UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JULY 1, 2017

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number: 000-24385

SCHOOL SPECIALTY, INC.

(Exact name of Registrant as specified in its charter

Delaware	39-0971239
(State or Other Jurisdiction of Incorporation)	(IRS Employer Identification No.)

W6316 Design Drive

Greenville, Wisconsin 54942

(Address of Principal Executive Offices) (Zip Code)

(920) 734-5712

(Registrant’s Telephone Number, including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐  (Do not check if a smaller reporting company)	Smaller reporting company	☐
		Emerging growth company	☐

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ☒  No  ☐

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

Class	Outstanding at August 9, 2017
Common Stock, $0.001 par value	1,000,004

SCHOOL SPECIALTY, INC.

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JULY 1, 2017

PART I - FINANCIAL INFORMATION
		Page Number
ITEM 1.	CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
	Condensed Consolidated Balance Sheets at July 1, 2017,  December 31, 2016 and June 25, 2016		2
	Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended July 1, 2017 and June 25, 2016		3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months and Six Months Ended July 1, 2017 and June 25, 2016		4
	Condensed Consolidated Statements of Cash Flows for Six Months Ended July 1, 2017 and June 25, 2016		5
	Notes to Condensed Consolidated Financial Statements		6
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION		23
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		30
ITEM 4.	CONTROLS AND PROCEDURES		30
PART II - OTHER INFORMATION
ITEM 6.	EXHIBITS		31

-Index-

PART I – FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Unaudited Financial Statements

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In Thousands, except share and per share amounts)

	July 1, 2017			December 31, 2016			June 25, 2016
ASSETS
Current assets:
Cash and cash equivalents	$	6,900		$	35,097		$	8,570
Accounts receivable, less allowance for doubtful accounts of $1,136, $1,159, and $1,073, respectively		87,461			61,713			78,736
Inventories, net		124,906			73,649			128,673
Deferred catalog costs		6,762			5,235			6,455
Prepaid expenses and other current assets		11,145			11,976			13,472
Refundable income taxes		1,325			728			5,080
Total current assets		238,499			188,398			240,986
Property, plant and equipment, net		32,180			28,684			28,497
Goodwill		21,588			21,588			21,588
Intangible assets, net		33,247			35,049			36,849
Development costs and other		12,600			13,703			17,269
Deferred taxes long-term		193			185			5
Investment in unconsolidated affiliate		—			—			715
Total assets	$	338,307		$	287,607		$	345,909
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities - long-term debt	$	46,882		$	5,493		$	46,400
Accounts payable		59,125			22,078			61,985
Accrued compensation		9,173			12,008			7,736
Deferred revenue		2,808			2,922			2,971
Other accrued liabilities		12,547			14,909			14,320
Total current liabilities		130,535			57,410			133,412
Long-term debt - less current maturities		124,849			131,994			143,948
Other liabilities		169			84			179
Total liabilities		255,553			189,488			277,538
Commitments and contingencies - Note 14
Stockholders’ equity:
Preferred stock, $0.001 par value per share, 500,000 shares authorized; none outstanding		—			—			—
Common stock, $0.001 par value per share, 2,000,000 shares authorized; 1,000,004 shares outstanding		1			1			1
Capital in excess of par value		121,946			120,855			119,955
Accumulated other comprehensive loss		(1,600	)		(1,784	)		(1,580	)
Accumulated deficit		(37,593	)		(20,953	)		(50,005	)
Total stockholders’ equity		82,754			98,119			68,371
Total liabilities and stockholders’ equity	$	338,307		$	287,607		$	345,909

See accompanying notes to condensed consolidated financial statements.

2

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands, Except Per Share Amounts)

	For the Three Months Ended					For the Six Months Ended
	July 1, 2017		June 25, 2016			July 1, 2017			June 25, 2016
Revenues	$	160,177	$	145,858		$	257,288		$	239,583
Cost of revenues		99,682		90,259			162,269			148,519
Gross profit		60,495		55,599			95,019			91,064
Selling, general and administrative expenses		51,721		53,212			99,189			100,523
Facility exit costs and restructuring		44		383			217			549
Operating income (loss)		8,730		2,004			(4,387	)		(10,008	)
Other expense (income):
Interest expense		4,197		4,455			8,247			8,845
Change in fair value of interest rate swap		—		(91	)		—			(176	)
Loss on early extinguishment of debt		4,298		—			4,298			—
Income (loss) before benefit from income taxes		235		(2,360	)		(16,932	)		(18,677	)
Provision for (benefit from) income taxes		99		(374	)		(292	)		(4,388	)
Net income (loss)	$	136	$	(1,986	)	$	(16,640	)	$	(14,289	)
Weighted average shares outstanding:
Basic EPS		1,000		1,000			1,000			1,000
Diluted EPS		1,011		1,000			1,000			1,000
Net loss per Share:
Basic	$	0.14	$	(1.99	)	$	(16.64	)	$	(14.29	)
Diluted	$	0.13	$	(1.99	)	$	(16.64	)	$	(14.29	)

See accompanying notes to condensed consolidated financial statements.

3

SCHOOL SPECIALTY, INC.

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

(In Thousands)

	For the Three Months Ended					For the Six Months Ended
	July 1, 2017		June 25, 2016			July 1, 2017			June 25, 2016
Net income (loss)	$	136	$	(1,986	)	$	(16,640	)	$	(14,289	)
Other comprehensive income, net of tax:
Foreign currency translation adjustments		139		124			184			339
Total comprehensive income (loss)	$	275	$	(1,862	)	$	(16,456	)	$	(13,950	)

See accompanying notes to condensed consolidated financial statements.

4

SCHOOL SPECIALTY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

	For the Six Months Ended
	July 1, 2017			June 25, 2016
Cash flows from operating activities:
Net loss	$	(16,640	)	$	(14,289	)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and intangible asset amortization expense		6,473			7,923
Amortization of development costs		2,283			3,075
Amortization of debt fees and other		797			1,027
Change in fair value of interest rate swap		—			(176	)
Loss on early extinguishment of debt		4,298			—
Unrealized foreign exchange (gain) loss		(30	)		(904	)
Share-based compensation expense		1,091			715
Deferred taxes		(7	)		1
Non-cash interest expense		1,921			923
Changes in current assets and liabilities:
Accounts receivable		(25,665	)		(20,239	)
Inventories		(51,254	)		(52,469	)
Deferred catalog costs		(1,526	)		72
Prepaid expenses and other current assets		233			(5,425	)
Accounts payable		37,141			42,122
Accrued liabilities		(5,353	)		(3,334	)
Net cash used by operating activities		(46,238	)		(40,978	)
Cash flows from investing activities:
Additions to property, plant and equipment		(8,167	)		(7,490	)
Investment in product development costs		(1,050	)		(1,309	)
Net cash used in investing activities		(9,217	)		(8,799	)
Cash flows from financing activities:
Proceeds from bank borrowings		220,485			146,404
Repayment of bank borrowings		(189,267	)		(101,825	)
Payment of debt fees and other		(4,009	)		—
Net cash provided in financing activities		27,209			44,579
Effect of exchange rate changes on cash		49			903
Net decrease in cash and cash equivalents		(28,197	)		(4,295	)
Cash and cash equivalents, beginning of period		35,097			12,865
Cash and cash equivalents, end of period	$	6,900		$	8,570
Supplemental disclosures of cash flow information:
Interest paid	$	5,529		$	6,895
Income taxes paid, net	$	244		$	1,112

See accompanying notes to condensed consolidated financial statements.

5

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature unless otherwise noted) considered necessary for a fair presentation have been included. The balance sheet at December 31, 2016 has been derived from School Specialty, Inc.’s (“School Specialty” or the “Company”) audited financial statements for the period ended December 31, 2016. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the period ended December 31, 2016.

