School Specialty (SCOO) 10-Q 2019 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2019

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)

Delaware	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

(Registrant’s Telephone Number, including Area Code)

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None	None	None

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of RegulationS-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule12b-2 of the Exchange Act (check one):

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at November 12, 2019
Common Stock, $0.001 par value	7,025,219

SCHOOL SPECIALTY, INC.

INDEX TO FORM10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2019

PART I - FINANCIAL INFORMATION
		Page Number
ITEM 1.	CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
	Condensed Consolidated Balance Sheets at September 28, 2019, December 29, 2018 and September 29, 2018		2
	Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 28, 2019 and September 29, 2018		3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months and Nine Months Ended September 28, 2019 and September 29, 2018		4
	Condensed Consolidated Statements of Stockholders’ Equity for the Three Months and Nine Months Ended September 28, 2019 and the Nine Months Ended September 29, 2018		5
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 28, 2019 and September 29, 2018		6
	Notes to Condensed Consolidated Financial Statements		7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		31
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		40
ITEM 4.	CONTROLS AND PROCEDURES		40
PART II - OTHER INFORMATION
ITEM 1A.	RISK FACTORS		41
ITEM 5.	OTHER INFORMATION		41
ITEM 6.	EXHIBITS		41

-Index-

PART I – FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Unaudited Financial Statements

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In Thousands, except share and per share amounts)

	September 28, 2019			December 29, 2018			September 29, 2018
ASSETS
Current assets:
Cash and cash equivalents	$	5,862		$	1,030		$	7,922
Accounts receivable, less allowance for doubtful accounts of $1,023, $1,909, and $1,004, respectively		162,127			77,888			175,111
Inventories, net		81,974			90,061			96,024
Prepaid expenses and other current assets		18,802			15,763			17,731
Refundable income taxes		397			1,019			—
Total current assets		269,162			185,761			296,788
Property, plant and equipment, net		29,497			31,902			31,732
Operating leaseright-of-use asset		11,275			—			—
Goodwill		—			4,580			26,842
Intangible assets, net		30,215			33,306			34,245
Development costs and other		13,818			14,807			15,407
Deferred income taxes long-term		282			320			2,002
Total assets	$	354,249		$	270,676		$	407,016
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities - long-term debt	$	199,068		$	30,352		$	90,450
Current operating lease liability		5,039			—			—
Accounts payable		49,341			41,277			43,219
Accrued compensation		7,156			7,302			5,211
Contract liabilities		7,589			5,641			7,232
Accrued royalties		1,542			2,678			2,105
Accrued income tax payable		—			—			6,001
Other accrued liabilities		20,829			11,379			17,884
Total current liabilities		290,564			98,629			172,102
Long-term debt - less current maturities		—			103,583			128,830
Operating lease liability		6,337			—			—
Other liabilities		3,580			1,101			569
Total liabilities		300,481			203,313			301,501
Commitments and contingencies - Note 15
Stockholders’ equity:
Preferred stock, $0.001 par value per share, 500,000 shares authorized; none outstanding		—			—			—
Common stock, $0.001 par value per share, 50,000,000 shares authorized; 7,025,219; 7,000,000 and 7,000,000 shares issued and outstanding, respectively		7			7			7
Capital in excess of par value		124,301			125,072			124,228
Treasury stock, at cost 5,145; 0 and 0 shares, respectively		(34	)		—			—
Accumulated other comprehensive loss		(1,902	)		(2,079	)		(1,720	)
Accumulated deficit		(68,604	)		(55,637	)		(17,000	)
Total stockholders’ equity		53,768			67,363			105,515
Total liabilities and stockholders’ equity	$	354,249		$	270,676		$	407,016

See accompanying notes to condensed consolidated financial statements.

2

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands, Except Per Share Amounts)

	For the Three Months Ended					For the Nine Months Ended
	September 28, 2019			September 29, 2018		September 28, 2019			September 29, 2018
Revenues	$	278,512		$	290,280	$	535,053		$	558,839
Cost of revenues		185,945			192,776		357,005			366,470
Gross profit		92,567			97,504		178,048			192,369
Selling, general and administrative expenses		64,436			59,607		167,416			170,553
Impairment Charges		4,580			—		4,863			—
Restructuring costs		1,080			667		2,290			1,149
Operating income		22,471			37,230		3,479			20,667
Other expense (income):
Interest expense		5,341			4,157		14,927			11,351
Change in fair value of warrant derivative		238			—		1,320			—
Income (loss) before provision for (benefit from) income taxes		16,892			33,073		(12,768	)		9,316
Provision for (benefit from) income taxes		(972	)		14,517		199			9,420
Net income (loss)	$	17,864		$	18,556	$	(12,967	)	$	(104	)
Weighted average shares outstanding:
Basic EPS		7,025			7,000		7,013			7,000
Diluted EPS		8,282			7,063		7,013			7,000
Net income (loss) per Share:
Basic	$	2.54		$	2.65	$	(1.85	)	$	(0.01	)
Diluted	$	2.16		$	2.63	$	(1.85	)	$	(0.01	)

See accompanying notes to condensed consolidated financial statements.

3

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In Thousands)

	For the Three Months Ended					For the Nine Months Ended
	September 28, 2019			September 29, 2018		September 28, 2019			September 29, 2018
Net income (loss)	$	17,864		$	18,556	$	(12,967	)	$	(104	)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		(81	)		112		177			(295	)
Total comprehensive income (loss)	$	17,783		$	18,668	$	(12,790	)	$	(399	)

See accompanying notes to condensed consolidated financial statements.

4

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(In Thousands)

(in thousands)	Common Stock		Capital in Excess of Par Value			Treasury Stock, at Cost			Retained Earnings (Accumulated Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance, December 29, 2018	$	7	$	125,072		$	—		$	(55,637	)	$	(2,079	)	$	67,363
Net loss		—		—			—			(24,975	)		—			(24,975	)
Purchase of treasury stock		—		—			—			—			—			—
Share-based compensation		—		(1,160	)		—			—			—			(1,160	)
Foreign currency translation adjustment		—		—			—			—			133			133
Balance, March 30, 2019	$	7	$	123,912		$	—		$	(80,612	)	$	(1,946	)	$	41,361
Net loss		—		—			—			(5,856	)		—			(5,856	)
Purchase of treasury stock		—		—			(34	)		—			—			(34	)
Share-based compensation		—		271			—			—			—			271
Foreign currency translation adjustment		—		—			—			—			125			125
Balance, June 29, 2019	$	7	$	124,183		$	(34	)	$	(86,468	)	$	(1,821	)	$	35,867
Net income		—		—			—			17,864			—			17,864
Purchase of treasury stock		—		—			—			—			—			—
Share-based compensation		—		118			—			—			—			118
Foreign currency translation adjustment		—		—			—			—			(81	)		(81	)
Balance, September 28, 2019	$	7	$	124,301		$	(34	)	$	(68,604	)	$	(1,902	)	$	53,768
Balance, December 30, 2017	$	7	$	123,083		$	—		$	(14,174	)	$	(1,425	)	$	107,491
Cumulative effect of change in accounting principle (1)		—		—			—			(2,722	)		—			(2,722	)
Net loss		—		—			—			(104	)		—			(104	)
Share-based compensation		—		1,145			—			—			—			1,145
Foreign currency translation adjustment		—		—			—			—			(295	)		(295	)
Balance, September 29, 2018	$	7	$	124,228		$	—		$	(17,000	)	$	(1,720	)	$	105,515

(1) See Note 4, “Change in Accounting Principle – Revenue from Contracts with Customers,” of the notes to condensed consolidated financial statements for further discussion

See accompanying notes to condensed consolidated financial statements.

5

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

	For the Nine Months Ended
	September 28, 2019			September 29, 2018
Cash flows from operating activities:
Net loss	$	(12,967	)	$	(104	)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and intangible asset amortization expense		13,118			13,607
Amortization of development costs		3,472			4,190
Impairment of goodwill and intangibles		4,863			—
Gain on disposal of assets		—			(20	)
Amortization of debt fees and other		1,417			815
Change in fair value of warrant derivative		1,320			—
Unrealized foreign exchange (gain) loss		1			(18	)
Share-based compensation expense		(771	)		1,145
Deferred taxes		—			990
Non-cash interest expense		2,677			1,717
Changes in current assets and liabilities:
Accounts receivable		(84,225	)		(105,744	)
Inventories		8,087			(20,333	)
Prepaid expenses and other current assets		(2,417	)		(1,412	)
Accounts payable		8,245			16,614
Accrued liabilities		8,441			2,488
Net cash used by operating activities		(48,739	)		(86,065	)
Cash flows from investing activities:
Additions to property, plant and equipment		(7,904	)		(8,921	)
Investment in product development costs		(2,623	)		(3,581	)
Proceeds from sale of assets		—			100
Net cash used in investing activities		(10,527	)		(12,402	)
Cash flows from financing activities:
Proceeds from bank borrowings		191,244			201,776
Repayment of debt and capital leases		(126,458	)		(126,190	)
Earnout payment for acquisition		(501	)		(816	)
Payment of debt fees and other		(131	)		—
Purchase of treasury stock		(34	)		—
Net cash provided in financing activities		64,120			74,770
Effect of exchange rate changes on cash		(22	)		(242	)
Net increase (decrease) in cash and cash equivalents		4,832			(23,939	)
Cash and cash equivalents, beginning of period		1,030			31,861
Cash and cash equivalents, end of period	$	5,862		$	7,922
Supplemental disclosures of cash flow information:
Interest paid	$	10,833		$	8,819
Income taxes paid, net	$	334		$	1,493

See accompanying notes to condensed consolidated financial statements.

6

SCHOOL SPECIALTY, INC.

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 U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form10-Q and Rule10-01 of RegulationS-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature unless otherwise noted) considered necessary for a fair presentation have been included. The balance sheet at December 29, 2018 has been derived from School Specialty, Inc.’s (“School Specialty” or the “Company”) audited financial statements for the period ended December 29, 2018. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Form10-K for the period ended December 29, 2018.

NOTE 2 – GOING CONCERN

The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business within one year after the date the condensed consolidated financial statements are issued. In accordance with Financial Accounting Standards Board, or the FASB, Accounting Standards Update No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), our management evaluates whether there are conditions or events, considered in aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date that the financial statements are issued.

As of September 28, 2019, the Company had $5.9 million in cash and excess availability of $59.2 million on its ABL facility. However, the Company’s operating results were below plan for the first nine months of 2019 which resulted in non-compliance with certain financial covenants of the Company’s debt facilities in the third quarter of 2019 and all of the Company’s debt has been classified as current in the condensed consolidated financial statements. See Note 11 – Debt for details regarding the Company’s debt facilities. To address the non-compliance, the Company entered into short-term forbearance agreements with its senior secured lenders and also reached agreement in principle with its senior lenders, subject to definitive documentation, on terms and conditions for a forbearance related to the third quarter non-compliance and amendments to the terms of its debt facilities (collectively, the “Term Sheets”). The Term Sheets contemplate, among other things, certain restrictions on the Company’s borrowing capacity, and an acceleration of the current maturity dates. However, the Term Sheets also contemplate allowing the Company to pursue an extension of the maturity date with the holders of the currently maturing deferred vendor obligations. The Company is having ongoing discussions with certain holders of the deferred vendor obligations, but no definitive agreement to extend maturity has been finalized as of the date of this report. Uncertainty as to the success of entering into binding amendments with the Company’s senior secured lenders, extensions to the currently-maturing unsecured vendor debt obligations consistent with the Term Sheets and the Company’s ability to remain in compliance with future period covenants could result in the Company’s senior secured lenders exercising their rights and remedies with respect to our current non-compliance, resulting in substantial doubt about the Company’s ability to continue as a going concern twelve months from the date the financial statements are issued.

Management believes that the Company’s ability to continue as a going concern is dependent on a combination of negotiating satisfactory terms related to the extension of the maturity date for a substantial portion of the currently-maturing deferred vendor obligations, obtaining the additional funding necessary to repay these currently-maturing debt obligations, renegotiating certain terms of its existing debt facilities, and pursuing other strategic alternatives. Management hired an investment banker in August 2019 to assist in both seeking additional capital financing and, as announced in October 2019, to pursue strategic alternatives. Management is also maintaining ongoing discussions with its current lenders. The Board and management believe that these steps, if successful, will result in enhanced liquidity and therefore mitigate the factors which raise doubt about the Company’s ability to continue as a going concern. Managements ultimate plan is to obtain additional financing or replacement financing or engage in a sale transaction. While management believes that its pursuit of strategic alternatives and additional funding through its investment banker, its other actions to improve the Company’s financial performance, and its discussions with existing lenders and holders of deferred vendor obligations will enable the Company to either retire or extend the deferred vendor obligations, there can be no assurance that additional debt or other financing will be available to the Company in sufficient amounts and on acceptable terms or at all, that the Company’s current lenders will agree to modify the terms of its debt facilities on acceptable terms or at all, or that the Company will achieve its forecasted performance at the level necessary to provide adequate liquidity and/or covenant compliance. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might result from this uncertainty.

See “Note 17 – Subsequent Event” for details regarding the forbearance agreements and the Term Sheets.

NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS

In August 2018, the FASB issued ASU2018-15,Intangibles – Goodwill andOther-Internal-Use Software.ASU2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtaininternal-use software. The standard is effective beginning January 1, 2020, with early adoption permitted and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We are currently assessing the impact this standard will have on our consolidated financial statements.

7

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 4 – CHANGE IN ACCOUNTING PRINCIPLE – REVENUE FROM CONTRACTS WITH CUSTOMERS

In the first quarter of 2018, the Company adopted ASUNo. 2014-09,“Revenue from Contracts with Customers.” Revenue is recognized upon the satisfaction of performance obligations, which occurs when control of the good or service transfers to the customer. Approximately 98% of the Company’s consolidated revenues are related to the sale of products. Under our standard contracts or purchase orders received from customers, the only performance obligation is the shipment of products. Revenue for products is recognized and the customer is invoiced when the control of the product transfers to the customer, which is generally when the product is shipped. The Company determines the time at which transfer and control of products has passed to its customers, and the time at which it is able to invoice the customers, based on review of contracts, sales agreements and purchase orders. Payment terms are generally established to be 30 days from the shipment date. We generally determine standalone selling prices based on the prices charged to customers for all material performance obligations.

The Company provides its customers an implicit right of return for full or partial refund. Prior to the adjustment for ASC 606, the Company reflected the right of return in accounts receivable. Under ASC 606, the Company has reclassified this right of return from accounts receivable into a combination of a refund liability, included within other accrued liabilities for the gross return or credit, and other current assets for the assumed value of the returned product.

Variable consideration is accounted for as a price adjustment (sales adjustment). Examples of variable consideration that affect the Company’s reported revenue include implicit rights of return and trade promotions.Implicit rights of return are typically contractually limited, amounts are estimable based upon historic return levels, and the Company records provisions for anticipated returns at the time revenue is recognized.Trade promotions are offered to cooperatives and end users through various programs, generally with terms of one year or less. Such promotions typically involve rebates based on annual purchases. Payment of incentives generally take the form of cash and are paid according to the terms of their agreement, typically within a year. Rebates are accrued as sales occur based on the program rebate rates.

Amounts billed to customers for shipping and handling are included in revenues when control of the goods and services transfers to the customer. Shipping and handling is arranged with third party carriers in connection with delivering goods to customers. Amounts billed to customers for sales tax are not included in revenues.

