Quarterly Overview

School Specialty, (the "Company"), 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.

Based on current surveys and recently reported results by education companies in the textbook and curriculum markets, school spending trends in 2012 have continued to be challenging across the industry this school season. While overall state budgets appear to be improving, pressure on educational budgets at the state and municipal level has continued in a significant number of states.

We experienced challenges similar to those of the overall industry in the first quarter while we continued to implement changes to improve the effectiveness of the organizational structure of our business. Total revenue of $252.1 million in the first quarter of fiscal 2013 was a decline of 8.7% compared to the first quarter of fiscal 2012. Educational Resources segment revenue declined 6.7% to $173.7 million, but increased gross margin through improved pricing, inventory planning and merchandising and supply chain management. The Accelerated Learning segment reported a decline in revenue of 12.9% to $78.3 million and a decline in gross margin, caused primarily by lower curriculum related sales in our science division, partially offset by intervention related sales.

The challenges related to the continued depressed educational markets have placed and are expected to continue to place in the near term, increasing pressure on our ability to maintain acceptable levels of liquidity and covenant compliance. In response to these challenges, we have pursued our ongoing management initiatives, which drove the first quarter gross margin improvements in the Educational Resources segment. We have also made progress on our four previously announced immediate priorities of:

• targeting investments that will best capitalize on growth opportunities and increase EBITDA,

• building product management and marketing capabilities to transform the organization,

• identifying and exiting product lines with inadequate returns or which are not synergistic fits with the balance of our product lines, and

• driving a change in culture that focuses on accountability and organic growth.

We intend to continue to take the steps necessary to achieve these priorities and address the challenges posed by current market trends.

SG&A increased as a percentage of revenues to 29.8% in the first quarter of fiscal 2013 as compared to 28.9% in the first quarter of fiscal 2012. SG&A increased as a percentage of revenue because cost cutting actions did not keep pace with revenue declines. The Company recorded $1.1 million in restructuring charges in the first quarter of fiscal 2013. Total permanent headcount is down approximately 10.0% percent in the first quarter of fiscal 2013 as compared to the first quarter of fiscal 2012. Total SG&A decreased by $4.7 million in the first quarter of fiscal 2013 as compared to the first quarter of fiscal 2012. The decrease in SG&A is due to a decrease in variable costs, such as transportation, warehouse and selling, associated with the decrease in revenue.

Operating income was $28.5 million for the first quarter of fiscal 2013, a decrease of $3.0 million from the prior year quarter. Net income was $18.4 million in the first quarter of fiscal 2013, an increase of $4.8 million from the prior year quarter, due to lower income taxes.

Results of Continuing Operations

The following table sets forth various items as a percentage of revenues on a
historical basis concerning the Company's results of operations for the three
months ended July 28, 2012 and July 30, 2011:



                                                                     Three Months Ended
                                                          July 28, 2012              July 30, 2011
Revenues                                                           100.0 %                    100.0 %
Cost of revenues                                                    58.9                       59.7

Gross profit                                                        41.1                       40.3
Selling, general and administrative expenses                        29.8                       28.9

Operating income/(loss)                                             11.3                       11.4
Interest expense, net                                                4.0                        2.9
Expense associated with convertible debt exchange                    0.0                        0.4

Income/(loss) before provision for income taxes                      7.3                        8.1
Provision for (benefit from) income taxes                            0.3                        3.2

Earnings/(loss) from continuing operations                           7.0 %                      4.9 %

Three Months Ended July 28, 2012 Compared to Three Months Ended July 30, 2011

Revenues

Revenues decreased 8.7% from $276.1 million in the first quarter of fiscal 2012 to $252.1 million in the first quarter of fiscal 2013.

Educational Resources segment revenues decreased 6.7% from $186.1 million in the first quarter of fiscal 2012 to $173.7 million in the first quarter of fiscal 2013. The decline in Educational Resources segment revenue was comprised of a decline of approximately $7 million in the supplies category and a decline of approximately $5 million in the furniture category. The decline in the supplies category is related primarily to classroom supplemental products and other specialty brands which schools consider more discretionary than basic school supplies. Sales of basic school supplies were essentially flat in the first quarter of fiscal 2013 as compared to the first quarter of fiscal 2012.

Accelerated Learning segment revenues decreased 12.9% from $89.9 million in the first quarter of fiscal 2012 to $78.3 million in the first quarter of fiscal 2013. The decline was primarily related to decreased school spending on our science division curriculum. While the majority of the decline in the science curriculum was anticipated due to large prior year shipments for science adoptions in Indiana, Nevada and New York City that were not expected to repeat in fiscal 2013, demand for school curriculum products continues to be soft. In addition, the prior year disposition of our SEEDS of Science product contributed to the sales decline. Approximately $3 million of the decline is related to our student planner and agenda products. The declines in the curriculum and agenda products have been partially offset by increased sales in our reading intervention products.

