UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
QUARTERLY PERIOD ENDED October 24, 1998.
[ ] 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 (IRS Employer
Jurisdiction of Incorporation) Identification No.)
1000 North Bluemound Drive
Appleton, Wisconsin
(Address of Principal Executive Offices)
54914
(Zip Code)
(920) 734-2756
(Registrant's Telephone Number, including Area Code)
Indicate by check mark whether the Registrant (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that
the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of
the issuer's classes of common stock, as of the latest
practicable date.
Outstanding at
Class November 30, 1998
Common Stock, $0.001 par value 14,572,784
SCHOOL SPECIALTY, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED OCTOBER 24, 1998
PART I - FINANCIAL INFORMATION
Page
Number
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at October 24, 1998
(Unaudited) and April 25, 1998 1
Unaudited Consolidated Statements of Income for
the Three Months Ended October 24, 1998 and
October 25, 1997 and For the Six Months Ended
October 24, 1998 and October 25, 1997 2
Unaudited Consolidated Statements of Cash Flows
for the Six Months Ended October 24, 1998 and
October 25, 1997 3
Notes to Unaudited Consolidated Financial
Statements 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 15
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 16
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SCHOOL SPECIALTY, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
October 24, April 25,
1998 1998
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ - $ -
Accounts receivable, less allowance for
doubtful accounts of $650 and $716,
respectively 149,795 38,719
Inventories 52,093 49,306
Prepaid expenses and other current assets 13,403 13,503
Total current assets 215,291 101,528
Property and equipment, net 39,491 22,553
Intangible assets, net 184,849 99,613
Deferred income tax asset 6,191 -
Other assets 316 35
Total assets $446,138 $223,729
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt $ 10,314 $ 11
Short-term payable to U.S. Office Products - 20,277
Accounts payable 31,023 23,788
Accrued compensation 12,616 4,458
Accrued income taxes 9,373 -
Accrued restructuring 4,200 -
Other accrued liabilities 10,789 5,204
Total current liabilities 78,315 53,738
Long-term payable to U.S. Office Products - 62,699
Long-term debt 205,233 315
Other 226 511
Total liabilities 283,774 117,263
Stockholders' equity:
Common stock, $0.001 par value per share,
151,000,000 shares authorized and
14,572,784 shares issued and
outstanding 15 -
Capital paid in excess of par
value 146,768 -
Divisional equity - 104,883
Accumulated other comprehensive income 5 -
Retained earnings 15,576 1,583
Total stockholders' equity 162,364 106,466
Total liabilities and stockholders' $446,138 $223,729
equity
See accompanying notes to consolidated financial statements.
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(In thousands, except per share
amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
October 24, October 25, October 24, October 25,
1998 1997 1998 1997
Revenues $ 212,316 $ 111,460 $ 338,973 $ 198,489
Cost of revenues 141,555 74,235 224,170 130,927
Gross profit 70,761 37,225 114,803 67,562
Selling, general and administrative
expenses 47,887 25,070 77,529 43,535
Non-recurring charges:
Strategic restructuring plan cost - - 1,074 -
Restructuring costs 4,200 - 4,200 -
Operating income 18,674 12,155 32,000 24,027
Other income (expense):
Interest expense (3,858) (1,385) (5,063) (2,745)
Interest income 45 79 77 124
Income before provision for income 14,861 10,849 27,014 21,406
taxes
Provision for income taxes 7,431 4,884 13,021 9,637
Net income $ 7,430 $ 5,965 $ 13,993 $ 11,769
Weighted average shares:
Basic 14,573 12,263 14,651 12,036
Diluted 14,573 12,588 14,710 12,301
Net income per share:
Basic $ 0.51 $ 0.49 $ 0.96 $ 0.98
Diluted $ 0.51 $ 0.47 $ 0.95 $ 0.96
See accompanying notes to consolidated financial statements.
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)
For the Six Months Ended
October 24, October 25,
1998 1997
Cash flows from operating activities:
Net income $ 13,993 $ 11,769
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization expense 4,271 1,967
Non-recurring charges 5,274 -
Change in current assets and liabilities (net
of assets acquired and liabilities assumed in
business combinations accounted for under the
purchase method):
Accounts receivable (66,923) (42,271)
Inventory 21,914 11,697
Prepaid expenses and other current assets 4,598 1,516
Accounts payable (16,386) 2,531
Accrued liabilities 16,813 8,035
Net cash used in operating activities (16,446) (4,756)
Cash flows from investing activities:
Cash paid in acquisitions, net of cash received (95,030) (68,286)
Additions to property and equipment (1,870) (2,480)
Other 575 (145)
Net cash used in investing activities (96,325) (70,911)
Cash flows from financing activities:
Payments of short-term debt, net (20,277) (1,840)
Advances from (payments to) U.S. Office (62,699) 7,745
Products
Capital contribution by U.S. Office Products 8,095 69,762
Proceeds from issuance of common stock 32,735 -
Payments of long term debt (132,823) -
Proceeds from issuance of long-term debt 290,700 -
Capitalized loan fees (2,960) -
Net cash provided by financing activities 112,771 75,667
Net increase (decrease) in cash and cash
equivalents - -
Cash and cash equivalents, beginning of period - -
Cash and cash equivalents, end of period $ - $ -
Supplemental disclosures of cash flow
information:
Interest paid $ 3,230 $ -
Income taxes paid $ 2,000 $ -
See accompanying notes to consolidated financial statements.
