Attached files
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED OCTOBER 23, 2010
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO |
Commission File Number: 000-24385
SCHOOL SPECIALTY, INC.
(Exact Name of Registrant as Specified in its Charter)
Wisconsin | 39-0971239 | |
(State or Other Jurisdiction of Incorporation) |
(IRS Employer Identification No.) |
W6316 Design Drive
Greenville, Wisconsin 54942
(Address of Principal Executive Offices)
(Zip Code)
(920) 734-5712
(Registrants Telephone Number, including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
Outstanding at December 1, 2010 | |
Common Stock, $0.001 par value |
18,870,135 |
Table of Contents
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED OCTOBER 23, 2010
-Index-
Table of Contents
PART I FINANCIAL INFORMATION
ITEM 1. | Condensed Consolidated Unaudited Financial Statements |
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In Thousands, Except Share Data)
October 23, 2010 |
April 24, 2010 |
October 24, 2009 |
||||||||||
(unaudited) | (unaudited) | |||||||||||
ASSETS |
||||||||||||
Current assets: |
||||||||||||
Cash and cash equivalents |
$ | 8,105 | $ | 21,035 | $ | 8,836 | ||||||
Accounts receivable, less allowance for doubtful accounts of $3,175, $2,104 and $4,657, respectively |
147,057 | 72,734 | 192,633 | |||||||||
Inventories |
75,190 | 99,910 | 109,784 | |||||||||
Deferred catalog costs |
7,997 | 13,593 | 5,843 | |||||||||
Prepaid expenses and other current assets |
16,099 | 14,318 | 13,651 | |||||||||
Refundable income taxes |
| 1,539 | | |||||||||
Deferred taxes |
9,866 | 9,867 | 9,805 | |||||||||
Total current assets |
264,314 | 232,996 | 340,552 | |||||||||
Property, plant and equipment, net |
64,259 | 66,607 | 68,331 | |||||||||
Goodwill |
127,146 | 540,248 | 545,222 | |||||||||
Intangible assets, net |
160,852 | 166,552 | 170,154 | |||||||||
Development costs and other |
33,321 | 33,118 | 28,760 | |||||||||
Investment in unconsolidated affiliate |
28,080 | 28,299 | | |||||||||
Total assets |
$ | 677,972 | $ | 1,067,820 | $ | 1,153,019 | ||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
Current liabilities: |
||||||||||||
Current maturities - long-term debt |
$ | 849 | $ | 132,397 | $ | 129,663 | ||||||
Accounts payable |
81,412 | 47,954 | 40,315 | |||||||||
Accrued compensation |
8,567 | 7,501 | 12,953 | |||||||||
Deferred revenue |
4,895 | 4,312 | 4,579 | |||||||||
Accrued income taxes |
29,103 | | 21,380 | |||||||||
Other accrued liabilities |
33,567 | 30,905 | 38,788 | |||||||||
Total current liabilities |
158,393 | 223,069 | 247,678 | |||||||||
Long-term debt - less current maturities |
266,471 | 199,742 | 230,658 | |||||||||
Deferred taxes |
15,252 | 92,398 | 93,896 | |||||||||
Other liabilities |
1,423 | 1,423 | 913 | |||||||||
Total liabilities |
441,539 | 516,632 | 573,145 | |||||||||
Commitments and contingencies |
||||||||||||
Shareholders equity: |
||||||||||||
Preferred stock, $0.001 par value per share, 1,000,000 shares authorized; none outstanding |
| | | |||||||||
Common stock, $0.001 par value per share, 150,000,000 shares authorized; 24,290,345; 24,280,097 and 24,265,678 shares issued, respectively |
24 | 24 | 24 | |||||||||
Capital paid-in excess of par value |
437,943 | 436,959 | 436,923 | |||||||||
Treasury stock, at cost 5,420,210; 5,420,210 and 5,420,210 shares, respectively |
(186,637 | ) | (186,637 | ) | (186,637 | ) | ||||||
Accumulated other comprehensive income |
21,839 | 24,052 | 20,599 | |||||||||
(Accumulated deficit)/retained earnings |
(36,736 | ) | 276,790 | 308,965 | ||||||||
Total shareholders equity |
236,433 | 551,188 | 579,874 | |||||||||
Total liabilities and shareholders equity |
$ | 677,972 | $ | 1,067,820 | $ | 1,153,019 | ||||||
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Amounts)
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Revenue |
$ | 291,879 | $ | 346,146 | $ | 544,863 | $ | 676,513 | ||||||||
Cost of revenue |
174,357 | 203,041 | 319,269 | 390,617 | ||||||||||||
Gross profit |
117,522 | 143,105 | 225,594 | 285,896 | ||||||||||||
Selling, general and administrative expenses |
79,318 | 86,445 | 157,166 | 174,697 | ||||||||||||
Impairment Charge |
| | 411,390 | | ||||||||||||
Operating income/(loss) |
38,204 | 56,660 | (342,962 | ) | 111,199 | |||||||||||
Other (income) expense: |
||||||||||||||||
Interest expense |
6,747 | 7,739 | 14,876 | 15,298 | ||||||||||||
Interest income |
| | | (10 | ) | |||||||||||
Income/(Loss) before provision for income taxes |
31,457 | 48,921 | (357,838 | ) | 95,911 | |||||||||||
Provision for (benefit from) income taxes |
13,222 | 19,324 | (44,447 | ) | 37,885 | |||||||||||
income/(loss) before investment in unconsolidated affiliate |
$ | 18,235 | $ | 29,597 | $ | (313,391 | ) | $ | 58,026 | |||||||
Equity in (losses) of unconsolidated affiliate |
(135 | ) | | (135 | ) | | ||||||||||
Net income/(loss) |
$ | 18,100 | $ | 29,597 | $ | (313,526 | ) | $ | 58,026 | |||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
18,870 | 18,837 | 18,867 | 18,833 | ||||||||||||
Diluted |
18,873 | 18,911 | 18,867 | 18,892 | ||||||||||||
Net Income/(Loss) per Share: |
||||||||||||||||
Basic |
$ | 0.96 | $ | 1.57 | $ | (16.62 | ) | $ | 3.08 | |||||||
Diluted |
$ | 0.96 | $ | 1.57 | $ | (16.62 | ) | $ | 3.07 |
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
For the Six Months Ended | ||||||||
October 23, 2010 |
October 24, 2009 |
|||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | (313,526 | ) | $ | 58,026 | |||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and intangible asset amortization expense |
13,869 | 13,196 | ||||||
Amortization of development costs |
2,931 | 3,514 | ||||||
Amortization of debt fees and other |
1,118 | 1,055 | ||||||
Impairment charge |
411,390 | | ||||||
Investment in unconsolidated affiliate |
135 | | ||||||
Share-based compensation expense |
1,443 | 2,159 | ||||||
Deferred taxes |
(77,606 | ) | 7,452 | |||||
Loss (gain) on disposal of property, plant and equipment |
| 275 | ||||||
Non-cash convertible debt deferred financing costs |
5,542 | 6,398 | ||||||
Changes in current assets and liabilities (net of assets acquired and liabilities assumed in business combinations): |
||||||||
Accounts receivable |
(74,064 | ) | (86,610 | ) | ||||
Inventories |
24,718 | 17,653 | ||||||
Deferred catalog costs |
5,596 | 9,694 | ||||||
Prepaid expenses and other current assets |
(243 | ) | 3,967 | |||||
Accounts payable |
33,051 | (17,190 | ) | |||||
Accrued liabilities |
33,248 | 25,189 | ||||||
Net cash provided by operating activities |
67,602 | 44,778 | ||||||
Cash flows from investing activities: |
||||||||
Cash paid in acquisitions, net of cash acquired |
| (11,700 | ) | |||||
Additions to property, plant and equipment |
(5,917 | ) | (6,364 | ) | ||||
Proceeds from disposal of discontinued operations |
| 500 | ||||||
Investment in product development costs |
(4,254 | ) | (4,436 | ) | ||||
Proceeds from disposal of property, plant and equipment |
| 2,083 | ||||||
Net cash used in investing activities |
(10,171 | ) | (19,917 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from bank borrowings |
449,400 | 283,700 | ||||||
Repayment of debt and capital leases |
(386,761 | ) | (301,433 | ) | ||||
Redemption of convertible debt |
(133,000 | ) | | |||||
Payment of debt and other |
| (238 | ) | |||||
Proceeds from exercise of stock options |
| 75 | ||||||
Net cash used in financing activities |
(70,361 | ) | (17,896 | ) | ||||
Net (decrease)/increase in cash and cash equivalents |
(12,930 | ) | 6,965 | |||||
Cash and cash equivalents, beginning of period |
21,035 | 1,871 | ||||||
Cash and cash equivalents, end of period |
$ | 8,105 | $ | 8,836 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Interest paid |
$ | 8,600 | $ | 8,327 | ||||
Income taxes paid |
$ | 2,370 | $ | 7,681 |
See accompanying notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature) considered necessary for a fair presentation have been included. The balance sheet at April 24, 2010 has been derived from the Companys audited financial statements for the fiscal year ended April 24, 2010. For further information, refer to the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended April 24, 2010.
During the first quarter of fiscal 2011, the Company determined that goodwill and certain indefinite lived assets were impaired at three of the Companys reporting units. Following the completion of the impairment assessment, the Company recorded pre-tax non-cash impairment charges of $411,390 in the first quarter of fiscal 2011. These charges were based on current projections and valuation assumptions that reflect the Companys belief that the current macro-economic environment and state budget crisis have decreased school funding more than anticipated. See Note 7 of the Notes to Condensed Consolidated Financial Statements for additional information regarding the non-cash impairment charges.
