UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________
FORM 10-K
______________________________________________
[(cid:1)]
[ ]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934: For the fiscal year ended April 28, 2007
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
Commission File No. 000-24385
SCHOOL SPECIALTY, INC.
(Exact name of Registrant as specified in its charter)
Wisconsin
(State or other jurisdiction of
incorporation or organization)
W6316 Design Drive
Greenville, Wisconsin
(Address of principal executive offices)
39-0971239
(I.R.S. Employer
Identification No.)
54942
(Zip Code)
Registrant’s telephone number, including area code: (920) 734-5712
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of class)
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.
Yes (cid:1) No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d)
of the Act.
Yes No (cid:1)
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 (cid:1) No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-
accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer (cid:1) Accelerated filer Non-accelerated filer ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).
Yes No (cid:1)
The aggregate market value of the voting stock held by nonaffiliates of the Registrant, as of October 28, 2006,
was approximately $861,869,465. As of June 1, 2007, there were 21,185,090 shares of the Registrant’s common stock
outstanding.
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on August 29, 2007 are
incorporated by reference into Part III.
DOCUMENTS INCORPORATED BY REFERENCE
Item 1. Business
PART I
Unless the context requires otherwise, all references to “School Specialty,” the “Company,” “we” or “our” refer to
School Specialty, Inc. and its subsidiaries. Our fiscal year ends on the last Saturday in April of each year. In this
Annual Report on Form 10-K (“Annual Report”), we refer to fiscal years by reference to the calendar year in which
they end (e.g., the fiscal year ended April 28, 2007 is referred to as “fiscal 2007”). Note that fiscal 2005 had 53 weeks,
while all other fiscal years reported and referenced represent 52 weeks.
Company Overview
School Specialty is a leading education company providing products, programs and services that enhance student
achievement and development. We are the largest provider of supplemental educational products and equipment to
the pre-kindergarten through twelfth grade (“preK-12”) education market in the United States and Canada. We
believe we are more than seven times larger than our nearest competitor in the supplemental educational products
and equipment market. With the industry’s broadest offering of more than 100,000 products, we are able to be the
single source supplier for substantially all of our customers’ supplemental educational product needs. Over 40% of
our revenues are derived from our proprietary products. We reach our customers through the industry’s largest sales
force of approximately 600 professionals, more than 47 million annual catalog mailings and our proprietary e-
commerce websites. In fiscal 2007, we sold products to approximately 80% of the 116,700 schools in the United
States and we believe we reached substantially all of the 3.7 million teachers in those schools. Our leading market
position has been achieved by emphasizing high-quality products, superior order fulfillment and exceptional
customer service. For fiscal 2007, we generated revenues of $1.043 billion.
We service the supplemental educational products market through two product categories, as described below.
Financial information about our segments is included in the notes under Item 8, Financial Statements and
Supplementary Data.
Specialty Products. Our Specialty products are value-added, curriculum- and age-focused products such as
customized academic agendas, hands-on science education materials, arts and crafts materials and physical
education and special needs equipment. Specialty products are sold to teachers and curriculum specialists to assist
with educational development in the classroom. Our Specialty brands include Premier Agendas, Sportime,
Childcraft Education, Delta Education, FOSS, Frey Scientific, Sax Arts & Crafts, School Specialty Publishing,
Educator’s Publishing Service (“EPS”) and Califone. Our Specialty products accounted for 55% of our revenues for
fiscal 2007.
Essentials Products. Our Essentials products include a comprehensive line of everyday consumables, instructional
materials, art supplies, educational games, school forms, school furniture and outdoor equipment. Essentials
products are typically sold to administrators of school districts and individual schools. We market our Essentials
products under the Education Essentials and School Smart brands, along with many well recognized brand name
products that we distribute. Our Essentials products accounted for 45% of our revenues for fiscal 2007.
Supplemental educational product procurement decisions are generally made at the classroom level by teachers and
curriculum specialists and at the district and school levels by administrators. To best reach these buyer groups, we
developed an innovative two-tiered sales and marketing approach. We target classroom level decision makers
through a “bottom up” marketing approach for Specialty products, and we target school districts and school
administrators through a “top down” marketing approach for Essentials products. Our “bottom up” approach utilizes
a Specialty sales force of approximately 250 professionals, over 150 individual Specialty catalogs and our brand-
specific websites to deliver premium educational products to teachers and curriculum specialists. Our “top down”
approach utilizes an Essentials sales force of approximately 330 professionals, our Education Essentials catalog and
School Specialty Online, an e-commerce solution that enables us to tailor our product offerings and pricing to
individual school districts and school administrators. This two-tiered approach is designed to maximize our
customer coverage and sales penetration.
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We have grown in recent years through acquisitions and internal growth. From fiscal 2003 through fiscal 2007, our
historical revenues, including revenues from acquired businesses, increased from $844.4 million to $1.043 billion,
representing a compound annual growth rate (“CAGR”) of 5.4%. Our acquisition strategy has allowed us to solidify
our leading position within the industry, enhance our product offering and leverage our national distribution network
and market reach to operate more efficiently. In addition, our disciplined integration execution has consistently
enabled us to reduce redundant costs, increase buying power and consolidate distribution facilities, resulting in
improved profitability for the businesses we have acquired. We remain focused on organic growth and will continue
to pursue selective acquisition opportunities that we believe will enhance our position as the leading provider of
supplemental educational products in the United States and Canada. Our business is highly seasonal, with peak sales
levels occurring from June through October.
School Specialty, Inc., founded in October 1959, was acquired by U.S. Office Products in May 1996. In June 1998,
School Specialty was spun-off from U.S. Office Products in a tax-free transaction. Our common stock is listed on The
Nasdaq Global Select Market under the symbol “SCHS.” In August 2000, we reincorporated from Delaware to
Wisconsin. Our principal offices are located at W6316 Design Drive, Greenville, Wisconsin 54942, and our telephone
number is (920) 734-5712. Our general website address is www.schoolspecialty.com. You may obtain, free of charge,
copies of this Annual Report on Form 10-K as well as our Quarterly Reports on Form 10-Q and our Current Reports on
Form 8-K (and amendments to those reports) filed with, or furnished to, the Securities Exchange Commission as soon
as reasonably practicable after we have filed or furnished such reports by accessing our website at
http://www.schoolspecialty.com, selecting “Investor Information” and then selecting the “SEC Filings” link.
Information contained in any of our websites is not deemed to be a part of this Annual Report.
On May 31, 2005, the Company announced that it had entered into an Agreement and Plan of Merger, as amended,
dated as of May 31, 2005 (the “Merger Agreement”), with LBW Holdings, Inc. and LBW Acquisition, Inc. On
October 25, 2005, a Termination and Release was entered into by and among the Company, LBW Holdings, Inc.
and LBW Acquisition, Inc. pursuant to which the Merger Agreement was terminated by mutual agreement and the
parties released each other from certain claims. No termination fees were payable by the Company or by LBW
Holdings, Inc., and each party was responsible for its own merger-related expenses.
During fiscal 2006, the Company incurred $5.2 million of costs related to the terminated merger transaction
consisting of accounting, legal and other transaction-related costs, including costs related to financial and legal
advisors to the special committee of our Board of Directors. These costs have been included in the statement of
operations for fiscal 2006.
Following the Company’s announcement of the Merger Agreement on May 31, 2005, the Company was named as a
defendant in three putative shareholder class actions. The complaints alleged that the Company and its directors
breached fiduciary duties to the Company’s shareholders by negotiating and agreeing to the transaction at a price
that the plaintiffs claimed to be inadequate. On January 17, 2006, the three putative shareholder class actions were
dismissed.
Industry Overview
The United States preK-12 education market is a large industry that has exhibited attractive and stable growth
characteristics, despite fluctuations in the U.S. economy. For example, during the recessions of 1981-1983, 1991-
1992 and 2001-2002, preK-12 education funding in the United States grew at CAGRs of 5.3%, 5.0% and 4.7%,
respectively. Educational expenditures are expected to rise from $376.6 billion (in constant 2002-2003 dollars) in
2002 to $498.0 billion in 2014. Spending per student and student enrollment are the two primary drivers of future
education expenditures, and are each predicted to steadily rise through 2014. Expenditures per student are predicted
to increase from $7,901 in 2002 to $10,043 in 2014. Over that same time period, public and private preK-12
enrollment is projected to rise from 54.6 million to 56.7 million.
Schools are funded primarily by state and local governments and, to a much lesser extent, the federal government.
All three sources raised their expenditures for K-12 education over the past year and are expected to increase
funding to continue their emphasis on public education funding in the coming years. State budgets remain strong as
a healthy economy prompted larger-than-expected tax receipts in fiscal 2007, setting the stage for reinvestment in
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state programs, such as education. Federal funding of education has increased significantly since early 2002 when
President Bush signed into law the No Child Left Behind Act of 2001, which was designed to improve student
achievement in classrooms across the country. The fiscal 2007 federal budget was approved for $57.5 billion in
discretionary spending for Department of Education programs, representing a 33% increase over 2001’s
appropriation.
Our focus within the United States preK-12 education market is on supplemental educational products and
equipment. Our customers are teachers, curriculum specialists, individual schools and school districts who purchase
products for school and classroom use. We believe that the supplemental educational products and equipment
market has generally grown in line with education funding and represented a market in excess of $7 billion in 2005.
The supplemental educational products and equipment market is highly fragmented with approximately 3,300
companies providing products and equipment, a majority of which are family- or employee-owned, regional
companies that generate annual revenues under $10 million. We believe the increasing customer demand for single
source suppliers, prompt order fulfillment and competitive pricing are acting as catalysts for industry consolidation.
School districts are increasingly decentralizing their purchasing, which increases schools’ and teachers’ roles in
educational product procurement decisions. We believe these changes are driving above-average growth in the
demand for curriculum- and age-focused Specialty products. We believe that these industry trends will have a
favorable competitive impact on our business, as we believe we are well positioned to utilize our operational
capabilities and broad product offering to meet evolving customer demands.
Recent Acquisitions
We have acquired nine businesses since May 2002. Purchase prices, net of cash acquired, ranged from $1 million to
$270 million.
Fiscal 2006
The Speech Bin, Inc. On December 14, 2005, we acquired certain assets of The Speech Bin, Inc. (“Speech Bin”) for
an aggregate purchase price of $1 million. Speech Bin offers books, products and tools to help educators in the
special needs market, focusing on speech and language. This business has been integrated into our Abilitations
offering, giving Abilitations a focused vehicle to expand into this segment of the special needs market.
Delta Education, LLC. On August 31, 2005, we acquired all of the membership interests of Delta Education, LLC
(“Delta”) for $270 million (approximately $10 million of which was to fund above average seasonal working capital
acquired). Delta is a leading provider of science education instructional materials for the preK-12 education market
in the United States. The Delta acquisition positions us as a leading provider of highly differentiated instructional
materials for the preK-12 education market in the United States, with a significant focus on elementary and
secondary science, an area that supplements our existing range of product offerings. Consistent with our overall
growth strategy, the Delta acquisition increases our revenue mix from proprietary and Specialty products. It also
establishes us as the second largest provider of supplemental science education products. We integrated our Frey
Scientific business into the Delta business, to form our Science business unit within the Specialty segment.
Fiscal 2005
The Guidance Channel, Inc. In September 2004 we acquired certain assets of The Guidance Channel, Inc. and its
subsidiaries or related companies, for approximately $19 million. The Guidance Channel is an educational
publishing and media company, providing children, students, parents and teachers with timely and effective tools
that help with critical life choices. The Guidance Channel offers over 5,000 proprietary publications and products,
including multimedia programs, videos, curricula, information handouts, therapeutic games and prevention-
awareness items. This business has been integrated with Teacher’s Media Company and Sunburst Visual Media in
our School Specialty Media business unit within our Specialty segment.
Fiscal 2004
School Specialty Publishing. In January 2004 we acquired select assets of the Children’s Publishing business of
McGraw-Hill Education, a division of The McGraw-Hill Companies, for approximately $46 million. The
Children’s Publishing business, renamed School Specialty Publishing, develops, produces, markets and distributes
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supplemental education materials (including literature, workbooks and manipulatives), to education companies,
retailers and consumers. This business is reported as part of our Specialty segment. This acquisition included an
operation based in the United Kingdom, which we sold in a stock transaction on February 29, 2004 for
approximately $4 million.
Califone. In January 2004 we acquired Califone International, Inc. (“Califone”) for an aggregate purchase price, net
of cash acquired, of approximately $26 million. Califone is the leading developer of quality sound presentation
systems including state of the art multimedia, audio-visual and presentation equipment for schools and industry.
Califone markets primarily to education companies. This business is reported as a part of our Specialty segment.
Select Agendas. In May 2003 we acquired Select Agendas, a Canadian-based company that produces and markets
student agendas, for an aggregate purchase price of approximately $17 million. The business was integrated with
Premier Agendas and is reported as part of our Specialty segment.
Fiscal 2003
Sunburst Visual Media. In February 2003 we acquired the visual media division of Sunburst Technology Corporation
(“Sunburst”) for approximately $8 million. Sunburst is a leading developer and marketer of proprietary videos, DVDs
and related curriculum materials covering the character education, health and guidance curriculums in K-12 schools.
Sunburst has been integrated with Teacher’s Media Company as a separate brand offering within our School Specialty
Media business unit, within our Specialty segment.
J.L. Hammett. In August 2002 we acquired the remaining wholesale operations of J.L. Hammett (“Hammett”) for
approximately $14 million. The Hammett business acquired primarily marketed preK-12 educational products to
charter schools and national early learning childhood centers. The business has been integrated into our Essentials and
Specialty segments.
abc School Supply. In August 2002 we acquired abc School Supply and related affiliates (“abc”). abc, a producer and
marketer of preK-8 educational products, was integrated as a separate brand offering into our Childcraft division within
the Specialty segment and a portion was integrated into our Essentials segment. We paid approximately $30 million for
abc and also assumed approximately $11 million of debt.
We attribute our strong competitive position to the following key factors:
Competitive Strengths
Clear Market Leader in Fragmented Industry. We are the largest provider of supplemental educational products
and equipment to the preK-12 education market in the United States and Canada, and we believe that we are more
than seven times larger than our nearest competitor in this market. Within our industry, there are approximately
3,300 competitors, a majority of which are family or employee-owned, regional companies that generate annual
revenues under $10 million. We believe that our significantly greater scale and scope of operations relative to our
education competitors provide several competitive advantages including a broader product offering, significant
purchasing power, a national distribution network and the ability to manage the seasonality and peak shipping
requirements of the school purchasing cycle.
Stable Industry with Attractive Trends and Dynamics. Government funding for education is a consistently popular
political issue enjoying broad-based voter support. From 1970 to 2003, preK-12 education funding in the United
States grew steadily at a CAGR of 7.5%. Recent increases in state and local tax receipts, as well as strong federal
support from the No Child Left Behind Act of 2001, have provided strong continued momentum for the education
industry that we expect will continue into the 2007-08 school year. Supplemental educational products represent a
small percentage of a school’s annual budget and a large majority of these products are consumable, further limiting
our industry’s exposure to fluctuations in demand relative to other segments in the education market.
Largest Product Offering and Premier Brands. With over 100,000 items ranging from classroom supplies and
furniture to playground equipment, we believe we are the only national provider of a full range of supplemental
educational products and equipment to meet substantially all of the needs of schools and teachers in the preK-12
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education market. We believe we have many of the most established brands in the industry that are recognized by
educators across the country, with some brands more than 100 years old. We believe that the brand loyalty our
products enjoy represents a significant competitive advantage. In addition, over 40% of our revenues are derived
from our proprietary products. Our proprietary products typically generate higher margins than our non-proprietary
products.
Unparalleled Customer Reach and Relationships. We have developed a highly integrated, two-tiered sales and
marketing approach which we believe provides us with an unparalleled ability to reach teachers and curriculum
specialists as well as school district and individual school administrators. We reach our customers through the
industry’s largest sales force of approximately 600 professionals, more than 47 million annual catalog mailings and
our proprietary e-commerce websites. In fiscal 2007, we sold products to approximately 80% of the 116,700 schools
in the United States and we believe we reached substantially all of the 3.7 million teachers in those schools. We
utilize our extensive customer databases to selectively target the appropriate customers for our Specialty catalog
offerings. Additionally, we have invested heavily in the development of our e-commerce websites, which provide
broad product offerings and generate higher internet sales than any of our education competitors. Our internet
revenues, which were approximately $175.5 million in fiscal 2007, have grown at a CAGR of 33.7% since fiscal
2003.
Ability to Effectively Integrate and Improve Operating Margins of Acquired Businesses. We have completed nine
acquisitions since May 2002. We typically establish a 6- to 12-month target for our integration process for which we
form a focused transition team. The transition team is assigned the responsibility of integrating the acquired entity’s
business systems, consolidating distribution centers, eliminating redundant expenses and any non-strategic product
lines, as well as realizing sales and margin enhancements through cross merchandising and increased purchasing
power. We have been able to rapidly improve the operating margins of the businesses we acquire by applying our
extensive integration experience. We have also been able to improve revenue growth for certain acquired businesses
through customer relationships, cross-merchandising and leveraging of our scale.
Highly Diversified Business Mix. Our broad product portfolio and extensive geographic reach minimize our
concentration and exposure to any one school district, state, product or supplier. In fiscal 2007, our top 10 school
district customers collectively accounted for less than 6% of revenues and our customers within any one state
collectively accounted for less than 10% of revenues. For the same period, our top 100 products accounted for less
than 5% of revenues and products from our top 10 suppliers generated less than 11% of revenues. We believe this
diversification limits our exposure to state and local funding cycles and to product demand trends.
Strong Historical Financial Performance, Attractive Cash Flow Attributes and Multiple Growth Opportunities.
We have historically demonstrated strong financial performance with high recurring revenues. Over 70% of our
revenues are generated from the sale of consumable products, which typically need to be replaced at least once each
school year. From fiscal 2003 through fiscal 2007, we grew our revenues through acquisitions and organic growth at
a CAGR of 5.4%. The financial performance of our business remained relatively stable even during the state budget
crisis from 2001 to 2003. We are continually focused on growing revenues within both our Specialty and Essentials
segments, increasing our mix of proprietary products and improving our operations. Due to our low maintenance
capital expenditure requirements, we convert a significant percentage of our operating income to cash flow available
for debt service, acquisitions and/or share repurchases. We also enjoy highly predictable working capital cycles. In
addition, we believe we have multiple revenue growth and margin improvement opportunities, including enhancing
our sales efforts in under-penetrated states, expanding private-label business, increasing sourcing from overseas,
optimizing direct marketing operations, increasing supply chain efficiency and pursuing strategic acquisitions. We
also believe our movement towards category management, which will organize us around product and customer
categories, will better synchronize our go-to-market strategies, product development efforts and supplier
relationships. We believe this transformation will create new revenue streams and profitability.
Strong Management Team. We have a deep, experienced management team. Our executive management team and
business unit leaders have an average of over 10 years of experience in the industry. Since David Vander Zanden,
our Chief Executive Officer, joined us in 1998, our senior management team has been successful in growing our
market share, diversifying our revenue streams into more profitable areas and improving the efficiency of our
operations.
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Growth Strategy
We use the following strategies to enhance our position as the leading provider of supplemental educational
products and equipment:
Internal Growth. We plan to organically grow our revenues by:
• Expanding our faster growth, higher margin Specialty products business;
• Unifying our marketing efforts within an integrated category management structure;
• Developing new, high-potential proprietary products that are curriculum- and age-focused;
•
Increasing our focus and selling resources in under-penetrated states and districts; and
• Utilizing direct marketing techniques and strategies to increase customer acquisition and retention.
Margin Improvement. As we continue to grow our revenues, we plan to increase margins by:
• Continuing to increase our mix of Specialty products, which, because of the large proportion of proprietary
products, typically generate higher gross margins than our Essentials products;
• Continuing to expand our private label business through the introduction of new products;
• Expanding our direct sourcing of products from low-cost, overseas manufacturers;
•
•
Increasing the sophistication and effectiveness of our direct marketing operations;
Improving efficiencies of our supply chain activities;
• Continuing the consolidation of distribution centers and the elimination of redundant expenses of acquired
businesses; and
• Utilizing our purchasing scale to negotiate favorable supplier terms and conditions.
Acquisitions. Our selective acquisition strategy and disciplined integration approach have allowed us to solidify our
leading position within the supplemental education products and equipment industry and enhance our strong
national marketing and distribution platform. This platform allows us to more readily integrate acquired brands,
strengthen our Specialty brand portfolio and enter supplemental learning categories in which we do not currently
compete, such as music and math. We believe that our size and national presence give us an advantage as a
potential acquirer in a consolidating industry.
The majority of our acquisitions have historically occurred in the second half of our fiscal year, which follows our
peak shipping season. This allows us to devote our resources to the effective integration of acquired businesses prior
to the upcoming selling season. We plan to continue to focus on acquisition candidates that expand our presence in
Specialty products.
Product Lines
We market two broad categories of supplemental education products and equipment: Specialty products and
Essentials products. Our Specialty products enrich our Essentials product offering and create opportunities to cross
merchandise our Specialty products, many of which are proprietary, to our Essentials customers.
Our Specialty offerings are focused in the following areas:
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Agendas and Forms. We are the largest provider of academic agendas in the United States and Canada. Our
agendas and related offerings are focused on developing better personal, social and organizational skills, as well as
serving as an effective tool for students and parents to track and monitor their daily activities, assignments and
achievements. Many of our agendas are customized at the school level to include each school’s academic, athletic
and extra-curricular activities. We are also able to customize our agendas for individual students. Our agendas are
primarily marketed under the Premier brand name. We are also a leading publisher of school forms, including
record books, grade books, teacher planners and other printed forms under the brand name Hammond & Stephens.
