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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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)
(417) 682-3322
(Registrant's telephone number, including area code)
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 [ ]
As of November 10, 2002, 1,368,000 shares of common stock of O'Sullivan
Industries Holdings, Inc., par value $0.01 per share, were outstanding.
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The Index to Exhibits is on page 25.
Page 1 of 27
PART I
ITEM 1. FINANCIAL STATEMENTS.
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
September 30, June 30,
Assets 2002 2002
----------- -----------
Current assets:
Cash and cash equivalents $ 13,327 $ 15,777
Trade receivables, net of allowance for doubtful accounts
of $4,302 and $4,101, respectively 34,028 37,035
Inventories, net 57,006 52,397
Prepaid expenses and other current assets 3,478 2,765
----------- -----------
Total current assets 107,839 107,974
Property, plant and equipment, net 77,373 79,144
Other assets 18,749 19,226
Goodwill, net of accumulated amortization 38,088 38,088
----------- -----------
Total assets $ 242,049 $ 244,432
=========== ===========
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 11,908 $ 10,887
Current portion of long-term debt 8,495 4,430
Accrued advertising 12,901 11,680
Accrued liabilities 15,472 18,399
----------- -----------
Total current liabilities 48,776 45,396
Long-term debt, less current portion 225,399 230,206
Other liabilities 6,621 6,040
----------- -----------
Total liabilities 280,796 281,642
Commitments and contingent liabilities (Notes 3, 6, 7 and 8)
Mandatorily redeemable senior preferred stock, $0.01 par value; $34,312 and
$33,312 liquidation value including accumulated dividends at September 30, 2002
and June 30, 2002, respectively; 17,000,000 shares authorized, 16,431,050 issued 19,182 18,319
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 77,457 74,838
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 (147,832) (142,792)
Notes receivable from employees (329) (337)
Accumulated other comprehensive loss (292) (305)
----------- -----------
Total stockholders' deficit (57,929) (55,529)
----------- -----------
Total liabilities and stockholders' deficit $ 242,049 $ 244,432
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
-2-
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Three months ended
September 30,
-----------------------------
2002 2001
------------- -------------
Net sales $ 71,557 $ 82,193
Cost of sales 51,584 61,725
------------- -------------
Gross profit 19,973 20,468
Operating expenses:
Selling, marketing and administrative 12,059 14,171
------------- -------------
Operating income 7,914 6,297
Other income (expense):
Interest expense (6,433) (8,600)
Interest income 58 91
------------- -------------
Income (loss) before income tax provision 1,539 (2,212)
Income tax provision (benefit) 3,097 (776)
------------- -------------
Net loss (1,558) (1,436)
Dividends and accretion on preferred stock (3,482) (3,002)
------------- -------------
Net loss attributable to common stockholders $ (5,040) $ (4,438)
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
-3-
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three months ended
September 30,
-----------------------------
2002 2001
------------- -------------
Cash flows provided (used) by operating activities:
Net loss $ (1,558) $ (1,436)
Adjustments to reconcile net loss to net cash provided (used) by operating
activities:
Depreciation and amortization 3,264 3,421
Amortization of debt issuance cost 403 403
Amortization of debt discount and accrued interest on senior note 738 653
Interest rate collar (584) 1,201
Bad debt expense 448 349
Loss on disposal of assets 11 117
Accrual of special payment on options to purchase Series A junior
preferred stock 300 262
Changes in current assets and liabilities:
Trade receivables 2,559 (169)
Inventories (4,609) (653)
Other assets (693) 331
Accounts payable, accrued liabilities and other liabilities (286) 11,872
------------- -------------
Net cash provided (used) by operating activities (7) 16,351
------------- -------------
Cash flows used for investing activities:
Capital expenditures (1,557) (4,084)
------------- -------------
Cash flows used for financing activities:
Repayment of borrowings (886) (5,886)
------------- -------------
Net increase (decrease) in cash and cash equivalents (2,450) 6,381
Cash and cash equivalents, beginning of period 15,777 7,060
------------- -------------
Cash and cash equivalents, end of period $ 13,327 $ 13,441
============= =============
Non-cash financing activities:
Capital expenditures included in accounts payable $ 128 $ 671
Dividends accrued but not paid 3,619 3,170
The accompanying notes are an integral part of these consolidated
financial statements.