NOTE 2 RECENT ACCOUNTING PRONOUNCEMENTS
In January 2010, the FASB issued Accounting Standard Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures, FASB ASC Topic 820. The purpose of ASU No. 2010-06 was to provide for more robust disclosures about the different classes of assets and liabilities measured at fair value, the valuation techniques and inputs used, the activity in Level 3 fair value measurements and the transfers between Level 1, 2, and 3. ASU No. 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. ASU No. 2010-06 is not expected to have a material impact on the Companys financial position, results of operations or cash flows.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 3 INCOME TAXES
The Company files income tax returns with the U.S., various U.S. states, and foreign jurisdictions. The most significant tax return the Company files is with the U.S. The Companys tax returns are no longer subject to examination by the U.S. for fiscal years before 2007. The Company has various state tax audits and appeals in process at any given time. It is not anticipated that any adjustments resulting from tax examinations or appeals would result in a material change to the Companys financial position or results of operations.
The balance of the Companys liability for unrecognized income tax benefits, net of federal tax benefits, at October 23, 2010, April 24, 2010 and October 24, 2009, was $1,423, $1,423 and $913, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any other material changes in the amount of unrecognized tax benefits within the next twelve months. The Company classifies accrued interest and penalties related to unrecognized tax benefits as income tax expense in its consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.
NOTE 4 SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
Changes in condensed consolidated shareholders equity during the six months ended October 23, 2010 and October 24, 2009 were as follows:
Shareholders equity balance at April 24, 2010. |
$ | 551,188 | ||
Net loss |
(313,526 | ) | ||
Share-based compensation |
1,443 | |||
Income tax deficiency from stock options |
(459 | ) | ||
Foreign currency translation adjustment |
(2,213 | ) | ||
Shareholders equity balance at October 23, 2010 |
$ | 236,433 | ||
Shareholders equity balance at April 25, 2009 |
$ | 510,279 | ||
Net income |
58,026 | |||
Share-based compensation |
2,159 | |||
Issuance of common stock in conjunction with stock option exercises |
75 | |||
Income tax deficiency from stock options |
(337 | ) | ||
Taxes payable on net settlement of stock options |
(123 | ) | ||
Foreign currency translation adjustment |
9,795 | |||
Shareholders equity balance at October 24, 2009 |
$ | 579,874 | ||
Comprehensive income/ (loss) for the periods presented in the condensed consolidated statement of operations was as follows:
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Net income/(loss) |
$ | 18,100 | $ | 29,597 | $ | (313,526 | ) | $ | 58,026 | |||||||
Foreign currency translation adjustment |
726 | 2,814 | (2,213 | ) | 9,795 | |||||||||||
Total comprehensive income/(loss) |
$ | 18,826 | $ | 32,411 | $ | (315,739 | ) | $ | 67,821 | |||||||
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 5 EARNINGS PER SHARE
Earnings Per Share
The following information presents the Companys computations of basic earnings per share (basic EPS) and diluted earnings per share (diluted EPS) for the periods presented in the condensed consolidated statements of operations:
Income (Numerator) |
Shares (Denominator) |
Per Share Amount |
||||||||||
Three months ended October 23, 2010: |
||||||||||||
Basic EPS |
$ | 18,100 | 18,870 | $ | 0.96 | |||||||
Effect of dilutive stock options |
| | ||||||||||
Effect of non-vested stock units |
| 3 | ||||||||||
Diluted EPS |
$ | 18,100 | 18,873 | $ | 0.96 | |||||||
Three months ended October 24, 2009: |
||||||||||||
Basic EPS |
$ | 29,597 | 18,837 | $ | 1.57 | |||||||
Effect of dilutive stock options |
| 29 | ||||||||||
Effect of non-vested stock units |
| 45 | ||||||||||
Diluted EPS |
$ | 29,597 | 18,911 | $ | 1.57 | |||||||
Income (Numerator) |
Shares (Denominator) |
Per Share Amount |
||||||||||
Six months ended October 23, 2010: |
||||||||||||
Basic and diluted EPS |
$ | (313,526 | ) | 18,867 | $ | (16.62 | ) | |||||
Six months ended October 24, 2009: |
||||||||||||
Basic EPS |
$ | 58,026 | 18,833 | $ | 3.08 | |||||||
Effect of dilutive stock options |
| 18 | ||||||||||
Effect of non-vested stock units |
| 41 | ||||||||||
Diluted EPS |
$ | 58,026 | 18,892 | $ | 3.07 | |||||||
The Company had additional stock options outstanding of 1,578 and 1,526 during the three and six months ended October 23, 2010, respectively, that were not included in the computation of diluted EPS because they were anti-dilutive. The Company had additional stock options outstanding of 1,602 and 1,559 during the three and six months ended October 24, 2009, that were not included in the computation of diluted EPS because they were anti-dilutive.
The $200,000, 3.75% convertible subordinated notes have no current impact on the Companys denominator for computing diluted EPS because conditions under which the notes may be converted have not been satisfied. See Note 10.
NOTE 6 SHARE-BASED COMPENSATION EXPENSE
Employee Stock Plans
The Company has three share-based employee compensation plans under which awards were outstanding as of October 23, 2010. On June 10, 1998, the Companys Board of Directors approved the School Specialty, Inc. 1998 Stock Incentive Plan (the 1998 Plan), on August 27, 2002 the Companys Board of Directors approved the School Specialty, Inc. 2002 Stock Incentive Plan (the 2002 Plan), and on June 24, 2008, the Companys Board of Directors approved the School Specialty, Inc. 2008 Equity Incentive Plan (the 2008 Plan). All plans have been approved by the Companys shareholders. The purpose of the 1998 Plan, the 2002 Plan and the 2008 Plan is to provide directors, officers, key employees and consultants with additional incentives by increasing their ownership interests in the Company. No new grants may be made under the 1998 Plan, which expired on June 8, 2008. Under the 2002 Plan, the maximum number of equity awards available for grant is 1,500 shares. Under the 2008 Plan, the maximum number of equity awards available for grant is 2,000 shares.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
A summary of option activity during the six months ended October 23, 2010 follows:
Options Outstanding | Options Exercisable | |||||||||||||||
Options | Weighted- Average Exercise Price |
Options | Weighted- Average Exercise Price |
|||||||||||||
Balance at April 24, 2010 |
1,465 | $ | 31.35 | 957 | $ | 34.02 | ||||||||||
Granted |
247 | 19.04 | ||||||||||||||
Exercised |
(15 | ) | 16.06 | |||||||||||||
Canceled |
(141 | ) | 32.15 | |||||||||||||
Balance at October 23, 2010 |
1,556 | $ | 29.47 | 958 | $ | 33.24 | ||||||||||
The following table details supplemental information regarding stock options outstanding at October 23, 2010:
Weighted Average Remaining Contractual Term |
Aggregate Intrinsic Value |
|||||
Options outstanding |
6.45 years | $ | | |||
Options vested and expected to vest |
6.38 years | | ||||
Options exercisable |
5.11 years | |
Options Outstanding | Options Exercisable | |||||||||||||||||||
Range of Exercise Prices |
Shares Underlying Options |
Weighted- Average Life (Years) |
Weighted- Average Exercise Price |
Shares Underlying Options |
Weighted- Average Exercise Price |
|||||||||||||||
$16.06 - $19.19 |
277 | 9.36 | $ | 18.94 | 12 | $ | 18.26 | |||||||||||||
$19.20 - $29.48 |
419 | 6.20 | 22.54 | 222 | 23.78 | |||||||||||||||
$29.49 - $36.01 |
325 | 5.68 | 33.28 | 261 | 33.62 | |||||||||||||||
$36.02 - 39.71 |
535 | 5.61 | 38.04 | 463 | 37.94 | |||||||||||||||
1,556 | 6.45 | $ | 29.47 | 958 | $ | 33.24 | ||||||||||||||
Options are generally exercisable beginning one year from the date of grant in cumulative yearly amounts of twenty-five percent of the shares granted and generally expire ten years from the date of grant. Options granted to directors and non-employee officers of the Company vest over a three year period, twenty percent after the first year, fifty percent (cumulative) after the second year and one hundred percent (cumulative) after the third year. Prior to fiscal 2009, the Company issued new shares of common stock to settle shares due upon option exercise. In fiscal 2009, the Companys option plans were amended to allow for the net settlement of the exercise price and related employee tax withholding liabilities for non-qualified stock option exercises. For the six months ended October 23, 2010, approximately 3 new shares were issued upon the exercise of stock options, 12 shares were tendered to satisfy the exercise price, and zero shares were surrendered to satisfy employee tax liabilities.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
During the first six months of each of fiscal 2011 and fiscal 2010, the Company granted 77 and 78 non-vested stock unit (NSU) awards to members of the Companys management under the 2002 Plan. The NSUs are performance-based awards that vest at the end of a three-year cycle and will result in the issuance of shares of the Companys common stock if targeted metrics are achieved at a threshold level or above. The NSUs will be settled in shares of Company common stock with actual shares awarded ranging from 80% to 200% of the target number of shares based on actual performance. The awards granted in fiscal 2011 and fiscal 2010 are subject to a one-year performance metric and three-year vesting period. Company performance was at 88% of the target for the fiscal 2010 awards and the associated expense related to the fiscal 2010 award has been adjusted to 88%, accordingly, and will be recognized over the vesting period which is three years of service from the date of grant. The vesting date for the fiscal 2010 NSU awards will occur on June 22, 2012. The approximate fair value of awards granted during the six months ended October 23, 2010 and October 24, 2009 is $1,468 and $1,590, respectively, provided the metrics are achieved at the target level. The Company is recognizing share-based compensation expense related to performance-based NSU awards on a straight-line basis over the vesting period adjusted for changes in the expected level of performance. During the three months ended October 23, 2010, the Company recognized income of $36 ($22, net of tax) due to forfeitures within the quarter, and during the three months ended October 24, 2009, the Company recognized income of $131 ($80 net of tax) related to performance-based NSU awards due to changes in estimated performance levels. During the six months ended October 23, 2010 and October 24, 2009, the Company recognized expense of $172 ($106, net of tax) and $112 ($69, net of tax), respectively, related to performance-based NSU awards.
