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UNITED STATES
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 March 31, 2005
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: 333-31282
O'Sullivan Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 43-0923022
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
10 Mansell Court East, Suite 100, Roswell, Georgia 30076
(Address of principal executive offices) (ZIP Code)
(678) 939-0800
(Registrant's telephone number, including area code)
1900 Gulf Street, Lamar, Missouri 64759
(Former name, former address and former fiscal year, if changed since last report)
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 May 10, 2005,100 shares of common stock, par value $1.00 per share, were outstanding and held by
O'Sullivan Industries Holdings, Inc.
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PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
March 31, June 30,
Assets 2005 2004
-------------- -------------
Current assets:
Cash and cash equivalents $ 4,584 $ 5,250
Trade receivables, net of allowance for doubtful accounts
of $1,947 and $2,144, respectively 29,067 22,579
Inventories, net 39,893 55,071
Prepaid expenses and other current assets 2,455 3,229
------------ -----------
Total current assets 75,999 86,129
Property, plant and equipment, net 53,666 61,683
Other assets 6,925 8,256
Goodwill, net of accumulated amortization 38,088 38,088
------------ -----------
Total assets $ 174,678 $ 194,156
============ ===========
Liabilities and Stockholder's Deficit
Current liabilities:
Accounts payable $ 11,787 $ 8,199
Accrued advertising 9,670 9,422
Accrued liabilities 16,453 15,177
Payable to parent - tax sharing agreement – 3,658
------------ -----------
Total current liabilities 37,910 36,456
Long-term debt 198,822 197,820
Other liabilities 3,064 3,276
Payable to parent - tax sharing agreement 70,067 66,409
Other payable to parent 3,634 2,254
------------ -----------
Total liabilities 313,497 306,215
Commitments and contingent liabilities (Notes 10, 11 and 12)
Stockholder's deficit:
Common stock, $1.00 par value; 100 shares authorized, issued and outstanding
at June 30, 2004 and March 31, 2005, respectively – –
Retained deficit (140,957) (113,620)
Accumulated other comprehensive income 2,138 1,561
------------ -------------
Total stockholder's deficit (138,819) (112,059)
------------ -------------
Total liabilities and stockholder's deficit $ 174,678 $ 194,156
============ ===========
The accompanying notes are an integral part of these consolidated financial statements.
============ ===========
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Three months ended Nine months ended
March 31, March 31,
-------------------------- --------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net sales $ 68,543 $ 73,239 $ 197,409 $ 209,937
Cost of sales 60,939 57,797 169,299 165,598
------------ ------------ ------------ ------------
Gross profit 7,604 15,442 28,110 44,339
------------ ------------ ------------ ------------
Operating expenses:
Selling, marketing and administrative 11,335 12,024 34,712 33,860
Restructuring charge 357 – 357 –
Casualty loss – – – 250
------------ ------------ ------------ ------------
Operating income (loss) (4,088) 3,418 (6,959) 10,229
Other income (expense):
Interest expense (6,818) (6,728) (20,384) (19,785)
Interest income 2 4 6 35
Other financing costs, net – – – (2,678)
------------ ------------ ------------ ------------
Loss before income tax provision (10,904) (3,306) (27,337) (12,199)
Income tax provision – – – –
------------ ------------ ------------ ------------
Net loss $ (10,904)$ (3,306) $ (27,337)$ (12,199)
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine months ended
March 31,
------------------------
2005 2004
---------- ----------
Cash flow provided (used) by operating activities:
Net loss $ (27,337) $ (12,199)
Adjustments to reconcile net loss to net cash provided (used)
by operating activities:
Depreciation and amortization 8,931 9,685
Amortization of debt issuance cost 1,245 1,234
Amortization of debt discount 1,001 705
Settlement of notes receivable from employees 283 –
Bad debt expense (recoveries) (265) 101
Gain (loss) on disposal of assets 16 (81)
Debt extinguishment costs, net – 2,678
Accrual of special payment on options to purchase Series A junior
preferred stock 1,210 1,053
Changes in assets and liabilities:
Trade receivables (6,223) (2,646)
Inventories 15,178 (189)
Other assets 774 143
Accounts payable and accrued liabilities 3,772 11,209
---------- ----------
Net cash provided (used) by operating activities (1,415) 11,693
Cash flow used for investing activities:
Capital expenditures (631) (1,538)
---------- ----------
Cash flow provided (used) for financing activities:
Proceeds from borrowings on revolving credit debt 5,700 –
Repayment of revolving credit debt (5,700) –
Proceeds from borrowings – 95,000
Extinguishment of borrowings – (92,265)
Debt issuance costs – (4,030)
Advances on intercompany loans 1,380 786
---------- ----------
Net cash flow provided (used) for financing activities 1,380 (509)
Net increase (decrease) in cash and cash equivalents (666) 9,646
Cash and cash equivalents, beginning of period 5,250 7,977
---------- ----------
Cash and cash equivalents, end of period $ 4,584 $ 17,623
========== ==========
Non-cash investing and financing activities:
Capital expenditures included in accounts payable $ 72 $ 170
The accompanying notes are an integral part of these consolidated financial statements.
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
UNAUDITED CONSOLIDATED STATEMENTS
OF CHANGES IN STOCKHOLDER'S DEFICIT
For the nine months ended March 31, 2005
(in thousands)
Accumulated
other Total
Retained comprehensive stockholder's Comprehensive
deficit income deficit income (loss)
------------ --------------- --------------- ----------------
------------ --------------- --------------- ----------------
Balance, June 30, 2004 $ (113,620) $ 1,561 $ (112,059)
Net loss (27,337) (27,337)$ (27,337)
Other comprehensive income 577 577 577
------------ --------------- --------------- ----------------
Balance, March 31, 2005 $ (140,957) $ 2,138 $ (138,819)$ (26,760)
============ =============== =============== ================
The accompanying notes are an integral part of these consolidated financial statements.
============ =============== =============== ================
O'SULLIVAN INDUSTRIES, INC.
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Note 1–Basis of Presentation
The unaudited consolidated financial statements of O'Sullivan Industries, Inc. and subsidiaries
("O'Sullivan"), a wholly owned subsidiary of O'Sullivan Industries Holdings, Inc. ("O'Sullivan Holdings"), included
herein have been prepared in accordance with generally accepted accounting principles for interim financial
information and pursuant to the requirements of 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, 2004. The
interim results are not necessarily indicative of the results that may be expected for a full year. O'Sullivan is the sole
owner of O'Sullivan Industries - Virginia, Inc. ("O'Sullivan Industries - Virginia") and O'Sullivan Furniture Factory
Outlet, Inc.
Note 2–Liquidity
O'Sullivan has a stockholder's deficit of approximately $138.8 million as of March 31, 2005, incurred a net
loss of $27.3 million for the nine months ended March 31, 2005 and expects to incur additional losses during the
remainder of the fiscal year ending June 30, 2005 and during fiscal 2006. O'Sullivan's net sales have declined each
of the past four years. O'Sullivan's sales and operating results during fiscal 2004 and the first three quarters of fiscal
2005 were impacted by increased competition from foreign and domestic competitors, a product mix reflecting more
promotional merchandise, unfavorable manufacturing overhead variances incurred from lower operating levels due
to lower sales and execution of its inventory reduction plan and higher raw material costs, principally particleboard
and fiberboard. The third quarter of fiscal 2005 and fiscal 2005 year to date results of operations have also been
adversely affected by an increase in O'Sullivan's reserves for raw materials and work-in-process inventories of $3.6
million and by charges and expenses aggregating $1.5 million in connection with the closing of its Australian
operations.