-4-
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
For the three months ended September 30, 2002
(in thousands)
Series B junior Notes
preferred stock Common Stock Additional receivable
----------------- --------------------- paid-in Retained from
Shares Dollars Shares Dollars capital deficit employees
------ --------- ------ ----------- ----------- ---------- ----------
Balance, June 30, 2002 529 $ 74,838 1,368 $ 14 $ 13,053 $ (142,792) $ (337)
Net loss (1,558)
Other comprehensive income
Loans to employees-interest
income (7)
Repayment of employee
loans 15
Dividends and accretion on
senior preferred stock (863)
Dividends and accretion on
junior preferred stock 2,619 (2,619)
----- --------- ------- ----------- ----------- ---------- ---------
Balance, September 30, 2002 529 $ 77,457 1,368 $ 14 $ 13,053 $ (147,832) $ (329)
===== ========= ======= =========== =========== ========== =========
Accumulated
other Total stock-
comprehensive holders' Comprehensive
loss deficit loss
------------- ------------ -------------
Balance, June 30, 2002 $ (305) $ (55,529)
Net loss (1,558) $ (1,558)
Other comprehensive income 13 13 13
Loans to employees-interest
income (7)
Repayment of employee
loans 15
Dividends and accretion on
senior preferred stock (863)
Dividends and accretion on
junior preferred stock --
---------- ---------- ---------
Balance, September 30, 2002 $ (292) $ (57,929) $ (1,545)
========== ========== =========
The accompanying notes are an integral part of these consolidated
financial statements.
-5-
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
NOTE 1--BASIS OF PRESENTATION
The unaudited consolidated financial statements of O'Sullivan
Industries Holdings, Inc. and subsidiaries ("O'Sullivan") included herein have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with instructions to Form 10-Q and Article 10
of Regulation S-X. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The financial statements should be read in conjunction with the
audited financial statements and notes thereto included in O'Sullivan's Annual
Report on Form 10-K for the fiscal year ended June 30, 2002. The interim results
are not necessarily indicative of the results that may be expected for a full
year.
NOTE 2--DERIVATIVE FINANCIAL INSTRUMENTS
As required under O'Sullivan's 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 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 $(584,000) and $1.2 million for the quarters ended September 30, 2002
and September 30, 2001, respectively. These amounts represent the changes in
fair value of the interest rate collar. To terminate this contract at September
30, 2002 and June 30, 2002, O'Sullivan would have been required to pay the
counter-party approximately $1.5 million and $2.1 million, respectively. The
fair value of the interest rate collar is included in accrued liabilities in the
accompanying consolidated balance sheets.
NOTE 3--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 O'Sullivan previously 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 (loss) or net income (loss). As a result of the adoption of
EITF 00-25, for the three months ended September 30, 2001, $4.1 million was
reclassified as a reduction in revenue rather than as selling, marketing and
administrative expense.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 adopted this pronouncement
effective July 1, 2002. The adoption of SFAS 143 did not have an impact on
O'Sullivan's financial results.
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. O'Sullivan adopted this pronouncement effective July 1, 2002.
The adoption of SFAS 144 had no effect on O'Sullivan's results of operations but
did impact its balance sheet presentation as described below.
-6-
In January 2001, O'Sullivan closed its Cedar City, Utah production
facility. 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 book value of $20.3
million were valued at the lower of their carrying amount or fair value less
cost to sell, resulting in an impairment charge of approximately $8.7 million in
the second quarter of fiscal 2001. The costs of the long-lived assets held for
sale and the associated accumulated depreciation have been reclassified from
property, plant and equipment to other assets on the accompanying consolidated
balance sheets. There are no other significant assets or liabilities relating to
the discontinued Utah operation. The fair value less cost to sell is an estimate
and the impairment may be adjusted in the future.
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 adopted SFAS 145
effective July 1, 2002. There was no impact on O'Sullivan's financial position
or results of operations.
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. O'Sullivan does not believe SFAS 146
will have a material impact on its financial position or results of operations.
NOTE 4--SHIPPING AND HANDLING COSTS
O'Sullivan reports amounts billed to customers as revenue, the cost for
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 the first quarters of fiscal
2003 and fiscal 2002 were approximately $2.1 million and $2.4 million,
respectively.
