset by the other
Pooled Companies' loss. In 1995, the Company recorded a full valuation allowance
of $5.3 million on the deferred tax asset resulting from the net operating loss
carryforwards created during 1995. The valuation allowance had been established
by one of the Pooled Companies prior to its acquisition by U.S. Office Products
to offset the tax benefit from such loss carryforwards, because at the time it
was not likely that such tax benefit would be realized. The benefit from income
taxes in Fiscal 1997 of $2.4 million arose primarily from the reversal of the
$5.3 million deferred tax asset valuation allowance in the fourth quarter. The
valuation allowance was reversed subsequent to the Company's being acquired by
U.S. Office Products, because it was deemed "more likely than not", based on
improved results, that the tax benefit from such operating loss carryforwards
would be realized.
LIQUIDITY AND CAPITAL RESOURCES
Subsequent to the acquisition by U.S. Office Products of the Pooled
Companies and prior to the School Specialty Distribution, U.S. Office Products
funded the cash portions of School Specialty's acquisitions, paid the
acquisition costs, repaid outstanding debt of acquired companies, allocated a
portion of U.S. Office Products' corporate expenses to School Specialty and made
daily advances or sweeps of cash to keep School Specialty's cash balance at or
near zero on a daily basis. The net amount of such transactions was recorded as
a payable from School Specialty to U.S. Office Products.
At April 25, 1998, the Company had working capital of $47.8 million. The
Company's capitalization, defined as the sum of long-term debt, long-term
payable to U.S. Office Products and stockholders' equity, at April 25, 1998 was
$169.5 million.
During fiscal 1998, net cash provided by operating activities was $3.7
million. Net cash used in investing activities was $99.7 million, including
$95.7 million for acquisitions and $4.0 million for additions to property and
equipment. Net cash provided by financing activities was $96 million, including
$95.7 million provided by U.S. Office Products to fund the cash portion of the
purchase price and the repayment of debt assumed with the acquisition of the
fiscal 1998 Purchased Companies, $81.3 million of which was
14
considered a contribution of capital by U.S. Office Products, partially offset
by $8.4 million used to repay indebtedness.
During fiscal 1997, net cash provided by operating activities was $918,000.
Net cash used in investing activities was $16.7 million, including $7.7 million
for acquisitions, $7.2 million for additions to property and equipment and $1.8
million to pay non-recurring acquisition costs. Net cash provided by financing
activities was $15.8 million, including $59.9 million provided by U.S. Office
Products to fund the cash portion of the purchase price and the repayment of
debt associated with the fiscal 1997 Purchased Companies and the payment of debt
of the Pooled Companies, partially offset by $46.9 million used for the net
repayment of indebtedness, primarily at the fiscal 1997 Purchased Companies.
During 1995, net cash provided by operating activities was $4.8 million. Net
cash used in investing activities was $6.0 million, including $5.4 million for
acquisitions and $881,000 for additions to property and equipment. Net cash
provided by financing activities was $1.2 million, including net proceeds from
the issuance of debt of $2.4 million and $500,000 received from the issuance of
common stock, partially offset by payments of indebtedness of $1.5 million.
On June 9, 1998, the Company closed on a five year $250 million revolving
credit facility (the "Credit Facility") from NationsBank, N.A. Interest on
borrowings under the Credit Facility will accrue at a rate of, at the Company's
option, either LIBOR plus 1.00% or the lender's base rate, for up to the first 6
months under the agreement. Thereafter, interest will accrue at a rate of (i)
LIBOR plus a range of .625% to 1.625%, or (ii) the lender's base rate plus a
range of 0% to .250% (depending on the Company's leverage ratio of funded debt
to EBITDA). Indebtedness is secured by substantially all of the assets of the
Company. The Credit Facility is subject to terms and conditions typical of
facilities of such size and includes certain financial covenants. The Company
made borrowings of $83.3 million under the Credit Facility to repay the U.S.
Office Products debt which it was obligated under the Distribution Agreement to
repay. On June 15, 1998, School Specialty used net proceeds of approximately
$32.7 million from the Offering and the sale of 250,000 shares of Common Stock
to Messrs. Spalding, Vander Zanden and Pate to repay a portion of the $83.3
million borrowed under the Credit Facility. After such repayment, the Company
had approximately $50 million borrowed under the Credit Facility, with the
remaining $200 million available under the Credit Facility (subject to
compliance with the financial covenants), for general corporate purposes,
including working capital, and for acquisitions.
The Company's anticipated capital expenditures budget for the next twelve
months is approximately $3.0 million. The largest items include operational and
financial reporting software, computer hardware and warehouse equipment.
FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS
The Company's business is subject to seasonal influences. The Company's
historical revenues and profitability have been dramatically higher in the first
two quarters of its fiscal year (May-October) primarily due to increased
shipments to customers coinciding with the start of each school year.
Quarterly results also may be materially affected by the timing of
acquisitions, the timing and magnitude of costs related to such acquisitions,
variations in the prices paid by the Company for the products it sells, the mix
of products sold and general economic conditions. Moreover, the operating
margins of companies acquired by the Company may differ substantially from those
of the Company, which could contribute to the further fluctuation in its
quarterly operating results. Therefore, results for any quarter are not
indicative of the results that the Company may achieve for any subsequent fiscal
quarter or for a full fiscal year.
The following table sets forth certain unaudited consolidated quarterly
financial data for fiscal 1997 and 1998 (in thousands). The information has been
derived from unaudited consolidated financial statements that in the opinion of
management reflect all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of such quarterly information. This
quarterly information is not
15
comparative because of the high degree of seasonability in School Specialty's
business. Revenues and profitability are significantly higher in the months of
May through October, with the most significant portion of revenue and profit
occurring in the months of July through September. On a fiscal year basis (years
ending in April), this six-month (May through October) period falls in the first
and second quarters of the fiscal year. On a calendar year basis, the most
profitable three months (July through September) fall in the third quarter.
YEAR ENDED APRIL 25, 1998
-------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
--------- ---------- --------- --------- ----------
Revenues................................................ $ 87,029 $ 111,460 $ 49,391 $ 62,575 $ 310,455
Gross profit............................................ 26,090 33,619 11,670 19,763 91,142
Operating income (loss)................................. 11,872 12,155 (4,048) (3,731) 16,248
Net income (loss)....................................... 5,804 5,965 (2,934) (3,596) 5,239
Per share amounts:
Basic................................................. 0.49 0.49 (0.20) (0.24) 0.40
Diluted............................................... 0.48 0.47 (0.20) (0.24) 0.39
YEAR ENDED APRIL 26, 1997
------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
--------- --------- --------- --------- ----------
Revenues.................................................. $ 58,991 $ 71,682 $ 29,304 $ 31,769 $ 191,746
Gross profit.............................................. 18,110 19,823 7,664 9,572 55,169
Operating income (loss)................................... 5,197 6,732 (1,520) (688) 9,721
Net income (loss)......................................... 1,981 2,692 (1,067) 4,526(1) 8,132
Per share amounts:
Basic................................................... 0.21 0.28 (0.11) 0.40 0.81
Diluted................................................. 0.21 0.27 (0.11) 0.39 0.80
- ------------------------
(1) For the year ended April 26, 1997, fourth quarter net income was increased
by $5.3 million due to the reversal of a deferred tax asset valuation
allowance. See Note 1 to "Selected Financial Data."
INFLATION
The Company does not believe that inflation has had a material impact on its
results of operations during the fiscal years ended April 25, 1998 and April 26,
1997 or the year ended December 31, 1995.
NEW ACCOUNTING PRONOUNCEMENTS
REPORTING COMPREHENSIVE INCOME. In June 1997, FASB issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS No. 130
is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Company intends to adopt SFAS No. 130 in
fiscal 1999.
16
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
reporting information about operating segments in annual and interim financial
statements. Operating segments are determined consistent with the way management
organizes and evaluates financial information internally for making decisions
and assessing performance. It also requires related disclosures about products,
geographic areas, and major customers. SFAS 131 is effective for fiscal years
beginning after December 15, 1997. The Company intends to adopt SFAS No. 131 in
fiscal 1999. Implementation of this disclosure standard will not affect the
Company's financial position or results of operations.
FACTORS AFFECTING THE COMPANY'S BUSINESS
POTENTIAL LIABILITY FOR TAXES RELATED TO THE DISTRIBUTIONS. In connection
with the School Specialty Distribution, U.S. Office Products entered into a tax
allocation agreement with School Specialty and the other Spin-Off Companies (the
"Tax Allocation Agreement") which provides that the Spin-Off Companies will
jointly and severally indemnify U.S. Office Products for any losses associated
with taxes related to the Distributions ("Distribution Taxes") if an action or
omission (an "Adverse Tax Act") of any of the Spin-Off Companies materially
contributes to a final determination that any or all of the Distributions are
taxable. School Specialty also entered into a tax indemnification agreement with
the other Spin-Off Companies (the "Tax Indemnification Agreement") under which
the Spin-Off Company that is responsible for the Adverse Tax Act will indemnify
the other Spin-Off Companies for any liability to indemnify U.S. Office Products
under the Tax Allocation Agreement. As a consequence, School Specialty will be
liable for any Distribution Taxes resulting from any Adverse Tax Act by School
Specialty and liable (subject to indemnification by the other Spin-Off
Companies) for any Distribution Taxes resulting from an Adverse Tax Act by the
other Spin-Off Companies. If there is a final determination that any or all of
the Distributions are taxable and it is determined that there has not been an
Adverse Tax Act by either U.S. Office Products or any of the Spin-Off Companies,
U.S. Office Products and each of the Spin-Off Companies will be liable for its
pro rata portion of the Distribution Taxes based on the value of each company's
Common Stock after the Distributions. As a result, School Specialty could become
liable for a pro rata portion of Distribution Taxes with respect not only to the
School Specialty Distribution, but also any of the other Distributions.
RISKS RELATED TO ALLOCATION OF CERTAIN LIABILITIES. The Company, U.S.
Office Products and the other Spin-Off Companies entered into an agreement (the
"Distribution Agreement") relating to the School Specialty Distribution. Under
the Distribution Agreement, if one of the Spin-Off Companies defaults on an
obligation owed to U.S. Office Products, School Specialty could be obligated to
U.S. Office Products in respect of obligations and liabilities not related to
its business or operations and over which neither it nor its management has or
has had any control or responsibility. The aggregate of such liabilities for
which the Company may be liable is, however, limited to $1.75 million.
RISKS RELATED TO INTEGRATION OF OPERATIONS AND ACQUISITIONS. An important
element of School Specialty's business strategy for its distribution divisions
is to integrate its acquisitions into its existing operations. There can be no
assurance that School Specialty will be able to integrate future acquisitions in
a timely manner without substantial costs, delays, or other problems. Once
integrated, acquisitions may not achieve sales, profitability, and asset
productivity commensurate with School Specialty's existing divisions. In
addition to integration risks for distribution divisions, acquisitions of both
distribution divisions and specialty brand companies involve a number of special
risks, including adverse short-term effects on School Specialty's reported
operating results (including those adverse short-term effects caused by
severance payments to employees of acquired companies, restructuring charges
associated with the acquisitions and other expenses associated with a change of
control, as well as non-recurring acquisition costs including accounting and
legal fees, investment banking fees, recognition of transaction-related
obligations, and various other acquisition-related costs), the diversion of
management's time and attention, the dependence on retaining, hiring, and
training key personnel, the amortization of acquired intangible assets, and
risks associated with unanticipated problems or liabilities, some or all of
which could have a material adverse
17
effect on School Specialty's operations and financial condition. Furthermore,
although School Specialty conducts due diligence and generally requires
representations, warranties, and indemnifications from the former owners of
acquired companies, there can be no assurance that such owners will have
accurately represented the financial and operating conditions of their
companies. If an acquired company's financial or operating results were
misrepresented, the acquisition could have a material adverse effect on the
results of operations and financial condition of School Specialty.
DEPENDENCE UPON ACQUISITIONS FOR FUTURE GROWTH. One of School Specialty's
strategies is to increase its revenues and the markets it serves through the
acquisition of additional school supply distribution businesses. There can be no
assurance that suitable candidates for acquisitions can be identified or, if
suitable candidates are identified, that acquisitions can be completed on
acceptable terms, if at all. There can be no assurance that future acquisitions
will prove profitable at the time of their acquisition or will achieve sales and
profitability that justify the investment therein. The failure to complete
acquisitions and continue its expansion could have a material adverse effect on
School Specialty's financial condition. In addition, prior to the School
Specialty Distribution, School Specialty's acquisitions were completed with
substantial business, legal, and accounting assistance from U.S. Office
Products, and some of the acquisitions were paid for with U.S. Office Products
Common Stock. The pace of School Specialty's acquisition program may be
adversely affected by the absence of U.S. Office Products' support for the
acquisitions. Also, School Specialty intends to use School Specialty Common
Stock to pay for a portion of the consideration for its acquisitions, and
therefore, if the owners of potential acquisition candidates are not willing to
receive, or School Specialty is not able to issue, shares of School Specialty
Common Stock in exchange for their business, School Specialty's acquisition
program could be adversely affected. Furthermore, the Company's ability to pay
for acquisitions with stock may be materially limited in the two-year period
following the School Specialty Distribution.