O'Sullivan has recently added several new key members to its executive management team. The new
executive management team has evaluated O'Sullivan's strategies and core competencies to determine the most
effective way to improve sales, reduce costs and increase operating income. Management has developed and is
implementing a strategic plan developed from that evaluation. O'Sullivan refinanced its previous senior credit
facility on September 29, 2003. As a result of the refinancing, O'Sullivan has no principal payments on debt due
until October 2008. In connection with the refinancing, O'Sullivan entered into a five year $40 million revolving
credit agreement. Borrowing availability under the credit agreement is subject to, among other things, a borrowing
base determined by qualified inventory and accounts receivable levels, and is further reduced by outstanding letters
of credit. O'Sullivan expects borrowing availability under the credit agreement to approximate $8.5 million to $10
million, after the effect of outstanding letters of credit, from April 2005 through the end of fiscal 2005. Decreased
demand for O'Sullivan products, as well as efforts to reduce working capital requirements, could negatively affect
levels of inventory and accounts receivable and thus the borrowing availability under the credit agreement. No
borrowings were outstanding under the credit agreement at March 31, 2005.
O'Sullivan management believes that cash on hand, net cash to be generated from operations, and forecasted
availability under the credit agreement will be sufficient to meet O'Sullivan's cash needs for the next twelve months.
O'Sullivan was in compliance with its debt covenants at March 31, 2005 and expects to remain in compliance with
these covenants during the next twelve months. In the event that revenues are significantly below fiscal year 2005 or
fiscal year 2006 forecasted revenues, O'Sullivan believes it has the ability to reduce or delay discretionary
expenditures and further reduce operating costs and expenses so that it will have sufficient cash resources through
the next twelve months. However, there can be no assurance that O'Sullivan will be able to adjust its costs in
sufficient time to respond to revenue shortfalls, should that occur.
Note 3–New Accounting Standards
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 123(R) ("SFAS 123(R)"). SFAS 123(R) revised SFAS 123, Accounting for
Stock-Based Compensation, and requires companies to expense the fair value of employee stock options and other
forms of stock-based compensation. O'Sullivan will adopt this standard for fiscal 2006 which begins on July 1,
2005. O'Sullivan is currently evaluating the impact of SFAS 123(R) on its consolidated financial statements and has
not yet selected a transition method for adopting this standard.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4, ("SFAS 151"). The amendments made by SFAS 151 clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be recognized as current-period charges.
SFAS 151 also requires that allocation of fixed production overheads to the costs of inventory conversion be based
on normal capacity of the production facilities. O'Sullivan will adopt this accounting standard on July 1, 2005.
O'Sullivan is currently evaluating the financial statement impact of the adoption of SFAS 151.
Note 4–Stock Based Compensation
O'Sullivan accounts for stock-based compensation for employees under Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and has elected the disclosure-only alternative
under SFAS 123, as amended by SFAS 148. No stock-based compensation cost is recorded, as all options granted
have an exercise price equal to the market value of the stock on the date of the grant. In accordance with SFAS 148,
the following table presents the effect on O'Sullivan's net income (loss) had compensation cost for O'Sullivan
Holdings' stock plans been determined consistent with SFAS 123:
Three months ended Nine months ended
March 31, March 31,
--------------------------- ------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
(in thousands)
----------- ----------- -----------
Net loss as reported $ (10,904) $ (3,306) $ (27,337$ (12,199)
Less: total stock-based compensation expense
determined under fair value method for all stock
options, net of related income tax – – (3) (3)
----------- ----------- ----------- -----------
Pro forma net loss $ (10,904) $ (3,306) $ (27,340$ (12,202)
=========== =========== =========== ===========
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over
the vesting period.
Effective November 18, 2004, the Board of Directors of O'Sullivan Holdings approved a new 2004 Class A
Common Stock Option Plan providing for the issuance of options to purchase up to 93,182 shares of Class A
common stock, par value $0.01 per share, subject to adjustment. Under the plan, options may be granted to
executives and other key employees of O'Sullivan and its subsidiaries. The plan will be administered by the
Compensation Committee of O'Sullivan Holdings' Board of Directors, which will set the terms for each option
agreement. Option terms may extend no longer than ten years, and exercise prices must be at least fair market value
on the date of grant of the stock option. Vesting terms will be subject to the attainment of certain performance
targets, the passage of time or otherwise; provided, however, that all shares will vest upon a sale, merger or change
in control of O'Sullivan Holdings. The Compensation Committee will designate options as incentive stock options or
non-qualified stock options at the time of grant. An option holder may pay the exercise price for options exercised in
cash, in shares of previously owned common stock of O'Sullivan Holdings or by a reduction in the number of shares
to be received by the exercising option holder. Any applicable withholding taxes must be paid in cash, by delivery
of previously owned shares or by a reduction in the number of shares to be received by the exercising option holder.
In November 2004, the Compensation Committee granted incentive stock options to purchase 48,000 shares
of Class
A common stock at an exercise price of $0.01 per share, which is the estimated fair value of the underlying
common stock at the date of grant. The options vest in five annual installments beginning on the first anniversary of
the date of grant of the option and expire on the tenth anniversary of the date of grant. None of these options were
exercisable at March 31, 2005.
Note 5–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 third quarter of fiscal 2005 and fiscal 2004 were approximately
$2.1 million and $2.1 million, respectively. Freight out costs in the nine months ended March 31, 2005 and 2004
were $6.1 million and $5.3 million, respectively.
Note 6–Inventory
Inventory, net, consists of the following:
March 31, June 30,
2005 2004
------------- -----------
(in thousands)
--
Finished goods $ 23,815 $ 36,645
Work in process 5,254 4,817
Raw materials 6,582 10,503
Maintenance and supplies 4,242 3,106
----------- ---------
$ 39,893 $ 55,071
=========== =========
During the quarter ended March 31, 2005, O'Sullivan increased its reserve for raw materials and work-in-
process inventories by $3.6 million. In addition, in connection with the closing of its Australian operations,
O'Sullivan increased its reserve for finished goods inventory located in Australia by $1.2 million. See Note 8. In the
first quarter, O'Sullivan decreased its allowance for maintenance and supplies inventory by approximately
$1.4 million.
Note 7–Accrued Liabilities
Accrued liabilities consist of the following:
March 31, June 30,
2005 2004
------------ ------------
(in thousands)
---
Accrued interest $ 8,356 $ 7,684
Accrued compensation 5,930 6,515
Other 2,167 978
---------- ---------
$ 16,453 $ 15,177
========== =========
Note 8–Closing of Australian Operations
In February 2005, O'Sullivan decided to close its Australian operations. The decision was made based on
an assessment of the business and the determination that sales in the region were not sufficient to support the
infrastructure required. In the closure of the sales office, warehouse and two retail stores of this operation, the
employment of approximately 17 employees has been or will be severed. The winding down of the operations is
expected to be completed by the end of the first quarter of fiscal 2006.
As a result of the closing of the Australian operations, O'Sullivan expects to incur expenses between
$1.6 million and $2.0 million. Of this amount, between $400,000 and $700,000 will represent cash charges related
to severance, termination of leases and other agreements and costs to administer the winding down of these
operations. In the quarter ended March 31, 2005, O'Sullivan recorded $1.5 million of expenses, of which $357,000
was a cash charge reflected in restructuring charge on our consolidated statement of income. The remainder was a
non-cash charge of $1.2 million in the third quarter of fiscal 2005 as a reserve against inventories in Australia and is
included in cost of sales. At March 31, 2005, O'Sullivan had paid the employee termination benefits and
administrative and other costs appearing in the restructuring charge. O'Sullivan expects the majority of the lease
termination expenses will be paid, and the inventory reserves will be depleted, by the end of the first quarter of fiscal
2006.
