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10Q-QTR3C
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 JANUARY 23, 1999
[ ] 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.)
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 FEBRUARY 23, 1999
----- -----------------
Common Stock, $0.001 par value 14,578,925
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SCHOOL SPECIALTY, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JANUARY 23, 1999
PART I - FINANCIAL INFORMATION
Page
Number
------
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at January 23, 1999
(Unaudited) and April 25, 1998........................................................... 1
Unaudited Consolidated Statements of Income for the Three
Months Ended January 23, 1999 and January 24, 1998 and
For the Nine Months Ended January 23, 1999 and January 24, 1998.......................... 2
Unaudited Consolidated Statements of Cash Flows for the Nine
Months Ended January 23, 1999 and January 24, 1998....................................... 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...................................................................................... 14
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION ................................................................................ 14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................................................. 15
-Index-
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SCHOOL SPECIALTY, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
January 23, April 25,
1999 1998
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ................................... $ - $ -
Accounts receivable, less allowance for doubtful accounts
of $1,778 and $716, respectively ....................... 84,843 38,719
Inventories ................................................. 46,799 49,307
Prepaid expenses and other current assets ................... 16,219 13,503
-------- --------
Total current assets ...................................... 147,861 101,529
Property and equipment, net ................................. 39,781 22,553
Intangible assets, net ...................................... 183,693 99,613
Deferred income tax asset ................................... 6,191 -
Other assets ................................................ 987 34
-------- --------
Total assets .............................................. $378,513 $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 ............................................ 15,485 23,788
Accrued compensation ........................................ 11,945 4,458
Accrued income taxes ........................................ 5,596 -
Accrued restructuring ....................................... 3,638 472
Other accrued liabilities ................................... 10,057 4,732
-------- --------
Total current liabilities ................................. 57,035 53,738
Long-term payable to U.S. Office Products....................... - 62,699
Long-term debt ................................................. 162,199 315
Other .......................................................... 212 511
-------- --------
Total liabilities ......................................... 219,446 117,263
Stockholders' equity:
Preferred stock, $0.001 par value per share, 1,000,000 shares
authorized; none outstanding ............................... - -
Common stock, $0.001 par value per share, 150,000,000 shares
authorized and 14,578,925 shares issued and outstanding .... 15 -
Capital paid in excess of par value.......................... 146,768 -
Divisional equity ........................................... - 104,883
Accumulated other comprehensive income ...................... 6 -
Retained earnings ........................................... 12,278 1,583
-------- --------
Total stockholders' equity ................................ 159,067 106,466
-------- --------
Total liabilities and stockholders' equity .............. $378,513 $223,729
======== ========
See accompanying notes to consolidated financial statements.
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SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
January 23, January 24, January 23, January 24,
1999 1998 1999 1998
Revenues ................................... $ 85,359 $ 49,391 $ 424,332 $ 247,880
Cost of revenues ........................... 57,266 33,178 281,436 164,105
--------- --------- --------- ---------
Gross profit .......................... 28,093 16,213 142,896 83,775
Selling, general and administrative expenses 30,476 19,860 108,005 63,395
Non-recurring charges:
Strategic restructuring plan cost ..... - - 1,074 -
Restructuring costs ................... - - 4,200 -
--------- --------- --------- ---------
Operating income ........................... (2,383) (3,647) 29,617 20,380
Other income (expense):
Interest expense ........................ (3,879) (1,411) (8,942) (4,100)
Interest income ......................... 37 - 114 109
Other ................................... - (441) - (441)
--------- --------- --------- ---------
Income before provision for income taxes ... (6,225) (5,499) 20,789 15,948
Provision for income taxes ................. (2,927) (2,565) 10,094 7,113
--------- --------- --------- ---------
Net income ................................. $ (3,298) $ (2,934) $ 10,695 $ 8,835
========= ========= ========= =========
Weighted average shares:
Basic ...................................... 14,579 14,181 14,625 12,751
Diluted .................................... 14,579 14,181 14,665 13,020
Net income per share:
Basic ...................................... $ (0.23) $ (0.21) $ 0.73 $ 0.69
Diluted .................................... $ (0.23) $ (0.21) $ 0.73 $ 0.68
See accompanying notes to consolidated financial statements.
