UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED OCTOBER 24, 2009
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO |
Commission File Number: 000-24385
SCHOOL SPECIALTY, INC.
(Exact Name of Registrant as Specified in its Charter)
Wisconsin | 39-0971239 | |
(State or Other Jurisdiction of Incorporation) |
(IRS Employer Identification No.) |
W6316 Design Drive
Greenville, Wisconsin 54942
(Address of Principal Executive Offices)
(Zip Code)
(920) 734-5712
(Registrants Telephone Number, including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
Outstanding at November 30, 2009 | |
Common Stock, $0.001 par value | 18,845,468 |
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED OCTOBER 24, 2009
Page Number | ||||
PART I - FINANCIAL INFORMATION |
||||
ITEM 1. | CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS | |||
Condensed Consolidated Balance Sheets at October 24, 2009, April 25, 2009 and October 25, 2008 |
1 | |||
2 | ||||
3 | ||||
4 | ||||
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION | 19 | ||
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 28 | ||
ITEM 4. | CONTROLS AND PROCEDURES | 28 | ||
PART II - OTHER INFORMATION | ||||
ITEM 1. | LEGAL PROCEEDINGS | 29 | ||
ITEM 1A. | RISK FACTORS | 29 | ||
ITEM 6. | EXHIBITS | 29 |
Index
PART I - FINANCIAL INFORMATION
ITEM 1. | Condensed Consolidated Unaudited Financial Statements |
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
October 24, 2009 |
(As Adjusted, From Audited Statements, See Note 10) April 25, 2009 |
(As Adjusted, See Note 10) October 25, 2008 |
||||||||||
(unaudited) | (unaudited) | |||||||||||
ASSETS |
||||||||||||
Current assets: |
||||||||||||
Cash and cash equivalents |
$ | 8,836 | $ | 1,871 | $ | 9,683 | ||||||
Accounts receivable, less allowance for doubtful accounts of $4,657, $4,332 and $5,109, respectively |
192,633 | 103,683 | 192,809 | |||||||||
Inventories |
109,784 | 127,108 | 129,474 | |||||||||
Deferred catalog costs |
5,843 | 15,537 | 11,006 | |||||||||
Prepaid expenses and other current assets |
11,497 | 17,347 | 21,143 | |||||||||
Refundable income taxes |
| 1,566 | | |||||||||
Deferred taxes |
9,805 | 9,805 | 16,275 | |||||||||
Total current assets |
338,398 | 276,917 | 380,390 | |||||||||
Property, plant and equipment, net |
68,331 | 70,183 | 71,841 | |||||||||
Goodwill |
545,222 | 532,318 | 530,300 | |||||||||
Intangible assets, net |
170,154 | 168,082 | 172,208 | |||||||||
Development costs and other |
28,760 | 27,551 | 28,160 | |||||||||
Total assets |
$ | 1,150,865 | $ | 1,075,051 | $ | 1,182,899 | ||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
Current liabilities: |
||||||||||||
Current maturities - long-term debt |
$ | 129,663 | $ | 127,071 | $ | 124,576 | ||||||
Accounts payable |
40,315 | 56,786 | 48,389 | |||||||||
Accrued compensation |
12,953 | 12,821 | 16,354 | |||||||||
Deferred revenue |
4,579 | 4,254 | 4,679 | |||||||||
Accrued income taxes |
21,380 | | 22,021 | |||||||||
Other accrued liabilities |
32,634 | 28,231 | 37,127 | |||||||||
Total current liabilities |
241,524 | 229,163 | 253,146 | |||||||||
Long-term debt - less current maturities |
230,658 | 244,586 | 289,359 | |||||||||
Deferred taxes |
93,896 | 86,109 | 93,855 | |||||||||
Other liabilities |
913 | 913 | 794 | |||||||||
Total liabilities |
566,991 | 560,771 | 637,154 | |||||||||
Commitments and contingencies |
||||||||||||
Shareholders equity: |
||||||||||||
Preferred stock, $0.001 par value per share, 1,000,000 shares authorized; none outstanding |
| | | |||||||||
Common stock, $0.001 par value per share, 150,000,000 shares authorized; 24,265,678; 24,243,438 and 24,206,938 shares issued, respectively |
24 | 24 | 24 | |||||||||
Capital paid-in excess of par value |
436,923 | 435,150 | 432,657 | |||||||||
Treasury stock, at cost 5,420,210; 5,420,210 and 5,420,210 shares, respectively |
(186,637 | ) | (186,637 | ) | (186,637 | ) | ||||||
Accumulated other comprehensive income |
20,599 | 10,804 | 8,116 | |||||||||
Retained earnings |
312,965 | 254,939 | 291,585 | |||||||||
Total shareholders equity |
583,874 | 514,280 | 545,745 | |||||||||
Total liabilities and shareholders equity |
$ | 1,150,865 | $ | 1,075,051 | $ | 1,182,899 | ||||||
See accompanying notes to condensed consolidated financial statements.
1
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Amounts)
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
(As Adjusted, See Note 10) |
(As Adjusted, See Note 10) |
||||||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
||||||||||||
Revenue |
$ | 346,146 | $ | 390,306 | $ | 676,513 | $ | 769,100 | |||||||
Cost of revenue |
203,041 | 231,189 | 390,617 | 445,981 | |||||||||||
Gross profit |
143,105 | 159,117 | 285,896 | 323,119 | |||||||||||
Selling, general and administrative expenses |
86,445 | 100,089 | 174,697 | 201,106 | |||||||||||
Operating income |
56,660 | 59,028 | 111,199 | 122,013 | |||||||||||
Other (income) expense: |
|||||||||||||||
Interest expense |
7,739 | 7,546 | 15,298 | 15,355 | |||||||||||
Interest income |
| (141 | ) | (10 | ) | (220 | ) | ||||||||
Other |
| 1,534 | | 2,089 | |||||||||||
Income before provision for income taxes |
48,921 | 50,089 | 95,911 | 104,789 | |||||||||||
Provision for income taxes |
19,324 | 19,664 | 37,885 | 41,014 | |||||||||||
Net income |
$ | 29,597 | $ | 30,425 | $ | 58,026 | $ | 63,775 | |||||||
Weighted average shares outstanding: |
|||||||||||||||
Basic |
18,837 | 18,785 | 18,833 | 18,813 | |||||||||||
Diluted |
18,911 | 18,900 | 18,892 | 19,002 | |||||||||||
Net Income per Share: |
|||||||||||||||
Basic |
1.57 | 1.62 | 3.08 | 3.39 | |||||||||||
Diluted |
1.57 | 1.61 | 3.07 | 3.36 |
See accompanying notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
For the Six Months Ended | ||||||||
(As Adjusted, See Note 10) |
||||||||
October 24, 2009 |
October 25, 2008 |
|||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 58,026 | $ | 63,775 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and intangible asset amortization expense |
13,196 | 12,043 | ||||||
Amortization of development costs |
3,514 | 3,502 | ||||||
Amortization of debt fees and other |
1,055 | 1,019 | ||||||
Share-based compensation expense |
2,159 | 2,389 | ||||||
Deferred taxes |
7,452 | 7,160 | ||||||
Loss (gain) on disposal of property, plant and equipment |
275 | 677 | ||||||
Non-cash convertible debt deferred financing costs |
6,398 | 5,893 | ||||||
Changes in current assets and liabilities (net of assets acquired and liabilities assumed in business combinations): |
||||||||
Change in amounts sold under receivables securitization, net |
| | ||||||
Accounts receivable |
(86,610 | ) | (117,308 | ) | ||||
Inventories |
17,653 | 19,938 | ||||||
Deferred catalog costs |
9,694 | 3,839 | ||||||
Prepaid expenses and other current assets |
3,967 | 7,675 | ||||||
Accounts payable |
(17,190 | ) | (17,322 | ) | ||||
Accrued liabilities |
25,189 | 27,626 | ||||||
Net cash provided by operating activities |
44,778 | 20,906 | ||||||
Cash flows from investing activities: |
||||||||
Cash paid in acquisitions, net of cash acquired |
(11,700 | ) | | |||||
Additions to property, plant and equipment |
(6,364 | ) | (5,115 | ) | ||||
Proceeds from disposal of discontinued operations |
500 | 2,235 | ||||||
Investment in product development costs |
(4,436 | ) | (4,055 | ) | ||||
Proceeds from disposal of property, plant and equipment |
2,083 | 109 | ||||||
Net cash used in investing activities |
(19,917 | ) | (6,826 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from bank borrowings |
283,700 | 441,600 | ||||||
Repayment of debt and capital leases |
(301,433 | ) | (439,109 | ) | ||||
Purchase of treasury stock |
| (15,250 | ) | |||||
Payment of debt fee and other |
(238 | ) | | |||||
Proceeds from exercise of stock options |
75 | 2,647 | ||||||
Excess income tax benefit from exercise of stock options |
| 1,681 | ||||||
Net cash used in financing activities |
(17,896 | ) | (8,431 | ) | ||||
Net increase in cash and cash equivalents |
6,965 | 5,649 | ||||||
Cash and cash equivalents, beginning of period |
1,871 | 4,034 | ||||||
Cash and cash equivalents, end of period |
$ | 8,836 | $ | 9,683 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Interest paid |
$ | 8,327 | $ | 9,430 | ||||
Income taxes paid |
$ | 7,681 | $ | 4,877 |
See accompanying notes to condensed consolidated financial statements.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature) considered necessary for a fair presentation have been included. The balance sheet at April 25, 2009 has been derived from the Companys audited financial statements for the fiscal year ended April 25, 2009. For further information, refer to the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended April 25, 2009.
Amounts previously reported in Note 14 Segment Information, have been reclassified to conform to the changes in the management and reporting structure of the Company made during the fourth quarter of fiscal 2009. The change in the Companys operating segments was a result of changes within the organizational management of the business, efficiencies obtained within the organization, and how the Chief Operating Decision Maker reviews results of the business on a monthly and quarterly basis.