The components of the exit costs for the nine months ended March 31, 2005 were as follows:
Paid or Remaining
Charges incurred eserve at
through through March 31,
March 31, March 31, 2005
Exit Costs 2005 2005 r
- --------------------------------------- ----------- ----------- -----------
(in thousands)
----------- ----------- -----------
Inventory reserves $ 1,182 $ – $ 1,182
Employee termination benefits 97 97 –
Lease termination expenses 121 – 121
Administrative and other costs 139 139 –
----------- ----------- -----------
Total $ 1,539 236 $ 1,303
=========== =========== ===========
Note 9–Condensed Consolidating Financial Information
In November 1999 O'Sullivan issued $100 million of 13.375% senior subordinated notes due 2009. These
notes are unsecured obligations of O'Sullivan; however, they were guaranteed on an unsecured basis by O'Sullivan
Industries - Virginia and any future subsidiaries created, including O'Sullivan Furniture Factory Outlet, Inc., which
commenced operations in April 2002. The guarantees are full and unconditional. In fiscal 2000, O'Sullivan
exchanged the senior subordinated notes issued in November 1999 for notes with substantially identical terms and
associated guarantees. The exchange notes have been registered under the Securities Act of 1933, as amended.
The accompanying condensed consolidating financial information has been prepared and presented
pursuant to SEC rules and regulations.
Condensed Consolidating Statements of Operations
Three months ended March 31, 2005
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net sales $ 48,213 $ 20,330$ –$ 68,543
Cost of sales 43,116 17,823 – 60,939
----------- ------------ -------------- -------------
Gross profit 5,097 2,507 – 7,604
Operating expenses:
Selling, marketing and administrative 9,145 2,190 – 11,335
Restructuring charge 357 – – 357
----------- ------------ -------------- -------------
Operating income (loss) (4,405) 317 – (4,088)
Other income (expense):
Interest expense (6,667) (151) – (6,818)
Interest income 2 – – 2
Other financing costs, net – – – –
Equity in earnings of subsidiary 166 – (166) –
----------- ------------ -------------- -------------
Loss before income tax provision (10,904) 166 (166) (10,904)
Income tax provision – – – –
----------- ------------ -------------- -------------
Net loss $ (10,904)$ 166$ (166$ (10,904)
=========== ============ ============== =============
Three months ended March 31, 2004
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net sales $ 62,217 $ 11,022$ –$ 73,239
Cost of sales 47,685 10,112 – 57,797
----------- ------------ -------------- -------------
Gross profit 14,532 910 – 15,442
Operating expenses:
Selling, marketing and administrative 10,840 1,184 – 12,024
Casualty loss – – – –
----------- ------------ -------------- -------------
Operating income (loss) 3,692 (274) – 3,418
Other income (expense):
Interest expense (6,504) (224) – (6,728)
Interest income 4 – – 4
Other financing costs, net – – – –
Equity in loss of subsidiary (498) – 498 –
----------- ------------ -------------- -------------
Loss before income tax provision (3,306) (498) 498 (3,306)
Income tax provision – – – –
----------- ------------ -------------- -------------
Net loss $ (3,306)$ (498$ 498$ (3,306)
=========== ============ ============== =============
Nine months ended March 31, 2005
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net sales $ 146,803 $ 50,606$ –$ 197,409
Cost of sales 124,761 44,538 – 169,299
----------- ------------ -------------- -------------
Gross profit 22,042 6,068 – 28,110
Operating expenses:
Selling, marketing and administrative 29,478 5,234 – 34,712
Restructuring charge 357 – – 357
----------- ------------ -------------- -------------
Operating income (loss) (7,793) 834 – (6,959)
Other income (expense):
Interest expense (19,981) (403) – (20,384)
Interest income 6 – – 6
Other financing costs, net – – – –
Equity in earnings of subsidiary 431 – (431) –
----------- ------------ -------------- -------------
Loss before income tax provision (27,337) 431 (431) (27,337)
Income tax provision – – – –
----------- ------------ -------------- -------------
Net loss $ (27,337)$ 431$ (431$ (27,337)
=========== ============ ============== =============
Nine months ended March 31, 2004
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net sales $ 169,899 $ 40,038$ –$ 209,937
Cost of sales 129,849 35,749 – 165,598
----------- ------------ -------------- -------------
Gross profit 40,050 4,289 – 44,339
Operating expenses:
Selling, marketing and administrative 29,796 4,064 – 33,860
Casualty loss 250 – – 250
----------- ------------ -------------- -------------
Operating income 10,004 225 – 10,229
Other income (expense):
Interest expense (19,105) (680) – (19,785)
Interest income 35 – – 35
Other financing costs, net (2,678) – – (2,678)
Equity in loss of subsidiary (455) – 455 –
----------- ------------ -------------- -------------
Loss before income tax provision (12,199) (455) 455 (12,199)
Income tax provision – – – –
----------- ------------ -------------- -------------
Net loss $ (12,199)$ (455$ 455$ (12,199)
=========== ============ ============== =============
Condensed Consolidating Balance Sheets
March 31, 2005
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating
Industries Subsidiaries CAdjustments Consolidated
----------- ------------ -------------- -------------
ASSETS:
Current assets $ 67,002 $ 8,997$ –$ 75,999
Property, plant and equipment, net 29,291 24,375 – 53,666
Other assets 6,876 49 – 6,925
Investment in subsidiaries 48,445 – (48,445) –
Goodwill 38,088 – – 38,088
Receivable from parent – 45,917 (45,917) –
----------- ------------ -------------- -------------
Total assets $ 189,702 $ 79,338$ (94,362$ 174,678
=========== ============ ============== =============
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):
Current liabilities $ 34,322 $ 3,588$ –$ 37,910
Long-term debt 188,822 10,000 – 198,822
Other liabilities 3,064 – – 3,064
Payable to parent - tax sharing
agreement 52,762 17,305 – 70,067
Other payable to parent 49,551 – (45,917) 3,634
Stockholder's equity (deficit) (138,819) 48,445 (48,445) (138,819)
----------- ------------ -------------- -------------
Total liabilities and $ 189,702 $ 79,338$ (94,362$ 174,678
stockholder's equity (deficit)
=========== ============ ============== =============
June 30, 2004
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating
Industries Subsidiaries CAdjustments Consolidated
----------- ------------ -------------- -------------
ASSETS:
Current assets $ 77,972 $ 8,157$ –$ 86,129
Property, plant and equipment, net 34,292 27,391 – 61,683
Other assets 8,186 70 – 8,256
Investment in subsidiaries 34,364 – (34,364) –
Goodwill 38,088 – – 38,088
Receivable from parent – 41,279 (41,279) –
----------- ------------ -------------- -------------
Total assets $ 192,902 $ 76,897$ (75,643$ 194,156
=========== ============ ============== =============
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):
Current liabilities $ 17,889 $ 18,567$ –$ 36,456
Long-term debt 187,820 10,000 – 197,820
Other liabilities 3,276 – – 3,276
Payable to parent - tax sharing
agreement 52,443 13,966 – 66,409
Other payable to parent 43,533 – (41,279) 2,254
Stockholder's equity (deficit) (112,059) 34,364 (34,364) (112,059)
----------- ------------ -------------- -------------
Total liabilities and $ 192,902 $ 76,897$ (75,643$ 194,156
stockholder's equity (deficit)
=========== ============ ============== =============
Condensed Consolidating Statements of Cash Flows
Nine months ended March 31, 2005
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net cash flows provided by operating $
activities: $ (6,145) 4,730$ –$ (1,415)
----------- ------------ -------------- -------------
Investing activities:
Capital expenditures (463) (168) – (631)
Repayment of loans to affiliates 4,638 – (4,638) –
----------- ------------ -------------- -------------
Net 4,175 (168) (4,638) (631)
----------- ------------ -------------- -------------
Op
Financing activities:
Advances (repayment) of loans from
affiliates 6,081 (4,638) (63) 1,380
Proceeds from borrowings 5,700 – – 5,700
Repayment of borrowings (5,700) – – (5,700)
----------- ------------ -------------- -------------
Net 6,081 (4,638) (63) 1,380
----------- ------------ -------------- -------------
Cash and cash equivalents:
Net increase in cash and cash
equivalents 4,111 (76) (4,701) (666)
Cash and cash equivalents, beginning
of period 5,023 227 – 5,250
----------- ------------ -------------- -------------
Cash and cash equivalents, end of $ 9,134 $ 151$ (4,701$ 4,584
period
=========== ============ ============== =============
Nine months ended March 31, 2004
(in thousands)
---------------------------------------------------------
O'Sullivan Guarantor onsolidating onsolidated
Industries Subsidiaries CAdjustments C
----------- ------------ -------------- -------------
Net cash flows provided by operating
activities: $ 3,682 $ 8,011$ –$ 11,693
----------- ------------ -------------- -------------
Investing activities:
Capital expenditures (1,388) (150) – (1,538)
Repayment of loans to affiliates 7,757 – (7,757) –
----------- ------------ -------------- -------------
Net 6,369 (150) (7,757) (1,538)
----------- ------------ -------------- -------------
Op
Financing activities:
Advances (repayment) of loans from
affiliates 786 (7,757) 7,757 786
Proceeds from borrowings 95,000 – – 95,000
Repayment of borrowings (92,265) – – (92,265)
Debt issuance costs (4,030) – – (4,030)
----------- ------------ -------------- -------------
Net (509) (7,757) 7,757 (509)
----------- ------------ -------------- -------------
Cash and cash equivalents:
Net increase in cash and cash
equivalents 9,542 104 – 9,646
Cash and cash equivalents, beginning
of period 7,878 99 – 7,977
----------- ------------ -------------- -------------
Cash and cash equivalents, end of $ 17,420 $ 203$ –$ 17,623
period
=========== ============ ============== =============
Note 10–Income Taxes
O'Sullivan Holdings entered into a significant tax sharing and tax benefit reimbursement agreement with
RadioShack Corporation (O'Sullivan's former parent) in 1994. See Note 3 to the consolidated financial statements
included in O'Sullivan's Annual Report on Form 10-K for the year ended June 30, 2004. Because of the current tax
benefits associated with the Section 338 election and the valuation allowance recorded in the fiscal year ended
June 30, 2002, O'Sullivan recorded no tax income expense for the three and nine months ended March 31, 2005 and
2004.
