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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:

For the fiscal year ended April 25, 2015

OR

 

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

Commission File No. 000-24385

SCHOOL SPECIALTY, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware   39-0971239
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
W6316 Design Drive  
Greenville, Wisconsin   54942
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (920) 734-5712

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

None   None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ

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   þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    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 definitions 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  þ    Non-accelerated filer  ¨    Smaller reporting company  ¨
      (Do not check if smaller reporting company)   

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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

The aggregate market value of the Registrant’s common stock held by non-affiliates as of October 25, 2014 was $88,311,720. As of June 15, 2015, there were 1,000,004 shares of the Registrant’s common stock outstanding.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  þ    No  ¨

INCORPORATION BY REFERENCE

Part III is incorporated by reference from the Proxy Statement from the Annual Meeting of Shareholders to be held on September 28, 2015.


PART I

 

Item 1. Business

Unless the context requires otherwise, all references to “School Specialty,” “SSI,” the “Company,” “we” or “our” refer to School Specialty, Inc. and its subsidiaries. Prior to April 26, 2015, our fiscal year ended on the last Saturday in April of each year. In this Annual Report on Form 10-K (“Annual Report”), we refer to these fiscal years by reference to the calendar year in which they ended (e.g., the fiscal year ended April 25, 2015 is referred to as “fiscal 2015”).

Company Overview

School Specialty is a leading distributor of supplies, furniture, technology products, supplemental learning products (“instructional solutions”) and curriculum solutions, primarily to the education marketplace. The Company provides educators with its own innovative and proprietary products and services, from basic school supplies to 21st century classroom designs to Science, Reading, Language and Math teaching materials, as well as planning and development tools. Through its nationwide distribution network, School Specialty also provides its customers with access to a broad spectrum of trusted, third-party brands across its business segments. This assortment strategy enables the Company to offer a broad range of products primarily serving the pre-kindergarten through twelfth grade (“preK-12”) education market at the state, district and school levels. The Company is expanding its presence outside the education market into channels such as e-commerce partnerships with e-tailers and retailers and the healthcare facilities. School Specialty offers its products through two operating groups: Distribution and Curriculum.

We believe our Distribution group offers educators the broadest range and deepest assortment of basic school supplies, instructional solutions, furniture and equipment, technology products, physical education products, and other classroom and school equipment available from a single supplier. This breadth of offering and unique positioning creates competitive advantages in our ability to aggregate an assortment of products to meet customer requirements across multiple categories. This group further differentiates itself through its distribution network and nationwide sales force, able to reach virtually all schools nationwide, as well as the Canadian marketplace. Another core differentiator is our commitment to innovation; working with teachers and administrators to develop proprietary products that result in innovative approaches to early childhood development and advanced student learning.

Our Curriculum group develops proprietary curriculum programs to help educators deepen students’ subject matter understanding and accelerate the learning process. This group offers curriculum solutions for Science, Reading and Math and works with teachers and educators to drive new offerings based on Common Core State Standards, Next Generation Science Standards, as well as its own and third-party, customized products for various grade levels (primarily preK-12). The Curriculum group also offers a number of innovative and highly targeted teaching solutions for educators that were designed to help students who are performing below grade level or could benefit from supplemental learning materials in a specific area of learning. This group continues to expand its portfolio of instructional programs, combining print-based and digital instructional and assessment tools to deliver value to educators and build competitive advantages in the marketplace.

Across both groups, we reach our customers through a sales force of approximately 350 professionals (65 of which are inside sales representatives), 8 million catalogs, and our proprietary e-commerce websites. In fiscal 2015, we believe we sold products to approximately 65% of the approximately 135,000 schools in the United States and we believe we reached a majority of the 3.4 million teachers in those schools. For fiscal 2015, we generated revenues of $621.9 million.

The following is a more complete description of our two operating groups, or segments. Financial information about our segments, as well as geographic information, is included in Note 16 under Item 8, Financial Statements and Supplementary Data.

 

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Distribution Segment. Our Distribution segment provides a wide assortment of products, solutions and services primarily to the preK-12 education market, e-tail and retail channel partners, and to the healthcare market. Products include a comprehensive line of everyday consumables, specialized supplies, indoor and outdoor furniture and equipment, technology products, instructional teaching materials, and planning and organizational products, among others. Distribution products are sold via a nationwide sales force and distribution network, with reach to the majority of schools throughout the United States. Distribution products also are sold direct to teachers and to consumers through the Company’s various e-commerce platforms. Distribution products are marketed using a management structure that focuses on five product categories which include:

 

   

Supplies

 

   

Furniture

 

   

Instructional Solutions

 

   

Student Organization and Planning Products

 

   

A/V Technology

By working closely with school administrators, teachers and other educators, the Distribution segment employs a curation strategy, offering a solutions-based approach across multiple product categories. The Company helps schools with their purchasing decisions by offering a suite of value-added products and services to fit within budget parameters, while also helping to manage supply chain issues, and back-to-school logistics to help school administrators save both time and money. This segment also offers project management services through its Project by Design® team (“PBD”), both for school retrofits and new school construction. As a systems integrator for schools, PBD is able to help schools outfit both indoor and outdoor school facilities with state-of-the-art furniture and equipment, while also serving as a single source for additional proprietary and/or third-party branded products.

Distribution products include both proprietary branded products and other national brands. Among the segment’s well-known proprietary brands are Childcraft®, Sax® Arts & Crafts, Califone®, Premier AgendasTM, Classroom Select®, Sportime®, Abilitations®, Hammond & StephensTM, SPARK®, Brodhead Garrett®, School Smart®, and Projects by Design®. Distribution products and services accounted for approximately 86% of our revenues for fiscal 2015.

Curriculum Segment. Our Curriculum segment is a publisher of proprietary and nonproprietary core, supplemental and intervention curriculum in the following areas of the preK-12 education market:

 

   

Science

 

   

Math

 

   

Comprehension, Vocabulary, Spelling and Grammar

 

   

Reading and Math Intervention

 

   

Security

Products in our Curriculum segment are typically sold to teachers, curriculum specialists and other educators with direct responsibility for advancing student outcomes.

The Curriculum segment develops standards-based curriculum products, supplemental and intervention curriculum materials, instructional programs and student assessment tools. Its offerings are tailored to address specific learning needs, drive improved student performance, engage learners and accelerate the learning process. A team of almost 35 product development associates leverage long-standing relationships with outside developers, authors, co-publishing strategic partners and consultants to develop educational products and solutions that satisfy curriculum standards and improve classroom teaching effectiveness.

 

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Our product portfolio is guided by preK-12 curriculum standards, which can vary by state. However, there is a consistency throughout the portfolio that allows for the creation of nationally marketed programs that can be customized to meet state-specific curriculum standards where needed. We believe our Curriculum segment provides a broad collection of educational programs that effectively combines supplemental curriculum solutions, academic planning and organization, inquiry based (hands-on) learning, comprehensive learning kits, extensive performance assessments, and consultant-led or web-delivered teacher training. New reading solutions, for example, combine research proven materials, technology, and teaching methods to create dynamic, systematic, and individualized instruction for each student. Additionally, these group solutions are designed to address Common Core State Standards at various grade levels as well as Next Generation Science Standards.

Our Curriculum segment product lines include Delta Education®, FOSS®, CPO ScienceTM, Frey Scientific®, Educator’s Publishing Service®, Academy of Reading®, Academy of Math®, Wordly Wise 3000®, Explode the Code®, ThinkMath!TM, Making Connections®, S.P.I.R.E. ® and EPS® E.P.I.C. TM. Our Curriculum products accounted for approximately 14% of our revenues in fiscal 2015.

School Specialty, Inc., founded in October 1959, was acquired by U.S. Office Products in May 1996. In June 1998, School Specialty was spun-off from U.S. Office Products in a tax-free transaction. In August 2000, we reincorporated from Delaware to Wisconsin. In accordance with the Reorganization Plan (as defined below), in June 2013, the Company was reincorporated in Delaware. Our principal offices are located at W6316 Design Drive, Greenville, Wisconsin 54942, and our telephone number is (920) 734-5712. Our general website address is www.schoolspecialty.com. You may obtain, free of charge, copies of this Annual Report on Form 10-K as well as our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K (and amendments to those reports) filed with, or furnished to, the Securities Exchange Commission as soon as reasonably practicable after we have filed or furnished such reports by accessing our website at http://www.schoolspecialty.com, selecting “Investors” and then selecting the “SEC Filings” link. Information contained in any of our websites is not deemed to be a part of this Annual Report.

Industry Overview

The United States preK-12 education market is a large industry that has historically exhibited attractive and stable growth characteristics, despite fluctuations in the U.S. economy. For example, during the recessions of 1981-1983, 1991-1992 and 2001-2002, preK-12 education funding in the United States grew at compound annual growth rates (“CAGRs”) of 5.3%, 5.0% and 4.7%, respectively. However, the significant downturn in the general economy from 2008 through 2013 had a major impact on all sectors of the economy, including education.

Public education funding for school districts during 2013-2014 came from three major sources: state funding which provided about 47%; local funding which provided about 43%; and federal funding which provided about 10%. The ongoing pressure on state budgets has negatively impacted school funding and, in turn, school spending has been more negatively affected than it had been during and following prior recessions. In addition, local tax revenues have been negatively affected by lower property tax receipts, further restricting educational spending.

Over the long-term, we expect total educational expenditures (excluding capital outlays and interest on debt) to stabilize and then rise as state and local funding returns to more normalized levels. While macroeconomic events over the past five years have created an unprecedented reduction in school budgets, spending per student and student enrollment are the two primary drivers of future education expenditures, and each is predicted to rise over the next several years.

According to the National Center for Education Statistics (“NCES”), enrollment in public elementary and secondary schools has increased every year between 2009 and 2013. This slow but steady growth trend is projected to continue through at least 2020. At the same time, per pupil expenditures are expected to rise each

 

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year, just as they have every year since 1995-1996. NCES projects that public and private preK-12 enrollment will rise from 55.1 million in the 2013-2014 school year to 57.9 million by the 2021-2022 school year. Total public school enrollment is projected to increase each year from 2013-2020. Similarly, according to Education Market Research, spending for technology products, instructional materials such as textbooks and supplements and other educational resources, such as trade books, periodicals and tests are expected to increase at an average rate of 8.1 percent from 2012-2013 through 2015-2016. Furthermore, there is increased activity at the federal level to increase investments in education, with a renewed focus on early learning. We believe there is also increasing demand for new school construction and retrofits at the federal, state and local level. This belief is supported by industry reports from McGraw-Hill which estimate the size of new K-12 school construction spending to be $24 billion in 2014 growing to $36 billion by 2017.

Our focus within the North America preK-12 education market is on basic school supplies, indoor and outdoor furniture and equipment, technology solutions, instructional solutions and curriculum-based teaching materials in targeted subject areas. Our customers are teachers, curriculum specialists, individual schools and school districts who purchase products and instructional solutions and teaching materials for school and classroom use. The addressable market size for our products has generally tracked education funding, with increased spending in the technology arena. Our customers are also parents who purchase similar products for their children via our proprietary e-commerce platform or those of our e-tail/retail channel partners, as well as administrators in various healthcare related markets.

The supplemental educational products and equipment market is highly fragmented with many retail and wholesale companies providing products and equipment, a majority of which are family- or employee-owned, regional companies. The standards-based curriculum market is highly competitive and School Specialty competes with several large, well-known education companies as well as smaller, niche companies. In certain states, Curriculum purchases are heavily influenced state-wide adoption calendars; in open territory states, Curriculum adoptions are more often made at the district level. According to industry reports from the American Association of Publishers and Education Market Research, the K-12 Curriculum market was estimated to be $10 billion in 2014 and is expected to grow to in excess of $12 billion by 2017.

We believe there is increasing customer demand for single source suppliers, prompt order fulfillment and competitive pricing in today’s economic environment, particularly as school districts centralize their purchasing decision-making and/or increasingly seek to participate in local, state, regional or national purchasing cooperatives. We believe these changes should drive growth in our instructional and educational products as well as our general school supplies, furniture and equipment and other technology-based in-class solutions. We also believe that in the long-term, these industry trends will have a favorable competitive impact on our business, and that we are well positioned to utilize our operational capabilities, recognized proprietary and third-party brands, respected educational content and curriculum development expertise, and broad product offering to meet evolving customer demands.

Bankruptcy Filing

On January 28, 2013, School Specialty, Inc. and certain of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under Chapter 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The cases (the “Chapter 11 Cases”) were jointly administered as Case No. 13-10125 (KJC) under the caption “In re School Specialty, Inc., et al.” The Debtors continued to operate their business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. The Company’s foreign subsidiaries were not part of the Chapter 11 Cases.

The Chapter 11 Cases were filed in response to an environment of ongoing declines in school spending and a lack of sufficient liquidity, including trade credit provided by the Debtors’ vendors, to permit the Debtors to

 

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pursue their business strategy to position the School Specialty brands successfully for the long-term. As a result of the Chapter 11 filing, the Company’s common stock was delisted from the NASDAQ Stock Market, effective March 1, 2013.

On May 23, 2013, the Bankruptcy Court entered an order confirming the Debtors’ Second Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the “Reorganization Plan”), and a corrected copy of such order was entered by the Bankruptcy Court on June 3, 2013. The Reorganization Plan, which is described in additional detail below, became effective on June 11, 2013 (the “Effective Date”). Pursuant to the Reorganization Plan, on the Effective Date, the Company’s existing credit agreements, outstanding convertible subordinated debentures, equity plans and certain other agreements were cancelled. In addition, all outstanding equity interests of the Company that were issued and outstanding prior to the Effective Date were cancelled on the Effective Date. Also on the Effective Date, in accordance with and as authorized by the Reorganization Plan, the Company reincorporated in Delaware and issued a total of 1,000,004 shares of Common Stock of the reorganized Company to holders of certain allowed claims against the Debtors in exchange for such claims. As of June 12, 2013, there were 60 record holders of the new common stock of the reorganized Company issued pursuant to the Reorganization Plan.

The Reorganization Plan

General

The Reorganization Plan generally provided for the payment in full in cash on or as soon as practicable after the Effective Date of specified claims, including:

 

   

All claims (the “DIP Financing Claims”) under the Debtor-in-Possession Credit Agreement (the “ABL DIP Agreement”) by and among Wells Fargo Capital Finance, LLC (as Administrative Agent, Co-Collateral Agent, Co-Lead Arranger and Joint Book Runner) and GE Capital Markets, Inc. (as Co-Collateral Agent, Co-Lead Arranger and Joint Book Runner and Syndication Agent), General Electric Capital Corporation (as syndication agent), the lenders party to the ABL DIP Agreement, and the Company and certain of its subsidiaries;

 

   

Certain pre-petition secured claims;

 

   

All claims relating to the costs and expenses of administering the Chapter 11 Cases; and

 

   

All priority claims.

In addition, the Reorganization Plan generally provides for the treatment of allowed claims against, and equity interests in, the Debtors as follows:

 

   

The lenders under the Senior Secured Super Priority Debtor-in-Possession Credit Agreement (the “Ad Hoc DIP Agreement”) by and among the Company, certain of its subsidiaries, U.S. Bank National Association, as Administrative Agent and Collateral Agent and the lenders party thereto were entitled to receive (i) cash in an approximate amount of $98.3 million, and (ii) 65% of the common stock of the reorganized Company;

 

   

Each holder of an allowed general unsecured claim is entitled to receive a deferred cash payment equal to 20% of such allowed claim, plus interest, on the terms described in the Reorganization Plan;

 

   

Each holder of an unsecured claim arising from the provision of goods and/or services to the Debtors in the ordinary course of its pre-petition trade relationship with the Debtors, with whom the reorganized Debtors continue to do business after the Effective Date, is entitled to receive a deferred cash payment equal to 20% of such claim, plus interest, on the terms described in the Reorganization Plan. Such holders may increase their percentage recoveries to 45%, plus interest, by electing to provide the reorganized Debtors with customary trade terms for a specified period, as described in the Reorganization Plan;

 

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Each holder of the Company’s 3.75% Convertible Subordinated Debentures due 2026, as further described elsewhere in this report, received its pro rata share of 35% of the common stock of the reorganized Company;

 

   

Each holder of an allowed general unsecured claim or allowed trade unsecured claim of $3,000 or less, or any holder of a general unsecured claim or trade unsecured claim in excess of $3,000 that agreed to voluntarily reduce the amount of its claim to $3,000 under the terms described in the Reorganization Plan, was entitled to receive a cash payment equal to 20% of such allowed claim on or as soon as practicable after the Effective Date; and

 

   

Holders of equity interests in the Company prior to the Effective Date, including claims arising out of or with respect to such equity interests, were not entitled to receive any distribution under the Reorganization Plan.

Exit Facilities

As of the Effective Date, the Debtors closed on the exit credit facilities, the proceeds of which were or will be, among other things, used to (i) pay in cash the DIP Financing Claims, to the extent provided for in the Reorganization Plan, (ii) make required distributions under the Reorganization Plan, (iii) satisfy certain Reorganization Plan-related expenses, and (iv) fund the reorganized Company’s working capital needs. The terms of the exit credit facilities are described under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, below.

Equity Interests

As mentioned above, all shares of the Company’s common stock outstanding prior to the Effective Date were cancelled and extinguished as of the Effective Date. In accordance with the Reorganization Plan, on the Effective Date, the reorganized Company issued the new common stock, subject to dilution pursuant to the 2014 Incentive Plan (as defined and described below). The Company issued 1,000,004 shares of new common stock on the Effective Date pursuant to the Reorganization Plan, which constitutes the total number of shares of new common stock outstanding immediately following the Effective Date, subject to dilution pursuant to the 2014 Incentive Plan.

On the Effective Date, equity interests in the Company’s U.S. subsidiaries were deemed cancelled and extinguished and of no further force and effect, and each reorganized subsidiary was deemed to issue and distribute the new subsidiary equity interests. The ownership and terms of such new subsidiary equity interests in the reorganized subsidiaries are the same as the ownership and terms of the equity interests in these subsidiaries immediately prior to the Effective Date, except as otherwise provided in the Reorganization Plan.

Recent Acquisitions

We have acquired one business since the beginning of fiscal 2011:

Fiscal 2011

Telex. On April 4, 2011, we completed the acquisition of a portion of the operating assets of Telex, a division of Bosch Security Systems, Inc., for an aggregate purchase price of $0.4 million. The assets acquired relate to Telex’s distribution of headphones, earphones, headsets, and their replaceable cords used in the education marketplace. The earphone and headphone models acquired included the Discovery, Odyssey, Explorer and 610 models. This business has been integrated into the Company’s Califone business unit within the Distribution segment.

 

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Competitive Strengths

We attribute our strong competitive position to the following key factors:

A Market Leader in Fragmented Industry. We are one of the largest providers of educational supplies, furniture and equipment, and both standards-based and supplemental curriculum products to the preK-12 education markets in the United States and Canada. Within our industry, we compete with many retail and wholesale competitors, a majority of which are family or employee-owned, regional companies. We believe that our scale and scope of operations relative to our education market competitors provide several competitive advantages, including a broader product offering, advantageous purchasing power, a national distribution network and the ability to manage the seasonality and peak shipping requirements of the school purchasing cycle.

Large Product Offering and Premier Brands. With over 123,000 items ranging from classroom supplies, school furniture and playground equipment, technology solutions and both standards-based and supplemental curriculum solutions, we believe we are the only national provider of a broad range of supplemental educational products and equipment to meet substantially all of the needs of schools and teachers in the preK-12 education market. Our breadth of offerings creates opportunities to repurpose or repackage traditional supplemental materials with supplemental curriculum solutions into kits or groups of related items that our customers value. In addition, we believe we have many of the most established brands in the industry that are recognized by educators across the country, with some brands more than 100 years old. This assortment strategy of our own proprietary brands, mixed with other trusted third-party brands, provides us with an assortment of solutions we believe is unmatched in the industry. In addition, over 35% of our revenues are derived from our proprietary products, many of which are curriculum-based, and typically generate higher margins than our non-proprietary products.

Strong Customer Reach and Relationships. We have developed a highly integrated, three-tiered sales and marketing approach, consisting of: a national sales force; paper-based catalogs and digital marketing campaigns; and our proprietary e-commerce websites. We believe this approach provides us with a unique ability to reach teachers and curriculum specialists as well as school district and individual school administrators. The wide assortment of products and solutions we offer has enabled us to establish strong and long-standing relationships with many of the largest school districts across the United States and Canada. We reach our customers through the industry’s largest sales force of approximately 350 professionals (65 of which are inside sales representatives), catalog mailings and our proprietary e-commerce websites. In fiscal 2015, we estimate that we sold products to approximately 65% of the estimated 135,000 schools in the United States and reached a majority of the 3.4 million teachers in those schools. We also estimate that, on average, we have enjoyed more than a 10-year relationship with our top accounts, and have recently invested in building our inside sales force to expand our nationwide reach. We utilize our extensive customer databases to selectively target the appropriate customers for our catalog offerings and digital marketing campaigns. Additionally, we have invested heavily in the development of our e-commerce websites, which provide broad product offerings and which we believe generate higher internet sales than many of our education competitors. Revenues derived directly from internet sales, which were approximately 25% of our sales in fiscal 2015 compared to less than 17% of our sales in fiscal 2009, have increased as more school districts and teachers go online to order supplies.

Highly Diversified Business Mix. Our broad product portfolio and geographic reach minimize our concentration and exposure to any one school district, state, product or supplier. In fiscal 2015, our top 10 school district customers collectively accounted for just over 11% of revenues and our customers within any one state collectively accounted for just over 11% of revenues. For the same period, our top 100 products accounted for slightly less than 13% of revenues. Products from our top 10 suppliers generated just over 24% of revenues in fiscal 2015. We believe this diversification somewhat limits our exposure to state and local funding cycles and to product demand trends, and at the same time, opens up opportunities for growth as educational spending increases, both with current and new customer accounts.

Strong Repeat Business. Over 70% of our revenues are generated from the sale of consumable products, which typically need to be replaced each school year. We continue to maintain strong relationships with schools,

 

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school districts and other customers and believe our retention rate of our school and school district customers is approximately 90% in a highly competitive business. We continue to evaluate and modify our product assortment, particularly in the consumable product area to ensure we have the right solutions for our customers and to capitalize on the recurring revenue opportunities from many of our long-standing accounts.

Strong Cost Controls and Focus on Working Capital. Despite our revenue declines in recent years, we believe our focus on cost reductions and aggressive management of working capital, are positioning the Company to capitalize on future revenue growth opportunities, irrespective of the economy and school funding levels. In fiscal 2015, several operational improvement initiatives resulted in significant cost reductions, and greater efficiencies throughout our organization. These initiatives also resulted in better working capital management and cash flow, which provided us with additional resources to invest in key growth areas of our business across both our Distribution and Curriculum business segments. We continue to focus on growing revenues and profits within our Curriculum and Distribution segments, improving our mix of proprietary products and our operations to enhance the customer experience. We also enjoy highly predictable working capital cycles which enable us to effectively manage our capital structure and invest in growth areas of our business and in our infrastructure.