The Company typically does not have contracts with significant financing components as payments are generally received within 60 days from the time of completion of the performance obligations. Cost incurred to obtain contracts are settled within 12 months of contract inception. Our accounting policy under ASC 606 remains consistent with past accounting policy whereby such costs are expensed as incurred.

In the analysis of the revenue streams, the Company identified three areas for which the timing of revenue recognition did change.

1) Equipment and furniture revenue associated with projects was previously recognized upon the completion of the project, or at customer acceptance. Under ASC 606, the Company has determined that is has two performance obligations within the project revenue stream: a) the delivery of equipment or furniture and b) the installation of the equipment or the furniture. Installation services are not typically complex and can be performed by multiple providers. The furniture is functional without customization or modification. For equipment or furniture associated with projects, the Company determined that control of the equipment or furniture was transferred to the customer upon delivery of the equipment or furniture to the customer site as

8

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

the customer is in possession of the product at that time. The revenue attributable to the performance obligation associated with the delivery of the equipment or furniture is accelerated under the new revenue recognition standard and recognized upon delivery. The revenue attributable to installation is recognized over time during the installation process based on costs incurred relative to total expected installation costs. Under the contract terms, the customer is not billed for the equipment, furniture, or installation until the installation is complete. The Company allocates revenues to these two performance obligations using a cost plus margin approach, whereby gross margins are consistent for each component. These contracts represent the only contracts in which there are remaining performance obligations, which are fulfilled upon completion of the project.

2) Professional development or training days are provided to customers that order certain curriculum products of the Company, the most prominent of which is the FOSS product line. The Company bills for these training days at the same time the customer is billed for the product based on the stand-alone selling price. After the adoption of ASC 606, the Company is deferring revenue associated with providing training days and will recognize the cost associated with providing the training when the costs are incurred. These contracts represent the only contracts in which there are remaining performance obligations, which are fulfilled upon delivery of the professional development days.

3) Certain customer contracts specifically indicate that the customer obtains control of the product upon delivery. A review of contracts has identified certain contracts for which the language associated with control of the product is deemed to supersede invoice terms and conditions resulting in transfer of control upon receipt.

The Company also evaluated its catalog costs under the new revenue recognition standard and determined that its catalog costs should be treated as costs incurred to obtain contracts. Since catalog costs are incurred regardless of whether specific customer contracts or purchase orders are obtained, catalog costs are now expensed as incurred.

At the beginning of the third quarter of fiscal 2019, the Company’s opening contract asset balance was $8,649 and the opening contract liability balance was $5,414. At the end of the third quarter of fiscal 2019, the Company’s closing contract asset balance was $3,324 and the closing contract liability balance was $7,589. Revenue recognized during the three and nine months ended September 28, 2019 which was deferred, or a contract liability as of December 29, 2018 was $984 and $4,963, respectively.

The below table shows the Company’s disaggregated revenues for the three months and nine months ended September 28, 2019 and September 29, 2018.

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SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

	For the Three Months Ended						For the Nine Months Ended
	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018
Distribution revenues by product line:
Supplies	$	122,303		$	119,681		$	253,007		$	253,354
Furniture		97,960			99,646			174,797			175,951
Instruction & Intervention		19,955			21,993			45,089			48,851
AV Tech		3,962			3,680			12,133			12,046
Agendas		19,456			23,872			21,636			28,706
Freight Revenue		4,226			4,762			8,010			9,149
Customer Allowances / Discounts		(2,472	)		(2,689	)		(7,354	)		(6,717	)
Total Distribution Segment	$	265,390		$	270,945		$	507,318		$	521,340
Curriculum revenues by product line:
Science	$	13,122		$	19,335		$	27,735		$	37,499
Total Curriculum Segment	$	13,122		$	19,335		$	27,735		$	37,499
Total revenues	$	278,512		$	290,280		$	535,053		$	558,839

Revenues from the sale of products comprise the significant portion of revenues in all product categories in the above table. Except as described above, the product revenues associated with the above disaggregated revenues are recorded when control of goods or services are transferred to the customer. The Furniture category includes installation revenues that are recorded over time as installation services are incurred. The Instruction & Intervention category includes subscription revenues which are recognized over the subscription period, typically twelve months. All product categories are impacted by school budget funding.

NOTE 5 – CHANGE IN ACCOUNTING PRINCIPLE – LEASES

In the first quarter of 2019, the Company adopted ASUNo. 2016-02, “Leases.”ASUNo. 2016-02 requires lessees to recognize the assets and liabilities arising from leases on the balance sheet. The new guidance requires that all leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements.

Lease assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. Lease assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. These assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using the Company’s incremental borrowing rate (“IBR”). The rate implicit in each lease was not readily determinable, thus the Company used its IBR of 10.5%, which was comprised of LIBOR as of December 30, 2018 of 2.5% plus the applicable margin pursuant to the Company’s New Term Loan (as defined below), or 8.0%. Lease assets also include any upfront lease payments made and exclude lease incentives. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised.

The Company leases certain distribution centers, office space, and equipment. At lease inception, the Company determined the lease term by assuming the exercise of those renewal options that are reasonably assured. Leases with an initial term of 12 months or less are not recorded in the Condensed Consolidated Balance Sheets and the Company recognizes lease expense for these leases on a straight-line basis over the lease term and includes the lease expense in selling, general and administrative (“SG&A”) expense. As of December 30, 2018, the Company’s leases had remaining contractual terms up to 4 years, some of which include options to extend the leases for up to 10 years. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. None of the Company’s variable lease payments depend on a rate or an index; therefore, are expensed as incurred.

10

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Following this adoption, the Company made the following elections:

• The Company did not elect the hindsight practical expedient for all leases.

• The Company elected the package of practical expedients to not reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs for all leases.

• In March 2018, the FASB approved an optional transition method that allows companies to use the effective date as the date of initial application on transition. The Company elected this transition method, and as a result, will not adjust its comparative period financial information or make the newly required lease disclosures for periods before the effective date.

• The Company elected to make the accounting policy election for short-term leases resulting in lease payments not being recorded on the Company’s balance sheet.

• The Company elected to not separate lease andnon-lease components for all leases.

Based on the present value of the lease payments for the remaining lease term of the Company’s existing leases, the Company recognizedright-of-use assets of approximately $14,200 and lease liabilities for operating leases consisting of approximately $5,100 in current maturities and approximately $9,100 in long term maturities on December 30, 2018.

As of September 28, 2019, future maturities of operating lease liabilities were as follows (in thousands):

Fiscal 2019 (3 months remaining)	$	1,619
Fiscal 2020		5,460
Fiscal 2021		2,572
Fiscal 2022		1,789
Fiscal 2023		1,789
Thereafter		70
Total lease payments		13,299
Present value adjustment		(1,923	)
Operating lease liabilities		11,376

As of December 29, 2018, the future minimum lease payments under operating leases for the Company’s fiscal years are as follows (in thousands):

Fiscal 2019	$	5,449
Fiscal 2020		4,744
Fiscal 2021		2,275
Fiscal 2022		1,606
Fiscal 2023		1,577
Thereafter		122
Total minimum lease payments	$	15,773

As of September 28, 2019, our operating leases had a weighted-average remaining lease term of 35 months and a weighted-average discount rate of 10.5%. Cash paid for amounts included in the measurement of operating lease liabilities was $1,617 for the three months ended September 28, 2019 and $4,740 for the nine months ended September 28, 2019. Operating lease cost and short-term lease costs included in SG&A for the three months ended September 28, 2019 was approximately $1,936 and $0, respectively. Operating lease cost and short-term lease costs included in SG&A for the nine months ended September 28, 2019 was approximately $5,334 and $50, respectively. The Company had no financing leases as of September 28, 2019.

��

11

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 6 – INCOME TAXES

In fiscal 2018, the Company concluded that the realization of substantially all of its net deferred tax assets did not meet the more likely than not threshold. This conclusion was based primarily on a combination of fiscal 2018 operating performance, cumulativepre-tax net losses over the priorthirty-six months, and future forecasts of taxable income. Based on the Company’s performance in the first nine months of fiscal 2019, the Company’s conclusion regarding the more likely than not threshold did not change. The Company has Federal and state net operating losses totaling $16,696. These net operating losses cannot be carried back, but the Federal net operating loss can be carried forward indefinitely and the majority of the state net operating losses can be carried forward for 20 years. The Company’s accumulated unremitted earnings from foreign affiliates is expected to be repatriated to the parent entity before year end. The Company’s foreign affiliate intends to treat the repatriation as a return of capital. Accordingly, the distribution will not be subject to any Canadian withholding tax.

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 Company’s tax returns are no longer subject to examination by the U.S. for fiscal years before 2016. 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 Company’s financial position or results of operations.

The balance of the Company’s liability for unrecognized income tax benefits, net of federal tax benefits, at September 28, 2019, December 29, 2018, and September 29, 2018, was $1,043, $1,101, and $569, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any 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 condensed consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.

12

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 7 – EARNINGS PER SHARE

Earnings Per Share

The following information presents the Company’s 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 (loss) (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Three months ended September 28, 2019:
Basic EPS	$	17,864			7,025	$	2.54
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Effect of dilutive derivatives		—			1,257
Diluted EPS	$	17,864			8,282	$	2.16
Three months ended September 29, 2018:
Basic EPS	$	18,556			7,000	$	2.65
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			63
Basic and diluted EPS	$	18,556			7,063	$	2.63
	Income (loss) (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Nine months ended September 28, 2019:
Basic EPS	$	(12,967	)		7,013	$	(1.85	)
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Effect of dilutive derivatives		—			—
Basic and diluted EPS	$	(12,967	)		7,013	$	(1.85	)
Nine months ended September 29, 2018:
Basic EPS	$	(104	)		7,000	$	(0.01	)
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Basic and diluted EPS	$	(104	)		7,000	$	(0.01	)

The Company had weighted average stock options outstanding of 344 and 647 for the three months ended September 28, 2019 and September 29, 2018, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive. The Company had weighted average stock options outstanding of 394 and 690 for the nine months ended September 28, 2019 and September 29, 2018, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive.

The Company had weighted average restricted stock units outstanding of 93 and 111 for the three and nine month periods ended September 28, 2019, respectively. The Company had weighted average restricted stock units outstanding of 285 and 232 for the three and nine month periods ended September 29, 2018, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive.

Based on the Company’s current senior leverage ratio as of September 28, 2019, the maximum number of potential warrants that could be issued to our New Term Loan lender could be 1,257. These warrants were included in the computation of diluted EPS as of the three months ended September 28, 2019. The assumed warrants of 1,257, were not included in the computation of diluted EPS for the nine months ended September 28, 2019 because they were anti-dilutive. See Note 11 – Debt for additional information regarding the warrants.

13

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 8 – SHARE-BASED COMPENSATION EXPENSE

As of September 28, 2019, the Company had one share-based employee compensation plan: the School Specialty, Inc. 2014 Incentive Plan (the “2014 Plan”). The 2014 Plan was adopted by the Board of Directors on April 24, 2014 and approved on September 4, 2014 by the Company’s stockholders. On June 12, 2018, the Company’s stockholders approved an amendment to the 2014 Plan, which increased the number of shares available under the 2014 Plan by an additional 700 shares.

Options

On February 1, 2019, the 249 shares that were previously awarded to our former CEO were effectively cancelled upon his resignation. The Company did not grant stock option awards during the three and nine month periods ended September 28, 2019. On May 29, 2019 and September 13, 2019, 16 and 72 shares, respectively, were effectively cancelled upon the resignation of three employees.

A summary of option transactions for the nine months ended September 28, 2019 and September 29, 2018 were as follows:

	Options Outstanding					Options Exercisable
	Options			Weighted- Average Exercise Price		Options		Weighted- Average Exercise Price
Balance at December 29, 2018		622		$	18.57		428	$	18.57
Granted		—
Exercised		—
Canceled		(337	)		18.57
Balance at September 28, 2019		285		$	18.57		223	$	18.57
Balance at December 30, 2017		721		$	18.57		350	$	18.57
Granted		—
Exercised		—
Canceled		(77	)		18.57
Balance at September 29, 2018		644		$	18.57		405	$	18.57

The weighted average life remaining of the stock options outstanding as of September 28, 2019 was 6.1 years and as of September 29, 2018 was 6.6 years.

Restricted Stock Units

On June 18, 2018, the Compensation Committee granted an aggregate of 109 Restricted Stock Units (“RSUs”) under the Company’s 2014 Plan to members of the Company’s senior management, with an aggregate value of $19.38 per share. 94 of the 109 RSUs that were granted were still outstanding as of the end of fiscal 2018. The RSUs have time-based vesting provisions, withone-third of the RSUs vesting on each March 15 of 2019, 2020 and 2021. The 49 RSUs that were previously awarded to the former CEO were forfeited immediately upon his resignation on February 1, 2019. On March 15, 2019, 15 of the remaining RSUs vested for which the Company issued 10 shares of common stock to members of senior management and 5 shares were used to satisfy tax withholding requirements for such persons and are reflected as Treasury Stock on the condensed consolidated balance sheet. On September 13, 2019, 7 of the remaining outstanding RSUs were canceled. As of the end of the third quarter of 2019, 23 RSUs associated with this grant remain outstanding.

14

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Also, on June 18, 2018, the Compensation Committee granted an aggregate of 15 RSUs under the 2014 Plan to thenon-employee members of the Board of Directors, with an aggregate value of $19.38 per share. The RSUs have time-based vesting provisions and vested on June 18, 2019. The Company issued 15 shares of common stock to each of thenon-employee members of the Board of Directors.

On March 15, 2019, the Compensation Committee granted 3 RSUs under the 2014 Plan to thenon-employee director appointed to the Board of Directors on that date, with a fair value of $6.25 per share. These RSUs have time-based vesting conditions, and all of these RSUs vest on March 15, 2020. All of these RSUs remain outstanding as of September 28, 2019.

On June 6, 2019 the Compensation Committee granted 45 RSUs under the 2014 Plan to members of the Company’s senior management, with a fair value of $5.55 per share. The RSUs have time-based vesting provisions, withone-third of the RSUs vesting on each March 15 of 2020, 2021 and 2022. On September 13, 2019, 10 of the remaining outstanding RSUs were canceled, and 35 RSUs associated with this grant remained outstanding.

Also, on June 6, 2019, the Compensation Committee granted 19 RSUs under the 2014 Plan to thenon-employee members of the Board of Directors, with a fair value of $5.55 per share. The RSUs have time-based vesting provisions, with all of the RSUs vesting on June 6, 2020. On September 24, 2019, 4 of the outstanding RSUs were canceled, and 15 RSUs associated with this grant remained outstanding.

On September 24, 2019, the Compensation Committee granted 4 RSUs under the 2014 Plan to thenon-employee director appointed to the Board of Directors on that date, with a fair value of $2.00 per share. These RSUs have time-based vesting conditions, and all of the RSUs vest on September 24, 2020. All of these RSUs remain outstanding as of September 28, 2019.