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, “Compensation—Stock Compensation: Scope of Modification Accounting.” ASU 2017-09 amends the scope of modification accounting for share-based payment arrangements. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early adoption is permitted for interim or annual periods. The adoption is not expected to have a material impact on the consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge, instead, an impairment charge will be based on excess of the reporting unit’s carrying amount over its fair value. The Company has elected to early adopt ASU 2017-04 and the ASU will be applied prospectively to all future goodwill impairment tests performed on an interim or annual basis.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows.” ASU No. 2016-15 is intended to reduce diversity in practice in the manner certain transactions are classified in the statement of cash flows. This guidance will be effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company is currently in the process of evaluating the impact of adoption of this ASU on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation.” ASU No. 2016-09 is intended to simplify various aspects related to the manner for which share-based payments are accounted for and presented in the financial statements. This guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases.” ASU No. 2016-02 requires lessees to recognize the assets and liabilities arising from leases on the balance sheet. The new guidance requires that all leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements. This guidance will be effective for periods beginning after December 15, 2018. The Company is currently in the process of evaluating the impact of adoption of this ASU on the Company’s consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes - Balance Sheet Classification of Deferred Taxes.” ASU No. 2015-17 simplifies the presentation of deferred taxes. The new guidance requires that deferred tax liabilities and assets be classified as noncurrent on the balance sheet, as opposed to being presented as current or non-current. This guidance is effective for annual periods beginning after December 15, 2016. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

6

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”. ASU No. 2014-09 provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This guidance will be effective for the Company in the first quarter of its fiscal year ending December 29, 2018.

The majority of our revenue transactions consist of one, distinct fixed-price performance obligation which is delivered to the customer at a single point in time, or over a subscription period for certain digital Curriculum segment products. The Company does continue to evaluate the impact this new standard may have on its project-related Furniture revenue, which can require services such as installation in addition to the delivery of product. This project-related Furniture revenue represents less than 10 percent of the Company’s total consolidated revenues. As such, the Company does not anticipate that the implementation of this new standard will have a material impact on the Company’s results of operations, financial position or cash flows. The new requirements may be implemented either retrospectively for all prior periods presented (i.e., the full retrospective approach), or retrospectively with a cumulative-effect adjustment at the date of initial application (i.e., the modified retrospective approach). The Company expects to adopt the standard under the modified retrospective approach upon its effective date with a cumulative-effect adjustment to opening retained earnings. The Company is currently assessing the impact of this standard on its disclosures and internal controls.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern.” ASU 2014-15 defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective in the annual period ending after December 15, 2016. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

NOTE 3 – INCOME TAXES

The Company files income tax returns with the U.S., various U.S. states, and foreign jurisdictions. The most significant tax return the Company files is with the U.S. The Company’s tax returns are no longer subject to examination by the U.S. for fiscal years before 2014. The Company has various state tax audits and appeals in process at any given time. It is not anticipated that any adjustments resulting from tax examinations or appeals would result in a material change to the Company’s financial position or results of operations.

In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that either all, or some portion, of the deferred tax assets will not be realized. The realization is dependent upon the future generation of taxable income, reversal of deferred tax liabilities, tax planning strategies, and expiration of tax attribute carryovers. As a result, the Company had concluded that the realization of a majority of the deferred tax assets did not meet the more likely than not threshold, and recorded a tax valuation allowance. As of December 31, 2016, the Company continued to maintain a valuation allowance against substantially all its net deferred tax assets as it has not generated taxable income during a twelve-month tax year since the emergence from bankruptcy, partially due to the Company’s recognition of net deferred tax assets in recent periods. As of December 31, 2016, the Company had a tax valuation allowance of $18,671. As of July 1, 2017, there remained a valuation allowance against substantially all the Company’s deferred tax assets. As of July 1, 2017, the Company had an immaterial amount of unremitted earnings from foreign investments.

The balance of the Company’s liability for unrecognized income tax benefits, net of federal tax benefits, at July 1, 2017, December 31, 2016, and June 25, 2016, was $169, $84, and $94, respectively, all of which would have an impact on the effective tax rate if recognized. The Company does not expect any material changes in the amount of unrecognized tax benefits within the next twelve months. The Company classifies accrued interest and penalties related to unrecognized tax benefits as income tax expense in its consolidated statements of operations. The amounts of accrued interest and penalties included in the liability for uncertain tax positions are not material.

7

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 4 – STOCKHOLDERS’ EQUITY

Changes in condensed consolidated stockholders’ equity during the six months ended July 1, 2017 and June 25, 2016, were as follows:

(in thousands)	Common Stock		Capital in Excess of Par Value		Retained Earnings (Accumulated Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance, December 31, 2016	$	1	$	120,855	$	(20,953	)	$	(1,784	)	$	98,119
Net loss		—		—		(16,640	)		—			(16,640	)
Share-based compensation expense		—		1,091		—			—			1,091
Foreign currency translation adjustment		—		—		—			184			184
Balance, July 1, 2017	$	1	$	121,946	$	(37,593	)	$	(1,600	)	$	82,754
Balance, December 26, 2015	$	1	$	119,240	$	(35,716	)	$	(1,919	)	$	81,606
Net loss		—		—		(14,289	)		—			(14,289	)
Share-based compensation expense		—		715		—			—			715
Foreign currency translation adjustment		—		—		—			339			339
Balance, June 25, 2016	$	1	$	119,955	$	(50,005	)	$	(1,580	)	$	68,371

NOTE 5 – EARNINGS PER SHARE

Earnings Per Share

The following information presents the Company’s computations of basic earnings per share (“basic EPS”) and diluted earnings per share (“diluted EPS”) for the periods presented in the condensed consolidated statements of operations:

8

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

	Income (loss) (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Three months ended July 1, 2017:
Basic EPS	$	136			1,000	$	0.13
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			11
Diluted EPS	$	136			1,011	$	0.13
Three months ended June 25, 2016:
Basic EPS	$	(1,986	)		1,000	$	(1.99	)
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Basic and diluted EPS	$	(1,986	)		1,000	$	(1.99	)

	Income (loss) (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Six months ended July 1, 2017:
Basic EPS	$	(16,640	)		1,000	$	(16.64	)
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Basic and diluted EPS	$	(16,640	)		1,000	$	(16.64	)
Six months ended June 25, 2016:
Basic EPS	$	(14,289	)		1,000	$	(14.29	)
Effect of dilutive stock options		—			—
Effect of dilutive restricted stock units		—			—
Basic and diluted EPS	$	(14,289	)		1,000	$	(14.29	)

The Company had stock options outstanding of 102 and 72 for the three months ended July 1, 2017 and June 25, 2016, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive. The Company had stock options outstanding of 89 and 72 for the six months ended July 1, 2017 and June 25, 2016, respectively, which were not included in the computation of diluted EPS because they were anti-dilutive. The Company had restricted stock units outstanding of 28 for the three and six month periods ended July 1, 2017 and June 25, 2016, respectively. For the three month period ended July 1, 2017, 18 of the restricted stock units were not included in the computation of diluted EPS because they were anti-dilutive. For the six month period ended July 1, 2017 and the three and six month periods ended June 25, 2016, 28 of the restricted stock units were not included in the computation of diluted EPS because they were anti-dilutive.

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SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 6 – SHARE-BASED COMPENSATION EXPENSE

Employee Stock Plans

As of July 1, 2017, the Company had one share-based employee compensation plan: the School Specialty, Inc. 2014 Incentive Plan (the “2014 Plan”). The 2014 Plan was adopted by the Board of Directors on April 24, 2014 and approved on September 4, 2014 by the Company’s stockholders.

The Company made 34 stock option awards during the six month period ended July 1, 2017 to members of management including its CEO. The options awarded to the Company’s CEO will vest as to one-fourth of the options on the first four anniversaries of the date of the award. The options that were awarded to the other members of management will vest as to one-half of the options on the second anniversary of the date of the award and as to one-fourth of the options on each of the third and fourth anniversaries of the award date.

The fair-value of the option awards granted in the three month period ended July 1, 2017 was $70.31 per share. The fair value of the options is estimated on the measurement date using the Black-Scholes single option pricing model. The assumptions included a risk-free rate of 1.92%, expected volatility of 59% and an expected term of 6.3 years. There were zero stock options granted in the three month period ended June 25, 2016.

The fair-value of the options granted in the six month period ended July 1, 2017 was $71.01 per share. The fair value of the options is estimated on the measurement date using the Black-Scholes single option pricing model. The assumptions included a risk-free rate of 2.31%, expected volatility of 59% and an expected term of 6.3 years. There were zero stock options granted in the six month period ended June 25, 2016.

