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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2002
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: 0-28493
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 43-1659062
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1900 Gulf Street, Lamar, Missouri 64759-1899
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (417) 682-3322
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Senior Preferred Stock, par value $0.01 per share
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 [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.|X|
As of September 1, 2002, 1,368,000 shares of common stock of O'Sullivan
Industries Holdings, Inc. were outstanding. The aggregate market value of the
voting stock held by non-affiliates of O'Sullivan Industries Holdings, Inc. can
not be calculated because this stock is not traded.
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The Index to Exhibits begins on page 72.
Page 1 of 173
PART I
ITEM 1. BUSINESS.
HISTORY AND OVERVIEW
O'Sullivan Industries Holdings, Inc., a Delaware corporation, is a
leading designer, manufacturer and distributor of ready-to-assemble furniture in
the United States. O'Sullivan was incorporated in November 1993 and acquired
O'Sullivan Industries, Inc. in February 1994. O'Sullivan Industries Holdings,
Inc. is a holding company with no material operations. It owns all the capital
stock of O'Sullivan Industries, Inc., a Delaware corporation. O'Sullivan
Industries, Inc. owns all of the capital stock of O'Sullivan Industries -
Virginia, Inc., a Virginia corporation, and O'Sullivan Furniture Factory Outlet,
Inc., a Missouri corporation. O'Sullivan Industries Holdings, Inc. is dependent
on O'Sullivan Industries, Inc., to fund the interest cost on $19.8 million of
debt, including accrued interest, and dividends on mandatorily redeemable senior
preferred stock (liquidation value plus accumulated dividends totaling $33.3
million at June 30, 2002).
References to the words "O'Sullivan," "we," "our" and "us" refer to
O'Sullivan Industries Holdings, Inc., and its subsidiaries. References to
"O'Sullivan Holdings" refer to O'Sullivan Industries Holdings, Inc. only.
References to "O'Sullivan Industries" refer to O'Sullivan Industries, Inc. and
its subsidiaries. References to "O'Sullivan Industries - Virginia" refer to
O'Sullivan Industries - Virginia, Inc.
We own manufacturing, warehouse and distribution facilities in Lamar,
Missouri and South Boston, Virginia. O'Sullivan commenced operations at the
Lamar, Missouri plant in 1965, and the South Boston, Virginia facility became
operational in 1989.
We engage in one industry segment: the design, manufacture and sale of
ready-to-assemble, or RTA, furniture.
BUSINESS OVERVIEW
After two years of sales growth in excess of 10%, our net sales
declined 11.5% in fiscal 2001. In fiscal 2002, our sales declined 2.7% as
improvements in the third quarter of the fiscal year did not overcome sales
declines in the other three quarters of the year. Our sales declined for several
reasons, including:
- the stalling of growth in sales of personal computers, which
reduced the need for computer desks and workstations;
- the slowdown of economic growth and consumer spending in the
United States, particularly in the office superstore channel;
- store closings by a number of customers, including OfficeMax,
Office Depot, Montgomery Ward, Kmart and Shopko;
- the bankruptcy of Ames and Kmart;
- the liquidation of Montgomery Ward and Service Merchandise;
- inventory reductions by our customers, particularly in the office
superstore channel;
- the decline in price of the average unit sold, reflecting a trend
toward more promotional merchandise; and
- the retrenchment in business capital outlays, particularly
relating to the purchase of office furniture.
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These factors, along with the economic repercussions from the September
11, 2001 terrorist attacks, will continue to affect our business into fiscal
2003. Improvements in the economy, coupled with new product introductions and
inventory replenishments by our customers, helped our net sales increase by 8.0%
in the quarter ended March 31, 2002 over the same quarter of fiscal 2001;
however, sales declined 8.4% in the fourth quarter of fiscal 2002 from the prior
year fourth quarter as the economic recovery slowed, inventory reductions
resumed and new product rollouts were delayed.
Reacting to the lower sales levels, we closed our Cedar City, Utah
manufacturing facility in January 2001. We also reduced support staff at the
Lamar, Missouri facility. We recorded a $10.5 million pre-tax restructuring
charge to reflect the costs of these actions. We are saving about $5.0 million
annually from the closing of our Cedar City, Utah facility.
As a result of the lower sales levels, coupled with the restructuring
charge in fiscal 2001 and the outcome of the arbitration proceedings with
RadioShack in fiscal 2002, we incurred a net loss before dividends and accretion
on preferred stock of $7.8 million and $7.9 million for fiscal 2002 and fiscal
2001, respectively. However, even with the lower sales level, we were able to
increase our earnings before interest, taxes, depreciation and amortization to
$54.4 million in fiscal 2002 from $36.8 million in fiscal 2001 due to lower raw
material prices, increased productivity, the closing of the less efficient Cedar
City, Utah facility and the $10.5 million restructuring charge taken in fiscal
2001.
While we have confidence in the long-term future of the RTA furniture
industry, sales in the first quarter of fiscal 2003 are anticipated to be down
approximately 10% from sales in the first quarter of fiscal 2002, as the factors
discussed above continue to affect our sales. We cannot yet predict when our
sales will return to a pattern of sales growth.
The 1999 Recapitalization and Merger
On November 30, 1999, O'Sullivan Holdings completed a recapitalization
and merger through which the outstanding stock of O'Sullivan Holdings was
purchased by a private equity firm, Bruckmann, Rosser, Sherrill & Co. II, LLC
("BRS"), 34 members of our management and an affiliate of a former director.
Management and the affiliate of a former director owned a total of 27.1% of the
outstanding common stock of O'Sullivan Holdings at June 30, 2002. BRS and
certain of its affiliates own the balance.
Each share of outstanding common stock of O'Sullivan Holdings was
exchanged for $16.75 in cash and one share of senior preferred stock with an
initial liquidation value of $1.50 per share. Some of the shares of O'Sullivan
Holdings common stock, options and cash held by the management participants in
the recapitalization and merger were exchanged for 371,400 shares of common
stock, 72,748 shares of Series B junior preferred stock and options to acquire
60,319 shares of Series A junior preferred stock of the surviving company.
The total amount of funds necessary to fund the recapitalization and
merger and related transactions was approximately $357.0 million. These funds
came primarily from the following sources:
- an equity investment by BRS of approximately $45.3 million in cash
in the recapitalization and merger. The cash investment was used
to purchase 996,600 shares of common stock and 442,933 shares of
Series B junior preferred stock of O'Sullivan Holdings;
- an equity investment in O'Sullivan Holdings by the management
participants in the recapitalization and merger in the amount of
approximately $13.7 million. This investment consisted of the
exchange by the management participants of common stock of
O'Sullivan Holdings with a value of $6.9 million, options to
acquire common stock of O'Sullivan Holdings with an intrinsic
value of $6.1 million and cash of $700,000 for shares of common
stock, shares
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of Series B junior preferred stock and options to acquire
shares of Series A junior preferred stock, each of O'Sullivan
Holdings;
- the issuance by O'Sullivan Holdings of senior preferred stock with
a total liquidation value of $24.6 million to the existing
stockholders of O'Sullivan Holdings;
- the issuance by O'Sullivan Holdings of a $15.0 million senior note
and warrants exercisable in aggregate into 6.0% of O'Sullivan
Holdings common stock and 6.0% of O'Sullivan Holdings junior
preferred stock on a fully diluted basis as of the date of the
issuance of the warrants;
- the issuance by O'Sullivan Industries of $100.0 million of senior
subordinated notes together with warrants issued by O'Sullivan
Holdings exercisable in aggregate into 6.0% of O'Sullivan Holdings
common stock and 6.0% of O'Sullivan Holdings junior preferred
stock on a fully diluted basis as of the date of issuance of the
warrants;
- borrowings by O'Sullivan Industries totaling approximately $139.0
million under the senior credit facility; and
- $9.4 million of cash from O'Sullivan Industries.
In addition, $10.0 million of variable rate industrial revenue bonds
remain outstanding following the recapitalization transactions.
The recapitalization and merger was approved by the board of directors
of O'Sullivan Holdings, the board of directors of OSI Acquisition, Inc. (the
merger vehicle created by BRS) and a majority of the stockholders of O'Sullivan
Holdings. We accounted for the merger under recapitalization accounting. Under
this method, the historical basis of our assets and liabilities was not
affected.
RTA FURNITURE
We are a leading designer, manufacturer and distributor of
ready-to-assemble furniture products, with over 45 years of experience. We sell
primarily to the home office and home entertainment markets. We manufacture
approximately 450 stock keeping units of ready-to-assemble furniture at retail
price points from $20 to $999. Our product offerings include ready-to-assemble
desks, computer workcenters, home entertainment centers, audio equipment racks,
pantries and microwave oven carts. We also manufacture a variety of other
ready-to-assemble furniture for home office, home entertainment, storage,
bedroom and other home uses. We design our products to provide high quality,
value and ease of assembly by the consumer using straight-forward, diagramed
instructions. For information regarding our sales, operating profits and assets,
see the financial statements included in Part II, Item 8 of this report,
"Financial Statements and Supplementary Data."
We distribute our products primarily through office superstores,
including OfficeMax, Office Depot and Staples, discount mass merchants,
including Wal-Mart, Target and Kmart, home centers such as Lowe's, and
electronic superstores such as Best Buy and Circuit City, as well as through
other retail channels. We own two modern manufacturing facilities totaling over
1.8 million square feet located in Lamar, Missouri and South Boston, Virginia.
COMPETITIVE STRENGTHS
We believe that we are able to compete effectively due to the following
strengths:
Leading market share position. We believe we are the second largest
North American ready-to-assemble furniture manufacturer in terms of domestic
sales. We estimate our share of the ready-to-assemble furniture
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market in calendar 2001 was approximately 17%. Many of our largest customers,
including office superstores and discount mass merchants, have substantial
purchasing requirements across the country. We are able to satisfy these
requirements because of our large manufacturing capacity and our innovative,
high quality products.
Leader in product quality, innovation and design. We believe that we
are recognized as a leader in product quality, innovation and design in the
ready-to-assemble furniture industry. Our computer-aided design software and our
modern manufacturing processes enable us to develop more than 150 new products
per year. Consequently, about one-third of our products are new each year. Our
ability to innovate allows us to keep pace with changes in retailer and consumer
tastes and demands. The American Society of Furniture Designers has awarded us
three Pinnacle Awards in the last four years.
Well-established customer relationships. We have well-established
relationships with many of the largest retailers of ready-to-assemble furniture
in the United States. These include office superstores like OfficeMax, Office
Depot and Staples. They also include national discount mass merchants, like
Wal-Mart, Target and Kmart, electronic superstores like Best Buy and Circuit
City and home centers such as Lowe's. We believe we have a long history as a
trusted vendor and have earned a reputation for product quality and innovation,
customer responsiveness and manufacturing flexibility.
Available capacity positions us for growth. In recent years, we have
expanded our manufacturing facilities to provide capacity to meet current and
anticipated demand. Two of these expansion projects, started in early 2000 to
meet anticipated demand growth in 2001 and beyond, were completed in fiscal
2002. Thus, even with the closure of the Cedar City, Utah manufacturing
facility, we have substantial available capacity that will enable us to meet
growing demand.
Low cost manufacturing operations. We believe that we are a low-cost
ready-to-assemble furniture producer due to our large scale, modern facilities
and efficient manufacturing processes.
Experienced management team with significant equity ownership. Our
senior management team has extensive experience in the ready-to-assemble segment
of the furniture industry. Our eleven officers have been with us for an average
of over 18 years. In addition, we have broadened our management's expertise by
hiring executives from other leading manufacturers. Management participants in
the recapitalization invested a total of $13.7 million. This retained equity
includes an interest of approximately 27.1% in the outstanding common stock of
O'Sullivan Holdings. As a result of their substantial equity interest, we
believe the management participants in the recapitalization have a significant
incentive to continue to increase our sales and profitability.
GROWTH STRATEGY
Sales of ready-to-assemble furniture, although expanding more rapidly
than sales of traditional case goods furniture in recent years, still represent
less than 7% of the overall domestic residential furniture market. As the
quality of ready-to-assemble furniture continues to improve, and discount mass
merchants and home centers continue to expand, we expect ready-to-assemble
furniture to gain additional market share. The key elements of our growth
strategy are as follows:
Continue to develop a broad range of innovative, high quality products.
We are dedicated to offering a broad range of high quality products at a variety
of retail prices. We believe that by maintaining a broad product line we can
appeal to a greater number of consumers and penetrate a larger number of
distribution channels. We seek to drive demand for our products and maintain
profitability in an otherwise price-rigid environment by providing a steady
supply of high quality product introductions. In fiscal 2002, we introduced
approximately 150 new products. For the future, we believe that there are
additional categories, such as storage and commercial office furniture, that
offer opportunities for us to grow.
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Further penetrate existing and new, growing distribution channels.
Sales to office superstores and discount mass merchants, our core distribution
channels, grew at a compound annual growth rate of about 8.5% since fiscal 1995
to over $250 million in fiscal 2002. However, total sales slumped sharply in
fiscal 2001 and were down 2.7% in fiscal 2002. To increase sales to our existing
customer base, we have developed several initiatives. These initiatives include
dedicated product lines, enhanced customer service and tailored marketing
programs. We have also focused on increasing sales to other growing distribution
channels. These channels include electronic specialty retailers and home
improvement centers.
Lower production costs. Producing ready-to-assemble furniture cost
effectively is vital to our competitive position. This belief was the premise
for capital expansions. Our capital investments have increased our total
manufacturing capacity. New equipment and employee training have also improved
our inventory management, order fulfillment rates and production efficiency.
Remain committed to customer service. We are committed to providing
superior customer service to maintain strong relationships with our customers.
We strive to develop marketing strategies that are consistent with our
customers' needs and their position in the marketplace. The recent investments
we have made to improve our management information systems and increase our
manufacturing capacity should enable us to provide a higher level of customer
responsiveness, improve the look and quality of our products and enhance our
ability to forecast orders.
PRODUCT OVERVIEW
We group our product offerings into three distinct categories:
- furniture for the home office and small office, including desks,
computer work centers, bookcases and filing cabinets;
- electronics display furniture, including home entertainment centers,
home theater systems, television and audio stands and audio and video
storage units; and
- home decor furniture, including microwave oven carts, pantries, living
room and recreation room furniture and bedroom pieces, including
dressers, night stands and wardrobes.
The following is a description of some of our products.
PRODUCT DESCRIPTION KEY CUSTOMERS
------- ----------- -------------
Living Dimensions...... contemporary small office/home OfficeMax, Staples
office. Upscale features include
Armortop(R) laminates and
Quickfit(TM) fastener system
Maestro................ a modular, light commercial OfficeMax
office furniture system
French Gardens......... country French style collection OfficeMax, Shopko,
with antique Odessa pine finish. Staples, Lowe's
Both home office and
entertainment products
Transitions............ contemporary small office/home Best Buy, Lowe's
office and entertainment furniture
collection in a medium alder
finish
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Manor Hill............. updated traditionally styled Lowe's, Meijer,
home entertainment and home Best Buy
office furniture
Elements............... a modular home office grouping Office Depot
PRODUCT DESIGN AND DEVELOPMENT
We believe we are an industry leader in product quality and
innovation. We are committed to the continuing development of unique furniture
that meets consumer needs. With over 50% of our sales to the home office and
small office market, we believe we are recognized as one of the industry's
premier producers of contemporary home office and small office ready-to-assemble
furniture. In the past three years, we introduced an average of over 150
products per year. In the ready-to-assemble furniture industry, a new product
can be a variation in color or styling of an existing product. By providing a
continuous supply of new product introductions, we endeavor to drive demand for
our products, which we believe will allow us to maintain our profit margins in
an otherwise price-rigid environment.
We maintain an in-house product design staff that collaborates with our
marketing personnel and customers to develop new products based on demographic
and consumer information. The product design professionals then work with our
engineering division to produce full-scale prototypes. The engineering staff
uses computer-aided design software, which provides three-dimensional graphics
capabilities. The software allows a design engineer to accelerate the
time-to-completion for a new product design. This allows us to reduce the time
for newly conceived products to reach the market. We then show our prototypes to
our customers to gauge interest. If initial indications of product appeal are
favorable, we usually can commence production within twelve weeks. We spent
approximately $1.1 million, $1.0 million and $1.0 million on product design and
development in fiscal years 2002, 2001 and 2000, respectively.
CUSTOMERS
Ready-to-assemble furniture is sold through a broad array of
distribution channels, including discount mass merchants, office superstores,
electronic superstores, national department stores and home centers. While the
ready-to-assemble segment historically has been dominated by discount mass
merchants like Wal-Mart, Target and Kmart, office superstores have become the
second largest distribution channel.
We have a large market share position in both of the two major
distribution channels and longstanding relationships with key customers. In
fiscal 2002, sales to OfficeMax accounted for about 19% of our gross sales,
Office Depot accounted for about 14% of our gross sales and Wal-Mart accounted
for about 12% of our gross sales. Similar to other large ready-to-assemble
furniture manufacturers, our sales are fairly concentrated.
SALES AND MARKETING
We manage our customer relationships both through our in-house sales
force and a network of independent sales representatives. Key accounts like
OfficeMax and Office Depot are called on jointly by our sales force and
independent sales representatives. Smaller customers are serviced mainly by
independent sales representatives, whose activities are reviewed by our in-house
sales force.
We work extensively with our customers to meet their specific
merchandising needs. Through customer presentations and other direct feedback
from the customer and consumers, we identify the consumer tastes and profiles of
a particular retailer. With this information, we make product recommendations to
our customers. We maintain a close dialogue with customers to ensure that the
design and functional requirements of our products are fulfilled.
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Our products are promoted by our customers to the public under
cooperative and other advertising agreements. Under these agreements, our
products are advertised in newspaper inserts and catalogs, among other
publications. We generally cover a portion of the customer's advertising
expenses if the customer places approved advertisements mentioning us and our
products by name. We may also provide support to some customers' advertising
programs. We generally do not advertise directly to consumers. We do, however,
advertise in trade publications to promote O'Sullivan as a producer of high
quality ready-to-assemble furniture.
We provide extensive service support to our customers. This support
includes designing and installing in-store displays, educating retailers' sales
forces and maintaining floor displays. We have been recognized for our
commitment to our retail partners and have earned several awards in recent
years.
We participate in the furniture markets held in High Point, North
Carolina in April and October of each year. High Point is the principal
international market in the furniture industry. It attracts buyers from the
United States and abroad. In 2001, we signed a lease for a new, larger showroom
in High Point. We also maintain other showrooms to market our product lines.
We sell our products throughout the United States and in Canada,
Mexico, the United Kingdom, Australia and other countries. Export sales were
$19.1 million, $23.9 million and $25.0 million in fiscal 2002, 2001 and 2000,
respectively. In fiscal 2002, sales decreases in Central & South America, the
Middle East and the United Kingdom were partially offset by sales increases in
the Canadian market. In fiscal 2001, sales increases in the United Kingdom and
Canada due to marketing successes were more than offset by sales decreases in
the Middle Eastern market. In fiscal 2000, international sales declined largely
due to the strength of the dollar against the pound and lower sales to the
Middle East.
MANUFACTURING
We operate two modern manufacturing facilities, in Lamar, Missouri and
South Boston, Virginia. In total, these facilities have about 1.8 million square
feet.
- Lamar, Missouri: Opened in 1965, this facility has about 1.15 million
square feet. It is our larger facility and has the capability to
produce our entire product offering. This facility also serves as our
corporate headquarters.
- South Boston, Virginia: Opened in 1989, our South Boston facility has
been expanded to approximately 675,000 square feet, including an
expansion of about 200,000 square feet completed in 2001. The South
Boston facility has the capability to manufacture most of our products.
RAW MATERIALS
The materials used in our manufacturing operations include
particleboard, fiberboard, coated paper laminates, glass, furniture hardware and
packaging materials. Our largest raw material cost is particleboard. We purchase
all of our raw material needs from outside suppliers. We buy our particleboard
and fiberboard at market-based prices from several independent wood product
suppliers. We purchase other raw materials from a limited number of vendors.
These raw materials are generally available from other suppliers, although the
cost from alternate suppliers might be higher.
As is customary in the ready-to-assemble furniture industry, we do not
maintain long-term supply contracts with our suppliers. We do, however, have
long standing relationships with all of our key suppliers and encourage supplier
partnerships. Our supplier base is sufficiently diversified so that the loss of
any one supplier in any given commodity should not have a material adverse
effect on our operations. We have never been unable to secure needed raw
materials. However, there could be adverse effects on our operations and
financial condition if we are unable to secure necessary raw materials like
particleboard and fiberboard.
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Because we purchase all of our raw materials from outside suppliers, we
are subject to changes in the prices charged by our suppliers. In fiscal 2000,
our operating income was reduced by price increases of these commodities. In
fiscal 2001, particleboard and fiberboard prices declined, increasing our
operating income in the latter portion of the year. Industry pricing for
particleboard was flat to slightly lower in fiscal 2002, and analysts anticipate
pricing will remain about the same through calendar 2002. Prices for fiberboard,
however, began to increase in the fourth quarter of fiscal 2002, and we expect
further price increases in fiscal 2003. We cannot assure you that raw material
prices will not increase in the future. If the demand for particleboard
increases, prices may rise in 2003 or even earlier. See "Cautionary Statement
Regarding Forward Looking Information and Risk Factors" in Item 7 of Part II of
this report.
COMPETITION
The residential furniture market is very competitive and includes a
large number of both domestic and foreign manufacturers. Our competitors include
manufacturers of both ready-to-assemble and assembled furniture. Although a
large number of companies manufacture ready-to-assemble furniture, the top five
ready-to-assemble furniture manufacturers accounted for an estimated 74% of the
domestic ready-to-assemble furniture market in 2001. Our top five competitors
are Sauder Woodworking, Inc., Bush Industries, Inc., Dorel Industries, Inc.,
Mills Pride and Creative Interiors. Some of our competitors have greater sales
volume and financial resources than we do. RTA furniture manufacturers compete
on the basis of price, style, functionality, quality and customer support.
In recent years, sales of imported RTA furniture have been increasing
in the United States. We anticipate that we will continue to compete with
imports in the United States. We are reacting to this new competition by
emphasizing our design capabilities, our quality and our ability to deliver
product from the factory more quickly, as well as being price competitive. We
have also begun to source the manufacture of certain products from other
countries.
Several manufacturers, including O'Sullivan, have excess manufacturing
capacity due to the current decline in sales in the RTA furniture segment. This
excess capacity is causing increased competition that is expected to continue,
and perhaps to intensify, in fiscal 2003. This adversely affected our margins
and results of operations in fiscal 2002, and will continue to affect margins
and results in fiscal 2003.
PATENTS AND TRADEMARKS
We have a United States trademark registration and international
trademark registrations or applications for the use of the O'Sullivan(R) name on
furniture. We believe that the O'Sullivan name and trademark are well-recognized
and associated with high quality by both our customers and consumers and are
important to the success of our business. Our products are sold under a variety
of trademarks in addition to O'Sullivan. Some of these names are registered
trademarks. We do not believe that the other trademarks we own enjoy the same
level of recognition as the O'Sullivan trademark. We also do not believe that
the loss of the right to use any one of these other trademarks would be material
to our business.
We hold a number of patents and licenses. We do not consider any one of
these patents and licenses to be material to our business.
SHIPPING
We offer customers the choice of paying their own freight costs or
having us absorb freight costs. If we absorb the freight costs, our product
prices are adjusted accordingly. When we pay freight costs, we use independent
trucking companies with whom we have negotiated competitive transportation
rates.
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BACKLOG
Our business is characterized by short-term order and shipment
schedules of generally less than two weeks. Accordingly, we do not consider
backlog at any given date to be indicative of future sales.
SEASONALITY
We generally experience a somewhat higher level of sales in the second
and third quarters of our fiscal year in anticipation of and following the
holiday selling seasons.
INSURANCE
We maintain liability insurance at levels that we believe are adequate
for our needs. We believe these levels are comparable to the level of insurance
maintained by other companies in the furniture manufacturing business.
EMPLOYEES
As of June 30, 2002, we had approximately 2,225 employees. About 71%
percent of these employees are located in Lamar, Missouri. None of our employees
are represented by a labor union. We believe that we have good relations with
our employees.
ENVIRONMENTAL AND SAFETY REGULATIONS
Our operations are subject to extensive federal, state and local
environmental laws, regulations and ordinances. Some of our operations require
permits. These permits are subject to revocation, modification and renewal by
governmental authorities.
Governmental authorities have the power to enforce compliance with
their regulations. Violators may be subject to fines, injunction, incarceration,
or all three. Compliance with these regulations has not had a significant effect
on our results of operations, capital expenditures or competitive position. In
fiscal 2001, we received a Title V operating permit for our facility in Lamar,
Missouri. The permit imposes additional monitoring restrictions on our
operations, but has not required us to modify our operations. We have addressed
certain issues with the Missouri Department of Natural Resources regarding the
effectiveness of the monitoring requirements.
Our manufacturing process creates by-products, including sawdust and
particleboard flats. At the South Boston facility, this material is given to a
recycler or disposed of in landfills. At the Lamar facility, the material has
been sent to recyclers and off-site disposal sites. In fiscal 2002, we were
successful in increasing the percentage of by-products delivered to recyclers at
a reduced cost to us. Our by-product disposal costs were approximately $600,000
for fiscal 2002, $1.1 million for fiscal 2001 and $1.9 million for fiscal 2000.
Our manufacturing facilities ship waste products to various disposal
sites. If our waste products include hazardous substances and are discharged
into the environment, we are potentially liable under various laws. These laws
may impose liability for releases of hazardous substances into the environment.
These laws may also provide for liability for damage to natural resources. One
example of these laws is the federal Comprehensive Environmental Response,
Compensation and Liability Act. Generally, liability under this act is joint and
several and is determined without regard to fault. In addition to the
Comprehensive Environmental Response, Compensation and Liability Act, similar
state or other laws and regulations may impose the same or even broader
liability for releases of hazardous substances.