NOTE 5--INVENTORY
Inventory, net, consists of the following:
September 30, June 30,
2002 2002
-------------- ----------
(in thousands)
Finished goods $ 40,932 $ 39,199
Work in process 5,175 5,158
Raw materials 10,899 8,040
-------------- ----------
$ 57,006 $ 52,397
============== ==========
NOTE 6--INCOME TAXES
O'Sullivan recorded tax expense of $3.1 million for the three months
ended September 30, 2002 that included a valuation allowance of $2.6 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,
-7-
RadioShack Corporation, its subsidiary 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.
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
the assets of O'Sullivan Industries, Inc., O'Sullivan's operating subsidiary
("O'Sullivan Industries") 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. For the
three months ended September 30, 2002, O'Sullivan paid RadioShack $3.1 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.
-8-
O'Sullivan has recorded the $30.8 million in payments pursuant to the
settlement agreement as a deferred tax asset. O'Sullivan has a net deferred tax
asset of approximately $18.6 million at September 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 net operating loss
carryforward for federal income tax purposes of approximately $58.3 million. In
2009, when substantially all of the tax deductions 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.
Pursuant to SFAS 109, management projected its expected future taxable
income utilizing operating performance O'Sullivan achieved 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 net operating losses
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
$18.6 million at September 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.
NOTE 7--RELATED PARTY TRANSACTIONS
O'Sullivan Industries entered into a management services agreement with
Bruckmann, Rosser, Sherrill & Co., Inc. ("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.
The management fees and reimbursable expenses of $110,000 and $97,000
recognized in the first quarter of fiscal years 2003 and 2002, respectively, are
included in selling, marketing and administrative expense in the accompanying
consolidated statements of operations. O'Sullivan Industries 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. The prepaid
balance at September 30, 2002 was $195,000 and is included in prepaid expenses
and other current assets on the consolidated balance sheet. The amount due BRS
at June 30, 2002 approximated $719,000 and is included in accrued liabilities on
the consolidated balance sheet.
At September 30, 2002, O'Sullivan held two notes receivable with a
balance of approximately $329,000 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 November 1999 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 are with full recourse to
the employees. The receivables are recorded on O'Sullivan's consolidated balance
sheets as an increase in stockholders' deficit.
-9-
NOTE 8--COMMITMENTS AND CONTINGENCIES
Tax Sharing Agreement with RadioShack. Future tax sharing agreement
payments are contingent on taxable income. (See Note 6) 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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. We have committed substantial resources to the
development and implementation of a diversified sales, marketing and product
strategy in order to capitalize on opportunities presented by large 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 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.
After several years of robust growth, the North American RTA furniture
industry stalled in 2001. Our sales declined 11.5% in fiscal 2001 and 2.7% in
fiscal 2002. This decline continued in the first quarter of fiscal 2003, when
our sales declined 12.9%. Our sales declined for several reasons:
o the lack of growth in sales of personal computers, which
reduced the need for computer desks and workcenters;
o the slowdown of economic growth and consumer spending in the
United States, particularly in the office superstore channel;
o liquidations and bankruptcies by a number of customers,
including Montgomery Ward, Ames and Kmart;
o inventory reductions by our customers;
o the decline in price of the average unit sold, reflecting a
trend toward more promotional merchandise and increased
competition;
o increasing competition from imported furniture, particularly
from China; and
o the retrenchment in business capital outlays, which reduced
purchases of office furniture.
These factors will continue to affect our business throughout the remainder of
fiscal 2003.
As a result of the lower sales levels, coupled with the outcome of the
arbitration proceedings with RadioShack in fiscal 2002, we incurred a net loss
before dividends and accretion on preferred stock of $1.6 million and $1.4
million for the first quarters of fiscal 2003 and fiscal 2002, respectively.
However, even with the lower sales level, we were able to increase our operating
income to $7.9 million in the first quarter of fiscal 2003 from $6.3 million in
the first quarter of fiscal 2002. Our earnings before interest, taxes,
depreciation and amortization also increased to $11.2 million in fiscal 2003
from $9.7 million in the same period of fiscal 2002 due principally to lower raw
material prices and reduced selling and administrative expenses.
-10-
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
for 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 prices declined slightly in the first quarter of fiscal 2003 from the fourth
quarter of fiscal 2002. Prices for fiberboard increased in the fourth quarter of
fiscal 2002, but remained flat for the first quarter of fiscal 2003. We did,
however, experience a price increase from several suppliers of another commodity
in the second quarter of 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.