POSSIBLE LIMITATIONS ON ISSUANCES OF COMMON STOCK. Section 355(e) of the
Internal Revenue Code of 1986, as amended (the "Code"), which was added in 1997,
generally provides that a company that distributes shares of a subsidiary in a
spin-off that is otherwise tax-free will incur U.S. federal income tax liability
if 50% or more, by vote or value, of the capital stock of either the company
making the distribution or the spun-off subsidiary is acquired by one or more
persons acting pursuant to a plan or series of related transactions that
includes the spin-off. Stock acquired by certain related persons is aggregated
in determining whether the 50% test is met. There is a presumption that any
acquisition occurring two years before or after the spin-off is pursuant to a
plan that includes the spin-off. However, the presumption may be rebutted by
establishing that the spin-off and such acquisition are not part of a plan or
series of related transactions. As a result of the provisions of Section 355(e),
there can be no assurance that issuances of stock by School Specialty, including
issuances in connection with an acquisition of another business by School
Specialty, will not create a tax liability for U.S. Office Products. This
limitation could adversely affect the pace of School Specialty's acquisitions
and its ability to issue Common Stock for other purposes, including equity
offerings.
School Specialty entered into the Tax Allocation Agreement and the Tax
Indemnification Agreement pursuant to which School Specialty will be liable to
U.S. Office Products and the other Spin-Off Companies if its actions or
omissions materially contribute to a final determination that the School
Specialty Distribution is taxable.
RISKS RELATED TO INABILITY TO USE POOLING-OF-INTERESTS METHOD TO ACCOUNT FOR
FUTURE ACQUISITIONS. Generally accepted accounting principles require that an
entity be autonomous for a period of two years before it is eligible to complete
business combinations under the pooling-of-interests method. As a result of
School Specialty being a wholly-owned subsidiary of U.S. Office Products prior
to the Distribution, School Specialty will be unable to satisfy this criterion
for a period of two years following the Distribution. Therefore, School
Specialty will be precluded from completing business combinations under the
pooling-
18
of-interests method for a period of two years and any business combinations
completed by School Specialty during such period will be accounted for under the
purchase method resulting in the recording of goodwill.
SEASONALITY: FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. School
Specialty's business is subject to seasonal influences, with sales and
profitability substantially higher from May to October due to increased school
orders during these months. As a result of this seasonality, historically,
School Specialty has earned more than 100% of its annual net income in the first
six months of its fiscal year and has historically operated at a loss in its
third fiscal quarter. Also, quarterly results may be materially affected by the
timing of acquisitions and the timing and magnitude of acquisition assimilation
costs. Therefore, operating results for any quarter are not necessarily
indicative of the results that may be achieved for any subsequent fiscal quarter
or full fiscal year. Fluctuations caused by variations in quarterly results may
adversely affect the market price of the School Specialty Common Stock.
RELIANCE ON KEY PERSONNEL. School Specialty's operations depend on the
continued efforts of Daniel P. Spalding, its Chief Executive Officer, its other
executive officers, and the senior management of certain of its subsidiaries.
Furthermore, School Specialty's operations will likely depend on the senior
management of certain of the companies that may be acquired in the future. If
any of these people become unable to continue in his or her present role, or if
School Specialty is unable to attract and retain other skilled employees, its
business could be adversely affected. School Specialty does have employment
contracts with some executive officers, but most of the Companies' executive
officers and senior management do not have employment contracts with School
Specialty. School Specialty does not have and does not intend to obtain key man
life insurance covering any of its executive officers or other members of senior
management of its subsidiaries. In addition, Jonathan J. Ledecky serves as a
director and an employee of School Specialty and provides services to School
Specialty pursuant to an employment agreement with School Specialty. Mr. Ledecky
also serves as a director of each of the other Spin-Off Companies, and is the
director or an officer of other public companies. Mr. Ledecky may be unable to
devote substantial time to the activities of School Specialty.
DEPENDENCE ON SYSTEMS. School Specialty believes that one of the
competitive advantages of its distribution divisions is its information systems,
including its proprietary PC-based customer Order Management System ("OMS").
School Specialty's operations in each of its integrated divisions under School
Specialty are generally dependent on these systems, which are run on a host
system located at School Specialty's headquarters in Appleton, Wisconsin. Each
division of School Specialty is linked to School Specialty's host system and
disruption or unavailability of these links could have a material adverse effect
on School Specialty's business and results of operations.
None of School Specialty's subsidiaries has a redundant computer system or a
redundant dedicated communication line. School Specialty has taken precautions
to protect itself from events that could interrupt its operations.
Notwithstanding these precautions, there can be no assurance that a fire, flood
or other natural disaster affecting School Specialty's system or its
communication lines would not disable the system or prevent the system from
communicating with School Specialty's divisions or the specialty brand
subsidiaries. The occurrence of any of these events would have a material
adverse effect on School Specialty's operations and financial condition.
School Specialty does not expect that it will incur any material costs and
expenses to meet information standards for Year 2000 compliance; however, there
is no assurance that School Specialty's customers or vendors meet information
standards for Year 2000 compliance, and their failure to meet such standards
could adversely affect School Specialty's revenues and product costs.
RISK OF RAPID GROWTH; ABSENCE OF HISTORY AS A STAND-ALONE COMPANY. Since
1991, School Specialty and U.S. Office Products have significantly expanded the
scope of School Specialty's operations by acquiring sixteen regional
distributors of educational supplies in different regions of the United States
and four specialty brand school supply companies. All of School Specialty's
specialty brand acquisitions and
19
eleven of its regional distribution acquisitions have occurred since June 1996.
There can be no assurance that School Specialty's management and financial
controls, personnel, computer systems, and other corporate support systems will
be adequate to manage the increased size and scope of School Specialty's
operations as a result of School Specialty's recently completed acquisitions.
Prior to the School Specialty Distribution, certain general and
administrative functions relating to School Specialty's business (including
legal, accounting, purchasing and management information services) were handled
by U.S. Office Products. School Specialty's future performance will depend on
its ability to function as a stand-alone entity, to finance and manage its
expanding operations and to adapt its information systems to changes in its
business. As a result, School Specialty's expenses are likely to be higher than
when it was a part of U.S. Office Products, and School Specialty may experience
disruptions of general and administrative functions that it would not have
encountered as a part of U.S. Office Products. Furthermore, the financial
information included herein may not necessarily reflect what the results of
operations and financial condition would have been had School Specialty been a
separate, stand-alone entity during the periods presented or be indicative of
future results of operations and financial condition of School Specialty.
DEPENDENCE ON KEY SUPPLIERS AND SERVICE PROVIDERS. School Specialty is
dependent on (i) a limited number of suppliers for certain of its product lines,
particularly its franchise furniture lines, and (ii) a limited number of service
providers, such as delivery service from United Parcel Service. Any interruption
of supply from current vendors or any material increased costs, particularly in
the peak season of June through September, could cause significant delays in the
shipment of such products and could have a material adverse effect on School
Specialty's business, financial condition, and results of operations. Increases
in freight costs charged to School Specialty or inability to ship products,
whether real or perceived, could have a material adverse effect on School
Specialty's business, financial condition, and results of operations. In
addition, as part of its business strategy, School Specialty strives to reduce
its number of suppliers and minimize duplicative lines, which may have the
effect of increasing its dependence on remaining vendors. The United Parcel
Service strike during August 1997 had an adverse effect on School Specialty due
to the perceived inability of School Specialty to ship products.
COMPETITION. The market for school supplies is highly competitive and
fragmented. School Specialty estimates that over 3,400 companies distribute
educational materials to pre-K-12 schools as a primary focus of their business.
In addition, School Specialty competes with alternate channel distributors such
as office product contract stationers and superstores, which may continue to
broaden their product lines in school supplies. Some of these competitors have
greater financial resources and buying power than School Specialty. School
Specialty believes that the educational supplies market will consolidate over
the next several years, which may make School Specialty's general and specialty
supply businesses more competitive. In addition, there may be increasing
competition for acquisition candidates and there can be no assurance that
acquisitions will continue to be available to School Specialty on favorable
terms, if at all.
MATERIAL AMOUNT OF GOODWILL. Approximately $99.6 million, or 44.5%, of
School Specialty's pro forma total assets as of April 25, 1998 represents
intangible assets, the significant majority of which is goodwill. Goodwill
represents the excess of cost over the fair market value of net assets acquired
in business combinations accounted for under the purchase method. School
Specialty generally amortizes goodwill on a straight line method over a period
of 40 years with the amount amortized in a particular period constituting a
non-cash expense that reduces School Specialty's net income. Amortization of
goodwill resulting from certain past acquisitions, and additional goodwill
recorded in certain acquisitions may not be deductible for tax purposes. In
addition, School Specialty will be required to periodically evaluate the
recoverability of goodwill by reviewing the anticipated undiscounted future cash
flows from the operations of the acquired companies and comparing such cash
flows to the carrying value of the associated goodwill. If goodwill becomes
impaired, School Specialty would be required to write down the carrying value of
the goodwill and incur a related charge to its income.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements
PAGE
---------
Financial Statements:
Reports of Independent Accountants...................................................................... 22-24
Consolidated Balance Sheets at April 25, 1998 and April 26, 1997........................................ 25
Consolidated Statements of Income for the fiscal years ended April 25, 1998 and April 26, 1997, the four
months ended April 30, 1996 and the year ended December 31, 1995...................................... 26
Consolidated Statements of Stockholder's (Deficit) Equity for the fiscal years ended April 25, 1998 and
April 26, 1997, the four months ended April 30, 1996 and the year ended December 31, 1995............. 27
Consolidated Statements of Cash Flows for the fiscal years ended April 25, 1998 and April 26, 1997, the
four months ended April 30, 1996 and the year ended December 31, 1995................................. 28
Notes to Consolidated Financial Statements.............................................................. 30
Financial Statement Schedules
For the fiscal years ended April 25, 1998 and April 26, 1997, the four months ended April 30, 1996 and
the year ended December 31, 1995.....................................................................
II--Valuation and Qualifying Accounts--Exhibit 99.1...................................................
All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
of School Specialty, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of School Specialty, Inc. (the "Company") and its subsidiaries at April
25, 1998 and April 26, 1997, and the results of their operations and their cash
flows for the four months ended April 30, 1996 and the fiscal years ended April
26, 1997 and April 25, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICEWATERHOUSECOOPERS LLP
Minneapolis, Minnesota
June 24, 1998
22
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
School Specialty, Inc.
We have audited the accompanying consolidated statements of operations,
stockholder's (deficit) equity and cash flows of School Specialty, Inc. (the
Company) for the year ended December 31, 1995. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits. We did not audit
the financial statements of Re-Print Corporation, a wholly owned subsidiary,
which statements reflect total revenues of $30,798,000 for the year ended
December 31, 1995. Those statements were audited by other auditors whose report
has been furnished to us, and our opinion, insofar as it relates to data
included for Re-Print Corporation, is based solely on the report of the other
auditors.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the results of the Company's operations and its cash flows for the year December
31, 1995, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Milwaukee, Wisconsin
February 2, 1996
23
REPORT OF INDEPENDENT AUDITORS
Board of Directors
The Re-Print Corporation
Birmingham, Alabama
We have audited the accompanying balance sheet of The Re-Print Corporation
as of December 31, 1995, and the related statements of income, stockholders'
equity, and cash flows for the year ended December 31, 1995 (not presented
separately herein). These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of The Re-Print Corporation at
December 31, 1995, and the results of its operations and its cash flows for the
years then ended, in conformity with generally accepted accounting principles.
BDO Seidman, LLP
Atlanta, Georgia
February 8, 1996
24
SCHOOL SPECIALTY, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
APRIL 25, APRIL 26,
1998 1997
---------- ---------
ASSETS
Current assets:
Cash and cash equivalents................................................................ $ $
Accounts receivable, less allowance for doubtful accounts of $716 and $471,
respectively........................................................................... 38,719 17,232
Inventories.............................................................................. 49,307 24,461
Prepaid expenses and other current assets................................................ 13,503 10,331
---------- ---------
Total current assets................................................................. 101,529 52,024
Property and equipment, net................................................................ 22,553 14,478
Intangible assets, net..................................................................... 99,613 20,824
Other assets............................................................................... 34 359
---------- ---------
Total assets......................................................................... $ 223,729 $ 87,685
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Short-term debt.......................................................................... $ 11 $ 262
Short-term payable to U.S. Office Products............................................... 20,277 26,692
Accounts payable......................................................................... 23,788 9,091
Accrued compensation..................................................................... 4,458 860
Other accrued liabilities................................................................ 5,204 628
---------- ---------
Total current liabilities............................................................ 53,738 37,533
Long-term debt............................................................................. 315 566
Long-term payable to U.S. Office Products.................................................. 62,699 33,226
Deferred income taxes...................................................................... 511 31
---------- ---------
Total liabilities.................................................................... 117,263 71,356
Commitments and contingencies
Stockholder's equity:
Divisional equity........................................................................ 104,883 19,985
Retained earnings (deficit).............................................................. 1,583 (3,656)
---------- ---------
Total stockholder's equity........................................................... 106,466 16,329
---------- ---------
Total liabilities and stockholder's equity........................................... $ 223,729 $ 87,685
---------- ---------
---------- ---------
See accompanying notes to consolidated financial statements.