On March 23, 2016, the Compensation Committee of the Board of Directors of the Company granted an aggregate of 196 RSUs under the Company’s 2014 Plan to members of the Company’s senior management. 23 of the 196 RSUs were cancelled in fiscal 2018 in connection with the end of an executive’s employment. The RSUs were performance-based. A certain percentage of the RSUs were scheduled to vest on the third anniversary of the date of grant, with such percentage based on the 15 day Volume Weighted Average Price (“VWAP”) of the Company’s common stock prior to the vesting date. The percentage of RSUs that were scheduled to vest was determined as follows:

Vesting %	15 Day VWAP
0%	VWAP less than $15.43
20%	VWAP greater than or equal to $15.43, but less than $16.86
40%	VWAP greater than or equal to $16.86, but less than $18.29
60%	VWAP greater than or equal to $18.29, but less than $19.71
80%	VWAP greater than or equal to $19.71, but less than $21.14
100%	VWAP greater than or equal to $21.14

Due to the nature of the vesting conditions of the RSUs, a valuation methodology was needed to incorporate potential equity value paths for the Company. As such, the fair value of the RSU grants was determined under a Monte Carlo approach with a simulation of the Company’s stock price to a date that was 15 trading days prior to the vesting date. A large number of trials were run under the Monte Carlo approach to ensure an adequate sampling of different potential scenarios was achieved. Based on this approach, the fair value of the RSUs granted on March 23, 2016 was $11.55 per share. Any RSUs that vested would have been settled in shares of Company common stock. The 114 RSUs that were previously awarded to the former CEO were forfeited immediately upon his resignation on February 1, 2019. As of March 23, 2019, the VWAP was determined to be less than $15.43 and as a result, all of the remaining RSUs from the March 23, 2016 grant did not vest and were canceled.

15

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Stock Appreciation Rights

On May 28, 2014, the Board granted 39 stock appreciation rights (“SARs”) to each of thenon-employee members of the Board under the 2014 Plan. On September 28, 2015, the Board granted 39 SARs to each of the two new non-employee members of the Board. On January 17, 2018, the Board granted 39 SARs to its newnon-employee member of the Board. Each SAR has a grant date value of $18.57 and will be settled in cash upon exercise. As such, the SARs are accounted for as liability awards. As the Company’s stock trading price was less than each SAR’s exercise price as of September 29, 2018, expense of $99 recorded for the SARs during the three months ended September 29, 2018 was effectively reversed as of September 29, 2018 based on the trading price of the stock on that date. The SARs vested or will vest as toone-half of the SARs on the second anniversary of the date of grant and vested or will vest as toone-fourth of the SARs on each of the third and fourth anniversaries of the date of grant. In the second quarter of 2018, 39 of the outstanding SARs were exercised by a member of the Board and $31 of expense was recognized. Total SARs that remain outstanding as of September 28, 2019 are 154.

The following table presents the share-based compensation recognized for the three and nine month periods ended September 28, 2019 and September 29, 2018:

	For the Three Months Ended
	September 28, 2019						September 29, 2018
	Gross			Net of Tax			Gross			Net of Tax
Stock Options	$	54		$	54		$	(154	)	$	(116	)
SARs		—			—			(99	)		(74	)
RSUs		64			64			234			176
Total stock-based compensation	$	118					$	(19	)
	For the Nine Months Ended
	September 28, 2019						September 29, 2018
	Gross			Net of Tax			Gross			Net of Tax
Stock Options	$	216		$	216		$	497		$	373
SARs		—			—			32			24
RSUs		(987	)		(987	)		649			487
Total stock-based compensation	$	(771	)				$	1,178

The stock-based compensation expense is reflected in selling, general and administrative (“SG&A”) expenses in the accompanying condensed consolidated statements of operations. The Company records actual forfeitures in the period the forfeiture occurs. During the three and nine month periods ended September 28, 2019, 72 stock options and 24 RSUs were forfeited and 337 stock options and 187 RSUs were forfeited, respectively. Since the Company recognizes stock-based compensation expense ratably over the vesting period of each award, the forfeitures of unvested awards resulted in negative stock-based compensation expense during the nine month period. Stock-based compensation expense associated with stock options and RSUs arenon-cash expenses which are recorded to additional paid in capital. Stock-based compensation expense associated with SARs must be cash-settled and is recorded to other accrued liabilities until settled.

The total unrecognized share-based compensation expense as of September 28, 2019 and September 29, 2018 was as follows:

	September 28, 2019		September 29, 2018
Stock Options, net of actual forfeitures	$	463	$	1,323
SARs		—		—
RSUs		565		2,162

16

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 9 – GOODWILL AND OTHER INTANGIBLE ASSETS

The following tables present details of the Company’s intangible assets, including the estimated useful lives, excluding goodwill:

September 28, 2019	Gross Value		Accumulated Amortization			Net Book Value
Amortizable intangible assets:
Customer relationships(10-13 years)	$	13,294	$	(5,937	)	$	7,357
Publishing rights (20 years)		4,000		(1,267	)		2,733
Trademarks (20 years)		26,587		(7,883	)		18,704
Developed technology (7 years)		6,600		(5,971	)		629
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(1,200	)		—
Favorable leasehold interests (10 years)		2,160		(1,368	)		792
Total intangible assets	$	58,241	$	(28,026	)	$	30,215
December 29, 2018	Gross Value		Accumulated Amortization			Net Book Value
Amortizable intangible assets:
Customer relationships(10-13 years)	$	13,294	$	(5,136	)	$	8,158
Publishing rights (20 years)		4,000		(1,117	)		2,883
Trademarks (20 years)		26,587		(6,612	)		19,975
Developed technology (7 years)		6,600		(5,264	)		1,336
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(1,200	)		—
Favorable leasehold interests (10 years)		2,160		(1,206	)		954
Total intangible assets	$	58,241	$	(24,935	)	$	33,306
September 29, 2018	Gross Value		Accumulated Amortization			Net Book Value
Amortizable intangible assets:
Customer relationships(10-13 years)	$	13,294	$	(4,868	)	$	8,426
Publishing rights (20 years)		4,000		(1,067	)		2,933
Trademarks (20 years)		26,587		(6,280	)		20,307
Developed technology (7 years)		6,600		(5,029	)		1,571
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(1,200	)		—
Favorable leasehold interests (10 years)		2,160		(1,152	)		1,008
Total intangible assets	$	58,241	$	(23,996	)	$	34,245

Intangible asset amortization expense was included in selling, general and administrative (“SG&A”) expense. Intangible asset amortization expense for the three month periods ended September 28, 2019 and September 29, 2018, was $935 and $939, respectively. Intangible asset amortization expense for the nine month periods ended September 28, 2019 and September 29, 2018, was $2,808 and $2,918, respectively. The Company recorded anon-cash impairment charge of $283 for the three months ended March 30, 2019 related to the discontinuation of a licensed product tradename previously recorded in the Distribution segment.

Intangible asset amortization expense for each of the five succeeding fiscal years is expected to be as follows:

17

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Fiscal 2019 (3 months remaining)	$	934
Fiscal 2020		3,187
Fiscal 2021		2,794
Fiscal 2022		2,794
Fiscal 2023		2,668
Fiscal 2024		2,578

The table below shows the allocation of the recorded goodwill as of September 28, 2019 and September 29, 2018 for both the reporting units and reporting segments.

	Distribution Segment		Curriculum Segment		Total
Goodwill	$	—	$	—	$	—
Balance at September 28, 2019	$	—	$	—	$	—
Goodwill	$	—	$	4,580	$	4,580
Balance at December 29, 2018	$	—	$	4,580	$	4,580
Goodwill	$	22,262	$	4,580	$	26,842
Balance at September 29, 2018	$	22,262	$	4,580	$	26,842

Typically, the Company tests its goodwill balance for impairment on an annual basis as of the end of December each year. The Company concluded that the third quarter 2019 forbearance agreements and terms of the proposed amendments to the Company’s senior secured loans reflected in the Term Sheets, along with the reduction in the trading price of the Company’s common stock, resulted in a reconsideration event that required the Company to reperform its goodwill impairment test as of the end of the third quarter of fiscal 2019. The Company determined the fair value of the reporting unit by utilizing a combination of the income approach (weighted 90%) and the market approach (weighted 10%) derived from comparable public companies. In completing the assessment, the fair value of the Science reporting unit indicated an impairment of goodwill of approximately $4.6 million. Indicators of impairment that were identified during the assessment were delayed recovery in the Science curriculum spend, increased competition and timing shifts into fiscal 2020 with the California adoption. Assumptions utilized in the impairment analysis are subject to significant management judgment. Changes in estimates or the application of alternative assumptions could have produced significantly different results.

The long-lived assets and definite-lived intangible assets of the reporting unit were tested for impairment before completing the goodwill impairment test in accordance with the accounting standard. No impairment of the long-lived assets was evident.

NOTE 10 – PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

	September 28, 2019			December 29, 2018			September 29, 2018
Projects in progress	$	2,454		$	3,768		$	3,513
Buildings and leasehold improvements		2,907			2,876			2,971
Furniture, fixtures and other		75,908			68,285			67,015
Machinery and warehouse equipment		15,195			14,903			14,894
Total property, plant and equipment		96,464			89,832			88,393
Less: Accumulated depreciation		(66,967	)		(57,930	)		(56,661	)
Net property, plant and equipment	$	29,497		$	31,902		$	31,732

Depreciation expense for the three and nine month periods ended September 28, 2019 and September 29, 2018 was $3,671 and $3,275 and $10,310 and $10,689, respectively.

For the three months ended September 28, 2019, $3,620 of depreciation expense was recorded as SG&A expense and $51 of depreciation expense was categorized as cost of revenues. For the three months ended September 29, 2018, $3,224 of depreciation expense was recorded as SG&A expense and $51 of depreciation expense was categorized as cost of revenues.

18

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

For the nine months ended September 28, 2019, $10,155 of depreciation expense was recorded as SG&A expense and $155 of depreciation expense was categorized as cost of revenues. For the nine months ended September 29, 2018, $10,561 of depreciation expense was recorded as SG&A expense and $128 of depreciation expense was categorized as cost of revenues.

Typically, the Company tests its long-lived assets for impairment on an annual basis as of the end of December each year if and when a reconsideration event indicates that the carrying value of the non-current assets may not be recoverable. The Company concluded that the third quarter 2019 forbearance agreements and terms of the proposed debt amendments to the Company’s senior secured loans reflected in the Term Sheets, along with the reduction in the trading price of the Company’s common stock, resulted in a reconsideration event that required the Company to perform its long-lived asset impairment test as of the end of the third quarter of fiscal 2019. Based on the Company’s impairment test, it concluded that there was not an impairment. Assumptions utilized in the impairment analysis are subject to significant management judgment. Changes in estimates or the application of alternative assumptions could have produced significantly different results.

NOTE 11 – DEBT

Long-term debt consisted of the following:

	September 28, 2019			December 29, 2018			September 29, 2018
ABL Facility, maturing in 2022	$	69,000		$	—		$	85,800
New Term Loan, maturing in 2022		108,417			111,725			111,725
Unamortized New Term Loan Debt Issuance Costs		(5,122	)		(2,799	)		(2,702	)
Deferred Cash Payment Obligations, maturing in 2019		26,773			25,009			24,457
Total debt		199,068			133,935			219,280
Less: Current maturities		(199,068	)		(30,352	)		(90,450	)
Total long-term debt	$	—		$	103,583		$	128,830

As of September 28, 2019, the outstanding balance on the New Term Loan Credit Agreement was $108,417. The Company has classified the full amount of the outstanding New Term Loan balances as currently maturing, long-term debt in the accompanying condensed consolidated balance sheets due to its non-compliance with certain financial covenants as of the end of the third quarter of fiscal 2019 and the short-term nature of the forbearance granted by the New Term Loan Lenders and ABL Lenders with respect to this non-compliance. As of September 29, 2018, the outstanding balance on the New Term Loan Credit Agreement was $111,725. Of this amount, $4,650 was reflected as currently maturing, long-term debt in the accompanying condensed consolidated balance sheets.

For additional details, see “Subsequent Events.”

ABL Facility

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

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 $175,000. On August 7, 2015, the aggregate commitments were permanently reduced, at the election of the Company, by $50,000, from $175,000 to $125,000.

Outstanding amounts under the ABL Facility bear interest at a rate per annum equal to, at the Company’s election: (1) a base rate (equal to the greatest of (a) the prime lending rate, (b) the federal funds rate plus 0.50%, and (c) the30-day LIBOR rate plus 1.00% per annum) (the “Base Rate”) plus an applicable margin (equal to a specified margin based on the interest rate elected by the Company, the fixed charge coverage ratio under the ABL Facility and the applicable point in the life of the ABL Facility (the “Applicable Margin”)), or (2) a LIBOR rate plus the Applicable Margin (the “LIBOR Rate”). Interest on loans under the ABL Facility bearing interest based upon the Base Rate will be due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate will be due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.

19

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

In November 2014, the Company amended the ABL Facility. The main purpose for the amendment was to provide the Company additional flexibility in its execution of certain restructuring actions by increasing the cap on the amount that may be added back under the definition of earnings before interest, taxes, depreciation, and amortization (“EBITDA”) fornon-recurring, unusual or extraordinary charges, business optimization expenses or other restructuring charges or reserves and cash expenses relating to earn outs or similar obligations.

In September 2015, the Company amended the ABL Facility. The main purposes for the amendment were to reduce the Applicable Margin for base rate and LIBOR loans, reduce the unused line fee rate and extend the scheduled maturity date. As amended, the maturity date was extended to September 16, 2020, which would have automatically become March 12, 2019 unless the Company’s term loan facility had been repaid, refinanced, redeemed, exchanged or amended prior to such date, in the case of any refinancing or amendment, to a date that was at least 90 days after the scheduled maturity date. In addition, the amendment provided for the withdrawal of Sun Trust Bank as a lender and the assumption of its commitments by the remaining lenders.

On April 7, 2017, the Company executed the Third Amendment to its ABL Facility (the “Third Amendment”). The ABL Amendment provided a new lower pricing tier of LIBOR plus 125 basis points, a seasonal increase in the borrowing base of 5.0% of eligible accounts receivable for the months of March through August, and the inclusion of certain inventory in the borrowing base, which previously had been excluded. Additionally, certain conforming changes were made in connection with the entry into the New Term Loan Agreement (as defined below). The Third Amendment extended the maturity of the ABL Facility, as amended, to April 7, 2022 (“ABL Termination Date”), provided that the ABL Termination Date will automatically become February 7, 2022 unless the New Term Loan (as defined below) has been repaid, prepaid, refinanced, redeemed, exchanged, amended or otherwise defeased or discharged prior to such date.

On August 9, 2018, the Company entered into the Fourth Amendment to the ABL Facility (the “Fourth Amendment”) in order to: (1) update the definition of “Change of Control” set forth in the ABL Facility, and (2) update the definition of “Specified Unsecured Prepetition Debt” and associated provisions set forth in the ABL Facility. The Fourth Amendment deletes the reference to “35%” in the “Change of Control” definition and inserts “50%” in its place. The Company amended this provision of the ABL Facility in order to ensure certain shareholders with large positions did not put the Company in violation of the terms within its loan agreements. The ABL Facility also amended and restated the definition “Specified Unsecured Prepetition Debt” in order to increase the cap on amounts prepaid because the original cap set forth therein was less than the amount due at maturity due to the fiscal 2017 revised interpretation of the interest calculation methodology pursuant to the bankruptcy Reorganization Plan (as defined in the ABL Facility).