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SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
For the Nine months Ended
January 23, January 24,
1999 1998
Cash flows from operating activities:
Net income .......................................................... $ 10,695 $ 8,835
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization expense ............................. 6,607 3,382
Non-recurring charges ............................................. 5,274 -
Amortization of loan fees ......................................... 420 -
Other ............................................................. - 43
Change in current assets and liabilities (net of assets acquired and
liabilities assumed in business combinations accounted for under the
purchase method):
Accounts receivable ............................................... (1,971) (6,450)
Inventory ......................................................... 27,208 9,590
Prepaid expenses and other current assets ......................... 1,722 3,844
Accounts payable .................................................. (31,924) (6,593)
Accrued liabilities ............................................... 11,069 2,741
--------- ---------
Net cash provided by operating activities ..................... 29,100 15,392
Cash flows from investing activities:
Cash paid in acquisitions, net of cash received ..................... (95,030) (92,076)
Additions to property and equipment ................................. (3,978) (4,095)
Other ............................................................... 171 (366)
--------- ---------
Net cash used in investing activities ......................... (98,837) (96,537)
--------- ---------
Cash flows from financing activities:
Payments of short-term debt, net .................................... (20,277) (1,841)
Advances from (payments to) U.S. Office Products .................... (62,699) 19,424
Capital contribution by U.S. Office Products ........................ 8,095 69,762
Proceeds from issuance of common stock .............................. 32,735 -
Payments of long term debt .......................................... (187,857) (6,200)
Proceeds from issuance of long-term debt ............................ 302,700 -
Capitalized loan fees ............................................... (2,960) -
--------- ---------
Net cash provided by financing activities ..................... 69,737 81,145
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 ....................................................... $ 7,153 $ 27
Income taxes paid ................................................... $ 3,429 $ -
See accompanying notes to consolidated financial statements.
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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 nine months ended
January 23, 1999 and January 24, 1998. The fair values of the assets and
liabilities of the acquired companies at the dates of the acquisitions are
presented as follows:
For the Nine months Ended
January 23, January 24,
1999 1998
Accounts receivable .......................... $ 44,153 $ 17,848
Inventories .................................. 24,701 18,075
Prepaid expenses and other current assets .... 3,251 2,431
Property and equipment ....................... 17,312 6,667
Intangible assets ............................ 85,312 74,741
Other assets ................................. 7,223 210
Short-term debt .............................. - (1,850)
Accounts payable ............................. (23,621) (9,410)
Accrued liabilities .......................... (6,303) (7,050)
Long-term debt ............................... (56,998) (6,020)
-------- --------
Net assets acquired .................. $ 95,030 $ 95,642
======== ========
Acquisitions were funded as follows:
U. S. Office Products common stock ........... $ - $ 3,566
Cash ......................................... 95,030 92,076
-------- --------
Total ............................... $ 95,030 $ 95,642
======== ========
See accompanying notes to consolidated financial statements.
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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
audited financial statements of School Specialty, Inc. (the "Company") 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 nine months ended January 23, 1999
were as follows:
Stockholders' equity balance at April 25, 1998 $106,466
Shares issued in June 1998 32,735
Contribution by U.S. Office Products 8,095
Compensation Expense from Officer Stock Purchase 1,074
Cumulative translation adjustment 2
Net income 10,695
-------
Stockholders' equity balance at January 23, 1999 $159,067
========
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 "spin-off"). 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. The current year share data also includes shares that the
Company issued during the first quarter of the fiscal year.
