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EX-99.1 - EX-99.1 - SCHOOL SPECIALTY INCd304899dex991.htm
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EX-21.1 - EX-21.1 - SCHOOL SPECIALTY INCd304899dex211.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

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

For the fiscal year ended December 31, 2016

OR

 

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

For the transition period from                     to                     

Commission File 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  

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  ☑

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☑    No  

Indicate by check mark 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.  ☐

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  ☑      Non-accelerated filer  ☐    Smaller reporting company  ☐
      (Do not check if smaller reporting company)   

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

The aggregate market value of the Registrant’s common stock held by non-affiliates as of June 25, 2016 was $64,443,300. As of February 28, 2017 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  ☑    No  

INCORPORATION BY REFERENCE

Part III is incorporated by reference from the Proxy Statement from the Annual Meeting of Shareholders to be held on June 8, 2017.


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. Effective December 26, 2015 the Company changed its fiscal year end from the last Saturday in April to the last Saturday in December. The December 27, 2015 to December 31, 2016 period will be referred to as “fiscal 2016” in this report. The April 26, 2015 to December 26, 2015 period will be referred to as the “short year 2015” in this report. Prior to April 26, 2015, our fiscal year ended on the last Saturday in April of each year. In this 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 well-recognized, third-party brands across its product categories. 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 beyond the education market by establishing relationships with e-tailers and retailers and marketing a sub-set of its offering to healthcare facilities and the purchasing organizations that serve them. 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 substantially all schools nationwide, as well as the Canadian marketplace. Another core differentiator is our commitment to innovation, which is achieved by working with teachers, administrators and other subject matter experts to develop proprietary products that result in innovative approaches to student development and 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 and supplemental learning solutions for science, reading and math and works with teachers and educators to drive new offerings based on standards, such as Common Core State Standards and 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 designed to help students who are performing below grade level or who could benefit from supplemental instruction 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 (approximately 100 of which are inside sales representatives), 8.3 million catalogs, and our proprietary e-commerce websites. In fiscal 2016, we believe we sold products to approximately 63% of the approximately 138,000 schools in the United States and we believe we reached a majority of the 3.5 million teachers in those schools. For fiscal 2016, we generated revenues of $656.3 million.

 

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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.

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 are also sold direct to teachers and to consumers through the Company’s various e-commerce platforms. Distribution products are grouped into 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 and design services through its Project by Design® team (“PbD”), for both school refurbishment and new construction projects. As an end-to-end solution provider 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®, Royal Seating®, and Projects by Design®. Distribution products and services accounted for approximately 84% of our revenues for fiscal 2016.

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

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.

 

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A team of approximately 20 product development associates leverage long-standing relationships with outside developers, authors, co-publishing strategic partners and consultants to develop educational products and solutions that meet curriculum standards and improve classroom teaching effectiveness.

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. Additionally, when applicable these 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® and S.P.I.R.E®. Our Curriculum products accounted for approximately 16% of our revenues in fiscal 2016.

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 resulted in education spending ranging from flat to low single digit growth rates (0.1% to 1.8%). Total expenditures for public elementary and secondary education were $590 billion in 2008-2009 and grew to $613 billion in 2012-2013, or a 1.0% CAGR, according to the National Education Association (“NEA”). Since 2012-2013, however, total expenditures have increased to $662 billion through 2014-2015, or a CAGR of 3.9%, according to the Rankings of States 2015 and Estimate of School Statistics 2016 published by the NEA in 2016. The NEA estimates that total expenditures increased to $675 billion in 2015-2016. Over the long-term, we expect total educational expenditures (excluding capital outlays and interest on debt) to continue to increase at mid-single digit growth rates based on projections from both the NEA and the National Center for Education Statistics (“NCES”).

Public education funding for school districts during 2014-2015 came from three major sources: state funding which provided about 44%; local funding which provided about 44%; and federal funding which provided about 12%. State funding for elementary and secondary education is generally allocated to school districts by formulas, typically based on number of pupils. State general funding expenditure budgets are

 

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projected to grow 4.3% in 2017, with a majority of the increase allocated to the two largest areas of state general funding expenditures, PreK-12 education and Medicaid. While there is significant variation within individual states, forty-one states have enacted budgets for fiscal 2017 with higher general fund spending levels as compared to fiscal 2016 according to the National Association of State Budget Officers. The majority of the funding provided by local governments is from property taxes. Local tax revenues have been relatively flat according to the most recent data from NEA; however, increases in 2016 housing starts and projected increases in new home sale prices could be expected to drive up property tax collections and local tax revenue. The two largest programs providing federal funding are the No Child Left Behind Title I Grants to school districts and the IDEA Special Education State Grants.

According to the NCES, enrollment in public and private elementary and secondary schools has had slow and steady growth over the past 15 years with a CAGR of 0.4% and is projected to grow at a CAGR of 0.5% through 2024. Specifically, NCES projects that public and private PreK-12 enrollment will rise from $55.0 million in the 2012-2013 school year to $57.9 million by the 2024-2025 school year. At the same time, per pupil expenditures are expected to rise each year. Expenditures in public elementary and secondary schools were $11,640 per pupil in 2014-2015 and are expected to rise to $12,460 per pupil, in constant dollars, by 2024-2025.

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. This belief is supported by industry reports from McGraw-Hill that indicate the amount of new K-12 school construction spending is expected to grow from an estimated $24 billion in 2014 to $36 billion by 2017. This growth in construction spending is related to a combination of higher enrollment levels and the impact of lower investment levels in recent years as maintenance construction projects were deferred and school districts placed an additional number of students into its existing facilities.

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, instructional programs and materials, and teacher resources for school and classroom use. 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 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. However, the market is also served by several large, well-recognized, national 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 by statewide adoptions which typically occur on multi-year cycle; in open territory states, Curriculum decisions 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 $11 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 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.

 

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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 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 provided 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

 

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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;

 

   

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.

 

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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 Recognized, Proprietary Brands. Providing access to over 100,000 items ranging from classroom supplies, school furniture and playground equipment, technology solutions and both standards-based and supplemental curriculum solutions, we believe we are a leading 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 products include over 20 proprietary brands, as well as many widely recognized third-party brands. 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 offer 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. Our assortment strategy, which combines our proprietary brands with other trusted third-party brands to create comprehensive offerings in a broad range of product categories, enables us to serve our customers in a manner that we believe is unmatched in the industry. As such, we are in a position to leverage our depth, breadth and brand portfolio to further penetrate key product categories. Over 40% of our revenues are derived from our proprietary products, including the majority of our curriculum segment products; typically, our proprietary products 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 (approximately 100 of which are inside sales representatives), catalog mailings and our proprietary e-commerce websites. In fiscal 2016, we estimate that we sold products to approximately 63% of the estimated 138,000 schools in the United States and reached a majority of the 3.7 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 improve our nationwide coverage. 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 27% of our sales in fiscal 2016 compared to less than 17% of our sales in fiscal 2009, have increased as more school districts and teachers go online to place orders.

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 2016, our top 10 school district customers collectively accounted for just over 8% of revenues and customers within our top state collectively accounted for just over 11% of revenues. For the same period, our top 100 products accounted for slightly less than 12% of revenues. Products from our top 10 suppliers generated just over 30% of revenues in fiscal 2016. We believe this diversification somewhat limits our exposure to state and local funding cycles and to

 

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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 ordered annually, if not more frequently. We continue to maintain strong relationships with schools, school districts and other customers and believe our retention rate of our school and school district customers is over 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. 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 2016, several operational improvement initiatives resulted in cost reductions, and greater efficiencies throughout our organization. These initiatives also facilitate effective working capital management and positive 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 by improving both our mix of proprietary products and our operations to enhance the customer experience. We also enjoy a highly predictable working capital cycle, which enables 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, optimizing direct marketing campaigns, increasing supply chain efficiency and expanding our product line through strategic distribution relationships. We are actively pursuing partnering opportunities for content development and distribution. We also believe our movement toward a team-based selling model will improve the effectiveness of our go-to-market strategies, better inform our product development efforts and better leverage our deep 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. In fiscal 2016, have realigned our sales, marketing and merchandising organizations to better develop and execute sustainable growth strategies for core product categories or market segments such as early childhood, special needs, physical education, art, furniture, technology, and instructional solutions. Our near-term strategy continues to be focused on the following areas:

 

   

Optimizing our Distribution Centers to improve customer delivery both in terms of speed and accuracy and to operate at a lower cost;

 

   

Deploying an innovative team-based selling model that increases and enhances the effectiveness of customer touch points and better leverages our deep product and market expertise;

 

   

Enhancing product management and marketing capabilities to promote our innovation and breath of offerings and bring new and innovative products to market;

 

   

Continuing to expand alternative channels that have annual purchasing cycles that will lessen our reliance on the heavy back-to-school spending season;

 

   

Introducing new and innovative curriculum-based training solutions and incorporating products, services and consulting that address the increased need for school safety and security;

 

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

 

   

Continuing to invest in technologies to improve our customer service capabilities throughout all business areas to improve the customer experience;

 

   

Continuing to build out our digital solutions and bundled packages, while enhancing our e-commerce platform; and

 

   

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

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:

 

   

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

 

   

Upgrading our IT systems and related technologies to create efficiencies within our organization, streamline processes, 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 making strategic investments in our business and generating higher returns for our stockholders.

Organic Growth. We continue our focus on growing revenues and profits from our existing product lines and possible line extensions. We are cautiously optimistic that demand for our products and services will remain stable and, in certain categories, experience modest growth as industry data suggests school spending will increase over the coming years based on continued growth in student population and spending per student. We plan to increase our share of this spending and organically grow our revenues by:

 

   

Deploying our team-based sales model that leverages territory sales managers, inside sales representatives, category sales managers and subject matter experts;

 

   

Optimizing product mix within each category;

 

   

Leveraging our new Customer Relationship Management (“CRM”) system to more effectively communicate customer and performance information to the sales organization, and collect market and customer intelligence which will enable more effective cross selling throughout the organization to drive balanced growth across our product categories;

 

   

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 solutions;

 

   

Expanding our reach into markets, such as health-care which purchase a large sub-set of our existing products;

 

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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 and;

 

   

Expanding our relationships with e-tail/retail partners and large purchasing cooperatives.