A summary of option transactions for the six months ended July 1, 2017 and June 25, 2016 were as follows:

	Options Outstanding					Options Exercisable
	Options			Weighted- Average Exercise Price		Options		Weighted- Average Exercise Price
Balance at December 31, 2016		71		$	130.00		32	$	130.00
Granted		34			130.00
Exercised		—
Canceled		(3	)		130.00
Balance at July 1, 2017		102		$	130.00		45	$	130.00
Balance at December 26, 2015		73		$	130.00		8	$	130.00
Granted		—
Exercised		—
Canceled		(2	)	$	130.00
Balance at June 25, 2016		71		$	130.00		21	$	130.00

The weighted average life remaining of the stock options outstanding as of July 1, 2017 was 1.9 years and as of June 25, 2016 was 2.1 years.

On May 28, 2014, the Board granted 6 stock appreciation rights (“SARs”) to each of the non-employee members of the Board under the 2014 Plan. Prior to the approval of the 2014 Plan at the Annual Meeting of Stockholders on September 4, 2014, the SARs were not considered outstanding, nor granted and therefore no expense was recognized prior to this date. On July 31, 2015, the Board granted 6 stock appreciation rights to each of the two new non-employee members of the Board. Each SAR has a grant date value of $130 and will be settled in cash upon exercise. As such, the SARs are accounted for as liability awards. Since the Company’s stock trading price was less

10

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

than each SAR’s exercise price as of July 1, 2017, no expense was recorded for the SARs. The SARs vested as to one-half of the SARs on the second anniversary of the date of grant and will vest as to one-fourth of the SARs on each of the third and fourth anniversaries of the date of grant. Total SARs that remain outstanding as of July 1, 2017 are 22.

On March 23, 2016, the Compensation Committee of the Board of Directors of the Company granted an aggregate of 28 Restricted Stock Units (“RSUs”) under the Company’s 2014 Plan to members of the Company’s senior management. The RSUs are performance-based. A certain percentage of the RSUs will vest on the third anniversary of the date of grant, with such percentage based on the 15 day Volume Weighted Average Price (“VWAP”) of the Company’s common stock prior to the vesting date. The percentage of RSUs that will vest shall be determined as follows:

Vesting %	15 Day VWAP
0%	VWAP less than $ 108.00
20%	VWAP greater than or equal to $ 108.00, but less than $118.00
40%	VWAP greater than or equal to $ 118.00, but less than $128.00
60%	VWAP greater than or equal to $ 128.00, but less than $138.00
80%	VWAP greater than or equal to $ 138.00, but less than $148.00
100%	VWAP greater than or equal to $148.00

Any RSUs that vest will be settled in shares of Company common stock. Due to the nature of the vesting conditions of the RSUs, a valuation methodology needed to incorporate potential equity value paths for the Company. As such, the fair value of the RSU grants was determined under a Monte Carlo approach with a simulation of the Company’s stock price to a date that is 15 trading days prior to the vesting date. A large number of trials were run under the Monte Carlo approach to ensure an adequate sampling of different potential scenarios was achieved. The fair value of the RSUs granted on March 23, 2016 was $80.88 per share.

The following table presents the share-based compensation expense recognized for the three and six month periods ended July 1, 2017 and June 25, 2016:

	For the Three Months Ended
	July 1, 2017				June 25, 2016
	Gross		Net of Tax		Gross		Net of Tax
Stock Options	$	322	$	196	$	261	$	202
SARs		—		—		—		—
RSUs		189		115		194		148
Total stock-based compensation expense	$	511			$	455
	For the Six Months Ended
	July 1, 2017				June 25, 2016
	Gross		Net of Tax		Gross		Net of Tax
Stock Options	$	704	$	430	$	521	$	399
SARs		—		—		—		—
RSUs		387		236		194		148
Total stock-based compensation expense	$	1,091			$	715

The stock-based compensation expense is reflected in selling, general and administrative (“SG&A”) expenses in the accompanying consolidated statements of operations. The Company records actual forfeitures in the period the forfeiture occurs.

11

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

The total unrecognized share-based compensation expense as of July 1, 2017 and June 25, 2016 was as follows:

	July 1, 2017		June 25, 2016
Stock Options, net of actual forfeitures	$	3,335	$	2,204
RSUs		1,378		2,074

NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS

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

	Gross Value		Accumulated Amortization			Net Book Value
July 1, 2017
Amortizable intangible assets:
Customer relationships (13 years)	$	11,300	$	(3,549	)	$	7,751
Publishing rights (20 years)		4,000		(817	)		3,183
Trademarks (20 years)		22,700		(4,635	)		18,065
Developed technology (7 years)		6,600		(3,850	)		2,750
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(980	)		220
Favorable leasehold interests (10 years)		2,160		(882	)		1,278
Total intangible assets	$	52,360	$	(19,113	)	$	33,247
	Gross Value		Accumulated Amortization			Net Book Value
December 31, 2016
Amortizable intangible assets:
Customer relationships (13 years)	$	11,300	$	(3,115	)	$	8,185
Publishing rights (20 years)		4,000		(717	)		3,283
Trademarks (20 years)		22,700		(4,067	)		18,633
Developed technology (7 years)		6,600		(3,379	)		3,221
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(860	)		340
Favorable leasehold interests (10 years)		2,160		(774	)		1,386
Total intangible assets	$	52,360	$	(17,311	)	$	35,049
	Gross Value		Accumulated Amortization			Net Book Value
June 25, 2016
Amortizable intangible assets:
Customer relationships (13 years)	$	11,300	$	(2,681	)	$	8,619
Publishing rights (20 years)		4,000		(617	)		3,383
Trademarks (20 years)		22,700		(3,501	)		19,199
Developed technology (7 years)		6,600		(2,908	)		3,692
Content (5 years)		4,400		(4,400	)		—
Perpetual license agreements (5 years)		1,200		(740	)		460
Favorable leasehold interests (10 years)		2,160		(664	)		1,496
Total intangible assets	$	52,360	$	(15,511	)	$	36,849

The gross values were determined by the valuation which was performed as part of the fresh start accounting. In addition to the intangible assets above, the Company recorded $21,588 of goodwill.

12

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Intangible asset amortization expense for the three month periods ended July 1, 2017 and June 25, 2016, was $901 and $901, respectively.

Intangible asset amortization expense was included in selling, general and administrative expense. Intangible asset amortization expense for the six month periods ended July 1, 2017 and June 25, 2016, was $1,802 and $1,802, respectively.

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

Fiscal 2017 (6 months remaining)	$	1,802
Fiscal 2018		3,463
Fiscal 2019		3,363
Fiscal 2020		2,813
Fiscal 2021		2,420
Fiscal 2022		2,420

Due to a change in the Company’s reporting segments (see Note 13 – Segment Information), the Company’s reporting units and the goodwill allocated to the reporting units has changed. The table below shows the allocation of the recorded goodwill as of July 1, 2017 for both the reporting units and reporting segments.

	Reporting Units						Reporting Unit
	Distribution		Instruction & Intervention		Distribution Segment		Science Curriculum Segment		Total
Goodwill	$	14,112	$	3,356	$	17,468	$	4,120	$	21,588
Balance at July 1, 2017	$	14,112	$	3,356	$	17,468	$	4,120	$	21,588

The re-allocation of goodwill from the prior reporting units to the above reporting units was based on the relative fair values of a portion of the prior reporting units which were transferred to the new reporting units in proportion to the fair value of the prior reporting unit.

13

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 8 – INVESTMENT IN UNCONSOLIDATED AFFILIATE

The Company’s ownership interest in Carson-Dellosa Publishing had been 35% prior to July 26, 2016. The Company’s interest in Carson-Dellosa Publishing was accounted for under the cost method as the Company did not have significant influence over the investee.

The investment in unconsolidated affiliate consisted of the following:

	July 1, 2017		December 31, 2016		June 25, 2016
Carson- Dellosa Publishing, LLC	$	—	$	—	$	715

On July 26, 2016, the Company sold its 35% interest in Carson Dellosa Publishing LLC for $9,839. The Company recorded a non-operating gain on disposal of $9,178. In accordance with the Term Loan Credit Agreement (as defined below), the Company used $8,053 of the net cash proceeds from this sale to pay down the Term Loan (as defined below) with the remaining net cash proceeds used to pay down the ABL Facility.