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 January 23, 1999:
Basic EPS $ (3,298) 14,579 $ (0.23)
Effect of dilutive employee stock options -- -- --
Diluted EPS $ (3,298) 14,579 $ (0.23)
Three months ended January 24, 1998:
Basic EPS $ (2,934) 14,181 $ (0.21)
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Effect of dilutive employee stock options -- -- --
Diluted EPS $ (2,934) 14,181 $ (0.21)
Nine months ended January 23, 1999:
Basic EPS $ 10,695 14,625 $ 0.73
Effect of dilutive employee stock options -- 40
Diluted EPS $ 10,695 14,665 $ 0.73
Nine months ended January 24, 1998:
Basic EPS $ 8,835 12,751 $ 0.69
Effect of dilutive employee stock options -- 269
Diluted EPS$ $ 8,835 13,020 $ 0.68
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 January
23, 1999 is $1 and $5, on a cumulative basis. The Company's comprehensive income
is comprised solely of translation adjustments. The adoption of SFAS No. 130
will have no impact on consolidated results of operations, financial position or
cash flow.
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.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." This statement, which is required to be
adopted for annual periods beginning after June 15, 1999, establishes standards
for recognition and measurement of derivatives and hedging activities. The
Company will implement this statement in fiscal year 2001 as required. The
adoption of SFAS No. 133 is not expected to have a material effect on the
Company's financial position or results of operations.
NOTE 5--CREDIT FACILITY
On September 30, 1998, the Company entered into a five year secured $350,000
senior credit facility consisting of a $250,000 revolving loan and $100,000 term
loan. Under the senior credit facility, interest on borrowings accrued through
the third fiscal quarter 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 an unused
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
an unused 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
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the assets of the Company. The senior credit facility is subject to terms and
conditions typical of facilities of such size and includes certain financial
covenants. The Company borrowed under the senior credit facility to repay the
U.S. Office Products' debt outstanding on June 10, 1998 in accordance with the
terms of the spin-off, to fund the two companies acquired in the first three
quarters of fiscal 1999 and for seasonal working capital. The balance of the
senior credit facility will be available for working capital, capital
expenditures and acquisitions, subject to compliance with financial covenants.
The amount outstanding as of January 23, 1999 under the senior credit facility
was approximately $172,000.
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 senior 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. The floating LIBOR interest rate
at January 23, 1999 was 4.94%.
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 eight
business combinations which were accounted for under the purchase method.
In the first nine 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 approximately $95,000, 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 nine month periods ended January 23, 1999 and January
24, 1998, 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 January 23, 1999 and January 24, 1998 respectively:
Three Months Ended Nine months Ended
January 23, January 24, January 23, January 24,
1999 1998 1999 1998
Revenues .................. $ 85,359 $ 81,257 $ 480,402 $ 472,975
Net income ................ (3,298) (6,045) 11,399 7,253
Net income per share:......
Basic ..................... $ (0.23) $ (0.43) $ .78 $ .57
Diluted ................... $ (0.23) $ (0.43) $ .78 $ .56
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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 $600 and ($24),
respectively, for the quarter ended January 23, 1999, compared with revenues and
net loss of $3,300 and $(350), respectively, for the quarter ended January 24,
1998. Revenues and net loss were $4,700 and ($150), respectively, for the nine
months ended January 23, 1999, compared with revenues and net income of $18,100
and $120, respectively, for the nine months ended January 24, 1998.
In addition, the Company incurred non-recurring charges in the quarters ended
July 25, 1998 and October 24, 1999. 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 costs of $4,200 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 $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 nine months ended January
23, 1999 is $3,158.
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 February 9, 1999 the Company purchased Sportime, LLC, the physical education,
athletic and recreation products business of Genesis Direct Inc. for
approximately $23 million in cash. Sportime had 1998 revenues of $32.6 million.