25
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE FOR THE
FISCAL YEAR ENDED FOUR MONTHS FOR THE
---------------------- ENDED YEAR ENDED
APRIL 25, APRIL 26, APRIL 30, DECEMBER 31,
1998 1997 1996 1995
---------- ---------- ------------ ------------
Revenues.................................................... $ 310,455 $ 191,746 $ 28,616 $ 150,482
Cost of revenues............................................ 219,313 136,577 20,201 105,757
---------- ---------- ------------ ------------
Gross profit............................................ 91,142 55,169 8,415 44,725
Selling, general and administrative expenses................ 71,403 43,462 10,307 39,869
Restructuring costs......................................... 2,491 194 2,532
Strategic restructuring costs............................... 1,000
Non-recurring acquisition costs............................. 1,792 1,122
---------- ---------- ------------ ------------
Operating income (loss)................................. 16,248 9,721 (3,014) 2,324
Other (income) expense:
Interest expense.......................................... 5,505 4,197 1,461 5,536
Interest income........................................... (132) (6)
Other..................................................... 156 (196) 67 (18)
---------- ---------- ------------ ------------
Income (loss) before provision for (benefit from) income
taxes..................................................... 10,719 5,720 (4,536) (3,194)
Provision for (benefit from) income taxes................... 5,480 (2,412) 139 173
---------- ---------- ------------ ------------
Net income (loss)........................................... $ 5,239 $ 8,132 $ (4,675) $ (3,367)
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Weighted average shares outstanding:
Basic..................................................... 13,284 10,003 8,611 6,562
Diluted................................................... 13,547 10,196 8,789 6,669
Net income (loss) per share:
Basic..................................................... $ 0.40 $ 0.81 $ (0.54) $ (0.51)
Diluted................................................... $ 0.39 $ 0.80 $ (0.53) $ (0.50)
See accompanying notes to consolidated financial statements.
26
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDER'S (DEFICIT) EQUITY
(IN THOUSANDS)
TOTAL
RETAINED STOCKHOLDER'S
DIVISIONAL (DEFICIT) (DEFICIT)
EQUITY EARNINGS EQUITY
---------- --------- -------------
Balance at December 31, 1994................................................ $ 5,327 $ (3,500) $ 1,827
Transactions of Pooled Companies:
Issuance of warrants.................................................... 672 672
Issuance of Pooled Company common stock for cash........................ 500 500
Repurchase of treasury stock............................................ (92) (92)
Cash dividends declared and paid........................................ (160) (160)
Net loss.................................................................. (3,367) (3,367)
---------- --------- -------------
Balance at December 31, 1995................................................ 6,407 (7,027) (620)
Transactions of Pooled Companies:
Exercise of warrants.................................................... 1,080 1,080
Cash dividends declared and paid........................................ (52) (52)
Net loss.................................................................. (4,675) (4,675)
---------- --------- -------------
Balance at April 30, 1996................................................... 7,487 (11,754) (4,267)
Transactions of Pooled Companies:
Exercise of warrants and stock options.................................. 1,979 1,979
Retirement of treasury stock............................................ 34 (34)
Issuances of U.S. Office Products Company common stock in conjunction with
acquisitions............................................................ 10,485 10,485
Net income................................................................ 8,132 8,132
---------- --------- -------------
Balance at April 26, 1997................................................... 19,985 (3,656) 16,329
Issuances of U.S. Office Products Company common stock in conjunction with
acquisitions............................................................ 3,566 3,566
Capital contribution by U.S. Office Products.............................. 81,332 81,332
Net income................................................................ 5,239 5,239
---------- --------- -------------
Balance at April 25, 1998................................................... $ 104,883 $ 1,583 $ 106,466
---------- --------- -------------
---------- --------- -------------
See accompanying notes to consolidated financial statements.
27
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
FOR THE
FISCAL YEAR ENDED FOR THE FOUR FOR THE
-------------------- MONTHS ENDED YEAR ENDED
APRIL 25, APRIL 26, APRIL 30, DECEMBER 31,
1998 1997 1996 1995
--------- --------- ------------- -------------
Cash flows from operating activities:
Net income (loss)......................................... $ 5,239 $ 8,132 $ (4,675) $ (3,367)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization expense................. 4,561 2,106 674 2,927
Non-recurring acquisition costs....................... 1,792 1,122
Other................................................. 78 115 118 277
Changes in current assets and liabilities (net of
assets acquired and liabilities
assumed in business combinations accounted for under
the purchase method):
Accounts receivable............................... (3,586) 1,277 3,727 2,666
Inventory......................................... (6,666) 2,737 (4,376) (2,523)
Prepaid expenses and other current assets......... (717) (2,361) (443) (338)
Accounts payable.................................. 5,256 (6,969) 3,459 2,642
Accrued liabilities............................... (441) (5,911) (784) 2,544
--------- --------- ------------- -------------
Net cash provided by (used in) operating
activities.................................... 3,724 918 (1,178) 4,828
--------- --------- ------------- -------------
Cash flows from investing activities:
Cash paid in acquisitions, net of cash received........... (95,670) (7,734) (5,389)
Additions to property and equipment....................... (3,558) (7,216) (120) (881)
Other..................................................... (514) 414 178
Payments of non-recurring acquisition costs............... (1,792) (1,122)
--------- --------- ------------- -------------
Net cash used in investing activities........... (99,742) (16,742) (828) (6,092)
--------- --------- ------------- -------------
Cash flows from financing activities:
Payments of long-term debt................................ (6,270) (16,962) (194) (1,488)
Proceeds from (payments of) short-term debt, net.......... (2,102) (29,908) 1,263 655
Advances from U.S. Office Products Company................ 23,058 59,919
Capital contribution by U.S. Office Products.............. 81,332
Proceeds from issuance of common stock.................... 1,979 1,080 500
Proceeds from issuance of long-term debt.................. 750 1,715
Payments of dividends at Pooled Companies................. (138) (134)
Purchase of treasury stock at Pooled Company.............. (92)
--------- --------- ------------- -------------
Net cash provided by financing activities....... 96,018 15,788 2,011 1,156
--------- --------- ------------- -------------
Net increase (decrease) in cash and cash equivalents........ (46) 5 (108)
Cash and cash equivalents at beginning of period............ 46 41 149
--------- --------- ------------- -------------
Cash and cash equivalents at end of period.................. $ $ $ 46 $ 41
--------- --------- ------------- -------------
--------- --------- ------------- -------------
Supplemental disclosures of cash flow information:
Interest paid............................................. $ 35 $ 456 $ 1,461 $ 5,564
Income taxes paid (refunded).............................. $ 1,148 $ (132) $ (3) $ 9
See accompanying notes to consolidated financial statements.
28
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS--(CONTINUED)
(IN THOUSANDS)
The Company issued common stock and cash in connection with certain business
combinations accounted for under the purchase method in the fiscal years ended
April 25, 1998 and April 26, 1997 and the year ended December 31, 1995. The fair
values of the assets and liabilities of the acquired companies at the dates of
the acquisitions are presented as follows:
FOR THE FISCAL FOR THE
YEAR ENDED FOUR MONTHS FOR THE
-------------------- ENDED YEAR ENDED
APRIL 25, APRIL 26, APRIL 30, DECEMBER 31,
1998 1997 1996 1995
--------- --------- ------------ ------------
Accounts receivable............................................ $ 17,900 $ 5,381 $ $ 1,589
Inventories.................................................... 18,180 6,922 1,823
Prepaid expenses and other current assets...................... 2,431 2,371 502
Property and equipment......................................... 6,379 1,155 4,536
Intangible assets.............................................. 80,359 14,248 3,268
Other assets................................................... 346 29 156
Short-term debt................................................ (1,850) (4,283) (191)
Accounts payable............................................... (9,400) (4,012) (274)
Accrued liabilities............................................ (9,089) (1,846) (225)
Long-term debt................................................. (6,020) (1,746) (5,795)
--------- --------- ------------ ------------
Net assets acquired................................ $ 99,236 $ 18,219 $ $ 5,389
--------- --------- ------------ ------------
--------- --------- ------------ ------------
The acquisitions were funded as follows:
U.S. Office Products common stock.............................. $ 3,566 $ 10,485 $ $
Cash paid, net of cash acquired................................ 95,670 7,734 5,389
--------- --------- ------------ ------------
Total.............................................. $ 99,236 $ 18,219 $ $ 5,389
--------- --------- ------------ ------------
--------- --------- ------------ ------------
See accompanying notes to consolidated financial statements.
29
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
NOTE 1--BACKGROUND
School Specialty, Inc. (the "Company") is a Delaware corporation which was a
wholly-owned subsidiary of U.S. Office Products Company ("U.S. Office Products")
at April 25, 1998. On June 9, 1998, U.S. Office Products spun-off its
Educational Supplies and Products Division (the "Education Division") as an
independent publicly owned company. This transaction was effected through the
distribution of shares of the Company to U.S. Office Products' shareholders (the
"Distribution"). Prior to the Distribution, U.S. Office Products contributed its
equity interests in certain wholly-owned subsidiaries associated with the
Education Division to the Company. U.S. Office Products and the Company entered
into a number of agreements to facilitate the Distribution and the transition of
the Company to an independent business enterprise. Additionally, concurrently
with the Distribution, the Company sold 2.1 million shares (2.4 million shares
if the over-allotment is sold) in an initial public offering (the "IPO").
The Education Division was created by U.S. Office Products in May 1996 in
connection with the acquisition of School Specialty, Inc., a Wisconsin
corporation ("Old School"). This business combination and the acquisition in
July 1996 of The Re-Print Corp. ("Re-Print") were accounted for under the
pooling-of-interests method (Old School and Re-Print are herein referred to as
the "Pooled Companies"). As a result of these business combinations being
accounted for under the pooling-of-interests method, the results of the Company
prior to the completion of such business combinations represent the combined
results of the Pooled Companies operating as separate autonomous entities.
NOTE 2--BASIS OF PRESENTATION
The consolidated financial statements reflect the assets, liabilities,
divisional equity, revenues and expenses that were directly related to the
Company as it was operated within U.S. Office Products. In cases involving
assets and liabilities not specifically identifiable to any particular business
of U.S. Office Products, only those assets and liabilities expected to be
transferred to the Company prior to the Distribution were included in the
Company's separate consolidated balance sheet. The Company's statement of income
includes all of the related costs of doing business, including an allocation of
certain general corporate expenses of U.S. Office Products which were not
directly related to these businesses including certain corporate executives'
salaries, accounting and legal fees, departmental costs for accounting, finance,
legal, purchasing, marketing, human resources as well as other general overhead
costs. These allocations were based on a variety of factors, dependent upon the
nature of the costs being allocated, including revenues, number and size of
acquisitions and number of employees. Management believes these allocations were
made on a reasonable basis.
U.S. Office Products uses a centralized approach to cash management and the
financing of its operations. As a result, minimal amounts of cash and cash
equivalents and an agreed upon amount of debt was to be allocated to the Company
at the time of the Distribution. The consolidated statement of income does not
include an allocation of interest expense on all debt allocated to the Company.
See Note 9 for further discussion of interest expense.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and
30
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
DEFINITION OF FISCAL YEAR
As used in these consolidated financial statements and related notes to
consolidated financial statements, "fiscal 1998" and "fiscal 1997" refer to the
Company's fiscal year ended April 25, 1998 and April 26, 1997, respectively.
CHANGE IN FISCAL YEAR
Prior to their respective dates of acquisition by U.S. Office Products, the
Pooled Companies reported results on years ending on December 31. Upon
acquisition by U.S. Office Products and effective for fiscal 1997, the Pooled
Companies changed their year-ends from December 31 to conform to U.S. Office
Products' fiscal year, which ends on the last Saturday in April. A four-month
fiscal transition period from January 1, 1996 through April 30, 1996 has been
presented for the Company to conform its fiscal year-end.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany transactions and
accounts are eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers temporary cash investments with original maturities of
three months or less from the date of purchase to be cash equivalents.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts receivable.
Receivables arising from sales to customers are not collateralized and, as a
result, management continually monitors the financial condition of its customers
to reduce the risk of loss.
INVENTORIES
Inventories are stated at the lower of cost or market with cost determined
on a first-in, first-out (FIFO) basis and consist primarily of products held for
sale.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Additions and improvements are
capitalized. Maintenance and repairs are expensed as incurred. Depreciation of
property and equipment is calculated using the straight-line method over the
estimated useful lives of the respective assets. The estimated useful lives
range from 25 to 40 years for buildings and its components and 3 to 15 years for
furniture, fixtures and
31
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
equipment. Property and equipment leased under capital leases is being amortized
over the lesser of its useful life or its lease terms.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill, which represents the excess
of cost over the fair value of assets acquired in business combinations
accounted for under the purchase method and non-compete agreements.
Substantially all goodwill is amortized on a straight line basis over an
estimated useful life of 40 years. Management periodically evaluates the
recoverability of goodwill, which would be adjusted for a permanent decline in
value, if any, by comparing anticipated undiscounted future cash flows from
operations to net book value. Other intangible assets are being amortized over
their estimated useful lives ranging from one to four years.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments including cash
and cash equivalents, accounts receivable and accounts payable approximate fair
value.
INCOME TAXES
As a division of U.S. Office Products, the Company does not file separate
federal income tax returns but rather is included in the federal income tax
returns filed by U.S. Office Products and its subsidiaries from the respective
dates that the entities within the Company were acquired by U.S. Office
Products. For purposes of the consolidated financial statements, the Company's
allocated share of U.S. Office Products' income tax provision was based on the
"separate return" method. Certain companies acquired in pooling-of-interests
transactions elected to be taxed as Subchapter S corporations, and accordingly,
no federal income taxes were recorded by those companies for periods prior to
their acquisition by U.S. Office Products.
REVENUE RECOGNITION
Revenue is recognized upon the delivery of products or upon the completion
of services provided to customers as no additional obligations to the customers
exist. Returns of the Company's product are considered immaterial.