During the first six months of fiscal 2011 and 2010, the Company granted 10 and 7 time-based NSU awards to independent members of the Companys Board of Directors with an approximate fair value of $194 and $146, respectively. The awards vest one year from the date of grant and the Company is recognizing share-based compensation expense related to these awards on a straight-line basis over the vesting period. During the three months ended October 23, 2010 and October 24, 2009, the Company recognized $48 ($29, net of tax) and $36 ($22, net of tax), respectively, of expense related to these awards. During the six months ended October 23, 2010 and October 24, 2009, the Company recognized $86 ($53, net of tax) and $82 ($51, net of tax), respectively, of expense related to these awards.
During the first six months of fiscal 2011, the Company awarded 118 time-based restricted stock units (RSU) to employees of the Company under the 2008 Plan. The RSUs awarded to senior management vest in cumulative increments of thirty percent after the third year from the date of grant, sixty percent after the fourth year and one-hundred percent after the fifth year. The RSUs awarded to other employees vest in cumulative increments of thirty percent after the second year from the date of grant, sixty percent after the third year and one-hundred percent after the fourth year. The approximate fair value of the awards granted during the six months ended October 23, 2010 was $2,250. During the three months and six months ended October 23, 2010, the Company recognized $89 ($53 net of tax) and $117 ($72 net of tax), respectively, of expense related to time-based RSU awards.
During each of the three months ended October 23, 2010 and October 24, 2009, the Company recognized $616 ($515 related to stock options, $12 of expense related to NSU awards, and $89 related to RSU awards) and $885 ($980 related to stock options, net of $95 of income related to NSU awards), respectively, in share-based compensation expense, which is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations. The income tax benefit recognized related to share-based compensation expense was $239 and $344 for the three months ended October 23, 2010 and October 24, 2009, respectively.
During the six months ended October 23, 2010 and October 24, 2009, the Company recognized $1,443 ($1,068 related to stock options, $258 related to NSU awards, and $117 related to RSU awards) and $2,159 ($1,964 related to stock options and $195 related to NSU awards), respectively, in share-based compensation expense, which is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations. The income tax benefit recognized related to share-based compensation expense was $560 and $846 for the six months ended October 23, 2010 and October 24, 2009, respectively. The Company recognizes share-based compensation expense ratably over the vesting period of each award along with cumulative adjustments for changes in the expected level of attainment for performance-based awards.
During the six months ended October 23, 2010 and October 24, 2009, total unrecognized share-based compensation expense related to stock options was $3,878 and $5,685, respectively, net of estimated forfeitures, total unrecognized share-based compensation expense related to NSUs was $994 and $1,404, respectively, and total unrecognized share-based compensation expense related to RSUs was $1,605 and zero, respectively, which the Company expects to recognize over a weighted average period of approximately 2.5 years.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
There were no options granted during either of the three months ended October 23, 2010 or October 24, 2009. The weighted average fair value of options granted during the six months ended October 23, 2010 and October 24, 2009 was $6.78 and $7.26, respectively. The fair value of options is estimated on the date of grant using the Black-Scholes single option pricing model with the following weighted average assumptions:
For the Six Months Ended | ||||||||
October 23, 2010 |
October 24, 2009 |
|||||||
Average-risk free interest rate |
2.00 | % | 2.89 | % | ||||
Expected volatility |
34.97 | % | 33.11 | % | ||||
Expected term |
5.5 years | 5.5 years |
For the Three Months Ended | For the Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Total intrinsic value of stock options exercised |
$ | | $ | 373 | $ | 61 | $ | 407 | ||||||||
Cash received from stock option exercises |
$ | | $ | | 0 | $ | 75 | |||||||||
Income tax deficiency from stock option/NSU activity |
$ | (187 | ) | $ | (40 | ) | $ | (459 | ) | $ | (337 | ) |
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 7 GOODWILL AND OTHER INTANGIBLE ASSETS
The following tables present details of the Companys intangible assets, excluding goodwill:
October 23, 2010 |
Gross Value | Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10 to 17 years) |
$ | 36,516 | $ | (19,311 | ) | $ | 17,205 | |||||
Publishing rights (15 to 25 years) |
113,260 | (26,004 | ) | 87,256 | ||||||||
Non-compete agreements (3.5 to 10 years) |
7,110 | (6,240 | ) | 870 | ||||||||
Tradenames and trademarks (10 to 30 years) |
3,504 | (946 | ) | 2,558 | ||||||||
Order backlog and other (less than 1 to 13 years) |
2,634 | (1,691 | ) | 943 | ||||||||
License agreement (10 years) |
14,506 | (2,606 | ) | 11,900 | ||||||||
Total amortizable intangible assets |
177,530 | (56,798 | ) | 120,732 | ||||||||
Non-amortizable intangible assets: |
||||||||||||
Tradenames and trademarks |
40,120 | | 40,120 | |||||||||
Total non-amortizable intangible assets |
40,120 | | 40,120 | |||||||||
Total intangible assets |
$ | 217,650 | $ | (56,798 | ) | $ | 160,852 | |||||
April 24, 2010 |
Gross Value | Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10 to 17 years) |
$ | 36,568 | $ | (18,121 | ) | $ | 18,447 | |||||
Publishing rights (15 to 25 years) |
113,260 | (23,211 | ) | 90,049 | ||||||||
Non-compete agreements (3.5 to 10 years) |
7,110 | (5,877 | ) | 1,233 | ||||||||
Tradenames and trademarks (10 to 30 years) |
3,504 | (850 | ) | 2,654 | ||||||||
Order backlog and other (less than 1 to 13 years) |
2,634 | (1,576 | ) | 1,058 | ||||||||
Perpetual license agreements (10 years) |
14,506 | (1,715 | ) | 12,791 | ||||||||
Total amortizable intangible assets |
177,582 | (51,350 | ) | 126,232 | ||||||||
Non-amortizable intangible assets: |
||||||||||||
Tradenames and trademarks |
40,320 | | 40,320 | |||||||||
Total non-amortizable intangible assets |
40,320 | | 40,320 | |||||||||
Total intangible assets |
$ | 217,902 | $ | (51,350 | ) | $ | 166,552 | |||||
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
October 24, 2009 |
Gross Value | Accumulated Amortization |
Net Book Value |
|||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (10 to 17 years) |
$ | 36,166 | $ | (16,844 | ) | $ | 19,323 | |||||
Publishing rights (15 to 25 years) |
106,510 | (20,258 | ) | 86,252 | ||||||||
Non-compete agreements (3.5 to 10 years) |
7,111 | (5,449 | ) | 1,662 | ||||||||
Tradenames and trademarks (10 to 30 years) |
3,024 | (750 | ) | 2,274 | ||||||||
Order backlog and other (less than 1 to 13 years) |
9,654 | (1,553 | ) | 8,101 | ||||||||
License agreement (10 years) |
12,700 | (855 | ) | 11,845 | ||||||||
Total amortizable intangible assets |
175,165 | (45,708 | ) | 129,457 | ||||||||
Non-amortizable intangible assets: |
||||||||||||
Tradenames and trademarks |
40,697 | | 40,697 | |||||||||
Total non-amortizable intangible assets |
40,697 | | 40,697 | |||||||||
Total intangible assets |
$ | 215,862 | $ | (45,708 | ) | $ | 170,154 | |||||
Intangible amortization expense included in selling, general and administrative expense for the three months ended October 23, 2010 and October 24, 2009 was $2,703 and $2,423, respectively, and $5,471 and $5,143 for the six months ended October 23, 2010 and October 24, 2009, respectively.
Intangible amortization expense for each of the five succeeding fiscal years and the remainder of fiscal 2011 is estimated to be:
Fiscal 2011 (six months remaining) |
$ | 5,384 | ||
Fiscal 2012 |
10,515 | |||
Fiscal 2013 |
9,940 | |||
Fiscal 2014 |
9,646 | |||
Fiscal 2015 |
9,429 | |||
Fiscal 2016 |
9,238 |
The following information presents changes to goodwill during the period beginning October 24, 2009 through October 23, 2010:
Reporting Units | Reporting Units | |||||||||||||||||||||||||||||||||||||||
(in $000s) | Education Resources |
Califone | Educational Resources Segment |
Science | Planning and Student Development |
Reading | School Specialty Publishing |
Health | Accelerated Learning Segment |
Total | ||||||||||||||||||||||||||||||
Balance at October 24, 2009 |
$ | 249,695 | $ | 14,852 | $ | 264,547 | $ | 75,652 | $ | 179,691 | $ | 17,798 | $ | 7,534 | $ | | $ | 280,675 | $ | 545,222 | ||||||||||||||||||||
Acquisitions |
| | | | | (324 | ) | | | (324 | ) | (324 | ) | |||||||||||||||||||||||||||
Divestitures |
| | | | | | (7,534 | ) | | (7,534 | ) | (7,534 | ) | |||||||||||||||||||||||||||
Currency translation adjustment |
| | | | 2,884 | | | | 2,884 | 2,884 | ||||||||||||||||||||||||||||||
Balance at April 24, 2010 |
$ | 249,695 | $ | 14,852 | $ | 264,547 | $ | 75,652 | $ | 182,575 | $ | 17,474 | $ | | $ | | $ | 275,701 | $ | 540,248 | ||||||||||||||||||||
Currency translation adjustment |
| | | | (1,912 | ) | | | | (1,912 | ) | (1,912 | ) | |||||||||||||||||||||||||||
Impairment losses |
(249,695 | ) | | (249,695 | ) | (55,372 | ) | (106,123 | ) | | | | (161,495 | ) | (411,190 | ) | ||||||||||||||||||||||||
Balance at October 23, 2010 |
$ | | $ | 14,852 | $ | 14,852 | $ | 20,280 | $ | 74,540 | $ | 17,474 | $ | | $ | | $ | 112,294 | $ | 127,146 | ||||||||||||||||||||
In accordance with the accounting guidance on goodwill and other intangible assets, the Company performs its impairment test of goodwill at the reporting unit level and indefinite-lived intangible assets at the unit of account level during the first quarter of each fiscal year, or more frequently if events or circumstances change that would more likely than not reduce the fair value of its reporting units below their carrying values. The following discussion relates to the goodwill impairment test performed during the first quarter of fiscal 2011.