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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 NINE MONTHS ENDED
JANUARY 23, JANUARY 24, JANUARY 23, JANUARY 24,
1999 1998 1999 1998
---- ---- ---- ----
Revenues ................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues ........................... 67.1% 67.2% 66.3% 66.2%
------ ------ ------ ------
Gross profit ............................... 32.9% 32.8% 33.7% 33.8%
Selling, general and administrative expenses 35.7% 40.2% 25.5% 25.6%
Non-recurring charges:
Strategic restructuring plan cost ........ -- -- 0.2% --
Restructuring costs ...................... -- -- 1.0% --
------ ------ ------ ------
Operating Income ......................... (2.8)% (7.4)% 7.0% 8.2%
Interest expense, net .................... 4.5% 2.9% 2.1% 1.6%
Other .................................... -- .9% -- --
------ ------ ------ ------
Income before provision for income taxes ... (7.3)% (11.2)% 4.9% 6.4%
Provision for income taxes ................. (3.4)% (5.2)% 2.4% 2.9%
------ ------ ------ ------
Net income ................................. (3.9)% (6.0)% 2.5% 3.5%
====== ====== ====== ======
THREE MONTHS ENDED JANUARY 23, 1999 COMPARED TO THREE MONTHS ENDED JANUARY 24,
1998
Revenues
Revenues increased 72.8%, from $49.4 million for the three months ended January
24, 1998 to $85.4 million for the three months ended January 23, 1999. This
increase was due primarily to the inclusion in the three months ended January
23, 1999 of (1) the revenues of the two businesses acquired during fiscal 1999
and (2) all of the revenues of two businesses acquired in the last two quarters
of fiscal 1998 (whose revenues were included in the three months ended January
23, 1998 only from the date of acquisition). Revenues also increased due to
sales to new accounts and increased sales to existing customers.
Gross Profit
Gross profit increased 73.3%, from $16.2 million for the three months ended
January 24, 1998 to $28.1 million for the three months ended January 23, 1999.
Gross margins (gross profit as a percentage of revenues) were essentially flat
at 32.8% for the three months ended January 24, 1998 and 32.9% for the three
months ended January 23, 1999. Gross margins were increased primarily by the
positive impact of increased sales of higher margin specialty products partially
offset by the acquisition of Beckley-Cardy in the second quarter of fiscal 1999
(which had a lower gross margin than our existing businesses).
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
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transportation costs), catalog costs and general administrative overhead (which
includes information systems, accounting, legal, human resources and purchasing
expense).
Selling, general and administrative expenses (which include depreciation and
amortization) increased 53.4%, from $19.9 million for the three months ended
January 24, 1998 to $30.5 million for the three months ended January 23, 1999.
As a percentage of revenues, these expenses decreased from 40.2% for the three
months ended January 24, 1998 to 35.7% for the three months ended January 23,
1999. The decrease in selling, general and administrative expenses as a
percentage of revenues was due primarily to the elimination of redundant
selling, general and administrative expenses and the consolidation of
warehousing under the restructuring plan discussed below.
Interest Expense
Interest expense, net of interest income, increased 36%, from $1.4 million, or
2.9% of revenues, for the three months ended January 24, 1998 to $3.9 million,
or 4.5% of revenues, for the three months January 23, 1999 primarily due to the
increase in debt attributable to the acquisition of the three businesses
acquired since January 24, 1998, offset by the reduction in debt from applying
the net proceeds from our initial public offering and private placement of
Common Stock in June 1998 and the forgiveness of debt from U.S. Office Products
in connection with the spin-off.
Provision for Income Taxes
Provision (benefit) for income taxes decreased 14.1 % from $(2.6 million) for
the three months ended January 24, 1998 to $(2.9 million) for the three months
ended January 23, 1999, due to slightly higher pre-tax losses attributed to the
increased size of the business and reflecting the same effective income tax rate
of 47% for each of the three month periods ended January 24, 1998 and January
23, 1999. The higher effective tax rate, compared to the federal statutory rate
of 35%, is primarily due to state income taxes and nondeductible goodwill
amortization.
NINE MONTHS ENDED JANUARY 23, 1999 COMPARED TO NINE MONTHS ENDED JANUARY 24,
1998
Revenues
Revenues increased 71.2%, from $247.9 million for the nine months ended
January 24, 1998 ("Interim 1998") to $424.3 million for the nine months ended
January 23, 1999 ("Interim 1999"). This increase was due primarily to the
inclusion in Interim 1999 of (1) the revenues of two businesses acquired during
Interim 1999 from their respective dates of acquisition and (2) all of the
Interim 1999 revenues of seven businesses acquired in Interim 1998 (whose
revenues were included in Interim 1998 only from the date of acquisition).