Note 11–Related Party Transactions
BRS. O'Sullivan entered into a management services agreement with Bruckmann, Rosser, Sherrill & Co.,
LLC ("BRS"), an affiliate of the holder of a majority of O'Sullivan's voting common stock, for strategic and financial
advisory services on November 30, 1999. The fee for these services is the greater of (a) 1% of O'Sullivan's
consolidated cash flow (as defined in the indenture related to the O'Sullivan senior subordinated notes) or (b)
$300,000 per year. Under the management services agreement, BRS can also receive reimbursement for expenses.
The credit agreement, the indenture for the senior secured notes and the management services agreement all
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 for the senior subordinated notes) for O'Sullivan's most recently ended four full fiscal quarters would have
been greater than 2.0 to 1.0. Similarly, the indenture for the senior secured notes provides that payments under the
management services agreement are conditional and contingent upon the fixed charge coverage ratio (as defined in
the indenture for the senior secured notes) for the four most recently ended full fiscal quarters immediately preceding
any payment date being at least 2.0 to 1.0. The credit agreement prevents O'Sullivan from paying fees and expenses
under the management services agreement if a default or event of default exists or if one would occur as a result of
the payment. All fees and expenses under the management services agreement are subordinated to the senior
subordinated notes.
The management fees and reimbursable expenses of $225,000 and $212,000 recognized in the first nine
months of fiscal years 2005 and 2004, respectively, are included in selling, marketing and administrative expenses in
the accompanying consolidated statements of operations. The accrued balance at March 31, 2005 and June 30, 2004
was $378,000 and $153,000, respectively, and is included in accrued liabilities on the consolidated balance sheet.
Employment Agreements and Executive Stock Agreements. In the first quarter of fiscal 2005, O'Sullivan
Holdings issued stock to three O'Sullivan executives pursuant to Executive Stock Agreements between O'Sullivan
Holdings and each executive. The stock was issued at fair value. O'Sullivan Holdings issued an aggregate of
701,422 shares of its Class B common stock, 384,085 shares of its Series B junior preferred stock and 50,000 shares
of its Series C junior preferred stock. The sales prices for the shares were $0.01 per share for the Class B common
stock and the Series B junior preferred stock and $0.10 per share for the Series C junior preferred stock. One of the
three executives resigned in February 2005. He subsequently sold his O'Sullivan Holdings shares to one of the other
executives.
Note 12–Commitments and Contingencies
Tax Sharing Agreement between O'Sullivan Holdings and RadioShack. Future tax sharing agreement
payments are contingent on taxable income. The maximum payments are: fiscal 2005 – $20.2 million; fiscal
2006 – $11.3 million; fiscal 2007– $12.3 million; fiscal 2008 – $14.5 million; and thereafter – $11.8 million.
O'Sullivan does not expect to pay O'Sullivan Holdings any amount during fiscal 2005 with respect to the tax sharing
agreement. See Note 3 to the consolidated financial statements included in O'Sullivan's Annual Report on Form 10-
K for the year ended June 30, 2004.
Litigation. There have been no significant changes in pending litigation involving O'Sullivan since June 30,
2004, except for the House2Home litigation described below.
In November 2001, House2Home filed for bankruptcy and eventually closed all of its stores. House2Home
filed a suit against O'Sullivan in the U.S. Bankruptcy Court, Central District of California, alleging that payments to
O'Sullivan made by House2Home within 90 days prior to its bankruptcy constituted preferential transfers under the
Bankruptcy Code that should be recovered from O'Sullivan by House2Home together with interest. The alleged
payments aggregated $700,000. O'Sullivan settled this suit in the second quarter of fiscal 2005 for a de minimis
amount.
Note 13–Other Comprehensive Income
O'Sullivan's comprehensive loss is comprised of net loss and foreign currency translation adjustments. The
components of comprehensive loss for the three and nine month periods ended March 31 are:
Three months ended Nine months ended
March 31, March 31,
--------------------------- ---------------------------
(in thousands)
-----------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net loss $ (10,904) $ (3,306) $ (27,337) $ (12,199)
Cumulative translation adjustments (63) 1,429 577 2,407
----------- ----------- ----------- -----------
Comprehensive loss $ (10,967) $ (1,877) $ (26,760) $ (9,792)
=========== =========== =========== ===========
Note 14–Accounting Change
Effective April 1, 2005, O'Sullivan changed the date of its annual goodwill impairment test to April 30th.
Previously, O'Sullivan performed this annual goodwill impairment test on June 30th, with the most recent test
occurring on June 30, 2004. O'Sullivan is now performing its annual business planning and forecasting in the fourth
quarter of its fiscal year based on actual data through April 30. O'Sullivan determined this change in accounting
principle is preferable because it will allow management to incorporate this test into the normal flow of the financial
planning and reporting cycle. The change in accounting principle will have no effect on O'Sullivan's consolidated
financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
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:
• changes from anticipated levels of sales, whether due to
• future national or regional economic and competitive conditions, as we have seen in recent years with
slower economic conditions and declines in the sales of personal computers;
• new domestic or foreign entrants into the industry, as with competitors and retailers sourcing products
competitive with ours from overseas in recent years;
• customer acceptance of existing and new products, as we have experienced in recent years;
• lower borrowing availability under our credit agreement due to our program to reduce our inventory levels;
• loss of liquidity due to the arbitration panel's opinion in RadioShack Corporation v. O'Sullivan Industries
Holdings, Inc.;
• lack of liquidity caused by lower sales, increased raw material costs and other expenses, which might make
us unable to pay our bills as they come due;
• significant indebtedness that may limit our financial and operational flexibility;
• raw material cost increases, particularly in particleboard and fiberboard, as occurred in fiscal 2004;
• pricing pressures due to excess capacity in the ready-to-assemble furniture industry, as is occurring now, or
customer demand in excess of our ability to supply product;
• 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 Ames in fiscal 2003 and with the reorganization of
Kmart beginning in fiscal 2002 and with the loss of significant business at Best Buy and a mass merchant in
fiscal 2004;
• actions of current or new competitors, foreign or domestic, that increase competition with our products or
prices, as has been occurring with imported products from China and other countries in recent years;
• 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 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, 2004.