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
According to ASC Topic 350-20-20, a reporting unit is the level at which goodwill impairment is tested. A reporting unit can be an operating segment or one level below an operating segment, also known as a component. ASC Topic 350-20-35-34 states that a component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available for segment management to regularly review the operating results of that component. As of April 24, 2010, the Company had six reporting units, five of which had goodwill balances. The Educational Resources segment consists of the Education Resources and Califone reporting units. The Accelerated Learning segment consists of the Science, Planning and Student Development, Reading, and Health reporting units. The goodwill for each reporting unit is shown in the table above.
The accounting guidance requires a two-step method for determining goodwill impairment. In the first step, the Company determined the fair value of the reporting unit, generally by utilizing a combination of the income approach (weighted 90%) and the market approach (weighted 10%) derived from comparable public companies. The Company believes that each approach has its merits. However, in the instances where we have utilized both approaches, the Company has weighted the income approach more heavily than the market approach because the Company believes that managements assumptions generally provide greater insight into the reporting units fair value. This fair value determination was categorized as level 3 in the fair value hierarchy pursuant to FASB ASC Topic 820, Fair Value Measurements and Disclosures. The estimated fair value of the reporting units was dependent on several significant assumptions, including earnings projections and discount rates.
In performing the impairment assessment, the Company estimated the fair value of its reporting units using the following valuation methods and assumptions:
1. | Income Approach (discounted cash flow analysis) the discounted cash flow (DCF) valuation method requires an estimation of future cash flows of an entity and then discounting those cash flows to their present value using an appropriate discount rate. The discount rate selected should reflect the risks inherent in the projected cash flows. The key inputs and assumptions of the DCF method are the projected cash flows, the terminal value of the reporting units and the discount rate. The growth rates used for the terminal value calculations and the discount rates of the respective reporting units were as follows: |
Terminal Value Growth Rates |
Discount Rate |
|||||||
Education Resources |
2.0 | % | 12.0 | % | ||||
Califone |
2.0 | % | 11.5 | % | ||||
Science |
6.0 | % | 14.5 | % | ||||
Planning and Student Development |
3.0 | % | 11.9 | % | ||||
Reading |
2.0 | % | 13.7 | % | ||||
Health |
2.0 | % | 13.7 | % |
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SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
2. | Market Approach (market multiples) this method begins with the identification of a group of peer companies in the same or similar industries as the company reporting unit being valued. A valuation average multiple is then computed for the peer group based upon a valuation metric. The Company selected a ratio of enterprise value to projected earnings before interest, taxes, depreciation and amortization (EBITDA) and a ratio of enterprise value to projected revenue as appropriate valuation metrics. These two metrics were evenly weighted for the Education Resources, Reading, and Planning and Student Development reporting units. Various operating performance measurements of the reporting unit being valued are then benchmarked against the peer group and a discount rate or premium is applied to reflect favorable or unfavorable comparisons. The resulting multiple is then applied to the reporting unit being valued to arrive at an estimate of its fair value. A control premium is then applied to the equity value. The Company selected 11 companies that were deemed relevant to the Planning and Student Development and Reading reporting units and 10 companies that were deemed relevant to the Education Resources and Califone reporting units under the guideline public company method to provide an indication of value. A control premium was then applied to the enterprise value of the reporting unit. The control premium was established based on a review of transactions over an 18 month period. The resulting multiples and control premiums were as follows: |
EBITDA Multiples |
Revenue Multiples |
Control Premium |
||||||||||
Education Resources |
8.5x | 0.4x | 13.4 | % | ||||||||
Califone |
6.5x | N/A | 13.4 | % | ||||||||
Reading |
7.1x | 2.2x | 17.9 | % | ||||||||
Planning and Student Development |
6.4x | 1.5x | 17.9 | % |
The Company did not use the market approach for the Science reporting unit because of the variability in revenue due to the curriculum adoption schedule. The Company did not use the market approach for the Health reporting unit because of the reporting units lack of financial history.
Based upon the assessment performed in the first quarter of fiscal 2011, the Education Resources, Science and Planning and Student Development reporting units failed step one of the goodwill impairment test, requiring a step two analysis with respect to those reporting units. In step two, the Company allocated the fair value of the reporting units to all of the assets and liabilities of the reporting units, including any unrecognized intangible assets, in a hypothetical calculation to determine the implied fair value of the goodwill. The impairment charge, if any, is measured as the difference between the implied fair value of goodwill and its carrying value.
As a result of this analysis, $411,190 of goodwill was considered impaired during the first quarter of fiscal 2011. Assumptions utilized in the impairment analysis are subject to significant management judgment. Changes in estimates or the application of alternative assumptions could have produced significantly different results. As shown above in the table, the Education Resources reporting unit, which is part of the Educational Resources segment, and the Science and Planning and Student Development reporting units, which are part of the Accelerated Learning segment, were determined to have an impairment of their goodwill balance as of July 24, 2010.
The Company believed the first quarter was the appropriate quarter for conducting its assessment since the Companys business is highly seasonal, with approximately 75% of its revenue and over 100% of its net income occurring in the first two quarters of the fiscal year. The Company has historically had much better insight into the projected annual performance during the first quarter due to the timing of school budgets and ordering by schools and school districts. The fiscal 2011 impairment charge was due in part to the continued deterioration of school spending amid the continuation of state budget challenges and school spending cuts. During the first quarter of fiscal 2011, the Company experienced a significant decline in actual revenue of 23.4% and operating income of 44.6% prior to the impact of the impairment charge. Additionally, the Company has experienced a decline in its market capitalization beginning in fiscal 2009 and which continued into the first quarter of fiscal 2011. As of April 24, 2010, the Companys market capitalization was $463,538, compared to the Companys book value of $551,188 on that date. As of the end of the first quarter ended July 24, 2010, the Companys market capitalization had decreased by an additional $109,461 to $354,077. During the second quarter of fiscal 2011, the Company reviewed both its current market capitalization and future cash flow projections and concluded no evidence of further impairment existed.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
The Company also performed an impairment test of its indefinite-lived intangible assets during the first quarter of fiscal 2011, and concluded that a $200 impairment charge related to a non-amortizable trademark in the Educational Resources segment was necessary. The following table presents a summary of the carrying value of indefinite-lived intangible assets:
Educational Resources |
Accelerated Learning |
Total | ||||||||||
Tradenames |
$ | | $ | 38,890 | $ | 38,890 | ||||||
Trademarks |
1,430 | | 1,430 | |||||||||
Impairment loss |
(200 | ) | | (200 | ) | |||||||
Balance at October 23, 2010: |
$ | 1,230 | $ | 38,890 | $ | 40,120 | ||||||
NOTE 8 INVESTMENT IN UNCONSOLIDATED AFFILIATE
Investment in unconsolidated affiliate is accounted for under the equity method, and consisted of the following as of October 23, 2010:
Percent- Owned |
Equity Method Investment |
|||||||
Carson- Dellosa Publishing, LLC |
35 | % | $ | 28,080 |
On November 13, 2009, the Company completed the divestiture of the School Specialty Publishing business unit to Carson-Dellosa Publishing, LLC, a newly-formed business entity. Under the divestiture agreement, the Company combined its publishing unit net assets with those of Cookie Jar Education, Inc. and received a 35% minority equity interest in Carson-Dellosa Publishing. The fair value of the total contribution was $29,438, including cash of $2,226, which was materially consistent with the book value of the Company net assets contributed.
The 35% investment represents the Companys maximum exposure to loss as a result of the Companys ownership interest. Earnings or losses, net of related income taxes, are reflected in Equity in (losses) earnings of unconsolidated affiliate, net of tax on the Condensed Consolidated Statement of Operations.
NOTE 9 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
October 23, 2010 |
April 24, 2010 |
October 24, 2009 |
||||||||||
Land |
$ | 158 | $ | 158 | $ | 158 | ||||||
Projects in progress |
6,583 | 2,787 | 10,991 | |||||||||
Buildings and leasehold improvements |
29,831 | 29,752 | 30,561 | |||||||||
Furniture, fixtures and other |
110,971 | 108,968 | 95,257 | |||||||||
Machinery and warehouse equipment |
39,579 | 39,397 | 42,543 | |||||||||
Total property, plant and equipment |
187,121 | 181,062 | 179,510 | |||||||||
Less: Accumulated depreciation |
(122,862 | ) | (114,455 | ) | (111,179 | ) | ||||||
Net property, plant and equipment |
$ | 64,259 | $ | 66,607 | $ | 68,331 | ||||||
Depreciation expense for the three months ended October 23, 2010 and October 24, 2009 was $4,178 and $4,011, respectively, and $8,398 and $8,053 for the six months ended October 23, 2010 and October 24, 2009, respectively.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 10 DEBT
On April 23, 2010, the Company entered into a Credit Agreement which replaced the Companys previous Amended and Restated Credit Agreement dated as of February 1, 2006. The Credit Agreement matures on April 23, 2014 and provides for a $350,000 revolving loan and an available $200,000 incremental term loan. Interest accrues at a rate of, at the Companys option, either a Eurodollar rate plus an applicable margin of up to 3.75%, or the lenders base rate plus an applicable margin of up to 2.75%. The Company also pays a commitment fee on the revolving loan of up to 0.50% on unborrowed funds. The Credit Agreement is secured by substantially all of the assets of the Company and contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charge coverage ratio and a limitation on consolidated capital expenditures. The Company was in compliance with these covenants at October 23, 2010. The effective interest rate under the credit facility for the second quarter of fiscal 2011 was 5.18%, which includes amortization of loan origination fees of $213 and commitment fees on unborrowed funds of $255. The revolving loan provides for a letter of credit sub-facility of up to $15,000, under which $2,695 was issued and outstanding as of October 23, 2010. As of October 23, 2010, $63,000 was the outstanding balance on the revolving loan was and reflected as non-currently maturing, long-term debt in the accompanying condensed consolidated balance sheets. No borrowings have been made on the term loan since inception.
