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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 December 31, 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
incorporation or organization) Identification No.)
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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes|_| No |X|
As of February 10, 2003, 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 26.
Page 1 of 28
PART I
ITEM 1. FINANCIAL STATEMENTS.
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
December 31, June 30,
Assets 2002 2002
------------ ---------
Current assets:
Cash and cash equivalents $ 8,968 $ 15,777
Trade receivables, net of allowance for doubtful accounts
of $4,414 and $4,101, respectively 37,762 37,035
Inventories, net 49,028 52,397
Prepaid expenses and other current assets 3,280 2,765
--------- ---------
Total current assets 99,038 107,974
Property, plant and equipment, net 76,188 79,144
Other assets 18,283 19,226
Goodwill, net of accumulated amortization 38,088 38,088
--------- ---------
Total assets $ 231,597 $ 244,432
========= =========
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 8,076 $ 10,887
Current portion of long-term debt 4,749 4,430
Accrued advertising 15,763 11,680
Accrued liabilities 11,033 18,399
--------- ---------
Total current liabilities 39,621 45,396
Long-term debt, less current portion 225,544 230,206
Other liabilities 6,240 6,040
--------- ---------
Total liabilities 271,405 281,642
Commitments and contingent liabilities (Notes 3, 6, 7 and 8)
Mandatorily redeemable senior preferred stock, $0.01 par value; $35,311 and
$33,312 liquidation value including accumulated dividends at December 31,
2002 and June 30, 2002, respectively; 17,000,000 shares authorized,
16,431,050 issued 20,044 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 80,077 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 (152,446) (142,792)
Notes receivable from employees (332) (337)
Accumulated other comprehensive loss (218) (305)
--------- ---------
Total stockholders' deficit (59,852) (55,529)
--------- ---------
Total liabilities and stockholders' deficit $ 231,597 $ 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 Six months ended
December 31, December 31,
----------------------- -------------------------
2002 2001 2002 2001
-------- -------- --------- ---------
Net sales $ 79,111 $ 84,313 $ 150,668 $ 166,506
Cost of sales 59,384 62,649 110,968 124,374
-------- -------- --------- ---------
Gross profit 19,727 21,664 39,700 42,132
-------- -------- --------- ---------
Operating expenses:
Selling, marketing and administrative 11,618 13,194 23,677 27,365
-------- -------- --------- ---------
Operating income 8,109 8,470 16,023 14,767
Other income (expense):
Interest expense (6,191) (6,797) (12,624) (15,397)
Interest income 48 76 106 167
-------- -------- --------- ---------
Income (loss) before income tax provision 1,966 1,749 3,505 (463)
Income tax provision (benefit) 3,098 613 6,195 (163)
-------- -------- --------- ---------
Net income (loss) (1,132) 1,136 (2,690) (300)
Dividends and accretion on preferred stock (3,482) (3,002) (6,964) (6,004)
-------- -------- --------- ---------
Net loss attributable to common stockholders $ (4,614) $ (1,866) $ (9,654) $ (6,304)
======== ======== ========= =========
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)
Six months ended
December 31,
-----------------------
2002 2001
-------- --------
Cash flows provided by operating activities:
Net loss $ (2,690) $ (300)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization 6,572 7,029
Amortization of debt issuance cost 805 805
Amortization of debt discount and accrued interest on senior note 1,505 1,339
Interest rate collar (1,308) 927
Bad debt expense 579 1,017
Loss on disposal of assets 25 166
Accrual of special payment on options to purchase Series A junior
preferred stock 599 524
Changes in current assets and liabilities:
Trade receivables (1,306) 3,070
Inventories 3,369 5,483
Other assets (434) 356
Accounts payable, accrued liabilities and other liabilities (6,002) 5,838
-------- --------
Net cash provided by operating activities 1,714 26,254
-------- --------
Cash flows used for investing activities:
Capital expenditures (2,704) (5,942)
-------- --------
Cash flows used for financing activities:
Repayment of borrowings (5,819) (6,772)
-------- --------
Net increase (decrease) in cash and cash equivalents (6,809) 13,540
Cash and cash equivalents, beginning of period 15,777 7,060
-------- --------
Cash and cash equivalents, end of period $ 8,968 $ 20,600
======== ========
Non-cash financing activities:
Capital expenditures included in accounts payable $ (788) $ 321
Dividends accrued but not paid 7,237 6,341
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 six months ended December 31, 2002
(in thousands)
Series B junior
preferred stock Common stock Additional
------------------ ---------------- paid-in
Shares Dollars Shares Dollars capital
------ ------- ------ ------- ----------
Balance, June 30, 2002 529 $ 74,838 1,368 $ 14 $13,053
Net loss
Other comprehensive income