On November 7, 2018, the Company entered into a Fifth Amendment to the ABL Facility (the “Fifth Amendment”) with its Asset-Based Lenders, effective as of September 29, 2018. The Sixth Amendment was entered into in order to: (1) give effect to ASUNo. 2014-09 for the purpose of the computation of any financial covenant retroactive to December 31, 2017 and for all other purposes effective as of the date of the ABL Amendment, and (2) substitute the LIBOR Screen Rate (as defined in the ABL Amendment) with the LIBOR Successor Rate (as defined in the ABL Amendment) in the event that the LIBOR Screen Rate is not available or published on a current basis, it was announced that LIBOR or LIBOR Screen Rate will no longer be made available or a new benchmark interest rate has been adopted to replace LIBOR.

On March 13, 2019, and effective as of December 29, 2018, the Company entered into a Sixth Amendment to the ABL Facility with its Asset-Based Lenders in order to, among other things: (1) amend the cap onadd-backs fornon-recurring, unusual or extraordinary charges, business optimization expenses and other restructuring charges or reserves and cash expenses relating to earn outs and similar obligations in definition of EBITDA; (2) amend the calculation of the net

20

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

senior leverage ratio; (3) limit the aggregate amount of outstanding revolving loans to no more than $10,000 on the last Saturday of fiscal year 2019 and each day during a twenty consecutive day period that includes the last Saturday of fiscal year 2019 if a junior capital raise event has not occurred, or $0 on the last Saturday of fiscal year 2019 and each day during a thirty-five consecutive day period that includes the last Saturday of fiscal year 2019 if a junior capital raise event has occurred; (4) expand the definition of permitted indebtedness to include subordinated debt in an aggregate principal amount not to exceed $30,000 the proceeds of which have been used, first, to repay the deferred cash payment obligations, and second, to the extent the deferred cash payment obligations have been repaid in full, to repay the New Term Loan; and (5) condition the repayment of indebtedness with junior capital proceeds upon satisfaction of the payment conditions and requiring the deferred cash payment obligations to be repaid in full before junior capital proceeds may be applied to the repayment of other indebtedness.

Pursuant to an Amended and Restated Guarantee and Collateral Agreement dated as of April 7, 2017 (the “ABL Security Agreement”), the Loan Agreement is secured by a first priority security interest in substantially all assets of the Company and the subsidiary borrowers. Under the New Intercreditor Agreement (as defined below), the ABL Lenders have a first priority security interest in substantially all working capital assets of the Company and the subsidiary borrowers, and a second priority security interest in all other assets, subordinate only to the first priority security interest of the New Term Loan Lenders (as defined below) in such other assets.

The effective interest rate under the ABL Facility for the three months ended September 28, 2019 was 5.0%, which includes interest on borrowings of $948, amortization of loan origination fees of $118 and commitment fees on unborrowed funds of $24. The effective interest rate under the ABL Facility for the three months ended September 29, 2018 was 4.8%, which includes interest on borrowings of $932, amortization of loan origination fees of $104 and commitment fees on unborrowed funds of $28.

The effective interest rate under the ABL Facility for the nine months ended September 28, 2019 was 5.8%, which includes interest on borrowings of $1,877, amortization of loan origination fees of $371 and commitment fees on unborrowed funds of $183. The effective interest rate under the ABL Facility for the nine months ended September 29, 2018 was 5.5%, which includes interest on borrowings of $1,470, amortization of loan origination fees of $312 and commitment fees on unborrowed funds of $209.

As of September 28, 2019, the outstanding balance on the ABL Facility was $69,000. As of September 29, 2018, the outstanding balance on the ABL Facility was $85,800. The Company has estimated that the fair value of its ABL Facility (valued under level 3) as of September 28, 2019 approximated the carrying value of $69,000.

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

The Asset-Based Credit Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to a springing financial covenant relating to the Company’s fixed charge coverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments.

The Company entered into a forbearance agreement and a non-binding term sheet relating to an amendment to the ABL Facility subsequent to September 28, 2019. See “Subsequent Events.”

New Term Loan

On April 7, 2017, the Company entered into a Loan Agreement (the “New Term Loan Agreement”) among the Company, as borrower, certain of its subsidiaries, as guarantors, the financial parties party thereto, as lenders (the “New Term Loan Lenders”) and TCW Asset Management Company LLC, as the agent (the “New Term Loan Agent”) .

21

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Under the New Term Loan Agreement, the Term Loan Lenders agreed to make a term loan (the “New Term Loan”) to the Company in aggregate principal amount of $140,000. The initial draw on the New Term Loan at closing was $110,000. These proceeds, along with proceeds received from a draw on the ABL Facility (as defined below), were used to repay the Term Loan which had a remaining principal balance including accrued interest of $118,167. The New Term Loan Agreement provided for a delayed draw feature that allowed the Company to draw up to an additional $30,000 through April 7, 2019. The ability to access the delayed draw commitment was subject to compliance with certain terms and conditions. The proceeds from the delayed draw could be used to fund distributions, permitted acquisitions, and repayments of existing indebtedness. In the third quarter of fiscal 2017, the Company drew $14,000 under the delayed draw term loan feature in conjunction with the Triumph Learning acquisition. At the Company’s option, the New Term Loan interest rate was to be either the prime rate or the LIBOR rate (with a LIBOR floor of 1.0%), plus an applicable margin based on the Company’s net senior leverage ratio. The Company may specify the interest rate period of one, three or six months for interest on loans under the New Term Loan Agreement bearing interest based on the LIBOR rate.

The New Term Loan matures on April 7, 2022. The New Term Loan required scheduled quarterly principal payments of 0.625% of the original principal amount which commenced June 30, 2017 and continued through the quarter ended March 31, 2019. Subsequent to March 31, 2019, the scheduled quarterly principal payments were 1.250% of the original principal amount. Required scheduled quarterly principal payments on borrowings under the delayed-draw feature began in the quarter following the draw on this feature. In addition to scheduled quarterly principal repayments, the New Term Loan Agreement requires prepayments at specified levels upon the Company’s receipt of net proceeds from certain events, including but not limited to certain asset dispositions, extraordinary receipts, and the issuance or sale of any indebtedness or equity interests (other than permitted issuances or sales). The New Term Loan Agreement also requires prepayments at specified levels from the Company’s excess cash flow. In the first quarter of fiscal 2019, the Company made a $951 repayment of principal based on fiscal 2018 excess cash flow. The Company was also permitted to voluntarily prepay the New Term Loan in whole or in part. Voluntary prepayments made before April 7, 2018 were subject to an early prepayment fee of 2.0%, while any voluntary prepayment made on or after April 7, 2018, but before April 7, 2019, were subject to a 1.0% early prepayment fee. Voluntary prepayments made on or after April 7, 2019 were not be subject to an early payment fee. All prepayments of the loans will be applied first to that portion of the loans comprised of prime rate loans and then to that portion of loans comprised of LIBOR rate loans. The New Term Loan Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants commencing with the fiscal quarter ending September 30, 2017 relating to the Company’s fixed charge coverage ratio and net senior leverage ratio, and an annual limitation on capital expenditures and product development investments, collectively.

On August 9, 2018, the Company entered into the First Amendment (the “First Term Loan Amendment”) of its New Term Loan Agreement dated April 7, 2017 in order to: (1) update the definition of “Change of Control” set forth in the New Term Loan Agreement, and (2) update the definition of “Specified Unsecured Prepetition Debt” and associated provisions set forth in the New Term Loan Agreement. The First Term Loan Amendment deletes the reference to “35%” in the “Change of Control” definition and inserts “50%” in its place. The Company amended this provision of the New Term Loan Agreement in order to accommodate certain shareholders of the Company with large positions. The New Term Loan Agreement also amended and restated the definition “Specified Unsecured Prepetition Debt” in order to increase the cap on amounts prepaid because the original cap set forth therein was less than the amount due at maturity due to the fiscal 2017 revised interpretation of the interest calculation methodology pursuant to the bankruptcy Reorganization Plan (as defined in the New Term Loan Agreement).

On November 7, 2018, the Company entered into a Second Amendment to the New Term Loan Agreement (the “Second Term Loan Amendment”) with its New Term Loan Lenders, each effective as of September 29, 2018. The Second Term Loan Amendment was entered into in order to (1) reduce its fixed charge coverage ratio for the five fiscal quarters ending December 29, 2018 through December 28, 2019, (2) reduce the number of days for fiscal 2018 during which the Company may have no revolving loans outstanding from 60 to 14 and adjust the time period of such reduction to be between December 15, 2018 and January 31, 2019, (3) to give effect to ASU2014-09 for the purpose of the computation of any financial covenant retroactive to December 31, 2017 and for all other purposes

22

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

effective as of the date of the Second Term Loan Amendment, (4) change the delayed draw term loan commitment termination date from April 7, 2019 to the effective date of the Second Term Loan Amendment and (5) provide that the Applicable Margin shall assume a net senior leverage ratio of greater than 3.75x from the date of the Second Term Loan Amendment until the Company delivers its financial statements for fiscal 2018 and the related compliance certificate.

On March 13, 2019, and effective as of December 29, 2018, the Company entered into the Third Amendment (the “Third Term Loan Amendment”) of its New Term Loan Agreement in order to, among other things: (1) increase the applicable margin based on the net senior leverage ratio and to further increase the applicable margin by a PIK interest rate which will be subject to adjustment based on the net senior leverage ratio; (2) provide the Agent with certain board observation rights; (3) limit the aggregate amount of outstanding revolving loans to no more than $10,000 on the last Saturday of fiscal year 2019 and each day during a twenty consecutive day period that includes the last Saturday of fiscal year 2019 if the Company has not raised $25,000 in junior capital proceeds, the proceeds of which were used in the manner specified in the New Term Loan Amendment, or $0 on the last Saturday of fiscal year 2019 and each day during a thirty-five consecutive day period that includes the last Saturday of fiscal year 2019 if a junior capital raise event has occurred; (4) reduce the limit on capital expenditures to $12,500 in the aggregate for the four fiscal quarters ending March 30, 2019, September 28, 2019, and September 28, 2019 and $10,000 in the aggregate for the four fiscal quarters ending December 28, 2019; (5) remove the obligation to comply with the net senior leverage ratio and fixed charge coverage ratio financial covenants for the fiscal year ended December 29, 2018; (6) amend the calculation of the fixed charge coverage ratio and reduce the fixed charge coverage ratio for the remainder of the term of the New Term Loan Agreement; (7) amend the calculation of the net senior leverage ratio and increase the net senior leverage ratio for the remainder of the term of the New Term Loan Agreement, which may be adjusted upon a junior capital raise satisfaction event; (8) amend the cap onadd-backs fornon-recurring, unusual or extraordinary charges, business optimization expenses and other restructuring charges or reserves and cash expenses relating to earn outs and similar obligations in the definition of EBITDA and require the Company to maintain a minimum EBITDA for the remainder of the term of the New Term Loan Agreement, which may be adjusted upon a junior capital raise satisfaction event; (9) require the Company to maintain specified availability under the ABL Agreement in an amount not less than the greater of $12,500 or 10% of the commitments (as defined in the ABL Agreement); (10) expand the definition of permitted indebtedness to include subordinated debt used to repay the New Term Loan or the deferred cash payment obligations; and (11) provide for additional inspection and audit rights to be conducted by an advisory firm to be appointed by the Agent.

In connection with the Third Term Loan Amendment, the Company separately agreed that, commencing with the Fiscal Month ending September 28, 2019, to the extent the payment in full in cash of the Obligations has not occurred on or prior to any such date, the Company shall deliver to the Agent, in form and substance reasonably satisfactory to the Agent, on or prior to the date that is 30 days following the last day of each Fiscal Month (but within 60 days after the last month in a fiscal year), warrants to purchase, for a price of $0.001 per share, the Designated Percentage of the outstanding common stock of the Company, with such warrants earned in full and vesting immediately on the date of issuance; provided that the aggregate number of warrants delivered to the Agent shall not exceed warrants to purchase more than 18% of the outstanding common stock of the Company in the aggregate. “Designated Percentage” means, with respect to each Fiscal Month, (x) if the financial statements delivered pursuant to the New Term Loan Agreement with respect to such fiscal month demonstrate that the net senior leverage ratio for the twelve consecutive fiscal month period is greater than or equal to 5.00:1.0, 2%, (y) if the financial statements delivered pursuant to the New Term Loan Agreement with respect to such fiscal month demonstrate that the net senior leverage ratio for the twelve consecutive fiscal month period is greater than or equal to 4.2:1.0 but less than 5.00:1.0, 1% and (z) if the financial statements delivered pursuant to the New Term Loan Agreement with respect to such fiscal month demonstrate that the net senior leverage ratio for the twelve consecutive fiscal month period is less than 4.20:1.0, 0%. Notwithstanding the foregoing, no warrants issued shall be exercisable until the date by which the Company is required to deliver the financial statements with respect to the fiscal year ending December 28, 2019.

If, on or prior to the 2019 financial delivery date, (i) the New Term Loan obligations were paid in full in cash, (ii) the junior capital raise satisfaction event had occurred or (iii) the financial statements delivered pursuant to the New Term Loan Agreement with respect to the Fiscal Year ending December 28, 2019 demonstrated that, after giving effect to the payment of the deferred cash payment obligations, the net senior leverage ratio for the four consecutive fiscal quarter

23

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

periods ending on December 28, 2019 was less than or equal to 4.00:1.0 and EBITDA for the four consecutive fiscal quarter periods ending on December 31, 2019 was at least $42,000, the Company would have the right to buy back, for a price of $0.001 per warrant, 50% of the amount of any third amendment warrants outstanding prior to such buy back event.

The Company accounted for the obligation to issue the warrants as a derivative that is bifurcated from the New Term Loan. This accounting treatment resulted in the Company recording a liability in the amount of $1,228 within other liabilities based on a valuation of the derivative completed in the second quarter of fiscal 2019. This liability was offset by issuance costs classified as a debt discount, also be recorded within long-term debt. The liability is marked to market each quarter the derivative is outstanding. During the second quarter of fiscal 2019, the Company recorded anon-cash charge of $1,320 as a change in fair value, of which $238 was recorded in the third quarter of 2019. The derivative was valued at $2,548 as of the end of the third quarter of fiscal 2019. The amortization of the issuance costs associated with the derivative is charged to interest expense on a quarterly basis asnon-cash interest, which amounted to $98 and $194 for the three and nine months ended September 28, 2019.

The Company has estimated that the fair value of these warrants (valued under Level 3) approximates $2,425 as of September 28, 2019. The Company estimated the fair value for its warrants based upon the net present value of future cash flows using the discount rate that is consistent with our New Term Loan. The warrants were valued using the Monte Carlo Simulation Model using the Company’s monthly projections of its senior leverage ratio over the life of the warrants. Changes in the inputs may result in a significantly higher or lower fair value measurement.

Pursuant to a Guarantee and Collateral Agreement dated as of April 7, 2017 (the “New Term Loan Security Agreement”), the New Term Loan is secured by a first priority security interest in substantially all assets of the Company and the subsidiary guarantors. Under an intercreditor agreement (the “New Intercreditor Agreement”) between the New Term Loan Lenders and the ABL Lenders, the New Term Loan Lenders have a second priority security interest in substantially all working capital assets of the Company and the subsidiary guarantors, subordinate only to the first priority security interest of the ABL Lenders in such assets, and a first priority security interest in all other assets.

The effective interest rate under the New Term Loan for the three months ended September 28, 2019 was 13.3%, which includes interest on borrowings of $3,161 and amortization of loan origination fees of $488. The effective interest rate under the New Term Loan for the three months ended September 29, 2018 was 8.9%, which includes interest on borrowings of $2,362 and amortization of loan origination fees of $183.