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

 

   

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

 

   

Developing and implementing improved strategies related to margin management, including optimization of list prices and discount strategies, managing the mix of items purchased based on line-item, bid pricing versus category discounts, and increasing sales of proprietary items;

 

   

Improving the effectiveness of our sourcing activities and vendor management to, among other things, negotiate more favorable supplier pricing, terms and conditions;

 

   

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

 

   

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

 

   

Utilizing our purchasing scale;

 

   

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 that 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:

 

   

Deploying process excellence and the implementation of lean principles across all departments to reduce complexity and improve business processes in a manner that will lower our overall staffing levels and improve operational effectiveness;

 

   

Simplifying our current ERP environment and lowering related support costs by implementing best in class business applications in conjunction with more efficient business processes;

 

   

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

 

   

Refining our sales compensation plans to drive balanced growth across our product categories in a cost-effective manner.

Evaluation of Capital Investment and Allocation: We have identified several areas for investment in fiscal 2017 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 done as part of 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.

 

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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.

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-like 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 (licensed) 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 marketing 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

 

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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 launched a product line of proprietary furniture under our Classroom Select® brand and also provide innovative furniture offerings through our Royal Seating®, Childcraft®, and Korners for Kids® 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.

SSI GUARDIAN: We believe we have the most comprehensive curriculum-based security initiative designed to keep schools and other facilities safe. Our SSI GUARDIANTM offering is focused on strengthening campus and school safety by providing administrators, teachers and other school personnel with the training and security-related products to address safety and risk mitigation. SSI GUARDIAN also offers consulting services that help schools and school districts conduct vulnerability assessments for school sites, emergency planning, contingency planning, and safe school design. Similar curriculum/training modules have also been developed for health care facilities including hospitals, outpatient care centers and rehab centers.

Soar Life Products: Leveraging our current product assortment, Soar Life ProductsTM offers thousands of innovative products intended to improve well-being, from early childhood to adults in senior care. The Soar Life offering includes proprietary School Specialty brands, including Childcraft®, Classroom Select®, Sax Arts & Crafts®, Sportime®, Abilitations®, among others, as well as third-party brands. Products span a range of categories and are tailored to address the needs of healthcare organizations, focusing on Arts & Crafts, Physical Activity and Recreational Sports, Furniture, Therapeutic Needs and general supplies, all of which are used by healthcare facilities on a daily basis. Soar Life Products focuses on the healthcare industry, including acute and non-acute settings such as hospitals, long-term care, therapeutic facilities, home care, surgery centers, early childhood and day care centers, physicians’ offices and clinics, both on a direct basis and through third parties.

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

 

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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. 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 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 products offer 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 InterventionTM, 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.

 

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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®, Royal Seating®, 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®, SSI GUARDIANTM, and Soar Life ProductsTM. We also sell products under brands we license, such as FOSS®, ThinkMath!™, SPARKTM and FranklinCovey® Seven Habits.

Product Development and Merchandising

Our product development managers apply their extensive education industry experience to design instructional solutions, 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.

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 300 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 2016 and short year 2015, we took steps to realign our nationwide sales team and our go-to-market strategy, which also included the expansion of an inside sales team and the implementation of a team-based selling model focused on driving growth through increased customer penetration.

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 and leverage category specific sales personnel. 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-project related segment of furniture, we capitalize on relationship selling through a direct sales force we believe is among the largest 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

 

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assigning accounts within a specific geographic territory to a territory sales manager who is supported by inside sales, category specialists and a customer service team. The sales 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 50 professionals. 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.

Internet Operations. Our internet channel activities through www.schoolspecialty.com 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 our website 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. Our website allows our customers to manage funding through the use of purchase order spending limits, approval workflows, order management and reporting. In addition, we offer schools and school districts the ability to fully integrate their procurement systems with our website, 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 a relationship with Amazon.com under which we offer our propriety branded products through the Amazon.com shopping portal. We believe that this channel allows us to reach educators, consumers 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 or list 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.

 

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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 purchase under annual supply agreements with our vendors. For our larger vendors we typically negotiate annual contracts that 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 2016, our revenue for School Smart branded products was approximately $52 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 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, through third party strategic relationships, have the ability to offer next-day delivery for many items 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 2016, the thirty-five week transition period ended December 26, 2015, fiscal 2015, and fiscal 2014.

Over the past two years, through a series of initiatives, we have realigned our Distribution Centers and warehouses to efficiently serve the majority of our customers and effectively access key suppliers. We have also invested significantly in lean manufacturing principles and upgraded technology and logistics platforms, which

 

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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 all 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. 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 February 25, 2017, we had approximately 1,156 full-time employees. Since the beginning of fiscal 2015, we have reduced the number of full-time employees by nearly 300 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 December 31, 2016. Our customers typically purchase products on an as-needed basis.

 

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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;

 

   

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

 

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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.

We are highly leveraged. As of December 31, 2016, we had $137 million of reported total debt, or $142 million of gross debt, which excludes debt issuance costs and original issue discount. 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.

 

20


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 softening of state and local tax collections may result in reduction to school funding, and thus, 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.

Until achieving revenue growth over the two most recent reporting periods, we had seen a decline in our operating margin, primarily as a result of our revenue declines, which we believe are primarily related to the continued school spending cuts. The Company will pursue further cost reductions if school spending declines significantly from current levels, 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.

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 from June to September of our fiscal year and operate at a net loss from October to May. This seasonality causes our operating results and operating cash flows to vary considerably from quarter to quarter within our fiscal years.

 

21


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.

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

 

22


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 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. Third parties 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.

 

23


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

At December 31, 2016, intangible assets represented 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 exist. As discussed in Note 8 to the consolidated financial statements in Item 8 of this report, the Company recorded an impairment charge of $2.7 million in fiscal 2015 related to definite-lived intangible assets. Goodwill and intangible assets are evaluated based on a 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 $12.2 million, $17.1 million, and $19.6 million at December 31, 2016, December 26, 2015, and April 25, 2015, 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. In fiscal 2016 and fiscal 2015, we recorded write-downs of capitalized product development costs of $1.3 million and $3.8 million, respectively.

Our operations are dependent on our information systems.

We have integrated the operations of our divisions and subsidiaries on a single ERP, which operates on a system located at our third-party hosted ERP system provider’s facilities. The system relies 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.

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 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 material adverse effect on our business. We also rely on certain copyrights, patents and licenses other than those described above, the termination or loss of which could have an adverse effect on our business.

 

Item 1B. Unresolved Staff Comments

None.

 

24


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 the following principal facilities as of February 28, 2017:

 

Locations

   Approximate
Square Footage
     Owned/
Leased
     Lease Expiration  

Bellingham, Washington (1)

     25,000        Leased        31-Jul-20  

Cambridge, Massachusetts (2)

     5,200        Leased        30-Apr-18  

Cameron, Texas (1)(4)

     277,000        Leased        31-Mar-17  

Lancaster, Pennsylvania (3)

     73,000        Leased        30-Jun-20  

Lancaster, Pennsylvania (1)

     125,000        Leased        30-Jun-20  

Mansfield, Ohio (3)

     315,000        Leased        31-Oct-20  

Nashua, New Hampshire (2)

     348,000        Leased        31-Dec-18  

 

(1) Location primarily services the Distribution segment
(2) Location primarily services the Curriculum segment.
(3) Location services both business segments.
(4) Lease automatically renews for a six month term unless notice is provided.

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 of our facilities to identify consolidation opportunities.

 

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.

 

25


EXECUTIVE OFFICERS OF THE REGISTRANT

As of February 28, 2017, the following persons served as executive officers of School Specialty:

 

Name and Age of Officer

    

Joseph M. Yorio

Age 52

   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, one of the world’s largest business-to-business suppliers of essential office and computer products and services, 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 43

   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 an 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 50

   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

 

26


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 51

   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 53

   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.

 

27


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 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 2016

   High      Low  

Quarter ended March 26, 2016

   $ 103.99      $ 70.00  

Quarter ended June 25, 2016

     107.00        100.00  

Quarter ended Sepember 24, 2016

     102.00        97.00  

Quarter ended December 31, 2016

     112.00        87.00  

Short Year 2015

   High      Low  

Quarter ended July 25, 2015

   $ 101.00      $ 92.50  

Quarter ended October 24, 2015

     92.50        82.00  

Nine weeks ended December 26, 2015

     82.00        74.00  

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  

Holders

As of February 28, 2017, 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.

 

28


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 December 31, 2016. 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     7/31/15     10/30/15     12/26/15     3/26/16     6/25/16     9/24/16     12/31/16  

School Specialty, Inc.

    100.00       89.77       125.06       136.36       136.36       123.01       113.52       105.11       88.47       84.09       113.64       113.64       113.64       113.64  

Russell 3000

    100.00       101.93       106.36       110.34       115.67       115.17       123.33       122.79       120.86       120.07       118.46       119.81       128.56       134.20  

Peer Group

    100.00       95.23       94.18       98.90       106.17       116.99       129.32       120.61       104.37       97.05       101.73       100.23       108.81       101.73  

 

29


Item 6. Selected Financial Data

SELECTED FINANCIAL DATA

(In thousands, except per share data)

 

    Successor Company     Predecessor Company  
    Fiscal Year
Ended
December 31,
2016

(53 weeks)
    Thirty-Five
Weeks
Ended
December 26,
2015
    Fiscal Year
Ended
April 25,
2015

(52 weeks)
    Forty-Six
Weeks
Ended

April 26,
2014
    Six
Weeks
Ended

June  11,
2013
    Fiscal Year
Ended
April 27,
2013

(52 weeks)
    Fiscal Year
Ended
April 28,
2012

(52 weeks)
 

Statement of Operations Data:

               

Revenues

  $ 656,322     $ 504,278     $ 621,868     $ 572,045     $ 58,697     $ 674,998     $ 731,991  

Cost of revenues

    416,394       317,891       393,710       349,845       35,079       411,118       448,977  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    239,928       186,387       228,158       222,200       23,618       263,880       283,014  

Selling, general and administrative expenses

    215,227       155,593       232,479       213,144       27,473       267,491       274,967  

(Gain) on sale of product line

    —         —         —         —         —         —         (4,376

Facility exit costs and restructuring

    1,740       901       6,056       6,552       —         —         —    

Impairment charge

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

    22,961       29,893       (13,090     2,504       (3,855     (49,400     (95,078

Interest expense

    17,682       12,973       19,599       16,882       3,235       28,600       27,182  

Loss on early extinguishment of debt

    —         877       —         —         —         10,201       —    

Change in fair value of interest rate swap .