Focus on Growth Opportunities through Transformation Initiatives and Partnerships. We believe we have multiple long term revenue growth and margin improvement opportunities, including enhancing our sales efforts in under-penetrated states, expanding our private-label business, further developing and refining our educational supplies, furniture, technology and curriculum offerings, increasing sourcing from overseas, optimizing direct marketing operations, increasing supply chain efficiency and expanding our product line through strategic extensions. We are actively pursuing partnering opportunities for content development and distribution. We also believe our movement toward organizing around product and customer categories has better synchronized our go-to-market strategies, product development efforts and supplier relationships. Additionally, we have and continue to expand our business outside of school districts by pursuing alternative distribution channels, such as e-commerce and health care markets, which we expect will further increase our brand recognition and lead to additional sales opportunities throughout the upcoming fiscal year and beyond.

Growth Strategy

We have implemented a number of operational changes that have strengthened our operations, lowered our cost structure and improved efficiencies throughout our organization. We are currently in the process of implementing a shared services operating model that better aligns critical business functions areas and will enable us to improve both our top- and bottom-line results. Our near-term strategy is focused on the following areas:

 

   

Optimizing our Distribution Centers to improve customer delivery cycles both in terms of speed and accuracy and to operate at a lower cost. Enhancing product management and marketing capabilities to promote our innovation and breath of offerings and bring new and innovative products to market;

 

   

Expanding in alternative channels that have annual purchasing cycles and which will lessen our reliance on the heavy back-to-school spending season;

 

   

Introducing new and innovative curriculum-based training solutions, incorporating products, services and consulting in light of the increased need for school security;

 

   

Identifying and exiting product lines with inadequate returns, while focusing on higher-margin, growth oriented product lines and categories;

 

   

Continue building out our digital solutions and bundled packages, while enhancing our e-commerce platform; and

 

   

Driving a change in culture that focuses on accountability and collaboration towards the attainment of our growth and margin improvement objectives.

 

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The Company’s longer term initiatives are intended to enhance organic growth, improve margins, and better evaluate capital investments and allocation of resources. Among the key initiatives are:

 

   

Aligning our sales, marketing and merchandising organizations to develop and execute sustainable growth strategies core product categories such as early childhood development, physical education, art, furniture, technology, and instructional solutions;

 

   

Developing multi-year customer retention and growth plans by geography, category and product lines;

 

   

Improving our customer service capabilities throughout all business areas to improve the customer experience;

 

   

Upgrading our IT systems and related technologies to create efficiencies within our organization, streamline processes, improve business oversight and provide insights that will enable us to better service customer needs;

 

   

Identifying potential acquisition opportunities which would synergistically enhance the revenue and EBITDA of the Company;

 

   

Leveraging our breadth of products to expand into new markets and customer segments, and expanding our product offering where appropriate; and

 

   

Improving communication, both internally and externally to educate all parties on our business operations, product and solution offerings and capabilities.

As part of our various initiatives, we are highly focused on generating organic growth within our business, improving our margin structure, lowering our cost basis while pursuing strategic investments and generating higher returns for our stockholders.

Organic Growth. We are focused on growing revenues and profits from our existing product lines and possible line extensions. We are cautiously optimistic that schools are at or near the bottom of funding levels and industry data suggests school spending will increase over the coming years based on continued growth in student population and spending per student. As schools return to more normalized spending we plan to increase our share of this spending and organically grow our revenues by:

 

   

Optimizing product mix within each category;

 

   

Unifying and aligning our marketing efforts with sales and merchandising;

 

   

Enhancing the usability of our website and our web-based marketing initiatives to capture an increasing portion of online customer sales;

 

   

Developing new and updating current curriculum, supplemental learning and technology solutions in response to education standards and educator needs;

 

   

Introducing new curriculum-based security solutions that address the increased need for school security;

 

   

Focusing our sales reach to further expand into adjacent markets, such as office supplies and health care;

 

   

Capitalizing on expected upcoming curriculum changes relating to Common Core State Standard and Next Generation Science Standards;

 

   

Increasing our focus and selling resources in under-penetrated states and districts;

 

   

Growing within key accounts and school districts through improved cross-selling of products and services; and

 

   

Expanding our relationships with etail/retail partners and large purchasing cooperatives.

 

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Margin Improvement. As we grow our revenues, we are seeking to increase product gross margins through a mix of product innovation, buying programs and supply chain improvements. Among the key initiatives are:

 

   

Continuing to expand our private label business through the introduction of new products;

 

   

Increasing the number of products sourced from low-cost, overseas manufacturers;

 

   

Improving the efficiency of our supply chain activities, and driving overall efficiencies through our company-wide, process improvement initiatives;

 

   

Realizing the benefits of consolidation of distribution centers and elimination of redundant expenses;

 

   

Utilizing our purchasing scale to negotiate more favorable supplier terms and conditions;

 

   

Driving new product innovation and introduction of products and solutions across both business segments that will generate better margins and returns; and

 

   

Eliminating those product offerings which are not justified by the return they provide the Company.

Reduction of Corporate Operating Expenses. We continue to focus on reducing our operating expenses to streamline our business and free up resources to invest in other key areas that will generate top-line growth and improve bottom-line performance. Among the initiatives we are focused on are:

 

   

Consolidate resources across various departments in a manner that will lower our overall staffing levels and improve operational effectiveness;

 

   

Implement lean principles in our operations to improve efficiencies;

 

   

Overhaul our marketing campaigns to have more direct interaction with customers and through more targeted catalog distribution;

 

   

Leverage shared corporate resources throughout our business segments to lower costs and optimize financial, IT, HR and marketing support; and

 

   

Institute a blend of an inside/outside sales model coverage to lower selling expenses and improve account coverage.

Evaluation of Capital Investment and Allocation: We have identified several areas for investment in fiscal 2016 that will strengthen our operations and back-end support, digital and e-commerce platform and solution sets, and overall systems management capabilities. This will be part of the continuous improvement initiatives that are underway. We are also in the process of major review of all of our product lines and businesses to determine those with unacceptable or inadequate profitability, while simultaneously analyzing the appropriate solutions to maximize our returns, either from disposition or further capital investment. This analysis is to identify both cost saving drivers and new investment opportunities that will strengthen our bottom-line performance both near- and long-term. The Company also intends to continue to analyze acquisition opportunities which may fill product offering gaps and provide improvement in the revenue and EBITDA of the Company.

Product Lines

We market our proprietary brands and third-party product assortments across a wide variety of industry categories including general school supplies, arts and crafts, physical education, instructional solutions and special needs, classroom furniture and equipment, outdoor furniture and equipment, technology solutions, and both standards-based and supplemental curriculum solutions. These products are marketed and sold through our two primary business segments: Distribution and Curriculum.

 

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Our Distribution offerings are focused in the following areas:

Supplies Category: We believe we are the largest marketer of school and classroom supplies into the education market. Through our School Specialty Distribution catalogs, which offer both national brands and many of our proprietary School Smart® products, we provide an extensive offering of basic supplies that are consumed in schools and classrooms as well as in home use. This offering includes office products, classroom supplies, janitorial and sanitation supplies, school equipment, planning and development products, physical education products, art supplies and paper, among others. These products are more commodity in nature and require an efficient supply chain and distribution and logistics expertise to be competitive. As a result of our large distribution network and supply chain expertise, our customers view us as a preferred supplier in the Supplies category. Our School Smart private label products are primarily sourced direct from low-cost, overseas manufacturers, which we believe will allow us to enhance our product offering and improve profitability.

Our leading market position in the art supplies area of this category is led by Sax® Arts & Crafts, which offers products and programs focused on nurturing creativity and self-expression through hands-on learning. The product line ranges from original cross-curricular lesson plans and teaching resource materials to basic art materials, such as paints, brushes and papers.

We also offer a full range of physical education programs, solutions, resources and equipment designed to help improve student and staff wellness. Our products, which are primarily offered under our Sportime® brand, range from traditional sports equipment to unique and innovative products designed to encourage participation by all, as well as research-based teaching materials that foster health and wellness both inside and outside of educational facilities. We also offer proven, research-based physical education and health solutions under our SPARK® brand, which is a curriculum and product-based program focused on promoting healthy, active lifestyles and combating childhood obesity. Each SPARK program provides a coordinated package of curriculum, on-site teacher training, and content-matched equipment from our Sportime® product line. The program maximizes physical activity during physical education classes by providing teachers with alternative games, dances and sports that ensure all students are actively engaged and learning.

Instructional Solutions: We believe we are one of the largest marketers of educator supplies and related educational materials and technology solutions, as well as instructional learning materials. Our Instructional Solutions category includes supplemental learning materials (reading, math and science), teaching resources, special needs and special education products and early childhood offerings. Innovation, proprietary products, brand strength and direct merchandising are key success factors. These product offerings create opportunity for margin enhancement through innovation and unique assortments.

We offer several proprietary and innovative instructional solutions and teaching materials to schools and school districts, all designed to help teachers teach and students remain on par with grade-level learning requirements. We also offer a full range of solutions for children with special learning needs through our Abilitations® and Integrations® product lines as well as several third party brands. Our proprietary solutions and products are designed to help educate children with learning, behavioral, sensory or physical differences and are focused on helping educators and therapists make a real difference in a child’s life.

Our early childhood offering provides educators of young children with products that promote learning and development. Our full-line, highly proprietary offering provides educators with everything from advanced literacy and dramatic play to manipulatives, and basic arts and crafts. We have several proprietary brands targeting the early childhood market and our flagship brand, Childcraft® is a well-known and trusted brand in the education market.

Furniture Category: We believe we are one of the most comprehensive providers of school furniture in the United States, offering a full range of school-specific furniture and equipment, for both in-school, in-classroom and outdoor use. Our offering allows us to equip an entire facility, refurbish a specific location within a school, such as a cafeteria, gymnasium or media center, or to replace individual items such as student desks and chairs. We manufacture award-winning early childhood wood furniture in our Bird-in-Hand Woodworks® facility. We

 

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launched a product line of proprietary furniture under our Classroom Select® brand and also provide innovative furniture offerings through our Royal Seating®, Childcraft®, Korners for Kids® and Bird-in-Hand® product lines. We are authorized national or regional distributors for leading third-party lines. In addition, we offer our proprietary service, Projects by Design®, which provides turn-key needs assessment and conforming design, budget analysis and project management for new construction projects.

Planning and Student Development: We believe we are one of the largest providers of planning and student organization products in the United States and Canada, which is delivered through student agendas and planners. Our offerings are focused on developing better personal, social and organizational skills, as well as serving as an effective tool for students and parents to track and monitor their daily activities, assignments and achievements. Many of our agendas and planners are customized at the school level to include each school’s academic, athletic and extra-curricular activities. Our agendas are primarily marketed under the Premier™ brand name. We are also a leading publisher of school forms, including record books, grade books, teacher planners and other printed forms under the brand name Hammond & StephensTM.

A/V Technology: We believe we are among the leading providers of educator-inspired quality audio technology products, including multi-media, audio visual and presentation equipment for the preK-12 education market. These products are marketed under the brand name Califone®. We also offer a host of other technology solutions under Califone and other third-party brands and are focused on expanding our assortment of products to take advantage of increased investments by schools and school districts in new and emerging technology platforms.

Our product development managers apply their extensive education industry experience to design instructional solutions and supplemental curriculum- and age-specific products to enhance the learning experience. New product ideas are reviewed with customer focus groups and advisory panels comprised of educators to ensure new offerings will be well received and meet an educational need.

Our merchandising managers continually review and update the product lines for each business. They determine whether current offerings are attractive to educators and anticipate future demand. The merchandising managers also travel to product fairs and conventions seeking out new product lines. This annual review process results in a continual reshaping and expansion of the educational materials and products we offer.

Our Curriculum offerings are focused in the following areas:

Science: Our science product category, largely comprised of highly recognized proprietary or exclusive offerings, provides learning resources focused on promoting scientific education and inquiry, literacy and achievement to the preK-12 education market. Our products range from laboratory supplies, equipment and furniture to highly effective hands-on learning curriculums. Our science brands include FOSS® (Full Option Science System), Frey Scientific®, Delta Science ModulesTM, Delta Education®, CPO ScienceTM, and Neo/SCI®. We have structured our solutions to engage students, focusing on science and engineering practices that promote scientific inquiry, literacy and achievements, all while aligning to the Next Generation Science Standards and supporting Common Core State Standards.

Science classroom resources offered by Delta Education for example, are focused on the pre-K to 8th-grade education level. Our science curriculum products embody the best in inquiry-based STEM (“Science, Technology, Engineering and Math”) education. Delta provides the research-based FOSS® curriculum and other programs such as Delta Science Modules, as well as hands-on classroom resources. The Full Option Science System® (FOSS) has evolved from a philosophy of teaching and learning at the Lawrence Hall of Science that has guided the development of successful active learning science curricula for more than 40 years. The FOSS program bridges research and practice by providing tools and strategies to engage students and teachers in enduring experiences that lead to a deeper understanding of the natural and designed worlds. Science is a

 

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discovery activity, and our belief is that the best way for students to appreciate the scientific enterprise, learn important scientific and engineering concepts, and develop the ability to think well is to actively participate in scientific practices through the use of manipulatives which enhance their own investigations and analyses. The FOSS Program was created specifically to provide students and teachers with meaningful experiences through active participation in scientific practices.

At Frey Scientific, we offer a wide selection of science education products, supplemental curriculum, lab equipment and supplies, all of which are a part of STEM solutions that advance effective learning. By working with a network of classroom teachers at various grade levels, we continually seek to understand and adapt to customers’ needs and Next Generation Science Standards. Our dedicated science education specialists, many with advanced degrees and teaching experience, provide powerful insights that continue to enhance our product line. Frey Scientific elementary, middle and high school education products include supplemental curriculum, Inquiry Investigations® hands-on kits with virtual labs, innovative equipment and precision instrumentation, essential science classroom supplies and laboratory design services and furniture.

Literacy & Intervention: Our reading and math intervention and supplemental learning programs, which are standards- and curriculum-based products, are focused on providing educators and parents with effective tools to encourage and enhance literacy and mathematics skills, serving the K-12 grade levels. Educator’s Publishing Service (EPS) provides tailored reading and language arts instruction for students with special needs and proprietary instructional materials for educators. For over 60 years, EPS Literacy and Intervention has been the leader in developing and publishing programs to help struggling students, including those with dyslexia and other reading difficulties, as well as providing materials that support on-level students so they can continue to meet their educational goals. Today, EPS provides K-12 blended, customized intervention solutions to help at-risk and on-level students build proficiency in reading and math. A variety of programs connect time-tested content and innovation to give educators the power of differentiation to reach all of their students and meet the changing demands of today’s classrooms. From screening through to intervention, progress monitoring, reporting and professional development, EPS offers an integrated approach to address the Common Core State Standards and Response to Intervention (RTI).

Our Academy of Reading® and Academy of Math® products offer comprehensive reading, math and response to intervention solutions to help K-12 schools close the achievement gap for students who fall below proficiency benchmarks. Our print and technology resources combine to meet the instructional needs of students possessing learning disabilities or who are at risk for reading and math failure. Some of our other innovative teaching materials include Explode the Code®, Making Connections® and Making Connections Intervention®, path driver for Math and path driver for Reading, Sitton Spelling and WordSkills®, S.P.I.R.E®, and WordlyWise®, among others.

For further information regarding our Distribution and Curriculum segments, see our “Segment Information” in the Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.

Intellectual Property

We maintain a number of patents, trademarks, trade names, service marks and other intangible property rights that we believe have significant value and are important to our business. Our trademarks, trade names and service marks include the following: School Specialty®, Education Essentials®, School Smart®, Projects by Design®, Academy of Reading®, Academy of Math®, abc School Supply®, Integrations®, Abilitations®, Brodhead Garrett®, Califone®, Childcraft®, ClassroomDirect®, Frey Scientific®, Hammond & StephensTM, Premier AgendasTM, Sax® Arts & Crafts, Sax® Family & Consumer Sciences, Sportime®, Delta Education®, Neo/SCI®, CPO Science™, EPS® and AutoSkill®. We also sell products under brands we license, such as FOSS®, ThinkMath!™, SPARKTM and FranklinCovey® Seven Habits.

 

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Sales and Marketing

Product procurement decisions within the education market are generally made at the classroom level by teachers and curriculum specialists and at the district and school levels by administrators. The Company currently has an expansive sales force that sells our products at the classroom, school and district level to educators nationwide.

Our Distribution segment sales and marketing approach utilizes a sales force of approximately 280 professionals, approximately 40 distinct catalog titles, and School Specialty Online®, an e-commerce solution that enables us to tailor our product offerings and pricing to individual school districts and school administrators. In fiscal 2015, we took steps to realign our nationwide sales team and our go-to-market strategy, which also included the build out of an inside sales team focused on under penetrated states.

In the Supplies category, we leverage our national sales force, which we believe represents the largest distribution network in the market, and our supply chain expertise, to reduce our customers’ cost of acquisition in the most commonly purchased, highest volume commodity items used by schools. In the Instructional Solution category, we market our products through direct marketing channels. We compete by offering deep assortments in the most commonly purchased products, by leveraging our size to reduce product costs, and by driving customer retention and acquisition through sophisticated database analytics. In the Furniture category, our unique Projects by Design® service gives us significant competitive advantages by providing customers with value-added construction management support, from interior design through installation and field support. In the non-construction segment of furniture, we capitalize on relationship selling through the largest direct sales force in the market.

Schools typically purchase educational supplies and supplemental educational products based on established relationships with relatively few vendors. We seek to establish and maintain these critical relationships by assigning accounts within a specific geographic territory to a local area account manager who is supported by a customer service team. The account managers frequently call on existing customers to ascertain and fulfill their supplemental educational resource and basic supply needs. The customer service representatives maintain contact with these customers throughout the order cycle and assist in order processing.

We have a national sales, marketing, distribution and customer service structure. We believe that this structure significantly improves our effectiveness through better sales management, resulting in higher regional penetration and significant cost savings through the reduction of distribution centers.

Projects by Design. Projects by Design® is a service we provide our customers free of charge to aid in the design, building and renovation of schools. Our professional designers prepare a detailed analysis of the building and individual classrooms to optimize the layout of student and teacher desks, student lockers and other classroom equipment and fixtures. Customers have the ability to view prospective classrooms through our innovative software in order to efficiently manage the project. We believe this service makes us an attractive alternative to other furniture and school fixture and equipment suppliers.

Our Curriculum segment sales and marketing approach utilizes a field sales force of approximately 70 professionals, supported by about 40 inside sales associates. The sales coverage is nationwide, with the largest student populated states served by a larger contingent of sales professionals. The field and inside sales associates are supported by 10 targeted catalogs and our brand-specific websites to deliver premium educational products to teachers and curriculum specialists.

Generally, for each Curriculum product line, a major catalog containing its full product offering is distributed near the end of the calendar year and during the course of the year we mail additional supplemental catalogs. Schools, teachers and curriculum specialists can also access websites for product information and purchasing. Further, we believe that by cross-marketing our Curriculum brands to Distribution customers, we can achieve substantial incremental sales.

 

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Internet Operations. Our internet channel activities through School Specialty Online are focused on enhancing customer loyalty, driving down cost by receiving more orders electronically and creating a customer self-service portal. Our brands are available through School Specialty Online which allows our customers a single access point for purchasing. Our systems provide functionality to meet the specific needs of school districts and school customers, who generally purchase Distribution products, as well as the needs of individual teachers and curriculum specialists, who tend to buy Curriculum products. School Specialty Online allows our customers to manage funding through the use of purchase order spending limitation, approval workflows, order management and reporting. In addition, we offer schools and districts the ability to fully integrate their procurement systems with School Specialty Online, which gives us another important link to our customers and a significant competitive advantage. It also includes other features that are more helpful to teachers, curriculum specialists and others with more sophisticated online ordering needs, including product search, custom catalogs and email notification, allowing users to have access to the full line of School Specialty products. We have maintained an electronic ordering system for the past 20 years and offer e-commerce solutions directed exclusively at the education market. Each of our Curriculum product lines has a dedicated website for its own products. We also continue to explore expanding our offerings provided through third party internet sources. As such, we have added a channel agreement with Amazon.com under which we have created our own branded storefront within the office and school segment of the Amazon.com shopping portal. We believe that this channel will allow us to reach educators and segments of the education space that we did not reach previously. Over the past two years, we have significantly invested in our ecommerce platform to improve website functionality, make the online ordering process easier and faster and improve the overall customer experience, which we believe, will help us grow organically.

Pricing. Pricing for our Distribution and Curriculum product offerings varies by product and market channel. We generally offer a negotiated discount from catalog prices for products from our Distribution catalogs, and respond to quote and bid requests. The pricing structure of proprietary Curriculum products offered through direct marketing is generally less subject to negotiation.

Procurement

Non-Proprietary Products. Each year, we add new items to our catalogs and our offerings. We begin to purchase and stock these items before the catalogs are released so that we can immediately satisfy customer demand. We typically negotiate annual supply contracts with our vendors. Contracts with larger vendors usually provide negotiated pricing and/or extended terms and often include volume discounts and rebate programs. We have exclusive distribution rights on several furniture and equipment lines.

Proprietary Products. We develop many proprietary products and generally outsource the manufacturing of these items.

Global Sourcing. We are decreasing our product unit costs by consolidating our international supplier network. We are also improving product quality by being very selective in our sourcing relationships. Working in conjunction with our supply partners, we have streamlined our international procurement process, gained real-time visibility, added in-process quality checks, and established new systems and procedures to ensure product safety.

Private Label Product. We launched the School Smart brand in 2005. Since that time we have focused our strategy on providing a private brand alternative for educators, using a combination of off-shoring and out-sourcing of products. In fiscal 2015, our revenue for School Smart branded products was approximately $55 million. We continue to evaluate the balance of branded and private brand products and we believe that there are additional opportunities to grow sales through new products, product line extensions and new product configurations.

We maintain close and stable relationships with our vendors to facilitate a streamlined procurement process. At the same time, we continually review alternative supply sources in an effort to improve quality and customer

 

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satisfaction and reduce product cost. Increasingly, transactions with our vendors are processed through an electronic procurement process. This electronic process reduces costs and improves accuracy and efficiency in our procurement and fulfillment process. When more than one of our business units buys from the same vendor, we typically negotiate one contract to fully leverage our combined purchasing power.

Logistics

We believe we have one of the largest and most sophisticated distribution networks among our direct competitors with three fully automated and seamlessly integrated distribution centers, two supporting the Distribution segment and one supporting the Curriculum segment, totaling approximately 1 million square feet of operating space. We believe this network represents a significant competitive advantage, allowing us to reach any school in a fast and efficient fashion. We have enhanced our distribution model, allowing most of our customers to receive their orders of in-stock items within 3 to 5 days, and have the capability of expediting delivery of certain shipments to next-day if and as required by specific customers. We utilize a third-party logistics provider in Asia to consolidate inbound shipments of items sourced overseas, lowering our transportation and inventory storage costs.