In June 2009, the FASB issued guidance now codified as Financial Accounting Standards Board (FASB) Accounting Standard Codification (ASC) Topic 105 Generally Accepted Accounting Principles (FASB ASC Topic 105), as the single source of authoritative nongovernmental U.S. GAAP. FASB ASC Topic 105 does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the FASB Codification will be considered non-authoritative. The Codification was effective for the Company for the interim reporting period ending October 24, 2009. The Company adopted FASB ASC Topic 105 during the second quarter of fiscal 2010. FASB ASC Topic 105 did not have a material impact on the Companys financial position, results of operations or cash flows.
As of the beginning of fiscal 2010, the Company adopted FASB ASC Topic 470-20, Debt with Conversion and Other. The adoption of FASB ASC Topic 470-20 required an adjustment of convertible debt, deferred taxes, equity, and interest expense. The adoption of FASB ASC Topic 470-20 required the Company to adjust previously disclosed condensed consolidated financial statements. As such, certain prior period amounts have been adjusted in the unaudited condensed consolidated financial statements to conform to the current period presentation. (See Note 10 of Notes to Condensed Consolidated Financial Statements.)
NOTE 2 RECENT ACCOUNTING PRONOUNCEMENTS
In May 2009, the FASB issued guidance now codified as FASB ASC Topic 855, Subsequent Events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. FASB ASC Topic 855 provides guidance on the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The Company adopted FASB ASC Topic 855 during the first quarter of fiscal 2010, and its application had no impact on the Companys condensed consolidated financial statements. The Company evaluated subsequent events through the date the accompanying financial statements were issued, which was November 30, 2009.
NOTE 3 INCOME TAXES
The Company files income tax returns with the U.S., various U.S. states, and foreign jurisdictions. The most significant tax return the Company files is with the U.S. The Companys tax returns are no longer subject to examination by the U.S. for fiscal years before 2007. The Company has various state tax audits and appeals in process at any given time. It is not anticipated that any adjustments resulting from tax examinations or appeals would result in a material change to the Companys financial position or results of operations.
4
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
The balance of the Companys liability for unrecognized income tax benefits, net of federal tax benefits, at October 24, 2009, April 25, 2009 and October 25, 2008, was $913, $913 and $794, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any other material changes in the amount of unrecognized tax benefits within the next twelve months. The Company classifies accrued interest and penalties related to unrecognized tax benefits as income tax expense in its consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.
NOTE 4 SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
Changes in condensed consolidated shareholders equity during the six months ended October 24, 2009 and October 25, 2008 were as follows:
Shareholders equity balance at April 25, 2009 (As Adjusted, See Note 10) |
$ | 514,280 | ||
Net income |
58,026 | |||
Share-based compensation |
2,159 | |||
Issuance of common stock in conjunction with stock option exercises |
75 | |||
Income tax deficiency from stock options |
(337 | ) | ||
Taxes payable on net settlement of stock options |
(124 | ) | ||
Foreign currency translation adjustment |
9,795 | |||
Shareholders equity balance at October 24, 2009 |
$ | 583,874 | ||
Shareholders equity balance at April 26, 2008 (As Adjusted, See Note 10) |
$ | 503,500 | ||
Net income |
63,775 | |||
Share-based compensation |
2,389 | |||
Issuance of common stock in conjunction with stock option exercises |
2,647 | |||
Tax benefit on option exercises |
5,726 | |||
Purchase of treasury shares |
(15,250 | ) | ||
Foreign currency translation adjustment |
(17,042 | ) | ||
Shareholders equity balance at October 25, 2008 |
$ | 545,745 | ||
Comprehensive income for the periods presented in the condensed consolidated statement of operations was as follows:
For the Three Months Ended | For the Six Months Ended | |||||||||||||
(As Adjusted, See Note 10) |
(As Adjusted, See Note 10) |
|||||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
|||||||||||
Net income |
$ | 29,597 | $ | 30,425 | $ | 58,026 | $ | 63,775 | ||||||
Foreign currency translation adjustment |
2,814 | (17,125 | ) | 9,795 | (17,042 | ) | ||||||||
Total comprehensive income |
$ | 32,411 | $ | 13,300 | $ | 67,821 | $ | 46,733 | ||||||
5
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
NOTE 5 EARNINGS PER SHARE
Earnings Per Share
The following information presents the Companys computations of basic earnings per share (basic EPS) and diluted earnings per share (diluted EPS) for the periods presented in the condensed consolidated statements of operations:
Income (Numerator) |
Shares (Denominator) |
Per Share Amount | ||||||
Three months ended October 24, 2009: |
||||||||
Basic EPS |
$ | 29,597 | 18,837 | $ | 1.57 | |||
Effect of dilutive stock options |
| 29 | ||||||
Effect of non-vested stock units |
| 45 | ||||||
Diluted EPS |
$ | 29,597 | 18,911 | $ | 1.57 | |||
Three months ended October 25, 2008: (As Adjusted, See Note 10) |
||||||||
Basic EPS |
$ | 30,425 | 18,785 | $ | 1.62 | |||
Effect of dilutive stock options |
| 100 | ||||||
Effect of non-vested stock units |
| 15 | ||||||
Diluted EPS |
$ | 30,425 | 18,900 | $ | 1.61 | |||
Income (Numerator) |
Shares (Denominator) |
Per Share Amount | ||||||
Six months ended October 24, 2009: |
||||||||
Basic EPS |
$ | 58,026 | 18,833 | $ | 3.08 | |||
Effect of dilutive stock options |
| 18 | ||||||
Effect of non-vested stock units |
| 41 | ||||||
Diluted EPS |
$ | 58,026 | 18,892 | $ | 3.07 | |||
Six months ended October 25, 2008: (As Adjusted, See Note 10) |
||||||||
Basic EPS |
$ | 63,775 | 18,813 | $ | 3.39 | |||
Effect of dilutive stock options |
| 174 | ||||||
Effect of non-vested stock units |
| 15 | ||||||
Diluted EPS |
$ | 63,775 | 19,002 | $ | 3.36 | |||
The Company had additional stock options outstanding of 1,602 and 1,559 during the three and six months ended October 24, 2009, respectively, that were not included in the computation of diluted EPS because they were anti-dilutive. The Company had additional stock options outstanding of 1,396 and 1,370 during the three and six months ended October 25, 2008, that were not included in the computation of diluted EPS because they were anti-dilutive.
The $133,000, 3.75% convertible subordinated notes have no current impact on the Companys denominator for computing diluted EPS because, although the notes are currently convertible, the average market price of the Companys stock during the periods presented was less than the initial conversion price per share. See Note 11.
The $200,000, 3.75% convertible subordinated notes have no current impact on the Companys denominator for computing diluted EPS because conditions under which the notes may be converted have not been satisfied. See Note 11.
6
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
NOTE 6 SHARE-BASED COMPENSATION EXPENSE
Employee Stock Plans
The Company has three share-based employee compensation plans under which awards were outstanding as of October 24, 2009. On June 10, 1998, the Companys Board of Directors approved the School Specialty, Inc. 1998 Stock Incentive Plan (the 1998 Plan), on August 27, 2002 the Companys Board of Directors approved the School Specialty, Inc. 2002 Stock Incentive Plan (the 2002 Plan), and on June 24, 2008, the Companys Board of Directors approved the School Specialty, Inc. 2008 Equity Incentive Plan (the 2008 Plan). All plans have been approved by the Companys shareholders. The purpose of the 1998 Plan, the 2002 Plan and the 2008 Plan is to provide directors, officers, key employees and consultants with additional incentives by increasing their ownership interests in the Company. No new grants may be made under the 1998 Plan, which expired on June 8, 2008. Under the 2002 Plan, the maximum number of equity awards available for grant is 1,500 shares. Under the 2008 Plan, the maximum number of equity awards available for grant is 2,000 shares.
A summary of option activity during the six months ended October 24, 2009 follows:
Options Outstanding | Options Exercisable | ||||||||||
Options | Weighted- Average Exercise Price |
Options | Weighted- Average Exercise Price | ||||||||
Balance at April 25, 2009 |
1,630 | $ | 32.87 | 1,067 | $ | 32.29 | |||||
Granted |
313 | 20.29 | |||||||||
Exercised |
(58 | ) | 17.30 | ||||||||
Canceled |
(152 | ) | 36.13 | ||||||||
Balance at October 24, 2009 |
1,733 | $ | 30.84 | 945 | $ | 32.65 | |||||
The following table details supplemental information regarding stock options outstanding at October 24, 2009:
Weighted Average Remaining Contractual Term |
Aggregate Instrinsic Value | ||||
Options outstanding |
6.71 years | $ | 1,869 | ||
Options vested and expected to vest |
6.60 years | 1,716 | |||
Options exercisable |
5.25 years | 581 |
Options Outstanding | Options Exercisable | |||||||||||
Range of Exercise Prices |
Shares Underlying Options |
Weighted- Average Life (Years) |
Weighted- Average Exercise Price |
Shares Underlying Options |
Weighted- Average Exercise Price | |||||||
$15.00 - $24.10 |
547 | 6.74 | $ | 20.39 | 197 | $ | 20.94 | |||||
$24.11 - $31.58 |
266 | 7.32 | 30.36 | 136 | 30.04 | |||||||
$31.59 - $36.82 |
575 | 6.23 | 36.24 | 416 | 36.13 | |||||||
$36.83 - $59.84 |
345 | 7.01 | 38.81 | 196 | 38.84 | |||||||
1,733 | 6.71 | $ | 30.84 | 945 | $ | 32.65 | ||||||
7
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
Options granted are generally exercisable beginning one year from the date of grant in cumulative yearly amounts of 25 percent of the shares granted and generally expire ten years from the date of grant. Options granted to directors and non-employee officers of the Company vest over a three year period, 20 percent after the first year, fifty percent (cumulative) after the second year and one hundred percent (cumulative) after the third year. Prior to fiscal 2009, the Company issued new shares of common stock to settle shares due upon option exercise. In fiscal 2009, the Companys option plans were amended to allow for the net settlement of the exercise price and related employee tax withholding liabilities for non-qualified stock option exercises. For the six months ended October 24, 2009, approximately 16 new shares were issued upon the exercise of stock options, 37 shares were tendered to satisfy the exercise price, and 5 shares were surrendered to satisfy employee tax liabilities.