We have been designated as a potentially responsible party under the
Arkansas Remedial Action Trust Fund Act for the cost of cleaning up a disposal
site in Diaz, Arkansas. We entered into a de minimis buyout
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agreement with some of the other potentially responsible parties. We have
contributed $2,000 to date toward cleanup costs under this agreement. The
agreement subjects potentially responsible parties to an equitable share of any
additional contributions if cleanup costs exceed $9 million. In this event, we
would be liable for our share of the excess. Cleanup expenses have approached $9
million. The state has approved a plan providing that groundwater at the site be
monitored. No further remediation activity is necessary unless further problems
are discovered. The monitoring activities, which are underway, should not
require the potentially responsible parties to make additional payments. We
believe that the amounts we may be required to pay in the future, if any,
relating to this site will be immaterial.
Our operations also are governed by laws and regulations relating to
workplace safety and worker health, principally the Occupational Safety and
Health Act and related regulations. Additionally, some of our products must
comply with the requirements and standards of the United States Consumer
Products Safety Commission. We believe that we are in substantial compliance
with all of these laws and regulations.
ITEM 2. PROPERTIES.
O'Sullivan owns two manufacturing, warehouse and distribution
facilities. The Lamar, Missouri facility, which also serves as O'Sullivan's
headquarters, consists of approximately 1,150,000 square feet. The South Boston,
Virginia facility has approximately 675,000 square feet. These properties are
subject to liens in favor of the holders of our senior credit facility.
We purchased additional land adjacent to our Lamar facility in July
2002. We have some excess land at South Boston which may be used for expansion.
We lease space for showrooms in High Point, North Carolina and in other
locations in the United States. We also lease warehouse space in Lamar and
Neosho, Missouri. We lease space for a factory outlet store in Springfield,
Missouri to sell close-out and excess inventory.
Our Canadian operations are in a leased facility in Markham, Ontario.
O'Sullivan's United Kingdom operations are in a leased facility in Oxfordshire.
The Cedar City, Utah manufacturing plant that we closed in January 2001
is for sale.
We consider our owned and leased facilities to be adequate for the
needs of O'Sullivan and believe that all of our owned and leased properties are
well maintained and in good condition.
ITEM 3. LEGAL PROCEEDINGS.
Prior to O'Sullivan Holdings' initial public offering in 1994, we were
owned by RadioShack Corporation (then named Tandy Corporation). In connection
with the 1994 initial public offering of O'Sullivan's common stock, RadioShack
Corporation, its subsidiary TE Electronics Inc. and O'Sullivan Holdings entered
into a Tax Sharing and Tax Benefit Reimbursement Agreement. Pursuant to the tax
sharing agreement, RadioShack is primarily responsible for all U.S. federal
income taxes, state income taxes and foreign income taxes with respect to
O'Sullivan for all periods ending on or prior to the date of consummation of the
offering and for audit adjustments to such federal income and foreign income
taxes. We are responsible for all other taxes owing with respect to us,
including audit adjustments to state and local income taxes and for franchise
taxes.
RadioShack and O'Sullivan made an election under Sections 338(g) and
338(h)(10) of the Internal Revenue Code with the effect that the tax basis of
O'Sullivan Industries' assets was increased to the deemed purchase price of the
assets. An amount equal to such increase was included in income in the
consolidated federal income tax return filed by RadioShack. This additional tax
basis results in increased income tax deductions and, accordingly, reduced
income taxes payable by us. Pursuant to the tax sharing agreement, we pay
RadioShack nearly all of the federal tax benefit expected to be realized with
respect to such additional basis.
11
We are incurring significantly higher interest expense associated with
our higher debt levels in connection with the financing of our November 1999
recapitalization and merger. We believed that this increased interest expense,
and certain expenses incurred to consummate the recapitalization and merger,
should be taken into account in determining the payments O'Sullivan Holdings is
required to make to RadioShack under the tax sharing agreement. RadioShack
claimed we could not deduct the additional interest and expenses in determining
the tax sharing payments.
On June 29, 1999, RadioShack filed a complaint against us in the
District Court of Texas in Tarrant County. RadioShack's complaint sought a court
order compelling us to submit to a dispute resolution process. We argued that no
dispute existed because at that time the recapitalization and merger had not
closed. On October 8, 1999, the court ordered us to commence dispute resolution
procedures before an arbitrator, according to the terms of the tax sharing
agreement. Mediation efforts failed to resolve the issue. Arbitrators were
selected to hear the dispute, the arbitration was heard in October 2001 and
briefing of the issue followed.
In March 2002, the arbitration panel ruled in favor of RadioShack on
this issue, concluding that the interest expense arising from the
recapitalization and merger is not deductible in calculating the payments due
from us to RadioShack under the tax sharing agreement.
Following the issuance of the opinion, we reached a settlement of the
dispute with RadioShack. Under the settlement, we paid RadioShack $21.5 million
in May 2002 to cover all amounts due through December 31, 2001; RadioShack
waived interest on the payments and its attorneys' fees. We agreed to make
future payments under the tax sharing agreement without deducting interest on
indebtedness incurred in the recapitalization and merger. For the six months
ended June 30, 2002, we paid RadioShack $6.2 million.
See "Cautionary Statement Regarding Forward Looking Statements and Risk
Factors" in Item 7 of Part II of this report.
Other Litigation and Claims. In addition, we are a party to various
pending legal actions arising in the ordinary operation of our business. These
include product liability claims, employment disputes and general business
disputes. We believe that these actions will not have a significant negative
effect on our operating results and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of O'Sullivan
during the quarter ended June 30, 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
There is no established public market for O'Sullivan Holdings' common
equity.
As of September 1, 2002, there were approximately 91 common
stockholders of record. No dividends have been paid or declared since our
initial public offering in 1994.
We currently intend to retain all earnings to finance the development
of our operations and to repay our indebtedness. Our credit agreements
effectively prohibit us from paying dividends on our common or preferred stock.
We do not anticipate paying cash dividends on our shares of common or preferred
stock in the near future. Our future dividend policy will be determined by our
Board of Directors on the basis of various factors, including but not limited to
our results of operations, financial condition, business opportunities and
capital requirements. The payment of dividends is subject to the requirements of
Delaware law, as well as restrictive financial covenants in our debt agreements.
12
ITEM 6. SELECTED CONSOLIDATED HISTORICAL FINANCIAL INFORMATION.
The selected historical consolidated results of operations and balance
sheet data for the five years ended June 30, 2002 are derived from O'Sullivan's
audited financial statements. This selected consolidated financial data should
be read in conjunction with Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and Item 8, "Consolidated
Financial Statements and Related Notes," in Part II of this report.
For the year ended June 30,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(in thousands)
Net sales(1) $ 349,098 $ 358,811 $ 405,234 $ 363,678 $ 326,531
Cost of sales 254,662 269,720 298,387 267,630 244,086
--------- --------- --------- --------- ---------
Gross profit 94,436 89,091 106,847 96,048 82,445
Selling, marketing and administrative
expense(1) 54,584 56,682 64,173 59,008 56,336
Restructuring charge -- 10,506 -- -- --
Merger related expenses -- -- 7,792 1,143 --
Transaction fee to related party -- -- 3,062 -- --
Compensation expense associated with
stock options -- -- 10,627 -- --
Loss on settlement of interest rate swap -- -- 408 -- --
--------- --------- --------- --------- ---------
Operating income 39,852 21,903 20,785 35,897 26,109
Interest expense, net 28,131 33,967 18,595 2,844 2,468
--------- --------- --------- --------- ---------
Income (loss) before income tax provision,
extraordinary item and cumulative
effect of accounting change 11,721 (12,064) 2,190 33,053 23,641
Income tax provision (benefit) 19,553 (4,221) 5,050 11,900 8,742
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item
and cumulative effect of
accounting change (7,832) (7,843) (2,860) 21,153 14,899
Extraordinary loss from early
extinguishment of debt -- -- (305) -- --
Cumulative effect of accounting change -- (95) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) $ (7,832) $ (7,938) $ (3,165) $ 21,153 $ 14,899
========= ========= ========= ========= =========
Cash flows provided by operating activities $ 25,897 $ 24,928 $ 30,320 $ 25,216 $ 27,209
Cash flows used for investing activities (8,644) (16,811) (17,129) (15,554) (28,359)
Cash flows used for financing activities (8,536) (12,924) (5,064) (7,732) (4,015)
EBITDA(2) $ 54,382 $ 36,848 $ 36,201 $ 49,859 $ 37,669
Depreciation and amortization 14,530 14,945 15,416 13,962 11,560
Capital expenditures 8,644 16,811 17,129 15,554 28,359
June 30,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(in thousands)
Working capital $ 62,578 $ 81,119 $ 93,584 $ 85,262 $ 72,893
Total assets 244,432 263,180 296,128 266,967 250,314
Long-term debt, less current portion 230,206 236,762 247,299 22,000 30,000
Mandatorily redeemable preferred stock 18,319 15,301 12,781 -- --
Stockholders' equity (deficit) (55,529) (44,695) (33,888) 185,136 163,670
13
- ----------
(1)Net sales and selling, marketing and administrative expense for the
fiscal years ended June 30, 1998 through June 30, 2001 have been adjusted to
reflect a new accounting pronouncement which requires a reclassification of
certain selling expenses to a reduction of net sales.
(2)EBITDA means earnings before interest expense and interest income,
income taxes, depreciation and amortization. EBITDA is presented here to provide
additional information about our operations. This item should be considered in
addition to, but not as a substitute for or superior to, operating income, net
income, cash flow and other measures of financial performance prepared in
accordance with generally accepted accounting principles. EBITDA may differ in
the method of calculation from similarly titled measures used by other
companies.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the more
detailed information in the historical financial statements, including the
related notes thereto, appearing elsewhere in this report.
OVERVIEW.
We are a leading ready-to-assemble furniture manufacturer in North
America with over 45 years of experience. We design, manufacture and distribute
a broad range of RTA furniture products--computer workcenters, desks,
entertainment centers, audio stands, bookcases and cabinets--with retail prices
ranging from $20 to $999. In recent years, we have committed substantial
resources to the development and implementation of a diversified sales,
marketing and product strategy in order to capitalize on growth opportunities
presented by growing retail channels of distribution and changes in consumer
demographics and preferences. We have structured our business to offer a wide
variety of RTA furniture products through increasingly popular retail
distribution channels, including office superstores, discount mass merchants,
electronic superstores, home improvement centers and home furnishings retailers.
We continue to strive towards building long-term relationships with quality
retailers in existing and emerging high growth distribution channels to develop
and sustain our future growth.
The domestic ready-to-assemble furniture market grew at a compound
annual growth rate of about 8.75% from 1997 through 2000, according to Homeworld
Business. Sales for the RTA furniture market, however, declined about 11% in
calendar 2001. Our net sales grew in excess of 10% in each of fiscal years 1999
and 2000 and declined 11.5% in fiscal 2001 and 2.7% in fiscal 2002. Our sales
declined for several reasons:
- the stalling of growth in sales of personal computers, which
reduced the need for computer desks and workcenters;
- the slowdown of economic growth and consumer spending in the
United States, particularly in the office superstore channel;
- store closings by a number of customers, including OfficeMax,
Office Depot, Montgomery Ward, Kmart and Shopko;
- the bankruptcy of Ames and Kmart;
- the liquidation of Montgomery Ward and Service Merchandise;
- inventory reductions by our customers, particularly in the office
superstore channel;
- the decline in price of the average unit sold, reflecting a trend
toward more promotional merchandise and increased competition; and
14
- the retrenchment in business capital outlays, particularly
relating to the purchase of office furniture.
These factors, along with the economic repercussions from the September
11, 2001 terrorist attacks, will continue to affect our business into fiscal
2003. Improvements in the economy, coupled with new product introductions and
inventory replenishments by our customers, helped our net sales increase by 8.0%
in the quarter ended March 31, 2002 over the same quarter of fiscal 2001;
however, sales declined 8.4% in the fourth quarter of fiscal 2002 from the prior
year fourth quarter as the economic recovery slowed, inventory reductions
resumed and new product rollouts were delayed.
Reacting to the lower sales levels, we closed our Cedar City, Utah
manufacturing facility in January 2001. We also reduced support staff at the
Lamar, Missouri facility. We recorded a $10.5 million pre-tax restructuring
charge to reflect the costs of these actions. We are saving about $5.0 million
annually from the closing of our Cedar City, Utah facility.
As a result of the lower sales levels, coupled with the restructuring
charge in fiscal 2001 and the outcome of the arbitration proceedings with
RadioShack in fiscal 2002, we incurred a net loss before dividends and accretion
on preferred stock of $7.8 million and $7.9 million for fiscal 2002 and fiscal
2001, respectively. However, even with the lower sales level, we were able to
increase our earnings before interest, taxes, depreciation and amortization to
$54.4 million in fiscal 2002 from $36.8 million in fiscal 2001 due to lower raw
material prices, increased productivity, the closing of the less efficient Cedar
City, Utah facility and the $10.5 million restructuring charge taken in fiscal
2001.
We purchase large quantities of raw materials, including particleboard
and fiberboard. We are dependent on our outside suppliers for all of our raw
materials. Therefore, we are subject to changes in the prices charged by our
suppliers. In fiscal 2000, our operating income was reduced by price increases
of these commodities. In fiscal 2001, particleboard and fiberboard prices
declined, increasing our operating income in the latter portion of the year.
Industry pricing for particleboard was flat to slightly lower in fiscal 2002,
and analysts anticipate pricing will remain about the same through calendar
2002. Prices for fiberboard, however, began to increase in the fourth quarter of
fiscal 2002, and we expect further fiberboard price increases in fiscal 2003. We
cannot assure you that raw material prices will not increase in the future. If
the demand for particleboard increases, prices may rise in 2003 or even earlier.
Several manufacturers, including O'Sullivan, have excess manufacturing
capacity due to the current decline in sales in the RTA furniture segment. This
excess capacity is causing increased competition that is expected to continue,
and perhaps to intensify, in fiscal 2003. This adversely affected our margins
and results of operations in fiscal 2002, and will continue to affect margins
and results in fiscal 2003.
While we have confidence in the long-term future of the RTA furniture
industry, sales in the first quarter of fiscal 2003 are anticipated to be down
approximately 10% compared with sales in the first quarter of fiscal 2002. We
cannot yet predict when our sales will return to a pattern of sales growth.
RadioShack Arbitration.
Prior to O'Sullivan Holdings' initial public offering in 1994, we were
owned by RadioShack Corporation (then named Tandy Corporation). In connection
with the 1994 initial public offering of O'Sullivan's common stock, RadioShack
Corporation, TE Electronics Inc. and O'Sullivan Holdings entered into a Tax
Sharing and Tax Benefit Reimbursement Agreement. Pursuant to the tax sharing
agreement, RadioShack is primarily responsible for all U.S. federal income
taxes, state income taxes and foreign income taxes with respect to O'Sullivan
for all periods ending on or prior to the date of consummation of the offering
and for audit adjustments to such federal income and foreign income taxes. We
are responsible for all other taxes owing with respect to us, including audit
adjustments to state and local income taxes and for franchise taxes.
15
RadioShack and O'Sullivan made an election under Sections 338(g) and
338(h)(10) of the Internal Revenue Code with the effect that the tax basis of
O'Sullivan Industries' assets was increased to the deemed purchase price of the
assets. An amount equal to such increase was included in income in the
consolidated federal income tax return filed by RadioShack. This additional tax
basis results in increased income tax deductions and, accordingly, reduced
income taxes payable by us. Pursuant to the tax sharing agreement, we pay
RadioShack nearly all of the federal tax benefit expected to be realized with
respect to such additional basis. Since our initial public offering by
RadioShack in 1994, the benefits of the tax deductions under the tax sharing
agreement have been accounted for as income taxes. Amounts payable to RadioShack
pursuant to the tax sharing agreement are recorded as current federal income tax
expense in our consolidated statements of operations. As those benefits reduced
our federal income tax obligations, payments were made to RadioShack as opposed
to the IRS.
We are incurring significantly higher interest expense associated with
our higher debt levels in connection with the financing of our November 1999
recapitalization and merger. We believed that this increased interest expense,
and certain expenses incurred to consummate the recapitalization and merger,
should be taken into account in determining the payments O'Sullivan Holdings is
required to make to RadioShack under the tax sharing agreement. RadioShack
claimed we could not deduct the additional interest and expenses in determining
the tax sharing payments.
On June 29, 1999, RadioShack filed a complaint against us in the
District Court of Texas in Tarrant County. RadioShack's complaint sought a court
order compelling us to submit to a dispute resolution process. We argued that no
dispute existed because at that time the recapitalization and merger had not
closed. On October 8, 1999, the court ordered us to commence dispute resolution
procedures before an arbitrator, according to the terms of the tax sharing
agreement. Mediation efforts failed to resolve the issue. Arbitrators were
selected to hear the dispute, the arbitration was heard in October 2001 and
briefing of the issue followed.
In March 2002, the arbitration panel ruled in favor of RadioShack on
this issue, concluding that the interest expense arising from the
recapitalization and merger is not deductible in calculating the payments due
from us to RadioShack under the tax sharing agreement.
Following the issuance of the opinion, we reached a settlement of the
dispute with RadioShack. Under the settlement, we paid RadioShack $21.5 million
in May 2002 to cover all amounts due through December 31, 2001; RadioShack
waived interest on the payments and its attorneys' fees. We agreed to make
future payments under the tax sharing agreement without deducting interest on
indebtedness incurred in the recapitalization and merger. For the six months
ended June 30, 2002, we paid RadioShack $6.2 million.
We funded the back payment and subsequent payments from cash on hand.
We expect to fund future payments from cash on hand or borrowings under our
senior credit facility. Payments under the tax sharing agreement for fiscal 2003
are expected to be about $11.0 million.
We have amended our senior credit facility as a result of the
arbitration settlement. The amendment excludes from the definition of
consolidated fixed charges $27.0 million of the total paid by us pursuant to the
tax sharing agreement through the period ended June 30, 2002.
See "Cautionary Statement Regarding Forward Looking Statements and Risk
Factors."
16
RESULTS OF OPERATIONS.
The following table sets forth the approximate percentage of items
included in the Consolidated Statement of Operations relative to net sales for
the three-year period ended June 30, 2002:
Year Ended June 30,
-------------------------------
2002 2001 2000
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Cost of sales 72.9% 75.2% 73.6%
----- ----- -----
Gross margin 27.1% 24.8% 26.4%
Selling, marketing and administrative 15.6% 15.8% 15.8%
Restructuring charge -- 2.9% --
Merger related expenses -- -- 1.9%
Transaction fee to related party -- -- 0.8%
Compensation expense associated with stock options -- -- 2.6%
Loss on settlement of interest rate swap -- -- 0.1%
----- ----- -----
Operating income 11.5% 6.1% 5.2%
Interest expense, net 8.1% 9.5% 4.6%
----- ----- -----
Income (loss) before taxes, extraordinary item and cumulative effect
of accounting change 3.4% (3.4)% 0.6%
Income tax provision (benefit) 5.6% (1.2)% 1.2%
----- ----- -----
Loss before extraordinary item and cumulative effect of accounting
change (2.2)% (2.2)% (0.6)%
Extraordinary loss from early extinguishment of debt, net of income
tax benefit -- -- (0.1)%
Cumulative effect of accounting change, net of income tax benefit -- 0.0% --
----- ----- -----
Net loss (2.2)% (2.2)% (0.7)%
===== ===== =====
Depreciation and amortization 4.2% 4.2% 3.8%
RESULTS OF OPERATIONS
YEAR ENDED JUNE 30, 2002 COMPARED TO THE YEAR ENDED JUNE 30, 2001.
Net Sales. Net sales for the fiscal year ended June 30, 2002 decreased
by $9.7 million, or 2.7%, to $349.1 million from $358.8 million for the fiscal
year ended June 30, 2001. Sales decreases in the office superstore, consumer
electronics and regional mass merchant channels were partially offset by
increases in the mass merchant and home center channels.
On January 22, 2002, Kmart Corporation, which accounted for around 9%
of our gross sales in fiscal 2002, filed for Chapter 11 bankruptcy court
protection. As part of its reorganization, Kmart has closed 283 stores. Kmart
said it has secured financing of $2 billion to help the company's cash flow
while it restructures and hopes to emerge from Chapter 11 in 2003. We increased
our allowance for doubtful accounts by $700,000 during the quarter ended
December 31, 2001 because of the Kmart bankruptcy. We resumed shipments to the
company on a post-petition basis and anticipate significant sales to Kmart in
the future. However, there can be no assurance that we will ship as much to
Kmart as we did in prior periods or that Kmart will be successful in its
restructuring efforts.
In August 2002, Ames decided to close all of its stores and liquidate.
We had anticipated sales to Ames would be less than 2% of our gross sales in
fiscal 2003.
Gross Profit. Gross profit increased to $94.4 million, or 27.1% of
sales, for fiscal 2002, from $89.1 million, or 24.8% of sales, for fiscal 2001.
Fiscal 2002 gross profit dollars increased primarily because of lower
17
material costs, primarily for particleboard, and enhanced operating efficiency,
particularly from the January 2001 closure of our less efficient Cedar City,
Utah manufacturing plant.
Selling, Marketing and Administrative Expenses. Selling, marketing and
administrative expenses decreased to $54.6 million, or 15.6% of sales, for
fiscal 2002 from $56.7 million, or 15.8% of sales, for fiscal 2001. In fiscal
2002, costs for incentive and profit sharing programs increased with our
improved financial results, and legal fees increased due to the RadioShack
arbitration. Offsetting these increases were lower freight costs due to
decreased sales to retailers with prepaid shipping programs, lower store display
expenses, less commission expense and the discontinuation of goodwill
amortization on July 1, 2001.
Restructuring Charge. In November 2000, we announced a strategic
restructuring plan. The slowdown in sales during the first half of fiscal 2001
caused us to reassess our business plan, specifically expenses and available
production capacity. The sales downturn, combined with improvements in
production efficiencies and expansions at the Missouri and Virginia plants
during the past few years, provided production capacity that exceeded our near
term sales requirements. Based on forecasted sales, the Missouri and Virginia
plants would provide sufficient production for the next two and possibly three
fiscal years with minimal capital expenditures for increased capacity after
ongoing projects were completed. Accordingly, we closed the Utah facility on
January 19, 2001.
We are actively attempting to sell the Utah land, building and excess
equipment as soon as practicable. We have relocated certain equipment to the
Missouri and Virginia plants. Fixed assets with a net book value of $20.3
million were written down to estimated fair value, less cost to sell, resulting
in an impairment charge of approximately $8.7 million. The impairment charge is
reflected in accumulated depreciation on the consolidated balance sheet. The
fair value is an estimate, and the impairment may be adjusted in the future. We
also recognized a $495,000 cash expense for the involuntary termination of 325
management and non-management employees at the Utah facility as well as exit
costs of approximately $527,000 for increased workers' compensation claims, real
and personal property taxes and security expenses applicable to the Utah
facility closure.
We reduced the administrative and support staff in the Lamar, Missouri
headquarters through voluntary and involuntary terminations. About 40 employees
received termination packages totaling approximately $807,000. The total
restructuring charge of $10.5 million is included as a separate line item on the
consolidated statement of operations.
The following summarizes the restructuring charge:
Charges Charges
through Balance through Balance
Original June 30, June 30, June 30, June 30,
Restructuring Charges Accrual 2001 2001 2002 2002
- --------------------------------- ------ ------ ------ ------ -------
(in thousands)
Employee termination benefits(1) $1,302 $ 915 $ 387 $ 387 $ --
Other Utah facility exit costs(1) 527 282 245 245 --
------ ------ ------ ------ -------
Total $1,829 $1,197 $ 632 $ 632 $ --
====== ====== ====== ====== =======
- ----------
(1)Included in accrued liabilities in the consolidated balance sheets.
Depreciation and Amortization. Depreciation and amortization expenses
decreased to $14.5 million for fiscal 2002 compared to $14.9 million for fiscal
2001. The decline was due to the discontinuance of goodwill amortization upon
the adoption of Statement of Financial Accounting Standards (or "SFAS") 142,
Goodwill and Other Intangible Assets, partially offset by the impact of capital
additions in recent years. Cash capital additions in fiscal 2002 and 2001 were
$8.6 million and $16.8 million, respectively. Fiscal 2002 capital expenditures
were primarily for normal replacement of equipment and efficiency improvements.
18
Operating Income. Operating income increased $18.0 million to $39.9
million for fiscal 2002 from $21.9 million in fiscal 2001. The restructuring
charge in fiscal 2001 reduced operating income by $10.5 million. Lower material
prices, lower selling costs and increased operating efficiency contributed to
the increase in fiscal 2002.
Net Interest Expense. Net interest expense decreased from $34.0 million
in fiscal 2001 to $28.1 million in fiscal 2002. Interest expense decreased due
to the change in fair value of our interest rate collar as well as our repayment
of debt and lower variable interest rates on a portion of our debt. The
following table describes the components of net interest expense.
Year ended
June 30,
-----------------------
(in thousands)
2002 2001
-------- --------
Interest expense on senior credit facility,
industrial revenue bonds and senior
subordinated notes $ 23,942 $ 27,860
Senior credit facility amendment fee 204 574
Interest income (395) (500)
Non-cash items:
Interest expense on O'Sullivan Holdings
note 2,231 2,003
Interest rate collar (5) 1,948
Amortization of debt discount 544 472
Amortization of loan fees 1,610 1,610
-------- --------
Net interest expense $ 28,131 $ 33,967
======== ========
Income Tax Provision (Benefit). We recorded tax expense of $19.6
million for fiscal 2002 that included an increase in the valuation allowance of
$16.0 million. Since our initial public offering by RadioShack in 1994, the
benefits of the tax deductions under the tax sharing agreement have been
accounted for as income taxes. As those benefits reduced our federal income tax
obligations, payments were made to RadioShack as opposed to the IRS. Since the
recapitalization in 1999 and prior to the settlement of the arbitration
proceedings with RadioShack, we made an $800,000 payment to RadioShack as we had
little taxable income to utilize the tax deductions. These deductions resulted
in net operating losses (NOL's) for federal tax purposes for which we recorded
no deferred tax assets as such deductions were assets of RadioShack under the
tax sharing agreement.