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 too much 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 have no obligation to revise these
forward-looking statements.
Overview
Our net sales for the third quarter of fiscal 2005 were down about 6.4% from sales for the same quarter in
fiscal 2004 as sales declines to certain customers, such as a major electronics chain and a major discount chain, more
than offset strong sales to other customers. For the first nine months of fiscal 2005, our sales declined about 6.0%,
primarily for the following reasons:
• market share losses at two large retailers in the last half of fiscal 2004;
• a weaker than expected back-to-school selling season;
• increasing competition from imported furniture, particularly from China;
• increased competition from domestic competition due to excess capacity in the RTA furniture industry and
increasing concentration of retail stores;
• a decline in price of the average unit sold, reflecting increased competition and a trend toward more
promotional merchandise as well as the mix of products sold; and
• a focus by several of our retail partners toward higher price point offerings, which include products using
materials other than our particleboard and laminate capabilities.
Operating income declined to a loss of $4.1 million in the third quarter of fiscal 2005 from operating
income of $3.4 million in fiscal 2004. The decline was due to:
• lower gross margins due to lower production levels resulting from lower year to date sales and efforts to
reduce our inventory levels, which unfavorably affected overhead absorption;
• an increase in our inventory reserves for raw material and work-in-process inventories of approximately
$3.6 million;
• the closing of our Australian operations, which resulted in expenses and charges of $1.5 million, including a
$1.2 million reserve against inventories in Australia;
• continued high cost of raw materials, particularly particleboard; and
• a product mix that contained more promotionally priced, lower margin units.
In response to the industry trends, we have taken steps to reduce costs, increase selling prices, lower our
inventories and mitigate the impact of the current market challenges. We may take similar actions in the future,
which may result in asset write-downs or impairment or other charges. See Item 3, "Quantitative and Qualitative
Disclosures about Market Risk," for more information regarding our raw material cost increases.
Closure of Australia Operations.
In February 2005, we decided to close our Australian operations. We based the decision on an assessment
of the business and the determination that sales in the region were not sufficient to support the infrastructure
required. In the closure of the sales office, warehouse and two retail stores of this operation, the employment of
approximately 17 employees has been or will be severed. The winding down of the operations is expected to be
completed by the end of the first quarter of fiscal 2006. Our Australian operation's sales during the first nine months
of fiscal 2005 were $2.5 million. Working capital and other funds for our Australian operations have always been
funded from O'Sullivan's United States operations; accordingly, any proceeds flowing from the closing of the
operations, net of expenses, will be repatriated.
As a result of the closing of the Australian operations, we expect to incur expenses between $1.6 million
and $2.0 million. Of this amount, between $400,000 and $700,000 will represent cash charges related to severance,
termination of leases and other agreements and costs to administer the winding down of these operations. We
recorded a non-cash charge of $1.2 million in the third quarter of fiscal 2005 as a reserve against inventories in
Australia and is included in cost of sales. In the quarter ended March 31, 2005, we recorded $1.5 million of
expenses, of which $357,000 was a cash charge. The cash charge is reflected in restructuring charge on our
consolidated statements of operations. At March 31, 2005, we had paid the employee termination benefits and
administrative and other costs appearing in the restructuring charge. We expect the majority of the lease termination
expenses will be paid, and the inventory reserves will be depleted, by the end of the first quarter of fiscal 2006.
The components of the exit costs for the nine months ended March 31, 2005 were as follows:
Paid or Remaining
Charges incurred eserve at
through through March 31,
March 31, March 31, 2005
Exit Costs 2005 2005 r
- --------------------------------------- ----------- ----------- -----------
(in thousands)
----------- ----------- -----------
Inventory reserves $ 1,182 $ – $ 1,182
Employee termination benefits 97 97 –
Lease termination expenses 121 – 121
Administrative and other costs 139 139 –
----------- ----------- -----------
Total $ 1,539 236 $ 1,303
=========== =========== ===========
Inventory Reserves
We increased our reserves for our raw materials and work-in-process inventories by $3.6 million
during the third quarter of fiscal 2005 to reflect revised estimates regarding the expected demand for such inventory.
During the first quarter of fiscal 2005, we decreased our allowance for maintenance and supplies inventory by
approximately $1.4 million.
New Management Team and Strategic Planning
In May 2004, we announced the hiring of Robert S. Parker as our President and Chief Executive
Officer, followed by the arrival of Rick A. Walters as Executive Vice President and Chief Financial Officer. These
gentlemen came from the Sharpie/Calphalon Group of Newell Rubbermaid Corporation. The new executive
management team has evaluated our strategies and core competencies to determine the most effective way to
improve sales, reduce costs and increase operating income. We have developed and are implementing a strategic
plan from that evaluation. Strategic initiatives that are currently underway at O'Sullivan include:
• creating a new sales and marketing organization to focus on targeted market segments and the key
customers in those segments;
• implementing a disciplined new product development program that is designed to introduce
consumer oriented products that provide distinctive value;
• implementing a global sourcing plan to source parts and products from outside the United States;
• focusing on our factories to improve their productivity and better control their costs, including the
introduction of lean manufacturing training programs and a new sales and operational planning
program;
• improving working capital management and cash flow through better planning, reduction in
required inventory levels and improving vendor and customer terms, among other things;
• moving our corporate headquarters from Lamar, Missouri to the Atlanta, Georgia area, which is
making us more accessible to our valued customers and expands our management recruiting
opportunities;
• adding seasoned professionals to our sales and marketing organization; and
• evaluating all aspects of our cost structure.
We are implementing these initiatives and are beginning to see some results. For example, we have
• completed the move of our corporate headquarters to the Atlanta, Georgia area;
• filled most of the vacant positions in our marketing organization;
• expanded our in-house sales organization to focus on building detailed growth plans and programs
with our larger customers and to provide increased attention to smaller customers;
• worked with our suppliers to encourage partnering and improved product features while
maintaining competitive pricing;
• reduced our net inventory by $15.2 million since June 30, 2004.
We have begun to see the results of our strategic initiatives; however, it will take time for the full impact of
these efforts to become evident in our financial results. We continue to believe these initiatives will help O'Sullivan
achieve improved long-term results.
Customer Bankruptcy
In August 2002, Ames Department Stores, Inc. decided to close all of its stores and liquidate. In August
2003, Ames filed suit against O'Sullivan Industries in the U.S. Bankruptcy Court, Southern District of New York
alleging that payments made by Ames within 90 days prior to its bankruptcy constituted preferential transfers under
the Bankruptcy Code that should be recovered from O'Sullivan Industries by Ames, together with interest. The
alleged payments aggregate $2.1 million. We have responded to the suit denying we received any preferential
payments. We are contesting this lawsuit vigorously.
Tax Sharing Agreement between O'Sullivan Holdings and RadioShack
In 1994, RadioShack, then Tandy Corporation, completed an initial public offering of O'Sullivan Holdings.
In connection with the offering, O'Sullivan Holdings entered into a tax sharing and tax benefit reimbursement
agreement with RadioShack. RadioShack and O'Sullivan Holdings made elections under Sections 338(g) and
338(h)(10) of the Internal Revenue Code with the effect that the tax basis of our assets was increased to the deemed
purchase price of the assets, and an equal amount of such increase was included as taxable income in the
consolidated federal tax return of RadioShack. The result was that the tax basis of our assets exceeded the historical
book basis we used for financial reporting purposes.
The increased tax basis of our assets results in increased tax deductions and, accordingly, reduced our
taxable income or increased our net operating loss. Under the tax sharing agreement, O'Sullivan Holdings is
contractually obligated to pay RadioShack nearly all of the federal tax benefit expected to be realized with respect to
such additional basis. The payments under the agreement represent additional consideration for our stock and further
increase the tax basis of our assets from the 1994 initial public offering when payments are made to RadioShack.
Accordingly, we recorded the deferred tax asset created by the step-up in tax basis and the additional tax basis from
the probable future payments to RadioShack.