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(unaudited)
(In thousands)
The Company issued common stock and cash in connection
with certain business combinations accounted for under
the purchase method in the six months ended October 24,
1998 and October 25, 1997. The fair values of the
assets and liabilities of the acquired companies at the
dates of the acquisitions are presented as follows:
For the Six Months Ended
October 24, October 25,
1998 1997
Accounts receivable $ 44,153 $ 11,907
Inventories 24,701 16,354
Prepaid expenses and other current
assets 3,251 2,229
Property and equipment 17,312 3,856
Intangible assets 85,312 52,206
Other assets 7,223 210
Short-term debt - (1,850)
Accounts payable (23,621) (7,933)
Accrued liabilities (6,303) (1,783)
Long-term debt (56,998) (3,344)
Net assets acquired $ 95,030 $ 71,852
Acquisitions were funded as follows:
U. S. Office Products common stock $ - $ 3,566
Cash 95,030 68,286
Total $ 95,030 $ 71,852
See accompanying notes to consolidated financial statements.
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(In thousands, except per share amounts)
NOTE 1_BASIS OF PRESENTATION
The accompanying unaudited consolidated financial
statements have been prepared in accordance with
generally accepted accounting principles for interim
financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and
footnotes required by generally accepted accounting
principles for complete financial statements. In the
opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a
fair presentation have been included. The Balance
Sheet at April 25, 1998 has been derived from the
Company's audited financial statements for the fiscal
year ended April 25, 1998. For further information,
refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K
for the year ended April 25, 1998.
NOTE 2_STOCKHOLDERS' EQUITY
Changes in stockholders' equity during the six months
ended October 24, 1998 were as follows:
Stockholders'equity balance at April 25, 1998 $106,466
Shares distributed in public offering 32,735
Contribution by U.S. Office Products 8,095
Compensation Expense from Officer Stock Purchase 1,074
Cumulative translation adjustments 1
Net income 13,993
Stockholders' equity balance at October 24, 1998 $162,364
On June 10, 1998, U.S. Office Products distributed to
its shareholders one share of School Specialty common
stock for every 9 shares of U.S. Office Products common
stock held by each respective shareholder (the
"Strategic Restructuring Plan"). The share data
reflected in the accompanying financial statements
represents the historical share data for U.S. Office
Products for the period or as of the date indicated,
and retroactively adjusted to give effect to the one
for nine distribution ratio and includes shares issued
in the public offering during the three months ended
July 25, 1998.
NOTE 3_EARNINGS PER SHARE
In fiscal 1998, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share." SFAS No. 128 simplifies the
standards required under current accounting rules for
computing earnings per share and replaces the
presentation of primary earnings per share and fully
diluted earnings per share with a presentation of basic
earnings per share ("basic EPS") and diluted earnings
per share ("diluted EPS").
The following information presents the Company's
computations of basic and diluted EPS for the periods
presented in the consolidated statement of income:
Income Shares Per Share
(Numerator) (Denominator) Amount
Three months ended October 24, 1998:
Basic EPS $7,430 14,573 $ 0.51
Effect of dilutive employee
stock options - - -
Diluted EPS $7,430 14,573 $ 0.51
Three months ended October 25, 1997:
Basic EPS $5,965 12,263 $ 0.49
Effect of dilutive employee
stock options - 325 $(0.02)
Diluted EPS $5,965 12,588 $ 0.47
Six months ended October 24, 1998:
Basic EPS $13,993 14,651 $ 0.96
Effect of dilutive employee
stock options - 59 $(0.01)
Diluted EPS $13,993 14,710 $ 0.95
Six months ended October 25, 1997:
Basic EPS $11,769 12,036 $ 0.98
Effect of dilutive employee
stock options - 265 $(0.02)
Diluted EPS $11,769 12,301 $ 0.96
The Company had additional employee stock options
outstanding during the periods presented that were not
included in the computation of diluted EPS because they
were anti-dilutive.
NOTE 4_ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board
("FASB") issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for the
reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a
full set of general purpose financial statements. SFAS
No. 130 is effective for fiscal years beginning after
December 15, 1997. The Company's other comprehensive
income for the period ended October 24, 1998 is $1 and
$5, on a cumulative basis. The Company's comprehensive
income is comprised solely of translation adjustments.