In order to maintain the proprietary nature of certain furniture products, we operate one manufacturing facility. Our Lancaster, Pennsylvania plant manufactures wood furniture for our early childhood offerings. Products that we manufacture accounted for less than 10% of sales during fiscal 2015, 2014, and 2013.

Over the past two years, through a series of initiatives, we have realigned our Distribution Centers and warehouses to be closer to the majority of our customers and key suppliers. We have also invested significantly in lean manufacturing principles and upgraded technology and logistics platforms, which have strengthened our operational footprint, enabling us to provide better, more accurate and faster shipments to our customers. This remains one of our key corporate priorities.

Information Systems

We believe that through the utilization of technology for process improvement in areas such as procurement, inventory management, customer order management, order fulfillment, and information management, we are able to offer customers more convenient and cost-effective ways to order products, improve the order fulfillment process to increase on-time and complete performance and effectively focus our sales and marketing strategies.

We have implemented a common enterprise resource planning (“ERP”) platform across the majority of our businesses. This platform primarily includes software from Oracle’s E-Business suite. One of the major benefits from the common ERP platform is the consolidation of both product and customer information, which is designed to enhance our ability to execute our sales and marketing strategies. In addition, by utilizing common business systems across the Company, we have improved business processes, reduced cycle time and enhanced integration between the business units. We believe the technologies of the systems will readily support continued growth and integration of our existing businesses. Our distribution centers utilize interfaced warehouse management software to manage orders from our ERP and legacy systems.

Competition

The supplemental educational products and equipment market is highly fragmented with many retail and wholesale companies providing products and equipment, many of which are family- or employee-owned, regional companies. We also compete, to a much lesser extent, with alternate channel competitors such as office product contract stationers, office supply superstores, purchasing cooperatives and internet-based businesses.

 

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Their primary advantages over us include size, location, greater financial resources and purchasing power. Their primary disadvantage is that their product mix typically covers a very small portion of a school’s needs (measured by volume). We believe we compete favorably with these companies on the basis of service, product offering and customer reach. The standards-based curriculum market is highly competitive and School Specialty competes with several large, well-known education companies as well as small, niche companies.

Employees

As of June 15, 2015, we had approximately 1,160 full-time employees. We have reduced the number of full-time employees as we have integrated and aligned core function areas across the Company, such as operations, supply chain management, procurement and logistics, marketing, finance, information technology and human resources. Additionally, to meet the seasonal demands of our customers, we employ many seasonal employees during the late spring and summer months. Historically, we have been able to meet our requirements for seasonal employment. None of our employees are represented by a labor union and we consider our relations with our employees to be good.

Backlog

We had no material backlog at April 25, 2015. Our customers typically purchase products on an as-needed basis.

 

Item 1A. Risk Factors

Forward-Looking Statements

Statements in this Annual 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 1, Business and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including, without limitation, statements with respect to internal growth plans, projected revenues, margin improvement, capital expenditures and adequacy of capital resources; (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission; and (3) information contained in written material, releases and oral statements issued by, or on behalf of, School Specialty including, without limitation, statements with respect to projected revenues, costs, earnings and earnings per share. 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 Annual 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 or on behalf of us, in this Annual 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 below.

The agreements governing our debt contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial and could lead to the acceleration of our debt and/or an increased cost of capital.

Our existing and future debt agreements impose and may impose operating and financial restrictions on our activities. These restrictions require us to comply with or maintain certain financial tests and ratios, and restrict our ability and our subsidiaries’ ability to:

 

   

incur additional debt;

 

   

create liens;

 

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make acquisitions;

 

   

redeem and/or prepay certain debt;

 

   

sell or dispose of a minority equity interest in any subsidiary or other assets;

 

   

make capital expenditures;

 

   

make certain investments;

 

   

enter new lines of business;

 

   

engage in consolidations, mergers and acquisitions;

 

   

repurchase or redeem capital stock;

 

   

guarantee obligations;

 

   

engage in certain transactions with affiliates; and

 

   

pay dividends and make other distributions.

Our credit facilities also require us to comply with certain financial ratios, including a maximum net total leverage ratio, a minimum fixed charge coverage ratio, and minimum interest coverage ratio, as well as minimum liquidity levels at the end of each month. These restrictions may hamper our ability to operate our business or could seriously harm our business by, among other things, limiting our ability to take advantage of financing, mergers and acquisitions, and other corporate opportunities. In the event that we fail to comply with the financial ratios or minimum liquidity levels contained in our credit facilities, the lenders could elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. If the lenders accelerate the repayment of borrowings, we may not have sufficient assets to repay the amounts due. Also, should there be an event of default, or a need to obtain waivers following an event of default, we may be subject to higher borrowing costs and/or more restrictive covenants in future periods.

See the Liquidity and Capital Resources section of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for a more detailed discussion of the Company’s projected compliance with these debt covenants.

Our common stock is thinly traded, and as a result our investors do not have a meaningful degree of liquidity.

Since October 2013, our common stock has been sporadically quoted on the OTCQB marketplace, meaning that the number of persons interested in purchasing our common stock at or near bid prices at any given time may be relatively small or nonexistent. We cannot predict the extent to which an active public market for our common stock will develop or be sustained. As a consequence, there may be extended periods of time when trading activity in our shares is minimal or nonexistent. We cannot give investors any assurance that a broader or more active public trading market for our common stock will develop or be sustained. An investor may find it difficult or impossible to dispose of shares or obtain accurate information as to the market value of the common stock. Investors may be unable to sell their shares of common stock at or above their purchase price if at all, which may result in substantial losses.

Our bankruptcy proceedings, which improved our capital structure and short-term liquidity position, contemplated that we would refine and implement our strategy and business plan, based upon assumptions and analyses developed by us. If these assumptions and analyses prove to be incorrect, we may be unsuccessful in executing our strategy and business plan, which could have a material adverse effect on our business, financial condition, and results of operations.

Our bankruptcy proceedings, which improved our capital structure and short-term liquidity position, contemplated that we would refine and implement our strategy and business plan based upon assumptions and

 

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analyses developed by us in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors that we considered appropriate under the circumstances. Whether actual future results and developments will be consistent with our expectations and assumptions depends on a number of factors, including but not limited to (i) our ability to obtain adequate liquidity and financing sources and establish an appropriate level of debt; (ii) our ability to restore customers’ confidence in our viability as a continuing entity and to attract and retain sufficient customers; (iii) our ability to retain key employees in those businesses that we intend to continue to emphasize, and (iv) the overall strength and stability of general economic conditions and, in particular, the school funding environment. The failure of any of these factors could materially adversely affect the successful execution of our strategy and business plan.

In connection with our bankruptcy proceedings, we prepared projected financial information to demonstrate to the Bankruptcy Court the feasibility of our Reorganization Plan and our ability to continue operations upon emergence from bankruptcy. The projections reflect numerous assumptions concerning anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Further, the projections were limited by the information available to us as of the date of their preparation, which is subject to change. Accordingly, our actual financial condition and results of operations may differ, perhaps materially, from what we have anticipated. Consequently, there can be no assurance that the results or developments contemplated by the Reorganization Plan or our strategy and business plan will occur or, even if they do occur, that they will have the anticipated effects on us and our subsidiaries or our businesses or operations. The failure of any such results or developments to materialize as anticipated could materially adversely affect the successful execution of the transactions contemplated by the Reorganization Plan or subsequent strategy and business plan. In addition, the accounting treatment required for our bankruptcy reorganization may have an impact on our results going forward.

We are highly leveraged. As of April 25, 2015, we had $182 million of total debt. This level of debt could adversely affect our operating flexibility and put us at a competitive disadvantage.

Our level of debt and the limitations imposed on us by our credit agreements could have important consequences for investors, including the following:

 

   

we will have to use a portion of our cash flow from operations for debt service rather than for our operations;

 

   

we may not be able to obtain additional debt financing for future working capital, capital expenditures or other corporate purposes or may have to pay more for such financing;

 

   

the debt under our credit agreements is at a variable interest rates, making us more vulnerable to increases in interest rates;

 

   

we could be less able to take advantage of significant business opportunities, such as acquisition opportunities, and to react to changes in market or industry conditions;

 

   

we will be more vulnerable to general adverse economic and industry conditions; and

 

   

we may be disadvantaged compared to competitors with less leverage.

We expect to service our debt primarily from cash flow from operations. Our ability to service our debt obligations thus depends on our future performance, which will be affected by financial, business, economic and other factors. We are not able to control many of these factors, such as economic conditions in the markets where we operate and pressure from competitors. The cash flow we generate may not be sufficient to allow us to service our debt obligations. If we do not have sufficient capital, we may be required to refinance all or part of our existing debt, sell assets or borrow additional funds. We may not be able to take such actions on terms that are acceptable to us, if at all. In addition, the terms of our existing or future debt agreements may restrict us from adopting any of these refinancing alternatives.

 

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As a result of the Chapter 11 Cases, our historical financial information may not be indicative of our future financial performance.

Our capital structure was significantly altered under the Reorganization Plan. Under fresh-start reporting rules that applied to us upon the effective date of the Reorganization Plan, our assets and liabilities were adjusted to fair value and our accumulated deficit was restated to zero. Accordingly, our financial condition and results of operations subsequent to the effective date of the Reorganization Plan are not comparable to the financial condition and results of operations reflected in our historical financial statements. It is also possible that additional restructuring and related charges may be identified and recorded in future periods. Such charges could be material to our consolidated financial position and results of operations.

Our net operating loss carryforwards may be limited and other tax attributes may be reduced.

The Company incurred a Federal net operating loss in fiscal 2015. However, in conjunction with matters that resulted in the Chapter 11 Cases and Reorganization Plan, the Company experienced a change in ownership under Section 382 of the Internal Revenue Code. This could limit annual federal net operating loss utilization to an amount equal to the net equity value of our stock at the time of the ownership change multiplied by the federal long-term tax exempt rate.

In addition, the Company’s Reorganization Plan resulted in a reduction of tax attributes, including net operating losses and tax attributes particularly related to goodwill and intangible assets, as a result of the cancellation of pre-bankruptcy indebtedness and obligations. The reduction of these tax attributes may result in increased tax expense in future years.

Our business depends upon the growth of the student population and school expenditures and can be adversely impacted by fixed or declining school budgets.

Our growth strategy and profitability depend in part on growth in the student population and expenditures per student in preK-12 schools. The level of student enrollment is largely a function of demographics, while expenditures per student are affected by federal, state and local government budgets. In addition, the current macroeconomic weakness has resulted in significantly reduced school budgets. In school districts in states that primarily rely on local tax proceeds for funding, significant reductions in those proceeds for any reason can restrict district expenditures and impact our results of operations. Any significant and sustained decline in student enrollment and/or expenditures per student could have a material adverse effect on our business, financial condition, and results of operations. Because school budgets are fixed on a yearly basis, any shift by schools in expenditures during a given fiscal year to areas that are not part of our business, such as facility operating costs and employee related expenditures, could also materially affect our business.

A decline in school spending will impact our ability to maintain operating margins.

We have seen a decline in our operating margin in recent years, primarily as a result of our revenue declines, which we believe are primarily related to the continued school spending cuts. The Company will continue to aggressively pursue further cost reductions if school spending continues to decline, but the Company does not intend to cut costs in areas that it believes could have a significant impact on future revenue growth. To the extent we are unable to identify additional cost reductions that can be made consistent with our strategy and the weakness in school spending persists, our operating margin may continue to decline. Additionally, spending declines can cause schools to consider purchasing lower priced products, which will lower the Company’s operating margins.

Increasing use of web-based products is affecting our printed supplemental materials business.

The growth in web-based and digital-based supplements has reduced the physical paper-based supplements the Company currently markets. While we continue to enhance some of our product lines with digital alternatives, it is possible that our paper-based products could be further supplanted and/or replaced by online sources other than our own.

 

21


Increased costs and other difficulties associated with the distribution of our products would adversely affect our results of operations.

Higher than expected costs and other difficulties associated with the distribution of our products could affect our results of operations. To the extent we incur difficulties or higher-than-expected costs related to updating our distribution centers, such costs may have a material adverse effect on our business, financial condition and results of operations. Any disruption in our ability to service our customers may also impact our revenues or profits. Moreover, as we update our distribution model, reduce the number of distribution centers or change the product mix of our remaining distribution centers, we may encounter unforeseen costs or difficulties that may have an adverse impact on our financial performance.

Our business is highly seasonal.

Because most of our customers want their school supplies delivered before or shortly after the commencement of the school year, we record most of our revenues from June to October. During this period, we receive, ship and bill the majority of orders for our products so that schools and teachers receive their products by the start of each school year. To the extent we do not sell our products to schools during the peak shipping season, many of such sales opportunities will be lost and will not be available in subsequent quarters. Our inventory levels increase in April through June in anticipation of the peak shipping season. We usually earn more than 100% of our annual net income in the first two quarters of our fiscal year and operate at a net loss in our third and fourth fiscal quarters. This seasonality causes our operating results and operating cash flows to vary considerably from quarter to quarter within our fiscal years.

If our key suppliers or service providers were unable or unwilling to provide the products and services we require, our business could be adversely affected.

We depend upon a limited number of suppliers for some of our products, especially furniture and proprietary products. We also depend upon a limited number of service providers for the delivery of our products. If these suppliers or service providers are unable or unwilling to provide the products or services that we require or materially increase their costs (especially during our peak season of June through October), our ability to deliver our products on a timely and profitable basis could be impaired and thus could have a material adverse effect on our business, financial condition and results of operations. Many of our agreements with our suppliers are terminable at any time or on short notice, with or without cause, and, we cannot assure that any or all of our relationships will not be terminated or that such relationships will continue as presently in effect.

Our business is highly competitive.

The market for supplemental educational products and equipment is highly competitive and fragmented with many retail and wholesale companies that market supplemental educational products and equipment to schools with preK-12 as a primary focus of their business. We also face competition from alternate channel marketers, including office supply superstores, office product contract stationers, and purchasing cooperatives that have not traditionally focused on marketing supplemental educational products and equipment. Our competitors impact the prices we are able to charge and we expect to continue to face pricing pressure from our competitors in the future, especially on our commodity-type products. These competitors are likely to continue to expand their product lines and interest in supplemental educational products and equipment. Some of these competitors have greater financial resources and buying power than we do. We believe that the supplemental educational products and equipment market will consolidate over the next several years, which could increase competition in both our markets. We also face increased competition and pricing pressure as a result of the accessibility of the internet.

 

22


If any of our key personnel discontinue their role with us, our business could be adversely affected.

Our business depends to a large extent on the abilities and continued efforts of our executive officers and senior management. If we are unable to attract and retain key personnel and qualified employees, our business could be adversely affected. We do not intend to maintain key man life insurance covering any of our executive officers or other members of our management.

A failure to successfully implement our business strategy could materially and adversely affect our operations and growth opportunities.

Our ability to achieve our business and financial objectives is subject to a variety of factors, many of which are beyond our control, and we may not be successful in implementing our strategy. This includes limitations due to the inability to obtain financing and/or the restrictiveness of our debt covenants. In addition, the implementation of our strategy may not lead to improved operating results. We may decide to alter or discontinue aspects of our business strategy and may adopt alternative or additional strategies due to business or competitive factors or factors not currently expected, such as unforeseen costs and expenses or events beyond our control. Any failure to successfully implement our business strategy could materially and adversely affect our results of operations and growth opportunities.

We face risks associated with our increasing emphasis on imported goods and private label products.

Increases in the cost or a disruption in the flow of our imported goods may adversely impact our revenues and profits and have an adverse impact on our cash flows. Our business strategy includes an increased emphasis on offering private label products and sourcing quality merchandise directly from low-cost suppliers. As a result, we expect to rely more heavily on imported goods from China and other countries and we expect the sale of imported goods to continue to increase as a percentage of our total revenues. To the extent we rely more heavily on the sale of private label products, our potential exposure to product liability claims may increase. In addition, our reputation may become more closely tied to our private label products and may suffer to the extent our customers are not satisfied with the quality of such products. Private label products will also increase our risks associated with returns and inventory obsolescence. Our reliance on imported merchandise subjects us to a number of risks, including: (a) increased difficulties in ensuring quality control; (b) disruptions in the flow of imported goods due to factors such as raw material shortages, work stoppages, strikes, and political unrest in foreign countries; (c) problems with oceanic shipping, including shipping container shortages; (d) economic crises and international disputes; (e) increases in the cost of purchasing or shipping foreign merchandise resulting from a failure of the United States to maintain normal trade relations with China and the other countries we do business in; (f) import duties, import quotas, and other trade sanctions; and (g) increases in shipping rates imposed by the trans-Pacific shipping cartel. If imported merchandise becomes more expensive or unavailable, we may not be able to transition to alternative sources in time to meet our customers’ demands. A disruption in the flow of our imported merchandise or an increase in the cost of those goods due to these or other factors would significantly decrease our revenues and profits and have an adverse impact on our cash flows.

We may be involved in lawsuits to defend against third party claims of intellectual property infringement, which in each case could require us to spend significant time and money and could prevent us from selling our products or conduct our business as presently conducted.

From time to time we are involved in litigation because others allege that we infringe on their intellectual property. These claims and any resulting lawsuits could subject us to significant liability for damages and invalidate our proprietary rights. In addition, these lawsuits, regardless of their merits, could be time consuming and expensive to resolve and may divert management’s time and attention. Any intellectual property litigation alleging our infringement of a third-party’s intellectual property also could force us or our customers to: i) stop producing or using products that use the challenged intellectual property, ii) obtain from the owner of the infringed intellectual property, at our expense, a license to sell or use the relevant technology at an additional cost, which license may not be available on reasonable terms, or at all, iii) redesign those products or services

 

23


that use the infringed technology or iv) change the ways in which we conduct our business so as to avoid infringing the technology. Any costs we incur from having to take any of these actions could be material.

Currency exchange rates may impact our financial condition and results of operations and may affect the comparability of our results between financial periods.

To the extent we source merchandise from overseas manufacturers and sell products internationally, exchange rate fluctuations could have an adverse effect on our results of operations and ability to service our U.S. dollar-denominated debt. All of our debt is in U.S. dollars while a portion of our revenue is derived from imported products and international sales. Therefore, fluctuations in the exchange rate of foreign currencies versus the U.S. dollar could impact our costs and revenues. In addition, for the purposes of financial reporting, any change in the value of the foreign currencies against the U.S. dollar during a given financial reporting period would result in a foreign currency loss or gain. Consequently, our reported earnings could fluctuate as a result of foreign exchange translation and may not be comparable from period to period.

It is difficult to forecast our revenue stream given the seasonal purchasing patterns of our customers and delays in passage of state budgets.

The seasonal purchasing patterns of our customers, the fact that our customers typically purchase products on an as-needed basis, and the lack of visibility into education funding levels if state budgets are delayed make it difficult for us to accurately forecast our revenue stream, which may vary significantly from period to period. Financial analysts and others that may seek to project our future performance face similar difficulties. The difficulty in accurately forecasting our revenue increases the likelihood that our financial results will differ materially from any projected financial results. Any shortfall in our financial results from our, or third-party, projected results could cause a decline in the trading price of our common stock.

We may have a material amount of intangible assets which are potentially subject to impairment.

At April 25, 2015, intangible assets represent approximately 20% of our total assets. We are required to evaluate goodwill for impairment on an annual basis and other intangibles if indicators of impairment exists. As discussed in Note 7 to the consolidated financial statements in Item 8 of this report, the Company recorded a goodwill impairment charge of $41.1 million in fiscal 2013, an impairment charge of $2.7 million in fiscal 2015 related to definite-lived intangible assets, and an impairment charge of $4.7 million related to indefinite-lived intangible assets in the third quarter of fiscal 2013. The impairments were determined as part of the fair value assessment of these assets. The fair value assessments of these assets are based on significant assumptions, including earnings projections and discount rates. Changes in these assumptions can have a significant impact on the fair value assessment and the resulting conclusion as to any potential asset impairment and the amount of any such impairment.

We have a material amount of capitalized product development costs which might be written-down.

We had capitalized product development costs of $19.6 million and $27.3 million at April 25, 2015 and April 26, 2014, respectively, related to internally developed products, which are amortized to expense over the lesser of five years or the product’s life cycle. Any changes in the estimated sales volume or life cycle of the underlying products could cause the currently capitalized costs or costs capitalized in the future to be impaired.

Our operations are dependent on our information systems.

We have integrated the operations of most of our divisions and subsidiaries, which operate on systems located at both our Greenville, Wisconsin, headquarters and our third-party hosted ERP system provider’s facilities. In addition, there are divisions running legacy systems hosted at their locations. All systems rely on continuous telecommunication connections to the main computers. If any of these connections becomes disrupted, or unavailable, for an extended period of time, the disruption could materially and adversely affect our business, operations and financial performance.

 

24


Increased cyber-security requirements and potential threats could pose a risk to our systems, networks, services and data.

Even though we have taken precautions to protect ourselves from unexpected events that could interrupt new and existing business operations and systems, we cannot be sure that fire, flood or other natural disasters would not disable our systems and/or prevent them from communicating between business segments. The occurrence of any such event could have a material adverse effect on our business, results of operations and financial condition.

We rely on our intellectual property in the design and marketing of our products.

We rely on certain trademarks, trade names and service names, along with licenses to use and exploit certain intellectual property related to designs of proprietary products, trademarks, trade names and service names (collectively, the “marks”) in the design and marketing of some of our products. We could lose our ability to use our brands if our marks were found to be generic or non-descriptive, as well as the right to sell proprietary products which are based upon licensed intellectual property. While no single mark is material to our business, the termination of a number of these marks could have an adverse effect on our business. The loss of certain licensed intellectual property related to proprietary products (for example, FOSS) may have a materially adverse effect on our business. We also rely on certain copyrights, patents and licenses other than those described above, the termination of which could have an adverse effect on our business.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

Our corporate headquarters is located in a leased facility. The lease on this facility expires in April 2021. The facility is located at W6316 Design Drive, Greenville, Wisconsin, a combined office and warehouse facility of approximately 332,000 square feet, which also services both our Curriculum and Distribution segments. In addition, we leased or owned the following principal facilities as of June 30, 2015:

 

Locations

   Approximate
Square Footage
     Owned/
Leased
     Lease Expiration

Bellingham, Washington

     25,000         Leased       31-Jul-20

Cambridge, Massachusetts (1)

     18,000         Leased       30-Apr-18

Cameron, Texas .