The Company closely evaluates its expected ability to remain in compliance with the consolidated total leverage and interest coverage ratios due to the ratios sensitivity to the Companys financial results. The recent economic trends impacting the Companys performance, such as the decline in school funding which had led to a decrease in the Companys revenues and margins, have put pressure on the Companys ability to remain in compliance with these ratios. Based on current forecasts reflected in our most recent guidance, the Company may be unable to maintain compliance with one or both of these financial covenants in the second half of fiscal 2011. The Company may need to work with its lenders to secure a waiver or amend such ratios in the near future. Any amendment or waiver would result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings. The Company believes it will be able to maintain compliance with the financial covenants by working with its lenders, if necessary.
During 2003, the Company sold an aggregate principal amount of $133,000 of convertible subordinated notes due in 2023. The Company used the total net proceeds from the offering of $128,999 to repay a portion of the debt outstanding under the Companys credit facility. All of the notes were repaid during the second quarter of fiscal 2011 using proceeds from the Credit Agreement. The notes carried an annual coupon interest rate of 3.75% until August 1, 2010, at which time the notes provided that they would cease bearing interest and the original principal amount of each note would commence increasing daily by the annual rate of 3.75%. The notes became convertible into shares of the Companys common stock at an initial conversion price of $40.00 per share during fiscal 2006 and were recorded as a current liability. Holders of the notes were entitled to surrender the notes for conversion at any time from October 1, 2005 until July 31, 2023. Holders that exercise their right to convert the notes would have received up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, in shares of Company common stock or cash, at the Companys discretion. No notes were converted into shares of common stock.
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
On November 22, 2006, the Company sold $200,000 of convertible subordinated debentures due 2026. The debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted or the Companys total conversion obligation, and will deliver, at its option, cash or shares of its common stock in respect of the remainder, if any, of its conversion obligation. The initial conversion rate is .0194574 shares per $1 principal amount of debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Companys option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require the Company to repurchase all or some of the debentures.
The estimated fair value of the Companys $200,000 convertible subordinated notes at October 23, 2010 was approximately $197,000, and the carrying value was $190,350. The estimated fair value was determined using Level 2 inputs as described in FASB ASC Topic 820, Fair Value Measurements and Disclosures.
NOTE 11 SEGMENT INFORMATION
The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Companys Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company has determined that it operates in two operating segments, Educational Resources and Accelerated Learning, which also constitute its reportable segments. The Company operates principally in the United States, with limited segment operations in Canada. The Educational Resources segment offers products that include basic classroom supplies and office products, supplemental learning materials, physical education equipment, classroom technology, and furniture. The Accelerated Learning segment is a PreK-12 curriculum-based publisher of proprietary and non-proprietary products in the categories of science, reading and literacy, coordinated school health, and planning and student development. The accounting policies of the segments are the same as those described in Summary of Significant Accounting Policies. Intercompany eliminations represent intercompany sales primarily from our Accelerated Learning segment to our Educational Resources segment, and the resulting profit recognized on such intercompany sales.
Three Months Ended | Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Revenue: |
||||||||||||||||
Educational Resources |
$ | 187,693 | $ | 239,864 | $ | 363,111 | $ | 464,807 | ||||||||
Accelerated Learning |
104,019 | 106,610 | 181,418 | 212,956 | ||||||||||||
Corporate and intercompany eliminations |
167 | (328 | ) | 334 | (1,250 | ) | ||||||||||
Total |
$ | 291,879 | $ | 346,146 | $ | 544,863 | $ | 676,513 | ||||||||
Operating income (loss) and income before provision for income taxes: |
||||||||||||||||
Educational Resources |
$ | 16,468 | $ | 32,760 | $ | (214,026 | ) | $ | 64,265 | |||||||
Accelerated Learning |
30,827 | 31,814 | (110,041 | ) | 63,769 | |||||||||||
Corporate and intercompany eliminations |
(9,091 | ) | (7,914 | ) | (18,895 | ) | (16,835 | ) | ||||||||
Operating income |
38,204 | 56,660 | (342,962 | ) | 111,199 | |||||||||||
Interest expense and other |
6,747 | 7,739 | 14,876 | 15,288 | ||||||||||||
Income before provision for income taxes |
$ | 31,457 | $ | 48,921 | $ | (357,838 | ) | $ | 95,911 | |||||||
16
Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
October 23, 2010 |
October 24, 2009 |
|||||||
Identifiable assets (as of quarter end): |
||||||||
Educational Resources |
$ | 192,412 | $ | 495,644 | ||||
Accelerated Learning |
110,633 | 569,561 | ||||||
Corporate and intercompany eliminations |
374,927 | 87,814 | ||||||
Total |
$ | 677,972 | $ | 1,153,019 | ||||
Three Months Ended | Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Depreciation and amortization of intangible assets and development costs: |
||||||||||||||||
Educational Resources |
$ | 1,697 | $ | 1,815 | $ | 3,470 | $ | 3,580 | ||||||||
Accelerated Learning |
3,885 | 3,989 | 7,913 | 8,494 | ||||||||||||
Corporate |
2,694 | 2,313 | 5,417 | 4,636 | ||||||||||||
Total |
$ | 8,276 | $ | 8,117 | $ | 16,800 | $ | 16,710 | ||||||||
Expenditures for property, plant and equipment, intangible and other assets and development costs: |
||||||||||||||||
Educational Resources |
$ | 284 | $ | 286 | $ | 632 | $ | 1,000 | ||||||||
Accelerated Learning |
2,676 | 9,716 | 5,403 | 11,763 | ||||||||||||
Corporate |
2,620 | 5,626 | 4,136 | 8,005 | ||||||||||||
Total |
$ | 5,580 | $ | 15,628 | $ | 10,171 | $ | 20,768 | ||||||||
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Table of Contents
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)
NOTE 12 COMMITMENTS AND CONTINGENCIES
Various claims and proceedings arising in the normal course of business are pending against the Company. The results of these matters are not expected to have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.
During the fourth quarter of fiscal 2010, the Company determined, based on an ongoing state tax audit, that the Delta Education, LLC (Delta) subsidiary had a liability to the state that survived the Companys acquisition of Delta in fiscal 2006. The Company has estimated the potential exposure for this liability, including interest and net of federal tax benefit, to be a range of $2,300 to $7,600, depending upon the resolution of certain outstanding issues related to the liability. The Companys best estimate of this liability is $4,000, and the Company believes the liability and corresponding operating expense should have been recorded in fiscal 2007. The final determination of the amount of the liability due is not expected to be finalized until later in fiscal 2011, or thereafter. Accordingly, the Company has restated the beginning retained earnings as of April 28, 2007 to reflect this liability. The Company is continuing to negotiate with the state, and it may have claims against various third parties to recover some or all of the amount of the liability.
In addition, the effects of this restatement have impacted the consolidated balance sheet as of April 24, 2010, October 24, 2009 and April 25, 2009 by increasing Other Accrued Liabilities by $6,154, related to the recording of the liability due to the state, increasing Prepaid expenses and other current assets by $2,154, related to the recording of the federal tax benefit to be realized, and decreasing Retained earnings by $4,000.
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Table of Contents
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operation (MD&A)
Overview
School Specialty is an education company that provides innovative and proprietary products, programs, and services to help educators engage and inspire students of all ages and abilities to learn. Through each of our leading brands, we design, develop, and provide preK-12 educators with the latest and very best curriculum, supplemental learning resources and classroom basics. Working in collaboration with educators, we reach beyond the scope of textbooks to help teachers, guidance counselors, and school administrators ensure that every student reaches his or her full potential.
Our business is subject to seasonal fluctuations. Our historical revenues and profitability have been dramatically higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Due to variations in the timing of shipments within this season primarily as a result of changes or delays in school start dates, the Company views a year-over-year comparison of the first six months of the fiscal year to be a more meaningful analysis than year-over-year comparative results for quarterly periods on an individual basis.
During the first six months of fiscal 2011, revenues decreased 19.5% as compared to the first six months of fiscal 2010. The Educational Resources and Accelerated Learning segments experienced revenue declines in the first six months of fiscal 2011 of 21.9% and 14.8%, respectively. The revenue declines in both the Educational Resources and Accelerated Learning segments were attributable primarily to the current macroeconomic conditions and the impact those conditions have had on state budget funding levels. According to the National Bureau of Economic Research, state revenue collection underperformed forecasts during the latest recession. Since approximately 50% of school funding is provided by states, the Company believes the decreased state revenues are adversely affecting school funding and the related spending by schools. The Company believes that the current year may be the bottom of the school spending decline. State revenues, a key component of school funding, are projected to begin to rise in fiscal 2011, according to the National Conference of State Legislatures. Also contributing to the revenue decline in the supplies category within Educational Resources were execution issues in the Companys pricing and bid strategies. Approximately 55% of the revenue decline in Accelerated Learning segment was attributable to the fiscal 2010 divestiture of the School Specialty Publishing (SSP) business unit.