Additionally, we recorded the remaining maximum obligation to RadioShack pursuant to the tax sharing
agreement. The remaining maximum obligation to RadioShack was $70.1 million at March 31, 2005 and June 30,
2004. Future payments to RadioShack are contingent upon achieving consolidated taxable income calculated on the
basis of the tax sharing agreement.
During the year ended June 30, 2002, we recorded a full valuation allowance against our net deferred tax
assets because we were unable to determine, based on objective evidence, that it was more likely than not that we
would be able to utilize our net operating losses prior to their expiration. If at a future date we determine that some
or all of the deferred tax asset will more likely than not be realized, we will reverse the appropriate portion of the
valuation allowance and credit income tax.
See "Cautionary Statement Regarding Forward Looking Information."
Results of Operations
Net Sales. Net sales for the quarter ended March 31, 2005 declined by $4.7 million, or 6.4%, to
$68.5 million from $73.2 million for the quarter ended March 31, 2004. Net sales for the nine months ended
March 31, 2005 decreased by $12.5 million, or 6.0%, to $197.4 million from $209.9 million for the nine months
ended March 31, 2004. Our third quarter and year to date sales declined in the office superstore, discount mass
merchant and electronic superstore channels due to extremely competitive conditions, economic uncertainties and the
loss of market share noted above. Sales in the home improvement channel and international sales increased for both
the third quarter and year to date. Our average price per unit declined, while the number of units sold increased as
our product mix shifted more toward lower priced and promotional merchandise in the first nine months of fiscal
2005 compared to the same period in fiscal 2004.
Gross Profit. Gross profit decreased to $7.6 million, or 11.1% of sales, for the three month period ended
March 31, 2005, from $15.4 million, or 21.1% of sales, for the comparable prior year quarter. The gross margin
percentage for the third quarter of fiscal 2005 declined primarily because of lower sales, lower production levels,
higher raw material costs, changes in our product mix, the $3.6 million increase in reserves for our raw materials and
work-in-process inventories noted above and $1.2 million of inventory reserves incurred in connection with the
closing of our Australian operations. For the nine months ended March 31, 2005, gross profit declined to $28.1
million, or 14.2% of sales, from $44.3 million, or 21.1% of sales. Gross profit declined for the first nine months of
fiscal 2005 for the same reasons as for the third quarter. Gross profit for the nine months ended March 31, 2005 was
also affected by a decrease in our allowance for maintenance and supplies inventory of $1.4 million and the
establishment of a $447,000 reserve for expenses expected to be incurred in connection with the termination of
agreements to purchase certain raw materials.
Selling, Marketing and Administrative Expenses. Selling, marketing and administrative expenses decreased
to $11.3 million for the three month period ended March 31, 2005, compared to $12.0 million for the quarter ended
March 31, 2004. Selling, marketing and administrative expenses increased to 16.5% of our net sales for the fiscal
2005 third quarter, slightly more than 16.4% of net sales in the third quarter of fiscal 2004. Royalty expenses
increased in fiscal 2005 due to royalties paid in connection with sales of products subject to license agreements.
Severance, relocation and recruiting expenses increased in fiscal 2005 in connection with our management changes
and the relocation of our corporate headquarters as part of the implementation of the new strategic plan discussed
previously. These charges were offset by lower selling costs, lower commissions, an insurance recovery of $451,000
and lower store reset and service expenses as a result of the timing of product introductions.
For the nine months ended March 31, 2005, selling, marketing and administrative expenses increased
$852,000 from $33.9 million in fiscal 2004 to $34.7 million in fiscal 2005. The major factors contributing to the
increase were royalty expenses, severance, relocation and recruiting expenses and higher salary expense due
primarily to increased headcount. The latter two increases were incurred in connection with our management
changes and implementation of the new strategic plan discussed previously. Lower store reset and service costs, due
mainly to the timing of product introductions, and lower commission expenses partially offset the increases.
Casualty Loss. In November 2003, a fire destroyed certain of our manufacturing equipment. We recorded
a casualty loss of $250,000 in the quarter ended December 31, 2003. During fiscal 2004, we deferred recognition of
gains resulting from estimated insurance recoveries until the insurance proceeds were realized. Those gains were
recognized in the fourth quarter of fiscal 2004.
Depreciation and Amortization. Depreciation and amortization expenses of $2.6 million for the third
quarter of fiscal 2005 and $8.9 million year to date were lower than the $3.1 million and $9.7 million of depreciation
and amortization expenses for the comparable periods of fiscal 2004. Depreciation expense is declining because of
our reduced capital expenditures in recent years.
Operating Income. Our operating loss was $4.1 million in the third quarter of fiscal 2005, or $7.5 million
lower than the operating income of $3.4 million for the third quarter of fiscal 2004 due to lower sales, lower
production levels which adversely affected our fixed cost absorption, higher raw material costs, the $3.6 million
increase in reserves for our raw materials and work-in-process inventories, the $1.5 million of expense and charges
related to the closing of our Australian operations and changes in customer mix. For the nine months ended
March 31, 2005, our operating loss was $7.0 million, or $17.2 million lower than the $10.2 million operating income
for the nine months ended March 31, 2004. Our year to date operating income declined for the same reasons as in
the third quarter.
Net Interest Expense. Net interest expense increased from $6.7 million in the third quarter of fiscal 2004 to
$6.8 million in the third quarter of fiscal 2005. Net interest expense increased $599,000 from $19.8 million for the
first nine months of fiscal 2004 to $20.4 million for the first nine months of fiscal 2005. Net interest expense
increased principally due to increased amortization of debt discount and issuance expenses and higher interest notes
on our senior secured notes than under the senior credit facility refinanced in September 2003. The following table
summarizes our net interest expense:
Three months ended Nine months ended
March 31, March 31,
----------------------------- ------------------------------
(in thousands) (in thousands)
2005 2004 2005 2004
----------- ----------- ----------- ------------
Interest expense on senior secured notes,
credit agreement, senior credit facility, industri $
revenue bonds and senior subordinated notes al 6,052 $ 6,011 $ 18,138 $ 17,846
Interest income (2) (4) (6) (35)
Non-cash items:
Amortization of debt discount 350 309 1,001 705
Amortization of debt issuance costs 416 408 1,245 1,234
----------- ----------- ----------- ------------
Net interest expense $ 6,816 $ 6,724 $ 20,378 $ 19,750
=========== =========== =========== ============
Debt Extinguishment Costs, Net. We recorded a gain of $616,000 in the quarter ended December 31, 2003
in connection with the repurchase of $4.0 million of our senior subordinated notes, net of original issue discount and
capitalized loan fees. For the nine months ended March 31, 2004, we recorded other financing costs expense of $2.7
million related to the write-off of capitalized loan fees for the old senior credit facility of about $3.3 million in the
September 2003 quarter, offset by the gain on the repurchase of the subordinated notes.
Income Tax Provision. We recorded no tax expense in the three and nine month periods ended March 31,
2005 and 2004 because of the current tax benefits associated with the Section 338 election (See "Tax Sharing
Agreement with RadioShack") and because of the valuation allowance against our net deferred tax assets.
Net Loss. We incurred a net loss of $10.9 million in the third quarter of fiscal 2005 compared to a net loss
of $3.3 million in the third quarter of fiscal 2004. Net loss increased $15.1 million from a net loss of $12.2 million
in the first nine months of fiscal 2004 to a net loss of $27.3 million in the first nine months of fiscal 2005. The
increase in the loss for both periods was due to the reasons discussed above.
Liquidity and Capital Resources
We are highly leveraged and have a stockholder's deficit of approximately $138.8 million at March 31,
2005. Our primary sources of liquidity are cash flows from operations and borrowings under our credit agreement,
which are discussed below. Our liquidity requirements will be to pay our debt, including interest expense under our
credit agreement and notes, to provide for working capital and capital expenditures and to pay RadioShack amounts
due under the tax sharing agreement. Decreased demand for our products could decrease our cash flow from
operations and the availability of borrowings under our credit agreement.
