Item 1. Business.
History and Overview
We are a leading designer, manufacturer and distributor of ready-to-assemble, or RTA, furniture products in the United States, with over 45 years of experience. Our products provide the consumer with high quality, value and easy-to-assemble furniture and comprise a broad range of product offerings, including desks, computer workcenters, entertainment centers, television and audio stands, bookcases, storage units and cabinets. Over 90% of our sales are for products offered at price points between $19 and $300, covering the majority of price points in the RTA furniture market. For the fiscal year ended June 30, 2004, we had net sales of $268.8 million, down 7.0% from $289.2 million in fiscal 2003, and operating income of $9.2 million, down 65% from $26.3 million in fiscal 2003. The sales and operating declines were caused primarily by a decline in the RTA furniture market, increased competition from foreign and domestic competitors, reduced margins due to increased competition and a product mix reflecting more promotional merchandise and increasing raw material prices, principally particleboard and fiberboard.
We distribute our products primarily through multi-store retail chains, including office superstores, discount mass merchants, home centers and consumer electronic superstores. Our largest retail customers include OfficeMax, Wal-Mart, Office Depot, Staples and Lowe's. We service our customers from two modern manufacturing and distribution facilities totaling approximately 1.8 million square feet, located in Lamar, Missouri and South Boston, Virginia. Our manufacturing facilities are equipped with highly automated manufacturing processes which enhance our efficiency and flexibility. Our production capabilities enable us to optimally serve our customers and profitably pursue the most attractive categories of the RTA furniture market.
O'Sullivan Industries Holdings, Inc., a Delaware corporation, is a holding company with no material operations. It owns all the capital stock of O'Sullivan Industries, Inc., a Delaware corporation. O'Sullivan's business was founded in 1954 by Thomas M. O'Sullivan, Sr. and was acquired by Tandy Corporation in 1983. In 1993, Tandy transferred O'Sullivan Industries to its subsidiary TE Electronics Inc. In February 1994, TE Electronics Inc. transferred O'Sullivan Industries to O'Sullivan Holdings in exchange for O'Sullivan Holdings common stock and O'Sullivan Holdings' obligations under a tax sharing agreement. TE Electronics Inc. then sold its shares of O'Sullivan Holdings stock in a public offering. On November 30, 1999, O'Sullivan Holdings completed a recapitalization and merger through which the outstanding stock of O'Sullivan Holdings was purchased by Bruckmann, Rosser Sherrill & Co. II, L.P. ("BRS"), 34 members of our management and an affiliate of a former director. O'Sullivan Industries owns all of the capital stock of O'Sullivan Industries - Virginia, Inc., a Virginia corporation, and O'Sullivan Furniture Factory Outlet, Inc., a Missouri corporation.
References to the words "O'Sullivan," "we," "our" and "us" refer to O'Sullivan Industries Holdings, Inc., and its subsidiaries. References to "O'Sullivan Holdings" refer to O'Sullivan Industries Holdings, Inc. only. References to "O'Sullivan Industries" refer to O'Sullivan Industries, Inc. and its subsidiaries. References to "O'Sullivan Industries - Virginia" refer to O'Sullivan Industries - Virginia, Inc.
We engage in one industry segment: the design, manufacture and sale of ready-to-assemble, or RTA, furniture. For information regarding our sales, operating profits and assets, see the financial statements included in Part II, Item 8 of this report, "Financial Statements and Supplementary Data."
New Management Team. In May 2004, we announced the hiring of Robert S. Parker as our President and Chief Executive Officer, followed in succeeding months by the arrival of Rick A. Walters as Executive Vice President and Chief Financial Officer and Michael D. Orr as Executive Vice President-Operations. Each of these gentlemen came from the Sharpie/Calphalon Group of Newell Rubbermaid Corporation. They are in the process of evaluating our strategies and core competencies to determine how best to improve our sales, reduce our costs and increase our operating income. Strategic initiatives that are currently underway at O'Sullivan Industries include:
o creating a new sales and marketing organization that will focus on targeted market segments and the key customers in those segments;
o expanding new product initiatives that already include successful launches of our Coleman(R) garage and business storage assortment and Intelligent Designs(R)commercial office furniture;
o building a more capable and far reaching organization to source parts and products from outside the United States;
o focusing on our factories to improve their productivity and better control their costs;
o improving working capital management and cash flow through better planning, reduction in required inventory levels, improving vendor and customer terms, etc.; and
o moving our corporate headquarters from Lamar, Missouri to the Atlanta, Georgia area, which will make us more accessible to our valued customers and expand our management recruiting opportunities.
We have begun to add seasoned professionals to our sales and marketing organization and to implement a disciplined new product development program that is designed to be consumer focused and deliver faster moving items with higher gross margins.
Industry Overview
The RTA furniture industry is a segment of the broader residential wood furniture industry with wholesale sales of approximately $19 billion per year. According to HomeWorld Business, RTA furniture retail sales totaled approximately $3.0 billion in calendar 2003, down about 9% from HomeWorld Business' estimate for calendar 2002. RTA furniture encompasses a broad range of furniture products including desks, computer workcenters, entertainment centers, television and audio stands, bookcases, cabinets and living room and bedroom furniture. RTA furniture is sold through a broad array of distribution channels, including discount mass merchants, office superstores, consumer electronic superstores, home centers, and national department stores. The majority of RTA furniture sales are made through discount mass merchants such as Wal-Mart, Target and Kmart and office superstores such as Office Depot, OfficeMax and Staples. Although a large number of companies manufacture RTA furniture, the RTA furniture industry is relatively concentrated with the top five North American RTA furniture manufacturers accounting for an estimated 70% of the United States RTA furniture retail sales in calendar 2003.
The RTA furniture industry experienced significant growth in the mid to late 1990s. According to HomeWorld Business, the compounded annual growth rate of RTA furniture retail sales from 1995 to 2000 was approximately 8%. Since 2000, RTA furniture industry sales have declined about 17%, largely as a result of the closure of several significant retailers, a reduction in the demand for home office furniture due to a slowdown in demand for personal computers and increased competition from imported RTA and other furniture products. In response to these industry challenges, we have recently expanded into new furniture categories, such as home storage and organization. The home storage and organization market includes product offerings such as closet shelving systems, garage storage and workshop storage. Annual retail sales for the home storage and organization market were estimated at approximately $6.4 billion for calendar 2003. We have also increased our presence in the commercial office furniture industry. The commercial office furniture market includes furniture used in commercial offices such as panel and modular systems, seating, storage units, files, tables and desks in wood and other materials, such as steel and glass. The commercial office furniture market is significantly larger than the RTA furniture market with wholesale sales estimated at approximately $8.5 billion in calendar 2003.
Product Overview
We group our product offerings into four distinct categories:
o Home office and small office furniture, including desks, computer work centers, bookcases and filing cabinets;
o Home furnishings, including entertainment furniture, home entertainment centers, home theater systems, television and audio stands, audio and video storage units, home decor furniture, including microwave oven carts, pantries, living room and recreation room furniture and bedroom pieces, including dressers, night stands and wardrobes;
o Commercial office furniture, including desks, computer work centers, bookcases and filing cabinets; and
o Storage furniture, including storage cabinets and workbenches for the home, garage and office.
Customers
RTA furniture is sold through a broad array of distribution channels, including discount mass merchants, office superstores, consumer electronic superstores, home centers and national department stores. The majority of RTA furniture sales are made through discount mass merchants such as Wal-Mart, Target and Kmart and office superstores such as OfficeMax, Office Depot and Staples.
We have longstanding relationships with key customers in both of these two major distribution channels. In fiscal 2004, sales to OfficeMax accounted for about 19% of our gross sales, Wal-Mart accounted for about 16% of our gross sales, Office Depot accounted for about 13% of our gross sales and Staples accounted for about 10% of our gross sales. Similar to other large RTA furniture manufacturers, our sales are concentrated.
Sales and Marketing
We manage our customer relationships both through our in-house sales force and a network of independent sales representatives. In general, key accounts such as OfficeMax, Office Depot and Wal-Mart are called on by our sales force. Smaller customers are serviced mainly by independent sales representatives, whose activities are reviewed by our in-house sales force. As noted above, we are in the process of creating a new sales and marketing organization that will focus on targeted market segments and the key customers in those segments.
Our marketing personnel work closely with consumers in order to identify their unmet product needs. We then design products to meet those needs. These products are taken to retail customers that serve the demographics of the consumer in question
Our products are promoted by our customers to the public under cooperative and other advertising agreements. Under these agreements, our products are advertised in newspaper inserts and catalogs, among other publications. We generally cover a portion of the customer's advertising expenses if the customer places approved advertisements mentioning us and our products by name. We may also provide support to some customers' advertising programs. We generally do not advertise directly to consumers. We do, however, advertise in trade publications to promote O'Sullivan as a producer of high quality RTA furniture.
We provide extensive service support to our customers. This support includes designing and installing in- store displays, educating retailers' sales forces and maintaining floor displays. We have been recognized for our commitment to our retail partners and have earned several awards in recent years.
We participate in the furniture trade shows held in High Point, North Carolina in April and October of each year. The High Point show is a major international trade show in the furniture industry. It attracts buyers from the U.S. and abroad. We also maintain other domestic and international showrooms to market our product lines.
We sell our products throughout the U.S. and in Canada, Mexico, the United Kingdom, Australia and other countries. Export sales were $24.1 million, $19.8 million and $19.1 million in fiscal 2004, 2003 and 2002, respectively. In fiscal 2004, sales increased, primarily due to increased sales in the Canadian market. In fiscal 2003, sales increased, primarily due to increased sales in Australia. In fiscal 2002, sales decreases in Central and South America, the Middle East and the United Kingdom were partially offset by sales increases in the Canadian market.
Manufacturing
Our production of RTA furniture begins with laminating paper or other materials to particleboard and fiberboard. Only after laminating the board do we cut the board into parts. Each part for a unit is processed over the machines necessary to provide the desired size and shape, edge treatment, holes for assembly, decorative embossing and other features. Each part is processed only over the machines needed for its completion; therefore, we do not process all parts for a particular product on a single production line. We then assemble outsourced items such as screws, dowels, glass and other pieces as necessary. Finally, all of the parts and outsourced items needed for a unit are placed in a carton with assembly instructions and sealed.
We operate two modern manufacturing facilities, in Lamar, Missouri and South Boston, Virginia. In total, these facilities have approximately 1.8 million square feet of space.
o Lamar, Missouri: Opened in 1965, this facility has approximately 1.1 million square feet of space. It is our larger facility and has the capability to produce our entire product offering.
o South Boston, Virginia: Opened in 1989, our South Boston facility has been expanded to approximately 675,000 square feet, including an expansion of approximately 200,000 square feet completed in 2001. The South Boston facility has the capability to manufacture most of our products.
Product Design and Development
We believe we are an industry leader in product quality and innovation. We are committed to the continuing development of unique furniture that meets consumer needs. With over 50% of our sales to the home office and small office market, we believe we are recognized as one of the industry's premier producers of contemporary home office and small office RTA furniture. In the past three years, we introduced an average of over 150 products per year. In the RTA furniture industry, a new product can be a variation in color or styling of an existing product. By providing a continuous supply of new product introductions, we endeavor to drive demand for our products, which we believe will help us to maintain our profit margins.
We maintain an in-house product design staff that collaborates with our marketing personnel to develop new products based on consumer needs and demographic and other consumer information. We also work with outside designers. The product design professionals work with our marketing and engineering areas to produce full- scale prototypes. The engineering staff uses computer-aided design software, which provides three-dimensional graphics capabilities. The software allows a design engineer to accelerate the time-to-completion for a new product design. This allows us to reduce the time for newly conceived products to reach the market. We then show our prototypes to our consumers and customers to gauge interest. We also respond to suggestions from our retail customers regarding potential new products. If initial indications of product appeal are favorable, we usually can commence production within twelve weeks. We spent approximately $1.5 million, $1.3 million and $1.1 million on product design and development in fiscal years 2004, 2003 and 2002, respectively.
Raw Materials
The materials used in our manufacturing operations include particleboard, fiberboard, coated paper or other laminates, glass, furniture hardware and packaging materials. Our largest raw material cost is particleboard. We purchase all of our raw material needs from outside suppliers. We buy our particleboard and fiberboard at market- based prices from several independent wood product suppliers. We purchase other raw materials from a limited number of vendors. These raw materials are generally available from other suppliers, although the cost from alternate suppliers might be higher.
As is customary in the RTA furniture industry, we do not maintain long-term supply contracts with our suppliers. We do, however, have long standing relationships with all of our key suppliers and encourage supplier partnerships. Our supplier base is sufficiently diversified so that the loss of any one supplier in any given commodity should not have a material adverse effect on our operations. We have never been unable to secure needed raw materials. However, there could be adverse effects on our operations and financial condition if we are unable to secure necessary raw materials like particleboard and fiberboard.
Because we purchase all of our raw materials from outside suppliers, we are subject to changes in the prices charged by our suppliers. Our two largest raw material costs are particleboard and fiberboard. Industry pricing for particleboard was flat to slightly lower in fiscal 2002 and the first half of fiscal 2003. We saw small increases in particleboard pricing in the second half of fiscal 2003. In fiscal 2004, however, industry pricing for particleboard increased 40% to 50%, and industry prices for fiberboard increased about 30%.
In reaction to these increases, we asked our retailer customers for increases in our sales prices for our products. We were generally successful in obtaining price increases to cover part of the particleboard price increases we suffered in fiscal 2004. We rarely ask for or receive price increases from our customers unless large price increases for our raw materials occur. Normally, as we introduce new models, our pricing for the model reflects our current costs.
We cannot assure you that raw material prices will not increase in the future. If the demand for particleboard increases, prices may rise further in fiscal 2005. See "Cautionary Statements Regarding Forward- Looking Information and Risk Factors--Our operating income would be reduced if the prices our suppliers charge us for raw materials increase."
Competition
The residential furniture market is highly competitive and includes a large number of both domestic and foreign manufacturers. Our competitors include manufacturers of both RTA and assembled furniture. Although a large number of companies manufacture RTA furniture, the top five North American RTA furniture manufacturers accounted for an estimated 70% of the United States RTA furniture retail sales in calendar 2003. Our top four competitors are Sauder Woodworking, Inc., Bush Industries, Inc., Dorel Industries, Inc. and Creative Interiors. Some of our competitors have greater sales volume and financial resources than we do. RTA furniture manufacturers compete on the basis of price, style, functionality, quality and customer support.
In recent years, sales of imported RTA furniture have been increasing in the U.S. We anticipate that we will continue to compete with imports in the U.S. We are reacting to this new competition by emphasizing our design capabilities, our quality and our ability to deliver products from the factory more quickly and at competitive prices. We have also begun to source the manufacture of certain products from other countries. As we design new products, we will decide whether to manufacture the product ourselves or source the product from domestic or international third parties.
Several manufacturers, including O'Sullivan, have excess manufacturing capacity due to the current decline in sales in the RTA furniture market and increasing imports. This excess capacity is causing increased price competition.
Patents and Trademarks
We have a U.S. trademark registration and international trademark registrations or applications for the use of the O'Sullivan(R)name on furniture. We believe that the O'Sullivan name and trademark are well-recognized and associated with high quality by both our customers and consumers and are important to the success of our business. Our products are sold under a variety of trademarks in addition to O'Sullivan. Some of these names are registered trademarks. We do not believe that the other trademarks we own enjoy the same level of recognition as the O'Sullivan trademark. We also do not believe that the loss of the right to use any one of these other trademarks would be material to our business.
We hold a number of patents and licenses, including the license of the Coleman(R)brand indoor storage products for garage, utility, and workshop. We do not consider any one of these patents and licenses to be material to our business.
Shipping
We offer customers the choice of paying their own freight costs or having us absorb freight costs. If we absorb the freight costs, our product prices are adjusted accordingly. When we pay freight costs, we use independent trucking companies with whom we have negotiated competitive transportation rates.
Backlog
Our business is characterized by short-term order and shipment schedules of generally less than two weeks. Accordingly, we do not consider backlog at any given date to be indicative of future sales.
Seasonality
We generally experience a somewhat higher level of sales in the second and third quarters of our fiscal year in anticipation of and following the holiday selling seasons.
Insurance
We maintain liability insurance at levels that we believe are adequate for our needs. We believe these levels are comparable to the level of insurance maintained by other companies in the furniture manufacturing business.
Employees
As of June 30, 2004, we had approximately 1,650 employees. About 85% percent of these employees are located in Lamar, Missouri. None of our employees are represented by a labor union. We believe that we have good relations with our employees.
Environmental and Safety Regulations
Our operations and current and/or former facilities are subject to extensive federal, state and local environmental, health and safety laws, regulations and ordinances. Some of our operations require permits. These permits are subject to revocation, modification and renewal by governmental authorities.
Governmental authorities have the power to enforce compliance with their regulations. Violators are subject to civil, and in some cases criminal, sanctions. Although compliance with these regulations imposes burdens and risks on us, in the past, they have not had a significant effect on our results of operations, capital expenditures or competitive position. In fiscal 2001, we received a Title V operating permit for our facility in Lamar, Missouri. The permit imposes additional monitoring restrictions on our operations, but has not required us to modify our operations. There can be no assurance that future changes in laws and or regulations will not require us to make significant additional expenditures to ensure compliance in the future.
Our manufacturing process creates by-products, including sawdust and particleboard flats. At the South Boston facility, this material is given to a recycler or disposed of in landfills. At the Lamar facility, the material has been sent to recyclers and off-site disposal sites. In fiscal 2004, our disposal costs declined by approximately 11% as we reduced our operating levels.
Our manufacturing facilities ship waste products to various disposal sites. If our waste products include hazardous substances and are discharged into the environment, we are potentially liable under various laws. These laws may impose liability for releases of hazardous substances into the environment. These laws may also provide for liability for damage to natural resources. One example of these laws is the federal Comprehensive Environmental Response, Compensation and Liability Act. Generally, liability under this act is joint and several and is determined without regard to fault. In addition, similar state or other laws and regulations may impose the same or even broader liability for releases of hazardous substances.
We have been designated as a potentially responsible party under the Arkansas Remedial Action Trust Fund Act for the cost of cleaning up a disposal site in Diaz, Arkansas. We entered into a de minimis buyout agreement with some of the other potentially responsible parties. We have contributed $2,000 to date toward cleanup costs under this agreement. The agreement subjects potentially responsible parties to an equitable share of any additional contributions if cleanup costs exceed $9 million. In this event, we would be liable for our share of the excess. Cleanup expenses have approached $9 million. The state has approved a plan providing that groundwater at the site be monitored. No further remediation activity is necessary unless further problems are discovered. The monitoring activities, which are underway, should not require the potentially responsible parties to make additional payments. Assuming no further problems are discovered, we believe that the amounts we may be required to pay in the future, if any, relating to this site will be immaterial.
Our operations also are governed by laws and regulations relating to workplace safety and worker health, principally the Occupational Safety and Health Act and related regulations. Additionally, some of our products must comply with the requirements and standards of the U.S. Consumer Products Safety Commission. We believe that we are in substantial compliance with all of these laws and regulations.
Item 2.
Item 2. Properties.
O'Sullivan owns two manufacturing, warehouse and distribution facilities. The Lamar, Missouri facility, consists of approximately 1.1 million square feet. The South Boston, Virginia facility has approximately 675,000 square feet. These properties are subject to liens in favor of the holders of our credit agreement.
We purchased additional land adjacent to our Lamar facility in July 2002. We have some excess land at South Boston which may be used for expansion.
We lease space for showrooms in High Point, North Carolina and in other locations in the United States. We also lease warehouse space in Lamar and Neosho, Missouri. We lease space for factory outlet stores in Springfield and Joplin, Missouri and Fayetteville, Arkansas to sell close-out and excess inventory.
Our Canadian operations are in a leased facility in Markham, Ontario. O'Sullivan's United Kingdom operations are in a leased facility in Oxfordshire. Our Australian operations are located in leased facilities near Melbourne.
We consider our owned and leased facilities to be adequate for the needs of O'Sullivan and believe that all of our owned and leased properties are well maintained and in good condition.
Item 3.
Item 3. Legal Proceedings.
On September 24, 2002, Montgomery Ward, LLC filed suit against O'Sullivan Industries in the U.S. 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 Industries by Montgomery Ward, together with interest. The alleged payments aggregated $3.7 million. We settled this suit in May 2004. The resolution of the litigation did not materially affect our results of operations.
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 responded to the suit denying we received any preferential payments. We are contesting this lawsuit vigorously.
In November 2001 House2Home filed for bankruptcy and eventually closed all of its stores. In January 2004 we received notice of a November 2003 suit against O'Sullivan Industries in the U.S. Bankruptcy Court, Central District of California alleging that payments made by House2Home within 90 days prior to its bankruptcy constituted preferential transfers under the Bankruptcy Code that should be recovered from O'Sullivan Industries by House2Home together with interest. The alleged payments aggregate $700,000. We have denied we received any preferential payments. We are contesting this lawsuit vigorously.
Other Litigation and Claims. In addition, we are a party to various pending legal actions arising in the ordinary operation of our business. These include product liability claims, employment disputes and general business disputes. We believe that these actions will not have a material adverse effect on our operating results, liquidity and financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders of O'Sullivan during the quarter ended June 30, 2004.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
There is no established public market for O'Sullivan Holdings' common equity.
As of September 1, 2004, there were approximately 91 holders of our Class A common stock and three holders of our Class B common stock. No dividends have been paid or declared since our initial public offering in 1994.
We currently intend to retain all earnings to finance the development of our operations and to repay our indebtedness. Our credit agreements effectively prohibit us from paying dividends on our common or preferred stock. We do not anticipate paying cash dividends on our shares of common or preferred stock in the near future. Our future dividend policy will be determined by our Board of Directors on the basis of various factors, including but not limited to our results of operations, financial condition, business opportunities and capital requirements. The payment of dividends is subject to the requirements of Delaware law, as well as restrictive financial covenants in our debt agreements.
During the fourth quarter of fiscal 2004 and the first quarter of fiscal 2005, we entered into Executive Stock Agreements with Messrs. Robert S. Parker, Rick A. Walters and Michael D. Orr. See "Employment Agreements" in Item 11, Executive Compensation, in Part III of this report for information regarding the Executive Stock Agreements. We used the proceeds of the sale of stock for general working capital purposes. The shares were issued and sold during the first quarter of fiscal 2005 to Messrs. Parker, Walters and Orr in reliance on the exemption from registration contained in Section 4(2) of the Securities Act, as amended.
Item 6.
Item 6. Selected Consolidated Historical Financial Information.
The selected historical consolidated results of operations for the five years ended June 30, 2004 and the balance sheet data as of June 30, 2004, 2003, 2002 and 2001 are derived from O'Sullivan's audited financial statements. The selected historical balance sheet data as of June 30, 2000 are from O'Sullivan's accounting records. This selected consolidated financial data should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8, "Consolidated Financial Statements and Related Notes," in Part II of this report.