Loans to employees-interest
income
Repayment of employee
loans
Dividends and accretion on
senior preferred stock
Dividends and accretion on
junior preferred stock 5,239
--- -------- ----- ----- -------
Balance, December 31, 2002 529 $ 80,077 1,368 $ 14 $13,053
=== ======== ===== ===== =======
Notes Accumulated Total
receivable other stock-
Retained from comprehensive holders' Comprehensive
deficit employees loss deficit loss
-------- ---------- ------------- ------- -------------
Balance, June 30, 2002 $(142,792) $ (337) $ (305) $(55,529)
Net loss (2,690) (2,690) $(2,690)
Other comprehensive income 87 87 87
Loans to employees-interest
income (12) (12)
Repayment of employee
loans 17 17
Dividends and accretion on
senior preferred stock (1,725) (1,725)
Dividends and accretion on
junior preferred stock (5,239) --
--------- -------- ------- -------- -------
Balance, December 31, 2002 $(152,446) $ (332) $ (218) $(59,852) $(2,603)
========= ======== ======= ======== =======
The accompanying notes are an integral part of these
consolidated financial statements.
5
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 a reduction of interest expense of $724,000 and
$274,000 for the quarters ended December 31, 2002 and December 31, 2001,
respectively. These amounts represent the changes in fair value of the interest
rate collar. For the six months ended December 31, 2002 and December 31, 2001,
O'Sullivan recognized additional (reduced) interest expense associated with the
interest rate collar of $(1.3 million) and $927,000, respectively. To terminate
this contract at December 31, 2002 and June 30, 2002, O'Sullivan would have been
required to pay the counter-party approximately $783,000 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 quarter and six months ended December 31, 2001, $3.6 million and $7.7
million, respectively, was reclassified as a reduction in revenue rather than as
selling, marketing and administrative expense.
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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.
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
6
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 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 second quarters of fiscal
2003 and fiscal 2002 were approximately $1.5 million and $2.2 million,
respectively. Freight out costs in the six months ended December 31, 2002 and
2001 were $3.6 million and $4.5 million, respectively.
NOTE 5--INVENTORY
Inventory, net, consists of the following:
December 31, June 30,
2002 2002
------------ --------
(in thousands)
Finished goods $34,219 $39,199
Work in process 5,211 5,158
Raw materials 9,598 8,040
------- -------
$49,028 $52,397
======= =======
NOTE 6--INCOME TAXES
O'Sullivan recorded tax expense of $3.1 million and $6.2 million for the
three months and six months ended December 31, 2002 that included a valuation
allowance of $2.4 million and $5.0 million, respectively.
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, 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.
7
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 O'Sullivan 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 and six months ended December 31, 2002, O'Sullivan paid RadioShack
$3.1 million and $6.2 million, respectively.
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.
As a result of the arbitration and settlement, O'Sullivan has to make
payments to RadioShack before all of O'Sullivan's deductions on its federal
income tax return reduce federal taxes. In effect, O'Sullivan contractually
prepays tax benefits to RadioShack that may be recovered by O'Sullivan from
federal income tax liabilities in the future.
O'Sullivan has recorded the $33.9 million in payments pursuant to the
settlement agreement as a deferred tax asset. O'Sullivan has a net deferred tax
asset of approximately $21.0 million at December 31, 2002. Under
8
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, 2002 (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 $73.0
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
$21.0 million at December 31, 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 $116,000 and $122,000
recognized in the second quarter of fiscal years 2003 and 2002, respectively,
are included in selling, marketing and administrative expense in the
accompanying consolidated statements of operations. Management fees and expenses
for the six months ending December 31, 2002 and 2001 were $233,000 and $220,000,
respectively. O'Sullivan Industries paid BRS $713,000 in the first quarter of
fiscal 2003 for the balance owed through June 30, 2002 and an additional
$305,000 as a prepayment of the fiscal 2003 management fee. The prepaid balance
at December 31, 2002 was $66,000 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 December 31, 2002, O'Sullivan held two notes receivable with a balance
of approximately $332,000 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, including $6.2 million paid through December 31, 2002 -- $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 grow our business.