NOTE 9 – PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

	July 1, 2017			December 31, 2016			June 25, 2016
Projects in progress	$	11,284		$	4,707		$	9,462
Buildings and leasehold improvements		3,298			3,347			3,318
Furniture, fixtures and other		49,383			48,224			41,812
Machinery and warehouse equipment		13,155			13,296			11,664
Total property, plant and equipment		77,120			69,574			66,256
Less: Accumulated depreciation		(44,940	)		(40,890	)		(37,759	)
Net property, plant and equipment	$	32,180		$	28,684		$	28,497

Depreciation expense for the three and six month periods ended July 1, 2017 and June 25, 2016 was $2,245 and $2,835 and $4,671 and $6,121, respectively.

14

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 10 – DEBT

Long-term debt consisted of the following:

	July 1, 2017			December 31, 2016			June 25, 2016
ABL Facility, maturing in 2022	$	44,132		$	—		$	46,400
New Term Loan, maturing in 2022		109,313			—			—
Term Loan, maturing in 2019		—			122,226			130,279
Term Loan Original Issue Discount		—			(1,377	)		(1,624	)
Unamortized New Term Loan Debt Issuance Costs		(3,533	)		—			—
Unamortized Term Loan Debt Issuance Costs		—			(3,388	)		(4,052	)
Deferred Cash Payment Obligations, maturing in 2019		21,819			20,026			19,345
Total debt		171,731			137,487			190,348
Less: Current maturities		(46,882	)		(5,493	)		(46,400	)
Total long-term debt	$	124,849		$	131,994		$	143,948

ABL Facility

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

Under the Asset-Based Credit Agreement, the Asset-Based Lenders agreed to provide a revolving senior secured asset-based credit facility (the “ABL Facility”) in an aggregate principal amount of $175,000. As of August 7, 2015, the aggregate commitments were permanently reduced, at the election of the Company, by $50,000, from $175,000 to $125,000.

Outstanding amounts under the ABL Facility will bear interest at a rate per annum equal to, at the Company’s election: (1) a base rate (equal to the greatest of (a) the prime lending rate, (b) the federal funds rate plus 0.50%, and (c) the 30-day LIBOR rate plus 1.00% per annum) (the “Base Rate”) plus an applicable margin (equal to a specified margin based on the interest rate elected by the Company, the fixed charge coverage ratio under the ABL Facility and the applicable point in the life of the ABL Facility (the “Applicable Margin”)), or (2) a LIBOR rate plus the Applicable Margin (the “LIBOR Rate”). Interest on loans under the ABL Facility bearing interest based upon the Base Rate will be due monthly in arrears, and interest on loans bearing interest based upon the LIBOR Rate will be due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.

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

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

15

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

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

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

The effective interest rate under the ABL Facility for the three months ended July 1, 2017 was 4.76%, which includes interest on borrowings of $250, amortization of loan origination fees of $104 and commitment fees on unborrowed funds of $83. The effective interest rate under the ABL Facility for the three months ended June 25, 2016 was 5.66%, which includes interest on borrowings of $167, amortization of loan origination fees of $194 and commitment fees on unborrowed funds of $87.

The effective interest rate under the ABL Facility for the six months ended July 1, 2017 was 8.03%, which includes interest on borrowings of $263, amortization of loan origination fees of $299 and commitment fees on unborrowed funds of $199. As of July 1, 2017, the outstanding balance on the ABL Facility was $44,132. The effective interest rate under the ABL Facility for the six months ended June 25, 2016 was 7.47%, which includes interest on borrowings of $234, amortization of loan origination fees of $389 and commitment fees on unborrowed funds of $192. As of June 25, 2016, the outstanding balance on the ABL Facility was $46,400.

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

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

Term Loan

On June 11, 2013, the Company entered into a Credit Agreement (the “Term Loan Credit Agreement”) among the Company, Credit Suisse AG, as Administrative Agent and Collateral Agent, and the Lenders defined in the Term Loan Credit Agreement (the “Term Loan Lenders”). In November 2014, the Company amended the Term Loan Credit Agreement. The main purpose for the amendment was to provide the Company additional flexibility in its execution of certain restructuring actions by increasing the cap on the amount that may be added back under the definition of consolidated EBITDA for non-recurring, unusual or extraordinary charges, business optimization expenses or other restructuring charges or reserves and cash expenses relating to earn outs or similar obligations.

16

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Under the Term Loan Credit Agreement, the Term Loan Lenders agreed to make a term loan (the “Term Loan”) to the Company in aggregate principal amount of $145,000, including an original issue discount of $2,900. The outstanding principal amount of the Term Loan bore interest at a rate per annum equal to the applicable LIBOR rate (with a 1% floor) plus 8.50%, or the base rate plus a margin of 7.50%. Interest on loans under the Term Loan Credit Agreement bearing interest based upon the base rate were due quarterly in arrears, and interest on loans bearing interest based upon the LIBOR Rate were due on the last day of each relevant interest period or, if sooner, on the respective dates that fall every three months after the beginning of such interest period.

The remaining principal amount of the Term Loan, plus accrued interest, was repaid in full on April 7, 2017, and the Term Loan Credit Agreement was terminated on April 7, 2017.

The Term Loan Credit Agreement contained customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants, relating to the Company’s (1) minimum interest coverage ratio and (2) maximum net total leverage ratio and restrictions on indebtedness, liens, investments, asset dispositions and dividends and other restricted payments. The Company was in compliance with the financial covenants of the loan during the period of time in which the loan was outstanding during the second quarter of 2017.

The Term Loan required the Company to enter into an interest rate hedge, within 90 days of the Effective Date, in an amount equal to at least 50% of the aggregate principal amount outstanding under the Term Loan. The purpose of the interest rate hedge was to effectively subject a portion of the Term Loan to a fixed or maximum interest rate. As such, the Company entered into an interest rate swap agreement on August 27, 2013 that effectively fixed the interest payments on a portion of the Company’s variable-rate debt. The swap, which terminated on September 11, 2016, effectively fixed the LIBOR-based interest rate on the debt in the amount of the notional amount of the swap at 9.985%. The Company did not enter into a subsequent interest rate swap after the termination of the above-mentioned interest rate swap. During the second quarter of fiscal 2016, the fair value of the derivative increased by $91 and a gain of $91 was recognized. During the first half of fiscal 2016, the fair value of the derivative increased by $176 and a gain of $176 was recognized. The gains related to the derivative were recorded in “Change in fair value of interest rate swap” on the consolidated statement of operations.

Under this swap agreement, the Company paid the counterparty interest on the notional amount at a fixed rate per annum of 1.485% and the counterparty paid the Company interest on the notional amount at a variable rate per annum equal to the greater of 1-month LIBOR or 1.0%. The notional amounts did not represent amounts exchanged by the parties, and thus were not a measure of exposure of the Company.

New Term Loan

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

Under the New Term Loan Agreement, the Term Loan Lenders agreed to make a term loan (the “New Term Loan”) to the Company in aggregate principal amount of $140,000. The initial draw on the New Term Loan at closing was $110,000. These proceeds, along with proceeds received from a draw on the ABL Facility (as defined below), were used to repay the Term Loan which had a remaining principal balance including accrued interest of $118,167. The New Term Loan Agreement provides for a delayed draw feature that allows the Company to draw up to an additional $30,000 through April 7, 2019. The ability to access the delayed draw commitment is subject to compliance with certain terms and conditions. The proceeds from the delayed draw can be used to fund distributions, permitted acquisitions, and repayments of existing indebtedness. At the Company’s option, the New Term Loan interest rate will be either the prime rate or the LIBOR rate, plus an applicable margin based on the Company’s net senior leverage ratio. The Company may specify the interest rate period of one, three or six months for interest on loans under the New Term Loan Agreement bearing interest based on the LIBOR rate. The New Term Loan will bear interest at a rate of one month LIBOR plus 625 basis points for the 2017 fiscal year.

