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SCOO > SEC Filings for SCOO > Form 10-Q on 5-Mar-2014All Recent SEC Filings

Show all filings for SCHOOL SPECIALTY INC

Form 10-Q for SCHOOL SPECIALTY INC


5-Mar-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

Quarterly Overview

School Specialty, Inc. (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 pre K-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 fiscal 2014 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.

Bankruptcy Filing

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

The Chapter 11 Cases were filed in response to an environment of ongoing declines in school spending and a lack of sufficient liquidity, including trade credit provided by the Debtors' vendors, to permit the Debtors to pursue their business strategy to position the School Specialty brands successfully for the long term.

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

Operation and Implication of the Bankruptcy Filing

Under Section 362 of the Bankruptcy Code, the filing of voluntary bankruptcy petitions by the Debtors automatically stayed most actions against the Debtors, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over the Company's property. Accordingly, although the Company defaulted on certain of the Debtors' debt obligations, creditors were stayed from taking any actions as a result of such defaults. Absent an order of the Bankruptcy Court, substantially all of the Company's pre-petition liabilities were subject to settlement under a reorganization plan or in connection with a Section 363 sale.

Subsequent to the Petition Date, the Company received approval from the Bankruptcy Court to pay or otherwise honor certain pre-petition obligations generally designed to stabilize the Company's operations. These obligations related to certain employee wages, salaries and benefits, and the payment of vendors and other providers in the


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ordinary course for goods and services received after the Petition Date. The Company retained, pursuant to Bankruptcy Court approval, legal and financial professionals to advise the Company in connection with the bankruptcy filing and certain other professionals to provide services and advice in the ordinary course of business.

Reorganization Plan

In order for the Company to emerge successfully from Chapter 11, the Company determined that it was in the best interests of the Debtors' estates to seek Bankruptcy Court confirmation of a reorganization plan. A reorganization plan determines the rights and satisfaction of claims of various creditors and security holders, subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on which the reorganization plan is confirmed.

On May 23, 2013, the Bankruptcy Court entered an order confirming the Debtors' Reorganization Plan, and a corrected copy of such order was entered by the Bankruptcy Court on June 3, 2013. The Reorganization Plan became effective on the Effective Date.

General

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

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

Certain pre-petition secured claims;

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

All priority claims.

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

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

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

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

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


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

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

Exit Facilities

As of the Effective Date, the Debtors closed on the exit credit facilities, the proceeds of which were or will be, among other things, used to (i) pay in cash the DIP Financing Claims, to the extent provided for in the Reorganization Plan,
(ii) make required distributions under the Reorganization Plan, (iii) satisfy certain Reorganization Plan-related expenses, and (iv) fund the reorganized Company's working capital needs. The terms of the exit credit facilities are described under Note 13 of the Notes to Condensed Consolidated Financial Statements - Debt.

Equity Interests

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

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

Process Improvement Program

In the second quarter of fiscal 2014, the Company began to implement a company-wide Process Improvement Program to better align the Company's operating groups, enhance systems and processes, and drive efficiency throughout the organization to improve the customer experience. The key elements of the Process Improvement Program include:

Distribution Center and Warehouse Consolidation/Reconfiguration. The Company has successfully completed the process of consolidating its Distribution business from four distribution centers to two. The Fresno, California and Salina, Kansas facilities were closed in the third quarter of fiscal 2014 as planned. The Company continues to build out its Mansfield, Ohio distribution center to make that its core hub center to better service nationwide customers. The Company plans to have the distribution center in Greenville, Wisconsin continue to serve as a distribution hub, and to leverage that distribution center during the peak-selling season. The Fresno and Salina distribution centers ceased processing customer shipments in the second quarter of fiscal 2014, and transitioning of inventory from these facilities to both its Mansfield and Greenville facilities was completed in the third quarter of fiscal 2014.

Sales and Operation Planning. The Company plans to implement lean processes and align its supply chain teams behind product groups and dedicated planning and forecasting teams in order to provide greater efficiencies in sourcing, purchasing and procurement. The Company expects these areas will be integrated directly with the sales teams to ensure better control over pricing, product development and inventory management, as well as leveraging global sourcing. This program also is expected to reduce freight and


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warehousing costs. During the third quarter of fiscal 2014 the Company successfully mapped out processes for its Sales, Marketing and Merchandising groups with the intent of implementing meaningful process reforms in these critical areas.

Product Management / SKU Rationalization. The Company is identifying and removing many of the lower-performing SKU's which is anticipated to result in cost savings in procurement and marketing, particularly associated with catalog and distribution functions. Through the third quarter of fiscal 2014, approximately 11,000 SKU's have been identified for removal. The Company also began a Product Profitability Analysis program, looking at its top selling SKU's. This effort is expected to enhance profitability as it analyzes the Company's product lines and how they are sourced, marketed, and sold.

