School Specialty Misses - Analyst Blog

School Specialty Inc. (SCHS) recently posted second-quarter 2011 results. The quarterly earnings of 96 cents a share missed the Zacks Consensus Estimate of $1.23, and tumbled 38.9% from $1.57 earned in the prior-year quarter.

Revenue Still Falling, Margins under Pressure

Greenville, Wisconsin-based company's total revenue plunged 15.7% to $291.9 million from the year-ago quarter, and also fell short of the Zacks Consensus Revenue Estimate of $293 million. Excluding prior-year quarter's divestiture of School Specialty Publishing, total revenue dropped 14%. It is to be noted that the rate of decline in the top-line has decelerated from 23.4% in the first quarter, as the economy gradually improves.

The recent economic downturn has resulted in an uncertainty related to state budget funding levels in the school districts, which has led to a cautious spending approach. Consequently, School Specialty has been registering a sustained decline in the top-line. A continued softness in demand still persists for both curriculum-based products and supplemental materials

The furniture market has been the worst hit by budget cuts, as school construction and modernization projects have been cancelled or postponed. Revenue from furniture slipped 27% during the quarter. To mitigate this, School Specialty has launched new furniture product lines at compelling prices. We believe aggressive pricing for both furniture and consumable products will weigh upon gross margins.

Despite a 14.1% decline in cost of revenues, gross profit for the quarter fell 17.9% to $117.5 million, reflecting a fall in the top-line, whereas gross margin contracted 100 basis points to 40.3%. The drop in gross margin was due to the increase in customer discounts at Educational Resources segment. Operating income plunged 32.6% to $38.2 million, whereas operating margin shrunk 330 basis points to 13.1%.

Educational Resources segment revenues tumbled 21.8% to $187.7 million, reflecting sustained sluggishness in both the consumables products and furniture categories due to school budget pressure and fall in school construction. Segment gross profit dipped 29% to $58.7 million, whereas gross margin contracted 320 basis points to 31.3%. To improve consumables revenue, School Specialty hinted at increasing its marketing expenditures that may weigh upon margins.

Accelerated Learning segment revenue declined 2.4% to $104 million. Gross profit fell 3% to $57.9 million, whereas gross margin shriveled 30 basis points to 55.7%.

Other Financial Details

School Specialty ended the quarter with cash and cash equivalents of $8.1 million, total long-term debt of $267.3 million, reflecting debt-to-capitalization ratio of 53.1%, and shareholders' equity of $236.4 million. During the quarter the company lowered its debt-load by $70 million.

The company generated free cash flows of $69.7 million during the quarter, portraying an increase of $6 million from the prior-year quarter, and reflecting prudent capital management and improvement in accounts receivables collections.

Management Guidance

Concurrent with the earnings release, management trimmed its guidance for fiscal 2011.

Given the sustained pricing pressures, School Specialty now expects to deliver loss per share between 30 cents and 60 cents for the fiscal year, significantly down from the earnings of 15 cents to 45 cents predicted earlier. Following this, a negative sentiment may be palpable among the analysts covering the stock, and we could witness a fall in the Zacks Consensus Estimate in the coming days.

However, the company has reaffirmed its revenue guidance of $735 million to $770 million. Management expects to generate free cash flows in the range of $50 million to $60 million versus $40 million to $50 million forecast earlier.