The effective interest rate under the New Term Loan for the nine months ended September 28, 2019 was 12.9%, which includes interest on borrowings of $9,566 and amortization of loan origination fees of $1,161. The effective interest rate under the New Term Loan for the nine months ended September 29, 2018 was 8.7%, which includes interest on borrowings of $7,102 and amortization of loan origination fees of $541.

The Company entered into a forbearance agreement and a non-binding term sheet relating to an amendment to the New Term Loan subsequent to September 28, 2019. See “Subsequent Events.”

Deferred Cash Payment Obligations

In connection with the previously disclosed 2013 Reorganization Plan, general unsecured creditors are entitled to receive a deferred cash payment obligation of 20% of the allowed claim in full settlement of the allowed unsecured claims. Such payment accrues quarterlypaid-in-kind interest of 5% per annum beginning on the Effective Date.

Trade unsecured creditors had the ability to make a trade election to provide agreed upon customary trade terms. If the election was made, those unsecured trade creditors received a deferred cash payment obligation of 45% of the allowed claim in full settlement of those claims. As of the Effective Date, the deferred payment obligations under the trade elections began to accrue quarterlypaid-in-kind interest of 10% per annum. All deferred cash payment obligations, along with interestpaid-in-kind, are payable on December 12, 2019. As such, these obligations have been classified as current maturities of long-term debt. As discussed in Note 2 Going concern, the Company’s ability to pay these obligations on the maturity date is limited. Due to the Company’s non-compliance with certain financial covenants in its ABL and New Term Loan facilities, the Company is having ongoing discussions with certain holders of the deferred cash payment obligations to, among other things, extend the maturity date of these obligations.

24

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

The Company’s reconciliation of general unsecured claims was completed in fiscal 2015. As of September 28, 2019, the Company’s deferred payment obligations were $26,773, of which $3,094 represents a 20% recovery for the general unsecured creditors and $12,095 represents a 45% recovery for those creditors who elected to provide the Company standard trade terms with the remaining $11,584 related to accruedpaid-in-kind interest.

The Company has estimated that the fair value of its Deferred Cash Payment Obligations (valued under Level 3) approximates $26,674 as of September 28, 2019. The Company estimated the fair value for its Deferred Cash Payment Obligations based upon the net present value of future cash flows using the discount rate that is consistent with our New Term Loan.

NOTE 12 – CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Changes in accumulated other comprehensive loss during the nine months ended September 28, 2019 and September 29, 2018 were as follows:

	Foreign Currency Translation
Accumulated Other Comprehensive Income (Loss) at December 29, 2018	$	(2,079	)
Other comprehensive income (loss) before reclassifications		133
Accumulated Other Comprehensive Income (Loss) at March 30, 2019	$	(1,946	)
Other comprehensive income (loss) before reclassifications		125
Accumulated Other Comprehensive Income (Loss) at June 29, 2019	$	(1,821	)
Other comprehensive income (loss) before reclassifications		(81	)
Accumulated Other Comprehensive Income (Loss) at September 28, 2019	$	(1,902	)
	Foreign Currency Translation
Accumulated Other Comprehensive Income (Loss) at December 30, 2017	$	(1,425	)
Other comprehensive income (loss) before reclassifications		(236	)
Accumulated Other Comprehensive Income (Loss) at March 31, 2018	$	(1,661	)
Other comprehensive income (loss) before reclassifications		(171	)
Accumulated Other Comprehensive Income (Loss) at June 30, 2018	$	(1,832	)
Other comprehensive income (loss) before reclassifications		112
Accumulated Other Comprehensive Income (Loss) at September 29, 2018	$	(1,720	)

NOTE 13 – RESTRUCTURING

In the three and nine months ended September 28, 2019 and September 29, 2018, the Company recorded restructuring costs associated with severance related to staffing reductions. The following is a reconciliation of accrued restructuring costs for these periods and are included in facility exit costs and restructuring in the Condensed Consolidated Statements of Operations.

25

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

	Distribution		Curriculum		Corporate			Total
Accrued Restructuring Costs at December 29, 2018	$	—	$	—	$	1,133		$	1,133
Amounts charged to expense		—		—		876			876
Payments		—		—		(1,008	)		(1,008	)
Accrued Restructuring Costs at March 30, 2019	$	—	$	—	$	1,001		$	1,001
Amounts charged to expense		—		—		334			334
Payments		—		—		(451	)		(451	)
Accrued Restructuring Costs at June 29, 2019	$	—	$	—	$	884		$	884
Amounts charged to expense		—		—		1,080			1,080
Payments		—		—		(1,288	)		(1,288	)
Accrued Restructuring Costs at September 28, 2019	$	—	$	—	$	676		$	676
	Distribution		Curriculum		Corporate			Total
Accrued Restructuring Costs at December 30, 2017	$	—	$	—	$	50		$	50
Amounts charged to expense		—		—		311			311
Payments		—		—		(189	)		(189	)
Accrued Restructuring Costs at March 31, 2018	$	—	$	—	$	172		$	172
Amounts charged to expense		—		—		171			171
Payments		—		—		(258	)		(258	)
Accrued Restructuring Costs at June 30, 2018	$	—	$	—	$	85		$	85
Amounts charged to expense		—		—		667			667
Payments		—		—		(245	)		(245	)
Accrued Restructuring Costs at September 29, 2018	$	—	$	—	$	507		$	507

NOTE 14 – SEGMENT INFORMATION

The Company determines its operating segments based on the information utilized by the chief operating decision maker, the Company’s Interim Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company has determined that it is organized in two operating segments, Distribution and Curriculum, which also constitute its reportable segments. The Company operates principally in the United States, with limited operations in Canada.

The Distribution segment offers products primarily to thepre-kindergarten through twelfth grade(“preK-12”) education market that include basic classroom supplies and office products, instructional materials, indoor and outdoor furniture and equipment, physical education equipment, classroom technology, and planning and organizational products. The Distribution sales team focuses on selling all Distribution segment products, including the reading and science supplies items.

The Curriculum segment is a publisher of proprietary core curriculum, primarily FOSS and Delta Science Module products, in the science category within thepreK-12 education market. The Curriculum segment has a sales team which is unique from the Distribution sales team and focuses exclusively on the products within this segment. In addition, these products have specific product development requirements, and customer purchasing decisions are made in a different manner than the products represented in our Distribution segment. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies as included in the Company’s Report on Form10-K for the fiscal year ended December 29, 2018.

26

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

The Company measures profitability of its operating segments at a gross profit level. Since the majority of SG&A costs are managed centrally and allocation methodologies of these costs to the operating segments is arbitrary, the Company’s chief operating decision maker does not review segment profitability using operating profit, only gross profit. Accordingly, the segment information reports gross profit at the segment level.

	Three Months Ended		Three Months Ended		Nine Months Ended			Nine Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019			September 29, 2018
Revenues:
Distribution	$	265,390	$	270,945	$	507,318		$	521,340
Curriculum		13,122		19,335		27,735			37,499
Total	$	278,512	$	290,280	$	535,053		$	558,839
Gross Profit:
Distribution	$	85,101	$	86,451	$	162,936		$	171,197
Curriculum		7,466		11,053		15,112			21,172
Total	$	92,567	$	97,504	$	178,048		$	192,369
Operating income and income (loss) before taxes: Operating income	$	22,471	$	37,230	$	3,479		$	20,667
Interest expense and Change in fair value of warrant derivative		5,579		4,157		16,247			11,351
Income (loss) before provision for or benefit from income taxes	$	16,892	$	33,073	$	(12,768	)	$	9,316
	September 28, 2019		December 29, 2018		September 29, 2018
Identifiable assets:
Distribution	$	300,676	$	227,744	$	342,781
Curriculum		36,837		41,666		54,030
Corporate assets		16,736		1,266		10,205
Total	$	354,249	$	270,676	$	407,016
	Three Months Ended		Three Months Ended		Nine Months Ended			Nine Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019			September 29, 2018
Depreciation and amortization of intangible assets and development costs:
Distribution	$	5,090	$	4,953	$	14,739		$	15,697
Curriculum		685		764		1,849			2,100
Total	$	5,775	$	5,717	$	16,589		$	17,797
Expenditures for property, plant and equipment, intangible and other assets and development costs:
Distribution	$	2,607	$	2,855	$	8,931		$	9,602
Curriculum		420		1,019		1,596			2,900
Total	$	3,027	$	3,874	$	10,527		$	12,502

The following table shows the Company’s revenues by each major product line within its two segments:

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SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

	For the Three Months Ended						For the Nine Months Ended
	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018
Distribution revenues by product line:
Supplies	$	122,303		$	119,681		$	253,007		$	253,354
Furniture		97,960			99,646			174,797			175,951
Instruction & Intervention		19,955			21,993			45,089			48,851
AV Tech		3,962			3,680			12,133			12,046
Agendas		19,456			23,872			21,636			28,706
Freight Revenue		4,226			4,762			8,010			9,149
Customer Allowances / Discounts		(2,472	)		(2,689	)		(7,354	)		(6,717	)
Total Distribution Segment	$	265,390		$	270,945		$	507,318		$	521,340
Curriculum revenues by product line:
Science	$	13,122		$	19,335		$	27,735		$	37,499
Total Curriculum Segment	$	13,122		$	19,335		$	27,735		$	37,499
Total revenues	$	278,512		$	290,280		$	535,053		$	558,839

The above table is an enhanced disclosure to provide additional details related to our revenues by segment.

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 effect on the Company’s consolidated financial position, results of operations or cash flows.

NOTE 16 – SUBSEQUENT EVENTS

The Company’s third quarter and year-to-date results have been negatively affected by the Agendas product category. This category of paper-based planners has been experiencing top-line pressures for over ten years as schools have been transitioning to digital solutions. In addition, the current year results have been further negatively impacted by operational challenges associated with the transition to a different technology platform to manage the process from order inception through shipment. The category has had a negative impact on 2019 earnings, and the Company has made a decision to exit the custom planner category in the fourth quarter of fiscal 2019.

On October 28, 2019, the “Company” entered into the Fourth Amendment (the “Fourth Amendment”) to the New Term Loan Agreement dated April 7, 2017, in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 30, 2019 required under the New Term Loan Agreement from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the New Term Loan Agent in its discretion. This date was subsequently extended several times by the New Term Loan Agent, most recently to November 12, 2019.

Also on October 28, 2019, the Company entered into the Seventh Amendment (the “Seventh Amendment”) to the ABL Facility dated June 11, 2013, in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 30, 2019 required under the ABL Facility from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the ABL Agent in its discretion. This date was subsequently extended several times by the ABL Agent, most recently to November 12, 2019.

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The Fourth Amendment and the Seventh Amendment each served as a short-term forbearance of the events of default that would have resulted from the delivery of those financial statements due to the Company’s non-compliance with the net senior leverage ratio and the minimum EBITDA covenants under the New Term Loan Agreement and the ABL Facility as of September 30, 2019 (the “Existing Events of Default”).

On November 12, 2019, the Company and the New Term Loan Agent reached agreement in principle with respect to a non-binding Summary of Terms and Conditions for Forbearance Agreement and Fifth Amendment to New Term Loan Agreement with the New Term Loan Lenders and the New Term Loan Agent (the “Term Loan Term Sheet”). Capitalized terms used below that are not otherwise defined have the meaning set forth in the New Term Loan Agreement. The Term Loan Term Sheet contemplates the Company entering into a Fifth Amendment to the New Term Loan Agreement no later than November 22, 2019, in order to, among other things: (1) establish a forbearance period during which the Term Loan Lenders would forbear the exercise of any rights or remedies with respect to the Existing Events of Default until a Termination Event (which would be the earliest of (a) January 31, 2020, (b) March 31, 2020 if a Specified Unsecured Prepetition Debt Satisfaction Event has occurred prior to January 31, 2020 (the earlier of (a) or (b), the “Outside Date”), (c) at the election of the Term Loan Agent, the occurrence of an event of default, other than the Existing Events of Default, (d) the expiration or termination of the forbearance period described in the ABL Term Sheet below, or (e) the occurrence of any other customary termination event); (2) the payment of a $6 million closing fee, which may be reduced to not less than $1.25 million under certain circumstances; (3) the addition of approximately $3.5 million in other fees to the principal balance of the New Term Loan; (4) in replacement of the Third Amendment Warrants, warrants to purchase, for a price of $0.01 per share, 18% of the outstanding common stock of the Company, with such warrants earned in full and vesting immediately on the date of issuance, but not exercisable until the Outside Date (the “Fourth Amendment Warrants”), provided that if the Obligations are paid in full in cash on or prior to (a) February 29, 2020, the Company shall have the right to buy back 50% of the Fourth Amendment Warrants, and (b) the Outside Date, the Company shall have the right to buy back 75% of the Fourth Amendment Warrants, in each case for a price of $0.01 per share; (5) amend the definition of Applicable Margin so that it will no longer depend on the Net Senior Leverage Ratio and will instead be set at 7.00% per annum for all Prime Rate Loans and 8.00% per annum for all LIBOR Rate Loans; (6) amend the definition of PIK Interest Rate so that it will no longer depend on the Net Senior Leverage Ratio and will instead be set at 2.00% per annum; (7) provide that the New Term Loan and other Obligations shall bear interest at the Default Rate and to increase the Default Rate by 1.00%, which increase will be paid in kind by adding such amount to the principal balance of the Term Loan; (8) convert LIBOR Rate Loans to Prime Rate Loans as their interest periods expire and eliminate the Company’s ability to request to convert or continue the Term Loan or any portion thereof as LIBOR Rate Loans; (9) require the delivery on a weekly basis of detailed 13-week budgets (each, a “Budget”); (10) amend the financial covenants, including the elimination of the Fixed Charge Coverage Ratio and the Net Senior Leverage Ratio during the forbearance period, resetting the Minimum EBITDA to be tested monthly, resetting the minimum Specified Availability to the greater of $12.5 million, replacing the existing clean-down and ABL Facility usage covenant with the same covenants as reflected in the ABL Term Sheet; (11) limit the use of cash receipts to payment of Budget disbursements and not submit ABL borrowing requests in excess of the amount needed to fund the Budget; (12) require the Company to pursue a merger, financing transaction, or sale transaction that will cause the Company to repay the Obligations in full prior to the Outside Date, subject to the satisfaction of various milestones and conditions; (13) provide full access rights to the Term Loan Agent, its counsel and its advisors; (14) extend the maturity date of the Term Loan to November 11, 2020; (15) eliminate a number of the Company’s rights under the New Term Loan Agreement, including but not limited to its right to consent to assignments, to make Permitted Acquisitions, to reinvest proceeds of Asset Dispositions and Extraordinary Proceeds, and to make Specified Asset Dispositions; and (16) provide for enhanced inspection rights for the New Term Loan Agent.

For purposes of the Term Loan Term Sheet, a “Specified Unsecured Prepetition Debt Satisfaction Event” means, among other things, that a specified percentage of the Specified Unsecured Prepetition Debt has been amended such that its final maturity is not on or before December 11, 2020, does not provide for any payments before that date except for limited percentages in certain limited circumstances, it accrues interest, payable solely in kind, at a rate per annum reasonably satisfactory to the New Term Loan Agent and the required New Term Loan Lenders, and can be secured by a third lien on the Term Loan Priority Collateral, that is subject to an intercreditor agreement, among other things.