Our sales declined 6.2% in the second quarter of fiscal 2003 and 9.5% for
the first six months of fiscal 2003. This decline continued the sales decreases
experienced by us in fiscal 2001 and fiscal 2002. Our sales declined for several
reasons:
- the lack of growth in sales of personal computers, which reduced the
need for computer desks and workcenters;
- increasing competition from imported furniture, particularly from
China;
- the slowdown of economic growth and consumer spending in the United
States;
- liquidations and bankruptcies by a number of customers, including
Montgomery Ward, Ames and Kmart;
- inventory reductions by our customers;
- the decline in price of the average unit sold, reflecting a trend
toward more promotional merchandise and increased competition; and
- 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 $1.1 million for the second
quarter of fiscal 2003 compared with net income of $1.1 million for the second
quarter of fiscal 2002. For the first half of fiscal 2003, our net loss before
dividends and accretion on preferred stock was $2.7 million compared to a net
loss of $300,000 for the first half of fiscal 2002. Operating income declined to
$8.1 million in the second quarter for fiscal 2003 from $8.5 million in fiscal
2002. For the first half of fiscal 2003, our operating income was $16.0 million,
compared with $14.8 million in the first half of fiscal 2002.
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 in the first half 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 half 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 also increase.
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, given our current sales trends in this economic environment, we expect
gross sales in the third quarter of fiscal 2003 will be about 15% lower than
sales in the third quarter of fiscal 2002. We anticipate our fiscal 2003 third
quarter operating income to decline approximately 20% to 30% from the fiscal
2002 third quarter. 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
11
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. For the three months and six months ended
December 31, 2002, we paid RadioShack $3.1 million and $6.2 million,
respectively.
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 the remainder of
fiscal 2003 are expected to be about $4.8 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 December 31, 2002 decreased by
$5.2 million, or 6.2%, to $79.1 million from $84.3 million for the quarter ended
December 31, 2001. Net sales for the six months ended December 31, 2002
decreased by $15.8 million, or 9.5%, to $150.7 million from $166.5 million for
the six months ended December 31, 2001. Our sales declined in every major
channel due to the economic uncertainties in the United States and the other
reasons cited above. Most of the decline for the quarter and six months was due
to a decline in unit volume, although the average price per unit declined
slightly.
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 announced that
it plans to close an additional 316 stores. Kmart has secured financing of $2
billion to help the company's cash flow while it restructures. Kmart has filed a
plan of reorganization 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 $19.7 million, or 24.9% of sales,
for the three month period ended December 31, 2002, from $21.7 million, or 25.7%
of sales, for the comparable prior year quarter. The gross margin percentage for
the second quarter of fiscal 2003 declined primarily because of lower sales and
operating levels, partially offset by lower material costs, particularly for
particleboard. For the six months ended December 31, 2002, gross profit declined
to $39.7 million, or 26.3% of sales, from $42.1 million, or 25.3% of sales. The
gross profit percentage increased for the first half of fiscal 2003 compared to
the prior year period as lower material prices offset the effects of lower sales
and operating volumes.
Selling, Marketing and Administrative Expenses. Selling, marketing and
administrative expenses decreased to $11.6 million, or 14.7% of sales, for the
three month period ended December 31, 2002, from $13.2 million, or 15.6% of
sales, for the quarter ended December 31, 2001. Freight out expense declined
because of lower sales and a change in a major customer's program. Sales
commissions were also lower in fiscal 2003 due to lower sales levels and changes
in the commission structure. Legal fees were higher in fiscal 2002 due to the
RadioShack arbitration. Bad debt expense was also higher in fiscal 2002 because
of the Kmart bankruptcy.
For the six months ended December 31, 2002, selling, marketing and
administrative expenses decreased $3.7 million from $27.4 million in fiscal 2002
to $23.7 million in fiscal 2003. The major factors were a decrease in freight
out expense and sales commission due to the reasons stated above and lower
incentive compensation and
12
profit sharing expenses because of our lower sales and financial performance.
Legal fees and bad debt expense were higher in fiscal 2002 because of the
RadioShack arbitration and Kmart bankruptcy, respectively.