Revenues also increased due to sales to new accounts, increased sales to
existing customers and higher pricing on certain products in response to
increased product costs.
Gross Profit
Gross profit increased 70.6%, from $83.8 million in Interim 1998 to $142.9
million in Interim 1999 primarily due to the acquisitions referred to above.
Gross margins (gross profit as a percentage of revenues) were essentially flat
at 33.8% for Interim 1998 and 33.7% for Interim 1999. Gross margins were reduced
by the acquisition of Beckley-Cardy in the second quarter of Interim 1999 (which
had a lower gross margin than our existing businesses) and an increase in lower
margin bid revenues in our traditional businesses. These reductions in gross
margins were almost entirely offset by the positive impact of increased sales of
higher margin specialty products and lower product costs due to higher vendor
purchase rebates, which reflected our increased buying power.
Selling, General and Administrative
Selling, general and administrative expenses (including depreciation and
amortization) increased 70.4%, from $63.4 million in Interim 1998 to $108.0
million in Interim 1999 due primarily to the acquisitions referred to above. As
a percentage of revenues, these expenses were essentially flat at 25.6% for
Interim 1998 and 25.5% for Interim 1999. The decrease in selling, general and
administrative expenses as a percentage of revenues resulting from cost savings
attributable to the integration of companies acquired during fiscal 1998 and the
consolidation of the Company's warehousing under the restructuring plan
discussed below were almost offset by increases attributable to the acquisition
of Beckley-Cardy in the second quarter of Interim 1999 (which had higher
selling, general and administrative expenses as a percentage of revenues than
the Company's existing businesses) and higher depreciation and amortization
expenses due to the acquisitions referred to above.
Restructuring Charges
Restructuring charges during Interim 1999 included (1) a non-cash
restructuring charge of $1.1 million in the first quarter of Interim 1999,
consisting of compensation expense attributed to the U.S. Office Products stock
option tender offer and the sale of shares of Common Stock to some of the
Company's executive management personnel, net of underwriting discounts and (2)
a $4.2 million restructuring charge in the second quarter of Interim 1999
relating to the Company's plan to consolidate its existing warehousing, customer
service and sales operations following the acquisition of Beckley-Cardy. Under
this restructuring plan, the Company intends to reduce its distribution centers
from 13 to eight and its customer service centers from seven to two during the
period from October 1998 through December 1999. The $4.2 million charge consists
of $2.1 million for employee severance and termination benefits, $1.3 million
for lease termination and facility shut-down costs and $0.8 million for write
down of fixed assets and inventories. On an after-tax basis these restructuring
charges reduced net income for Interim 1999 by $3.2 million.
Interest Expense
Interest expense, net of interest income, increased 121%, from $4.0
million, or 1.6% of revenues, for Interim 1998 to $8.8 million, or 2.1% of
revenues, for Interim 1999 primarily due to the increase in debt attributable to
the acquisition of the three businesses since January 24, 1998 offset by the
reduction in debt from applying the net proceeds from the Company's initial
public offering of Common Stock and private placement in June 1998 and the
forgiveness of debt from U.S. Office Products in connection with the spin-off.
Provision for Income Taxes
Provision for income taxes increased 41.9% from $7.1 million for Interim
1998 to $10.1 million for Interim 1999, reflecting effective income tax rates of
49% for Interim 1999 and 45% for Interim 1998. The higher effective tax rate,
compared to the federal statutory rate of 35%, is primarily due to state income
taxes and nondeductible goodwill amortization.
10
13
LIQUIDITY AND CAPITAL RESOURCES
At January 23, 1999, the Company had working capital of $90.8 million. The
Company's capitalization at January 23, 1999 was $331.6 million and consisted of
debt of $172.5 million and stockholders' equity of $159.1 million.