Competitive pressures have resulted in more significant price discounting, especially in the furniture and supply categories. Gross margin decreased 90 basis points to 41.4% for the first six months of fiscal 2011 as compared to 42.3% for the first six months of fiscal 2010. The decreased gross margin was related to unfavorable product mix between both segments and decreased gross margins in our Educational Resources segment due to competitive pricing pressures.
Selling, general and administrative expenses (SG&A) increased 300 basis points as a percent of revenues in the first six months of fiscal 2011 as compared to the first six months of fiscal 2010. The increase in SG&A as a percentage of revenue is due to the fixed cost portion of SG&A being spread over a smaller revenue base. Total SG&A declined by $17.5 million in the first six months of fiscal 2011 as compared to the first six months of fiscal 2010. The Companys current full-time staffing is down approximately 240 individuals as compared to last years second quarter.
We recorded $411.4 million of pre-tax non-cash impairment charges primarily to reduce the carrying value of goodwill of the Education Resources reporting unit, which is part of the Educational Resources segment, and the Science and Planning and Student Development reporting units, which are part of the Accelerated Learning segment. The Company experienced a significant decline in revenue and operating income in the first quarter, as education spending continued to suffer from the ongoing economic downturn. This, coupled with the decline in the Companys market capitalization during the first quarter of fiscal 2011, led to the determination that goodwill and an indefinite-lived tradename were impaired.
Operating (loss) was $(343.0) million in the first six months of fiscal 2011, a decrease of $454.2 million from income of $111.2 million the first six months of the prior year. Net (loss) was ($313.5) million in the first six months of fiscal 2011, a decrease of $371.5 million from income of $58.0 million in the first six months of the prior year.
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Results of Continuing Operations
The following table sets forth various items as a percentage of revenues for the three and six months ended October 23, 2010 and October 24, 2009:
Three Months Ended | Six Months Ended | |||||||||||||||
October 23, 2010 |
October 24, 2009 |
October 23, 2010 |
October 24, 2009 |
|||||||||||||
Revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of revenues |
59.7 | 58.7 | 58.6 | 57.7 | ||||||||||||
Gross profit |
40.3 | 41.3 | 41.4 | 42.3 | ||||||||||||
Selling, general and administrative expenses |
27.2 | 25.0 | 28.8 | 25.8 | ||||||||||||
Impairment Charge |
| | 75.5 | | ||||||||||||
Operating income/(loss) |
13.1 | 16.3 | (62.9 | ) | 16.5 | |||||||||||
Interest expense, net |
2.3 | 2.2 | 2.7 | 2.3 | ||||||||||||
Income/(loss) before provision for income taxes |
10.8 | 14.1 | (65.6 | ) | 14.2 | |||||||||||
Provision for (benefit from) income taxes |
4.6 | 5.6 | (8.1 | ) | 5.6 | |||||||||||
Earnings/(loss) before investment in unconsolidated affiliate |
6.2 | % | 8.5 | % | (57.5 | )% | 8.6 | % | ||||||||
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Three Months Ended October 23, 2010 Compared to Three Months Ended October 24, 2009
Revenue
Revenue decreased 15.7% from $346.1 million for the three months ended October 24, 2009 to $291.9 million for the three months ended October 23, 2010.
Educational Resources segment revenue decreased 21.8% from $239.9 million for the three months ended October 24, 2009 to $187.7 million for the three months ended October 23, 2010. Both periods are comprised solely of sales to external parties. The decrease in Educational Resources segment revenue was comprised of a decline of approximately $20 million in the supplies category and a decline of approximately $30 million in the furniture category. The reduction in the furniture category revenue was primarily related to the continued weakness in school construction activity, and the reduction in the supplies category revenue was a result of the continued reductions in ongoing school funding. In addition, the Companys execution issues with respect to pricing and bid strategy contributed to the revenue decline. The Company has been addressing these issues as it prepares upcoming catalog issuances. However, due to the seasonality of the Companys revenues, assessing the success of new pricing and bid strategies will become more clear as we approach next years back to school season. Additional catalogs will be issued in December and the Company expects to see results from these catalogs in its fourth quarter. Order trends in the furniture category have remained down in the second quarter. The Company expects some improvement in the order rate in the fourth quarter as a new furniture catalog is introduced.
Accelerated Learning segment revenue decreased by 2.4% from $106.6 million for the three months ended October 24, 2009 (which includes $0.5 million of intersegment revenues) to $104.0 million for the three months ended October 23, 2010 (which was comprised solely of sales to external parties). The divestiture of the School Specialty Publishing business unit (SSP) in the second quarter of last year accounted for $6.8 million of revenue decline. The remaining businesses within the segment had revenue growth of $4.2 million or 4.2%. This revenue growth was related to a shift in the timing of orders between the first and second quarters. The Company believes that approximately $10 million of the second quarter revenue was related to a later ordering back-to-school season. Partially offsetting the incremental revenue associated with the later ordering season was a decline in small dollar orders.
Gross Profit
Gross profit decreased 17.9%, from $143.1 million for the three months ended October 24, 2009 to $117.5 million for the three months ended October 23, 2010. The decrease in consolidated revenue resulted in $22.4 million of the decline in gross profit had consolidated gross margin remained constant. Gross margin decreased 100 basis points from 41.3% for the three months ended October 24, 2009 to 40.3% for the three months ended October 23, 2010. The decrease in consolidated gross margin resulted in a decrease in gross profit of $3.2 million. The decrease in gross margin was related to price discounting in response to competitive pressures within the Educational Resources segment. A shift in product mix between the Companys segments accounted for approximately 130 basis points of gross margin increase in the second quarter of fiscal 2011 as compared to the second quarter of fiscal 2010. The Accelerated Learning segment, which generates a higher gross margin due to its curriculum-based products than the Educational Resources segment, accounted for 36% of the consolidated revenue in the second quarter of fiscal 2011 compared to 31% of the consolidated revenue in the second quarter of fiscal 2010.
Educational Resources segment gross profit decreased $24.0 million from $82.8 million for the three months ended October 24, 2009 to $58.7 million for the three months ended October 23, 2010. The decrease in segment revenue resulted in $18.0 million of the decline in gross profit had consolidated gross margin remained constant. Gross margin decreased 320 basis points from 34.5% for the three months ended October 24, 2009 to 31.3% for the three months ended October 23, 2010. The decrease in gross margin was related to increased price discounting in the furniture and high-volume commodity supply categories in response to competitive pressures. As a result of cuts in education funding, the Company believes educators have become more sensitive to price. As such, the Company determined that additional discounting was necessary to maintain competitive prices and expects this level of discounting will continue for the remainder of the fiscal year.
Accelerated Learning segment gross profit decreased $1.8 million from $59.7 million for the three months ended October 24, 2009 to $57.9 million for the three months ended October 23, 2010. The decrease in segment revenue resulted in approximately $1.5 million decline in gross profit had segment gross margin remained constant. The remaining decline was related to a decline of 30 basis points in segment gross margin from 56.0% for the three months ended October 24, 2009 to 55.7% for the three months ended October 23, 2010. The decrease in gross margin was related to expedited printing and freight costs for agenda products in order to meet customer due dates. Favorable product mix in the quarter partially offset these increases.
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Selling, General and Administrative Expenses
SG&A includes selling expenses, the most significant of which are sales wages and commissions; operations expenses, which includes customer service, warehouse and out-bound freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal and human resources; and depreciation and intangible asset amortization expense.
As a percent of revenue, SG&A increased from 25.0% for the three months ended October 24, 2009 to 27.2% for the three months ended October 23, 2010, as cost cutting actions have not kept pace with the decline in revenues. SG&A decreased $7.1 million from $86.4 million in the second quarter of fiscal 2010 to $79.3 million in the second quarter of fiscal 2011. SG&A attributable to the Educational Resources and Accelerated Learning segments decreased a combined $8.5 million and Corporate SG&A increased $1.4 million in the second quarter as compared to last years second quarter. The increase in Corporate SG&A is a result of an approximately $1.3 million increase in business technology spending to support the Companys business systems and eCommerce platform.
Educational Resources segment SG&A decreased $7.7 million, or 15.5%, from $50.0 million for the three months ended October 24, 2009 to $42.3 million for the three months ended October 23, 2010. The segment had a decrease of approximately $6 million in its variable costs such as transportation, warehousing, and selling expenses associated with decreased revenues. In addition, the segment had a decrease of $1.2 million in its marketing costs, primarily associated with a reduction in catalog amortization associated with the decline in this past back-to-school season catalog circulation. Educational Resources segment SG&A increased as a percent of revenues from 20.9% for the three months ended October 24, 2009 to 22.5% for the three months ended October 23, 2010.
Accelerated Learning segment SG&A decreased $0.8 million, or 2.9%, from $27.9 million for the three months ended October 24, 2009 to $27.1 million for the three months ended October 23, 2010. The divestiture of SSP business in the second quarter of fiscal 2010 led to a $3.0 million decrease in SG&A. Partially offsetting this decrease was an increase of $0.5 million attributable primarily to an increase in its variable costs such as transportation due to the shift in timing of revenue from the first quarter to the second quarter of fiscal 2011. In addition, the segments selling expense increased by approximately $1.4 million as a result of the expansion of its reading intervention and health sales force. Accelerated Learning segment SG&A decreased as a percent of revenues from 26.2% for the three months ended October 24, 2009 to 26.0% for the three months ended October 23, 2010.
Interest Expense
Net interest expense decreased $1.0 million from $7.7 million for the three months ended October 24, 2009 to $6.7 million for the three months ended October 23, 2010. Approximately $1.1 million of the decrease in interest expense was related to the non-cash interest expense associated with the Companys convertible notes. The Companys overall effective borrowing rate increased from 3.95% in the second quarter of fiscal 2010 to 4.74% in the second quarter of fiscal 2011. This increase in the effective borrowing rate was primarily related to the impact of the debt pricing on the Companys current credit facility, which became effective on April 23, 2010.