COST OF REVENUES
Vendor rebates are recorded as a reduction in the cost of inventory and
recognized as a reduction in cost of revenues when such inventory is sold.
Delivery and occupancy costs are included in cost of revenues.
ADVERTISING COSTS
The Company expenses advertising costs when the advertisement occurs.
Advertising costs are included in the consolidated statement of income as a
component of selling, general and administrative expenses.
32
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEFERRED CATALOG COSTS
Deferred catalog costs are amortized in amounts proportionate to revenues
over the life of the catalog, which is typically one to two years. Amortization
expense related to deferred catalog costs is included in the consolidated
statement of income as a component of selling, general and administrative
expenses. Such amortization expense for the year ended December 31, 1995, the
four months ended April 30, 1996, the fiscal years ended April 26, 1997 and
April 25, 1998 was $4,395, $832, $3,621 and $6,934, respectively.
INTERNALLY DEVELOPED SOFTWARE
Internal costs related to internally developed software, such as internal
salaries and supplies, are expensed as incurred as a component of selling,
general and administrative expenses. External costs related to internally
developed software, such as fees for outside programmers and consultants, are
capitalized and expensed over the expected useful life of the software, normally
three to five years.
NON-RECURRING ACQUISITION COSTS
Non-recurring acquisition costs represent acquisition costs incurred by the
Company in business combinations accounted for under the pooling-of-interests
method. These costs include accounting, legal, and investment banking fees, real
estate and environmental assessments and appraisals, and various regulatory
fees. Generally accepted accounting principles require the Company to expense
all acquisition costs (both those paid by the Company and those paid by the
sellers of the acquired companies) related to business combinations accounted
for under the pooling-of-interests method.
RESTRUCTURING COSTS
The Company records the costs of consolidating existing Company facilities
into acquired operations, including the external costs and liabilities to close
redundant Company facilities and severance and relocation costs related to the
Company's employees in accordance with EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in Restructuring)."
STRATEGIC RESTRUCTURING COSTS
Strategic restructuring costs represent the Company's portion of the costs
incurred by U.S. Office Products as a result of U.S. Office Products' recently
completed comprehensive restructuring.
NET INCOME PER SHARE
Net income per share is calculated in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share."
33
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for the reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general purpose
financial statements. SFAS No. 130 requires that all items required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. The Company intends to
adopt SFAS No. 130 in fiscal 1999. Implementation of this disclosure standard
will not affect the Company's financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
reporting information about operating segments in annual and interim financial
statements. Operating segments are determined consistent with the way management
organizes and evaluates financial information internally for making decisions
and assessing performance. It also requires related disclosures about products,
geographic areas, and major customers. SFAS 131 is effective for fiscal years
beginning after December 15, 1997. The Company intends to adopt SFAS No. 131 in
fiscal 1999. Implementation of this disclosure standard will not affect the
Company's financial position or results of operations.
DISTRIBUTION RATIO
On May 14, 1998, the U.S. Office Products Board of Directors approved the
distribution ratio for the Company in connection with the Distribution. At the
date of Distribution, the Company issued approximately 12.2 million shares of
its common stock to U.S. Office Products, which then distributed such shares to
its shareholders in the ratio of one share of Company common stock for every
nine shares of U.S. Office Products common stock held by each shareholder. The
share data reflected in the accompanying financial statements represents the
historical share data for U.S. Office Products for the period or as of the date
indicated, retroactively adjusted to give effect to the one for nine
distribution ratio.
NOTE 4--BUSINESS COMBINATIONS
POOLING-OF-INTERESTS METHOD
In fiscal 1997, the Company issued 4,257,693 shares of U.S. Office Products
common stock to acquire the Pooled Companies. The Pooled Companies and the
number of shares issued are as follows:
NUMBER OF
COMPANY NAME SHARES ISSUED
- ------------------------------------------------------------------------------- -------------
School Specialty, Inc.......................................................... 2,307,693
Re-Print....................................................................... 1,950,000
-------------
Total shares issued........................................................ 4,257,693
-------------
-------------
The Company's consolidated financial statements give retroactive effect to
the acquisitions of the Pooled Companies for all periods presented. Prior to
being acquired by U.S. Office Products, the Pooled
34
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 4--BUSINESS COMBINATIONS (CONTINUED)
Companies reported on years ending on December 31. Upon completion of the
acquisitions of the Pooled Companies, their year-ends were changed to U.S.
Office Products' year-end of the last Saturday in April.
The following presents the separate results, in each of the periods
presented, of the Company (excluding the results of Pooled Companies prior to
the dates on which they were acquired), and the Pooled Companies up to the dates
on which they were acquired:
SCHOOL POOLED
SPECIALTY COMPANIES COMBINED
---------- ----------- ----------
For the year ended April 26, 1997
Revenues............................................... $ 181,420 $ 10,326 $ 191,746
Net income............................................. $ 7,791 $ 341 $ 8,132
For the four months ended April 30, 1996
Revenues............................................... $ $ 28,616 $ 28,616
Net loss............................................... $ $ (4,675) $ (4,675)
For the year ended December 31, 1995
Revenues............................................... $ $ 150,482 $ 150,482
Net loss............................................... $ $ (3,367) $ (3,367)
PURCHASE METHOD
In fiscal 1998, the Company made eight acquisitions accounted for under the
purchase method for an aggregate purchase price of $99,236, consisting of
$95,670 of cash and U.S. Office Products common stock with a market value of
$3,566. The total assets related to these eight acquisitions were $125,595,
including goodwill of $80,359. The results of these acquisitions have been
included in the Company's results from their respective dates of acquisition.
In fiscal 1997, the Company made six acquisitions accounted for under the
purchase method for an aggregate purchase price of $18,219, consisting of $7,734
of cash and U.S. Office Products common stock with a market value of $10,485.
The total assets related to these six acquisitions were $30,106, including
goodwill of $14,248. The results of these acquisitions have been included in the
Company's results from their respective dates of acquisition.
In 1995, one of the Pooled Companies made one acquisition accounted for
under the purchase method for an aggregate cash purchase price of $5,389. The
total assets related to the acquisition were $11,874, including goodwill of
$3,268. The results of the acquisition have been included in the Company's
results from its date of acquisition.
The following presents the unaudited pro forma results of operations of the
Company for the fiscal year ended April 25, 1998 and April 26, 1997 and includes
the Company's consolidated financial statements, which give retroactive effect
to the acquisitions of the Pooled Companies for all periods presented, and the
results of the companies acquired in purchase acquisitions as if all such
purchase acquisitions had been made at the beginning of fiscal 1997. The results
presented below include certain pro forma adjustments to reflect the
amortization of intangible assets, adjustments in executive compensation
35
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 4--BUSINESS COMBINATIONS (CONTINUED)
of $573 and $124 for the fiscal years ended April 25, 1998 and April 26, 1997,
respectively, and the inclusion of a federal income tax provision on all
earnings:
FOR THE FISCAL YEAR
ENDED
----------------------
APRIL 25, APRIL 26,
1998 1997
---------- ----------
Revenues........................................................... $ 381,242 $ 350,760
Net income......................................................... 7,538 11,714
Net income per share:
Basic............................................................ $ 0.57 $ 1.17
Diluted.......................................................... 0.56 1.15
The unaudited pro forma results of operations are prepared for comparative
purposes only and do not necessarily reflect the results that would have
occurred had the acquisitions occurred at the beginning of fiscal 1997 or the
results which may occur in the future.
NOTE 5--RESTRUCTURING COSTS
The Company records the costs of consolidating existing Company facilities
into acquired operations, including the external costs and liabilities to close
redundant Company facilities and severance and relocation costs related to the
Company's employees. The following table sets forth the Company's accrued
restructuring costs for the periods ended April 30, 1996, April 26, 1997 and
April 25, 1998:
FACILITY SEVERANCE OTHER ASSET
CLOSURE AND AND WRITE-DOWNS
CONSOLIDATION TERMINATIONS AND COSTS TOTAL
--------------- ------------- ----------- ---------
Balance at April 30 1996................ $ 641 $ 469 $ 1,422 $ 2,532
Additions............................. 194 194
Utilizations.......................... (641) (469) (1,465) (2,575)
----- ----- ----------- ---------
Balance at April 26, 1997............... 151 151
Additions............................. 728 214 1,550 2,491
Utilizations.......................... (728) (1,443) (2,170)
----- ----- ----------- ---------
Balance at April 25, 1998............... $ $ 214 $ 258 $ 472
----- ----- ----------- ---------
----- ----- ----------- ---------
36
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 6--PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following:
APRIL 25, APRIL 26,
1998 1997
--------- ---------
Deferred catalog costs.................................................. $ 7,206 $ 5,740
Deferred income taxes................................................... 1,886 2,055
Notes Receivable........................................................ 1,558 1,643
Other................................................................... 2,853 893
--------- ---------
Total prepaid expenses and other current assets..................... $ 13,503 $ 10,331
--------- ---------
--------- ---------
Deferred catalog costs represent costs which have been paid to produce
Company catalogs which will be used in future periods. These deferred catalog
costs will be expensed in the periods the catalogs are used.
NOTE 7--PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
APRIL 25, APRIL 26,
1998 1997
--------- ---------
Land.................................................................... $ 1,144 $ 729
Buildings............................................................... 10,064 6,488
Furniture and fixtures.................................................. 6,725 6,502
Warehouse equipment..................................................... 7,052 3,163
Leasehold improvements.................................................. 3,341 2,185
--------- ---------
28,326 19,067
Less: Accumulated depreciation.......................................... (5,773) (4,589)
--------- ---------
Net property and equipment.............................................. $ 22,553 $ 14,478
--------- ---------
--------- ---------
Depreciation expense (which includes capital lease amortization) for the
fiscal years ended April 25, 1998 and April 26, 1997, the four months ended
April 30, 1996 and the year ended December 31, 1995 was $2,499, $1,540, $470 and
$1,645, respectively.
NOTE 8--INTANGIBLE ASSETS
Intangible assets consist of the following:
APRIL 25, APRIL 26,
1998 1997
---------- ---------
Goodwill............................................................... $ 102,487 $ 22,128
Other.................................................................. 2,487 2,020
---------- ---------
104,974 24,148
Less: Accumulated amortization......................................... (5,361) (3,324)
---------- ---------
Net intangible assets................................................ $ 99,613 $ 20,824
---------- ---------
---------- ---------
37
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 8--INTANGIBLE ASSETS (CONTINUED)
Amortization expense for the fiscal years ended April 25, 1998 and April 26,
1997, the four months ended April 30, 1996 and the year ended December 31, 1995
was $2,061, $566, $204 and $1,098, respectively.
NOTE 9--CREDIT FACILITIES
SHORT-TERM DEBT
Short-term debt consists of the following:
APRIL 25, APRIL 26,
1998 1997
----------- -----------
Other.................................................................... $ $ 30
Current maturities of long-term debt..................................... 11 232
--- -----
Total short-term debt.................................................. $ 11 $ 262
--- -----
--- -----
LONG-TERM DEBT
Long-term debt consists of the following:
APRIL 25, APRIL 26,
1998 1997
----------- -----------
Other.................................................................... $ 310 $ 483
Capital lease obligations................................................ 16 315
----- -----
326 798
Less: Current maturities of long-term debt............................... (11) (232)
----- -----
Total long-term debt................................................... $ 315 $ 566
----- -----
----- -----
MATURITIES OF LONG-TERM DEBT
Maturities on long-term debt, including capital lease obligations, are as
follows:
1999................................................................. $ 11
2000................................................................. 181
2001................................................................. 92
2002................................................................. 36
2003................................................................. 6
Thereafter...........................................................
---------
Total maturities of long-term debt................................. $ 326
---------
---------
PAYABLE TO U.S. OFFICE PRODUCTS
The short-term payable to U.S. Office Products was incurred by the Company
primarily as a result of U.S. Office Products repaying short-term debt
outstanding of the businesses acquired by U.S. Office
38
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 9--CREDIT FACILITIES (CONTINUED)
Products at or soon after the respective dates of acquisition and through the
centralized cash management system, which involves daily advances or sweeps of
cash to keep the cash balance at or near zero on a daily basis.
The long-term payable to U.S. Office Products primarily represents payments
made by U.S. Office Products on behalf of the Company and a reasonable
allocation by U.S. Office Products of certain general corporate expenses. An
analysis of the activity in this account is as follows:
Balance at April 30, 1996.......................................... $
Payments of long-term debt of acquired companies................. 21,379
Funding of acquisitions and payment of acquisition costs......... 8,203
Allocated corporate expenses..................................... 2,221
Normal operating costs paid by U.S. Office Products.............. 1,423
---------
Balance at April 26, 1997.......................................... 33,226
Payments of long-term debt of acquired companies................. 822
Funding of acquisitions and payment of acquisition costs......... 20,706
Allocated corporate expenses..................................... 7,145
Normal operating costs paid by U.S. Office Products.............. 800
---------
Balance at April 25, 1998.......................................... $ 62,699
---------
---------
The average outstanding long-term payable to U.S. Office Products during the
fiscal years ended April 25, 1998 and April 26, 1997 was $52,207 and $27,269,
respectively.
Interest has been allocated to the Company based upon the Company's average
outstanding payable (short-term and long-term) balance with U.S. Office Products
at U.S. Office Products' weighted average interest rate during such period. The
Company's financial statements include allocations of interest expense from U.S.
Office Products totaling $5,414 and $3,839 during the fiscal years ended April
25, 1998 and April 26, 1997, respectively.