During the first six months of each of fiscal 2010 and fiscal 2009, the Company granted 78 non-vested stock unit (NSU) awards to members of the Companys management under the 2008 Plan and 2002 Plan, respectively. The NSUs are performance-based and vest at the end of a three-year cycle and will result in the issuance of shares of Companys common stock if targeted metrics are achieved at a threshold level or above. The NSUs will be settled in shares of Company common stock with actual shares awarded ranging from 80% of the target number of shares if performance is at the threshold level up to 200% of the target number of shares if performance is at or above the maximum level. The approximate fair value of awards granted during the six months ended October 24, 2009 and October 25, 2008 is $1,590 and $2,404, respectively, provided the metrics are achieved at the target level. The Company is recognizing share-based compensation expense related to performance-based NSU awards on a straight-line basis over the vesting period adjusted for changes in the expected level of performance. During the three months ended October 24, 2009, the Company recognized income of $131 ($80, net of tax) due to forfeitures within the quarter and during the three months ended October 25, 2008, the Company recognized expense of $193 ($118 net of tax) related to performance-based NSU awards due to changes in estimated performance levels. During the six months ended October 24, 2009 and October 25, 2008, the Company recognized expense of $112 ($69, net of tax) and $213 ($130, net of tax), respectively, related to performance-based NSU awards.
During the first six months of fiscal 2010 and 2009, the Company granted 7 time-based NSU awards to independent members of the Companys Board of Directors with an approximate fair value of $146 and $203, respectively. The awards vest one year from the date of grant and the Company is recognizing share-based compensation expense related to these awards on a straight-line basis over the vesting period. During the three months ended October 24, 2009 and October 25, 2008, the Company recognized $36 ($22, net of tax) and $18 ($11, net of tax), respectively, of expense related to these awards. During the six months ended October 24, 2009, the Company recognized $82 ($51, net of tax) and $69 ($42, net of tax), respectively, of expense related to these awards.
During each of the three months ended October 24, 2009 and October 25, 2008, the Company recognized $885 ($980 related to stock options, net of $95 of income related to NSU awards) and $779 ($954 related to stock options, net of $175 of income related to NSU awards), respectively, in share-based compensation expense, which is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations. The income tax benefit recognized related to share-based compensation expense was $344 and $280 for the three months ended October 24, 2009 and October 25, 2008, respectively.
During the six months ended October 24, 2009 and October 25, 2008, the Company recognized $2,159 ($1,964 related to stock options and $195 related to NSU awards) and $2,389 ($2,107 related to stock options and $282 related to NSU awards), respectively, in share-based compensation expense, which is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations. The income tax benefit recognized related to share-based compensation expense was $846 and $863 for the six months ended October 24, 2009 and October 25, 2008, respectively. The Company recognizes share-based compensation expense ratably over the vesting period of each award
8
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
along with cumulative adjustments for changes in the expected level of attainment for performance-based awards. During the six months ended October 24, 2009 and October 25, 2008, total unrecognized share-based compensation expense related to stock options was $5,685 and $7,780, net of estimated forfeitures, and total unrecognized share-based compensation expense related to NSUs was $1,404 and $1,204, which the Company expects to recognize over a weighted average period of approximately 2.3 years.
There were no options granted during either of the three months ended October 24, 2009 or October 25, 2008. The weighted average fair value of options granted during the six months ended October 24, 2009 and October 25, 2008 was $7.26 and $9.81, respectively. The fair value of options is estimated on the date of grant using the Black-Scholes single option pricing model with the following weighted average assumptions:
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
||||||||||||
Average-risk free interest rate |
n/a | n/a | 2.89 | % | 3.50 | % | |||||||||
Expected volatility |
n/a | n/a | 33.11 | % | 26.86 | % | |||||||||
Expected term |
n/a | n/a | 5.5 years | 5.5 years | |||||||||||
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
||||||||||||
Total intrinsic value of stock options exercised |
$ | 373 | $ | 245 | $ | 407 | $ | 15,253 | |||||||
Cash received from stock option exercises |
$ | | $ | 176 | $ | 75 | $ | 2,647 | |||||||
Income tax deficiency/benefit from the exercise of stock options |
$ | (40 | ) | $ | 95 | $ | (337 | ) | $ | 5,918 |
NOTE 7 GOODWILL AND OTHER INTANGIBLE ASSETS
The following tables present details of the Companys intangible assets, excluding goodwill:
October 24, 2009 |
Gross Value |
Accumulated Amortization |
Net Book Value | |||||||
Amortizable intangible assets: |
||||||||||
Customer relationships (10 to 17 years) |
$ | 36,166 | $ | (16,844 | ) | $ | 19,323 | |||
Publishing rights (15 to 25 years) |
106,510 | (20,258 | ) | 86,252 | ||||||
Non-compete agreements (3.5 to 10 years) |
7,111 | (5,449 | ) | 1,662 | ||||||
Tradenames and trademarks (10 to 30 years) |
3,024 | (750 | ) | 2,274 | ||||||
Order backlog and other (less than 1 to 13 years) |
9,654 | (1,553 | ) | 8,101 | ||||||
License agreement (10 years) |
12,700 | (855 | ) | 11,845 | ||||||
Total amortizable intangible assets |
175,165 | (45,708 | ) | 129,457 | ||||||
Non-amortizable intangible assets: |
||||||||||
Tradenames and trademarks |
40,697 | | 40,697 | |||||||
Total non-amortizable intangible assets |
40,697 | | 40,697 | |||||||
Total intangible assets |
$ | 215,862 | $ | (45,708 | ) | $ | 170,154 | |||
9
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
April 25, 2009 |
Gross Value |
Accumulated Amortization |
Net Book Value | |||||||
Amortizable intangible assets: |
||||||||||
Customer relationships (10 to 17 years) |
$ | 35,837 | $ | (15,553 | ) | $ | 20,284 | |||
Publishing rights (15 to 25 years) |
106,510 | (17,898 | ) | 88,612 | ||||||
Non-compete agreements (3.5 to 10 years) |
7,110 | (5,021 | ) | 2,089 | ||||||
Tradenames and trademarks (10 to 30 years) |
3,024 | (667 | ) | 2,357 | ||||||
Order backlog and other (less than 1 to 13 years) |
2,634 | (1,291 | ) | 1,343 | ||||||
Total amortizable intangible assets |
155,115 | (40,430 | ) | 114,685 | ||||||
Non-amortizable intangible assets: |
||||||||||
Perpetual license agreement |
12,700 | | 12,700 | |||||||
Tradenames and trademarks |
40,697 | | 40,697 | |||||||
Total non-amortizable intangible assets |
53,397 | | 53,397 | |||||||
Total intangible assets |
$ | 208,512 | $ | (40,430 | ) | $ | 168,082 | |||
October 25, 2008 |
Gross Value |
Accumulated Amortization |
Net Book Value | |||||||
Amortizable intangible assets: |
||||||||||
Customer relationships (10 to 17 years) |
$ | 35,766 | $ | (14,381 | ) | $ | 21,385 | |||
Publishing rights (15 to 25 years) |
106,510 | (15,539 | ) | 90,971 | ||||||
Non-compete agreements (4 to 10 years) |
7,504 | (4,985 | ) | 2,519 | ||||||
Tradenames and trademarks (10 to 30 years) |
3,024 | (588 | ) | 2,436 | ||||||
Order backlog and other (2 to 13 years) |
2,706 | (1,206 | ) | 1,500 | ||||||
Total amortizable intangible assets |
155,510 | (36,699 | ) | 118,811 | ||||||
Non-amortizable intangible assets: |
||||||||||
Perpetual license agreement |
12,700 | | 12,700 | |||||||
Tradenames and trademarks |
40,697 | | 40,697 | |||||||
Total non-amortizable intangible assets |
53,397 | | 53,397 | |||||||
Total intangible assets |
$ | 208,907 | $ | (36,699 | ) | $ | 172,208 | |||
During the first quarter of fiscal 2010, the Company reclassified the $12,700 perpetual license agreement from a non-amortizable asset to an amortizable asset. The Company anticipates the content related to this license agreement will be de-emphasized over the next ten years as the Companys long-term strategy is to develop and/or acquire replacement content. Based on these factors, the Company has begun to amortize this intangible asset over a 10 year period in amounts consistent with the expected revenue curve.
Intangible amortization expense included in selling, general and administrative expense for the three months ended October 24, 2009 and October 25, 2008 was $2,423 and $2,110, respectively, and $5,143 and $4,261 for the six months ended October 24, 2009 and October 25, 2008, respectively.
Intangible amortization expense for each of the five succeeding fiscal years and the remainder of fiscal 2009 is estimated to be:
Fiscal 2010 (six months remaining) |
$ | 5,352 | |
Fiscal 2011 |
10,532 | ||
Fiscal 2012 |
10,176 | ||
Fiscal 2013 |
9,620 | ||
Fiscal 2014 |
9,339 | ||
Fiscal 2015 |
9,147 |
10
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
The following information presents changes to goodwill during the period beginning October 25, 2008 through October 24, 2009:
Segment |
Balance at October 25, 2008 |
Fiscal 2009 Acquisitions |
Adjustments | Balance at April 25, 2009 |
Fiscal 2010 Acquisitions |
Adjustments | Balance at October 24, 2009 | ||||||||||||||
Publishing |
$ | 265,753 | $ | | $ | 2,018 | $ | 267,771 | $ | 3,567 | $ | 9,337 | $ | 280,675 | |||||||
Educational Resources |
264,547 | | | 264,547 | | | 264,547 | ||||||||||||||
Total |
$ | 530,300 | $ | | $ | 2,018 | $ | 532,318 | $ | 3,567 | $ | 9,337 | $ | 545,222 | |||||||
The Publishing segment adjustments during the period October 25, 2008 to April 25, 2009 of $2,018 are comprised entirely of foreign currency translation adjustments.
The Publishing segment adjustments during the six months ended October 24, 2009 of $9,337 are comprised of foreign currency translation adjustments. The incremental goodwill of $3,567 in the six months ended October 24, 2009 was related to the acquisition of AutoSkill International, Inc. (AutoSkill).