Science. Our leading science position, largely comprised of highly recognized proprietary or exclusive offerings,
provides learning resources focused on promoting scientific education and inquiry, literacy and achievement to the
preK-12 education market. Our products range from laboratory supplies, equipment and furniture to highly effective
hands-on learning curriculums. Our science brands include FOSS (Full Option Science System), Frey Scientific,
Delta Science Modules, Delta Education, CPO Science and Neo/SCI.
Early Childhood. Our early childhood offering provides educators of young children products that promote learning
and development. Our full-line, highly proprietary offering provides educators everything from advanced literacy
and dramatic play to manipulatives, basic arts and crafts and classroom furniture. We manufacture award-winning
early childhood wood furniture in our Bird-in-Hand Woodworks facility. Our well-known early childhood brands
include Childcraft and abc.
Reading & Literacy. Our reading and literacy programs, which are standards-based products and curriculum, are
focused on providing educators and parents effective tools to encourage and enhance literacy, particularly in the K-6
grade levels. Educators Publishing Service (EPS) provides tailored reading and language arts instruction for
students with special needs and proprietary instructional materials for educators. We also develop supplemental
reading products including literature, workbooks and manipulatives to educators and parents under our leading
imprints, including Instructional Fair, Frank Schaffer, Judy Instructo, Brighter Child, American Education
Publishing, School Specialty Publishing and Spectrum.
Arts Education. Our leading market position is led by Sax Arts & Crafts, which offers products and programs
focused on nurturing creativity and self-expression through hands-on learning. The product line ranges from
original cross-curricular lesson plans and teaching resource materials to basic art materials, such as paints, brushes
and papers. Our Arts Education group is supported by our team of art consultants who proactively serve the
education process locally and nationally by conducting workshops and providing curriculum assistance to art
educators.
Physical Education & Health. We offer a full range of programs, solutions, resources and equipment designed to
help improve student and staff wellness. Our products, which are primarily offered under our Sportime brand, range
from traditional sports equipment to unique and innovative products designed to encourage participation by all. We
also offer proven, research-based solutions such as SPARK and WAY, which are curriculum- and product-based
programs focused on promoting healthy, active lifestyles and target childhood obesity.
Special Learning Needs. We offer a full range of solutions for children with special learning needs through our
Abilitations brand. Our proprietary solutions and products are designed to help educate children with learning,
behavioral, sensory or physical differences and are focused on helping educators and therapists make a real
difference in a child’s life.
Audio Technology. We are the leading developer of educator-inspired quality audio technology products, including
state of the art multi-media, audio visual and presentation equipment for the preK-12 education market. These
products are marketed under the brand name Califone.
Teacher Focused Classroom Supplies. We provide a full-line offering of general supplemental educational products
to teachers and curriculum specialists directly through our ClassroomDirect catalog and website.
Our Essentials offerings are focused in the following areas:
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School & Classroom Essentials. We are the largest marketer of school and classroom supplies. Through our School
Specialty Education Essentials catalog, which offers many of our proprietary School Smart products, we provide an
extensive offering of basic supplies that are consumed in the school and classrooms. This offering includes pencils,
glue, paper, crayons, scissors, stickers and classroom decorations. Our School Smart brand was launched in 2005
and includes over 2,400 products. We plan to add an additional 700 products under the School Smart brand by the
end of fiscal 2008. These products are primarily sourced directly from low-cost, overseas manufacturers, which we
believe will allow us to enhance our product offering and improve profitability. Our School Smart brand is also
represented in many of our Specialty offerings.
School and Classroom Furniture & Equipment. We believe we are the largest source for school furniture in the
United States, offering a full range of school-specific furniture and equipment. Our offering allows us to equip an
entire facility, refurbish a specific location within a school, such as a cafeteria, gymnasium or media center, or to
replace individual items such as student desks and chairs. Our Classroom Select proprietary furniture offering is a
highly functional and outstanding quality classroom furniture line. We also have been granted exclusive franchises
for certain furniture lines in specific territories. We also offer our proprietary service, Projects by Design, which
provides turn-key needs assessment, budget analysis and project management for new construction projects.
Our product development managers apply their extensive education industry experience to design curriculum- and
age-specific products to enhance the learning experience. New product ideas are reviewed with customer focus
groups and advisory panels comprised of educators to ensure new offerings will be well received and meet an
educational need.
Our merchandising managers, many of whom were educators, continually review and update the product lines for
each business. They determine whether current offerings are attractive to educators and anticipate future demand.
The merchandising managers also travel to product fairs and conventions seeking out new product lines. This
annual review process results in a constant reshaping and expansion of the educational materials and products we
offer.
For further information regarding our Essentials and Specialty segments, see our “Segment Information” in the notes
under Item 8, Financial Statements and Supplementary Data.
Intellectual Property
We maintain a number of trademarks, trade names, service marks and other intangible property rights that we
believe have significant value and are important to our business. Our trademarks, trade names and service marks
include the following: School Specialty, Education Essentials, School Smart, Projects by Design, School Specialty
Publishing, American Education Publishing, Brighter Child, Frank Schaffer, Instructional Fair, Ideal, Judy Instructo,
abc School Supply, Integrations, Abilitations, Brodhead Garrett, Califone, Childcraft, ClassroomDirect, Frey
Scientific, Hammond & Stephens, Premier Agendas, Sax Arts & Crafts, Sax Family & Consumer Sciences,
Spectrum, Sportime, Sunburst Visual Media, Teacher’s Media Company, Delta Education, NeoSCI, CPO Science
and EPS. We also sell products under brands we license, such as FOSS and Franklin Covey Seven Habits.
Sales and Marketing
We developed our innovative two-tiered sales and marketing strategy that includes the industry’s largest sales force
of approximately 600 professionals, more than 47 million annual catalog mailings and proprietary e-commerce
websites. We believe our sales and marketing model is different from that of our competitors. Our strategy is to use
two separate sales and marketing approaches (“bottom up” and “top down”) to reach all the prospective purchasers
in the education system.
“Bottom Up.” We use the “bottom up” approach to target the classroom level decision-makers through our
Specialty sales force of approximately 250 professionals, catalog mailings featuring our proprietary products and our
Specialty brands and brand-specific websites. These catalogs allow teachers to choose products that are specific to
their curriculum and classroom needs and may not have been purchased by school administration.
9
Generally, for each Specialty brand, a major catalog containing its full product offering is distributed near the end of
the calendar year and during the course of the year we mail additional supplemental catalogs. Schools, teachers and
curriculum specialists can also access websites for product information and purchasing. Further, we believe that by
cross-marketing our Specialty brands to Essentials customers, we can achieve substantial incremental sales.
“Top Down.” Our “top down” marketing approach targets administrators through our Essentials sales force of
approximately 330 professionals, the Education Essentials catalog and School Specialty Online, an e-commerce
solution that enables us to generate higher internet sales than any of our education competitors.
Schools typically purchase supplemental education products based on established relationships with relatively few
vendors. We seek to establish and maintain these critical relationships by assigning accounts within a specific
geographic territory to a local area sales representative who is supported by a centrally located customer service
team. The sales representatives frequently call on existing customers to ascertain and fulfill their supplemental
educational resource needs. The customer service representatives maintain contact with these customers throughout
the order cycle and assist in order processing.
We have a centralized and national sales, marketing, distribution and customer service structure. We believe that
this structure significantly improves our effectiveness through better sales management, resulting in higher regional
penetration and significant cost savings through the reduction of distribution centers.
Projects by Design. Projects by Design is a service we provide our customers free of charge to aid in the design,
building and renovation of schools. Our professional designers prepare a detailed analysis of the building and
individual classrooms to optimize the layout of student and teacher desks, student lockers and other classroom
equipment and fixtures. Customers have the ability to view prospective classrooms through our innovative software
in order to efficiently manage the project. We believe this service makes us an attractive alternative to other
furniture and school fixture suppliers.
Internet Operations. Our internet channel activities through School Specialty Online are focused on enhancing
customer loyalty, driving down cost by receiving more orders electronically and creating a full customer self-service
portal. Our brands are available through School Specialty Online which allows our customers a single access point
for purchasing. Our systems provide functionality to meet the specific needs of school districts and school customers
who generally purchase Essentials products as well as the needs of individual teachers and curriculum specialists
who tend to buy Specialty products. School Specialty Online allows our customers to manage funding through the
use of purchase order spending limitation, approval workflows, order management and reporting. It also includes
other features that are more helpful to teachers, curriculum specialists and others with more sophisticated needs,
including product search, custom catalogs and email notification, allowing users to have access to the full line of
School Specialty products. In addition, we have maintained an electronic ordering system for over 15 years and offer
e-commerce solutions directed exclusively at the education market. Each of our Specialty brands has a dedicated
website for its own products.
Pricing. Pricing for our Essentials and Specialty product offerings varies by product and market channel. We
generally offer a negotiated discount from catalog prices for products from our Education Essentials catalog and
respond to quote and bid requests. The pricing structure of proprietary Specialty products offered through direct
marketing is generally less subject to negotiation.
Procurement
Essentials Products. Each year, we add new items to our Education Essentials catalog. We purchase and stock
these items before the catalog is released so that we can immediately satisfy customer demand. Slow-moving
products are removed from the catalog and from stock to make room for better performing inventory. We typically
negotiate annual supply contracts with our vendors. Contracts with larger vendors usually provide negotiated
pricing and/or extended terms and often include volume discounts and rebate programs. We have exclusive
distribution rights on several furniture and equipment lines.
10
Specialty Products. Our Specialty segment develops many proprietary products and generally outsources the
manufacturing of these items. We purchase non-proprietary Specialty products in a similar manner to that of our
purchasing process for Essentials products.
Global Sourcing. We have increased our gross profit while improving product quality by directly sourcing product
through overseas channels. Increasingly, we are looking to foreign vendors to manufacture proprietary products and
develop exclusive products on our behalf.
Private Label Product. We launched the School Smart brand in 2005 to build brand loyalty and leverage our global
sourcing efforts. The School Smart brand strategy involves taking third party Essentials products sourced overseas,
enhancing them and selling them under the School Smart brand. The program included over 2,400 products in fiscal
2007 and we plan to add an additional 700 products under the School Smart brand by the end of fiscal 2008. This
will represent a significant portion of the Essentials segment revenue which we believe will drive margin
improvement and increased profitability in this segment.
We maintain close and stable relationships with our vendors to facilitate a streamlined procurement process. At the
same time, we continually review alternative supply sources in an effort to improve quality and customer
satisfaction and reduce product cost. Transactions with our larger vendors are processed through an electronic
procurement process. This electronic process reduces costs and improves accuracy and efficiency in our
procurement and fulfillment process. When more than one of our brands buys from the same vendor, we typically
negotiate one contract to fully leverage our combined purchasing power.
Logistics
We believe we have the largest and most sophisticated distribution network among our direct competitors with eight
fully-automated and seamlessly-integrated distribution centers, totaling over two million square feet of operating
space. We believe this network represents a significant competitive advantage for us, allowing us to reach any
school in a fast and efficient fashion. We recently enhanced our distribution model, allowing most of our customers
to receive their orders one day after shipment. We utilize a third-party logistics provider in China to consolidate
inbound shipments, lowering our transportation and inventory storage costs.
In order to maintain the proprietary nature of some of our products, we operate four manufacturing facilities. Our
Lancaster, Pennsylvania plant manufactures wood furniture for our early childhood offerings. The Bellingham,
Washington; Fremont, Nebraska; and Langley, British Columbia facilities produce products for our agenda and
forms offerings. Products that we manufacture accounted for less than 10% of sales during fiscal 2007, 2006 and
2005.
Information Systems
We believe that through the utilization of technology for process improvement in areas such as procurement,
inventory management, customer order management, order fulfillment, and information management, we are able to
offer customers more convenient and cost-effective ways to order products, improve the order fulfillment process to
increase on-time and complete performance and effectively focus our sales and marketing strategies.
Our Essentials segment and certain Specialty businesses use a specialized distribution software package called
System for Distributors. We have made numerous enhancements to the system that allow us to track multiple
marketing promotions and utilize significant list management capabilities. Most of the remaining Specialty brands
use a mail-order and catalog system from Ecometry Corporation that allows us to manage extensive customer lists
and track multiple marketing offers and promotions. Our distribution centers utilize interfaced warehouse
management software to manage orders from the respective business systems.
In fiscal 2006, we began implementing a common ERP platform across all of our businesses over a three year
period. This platform will replace most of our existing systems and primarily includes software from Oracle’s E-
Business suite. By utilizing common business systems across the corporation, we expect to achieve improved
business processes, reduce cycle time and enhance integration between the business units. We believe the
technologies of the new systems will readily support continued growth and integration of our existing and newly-
11
acquired businesses. In fiscal 2007, three of our business units were converted to the new ERP platform. It is
currently estimated that 80% of our business units will be converted by the end of fiscal 2008.
Competition
The supplemental educational products and equipment market is highly fragmented with approximately 3,300
companies providing products and equipment, many of which are family- or employee-owned, regional companies
that generate annual revenues under $10 million. We also compete, to a much lesser extent, with alternate channel
competitors such as office product contract stationers, office supply superstores, purchasing cooperatives and
internet-based businesses. Their primary advantages over us include size, location, greater financial resources and
purchasing power. Their primary disadvantage is that their product mix typically covers a very small portion of the
school’s needs (measured by volume). We believe we compete favorably with these companies on the basis of
service, product offering and customer reach.
Employees
As of June 1, 2007, we had approximately 2,650 full-time employees. To meet the seasonal demands of our
customers, we employ many seasonal employees during the late spring and summer months. Historically, we have
been able to meet our requirements for seasonal employment. None of our employees are represented by a labor
union and we consider our relations with our employees to be very good.
Backlog
We have no material backlog at April 28, 2007. Our customers typically purchase products on an as-needed basis.
Item 1A. Risk Factors
Forward-Looking Statements
Statements in this Annual Report which are not historical are “forward-looking” statements within the meaning of
the Private Securities Litigation Reform Act of 1995. The forward-looking statements include: (1) statements made
under Item 1, Business and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of
Operations, including, without limitation, statements with respect to internal growth plans, projected revenues,
margin improvement, future acquisitions, capital expenditures and adequacy of capital resources; (2) statements
included or incorporated by reference in our future filings with the Securities and Exchange Commission; and (3)
information contained in written material, releases and oral statements issued by, or on behalf of, School Specialty
including, without limitation, statements with respect to projected revenues, costs, earnings and earnings per share.
Forward-looking statements also include statements regarding the intent, belief or current expectation of School
Specialty or its officers. Forward-looking statements include statements preceded by, followed by or that include
forward-looking terminology such as “may,” “should,” “believes,” “expects,” “anticipates,” “estimates,”
“continues” or similar expressions.
All forward-looking statements included in this Annual Report are based on information available to us as of the
date hereof. We do not undertake to update any forward-looking statements that may be made by or on behalf of us,
in this Annual Report or otherwise. Our actual results may differ materially from those contained in the forward-
looking statements identified above. Factors which may cause such a difference to occur include, but are not limited
to, the risk factors set forth below.
Our business depends upon the growth of the student population and school expenditures and can be adversely
impacted by fixed school budgets.
Our growth strategy and profitability depend in part on growth in the student population and expenditures per
student in preK-12 schools. The level of student enrollment is largely a function of demographics, while
expenditures per student are affected by federal, state and local government budgets. For example, from 2002 to
2004, the industry was negatively affected by a generally weakened economic environment which placed pressure
on some state and local budgets, the primary sources of school funding. This was evidenced, among other things, by
12
the 5.7% decline in state tax revenue in 2002. In school districts in states that primarily rely on local tax proceeds for
funding, significant reductions in those proceeds for any reason can restrict district expenditures and impact our
results of operations. Any significant and sustained decline in student enrollment and/or expenditures per student
could have a material adverse effect on our business, financial condition, and results of operations. Because school
budgets are fixed on a yearly basis, any shift by schools in expenditures during a given fiscal year to areas that are
not part of our business could also materially affect our business. For example, as was the case in fiscal 2006, our
results were adversely affected and our organic revenues throughout our business declined in part because we
believe schools unexpectedly increased their expenditures on fuel and health-related costs, and consequently
decreased their spending on supplemental educational products and equipment.
If we are unable to successfully identify and integrate acquisitions, our results of operations could be adversely
affected.
In recent years, a significant amount of our growth has come from acquisitions. Future growth in our revenues and
earnings will be impacted by our ability to continue to acquire and successfully integrate businesses. We cannot
guarantee that we will be able to identify and acquire businesses on reasonable terms or at all. If we are unable to do
so, our future growth may be limited, or our revenues could decline. In addition, the integration of acquired
businesses with our existing business operations presents many challenges and can demand significant attention
from our key managers. The demands placed upon the time of our management team may adversely affect the
operation of our existing business. Managing and integrating acquired businesses may result in substantial costs,
delays, or other operating or financial problems that could materially and adversely affect our financial condition
and results of operations.
Key risks involve:
•
•
•
•
•
failure to execute as well or as quickly as anticipated on our integration plans, including the integration of
acquired employees, operations, technologies and products with our existing business and products;
retention of business relationships with suppliers and customers of the acquired business;
loss of key personnel of the acquired business;
the diversion of our management during the integration process; and
resistance to cultural changes in the acquired organization.
Increased costs associated with the distribution of our products would adversely affect our results of operations.
Higher than expected costs and other difficulties associated with the distribution of our products could affect our
results of operations. To the extent we incur difficulties or higher than expected costs related to updating our
distribution centers, such costs may have a material adverse effect on our business, financial condition and results of
operations. Any disruption in our ability to service our customers may also impact our revenues or profits.
Moreover, as we update our distribution model or change the product mix of our distribution centers, we may
encounter unforeseen costs or difficulties that may have an adverse impact on our financial performance.
Our business is highly seasonal.
Because most of our customers want their school supplies delivered before or shortly after the commencement of the
school year, we record most of our revenues from June to October. During this period, we receive, ship and bill the
majority of orders for our products so that schools and teachers receive their merchandise by the start of each school
year. To the extent we do not sell our products to schools during the peak shipping season, many of such sales
opportunities will be lost and will not be available in subsequent quarters. Our inventory levels increase in April
through June in anticipation of the peak shipping season. We usually earn more than 100% of our annual net income
in the first two quarters of our fiscal year and operate at a net loss in our third and fourth fiscal quarters. This
seasonality causes our operating results to vary considerably from quarter to quarter and significantly impacts our
liquidity position.
If our key suppliers or service providers were unable to provide the products and services we require, our
business could be adversely affected.
13
We depend upon a limited number of suppliers for some of our products, especially furniture and proprietary
products. We also depend upon a limited number of service providers for the delivery of our products. If these
suppliers or service providers are unable to provide the products or services that we require or materially increase
their costs (especially during our peak season of June through October), our ability to deliver our products on a
timely and profitable basis could be impaired and thus could have a material adverse effect on our business,
financial condition and results of operations. Many of our agreements with our suppliers are terminable at any time
or on short notice, with or without cause, and, while we consider our relationships with our suppliers to be good, we
cannot assure that any or all of our relationships will not be terminated or that such relationships will continue as
presently in effect.
Our business is highly competitive.
The market for supplemental educational products and equipment is highly competitive and fragmented. We
estimate that over 3,300 companies market supplemental educational products and equipment to schools with preK-
12 as a primary focus of their business. We also face competition from alternate channel marketers, including office
supply superstores, office product contract stationers, and purchasing cooperatives that have not traditionally
focused on marketing supplemental educational products and equipment. Our competitors impact the prices we are
able to charge and we expect to continue to face pricing pressure from our competitors in the future. These
competitors are likely to continue to expand their product lines and interest in supplemental educational products
and equipment. Some of these competitors have greater financial resources and buying power than we do. We
believe that the supplemental educational products and equipment market will consolidate over the next several
years, which could increase competition in both our markets and our search for attractive acquisition candidates. We
also face increased competition and pricing pressure as a result of the accessibility of the internet.
If any of our key personnel discontinue their role with us, our business could be adversely affected.
Our business depends to a large extent on the abilities and continued efforts of current executive officers and senior
management. We are also likely to depend heavily on the executive officers and senior management of businesses
that we acquire in the future. If any of these people become unable or unwilling to continue in his or her role, or if
we are unable to attract and retain other qualified employees, including a new chief financial officer and other key
personnel, our business could be adversely affected. Although we have employment contracts with many of our
executive officers, we generally do not have employment agreements with other members of our management. Other
than the life insurance we have in place for our Chief Executive Officer, we do not have and do not intend to obtain
key man life insurance covering any of our executive officers or other members of our management.
A failure to successfully implement our business strategy could materially and adversely affect our operations
and growth opportunities.
Our ability to achieve our business and financial objectives is subject to a variety of factors, many of which are
beyond our control, and we may not be successful in implementing our strategy. In addition, the implementation of
our strategy may not lead to improved operating results. We may decide to alter or discontinue aspects of our
business strategy and may adopt alternative or additional strategies due to business or competitive factors or factors
not currently expected, such as unforeseen costs and expenses or events beyond our control. Any failure to
successfully implement our business strategy could materially and adversely affect our results of operations and
growth opportunities.
We face risks associated with our increasing emphasis on imported goods and private label products.