Working Capital. As of March 31, 2005, cash and cash equivalents totaled $4.6 million. Net working
capital was $38.1 million at March 31, 2005 compared to $49.7 million at June 30, 2004.
Operating Activities. Operating cash flow for the nine months ended March 31, 2005 was a negative $1.4
million compared to net cash provided of $11.7 million for the nine months ended March 31, 2004. Operating cash
flow decreased for the following reasons.
• Net loss was $15.1 million higher in fiscal 2005 than in the first nine months of fiscal 2004 for the reasons
explained above.
• Inventories declined $15.2 million in the first nine months of fiscal 2005, $15.4 million more than the
$189,000 increase in the first nine months of fiscal 2004. The decline was the result of our program to
lower our inventories in fiscal 2005, a $3.6 million increase in our inventory reserves for raw material and
work-in-process inventories taken in the third quarter of fiscal 2005 and a $1.2 million increase in our
reserves for finished goods inventory taken in connection with the closure of our Australian operations,
partially offset by a $1.4 million decrease in our reserves for maintenance and supplies inventory.
• Included in net loss for fiscal 2004 were non-cash charges of $2.7 million of debt extinguishment costs,
net.
• Accounts receivable increased $6.2 million in the first nine months of fiscal 2005 compared with an
increase of $2.5 million in the first nine months of fiscal 2004. The greater increase in fiscal 2005 was
due to timing of sales within the respective quarters and customer mix.
Investing Activities. We invested $631,000 for capital expenditures for the nine months ended March 31,
2005 compared to $1.5 million for the prior year nine month period. We currently estimate that the total capital
expenditure requirements for the remainder of the fiscal year will be between $200,000 to $500,000, which we
expect to fund from cash flow from operations or cash on hand. Our ability to make future capital expenditures is
limited to $10.0 million per year, with certain carryforwards, under the indenture governing our senior secured notes.
Financing Activities. Our net cash provided by financing activities was $1.4 million from intercompany
loans. In the first nine months of fiscal 2004, the refinancing of our old senior credit facility provided $2.5 million
of cash, net of cash used to pay debt issuance related costs, while a repurchase of $4.0 million of our senior
subordinated notes required $3.2 million of cash.
Our consolidated principal amount of indebtedness at March 31, 2005 was $206.0 million, consisting of the
following:
• a credit agreement providing for asset-based revolving credit of up to $40.0 million. The
borrowing base at March 31, 2005 was approximately $25.1 million. No borrowings were
outstanding under the credit agreement at March 31, 2005, although letters of credit aggregating
approximately $15.2 million were outstanding under the credit agreement. The outstanding letters
of credit reduced the available borrowing base to approximately $9.9 million. The credit
agreement is secured by a first-priority security interest in and lien on substantially all of our
accounts receivable, inventory, deposit accounts, certain books and records and certain licenses,
and a second-priority security interest in and lien on substantially all of our assets other than
accounts receivable, inventory, capital stock of our subsidiaries, deposit accounts, certain books
and records and certain licenses. The interest rate on loans under the credit agreement is a LIBOR
rate plus 2.5% or an index rate plus 1.0%. We also pay a quarterly fee equal to 0.5% per annum of
the unused commitment under the credit agreement. O'Sullivan Industries - Virginia and
O'Sullivan Furniture Factory Outlet, Inc. are also parties to the credit agreement. In connection
with the execution and delivery of the credit agreement, we entered into a lockbox agreement with
the agent under the agreement. Pursuant to the agreement, we granted the agent a security interest
in the cash deposited, or received in the future, in the account. Under the terms of the lockbox
agreement, the agent has control over the accounts and amounts deposited therein. Because of the
nature of the lockbox arrangement and other provisions of the credit agreement, accounting
principles require any borrowings under the credit agreement to be classified as short term even
though the term of the credit agreement does not expire until September 2008.
• $100.0 million in 10.63% senior secured notes due October 2008. We sold the notes in September
2003 at 95% of their par value, yielding $95.0 million in proceeds before issuance expenses of
approximately $3.8 million. We used proceeds of the senior secured notes to repay the $88.7
million outstanding under our old senior credit facility and to pay issuance expenses. The notes
are secured by a first-priority security interest in and lien on substantially all of our assets (and on
our capital stock) other than accounts receivable, inventory, capital stock of our subsidiaries,
deposit accounts, certain books and records and certain licenses, and by a second-priority security
interest in and lien on substantially all of our accounts receivable, inventory, deposit accounts,
certain books and records and certain licenses. The notes are guaranteed by O'Sullivan Holdings,
O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc.
• $96.0 million in 13-3/8% senior subordinated notes due October 2009 issued with warrants to
purchase 93,273 shares of our Class A common stock and 39,273 shares of our Series B junior
preferred stock on a fully diluted basis. These warrants were assigned a value of $3.5 million. We
issued $100.0 million of these notes in 1999 at a price of 98.046%, providing $98.0 million in cash
proceeds before expenses related to the issuance. We repurchased $4.0 million of the notes during
fiscal 2004.
• $10.0 million in variable rate industrial revenue bonds.
The reconciliation of consolidated indebtedness to recorded book value at March 31, 2005 is as follows:
onsolidated Original
ndebtedness Issue
Discount Warrants
C Net of Net of Recorded
I Accretion Accretion Book Value
------------- --------------- ------------- ------------
(in thousands)
---- -- ---
---- -- ---
Senior secured notes $ 100,000 $ (3,798) $ – $ 96,202
Senior subordinated notes 96,000 (1,180) (2,201) 92,619
Industrial revenue bonds 10,000 – – 10,000
----------- ----------- ----------- ---------
Total $ 206,000 $ (4,978) $ (2,201) $ 198,821
=========== =========== =========== =========
Liquidity
We have a stockholder's deficit of approximately $138.8 million as of March 31, 2005, incurred a net loss
of $27.3 million for the nine months ended March 31, 2005 and expect to incur additional losses during the
remainder of the fiscal year ending June 30, 2005 and during fiscal 2006. Our net sales have declined each of the
past four years. Our sales and operating results during fiscal 2004 and the first three quarters of fiscal 2005 were
impacted by a decline in the RTA furniture market, increased competition from foreign and domestic competitors, a
product mix reflecting more promotional merchandise, and higher raw material costs, principally particleboard and
fiberboard.
As noted above, we refinanced our previous senior credit facility on September 29, 2003. As a result of the
refinancing, we have no principal payments on debt due until October 2008. In connection with the refinancing, we
entered into the five year $40 million revolving credit agreement discussed above. Borrowing availability under the
credit agreement is subject to, among other things, a borrowing base determined by qualified inventory and accounts
receivable levels, and is further reduced by outstanding letters of credit ($15.2 million at March 31, 2005). We
expect borrowing availability under the credit agreement to approximate $8.5 million to $11 million, after deducting
outstanding letters of credit, from April 2005 through the end of fiscal 2006. Decreased demand for our products, as
well as efforts to reduce working capital requirements, could negatively affect levels of inventory and accounts
receivable and thus the borrowing availability under the credit agreement. No borrowings were outstanding under
the credit agreement at March 31, 2005.
Our management believes that cash on hand, net cash to be generated from operations, and forecasted
availability under the credit agreement will be sufficient to meet our cash needs for the next twelve months. We
were in compliance with our debt covenants at March 31, 2005 and expect to remain in compliance with these
covenants during the next twelve months. In the event that revenues are significantly below forecasted revenues, we
believe we have the ability to reduce or delay discretionary expenditures and further reduce operating costs and
expenses so that we will have sufficient cash resources through the next twelve months. However, there can be no
assurance that we will be able to adjust our costs in sufficient time to respond to revenue shortfalls, should that
occur.
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 tax sharing agreement with RadioShack on our liquidity and financial
condition.