The Distribution Agreement allocated a specified amount of U.S. Office
Products' debt outstanding under its credit facilities to each Spin-Off Company
and required each Spin-Off Company, on or prior to the Distribution, to obtain
credit facilities, to borrow funds under such facilities and to use the proceeds
of such borrowings to pay off the U.S. Office Products' debt so allocated plus
any additional debt incurred by U.S. Office Products after January 12, 1998 (the
date of the Investment Agreement) in connection with the acquisition of an
entity that has become or will become a subsidiary of such Spin-Off Company.
Under the Distribution Agreement, $80,000 of U.S. Office Products' debt has been
allocated to School Specialty, and since January 12, 1998, U.S. Office Products
has incurred an additional $3,300 of debt in connection with one additional
acquisition completed by the Company. Prior to the Distribution, the Company
entered into the credit facility and at the time of the Distribution borrowed
$83,300 under the facility to pay off debt of U.S. Office Products.
39
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 10--INCOME TAXES
The provision for income taxes consists of:
FOR THE FOR THE
FISCAL YEAR ENDED FOUR MONTHS FOR THE
---------------------- ENDED YEAR ENDED
APRIL 25, APRIL 26, APRIL 30, DECEMBER 31,
1998 1997 1996 1995
----------- --------- --------------- ---------------
Income taxes currently payable:
Federal................................... $ 3,646 $ 71 $ $ (66)
State..................................... 907 99
----------- --------- ----- -----
4,553 170 (66)
----------- --------- ----- -----
Deferred income tax expense
(benefit)................................. 927 (2,582) 139 239
----------- --------- ----- -----
Total provision for (benefit from) income
taxes................................... $ 5,480 $ (2,412) $ 139 $ 173
----------- --------- ----- -----
----------- --------- ----- -----
Deferred taxes are comprised of the following:
APRIL 25, APRIL 26,
1998 1997
----------- ---------
Current deferred tax assets:
Inventory.............................................................. $ 743 $ 265
Allowance for doubtful accounts........................................ 164 193
Net operating loss carryforward........................................ 851 3,069
Accrued liabilities.................................................... 128 421
Prepaid catalog advertising/restructuring.............................. (1,893)
----------- ---------
Total current deferred tax assets.................................... 1,886 2,055
----------- ---------
Long-term deferred tax assets (liabilities):
Property and equipment................................................... (591) (289)
Intangible assets........................................................ 80 258
----------- ---------
Total long-term deferred tax liabilities............................. (511) (31)
----------- ---------
Net deferred tax assets.............................................. $ 1,375 $ 2,024
----------- ---------
----------- ---------
At April 30, 1996, the valuation allowance had been recorded, related to
deferred tax assets of a Pooled Company, including net operating loss
carryforwards. Based upon the improved profitability of this Pooled Company
during fiscal 1997, the valuation allowance was reversed, resulting in a benefit
from income taxes.
40
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 10--INCOME TAXES (CONTINUED)
The Company's effective income tax rate varied from the U.S. federal
statutory tax rate as follows:
FOR THE FOR THE
FISCAL YEAR ENDED FOUR MONTHS FOR THE
------------------------ ENDED YEAR ENDED
APRIL 25, APRIL 26, APRIL 30, DECEMBER 31,
1998 1997 1996 1995
----------- ----------- --------------- ---------------
U.S. federal statutory rate................. 34.0% 35.0% 35.0% 34.0%
State income taxes, net of federal income
tax benefit for fiscal 1997............... 6.6 1.0
Net benefit for current year net operating
loss...................................... (32.8) (34.0)
Reversal of valuation allowance............. (84.8)
Nondeductible goodwill...................... 6.0 1.6 (2.2)
Nondeductible acquisition costs............. 3.3 5.0
Tax on separate company income not offset
against other company's loss.............. (3.0) (5.4)
Other....................................... 1.2
--- ----- ----- -----
Effective income tax rate................... 51.1% (42.2)% (3.0 )% (5.4 )%
--- ----- ----- -----
--- ----- ----- -----
At April 25, 1998, the Company has available for tax purposes net operating
loss carryforwards of approximately $2,500. These carryforwards expire in the
years ending 2002-2011. The net operating loss caryforwards are subject to
certain limitations pursuant to IRS Code Section 382.
NOTE 11--LEASE COMMITMENTS
The Company leases various types of retail, warehouse and office facilities
and equipment, furniture and fixtures under noncancelable lease agreements which
expire at various dates. Future minimum lease payments under noncancelable
capital and operating leases are as follows:
CAPITAL OPERATING
LEASES LEASES
----------- -----------
1999..................................................................... $ 12 $ 1,556
2000..................................................................... 6 1,183
2001..................................................................... 1,027
2002..................................................................... 659
2003..................................................................... 323
Thereafter...............................................................
--- -----------
Total minimum lease payments............................................. 18 $ 4,748
--- -----------
-----------
Less: Amounts representing interest...................................... (2)
---
Present value of net minimum lease payments.............................. $ 16
---
---
Rent expense for the fiscal years ended April 25, 1998 and April 26, 1997,
the four months ended April 30, 1996 and the year ended December 31, 1995 was
$3,389, $1,817, $600 and $1,947, respectively.
41
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 12--COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is, from time to time, a party to litigation arising in the
normal course of its business. Management believes that none of this litigation
will have a material adverse effect on the financial position, results of
operations or cash flows of the Company.
POSTEMPLOYMENT BENEFITS
The Company has entered into employment agreements with several employees
that would result in payments to these employees upon a change of control or
certain other events. No amounts have been accrued at April 25, 1998 or April
26, 1997 related to these agreements, as no change of control has occurred.
DISTRIBUTION
Under the Distribution Agreement, the Company was required, on or prior to
the Distribution, to obtain a credit facility, to borrow funds under such
facility and to use the proceeds of such borrowings to pay off $83.3 million of
U.S. Office Products' debt. See additional discussion in Note 9.
At the date of the Distribution, School Specialty, U.S. Office Products and
the other Spin-Off Companies entered into the Distribution Agreement, the Tax
Allocation Agreement, and the Employee Benefits Agreement and the Spin-Off
Companies entered into the Tax Indemnification Agreement and may enter into
other agreements, including agreements relating to referral of customers to one
another. These agreements provide, among other things, for U.S. Office Products
and School Specialty to indemnify each other from tax and other liabilities
relating to their respective businesses prior to and following the Distribution.
Certain of the obligations of School Specialty and the other Spin-Off Companies
to indemnify U.S. Office Products are joint and several. Therefore, if one of
the other spin-off companies fails to satisfy its indemnification obligations to
U.S. Office Products when such a loss occurs, School Specialty may be required
to reimburse U.S. Office Products for all or a portion of the losses that
otherwise would have been allocated to other spin-off companies. In addition,
the agreements allocate liabilities, including general corporate and securities
liabilities of U.S. Office Products not specifically related to the school
supplies business, between U.S. Office Products and the Company and the other
Spin-Off Companies. The terms of the agreements that will govern the
relationship between School Specialty and U.S. Office Products were established
by U.S. Office Products in consultation with School Specialty's management prior
to the Distribution while School Specialty was a wholly-owned subsidiary of U.S.
Office Products.
NOTE 13--EMPLOYEE BENEFIT PLANS
Effective September 1, 1996, the Company implemented the U.S. Office
Products 401(k) Retirement Plan (the "401(k) Plan") which allows employee
contributions in accordance with Section 401(k) of the Internal Revenue Code.
The Company matches a portion of employee contributions and all full-time
employees are eligible to participate in the 401(k) Plan after one year of
service.
Certain subsidiaries of the Company have, or had prior to implementation of
the 401(k) Plan, qualified defined contribution benefit plans, which allow for
voluntary pre-tax contributions by the employees. The subsidiaries paid all
general and administrative expenses of the plans and in some cases made matching
contributions on behalf of the employees. For the four months ended April 30,
1996 and
42
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 13--EMPLOYEE BENEFIT PLANS (CONTINUED)
the year ended December 31, 1995, the subsidiaries incurred expenses totaling $6
and $105, respectively, related to these plans.
NOTE 14--STOCKHOLDER'S EQUITY
EARNINGS PER SHARE
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS
No. 128 establishes standards for computing and presenting earnings per share
("EPS"). SFAS No. 128 requires the dual presentation of basic and diluted EPS on
the face of the consolidated statement of income. Basic EPS excludes dilution
and is computed by dividing income available to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
The Company has adopted SFAS No. 128 during fiscal 1998 and has restated all
prior period EPS data. The following information presents the Company's
computations of basic and diluted EPS for the periods presented in the
consolidated statement of income.
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ ------------- -----------
FISCAL 1998:
Basic EPS.............................................................. $ 5,239 13,284,003 $ 0.40
-----------
-----------
Effect of dilutive employee stock options.............................. 263,461
------------ -------------
Diluted EPS............................................................ $ 5,239 13,547,464 $ 0.39
------------ ------------- -----------
------------ ------------- -----------
FISCAL 1997:
Basic EPS.............................................................. $ 8,132 10,002,875 $ 0.81
-----------
-----------
Effect of dilutive employee stock options.............................. 192,766
------------ -------------
Diluted EPS............................................................ $ 8,132 10,195,641 $ 0.80
------------ ------------- -----------
------------ ------------- -----------
FOUR MONTHS ENDED APRIL 30, 1996:
Basic EPS.............................................................. $ (4,675) 8,611,240 $ (0.54)
-----------
-----------
Effect of dilutive employee stock options.............................. 177,702
------------ -------------
Diluted EPS............................................................ $ (4,675) 8,788,942 $ (0.53)
------------ ------------- -----------
------------ ------------- -----------
YEAR ENDED DECEMBER 31, 1995:
Basic EPS.............................................................. $ (3,367) 6,562,210 $ (0.51)
-----------
-----------
Effect of dilutive employee stock options.............................. 107,199
------------ -------------
Diluted EPS............................................................ $ (3,367) 6,669,409 $ (0.50)
------------ ------------- -----------
------------ ------------- -----------
43
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 14--STOCKHOLDER'S EQUITY (CONTINUED)
CAPITAL CONTRIBUTION BY U.S. OFFICE PRODUCTS
During the fiscal year ended April 25, 1998, U.S. Office Products
contributed $81,332 of capital to the Company. The contribution reflects the
forgiveness of intercompany debt by U.S. Office Products, as it was agreed that
the Company would be allocated only $80,000 of debt plus the amount of any
additional debt incurred after January 12, 1998 in connection with the
acquisition of entities that will become subsidiaries of School Specialty.
EMPLOYEE STOCK PLANS
The Company currently has stock options outstanding under the U.S. Office
Products 1994 Long-Term Compensation Plan. The Company expects to replace the
options to purchase shares of common stock of U.S. Office Products held by
employees with options to purchase shares of common stock of the Company. In
order to keep the option holders in the same economic position immediately
before and after the Distribution, the number of U.S. Office Products options
held by Company personnel was multiplied by 0.903 and the exercise price of
those options was divided by 0.903 for purposes of the replacement options. The
vesting provisions and option period of the original grants were not changed.
All option data reflected below has been retroactively restated to reflect the
effects of the Distribution. The Company accounts for options issued in
accordance with APB Opinion No. 25. Accordingly, because the exercise prices of
the options have equaled the market price on the date of grant, no compensation
expense has been recognized for the options granted. Had compensation cost for
the Company's stock options been recognized based upon the fair value of the
stock options on the grant date under the methodology prescribed by SFAS 123,
the Company's net income and net income per share would have been impacted as
indicated in the following table.
FOR THE
FISCAL YEAR ENDED
------------------------
APRIL 25, APRIL 26,
1998 1997
----------- -----------
Net income:
As reported............................................................ $ 5,239 $ 8,132
Pro Forma.............................................................. 4,436 7,383
Net income per share:
As reported:
Basic................................................................ 0.40 0.81
Diluted.............................................................. 0.39 0.80
Pro Forma:
Basic................................................................ 0.33 0.74
Diluted.............................................................. 0.33 0.72
44
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 14--STOCKHOLDER'S EQUITY (CONTINUED)
The fair value of options granted (which is amortized to expense over the
option vesting period in determining the pro forma impact) is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions:
FOR THE
FISCAL YEAR ENDED
------------------------
APRIL 25, APRIL 26,
1998 1997
----------- -----------
Expected life of option.................................................. 7 years 7 years
Risk free interest rate.................................................. 6.35% 6.66%
Expected volatility of stock............................................. 44.10% 44.00%
The weighted-average fair value of options granted was $9.75 and $15.31 for
fiscal 1998 and 1997, respectively.
A summary of option transactions follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------- ------------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
---------- ----------- ----------- -----------
Balance at April 30, 1995.......................
Granted.......................................
Exercised.....................................
Canceled......................................
Balance at April 30, 1996.......................
Granted....................................... 225,445 $ 27.03
Exercised.....................................
Canceled...................................... (14,565) 28.37
---------- -----------
Balance at April 26, 1997....................... (210,880) 26.93
Granted....................................... 257,020 18.01
Exercised.....................................
Canceled...................................... (25,606) 25.45
---------- -----------
Balance at April 25, 1998....................... 442,294 $ 21.83 46,319 $ 27.14
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
45
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 14--STOCKHOLDER'S EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
at April 25, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- ------------------------
WEIGHTED WEIGHTED
WEIGHTED- AVERAGE AVERAGE
AVERAGE EXERCISE EXERCISE
RANGE OF EXERCISE PRICES OPTIONS LIFE PRICE OPTIONS PRICE
- ---------------------------------- ----------- ------------- ----------- ----------- -----------
$16.80-$21.77..................... 257,020 9.23 $ 18.01
$24.36-$29.43..................... 185,274 8.17 27.14 46,319 $ 27.14
----------- ----------- ----------- -----------
$16.80-$29.43..................... 442,294 8.79 $ 21.83 46,319 $ 27.14
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Non-qualified options granted to employees are generally exercisable
beginning one year from the date of grant in cumulative yearly amounts of 25% of
the shares under option and generally expire ten years from the date of grant.