During the first quarter of fiscal 2010, the Company performed its annual goodwill impairment test pursuant to FASB ASC Topic FASB 350, Intangibles Goodwill and Other. The fair value of the Companys reporting units was estimated using a combined income (discounted cash flow) and market approach (guideline public company comparables) valuation model which indicated that the fair value of the Companys net assets exceeded the carrying value. The estimated fair value of the reporting units was dependent on several significant assumptions, including earnings projections and discount rate.
During fiscal 2009, the Company experienced a decline in its market capitalization. As of May 1, 2009, the market capitalization was $336,743, compared to the Companys book value of $496,800 on that date. During the first six months of fiscal 2010, the Companys market capitalization increased by $111,025 to $447,768. FASB ASC Topic 350 requires the performance of an interim goodwill impairment test if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. After evaluating the movement in its stock price over the past quarter, along with the first quarter operating performance, cash flow performance and industry outlook, the Company did not believe any events over the course of the current quarter would require a reconsideration of these impairment testing results.
11
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
NOTE 8 BUSINESS COMBINATIONS
During the second quarter of fiscal 2010, the Company completed the acquisition of AutoSkill for an aggregate purchase price of $11,700. This transaction was funded in cash through borrowings under the Companys credit facility. AutoSkill is a leading education technology company that provides educators with reading and math intervention solutions for struggling students. This business will be integrated into the Companys Educators Publishing Service business within the Publishing segment. Net assets acquired included $2,075 of current assets, $137 of fixed assets, $7,020 of amortizable intangible assets and $3,567 of goodwill, all of which are deductible for tax purposes. The Company has engaged a third party specialist to assist the Company in the valuation of AutoSkills intangible assets. The valuation is preliminary as of the quarter ended October 24, 2009 due to the gathering of additional information relevant to valuation of intangible assets. The preliminary valuation of $7,020 of amortizable intangible assets is made up of internally developed software, customer relationships, trademarks, and patents, which are deductible for tax purposes and should be finalized in the third quarter of fiscal 2010. All of the acquired intangible assets of AutoSkill will be amortized over a 10 year useful life. The results of AutoSkill have been included in the accompanying consolidated financial statements since the date of acquisition and would not have had a material effect on the Companys overall performance on a pro forma basis and did not have a material effect on the Companys fiscal 2010 performance.
NOTE 9 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
October 24, 2009 |
April 25, 2009 |
October 25, 2008 |
||||||||||
Land |
$ | 158 | $ | 502 | $ | 158 | ||||||
Projects in progress |
10,991 | 6,833 | 3,474 | |||||||||
Buildings and leasehold improvements |
30,561 | 31,605 | 31,119 | |||||||||
Furniture, fixtures and other |
95,257 | 95,506 | 98,666 | |||||||||
Machinery and warehouse equipment |
42,543 | 42,676 | 43,908 | |||||||||
Total property, plant and equipment |
179,510 | 177,122 | 177,325 | |||||||||
Less: Accumulated depreciation |
(111,179 | ) | (106,939 | ) | (105,484 | ) | ||||||
Net property, plant and equipment |
$ | 68,331 | $ | 70,183 | $ | 71,841 | ||||||
Depreciation expense for the three months ended October 24, 2009 and October 25, 2008 was $4,011 and $3,667, respectively, and $8,053 and $7,782 for the six months ended October 24, 2009 and October 25, 2008, respectively.
NOTE 10 ADOPTION OF FASB ASC TOPIC 470-20
As discussed in Note 1, the Company adopted FASB ASC Topic 470-20, Debt with Conversion and Other Options, effective April 26, 2009, which required retrospective application. This standard requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuers non-convertible debt borrowing rate. The Company has two currently outstanding convertible debt instruments that are impacted by FASB ASC Topic 470-20. The new standard requires that a fair value be assigned to the equity conversion option of the Companys $133,000, 3.75% convertible subordinated notes and the Companys $200,000, 3.75% convertible subordinated debentures (the Convertibles Notes) as of July 14, 2003 and November 22, 2006, respectively, the date of issuance of the Convertible Notes. This change results in a corresponding decrease in the value assigned to the carrying value of the debt portion of the instruments.
The values assigned to the debt portions of the Convertible Notes was determined based on market interest rates for similar debt instruments without the conversion feature as of the respective July 14, 2003 and November 22, 2006
12
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
issuance dates of the Convertible Notes. The difference in market interest rates versus the coupon rates on the Convertible Notes results in non-cash interest that is amortized into interest expense over the expected terms of the Convertible Notes. For purposes of the valuation, the Company used an expected term of seven years for the Convertible Notes issued on July 14, 2003 and an expected term of five years for the Convertible Notes issued on November 22, 2006.
The seven year anniversary will occur on July 30, 2010 for the $133,000 Convertible Notes and the five year anniversary will occur on November 30, 2011 for the $200,000 Convertible Notes.
The following tables reflect the Companys previously reported amounts, along with the adjusted amounts after adoption.
(In thousands, except per share) |
As Reported | As Adjusted | Effect of Change |
|||||||
Condensed Consolidated Statement of Operations (Unaudited) |
||||||||||
Three Months Ended October 25, 2008 |
||||||||||
Interest expense |
$ | 4,569 | $ | 7,546 | $ | 2,977 | ||||
Income before provision for income taxes |
53,066 | 50,089 | (2,977 | ) | ||||||
Provision for income taxes |
20,807 | 19,664 | (1,143 | ) | ||||||
Net income |
32,259 | 30,425 | (1,834 | ) | ||||||
Earnings per Share of Common Stock: |
||||||||||
Basic |
$ | 1.72 | $ | 1.62 | $ | (0.10 | ) | |||
Diluted |
1.71 | 1.61 | (0.10 | ) | ||||||
Condensed Consolidated Statement of Operations (Unaudited) |
||||||||||
Six Months Ended October 25, 2008 |
||||||||||
Interest expense |
$ | 9,462 | $ | 15,355 | $ | 5,893 | ||||
Income before provision for income taxes |
110,682 | 104,789 | (5,893 | ) | ||||||
Provision for income taxes |
43,277 | 41,014 | (2,263 | ) | ||||||
Net income |
67,405 | 63,775 | (3,630 | ) | ||||||
Earnings per Share of Common Stock: |
||||||||||
Basic |
$ | 3.58 | $ | 3.39 | $ | (0.19 | ) | |||
Diluted |
3.55 | 3.36 | (0.19 | ) | ||||||
(In thousands, except per share) |
As Reported | As Adjusted | Effect of Change |
|||||||
Condensed Consolidated Balance Sheet (Unaudited) |
||||||||||
As of April 25, 2009 |
||||||||||
Current maturities - long-term debt |
$ | 133,682 | $ | 127,071 | $ | (6,611 | ) | |||
Long-term debt - less current maturities |
266,229 | 244,586 | (21,643 | ) | ||||||
Net deferred tax liability |
65,450 | 76,304 | 10,854 | |||||||
Capital paid-in-excess of par value |
393,328 | 435,150 | 41,822 | |||||||
Retained earnings |
279,361 | 254,939 | (24,422 | ) | ||||||
Condensed Consolidated Balance Sheet (Unaudited) |
||||||||||
As of October 25, 2008 |
||||||||||
Current maturities - long-term debt |
$ | 133,654 | $ | 124,576 | $ | (9,078 | ) | |||
Long-term debt - less current maturities |
314,675 | 289,359 | (25,316 | ) | ||||||
Net deferred tax liability |
64,368 | 77,580 | 13,212 | |||||||
Capital paid-in-excess of par value |
390,835 | 432,657 | 41,822 | |||||||
Retained earnings |
312,225 | 291,585 | (20,640 | ) |
13
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
The following table provides additional information about the Convertible Notes.
As of October 24, 2009 | As of April 25, 2009 | |||||||||||||||
($ and shares in thousands, except conversion prices) |
$133 million Convertible Notes |
$200 million Convertible Notes |
$133 million Convertible Notes |
$200 million Convertible Notes |
||||||||||||
Carrying amount of the equity component |
$ | 29,854 | $ | 38,052 | $ | 29,854 | $ | 38,052 | ||||||||
Principal amount of the liability component |
133,000 | 200,000 | 133,000 | 200,000 | ||||||||||||
Unamortized discount of liability component |
4,045 | 17,812 | 6,611 | 21,643 | ||||||||||||
Net carrying amount of liability component |
128,955 | 182,188 | 126,389 | 178,357 | ||||||||||||
Remaining amortization period of discount |
9 months | 25 months | 15 months | 31 months | ||||||||||||
Conversion price |
$ | 40.00 | $ | 51.39 | $ | 40.00 | $ | 51.39 | ||||||||
Number of shares to be issued upon conversion |
3,325 | 3,892 | 3,325 | 3,892 | ||||||||||||
Effective interest rate on liability component |
8.0 | % | 8.5 | % | 8.0 | % | 8.5 | % |
The following table presents the associated interest cost related to the Convertible Notes, which consists of both the contractual interest coupon and amortization of the discount on the liability component.
$133 million Convertible Notes | $200 million Convertible Notes | |||||||||||
(in thousands) |
Six Months Ended October 24, 2009 |
Six Months Ended October 25, 2008 |
Six Months Ended October 24, 2009 |
Six Months Ended October 25, 2008 | ||||||||
Non-cash interest cost (a) |
$ | 2,566 | $ | 2,371 | $ | 3,831 | $ | 3,522 | ||||
Cash interest cost |
2,487 | 2,487 | 3,740 | 3,740 |
(a) | Amounts represent the impact of adoption of FASB ASC Topic 470-20 on interest expense for the six months ended October 24, 2009 and October 25, 2008, respectively. The related negative impact of adoption on diluted earnings per share for the six months ended October 24, 2009 and October 25, 2008 is $0.20 and $0.19, respectively. |
The full year impact of the adjustment for the fiscal year ended April 25, 2009 reduced diluted earnings per share from $1.83 to $1.44.