Increases in the cost or a disruption in the flow of our imported goods may adversely impact our revenues and
profits and have an adverse impact on our cash flows. Our business strategy includes an increased emphasis on
offering private label products and sourcing quality merchandise directly from low cost suppliers. As a result, we
expect to rely more heavily on imported goods from China and other countries and we expect the sale of imported
goods to continue to increase as a percentage of our total revenues. To the extent we rely more heavily on the sale of
private label products, our potential exposure to product liability claims may increase. In addition, our reputation
14
may become more closely tied to our private label products and may suffer to the extent our customers are not
satisfied with the quality of such products. Private label products will also increase our risks associated with returns
and inventory obsolescence. Our reliance on imported merchandise subjects us to a number of risks, including: (a)
increased difficulties in ensuring quality control; (b) disruptions in the flow of imported goods due to factors such as
raw material shortages, work stoppages, strikes, and political unrest in foreign countries; (c) problems with oceanic
shipping, including shipping container shortages; (d) economic crises and international disputes; (e) increases in the
cost of purchasing or shipping foreign merchandise resulting from a failure of the United States to maintain normal
trade relations with China and the other countries we do business in; (f) import duties, import quotas, and other trade
sanctions; and (g) increases in shipping rates imposed by the trans-Pacific shipping cartel. If imported merchandise
becomes more expensive or unavailable, we may not be able to transition to alternative sources in time to meet our
demands. A disruption in the flow of our imported merchandise or an increase in the cost of those goods due to these
or other factors would significantly decrease our revenues and profits and have an adverse impact on our cash flows.
Currency exchange rates may impact our financial condition and results of operations and may affect the
comparability of our results between financial periods.
To the extent we source merchandise from overseas manufacturers and sell products internationally, exchange rate
fluctuations could have an adverse effect on our results of operations and ability to service our U.S. dollar-
denominated debt. The majority of our debt will be in U.S. dollars while a portion of our revenue is derived from
imported products and international sales. Therefore, fluctuations in the exchange rate of foreign currencies versus
the U.S. dollar could impact our costs and revenues. In addition, for the purposes of financial reporting, any change
in the value of the foreign currencies against the U.S. dollar during a given financial reporting period would result in
a foreign currency loss or gain. Consequently, our reported earnings could fluctuate as a result of foreign exchange
translation gains or losses and may not be comparable from period to period.
It is difficult to forecast our revenue stream given the seasonal purchasing patterns of our customers.
The seasonal purchasing patterns of our customers, and the fact that our customers typically purchase products on an
as-needed basis, make it difficult for us to accurately forecast our revenue stream, which may vary significantly
from period to period. Financial analysts and others that may seek to project our future performance face similar
difficulties. The difficulty in accurately forecasting our revenue increases the likelihood that our financial results
will differ materially from any projected financial results. Any shortfall in our financial results from our or third
party projected results could cause a decline in the trading price of our common stock and our convertible
subordinated notes.
We have a material amount of goodwill, other intangible assets and capitalized product development costs which
might be written-down.
At April 28, 2007, goodwill and intangible assets represented approximately 64.6% of our total assets. Goodwill is
the amount by which the costs of an acquisition exceed the fair value of the net assets we acquire. In addition, we
are required to evaluate whether our goodwill and other intangible assets have been impaired. Reductions in our net
income caused by the write-down of our existing goodwill or intangible assets or any goodwill or intangible assets
acquired in any future acquisition we may make could materially adversely affect our results of operations. For
example, during fiscal 2007 and fiscal 2006 we recorded pre-tax impairment charges of $23.5 million and $25.6
million, respectively, related to goodwill and other intangibles assets of our discontinued School Specialty Media
(“SSM”) business unit. In addition, we have capitalized product development costs of $18.0 million and $22.8
million at April 28, 2007 and April 29, 2006, respectively, related to both internally developed and acquired
proprietary products, which are amortized to expense over the lesser of five years or the product’s life cycle. Any
changes in the estimated sales volume or life cycle of the underlying products could cause the currently capitalized
costs or costs capitalized in the future to be impaired. For example, during fiscal 2007 and 2006 we recorded pre-
tax impairments charges of $3.6 million and $1.0 million, respectively, related to product development costs of
SSM.
Our operations are dependent on our information systems.
15
We have integrated the operations of most of our divisions and subsidiaries, which operate on a host system located
at our Greenville, Wisconsin headquarters. In addition, there are several divisions running legacy systems hosted at
their locations. All systems rely on continuous telecommunication connections to the main computers. If any of
these connections becomes disrupted, or unavailable, for an extended period of time, the disruption could materially
and adversely affect our business, operations and financial performance. We also continue to introduce new
information systems to achieve a common processing infrastructure for all of our businesses, particularly the new
ERP platform described elsewhere in this report, which will displace existing legacy systems. As we implement the
new systems to the businesses, there is the possibility that it can be disruptive should the new systems not perform as
expected.
Even though we have taken precautions to protect ourselves from unexpected events that could interrupt new,
existing and acquired business operations and systems, we cannot be sure that fire, flood or other natural disasters
would not disable our systems and/or prevent them from communicating between business segments. The
occurrence of any such event could have a material adverse effect on our business, results of operations and
financial condition. We also confront challenges in integrating the information systems of any companies we
acquire. The costs associated with performing such integrations or any disruptions resulting from a failure to
successfully make any such integration could materially impact our business.
We rely on our intellectual property in the design and marketing of our products.
We rely on certain trademarks, trade names and service names, along with licenses to use and exploit certain
trademarks, trade names and service names (collectively, the “marks”) in the design and marketing of some of our
products. We could lose our ability to use our brands if our marks were found to be generic or non-descriptive.
While no single mark is material to our business, the termination of a number of these marks could have an adverse
effect on our business. We also rely on certain copyrights, patents and licenses other than those described above, the
termination of which could have an adverse effect on our business.
The agreements governing our debt contain various covenants that limit our discretion in the operation of our
business, could prohibit us from engaging in transactions we believe to be beneficial and could lead to the
acceleration of our debt.
redeem and/or prepay certain debt;
sell or dispose of a minority equity interest in any subsidiary or other assets;
Our existing and future debt agreements impose and will impose operating and financial restrictions on our
activities. These restrictions require us to comply with or maintain certain financial tests and ratios and restrict our
ability and our subsidiaries’ ability to:
•
incur additional debt;
•
create liens;
• make acquisitions;
•
•
• make capital expenditures;
• make certain investments;
•
•
•
•
•
•
enter new lines of business;
engage in consolidations, mergers and acquisitions;
repurchase or redeem capital stock;
guarantee obligations;
engage in certain transactions with affiliates; and
pay dividends and make other distributions.
Our amended and restated senior credit facility also requires us to comply with certain financial ratios, including a
total leverage ratio, a senior leverage ratio and a minimum fixed charge coverage ratio. These restrictions on our
ability to operate our business could seriously harm our business by, among other things, limiting our ability to take
advantage of financing, mergers and acquisitions and other corporate opportunities.
16
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters is located in a leased facility. The lease on this facility expires in April 2021. The facility is
located at W6316 Design Drive, Greenville, Wisconsin, a combined office and warehouse facility of approximately
332,000 square feet, which also services both of our Specialty and Essentials segments. In addition, we lease or own
the following principal facilities as of June 15, 2007:
Locations
Bellingham, Washington (1) ........................................
Bellingham, Washington (1) ........................................
Bellingham, Washington (1) ........................................
Bellingham, Washington (1) (3) ..................................
Birmingham, Alabama (1) ...........................................
Cambridge, Massachusetts (1) .....................................
Columbus, Ohio (1)......................................................
Fremont, Nebraska (1)..................................................
Fresno, California (2) ...................................................
Hawthorne, New York (4)............................................
Lancaster, Pennsylvania (2) .........................................
Langley, British Columbia (1) .....................................
Langley, British Columbia (1) .....................................
Lyons, New York (2) ...................................................
Mansfield, Ohio (2) ......................................................
Mount Joy, Pennsylvania (2)........................................
Nashua, New Hampshire (1)........................................
New Berlin, Wisconsin (1)...........................................
Norcross, Georgia (2) ...................................................
Peabody, Massachusetts (1) .........................................
Plainview, New York (4) .............................................
Salina, Kansas (2).........................................................
Salina, Kansas (2).........................................................
San Fernando, California (1)........................................
Walker, Michigan (1) ...................................................
________________
Approximate
Square
Footage
48,000
61,000
22,000
14,000
25,000
18,000
18,000
95,000
163,000
9,000
73,000
9,000
10,000
195,000
315,000
400,000
349,000
16,000
41,000
18,000
27,000
115,000
45,000
37,000
198,000
—
Lease Expiration
July 31, 2009
October 30, 2007
October 31, 2012
July 31, 2008
July 31, 2011
June 30, 2011
October 31, 2009
June 30, 2008
December 31, 2007
August 31, 2008
August 31, 2008
Owned/
Leased
Leased March 31, 2011
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Leased
Owned
Leased
Leased
Leased
Leased
Leased
Leased March 14, 2011
Leased
Owned
Leased
Leased
Leased
—
November 30, 2020
December 31, 2024
December 31, 2018
September 30, 2011
December 31, 2010
—
February 29, 2008
July 31, 2012
July 31, 2011
June 30, 2010
(1) Location primarily services the Specialty segment.
(2) Location services both business segments.
(3) Facility lease at this location is renewed monthly.
(4) Location services our discontinued School Specialty Media business unit.
The 73,000 square foot Lancaster, Pennsylvania facility is used for manufacturing wood products and the Fremont,
Nebraska; Langley, British Columbia; and Bellingham, Washington facilities are used for production of agendas and
school forms. The other facilities are distribution centers and/or office space. We believe that our properties, as
enhanced for our ongoing expansion, are adequate to support our operations for the foreseeable future. We regularly
review the utilization and consolidation of our facilities.
17
Item 3. Legal Proceedings
We are, from time to time, a party to legal proceedings arising in the normal course of business. We believe that
none of these legal proceedings will materially or adversely affect our financial position, results of operations or
cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted during the quarter ended April 28, 2007 to a vote of our security holders.
EXECUTIVE OFFICERS OF THE REGISTRANT
As of June 1, 2007, the following persons served as executive officers of School Specialty:
Name and Age
of Officer
David J. Vander Zanden
Age 52
Thomas M. Slagle
Age 45
Mr. Vander Zanden became Chief Executive Officer of School Specialty in
September 2002, after serving as Interim Chief Executive Officer since March 2002.
Mr. Vander Zanden served as Chief Operating Officer from March 1998 to March
2002, as well as President from March 1998 to March 2007. From 1992 to March
1998, he served as President of Ariens Company, a manufacturer of outdoor lawn and
garden equipment. Mr. Vander Zanden has served as a director of School Specialty
since June 1998.
Mr. Slagle joined School Specialty as President and Chief Operating Officer in March
2007. Prior to joining School Specialty, Mr. Slagle served as Group President, Supply
Chain Services - Medical for Cardinal Health, Inc., where he held profit and loss
responsibility for five business segments with over $7 billion of revenue. Mr. Slagle's
11 years with Cardinal Health, as well as prior executive management positions with
Johnson & Johnson Ortho Diagnostics Division and Baxter Healthcare, included
advancing through positions of increasing responsibility in operations, sales, supply
chain and distribution management.
David G. Gomach
Age 48
Mr. Gomach, a Certified Public Accountant, joined School Specialty in August 2006
as Executive Vice President Finance and was named Chief Financial Officer and
Treasurer effective September 15, 2006. He spent most of his career with the Chicago
Mercantile Exchange, joining that firm as a Manager of Budgets in 1987 and
advancing through several promotions to become the CFO.
18
Gregory D. Cessna
Age 50
Steven Korte
Age 52
Mr. Cessna joined School Specialty in July 2005 as the President of Education
Essentials and corporate Executive Vice President. From 1999 until joining School
Specialty, Mr. Cessna served as the Executive Vice President of PolyVision
Corporation, A Steelcase Company. PolyVision Corporation was a manufacturer of
Visual Communication products for the education and office products market. Mr.
Cessna was President of ABB Process Analytics, a manufacturer of on-line analytical
instruments, from 1990 until 1999.
Mr. Korte joined School Specialty in September 2005 as a result of the Delta
Education LLC acquisition and was appointed President, Educational Publishing
Group and corporate Executive Vice President shortly thereafter. From January 2004
to August 2005, Mr. Korte held the position of President and COO of Delta Education
LLC. For the prior ten years 1994-2003, Mr. Korte was the President of Rigby
Education/Harcourt Supplemental Publishers, a division of Reed Elsevier plc.
The term of office of each executive officer is from one annual meeting of the Board of Directors until the next annual
meeting of the Board of Directors or until a successor for each is selected. On May 23, 2007, Mr. Gomach announced
his resignation as Chief Financial Officer and Treasurer of the Company effective July 2, 2007. There are no
arrangements or understandings between any of our executive officers and any other person (not an officer or director
of School Specialty acting as such) pursuant to which any of our executive officers were selected as an officer of
School Specialty.
19
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
PART II
Securities
Market Information
Our common stock is traded under the symbol “SCHS” on The Nasdaq Global Select Market. The table below sets
forth the reported high and low closing sale prices for shares of the common stock, as reported by the National
Association of Securities Dealers, Inc. during the indicated quarters.
Fiscal 2007 quarter ended
July 29, 2006………………………………………..
$
October 28, 2006………………………………………
January 27, 2007…………………………………….
April 28, 2007…………………………………………
36.26
39.28
39.50
40.24
High
Fiscal 2006 quarter ended
July 30, 2005…………………………………………
October 29, 2005………………………………..
January 28, 2006………………………………..
April 29, 2006…………………………………….
$
47.00
48.89
37.43
38.04
High
Low
$
30.36
32.00
36.59
32.89
Low
$
37.22
33.38
32.83
32.42
Holders
As of June 1, 2007, there were 1,970 record holders of our common stock.
Historical Dividends
We have not declared or paid any cash dividends on our common stock to date. We currently intend to retain our
future earnings to finance the growth, development and expansion of our business. Accordingly, we do not expect to
pay cash dividends on our common stock in the foreseeable future. In addition, our ability to pay dividends may be
restricted or prohibited from time to time by financial covenants in our credit agreements and debt instruments. Our
current credit facility contains restrictions on, and in some circumstances, may prevent our payment of dividends.
Share Repurchase Program
On June 15, 2006 the Company’s Board of Directors approved a share repurchase program, which allowed the
Company to purchase up to $50.0 million of the Company’s outstanding common stock. In November 2006, the
Company’s Board of Directors authorized an additional $26.5 million repurchase, bringing the total authorization to
$76.5 million. During fiscal 2007, the Company repurchased a total of 2,126,121 shares, substantially completing the
available purchases under authorizations at April 28, 2007. No repurchases were made in the fourth quarter of fiscal
2007. Common stock acquired through the share repurchase program is available for general corporate purposes and is
reflected as Treasury Stock in the accompanying consolidated balance sheets.
On June 5, 2007 the Company announced that its Board of Directors approved a new share repurchase program, which
allows the company to purchase up to $45.0 million of our outstanding common stock. Purchases under the share
repurchase program may be made from time to time in the open market or privately negotiated transactions. Common
stock acquired through the share repurchase program will be available for general corporate purposes.
20
PERFORMANCE GRAPH
The following graph compares the total shareholder return on our Common Stock since April 27, 2002 with that
of the Russell 2000 Stock Market Index and a peer group index constructed by us. The companies included in
our peer group index are: Renaissance Learning, Inc. (RLRN), Scholastic Corporation (SCHL), and The
Aristotle Corporation (ARTL).
The total return calculations set forth below assume $100 invested on April 27, 2002, with reinvestment of any
dividends into additional shares of the same class of securities at the frequency with which dividends were paid
on such securities through April 28, 2007. The stock price performance shown in the graph below should not
be considered indicative of potential future stock price performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among School Specialty, Inc., The Russell 2000 Index
And A Peer Group
$200
$180
$160
$140
$120
$100
$80
$60
$40
$20
$0
4/27/02
4/26/03
4/24/04
4/30/05
4/29/06
4/28/07
School Specialty, Inc.
Russell 2000
Peer Group
School Specialty, Inc.
Russell 2000
Peer Group
4/27/02
4/26/03
4/24/04
4/30/05
4/29/06
4/28/07
100.00
100.00
100.00
63.41
79.24
56.04
130.29
112.53
65.94
131.32
117.83
67.11
128.70
157.27
55.96
116.70
172.73
60.36
21
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
(In thousands, except per share data)(1)
Fiscal Year
$
Gross profit…………………………………………………………………………
Statement of Operations Data:
Revenues…………………………………………………………………………….
Cost of revenues……………………………………………………………….
2006
(52 weeks)
977,302
568,623
408,679
349,302
Selling, general and administrative expenses…………………………………….
5,202
Merger-related expenses…………………………………….
54,175
19,186
4,160
Interest expense (net)……………………………………………………………….
Other expense…………………………………………………………………………
Redemption costs and fees for convertible
2007
(52 weeks)
1,043,152
597,515
445,637
351,839
-
93,798
22,086
6,019
Operating income……………………………………………………………………
$
2005
(53 weeks)
970,435
$
573,488
396,947
309,582
-
87,365
12,882
2,115
2004
(52 weeks)
882,049
$
525,099
356,950
272,133
-
84,817
18,284
1,136
debt redemption……………………………………………………
Income before provision for income taxes……………………………………………..
Provision for income taxes……………………………………………………………………
-
30,829
12,581
18,248
1,839
70,529
27,402
43,127
-
65,397
25,408
39,989
Earnings from continuing operations……………………………………………………………………………..
-
65,693
26,468
39,225
2003
(52 weeks)
844,402
$
504,921
339,481
256,708
-
82,773
18,001
1,951
-
62,821
25,209
37,612
Earnings (loss) from operations of discontinued
School Specialty Media business unit,
(126)
net of income taxes……………………………………………………………………………
(18,187)
(21,179)
Net income……………………………………………………………………………..
$
18,046
$
$
61
43,001
808
1,978
$
40,797
$
39,590
Weighted average shares outstanding:
22,898
Basic………………………………………………………………………………..
23,739
Diluted…………………………………………………………………………..
21,873
22,545
21,612
23,910
18,828
24,125
18,324
23,378
Basic earnings per share of common stock:
Earnings from continuing operations………………………………………………………………………………..
$
Earnings (loss) from discontinued operations…………………………………………………………………………..
$
Total…………………………………………………………………………..
2.00
(0.01)
1.99
1.79
(0.96)
0.83
0.80
(0.80)
0.00
2.12
0.05
2.17
$
$
$
$
$
$
$
$
2.05
0.11
2.16
Diluted earnings per share of common stock:
Earnings from continuing operations………………………………………………………………………………..
$
Earnings (loss) from discontinued operations…………………………………………………………………………..
$
Total…………………………………………………………………………..
1.88
(0.00)
1.88
1.74
(0.94)
0.80
0.77
(0.77)
0.00
1.90
0.04
1.94
$
$
$
$
$
$
$
$
1.86
0.08
1.94
Balance Sheet Data:
Working capital (2)…………………………………………………………………….
Total assets………………………………………………………………………….
Long-term debt…………………………………………………………………………
Total debt………………………………………………………………………………
Shareholders' equity……………………………………………………………………
$
$
April 28,
2007
34,103
1,110,879
293,139
426,729
512,545
April 29,
2006
34,767
1,130,375
283,629
417,207
553,733
$
April 30,
2005
114,513
884,605
149,680
195,671
544,545
$
April 24,
2004
132,001
832,607
314,104
314,628
378,975
$
April 26,
2003
95,946
736,335
292,844
293,356
321,453
_______________
22
(1) Our business has grown since 2003 through acquisitions and internal growth. For detailed information on
acquisitions during fiscal years 2006 and 2005, see the “Business Combinations” note in our notes to consolidated
financial statements. During fiscal 2003, we made three acquisitions for an aggregate purchase price of
approximately $51.4 million.
(2) At April 28, 2007 and April 29, 2006, working capital includes the convertible subordinated notes balance of
$133.0 million as a current liability. During fiscal 2006, the notes became convertible as the closing price of the
Company’s stock exceeded $48.00 for the specified amount of time. The notes may be converted at any time
into cash for the accreted principal amount and cash or our common stock for the balance, if any, of the
obligation. Working capital at April 30, 2005 includes the balance on the revolving credit facility of $45.5
million as a current liability. Working capital for other periods reflected above excludes the balance on the
revolving credit facility as it was considered long-term in nature.
23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”)
You should read the following discussion and analysis in conjunction with our consolidated financial statements and
related notes, included elsewhere in this Annual Report.
Background
We are a leading education company serving the preK-12 education market by providing products, services and
ideas that enhance student achievement and development to educators and schools across the United States and
Canada. We offer more than 100,000 items through an innovative two-pronged marketing approach that targets both
school administrators and individual teachers.
We have grown in recent years through acquisitions and internal growth. For information on our recent acquisitions
see the “Business Combinations” note in the notes to our consolidated financial statements. Our revenues for fiscal
2007 were $1.043 billion, which represented a compound annual revenue growth, including acquisitions, of 5.4%
compared to our fiscal 2003 results.
Our gross margin has improved from 40.2% in fiscal 2003 to 42.7% in fiscal 2007. This improvement was due to an
increase in our offering of proprietary products and increased buying power. We have acquired many Specialty
businesses, which tend to have more proprietary products in their offerings and consequently higher gross margins
than our Essentials businesses. The Specialty businesses have also experienced higher revenue growth than the
Essentials businesses, resulting in a product mix with higher gross margins. In addition, our growth has increased
our purchasing power, resulting in reduced costs of the products we purchase. Further, through the vertical
acquisitions of School Specialty Publishing and Califone, we have acquired suppliers and have thereby captured the
suppliers’ margins. Another factor contributing to the increase in gross margin is the direct sourcing of product
through overseas channels.