As more fully described above, we can no longer consider the increased
interest costs in calculating the amounts due to RadioShack. Therefore, we will
have to make payments to RadioShack before all of our deductions on our federal
income tax return reduce federal taxes. In effect, as a result of the
arbitration decision and settlement, we will contractually prepay tax benefits
to RadioShack that may be recovered from reduced federal income tax liabilities
in the future.
As a result of the arbitration decision and settlement, we paid $21.5
million to RadioShack in May 2002 relating to periods through December 31, 2001.
We also paid RadioShack an additional $6.2 million for the six months ended June
30, 2002. We recorded these payments as a deferred tax asset. We have a net
deferred tax asset of approximately $16.0 million at June 30, 2002. Under SFAS
109, Accounting for Income Taxes, we must determine if it is more likely than
not that the tax assets will be realized as reductions in tax liabilities in the
future. At December 31, 2001 (we file federal income tax returns on a calendar
year basis), we had a NOL carryforward for federal income tax purposes of
approximately $58.3 million. In 2009, when substantially all of the tax
deductions (which can no longer be calculated considering certain interest costs
pursuant to the arbitration decision) are expected to have been taken,
O'Sullivan and RadioShack are to negotiate a settlement of the then present
value of the realizable tax benefits O'Sullivan has yet to deduct.
19
Pursuant to SFAS 109, we projected our expected future taxable income
utilizing operating performance achieved in fiscal 2002 assuming that our
performance would be no better or worse over an extended period of time. Such
projections indicate that we will not have taxable income until 2009 when
substantially all the RadioShack tax benefit deductions have been taken. At that
point, the projections indicate that the NOL's existing at that time would be
utilized before they expire. However, we currently have and are expected to have
taxable losses for a number of years in the future, and SFAS 109 requires
objective evidence to support the more likely than not conclusion. Projections
over a long time frame are inherently uncertain and we cannot provide objective
evidence that our operations in 2009 and beyond will produce sufficient taxable
income. As a result, we have provided a valuation allowance on our net deferred
tax assets of $16.0 million at June 30, 2002 and will continue to provide an
allowance as those net deferred tax assets grow into the future until sufficient
objective evidence exists about future results of operations which supports the
reversal of all or part of the valuation allowance.
Cumulative Effect of Accounting Change. Upon the adoption of SFAS 133,
Accounting for Derivative Instruments and Hedging Activities, in July 2000, we
recognized a liability of $386,000 based upon the fair value of a costless
interest rate collar initiated on February 28, 2000. That portion of the
liability incurred prior to fiscal 2001, $148,000, is included, net of income
tax benefit of $53,000, as cumulative effect of accounting change on the
consolidated statement of operations.
Net Income (Loss). Net loss decreased $106,000 from a loss of $7.9
million in fiscal 2001 to a loss of $7.8 million in fiscal 2002 due to the
increased tax expense, partially offset by lower material costs and improved
operating efficiency.
EBITDA. EBITDA, which we define as earnings before interest income and
interest expense, income taxes, depreciation and amortization, increased by
$17.6 million to $54.4 million for fiscal 2002 from $36.8 million for the prior
year. EBITDA for fiscal 2002 improved over the prior year period because of the
$10.5 million restructuring charge in fiscal 2001. Performance in fiscal 2002
also improved because of lower material prices, improved operating efficiencies
and cost savings associated with the January 2001 closure of the Cedar City,
Utah manufacturing facility.
EBITDA is presented to provide additional information about our
operations. This item should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, operating cash flow
and other measures of financial performance prepared in accordance with
generally accepted accounting principles. EBITDA may differ in the method of
calculation from similarly titled measures used by other companies.
The following table reconciles net loss to EBITDA for the year ended June 30,
2002 and June 30, 2001.
Year ended
June 30,
-----------------------
(in thousands)
2002 2001
-------- --------
Net loss $ (7,832) $ (7,938)
Cumulative effect of accounting change,
net of income tax benefit of $53 -- 95
Income tax provision (benefit) 19,553 (4,221)
Interest expense, net 28,131 33,967
-------- --------
Operating income $ 39,852 $ 21,903
Depreciation and amortization 14,530 14,945
-------- --------
EBITDA $ 54,382 $ 36,848
======== ========
20
YEAR ENDED JUNE 30, 2001 COMPARED TO THE YEAR ENDED JUNE 30, 2000
Net Sales. Net sales decreased by $46.4 million, or 11.5%, to $358.8
million in fiscal 2001, down from $405.2 million in fiscal 2000. The decrease in
net sales was primarily driven by a 4.9% decrease in the number of units sold
and a 6.2% decrease in the average selling price. The sales decline generally
came from the office superstore and department store/catalog showroom channels
of distribution and to a lesser extent from the mass merchant channel of
distribution. These declines were partially offset by increases in the home
improvement, electronic superstore, regional mass merchant and other channels of
distribution. Retailers reacted to the economic slowdown by increasing their
assortment of lower-priced promotional units, which was the primary reason for
the decline in the average selling price.
The sales decline in the department store/catalog showroom channel of
distribution was primarily due to customer bankruptcies. In December 2000,
Montgomery Ward, one of our largest customers, filed for bankruptcy and was
subsequently liquidated. Gross sales to Montgomery Ward declined from
approximately 2.5% of gross sales in fiscal 2000 to approximately 1.4% of gross
sales in fiscal 2001.
On February 22, 2000, Service Merchandise announced that as part of its
bankruptcy reorganization plan, it would no longer sell a number of product
lines, including home office and entertainment furniture. Gross sales to Service
Merchandise declined from approximately 4% of gross sales in fiscal 2000 to
approximately 0.4% of gross sales in fiscal 2001. Sales to Service Merchandise
ceased with the liquidation of Service Merchandise in fiscal 2002.
Sales declines in other distribution channels were generally related to
the slowdown of the economy and consumer spending in the United States, the
resulting inventory reductions in some of our retail customers' supply chains
and a decline in the average unit selling price.
Gross Profit. Our gross profit for fiscal 2001 was $89.1 million, a
decrease of $17.7 million, or 16.6%, from $106.8 million in fiscal 2000. Our
gross profit margin for fiscal 2001 was 24.8%, a decrease from 26.4% in fiscal
2000. The decrease in gross profit dollars was primarily the result of lower
sales volumes and declining average unit prices. This decrease was partially
offset by lower material costs in the second half of fiscal 2001, productivity
gains in our Missouri and Virginia facilities and the closing of the less
efficient Utah facility. In the last half of fiscal 2001 we experienced a
reduction in the price of certain raw materials due to softening market demands.
Selling, Marketing and Administrative. Selling, marketing and
administrative expenses decreased to $56.7 million, or 15.8% of net sales, from
$64.2 million, or 15.8% of net sales, in fiscal 2000. The majority of the dollar
decrease in selling, marketing and administrative expenses was due to lower
freight and commission expenses associated with decreased sales activity. We
expensed $11.6 million and $17.1 million for freight out in fiscal 2001 and
2000, respectively. Employee benefit program expenses such as bonuses and profit
sharing also decreased due to lower operating income levels. We did incur
$946,000 and $498,000 of non-cash compensation expense associated with employee
stock options in fiscal 2001 and 2000, respectively.
In August 2001, Ames Department Stores, Inc. filed for protection under
Chapter 11 of the Bankruptcy Code. As a result, we increased our allowance for
doubtful accounts by approximately $1.5 million in the fourth quarter of fiscal
2001. We shipped to Ames while it attempted to restructure its indebtedness
under Chapter 11 before deciding to liquidate in August 2002. Sales to Ames
represented over 3% of our gross sales in fiscal 2001.
Restructuring Charge. On November 17, 2000, we announced a
restructuring plan and recorded $10.5 million of related expense in the second
quarter of fiscal 2001. The slowdown in sales during the first half of fiscal
year 2001 caused us to reassess our business plan, specifically expenses and
available production capacity. It became evident that the sales downturn,
combined with improvements in production efficiencies and expansions in the
Missouri and Virginia plants during the past few years, provided production
capacity that
21
exceeded near term sales requirements. Accordingly, we closed the Utah facility
in January 2001. See the discussion of the restructuring charge in "Year Ended
June 30, 2002 Compared to the Year Ended June 30, 2001" above for additional
information.
Costs that benefitted continuing activities were excluded from the
restructuring charge and were included in cost of sales on the consolidated
statement of operations. The unusual and non-recurring portion of these costs
associated with the shutdown of the Utah facility was approximately $669,000 in
fiscal 2001.
Merger Related and Other Special Charges. We expensed merger-related
costs as incurred in connection with the November 30, 1999 recapitalization and
merger. Merger related costs, consisting of investment banking, legal,
accounting, printing and other services, totaled $7.8 million in fiscal 2000.
Other merger related costs were payments for fees and expenses to BRS of which
$3.1 million was recorded as a transaction fee to a related party in fiscal
2000. The merger related expenses and fees paid to BRS have been included as
separate line items in the consolidated statements of operations.
Compensation Expense Associated with Stock Options. O'Sullivan
Industries incurred compensation expense of $10.6 million in connection with
stock options related to the November 30, 1999 recapitalization and merger in
fiscal 2000. The compensation expense relating to the options has been included
as a separate line item in the consolidated statement of operations.
Loss on Settlement of Interest Rate Swap. On November 30, 1999,
O'Sullivan Industries terminated an interest rate swap agreement, as required by
the counter-party due to the recapitalization and merger, incurring a charge of
$408,000 in fiscal 2000. The loss on the settlement of the interest rate swap
has been included as a separate line item in the consolidated statement of
operations.
Depreciation and Amortization. Our depreciation and amortization
expense decreased $471,000 to $14.9 million in fiscal 2001 from $15.4 million in
fiscal 2000. The decrease in depreciation and amortization was due to the
closing of the Utah facility. Cash capital additions in fiscal 2001 and 2000
were $16.8 million and $17.1 million, respectively. Fiscal 2001 capital
expenditures were for a capacity and warehouse expansion program in our Virginia
facility and equipment upgrade and capacity expansion in our Missouri facility.
Operating Income. Operating income increased $1.1 million to $21.9
million in fiscal 2001 from $20.8 million in fiscal 2000. Excluding
restructuring, merger and other related charges, operating income decreased
$10.3 million, or 24.1%, to $32.4 million in fiscal 2001 from $42.7 million in
fiscal 2000. The decrease in operating income was primarily the result of lower
sales volumes and declining average unit prices. This decrease was partially
offset by lower material costs in the second half of the year, productivity
gains in our Missouri and Virginia facilities, the closing of our less efficient
Utah facility, lower freight and commission expenses, and lower employee benefit
program expenses such as bonuses and profit sharing.
Net Interest Expense. Net interest expense increased to $34.0 million
in fiscal 2001 from $18.6 million in fiscal 2000. Net interest expense increased
principally due to the increased indebtedness incurred in the recapitalization
and merger, the senior credit amendment fee paid in January 2001 and non-cash
charges for the interest rate collar. Other non-cash interest items affecting
both fiscal years were interest on our senior note and amortization of loan
discounts and fees. The merger closed on November 30, 1999, so only seven months
of increased expense associated with the new debt was reflected in the fiscal
2000 results.
22
The following table describes the components of net interest expense
for the periods indicated:
Year ended
June 30,
------------------------
(in thousands)
2001 2000
-------- --------
Interest expense on senior credit facility,
industrial revenue bonds and senior
subordinated notes $ 27,860 $ 17,146
Senior credit facility amendment fee 574 --
Interest income (500) (792)
Non-cash items:
Interest expense on O'Sullivan Holdings note 2,003 1,050
Interest rate collar 1,948 --
Amortization of debt discount 472 253
Amortization of loan fees 1,610 938
-------- --------
Net interest expense $ 33,967 $ 18,595
======== ========
Income Tax Provision (Benefit). Income tax declined by $9.6 million to
a benefit of $4.2 million in fiscal 2001 from a tax provision of $5.1 million in
fiscal 2000. The effective tax rate in fiscal 2001 was 35%.
Extraordinary Item. In fiscal 2000 O'Sullivan Industries repaid private
placement notes with a principal amount of $16.0 million for $16.5 million. The
$476,000 repayment fee has been recognized as an extraordinary loss of $305,000,
net of related tax benefit.
Accounting Change. O'Sullivan adopted SFAS 133 on July 1, 2000.
O'Sullivan recorded a net-of-tax cumulative effect type adjustment of $148,000,
less a tax benefit of $53,000.
Net Income (Loss). As a result of the preceding factors, the fiscal
2001 net loss before dividends and accretion on preferred stock increased by
$4.7 million from a net loss of $3.2 million in fiscal 2000 to a net loss of
$7.9 million in fiscal 2001.
EBITDA. EBITDA, which we define as earnings before interest, taxes,
depreciation and amortization, increased $647,000 to $36.8 million in fiscal
2001 from $36.2 million in fiscal 2000. The decline in sales in fiscal 2001 and
the restructuring charge depressed EBITDA in fiscal 2001, partially offset by
lower material costs in the second half of the year, productivity gains in our
Missouri and Virginia facilities and the closing of our less efficient Utah
facility. Our EBITDA in fiscal 2000 was reduced by the expenses and other
charges related to the recapitalization and merger and by increasing
particleboard and fiberboard prices.
EBITDA is presented to provide additional information about our
operations. This item should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, operating cash flow
and other measures of financial performance prepared in accordance with
generally accepted accounting principles. EBITDA may differ in the method of
calculation from similarly titled measures used by other companies.
LIQUIDITY AND CAPITAL RESOURCES.
Our primary sources of liquidity are cash on hand and borrowings under
our senior credit facility, which is discussed below. Our liquidity requirements
will be to pay our debt, including interest expense under the senior credit
facility and the notes, payments to RadioShack and to provide for working
capital and capital expenditures.
23
Working Capital. As of June 30, 2002, we had cash and cash equivalents
of $15.8 million compared to $7.1 million at June 30, 2001. Net working capital
was $62.6 million at June 30, 2002 compared to $81.1 million at June 30, 2001.
The $18.5 million decrease in net working capital resulted primarily from the
reduced investments in trade receivables and prepaid and other current assets,
plus increases in accounts payable, accrued compensation and accrued
advertising. These were partly offset by an increased investment in inventories
and declines in other accrued liabilities and the restructuring accrual.
Inventory investment increased because of an unanticipated sales decline in the
fourth quarter of fiscal 2002. The decline in trade receivables was primarily
due to lower sales in the fourth quarter and fewer days sales outstanding.
Operating Activities. Net cash provided by operating activities for the
fiscal year ended June 30, 2002 was $25.9 million compared to net cash provided
of $24.9 million for the fiscal year ended June 30, 2001. Cash flow from
operations increased year-over-year for the following reasons.
- Net loss of $7.8 million for fiscal 2002 improved slightly from the
$7.9 million loss for fiscal 2001. Net loss for fiscal 2002 includes
an income tax provision of $19.6 million primarily due to the payment
to RadioShack of $27.7 million and a reduction in deferred income
taxes of $8.5 million. We recorded a valuation allowance for deferred
income taxes of $16.0 million. The fiscal 2001 results included the
December 2000 restructuring charge of $10.5 million of which $8.7
million was non-cash.
- The change in value of our interest rate collar resulted in non-cash
income of $5,000 in fiscal 2002, compared with $2.1 million of
non-cash expense in the same period of fiscal 2001.
- Accounts receivable decreased $14.1 million in fiscal 2002 and $4.7
million in fiscal 2001, providing more cash in fiscal 2002 than in the
same period of fiscal 2001. The declines in both years were due to
changes in terms with customers and lower sales.
- Inventories increased in fiscal 2002, using $3.9 million of cash, as
opposed to a $16.7 million decline that provided cash in fiscal 2001.
The fiscal 2002 inventory build-up was due to lower than anticipated
sales in the fourth quarter of fiscal 2002.
- Cash was provided by increases in accounts payable, accrued
advertising and accrued compensation totaling $9.1 million in the
fiscal year ended June 30, 2002. In the prior year, cash totaling
$15.6 million was used to fund decreases in other accrued liabilities
and the restructuring charge. The largest increases in fiscal 2002
were profit sharing and incentive compensation accruals which were
paid in the first quarter of fiscal 2003. The use of cash in the prior
year was primarily from lower profit sharing and incentive
compensation and reduced accounts payable due to the shutdown of our
manufacturing facilities in the last week of fiscal 2001.
Investing Activities. We invested $8.6 million for capital expenditures
in fiscal 2002 compared to $16.8 million during the previous fiscal year. Our
ability to make future capital expenditures is subject to certain restrictions
under our senior credit facility. Our plans are to invest about $10.0 million
for capital expenditures in fiscal 2003, primarily for equipment replacements
and upgrades.
Financing Activities. On November 30, 1999 we completed our merger and
recapitalization. Our consolidated indebtedness at June 30, 2002 was $242.3
million, consisting of the following.
- $100.0 million in 13-3/8% senior subordinated notes due 2009
issued with warrants to purchase 6.0% of our common and Series B
junior preferred stock on a fully diluted basis. These warrants
were assigned a value of $3.5 million. These notes were issued at
a price of 98.046% providing $98.0 million in cash proceeds before
expenses related to the issuance.
24
- $112.5 million in a senior credit facility consisting of a
sixty-three month $25.2 million term loan, a seven and one-half
year $87.3 million term loan and a $40.0 million revolving line of
credit, currently with no borrowings. The revolving line of credit
has a $15.0 million sub-limit for letters of credit, of which we
are currently utilizing approximately $14.0 million.
- $10.0 million in variable rate industrial revenue bonds.
- $19.8 million, including $4.8 million of interest added to the
principal of the note, in a senior note issued with warrants to
purchase 6.0% of our common and Series B junior preferred stock on
a fully diluted basis. These warrants were assigned a value of
$3.5 million.
The reconciliation of consolidated indebtedness to recorded book value is as
follows:
Original
issue discount Warrants Recorded
Consolidated Current net of net of book value of
indebtedness portion accretion accretion long-term debt
------------ -------- -------------- --------- --------------
(in thousands)
Term loan A $ 25,247 $ (3,544) $ -- $ -- $ 21,703
Term loan B 87,285 (886) -- -- 86,399
-------- -------- -------- -------- --------
Senior secured credit facility 112,532 (4,430) -- -- 108,102
Senior subordinated note 100,000 -- (1,666) (2,984) 95,350
Industrial revenue bonds 10,000 -- -- -- 10,000
Senior note 19,789 -- -- (3,035) 16,754
-------- -------- -------- -------- --------
Total $242,321 $ (4,430) $ (1,666) $ (6,019) $230,206
======== ======== ======== ======== ========
During fiscal 2002, we repaid $8.6 million of our indebtedness,
including $5.0 million of prepayments. We expect to fund principal and interest
payments on our debt from cash on hand or borrowings under our revolver.
The senior credit facility and notes are subject to certain financial
and operational covenants and other restrictions, including among others,
requirements to maintain certain financial ratios and restrictions on our
ability to incur additional indebtedness. The financial covenants contained in
the senior credit facility, as amended, are as follows:
- Our consolidated leverage ratio must be less than 4.35. The ratio at
June 30, 2002 was 3.99.
- Our consolidated interest coverage ratio must be greater than 1.90. The
ratio at June 30, 2002 was 2.17.
- Our consolidated fixed charge coverage ratio must be greater than 1.10.
The ratio at June 30, 2002 was 1.57.
- Our senior debt coverage ratio must be less than 2.50. The ratio at
June 30, 2002 was 2.20.
- Our consolidated EBITDA must be at least $52 million for the fiscal
year ended June 30, 2002. Our consolidated EBITDA, as defined in the
credit agreement, was $55.7 million.
Consolidated interest expense as defined in the senior credit facility for the
twelve months ended June 30, 2002 was $25.7 million. O'Sullivan Industries is
the borrower under the senior credit facility, so the covenants do not include
the $19.8 million senior note of O'Sullivan Holdings or interest on the note.
Pursuant to an amendment to our senior credit facility as of May 15, 2002, $27.0
million of the payments to RadioShack under the tax sharing
25
agreement through the period ending June 30, 2002 were excluded from the
definition of consolidated fixed charges and thus from calculations of the
consolidated fixed charge coverage ratio.
In addition, the agreements effectively prohibit the payment of
dividends on any class of our stock. At June 30, 2002, we were in compliance
with all applicable debt covenants.
As required under the senior credit facility, we hedged one-half of our
term loans with an initial notional amount of $67.5 million with a costless
interest rate collar. The collar is based on three-month LIBOR with a floor of
6.43% and a ceiling of 8.75%. To terminate this contract at June 30, 2002, we
would have been required to pay the counter-party approximately $2.1 million.
The counter-party to our interest rate collar provides us with the payment
amount that would be required to terminate the collar as of the end of each
quarter. We recorded the change in fair value of the collar as increased or
decreased interest expense in the consolidated statements of operations and
included the resulting liability in accrued liabilities on the consolidated
balance sheets.
The restriction on the incurrence of additional indebtedness in the
senior credit facility limited our ability to incur additional debt to
approximately $16.8 million on June 30, 2002.
MARKET RISK AND INFLATION.
Our market risk is affected by changes in interest rates, foreign
currency exchange rates and certain commodity prices. Under our policies, we may
use natural hedging techniques and derivative financial instruments to reduce
the impact of adverse changes in market prices. We do not hold or issue
derivative instruments for trading purposes. We believe that our foreign
exchange risk is not material.
We have market risk in interest rate exposure, primarily in the United
States. We manage interest rate exposure through our mix of fixed and floating
rate debt. As required under our senior credit facility, we hedged one-half of
our term loans with a current notional amount of $65.5 million with a costless
interest rate collar. The collar is based on three-month LIBOR with a floor of
6.43% and a ceiling of 8.75%. To terminate this contract at June 30, 2002, we
would have been required to pay the counter-party approximately $2.1 million.
Interest rate instruments may be used to adjust interest rate exposures when
appropriate based on market conditions.
Due to the nature of our product lines, we have material sensitivity to
some commodities, including particleboard, fiberboard, corrugated cardboard and
hardware. We manage commodity price exposures primarily through the duration and
terms of our vendor agreements. A 1.0% change in these commodity prices would
affect our cost of sales by approximately $1.7 million annually.
In fiscal 2000, certain particleboard and fiberboard suppliers imposed
price increases, which increased our cost of sales in fiscal 2000 and the first
half of fiscal 2001. We were able to reduce the effect of the increases somewhat
through our value analysis program and productivity gains in manufacturing. In
the fourth quarter of fiscal 2000, certain suppliers of cartons increased their
prices to us. We were able to partially offset the effect of these price
increases through the programs mentioned above combined with increased operating
leverage from higher sales levels.
In fiscal 2001 and continuing into fiscal 2002, prices for
particleboard and fiberboard fell in response to declining demand. However,
these prices or others may increase in fiscal 2003 or beyond. We believe that we
can continue to partially offset the effect of such increases through the
programs mentioned above and through the eventual inclusion of the higher costs
in the selling price of our products. However, there can be no assurance that we
will be successful in offsetting these or future potential price increases.
26
NEW ACCOUNTING STANDARDS.
In April 2001, the Emerging Issues Task Force ("EITF") reached a
consensus on EITF No. 00-25, Vendor Income Statement Characterization of
Consideration Paid to a Reseller of the Vendor's Products. This issue addresses
the income statement classification of slotting fees, cooperative advertising
arrangements and buydowns. The consensus requires that certain customer
promotional payments that are currently classified as selling expenses be
classified as a reduction of revenue. We adopted EITF 00-25 effective January 1,
2002 and reclassified certain selling, marketing and administrative expenses as
a reduction of net sales. Our adoption of EITF 00-25 had no impact on operating
income or net income (loss). As a result of the adoption of EITF 00-25, for the
six months ended December 31, 2001, $7.7 million was reclassified as a reduction
in revenue rather than as selling, marketing and administrative expense.
Reclassifications for fiscal years 2001 and 2000 were $16.9 million and $18.2
million, respectively.
The Financial Accounting Standards Board ("FASB") issued SFAS 142,
Goodwill and Other Intangible Assets, on June 30, 2001. We adopted SFAS 142 on
July 1, 2001, the beginning of our 2002 fiscal year. With the adoption of SFAS
142, goodwill of approximately $38.1 million is no longer subject to
amortization over its estimated useful life. Rather, goodwill will be assessed
regularly for impairment by applying a fair-value-based test. We have completed
the initial valuation of the reporting unit, using the enterprise as the
reporting unit. Because the book value of the reporting unit is below the fair
value of the reporting unit, there is no impairment loss. We have discontinued
amortizing approximately $1.7 million of goodwill per year. Adjusted net loss
and adjusted net loss attributable to common stockholders for the two previous
fiscal years ending June 30, had such amortization not been recorded are shown
in the following table.
Fiscal year ended June 30,
2001 2000
---------- ----------
(in thousands)
Adjusted net income (loss) $ (6,543) $ (1,778)
Adjusted net income (loss) attributable
to common stockholders $(17,276) $ (7,313)
In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. This pronouncement, which is effective for fiscal years beginning
after June 15, 2002, addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. We do not believe this pronouncement will
have a material impact on our financial position or results of operation. We
will adopt SFAS 143 effective July 1, 2002.
In August 2001, the FASB issued SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. This pronouncement, which is effective for
fiscal years beginning after December 15, 2001, addresses financial accounting
and reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of. Although the Utah long-lived assets to be disposed of by sale
will be presented as long-lived assets to be disposed of after the adoption of
this pronouncement, we do not believe SFAS 144 will have an adverse material
impact on our financial position or results of operations. We will adopt SFAS
144 effective July 1, 2002.
In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections.
SFAS 145 addresses the accounting for gains and losses from extinguishment of
debt and for certain lease modifications. We do not believe SFAS 145 will have a
material impact on our financial position or results of operations. We will
adopt SFAS 145 effective July 1, 2002.
27
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities. This pronouncement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring). SFAS 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
rather than the date of an entity's commitment to an exit plan and establishes
that fair value is the objective for initial measurement of the liability. The
provisions of this pronouncement are effective for exit or disposal activities
that are initiated after December 31, 2002.
CONTRACTUAL OBLIGATIONS.