In June 1997, the FASB issued SFAS No. 131,
"Disclosures about segments of an enterprise and
related information. " SFAS No. 131 establishes
standards for the way that public business enterprises
report information about operating segments in annual
financial statements and requires that those
enterprises report selected information about operating
segments in interim financial reports issued to
shareholders. It also establishes standards for related
disclosures about products and services, geographic
areas, and major customers. SFAS No. 131 is effective
for financial statements for fiscal years beginning
after December 15, 1997 and will be presented in the
Company's Annual Report on Form 10-K for the year
ending April 24, 1999. Financial statement disclosures
for prior periods are required to be restated. The
Company is in the process of evaluating the disclosure
requirements. The adoption of SFAS No. 131 will have no
impact on consolidated results of operations, financial
position or cash flow.
In March 1998, the American Institute of Certified
Public Accountants ("AICPA") issued Statement of
Position 98-1, "Accounting for the costs of computer
software developed or obtained for internal use" ("SOP
98-1"). SOP 98-1 requires computer software costs
associated with internal use software to be expensed as
incurred until certain capitalization criteria are met.
The Company will adopt SOP 98-1 during fiscal year
1999. Adoption of this Statement is not expected to
have a material impact on the Company's consolidated
financial position or results of operations.
NOTE 5_CREDIT FACILITY
On June 9, 1998, the Company entered into a secured
$250,000 revolving credit facility with NationsBank,
N.A. as administrative agent. On August 14, 1998, the
Company received a commitment from NationsBank for an
additional $100,000 term loan, amending and increasing
the existing $250,000 credit facility to a total of
$350,000. On September 30, 1998, the Company entered
into a five year secured revolving $350,000 credit
facility upon completion of the syndication led by
NationsBank. Interest on borrowings under the credit
facility will accrue through January 1999 at a rate of,
at the Company's option, either ( i) LIBOR plus 2.375%,
or (ii) the lender's base rate plus a margin of .75%
plus a fee of .475 on the unborrowed amount under the
revolving credit facility. Thereafter, interest will
accrue at a rate of (i) LIBOR plus a range of 1.000% to
2.000%, or (ii) the lender's base rate plus a range of
.000% to .750% plus a fee ranging from .275 to .475 on
the unborrowed amount under the revolving credit
facility (depending on the Company's leverage ratio of
funded debt to EBITDA). Indebtedness is secured by
substantially all of the assets of the Company. The
credit facility is subject to terms and conditions
typical of facilities of such size and includes certain
financial covenants. The Company borrowed under the
credit facility to repay the U.S. Office Products' debt
outstanding on June 10, 1998 in accordance with the
terms of the U.S. Office Products Strategic
Restructuring Plan and to fund the two companies
acquired in Fiscal 1999. The balance of the credit
facility will be available for working capital, capital
expenditures and acquisitions, subject to compliance
with financial covenants. The amount outstanding as of
October 24, 1998 under the credit facility was
approximately $215,000.
The term loan will amortize quarterly over five years
under the following amortization schedule with the
first principal payment due January 30, 1999:
Year 1 $10,000
Year 2 15,000
Year 3 15,000
Year 4 30,000
Year 5 30,000
$100,000
NOTE 6_BUSINESS COMBINATIONS
During the fiscal period ended April 25, 1998, the
Company completed 8 business combinations which were
accounted for under the purchase method.
In the first six months of fiscal 1999, the Company
made two significant acquisitions which were accounted
for under the purchase method of accounting for an
aggregate cash purchase price of $94,819, resulting in
goodwill of approximately $85,000 which will be
amortized over 40 years. The results of these
acquisitions have been included in the Company's
results from their respective dates of acquisition.
The following presents the unaudited pro forma results
of operations of the Company for the three and six
month periods ended October 24, 1998 and October 25,
1997, and includes the Company's consolidated financial
statements, which give retroactive effect to the
acquisitions as if all such purchase acquisitions had
been made at the beginning of fiscal 1998. The results
presented below include certain pro forma adjustments
to reflect the amortization of intangible assets,
adjustments to interest expense, adjustments to
depreciation, and the inclusion of a federal income tax
provision on all earnings for the periods ended October
24, 1998 and October 25, 1997 respectively:
Three Months Ended Six Months Ended
Ended
October 24, October 25, October 24, October 25,
1998 1997 1998 1997
Revenues $212,316 $206,937 $395,043 $391,715
Net income 7,430 6,639 14,697 13,298
Net income per share:
Basic $ 0.51 $ 0.54 $ 1.00 $ 1.10
Diluted $ 0.51 $ 0.53 $ 1.00 $ 1.08
On March 30, 1998, the Company acquired certain assets
of Education Access out of a Federal bankruptcy
proceeding. Accordingly, revenues and net loss for
Education Access included in the above pro forma
results were $2,200 and ($20), respectively, for the
quarter ended October 24, 1998, compared with revenues
and net income of $5,100 and $70, respectively, for the
quarter ended October 25, 1997. Revenues and net loss
were $4,100 and ($110), respectively, for the six
months ended October 24, 1998, compared with revenues
and net income of $14,800 and $540, respectively, for
the six months ended October 25, 1997.