Off-balance Sheet Arrangements. At March 31, 2005, we had no off-balance sheet arrangements that have
or are likely to have a material current or future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations. As of March 31, 2005, our contractual obligations due in the future mature as
follows:
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 $ 206,000 $ – $ – $ 206,000 $ –
Cash interest on indebtedness1 106,729 24,223 48,446 34,060 –
Payable to parent - tax sharing
agreement2 70,067 25,614 24,632 19,821 –
Operating leases–unconditional 5,013 2,107 2,104 446 356
Other long-term obligations3 335 192 143 – –
----------- ------------ ------------ ----------- -----------
Total contractual cash obligations $ 388,144 $ 52,136 $ 75,325 $ 260,327 $ 356
=========== ============ ============ =========== ===========
- ------------------------------------
1Assumes interest expense on the industrial revenue bonds will be $600,000 per year and that we will
have no borrowings under the credit agreement.
=========== ============ ============ =========== ===========
2Timing and amounts of payments by O'Sullivan Holdings to RadioShack are contingent on actual taxable
income adjusted to exclude the increased interest expense arising from the 1999 recapitalization and merger. The
amounts in the table above represent the maximum amounts payable by O'Sullivan Holdings to RadioShack.
=========== ============ ============ =========== ===========
3Represents payments due under retirement agreements.
=========== ============ ============ =========== ===========
Critical Accounting Policies and Estimates
Preparation of our consolidated financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the
most complex and sensitive judgments, because of their significance to our consolidated financial statements, result
primarily from the need to make estimates about the effects of matters that are inherently uncertain. Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 2 to the
Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2004 filed
with the Securities and Exchange Commission on September 28, 2004, describe the significant accounting estimates
and policies used in preparation of our consolidated financial statements. Actual results in these areas could differ
from management's estimates. There have been no significant changes in our accounting policies and estimates
during the first nine months of fiscal 2005.
Legal Proceedings
In August 2002, Ames decided to close all of its stores and liquidate. Actual net sales to Ames in fiscal
2004 were minimal. In August 2003, Ames Department Stores, Inc. filed suit against O'Sullivan Industries in the
U.S. Bankruptcy Court, Southern District of New York alleging that payments made by Ames within 90 days prior to
its bankruptcy constituted preferential transfers under the Bankruptcy Code that should be recovered from O'Sullivan
Industries by Ames, together with interest. The alleged payments aggregate $2.1 million. We received the summons
in this action on September 22, 2003. We responded to the suit denying we received any preferential payments. We
are contesting this lawsuit vigorously.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk is affected by changes in interest rates, foreign currency exchange rates and certain
commodity prices. Under our policies, we may use natural hedging techniques and derivative financial instruments
to reduce the impact of adverse changes in market prices. We do not hold or issue derivative instruments for trading
purposes. We believe that our foreign exchange risk is not material.
We have market risk in interest rate exposure, primarily in the United States. We manage interest rate
exposure through our mix of fixed and floating rate debt. Interest rate instruments may be used to adjust interest rate
exposures when appropriate based on market conditions. At March 31, 2005, $10.0 million of our debt was subject
to variable interest rates. A change in interest rates of one percentage point would change our cash interest by about
$100,000 annually.
Due to the nature of our product lines, we have material sensitivity to some commodities, including
particleboard, fiberboard, corrugated cardboard and hardware. We manage commodity price exposures primarily
through the duration and terms of our vendor agreements. A 1.0% change in our raw material prices would affect
our cost of sales by approximately $1.4 million annually.
In fiscal 2004, market prices for particleboard, our largest raw material cost, increased about 40% to 50%,
depending on thickness and origin. Market prices for fiberboard increased about 30%. Prices increased as demand
for particleboard and fiberboard increased and because producers reduced their manufacturing capacity. Market
prices for particleboard declined slightly in the first nine months of fiscal 2005, while fiberboard prices declined
slightly in the second quarter of fiscal 2005. Industry sources anticipate flat to slightly higher prices for
particleboard and fiberboard through the remainder of fiscal 2005, with the potential for further increases in fiscal
2006. The high costs for particleboard and fiberboard will reduce our operating margins and operating income for
the last quarter of fiscal 2005 and beyond.
We are endeavoring to reduce the impact of the cost increases through our productivity programs, by price
increases and by the eventual inclusion of the higher costs in the pricing of our products. We have negotiated higher
prices for our products with our customers, although these price increases recovered only a part of the cost increases
we have incurred. In our productivity programs, we endeavor to remove costs from the production of a product
without sacrificing utility or quality of the product. We cannot assure you that we will be successful in offsetting
these or future potential raw material cost increases or that raw materials costs will not increase further in the future.
ITEM 4. CONTROLS AND PROCEDURES.
O'Sullivan maintains disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) 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.
As of the end of the period covered by 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.
During our most recent quarter, there have been no changes in O'Sullivan's internal controls over financial
reporting identified in the evaluation described above that has materially affected or is reasonably likely to materially
affect, O'Sullivan's internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 5. OTHER INFORMATION.
O’Sullivan Holdings is a guarantor of our 10.63% senior secured notes due 2008. O’Sullivan Holdings files
quarterly reports on Form 10-Q and annual reports on Form 10-K with the Securities and Exchange Commission.
These reports are available from the SEC’s web site at http://www.sec.gov or through our web site at
www.osullivan.com.
ITEM 6. 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.
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, INC.
Date: May 16, 2005 By: /s/ Robert S. Parker
--------------------------------------------------
Robert S. Parker
President and
Chief Executive Officer
Date: May 16, 2005 By: /s/ Rick A. Walters
-------------------------------------------------------------------------------------------------------------------
Rick A. Walters
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
INDEX TO EXHIBITS
Page
Exhibit No. Description No.
3.1 & 4.1 Certificate of Incorporation of O'Sullivan (incorporated by reference to Exhibit 3.1 to
Registration Statement on Form S-4 (File No.333-31282))
3.2 & 4.2 Bylaws of O'Sullivan (incorporated by reference from Exhibit 3.2 to Registration Statement
on Form S-4 (File No. 333-31282))
3.2a & 4.2a Amendment to By-laws of O'Sullivan (incorporated by reference to Exhibit 3.2a to Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004 (File No. 333-31282))
4.3 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))
4.4 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 Exhibi
4.5 to Quarterly Report on Form 10-Q for the quarter ended December 31, 1999 (File No. 0-
28493)) t
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 93,273 shares of O'Sullivan Industries Holdings, Inc. common stock,
including form of warrant certificate (incorporated by reference to Exhibit 4.6 to Quarterl
Report on Form 10-Q for the quarter ended December 31, 1999 (File No. 0-28493)) y
4.6 Indenture dated as of September 29, 2003 between O'Sullivan Industries, Inc. and each of
the guarantors party thereto and The Bank of New York, as Trustee, including form of Notes
(incorporated by reference to Exhibit 4 to Current Report on Form 8-K dated September 29,
2003 (File No. 333-31282))
10.1 Severance Agreement between O'Sullivan Industries and Stuart D. Schotte dated as of
January 10, 2005 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K
of O'Sullivan dated March 29, 2005 (File No. 333-31282))
10.2 Revised schedule of fees for outside directors of O'Sullivan Holdings (Incorporated by
reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the
quarter ended March 31, 2005 (File No. 0-28493))
10.3 Form of Director Stock Agreement (incorporated by reference to Exhibit 10.1 to Current
Report on Form 8-K of O'Sullivan Holdings dated March 24, 2005 (File No. 0-28493))
10.4 Description of compensation arrangements with an executive officer of O'Sullivan
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K dated May 3,
2005 (File No. 333-31282))
18.1 Letter of PricewaterhouseCoopers LLP regarding change in accounting principle 31
31.1 Certification of chief executive officer pursuant to Section 302 of the Sarbanes-Oxley Act
2002 of 32
Page
31.2 Certification of chief financial officer pursuant to Section 302 of the Sarbanes-Oxley Act
2002 of 33
32.1 Certification of chief executive officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 34
32.2 Certification of chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 35