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Also on November 12, 2019, the Company entered into a non-binding Summary of Terms and Conditions for Forbearance Agreement and Eighth Amendment to Loan Agreement with the ABL Lenders and the ABL Agent (the “ABL Term Sheet”). Capitalized terms used below that are not otherwise defined have the meaning set forth in the ABL Agreement. The ABL Term Sheet contemplates the Company entering into an Eighth Amendment to the ABL Agreement no later than November 22, 2019, in order to, among other things: (1) establish a forbearance period during which the ABL Lenders would forbear the exercise of any rights or remedies with respect to the Existing Events of Default until a Termination Event (which would be the earliest of (a) January 31, 2020, (b) March 31, 2020 if a Specified Unsecured Prepetition Debt Satisfaction Event has occurred prior to January 31, 2020 (the earlier of (a) or (b), the “Outside Date”), (c) at the election of the ABL Agent, the occurrence of an event of default, other than the Existing Events of Default, (d) the expiration or termination of the forbearance period provided by the Term Loan Sheet described above, or (e) the occurrence of any other customary termination event); (2) the payment of a fee equal to 0.50% times the amount of the Commitments in effect as of the Closing Date under the ABL; (3) amend the definition of Applicable Margin so that it will no longer depend on the Fixed Charge Coverage Ratio and will instead be set at 300 bps for all Base Rate Loans and 400 bps for all LIBOR Loans; (4) require the delivery on a weekly basis of detailed 13-week budgets (each, a “Budget”); (5) amend the financial covenants, including the elimination of the Fixed Charge Coverage Ratio during the forbearance period, adding a covenant testing trailing twelve-month EBITDA on a monthly basis, in a manner consistent with the Fifth Amendment, replacing the existing clean-down covenant in Section 10.2.3 of the ABL Agreement with a clean-down covenant requiring the Loans be paid down to $10,000,000 at fiscal year end December 28, 2019; (6) limit the use of cash receipts to payment of Budget disbursements and not submit ABL borrowing requests in excess of the amount needed to fund the Budget; (7) require the Company to pursue a merger, sale, or other restructuring transaction that will cause the Company to repay the Term Loan Obligations in full on or prior to the Outside Date, subject to the satisfaction of various milestones and conditions; (8) provide full access rights to the ABL Agent, its counsel and its advisors; (9) extend the maturity date of the ABL 30 days prior to the extended maturity date of the New Term Loan Agreement described above (expected to be to October 11, 2020); (10) eliminate a number of the Company’s rights under the ABL Agreement, including but not limited to its right to consent to assignments, to make Permitted Acquisitions, and to make Specified Asset Dispositions; (11) amend the definitions of Availability Reserve and Borrowing Base to add an availability block equal to $15,000,000; and (12) provide for enhanced inspection rights for the ABL Agent.

The foregoing descriptions of the Term Loan Term Sheet and the ABL Term Sheet are summaries and do not purport to be complete descriptions of the terms thereof. The closing of the Fifth Amendment and the Eighth Amendment are each subject to a number of conditions that the Company may not be able to satisfy, and do not represent binding commitments on the part of the New Term Loan Lenders or the ABL Lenders to enter into such amendments on these terms or at all. There is no assurance that the Company will enter into the Fifth Amendment or the Eighth Amendment before November 22, 2019 or at all, or if it does, that the Fifth Amendment and the Eighth Amendment will contain the terms set forth in the Term Loan Term Sheet and the ABL Term Sheet, respectively. In the event the Company is not able to enter into the Fifth Amendment and the Eighth Amendment in a timely manner and the New Term Loan Lenders and the ABL Lenders do not otherwise extend their forbearance, such lenders will be entitled to exercise their rights and remedies under the New Term Loan Agreement and the ABL Agreement, respectively, with respect to the Existing Events of Default.

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

Quarterly Overview

School Specialty is a leading provider of educational products, services and programs serving thePreK-12 education market across the United States and Canada. We offer more than 100,000 items through an innovativetwo-pronged marketing and sales approach that targets both school administrators and individual teachers. School Specialty designs, develops and delivers a broad assortment of innovative and proprietary products, programs and services to the education marketplace, including essential classroom supplies, furniture, educational technology, supplemental learning resources (“Instruction & Intervention”), science curriculum solutions, and evidence-based safety and security training. The Company applies its unmatched team of subject-matter experts and customized planning, development and project management tools to deliver this comprehensive learning environments that support the social, emotional, mental, and physical development of students – improving both learning outcomes and school district performance. The Company provides educators with innovative and proprietary products and services, from basic school supplies to 21^st century learning environments to Science, English and Language Arts (“ELA”), and Math core and supplemental instructional materials. Through its nationwide distribution network, School Specialty also provides its customers with access to a broad spectrum of trusted, third-party brands across its business segments. This assortment strategy enables the Company to offer a broad range of products primarily serving thepreK-12 education market at the state, district and school levels. The Company is expanding the distribution of its products beyond selling directly to the education market into channels such as partnerships withe-tailers and healthcare facilities.

Our goal is to grow profitably as a leading provider of supplies, learning environment solutions, services and curriculum for the education market. While we had experienced four consecutive years of overall revenue growth, we expect fiscal 2019 revenues to be down modestly partially due to the Company not pursuing low margin business. One of our fiscal 2019 objectives is to return to balanced revenue growth. We plan to achieve this goal over the long-term through an organic growth strategy based on leveraging our strong brand names and distribution capabilities and transforming the Company’s sales and marketing to a team-based selling approach focused on new customer acquisition, customer retention and penetration, and expanding into new markets or product areas. In addition, we will continue to present our uniquely comprehensive value propositions to schools. We believe this will enable us to drive deeper penetration of the full scope of our product offerings. New revenue streams may include opportunities in areas that could expand our addressable market, such as distribution tonon-education customers, expansion into new product lines, continued growth in oure-tail partnerships, and potentially, abroad in select international markets. In addition, the Company is committed to continuing to invest in product development in order to expand and improve its product offerings.

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

• Successful execution of a new team sell model and go to market strategy;

• Properly positioning the Company’s unique and comprehensive value proposition;

• Improving the effectiveness of margin management through a renewed emphasis on selling proprietary brands;

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

• Increase product category specific sales and support expertise; and

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

The Company’s Supplies and transactional Furniture product areas, which represent approximately 69% of our annual revenues, are collectively a key measure of the strength of our customer relationships and penetration trends therein. Order rates for these products in the post peak season (September and October) of 2019 were up a combined 6.3% year-over-year, with the order rate being particularly strong in large districts. In addition, the booked gross margin on incoming orders in this period was up 140 basis points over the comparable period last year. The Company views these trends as an indication that its initiatives, especially those related to team-sell and margin management are continuing to gain traction.

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

The Company’s third quarter andyear-to-date results have been negatively affected by the Agendas product category. This category of paper-based planners has been experiencingtop-line pressures for over ten years as schools have been transitioning to digital solutions. In addition, the current year results have been further negatively impacted by operational challenges associated with the transition to a different technology platform to manage the process from order inception through shipment. The category has had a negative impact on 2019 earnings, and the Company has made a decision to exit the custom planner category in the fourth quarter of fiscal 2019.

The Company’s actions to improve its operating results through pricing, improvements to the bid/quote processes, and the continued management of costs have resulted in gross margin improvement in the Supplies and Furniture product categories in the third quarter of 2019, the improvements have been offset by continued pressures in its Agendas and Science product categories. The Company announced in the fourth quarter of 2019 that the Agendas product category will be discontinued and is actively pursuing a sale of the category. The Science business has been adversely impacted by many districts delaying the purchase of science curriculum. However, the Company is confident that the Science product category is well-positioned for growth in 2020.

However, as the Company’s operating results were below plan for the first nine months of 2019 which resulted in non-compliance with certain financial covenants of the Company’s debt facilities in the third quarter of 2019. See Note 11 – Debt for details regarding the Company’s debt facilities. To address the non-compliance, the Company entered into short-term forbearance agreements with its senior secured lenders and also reached agreement in principle with its senior-secured lenders, subject to definitive documentation, on terms and conditions for a forbearance related to the third quarter non-compliance and amendments to the terms of its debt facilities (the “Term Sheets”). The Term Sheets contemplate, among other things, certain restrictions on the Company’s borrowing capacity, such that the Company will not have sufficient liquidity necessary to retire currently-maturing debt obligations on the maturity date. However, the Term Sheets also contemplate allowing the Company to pursue an extension of the maturity date with the holders of the currently maturing deferred vendor obligations. The Company is having ongoing discussions with certain holders of the deferred vendor obligations to extend the maturity date. Uncertainty as to the success of negotiating binding amendments with the Company’s senior secured lenders and extensions to the currently-maturing debt obligations consistent with the Term Sheets and the Company’s ability to remain in compliance with future period covenants could result in the Company’s senior secured lenders exercising their rights and remedies with respect to our current non-compliance, resulting in substantial doubt about the Company’s ability to continue as a going concern twelve months from the date the financial statements are issued.

Management believes that the Company’s ability to continue as a going concern is dependent on a combination of negotiating satisfactory terms related to the extension of the maturity date for a substantial portion of the currently-maturing deferred vendor obligations, obtaining the additional funding necessary to repay its currently maturing debt obligations, renegotiating certain terms of its existing debt facilities, and pursuing other strategic alternatives. Management hired an investment banker in August 2019 to assist in both seeking additional capital financing and, as announced in October 2019, to pursue strategic alternatives. Management is also maintaining ongoing discussions with its current lenders. The Board and management believe that these steps, if successful, will result in enhanced liquidity and therefore mitigate the factors which raise doubt about the Company’s ability to continue as a going concern. Management’s ultimate plan is to obtain additional or replacement financing, or to engage in a sale transaction. While management believes that its pursuit of strategic alternatives and additional funding through its investment banker, and its actions to improve the Company’s financial performance, and its discussions with existing lenders and holders of deferred vendor obligations will enable the Company to either retire or extend the deferred vendor obligations, there can be no assurance that additional debt or other financing will be available to the Company in sufficient amounts and on acceptable terms or at all, that the Company’s current lenders will agree to modify the terms of its debt facilities on acceptable terms or at all, or that the Company will achieve its forecasted performance at the level necessary to provide adequate liquidity and/or covenant compliance. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might result from this uncertainty.

See “Liquidity and Capital Resources,” below.

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Results of Operations

Costs of Revenues and Selling, General and Administrative Expenses

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

Cost of Revenues

Selling, General and Administrative Expenses

•  Direct costs of merchandise sold, net of vendor rebates other than vendor payments for or the reimbursement of specific, incremental and identifiable costs, and net of early payment discounts. •  Amortization of product development costs. •  Freight expenses associated with moving merchandise from our vendors to fulfillment centers or from our vendors directly to our customers.

•  Compensation and benefit costs for all selling (including commissions), marketing, customer care and fulfillment center operations (which include the pick, pack and shipping functions), and other general administrative functions such as finance, human resources and information technology. •  Occupancy and operating costs for our fulfillment centers and office operations. •  Freight expenses associated with moving our merchandise from our fulfillment centers to our customers. •  Catalog expenses, offset by vendor payments for or reimbursement of specific, incremental and identifiable costs. •  Depreciation and intangible asset amortization expense, other than amortization of product development costs.

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

Three Months Ended September 28, 2019 Compared to Three Months Ended September 29, 2018

Revenues

Revenues of $278.5 million for the three months ended September 28, 2019 decreased by $11.8 million, or 4.2%, as compared to the three months ended September 29, 2018.

Distribution segment revenues of $265.4 million for the three months ended September 28, 2019 decreased by 2.1%, or $5.6 million, from the three months ended September 29, 2018. Revenues from the Agendas, Furniture, and Instruction and Intervention categories contributed to this year-over-year decline. The majority of the decline in the quarter was in the Agendas product category, which was down $4.4 and ongoing operational challenges associated with the transition to a new technology platform to support the sale and production of Agenda products contributed to an acceleration in the historical revenue decline in the category. The decline in Furniture was primarily due to our decision to forego pursuing lower margin projects. Instruction & Intervention revenues of $20.0 million were down $2.0 million, or 9.3%. The main contributor to the softness in Instruction & Intervention orders was the Triumph Learning product line, particularly declining orders for consumable products (i.e. workbooks) for which the renewal rate has been lower than historical levels. Revenues for Supplies were up $2.6 million, or 2.2% due to strong operational performance in the fulfillment centers which resulted in shorter lead times and materially lower open orders entering the fourth quarter of 2019. AV Tech revenues of $4.0 million were up $0.3 million as compared to last year’s third quarter.

Curriculum segment revenues of $13.1 million for the three months ended September 28, 2019 decreased by 32.1%, or $6.2 million from the three months ended September 29, 2018, reflecting a delayed recovery in the Science curriculum spend, increased competition and timing shifts into fiscal 2020 with the California adoption. While the competitive landscape has changed since the last major adoption cycle with an increase in the number of competing products which could affect our adoption revenues, we believe the quality and effectiveness of our FOSS program is superior which we are highlighting in both our marketing and sales positioning.

Gross Profit

Gross profit for the three months ended September 28, 2019 was $92.6 million, as compared to $97.5 million for the three months ended September 29, 2018. Gross margin for the three months ended September 28, 2019 was 33.2%, as compared to 33.6% for the three months ended September 29, 2018.

Distribution segment gross margin was 32.1% for the three months ended September 28, 2019, as compared to 31.9% for the three months ended September 29, 2018. Pricing actions taken in 2018 and early 2019 have begun to positively impact gross margins over the past three quarters. The growth in segment gross margin in the third quarter of fiscal 2019 is based on a combination of newly-effective pricing arrangements and our decision to not pursue certain low margin opportunities which did not result in additional pull-through revenues at higher gross margins. The gross margin improvement in the quarter for the segment have been partially offset by lower Agenda gross margin as compared to last year’s third quarter. The operational challenges associated with the transition to a new technology platform for Agendas contributed 120 basis points of gross margin decline in the quarter.

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Curriculum segment gross margin for the quarter was generally consistent with the prior year’s third quarter. Curriculum segment gross margin was 56.9% for the three months ended September 28, 2019, as compared to 57.2% for the three months ended September 29, 2018.

Selling, General and Administrative Expenses

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

SG&A increased $4.8 million in the third quarter of fiscal 2019, from $59.6 million for the three months ended September 29, 2018 to $64.4 million for the three months ended September 28, 2019. The increased SG&A in the quarter was related to a combination of incentive compensation adjustments in the prior year’s third quarter, increased costs associated with the Agenda product category which is in the process of being discontinued and costs associated with the Company’s efforts to address its capital structure.

• Approximately $3.1 million of the SG&A increase in the quarter is related to the Company’s incentive compensation plans. Commission expense for the quarter was $3.6 million, or 1.3% of revenues, while commission expense in last year’s third quarter was $1.7 million or 0.6% of revenues. The lower commission rate in last year’s third quarter reflected an adjustment in the Company’s estimate as to the number of sales representatives that would achieve full year targets. Management incentive compensation expense was zero in the third quarter of fiscal 2019 compared to a negative expense of $1.2 million in last year’s third quarter. The prior year’s negative expense reflected the adjustment for previously recorded expense based on the Company’s third quarter 2018 performance.

• SG&A cost directly related to the Company’s Agenda product category increased by $1.8 million in the quarter related to incremental customer care, expedited shipment expense and costs associated with transitioning to a new technology platform.

• Approximately $0.8 million of advisory, legal and consultant SG&A costs were incurred in the third quarter of 2019 related to efforts associated with our exploration of strategic alternatives announced on October 9, 2019.