Depreciation and Amortization. Depreciation and amortization expenses
decreased to $3.3 million for the second quarter of fiscal 2003 compared to $3.6
million for the second quarter of fiscal 2002. For the six month periods ended
December 31, 2002 and 2001, depreciation and amortization expenses were $6.6
million and $7.0 million, respectively. Depreciation and amortization declined
because equipment placed into service during the twelve months ended December
31, 2002 was less than the amount of equipment that became fully depreciated
during the same time period.
Operating Income. Operating income decreased $361,000 to $8.1 million for
the quarter ended December 31, 2002 from $8.5 million in the quarter ended
December 31, 2001. Lower sales and operating levels were partially offset by
lower material costs and lower selling, marketing and administrative expenses in
the three months ended December 31, 2002. For the six months ended December 31,
2002, operating income increased $1.3 million over the six months ended December
31, 2001. Reduced raw material prices, incentive compensation and profit sharing
expense and lower freight out expense, commission costs, legal fees and bad debt
expense contributed to the increased operating income during the first six
months in fiscal 2003, partially offset by lower sales and operating levels.
Net Interest Expense. Net interest expense decreased from $6.7 million in
the second quarter of fiscal 2002 to $6.1 million in the second quarter of
fiscal 2003. Net interest expense declined $2.7 million from $15.2 million for
the first half of fiscal 2002 to $12.5 million for the first half of fiscal
2003. 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.
Three months ended Six months ended
December 31, December 31,
--------------------- -----------------------
(in thousands) (in thousands)
2002 2001 2002 2001
------- ------- -------- --------
Interest expense on senior credit
facility, industrial revenue bonds
and senior subordinated notes $ 5,746 $ 5,983 $ 11,622 $ 12,326
Interest income (48) (76) (106) (167)
Non-cash items:
Interest expense on O'Sullivan
Holdings note 623 555 1,217 1,083
Interest rate collar (724) (274) (1,308) 927
Amortization of debt discount 144 131 288 256
Amortization of loan fees 402 402 805 805
------- ------- -------- --------
Net interest expense $ 6,143 $ 6,721 $ 12,518 $ 15,230
======= ======= ======== ========
Income Tax Provision (Benefit). We recorded tax expense of $3.1 million
for the second quarter of fiscal 2003 that included an increase in the valuation
allowance of $2.4 million. For the first half of fiscal 2003, we recorded tax
expense of $6.2 million and a valuation allowance of $5.0 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
for federal tax purposes for which we recorded no deferred tax assets as such
deductions were assets of RadioShack under the tax sharing agreement.
13
As more fully described above, we can no longer consider the increased
interest costs in calculating the amounts due to RadioShack. Therefore, we 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 and $6.2 million for the three months and six months
ended December 31, 2002, respectively. We recorded these payments as a deferred
tax asset. We have a net deferred tax asset of approximately $21.0 million at
December 31, 2002. At December 31, 2002 (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 $73.0 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 $21.0 million at December 31, 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 Income (Loss). Our net income declined from $1.1 million in the second
quarter of fiscal 2002 to a net loss of $1.1 million in fiscal 2003 due to
increased tax expense and lower sales and operating levels, partially offset by
lower material prices, lower selling, marketing and administrative expenses and
lower interest expense. Net loss increased $2.4 million from a loss of $300,000
in the first half of fiscal 2002 to a loss of $2.7 million in the first half of
fiscal 2003 due to increased tax expense, partially offset by lower raw material
costs, decreased selling and administrative expenses and lower interest expense.
EBITDA. EBITDA, which we define as earnings before interest income and
interest expense, income taxes, depreciation and amortization, decreased by
$661,000 to $11.4 million for the quarter ended December 31, 2002 from $12.1
million for the prior year quarter. EBITDA for the fiscal 2003 second quarter
decreased primarily due to lower sales and operating levels, partially offset by
lower material costs and selling and administrative expenses. For the six months
ended December 31, 2002, EBITDA was $22.6 million, up $799,000 from the six
months ended December 31, 2001. The increase was due primarily to lower material
costs and lower selling and administrative expenses, partially offset by lower
sales and operating levels.
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. EBITDA
provides another measure of the operations of the business of O'Sullivan prior
to the impact of interest, taxes and depreciation. Further, EBITDA is a common
method of valuing highly leveraged companies such as O'Sullivan, and the measure
is a component of each of the financial covenants in our senior credit facility.
