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School Specialty Loss Narrows

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School Specialty Inc. posted better-than-expected third-quarter 2012 results on the back of effective cost management and margin improvement. However, budgetary constraint and a competitive pricing environment remain the headwinds.

The company posted a loss of 86 cents a share that bettered the Zacks Consensus Estimate of 91 cents loss and substantially narrowed from a loss of $1.07 incurred in the year-ago quarter. On a reported basis, including one-time items, quarterly loss came in at $5.54 per share.

Let’s Unveil the Picture

Greenville, Wisconsin-based School Specialty’s total revenue decreased 5.1% year over year to $85.3 million in the third quarter of 2012, following a decline of 13.9% in the second quarter, and fell short of the Zacks Consensus Estimate of $97 million. Looking back, School Specialty registered an increase of 9.1% in the first quarter of 2012 and 8.8% in the fourth quarter of 2011. But it had registered declines of 12.9% in the third quarter, 15.7% in the second quarter and 23.4% in the first quarter of 2011. Management hinted that the third quarter reflects a smallest volume in terms of revenue, in the year.

The recent economic downturn has resulted in an uncertainty related to state budget funding levels in the school districts, and in turn a cautious spending approach.

The company operates in a highly fragmented industry with more than 3,000 smaller companies offering supplemental educational products and equipment. Moreover, School Specialty also competes with alternate channel marketers, which include office product contract stationers and office supply superstores, such as Office Depot Inc. (ODP - Free Report) .

Despite a 4% decline in the cost of revenue, gross profit for the quarter dropped 7% to $30.6 million due to a fall in the top line. Gross margin contracted 80 basis points to 35.9% on account of change in the sales mix, reflecting a decrease in comparable sales in the Accelerated Learning segment.

School Specialty hinted that it remains committed to augment sales, improve margins and market position through cost containment efforts, effective working capital management and operating efficiencies.

The company reported adjusted EBITDA loss of $10.2 million for the quarter compared with EBITDA loss of $18.4 million in the prior-year quarter.

Segment Discussion

Educational Resources segment revenue inched up 0.9% to $70.4 million, reflecting improvement across the Furniture division with new orders or bookings up approximately 10%, and Web-based initiatives primarily related to supplies that also contributed to the segment’s sales. Segment gross profit grew 6.9% to $23.7 million, whereas gross margin expanded 190 basis points to 33.7%.

School Specialty indicated that the Educational Resources segment has been portraying improvement in the current fiscal year, with gross margin improving sequentially as well as year over year. Further, the company in order to augment sales intends to widen its multi-channel and multi-market approach.

Accelerated Learning segment revenue plunged 28.1% to $14.3 million due to a fall in curriculum sales in Science and Reading. Many districts opted to defer their purchasing as states delayed their traditional adoption cycles for a new curriculum, indicating ambiguity in the marketplace about the school budgets and the alteration in common core standards.

Gross profit declined 37.8% to $6.4 million, whereas gross margin shriveled 700 basis points to 44.6% attributable to lower revenue from the products carrying higher margin and increased amortization charges due to product expansion.

Other Financial Details

School Specialty ended the quarter with cash and cash equivalents of $975,000 and total long-term debt of $266.1 million, reflecting a debt-to-capitalization ratio of 69.2%, and shareholders’ equity of $118.5 million. The company generated free cash flow of $28.5 million during first-nine month of fiscal 2012.

Strolling Through Guidance

School Specialty reiterated its fiscal 2012 guidance. Management continues to project loss per share between 50 cents and 65 cents, revenue between $730 million and $740 million and free cash flow in the range of $0 million to $10 million. EBITDA is projected in the range of $48 million to $52 million. The current Zacks Consensus Estimate for the year is 52 cents loss per share.

Currently, we have a long-term Outperform recommendation on the stock. However, the stock holds a Zacks #3 Rank that translates into a short-term ‘Hold’ rating.

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