Under a services agreement entered into with Jonathan J. Ledecky, the Board
of Directors of U.S. Office Products agreed that Jonathan J. Ledecky would
receive a stock option for School Specialty Common Stock from School Specialty
as of the date of the Distribution. The U.S. Office Products Board intends the
option to be compensation for Mr. Ledecky's services as a director of the
Company, and certain services as an employee of the Company. The option covers
7.5% of the outstanding Company common stock determined as of the date of the
Distribution, with no anti-dilution provisions in the event of issuance of
additional shares of common stock (other than with respect to stock splits or
reverse stock splits). The option will has a per share exercise price equal to
the IPO price.
Immediately following the effective date of the registration statements
filed in connection with the IPO and the Distribution, the Company's Board of
Directors granted 850,083 options covering 7% of the outstanding shares of the
Company's common stock, immediately following the Distribution and prior to the
IPO, to certain executive management personnel (excluding the 7.5% granted to
Mr. Ledecky). The options granted were granted under the 1998 Stock Incentive
Plan (the "Plan") and have a per share exercise price equal to the IPO price,
with other terms to be determined by the Company's Board of Directors.
Total options available for grant under the Plan are equal to 20.0% of the
outstanding shares of the Company's common stock immediately following the
Distribution and the IPO, including the options to be granted to Mr. Ledecky on
that date.
46
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 15--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following presents certain unaudited quarterly financial data for the
fiscal years ended April 25, 1998 and April 26, 1997:
YEAR ENDED APRIL 25, 1998
-------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
--------- ---------- --------- --------- ----------
Revenues.................................... $ 87,029 $ 111,460 $ 49,391 $ 62,575 $ 310,455
Gross profit................................ 26,090 33,619 11,670 19,763 91,142
Operating income (loss)..................... 11,872 12,155 (4,048) (3,731) 16,248
Net income (loss)........................... 5,804 5,965 (2,934) (3,596) 5,239
Per share amounts:
Basic..................................... 0.49 0.49 (0.20) (0.24) 0.40
Diluted................................... 0.48 0.47 (0.20) (0.24) 0.39
YEAR ENDED APRIL 26, 1997
-------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
--------- ---------- --------- --------- ----------
Revenues.................................... $ 58,991 $ 71,682 $ 29,304 $ 31,769 $ 191,746
Gross profit................................ 18,110 19,823 7,664 9,572 55,169
Operating income (loss)..................... 5,197 6,732 (1,520) (688) 9,721
Net income (loss)........................... 1,981 2,692 (1,067) 4,526 8,132
Per share amounts:
Basic..................................... 0.21 0.28 (0.11) 0.40 0.81
Diluted................................... 0.21 0.27 (0.11) 0.39 0.80
NOTE 16--SUBSEQUENT EVENTS
CREDIT FACILITY
On June 9, 1998, the Company received a five year $250,000 revolving credit
facility from NationsBank, N.A. Interest on borrowings under the credit facility
will accrue interest at a rate of, at the Company's option, either LIBOR plus
1.00% or the lender's base rate, for up to the first 6 months under the
agreement. Thereafter, interest will accrue at a rate of (i) LIBOR plus a range
of .625% to 1.625%, or (ii) the lender's base rate plus a range of 0% to .250%
(depending on the Company's leverage ratio of funded debt to EBITDA).
Indebtedness is secured by substantially all of the assets of the Company. The
credit facility is subject to terms and conditions typical of facilities of such
size and includes certain financial covenants. The Company has made borrowings
under the credit facility to repay the US Office Products debt which it was
obligated under the Distribution Agreement to repay. The balance of the credit
facility will be available for working capital, capital expenditures and
acquisitions, subject to compliance with financial covenants.
47
ITEM 9:CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of School Specialty as of July 17, 1998
are as follows:
NAME AGE POSITION
- --------------------------------------- --- ------------------------------------------------------------------
Daniel P. Spalding..................... 43 Chairman of the Board and Chief Executive Officer
David J. Vander Zanden................. 43 President, Chief Operating Officer, and Director
Donald J. Noskowiak.................... 40 Executive Vice President and Chief Financial Officer
Douglas Moskonas....................... 53 Executive Vice President for School Specialty Divisions
Melvin D. Hilbrown..................... 50 Executive Vice President for Gresswell
Richard H. Nagel....................... 57 Executive Vice President for Sax Arts & Crafts
Donald Ray Pate, Jr.................... 35 Executive Vice President for Re-Print
Ronald E. Suchodolski.................. 52 Executive Vice President for Childcraft
Michael J. Killoren.................... 41 Vice President for School Specialty Divisions
Lillian R. Kellogg..................... 45 President for Education Access Division
Jonathan J. Ledecky.................... 40 Director
Leo C. McKenna (1)..................... 64 Director
Rochelle Lamm Wallach (1).............. 50 Director
- ------------------------
(1) Member of Audit and Compensation Committees
DANIEL P. SPALDING became Chairman of the Board and Chief Executive Officer
of School Specialty in February 1998. Mr. Spalding has served as President of
the Educational Supplies and Products Division of U.S. Office Products since
1996. Prior to that time, he served as President, Chief Executive Officer, and a
director of Old School since 1988. Prior to 1988, Mr. Spalding was an officer of
JanSport, a manufacturer of sports apparel and backpacking equipment. Mr.
Spalding was a co-founder of JanSport, and served as President and Chief
Executive Officer from 1977 to 1984. Mr. Spalding has been a director of the
National School Supply and Equipment Association since 1992 and completed his
term as the association's Chairman in November 1997. Mr. Spalding is Michael J.
Killoren's cousin.
DAVID J. VANDER ZANDEN became the Chief Operating Officer of School
Specialty in March 1998. Prior to that time, he served as President of Ariens
Company since 1992, a manufacturer of outdoor lawn and garden equipment.
DONALD J. NOSKOWIAK has served as Chief Financial Officer of School
Specialty since 1997. In February 1998, Mr. Noskowiak became an Executive Vice
President of School Specialty. He was Vice President, Treasurer and Principal
Financial Officer of Old School since 1994. From 1992 through 1994 he was the
Corporate Controller of Old School.
DOUGLAS MOSKONAS has served as Executive Vice President of School Specialty
for School Specialty Divisions since completion of the School Specialty
Distribution on June 1998. Mr. Moskonas joined Old School in 1993 as Vice
President of Sales for the Valley Division. Since that time he has served as
General Manager for the Valley Division from 1994 through 1996 and was appointed
President of School Specialty Distribution in 1997. Prior to joining School
Specialty, Mr. Moskonas served as Vice President of Sales for Emmons-Napp Office
Products from 1979 through 1993.
48
MELVIN D. HILBROWN has served as Executive Vice President of School
Specialty for Greswell since completion of the School Specialty Distribution in
June 1998. Mr. Hilbrown joined School Specialty as Managing Director of
Gresswell with School Specialty's acquisition of Don Gresswell, Ltd. in 1997. He
has been Managing Director of Gresswell since 1989.
RICHARD H. NAGEL has served as Executive Vice President of School Specialty
for Sax Arts & Crafts since completion of the School Specialty Distribution in
June 1998. Mr. Nagel joined School Specialty with the acquisition of Sax Arts &
Crafts in 1997 and serves as President of Sax Arts & Crafts. Mr. Nagel has been
with Sax Arts & Crafts since 1975 when he was hired as Assistant General
Manager. He was named President of Sax Arts & Crafts in 1990.
DONALD RAY PATE, JR. has served as Executive Vice President of School
Specialty for Re-Print since completion of the School Speciality Distribution in
June 1998. Mr. Pate joined School Specialty with the acquisition of Re-Print in
1996 and serves as President of Re-Print. Mr. Pate has served as President of
Re-Print since he acquired it in 1988.
RONALD E. SUCHODOLSKI has served as Executive Vice President of School
Specialty for Childcraft since completion of the School Speciality Distribution
in June 1998. Mr. Suchodolski joined School Specialty with the acquisition of
Childcraft in 1997 and serves as President of Childcraft. Mr. Suchodolski has
been President of Childcraft since 1995 and was Director of Childcraft's School
Division from 1984 through 1989. From 1989 to 1993, Mr. Suchodolski was
President of the Judy/Instructo Division of Paramount, and from 1993 through
1995 Mr. Suchodolski served as Senior Vice President of Sales and Marketing for
Paramount Publishing's Supplementary Materials Division.
MICHAEL J. KILLOREN has served as Vice President of School Specialty for
School Speciality Divisions since completion of the School Specialty
Distribution in June 1998. Mr. Killoren has served as Chief Operating Officer of
School Specialty Distribution since 1997. From 1992 to 1997, he was Vice
President/Operations of School Specialty. Mr. Killoren is Daniel P. Spalding's
cousin.
LILLIAN R. KELLOGG joined the Company with the acquisition of Education
Access in March 1998 and serves as President of the Company's Education Access
Division. Ms. Kellogg previously served as Executive Vice President of Education
Access, Inc. from March 1997 to March 1998 and as President of Computer Plus,
Inc. from March 1984 to March 1997. On January 19, 1998, Education Access, Inc.
filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy
Code. The Company acquired substantially all of the assets of its catalog
division on March 20, 1998.
JONATHAN J. LEDECKY has served as a director and an employee of School
Specialty since completion of the School Specialty Distribution in June 1998. He
founded Consolidation Capital Corporation in February 1997 and serves as its
Chairman and Chief Executive Officer. Mr. Ledecky founded U.S. Office Products
in October 1994, served as its Chairman of the Board until the June 1998 and
served as its Chief Executive Officer until November 5, 1997. Mr. Ledecky has
also served as the Non-Executive Chairman of the Board of USA Floral Products,
Inc. since April 1997 and as a director of UniCapital Corporation since October
1997. Mr. Ledecky served from 1989 to 1991 as the President of The Legacy Fund,
Inc., and from 1991 to September 1994 as President and Chief Executive Officer
of Legacy Dealer Capital Fund, Inc., a wholly-owned subsidiary of Steelcase Inc.
Prior to his tenure at The Legacy Fund, Inc., Mr. Ledecky was a partner at Adler
and Company and a Senior Vice President at Allied Capital Corporation, an
investment management company.
LEO C. MCKENNA is a self-employed financial consultant working with personal
asset management, corporate planning, acquisitions, merger studies, and
negotiations. Mr. McKenna is currently a Member of the Board of Life Insurance
Company of Boston and New York (Subsidiary of Boston Mutual Life). He is founder
and a director of Ledyard National Bank, where he also serves on the Audit
Committee. He is also a director of Rosenthal, A.G. USA. He is a director and
member of the John Brown Cook Foundation and
49
an overseer and Chairman of the Finance Committee for the Catholic Student
Center at Dartmouth College.
ROCHELLE LAMM WALLACH was associated with Strong Advisory Services, a
division of Strong Capital Management, as its President from 1995 to March 1998.
Prior to that time, she was Chief Operating Officer of AAL Capital Management, a
mutual fund manager which she founded in 1986.
COMMITTEES OF THE BOARD
The Audit Committee of the Board of Directors is charged with reviewing
School Specialty's annual audit and meeting with School Specialty's independent
accountants to review School Specialty's internal controls and financial
management practices.
The Compensation Committee of the Board of Directors is charged with
determining the compensation of executive officers of School Specialty and
administering the Company's stock option plan.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information with respect to the compensation
paid by School Specialty for services rendered during the years ended April 26,
1997 and April 25, 1998 to the Chief Executive Officer and to each of the four
other most highly compensated officers of School Specialty (the "Named
Officers").
SUMMARY COMPENSATION TABLE
ANNUAL LONG TERM
COMPENSATION COMPENSATION
--------------------- OPTIONS(#) ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS (1) COMPENSATION
- ---------------------------------------------------- --------- ---------- --------- ------------- -------------
Daniel P. Spalding.................................. 1997 $ 178,846 $ 34,200 135,484 --
Chairman of the Board, CEO and Director 1998 212,104 --
Ronald E. Suchodolski(2)............................ 1997 $ 141,535 $ 30,000 -- --
Executive Vice President for Childcraft 1998 157,646 154,633 18,065 --
Richard H. Nagel(2)(3).............................. 1997 $ 118,000 $ 29,500 -- $ 32,000
Executive Vice President for Sax Arts & Crafts 1998 130,660 29,500 18,065 --
Donald Ray Pate, Jr.(2)............................. 1997 $ 220,901 -- -- --
Executive Vice President for Re-Print 1998 117,000 -- --
Douglas Moskonas.................................... 1997 $ 97,266 $ 44,500 13,548 --
Executive Vice President for School Specialty 1998 139,525 -- 18,065 --
Division
- ------------------------
(1) Options were issued by U.S. Office Products to acquire U.S. Office Products
common stock and options remaining after U.S. Office Products' tender offer
were replaced with options to acquire School Speciality Common Stock in
connection with the School Specialty Distribution. The number of options set
forth in the table represents the number of options for School Specialty
Common Stock the officer would have been granted if all U.S. Office Products
options granted during the year were replaced with School Specialty options.