17

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

The New Term Loan matures on April 7, 2022. In addition to scheduled quarterly principal repayments, which commenced on June 30, 2017, the New Term Loan Agreement requires prepayments at specified levels upon the Company’s receipt of net proceeds from certain events, including but not limited to certain asset dispositions, extraordinary receipts, and the issuance or sale of any indebtedness or equity interests (other than permitted issuances or sales). The New Term Loan Agreement also requires prepayments at specified levels from the Company’s excess cash flow. The Company is also permitted to voluntarily prepay the New Term Loan in whole or in part. Voluntary prepayments made before April 7, 2018 will be subject to an early prepayment fee of 2%, while voluntary prepayment made on or after April 7, 2018, but before April 7, 2019, will be subject to a 1% early prepayment fee. Voluntary prepayments made on or after April 7, 2019 will not be subject to an early payment fee. All prepayments of the loans will be applied first to that portion of the loans comprised of prime rate loans and then to that portion of loans comprised of LIBOR rate loans. The New Term Loan Agreement contains customary events of default and financial, affirmative and negative covenants, including but not limited to quarterly financial covenants commencing with the fiscal quarter ending July 1, 2017 relating to the Company’s fixed charge coverage ratio and net senior leverage ratio, and an annual limitation on capital expenditures and product development investments, collectively. The Company was in compliance with all such financial covenants during the second quarter of fiscal 2017.

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

The effective interest rate under the term loan credit facility for the three months ended July 1, 2017 was 8.27%, which includes interest on borrowings of $2,139 and amortization of loan origination fees of $170. As of July 1, 2017, the outstanding balance on the New Term Loan Credit Agreement was $109,313. Of this amount, $2,750 was reflected as currently maturing, long-term debt in the accompanying condensed consolidated balance sheets.

The Company has estimated that the fair value of its New Term Loan (valued under Level 3) as of July 1, 2017 approximated the carrying value of $109,313.

Deferred Cash Payment Obligations

In connection with the Company’s plan of reorganization under Chapter 11 of the Bankruptcy Code (see Note 4 in the Company’s Form 10-K as of December 31, 2016), general unsecured creditors are entitled to receive a deferred cash payment obligation of 20% of the allowed claim in full settlement of the allowed unsecured claims. Such payment accrues quarterly paid-in-kind interest of 5% per annum beginning on the Effective Date. Trade unsecured creditors had the ability to make a trade election to provide agreed upon customary trade terms. If the election was made, those unsecured trade creditors received a deferred cash payment obligation of 45% of the allowed claim in full settlement of those claims. As of the Effective Date, the deferred payment obligations under the trade elections began to accrue quarterly paid-in-kind interest of 10% per annum. All deferred cash payment obligations, along with interest paid-in-kind, are payable in December 2019.

As of July 1, 2017, the Company’s deferred payment obligations were $21,819, of which $3,082 represents a 20% recovery for the general unsecured creditors and $12,095 represents a 45% recovery for those creditors who elected to provide the Company standard trade terms with the remaining $6,642 related to accrued paid-in-kind interest. In the second quarter of fiscal 2017, the Company accrued an additional $833k of paid-in-kind interest related to a revised interpretation of the interest calculation methodology pursuant to the bankruptcy Reorganization Plan, which is defined in Note 4 – Bankruptcy Proceedings of the Company’s Form 10-K for the period ended December 31, 2016. The deferred payment obligations mature on December 11, 2019. The total amount due upon maturity, including accrued paid-in-kind interest, will be $27,242.

18

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

NOTE 11 – CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Changes in accumulated other comprehensive loss during the six months ended July 1, 2017 and June 25, 2016 were as follows:

	Foreign Currency Translation
Accumulated Other Comprehensive Income (Loss) at December 31, 2016	$	(1,784	)
Other comprehensive income before reclassifications		45
Amounts reclassified from other comprehensive income		—
Accumulated Other Comprehensive Income (Loss) at April 1, 2017	$	(1,739	)
Other comprehensive income before reclassifications		139
Amounts reclassified from other comprehensive income		—
Accumulated Other Comprehensive Income (Loss) at July 1, 2017	$	(1,600	)
	Foreign Currency Translation
Accumulated Other Comprehensive Income (Loss) at December 26, 2015	$	(1,919	)
Other comprehensive income before reclassifications		215
Amounts reclassified from other comprehensive income		—
Accumulated Other Comprehensive Income (Loss) at March 26, 2016	$	(1,704	)
Other comprehensive income before reclassifications		124
Amounts reclassified from other comprehensive income		—
Accumulated Other Comprehensive Income (Loss) at June 25, 2016	$	(1,580	)

NOTE 12 – RESTRUCTURING

In the three and six months ended July 1, 2017 and June 25, 2016, the Company recorded restructuring costs associated with the closure or disposal of distribution centers, lease termination costs and severance related to headcount reductions. The following is a reconciliation of accrued restructuring costs for the six months ended July 1, 2017 and June 25, 2016 and are included in facility exit costs and restructuring in the Condensed Consolidated Statements of Operations.

19

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

	Distribution		Curriculum		Corporate			Total
Accrued Restructuring Costs at December 31, 2016	$	—	$	—	$	561		$	561
Amounts charged to expense		—		—		173			173
Payments		—		—		(574	)		(574	)
Accrued Restructuring Costs at April 1, 2017	$	—	$	—	$	160		$	160
Amounts charged to expense		—		—		44			44
Payments		—		—		(161	)		(161	)
Accrued Restructuring Costs at July 1, 2017	$	—	$	—	$	43		$	43
	Distribution		Curriculum		Corporate			Total
Accrued Restructuring Costs at December 26, 2015	$	—	$	—	$	375		$	375
Amounts charged to expense		—		—		166			166
Payments		—		—		(288	)		(288	)
Accrued Restructuring Costs at March 26, 2016	$	—	$	—	$	253		$	253
Amounts charged to expense		—		—		383			383
Payments		—		—		(460	)		(460	)
Accrued Restructuring Costs at June 25, 2016	$	—	$	—	$	176		$	176

NOTE 13 – 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, Distribution and Curriculum, which also constitute its reportable segments. The Company operates principally in the United States, with limited operations in Canada.

Beginning in the second quarter of fiscal 2017, the Company revised its internal management reporting structure whereby a) a new Instruction & Intervention product line was formed consisting of its Reading products, formerly managed as a separate product line and the supplemental education products, which were previously included within the former Instructional Solutions product line, b) the early learning and special needs products from the former Instructional Solutions product line combined with the Supplies product line and c) the science supplies, previously included in the Science product line, within the Curriculum operating segment, were combined within the Supplies product line within the Distribution operating segment. The Company has revised its go-to-market strategy and management structure resulting in the alignment of the reading and science supply products to be consistent with other distributed items within the Distribution operating segment. This change also is consistent with the Company’s internal realignment of the new team sell model established in 2017 whereby every customer, district and territory will have a Distribution team supporting their business. The Distribution sales team focuses on selling all Distribution segment products, including the reading and science supplies items. The Distribution segment offers products primarily to the pre-kindergarten through twelfth grade (“preK-12”) education market that include basic classroom supplies and office products, instructional teaching materials, indoor and outdoor furniture and equipment, physical education equipment, classroom technology, and planning and organizational products.

The Curriculum segment is a publisher of proprietary core curriculum, primarily FOSS and Delta Science Module products, in the science category within the preK-12 education market. The Curriculum segment has a sales team which is unique from the Distribution sales team and focuses exclusively on the products within this segment. In addition, these products have specific product development requirements, and customer purchasing decisions are made in a different manner than the products represented in our Distribution segment. The accounting policies of the segments are the same as those described in Summary of Significant Accounting Policies as included in the Company’s Report on Form 10-K for the fiscal year ended December 31, 2016.