Provision for Income Taxes
Provision for income taxes decreased $6.1 million due to lower pre-tax income. The effective income tax rate increased 250 basis points from 39.5% for the three months ended October 24, 2009 to 42.0% for the three months ended October 23, 2010. The increase in the effective tax rate is related primarily to valuation allowances on the utilization of foreign tax credits.
The effective income tax rate of 42.0% exceeds the federal statutory rate of 35% primarily due to state income taxes.
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Six Months Ended October 23, 2010 Compared to Six Months Ended October 24, 2009
Revenue
Revenue decreased 19.5% from $676.5 million for the six months ended October 24, 2009 to $544.9 million for the six months ended October 23, 2010.
Educational Resources segment revenue decreased 21.9% from $464.8 million for the six months ended October 24, 2009 to $363.1 million for the six months ended October 23, 2010. Revenue amounts for both periods are comprised solely of sales to external parties. The decline in Educational Resources segment revenue was comprised of a decline of approximately $45 million in the supplies category and a decline of approximately $55 million in the furniture category. The decline in the supplies category revenue was related to reductions or delays in school spending as a result on-going school funding issues, as well as execution issues in the Companys pricing and bid strategy. The decline in the furniture category revenue was a result of the continued weakness in the school construction activity. The Company does not anticipate any near-term improvement in this activity.
Accelerated Learning segment revenues decreased by 14.8% from $213.0 million for the six months ended October 24, 2009 (which includes $1.5 million of intersegment revenues) to $181.4 million for the six months ended October 23, 2010 (which is comprised solely of sales to external parties). The divestiture of the SSP business accounted for $17.5 million of the decline. The acquisition of AutoSkill International, Inc. (AutoSkill), acquired in last years second quarter, added $2.8 million of revenue in the first half of fiscal 2011. The remaining decline of $16.9 million is a result of spending reductions across all education categories due to education spending cuts by states, which the Company believes are affecting school districts spending decisions on purchasing new curriculum-based materials.
The Company believes that the current year may be the bottom of the school funding decline. State revenues, a key component of school funding, are projected to begin to rise in fiscal 2011, according to the National Conference of State Legislatures.
Gross Profit
Gross profit decreased 21.1% from $285.9 million for the six months ended October 24, 2009 to $225.6 million for the six months ended October 23, 2010. The decrease in consolidated revenue resulted in $55.7 million decline in gross profit had consolidated gross margin remained constant. Gross margin decreased 90 basis points from 42.3% for the six months ended October 24, 2009 to 41.4% for the six months ended October 23, 2010. The decrease in consolidated gross margin of 90 basis points resulted in a decrease in gross profit of $1.2 million. The decreased gross margin was related to higher price discounts within the Educational Resources segment due to competitive pricing within the market partially offset by increased margins within the Accelerated Learning segment. In addition, a shift in product mix between the Companys segments accounted for approximately 40 basis points of gross margin improvement for the six months ended October 23, 2010. The Accelerated Learning segment, which generates a higher gross margin, due to its curriculum-based products, than the Educational Resources segment, accounted for 33% of the consolidated revenue in the second quarter of fiscal 2011 compared to 32% of the consolidated revenue in the second quarter of fiscal 2010.
Educational Resources segment gross profit decreased $44.6 million from $165.5 million for the six months ended October 24, 2009 to $120.9 million for the six months ended October 23, 2010. The decrease in segment revenue resulted in a $36.2 million decline in gross profit had segment gross margin remained constant. The decrease in gross margin of 230 basis points from 35.6% for the six months ended October 24, 2010 to 33.3% for the six months ended October 23, 2010 decreased gross profit by $8.4 million. Approximately 300 basis points of the decline in gross margin is related to higher price discounting in the furniture and high-volume commodity supply categories. The decline was partially offset by an increase of approximately 70 basis points in gross margin related to product mix shift towards more profitable products within the Educational Resources segment.
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Accelerated Learning segment gross profit decreased $16.0 million from $119.2 million for the six months ended October 24, 2009 to $103.2 for the six months ended October 23, 2010. The decrease in segment revenue resulted in a $17.7 million decline in gross profit had segment gross margin remained constant. The increase in gross margin of 90 basis points from 56.0% for the first six months ended October 24, 2009 to 56.9% for the first six months ended October 23, 2010 resulted in an increase in gross margin of $1.6 million. The increase of 90 basis points for the six months ended October 23, 2010 was primarily a result of the acquisition of AutoSkill International, Inc. in the second quarter of fiscal 2010. Expedited printing and freight costs for the agenda products reduced gross margin by approximately 50 basis points, partially offsetting this increase.
Selling, General and Administrative Expenses
As a percent of revenue, SG&A increased from 25.8% for the six months ended October 24, 2009 to 104.3% for the six months ended October 23, 2010. SG&A increased $393.9 million from $174.7 million for the six months ended October 24, 2009 to $568.8 million for the six months ended October 23, 2010. The primary increase in SG&A is attributable to the non-cash impairment charge of $411.4 million the Company took in the first quarter of fiscal 2011. Due to the significance of the impairment charge in the current year, the Company believes it is more meaningful to compare SG&A excluding the impairment charge to last years SG&A in the comparable period. Excluding the impact of the impairment charge taken by the Company in the first quarter of fiscal 2011, SG&A decreased $17.5 million from $174.7 million in the first six months of fiscal 2010 to $157.2 million in the first six months of fiscal 2011. On the same basis, SG&A attributable to the Educational Resources and Accelerated Learning segments decreased a combined $19.9 million and Corporate SG&A increased $2.4 million in the first six months of fiscal 2011 as compared to last years first six months. The increase in Corporate SG&A was related primarily to increases in business technology spending to support the Companys business systems and eCommerce platform and incremental depreciation related to the Companys enterprise resource planning (ERP) system. Excluding the impact of the impairment charge taken by the Company in the first quarter of fiscal 2011, SG&A as a percent of revenue increased from 25.8% for the six months ended October 24, 2009 to 28.8% for the six months ended October 23, 2010, as cost cutting actions did not keep pace with the decline in revenues.
Educational Resources segment SG&A decreased $16.2 million, or 16.0%, from $101.2 million for the six months ended October 24, 2009 to $85.0 million for the six months ended October 23, 2010. The segment experienced a decrease of approximately $11 million in its variable SG&A costs such as transportation, warehousing, and selling expenses associated with decreased revenues. In addition, the segment had a decline of approximately $4 million in its marketing costs primarily associated with a reduction in catalog amortization through reduced circulation of supplemental catalogs. The remaining decline was related primarily to the compensation savings associated with headcount reductions that resulted from operational consolidations. Educational Resources segment SG&A increased as a percent of revenues from 21.8% for the six months ended October 24, 2009 to 23.4% for the six months ended October 23, 2010.
Accelerated Learning segment SG&A decreased $3.6 million, or 6.6%, from $55.4 million for the six months ended October 24, 2009 to $51.8 million for the six months ended October 23, 2010. The divestiture of the SSP business led to a $6.4 million decrease in SG&A. Reduced volume led to approximately $1.8 million of a decrease in its variable costs such as transportation, warehousing, and selling expenses. Partially offsetting these decreased expenses was an increase of $2.5 million in selling expenses as a result of the expansion of the reading intervention and health sales forces. Accelerated Learning segment SG&A increased as a percent of revenues from 26.0% for the six months ended October 24, 2009 to 28.5% for the six months ended October 23, 2010.
Impairment
The Company recorded $411.4 million of impairment charges in the first six months of fiscal 2011 pursuant to its goodwill assessment. The goodwill impairment charge was $411.2 million, which consisted of $247.9 million, $55.4 million, and $106.1 million for the Educational Resources, Science, and Planning and Student Development reporting units, respectively. An impairment of $0.2 million was related to an indefinite-lived tradename intangible.
Interest Expense
Net interest expense decreased $0.4 million from $15.3 million for the six months ended October 24, 2009 to $14.9 million for the six months ended October 23, 2010. Approximately $0.9 million of the decrease in interest expense was related to the decreased non-cash interest expense associated with the Companys redemption of $133.0 million convertible notes offset by an increase in the Companys overall effective borrowing rate from 4.0% for the six months ended October 24, 2009 to 4.9% for the six months ended October 23, 2010. This increase in the effective borrowing rate was primarily related to the increased commitment fees in the Companys existing credit facility as compared to its previous facility and an increased rate on the Companys average borrowings. The commitment fees on the unused portion of the credit facility are approximately 40 basis points and the increase in the rate related to average borrowings is 50 basis points.
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Provision for (Benefit from) Income Taxes
The benefit for income taxes was $44.4 million for the first six months of fiscal 2011. The current year income tax benefit includes $66.5 million of income tax benefit related to the $411.4 million goodwill and non-amortizable asset impairment. Approximately $237.8 million of the goodwill impairment was related to non-deductible goodwill associated with past stock acquisitions for which a tax benefit was not recorded. The remaining impairment of $173.4 million generated the $66.5 million of tax benefit. The effective tax rate in the first six months of fiscal 2011 was 12.4%. Due to the significance that the impairment charge has on the effective tax rate, the Company believes the tax provision (benefit) and the effective tax rate excluding the impairment charge are more meaningful comparisons to last years comparable period. Excluding impairment, the tax provision for the first six months of fiscal 2011 was $22.2 million as compared to $37.9 million in the first six months of fiscal 2010. The decline is related to the decrease in earnings before tax. Excluding impairment, the effective tax rate was 41.4% in the first six months of fiscal 2011 as compared to 39.5% in the first six months of fiscal 2010. The increase in the effective tax rate is related primarily to the valuation allowance on foreign tax credit utilization.
The effective income tax rate of 41.4% exceeds the federal statutory rate of 35% primarily due to state income taxes.
