SCHOOL SPECIALTY, LLC You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes, included elsewhere in this Annual Report. Background We are a leading provider of educational products, services and programs serving the PreK-12 education market acrossthe United States andCanada . We offer more than 100,000 items through an innovative two-pronged marketing and sales approach that targets both school administrators and individual teachers. In fiscal 2019, the Company had revenues of$626.1 million and an operating loss of$22 million , as compared to revenues of$673.5 million and an operating loss of$18.4 million for fiscal 2018. In fiscal 2019, the Company's revenue decreased by 7.0% over fiscal 2018. The Company continues to focus on, and effectively manage, its SG&A costs. SG&A expenses decreased by 1.9%, or$4.2 million , in fiscal 2019 as compared to fiscal 2018.
The Company delivered on some of its core initiatives during fiscal 2019. These included:
1. The performance of the Company's fulfillment centers was exceptional as
measured by all customer-facing metrics. Lead times, fill rates and
productivity levels exceeded the Company's target levels.
2. The Company's pricing actions drove gross margin improvement in the
second half of 2019 in both the Supplies and Furniture product
categories, and the Company expects the favorable year-over-year gross
margin trends to continue in 2020.
3. Working capital levels returned to historical levels. Working capital
changes provided
to $17.8 million of negative working capital in 2018.
4. The achievement of cost reductions in key areas of the business, such as
transportation and fulfillment center costs which both decreased on a
volume-adjusted basis.
However, the positive impact generated by these initiatives was more than offset
by challenges in our Curriculum segment and Agendas category. Our financial
results for fiscal 2019 were negatively impacted by a delayed recovery of the
Curriculum segment. Material timing shifts in the California science adoption
was a key contributor to the delayed recovery. However, a strong and more
advanced opportunity pipeline, particularly in California , results in our
forecast of a strong rebound in 2020 Curriculum revenues. This view is further
supported with advanced discussions with a number of key districts. Furthermore,
ongoing product enhancements and sales and marketing improvements also are
expected to improve our success rates in closing Curriculum pipeline
opportunities.
The 2019 financial results also were negatively impacted by a significant
decline in our Agendas product category, both in terms of revenue and gross
margin. Operational challenges from our transition to a new platform combined
with the ongoing decline in the overall custom planner market, contributed to
approximately $11.4 million of operating loss from our Agendas product category.
In late December 2019 , we exited the Agenda product category and sold the
intellectual property for $0.7 million , resulting in a loss on sale of
$4.1 million . Exiting this category will remove the negative impact to our
operating earnings and allow us to shift resources to core areas. We do not
expect any material charges or expenses in 2020 related to this product
category.
The outbreak of the novel coronavirus disease (COVID-19) has significantly
affected our business beginning with the latter part of March 2020 . The ultimate
impact of coronavirus is highly uncertain and subject to change. Our business is
predominantly focused on serving public and private school districts. However,
most states have taken the rare step of closing schools to try to slow the
spread of the virus. As of March 23, 2020 , forty-seven states have mandated
state-wide school closures, and many districts in the remaining three states
have independently decided to shutdown. School shutdowns have resulted in our
customers' inability to accept shipments of our products and substantially lower
orders. While the Company does not yet know the full effect or length of school
closures or the impact to the global economy as a whole, the effects could have
a material impact on the Company's business, results of operations, liquidity,
and financial condition, as well as those of the third parties on which we rely.
The Company's operating results were below plan for 2019 which resulted in
non-compliance with certain financial covenants of the Company's debt facilities
in the third quarter of 2019. See Note 9 - Debt for details regarding the
Company's debt facilities. To address the non-compliance, the Company entered
into short-term forbearance agreements with its senior secured lenders and also
entered into amendments to its credit facilities. The amendments
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resulted in certain restrictions on the Company's borrowing capacity, such that
the Company did not have sufficient liquidity necessary to retire currently
maturing deferred cash payment obligations on the December 12, 2019 maturity
date. However, the amendments allowed the Company to pursue an extension of the
maturity date with the holders of the currently maturing deferred cash payment
obligations. The Company was able to successfully extend to December 12, 2020
approximately 76%, or $21.3 million of the deferred vendor obligations. In
consideration for the extension, the Company made a 10% partial payment, or
$2.1 million , in early 2020. Despite the extensions, remaining uncertainty as to
the Company's ability to remain in compliance with future period covenants and
liquidity requirements could result in the Company's senior secured lenders
exercising their rights and remedies with respect to our current non-compliance
and in the Company's inability to continue as a going concern.