20

SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

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

	Three Months Ended July 1, 2017		Three Months Ended June 25, 2016			Six Months Ended July 1, 2017			Six Months Ended June 25, 2016
Revenues:
Distribution	$	141,344	$	130,491		$	233,297		$	216,465
Curriculum		18,833		15,367			23,991			23,118
Total	$	160,177	$	145,858		$	257,288		$	239,583
Gross Profit:
Distribution	$	50,440	$	48,098		$	82,939		$	79,583
Curriculum		10,055		7,501			12,080			11,481
Total	$	60,495	$	55,599		$	95,019		$	91,064
Operating income (loss) and loss before taxes:
Operating income (loss)		8,730		2,004			(4,387	)		(10,008	)
Interest expense and reorganization items, net		8,495		4,364			12,545			8,669
Income (loss) before provision for or benefit from income taxes	$	235	$	(2,360	)	$	(16,932	)	$	(18,677	)

	July 1, 2017		December 31, 2016		June 25, 2016
Identifiable assets:
Distribution	$	276,588	$	206,353	$	271,182
Curriculum		56,630		47,461		60,115
Corporate assets		5,089		33,793		14,612
Total	$	338,307	$	287,607	$	345,909

	Three Months Ended July 1, 2017		Three Months Ended June 25, 2016		Six Months Ended July 1, 2017		Six Months Ended June 25, 2016
Depreciation and amortization of intangible assets and development costs:
Distribution	$	3,353	$	4,029	$	6,832	$	8,421
Curriculum		964		1,398		1,924		2,577
Total	$	4,317	$	5,428	$	8,756	$	10,998
Expenditures for property, plant and equipment, intangible and other assets and development costs:
Distribution	$	4,768	$	5,700	$	8,053	$	7,586
Curriculum		662		633		1,164		1,213
Total	$	5,430	$	6,333	$	9,217	$	8,799

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SCHOOL SPECIALTY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

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

	For the Three Months Ended						For the Six Months Ended
	July 1, 2017			June 25, 2016			July 1, 2017			June 25, 2016
Distribution revenues by product line:
Supplies	$	76,756		$	74,722		$	134,955		$	127,689
Furniture		42,774			34,486			65,370			55,672
Instruction & Intervention		10,238			9,850			16,420			16,437
AV Tech		4,502			4,556			9,286			9,238
Agendas		6,476			6,062			6,746			6,554
Freight Revenue		2,454			1,987			3,993			3,227
Customer Allowances / Discounts		(1,856	)		(1,172	)		(3,473	)		(2,352	)
Total Distribution Segment	$	141,344		$	130,491		$	233,297		$	216,465
Curriculum revenues by product line:
Science	$	18,833		$	15,367		$	23,991		$	23,118
Total Curriculum Segment	$	18,833		$	15,367		$	23,991		$	23,118
Total revenues	$	160,177		$	145,858		$	257,288		$	239,583

The above table is an enhanced disclosure to provide additional details related to our revenues by segment. The total revenues in this enhanced disclosure are consistent with amounts reported in prior filings. Prior period amounts in this note have been reclassified in order to present segment and product line amounts consistent with the Company’s current reporting structure.

NOTE 14 – COMMITMENTS AND CONTINGENCIES

Various claims and proceedings arising in the normal course of business are pending against the Company. The results of these matters are not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

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

Quarterly Overview

School Specialty is a leading distributor of supplies, furniture, technology products, supplemental learning products (“instructional solutions”) and curriculum solutions, primarily to the education marketplace. The Company provides educators with its own innovative and proprietary products and services, from basic school supplies to 21^st century classroom designs to Science, Reading, Language and Math teaching materials, as well as planning and development tools. Through its nationwide distribution network, School Specialty also provides its customers with access to a broad spectrum of trusted, third-party brands across its business segments. This assortment strategy enables the Company to offer a broad range of products primarily serving the preK-12 education market at the state, district and school levels. The Company is expanding its presence outside the education market into channels such as partnerships with e-tailers, retailers and healthcare facilities.

Our goal is to grow profitably as a leading provider of supplies, products, services and curriculum for the education market and select other markets. We have experienced two consecutive years of overall revenue growth. Our revenue growth in fiscal 2016 was balanced in that four of our six product lines had growth over the fifty-two week year ended December 26, 2015. We expect to continue to achieve this goal over the long-term through an organic growth strategy based on leveraging our strong brand names and distribution capabilities and transforming the Company’s sales and marketing to a team-based selling approach with a balance of new customer acquisition and customer retention, and exploring new markets or revenue streams. New revenue streams may include opportunities in areas that could expand our addressable market, such as distribution to non-education customers, expansion into new product lines, continued growth in our e-tail and retailer partnerships, and potentially, abroad in select international markets. In addition, the Company is committed to continuing to invest in its product development in order to expand and improve its product offerings.

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

• Successful execution of a new team sell model;

• Establish momentum in delivering the “21st Century Safe School” value proposition;

• Improve the effectiveness of margin management;

• Development of effective strategies to manage margin in competitive bidding scenarios;

• Increase product line specific sales and support expertise; and

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

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

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Results of Operations

Costs of Revenues and Selling, General and Administrative Expenses

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

Cost of Revenues	Selling, General and Administrative Expenses
•     Direct costs of merchandise sold, net of vendor rebates other than the reimbursement of specific, incremental and identifiable costs, and net of early payment discounts.	•     Compensation and benefit costs for all selling (including commissions), marketing, customer care and fulfillment center operations (which include he pick, pack and shipping functions), and other general adminstrative functions such as finance, human resources and information technology.
•     Amortization of product development costs.
•     Freight expenses associated with moving merchandise from our vendors to fulfillment centers or from our vendors directly to our customers.	•     Occupancy and operating costs for our fulfillment centers and office operations.
	•     Freight expenses associated with moving our merchandise from our fulfillment centers to our customers.
	•     Catalog expenses, offset by vendor payments or reimbursement of specific, incremental and identifiable costs.
	•     Depreciation and intangible asset amortization expense, other than amortization of product development costs.

Three Months Ended July 1, 2017 Compared to Three Months Ended June 25, 2016

Revenues

Revenue of $160.2 million for the three months ended July 1, 2017 increased by $14.3 million, or 9.8%, as compared to the three months ended June 25, 2016.

Distribution segment revenues of $141.3 million for the three months ended July 1, 2017 increased by 8.3%, or $10.9 million, from the three months ended June 25, 2016. Revenues from our two largest product lines, Supplies and Furniture, increased by $2.0 million and $8.3 million, respectively, in the current quarter. Revenues from our Instruction & Intervention product line increased by $0.4 million in the current quarter. While we believe our growth initiatives and changes in our sales model are beginning to have positive impacts, we also benefited from a one-week calendar shift in fiscal 2017 compared to 2016.

Curriculum segment revenues of $18.8 million for the three months ended July 1, 2017 increased by 22.6%, or $3.5 million, from the three months ended June 25, 2016. Curriculum segment revenues for the first quarter were not materially impacted by the one-week calendar shift in 2017 as this business is less transactional as compared to our Distribution segment. Several large orders for the Company’s FOSS products, which is aligned with Next Generation Science Standards and has received widespread acceptance, contributed to the second quarter revenue growth in the Curriculum segment.

Gross Profit

Gross profit for the three months ended July 1, 2017 was $60.5 million, as compared to $55.6 million for the three months ended June 25, 2016. Gross margin for the three months ended July 1, 2017 was 37.8% as compared to 38.1% for the three months ended June 25, 2016. A shift in product mix resulted in 30 basis points of gross margin decline in the second quarter of fiscal 2017 as compared to the second quarter of fiscal 2016. Lower rates in certain product line gross margins contributed 50 basis points of gross margin decline. A combination of lower product development amortization expense and higher revenue in the quarter resulted in 50 basis points of gross margin improvement in the second quarter of fiscal 2017 versus the second quarter of fiscal 2016.

Distribution segment gross margin was 35.7% for the three months ended July 1, 2017, as compared to 36.9% for the three months ended June 25, 2016. Lower rates in certain product line gross margins, primarily in the Supplies and AV Tech lines, resulted in 50 basis points of the gross margin decline in the quarter. A shift in product mix contributed 60 basis points of the gross margin decline.

Curriculum segment gross margin was 53.4% for the three months ended July 1, 2017, as compared to 48.8% for the three months ended June 25, 2016. A combination of lower product development amortization expenses and higher revenue in the quarter resulted in 360 basis points of the gross margin improvement.

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Selling, General and Administrative Expenses

SG&A decreased $1.5 million in the second quarter of fiscal 2017, from $53.2 million for the three months ended June 25, 2016 to $51.7 million for the three months ended July 1, 2017. SG&A for the second quarter of 2017 decreased despite the incremental variable SG&A costs, such as outbound transportation, fulfillment center and commission expense, incurred in support of the incremental $14.3 million of revenue in the quarter as compared to last year’s second quarter. The improvement to our cost structure, in addition to the incremental revenue in the quarter versus the prior year quarter, resulted in SG&A as a percent of revenue decreasing from 36.5% for the three months ended June 25, 2016 to 32.3% for the three months ended July 1, 2017.