NOTE 11 DEBT
On February 1, 2006, the Company entered into an Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement matures on February 1, 2011 and provides for a $350,000 revolving loan and an available $100,000 incremental term loan. Interest accrues at a rate of, at the Companys option, either a Eurodollar rate plus an applicable margin of up to 1.75%, or the lenders base rate plus an applicable margin of up to 0.50%. The Company also pays a commitment fee on the revolving loan of up to 0.375% on unborrowed funds. The Amended and Restated Credit Agreement is secured by substantially all of the assets of the Company and contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charges
14
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
coverage ratio and a limitation on consolidated capital expenditures. The Company was in compliance with these covenants at October 24, 2009. The effective interest rate under the credit facility for the second quarter of fiscal 2010 was 2.54%, which includes amortization of the loan origination fees of $104 and commitment fees on unborrowed funds of $142. The effective interest rate under the credit facility for the second quarter of fiscal 2009 was 6.34%, which includes amortization of the loan origination fees of $78 and commitment fees on unborrowed funds of $183. The revolving loan provides for a letter of credit sub-facility of up to $15,000, under which $2,800 was issued and outstanding as of October 24, 2009. As October 24, 2009, April 25, 2009 and October 25, 2008, respectively, $34,500, $51,900 and $100,000 was outstanding on the revolving loan and reflected as non-currently maturing, long-term debt in the accompanying condensed consolidated balance sheets. No borrowings have been made on the term loan since inception.
During 2003, the Company sold an aggregate principal amount of $133,000 of convertible subordinated notes due in 2023. The Company used the total net proceeds from the offering of $128,999 to repay a portion of the debt outstanding under the Companys credit facility. The notes carry an annual interest rate of 3.75% until August 1, 2010, at which time the notes will cease bearing interest and the original principal amount of each note will commence increasing daily by the annual rate of 3.75%. Depending on the market price of the notes, the Company may be required to make additional payments of interest. The notes became convertible into shares of the Companys common stock at an initial conversion price of $40.00 per share during fiscal 2006 and are recorded as a current liability. Holders of the notes may surrender the notes for conversion at any time from October 1, 2005 until July 31, 2023. Holders that exercise their right to convert the notes will receive up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, to be satisfied in shares of Company common stock or cash, at the Companys discretion. Holders may require the Company to repurchase the notes for cash on August 1, 2010, 2013 and 2018 at a repurchase price equal to 100% of their accreted principal amount, plus accrued and unpaid interest, if any. No notes have been converted into cash or shares of common stock as of October 24, 2009. The notes are currently redeemable at the option of the Company.
On November 22, 2006, the Company sold $200,000 of convertible subordinated debentures due 2026. The debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted or the Companys total conversion obligation, and will deliver, at its option, cash or shares of its common stock in respect of the remainder, if any, of its conversion obligation. The initial conversion rate is .0194574 shares per $1 principal amount of debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Companys option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require the Company to repurchase all or some of the debentures.
The estimated fair value of the Companys $133,000 and $200,000 convertible subordinated notes at October 24, 2009 was approximately $129,675 and $184,500, respectively and the carrying value was $128,955 and 182,188, respectively. The estimated fair value was determined using Level 2 inputs as described in FASB ASC Topic 820, Fair Value Measurements and Disclosures.
NOTE 12 SECURITIZATION OF ACCOUNTS RECEIVABLE
The Company and certain of its U.S. subsidiaries entered into an agreement (the Receivables Facility) in November 2000 with a financial institution whereby it sold on a continuous basis an undivided interest in all eligible trade accounts receivable. Pursuant to the Receivables Facility, the Company formed New School, Inc. (NSI), a wholly-owned, special purpose, bankruptcy-remote subsidiary. As such, the assets of NSI were available first and foremost to satisfy the claims of the creditors of NSI. NSI was formed for the sole purpose of buying and selling receivables generated by the Company and certain subsidiaries of the Company. NSI does not meet the conditions of a qualifying Special Purpose Entity and therefore the results of NSI have been included in the Companys consolidated results for financial reporting purposes. Under the Receivables Facility, the Company and certain subsidiaries transferred without recourse all their accounts receivables to NSI. NSI, in turn, sold undivided interest in these receivables. The Company received a fee from the financial institution for billing and collection functions, which remained the responsibility of the Company, which approximates fair value of the Companys obligations.
15
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
The facility expired January 28, 2009 and the Company elected to not renew the agreement due to the expected future expenses of the facility compared to other sources of liquidity available to the Company.
This two-step transaction was accounted for as a sale of receivables under the provision of FASB ASC Topic 860, Transfers and Servicing and FASB ASC Topic 405-20, Liabilities. At October 25, 2008, $50,000 was advanced under the accounts receivable securitization and accordingly, that amount of accounts receivable has been removed from the condensed consolidated balance sheets as of that date. Costs associated with the sale of receivables, primarily related to the discount and loss on sale, were $1,529 for three months ended October 25, 2008, and $2,084 for the six months ended October 25, 2008, and are included in other expenses in the condensed consolidated statement of operations for those periods. Supplemental information related to the accounts receivable securitization transactions is provided below. Proceeds under accounts receivable securitization and collections as servicer of receivables sold have been netted in the accompanying consolidated statements of cash flows under the caption, Change in amounts sold under receivables securitization, net.
Six Months Ended October 25, 2008 |
||||
Proceeds under accounts receivable securitization |
$ | 344,560 | ||
Collections as servicer of receivables sold |
(344,560 | ) | ||
Retained interest in gross accounts receivable at end of period |
$ | 195,477 | ||
Cash flows from retained interests |
309,062 |
NOTE 13 RESTRUCTURING
The Company accounts for restructuring costs associated with the closure or disposal of distribution centers in accordance with FASB ASC Topic 420, Exit or Disposal Cost Obligation. During the second quarter of fiscal 2009, the Company recorded $1,670 of expenses primarily related to severance, facility costs and impairment of non-facility related fixed assets associated with the closing of the Companys Lyons, New York distribution center. In addition, the Company classified the real property and building assets of the Lyons facility center as held for sale as of October 25, 2008 and reflected the assets under the caption Prepaid expense and other current assets in the condensed consolidated balance sheet as of that date. As of October 25, 2008, there was $839 of accrued restructuring costs for this distribution center closing recorded in other current liabilities on the condensed consolidated balance sheet as of that date. As of October 24, 2009, the Company has no restructuring costs recorded on the condensed consolidated balance sheet. In the second quarter of fiscal 2010, the Company sold the Lyons facility for $2,083, which is reflected as cash flows from investing activities in the condensed consolidated statements of cash flows.
NOTE 14 SEGMENT INFORMATION
The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Companys Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company has determined that it operates in two operating segments, Educational Resources and Publishing, which also constitute its reportable segments. The change in the Companys operating segments during the fourth quarter of fiscal 2009 was a result of changes within the organizational management of the business, efficiencies obtained within the organization, and how management reviews results of the business on a monthly and quarterly basis. The Company has restated the prior year numbers accordingly with the change in the Companys operating segments. The Company operates principally in the United States, with limited segment operations in
16
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
Canada. The Educational Resources segment offers products that include basic classroom supplies and office products, supplemental learning materials, physical education equipment, classroom technology, and furniture. The Publishing segment is a PreK-12 curriculum-based publisher of proprietary and non-proprietary products in the categories of science, reading and literacy, coordinated school health, and planning and student development. The accounting policies of the segments are the same as those described in Summary of Significant Accounting Policies. Intercompany eliminations represent intercompany sales primarily from our Publishing segment to our Educational Resources segment, and the resulting profit recognized on such intercompany sales.
Three Months Ended | Six Months Ended | |||||||||||||||
(As Adjusted, See Note 10) |
(As Adjusted, See Note 10) |
|||||||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
|||||||||||||
Revenue: |
||||||||||||||||
Educational Resources |
$ | 239,864 | $ | 266,286 | $ | 464,807 | $ | 518,536 | ||||||||
Publishing |
106,610 | 124,089 | 212,956 | 250,916 | ||||||||||||
Corporate and intercompany eliminations |
(328 | ) | (69 | ) | (1,250 | ) | (352 | ) | ||||||||
Total |
$ | 346,146 | $ | 390,306 | $ | 676,513 | $ | 769,100 | ||||||||
Operating income (loss) and income before provision for income taxes: |
||||||||||||||||
Educational Resources |
$ | 32,760 | $ | 31,014 | $ | 64,265 | $ | 61,113 | ||||||||
Publishing |
31,814 | 37,944 | 63,769 | 80,879 | ||||||||||||
Corporate and intercompany eliminations |
(7,914 | ) | (9,930 | ) | (16,835 | ) | (19,979 | ) | ||||||||
Operating income |
56,660 | 59,028 | 111,199 | 122,013 | ||||||||||||
Interest expense and other |
7,739 | 5,962 | 15,288 | 11,331 | ||||||||||||
Income before provision for income taxes |
$ | 48,921 | $ | 53,066 | $ | 95,911 | $ | 110,682 | ||||||||
October 24, 2009 |
October 25, 2008 | |||||
Identifiable assets (as of quarter end): |
||||||
Educational Resources |
$ | 495,644 | $ | 567,650 | ||
Publishing |
569,561 | 567,974 | ||||
Corporate and intercompany eliminations |
85,660 | 47,275 | ||||
Total |
$ | 1,150,865 | $ | 1,182,899 | ||
17
SCHOOL SPECIALTY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(In thousands, except per share amounts)
Three Months Ended | Six Months Ended | |||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 | |||||||||
Depreciation and amortization of intangible assets and development costs: |
||||||||||||
Educational Resources |
$ | 1,815 | $ | 1,680 | $ | 3,580 | $ | 3,463 | ||||
Publishing |
3,989 | 3,498 | 8,494 | 7,436 | ||||||||
Corporate |
2,313 | 2,329 | 4,636 | 4,646 | ||||||||
Total |
$ | 8,117 | $ | 7,507 | $ | 16,710 | $ | 15,545 | ||||
Expenditures for property, plant and equipment, intangible and other assets and development costs: |
||||||||||||
Educational Resources |
$ | 286 | $ | 385 | $ | 1,000 | $ | 639 | ||||
Publishing |
9,716 | 2,580 | 11,763 | 4,339 | ||||||||
Corporate |
5,626 | 2,305 | 8,005 | 4,192 | ||||||||
Total |
$ | 15,628 | $ | 5,270 | $ | 20,768 | $ | 9,170 | ||||
NOTE 15 COMMITMENTS AND CONTINGENCIES
Various claims and proceedings arising in the normal course of business are pending against the Company. The results of these matters are not expected to have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.