    (271     (174     (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 .

    —         200       —         —         —         26,247       —    

Impairment of long-term asset .

    —         —         —         —         —         1,414       —    

Impairment of investment in unconsolidated affiliate

    —         —         —         —         —         7,749       9,012  

Gain on sale of unconsolidated affiliate

    (9,178              

Expense associated with convertible debt exchange

    —         —         —         —         —         —         1,090  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

    14,728       16,017       (32,915     (17,227     77,709       (146,590     (132,362

Provision for (benefit from) income taxes .

    (36     716       617       258       1,641       (334     167  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) before losses from investment in unconsolidated affiliate

    14,764       15,301       (33,532     (17,485     76,068       (146,256     (132,529

Losses of unconsolidated affiliate

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 14,764     $ 15,301     $ (33,532   $ (17,485   $ 76,068     $ (147,692   $ (134,017
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

               

Basic and Diluted

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

Earnings (loss) per share of common stock:

               

Basic and Diluted

  $ 14.76     $ 15.30     $ (33.53   $ (17.49   $ 4.02     $ (7.81   $ (7.10
 
    Successor Company           Predecessor Company  
    December 31,
2016
    December 26,
2015
    April 25,
2015
    April 26,
2014
          April 27,
2013
    April 28,
2012
 
Balance Sheet Data:                

Working capital (deficit)

  $ 130,988     $ 117,197     $ 100,595     $ 111,922       $ (30,325   $ 89,709  

Total assets

    287,607       274,489       307,672       334,377         427,573       461,339  

Total debt .

    137,487       144,259       176,913       161,133         198,302       288,441  

Stockholders’ equity (deficit) .

    98,119       81,606       66,377       103,057         (79,192     67,946  

 

30


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

Change in Fiscal Year

On April 29, 2015, the Board of Directors of School Specialty, Inc. approved a change in the Company’s fiscal year end from the last Saturday in April to the last Saturday in December. This change became effective on December 26, 2015, resulting in a transition period covering a thirty-five week period ended December 26, 2015 (“short year 2015”). As a result of this change, this MD&A compares the financial results for the fifty-three week year ended December 31, 2016 (“fiscal 2016”) to the unaudited fifty-two week period ended December 26, 2015, as well as comparing the financial results for short year 2015 to the comparable thirty-five week period ended December 27, 2014. See Note 2 of the consolidated financial statements.

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 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 100,000 items through an innovative two-pronged marketing and sales 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

 

31


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 fiscal 2016, as of and for the thirty five weeks ended December 26, 2015, as of and for the thirty-five weeks ended December 27, 2014, as of and for the year ended April 25, 2015, as of and for the forty-six weeks ended April 26, 2014 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.

Our goal is to grow profitably as a leading provider of supplies, product, services and curriculum for the education market. We have experienced two consecutive years of overall revenue growth. Our revenue growth in fiscal 2016 was balanced in that five or our seven product categories had growth over the fifty-two week year ended December 26, 2015. We expect to continue to achieve this goal over the long-term through an organic growth strategy based on leveraging our strong brand names and distribution capabilities and transforming the Company’s sales and marketing to a team-based selling 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 2016, the Company had revenue of $656.3 million and operating income of $23.0 million, as compared to revenue of $504.3 million and operating income of $29.9 million for the thirty-five week period ended December 26, 2015 and as compared to revenue of $637.5 million and operating income of $1.6 million in the fifty-two week year December 26, 2015. Due to the change in fiscal year, we believe it is more relevant to compare fiscal 2016 results to the comparable period for prior year instead of the thirty-five week period ended December 26, 2015. In fiscal 2015, the Company had revenues of $621.9 million and an operating loss of $13.1 million. The Company had cash flow from operations of $35.5 million in fiscal 2016 as compared to $34.2 million of cash flow from operations for the fifty-two week year ended December 26, 2015. In fiscal 2015, the Company had $5.4 million of cash flow from operations. The changes in the results for fiscal 2016 as compared to the thirty-five weeks ended December 26, 2015 are primarily attributable to the following:

 

   

The transition period, short year 2015, covered thirty-five weeks, while fiscal 2016 represented a full twelve months (fifty-three weeks); and

 

   

The change to a fiscal year end in December versus a fiscal year end in April resulted in the thirty five week period which did not include seventeen weeks that, due to our seasonality, historically generate operating losses and, thus, used cash in our operating activities.

In fiscal 2016, the Company’s revenue grew by 3.0% over the fifty-two week period ended December 26, 2015. In short year 2015, the Company’s revenues grew by 3.2% over the comparable thirty-five week period ended December 27, 2014. In fiscal 2015, the Company’s revenue declined 1.4% from combined fiscal 2014. The Company’s most significant revenue growth in fiscal 2016 as compared to the fifty-two week period ended December 26, 2015 was in the Furniture and Science product categories. Gross margin declined in fiscal 2016 as compared to the fifty-two week period ended December 26, 2015 through a combination of product mix and a gross margin rate decline in our Supplies category as a greater percentage of orders are being placed through strategic purchasing agreements which have lower gross margins. These declines have been more than offset by expense reductions.

 

32


While remaining focused on lowering costs through consolidation and process improvements, the Company is equally focused on revenue growth and gross margin management. The Company believes the following initiatives will contribute to continued revenue growth, while effectively managing gross margin and operating costs:

 

   

Successful execution of a new team sell model;

 

   

Establish momentum with the “21st Century Safe School” concept

 

   

Improve the effectiveness of margin management;

 

   

Development of an effective strategy to manage pricing in competitive bidding scenarios;

 

   

Increase product category specific sales and support expertise;

 

   

Execute on key platform investments to both drive efficiency and improve customer experiences.

Our business and working capital needs are highly seasonal, and we operate with an objective that schools and teachers receive their products by the start of the school year. As such, our peak sales levels occur from June through September. We expect to ship approximately 50% of our revenue and earn more than 100% of our annual net income from June through September of our fiscal year and operate at a net loss from January through May, and October through December. In anticipation of the peak shipping season, our inventory levels increase during the months of April through June. Our working capital historically peaks in August or September mainly due to the higher levels of accounts receivable related to our peak revenue months. Historically accounts receivable collections are strong in the months of September thru December as over 100% of our annual operating cash flow is generated in those months.

 

33


Results of Operations

The following table sets forth our results of operations for fiscal 2016, the unaudited fifty-two week period ended December 26, 2015, the thirty-five weeks ended December 26, 2015, fiscal 2015, the unaudited thirty-five week period ended December 27, 2014, the forty-six weeks ending April 26, 2014, and the six weeks ending June 11, 2013:

 

    Successor Company    

 

    Predecessor Company  
    Fiscal Year
Ended

December  31,
2016

(53 weeks)
    (Unaudited)
Fifty-Two
Weeks
Ended
December 26,
2015
    Thirty-Five
Weeks
Ended
December  26,
2015
    (Unaudited)
Thirty-Five
Weeks
Ended
December 27,
2014
    Fiscal Year
Ended
April 25,
2015
(52 weeks)
    Forty-Six
Weeks
Ended
April 26,
2014
   

 

    Six Weeks Ended
June 11, 2013
 

Revenues

  $ 656,322     $ 637,464     $ 504,278     $ 488,682     $ 621,868     $ 572,045         $ 58,697  

Cost of revenues

    416,394       405,123       317,891       306,478       393,710       349,845           35,079  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    239,928       232,341       186,387       182,204       228,158       222,200           23,618  

Selling, general and administrative expenses

    215,227       224,937       155,593       163,135       232,479       213,144           27,473  

Facility exit costs and restructuring

    1,740       3,117       901       3,840       6,056       6,552           —    

Impairment charge

    —         2,714       —         —         2,713       —             —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    22,961       1,573       29,893       15,229       (13,090     2,504           (3,855

Other expense:

                 

Interest expense

    17,682       18,838       12,973       13,734       19,599       16,882           3,235  

Loss on early extinguishment of debt

    —         876       877       —         —         —             —    

Early termination of long-term indebtedness

    —         200       200       —         —         —             —    

Gain on sale of unconsolidated affiliate

    (9,178     —         —         —         —         —             —    

Change in fair value of interest rate swap

    (271     (125     (174     (93     (45     483           —    

Refund of early termination fee

    —         —         —         —         —         (4,054         —    

Reorganization items, net

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

    14,728       (18,216     16,017       1,317       (32,915     (17,227         77,709  

Provision for (benefit from) income taxes

    (36     1,348       716       (25     617       258           1,641  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 14,764     $ (19,564   $ 15,301     $ 1,342     $ (33,532   $ (17,485       $ 76,068  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We have included the unaudited periods in the above table in order to better compare audited results to those results from a comparable period.

 

34


Costs of Revenues and Selling, General and Administrative Expenses

The following table illustrates the primary costs classified in Cost of Revenues and Selling, General and Administrative Expenses:

 

Cost of Revenues

  

Selling, General and Administrative Expenses

•    Direct costs of merchandise sold, net of vendor rebates other than the reimbursement of specific, incremental and identifiable costs and, and net of early payment discounts.

 

•    Amortization of product development costs

 

•    Freight expenses associated with moving merchandise from our vendors to fulfillment centers or from our vendors directly to our customers.

  

•    Compensation and benefit costs for all selling (including commissions), marketing, customer care and fulfillment center operations (which include the pick, pack and shipping functions), and other general adminstrative functions such as finance, human resources and information technology.