Several manufacturers, including O'Sullivan, have excess manufacturing
capacity due to the current decline in sales in the RTA furniture segment and
increasing imports. This excess capacity is causing increased competition that
is expected to continue, and perhaps to intensify, through the remainder of
fiscal 2003. This adversely affected our margins and results of operations in
fiscal 2002, and is continuing to affect sales, margins and results of
operations in fiscal 2003.
While we have confidence in the long-term future of the RTA furniture
industry, sales in the second quarter of fiscal 2003 are anticipated to be the
same as or slightly lower than sales in the second quarter of fiscal 2002. We
anticipate our operating earnings and EBITDA will be slightly higher than those
reported for the second quarter of fiscal 2002. We cannot yet predict when our
sales will return to a pattern of sales growth.
RadioShack Arbitration
Prior to our initial public offering in 1994, we were owned by
RadioShack Corporation (then named Tandy Corporation). In connection with the
1994 initial public offering of our 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 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. 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 1994, 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 we are 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.
This disagreement was the subject of an arbitration hearing. 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
-11-
merger. For the six months ended June 30, 2002, we paid RadioShack $6.2 million.
For the three months ended September 30, 2002, we paid RadioShack $3.1 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 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 INFORMATION."
RESULTS OF OPERATIONS
Net Sales. Net sales for the quarter ended September 30, 2002 decreased
by $10.6 million, or 12.9%, to $71.6 million from $82.2 million for the quarter
ended September 30, 2001. During the quarter, sales declined in every major
sales channel as the economic weakness in the United States continued.
In January 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 and has
secured financing of $2 billion to help the company's cash flow while it
restructures. Kmart hopes to emerge from Chapter 11 in 2003. We resumed
shipments to Kmart on a post-petition basis after the filing 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 Department Stores, Inc. 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 decreased to $20.0 million, or 27.9% of
sales, for the three month period ended September 30, 2002, from $20.5 million,
or 24.9% of sales, for the comparable prior year quarter. Fiscal 2003 first
quarter gross profit dollars declined because of lower sales. The gross margin
percentage increased primarily because of lower material costs, particularly for
particleboard, as compared to prices in the same period in fiscal 2002.
Selling, Marketing and Administrative Expenses. Selling, marketing and
administrative expenses decreased to $12.1 million, or 16.9% of sales, for the
three month period ended September 30, 2002, from $14.2 million, or 17.2% of
sales, for the quarter ended September 30, 2001. In fiscal 2003, incentive
compensation and profit sharing expenses decreased because of our lower sales
and financial performance. Legal fees increased costs in fiscal 2002 due to the
RadioShack arbitration. Freight out, commissions and store display expense were
also lower in fiscal 2003 compared to the prior year.
Depreciation and Amortization. Depreciation and amortization expenses
decreased to $3.3 million for the first quarter of fiscal 2003 compared to $3.4
million for the first quarter of fiscal 2002.
Operating Income. Operating income increased $1.6 million to $7.9
million for the quarter ended September 30, 2002 from $6.3 million in the
quarter ended September 30, 2001. Lower material prices were partially offset by
lower sales in the three months ended September 30, 2002. Reduced incentive
compensation and profit sharing expense as well as lower freight out expense,
commission costs and store display expense contributed to the increased
operating income during the quarter.
Net Interest Expense. Net interest expense decreased from $8.5 million
in the first quarter of fiscal 2002 to $6.4 million in the first quarter of
fiscal 2003. Interest expense decreased due to the change in fair value of our
-12-
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.
Three months ended
September 30,
---------------------------
(in thousands)
2002 2001
----------- ------------
Interest expense on senior credit facility,
industrial revenue bonds and senior
subordinated notes $ 5,876 $ 6,343
Interest income (58) (91)
Non-cash items:
Interest expense on O'Sullivan Holdings note 594 528
Interest rate collar (584) 1,201
Amortization of debt discount 144 125
Amortization of loan fees 403 403
----------- ------------
Net interest expense $ 6,375 $ 8,509
=========== ============
Income Tax Provision (Benefit). We recorded tax expense of $3.1 million
for the first quarter of fiscal 2003 that included an increase in the valuation
allowance of $2.6 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 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 and $3.1 million for the quarter ended September 30, 2002. We recorded
these payments as a deferred tax asset. We have a net deferred tax asset of
approximately $18.6 million at September 30, 2002. At December 31, 2001 (we file
federal income tax returns on a calendar year basis), we had a net operating
loss carryforward for federal income tax purposes of approximately $58.3
million. In 2009, when substantially all of the tax deductions 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 we have yet to deduct.