(2) Mr. Suchodolski, Mr. Nagel and Mr. Pate joined School Specialty in May 1997,
July 1997 and July 1996, respectively. The compensation information included
in this table reflects the compensation received when employed by
predecessor companies.
(3) Other compensation refers to Mr. Nagel's automobile allowance and stay-bonus
compensation received by his prior employer.
50
OPTIONS GRANTED IN FISCAL YEAR 1998
The following table sets forth certain information regarding options to
acquire School Speciality Common Stock granted to the Named Officers during the
year ended April 25, 1998. All options were granted by U.S. Office Products as
options to acquire U.S. Office Products common stock and options remaining after
U.S. Office Products' tender offer were replaced with options to acquire School
Specialty Common Stock, utilizing the option conversion formula applied in
connection with the School Specialty Distribution, which affected the number of
shares issuable upon exercise of the options and the exercise price of the
options. The number of options and exercise prices set forth below represent the
number of options (and exercise price of options) for School Specialty Common
Stock that the officer would have been granted if all U.S. Office Products
options granted during the fiscal year were replaced with School Specialty
options.
OPTIONS GRANTED IN FISCAL YEAR ENDED APRIL 25, 1998
POTENTIAL REALIZABLE VALUE
PERCENT OF
TOTAL OPTIONS AT ASSUMED ANNUAL RATES OF
GRANTED TO STOCK PRICE APPRECIATION
OPTIONS EMPLOYEES IN FOR OPTION TERM(3)
GRANTED FISCAL EXERCISE EXPIRATION --------------------------
NAME (1) YEAR(2) PRICE(2) DATE 5% 10%
- ---------------------------------------------- --------- ------------- ----------- ----------- ------------ ------------
Daniel P. Spalding............................ 135,484 52.7% $ 16.80 4/28/07 $ 1,431,447 $ 3,627,567
Ronald E. Suchodolski......................... 18,065 7.0% 19.93 12/12/07 226,424 573,804
Richard H. Nagel.............................. 18,065 7.0% 19.93 12/12/07 226,424 573,804
Donald Ray Pate, Jr........................... -- -- -- -- -- --
Douglas Moskonas.............................. 18,065 7.0% 19.93 12/12/07 226,424 573,804
- ------------------------
(1) The options granted are non-qualified stock options, which are exercisable
at the market price on the date of grant, beginning one year from the date
of grant in cumulative yearly amounts of 25% of the shares and expire ten
years from the date of grant. The options become fully exercisable upon a
change in control, as defined in the Incentive Plan.
(2) Total options granted refers to options to acquire U.S. Office Products
common stock given to all employees of the Educational Supplies and Products
Division of U.S. Office Products during fiscal 1998.
(3) The dollar amounts under these columns are the results of calculations at
assumed annual rates of stock appreciation of 5% and 10%. These assumed
rates of growth were selected by the SEC for illustration purposes only.
They are not intended to forecast possible future appreciation, if any, of
stock prices. No gain to the optionees is possible without an increase in
stock prices, which will benefit all stockholders.
51
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED APRIL 25, 1998 AND FISCAL
YEAR-END 1998 OPTION VALUES
The following table sets forth certain information regarding unexercised
options held by the Named Officers at April 25, 1998. All options were granted
by U.S. Office Products as options to acquire U.S. Office Products common stock
and options remaining after U.S. Office Products' tender offer were replaced
with options to acquire shares of School Specialty Common Stock, utilizing the
option conversion formula applied in connection with the School Speciality
Distribution. The number of options set forth below represents the number of
options for School Specialty Common Stock that the officer would have held at
the end of the fiscal year if all U.S. Office Products options held on that date
(prior to the U.S. Office Products tender offer) were replaced with School
Specialty options.
VALUE OF
UNEXERCISED
IN- THE-MONEY
NUMBER UNEXERCISED OPTIONS OPTIONS AT
FISCAL YEAR
SHARES HELD AT APRIL 25, 1998 (#) END ($)(1)
ACQUIRED ON VALUE ------------------------------ -------------
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE
- ---------------------------------------- ----------------- ------------- --------------- ------------- -------------
Daniel P. Spalding...................... -- $ -- -- 135,484 $ --
Ronald E. Suchodolski................... -- -- -- 18,065 --
Richard H. Nagel........................ -- -- -- 18,065 --
Donald Ray Pate, Jr..................... -- -- -- -- --
Douglas Moskonas........................ -- -- -- 31,613 --
NAME UNEXERCISABLE
- ---------------------------------------- -------------
Daniel P. Spalding...................... N/A
Ronald E. Suchodolski................... N/A
Richard H. Nagel........................ N/A
Donald Ray Pate, Jr..................... N/A
Douglas Moskonas........................ N/A
- ------------------------
(1) At the end of fiscal 1998, School Specialty Common Stock was not traded.
Therefore it is not possible to determine the value of unexercised
in-the-money options as of that date.
1998 STOCK INCENTIVE PLAN
The purpose of the 1998 Stock Incentive Plan (the "Plan") is to promote the
long-term growth and profitability of the Company by providing employees with
incentives to improve stockholder value and contribute to the growth and
financial success of the Company, and by enabling the Company to attract, retain
and reward highly motivated and qualified employees. The maximum percentage of
shares of Company Common Stock that may be issued with respect to awards granted
under the Plan is 20% of the outstanding Common Stock of the Company determined
immediately after the grant of the award. The maximum number of shares that may
be issued with respect to awards granted under the Plan to an individual in a
calendar year may not exceed 1.2 million shares. The Plan will be administered
by the Compensation Committee of the Board of Directors. All employees of the
Company and its subsidiaries, as well as non-employee directors of the Company,
are eligible to receive awards under the Plan. The Plan authorizes the
Compensation Committee to make awards of incentive stock options, non-qualified
stock options, restricted stock, and other stock-based awards. The Compensation
Committee will determine the prices (which may not be less than the fair market
value on the date of award), vesting schedules, expiration dates and other
material conditions under which such awards may be exercised.
Mr. Ledecky received 914,079 stock options for Company Common Stock, which
is equal to 7.5% of the outstanding Company Common Stock determined as of June
9, 1998, without regard to the public offering that closed on June 15,1998. The
options are intended to compensate Mr. Ledecky for his services to School
Specialty as an employee. The option has a per share exercise price equal to
$15.50. Based on the exercise price of $15.50 and an assumed trading volatility
index of the School Specialty Common Stock of 35.0%, the estimated value of the
option is approximately $2.6 million, net of taxes at an assumed 40% rate. Mr.
Ledecky's option is fully vested when granted but will not be exercisable until
June 9, 1999. Mr. Ledecky's option from the Company will be exercisable
immediately if Mr. Ledecky dies before the option expires or if and to the
extent that School Specialty accelerates the exercise schedule of substantially
all management options. All unexercised portions of the option will expire ten
years after its date of grant or, if applicable, as of the date Mr. Ledecky
violates his non-competition agreement with School Specialty.
52
As of June 10, 1998 Daniel P. Spalding received an option (the "Spalding
Option") pursuant to the Plan for 228,519 shares, which is equal to 1.9% of the
outstanding Common Stock as of that date. The Spalding Option has the same terms
as Mr. Ledecky's option, including an exercise price equal to $15.50. Based on
the exercise price of $15.50 an assumed trading volatility index of the School
Specialty Common Stock of 35.0%, the estimated value of the option is
approximately $0.7 million, net of taxes at an assumed 40% rate. In addition,
certain executive officers of the Company received options for in aggregate
621,564 shares (approximately 5.1% of the Common Stock) on June 10, 1998 also at
an exercise price of $15.50.
DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS
School Specialty granted each non-management director 15,000 options to
purchase School Specialty Common Stock upon their initial election as members of
the Board of Directors. The Company intends to grant options to acquire 5,000
shares for each additional year of service. Non-management directors are paid an
annual retainer of $20,000 and $1,000 for each additional special meeting
attended and will also be reimbursed for all out-of-pocket expenses related to
their service as directors.
The Company entered into an employment agreement with Mr. Ledecky effective
as of June 10, 1998 that implemented certain portions of an agreement (the
"Ledecky Services Agreement") that Mr. Ledecky had previously entered into with
U.S. Office Products. Under the employment agreement, Mr. Ledecky reports to the
Board of Directors and senior management of the Company. In such capacity, Mr.
Ledecky provides high-level acquisition negotiation services and strategic
business advice. The Company can require Mr. Ledecky's performance of such
services, consistent with his other contractual obligations to Consolidation
Capital Corporation, U.S. Office Products and the other Spin-Off Companies. As
an employee, Mr. Ledecky is also subject to the generally applicable personnel
policies of the Company and is eligible for such benefit plans in accordance
with their terms. The Company pays Mr. Ledecky an annual salary of $48,000 for
up to two years. The Company may terminate Mr. Ledecky's employment with
"cause", where cause consists of (i) his conviction of or guilty or nolo
contendere plea to a felony demonstrably and materially injurious to the
Company, or (ii) his violation of the non-competition provision as it relates to
the Company.
The Ledecky Services Agreement provides for non-competition and
non-solicitation restrictions that continue until the later of June 10, 2000 or
one year after Mr. Ledecky leaves School Specialty's employ. These provisions
generally restrict Mr. Ledecky from, among other things, investing in or working
for or on behalf of any business selling any products or services in direct
competition with U.S. Office Products or the Spin-Off Companies (collectively,
the "U.S. Office Products Companies"), within 100 miles of any location where
the relevant U.S. Office Products Company regularly maintains an office with
employees. (For this purpose, "products or services" includes products or
services offered by School Specialty.) Notwithstanding this prohibition, Mr.
Ledecky may serve in a policy making role (but not engage in direct personal
competition) with respect to the following businesses: (i) businesses selling,
supplying, or distributing janitorial or sanitary products or services; (ii)
businesses managing or servicing equipment (other than computers); (iii)
businesses providing internet services; (iv) UniCapital Corporation's current
businesses (which include equipment leasing); or (v) U.S. Marketing Services'
shelf-stocking and merchandising and point-of-purchase display creation
business. The Ledecky Services Agreement prohibits Mr. Ledecky from trying to
hire away managerial employees of School Specialty or from calling upon
customers of the School Specialty to solicit or sell products or services in
direct competition with School Specialty. Mr. Ledecky also may not hire away for
Consolidation Capital Corporation any person then or in the preceding one year
employed by School Specialty.
EMPLOYMENT CONTRACTS AND RELATED MATTERS
School Specialty has entered into employment agreements with the following
four of its Named Officers: Daniel P. Spalding (Chairman and Chief Executive
Officer), Donald Ray Pate, Jr. (Executive Vice
53
President and President of Re-Print), Richard H. Nagel (Executive Vice President
and President of Sax Arts & Crafts) and David J. Vander Zanden, (President and
Chief Operating Officer).
Daniel P. Spalding, Chief Executive Officer of School Specialty, entered
into an employment contract with Old School on April 29, 1996. The contract has
an initial term of four years but, unless terminated, is automatically extended
at the end of each of the last three years of the initial term for another year.
Mr. Spalding receives a base salary of at least $180,000 and participates in an
incentive bonus plan which provides for an annual bonus up to 100% of base
salary upon the attainment of profit and revenue objectives. Following the
termination of his employment for any reason, Mr. Spalding has agreed not to
compete with School Specialty for a period equal to the longer of two years or,
in the case of early termination, the years remaining on his contract. If Mr.
Spalding is terminated without cause, as defined in the contract, he is entitled
to his entire base salary for the years remaining on the contract. In addition,
Mr. Spalding may terminate his contract for good cause (e.g., a material,
adverse change in his position or responsibilities or any material breach on the
part of School Specialty) or within five days of a change in control of School
Specialty. The contract defines a change of control to mean: (i) the acquisition
of beneficial ownership of 50% or more of voting securities of School Specialty
by any person other than U.S. Office Products; (ii) a loss of majority status by
the combination of members of U.S. Office Products' Board at the time of its
initial public offering and any Board members installed by a two-thirds vote of
the then-present initial Directors or any Directors subsequently installed by
them; (iii) any reorganization of U.S. Office Products unless 75% of the
beneficial ownership of U.S. Office Products voting securities remains in the
same hands; or (iv) U.S. Office Products or more than 49% of its assets are
liquidated. The Company expects to enter into an amendment to Mr. Spalding's
employment agreement in respect of the change of control provisions to reflect
the Company's public status.
Donald Ray Pate, Jr., serves as President of Re-Print and entered into an
employment contract with Re-Print on July 26, 1996 to serve as its President.
The contract runs for four years but provides for two automatic one-year
extensions unless Re-Print gives 60 days written notice of its intent not to
renew. Mr. Pate's annual base salary is $125,000, and he participates in an
executive compensation program and incentive bonus plan based upon the
attainment of profit and revenue objectives. Following the termination of his
employment for any reason, Mr. Pate has agreed not to compete with Re-Print for
the longer of two years or until the end of the contractual term. If Mr. Pate is
terminated without cause, he is entitled to receive his base salary for three
months or until the end of the initial contractual term, whichever period is
greater. Mr. Pate was granted options on June 10, 1998 to purchase 45,703 shares
with the same terms as Mr. Ledeckys' options, including an excercise price of
$15.50 (See "--1998 Stock Incentive Plan").