In addition, the Company incurred non-recurring charges
in the quarters ended July 25, 1998 and October 24,
1998. The first quarter non-cash strategic
restructuring plan cost of $1,074 consisted of
compensation expense attributed to the U.S. Office
Products stock option tender offer and the sale of
shares of stock to certain executive management
personnel of the Company, net of underwriting
discounts. The second quarter restructuring cost of
$4,200 is related to the consolidation of the Company's
existing warehousing, customer service and sales
operations resulting from the acquisition of Beckley-
Cardy, Inc. The $4,200 charge includes $2,100 for
employee severance and termination benefits, $1,300 for
lease termination and facility shut-down costs and $800
for write down of fixed assets and inventories.
The after-tax charge included in net income for the
quarter and six months ended October 24, 1998 is $2,516
and $3,158, respectively.
The unaudited pro forma results of operations are
prepared for comparative purposes only and do not
necessarily reflect the results that would have
occurred had the acquisitions occurred at the beginning
of fiscal 1998 or the results which may occur in the
future.
Note 7- Subsequent Events
On October 28, 1998 the Company entered into an
interest rate swap agreement with the Bank of New York
covering $50,000 of the outstanding credit facility.
The agreement fixes the 30 day LIBOR interest rate at
4.37% per annum on the $50,000 notional amount and has
a three year term that may be canceled by the Bank of
New York on the second anniversary.
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The following table sets forth various items as a
percentage of revenues on a historical basis.
THREE MONTHS ENDED SIX MONTHS ENDED
OCTOBER 24, OCTOBER 25, OCTOBER 24, OCTOBER 25,
1998 1997 1998 1997
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 66.7% 66.6% 66.1% 66.0%
Gross profit 33.3% 33.4% 33.9% 34.0%
Selling, general and 22.5% 22.5% 22.9% 21.9%
administrative
expenses
Non-recurring charges:
Strategic restructuring - - 0.3% -
plan cost
Restructuring costs 2.0% - 1.3% -
Operating income 8.8% 10.9% 9.4% 12.1%
Interest expense, net 1.8% 1.2% 1.5% 1.4%
Income before provision
for income taxes 7.0% 9.7% 7.9% 10.7%
Provision for income 3.5% 4.4% 3.8% 4.8%
taxes
Net income 3.5% 5.3% 4.1% 5.9%
Three Months Ended October 24, 1998 Compared to Three
Months Ended October 25, 1997
Revenues
Revenues increased 90.5% from $111.5 million for the
three months ended October 25, 1997 to $212.3 million
for the three months ended October 24, 1998. This
increase was primarily due to the inclusion of revenues
from (i) the two companies acquired in business
combinations accounted for under the purchase method
during the first and second quarters of fiscal 1999,
and (ii) the two companies acquired during the second
half of fiscal 1998 in business combinations accounted
for under the purchase method. Revenues also increased
due to sales to new accounts and increased sales to
existing customers.
Gross Profit
Gross profit increased 90.1%, from $37.2 million or
33.4% of revenues for the three months ended October
25, 1997 to $70.8 million or 33.3% of revenues for the
three months ended October 24, 1998. The decrease in
gross profit as a percentage of revenues was due
primarily to a shift in revenue mix, primarily
attributed to (i) the acquisition of Beckley-Cardy in
the second quarter of fiscal 1999, which has a lower
gross profit as a percentage of
revenues, and (ii)
increases in lower margin bid revenues, offset by
the Childcraft and Sax shifts in reveune mix which
increased the higher gross margins in the specialty
companies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include
selling expenses (the most significant component of
which is sales wages and commissions), operations
expenses (which includes customer service, warehouse
and outbound transportation costs), catalog costs and
general administrative overhead (which includes
information systems, accounting, legal, human resources
and purchasing expense).
Selling, general and administrative expenses increased
91.0%, from $25.0 million or 22.5% of revenues for the
three months ended October 25, 1997 to $47.9 million or
22.5% of revenues for the three months ended October
24, 1998. Lower customer service costs and general
administrative overhead as a percent of revenues
attributed to the integration of the companies acquired
in fiscal 1998 were offset by higher sales,
depreciation and amortization expenses, resulting in no
change in selling, general and administrative expenses
as a percentage of sales.
Non-recurring Charges
The second quarter restructuring costs of $4.2 million
is related to the consolidation of School Specialty
Inc's existing warehousing, customer service and sales
operations resulting from the acquisition of Beckley-
Cardy, Inc. The Company will close and consolidate five
warehouses and seven customer service locations. After
the restructuring, the Company will have eight
distribution centers located in Massachusetts,
Wisconsin, Ohio, Kansas, Texas, Nevada, Oregon and
California and two customer service centers in Ohio and
Wisconsin. The $4.2 million charge includes $2.1
million for employee severance and termination
benefits, $1.3 million for lease termination and
facility shut-down costs and $.8 million for write
down of fixed assets and inventories.
The after-tax charge included in net income for the
quarter is $2.5 million.