For the year ended June 30, --------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ---------- (in thousands) ----------- ----------- ----------- ---------- Net sales $ 268,829$ 289,152$ 349,098$ 358,811 $ 405,234 Cost of sales 213,989 214,977 254,662 269,720 298,387 ----------- ----------- ----------- ----------- ---------- Gross profit 54,840 74,175 94,436 89,091 106,847 Selling, marketing and administrative expense 46,138 45,834 54,584 56,682 64,173 Restructuring charge1 - 2,049 - 10,506 - Merger related expenses2 - - - - 7,792 Transaction fee to related party - - - - 3,062 Compensation expense associated with stock options3 - - - - 10,627 Loss on settlement of interest rate swap - - - - 408 Casualty gain (490) - - - - ----------- ----------- ----------- ----------- ---------- Operating income 9,192 26,292 39,852 21,903 20,785 Interest expense, net4 33,947 24,286 27,927 33,393 18,595 Other financing costs4 2,678 445 204 574 476 ----------- ----------- ----------- ----------- ---------- Income (loss) before income tax provision (benefit) and cumulative effect of accounting change (27,433) 1,561 11,721 (12,064) 1,714 Income tax provision (benefit)5 - - 100,927 (4,221) 4,879 ----------- ----------- ----------- ----------- ---------- Income (loss) before cumulative effect of accounting change (27,433) 1,561 (89,206) (7,843) (3,165) Cumulative effect of accounting change, net of income tax benefit - - - (95) - ----------- ----------- ----------- ----------- ----------
Net income (loss) $ (27,433$ 1,561$ (89,206$ (7,938)$ (3,165) =========== =========== =========== =========== ==========
Cash flows provided by operating activities $ 1,029$ 14,740$ 25,897$ 24,928 $ 30,320 Cash flows provided by (used for) investing activities (2,459) 1,707 (8,644) (16,811) (17,129) Cash flows used for financing activities (1,297) (24,247) (8,536) (12,924) (5,064)
Depreciation and amortization 12,754 13,621 14,530 14,945 15,416 Capital expenditures 2,459 5,081 8,644 16,811 17,129
June 30, --------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ---------- (in thousands) ----------- ----------- ----------- ---------- Total assets $ 194,362$ 207,388$ 244,432$ 357,526 $ 387,569 Long-term debt, less current portion 220,279 209,405 230,206 236,762 247,299 Payable to RadioShack 70,067 72,067 81,374 109,067 109,067 Mandatorily redeemable preferred stock 26,258 21,933 18,319 15,301 12,781 Stockholders' equity (deficit) (164,552) (138,360) (136,903) (44,695) (33,888)
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Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the more detailed information in the historical financial statements, including the related notes thereto, appearing elsewhere in this report.
Overview.
Recent Trends
Our net sales declined 7.0% in fiscal year 2004 from $289.2 million to $268.8 million. This decline continued the net sales decreases experienced by us in fiscal 2001, 2002 and 2003. Our net sales declined for several reasons:
o a decline in sales of RTA furniture;
o increasing competition from imported furniture, particularly from China;
o increased competition from domestic competition due to excess capacity in the RTA furniture industry and increasing concentration of retail stores;
o the decline in price of the average unit sold, reflecting increased competition and a trend toward more promotional merchandise and increased competition;
o market share losses at Best Buy and a large mass merchant; and
o liquidations and bankruptcies by a number of customers, including Montgomery Ward, Ames and Kmart.
In addition to declining net sales, the market conditions described above, coupled with price increases in particleboard and fiberboard, also reduced our margins and results of operations in fiscal 2003 and fiscal 2004. Operating income declined to $9.2 million in fiscal 2004 from $26.3 million in fiscal 2003 and $39.9 million in fiscal 2002. In response to the industry trends, we have taken steps to reduce costs, increase selling prices 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 "--Market Risk and Inflation" for more information regarding our raw material price increases.
While we have confidence in the long-term future of the RTA furniture industry, we expect these conditions to continue into fiscal 2005.
New Management Team
In May 2004, we announced the hiring of Robert S. Parker as our President and Chief Executive Officer, followed in succeeding months by the arrival of Rick A. Walters as Executive Vice President and Chief Financial Officer and Michael D. Orr as Executive Vice President-Operations. Each of these gentlemen came from the Sharpie/Calphalon Group of Newell Rubbermaid Corporation. They are in the process of evaluating our strategies and core competencies to determine how best to improve our sales, reduce our costs and increase our operating income. Strategic initiatives that are currently underway at O'Sullivan Industries include:
o creating a new sales and marketing organization that will focus on targeted market segments and the key customers in those segments;
o expanding new product initiatives that already include successful launches of our Coleman(R) garage and business storage assortment and Intelligent Designs(R)commercial office furniture;
o building a more capable and far reaching organization to source parts and products from outside the United States;
o focusing on our factories to improve their productivity and better control their costs;
o improving working capital management and cash flow through better planning, reduction in required inventory levels, improving vendor and customer terms, etc.; and
o moving our corporate headquarters from Lamar, Missouri to the Atlanta, Georgia area, which will make us more accessible to our valued customers and expand our management recruiting opportunities.
We have begun to add seasoned professionals to our sales and marketing organization and to implement a disciplined new product development program that is designed to be consumer focused and deliver faster moving items with higher gross margins.
Customer Bankruptcies
On September 24, 2002, Montgomery Ward, LLC filed suit against O'Sullivan Industries in the U.S. 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 Industries by Montgomery Ward, together with interest. The alleged payments aggregated $3.7 million. We settled this suit in the fourth quarter of fiscal 2004. The settlement did not have an adverse impact on our results of operations.
In August 2002, Ames decided to close all of its stores and liquidate. Actual net sales to Ames in fiscal 2003 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 have responded to the suit denying we received any preferential payments. We are contesting this lawsuit vigorously.
In November 2001 House2Home filed for bankruptcy and eventually closed all of its stores. In January 2004 we received notice of a November 2003 suit against O'Sullivan Industries in the U.S. Bankruptcy Court, Central District of California alleging that payments made by House2Home within 90 days prior to its bankruptcy constituted preferential transfers under the Bankruptcy Code that should be recovered from O'Sullivan Industries by House2Home together with interest. The alleged payments aggregate $700,000. We have denied we received any preferential payments. We are contesting this lawsuit vigorously.
Tax Sharing Agreement with RadioShack
In 1994, RadioShack, then Tandy Corporation, completed an initial public offering of O'Sullivan. In connection with the offering, we entered into a tax sharing and tax benefit reimbursement agreement with RadioShack. RadioShack and O'Sullivan 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, we are 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 the stock of O'Sullivan Industries 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. The deferred tax asset had a balance of $69.4 million and $72.1 million at June 30, 2004 and 2003, respectively.
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 and $72.1 million at June 30, 2004 and 2003, respectively. 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 Statements and Risk Factors."
Results of Operations.
The following table sets forth the approximate percentage of items included in the Consolidated Statement of Operations relative to net sales for the three-year period ended June 30, 2004:
Year ended June 30, -------------------------------------- 2004 2003 2002 ---------- ---------- ---------
Net sales 100.0% 100.0% 100.0% Cost of sales 79.6% 74.3% 72.9% ---------- ---------- --------- Gross profit 20.4% 25.7% 27.1% Selling, marketing and administrative 17.2% 15.9% 15.6% Restructuring charge - 0.7% - Casualty gain (0.2)% - - ---------- ---------- --------- Operating income 3.4% 9.1% 11.5% Interest expense, net 12.6% 8.4% 8.0% Other financing costs 1.0% 0.2% 0.1% ---------- ---------- --------- Income (loss) before income tax provision (10.2)% 0.5% 3.4% Income tax provision 0.0% 0.0% 28.9% ---------- ---------- --------- Net income (loss) (10.2)% 0.5% (25.5)% Depreciation and amortization 4.7% 4.7% 4.2%
Year Ended June 30, 2004 Compared to the Year Ended June 30, 2003.
Net Sales. Net sales consists of our gross sales less returns, allowances, rebates and certain advertising allowances given to customers. Net sales for the fiscal year ended June 30, 2004 decreased by $20.3 million, or 7.0%, to $268.8 million from $289.2 million for the fiscal year ended June 30, 2003. Net sales were down in every major channel with substantially all of the decline due to lower unit prices. Net sales declined principally because of increased competition from North American manufacturers and Asian and South American manufacturers with substantially lower labor costs and because of a trend toward smaller, more promotional products with lower prices. Finally, according to HomeWorld Business, the size of the RTA furniture market declined approximately 9% in calendar 2003.
Gross Profit. For fiscal 2004, gross profit declined to $54.8 million, or 20.4% of net sales, from $74.2 million, or 25.7% of net sales, during fiscal 2003. Gross profit declined for fiscal 2004 due to increases in raw material prices, lower sales levels, lower production levels, changes in our customer mix and increased advertising allowances.
Selling, Marketing and Administrative Expenses. Selling costs include the salaries and expenses of our inside sales force, commissions to outside sales representatives, customer service expenses, freight out expense, bad debt expense and rent expense for showrooms. Marketing costs include costs of product research and development, catalogs, trade show costs and store display costs. Administrative costs include salaries for our corporate staff, incentive compensation, benefits and professional fees.
Selling, marketing and administrative expenses increased to $46.1 million, or 17.2% of net sales, for fiscal 2004 from $45.8 million, or 15.9% of net sales, for fiscal 2003 due to increased royalty payments, freight out expense and professional fees, partially offset by lower sales commissions, bad debt expense, advertising allowances, and benefit plan expense. Royalty expenses increased because of increased sales of products subject to royalties. Freight out expense increased because of increased sales where we shipped product directly to the end consumer. Commission expenses declined because of lower net sales levels and customer mix. Legal and professional fees increased due to higher recruiting and legal fees in connection with the hiring of our new executives and increased use of consultants in connection with our commercial office and storage product initiatives.
Restructuring Charges. A restructuring charge in the amount of $2 million was recorded during fiscal 2003. This charge consisted of severance actions of $1.5 million and an asset impairment charge of $540,000. No
restructuring charges were recorded in fiscal 2004. In the fourth quarter of fiscal 2003, we determined to reduce our operations at our South Boston, Virginia facility to one shift. As a result, we reduced our workforce by about 200 people in Virginia. We also reduced our corporate staff in Lamar, Missouri by about 50 people, or about 15%. Substantially all of the severance had been paid by June 30, 2004.
In January 2001, we closed our Cedar City, Utah production facility. Fixed assets with a net book value of $20.3 million were written down to estimated fair value, less cost to sell, resulting in an impairment charge of approximately $8.7 million. An additional impairment charge of $540,000 was recognized in fiscal 2003. The additional charge resulted from subsequent changes in the carrying amount of the assets held for sale due to unfavorable market conditions. In June 2003, we sold the Cedar City, Utah land and building. We used the net proceeds of $6.8 million from the sale to reduce indebtedness under our senior credit facility.
Casualty Gain. In November 2003 a fire destroyed certain of our manufacturing equipment. The net insurance proceeds used to replace the equipment destroyed exceeded the net book value of the destroyed equipment, resulting in a gain. Accordingly, we recorded a net gain of $490,000 in connection with the casualty. All proceeds from the insurance company have been received.
Depreciation and Amortization. Depreciation and amortization represents the allocation of costs of long- lived assets such as buildings and equipment. Depreciation is included in cost of goods sold and selling, marketing and administrative expenses in our statements of operations. Depreciation and amortization expenses decreased to $12.8 million for fiscal 2004 compared to $13.6 million for fiscal 2003. Capital additions in fiscal 2004 and 2003 were $2.5 million and $5.1 million, respectively. Fiscal 2004 and 2003 capital expenditures were primarily for normal replacements of equipment.
Operating Income. Operating income decreased $17.1 million to $9.2 million for fiscal 2004 from $26.3 million in fiscal 2003. Lower net sales and operating levels, as well as increases in raw material costs, contributed to lower operating income in fiscal 2004. These additional costs were offset to a small extent by the casualty gain.
Net Interest Expense. Net interest expense is the cost for borrowed money. It represents interest paid to, or accrued for future payment to, lenders and the amortization of debt issuance costs, debt discount and loan fees. Changes in the value of our interest rate collar which expired in March 2003 were also reflected in interest expense. Net interest expense increased to $33.9 million in fiscal 2004 from $24.3 million in fiscal 2003. Interest expense increased principally due to accounting for approximately $4.3 million of dividends on our mandatorily redeemable senior preferred stock as interest expense in fiscal 2004, the higher interest rate on our senior secured notes issued in September 2003 as compared to the variable rates under our former senior credit facility, and the expiration of our interest rate collar, as changes in the value of the interest rate collar reduced interest expense by $2.1 million in fiscal 2003. The following table describes the components of net interest expense.
Year ended June 30, ---------------------------- (in thousands) 2004 2003 ---------- ---------- Interest expense on senior credit facility, industrial revenue bonds and senior subordinated notes $ 23,894 $ 21,899 Interest income (64) (266) Non-cash items: Interest expense on O'Sullivan Holdings note 2,817 2,506 Interest expense on mandatorily redeemable senior preferred stock 4,326 - Interest rate collar - (2,091) Amortization of debt discount 1,294 628 Amortization of loan fees 1,680 1,610 ---------- ---------- Net interest expense $ 33,947 $ 24,286 ========== ==========
Other Financing Income (Expense). We recorded a gain of $616,000 in connection with the October 2003 repurchase of $4.0 million of our senior subordinated notes, net of original issue discount and capitalized loan fees. This gain was offset by the write-off of capitalized loan fees for our old senior credit facility of about $3.3 million in the September 2003 quarter as a result of the refinancing of this debt. The net amount of $2.7 million is reflected as other financing expense on our statement of operations for fiscal 2004.
Pre-Tax Income (Loss). Our pre-tax loss in fiscal 2004 was $27.4 million compared to pre-tax income of $1.6 million in fiscal 2003. The decline was due principally to our lower net sales and operating levels, higher raw material costs and increased interest expense.
Income Tax Provision. We recorded no tax expense in fiscal 2004 or fiscal 2003 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 Income (Loss). Our net loss was $27.4 million in fiscal 2004 compared to net income of $1.6 million in fiscal 2003 due principally to our lower net sales and operating levels, higher raw material costs and increased interest expense.
Year Ended June 30, 2003 Compared to the Year Ended June 30, 2002.
Net Sales. Net sales for the fiscal year ended June 30, 2003 decreased by $59.9 million, or 17.2%, to $289.2 million from $349.1 million for the fiscal year ended June 30, 2002. Net sales were down in every major channel with substantially all of the decline due to lower unit sales. Net sales declined principally because of U.S. economic conditions, increased competition from North American manufacturers and increased competition from Asian and South American manufacturers with substantially lower labor costs.
Gross Profit. Gross profit decreased to $74.2 million, or 25.7% of net sales, for fiscal 2003, from $94.4 million, or 27.1% of net sales, for fiscal 2002. Fiscal 2003 gross profit decreased primarily because of lower sales and operating levels, partially offset by lower material costs, primarily for particleboard. Lower operating levels hurt our gross profit and our gross profit as a percentage of net sales because our fixed manufacturing overhead was allocated over a smaller number of units produced.
Selling, Marketing and Administrative Expenses. Selling, marketing and administrative expenses decreased to $45.8 million, or 15.9% of net sales, for fiscal 2003 from $54.6 million, or 15.6% of net sales, for fiscal 2002 due to lower freight out expense, incentive compensation, professional fees and bad debt expense, partially offset by increased marketing expense. Profit sharing and incentive compensation declined because of lower net sales and operating income compared to fiscal 2002. Freight out expense declined because of lower net sales and a change in the selling terms with a major customer. Commission expenses declined because of lower net sales levels. Legal fees and bad debt expense were higher in fiscal 2002 because of the RadioShack arbitration and Kmart bankruptcy, respectively. Marketing costs increased slightly due to store display costs and other promotional costs.
Restructuring Charges. A restructuring charge in the amount of $2 million was recorded during fiscal 2003. This charge consisted of severance actions of $1.5 million and an asset impairment charge of $540,000. No restructuring charges were recorded in fiscal 2002.
Depreciation and Amortization. Depreciation and amortization expenses decreased to $13.6 million for fiscal 2003 compared to $14.5 million for fiscal 2002. Capital additions in fiscal 2003 and 2002 were $5.1 million and $8.6 million, respectively. Fiscal 2003 capital expenditures were primarily for normal replacements of equipment.
Operating Income. Operating income decreased $13.6 million to $26.3 million for fiscal 2003 from $39.9 million in fiscal 2002. Lower net sales and operating levels, as well as the restructuring charge, were partially offset by lower material costs and lower selling, marketing and administrative expenses in fiscal 2003.
Net Interest Expense. Net interest expense decreased to $24.3 million in fiscal 2003 from $27.9 million in fiscal 2002. Interest expense decreased due to the change in fair value of our interest rate collar, prior to its expiration on March 31, 2003, as well as our repayment of debt and lower variable interest rates on a portion of our debt. The following table describes the components of net interest expense.
Year ended June 30, ----------------------------- (in thousands) 2003 2002 ---------- ---------- Interest expense on senior credit facility, industrial revenue bonds and senior subordinated notes $ 21,899 $ 23,942 Interest income (266) (395) Non-cash items: Interest expense on O'Sullivan Holdings note 2,506 2,231 Interest rate collar (2,091) (5) Amortization of debt discount 628 544 Amortization of loan fees 1,610 1,610 ---------- ---------- Net interest expense $ 24,286 $ 27,927 ========== ==========
Pre-Tax Income. Pre-tax income declined $10.1 million from $11.7 million in fiscal 2002 to $1.6 million in fiscal 2003. The decline was due principally to our lower net sales and operating levels, partially offset by lower raw material costs, lower selling, marketing and administrative expenses and a decrease in interest expense.
Income Tax Provision. We recorded no tax expense in fiscal 2003 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. As described in "Overview--Tax Sharing Agreement with RadioShack", we recorded a full valuation allowance against our deferred tax assets in fiscal 2002 resulting in increased income tax expense.
Net Income (Loss). Our net income was $1.6 million in fiscal 2003 compared to a net loss of $89.2 million in fiscal 2002 due to the fiscal 2002 valuation allowance, partially offset by our lower net sales and operating levels.
Liquidity and Capital Resources.
We are highly leveraged and have a stockholders' deficit of approximately $164.6 million at June 30, 2004. Our liquidity requirements will be to pay our debt, including interest expense under our credit agreement and notes, to pay RadioShack amounts due under the tax sharing agreement and to provide for working capital and capital expenditures. Our primary sources of liquidity are cash flows from operating activities and borrowings under our credit agreement, which is discussed below. Decreased demand for our products could further decrease our cash flows from operating activities and the availability of borrowings under our credit agreement.
Working Capital. As of June 30, 2004, cash and cash equivalents totaled $5.3 million. Net working capital was $49.6 million at June 30, 2004 compared to $45.8 million at June 30, 2003. The $3.8 million increase in net working capital resulted primarily from the increased investments in inventories and decreases in accounts payable and the current portions of long-term debt and the payable to RadioShack, partially offset by reductions to cash and accounts receivable and an increase in accrued liabilities.
Operating Activities. Net cash provided by operating activities for the fiscal year ended June 30, 2004 was $1.0 million compared to net cash provided of $14.7 million for the fiscal year ended June 30, 2003. Cash flows from operating activities decreased year-over-year for the following reasons:
o Our net loss in fiscal 2004 was $27.4 million compared to net income of $1.6 million in fiscal 2003.
o Accounts payable and accrued liabilities increased $4.0 million in fiscal 2004 compared to a decrease of $7.7 million in fiscal 2003. This change is due primarily to higher accrued interest, as we now pay interest on our senior secured notes semi-annually in July as compared to more frequent payments under our prior senior credit facility.
o Accounts receivable decreased $2.5 million in fiscal 2004 compared to a decrease of $11.3 million in fiscal 2003. The change was due primarily to increased sales in the latter portion of the fourth quarter of fiscal 2004 compared to a decline in sales for the same period of fiscal 2003.
o We paid RadioShack $2.0 million in fiscal 2004, decreasing our liability by that amount. In fiscal 2003, we paid RadioShack $9.3 million.
o In fiscal 2004, we reclassified our mandatorily redeemable senior preferred stock to liabilities, and the $4.3 million of dividends that accrued on this class of stock during fiscal 2004 was accounted for as interest expense.
o Inventories increased $2.6 million in fiscal 2004, but were essentially flat in fiscal 2003.
Investing Activities. We invested $2.5 million for capital expenditures for fiscal 2004 compared to $5.1 million for the prior year. We also sold our Cedar City, Utah manufacturing facility for net proceeds of $6.8 million in fiscal 2003. 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. Net cash flows used for investing activities decreased $23.0 million in fiscal 2004 from fiscal 2003 primarily because we repaid $24.3 million of debt in fiscal 2003. In fiscal 2004 we replaced our senior credit facility with $100.0 million principal amount of senior secured notes. Our consolidated principal amount of indebtedness at June 30, 2004 was $231.0 million, consisting of the following.
o a credit agreement providing for asset-based revolving credit of up to $40.0 million. The borrowing base at June 30, 2004 was approximately $26.9 million. No borrowings were outstanding under the credit agreement at June 30, 2004, although letters of credit aggregating approximately $14.0 million were outstanding under the credit agreement. Outstanding letters of credit reduce the borrowing base.
o $100.0 million in 10.63% senior secured notes due 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. The proceeds of the senior secured notes were used to repay $88.7 million outstanding under our senior credit facility and to pay issuance expenses.
o $96.0 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. We issued $100.0 million of these notes 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 and recorded other financing income of $616,000 net of original issue discount and capitalized loan fees.
o $10.0 million in variable rate industrial revenue bonds.
o $25.0 million, including $10.0 million of interest added to the principal of the note, in a note issued by O'Sullivan Holdings 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 principal amount of indebtedness to recorded book value as of June 30, 2004, is as follows:
Original Warrants Recorded Consolidated issue discount net of book value of indebtedness net of accretion accretion long-term debt --------------- ---------------- ----------------- ----------------- (in thousands) ----- -- ---
----- -- --- Senior secured notes $ 100,000 $ (4,426) $ - $ 95,574 Senior subordinated notes 96,000 (1,310) (2,444) 92,246 Industrial revenue bonds 10,000 - - 10,000 O'Sullivan Holdings note 24,984 - (2,525) 22,459 ------------ ----------- --------------- -------------- Total $ 230,984 $ (5,736) $ (4,969) $ 220,279 ============ =========== =============== ==============
Refinancing
On September 29, 2003, we refinanced our senior credit facility with $100.0 million of new privately placed senior secured notes and an asset-based credit agreement.
The $100.0 million senior secured notes mature on October 1, 2008 and bear interest at 10.63%. The notes were issued by O'Sullivan Industries at a price of 95%, providing $95.0 million in cash proceeds before about $3.8 million of expenses related to the issuance. The notes are secured by a first-priority security interest in and lien on substantially all of our assets (and on O'Sullivan Industries' capital stock) other than accounts receivable, inventory, capital stock of O'Sullivan Industries' 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. Pursuant to a registration rights agreement, we filed a registration statement with the Securities and Exchange Commission with respect to an offer to exchange the notes for a new issue of identical notes registered under the Securities Act of 1933, as amended, in December 2003. The registration statement became effective on January 8, 2004, and the exchange offer closed on February 25, 2004.
The asset-based credit agreement permits revolving borrowings of up to $40.0 million to the extent of availability under a collateral borrowing base. The credit agreement has a $25.0 million sub-limit for letters of credit, of which we were utilizing approximately $15.2 million as of September 27, 2004. 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. No loans were outstanding under the credit agreement as of June 30, 2004, although letters of credit aggregating approximately $14.0 million were outstanding under 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, any borrowings under the credit agreement would be classified as short term even though the term of the credit agreement does not expire until September 2008.
In connection with the repayment of the term loans and the termination of the revolving credit facility under the senior credit facility, we expensed approximately $3.1 million of unamortized loan issuance costs related to the facility in the first quarter of fiscal 2004.
During fiscal 2004 we repurchased $4.0 million principal amount of our senior subordinated notes.
Liquidity
We have a stockholders' deficit of approximately $165 million as of June 30, 2004, incurred a net loss of $27.4 million for the year ended June 30, 2004 and expect to incur a net loss during the year ending June 30, 2005. Our net sales have declined each of the past four years. Our sales and operating results during 2004 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.