The following table illustrates our contractual obligations due in the
future:
Payments Due by Period
--------------------------------------------------
(in thousands)
Less
than 1 After
Contractual Obligations Total year 2-3 years 4-5 years 5 years
- -------------------------- -------- -------- -------- -------- --------
Long-term debt $242,321 $ 4,430 $ 39,426 $ 68,676 $129,789
Tax benefit payments to
RadioShack(1)
Capital lease obligations -- -- -- -- --
Operating
leases--unconditional 4,176 1,398 2,462 316 --
Other long-term obligations 793 385 394 14 --
-------- -------- -------- -------- --------
Total contractual cash
obligations $247,290 $ 6,213 $ 42,282 $ 69,006 $129,789
======== ======== ======== ======== ========
- --------------------------
(1) Payments to RadioShack
are contingent on taxable
income. The maximum
payments are: $ 84,173 $ 11,020 $ 20,467 $ 23,599 $ 29,087
======== ======== ======== ======== ========
SEASONALITY.
Historically, we have generally experienced a somewhat higher level of
sales in the second and third quarters of our fiscal year in anticipation of and
following the holiday selling season.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities.
On an on-going basis, we evaluate our estimates, including those
related to customer programs and incentives, bad debts, inventories, intangible
assets, income taxes, restructuring, contingencies and litigation. We base our
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. The results of these estimates
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
28
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
- We derive our revenue from product sales. We recognize revenue from
the sale of products when persuasive evidence of an arrangement
exists, the product has been delivered, the price is fixed and
determinable and collection of the resulting receivable is
reasonably assured. For all sales, we use purchase orders from the
customer, whether oral, written or electronically transmitted, as
evidence that a sales arrangement exists. Generally, delivery occurs
when product is delivered to a common carrier or private carrier,
with standard terms being FOB shipping point. We assess whether the
price is fixed and determinable based upon the payment terms
associated with the transaction. We assess collection based on a
number of factors, including past transaction history with the
customer and the creditworthiness of the customer. Collateral is not
requested from the customers.
- We record estimated reductions to revenue for customer programs and
incentive offerings including special pricing agreements, price
protection, promotions and other volume-based incentives. Market
conditions could require us to take actions to increase customer
incentive offerings. These offerings could result in our estimates
being too small and reduce our revenues when the incentive is
offered.
- We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required
payments. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.
- We write down our inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of
inventory and its estimated market value based upon assumptions
about future demand and market conditions. If actual market
conditions are less favorable than those projected by us, additional
inventory write-downs may be required. Obsolete and slow-moving
inventory reserves were approximately $4.9 million and $4.4 million
at June 30, 2002 and 2001, respectively.
- We record our deferred tax assets at the amount that the asset is
more likely than not to be realized. While we have considered future
taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for a valuation allowance, our
determinations can change. If we objectively determine it was more
likely than not we would be able to realize our deferred tax assets
in the future in excess of our recorded amount, we would reduce our
valuation allowance, increasing income in the period such
determination was made. Likewise, should we determine that we would
not be able to realize all or part of our recorded gross deferred
tax assets in the future, we would increase our valuation allowance
by decreasing income in the period such determination was made.
- We periodically review our long-lived assets, including property,
equipment and goodwill, for impairment and determine whether an
event or change in facts and circumstances indicates their carrying
amount may not be recoverable. We determine recoverability of the
assets by comparing the carrying amount of the assets to the net
future undiscounted cash flows expected to be generated by those
assets. If the sum of the undiscounted cash flows is less than the
carrying value of the assets, an impairment charge is recognized.
Adverse economic conditions could cause us to record impairment
charges in the future.
- In the second quarter of fiscal 2001, we recorded asset impairment
charges, employee termination benefits and other exit costs
totaling $10.5 million related to a business restructuring plan to
reduce production capacity and operating expenses. The restructuring
plan included closing our Cedar City, Utah facility and a reduction
in our staff at our Lamar, Missouri facility. The asset impairment
charges related to land, building and equipment located in Cedar
City, Utah. The land and building
29
and a limited amount of equipment are still for sale. If
market conditions deteriorate further, additional write-downs
on the land, building and equipment may be necessary.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION AND RISK FACTORS.
Certain portions of this report, and particularly the Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
Notes to the Consolidated Financial Statements in Part II of this report, the
portions of Item 1 in Part I captioned "Business Overview," "Competitive
Strengths," "Growth Strategy," "Raw Materials," "Competition" and "Environmental
and Safety Regulations" and Item 3 in Part I contain forward-looking statements.
These include information relating to cost savings, benefits, revenues and
estimated sales, and earnings and expenses. These statements can be identified
by the use of future tense or dates or terms such as "believe," "would," "may,"
"expect," "anticipate" or "plan."
These forward-looking statements involve risks and uncertainties.
Actual results may differ materially from those predicted by the forward-looking
statements. Because these forward-looking statements involve risks and
uncertainties, actual results may differ significantly from those predicted in
these forward-looking statements. You should not place a lot of weight on these
statements. These statements speak only as of the date of this document or, in
the case of any document incorporated by reference, the date of that document.
Factors and possible events which could cause results to differ include:
- OUR SUBSTANTIAL LEVERAGE COULD MAKE IT MORE DIFFICULT TO PAY OUR
DEBTS, DIVERT OUR CASH ON HAND FOR DEBT PAYMENTS, LIMIT OUR ABILITY TO BORROW
FUNDS AND INCREASE OUR VULNERABILITY TO GENERAL ADVERSE ECONOMIC AND INDUSTRY
CONDITIONS. Any of these consequences of our substantial indebtedness could
prevent us from fulfilling our obligations under our indebtedness because our
ability to make required payments on our debt depends on our ability to generate
sufficient cash flow to make these payments. We have a significant amount of
indebtedness as shown in the chart below:
JUNE 30, 2002
(DOLLARS IN MILLIONS)
Total indebtedness ................................. $ 242.3
Indebtedness senior to O'Sullivan Holdings note .... $ 222.5
Indebtedness senior to O'Sullivan Industries
senior subordinated notes ..................... $ 122.5
Stockholders' deficit .............................. $ (55.5)
Our substantial indebtedness could have important consequences to
holders of our debt and equity. For example, it could:
- make it more difficult for us to satisfy our obligations with
respect to our debt, particularly our subordinated debt;
- increase our vulnerability to general adverse economic and
industry conditions;
- limit our ability to fund future working capital, capital
expenditures and other general corporate requirements;
- require a substantial portion of our cash on hand for debt
payments;
- limit our flexibility to plan for, or react to, changes in our
business and the industry in which we operate;
- place us at a competitive disadvantage compared to our competitors
that are less leveraged;
- limit our ability to borrow additional funds; and
- expose us to fluctuations in interest rates because some of our
debt has a variable rate of interest.
- FAILURE TO COMPLY WITH ANY OF THE RESTRICTIONS CONTAINED IN THE
AGREEMENTS GOVERNING OUR INDEBTEDNESS COULD RESULT IN ACCELERATION OF OUR DEBT.
WERE THIS TO OCCUR, WE WOULD NOT HAVE SUFFICIENT CASH TO PAY OUR ACCELERATED
INDEBTEDNESS. We must maintain minimum debt service and maximum leverage ratios
30
under our senior credit facility. A failure to comply with the restrictions
contained in our senior credit facility could lead to an event of default, which
could result in an acceleration of that indebtedness. Were this to occur, we
would not have sufficient cash to pay our accelerated indebtedness or other
debt.
Due to our lower sales in fiscal 2001, we negotiated amendments to the
financial covenants in our senior credit facility. Without the amendments, we
may have been in default under the facility. If our sales continue to decline,
we may face default under the amended senior credit facility. There is no
assurance that the creditors under the facility would further amend the
covenants or, if an amendment were agreed to, what the cost would be to
O'Sullivan.
Our senior credit facility, senior subordinated notes and the
O'Sullivan Holdings note restrict our ability, among others, to:
- incur additional indebtedness;
- pay dividends and make distributions;
- issue common and preferred stock of subsidiaries;
- make certain investments;
- repurchase stock;
- create liens;
- enter into transactions with affiliates;
- enter into sale and leaseback transactions;
- merge or consolidate; and
- transfer and sell assets other than in the ordinary course of
business.
An acceleration under our senior credit facility would also constitute
an event of default under the indenture relating to the O'Sullivan Industries
subordinated notes and the securities purchase agreement relating to the
O'Sullivan Holdings note.
- WE MAY NOT HAVE SUFFICIENT CASH FROM CASH FLOW, CASH ON HAND AND
AVAILABLE BORROWINGS UNDER OUR SENIOR CREDIT FACILITY TO SERVICE OUR
INDEBTEDNESS AND TO PAY AMOUNTS DUE RADIOSHACK UNDER THE TAX SHARING AGREEMENT.
THESE OBLIGATIONS REQUIRE A SIGNIFICANT AMOUNT OF CASH. Our business may not
generate sufficient cash flow from operations and we may not realize operating
improvements on schedule. Our ability to make payments on and to refinance our
indebtedness will depend on our ability to generate cash in the future. This, to
some extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our control. Lower
sales will generally reduce our cash flow.
Future borrowings may not be available to us under our senior credit
facility in an amount sufficient to enable us to service our indebtedness or to
fund our other liquidity needs. We may need to refinance all or a portion of our
indebtedness, including the O'Sullivan Industries senior credit facility, the
O'Sullivan Industries senior subordinated notes and the O'Sullivan Holdings
note, on or before maturity. In such an event, we probably would not be able to
refinance any of our indebtedness on favorable terms if at all.
- CONTINUED REDUCTIONS IN RETAIL SALES COULD REDUCE OUR SALES,
ESPECIALLY IF THE REDUCTIONS OCCUR IN THE INDUSTRIES THAT WE BELIEVE CONTRIBUTE
TO THE GROWTH OF THE READY-TO-ASSEMBLE FURNITURE INDUSTRY AND COULD REDUCE OUR
ABILITY TO PAY OUR DEBTS. Most of our sales are to major retail chains. If there
is a reduction in the overall level of retail sales, our sales could also
decline and our ability to pay our debts could be reduced. We believe that sales
of ready-to-assemble furniture increased from fiscal 1995 through fiscal 2000 in
part because of an increase in sales of personal computers and home
entertainment electronic equipment. The slowdown in growth of sales of these
products hurt our sales in fiscal 2001 and 2002 and could continue to lower
sales in fiscal 2003. As the markets for personal computers and home
entertainment electronic equipment, and the market for our products, are now
substantially larger, it is apparent that our business is being hurt by a
recession more than in previous recessions.
31
- OUR PROFITS AND CASH WOULD BE REDUCED IF THE PRICES OUR SUPPLIERS
CHARGE US FOR RAW MATERIALS INCREASE. We are dependent on outside suppliers for
all of our raw material needs and are subject to changes in the prices charged
by our suppliers. If these prices were to increase significantly, this could
lead to our being unable to service our indebtedness.
In the past, our profits have been reduced by increases in prices of
particleboard and fiberboard. Price increases in fiscal 2000 increased our cost
of sales in fiscal 2000 and continued to reduce earnings in the first half of
fiscal 2001.
Prices for particleboard declined in fiscal 2001, reducing our cost of
sales in the second half of fiscal 2001 and in fiscal 2002. However, prices for
particleboard or other raw materials may increase in the future. Fiberboard
prices began to increase in the fourth quarter of fiscal 2002. We will try to
offset any price increases through cost savings, production efficiencies and
higher prices, but these efforts may not be successful or sufficient.
- OUR PAYMENTS TO RADIOSHACK UNDER THE TAX SHARING AGREEMENT WILL
REQUIRE SUBSTANTIAL AMOUNTS OF CASH. Because of the arbitration panel's ruling
and the subsequent settlement agreement in the arbitration proceedings between
RadioShack and O'Sullivan, our payments to RadioShack under the tax sharing
agreement have increased substantially. In fiscal 2002, we paid RadioShack $27.7
million. We expect to pay RadioShack $11.0 million, $9.9 million and $10.5
million under the tax sharing agreement in fiscal 2003, 2004 and 2005,
respectively.
We plan to fund these increased payment obligations from cash on hand,
borrowing under the senior credit facility or other sources of capital, if
available. Payment of this amount, however, could cause us to be in violation of
one or more of our covenants under our senior credit facility. See Item 3,
"Legal Proceedings" in Part I of this report.
Payments to RadioShack under the tax sharing agreement are treated as
taxes for purposes of calculating our fixed charge coverage ratio under the
senior credit facility. Accordingly, the increased payments make compliance with
this covenant more difficult. See "FAILURE TO COMPLY WITH ANY OF THE
RESTRICTIONS CONTAINED IN THE AGREEMENTS GOVERNING OUR INDEBTEDNESS COULD RESULT
IN ACCELERATION OF OUR DEBT. WERE THIS TO OCCUR, WE WOULD NOT HAVE SUFFICIENT
CASH TO PAY OUR ACCELERATED INDEBTEDNESS" above.
- BECAUSE WE SELL PRODUCTS TO A SMALL NUMBER OF CUSTOMERS, OUR SALES
WOULD BE REDUCED IF ONE OF OUR MAJOR CUSTOMERS SIGNIFICANTLY REDUCED ITS
PURCHASES OF OUR PRODUCTS OR WERE UNABLE TO FULFILL ITS FINANCIAL OBLIGATIONS TO
US. IF THIS WERE TO HAPPEN, OUR ABILITY TO PAY OUR DEBTS MAY BE SIGNIFICANTLY
AFFECTED. Our sales are concentrated among a relatively small number of
customers. Any of our major customers can stop purchasing product from us or
significantly reduce their purchases at any time. Any loss or reduction may
adversely affect our cash flows and our ability to pay our debts. During fiscal
year 2002, our three largest customers, OfficeMax, Office Depot and Wal-Mart
accounted for approximately 45% of our gross sales. Reduced orders from some of
our largest customers significantly reduced our sales in fiscal 2002. Further,
Montgomery Ward closed all of its stores in fiscal 2001, and Kmart and Ames
filed for reorganization under the United States Bankruptcy Code in fiscal 2002.
In August 2002, Ames decided to close all its stores and liquidate. We are
continuing to ship to Kmart while it endeavors to restructure under Chapter 11
of the Bankruptcy Code.
We do not have long term contracts with any of our customers and our
sales depend on our continuing ability to deliver attractive products at
reasonable prices.
At June 30, 2002, our largest five customer accounts receivable
balances comprised approximately 66% of our net trade receivables balance. The
bankruptcy of Ames in August 2001 and Kmart in January 2002 caused us to
increase our reserves for doubtful accounts by $1.5 million in the fourth
quarter of fiscal 2001 and $700,000 in the second quarter of fiscal 2002,
respectively.
32
- WE OPERATE IN A HIGHLY COMPETITIVE MARKET WHICH MAY FORCE US TO
REDUCE MARGINS, REDUCING OUR CASH FLOWS AND OUR ABILITY TO PAY OUR DEBTS. The
industry in which we operate is highly competitive. Some of our competitors are
significantly larger and have greater financial, marketing and other resources
than we do. Because of lower sales of RTA furniture generally, a number of
manufacturers have excess capacity. The competitive nature of our industry could
lead to smaller profit margins due to competitive pricing policies or excess
capacity. If this were to occur, our cash flows and our ability to pay our debts
may be reduced. This competitive pressure could be further exacerbated if
additional excess manufacturing capacity develops in the RTA furniture industry
due to over-expansion by manufacturers, further reduction in demand or
otherwise. Foreign manufacturers entering the United States market could also
increase competition in our markets.
- BECAUSE THE O'SULLIVAN INDUSTRIES SENIOR SUBORDINATED NOTES, AND
THE SUBSIDIARY GUARANTEE THEREOF, AND THE O'SULLIVAN HOLDINGS NOTE RANK BEHIND
OUR SENIOR DEBT, HOLDERS OF THESE NOTES MAY RECEIVE PROPORTIONATELY LESS THAN
HOLDERS OF OUR SENIOR DEBT IN A BANKRUPTCY, LIQUIDATION, REORGANIZATION OR
SIMILAR PROCEEDING. In the event of a bankruptcy, liquidation, reorganization or
similar proceeding relating to us, holders of O'Sullivan Industries senior
subordinated notes and then the O'Sullivan Holdings note will participate with
all other holders of our subordinated indebtedness in the assets remaining after
we have paid all of the senior debt. Because our senior debt must be paid first,
holders of these notes may receive proportionately less than trade creditors in
any proceedings of this nature. In any of these cases, we may not have
sufficient funds to pay all of our creditors. Therefore, holders of our
subordinated indebtedness may receive ratably less than trade creditors.
In addition, all payments on the subordinated debt will be blocked in
the event of a payment default on our senior debt and may be prohibited for up
to 179 days each year in the event of some non-payment defaults on senior debt.
- DESPITE OUR CURRENT LEVELS OF DEBT, WE MAY STILL INCUR MORE DEBT
AND INCREASE THE RISKS DESCRIBED ABOVE. We may be able to incur significant
additional indebtedness in the future. If we or our subsidiaries add new debt to
our current debt levels, the related risks that we and they now face could
intensify, making it less likely that we will be able to fulfill our obligations
to holders of the O'Sullivan Industries senior subordinated notes or the
O'Sullivan Holdings senior note. None of the agreements
governing our indebtedness completely prohibits us or our subsidiaries from
doing so. The revolving credit facility of the senior credit facility permits
additional borrowings of up to $16.8 million at June 30, 2002, plus $1.0 million
for letters of credit. These additional borrowings would be senior to the
O'Sullivan Industries senior subordinated notes and the O'Sullivan Holdings
note.
- IF WE BECOME BANKRUPT, THE CLAIMS OF HOLDERS OF THE O'SULLIVAN
INDUSTRIES SENIOR SUBORDINATED NOTES AGAINST US MAY BE LESS THAN THE FACE VALUE
OF THE NOTES DUE TO ORIGINAL ISSUE DISCOUNT. The O'Sullivan Industries senior
subordinated notes bear a discount from their stated principal amount at
maturity. If a bankruptcy case is commenced by or against O'Sullivan Industries
under the U.S. Bankruptcy Code, the claim of a holder of the notes with respect
to the principal amount thereof would likely be limited to an amount equal to
the sum of (1) the initial offering price and (2) the portion of the original
issue discount, or OID, that is not deemed to constitute "unmatured interest"
for purposes of the U.S. Bankruptcy Code. Any OID that was not accrued as of the
bankruptcy filing would constitute "unmatured interest."
- WE ARE AT RISK THAT USERS OF OUR PRODUCTS WILL SUE US FOR PRODUCT
LIABILITY. IF WE WERE UNABLE TO DEFEND OURSELVES AGAINST SOME PRODUCT LIABILITY
LAWSUITS, OUR SUCCESS AND OUR ABILITY TO PAY OUR DEBTS MAY BE REDUCED. All of
our products are designed for use by consumers. Like other manufacturers of
similar products, we are subject to product liability claims and could be
subject to class action litigation with respect to our products. If we were
unable to defend ourselves against certain product liability lawsuits, our
success and ability to pay our debts may be adversely affected. We are party to
various pending product liability claims and legal actions arising in the
ordinary operation of our business. Our liability insurance may not be adequate
for our needs, and we may not be fully insured against any particular lawsuit
which may adversely affect us.
33
- WE MAY BE LIABLE FOR PENALTIES UNDER ENVIRONMENTAL LAWS, RULES AND
REGULATIONS. THIS COULD NEGATIVELY AFFECT OUR SUCCESS AND OUR ABILITY TO PAY OUR
DEBTS. Our operations are subject to many federal, state and local environmental
laws, regulations and ordinances. Some of our operations require permits that
are subject to revocation, modification and renewal by governmental authorities.
Governmental authorities have the power to enforce compliance with their
regulations, and violators may be subject to fines, injunction or both.
Compliance with them may require substantial capital expenditures or increase
our operating expense. These costs and expenses may adversely affect our success
and ability to pay our debts.
- THE INTERESTS OF OUR CONTROLLING STOCKHOLDERS MAY BE IN CONFLICT
WITH INTERESTS OF THE HOLDERS OF OUR INDEBTEDNESS. THIS CONFLICT COULD RESULT IN
CORPORATE DECISION MAKING THAT INVOLVES DISPROPORTIONATE RISKS TO THE HOLDERS OF
OUR INDEBTEDNESS, INCLUDING OUR ABILITY TO SERVICE OUR DEBTS OR PAY THE
PRINCIPAL AMOUNT OF INDEBTEDNESS WHEN DUE. Following the recapitalization and
merger, BRS owns securities representing approximately 72.7% of the voting power
of the outstanding common stock of O'Sullivan Holdings. By reason of their
ownership, they control our affairs and policies. There may be circumstances
where the interests of BRS and its affiliates could be in conflict with the
interests of the holders of our indebtedness. For example, BRS and its
affiliates may have an interest in pursuing transactions that, in their
judgment, could enhance their equity investment, even though these transactions
might involve risks to the holders of O'Sullivan's debt. See Item 10, "Directors
and Executive Officers of the Registrant," and Item 12, "Security Ownership of
Certain Beneficial Owners and Management," in Part III of this report.
- IF OUR KEY PERSONNEL WERE TO LEAVE, OUR SUCCESS COULD BE NEGATIVELY
AFFECTED AND OUR ABILITY TO SERVICE OUR DEBTS COULD BE ADVERSELY AFFECTED. Our
continued success is dependent, to a certain extent, upon our ability to attract
and retain qualified personnel in all areas of our business, including
management positions and key sales positions, especially those positions
servicing our major customers. If any of our key personnel were to leave, it
might adversely affect our ability to service our debt. Members of the
O'Sullivan family in particular have been instrumental in the development of our
business and the implementation of our corporate strategy. We do not have
employment agreements with any of our officers or key personnel located in the
United States and we do not carry key person life insurance on any of our
employees. We may not be able to keep existing personnel, including O'Sullivan
family members, or be able to attract qualified new personnel. Our inability to
do so could have a negative effect on us as we may be unable to efficiently and
effectively run our business without these key personnel.
- FEDERAL AND STATE STATUTES ALLOW COURTS, UNDER SPECIFIC
CIRCUMSTANCES, TO VOID GUARANTEES, SUBORDINATE CLAIMS IN RESPECT OF OUR
INDEBTEDNESS AND REQUIRE HOLDERS OF OUR DEBT TO RETURN PAYMENTS RECEIVED FROM
GUARANTORS. Under federal bankruptcy law and comparable provisions of state
fraudulent transfer laws, courts may void guarantees or claims related to our
indebtedness, or subordinate any guarantees to all of our other debts or all
other debts of our guarantor if, among other things, at the time our guarantor
incurred the indebtedness connected with its guarantee, we or the guarantor:
- received less than reasonably equivalent value or fair
consideration for the issuance of the guarantee; and
- we were or the guarantor was insolvent or rendered insolvent by
the incurrence; or
- we were or the guarantor was engaged in a business or transaction
for which our or the guarantor's remaining assets constituted
unreasonably small capital; or
- we or the guarantor intended to incur or believed that we or it
would incur debts beyond our or its ability to pay these debts as
they mature.
In addition, a court could void any payment by us or the guarantor
related to its guarantee and require that payment to be returned to us or the
guarantor, or to a fund for the benefit of our creditors or the creditors of the
guarantor.
34
The measures of insolvency for purposes of these fraudulent transfer
laws will vary depending upon the law applied. Generally, a guarantor would be
considered insolvent if:
- the sum of its debts, including contingent liabilities, were
greater than the fair saleable value of all of its assets; or
- the present fair saleable value of its assets were less than the
amount that would be required to pay its probable liability on its
existing debts, including contingent liabilities, as they became
absolute and mature; or
- it could not pay its debts as they became due.
If a court were to disagree with our conclusions as to the legality of
any subsidiary guarantees it could adversely affect the rights of holders of
O'Sullivan Industries' indebtedness.
- WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO FINANCE
A CHANGE OF CONTROL OFFER REQUIRED BY OUR DEBT AGREEMENTS. Upon certain change
of control events, we will be required to offer to repurchase all of the
O'Sullivan Industries senior subordinated notes and the O'Sullivan Holdings
note. If we do not have sufficient funds at the time of a change of control, we
will not be able to make the required repurchase of these notes. This could be
because of cash flow difficulties or because of restrictions in our senior
credit facility and any future credit agreements that will not allow these
repurchases.
In addition, some kinds of corporate events, such as a leveraged
recapitalization, would increase the level of our indebtedness but would not
necessarily constitute a "Change of Control" and would therefore not require us
to repurchase the notes.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item is incorporated herein by
reference to the section entitled "Market Risk and Inflation" in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Part II of this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Immediately following are the report of independent accountants, the
consolidated balance sheets of O'Sullivan Industries Holdings, Inc. and
subsidiaries as of June 30, 2002 and 2001, and the related consolidated
statements of operations, cash flows and changes in stockholders' equity
(deficit) for each of the three years in the period ended June 30, 2002, and the
notes thereto.
35
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
O'Sullivan Industries Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of changes in
stockholders' equity (deficit) present fairly, in all material respects, the
financial position of O'Sullivan Industries Holdings, Inc. and its subsidiaries
at June 30, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended June 30, 2002, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company
discontinued the amortization of goodwill effective July 1, 2001 upon adoption
of a new accounting standard for goodwill.