Interest Expense
Interest expense, net of interest income, increased
$2.5 million from $1.3 million or 1.2% of revenues for
the three months ended October 25, 1997 to $3.8 million
or 1.8% of revenues for the three months October 24,
1998 primarily due to the increase in debt attributed
to the debt assumed and cash paid for the four
companies acquired since October 25, 1997, offset by
debt repaid from the net proceeds of the Company's
initial public offering and the sale of 250,000 shares
of Common Stock to certain employees in the first
quarter of Fiscal 1999.
Provision for Income Taxes
Provision for income taxes for the three months ended
October 24, 1998 increased 52.2 % or $2.5 million over
the three months ended October 25, 1997, reflecting
income tax rates of 50% and 46% for the three months
ended October 24, 1998 and October 25, 1997, respectively.
The higher effective tax rate, compared to the federal
statutory rate of 35.0%, is primarily due to state
income taxes and non-deductible goodwill amortization.
The increase in the tax rate from 46% to 50% reflects
higher non-deductible goodwill primarily attributed to
the Beckley-Cardy acquisition in the second quarter of
fiscal 1999.
Six Months Ended October 24, 1998 Compared to Six
Months Ended October 25, 1997
Revenues
Revenues increased 71% from $198.5 million for the six
months ended October 25, 1997 to $339.0 million for the
six months ended October 24, 1998. This increase was
primarily due to the inclusion of revenues from (i) the
two companies acquired in business combinations
accounted for under the purchase method during the
first and second quarters of fiscal 1999, and (ii) the
eight companies acquired during fiscal 1998 in business
combinations accounted for under the purchase method.
Revenues also increased due to sales to new accounts
and increased sales to exiting customers.
Gross Profit
Gross profit increased 69.9%, from $67.6 million or
34.0% of revenues for the six months ended October 25,
1997 to $114.8 million or 33.9% of revenues for the six
months ended October 24, 1998. The decrease in gross
profit as a percentage of revenues was due primarily to
a shift in revenue mix, primarily attributed to (i) the
acquisition of Beckley-Cardy in the second quarter of
fiscal 1999, which has a lower gross profit as a
percentage of revenues, and (ii) increases in lower
margin bid revenues, offset by the Childcraft and Sax
shifts in revenue mix which increased the higher gross
margins in the specialty companies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased
78.1%, from $43.5 million or 21.9% of revenues for the
six months ended October 25, 1997 to $77.5 million or
22.9% of revenues for the six months ended October 24,
1998. The increase in selling, general and
administrative expenses as a percentage of revenues was
primarily due to (i) the inclusion of the results of
the six companies acquired in the first and second
quarters of fiscal 1998, which had higher selling,
general and administrative expenses as a percentage of
revenue and (ii) higher depreciation and amortization
expenses.
Non-recurring Charges
In the first quarter of Fiscal 1999, the Company
recorded a non-cash strategic restructuring plan cost
of $1.1 million consisting of compensation expense
attributed to the U.S. Office Products stock option
tender offer and the sale of shares of stock to certain
executive management personnel of the Company, net of
underwriting discounts.
The $4.2 million second quarter charge is related to
the consolidation of the Company's existing
warehousing, customer service and sales operations
resulting from the acquisition of Beckley-Cardy, Inc.
The Company will close and consolidate five warehouses
and seven customer service locations. After the
restructuring, the Company will have eight distribution
centers located in Massachusetts, Wisconsin, Ohio,
Kansas, Texas, Nevada, Oregon and California and two
customer service centers in Ohio and Wisconsin. The
$4.2 million charge includes $2.1 million for employee
severance and termination benefits, $1.3 million for
lease termination and facility shut-down costs and $.8
million for write down of fixed assets and inventories.
The after-tax charge included in net income for the
three months and six months ended October 24, 1998 is
$2.5 million and $3.2 million, respectively.
Interest Expense
Interest expense, net of interest income, increased
$2.4 million from $2.6 million or 1.3% of revenues for
the six months ended October 25, 1997 to $5.0 million
or 1.5% of revenues for the six months October 24, 1998
primarily due to the increase in debt attributed to the
debt assumed and cash paid for the four companies
acquired since October 25, 1997 offset by a reduction
of debt from applying the net proceeds from the
Company's initial public offering and the sale of
250,000 shares of Common Stock to certain employees.
Provision for Income Taxes
Provision for income taxes for the six months ended
October 24, 1998 increased 35.1 % or $3.4 million over
the six months ended October 25, 1997, reflecting
income tax rates of 48.2% and 45% for the six months
ended
October 24, 1998 and the six months ended
October 25, 1997, respectively. The higher effective
tax rate, compared to the federal statutory rate of
35.0%, is primarily due to state income taxes and non-
deductible goodwill amortization, including the non-
deductible goodwill attributed to the second quarter
acquisition of Beckley-Cardy.