NOTE 16 SUBSEQUENT EVENTS
The Company completed the previously announced divestiture of the School Specialty Publishing business unit to Carson-Dellosa Publishing, LLC, a newly-formed business entity, on November 13, 2009. Under the divestiture agreement, the Company combined its publishing unit assets with those of Cookie Jar Education, Inc. and received a 35% minority equity interest in Carson-Dellosa Publishing. The net book value of the total contribution was $29,438, which also is the fair value of the Companys minority interest. The contribution consisted of $28,315 of estimated net assets plus $1,123 of cash. The agreement provides that the net book value of the net assets contributed will be finalized within 30 days of the above-mentioned date with any variance to the estimated amount of net assets to be settled in cash. The Company will record the minority interest on its balance sheet at fair value.
18
ITEM 2. | Managements Discussion and Analysis of Financial Condition and Results of Operation (MD&A) |
School Specialty is an education company that provides innovative and proprietary products, programs, and services to help educators engage and inspire students of all ages and abilities to learn. Through each of our leading brands, we design, develop, and provide preK-12 educators with the latest and very best curriculum, supplemental learning resources and classroom basics. Working in collaboration with educators, we reach beyond the scope of textbooks to help teachers, guidance counselors, and school administrators ensure that every student reaches his or her full potential.
Our business is subject to seasonal fluctuations. Our historical revenues and profitability have been dramatically higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Due to variations in the timing of shipments within this season primarily as a result of changes or delays in school start dates, the Company views a year-over-year comparison of the first six months of the fiscal year to be a more meaningful analysis than year-over-year comparative results for quarterly periods on an individual basis.
During the first six months of fiscal 2010, revenues decreased 12.0% as compared to the first six months of fiscal 2009. The Educational Resources and Publishing segments experienced revenue declines in the first six months of fiscal 2010 of 10.4% and 15.1% respectively. The revenue declines in both the Educational Resources and Publishing segment were attributable to the current macroeconomic conditions which have created uncertainty in the school districts related to state budget funding levels, which, in turn, has led to a cautious spending approach by our customers. Gross margin increased 30 basis points to 42.3% for the first six months of fiscal 2010 as compared to the first six months of fiscal 2009. The increased gross margin was related to improvements in the Educational Resources segment gross margin, which were partially offset by unfavorable product mix, both between segments and within the Publishing segment.
Selling, general and administrative expenses (SG&A) decreased 30 basis points as a percent of revenues in the first six months of fiscal 2010 as compared to the first six months of fiscal 2009. The decrease in SG&A is due to cost cutting initiatives primarily associated with the consolidation of operating activities. The Companys current full-time staffing is down approximately 200 individuals as compared to last years second quarter.
Operating income was $111.2 million in the first six months of fiscal 2010, a decrease of $10.8 million from the prior years comparable period. Net income was $58.0 million in the first six months of fiscal 2010, a decrease of $5.7 million from the prior year quarter.
19
Results of Continuing Operations
The following table sets forth various items as a percentage of revenues for the three and six months ended October 24, 2009 and October 25, 2008:
Three Months Ended | Six Months Ended | |||||||||||
(As Adjusted, See Note 10) |
(As Adjusted, See Note 10) |
|||||||||||
October 24, 2009 |
October 25, 2008 |
October 24, 2009 |
October 25, 2008 |
|||||||||
Revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Cost of revenues |
58.7 | 59.2 | 57.7 | 58.0 | ||||||||
Gross profit |
41.3 | 40.8 | 42.3 | 42.0 | ||||||||
Selling, general and administrative expenses |
25.0 | 25.6 | 25.8 | 26.1 | ||||||||
Operating income |
16.3 | 15.2 | 16.5 | 15.9 | ||||||||
Interest expense, net |
2.2 | 2.0 | 2.3 | 2.0 | ||||||||
Other expense |
| 0.4 | | 0.3 | ||||||||
Income before provision for income taxes |
14.1 | 12.8 | 14.2 | 13.6 | ||||||||
Provision for income taxes |
5.6 | 5.0 | 5.6 | 5.3 | ||||||||
Earnings from continuing operations |
8.5 | % | 7.8 | % | 8.6 | % | 8.3 | % | ||||
20
Three Months Ended October 24, 2009 Compared to Three Months Ended October 25, 2008
Revenue
Revenue decreased 11.3% from $390.3 million for the three months ended October 25, 2008 to $346.1 million for the three months ended October 24, 2009.
Educational Resources segment revenue decreased 9.9% from $266.3 million for the three months ended October 25, 2008 to $239.9 million for the three months ended October 24, 2009. Both periods are comprised solely of sales to external parties. The decline in Educational Resources segment revenue was comprised of a decline of approximately $6 million, or approximately 4%, in the administrator and education supplies product lines and a decline of approximately $20 million, or approximately 18%, in the furniture product line. These declines were primarily attributable to the ongoing weakened economic conditions which the Company believes have negatively impacted school purchasing decisions. This has been particularly noticeable in those states which have been more seriously affected by the economic decline, such as California, Florida, Illinois, and Michigan. The decline was greater in the furniture category as furniture purchase decisions are more discretionary in nature for schools.
Publishing segment revenues decreased by 14.1% from $124.1 million for the three months ended October 25, 2008 (which includes $0.2 million of intersegment revenues) to $106.6 million for the three months ended October 24, 2009 (which includes $0.5 million of intersegment revenues). Approximately $10 million of the decline in Publishing segment revenue was due to the decrease in state adoption revenue of the Companys curriculum-based products, primarily in the state of California, which the Company had anticipated would occur. The remaining $7.0 million decrease was attributable to the continued impact that the downturn in the general economic conditions has had on school districts spending decisions, as school districts are deferring their decisions on replacing or purchasing new curriculum-based materials. Partially offsetting this decrease is an incremental $1.3 million in revenue related to the Companys acquisition of AutoSkill International, Inc.
Gross Profit
Gross profit decreased 10.1%, from $159.1 million for the three months ended October 25, 2008 to $143.1 million for the three months ended October 24, 2009. The decrease in consolidated revenue resulted in $18.0 million of the decline in gross profit had consolidated gross margin remained constant. The increase in consolidated gross margin of 50 basis points increased gross profit by $2.0 million. Gross margin increased 50 basis points from 40.8% for the three months ended October 25, 2008 to 41.3% for the three months ended October 24, 2009. The increase was related to improved gross margins within the Educational Resources segment, which was partially offset by a decline in Publishing segment gross margins. A shift in product mix between the Companys segments accounted for approximately 30 basis points of gross margin decline in the second quarter of fiscal 2010 as compared to the second quarter of fiscal 2009. The Publishing segment, which generates a higher gross margin due to its curriculum-based products than the Educational Resources segment, accounted for 31% of the consolidated revenue in the second quarter of fiscal 2010 compared to 32% of the consolidated revenue in the second quarter of fiscal 2009.
Educational Resources segment gross profit decreased $5.4 million from $88.2 million for the three months ended October 25, 2008 to $82.8 million for the three months ended October 24, 2009. The decrease in segment revenue resulted in the decline in gross profit, which was partially offset by increased gross margin. Gross margin increased 140 basis points from 33.1% for the three months ended October 25, 2008 to 34.5% for the three months ended October 24, 2009. Approximately 110 basis points of the increase in gross margin was related to net price increases in excess of product cost increases as the segment executed on its initiative to better align its pricing structure with product costs. The remaining increase in gross margin was due primarily to a product mix shift towards more profitable products within the Educational Resources segment.
Publishing segment gross profit decreased $10.4 million from $70.1 million for the three months ended October 25, 2008 to $59.7 for the three months ended October 24, 2009. The decrease in segment revenue resulted in approximately $9 million decline in gross profit had segment gross margin remained constant. The remaining decline was related to a decline of 50 basis points in segment gross margin from 56.5% for the three months ended October 25, 2008 to 56.0% for the three months ended October 24, 2009. This decrease in gross margin is related primarily to unfavorable mix within the segment, particularly the decline in the higher margin curriculum-based adoption revenue.
21
Selling, General and Administrative Expenses
SG&A includes selling expenses, the most significant of which are sales wages and commissions; operations expenses, which includes customer service, warehouse and out-bound freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal and human resources; and depreciation and intangible asset amortization expense.
As a percent of revenue, SG&A decreased from 25.6% for the three months ended October 25, 2008 to 25.0% for the three months ended October 24, 2009. SG&A decreased $13.6 million from $100.1 million in the second quarter of fiscal 2009 to $86.4 million in the second quarter of fiscal 2010. SG&A attributable to the Educational Resources and Publishing decreased a combined $11.4 million and Corporate SG&A decreased $2.2 million in the second quarter as compared to last years second quarter. The decrease in Corporate SG&A was related primarily to $1.7 million of facility shutdown costs for the Lyons, New York distribution center included in last years second quarter. The remaining Corporate SG&A decrease was related primarily to the lower compensation and benefits costs, including headcount reductions, associated with the Companys cost reduction efforts.
Educational Resources segment SG&A decreased as a percent of revenues from 21.5% for the three months ended October 25, 2008 to 20.9% for the three months ended October 24, 2009. Educational Resources segment SG&A decreased $7.2 million, or 12.5%, from $57.2 million for the three months ended October 25, 2008 to $50.0 million for the three months ended October 24, 2009. The segment experienced a decrease of approximately $4 million in its variable costs such as transportation, warehousing, and selling expenses associated with decreased revenues. Improvements in order fulfillment, along with decreased fuel costs, during the quarter resulted in approximately $3 million of decreased warehouse and transportation costs. Incremental costs of $1.2 million for additional marketing initiatives were offset by compensation savings resulting from the headcount reductions associated with operational consolidations and restructuring, and other cost control initiatives.