Gross Profit

Gross profit decreased 6.9% from $111.3 million in the first quarter of fiscal 2012 to $103.6 million in the first quarter of fiscal 2013. The decrease in consolidated revenue accounted for $9.6 million of the decrease in gross profit had gross margin remained constant. Gross margin increased 80 basis points from 40.3% in the first quarter of fiscal 2012 to 41.1% in the first quarter of fiscal 2013 due to improvements in Educational Resources gross margin. The Accelerated Learning segment generates higher gross margin due to its curriculum-based products than the Educational Resources segment and accounted for 31.0% of the consolidated revenue in the first quarter of fiscal 2013 compared to 32.5% of the consolidated revenue in the first quarter of fiscal 2012. This shift of sales between segments contributed approximately 30 basis points of a decrease in gross margin.

Educational Resources segment gross profit increased $0.2 million from $60.4 million in the first quarter of fiscal 2012 to $60.6 million in the first quarter of fiscal 2013. Gross margin increased by 240 basis points from 32.5% in the first quarter of fiscal 2012 to 34.9% in the first quarter of fiscal 2013. Approximately 200 basis points of the increase were related to margin improvements in furniture and supplies associated with product pricing. The remaining increase of 40 basis points was due to favorable product mix.

Accelerated Learning segment gross profit decreased $7.3 million from $50.2 million in the first quarter of fiscal 2012 to $42.9 million in the first quarter of fiscal 2013 due to the decreased spending on the Company's curriculum products for which demand has continued to soften as schools are delaying purchases. Gross margin decreased by 100 basis points from 55.8% in the first quarter of fiscal 2012 to 54.8% in the first quarter of fiscal 2013. Product mix and product development amortization were the primary reasons for the decline in this segment.

Selling, General and Administrative Expenses

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

SG&A decreased $4.7 million from $79.8 million in the first quarter of fiscal 2012 to $75.1 million in the first quarter of fiscal 2013. As a percent of revenue, SG&A increased from 28.9% for the three months ended July 30, 2011 to 29.8% for the three months ended July 28, 2012. SG&A attributable to the Educational Resources and Accelerated Learning segments decreased a combined $5.7 million and Corporate SG&A increased $1.0 million in the first quarter as compared to last year's first quarter. The increase in Corporate SG&A was related primarily to an increase in professional and outside services.

Educational Resources segment SG&A decreased $4.9 million, or 11.0%, from $44.3 million in the first quarter of fiscal 2012 to $39.4 million in the first quarter of fiscal 2013. Approximately $1.6 million of the decrease was due to variable costs such as transportation, warehousing, and selling expenses associated with increased revenues. In addition, the segment had a decrease of $2.5 million in its marketing costs primarily associated with a decrease in catalog costs. Educational Resources segment SG&A decreased as a percent of revenues from 23.8% for the three months ended July 30, 2011 to 22.7% for the three months ended July 28, 2012.

Accelerated Learning segment SG&A decreased $0.8 million, or 3.3%, from $24.5 million for the three months ended July 30, 2011 to $23.7 million for the three months ended July 28, 2012. Accelerated Learning segment SG&A increased as a percent of revenues from 27.2% for the three months ended July 30, 2011 to 30.2% for the three months ended July 28, 2012. The increase in SG&A as a percent of revenue reflects the impact of fixed SG&A spread over a smaller revenue base.

Interest Expense

Net interest expense increased $2.1 million from $7.9 million in the first quarter of fiscal 2012 to $10.0 million in the first quarter of fiscal 2013. The increase in interest expense was due to the write-off of $2.5 million of debt issuance costs related to the Company's former revolving credit facility which was refinanced in the first quarter of fiscal 2013. The increase was partially offset by $0.3 million of a decrease in non-cash interest associated with the Company's convertible notes.

Provision for Income Taxes

The provision for income taxes was $0.3 million in the first quarter of fiscal 2013 compared to a provision for income taxes of $8.9 million for the first quarter of fiscal 2012. The effective tax rate in the first quarter of fiscal 2013 was 1.4% compared to 39.8% for the first quarter of fiscal 2012. The Company is forecasting a taxable loss for fiscal 2013. The decline in taxes was related to projected annual tax losses for fiscal 2013 for which tax benefits are not expected to be recognized at this time due to valuation allowances. In fiscal 2012, the Company recorded a valuation allowance against all of its deferred tax assets, net of the potential $5 million refund. Therefore, the Company has not recorded a current or deferred federal tax expense in fiscal 2013. The $0.3 million tax expense in the first quarter of fiscal 2013 relates to state and foreign taxes.