Management believes that the Company's ability to continue as a going concern is
dependent on a combination of its ability to return to normal business
operations, negotiating satisfactory terms related to obtaining the additional
funding necessary to repay its currently maturing debt obligations,
renegotiating certain terms of its existing debt facilities, and pursuing other
strategic alternatives. Management hired an investment banker in August 2019 to
assist in both seeking additional capital financing and, as announced in October
2019 , to pursue strategic alternatives. Indications received from the process,
thus far, have not ascribed meaningful, if any, value to the equity. It is
likely that our current financial situation will depend on the negotiations with
senior secured lenders, and we expect those negotiations will result in our
existing equity having little or no value, and the senior secured lenders taking
control of the Company. The Board and management believe that, if the senior
secured lenders acquire substantially all of the equity of the Company, it will
result in a restructuring of our debt obligations and other measures intended to
improve the liquidity position of the Company. To the extent the senior secure
lenders take control of the Company, it is our expectation that such measures
would be taken in an effort to enable the Company to operate as a going concern.
However, there can be no assurance that additional debt or other financing from
the Company's current lenders will be sufficient amounts and on acceptable
terms, necessary to provide adequate liquidity.
Our business and working capital needs are highly seasonal, and we operate
assuming that schools and teachers are able to receive products to support the
start of the school year. As such, our peak sales levels occur from June through
September. We expect to ship orders representing 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 October through May.
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 strongest in the months of September through December as over
100% of our annual operating cash flow is generated in those months.
Results of Operations
The following table sets forth our results of operations for fiscal 2019 and
fiscal 2018.
Fiscal Year Ended Fiscal Year Ended
December 28, 2019 December 29, 2018
(52 weeks) (52 weeks)
Revenues $ 626,073 $ 673,452
Cost of revenues 418,475 444,937
Gross profit 207,598 228,515
Selling, general and administrative
expenses 217,921 222,168
Facility exit costs and restructuring 2,681 2,463
Loss on asset sold 4,089 -
Impairment charge 4,863 22,262
Operating income (21,956 ) (18,378 )
Other expense:
Interest expense 20,519 15,548
Loss on early extinguishment of debt 8,032 -
Gain on sale of unconsolidated
affiliate - -
Change in fair value of warrant
derivative 82 -
Income (loss) before provision for
(benefit from) income taxes (50,589 ) (33,926 )
Provision (benefit) from income taxes (1,041 ) 4,815
Net income (loss) $ (49,548 ) $ (38,741 )
Costs of Revenues and Selling, General and Administrative Expenses
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The following table illustrates the primary costs classified in Cost of Revenues and Selling, General and Administrative Expenses:
Cost of Revenues and Selling, General and Administrative Expenses
Selling, General and Administrative
Cost of Revenues Expenses
• Direct costs of merchandise sold, net • Compensation and benefit costs for of vendor rebates other than the
all selling (including commissions),
reimbursement of specific, incremental marketing, customer care and and identifiable costs, and net of early fulfillment center operations (which payment discounts.
include the pick, pack and shipping
functions), and other general
• Amortization of product development administrative functions such as costs and certain depreciation.
finance, human resources and
information technology.
• Freight expenses associated with • Occupancy and operating costs for
receiving merchandise from our vendors our fulfillment centers and office
to our fulfillment centers. operations.
• Freight expenses associated with • Freight expenses associated with
merchandise shipped from our vendors moving our merchandise from our
directly to our customers. 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.
The classification of these expenses varies across the distribution industry. As
a result, the Company's gross margin may not be comparable to other retailers or
distributors.