Publishing segment SG&A increased as a percent of revenues from 25.9% for the three months ended October 25, 2008 to 26.2% for the three months ended October 24, 2009. Publishing segment SG&A decreased $4.2 million, or 13.2%, from $32.1 million for the three months ended October 25, 2008 to $27.9 million for the three months ended October 24, 2009. The decrease in Publishing segment SG&A was attributable primarily to approximately $2 million decrease in its variable costs such as transportation, warehousing, and selling expenses associated with decreased revenues. The remaining decrease was related primarily to compensation savings associated with headcount reductions. The increase in SG&A as a percentage of revenue is due to the base non-variable costs in comparison to decreased revenues.
Interest Expense
On April 26, 2009, the Company adopted FASB ASC Topic 470-20, Debt with Conversion and Other Options. Net interest expense including the impact of the adoption of FASB ASC Topic 470-20 was $7.7 million for the three months ended October 24, 2009 compared to $7.4 million for the three months ended October 25, 2008. The non-cash interest related to the adoption of FASB ASC Topic 470-20 was $3.2 million in the second quarter of fiscal 2010 as compared to $3.0 million in the second quarter of fiscal 2009, as adjusted for FASB ASC Topic 470-20.
Net interest expense excluding the adoption of FASB ASC Topic 470-20 increased $0.1 million from $4.4 million for the three months ended October 25, 2008 to $4.5 million for the three months ended October 24, 2009. The increase was related primarily to an increase of approximately $57.4 million in average outstanding borrowings in the second quarter of fiscal 2010 as compared to the second quarter of fiscal 2009. The increase in the Companys average borrowings is primarily related to the expiration of the Companys securitization facility on January 28, 2009 offset by free cash flow generated in the previous 12 months. Approximately $0.2 million of a decrease in interest expense was due to a reduction in the overall effective borrowing rate of 3.95% in the second quarter of fiscal 2010 as compared to an effective borrowing rate of 4.61% in the second quarter of fiscal 2009.
22
Other Expense
Other expense, which consisted of the discount and loss on the accounts receivable securitization, was $0 in the second quarter of fiscal 2010, compared to $1.5 million in the second quarter of fiscal 2009. This decrease was due to the non-renewal of the Companys securitization facility, which expired on January 28, 2009.
Provision for Income Taxes
Provision for income taxes decreased $0.3 million due to lower pre-tax income. The effective income tax rate increased 30 basis points from 39.2% for the three months ended October 25, 2008 to 39.5% for the three months ended October 24, 2009. The increase in the effective tax rate is related primarily to incremental state income taxes.
The effective income tax rate of 39.5% exceeds the federal statutory rate of 35% primarily due to foreign income that is taxed at higher rates than domestic income along with state taxes.
23
Six Months Ended October 24, 2009 Compared to Six Months Ended October 25, 2008
Revenue
Revenue decreased 12.0% from $769.1 million for the six months ended October 25, 2008 to $676.5 million for the six months ended October 24, 2009.
Educational Resources segment revenue decreased 10.4% from $518.5 million for the six months ended October 25, 2008 to $464.8 million for the six months ended October 24, 2009. Revenue amounts for both periods are comprised solely of sales to external parties. The decline in Educational Resources segment revenue was comprised of a decline of approximately $24 million, or approximately 7%, in the administrator and education supplies product lines and a decline of approximately $30 million, or approximately 16%, in the furniture and supplemental materials product lines. These declines were most directly attributable to the ongoing weakened economic conditions which we believe have negatively impacted school purchasing decisions. This has been particularly noticeable in those states which have been more seriously affected by the economic decline, such as California, Florida, Illinois, and Michigan. The larger decline in the furniture product line is reflective that those purchases are more discretionary in nature.
Publishing segment revenues decreased by 15.1% from $250.9 million for the six months ended October 25, 2008 (which includes $0.7 million of intersegment revenues) to $213.0 million for the six months ended October 24, 2009 (which includes $1.5 million of intersegment revenues). Approximately $21 million of the decline in Publishing segment revenue was due to the decrease in state adoption revenue of the Companys curriculum-based products, primarily in the state of California, which the Company had anticipated would occur. The remaining decrease was attributable to the impact that the downturn in the general economic conditions has had on school districts spending decisions. The Company is seeing school districts delaying some purchasing decisions on large curriculum orders in light of these economic conditions.
Gross Profit
Gross profit decreased 11.5% from $323.1 million for the six months ended October 25, 2008 to $285.9 million for the six months ended October 24, 2009. The decrease in consolidated revenue resulted in $39.3 million decline in gross profit had consolidated gross margin remained constant. The increase in consolidated gross margin of 30 basis points increased gross profit by $2.1 million. Gross margin increased 30 basis points from 42.0% for the six months ended October 25, 2008 to 42.3% for the six months ended October 25, 2009. The increased gross margin was related to improved gross margins within the Educational Resources segment, this was partially offset by decreased margins in the Publishing segment. In addition, approximately 20 basis points of gross margin was lost due to a shift in the revenue mix between segments. The Publishing segment, which generates a higher gross margin, due to its curriculum-based products, than the Educational Resources segment, accounted for 32% of the consolidated revenue in the second quarter of fiscal 2010 compared to 33% of the consolidated revenue in the second quarter of fiscal 2009.
Educational Resources segment gross profit decreased $11.8 million from $177.3 million for the six months ended October 25, 2008 to $165.5 million for the six months ended October 24, 2009. The decrease in gross profit was related to the revenue decline, partially offset by higher gross margins. The increase in gross margin of 140 basis points from 34.2% for the six months ended October 25, 2008 to 35.6% for the six months ended October 24, 2009 increased gross profit by $6.6 million. Approximately 130 basis points of the increase in gross margin is related to net price increased in excess of product costs. Lower direct transportation costs, related to decreases in fuel costs, contributed another 10 basis points of gross margin improvement.
Publishing segment gross profit decreased $24.9 million from $144.1 million for the six months ended October 25, 2008 to $119.2 for the six months ended October 24, 2009. The decrease in segment revenue resulted in approximately $22 million of the decline in gross profit had segment gross margin remained constant. The remaining decline of $3.1 million in gross profit was related to a decline of 140 basis points in segment gross margin from 57.4% for the six months ended October 25, 2008 to 56.0% for the six months ended October 24, 2009. Approximately 90 basis points of this decline was related to a combination of unfavorable product mix and the impact of product development amortization spread over lower revenue base. The remaining decrease of 50 basis points was related to product cost increases being passed along to the Company from its vendors.
24
Selling, General and Administrative Expenses
As a percent of revenue, SG&A decreased from 26.1% for the six months ended October 25, 2008 to 25.8% for the six months ended October 24, 2009. SG&A decreased $26.4 million from $201.1 million in the first six months of fiscal 2009 to $174.7 million in the first six months of fiscal 2010. SG&A attributable to the Educational Resources and Publishing segments decreased a combined $22.7 million and Corporate SG&A decreased $3.7 million in the first six months of fiscal 2010 as compared to last years first six months. Approximately $1.7 million of the decrease in Corporate SG&A was related to the prior year charge for the closing of the Lyons, New York distribution center. The remaining decrease was related to the lower compensation and benefit costs, including headcount reductions, associated with the Companys cost reduction efforts
Educational Resources segment SG&A decreased as a percent of revenues from 22.4% for the six months ended October 25, 2008 to 21.8% for the six months ended October 24, 2009. Educational Resources segment SG&A decreased $14.9 million, or 12.9%, from $116.1 million for the six months ended October 25, 2008 to $101.2 million for the six months ended October 24, 2009. The segment experienced a decrease of approximately $7 million in its variable SG&A costs such as transportation, warehousing, and selling expenses associated with decreased revenues. Improvements in order fulfillment, along with decreased fuel costs, during the six months ended October 24, 2009 resulted in approximately $5 million of decreased warehouse and transportation costs. The remaining decline was related primarily to the compensation savings associated with the headcount reductions associated with operational consolidations and restructuring, partially offset by severance and approximately $2 million of incremental spend on marketing initiatives.
Publishing segment SG&A increased as a percent of revenues from 25.2% for the six months ended October 25, 2008 to 26.0% for the six months ended October 24, 2009. Publishing segment SG&A decreased $7.8 million, or 12.3%, from $63.2 million for the six months ended October 25 2008 to $55.4 million for the six months ended October 24, 2009. The decrease in the Publishing segment SG&A was attributable to approximately $4 million of a decrease in its variable costs such as transportation, warehousing, and selling expenses associated with decreased revenues. The segment experienced a decrease of approximately $1 million in its marketing initiatives. The remaining reduction is related primarily to compensation savings associated with headcount reductions. The increase in SG&A as a percentage of revenue is due to the base non-variable costs in comparison to decreased revenues.
Interest Expense
On April 26, 2009, the Company adopted FASB ASC Topic 470-20, Debt with Conversion and Other Options. Net interest expense including the impact of the adoption of FASB ASC Topic 470-20 was $15.3 million for the six months ended October 24, 2009 compared to $15.1 million for the six months ended October 25, 2008. The non-cash interest related to the adoption of FASB ASC Topic 470-20 was $6.4 million in the six months of fiscal 2010 as compared to $5.9 million in the first six months of fiscal 2009, as adjusted for FASB ASC Topic 470-20.
Net interest expense excluding the adoption of FASB ASC Topic 470-20 decreased $0.3 million from $9.2 million for the six months ended October 25, 2008 to $8.9 million for the six months ended October 24, 2009. Approximately $0.8 million of the decrease in interest expense was due to a reduction in the overall effective borrowing rate of 4.0% in the first six months of fiscal 2010 as compared to an effective borrowing rate of 4.5% in the first six months of fiscal 2009. Partially offsetting this decrease was incremental interest expense of $0.4 million related to an increase of approximately $22.6 million in average outstanding borrowings in the first six months of fiscal 2010 as compared to the first six months of fiscal 2009. The increase in the Companys average borrowings is primarily related to the expiration of the Companys securitization facility on January 28, 2009, partially offset by free cash flow generated in the previous 12 months.