We have recently added several new key members to our executive management team. The new executive management team is in the process of evaluating our strategies and core competencies to determine the most effective way to improve sales, reduce costs and increase operating income. 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. We expect borrowing availability under the credit agreement to approximate $10 million to $15 million, after the effect of outstanding letters of credit, from October 2004 through the end of fiscal 2005. Decreased demand for our products, as well as efforts to reduce working capital requirements, could negatively affect levels of inventory and accounts receivable and the availability of borrowings under the credit agreement.
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 June 30, 2004 and expect to remain in compliance with these covenants during the next twelve months. In the event that revenues are significantly below fiscal year 2005 forecasted revenues, we believe we have the ability to reduce or delay discretionary expenditures, including capital purchases, 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.
Off-balance Sheet Arrangements.
At June 30, 2004, 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.
The following table illustrates our contractual obligations as of June 30, 2004 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 $ 230,984 $ - $ - $ 110,000 $ 120,984 Tax benefit payments to RadioShack1 70,067 20,181 23,599 26,287 - Operating leases--unconditional 3,632 1,603 1,782 247 Other long-term obligations2 435 131 214 90 - ----------- ------------ ------------ ----------- ----------- Total contractual cash obligations $ 305,118 $ 21,915 $ 25,595 $ 136,624 $ 120,984 =========== ============ ============ =========== ===========
------------------------------------- 1Timing and amounts of payments 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 to RadioShack. 2Represents payments due under retirement agreements.
Market Risk and Inflation.
Our market risk is affected by changes in interest rates, foreign currency exchange rates and certain commodity prices. Under our policies, we may use natural hedging techniques and derivative financial instruments to reduce the impact of adverse changes in market prices. We do not hold or issue derivative instruments for trading purposes. We believe that our foreign exchange risk is not material.
We have market risk in interest rate exposure, primarily in the United States. Interest rate instruments may be used to adjust interest rate exposures when appropriate based on market conditions. Our interest rate collar expired on March 31, 2003. At June 30, 2004, $10.0 million of our indebtedness 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.
From fiscal 2001 through fiscal 2002, particleboard and fiberboard prices declined, increasing our operating income in the later portion of the year. We saw small increases in particleboard pricing in the third quarter of fiscal 2003. Prices for fiberboard increased in the fourth quarter of fiscal 2002, but declined slightly during fiscal 2003.
In fiscal 2004, market prices for particleboard, our largest-cost raw material, increased about 40% to 50%, depending on thickness and origin. Market prices for fiberboard increased about 30%. We expect additional price increases in fiscal 2005, and perhaps beyond, as demand for particleboard has increased and suppliers have reduced capacity. Because we utilize first-in, first-out accounting for our inventory, not all of the price increases are reflected in our cost of goods sold for fiscal 2004. These price increases will reduce our operating margins and operating income for fiscal 2005 and perhaps beyond.
We are endeavoring to reduce the impact of the price increases through our productivity programs 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 were not fully effective in the fourth quarter of fiscal
2004. 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 price increases.
We cannot assure you that raw materials prices will not increase further in the future.
Effect of Recent Changes in Accounting Standards.
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This pronouncement changes the accounting for certain financial instruments that, under previous guidance, could be accounted for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) on the balance sheet. SFAS 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities all of whose shares are mandatorily redeemable. We adopted SFAS 150 on July 1, 2003 and reclassified our mandatorily redeemable senior preferred stock as a non-current liability, instead of as an item between the liabilities and equity sections of the balance sheet as historically presented. Prior period amounts have not been restated in accordance with this statement.
Also in accordance with SFAS 150, dividends on mandatorily redeemable financial instruments are now accounted for as interest expense on the consolidated statement of operations instead of as dividends and accretion on preferred stock. Interest expense for the senior preferred stock was approximately $4.3 million during fiscal 2004. Adoption of SFAS 150 did not affect our cash payments or liquidity.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. FIN 46 applies to any business enterprise, public or private, that has a controlling interest, contractual relationship or other business relationship with a variable interest entity. In December 2003, the FASB issued Interpretation No. 46(R) ("FIN 46(R)") which superceded FIN 46. FIN 46(R) is effective for all Special Purpose Entities ("SPE's") created prior to February 1, 2003 at the end of the first interim or annual reporting period ending after December 15, 2003. FIN 46(R) will be applicable to all non-SPE's created prior to February 1, 2003 by public entities at the end of the first interim or annual reporting period ending after March 15, 2004. We have determined that we have no SPE's. We reviewed the applicability of FIN 46(R) to entities other than SPE's and determined that the adoption of FIN 46(R) did not have a material effect on our consolidated financial statements.
Seasonality
Historically, we have generally experienced a somewhat higher level of sales in the second and third quarters of our fiscal year in anticipation of and following the holiday selling season.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. 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 costs, 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. Changes in our judgments or estimates with respect to these matters could increase our expenses, affect the timing of recording of sales and affect the recorded value of our assets.
o We derive our revenue from product sales. We recognize revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or 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 or 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 generally is not requested from customers.
o We record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, promotions and other volume-based incentives. Market conditions could require us to take actions to increase customer incentive offerings. These offerings could result in our estimates being too small and reduce our revenues when the incentive is offered.
o We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We determine our allowance by performing a monthly aging analysis of customer receivables. All past due amounts greater than 60 days and over a specified dollar amount are reviewed individually for collectibility. Account balances are charged off against the allowance when we determine the receivable will not be recovered.
o We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and its estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by us, additional inventory write-downs may be required. Obsolete and slow-moving inventory reserves were approximately $3.7 million and $4.3 million at June 30, 2004 and 2003, respectively.
o We record our deferred tax assets at the amount that the asset is more likely than not to be realized. As of June 30, 2004, we have provided a valuation allowance against our total net deferred tax asset. 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 is 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.
o We periodically review our long-lived assets, including property and equipment, for impairment and determine whether an event or change in facts and circumstances indicates their carrying amount may not be recoverable. We determine recoverability of the assets by comparing the carrying amount of the assets to the net future undiscounted cash flows expected to be generated by those assets. If the sum of the undiscounted cash flows is less than the carrying value of the assets, an impairment charge is recognized. Adverse economic conditions could cause us to record impairment charges in the future.
o We assess goodwill regularly for impairment by applying a fair-value-based test, using the enterprise as the reporting unit. If the book value of the reporting unit is below the fair value of the reporting unit, there is no impairment loss. Adverse economic conditions could cause us to record impairment charges in the future.
Cautionary Statement Regarding Forward Looking Information and Risk Factors.
Certain portions of this report, and particularly the Management's Discussion and Analysis of Financial Condition and Results of Operations and the Notes to the Consolidated Financial Statements in Part II of this report, the portions of Item 1 in Part I captioned "History and Overview--New Management Team," "Customers," "Sales and Marketing," "Product Design and Development," "Raw Materials," "Competition," "Patents and Trademarks" and "Environmental and Safety Regulations" and Item 3 in Part I contain forward-looking statements. Item 5 in Part II of this report also contains our expectations regarding the future use of our cash flow. These include information relating to cost savings, benefits, revenues and estimated sales, litigation, earnings and expenses. These statements can be identified by the use of future tense or dates or terms such as "believe," "would," "may," "expect," "anticipate" or "plan."
These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those predicted by the forward-looking statements. Because these forward-looking statements involve risks and uncertainties, actual results may differ significantly from those predicted in these forward-looking statements. You should not place a lot of weight on these statements. These statements speak only as of the date of this document or, in the case of any document incorporated by reference, the date of that document.
Factors and possible events which could cause results to differ include:
o Our substantial leverage could make it more difficult to pay our debts, divert our cash on hand for debt payments, limit our ability to borrow funds and increase our vulnerability to general adverse economic and industry conditions. Any of these consequences of our substantial indebtedness could prevent us from fulfilling our obligations under our indebtedness because our ability to make required payments on our debt depends on our ability to generate sufficient cash flow to make these payments. We have a significant principal amount of indebtedness as shown in the chart below: June 30, 2004 (dollars in millions) Total principal amount of indebtedness.........................................................$ 231.0 Principal amount of indebtedness senior to O'Sullivan Holdings note............................$ 206.0 Principal amount of indebtedness senior to O'Sullivan Industries senior subordinated notes.....$ 110.0 Stockholders' deficit..........................................................................$ 164.6
Our substantial indebtedness could have important consequences to holders of our debt or equity. For example, it could:
o make it more difficult for us to satisfy our obligations with respect to our debt, particularly our subordinated debt; o increase our vulnerability to general adverse economic and industry conditions; o limit our ability to fund future working capital, capital expenditures and other general corporate requirements; o require a substantial portion of our cash on hand for debt payments; o limit our flexibility to plan for, or react to, changes in our business and the industry in which we operate; o place us at a competitive disadvantage compared to our competitors that are less leveraged; o limit our ability to borrow additional funds; and o expose us to fluctuations in interest rates because some of our debt has a variable rate of interest.
o We may not have sufficient cash from cash flows from operating activities, cash on hand and available borrowings under our credit agreement to service our indebtedness and to pay amounts due RadioShack under the tax sharing agreement. These obligations require a significant amount of cash. Our business may not generate sufficient cash flows from operating activities. In the last two fiscal years, our net cash flow from operations has declined from $25.9 million to $1.0 million. Our ability to make payments on and to refinance our indebtedness will depend on our ability to generate cash in the future. This, to some extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Lower net sales will generally reduce our cash flow. In addition to servicing the payment of principal and interest
on our indebtedness, we are obligated to make substantial payments to RadioShack under the tax sharing agreement. The maximum payments to RadioShack for fiscal 2005, 2006 and 2007 are $20.2 million, $11.3 million and $12.3 million, respectively. The timing and payments to RadioShack are contingent on taxable income. We currently estimate approximately $3.7 million will be paid in fiscal 2005.
We cannot assure you that our future cash flow will be sufficient to meet our obligations and commitments. If we are unable to generate sufficient cash flows from operating activities in the future to service our indebtedness and to meet our other commitments, we will be required to adopt one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or operations or seeking to raise additional debt or equity capital. We cannot assure you that any of these actions could be effected on a timely basis or on satisfactory terms or at all, or that these actions would enable us to continue to satisfy our capital requirements. In addition, our existing or future debt agreements and the tax sharing agreement may contain restrictive covenants prohibiting us from adopting any of these alternatives. Our failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources."
o Failure to comply with any of the restrictions contained in the agreements governing our indebtedness could result in acceleration of our debt. Were this to occur, we would not have sufficient cash to pay our accelerated indebtedness. A failure to comply with the restrictions contained in our credit agreement, the indenture governing our senior secured notes or the indenture governing our senior subordinated notes could lead to an event of default, which could result in an acceleration of that indebtedness and our other indebtedness by cross- default provisions. Were this to occur, we would not have sufficient cash to pay our accelerated indebtedness or other debt.
Due to our lower sales in fiscal 2003, we negotiated amendments to the financial covenants in our previous senior credit facility. Without the amendments, we may have been in default under the facility.
Our credit agreement, senior secured notes, senior subordinated notes and the O'Sullivan Holdings note restrict our ability, among others, to:
o incur additional indebtedness; o pay dividends and make distributions; o issue common and preferred stock of subsidiaries; o make certain investments; o repurchase stock; o create liens; o enter into transactions with affiliates; o enter into sale and leaseback transactions; o merge or consolidate; and o transfer and sell assets other than in the ordinary course of business.
An acceleration under our credit agreement, the indenture governing our senior secured notes or the indenture governing our senior subordinated notes would also constitute an event of default under the other agreements or indentures and the securities purchase agreement relating to the O'Sullivan Holdings note.
o Reductions in retail sales could reduce our sales, especially if the reductions occur in the industries that we believe contribute to the growth of the ready-to-assemble furniture industry and could reduce our ability to pay our debts. Most of our sales are to major retail chains. If there is a reduction in the overall level of retail sales, our sales could also decline and our ability to pay our debts could be reduced. We believe that retail sales of ready-to-assemble furniture increased from fiscal 1995 through fiscal 2000 in part because of an increase in sales of personal computers and home entertainment electronic equipment. The slowdown in growth of sales of these products hurt our sales since fiscal 2001 through fiscal 2004 and could again lower sales in the future.
o Our payments to RadioShack under the tax sharing agreement could reduce our liquidity. Because of the arbitration panel's ruling and the subsequent settlement agreement in the arbitration proceedings
between RadioShack and O'Sullivan, our payments to RadioShack under the tax sharing agreement have increased substantially. In fiscal 2002 we paid RadioShack $27.7 million, representing amounts due from November 1999 through June 2002. In fiscal 2003 and 2004, we paid RadioShack $9.3 million and $2.0 million, respectively. As of June 30, 2004, the aggregate amount payable to RadioShack under the tax sharing agreement was approximately $70.1 million. The maximum amounts due RadioShack under the tax sharing agreement are $20.2 million, $11.3 million and $12.3 million in fiscal 2005, 2006 and 2007, respectively. The timing and payments to RadioShack are contingent on taxable income. The funds for these payments have come, and funds for future payments will continue to come, from O'Sullivan Industries. We plan to fund these increased payment obligations from cash flows from operating activities, cash on hand, borrowing under our credit agreement or other sources of capital, if available.
o Our operating income would be reduced if the prices our suppliers charge us for raw materials increase. We are dependent on outside suppliers for all of our raw material needs and are subject to changes in the prices charged by our suppliers. If these prices were to increase significantly, our gross profit would be reduced and could in turn lead to our being unable to service our indebtedness.
In fiscal 2004, market prices for particleboard, our largest-cost raw material, increased about 40% to 50%, depending on thickness and origin. Market prices for fiberboard increased about 30%. We expect additional price increases in the first half of fiscal 2005, and perhaps beyond, as demand for particleboard has increased and suppliers have reduced capacity. Because we utilize first-in, first-out accounting for our inventory, not all of the price increases are reflected in our cost of goods sold for fiscal 2004. These price increases will reduce our operating margins and operating income for fiscal 2005 and perhaps beyond.
We are endeavoring to reduce the impact of the price increases through our productivity programs 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; these price increases were not fully effective in the fourth quarter of fiscal 2004. 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 price increases.
o Because we sell products to a small number of customers, our sales would be reduced if one of our major customers significantly reduced its purchases of our products or were unable to fulfill its financial obligations to us. If this were to happen, our ability to pay our debts may be significantly affected. Our sales are concentrated among a relatively small number of customers. Any of our major customers can stop purchasing product from us or significantly reduce their purchases at any time. During fiscal year 2004, our four largest customers, OfficeMax, Wal-Mart, Office Depot and Staples, accounted for approximately 58% of our gross sales. We do not have long term contracts with any of our customers and our sales depend on our continuing ability to deliver attractive products at reasonable prices. Reduced orders from some of our largest customers significantly reduced our sales in fiscal 2003 and 2004. Further, Montgomery Ward closed all of its stores in fiscal 2001, Ames closed all of its stores in 2002 and Kmart closed approximately 600 stores during its reorganization under the United States Bankruptcy Code in fiscal 2002 and 2003 and has announced plans to sell additional stores. We cannot assure you that our other customers will not experience similar financial difficulties in the future.
Further, in December 2003, Best Buy informed us that they would be reducing orders of particleboard furniture. As a result, our sales to Best Buy declined significantly in the last half of fiscal 2004. We expect sales to Best Buy to continue at the lower level. We hope to partially offset this loss by increasing sales to other customers, but we cannot assure you that this will occur.
There can be no assurance that we will be able to maintain our current level of sales to our customers or that we will be able to sell our products to other customers on terms that will be favorable. The loss of, or substantial decrease in the amount of purchases by, or a write-off of any significant receivables due from, any of our major customers would have a material adverse effect on our business, results of operations, liquidity and financial condition.
At June 30, 2004, our largest five customer accounts receivable balances comprised approximately 65% of our net trade receivables balance. The bankruptcy of a large customer, such as Kmart's bankruptcy in January 2002,
could cause us to increase our reserves for doubtful accounts substantially, reducing our operating income and net income accordingly.
o We operate in a highly competitive market which may force us to reduce margins, reducing our cash flows and our ability to pay our debts. The industry in which we operate is highly competitive. Some of our competitors are significantly larger and have greater financial, marketing and other resources than we do. Because of lower sales of RTA furniture generally and an increase in imports, a number of manufacturers, including us, have excess capacity. The competitive nature of our industry has led and could continue to lead to smaller profit margins due to competitive pricing policies or excess capacity. If this were to occur, our cash flows and our ability to pay our debts may be reduced. Foreign manufacturers entering the United States market are also increasing competition in our markets. This competitive pressure could be further exacerbated if additional excess manufacturing capacity develops in the RTA furniture industry due to over-expansion by manufacturers, further reduction in demand or otherwise.
o Because the O'Sullivan Industries senior subordinated notes, and the subsidiary guarantee thereof, and the O'Sullivan Holdings note rank behind O'Sullivan Industries' senior debt, holders of these notes may receive proportionately less than holders of our senior debt in a bankruptcy, liquidation, reorganization or similar proceeding. In the event of a bankruptcy, liquidation, reorganization or similar proceeding relating to us, holders of O'Sullivan Industries senior subordinated notes and then the O'Sullivan Holdings note will participate with all other holders of our subordinated indebtedness in the assets remaining after we have paid all of the senior debt. Because our senior debt must be paid first, holders of these notes may receive proportionately less than trade creditors in any proceedings of this nature. In any of these cases, we may not have sufficient funds to pay all of our creditors. Therefore, holders of our subordinated indebtedness may receive ratably less than trade creditors.
In addition, all payments on the subordinated debt will be blocked in the event of a payment default on our senior debt and may be prohibited for up to 179 days each year in the event of some non-payment defaults on senior debt.
o Despite our current levels of debt, we may still incur more debt and increase the risks described above. We may incur significant additional indebtedness in the future. If we or our subsidiaries add new debt to our current debt levels, the related risks that we and they now face could intensify, making it less likely that we will be able to fulfill our obligations to holders of the O'Sullivan Industries senior subordinated notes or the O'Sullivan Holdings note. None of the agreements governing our indebtedness completely prohibits us or our subsidiaries from doing so. Our credit agreement permits additional borrowings of up to $26.9 million at June 30, 2004, although about $14.0 million of this capacity was utilized by the issuance of letters of credit. These additional borrowings would be senior to the O'Sullivan Industries senior subordinated notes and the O'Sullivan Holdings note.
o If we become bankrupt, the claims of holders of the O'Sullivan Industries senior secured notes and senior subordinated notes against us may be less than the face value of the notes due to original issue discount. The O'Sullivan Industries senior secured notes and senior subordinated notes bear a discount from their stated principal amount at maturity. If a bankruptcy case is commenced by or against O'Sullivan Industries under the U.S. Bankruptcy Code, the claim of a holder of the notes with respect to the principal amount thereof would likely be limited to an amount equal to the sum of (1) the initial offering price and (2) the portion of the original issue discount, or OID, that is not deemed to constitute "unmatured interest" for purposes of the U.S. Bankruptcy Code. Any OID that was not accrued as of the bankruptcy filing would constitute "unmatured interest."
o We are at risk that users of our products will sue us for product liability. If we were unable to defend ourselves against some product liability lawsuits, our success and our ability to pay our debts may be reduced. All of our products are designed for use by consumers. Like other manufacturers of similar products, we are subject to product liability claims and could be subject to class action litigation with respect to our products. If we were unable to defend ourselves against certain product liability lawsuits, our success and ability to pay our debts may be adversely affected. We are party to various pending product liability claims and legal actions arising in the ordinary operation of our business. Our liability insurance may not be adequate for our needs, and we may not be fully insured against any particular lawsuit which may adversely affect us.
o We may be liable for penalties under environmental, health and safety laws rules and regulations. This could negatively affect our success and our ability to pay our debts. We are subject to many federal, state and local, environmental, health and safety laws, regulations and ordinances including the requirements and standards of the U.S. Consumer Products Safety Commission and the Occupational Health and Safety Act. Violations of environmental, health and safety laws are subject to civil, and in some cases criminal, sanctions. We have made and will continue to make capital and other expenditures in order to comply with these laws and regulations. However, the requirements of these laws and regulations are complex, change frequently, and could become more stringent in the future. We cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist. These costs and expenses may adversely affect our success and ability to pay our debts.
Our manufacturing facilities ship waste products to various disposal sites. To the extent that these waste products include hazardous substances that could be discharged into the environment at these disposal sites or elsewhere, we are potentially subject to laws that provide for responses to, and liability for, releases of hazardous substances into the environment and liability for natural resource damages. One example of these laws is the federal Comprehensive Environmental Response, Compensation and Liability Act. Generally, liability under this act is joint and several and is determined without regard to fault. In addition to the Comprehensive Environmental Response, Compensation and Liability Act, similar state or other laws and regulations may impose the same or even broader liability for releases of hazardous substances. Because these laws could subject us to liability even if we are not at fault, it is difficult for us to estimate the cost of complying with them.
o The interests of our controlling stockholders may be in conflict with interests of the holders of our indebtedness. This conflict could result in corporate decision making that involves disproportionate risks to the holders of our indebtedness, including our ability to service our debts or pay the principal amount of indebtedness when due. BRS owns securities representing approximately 72.7% of the voting power of the outstanding common stock of O'Sullivan Holdings. Pursuant to the stockholders agreement among O'Sullivan Holdings, BRS and certain other of our stockholders, BRS has the right to appoint five directors to the board of directors of O'Sullivan Holdings. As a result, directors appointed by BRS will be in a position to control all matters affecting us. Such concentration of ownership may have the effect of preventing a change in control. As a result, BRS will continue to have the ability to elect and remove directors and determine the outcome of matters presented for approval by our stockholders. In addition, there may be circumstances where the interests of BRS could be in conflict with the interests of the holders of our indebtedness. For example, BRS may have an interest in pursuing transactions that, in their judgment, could enhance their equity investment, even though these transactions might involve risks to the holders of O'Sullivan's debt. See Item 10, "Directors and Executive Officers of the Registrant," and Item 12, "Security Ownership of Certain Beneficial Owners and Management," in Part III of this report.
o If our key personnel were to leave, our success could be negatively affected and our ability to service our debts could be adversely affected. Our continued success is dependent, to a certain extent, upon our ability to attract and retain qualified personnel in all areas of our business, including management positions and key sales positions, especially those positions servicing our major customers. We do not have employment agreements with any of our officers or key personnel located in the United States other than with Messrs. Parker, Walters and Orr and we do not carry key person life insurance on any of our employees. We may not be able to keep existing personnel or be able to attract qualified new personnel. Our inability to do so could have a negative effect on us as we may be unable to efficiently and effectively run our business without these key personnel. See "Directors and Executive Officers of the Registrant," Item 10 of Part III of this report.
o We rely heavily on product innovation. Product life cycles can be short in the RTA furniture industry, and innovation is an important component of the competitive nature of the industry. While we emphasize new product innovation and product repositioning (i.e., design changes or revised marketing strategies), we may be unable to continue to develop competitive products in a timely manner or to respond adequately to market trends. In addition, we may not be able to ensure that repositioned products will gain initial market acceptance, that interest in our products will be sustained, or that significant start-up costs with respect to new products will be recouped.
o Our net sales are highly price sensitive, which can prevent us from passing cost increases to our customers. Sales to mass retailers, which are among our primary customers, are highly price sensitive. We set
many product prices on an annual basis or for longer periods, but we typically purchase raw materials and components under purchase orders within periods of less than one year. Accordingly, we often must set prices for many products before production costs have been firmly established, before we have complete knowledge of the costs of raw materials and components and sometimes before product development is complete. After we have established prices, we generally have difficulty passing cost increases along to our customers, nor can we compete as effectively if we seek to pass such costs along.
o Fraudulent conveyance laws permit courts to void guarantees, subordinate claims and require holders of our debt to return payments received from guarantors in specific circumstances. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of a guarantor, if, among other things, the guarantor, at the time it incurred the indebtedness connected with its guarantee:
o received less than reasonably equivalent value or fair consideration for the issuance of the guarantee, and was rendered insolvent by reason of such guarantee; or o was engaged in a business or transaction for which the guarantor's remaining assets constituted unreasonably small capital; or o intended to incur or believed that it would incur debts beyond our or its ability to pay such debts as they mature.