 

•    Occupancy and operating costs for our fulfillment centers and office operations.

 

•    Freight expenses associated with moving our merchandise from our fulfillment centers to our customers

 

•    Catalog expenses, offset by vendor payments or reimbursement of specific, incremental and identifiable costs.

The classification of these expenses varies across the distribution industry. As a result, the Company’s gross margin may not be comparable to other retailers or distributors.

Financial Information

As a result of the change in fiscal year effective December 26, 2015, management believes that the comparison of the fifty-three weeks ended December 31, 2016 to the unaudited fifty-two weeks ended December 26, 2015 offers a more useful comparison than comparing the results for the fifty-three weeks ended December 31, 2016 to the results for the thirty-five weeks ended December 26, 2015. See Note 21 of the consolidated financial statements for the comparative statements. This MD&A refers to the fifty-three weeks ended December 31, 2016 as “fiscal 2016”.

Consolidated Results

Overview of Fifty-Three Weeks Ended December 31, 2016 Compared to the Fifty-Two Weeks Ended December 26, 2015

Revenues

Revenue for the year ended December 31, 2016 increased by $18.9 million, or 3.0%, as compared to the fifty-two weeks ended December 26, 2015.

Distribution segment revenues increased 1.6%, or $8.6 million, from the fifty-two weeks ended December 26, 2015. Revenues from our two largest product categories, Supplies and Furniture, increased by $5.5 million and $13.4 million, respectively. These increases were partially offset by declines of $4.7 million and $4.5 million in our AV Tech and Agendas categories, respectively. Growth in art supplies, paper and writing instruments contributed to growth in the Supplies category. Revenue growth in these areas combined with growth of 26.6%, or $6.1 million, through our e-tail channel offset normal spending fluctuations in other areas of our education end market for Supplies. The Furniture category revenue growth was related to increased spending on new school construction and refurbishment projects, strong growth in our private label furniture lines, the

 

35


introduction of new products and more effective sales and marketing efforts. The Furniture order trends have continued to show strong growth while Supplies category order trends continued to show low single digit growth rates as compared to prior year. Revenues in the AV Tech category are down due to a decrease in demand for the Company’s listening devices; in the prior year, the product category benefited from several large orders driven by common core assessments. As a result, we expect revenue declines in the AV Tech category to lessen in 2017 as we continue to review and improve our offering. The Agendas category has continued to decline as we believe schools have transitioned away from the customized content-rich planners and shifted purchases to lower-priced planners with less customized content or moved away from paper-based planners altogether. While current year order trends for planners have been consistent with internal expectations, we expect the rate of decline for Agenda products to lessen as we more effectively address the market through changes to our product offering and pricing, as well as changes to our sales strategy. It is important to note the Fiscal 2016 Distribution revenue benefited from a fifty-third week.

Curriculum segment revenues increased 10.8%, or $10.3 million in fiscal 2016, from the fifty-two weeks ended December 26, 2015. This increase was related primarily to the Science category with fiscal 2016 revenues of $80.1 million, up $9.6 million, or 13.6% over the comparable period in 2015. Strong acceptance of the FOSS curriculum, which is aligned with the Next Generation Science Standards, continued throughout fiscal 2016 and contributed to the revenue increase. State science adoptions in West Virginia, Alabama and South Carolina also contributed to the increase in Science revenues in fiscal 2016. As fewer state Science adoptions are scheduled for 2017, we expect modest declines in Science revenues in fiscal 2017. Product enhancements in the Reading category, combined with structural changes to our Reading sales organization, contributed to the 2.8%, or $0.7 million, of revenue growth in fiscal 2016.

Gross Profit

Gross margin for fiscal 2016 was 36.6% as compared to 36.5% for the fifty-two weeks ended December 26, 2015.

Distribution segment gross margin was 33.7% for fiscal 2016 as compared to 34.4% for the fifty-two weeks ended December 26, 2015. A shift in mix within the segment, particularly towards our Furniture category, resulted in a 40 basis point decline. Lower gross margins at the product category level resulted in 30 basis points of decline in fiscal 2016 segment gross margin. The decrease in product category gross margin for fiscal 2016 was primarily related to our Supplies category as a greater percentage of our Supplies orders were placed through strategic purchasing co-operative agreements. These agreements typically price basic supplies at lower gross margins. Additionally, increased volume associated with orders placed through certain strategic purchasing agreements and certain e-tail channels resulted in increased customer rebates which caused 30 basis points of gross margin decline in the category. Decreased product development amortization in the Agendas product category, due to the impairment in the fifty-two weeks ended December 26, 2015, positively impacted the gross margin rate by 25 basis points.

Curriculum segment gross margin was 51.4% for fiscal 2016 as compared to 48.1% for the fifty-two weeks ended December 26, 2015. A decrease in product development amortization of $2.6 million in fiscal 2016 as compared to the fifty-two weeks ended December 26, 2015 resulted in 350 basis points of gross margin improvement. Improved product margins within the Science category associated with a combination of the new curriculum products and pricing resulted in approximately 25 basis points of gross margin improvement; however, the impact of mix shifting towards Science versus Reading resulted in 50 basis points of gross margin decline in fiscal 2016.

Selling, General and Administrative Expenses

SG&A decreased $9.7 million from $224.9 million for the fifty-two weeks ended December 26, 2015 to $215.2 million for fiscal 2016. Compensation and benefit costs, excluding performance-based compensation, decreased $0.7 million in fiscal 2016 as compared to the fifty-two weeks ended December 26, 2015. The

 

36


decrease is due to lower staffing levels in fiscal 2016 versus 2015, partially offset by $1.5 million of additional compensation and benefit costs in fiscal 2016 associated with an additional week (fifty-three weeks versus fifty-two weeks). Average staffing levels decreased by approximately 80 in fiscal 2016 as compared to the fifty-two weeks ended December 26, 2015. Additionally, sales commissions in fiscal 2016 are down approximately $2.6 million due to accelerated commission rates associated with above-plan performance in the certain product categories in the prior year. Variable outbound transportation costs increased in fiscal 2016 by $0.6 million. This increase is related primarily to increased shipments from our fulfillment centers associated with the revenue increase during the year. We recognized a net foreign currency gain in fiscal 2016 of $0.7 million due to the Canadian dollar strengthening versus the U.S. dollar in the period; this compares to a net foreign currency loss of $1.2 million in the fifty-two weeks December 26, 2015.

Depreciation and amortization expense in SG&A was down approximately $4.6 million in fiscal 2016 as compared to the fifty-two week period ended December 26, 2015 due partially to the prior year write-off of the intangible asset associated with Agenda content.

As a percent of revenue, SG&A decreased from 35.3% for the fifty-two weeks ended December 26, 2016 to 32.8% for fiscal 2016.

Facility exit costs and restructuring

During fiscal 2016, the Company recorded $1.7 million of restructuring charges which were all related to severance.

During the fifty-two weeks ended December 26, 2015, the Company recorded $3.1 million of restructuring charges related primarily to severance.

Impairment Charges

The Company recorded an impairment charge of $2.7 million during the fifty-two weeks ended December 26, 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. No such impairment charge has been incurred in fiscal 2016.

Interest Expense

Interest expense decreased $1.1 million, from $18.8 million during the fifty-two weeks ended December 26, 2015 to $17.7 million for fiscal 2016, which was primarily due to a decrease in cash interest associated with the Company’s lower average debt balances in 2016. The Company’s average debt balance was approximately $23.4 million lower in fiscal 2016 as compared to the fifty-two weeks ended December 26, 2015.

Loss on Prepayment of Long Term Indebtedness

The Company recorded a $0.2 million charge during the fifty-two weeks ended December 26, 2015 associated with the prepayment of $10.0 million of its Term Loan. No such charge has been incurred in fiscal 2016.

Loss on Early Extinguishment of Debt

During the fifty-two weeks ended December 26, 2015, the Company recorded a non-cash charge of $0.9 million related to the acceleration of the remaining unamortized debt issuance costs associated with the second amendment of its ABL facility. No such charge has been incurred in fiscal 2016.

 

37


Gain on Sale of Unconsolidated Affiliate

During fiscal 2016, the Company sold its 35% ownership interest in Carson Dellosa LLC for $9.9 million. The Company recorded a gain on the sale of $9.2 million.

Change in Fair Value of Interest Rate Swap

The Company had an interest rate swap agreement that effectively fixed the interest payments on a portion of the Company’s variable-rate debt. The swap, which terminated on September 11, 2016, effectively fixed the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. Prior to the termination of the interest rate swap, the notional amount of the swap was $72.5 million. During fiscal 2016, prior the termination of the interest rate swap, the fair value of the derivative increased by $0.3 million and, accordingly, a non-cash gain of $0.3 million was recorded. As the interest rate swap expired in the third quarter of fiscal 2016, no additional income or loss will be realized in future periods. For the fifty-two weeks ended December 26, 2015, the fair value of the derivative increased by $0.1 million and a non-cash gain of $0.1 million was recorded.

Provision for (Benefit from) Income Taxes

The benefit from income taxes was less than $0.1 million for fiscal 2016 as compared to a provision for income taxes income taxes of $1.4 million for the fifty-two weeks ended December 26, 2015.

The effective tax rate for fiscal 2016 is -0.3% as compared to an effective tax rate of 7.4% for the fifty-two week period ended December 26, 2015. The tax benefit in fiscal 2016 reflected the utilization of deferred tax assets, and subsequent reversal of valuation allowances against such deferred tax assets, which offset the Company’s pre-tax book income. The tax expense for the fifty-two week period ended December 26, 2015 primarily related to foreign and alternative minimum tax.

Overview of Thirty-Five Weeks Ended December 26, 2015 Compared to the Thirty-Five Weeks Ended December 27, 2014

Revenues

Revenue for the thirty-five weeks ended December 26, 2015 increased by $15.6 million, or 3.2%, as compared to the thirty-five weeks ended December 27, 2014.