All other SG&A costs in the third quarter of 2019 were down by approximately $2.0 million as compared to the third quarter of 2018. Variable SG&A expenses, consisting primarily of fulfillment center and outbound transportation costs were relatively flat in the quarter. Decreases in volume, improved operating efficiencies and the impact of favorable freight rates were offset by higher fulfillment center labor costs. All other fixed compensation and benefit costs decreased by $1.1 million in the third quarter of fiscal 2019 due to lower staffing levels. The remaining SG&A improvements in the quarter were related to the Company’s ongoing cost control efforts which resulted in cost savings across a number of categories including travel and use of consultants.

As a percent of revenue, SG&A increased from 20.5% for the three months ended September 29, 2018 to 23.1% for the three months ended September 28, 2019.

Impairment Charges

The Company recorded $4.6 million of goodwill impairment charges in the three months ended September 28, 2019 based on the assessment conducted during the third quarter of fiscal 2019. The goodwill impairment charge was for the Science reporting unit. See Note 9 – Goodwill and Other Intangible.

Restructuring Costs

For the three month period ended September 28, 2019, the Company recorded $1.1 million of restructuring charges. For the three month period ended September 29, 2018, the Company recorded $0.7 million of restructuring charges. The amounts in both periods were entirely related to severance. The increase in third quarter of fiscal 2019 was due primarily to a sales force restructuring as we completed the transition to a team sell-model.

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Interest Expense

Interest expense increased by $1.1 million from $4.2 million for the three months ended September 29, 2018 to $5.3 million for the three months ended September 28, 2019. Cash interest expense increased $0.5 million in the third quarter of the current year due primarily to an increase in our cash interest rate of 120 basis points due to a combination of a year-over-year increase in LIBOR and an increase in our applicable margin related to our increased senior leverage ratio over the past twelve months. The additional interest expense due to the higher interest rates was partially offset by lower average outstanding debt of approximately $6.0 million at the end of the third quarter of fiscal 2019 as compared to the outstanding debt at the end of the third quarter of fiscal 2018.

Non-cash interest expense increased by $0.7 million in the third quarter of fiscal 2019 due to a combination of incrementalpaid-in-kind interest related to our New Term Loan and higher loan fee amortization due to the loan fees associated with the debt amendments executed in the first quarter of 2019.

Change in Fair Value of Warrant Derivative

In the third quarter of fiscal 2019, we recorded anon-cash charge of $0.2 million in order to reflect the current fair value of the obligation to issue warrants to the New Term Loan lenders. We did not have a fair value adjustment in fiscal 2018.

Benefit for Income Taxes

The benefit for income taxes was $1.0 million for the three months ended September 28, 2019, as compared to $14.5 million for the three months ended September 29, 2018. The change in income taxes was due primarily to the valuation allowance recorded in December 2018.

The effective income tax rate for the three months ended September 28, 2019 and the three months ended September 29, 2018 was-5.8% and 43.9%, respectively.

Nine Months Ended September 28, 2019 Compared to Nine Months Ended September 29, 2018

Revenues

Revenues of $535.1 million for the nine months ended September 28, 2019 decreased by $23.8 million, or 4.4%, as compared to the nine months ended September 29, 2018.

Distribution segment revenues of $507.3 million for the nine months ended September 28, 2019 decreased by 2.8%, or $14.0 million, from the nine months ended September 29, 2018. Revenues from the Agendas and Instruction & Intervention product categories are the primary drivers of the year-over-year decline. Agendas revenues were down by $7.1 million, or 24.6%, in the first nine months year-over-year. The Company has experienced challenges associated with the transition to a new technology platform to support the sale and production of Agenda products. Instruction & Intervention revenue was down year-over-year by $3.8 million, or 7.7%, in the first nine months. The main contributor to the softness in Instruction & Intervention orders was the Triumph Learning product line, particularly declining orders for consumable products (i.e. workbooks) for which the renewal rate has been lower than historical levels. In the fall of 2019 we are launching Success Coach, a major publishing initiative for our Company and the evolution of our existing Coach family of products. We are beginning to experience building momentum in the Instruction & Intervention category as incoming orders in the fourthquarter-to-date of 2019 are up year-over-year by over 15%. Supplies revenues were down slightly, 0.1%, due to a decline in smaller districts andnon-district customers year-over-year. However, Supplies revenue has grown year-over-year in larger school districts and the Company deployed multiple sales and marketing initiatives aimed at improving our performance with the smaller customers. While we entered the fourth quarter with a lower open order position in Supplies due to strong operating performance in our fulfillment centers in 2019 as compared to 2018, incoming Supplies orders over the months of September and October are up 4.2% year-over-year. We believe our strong operating performance in the 2019 season, along with the team-sell model gaining effectiveness, are contributing to the increased order rate. Revenues for Furniture were down $1.2 million and AV Tech revenues were up $0.1 million as compared to fiscal 2018. Although we have not pursued certain lower-margin Furniture opportunities in 2019, the performance in our Furniture product category has been relatively consistent across all segments of our customer base, including the smaller district andnon-district customers.

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Curriculum segment revenues of $27.7 million for the nine months ended September 28, 2019 decreased by 26.0%, or $9.8 million, from the nine months ended September 29, 2018. The California adoption was a key driver in our fiscal 2019 growth expectations, as we expected approximately 50% of California school districts to purchase science curriculum in fiscal 2019, with the balance to purchase in 2020 and 2021. Our current expectation is that less than 25% of California districts will purchase in fiscal 2019. With the shift to later purchases, our opportunities in California for 2020 and 2021 have increased versus original expectations. Outside of California, our Curriculum revenues are down. With more active competition, ourwin-rates have been below historical levels. We believe our Science curriculum remains an effective and competitive product. We continue to enhance our offering and refine the sales and marketing process to better respond to competitive pressures. In addition, we have recently begun the process of upgrading our digital content delivery platform, which will add important features and functionality to our Science Curriculum offering and improve its competitive positioning.

Gross Profit

Gross profit for the nine months ended September 28, 2019 was $178.0 million, as compared to $192.4 million for the nine months ended September 29, 2018. Gross margin for the nine months ended September 28, 2019 was 33.3%, as compared to 34.4% for the nine months ended September 29, 2018.

Distribution segment gross margin was 32.1% for the nine months ended September 28, 2019, as compared to 32.8% for the nine months ended September 29, 2018. A year-over-year shift in product mix negatively impacted gross margin by 50 basis points for the first three quarters of 2019. Rate variances at a product line level, particularly Agendas, negatively impacted gross margin by 20 basis points. Agenda product gross margin has been negatively impacted by the operational challenges related to the transition to a new technology platform. Overall, Agendas contributed 60 basis points of gross margin decline to the segment for the first nine months of 2019. The gross margin of the remaining product category in the segment were essentially flat year-over-year. The gross margin trend has improved throughout the year. In our two largest product categories, Supplies and Furniture, strategic pricing actions taken over the past nine months, including a decision to not pursue certainlow-margin business, are resulting in higher second half 2019 gross margin versus 2018 gross margin. Booked gross margins for June through October of 2019 were up materially year-over-year.

Curriculum segment gross margin was 54.5% for the nine months ended September 28, 2019, as compared to 56.5% for the nine months ended September 29, 2018. Higher training revenues in 2018 versus training revenues in 2019 and increases in product cost in 2019, primarily associated with smaller runs of printed material due to lower volumes, contributed to the gross margin decline.

Selling, General and Administrative Expenses

SG&A decreased $3.2 million in the first nine months of fiscal 2019, from $170.6 million for the nine months ended September 29, 2018 to $167.4 million for the nine months ended September 28, 2019.

Fixed compensation and benefit costs decreased by $2.7 million in the current year’s first nine months due to lower staffing levels. Stock-based compensation expense was down year-over-year by $1.9 million as previously recognized unvested RSU expense for the former CEO was reversed in the first quarter of 2019. Travel expense was down year-over-year by $1.1 million primarily due to a decrease in the number of consultants and sales associates. Depreciation and amortization expense decreased by $0.5 million in the current year related primarily to incremental depreciation in fiscal 2018 associated with the Company’s new phone system implementation. In the second quarter of fiscal 2019, the Company received $1.3 million as a recovery of previously incurred SG&A costs associated with a claim against a former vendor, which also contributed to the lower SG&A costs in the current year. Partially offsetting these decreases, commission expense was up $1.9 million year-over-year due to a change in the earning thresholds within the 2019 commission plans. Variable labor was up in the current year by $1.4 million primarily due to switching to using associates from temp agencies versus using seasonal help. This ensured the correct staffing levels throughout busy season. Financial advisor fees increased year-over-year by $2.2 million related to the Company’s exploration of strategic alternatives. Transitioning Agendas to a new technology platform resulted in a one timeset-up fee of $1.3 million in the current fiscal year.

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As a percent of revenue, SG&A increased from 30.5% for the nine months ended September 29, 2018 to 31.3% for the nine months ended September 28, 2019.

Impairment Charges

For the nine month period ended September 28, 2019, the Company recorded an impairment of $0.3 million related to the discontinuation of the use of a tradename and $4.6 million of a goodwill impairment charge based on the assessment conducted during the third quarter of fiscal 2019. The goodwill impairment charge was for the Science reporting unit. See Note 9 – Goodwill and Other Intangible. The Company did not have an impairment charge in the first nine months of fiscal 2018.

Restructuring Costs

For the nine month period ended September 28, 2019, the Company recorded $2.3 million of restructuring charges. For the nine month period ended September 29, 2018, the Company recorded $1.1 million of restructuring charges. The amounts in both periods were related entirely to severance. The increase in fiscal 2019 is due to a sales force restructuring and changes at the leadership level.

Interest Expense

Interest expense increased by $3.5 million from $11.4 million for the nine months ended September 29, 2018 to $14.9 million for the nine months ended September 28, 2019. Cash interest expense increased $2.0 million in the first nine months of the current year versus the first nine months of the prior year due primarily to an increase in our cash interest rate for fiscal 2019 of approximately 150 basis points. The increase in the cash interest rate was due primarily to a year-over-year increase in our applicable margin as a result of an increase in our senior leverage ratio over the past twelve months. In addition, our cash interest increased by approximately $0.1 million in the first nine months of 2019 as our average borrowings were up $1.6 million year-over year.

Non-cash interest expense increased by $1.5 million in the first nine months of fiscal 2019 due primarily to incrementalpaid-in-kind interest related to our New Term Loan.

Change in Value of Warrant Derivative

In fiscal 2019, the Company recorded anon-cash charge of $1.3 million in order to reflect the change in the current fair value of the obligation to issue warrants to the New Term Loan lenders. We did not have a fair value adjustment in fiscal 2018.

Provision for (Benefit from) Income Taxes

The provision for income taxes was $0.2 million for the nine months ended September 28, 2019, as compared to a provision for income taxes of $9.4 million for the nine months ended September 29, 2018.

The effective income tax rate for the nine months ended September 28, 2019 and the nine months ended September 29, 2018 was -1.6% and 101.1%, respectively. The decrease in the year-over-year effective tax rate for the first nine months of 2019 is due to the tax valuation allowance which the Company recorded in the fourth quarter of 2018. The Company determined as of the end of the third quarter of fiscal 2019 that the tax valuation allowance was still necessary. As a result, the Company has not provided a tax benefit in the current year for anticipated net operating losses. In the second quarter of fiscal 2019, the Company determined that unremitted earnings and profits in foreign subsidiaries would likely be repatriated to the parent entity over the next twelve months; however, the majority of any earnings and profits repatriated would be treated as a return of capital for Canadian purposes and, thus, not subject to a withholding tax based on the U.S./Canada tax treaty. Based on the Company’s current full year forecast, it anticipates utilizing a net operating loss in fiscal 2019. The Company expects cash taxes to be less than $0.5 million in fiscal 2019.

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Liquidity and Capital Resources

At September 28, 2019, the Company had negative working capital of $21.4 million, a decrease of $146.1 million as compared to September 29, 2018. Net working capital in the current year includes both $5.9 million of cash and $199.1 million of current maturities of long-term debt. Current maturities of long-term debt have increased year over year because the Company has classified the full amount of the outstanding New Term Loan balances outstanding as of September 28, 2019, approximately $108.4 million, as currently maturing long-term debt due to the Company’s non-compliance with certain financial covenants as of the end of the third quarter of fiscal 2019 and the short-term nature of the forbearance granted by the New Term Loan Lenders and ABL Lenders with respect to this non-compliance. The Company’s capitalization at September 28, 2019 was $252.9 million and consisted of total debt of $199.1 million and stockholders’ equity of $53.8 million.

Net cash used by operating activities was $48.7 million and $86.1 million for the nine months ended September 28, 2019 and September 29, 2018, respectively. The decrease in cash used by operating activities related primarily to working capital changes. As of fiscal 2018 year end, the Company’s working capital balances were higher than historical year end working capital balances due to the impact of late order and split order fulfillment in fiscal 2018. This year-over-year decrease reflects that working capital balances have returned to historical levels. As a result, over the first nine months of fiscal 2019, the Company’s cash used for working capital changes was down $37.4 million versus the first nine months of fiscal 2018.

Net cash used in investing activities was $10.5 million in the first nine months of fiscal 2019 as compared to $12.4 million in the first nine months of fiscal 2018. The Company expects net cash used in investing activities to decrease by approximately $2.7 million for the full year fiscal 2019 as compared to full year fiscal 2018 due to lower investments in the Company’se-commerce platform and product information management systems as these projects are approaching completion. The completion of these projects is expected to result in improvements to the Company’s platforms and processes and lower both ongoing operating costs and future investments.

Net cash provided by financing activities was $64.1 million in fiscal 2019 versus $74.8 million in fiscal 2018. In both periods the net cash provided from financing activities represents net draws from the ABL Facility, which combined with beginning of period cash balances, were used to fund operating and investing cash outflows, as well as Term Loan repayments in fiscal 2019. The Company repaid principal on its Term Loan in the amount of $4.1 million during the first nine months of fiscal 2019, which consisted of an excess cash flow payment of $0.8 million and regularly scheduled principal payments of $3.3 million.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business within one year after the date the consolidated financial statements are issued. In accordance with Financial Accounting Standards Board, or the FASB, Accounting Standards UpdateNo. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic205-40), our management evaluates whether there are conditions or events, considered in aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date that the financial statements are issued.

As of September 28, 2019, outstanding borrowings on the ABL Facility were $69.0 million, while the excess availability on that date for the ABL Facility was $52.9 million. In addition to the Company’s excess availability, it had $5.9 million of cash on its balance sheet as of September 28, 2019.

The increase in current maturities in the first nine months of fiscal 2019 as compared to the first nine months of fiscal 2018 is due to the deferred cash payment obligations which are payable in December 2019 and the forbearance associated with the Company’s term loan as of the end of the third quarter 2019.

As described in Note – 2 Going Concern to the condensed consolidated financial statements, the Company may not have the liquidity necessary to retire currently maturing debt obligations and may not be able to remain in compliance with future period covenants, which could result in the Company’s inability to continue as a going concern.

On October 28, 2019, the “Company” entered into the Fourth Amendment (the “Fourth Amendment”) to the New Term Loan Agreement dated April 7, 2017, in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 28, 2019 required under the New Term Loan Agreement from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the New Term Loan Agent in its discretion. This date was subsequently extended several times by the New Term Loan Agent, most recently to November 12, 2019.