/s/ PricewaterhouseCoopers LLP
Kansas City, Missouri
August 20, 2002
36
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
June 30,
-------------------------
2002 2001
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 15,777 $ 7,060
Trade receivables, net of allowance for doubtful accounts
of $4,101 and $4,750 respectively 37,035 52,570
Inventories, net 52,397 48,538
Prepaid expenses and other current assets 2,765 8,820
--------- ---------
Total current assets 107,974 116,988
Property, plant and equipment, net 87,834 95,872
Other assets 10,536 12,232
Goodwill, net of accumulated amortization 38,088 38,088
--------- ---------
Total assets $ 244,432 $ 263,180
========= =========
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 10,887 $ 8,534
Current portion of long-term debt 4,430 3,696
Accrued advertising 11,680 10,285
Accrued liabilities 18,399 13,354
--------- ---------
Total current liabilities 45,396 35,869
Long-term debt, less current portion 230,206 236,762
Other liabilities 6,040 5,222
Deferred income taxes -- 14,721
--------- ---------
Total liabilities 281,642 292,574
Commitments and contingent liabilities (Notes 3, 12, 17 and 18)
Mandatorily redeemable senior preferred stock, $0.01 par value; $33,312 and
$29,648 liquidation value including accumulated dividends at June 30,
2002 and June 30, 2001, respectively, 17,000,000 shares authorized,
16,431,050 issued 18,319 15,301
Stockholders' deficit:
Junior preferred stock, Series A, $0.01 par value; 100,000 shares
authorized, none issued -- --
Junior preferred stock, Series B, $0.01 par value; at liquidation value
including accumulated dividends; 1,000,000 shares authorized;
529,009.33 issued 74,838 65,366
Common stock, $0.01 par value; 2,000,000 shares authorized,
1,368,000 issued 14 14
Additional paid-in capital 13,053 13,053
Retained deficit (142,792) (122,470)
Accumulated other comprehensive loss (305) (336)
Notes receivable from employees (337) (322)
--------- ---------
Total stockholders' deficit (55,529) (44,695)
--------- ---------
Total liabilities and stockholders' deficit $ 244,432 $ 263,180
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
37
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
For the year ended June 30,
-----------------------------------------
2002 2001 2000
--------- --------- ---------
Net sales $ 349,098 $ 358,811 $ 405,234
Cost of sales 254,662 269,720 298,387
--------- --------- ---------
Gross profit 94,436 89,091 106,847
Operating expenses:
Selling, marketing and administrative 54,584 56,682 64,173
Restructuring charge -- 10,506 --
Merger related expenses -- -- 7,792
Transaction fee to related party -- -- 3,062
Compensation expense associated with stock options -- -- 10,627
Loss on settlement of interest rate swap -- -- 408
--------- --------- ---------
Total operating expenses 54,584 67,188 86,062
--------- --------- ---------
Operating income 39,852 21,903 20,785
Other income (expense):
Interest expense (28,526) (34,467) (19,387)
Interest income 395 500 792
--------- --------- ---------
Income (loss) before income tax provision, extraordinary item
and cumulative effect of accounting change 11,721 (12,064) 2,190
Income tax provision (benefit) 19,553 (4,221) 5,050
--------- --------- ---------
Loss before extraordinary item and cumulative effect of
accounting change (7,832) (7,843) (2,860)
Extraordinary loss from early extinguishment of debt, net of
income tax benefit of $171 -- -- (305)
Cumulative effect of accounting change, net of income tax
benefit of $53 -- (95) --
--------- --------- ---------
Net loss (7,832) (7,938) (3,165)
Dividends and accretion on preferred stock (12,490) (10,733) (5,535)
--------- --------- ---------
Net loss attributable to common stockholders $ (20,322) $ (18,671) $ (8,700)
========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
38
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the year ended June 30,
-----------------------------------------
2002 2001 2000
--------- --------- ---------
Cash flows provided by operating activities:
Net loss $ (7,832) $ (7,938) $ (3,165)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 14,530 14,945 15,416
Amortization of debt issuance costs 1,610 1,610 938
Amortization of debt discount and accrued interest on senior note 2,775 2,475 1,303
Interest rate collar (5) 2,096 --
Bad debt expense 1,460 1,741 1,047
Loss on disposal of assets 991 230 117
Impairment of long-lived assets to be sold -- 8,677 --
Deferred income taxes (8,506) (4,028) (540)
Accrual of special payment of options to purchase Series A
junior preferred stock 1,083 946 498
Compensation expense associated with stock options -- -- 10,627
Changes in current assets and liabilities:
Trade receivables 14,075 4,664 3,246
Inventories (3,859) 16,718 (9,122)
Other assets 465 (1,600) (1,132)
Accounts payable and accrued liabilities 9,110 (15,608) 11,087
--------- --------- ---------
Net cash flows provided by operating activities 25,897 24,928 30,320
--------- --------- ---------
Cash flows used for investing activities:
Capital expenditures (8,644) (16,811) (17,129)
--------- --------- ---------
Cash flows used by financing activities:
Issuance of stock, net of expenses -- -- 45,884
Redemption and cancellation of stock -- -- (269,044)
Employee loans 8 -- (296)
Proceeds from borrowings, including issuance of warrants -- -- 252,018
Repayment of borrowings (8,544) (12,924) (21,000)
Debt issuance costs -- -- (13,021)
Exercise of stock options -- -- 395
--------- --------- ---------
Net cash flows used for financing activities (8,536) (12,924) (5,064)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 8,717 (4,807) 8,127
Cash and cash equivalents, beginning of year 7,060 11,867 3,740
--------- --------- ---------
Cash and cash equivalents, end of year $ 15,777 $ 7,060 $ 11,867
========= ========= =========
Supplemental cash flow information:
Interest paid $ 24,915 $ 28,258 $ 13,571
Income taxes paid (refunded) $ 27,771 $ (17) $ 5,172
Non-cash financing activities:
Loans issued to purchase company stock $ -- $ -- $ 285
Dividends accrued but not paid $ 13,136 $ 11,473 $ 5,994
Capital expenditures included in accounts payable $ 288 $ 1,821 $ 589
The accompanying notes are an integral part of these consolidated
financial statements.
39
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Series B junior
preferred stock Common stock Additional Retained
-------------------- ---------------------- paid-in earnings
Shares Dollars Shares Dollars capital (deficit)
-------- --------- -------- --------- ---------- ---------
Balance, June 30, 1999 -- $ -- 16,820 $ 16,820 $ 87,549 $ 89,470
Net loss (3,165)
Other comprehensive income
Exercise of stock options, net of tax benefit (138)
Compensation expense associated with stock options 12,982
Redemption and cancellation of common stock (16,820) (16,820) (93,008) (184,569)
Issue of warrants 7,000
Loans to employees 3 285 12 --
Issuance of preferred stock 513 51,283
Issuance of common stock 1,356 14
Dividends and accretion on senior preferred stock (1,281)
Dividends and accretion on junior preferred stock 4,254 (4,254)
-------- --------- -------- --------- --------- ---------
Balance, June 30, 2000 516 $ 55,822 1,368 $ 14 $ 14,385 $(103,799)
Net loss (7,938)
Other comprehensive loss
Loans to employees-interest income
Issuance of preferred stock upon exercise of
warrants 13 1,332 (1,332)
Dividends and accretion on senior preferred stock (2,521)
Dividends and accretion on junior preferred stock 8,212 (8,212)
-------- --------- -------- --------- --------- ---------
Balance, June 30, 2001 529 $ 65,366 1,368 $ 14 $ 13,053 $(122,470)
Net loss (7,832)
Other comprehensive income
Loans to employees-interest income
Repayment of employee loans
Dividends and accretion on senior preferred stock (3,018)
Dividends and accretion on junior preferred stock 9,472 (9,472)
-------- --------- -------- --------- --------- ---------
Balance, June 30, 2002 529 $ 74,838 1,368 $ 14 $ 13,053 $(142,792)
======== ========= ======== ========= ========= =========
Accumulated Total
Notes other stock- Compre-
receivable Treasury stock comprehensive holders' hensive
from -------------------- income equity income
employees Shares Dollars (loss) (deficit) (loss)
--------- -------- --------- --------- --------- ---------
Balance, June 30, 1999 $ -- (771) $ (8,660) $ (43) $ 185,136
Net loss (3,165) $ (3,165)
Other comprehensive income 29 29 29
Exercise of stock options, net of tax benefit 42 533 395
Compensation expense associated with stock options 12,982
Redemption and cancellation of common stock 729 8,127 (286,270)
Issue of warrants 7,000
Loans to employees (296) (11)
Issuance of preferred stock 51,283
Issuance of common stock 14
Dividends and accretion on senior preferred stock (1,281)
Dividends and accretion on junior preferred stock --
--------- -------- --------- --------- --------- ---------
Balance, June 30, 2000 $ (296) -- $ -- $ (14) $ (33,888) $ (3,136)
=========
Net loss (7,938) $ (7,938)
Other comprehensive loss (322) (322) (322)
Loans to employees-interest income (26) (26)
Issuance of preferred stock upon exercise of
warrants --
Dividends and accretion on senior preferred stock (2,521)
Dividends and accretion on junior preferred stock --
--------- -------- --------- --------- --------- ---------
Balance, June 30, 2001 $ (322) -- $ -- $ (336) $ (44,695) $ (8,260)
=========
Net loss (7,832) $ (7,832)
Other comprehensive income 31 31 31
Loans to employees-interest income (24) (24)
Repayment of employee loans 9 9
Dividends and accretion on senior preferred stock (3,018)
Dividends and accretion on junior preferred stock
--------- -------- --------- --------- --------- ---------
Balance, June 30, 2002 $ (337) -- $ -- $ (305) $ (55,529) $ (7,801)
========= ======== ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
40
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - GENERAL INFORMATION.
O'Sullivan Industries Holdings, Inc. ("O'Sullivan"), a Delaware
corporation, is a domestic producer of ready-to-assemble ("RTA") furniture.
O'Sullivan's RTA furniture includes desks, computer workcenters, cabinets, home
entertainment centers, audio equipment racks, bookcases, microwave oven carts
and a wide variety of other RTA furniture for use in the home, office and home
office. The products are distributed primarily through office superstores,
discount mass merchants, mass merchants, home centers, electronics retailers,
furniture stores and internationally. O'Sullivan owns all of the stock of
O'Sullivan Industries, Inc. ("O'Sullivan Industries"). O'Sullivan Industries is
the sole owner of O'Sullivan Industries - Virginia, Inc. ("O'Sullivan Industries
- - Virginia") and O'Sullivan Furniture Factory Outlet, Inc.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
Basis of Presentation: The consolidated financial statements include
the accounts of O'Sullivan and its wholly owned subsidiaries. All significant
intercompany transactions, balances and profits have been eliminated.
Use of Estimates: O'Sullivan's consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires O'Sullivan
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and disclosure of contingent assets and
liabilities at the date of the financial statements. On an on-going basis,
O'Sullivan evaluates its estimates, including those related to customer programs
and incentives, uncollectible receivables, sales returns and warranty reserves,
inventory valuation, restructuring costs, intangible assets, certain accrued
liabilities, deferred taxes, and contingencies and litigation, among others.
O'Sullivan bases its estimates on historical experience and on various other
assumptions that it believes are reasonable under the circumstances. The results
of these estimates form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results could differ from the estimates made by O'Sullivan with respect
to these items and other items that require management's estimates.
Cash and Cash Equivalents: Cash and cash equivalents include cash on
hand and all highly liquid investments with original maturities of three months
or less.
Business and Credit Risk Concentrations: The largest five customer
accounts receivable balances accounted for approximately 66% and 59% of the
trade receivable balance at June 30, 2002 and 2001, respectively. Credit is
extended to customers based on evaluation of the customer's financial condition,
generally without requiring collateral. Exposure to losses on receivables is
dependent on each customer's financial condition. Therefore, O'Sullivan would be
exposed to a large loss if one of its major customers were not able to fulfill
its financial obligations. From time to time, O'Sullivan maintains certain
limited credit insurance which may help reduce, but not eliminate, exposure to
potential credit losses. In addition, O'Sullivan monitors its exposure for
credit losses and maintains allowances for anticipated losses.
Revenue Recognition: O'Sullivan recognizes revenue from the sale of
products when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable and collection of the resulting
receivable is reasonably assured. For all sales, O'Sullivan uses purchase orders
from the customer, whether oral, written or electronically transmitted, as
evidence that a sales arrangement exists.
Generally, delivery occurs when product is delivered to a common
carrier or private carrier, with standard terms being FOB shipping point.
O'Sullivan assesses whether the price is fixed and determinable based upon the
payment terms associated with the transaction.
41
O'Sullivan assesses collection based on a number of factors, including
past transaction history with the customer and the creditworthiness of the
customer. Collateral is not requested from the customers.
Shipping and Handling: O'Sullivan reports amounts billed to customers
as revenue, the cost of warehousing operations in cost of sales and freight out
costs as part of selling, marketing and administrative expenses. Freight out
costs included in selling, marketing and administrative expenses in fiscal 2002,
2001 and 2000 were approximately $9.7 million, $11.6 million and $17.1 million,
respectively.
Inventories: Inventories are stated at the lower of cost, determined on
a first-in, first-out (FIFO) basis, or market. Provision for potentially
obsolete or slow-moving inventory is made based on management's evaluation of
inventory levels and future sales forecasts.
Property, Plant and Equipment: Depreciation and amortization of
property, plant and equipment is calculated using the straight-line method,
which amortizes the cost of the assets over their estimated useful lives. The
ranges of estimated useful lives are: buildings--30 to 40 years; machinery and
equipment--3 to 10 years; leasehold improvements--the lesser of the life of the
lease or asset. Maintenance and repairs are charged to expense as incurred.
Renewals and betterments which materially prolong the useful lives of the assets
are capitalized. The cost and related accumulated depreciation of assets retired
or sold are removed from the accounts, and gains or losses on disposal are
recognized in the statement of operations.
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
Intangible Assets: As described further under "New Accounting
Standards," the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"), in June 2001. Upon adoption of SFAS 142 on July
1, 2001, goodwill is no longer subject to amortization over its estimated useful
life. O'Sullivan assesses goodwill regularly for impairment by applying a
fair-value-based test, using the enterprise as the reporting unit. If the book
value of the reporting unit is below the fair value of the reporting unit, there
is no impairment loss. For fiscal years ended June 30, 2001 and earlier,
goodwill was amortized over a 40-year period using the straight-line method.
Accumulated amortization at June 30, 2002 and 2001 approximated $29.8 million.
Fair Value of Financial Instruments: The fair value of financial
instruments is determined by reference to various market data and other
valuation techniques, as appropriate. Unless otherwise disclosed, the fair value
of financial instruments approximates their recorded values due primarily to the
short-term nature of their maturities.
Advertising Costs: The Emerging Issues Task Force ("EITF") in April
2001 reached a consensus on EITF No. 00-25, Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's Products.
This issue requires that certain customer promotional payments that were
classified as selling expenses be classified as a reduction of revenue.
O'Sullivan adopted EITF 00-25 effective January 1, 2002. As a result of the
adoption, $16.9 million and $18.2 million were reclassified as a reduction in
revenue rather than as a selling expense for fiscal years 2001 and 2000,
respectively.
Advertising costs are expensed as incurred. Advertising expense is
included in selling, marketing and administrative expense and amounted to $7.0
million, $8.5 million and $6.8 million in fiscal 2002, 2001 and 2000,
respectively.
Income Taxes: Deferred taxes are provided on the liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss carryforwards and deferred tax liabilities for
42
taxable temporary differences. Temporary differences are the differences between
the reported amounts of assets and liabilities and their tax bases. Deferred tax
assets are reduced by a valuation allowance when it can not be established that
it is more likely than not that all of the deferred tax assets will be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
Environmental Remediation and Compliance: Environmental remediation and
compliance expenditures that relate to current operations are expensed or
capitalized, as appropriate. Expenditures that relate to an existing condition
caused by past operations and that do not contribute to current or future
revenue generation are expensed. Liabilities are recognized when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Generally, the timing of these accruals coincides with completion of
a feasibility study or O'Sullivan's commitment to a formal plan of action. To
date, environmental expenditures have not been material, and management is not
aware of any material environmental related contingencies.
Significant Fourth Quarter Adjustments: During the fourth quarter of
fiscal 2001, O'Sullivan recorded bad debt expense of $1.5 million associated
with the August 20, 2001 bankruptcy filing of Ames Department Stores, Inc.
Accounting for Stock-Based Compensation: O'Sullivan accounts for stock
based compensation pursuant to the intrinsic value based method of accounting as
prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. O'Sullivan has made pro forma disclosures of net income as
if the fair value based method of accounting defined in SFAS 123, Accounting for
Stock-Based Compensation, had been applied. See Note 13.
Comprehensive Income: Other comprehensive income consists of foreign
currency translation adjustments. The tax benefit (expense) related to other
comprehensive income (loss) approximated $(10,000), $113,000 and $(10,000) for
the years ended June 30, 2002, 2001 and 2000, respectively.
New Accounting Standards: In April 2001, the EITF reached a consensus
on EITF 00-25. This issue addresses the income statement classification of
slotting fees, cooperative advertising arrangements and buydowns. The consensus
requires that certain customer promotional payments were classified as selling
expenses be classified as a reduction of revenue. O'Sullivan adopted EITF 00-25
effective January 1, 2002 and reclassified certain selling, marketing and
administrative expenses as a reduction of net sales. Its adoption by O'Sullivan
had no impact on operating income or net income (loss). As a result of the
adoption of EITF 00-25, for the six months ended December 31, 2001, $7.7 million
was reclassified as a reduction in revenue rather than as selling, marketing and
administrative expense. Reclassifications for fiscal years 2001 and 2000 were
$16.9 million and $18.2 million, respectively.
O'Sullivan adopted SFAS 142 on July 1, 2001, the beginning of its 2002
fiscal year. With the adoption of SFAS 142, goodwill of approximately $38.1
million is no longer subject to amortization over its estimated useful life.
Rather, goodwill will be assessed regularly for impairment by applying a fair-
value-based test. O'Sullivan has completed the initial valuation of the
reporting unit, using the enterprise as the reporting unit. Because the book
value of the reporting unit is below the fair value of the reporting unit, there
is no impairment loss. O'Sullivan has discontinued amortizing approximately $1.7
million of goodwill per year. Adjusted net loss
43
and adjusted net loss attributable to common stockholders for the two previous
fiscal years ending June 30, had such amortization not been recorded are shown
in the following table.
Fiscal year ended June 30,
2001 2000
---------- ----------
(in thousands)
Adjusted net loss $ (6,543) $ (1,778)
Adjusted net loss attributable to
common stockholders $(17,276) $ (7,313)
In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. This pronouncement, which is effective for fiscal years beginning
after June 15, 2002, addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. O'Sullivan does not believe that this
pronouncement will have a material impact on its financial position or results
of operations. O'Sullivan will adopt this pronouncement effective July 1, 2002.
In August 2001, the FASB issued SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. This pronouncement, which is effective for
fiscal years beginning after December 15, 2001, addresses financial accounting
and reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of. Although the Utah long-lived assets to be disposed of by sale
will be presented as long-lived assets to be disposed of after the adoption of
this pronouncement, O'Sullivan does not believe this pronouncement will have an
adverse material impact on its financial position or results of operations.
O'Sullivan will adopt this pronouncement effective July 1, 2002.
In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections.
This pronouncement updates, clarifies and simplifies existing accounting
pronouncements. The pronouncement, in part, addresses the accounting for gains
and losses from the extinguishment of debt. O'Sullivan does not believe SFAS 145
will have a material impact on its financial position or results of operations.
O'Sullivan will adopt SFAS 145 effective July 1, 2002.
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities. This pronouncement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring). SFAS 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
rather than the date of an entity's commitment to an exit plan and establishes
that fair value is the objective for initial measurement of the liability. The
provisions of this pronouncement are effective for exit or disposal activities
that are initiated after December 31, 2002.
Reclassifications: Certain items in the prior years' financial
statements have been reclassified to conform with the current year's
presentation.
NOTE 3 - RESTRUCTURING CHARGE.
In November 2000, O'Sullivan announced a business restructuring plan to
reduce production capacity and operating expenses. The plan included the January
2001 shutdown of the Cedar City, Utah production facility and reduction of the
administrative and support staff in the Lamar, Missouri headquarters. In
connection with the plan, O'Sullivan recorded a pre-tax charge of $10.5 million
in the second quarter of fiscal 2001.
O'Sullivan is actively attempting to sell the Utah land, building and
excess equipment as soon as practicable. Certain equipment has been relocated to
the Missouri and Virginia plants. Fixed assets with a net
44
book value of $20.3 million were written down to estimated fair value, resulting
in an impairment charge of approximately $8.7 million. The impairment charge is
reflected in accumulated depreciation on the consolidated balance sheets. The
fair value is an estimate, and the impairment may be adjusted in the future.
The components of the restructuring charge and an analysis of the
amounts charged against the accrual are outlined below:
Charges Charges
through Balance through Balance
Original June 30, June 30, June 30, June 30,
Restructuring Charges Accrual 2001 2001 2002 2002
------ ------ ------ ------ ----
(in thousands)
Employee termination benefits (1) $1,302 $ 915 $ 387 $ 387 $ --
Other Utah facility exit costs (1) 527 282 245 245 --
------ ------ ------ ------ ----
Total $1,829 $1,197 $ 632 $ 632 $ --
====== ====== ====== ====== ====
(1) Included in accrued liabilities in the consolidated balance sheet.
Accumulated depreciation was increased $8.7 million to record asset impairments.
NOTE 4 - LEVERAGED RECAPITALIZATION.
On November 30, 1999, O'Sullivan completed a recapitalization and
merger through which the outstanding stock of O'Sullivan was purchased by an
investment firm, Bruckmann, Rosser, Sherrill & Co. II, LLC ("BRS"), certain
directors and members of O'Sullivan's senior management. The leveraged
recapitalization required approximately $357 million to complete the merger and
pay related fees and expenses. Approximately $264 million was funded with debt
proceeds.
In fiscal 2000, O'Sullivan recognized $10.9 million of merger related
expenses for investment banking, legal, accounting, printing and other services.
These costs included a payment to BRS of $3.1 million. The merger related
expenses and the fee paid BRS have been included as separate line items in the
consolidated statement of operations.
O'Sullivan also incurred approximately $10.6 million in compensation
expense associated with stock options as part of the merger. Of this amount,
$6.0 million was exchanged for options to purchase shares of Series A junior
preferred stock, $5.9 million in cash was paid and $1.1 million in liquidation
value of senior preferred stock was distributed to the option holders.
O'Sullivan had previously incurred approximately $2.3 million in compensation
expense for the options prior to the merger. The compensation expense relating
to the options has been included as a separate line item in the consolidated
statement of operations.
At the time of the merger, O'Sullivan repaid private placement notes
held with a principal amount of $16.0 million for $16.5 million. The $476,000
prepayment fee has been recognized as a $305,000 extraordinary loss, net of
related tax benefit.
NOTE 5 - DERIVATIVE FINANCIAL INSTRUMENTS.
O'Sullivan adopted SFAS 133 on July 1, 2000. As required by the
transition provisions of SFAS 133, O'Sullivan recorded a net-of-tax
cumulative-effect type loss of $95,000 in fiscal 2001 to recognize the fair
value of its derivatives designated as cash-flow hedging instruments.
As required under its senior credit facility, O'Sullivan hedged
one-half of its term loans with an initial notional amount of $67.5 million with
a three-year, costless interest rate collar. The collar, which expires in
45
March 2003, is based on three-month LIBOR and has a floor of 6.43% and a ceiling
of 8.75%. O'Sullivan recorded additional (reduced) interest expense of $(5,000)
and $2.1 million for fiscal 2002 and 2001, respectively. These amounts represent
the changes in fair value of the interest rate collar. To terminate this
contract at June 30, 2002, O'Sullivan would have been required to pay the
counter-party approximately $2.1 million. At June 30, 2001, this amount was
recorded in other liabilities in the consolidated balance sheets. Since the
interest rate collar expires in March 2003, the fair value of the interest rate
collar on June 30, 2002 has been reclassified to accrued liabilities in the
consolidated balance sheets.
NOTE 6 - INVENTORY.
Inventory consists of the following:
June 30,
---------------------
2002 2001
------- -------
(in thousands)
Finished goods $39,199 $35,798
Work in process 5,158 4,256
Raw materials 8,040 8,484
------- -------
$52,397 $48,538
======= =======
NOTE 7 - PROPERTY, PLANT AND EQUIPMENT.
Property, plant and equipment consists of the following:
June 30,
-------------------------
2002 2001
--------- ---------
(in thousands)
Land $ 1,034 $ 1,034
Buildings and improvements 49,813 49,557
Machinery and equipment 135,449 129,125
Construction in progress 667 5,596
--------- ---------
186,963 185,312
Less: accumulated depreciation (99,129) (89,440)
--------- ---------
$ 87,834 $ 95,872
========= =========
Depreciation expense was $14,158,000, $12,814,000 and $13,578,000 for
fiscal 2002, 2001 and 2000, respectively, of which $12,147,000, $10,563,000 and
$11,098,000, respectively, was included in cost of sales.
NOTE 8 - ACCRUED LIABILITIES.
Accrued liabilities consists of the following:
June 30,
--------------------
2002 2001
------- -------
(in thousands)
Accrued employee compensation $10,953 $ 6,871
Accrued interest 2,839 3,677
Other current liabilities 4,607 2,806
------- -------
$18,399 $13,354
======= =======
46
NOTE 9 - LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS.
Long-term debt consists of the following:
June 30,
-------------------------
2002 2001
--------- ---------
(in thousands)
Senior term loan, tranche A $ 25,247 $ 29,107
Senior term loan, tranche B 87,285 91,969
Industrial revenue bonds 10,000 10,000
Senior subordinated notes 95,350 95,007
Senior note 16,754 14,375
--------- ---------
Total debt 234,636 240,458
Less current portion (4,430) (3,696)
--------- ---------
Total long-term debt $ 230,206 $ 236,762
========= =========
Total debt, including the discount of $4.6 million on the senior
subordinated notes and $3.0 million on the senior note, matures as follows (in
thousands):
2003 $ 4,430
2004 7,530
2005 12,402
2006 19,494
2007 68,676
Thereafter 129,789
--------
$242,321
========
SENIOR CREDIT FACILITY. O'Sullivan Industries is the obligor under a
senior credit facility totaling $175.0 million. O'Sullivan Industries entered
into an agreement for the senior credit facility on November 30, 1999. The
senior credit facility consisted of the following:
- Senior term loan, tranche A - $35.0 million term loan facility
payable in 23 quarterly installments beginning March 31, 2000. The
outstanding balance has been reduced to $25.2 million.
- Senior term loan, tranche B - $100.0 million term loan facility
payable in 26 quarterly installments beginning March 31, 2001. The
balance of these loans has been reduced to $87.3 million.