Financial Information
Consolidated Results
Overview of Fifty-Two Weeks Ended
Revenues
Revenue of
Distribution segment revenues of$593.9 million for fiscal 2019 decreased by 5.6%, or$35.5 million , from fiscal 2018. Supplies revenues were down$14.4 million , or 4.7%, in fiscal 2019, due primarily to a decline in smaller districts,Canada and non-district customers year-over-year. However, Supplies revenue has grown year-over-year in larger school districts. The Company deployed multiple sales and marketing initiatives aimed at improving our performance with the smaller customers. We believe our strong operating performance in the 2019 season, along with the team-sell model gaining effectiveness, will contribute to increased order rates in 2020. Instruction & Intervention revenue was down year-over-year by$5.1 million , or 8.6%, in fiscal 2019. The main contributor to the softness in Instruction & Intervention orders was the Triumph Learning product line, particularly declining orders for consumable products (i.e. workbooks) for which the renewal rate has been lower than historical levels. Revenues for Furniture were down$7.0 million and AV Tech revenues were down$0.7 million as compared to fiscal 2018. Agendas revenues were down by$7.1 million , or 24.0%, year-over-year due to the Company experiencing challenges associated with the transition to a new technology platform to support the sale and production of custom agenda products. The custom agendas product line was exited at the end of fiscal 2019. Curriculum segment revenues of$32.2 million for fiscal 2019 decreased by 26.9%, or$11.8 million , from fiscal 2018. TheCalifornia adoption was a key driver in our fiscal 2019 growth expectations, as we expected approximately 50% ofCalifornia school districts to purchase science curriculum in fiscal 2019, with the balance to purchase in 2020 and 2021. However, we believe that less than 25% ofCalifornia districts purchased science curriculum in fiscal 2019, as many districts' purchase decisions were deferred until 2020 or 2021. With the shift to later purchases, our opportunities inCalifornia for 2020 and 2021 have increased versus original expectations, and early indications in 2020 shows strong support for our science curriculum inCalifornia . Outside ofCalifornia , our Curriculum revenues are down. With more active competition, our win-rates have been below historical levels. We believe our Science curriculum remains an effective and competitive product. We continue to enhance our offering and refine the sales and marketing process to better respond to competitive pressures. In addition, we have recently begun the process of upgrading our digital content delivery platform, which will add important features and functionality to our Science Curriculum offering and improve its competitive positioning. 21
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Gross Profit
Gross profit for fiscal 2019 was
Distribution segment gross margin was 32.2% for fiscal 2019, as compared to 32.4% for fiscal 2018. Excluding product development, gross margin for fiscal 2019 was 32.8% compared to 33.2% in fiscal 2018. A year-over-year shift in product mix negatively impacted gross margin by 70 basis points in fiscal 2019. Rate variances at a product line level positively impacted gross margin by 10 basis points. Agenda product gross margin has been negatively impacted by the operational challenges related to the transition to a new technology platform. This product category was exited at the end of fiscal 2019. The gross margin trend has improved throughout the year. In our two largest product categories, Supplies and Furniture, strategic pricing actions taken over the past twelve months, including a decision to not pursue certain low-margin business, are resulting in higher second half 2019 gross margin versus 2018 gross margin. Booked gross margins in our two largest product categories, Supplies and Furniture, were up 220 basis points in the second half of fiscal 2019 as compared to the second half of fiscal 2018. Curriculum segment gross margin was 50.4% for fiscal 2019, as compared to 55.2% for fiscal 2018. Higher than anticipated kitting costs, scrap, training costs and living material costs compared to fiscal 2018 are contributing to the unfavorable gross margin. The lower revenue in 2019 versus 2018 has resulted in an under absorption of the above costs, leading to lower overall gross margin for the product category.
Selling, General and Administrative Expenses
SG&A decreased
Variable-related SG&A costs, primarily outbound transportation costs and fulfillment center costs, decreased by$4.5 million in fiscal 2019 due to lower volume. Fixed compensation and benefit costs decreased by$4.3 million in fiscal 2019 due to lower staffing levels. Stock-based compensation expense was down year-over-year by$2.6 million as previously recognized unvested RSU expense for the former CEO was reversed in the first quarter of fiscal 2019. Travel expense was down year-over-year by$1.4 million primarily due to a decrease in the number of consultants and sales associates. In the second quarter of fiscal 2019, the Company received$1.3 million as a recovery of previously incurred SG&A costs associated with a claim against a former vendor, which also contributed to the lower SG&A costs in 2019. Marketing and selling expenses decreased by$1.7 million in fiscal 2019. Partially offsetting these decreases, commission expense was up$3.3 million year-over-year due to changes in the earning thresholds within the 2019 commission plans. Also, restructuring-related costs in SG&A increased year-over-year by$9.8 million related primarily to a combination of fees incurred associated with the Company's process to explore strategic alternatives and costs associated with transition to a new platform for custom planners.
As a percent of revenue, SG&A increased from 33.0% for fiscal 2018 to 34.8% for fiscal 2019.