     277,000         Leased       30-Sep-15

Fresno, California (3)

     163,000         Leased       31-Oct-17

Lancaster, Pennsylvania (2)

     73,000         Leased       30-Jun-17

Lancaster, Pennsylvania

     125,000         Leased       30-Jun-17

Mansfield, Ohio (2)

     315,000         Leased       31-Oct-16

Nashua, New Hampshire (1)

     348,000         Leased       31-Dec-18

San Fernando, California

     37,000         Leased       31-Jan-16

 

(1) Location primarily services the Curriculum segment.
(2) Location services both business segments.
(3) Subleased through October 31, 2017

The 73,000 square foot Lancaster, Pennsylvania facility is used for manufacturing wood products. The other facilities are distribution centers and/or office space. We believe that our properties are adequate to support our operations for the foreseeable future. We regularly review the utilization and consolidation of our facilities.

 

25


Item 3. Legal Proceedings

The Company is not currently party to any material pending legal proceedings, other than routine litigation incidental to the Company’s business in the ordinary course.

 

Item 4. Mine Safety Disclosure.

Not applicable.

 

26


EXECUTIVE OFFICERS OF THE REGISTRANT

As of June 30, 2015, the following persons served as executive officers of School Specialty:

 

Name and Age of Officer

    

Joseph M. Yorio

Age 50

   Mr. Yorio joined the Company as its President and Chief Executive Officer and a member of the Board of Directors in April 2014. Prior to joining the Company, Mr. Yorio served as President and Chief Executive Officer of NYX Global LLC, a business services and consulting company, from January 2011 to April 2014. Concurrently, he also performed the duties and responsibilities of Managing Director for Vertx (a NYX Global client), a developer, manufacturer, marketer and distributor of tactical and outdoor apparel and equipment. Prior to that, Mr. Yorio was President from March 2009 to December 2010 and Chief Executive Officer from June 2009 to December 2010 of Xe Services LLC (now known as Academi), a private aerospace and defense company. In addition, Mr. Yorio previously held a variety of executive, operations and sales positions primarily focused on distribution and logistics. He served as the Vice President, U.S. and North American Air Hub Operations with DHL Express, where he was responsible for sortation, inbound and outbound freight from the largest private airport in North America servicing the global markets. Prior to that, he was President of the Central Midwest Division of Corporate Express, where he led a self-sustaining operating division that included six distribution centers. He also served in the U.S. Army as a 75th Ranger Regiment and Special Forces officer and is a medically retired combat veteran. Mr. Yorio holds a B.A. degree in psychology from Saint Vincent College, a Master’s Certificate in executive leadership from Cornell University, S.C. Johnson Graduate School of Management, and an M.B.A in management from Florida Institute of Technology, Nathan M. Bisk College of Business.

Ryan Bohr

Age 41

   Mr. Bohr has served as Executive Vice President and Chief Financial Officer of the Company since October 2014. Prior to joining the Company, Mr. Bohr served as Chief Executive Officer of Fresh Matters LLC, an early stage specialty beverage company, from January 2014 to October 2014 after serving as operations advisor to the Company during 2013. Prior to that, Mr. Bohr was a Partner at Hilco Equity Partners, a private equity firm focused on special situations, where he worked from March 2003 to December 2012. While with Hilco Equity, Mr. Bohr played a key role in all aspects of the Fund’s activities, including fundraising, day-to-day operations for certain portfolio companies and execution of the firm’s investment strategy across the consumer and industrial industries. In addition, Mr. Bohr has previously held other senior operating and financial positions and worked in private equity, investment banking and public accounting for several years. Mr. Bohr holds a BBA degree in accounting from the University of Notre Dame and earned the CPA designation in 1996.

Edward J. Carr, Jr.

Age 49

   Mr. Carr has served as Executive Vice President and Chief Sales Officer of the Company since January 2015. Prior to joining the Company, Mr. Carr served as Corporate Vice President of Sales with Reinhart Foodservice (RFS), LLC, a multi-billion dollar foodservice distribution company with over 30 distribution centers serving independent and chain restaurants, schools and healthcare facilities throughout the United States, from January 2014 to January 2015. In this position, he was responsible for managing the RFS’s largest customer accounts and developing and overseeing the national go-to-market strategy and sales force. Mr. Carr served as the RFS Board member on the Boards of Directors for the International Foodservice Distributors Association (IFDA) and the Distribution

 

27


Name and Age of Officer

    
   Market Advantage (DMA). Prior to RFS, Mr. Carr served as Executive Vice President of Sales and Marketing of Nicholas and Company, an independent food service distributor, from June 2006 to January 2014. In this role, Mr. Carr was responsible for all strategies related to account acquisition, retention and penetration. He oversaw and led all sales initiatives and was successful in driving marketing programs across multiple sales channels and industry subsets. Mr. Carr represented Nicholas and Company nationally with the IFDA, Independent Marketing Alliance (IMA), DMA, and Markon Produce Cooperative. He also served as the co-chair of the IFDA Supplier Advisory Council while at both RFS and Nicholas and Company. From 1996 to 2006, Mr. Carr held several leadership positions with Corporate Express, one of the world’s largest business-to-business suppliers of essential office and computer products and services, where he most recently served as President, Pennsylvania Division. Prior to this role, he served as Vice President of Sales, Central Midwest Division and Division Sales Manager, Washington Division. Prior to Corporate Express, Mr. Carr held management positions with Western Parcel Express and with Airborne Express. He is a graduate of the University of Utah, with a B.S. in Mass Communications, Public Relations.

Todd A. Shaw

Age 49

   Mr. Shaw has served as the Executive Vice President, Operations of the Company since December 2014. Mr. Shaw previously served as the Company’s Vice President, Operational Excellence and Continuous Improvement from July 2014 to November 2014. Prior to joining the Company, Mr. Shaw served as Vice President of Operations of Prolitec Inc., a provider of air treatment and indoor air quality technologies from September 2011 to July 2014. Prior to that, Mr. Shaw served as Chief Operating Officer of NYX Global LLC, a business services and consulting company, from October 2010 to September 2011. From May 2009 to October 2010, Mr. Shaw served as Senior Vice President of Facility Services and Logistics of Xe Services LLC (now known as Academi), a private aerospace and defense company. Earlier in his career, he worked primarily in operational roles, serving as Division Manager with Shorr Packaging Corporation, Vice President of Operations with Corporate Express, and Area Operations Director with Unisource Worldwide. Mr. Shaw attended the University of Wisconsin—Platteville where he studied criminal justice.

Kevin Baehler

Age 51

   Mr. Baehler has served as Senior Vice President, Corporate Controller and Chief Accounting Officer of the Company since October 2014. Mr. Baehler joined the Company in 2004 as Corporate Controller, and was promoted to Vice President, Corporate Controller in 2007. From June 2007 to April 2008, he served as interim Chief Financial Officer. In April 2008, after stepping down as interim Chief Financial Officer, he was appointed to the position of Senior Vice President, Corporate Controller. From January 2014 to October 2014, he served as interim Chief Financial Officer. Since joining the Company, he has been responsible for all aspects of the Company’s financial reporting process. Prior to joining the Company, Mr. Baehler spent six years with GE Healthcare, a division of General Electric Company in various financial positions, most recently as Assistant Global Controller. Mr. Baehler obtained his undergraduate degree in accounting from the University of Wisconsin—Whitewater and he is a Certified Public Accountant.

The term of office of each executive officer is from one annual meeting of the Board of Directors until the next annual meeting of the Board of Directors or until a successor for each is selected. There are no arrangements or understandings between any of our executive officers and any other person (not an officer or director of School Specialty acting as such) pursuant to which any of our executive officers was selected as an officer of School Specialty.

 

28


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

The Company’s common stock traded on the OTCQB market place of the OTC Market Groups as of February 6, 2013 under the symbol “SCHSQ” through June 11, 2013, the Effective Date of the Reorganization Plan. The Company’s common stock currently trades on the OTCQB market place of the OTC Market Groups under the symbol “SCOO”. The table below sets forth the reported high and low closing sale prices for shares of our common stock, during the indicated quarters.

 

Fiscal 2015

   High      Low  

Quarter ended July 26, 2014

   $ 121.00       $ 107.00   

Quarter ended October 25, 2014

     120.50         118.00   

Quarter ended January 24, 2015

     120.00         110.25   

Quarter ended April 25, 2015

     110.25         95.00   

Fiscal 2014

   High      Low  

Six weeks ended June 11, 2013 (Predecessor)

     N/A         N/A   

Seven weeks ended July 27, 2013 (Successor)

     N/A         N/A   

Quarter ended October 26, 2013

     N/A         N/A   

Quarter ended January 25, 2014

   $ 88.00       $ 74.00   

Quarter ended April 26, 2014

     110.50         74.50   

The first trade of the Successor Company’s common stock occurred in the third quarter of fiscal 2014.

Holders

As of June 30, 2015, there were approximately 60 record holders of the common stock of the Company.

Dividends

We have not declared or paid any cash dividends on our common stock to date. We currently intend to retain our future earnings to pay down debt, finance the growth, development and expansion of our business or for other endeavors deemed prudent. Accordingly, we do not expect to pay cash dividends on our common stock in the foreseeable future. In addition, our ability to pay dividends is restricted or prohibited from time to time by financial covenants in our credit agreements and debt instruments. Our asset based lending facility and our term loan credit agreement contains restrictions on, and in some circumstances may prevent, our payment of dividends.

 

29


PERFORMANCE GRAPH

The following graph compares the total shareholder return on our Common Stock since October 30, 2013 with that of the Russell 3000 Stock Market Index and a peer group index including: Office Depot, Inc. (ODP), Staples, Inc. (SPLS), Cambium Learning Group, Inc. (ABCD), The McGraw-Hill Companies, Inc. (MHP), Pearson PLC (PSO), Scholastic Corporation (SCHL), Scientific Learning Corp (SCIL) and Virco Manufacturing Corp (VIRC).

The total return calculations set forth below assume $100 invested on October 30, 2013, which is the first date on which shares of the Successor Company were traded. The total return calculations assume the reinvestment of any dividends into additional shares of the same class of securities at the frequency with which dividends were paid on such securities through April 25, 2015. The stock price performance shown in the graph below should not be considered indicative of potential future stock price performance.

 

LOGO

 

      10/30/13      1/31/14      4/26/14      7/31/14      10/31/14      1/31/15      4/25/15  

School Specialty, Inc.

     100.00         89.77         125.06         136.36         136.36         123.01         113.52   

Russell 3000

     100.00         101.93         106.36         110.34         115.67         115.17         123.33   

Peer Group

     100.00         95.23         94.18         98.90         106.17         116.99         129.32   

 

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Item 6. Selected Financial Data

SELECTED FINANCIAL DATA

(In thousands, except per share data)

 

    Fiscal Year  
    Successor Company          Predecessor Company  
    2015     2014          2014     2013     2012     2011  
    (52 weeks)     (46 weeks ended
April 26, 2014)
         (6 weeks ended
June 11, 2013)
    (52 weeks)     (52 weeks)     (53 weeks)  

Statement of Operations Data:

               

Revenues

  $ 621,868      $ 572,045          $ 58,697      $ 674,998      $ 731,991      $ 762,078   

Cost of revenues

    393,710        349,845            35,079        411,118        448,977        454,557   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    228,158        222,200            23,618        263,880        283,014        307,521   

Selling, general and administrative expenses

    232,479        213,144            27,473        267,491        274,967        287,560   

(Gain) on sale of product line

    —          —              —          —          (4,376     —     

Facility exit costs and restructuring

    6,056        6,552            —          —          —          —     

Impairment charge

    2,713        —              —          45,789        107,501        411,390   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

    (13,090     2,504            (3,855     (49,400     (95,078     (391,429

Interest expense

    19,599        16,882            3,235        28,600        27,182        28,157   

Loss on early extinguishment of debt

    —          —              —          10,201        —          —     

Change in fair value of interest rate swap

    (45     483            —          —          —          —     

Refund of early termination fee

    —          (4,054         —          —          —          —     

Reorganization item, net

    271        6,420            (84,799     22,979        —          —     

Early termination of long-term indebtedness

    —          —              —          26,247        —          —     

Impairment of long-term asset

    —          —              —          1,414        —          —     

Impairment of investment in unconsolidated affiliate

    —          —              —          7,749        9,012        6,861   

Expense associated with convertible debt exchange

    —          —              —          —          1,090        1,920   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (32,915     (17,227         77,709        (146,590     (132,362     (428,367

Provision for (benefit from) income taxes

    617        258            1,641        (334     167        (73,132
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) before losses from investment in unconsolidated affiliate

    (33,532     (17,485         76,068        (146,256     (132,529     (355,235

Losses of unconsolidated affiliate

    —          —              —          (1,436     (1,488     (1,038
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (33,532   $ (17,485       $ 76,068      $ (147,692   $ (134,017   $ (356,273
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

               

Basic and Diluted

    1,000        1,000            18,922        18,922        18,878        18,870   

Earnings (loss) per share of common stock:

               

Basic and Diluted

  $ (33.53   $ (17.49       $ 4.02      $ (7.81   $ (7.10   $ (18.88
 
    Successor Company                Predecessor Company  
    April 25,
2015
    April 26,
2014
               April 27,
2013
    April 28,
2012
    April 30,
2011
 

Balance Sheet Data:

               

Working capital (deficit)

  $ 100,595      $ 111,922            $ (30,325   $ 89,709      $ (17,507

Total assets

    312,952        339,619              427,573        463,521        637,544   

Long-term debt

    156,549        153,987              —          289,668        198,036   

Total debt

    182,193        166,375              198,302        290,623        296,279   

Stockholders’ equity (deficit)

    66,377        103,057              (79,192     67,946        201,629   

 

31


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes, included elsewhere in this Annual Report.

Factors Affecting Comparability

Fresh Start Accounting Adjustments

The Company adopted fresh start accounting and reporting effective June 11, 2013, the Fresh Start Reporting Date. The financial statements as of the Fresh Start Reporting Date report the results of the Successor Company with no beginning retained earnings or accumulated deficit. Any financial statement presentation of the Successor Company represents the financial position and results of operations of a new reporting entity and is not comparable to prior periods presented by the Predecessor Company. The financial statements for periods ended prior to the Fresh Start Reporting Date do not include the effect of any changes in the Predecessor Company’s capital structure or changes in the fair value of assets and liabilities as a result of fresh start accounting.

Accordingly, management has provided a non-GAAP analysis entitled “Non-GAAP Financial Information—Combined Results” for the twelve months ended April 26, 2014. Non-GAAP Financial Information—Combined Results combines GAAP results of the Successor Company for the forty-six weeks ended April 26, 2014 and GAAP results of the Predecessor Company for the six weeks ended June 11, 2013. Management’s non-GAAP analysis compares the Successor Company’s GAAP results for the twelve months ended April 25, 2015 and April 27, 2013 for certain financial items to the Non-GAAP Financial Information—Combined Results.

Background

We are a leading distributor of educational products, services and programs serving the preK-12 education market across the United States and Canada. We offer more than 60,000 items through an innovative two-pronged marketing approach that targets both school administrators and individual teachers.

On January 28, 2013, we filed voluntary petitions for relief under Chapter 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The cases (the “Chapter 11 Cases”) were jointly administered as Case No. 13-10125 (KJC) under the caption “In re School Specialty, Inc., et al.” We continued to operate our business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. Our foreign subsidiaries were not part of the Chapter 11 Cases.

On May 23, 2013, the Bankruptcy Court entered an order confirming the Reorganization Plan, and a corrected copy of the Reorganization Plan was entered by the Bankruptcy Court on June 3, 2013. The Reorganization Plan became effective on June 11, 2013 (the “Effective Date”). Pursuant to the Reorganization Plan, on the Effective Date, the Company’s existing credit agreements, outstanding convertible subordinated debentures, equity plans and certain other agreements were cancelled. In addition, all outstanding equity interests of the Company that were issued and outstanding prior to the Effective Date were cancelled on the Effective Date. Also on the Effective Date, in accordance with and as authorized by the Reorganization Plan, the Company reincorporated in Delaware and issued a total of 1,000,004 shares of Common Stock of the reincorporated company to holders of certain allowed claims against the Debtors in exchange for such claims. As of June 12, 2013, there were 60 record holders of the new common stock of the reorganized Company issued pursuant to the Reorganization Plan. The Reorganization Plan is described in additional detail above in Item 1, Business. The consolidated financial statements as of and for the year ended April 25, 2015 and as of April 26, 2014 and for the forty-six weeks then ended and any references to “Successor” or “Successor Company” show the financial position and results of operations of the reorganized Company subsequent to bankruptcy emergence on June 11, 2013. References to “Predecessor” or “Predecessor Company” refer to the financial position and results of operations of the Company prior to the bankruptcy emergence.

 

32


Our goal is to grow profitably as a leading provider of supplies, product, services and curriculum for the education market. We have experienced revenue declines in each of the last five fiscal years due primarily to the significant impact the current macroeconomic conditions have had on school spending. We believe revenue growth can be realized in future years. We expect to achieve this goal over the long-term through an organic growth strategy based on leveraging our strong brand names and distribution capabilities and transforming the Company’s sales and marketing to a more market/category focused approach with a balance of new customer acquisition and customer retention, and exploring new markets or revenue streams. New revenue streams include exploring opportunities in areas that could expand our addressable market, such as distribution to non-education customers, expansion into new product categories, continued growth in the alternative channel segment, and potentially, abroad in select international markets. In addition, the Company is committed to continuing to invest in its internal product development efforts in order to expand curriculum-based product offerings.

In fiscal 2015, the Company had an operating loss of $13.1 million. During the forty-six weeks ended April 26, 2014 the Company had operating income of $2.5 million and during the six weeks ended June 11, 2013 the Company had an operating loss of $3.9 million. The Company’s operating loss included $6.1 million of facility exit and restructuring costs and $2.7 million of impairment charges in fiscal 2015 and $6.6 million of facility exit and restructuring costs in the forty-six weeks ended April 26, 2014. Due to the significance of the restructuring costs and impairment charges in fiscal 2015 and fiscal 2014, the Company believes it is more meaningful to compare operating income and margin excluding these restructuring costs and pre-petition bankruptcy related charges. Excluding the impact of the restructuring costs and bankruptcy charges, the Company’s operating loss was $4.3 million for fiscal 2015 and its operating income was $9.1 million for the forty-six weeks ended April 26, 2014. In fiscal 2015, the Company’s revenue declined 1.4% from combined fiscal 2014 compared to a decline of 6.6% in combined fiscal 2014 compared to fiscal 2013. The Company did have positive revenue growth in certain product categories, most notably Furniture and Science. Gross margin declined in fiscal 2015 through a combination of product mix and incremental product development amortization. These declines, though, have been significantly offset by expense reductions. In fiscal 2015, the Company completed an organizational realignment to drive growth, achieve efficiencies, and increase profit margins. These organizational realignment actions included the following:

 

   

Sales Force Realignment—This included adapting the sales force to a newly implemented coverage model to improve customer service, increase customer touch points, and grow revenues. This included the expansion of the Company’s inside sales organization in order to increase contact with smaller districts.

 

   

Top Grading Assessments—This included a review of business functions and employee performance.

 

   

Right-Sizing the Organization—This included integrating disparate departments across the organization to optimize operational efficiency and to match the employee footprint to the size of the business. This resulted in better aligning departments in a shared service model.

The implementation of these actions was completed in fiscal 2015. These actions resulted in lowering the employee count from 1,450 to approximately 1,180 while consolidating redundant roles and activities. We estimate the annualized impact of these actions will be approximately $20 million.

While remaining focused on lowering costs through consolidation and process improvements, the Company is equally focused on revenue growth. While overall revenue was relatively stable in fiscal 2015, product categories with revenue growth were offset by categories that continued to have revenue declines. The Company believes it can generate revenue growth through initiatives that improve or enhance:

 

   

Collaboration among sales, marketing, merchandising, and operations,

 

   

Product innovation,

 

   

Product category specific sales and support expertise,

 

   

Effectiveness of the sales model, and

 

   

Customer experiences.

 

33


Our business and working capital needs are highly seasonal, with peak sales levels occurring from June through October. During this period, we receive, ship and bill the majority of our business so that schools and teachers receive their products by the start of each school year. Our inventory levels increase in April through June in anticipation of the peak shipping season. The majority of shipments are made between June and October and the majority of cash receipts are collected from September through December. As a result, we usually earn more than 100% of our annual net income in the first two quarters of our fiscal year and operate at a net loss in our third and fourth fiscal quarters.

Results of Operations

The following table sets forth certain information as a percentage of revenues on a historical basis concerning our results of operations for fiscal 2015, forty-six weeks ending April 26, 2014, the six weeks ending June 11, 2013 and fiscal 2013:

 

     Successor Company          Predecessor Company  
     Fiscal
Year
2015
    Forty-Six
Weeks
Ended
April 26,
2014
         Six
Weeks
Ended
June 11,
2013
    Fiscal
Year
2013
 

Revenues

     100.0     100.0         100.0     100.0

Cost of revenues

     63.3        61.2            59.8        60.9   
  

 

 

   

 

 

       

 

 

   

 

 

 

Gross profit

     36.7        38.8            40.2        39.1   

Selling, general and administrative expenses

     37.4        37.3            46.8        39.6   

Facility exit costs and restructuring

     1.0        1.1            0.0        0.0   

Impairment charge

     0.4        0.0            0.0        6.8   
  

 

 

   

 

 

       

 

 

   

 

 

 

Operating income (loss)

     -2.1        0.4            -6.6        -7.3   

Interest expense

     3.2        3.0            5.5        4.2   

Loss on early extinguishment of debt

     0.0        0.0            0.0        1.5   

Early termination of long-term indebtedness

     0.0        0.0            0.0        3.9   

Impairment of long-term asset

     0.0        0.0            0.0        0.2   

Impairment of investment in unconsolidated affiliate

     0.0        0.0            0.0        1.1   

Change in fair value of interest rate swap

     0.0        0.1            0.0        0.0   

Refund of early termination fee

     0.0        -0.7            0.0        0.0   

Reorganization items, net

     0.0        1.1            -144.5        0.0   
  

 

 

   

 

 

       

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

     -5.3        -3.1            132.4        -18.2   

Provision for (benefit from) income taxes

     0.1        0.0            2.8        3.4   
  

 

 

   

 

 

       

 

 

   

 

 

 

Income (loss) before losses from investment in unconsolidated affiliate

     -5.4        -3.1            129.6        -21.6   

Losses of unconsolidated affiliate

     0.0        0.0            0.0        0.0   
  

 

 

   

 

 

       

 

 

   

 

 

 

Net income (loss)

     -5.4     -3.1         129.6     -21.6
  

 

 

   

 

 

       

 

 

   

 

 

 

Non-GAAP Financial Information—Combined Results

As a result of the emergence from bankruptcy occurring six weeks into fiscal 2014, management believes that the presentation of Non-GAAP Financial Information—Combined Results offers a more useful non-GAAP normalized comparison to GAAP results for the twelve months ended April 25, 2015 and April 27, 2013. The Non-GAAP Financial Information—Combined Results presented below are reconciled to the most comparable GAAP measures. Thus, the combined results noted below for fiscal 2014 include the full fifty-two weeks of the fiscal year.