- Revolving credit facility - $40.0 million revolving credit
facility due November 30, 2005, which includes a $15.0 million
letter of credit subfacility and a $5.0 million swing line
subfacility. At June 30, 2002, O'Sullivan had no borrowings
outstanding on the senior credit facility and approximately $14.0
million of letters of credit outstanding.
O'Sullivan Industries' obligations under the senior credit facility are
secured by first priority liens and security interests in the stock of
O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture
Factory Outlet, Inc. and substantially all of the assets of O'Sullivan
Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory
Outlet, Inc.
At O'Sullivan Industries' option, borrowings under the senior secured
credit facility accrue interest at the varying rates based on (a) a Eurodollar
rate plus an applicable margin or (b) an applicable margin plus the highest of a
bank's prime rate, the federal funds effective rate plus 0.5% or three-month
certificates of deposit secondary market rates as adjusted for statutory
reserves plus 1.0%. The applicable margins for the $35.0 million term loan are
3.25% for Eurodollar loans and 2.25% for base rate loans, which may be reduced
by 25 basis points if O'Sullivan Industries reduces its consolidated leverage
ratio to 4.0:1 or below. The applicable margins for the
47
$100.0 million term loan are 3.75% for Eurodollar loans and 2.75% for base rate
loans. O'Sullivan Industries also pays a quarterly fee equal to 0.5% per annum
of the unused commitment under the senior secured credit facility. On June 30,
2002, the interest rate for Tranche A notes was 5.1%. The interest rate for
Tranche B notes was 5.6%. See also Note 5.
The senior credit facility and notes are subject to certain financial
and operational covenants and other restrictions, including among others, a
requirement to maintain certain financial ratios and restrictions on O'Sullivan
Industries' ability to make capital expenditures, sell assets, sell securities,
engage in acquisitions and incur additional indebtedness. In addition, the
agreements effectively prohibit the payment of dividends on O'Sullivan stock.
The senior credit facility was amended as of January 30, 2001. The
primary changes to the senior credit facility were to the covenants for minimum
consolidated EBITDA, consolidated leverage ratios, consolidated interest
coverage ratio and the consolidated fixed charge coverage ratio. The amended
covenants are less restrictive than those in the original senior credit
facility. The amendment also required a $10.0 million prepayment of the term
loans on or before June 30, 2001. The prepayment was completed on May 1, 2001.
The senior credit facility was further amended in May 2002. The
amendment excludes from the definition of consolidated fixed charges $27.0
million paid by O'Sullivan to RadioShack Corporation pursuant to the tax sharing
agreement in the quarter ended June 30, 2002.
The restriction on the incurrence of additional indebtedness in the
senior credit facility limited O'Sullivan Industries' ability to incur
additional debt to approximately $16.8 million on June 30, 2002. In addition,
about $1.0 million of the line of credit can be used for letters of credit.
At June 30, 2002, O'Sullivan was in compliance with all debt covenants.
INDUSTRIAL REVENUE BONDS. O'Sullivan Industries - Virginia is obligor
on $10.0 million of variable rate industrial revenue bonds ("IRB's") that mature
on October 1, 2008. Interest on the IRB's is paid monthly. The loan is secured
by a $10.2 million standby letter of credit under the senior credit facility. At
June 30, 2002 the interest rate on these bonds was about 1.45%. A letter of
credit provides liquidity and credit support for the IRB's; the cost of the
letter of credit was an additional 3.25% in fiscal 2002.
Effective October 1, 1998, O'Sullivan Industries entered into a forward
starting interest rate swap agreement with a notional principal amount of $10.0
million that was to terminate October 1, 2008. O'Sullivan Industries contracted
to pay a fixed rate of 7.13% and receive a floating interest rate during the
duration of the swap agreement. On November 30, 1999, as part of the merger and
recapitalization, O'Sullivan Industries terminated this swap incurring a loss of
$408,000. The loss has been included as a separate line item in the consolidated
statement of operations.
SENIOR SUBORDINATED NOTES. The senior subordinated notes issued by
O'Sullivan Industries totaling $100.0 million bear interest at the rate of
13.375% per annum and are due in 2009. The notes were sold at 98.046% of their
face value. Interest is payable semiannually on April 15 and October 15. The
senior subordinated notes contain various covenants including restrictions on
additional indebtedness based on EBITDA coverage. In connection with these
notes, O'Sullivan issued warrants to purchase 93,273 shares of O'Sullivan common
stock at an exercise price of $0.01 per share and 39,273 shares of O'Sullivan
Series B junior preferred stock at an exercise price of $0.01 per share. The
warrants were immediately exercisable and were recorded at their fair value of
$3.5 million. The notes were recorded net of discount, which consists of $2.0
million of original issue discount and $3.5 million of the original proceeds
allocated to the estimated fair value of the warrants and which has been
classified as paid-in capital in the consolidated balance sheets.
SENIOR NOTE. The $19.8 million senior note, including accrued interest,
issued by O'Sullivan bears interest at the rate of 12.0% per annum, compounding
semiannually, and principal and interest are due in 2009.
48
In connection with this note, O'Sullivan issued warrants to purchase 93,273
shares of O'Sullivan common stock at an exercise price of $0.01 per share and
39,273 shares of O'Sullivan Series B junior preferred stock at an exercise
price of $0.01 per share. The note was recorded net of discount of $3.5 million,
which represents the estimated fair value of the warrants. Accordingly, this
amount has been recognized as additional paid-in capital in the consolidated
balance sheets. At O'Sullivan's election, interest on this note may be added to
the principal of the note rather than being paid currently.
The original issue discount and the warrants are amortized over the
life of the notes using the effective interest rate method. Expenses related to
the issuance of the debt financing were approximately $13.0 million and have
been capitalized and recorded as other assets. Of this amount, $1.0 million was
paid to BRS.
REPAYMENT OF PRIVATE PLACEMENT NOTES. O'Sullivan repaid private
placement notes held with a principal amount of $16.0 million for $16.5 million
on November 30, 1999. The $476,000 prepayment fee has been recognized as a
$305,000 extraordinary loss, net of the related tax benefit.
NOTE 10 - MANDATORILY REDEEMABLE PREFERRED STOCK.
As part of the recapitalization and merger, O'Sullivan issued shares of
senior preferred stock, par value $0.01 per share, to the stockholders of
O'Sullivan as partial consideration for their shares of common stock. The senior
preferred stock has a liquidation preference of $1.50 per share. Dividends
accrue at a rate of 12% per annum, compounding semiannually if unpaid. The
liquidation value plus accumulated dividends on June 30, 2002 was $33.3 million.
The senior preferred stock may be redeemed by O'Sullivan at any time and must be
redeemed on November 30, 2011, or earlier in the event of a change in control of
O'Sullivan.
The carrying amount of the senior preferred stock is based upon the
fair market value of the senior preferred stock on November 30, 1999 plus
accretion to June 30, 2002.
NOTE 11 - JUNIOR PREFERRED STOCK.
As part of the recapitalization and merger, O'Sullivan issued
515,681.33 shares of Series B junior preferred stock, par value $0.01 per share,
to BRS and the management participants in the recapitalization and merger.
Consideration paid for these consisted of cash and shares of O'Sullivan common
stock. In fiscal 2001, 13,328 shares of Series B junior preferred stock were
issued pursuant to the exercise of warrants, increasing junior preferred stock
by $1.3 million and decreasing additional paid-in capital by the same amount.
Dividends accrue at a rate of 14% per annum, compounding semiannually if unpaid.
The liquidation value plus accumulated dividends on June 30, 2002 was $74.8
million, which is the carrying amount for the stock on the accompanying balance
sheet. The junior preferred stock may be redeemed by O'Sullivan at any time, but
there is no mandatory redemption date for the Series B junior preferred stock.
NOTE 12 - INCOME TAXES.
The income tax provision consists of the following:
For the year ended June 30,
--------------------------------------
2002 2001 2000
-------- -------- --------
(in thousands)
Current:
Federal $ 27,739 $ (210) $ 5,511
State 320 17 79
-------- -------- --------
28,059 (193) 5,590
Deferred (8,506) (4,028) (540)
-------- -------- --------
$ 19,553 $ (4,221) $ 5,050
======== ======== ========
49
The following table reconciles O'Sullivan's federal corporate statutory rate and
its effective income tax rate:
For the year ended June 30,
-------------------------------
2002 2001 2000
----- ----- -----
Statutory rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 1.6 (1.6) 1.6
Goodwill amortization -- 2.5 14.2
Merger related expenses -- -- 173.5
Valuation allowance 129.0 -- --
Other, net 1.2 (0.9) 6.4
----- ----- -----
Effective tax rate 166.8% 35.0% 230.0%
===== ===== =====
Deferred tax assets and liabilities consist of the following:
June 30,
-----------------------
2002 2001
-------- --------
(in thousands)
Deferred tax assets:
Allowance for doubtful accounts $ 1,517 $ 1,757
Insurance liabilities 606 564
Accrued compensation 3,402 3,149
Inventories 1,621 286
Other 425 240
Net operating loss carryforwards 21,520 --
-------- --------
Subtotal 29,091 5,996
Valuation allowance (15,990) --
-------- --------
Total deferred tax assets 13,101 5,996
-------- --------
Deferred tax liabilities:
Depreciation and amortization (13,101) (14,808)
Other -- (573)
-------- --------
Total deferred tax liabilities (13,101) (15,381)
-------- --------
Net deferred tax liability $ -- $ (9,385)
======== ========
Reported as:
Current assets (included in prepaid expenses and other current assets) $ -- $ 5,336
Noncurrent liabilities-deferred income taxes -- (14,721)
-------- --------
Net deferred tax liability $ -- $ (9,385)
======== ========
O'Sullivan recorded tax expense of $19.6 million for the year ended
June 30, 2002 that included a valuation allowance of $16.0 million.
Prior to O'Sullivan's initial public offering in 1994, it was owned by
RadioShack Corporation (then named Tandy Corporation). In connection with the
1994 initial public offering of O'Sullivan's common stock, RadioShack
Corporation, TE Electronics Inc. and O'Sullivan entered into a Tax Sharing and
Tax Benefit Reimbursement Agreement. Pursuant to the tax sharing agreement,
RadioShack is primarily responsible for all U.S. federal income taxes, state
income taxes and foreign income taxes with respect to O'Sullivan for all periods
ending on or prior to the date of consummation of the offering and for audit
adjustments to such federal income and foreign income taxes. O'Sullivan is
responsible for all other taxes owing with respect to O'Sullivan, including
audit adjustments to state and local income and for franchise taxes.
50
RadioShack and O'Sullivan made an election under Sections 338(g) and
338(h)(10) of the Internal Revenue Code with the effect that the tax basis of
O'Sullivan Industries' assets was increased to the deemed purchase price of the
assets. An amount equal to such increase was included in income in the
consolidated federal income tax return filed by RadioShack. This additional tax
basis results in increased income tax deductions and, accordingly, reduced
income taxes payable by O'Sullivan. Pursuant to the tax sharing agreement,
O'Sullivan pays RadioShack nearly all of the federal tax benefit expected to be
realized with respect to such additional basis. Since O'Sullivan's initial
public offering by RadioShack in 1994, the benefits of the tax deductions under
the tax sharing agreement have been accounted for as income taxes. Amounts
payable to RadioShack pursuant to the tax sharing agreement are recorded as
current federal income tax expense in O'Sullivan's consolidated statements of
operations. As those benefits reduced O'Sullivan's federal income tax
obligations, payments were made to RadioShack as opposed to the IRS.
O'Sullivan is incurring significantly higher interest expense
associated with its higher debt levels in connection with the financing of the
November 1999 recapitalization and merger. O'Sullivan believed that this
increased interest expense, and certain expenses incurred to consummate the
recapitalization and merger, should be taken into account in determining the
payments O'Sullivan is required to make to RadioShack under the tax sharing
agreement. RadioShack claimed O'Sullivan could not deduct the additional
interest and expenses in determining the tax sharing payments.
On June 29, 1999, RadioShack filed a complaint against O'Sullivan in
the District Court of Texas in Tarrant County. RadioShack's complaint sought a
court order compelling us to submit to a dispute resolution process. O'Sullivan
argued that no dispute existed because at that time the recapitalization and
merger had not closed. On October 8, 1999, the court ordered O'Sullivan to
commence dispute resolution procedures before an arbitrator, according to the
terms of the tax sharing agreement. Mediation efforts failed to resolve the
issue. Arbitrators were selected to hear the dispute, the arbitration was heard
in October 2001 and briefing of the issue followed.
In March 2002, the arbitration panel ruled in favor of RadioShack on
this issue, concluding that the interest expense arising from the
recapitalization and merger is not deductible in calculating the payments due
from O'Sullivan to RadioShack under the tax sharing agreement.
Following the issuance of the opinion, O'Sullivan reached a settlement
of the dispute with RadioShack. Under the settlement, O'Sullivan paid RadioShack
$21.5 million in May 2002 to cover all amounts due through December 31, 2001;
RadioShack waived interest on the payments and its attorneys' fees. O'Sullivan
agreed to make future payments under the tax sharing agreement without deducting
interest on indebtedness incurred in the recapitalization and merger. For the
six months ended June 30, 2002, O'Sullivan paid RadioShack $6.2 million.
O'Sullivan funded the back payment and subsequent payments from cash on
hand. O'Sullivan expects to fund future payments from cash on hand or borrowings
under its senior credit facility.
O'Sullivan Industries amended its senior credit facility as a result of
the arbitration settlement. The amendment excludes from the definition of
consolidated fixed charges $27.0 million of the total paid by O'Sullivan
pursuant to the tax sharing agreement through the period ended June 30, 2002.
O'Sullivan has recorded the $27.7 million in payments pursuant to the
settlement agreement as a deferred tax asset. O'Sullivan has a net deferred tax
asset of approximately $16.0 million at June 30, 2002. Under SFAS 109,
Accounting for Income Taxes, O'Sullivan must determine if it is more likely than
not that the net deferred tax assets will be realized as reductions in tax
liabilities in the future. At December 31, 2001 (O'Sullivan files federal income
tax returns on a calendar year basis), O'Sullivan had a NOL carryforward for
federal income tax purposes of approximately $58.3 million. In 2009, when
substantially all of the tax deductions (which can no longer be calculated
considering certain O'Sullivan interest costs pursuant to the arbitration
decision and settlement) are expected to have been taken, O'Sullivan and
RadioShack are to negotiate a settlement of the then present value of the
realizable tax benefits O'Sullivan has yet to deduct.
51
Pursuant to SFAS 109, management projected its expected future taxable
income utilizing operating performance O'Sullivan expects to achieve in fiscal
2002 assuming O'Sullivan's performance would be no better or worse over an
extended period of time. Such projections indicate that O'Sullivan will not have
taxable income until 2009 when substantially all the tax benefit deductions have
been taken. At that point, the projections indicate that the NOL's existing at
that time would be utilized before they expire. However, O'Sullivan currently
has and is expected to have taxable losses for a number of years in the future
and SFAS 109 requires objective evidence to support the more likely than not
conclusion. Projections over a long time frame are inherently uncertain, and
O'Sullivan cannot provide objective evidence that its operations in 2009 and
beyond will produce sufficient taxable income. As a result, O'Sullivan has
provided a valuation allowance on its net deferred tax assets of $16.0 million
at June 30, 2002 and will continue to provide an allowance as those net deferred
tax assets grow into the future until sufficient objective evidence exists about
future results of operations which supports the reversal of all or part of the
valuation allowance.
During fiscal 2002, 2001 and 2000, $27.7 million, $0.0 and $4.3
million, respectively, were paid to RadioShack pursuant to this agreement.
NOTE 13 - STOCK OPTIONS.
In connection with the recapitalization and merger of O'Sullivan, all
outstanding options issued by O'Sullivan were either converted into options to
purchase shares of O'Sullivan Series A junior preferred stock or exchanged for
shares of O'Sullivan's senior preferred stock and a cash payment equal to the
difference between $16.75 and the exercise price of the option times the number
of option shares. As a result, all of the outstanding options under O'Sullivan's
Amended and Restated 1994 Incentive Stock Plan were converted or exchanged. In
fiscal 2000, O'Sullivan recognized compensation expense of $10.6 million in
connection with the conversion and exchange of the stock options, which has been
shown as a separate line item on the consolidated statement of operations.
In January 2000, O'Sullivan adopted its 2000 Common Stock Option Plan.
Pursuant to this plan, O'Sullivan may issue up to 81,818 shares of O'Sullivan
common stock to employees of O'Sullivan. The exercise price for shares issued
under the plan is equal to the fair market value on the date of grant. Options
issued pursuant to the plan will vest in five annual installments if certain
performance targets are met; otherwise, the options will vest in seven years
from their date of grant or one day prior to their expiration. On June 19, 2000,
the compensation committee granted options to purchase 75,800 shares of common
stock at an exercise price of $1.90 per share, which was the estimated fair
value of the underlying common stock at the date of grant. The expiration date
of these options is November 30, 2009. Twenty percent of these options were
exercisable at June 30, 2002.
In November 2001, O'Sullivan adopted its 2001 Director Common Stock
Option Plan. Pursuant to this plan, O'Sullivan may issue up to 15,000 shares of
O'Sullivan common stock to O'Sullivan directors who are not employees of, or
consultants to, O'Sullivan or BRS. The exercise price for shares issued under
the plan is equal to the fair market value on the date of grant. Options issued
pursuant to the plan will vest in three equal annual installments. On November
15, 2001, the Board granted options to purchase 6,000 shares of common stock at
an exercise price of $1.90 per share, which was the estimated fair value of the
underlying common stock at the date
52
of grant. The expiration date of these options is November 15, 2011. None of
these options were exercisable at June 30, 2002.
Summary of Common Stock Option Transactions
(share amounts in thousands)
June 30, 2002 June 30, 2001 June 30, 2000
----------------------- ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Outstanding at beginning of year 76 $ 1.90 76 $ 1.90 1,593 $ 9.84
Grants 6 1.90 1 1.90 86 3.50
Exercised -- -- (42) 8.68
Converted into Series A junior
preferred stock options -- -- (828) 10.97
Extinguished and exchanged for
senior preferred stock and cash -- -- (725) 8.66
Canceled -- (1) 1.90 (8) 12.94
--------- --------- ---------
Outstanding at end of year 82 1.90 76 1.90 76 1.90
========= ========= =========
Exercisable at end of year 15 1.90 15 1.90 --
========= ========= =========
Weighted average fair value of
options granted during the year $ 0.37 $ 0.43 $ 0.53
========= ========= =========
In the merger, O'Sullivan issued options to purchase 60,318.67 shares
of its Series A junior preferred stock, par value $0.01 per share, in exchange
for certain options held by management participants in the buyout. All of these
options are currently vested and exercisable and expire on December 31, 2025.
The agreements for the options to purchase O'Sullivan's Series A junior
preferred stock provide for a special accrual at the rate of 14% per annum on
the difference between the liquidation value of the stock ($150.00 per share)
and the exercise price of the option ($50.00 per share). The special accrual
accrues at the same time and in the same manner as would dividends on issued and
outstanding shares of O'Sullivan's Series A junior preferred stock. No amount is
payable until the exercise of the option, and payment is further subject to the
terms of any debt agreement of O'Sullivan. When made, payment of the special
accrual may be made in cash or by a reduction in the exercise price for the
option. The special accrual approximated $1.1 million, $946,000 and $498,000 for
fiscal 2002, 2001 and fiscal 2000, respectively, and is included in selling,
marketing and administrative expense in the consolidated statements of
operations.
O'Sullivan has adopted the disclosure-only provisions of SFAS 123.
Accordingly, no compensation cost has been recognized for options granted except
as mentioned above. Had compensation cost for O'Sullivan's stock option plans
been determined based on the fair value at the grant date for awards in fiscal
2002, 2001 and
53
2000 in accordance with the provisions of SFAS 123, O'Sullivan's net income
(loss) would have been adjusted to the pro forma amounts indicated below (in
thousands):
Year Ended June 30,
-----------------------------------
2002 2001 2000
------- ------- -------
Net income (loss)
As reported $(7,832) $(7,938) $(3,165)
Pro forma (7,837) (7,942) 2,356
The fair value of each option on the date of grant is estimated using
the Black-Scholes option-pricing model based upon the following weighted average
assumptions:
2002 2001 2000
------ ----- -----
Risk-free interest rate 4.35% 5.09% 6.24%
Dividend yield None None None
Volatility factor 0.1% 0.1% 5.5%
Weighted average expected life (years) 5.0 5.0 3.6
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period.
NOTE 14 - EMPLOYEE BENEFIT PLANS.
O'Sullivan maintains a stock purchase program that is available to most
employees. The stock purchase program (the "SPP"), as amended, allows a maximum
employee contribution of 5%, while O'Sullivan's matching contribution is 25%,
40% or 50% of the employee's contribution, depending on the length of the
employee's participation in the program. Effective with the closing of the
recapitalization and merger, the program was amended to invest contributions in
a broad-based mutual fund. The matching contributions to the stock purchase
program were $640,000, $673,000 and $685,000 in fiscal years 2002, 2001 and
2000, respectively. O'Sullivan will terminate the SPP effective December 31,
2002.
O'Sullivan also has a Savings and Profit Sharing Plan in which most
employees are eligible to participate. Under the savings or Section 401(k)
portion of the plan, employees may contribute from 1% to 15% of their
compensation (subject to certain limitations imposed by the Internal Revenue
Code), and O'Sullivan makes matching contributions equal to 50% of the first 5%
of eligible employee contributions. The matching contribution will increase to
100% of the first 5% of eligible employee contributions effective January 1,
2003. Under the profit sharing portion of the plan, O'Sullivan may contribute
annually an amount determined by the Board of Directors. Employer matching
contributions vest immediately, while profit sharing contributions vest 100%
when the employee has five years of service with O'Sullivan. For fiscal 2002,
2001 and 2000, O'Sullivan accrued approximately $2.2 million, $0 and $2.5
million, respectively, for the profit sharing portion of the plan. The matching
contributions to the savings portion of the plan were $458,000, $600,000 and
$750,000 in fiscal years 2002, 2001 and 2000, respectively.
Effective July 1, 1997, O'Sullivan implemented its Deferred
Compensation Plan. This plan is available to employees of O'Sullivan deemed to
be "highly compensated employees" pursuant to the Internal Revenue Code.
O'Sullivan makes certain matching and profit sharing accruals to the accounts of
participants. All amounts deferred or accrued under the terms of the plan
represent unsecured obligations of O'Sullivan to the participants. Matching and
profit sharing accruals under this plan were not material in fiscal 2002, 2001
or 2000.
54
NOTE 15 - TERMINATION PROTECTION AGREEMENTS.
O'Sullivan has entered into Termination Protection Agreements with its
officers. These Termination Protection Agreements, all of which are
substantially similar, have initial terms of two years which automatically
extend to successive one-year periods unless terminated by either party. If the
employment of any of these officers is terminated, with certain exceptions,
within 24 months following a change in control, the officers are entitled to
receive certain cash payments, as well as the continuation of fringe benefits
for a period of up to twelve months. Additionally, all benefits under the
Savings and Profit Sharing Plan and the Deferred Compensation Plan vest, all
restrictions on any outstanding incentive awards or shares of restricted common
stock will lapse and such awards or shares will become fully vested, all
outstanding stock options will become fully vested and immediately exercisable,
and O'Sullivan will be required to purchase for cash, on demand made within 60
days following a change in control, any shares of unrestricted common stock and
options for shares at the then current per-share fair market value. The
agreements also provide one year of outplacement services for the officer and
that, if the officer moves more than 20 miles from his primary residence in
order to accept permanent employment within 36 months after leaving O'Sullivan,
O'Sullivan will, upon request, repurchase the officer's primary residence at a
price determined in accordance with the agreement.
Under the Termination Protection Agreements, a "Change in Control" will
be deemed to have occurred if either (i) any person or group acquires beneficial
ownership of 15% of the voting securities of O'Sullivan; (ii) there is a change
in the composition of a majority of the board of directors within any two-year
period which is not approved by certain of the directors who were directors at
the beginning of the two-year period; (iii) the stockholders of O'Sullivan
approve a merger, consolidation or reorganization involving O'Sullivan; (iv)
there is a complete liquidation or reorganization involving O'Sullivan; or (v)
O'Sullivan enters into an agreement for the sale or other disposition of all or
substantially all of the assets of O'Sullivan.
NOTE 16 - STOCKHOLDER RIGHTS PLAN.
O'Sullivan has adopted a Stockholder Rights Plan under which one right
(a "Right") was issued with respect to each share of common stock. Each Right
entitles the holder to purchase from O'Sullivan a unit consisting of one
one-thousandth of a share of Series A junior participating preferred stock at a
purchase price of $110 per Right, subject to adjustment in certain events.
The Rights are currently attached to all certificates representing
outstanding shares of common stock, and separate certificates for the Rights
will be distributed only upon the occurrence of certain specified events. The
Rights will separate from the common stock and a "Distribution Date" will occur
upon the earlier of (i) ten days following a public announcement that a person
or group of affiliated or associated persons (an "Acquiring Person") has
acquired, or obtained the right to acquire, beneficial ownership of 15% or more
of the outstanding shares of common stock, or (ii) ten business days (or such
later date as may be determined by O'Sullivan's Board of Directors before the
Distribution Date occurs) following the commencement of a tender offer or
exchange offer that would result in a person becoming an Acquiring Person.
The Rights Plan was amended in March 1999 to change the Rights Agent
and to conform the plan to recent Delaware court decisions. The Rights are not
exercisable until the Distribution Date and will expire at the close of business
on February 1, 2004, unless earlier redeemed or exchanged by O'Sullivan. In the
merger agreement discussed in note 4 above, O'Sullivan amended the stockholder
rights plan so that the recapitalization and merger did not trigger the Rights
Agreement.
NOTE 17 - RELATED PARTY TRANSACTIONS.
BRS. BRS provided various advisory services to O'Sullivan related to
the merger. These services included arranging and negotiating the financing of
the merger, arranging and structuring the transaction, planning O'Sullivan's
capital structure and related services. BRS received a transaction fee of $4.0
million from O'Sullivan and expenses of $62,000 for these services. Of the $4.0
million transaction fee, $3.0 million was
55
recognized as a merger related expense by O'Sullivan and $1.0 million was
capitalized into loan fees at O'Sullivan Industries.