Liquidity and Capital Resources

At July 28, 2012, the Company had working capital of $103.6 million. Our capitalization at July 28, 2012 was $450.0 million and consisted of total debt of $365.0 million and shareholders' equity of $85.0 million.

On May 22, 2012, the Company entered into an Asset-Based Credit Agreement (the "ABL Facility") and Term Loan Credit Agreement (the "Term Loan"), which replaced the Company's then-existing credit facility. Both the ABL Facility and the Term Loan contain customary events of default and financial, affirmative and negative covenants, including quarterly financial covenants relating to the Company's
(1) maximum secured leverage ratio, (2)

maximum total leverage ratio, (3) maximum term loan ratio, (4) minimum fixed charge coverage ratio and (5) minimum interest coverage ratio. In addition, the Term Loan contains a minimum liquidity covenant requiring the Company to maintain minimum liquidity levels at the end of each month during the life of the Term Loan (consisting of qualified cash, subject to a $2.0 million cap, plus availability under the ABL Facility).

Under the ABL Facility, the Asset-Based Lenders agreed to provide a revolving senior secured asset-based credit facility in an aggregate principal amount of $200 million. Outstanding amounts under the ABL Facility will bear interest at a rate per annum equal to, at the Company's election: (1) a base rate (equal to the greatest of (a) the prime lending rate, (b) the federal funds rate plus 0.50%, or (c) the 30-day LIBOR rate plus 1.00% per annum) (the "Base Rate") plus an applicable margin (equal to a specified margin based on the interest rate elected by the Company, the excess availability under the ABL Facility and the applicable point in the life of the ABL Facility) (the "Applicable Margin"), or
(2) a LIBOR rate plus the Applicable Margin (the "LIBOR Rate"). Interest on loans under the ABL Facility bearing interest based upon the Base Rate will be due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate will be due on the last day of each relevant interest period.

The ABL Facility will mature on September 30, 2014, but may be extended to October 31, 2015 if the Company's indebtedness under its convertible subordinated debentures has been refinanced. Advances under the ABL Facility may be prepaid by the Company in whole or in part at any time without penalty or premium. The Company will be required to make specified prepayments upon the occurrence of certain events, including: (1) the amount outstanding on the ABL Facility exceeding the Borrowing Base; (2) the Company's receipt of net cash proceeds of any sale or disposition of assets that are first priority collateral for the ABL Facility; (3) the Company's receipt of Extraordinary Receipts that would constitute collateral for the ABL Facility; (4) the incurrence by the Company of any indebtedness that is not Permitted Indebtedness; (5) the Company's issuance of certain equity interests; (6) the receipt by the Company of any proceeds of business interruption insurance; and (7) the Company's receipt of cash proceeds in connection with certain asset sales.

Under the Term Loan, the Term Loan Lenders agreed to make a term loan to the Company in aggregate principal amount of $70 million. The outstanding principal amount of the Term Loan will bear interest at a rate per annum equal to the applicable LIBOR rate (calculated as the greater of (1) the current three-month LIBOR rate and (2) 1.5%) plus 11.0%, accruing and paid on a quarterly basis in arrears.

The Term Loan matures on October 31, 2014, but may be extended to December 31, 2015 if the Company's indebtedness under its convertible subordinated debentures has been refinanced. The Term Loan requires prepayments at specified levels upon the Company's receipt of net proceeds from certain events, including: (1) certain dispositions of property, divisions, business units or business lines, including any Permitted Divestiture; (2) issuances of debt for the refinancing of the Term Loan; (3) other issuances of debt other than Permitted Debt;
(4) issuances of certain equity interests; (5) the Company's receipt of certain Extraordinary Receipts; and (6) any insurance proceeds in respect of business interruption insurance or loss or destruction of collateral property. The Company is also permitted to voluntarily prepay the Term Loan in whole or in part. Any prepayments are to be made at par, plus an early payment fee calculated in accordance with the terms of the Term Loan Credit Agreement.

The Company used the proceeds of the ABL Facility and the Term Loan to repay outstanding indebtedness under the Company's previous credit facility.