Restructuring Costs During fiscal 2019, the Company recorded$2.7 million of restructuring charges and for fiscal 2018, the Company recorded$2.5 million of facility exit costs and restructuring charges. The amounts in both periods were related entirely to severance. Loss on Asset Sold During fiscal 2019, the Company incurred a loss of$4.1 million due to the sale of the intellectual property assets associated with the custom agenda product line. See Note 6 for additional details on the sale. No loss occurred in fiscal 2018. Impairment Charge For fiscal 2019, the Company recorded an impairment of$0.3 million related to the discontinuation of the use of a tradename and$4.6 million of a goodwill impairment charge based on the assessment conducted during the third quarter of fiscal 2019 related to the Science reporting unit. The Company recorded$22.3 million of goodwill impairment charges in fiscal 2018 based on the annual assessment conducted during the fourth quarter of fiscal 2018. The goodwill impairment charge was for the Distribution reporting unit. See Note 7 -Goodwill and Other Intangible to the consolidated financial statements in Item 8 of this report. 22
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Interest Expense
Interest expense increased from$15.5 million for fiscal 2018 to$20.5 million for fiscal 2019. Non-cashinterest and amortization of debt fees were up approximately$2.8 million year-over-year primarily due to$1.6 million associated with incremental paid-in-kindinterest related to our New Term Loan and$0.9 million of higher amortization of debt issuance costs. Cash interest expense was up$2.2 million in fiscal 2019 as compared to fiscal 2018 due primarily to an increase in our cash interest rate for fiscal 2019. The increase in the cash interest rate was due primarily to a year-over-year increase in our applicable margin as a result of an increase in our senior leverage ratio over the past twelve months.
Loss on Early Extinguishment of Debt
During fiscal 2019, the Company recorded a charge of$8.0 million . The charge related to a combination of the write-off of unamortized debt issuance costs associated with the term loan and ABL amendments during the fourth quarter of fiscal 2019 of$6.6 million and fees related to the various debt amendments paid to lenders of$2.3 million . The charge was partially offset by a gain of$0.9 million related to write-off of a portion of the derivate obligation associated with the issuance of warrants. No such charge was recorded in fiscal 2018.
Change in Value of Warrant Derivative
In fiscal 2019, the Company recorded a non-cash charge of$0.1 million in order to reflect the change in the current fair value of the obligation to issue warrants to certain of its lenders. The obligation to issue warrants arose from the Company's amendments to its credit facilities in 2019. All warrants related to this obligation were issued by the end of fiscal 2019. We did not have a fair value adjustment in fiscal 2018.
Income Taxes
The benefit for income taxes was
The effective income tax rate for fiscal 2019 and fiscal 2018 was 2.1% and -14.2%, respectively. The negative tax rate for fiscal 2018 was related to an incremental valuation allowance of$11.5 million which the Company recorded against substantially all of its net deferred tax assets. The tax benefit in fiscal 2019 was related primarily to ASC 740-10 adjustments for uncertain tax provisions. Based on a combination of the Company's fiscal 2019 performance, negative earnings before tax over the past thirty-six cumulative months, and future year taxable income projections, we believe it is more likely than not that the tax benefits associated with the majority of our net deferred tax assets will not be realized. The Company expects its effective income tax rate in fiscal 2020 to be significantly lower than the statutory rate due to its net operating losses.
Liquidity and Capital Resources
AtDecember 28, 2019 , the Company had negative working capital of$51.9 million , a decrease of$139.0 million as compared to fiscal 2018. Working capital in the current year includes both$2.1 million of cash and$145.2 million of current maturities of long-term debt. Current maturities of long-term debt have increased year over year because the Company has classified the full amount of the outstanding New Term Loan balances outstanding as ofDecember 28, 2019 , approximately$110.9 million , as currently maturing long-term debt due to the Company's non-compliance with certain financial covenants and the short-term nature of the forbearance granted by the New Term Loan Lenders and ABL Lenders with respect to this non-compliance. The Company's capitalization atDecember 28, 2019 was$164.0 million and consisted of total debt of$145.2 million and stockholders' equity of$18.8 million . Net cash provided by operating activities was$13.5 million for fiscal 2019 and net cash used for operating activities was$2.6 million for fiscal 2018. Approximately,$35.8 million of the increase in cash provided by operating activities related to working capital changes. As of fiscal 2018 year end, the Company's working capital balances were higher than historical year end working capital balances due to the impact of late order and split order fulfillment in fiscal 2018. The year-over-year increase in cash provided by operating activities reflects that working capital balances have returned to historical levels. As a result, for fiscal 2019, the Company's cash provided by working capital changes was$18.8 million as compared to cash used by operating activities in 2018. The increase in cash flow related to working capital changes was partially offset by an increased operating loss in fiscal 2019.