Distribution segment revenues increased 2.6%, or $10.9 million, from the thirty-five weeks ended December 27, 2014. The revenue growth in the short year 2015 was negatively impacted by approximately $3.1 million of foreign exchange translation related to a year-over-year decline in the value of the Canadian dollar. Revenue from our Furniture product lines increased by $24.8 million, or 21.3%, which offset declines of $8.0 million and $3.2 million in the Agenda and Supplies categories, respectively. The increased revenues in our Furniture category was related to increased spending in new school construction which was projected to be up 16% in 2015, strong growth in our private label furniture lines, the introduction of new products and more effective sales and marketing efforts. Supplies category revenue was negatively impacted by delayed budget approvals in certain larger states. In addition, competitive pressures in traditional office supplies contributed to the decline. Revenues in the Agenda category have continued to decline as we believe schools have de-emphasized paper-based planners and shifted to lower-priced products. The period-over-period decline in the value of the Canadian dollar versus the U.S. dollar has contributed approximately $1.6 million of the period-over-period revenue decline for the Agenda category.

Curriculum segment revenues increased 6.8%, or $4.7 million, from the thirty-five weeks ended December 27, 2014. Revenues in the Science category increased by $5.9 million in the thirty-five week period ended December 26, 2015 mainly due to the strong acceptance in the current year for the Science category’s new

 

38


products which are aligned with Next Generation Science Standards and contain more digital content. Success with new Science offerings has enabled the segment to replace prior year revenue from the Texas adoption of its state science curriculum. Partially offsetting the revenue increase from the Science category is a decline of $1.1 million in Reading category revenue as demand for the Company’s products was slightly weaker than prior year.

Gross Profit

Gross margin for the thirty-five weeks ended December 26, 2015 was 37.0% as compared to 37.3% for the thirty-five weeks ended December 27, 2014.

Distribution segment gross margin was 34.1% for the thirty-five weeks ended December 26, 2015 as compared to 35.2% for the thirty-five weeks ended December 27, 2014. Mix within the segment resulted in a 120 basis point decline with Supplies and Agenda revenues declining and Furniture revenues increasing. The impact of the weaker Canadian dollar versus the U.S. dollar in short year 2015 as compared to the thirty-five week period 2014 resulted in 50 basis points of gross margin decline. These gross margin declines were partially offset by an overall improved gross margin rate at the product category level which netted a 50 basis point positive impact. Decreased product development amortization in the agendas product category, due to the impairment in fiscal 2015, positively impacted the gross margin rate by 10 basis points.

Curriculum segment gross margin was 53.4% for the thirty-five weeks ended December 26, 2015 as compared to 50.0% for the thirty-five weeks ended December 27, 2014. A decrease in product development amortization of $2.3 million in the short year 2015 as compared to the thirty-five week period ended December 27, 2014 resulted in 370 basis points of gross margin improvement. Improved product margins within the Science category associated with a combination of the new curriculum products and pricing resulted in approximately 60 basis points of gross margin improvement; however, the impact of mix shifting towards Science versus Reading resulted in 90 basis points of gross margin decline in the current period.

Selling, General and Administrative Expenses

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

SG&A decreased $7.3 million from $163.1 million for the thirty-five weeks ended December 27, 2014 to $155.8 million for the thirty-five weeks ended December 26, 2015. Compensation and benefit costs, excluding performance-based compensation, decreased $9.9 million due to a reduction in average headcount of approximately 200 for the thirty-five weeks ended December 26, 2015 as compared to the thirty-five weeks ended December 27, 2014. This reduction has been partially offset by approximately $4.1 million of incremental performance-based incentive compensation and $0.6 million of incremental stock-based compensation expense in the current year’s period. Based on performance in the prior year, last year’s incentive compensation was zero for the thirty-five week period. Additionally, sales commissions in the current period are up approximately $2.9 million due to the incremental volume and accelerated commission rates associated with above-plan performance in certain product categories. As planned, approximately $1.4 million of the savings associated with the reduction in the number of associates was offset by incremental expense related to outsourcing a portion of our customer care call center and transferring certain west coast fulfillment activities to a third-party logistics provider to better service our customers. The resulting shorter lead times for west coast customers is expected to lead to revenue growth from these customers. Variable outbound transportation costs decreased in short year 2015 by $1.0 million. This decline is related primarily to decreased shipments from our fulfillment centers associated with the revenue decline in the Supplies and Agenda categories. Catalog expense declined by

 

39


$2.6 million in short year 2015 as compared to the thirty-five week period 2014 associated with the Company’s continued strategy of increasing customer interactions through digital marketing campaigns and more efficient use of print catalogs.

The Company incurred $6.1 million of transition expenses in the thirty-five weeks ended December 27, 2014 associated with transferring the majority of the fulfillment center activities to the Mansfield, Ohio distribution center and consulting fees associated the process improvement initiatives. These costs did not recur in short year 2015.

The Company incurred $1.2 million of costs in the thirty-five weeks ended December 26, 2015 related to the write-off of prepaid royalties for a supplemental curriculum product that is not core to the Company’s future growth strategies. In addition, the Company incurred $0.4 million in the thirty-five weeks ended December 26, 2015 associated with various contract terminations related to software license fees that have been re-negotiated in order to lower future costs.

Depreciation and amortization expense in SG&A was down approximately $0.4 million in the thirty-five weeks ended December 26, 2015 as compared to the thirty-five week period ended December 27, 2014 due primarily to the April, 2015 write-off of the intangible asset associated with Agenda content.

As a percent of revenue, SG&A decreased from 33.4% for the thirty-five weeks ended December 27, 2014 to 30.9% for the thirty-five weeks ended December 26, 2015.

Facility exit costs and restructuring

During the thirty-five weeks ended December 26, 2015, the Company recorded $0.9 million of restructuring charges related primarily to $0.5 million of lease termination costs and severance. The lease termination relates to the reduction in the square footage of its Cambridge, Massachusetts facility.

During the thirty-five weeks ended December 27, 2014, the Company recorded $3.8 million of restructuring charges related primarily to severance.

Interest Expense

Interest expense decreased $0.7 million, from $13.7 million for the thirty-five weeks ended December 27, 2014 to $13.0 million for the thirty-five weeks ended December 26, 2015, which was primarily due to a decrease in non-cash interest associated with the Company’s deferred payment obligations. In last year’s quarter ended July 26, 2014, the principal balance of the Company’s deferred cash payment obligations were increased as a result of an adjustment to the fresh start accounting estimate. Accordingly, an incremental $0.5 million of non-cash interest was recorded in last year’s first quarter. Cash interest for the thirty-five week period ended December 26, 2015 was down $0.3 million as compared to last year’s comparable period due to the combination of reduced commitment fees on any unused portion of the ABL facility and the $10.0 million pay down on the Term Loan during the second quarter of 2015, offset in part by higher borrowings under the ABL facility.

Loss on Prepayment of Long Term Indebtedness

The Company recorded a $0.2 million charge in short year 2015 associated with the prepayment of $10.0 million of its Term Loan.

Loss on Early Extinguishment of Debt

In short year 2015, the Company recorded a non-cash charge of $0.9 million related to the acceleration of the remaining unamortized debt issuance costs associated with the second amendment of its ABL facility.

 

40


Change in Fair Value of Interest Rate Swap

The Company has 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 December 26, 2015 was $72.5 million. As of December 26, 2015, the fair value of the derivative increased by $0.2 million and, accordingly, a non-cash gain of $0.2 million was recorded. For the thirty-five weeks ended December 27, 2014, the fair value of the derivative increased by $0.1 million and a non-cash gain of $0.1 million was recorded.

Reorganization Items, Net

In the thirty-five weeks ended December 27, 2014, the Company recorded a $0.3 million net reorganization loss. This consists of professional advisory fees and other costs related to the continued implementation of the Reorganization Plan and the resolution of unresolved claims. The Company did not record reorganization items in the thirty-five weeks ended December 26, 2015, nor does it expect to incur significant costs related to the Reorganization Plan in future periods. The Chapter 11 Case was closed during the Company’s second quarter of short year 2015.

Provision for (Benefit from) Income Taxes

The provision for income taxes was $0.7 million for the thirty-five weeks ended December 26, 2015 as compared to a benefit from income taxes of $0.0 million for the thirty-five weeks ended December 27, 2014.

The effective tax rate for the thirty-five weeks ended December 26, 2015 and the thirty-five weeks ended December 27, 2014 was 4.5% and -1.9%, respectively. The tax expense for the thirty-five weeks ended December 26, 2015 primarily relates to foreign and alternative minimum tax. 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 December 26, 2015. The benefit recorded in the thirty-five weeks ended December 27, 2014 is related to foreign tax true-ups.

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.

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.

Overview of Fiscal 2015

Revenues

 

     Successor
Company
     Successor
Company
          Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     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
     Twelve  Months
Ended

April 27, 2013
 

Revenues

   $ 621,868      $ 572,045         $ 58,697      $ 630,742      $ 674,998  

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.

 

41


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 considered agenda products more discretionary in nature and some schools were de-emphasizing paper-based agendas in favor of digital products. In addition, schools were 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 combined 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 was 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 were 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 adoption of new science standards.

Gross Profit

 

     Successor
Company
     Successor
Company
          Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     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
     Twelve  Months
Ended

April 27, 2013
 

Gross profit

   $ 228,158      $ 222,200         $ 23,618      $ 245,818      $ 263,880  

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 was primarily related to the Company’s agenda product category. Approximately 130 basis points of the gross margin decline related 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 category were related to a combination of the lower average selling prices of agendas and incremental product development amortization. The remaining decline in gross margin was 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.

 

42


Selling, General and Administrative Expenses

 

     Successor
Company
     Successor
Company
          Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     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
     Twelve  Months
Ended

April 27, 2013
 

Selling, general and administrative expenses

   $ 232,479      $ 213,144         $ 27,473      $ 240,617      $ 267,491  

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. 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 reflected 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 was 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 was 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 was related primarily to process improvement implementation costs such as consulting fees and warehouse implementation costs associated with transitioning the majority of fulfillment activities to the Company’s Mansfield, Ohio distribution center. Approximately $0.6 million of the increase was 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 total $3.8 million total facility exit and restructuring costs.