Liquidity and Capital Resources
At October 24, 1998, the Company had working capital of
$137 million. The Company's capitalization at October
24, 1998 was $367.6 million and consisted of long-term
debt of $205.2 million and stockholders' equity of
$162.4 million.
The Company anticipates that its cash flow from
operations and borrowings available from its existing
bank credit facility will be sufficient to meet its
liquidity requirements for its operations (including
anticipated capital expenditures) and for its
additional debt service obligations for the remainder
of the fiscal year.
On June 9, 1998, the Company entered into a secured
$250 million revolving credit facility with
NationsBank, N.A. as administrative agent. On August
14, 1998, the Company received a commitment from
NationsBank for an additional $100 million term loan,
amending and increasing the existing $250 million
credit facility to a total of $350 million. On
September 30, 1998, the Company entered into a five
year secured $350 million revolving credit facility
upon completion of the syndication led by NationsBank.
Interest on borrowings under the credit facility will
accrue through January 1999 at a rate of, at the
Company's option, either (i) LIBOR plus 2.375%, or (ii)
the lender's base rate, plus a margin of .75% plus a
fee of .475 on the unborrowed amount under the
revolving credit facility. Thereafter, interest will
accrue at a rate of (i) LIBOR plus a range of 1.000% to
2.000%, or (ii) the lender's base rate plus a range of
.000% to .750% plus a fee ranging from .275 to .475 on
the unborrowed amount under the revolving credit
facility (depending on the Company's leverage ratio of
funded debt to EBITDA). Indebtedness is secured by
substantially all of the assets of the Company. The
credit facility is subject to terms and conditions
typical of facilities of such size and includes certain
financial covenants. The Company borrowed under the
credit facility to repay the U.S. Office Products' debt
outstanding on June 10, 1998 in accordance with the
terms of the U.S. Office Products Strategic
Restructuring Plan and to fund the two companies
acquired in Fiscal 1999. The balance of the credit
facility will be available for working capital, capital
expenditures and acquisitions, subject to compliance
with financial covenants. The amount outstanding as of
October 24, 1998 under the credit facility was
approximately $215 million.
The term loan will amortize quarterly over five years
under the following amortization schedule with the
first principal payment due January 30, 1999:
(000 omitted)
Year 1 $10,000
Year 2 15,000
Year 3 15,000
Year 4 30,000
Year 5 30,000
$100,000
On October 28, 1998 the Company entered into an
interest rate swap agreement with the Bank of New York
covering $50 million of the outstanding credit
facility. The agreement fixes the 30 day LIBOR
interest rate at 4.37% per annum on the $50 million
notional amount and has a three year term that may be
canceled by the Bank of New York on the second
anniversary.
On June 9, 1998, the Company's registration statement
on Form S-1 filed pursuant to the Securities Act of
1933, as amended, was declared effective by the
Securities and Exchange Commission. The registration
statement related to an offering of 2,125,000 shares of
the Common Stock, par value $.001, of the Company at an
aggregate offering price of $32,937,500. On June 10,
1998, the Company sold 2,125,000 shares of Common
Stock. The total proceeds to the Company of the
offering, net of underwriting discounts and commissions
of $2,305,625, were $30,631,875. In addition, the
Company sold 250,000 shares directly to Daniel P.
Spalding, the Chairman of the Board and its Chief
Executive Officer, David J. Vander Zanden, its
President and Chief Operating Officer, and Donald Ray
Pate,
Jr., its Executive Vice President for Re-Print.
The shares were sold at a price of $14.415 for
aggregate consideration of $3,603,750. The sale of
these shares was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
In connection with the offering, the Company incurred
approximately $1,500,000 of expenses. The total net
proceeds to the Company of the offering and the sale of
250,000 shares to certain members of management were
approximately $32,735,625. The net proceeds were used
to reduce indebtedness outstanding under the Company's
credit facility. The debt under the credit facility
had been incurred to pay debt of U.S. Office Products
allocated to the Company in connection with the
Company's spin-off from U.S. Office Products.
During the six months ended October 24, 1998, net
cash used in operating activities was $17.0 million.
This net use of cash by operating activities during the
period is indicative of the high seasonal nature of the
business, with sales occurring in the first and second
quarter of the fiscal year and cash receipts in the
second and third quarters. Net cash used in investing
activities was $96.3 million, including $95.0 million
for acquisitions and $1.9 million for additions to
property and equipment. Net cash provided by financing
activities was $112.8 million. Borrowings under the
revolving credit facility included (i) $16.9 million used
to fund the cash portion of the purchase price of the
Hammond & Stephens acquisition,(ii) $134.7 million used to
fund the Beckley-Cardy acquisition consisting of $78.1
million for the cash portion of the purchase price and
$56.6 million for debt repayment, (iii) $83.3 million used
to repay the U.S. Office Products debt in accordance with the
terms of the Strategic Restructuring Plan and (iv) $56 million
used for short-term funding of seasonal working capital and
the purchase of property and equipment. $32.7 million net
proceeds from the Company's initial public offering and the
sale of 250,000 shares of Common Stock to certain employees
was used to repay a portion of the $290.7 million borrowed
under the revolving credit facility. U. S. Office Products
contributed capital of $8.1 million as required under the
distribution agreement entered into with the Company in
connection with the spin-off.