 

34


Consolidated Results

Successor Company GAAP results for the Twelve Months Ended April 25, 2015 Compared to Non-GAAP Combined Results for the Twelve Months Ended April 26, 2014

Overview of Fiscal 2015

Revenues

 

     Successor
Company
     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
 
     Twelve Months
Ended
April 25, 2015
     Forty-Six Weeks
Ended
April 26,  2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
 

Revenues

   $ 621,868       $ 572,045          $ 58,697       $ 630,742   

Revenues for the twelve months ended April 25, 2015 decreased 1.4%, or $8.8 million from the combined twelve months ended April 26, 2014.

Distribution segment revenues decreased $10.9 million, from the combined revenue in fiscal 2014 of $542.4 million to $531.5 million in fiscal 2015. The student planner and agenda products accounted for $8.7 million of the decline. We believe schools consider agenda products more discretionary in nature and some schools are de-emphasizing paper-based agendas in favor of digital products. In addition, schools are shifting their remaining agenda purchases to those with less content and, thus, lower average selling prices. The Company’s agenda product line’s average selling price decreased by approximately 5%, which resulted in $2.5 million of the decline in the category. Commercial printing generated zero revenues in fiscal 2015 as compared to $4.3 million of revenues generated in fiscal 2014 prior to the sale of the print plant assets in November 2013. Furniture revenues were up $3.8 million for the twelve months of fiscal 2015 as the Company has been successful in both re-establishing credit terms with most furniture vendors and gaining back customer confidence in the year following the emergence from bankruptcy. Overall furniture orders are up over 13.8%, year-over-year, in fiscal 2015. Revenue in the remaining product categories declined by $1.5 million in fiscal 2015.

Curriculum segment revenues increased $2.1 million, from $88.3 million of combined revenue in fiscal 2014 to $90.4 million in fiscal 2015. The Company experienced strong sales of its science curriculum products in Texas in connection with the state’s recent adoption of new science standards.

Gross Profit

 

     Successor
Company
     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
 
     Twelve Months
Ended
April 25, 2015
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
 

Gross profit

   $ 228,158       $ 222,200          $ 23,618       $ 245,818   

Gross profit of $228.2 million for fiscal 2015 was down 7.2% from the combined gross profit of $245.8 million in fiscal 2014. Gross margin was 36.7% for fiscal 2015 as compared to combined gross margin of 39.0% for fiscal 2014. The primary driver of the gross margin decline was incremental product development amortization of $7.1 million in fiscal 2015 which contributed 120 basis points of the gross margin decline.

Distribution segment gross profit decreased $11.8 million from $199.7 million of combined gross profit in fiscal 2014 to $187.9 million in fiscal 2015. Distribution gross margins declined by 150 basis points from 36.8% in fiscal 2014 to 35.3% in fiscal 2015. The decrease in gross margin is primarily related to the Company’s agenda product category. Approximately 130 basis points of the gross margin decline relates to the Company’s student planner and agenda product category, as both the mix of agendas as a percentage of the overall segment revenues and gross margins within the agendas category declined. The lower gross margins within the agenda

 

35


category are related to a combination of the lower average selling prices of agendas and incremental product development amortization. The remaining decline in gross margin is related to volume decline and product mix within the remaining product categories.

Curriculum segment gross profit decreased $5.8 million from a combined $46.1 million of gross profit in fiscal 2014 to $40.3 million in fiscal 2015. Gross margin was down 720 basis points from 52.2% in fiscal 2014 to 45.0% in fiscal 2015 resulting from, incremental product development amortization of $5.8 million. The incremental product development amortization was related to a combination of the increased amortization of the investment in custom CPO and FOSS product in support of the Texas Science adoption and approximately $2.5 million of product development write downs.

Selling, General and Administrative Expenses

 

     Successor
Company
     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
 
     Twelve Months
Ended
April 25, 2015
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
 

Selling, general and administrative expenses

   $ 232,479       $ 213,144          $ 27,473       $ 240,617   

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

SG&A decreased $8.1 million from $240.6 million in fiscal 2014 to $232.5 million in fiscal 2015. As a percent of revenue, SG&A decreased from 38.1% in fiscal 2014 to 37.4% in fiscal 2015. The previously mentioned restructurings and employee reductions contributed to the improved SG&A leverage.

SG&A attributable to the Distribution and Curriculum segments decreased $9.9 million and Corporate SG&A increased $1.8 million in fiscal 2015 as compared to combined SG&A in fiscal 2014.

Distribution segment SG&A decreased $4.3 million, or 2.4%, from $183.4 million of combined SG&A in fiscal 2014 to $179.1 million in fiscal 2015. The segment had a decrease of $1.6 million in its marketing costs primarily associated with a decrease in catalog costs as the Company reduced the number of seasonal catalog mailings and reduced circulation of other catalogs. This reduction reflects the Company’s continued strategy of increasing customer interactions through digital marketing campaigns and a more efficient use of printed catalogs. Compensation and benefit costs for the Distribution segment decreased $4.3 million which is net of a $1.0 million current year increase related to the elimination of an unpaid furlough week. Headcount for the Distribution segment has been reduced by approximately 14% compared to fiscal 2014. These decreases were partially offset by $1.9 million of additional outbound freight costs. Distribution segment SG&A decreased as a percent of revenue from 33.8% in fiscal 2014 to 33.7% in fiscal 2015.

Curriculum segment SG&A decreased $5.6 million, or 11.5%, from $48.9 million of combined SG&A in fiscal 2014 to $43.3 million fiscal 2015. The segment had a decrease of $0.7 million in its marketing costs primarily associated with a decrease in catalog costs as the Company reduced the number of seasonal catalog mailings. Compensation and benefit costs for the Curriculum segment decreased by $3.0 million. Headcount for the Curriculum segment has been reduced by approximately 25% compared to fiscal 2014. Curriculum segment SG&A decreased as a percent of revenue from 55.4% in fiscal 2014 to 47.9% in fiscal 2015.

The Corporate SG&A increase of $1.8 million is related primarily to process improvement implementation costs such as consulting fees and warehouse implementation costs associated with transitioning the majority of

 

36


fulfillment activities to the Company’s Mansfield, Ohio distribution center. Approximately $0.6 million of the increase is attributable to the fiscal 2015 write down of the Company’s Salina, Kansas facility which was classified as an asset held for sale, and was sold for $1.6 million in the fourth quarter of fiscal 2015.

Facility Exit Costs and Restructuring

In fiscal 2015, the Company recorded $6.1 million of restructuring charges related primarily to severance and adjustments to estimated lease termination costs associated with a prior year distribution center closure. Severance in fiscal 2015 associated with the integration of functions and transition to an integrated shared services model was $5.5 million of the $6.1 million total facility exit and restructuring costs.

In fiscal 2014, the Company recorded $6.6 million of bankruptcy-related facility exit costs and restructuring charges. The closure of the Company’s distribution centers and printing plants resulted in charges of $3.8 million which included lease termination costs and other shutdown related expenditures. Severance costs in fiscal 2014 were $2.8 million of the $3.8 million total facility exit and restructuring costs.

Impairment Charges

The Company recorded an impairment charge of $2.7 million in fiscal 2015 related to the amortizable asset associated with the agenda product category’s digital content and digital delivery development efforts. The Company is focused on the print-based agenda products and does not currently plan to continue to invest in the digital agenda product offerings.

Interest Expense

 

     Successor
Company
     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
 
     Twelve Months
Ended
April 25, 2015
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
 

Interest expense

   $ 19,599       $ 16,882          $ 3,235       $ 20,117   

Interest expense decreased $0.5 million, from $20.1 million in fiscal 2014 to $19.6 million in fiscal 2015.

Non-cash interest increased in fiscal 2015 by $0.6 million as compared to fiscal 2014. Non-cash interest expense associated with paid-in-kind interest on deferred vendor obligations increased by $0.9 million, mainly due to the increase in deferred vendor obligations. This increase was partially offset by a decrease of $0.3 million in non-cash interest related to debt fee amortization and original issue discount accretion. In fiscal 2015, interest expense associated with the Successor Company’s New Term Loan was approximately $0.7 million lower than the term loan interest expense in fiscal 2014, primarily due to a lower interest rate under the New Term Loan as compared to the Predecessor Company’s term loan. In fiscal 2015, interest expense associated with the Successor Company’s New ABL Facility was approximately $0.2 million lower than the interest expense for fiscal 2014, primarily due to a lower average outstanding balance.

Change in Fair Value of Interest Rate Swap

In the second quarter of fiscal 2014, the Company entered into an interest rate swap agreement that effectively fixes the interest payments on a portion of the Company’s variable-rate debt. The swap, which has a termination date of September 11, 2016, effectively fixes the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. The notional amount of the swap at April 25, 2015 was $72.5 million. During the year ended April 25, 2015, the fair value of the derivative increased by less than $0.1 million and, accordingly, a non-cash gain of less than $0.1 million was recorded.

 

37


Partial Refund of Early Termination Fee

During the third quarter of fiscal 2013, the Company recorded a $25.1 million prepayment charge related to the acceleration of the obligations under the Bayside term loan credit agreement. The charge was triggered by the Company’s non-compliance with the minimum liquidity covenant. The early payment fee represented the present value of interest payments due to Bayside (our pre-bankruptcy term loan lender) during the term of the term loan agreement. The $25.1 million early termination fee plus approximately $1.3 million of potential interest expense was placed in an escrow account. The escrow funds, totaling $26.4 million, were released to Bayside early in the second quarter of fiscal 2014.

During the second quarter of fiscal 2014, the parties reached an agreement whereby the early termination fee was fixed at $21.0 million. As such, Bayside retained $21.0 million, and refunded to the Company the $5.4 million escrow. The refund was received by the Company in the second quarter of fiscal 2014, of which $4.1 million was a partial refund of the early termination fee and the remainder was a refund of interest expense.

Reorganization Items, Net

In the first quarter of fiscal 2015, the Company recorded a $0.3 million net reorganization loss. This consisted of professional advisory fees and other costs related to the continued implementation of the Reorganization Plan and the resolution of unresolved claims.

In fiscal 2014, the Company recorded a $78.4 million net reorganization gain. This consists of $162.4 million of cancellation of indebtedness income related to the settlement of prepetition liabilities and changes in the Predecessor’s capital structure arising from implementation of the Reorganization Plan, offset by $30.2 million of fresh start adjustments, $21.4 million of cancellation of debt upon the issuance of equity, $19.4 million of professional, financing and other fees, $7.0 million of contract rejections and $5.1 million of other reorganization adjustments.

Provision for (Benefit from) Income Taxes

 

     Successor
Company
     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
 
     Twelve Months
Ended
April 25, 2015
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
 

Provision for (benefit from) income taxes

   $ 617       $ 258          $ 1,641       $ 1,899   

The provision for income taxes was $0.6 million for fiscal 2015 as compared to a combined provision for income taxes of $1.9 million for fiscal 2014.

The provision recorded in fiscal 2015 is related to foreign and state taxes. The Company generated a taxable loss in fiscal 2015. The effective rate for fiscal 2015 was (1.9%). As future realization of deferred tax assets, including net operating loss carryforwards, did not meet the more likely than not threshold, the Company recorded a full valuation allowance as of April 25, 2015. The effective tax rate for fiscal 2015 was (1.9%) which was significantly lower than the statutory rate as a result of the valuation allowances.

The combined effective tax rate for fiscal 2014 was 3.1%. This rate was significantly lower than the statutory rate because the net reorganization income realized during this period was primarily related to cancellation of indebtedness income. During the six weeks ended June 11, 2013, the Company excluded from taxable income $129,084 of cancellation of indebtedness income as defined under Internal Revenue Code (“IRC”) Section 108. IRC Section 108 excludes from taxable income the amount of indebtedness discharged under a Chapter 11 case. IRC Section 108 also requires a reduction of tax attributes equal to the amount of excluded taxable income. As a result, the Company reduced the available federal and state net operating loss

 

38


carryforward and adjusted the tax reporting basis of tangible and intangible assets for the discharge of indebtedness income. In addition to the adjustment to the tax reporting basis as described above, the fresh start accounting adjustments also created additional basis differences in basis between for income tax and financial reporting purposes. Because the Company had recorded a full valuation allowance in fiscal 2013, the reduction of tax attributes resulted in a corresponding reduction of the valuation allowance. Thus, the reduction of tax attributes did not result in an increased effective tax rate for fiscal 2014.

Non-GAAP Combined Results for the Twelve Months Ended April 26, 2014 to the Predecessor GAAP results for the Twelve Months Ended April 27, 2013.

Overview of Fiscal 2014

Revenues for the combined periods of fiscal 2014 decreased 6.6% to $630.7 million as compared to $675.0 million in fiscal 2013. The Distribution and Curriculum segments experienced combined revenue declines of 7.1% and 3.3% in fiscal 2014, respectively. The revenue declines in both the Distribution and the Curriculum segments were partially attributable to the lower school spending as the Company believes state budget funding for education continued to decline. According to the National Bureau of Economic Research, state revenue collections 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. State tax receipts, a key component of school funding, have shown modest signs of recovery. In addition, the Company believes that customer uncertainty related to the bankruptcy negatively impacted fiscal 2014 revenues.

Combined gross margin decreased 10 basis points to 39.0% in fiscal 2014 as compared to 39.1% in fiscal 2013.

Combined SG&A decreased $26.9 million or 150 basis points as a percent of revenue in fiscal 2014 as compared to fiscal 2013. SG&A attributable to the Distribution and Curriculum segments decreased a combined $27.6 million and Corporate SG&A increased $0.7 million in fiscal 2014 as compared fiscal 2013.

Operating loss was $1.4 million in fiscal 2014 as compared to $49.4 million in fiscal 2013. Operating margins increased from 0.2% in fiscal 2013 to 0.8% in fiscal 2014 excluding the impact of the restructuring costs, impairment charges and bankruptcy related charges. The increase in operating margins was a result of expense reductions as a result of the Process Improvement Program described above partially offset by declines in school spending in fiscal 2014 due to the uncertainty in education funding levels and state budgetary concerns.

Revenues

 

     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
     Twelve Months
Ended
April 27, 2013
 

Revenues

   $ 572,045          $ 58,697       $ 630,742       $ 674,998   

Combined revenues decreased 6.6% from $675.0 million in fiscal 2013 to $630.7 million in fiscal 2014.

Distribution segment combined revenues decreased 7.1% from $583.7 million in fiscal 2013 to $542.4 million in fiscal 2014. Approximately $12 million of the decline was related to the supplies product lines, while the furniture product lines declined approximately $18 million. This decline was primarily due to the fact that revenue in the back-to-school season was negatively impacted by factors related to the Chapter 11 Cases. These factors included continued customer uncertainty during the Chapter 11 Cases which we believe was a contributing factor to the decline in incoming orders. Approximately $10 million of the decline was related to our

 

39


student planner and agenda products. We believe schools consider agenda products more discretionary in nature and some schools are de-emphasizing paper-based agendas in favor of digital products.

Curriculum segment combined revenues decreased by 3.3% from $91.3 million in fiscal 2013 to $88.3 in fiscal 2014. The decline is related primarily to large curriculum orders in Florida and Mississippi in fiscal 2013, which were not expected to recur in fiscal 2014.

Gross Profit

 

     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
     Twelve Months
Ended
April 27, 2013
 

Gross profit

   $ 222,200          $ 23,618       $ 245,818       $ 263,880   

Combined gross profit decreased 6.8% from $263.9 million in fiscal 2013 to $245.8 million in fiscal 2014. The decrease in consolidated revenue resulted in approximately $17.3 million of the decline in gross profit had consolidated gross margin remained constant. Gross margin decreased 10 basis points, from 39.1% in fiscal 2013 to combined 39.0% in fiscal 2014.

Distribution segment combined gross profit decreased $15.3 million from $215.0 million in fiscal 2013 to $199.7 in fiscal 2014. Combined gross margin was unchanged between fiscal 2013 and fiscal 2014 at 36.8%. Declines in vendor rebates earned negatively impacted gross margin in fiscal 2014 by approximately 40 basis points, but favorable product mix offset this decline.

Curriculum segment combined gross profit decreased $2.8 million from $48.9 million in fiscal 2013 to $46.1 million in fiscal 2014. Combined gross margin decreased 140 basis points from 53.6% in fiscal 2013 to 52.2% in fiscal 2014. The decrease in segment revenue resulted in approximately $1.6 million of the decline in segment gross profit had segment gross margin remained constant. The remaining decline was primarily related to product mix as sales of curriculum-related products were still under pressure because common core standards had not been finalized across states, and school budgets had not improved.

Selling, General and Administrative Expenses

 

     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
     Twelve Months
Ended
April 27, 2013
 

Selling, general and administrative expenses

   $ 213,144          $ 27,473       $ 240,617       $ 267,491   

SG&A includes selling expenses, the most significant of which are wages and sales commissions; operations expenses, which include 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, combined SG&A decreased from 39.6% in fiscal 2013 to 38.1% in fiscal 2014. Combined SG&A decreased $26.9 million from $267.5 million in fiscal 2013 to $240.6 million in fiscal 2014. Combined SG&A attributable to the Distribution and Curriculum segments decreased a combined $27.6 million and combined Corporate SG&A increased $0.7 million in fiscal 2014 as compared to fiscal 2013.

Distribution segment combined SG&A decreased $23.1 million, or 11.2%, from $206.5 million in fiscal 2013 to $183.4 million in fiscal 2014. Approximately $4.3 million of the decline was due to variable costs such

 

40


as transportation and warehousing expenses associated with the decline in revenue. In addition, the segment had a decrease of $5.2 million in marketing costs primarily associated with a decrease in catalog costs as the Company reduced the number of seasonal catalog mailings and reduced circulation of other catalogs. Depreciation and amortization expense decreased by $5.5 million, primarily as a result of fresh start accounting. The remaining decrease is primarily compensation and benefit costs associated with headcount reductions. As a percent of revenue, Distribution segment combined SG&A decreased from 35.4% in fiscal 2013 to 33.8% in fiscal 2014.

Curriculum segment combined SG&A decreased $4.5 million, or 8.5%, from $53.5 million in fiscal 2013 to $48.9 million in fiscal 2014. Decreases in depreciation and amortization associated with fresh start accounting comprised $3.5 million of this decline. The remaining decline was primarily attributable to reduced compensation and benefit costs associated with headcount reductions. As a percent of revenue, Curriculum segment combined SG&A decreased from 58.6% in fiscal 2013 to 55.4% in fiscal 2014.

The increase in combined Corporate SG&A was related to approximately $6.4 million of costs incurred primarily to implement the process improvement actions. In addition, approximately $1.9 million of the increase in fiscal 2014 was related to incremental freight and warehousing costs incurred due to backorders that resulted from supply chain interruptions related to the Company’s bankruptcy. The bankruptcy created uncertainty in the vendor base which contributed to an increase in backorders of approximately 90%. By the end of the fiscal year, backorder levels had been reduced to below historic norms. These costs were partially offset by $4.7 million of pre-petition expenses associated with attorney and advisor fees incurred in preparation of the Company’s bankruptcy filing and $2.8 million of costs associated with the Company’s shutdown of the Mt. Joy, Pennsylvania distribution center in fiscal 2013.

Facility Exit Costs and Restructuring

In fiscal 2014, the Successor Company recorded $6.6 million of facility exit costs and restructuring charges. The closure of the Company’s distribution centers and printing plants resulted in charges of $3.8 million which included lease termination costs and other shutdown related expenditures. Severance in fiscal 2014 was $2.8 million.

Impairment Charges

The Company recorded $45.8 million of impairment charges in fiscal 2013. Due to a triggering event in the third quarter of fiscal 2013, the Company recorded a goodwill impairment charge of $41.1 million, which consisted of $27.5 million, $9.7 million and $3.9 million for the Planning and Student Development, Reading and Califone reporting units, respectively. An impairment charge of $4.7 million was related to indefinite-lived intangible assets of the Curriculum segment.

Interest Expense

 

     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
     Twelve Months
Ended
April 27, 2013
 

Interest expense

   $ 16,882          $ 3,235       $ 20,117       $ 28,600   

Combined interest expense decreased $8.5 million from $28.6 million in fiscal 2013 to $20.1 million in fiscal 2014. The decrease is related to $11.3 million of interest expense incurred by the Predecessor Company in fiscal 2013 on its convertible debt, of which $6.8 million was non-cash. The Company incurred no additional interest expense on the convertible debt subsequent to the Chapter 11 filing. The convertible debt was canceled in accordance with the Reorganization Plan with those debt holders receiving 35% of the equity of the Successor

 

41


Company. In addition, decreased borrowings on the Company’s New ABL Facility as compared to the Company’s 2012 ABL Facility resulted in $1.6 million of decreased interest expense in fiscal 2014. These decreased borrowings were related to the recapitalization of the Company under the Reorganization Plan. Interest expense related to the Company’s Ad Hoc DIP Term Loan decreased by $1.5 million in fiscal 2014.

The decreases in combined interest expense were partially offset with $6.1 million of additional interest expense related to the Successor Company’s New Term Loan as compared to the Predecessor Company’s pre-bankruptcy Term Loan interest expense in fiscal 2013. This increase was due to higher average borrowings under the New Term Loan partially offset by a decrease in the interest rate.

Loss on Early Extinguishment of Debt

The Company recorded a $10.2 million charge in fiscal 2013 associated with the unamortized debt issuance costs related to the pre-bankruptcy credit facilities.

Early Termination of Long-Term Indebtedness

During the third quarter of fiscal 2013, the Company recorded a $25.1 million prepayment charge related to the acceleration of the obligations under the Bayside term loan credit agreement. The charge was triggered by the Company’s non-compliance with the minimum liquidity covenant. The early prepayment fee represented the present value of interest payments due to Bayside during the term of the term loan credit agreement. The $25.1 million early termination fee plus approximately $1.3 million of potential interest expense was placed in an escrow account. These escrow funds, totaling $26.4 million, were released to Bayside early in the second quarter of fiscal 2014.

During the second quarter of fiscal 2014, the parties reached an agreement whereby the early termination fee was fixed at $21.0 million. As such, Bayside retained $21.0 million, and refunded to the Company the $5.4 million excess. The refund was received by the Company in the second quarter of fiscal 2014, of which $4.1 million was a partial refund of the early termination fee and the remainder was a recovery of interest expense.

Impairment of Long-Term Asset

In the second quarter of fiscal 2013 the Company recorded a $1.4 million impairment charge related to the note receivable it had recorded on its balance sheet from the sale of the Visual Media business in fiscal 2008. The Company received proceeds of $3.0 million in conjunction with the settlement of the note receivable that was used to pay down a portion of the then-outstanding term loan.