Other Expense
Other expense, which consisted of the discount and loss on the accounts receivable securitization, was $0 in the first six months of fiscal 2010, compared to $2.1 million in the first six months of fiscal 2009. This decrease was due to the non-renewal of the Companys securitization facility, which expired on January 28, 2009.
25
Provision for Income Taxes
Provision for income taxes decreased $3.1 million primarily due to lower pre-tax income. The effective income tax rate increased 40 basis points from 39.1% for the six months ended October 25, 2008 to 39.5% for the six months ended October 24, 2009.
The effective income tax rate of 39.5% exceeds the federal statutory rate of 35% primarily due to foreign income that is taxed at higher rates than domestic income along with state taxes.
Liquidity and Capital Resources
At October 24, 2009, the Company had working capital of $96.9 million. The Companys capitalization at October 24, 2009 was $944.2 million and consisted of total debt of $360.3 million and shareholders equity of $583.9 million.
The Companys credit facility matures on February 1, 2011 and provides for $350.0 million of revolving loan availability and $100.0 million incremental term loan availability. The amount outstanding as of October 24, 2009 under the revolving and incremental term loans was $34.5 million and $0, respectively. The credit facility is secured by substantially all of the Companys assets and contains certain financial and other covenants. During the first six months of fiscal 2009, the Company borrowed under its credit facility primarily to meet seasonal working capital requirements. The Companys borrowings are usually significantly higher during the first two quarters of its fiscal year to meet the working capital requirements of the Companys peak selling season. As of October 24, 2009, the Companys effective interest rate on borrowings under its credit facility was approximately 2.47%, which excludes amortization of loan origination fee costs and the commitment fees on unborrowed funds. During the six months ended October 24, 2009, the Company paid commitment fees on unborrowed funds under the credit facility of $0.3 million and amortized loan origination fee costs of $0.2 million related to the credit facility. The credit facility contains certain financial covenants, including a consolidated total and senior leverage ratio, a consolidated fixed charge ratio and a limitation on consolidated capital expenditures. The Company was in compliance with these covenants at October 24, 2009.
While the Company will continue to monitor its expected ability to remain in compliance with these covenants through the remainder of fiscal 2010, the Company expects to remain in compliance with these covenants based on our projected financial results for fiscal 2010. If the Company is unable to meet these covenants, our ability to access available lines of credit could be limited, our liquidity could be adversely affected and the Companys debt obligations could be accelerated. These circumstances could have a material adverse effect on the Companys future results of operations, financial position and liquidity.
The Companys $133.0 million, 3.75% convertible subordinated notes became convertible during the second quarter of fiscal 2006 as the closing price of the Companys common stock exceeded $48.00 for the specified amount of time. As a result, holders of the notes may surrender the notes for conversion at any time from October 1, 2005 until July 31, 2023. The notes are recorded as a current liability. Holders that exercise their right to convert the notes will receive up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, to be satisfied in shares of Company common stock or cash, at the Companys discretion. Holders may require the Company to repurchase the notes for cash on August 1, 2010, 2013 and 2018 at a repurchase price equal to 100% of their accreted principal amount, plus accrued and unpaid interest, if any. No notes have been converted into cash or shares of common stock as of July 26, 2008. The notes are currently redeemable at the option of the Company.
In November 2006, we sold $200.0 million of convertible subordinated debentures due 2026. The debentures are unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November 30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted and the Companys total conversion obligation, and will deliver, at its option, cash or shares of the Companys common stock in respect of the remainder, if any, of the Companys conversion obligation. The initial conversion rate is 19.4574 shares per $1,000 principal amount of debentures, which represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Companys option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances, holders will have the right to require us to repurchase all or some of the debentures.
26
Net cash provided by operating activities increased $23.9 million to $44.8 million in the first six months of fiscal 2010 as compared to $20.9 million provided in the first six months of fiscal 2010. The net cash provided by operating activities is indicative of the highly seasonal nature of our business, with the majority of purchases and other operating cash outflows occurring in the first and second quarters of the fiscal year and the majority of cash receipts occurring in the second and third quarters of the fiscal year. The increase in cash provided in operating activities between years is due to working capital improvements, primarily in the Companys collections of accounts receivable in the first six months of fiscal 2010 as compared to the first six months of fiscal 2009.
Net cash used in investing activities increased $13.1 million to $19.9 million in the first six months of fiscal 2010 as compared to $6.8 million for the first six months of fiscal 2009. The increase in cash used in investing activities was primarily attributable to the AutoSkill acquisition purchase price of $11.7 million. In the first six months of fiscal 2009, the Company received $2.2 million attributable to the notes received as part of the School Specialty Media sale, as compared to $0.5 million in the first six months of fiscal 2010. Additions to property, plant and equipment increased $1.2 million from the first six months of fiscal 2009 to $6.4 million in the first six months of fiscal 2010 as a result of spending related to the implementation of the Companys ERP system. Product development spending increased $0.4 million in the first six months of fiscal 2010 as compared to the first six months of fiscal 2009. This increase is attributable to the Companys ongoing investment in the development of curriculum-based products. The Company received $2.0 million during the first six months of fiscal 2010 attributable to the sale of the Lyons facility.
Net cash used in financing activities increased $9.5 million to $17.9 million in the first six months of fiscal 2010 as compared to $8.4 million for the first six months of fiscal 2009. The increase in net cash used by financing activities was primarily related to the Companys increased ability to pay down its debt. In the first six months of fiscal 2010, the Company has repaid $17.7 million of its outstanding debt. In the first six months of fiscal 2009, the Company repurchased $15.3 million of its common stock. There were no stock repurchases in the first six months of fiscal 2010.
We anticipate that our cash flow from operations, borrowings available from our existing credit facility and other sources of capital will be sufficient to meet our liquidity requirements for operations, including anticipated capital expenditures and our contractual obligations for the foreseeable future.
Off Balance Sheet Arrangements
Our accounts receivable securitization facility expired on January 28, 2009 and the Company elected not to renew the agreement due to the significant cost increases in accounts receivable asset-backed securities markets compared to the costs of other sources of liquidity available to the Company. At October 25, 2008, $50.0 million was advanced under the accounts receivable securitization and accordingly, that amount of accounts receivable was removed from the Companys consolidated balance sheet. Costs associated with the sale of receivables, primarily related to the discount and loss on sale, for the six months ended October 25, 2008 were $2.1 million. These costs are included in other expenses in the Companys consolidated statements of operations.
Fluctuations in Quarterly Results of Operations
The Companys business is subject to seasonal fluctuations. The Companys historical revenues and profitability have been dramatically higher in the first two quarters of its fiscal year, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by the timing of acquisitions, the timing and magnitude of costs related to such acquisitions, variations in the Companys costs for the products sold, the mix of products sold and general economic conditions. Moreover, the operating margins of businesses the Company acquires may differ substantially from its own, which could contribute to further fluctuation in quarterly operating results. Therefore, results for any fiscal quarter are not indicative of the results that the Company may achieve for any subsequent fiscal quarter or for a full fiscal year.
Inflation
Inflation, particularly in energy costs, has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.
27
Forward-Looking Statements
Statements in this Quarterly Report which are not historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include: (1) statements made under Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operation, including, without limitation, statements with respect to internal growth plans, projected revenues, margin improvement, future acquisitions, capital expenditures and adequacy of capital resources; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, belief or current expectation of School Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include forward-looking terminology such as may, should, believes, expects, anticipates, estimates, continues or similar expressions.
All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof. We do not undertake to update any forward-looking statements that may be made by us or on our behalf, in this Quarterly Report or otherwise. Our actual results may differ materially from those contained in the forward-looking statements identified above. Factors which may cause such a difference to occur include, but are not limited to, the risk factors set forth in Item 1A, Risk Factors of our Annual Report on Form 10-K for the fiscal year ended April 25, 2009.
ITEM 3. | Quantitative and Qualitative Disclosures About Market Risk |
There have been no material changes in qualitative and quantitative disclosures about market risk from what was reported in our Annual Report on Form 10-K for the fiscal year ended April 25, 2009.
ITEM 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Based on an evaluation as of the end of the period covered by this quarterly report, the Companys principal executive officer and principal financial officer have concluded that the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective for the purposes set forth in the definition of the Exchange Act rules.
Changes in Internal Control
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially effect, our internal control over financial reporting.
28
PART II - OTHER INFORMATION
ITEM 1. | Legal Proceedings |
During the first six months of fiscal 2009, the Company reached a settlement of potential compliance claims with the United States Environmental Protection Agency (EPA) related to the alleged unauthorized distribution during fiscal 2008 of certain product offerings containing an anti-microbial agent. The amount of the settlement with the EPA was $0.2 million, which the Company has accrued as of October 24, 2009. The liability is recorded in the Other Liabilities in the consolidated balance sheet as of October 24, 2009. The Company believes the matter to be closed.
ITEM 1A. | Risk Factors |
The business and financial results of the Company are subject to numerous risks and uncertainties. The risks and uncertainties have not changed materially from those reported in the fiscal 2009 Annual Report on Form 10-K.
ITEM 6. | Exhibits |
See the Exhibit Index, which is incorporated herein by reference.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SCHOOL SPECIALTY, INC. | ||
(Registrant) | ||
November 30, 2009 | /S/ DAVID J. VANDER ZANDEN | |
Date | David J. Vander Zanden Chief Executive Officer (Principal Executive Officer) | |
November 30, 2009 | /S/ DAVID N. VANDER PLOEG | |
Date | David N. Vander Ploeg Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |
30
EXHIBIT INDEX
Exhibit No. |
Description | |
12.1 | Statement Regarding Computation of Ratio of Earnings to Fixed Charges. | |
31.1 | Rule 13a-14(a)/15d-14(a) Certification, by Chief Executive Officer. | |
31.2 | Rule 13a-14(a)/15d-14(a) Certification, by Chief Financial Officer. | |
32.1 | Section 1350 Certification, by Chief Executive Officer. | |
32.2 | Section 1350 Certification, by Chief Financial Officer. |