Pursuant to SFAS 109, we have provided a valuation allowance on our net
deferred tax assets of $18.6 million at September 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. See Note 6 to
the accompanying consolidated financial statements.
Net Loss. Net loss increased $122,000 from a loss of $1.4 million in
the first quarter of fiscal 2002 to a loss of $1.6 million in the first quarter
of fiscal 2003 due to increased tax expense, partially offset by lower raw
material costs, decreased selling and administrative expenses and lower interest
expense.
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EBITDA. EBITDA, which we define as earnings before interest income and
interest expense, income taxes, depreciation and amortization, increased by $1.5
million to $11.2 million for the quarter ended September 30, 2002 from $9.7
million for the prior year quarter. EBITDA for the fiscal 2003 first quarter
increased primarily due to lower material costs and lower selling and
administrative expenses, partially offset by lower sales.
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 first
quarters of fiscal 2003 and 2002.
Three months ended
September 30,
-----------------------------
(in thousands)
2002 2001
------------ -----------
Net loss $ (1,558) $ (1,436)
Income tax provision (benefit) 3,097 (776)
Interest expense, net 6,375 8,509
------------ -----------
Operating income 7,914 6,297
Depreciation and amortization 3,264 3,421
------------ -----------
EBITDA $ 11,178 $ 9,718
============ ===========
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are cash flows from operations and
borrowings under our senior secured credit facility, which is discussed below.
Our liquidity requirements will be to pay our debt, including interest expense
under the senior credit facility and notes, to pay RadioShack amounts due under
the tax sharing agreement and to provide for working capital and capital
expenditures. Decreased demand for our products could decrease our cash flow
from operations and the availability of borrowings under our credit facility.
Working Capital. As of September 30, 2002, cash and cash equivalents
totaled $13.3 million. Net working capital was $59.1 million at September 30,
2002 compared to $62.6 million at June 30, 2002.
Operating Activities. Net cash used by operating activities for the
three months ended September 30, 2002 was $7,000 compared to net cash provided
of $16.4 million for the three months ended September 30, 2001. Cash flow from
operations decreased year-over-year for the following reasons.
o During the first quarter of fiscal 2002, accounts payable increased
$5.9 million from unusually low levels on June 30, 2001 when production
was shut down for two weeks. Accounts payable increased $1.0 million
during the first quarter of fiscal 2003 due to a shutdown of only one
week. Accounts payable balances at September 30, 2002 are lower than
the balances at September 30, 2001 because of lower production levels
this year and the timing of a large purchase last year.
o Profit sharing and incentive compensation payments during the first
quarter of fiscal 2003 were approximately $3.0 million higher than in
the first quarter of fiscal 2002 because of the respective prior year
financial results. Changes in the accrued balances for profit sharing
and incentive compensation decreased the cash provided by operations an
additional $1.1 million.
-14-
o Increases in accrued advertising provided net cash of $1.2 million in
fiscal 2003 compared to $3.9 million during the first quarter of fiscal
2002. The decrease this year was due to lower sales and associated
decreases in vendor incentive programs. Cash payments were also
accelerated for a particular customer that changed its pattern of
claiming certain incentives.
o In fiscal 2003, increases in inventories absorbed $4.6 million of cash,
compared with only $653,000 in fiscal 2002.
o During the September 2002 quarter, we paid RadioShack $3.1 million
under the tax sharing agreement.
o In fiscal 2003, the liability associated with the interest rate collar
declined by $584,000 as opposed to a $1.2 million increase in fiscal
2002.
o Trade receivables declined $2.8 million in fiscal 2003 as opposed to a
$169,000 increase in fiscal 2002. The decline was due to lower sales in
fiscal 2003 and shorter terms.
Investing Activities. We invested $1.6 million for capital expenditures
for the three months ended September 30, 2002 compared to $4.1 million for the
prior year three month period. We currently estimate that the total capital
expenditure requirements for the remainder of the fiscal year will be
approximately $5.0 to $8.0 million, which we expect to fund from cash flow from
operations or cash on hand. Our ability to make future capital expenditures is
subject to certain restrictions under our senior credit facility.