In addition, any payment by that guarantor pursuant to its guarantee could be voided and required to be returned to the guarantor, or to a fund for the benefit of the creditors of the guarantor.
The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if:
o the sum of its debts, including contingent liabilities, were greater than the fair saleable value of all of its assets; or o the present fair saleable value of its assets were less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they became absolute and mature; or o it could not pay its debts as they became due.
If a court were to disagree with our conclusions as to the legality of any subsidiary guarantees it could adversely affect the rights of holders of O'Sullivan Industries' indebtedness.
o We may not have the ability to raise the funds necessary to finance a change of control offer required by our debt agreements. Upon certain change of control events, we will be required to offer to repurchase all of the O'Sullivan Industries senior secured notes and senior subordinated notes, and O'Sullivan Holdings may be required to repurchase its note upon a change of control of O'Sullivan Holdings. If we do not have sufficient funds at the time of a change of control, we will not be able to make the required repurchase of these notes. This could be because of cash flow difficulties or because of restrictions in our credit agreement and any future credit agreements that will not allow these repurchases.
In addition, some kinds of corporate events, such as a leveraged recapitalization, would increase the level of our indebtedness but would not necessarily constitute a "Change of Control" and would therefore not require us to repurchase the notes.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is incorporated herein by reference to the section entitled "Market Risk and Inflation" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 8.
Item 8. Financial Statements and Supplementary Data.
Immediately following are the report of the independent registered public accounting firm, the consolidated balance sheets of O'Sullivan Industries Holdings, Inc. and subsidiaries as of June 30, 2004 and 2003, and the related consolidated statements of operations, cash flows and changes in stockholders' equity (deficit) for each of the three years in the period ended June 30, 2004, and the notes thereto.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of O'Sullivan Industries Holdings, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of changes in stockholders' equity (deficit) present fairly, in all material respects, the financial position of O'Sullivan Industries Holdings, Inc. and its subsidiaries at June 30, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, on July 1, 2003 the Company adopted SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.
PricewaterhouseCoopers LLP Kansas City, Missouri September 27, 2004
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except for share data) June 30, --------------------------- Assets 2004 2003 ------------ ------------ Current assets: Cash and cash equivalents $ 5,250 $ 7,977 Trade receivables, net of allowance for doubtful accounts of $2,144 and $2,978, respectively 22,579 25,032 Inventories, net 55,071 52,426 Prepaid expenses and other current assets 3,229 2,772 ------------ ------------ Total current assets 86,129 88,207
Property, plant and equipment, net 61,683 71,867 Other assets 8,462 9,226 Goodwill, net of accumulated amortization 38,088 38,088 ------------ ------------ Total assets $ 194,362 $ 207,388 ============ ============ Liabilities and Stockholders' Deficit Current liabilities: Accounts payable $ 8,199 $ 10,006 Current portion of long-term debt - 4,039 Accrued advertising 9,422 9,493 Accrued liabilities 15,237 12,043 Payable to RadioShack 3,658 6,798 ------------ ------------ Total current liabilities 36,516 42,379
Long-term debt, less current portion 220,279 209,405 Mandatorily redeemable senior preferred stock (Note 10) 26,258 - Other liabilities 9,452 6,762 Payable to RadioShack 66,409 65,269 ------------ ------------ Total liabilities 358,914 323,815
Commitments and contingent liabilities (Notes 3, 12, 17 and 18)
Mandatorily redeemable senior preferred stock (Note 10) - 21,933
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 98,097 85,682 Junior preferred stock, Series C, $0.01 par value, 50,000 shares authorized, none issued - - Class A common stock, $0.01 par value; 2,000,000 shares authorized, 1,368,000 issued 14 14 Class B common stock, $0.01 par value; 1,000,000 shares authorized, none issued - - Additional paid-in capital 13,053 13,053 Retained deficit (276,910) (237,062) Notes receivable from employees (367) (343) Accumulated other comprehensive income 1,561 296 Total stockholders' deficit (164,552) (138,360) ------------ ------------ Total liabilities and stockholders' deficit $ 194,362 $ 207,388 ============ ============
============ ============ The accompanying notes are an integral part of these consolidated financial statements. ============ ============
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands) For the year ended June 30, ---------------------------------------- 2004 2003 2002 ------------- ------------ ------------ Net sales $ 268,829$ 289,152$ 349,098 Cost of sales 213,989 214,977 254,662 ------------- ------------ ------------
Gross profit 54,840 74,175 94,436
Operating expenses: Selling, marketing and administrative 46,138 45,834 54,584 Restructuring charge - 2,049 - Casualty gain (490) - - ------------- ------------ ------------ Total operating expenses 45,648 47,883 54,584 ------------- ------------ ------------
Operating income 9,192 26,292 39,852 Other income (expense): Interest expense (34,011) (24,552) (28,322) Interest income 64 266 395 Other financing costs, net (2,678) (445) (204) ------------- ------------ ------------
Income (loss) before income tax provision (27,433) 1,561 11,721 Income tax provision - - 100,927 ------------- ------------ ------------
Net income (loss) (27,433) 1,561 (89,206) Dividends and accretion on preferred stock (12,415) (14,457) (12,490) ------------- ------------ ------------
Net loss attributable to common stockholders $ (39,848$ (12,896$ (101,696) ============= ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the year ended June 30, ----------------------------------------- 2004 2003 2002 ------------ ------------ ------------ Cash flows provided (used) in operating activities: Net income (loss) $ (27,433$ 1,561 $ (89,206) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 12,754 13,621 14,530 Amortization of debt issuance costs 1,680 1,610 1,610 Amortization of debt discount and accrued interest on 4,111 3,134 2,775 O'Sullivan Holdings note Interest and accretion on senior preferred stock 4,326 - - Interest rate collar - (2,091) (5) Bad debt expense (recovery) (20) 735 1,460 Gain on disposal of assets 99 154 991 Impairment of long-lived assets - 540 - Deferred income taxes - - 100,562 Debt extinguishment costs, net 2,678 - - Accrual of special payment on options to purchase Series A junior preferred stock 1,420 1,240 1,083 Changes in assets and liabilities: Trade receivables 2,473 11,268 14,075 Inventories (2,645) (29) (3,859) Other assets (457) (6) 465 Payable to RadioShack (2,000) (9,307) (27,694) Accounts payable and accrued liabilities 4,043 (7,690) 9,110 ------------ --------------------------- Net cash flows provided by operating activities 1,029 14,740 25,897 ------------ ---------------------------
Cash flows provided (used) by investing activities: Capital expenditures (2,459) (5,081) (8,644) Proceeds from sale of manufacturing facility - 6,788 - ------------ ------------ ------------ Net cash flows provided (used) by investing activities (2,459) 1,707 (8,644)
Cash flows provided (used) for financing activities: Employee loans - 18 8 Proceeds from borrowings 99,000 - - Repayment of borrowings (96,265) (24,265) (8,544) Debt issuance costs (4,032) - - ------------ ------------ ------------ Net cash flows used for financing activities (1,297) (24,247) (8,536)
Net increase (decrease) in cash and cash equivalents (2,727) (7,800) 8,717 Cash and cash equivalents, beginning of year 7,977 15,777 7,060 ------------ --------------------------- Cash and cash equivalents, end of year $ 5,250$ 7,977 $ 15,777 ============ =========================== Supplemental cash flow information: Interest paid $ 20,530$ 21,638 $ 24,915 Income taxes paid - - 76 Non-cash investing and financing activities: Dividends accrued but not paid 12,415 14,961 13,136 Capital expenditures included in accounts payable 93 215 288
The accompanying notes are an integral part of these consolidated financial statements.
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT (in thousands) dditional etained Notes Accumu Total stock- omprehensive paid-in arnings eceivable ated othe olders' equit ncome (loss) capital deficit) from compre (deficit) R employees hensive Series B junior e income C preferred stock Common stock A ( r l (loss) r h y i ----------------- ------------------- ----------- --------- ----------- ---------- -------------- ------------- Shares Dollars Shares Dollars ------ --------- -------- --------- ----------- --------- ----------- ---------- -------------- ------------- Balance, June 30, 2001 529$ 65,366 1,368$ 14$ 13,053$ (122,470$ (322$ (336$ (44,695) Net loss (89,206) (89,206$ (89,206) Cumulative translation adjustments 31 31 31 Loans to employees-interest income (24) (24) Repayment of employee loans 9 9 Dividends and accretion on senior preferred stock (3,018) (3,018) Dividends and accretion on junior preferred stock 9,472 (9,472) ------ --------- -------- --------- ----------- --------- ----------- ---------- -------------- ------------- Balance, June 30, 2002 529$ 74,838 1,368$ 14$ 13,053$ (224,166$ (337$ (305$ (136,903$ (89,175) ============= Net income 1,561 1,561$ 1,561 Cumulative translation adjustments 601 601 601 Loans to employees-interest income (24) (24) Repayment of employee loans 18 18 Dividends and accretion on senior preferred stock (3,613) (3,613) Dividends and accretion on junior preferred stock 10,844 (10,844) ------ --------- -------- --------- ----------- --------- ----------- ---------- -------------- ------------- Balance, June 30, 2003 529$ 85,682 1,368$ 14$ 13,053$ (237,062$ (343$ 296$ (138,360$ 2,162 ============= Net loss (27,433) (27,433$ (27,433) Cumulative translation adjustments 1,265 1,265 1,265 Loans to employees-interest income (24) (24) Dividends and accretion on junior preferred stock 12,415 (12,415) ------ --------- -------- --------- ----------- --------- ----------- ---------- -------------- ------------- Balance, June 30, 2004 529$ 98,097 1,368$ 14$ 13,053$ (276,910$ (367$ 1,561$ (164,552$ (26,168) ====== ========= ======== ========= =========== ========= =========== ========== ============== =============
The accompanying notes are an integral part of these consolidated financial statements.
O'SULLIVAN INDUSTRIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - General Information.
O'Sullivan Industries Holdings, Inc. ("O'Sullivan"), a Delaware corporation, is a domestic producer of ready-to-assemble ("RTA") furniture. O'Sullivan's RTA furniture includes desks, computer workcenters, cabinets, home entertainment centers, audio equipment racks, bookcases, microwave oven carts and a wide variety of other RTA furniture for use in the home, office and home office. The products are distributed primarily through office superstores, discount mass merchants, mass merchants, home centers, electronics retailers, furniture stores and internationally. O'Sullivan owns all of the stock of O'Sullivan Industries, Inc. ("O'Sullivan Industries"). O'Sullivan Industries is the sole owner of O'Sullivan Industries - Virginia, Inc. ("O'Sullivan Industries - Virginia") and O'Sullivan Furniture Factory Outlet, Inc.
Note 2 - Summary of Significant Accounting Policies.
Basis of Presentation: The consolidated financial statements include the accounts of O'Sullivan and its wholly owned subsidiaries. All significant intercompany transactions, balances and profits have been eliminated.
Use of Estimates: O'Sullivan's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires O'Sullivan to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements. On an on-going basis, O'Sullivan evaluates its estimates, including those related to customer programs and incentives, uncollectible receivables, sales returns and warranty reserves, inventory valuation, restructuring costs, intangible assets, certain accrued liabilities, deferred taxes, and contingencies and litigation, among others. O'Sullivan bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from the estimates made by O'Sullivan with respect to these items and other items that require management's estimates.
Cash and Cash Equivalents: Cash and cash equivalents include cash on hand and all highly liquid investments with original maturities of three months or less.
Business and Credit Risk Concentrations: The largest five customer accounts receivable balances accounted for approximately 65% and 62% of the trade receivable balance at June 30, 2004 and 2003, respectively. Credit is extended to customers based on evaluation of the customer's financial condition, generally without requiring collateral. Exposure to losses on receivables is dependent on each customer's financial condition. Therefore, O'Sullivan would be exposed to a large loss if one of its major customers were not able to fulfill its financial obligations. From time to time, O'Sullivan maintains certain limited credit insurance which may help reduce, but not eliminate, exposure to potential credit losses. In addition, O'Sullivan monitors its exposure for credit losses and maintains allowances for anticipated losses. O'Sullivan determines its allowance by performing a monthly aging analysis of customer receivables. All past due amounts greater than 60 days and over a specified dollar amount are reviewed individually for collectibility. Account balances are charged off against the allowance when O'Sullivan determines the receivable will not be recovered.
Revenue Recognition: O'Sullivan recognizes revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or determinable and collection of the resulting receivable is reasonably assured. For all sales, O'Sullivan uses purchase orders from the customer, whether oral, written or electronically transmitted, as evidence that a sales arrangement exists.
Generally, delivery occurs when product is delivered to a common carrier or private carrier, with standard terms being FOB shipping point. O'Sullivan assesses whether the price is fixed or determinable based upon the payment terms associated with the transaction.
O'Sullivan assesses collection based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. Collateral is generally not requested from customers.
Shipping and Handling: O'Sullivan reports amounts billed to customers as revenue, the cost of warehousing operations in cost of sales and freight out costs as part of selling, marketing and administrative expenses. Freight out costs included in selling, marketing and administrative expenses in fiscal 2004, 2003 and 2002 were approximately $7.4 million, $6.3 million and $9.7 million, respectively.
Inventories: Inventories are stated at the lower of cost, determined on a first-in, first-out ("FIFO") basis, or market. Provision for potentially obsolete or slow-moving inventory is made based on management's evaluation of inventory levels and future sales forecasts.
Property, Plant and Equipment: Depreciation and amortization of property, plant and equipment is calculated using the straight-line method, which amortizes the cost of the assets over their estimated useful lives. The ranges of estimated useful lives are: buildings--30 to 40 years; machinery and equipment--3 to 10 years; leasehold improvements--the lesser of the life of the lease or asset. Maintenance and repairs are charged to expense as incurred. Renewals and betterments which materially prolong the useful lives of the assets are capitalized. The cost and related accumulated depreciation of assets retired or sold are removed from the accounts, and gains or losses on disposal are recognized in the statement of operations.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.
Intangible Assets: Included in non-current other assets is a non-competition agreement with a former O'Sullivan executive. This intangible asset is being amortized on a straight-line basis over the life of the agreement. At June 30, 2004 and 2003, the cost of this intangible asset was approximately $1.9 million, and accumulated amortization at June 30, 2004 and 2003 was approximately $1.3 million and approximately $1.0 million, respectively. Amortization expense for this agreement is estimated to be approximately $300,000 per year in fiscal 2005 and fiscal 2006.
Goodwill: O'Sullivan assesses goodwill annually 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. O'Sullivan discontinued amortizing goodwill in connection with the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, on July 1, 2001. Accumulated amortization at June 30, 2004 and 2003 approximated $29.8 million.
Fair Value of Financial Instruments: The fair value of financial instruments is determined by reference to various market data and other valuation techniques, as appropriate. Unless otherwise disclosed, the fair value of financial instruments approximates their recorded values due primarily to the short-term nature of their maturities.
Advertising Costs: Advertising costs are expensed as incurred. Advertising expense is included in selling, marketing and administrative expense and amounted to $7.2 million, $7.5 million and $7.0 million in fiscal 2004, 2003 and 2002, respectively. Customer promotional payments are classified as a reduction of revenue.
Income Taxes: Deferred taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when it can not be established that it is more likely than not that all of the deferred tax assets will be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Environmental Remediation and Compliance: Environmental remediation and compliance expenditures that relate to current operations are expensed or capitalized, as appropriate. Expenditures that relate to an existing condition caused by past operations and that do not contribute to current or future revenue generation are expensed.
Liabilities are recognized when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or O'Sullivan's commitment to a formal plan of action. To date, environmental expenditures have not been material, and management is not aware of any material environmental related contingencies.
Significant Fourth Quarter Adjustments: Note 4 describes the $2.0 million restructuring charge recorded by O'Sullivan in the fourth quarter of fiscal 2003. In the fourth quarter of fiscal 2004, O'Sullivan increased its inventory reserve by approximately $1.0 million to bring its recorded inventory balance more in line with current market conditions. In November 2003 a fire destroyed certain of O'Sullivan's manufacturing equipment. O'Sullivan recorded a $250,000 casualty loss during the second quarter of fiscal 2004 and recorded a $740,000 casualty gain during the fourth quarter of fiscal 2004 when the insurance recoveries were realized. All proceeds from the insurance company have been received.
Accounting for Stock-Based Compensation: O'Sullivan accounts for stock based compensation pursuant to the intrinsic value based method of accounting as prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. O'Sullivan has made pro forma disclosures of net income as if the fair value based method of accounting defined in SFAS 123, Accounting for Stock-Based Compensation, had been applied. See also Note 13.
No stock-based compensation cost is included in net income (loss), as all historical options granted had an exercise price equal to the market value of the stock on the date of the grant. The following tables present the effect on net income (loss) had compensation cost for the company's stock plans been determined consistent with SFAS 123.
For the year ended June 30, ---------------------------------- 2004 2003 2002 ---------- ---------- ---------- (in thousands) ---------- ---------- Net income (loss) as reported $ (27,433)$ 1,561$ (89,206) Less: total stock-based compensation expense determined under fair value method for all stock options, net of related income tax benefit (2) (7) (5) ---------- ---------- ----------
Pro forma net income (loss) $ (27,435)$ 1,554$ (89,211) ========== ========== ==========
The fair value of each option on the date of the grant is estimated using the Black-Scholes option-pricing model based upon the following weighted average assumptions:
2004 2003 2002 ---------------- --------------- -----------
--------------- ----------- Risk-free interest rate None granted None granted 4.35% Dividend yield None Volatility factor 0.1% Weighted average expected life (years) 5.0
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period.
Comprehensive Income: Other comprehensive income consists of foreign currency translation adjustments from O'Sullivan's operations in Canada, the United Kingdom, and Australia. The tax benefit (expense) related to other comprehensive income (loss) approximated $0, $0 and ($10,000) for the years ended June 30, 2004, 2003 and 2002, respectively.
New Accounting Standards: In May 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This pronouncement changes the accounting for certain financial instruments that, under previous guidance, could be accounted for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) on the balance sheet. SFAS 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities all of whose shares are mandatorily redeemable. O'Sullivan adopted
SFAS 150 on July 1, 2003 and reclassified its mandatorily redeemable senior preferred stock as a non-current liability, instead of as an item between the liabilities and equity sections of the balance sheet as historically presented. Prior period amounts have not been restated in accordance with this statement.
Also in accordance with SFAS 150, dividends on mandatorily redeemable financial instruments are now accounted for as interest expense on the consolidated statement of operations instead of as dividends and accretion on preferred stock. Interest expense for the senior preferred stock was approximately $4.3 million during fiscal 2004. Adoption of SFAS 150 did not affect O'Sullivan's cash payments or liquidity. See further discussion of the senior preferred stock in Note 10.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. FIN 46 applies to any business enterprise, public or private, that has a controlling interest, contractual relationship or other business relationship with a variable interest entity. In December 2003, the FASB issued Interpretation No. 46(R) ("FIN 46(R)") which superceded FIN 46. FIN 46(R) is effective for all Special Purpose Entities ("SPE's") created prior to February 1, 2003 at the end of the first interim or annual reporting period ending after December 15, 2003. FIN 46(R) will be applicable to all non-SPE's created prior to February 1, 2003 by public entities at the end of the first interim or annual reporting period ending after March 15, 2004. O'Sullivan has determined that it has no SPE's. O'Sullivan reviewed the applicability of FIN 46(R) to entities other than SPE's and has determined that the adoption of FIN 46(R) did not have a material effect on its consolidated financial statements.
Liquidity: O'Sullivan has a stockholders' deficit of approximately $165 million as of June 30, 2004, incurred a net loss of $27.4 million for the year ended June 30, 2004 and expects to incur a loss during the year ending June 30, 2005. O'Sullivan's net sales have declined each of the past four years. O'Sullivan's sales and operating results during 2004 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.
O'Sullivan has recently added several new key members to its executive management team. The new executive management team is in the process of evaluating O'Sullivan's strategies and core competencies to determine the most effective way to improve sales, reduce costs and increase operating income. 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 (discussed further in Note 9). 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 $10 million to $15 million, after the effect of outstanding letters of credit ($14.0 million at June 30, 2004), from October 2004 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 the availability of borrowings under the credit agreement.
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 June 30, 2004 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 forecasted revenues, O'Sullivan believes it has the ability to reduce or delay discretionary expenditures, including capital purchases, 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--Accounting for Tax Sharing Agreement with RadioShack.
In 1994, RadioShack, then Tandy Corporation, completed an initial public offering of O'Sullivan. In connection with the offering, O'Sullivan entered into a tax sharing and tax benefit reimbursement agreement with RadioShack. O'Sullivan Holdings and RadioShack made elections under Sections 338(g) and 338(h)(10) of the Internal Revenue Code with the effect that the tax basis of O'Sullivan's 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 O'Sullivan's assets exceeded the historical book basis O'Sullivan used for financial reporting purposes.
The increased tax basis of O'Sullivan's assets results in increased tax deductions and, accordingly, reduced its taxable income or increased its net operating loss. Under the tax sharing agreement, O'Sullivan 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 the stock of O'Sullivan Industries and further increase the tax basis of its assets from the 1994 initial public offering when payments are made to RadioShack. Accordingly, O'Sullivan 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. The deferred tax asset had a balance of $69.4 million and $72.1 million at June 30, 2004 and 2003, respectively.
Additionally, O'Sullivan recorded the remaining maximum obligation to RadioShack pursuant to the tax sharing agreement. The remaining maximum obligation to RadioShack was $70.1 million and $72.1 million at June 30, 2004 and 2003, respectively. Future payments to RadioShack are contingent upon achieving consolidated taxable income calculated on the basis of the tax sharing agreement.
Note 4 - Restructuring Charges.
In the fourth quarter of fiscal 2003, O'Sullivan determined to reduce its operations at its South Boston, Virginia facility to one shift. As a result, O'Sullivan reduced its workforce by about 200 people in Virginia. O'Sullivan also reduced its corporate staff in Lamar, Missouri by about 40 people, or about 15%. In connection with these reductions, O'Sullivan incurred severance costs of approximately $1.5 million, which it recorded as a restructuring charge in the fourth quarter of fiscal 2003. Substantially all of the severance had been paid by June 30, 2004.
In January 2001, O'Sullivan closed its Cedar City, Utah production facility. Fixed assets with a net book value of $20.3 million were written down to estimated fair value, less cost to sell, resulting in an impairment charge of approximately $8.7 million in the second quarter of fiscal 2001. An additional impairment charge of $540,000 was recognized in the quarter ended March 31, 2003. The additional charge resulted from subsequent changes in the carrying amount of the assets held for sale due to unfavorable market conditions.
In June 2003, O'Sullivan sold the land and building it owned in Cedar City, Utah. The net proceeds from the sale were used to reduce indebtedness under O'Sullivan's senior credit facility. The sale did not require a further significant adjustment to the carrying value of the land and building. No significant assets remain from the closing of the facility.
Note 5 - Derivative Financial Instruments.
As required under its previous senior credit facility (refinanced on September 29, 2003 - See Note 9), 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 expired in March 2003, was based on three-month LIBOR with a floor of 6.43% and a ceiling of 8.75%. O'Sullivan recorded additional (reduced) interest expense of $(2.1 million) and $(5,000) for fiscal 2003 and 2002, respectively. These amounts represent the changes in fair value of the interest rate collar.
Note 6 - Inventory.
Inventory consists of the following:
June 30, ------------------------ 2004 2003 ----------- ----------- (in thousands) ----------- Finished goods $ 36,645$ 37,744 Work in process 4,817 3,923 Raw materials 13,609 10,759 ----------- ----------- $ 55,071$ 52,426 =========== =========== Note 7 - Property, Plant and Equipment.