Customer Care and Service Functions. The Company plans to streamline administrative functions and seek to improve its data-capture capabilities as there is significant expertise in this area that we would like to integrate into other areas of our operations. The Greenville, WI facility is intended to become our consolidated Customer Care Center of Excellence. During the third quarter of fiscal 2014 the Company announced its intent to outsource some administrative Customer Care functions in Greenville. We have entered into a relationship with a vendor with extensive experience in customer service support and training processes have begun. We intend to transition solely the order entry functions in Greenville and not customer-facing Customer Care group functions. Additionally, the Company is working with the Customer Care team and other functional divisions to put into place the right metrics for tracking, evaluation and improvement to achieve 100% customer satisfaction.

Expanding the Digital Platform. The Company intends to transition its marketing spend to enhance its digital capabilities. This includes a robust e-commerce platform, various branded web redesigns to drive traffic and online sales, search engine optimization and social media. All of the investments for the information technology spend were part of the fiscal 2014 budget and new investments are anticipated to be offset by lower costs in other marketing areas.

Continuous Improvement and Project Management Alignment. The Company has established a Project Management Office and a Steering Committee that is comprised of team leaders to establish greater accountability. The Company's Chief Executive Officer serves on the Steering Committee as Chairman.

The Company anticipates these Process Improvement Programs will reduce SG&A costs by between $3 million and $5 million in fiscal 2014, with the majority of these savings expected in the fourth quarter. The annualized recurring savings from these programs are estimated to be approximately $12 million to $15 million. The Company expects to incur approximately $12 million of non-recurring or restructuring costs in fiscal 2014 associated with these initiatives and other bankruptcy-related activities.

Results of Operations

Factors Affecting Comparability

Fresh Start Accounting Adjustments

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

Accordingly, in addition to providing the GAAP analysis for the third fiscal quarter below, management has provided a non-GAAP analysis entitled "Non-GAAP Financial Information - Combined Results" for the nine months ended January 25, 2014. Non-GAAP Financial Information - Combined Results combines GAAP results of the Successor Company for the thirty-three weeks ended January 25, 2014 and GAAP results of the Predecessor


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Company for the six weeks ended June 11, 2013. Management's non-GAAP analysis compares the Non-GAAP Financial Information - Combined Results for certain financial items to the Predecessor Company's GAAP results for the nine months ended January 26, 2013.

Successor Company GAAP Results for the Three Months Ended January 25, 2014 Compared to Predecessor Company GAAP Results for the Three Months Ended January 26, 2013

Revenues

Revenues for the three months ended January 25, 2014 decreased 7.6%, or $6.1 million from the Predecessor Company three months ended January 26, 2013.

Distribution (formerly referred to as "Educational Resources") segment revenues decreased 5.3%, or $3.5 million, from the Predecessor Company three months ended January 26, 2013. The revenue decrease in Distribution primarily is a result of furniture revenue declining approximately $3 million compared to the prior year. The furniture product category has been most affected by our bankruptcy as customers were hesitant to enter into long-term projects while the Company was going through bankruptcy and these impacts are still being felt in the Company's third quarter.

Curriculum (formerly referred to as "Accelerated Learning") segment revenues decreased 16.4%, or $2.5 million, from the Predecessor Company three months ended January 26, 2013. The majority of this decline is related to the Company's Science and Reading businesses. Specifically, the number of larger orders realized in this fiscal year's third quarter was down as compared to last fiscal year's third quarter. In addition, sales rep turnover has negatively impacted Reading revenue in the three months ended January 25, 2014. The segment is in the process of rebuilding the sales team. Approximately $0.6 million of this decline is related to the sale of the Company's agenda print plant assets. In the Company's off season, these print plant assets had been used to generate commercial printing revenue.

Gross Profit

Gross margin for the three months ended January 25, 2014 was 35.4% as compared to 36.4% for the Predecessor Company's three months ended January 26, 2013.

Distribution segment gross margin was 32.6% for the three months ended January 25, 2014 as compared to 33.5% for the Predecessor Company three months ended January 26, 2013. A reduction in vendor rebates earned of approximately $0.2 million in the third quarter of fiscal 2014 has resulted in approximately 40 basis points of the gross margin decline. Until normal terms are established with all vendors, we expect that benefits received from rebate programs will be negatively impacted. In addition, the Company's mix of revenue in the third quarter shifted more towards products that ship directly to customers from vendors as compared to warehouse shipments. This mix shift resulted in an increase of $0.2 million in direct ship freight expense which negatively impacted gross margins by 40 basis points.