The covenants for fiscal 2013 are as follows:

                                                     Fiscal 2013 Covenants
         Ratio                              Q1          Q2          Q3          Q4
         Maximum secured leverage ratio     5.12x       3.21x       2.45x       3.09x
         Maximum total leverage ratio       9.52x       7.15x       6.55x       6.99x
         Maximum term loan ratio            2.28x       2.29x       2.32x       2.28x
         Minimum fixed charge ratio         0.82x       0.97x       0.92x       0.96x

The Company closely evaluates its ability to remain in compliance with the financial covenants under our Asset-Based Credit Agreement and Term Loan Credit Agreements. The recent challenges affecting the Company's performance have placed, and are expected to continue to place in the near term, pressure on the Company's ability to maintain acceptable levels of liquidity and to remain in compliance with its covenants. To the extent that management's forecasts indicate that the Company may be unable to comply with any of these financial covenants in the future, the Company may need to work with its lenders to secure a waiver or amend these covenants. We expect that any amendment or waiver would result in additional fees and more restrictive terms, and may increase the cost of any future borrowings. The Company believes it will be able to maintain compliance with the financial covenants by working with its lenders, if necessary. If the Company fails to maintain compliance with these financial covenants and fails to obtain amendments to or waivers under these credit agreements, the Company's lenders could pursue remedies, which could include an acceleration of our debt. Should such acceleration occur, the Company may have difficulty obtaining sufficient additional funds to refinance the accelerated debt.

The Company was in compliance with these covenants as of the end of the first quarter of fiscal 2013 and was in compliance with the minimum liquidity covenant as of the end of each fiscal month in the first quarter of fiscal 2013 under the Term Loan.

In November 2006, we sold $200.0 million of convertible subordinated debentures due 2026, ("the 2006 Debentures"). The 2006 Debentures were unsecured, subordinated obligations of the Company, which paid interest at 3.75% per annum and were convertible upon satisfaction of certain conditions. The debentures were redeemable at our option on or after November 30, 2011. On November 30, 2011, the holders had the right to require us to repurchase all or some of the 2006 Debentures.

On March 1, 2011 and July 7, 2011, we exchanged $100.0 million and $57.5 million, respectively, in aggregate principal amount of the outstanding 2006 Debentures, for $100.0 million and $57.5 million, respectively, in aggregate principal amount of convertible debentures also due November 30, 2026, ("the 2011 Debentures"). The 2011 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. Principal will accrete on the 2011 Debentures at a rate of 3.9755% per year, compounding on a semi-annual basis. In connection with any such conversion, the Company will deliver cash equal to the lesser of the aggregate principal amount of 2011 Debentures to be converted and the Company's total conversion obligation, and will deliver, at its option, cash or shares of the Company's common stock in respect of the remainder, if any, of the Company's conversion obligation. The initial conversion rate is 44.2087 shares per $1,000 principal amount of 2011 Debentures, which represents an initial conversion price of approximately $22.62 per share. The 2011 Debentures are redeemable at the Company's option on or after May 30, 2014. On November 30, 2014, 2018 and 2022 and upon the occurrence of certain circumstances, holders will have the right to require us to repurchase all or some of the 2011 Debentures. The Company's ABL Facility and Term Loan will mature on September 30, 2014 and October 31, 2014, respectively, if the 2011 Debentures have not been refinanced prior to those dates. The Company expects to refinance the 2011 Debentures prior to September 30, 2014 with proceeds from the issuance of new debt and/or additional equity, but there can be no assurance that the Company will be able to do so on terms that are acceptable to the Company or at all.

Net cash used in operating activities decreased by $0.7 million to $52.9 million in the first quarter of fiscal 2013 as compared to $53.6 million used in the first quarter of fiscal 2012. The net use of cash in operating activities during the first quarter 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.

Net cash used in investing activities decreased by $0.3 million to $2.9 million in the first quarter of fiscal 2013 as compared to $3.2 million for the first quarter of fiscal 2012. Additions to property, plant and equipment decreased $0.1 million from the first quarter of fiscal 2012 to $1.2 million in the first quarter of fiscal 2013. Product development spending decreased $0.3 million from the first quarter of fiscal 2012 to $1.7 million in the first quarter of fiscal 2013.

Cash flows provided by financing activities increased by $12.5 million from net cash flows provided by financing activities of $51.1 million in the first quarter of fiscal 2012 to net cash flows provided by financing activities of $63.6 million in the first quarter of fiscal 2013. The increase was used to fund cash used in operations. In the first quarter of fiscal 2013, the Company's total borrowings increased by $15.3 million as compared to the first quarter of fiscal 2012.

Fluctuations in Quarterly Results of Operations

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

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, Management's Discussion and Analysis of Financial Condition and Results of Operation, including, without limitation, statements with respect to internal growth plans, projected revenues, margin improvement, capital expenditures, adequacy of capital resources and ability to comply with financial covenants; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, belief or current expectation of School Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include forward-looking terminology such as "may," "should," "believes," "expects," "anticipates," "estimates," "continues" or similar expressions.

All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof. We do not undertake to update any forward-looking statements that may be made by us or on our behalf, in this Quarterly Report or otherwise. Our actual results may differ materially from those contained in the forward-looking statements identified above. Factors which may cause such a difference to occur include, but are not limited to, the risk factors set forth in Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended April 28, 2012.