Financing Activities. On November 30, 1999 we completed our merger and
recapitalization. Our consolidated indebtedness at September 30, 2002 was $241.4
million consisting of:
o $111.6 million in a senior secured credit facility consisting of a five
year $24.6 million term loan A, a seven and one-half year $87.0 million
term loan B and a $40.0 million revolving line of credit, with no
borrowings at September 30, 2002. The current portion of these term
loans was approximately $8.5 million at September 30, 2002. The
revolving line of credit has a $15.0 million sub-limit for letters of
credit, of which we are currently utilizing approximately $13.9
million.
o $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.
o $10.0 million in variable rate industrial revenue bonds.
o $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.
-15-
The reconciliation of consolidated indebtedness to recorded book value at
September 30, 2002 is as follows:
Original
Issue
Discount Warrants
Consolidated Current Net of Net of Recorded
Indebtedness Portion Accretion Accretion Book Value
------------- -------- ----------- ----------- -----------
(in thousands)
Term loan A $ 24,583 $ (6,572) $ -- $ -- $ 18,011
Term loan B 87,063 (1,923) -- -- 85,140
------------- -------- ----------- ----------- -----------
Senior secured credit 111,646 (8,495) -- -- 103,151
Senior subordinated note 100,000 -- (1,633) (2,926) 95,441
Industrial revenue bonds 10,000 -- -- -- 10,000
Senior note 19,789 -- -- (2,982) 16,807
------------- -------- ----------- ----------- -----------
Total $ 241,435 $ (8,495) $ (1,633) $ (5,908) $ 225,399
============= ======== =========== =========== ===========
During the three months ended September 30, 2002, we made regularly
scheduled principal payments of $886,000 against the term loans included in our
senior secured credit facility. We expect to fund principal and interest
payments on our debt from cash flow from operations, cash on hand or borrowings
under our revolver. Our borrowing availability under our credit facility was
approximately $21.4 million at September 30, 2002. Decreased demand for our
products could decrease our cash flow from operations and the availability of
borrowings under our credit facility. In October 2002, we paid an additional
$4.1 million of principal on the amounts outstanding under the senior credit
facility and increased the revolving credit line borrowings by $4.1 million.
The 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 credit facility, as amended, are as follows:
o Our consolidated leverage ratio must be less than 4.35. The ratio at
September 30, 2002 was 3.87. At June 30, 2003, our consolidated
leverage ratio must be less than 4.00.
o Our consolidated interest coverage ratio must be greater than 2.00. The
ratio at September 30, 2002 was 2.26. At June 30, 2003, our
consolidated interest coverage ratio must be greater than 2.00.
o Our consolidated fixed charge coverage ratio must be greater than 1.10.
The ratio at September 30, 2002 was 1.57. At June 30, 2003, our
consolidated fixed charge coverage ratio must be greater than 1.10.
o Our senior debt coverage ratio must be less than 2.50. The ratio at
September 30, 2002 was 2.13. At June 30, 2003, our senior debt coverage
ratio must be less than 2.35.
o Our consolidated EBITDA must be at least $53 million for the fiscal
year ending June 30, 2003.
EBITDA and consolidated interest expense as defined in the credit facility for
the twelve months ended September 30, 2002 were $57.2 million and $25.3 million,
respectively. O'Sullivan Industries is the borrower under the credit facility,
so the covenants do not include the $19.8 million senior note of O'Sullivan
Industries Holdings, Inc. or interest on the note. Pursuant to an amendment to
our senior credit facility, $27.0 million of our payments to RadioShack under
the tax sharing agreement through the period ending June 30, 2002 are
-16-
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 our stock. At September 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 September 30, 2002,
we would have been required to pay the counter-party approximately $1.5 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.
See the overview section of this Management's Discussion and Analysis
of Financial Condition and Results of Operations for a discussion of the impact
of the Settlement Agreement with RadioShack on our liquidity and financial
condition.