 

43


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 decided to focus on the print-based agenda products and no longer planned to continue to invest in the digital agenda product offerings.

Interest Expense

 

     Successor
Company
     Successor
Company
          Predecessor
Company
     Non-GAAP
Combined
     Predecessor
Company
 
     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
     Twelve Months
Ended

April  27, 2013
 

Interest expense

   $ 19,599      $ 16,882         $ 3,235      $ 20,117      $ 28,600  

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 fixed the interest payments on a portion of the Company’s variable-rate debt. The swap, which had a termination date of September 11, 2016, effectively fixed the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. The 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.

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 previous 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 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 the lenders 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, the lender 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.

 

44


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 consisted 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
     Predecessor
Company
 
     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
     Twelve Months
Ended

April  27, 2013
 

Provision for (benefit from) income taxes

   $ 617      $ 258         $ 1,641      $ 1,899      $ (334

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 was 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 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.

Liquidity and Capital Resources

At December 31, 2016, the Company had net working capital of $128.3 million. The Company’s capitalization at December 31, 2016 was $235.6 million and consisted of total debt of $137.5 million and stockholders’ equity of $98.1 million.

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.,

 

45


as Joint Lead Arrangers and Bookrunners, and the Lenders that are party to the Asset-Based Credit Agreement (the “Asset-Based Lenders”).

Under the Asset-Based Credit Agreement, the Asset-Based Lenders agreed to provide a revolving senior secured asset-based credit facility (the “ABL Facility”) in an aggregate principal amount of $175.0 million. As of August 7, 2015, the aggregate commitments were permanently reduced, at the election of the Company, by $50.0 million, from $175.0 million to $125.0 million. The Company believes that this reduction will enable the Company to reduce its annual interest expense through lower commitment fees, and that the commitments, as reduced, will continue to provide sufficient borrowing capacity for the remaining term of the agreement. Outstanding amounts under the ABL Facility 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 ABL Facility and the applicable point in the life of the ABL Facility) (the “Applicable Margin”), or (2) a LIBOR rate plus the Applicable Margin (the “LIBOR Rate”). Interest on loans under the ABL Facility bearing interest based upon the Base Rate are due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate are 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 Company may prepay advances under the ABL Facility in whole or in part at any time without penalty or premium. The Company will be required to make specified prepayments upon the occurrence of certain events, including: (1) the amount outstanding on the ABL Facility exceeding the Borrowing Base, and (2) the Company’s receipt of net cash proceeds of any sale or disposition of assets that are first priority collateral for the ABL Facility.

Pursuant to a Guaranty and Collateral Agreement dated as of June 11, 2013 (the “ABL Security Agreement”), the 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 2016. Based on current projections, the Company believes it will maintain compliance with these financial covenants through the next twelve months.

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

Under the Term Loan Credit Agreement, the Term Loan Lenders agreed to make a term loan (the “Term Loan”) to the Company in aggregate principal amount of $145 million. The outstanding principal amount of the Term Loan bears interest at a rate per annum equal to the applicable LIBOR rate (with a 1% floor) plus 8.50%, or the base rate plus a margin of 7.50%. Interest on loans under the Term Loan Credit Agreement bearing interest based upon the base rate are due quarterly in arrears, and interest on loans bearing interest based upon the LIBOR rate are 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 Term Loan matures on June 11, 2019. The Term Loan Credit Agreement requires prepayments at specified levels upon the Company’s receipt of net proceeds from certain events, including: (1) certain

 

46


dispositions of property, divisions, business units or business lines; and (2) other issuances of debt other than Permitted Debt, as defined in the Term Loan Credit Agreement. The 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 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 Term Loan Credit Agreement, as amended, if prepaid prior to October 31, 2016.

Pursuant to a Guarantee and Collateral Agreement dated as of June 11, 2013 (the “Term Loan Security Agreement”), the 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 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 October 26, 2013, 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 2016.

On October 31, 2014, the Company obtained amendments to both its Asset-Based Credit Agreement and 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 ability to remain in compliance with the financial covenants under the Asset-Based Credit Agreement and Term Loan Credit Agreement. Based on current projections, the Company believes it will maintain compliance with these financial covenants through the next twelve months.

On September 16, 2015, the Company obtained a second amendment to its Asset-Based Credit Agreement. The amendment provided for the following; (1) a reduction in the Applicable Margin for base rate loans and LIBOR loans; (2) a reduction in the unused line fee rate; (3) and extension of the scheduled maturity date to September 16, 2020, which automatically becomes March 12, 2019 unless the Term Loan has been repaid, refinanced, redeemed, exchanged or amended prior to such date (in the case of a refinancing or amendment to a date that is at least 90 days after the scheduled maturity date); (4) the withdrawal of SunTrust Bank as a lender and the assumption of its commitments by the remaining lenders; (5) an expansion of the Company’s ability to use excess availability to satisfy financial covenants during the peak season of July through September; and (6) certain amendments relating to the previously announced permanent reduction in the aggregate commitments.

Net cash provided by operating activities was $35.5 million in fiscal 2016 as compared to $34.2 million for the fifty-two weeks ended December 26, 2015. The increase in cash provided by operating activities was related to additional net income partially offset by period-over-period changes in net working capital. While net income increased by $34.2 million in fiscal 2016 as compared to the fifty-two weeks ended December 26, 2015, $15.1 million of the improvement related to a reduction in non-cash charges, particularly decreased depreciation and amortization in fiscal 2016. Additionally, $9.2 million of the increase in net income in fiscal 2016 was related to the gain on sale of unconsolidated affiliate for which the proceeds did not benefit cash provided by operating activities, but rather benefited cash from investing activities. Net working capital changes provided positive cash flow of $4.6 million in fiscal 2016 as compared to positive cash flow of $13.2 million in the fifty-two weeks ended December 26, 2015. The largest variances within net working capital related to the change in the Company’s accrued liabilities. In the fifty-two week period ended December 26, 2015, the combination of incremental accrued commissions and incremental accrued incentive compensation provided the majority of the incremental cash flow associated with working capital changes.

 

47


Net cash used in investing activities was $4.5 million in fiscal 2016 as compared to $12.4 million for the fifty-two weeks ended December 26, 2015. The year-over-year variance is primarily attributable to $9.9 million of proceeds received from the sale of our investment in an unconsolidated affiliate. For fiscal 2016, the Company’s cash used in investing activities related to property, plant, equipment was $11.8 million as compared to $8.8 million for the fifty-two week period ended December 26, 2015. The increase is related to the implementation of a new phone system, which will provide necessary functionality and feature enhancements to our call centers and other key business application tools to improve operating effectiveness. The implementation of the new phone system began during the nine months ended September 24, 2016. The Company’s cash used in investing activities related to product development was $2.5 million in fiscal 2016 as compared to $5.3 million in the fifty-two week period ended December 26, 2015. The decrease was partially related to timing shifts in the product development schedules. Additionally, the prior year amounts included spending associated with the development of our FOSS Next Generation Science offerings which did not require significant incremental product development spending in fiscal 2016.

Net cash used in financing activities was $9.9 for fiscal 2016 as compared to $17.9 million for the fifty-two weeks ended December 26, 2015. In fiscal 2016, the net cash used in financing activities represents paydowns of our Term Loan using primarily cash proceeds from the sale of the Company’s investment in unconsolidated affiliate. In the fifty-two week period ended December 26, 2015, the net cash used in financing activities represents combined net paydowns of our ABL Facility and Term Loan using net cash provided by operations less cash used in investing. Outstanding borrowings on the ABL Facility were $0 as December 31, 2016, while the excess availability on that date for the ABL Facility, as amended, was $38.6 million. In addition to the excess availability as of December 31, 2016, the Company had a cash balance of $35.1 million. The Company’s remaining gross Term Loan balance as of December 31, 2016 was $122.2 million.

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 next twelve months.

Off Balance Sheet Arrangements

None.

Summary of Contractual Obligations

The following table summarizes our contractual debt and operating lease obligations as of December 31, 2016:

 

     Payments Due
(in thousands)
 
     Total      Less than
1 year
     1 - 3
years
     4 - 5
years
     More than
5 years
 

Long-term debt obligations (1)

   $ 150,303      $ 17,336      $ 132,967      $ —        $ —    

Deferred cash payment obligations (1)

     24,055           24,055        

Operating lease obligations

     13,590        4,312        6,325        2,775        178  

Purchase obligations (2)

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 187,948      $ 21,648      $ 163,347      $ 2,775      $ 178  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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 December 31, 2016.
(2) As of December 31, 2016, we did not have any material long-term or short term purchase obligations.

 

48


Fluctuations in Quarterly Results of Operations

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

The following table sets forth certain unaudited consolidated quarterly financial data for fiscal year 2016, short year 2015 and fiscal year 2015 (in thousands, except per share data). We derived this quarterly data from our unaudited consolidated financial statements.

 

     Fiscal 2016  
     Successor Company  
     First     Second     Third      Fourth     Total  

Revenues

   $ 93,725     $ 145,858     $ 301,569      $ 115,170     $ 656,322  

Gross profit

     35,465       55,599       111,558        37,306       239,928  

Operating income (loss)

     (12,012     2,004       47,011        (14,042     22,961  

Net income (loss)

     (12,303     (1,986     42,895        (13,842     14,764  

Basic earnings per share of common stock:

           

Earnings/(loss)

   $ (12.30   $ (1.99   $ 42.90      $ (13.85   $ 14.76  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Diluted earnings per share of common stock:

           

Earnings/(loss)

   $ (12.30   $ (1.99   $ 42.90      $ (13.85   $ 14.76  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

     Short Year 2015  
     Successor Company  
     First      Second      Nine Weeks Ended
December 26, 2015
    Total  

Revenues

   $ 199,530      $ 245,148      $ 59,600     $ 504,278  

Gross profit

     78,002        88,533        19,852       186,387  

Operating income (loss)

     20,076        26,789        (16,972     29,893  

Net income (loss)

     14,958        19,825        (19,482     15,301  

Basic earnings per share of common stock:

          

Earnings/(loss)

   $ 14.96      $ 19.83      $ (19.49   $ 15.30  
  

 

 

    

 

 

    

 

 

   

 

 

 

Diluted earnings per share of common stock:

          

Earnings/(loss)

   $ 14.96      $ 19.83      $ (19.49   $ 15.30  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     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
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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 areas such as wages, healthcare and energy costs, has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.