Our historical operating profit and margins have been substantially impacted by the timing of our acquisitions and
the integration of acquired businesses. In fiscal 2003, our operating profit and margin from continuing operations
were $82.8 million and 9.8%, respectively. In fiscal 2007, our operating income and margin from continuing
operations were $93.8 million and 9.0%, respectively.
Our business and working capital needs are highly seasonal with peak sales levels occurring from June through
October. During this period, we receive, ship and bill the majority of our business so that schools and teachers
receive their merchandise by the start of each school year. Our inventory levels increase in April through June in
anticipation of the peak shipping season. The majority of shipments are made between June and October and the
majority of cash receipts are collected from September through December. As a result, we usually earn more than
100% of our annual net income in the first two quarters of our fiscal year and operate at a net loss in our third and
fourth fiscal quarters.
Our business is highly seasonal, and the acquisitions of seasonal businesses during the off season has depressed
operating and net income in the year of acquisition, the most dramatic of which in recent years was the Delta
Education acquisition in fiscal 2006.
The Company announced in fiscal 2007 its intention to sell the School Specialty Media (“SSM”) business unit. The
intended sale of the Hawthorne, New York-based SSM reflects the Company’s desire to focus investments and
management’s attention on those businesses that advance the Company’s long-term growth strategies. It also
represents a first step in the Company’s effort to create a less complex organization that is more customer focused
and more efficient. The Company has reflected SSM as a discontinued operation in the accompanying consolidated
statements of operations.
Results of Continuing Operations
The following table sets forth certain information as a percentage of revenues on a historical basis concerning our
results of operations for the fiscal years 2007, 2006 and 2005:
24
2007
Fiscal Year
2006
Selling, general and administrative expenses………………………………
Gross profit…………………………………..………………………………
Revenues……………………………………….…………………………
Cost of revenues……………………………….…………………………
100.0 %
57.3
42.7
33.7
-
Merger-related expenses………………………………………………………
9.0
Operating income ……………………………………………………
Interest expense, net……………………………………………………
2.1
0.6
Other expense………………………………………………………………
-
Redemption costs and fees for convertible debt redemption…………
6.3
Income before provision for income taxes………………………………
2.5
Provision for income taxes………………………………………………
3.8 %
Earnings from continuing operations…………………………………………………………………
100.0 %
58.2
41.8
35.7
0.5
5.6
2.0
0.4
-
3.2
1.3
1.9 %
2005
100.0 %
59.1
40.9
31.9
-
9.0
1.3
0.2
0.2
7.3
2.9
4.4 %
Consolidated Historical Results of Continuing Operations
Fiscal 2007 Compared to Fiscal 2006
The following discussion and analysis of fiscal 2007 results compared to fiscal 2006 results, is based on a
comparison of the Company’s results of operations from continuing operations.
Overview of Fiscal 2007
Revenues from continuing operations for fiscal 2007 increased 6.7% to $1.043 billion as compared to $977.3 million
in fiscal 2006. This increase was related primarily to the inclusion of a full year of revenues from the August, 2005
acquisition of Delta Education LLC (“Delta”). The Company’s product mix continued to shift to the higher margin
proprietary products, with the Specialty segment comprising 54.8% of revenues in fiscal 2007 as compared with
52.0% in fiscal 2006. This shift in product mix to higher margin Specialty products expanded gross margins to
42.7% from 41.8%.
Operating income was $93.8 million in fiscal 2007 as compared to $54.2 million in fiscal 2006. Operating margins
increased from 6.1% in fiscal 2006 (before terminated merger costs) to 9.0% in fiscal 2007. The increase in the
operating income and operating margin were related to the increased revenues and expansion in the gross margin
due to the aforementioned product mix shift, as well as expense reductions due to cost control initiatives and non-
recurring expenses in fiscal 2006.
Revenue
Revenues increased 6.7% from $977.3 million in fiscal 2006 to $1.043 billion in fiscal 2007. The growth in
revenues was attributable primarily to the acquisition of Delta. Specialty segment revenues increased 12.3% from
$527.2 million in fiscal 2006 (which included $19.2 million of intersegment revenues) to $591.9 million in fiscal
2007 (which included $20.5 million of intersegment revenues). The increase in Specialty segment revenues was due
primarily to the Delta acquisition as fiscal 2007 included a full twelve months of activity from Delta, in addition to
organic growth in the Specialty segment. Essentials segment revenues increased 0.5% from $468.8 million in fiscal
2006 (which includes $0.1 million of intersegment revenues) to $471.1 million in fiscal 2007 (which includes $0.1
million of intersegment revenues). The increase in Essentials segment revenues was related to modest increases in
both the consumable and furniture product offerings.
25
Gross Profit
Gross profit increased 9.0% to $445.6 million compared with $408.7 million in fiscal 2006. The increase in gross
profit was primarily due to the increase in revenues and the shift in revenue mix to the higher margin specialty
products. The revenue mix shift to the higher margin specialty products was the main reason for the 90 basis point
improvement in gross margins from 41.8% in fiscal 2006 to 42.7% in fiscal 2007. In addition to the revenue mix,
our gross margins were affected by the continuation of the global sourcing initiative, which is translating into lower
product costs, and the increase in offerings of private label products that carry higher margins. Offsetting the gross
margin expansion associated with global sourcing and increased private label products were the continued pricing
and competitive pressures that we experienced in more of our commodity type products. Specialty segment gross
profit increased $37.0 million or 14.3% from $258.2 million in fiscal 2006 to $295.2 million in fiscal 2007. The
increase in Specialty segment gross profit was due to the increased revenues and gross margin improvement. The 90
basis point improvement from 49.0% in fiscal 2006 to 49.9% in fiscal 2007 was due primarily to the acquisition of
Delta. Essentials segment gross profit was up from $151.6 million to $152.0 million. The increase in gross profit
was related to the increased revenues.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (“SG&A”) include selling expenses, the most significant of which are
sales wages and commissions; operations expenses, which include customer service, warehouse and out-bound
freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal
and human resources; depreciation and intangible asset amortization expense.
SG&A increased 0.7% or $2.5 million from $349.3 million, or 35.7% of revenues, in fiscal 2006 to $351.8 million,
or 33.7% of revenues, in fiscal 2007. The increase in SG&A costs was due primarily to the incremental variable
costs associated with the $65.9 million incremental revenues, the fixed costs associated with the inclusion of Delta
and stock-based compensation expense. These increases were offset by cost reduction initiatives, which included
headcount reductions, supply chain productivity enhancements and non-recurring expenses incurred in fiscal 2006.
Specialty segment SG&A increased from $204.1 million in fiscal 2006 to $211.6 million in fiscal 2007. However,
Specialty segment SG&A decreased as a percent of revenues from 38.7% in fiscal 2006 to 35.8% in fiscal 2007.
The increase in SG&A was due to the incremental four months of expenses related to the Delta acquisition and
stock-based compensation expense of $1.6 million. The decrease in SG&A as a percent of revenue was primarily
attributable to supply chain efficiencies, reduced catalog costs and headcount reductions. The reduction in catalog
costs was achieved through the optimization of the circulation which reduced the number of unproductive catalogs
mailed. The headcount reductions were primarily related to the integration of Delta.
Essentials segment SG&A decreased $0.5 million from $105.7 million or 22.5% of revenues in fiscal 2006 to $105.2
million or 22.3% of revenues for fiscal 2007. The decrease was primarily related to a headcount reduction as a
result of sales force integration. In addition, there was a reduction in supply chain costs as the Essentials segment
revenue shifted towards a higher mix of furniture which is shipped to the customers directly from the Company’s
vendors. These decreases were partially offset by increased marketing costs associated with the Company’s School
Smart brand and $0.8 million of stock-based compensation expense.
Corporate SG&A decreased by $4.5 million from $39.5 million in fiscal 2006 to $35.0 million in fiscal 2007. The
decrease was related to non-recurring charges in fiscal 2006 related to the closure of the Southaven, Mississippi
distribution center and reduction in headcount. These reductions were partially offset by planned investments in
technology and $2.1 million of stock-based compensation expense.
Terminated Merger Costs
During fiscal 2006, the Company incurred $5.2 million of accounting, legal and other transaction-related costs
associated with the terminated merger.
26
Net Interest Expense
Net interest expense increased $2.9 million from $19.2 million in fiscal 2006 to $22.1 million in fiscal 2007. The
increase in interest expense was primarily due to an increase in average debt outstanding, offset to some extent by a
lower effective borrowing rate attributable to the Company’s November, 2006 sale of $200.0 million principal
amount of subordinated debentures due 2026 at an interest rate of 3.75%. The Company used the proceeds of this
debt offering to pay down its higher rate revolver debt and to repurchase shares of the Company’s common stock
under its 2007 share repurchase program.
Other Expense
Other expense, which primarily consists of the discount and loss on the accounts receivable securitization, was $6.0
million in fiscal 2007 as compared to $4.2 million in fiscal 2006. The $1.8 million increase in the discount and loss
was primarily due to the increased average securitized receivables primarily related to the Delta acquisition as well
an increase in the effective discount rate on the accounts receivable securitization.
Provision for Income Taxes
Provision for income taxes increased to $26.5 million in fiscal 2007 from $12.6 million in fiscal 2006. The increase
was due to higher pre-tax income. The effective income tax rate was 40.3% in fiscal 2007 as compared to 40.8% in
fiscal 2006. The reduction between years is related to a decrease in state and foreign income taxes offset by the tax
treatment of incentive stock options in accordance with SFAS No. 123R. The effective income tax rate exceeds the
federal statutory rate of 35% in both years primarily due to the impact of state and foreign taxes.
Fiscal 2006 (52 weeks) Compared to Fiscal 2005 (53 weeks)
The following discussion and analysis of fiscal 2006 results compared to fiscal 2005 results, is based on a
comparison of the Company’s results of operations from continuing operations.
Overview of Fiscal 2006
On August 31, 2005, the Company acquired Delta Education, LLC (“Delta”) for an aggregate purchase price, net of
cash acquired, of $270.3 million. The business operates from Nashua, New Hampshire and is the exclusive
publisher of inquiry based hands-on science curriculum for the elementary school market developed by the
University of California, Berkeley. Its products include comprehensive science kits, books, instructional materials
and education software. This business was merged with our existing science business, Frey Scientific. As part of the
transaction, we also acquired Delta’s Educators Publishing Service division, a supplemental publisher of reading
titles for grades K-8 which integrated into our existing publishing business. The results of this acquisition have been
included in the Specialty segment since the date of acquisition.
Revenues for fiscal 2006 increased 0.7% to $977.3 million as compared to $970.4 million in fiscal 2005. The
revenue growth was driven by the acquisition of Delta, partially offset by the impact of an extra week of revenues in
fiscal 2005 and a modest decline in revenues in both segments. We believe the modest decline in revenues was the
result of schools unexpectedly increasing their expenditures on fuel and health-related costs, which conversely
reduced funds available and consequently their spending on supplemental education products and equipment. We
continued to drive our product mix to higher margin proprietary products, with the Specialty segment representing
52.0% of revenues in fiscal 2006 as compared with 49.9% in fiscal 2005. This shift in product mix to higher margin
specialty products expanded gross margins to 41.8% from 40.9%.
27
Operating income was $54.2 million in fiscal 2006 as compared to $87.4 million in fiscal 2005. Fiscal 2006 results
included $5.2 million in terminated merger transaction costs and an operating loss of $4.0 million from Delta, driven
primarily by acquiring Delta after their peak sales season. Included in selling, general and administrative expenses
in fiscal 2006 was $5.6 million of facility closure and redundancy costs primarily related to the closure of our
Southaven, Mississippi facility and the integration of our Frey business into Delta; $4.3 million in excess costs
related to the start-up of our Mount Joy, Pennsylvania facility and $3.0 million in costs related to the start-up of
Symposium and investments in our AWARD businesses.
Revenues
Revenues increased 0.7% from $970.4 million in fiscal 2005 to $977.3 million in fiscal 2006. The growth in
revenues was attributable to revenues from acquired businesses, partially offset by an extra week of revenues in
fiscal 2005 and a modest decline in revenues of the non-acquired businesses in both segments. Specialty segment
revenues increased 5.0% from $502.2 million in fiscal 2005 (which includes $17.5 million of intersegment
revenues) to $527.2 million in fiscal 2006 (which includes $19.2 million of intersegment revenues). The increase in
Specialty segment revenues was primarily due to acquisitions, partially offset by fiscal 2005 including an extra week
and a modest decline in some Specialty businesses. Essentials segment revenues decreased 3.6% from $486.2
million in fiscal 2005 (which includes $0.2 million of intersegment revenues) to $468.8 million in fiscal 2006
(which includes $0.1 million of intersegment revenues). The decline in Essentials segment revenues was primarily
the result of fiscal 2005 including an extra week and a modest decline in revenues from consumable products.
Gross Profit
Gross profit increased 3.0% from $396.9 million in fiscal 2005 to $408.7 million in fiscal 2006. The increase in
gross profit was primarily due to an increase in revenues and improved gross margins mainly related to a shift in
revenues to the higher gross margin Specialty segment and a decrease in product costs through the direct sourcing of
product from overseas channels. Gross margin improved 90 basis points to 41.8% of revenues in fiscal 2006 as
compared to 40.9% of revenues in fiscal 2005. The increase in gross margin was primarily driven by an increase in
sales of higher margin proprietary products by the Specialty segment as a percentage of overall sales mix, reduced
costs of products associated with our global sourcing initiative and price expansion in the Essentials segment,
particularly in the furniture lines. Specialty segment gross profit increased $13.1 million or 5.3% from $245.1
million in fiscal 2005 to $258.2 million in fiscal 2006. The increase in Specialty segment gross profit was due to the
aforementioned increased revenues and gross margin improvement. The 20 basis point improvement in gross
margin from 48.8% in fiscal 2005 to 49.0% in fiscal 2006 was primarily driven by acquired businesses, which have
a higher gross margin than the average gross margin of our existing Specialty segment businesses. Essentials
segment gross profit was $151.6 million in fiscal 2006 as compared with $154.6 million in fiscal 2005. The decline
in gross profit in fiscal 2006 is due to reduced revenue, partially offset by gross margin expansion from 31.8% in
fiscal 2005 to 32.3% in fiscal 2006, driven by improved margins in all business lines, particularly furniture.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (“SG&A”) include selling expenses, the most significant of which are
sales wages and commissions; operations expenses, which includes customer service, warehouse and out-bound
freight costs; catalog costs; general administrative overhead, which includes information systems, accounting, legal
and human resources; and depreciation and intangible asset amortization expense.
SG&A increased 12.8% or $39.7 million from $309.6 million or 31.9% of revenues in fiscal 2005 to $349.3 million
or 35.7% of revenues in fiscal 2006. The increase in SG&A resulted from an increase in costs associated with the
off-season acquisition of Delta, $5.6 million of facility closure and redundancy costs primarily related to the closure
of our Southaven, Mississippi facility and the integration of our Frey business into Delta; $4.3 million in excess
costs related to the start-up of our Mount Joy, Pennsylvania facility and $3.0 million in costs related to the start-up
28
of AWARD and Symposium. Additionally, revenues from the Specialty segment increased as a percentage of our
overall revenue mix. The Specialty segment typically requires higher SG&A costs to support the proprietary
product base and marketing and merchandising efforts. Partially offsetting these increases is a reduction in
warehouse and transportation costs as a percent of revenues. The cost reductions have been achieved through
improved operational efficiencies.
Specialty segment SG&A increased from $172.4 million in fiscal 2005 to $204.1 million in fiscal 2006. Specialty
segment SG&A as a percent of revenues, increased from 34.3% in fiscal 2005 to 38.7% in fiscal 2006. The increase
in Specialty segment SG&A was primarily due the inclusion of Delta, $4.3 million in excess costs related to the
start-up of our Mount Joy, Pennsylvania facility, and $3.0 million in costs related to the start-up of AWARD and
Symposium. Essentials segment SG&A decreased $3.9 million from $109.6 million in fiscal 2005 to $105.7 million
in fiscal 2006, representing 22.5% of revenues for both years.
Corporate SG&A increased $11.9 million from $27.6 million in fiscal 2005 to $39.5 million in fiscal 2006. The
increase in corporate SG&A is due to the closure of our Southaven, Mississippi facility and planned investments in
technology and marketing related initiatives.
Costs Related to the Terminated Merger of School Specialty, Inc.
During fiscal 2006, we incurred $5.2 million of merger-related expenses consisting of accounting, legal and other
transaction-related costs.
Net Interest Expense
Net interest expense increased $6.3 million from $12.9 million in fiscal 2005 to $19.2 million in fiscal 2006. The
increase in interest expense was due to an increase in average debt outstanding, primarily due to the acquisition of
Delta, which was funded through borrowings under our credit facility, and an increase in our effective borrowing
rate.
Other Expense and Convertible Debt Redemption Costs
Other expense, which primarily consists of the discount and loss on the accounts receivable securitization, was $4.2
million in fiscal 2006 as compared to $2.1 million in fiscal 2005. The increase in the discount and loss was due to
an increase in the discount rate. In August 2004, $34.8 million in aggregate principal amount of our 6.0%
convertible subordinated notes were redeemed for cash. As a result, we recorded $1.8 million of expense comprised
of $1.2 million related to the premium on redemption of the notes and $0.6 million to write off deferred financing
costs related to the notes.
Provision for Income Taxes
Provision for income taxes was $12.6 million in fiscal 2006 compared with $27.4 million in fiscal 2005. The
decrease was due to lower pre-tax income in fiscal 2006. The effective income tax rate in fiscal 2006 was 40.8% as
compared to 38.9% in fiscal 2005. The effective rate in 2006 is higher than fiscal 2005 due to the impact of foreign
income taxes that are assessed at a higher rate than the federal statutory rate. Our fiscal 2005 effective income tax
rate of 38.9% exceeds the federal statutory rate of 35% primarily due to the impact of state taxes.
Discontinued Operation
As mentioned under ‘Background’ in this Item 7, the Company has been authorized by the Board of Directors to sell
the School Specialty Media (“SSM”) business unit, and the Company has classified SSM as a discontinued
29
operation. In fiscal 2007 the discontinued operation resulted in a $21.2 million loss, net of tax. The operations of
the SSM business unit resulted in a net of tax loss of $3.4 million and a net of tax impairment charge of $17.8
million was recorded in anticipation of the intended sale.
In fiscal 2006 the discontinued operation resulted in an $18.2 million loss, net of tax. The operations of the SSM
business unit resulted in a net of tax loss of $1.8 million and a net of tax impairment charge of $16.4 million was
recorded. SSM results for fiscal 2005, net of tax, were negligible.
Liquidity and Capital Resources
At April 28, 2007, we had working capital of $34.1 million. Our capitalization at April 28, 2007 was $939.2 million
and consisted of debt of $426.7 million and shareholders’ equity of $512.5 million.
Our credit facility matures on February 1, 2011 and provides for $350.0 million of revolving loan availability and
$100.0 million incremental term loan availability. The amount outstanding as of April 28, 2007 under the revolving
and incremental term loans was $77.5 million and $0, respectively. The credit facility is secured by substantially all
of our assets and contains certain financial and other covenants. Our borrowings are usually significantly higher
during the first two quarters of our fiscal year to meet the working capital requirements of our peak selling season.
As of April 28, 2007, our effective interest rate on borrowings under our credit facility was approximately 6.67%,
which excludes amortization of loan origination and commitment fees on unborrowed funds. During fiscal 2007, we
incurred commitment fees on unborrowed funds under the credit facility of $0.5 million and amortized loan
origination fee costs of $0.3 million. The credit facility contains certain financial covenants, including a
consolidated total and senior leverage ratio, a consolidated fixed charge ratio and a limitation on capital
expenditures. The Company was in compliance with these covenants at April 28, 2007.
The $133.0 million, 3.75% convertible subordinated notes became convertible during the second quarter of fiscal
2006 as the closing price of the Company’s common stock exceeded $48.00 for the specified amount of time. As a
result, holders of the notes may surrender the notes for conversion at any time from October 1, 2005 until July 31,
2023. The notes are recorded as a current liability. Holders that exercise their right to convert the notes will receive
up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, to be satisfied in
shares of Company common stock or cash, at the Company’s discretion. No notes have been converted into cash or
shares of common stock as of April 28, 2007. The notes can be redeemed at the option of the Company no earlier
than August 7, 2008.
Net cash provided by operating activities increased $14.0 million from $76.8 million in fiscal 2006 to $90.9 million
for fiscal 2007. The increase in cash provided by operating activities was primarily related to the increased net
income. Partially offsetting the increase was an increased aging of our accounts receivable associated with the mix
towards furniture revenues which historically have longer collection times, increased inventory in preparation of the
upcoming season, and the liquidation of the acquired working capital of Delta last year. These decreases were
partially offset by an increase in accrued liabilities, primarily related to incremental income taxes payable
attributable to the increased net income.
Net cash used in investing activities for fiscal 2007 was $27.0 million, compared to $301.3 million for fiscal 2006,
which included $270.3 million for the acquisition of Delta. Additions to property, plant and equipment increased
$2.5 million from $15.7 million in fiscal 2006 to $18.2 million in fiscal 2007, primarily consisting of costs related to
the continued implementation of our new enterprise resource planning platform.