The following table illustrates our contractual obligations due in the
future:
Payments Due by Period
--------------------------------------------------------------
(in thousands)
Less
than 12 12-36 36-60 After
Contractual Obligations Total months months months 60 months
----------------------- ------------ ------------- ------------- ------------ --------------
Long-term debt $ 241,435 $ 8,495 $ 19,762 $ 83,389 $ 129,789
Tax Benefit payments to
RadioShack(1)
Capital lease obligations -- -- -- -- --
Operating leases--unconditional 4,534 1,479 2,666 389 --
Other long-term obligations 676 268 394 14 --
------------ ------------- ------------- ------------ --------------
Total contractual cash obligations $ 246,645 $ 10,242 $ 22,822 $ 83,792 $ 129,789
============ ============= ============= ============ ==============
(1) Payments to RadioShack are
contingent on taxable income.
The maximum payments are: $ 81,077 $ 10,337 $ 20,770 $ 24,116 $ 25,854
============ ============= ============= ============ ==============
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, asset impairments, 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.
-17-
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
o 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.
o 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.
o 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.
o 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 $5.8 million and
$4.9 million at September 30, 2002 and 2001, respectively.
o 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, decreasing income in the period such determination was
made.
o We periodically review our long-lived assets, including property
and equipment, 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.
o We assess 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. Adverse economic
conditions could cause us to record impairment charges in the
future.
-18-
o 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 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.
Certain portions of this Report, and particularly the Notes to the
Consolidated Financial Statements and the Management's Discussion and Analysis
of Financial Condition and Results of Operations, contain forward-looking
statements. These statements can be identified by the use of future tense or
dates or terms such as "believe," "would," "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.
Factors and possible events which could cause results to differ include:
o loss of liquidity due to the arbitration panel's opinion in
RadioShack Corporation v. O'Sullivan Industries Holdings, Inc.;
o significant indebtedness that may limit our financial and
operational flexibility;
o changes from anticipated levels of sales, whether due to future
national or regional economic and competitive conditions,
including new domestic or foreign entrants into the industry,
customer acceptance of existing and new products, terrorist
attacks or otherwise, as we are experiencing now;
o pricing pressures due to excess capacity in the ready-to-assemble
furniture industry, as occurred in 1995 and is occurring again
now, or customer demand in excess of our ability to supply
product;
o raw material cost increases, particularly in particleboard and
fiberboard, as occurred in 1994 and 1995 and to a lesser extent in
fiscal 2000;
o transportation cost increases, due to higher fuel costs or
otherwise;
o loss of or reduced sales to significant customers as a result of
bankruptcy, liquidation, merger, acquisition or any other reason,
as occurred with the liquidation of Montgomery Ward in fiscal
2001, the liquidation of Ames in 2002 and with the reorganization
of Service Merchandise Co., Inc. in 2000;
o actions of current or new competitors, foreign or domestic, that
increase competition with our products or prices;
o the consolidation of manufacturers in the ready-to-assemble
furniture industry;
o increased advertising costs associated with promotional efforts;
o increased interest rates;
o pending or new litigation or governmental regulations such as the
recently settled arbitration involving RadioShack;
o other uncertainties which are difficult to predict or beyond our
control; and
o the risk that we incorrectly analyze these risks and forces, or
that the strategies we develop to address them could be
unsuccessful.
See also the Risk Factors section in our annual report on Form 10-K for the year
ended June 30, 2002.
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.
All subsequent written and oral forward-looking statements attributable
to O'Sullivan or any person acting on our behalf are qualified by the cautionary
statements in this section. We will have no obligation to revise these
forward-looking statements.
-19-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk is impacted by changes in interest rates, foreign
currency exchange rates and certain commodity prices. Pursuant to 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. A change in interest rates of one
percentage point would affect our cash interest expense by about $600,000 per
year.
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. Interest rate swaps or collars may be used to adjust interest rate
exposures when appropriate based on market conditions. For qualifying hedges,
the interest differential of swaps is included in interest expense. We believe
that our foreign exchange risk is not material.
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 contracts. A one percent change in our raw material prices
would affect our cost of sales by approximately $1.7 million annually.
As noted above, in fiscal 2000 we encountered price increases in
certain commodities, which reduced our gross margin. During fiscal 2001, prices
for these products declined, which helped gross margins. Prices for these and
other commodities will continue to fluctuate.
ITEM 4. CONTROLS AND PROCEDURES.