While the incremental revenue volume resulted in approximately $1.2 million of additional variable-related SG&A costs in the second quarter of 2017, assuming a consistent variable SG&A rate year-over-year, the company’s actual variable SG&A expenses in the current quarter increased by $0.1 million. Process excellence improvements resulted in $1.1 million of variable SG&A reduction in the quarter. Catalog and marketing costs decreased by $1.1 million in the second quarter of fiscal 2017 as compared to the second quarter of fiscal 2016 due to a combination of later catalog drop dates and increased catalog support received from vendors. Depreciation and amortization expense was down $0.6 million in the second quarter of fiscal 2017 as compared to the second quarter of fiscal 2016. Stock-based compensation expense increased by $0.1 million in the second quarter of 2017 as compared to the second quarter of 2016 due to the stock option awards made in March 2017.

Facility exit costs and restructuring

For three month periods ended July 1, 2017 and June 25, 2016, the Company recorded $0.1 million and $0.4 million, respectively, of facility exit costs and restructuring charges, which were entirely related to severance.

Interest Expense

Interest expense decreased from $4.5 million for the three months ended June 25, 2016 to $4.2 million for the three months ended July 1, 2017. Approximately $1.0 million of this decline is related to reduced cash interest due to lower outstanding average loan balances, particularly the average term loan balance, and a lower interest rate on the New Term Loan. Non-cash interest increased by $0.7 million in the three months ended July 1, 2017 as compared to the three months ended June 25, 2016. This increase was related primarily to incremental interest attributable to the Company’s vendor note obligations.

Change in Fair Value of Interest Rate Swap

The Company had an interest rate swap agreement that effectively fixed the interest payments on a portion of the Company’s variable-rate debt. The swap terminated as of September 11, 2016. The Company did not enter into a subsequent interest rate swap after the termination of the above-mentioned interest rate swap. Thus, the Company did not have any gain or loss during the three month period ended July 1, 2017. During the three month period ended June 25, 2016, the fair value of the derivative increased by $0.1 million and, accordingly, a non-cash gain of $0.1 million was recorded.

Loss on Early Extinguishment of Debt

During the three months ended July 1, 2017, the Company recorded a non-cash charge of $4.3 million related to the write-off of $3.1 million of remaining unamortized debt issuance costs and $1.2 million of remaining original issue discount both of which were associated with the term loan that was repaid on April 7, 2017. No such charge was recorded in fiscal 2016.

Provision for (Benefit from) Income Taxes

The provision for income taxes was $0.1 million for the three months ended July 1, 2017, as compared to a benefit from income taxes of $1.4 million for the three months ended June 25, 2016.

The effective income tax rate for the three months ended July 1, 2017 and the three months ended June 25, 2016 was 42.1% and 15.8%, respectively. The effective income tax rate for the three months ended July 1, 2017 is not representative of the expected full year effective tax rate as relatively minor discrete tax items in the quarter have a significant impact on the tax rate due to a relatively small amount of income before income taxes.

25

Six Months Ended July 1, 2017 Compared to Six Months Ended June 25, 2016

Revenues

Revenue of $257.3 million for the six months ended July 1, 2017 increased by $17.7 million, or 7.4%, as compared to the six months ended June 25, 2016.

Distribution segment revenues of $233.3 million for the six months ended July 1, 2017 increased by 7.8%, or $16.8 million, from the six months ended June 26, 2016. The increase is primarily related to stronger momentum within larger school districts along with a one-week calendar shift in fiscal 2017. Revenues from our two largest product lines, Supplies and Furniture, increased by $7.3 million and $9.7 million, respectively, in the six months ended July 1, 2017.

Curriculum segment revenues of $24.0 million for the six months ended July 1, 2017 increased by 3.8%, or $0.9 million, from the six months ended June 25, 2016. Although Curriculum revenue was expected to decline in the current year as revenue from state adoptions will not generate the same level of revenue in 2017, the continued strength of the Company’s FOSS products, especially in open territories, is offsetting the anticipated revenue declines associated with fewer state adoption opportunities. Curriculum segment revenues for the first half of 2017 were not materially impacted by the one-week calendar shift in 2017 as this business is less transactional as compared to our Distribution segment.

Gross Profit

Gross profit for the six months ended July 1, 2017 was $95.0 million, as compared to $91.1 million for the six months ended June 25, 2016. Gross margin for the six months ended July 1, 2017 was 36.9%, as compared to 38.0% for the six months ended June 25, 2016. The lower gross margin rate as compared to the first half of 2016 resulted in a $3.6 million reduction in gross margin. Increased revenues contributed $6.7 million of additional gross profit and lower product development amortization expense contributed $0.8 million of the increase.

Distribution segment gross margin was 35.6% for the six months ended July 1, 2017, as compared to 36.8% for the six months ended June 25, 2016. Approximately 80 basis points of the decrease in gross margin was related to a combination of lower Supplies gross margins driven by strategic agreement pricing, increased channel partner rebates commensurate with our growth in revenues with e-tail partners and modestly lower margins realized in our furniture projects. A shift in product mix resulted in approximately 30 basis points of gross margin decline.

Curriculum segment gross margin was 50.4% for the six months ended July 1, 2017, as compared to 49.7% for the six months ended June 25, 2016. Lower product development costs against a modest increase in revenue resulted in 150 basis points of gross margin improvement. Modest product cost increases in the current year have resulted in approximately 80 basis points of gross margin decline in the current year.

Selling, General and Administrative Expenses

SG&A decreased $1.3 million in the first half of fiscal 2017, from $100.5 million for the six months ended June 25, 2016 to $99.2 million for the six months ended July 1, 2017. SG&A for the first half of 2017 decreased despite the incremental variable SG&A costs, such as outbound transportation, fulfillment center and commission expense, incurred in support of the incremental $17.6 million of revenue in the quarter as compared to last year’s first half. While the incremental volume resulted in approximately $1.5 million of additional variable-related SG&A costs in the current year, assuming a consistent variable SG&A rate year-over-year, the company’s actual variable SG&A expenses in the current year were flat versus prior year due to process excellence related improvements. The improvement to our cost structure, combined with the incremental revenue in the first six months of 2017 versus the first six months of 2016, contributed to a decrease in SG&A as percent of revenue, from 42.0% for the six months ended June 25, 2016 to 38.6% for the six months ended July 1, 2017.

Catalog and marketing costs decreased by $0.8 million in the first six months of fiscal 2017 as compared to the first six months of fiscal 2017 due to a combination of later catalog drop dates and increased catalog support received from vendors. A decrease in full-time staffing levels resulted in $0.5 million of lower compensation and benefit costs in the first six months of fiscal 2017 as compared to the first six months of fiscal 2016. Depreciation and amortization expense was down $1.5 million in the first six months of fiscal 2017 as compared to the first six months of fiscal 2016.

26

Stock-based compensation expense increased by $0.4 million in the first half of 2017 as compared to the first half of 2016 due to a combination of stock option awards made in March 2017 and the award of restricted stock units in March 2016. The SG&A costs in the first half of the prior year included a $0.7 million foreign exchange gain related to a strengthening Canadian dollar versus the U.S. dollar in that period. In the first half of the current year, the Company realized a nominal foreign exchange gain of less than $0.1 million.

Facility exit costs and restructuring

For the six month periods ended July 1, 2017 and June 25, 2016, the Company recorded $0.2 million and $0.5 million, respectively, of facility exit costs and restructuring charges, which were entirely related to severance.

Interest Expense

Interest expense decreased from $8.8 million for the six months ended June 25, 2016 to $8.2 million for the six months ended July 1, 2017. Approximately $1.4 million of this decline is related to reduced cash interest due to lower outstanding average loan balances, particularly the average term loan balance, and a lower interest rate on the New Term Loan. Non-cash interest increased by $0.8 million in the first six months of fiscal 2017 as compared to the first six months of fiscal 2016. This increase was related primarily to incremental interest attributable to the Company’s vendor note obligations.

Change in Fair Value of Interest Rate Swap

The Company had an interest rate swap agreement that effectively fixed the interest payments on a portion of the Company’s variable-rate debt. The swap terminated as of September 11, 2016. The Company did not enter into a subsequent interest rate swap after the termination of the above-mentioned interest rate swap. Thus, the Company did not have any gain or loss during the six month period ended July 1, 2017. During the six month period ended June 25, 2016, the fair value of the derivative increased by $0.2 million and, accordingly, a non-cash gain of $0.2 million was recorded.

Loss on Early Extinguishment of Debt

During the six months ended July 1, 2017, the Company recorded a non-cash charge of $4.3 million related to the write-off of $3.1 million of remaining unamortized debt issuance costs and $1.2 million of remaining original issue discount both of which were associated with the term loan that was repaid on April 7, 2017. No such charge was recorded in fiscal 2016.