Impairment of Unconsolidated Affiliate Investment

The Company recorded an impairment of its investment in Carson-Dellosa in fiscal 2013. The value of the Company’s 35% ownership interest was re-evaluated in fiscal 2013 as Carson-Dellosa operating results did not achieve expectations and prospective forecasts were lowered based on continued school spending declines in the supplemental education market. The decline in current and projected cash flows resulted in the value of the Company’s ownership interest being $7.7 million less than the Company’s carrying amount in fiscal 2013. The write-down have been reflected in other expense.

Change in fair value of interest rate swap

In the second quarter of fiscal 2014, the Company entered into an interest rate swap agreement that effectively fixes the interest payments on a portion of the Company’s variable-rate debt. The swap, which has a termination date of September 11, 2016, effectively fixes the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. The notional amount of the swap at April 26, 2014 was $72.5 million. As of April 26, 2014, the fair value of the derivative decreased by $0.5 million and, accordingly, a non-cash loss of $0.5 million was recorded.

 

42


Reorganization Items, Net

 

     Successor
Company
         Predecessor
Company
    Non-GAAP
Combined
    Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
    Twelve Months
Ended
April 26, 2014
    Twelve Months
Ended
April 27, 2013
 

Reorganization items, net

   $ 6,420          $ (84,799   $ (78,379   $ 22,979   

In fiscal 2014, the Company recorded a $78.4 million combined net reorganization gain. This consists of $162.4 million of cancellation of indebtedness income related to the settlement of prepetition liabilities and changes in the Predecessor’s capital structure arising from implementation of the Reorganization Plan, offset by $30.2 million of fresh start adjustments, $21.4 million upon the issuance of equity in excess of debt carrying amount, $20.3 million of professional, financing and other fees, $7.0 million of contract rejections and $5.1 million of other reorganization adjustments.

Included in the $20.3 million of professional and other financing fees are $6.9 million of professional fees incurred after the Effective Date which pertained to post-emergence activities related to the implementation of the Reorganization Plan and other transition costs attributable to the reorganization.

Provision for/(Benefit from) Income Taxes

 

     Successor
Company
         Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     Forty-Six Weeks
Ended
April 26, 2014
         Six Weeks
Ended
June 11, 2013
     Twelve Months
Ended
April 26, 2014
     Twelve Months
Ended
April 27, 2013
 

Provision for (benefit from) income taxes

   $ 258          $ 1,641       $ 1,899       $ (334

The provision for taxes was $1.6 million for the Predecessor Company for the six weeks ended June 11, 2013. Approximately $1.5 million of this provision related to foreign withholding taxes associated with prior deemed dividend distributions from the Company’s foreign subsidiary. The pre-tax income for the six weeks ended June 11, 2013 for the Predecessor Company results from the Reorganization gain. This gain is primarily related to cancellation of indebtedness income which is not taxable, but reduces the Company’s net operating loss carryforwards and other tax attributes. Because the Company had previously recorded a full valuation allowance against its deferred tax assets, this reduction in tax attributes does not impact the tax provision. The provision for taxes was $0.3 million for the Successor Company for the forty-six weeks ended April 26, 2014. This provision is related primarily to foreign and state taxes. Any U.S. federal tax benefit associated with the Successor Company’s pre-tax loss was offset with valuation allowances as the Company determined its deferred tax assets are not more likely than not of being realized, at this time.

Liquidity and Capital Resources

At April 25, 2015, the Company had working capital of $100.6 million. The Company’s capitalization at April 25, 2015 was $248.6 million and consisted of total debt of $182.2 million and stockholders’ equity of $66.4 million.

As discussed in Note 3—Bankruptcy Proceedings, all of the Predecessor Company debt was cancelled as of the Effective date.

On June 11, 2013, in accordance with the Reorganization Plan, the Company entered into a Loan Agreement (the “Asset-Based Credit Agreement”) among the Company, Bank of America, N.A, as Agent, SunTrust Bank, as Syndication Agent, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SunTrust Robinson Humphrey, Inc., as Joint Lead Arrangers and Bookrunners, and the Lenders that are party to the Asset-Based Credit Agreement (the “Asset-Based Lenders”).

 

43


Under the Asset-Based Credit Agreement, the Asset-Based Lenders agreed to provide a revolving senior secured asset-based credit facility (the “New ABL Facility”) in an aggregate principal amount of $175 million. Outstanding amounts under the New ABL Facility will bear interest at a rate per annum equal to, at the Company’s election: (1) a base rate (equal to the greatest of (a) the prime lending rate, (b) the federal funds rate plus 0.50%, and (c) the 30-day LIBOR rate plus 1.00% per annum) (the “Base Rate”) plus an applicable margin (equal to a specified margin based on the interest rate elected by the Company, the fixed charge coverage ratio under the New ABL Facility and the applicable point in the life of the New ABL Facility) (the “Applicable Margin”), or (2) a LIBOR rate plus the Applicable Margin (the “LIBOR Rate”). Interest on loans under the New ABL Facility bearing interest based upon the Base Rate will be due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate will be due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.

The New ABL Facility will mature on June 11, 2018. The Company may prepay advances under the New ABL Facility in whole or in part at any time without penalty or premium. The Company will be required to make specified prepayments upon the occurrence of certain events, including: (1) the amount outstanding on the New ABL Facility exceeding the Borrowing Base, and (2) the Company’s receipt of net cash proceeds of any sale or disposition of assets that are first priority collateral for the New ABL Facility.

Pursuant to a Guaranty and Collateral Agreement dated as of June 11, 2013 (the “New ABL Security Agreement”), the New ABL Facility is secured by a first priority security interest in substantially all assets of the Company and the guarantor subsidiaries. Under an intercreditor agreement between the Asset-Based Lenders and the Term Loan Lenders, as defined and described below, the Asset-Based Lenders have a first priority security interest in substantially all working capital assets of the Company and the guarantor subsidiaries, and a second priority security interest in all other assets, subordinate only to the first priority security interest of the Term Loan Lenders in such other assets.

The Asset-Based Credit Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to a springing financial covenant relating to the Company’s fixed charge coverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments. The Company was in compliance with the financial covenants during fiscal 2015 and expects to remain in compliance with these covenants over the next 12 months.

Also on June 11, 2013, the Company entered into a credit agreement (the “New Term Loan Credit Agreement”) among the Company, Credit Suisse AG, as Administrative Agent and Collateral Agent, and the lenders party to the New Term Loan Credit Agreement (the “Term Loan Lenders”).

Under the New Term Loan Credit Agreement, the Term Loan Lenders agreed to make a term loan (the “New Term Loan”) to the Company in aggregate principal amount of $145 million. The outstanding principal amount of the New Term Loan will bear interest at a rate per annum equal to the applicable LIBOR rate (with a 1% floor) plus 8.50%, or the base rate plus a margin of 7.50% as determined by the elective form of borrowings under the New Term Loan Credit Agreement by the Company. Interest on loans under the New Term Loan Credit Agreement bearing interest based upon the base rate will be due quarterly in arrears, and interest on loans bearing interest based upon the LIBOR rate will be due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.

The New Term Loan matures on June 11, 2019. The New Term Loan Credit Agreement requires prepayments at specified levels upon the Company’s receipt of net proceeds from certain events, including: (1) certain dispositions of property, divisions, business units or business lines; and (2) other issuances of debt other than Permitted Debt, as defined in the New Term Loan Credit Agreement. The New Term Loan Credit Agreement also requires prepayments at specified levels from the Company’s excess cash flow. The Company is also permitted to voluntarily prepay the New Term Loan in whole or in part. Any prepayments are to be made at par, plus an early payment fee calculated in accordance with the terms of the New Term Loan Credit Agreement if prepaid prior to the second anniversary of October 31, 2016.

 

44


Pursuant to a Guarantee and Collateral Agreement dated as of June 11, 2013 (the “New Term Loan Security Agreement”), the New Term Loan is secured by a first priority security interest in substantially all assets of the Company and the guarantor subsidiaries. Under an intercreditor agreement between the Asset-Based Lenders and the Term Loan Lenders, the Term Loan Lenders have a second priority security interest in substantially all working capital assets of the Company and the subsidiary guarantors, subordinate only to the first priority security interest of the Asset-Based Lenders in such assets, and a first priority security interest in all other assets.

The New Term Loan Credit Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants that commenced on the fiscal quarter ending January 25, 2014, relating to the Company’s (1) minimum interest coverage ratio and (2) maximum net total leverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments. The Company was in compliance with the financial covenants during fiscal 2015 and expects to remain compliant with these covenants over the next twelve months.

On October 31, 2014 the Company obtained amendments to both its Asset-Based Credit Agreement and New Term Loan Credit Agreement. The amendments provide the Company additional flexibility in its execution of certain restructuring actions by increasing the dollar amount of EBITDA covenant add backs for non-recurring, unusual or extraordinary charges, business optimization expenses or other restructuring charges or reserves and cash expenses relating to earn outs or similar obligations. The Company closely evaluates its expected ability to remain in compliance with the financial covenants under our New ABL Security Agreement and New Term Loan Credit Agreement. Based on current projections, the Company believes it will maintain compliance with these financial covenants through the next twelve months.

Net cash provided by operating activities was $5.4 million for fiscal 2015 and $19.5 million for the forty-six weeks ended April 26, 2014 (Successor Company), and net cash used in operating activities was $20.0 million in the six weeks ended June 11, 2013 (Predecessor Company). The increase of $5.8 million is due to a reduction in bankruptcy-related costs or other financing related fees of $26.9 million which were paid in fiscal 2014, partially offset by the impact of working capital changes of $17.0 million, excluding accrued bankruptcy fees. Operating cash flow in fiscal 2014 was benefited by approximately $15.0 million of inventory prepayments made in the fourth quarter of fiscal 2013. These prepayments were necessary due to the impact the bankruptcy filing had on vendor relationships and terms. As the Company was able to return vendors to more customary terms in the year following the bankruptcy, large inventory prepayments were not necessary in fiscal 2015.

Net cash used in investing activities was $15.6 million for fiscal 2015. Net cash provided by investing activities was $9.9 million for the forty-six weeks ended April 26, 2014 (Successor Company) and net cash used in investing activities was $0.7 million for the six weeks ended June 11, 2013 (Predecessor Company). The change was primarily due to the release of $26.3 million of restricted cash in fiscal 2014 which related primarily to the Bayside early termination fee dispute, which was settled in the second quarter of fiscal 2014. The decrease related to the restricted cash was partially offset by decreased spending of $1.6 million on property, plant, and equipment in fiscal 2015.

Net cash used by financing activities was $36.0 million for the forty six weeks ended April 26, 2014 (Successor Company). Net cash provided by financing activities was $15.5 million for the six weeks ended June 11, 2013 (Predecessor Company). The combined net cash used in financing activities for fiscal 2014 was $21.5 million. Net cash provided by financing activities was $11.1 million for fiscal 2015, or an increase of $31.6 million from fiscal 2014. The combined increase of $31.6 million relates primarily to the payment of the $26.4 million of early termination fee in fiscal 2014. Outstanding borrowings on the New ABL Facility were $24.2 million as of April 25, 2015, while the excess availability on that date for the New ABL Facility was $51.6 million. Consistent with previous years, the Company expects excess availability to increase during its 2015 back to school season.

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

 

45


Off Balance Sheet Arrangements

None.

Summary of Contractual Obligations

The following table summarizes our contractual debt and operating lease obligations as of April 25, 2015:

 

     Payments Due
(in thousands)
 
     Total      Less than
1 year
     1 – 3 years      3 – 5
years
     More than
5 years
 

Long-term debt obligations (1)

   $ 223,620       $ 40,733       $ 29,729       $ 153,158       $ —     

Deferred cash payment obligations (1)

     24,027         —           —           24,027         —     

Operating lease obligations

     20,004         6,639         8,536         3,571         1,258   

Purchase obligations (2)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 267,651       $ 47,372       $ 38,265       $ 180,756       $ 1,258   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Long-term debt obligations and deferred cash payment obligations include principal and interest using either fixed rates or variable rates in effect as of April 25, 2015.
(2) As of April 25, 2015, we did not have any material long-term purchase obligations. The Company’s short-term purchase obligations as of April 25, 2015 were primarily for the purchase of inventory in the normal course of business.

Fluctuations in Quarterly Results of Operations

Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by variations in our costs for the products sold, the mix of products sold and general economic conditions. Therefore, results for any quarter are not indicative of the results that we may achieve for any subsequent fiscal quarter or for a full fiscal year.

The following table sets forth certain unaudited consolidated quarterly financial data for fiscal years 2015 and 2014 (in thousands, except per share data). We derived this quarterly data from our unaudited consolidated financial statements.

 

     Fiscal 2015  
     Successor Company  
     First      Second      Third     Fourth     Total  

Revenues

   $ 199,469       $ 238,670       $ 77,754      $ 105,975      $ 621,868   

Gross profit

     78,566         86,822         26,808        35,962        228,158   

Operating income (loss)

     16,491         17,000         (26,292     (20,289     (13,090

Net income (loss)

     11,014         11,923         (30,651     (25,818     (33,532

Basic earnings per share of common stock:

          

Earnings/(loss)

   $ 11.01       $ 11.92       $ (30.65   $ (25.82   $ (33.53
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Diluted earnings per share of common stock:

          

Earnings/(loss)

   $ 11.01       $ 11.92       $ (30.65   $ (25.82   $ (33.53
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

46


     Fiscal 2014  
     Predecessor
Company
          Successor Company  
     6 weeks           7 weeks      Second      Third     Fourth     Total  

Revenues

   $ 58,697           $ 143,499       $ 245,629       $ 74,664      $ 108,253      $ 572,045   

Gross profit

     23,618             59,758         93,205         26,448        42,789        222,200   

Operating income (loss)

     (3,855          21,296         19,243         (24,653     (13,382     2,504   

Net income (loss)

     76,068             16,943         14,697         (30,135     (18,990     (17,485

Basic earnings per share of common stock:

                   

Earnings/(loss)

   $ 4.02           $ 16.94       $ 14.70       $ (30.14   $ (18.99   $ (17.49
  

 

 

        

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Diluted earnings per share of common stock:

                   

Earnings/(loss)

   $ 4.02           $ 16.94       $ 14.70       $ (30.14   $ (18.99   $ (17.49
  

 

 

        

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

The summation of quarterly net income (loss) per share may not equate to the calculation for the full fiscal year as quarterly calculations are performed on a discrete basis.

Inflation

Inflation, particularly in fuel and other oil-related costs, has had and could continue to have an effect on our results of operations, in both our cost of revenues and SG&A expenses, and our internal and external sources of liquidity.

Critical Accounting Policies

We believe the policies identified below are critical to our business and the understanding of our results of operations. The impact and any associated risks related to these policies on our business are discussed throughout this section where applicable. Refer to the notes to our consolidated financial statements in Item 8 for detailed discussion on the application of these and other accounting policies. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis and base them on a combination of historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical accounting policies that require significant judgments and estimates and assumptions used in the preparation of our consolidated financial statements are as follows:

Revenue Recognition

Revenue, net of estimated returns and allowances, is recognized upon the shipment of products or upon the completion of services to customers, which corresponds to the time when risk of ownership transfers, the selling price is fixed, the customer is obligated to pay, collectability is reasonably assured and we have no significant remaining obligations. Cash received in advance from customers is deferred on our balance sheet as a current liability until revenue is recognized.

Catalog Costs and Related Amortization

We spend approximately $15 million annually to produce and distribute catalogs. We accumulate all direct costs incurred, net of vendor cooperative advertising payments, in the development, production and circulation of our catalogs on our balance sheet until such time as the related catalog is mailed. They are subsequently amortized into SG&A over the expected sales realization cycle, which is one year or less. Consequently, any difference between our estimated and actual revenue stream for a particular catalog and the related impact on amortization expense is neutralized within a period of one year or less. Our estimate of the expected sales

 

47


realization cycle for a particular catalog is based on, among other possible considerations, our historical sales experience with identical or similar catalogs and our assessment of prevailing economic conditions and various competitive factors. We track our subsequent sales realization, reassess the marketplace, and compare our findings to our previous estimate and adjust the amortization of our future catalogs, if necessary.

Development Costs

We accumulate external and certain internal costs incurred in the development of our products which can include a master copy of a book, video or other media, on our balance sheet. As of April 25, 2015, we had $19.6 million in development costs on our balance sheet. A majority of these costs are associated with science and reading curriculum businesses. The capitalized development costs are subsequently amortized into cost of revenues over the expected sales realization cycle of the products, which is typically five years. During fiscal 2015 we amortized development costs of $14.3 million to expense. The fiscal 2015 amortization includes write downs totaling $2.3 million in the Distribution segment and $1.4 in the Curriculum segment based on the company’s reassessment of revenue projections for certain products. We continue to monitor the expected sales realization cycle for each product, and will adjust the remaining expected life of the development costs or recognize impairments, if warranted.

Goodwill and Intangible Assets, and Long-Lived Assets

At April 25, 2015, intangible assets represented approximately 20% of our total assets. We review our goodwill and other indefinite life intangible assets for impairment annually, or more frequently if indicators of impairment exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements.

As it relates to goodwill and indefinite life intangible assets, we apply the impairment rules in accordance with FASB ASC Topic 350, “Intangibles—Goodwill and Other”. As required by FASB ASC Topic 350, the recoverability of these assets is subject to a fair value assessment, which includes judgments regarding financial projections, including forecasted cash flows and discount rates, and comparable market values. As it relates to finite life intangible assets, we apply the impairment rules as required by FASB ASC Topic 360-10-15, “Impairment or Disposal of Long-Lived Assets” which also requires significant judgments related to the expected future cash flows attributable to the primary asset. Key assumptions used in the impairment analysis include, but are not limited to, expected future cash flows, business plan projections, revenue growth rates, and the discount rate utilized for discounting such cash flows. 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.

In completing the fiscal 2015 assessment, the Science and Reading reporting units each had fair value in excess of carrying value of greater than 10%. The fair value of the Distribution reporting unit was in excess of its carrying value by 3%. In order to conclude upon the assumptions for the discounted cash flow analysis, the Company considered multiple factors, including (a) macroeconomic conditions, (b) industry and market factors such as school funding trends and school construction forecasts, (c) overall financial performance such as planned revenue, profitability and cash flows and (d) the expected impact of current revenue enhancing and cost saving initiatives. A reduction in the revenue growth rate or profitability assumptions of 100 basis points would result in a failure in the first step of the goodwill assessment. In addition, the discount rate assumptions can have a material impact on the fair value determinations. An increase in the discount rate of 100 basis points for the Distribution reporting unit would result in a failure in the first step of the goodwill assessment.

 

48


As discussed in Note 7—Goodwill and Other Intangible Assets of the consolidated financial statements, the Company recorded goodwill impairment charges of $41.1 million in fiscal 2013. In addition, the Company recorded an impairment charge of $2.7 million in fiscal 2015 related to definite-lived intangible assets and a charge of $4.7 million in fiscal 2013 related to indefinite-lived intangible assets. The goodwill impairment recorded in fiscal 2013 reduced the Predecessor’s Company’s goodwill balance to zero. The impairments were determined as part of the fair value assessment of these assets.

Valuation Allowance for Deferred Tax Assets

We initially recorded a tax valuation allowance against our deferred tax assets in the fourth quarter of fiscal 2012. In recording the valuation allowance, management considered whether it was more likely than not that some or all of the deferred tax assets would be realized as the Company has generated net operating losses in recent years and does not have an ability to carry these back to previous years. This analysis included consideration of scheduled reversals of deferred tax liabilities, projected future taxable income, carry back potential and tax planning strategies, in accordance with FASB ASC Topic 740, “Income Taxes”. At April 25, 2015, our valuation allowance totaled $41.7 million.

Fresh Start Accounting

The Company adopted fresh start accounting and reporting on the Effective Date in accordance with FASB ASC 852, Reorganizations (“FASB ASC 852”), as the holders of existing voting shares immediately before confirmation of the Plan received less than 50% of the voting shares of the emerging entity and the reorganization value of the Company’s assets immediately before the date of confirmation was less than the post-petition liabilities and allowed claims. FASB ASC 852 provides for, among other things, a determination of the value to be assigned to the assets of the reorganized Company as of a date selected for financial reporting purposes.

Enterprise value represents the fair value of an entity’s interest-bearing debt and stockholders’ equity. In the disclosure statement associated with the Reorganization Plan, which was confirmed by the Bankruptcy Court, the Company estimated a range of enterprise values between $275.0 million and $325.0 million, with a midpoint of $300.0 million. Based on current and anticipated economic conditions and the direct impact these conditions have on our business, the Company deemed it appropriate to use the midpoint between the low end and high end of the range to determine the final enterprise value of $300.0 million, comprised of debt valued at approximately $179.0 million and equity valued at approximately $121.0 million.

The Company adjusted its enterprise value of $300.0 million for certain items such as post-petition liabilities to determine a reorganization value attributable to assets of $415.4 million. Under fresh start accounting, the reorganization value was allocated to the Company’s assets based on their respective fair values in conformity with the purchase method of accounting for business combinations included in FASB ASC 805, Business Combinations. The excess reorganization value over the fair value of identified tangible and intangible assets of $21.6 million was recorded as goodwill.

The adoption of fresh-start reporting by the Company resulted in a new reporting entity for financial reporting purposes reflecting the Successor’s capital structure and with no beginning retained earnings (deficit) as of the Effective Date. Any presentation of the Successor Company’s consolidated financial statements as of and for periods subsequent to the Effective Date represents the financial position, results of operations and cash flows of a new reporting entity and will not be comparable to any presentation of the Predecessor’s consolidated financial statements as of and for periods prior to the Effective Date, and the adoption of fresh-start reporting. The Predecessor’s consolidated financial statements for periods prior to the Effective Date have not been adjusted to reflect any changes in the Predecessor’s capital structure as a result of the Plan nor have they been adjusted to reflect any changes in the fair value of assets and liabilities as a result of the adoption of fresh-start reporting.

 

49


In accordance with FASB ASC 852, the Predecessor Company’s results of operations prior to the Effective Date include (i) a pre-emergence gain of $161.9 million resulting from the discharge of liabilities under the Reorganization Plan; (ii) pre-emergence charges to earnings of $46.9 million recorded as reorganization items resulting from certain costs and expenses relating to the Reorganization Plan becoming effective, including the cancellation of certain debt upon issuance of new equity and the cancellation of equity-based awards of the Predecessor; and (iii) a pre-emergence decrease in earnings of $30.3 million resulting from the aggregate changes to the net carrying value of the Predecessor Company’s pre-emergence assets and liabilities to reflect their fair values under fresh start accounting, as well as the recognition of goodwill.