Net cash used in financing activities was $63.8 million in fiscal 2007 as compared to net cash provided by financing
activities of $222.6 million in fiscal 2006. The net cash used in financing activities in fiscal 2007 reflected the
repurchase of 2.1 million shares of our common stock at a net cost of $76.5 million. See Part II, Item 2, Issuer
Purchases of Equity Securities for additional information regarding share repurchases. Net cash provided by
financing activities in fiscal 2006 was used primarily to fund the Delta acquisition.
On November 22, 2006, we sold $200.0 million of convertible subordinated debentures due 2026. The debentures are
30
unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November
30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, we will deliver
cash equal to the lesser of the aggregate principal amount of debentures to be converted and our total conversion
obligation, and will deliver, at our option, cash or shares of our common stock in respect of the remainder, if any, of our
conversion obligation. The initial conversion rate is 19.4574 shares per $1,000 principal amount of debentures, which
represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at our option on
or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain circumstances,
holders will have the right to require us to repurchase all or some of the debentures. We used a portion of the proceeds to
repurchase approximately 1.1 million shares of our common stock at a cost of $40.0 million. The remaining proceeds
were used to pay down a portion of our existing debt under the credit facility.
On June 5, 2007 we announced that our Board of Directors approved a share repurchase program, which allows us to
purchase up to $45.0 million of our outstanding common stock. Purchases under the share repurchase program may be
made from time to time in the open market or privately negotiated transactions. Common stock acquired through the
share repurchase program will be available for general corporate purposes.
We anticipate that our cash flow from operations, borrowings available from our existing credit facility and other
sources of capital will be sufficient to meet our liquidity requirements for operations, including anticipated capital
expenditures and our contractual obligations for the foreseeable future.
We expect our fiscal 2008 capital expenditures to be approximately $19.0 to $21.0 million and to consist primarily
of computer hardware and software costs related to the continued implementation of the new enterprise resource
planning platform and warehouse equipment costs. We expect our investment in product development to be
approximately $11.0 to $13.0 million.
Off Balance Sheet Arrangements
We have an accounts receivable securitization facility. The facility expires January 30, 2008 and it may be extended
further with the financial institution’s consent. The facility permits advances up to $175.0 million from July 1
through November 30 of each year, and advances up to $75.0 million from December 1 through June 30 of each
year. We entered into the facility for the purpose of reducing our variable rate interest expense. At April 28, 2007
and April 29, 2006, respectively, $50.0 million was advanced under the accounts receivable securitization and
accordingly, that amount of accounts receivable has been removed from our consolidated balance sheets. Costs
associated with the sale of receivables, primarily related to the discount and loss on sale, for the fiscal years 2007,
2006 and 2005 were $6.0, $3.6 and $2.1 million, respectively. The increase in these costs was related to higher
average balance of accounts receivable securitized due to the increase in the advance limits permitted by the facility.
These costs are included as a component of other expense in our consolidated statements of operations.
Summary of Contractual Obligations
The following table summarizes our contractual debt and operating lease obligations as of April 28, 2007:
31
Long-term debt obligations (1)………………………
Convertible subordinated notes (2)(3)……………………
Capital lease obligations………………………………
Operating lease obligations………………………
Purchase obligations (4)…………………………………
Other long-term liabilities reflected on the
$
Total
125,205
364,323
81
69,376
-
Payments Due
(in thousands)
1 - 3
years
14,301
15,000
37
14,887
-
$
Less than
1 year
$
7,150
141,709
37
9,070
-
$
3 - 5
years
85,474
7,614
7
10,065
-
More than
5 years
18,280
$
200,000
-
35,354
-
Company's balance sheet under GAAP…………
$
Total contractual obligations………………………
145
559,130
-
157,966
$
145
44,370
$
-
103,160
$
-
253,634
$
________________
(1)
(2)
(3)
(4)
Debt obligations include principal and interest payments on our credit facility and sale-leaseback
obligations, and assume these obligations remain outstanding until maturity at current or contractually
defined interest rates.
Convertible subordinated notes of $133,000 are recorded as a current liability at April 28, 2007 and April
29, 2006. During fiscal 2006 the notes became convertible and may be surrendered for conversion at any
time. The notes can be redeemed at the option of the Company no earlier than August 7, 2008. The amount
reflected includes principal and accrued interest as of the balance sheet date only. If the notes are held to
maturity in 2023, our obligation, including interest at current rates and accreted principal, is $241.8 million.
Convertible subordinated notes of $200,000 are recorded as maturing in more than five years as the bonds
are not currently convertible. The notes can be redeemed at the option of the Company no earlier than
November 30, 2011. The amounts reflected for these notes include accrued interest at the balance sheet
date and interest at 3.75% through November 30, 2011.
As of April 28, 2007, we did not have any material long-term purchase obligations. The short-term
purchase obligations the Company had as of April 28, 2007 were primarily for the purchase of inventory in
the normal course of business.
Fluctuations in Quarterly Results of Operations
Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically
higher in the first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with
the start of each school year. Quarterly results also may be materially affected by the timing of acquisitions, the
timing and magnitude of costs related to such acquisitions, variations in our costs for the products sold, the mix of
products sold and general economic conditions. Moreover, the operating margins of companies we acquire may
differ substantially from our own, which could contribute to further fluctuation in quarterly operating results.
Therefore, results for any quarter are not indicative of the results that we may achieve for any subsequent fiscal
quarter or for a full fiscal year.
The following table sets forth certain unaudited consolidated quarterly financial data for fiscal years 2007 and 2006
(in thousands, except per share data). We derived this quarterly data from our unaudited consolidated financial
statements.
32
First
(13 weeks)
Revenues………………………………………………..
Gross profit…………………………………………………………
Operating income (loss)……………………………….
Earnings (loss) from continuing operations,
377,071
167,911
69,072
$
Second
(13 weeks)
$
371,225
154,821
56,931
Fiscal 2007 (1)
Third
(13 weeks)
Fourth
(13 weeks)
Total
(52 weeks)
$
128,816
50,856
(20,725)
$
166,040
72,049
(11,480)
$
1,043,152
445,637
93,798
37,745
net of income taxes…………………………………………..
29,644
(16,906)
(11,258)
39,225
Earnings (loss) from discontinued operations,
net of income taxes…………………………………………..
(878)
36,867
Net income (loss)……………………………………….…….
(442)
29,202
(1,917)
(18,823)
(17,942)
(29,200)
(21,179)
18,046
Basic earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.65
1.33
(0.02)
(0.04)
Earnings (loss) from discontinued operations…………………………………………………………………………..
1.31
1.61
Total…………………………………………………………………………..
(0.79)
(0.09)
(0.88)
(0.53)
(0.85)
(1.38)
$
$
$
$
$
$
$
$
$
$
1.79
(0.96)
0.83
Diluted earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.60
1.29
(0.01)
(0.03)
Earnings (loss) from discontinued operations…………………………………………………………………………..
1.28
1.57
Total…………………………………………………………………………..
(0.79)
(0.09)
(0.88)
(0.53)
(0.85)
(1.38)
$
$
$
$
$
$
$
$
$
$
1.74
(0.94)
0.80
First
(13 weeks)
347,335
Revenues………………………………………………..
Gross profit………………………………………………………..
150,331
59,431
Operating income (loss)……………………………….
Earnings (loss) from continuing operations,
$
Second
(13 weeks)
$
331,733
137,897
37,483
Fiscal 2006 (1)
Third
(13 weeks)
Fourth
(13 weeks)
Total
(52 weeks)
$
126,863
49,458
(28,617)
$
171,371
70,993
(14,122)
$
977,302
408,679
54,175
34,494
net of income taxes…………………………………………..
19,194
(21,789)
(13,651)
18,248
Earnings (loss) from discontinued operations,
102
net of income taxes…………………………………………..
34,596
Net income (loss)……………………………………….…….
1,374
20,568
(735)
(22,524)
(18,928)
(32,579)
(18,187)
61
Basic earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.50
0.84
0.06
0.01
Earnings (loss) from discontinued operations…………………………………………………………………………..
0.90
Total…………………………………………………………………………..
1.51
(0.95)
(0.03)
(0.98)
(0.59)
(0.83)
(1.42)
$
$
$
$
$
$
$
$
$
$
0.80
(0.80)
0.00
Diluted earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.43
0.79
0.06
0.01
Earnings (loss) from discontinued operations…………………………………………………………………………..
0.85
Total…………………………………………………………………………..
1.44
(0.95)
(0.03)
(0.98)
(0.59)
(0.83)
(1.42)
$
$
$
$
$
$
$
$
$
$
0.77
(0.77)
0.00
(1) On August 31, 2005, we acquired Delta, a seasonal business that generated operating and net losses during the
third and fourth quarters of fiscal 2006. Fiscal 2007 includes the results of Delta for all quarters listed.
33
Inflation
Inflation has had and is expected to have only a minor effect on our results of operations and our internal and
external sources of liquidity.
Critical Accounting Policies
We believe the policies identified below are critical to our business and the understanding of our results of
operations. The impact and any associated risks related to these policies on our business are discussed throughout
MD&A where applicable. Refer to the notes to our consolidated financial statements in Item 8 for detailed
discussion on the application of these and other accounting policies. The preparation of the consolidated financial
statements requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions
on an ongoing basis and base them on a combination of historical experience and various other assumptions that we
believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical
accounting policies that require significant judgments and estimates and assumptions used in the preparation of our
consolidated financial statements are as follows:
Revenue Recognition
Revenue, net of estimated returns and allowances, is recognized upon the shipment of products or upon the
completion of services provided to customers, which corresponds to the time when risk of ownership transfers, the
selling price is fixed, the customer is obligated to pay and we have no significant remaining obligations. Cash
received in advance from customers is deferred on our balance sheet as a current liability and recognized upon the
shipment of products or upon the completion of services provided to the customers.
Catalog Costs and Related Amortization
We spend over $40.0 million annually to produce and distribute catalogs. We accumulate all direct costs incurred,
net of vendor cooperative advertising payments, in the development, production and circulation of our catalogs on
our balance sheet until such time as the related catalog is mailed. They are subsequently amortized into SG&A over
the expected sales realization cycle, which is one year or less. Consequently, any difference between our estimated
and actual revenue stream for a particular catalog and the related impact on amortization expense is neutralized
within a period of one year or less. Our estimate of the expected sales realization cycle for a particular catalog is
based on, among other possible considerations, our historical sales experience with identical or similar catalogs and
our assessment of prevailing economic conditions and various competitive factors. We track our subsequent sales
realization, reassess the marketplace, and compare our findings to our previous estimate and adjust the amortization
of our future catalogs, if necessary.
Development Costs
We accumulate external and certain internal costs incurred in the development of our products which can include a
master copy of a book, video or other media, on our balance sheet. As of April 28, 2007, we had $18.0 million in net
development costs on our balance sheet. A majority of these costs are associated with our publishing, science and
visual media businesses. The capitalized development costs are subsequently amortized into cost of revenues over
the expected sales realization cycle of the products, which is typically five years. During fiscal 2007, we amortized
development costs of $3.7 million to expense related to our continuing businesses. We continue to monitor the
expected sales realization cycle for each product, and will adjust the remaining expected life of the development
costs or recognize an impairment, if warranted. During fiscal 2007 we recorded a $3.6 million impairment charge
related to product development costs at our SSM business unit in addition to a $1.0 million impairment charge
related to product development costs at SSM recorded in fiscal 2006.
Goodwill and Intangible Assets, and Long-Lived Assets
34
At April 28, 2007, goodwill and intangible assets represented approximately 64.6% of our total assets. Determining
the recoverability of these assets requires considerable judgment and is evaluated on an annual basis or more
frequently if events or circumstances indicate that the assets may be impaired.
As it relates to goodwill and indefinite life intangible assets, we apply the impairment rules in accordance with
SFAS No. 142, “Goodwill and Other Intangible Assets.” As required by SFAS No. 142, the recoverability of these
assets is subject to a fair value assessment which includes judgments regarding financial projections, including
forecasted cash flows and discount rates, and comparable market values. As it relates to finite life intangible assets,
we apply the impairment rules as required by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-
Lived Assets” which also requires significant judgments related to the expected future cash flows attributable to the
intangible asset. The impact of modifying any of these assumptions can have a significant impact on the estimate of
fair value and, thus, the estimated recoverability, or impairment, if any, of the asset.
During fiscal 2007, we recorded a $13.1 million goodwill impairment charge, a $10.4 million intangible asset
impairment charge and a $0.3 million impairment of property, plant and equipment related to the SSM business unit in
addition to a $25.6 million goodwill impairment charge related to SSM recorded in fiscal 2006. As of April 28, 2007, no
remaining goodwill or intangible assets were recorded as assets related to SSM. The impairment was the result of
deteriorating financial performance. During the fourth quarter of fiscal 2007, the Board of Directors authorized the
sale of SSM and we have reflected SSM as a discontinued operation in the accompanying consolidated statements of
operations.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities
and debt. Market risks relating to our operations result primarily from changes in interest rates. Our borrowings under
our credit facility and our discount expense related to our accounts receivable securitization are primarily dependent
upon LIBOR rates. Assuming no change in our financial structure, if variable interest rates were to average 100 basis
points higher during fiscal 2007, pre-tax earnings would have decreased by approximately $2.6 million. This amount
was determined by considering a hypothetical 100 basis point increase in interest rates on average variable-rate debt
outstanding and the average advanced under the accounts receivable securitization facility during fiscal 2007. The
estimated fair value of long-term debt approximated its carrying value at April 28, 2007, with the exception of our
convertible debt which at April 28, 2007 had a carrying value of $333.0 million and a fair market value of $326.7
million.
35
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
School Specialty, Inc.
Greenville, Wisconsin
We have audited the accompanying consolidated balance sheets of School Specialty, Inc., and subsidiaries (the
“Company”) as of April 28, 2007 and April 29, 2006, and the related consolidated statements of operations,
shareholders’ equity, and cash flows for each of the three years in the period ended April 28, 2007. Our audits also
included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and
financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express
an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of
School Specialty, Inc. and subsidiaries as of April 28, 2007 and April 29, 2006, and the results of their operations
and their cash flows for each of the three years in the period ended April 28, 2007 in conformity with accounting
principles generally accepted in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects, the information set forth therein.
As discussed in Note 13 to the consolidated financial statements, on April 30, 2006, the Company adopted
Statement of Financial Accounting Standard No. 123(R), Share Based Payment.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the effectiveness of the Company’s internal control over financial reporting as of April 28, 2007, based on
the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated June 25, 2007 expressed an unqualified opinion on
management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an
unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Milwaukee, Wisconsin
June 25, 2007
36
FINANCIAL STATEMENTS
SCHOOL SPECIALTY, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
ASSETS
Current assets:
Cash and cash equivalents…………………………………………………
Accounts receivable, less allowance for doubtful accounts
$
2,386
$
2,403
April 28,
2007
April 29,
2006
of $4,801 and $3,880, respectively………………………………………
Inventories ……………………………………………………………………
Deferred catalog costs ……………………………………………………
Prepaid expenses and other current assets ……………………………..
Refundable federal income taxes …………………………………...…
Deferred taxes ………………………………………………………………
Total current assets ……………………………………………………
Property, plant and equipment, net ………………………………………………
Goodwill ………………………………………………………………………
Intangible assets, net ………………………………………………………..
Development costs and other …………………………………………………………………………
65,900
177,319
14,848
16,548
1,850
10,201
289,052
77,345
534,488
183,660
26,334
1,110,879
60,553
158,892
21,139
17,415
11,264
7,097
278,763
76,774
582,451
164,790
27,597
1,130,375
$
$
Total assets ……………………………………………………………
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities - long-term debt………………………………………
Accounts payable……………………………………………………………
Accrued compensation………………………………………………………
Deferred revenue……………………………………………………………
Other accrued liabilities……………………………………………………
Total current liabilities……………………………………………………
Long-term debt - less current maturities………………………………….
Deferred taxes………………………………………………………………
Other liabilities………………………………………………………………………
Total liabilities………………………………………………………………
$
133,590
77,794
14,709
5,464
23,392
254,949
293,139
50,101
145
598,334
$
133,578
74,919
11,781
4,133
19,585
243,996
283,629
48,627
390
576,642
Commitments and contingencies
Shareholders' 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; 23,310,461 and 22,962,111 shares issued, respectively…..
Capital paid-in excess of par value…………………………………………
Treasury stock, at cost - 2,126,121 and 0 shares, respectively………..
Accumulated other comprehensive income………………………………
Retained earnings……………………………………………………………
Total shareholders' equity……………………...……………………………
$
Total liabilities and shareholders' equity……………………………..…
23
367,068
(76,508)
17,763
204,199
512,545
1,110,879
23
352,865
-
14,692
186,153
553,733
1,130,375
$
See accompanying notes to consolidated financial statements.
37
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
For the Fiscal Year Ended
April 29,
2006
(52 weeks)
$
Revenues……………………………………………………………………………………….
Cost of revenues……………………………………………………………………………..
April 30,
2005
(53 weeks)
$
Gross profit………………………………………………………………………………….
Selling, general and administrative expenses……………………………………………….
Merger-related expenses……………………………………………………….
Operating income…………………………………………………………………………..
Other (income) expense:
Interest expense………………………………………………………………………………
Interest income………………………………………………………………………………
Other…………………………………………………………………………………………
Redemption costs and fees for convertible debt redemption……
Income before provision for income taxes…………………………………………………
Provision for income taxes…………………………………………………………………….
22,203
(117)
6,019
-
65,693
26,468
39,225
977,302
568,623
408,679
349,302
5,202
54,175
19,314
(128)
4,160
-
30,829
12,581
18,248
970,435
573,488
396,947
309,582
-
87,365
13,058
(176)
2,115
1,839
70,529
27,402
43,127
April 28,
2007
(52 weeks)
$
1,043,152
597,515
445,637
351,839
-
93,798
Earnings from continuing operations………………………………………………………………………………………
Earnings (loss) from operations of discontinued
School Specialty Media business unit, net of income taxes……………………………………………………………………………
(21,179)
(18,187)
(126)
$
Net income………………………………………………………………………………………
18,046
$
61
Weighted average shares outstanding:
Basic……………………………………………………………………………………………
Diluted ………………………………………………………………………………………
21,873
22,545
22,898
23,739
$
43,001
21,612
23,910
Basic earnings per share of common stock:
Earnings from continuing operations ………………………………………………………………………………………….
Earnings (loss) from discontinued operations……………………………………………………………………………………….
Total………………………………………………………………………………………
$
$
$
$
$
$
$
$
$
1.79
(0.96)
0.83
0.80
(0.80)
0.00
2.00
(0.01)
1.99
Diluted earnings per share of common stock:
$
Earnings from continuing operations ………………………………………………………………………………………….
$
Earnings (loss) from discontinued operations……………………………………………………………………………………….
$
Total…………………………………………………………………………………………..
$
$
$
$
$
$
1.74
(0.94)
0.80
0.77
(0.77)
0.00
1.88
(0.00)
1.88
See accompanying notes to consolidated financial statements.
38
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 and APRIL 30, 2005
(In Thousands)
Balance at April 24, 2004…………………………
Issuance of common stock in conjunction
Common Stock
Shares
19,070
Dollars
19
with stock option exercises………………………
230
Tax benefit on option exercises…………………
Issuance of common stock in conjunction
with conversion of convertible debt………………
3,551
Unamortized deferred financing fees related to
conversion of convertible debt…………………
Foreign currency translation adjustment…………
Net income………………………………………
Total comprehensive income……………………
Balance at April 30, 2005……………………………
22,851
Issuance of common stock in conjunction
with stock option exercises………………………
111
Tax benefit on option exercises…………………
Foreign currency translation adjustment…………
Net income……………………………………………
Total comprehensive income……………………
-
4
23
-
Capital Paid-in
Excess of Par
Value
Treasury
Stock, at
Cost
Accumulated Other
Comprehensive
Income
Retained
Earnings
Total
Shareholders'
Equity
Total
Comprehensive
Income
230,258
-
5,607
143,091
378,975
5,375
1,252
114,653
(2,117)
5,375
1,252
114,657
(2,117)
3,402
43,001
3,402
43,001
349,421
-
9,009
186,092
544,545
2,871
573
5,683
61
2,871
573
5,683
61
$
$
3,402
43,001
46,403
$
$
5,683
61
5,744
Balance at April 29, 2006………………………… 22,962
$
23
$
352,865
$
-
$
14,692
$
186,153
$
553,733
Issuance of common stock in conjunction
with stock option exercises………………………
Tax benefit on option exercises……………………
Stock based compensation expense…………………
Treasury stock purchases……………………………
Foreign currency translation adjustment…………
Net income……………………………………………
Total comprehensive income………………….
348
-
7,798
1,898
4,507
(76,508)
7,798
1,898
4,507
(76,508)
3,071
18,046
3,071
18,046
Balance at April 28, 2007……………………… 23,310
$
23
$
367,068
$
(76,508)
$
17,763
$
204,199
$
512,545
See accompanying notes to consolidated financial statements.
39
$
$
3,071
18,046
21,117
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
For the Fiscal Year Ended
Cash flows from operating activities:
April 28,
2007
(52 weeks)
Net income………………………………………………………………………………………..
Adjustments to reconcile net income to net cash provided
18,046
$
April 29,
2006
(52 weeks)
$
61
April 30,
2005
(53 weeks)
$
43,001
by operating activities:
18,119
Depreciation and intangible asset amortization expense………………………………………………………
4,418
Amortization of development costs……………………………………………………………..