14
The following table reconciles net income (loss) to EBITDA for the three
months and six months ended December 31, 2002 and 2001.
Three months ended Six months ended
December 31, December 31,
---------------------- -----------------------
(in thousands) (in thousands)
2002 2001 2002 2001
-------- ------- -------- --------
Net income (loss) $ (1,132) $ 1,136 $ (2,690) $ (300)
Income tax provision (benefit) 3,098 613 6,195 (163)
Interest expense, net 6,143 6,721 12,518 15,230
-------- ------- -------- --------
Operating income 8,109 8,470 16,023 14,767
Depreciation and amortization 3,308 3,608 6,572 7,029
-------- ------- -------- --------
EBITDA $ 11,417 $12,078 $ 22,595 $ 21,796
======== ======= ======== ========
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 December 31, 2002, cash and cash equivalents
totaled $9.0 million. Net working capital was $59.4 million at December 31, 2002
compared to $62.6 million at June 30, 2002.
Operating Activities. Net cash provided by operating activities for the
six months ended December 31, 2002 was $1.7 million compared to net cash
provided of $26.3 million for the six months ended December 31, 2001. Cash flow
from operations decreased year-over-year for the following reasons.
- Accounts payable increased $1.2 million during the first half of
fiscal 2002 and declined $2.8 million during the first half of
fiscal 2003. The change was due to differences in the timing of
plant shutdowns in the two years and to lower operating levels in
fiscal 2003.
- Profit sharing and incentive compensation payments during the first
half of fiscal 2003 were approximately $3.0 million higher than in
the first half 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 $730,000 in fiscal 2002 compared to
fiscal 2003.
- Trade receivables increased in fiscal 2003, reducing cash by $1.3
million, compared with a decrease of $3.1 million that provided cash
in fiscal 2002. The fiscal 2003 receivables increase was due to
higher sales levels in December 2002 compared to June 2002 sales.
- Increases in accrued advertising provided net cash of $4.1 million
in fiscal 2003 compared to $5.7 million during fiscal 2002. The
decrease this year was due to lower sales and associated decreases
in vendor incentive programs. In addition, a particular customer
changed its pattern of claiming certain incentives, lowering accrued
advertising.
- In fiscal 2003, decreases in inventories provided $3.4 million of
cash, compared with $5.5 million in fiscal 2002.
- During the first half of fiscal 2003, we paid RadioShack $6.2
million under the tax sharing agreement.
15
- In fiscal 2003, the liability associated with the interest rate
collar declined by $1.3 million as opposed to a $927,000 increase in
fiscal 2002.
Investing Activities. We invested $2.7 million for capital expenditures
for the six months ended December 31, 2002 compared to $5.9 million for the
prior year six month period. We currently estimate that the total capital
expenditure requirements for the remainder of the fiscal year will be
approximately $3.0 million to $5.0 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 December 31, 2002 was $237.7
million consisting of:
- $106.7 million in a senior secured credit facility consisting of a
five year $20.9 million term loan A, a seven and one-half year $85.8
million term loan B and a $40.0 million revolving line of credit,
with no borrowings at December 31, 2002. The current portion of
these term loans was approximately $4.7 million at December 31,
2002. The revolving line of credit has a $15.0 million sub-limit for
letters of credit, of which we are currently utilizing approximately
$13.8 million.
- $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.
- $10.0 million in variable rate industrial revenue bonds.
- $21.0 million, including $6.0 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 at
December 31, 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 $ 20,917 $(3,874) $ -- $ -- $ 17,043
Term loan B 85,796 (875) -- -- 84,921
-------- ------- ------- ------- --------
Senior secured credit 106,713 (4,749) -- -- 101,964
Senior subordinated note 100,000 -- (1,601) (2,868) 95,531
Industrial revenue bonds 10,000 -- -- -- 10,000
Senior note 20,977 -- -- (2,928) 18,049
-------- ------- ------- ------- --------
Total $237,690 $(4,749) $(1,601) $(5,796) $225,544
======== ======= ======= ======= ========
During the six months ended December 31, 2002, we made regularly scheduled
principal payments of $1.7 million 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
$23.9 million at December 31, 2002. Decreased demand for our products could
decrease our cash flow from operations and the availability of
16
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. We
repaid the revolving credit line borrowings in November 2002.