For further details on fresh start accounting, see Note 4 of the consolidated financial statements.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and debt. Market risks relating to our operations result primarily from changes in interest rates. Interest rates on our borrowings under our credit facility are primarily dependent upon LIBOR rates. Assuming no change in our financial structure, if variable interest rates were to have averaged 100 basis points higher during fiscal 2015 and fiscal 2014, pre-tax earnings would have decreased by approximately $0.5 million and $0.6 million respectively. This amount was determined by considering a hypothetical 100 basis point increase in interest rates on average variable-rate debt outstanding. These decreases in pre-tax earnings reflect that our interest rate on $72.5 million of our New Term Loan is, effectively, fixed due to an interest rate swap agreement with a notional amount of $72.5 million which hedges changes in the variable interest rate (See Note 10—Debt). The estimated fair value of long-term debt approximated its carrying value at April 25, 2015 and April 26, 2014.

 

Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

School Specialty, Inc.

Greenville, Wisconsin

We have audited the accompanying consolidated balance sheets of School Specialty, Inc. and subsidiaries (the “Company”) as of April 25, 2015 and April 26, 2014 (Successor Company), and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity (deficit), and cash flows for the fiscal year ended April 25, 2015 (Successor Company), the forty-six weeks ended April 26, 2014 (Successor Company) and six weeks ended June 11, 2013 (Predecessor Company), and the fiscal year ended April 27, 2013 (Predecessor Company). Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of School Specialty, Inc. and subsidiaries as of April 25, 2015 and April 26, 2014, (Successor Company)

 

50


and the results of their operations and their cash flows for the fiscal years ended April 25, 2015, (Successor Company), the forty-six weeks ended April 26, 2014 (Successor Company) and six weeks ended June 11, 2013 (Predecessor Company) and the fiscal year ended April 27, 2013 (Predecessor Company), in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of April 25, 2015, based on the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 9, 2015 expressed an adverse opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Milwaukee, Wisconsin

July 9, 2015

 

51


FINANCIAL STATEMENTS

SCHOOL SPECIALTY, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

 

    April 25,
2015
    April 26,
2014
 

ASSETS

   

Current assets:

   

Cash and cash equivalents

  $ 8,920      $ 9,008   

Accounts receivable, less allowance for doubtful accounts of $806 and $984, respectively

    58,685        62,631   

Inventories, net

    96,935        93,387   

Deferred catalog costs

    7,424        8,057   

Prepaid expenses and other current assets

    15,868        18,043   

Refundable income taxes

    1,549        —     

Asset held for sale

    —          2,200   
 

 

 

   

 

 

 

Total current assets

    189,381        193,326   

Property, plant and equipment, net

    32,024        39,045   

Goodwill

    21,588        21,588   

Intangible assets, net

    41,055        48,251   

Development costs and other, net

    28,187        36,646   

Deferred taxes long-term

    2        48   

Investment in unconsolidated affiliate

    715        715   
 

 

 

   

 

 

 

Total assets

  $ 312,952      $ 339,619   
 

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

   

Current liabilities:

   

Current maturities of long-term debt

  $ 25,644      $ 12,388   

Accounts payable

    41,587        42,977   

Accrued compensation

    7,341        8,966   

Deferred revenue

    2,490        2,613   

Other accrued liabilities

    11,724        14,460   
 

 

 

   

 

 

 

Total current liabilities

    88,786        81,404   

Long-term debt less current maturities

    156,549        153,987   

Other liabilities

    1,240        1,171   
 

 

 

   

 

 

 

Total liabilities

    246,575        236,562   

Commitments and contingencies—Note 20

   

Stockholders’ equity:

   

Preferred stock, $0.001 par value per share, 500,000 shares authorized; none outstanding

    —          —     

Common stock, $0.001 par value per share, 2,000,000 shares authorized; 1,000,004 shares outstanding

    1        1   

Capital in excess of par value

    118,544        120,955   

Accumulated other comprehensive income (loss)

    (1,151     (414

Accumulated deficit

    (51,017     (17,485
 

 

 

   

 

 

 

Total stockholders’ equity

    66,377        103,057   
 

 

 

   

 

 

 

Total liabilities and stockholders’ equity

  $ 312,952      $ 339,619   
 

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

52


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

 

            Successor Company                           Predecessor Company           
    Fiscal Year
Ended April 25,
2015
    Forty-Six Weeks
Ended April 26,
2014
          Six Weeks
Ended June 11,
2013
     Fiscal Year
Ended April 27,
2013
 

Revenues

  $ 621,868      $ 572,045           $ 58,697       $ 674,998   

Cost of revenues

    393,710        349,845             35,079         411,118   
 

 

 

   

 

 

        

 

 

    

 

 

 

Gross profit

    228,158        222,200             23,618         263,880   

Selling, general and administrative expenses

    232,479        213,144             27,473         267,491   

Facility exit costs and restructuring

    6,056        6,552             —           —     

Impairment charge

    2,713        —               —           45,789   
 

 

 

   

 

 

        

 

 

    

 

 

 

Operating income (loss)

    (13,090     2,504             (3,855      (49,400

Other expense:

             

Interest expense

    19,599        16,882             3,235         28,600   

Loss on early extinguishment of debt

    —          —               —           10,201   

Early termination of long-term indebtedness

    —          —               —           26,247   

Impairment of long-term asset

    —          —               —           1,414   

Impairment of investment in unconsolidated affiliate

    —          —               —           7,749   

Change in fair value of interest rate swap

    (45     483             —           —     

Refund of early termination fee

    —          (4,054          —           —     

Reorganization items, net

    271        6,420             (84,799      22,979   
 

 

 

   

 

 

        

 

 

    

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (32,915     (17,227          77,709         (146,590

Provision for (benefit from) income taxes

    617        258             1,641         (334
 

 

 

   

 

 

        

 

 

    

 

 

 

Income (loss) before losses from investment in unconsolidated affiliate

    (33,532     (17,485          76,068         (146,256

Losses of unconsolidated affiliate

    —          —               —           (1,436
 

 

 

   

 

 

        

 

 

    

 

 

 

Net income (loss)

  $ (33,532   $ (17,485        $ 76,068       $ (147,692
 

 

 

   

 

 

        

 

 

    

 

 

 

Weighted average shares outstanding:

             

Basic and Diluted

    1,000        1,000             18,922         18,922   

Net income (loss) per share:

             

Basic and Diluted

  $ (33.53   $ (17.49        $ 4.02       $ (7.81

See accompanying notes to consolidated financial statements.

 

53


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In Thousands)

 

     Successor Company           Predecessor Company  
     Fiscal Year
Ended
April 25, 2015
    Forty-Six Weeks
Ended

April 26, 2014
          Six Weeks
Ended
June 11, 2013
    Fiscal Year
Ended
April 27, 2013
 

Net income (loss)

   $ (33,532   $ (17,485        $ 76,068      $ (147,692

Other comprehensive (loss) income

             

Foreign currency translation adjustments

     (737     (414          (101     (1,250
  

 

 

   

 

 

        

 

 

   

 

 

 

Total comprehensive income (loss)

   $ (34,269   $ (17,899        $ 75,967      $ (148,942
  

 

 

   

 

 

        

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

54


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014, SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands)

 

     Common
Stock
    Additional
Paid-in
Capital
    Accumulated
Deficit
    Treasury
Stock
    Accumulated Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
(Deficit)
 

Balance at April 28, 2012 (Predecessor Company)

   $ 24      $ 444,428      $ (213,500   $ (186,637   $ 23,631      $ 67,946   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tax deficiency on option exercises

       (91           (91

Share-based compensation expense

       1,895              1,895   

Foreign currency translation adjustment

             (1,250     (1,250

Net loss

         (147,692         (147,692
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at April 27, 2013 (Predecessor Company)

     24        446,232        (361,192     (186,637     22,381        (79,192
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

         76,068            76,068   

Foreign currency translation adjustment

             (101     (101

Cancellation of Predecessor Company common stock

     (24             (24

Elimination of Predecessor Company capital in excess of par

       (446,232           (446,232

Elimination of Predecessor Company accumulated deficit

         285,124            285,124   

Elimination of Predecessor Company treasury stock

           186,637          186,637   

Elimination of Predecessor Company accumulated other comprehensive loss

             (22,280     (22,280
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 11, 2013 (Predecessor Company)

     —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Issuance of Successor Company Common Stock

     1                1   

Establishment of Successor Company capital in excess of par

       120,955              120,955   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 12, 2013 (Successor Company)

     1        120,955        —          —          —          120,956   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

         (17,485         (17,485

Foreign currency translation adjustment

             (414     (414
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, April 26, 2014 (Successor Company)

     1        120,955        (17,485     —          (414     103,057   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

         (33,532         (33,532

Share-based compensation expense

       581              581   

Foreign currency translation adjustment

             (737     (737

Change in Fresh Start estimate

       (2,992           (2,992
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, April 25, 2015 (Successor Company)

   $ 1      $ 118,544      $ (51,017   $ —        $ (1,151   $ 66,377   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

55


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

    Successor Company          Predecessor Company  
    Fiscal
Year
Ended
April 25,
2015
    Forty-Six
Weeks
Ended
April 26,
2014
         Six
Weeks
Ended
June 11,
2013
    Fiscal
Year
Ended
April 27,
2013
 

Cash flows from operating activities:

           

Net income (loss)

  $ (33,532   $ (17,485       $ 76,068      $ (147,692

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

           

Depreciation and intangible asset amortization expense

    19,233        18,876            2,983        33,220   

Amortization of development costs

    14,310        6,306            918        7,179   

Non-cash reorganization items

    —          1,292            (99,668     —     

Losses of unconsolidated affiliate

    —          —              —          1,436   

Loss on early extinguishment of debt

    —          —              —          10,201   

Early termination of long-term indebtedness

    —          —              —          1,247   

Fees related to DIP financing

    —          —              —          9,855   

Amortization of debt fees and other

    1,946        2,139            9        2,019   

Change in fair value of interest rate swap

    (45     483            —          —     

Share-based compensation expense

    581        —              —          1,895   

Impairment of goodwill and intangible assets

    2,713        —              —          45,789   

Impairment of investment in unconsolidated affiliate

    —          —              —          7,749   

Impairment of long-term asset

    —          —              —          1,414   

Deferred taxes

    45        —              —          5,206   

Loss on disposal of property, equipment, other

    774             

Non-cash interest expense

    2,033        1,282            —          6,828   

Changes in current assets and liabilities:

           

Accounts receivable

    3,437        3,843            (8,011     3,960   

Inventories

    (3,548     9,295            (18,255     7,922   

Deferred catalog costs

    633        (887         1,754        2,813   

Prepaid expenses and other current assets

    422        20,121            722        (20,221

Accounts payable

    846        5,013            11,012        110   

Accrued liabilities

    (4,465     (24,563         12,488        15,430   

Accrued bankruptcy related reorganization costs

    —          (6,188         —          6,188   
 

 

 

   

 

 

       

 

 

   

 

 

 

Net cash provided by (used in) operating activities

    5,383        19,527            (19,980     2,548   
 

 

 

   

 

 

       

 

 

   

 

 

 

Cash flows from investing activities:

           

Additions to property, plant and equipment

    (10,732     (12,050         (243     (4,734

Proceeds from note receivable

    —          —              —          3,000   

Change in restricted cash

    —          26,302            —          (26,302

Investment in product development costs

    (6,649     (5,866         (463     (7,579

Investment in product line

    —          —              —          (1,250

Proceeds from sale of assets

    1,813        1,511            —          —     
 

 

 

   

 

 

       

 

 

   

 

 

 

Net cash provided by (used in) investing activities

    (15,568     9,897            (706     (36,865
 

 

 

   

 

 

       

 

 

   

 

 

 

Cash flows from financing activities:

           

Proceeds from bank borrowings

    321,946        277,605            87,538        1,336,767   

Repayment of bank borrowings

    (309,796     (291,919         (79,977     (1,260,659

Issuance of debt

    —          —              165,924        —     

Repayment of debtor-in-possesion financing

    —          —              (148,619     —     

Payment of early termination fee

    —          (26,399         —          —     

Recovery of interest and reduction of early termination fee

    —          5,399            —          —     

Early termination of long-term indebtedness

    —          —              —          (1,247

Fees related to DIP financing

    —          —              —          (9,855

Payment of debt fees and other

    (1,034     (636         (9,415     (10,404
 

 

 

   

 

 

       

 

 

   

 

 

 

Net cash provided by (used in) financing activities

    11,116        (35,950         15,451        54,602   
 

 

 

   

 

 

       

 

 

   

 

 

 

Effect of exchange rate changes on cash

    (1,019     —              —          —     

Net (decrease) increase in cash and cash equivalents

    (88     (6,526         (5,235     20,285   

Cash and cash equivalents, beginning of period

    9,008        15,534            20,769        484   
 

 

 

   

 

 

       

 

 

   

 

 

 

Cash and cash equivalents, end of period

  $ 8,920      $ 9,008          $ 15,534      $ 20,769   
 

 

 

   

 

 

       

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

           

Interest paid

  $ 15,705      $ 11,109          $ 5,578      $ 20,162   

Income taxes paid

  $ 3,461      $ 1,346          $ —        $ 534   

Bankruptcy related reorganization costs paid (included in operating activities, above)

  $ 957      $ 23,118          $ 3,802      $ 16,791   

See accompanying notes to consolidated financial statements.

 

56


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

School Specialty, Inc. and subsidiaries (the “Company”) is a leading distributor of supplies, furniture, technology products and curriculum solutions to the education market place, with operations, in the United States and Canada. Primarily serving the pre-kindergarten through twelfth grade (“preK-12”) market, the Company also sells through non-traditional channels, such as e-commerce in conjunction with e-tail and retail relationships.

During the period January 28, 2013 through June 11, 2013, School Specialty, Inc. and certain of its subsidiaries operated as debtors-in-possession under bankruptcy court jurisdiction (see Note 3). In accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 852, Reorganizations, for periods including and subsequent to the filing of the Chapter 11 petition, all expenses, gains and losses that resulted from the reorganization were reported separately as reorganization items in the Consolidated Statements of Operations. Net cash used for reorganization items was disclosed separately in the Consolidated Statements of Cash Flows, and liabilities subject to compromise were reported separately in the Consolidated Balance Sheets.

As discussed in Note 4—Fresh Start Accounting, as of June 11, 2013 (the “Effective Date”), the Company adopted fresh start accounting in accordance with ASC 852. The adoption of fresh start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to June 11, 2013 are not comparable with the financial statements for periods after June 11, 2013. The consolidated financial statements as of April 25, 2015 and April 26, 2014 and for the twelve months ended April 25, 2015 and the forty six weeks ended April 26, 2014 and any references to “Successor” or “Successor Company” relate to the financial position and results of operations of the reorganized Company subsequent to bankruptcy emergence on June 11, 2013. References to “Predecessor” or “Predecessor Company” refer to the financial position and results of operations of the Company prior to the bankruptcy emergence.

The accompanying consolidated financial statements and related notes to consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, and include the accounts of School Specialty, Inc. and all of its subsidiaries. All inter-company accounts and transactions have been eliminated. As discussed in Note 6—Investment in Unconsolidated Affiliate, the Company’s investment in its unconsolidated affiliate is accounted for under the cost method as of the fourth quarter of fiscal 2013 as the Company no longer had significant influence over the consolidated affiliate.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Definition of Fiscal Year

The Company’s fiscal year ends on the last Saturday in April in each year. As used in these consolidated financial statements and related notes to consolidated financial statements, “fiscal 2015,” “fiscal 2014” and “fiscal

 

57


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

2013” refer to the Company’s fiscal years ended April 25, 2015, April 26, 2014, and April 27, 2013, respectively. On April 29, 2015 the Board of Directors of the Company approved a change in the Company’s fiscal year end from the last Saturday in April to the last Saturday in December. See Footnote 22—SUBSEQUENT EVENTS.

Cash and Cash Equivalents

The Company considers cash investments with original maturities of three months or less from the date of purchase to be cash equivalents.

Inventories

Inventories, which consist primarily of products held for sale, are stated at the lower of cost or market on a first-in, first-out basis in accordance with FASB ASC Topic 330, “Inventories”. Excess and obsolete inventory reserves recorded were $5,679 and $8,416 as of April 25, 2015 and April 26, 2014, respectively.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Additions and improvements are capitalized, whereas maintenance and repairs are expensed as incurred. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives of the respective assets. The estimated useful lives range from twenty-five to forty years for buildings and their components and three to fifteen years for furniture, fixtures and equipment.

Goodwill and Non-amortizable Intangible Assets

Goodwill represents the excess of reorganization value over fair-value of identified net assets upon emergence from bankruptcy. Prior to bankruptcy, goodwill represented the excess of cost over the fair value of net assets acquired in business combinations accounted for under the purchase method. Certain intangible assets of the Predecessor-Company including a perpetual license agreement and various trademarks and tradenames were estimated to have indefinite lives and were not subject to amortization. Under FASB ASC Topic 350, “Intangibles—Goodwill and Other,” goodwill and indefinite-lived intangible assets are not subject to amortization but rather must be tested for impairment annually or more frequently if events or circumstances indicate they might be impaired. The Company performs the annual impairment test during the fourth quarter of each fiscal year.

In the third quarter of fiscal 2013, the Company concluded that a triggering event had occurred which required the Company to assess whether the fair values of the reporting units were below their carrying values. The triggering event was a combination of the declines in the Company’s forecasted future years’ operating results and cash flows, and the liquidity concerns and eventual default under pre-bankruptcy credit agreements. As a result of the Company’s performance of the goodwill and indefinite-lived intangible asset impairment test in the third quarter of fiscal 2013, the Company recorded impairment charges of $41,089 for goodwill and $4,700 for indefinite-lived intangible assets. See Note 7—Goodwill and Other Intangible Assets for details of these impairment charges. There was no impairment charge recorded in fiscal 2015 or fiscal 2014 related to goodwill or indefinite-lived intangible assets.

Impairment of Long-Lived Assets

As required by FASB ASC Topic 360-10-35 “Impairment or Disposal of Long-Lived Assets,” the Company reviews property, plant and equipment, definite-lived, amortizable intangible assets and development costs for

 

58


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

impairment if events or circumstances indicate an asset might be impaired. Amortizable intangible assets include customer relationships, publishing rights, trademarks and tradenames and copyrights and are being amortized over their estimated useful lives. The Company assesses impairment and writes down to fair value long-lived assets when facts and circumstances indicate that the carrying value may not be recoverable through future undiscounted cash flows. The analysis of recoverability is based on management’s assumptions, including future revenue and cash flow projections. In fiscal 2015, the Company concluded $3,690 of its long-lived development costs would not be recovered by future cash flows from related products and, as such, recorded an impairment of certain product development costs. This incremental charge was related to lowered revenue projections for certain products as the Company re-evaluates its strategy for certain product offerings. This change was recorded as accelerated development cost amortization included in the Company’s costs of revenue.

In fiscal 2015, the Company recorded an impairment charge of $2,713 related to its definite-lived intangible asset for content within its Agenda product category. This content was associated with the development of digital capabilities for its agenda product offering.

Development Costs

Development costs represent external and internal costs incurred in the development of a master copy of a book, workbook, video or other supplemental educational materials and products. The Company capitalizes development costs and amortizes these costs into costs of revenues over the lesser of five years or the product’s life cycle in amounts proportionate to expected revenues. At April 25, 2015 and April 26, 2014, net development costs totaled $19,557 and $27,305, respectively, and are included as a component of development costs and other assets, net, in the consolidated balance sheets.

Fair Value of Financial Instruments

U.S. GAAP defines fair value as the price that would be received for an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability. U.S. GAAP also classifies the inputs used to measure fair value into the following hierarchy:

 

Level 1:

   Quoted prices in active markets for identical assets or liabilities.

Level 2:

   Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or input other than quoted prices that are observable for the asset or liability.

Level 3:

   Unobservable inputs for the asset or liability.

The following table sets forth the non-financial items measured at fair value on a non-recurring basis during fiscal years 2015 and 2014. All items were categorized as Level 3 within the fair value hierarchy. Refer to these notes to the consolidated financial statements for descriptions valuation techniques and inputs used to develop these fair value measurements:

 

Description

 

Balance Sheet Location

  Fiscal 2015     Fiscal 2014     Categorization  

Assets held for sale

  Assets held for sale     —        $ 2,200        Level 3   

 

59


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

In accordance with FASB ASC Topic 825, “Financial Instruments” and FASB ASC Topic 820, “Fair Value Measurement,” the carrying amounts of the Company’s financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate fair value given the short maturity of these instruments.

The following table sets forth the financial instruments where carrying amounts may vary from fair value as of April 25, 2015:

 

Description

 

Balance Sheet Location

  Carrying Value     Fair Value     Categorization  

New ABL Facility

  Current maturities of long-term debt   $ 24,200      $ 24,200        Level 3   

New Term Loan

  Long-term debt less current maturities     142,462        142,462        Level 2   

Deferred Cash Payment Obligations

  Long-term debt less current maturities     17,684        15,565        Level 3   

The Company has estimated the April 25, 2015 fair value of the amounts outstanding under its New ABL Facility approximated its carrying value at the end of fiscal 2015 given the variable interest rates and the proximate maturity date of the facility. The Company estimated the April 25, 2015 fair value of its amounts outstanding under its New Term Loan based on traded prices. The Company estimated the fair value for its Deferred Cash Payment Obligations based upon the net present value of the future cash flows using a discount rate that is consistent with our New Term Loan.

The Company’s Consolidated Balance Sheets as of April 25, 2015 and April 26, 2014 reflect its interest rate swap agreement at fair value. The fair values of the interest rate swap agreement as of April 25, 2015 and April 26, 2014 (valued under Level 2) were $438 and $483, respectively, and are included in “Other Liabilities” of the Consolidated Balance Sheet.

The following table sets forth the financial instruments where carrying amounts may vary from fair value as of April 26, 2014:

 

Description

 

Balance Sheet Location

  Carrying Value     Fair Value     Categorization  

New ABL Facility

  Current maturities of long-term debt   $ 10,600      $ 10,600        Level 3   

New Term Loan

  Long-term debt less current maturities     143,913        143,913        Level 2   

Deferred Cash Payment Obligations

  Long-term debt less current maturities     14,335        14,335        Level 3   

Income Taxes

In accordance with FASB ASC Topic 740, “Income Taxes”, income taxes have been computed utilizing the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Valuation allowances are provided when it is anticipated that some or all of a deferred tax asset is not likely to be realized.

 

60


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

Revenue Recognition

Revenue, net of estimated returns and allowances, is recognized upon the shipment of products or upon the completion of services to customers, which corresponds to the time when risk of ownership transfers, the selling price is fixed, the customer is obligated to pay, collectability is reasonably assured and we have no significant remaining obligations. These criteria may be met upon shipment of customer receipt for products, or upon completion of services provided to customers. Cash received in advance from customers is deferred on our balance sheet as a current liability until revenue is recognized.

Concentration of Credit Risks

The Company grants credit to customers in the ordinary course of business. The majority of the Company’s customers are school districts and schools. Concentration of credit risk with respect to trade receivables is limited due to the significant number of customers and their geographic dispersion. During fiscal 2015, the forty-six weeks ended April 26, 2014, the six weeks ended June 11, 2013, fiscal 2013, no customer represented more than 10% of revenues or accounts receivable.