-
Impairment Charge……………………………………………………………..
1,405
Amortization of debt fees and other……………………………………………………..
-
Share-based compensation expense……………………………………………………..
11,639
Deferred taxes……………………………………………………………………………………
1,839
Loss on redemption of convertible debt……………………………………………………
Gain on disposal of property, equipment and other…………………………………………………………………..
152
Changes in current assets and liabilities (net of assets
acquired and liabilities assumed in business combinations):
Change in amounts sold under receivables securitization, net…..
Accounts receivable……………………………………………………………………….
Inventories………………………………………………………………………………..
Deferred catalog costs……………………………………………………………………..
Prepaid expenses and other current assets……………………………………………..
Accounts payable………………………………………………………………………….
Accrued liabilities………………………………………………………………………….
23,382
4,610
26,600
1,493
-
(3,887)
-
424
25,843
6,237
29,000
1,361
4,507
(1,630)
-
292
Net cash provided by operating activities………………………………………………….
-
(5,995)
(19,503)
6,291
14,124
2,874
9,413
90,860
(2,800)
(2,682)
(890)
(2,254)
(8,314)
(3,358)
(8,244)
52,031
2,800
22,313
601
469
(7,087)
11,802
(6,740)
76,841
Cash flows from investing activities:
Cash paid in acquisitions, net of cash acquired………………………………………….
-
(18,169)
Additions to property, plant and equipment………………………………………………….
(202)
Investment in intangible and other assets…………………………………………………..
(9,684)
Investment in product development costs…………………………………………………………
-
Proceeds from business dispositions, net of cash disposed………………………………………………………….
1,013
Proceeds from disposal of property, plant and equipment…………………………………………………………………
(27,042)
Net cash used in investing activities……………………………………………………..
(271,560)
(15,694)
(4,391)
(10,321)
453
245
(301,268)
(19,219)
(23,376)
(1,710)
(5,835)
193
128
(49,819)
Cash flows from financing activities:
Proceeds from convertible debt offering……………………………………………………………..
200,000
Proceeds from bank borrowings……………………………………………………………..
704,400
Repayment of debt and capital leases…………………………………………………….
(894,878)
Purchase of treasury stock…………………………………………………….
(76,508)
Redemption of convertible debt…………………………………………………………………..
-
Premium on redemption of convertible debt……………………………………………………………….
-
(5,223)
Payment of debt fees and other…………………………………………………………..
7,798
Proceeds from exercise of stock options………………………………………………….
576
Excess income tax benefit from exercise of stock options………………………………………………….
(63,835)
-
2,275,000
(2,053,574)
-
-
-
(1,660)
2,871
-
222,637
Net cash provided by (used in) financing activities…………………………………………..
-
540,900
(510,360)
-
(34,843)
(1,195)
(265)
5,375
-
(388)
(17)
Net (decrease) increase in cash and cash equivalents………………………………………………….
Cash and cash equivalents, beginning of period…………………………………………..
2,403
2,386
Cash and cash equivalents, end of period……………………………………………………
(1,790)
4,193
2,403
$
$
Supplemental disclosures of cash flow information:
Interest paid…………………………………………………………………………………………
Income taxes paid……………………………………………………………………………………
$
$
17,610
3,443
$
$
17,703
10,344
Non-cash financing activities:
Conversion of convertible debt into common stock………………………………………………
$
-
$
-
40
1,824
2,369
4,193
$
$
$
13,520
17,506
$
112,540
SCHOOL SPECIALTY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS—(Continued)
(In Thousands)
The Company paid cash in connection with certain business combinations accounted for under the purchase method in the
fiscal years ended April 29, 2006 and April 30, 2005. The fair values of the assets and liabilities of the acquired
companies are presented as follows:
For the Fiscal Year Ended
April 30,
2005
(53 weeks)
April 29,
2006
(52 weeks)
24,829
$
Accounts receivable……………………………………………
22,139
Inventories……………………………………………………
3,785
Prepaid expenses and other current assets………………
4,042
Property, plant and equipment……………………………………
Goodwill (2)………………………………………………………
124,041
Intangible assets (2)……………………………………………………
109,326
118
Other assets………………………………………………
(25)
Short-term debt and capital lease obligations……………
(6,934)
Accounts payable…………………………………………
(9,586)
Accrued liabilities…………………………………………
Long-term debt and capital lease obligations…………
(85)
Other liabilities…………………………………………………
(190)
$
271,460
Net assets acquired (1) ……………………………………
$
1,339
2,228
1,180
257
6,004
10,829
132
(3)
(1,802)
(1,120)
-
-
19,044
$
___________________
(1) Fiscal 2006 cash paid in acquisitions, net of cash acquired, as reported within cash flows from investing
activities includes a deferred purchase price payment of $100 related to the October 2001 acquisition of
Premier Science. Fiscal 2005 cash paid in acquisitions, net of cash acquired, as reported within cash flows
from investing activities includes the payment of $75 to the selling shareholders of Select Agendas and a
deferred purchase price payment of $100 related to the October 2001 acquisition of Premier Science.
(2) During fiscal 2007, valuations of the intangible assets acquired in the purchase of Delta Education LLC were
finalized. As a result, the Company increased intangible assets recorded by $38,544 from what is reflected in
the table with an offsetting decrease to goodwill.
See accompanying notes to consolidated financial statements.
41
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION
School Specialty, Inc. (the “Company”) is an education company, serving the preK-12 market, with leading brands that provide
educators with innovative and proprietary products, programs and services designed to help educators engage and inspire students
of all ages and abilities, with operations primarily in the United States and Canada.
The accompanying consolidated financial statements and related notes to consolidated financial statements include the accounts of
School Specialty, Inc., its subsidiaries and the companies acquired in business combinations from their respective dates of
acquisition. All significant inter-company accounts and transactions have been eliminated.
NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Definition of Fiscal Year
The Company’s fiscal year ends on the last Saturday in April in each year. As used in these consolidated financial statements and
related notes to consolidated financial statements, “fiscal 2007,” “fiscal 2006” and “fiscal 2005” refer to the Company’s fiscal
years ended April 28, 2007, April 29, 2006 and April 30, 2005, respectively. All fiscal years reported represent 52 weeks with the
exception of fiscal 2005 which had 53 weeks.
Cash and Cash Equivalents
The Company considers cash investments with original maturities of three months or less from the date of purchase to be cash
equivalents.
Inventories
Inventories, which consist primarily of products held for sale, are stated at the lower of cost or market on a first-in, first-out basis.
Property, Plant and Equipment
Property, plant and equipment are stated at the lower of cost or net realizable value. Additions and improvements are capitalized,
whereas maintenance and repairs are expensed as incurred. Depreciation of property, plant and equipment is calculated using the
straight-line method over the estimated useful lives of the respective assets. The estimated useful lives range from twenty-five to
forty years for buildings and its components and three to fifteen years for furniture, fixtures and equipment. Property and
equipment leased under sale-leaseback obligations and capital leases are being amortized over the lesser of its useful life or its
lease term.
Goodwill and Non-amortizable Intangible Assets
Goodwill represents the excess of cost over the fair value of net assets acquired in business combinations accounted for under the
purchase method. Certain intangible assets including a perpetual license agreement and various trademarks and tradenames are
estimated to have indefinite lives and are not subject to amortization. Under Statement of Financial Accounting Standards
(“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” goodwill and indefinite-lived intangible assets are not subject to
amortization but rather must be tested for impairment annually or more frequently if events or circumstances indicate they might
be impaired. The Company performs the annual impairment test during the first quarter of each fiscal year. Amortizable intangible
assets include customer relationships, publishing rights, non-compete agreements, trademarks and tradenames, order backlog and
42
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
copyrights and are being amortized over their estimated useful lives. During fiscal 2007, the Company recorded a $13,051
goodwill impairment charge related to the School Specialty Media (“SSM”) business unit in addition to a $25,600 goodwill
impairment charge related to SSM recorded in fiscal 2006. As of April 28, 2007, no remaining goodwill was recorded as an asset
related to SSM. The impairment charges and operations of SSM have been reflected as discontinued operations in the
accompanying consolidated statements of operations for all periods presented. See Note 3.
Impairment of Long-Lived Assets
As required by SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviews
property, plant and equipment, definite-lived intangible assets and development costs for impairment if events or circumstances
indicate an asset might be impaired. The Company assesses impairment based on undiscounted cash flows and records any
impairment based on estimated fair value determined using discounted cash flows. The Company recorded a $14,349 and a
$1,000 impairment charge related to long-lived assets of SSM in fiscal 2007 and 2006, respectively See Note 3.
Development Costs
Development costs represent external and internal costs incurred in the development of a master copy of a book, workbook, video
or other supplemental educational materials and products. The Company capitalizes development costs and amortizes these costs
into costs of revenues over the lesser of five years or the product’s life cycle in amounts proportionate to expected revenues. At
April 28, 2007 and April 29, 2006, net development costs totaled $17,982 and $22,783, respectively, and are included as a
component of development costs and other assets in the consolidated balance sheets.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments including cash and cash equivalents, accounts receivable, including
retained interests in securitized receivables, accounts payable, and accrued liabilities approximate fair value given the short
maturity of these instruments. The estimated fair value of the credit facility approximated its carrying value at April 28, 2007 and
April 29, 2006 given the variable interest rates included with this facility. The Company’s convertible debt had a carrying value of
$333,000 and a fair market value of $326,660 at April 28, 2007, and a carrying value of $133,000 and a fair market value of
$136,159 at April 29, 2006, as determined using the closing bid prices as reported on the National Association of Securities
Dealers, Inc.’s Portal Market on April 28, 2007 and April 29, 2006, respectively. The Company’s sale-leaseback obligations had a
carrying value of $16,154 and $16,663 and a fair market value of $17,214 and $17,342 at April 28, 2007 and April 29, 2006,
respectively, as determined using estimated interest rates available at April 28, 2007 and April 29, 2006 for similar long-term
borrowings.
Income Taxes
Income taxes have been computed utilizing the asset and liability approach which requires the recognition of deferred tax assets
and liabilities for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years
to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Valuation
allowances are provided when it is anticipated that some or all of a deferred tax asset is not likely to be realized.
Revenue Recognition
Revenue, net of estimated returns and allowances, is recognized upon the shipment of products or upon the completion of
services provided to customers, which corresponds to the time when risk of ownership transfers, the selling price is fixed, the
customer is obligated to pay and the Company has no significant remaining obligations. Cash received in advance from
customers is deferred on the balance sheet as a current liability and recognized upon the shipment of products or upon the
completion of services provided to customers.
Concentration of Credit Risks
43
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
The Company grants credit to customers in the ordinary course of business. The majority of the Company’s customers are school
districts and schools. Concentration of credit risk with respect to trade receivables is limited due to the significant number of
customers and their geographic dispersion. During fiscal 2007, 2006 and 2005, no customer represented more than 10% of
revenues or accounts receivable.
Vendor Rebates
The Company receives reimbursements from vendors (vendor rebates) based on annual purchased volume of products from its
respective vendors. The Company’s vendor rebates are earned based on pre-determined percentage rebates on the purchased
volume of products within a calendar year. The majority of the rebates are not based on minimum purchases or milestones, and
therefore the Company recognizes the rebates on an accrual basis and reduces cost of revenues over the estimated period the
related products are sold.
Deferred Catalog Costs
Deferred catalog costs represent costs which have been paid to produce Company catalogs, net of vendor cooperative advertising
payments, which will be used in and benefit future periods. Deferred catalog costs are amortized in amounts proportionate to
expected revenues over the life of the catalog, which is one year or less. Amortization expense related to deferred catalog costs is
included in the consolidated statements of operations as a component of selling, general and administrative expenses. Such
amortization expense for fiscal years 2007, 2006 and 2005 was $28,141, $29,132 and $25,236, respectively.
Restructuring
The Company accounts for restructuring costs associated with the closure or disposal of distribution centers in accordance with
SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” During fiscal 2006, $4,002 of expenses related
to severance and lease costs was incurred. At April 28, 2007, there was $225 of accrued restructuring costs recorded in other
accrued liabilities on the consolidated balance sheet primarily related to lease exit costs of the Southaven, Mississippi distribution
center that have no future benefit to the Company.
Shipping and Handling Costs
The Company accounts for shipping and handling costs billed to customers as a component of revenues. The Company
accounts for shipping and handling costs incurred as a cost of revenues for shipments made directly from vendors to
customers. For shipments made from the Company’s warehouses, the Company accounts for shipping and handling costs
incurred as a selling, general and administrative expense. The amount of shipping and handling costs included in selling,
general and administrative expenses for fiscal years 2007, 2006 and 2005 was $49,128, $44,967 and $41,629, respectively.
Foreign Currency Translation
The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, “Foreign
Currency Translation.” All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date.
Amounts in the statements of operations have been translated using the weighted average exchange rate for the year. Resulting
translation adjustments are included in foreign currency translation adjustment within other comprehensive income.
Share-Based Compensation
Beginning in fiscal 2007, the Company accounts for its share-based compensation plans under the recognition and measurement
principles of SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”). Prior to the adoption of SFAS No. 123(R), the
Company accounted for share-based compensation in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (“APB 25”). See Note 13.
44
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements.
SFAS No. 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies
whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand
the use of fair value in any new circumstances. Under the standard, fair value refers to the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the
reporting entity in engaged. SFAS No. 157 will be effective for the Company at the beginning of fiscal 2009 (April 27,
2008), although early adoption is permitted. The Company is currently evaluating the financial statement impact, if any, of
adopting SFAS No. 157.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Options for Financial Assets and Financial Liabilities,
Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure
many financial instruments and certain other items generally on an instrument-by-instrument basis at fair value that are not
currently required to be measured at fair value. SFAS No. 159 is intended to provide entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex
hedge accounting provisions. SFAS No. 159 does not change requirements for recognizing and measuring dividend income,
interest income or interest expense. SFAS No. 159 is effective for the Company at the beginning of fiscal 2009 (April 27,
2008), although early adoption is permitted. If the Company elects to adopt SFAS No. 159 early, it would need to
concurrently early adopt the provisions of SFAS No. 157. The Company is currently evaluating the provisions of SFAS No.
159.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”).
SAB 108 provides guidance on how to evaluate prior period financial statement misstatements for purposes of assessing their
materiality in the current period. If the prior period effect is material to the current period, then the prior period is required to
be corrected. Correcting prior year financial statements would not require an amendment of prior year financial statements,
but such corrections would be made the next time the Company files the prior year financial statements. SAB 108 allows a
one-time transitional cumulative effect adjustment to retained earnings for corrections of prior period misstatements required
under this statement. SAB 108 is effective for the Company at the beginning of fiscal 2008. The Company does not expect
the adoption of SAB 108 to have a material impact to the Company’s results of operations or financial position.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation
of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in
financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for the Company at the
beginning of fiscal 2008 and the adoption of FIN 48 is not expected to have a material impact on the Company’s results of
operations or financial position.
Reclassifications
Amounts previously reported in Note 14 – Segment Information, under the caption Identifiable Assets, have been reclassified
to conform to the current year presentation which reflects substantially all accounts receivable as segment assets rather than
corporate assets. In addition, all income and expense items previously reported have been restated to conform to the
presentation of Continuing Operations, based on the classification of SSM as a Discontinued Operation. See Note 3.
NOTE 3—DISCONTINUED OPERATION
On April 12, 2007, the Company’s Board of Directors authorized the Company’s management to proceed with the sale and
ultimate disposition of the Company’s SSM business unit, which was previously reported as a component of the Specialty
segment. Based upon this action, the Company recorded an asset impairment charge during the fourth quarter of fiscal 2007
45
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
of $29,000. The charge includes the write-off of SSM’s goodwill of $13,051 and intangible assets of $10,410. In addition,
the Company wrote down the carrying value of SSM’s product development costs by $3,639 and other assets of $1,900. The
Company also recorded a $26,600 impairment charge related to SSM in the fourth quarter of fiscal 2006 at the initial onset of
deteriorating financial performance and revised expected future results of the business unit. The $26,600 charge included the
write-off of goodwill of $25,600 and a reduction in the carrying value of product development costs of $1,000. In accordance
with SFAS No. 144, the Company has reflected the impairment charges and operations related to SSM as discontinued
operations in the accompanying consolidated statements of earnings for all periods presented. The accompanying
consolidated balance sheets include the following assets and liabilities of SSM at April 28, 2007 and April 29, 2006:
April 28,
2007
April 29,
2006
Accounts receivable…………………………………………………………..
Inventory……………………………………………………….
Prepaid catalog and other current assets……………………………………………………….
Property, plant and equipment……………………………………………………….
Goodwill and other intangible assets, net…………………………………………….
Product development costs…………………………………………
$
$
Total assets
$
$
5,438
6,477
6,345
616
24,115
7,012
50,003
3,174
6,109
3,402
185
-
2,839
15,709
Total current liabilities
$
772
$
1,403
The following table illustrates the amounts of revenues and earnings (losses) reported in discontinued operations in the
accompanying consolidated statements of operations:
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
Revenues…………………………………………………………..
$
25,358
$
38,427
$
32,072
Earnings (loss) from operations of SSM……………………………………………………….
Impairment charge…………………………………………
(5,437)
(29,000)
(2,972)
(26,600)
Earnings (loss) from discontinued operations
before income taxes…………………………………………….
Provision for (benefit from) income taxes…………………………………………
Earnings (loss) from discontinued operations,
net of income taxes……………………………………………………….
(21,179)
$
$
(34,437)
(13,258)
(29,572)
(11,385)
(18,187)
(205)
-
(205)
(79)
$
(126)
NOTE 4—BUSINESS COMBINATIONS
Fiscal 2006
On December 14, 2005, the Company acquired certain assets of The Speech Bin, Inc. (“Speech Bin”) for an aggregate
purchase price of $1,150. This transaction was funded in cash through borrowings under the Company’s credit facility. The
Speech Bin offers books, products and tools to help educators in the special needs market, focusing on speech and language.
This business has been integrated into the Company’s Abilitations offering, giving Abilitations a focused vehicle to expand
into this segment of the special needs market. The purchase price allocation resulted in $856 of acquired tradenames, which
are deductible for tax purposes, with amortizable lives of 10 years. The results of this acquisition have been included in the
Specialty segment since the date of acquisition.
46
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
On August 31, 2005, the Company acquired all of the membership interests of Delta Education, LLC (“Delta”) from Wicks
Learning Group, LLC, an affiliate of the Wicks Group of Companies L.L.C., a New York-based private equity firm, for an
aggregate purchase price, net of cash acquired, of $270,310. The transaction was funded in cash through borrowings under
the Company’s credit facility as well as through a $100,000 term loan facility, both of which were subsequently replaced by
the Company’s Amended and Restated Credit Agreement. The business operates primarily from Nashua, New Hampshire
and is the exclusive publisher of inquiry based hands-on science curriculum for the elementary school market developed by
the University of California, Berkeley. Its products include comprehensive science kits, books, instructional materials and
education software. As part of the transaction, the Company also acquired Delta’s Educators Publishing Service division, a
supplemental publisher of reading titles for grades K-8. The Delta business complements the Company’s Frey Scientific
brand, and the Educators Publishing Service division enhances the offerings of the School Specialty Publishing division. The
preliminary purchase price allocation resulted in goodwill of $124,041 recorded at April 29, 2006, which is deductible for tax
purposes. The final purchase price allocation resulted in goodwill of $86,264 recorded at April 28, 2007, which is deductible
for tax purposes. The results of this acquisition have been included in the Specialty segment since the date of acquisition.
The Company engaged a third party to assist the Company in the valuation of Delta’s intangible assets. The valuation was
preliminary at April 29, 2006. During fiscal 2007, the valuation was finalized with an adjustment being recorded to increase
the intangible assets acquired by $38,544, with an offsetting decrease to goodwill. Details of Delta’s acquired intangible
assets, which are deductible for tax purposes, are as follows:
Acquired Intangibles
Amortizable intangibles:
Final as of
Preliminary as of
April 28, 2007
April 29, 2006
Allocated
Value
Amortizable
Life
Allocated
Value
Amortizable
Life
Publishing rights…………………………
Non-compete agreements…………………………………
Backlog and other………………………………………
Customer relationships………………………………………
15 to 25 years
5 years
<1 to 13 years
$
Total……………………………………………
Non-amortizable intangibles:
Tradenames and trademarks…………………………
N/A
Total acquired intangibles……………………………
$
105,010
1,600
1,514
-
108,124
38,890
147,014
$
33,200
-
-
31,100
64,300
44,170
108,470
$
10 years
15 years
N/A
The following information presents the unaudited pro forma results of operations of the Company for fiscal 2006, and
includes the Company’s consolidated results of operations and the results of the companies acquired during fiscal 2006 as if
all such purchase acquisitions had been made at the beginning of fiscal 2006. The results presented below include certain pro
forma adjustments to reflect the amortization of certain amortizable intangible assets, adjustments to interest expense, and the
inclusion of an income tax provision on all earnings:
Fiscal 2006
(52 weeks)
Revenue…………………………………………………………
Net income………………………………………………………
Net income per share:
$1,033,924
25,955
Basic……………………………………………………………
Diluted…………………………………………………………
$1.13
$1.09
47
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
The pro forma results of operations have been prepared using unaudited historical results of acquired companies. These
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 2006 or the results that may occur in
the future.
NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents details of the Company’s intangible assets, including the range of useful lives, excluding
goodwill:
April 30, 2007
Amortizable intangible assets:
Gross Value
Accumulated
Amortization
Net Book
Value
Customer relationships (10 to 17 years)……………………………………………………
Publishing rights (15 to 25 years)………………………………………………
Non-compete agreements (3.5 to 10 years)……………………………………………
Tradenames and trademarks (5 to 30 years)……………………………………………
Order backlog and other (less than 1 to 13 years)……………………………………………………………………
$
$
$
Total amortizable intangible assets………………………………
Non-amortizable intangible assets:
Perpetual license agreement……………………………………………
Tradenames and trademarks……………………………………………………………
Total non-amortizable intangible assets……………………………
$
Total intangible assets……………………………………………
$
36,014
105,010
8,576
3,034
3,666
156,300
12,700
40,697
53,397
209,697
(11,012)
(8,519)
(4,728)
(360)
(1,418)
(26,037)
-
-
-
(26,037)
25,002
96,491
3,848
2,674
2,248
130,263
12,700
40,697
53,397
183,660
$
April 29, 2006
Amortizable intangible assets:
Gross Value
Accumulated
Amortization
Net Book
Value
59,573
Customer relationships (10 to 17 years)………………………………………………..
30,987
Publishing rights (10 years)………………………………………………..
3,221
Non-compete agreements (3.5 to 10 years)………………………………………………
6,586
Copyrighted materials (23 years)…………………………………
4,134
Tradenames and trademarks (5 to 30 years)……………………………………….
Order backlog and other (less than 1 to 10 years)………………………………………………………………..
1,297
105,798
(10,629)
(2,213)
(3,764)
(514)
(302)
(432)
(17,854)
70,202
33,200
6,985
7,100
4,436
1,729
123,652
Total amortizable intangible assets…………………………………
$
$
$
Non-amortizable intangible assets:
Perpetual license agreement…………………………………………….
Tradenames and trademarks……………………………………………………………..
Total non-amortizable intangible assets…………………………….
$
Total intangible assets……………………………………………
12,700
46,292
58,992
182,644
-
-
-
(17,854)
12,700
46,292
58,992
164,790
$
$
Intangible asset amortization expense included in selling, general and administrative expenses for fiscal years 2007, 2006 and
2005 was $9,308, $6,942 and $3,380, respectively.
During fiscal 2007, valuations of the intangible assets acquired in the purchase of Delta were finalized. As a result, the
Company increased intangible assets recorded by $38,544 in fiscal 2007 with an offsetting decrease to goodwill.
During the fourth quarter of fiscal 2007, the Company wrote off intangible assets related to SSM with a gross value of
$12,363 and an unamortized value of $10,410. See Note 3.
48
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Estimated intangible asset amortization expense for each of the five succeeding fiscal years is:
2008 ................................................................................ $8,583
2009 .................................................................................. 8,313
2010 .................................................................................. 8,201
2011 .................................................................................. 7,887
2012 .................................................................................. 7,720
The following information presents changes to goodwill during the two-year period ended April 28, 2007:
Balance at
April 30,
2005
Segment
314,370
Specialty………………
165,143
Essentials………………
479,513
Total………………
$
$
Fiscal 2006
Acquisitions
124,041
$
-
124,041
$
Adjustments
(21,103)
$
-
(21,103)
$
Balance at
April 29,
2006
417,308
165,143
582,451
$
$
Fiscal 2007
Acquisitions Adjustments
(47,963)
-
$
-
-
(47,963)
$
-
$
$
Balance at
April 28,
2007
369,345
165,143
534,488
$
$
The Specialty segment adjustments during fiscal 2006 of $(21,103) are comprised of a $(25,600) impairment charge related
to SSM, $4,747 related to foreign currency translation, $100 for a deferred purchase price payment related to the October
2001 acquisition of Premier Science and $(350) related to final purchase accounting adjustments. The Specialty segment
adjustments during fiscal 2007 of $(47,963) are comprised of a $(37,777) purchase price adjustment for the finalization of the
valuation of intangible and other assets and liabilities acquired from Delta, a $(13,051) impairment charge related to SSM,
$2,765 related to foreign currency translation, and $100 for a deferred purchase price payment related to the acquisition of
Premier Science.
As a result of the deteriorating financial performance of the SSM business unit during fiscal 2006’s fourth quarter,
particularly the video line, the Company performed an interim goodwill impairment test. The Company prepared a fair value
assessment of the reporting unit, as defined in SFAS No. 142, using a discounted cash flow approach which includes
judgments regarding financial projections, including forecasted cash flows and discount rates, and comparable market values.
Utilizing updated operating profit and cash flow assumptions of the SSM business unit, the Company recorded a $25,600
goodwill impairment charge. During the fourth quarter of fiscal 2007, it was determined that SSM was not a core business in
the Company’s growth strategy and therefore, the Company would reduce future investment in SSM. On April 12, 2007, the
Company’s Board of Directors authorized the Company’s management to proceed with the sale and ultimate disposition of
SSM. The Company once again performed an interim goodwill impairment test and as a result, recorded an additional
$13,051 goodwill impairment charge. At April 28, 2007, all goodwill originally recorded for the SSM business unit has been
written off as a result of the impairment charges noted above. See Note 3.
NOTE 6—PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
49
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Land……………………………………………………
Projects in progress……………………………………
Buildings and leasehold improvements……………………
Furniture, fixtures and other……………………………
Machinery and warehouse equipment……………
Total property, plant and equipment……………
Less: Accumulated depreciation……………………
Net property, plant and equipment……………
$
April 28,
2007
$
502
3,976
33,182
81,541
44,371
163,572
(86,227)
77,345
April 29,
2006
$
502
8,021
33,096
64,305
41,892
147,816
(71,042)
76,774
$
Depreciation expense related to continuing operations for fiscal years 2007, 2006 and 2005 was $15,627, $15,360 and $13,572,
respectively.
NOTE 7—DEBT
Long-Term Debt
Long-term debt consists of the following:
April 29,
April 28,
2006
2007
267,400
77,500
Amended and Restated Credit Agreement, maturing in 2011…………………………………………..
133,000
3.75% Convertible Subordinated Notes due 2023…………………………………….
133,000
3.75% Convertible Subordinated Notes due 2026…………………………………….
-
200,000
16,663
16,154
Sale-leaseback obligations, effective rate of 8.97%, expiring in 2020………………………………………………………….
144
75
Capital lease obligations………………………...………………………………..
417,207
426,729
Total debt…………………………………………………………………..
(133,578)
(133,590)
Less: Current maturities…………………………………………………………
$
283,629
$
293,139
Total long-term debt……………………………………………………….
$
$
On February 1, 2006, the Company entered into an Amended and Restated Credit Agreement which replaced the existing
credit facility and the $100,000 term loan used as partial financing for the Delta acquisition. The Amended and Restated
Credit Agreement matures on February 1, 2011 and provides for a $350,000 revolving loan and an available $100,000
incremental term loan. Interest accrues at a rate of, at the Company’s option, either a Eurodollar rate plus an applicable
margin of up to 1.75%, or the lender’s base rate plus an applicable margin of up to 0.50%. The Company also pays a
commitment fee on the revolving loan of up to 0.375% on unborrowed funds. The Amended and Restated Credit Agreement
is secured by substantially all of the assets of the Company and contains certain financial covenants, including a consolidated
total and senior leverage ratio, a consolidated fixed charges coverage ratio and a limitation on consolidated capital
expenditures. The Company was in compliance with these covenants at April 28, 2007. The effective interest rate under the
credit facility for fiscal 2007 was 7.17%, which includes amortization of the loan origination fees of $309 and commitment fees
on unborrowed funds of $492. The effective interest rate under the credit facility for fiscal 2006 was 6.78%, which includes
amortization of the loan origination fees of $658 and commitment fees on unborrowed funds of $464. As of April 28, 2007 and
April 29, 2006, $77,500 and $267,400, respectively, were outstanding on the revolving loan.
During 2003, the Company sold an aggregate principal amount of $133,000 of convertible subordinated notes due in 2023.
The Company used the total net proceeds from the offering of $128,999 to repay a portion of the debt outstanding under the
Company’s credit facility. The notes carry an annual interest rate of 3.75% until August 1, 2010, at which time the notes will
cease bearing interest and the original principal amount of each note will commence increasing daily by the annual rate of
3.75%. Depending on the market price of the notes, the Company will make additional payments of interest commencing
50
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
August 1, 2008. The notes became convertible into shares of the Company’s common stock at an initial conversion price of
$40.00 per share during fiscal 2006 and are recorded as a current liability. Holders of the notes may surrender the notes for
conversion at any time from October 1, 2005 until July 31, 2023. Holders that exercise their right to convert the notes will
receive up to the accreted principal amount in cash, with the balance of the conversion obligation, if any, to be satisfied in
shares of Company common stock or cash, at the Company’s discretion. No notes have been converted into cash or shares of
common stock as of April 28, 2007. The notes can be redeemed at the option of the Company no earlier than August 7, 2008.
On November 22, 2006, the Company sold $200,000 of convertible subordinated debentures due 2026. The debentures are
unsecured, subordinated obligations of the Company, pay interest at 3.75% per annum on each May 30th and November
30th, and are convertible upon satisfaction of certain conditions. In connection with any such conversion, the Company will
deliver cash equal to the lesser of the aggregate principal amount of debentures to be converted or the Company’s total
conversion obligation, and will deliver, at its option, cash or shares of its common stock in respect of the remainder, if any, of
its conversion obligation. The initial conversion rate is .0194574 shares per $1 principal amount of debentures, which
represents an initial conversion price of approximately $51.39 per share. The debentures are redeemable at the Company’s
option on or after November 30, 2011. On November 30, 2011, 2016 and 2021 and upon the occurrence of certain
circumstances, holders will have the right to require the Company to repurchase all or some of the debentures.
The Company entered into two sale-leaseback transactions during fiscal 2001 which are accounted for as financings due to a
technical default provision within the leases which could allow, under remote circumstances, for continuing ownership
involvement by the Company in the two properties.
During 2001, the Company sold an aggregate principal amount of $149,500 of 6.0% convertible subordinated notes that were
due in 2008. During 2004, the Company called the notes for redemption. Prior to redemption, certain holders of the notes
exercised their right to convert $114,657 in aggregate principal amount of the notes into 3,551 shares of the Company’s
common stock. The remaining $34,843 in aggregate principal amount of these notes was redeemed for the contractual
redemption price of $36,038. The Company recognized pre-tax expense of $1,839 in fiscal 2005 related to the write-off of
deferred financing costs of $644 and the premium upon redemption of the notes of $1,195. An additional $2,117 of
unamortized deferred financing fees was charged to capital paid-in excess of par value related to this conversion.
Maturities of Long-Term Debt
Maturities of long-term debt, including capital lease obligations, for subsequent fiscal years, are as follows:
2008…………………………………………………………
133,590
2009…………………………………………………………
629
679
2010………………………………………………………
78,273
2011………………………………………………………
2012………………………………………………………
895
212,663
Thereafter…………………………………………………
426,729
Total maturities of long-term debt…………………
$
NOTE 8—SECURITIZATION OF ACCOUNTS RECEIVABLE
The Company and certain of its U.S. subsidiaries entered into an agreement (the “Receivables Facility”) in November 2000 with a
financial institution whereby it sells on a continuous basis an undivided interest in all eligible trade accounts receivable. Pursuant
to the Receivables Facility, the Company formed New School, Inc. (“NSI”), a wholly-owned, special purpose, bankruptcy-remote
subsidiary. As such, the assets of NSI will be available first and foremost to satisfy the claims of the creditors of NSI. NSI was
formed for the sole purpose of buying and selling receivables generated by the Company and certain subsidiaries of the Company.
NSI does not meet the conditions of a qualifying Special Purpose Entity and therefore the results of NSI have been included in the
Company’s consolidated results for financial reporting purposes. Under the Receivables Facility, the Company and certain
51
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
subsidiaries transfer without recourse all their accounts receivables to NSI. NSI, in turn, has sold and, subject to certain conditions,
may from time to time sell an undivided interest in these receivables. The Company receives a fee from the financial institution for
billing and collection functions, which remain the responsibility of the Company that approximates fair value. The facility has
been amended to extend its expiration to January 31, 2008 and it may be extended further with the financial institution’s consent.
In addition, the facility was amended to permit advances up to $175,000 from July 1 through November 30 of each year, and
advances up to $75,000 from December 1 through June 30 of each year. The Company’s retained interests in the receivables sold
are recorded at fair value, which approximates cost, due to the short-term nature of the receivables sold.
This two-step transaction is accounted for as a sale of receivables under the provision of SFAS No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” At April 28, 2007 and April 29, 2006,
respectively, $50,000 was advanced under the accounts receivable securitization and accordingly, that amount of accounts
receivable has been removed from our consolidated balance sheets. Costs associated with the sale of receivables, primarily
related to the discount and loss on sale, were $6,028, $3,592 and $2,070 and are included in other expenses in the consolidated
statement of operations for fiscal years 2007, 2006 and 2005, respectively. Supplemental information related to the accounts
receivable securitization transactions is provided below. Proceeds under accounts receivable securitization and collections as
servicer of receivables sold have been netted in the accompanying consolidated statements of cash flows under the caption,
“Change in amounts sold under receivables securitization, net.”
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
459,011
Proceeds under accounts receivable securitization…………………………………………………………………………
(461,811)
Collections as servicer of receivables sold………………………………………………………………………………….
492,337
(489,537)
614,033
(614,033)
$
$
$
Retained interest in accounts receivable at end of period…………………………………………………………………………
Cash flows from retained interests………………………………………………………………………………….
61,383
538,557
61,511
518,452
67,139
448,500
$
$
$
52
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
NOTE 9—INCOME TAXES
The provision for income taxes consists of:
Current income tax expense from continuing operations:
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
$
Federal…………………………………………………………………………
State………………………………………………………………………………….
Foreign…………………………………………………………………………
Total…………………………………………………………………………
Deferred income tax expense from continuing operations………………………………………….
Total provision for income taxes from continuing operations………………………………
13,049
1,988
2,339
17,376
9,092
26,468
$
3,239
2,261
2,483
7,983
4,598
12,581
$
12,664
2,776
1,680
17,120
10,282
27,402
Current income tax expense (benefit) from discontinued operations…….
Deferred income tax expense (benefit) from discontinued operations…….
(2,536)
(10,722)
(2,900)
(8,485)
(1,436)
1,357
Total provision for (benefit from) income taxes
from discontinued operations……………………………………………….
(13,258)
(11,385)
(79)
Total provision for income taxes……………………….……………
$
13,210
$
1,196
$
27,323
Deferred taxes are comprised of the following:
April 28,
2007
April 29,
2006
Current deferred tax assets:
Inventory……………………………………………………………..
Allowance for doubtful accounts…………………………………..
Accrued liabilities…………………………………………………….
Accrued restructuring……………………………………………….
Total current deferred tax assets……………………………….
$
6,224
2,155
1,655
167
10,201
Long-term deferred tax assets (liabilities):
Net operating loss carryforward…………………………………….
Property and equipment……………………………………………..
Accrued liabilities…………………………………………………….
Intangible assets……………………………………………………..
Total long-term deferred tax liabilities…………………………..
Net deferred tax liablities…………………………………………
2,701
(10,665)
(7,388)
(34,749)
(50,101)
(39,900)
$
$
4,152
1,653
375
917
7,097
2,898
(10,031)
(5,431)
(36,063)
(48,627)
(41,530)
$
At April 28, 2007, the Company has state net operating losses of approximately $64,152, which expire during fiscal years 2008 –
2026. The Company believes that the realization of the deferred tax assets is more likely than not, based on the expectation that
the Company will generate the necessary taxable income in future periods and, accordingly, no valuation reserve has been
provided. In fiscal 2007, fiscal 2006 and fiscal 2005, the Company had not recorded U.S. tax provisions of $980, $1,026 and $895
relating to $2,799, $3,445 and $2,558 of unremitted earnings from foreign investments, respectively, as these earnings are
expected to be reinvested indefinitely.
The Company’s effective income tax rate varied from the U.S. federal statutory tax rate as follows:
53
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
U.S. federal statutory rate………………………………………
State income taxes, net of federal income tax benefit……….
Foreign income tax……………………………………………...………………
Stock-based compensation……………………………………………...………………
Meals and entertainment, inventory donations and other……………………………………………………………
Effective income tax rate……………………………………….
35.0%
3.2%
1.0%
0.7%
0.4%
40.3%
35.0%
3.6%
1.8%
-
0.4%
40.8%
35.0%
3.4%
0.2%
-
0.3%
38.9%
NOTE 10—OPERATING LEASE COMMITMENTS
The Company leases various types of warehouse and office facilities and equipment, under noncancelable lease agreements which
expire at various dates. Future minimum lease payments under noncancelable operating leases for the Company’s fiscal years are
as follows:
2008…………………………………………………………
9,070
2009…………………………………………………………
7,901
2010………………………………………………………
6,986
5,698
2011………………………………………………………
4,367
2012………………………………………………………
35,354
Thereafter…………………………………………………
69,376
Total minimum lease payments…………………
$
Rent expense related to continuing operations for fiscal 2007, 2006 and 2005, was $9,995, $11,478 and $11,206, respectively.
NOTE 11—EMPLOYEE BENEFIT PLANS
The Company sponsors the School Specialty, Inc. 401(k) Plan (the “401(k) Plan”) which allows employee contributions in
accordance with Section 401(k) of the Internal Revenue Code. The Company matches a portion of employee contributions
and virtually all full-time employees are eligible to participate in the 401(k) Plan after 90 days of service. In fiscal 2007,
2006 and 2005, the Company’s matching contribution expense was $2,611, $2,727 and $2,132, respectively.
NOTE 12—SHAREHOLDERS’ EQUITY
Share Repurchase Program
On June 15, 2006 the Company’s Board of Directors approved a share repurchase program, which allowed the Company to
purchase up to $50,000 of the Company’s outstanding common stock. In November 2006, the Company’s Board of Directors
authorized an additional $26,508 repurchase, bringing the total authorization to $76,508. During fiscal 2007, the Company
repurchased a total of 2,126,121 shares, substantially completing the available purchases under authorizations at April 28, 2007.
Common stock acquired through the share repurchase program is available for general corporate purposes and is reflected as
Treasury Stock in the accompanying consolidated balance sheets.
Earnings Per Share (“EPS”)
Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities to
issue common stock were exercised. The following information presents the Company’s computations of basic and diluted EPS
54
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
for the periods presented in the consolidated statements of operations:
Fiscal 2007:
Income
(Numerator)
Shares
(Denominator)
Per Share
Amount
18,046
Basic EPS…………………………………………………….
Effect of dilutive employee stock options………………………………
-
18,046
Diluted EPS…………………………………………………..
$
$
Fiscal 2006:
61
Basic EPS…………………………………………………….
Effect of dilutive employee stock options………………………………
-
61
Diluted EPS…………………………………………………..
$
$
Fiscal 2005:
43,001
Basic EPS…………………………………………………….
Effect of dilutive employee stock options………………………………
-
1,891
Effect of dilutive 6.0% convertible debt…………………………………….
44,892
Diluted EPS…………………………………………………..
$
$
21,873
672
22,545
22,898
841
23,739
21,612
826
1,472
23,910
$
0.83
$
0.80
$
0.00
$
0.00
$
1.99
$
1.88
The Company had additional employee stock options outstanding of 904, 0, and 33 during fiscal 2007, 2006 and 2005,
respectively, which were not included in the computation of diluted EPS because they were anti-dilutive. In fiscal 2005, the
effect of convertible debt on the Company’s diluted EPS relates to the Company’s 6% convertible subordinated notes which
were redeemed and/or converted during fiscal 2005. Because the Company is required to satisfy in cash the portion of its
conversion obligation equal to the accreted principal amount, the 3.75% convertible subordinated notes did not have a
material impact on the Company’s diluted EPS.
NOTE 13—SHARE-BASED COMPENSATION EXPENSE
Employee Stock Plans
The Company has two stock-based employee compensation plans. On June 10, 1998, the Company’s Board of Directors
approved the School Specialty, Inc. 1998 Stock Incentive Plan (the “1998 Plan”) and on August 27, 2002 the Company’s
Board of Directors approved the School Specialty, Inc. 2002 Stock Incentive Plan (the “2002 Plan”). Both plans have been
approved by the Company’s shareholders. The purpose of the 1998 Plan and the 2002 Plan is to provide directors, officers,
key employees and consultants with additional incentives by increasing their ownership interests in the Company. Under the
1998 Plan, the maximum number of options available for grant is equal to 20% of the Company’s outstanding common stock.
Under the 2002 Plan, the maximum number of options available for grant is 1,500 shares.
55
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
A summary of option transactions for fiscal 2005, fiscal 2006 and fiscal 2007 follows:
Options Outstanding
Options Exercisable
Weighted-
Average
Exercise
Price
$
Balance at April 24, 2004…………………………………
Granted………………………………………………
Exercised………………………………………………
Canceled……………………………
Balance at April 30, 2005…………………………………
Granted………………………………………………
Exercised………………………………………………
Canceled……………………………
Balance at April 29, 2006………………………………
Granted………………………………………………
Exercised………………………………………………
Canceled……………………………
Options
2,638
305
(230)
(85)
2,628
477
(111)
(112)
2,882
560
(348)
(103)
2,991
Balance at April 28, 2007…………………………………
$
$
$
20.08
36.35
23.33
29.34
21.38
36.87
25.89
33.35
23.29
36.97
22.39
33.17
25.62
Weighted-
Average
Exercise
Price
$
16.87
Options
1,809
1,886
$
17.55
2,054
$
18.67
1,975
$
20.00
The following tables detail supplemental information regarding stock options outstanding at April 28, 2007:
Weighted Average
Remaining
Contractual Term
Aggregate
Instrinsic
Value
Options outstanding…………………………………………………………..