Curriculum segment gross margin was 49.3% for the three months ended January 25, 2014 as compared to 48.4% for the Predecessor Company three months ended January 26, 2013. Increased product development amortization of $0.2 million, spread over a lower revenue base, negatively impacted the segment gross margins by 280 basis points. This was offset with a reduction of approximately $0.4 million of plant overhead costs which were eliminated through the Company's sale of the agenda print plant assets. The remaining change in the segment gross margin was attributable to product mix within the 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.


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SG&A for the three months ended January 25, 2014 decreased $11.6 million from $60.2 million in the third quarter of fiscal 2013 to $48.7 million in the third quarter of fiscal 2014. As a percent of revenue, SG&A decreased from 74.5% for the three months ended January 26, 2013 to 65.2% for the three months ended January 25, 2014.

SG&A attributable to the Distribution and Curriculum segments decreased $5.5 million and Corporate SG&A decreased $6.1 million in the third quarter as compared to last year's third quarter.

Distribution segment SG&A decreased $3.4 million, or 14.8%, from $26.3 million in the third quarter of fiscal 2013 to $22.9 million in the third quarter of fiscal 2014. The decrease is primarily due to a decrease in total personnel costs of $1.2 million which represents a combination of reduced headcount and a furlough week in the third quarter of fiscal 2014. Approximately $0.7 million of the decline is related to decreased catalog costs as the Company has reduced the size and circulation of its catalogs. The revenue decline also has resulted in a decrease in the variable warehouse and transportation costs of approximately $0.7 million.

Curriculum segment SG&A decreased $2.1 million, or 13.7%, from $16.9 million for the three months ended January 26, 2013 to $14.8 million for the three months ended January 25, 2014. The decrease is attributable to a $1.2 million reduction in intangible amortization recognized in third quarter fiscal 2013 as compared to the same period fiscal 2014 and a reduction in payroll costs associated with a one-week furlough in the third quarter of fiscal 2014. The reduction in intangible amortization is related to the revaluation of intangible assets as part of the fresh start accounting.

The Corporate SG&A decrease was due primarily to $4.7 million of prior year bankruptcy-related costs associated with professional fees paid prior to the Chapter 11 filing and thus were included in SG&A in the third quarter of fiscal 2013. Approximately $1.7 million of the decrease is related to a decrease in payroll and benefits, as headcount is down from prior year and the occurrence of a one week furlough in third quarter of fiscal 2014. Depreciation expense had decreased by approximately $1.0 million in the current year's third quarter as a result of the fresh start accounting. These declines were partially offset by $1.6 million of additional costs incurred in the current year's third quarter associated with the Company's process improvement actions.

Facility Exit Costs and Restructuring

In the third quarter of fiscal 2014, the Company recorded $2.4 million of facility exit costs and restructuring associated with the shutdown of distribution centers related to the Company's restructuring.

Impairment Charges

The Company recorded $45.8 million of impairment charges in the third quarter fiscal 2013 due to a triggering event in the quarter. A goodwill impairment charge of $41.1 million, and an impairment of $4.7 million related to indefinite-lived intangible assets were recognized. The Company did not have a re-consideration event in the third quarter fiscal 2014 and thus no impairment charges for the current year third quarter.

Interest Expense

Interest expense decreased $3.3 million, from $8.0 million in the third quarter of fiscal 2013 to $4.7 million in the third quarter of fiscal 2014.

The Predecessor Company recorded $3.8 million of interest expense on its convertible debt in the third quarter of fiscal 2013, of which $2.3 million was non-cash interest expense. There was no interest expense on the convertible debt in the third quarter of fiscal 2014 as the convertible debt was canceled on the Effective Date in accordance with the Reorganization Plan with those debt holders receiving 35% of the equity of the Successor Company.

Third quarter fiscal 2014 interest expense associated with the Successor Company's term loan was approximately $0.8 million greater than the Predecessor Company's term loan interest expense in the third quarter of fiscal 2013 due to an increase in average borrowings in the term loan as compared to the pre-bankruptcy term loan, partially offset by a decrease in the borrowing rate. In addition, the interest expense in the third quarter of fiscal 2013 included interest at a default interest rate. This default rate, an incremental 300 basis points on the term loan, was triggered by the Company's non-compliance with the minimum liquidity covenant in last year's third quarter.


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The Company incurred $0.5 million of lower interest expense related to the decreased borrowings on the Company's New ABL Facility. Partially offsetting these declines was incremental paid-in-kind interest expense in the current year's third quarter associated with the vendor deferred payment obligations.

Change in fair value of interest rate swap

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

Early Termination of Long-Term Indebtedness

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

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

Reorganization Items, Net

In the third quarter of fiscal 2014, the Successor Company recorded $0.9 million of reorganization items. This consisted primarily of professional fees associated with activities attributable to the implementation of the Company's Reorganization Plan.

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