During the six months ended October 25, 1997, net
cash used in operating activities was $4.8 million.
Net cash used in investing activities was $70.9
million, including $68.3 million for acquisitions and
$2.5 million for additions to property and equipment.
Net cash provided by financing activities was $75.7
million, including $68.3 million provided by U.S.
Office Products to fund the cash portion of the
purchase price and the repayment of debt associated
with the fiscal 1998 purchased companies and $7.7
million advanced by U.S. Office Products to fund
working capital and the purchase of property and
equipment, partially offset by $1.8 million used to
repay indebtedness.
Fluctuations in Quarterly Results of Operations
The Company's business is subject to seasonal
influences. The Company's historical revenues and
profitability have been dramatically higher in the
first two quarters of its fiscal year (May-October)
primarily due to increased shipments to customers
coinciding with the start of each school year.
Quarterly results also may be materially affected by
the timing of acquisitions, the timing and magnitude of
costs related to such acquisitions, variations in
prices paid by the Company for the products it sells,
the mix of products sold and general economic
conditions. Moreover, the operating margins of
companies acquired by the Company may differ
substantially from those of the Company which could
contribute to the further fluctuation in its quarterly
operating results. Therefore, results for any quarter
are not indicative of the results that the Company may
achieve for any subsequent fiscal quarter or for a full
fiscal year.
Inflation
The Company does not believe that inflation has had a
material impact on its results of operations during the
three or six months ended October 24, 1998 and October
25, 1997, respectively.
Year 2000
The Year 2000 issue exists because many computer
systems and applications, including those embedded in
equipment and facilities, use two digit rather than
four digit date fields to designate an applicable year.
As a result,
the systems and applications may not
properly recognize the year 2000 or process data which
includes it, potentially causing data miscalculations
or inaccuracies or operational malfunctions or
failures.
The Company has established a centrally-managed,
company-wide plan to identify, evaluate and address
Year 2000 issues. Included in the scope of this plan
are the Company's operational and financial information
technology ("IT") systems and applications, and end-
user computing resources. Defined in the plan are
compliance definitions and testing guidelines for in-
house developed applications and computer hardware
platforms. The plan defines a methodology for assessing
in-house developed applications. Certifications are
being acquired from suppliers for purchased software,
including standard software used on personal computers.
In addition, the plan contemplates a review of the Year
2000 compliance efforts of the Company's key suppliers and
other principal business partners and, as appropriate, the
development of joint business support and continuity plans
for Year 2000 issues. While this initiative is broad in scope,
it has been structured to identify and prioritize the Company's
efforts for mission critical systems, network elements and
products and key business partners.
Work is progressing in the following phases:
assessment, remediation, and verification. The
assessment phase involves identifying all in-house
developed computer applications, purchased software and
hardware, merchandise vendors and non-IT systems. The
assessment phase also includes developing a plan for
addressing each item and/or vendor to ensure Year 2000
compliance. The remediation phase is implementing the
change to reach compliance and unit testing. This
includes correspondence with vendors that have products
or services that impact the Company's ability to
continue normal business operations. The verification
phase is system testing the change(s) in similar
environments. This includes testing with vendors and
service provider organizations. Although the pace of
the work varies among the Company's business units and
the phases are often conducted in parallel, as of
October 24, 1998, the assessment phase has been
substantially completed and the remediation and
verification phases are in progress.
The Company expects that most of its mission critical
systems, network elements and products will be
remediated and verified by May, 1999, subject to
additional Year 2000 testing and responsive actions.
The Company's ability to meet that target is dependent
upon a variety of factors, including the timely
provision of necessary upgrades and modifications by
the Company's suppliers and contractors. In some
instances, upgrades or modifications are not expected to
be available until late 1998 or early 1999; accordingly,
the Company's testing and redeployment of affected
items may be delayed until later in 1999. In addition,
the Company has no method of ensuring that third
parties on whom the Company depends for essential
services (such as electric utilities, communication
carriers, freight carriers, etc.) will convert their
critical systems and processes in a timely manner.
Failure or delay by any of these parties could
significantly disrupt the Company's business. However,
the Company has established a supplier compliance
program, and is working with its key suppliers to
minimize such risks.
The Company is utilizing both internal and external
resources to reprogram, or replace and test the
software for Year 2000 modifications. The Company
currently estimates that it will incur expenses of
approximately $0.1 million through 1999 in connection
with the Company's anticipated Year 2000 efforts, in
addition to approximately $0.05 million in expenses
incurred through October 24, 1998 for matters historically
identified as Year 2000-related. The timing of expenses
may vary and is not necessarily indicative of readiness
efforts or progress to date. The Company anticipates
that a portion of its Year 2000 expenses will not be
incremental costs, but rather will represent the
redeployment of existing IT resources. The Company also
expects to incur certain capital improvement costs
(totaling approximately $0.3 million) to support this
project. Such capital costs are being incurred sooner
than originally planned, but, for the most part, would
have been required in the normal course of business.