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:
- Our consolidated leverage ratio must be less than 4.25. The ratio at
December 31, 2002 was 3.83. At June 30, 2003, our consolidated
leverage ratio must be less than 4.00.
- Our consolidated interest coverage ratio must be greater than 2.00.
The ratio at December 31, 2002 was 2.26. At June 30, 2003, our
consolidated interest coverage ratio must be greater than 2.00.
- Our consolidated fixed charge coverage ratio must be greater than
1.10. The ratio at December 31, 2002 was 1.45. At June 30, 2003, our
consolidated fixed charge coverage ratio must be greater than 1.10.
- Our senior debt coverage ratio must be less than 2.50. The ratio at
December 31, 2002 was 2.06. At June 30, 2003, our senior debt
coverage ratio must be less than 2.35.
- 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 and six months ended December 31, 2002 were $56.6 million and $23.3
million, respectively. O'Sullivan Industries is the borrower under the credit
facility, so the covenants do not include the $21.0 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 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 December 31, 2002, we were in compliance with all applicable debt
covenants. However, if our sales and earnings do not improve from the current
outlook, we may be in violation of certain of our covenants under the senior
credit facility at June 30, 2003. We are currently working with our lenders to
obtain a waiver or amendment of these 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 December 31, 2002,
we would have been required to pay the counter-party approximately $783,000. 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.
17
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 $237,690 $4,749 $18,794 $83,170 $130,977
Tax benefit payments to
RadioShack(1)
Capital lease obligations -- -- -- -- --
Operating leases--unconditional 4,224 1,830 2,273 121 --
Other long-term obligations 558 200 358 -- --
-------- ------ ------- ------- --------
Total contractual cash obligations $242,472 $6,779 $21,425 $83,291 $130,977
======== ====== ======= ======= ========
(1) Payments to RadioShack are
contingent on taxable income. The
maximum payments are: $ 77,980 $9,654 $21,073 $24,632 $ 22,621
======== ====== ======= ======= ========
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.
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.
18
- 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 $5.4 million and $4.9 million
at December 31, 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,
decreasing income in the period such determination was made.
- 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.
- 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.
- 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:
- loss of liquidity due to the arbitration panel's opinion in
RadioShack Corporation v. O'Sullivan Industries Holdings, Inc.;
- significant indebtedness that may limit our financial and
operational flexibility;
19
- 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;
- 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;
- raw material cost increases, particularly in particleboard and
fiberboard, as occurred in 1994 and 1995 and to a lesser extent in
fiscal 2000;
- transportation cost increases, due to higher fuel costs or
otherwise;
- 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;
- actions of current or new competitors, foreign or domestic, that
increase competition with our products or prices;
- the consolidation of manufacturers in the ready-to-assemble
furniture industry;
- increased advertising costs associated with promotional efforts;
- increased interest rates;
- pending or new litigation or governmental regulations such as the
recently settled arbitration involving RadioShack;
- other uncertainties which are difficult to predict or beyond our
control; and
- 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.
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 $1.1 million
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 $1.5 million annually.
20
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.
21
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.
We responded to the suit denying we received any preferential payments. We
plan to contest this litigation vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
An annual meeting of stockholders of O'Sullivan was held on November 14,
2002 to elect one Class III director. We did not solicit proxies. Mr. Daniel F.
O'Sullivan was reelected as a Class III director. Mr. O'Sullivan received
1,175,801 votes for reelection; no votes were withheld. The terms of office of
Messrs. Charles A. Carroll, Richard D. Davidson and Harold O. Rosser did not
expire in 2002; they continue as directors of O'Sullivan.
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
22
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: February 13, 2003 By: /s/ Richard D. Davidson
-------------------------------------------
Richard D. Davidson
President and
Chief Executive Officer
Date: February 13, 2003 By: /s/ Phillip J. Pacey
-------------------------------------------
Phillip J. Pacey
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
23
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: February 13, 2003 /s/ Richard D. Davidson
-------------------------------------
Richard D. Davidson
President and Chief Executive Officer
24
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: February 13, 2003 /s/ Phillip J. Pacey
-------------------------------
Phillip J. Pacey
Senior Vice President and
Chief Financial Officer
25
INDEX TO EXHIBITS
Page
Exhibit No. Description 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 December 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 December 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 27
99.2 Certificate of chief financial officer under Section 906 of the
Sarbanes-Oxley Act of 2002 28
26