BRS also provided $15.0 million in financing pursuant to a securities
purchase agreement with O'Sullivan. BRS received a transaction fee of $300,000
in connection with this financing, which was capitalized into loan fees at
O'Sullivan. BRS later sold this note and the related warrants to an unrelated
third party which received the $300,000 transaction fee from BRS.
O'Sullivan Industries entered into a management services agreement with
BRS for strategic and financial advisory services on November 30, 1999. The fee
for these services is the greater of (a) 1% of O'Sullivan Industries'
consolidated cash flow (as defined in the indenture related to the O'Sullivan
Industries senior subordinated notes) or (b) $300,000 per year. Under the
management services agreement, BRS can also receive reimbursement for expenses
which are limited to $50,000 a year by the senior credit facility.
The senior credit facility and the management services agreement both
contain certain restrictions on the payment of the management fee. The
management services agreement provides that no cash payment for the management
fee can be made unless the fixed charge coverage ratio (as defined in the
indenture relating to the O'Sullivan Industries senior subordinated notes) for
O'Sullivan Industries' most recently ended four full fiscal quarters would have
been at least 2.0 to 1.0. All fees and expenses under the management services
agreement are subordinated to the senior subordinated notes.
In September 2000, O'Sullivan paid BRS $682,000 under the management
services agreement, of which $266,000 was a prepayment of a portion of the
fiscal 2001 management fees. The management fee and other reimbursable costs of
$501,000, $536,000 and $364,000 recognized during fiscal years 2002, 2001 and
2000, respectively, are included in selling, marketing and administrative
expense in the consolidated statement of operations. The amounts due BRS at June
30, 2002 and June 30, 2001 approximated $719,000 and $218,000, respectively, and
are included in accrued liabilities on the consolidated balance sheets.
O'Sullivan paid BRS $713,000 in the first quarter of fiscal 2003 for the balance
owed through June 30, 2002 and $305,000 as a prepayment of the fiscal 2003
management fee.
At June 30, 2002, O'Sullivan held two notes receivable with a balance
of approximately $337,000 from employees of O'Sullivan. O'Sullivan loaned the
employees money to purchase common stock and Series B junior preferred stock of
O'Sullivan in the recapitalization and merger. The notes bear interest at the
rate of 9% per annum and mature on November 30, 2009, or earlier if there is a
change of control and is with full recourse to the employees. The receivables
are recorded on the O'Sullivan balance sheet as a reduction in stockholders'
equity.
NOTE 18 - COMMITMENTS AND CONTINGENCIES.
Leases. O'Sullivan leases warehouse space, computers and certain other
equipment under operating leases. As of June 30, 2002, minimum future lease
payments for all noncancellable lease agreements were as follows (in thousands):
2002 $1,398
2003 1,146
2004 806
2005 510
2006 316
Thereafter 0
------
Total $4,176
=======
Amounts incurred by O'Sullivan under operating leases (including
renewable monthly leases) were $1,912,000, $1,868,000 and $1,945,000 in fiscal
2002, 2001 and 2000, respectively.
56
Tax Sharing Agreement with RadioShack. Future tax sharing agreement
payments are contingent on taxable income. The maximum payments are fiscal 2003
- -- $11.0 million; fiscal 2004 -- $9.9 million; fiscal 2005 -- $10.5 million;
fiscal 2006 -- $11.3 million; and thereafter -- $41.4 million. See Note 12.
Litigation. O'Sullivan Industries is a party to various legal actions
arising in the ordinary course of its business. O'Sullivan does not believe that
any such pending actions will have a material adverse effect on its results of
operations, liquidity or financial position. O'Sullivan maintains liability
insurance at levels which it believes are adequate for its needs.
Regulatory Matters. O'Sullivan's operations are subject to extensive
federal, state and local laws, regulations and ordinances relating to the
generation, storage, handling, emission, transportation and discharge of certain
materials, substances and waste into the environment. Permits are required for
certain of O'Sullivan's operations and are subject to revocation, modification
and renewal by governmental authorities. In general, compliance with air
emission regulations is not expected to have a material adverse effect on
O'Sullivan's business, results of operations or financial condition.
O'Sullivan's manufacturing facilities ship waste product to various
disposal sites. O'Sullivan Industries has been designated as a potentially
responsible party under the Arkansas Remedial Action Trust Fund Act in
connection with the cost of cleaning up one site in Diaz, Arkansas and has
entered into a de minimis buyout agreement with certain other potentially
responsible parties, pursuant to which it has contributed $2,000 to date toward
cleanup costs. O'Sullivan believes that amounts it may be required to pay in the
future, if any, will be immaterial.
Retirement Agreement. In October 1998, O'Sullivan entered into a
Retirement and Consulting Agreement, Release and Waiver of Claims with Daniel F.
O'Sullivan. Under the retirement agreement, as amended in May 1999, Mr.
O'Sullivan resigned as Chief Executive Officer in October 1998 and retired as an
executive on March 31, 2000. O'Sullivan agreed to pay Mr. O'Sullivan $42,160 per
month for 36 months after his retirement and then to pay him $11,458 per month
until he reaches age 65. Payments under Mr. O'Sullivan's retirement and
consulting agreement amount to an aggregate of $2.2 million and a present value
of approximately $1.9 million. During this period, Mr. O'Sullivan is required to
provide consulting, marketing and promotional services with respect to
O'Sullivan's manufacturing activities and relations with major customers, if
requested by O'Sullivan, from time to time. Mr. O'Sullivan has agreed not to
compete with O'Sullivan during the period he is a consultant. O'Sullivan will
also provide Mr. O'Sullivan with health insurance during the term of the
agreement and thereafter until he becomes eligible for Medicare and life
insurance during the term of the agreement.
NOTE 19 - MAJOR CUSTOMERS.
Sales to three customers exceeded 10% of gross sales. Sales to such
customers as a percentage of gross sales were:
Year ended June 30,
-------------------------
2002 2001 2000
------ ----- -----
Customer A 19% 19% 22%
Customer B 14% 17% 18%
Customer C 12% 11% 11%
57
NOTE 20 - QUARTERLY OPERATING RESULTS - UNAUDITED.
(in thousands)
---------------------------------------------------
Fiscal 2002 (By Quarter)
---------------------------------------------------
1 2 3 4
-------- -------- -------- --------
Net sales(1) $ 82,193 $ 84,314 $105,467 $ 77,124
Gross profit(1) 20,468 21,665 30,507 21,796
Net income (loss) (1,436) 1,136 (7,282)(2) (250)(2)
Fiscal 2001 (By Quarter)
---------------------------------------------------
1 2 3 4
-------- -------- -------- --------
Net sales(1) $ 85,027 $ 91,940 $ 97,636 $ 84,208
Gross profit(1) 18,852 22,074 25,091 23,074
Net income (loss) (2,388) (7,486)(3) 979 957
- -----------------------------------------
(1) Net sales, gross profit and selling, marketing and administrative
expense for the fiscal year ended June 30, 2001 and the first and second
quarters of fiscal 2002 have been adjusted to reflect a new accounting
pronouncement which requires a reclassification of certain selling expenses to a
reduction of net sales.
(2) The third and fourth quarters of fiscal 2002 include income tax
expense of $13.4 million and $3.1 million, respectively, resulting from
valuation allowances recorded in connection with the settlement of the
RadioShack arbitration.
(3) Amount includes a restructuring charge of $10.5 million ($6.8
million, after-tax) primarily related to the closing of the Utah manufacturing
facility.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following sets forth certain information with respect to the
business experience of each Director of O'Sullivan during the past five years
and certain other directorships held by each Director. References to service
with O'Sullivan in this section include service with O'Sullivan Industries.
CLASS I DIRECTORS--TERM EXPIRING 2003.
Charles A. Carroll, 53, became President and Chief Executive Officer of Goodman
Global Holdings, Inc., a manufacturer of air conditioning and heating equipment,
in September 2001. Prior to that, he served for two years as President and Chief
Executive Officer of Goodman Global's Amana Appliances Division until its sale
by Goodman Global to Maytag. From 1993 to 1999, Mr. Carroll was President and
Chief Operating Officer and a director of Rubbermaid, Inc. Mr. Carroll was
appointed a Director of O'Sullivan Holdings, O'Sullivan Industries and
O'Sullivan - Virginia in July 2001.
Richard D. Davidson, 54, was promoted to President and Chief Executive Officer
of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries -
Virginia in January 2000. He was named President and Chief
58
Operating Officer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia in July 1996. He was named a Director of O'Sullivan
Industries and O'Sullivan Industries - Virginia in July 1996 and of O'Sullivan
Holdings in August 1996. He has also served as President and Chief Executive
Officer and a director of O'Sullivan Furniture Factory Outlet, Inc., a
subsidiary of O'Sullivan Industries, since March 2002.
CLASS II DIRECTOR--TERM EXPIRING 2004.
Harold O. Rosser, 53, was appointed a director of O'Sullivan Holdings,
O'Sullivan Industries and O'Sullivan Industries - Virginia in connection with
the merger and recapitalization in November 1999. Mr. Rosser has been a
principal of BRS since August 1995. Mr. Rosser was an officer of Citicorp
Venture Capital from 1987 through July 1995. He is a director of Acapulco
Restaurants, Inc., American Paper Group, Inc., California Pizza Kitchen, Inc.,
H&E Equipment Services, LLC, II Fornaio (America) Corporation, McCormick and
Schmick Restaurant Corp. and Penhall International, Inc.
CLASS III DIRECTOR--TERM EXPIRING 2002.
Daniel F. O'Sullivan, 61, was named President, Chief Executive Officer and a
Director of O'Sullivan Holdings in November 1993 and became Chairman of the
Board in December 1993. He relinquished the position of President of O'Sullivan
Holdings in July 1996 and resigned as Chief Executive Officer in October 1998.
He served as President of O'Sullivan Industries from 1986 until July 1996, and
was appointed Chairman of the Board and Chief Executive Officer in 1994. He also
served as Chairman of the Board and Chief Executive Officer of O'Sullivan
Industries - Virginia. Mr. O'Sullivan was employed by O'Sullivan from 1962 until
his retirement. Under the terms of his retirement and consulting agreement with
O'Sullivan Holdings, Mr. O'Sullivan retired as an executive of O'Sullivan
Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia effective
March 31, 2000. He remains as non-executive Chairman of the Board for each
company.
EXECUTIVE OFFICERS.
O'Sullivan's executive officers, and their ages and positions with
O'Sullivan as of September 1, 2002, are as follows:
OFFICE
NAME AGE SINCE(1) POSITION(S)
- ---- --- -------- -----------
Richard D. Davidson 54 1996 President and Chief Executive Officer and Director
Tyrone E. Riegel 59 1969 Executive Vice President
Phillip J. Pacey 37 1999 Senior Vice President and Chief Financial Officer
Thomas M. O'Sullivan, Jr. 47 1993 Senior Vice President-Sales
Michael P. O'Sullivan 43 1995 Senior Vice President-Marketing
Rowland H. Geddie, III 48 1993 Vice President, General Counsel and Secretary
E. Thomas Riegel 58 1993 Vice President-Strategic Operations
James C. Hillman 57 1973 Vice President-Human Resources
Tommy W. Thieman 51 1999 Vice President-Manufacturing-Lamar
Stuart D. Schotte 40 1999 Vice President-Supply Chain Management
Neal C. Ruggeberg 45 2002 Vice President and Chief Information Officer
- ---------------------------------
(1)Includes officer positions held with O'Sullivan Industries
Tyrone E. Riegel has been Executive Vice President of O'Sullivan
Industries since July 1986 and served as a Director from March 1994 through
November 1999. He was appointed as Executive Vice President and a Director of
O'Sullivan Holdings in November 1993. His service as a director of O'Sullivan
Holdings ended November 1999. Mr. Riegel also serves as Executive Vice President
of O'Sullivan Industries - Virginia. Mr. Riegel has been employed by O'Sullivan
since January 1964. Since March 2002, he has served as Executive Vice President
and a Director of O'Sullivan Furniture Factory Outlet, Inc.
59
Phillip J. Pacey was promoted to Senior Vice President and Chief
Financial Officer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia in January 2000. He was appointed Vice President-Finance
and Treasurer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia in July 1999. From November 1995 until July 1999, he
served as Treasurer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. Since March 2002, he has served as Senior Vice President
and Chief Financial Officer and a Director of O'Sullivan Furniture Factory
Outlet, Inc.
Thomas M. O'Sullivan, Jr. was promoted to Senior Vice President-Sales
of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries -
Virginia in January 2000. He had been Vice President-Sales of O'Sullivan
Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia since
1993. Since March 2002, he has served as Senior Vice President-Sales and a
Director of O'Sullivan Furniture Factory Outlet, Inc. Mr. O'Sullivan has been
employed by O'Sullivan since June 1979.
Michael P. O'Sullivan was named Senior Vice President-Marketing of
O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia
in January 2000. He had been Vice President-Marketing of O'Sullivan Holdings,
O'Sullivan Industries and O'Sullivan Industries - Virginia since November 1995.
He served as National Sales Manager of O'Sullivan Industries and O'Sullivan
Industries - Virginia from July 1993 until November 1995. He is also Senior Vice
President-Marketing of O'Sullivan Furniture Factory Outlet, Inc. Mr. O'Sullivan
has been employed by O'Sullivan since 1984.
Rowland H. Geddie, III has been Vice President, General Counsel and
Secretary of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia since December 1993. He served as a Director of O'Sullivan
Industries and O'Sullivan Industries - Virginia from March 1994 through November
1999. Since March 2002, he has served as Vice President, General Counsel and
Secretary and a Director of O'Sullivan Furniture Factory Outlet, Inc.
E. Thomas Riegel has been Vice President-Strategic Operations of
O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia
since November 1995. From June 1993 until November 1995, he was Vice
President-Marketing of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. He is also Vice President-Strategic Operations of
O'Sullivan Furniture Factory Outlet, Inc. Mr. Riegel has been employed by
O'Sullivan since May 1971.
James C. Hillman has been Vice President-Human Resources of O'Sullivan
Holdings since November 1993 and of O'Sullivan Industries since 1980. He also
serves as Vice President-Human Resources of O'Sullivan Industries - Virginia and
O'Sullivan Furniture Factory Outlet, Inc. Mr. Hillman has been employed by
O'Sullivan since May 1971.
Tommy W. Thieman was appointed Vice President-Manufacturing-Lamar in
July 1999 for O'Sullivan Holdings and O'Sullivan Industries. Since 1987, he has
served as the Plant Manager in Lamar for O'Sullivan Industries. Mr. Thieman has
been employed by O'Sullivan since 1972.
Stuart D. Schotte was appointed Vice President-Supply Chain Management
in July 1999 for O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. From February 1998 to July 1999, Mr. Schotte served as
Controller for O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. From July 1996 until February 1998, Mr. Schotte served as
Director of Financial Analysis and Planning for Fast Food Merchandisers, Inc.
Since March 2002, he has also served as Vice President-Supply Chain Management
for O'Sullivan Furniture Factory Outlet, Inc.
Neal C. Ruggeberg was promoted to Vice President and Chief Information
Officer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries
- - Virginia in July 2002. From 1996 to July 2002, Mr. Ruggeberg has served as
Director of Information Services for O'Sullivan Industries and O'Sullivan
Industries - Virginia.
60
CERTAIN RELATIONSHIPS. Daniel F. O'Sullivan, Thomas M. O'Sullivan, Jr.
and Michael P. O'Sullivan are brothers. Tommy W. Thieman is the brother-in-law
of Daniel F. O'Sullivan, Thomas M. O'Sullivan, Jr. and Michael P. O'Sullivan.
Tyrone E. Riegel and James C. Hillman were, prior to the deaths of their
respective spouses, brothers-in-law of Daniel F. O'Sullivan, Thomas M.
O'Sullivan, Jr. and Michael P. O'Sullivan. Tyrone E. Riegel and E. Thomas Riegel
are brothers.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table reflects the cash and non-cash compensation for the
chief executive officer of O'Sullivan and the four next most highly compensated
executive officers at June 30, 2002.
LONG-TERM
ANNUAL COMPENSATION(1) COMPENSATION
---------------------- ----------------
SECURITIES ALL OTHER
NAME AND PRINCIPAL FISCAL SALARY BONUS UNDERLYING STOCK COMPENSATION
POSITION YEAR ($) ($) OPTIONS(#)(2) ($)(3)
- ------------------ ------ -------- -------- ---------------- -------------
Richard D. Davidson 2002 300,000 199,800 -- 31,281
President and 2001 297,885 105,000 -- 49,896
Chief Executive Officer 2000 244,231 176,623 8,500 45,984
Tyrone E. Riegel 2002 231,200 110,120 -- 25,872
Executive Vice President 2001 212,885 53,300 -- 39,603
2000 204,616 109,586 4,000 39,860
Thomas M. O'Sullivan, Jr 2002 160,000 76,300 -- 19,351
Senior Vice President-Sales 2001 159,423 40,000 -- 28,067
2000 144,423 66,005 4,000 26,181
Phillip J. Pacey 2002 150,000 81,550 -- 18,220
Senior Vice President and 2001 149,615 37,500 -- 24,970
Chief Financial Officer 2000 123,808 59,074 4,000 20,284
Michael P. O'Sullivan 2002 140,400 66,990 -- 17,653
Senior Vice President- 2001 140,192 35,100 -- 25,876
Marketing 2000 134,423 61,473 4,000 24,807
- -----------------------------------------
(1)For the years shown, the named officers did not receive any annual
compensation not properly categorized as salary or bonus, except for certain
perquisites and other personal benefits. The amounts for perquisites and other
personal benefits for the named officers are not shown because the aggregate
amount of such compensation, if any, for each of the named officers during the
fiscal year shown does not exceed the lesser of $50,000 or 10% of total salary
and bonus reported for such officer.
(2)Includes all options granted to the named officers during fiscal
years shown under O'Sullivan's 2000 Common Stock Option Plan. No stock
appreciation rights were granted with any options.
(Footnotes are continued on the following page.)
61
(3) In fiscal 2002, other compensation for the named officers consisted
of the following:
STOCK
PURCHASE
GROUP PROGRAM DEFERRED
LIFE SPSP ("SPP") COMPENSATION
INSURANCE AUTO MATCHING MATCHING PLAN MATCHING
NAME PREMIUMS ALLOWANCE CONTRIBUTIONS CONTRIBUTIONS CONTRIBUTIONS
- ---- --------- --------- ------------- ------------- ----------------
Richard D. Davidson $2,016 $9,000 $3,625 $10,132 $6,507
Tyrone E. Riegel $4,032 $8,500 $3,623 $ 6,670 $3,048
Thomas M. O'Sullivan, Jr. $ 835 $8,500 $3,623 $ 5,008 $1,385
Phillip J. Pacey $ 330 $8,500 $3,625 $ 4,695 $1,070
Michael P. O'Sullivan $ 363 $8,500 $3,720 $ 4,395 $ 675
The table does not include amounts payable in the event of a Change in
Control. See "Change in Control Protections".
OPTION GRANTS IN THE LAST YEAR
During the fiscal year ended June 30, 2002, no options were granted to
the named officers.
OPTION EXERCISES IN THE LAST YEAR
AND YEAR-END OPTION VALUES
No options were exercised by the named officers in fiscal 2002. The
following table summarizes information regarding outstanding options to purchase
stock held by the named officers as of June 30, 2002. All options to purchase
Series A junior preferred stock are vested and exercisable.
SERIES A JUNIOR
COMMON STOCK PREFERRED STOCK
--------------------------------------------------- ----------------------------
VALUE OF
OPTION VALUE OF UNEXERCIS-
OPTION SHARES EXERCIS- ABLE OPTION VALUE OF
SHARES UNEXERCIS- ABLE OPTIONS SHARES EXERCISABLE
EXERCISABLE ABLE AT OPTIONS AT AT EXERCISABLE OPTIONS
NAME AT 6/30/02 6/30/02 6/30/02 6/30/02 AT 6/30/02 AT 6/30/02
- ---- ----------- ---------- ---------- ---------- ----------- -------------
Richard D. Davidson 1,700 6,800 $-- $-- 10,929 $1,550,772
Tyrone E. Riegel 800 3,200 $-- $-- 3,378 $ 479,261
Thomas M. O'Sullivan, Jr. 800 3,200 $-- $-- 5,996 $ 850,827
Phillip J. Pacey 800 3,200 $-- $-- 1,411 $ 200,268
Michael P. O'Sullivan 800 3,200 $-- $-- 6,176 $ 876,313
62
CHANGE IN CONTROL PROTECTIONS
O'Sullivan has termination agreements with its executive officers. If
the employment of a protected employee is terminated by us within a period of up
to 24 months after a change in control, the employee will be entitled to receive
various benefits. The completion of the merger was a change of control for
purposes of these agreements. These benefits include:
1. a cash payment equal to the current base salary and highest bonus
received in the previous three years;
2. a cash payment equal to the bonus earned by the employee in the year
of termination, calculated on a pro rated basis on the date of
termination;
3. a cash payment equal to accrued and unpaid vacation pay;
4. a cash payment for an automobile allowance of 12 months;
5. continued life and health insurance coverage for up to 12 months;
6. a lump sum payment, adjusted for taxes, to the employee in an amount
equal to the protected employee's unvested profit sharing account in
the Savings and Profit Sharing Plan;
7. a cash payment based on the amount that the protected employee would
have received under our Deferred Compensation Plan had he continued
to work for O'Sullivan until he attained the age of 65;
8. all outstanding stock options vest and become immediately
exercisable;
9. O'Sullivan will be required to purchase for cash any shares of
unrestricted common stock and options for shares at the fair market
value;
10. one year of outplacement services;
11. for certain executive officers, if the protected employee moves more
than 20 miles from his primary residence in order to accept
permanent employment within 36 months after leaving O'Sullivan, we
will repurchase the employee's primary residence; and
12. if the executive officer is required to pay an excise tax under
Section 4999 of the Internal Revenue code of 1986, we will pay the
employee an additional amount to offset the effect of the tax.
The agreements for certain executive officers also provide for cash
payments in lieu of matching payments under the Stock Purchase Program and the
Savings and Profit Sharing Plan. The agreements for certain executive officers
also provide that, in some circumstances, they may voluntarily leave our
employment after a change in control and receive the benefits under the
protection agreements. These circumstances include:
- an adverse change in the executive's status, title or duties;
- a reduction in the executive's salary or bonus;
- relocation of the executive's office to a site which is more than 20
miles from its present location;
- a reduction in the executive's benefit levels;
- the insolvency or bankruptcy of O'Sullivan; or
- the executive leaves the employment of O'Sullivan for any reason
during the 60-day period beginning on the first anniversary of the
change in control.
However, for purposes of the recapitalization and merger, each of the
executive officers waived his right to receive benefits under the protection
agreements in these circumstances, other than a reduction in his salary or
bonus.
63
The table below sets forth the total payments that may be received by
each of the named officers if these persons are terminated during fiscal 2003,
assuming the provisions of his Termination Protection Agreement were applicable.
The values of non-cash benefits have been included on the basis of their
estimated fair value. These amounts do not include any payments to be received
for shares of O'Sullivan stock or options to acquire O'Sullivan stock. These
amounts also do not include payments which we would make to offset the effect of
excise taxes or to purchase any officer's home. We have assumed for this purpose
that the named officers are terminated on September 30, 2002.
OFFICER AMOUNT
- ------- ---------
Richard D. Davidson............................................................................ $790,363
President and Chief Executive Officer
Tyrone E. Riegel............................................................................... $481,394
Executive Vice President
Thomas M. O'Sullivan, Jr....................................................................... $378,931
Senior Vice President-Sales
Phillip J. Pacey............................................................................... $376,814
Senior Vice President and Chief Financial Officer
Michael P. O'Sullivan.......................................................................... $330,845
Senior Vice President-Marketing
COMPENSATION COMMITTEE INTERLOCKS
AND INSIDER PARTICIPATION
The members of the Compensation Committee are Harold O. Rosser and
Charles A. Carroll. No member of the Compensation Committee was an officer or
employee of O'Sullivan or its subsidiaries during the fiscal year ended June 30,
2002. Neither was formerly an officer of O'Sullivan or any of its subsidiaries.
In addition, no executive officer of O'Sullivan serves on the board of directors
or the compensation committee of another entity where a committee member is
employed.
DIRECTORS' COMPENSATION
Directors of O'Sullivan who are not employees of O'Sullivan or its
subsidiaries or of BRS are paid $2,500 per meeting (with all meetings that occur
on the same day being considered as one meeting). The chairmen of the
compensation committee and the audit committee each receive an additional $1,000
per year if not employed by BRS. Expenses of attendance at meetings are paid by
O'Sullivan. Directors who are not employees of O'Sullivan or BRS will also
receive an option to purchase shares of common stock of O'Sullivan. Employees of
O'Sullivan do not receive additional compensation for their service as a
director other than payment of expenses, if any, to attend a meeting.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, O'Sullivan Holdings'
directors, executives and any persons holding 10% or more of Common Stock are
required to report their ownership of O'Sullivan Holdings' securities and any
change in that ownership to the Securities and Exchange Commission. Specific due
dates for these reports have been established and we are required to report in
this report any failure to file by these dates during the fiscal year ended June
30, 2002. All of these filing requirements were satisfied by our directors and
executives during fiscal 2002.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth, as of September 15, 2002, certain
information with respect to the beneficial ownership of the securities of
O'Sullivan Holdings by (i) each of our directors, (ii) each of the named
64
executives, (iii) our executives and directors as a group and (iv) the only
other owner of five percent of any class of O'Sullivan Holdings' equity
securities known to us.