Property, plant and equipment consists of the following:
June 30, ------------------------ 2004 2003 ----------- ----------- (in thousands) ----------- Land $ 723$ 723 Buildings and improvements 34,689 34,660 Machinery and equipment 136,983 137,856 Construction in progress 310 220 ----------- ----------- 172,705 173,459 Less: accumulated depreciation (111,022) (101,592) ----------- ----------- $ 61,683$ 71,867 =========== ===========
Depreciation expense was $12.4 million, $13.3 million and $14.2 million for fiscal 2004, 2003 and 2002, respectively, of which $10.6 million, $11.4 million and $12.1 million, respectively, was included in cost of sales.
Note 8 - Accrued Liabilities.
Accrued liabilities consists of the following:
June 30, -------------------- 2004 2003 --------- --------- (in thousands) --------- Accrued employee compensation $ 6,515$ 6,302 Accrued interest 7,684 3,170 Accrued termination benefits - 1,509 Other current liabilities 1,038 1,062 --------- --------- $ 15,237$ 12,043 ========= =========
Note 9 - Long-Term Debt and Other Borrowing Arrangements.
Long-term debt consists of the following:
June 30, ------------------------ 2004 2003 ----------- ----------- (in thousands) ----------- Senior term loan, tranche A $ -$ 10,593 Senior term loan, tranche B - 77,673 Industrial revenue bonds 10,000 10,000 Senior secured notes 95,574 - Senior subordinated notes 92,246 95,743 O'Sullivan Holdings note 22,459 19,435 ----------- ----------- Total debt 220,279 213,444 Less current portion - (4,039) ----------- ----------- Total long-term debt $ 220,279$ 209,405 =========== ===========
Total debt, including the discount, net of accretion, of $4.4 million on the senior secured notes, $3.8 million on the senior subordinated notes and $2.5 million on the O'Sullivan Holdings note, matures as follows (in thousands):
Fiscal year Maturities 2005 $ - 2006 - 2007 - 2008 - 2009 110,000 Thereafter 120,984 ----------- $ 230,984 ===========
Senior Credit Facility. Until September 29, 2003, O'Sullivan Industries was the obligor under a senior credit facility totaling $175.0 million. O'Sullivan Industries entered into an agreement for the senior credit facility on November 30, 1999. The senior credit facility consisted of the following:
o Senior term loan, tranche A - $35.0 million term loan facility payable in 23 quarterly installments beginning March 31, 2000. The outstanding balance was $10.6 million at June 30, 2003.
o Senior term loan, tranche B - $100.0 million term loan facility payable in 26 quarterly installments beginning March 31, 2001. The balance of these loans $77.7 million at June 30, 2003.
o Revolving credit facility - $30.0 million ($40.0 million before an amendment effective June 30, 2003) revolving credit facility due November 30, 2005, which included a $15.0 million letter of credit subfacility and a $5.0 million swing line subfacility. At June 30, 2003, O'Sullivan had no borrowings outstanding on the revolving credit facility and approximately $13.5 million of letters of credit outstanding.
Interest rates on borrowings under the senior credit facility were either a LIBOR rate plus a margin or a base rate plus a margin. A fee equal to 0.5% per annum was paid on the unused commitment under the credit agreement. At June 30, 2003, the interest rate on loans under the senior credit facility was increased to a Eurodollar rate plus 4.75% or prime plus 3.75% for revolving credit and tranche A term loans and a Eurodollar rate plus 5.25% or a base rate plus 4.25% for tranche B term loans. On June 30, 2003, the interest rate for tranche A loans was 6.1%. The interest rate for tranche B loans was 6.6%. In addition, O'Sullivan paid additional interest of 2.0% on the outstanding balance of the tranche B loans on when the loans were repaid.
O'Sullivan Industries' obligations under the senior credit facility were secured by first priority liens and security interests in the stock of O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. and substantially all of the assets of O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. The senior credit facility and notes were subject to certain financial and operational covenants and other restrictions. The senior credit facility was amended three times after its November 30, 1999 execution date. The first two amendments modified the existing financial covenants and increased interest rates. The last amendment on June 30, 2003 lowered the revolver commitment, waived certain covenants and increased the interest rates. At June 30, 2003, O'Sullivan was in compliance with the amended debt covenants.
Refinancing. On September 29, 2003, O'Sullivan Industries issued $100.0 million of privately placed, 10.63% senior secured notes maturing on October 1, 2008. The notes were issued at a price of 95% providing $95.0 million in cash proceeds before approximately $3.8 million of expenses related to the issuance. The proceeds were used to repay the term loans under O'Sullivan's senior credit facility. The notes are secured by a first-priority security interest in and lien on substantially all of O'Sullivan's assets (and on O'Sullivan Industries' capital stock) other than accounts receivable, inventory, capital stock of O'Sullivan Industries' subsidiaries, deposit accounts, certain books and records and certain licenses, and by a second-priority security interest in and lien on substantially all of O'Sullivan's 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. Pursuant to a registration rights agreement, we filed a registration statement with the Securities and Exchange Commission with respect to an offer to exchange the notes for a new issue of identical notes registered
under the Securities Act of 1933, as amended, in December 2003. The registration statement became effective on January 8, 2004, and the exchange offer closed on February 25, 2004. Interest is payable on these notes semi- annually in January and July.
On September 29, 2003, O'Sullivan Industries, O'Sullivan - Virginia and O'Sullivan Furniture Factory Outlet, Inc. also entered into a new asset-based credit agreement which permits revolving borrowings of up to $40.0 million to the extent of availability under a collateral borrowing base. The credit agreement has a $25.0 million sub-limit for letters of credit, of which O'Sullivan was currently utilizing $14.0 million at June 30, 2004. The credit agreement is secured by a first-priority security interest in and lien on substantially all of O'Sullivan's 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 O'Sullivan's assets other than accounts receivable, inventory, capital stock of O'Sullivan Industries and its subsidiaries, deposit accounts, certain books and records and certain licenses. O'Sullivan guaranteed the obligations under the credit agreement. O'Sullivan was in compliance with the debt covenants contained in the credit agreement at June 30, 2004. The interest rate on loans under the credit agreement is a LIBOR rate plus 2.5% or an index rate plus 1.0%. A fee equal to 0.5% per annum is paid on 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. No loans were outstanding under the credit agreement as of June 30, 2004.
In connection with the execution and delivery of the credit agreement, O'Sullivan entered into a lockbox agreement with the agent under the agreement. Pursuant to the agreement, O'Sullivan 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.
In connection with the repayment of the term loans and the termination of the revolving credit facility under the senior credit facility, O'Sullivan expensed approximately $2.3 million of unamortized issuance costs related to the facility in the first quarter of fiscal 2004.
Industrial Revenue Bonds. O'Sullivan Industries - Virginia is obligor on $10.0 million of variable rate industrial revenue bonds ("IRB's") that mature on October 1, 2008. Interest on the IRB's is paid monthly. The loan is secured by a $10.2 million standby letter of credit under the credit agreement. At June 30, 2004 the interest rate on these bonds was about 1.25%. A letter of credit provides liquidity and credit support for the IRB's; the cost of the letter of credit was an additional 3.5% at June 30, 2004.
Senior Subordinated Notes. The senior subordinated notes issued by O'Sullivan Industries totaling $100.0 million bear interest at the rate of 13.375% per annum and are due in 2009. The notes were sold at 98.046% of their face value. Interest is payable semiannually on April 15 and October 15. In connection with these notes, O'Sullivan issued warrants to purchase 93,273 shares of O'Sullivan common stock at an exercise price of $0.01 per share and 39,273 shares of O'Sullivan Series B junior preferred stock at an exercise price of $0.01 per share. The warrants were immediately exercisable and were recorded at their fair value of $3.5 million. The notes were recorded net of discount, which consists of $2.0 million of original issue discount and $3.5 million of the original proceeds allocated to the estimated fair value of the warrants and which has been classified as paid-in capital in the consolidated balance sheets.
During fiscal 2004, O'Sullivan repurchased $4.0 million of these notes. O'Sullivan realized a gain from this transaction of $616,000 which is net of original issue discount and other capitalized loan fees that were expensed. This gain is presented in other financing costs, net, on the 2004 statement of operations.
O'Sullivan Holdings note. The $25.0 million note issued by O'Sullivan bears interest at the rate of 12.0% per annum, compounding semiannually, and principal and interest are due in 2009. In connection with this note, O'Sullivan issued warrants to purchase 93,273 shares of O'Sullivan common stock at an exercise price of $0.01 per share and 39,273 shares of O'Sullivan Series B junior preferred stock at an exercise price of $0.01 per share. The note was recorded net of discount of $3.5 million, which represents the estimated fair value of the warrants.
Accordingly, this amount has been recognized as additional paid-in capital in the consolidated balance sheets. At O'Sullivan's election, interest on this note may be added to the principal of the note rather than being paid currently.
The original issue discount and the warrants are amortized over the life of the notes using the effective interest rate method. Expenses related to the issuance of the debt financing as part of the 1999 recapitalization and merger were approximately $13.0 million and have been capitalized and recorded as other assets. Of this amount, $1.0 million was paid to Bruckmann, Rosser, Sherrill & Co., LLC ("BRS, LLC").
The credit agreement, senior secured notes, senior subordinated notes and the O'Sullivan Holdings note contain covenants that restrict O'Sullivan's ability, among others, to incur additional indebtedness; create certain liens and security interests; make certain investments; create certain or be liable with respect to certain contingent obligations; pay dividends and make certain distributions; modify the certificate of incorporation or by-laws of O'Sullivan Industries or its subsidiaries; issue common and preferred stock of subsidiaries; repurchase stock; enter into transactions with affiliates; enter into sale and leaseback transactions; merge or consolidate; enter into certain new types of business; and transfer and sell assets other than in the ordinary course of business. Other covenants require O'Sullivan to comply with applicable laws, including applicable environmental laws and permit requirements, and contractual obligations; maintain insurance; maintain its existence; maintain its properties; and provide certain financial and other information to the note holder, trustee or agent, as applicable. In connection with the hiring of a new management team for O'Sullivan in fiscal 2004 and the issuance of equity securities to them, O'Sullivan obtained an amendment to the credit agreement changing the minimum percentage of our equity required to be held by Bruckmann, Rosser, Sherrill & Co. II, L.P. ("BRS") and consenting to the amendment of O'Sullivan's certificate of incorporation to create a new series of preferred stock and to increase the amount of shares it is authorized to issue. O'Sullivan was in compliance with all debt covenants at June 30, 2004.
At June 30, 2004, the estimated fair value of the senior secured notes and the senior subordinated notes was approximately 85% and 48.5% of their principal amount, respectively. The estimated fair value of the O'Sullivan Holdings note and the industrial revenue bonds approximated their respective book values at June 30, 2004.
Note 10 - Mandatorily Redeemable Preferred Stock.
As part of the 1999 recapitalization and merger, O'Sullivan issued 16,431,050 shares of senior preferred stock, par value $0.01 per share, to the stockholders of O'Sullivan as partial consideration for their shares of common stock. The senior preferred stock has a liquidation preference of $1.50 per share. Dividends accrue at a rate of 12% per annum, compounding semiannually if unpaid. The liquidation value plus accumulated dividends on June 30, 2004 and 2003 was $42.1 million and $37.4 million, respectively. O'Sullivan may, at its option, redeem the stock at any time. O'Sullivan is required to redeem the outstanding shares of stock if an unaffiliated third party acquires more than 50% of O'Sullivan's outstanding common stock. O'Sullivan is required to redeem the stock if outstanding on November 30, 2011 at a price equal to the initial liquidation value plus unpaid dividends accruing on a daily basis at the rate of 12% per year. The mandatorily redeemable senior preferred stock is recorded at its present value of $26.3 million and $21.9 million, including accrued interest and accretion, at June 30, 2004 and 2003, respectively.
The carrying amount of the senior preferred stock is being accreted over time for accumulated dividends and liquidation value.
Note 11 - Common and Junior Preferred Stock.
O'Sullivan's securities included in the equity section of its balance sheet consist of three series of junior preferred stock and two classes of common stock as described below and in Note 13.
As part of the 1999 recapitalization and merger, O'Sullivan issued 515,681.33 shares of Series B junior preferred stock, par value $0.01 per share, to BRS and the management participants in the recapitalization and merger. Consideration paid for these consisted of cash and shares of O'Sullivan common stock. In fiscal 2001, 13,328 shares of Series B junior preferred stock were issued pursuant to the exercise of warrants, increasing junior preferred stock by $1.3 million and decreasing additional paid-in capital by the same amount. Dividends accrue at a rate of 14% per annum, compounding semiannually if unpaid. The liquidation value plus accumulated dividends on June 30, 2004 and 2003 was $98.1 million and $85.7 million, respectively, which is the carrying amount for the
stock on the accompanying balance sheets. The junior preferred stock may be redeemed by O'Sullivan at any time, but there is no mandatory redemption date for the Series B junior preferred stock.
In connection with the hiring of new management, O'Sullivan amended its certificate of incorporation in May 2004 to authorize the issuance of 50,000 shares of a new Series C junior preferred stock and 1.0 million shares of a new Class B non-voting common stock. O'Sullivan entered into executive stock agreements with new executives in the fourth quarter of fiscal 2004 and the first quarter of fiscal 2005. An aggregate of 50,000 shares of Series C junior preferred stock, 384,085 shares of Series B junior preferred stock and 701,422 shares of Class B common stock were issued to the executives in the first quarter of fiscal 2005.
The Series C junior preferred stock has a liquidation value of $100.00 per share; no dividends accrue on this series of stock. The Series C junior preferred stock may be redeemed by O'Sullivan at any time, but there is no mandatory redemption date for the Series C junior preferred stock.
The Class B common stock is identical in rights to O'Sullivan's previously outstanding common stock, now designated as Class A common stock, except that the Class B common stock has no voting rights, except as otherwise required by applicable law.
Note 12 - Income Taxes.
The income tax provision consists of the following:
For the year ended June 30, ---------------------------------- 2004 2003 2002 ---------- ---------- ---------- Current: (in thousands) ---------- ---------- Federal $ - $ - $ 45 State - - 320 ---------- ---------- ---------- - - 365 Deferred - - 100,562 ---------- ---------- ---------- $ - $ - $ 100,927 ========== ========== ==========
The following table reconciles O'Sullivan's federal corporate statutory rate and its effective income tax rate:
For the year ended June 30, -------------------------------------- 2004 2003 2002 ----------- ---------- ----------- Statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit - - 1.6 Valuation allowance (35.0) (35.0) 823.3 Other, net - - 1.2 ----------- ---------- ----------- Effective tax rate 0.0% 0.0% 861.1% =========== ========== ===========
Deferred tax assets and liabilities consist of the following:
June 30, --------------------------- 2004 2003 ----------- ----------- (in thousands) ----------- Deferred tax assets: Allowance for doubtful accounts $ 793 $ 1,102 Insurance liabilities 410 370 Accrued compensation 4,489 3,498 Inventories 1,170 1,561 Other 189 400 Section 338 deductions for future periods and unpaid liability to RadioShack 69,392 72,067 Net operating loss carryforwards 48,506 30,604 ----------- ----------- Subtotal 124,949 109,602 Valuation allowance (113,576) (97,554) ----------- ----------- Total deferred tax assets 11,373 12,048 ----------- -----------
Deferred tax liabilities: Depreciation and amortization (11,373) (12,048) ----------- ----------- Net deferred tax asset $ - $ - =========== ===========
During the year ended June 30, 2002, O'Sullivan recorded a full valuation allowance of $97.4 million against its net deferred tax assets because it was unable to determine, based on objective evidence, that it was more likely than not that O'Sullivan would be able to utilize its net operating losses prior to their expiration. If at a future date O'Sullivan determines that some or all of the deferred tax asset will more likely than not be realized, O'Sullivan will reverse the appropriate portion of the valuation allowance and credit income tax expense.
Because of the current tax benefits associated with the Section 338 election and because of the valuation allowance recorded in the fiscal year ended June 30, 2002, O'Sullivan recorded no tax expense in the two years ended June 30, 2004. See Note 3 for a discussion of O'Sullivan's accounting with respect to the tax sharing agreement between RadioShack Corporation and O'Sullivan.
Note 13 - Stock Options.
In January 2000, O'Sullivan adopted its 2000 Common Stock Option Plan. Pursuant to this plan, O'Sullivan may issue up to 81,818 shares of O'Sullivan Class A common stock to employees of O'Sullivan. The exercise price for shares issued under the plan is equal to the fair market value on the date of grant. Options issued pursuant to the plan will vest in five annual installments if certain performance targets are met; otherwise, the options will vest in seven years from their date of grant or one day prior to their expiration. On June 19, 2000, the compensation committee granted options to purchase 75,800 shares of common stock at an exercise price of $1.90 per share, which was the estimated fair value of the underlying common stock at the date of grant. The expiration date of these options is November 30, 2009. Twenty percent of these options were exercisable at June 30, 2004.
In November 2001, O'Sullivan adopted its 2001 Director Common Stock Option Plan. Pursuant to this plan, O'Sullivan may issue up to 15,000 shares of O'Sullivan Class A common stock to O'Sullivan directors who are not employees of, or consultants to, O'Sullivan or BRS or any affiliate of BRS. The exercise price for shares issued under the plan is equal to the fair market value on the date of grant. Options issued pursuant to the plan will vest in three equal annual installments. On November 15, 2001, the Board granted options to purchase 6,000 shares of common stock at an exercise price of $1.90 per share, which was the estimated fair value of the underlying common stock at the date of grant. The options were cancelled in June 2004 with the resignation of the option holder.
Summary of Class A Common Stock Option Transactions (share amounts in thousands) June 30, 2004 June 30, 2003 June 30, 2002 ------------------------ ------------------------ ------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Price Shares Price Shares Price ------------ ----------- ---------- ------------- --------- ------------- Outstanding at beginning of year 81 $ 1.90 82 $ 1.90 76 $ 1.90 Grants - - 6 1.90 Exercised - - - Cancelled (15) 1.90 (1) 1.90 - ---------- ---------- --------- Outstanding at end of year 66 1.90 81 1.90 82 1.90 ========== ========== ========= Exercisable at end of year 13 1.90 17 1.90 15 1.90 ========== ========== ========= Weighted average fair value of N/A N/A $ 0.37 options granted during the year =============
In the 1999 recapitalization and merger, O'Sullivan issued options to purchase 60,318.67 shares of its Series A junior preferred stock, par value $0.01 per share, in exchange for certain options held by management participants in the buyout. All of these options are currently vested and exercisable and expire on December 31, 2025. The agreements for the options to purchase O'Sullivan's Series A junior preferred stock provide for a special accrual at the rate of 14% per annum on the difference between the liquidation value of the stock ($150.00 per share) and the exercise price of the option ($50.00 per share). The special accrual accrues at the same time and in the same manner as would dividends on issued and outstanding shares of O'Sullivan's Series A junior preferred stock. No amount is payable until the exercise of the option, and payment is further subject to the terms of any debt agreement of O'Sullivan. When made, payment of the special accrual may be made in cash or by a reduction in the exercise price for the option. The special accrual approximated $1.4 million, $1.2 million and $1.1 million for fiscal 2004, 2003 and 2002, respectively, and is included in selling, marketing and administrative expense in the consolidated statements of operations.
O'Sullivan accounts for stock-based compensation for employees under Accounting Principles Board No. 25 and has adopted the disclosure-only provisions of SFAS 123. Accordingly, no stock-based compensation cost has been recognized for options except as mentioned above. See Note 2 for the pro forma disclosures had compensation cost for stock option plans been determined in accordance with the provisions of SFAS 123.
Note 14 - Employee Benefit Plans.
Prior to December 31, 2002, O'Sullivan maintained a stock purchase program that was available to most employees. The stock purchase program (the "SPP"), as amended, allowed a maximum employee contribution of 5%, while O'Sullivan's matching contribution was 25%, 40% or 50% of the employee's contribution, depending on the length of the employee's participation in the program. The program invested contributions in a broad-based mutual fund. The matching contributions to the stock purchase program were $307,000 and $640,000 in fiscal years 2003 and 2002, respectively. O'Sullivan terminated the SPP effective December 31, 2002.
O'Sullivan also has a Savings and Profit Sharing Plan in which most employees are eligible to participate. Under the savings orss. 401(k) portion of the plan, employees may contribute from 1% to 100% of their compensation (subject to certain limitations imposed by the Internal Revenue Code). Prior to January 1, 2003, O'Sullivan made matching contributions equal to 50% of the first 5% of eligible employee contributions. The matching contribution increased to 100% of the first 5% of eligible employee contributions effective January 1, 2003. Under the profit sharing portion of the plan, O'Sullivan may contribute annually an amount determined by the Board of Directors. Employer matching contributions vest immediately, while profit sharing contributions vest 100% when the employee has five years of service with O'Sullivan. For fiscal 2004, 2003 and 2002, O'Sullivan accrued approximately $0, $0 and $2.2 million respectively, for the profit sharing portion of the plan. The matching contributions to the savings portion of the plan were $1.4 million, $858,000 and $458,000 in fiscal years 2004, 2003 and 2002, respectively.
Effective July 1, 1997, O'Sullivan implemented its Deferred Compensation Plan. This plan is available to employees of O'Sullivan deemed to be "highly compensated employees" pursuant to the Internal Revenue Code. O'Sullivan makes certain matching and profit sharing accruals to the accounts of participants. All amounts deferred or accrued under the terms of the plan represent unsecured obligations of O'Sullivan to the participants. Matching and profit sharing accruals under this plan were not material in fiscal 2004, 2003 or 2002.
Note 15 - Condensed Consolidating Financial Information.