Critical Accounting Policies

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 a 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:

Catalog Costs and Related Amortization

We spend approximately $14 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, for which future revenue can be directly attributable, 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 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 December 31, 2016, we had $12.2 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 2016 we amortized development costs of $7.5 million to expense. 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. In fiscal 2016 and fiscal 2015, we recorded write-downs of capitalized product development costs of $1.3 million and $3.8 million, respectively.

Goodwill and Intangible Assets

At December 31, 2016, intangible assets represented approximately 20% of our total assets. We review our goodwill intangible assets for impairment annually, or more frequently if indicators of impairment exist. A

 

50


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, 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 2016 assessment, the fair value of the Distribution, Science and Reading reporting units were in excess of their carrying values by over 20%. 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 revenue enhancing and cost saving initiatives. These assumptions, along with discount rate assumptions, can have a material impact on the fair value determinations. As such, the Company performs a sensitivity analysis whereby changes to the assumptions include: i) an increase in the discount rate to reflect 100 basis points of additional company-specific risk premium; ii) lower long-term revenue growth rates by over 40%; and iii) reduced operating margin assumptions by at least 20 basis points. Based on this sensitivity analysis, these changes to the assumptions would not have resulted in a failure in the first step of the goodwill impairment testing.

As discussed in Note 8—Goodwill and Other Intangible Assets of the consolidated financial statements, 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. There were no impairments recorded in short year 2015 and fiscal 2016. 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 December 31, 2016, our valuation allowance totaled $18.7 million.

 

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

 

51


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 2016 and short year 2015, pre-tax earnings would have decreased by approximately $0.7 million and $0.6 million. 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 Term Loan was, 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 through September 11, 2016 (See Note 10 – Debt). The estimated fair value of long-term debt was approximately $122.8 million as of December 31, 2016 based on its trading value.

 

52


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 December 31, 2016 and December 26, 2015 and April 25, 2015 (Successor Company) and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity (deficit), and cash flows for the year ended December 31, 2016 (Successor Company), the 35 week period ended December 26, 2015 (Successor Company), the year ended April 25, 2015 (Successor Company), the 46 week period ended April 26, 2014 (Successor Company), and the six week period ended June 11, 2013 (Predecessor Company). Our audits also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 December 31, 2016, December 26, 2015, and April 25, 2015 (Successor Company) and the results of their operations and their cash flows for the year ended December 31, 2016 (Successor Company), the 35 week period ended December 26, 2015 (Successor Company), the year ended April 25, 2015 (Successor Company), the 46 week period ended April 26, 2014 (Successor Company), and the six week period ended June 11, 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, presents 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 December 31, 2016, 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 March 14, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Milwaukee, Wisconsin

March 14, 2017

 

53


FINANCIAL STATEMENTS

SCHOOL SPECIALTY, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

     Successor Company  
     December 31,
2016
    December 26,
2015
    April 25,
2015
 

ASSETS

      

Current assets:

      

Cash and cash equivalents.

   $ 35,097     $ 12,865     $ 8,920  

Accounts receivable, less allowance for doubtful accounts of $1,159, $1,077, and $806, respectively

     61,713       58,370       58,685  

Inventories, net

     73,649       76,199       96,935  

Deferred catalog costs

     5,235       6,527       7,424  

Prepaid expenses and other current assets

     11,976       13,111       15,868  

Refundable income taxes

     728       9       1,549  
  

 

 

   

 

 

   

 

 

 

Total current assets

     188,398       167,081       189,381  

Property, plant and equipment, net

     28,684       27,127       32,024  

Goodwill

     21,588       21,588       21,588  

Intangible assets, net

     35,049       38,652       41,055  

Development costs and other, net

     13,703       19,321       22,907  

Deferred taxes long-term

     185       5       2  

Investment in unconsolidated affiliate

     —         715       715  
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 287,607     $ 274,489     $ 307,672  
  

 

 

   

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities:

      

Current maturities of long-term debt

   $ 5,493     $ 1,821     $ 25,644  

Accounts payable

     22,078       20,076       41,587  

Accrued compensation

     12,008       10,488       7,341  

Deferred revenue

     2,922       2,705       2,490  

Accrued royalties

     3,724       3,091       992  

Other accrued liabilities

     11,185       11,703       10,732  
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     57,410       49,884       88,786  

Long-term debt less current maturities

     131,994       142,438       151,269  

Other liabilities

     84       561       1,240  
  

 

 

   

 

 

   

 

 

 

Total liabilities

     189,488       192,883       241,295  

Commitments and contingencies—Note 19

      

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       1  

Capital in excess of par value

     120,855       119,240       118,544  

Accumulated other comprehensive income (loss)

     (1,784     (1,919     (1,151

Accumulated deficit

     (20,953     (35,716     (51,017
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity

     98,119       81,606       66,377  
  

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 287,607     $ 274,489     $ 307,672  
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

54


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

 

    Successor Company           Predecessor Company  
    Fiscal Year
Ended December 31,
2016
(53 weeks)
    Thirty-Five Weeks
Ended December  26,

2015
    Fiscal Year
Ended April  25,

2015
(52 weeks)
    Forty-Six Weeks
Ended

April 26, 2014
          Six Weeks
Ended June  11,

2013
 

Revenues

  $ 656,322     $ 504,278     $ 621,868     $ 572,045         $ 58,697  

Cost of revenues

    416,394       317,891       393,710       349,845           35,079  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Gross profit.

    239,928       186,387       228,158       222,200           23,618  

Selling, general and administrative expenses

    215,227       155,593       232,479       213,144           27,473  

Facility exit costs and restructuring

    1,740       901       6,056       6,552           —    

Impairment charge

    —         —         2,713       —             —    
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Operating income (loss)

    22,961       29,893       (13,090     2,504           (3,855

Other expense:

             

Interest expense

    17,682       12,973       19,599       16,882           3,235  

Loss on early extinguishment of debt

    —         877       —         —             —    

Early termination of long-term indebtedness

    —         200       —         —             —    

Gain on sale of unconsolidated affiliate.

    (9,178     —         —         —             —    

Change in fair value of interest rate swap

    (271     (174     (45     483           —    

Refund of early termination fee

    —         —         —         (4,054         —    

Reorganization items, net

    —         —         271       6,420           (84,799
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

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

    14,728       16,017       (32,915     (17,227         77,709  

Provision for (benefit from) income taxes

    (36     716       617       258           1,641  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net income (loss)

  $ 14,764     $ 15,301     $ (33,532   $ (17,485       $ 76,068  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Weighted average shares outstanding:

             

Basic and Diluted

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

Net income (loss) per share:

             

Basic and Diluted

  $ 14.76     $ 15.30     $ (33.53   $ (17.49       $ 4.02  

See accompanying notes to consolidated financial statements.

 

55


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In Thousands)

 

    Successor Company           Predecessor Company  
    Fiscal Year
Ended  December 31,
2016
(53 weeks)
    Thirty-Five Weeks
Ended December  26,
2015
    Fiscal Year
Ended April  25,

2015
(52 weeks)
    Forty-Six Weeks
Ended

April 26, 2014
          Six Weeks
Ended
June 11, 2013
 

Net income (loss)

  $ 14,764     $ 15,301     $ (33,532   $ (17,485       $ 76,068  

Other comprehensive (loss) income

             

Foreign currency translation adjustments

    135       (768     (737     (414         (101
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Total comprehensive income (loss)

  $ 14,899     $ 14,533     $ (34,269   $ (17,899       $ 75,967  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

See accompanying notes to consolidated financial statements.

 

56


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(In Thousands)

 

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

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  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

         15,301           15,301  

Share-based compensation expense

       696             696  

Foreign currency translation adjustment

             (768     (768
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 26, 2015 (Successor Company)

   $ 1     $ 119,240     $ (35,716   $ —       $ (1,919   $ 81,606  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

         14,764           14,764  

Share-based compensation expense

       1,615             1,615  

Foreign currency translation adjustment

             135       135  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2016 (Successor Company)

   $ 1     $ 120,855     $ (20,953   $ —       $ (1,784   $ 98,119  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

57


SCHOOL SPECIALTY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

    Successor Company           Predecessor
Company
 
    Fiscal
Year
Ended
December 31,
2016

(53 weeks)
    Thirty-Five
Weeks
Ended
December 26,
2015
    Fiscal
Year
Ended
April  25,
2015

(52 weeks)
    Forty-Six
Weeks
Ended

April 26,
2014
          Six
Weeks
Ended

June 11,
2013
 

Cash flows from operating activities:

             

Net income (loss)

  $ 14,764     $ 15,301     $ (33,532   $ (17,485       $ 76,068  

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

             

Depreciation and intangible asset amortization expense

    13,863       11,644       19,233       18,876           2,983  

Amortization of development costs

    7,488       5,291       14,310       6,306           918  

Non-cash reorganization items

    —         —         —         1,292           (99,668

Loss on early extinguishment of debt

    —         877       —         —             —    

Unrealized foreign exchange (gain) loss

    (1,091     —         —         —             —    

Early termination of long-term indebtedness

    —         200       —         —             —    

Gain on sale of unconsolidated affiliate

    (9,178            

Amortization of debt fees and other

    2,079       1,461       1,946       2,139           9  

Change in fair value of interest rate swap

    (271     (174     (45     483           —    

Share-based compensation expense

    1,615       696       581       —             —    

Impairment of goodwill and intangible assets

    —         —         2,713       —             —    

Deferred taxes

    (180     (1     45       —             —    

(Gain) loss on disposal of property, equipment, other

    —         (69     774       —             —    

Non-cash interest expense

    1,850       1,208       2,033       1,282           —    

Changes in current assets and liabilities:

             

Accounts receivable

    (3,429     (24     3,437       3,843           (8,011

Inventories

    2,551       20,697       (3,548     9,295           (18,255

Deferred catalog costs

    1,292       897       633       (887         1,754  

Prepaid expenses and other current assets

    422       4,279       422       20,121           722  

Accounts payable

    2,876       (20,730     846       5,013           11,012  

Accrued liabilities

    889       5,752       (4,465     (24,563         12,488  

Accrued bankruptcy related reorganization costs

    —         —         —         (6,188         —    
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net cash provided by (used in) operating activities

    35,540       47,305       5,383       19,527           (19,980
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Cash flows from investing activities:

             

Additions to property, plant and equipment

    (11,816     (4,339     (10,732     (12,050         (243

Change in restricted cash

    —         —         —         26,302           —    

Investment in product development costs

    (2,545     (2,868     (6,649     (5,866         (463

Proceeds from sale of assets

    9,893       84       1,813       1,511           —    
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net cash provided by (used in) investing activities

    (4,468     (7,123     (15,568     9,897           (706
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Cash flows from financing activities:

             

Proceeds from bank borrowings

    284,720       255,497       321,946       277,605           87,538  

Repayment of bank borrowings

    (294,594     (290,060     (309,796     (291,919         (79,977

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

    —         (200     —         —             —    

Payment of debt fees and other

    —         (262     (1,034     (636         (9,415
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net cash provided by (used in) financing activities

    (9,874     (35,025     11,116       (35,950         15,451  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Effect of exchange rate changes on cash

    1,034       (1,212     (1,019     —             —    

Net increase (decrease) in cash and cash equivalents

    22,232       3,945       (88     (6,526         (5,235

Cash and cash equivalents, beginning of period

    12,865       8,920       9,008       15,534           20,769  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Cash and cash equivalents, end of period

  $ 35,097     $ 12,865     $ 8,920     $ 9,008         $ 15,534  
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Supplemental disclosures of cash flow information:

             

Interest paid

  $ 13,753     $ 10,304     $ 15,705     $ 11,109         $ 5,578  

Income taxes paid

  $ 1,524     $ 418     $ 3,461     $ 1,346         $ —    

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

  $ —       $ —       $ 957     $ 23,118         $ 3,802  

See accompanying notes to consolidated financial statements.

 

58


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 and healthcare facilities.

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 4). 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 5—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 December 31, 2016, December 26, 2015, and April 25, 2015 and for the fifty-three weeks ended December 31, 2016, thirty-five weeks ended December 26, 2015, 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 amounts in the accompanying consolidated financial statements and related notes to the consolidated financial statements are expressed in thousands except for per share amounts. All inter-company accounts and transactions have been eliminated. As discussed in Note 7—Investment in Unconsolidated Affiliate, the Company’s investment in its unconsolidated affiliate was accounted for under the cost method as the Company did not have significant influence over the unconsolidated affiliate.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and 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 and Change in Fiscal Year End

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. As a result of this change, the consolidated financial statements include presentation of the transition period beginning on April 26, 2015 and ending on December 26, 2015. This transition period is referred to as the “thirty-five weeks ended December 26, 2015” or the “short year 2015” in these consolidated financial statements and related notes to the consolidated financial statements. Fiscal 2016 represents a fifty-three week year while the fiscal 2015 and fiscal 2104 represent fifty-two week years.

 

59


As used in these consolidated financial statements and related notes to consolidated financial statements, “fiscal 2016”, “fiscal 2015”, “fiscal 2014” refer to the Company’s twelve-months ended December 31, 2016, April 25, 2015, and April 26, 2014, respectively.

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 $8,172, $7,016, and $5,679 as of December 31, 2016, December 26, 2015, and April 25, 2015, 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

Goodwill represents the excess of reorganization value over fair-value of identified net assets upon emergence from bankruptcy. Under FASB ASC Topic 350, “Intangibles—Goodwill and Other,” goodwill is not subject to amortization but rather must be tested for impairment annually or more frequently if events or circumstances indicate they might be impaired.

In accordance with the accounting guidance on goodwill, the Company performs its impairment test of goodwill at the reporting unit level annually each fiscal year, or more frequently if events or circumstances change that would more likely than not reduce the fair value of its reporting units below their carrying values.

There was no impairment charge recorded in fiscal 2016, short year 2015, 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 impairment if events or circumstances indicate an asset might be impaired. Amortizable intangible assets include customer relationships, publishing rights, trademarks and trade names 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 2016 and fiscal 2015, the Company concluded $1,347 and $3,690, respectively, 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 decreased revenue projections for certain products as the Company re-evaluated its strategy for certain product offerings. This change was recorded as accelerated development cost amortization included in the Company’s costs of revenue.

 

60


In fiscal 2015, the Company recorded an impairment charge of $2,713 which resulted in a write-off of all of its definite-lived intangible asset for digital content within its Agenda product category. This content was associated with the development of digital capabilities for its agenda product offering. Other than these charges, there were no impairment charges recorded in fiscal 2016, short year 2015, fiscal 2015, and fiscal 2014.

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 December 31, 2016, December 26, 2015, and April 25, 2015, net development costs totaled $12,187, $17,131, and $19,557, 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.

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 December 31, 2016:

 

Description

  

Balance Sheet Location

   Carrying Value      Fair Value      Categorization  

Term Loan

   Long-term debt less current maturities    $ 122,226      $ 122,837        Level 2  

Deferred Cash Payment Obligations

   Long-term debt less current maturities      20,026        18,016        Level 3  

The following table sets forth the financial instruments where carrying amounts may vary from fair value as of December 26, 2015:

 

Description

  

Balance Sheet Location

   Carrying Value      Fair Value      Categorization  

Term Loan

   Long-term debt less current maturities    $ 132,100      $ 127,807        Level 2  

Deferred Cash Payment Obligations

   Long-term debt less current maturities      18,608        16,361        Level 3  

 

61


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  

ABL Facility

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

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

The Company’s Consolidated Balance Sheets as of December 26, 2015, and April 25, 2015 reflect its interest rate swap agreement at fair value. The interest rate swap terminated in September 11, 2016. The fair values of the interest rate swap agreement as of December 26, 2015, and April 25, 2015 (valued under Level 2) were $265, and $438, respectively, and are included in “Other Accrued Liabilities” of the Consolidated Balance Sheet as of December 26, 2015, and are included in “Other Liabilities” of the Consolidated Balance Sheet as of April 25, 2015.

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.

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 correspond 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 2016, short year 2015, fiscal 2015, the forty-six weeks ended April 26, 2014, and the six weeks ended June 11, 2013, no customer represented more than 10% of revenues or accounts receivable.

 

62


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. These payments, as specified in our vendor agreements, are to reimburse the specific, incremental and identifiable costs the Company incurs associated with promoting and selling the Company’s merchandise. Deferred catalog costs are amortized in amounts proportionate to expected revenues over the life of the catalog, which is one year or less. These expected revenues, over which the catalog costs are amortized, are based on historical revenue patterns directly attributable to the catalogs. Amortization expense related to net deferred catalog costs is included in the consolidated statements of operations as a component of selling, general and administrative expenses. Net catalog expense for fiscal 2016, short year 2015, fiscal 2015, the forty-six weeks ended April 26, 2014, and six weeks ended June 11, 2013 consisted of the following:

 

     Successor Company           Predecessor
Company
 
     Fiscal Year
Ended
December 31,
2016
    Thirty-Five
Weeks Ended
December 26,
2015
    Fiscal Year
Ended
April 25,
2015
    Forty-Six
Weeks Ended

April 26,
2014
          Six Weeks
Ended

June 11,
2013
 

Catalog expense

   $ 14,031     $ 8,790     $ 15,780     $ 14,248         $ 2,004  

Less: Cooperative advertising payments

     (6,195     (4,849     (6,029     (4,070         (451
  

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net catalog expense

   $ 7,836     $ 3,941     $ 9,751     $ 10,178         $ 1,553  
  

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

The above table is an enhanced disclosure to provide additional details related to our catalog expense. The net catalog expense shown in this enhanced disclosure is consistent with amounts reported in prior filings.

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 2016, short year 2015, fiscal 2015, and the forty-six weeks ended April 26, 2014, the Company recorded $1,740, $901, $5,477, and $4,210, respectively, of severance expense and lease termination fees. These costs are included in the facility exit costs and restructuring line of the consolidated statement of operations. As of December 31, 2016, December 26, 2015, and April 25, 2015, there was $561, $375, and $1,579, respectively, of accrued restructuring costs recorded in other accrued liabilities on the consolidated balance sheet primarily related to various cost reduction activities. See Note 18 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 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

 

63


of shipping and handling costs included in selling, general and administrative expenses for fiscal 2016, short year 2015, fiscal 2015, the forty-six weeks ended April 26, 2014, and six weeks ended June 11, 2013 was $30,594, $23,284, $31,061, $26,231, and $3,249, 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.

Costs of Revenues and Selling, General and Administrative Expenses

The following table illustrates the primary costs classified in Cost of Revenues and Selling, General and Administrative Expenses:

 

Cost of Revenues

 

Selling, General and Administrative Expenses

•    Direct costs of merchandise sold, net of vendor rebates other than the reimbursement of specific, incremental and identifiable costs and, and net of early payment discounts.

 

•    Amortization of product development costs

 

•    Freight expenses associated with moving merchandise from our vendors to fulfillment centers or from our vendors directly to our customers.

 

•    Compensation and benefit costs for all selling (including commissions), marketing, customer care and fulfillment center operations (which include the pick, pack and shipping functions), and other general adminstrative functions such as finance, human resources and information technology.

 

•    Occupancy and operating costs for our fulfillment centers and office operations.

 

•    Freight expenses associated with moving our merchandise from our fulfillment centers to our customers

 

•    Catalog expenses, offset by vendor payments or reimbursement of specific, incremental and identifiable costs.

The classification of these expenses varies across the distribution industry. As a result, the Company’s gross margin may not be comparable to other retailers or distributors. <