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School Specialty Inc.’s second quarter fiscal 2013 adjusted earnings of 82 cents a share surpassed the Zacks Consensus Estimate of 64 cents by 28% and the prior-year quarter earnings of 51 cents by 60.8%. The earnings beat for this leading provider of K-12 supplemental educational products and curriculum was largely aided by overall margin improvement and the company’s cost control strategy.

However, School Specialty’s total revenue decreased 5.8% year over year to $236.9 million. Both its segments, Educational Resources and Accelerated Learning witnessed revenue declines of 1.2% and 15.9%, respectively due to constrained spending by schools, which negatively impacted total revenue. Revenues were marginally ahead of the Zacks Consensus Estimate of $236 million. The soft educational market continued its uneven pace of recovery.

Quarter in Detail

A peer of Acorn International Inc. , School Specialty is in the midst of its busiest selling season. The company enjoys significantly higher revenues and earnings during the first two quarters of its fiscal year, i.e. from June to October, which usually marks the start of each school year. Schools usually prefer their school supplies being delivered before or shortly after the commencement of the school year.

Gross profit in the quarter dropped 2.5% to $92.7 million due to a fall in the top line. However, gross margin expanded 130 basis points to 39.1% boosted by better gross margins in both Education Resources segment and Accelerated Learning segment. Earnings before interest, taxes, depreciation, and amortization (EBITDA) grew 9.3% in the quarter to $34.2 million.

Segment Discussion

Educational Resources: Revenue at this educational supplies related segment declined 1.2% from the prior-year quarter to $171.1 million. Within this segment, the Supplies category witnessed order growth for basic school supplies as schools purchased products, which were absolutely essential. However, various specialty branded products, considered by the schools to be more discretionary, suffered weakness.

Gross profit for the segment came in at $57.1 million, up 6.7% year over year. Gross margin improved 250 basis points to 33.4% attributable to improved pricing and School Specialty’s disciplined cost control.  

Accelerated Learning: Revenue at this curriculum related segment fell 15.9% from the prior-year quarter to $65.6 million. The decline in segment revenue was due to funding uncertainty and delay in finalization of science curriculum for the next generation. Gross profit declined 13.2% to $35.5 million; however, gross margin grew 170 basis points to 54.0% due to favorable product mix in Reading, Health and Agenda categories.

Outlook

School Specialty has witnessed significant revenue and margin declines in the last few fiscal years due to cautious spending by schools. Strict state and local government budgets have limited school spending. Approximately 47% of school funding is provided by states and 44% by local governments and the rest is provided by federal funds. Though state tax receipts show modest signs of recovery, local taxes continue to be challenged. Owing to the cuts in state funding, school budgets and spending on products and instructional solutions have been severely affected.

Given a challenging market environment, School Specialty lowered its revenue expectations for fiscal 2013. The company now expects fiscal 2013 revenue to decline in mid-single digit from 2012 revenue of $732 million. The revenue guidance was lowered from prior forecast of low-single digit decline from the 2012 level. However, management continues to expect its fiscal year 2013 EBITDA results to be almost in line with 2012 results, despite the anticipated revenue slip.

Though consistent weak revenue and lowered guidance are a concern, we believe that the company’s diversified product and geographic mix; strategic and cost-control initiatives combined with its product innovation efforts place it well for long-term growth once the school spending trends return to more normal levels.

We currently have a Neutral recommendation on School Specialty. The stock carries a Zacks #3 Rank (a short-term ‘Hold’ rating).

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