In September 2003 O'Sullivan Industries issued $100.0 million of 10.63% senior secured notes due 2008. These notes are secured by substantially all the assets of O'Sullivan Industries and its guarantor subsidiaries O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. The senior secured notes are also guaranteed by O'Sullivan Holdings. The guarantees are full and unconditional. Security for the senior secured notes includes first priority liens and security interests in the stock of O'Sullivan Industries. In the third quarter of fiscal 2004, O'Sullivan exchanged the senior secured notes issued in September 2003 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
Fiscal year ended June 30, 2004 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net sales $ - $ 218,604$ 50,225$ -$ 268,829 Cost of sales - 168,861 45,128 - 213,989 ----------- ----------- ------------ -------------- --------------
Gross profit - 49,743 5,097 - 54,840 Operating expenses: Selling, marketing and administrative 199 40,825 5,114 - 46,138 Casualty gain - (490) - - (490) ----------- ----------- ------------ -------------- --------------
Operating income (loss) (199) 9,408 (17) - 9,192 Other income (expense): Interest expense (7,456) (25,744) (811) - (34,011) Interest income 23 41 - - 64 Other financing costs, net - (2,678) - - (2,678) Equity in loss of subsidiary (19,801) (828) - 20,629 - ----------- ----------- ------------ -------------- --------------
Income (loss) before income tax provision (27,433) (19,801) (828) 20,629 (27,433) Income tax provision - - - - - ----------- ----------- ------------ -------------- --------------
Net loss (27,433) (19,801) (828) 20,629 (27,433) Dividends and accretion on preferred stock (12,415) - - - (12,415) ----------- ----------- ------------ -------------- -------------- Net loss attributable to common $ (39,848)$ (19,801$ (828$ 20,629$ (39,848) stockholders =========== =========== ============ ============== ==============
Fiscal year ended June 30, 2003 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net sales $ - $ 204,181$ 84,971$ -$ 289,152 Cost of sales - 148,754 66,223 - 214,977 ----------- ----------- ------------ -------------- --------------
Gross profit - 55,427 18,748 - 74,175 Operating expenses: Selling, marketing and administrative 371 37,279 8,184 - 45,834 Restructuring charge - 1,863 186 - 2,049 ----------- ----------- ------------ -------------- --------------
Op Operating income (loss) (371) 16,285 10,378 - 26,292 Other income (expense): Interest expense (2,779) (21,277) (496) - (24,552) Interest income 23 243 - - 266 Other financing costs, net - (445) - - (445) Equity in earnings of subsidiary 4,688 9,882 - (14,570) - ----------- ----------- ------------ -------------- --------------
Income before income tax provision 1,561 4,688 9,882 (14,570) 1,561 Income tax provision - - - - - ----------- ----------- ------------ -------------- --------------
Net income 1,561 4,688 9,882 (14,570) 1,561 Dividends and accretion on preferred stock (14,457) - - - (14,457) ----------- ----------- ------------ -------------- -------------- Net income (loss) attributable to $ (12,896)$ 4,688$ 9,882$ (14,570$ (12,896) common stockholders =========== =========== ============ ============== ==============
Fiscal year ended June 30, 2002 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net sales $ - $ 243,563$ 105,535$ -$ 349,098 Cost of sales - 173,960 80,702 - 254,662 ----------- ----------- ------------ -------------- --------------
Gross profit - 69,603 24,833 - 94,436 Operating expenses: Selling, marketing and administrative 254 43,397 10,933 - 54,584 ----------- ----------- ------------ -------------- --------------
Op Operating income (254) 26,206 13,900 - 39,852 Other income (expense): Interest expense (2,470) (25,267) (585) - (28,322) Interest income 25 370 - - 395 Other financing costs, net - (204) - - (204) Equity in earnings of subsidiary (84,293) (11,293) - 95,586 - ----------- ----------- ------------ -------------- --------------
Income before income tax provision (86,992) (10,188) 13,315 95,586 11,721 Income tax provision 2,214 74,105 24,608 - 100,927 ----------- ----------- ------------ -------------- --------------
Net loss (89,206) (84,293) (11,293) 95,586 (89,206) Dividends and accretion on preferred stock (12,490) - - - (12,490) ----------- ----------- ------------ -------------- -------------- Net loss attributable to $ (101,696)$ (84,293$ (11,293$ 95,586$ (101,696) common stockholders =========== =========== ============ ============== ==============
Condensed Consolidating Balance Sheets
June 30, 2004 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings 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 206 8,186 70 - 8,462 Investment in subsidiaries (112,059) 34,364 - 77,695 - Goodwill - 38,088 - - 38,088 Receivable from subsidiary - tax sharing agreement 70,067 - - (70,067) - Receivable from affiliates 2,254 - 41,279 (43,533) - ----------- ----------- ------------ -------------- -------------- Total assets $ (39,532)$ 192,902$ 76,897$ (35,905$ 194,362 =========== =========== ============ ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): Current liabilities $ 3,718 $ 17,889$ 18,567$ (3,658$ 36,516 Long-term debt 22,459 187,820 10,000 - 220,279 Mandatorily redeemable senior preferred stock 26,258 - - - 26,258 Payable to affiliates - 43,533 - (43,533) - Other liabilities 6,176 3,276 - - 9,452 Payable to RadioShack 66,409 - - - 66,409 Payable to parent - tax sharing agreement - 52,443 13,966 (66,409) - Stockholders' equity (deficit) (164,552) (112,059) 34,364 77,695 (164,552) ----------- ----------- ------------ -------------- -------------- Total liabilities and $ (39,532)$ 192,902$ 76,897$ (35,905$ 194,362 stockholders' equity (deficit) =========== =========== ============ ============== ==============
June 30, 2003 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- ASSETS: Current assets $ - $ 74,930$ 13,277$ -$ 88,207 Property, plant and equipment, net - 40,356 31,511 - 71,867 Other assets 244 8,896 86 - 9,226 Investment in subsidiaries (93,523) 33,725 - 59,798 - Goodwill - 38,088 - - 38,088 Receivable from subsidiary - tax sharing agreement 72,067 - - (72,067) - Receivable from affiliates 1,190 - 33,425 (34,615) - ----------- ----------- ------------ -------------- -------------- Total assets $ (20,022)$ 195,995$ 78,299$ (46,884$ 207,388 =========== =========== ============ ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): Current liabilities $ 7,378 $ 20,951$ 20,848$ (6,798$ 42,379 Long-term debt 19,435 179,970 10,000 - 209,405 Payable to affiliates - 34,615 - (34,615) - Other liabilities 4,323 2,439 - - 6,762 Payable to RadioShack 65,269 - - - 65,269 Payable to parent - tax sharing agreement - 51,543 13,726 (65,269) - Mandatorily redeemable senior preferred stock 21,933 - - - 21,933 Stockholders' equity (deficit) (138,360) (93,523) 33,725 59,798 (138,360) ----------- ----------- ------------ -------------- -------------- Total liabilities and $ (20,022)$ 195,995$ 78,299$ (46,884$ 207,388 stockholders' equity (deficit) =========== =========== ============ ============== ==============
Condensed Consolidating Statements of Cash Flows
Fiscal year ended June 30, 2004 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net cash flows provided by operating activities: $ 1,064 (7,937) 7,902$ -$ 1,029 ----------- ----------- ------------ -------------- -------------- Investing activities: Capital expenditures - (2,260) (199) - (2,459) Repayment of loans to affiliates (1,064) - - 1,064 - ----------- ----------- ------------ -------------- -------------- Net (1,064) (2,260) (199) 1,064 (2,459) ----------- ----------- ------------ -------------- -------------- Financing activities: Advances (repayment) of loans from affiliates - 8,639 (7,575) (1,064) - Proceeds from borrowings - 99,000 - - 99,000 Repayment of borrowings - (96,265) - - (96,265) Debt issuance costs - (4,032) - - (4,032) ----------- ----------- ------------ -------------- -------------- Net - 7,342 (7,575) (1,064) (1,297) ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents: Net increase (decrease) in cash and cash equivalents - (2,855) 128 - (2,727) Cash and cash equivalents, beginning of period - 7,878 99 - 7,977 ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents, end of $ - $ 5,023$ 227$ -$ 5,250 period =========== =========== ============ ============== ==============
Fiscal year ended June 30, 2003 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net cash flows provided by operating activities: $ 991 $ (1,654$ 15,403$ -$ 14,740 ----------- ----------- ------------ -------------- -------------- Investing activities: Capital expenditures - (3,310) (1,771) - (5,081) Proceeds from sale of manufacturing ,788 ,788 facility - 6 - 6 Repayment of loans to affiliates (1,009) 13,662 - (12,653) - ----------- ----------- ------------ -------------- -------------- Net (1,009) 17,140 (1,771) (12,653) 1,707 ----------- ----------- ------------ -------------- -------------- Financing activities: Advances (repayment) of loans from affiliates - 1,009 (13,662) 12,653 - Employee loans 18 - - - 18 Repayment of borrowings - (24,265) - - (24,265) ----------- ----------- ------------ -------------- -------------- Net 18 (23,256) (13,662) 12,653 (24,247) ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents: Net decrease in cash and cash equivalents - (7,770) (30) - (7,800) Cash and cash equivalents, beginning of period - 15,648 129 - 15,777 ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents, end of $ - $ 7,878$ 99$ $ 7,977 period - =========== =========== ============ ============== ==============
Fiscal year ended June 30, 2002 (in thousands) ----------------------------------------------------------------------- 'Sullivan O'Sullivan Guarantor onsolidating OHoldings Industries Subsidiaries CAdjustments Consolidated ----------- ----------- ------------ -------------- -------------- Net cash flows provided by operating activities: $ 782 $ 7,022$ 18,093$ -$ 25,897 ----------- ----------- ------------ -------------- -------------- Investing activities: Capital expenditures - (6,170) (2,474) - (8,664) (Advances) repayment of loans to affiliates (790) 15,494 - (14,704) - ----------- ----------- ------------ -------------- -------------- Net (790) 9,324 (2,474) (14,704) (8,664) ----------- ----------- ------------ -------------- -------------- Financing activities: Advances (repayment) of loans from affiliates - 790 (15,494) 14,704 - Employee loans 8 - - - 8 Repayment of borrowings - (8,544) - - (8,544) ----------- ----------- ------------ -------------- -------------- Net 8 (7,754) (15,494) 14,704 (8,536) ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents: Net decrease in cash and cash equivalents - 8,592 125 - 8,717 Cash and cash equivalents, beginning of period - 7,056 4 - 7,060 ----------- ----------- ------------ -------------- -------------- Cash and cash equivalents, end of $ - $ 15,648$ 129$ $ 15,777 period - =========== =========== ============ ============== ==============
Note 16 - Termination Protection Agreements.
O'Sullivan has entered into Termination Protection Agreements with certain of its officers. These Termination Protection Agreements, all of which are substantially similar, have initial terms of two years which
automatically extend to successive one-year periods unless terminated by either party. If the employment of any of these officers is terminated, with certain exceptions, within 24 months following a change in control, the officers are entitled to receive certain cash payments, as well as the continuation of fringe benefits for a period of up to twelve months. Additionally, all benefits under the Savings and Profit Sharing Plan and the Deferred Compensation Plan vest, all restrictions on any outstanding incentive awards or shares of restricted common stock will lapse and such awards or shares will become fully vested, all outstanding stock options will become fully vested and immediately exercisable, and O'Sullivan will be required to purchase for cash, on demand made within 60 days following a change in control, any shares of unrestricted common stock and options for shares at the then current per-share fair market value. The agreements also provide one year of outplacement services for the officer and that, if the officer moves more than 20 miles from his primary residence in order to accept permanent employment within 36 months after leaving O'Sullivan, O'Sullivan will, upon request, repurchase the officer's primary residence at a price determined in accordance with the agreement.
Under the Termination Protection Agreements, a "Change in Control" will be deemed to have occurred if either (i) any person or group acquires beneficial ownership of 15% of the voting securities of O'Sullivan; (ii) there is a change in the composition of a majority of the board of directors within any two-year period which is not approved by certain of the directors who were directors at the beginning of the two-year period; (iii) the stockholders of O'Sullivan approve a merger, consolidation or reorganization involving O'Sullivan; (iv) there is a complete liquidation or reorganization involving O'Sullivan; or (v) O'Sullivan enters into an agreement for the sale or other disposition of all or substantially all of the assets of O'Sullivan.
Note 17 - Related Party Transactions.
BRS. O'Sullivan Industries entered into a management services agreement with BRS, LLC 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, LLC 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 Industries' 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. The credit agreement prevents O'Sullivan Industries 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 fee and other reimbursable costs of $300,000, $442,000 and $501,000 recognized during fiscal years 2004, 2003 and 2002, respectively, are included in selling, marketing and administrative expense in the consolidated statement of operations. O'Sullivan paid BRS, LLC $713,000 in the first quarter of fiscal 2003 for the balance owed through June 30, 2002 and $305,000 as a prepayment of the fiscal 2003 management fee. In January 2003, O'Sullivan made an additional prepayment of $285,000 for the fiscal 2003 management fee. At June 30, 2003, the prepaid balance of $147,000 is included in prepaid expenses on the consolidated balance sheets. At June 30, 2004, the amount due BRS of $153,000 is included in accrued liabilities.
Employee Loans. At June 30, 2004, O'Sullivan held two notes receivable with a balance of approximately $367,000 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 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 is with full recourse to the employees. The receivables are recorded on the O'Sullivan balance sheet as a reduction in stockholders' equity. In August 2004, one of the loans, aggregating $30,289 of principal and accrued interest, was paid to O'Sullivan.
Note 18 - Commitments and Contingencies.
Leases. O'Sullivan leases warehouse space, computers and certain other equipment under operating leases. As of June 30, 2004, minimum future lease payments for all noncancellable lease agreements were as follows (in thousands):
2005 $ 1,603 2006 1,126 2007 417 2008 239 2009 171 Thereafter 76 -------- Total $ 3,632 ========
Rent expense incurred by O'Sullivan under operating leases (including renewable monthly leases) were $1.8 million, $1.8 million and $1.9 million in fiscal 2004, 2003 and 2002, respectively.
Tax Sharing Agreement with RadioShack. During fiscal 2004, 2003 and 2002, O'Sullivan paid $2.0 million, $9.3 million and $27.7 million, respectively, to RadioShack pursuant to the tax sharing agreement. 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. The amount O'Sullivan estimates it will pay during fiscal 2005 has been recorded in current liabilities. See footnote 3 for additional information regarding the tax sharing agreement.
Litigation. In September 2002, Montgomery Ward, LLC filed suit against O'Sullivan Industries in the U.S. 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 Industries by Montgomery Ward, together with interest. The alleged payments aggregated $3.7 million. We settled this suit in May 2004. The resolution of the litigation did not materially affect our results of operations.
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. O'Sullivan believes it did not receive any preferential payments and is contesting this lawsuit vigorously. However, until the claim can be investigated further, O'Sullivan is unable to predict the outcome of this litigation.
In November 2001 House2Home filed for bankruptcy and eventually closed all of its stores. In fiscal 2004 we received notice of a suit against O'Sullivan Industries in the U.S. Bankruptcy Court, Central District of California alleging that payments made by House2Home within 90 days prior to its bankruptcy constituted preferential transfers under the Bankruptcy Code that should be recovered from O'Sullivan Industries by House2Home together with interest. The alleged payments aggregate $700,000. We have denied we received any preferential payments. We are contesting this lawsuit vigorously. However, until the claim can be investigated further, O'Sullivan is unable to predict the outcome of this litigation.
O'Sullivan Industries is a party to various legal actions arising in the ordinary course of its business. O'Sullivan does not believe that any such pending actions will have a material adverse effect on its results of operations, liquidity or financial position. O'Sullivan maintains liability insurance at levels which it believes are adequate for its needs.
Regulatory Matters. O'Sullivan's operations are subject to extensive federal, state and local laws, regulations and ordinances relating to the generation, storage, handling, emission, transportation and discharge of certain materials, substances and waste into the environment. Permits are required for certain of O'Sullivan's operations and are subject to revocation, modification and renewal by governmental authorities. In general, compliance with air emission regulations is not expected to have a material adverse effect on O'Sullivan's business, results of operations or financial condition.
O'Sullivan's manufacturing facilities ship waste product to various disposal sites. O'Sullivan Industries has been designated as a potentially responsible party under the Arkansas Remedial Action Trust Fund Act in connection with the cost of cleaning up one site in Diaz, Arkansas and has entered into a de minimis buyout agreement with certain other potentially responsible parties, pursuant to which it has contributed $2,000 to date toward cleanup costs. O'Sullivan believes that amounts it may be required to pay in the future, if any, will be immaterial.
Retirement Agreements. In October 1998, O'Sullivan entered into a Retirement and Consulting Agreement, Release and Waiver of Claims with Daniel F. O'Sullivan. Under the retirement agreement, as amended in May 1999, Mr. O'Sullivan resigned as Chief Executive Officer in October 1998 and retired as an executive on March 31, 2000. O'Sullivan agreed to pay Mr. O'Sullivan $42,160 per month for 36 months after his retirement and then to pay him $11,458 per month until he reaches age 65. The final $42,160 payment was made in March 2003. Payments under Mr. O'Sullivan's retirement and consulting agreement amount to an aggregate of $2.2 million and a present value of approximately $1.9 million. During this period, Mr. O'Sullivan is required to provide consulting, marketing and promotional services with respect to O'Sullivan's manufacturing activities and relations with major customers, if requested by O'Sullivan, from time to time. Mr. O'Sullivan has agreed not to compete with O'Sullivan during the period he is a consultant. O'Sullivan will also provide Mr. O'Sullivan with health insurance during the term of the agreement and thereafter until he becomes eligible for Medicare and life insurance during the term of the agreement. In July 2004, the agreement was amended to add O'Sullivan Industries as a party with the right to enforce Mr. O'Sullivan's covenants directly and the joint obligation to make payments to Mr. O'Sullivan.
Tyrone E. Riegel, O'Sullivan's former Executive Vice President, entered into an early retirement agreement with O'Sullivan. Pursuant to the agreement, he retired effective November 15, 2003. O'Sullivan paid him $335,337 in a lump sum on January 2, 2004, and agreed to pay him $5,000 per month for thirty months, beginning May 15, 2005. In addition, O'Sullivan will pay health insurance for Mr. Riegel and his family through November 15, 2007. Mr. Riegel has agreed to act as our consultant through November 15, 2007 and has agreed not to compete with O'Sullivan through that period. In addition, O'Sullivan's Compensation Committee has approved an amendment to Mr. Riegel's common stock option agreement that permits him to retain his options after he is no longer an O'Sullivan employee. His options will continue to vest as though he were still an O'Sullivan employee.
Note 19 - Major Customers.
Sales to four customers exceeded 10% of gross sales in fiscal 2004. Sales to such customers as a percentage of gross sales were:
Year ended June 30, --------------------------------- 2004 2003 2002 ----------- ---------- ---------- Customer A 19% 19% 19% Customer B 16% 12% 12% Customer C 13% 13% 14% Customer D 10% 8% 5%
Note 20 - Segment Information.
O'Sullivan operates in one industry segment: the design, manufacture and sale of ready-to-assemble furniture.
O'Sullivan sells its products throughout the United States and in Canada, Mexico, the United Kingdom, Australia and other countries. Export sales were $24.1 million, $19.8 million and $19.1 million in fiscal 2004, 2003 and 2002, respectively. Long-lived assets located outside the United States are immaterial.
Note 21 - Quarterly Operating Results - Unaudited
(in thousands) ------------------------------------------------------------------------ Fiscal 2004 (By Quarter) ------------------------------------------------------------------------ 1 2 3 4 ------------------------------------------------------------------------
Net sales $ 71,464 $ 65,234 $ 73,239 $ 58,892 Gross profit 14,308 14,589 15,442 10,501 Net income (loss) (7,2991 (5,4001 (5,3391 (9,3951
(in thousands) ------------------------------------------------------------------------ Fiscal 2003 (By Quarter) ------------------------------------------------------------------------ 1 2 3 4 ------------------------------------------------------------------------
Net sales $ 71,557 $ 79,111 $ 86,866 $ 51,618 Gross profit 19,973 19,727 21,246 13,229 Net income (loss) 1,539 1 1,966 1 2,684 1, 2 (4,6281, 2
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1Net income (loss) reflects the absence of tax expense because of the valuation allowance taken against O'Sullivan's net deferred tax asset in the third quarter of fiscal 2002.
2The third and fourth quarters of fiscal 2003 include $540,000 and $1.5 million, respectively, of restructuring charges as described in Note 4.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A. 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.
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.
Item 9B.
Item 9B. Other Information.
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The following sets forth certain information with respect to the business experience of each Director of O'Sullivan during the past five years and certain other directorships held by each Director. References to service with O'Sullivan in this section include service with O'Sullivan Industries.
Class I Directors--Term Expiring 2006.
Charles Macaluso, 60, was appointed a director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia on July 27, 2004. Mr. Macaluso has been a principal of Dorchester Capital Advisors LLP, a management consulting and corporate advisory firm, since 1998. He serves as a director of Darling International Inc., a recycler of food processing by-products, Global Crossing Limited, a provider of telecommunications services, Lazy Days Recreational Vehicles, Inc., a retailer of recreational vehicles, and Crescent Public Telephone, Inc., an owner and operator of pay telephones.
Richard D. Davidson, 56, served as President and Chief Executive Officer and a Director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia from January 2000 to May 2004. He served as President and Chief Operating Officer and a Director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia in 1996. He has also served as President and Chief Executive Officer and a director of O'Sullivan Furniture Factory Outlet, Inc. since March 2002. Mr. Davidson continues to serve as a director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia. Mr. Davidson is the owner of Marco Group, Inc., a private trading and manufacturing concern.
Class II Director--Term Expiring 2004.
Robert S. Parker, 58, was appointed President and Chief Executive Officer and a Director of O'Sullivan Holdings, O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. on May 14, 2004. Mr. Parker served as Chief Operating Officer of the Sharpie/Calphalon Group of Newell Rubbermaid Inc. since September 2003. Newell Rubbermaid is a global manufacturer and full-service marketer of name-brand consumer products. From August 1998 through August 2003, he was Group President of Newell Rubbermaid's Sharpie business segment. From October 1990 to August 1998, Mr. Parker was President of Sanford Corporation, both before and after its acquisition by Newell.
Harold O. Rosser, 55, was appointed a director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia in connection with the November 1999 recapitalization and merger. Mr. Rosser has been a principal of BRS, LLC since August 1995. Mr. Rosser was an officer of Citicorp Venture Capital from 1987 through July 1995. He is a director of Real Mex Restaurants, Inc., H&E Equipment Services, LLC, Il Fornaio (America) Corporation, McCormick and Schmick Restaurant Corporation, Penhall International, Inc. and RACI Holdings Inc./Remington Arms Co., Inc.
Class III Directors--Term Expiring 2005.
Daniel F. O'Sullivan, 63, was named President, Chief Executive Officer and a Director of O'Sullivan Holdings in November 1993 and became Chairman of the Board in December 1993. He relinquished the position of President of O'Sullivan Holdings in July 1996 and resigned as Chief Executive Officer in October 1998. He served as President of O'Sullivan Industries from 1986 until July 1996, and was appointed Chairman of the Board and Chief Executive Officer in 1994. He also served as Chairman of the Board and Chief Executive Officer of O'Sullivan Industries - Virginia. Mr. O'Sullivan was employed by O'Sullivan from 1962 until his retirement. Mr. O'Sullivan retired as an executive of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia effective March 31, 2000. He remains as non-executive Chairman of the Board for each company.
Richard R. Leonard, 35, was named as a Director of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia in July 2004. Mr. Leonard has served as a Vice President of Bruckmann, Rosser, Sherrill & Co., LLC since 2001. From 1999 to 2001, he was a Vice President in private equity at Audax Management Company. Mr. Leonard also worked in private equity with J.W. Childs Associates from 1997 to 1999. Mr. Leonard
is a director of Eurofresh, Inc., a producer of hydroponically grown, pesticide free tomatoes, and Anvil Holdings, Inc., a manufacturer of activewear.
Executive Officers.
O'Sullivan's executive officers, and their ages and positions with O'Sullivan as of September 1, 2004, are as follows:
Officer Name Age Since1 Position(s) Robert S. Parker 58 2004 President and Chief Executive Officer and Director Rick A. Walters 41 2004 Executive Vice President and Chief Financial Officer Michael D. Orr 42 2004 Executive Vice President-Operations Michael P. O'Sullivan 44 1995 Senior Vice President-Marketing Rowland H. Geddie, III 50 1993 Vice President, General Counsel and Secretary
------------------------------------
1Includes officer positions held with O'Sullivan Industries.
Rick A. Walters was appointed Executive Vice President and Chief Financial Officer of O'Sullivan Holdings, O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. in June 2004. He is also a director of O'Sullivan Furniture Factory Outlet, Inc. Prior to his appointment at O'Sullivan, he served as Group Vice President and Chief Financial Officer of the Sharpie/Calphalon Group at Newell Rubbermaid from 2001 to 2004. From 1998 through 2001, he was Vice President and Controller of Newell Rubbermaid's Sanford Corporation.
Michael D. Orr was appointed Executive Vice President-Operations of O'Sullivan Holdings, O'Sullivan Industries, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. in July 2004. He is also a director of O'Sullivan Furniture Factory Outlet, Inc. Prior to joining O'Sullivan, Mr. Orr was Group Vice President of Operations for Newell Rubbermaid's Sharpie/Calphalon Group from 2002 to 2004. From 1999 to 2002, he served as Vice President, Operations of Sanford Corporation, a division of Newell Rubbermaid.
Michael P. O'Sullivan was named Senior Vice President-Marketing of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia in January 2000. He had been Vice President-Marketing of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia since November 1995. He served as National Sales Manager of O'Sullivan Industries and O'Sullivan Industries - Virginia from July 1993 until November 1995. He is also Senior Vice President-Marketing of O'Sullivan Furniture Factory Outlet, Inc. Mr. O'Sullivan has been employed by O'Sullivan since 1984.