Net cash used in investing activities was
Net cash provided by financing activities in fiscal 2019 was$0.1 million and net cash used in fiscal 2018 was$11.3 million . In both periods the net cash provided from financing activities represents net draws from 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 repayments in fiscal 2018. Outstanding borrowings on the ABL Facility were$7.8 million as ofDecember 28, 2019 , while the excess availability on that date for the ABL Facility was$19.9 million . The Company repaid principal on its Term Loan in the amount of$5.6 million during fiscal 2019, which consisted of an excess cash flow payment of$1.0 million and regularly scheduled principal payments of$4.7 million . 23
-------------------------------------------------------------------------------- For a description of the agreements governing our debt, please refer to Note 9-Debt and Note 18-Subsequent Events of the Notes to the Consolidated Financial Statements. As ofDecember 28, 2019 , the Company had$2.1 million in cash and excess availability of$19.9 million on its ABL facility. However, the Company's operating results were below plan for fiscal 2019 which resulted in non-compliance with certain financial covenants of the Company's debt facilities in the third quarter of 2019 and all of the Company's debt has been classified as current in the consolidated financial statements. See Note 9 - Debt for details regarding the Company's debt facilities. To address the non-compliance,the Company entered into short-term forbearance agreements and amendments with its senior secured lenders for a forbearance related to the third quarter non-compliance and amendments to the terms of its debt facilities. In 2020, we have received several short-term extensions of the forbearance. These extensions are at the discretion of the secured lenders, and the lenders can exercise their rights or remedies at any time. The forbearance and amendment, among other things, resulted in restrictions on the Company's borrowing capacity and an acceleration of the current maturity dates. The forbearance and amendments also allowed the Company to pursue an extension of the maturity date with the holders of the currently maturing deferred cash payment obligations and the Company was able to successfully negotiate extensions on$21.3 million of the total maturing obligations of$27.9 million onDecember 12, 2019 , or 76 percent. Those obligations which were not extended, approximately$6.6 million , are past due. Uncertainty as to the success of entering into amendments with the Company's senior secured lenders, extensions to the currently-maturing deferred cash payment obligations and the Company's ability to remain in compliance with future period covenants could result in the Company's senior secured lenders exercising their rights and remedies with respect to our current non-compliance, resulting in substantial doubt about the Company's ability to continue as a going concern twelve months from the date the financial statements are issued. OnApril 5, 2020 , and effective as ofMarch 13, 2020 , the Company entered into (i) the Seventh Amendment to Loan Agreement and Forbearance Agreement among the Company, as borrower, certain of its subsidiaries, as guarantors, the financial institutions party thereto, as lenders andTCW Asset Management Company LLC , as the agent (the "Term Loan Amendment"), and (ii) the Tenth Amendment to Loan Agreement and Forbearance Agreement among the Company, certain of its subsidiary borrowers,Bank of America, N.A . and Bank of Montreal as lenders, andBank of America, N.A ., as agent for the lenders (the "ABL Amendment"), in order to, among other things: (1) extend the outside date of the Forbearance Period (as defined in the Term Loan Agreement) toApril 30, 2020 ; (2) to delay the Scheduled Term Loan Installment Payment (as defined in the Term Loan Amendment) and interest due onMarch 31, 2020 toJune 30, 2020 ; (3) on or beforeApril 30, 2020 , enter into a restructuring support agreement in form and substance satisfactory to Agent and the Required Lenders (each as defined in the Term Loan Agreement), which shall include, among other things, milestones in connection with a potential restructuring or sale transaction of the Company and an agreement among Agent, the Lenders and the Company regarding the terms, scope, and fees to be incurred in connection with the consummation of the transactions contemplated thereunder; and (4) to increase the Borrowing Base under the ABL Facility by adding the Seasonal Formula Amount (as defined in the ABL Amendment) during the fiscal months of February March, April, May and June.
Off Balance Sheet Arrangements
None.