COMMON STOCK SENIOR PREFERRED STOCK
---------------------- --------------------------
NAME OF BENEFICIAL OWNER SHARES % SHARES %
- ------------------------ --------- ------ ------- ------
BRS(1) 994,998(2) 72.73% -- --
Harold O. Rosser 994,998(2) 72.73% -- --
Charles A. Carroll 2,000(3) 0.15% -- --
Daniel F. O'Sullivan 9,972 0.73% 197,681 1.20%
Richard D. Davidson 83,249(4) 6.08% 14,707(4) (5)
Tyrone E. Riegel 22,065(6) 1.61% 101,806 (5)
Thomas M. O'Sullivan, Jr. 34,951(7) 2.55% 23,963 (5)
Phillip J. Pacey 12,549(7) 0.92% 29,590 (5)
Michael P. O'Sullivan 32,105(7) 2.35% 32,303 (5)
Directors and executive
officers as a group (14
persons) 1,298,149(8) 94.20% 464,046 2.82%
BancBoston Investments,
Inc. 93,273(9) 6.38% -- --
OPTIONS TO
PURCHASE SERIES
A JUNIOR SERIES B JUNIOR
PREFERRED STOCK PREFERRED STOCK
------------------- ---------------------
NAME OF BENEFICIAL OWNER OPTIONS % SHARES %
- ------------------------ ------- ------- ------- -----
BRS(1) -- -- 442,223(2) 83.59%
Harold O. Rosser -- -- 442,223(2) 83.59%
Charles A. Carroll -- -- -- --
Daniel F. O'Sullivan 4,432 7.35% -- --
Richard D. Davidson 10,929 18.12% 20,839(4) 3.94%
Tyrone E. Riegel 3,378 5.60% 3,644 (5)
Thomas M. O'Sullivan, Jr 5,996 9.94% 6,561(6) 1.24%
Phillip J. Pacey 1,411 2.34% 1,722 (5)
Michael P. O'Sullivan 6,176 10.24% 5,117 (5)
Directors and executive
officers as a group (14
persons) 52,539 87.10% 495,295(8) 93.63%
BancBoston Investments,
Inc. -- -- 39,273(9) 6.91%
- --------
(1)The principals of BRS' general partner are Bruce C. Bruckmann,
Harold O. Rosser, Stephen C. Sherrill, Thomas J. Baldwin and Paul D. Kaminski,
each of whom could be deemed to beneficially own the shares of O'Sullivan
Holdings held by BRS.
(2)BRS holds 989,617 shares of common stock and 439,831 shares of
Series B junior preferred stock. BRS's general partner holds 5,385 shares of
common stock and 2,392 shares of Series B junior preferred stock. All of these
shares of common and Series B junior preferred stock may be deemed to be
beneficially owned by Harold O. Rosser, a Director of O'Sullivan.
(3)These shares are issuable upon the exercise of options.
(4)Includes 77,533 shares of common stock, 19,054 shares of Series B
junior preferred stock and 13,874 shares of senior preferred stock held in a
limited partnership of which Mr. Davidson and his wife are the general partners.
Also includes 1,700 shares of common stock issuable upon the exercise of
options.
(5)Less than one percent.
(6)Includes 16,423 shares of common stock and 1,503 shares of Series B
junior preferred stock held in a trust of which Mr. Riegel is the trustee. Also
includes 800 shares of common stock issuable upon the exercise of options.
(7)Includes 800 shares of common stock issuable upon the exercise of
options.
(8)Includes the shares held by BRS and its general partner described in
note 2. Also includes 7,900 shares of common stock issuable upon the exercise of
options. In addition, includes the partnership and trust shares described in
notes 4 and 6, respectively.
(9)BancBoston Investments, Inc. holds warrants to purchase these
shares.
65
Each management participant has a business address at 1900 Gulf Street,
Lamar, Missouri 64759-1899. BRS' address is 126 East 56th Street, 29th Floor,
New York, New York 10022. Mr. Carroll's address is 2550 North Loop West, Suite
400, Houston, Texas 77092. BancBoston Investments, Inc.'s address is 175 Federal
Street, 10th Floor, Boston, Massachusetts 02110. BancBoston Investments, Inc. is
a subsidiary of Fleet Boston Financial Corporation, a publicly held corporation.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth the number of shares issuable upon
exercise of outstanding options pursuant to O'Sullivan's 1999 Preferred Stock
Option Plan, 2000 Common Stock Option Plan and 2001 Director Common Stock Option
Plan at June 30, 2002. Each of these plans has been approved by O'Sullivan's
Board of Directors, including two directors representing BRS, the holder of 71%
of our outstanding common stock. However, none of these plans has been submitted
to our stockholders for approval. We do not have any warrants or rights issuable
pursuant to compensation plans.
NUMBER OF WEIGHTED- NUMBER OF SECURITIES
SECURITIES TO BE AVERAGE REMAINING AVAILABLE FOR FUTURE
ISSUED UPON EXERCISE ISSUANCE UNDER EQUITY
EQUITY COMPENSATION PLANS EXERCISE OF PRICE OF COMPENSATION PLANS
NOT APPROVED BY SECURITY OUTSTANDING OUTSTANDING (EXCLUDING SECURITIES REFLECTED
HOLDERS OPTIONS OPTIONS IN SECOND COLUMN)
- ------------------------- ---------------- ----------- --------------------------------
Common Stock 82,100 $ 1.90 14,718
Series A Junior Preferred Stock 60,319 $50.00 --
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During fiscal 2002 through October 29, 2001, Casey O'Sullivan, a son of
Daniel F. O'Sullivan, worked as a salesman for Bennett Packaging, which provides
O'Sullivan corrugated boxes for its products. Bennett Packaging has long been
one of O'Sullivan's suppliers; O'Sullivan paid Bennett $1.4 million from July 1,
2001 through October 29, 2001. Bennett remains a supplier to O'Sullivan. In
November 2001, Casey O'Sullivan commenced work at Sun Container, another
pre-existing supplier of corrugated boxes to O'Sullivan. From November 2001
through June 30, 2002, O'Sullivan paid Sun $2.2 million for corrugated boxes. We
have followed the practice of awarding purchase orders for cartons for a model
to the lowest bidder for the carton. Mr. Casey O'Sullivan's relationships with
Bennett and Sun have been approved pursuant to O'Sullivan's conflict of interest
policy.
Ryan Fullerton, a son-in-law of Tom Riegel, also works for Sun
Container, although he does not call on O'Sullivan. During fiscal 2002,
O'Sullivan paid Sun $3.3 million. This relationship has been approved pursuant
to O'Sullivan's conflict of interest policy.
In connection with the November 1999 recapitalization and merger,
O'Sullivan loaned Stuart D. Schotte, Vice President-Supply Chain Management,
$256,830.94 to purchase O'Sullivan Holdings common stock and Series B junior
preferred stock. The loan bears interest at 9% per annum simple interest and is
payable on November 30, 2009 or earlier if there is a change in control of
O'Sullivan Holdings. The note is with full recourse to Mr. Schotte. During the
fiscal year ended June 30, 2002, the largest amount outstanding under the note,
including principal and interest, was $308,343; the amount outstanding at
September 1, 2002, was $293,590 including principal and interest.
BRS TRANSACTION FEES
BRS provided various advisory services to us related to the
recapitalization and merger. These services included arranging and negotiating
the financing of the recapitalization and merger, arranging and structuring the
66
transaction, including forming OSI, planning its capital structure, planning our
capital structure and related services. For these services, BRS received a
transaction fee of $4.0 million plus $62,000 in expenses upon completion of the
recapitalization and merger.
BRS also provided $15.0 million of financing pursuant to a securities
purchase agreement with O'Sullivan Holdings. BRS received a transaction fee of
$300,000 in connection with its provision of this financing. BRS subsequently
sold the securities it acquired under this agreement to BancBoston Investments,
Inc.
BRS MANAGEMENT SERVICES AGREEMENT
In connection with the merger, O'Sullivan Industries entered into a
management services agreement with BRS. Under the terms of this agreement, BRS
provides:
- general management services;
- assistance with the negotiation and analysis of financial
alternatives; and
- other services agreed upon by BRS.
In exchange for these services, BRS will earn an annual fee equal to the greater
of:
- 1.0% of O'Sullivan Industries' annual consolidated cash flow (as
defined in the indenture related to the O'Sullivan Industries senior
subordinated notes); or
- $300,000.
In addition to certain restrictions on the payment of the management
fee contained in the senior credit facility, the management services agreement
contains certain restrictions on the payment of that fee. The management
services agreement, among other things, provides that no cash payment of the
management fee will be made unless the fixed charge coverage ratio (as defined
in the indenture related to the O'Sullivan Industries senior subordinated notes)
for our most recently ended four full fiscal quarters for which internal
financial statements are available to management immediately preceding the date
when the management fee is to be paid is at least 2.0 to 1. The management
services agreement also provides that the payment of all fees and other
obligations under the management services agreement will be subordinated to the
prior payment in full in cash of all interest, principal and other obligations
on O'Sullivan Industries' senior subordinated notes in the event of a
bankruptcy, liquidation or winding-up of O'Sullivan Industries.
Pursuant to the management services agreement, O'Sullivan paid BRS
$1,017,817 in the first quarter of fiscal 2003, representing payments of
$206,150 for the remaining portion of the fee for fiscal 2001, the $459,890
payment for the fiscal 2002 fee, expenses of $47,216 for periods through fiscal
2002 and $304,561 as a prepayment of the fees and expenses for the first six
months of fiscal 2003.
SEVERANCE AGREEMENT
In October 1998, O'Sullivan Holdings entered into a Retirement and
Consulting Agreement, Release and Waiver of Claims with Daniel F. O'Sullivan.
Under the retirement agreement, as amended in May 1999, Mr. O'Sullivan resigned
as Chief Executive Officer in October 1998 and retired as an executive on March
31, 2000. O'Sullivan Holdings agreed to pay Mr. O'Sullivan $42,160 per month for
36 months after his retirement and then to pay him $11,458 per month until he
reaches age 65. Payments under Mr. O'Sullivan's retirement and consulting
agreement amount to an aggregate of $2.2 million and a present value of
approximately $1.9 million. During this period, Mr. O'Sullivan is required to
provide consulting, marketing and promotional services with respect to our
manufacturing activities and relations with major customers, if requested by us,
from time to time. Mr. O'Sullivan has agreed not to compete with us during the
period he is a consultant. O'Sullivan Holdings will also provide Mr. O'Sullivan
with health insurance during the term of the agreement and thereafter until he
becomes eligible for Medicare and life insurance during the term of the
agreement.
67
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following consolidated statements of O'Sullivan Industries
Holdings, Inc. and subsidiaries are filed as part of this report:
Report of Independent Accountants ........................................................ 41
Consolidated Balance Sheets as of June 30, 2002 and 2001 ................................. 42
Consolidated Statements of Operations for each of the three
years in the period ended June 30, 2002 .................................................. 43
Consolidated Statements of Cash Flows for each of the three
years in the period ended June 30, 2002 .................................................. 44
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for each of the three years in the period ended June 30, 2002 ............................ 45
Notes to Consolidated Financial Statements ............................................... 46
(a)(2) Financial Statements Schedules
Schedules have been omitted because they are not required or are not
applicable or the information required to be set forth therein either is not
material or is included in the financial statements or notes thereto.
(a)(3) Exhibits:
A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits, which immediately precedes such exhibits, and is
incorporated herein by reference.
(b) Reports on Form 8-K
None
68
SIGNATURES
Pursuant to the requirements of Sections 13 and 15(d) 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, on the 25th day of
September, 2002.
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
By /s/ Richard D. Davidson
-------------------------------------
Richard D. Davidson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Daniel F. O'Sullivan Chairman of the Board September 25, 2002
- -------------------------
Daniel F. O'Sullivan
/s/ Richard D. Davidson President and Chief Executive Officer September 25, 2002
- ------------------------- and Director
Richard D. Davidson (Principal Executive Officer)
/s/ Phillip J. Pacey Senior Vice President and September 25, 2002
- ------------------------- Chief Financial Officer
Phillip J. Pacey (Principal Financial and Accounting Officer)
/s/ Charles A. Carroll Director September 25, 2002
- -------------------------
Charles A. Carroll
/s/ Harold O. Rosser Director September 25, 2002
- -------------------------
Harold O. Rosser
69
CERTIFICATION
I, Richard D. Davidson, certify that:
1. I have reviewed this annual report on Form 10-K of O'Sullivan Industries
Holdings, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: September 25, 2002 /s/ Richard D. Davidson
-------------------------------------
Richard D. Davidson
President and Chief Executive Officer
70
CERTIFICATION
I, Phillip J. Pacey, certify that:
1. I have reviewed this annual report on Form 10-K of O'Sullivan Industries
Holdings, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: September 25, 2002 /s/ Phillip J. Pacey
-------------------------
Phillip J. Pacey
Senior Vice President and
Chief Financial Officer
71
INDEX TO EXHIBITS
EXHIBIT PAGE
NO. DESCRIPTION NO.
- ------- ------------ -----
2.1 Amended and Restated Agreement of Merger dated as of October 18, 1999
by and among OSI Acquisition, Inc. and O'Sullivan Holdings
(incorporated by reference to Appendix A to Proxy Statement /Prospectus
included in Registration Statement on Form S-4 (File No. 333-81631))
3.1& Amended and Restated Certificate of Incorporation of O'Sullivan
4.1 Holdings (incorporated by reference to Exhibit 2.4(a) to Appendix A to
Proxy Statement /Prospectus included in Registration Statement on Form
S-4 (File No. 333-81631))
3.2& By-laws of O'Sullivan Holdings (incorporated by reference to Exhibit
4.2 3.2 to Registration Statement on Form S-1 (File No. 33-72120))
4.3 Indenture dated as of November 30, 1999 by and among O'Sullivan
Industries, O'Sullivan Industries - Virginia as Guarantor and the
Norwest Bank of Minnesota, National Association, as Trustee
(incorporated by reference to Exhibit 4.4 to Quarterly Report on Form
10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
4.4 Warrant Agreement dated as of November 30, 1999 between O'Sullivan
Holdings and Norwest Bank Minnesota, National Association, as Warrant
Agent, relating to warrants to purchase 39,273 shares of O'Sullivan
Holdings Series B junior preferred stock, including form of warrant
certificate (incorporated by reference to Exhibit 4.5 to Quarterly
Report Form 10-Q of O'Sullivan Holdings for the quarter ended December
31, 1999 (File No. 0-28493))
4.5 Warrant Agreement dated as of November 30, 1999 between O'Sullivan
Holdings and Norwest Bank Minnesota, National Association, as Warrant
Agent, relating to warrants to purchase 93,273 shares of O'Sullivan
Holdings common stock, including form of warrant certificate
(incorporated by reference to Exhibit 4.6 to Quarterly Report Form 10-Q
of O'Sullivan Holdings for the quarter ended December 31, 1999 (File
No. 0-28493))
4.6 Amended and Restated Warrant Agreement dated as of January 31, 2000
between O'Sullivan Holdings and the holder thereof relating to warrants
to purchase 39,273 shares of O'Sullivan Holdings Series B junior
preferred stock, including form of warrant certificate (incorporated by
reference to Exhibit 4.7 to Quarterly Report Form 10-Q of O'Sullivan
Holdings for the quarter ended December 31, 1999 (File No. 0-28493))
4.7 Amended and Restated Warrant Agreement dated as of January 31, 2000
between O'Sullivan Industries Holdings, Inc. and the holder thereof
relating to warrants to purchase 93,273 shares of O'Sullivan Industries
Holdings, Inc. common stock, including form of warrant certificate
(incorporated by reference to Exhibit 4.8 to Quarterly Report Form 10-Q
of O'Sullivan Industries Holdings, Inc. for the quarter ended December
31, 1999 (File No. 0-28493))
72
EXHIBIT PAGE
NO. DESCRIPTION NO.
- ------- ------------ -----
9 Stockholders Agreement dated November 30, 1999 by and among O'Sullivan
Holdings, Bruckmann, Rosser, Sherrill & Co. II L.P., each of the
persons executing and investor or executive signature page thereto and
each of the warrant holders executing a warrant holder signature page
attached thereto and such other persons acquiring a warrant after the
date thereof (incorporated by reference to Exhibit 10.5 to Quarterly
Report Form 10-Q of O'Sullivan Holdings for the quarter ended December
31, 1999 (File No. 0-28493))
10.1 Debt Registration Rights Agreement dated as of November 30, 1999 by and
among O'Sullivan Industries, Lehman Brothers and O'Sullivan Industries
- Virginia as guarantor (incorporated by reference to Exhibit 10.1 to
Registration Statement on Form S-4 (File No. 333-31282))
*10.2 Stock Purchase Agreement dated as of November 30, 1999 by and among
Bruckmann, Rosser, Sherrill & Co. II, L.P. and the individuals whose
names appear on the signature pages attached thereto (incorporated by
reference to Exhibit 10.2 to Registration Statement on Form S-4 (File
No. 333-31282))
10.3 Unit Agreement dated as of November 30, 1999 by and among O'Sullivan
Industries, O'Sullivan Holdings, O'Sullivan Industries - Virginia and
Norwest Bank of Minnesota, National Association (incorporated by
reference to Exhibit 10.3 to Registration Statement on Form S-4 (File
No. 333-31282))
10.4 Credit Agreement dated as of November 30, 1999 by and among O'Sullivan
Industries, O'Sullivan Holdings, Lehman Brothers Inc. and Lehman
Commercial Paper, Inc. (incorporated by reference to Exhibit 10.1 to
Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter
ended December 31, 1999 (File No. 0-02843))
10.4a First Amendment to Credit Agreement, effective as of November 30, 1999
(incorporated by reference to Exhibit 10.4a to Amendment No. 2 to
Registration Statement on Form S-4 (File No. 333-31282))
10.4b Second Amendment to Credit Agreement dated as of January 25, 2001
(incorporated by reference to Exhibit 10.1 to Quarterly Report on Form
10-Q for the quarter ended December 31, 2000 (File No. 0-28493))
10.4c Third Amendment to Credit Agreement dated as of May 15, 2002 77
10.5 Deed of Trust, Assignment of Leases and Rents, Security Agreement and
Fixture Filing dated as of November 30, 1999 from O'Sullivan Industries
to the trustee named therein for the benefit of Lehman Brothers Inc.,
Lehman Commercial Paper, Inc. and the several lenders and financial
institutions which become parties thereto from time to time
(incorporated by reference to Exhibit 10.5 to Registration Statement on
Form S-4 (File No. 333-31282))
10.6 Guarantee and Collateral Agreement dated as of November 30, 1999 by and
among O'Sullivan Industries, O'Sullivan Holdings, O'Sullivan Industries
- Virginia, and Lehman Commercial Paper, Inc. (incorporated by
reference to Exhibit 10.6 to Registration Statement on Form S-4 (File
No. 333-31282))
73
EXHIBIT PAGE
NO. DESCRIPTION NO.
- ------- ------------ -----
10.7 Intellectual Property Security Agreement dated as of November 30, 1999
by and among O'Sullivan Industries and Lehman Commercial Paper, Inc.
(incorporated by reference to Exhibit 10.7 to Registration Statement on
Form S-4 (File No. 333-31282))
10.8 Intercompany Subordinated Demand Promissory Note dated as of November
30, 1999 by and among O'Sullivan Industries and O'Sullivan Industries
- Virginia (incorporated by reference to Exhibit 10.8 to Registration
Statement on Form S-4 (File No. 333-31282))
*10.9 Management Stock Agreement dated November 30, 1999 by and among
O'Sullivan Holdings, Bruckmann, Rosser, Sherrill & Co. II, L.P., and
the individuals whose signatures appear on the signature pages thereto
(incorporated by reference to Exhibit 10.7 to Quarterly Report on Form
10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
*10.10 Subscription Agreement dated November 30, 1999 by and among OSI
Acquisition, Inc., Bruckmann, Rosser, Sherrill & Co. II, L.P. and the
individuals whose signatures appear on the signature pages thereto
(incorporated by reference to Exhibit 10.10 to Registration Statement
on Form S-4 (File No. 333-31282))
*10.11 O'Sullivan Holdings Common Stock Option Plan (incorporated by reference
to Exhibit 10.11 to Registration Statement on Form S-4 (File No.
333-31282))
*10.11a First Amendment to Common Stock Option Plan (incorporated by reference
to Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarter ended
March 31, 2001 (File No. 0-28493))
*10.12 Form of Common Stock Option Agreement (incorporated by reference to
Exhibit 10.12 to Annual Report on Form 10-K for the year ended June 30,
2000 (File No. 0-28493))
*10.13 O'Sullivan Holdings Preferred Stock Option Plan (incorporated by
reference to Exhibit 10.3 to Quarterly Report on Form 10-Q of
O'Sullivan Holdings for the quarter ended December 31, 1999 (File No.
0-28493))
*10.14 Form of Preferred Stock Option Agreement dated November 30, 1999
(incorporated by reference to Exhibit 10.4 to Quarterly Report on Form
10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
*10.15 Registration Rights Agreement dated November 30, 1999 by and among
O'Sullivan Holdings, Bruckmann, Rosser, Sherrill & Co. II, L.P. and the
individuals who executed executive signature pages or warrant holder
signature pages or acquired warrants after execution of the signature
pages attached thereto (incorporated by reference to Exhibit 10.6 to
Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter
ended December 31, 1999 (File No. 0-28493))
*10.16 Agreement and Acknowledgment of Optionee dated November 30, 1999 by and
among O'Sullivan Holdings and each of the individuals who executed an
individual signature page thereto (incorporated by reference to Exhibit
10.15 to Registration Statement on Form S-4 (File No. 333-31282))
74
EXHIBIT PAGE
NO. DESCRIPTION NO.
- ------- ------------ -----
*10.17 Form of Election to Roll Shares dated November 30, 1999 by and among
O'Sullivan Holdings and each of the individuals who executed an
individual signature page thereto (incorporated by reference to
Exhibit 10.1 to Registration Statement on Form S-4 (File No.
333-31282))
*10.18 Management Services Agreement dated November 30, 1999 by and among
O'Sullivan Holdings and Bruckmann, Rosser, Sherrill & Co. II, L.P.
(incorporated by reference to Exhibit 10.2 to Quarterly Report on Form
10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
*10.19 Form of Amended and Restated Termination Protection Agreement between
O'Sullivan Holdings and certain members of management (incorporated by
reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of
O'Sullivan Holdings for the quarter ended March 31, 1996 (File No.
1-12754))
*10.20 Form of Termination Protection Agreement between O'Sullivan Holdings
and certain members of management (incorporated by reference to
Exhibit 10.3 to Annual Report on Form 10-K of O'Sullivan Holdings for
the year ended June 30, 1999 (File No. 1-12754))
*10.21 O'Sullivan Holdings Deferred Compensation Plan (the "DCP")
(incorporated by reference to Exhibit 10.2 to Quarterly Report on Form
10-Q of O'Sullivan Holdings for the quarter ended March 31, 1997 (File
No. 1-12754))
*10.21a First Amendment to the DCP (incorporated by reference to Exhibit 10.4a
to Annual Report on Form of O'Sullivan Holdings 10-K for the year
ended June 30, 1997 (File No. 1-12754))
*10.21b Second Amendment to the DCP (incorporated by reference to Exhibit
10.20b to Registration Statement on Form S-4 (File No. 333-31282))
*10.21c Third Amendment to the DCP (incorporated by reference to Exhibit
10.21c to Annual Report on Form 10-K for the year ended June 30, 2000
(File No. 0-28493))
10.22 Amended and Restated Tax Sharing and Tax Reimbursement Agreement dated
as of June 19, 1997 between O'Sullivan Holdings and RadioShack
Corporation and TE Electronics Inc. (incorporated by reference to
Exhibit 10.5 to Annual Report on Form 10-K of O'Sullivan Holdings for
the year ended June 30, 1997 (File No. 1- 12754))
10.22a Settlement Agreement between O'Sullivan Holdings and RadioShack dated
May 13, 2002 85
*10.23 Form of Indemnity Agreement between O'Sullivan Holdings and certain
directors and officers (incorporated by reference to Exhibit 10.7 to
Amendment No. 1 to Registration Statement on Form S-1 (File No.
33-72120))
*10.24 Retirement and Consulting Agreement, Release and Waiver of Claims
between O'Sullivan Holdings and Daniel F. O'Sullivan dated October 16,
1998 (incorporated by reference to Exhibit 10 to Quarterly Report on
Form 10-Q of O'Sullivan Holdings for the quarter ended September 30,
1998 (File No. 1-12754))
*10.24a Amendment to Retirement Agreement dated as of May 16, 1999 between
O'Sullivan Holdings and Daniel F. O'Sullivan (incorporated by
reference to Exhibit 10.9a to Annual Report on Form 10-K of O'Sullivan
Holdings for the year ended June 30, 1999 (File No. 1-12754))
75
EXHIBIT PAGE
NO. DESCRIPTION NO.
- ------- ------------ -----
*10.25 Description of O'Sullivan Holding's annual incentive compensation plan
(incorporated by reference to Exhibit 10.13 to Annual Report on Form
10-K of O'Sullivan Holdings for the year ended June 30, 1999 (File No.
1-12754))
10.26 Schedule of outside director fees (incorporated by reference to
Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended
December 31, 2001 (File No. 0-28493))
*10.27 O'Sullivan Industries Holdings, Inc. 2001 Director Common Stock Option
Plan (incorporated by reference to Exhibit 10.2 to Quarterly Report on
Form 10-Q of O'Sullivan Holdings for the quarter ended December 31,
2001 (File No. 0-28493))
*10.28 Form of Director Common Stock Option Agreement (incorporated by
reference to Exhibit 10.3 to Quarterly Report on Form 10-Q of
O'Sullivan Holdings for the quarter ended December 31, 2001 (File No.
0-28493))
*10.29 O'Sullivan Industries Holdings, Inc. Amended and Restated Savings and
Profit Sharing Plan 96
21 Subsidiaries of the Registrant 170
23 Consent of PricewaterhouseCoopers LLP 171
99.1 Certificate of chief executive officer under Section 906 of the
Sarbanes-Oxley Act of 2002 172
99.2 Certificate of chief financial officer under Section 906 of the
Sarbanes-Oxley Act of 2002 173
- ------------------------------------
* Each of these exhibits is a "management contract or
compensatory plan or arrangement."
Pursuant to item 601(b)(4)(iii) of Regulation S-K, O'Sullivan has not filed
agreements relating to certain long-term debt of O'Sullivan aggregating $10
million. O'Sullivan agrees to furnish the Securities and Exchange Commission a
copy of such agreements upon request.
76