Rowland H. Geddie, III has been Vice President, General Counsel and Secretary of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia since December 1993. He served as a Director of O'Sullivan Industries and O'Sullivan Industries - Virginia from March 1994 through November 1999. Since March 2002, he has served as Vice President, General Counsel and Secretary and a Director of O'Sullivan Furniture Factory Outlet, Inc.
Certain Relationships. Daniel F. O'Sullivan and Michael P. O'Sullivan are brothers.
Section 16(a) Beneficial Ownership Reporting Compliance
Under the securities laws of the United States, O'Sullivan Holdings' directors, executives and any persons holding 10% or more of Common Stock are required to report their ownership of O'Sullivan Holdings' securities and any change in that ownership to the Securities and Exchange Commission. Specific due dates for these reports have been established and we are required to report in this report any failure to file by these dates during the fiscal year ended June 30, 2004. All of these filing requirements were satisfied by our directors and executives during fiscal 2004.
Code of Ethics
O'Sullivan has long had a code of ethics applicable to all of its employees. In response to the adoption of the Sarbanes-Oxley Act of 2002, we adopted an additional code of ethics applicable to our chief executive officer, chief financial officer, controller and the members of our disclosure committee. We will provide a copy of both codes of ethics to any person without charge upon request. Requests should be sent in writing to General Counsel, O'Sullivan Industries Holdings, Inc., 1900 Gulf Street, Lamar, Missouri 64759-1899, including the name and address of the person to whom the copies should be sent.
Audit Committee Financial Expert
Our Audit Committee is composed of Mr. Harold O. Rosser. The Board of Directors has not determined that any member of the Committee is an "audit committee financial expert" as defined in Item 401(h)(2) of Regulation S-K promulgated by the Securities Exchange Commission. While O'Sullivan considers that Mr. Rosser is financially literate and able to understand financial statements, he does not have the experience required by Item 401(h)(2). We are looking for an additional member of the Audit Committee who would be designated as an audit committee financial expert.
Item 11.
Item 11. Executive Compensation.
SUMMARY COMPENSATION TABLE
The following table reflects the cash and non-cash compensation for the chief executive officer of O'Sullivan and the four next most highly compensated executive officers at June 30, 2004.
Annual Compensation1 ------------------------------------- All Other Salary Bonus Compensation Name and Principal Position Fiscal Year ($) ($) ($)2
Robert S. Parker3 2004 76,923 - 1,108 President and Chief Executive Officer 2003 - - - 2002 - - -
Richard D. Davidson4 2004 375,300 - 50,436 President and Chief Executive Officer 2003 372,415 - 59,631 2002 300,000 199,800 18,359
Tyrone E. Riegel6 2004 95,192 - 348,845 Executive Vice President 2003 224,846 - 42,771 2002 231,200 101,570 20,614
Rick A. Walters5 2004 9,615 - 554 Executive Vice President and 2003 - - - Chief Financial Officer 2002 - - -
Phillip J. Pacey7 2004 155,108 10,000 23,571 Senior Vice President and 2003 174,338 - 30,060 Chief Financial Officer 2002 150,000 81,550 12,930
Thomas M. O'Sullivan, Jr.8 2004 180,300 - 23,678 Senior Vice President-Sales 2003 179,531 - 31,257 2002 160,000 76,300 16,661
Michael P. O'Sullivan 2004 151,700 - 21,170 Senior Vice President-Marketing 2003 151,277 - 27,739 2002 140,400 66,990 16,066
Stuart D. Schotte 2004 161,715 - 19,322 Vice President-Supply Chain 2003 150,515 - 25,897 Management 2002 136,000 51,680 17,426
Rowland H. Geddie, III 2004 151,700 10,000 19,511 Vice President, General Counsel & 2003 151,277 - 26,865 Secretary 2002 140,400 63,352 15,648
E. Thomas Riegel9 2004 151,700 - 21,727 Vice President-Strategic Operations 2003 151,277 - 30,165 2002 140,400 53,352 15,018
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1For the years shown, the named officers did not receive any annual compensation not properly categorized as salary or bonus, except for certain perquisites and other personal benefits. The amounts for perquisites and other personal benefits for the named officers are not shown because the aggregate amount of such compensation, if any, for each of the named officers during the fiscal year shown does not exceed the lesser of $50,000 or 10% of total salary and bonus reported for such officer.
2In fiscal 2004, other compensation for the named officers consisted of the following:
Matching Group Life, Matching Contributions AD&D and Contributions under Total Earnings LTD under Savings Deferred on Deferred Early Insurance Auto and Profit Compensation Compensation Retirement Name Premiums Allowance Sharing Plan Plan Balance Payments Robert S. Parker $ - $ 1,108 $ - $ -$ -$ - Richard D. Davidson 1,219 9,000 9,639 8,703 21,875 - Rick A. Walters - 554 - - - - Tyrone E. Riegel 444 3,596 1,567 2,163 5,738 335,337 Thomas M. O'Sullivan, Jr. 1,119 8,500 5,769 2,784 5,506 - Phillip J. Pacey 953 7,519 9,265 - 5,834 - Michael P. O'Sullivan 966 8,500 5,823 1,990 3,891 - Stuart D. Schotte 867 8,212 8,107 - 2,136 - Rowland H. Geddie, III 975 8,000 8,085 - 2,451 - E. Thomas Riegel 966 8,000 7,585 - 5,176 -
The table does not include amounts payable in the event of a Change in Control. See "Change in Control Protections". Other compensation for fiscal 2002 and 2003 has been adjusted from prior presentations to include earnings and losses on the named officers' respective Deferred Compensation Plan balances.
3Mr. Parker was appointed President and Chief Executive Officer effective May 14, 2004.
4Mr. Davidson resigned as President and Chief Executive Officer effective May 14, 2004.
5Mr. Walters was appointed Executive Vice President and Chief Financial Officer effective June 9, 2004.
6Mr. Tyrone E. Riegel retired effective November 15, 2003.
7Mr. Pacey resigned effective April 30, 2004.
8Mr. Thomas M. O'Sullivan left O'Sullivan effective August 9, 2004.
9Mr. E. Thomas Riegel left O'Sullivan effective August 13, 2004.
OPTION GRANTS IN THE LAST YEAR
During the fiscal year ended June 30, 2004, no options were granted to the named officers.
OPTION EXERCISES IN THE LAST YEAR AND YEAR-END OPTION VALUES
No options were exercised by the named officers in fiscal 2004. The following table summarizes information regarding outstanding options to purchase stock held by the named officers as of June 30, 2004. All options to purchase Series A junior preferred stock are vested and exercisable. The value of the options to purchase Series A junior preferred stock is calculated as the purchase price for the option plus the special accrual provided for under the option agreements.
Series A junior preferred Common stock stock ------------------------------------------------------- ------------------------------ Option Value of Value of Option shares exercis- unexercis- Option Value of shares unexercis- able able shares exercisable exercisable able at options at options at exercisable options at Name at 6/30/04 6/30/04 6/30/04 6/30/04 at 6/30/04 6/30/04 Robert S. Parker - - $ -$ - - $ - Richard D. Davidson 1,700 6,800 - - 10,929 2,031,212 Rick A. Walters - - - - - - Tyrone E. Riegel 800 3,200 - - 3,378 627,740 Thomas M. O'Sullivan, Jr. 800 3,200 - - 5,996 1,114,419 Phillip J. Pacey 800 3,200 - - 1,411 262,313 Michael P. O'Sullivan 800 3,200 - - 6,176 1,147,801 Stuart D. Schotte 600 2,400 - - 493 91,589 Rowland H. Geddie, III 600 2,400 - - 6,375 1,184,797 E. Thomas Riegel 600 2,400 - - 4,390 815,839
EMPLOYMENT AND SEVERANCE AGREEMENTS
Robert S. Parker. On May 17, 2004, we entered into an employment agreement with Robert S. Parker. The term of the agreement is two years, and is automatically renewed on a year-to-year basis unless either party provides at least 30 days' notice of termination. The agreement will terminate upon Mr. Parker's death, permanent disability or resignation, and O'Sullivan may terminate the agreement for any reason with 30 days' notice. Mr. Parker's initial base compensation is $1,000,000 per year, and he has the opportunity to earn a bonus of up to 50% of his base compensation subject to the achievement of certain performance targets determined by the Board. Mr. Parker is entitled to participate in all employee benefit programs offered to our other executive employees, provided that such programs are not to be less than those provided him by his previous employer.
If we terminate Mr. Parker's employment other than for cause (as defined in the agreement), or if Mr. Parker resigns within 30 days after we (a) substantially diminish his title or responsibilities, (b) require him to relocate from the greater metropolitan Atlanta area or (c) materially breach the employment agreement, we will pay him his salary and benefits for the longer of twelve months or the remaining portion of the initial term of the employment agreement. If the agreement is terminated because Mr. Parker resigns for reasons other than those described in the preceding sentence, or if we terminate his employment because of his death, disability or for cause, we will pay him his salary through his termination date.
In connection with Mr. Parker's employment with O'Sullivan, we entered into an executive stock agreement with him. Pursuant to the executive stock agreement, we sold Mr. Parker
o 467,614 shares of the Company's Class B common stock, par value $0.01 per share, at a price of $0.01 per share;
o 291,905 shares of the Company's Series B junior preferred stock, par value $0.01 per share, at a price of $0.01 per share; and
o and 40,000 shares of the Company's Series C junior preferred stock, par value $0.01 per share, at a price of $0.10 per share.
The shares were issued to Mr. Parker in July 2004 upon his payment of the purchase price. Mr. Parker's shares will "vest" pro rata over a five year period ending on June 1, 2009, or sooner upon a sale of O'Sullivan, if Mr. Parker is still employed by O'Sullivan. Pursuant to the executive stock agreement, if Mr. Parker's employment with O'Sullivan terminates for any reason, O'Sullivan and BRS will have the option to repurchase Mr. Parker's stock. The purchase price for unvested shares is the lower of Mr. Parker's original cost or the fair value of the shares. The purchase price for vested shares is fair value.
Rick A. Walters. In June 2004, we entered into an employment agreement with Rick A. Walters for him to serve as our Executive Vice President and Chief Financial Officer. The term of the agreement is one year, and the term is automatically renewed on a year-to-year basis unless either party provides at least 30 days' notice of termination. The agreement will terminate upon Mr. Walter's death, permanent disability or resignation, and O'Sullivan may terminate the agreement for any reason with 30 days' notice. Mr. Walter's initial base compensation is $250,000 per year, and he has the opportunity to earn a bonus of up to 80% of his base compensation subject to the achievement of certain performance targets determined by the Board. The agreement provides that Mr. Walters' bonus for fiscal 2005 will not be less than $200,000. Mr. Walters is entitled to participate in all employee benefit programs offered to our other executive employees, provided that such programs are not to be less than those provided him by his previous employer.
If we terminate Mr. Walters' employment other than for cause (as defined in the agreement), or if Mr. Walters resigns within 30 days after we substantially diminish his title or responsibilities or materially breach the employment agreement, we will pay him his salary and benefits for twelve months. If the agreement is terminated because Mr. Walters resigns for reasons other than those described in the preceding sentence, or if we terminate his employment because of his death, disability or for cause, we will pay him his salary through his termination date.
In connection with Mr. Walters' employment with O'Sullivan, we entered into an executive stock agreement with him. Pursuant to the executive stock agreement, we sold Mr. Walters
o 116,904 shares of the Company's Class B common stock, par value $0.01 per share, at a price of $0.01 per share;
o 46,090 shares of the Company's Series B junior preferred stock, par value $0.01 per share, at a price of $0.01 per share; and
o and 5,000 shares of the Company's Series C junior preferred stock, par value $0.01 per share, at a price of $0.10 per share.
The shares were issued to Mr. Walters in August 2004 upon his payment of the purchase price. Mr. Walters' shares will "vest" pro rata over a five year period ending on June 1, 2009, or sooner upon a sale of O'Sullivan, if Mr. Walters is still employed by O'Sullivan. Pursuant to the executive stock agreement, if Mr. Walters' employment with O'Sullivan terminates for any reason, O'Sullivan and BRS will have the option to repurchase Mr. Walters' stock. The purchase price for unvested shares is the lower of Mr. Walters' original cost or the fair value of the shares. The purchase price for vested shares is fair value.
Michael D. Orr. In July 2004, we hired Michael D. Orr as our Executive Vice President-Operations. The term of the agreement is one year, and the term is automatically renewed on a year-to-year basis unless either party provides at least 30 days' notice of termination. The agreement will terminate upon Mr. Orr's death, permanent disability or resignation, and O'Sullivan may terminate the agreement for any reason with 30 days' notice. Mr. Orr's initial base compensation is $230,000 per year, and he has the opportunity to earn a bonus of up to 80% of his base compensation subject to the achievement of certain performance targets determined by the Board. The agreement provides that Mr. Orr's bonus for fiscal 2005 will not be less than $184,000. Mr. Orr is entitled to participate in all employee benefit programs offered to our other executive employees, provided that such programs are not to be less than those provided him by his previous employer.
If we terminate Mr. Orr's employment other than for cause (as defined in the agreement), or if Mr. Orr resigns within 30 days after we substantially diminish his title or responsibilities or materially breach the employment agreement, we will pay him his salary and benefits for twelve months. If the agreement is terminated because Mr. Orr resigns for reasons other than those described in the preceding sentence, or if we terminate his employment because of his death, disability or for cause, we will pay him his salary through his termination date.
In connection with Mr. Orr's employment with O'Sullivan, we entered into an executive stock agreement with him. Pursuant to the executive stock agreement, we sold Mr. Orr
o 116,904 shares of the Company's Class B common stock, par value $0.01 per share, at a price of $0.01 per share;
o 46,090 shares of the Company's Series B junior preferred stock, par value $0.01 per share, at a price of $0.01 per share; and
o and 5,000 shares of the Company's Series C junior preferred stock, par value $0.01 per share, at a price of $0.10 per share.
The shares were issued to Mr. Orr in July 2004 upon his payment of the purchase price. Mr. Orr's shares will "vest" pro rata over a five year period ending on June 1, 2009, or sooner upon a sale of O'Sullivan, if Mr. Orr is still employed by O'Sullivan. Pursuant to the executive stock agreement, if Mr. Orr's employment with O'Sullivan terminates for any reason, O'Sullivan and BRS will have the option to repurchase Mr. Orr's stock. The purchase price for unvested shares is the lower of Mr. Orr's original cost or the fair value of the shares. The purchase price for vested shares is fair value.
Retirement and Severance Agreements
Tyrone E. Riegel entered into an early retirement agreement with O'Sullivan and retired as our Executive Vice President effective November 15, 2003. O'Sullivan paid him $335,336.54 in a lump sum on January 2, 2004, and has agreed to pay him $5,000 per month for thirty months, beginning May 15, 2005. In addition, we will pay health insurance for Mr. Riegel and his family through November 15, 2007. Mr. Riegel has agreed to act as our consultant through November 15, 2007 and has agreed not to compete with us through that period. In addition, the Compensation Committee has approved an amendment to Mr. Riegel's common stock option agreement that permits him to retain his options after he is no longer an O'Sullivan employee. His options will continue to vest as though he were still an O'Sullivan employee.
We are negotiating severance agreements with several executive officers who have left O'Sullivan since May 2004.
CHANGE IN CONTROL PROTECTIONS
O'Sullivan has termination protection agreements with its executive officers other than Messrs. Parker, Walters and Orr (who have severance provisions incorporated in their respective employment agreements). If the employment of a protected employee is terminated by us within a period of up to 24 months after a change in control, the employee will be entitled to receive various benefits. These benefits include:
1. a cash payment equal to the current base salary and highest bonus received in the previous three years; 2. a cash payment equal to the bonus earned by the employee in the year of termination, calculated on a pro rated basis on the date of termination; 3. a cash payment equal to accrued and unpaid vacation pay; 4. a cash payment for an automobile allowance of 12 months; 5. continued life and health insurance coverage for up to 12 months; 6. a lump sum payment, adjusted for taxes, to the employee in an amount equal to the protected employee's unvested profit sharing account in the Savings and Profit Sharing Plan; 7. a cash payment based on the amount that the protected employee would have received under our Deferred Compensation Plan had he continued to work for O'Sullivan until he attained the age of 65; 8. all outstanding stock options vest and become immediately exercisable; 9. O'Sullivan will be required to purchase for cash any shares of unrestricted common stock and options for shares at the fair market value;
10. one year of outplacement services; 11. for certain executive officers, if the protected employee moves more than 20 miles from his primary residence in order to accept permanent employment within 36 months after leaving O'Sullivan, we will repurchase the employee's primary residence; and 12. if the executive officer is required to pay an excise tax under Section 4999 of the Internal Revenue code of 1986, we will pay the employee an additional amount to offset the effect of the tax.
The agreements for certain executive officers also provide for cash payments in lieu of matching payments under the Savings and Profit Sharing Plan. The agreements for certain executive officers also provide that, in some circumstances, they may voluntarily leave our employment after a change in control and receive the benefits under the protection agreements. These circumstances include:
o an adverse change in the executive's status, title or duties; o a reduction in the executive's salary or bonus; o relocation of the executive's office to a site which is more than 20 miles from its present location; o a reduction in the executive's benefit levels; o the insolvency or bankruptcy of O'Sullivan; or o the executive leaves the employment of O'Sullivan for any reason during the 60-day period beginning on the first anniversary of the change in control.
The employment agreements for Messrs. Parker, Walters and Orr contain severance provisions as described under "--Employment Agreements" above.
The table below sets forth the total payments that may be received by each of the named officers if these persons are terminated during fiscal 2005, assuming the provisions of his employment agreement or Termination Protection Agreement were applicable. The values of non-cash benefits have been included on the basis of their estimated fair value. These amounts do not include any payments to be received for shares of O'Sullivan stock or options to acquire O'Sullivan stock. These amounts also do not include payments which we would make to offset the effect of excise taxes or to purchase any officer's home. We have assumed for this purpose that the named officers are terminated on September 30, 2004.
Officer Amount
Robert S. Parker......................................................................................$ 2,055,985 President and Chief Executive Officer Richard D. Davidson...................................................................................$ 0 President and Chief Executive Officer Rick A. Walters.......................................................................................$ 309,810 Executive Vice President and Chief Financial Officer Tyrone E. Riegel......................................................................................$ 0 Executive Vice President Thomas M. O'Sullivan, Jr..............................................................................$ 0 Senior Vice President-Sales Phillip J. Pacey......................................................................................$ 0 Senior Vice President and Chief Financial Officer Michael P. O'Sullivan.................................................................................$ 331,486 Senior Vice President-Marketing Stuart D. Schotte.....................................................................................$ 316,320 Vice President-Supply Chain Management Rowland H. Geddie, III................................................................................$ 323,414 Vice President, General Counsel & Secretary E. Thomas Riegel......................................................................................$ 0 Vice President-Strategic Operations
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Harold O. Rosser, Richard R. Leonard and Charles Macaluso. No member of the Compensation Committee was an officer or employee of O'Sullivan or its subsidiaries during the fiscal year ended June 30, 2004. None were formerly an officer of O'Sullivan or any of its subsidiaries. In addition, no executive officer of O'Sullivan serves on the board of directors or the compensation committee of another entity where a committee member is employed. Mr. Rosser is a managing director, and Mr. Leonard is a Vice President, of the general partner of BRS, which owns 72% of our Class A common stock. BRS, LLC and O'Sullivan Industries have entered into a Management Services Agreement pursuant to which BRS, LLC provides general management services, assistance with the negotiation and analysis of financial alternatives and other services for O'Sullivan Industries. In exchange for these services, O'Sullivan Industries pays BRS, LLC a fee equal to the greater of 1.0% of O'Sullivan Industries' consolidated cash flow or $300,000. See Item 13, "Certain Relationships and Related Transactions."
DIRECTORS' COMPENSATION
Directors of O'Sullivan who are not employees or consultants of O'Sullivan, BRS or affiliates of either of them are paid $7,500 per meeting held in person and $2,500 per telephone conference meeting (with all meetings that occur on the same day being considered as one meeting). The chairmen of the compensation committee and the audit committee each receive an additional $1,000 per year if not employed by BRS or its affiliates. Expenses of attendance at meetings are paid by O'Sullivan. Directors who are not employees of O'Sullivan, BRS or affiliates of either of them will also receive a one-time option to purchase shares of common stock of O'Sullivan. The normal exercise price of the options is fair market value on the date of grant, and the options normally vest in equal installments over three years. The number of option shares is negotiated; Mr. Macaluso's grant is pending. Employees and consultants of O'Sullivan do not receive additional compensation for their service as a director other than payment of expenses, if any, to attend a meeting.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table sets forth, as of September 15, 2004, certain information with respect to the beneficial ownership of the securities of O'Sullivan Holdings by (i) each of our directors, (ii) each of the named executives, (iii) our executive officers and directors (as of June 30, 2004) as a group and (iv) the only other owner of five percent of any class of O'Sullivan Holdings' equity securities known to us.
Class A Common Class B Common Senior Preferred Stock Stock Stock ------------------------- ---------------------- ---------------------- Name of Beneficial Owner Shares % Shares % Shares % -------------- --------- ----------- --------- ----------- --------- BRS1 994,9982 72.7% - - - - Harold O. Rosser 994,9982 72.7% - - - - Daniel F. O'Sullivan 9,972 0.7% - - 197,681 1.0% Charles Macaluso - - - - - - Richard R. Leonard - - - - - - Robert S. Parker - - 467,614 66.7% - - Richard D. Davidson 83,2493 6.1% - - 14,7073 4 Rick A. Walters - - 116,904 16.7% - - Tyrone E. Riegel 22,0655 1.6% - - 101,806 4 Thomas M. O'Sullivan, Jr. 34,9516 2.6% - - 23,963 4 Phillip J. Pacey 11,749 0.9% - - 29,590 4 Michael P. O'Sullivan 32,1056 2.3% - - 32,303 4 Stuart D. Schotte 11,8097 0.8% - - 30,630 4 Rowland H. Geddie, III 25,3597 1.9% - - 5,340 4 E. Thomas Riegel 20,4167 1.5% - - 30,630 4 Directors and executive 0 8% officers as a group (15 persons) 1,288,0098 94.2% 584,518 80. % 452,064 2. BancBoston Investments, 93,2739 6.4% - - - - Inc.
Options to Purchase Series A Junior Preferred Series B Junior Series C Junior Stock Preferred Stock Preferred Stock ----------------------- -------------------------- ------------------------ Name of Beneficial Owner Options % Shares % Shares % ----------- ---------- -------------- ---------- ----------- --------- BRS - - 442,22310 48.5% - - Harold O. Rosser - - 442,22310 48.5% - - Daniel F. O'Sullivan 4,432 7.3% - - - - Charles Macaluso - - - - - - Richard R. Leonard - - - - - - Robert S. Parker - - 291,905 32.0% 40,000 80.0% Richard D. Davidson 10,929 18.1% 20,83911 3.9% - - Rick A. Walters - - 46,090 5.1% 5,000 10.0% Tyrone E. Riegel 3,378 5.6% 3,64412 13 - - Thomas M. O'Sullivan, Jr. 5,996 9.9% 6,561 1.2% - - Phillip J. Pacey 1,411 2.3% 1,722 13 - - Michael P. O'Sullivan 6,176 10.2% 5,117 13 - - Stuart D. Schotte 4,390 7.3% 2,425 13 - - Rowland H. Geddie, III 6,375 10.6% 2,636 13 - - E. Thomas Riegel 4,432 7.3% 2,425 13 - - Directors and executive 40,000 0% officers as a group (15 833,29014 persons) 52,539 87.1% 91.4% 80. BancBoston Investments, - - 39,27315 6.9% - - Inc.