Vendor Rebates

The Company receives reimbursements from vendors (vendor rebates) based on annual purchased volume of products from its respective vendors. The Company’s vendor rebates are earned based on pre-determined percentage rebates on the purchased volume of products within a calendar year. The majority of the rebates are not based on minimum purchases or milestones, and therefore the Company recognizes the rebates on an accrual basis and reduces cost of revenues over the estimated period the related products are sold.

Deferred Catalog Costs

Deferred catalog costs represent costs which have been paid to produce Company catalogs, net of vendor cooperative advertising payments, which will be used in and benefit future periods. Deferred catalog costs are amortized in amounts proportionate to expected revenues over the life of the catalog, which is one year or less. Amortization expense related to deferred catalog costs is included in the consolidated statements of operations as a component of selling, general and administrative expenses. Such amortization expense for fiscal 2015, the forty-six weeks ended April 26, 2014, six weeks ended June 11, 2013, and fiscal 2013 was $9,751, $10,178, $1,553, and $16,057, respectively.

Restructuring

The Company accounts for restructuring costs associated with both the closure or disposal of distribution centers and severance related to headcount reductions in accordance with FASB ASC Topic 712, “Compensation—Retirement Benefits.” During fiscal 2015, the forty-six weeks ended April 26, 2014 and the six weeks ended June 11, 2013, the Company recorded $5,477, $4,210 and ($161), respectively, of severance expense. During fiscal 2013, the Company recorded $1,561 of severance expense. As of April 25, 2015, April 26, 2014, and April 27, 2013, there was $1,579, $193, and $716, respectively, of accrued restructuring costs recorded in other accrued liabilities on the consolidated balance sheet primarily related to various cost reduction activities. See Note 19 for details of these restructuring charges.

Shipping and Handling Costs

In accordance with FASB ASC Topic 605-45-45, “Revenue Recognition—Principal Agent Considerations—Other Presentation,” the Company accounts for shipping and handling costs billed to customers

 

61


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

as a component of revenues. The Company accounts for shipping and handling costs incurred as a cost of revenues for shipments made directly from vendors to customers. For shipments made from the Company’s warehouses, the Company accounts for shipping and handling costs incurred as a selling, general and administrative expense. The amount of shipping and handling costs included in selling, general and administrative expenses for fiscal 2015, the forty-six weeks ended April 26, 2014, six weeks ended June 11, 2013, and fiscal 2013 was $31,061, $26,231, $3,249, and $31,631, respectively.

Foreign Currency Translation

The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with FASB ASC Topic 830, “Foreign Currency Matters.” All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Amounts in the statements of operations have been translated using the weighted average exchange rate for the reporting period. Resulting translation adjustments are included in foreign currency translation adjustment within other comprehensive income.

Share-Based Compensation Expense

The Company accounts for its share-based compensation plans under the recognition and measurement principles of FASB ASC Topic 718, “Compensation—Stock Compensation” and FASB ASC Topic 505, “Equity-Based Payments to Non-Employees”. See Note 15.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”. ASU No. 2014-09 provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This guidance will be effective for the Company in the first quarter of its fiscal year ending December 24, 2017. The Company is currently in the process of evaluating the impact of adoption of this ASU on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements—Going Concern.” ASU 2014-15 defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective in the annual period ending after December 15, 2016. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE 3—BANKRUPTCY PROCEEDINGS

On January 28, 2013 (the “Petition Date”), School Specialty, Inc. and certain of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under Chapter 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The cases (the “Chapter 11 Cases”) were jointly administered as Case No. 13-10125 (KJC) under the

 

62


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

caption “In re School Specialty, Inc., et al.” The Debtors continued to operate their business as “debtors-in-possession” (“DIP”) under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. The Company’s foreign subsidiaries (collectively, the “Non-Filing Entities”) were not part of the Chapter 11 Cases.

The Chapter 11 Cases were filed in response to an environment of ongoing declines in school spending and a lack of sufficient liquidity, including trade credit provided by the Debtors’ vendors, to permit the Debtors to pursue their business strategy to position the School Specialty brands successfully for the long term. As a result of the Chapter 11 filing, the Company’s common stock was delisted from the NASDAQ Stock Market, effective March 1, 2013.

On May 23, 2013, the Bankruptcy Court entered an order confirming the Debtors’ Second Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the “Reorganization Plan”), and a corrected copy of such order was entered by the Bankruptcy Court on June 3, 2013. The Reorganization Plan, which is described in additional detail below, became effective on June 11, 2013 (the “Effective Date”.) Pursuant to the Reorganization Plan, on the Effective Date, the Company’s existing credit agreements, outstanding convertible subordinated debentures, equity plans and certain other agreements were cancelled. In addition, all outstanding equity interests of the Company that were issued and outstanding prior to the Effective Date were cancelled on the Effective Date. Also on the Effective Date, in accordance with and as authorized by the Reorganization Plan, the Company reincorporated in Delaware and issued a total of 1,000,004 shares of Common Stock of the reorganized Company to holders of certain allowed claims against the Debtors in exchange for such claims. As of June 12, 2013, there were 60 record holders of the new common stock of the reorganized Company issued pursuant to the Reorganization Plan.

Reorganization Plan

General

The Reorganization Plan generally provided for the payment in full in cash on or as soon as practical after the Effective Date of specified claims, including:

 

   

All claims (the “DIP Financing Claims”) under the Debtor-in-Possession Credit Agreement (the “ABL DIP Agreement”) by and among Wells Fargo Capital Finance, LLC (as Administrative Agent, Co-Collateral Agent, Co-Lead Arranger and Joint Book Runner) and GE Capital Markets, Inc. (as Co-Collateral Agent, Co-Lead Arranger and Joint Book Runner and Syndication Agent), General Electric Capital Corporation (as syndication agent), the lenders party to the ABL DIP Facility (as defined below), and the Company and certain of its subsidiaries;

 

   

Certain pre-petition secured claims;

 

   

All claims relating to the costs and expenses of administering the Chapter 11 Cases; and

 

   

All priority claims.

In addition, the Reorganization Plan generally provides for the treatment of allowed claims against, and equity interests in, the Debtors as follows:

 

   

The lenders under the Senior Secured Super Priority Debtor-in-Possession Credit Agreement (the “Ad Hoc DIP Agreement”) by and among the Company, certain of its subsidiaries, U.S. Bank National Association, as Administrative Agent and Collateral Agent and the lenders party thereto were entitled

 

63


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

 

to receive (i) cash in an approximate amount of $98,000, and (ii) 65% of the common stock of the reorganized Company. The fair value of the 65% ownership interest was approximately $78,600 as of the Effective Date. Approximately $57,200 of this value was in satisfaction of the portion of the Ad Hoc DIP not settled in cash with approximately $21,375 representing excess value received by the Ad Hoc DIP lenders. The $21,375 of excess value received by the Ad Hoc DIP lenders was recognized as a reorganization loss;

 

   

Each holder of an allowed general unsecured claim is entitled to receive a deferred cash payment equal to 20% of such allowed claim, plus interest, on the terms described in the Reorganization Plan;

 

   

Each holder of an unsecured claim arising from the provision of goods and/or services to the Debtors in the ordinary course of its pre-petition trade relationship with the Debtors, with whom the reorganized Debtors continue to do business after the Effective Date, is entitled to receive a deferred cash payment equal to 20% of such claim, plus interest, on the terms described in the Reorganization Plan. Such holders may increase their percentage recoveries to 45%, plus interest, by electing to provide the reorganized Debtors with customary trade terms for a specified period, as described in the Reorganization Plan;

 

   

Each holder of the Company’s 3.75% Convertible Subordinated Debentures due 2026, as further described elsewhere in this report, received its pro rata share of 35% of the common stock of the reorganized Company;

 

   

Each holder of an allowed general unsecured claim or allowed trade unsecured claim of $3 or less, or any holder of a general unsecured claim or trade unsecured claim in excess of $3 that agreed to voluntarily reduce the amount of its claim to $3 under the terms described in the Reorganization Plan, was entitled to receive a cash payment equal to 20% of such allowed claim on or as soon as practicable after the Effective Date; and

 

   

Holders of equity interests in the Company prior to the Effective Date, including claims arising out of or with respect to such equity interests, were not entitled to receive any distribution under the Reorganization Plan.

Exit Facilities

As of the Effective Date, the Debtors closed on the exit credit facilities, the proceeds of which were or will be, among other things, used to (i) pay in cash the DIP Financing Claims, to the extent provided for in the Reorganization Plan, (ii) make required distributions under the Reorganization Plan, (iii) satisfy certain Reorganization Plan-related expenses, and (iv) fund the reorganized Company’s working capital needs. The terms of the exit credit facilities are described under Note 10 of the Notes to Condensed Consolidated Financial Statements—Debt.

Equity Interests

As mentioned above, all shares of the Company’s common stock outstanding prior to the Effective Date were cancelled and extinguished as of the Effective Date. The Company issued 1,000,004 shares of new common stock on the Effective Date pursuant to the Reorganization Plan, which constitutes the total number of shares of new common stock outstanding immediately following the Effective Date.

On the Effective Date, equity interests in the Company’s U.S. subsidiaries were deemed cancelled and extinguished and of no further force and effect, and each reorganized subsidiary was deemed to issue and

 

64


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

distribute the new subsidiary equity interests. The ownership and terms of such new subsidiary equity interests in the reorganized subsidiaries are the same as the ownership and terms of the equity interests in these subsidiaries immediately prior to the Effective Date, except as otherwise provided in the Reorganization Plan.

Financial Statement Presentation

We have prepared the accompanying consolidated financial statements in accordance with FASB ASC Topic 852 “Reorganizations” (“FASB ASC 852”). FASB ASC 852 required that the financial statements distinguish transactions and events that were directly associated with the reorganization from the ongoing operations of the business. Accordingly, certain expenses including professional fees, realized gains and losses and provisions for losses that were realized from the reorganization and restructuring process were classified as reorganization items on the consolidated statement of operations.

In connection with the Company’s emergence from Chapter 11, the Company was required to adopt fresh start accounting as of June 11, 2013 in accordance with ASC 852 “Reorganizations”. The Company elected to use June 8, 2013 (the “Convenience Date”), which was the week ended date nearest to the Effective Date, to avoid disruption to the Company’s weekly accounting processes. The Company performed a qualitative and quantitative assessment in order to determine the appropriateness of using the Convenience Date for fresh start accounting instead of the Effective Date. The Company’s assessment determined that the use of the Convenience Date did not have a material impact on either the predecessor or successor periods in fiscal 2014 and there were no qualitative factors that would preclude the use of the Convenience Date for accounting and reporting purposes. The adoption of fresh start accounting resulted in the Company becoming a new entity for financial reporting purposes. Accordingly, the financial statements on or prior to June 11, 2013 are not comparable with the financial statements for periods after June 11, 2013. The consolidated financial statements for fiscal 2015 and as of April 26, 2014 and for the forty-six weeks then ended and any references to “Successor” or “Successor Company” show the financial position and results of operations of the reorganized Company subsequent to bankruptcy emergence on June 11, 2013. References to “Predecessor” or “Predecessor Company” refer to the financial position and results of operations of the Company prior to the bankruptcy emergence.

NOTE 4—FRESH START ACCOUNTING

On the Effective Date, the Company adopted fresh start accounting and reporting in accordance with FASB ASC 852. The Company was required to apply the provisions of fresh start reporting to its financial statements, as the holders of existing voting shares of the Predecessor Company received less than 50% of the voting shares of the emerging entity and the reorganization value of the Predecessor Company’s assets immediately before the date of confirmation was less than the post-petition liabilities and allowed claims.

Fresh start reporting generally requires resetting the historical net book value of assets and liabilities to fair value as of the Effective Date by allocating the entity’s enterprise value as set forth in the Reorganization Plan to its assets and liabilities pursuant to accounting guidance related to business combinations. The financial statements as of the Effective Date report the results of the Successor Company with no beginning retained earnings or accumulated deficit. Any presentation of the Successor Company represents the financial position and results of operations of a new reporting entity and is not comparable to prior periods. The consolidated financial statements for periods ended prior to the Effective Date do not include the effect of any changes in capital structure or changes in the fair value of assets and liabilities as a result of fresh start accounting.

 

65


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

In accordance with FASB ASC 852, the Predecessor Company’s results of operations prior to the Effective Date include (i) a pre-emergence gain of $161,943 resulting from the discharge of liabilities under the Reorganization Plan; (ii) pre-emergence charges to earnings of $46,878 recorded as reorganization items resulting from certain costs and expenses relating to the Reorganization Plan becoming effective, including the cancellation of certain debt upon issuance of new equity and the cancellation of equity-based awards of the Predecessor; and (iii) a pre-emergence decrease in earnings of $30,266 resulting from the aggregate changes to the net carrying value of the Predecessor Company’s pre-emergence assets and liabilities to reflect their fair values under fresh start accounting, as well as the recognition of goodwill. See Note 5, “Reorganization Items, Net” for additional information.

Enterprise Value / Reorganization Value Determination

Enterprise value represents the fair value of an entity’s interest-bearing debt and stockholders’ equity. In the disclosure statement associated with the Reorganization Plan, which was confirmed by the Bankruptcy Court, the Company estimated a range of enterprise values between $275,000 and $325,000, with a midpoint of $300,000. Based on current and anticipated economic conditions and the direct impact these conditions have on our business, the Company deemed it appropriate to use the midpoint between the low end and high end of the range to determine the final enterprise value of $300,000, comprised of debt valued at approximately $179,000 and equity valued at approximately $121,000.

FASB ASC 852 provides for, among other things, a determination of the value to be assigned to the assets of the reorganized Company as of a date selected for financial reporting purposes. The Company adjusted its enterprise value of $300,000 for certain items such as post-petition liabilities to determine a reorganization value attributable to assets of $415,410. Under fresh start accounting, the reorganization value was allocated to the Company’s assets based on their respective fair values in conformity with the purchase method of accounting for business combinations included in FASB ASC 805, Business Combinations. The excess reorganization value over the fair value of identified tangible and intangible assets of $21,588 was recorded as goodwill.

The reorganization value represents the amount of resources available, or that become available, for the satisfaction of post-petition liabilities and allowed claims, as negotiated between the Company and its creditors (the “Interested Parties”). This value, along with other terms of the Reorganization Plan, was determined only after extensive arms-length negotiations between the Interested Parties. Each Interested Party developed its view of what the value should be based upon expected future cash flows of the business after emergence from Chapter 11, discounted at rates reflecting perceived business and financial risks. This value is viewed as the fair value of the entity before considering liabilities and is intended to approximate the amount a willing buyer would pay for the assets of the Successor Company immediately after restructuring. The reorganization value was determined using numerous projections and assumptions that are inherently subject to significant uncertainties and the resolution of contingencies beyond the control of the Company. Accordingly, there can be no assurance that the estimates, assumptions and amounts reflected in the valuation will be realized.

Methodology, Analysis and Assumptions

The Company’s valuation was based upon a discounted cash flow methodology, which included a calculation of the present value of expected un-levered after-tax free cash flows reflected in our long-term financial projections, including the calculation of the present value of the terminal value of cash flows, and supporting analysis that included a comparison of selected financial data of the Company with similar data of

 

66


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

other publicly held companies comparable to the Company in terms of end markets, operational characteristics, growth prospects and geographical footprint. The Company also considered precedent transaction analysis but ultimately determined there was insufficient data for a meaningful analysis. A detailed discussion of this methodology and supporting analysis is presented below.

The Company’s multi-year business plan was the foundation for developing long-term financial projections used in the valuation of our business. The business planning and forecasting process included a review of Company, industry and macroeconomic factors including, but not limited to, achievement of future financial results, projected changes associated with our reorganization initiatives, anticipated changes in general market conditions including variations in market regions, and known new business initiatives and challenges.

The following represents a detailed discussion of the methodology and supporting analysis used to value our business using the business plan and long-term financial projections developed by the Company:

Discounted Cash Flow Methodology

The Discounted Cash Flow (“DCF”) analysis is a forward-looking enterprise valuation methodology that relates the value of an asset or business to the present value of expected future cash flows to be generated by that asset or business. Under this methodology, projected future cash flows are discounted by the business’ weighted average cost of capital (“WACC”). The WACC reflects the estimated blended rate of return that debt and equity investors would require to invest in the business based on its capital structure. Our DCF analysis has two components: (1) the present value of the expected un-levered after-tax free cash flows for a determined period, and (2) the present value of the terminal value of cash flows, which represents a firm value beyond the time horizon of the long-term financial projections.

The DCF calculation was based on management’s financial projections of un-levered after-tax free cash flows for the period 2014 to 2017. The Company used a WACC of 13.3% to discount future cash flows and terminal values. This WACC was determined based upon an estimated cost of debt for similar sized companies, rather than the anticipated cost of debt of the reorganized Company upon emergence from bankruptcy, and a market cost of equity using a capital asset pricing model. Assumptions used in the DCF analysis, including the appropriate components of the WACC, were deemed to be those of “market participants” upon analysis of peer groups’ capital structures.

In conjunction with our analysis of publicly traded companies described below, the Company used a range of exit multiples of 2013 earnings before interest, taxes, depreciation and amortization (“EBITDA”) between 4.4 and 8.1, with a lower than midpoint exit multiple of 5.5 selected, to determine the present value of the terminal value of cash flows. The selected exit multiple is weighted towards those comparable companies which are more similar to the Company’s Distribution (formerly referred to as “Educational Resources”) segment which represents a higher percentage of consolidated revenues as compared to the Curriculum (formerly referred to as “Accelerated Learning”) segment.

The sum of the present value of the projected un-levered after-tax free cash flows was added to the present value of the terminal value of cash flows to determine the Company’s enterprise value.

Publicly Traded Company Analysis

As part of our valuation analysis, the Company identified publicly traded companies whose businesses are relatively similar to each of our reporting segments and have comparable operational characteristics to derive

 

67


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

comparable revenue and EBITDA multiples for our DCF analysis. Criteria for selecting comparable companies for the analysis included, among other relevant characteristics, similar lines of businesses, business risks, growth prospects, maturity of businesses, market presence, size, and scale of operations. The analysis included a detailed multi-year financial comparison of each company’s income statement, balance sheet and statement of cash flows. In addition, each company’s performance, profitability, margins, leverage and business trends were also examined. Based on these analyses, a number of financial multiples and ratios were calculated to gauge each company’s relative performance and valuation. The ranges of ratios derived were then applied to the Company’s projected financial results to develop a range of implied values.

Enterprise Value, Accounting Policies and Reorganized Consolidated Balance Sheet

In determining the final enterprise value attributed to the Company of $300,000, the Company blended its DCF methodology and publicly traded company analysis, with more emphasis on the DCF methodology.

Fresh start accounting and reporting permits the selection of appropriate accounting policies for Successor Company. The Predecessor Company’s significant accounting policies that were disclosed in the Annual Report on Form 10-K for the year ended April 27, 2013 were generally adopted by the Successor Company as of the Effective Date, though many of the account balances were affected by the reorganization and fresh start adjustments presented below.

The adjustments presented below were made to the June 11, 2013 consolidated balance sheet and contain estimates of fair value. Estimates of fair value represent the Company’s best estimates, which are based on industry and data trends, and by reference to relevant market rates and discounted cash flow valuation methods, among other factors. The determination of the fair value of assets and liabilities is subject to significant estimation and assumptions. In accordance with ASC No. 805, the allocation of the reorganization value is subject to additional adjustment until the Company completed its analysis. The Company finalized its analysis in fiscal 2015.

The condensed consolidated balance sheet, reorganization adjustments and fresh start adjustments presented below summarize the impact of the Reorganization Plan and the adoption of fresh start accounting as of the Effective Date. Certain fresh start adjustments were updated between the Effective Date and finalization of fresh start accounting in fiscal 2015. The Successor Company updated the estimated value of unsecured claims certain holders of which elected to provide the Company with customary trade terms and thereby recover 45% of their claims, in accordance with the Reorganization Plan (Note 3).

 

68


SCHOOL SPECIALTY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR FISCAL 2015, THE FORTY-SIX WEEKS ENDED APRIL 26, 2014,

SIX WEEKS ENDED JUNE 11, 2013 AND FISCAL 2013

(In Thousands, Except Per Share Amounts)

 

REORGANIZED CONDENSED CONSOLIDATED BALANCE SHEET

AS OF JUNE 11, 2013

 

     June 11, 2013  
     Predecessor
Company
    Reorganization
Adjustments
    Fresh Start
Adjustments
    Successor
Company
 

ASSETS

        

Current assets:

        

Cash and cash equivalents

   $ 11,052      $ 4,363  (1)    $ —        $ 15,415   

Restricted cash

     26,421        —          —          26,421   

Accounts receivable

     66,894        —          (250 )(8)      66,644   

Inventories

     110,830        —          (8,147 )(8)      102,683   

Other current assets

     45,819        321  (2)      (788 )(8)      45,352   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

     261,016        4,684        (9,185     256,515   

Property, plant and equipment, net

     37,604        (6,202 )(2)      14,148  (8)      45,550   

Goodwill

     —          —          21,588  (8)(9)      21,588   

Intangible assets, net

     109,155        —          (56,795 )(8)      52,360   

Development costs and other

     31,142        8,255  (3)      —          39,397   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ 438,917      $ 6,737      $ (30,244   $ 415,410   
  

 

 

   

 

 

   

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

        

Current liabilities:

        

Accounts payable

   $ 38,226      $ —        $ —        $ 38,226   

Accrued compensation

     7,229        (315 )(2)      —          6,914   

Other accrued liabilities

     60,301        9,947  (2)(4)(6)      22  (8)      70,270   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     105,756        9,632        22        115,410   

Long-term debt

     205,863        (39,939 )(5)      —          165,924   

Other liabilities

     925        12,195  (2)(6)      —          13,120   

Liabilities subject to compromise

     223,988        (223,988 )(6)      —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

   $ 536,532      $ (242,100   $ 22      $ 294,454   
  

 

 

   

 

 

   

 

 

   

 

 

 

Commitments and contingencies

        

Stockholders’ equity:

        

Common stock—Predecessor

   $ 24      $ (24 )(7)    $ —        $ —     

Capital in excess of par value—Predecessor

     446,232        (446,232 )(7)      —          —     

Treasury Stock—Predecessor

     (186,637     186,637  (7)      —          —     

Accumulated (deficit) and other comprehensive income—Predecessor

     (357,234     387,500  (7)      (30,266 )(7)(8)      —     

Common stock—Successor

     —          1  (7)      —          1   

Capital in excess of par value—Successor

     —          120,955  (7)      —          120,955   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’ equity

     (97,615     248,837        (30,266     120,956   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 438,917      $ 6,737      $ (30,244   $ 415,410