Provision for (Benefit from) Income Taxes

The benefit from income taxes was $0.3 million for the six months ended July 1, 2017, as compared to $4.4 million for the six months ended June 25, 2016.

The effective income tax rate for the six months ended July 1, 2017 and the six months ended June 25, 2016 was 1.7% and 23.5%, respectively. The effective income tax rate for the six months ended April 1, 2017 includes the Company’s current estimate of the fiscal 2017 full year effective tax rate of approximately 3.5%, partially offset by discrete tax items. The tax benefit recorded in the six months ended July 1, 2017 is expected to be entirely offset by tax provisions recognized against the net income expected to be generated over the remainder of 2017.

Liquidity and Capital Resources

At July 1, 2017, the Company had net working capital of $108.0 million, an increase of $0.4 million as compared to the six months ended June 25, 2016. The Company’s capitalization at July 1, 2017 was $254.5 million and consisted of total debt of $171.7 million and stockholders’ equity of $82.8 million.

27

Net cash used by operating activities was $46.2 million and $41.0 million for the six months ended July 1, 2017 and June 25, 2016, respectively. The increase in cash used by operating activities related primarily to working capital changes. Accounts receivable balances increased by $25.7 million in the first six months of fiscal 2017 as compared to an increase of $20.2 million in the first six months of fiscal 2016. The increase in accounts receivable levels is related to the incremental volume in the first half of 2017 as compared to the first half of 2016. Accordingly, inventory levels were down slightly at the end of the second quarter of fiscal 2017 as compared to the end of the second quarter 2016. We expect peak and year end inventory levels to be consistent with fiscal 2016 levels. Accounts payable balances increased by $37.1 million during the first six months of 2017 as compared to an increase of $42.2 million over the first six months of 2016. The change in the year-over-year growth in accounts payable was attributable primarily to the one-week calendar shift. The year-over-year increases in working capital related to accounts receivable and accounts payable were partially offset by incremental receipts associated with vendor volume and catalog rebates.

Net cash used in investing activities was $9.2 million in the first half of fiscal 2017 as compared to $8.8 million in the first half of fiscal 2016. The Company expects net cash used in investing activities to increase by approximately $5.0 million for the full year fiscal 2017 as compared to full year fiscal 2016 due to investments in the Company’s ecommerce platform, telephone system upgrades, and product management systems. The completion of these projects is expected to result in improvements to the Company’s platforms and processes, lower both annual operating costs and ongoing maintenance investments. In addition, we expect these investments will enable revenue growth.

Net cash provided from financing activities was $27.2 million in fiscal 2017 versus $44.6 million in fiscal 2016. In both periods, the net cash provided from financing activities represents net draws on the ABL Facility, which combined with beginning of period cash balances, were used to fund operating and investing cash outflows, as well as Term Loan and New Term Loan repayments. Outstanding borrowings on the ABL Facility were $44.1 million as of July 1, 2017, while the excess availability on that date for the ABL Facility was $75.0 million. In the second quarter of fiscal 2017, the Company drew $11.4 million on its ABL to fund the New Term Loan refinancing fees of $4.0 million and to repay a portion of the Term Loan. The Company made a principal payment on its Term Loan in the amount of $4.8 million during the first quarter of fiscal 2017. The remainder of the Term Loan balance was repaid using proceeds from the New Term Loan. In the second quarter of fiscal 2017, the Company made a regularly scheduled payment of principal on its New Term Loan in the amount of $0.7 million.

On April 7, 2017, the Company entered into a New Term Loan Agreement with an aggregate principal amount of $140 million. The initial draw on the New Term Loan at closing was $110 million. These proceeds, along with proceeds received from a draw on the Company’s ABL Facility, were used to repay the Term Loan, which had a remaining principal balance plus accrued interest of $118.2 million. The New Term Loan Agreement provides for a delayed draw feature that allows the Company to draw up to an additional $30 million through April 7, 2019. The ability to access the delayed draw commitment is subject to compliance with certain terms and conditions. The proceeds from the delayed draw can be used to fund distributions, permitted acquisitions, and repayments of existing indebtedness. Also, on April 7, 2017, the Company amended its ABL Facility. The amendment provided a new lower pricing tier of LIBOR plus 125 basis points, a seasonal increase in the borrowing base of 5.0% of eligible accounts receivable for the months of March through August, and the inclusion of certain inventory in the borrowing base, which previously had been excluded.

The Company’s ABL Facility, as amended, and New Term Loan, as described above, contain customary events of default and financial, affirmative negative covenants. Based on current projections, the Company believes it will maintain compliance with these covenants throughout the next twelve months.

We believe 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 next twelve months.

28

Fluctuations in Quarterly Results of Operations

Our business is subject to seasonal influences. Our historical revenues and profitability have been dramatically higher in the periods from June through September, primarily due to increased shipments to customers coinciding with the start of each school year. Quarterly results also may be materially affected by variations in our costs for the products sold, the mix of products sold and general economic conditions. Therefore, results for any quarter are not indicative of the results that we may achieve for any subsequent fiscal quarter or for a full fiscal year.

Inflation

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

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q that are not historical are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include: (1) statements made under Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including, without limitation, statements with respect to our internal growth plans, projected revenues and revenue growth, margin improvement, capital expenditures, adequacy of capital resources and ability to comply with financial covenants; and (2) statements included or incorporated by reference in our future filings with the Securities and Exchange Commission. Forward-looking statements also include statements regarding the intent, 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,” “projects” or similar expressions.

All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof. We do not undertake to update any forward-looking statements that may be made by us or on our behalf, in this Quarterly Report on Form 10-Q or otherwise. Our actual results may differ materially from those contained in the forward-looking statements identified above. Factors which may cause such a difference to occur include, but are not limited to, the risk factors set forth in Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

29

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in qualitative and quantitative disclosures about market risk from what was reported on Form 10-K for the fiscal year ended December 31, 2016.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on an evaluation as of the end of the period covered by this quarterly report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective for the purposes set forth in the definition of the Exchange Act rules.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter ended July 1, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

30

PART II – OTHER INFORMATION

ITEM 6. Exhibits

See the Exhibit Index, which is incorporated herein by reference.

31

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SCHOOL SPECIALTY, INC.
	(Registrant)
August 9, 2017		/s/ Joseph M. Yorio
Date		Joseph M. Yorio
		President and Chief Executive Officer
		(Principal Executive Officer)
August 9, 2017		/s/ Kevin L. Baehler
Date		Kevin L. Baehler
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer)

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EXHIBIT INDEX

Exhibit No.	Description
3.1(a)	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of School Specialty, Inc. dated June 8, 2017
3.1(b)	Certificate of Incorporation of School Specialty, Inc. (Complete Copy, as Amended Through June 8, 2017)
10.1	Loan Agreement, dated as of April 7, 2017, by and between School Specialty, Inc., as borrower, certain of its subsidiaries, as guarantors, the financial parties party thereto, as lenders, and TCW Asset Management Company, LLC, as agent, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated April 13, 2017.
10.2	Guarantee and Collateral Agreement, dated as of April 7, 2017, among School Specialty, Inc., the guarantors party thereto, and TCW Asset Management Company, LLC, as agent, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated April 13, 2017.
10.3	Third Amendment, dated as of April 7, 2017, to the Loan Agreement among School Specialty, Inc. and certain of its subsidiaries, as borrowers, Bank of America, N.A. and Bank of Montreal, as lenders, Bank of Montreal as syndication agent, and Bank of America, N.A., as agent for the lenders, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated April 13, 2017.
10.4	Amended and Restated Guarantee and Collateral Agreement, dated April 7, 2017, amending and restating the Guarantee and Collateral Agreement, dated as of June 11, 2013, among School Specialty, Inc., the guarantors party thereto and Bank of America, N.A., as agent, incorporated by reference to School Specialty, Inc.’s Current Report on Form 8-K dated April 13, 2017.
31.1	Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
31.2	Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Executive Officer.
32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, by Chief Financial Officer.
101	The following materials from School Specialty, Inc.’s. Quarterly Report on Form 10-Q for the quarter ended July 1, 2017 are filed herewith, formatted in XBRL (Extensive Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statement of Operations, (iii) the Condensed Consolidated Statement of Comprehensive Income, (iv) the Condensed Consolidated Statement of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

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