Liquidity and Capital Resources
At October 23, 2010, the Company had working capital of $105.9 million. The Companys capitalization at October 23, 2010 was $503.7 million and consisted of total debt of $267.3 million and shareholders equity of $236.4 million.
The Companys credit facility matures on April 23, 2014 and provides for $350.0 million of revolving loan availability and $200.0 million incremental term loan availability. The amount outstanding as of October 23, 2010 under the revolving and incremental term loans was $63.0 million and zero, respectively. The credit facility is secured by substantially all of the Companys assets and contains certain financial and other covenants. During the first six months of fiscal 2011, the Company borrowed under our credit facility primarily to meet seasonal working capital requirements. The Companys borrowings are usually significantly higher during the first two quarters of the fiscal year to meet the working capital requirements of our peak selling season. As of October 23, 2010, the Companys effective interest rate on borrowings under our credit facility was 4.0%, which excludes amortization of loan origination fee costs and the commitment fees on unborrowed funds. During the six months ended October 23, 2010, the Company paid commitment fees on unborrowed funds under the credit facility of $0.7 million and amortized loan origination fee costs of $0.4 million related to the credit facility. The credit facility contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures and places certain limitations on our ability to repurchase our common stock. The Company was in compliance with these covenants and restrictions at October 23, 2010.
The Company closely evaluates its expected ability to remain in compliance with the consolidated total leverage and interest coverage ratios due to the ratios sensitivity to the Companys financial results. The recent economic trends impacting the Companys performance, such as the decline in school funding which had led to a decrease in the Companys revenues and margins, have put pressure on the Companys ability to remain in compliance with these ratios. Based on current forecasts reflected in our most recent guidance, the Company may be unable to maintain compliance with one or both of these financial covenants in the second half of fiscal 2011. The Company may need to work with its lenders to secure a waiver or amend such ratios in the near future. Any amendment or waiver would result in additional bank fees and more restrictive terms, and may increase the cost of any future borrowings. The Company believes it will be able to maintain compliance with the financial covenants by working with its lenders, if necessary.
Holders of the Companys $133.0 million, 3.75% convertible subordinated notes due to mature in 2023 presented $132.9 million to the Company for redemption during the second quarter of fiscal 2011. The remaining outstanding amount of this issuance, $0.1 million, was called by the Company during the second quarter of fiscal 2011. The Company satisfied the $133.0 million repayment in cash by borrowing on its credit facility.
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In November 2006, we sold $200.0 million of convertible subordinated debentures due 2026. The debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted and the Companys total conversion obligation, and will deliver, at its option, cash or shares of the Companys common stock in respect of the remainder, if any, of the Companys conversion obligation. The initial conversion rate is 19.4574 shares per $1,000 principal amount of debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Companys option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require us to repurchase all or some of the debentures.
Net cash provided by operating activities increased $22.8 million to $67.6 million in the first six months of fiscal 2011 as compared to $44.8 million provided in the first six months of fiscal 2010. The net cash provided by operating activities is indicative of the highly seasonal nature of our business, with the majority of purchases and other operating cash outflows typically occurring in the first and second quarters of the fiscal year and the majority of cash receipts typically occurring in the second and third quarters of the fiscal year. The increase in cash provided in operating activities between years is due to working capital improvements, primarily in the Companys collections of accounts receivable and decreasing inventory levels in the first six months of fiscal 2011 as compared to the first six months of fiscal 2010. In addition, the Company has negotiated extended payment terms with vendors which allowed it to defer accounts payable payments into its third quarter.
Net cash used in investing activities decreased $9.7 million to $10.2 million in the first six months of fiscal 2011 as compared to $19.9 million for the first six months of fiscal 2010. The decrease in cash used in investing activities was primarily attributable to two transactions from the first six months of fiscal 2010. The Company used cash for the $11.7 million purchase price for the fiscal 2010 acquisition of AutoSkill. In addition, the Company received $2.0 million during the first six months of fiscal 2010 attributable to the sale of the Companys Lyons, New York facility.
Net cash used in financing activities increased $52.5 million to $70.4 million in the first six months of fiscal 2011 as compared to $17.9 million for the first six months of fiscal 2010. The increase in net cash used by financing activities was primarily related to the Companys redemption of its $133.0 million convertible debt in the second quarter of fiscal 2011, which was partially offset by the combination of incremental cash generated by operating activities and the reduction in cash used in investing activities.
Fluctuations in Quarterly Results of Operations
The Companys business is subject to seasonal fluctuations. The Companys historical revenues and profitability have been dramatically higher in the first two quarters of its fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by the timing of acquisitions, the timing and magnitude of costs related to such acquisitions, variations in the Companys costs for the products sold, the mix of products sold and general economic conditions. Moreover, the operating margins of businesses the Company acquires may differ substantially from its own, which could contribute to further fluctuation in quarterly operating results. Therefore, results for any fiscal quarter are not indicative of the results that the Company may achieve for any subsequent fiscal quarter or for a full fiscal year.
Inflation
Inflation, particularly in energy costs, has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.
Critical Accounting Policies
Goodwill and Intangible Assets, and Long-Lived Assets.
As discussed in Item 1, Note 7 of the unaudited consolidated financial statements, the Company recorded impairment charges of $411.2 million and $0.2 million related to goodwill and an indefinite-lived tradename intangible, respectively, in the first quarter of fiscal 2011. The impairment was determined as part of the fair value assessment of these assets.
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Indicators of impairment that were identified during the assessment were a significant decline in our stock price and market capitalization and a decline in our expected future cash flows. The Companys market capitalization declined approximately 24% during the first quarter of fiscal 2011. In addition, the decline in expected future cash flows was related to the continued deteriorating economic conditions that we believe have resulted in decreased funding of education which, in turn, has caused schools to reduce spending levels. These reductions led to a 23.4% revenue decline in the first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010. During the second quarter of fiscal 2011, the Company reviewed both its current market capitalization and future cash flow projections and concluded no evidence of further impairment existed.
We tested goodwill for impairment by determining the fair value of the Companys reporting units using a combined income (discounted cash flow) and market approach (guideline public company comparables) valuation model. The details regarding the determination of the fair value of the reporting units, including the key assumptions used in the impairment analysis, are discussed in Item 1, Note 7 of this report. The impact of modifying any of these assumptions can have a significant impact on the estimate of fair value and, thus, the estimated recoverability, or impairment, if any, of the asset. Changes in estimates or the application of alternative assumptions could have produced significantly different results.
During the first quarter fiscal 2011 impairment analysis, the Company determined that its Education Resources, Science and Planning and Student Development reporting units had goodwill balances that were impaired. The fair value assessment of the two remaining reporting units with goodwill balances, Califone and Reading, indicated that the goodwill balances of these two reporting units were not impaired as the fair value exceeded the carrying value of the units. Since the modification of assumptions used in the valuation model can have a significant impact on the fair value, the Company performed a sensitivity analysis for the Califone and Reading reporting units. This analysis was completed assuming a 100 basis point increase in the discount rate and a 100 basis point decrease in the terminal growth rate. The Company believes these assumptions have the most sensitivity in the valuation model. The results of this sensitivity analysis are as follows:
Decrease in FV of | ||||||||
Reading | Califone | |||||||
100 basis point increase in discount rate |
$ | (9,258 | ) | $ | (2,294 | ) | ||
100 basis point decrease in terminal growth rate |
$ | (4,121 | ) | $ | (1,215 | ) |
Because the valuation of the Reading and Califone reporting units concluded the fair value exceeded carrying value by $52,154 and $5,769, respectively, the decreases in fair value for the sensitivity analysis would not have impaired the goodwill assessment of these two reporting units.
Forward-Looking Statements
Statements in this Quarterly Report which are not historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include: (1) statements made under Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operation, including, without limitation, statements with respect to internal growth plans, projected revenues, margin improvement, future acquisitions, capital expenditures, adequacy of capital resources and compliance with credit facility covenants; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, belief or current expectation of School Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include forward-looking terminology such as may, should, believes, expects, anticipates, estimates, continues or similar expressions.
All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof. We do not undertake to update any forward-looking statements that may be made by us or on our behalf, in this Quarterly Report or otherwise. Our actual results may differ materially from those contained in the forward-looking statements identified above. Factors which may cause such a difference to occur include, but are not limited to, the risk factors set forth in Item 1A, Risk Factors of our Annual Report on Form 10-K for the fiscal year ended April 24, 2010.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in qualitative and quantitative disclosures about market risk from what was reported in our Annual Report on Form 10-K for the fiscal year ended April 24, 2010.
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ITEM 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Based on an evaluation as of the end of the period covered by this quarterly report, the Companys principal executive officer and principal financial officer have concluded that the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective for the purposes set forth in the definition of the Exchange Act rules.
Changes in Internal Control
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially effect, our internal control over financial reporting.
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There have been no material changes in litigation matters subject to the Company in the first six months of fiscal 2011.
The business and financial results of the Company are subject to numerous risks and uncertainties. The risks and uncertainties have not changed materially from those reported in the fiscal 2010 Annual Report on Form 10-K.
See the Exhibit Index, which is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SCHOOL SPECIALTY, INC. | ||
(Registrant) | ||
December 1, 2010 |
/s/ David J. Vander Zanden | |
Date |
David J. Vander Zanden | |
Chief Executive Officer | ||
(Principal Executive Officer) | ||
December 1, 2010 |
/s/ David N. Vander Ploeg | |
Date |
David N. Vander Ploeg | |
Executive Vice President and Chief Financial Officer | ||
(Principal Financial and Accounting Officer) |
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EXHIBIT INDEX
Exhibit No. |
Description | |
12.1 | Statement Regarding Computation of Ratio of Earnings to Fixed Charges. | |
31.1 | Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer. | |
31.2 | Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer. | |
32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer. | |
32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer. |
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