Richard H. Nagel, President of Sax Arts & Crafts, entered into a four-year
employment contract with Sax Arts & Crafts on June 27, 1997 to serve as its
President. Mr. Nagel's annual base salary is at least $125,000, and he
participates in an executive compensation program and an incentive bonus plan
based upon the attainment of profit and revenue objectives. Following the
termination of his employment for any reason, Mr. Nagel has agreed not to
compete with Sax Arts & Crafts for one year. If Mr. Nagel is terminated without
cause, he is entitled to receive his base salary for one year or until the end
of the contractual term, whichever period is lesser. Mr. Nagel was granted
options on June 10, 1998 to purchase 45,703 shares with the same terms as Mr.
Ledecky's options, including an excercise price of $15.50. (See "--1998 Stock
Incentive Plan").
David J. Vander Zanden became President and Chief Operating Officer in March
1998. After the School Specialty Distribution, School Specialty entered into a
two-year employment contract with Mr. Vander Zanden, with automatic two-year
extensions unless School Specialty or Mr. Vander Zanden gives 90 days written
notice of either party's intent not to renew. The employment contract provides
for a base salary of $225,000 and participation in an incentive bonus plan based
upon the attainment of profit and revenue objectives. The employment contract
also contains a covenant not to compete upon termination of the agreement, and
provides Mr. Vander Zanden the right to terminate the agreement upon a change of
control in School Specialty, defined in the agreement. Mr. Vander Zanden was
granted options
54
on June 10, 1998 to purchase 228,519 shares with the same terms as Mr. Ledecky's
options, including an excercise price of $15.50. (See "--1998 Stock Incentive
Plan").
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee consists of Mr. McKenna and Ms. Wallach. No
member of the Compensation Committee has ever been an officer of School
Specialty or any of its subsidiaries and no executive officer of the Company has
served on the Compensation Committee or the board of directors of any company of
which any director of the Company is an executive officer.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of July 17, 1998, the number and
percentage of outstanding shares of School Specialty Common Stock beneficially
owned by (i) all persons known by School Specialty to own beneficially more than
5% of the Common Stock, (ii) each director, (iii) the Chief Executive Officer
and each of the four other most highly compensated executive officers of the
Company (the "Named Executive Officers"), and (iv) all directors and executive
officers as a group.
NUMBER OF PERCENT OF
SHARES OUTSTANDING
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED SHARES
- -------------------------------------------------------------------- ---------- ---------------
Daniel P. Spalding (1).............................................. 199,219 1.4%
Ronald Suchodolski.................................................. -- --
Jonathan J. Ledecky (2)............................................. 207,100 1.4
Richard H. Nagel.................................................... -- --
Donald Ray Pate, Jr. (3)............................................ 158,444 1.1
Douglas Moskonas (1)................................................ 6,500 *
Leo C. McKenna...................................................... 5,016 *
David J. Vander Zanden.............................................. 50,000 *
Rochelle Lamm Wallach............................................... 1,950 *
All current executive officers and directors as a group (13 persons)
(1)............................................................... 645,251 4.4
5% STOCKHOLDERS (4)
FMR Corp............................................................ 1,342,687 9.2
82 Devonshire Street
Boston, MA 02109
Gardner-Lewis Asset Mgmt............................................ 899,292 6.2
285 Wilmington Westchester Pike
Chadd-Ford, PA 19317
- ------------------------
* Less than 1%.
(1) Share amounts include options currently exercisable, or exercisable within
60 days after July 17, 1998, in the amount of 52,001, 5,200 and 67,601 for
Mr. Spalding, Mr. Moskonas and all executive officers and directors as a
group.
(2) Does not include shares underlying Mr. Ledecky's options described under
"Executive Compensation--1998 Stock Incentive Plan," none of which are
exercisable within the next twelve months.
(3) Mr. Pate has entered into hedging arrangements that place a ceiling and a
floor on the price of certain of his shares of U.S. Office Products common
stock.
(4) Share amounts were determined by the Company from sources the Company
believes to be reliable.
55
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On April 29, 1996, U.S. Office Products acquired Old School in a business
combination accounted for under the pooling-of-interests method in which 576,923
shares (as adjusted for a one for four reverse stock split) of U.S. Office
Products common stock were issued as consideration. Current officers of School
Specialty who received shares of U.S. Office Products common stock in the
transaction include Daniel P. Spalding (77,441 shares as adjusted), and an
additional 7,504 shares (as adjusted) through an IRA for his benefit), Michael
J. Killoren (6,754 shares as adjusted), and Donald J. Noskowiak (6,754 shares as
adjusted). In addition, John S. Spalding (Daniel P. Spalding's father) received
162 shares (as adjusted) and an additional 15,008 shares (as adjusted) through
an IRA for his benefit, the Patricia M. Spalding Revocable Trust received 17,731
shares (as adjusted), Joanne Lee Killoren received 15,076 shares (as adjusted),
Donald Killoren (Michael J. Killoren's father) received 15,194 shares (as
adjusted) and Leo C. McKenna received 69,501 shares (as adjusted). The other
parties to the foregoing transactions had no relationship to the Company or U.S.
Office Products Company at the time such transactions were entered into, and
accordingly, the Company believes that these transactions were as favorable as
could be negotiated with third parties.
U.S. Office Products acquired Re-Print on July 26, 1996 in a business
combination accounted for under the pooling-of-interests method in which it
issued 487,500 shares (as adjusted) of U.S. Office Products common stock as
consideration. In that transaction, Donald Ray Pate, Jr., President of Re-Print,
received 269,007 shares (as adjusted) of U.S. Office Products common stock for
his interest in Re-Print. Other shareholders related to Mr. Pate who received
shares of U.S. Office Products common stock in the merger were Celita Pate
Carmichael (7,560 shares as adjusted), Phillip S. Pate (21,338 shares as
adjusted), Richard K. Pate (18,480 shares as adjusted), and Mary K. Pate (29,126
shares as adjusted). The other parties to the foregoing transactions had no
relationship to the Company or U.S. Office Products Company at the time such
transactions were entered into, and accordingly, the Company believes that these
transactions were as favorable as could be negotiated with third parties.
On March 20, 1998, School Specialty acquired substantially all of the assets
of the catalog division of Education Access, Inc., a debtor in possession under
Chapter 11 of the United States Bankruptcy Code. In this transaction, the
secured creditors of Education Access received all of the consideration paid by
School Specialty. Lillian R. Kellogg, President of School Specialty's Education
Access Division, owns approximately 40% of the capital stock of Education
Access. This transaction was the subject of arm's length negotiation between
School Specialty and the secured creditors of Education Access, Inc.
School Specialty's main office and warehouse facility, a 120,000 square foot
building located in Appleton, Wisconsin, is leased from Bluemound Corporation.
John S. Spalding, a former member of the Board of Old School and the father of
Daniel P. Spalding, Chairman of the Board and Chief Executive Officer of School
Specialty, holds a one-third stake in Bluemound. Donald Killoren, father of
Michael J. Killoren, an officer of School Specialty, also holds a one-third
stake in Bluemound. The lease provides for annual payments of $196,000 through
December 31, 2001. The Company believes that this transaction was as favorable
as could be negotiated with third parties.
For a discussion of transactions between the Company and Mr. Ledecky, see
"Item 11--Executive Compensation."
56
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS, EXHIBITS AND SCHEDULES
1. FINANCIAL STATEMENTS (See Item 8 hereof.)
2. FINANCIAL STATEMENT SCHEDULES (See Item 8 hereof.)
3. EXHIBITS
NUMBER DESCRIPTION
- ----------- -------------------------------------------------------------------------------------------------------
3.1* Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1* Distribution Agreement among U.S. Office Products Company, Workflow Management, Inc., Aztec Consulting,
Inc., Navigant International, Inc., and School Specialty, Inc.
10.2* Tax Allocation Agreement among U.S. Office Products Company, Workflow Management, Inc., Aztec
Technology Partners, Inc., Navigant International, Inc., and School Specialty, Inc.
10.3* Tax Indemnification Agreement among Workflow Management, Inc., Aztec Technology Partners, Inc.,
Navigant International, Inc., and School Specialty, Inc.
10.4* Employee Benefits Agreement among Workflow Management, Inc., Aztec Technology Partners, Inc., Navigant
International, Inc., and School Specialty, Inc.
10.5* Employment Agreement dated April 29, 1996, between Daniel P. Spalding and School Specialty, Inc.
10.6* Employment Agreement dated July 26, 1996, between Donald Ray Pate, Jr. and The Re-Print Corp.
10.7* Employment Agreement dated June 27, 1997, between Richard H. Nagel and Sax Arts & Crafts, Inc.
10.8 Employment Agreement between David Vander Zanden and School Specialty, Inc.
10.9 Employment Agreement between School Specialty, Inc. and Jonathan J. Ledecky
10.10* Amended Services Agreement dated as of June 8, 1998 between U.S. Office Products and Jonathan J.
Ledecky
10.11 1998 Stock Incentive Plan
10.12 Credit Agreement dated as of June 9, 1998 among School Specialty, Inc., the lenders named therein and
Nationsbank, N.A.
10.13** Asset Purchase Agreement dated as of June 10, 1998 by and among School Specialty, Inc., Hammond and
Stephens Co. and Roger D. Pannier and Pamela S. Pannier
21* Subsidiaries of Registrant
27 Financial data schedule
99.1 Schedule II--Valuation and Qualifying Accounts
- ------------------------
* Incorporated by reference herein from School Specialty's Registration
Statement on Form S-1 initially filed with the Securities and Exchange
Commission on February 19, 1996, as amended (File No. 333-46357).
** Incorporated by reference herein from School Specialty's Current Report on
Form 8-K filed July 15, 1998.
(b) REPORTS ON FORM 8-K. During the last quarter of the fiscal year covered by
this report, the Company filed no Current Reports on Form 8-K.
57
SIGNATURES
Pursuant to the requirements Section 13 or 15(d) 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, in the City of Appleton,
Wisconsin on July 24, 1998.
SCHOOL SPECIALTY, INC.
BY: /S/ DANIEL P. SPALDING
-----------------------------------------
Name: Daniel P. Spalding
TITLE: CHAIRMAN OF THE BOARD AND CHIEF
EXECUTIVE OFFICER
Each person whose signature appears below hereby appoints Daniel P. Spalding
and Donald J. Noskowiak, and both of them either of whom may act without the
joinder of the other, as his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K, and to file the same, with all exhibits thereto and
all other documents in connection therewith, with the Commission, granting unto
said attorneys-in-fact and agents full power and authority to perform each and
every act and thing appropriate or necessary to be done, as fully and for all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
- ------------------------------ --------------------------- ---------------
/s/ DANIEL P. SPALDING
- ------------------------------
Daniel P. Spalding Chairman of the Board, July 22, 1998
Chief Executive Officer and
Director (Principal
Executive Officer)
/s/ DAVID J. VANDER ZANDEN
- ------------------------------
David J. Vander Zanden Director July 23, 1998
/s/ DONALD J. NOSKOWIAK
- ------------------------------
Donald J. Noskowiak Executive Vice President July 22, 1998
and Chief Financial Officer
(Principal Financial
Officer and Principal
Accounting Officer)
/s/ JONATHAN J. LEDECKY
- ------------------------------
Jonathan J. Ledecky Director July 24, 1998
/s/ LEO C. MCKENNA
- ------------------------------
Leo C. McKenna Director July 23, 1998
/s/ ROCHELLE LAMM WALLACH
- ------------------------------
Rochelle Lamm Wallach Director July 23, 1998
58
INDEX TO EXHIBITS
NUMBER DESCRIPTION
- ----------- -------------------------------------------------------------------------------------------------------
3.1* Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1* Distribution Agreement among U.S. Office Products Company, Workflow Management, Inc., Aztec Consulting,
Inc., Navigant International, Inc., and School Specialty, Inc.
10.2* Tax Allocation Agreement among U.S. Office Products Company, Workflow Management, Inc., Aztec
Technology Partners, Inc., Navigant International, Inc., and School Specialty, Inc.
10.3* Tax Indemnification Agreement among Workflow Management, Inc., Aztec Technology Partners, Inc.,
Navigant International, Inc., and School Specialty, Inc.
10.4* Employee Benefits Agreement among Workflow Management, Inc., Aztec Technology Partners, Inc., Navigant
International, Inc., and School Specialty, Inc.
10.5* Employment Agreement dated April 29, 1996, between Daniel P. Spalding and School Specialty, Inc.
10.6* Employment Agreement dated July 26, 1996, between Donald Ray Pate, Jr. and The Re-Print Corp.
10.7* Employment Agreement dated June 27, 1997, between Richard H. Nagel and Sax Arts & Crafts, Inc.
10.8 Employment Agreement between David Vander Zanden and School Specialty, Inc.
10.9 Employment Agreement between School Specialty, Inc. and Jonathan J. Ledecky
10.10* Amended Services Agreement dated as of June 8, 1998 between U.S. Office Products and Jonathan J.
Ledecky
10.11 1998 Stock Incentive Plan
10.12 Credit Agreement dated as of June 9, 1998 among School Specialty, Inc., the lenders named therein and
Nationsbank, N.A.
10.13* Asset Purchase Agreement dated as of June 10, 1998 by and among School Specialty, Inc., Hammond and
Stephens Co. and Roger D. Pannier and Pamela S. Pannier
21* Subsidiaries of Registrant
27 Financial data schedule
99.1 Schedule II - Valuation and Qualifying Accounts
- ------------------------
* Incorporated by reference herein from School Specialty's Registration
Statement on Form S-1 initially filed with the Securities and Exchange
Commission on February 19, 1996, as amended (File No. 333-46357).
** Incorporated by reference herein from School Specialty's Current Report on
Form 8-K filed July 15, 1998.
59