O'Sullivan maintains disclosure controls and procedures (as defined in
Rule 13a-14(c) of the Securities Exchange Act of 1934) that are designed to
ensure that information required to be disclosed in O'Sullivan's Exchange Act
reports is recorded, processed, summarized and reported accurately within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to O'Sullivan's Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosures. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management was necessarily
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
Within 90 days prior to the date of this report, O'Sullivan carried out
an evaluation, under the supervision and with the participation of O'Sullivan's
management, including O'Sullivan's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of O'Sullivan's
disclosure controls and procedures. Based on the foregoing, O'Sullivan's Chief
Executive Officer and Chief Financial Officer concluded that O'Sullivan's
disclosure controls and procedures were effective.
There have been no significant changes in O'Sullivan's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date O'Sullivan completed its evaluation. Therefore,
no corrective actions were taken.
-20-
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On September 24, 2002, Montgomery Ward, LLC, et al., Debtor in
Possession, filed suit against O'Sullivan in the United States Bankruptcy Court,
District of Delaware, alleging that payments made by Montgomery Ward within 90
days prior to its bankruptcy constituted preferential transfers under the
Bankruptcy Code that should be recovered from O'Sullivan by Montgomery Ward,
together with interest. The alleged payments aggregate $3.7 million. We received
the summons in this action on October 29, 2002.
O'Sullivan plans to defend itself vigorously in this matter and is
carefully reviewing its defenses.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) 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
-21-
SIGNATURES
Pursuant to the requirements 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.
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
Date: November 13, 2002 By: /s/ Richard D. Davidson
--------------------------------------------
Richard D. Davidson
President and
Chief Executive Officer
Date: November 13, 2002 By: /s/ Phillip J. Pacey
--------------------------------------------
Phillip J. Pacey
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
-22-
CERTIFICATION
I, Richard D. Davidson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of O'Sullivan Industries
Holdings, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Richard D. Davidson
---------------------------------------
Richard D. Davidson
President and Chief Executive Officer
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CERTIFICATION
I, Phillip J. Pacey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of O'Sullivan Industries
Holdings, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Phillip J. Pacey
--------------------------------------
Phillip J. Pacey
Senior Vice President and
Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit No. Description Page No.
----------- ----------- --------
3.1 & 4.1 Amended and Restated Certificate of Incorporation of O'Sullivan
(incorporated by reference from 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 & 4.2 Bylaws of O'Sullivan (incorporated by reference from Exhibit 3.2
to Registration Statement on Form S-1 (File No. 33-72120))
4.3 Specimen Senior Preferred Stock Certificate of O'Sullivan
(incorporated by reference from Exhibit 3 to Registration
Statement on Form 8-A (File No. 0-28493))
4.4 Indenture dated as of November 30, 1999, by O'Sullivan
Industries, Inc., as Issuer, O'Sullivan Industries - Virginia,
Inc., as Guarantor, and Norwest Bank Minnesota, National
Association, as Trustee, relating to O'Sullivan Industries,
Inc.'s $100,000,000 principal amount of 13.375% senior
subordinated notes (incorporated by reference to Exhibit 4.4 to
Quarterly Report on Form 10-Q for the quarter ended March 31,
1999 (File No. 0-28493))
4.5 Warrant Agreement dated as of November 30, 1999 between
O'Sullivan Industries Holdings, Inc. and Norwest Bank Minnesota,
National Association, as Warrant Agent, relating to warrants to
purchase 39,273 shares of O'Sullivan Industries Holdings, Inc.
Series B junior preferred stock, including form of warrant
certificate (incorporated by reference to Exhibit 4.5 to
Quarterly Report on Form 10-Q for the quarter ended March 31,
1999 (File No. 0-28493))
4.6 Warrant Agreement dated as of November 30, 1999 between
O'Sullivan Industries Holdings, Inc. and Norwest Bank Minnesota,
National Association, as Warrant Agent, 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 4.6 to Quarterly Report on Form 10-Q 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 39,273 shares of
O'Sullivan Industries Holdings, Inc. Series B junior preferred
stock, including form of warrant certificate (incorporated by
reference to Exhibit 4.7 to Quarterly Report on Form 10-Q for the
quarter ended December 31, 1999 (File No. 0-28493))
4.8 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 on Form 10-Q for the quarter ended December
31, 1999 (File No. 0-28493))
99.1 Certificate of chief executive officer under Section 906 of the
Sarbanes-Oxley Act of 2002 26
99.2 Certificate of chief financial officer under Section 906 of the
Sarbanes-Oxley Act 2002 27
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