Summary of Contractual Obligations
The following table summarizes our contractual debt and operating lease
obligations as of
Payments Due
(in thousands)
Less than 1 - 3 4 - 5 More than
Total 1 year years years 5 years
Long-term debt obligations (1) $ 135,544 $ 135,544 $ - $ - $ -
Deferred cash payment obligations (1) 27,897 27,897 - - -
Operating lease obligations 17,765 6,215 8,279 3,271 -
Purchase obligations (2) - - - - -
Total contractual obligations $ 181,206 $ 169,656 $ 8,279 $ 3,271 $ -
(1) Long-term debt obligations and deferred cash payment obligations include
principal and interest using either fixed rates or variable rates in effect
as of
been extended through
is past due.
(2) As of
purchase obligations.
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.
24
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The following table sets forth certain unaudited consolidated quarterly
financial data for fiscal 2019 and fiscal 2018 (in thousands, except per share
data). We derived this quarterly data from our unaudited consolidated financial
statements.
Fiscal 2019
First Second Third Fourth Total
Revenues $ 95,932 $ 160,609 $ 278,512 $ 91,020 $ 626,073
Gross profit 32,803 52,679 92,567 29,549 207,598
Operating income (loss) (20,804 ) 1,813 22,471 (25,436 ) (21,956 )
Net income (loss) (24,975 ) (5,856 ) 17,864 (36,581 ) (49,548 )
Basic earnings per share of common stock:
Earnings/(loss) $ (3.57 ) $ (0.84 ) Diluted earnings per share of common stock: Earnings/(loss)$ (3.57 ) $ (0.84 ) $ 2.16 $ (5.22 ) $ (7.06 ) Fiscal 2018 First Second Third Fourth Total Revenues$ 99,287 $ 169,272 $ 290,280 $ 114,613 $ 673,452 Gross profit 36,121 58,744 97,504 36,146 228,515 Operating income (loss) (21,328 ) 4,765 37,230 (39,045 ) (18,378 ) Net income (loss) (18,678 ) 18 18,556 (38,637 ) (38,741 ) Basic earnings per share of common stock: Earnings/(loss)$ (2.67 ) $ 0.00
Diluted earnings per share of common stock: Earnings/(loss)$ (2.67 ) $ 0.00 $ 2.63 $ (5.52 ) $ (5.53 ) The summation of quarterly net income (loss) per share may not equate to the calculation for the full fiscal year as quarterly calculations are performed on a discrete basis. Inflation
Inflation, particularly in areas such as wages, transportation, healthcare and energy costs, has had and is expected to have an effect on our results of operations and our internal and external sources of liquidity.
Critical Accounting Policies
We believe the policies identified below are critical to our business and the understanding of our results of operations. The impact and any associated risks related to these policies on our business are discussed throughout this section where applicable. Refer to the notes to our consolidated financial statements in Item 8 for a detailed discussion on the application of these and other accounting policies. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis and base them on a combination of historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical accounting policies that require significant judgments and estimates and assumptions used in the preparation of our consolidated financial statements are as follows:
Catalog Costs and Related Amortization
We spend approximately$8.7 million annually to produce and distribute catalogs. We accumulate all direct costs incurred, net of vendor cooperative advertising payments, in the development, production and circulation of our catalogs, for which future revenue can be directly attributable, on our balance sheet until such time as the related catalog is mailed. The Company evaluated its catalog costs under the new revenue recognition standard and determined that its catalog costs should be treated as costs incurred to obtain contracts. Since catalog costs are incurred regardless of whether specific customer contracts or purchase orders are obtained, catalog costs are now expensed as incurred. Under the prior guidance, the Company capitalized catalog costs and amortized over the period within which revenues attributable to the catalogs were generated, which was generally one year or less. 25
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Development Costs
We accumulate external and certain internal costs incurred in the development of our products which can include a master copy of a book, video or other media, on our balance sheet. As ofDecember 28, 2019 , we had$12.6 million in development costs on our balance sheet. A majority of these costs are associated with supplemental instruction and intervention curriculum products within the Distribution Segment and Science curriculum products. The capitalized development costs are subsequently amortized into cost of revenues over the expected sales realization cycle of the products, which is typically five years. The Company capitalized$4.1 million and$3.4 million of development costs in fiscal 2018 and fiscal 2019. We amortized development costs of$5.6 million and$4.5 million to expense during fiscal 2018 and fiscal 2019. We continue to monitor the expected sales realization cycle for each product and will adjust the remaining expected life of the development costs or recognize impairments, if warranted.