Also on October 28, 2019, the Company entered into the Seventh Amendment (the “Seventh Amendment”) to the ABL Facility Loan Agreement dated June 11, 2013, in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 28, 2019 required under the ABL Facility from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the ABL Agent in its discretion. This date was subsequently extended several times by the ABL Agent, most recently to November 12, 2019.

The Fourth Amendment and the Seventh Amendment each served as a short-term forbearance of the events of default that would have resulted from the delivery of those financial statements due to the Company’s non-compliance with the net senior leverage ratio and the minimum EBITDA covenants under the New Term Loan Agreement and the ABL Facility as of September 30, 2019 (the “Existing Events of Default”).

The Fourth Amendment and the Seventh Amendment are filed as exhibits to this report and are incorporated herein by reference. The foregoing descriptions of the Fourth Amendment and the Seventh Amendment do not purport to be complete and are qualified in their entirety by the full text of such agreements.

On November 12, 2019, the Company and the New Term Loan Agent reached a non-binding Summary of Terms and Conditions for Forbearance Agreement and Fifth Amendment to the New Term Loan Agreement with the New Term Loan Lenders and the New Term Loan Agent (the “Term Loan Term Sheet”). Capitalized terms used below that are not otherwise defined have the meaning set forth in the New Term Loan Agreement. The Term Loan Term Sheet contemplates the Company entering into a Fifth Amendment to the New Term Loan Agreement no later than November 22, 2019, in order to, among other things: (1) establish a forbearance period during which the Term Loan Lenders would forbear the exercise of any rights or remedies with respect to the Existing Events of Default until a Termination Event (which would be the earliest of (a) January 31, 2020, (b) March 31, 2020 if a Specified Unsecured Prepetition Debt Satisfaction Event has occurred prior to January 31, 2020 (the earlier of (a) or (b), the “Outside Date”), (c) at the election of the Term Loan Agent, the occurrence of an event of default, other than the Existing Events of Default, (d) the expiration or termination of the forbearance period described in the ABL Term Sheet described below, or (e) the occurrence of any other customary termination event); (2) the payment of a $6 million closing fee, which may be reduced to not less than $1.25 million under certain circumstances; (3) the addition of approximately $3.5 million in other fees to the principal balance of the New Term Loan; (4) in replacement of the Third Amendment Warrants, warrants to purchase, for a price of $0.01 per share, 18% of the outstanding common stock of the Company, with such warrants earned in full and vesting immediately on the date of issuance, but not exercisable until the Outside Date (the “Fourth Amendment Warrants”), provided that if the Obligations are paid in full in cash on or prior to (a) February 29, 2020, the Company shall have the right to buy back 50% of the Fourth Amendment Warrants, and (b) the Outside Date, the Company shall have the right to buy back 75% of the Fourth Amendment Warrants, in each case for a price of $0.01 per share; (5) amend the definition of Applicable Margin so that it will no longer depend on the Net Senior Leverage Ratio and will instead be set at 7.00% per annum for all Prime Rate Loans and 8.00% per annum for all LIBOR Rate Loans; (6) amend the definition of PIK Interest Rate so that it will no longer depend on the Net Senior Leverage Ratio and will instead be set at 2.00% per annum; (7) provide that the New Term Loan and other Obligations shall bear interest at the Default Rate and to increase the Default Rate by 1.00%, which increase will be paid in kind by adding such amount to the principal balance of the Term Loan; (8) convert LIBOR Rate Loans to Prime Rate Loans as their interest periods expire and eliminate the Company’s ability to request to convert or continue the Term Loan or any portion thereof as LIBOR Rate Loans; (9) require the delivery on a weekly basis of detailed 13-week budgets (each, a “Budget”); (10) amend the financial covenants, including the elimination of the Fixed Charge Coverage Ratio and the Net Senior Leverage Ratio during the forbearance period, resetting the Minimum EBITDA to be tested monthly, resetting the minimum Specified Availability to the greater of $12.5 million, replacing the existing clean-down and ABL Facility usage covenant with the same covenants as reflected in the ABL Term Sheet (11) limit the use of cash receipts to payment of Budget disbursements and not submit ABL borrowing requests in excess of the amount needed to fund the Budget; (12) require the Company to pursue a merger, financing transaction, or sale transaction that will cause the Company to repay the Obligations in full prior to the Outside Date, subject to the satisfaction of various milestones and conditions; (13) provide full access rights to the Term Loan Agent, its counsel and its advisors; (14) extend the maturity date of the Term Loan to November 11, 2020; (15) eliminate a number of the Company’s right under the New Term Loan Agreement, including but not limited to its right to consent to assignments, to make Permitted Acquisitions, to reinvest proceeds of Asset Dispositions and Extraordinary Proceeds, and to make Specified Asset Dispositions; and (16) provide for enhanced inspection rights for the New Term Loan Agent.

For purposes of the Term Loan Term Sheet, a “Specified Unsecured Prepetition Debt Satisfaction Event” means, among other things, that a specified percentage of the Specified Unsecured Prepetition Debt has been amended such that its final maturity is not on or before December 11, 2020, does not provide for any payments before that date except for limited percentages in certain limited circumstances, it accrues interest, payable solely in kind, at a rate per annum reasonably satisfactory to the New Term Loan Agent and the required New Term Loan Lenders, and can be secured by a third lien on the Term Loan Priority Collateral, that is subject to an intercreditor agreement, among other things.

Also on November 12, 2019, the Company entered into a non-binding Summary of Terms and Conditions for Forbearance Agreement and Eighth Amendment to Loan Agreement with the ABL Lenders and the ABL Agent (the “ABL Term Sheet”). Capitalized terms used below that are not otherwise defined have the meaning set forth in the ABL Agreement. The ABL Term Sheet contemplates the Company entering into an Eighth Amendment the ABL Agreement no later than November 22, 2019, in order to, among other things: (1) establish a forbearance period during which the ABL Lenders would forbear the exercise of any rights or remedies with respect to the Existing Events of Default until a Termination Event (which would be the earliest of (a) January 31, 2020, (b) March 31, 2020 if a Specified Unsecured Prepetition Debt Satisfaction Event has occurred prior to January 31, 2020 (the earlier of (a) or (b), the “Outside Date”), (c) at the election of the ABL Agent, the occurrence of an event of default, other than the Existing Events of Default, (d) the expiration or termination of the forbearance period provided by the Term Loan Sheet described above, or (e) the occurrence of any other customary termination event); (2) the payment of a fee equal to 0.50% times the amount of the Commitments in effect as of the Closing Date under the ABL; (3) amend the definition of Applicable Margin so that it will no longer depend on the Fixed Charge Coverage Ratio and will instead be set at 300 bps for all Base Rate Loans and 400 bps for all LIBOR Loans; (4) require the delivery on a weekly basis of detailed 13-week budgets (each, a “Budget”); (5) amend the financial covenants, including the elimination of the Fixed Charge Coverage Ratio during the forbearance period, adding a covenant testing trailing twelve-month EBITDA on a monthly basis, in a manner consistent with the Fifth Amendment, replacing the existing clean-down covenant in Section 10.2.3 of the ABL Agreement with a clean-down covenant requiring the Loans be paid down to $10,000,000 at fiscal year end December 28, 2019; (6) limit the use of cash receipts to payment of Budget disbursements and not submit ABL borrowing requests in excess of the amount needed to fund the Budget; (7) require the Company to pursue a merger, sale, or other restructuring transaction that will cause the Company to repay the Term Loan Obligations in full on or prior to the Outside Date, subject to the satisfaction of various milestones and conditions; (8) provide full access rights to the ABL Agent, its counsel and its advisors; (9) extend the maturity date of the ABL to 30 days prior to the extended maturity date of the New Term Loan Agreement described above (expected to be October 11, 2020); (10) eliminate a number of the Company’s rights under the ABL Agreement, including but not limited to its right to consent to assignments, to make Permitted Acquisitions, and to make Specified Asset Dispositions; (11) amend the definitions of Availability Reserve and Borrowing Base to add an availability block equal to $15,000,000; and (12) provide for enhanced inspection rights for the ABL Agent.

The foregoing descriptions of the Term Loan Term Sheet and the ABL Term Sheet are summaries and do not purport to be complete descriptions of the terms thereof. The closing of the Fifth Amendment and the Eighth Amendment are subject to a number of conditions that the Company may not be able to satisfy, and do not represent binding commitments on the part of the New Term Loan Lenders or the ABL Lenders to enter into such amendments on these terms or at all. There is no assurance that the Company will enter into the Fifth Amendment or the Eighth Amendment before November 22, 2019 or at all, or if it does, that the Fifth Amendment and the Eighth Amendment will contain the terms set forth in the Term Loan Term Sheet and the ABL Term Sheet, respectively. In the event the Company is not able to enter into the Fifth Amendment and the Eighth Amendment in a timely manner and the New Term Loan Lenders and the ABL Lenders do not otherwise extend their forbearance, such lenders will be entitled to exercise their rights and remedies under the New Term Loan Agreement and the ABL Agreement, respectively, with respect to the Existing Events of Default.

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Fluctuations in Quarterly Results of Operations

Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the periods from June through September, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by variations in our costs for labor, the products sold, the mix of products sold and general economic conditions. Therefore, results for any quarter are not indicative of the results that we may achieve for any subsequent fiscal quarter or for a full fiscal year. In addition, the 2018 quarterly results may not be comparable to similar quarters in past or future years due to the fulfillment center staffing challenges in 2018. The staffing challenges resulted in orders being fulfilled in the fourth quarter of 2018 versus the third quarter.

Inflation

Inflation, particularly in wage rates, transportation costs, and energy costs has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.

Forward-Looking Statements

Statements in this Quarterly Report on Form10-Q that 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 Operations, including, without limitation, statements with respect to our internal growth plans, projected revenues and revenue growth, 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, beliefs or current expectations 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,” “projects” 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 on Form10-Q 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 Form10-K for the fiscal year ended December 29, 2018.

Other risks and uncertainties include, but are not limited to, the following: failure to comply with restrictive covenants under our credit facilities and other debt instruments; material adverse effects on our operating flexibility resulting from our debt levels; our ability to refinance our currently maturing debt; volatile or uncertain economic conditions; inability to timely respond to the needs of our clients; declining school budgets; cyberattack or improper disclosure or loss of sensitive or confidential company, employee or client data; increasing competition with our Science Curriculum products; and other factors that may be disclosed from time to time in our SEC filings or otherwise.

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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 on Form10-K for the fiscal year ended December 29, 2018.

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 Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective for the purposes set forth in the definition of the Exchange Act rules.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule13a-15(f) under the Exchange Act) during the fiscal quarter ended September 28, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1A. Risk Factors

The following risk factors supplement the Risk Factors described in the Company’s 2018 Annual Report on Form 10-K and should be read in conjunction therewith.

We are highly leveraged and, due to our noncompliance with certain financial covenants, we are subject to short-term forbearance agreements with our term loan lenders and ABL lenders as of the date of this report.

As of September 28, 2019, we had $199.1 million of reported debt, or $204.2 million of gross debt, which excludes debt issuance costs. Due to our noncompliance with certain financial covenants and the short-term nature of the forbearance we have received from our term loan lenders and ABL lenders, as well as the scheduled maturity of certain of this debt in December 2019, all of this debt has been reflected as currently maturing on our balance sheet as of September 28, 2019. If our efforts to extend the forbearance period in effect as of November 12, 2019 and modify the terms of our debt obligations, and either borrow additional funds in sufficient amounts or engage in a sale transaction within the required time period and/or upon the terms specified in those modifications, we may not have the liquidity necessary to retire our debt obligations, which could result in our lenders and other creditors accelerating our debt obligations and our inability to continue as a going concern.

See Item 3, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for a more detailed discussion of our liquidity and how this may affect our ability to continue as a going concern.

As a result of our financial performance in the month ended September 28, 2019, we are obligated to begin issuing warrants to our term loan lenders, which will cause immediate and substantial dilution to our current stockholders.

Under the terms of the third amendment to our term loan agreement, we agreed to issue each month beginning with the month ended September 28, 2019 fully vested and exercisable warrants to our term loan lenders entitling them to purchase up to 2% of our outstanding common stock for a purchase price of $0.001 per share in the event our monthly financial performance does not meet certain thresholds, with the total number of warrants issued not to exceed in the aggregate 18% of our outstanding common stock. The issuance of these warrants will cause immediate and substantial dilution to our shareholders and are expected to cause our share price to decline, and if the conditions for repurchasing them are not satisfied, will substantially reduce the amount our existing common stockholder would receive in any sale transaction. In light of our current financial performance, we anticipate that all of these warrants will be issued.

ITEM 5. Other Information

On October 28, 2019, the “Company” entered into the Fourth Amendment (the “Fourth Amendment”) to the New Term Loan Agreement dated April 7, 2017, in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 28, 2019 required under the New Term Loan Agreement from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the New Term Loan Agent in its discretion. This date was subsequently extended several times by the New Term Loan Agent, most recently to November 12, 2019.

Also on October 28, 2019, the Company entered into the Seventh Amendment (the “Seventh Amendment”) to the ABL Facility dated June 11, 2013, as amended (the “ABL Agreement”) among the Company, certain of its subsidiary borrowers, Bank of America, N.A. and Bank of Montreal as lenders (the “ABL Lenders”), and Bank of America, N.A., as agent for the ABL Lenders (the “ABL Agent”) in order to extend the required delivery date of the unaudited financial statements of the Company and its subsidiaries with respect to the month ended September 28, 2019 required under the ABL Facility from within 30 days after the end of such month to November 4, 2019 or such later date as agreed to in writing by the ABL Agent in its discretion. This date was subsequently extended several times by the ABL Agent, most recently to November 12, 2019.

The Fourth Amendment and the Seventh Amendment each served as a short-term forbearance of the events of default that would have resulted from the delivery of those financial statements due to the Company’s non-compliance with the net senior leverage ratio and the minimum EBITDA covenants under the New Term Loan Agreement as of September 28, 2019 (the “Existing Events of Default”).

The Fourth Amendment and the Seventh Amendment are filed as exhibits to this report and are incorporated herein by reference. The foregoing descriptions of the Fourth Amendment and the Seventh Amendment do not purport to be complete and are qualified in their entirety by the full text of such agreements.

ITEM 6. Exhibits

Exhibit No.	Description
10.1	Fourth Amendment, dated as of October 28, 2019, to the Loan Agreement, dated as of April 7, 2017, by and among School Specialty, Inc., as borrower, certain of its subsidiaries, as guarantors, the financial parties thereto, as lenders, and TCW Asset Management Company, LLC, as agent.
10.2	Seventh Amendment, dated as of October 28, 2019, to the Loan Agreement dated as of June  11, 2013, by and among School Specialty, Inc. and certain of its subsidiaries, as borrowers, Bank of America, N.A. and Bank of Montreal, as lenders, and Bank of America, N.A., as agent for the lenders.
31.1	Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
31.2	Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
101	The following materials from School Specialty, Inc.’s. Quarterly Report on Form10-Q for the quarter ended September 28, 2019 are filed herewith, formatted in XBRL (Extensive Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) the Condensed Consolidated Statement of Stockholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements.

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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 12, 2019	/s/ Michael Buenzow
Date	Michael Buenzow
	Interim Chief Executive Officer
	(Principal Executive Officer)
November 12, 2019	/s/ Kevin L. Baehler
Date	Kevin L. Baehler
	Executive Vice President and Chief Financial Officer
	(Principal Financial Officer)

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