The Company expects to fund its Year 2000 efforts
through operating cash flows. The Company will utilize
its credit facility for capital improvements related to
the effort.
As part of the Company's Year 2000 initiative, the
Company is evaluating scenarios that may occur as a
result of the century change and are in the process of
developing contingency and business continuity plans
tailored for Year 2000-related occurrences. The
Company is highly reliant on its order processing and
inventory systems to fill orders, bill the customer and
collect payments. A loss of either of these systems
would cause long delays in filling and shipping
products, billing the customer and collecting accounts
receivable. The highly seasonal nature of the
Company's business does not allow for any delay in
shipping products to customers. Although the seasonal
nature of the Company's business would heighten any
problems encountered, the timing of the majority of the
Company's sales, shipping, billing and collection
efforts for Fiscal 1999 will be complete prior to the
Year 2000. The Company expects that any unforeseen
problems related to Year 2000 issues would be
identified within the months of January and February
2000, which is the slowest period for the Company. The
Company has identified that it may experience certain
inconveniences or inefficiencies as a result of a
supplier's failure to remediate its Year 2000 issue.
The Company believes however, that the vast majority of
the Company's business will proceed without any
significant interruption.
The above information is based on the Company's current
best estimates, which were derived using numerous
assumptions of future events, including the
availability and future costs of certain technological
and other resources, third party modification actions
and other factors. Given the complexity of these issues
and possible unidentified risks, actual results may
vary materially from those anticipated and discussed
above. Specific factors that might cause such
differences include, among others, the availability and
cost of personnel trained in this area, the ability to
locate and correct all affected computer code, the
timing and success of remedial efforts of the Company's
third party suppliers and similar uncertainties.
Forward-Looking Statements
In accordance with the Private Securities
Litigation Reform Act of 1995, the Company can obtain a
"safe-harbor" for forward-looking statements by
identifying those statements and by accompanying those
statements with cautionary statements which identify
factors that could cause actual results to differ
materially from those in the forward-looking
statements. Accordingly, the foregoing "Management's
Discussions and Analysis of Financial Condition and
Results of Operations" contains certain forward-looking
statements relating to growth plans and projected
revenues, earnings and costs. The Company's actual
results may differ materially from those contained in
the forward-looking statements herein. Factors which
may cause such a difference to occur include those
factors identified in Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of
Operation_Factors Affecting the Company's Business,"
contained in the Company's Form 10-K for the year ended
April 25, 1998, which factors are incorporated herein
by reference to such Form 10-K.
Item 3. Quantitative and Qualitative Disclosures about
Market Risk
Not applicable.
Part II - OTHER INFORMATION
Item 5. Other Information
Under the terms of the agreement entered into on June
9, 1998 between the Company and U.S. Office Products in
connection with the Strategic Restructuring Plan (the
"Distribution Agreement"), the Company has agreed to
indemnify U.S. Office Products for certain liabilities
incurred by U.S. Office Products prior to the spin-off
of the Company from U. S. Office Products, including
liabilities under federal securities laws (the
"Indemnification Obligation"). The Company's
Indemnification Obligation is shared on a pro rata
basis with the three other former divisions of U.S.
Office Products which were simultaneously spun off with
the Company as separate publicly traded entities in
connection with the Strategic Restructuring Plan.
U.S. Office Products has been named as a defendant in
various class action lawsuits. These lawsuits
generally allege violations of federal securities laws
by U.S. Office Products and other named defendants
during the months preceding the Strategic Restructuring
Plan. The Company has not received any notice or claim
from U.S. Office Products alleging that these lawsuits
are within the scope of the Indemnification Obligation.
Also, U.S. Office Products may have insurance which may
reduce the amount of any "indemnifiable loss" it may
suffer as a result of these lawsuits. To the extent
the
Company would incur
liability under the Company's Indemnification
Obligation, the Company's pro rata share of the
liabilities, including any deductible under insurance
coverage, according to the Distribution Agreement is
approximately 12%, limited in aggregate to $1.75
million.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No. Description
27.1 Financial Data Schedule
(b) The Company filed 1 report on Form 8-K during the
quarter covered by this report, as follows:
(i) Form 8-K/A dated June 30, 1998, filed on
September 14, 1998 under Items 2 and 7. Financial
statements for Hammond & Stephens Company and the
National School Supply Company are included in this
report, as are pro forma combined financial statements
for the Company.
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)
12/7/98 /s/ Daniel P. Spalding
- ------------------- -------------------------
Date Daniel P. Spalding
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
12/7/98 /s/ Donald J. Noskowiak
- ------------------- -----------------------------
Date Donald J. Noskowiak
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
INDEX TO EXHIBITS
Exhibit No. Description
27.1 Financial Data Schedule