AtDecember 28, 2019 , intangible assets represented approximately 10% of our total assets. Our remaining goodwill balance of$4.6 million was written-off in 2019. We review intangible assets for impairment when an event occurs that leads us to believe the carrying value of an asset or group of assets may be less than the undiscounted cash flow. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. Typically, the Company tests its goodwill balance for impairment on an annual basis as of the end of December each year. The Company concluded that the third quarter 2019 forbearance agreements and terms of the proposed amendments to the Company's senior secured loans reflected in the term sheets entered into onNovember 12, 2019 and previously disclosed in Note 16-Subsequent Events of the Notes to Consolidated Financial Statements included in the Company's Quarterly Report on Form 10-Q for the quarter endedSeptember 28, 2019 , along with the reduction in the trading price of the Company's common stock, resulted in a reconsideration event that required the Company to reperform its goodwill impairment test as of the end of the third quarter of fiscal 2019. The Company determined the fair value of the reporting unit by utilizing a combination of the income approach (weighted 90%) and the market approach (weighted 10%) derived from comparable public companies. In completing the assessment, the fair value of the Science reporting unit indicated an impairment of goodwill of approximately$4.6 million . Indicators of impairment that were identified during the assessment were delayed recovery in the Science curriculum spend, increased competition and timing shifts into fiscal 2020 with theCalifornia adoption. Assumptions utilized in the impairment analysis are subject to significant management judgment. Changes in estimates or the application of alternative assumptions could have produced significantly different results. In completing the fiscal 2018 assessment, the Company determined that its Distribution reporting unit goodwill balance was impaired. The fair value assessment of the Science reporting unit indicated that the goodwill balance of this reporting unit was not impaired as the fair value exceeded the carrying value by over 100%. In order to establish the assumptions for the discounted cash flow analysis, the Company considered multiple factors, including (a) macroeconomic conditions, (b) industry and market factors such as school funding trends and school construction forecasts, (c) overall financial performance such as planned revenue, profitability and cash flows and (d) the expected impact of revenue enhancing and cost saving initiatives. These assumptions, along with discount rate assumptions, can have a material impact on the fair value determinations. As such, the Company performs a sensitivity analysis whereby changes to the assumptions include: i) an increase in the discount rate to reflect 100 basis points of additional company-specific risk premium; ii) lower long-term revenue growth rates by over 40%; and iii) reduced operating margin assumptions by at least 20 basis points. Based on this sensitivity analysis, these changes to the assumptions would not have resulted in a failure in the first step of the goodwill impairment testing for the Science reporting unit. As it related to goodwill, the Company applied the impairment rules in accordance with FASB ASC Topic 350, "Intangibles -Goodwill and Other". As required by FASB ASC Topic 350, the recoverability of these assets is subject to a fair value assessment, which includes judgments regarding financial projections, including forecasted cash flows and discount rates, and comparable market values. As it relates to finite life intangible assets, we apply the impairment rules as required by FASB ASC Topic 360-10-15, "Impairment or Disposal of Long-Lived Assets" which also requires significant judgments related to the expected future cash flows attributable to the primary asset. Key assumptions used in the impairment analysis include, but are not limited to, expected future cash flows, business plan projections, revenue growth rates, and the discount rate utilized for discounting such cash flows. The impact of modifying any of these assumptions can have a significant impact on the estimate of fair value and thus the estimated recoverability, or impairment, if any, of the asset. 26
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Valuation Allowance for Deferred Tax Assets
We initially recorded a tax valuation allowance against our deferred tax assets in the fourth quarter of fiscal 2012. In recording the valuation allowance, management considered whether it was more likely than not that some or all of the deferred tax assets would be realized as the Company has generated net operating losses in recent years and does not have an ability to carry these back to previous years. This analysis included consideration of scheduled reversals of deferred tax liabilities, projected future taxable income, carry back potential and tax planning strategies, in accordance with FASB ASC Topic 740, "Income Taxes". Based on a combination of fiscal 2018 results and prospective year taxable income projections, the Company assessed that it was more likely than not that the benefits of substantially all of its net deferred tax assets would not be realized and recorded a valuation allowance of$16.7 million . As a result, the Company increased its valuation allowance to$29.9 million as ofDecember 28, 2019 .
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