The Company currently has a five year secured $350 million revolving Senior
Credit Facility with NationsBank, N.A. The Senior Credit Facility has a $100
million term loan payable quarterly over five years commencing in January 1999
and revolving loans which mature on September 30, 2003. The amount outstanding
as of January 23, 1999 under the Senior Credit Facility was approximately $172
million. Borrowings under the Senior Credit Facility are usually significantly
higher during the Company's first and second quarters to meet the working
capital needs of the Company's peak selling season. 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 Senior Credit Facility. The agreement
fixes the 30 day LIBOR interest rate at 4.37% per annum (floating LIBOR on
January 23, 1999 was 4.94%) 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. As of January 23, 1999, the effective interest rate on borrowings
under the Company's Senior Credit Facility was approximately 8%. Since the
beginning of fiscal 1999, the Company borrowed under the Senior Credit Facility
to fund three acquisitions and for seasonal working capital and capital
expenditures.
On June 9, 1998, the Company sold 2,125,000 shares of Common Stock in a
public offering for $30,631,875 in net proceeds. In addition, the Company sold
250,000 shares of Common Stock in a private placement directly to Daniel P.
Spalding, its Chairman of the Board and Chief Executive Officer, David J. Vander
Zanden, its President and Chief Operating Officer, and Donald Ray Pate, Jr., its
Executive Vice President for ClassroomDirect.com (formerly named Re-Print), at a
price of $14.415 per share for aggregate consideration of $3,603,750. In
connection with the offerings, the Company incurred approximately $1,500,000 of
expenses. The total net proceeds to the Company from the offerings were
approximately $32,735,625. The net proceeds were used to reduce indebtedness
outstanding under the Company's Senior Credit Facility.
During the nine months ended January 23, 1999, net cash provided by
operating activities was $29.1 million. This net cash provided 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 $98.8 million, including $95 million for acquisitions
and $3.9 million for additions to property and equipment and other. Net cash
provided by financing activities was $69.7 million. Borrowing under the Senior
Credit Facility included (1) $16.9 million used to fund the cash portion of the
purchase price of the Hammond & Stephens acquisition, (2) $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, (3) $83.3
million used to repay the U.S. Office Products debt in connection with the
spin-off and (4) $67.8 million used for short-term funding of seasonal working
capital and the purchase of property and equipment. The $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
$302.7 million borrowed under the Senior 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 nine months ended January 24, 1998, net cash used in operating
activities was $15.4 million. Net cash used in investing activities was $96.5
million, including $92.1 million for acquisitions and $4.1 million for additions
to property and equipment and other. Net cash provided by financing activities
was $81.1 million, including $89.2 million provided by U.S. Office Products to
fund the cash portion of the purchase price and the repayment of debt associated
with the eight companies acquired in business combinations accounted for under
the purchase method during fiscal 1998 and to fund working capital and the
purchase of property and equipment, partially offset by $8 million used to repay
indebtedness.
The Company's anticipated capital expenditures for the next twelve months
is approximately $10 million. The largest items include software development for
the Company's Internet initiative, computer hardware and software and warehouse
equipment.
The Company is currently considering, and has hired a nationally known
commercial real estate agent to market, a sale and leaseback transaction
involving six distribution facilities in Ohio, Massachusetts, Kansas, Texas,
Nevada and Illinois. The Company is currently seeking bids on these properties
for such a transaction. The Company may sell all or any number of these
facilities or could substitute other properties it owns in this transaction. The
Company believes that the current fair market value for these distribution
facilities is approximately $26 million with net proceeds to the Company of
approximately $25 million which would be used to repay outstanding indebtedness
under the Company's Senior Credit Facility or for general corporate purposes,
including working capital and for acquisitions. If the Company determines to
proceed with this transaction, the Company expects that it would close in the
fourth quarter of fiscal 1999 or the first quarter of fiscal 2000.
11
14
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.