$
Options vested and expected to vest……………………………………………………….
Options exercisable……………………………………………………….
4.86 years
4.70 years
2.79 years
26,904
26,879
26,589
Range of
Exercise
Prices
$15.00 - $16.06
$17.00 - $24.10
$27.20 - $31.51
$34.00 - $36.82
$37.51 - $59.84
Options
1,268
319
222
762
420
2,991
Options Outstanding
Weighted-
Average
Life
(Years)
Weighted-
Average
Exercise
Price
1.23
3.63
7.23
8.32
9.24
4.86
$
$
15.48
20.92
29.07
36.22
38.73
25.62
Options Exercisable
Weighted-
Average
Exercise
Price
$
15.48
20.92
27.76
35.84
38.77
20.00
$
Options
1,268
319
106
235
47
1,975
Options granted are generally exercisable beginning one year from the date of grant in cumulative yearly amounts of twenty-
five percent of the shares granted and generally expire ten years from the date of grant. Options granted to directors and non-
employee officers of the Company vest over a three year period, twenty percent after the first year, fifty percent (cumulative)
56
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
after the second year and one-hundred percent (cumulative) after the third year. The Company has historically issued new
shares of common stock to settle shares due upon option exercise. For fiscal 2007, approximately 348 new shares were issued
upon the exercise of stock options.
The Company adopted SFAS No. 123(R) using the modified prospective application transition method effective with the
beginning of fiscal 2007. Prior to the adoption of SFAS No. 123(R), the Company accounted for share-based compensation
in accordance with APB 25. Under APB 25, no employee or director share-based compensation expense was reflected in the
consolidated statements of operations prior to fiscal 2007.
During the fiscal year ended April 28, 2007, the Company recognized $4,507 in share-based compensation expense which is
reflected in selling, general and administrative expenses in the fiscal 2007 statement of operations. The fiscal 2007 income
tax benefit recognized related to share-based compensation expense was $1,233. As a result of adopting SFAS No. 123(R),
net income for the fiscal year ended 2007 was $3,274 lower, and both basic and diluted EPS were $0.15 lower. The Company
recognizes share-based compensation expense on a straight-line basis over the vesting period of each award. As of April 28,
2007, total unrecognized share-based compensation expense was $12,355, net of estimated forfeitures, which the Company
expects to recognize over a weighted average period of approximately 2.8 years.
Prior Year Pro Forma Expense
The following table illustrates the effect on net income and earnings per share if the fair value-based method provided by
SFAS No. 123 had been applied for all outstanding and unvested awards prior to the adoption of SFAS No. 123(R):
Net income, as reported……………………………………………
Deduct: Total stock-based employee compensation
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
$
61
$
43,001
expense determined under fair value based
method for all awards, net of related tax effects…………………………………………
Pro forma net (loss) income………………………………………………
(2,860)
(2,799)
$
(3,008)
39,993
$
EPS:
As reported:
Basic………………………………………………………………
Diluted………………………………………………………………
$ 0.00
$ 0.00
$
$
1.99
1.88
Pro forma:
Basic………………………………………………………………
Diluted………………………………………………………………
$
$
(0.12)
(0.12)
$
$
1.85
1.75
The weighted average fair value of options granted during fiscal 2007, 2006 and 2005, was $14.43, $15.70 and $17.88,
respectively. The fair value of options is estimated on the date of grant using the Black-Scholes single option pricing model
with the following weighted average assumptions:
57
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Fiscal 2007
Average-risk free interest rate………………………………………………
4.68%
0.00%
Expected dividend yield……………………………………………
32.84%
Expected volatility………………………….…………………
5.5 years
Expected term…………………...………………………………
Fiscal 2006
4.40%
0.00%
38.30%
5.5 years
Fiscal 2005
3.90%
0.00%
48.73%
5.5 years
Fiscal 2007
5,057
$
Total intrinsic value of stock options exercised………………………………
7,798
Cash received from stock option exercises……………………………………
1,962
Income tax benefit from the exercise of stock options………………………
Fiscal 2006
1,493
$
2,871
579
Fiscal 2005
3,253
$
5,375
1,262
NOTE 14—SEGMENT INFORMATION
The Company determines its operating segments based on the information utilized by the chief operating decision maker, the
Company’s Chief Executive Officer, to allocate resources and assess performance. Based on this information, the Company
has determined that it operates in two operating segments, Specialty and Essentials, which also constitute its reportable
segments. The Company operates principally in the United States, with limited Specialty segment operations in Canada.
Products supplied within the Specialty segment primarily target specific educational disciplines, such as art, industrial arts,
physical education, sciences, and early childhood. This segment also supplies student academic planners, videos, DVDs,
published educational materials and sound presentation equipment. Products supplied within the Essentials segment include
consumables (consisting of classroom supplies, instructional materials, educational games, art supplies and school forms),
school furniture and indoor and outdoor equipment. The accounting policies of the segments are the same as those described
in Summary of Significant Accounting Policies. Intercompany eliminations represent intercompany sales between our
Specialty and Essential segments, and the resulting profit recognized on such intercompany sales.
The following table presents segment information:
Revenues:
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
Specialty………………………………………………………………………………………………………………
Essentials..…………………………………………………………………………………………
Corporate………………………………………………………………
Intercompany eliminations………………………………………
$
Total……………………………………………………………………………………………
591,866
471,141
720
(20,575)
1,043,152
502,178
486,238
106
(18,087)
970,435
527,201
468,757
686
(19,342)
977,302
$
$
$
$
$
Operating income (loss) and income before taxes:
54,075
Specialty…………………………………………………………………………………………
Essentials..………………………………………………………………………………………
45,954
(44,035)
Corporate………………………………………………………
(1,819)
Intercompany eliminations……………………………………………
54,175
Interest expense and other……………………………………………………………………
23,346
30,829
Operating income……………………………………………………………………………
Income before taxes……………………………………………………………………………
83,566
46,726
(34,259)
(2,235)
93,798
28,105
65,693
$
$
$
$
58
$
72,694
45,003
(27,486)
(2,846)
87,365
16,836
70,529
$
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
Identifiable assets:
April 28,
2007
April 29,
2006
Specialty………………………………………………………..
Essentials………………………………………………………
Corporate assets (1)……………………………………………..
Total assets of continuing segments…………………………………………………………….
Discontinued operations………………………………………………………
Total…………………………………………………………….
$
$
782,625
275,300
37,245
1,095,170
15,709
1,110,879
$
777,660
261,133
41,579
1,080,372
50,003
1,130,375
$
Depreciation and amortization of intangible assets
and development costs:
Fiscal 2007
(52 weeks)
Fiscal 2006
(52 weeks)
Fiscal 2005
(53 weeks)
Specialty………………………………………………………..
Essentials...………………………………………………………
Corporate………………………………………………………….
$
Total continuing segments…………………………………………………………….
Discontinued operations………………………………………………………….
$
Total…………………………………………………………….
$
$
18,500
3,382
6,769
28,651
3,429
32,080
$
$
17,255
2,928
5,719
25,902
2,090
27,992
12,741
3,377
4,783
20,901
1,636
22,537
Expenditures for property, plant and equipment, intangible
and other assets and development costs:
Specialty………………………………………………………..
Essentials...………………………………………………………
Corporate………………………………………………………………..
16,161
719
10,770
Total continuing segments………………………………………………………………..
27,650
2,756
30,406
Discontinued operations………………………………………………………………..
$
$
Total…………………………………………………………….
9,019
75
16,974
26,068
1,987
28,055
$
$
$
7,661
412
19,802
27,875
3,046
30,921
$
__________________
(1) Corporate assets have been reduced by $50,000 and $50,000 at April 28, 2007 and April 29, 2006, respectively, to reflect the
removal of accounts receivable from the balance sheet in accordance with the Accounts Receivable Securitization
transactions described in Note 8.
NOTE 15—COMMITMENTS AND CONTINGENCIES
Various claims and proceedings arising in the normal course of business are pending against the Company. The results of
these matters are not expected to have a material adverse effect on the Company’s consolidated financial position, results of
operations or cash flows.
59
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
NOTE 16—QUARTERLY FINANCIAL DATA (UNAUDITED)
The following presents certain unaudited quarterly financial data for fiscal 2007 and fiscal 2006:
First
(13 weeks)
Revenues………………………………………………..
Gross profit…………………………………………………………
Operating income (loss)……………………………….
Earnings (loss) from continuing operations,
377,071
167,911
69,072
$
Second
(13 weeks)
$
371,225
154,821
56,931
Fiscal 2007 (1)
Third
(13 weeks)
Fourth
(13 weeks)
Total
(52 weeks)
$
128,816
50,856
(20,725)
$
166,040
72,049
(11,480)
$
1,043,152
445,637
93,798
37,745
net of income taxes…………………………………………..
29,644
(16,906)
(11,258)
39,225
Earnings (loss) from discontinued operations,
net of income taxes…………………………………………..
(878)
36,867
Net income (loss)……………………………………….…….
(442)
29,202
(1,917)
(18,823)
(17,942)
(29,200)
(21,179)
18,046
Basic earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.65
1.33
(0.02)
(0.04)
Earnings (loss) from discontinued operations…………………………………………………………………………..
1.31
1.61
Total…………………………………………………………………………..
(0.53)
(0.85)
(1.38)
(0.79)
(0.09)
(0.88)
$
$
$
$
$
$
$
$
$
$
1.79
(0.96)
0.83
Diluted earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.60
1.29
(0.01)
(0.03)
Earnings (loss) from discontinued operations…………………………………………………………………………..
1.28
1.57
Total…………………………………………………………………………..
(0.53)
(0.85)
(1.38)
(0.79)
(0.09)
(0.88)
$
$
$
$
$
$
$
$
$
$
1.74
(0.94)
0.80
First
(13 weeks)
347,335
Revenues………………………………………………..
Gross profit………………………………………………………..
150,331
59,431
Operating income (loss)……………………………….
Earnings (loss) from continuing operations,
$
Second
(13 weeks)
$
331,733
137,897
37,483
Fiscal 2006 (1)
Third
(13 weeks)
Fourth
(13 weeks)
Total
(52 weeks)
$
126,863
49,458
(28,617)
$
171,371
70,993
(14,122)
$
977,302
408,679
54,175
34,494
net of income taxes…………………………………………..
19,194
(21,789)
(13,651)
18,248
Earnings (loss) from discontinued operations,
102
net of income taxes…………………………………………..
34,596
Net income (loss)……………………………………….…….
1,374
20,568
(735)
(22,524)
(18,928)
(32,579)
(18,187)
61
Basic earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.50
0.84
0.06
0.01
Earnings (loss) from discontinued operations…………………………………………………………………………..
0.90
Total…………………………………………………………………………..
1.51
(0.95)
(0.03)
(0.98)
(0.59)
(0.83)
(1.42)
$
$
$
$
$
$
$
$
$
$
0.80
(0.80)
0.00
Diluted earnings per share of common stock:
Earnings (loss) from continuing operations………………………………………………………………………………..
1.43
0.79
0.06
0.01
Earnings (loss) from discontinued operations…………………………………………………………………………..
0.85
Total…………………………………………………………………………..
1.44
(0.95)
(0.03)
(0.98)
(0.59)
(0.83)
(1.42)
$
$
$
$
$
$
$
$
$
$
0.77
(0.77)
0.00
________________
(1) On August 31, 2005, the Company acquired Delta, a seasonal business that generated operating and net losses during the
third and fourth quarters of fiscal 2006. Fiscal 2007 includes the results of Delta for all quarters presented.
60
SCHOOL SPECIALTY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED APRIL 28, 2007, APRIL 29, 2006 AND APRIL 30, 2005
(In Thousands, Except Per Share Amounts)
The summation of quarterly net income per share may not equate to the calculation for the full fiscal year as quarterly calculations
are performed on a discrete basis.
Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the
first two quarters of our fiscal year, primarily due to increased shipments to customers coinciding with the start of each
school year. Quarterly results also may be materially affected by the timing of acquisitions, the timing and magnitude of
costs related to such acquisitions, variations in our costs for the products sold, the mix of products sold and general economic
conditions. Moreover, the operating margins of companies we acquire may differ substantially from our own, which could
contribute to further fluctuation in quarterly operating results. Therefore, results for any quarter are not indicative of the
results that we may achieve for any subsequent fiscal quarter or for a full fiscal year.
NOTE 17—MERGER TRANSACTION
On May 31, 2005, the Company announced that it had entered into an Agreement and Plan of Merger, as amended, dated as
of May 31, 2005 (the “Merger Agreement”), with LBW Holdings, Inc. and LBW Acquisition, Inc. On October 25, 2005, a
Termination and Release Agreement was entered into by and among the Company, LBW Holdings, Inc. and LBW
Acquisition, Inc. pursuant to which the Merger Agreement was terminated by mutual agreement and the parties released each
other from certain claims. No termination fees were payable by the Company or by LBW Holdings, Inc., and each party was
responsible for its own merger-related expenses.
During fiscal 2006, the Company incurred $5,202 of costs related to the terminated merger transaction consisting of
accounting, legal and other transaction-related costs, including costs related to financial and legal advisors to the special
committee of our Board of Directors. These costs have been included in the statement of operations for fiscal 2006.
Following the Company’s announcement of the Merger Agreement on May 31, 2005, the Company was named as a
defendant in three putative shareholder class actions. The complaints alleged that the Company and its directors breached
fiduciary duties to the Company’s shareholders by negotiating and agreeing to the transaction at a price that the plaintiffs
claimed to be inadequate. On January 17, 2006, the three putative shareholder class actions were dismissed.
NOTE 18—SUBSEQUENT EVENTS
On June 5, 2007 School Specialty, Inc. announced that its Board of Directors approved a new share repurchase program
which gives School Specialty the ability to purchase up to $45,000 of its issued and outstanding common stock. Purchases
under this program may be made from time to time in open market or privately negotiated transactions. Common stock
acquired through the repurchase program will be available for general corporate purposes.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Based on an evaluation as of the end of the period covered by this annual report, the Company’s principal executive officer
and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective for the purposes set forth in the
definition of the Exchange Act rules.
Management’s Report on Internal Control Over Financial Reporting
61
Management is responsible for establishing and maintaining adequate internal control over financial reporting. As such term
is defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the
supervision of, the principal executive and principal financial officers, or persons performing similar functions, and effected
by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles
generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that:
(1)
(2)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of assets of the Company;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of the
financial statements in accordance with accounting principles generally accepted in the United States, and
that receipts and expenditures of the Company are being made only in accordance with authorizations of
management and the directors of the Company; and
(3)
provide reasonable assurance regarding prevention of unauthorized acquisition, use, or disposition of the
Company’s assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based
on the criteria in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation under the criteria in Internal Control—Integrated Framework, management
concluded that internal control over financial reporting was effective as of April 28, 2007.
Management’s assessment of the effectiveness of internal control over financial reporting as of April 28, 2007 has been
audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report dated June 25,
2007, which is included herein.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
School Specialty, Inc.
Greenville, Wisconsin
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over
Financial Reporting, that School Specialty, Inc., and subsidiaries (the “Company”) maintained effective internal control over
financial reporting as of April 28, 2007, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of
the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s
principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board
of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
62
accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material
effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper
management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.
Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject
to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of
April 28, 2007, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the
Company maintained, in all material respects, effective internal control over financial reporting as of April 28, 2007, based on the
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated financial statements and financial statement schedule as of and for the year ended April 28, 2007 of the Company
and our report dated June 25, 2007 expressed an unqualified opinion on those financial statements, financial statement schedule,
and included explanatory paragraph relating to the Company’s adoption of Statement of Financial Accounting Standard No.
123®, Share Based Payment.
/s/ DELOITTE & TOUCHE LLP
Milwaukee, Wisconsin
June 25, 2007
Changes in Internal Controls
During fiscal 2007, the Company began implementation of a common enterprise resource planning (“ERP”) platform. Over a
three year period, this platform will replace most of our existing systems. As a result, the Company’s entities will be more
closely aligned with standardized processes and internal controls at the completion of the implementation. As of April 28,
2007, three of our business units within the Specialty segment had been converted to the new ERP system and it is estimated
that a total of 80% of the Company’s businesses will be converted by the end of fiscal 2008.
Item 9B. Other Information
Not applicable
63
Item 10. Directors and Executive Officers of the Registrant
PART III
(a)
(b)
(c)
(d)
(e)
Executive Officers. Reference is made to “Executive Officers of the Registrant” in Part I hereof.
Directors. The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of
Shareholders to be held on August 29, 2007, under the caption “Proposal One: Election of Directors,” which
information is incorporated by reference herein.
Section 16 Compliance. The information required by this Item is set forth in our Proxy Statement for the Annual
Meeting of Shareholders to be held on August 29, 2007, under the caption “Section 16(a) Beneficial Ownership
Reporting Compliance,” which information is incorporated by reference herein.
We have adopted a Code of Ethics that applies to our directors, officers and employees, including the principal
executive officer, principal financial officer, principal accounting officer and controller. The Code of Ethics is posted
on our internet website at www.schoolspecialty.com. We intend to satisfy the disclosure requirement under Item 10 of
Form 8-K by posting such information on our internet website.
The Company has a separately-designated standing Audit Committee of its Board of Directors. The Audit Committee
is responsible for oversight of the Company’s accounting and financial reporting processes and the audit of the
Company’s financial statements. The Audit Committee currently consists of three members, including Mr.
Trucksess (Chairman), Mr. Lay and Mr. Emma, each of whom is “independent” under the listing standards of the
Nasdaq National Market. Mr. Trucksess, Mr. Lay and Mr. Emma have each been deemed by the Board of Directors
to be an “audit committee financial expert” for purposes of the SEC’s rules. The Audit Committee has adopted, and
the Board of Directors has approved, a charter for the Audit Committee. The Audit Committee held four meetings in
fiscal 2007.
Item 11. Executive Compensation
The information required by this Item is set forth in our Proxy statement for the Annual Meeting of Shareholders to be held on
August 29, 2007, under the captions “Executive Compensation Discussion and Analysis,” and “Compensation Committee
Interlocks and Insider Participation,” which information is incorporated by reference herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by this Item is set forth in our Proxy statement for the Annual Meeting of Shareholders to be held on
August 29, 2007, under the captions “Security Ownership of Management and Certain Beneficial Owners” and “Executive
Compensation Discussion and Analysis,” which information is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is set forth in our Proxy statement for the Annual Meeting of Shareholders to be held
on August 29, 2007, under the captions “Related Party Transactions” and “Corporate Governance,” which information is
incorporated by reference herein.
Item 14. Principal Accountant Fees and Services
The information required by this Item is set forth in our Proxy Statement for the Annual Meeting of Shareholders to be held on
August 29, 2007, under the caption “Audit Committee Report,” which information is incorporated by reference herein.
64
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements (See Part II, Item 8).
Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of April 28, 2007 and April 29, 2006
Consolidated Statements of Operations for the fiscal years ended April 28, 2007, April 29, 2006 and April 30,
2005
Consolidated Statements of Shareholders’ Equity for the fiscal years ended April 28, 2007, April 29, 2006 and
April 30, 2005
Consolidated Statements of Cash Flows for the fiscal years ended April 28, 2007, April 29, 2006 and April 30,
2005
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedule (See Exhibit 99.1).
Schedule for the fiscal years ended April 28, 2007, April 29, 2006 and April 30, 2005: Schedule II – Valuation and
Qualifying Accounts.
(a)(3) Exhibits.
See (b) below
(b)
Exhibits.
See the Exhibit Index, which is incorporated by reference herein
(c)
Financial Statements Excluded from Annual Report to Shareholders.
Not applicable
65
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized, on June 25, 2007.
SIGNATURES
SCHOOL SPECIALTY, INC.
By: /s/ David J. Vander Zanden
David J. Vander Zanden
Chief Executive Officer
(Principal Executive Officer)
By: /s/ David G. Gomach
David G. Gomach
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Each person whose signature appears below hereby constitutes and appoints David J. Vander Zanden and David G.
Gomach, and each of them, as his or her true and lawful attorney-in-fact and agent, with full power of substitution,
to sign on his or her behalf individually and in the capacity stated below and to perform any acts necessary to be
done in order to file any and all amendments to this Annual Report on Form 10-K, and to file the same, with all
exhibits thereto and all other documents in connection therewith and each of the undersigned does hereby ratify and
confirm all that said attorney-in-fact and agent, or his substitutes, shall do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following
persons in the capacities and on the dates indicated below.
Name
Title
/s/ David J. Vander Zanden
David J. Vander Zanden
Chief Executive Officer and Director
(Principal Executive Officer)
Date
June 25, 2007
/s/ David G. Gomach
David G. Gomach
/s/ Terry L. Lay
Terry L. Lay
/s/ Jonathan J. Ledecky
Jonathan J. Ledecky
/s/ Edward C. Emma
Edward C. Emma
/s/ Herbert A. Trucksess
Herbert A. Trucksess
/s/ Jacqueline F. Woods
Jacqueline F. Woods
Executive Vice President and Chief Financial
Officer (Principal Financial and Accounting Officer)
June 25, 2007
Chairman of the Board
Director
Director
Director
Director
June 25, 2007
June 25, 2007
June 25, 2007
June 25, 2007
June 25, 2007