Each management participant has a business address at 1900 Gulf Street, Lamar, Missouri 64759-1899. BRS' address is 126 East 56th Street, 29th Floor, New York, New York 10022. BancBoston Investments, Inc.'s address is 175 Federal Street, 10th Floor, Boston, Massachusetts 02110. BancBoston Investments, Inc. is a subsidiary of Fleet Boston Financial Corporation, a publicly held corporation. -------- 1The managing directors of BRS' general partner are Bruce C. Bruckmann, Harold O. Rosser, Stephen C. Sherrill, Thomas J. Baldwin and Paul D. Kaminski, each of whom could be deemed to beneficially own the shares of O'Sullivan Holdings held by BRS. 2BRS holds 989,617 shares of common stock, and an affiliate of BRS holds 5,382 shares of common stock. All of these shares of common stock may be deemed to be beneficially owned by Harold O. Rosser, a Director of O'Sullivan. 3Includes 77,533 shares of common stock, 19,054 shares of Series B junior preferred stock and 13,874 shares of senior preferred stock held in a limited partnership of which Mr. Davidson and his wife are the general partners. Also includes 1,700 shares of common stock issuable upon the exercise of options. 4Less than one percent. 5Includes 16,423 shares of common stock held in a trust of which Mr. Riegel is the trustee. Also includes 800 shares of common stock issuable upon the exercise of options. 6Includes 800 shares of common stock issuable upon the exercise of options. 7Includes 600 shares of common stock issuable upon the exercise of options. 8Includes the shares of common stock held by BRS and its affiliate described in note 2. Also includes shares of common stock issuable upon the exercise of options. In addition, includes the partnership shares of common stock described in note 3 and the shares of common stock held in trust as described in note 5. 9BancBoston Investments, Inc. holds warrants to purchase these shares. 10BRS holds 439,831 shares of Series B junior preferred stock, and BRS's general partner holds 2,392 shares of Series B junior preferred stock. All of these shares of Series B junior preferred stock may be deemed to be beneficially owned by Harold O. Rosser, a Director of O'Sullivan. 11Includes 19,054 shares of Series B junior preferred stock held in a limited partnership of which Mr. Davidson and his wife are the general partners. 12Includes 1,503 shares of Series B junior preferred stock held in a trust of which Mr. Riegel is the trustee. 13Less than one percent. 14Includes the shares of junior preferred stock held by BRS and its affiliate described in note 10. In addition, includes the partnership shares of preferred stock described in note 3 and the shares of preferred stock held in trust as described in note 12. 15BancBoston Investments, Inc. holds warrants to purchase these shares.
Equity Compensation Plan Information
The following table sets forth the number of shares issuable upon exercise of outstanding options pursuant to O'Sullivan's 1999 Preferred Stock Option Plan, 2000 Common Stock Option Plan and 2001 Director Common Stock Option Plan at June 30, 2004. Each of these plans has been approved by O'Sullivan's Board of Directors and stockholders. We do not have any warrants or rights issuable pursuant to compensation plans.
Number of Weighted- Number of securities remaining securities to be average available for future issuance issued upon exercise exercise price under equity compensation plans Equity compensation plans of outstanding of outstanding (excluding securities reflected in approved by security holders options options second column) Common Stock 66,100 $1.90 30,718 Series A Junior Preferred Stock 60,319 $50.00 -
Item 13.
Item 13. Certain Relationships and Related Transactions.
Casey O'Sullivan, a son of Daniel F. O'Sullivan, works at Sun Container, a supplier of corrugated boxes to O'Sullivan, although he does not call regularly on O'Sullivan. Ryan Fullerton, a son-in-law of E. Thomas Riegel, our former Vice President-Strategic Operations, worked for Sun Container in the past, although he did not call on O'Sullivan. In fiscal 2004, O'Sullivan paid Sun $5.1 million for corrugated boxes. We have followed the practice of awarding purchase orders for cartons for a model to the lowest bidder for the carton. These relationships have been approved pursuant to O'Sullivan's conflict of interest policy.
World Charter Trading, Inc. is a corporation owned by the son of Richard D. Davidson, our former president and chief executive officer and one of our directors. WCT sources furniture and other products from the Far East. During fiscal 2004, we paid WCT $3.4 million for furniture it sold to us. We source furniture products from the Far East from different sources; we select the best vendor for a product based on price, quality, and ability to make timely deliveries. Mr. Davidson is not involved in the sourcing of furniture through WCT. This relationship has been approved pursuant to O'Sullivan's conflict of interest policy. It is also monitored by O'Sullivan Holdings' Audit Committee.
Mr. Bill Hillman, a brother of Jim Hillman, our former Vice President-Human Resources, operated a furniture factory outlet store until it closed during fiscal 2004. The store purchased $75,000 of furniture from us during fiscal 2004. We sold to Mr. Hillman on terms and conditions available to other similarly situated customers. This relationship was approved pursuant to O'Sullivan's conflict of interest policy.
In connection with the November 1999 recapitalization and merger, O'Sullivan loaned Stuart D. Schotte, Vice President-Supply Chain Management, $256,831 to purchase O'Sullivan Holdings common stock and Series B junior preferred stock. The loan bears interest at 9% per annum simple interest and is payable on November 30, 2009 or earlier if there is a change in control of O'Sullivan Holdings. The note is with full recourse to Mr. Schotte. During the fiscal year ended June 30, 2004, the largest amount outstanding under the note, including principal and interest, was $336,720, which was also the amount outstanding on June 30, 2004.
BRS, LLC Management Services Agreement
At the closing of the 1999 recapitalization and merger, O'Sullivan Industries entered into a management services agreement with BRS, LLC. Under the terms of this agreement, BRS, LLC provides:
o general management services; o assistance with the negotiation and analysis of financial alternatives; and o other services agreed upon by BRS, LLC.
In exchange for these services, BRS, LLC will earn an annual fee equal to the greater of:
o 1.0% of O'Sullivan Industries' annual consolidated cash flow (as defined in the indenture related to the O'Sullivan Industries senior subordinated notes); or o $300,000.
The credit agreement, the indentures for our senior secured notes and the management services agreement all contain certain restrictions on the payment of the management fee. The management services agreement, among other things, provides that no cash payment of the management fee will be made unless the fixed charge coverage ratio (as defined in the indenture for our senior subordinated notes) for our most recently ended four full fiscal quarters for which internal financial statements are available to management immediately preceding the date when the management fee is to be paid is at least 2.0 to 1. Similarly, the indenture for our 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 our senior secured notes) for the four most recently ended full fiscal quarters immediately preceding any payment date being at least 2.0 to 1. The credit agreement prevents us from paying fees or 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. The management services agreement also provides that the payment of all fees and other obligations under the management services agreement will be subordinated to the prior payment in full in cash of all interest, principal and other obligations on O'Sullivan Industries' senior subordinated notes in the event of a bankruptcy, liquidation or winding-up of O'Sullivan Industries.
Pursuant to the management services agreement and the provisions of our debt agreements, we did not pay any amounts to BRS, LLC in fiscal 2004. At June 30, 2004, the amount accrued under the agreement, which represents the fee for fiscal 2004 less a prepaid balance at July 1, 2003 of $147,000, was $153,000.
Retirement Agreements
In October 1998, O'Sullivan Holdings entered into a Retirement and Consulting Agreement, Release and Waiver of Claims with Daniel F. O'Sullivan. Under the retirement agreement, as amended in May 1999, Mr. O'Sullivan resigned as Chief Executive Officer in October 1998 and retired as an executive on March 31, 2000. O'Sullivan Holdings agreed to pay Mr. O'Sullivan $42,160 per month for 36 months after his retirement and then to pay him $11,458 per month until he reaches age 65. Payments under Mr. O'Sullivan's retirement and consulting agreement amount to an aggregate of $2.2 million and a present value of approximately $1.9 million. During this period, Mr. O'Sullivan is required to provide consulting, marketing and promotional services with respect to our manufacturing activities and relations with major customers, if requested by us, from time to time. Mr. O'Sullivan has agreed not to compete with us during the period he is a consultant. O'Sullivan Holdings will also provide Mr. O'Sullivan with health insurance during the term of the agreement and thereafter until he becomes eligible for Medicare and life insurance during the term of the agreement. In July 2004, we amended the agreement to add O'Sullivan Industries as a party with the right to enforce Mr. O'Sullivan's covenants directly and the joint obligation to make payments to Mr. O'Sullivan.
See "Executive Compensation--Employment and Severance Agreements" for a description of certain retirement and other agreements with certain of our former executive officers.
Item 14.
Item 14. Principal Accountant Fees and Services.
PricewaterhouseCoopers LLP, Kansas City, Missouri, serves as our independent registered public accounting firm. The aggregate fees billed by our independent auditors for professional services rendered in connection with (i) the audit of our annual financial statements set forth in this report for the fiscal years ended June 30, 2004 and June 30, 2003, and (ii) the review of our quarterly financial statements set forth in our Quarterly Reports on Form 10-Q for each of our fiscal quarters during fiscal 2004 and 2003, as well as fees paid to our audit firm for audit-related work, tax compliance, tax planning and other consulting services are set forth below.
Type of Service Amount Paid Amount Paid with Respect with Respect to Fiscal 2004 to Fiscal 2003 Audit Fees $579,461 $294,698 Audit-Related Fees - - Tax Fees - 22,508 All Other Fees - 53,497 --------------- --------------- Total $579,461 $370,703 =============== ===============
The Audit Committee's policy is to pre-approve all audit and permissible non-audit services.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)(1) Financial Statements
The following consolidated statements of O'Sullivan Industries Holdings, Inc. and subsidiaries are filed as part of this report:
Report of Independent Registered Public Accounting Firm.............................................. 31 Consolidated Balance Sheets as of June 30, 2004 and 2003............................................. 32 Consolidated Statements of Operations for each of the three years in the period ended June 30, 2004 33 Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 2004.. 34 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for each of the three years in t period ended June 30, 2004...........................................................................he 35 Notes to Consolidated Financial Statements........................................................... 36
(a)(2) Financial Statements Schedules
Schedules have been omitted because they are not required or are not applicable or the information required to be set forth therein either is not material or is included in the financial statements or notes thereto.
(a)(3) Exhibits:
A list of exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Sections 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 28th day of September, 2004.
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
By /s/ Robert S. Parker Robert S. Parker President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Daniel F. O'Sullivan Chairman of the Board September 28, 2004 Daniel F. O'Sullivan President and Chief Executive Officer /s/ Robert S. Parker and Director September 28, 2004 Robert S. Parker (Principal Executive Officer) Executive Vice President and /s/ Rick A. Walters Chief Financial Officer September 28, 2004 Rick A. Walters (Principal Financial and Accounting Officer)
/s/ Richard D. Davidson Director September 28, 2004 Richard D. Davidson
/s/ Harold. O. Rosser Director September 28, 2004 Harold O. Rosser
/s/ Richard R. Leonard Director September 28, 2004 Richard R. Leonard
/s/ Charles Macaluso Director September 28, 2004 Charles Macaluso
INDEX TO EXHIBITS Exhibit Description Page No. No. 3.1 & Second Amended and Restated Certificate of Incorporation of O'Sullivan Holdings 4.1 (incorporated by reference to Exhibit 3 to Current Report on Form 8-K dated May 17, 2004 (File No. 0-28493)) 3.2 & By-laws of O'Sullivan Holdings 4.2 78 3.2a & Amendment to By-Laws of O'Sullivan Holdings 4.2a 98 4.3 Indenture dated as of November 30, 1999 by and among O'Sullivan Industries, O'Sullivan Industries - Virginia as Guarantor and the Norwest Bank of Minnesota, National Association, as Trustee (incorporated by reference to Exhibit 4.4 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) 4.4 Warrant Agreement dated as of November 30, 1999 between O'Sullivan Holdings and Norwest Bank Minnesota, National Association, as Warrant Agent, relating to warrants to purchase 39,273 shares of O'Sullivan Holdings Series B junior preferred stock, including form of warrant certificate (incorporated by reference to Exhibit 4.5 to Quarterly Report Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) 4.5 Warrant Agreement dated as of November 30, 1999 between O'Sullivan Holdings and Norwest Bank Minnesota, National Association, as Warrant Agent, relating to warrants to purchase 93,273 shares of O'Sullivan Holdings common stock, including form of warrant certificate (incorporated by reference to Exhibit 4.6 to Quarterly Report Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) 4.Amended and Restated Warrant Agreement dated as of January 31, 2000 between O'Sullivan Holdings and the holder thereof relating to warrants to purchase 39,273 shares of O'Sullivan Holdings Series B junior preferred stock, including form of warrant certificate (incorporated by reference to Exhibit 4.7 to Quarterly Report Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) 4.Amended and Restated Warrant Agreement dated as of January 31, 2000 between O'Sullivan Holdings and the holder thereof relating to warrants to purchase 93,273 shares of O'Sullivan Holdings common stock, including form of warrant certificate (incorporated by reference to Exhibit 4.8 to Quarterly Report Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) 4.Indenture dated as of September 29, 2003 between O'Sullivan Industries and each of the guarantors party thereto and The Bank of New York, as Trustee, including forms of Notes (incorporated by reference to Exhibit 4 to Current Report on Form 8-K of O'Sullivan Holdings dated September 29, 2003 (File No. 0-28493)) 9 Stockholders Agreement dated November 30, 1999 by and among O'Sullivan Holdings, Bruckmann, Rosser, Sherrill & Co. II L.P., each of the persons executing and investor or executive signature page thereto and each of the warrant holders executing a warrant holder signature page attached thereto and such other persons acquiring a warrant after the date thereof (incorporated by reference to Exhibit 10.5 to Quarterly Report Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493))
Exhibit Description Page 10.1 Credit Agreement dated as of September 29, 2003 by and among O'Sullivan Industries, O'Sullivan Furniture Factory Outlet, Inc. and O'Sullivan Industries - Virginia, as Borrowers, and the other persons party thereto that are designated as credit parties and General Electric Capital Corporation, as Agent, L/C issuer and as a lender, and the other financial institutions party hereto, as lenders (incorporated by reference to Exhibit 99.2 to Current Report on Form 8-K of O'Sullivan Holdings dated September 29, 2003 (File No. 0-28493)) 10.1a Amendment No. 1 to the Credit Agreement dated as of October 29, 2003 (incorporated by reference to Exhibit 10.1a to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493)) 10.1b Amendment and Consent No. 2 to the Credit Agreement dated as of May 5, 2004 (incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K of O'Sullivan Holdings dated May 17, 2004 (File No. 0-28493)) 10.2 Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated as of November 13, 2003 from O'Sullivan Industries, Inc. to the trustee named therein for the benefit of The Bank of New York, as Trustee (incorporated by reference to Exhibit 10.6 to Registration Statement on Form S-4 (File No. 333-111514)) 10.3 Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated as of November 13, 2003 from O'Sullivan Industries - Virginia to the trustee named therein for the benefit of The Bank of New York, as Trustee and General Electric Capital Corporation, as Agent (incorporated by reference to Exhibit 10.7 to Registration Statement on Form S-4 (File No. 333-111514)) 10.4 Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated as of November 13, 2003 from O'Sullivan Industries to the trustee named therein for the benefit of General Electric Capital Corporation, as Agent (incorporated by reference to Exhibit 10.8 to Registration Statement on Form S-4 (File No. 333-111514)) 10.5 Security Agreement dated as of September 29, 2003 between O'Sullivan Industries, O'Sullivan Furniture Factory Outlet, Inc. and O'Sullivan Industries - Virginia, as Grantors, and General Electric Capital Corporation, as Agent (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493)) 10.6 Security and Pledge Agreement dated as of September 29, 2003 among O'Sullivan Industries, O'Sullivan Holdings, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc., as grantors, and The Bank of New York, Trustee (incorporated by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493)) 10.7 Registration Rights Agreement dated as of September 29, 2003 among O'Sullivan Industries, O'Sullivan Holdings, O'Sullivan Industries - Virginia and O'Sullivan Furniture Factory Outlet, Inc. and Credit Suisse First Boston LLC with respect to the O'Sullivan 10.63% senior secured notes (incorporated by reference to Exhibit 10.4 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493)) 10.8 Lockbox Account Agreement dated as of October 28, 2003 among Bank of America, N.A., O'Sullivan Industries and General Electric Capital Corporation (incorporated by reference to Exhibit 10.5 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493))
Exhibit Description Page 10.9 Blocked Account Agreement dated as of October 28, 2003 among Bank of America, N.A., O'Sullivan Industries and General Electric Capital Corporation (incorporated by reference to Exhibit 10.6 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 2003 (File No. 0-28493)) 10.10 Intercompany Subordinated Demand Promissory Note dated as of November 30, 1999 by and among O'Sullivan Industries and O'Sullivan Industries - Virginia (incorporated by reference to Exhibit 10.8 to Registration Statement on Form S-4 (File No. 333-31282)) *10.Early Retirement Agreement dated as of June 25, 2003 between O'Sullivan Industries and Tyrone E. Riegel (incorporated by reference to Exhibit 10.6 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2003 (File No. 0-28493)) *10.O'Sullivan Holdings 2000 Common Stock Option Plan (incorporated by reference to Exhibit 10.11 to Registration Statement on Form S-4 (File No. 333-31282)) *10.First Amendment to 2000 Common Stock Option Plan (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended March 31, 2001 (File No. 0-28493)) *10.Form of Common Stock Option Agreement (incorporated by reference to Exhibit 10.12 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2000 (File No. 0-28493)) *10.14 O'Sullivan Holdings 1999 Preferred Stock Option Plan (incorporated by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) *10.15 Form of Preferred Stock Option Agreement dated November 30, 1999 (incorporated by reference to Exhibit 10.4 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) *10.16 Registration Rights Agreement dated November 30, 1999 by and among O'Sullivan Holdings, Bruckmann, Rosser, Sherrill & Co. II, L.P. and the individuals who executed executive signature pages or warrant holder signature pages or acquired warrants after execution of the signature pages attached thereto (incorporated by reference to Exhibit 10.6 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) *10.17 Management Services Agreement dated November 30, 1999 by and among O'Sullivan Holdings and Bruckmann, Rosser, Sherrill & Co., L.L.C. (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493)) *10.18 Form of Amended and Restated Termination Protection Agreement between O'Sullivan Holdings and certain members of management 99 *10.19 Form of Termination Protection Agreement between O'Sullivan Holdings and certain members of management (incorporated by reference to Exhibit 10.3 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1999 (File No. 1-12754)) *10.20 O'Sullivan Holdings Deferred Compensation Plan (the "DCP") (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended March 31, 1997 (File No. 1-12754))
Exhibit Description Page *10.20a First Amendment to the DCP (incorporated by reference to Exhibit 10.4a to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1997 (File No. 1-12754)) *10.20b Second Amendment to the DCP (incorporated by reference to Exhibit 10.20b to Registration Statement on Form S-4 (File No. 333-31282)) *10.20c Third Amendment to the DCP (incorporated by reference to Exhibit 10.21c to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2000 (File No. 0-28493)) 10.21 Amended and Restated Tax Sharing and Tax Reimbursement Agreement dated as of June 19, 1997 between O'Sullivan Holdings and RadioShack Corporation and TE Electronics Inc. (incorporated by reference to Exhibit 10.5 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1997 (File No. 1-12754)) 10.21a Settlement Agreement between O'Sullivan Holdings and RadioShack dated May 13, 2002 (incorporated by reference to Exhibit 10.22a to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2002 (File No. 0-28493)) *10.22 Form of Indemnity Agreement between O'Sullivan Holdings and certain directors and officers 116 *10.23 Retirement and Consulting Agreement, Release and Waiver of Claims between O'Sullivan Holdings and Daniel F. O'Sullivan dated October 16, 1998 (incorporated by reference to Exhibit 10 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended September 30, 1998 (File No. 1-12754)) *10.23a Amendment to Retirement Agreement dated as of May 16, 1999 between O'Sullivan Holdings and Daniel F. O'Sullivan (incorporated by reference to Exhibit 10.9a to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1999 (File No. 1 -12754)) *10.23b Second Amendment to Retirement Agreement dated as of July 27, 1999 among O'Sullivan Holdings, O'Sullivan Industries and Daniel F. O'Sullivan 123 *10.24 Employment Agreement dated as of May 17, 2004 between O'Sullivan Industries, O'Sullivan Holdings and Robert S. Parker (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K of O'Sullivan Holdings dated May 17, 2004 (File No. 0-28493)) *10.25 Executive Stock Agreement dated as of May 17, 2004 between O'Sullivan Holdings, Robert S. Parker and Bruckmann, Rosser, Sherrill & Co. II, L.P. (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K of O'Sullivan Holdings dated May 17, 2004 (File No. 0-28493)) *10.26 Employment Agreement dated as of June 9, 2004 between O'Sullivan Industries, O'Sullivan Holdings and Rick A. Walters (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K of O'Sullivan Holdings dated June 9, 2004 (File No. 0-28493)) *10.27 Executive Stock Agreement dated as of June 9, 2004 between O'Sullivan Holdings, Rick A. Walters and Bruckmann, Rosser, Sherrill & Co. II, L.P. (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K of O'Sullivan Holdings dated June 9, 2004 (File No. 0-28493))
Exhibit Description Page *10.28 Employment Agreement dated as of June 23, 2004 between O'Sullivan Industries, O'Sullivan Holdings and Michael D. Orr (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K of O'Sullivan Holdings dated July 14, 2004 (File No. 0-28493)) *10.29 Executive Stock Agreement dated as of June 1, 2004 between O'Sullivan Holdings, Michael D. Orr and Bruckmann, Rosser, Sherrill & Co. II, L.P. (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K of O'Sullivan Holdings dated July 14, 2004 (File No. 0-28493)) *10.30 Description of O'Sullivan Holding's annual incentive compensation plan (incorporated by reference to Exhibit 10.13 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1999 (File No. 1-12754)) *10.31 Schedule of O'Sullivan Holdings' outside director fees (incorporated by reference to Exhibit 10.26 to Registration Statement on Form S-4 (File No. 333-111514)) *10.32 O'Sullivan Holdings 2001 Director Common Stock Option Plan (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 2001 (File No. 0-28493)) *10.33 Form of Director Common Stock Option Agreement (incorporated by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 2001 (File No. 0-28493)) *10.34 O'Sullivan Holdings Amended and Restated Savings and Profit Sharing Plan (incorporated by reference to Exhibit 10.29 to Annual Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2002 (File No. 0-28493)) *10.34a Amendment No. 1 to O'Sullivan Holdings Amended and Restated Savings and Profit Sharing Plan dated as of October 29, 2002 125 *10.34b Amendment No. 2 to O'Sullivan Industries Holdings, Inc. Amended and Restated Savings and Profit Sharing Plan dated as of January 29, 2004 128 21 Subsidiaries of the Registrant 133 23 Consent of PricewaterhouseCoopers LLP 134 31.1 Certificate of chief executive officer under Section 302 of the Sarbanes-Oxley Act of 2002 135 31.2 Certificate of chief financial officer under Section 302 of the Sarbanes-Oxley Act of 2002 136 32.1 Certificate of chief executive officer under Section 906 of the Sarbanes-Oxley Act of 2002 (furnished pursuant to Item 601(b)(31) of Regulation S-K) 137 32.2 Certificate of chief financial officer under Section 906 of the Sarbanes-Oxley Act of 2002 138 (furnished pursuant to Item 601(b)(31) of Regulation S-K)
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*Each of these exhibits is a "management contract or compensatory plan or arrangement."
Pursuant to item 601(b)(4)(iii) of Regulation S-K, O'Sullivan has not filed agreements relating to certain long-term debt of O'Sullivan. O'Sullivan agrees to furnish the Securities and Exchange Commission a copy of such agreements upon request.