12
15
Quarterly results also may be materially affected by the timing of acquisitions,
the timing and magnitude of costs related to such acquisitions, variations in
costs to 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 nine months ended January 23, 1999 and
January 24, 1998, 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 include it, potentially causing data miscalculations or inaccuracies
or operational malfunctions or failures. Because any disruption to the
Company's computerized order processing and inventory systems could materially
and adversely affect the Company's operations, the Company has established a
centrally managed, company wide plan to identify, evaluate and address Year 2000
issues. Although the Company expects that most of its mission critical systems,
network elements and products will be verified for Year 2000 compliance by May
1999, its ability to meet this target is dependent upon a variety of factors. In
addition, if the Company's suppliers, service providers and/or customers fail to
resolve their Year 2000 issues in an effective and timely manner, the Company's
business could be significantly and adversely affected. The Company believes
that many of its school customers have not yet addressed or resolved their Year
2000 issues.
The Company currently estimates that it will incur expenses of approximately
$100,000 through 1999 in connection with its anticipated Year 2000 efforts. In
addition to approximately $50,000 in expenses incurred through January 23, 1999
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 also expects to incur certain capital improvement
costs (totaling approximately $300,000) 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
use its Senior Credit Facility for capital improvements related to the effort.
As part of its Year 2000 initiative, the Company is evaluating scenarios that
may occur as a result of the century change and is in the process of developing
contingency and business continuity plans tailored for Year 2000-related
occurrences. The Company is highly reliant on its computer order processing and
inventory systems to fill orders, bill the customer and collect payments. A
loss of either of the Company's 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 its slowest period. 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 most of its business will proceed without any
significant interruption.
13
16
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 Discussion and Analysis of Financial Condition and Results of
Operations" contains certain forward-looking statements relating to growth and
other plans, 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
14
17
Under the terms of the agreement entered into on June 9, 1998 between the
Company and U.S. Office Products in connection with the spin-off (the
"Distribution Agreement"), the Company agreed with the other three spin-off
companies to indemnify U.S. Office Products for certain liabilities incurred by
U.S. Office Products prior to the spin-off, including liabilities under federal
securities laws (the "Indemnification Obligation"). The portion of the shared
liabilities payable by each spin-off company is determined by the relative
aggregate market values of the common stock of the spin-off companies
immediately after the spin-off. The maximum aggregate amount the Company can be
required to pay for all indemnification obligations is limited by the
Distribution Agreement to $1.75 million.
U.S. Office Products has been named 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 spin-off. 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, the Company has not yet determined the extent
to which certain insurance coverage of U.S. Office Products may be available to
the Company in connection with any Indemnification Obligation triggered by these
lawsuits. As discussed above, to the extent there would be any liability subject
to the Company's Indemnification Obligation, including any deductible under
insurance coverage, such liability is limited to the Company's pro rata share
(based on the aggregate market value of the spin-off companies following the
spin-off) under the Distribution Agreement, limited to a maximum of $1.75
million.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No. Description
----------- -----------
10.1 Amended and Restated 1998
Stock Incentive Plan
10.2 Amended and Restated Credit
Agreement dated as of
September 30, 1998 among
School Specialty, Inc.,
certain subsidiaries and
affiliates of School
Specialty, Inc., the
lenders named therein,
Nationsbank, N.A., Bank
One, Wisconsin and U.S.
Bank National Association
27.1 Financial Data Schedule
15
18
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)
March 1, 1999 /s/ Daniel P. Spalding
- ---------------------- ----------------------------------------------------
Date Daniel P. Spalding
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
March 1, 1999 /s/ Donald J. Noskowiak
- ---------------------- ----------------------------------------------------
Date Donald J. Noskowiak
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
19
INDEX TO EXHIBITS
Exhibit No. Description
- ------------ -----------
10.1 Amended and Restated 1998
Stock Incentive Plan
10.2 Amended and Restated Credit
Agreement dated as of
September 30, 1998 among
School Specialty, Inc.,
certain subsidiaries and
affiliates of School
Specialty, Inc., the
lenders named therein,
Nationsbank, N.A., Bank
One, Wisconsin and U.S.
Bank National Association
27.1 Financial Data Schedule